Deconstructing Nigeria’s Automotive Policy

There has been a lot of discussion on Nigeria’s auto policy and the success (or failure) of it. The whole debate has been spurred by the recent announcements by Nissan, Toyota, Honda, Volkswagen, and others, on setting up assembly plants in Nigeria. Before we get into the details of the automotive policy it is useful to understand some key concepts.

1. Social Welfare

Social welfare in economics is loosely defined as the combined well-being of every person in a particular society. Each person’s welfare might vary but at any given point in time we can imagine social welfare as the aggregate of individual well-being. Technically it is not exactly a summation of individual welfare but it’s a useful way to think about things. The goal for society is to improve social welfare in an optimal manner i.e. to make as many people better off as possible to a larger extent than others are made worse off. An even better goal is to make as many people well off without making anyone worse off although that is a bit more difficult in reality.

There are also other nuances which matter for society in reality. Not all persons are equal. Some are rich, some are poor, and some are in the middle. Improving overall social welfare while improving the welfare of the richer members of society and reducing the welfare of the poorer members of society might be deemed a socially undesirable outcome. On the flip side re-balancing things to improve the welfare of the poor whilst reducing the welfare of the rich might be deemed a desirable outcome even though it might reduce overall social welfare.

In terms of policy impacts; Good policy is one that improves social welfare and improves the welfare of the poorer parts of society. Policy that improves welfare for the rich but does nothing for the poor is not necessarily bad. However policy that improves welfare for the rich whilst reducing welfare for the poor is bad policy, even if it improves overall welfare.

Judging good policy is therefore not dependent on only the positives but on a holistic examination of the positive effects and negative effects on social welfare. 99% of all policies will have positive and negative effects. Using only the positives to judge the success or failure is simply just wrong.

2. Capital – Labour Ratio

this is the way we typically think of the production process; as an entrepreneur (or a firm) you combine a bit of capital with a bit of labour using some type of technology to create stuff. The ratio with which you combine capital and labour depends on the type of stuff being produced and the technique. Some processes are labour intensive while other are capital intensive. The relative distribution of these factors of production and the costs of renting or hiring these factors determine where the benefits go. For example, the production of a labour intensive product in an economy where the labour cost and capital costs are similar will result in the benefits flowing more towards labour. On the flip side the production of a capital intensive product in an economy with similar labour and capital costs will probably result in the benefits flowing to the owners of capital.

In reality the distribution of proceeds between the owners of capital and labour depends on a lot of factors. Generally though, labour intensive production tends to benefit labour more, whilst capital intensive production tends to benefit the owners of capital.

This distribution of benefits from production is very important especially as it relates to social welfare and the distribution of improvements. This is because in most cases the owners of capital are on the rich side of the social order, whilst labour is on the poor side. Policies that promote labour intensive production therefore tends to disproportionately benefit the poor. On the flip side, policies that promote capital intensive production tend to disproportionately favour the richer parts of society, the owners of capital.

At this point I should point out that the distribution I describe is not always true. There are certainly many cases where capital is distributed relatively evenly across societies. There are also many cases where the poorer parts of society own capital. However in most cases, and definitely in the Nigerian case, the rich own capital, the poor have labour. The relative costs of capital and labour also matter but we can ignore that for the purpose of this discussion.

3. Value Added

The final concept to understand is what is now commonly referred to as “value added”. Improvement in communications and transportation technology mean the world is now a global village. Production has moved into some kind of hyper efficient mode with firms constantly seeking ways to improve. The consequence is that nothing is really made in any particular location but is made in lots of places with some “value added” at each stage.

For example, think of all the stages involved in making the average t-shirt. Farmers grow cotton in the US, Brazil, India, Uganda or China. The cotton is moved to Mexico or Guatemala or Vietnam or China where the spinning takes place, turning cotton into cloth. The cloth is then moved to one of the many “sewing hubs” such as Bangladesh or China were it is turned into a blank t-shirt. The blank t-shirt is then moved to the US or Europe or China where it is screen printed and then sold to you the final buyer. In the end the average t-shirt would have visited more countries than most humans would visit in their entire lives and still land at your local shop on sale for N1000. Surprisingly, one of the cheapest parts of this entire process is the moving of stuff from place to place.
What does this mean for policy? It means the idea of producing most tradeable goods in one particular place from beginning to end is dying. So the idea that you can create some kind of industrial policy to produce shirts from beginning to end in Kano or Aba will likely result in shirts that are significantly more expensive than shirts produced via the global machine. Which means without some kind of persistent protection (i.e. protection with no end) this policy is likely to fail long term.

Smart industrial policy in today’s world focuses on what part of the supply chain you can conquer in the long term.

