How a Minister forgot basic economics and dismissed a multi-billion ringgit opportunity. This article was published in Loyarburok.
Last week, Bernama and other sources reported Dato’ Mukhriz Mahathir’s bewilderment at Pakatan Rakyat’s proposal to auction Approved Permits (APs) to import cars. Essentially, Mukhriz said that auctioning APs (instead of giving them out at a fixed price) would increase car prices. Mukhriz is of course the Deputy International Trade and Industry Minister. In a letter to Malaysiakini, Pakatan Rakyat’s Rafizi Ramli promptly responded to these concerns, describing in generous detail why the good Deputy Minister had been mistaken.
Of course, only one of them can be right. I drew some graphs to help illustrate who was right (spoiler alert – it’s Rafizi), and where the other person (read: Mukhriz) may have got it wrong. The mistake comes down to an oversight of one of the most fundamental concepts in economics: that prices are determined by both supply and demand.
To illustrate how this fundamental concept comes into play in this case, I drew some simple graphs. So if you’re like me and you like pictures, maybe this explanation will be helpful.
Let’s start with the status quo, illustrated in Figure 1.
PGL = Global price of cars imported to Malaysia, including taxes, duties, and shipping cost (for simplicity, we pick a single price for imported cars and assume the Malaysian market has no effect on the global price)
DMY = Aggregate demand curve for imported cars in Malaysia
E = Market equilibrium, in absence of AP limits
QAP = Number of APs issued
PMY = Profit maximizing price for imported cars in the Malaysian market
PAP = PGL + Price of AP
The purpose of issuing APs is to limit the number of imported vehicles in the Malaysian market to give an advantage to local automotive makers. Without the AP system, Malaysians would buy more imported cars (QE imported cars at the global price PGL) and fewer local cars. Instead, the government issues only QAP APs to import cars, and issues them to selected importers.
By reducing the supply of imported cars to QAP, its price (you guessed it!) increases. Malaysians are now willing to pay PMY for imported cars, instead of PGL. This is where I’m guessing Mukhriz forgot about the demand curve.
So where does the extra money (PMY – PGL) go to? Some of the money (PAP – PGL) goes to the government when it sells the APs to the importers. The remainder (PMY – PAP) turns into profit for either the importer, or the dealer who buys the cars from the importer.
So what happens if the government auctions the APs instead of giving them to select importers? Will car prices increase? Let’s take a look at Figure 2.
In this scenario, car dealers no longer need to depend on importers – they can buy APs directly from the government. The dealers will start bidding at the original AP price (PAP – PGL). They will bid higher and higher, continuously increasing the AP price (P’AP – PGL) until P’AP is so close to PMY that paying any more for APs would make selling cars unprofitable.
The price of APs has increased, but the price of the car PMY remains unchanged.
All else constant, the price of the car will only increase, as Mukhriz reportedly asserted, if to begin with importers and dealers were not selling the cars at the profit maximizing PMY.
Dealer don’t lose
So where does the money go to now? Under the auction system, a much larger share (P’AP – PGL in Figure 2) will go to the government, while dealers will make PMY – P’AP.
But dealers will not lose out. The only party that loses is the middle person importers that are made redundant (of course, some companies are both importers and dealers). Under the original AP system, the dealers were engaging in the same bidding process, only they were beholden to the importers instead of the government.
Reducing duties reduces price for all cars
Pakatan Rakyat also plans to reduce car prices by reducing duties. This will of course work, but how this reduces prices of imported cars subject to APs is less straightforward as it is for cars not subject to APs.
Reducing duties alone (PGL to P’GL in Figure 3) will not directly reduce prices of imported cars. As long as QAP remains the same, PMY will remain unchanged.
But by reducing duties on all cars, the demand for all cars will increase and more cars are purchased. QAP is set at 10% of total market volume. So when more cars are bought, QAP increases proportionally, to Q’AP in Figure 3. With this increase in supply of imported cars, PMY decreases to P’MY.
The government currently issues APs at RM10,000 per AP to around 100 select companies. As Rafizi explained at a forum on car prices, the government could gain more than RM3 billion every year by auctioning the APs.
So there you have it. By overlooking the fundamental concept of supply and demand, our Deputy Minister has dismissed a multi-billion dollar proposal.