Infant Industry Paper Final

This economic isolationism Is very difficult to overcome and Industries developed under It can never compete freely In he International market. Infant Industry Without overstating the obvious, not all countries are endowed with equivalent natural resources and other key factors of production, including labor and even cultural attributes. For many reasons, countries may want to foster the development of advanced industrial goods, even though such a country does not possess the necessary technology or skill sets to produce such goods.

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Advanced industrial countries that have Invested heavily in technology and education have taken the lead in the production of many of the worlds technologically advanced products such as automobiles, computers and aircraft, In some cases because they were first movers In these Industries. For instance, when a country such as Brazil wishes to foster the development of an automobile industry, it must recognize that these domestically produced automobiles will be competing with foreign automobiles.

The foreign competitors will have the advantage of scale, driving down costs and in most cases the reputation for producing quality goods in a very competitive world market. In order for the fledgling domestic producer of automobiles, in the case of Brazil, to sell any vehicles at all, rises for the first models will be far below the actual cost of production and will not likely contribute to any return on the initial Investment.

If Brazil as a sovereign nation feels that the development of this Industry Is critical to the economic fortunes and welfare of Brazil, It may choose to protect It from International competition In order for the Industry to develop a level of scale that allows It to make a profit relative to its cost. A further benefit of the infant industry is the “learning by doing” effect. The government is essentially going to protect the industry from foreign competition y creating a barrier to entry by foreign competitors either through import quotas or tariffs on incoming vehicles.

The Impact of Infant Industry Protectionism Much has been written around the subject of infant industry protection and the detrimental impact on the society which employs them. The near term reduction in social benefit to countries that adopt infant industry practices can be visualized in the graph below. The red area shows the “tax” paid by the country that is protecting it infant industry and shows how consumers would demand more that good if it could be acquired more cheaply.

The average cost curve (not pictured) of the domestic protected industry would have to move down and to the right more rapidly than the pace of the foreign or world market in order the domestic industry to compete on par with the world supplier of this good. The other aspect of this argument against the protection of infant industries is that these countries are ineffectively and inefficiently using their resources. In short, these countries are not drawing on their natural competitive advantage. This concept has been forwarded by many classical economists, especially John Stuart

Mill, in the following: “”… The importation of foreign goods, in the common course of traffic, never takes place, except when it is, economically speaking, a national good, by causing the same amount of commodities to be obtained at smaller cost of labor and capital to the country. To prohibit, therefore, this importation, or impose duties which prevent it, is to render the labor and capital of the country less efficient in production than they would otherwise be; and compel a waste of the difference between the labor and capital for producing the things with which it can be purchased from abroad””

A key real world example of the impact of infant industry protection can be illustrated by the automobile industry of India. India is home to nearly one-sixth of the world’s population yet has a passenger car industry of only 1 million vehicles per year. (Most vehicles sold are of the two and three wheeled type)iii. Indian’s automobile market was so protected that, as the Joke went, you could buy any car you wanted- so long as it was an Ambassador. Ambassador had a hammer lock on the Indian market, commanding over 70% of the market, with the remaining 30% controlled by another small Indian firm, Premier Padding.

People in India did not buy these cars because the quality was better or even for national pride. They bought them due t to the huge import tariffs on imported vehicles, that virtually barred the purchase of these vehicle by other than the extremely wealthy. Often, produce them. Waiting list to get one of these sub optimal cars ranged from months to even years. Of course if you were willing to pay a “facility’ payment, one could be obtained more expeditiously. Iv Since 1990, India has removed most tariffs and opened up its economy to much more liberalized trade practices.

The India automotive industry now supplies nearly 7% of the automotive output to the world versus virtually nothing two decades ago. Many of the companies operating in India are partnerships with multinational automotive manufacturers, including Ford, Haunted, Renault and Honda, to name a few. (Sacristans 2006) By allowing these foreign competitors to come in a build and sell cars in India, greater than 25 million Jobs are expected to be created over the next decade. Beyond likely getting better cars at a better price, consumers in India now have choices as never before.

As noted when Ambassador and Padding dominated he market, there were few choices. Now foreign and domestic automakers are planning on rolling out over 50 new car models in 2007 according to the Society of Indian Automobile Manufacturers. (Sacristans 2006) Other industries that support the automotive industry will no doubt flourish. To further the argument against infant industry protection, again in India, one can look to Data Motors. For years Data Motors made light trucks, heavy trucks, buses, cement mixers and heavy vehicles of all kinds.

