Protection or incentive?
Local car assemblers find favourable ground

By Syed Asad Hussain

Automobile industry made its appearance in Pakistan in the 50s when General Motors launched assembling of Bedford trucks and buses. In the 60s, during Ayub Khan’s regime, General Motors became Ghandara Industries and expanded their assemble business to other makes of Vauxhall, Ford Perfect, Ford Cortina, Dodge and Dart cars. The Japanese landed in Pakistan in 1983 to start assembling the FX 800cc Suzuki car followed by Indus Motor Company assembling Toyota cars.  Their first product that hit the market was Toyota Corolla. One year later Honda Atlas cars (Pak) introduced Honda Civic having 1300cc engine capacity. 

The last three years have been exceptionally good for the auto sector due to SBP easy monetary policy and historically low interest rates. Availability of cheap credit induced people to lease out cars, motorcycles, auto rickshaws, buses, trucks, etc. which in turn helped factories to churn out more units than before. According to Economic Survey of Pakistan, there are now more than 5 million motorised vehicles on the road. As per the survey, the size of the vehicular fleet is increasing at a rate of about 5 per cent per annum. The production of car and motorcycle has grown over 50 per cent and 100 per cent, respectively. The trucks, buses and tractors and the light commercial vehicles (LCV) sector are having their best years. The record production prompted the establishment of ‘Original Equipment Manufacturers’ (OEMs) to invest more.  

The deletion policy, introduced in 1996, provided broader guidelines to local industry but it also called for making an effort to stand on its feet. The encouraging result was that the industry not only was able to supply parts to local OEMs like Toyota, Honda, Suzuki, Nissan, etc. but was also able to export. The methodology to offer tariff incentives for progressive local manufacturers of automobiles and other engineering goods helped the industry to achieve 56-70 per cent local contents in the case of cars, 63.5-85.5 per cent for tractors, 81-88 per cent for motorcycles, 42.7-55 per cent for LCV and 46.5-48.5 per cent in the case of buses and trucks.

The automobile industry operates under franchise and technical cooperation agreements with Japanese, European, and Korean manufacturers. The latest figures of auto sector indicate that Rs17 billion investments were made in cars/commercial vehicles, Rs5.50 billion motorcycles, and Rs3.5 billion in tractors.  Cars/commercial vehicles contributed Rs84.0 billion to country’s GDP, motorcycles Rs30 billion, and tractors Rs15.08 billion. Revenues paid by the industry to the government was estimated to be Rs28 billion for commercial vehicles, Rs11 billion for motorcycles, and Rs4.50 billion for tractors.  As stated earlier, the automobile sector benefited from the rising credit disbursement. Auto loans disbursement which was Rs18.7 billion in 2003, increased to Rs27.8 billion in 2004 and Rs65.9 billion in 2005. The rising demand provided great stimulus to the production. Currently, the penetration ratio stands at 8 cars per 1000 people in Pakistan, as compared to 12 in India, 10 in China, 21 in Indonesia, 23 in Iran, 25 in Sri Lanka, and 31 in the Philippines. An average, 28 out of 1000 Asians own a car. This means there is further room for expansion. 

At present, three out of four major players are from Japan working with local partners. The fourth player is working in collaboration with a Korean partner. The latest entrants are the assemblers of Chinese cars and commercial vehicles. According to the data available, car demand is skewed towards small cars due to increasing petrol prices. Pak Suzuki emerges as the market leader with 58 per cent market share in production and 55 per cent in sales of total cars and 95 per cent share in 1000 cc cars, followed by Toyota 22 per cent, Honda 18 per cent, and Kia 5 per cent.

The above statistics clearly demonstrate that Pakistan’s automobile industry is tight oligopoly dominated by a few players. In such a market, collusion to set prices and output is very much possible and the players might behave like a monopoly to exploit the market. Both print and electronic media are full of stories commenting on the black market that the players have created. Easy access to credit stimulated demand for cars. With limited production capacity, the demand supply gap increased in the short run and provided an opportunity to assemblers to raise prices, leading to the emergence of black market.

