July 25th, 2012 by Hafiz Noor Shams
Several new points were raised with regards to my post on duties and cars yesterday. One was pollution, two was government revenue and three, in one way or another, income effect. It is not exactly income effect but close enough.
Concern number one is easy. But let us state the pollution concern. The concern is that there is already too many cars on the streets and there is a need to reduce pollution, which I take as carbon and other greenhouse gases emissions. I also take that as actually reducing the number of cars. But here is the thing, substitution to foreign cars may actual reduce emissions without having to reduce the number of car on the roads. The reason is that comparable foreign cars-European, Japanese and possibly Korean-have higher emission standard than locally-produced cars. With more competition, consumers have a chance to choose emission-efficient cars over relative gas-guzzlers without too much price variation. End result: less emission given the quantity of cars.
Concern number two deserves a very libertarian answer. Cut government spending instead. The duties on foreign cars were always meant as protectionist measure, not primarily for revenue-generating purpose. The revenue derived from the duties should really be considered as a bonus. Except that the government is so used to it, that it forgets. With the fiscal discipline, they need the bonus. One way to cut spending is to cut fuel subsidy. In fact, tax it. Yes, tax fuel purchase.
Concern number three is harder to address and I actually thought about it but ultimately decided to not touch it. As try to explain it below, you will understand why I decided against touching it.
Income effect (not exactly but close) or specifically, the new competitive environment may push prices down across the board. This may be true and I have alluded to this in an article I wrote for The Malaysian Insider earlier. In turn, this may increase vehicles on the road as more are able to purchase cars. Or it may not. There is a sound theoretical case for an increase, but there is also a sound theoretical case for the opposite.
Initially, I wanted to address this in terms of stickiness and temporally. In English, prices will adjust only slowly to a new reality. More technically, all-in prices of domestic cars are sticky and that of foreign cars are not.
Why do I apply stickiness on domestic cars but not foreign cars? It is because the abolition or the reduction of duties is easy to calculate. It is on top of the car price in the sense that pre-duties prices are associated with the way companies run their business. It is this pre-tax, pre-duties prices that are sticky.
Most of domestic car prices are made up of sticky components. For foreign-manufactured cars, a significant portion of its end prices are made up of non-sticky components, i.e. the tax and the duties. This is why I apparently apply stickiness only on domestic cars. In truth, I am applying stickiness on both domestic and foreign cars while taking into account domestic cars have significantly less portion of non-sticky components than foreign cars, within the context of import duties abolition.
Also, consider this. The net earnings of Proton in 2011 was not even 2% of its revenue. How much room Proton has for a serious price war? Not much in the near future. This, I think, is an indication that there is a price floor: there is not much incentive to push price of sedans down too much beyond whatever Proton is charging. Proton cannot charge less anyway.
So, in the short term, the specific income effect will not be present. And no traffic congestion issue.
The long term issue is hard to say. It depends on non-cooperation (it is quite possible for firms to achieve implicit understanding in price settings without getting into trouble with anti-trust law).
Ultimately, it depends on how efficient those under pressure can be. What is certain is that that takes time.
It also depends on how low prices would get. I have not done the calculation but I have a feeling, both Proton’s small margin and game theory will provide a floor how low prices can get. And foreign manufacturers definitely would not want to price their cars so low as to earn a loss. Furthermore, that would be dumping and they will get into trouble with that.
So, in the long run, it may, or it may not have effect on congestion.
Besides, if there would be worse congestion, it would be very naive to think there is no other accompanying policy to address it. I have one immediately in my mind: congestion fee within the cities.