Monday, March 06, 2006

Protection: A Tale of Three Countries

Imagine three countries: Wonderland, Dixieland, and Boogieland. Dixieland has lots of cheap labor who can produce hundreds of broomsticks everyday. They export them to Wonderland. As time goes by, Wonderland's people start to make their own broomstick, in addition to their famous cheese. Alas, the people there don't accept as low wage as Dixie people do. So, Wonderland's broomsticks end up more expensive than Dixieland's. What about Boogieland? Boogie people don't make broomsticks. While they do have cheap labour, they lack the raw materials for broomstick -- they're happy producing toothpicks.

What would economics suggest? Yes, Wonderland should not produce broomstick and stay with cheesecake factories. Let Dixieland make all the broomsticks. Of course Boogieland should stay with toothpick industry. Then all three should gain from trading one another. They all gain. But who is the biggest gainer? No doubt, it's the consumers. Is it not fair to the producers? Only to producers who never consume anything (Can you think of somebody like that? Ask any producer who happens to shop in a supermarket, does he like his apple cheaper or expensive).

Enter politics. The Wonderland Association of Broomstick Producers (W-ABP) lobby their government to impose an import duty on Dixieland's broomsticks. "This is the only way to save us, Mr. Minister. Otherwise we'd all go bangkrupt. How can we pay our employees? For the love of God, impose a duty". Their demand is granted by the Department of Protection. As a result, Dixie broomsticks become more expensive in Wonderland's market. Now the consumers (incl. broomstick factory employees) have to pay higher price for the benefit of local broomstick factory owners.

Across the ocean, the Dixieland's D-ABP's Chairman is outraged. "This is insane. We can produce broomstick more efficiently than them. We're actually supplying their people with inexpensive broomsticks! We even come with better quality! But because of that we're punished?". The Dixieland broomstick makers decide to go to their own Minister of Protection. Without further ado, they are granted their own form of protection. It's an export subsidy. They're happy, as if they don't know that their government finances the subsidy using their (the people's) own money, and consumers' money. Both Dixieland's producers and consumers don't realize that they are paying for the protection, with bigger share from the latter. All consumers pay for the protections.

Again, time goes by. Two years later, both Wonderland and Dixieland forget already that there has been an import duty on Dixie's broomsticks that enter Wonderland. All they know is the current price is higher than it used to be.

But Dixieland's broomstick makers "adjust faster". In order to "steal" more of Wonderland's broomstick market, they decide to set the profit margin there to ... zero. Of course, to ensure profit overall, they maintain a positive margin back home.* They make huge profit. They attract many foreign investors, including the now-called Broomstick Worldwide Inc. Soon, all the shares in Dixieland broomstick industries are owned by multinationals.

Now it's the time again for W-ABP to visit the Department of Protection. "Mr. Minister, this isn't pretty. Those Dixie people are stealing our market. They set their price lower here than there at their home. You should do something, for the good of the country". Mr. Protect grants them another sweet candy: import quota. (No one tells him that "dumping" is actually a ... charity **). Now, only 50 Dixie broomsticks a year are allowed to enter Wonderland. Dixie's D-ABP has a big headache. As for Broomstick Worlwide Inc it's a heart attack. Finally they should decide to make their broomstick somewhere. "It should be at least as 'efficient' as here," says the BW Inc's CEO Bill Bads. That means, "Find a place where we can pay labor as low as here. No, lower". And they fly to Boogieland. Broomstick industry in Dixieland is pronounced dead.

It's no surprise at all, Boogieland people are happy. Now they can score a punch on Dixieland's face. Ugh, why is that? Well, rumor has it, Boogieland's market has been flooded by cheap garment from ... Dixieland. Darn it, it turns out Dixieland also produces garment, contrary to what I told you above! No wonder it loses the broomstick! ***

End of the story? Not quite so... You can expect the protection pendulum to swing again. And it'll keep swingin'... Someday, Boogieland's broomstick association representatives will visit Ind..., oops, I mean Boogieland's Department of Protection. And you will tell yourself, "This looks familiar. Where did I read it?"

*) In economics we call this practice "price discrimination". In politics, people call it "dumping" -- even though we reserve the latter word for a situation where the price is lower than the marginal cost in one market and compensated in the other; alas this too has its political name: "predatory price".
**) Is it not? Look, somebody produces identical toys. He sells it to his friends at $2 and to you at $1. Don't you like it?
***) This is the infamous principle of "comparative advantage", after David Ricardo.

p/s. Sorry for no links -- It's imaginary world! But hey, this partly looks like a real word representation in a way...


  1. An excellent piece worthy of Paul Krugman (at his best days)!

    Modified it to suit US - China - India relations and send it to New York Times.

  2. Would also find a perfect home in "Issue and Igauan dari Salemba" columns. But hey, the Cafe is home.