Should Developing-Country Governments Use Tariffs to Jump-start Growth? Season 9 of international trade economic analysis of globalization and policy book by john mclaren

1. Season 9
INTERNATIONAL TRADE
ECONOMIC ANALYSIS OF
GLOBALIZATION AND POLICY
Should Developing-Country
Governments Use Tariffs
to Jump-start Growth?
‫امللل‬‫بین‬‫تجارت‬
‫میرزایی‬ ‫دکتر‬ ‫آقای‬
‫ان‬‫ر‬‫مازند‬ ‫دانشگاه‬
‫ی‬‫گردشگر‬ ‫گروه‬
‫منش‬‫جوان‬‫سیاوش‬
‫بهار‬97

2.  In its early days. the U.S. textile industry was
incubated behind a high tariff wall, as were
many industries in today's affluent economies
during their early industrial growth. Was this
protectionism a help or hindrance? And
should today's developing economies follow
the same strategy?

3. Neoliberal economists claim
rich countries got that way by
removing their barriers to trade.

4. The industrial revolution was built
on protectionism .... Between 1864
and 1913 [the United States] was
the most heavily protected nation
on earth, and the fastest-growing. It
wasn't until after the second world
war, when it had already become
top dog, that it dropped most of its
tariffs.

5. The same strategy was followed by
Japan, South Korea, Taiwan and
almost every other country that is
rich today ....
Protectionism, which can be easily
exploited by corrupt elites,
does not always deliver wealth; but
development is much harder
without it. (Monbiot, 2008)

6. temporary import tariffs
can be an effective way
of starting economic
growth.
This is an extremely common-and extremely contentious-view
among watchers of economic development and is indeed common
enough to have its own name:
the infant-industry argument for
protection

7. It implies that pressure by rich-
country governments to convince
the low-income countries to open
up their markets to trade could in
fact condemn millions of people to
a future of unrelenting poverty,
while judicious use of tariffs could
be the silver bullet that would
break the curse of poverty.

8. Our Path here …
 The Infant-Industry Argument: Background
 Reseans:
 Learning by Doing: An Insufficient Argument
 Market-Failure Arguments for Infant-Industry
Protection
 What Has Actually Happened?

9. The Infant-Industry Argument
Temporary protection of an industry
in which a country does not
currently have a comparative
advantage, in the hopes that it will
thereby gain a comparative
advantage in it over time.

10. Infant-industry protection is a
commonly used strategy in countries
whose governments are trying to
promote industrialization.
It is a key component of import-
substituting industrialization (ISI), a
strategy of aggressive import
restrictions designed to jump-start
industrial growth by replacing imported
manufactures with domestically
produced manufactures.

11.  These strategies became very popular in
middle- and lower-income countries after the
Second World War
 They have always been controversial, and
many governments moved away from them in
waves of trade liberalization in the1980s and
1990s as frustration over the growth
performance of ISI economies grew

12.  The emerging majority view among
economists was formulated by Anne Krueger
(1981) as a call for "export-led growth," with
unrestricted imports and exports encouraged
or even subsidized, in contrast to growth
based on import substitution

13. Argentina provides a clear
example
 Under Juan Peron in the 1940s,
 Argentina was a pioneer in ISI (import-
substituting industrialization) techniques
 and the government imposed steep tariffs on
a wide range of manufactures in order to
support domestic industry.

14. Argentinian manufacturing tariffs
from 1974 to 2001

15.  In the 1970s,
 not only were manufacturing tariffs high
overall (with a median around 80%)
 but tariffs varied greatly
 targeted industries receiving protection
 above 200%, while the least favored received
a tariff close to 50%.

16. This is a
hallmark of an ISI policy: Tariffs
were used aggressively to
promote particular
targeted industries to which the
government gave a high priority

17.  Argentina has changed dramatically, with the
median,
 highest, and lowest tariffs all dropping, and
the range of tariffs becoming much
 more compressed
 This pattern is similar to the tariff history of
 a great many Latin American countries.