It dominated the Indian market through 1991, when India began lowering its trade tariffs and allowing the import of reign trucks. Data experienced much more competition for its core product and made the decision to diversify its portfolio and begin producing passenger cars, to offset the cyclical swings it experienced in the heavy truck market. Up until this time, Data had counted on a virtual monopoly and exactly like Ambassador would simply work down its waiting list as new orders softened in the cycle. Competition forced Data to make a bold move- it aimed to produce the world’s least expensive passenger car. Prior to the opening of Indian’s markets, this move would have been wholly unnecessary. Now, Data stands at the forefront of becoming a world leader in small vehicle production. This car would be aimed at the “bottom of the pyramid” and allow people who could only dream of owning a car, the reality of being able to afford it. (Meredith 2007) The impact of removing infant industry protections has allowed and some would say forced Data to become more efficient.

This efficiency will benefit the Indian economy and the world economy as well. The social surplus will now return to the consumer and all will benefit. Beyond the automotive industry, lowering trade barriers and opening up industries o competition also attracts further foreign direct investment in other industries. In the case of India, reforms to its trade protection policy have opened many opportunities to both foreign companies and domestic companies that thrive in the Indian economy.

Indian’s Data Tea’s purchased Outlet Tea in 2000 in much the same way Western companies acquire complementary businesses- by leveraging its benefiting from this trade liberalizing as foreign companies invest in India for its low wage, highly skilled workforce. Vi Others have argued that industries need to be fostered and protected to overcome he first mover advantage of more developed economies. The fallacy with this argument stems from the fact that all companies and therefore industries are “infant” at some point. Whenever a business is started, costs almost always exceed price on the initial units produced.

As stated previously, as size and scale are obtained the average cost of a good comes down with each successive unit produced. The protectionist argument allows for the “infant” industry to gain profits from these inefficiently produced units from its earliest stage. There are two problems with this- en it removes the incentive to move as quickly as possible to lower costs and compete and- two industries will continually petition to be protected claiming dumping and anti free trade practices by other countries. The US steel industry is one such “infant” industry that has never grown up. Ii Developing countries are not alone in using protectionist policies to shore up infant industries. Recently the US Government enacted steel tariffs to protect US steel companies from foreign competition, ostensibly to protect it from dumping. While steel producers are protected, other down stream industries also suffer. The US auto industry is twice burdened by these tariffs- first it raises their costs and as recently as 2006 has caused shortages of critical types of steel forcing them to lower production runs or pay higher prices for available supplies of critical materials. Iii It has been noted that other domestic industries that must compete with foreign imports are hurt by these tariffs as well, since they cannot pass along these higher costs. This is especially relevant to the domestic manufacturers of products that used rolled steel in appliances and as mentioned automobiles. The profits in these industries are retarded in order to support the domestic steel industry. GM chief economist Mustang Monetary states that keeping these tariffs also hurts the domestic steel industry.

The steel industry will react by trying to get more competitive in the face of imported steel benefiting all upstream and downstream industries. (Nicolas 2006) While the foregoing examples of the impact of infant industry practices are largely anecdotal, there have been some studies that have empirically analyzed the impact of such policies. Anne O. Krueger and Barn Tuner examined the infant industry protection practices of Turkey. The authors establish these 4 basic reasons to promote the development industry through infant industry protection: 1 .

Newly established enterprises will have much higher costs than foreign companies and time will be needed to become competitive. 2. An individual entrepreneur would not undertake this project at the free trade prices 3. If developed the industry would have a reasonable rate of return on the initial investment 4. Development of such industry requires only temporary protection, given enough time costs will fall and The authors argue that in order for an industry to qualify for infant industry retention, cost per unit of output in the protected industry must fall at a greater pace than the industry as a whole.

