automobile deletion policy

8/2/2019 Automobile Deletion Policy

1/14

CMER Working Paper Series

CENTRE FOR MANAGEMENT AND ECONOMICRESEARCH

Lahore University of Management SciencesOpp. Sector U, DHA, Lahore Cantt. 54792, Lahore, Pakistan

Tel.: 92-42-5722670-79, x4222, 4201 Fax: 92-42-5722591Website: www.lums.edu.pk/cmer

Working Paper No. 97-15

AUTOMOBILE DELETION POLICY: ANANALYSIS

By

Dr. Jawaid A. Ghani

OCTOBER 1997


2/14

AUTO DELETION POLICY Page

TABLE OF CONTENTS

1.INTRODUCTION............ ............. ............. .............. ............. ............. ............. ............. .............. ............. ............. .... 3

2.EFFECTIVE PROTECTION RATES............... ............. ............. .............. ............. ............. ............. ............. ........... 4

3.ESTIMATED REVENUE BREAKDOWN..................... ............. .............. ............. ............. ............. ............. ........... 5

3.1ASSUMPTIONS.................. .............. ............. ............. ............. ............. .............. ............. ............. ............. ............. 83.2FOREIGN MANUFACTURING............................................................................................................ '.................. 93.3LOCAL MANUFACTURING....... ............. .............. ............. ............. ............. ............. .............. ............. ............. .... 93.4GOVERNMENT TARIFF REVENUE............. ............. ............. ............. .............. ............. ............. ............. ............. 93.5REVENUE TO LOCAL ASSEMBLER ............. ............. ............. .............. ............. ............. ............. ............. ........... 93.6SUBSIDY AVAILABLE TO LOCAL MANUFACTURING.............. ............. ............. ............. .............. ............. ...... 94. POLICY MEASURES.............................................................................................................................................10

4.1 REDUCTION IN CBU TARIFFS............................................................................................................................104.2IMPORT OF USED CARS............. .............. ............. ............. ............. ............. .............. ............. ............. ............. .104.3REDUCTION IN RAW MATERIAL TARIFFS ............ ............. ............. .............. ............. ............. ............. ............104.4VENDOR DEVELOPMENT FUND.......................................................................................................................114.5IMPLEMENTATION OF DELETION POLICY.......... ............. ............. ............. .............. ............. ............. ............. .125. LOCAL MANUFACTURING CAPABILITY..... ............. .............. ............. ............. ............. ............. .............. ....... 12

LIST OF TABLES AND FIGURES

TABLE 1: EFFECTIVE PROTECTION TO AUTO INDUSTRY ......................................................................................................4

TABLE 2: REVENUE BREAKDOWN FOR 1500CCCAR ...........................................................................................................6TABLE 3: ESTIMATED SUBSIDY PROVIDED TO AUTO ASSEMBLERS (1996-97) ...................................................................... 8

TABLE 4: DELETION LEVELS (800 cc CAR)...................................................................................................................... 14TABLE 5: DELETION LEVELS (1500 cc CAR).................................................................................................................... 14

FIGURE 1:EPR AT DIFFERENT DELETION LEVELS.............................................................................................................. 5FIGURE 2: REVENUE BREAK-DOWN BY STAKEHOLDER....................................................................................................... 6FIGURE 3: MANUFACTURING COST BREAKDOWN FOR 800 cc CAR .....................................................................................13


3/14

AUTO DELETION POLICY Pag

1. INTRODUCTION

This paper estimates the protection provided to the automobile industry, and discusses various policy

measures. A discussion of the following issues is presented:

1. Effective protection rates being provided to different segments of the automobile industry.

2. Analysis of protection in terms of revenue break-down. These figures estimate the revenue goingto different stakeholders at different levels of deletion. The revenue is provided by the consumer.

It goes to:

cost of foreign manufacturing cost of local manufacturing (both local OEMs and vendors) subsidy to local manufacturing (mostly to local OEMs) government as tax revenues (I have only considered tariff revenues)

The various assumptions while making these calculations are also listed.

3. Policy measures. These are discussed in terms of the net effect on each of the stakeholders. The

options considered are:

reduction in CBU duty rates allowing import of used cars at reduced CBU duty rates reduction in raw material duty rates redistributing a portion of the subsidy to a vendor development fund strengthening the implementation of the deletion policy

4. Local manufacturing capability. This is discussed by presenting a break-down of manufacturing

costs by major component. Deletion plans are discussed in terms of percentage of major

automobile components being locally manufactured and the percentage which is planned to be

located manufactured in the next five years.


4/14


2. EFFECTIVE PROTECTION RATES

The levels of protection provided to auto assemblers are very high. The following table shows the

effective protection rate (EPR) for various segments of the industry.