18. A contrasting example is provided
by Singapore and Hong Kong,
two East
Asian island economies with
similar trajectories but very
different policy

20.  As of the end of the Second World War, both
economies were very poor, but over the
following three decades, both experienced
spectacular, unimaginable growth, as shown
in Figure 9.2: From 1960 to 1980, real per
capita GDP grew by a factor of 11 in Hong
Kong and 8 in Singapore. This growth
transformed both countries into prosperous
economic powerhouses in a single generation

21.  Although both are exceptionally open
economies (and both are often used as
examples of export-led growth), Singapore
used a strategy of infantindustry protection as
a central part of its strategy during the 1960s,
1970s, and 1980s

22. Singapore
 The government would identify an industry for
targeting and then provide that industry with
huge assistance in the form of a high tariff
wall, tax breaks, and subsidized credit, all
temporary
 After a few years, a different set of industries
would be identified as targets, and incentives
and protection would move on to those new
industries

23. Homg Kong
 By contrast, Hong Kong, governed during this
period by the British colonial governor,
followed a policy of almost unalloyed free
trade with no government intervention to favor
one industry over another

24.  Young (1992) describes the Hong Kong
development approach as "minimalist" and the
Singaporean approach as "maximalist.“
 The difference can be seen in the rate of industrial
transformation in the two economies: The shares
of the economy accounted for by different
industries changed in Singapore at a dramatically
more rapid rate compared with Hong Kong.

25.  We thus have three different economies with
very different experiences: one (Argentina)
that used infant-industry protection in an ISi
strategy with modest growth results; another
(Singapore) that used infant-industry
protection in an export-promoting strategy
with breathtaking results; and a third (Hong
Kong) that followed free trade with
spectacular success.

26.  The question arises: Is infant-industry protection ever a
good idea? Is it possible that that is what led to
Singapore's success? Is it possible that it led to
Argentina's slower growth? We will look at the main
theoretical arguments, first at the most common
argument for infant-industry protection (learning by
doing), which we will see is not a convincing argument
on its own, and then at arguments based on market
failures (credit-market failures and learning spillovers),
which can be sufficient but come with qualifications and
caveats. In doing so, we will fill out the last branch in
our family tree of trade models. Finally, we will look
briefly at the evidence.

27. Learning by Doing: An Insufficient
Argument
 The most commonly cited reason for infant-
industry protection is learning by Doing that
results from performing that activity over time
 why not use a tariff to help fledgling DRAM
chip makers survive, until they have become
productive enough to withstand international
competition?

28. logic of this idea with a simple
model of Radio and Jeans …
 The point is that, although the learning-by-
doing job offers higher long-run income, that
is not enough to conclude that it is the job that
the worker will choose, or should choose,
because the long-run benefit needs to be
weighed against the up-front losses from the
initial low productivity

29. two logical
errors that creep into discussions
of infant-industry policies
 First, even if an economy has a potential long-
run comparative advantage in an industry
because of learning by doing, it is not
necessarily desirable to exploit that If the
future is sufficiently discounted or the
learning is sufficiently slow, it will not be
desirable to do so.

30. two logical
errors that creep into discussions
of infant-industry policies
 Second, even if an economy has a current static
comparative disadvantage in the learning-by
doing sector (as here, with the marginal product of
labor in radios actually equal to zero at the start),
there is no reason to assume that workers and
entrepreneurs will not enter the sector and begin
to acquire experience.
 Learning by doing does not imply that workers
and firms will not be able to make the right
decision; it merely implies a dynamic model, and it
requires dynamic thinking.

31. Example …
 Now, suppose that the government imposes an import
tariff on radios, say, for five years, and explains as it
does so that this is just until the radio industry gets on
its feet.
 Such a tariff would raise the domestic price of radios as
long as it is in effect, thus raising the local piece rate on
radios. A high enough increase in this piece rate would
then raise the PDV of income in the radio job above
that of the blue jeans
 job, causing the worker to switch to the radio industry,
along with all
 other workers in similar situations.

