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© 2007 Pearson Addison-Wesley. All rights reserved Lecture 11 Infant Industry Protection.

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1 © 2007 Pearson Addison-Wesley. All rights reserved Lecture 11 Infant Industry Protection

2 Copyright © 2006 Pearson Addison-Wesley. All rights reserved Infant Industry Protection Infant industry protection occurs when a tariff in one period causes an increase in output, and therefore a reduction in future costs, sufficient to allow the firm to survive, whereas otherwise it would not. Old idea raised by Hamilton (1791), List (1856), and Mill (1909). Crucial assumption: the firm needs to earn positive profits in each period, and the intertemporal financing is not allowed.

3 Naive Form of Infant Industry Argument 1.Some newly established activities are initially high cost relative to established foreign enterprises and it requires time for them to become competitive. 2.It does not pay any individual entrepreneur to enter an infant industry at free trade prices, but, 3.The industry, if developed, would be economic enough to permit a reasonable rate of return on the initial losses; and therefore 4.The industry requires a temporary period of protection or assistance during which its costs will fall enough to permit it to survive international competition without assistance. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

4 Empirical Test Input per unit of output must fall more rapidly in more protected industries if there is to be any rational for infant industry protection. Krueger (1982) finds no such tendency over the period covered in the Turkish case. Historical example: U.S. steel rail industry (Head, 1994); India and Pakistan’s protection on manufacturing goods. CAVEAT: Protecting manufacturing does no good unless the protection itself help make industry competitive Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

5 A Current Example Protection of U.S. motorcycle industry. The tariff rate of motorcycle imported from Japan dropped in each year starting from 1982: 1983: 45% 1984: 35% 1985: 25% 1986: 15% 1987: 10% Feenstra (1989) found that the whole tariff increase was almost fully passed through to the U.S. domestic price. In other words, the terms of trade didn’t increase due to the tariff Why?

6 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. A Current Example At that moment, there is already a price war in the motorcycle market, the world price is almost close to its marginal cost. Hence, the exporter (Japan) doesn’t want to absorb partial price decrease due to the tariffs. It looks harm the U.S. welfare, but actually it protects the motorcycle industry in the U.S. since it is an infant industry.

7 Copyright © 2006 Pearson Addison-Wesley. All rights reserved. Economic Analysis Three types of marginal cost curves:  Constant M.C. (like the case of IRS)  Increasing M.C. (like the case of CRS)  Decreasing M.C. (like the infant industry) The future marginal costs are a decreasing function of current output. Krugman (1984) argues that import protection today might act as export promotion using Decreasing M.C. Example: Memory chips in the U.S. Example: European Agricultural Products.


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