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What’s it? The infant industry argument is an economic rationale used in international trade to justify trade protectionism. The idea behind this argument is that a new domestic industry is vulnerable to competition from established players in the international trade arena. It requires protection from these international competitors until it matures, stabilizes, and develops stronger competitiveness.
This argument becomes one of the reasons to justify trade protection measures aimed at shielding the domestic economy’s interests. New industries may be strategic for national security, job creation, and for fostering the development of other domestic industries involved in the same value chain.
Protection can take many forms. The government can impose import tariffs, quotas, subsidies, or other trade barriers to limit competition from international imports. That way, the pressure on the new industry due to imported goods is relatively minimal. This, in turn, creates a favorable growing environment for the new industry to develop within the domestic market.
Reasons behind the infant industry argument
Alexander Hamilton introduced this argument for the first time in 1791. He argued about the need to protect American industry from the invasion of imported goods from England.
Friedrich List later developed his thinking through his book The National System of Political Economy in 1841. He tried to help in formulating and comprehensively reviewing this argument.
Characteristics of infant industries
Not yet established market demand: Infant industries are in the early stages of development, and consumer demand for their products or services may not be fully established. While there’s potential for future growth, current demand might be limited. This can be due to several factors:
- Lack of consumer awareness: Consumers may not be familiar with the product or its benefits.
- Limited product availability: Production capacity may be low, restricting product availability to a small portion of the market.
- High initial prices: Due to inefficiencies, infant industries often have higher production costs, leading to pricier products that some consumers might not be willing or able to afford.
Production inefficiencies: Infant industries haven’t yet achieved economies of scale, which means they produce at a smaller volume. This results in higher production costs per unit compared to established competitors. Here’s why:
- Limited production capacity: New industries may have smaller factories or less advanced technology, hindering efficient production.
- Lack of skilled labor: They might lack a skilled workforce experienced in optimizing production processes.
- Limited access to resources: Negotiating power with suppliers might be lower, leading to higher costs for raw materials or components.
Vulnerability to external competition: Established foreign competitors in the same industry likely have a significant advantage over infant industries. This vulnerability stems from the infant industry’s inefficiencies:
- Lower production costs: Established competitors benefit from economies of scale, allowing them to offer lower prices.
- Brand recognition: Consumers may be more familiar with established brands, making it harder for the infant industry to compete.
- Advanced technology: Established competitors may have more advanced technology and production processes, leading to higher quality or more features in their products.
Low competitiveness: Due to the above limitations, infant industries generally struggle to compete effectively in the international market. They may not be able to match the prices, quality, or features offered by established foreign competitors. This makes it difficult for them to gain market share and grow their businesses.
In essence, infant industries are like seedlings. They have the potential to become strong and productive, but they need time, nurturing, and protection from harsh elements to reach their full potential.
Potential benefits of protection
The infant industry argument centers on protecting new, strategically important industries. However, implementing such protection can lead to various broader benefits for the domestic economy. Here’s a breakdown of the potential advantages:
Stimulating and diversifying domestic production: Protection can encourage the development of new industries within a country’s borders. This reduces reliance on imports and fosters a more diversified domestic production base. A diversified economy is less vulnerable to external shocks and fluctuations in global markets.
Creating domestic jobs: As infant industries grow due to protection, they create new job opportunities for domestic workers. This can contribute to lower unemployment rates and increased economic activity.
Protecting national security: Some infant industries may be strategically important for national security. For example, industries producing defense equipment or essential technology might be crucial for a country’s self-reliance in times of conflict. Protection helps ensure these industries can develop domestically and reduce dependence on foreign sources.
Reducing dependence on foreign production: Protection can help a country lessen its reliance on imported goods. This reduces the vulnerability to fluctuations in foreign prices and potential supply chain disruptions. Additionally, it encourages domestic innovation and production capabilities.
New source of government revenue and exports: As infant industries mature and become competitive, they can become a significant source of export revenue for the government. This can improve the country’s trade balance and generate additional tax revenue.
Encouraging domestic consumption: Protection can increase import prices, making domestically produced goods more attractive to consumers. This can shift consumer behavior towards supporting domestic businesses, further stimulating domestic production.
Preventing trade dumping: Trade dumping occurs when foreign producers sell goods in a country at a price lower than their domestic market price. Protection measures like import tariffs can help deter dumping practices and create a fairer playing field for domestic industries.
Stimulating and diversifying economic growth: The development of new industries can lead to broader economic growth. New technologies and innovations can spill over to other sectors, fostering overall economic dynamism and diversification.
It’s important to remember that these benefits are potential outcomes, and the success of the infant industry argument depends on several factors, including the effectiveness of the implemented protection measures and the industry’s ability to become competitive in the long run.
Examples of infant industry protection
The infant industry argument isn’t just theoretical. Here are some real-world examples that illustrate its potential benefits:
Many developing countries rely heavily on exporting raw materials like minerals or agricultural products. These “primary products” have a low added value, meaning they haven’t undergone significant processing or manufacturing.