Without a high positive spread between the protected industry and the international industry, the “investment” or social losses generated by protectionism will never have a chance to be recovered. Krueger and Tuner’s study of Turkey proposed that protecting an industry greater than 10 years, with a real rate of return of 10% would only net of the initial investment. Any industry that is projected to fail this test would not warrant any type of protection and should not be supported. It is also recognized that the industry is impacted by both dynamic factors and externalities. Kruger and Tuner 1982) It is argued that the dynamic factors are captured within the calculation of the rate of decrease of unit costs, though it is not completely clear as to which unit of production this applies. They are argue that industries requiring higher levels of protection, therefore higher “cost”, need to have a higher return. Externalities to the industry might not impact the infant industry and the established foreign industry equally, but for purposes of their study they assumed that these impacts would be felt by

The results of the study indicated that where Turkey had protected industries from foreign competition, some level of accelerating cost decreases were observed versus competing foreign industries. In total, it was estimated that the protected industries did experience some accelerating decrease of costs; though these small spreads versus their global competition did not warrant the protection afforded these industries. The return period was also deemed too long and the returns too small to offset the original investment.

Additionally, Krueger and Tuner examined the attention positive externalities of supporting infant industries on the manufacturing sector as a whole. By examining the output of the entire manufacturing sector they found that total output, based on their testing, only increased 1. 8% in the observed period. It was calculated that the industries that were protected, assuming a 50% cost disadvantage, would have had to grow at greater than 5. 8% growth in output per unit of input in order to warrant protection.

As can be seen from the table below, only two industries even approached this level of rate of growth. While Krueger and Tuner present a viable approach to examining infant industry retention policies and use this technique to examine the results of Turkeys protected industries, others have reexamined these results and found the opposite or at least a more favorable conclusion. Ann E. Harrison argues that taken as a whole, the protection of infant industries in the case of Turkey may be bad, but infant industry protection by its nature is selective and not meant to be economy wide.

She argues that based on excluding some outliers from the original table and performing correlation test based Superman Correlation Coefficients, protection of infant industries can be shown to have a high correlation between protection and increase productivity growth in the protected industry. She further states that if the for protection is even higher. X Another key empirical study that tests the performance of protected infant industries is that of Eduardo Luzon and Shame Greeting on the Brazilian Microcomputer industry.

Brazil had enacted policies in 1977 to protect its “informatics” firms and develop a domestic micro computer industry. These policies pursued “technological autonomy and absolute exclusion of foreign goods”. Xi One initial impact of these elicits was the creation of a black market for small purchasers that negatively impacted large firms who were subject to review and enforcement raids. It was estimated that up to 65% of the total PC market for individuals was supplied by this black market in 1991. An interview with a colleague Monica Simmer confirmed this situation.

She asserted that the everyday Brazilian paid more for the foreign computers on the “black market” due to their higher quality and more updated programming. There was also little or no enforcement on the individual versus the larger corporation she confirmed. Ii In this instance a government policy actually created a black market for which the Brazilian society as a whole paid a very high price, both in monetary and opportunity terms. Forgone buyer surplus was estimated at $143. 3 million from 1984 to 1988. Luzon and Greeting, 1995) Beyond just the forgone buyer surplus, it was also estimated that over the 13 year period of this policy, Brazil lost approximately $716. 4 million in surplus, which totaled roughly one-third of the expenditures on domestically produced computers. A high cost indeed. One aspect not addressed in the study was the potential additional mainstream costs borne by the Brazilian consumers. (Luzon and Greeting, 1995) The effectiveness of trying to nurture a high technology industry such as microcomputers may require a different approach other than tariffs and or import bans.

Eventually, these “informatics” laws were repealed. The results to the “infant” computer industry in Brazil were devastating. Almost at the time of the announcement of this policy change, large Brazilian firms cancelled their orders to the domestic computer makers and massive layoffs of engineers and factory workers ensued. The authors concluded that while the pace of technological improvement in he Brazilian PC industry somewhat matched that of worldwide technological improvement, it was never enough to overcome the lead the rest of the world had.

Further, since the price started high and remained relatively so throughout the period of protection there was never a chance that the protected industry could overcome the “initial” investment and return any meaningful surplus to the Brazilian economy. (Luzon and Greeting, 1995) The conclusion reached here support indirectly the Kruger and Tuner conclusion that in order for an infant industry to be protected it needs to have the ability to pay back its initial investment. The case of Malaysia also bears a brief review.

