What’s it: The infant industry argument is an economic rationale for the need for trade protectionism. The idea behind this argument is that the new industry is vulnerable to competition. It requires protection from international competitors until they are mature, stable, and have stronger competitiveness.
The argument becomes one of the reasons to justify trade protection. The main objective is to protect the interests of the domestic economy. New industries may not only be strategic for national security, but also for job creation and for other national industries.
Protection can take many forms. The government can impose import tariffs, quotas, subsidies, or other trade barriers. That way, the pressure due to imported goods is relatively minimal. That, in turn, creates a favorable growing environment for the new industry.
Reasons for protecting infant industry
Alexander Hamilton introduced this argument for the first time in 1791. He argued about the need to protect industry in the United States 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.
The infant industry refers to industries that are still in the early stages of the industry life cycle. Because it is still new, the industry needs time to mature.
The infant industry usually has the following characteristics:
- Market demand is not yet solid but has bright prospects in the long term
- Production is less efficient because it has not reached economies of scale
- More vulnerable to external competitive pressures.
- Low competitiveness and not ready to compete with the same industry abroad.
As I said before, the infant industry argument’s main reason is to protect new strategic industries. However, the implementation of protection policies has broader implications. And that may be an indirect reason for protection. Among the advantages of protecting the infant industry are:
- Stimulating and diversifying domestic production.
- Creating domestic jobs.
- Protecting national security
- Reducing dependence on production from abroad
- Becoming a new source of government revenue and exports at a later date.
- Encouraging consumer goods behavior with more emphasis on domestic products
- Preventing trade dumping
- Stimulate and diversify sources of economic growth
Some developing countries may have a comparative advantage for primary-based products because they have abundant natural resources.
However, such products are of lower added value than products such as automotive, heavy equipment, or at least downstream industries from natural-based products.
As a result, the balance of payments is often unbalanced. The balance of payments position becomes vulnerable when commodity prices fall.
Such a situation encourages those countries to reduce dependence on exports of natural resources. They began to diversify the economy into sectors with added value, especially downstream industries such as natural resource-based manufacturing.
Indonesia, for example, has highly depended on exports of palm oil products. The government promotes and develops downstream industries such as oleochemicals, which have many applications in other industries ranging from soap to pharmaceuticals to increase added value.
If the downstream industry develops, Indonesia can reduce the impact of falling CPO prices on domestic exports.
At their early stage, downstream industries have to struggle to compete with foreign rivals, which is usually one step ahead in technology and competitiveness.
To support the downstream industry to grow, the government imposes barriers to entry of imported goods to not flood the domestic market. This provides an opportunity for the new industry to grow and gain strong competitiveness.
The infant industry has a wide value chain to other industries. If it develops, it also spurs other industries to develop.
Oleochemicals from palm oil, for example, are widely used in the pharmaceutical, rubber, plastics, paints, and lubricants industries. So, if the oleochemical industry develops, it will stimulate production in those other industries. They get a cheap supply of inputs from within the country. And, of course, it reduces dependence on imports and exposure to exchange rate risk.
Take another example. The government protects the e-commerce industry. Its development affects not only the retail industry, but also other industries such as manufacturing and logistics. If e-commerce develops, it will undoubtedly have a more significant impact on job creation and increasing population income.
Over time, the new industries will become more efficient, benefiting from economies of scale and economies of scope.
How to protect industrial infantry
There are several ways to protect domestic industry, three of which are:
- Import tariffs
- Import quota
- Production subsidies
The government imposes extra import duties on imported goods. Tariffs can be in the form of a fixed nominal or a percentage of the imported goods’ original price.
When tariffs apply, imported goods become more expensive when they arrive in the domestic market. That reduces the interest of domestic consumers to buy it. Apart from that, tariffs are also a source of revenue for the government.
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. The government limits the quantity of imports. The government still tolerates higher imports, but with very high duties for each additional imported.
Quotas reduce supply in the domestic market. If it is not balanced with domestic production, it will push up prices in the domestic market.
Production subsidies are payments made by the government to producers, the amount of which can be based on a specific nominal value or based on a certain percentage of the value of the goods produced.
Such subsidies reduce production costs and provide incentives for producers to increase output and achieve economies of scale.
With lower production costs, producers can sell products at lower prices. It will attract more buyers.
Lower prices spur sales volumes. It accelerates domestic producers to quickly achieve economies of scale.
Criticisms of the infant industry argument
Protectionism makes the infant industry inefficient. Due to their high dependence on government policies, these industries tend to have less incentive to be efficient and competitive.
Also, protectionism often invites reactions from other countries. Partner countries are likely to retaliate by adopting a similar policy.
Once an industry has received government protection, it is politically challenging to remove protection later. For example, It may be due to economic reasons such as the fact that the industry absorbs a lot of labor.
Protectionism reduces consumer surplus. The benefits felt by consumers are reduced because they have to pay a higher price.