The lopsided market structure of the automobile industry Ammar H Khan

OPINION

Ammar H. Khan

The lopsided market structure cases. In-effect, an automobile buyer will have to pay a certain percentage of the price in advance for booking, following with full payment. Furthermore, any price increases during this period are also borne by the customer. Such an erratic pricing and payment regime as well as waiting times extended to twelve months or of the automobile more, automobiles have essentially become financial assets. Many individuals even use automobiles as an asset class, industry given its strong correlation with value of PKR against major currencies. A depreciating PKR eventually results in an increase in price of automobiles. More importantly due to a long wait time, Cars are supposed to go down in there exists a substantial premium for delivery of vehicles on spot. A premium of 10 to 15 percent is fairly common on various models, value. Here they are a fixed asset if someone wants the automobile on spot, or with a much shorter waiting. Such market distortions have resulted in emergence An automobile is supposed to be a depreciating asset. An asset which is used and over time its value depreciates as wear and tear takes hold, and new technology results in better, and safer cars. In Pakistan, it is the complete opposite. A protectionist regime which has protected the incumbents for almost three decades now continof a class of investors who act as market makers, and pocket a sweet low-risk financial spread on automobiles bought and sold. Creation of a shadow financial market has also been made possible due to increasing prevalence of cash in the economy, with most transactions being done outside the financial system, devoid of any potential capital gains taxes, or even income taxes. A market disues to manufacture cars which are not just expensive relative to other tortion eventually having a ripple effect across the economy, from regional markets in US$ terms, but also of substandard quality, often welfare loss to consumers, to creation of a shadow market. skimping on technological advances available in similar models in other There must be some kind of way out of here, said the joker regional, and global markets. to the thief. Jimi Hendrix uttered these words in his seminal

In presence of a protectionist regime, competition from import- work, all along the watchtower. The way out of a protectionism ed automobiles is discouraged through an excessive duties regime. In regime is creation of a vibrant, and more open market. Reducing absence of competition from imported automobiles, local manufacturers duties on imports is one way to enable more competition, but an do not have the incentive to improve their product offering resulting in unintended consequence of increased automobile imports can be a welfare loss for consumers, as they continue to pay a higher price for a deteriorating current account deficit situation given precarious substandard automobiles, relative to the choice set available in other state of our foreign exchange reserves. However, any such incremarkets. mental imports must be compared with imports of Completely

Through an extended protectionist regime, and absence of any ex- Knocked Down (CKD) units, and other components. ternal competition, local manufacturers increase prices every few weeks, It is estimated that roughly 60 to 70 percent of components often pegging the prices with parity of PKR against major currencies. of an automobile sold in Pakistan are imported. In essence, we Any depreciation in PKR results in increase of prices locally by a pro- are importing a significant quantum of components regardless. portionate, or higher increase in prices. Furthermore, as demand often Restricting imports further disincentivizes local automobile manoutstrips local supply, there is an extended wait time for delivery of ufacturers to increase local production of components and reduce automobiles, often stretching from six months to even one year in many the import component. Increasing competition through reduction in duties and sticking with the policy rather than succumbing to pressure of the automobile lobby may actually benefit consumers in the long-run. A tiered taxation structure where a lower tax is The writer is an applied on automobiles with higher proportion of local components, thereby making the automobiles relativeindependent ly more affordable can also be a policy action to steer the industry towards a more competitive market regime. macroeconomist and Policy actions need to focus on enhancing consumer welfare, rather than safeguarding producer surplus. energy analyst. A protectionist regime rarely enhances consumer welfare and often results in creation of a market structure which even stunts growth of an industry when a global marketplace is considered. Automobile industry is a classic example of the same where adverse incentives has created more problems than it has solved. A gradual opening up of competition in the industry and ensuring policy continuity for the same would enable availability of better and affordable products for the local consumer. In essence protection of infant industries shouldn’t be till perpetuity, the infant has got to grow someday. n