32. However, is it beneficial?
Infant-industry protection would indeed "work," given that its
purpose was
to get a nascent radio industry going and keep it going until
it can stand up to
international competition

33.  Since the PDV of a country's consumption
must be equal to the PDV of its production
because of consumers' intertemporal budget
constraints, we conclude that the tariff
reduces the PDV of national consumption. It
also creates a consumption distortion, as in
Chapter 7, because consumers face distorted
domestic prices when making their
consumption decisions.

34. Therefore, although infant-
industry protection is successful
on its own terms because it
gets the new radio industry off
the ground, it is harmful to
national welfare.

35. ‫منش‬ ‫جوان‬ ‫سیاوش‬-‫جهانگردی‬ ‫ارشد‬ ‫کارشناسی‬-‫مازندران‬ ‫دانشگاه‬1396
Market-Failure
Arguments for
Infant-Industry Protection
 Credit-Market Failures
 learning spillovers

36. Credit-Market Failures

37. Example
 If worker wants to take the radio job because
it would give her a higher PDV of income, she
might need to take out a loan to smooth out
her consumption due to the low income to
cover a few years of losses as learning by
doing proceeds.
 if the loan is not available, we may have labor
and capital stuck in the less remunerative
sector.

38.  This is a consequence of credit-market failures
and provides a possible rationale for infant-
industry policies.
 If a tariff raises the domestic price of radios during
the learning-by-doing period, that may alleviate
the need for a loan, thus leading entrepreneurs
and workers to enter the industry and profit from
it. This creates a consumer distortion by distorting
the prices consumers face, but since it corrects a
production inefficiency, it may be worth it.

39. Credit markets can fail for many
reasons: 1
 financial repression-regulations that keep
interest rates for bank lending below market-
clearing levels, and that keep banks' reserve
requirements high, which have in the past
been practiced by the governments of many
medium- and low income countries
 Financial repression, naturally, can lead to the
rationing of loans

40.  and thus to a failure of the economy to develop
learning-by-doing industries to an optimal degree
 As a result, it can lead to a case for infant-industry
protection
 However, it must be emphasized that this is a
second-best policy: If the credit market is
malfunctioning because of financial repression
policies, the first-best strategy is to remove those
policies rather than introduce a new distortion by
imposing a tariff.

41. Credit markets can fail for many
reasons: 2
 Asymmetric information
 a situation in which one party to a transaction has
information relevant to the transaction that the
other party does not have.
 lender and borrower story and interest rate
 Therefore, asymmetric information in the credit
market can lead to a coherent case for infant-
industry protection.

42. Infant-industry
protection is, by definition,
temporary assistance to the
industry.

43. Learning Spillovers

44. Example
 Now, suppose that the worker has accepted the radio job and
proceeds down the learning curve month by month as described,
learning from her mistakes as she goes along. In addition, however,
suppose that at lunch, during work breaks, and after hours, she also
describes her experiences to her coworkers,
 who thereby also learn from her mistakes. Similarly, she learns from
the experiences of her coworkers, not only at her own firm, but
through informal interactions with workers from radio assembly
operations in the area.
 In this case, each radio worker confers a positive externality on the
others: A portion of the learning achieved by each worker benefits
other workers in the same industry.
 This phenomenon is called learning spillovers and is an
important argument for infant-industry protection in its own
right.

45. Called: agglomeration
externalities, or positive
externalities from locating a
particular economic
activity close to other firms or
workers undertaking the same
activity.such as the
famous Silicon Valley of California. Fallows (2007) describes the productivity
benefits of a huge concentration of manufacturers in Shenzhen, China, the
largest manufacturing center in the Pearl River Delta, which has become
"the world's manufacturing center"

46. Exapmle
 consider what happens when we open up Home
to trade
 Suppose that Foreign is somewhat larger than
Home so that under autarky Foreign has more
workers producing radios, and therefore more
productive radio workers and a lower relative price
for radios
 Then, when the two countries are able to trade
with each other
 price of radios in Home will fall below its autarkic
value