Table 1: Effective Protection to Auto Industry

IMPORT % TARIFF TARIFF EPR

CKD/ RM CBU CKD/ RM

1500 CC 70% 150% 32% 425%

800 CC 40% 110% 32% 162%

TRACTOR 20% 35% 32% 36%

VENDOR

using S-FORM 30% 45% 20% 56%

without S-FORM 30% 45% 65% 36%

without S-FORM 30% 20% 65% 1%

and competing against

smuggled items

EPR can be considered as the ratio of implicit subsidy provided (to local manufacturing) to the cost of

local manufacturing (assuming international levels of efficiency), i.e.,

Implicit subsidy to local manufacturing

Fair cost of local manufacturing

Thus a local plant making 1500 cc cars is being provided a subsidy which is 4.25 times the amount it

would cost to manufacture internationally. In other words local manufacturing can be 5.25 more

expensive (inefficient) compared to international standards, and yet remain profitable. This can be


5/14


understood somewhat more clearly by examining the level of subsidy provided to local

manufacturing at different levels of deletion.

Figure 1: EPR at Different Deletion Levels

3. ESTIMATED REVENUE BREAKDOWN

In order to understand the nature of protection provided to local manufacturing it is useful to examine

the revenues which go to various stakeholders on the sale of a car. The estimated revenue breakdown

at different levels of deletion for a 1500 cc car is shown in Figure 2 and Table 2.

The detailed formulas and assumptions are listed separately below. Thus the international price is

taken as $100, the local price is taken as equal to the duty-paid price of an equivalent imported car,

CBU duty is taken as 150%, and CKD duty as 32%.


6/14

AUTO DELETION POLICY Pa

Figure 2: Revenue Break-down by Stakeholder

Table 2: Revenue Breakdown for 1500 cc car

Deletion Foreign Local Tariff Company Implicit

Percentage Mfg Mfg Revenues Revenues Subsidy

0 100 0 32 250 118

10 90 10 29 250 121

20 80 20 26 250 124

30 70 30 22 250 128

40 60 40 19 250 131

50 50 50 16 250 134

60 40 60 13 250 137

70 30 70 10 250 140

80 20 80 6 250 144

90 10 90 3 250 147

100 0 100 0 250 150

The subsidy is:

{ Revenues obtained by the local car assembler }

minus

{cost of foreign manufacturing + fair cost of local manufacturing +

amount paid as government import tariff}


7/14


According to the above analysis the subsidy increases as deletion levels increase. In reality this is

probably not the case since local manufacturing is probably considerably less efficient than foreign

manufacturing. Thus the slope of local manufacturing is far more steeper than the above estimates

would suggest. That is, at 100% deletion the cost of local manufacturing will not be $100 (the

international cost) but rather maybe $150 or even $200. As a result of a steeper local manufacturing

slope, the subsidy decreases as deletion levels increase, thus discouraging assemblers to manufacture

locally (and resisting attempts to enforce the deletion policy). The policy implication (which will be

discussed later) is that efforts need to be made to bring down the cost of local manufacturing. This

could be done through redistributing the subsidy from the auto assemblers to a vendor development

fund and also by bring tariffs on raw materials down.

Table 3 estimates the subsidy provided to various auto assemblers. A key assumption is that the price

being charged is equal to the duty-paid price of an equivalent imported car1. This subsidy is a net

transfer from consumers to local manufacturing. There is considerable evidence that most of this

subsidy is captured as economic rent by the auto assemblers (rather than by auto vendors) due to the

greater bargaining power of the former over the latter and due to the weak enforcement of the deletion

policy by the government.

1 It is suggested that theEngineering Development Boardobtain estimates of international prices of equivalent cars, in

order to make more accurate estimates of subsidy.


8/14


Table 3: Estimated Subsidy Provided to Auto Assemblers (1996-97)

COMPANY REVENUES

(Rs. million)COST AT

INTL

LEVELS

%DELETION

GOVT

REVENUES

SUBSIDY

PAK SUZUKI 7,904 3,764 50% 602 3,538

HONDA 2,794 1,118 30% 250 1,426

INDUS

(Toyota)

4,136 1,654 33% 355 2,127

TOTAL 14,834 6,536 1,207 7,091

Note: Revenue figures are taken from published company annual reports

Int'l cost levels are calculated as [Revenue/(1+ CBU duty)]

Deletion for Pak Suzuki is approximated as the average of 61% (Mehran) and 36% (Margalla)Government tariff revenues are [%import x CKD duty x Intl cost level] Subsidy is calculated

as [(Company Revenue) -(Intl cost + Govt tax revenue)]

3.1 ASSUMPTIONS

1. For the sake of illustration the international price of a completely built unit (CBU) is taken to be$100.

2. In order to make a meaningful measure of subsidy, the fair cost of local manufacturing isestimated. This assumes that the level of efficiency (cost effectiveness) of local manufacturing is

at par with international levels. In reality local costs may be higher (due to low scale economies)

or lower (due to lower labour costs).