Petrol and diesel cars were sold at a premium of Rs125,000 and Rs150,000 while Honda Civic and City at Rs80,000 and Rs50,000, respectively. Dealers charged Rs40,000 each for Daihatsu Cuore and Suzuki Mehran and Rs42,000 for Hyundai Santro.  Analysts contended that the sharing of the black market premium was quite an organised game between the dealers, investors ( also called the middlemen, they booked cars by paying full amount in advance and sold it to immediate buyers at a premium), and the assemblers. 

The agreement between the buyers and company explicitly stated “the prices can be changed without any prior notice”. The above malpractice on the part of the middlemen and companies has been witnessed over the last couple of years. Whenever public pressure would build up, the government would send a warning to the companies that it might reduce duty to allow import of used cars to cool down the market. But the warning has been falling on deaf ears. The premium story, delivery waiting time period and the game of middlemen has continued. However recently, the premium rates have been cut down substantially as a result of change in import policy of used cars.

Beyond the cut in duties not much has changed as yet, as prices of cars continued to soar and factories have continued churning out products with low quality product.  After the approval of one per cent special federal excise duty on imports in 2007/08 budget, the three Japanese assemblers have increased prices by one per cent from July1. Here it should also be acknowledged that the assemblers are also facing high costs of production in the backdrop of increasing utility charges, high wages, and different taxes. 

Protection or incentives

One of the earliest statements of the “infant industry argument” in favour of trade restrictions was put forth by Alexander Hamilton in 1791 in his Report on Manufacturers. He argued that manufacturing firms in the newly created US should be protected from imports. Once the industries were established, they could compete with foreign imports. But as they got started, they needed protection until they reached a certain scale.

The same school of thought in the modern age argues that even in today’s world of globalisation, competitive advantage alone cannot determine the success. Hidden protection, access to markets and technology are still as much barriers to entry as they were a decade ago. In order to hedge their bets, developing countries with growing demand are, therefore, cautious in opening certain industries to free trade. Unless their trade can be ensured, the onus is still on the government to provide necessary support.

The opponents of infant industry argument emphasise that in the developing nations, it is difficult to determine which industries are the infants, capable of achieving economic maturity and therefore deserving protection. They also argue that protective tariffs may persist even after industrial maturity has been realised. Most economists feel that if the infant industries are to be subsidised, there are better means than tariffs for doing so which maybe through granting direct subsidies to them. It is true that the people are not happy about protecting the local industry through tariffs. It is a fact that domestic assemblers have been in business for up to two decades but they are still not competitive. Protectionism has created inefficiency in the local auto industry. Rather than taking advantage of government’s support policy, the local industry used the facility to exploit the market. The more money we spend on producing goods that are not competitive, the less money we would have for our efficient sectors. In essence, encouraging inefficient auto assemblers means encouraging inefficiency throughout the economy.  Given the poor quality of cars and absence of any road safety measures in the product, the assemblers cannot export locally assembled cars even to the Middle East, let alone to the USA or Europe. Even they could have targeted the African continent where demand for inferior quality cars remains current due to low income level.  Had the local assemblers were good and competitive; Pakistan would have diversified its export base from the textile to auto. The policy of protectionism would have paid the dividend.

In India, excellent mass transit system exists, besides low priced better quality locally assembled cars, in New Delhi. The city was put on further expansion so that more remote areas could also benefit from the mass transit facility.   Given the road conditions and air pollution that cars, buses, and trucks, contributes, the government should have focused more on bringing in mass transit system to urban areas rather than encouraging more cars and buses to ply on already congested roads causing traffic jams, pollution and adding to country’s rising oil import bill. A good cheap mass transit system will have created more jobs and incomes in the economy than the auto sector has created and saved contributed in making the environment clean and healthy and a cut in oil import bill.

The absence of competition encouraged inefficiency and denied a million Pakistanis access to a cheaper, better product (in return no apparent benefit to Pakistan). Suzuki not only survived but prospered and kept on improving itself during its first decade of existence (when there was no ban), they argue. The competition must be brought back. The duties on the import of used cars must go away. In the absence of competition they will never improve the quality.