47. Exapmle
 Home workers will be able to earn a higher
income producing blue jeans
 As a result, the radio sector in Home will
shrink
 Home radio workers will become less
productive;
 There are two possible outcomes:

48.  Case 1. The Home radio sector survives, but on a
smaller scale than it had under auta
 This will happen if Foreign is not quite large
enough to absorb the entire world radio industry
on its own rky.
 If Foreign is not too much larger than Home; these
two conditions make it possible that Foreign will
not be able to satisfy all of world demand for
radios on its own

49.  Case 2. The Home radio sector is wiped out by
competition with the radio sector in Foreign
 If Foreign is sufficiently larger than Home, the new
relative price of radios will be lower than the autarkic
price in Home
 Home workers will all benefit from trade. Here, the
spillover distortion is exacerbated by trade,
 Picture a tiny island economy that always produced its
own radios under autarky, at very high unit cost
because it was on a small scale; but with trade it can
import them cheaply from large countries that make
them on a huge scale.

50.  Thus, the outcome is that Home benefits from trade
either if it is the large country or if it is much smaller
than its trade partner.
 The implication is that there is some scope for trade
restrictions to improve Home's welfare by preventing
deindustrialization, but only in the event that the Home
economy is in the middle range of sizes consistent with
Case 1 above
 If Home is quite small, then it has a serious natural
disadvantage in the industry with increasing returns,
and its best strategy is to welcome deindustrialization
and benefit from low prices abroad

51.  There would be a role for a temporary tariff until
the learning by doing is complete, provided that
Home is small (or inexperienced in radio
production) compared to its trade partners, but not
too small or too inexperienced.
 It should be emphasized that where protection is
called for, it must be given only to the industry with
the learning-by-doing spillovers, and the problem
is muddied considerably if there are multiple such
industries

52.  In practice, learning-by-doing spillovers could
show up anywhere, in agriculture or in
manufacturing, and in any manufacturing
industry. Knowing where those spillovers are
is a very serious informational constraint on
the use of infant-industry policy.

53. What Has Actually
Happened?

54.  trade protection as a strategy of industrial
development, but it needs to be made
carefully and it depends on special conditions-
particular forms of market failure, particular
values of parameters, and so on-that may or
may not be satisfied in practice.
 We cannot say as a matter of theory whether
or not this use of trade policy will help spur
growth

55.  Head (1994) studied the use of this strategy in the steel rail
industry. Steel rails were crucial to the expansion of ailroads,
and the U.S. steelrail industry had a disadvantage against the
more experienced British industry.
 The U.S. government employed high and temporary tariffs to get
U.S. industryup to speed, and for the last quarter of the
nineteenth century U.S. steel-rail tariffs were well above 50%,
even approaching 100% for a time. After the turn of the twentieth
century, with the U.S. industry well established, the tariffs fell and
eventually were eliminated.
 He found that, taking the consumer distortions into account the
tariff had a positive but very small effect on U.S. welfare

56.  Another way of investigating this question is to
collect data on growth rates across countries over
time together with data on each country's trade
restrictions
 difficulties in practice. First, a country's degree of
trade restrictiveness is difficult to measure:
average tariffs,
 Furthermore, for many countries quantitative
barriers (such as quotas) are more important than
tariffs, but it is much more difficult to measure
their restrictiveness than it is for a tariff

57.  When two of the most successful economies in the
world are found to have pursued almost opposite policy
strategies, and two different economies that used
targeted protection (in very different ways) are found to
have extremely different success rates, it should not be
surprising that the data do not provide a simple story
about one policy as a recipe for success and the other
as a path to failure.
 the most important thing a country can do to pave the
way for long-run growth is to develop high-quality
political and economic institutions; trade policy is far
less important.

58. The message is that no trade
strategy-not infant industry
protection, not
free trade, not export
promotion-appears to be either
a silver bullet that
solves the growth problem or
an insurmountable obstacle to
growth.