Many developing countries support new industries by providing high levels of protection to insure economic efficiency. Sceptics have questioned whether this would yield benefits for the industry and the economy. They also questioned the prospect of various dynamic factors and externalities that have to be met first to justify infant industry intervention.
The Infant Industry Argument
The conditions under which the infant industry argument is valid include the following:
· Some newly established activities have high initial costs compared to established foreign enterprises and it requires time for them to become competitive. High costs may be due to “learning by doing” (i.e. training costs, shake-down periods, etc.) and the possibility of linkages between industries.
· It does not pay any single entrepreneur to enter an infant industry at free trade prices. While costs will decline, the individuals starting the activity will not reap the full rewards. There must be positive externalities which go to to individuals other than those undertaking the activity initially.
· When it is fully developed, the industry would be economic enough to permit a reasonable rate of return. The losses and the costs for production during the initial phase of the activity must decline and be recovered at a later date.
· The industry only requires a temporary period of assistance or protection during which its costs will be lower to survive international competition. Analysts have agreed that if the first three conditions are met, assistance to the externality-generating activity can be given.
For the infant industry to be empirically valid, costs in assisted or protected industries should have fallen over time faster than costs from nonprotected ones.
Empirical test
An industry’s costs per unit of output can change relative to another’s costs per unit of output when: share-weighted inputs per unit falls more than the other’s share-weighted inputs per unit, or when relative price of the factor it intensively uses declines.
For infant industry considerations to have warranted intervention on a particular industry, cost per unit of output must have fallen in that industry than in another industry. A necessary condition for this is that inputs per unit of output must decrease more rapidly in this industry. This reduction could come about because of technical change, the overcoming of indivisibilities, the realization of scale economies, or genuine infant industry reasons.
Dynamic factors will warrant intervention if a particular industry has been protected on infant industry grounds and its costs have fallen relative to another industry. Passing the test is a necessary but not a sufficient condition since the industry might have developed anyway; the rewards may all have gone to the entrepreneurs in the industry; the reduction in costs might have come for other reasons; or the reduction in costs was not sufficient to provide an adequate rate of return on earlier losses.
Two issues must be tackled before proceeding to the empirical results:
· The time period over which infant industry considerations warrant intervention.
· The range of activities over which the test is carried out.
For the first issue, all that is required s a long period so that, if cost reductions were not incurred, it could be concluded that the cost of protection will not be recovered anymore. Since the data that was utilized lasted for 13 years, it should be noted that with a real rate of return of 10%, the present value of cost savings ten years hence is less than 40% of the anticipated amount.
For the second issue, since protection is granted at different rates for different industries, it seems natural to suppose that the relevant activities to contrast would be different industries subject to different levels of protection. As benefits seem to be external for the firm but internal to the industry, rates of growth of output per unit of input should be higher for the industry than for new firms. However, it is also possible that externalities spread across entrants, and do not affect traditional firms within industries. In this case, output per unit of input will grow faster in newly established firms than in in pre-existing ones. Both of these relationships indicate that the unit of externalities to be recaptured is somewhere within a given, protected industry. If the relevant source of externalities is the entire industrial sector, the sector as a whole should be observed.
Results
Data from Turkey was used in estimation as protection in this country became automatic when authorities prohibited imports of any good once production began. Two sets of estimates are available: one from a sample of 92 firms and another for two-digit manufacturing industries in the private sector of the Turkish economy. The main thrust of the import substitution was during the early and mid-1960’s. Estimates were generated for three separate inputs: labor, capital, and material inputs.
Three different estimates of sectoral protection were generated. The first is based on sectoral averages; the second is based on input-output tariff data adjusted for the estimated additional protection accorded by import quotas and prohibitions; and the third consists of domestic resource-cost estimates from sample firms. This variability is due to the fact that an import-licensing regime inherently provides different levels of protection to the same industry at different points in time. There are also import-substitution industries within traditional sectors, and traditional activities within import-substitution sectors.
The three sets of estimates provide evidence of the height of protection in the 1960’s and its difference across industries. Import-substitution sectors were encouraged and were given supporting policies on infant industry grounds. The positive rate of protection for traditional sectors did little more than offset the currency overvaluation during this period.
No systematic tendency was observed for more-protected firms or industries to have higher growth of output per unit of input than less-protected ones. There is also no tendency for new activities to have experienced rates of growth of output per unit of input systematically higher or lower than the industry to which they belong. Hence, the externality argument does not seem borne out by the data.
To see whether externalities could be realized elsewhere in the manufacturing sector, the estimated rate of growth of output per unit of input in the manufacturing sector as a whole must be evaluated. This involves comparing the rate in Turkey with that in other countries. This is hazardous because data are not comparable but despite this, it hardly seems plausible that differences in measurement account for the lower figure in Turkey.
Protected Turkish industries did not experience rapid increases of output per unit on input. This shows that protection was not warranted. However, it does not prove that there are no infant industries. It is possible that trade regime provided the wrong incentives and rapid growth could have been possible under an alternative incentive structure. What is clear is that for the Turkish case, protection did not provide the growth in output per unit of input on which infant industries base their claim for protection.
Source:
Krueger, Anne and Baran Tuncer, “An Empirical Test of the Infant Industry Argument.” American Economic Review (December 1982), Volume 72, Number 5, pp. 1142-1152.
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