Infant Industry

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Infant Industry

Governments in both developed and developing nations regularly apply the concept of infant industry to justify protective industrial and trade policy measures. The idea is that temporary support for a new branch of industry (for example, electronics, car manufacturing, or biotechnology) might be needed to help industry to grow and flourish, especially when efficient scales of production and technological skills have not yet been developed. If a young industry were exposed to foreign competition at an early stage, it is argued, it would not be able to survive. Temporary government protection in the form of subsidies, tariffs, or important quotas, then, allows an infant industry to “grow up.”

Although Alexander Hamilton (1755-1804), the first secretary of the treasury of the United States, followed this line of reasoning in his Report on the Subject of Manufactures (1791), the infant-industry argument is usually attributed to the German economist Friedrich List (1789-1846). In The National System of Political Economy ([1841] 1856, p. 378), List argued that the transition of a country’s economy from the agricultural to the industrial stage would not occur through the “natural course of things.” He recommended, therefore, that the government protect nation-specific manufacturing activities if some countries “outdistanced others in manufactures” (List [1841] 1856, p. 394). List stressed that this promotion of infant industries should build on unique national resources. Moreover, the protection should be temporary; it should stop as the infant industry matures.

International and development economists have related List’s infant-industry argument to the theory of comparative advantage. According to this view, countries should concentrate on those economic sectors in which they can produce more efficiently and cheaply than their trading partners. In theoretical terms, infant-industry protection is only legitimized until a potential comparative-advantage sector has become an actual comparative-advantage sector. Thus stated, the infant-industry argument does not conflict with the principle of comparative cost advantage. Economists have also identified other cases in which infant industries might need temporary protection. Countries that lack well-functioning capital-market institutions, such as banks and stock markets, usually have a shortage of venture capital that new industries urgently need to invest and grow. In such a case of market failure, supporting a sector in its early growth phase is justified. Moreover, whenever new industries generate social benefits for which they are not compensated (for example, a biotechnology sector contributing to the improvement of national health care), a government may reward them by offering temporary protection from foreign competition.

In all these cases, an industry should receive public assistance only if it meets two theoretical conditions. The first is that the sector must eventually be able to compete on its own. The second is that the ultimate gains of infant-industry protection for society must be large enough to compensate for the costs incurred during the period of government support. In practice, it is almost impossible to make a proper cost-benefit analysis, which explains why governments generally refer to the infant-industry argument on political rather than theoretical grounds.

MIXED RESULTS

Over the years, the infant-industry argument has persuaded many policymakers all over the globe. Indeed, the argument seems plausible and is theoretically valid under the right set of circumstances. The empirical evidence on the effectiveness of infant-industry protection is inconclusive, however; both developed and developing nations show mixed results. On the one hand, the economic history of some advanced countries suggests that protecting young industries was conducive for industrial development. The United States and Germany, for example, enjoyed high tariffs on manufacturing in the nineteenth century, while Japan benefited from import quotas until the 1970s. On the other hand, there are many examples of industries in North America and Europe (for example, the U.S. computer industry and the Swedish automobile industry) that were infants at one stage but grew and flourished without any government protection. During the 1950s and 1960s, infant-industry promotion in Latin America and Africa often took the form of import substitution, or the replacement of imported goods by products from domestic industries. In countries such as Mexico and Brazil the results of this inward-looking strategy to promote local industrial development were disappointing. In contrast, young industries in East Asian countries such as Taiwan and South Korea benefited from temporary protection, most likely because these sectors were oriented toward exports. The degree to which a country’s economic performance is due to such infant-industry strategies, however, is a matter of ongoing academic debate.

Despite its appeal to common sense, the infant-industry argument is often criticized. The crucial problem is how a government can determine in advance which industries have a potential comparative advantage for the country. In assessing opportunities for industrial growth, the state usually is no better informed than the market. In other words, it is hard for policymakers to “pick winners.” Moreover, if a government selects the wrong sector to protect, the costs to society are significant: The infant industry will use the support to expand its capacity but will require continued protection for its survival because no real comparative advantage can be developed. Instead of growing up, the industry will keep producing inefficiently and will become dependent on state assistance. In this case, a policy change is difficult since the infant industry has a vested interest and will fight to stay protected. Telling examples of protective strategies that turned out to be policies of “backing losers” are the British policy toward car manufacturing in the 1970s and the promotion of French microelectronics during the 1980s. In both cases sound economic reasons to stop protection were overridden by political desires to keep the “national champions” alive. Another problem with the infant-industry argument as applied by policymakers follows from historical evidence that countries tend to support similar growth industries during a given period of time. Since the end of the 1990s, for example, most advanced economies have treated their domestic information-technology sector as a growth industry. Hamilton and List, the pioneers of the infant-industry concept, already noted that such a bandwagon effect in industrial policy is inefficient from an economic perspective. After all, national comparative advantage comes from being different, not from doing the same as others do.