Selling raw materials generates income, but it limits a country’s economic potential. Here’s why:
- Lower profits: Processed goods generally command higher prices than raw materials. Countries miss out on these additional profits when they only export unprocessed resources.
- Limited job creation: Processing raw materials often creates more jobs than simply extracting them. This can hinder job growth in developing economies.
The solution: infant industry protection can help developing countries create “downstream industries.” These industries take the raw materials and process them into higher-value products.
Palm oil industry in Indonesia
Take Indonesia as an example. The country is a major producer of palm oil, a raw material used in various products. By protecting its infant oleochemical industry, Indonesia encourages the processing of palm oil into higher-value chemicals used in pharmaceuticals, rubber, and plastics. This creates:
- More revenue: Indonesia benefits from selling finished oleochemical products instead of just raw palm oil.
- More jobs: The oleochemical industry creates jobs in processing, manufacturing, and research.
Infant industries with a broad value chain can stimulate entire ecosystems of related domestic industries. The development of Indonesia’s oleochemical industry, for instance, doesn’t just benefit oleochemical companies. It also:
- Lowers costs for other industries: Domestic manufacturers of pharmaceuticals, rubber, and plastics can now source these oleochemical inputs locally, potentially reducing production costs.
- Reduces reliance on imports: With a domestic oleochemical industry, Indonesia becomes less reliant on importing these chemicals, strengthening its economic independence.
Methods of protecting infant industries
There are several ways to protect domestic industry, three of which are:
- Import tariffs
- Import quota
- Production subsidies
Import tariffs
In the infant industry argument, the government may use import tariffs to protect domestic industries. Tariffs are essentially extra taxes placed on imported goods. They can be fixed nominal (a set dollar amount added to the price of each imported good) or a percentage of the original price (a tax calculated as a percentage of the good’s original price before import).
When tariffs apply, imported goods become more expensive in the domestic market. This discourages domestic consumers from buying them and protects domestic producers from foreign competition.
This protection is a key tool used by governments to support infant industries – new industries that are seen as having the potential for future growth but are not yet competitive with established foreign competitors. By making imports more expensive, tariffs create space in the market for domestic infant industries to grow and develop their competitive edge.
Import quota
An import quota is a limit on the quantity of goods imported for a certain period. It can take many forms. For example, the government can impose a maximum quota on the number of goods that can be imported.
Alternatively, the government could also combine quotas with import tariffs. This would limit the quantity of imports. The government would still tolerate higher imports, but with very high duties for each additional importation.
Quotas reduce supply in the domestic market. If this is not balanced with domestic production, it will push up prices.
Production subsidies
Production subsidies are financial incentives offered by the government to producers within the infant industry argument. These subsidies can be a fixed amount or a percentage of the value of the goods produced.
By lowering production costs, subsidies aim to:
- Boost competitiveness: Help infant industries compete with established foreign rivals by reducing their production costs.
- Increase output: Incentivize domestic producers to increase production volume, paving the way for economies of scale.
- Lower prices: Enable domestic producers to offer more competitive prices, attracting buyers and boosting sales.
- Accelerate growth: Speed up the process of infant industries achieving economies of scale, which can lead to long-term sustainability and competitiveness.
Production subsidies are one of several tools governments can use to support infant industries and potentially achieve the goals outlined in the infant industry argument.
Criticisms of the infant industry argument
While the infant industry argument holds promise for developing domestic economies, it’s not without its criticisms. Here are some key concerns:
Sheltered industries, lower efficiency
Protection from foreign competition can act like a crutch. Infant industries, shielded from the pressures of the global market, might become less motivated to improve efficiency and reduce production costs. This can lead to:
- Higher prices for consumers: Without the pressure to compete, infant industries might be less likely to lower prices for consumers.
- Slower innovation: A lack of competition can stifle innovation, as there is less incentive to develop new technologies or production methods.
Trade wars: tit for tat
Protectionist policies often trigger retaliation. If one country protects its infant industries, other countries might feel compelled to do the same to shield their own industries. This tit-for-tat response can escalate into trade wars, where both sides raise barriers, ultimately harming global economic growth.
The sticky embrace of protection
Once protection is implemented, it can be difficult to remove later. Industries that benefit from protection may lobby governments to keep it in place, even if the industry has matured and is no longer truly “infant.” This continued protection can:
- Distort markets: Artificial protection prevents the efficient allocation of resources, potentially hindering the growth of other sectors.
- Hinder long-term competitiveness: Overreliance on protection can make it harder for industries to compete in the global market once protection is eventually removed.
Consumers left holding the bill
Protection often leads to higher import prices. Consumers end up paying more for goods produced by infant industries, reducing their purchasing power and potentially lowering overall economic welfare.
The infant industry argument offers a potential path to economic growth, but policymakers must carefully weigh the potential benefits against these drawbacks.