Malaysia protected many of its domestic industries, especially autos, and at the same time promoted exports through the use manufactured exports during the sass’s, little was done to push the protected industries to become more competitive. There was never a concerted effort to move these industries beyond domestic production and have them compete in the international market. Perhaps there was not enough political will in the Malaysian government to expose their home grown industries to the rigors of international competition, and this ended burdening the Malaysian populace with higher price ND most likely inferior products. Iii While most arguments against protectionist policies for infant industries relate to manufacturing, there is a growing tide of sentiment of protection for service Jobs as well. While these do not represent pure infant industry examples, the same issue of negative overall social benefit remains true. Lower priced resources can be used to complete the same low level and mid level service functions such as call centers and basic graphic design in foreign countries as in the developed countries. Leached 2004) This shift may also lead countries towards “protecting” their service industries, Hough claiming development under the infant industry argument will be seen as far fetched. Further examples of this sentiment have been echoed by former Federal Reserve Chairman Alan Greenshank, as he stated that protectionist cures would only make matters worse in terms of stemming the tide of service outsourcing. Xiv Countries will be able to trade what they produce most efficiently for goods that they would produce inefficiently.

As an industry or agricultural process becomes more efficient, prices can be lowered and more can be produced and therefore more social benefit realized by trading. Our in class example clearly showed how both countries can benefit from trade even if one country has an absolute advantage over the other. Protectionism merely causes the social loss already illustrated. Arguments for Infant Industry Protection Brief Background While laissez fairer policies are seen by the developing world as the best way for a country to benefit from the global economy, there are many critics of these policies and those who argue for infant industry protection.

Throughout history, even countries that dominate the global economic landscape have used tariffs and other assures to protect their infant or simply domestic industries from foreign competition. Therefore it is unreasonable to expect that a developing country in today’s interconnected global economy will be able to develop any significant advanced technological enterprise without the benefit of infant industry protectionist policies. The protection of these industries is done not solely for the present benefit, but is adopted to ensure the industries existence far into the future and some level of economic security for the country.

One such analogy of this idea is put forth by List, as he describes the planting of a pear tree. He states that one would not forgo the planting of a pear tree simply because one could purchase the pears now from some foreign supplier. The planting of the tree and subsequent harvesting are Further, the perfect competition between industries that are already developed can create a marked imbalance between the rich and poor countries- those with the economic clout can dictate policies for their own benefit.

A Historical Perspective While much of the developed world calls for trade liberalizing and open markets, many of these countries have been able to develop the strong industries they have today because they protected their fledgling industries from international competition. The economic world powers of the past century, especially Britain and the United States used “interventionist industrial, trade, and technology policies that are aimed at promoting infant industries during their catch up periods. Xvi In the United States, Alexander Hamilton set out the initial framework for protecting manufacturing. He proposed tariffs and in some cases import quotas in order to develop the infant industries. Even Adam Smith warned that the US should they adopt protectionist policies that the value of US output would be severely retarded. Change 2002) These protectionist policies even created internal friction within the US leading up to the US Civil War. Protectionist measures persisted in the US until the early sass’s when there was some lowering of tariffs and trade liberalizing as well.

The two World Wars saw the rise of more protectionism. Only in the post World War II period where the US had established both military and economic superiority, did the US relax some of its trade restrictions. (Change 2002) Tariff protection is not the only mechanism used by the US to protect its domestic industries, infant or not. Other forms of protection include voluntary export restraints, quotas on textiles and protection and subsidies for agriculture.

It is interesting to note that the textile industry is still under some form of protection, the multi fiber agreement. (Change 2002) Another position pointed out by Brooch , (1993) shows that the US had the fastest growing economy in the world from the nineteenth century up to the sass’s even though it had some of the highest tariffs in the world. Change concludes that without certain infant industry protections, the US economy would not have industrialized and remained largely based on agriculture.

Further, the newest industries, especially those based on technology and pharmaceuticals are largely supported by the US governments R&D program. (Change 2002) It can also be highlighted, that while Great Britain was one of the first countries to truly eliminate its very stiff tariff structure, though it only did this after it became a world economic leader. Until the sass’s, Britain was an importer of technology from the European continent principally the Netherlands. Its first industry was the export of raw wool and some “IoW’ technology wool products.

It is widely held that with the genealogical lead the Dutch had over Britain that if they had not protected their fledgling wool producing industry, it never would have flourished. At one point, when Britain’s wool industry had gained some scale through tariff protectionist measures, it pulled the ultimate checkmate, banning export of raw wool, virtually eliminating the emphasized here is the fact that the wool industry provided half of the export revenue of Britain at the time and without these protectionist policies in place, would never have allowed the British to grow as fast as it did.