3. Only government tariff revenue is considered in order to simplify calculations. Several of the newOEMs are able to avail tax holidays, while the older ones have accumulated tax loss carryovers,

which results in minimal income tax revenues .

4. Sales tax is not considered in order to simplify calculations. Since GST is adjusted and theconsumer pays the same amount irrespective of level of deletion, the estimates should not be

affected.

5. Import tariffs on CKD are taken as 32%. Import tariffs on CBU are taken as 110% for cars lessthan lOOOcc, 120% on 1000-1300 cc cars, and 150% on 1301-1800 cc cars.

2 Total taxes paid by Pak Suzuki, Honda, and Indus Motors in 1995-96 was Rs 217 million on sales of Rs. 14.8 billion, i.e.,

1.5 percent.


9/14

AUTO DELETION POLICY Page 9

3.2 FOREIGN MANUFACTURING

FM = ($100) x (% imported)

If deletion is zero then FM is $100; if deletion is 100 percent then FM is zero

3.3 LOCAL MANUFACTURING

LM= ($100) x(% deleted)

If deletion is zero then LM is zero; if deletion is 100 percent then LM is $100

3.4 GOVERNMENT TARIFF REVENUE

TAX = ($100) x (%imported) x (CKD duty rate)

If deletion is zero then TAX is $32; if deletion is 100 percent then TAX is zero

3.5 REVENUE TO LOCAL ASSEMBLER

REVENUE = (S100) x (1 + CBU duty rate)

The maximum price which can be charged for an car produced locally is the duty paid price of an

equivalentimported car.

Thus REVENUE is $250 for a 1500 cc car and $220 for a 1000 cc car (with duty rates of 150% and

120% respectively).

3.6 SUBSIDY AVAILABLE TO LOCAL MANUFACTURING

SUBSIDY = REVENUE - (FM + LM + TAX)

= [$100] x [(CBU duty rate - (%imported) x (CKD duty rate)]

For a 1500 cc car with zero deletion SUBSIDY is $118. With 100% deletion the SUBSIDY is $150.


10/14


4. POLICY MEASURES

4.1 REDUCTION IN CBU TARIFFS

CBU tariff levels could be decreased from the existing high levels. This would bring down the price of

duty-paid imported cars, thus directly bringing down the price ceiling for local cars, i.e., the maximum

price which can be charged. This increases consumer welfare, and decreases the subsidy available to

local assemblers.

This step would adversely affect existing investments, i.e., plants which have already been set up

assuming that previous protection levels would continue. Before pursuing this policy option it is

important that the cost structure of existing manufacturing capabilities for different car segments and

components be thoroughly examined by theEngineering Development Board.

4.2 IMPORT OF USED CARS

This involves permitting the import of used cars and allowing for a depreciation allowance on the

price of the car. In effect this decreases the CBU tariff rates applied to used car imports.

The availability of used cars would have a substitution effect on new car sales. It is expected that new

car sales will thus go down, resulting in further decreasing scale economies to local manufacturing

and thus increasing the cost of local manufacturing. Since there is no system for certifying the

condition of the imported used cars, consumers might lose out through the sale of lemons. Consumers

might end up providing a subsidy to car traders.

In order to properly analyze this policy option it is necessary to have demand cross-elasticities

available (to understand how consumer purchase behaviour would change if used cars were available)

and also to understand the effect of volume on local manufacturing costs.


11/14


4.3 REDUCTION IN RAW MATERIAL TARIFFS

A decrease in raw material import duties would decrease the cost of local manufacturing. This would

encourage assemblers to increase the level of deletion voluntarily (rather than just through monitoring

by government agencies).

Local manufacturers can obtain concessions on import duties in raw material imports provided they

use the S-form. However there is evidence that the vast majority of automobile vendors are unable to

avail this facility3. As a result they often buy small quantities of expensive raw materials from traders

(who make bulk import purchase paying the full import duty rates). Alternatively they sacrifice quality

by purchasing inferior quality raw material.

A decrease in raw material import duties would not only make the vendor industry competitive for

supplying to OEMs (thereby increasing deletion levels) but also increase the share of local

manufacturing in the large replacement market and also encourage exports.

4.4 VENDOR DEVELOPMENT FUND

A percentage of the subsidy available to local assemblers could be put into a vendor development

fund. This fund would help in bringing down the cost of local manufacturing by providing technology

transfer, quality control, and training facilities. The net effect would be that the subsidy would be

redistributed, and assemblers would be willing to increase the level of deletion due to a more

competitive local vendor industry.