And back to Nigeria’s Automotive Policy Development Plan

The policy proposition is straight forward; it is an attempt to induce global auto manufacturers to set up assembly plants in Nigeria. The strategy is to raise tariffs on all imported vehicles and give auto manufacturers a discount if they set up assembly plants in the country. The policy raised tariffs on imported vehicles from 20% to 70% (35% duty and 35% levy) for fully built cars and to 35% for commercial vehicles. However completely knocked down vehicles can be imported with no tariffs while semi knocked down vehicles can be imported with a 5-10% tariff. Firms who set up local manufacturing operation will also be allowed to import vehicles with no levy (only a 35% tariff) on a 2:1 scale. That is for every one car they assemble locally, they can import two cars with no levies. It wouldn’t be a Nigeria policy if there were no caveats. Firms who sign a memorandum of understanding with the Federal Government, promising to set up an assembly plant would be allowed to import vehicles with no levy until the 31st of June 2015. From July 1st 2015 only firms with “actual assembly” would be allowed to import under the zero levy regime.

Sidebar: Now you know why we have had a flurry of “new assembly plants” in the last month or so. Assembly, according to the policy means any activity as meagre as putting together a SKD. SKD being the Car Body is fully painted and glazed. The Engine, gearbox, axles, steering, suspension, driveshaft, seats, tyres, batteries, exhaust system, electrical etc. are supplied as individual units for assembly in Nigeria. It is unclear if assembly means all of the above items or one of the above items. Your guess is as good as mine.

Success of Failure?

As mentioned earlier, in determining the success or failure of any policy we have to consider the welfare losses and the welfare gains, and the distribution of those losses and gains.
First the losses. The increase in tariff implies a welfare loss to whoever had to pay the new tariff. In 2012 Nigeria officially imported about 500,000 vehicles worth about $4bn at the 20% tariff rate. A hike in tariff assuming, assuming no change in the number of vehicles imported gives an estimated direct welfare loss of about $1.7bn. The reality will of course be a bit difficult to measure. According to sources the number of vehicles officially imported into the country dropped by 20% in 2014. This of course comes with the associated spill over effects in vehicle importing businesses and all that.
What are the benefits? First it is important to realize that there was already an admittedly small automotive industry before the policy was implemented. Firms like Peugeot and Innoson were already assembling cars in the country. According to the National Bureau of Statistics there were over 280,000 people employed in the automotive industry in 2012. Local components used in the automotive industry was valued at around N365m in 2012. The point here is that the Nigerian automotive industry was not zero before the policy. Labelling the entire industry as a product of the automotive policy is therefore dishonest. We will have to wait for the next few rounds of data from the NBS to see what the impact on jobs and economic activity has been. We would then have to compare the improvement to the welfare losses from the implementation of the policy to see if we can really label it as “successful”.

However, even if the policy proves successful based on a benefits vs costs basis, the next question is for whom? Most parts of the automotive industry, including the assembly line, are notoriously capital intensive with huge relative costs required to set up plants and processes, and to train workers. According to data from the National Highway Traffic Safety Administration, the typical car plant in the US employs only about 2000 people per car model. The plant for the most popular model, the Toyota Camry, employs only about 7000 people. The assembly line is very capital intensive. This, of course implies that, even if the policy is “successful”, the benefits of this success will disproportionately flow to the owners of capital. The more affluent parts of society. Of course, there will be jobs created and of course some workers will earn a living where they may have had none. However the bulk of the benefits will flow to the investors, the owners of capital, the more affluent part of society.

There is the argument that the first stage of the policy is to induce the auto manufacturers to set up shop in the country. This, it might be argued, would lead to technology transfer and a gradual increase in the locally made components and create more jobs and so on. The auto industry is unfortunately not immune to the effects of globalization. The distribution of the auto manufacturing process has changed dramatically as well. Cars are no longer made in a single location with components from the “local industry”. For example, “not a single 2014 model year vehicle sold in the United States now can claim 85 percent of the parts were made in North America” according to the National Highway Traffic Safety Association. Legendary American brands, such as the Lincoln MKS have only about 51% of the parts sourced from North America. In fact according to the “American-made index” the most American car in 2015 was the Toyota Camry, a Japanese car brand. This trend is set to continue with more and more components sourced from various parts of the world. The model of building a local automotive parts supply industry to support local assembly is dying a slow but sure death. So it is safe to say that our auto policy cannot create the kind of local parts industry that the policy makers want.

In summary, the automotive policy has not yet produced results enough to be labelled a success and it is unlikely that it will. In the unlikely event that it does, the benefits will probably mostly go to the richer and more affluent capital owning parts of society. The policy is also unlikely to improve the local auto parts supply industry. The policy is also not going to make a dent in our unemployment numbers.

So what should a sensible auto-policy look like? For starters it should be focussed on globally dominating a certain part of the automotive industry. A part that is preferably labour intensive and one that we have a natural advantage in. The tire manufacturing part of the industry is the most likely candidate. It is relatively labour intensive (at least until someone figures out how to synthetically make tires from plastic using machines). We have a natural advantage in the sense that we have a local rubber industry. Finally it is a relatively simple process without the need for massive technology transfers. Economists like Prof. Pat Utomi have suggested focussing on this part of the industry for years. I guess our government only wants the glitz and glamour of announcing that Toyota has set up a plant in Nigeria. There is a very interesting political economy reason there but that is a story for another day.

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One thought on “Deconstructing Nigeria’s Automotive Policy

  1. We do little to look through the actual benefits or cost of such policies, but then the incentive lies in using the glitz of these inane policies to get reelected. Thanks for this Nonso. It was brilliantly written.

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