Current Trends in Infant Industry Protection vs.. Trade Liberalizing The arguments for infant industry protection are many. A few that bear examination relate to a country’s need to develop beyond the basic industries of agriculture and raw materials. Countries that produce only agricultural products or export only raw materials can be deemed at the mercy of the far more technologically developed country. It has been argued that “the real wealth off nation lies in its scientific and manufacturing stock” as opposed to its natural resources. Perpetrate, Elliot 1996) This argument states that the real gain in protecting the infant industry is twofold. First the country gains by developing a technology that it does not have and can reasonably establish and second, the “beneficial” collateral industries that support the infant industry will also help to increase the nations stock of technology and manufacturing capacity. In the first instance, many of the arguments for infant industry protection, is their development is done in the interest of national security.

Industries in many countries are protected by their governments in order to maintain the ability to defend the sovereign nation from foreign attacks. This argument has been used to rotten the US aviation industry from foreign competition as well as other heavy industries that have military defense related ties. A furthering of this argument can also be stated that if a nations goal is to develop technologically and not be at the mercy of a powerful neighbor, it can and should develop with protection if necessary many different industries.

This extension Justified in Cancellation’s work as he states that the defense of a nation is the necessary development of industries that it is self sustaining, calling this the “natural” state of affairs in the world. (Perpetrate, Elliot 996) Since all countries are striving for this independence of sorts, there is clear justification for protection of these industries. The secondary collateral effect has been labeled the “learning by doing model”. (Emilie 2004) Even Adam Smith recognized that as the infant industries mature and improves; the developed technology eventually influences and bolsters other sectors of the economy.

The learning process creates a virtuous cycle, eventually leading to the ability of these firms to compete without protection. (Perpetrate, Elliot 1996) Infant Industry Protection- review of various countries policies regarding protectionism Two countries that provide contrasting success of free trade versus protectionism are Vietnam and Mexico. Mexico sits at the doorstep to the richest country in the world in terms of economic might and has had a free trade agreement with the US for over a decade.

Mexico generally trades quite freely with the US and should be growing a great pace since the liberalizing of trade with the US and Canada under NONFAT. Barely above 1% and real wages have fallen. Xvii Another more recent development is the massive imports of cheap goods from Asia that are supplanting the domestic production of goods such as shoes and tableware. Even in the local markets, stall vendors are selling goods made in China and other Asian countries in lieu of locally produced goods. Viii While free trade has not vaulted the Mexican economy into high gear, one can also wonder what it would be like without any free trade agreements in place. Other Latin American countries that have adopted free trade policies have also shown wild swings in economic performance such as Argentina and Chile. Another country, notably Senegal also liberalized their trade policies prematurely and saw their domestic industries wiped out by foreign competition. Elliot 2005) Senegal is a third world country that is debt in foreign debt with very little domestic industry.

If Senegal were allowed to protect its domestic industry and develop imports based on the production of goods rather than commodities and agricultural products, it may be able to create a knowledge base and foster other more advanced industries. Xix The selling off of Senegal natural resources and public and private industry to foreign multinational companies in the name of free trade and poverty reduction does little to establish a foundation on which to build industry. Elliot 2003) Vietnam on the other hand has been isolated from the US market since the sass’s and has been the subject of many trade restrictions as well.

Unlike Mexico, which has the geographic fortune of being next to the US, Vietnam has focused on developing their domestic export industries and as such, has seen per capital income grow by greater than 5%. (Elliot 2005) Vietnam followed the model much like Taiwan and South Korea, focusing their energies on the right domestic policies that would eventually lead to the ability to compete internationally. China has also followed a al strategy of developing it internal industries for export using protective policies.

Two of the greater success stories in Asia in terms of economic development are certainly Taiwan and South Korea. It has been widely documented that neither of these two nations developed their domestic industries using any free trade practices. Instead these countries focused “on land reform, the protection and funding of key industries and the active promotion of exports by the state”. Xx Only after their domestic industries were healthy enough to compete on the world economic scene n their own were foreign competitors allowed in and protectionist measures eased.

Economic Model for Illustrating Social Welfare of Infant Industry Protection A brief discussion is warranted describing the tools available for analyzing the impact of adopting infant industry. Economists have used the Mills-Passable Test to describe the impact of adopting protectionist measures in order to develop a successful infant industry. The positive outcome of the test depends on industries learning potential, the speed of learning and the degree to which goods are