This policy would be consistent with the actual purpose of the large protection being given to the autoindustry, i.e., to contribute to developing the technological base of the country. The experience of

3 A survey of auto vendors conducted in December 1996 indicated that less than 10 percent of vendors use the S-form for

purchasing raw materials. See J. Ghani, "Vertical inter-firm linkages in the Pakistan automotive industry", CMERWorking Paper, Lahore University of Management Sciences, April 1997.

4 It is estimated that the size of the replacement market (for cars and all commercial vehicles) is worth Rs. 60 billion. This

is thrice the size of the OEM market. Unfortunately extensive smuggling has resulted in a reduction of localmanufacturing share from 40 to 20 percent during the last few years. Note that this is the segment which receives the least

protection due to high cost of raw material (due to not using S-form) and minimal barriers to smuggling.


12/14


several industrializing and industrialized countries suggests that a strong technological base results in

positive externalities to the rest of the economy through skill development and a variety of spin-off

effects. Once adequate scale economies are achieved (usually through long-term supply arrangements

with large OEMs), vendors are able to diversify into other engineering goods for the local and the

export markets.

In order to effectively manage the vendor development fund it is necessary that current technological

capabilities available in the country be understood. The deletion plans of different assemblers need to

be coordinated with the plans for technological upgradation by vendors. The role of theEngineering

Development Boardwould be to ensure transparency and proper coordination as part of a long-term

plan for enhancing the technological base of the country.

4.5 IMPLEMENTATION OF DELETION POLICY

An effectively implemented deletion can indeed result in the kind of positive externalities discussed

above . A good example is the tractor industry whereby a large cluster of vendors were developed in

a short period of time during the eighties. As a result deletion levels are high (80%) and protection is

low (EPR of 36%), and were it not for ad-hoc policies (such as fluctuations in ADBP credit levels and

the Awami Tractor Scheme) the industry could well have been an export industry by now.

It is thus imperative that detailed deletion plans and achievements become transparent and be

coordinated as part of a broad engineering development plan.

5. LOCAL MANUFACTURING CAPABILITY

A first step towards understanding the technological capabilities available in the country is to identify

the components being manufactured in the country. A summary is provided in the tables and figure

5 For instance Brazil was able to achieve over 90 percent deletion and lay the base for a strong engineering industrywithin five years in the late fifties. See H. Shapiro,Engines of Growth: The State and Transnational Auto Companies in

Brazil, Cambridge: Cambridge University Press, 1994.


13/14

AUTO DELETION POLICY Page 1

below. Details for each component are available in various published documents. Further studies are

necessary to examine the competitiveness of local manufacturing (compared to international levels) in

terms of cost structures, skill and investment requirements.

Figure 3: Manufacturing Cost Breakdown for 800 cc car

- , Source:Industry Specific Deletion Program (ISDP) 1996-97, Engineering Development Board

Tables 4 and 5 present deletion levels for 800 cc and 1500 cc cars by major component category. An

explanation of the columns is as follows:

Maximum: The maximum which can be deleted in this category. This is actually the same asthe percentage of manufacturing cost for the component. Thus for an 800 cc car 22 percent of

the cost is allocated to the engine6.

Column A: The percentage of parts which have been successfully developed by at least oneOEM.

6 TheEngineering Development Board should undertake a study of cost structures in different countries. Due to differentfactor costs (labour versus capital) the cost structures would be quite different.


14/14

AUTO DELETION POLICY P

Table 4: Deletion levels (800 cc car)

Component Maximum A B C

Engine 22 6.30 6.67 9.03

Power train & Chassis 18 7.82 4.96 5.22

Body 22 15.66 4.57 1.77

Interior Trim 18 14.02 2.63 1.35

Electrical 10 6.46 2.04 1.50

Vehicle Assembly 10.00 10.00 0 0

Total 100 60.26 20.87 18.87

Source:Industry Specific Deletion Program (ISDP) 1996-97, Engineering Development Board

Table 5: Deletion levels (1500 cc car)

Component Maximum A B C

Engine 20.0 2.46 6.84 10.70

Power train & Chassis 17.5 2.93 5.93 8.64

Body 29.0 2.20 7.34 19.46

Interior Trim 11.5 5.56 4.82 1.12

Electrical 10.0 5.55 3.05 1.40

Vehicle Assembly 12.0 11.35 0.65 0

Total 100 30.05 28.63 41.32

Source:Industry Specific Deletion Program (ISDP) 1996-97, Engineering Development Board

automobile deletion policy

Documents