Principles and Policies of Economics - Term Paper Example

INTERNATIONAL ECONOMIC Introduction This paper aims at addressing the "infant industry" argument from different perspectives. It also explains its significance in international economics and relates it to economy theory and history. Infant Industry As the word infant suggests, these industries are newly setup and can not avail the benefits of economies of scales. They can not survive open competition and would be wiped off if some sort of protection is not given to them. They need a boost to survive and come up to the mark. For example, in case of textiles, if a new industry is set up, it would have to bear the costs of setting its processes. All the old companies have been well established and have managed to cover initial costs, thus they can charge a lower price than the new company for better quality. This would lead customers to prefer the old company than the new one and thus the infant industry would be trapped in a vicious cycle and in the end would have to close down. Infant Industry Argument: Positive Aspects The infant industry argument is regarded as one of the greatest arguments of protection known. The argument claims that newly developed small firms should be granted some protection for their survival. The new firms have very little chance of competing with the already established and flourishing old firms in the developed countries that is why they require some sort of protection to enable their survival. The already established industries have more exposure to the world and have greater knowledge of the ways of production, market, labor etc and are able to sell their goods at a lower price in the international market without suffering any kind of loss, in fact for a greater profit. On the other hand, a firm producing the same product in a relatively new setup industry would not have the same production technologies available to it. The employees and the management would lack the experience and knowledge. A head on competition with the old industries, would make them a cripple and they might have to close down. Now narrowing it down to the international scenario, we see that developing countries are the ones that need the protection more. They lack the basic resources required to establish an industry and even if established they have little resources or talent to keep it thriving. Instead they become victim to the developed countries, and can not meet their standard of production, quality, expertise etc. The under developed nations lack human resources and therefore can not develop the natural ones. As the porter model suggests the availability of raw material can not give an industry a competitive edge until and unless we are able to develop and upgrade them. However the third world country lacks the modern technology and knowledge base that the developed countries possess. Therefore no matter how hard they fight, no matter what advertising policies they adopt, it is very difficult for them to come up to the mark and challenge the old firms. Thus the laws of humanity suggest that some sort of protection must be given to "infant industries" for the purpose of their survival. These protections can be given in many forms. For instance, Quotas. For many years, the textile industry of Pakistan, India and Bangladesh have been given subsidies. Also protection can be given in the form of import tariffs. With this the domestic price of the goods will rise and the imports will decrease from the rest of the world. If the prices are raised within a certain limit then the firm would be able to cover its high production costs and then remain in business. After a span of some years, these firms would acquire more experience and knowledge which in turn would lead to them being able to produce more cheaply. The firms would then do the same things that the developed country firms did and thus would be able to improve even more. So protection in simple words, gives an infant industry time to settle into the fast paced world. Furthermore since the firm's production efficiency would improve, the government would reduce the protective tariffs until such a time comes when the tariffs are totally eliminated. After this the firm would be able to compete with the firms in the developed countries on an equal footing. (Suranovic, 2002) Negative Aspects However, there are arguments against it as well. This theory is based on the assumption that after some time the infant industries would be able to take care of themselves and would generate sufficient profits. Though the question remains that if they are expected to generate excellent profits in the future then why does not private capital surge in' Why is it necessary to formulate policies' (Baumole, 1997) Many argue that, the countries making these policies are actually responsible for the prevalent environment. They say that the developed industries cease to continually try to outwit others. They have erected a wall around themselves and now have formed a supply chain not giving their raw materials to other companies to develop them. Also a discrepancy in the static and dynamic comparative advantage creates issues. The infant industry argument is based on the dynamic comparative advantages, as it focuses more on the long term. It may be quiet different from the strategies which benefit the present day. Based on the below example, I would explain the static and dynamic comparative advantage. The figure shows a production possibility curve, QQ, showing the different amounts of coffee and steel Brazil can produce. On the international price line, the optimal production point of the country is at x, where it is producing quite a large amount of coffee and a little amount of steel. However if the government comes in and shifts the production point to y, where the output of steel is greater than the output of coffee, the country will shortly be able to shift its production possibility curve to Q'Q'. The new production possibility curve allows a much greater amount of steel to be produced but only a little more of coffee. Thus, Brazil will be having dynamic comparative advantage in steel but static comparative advantage in coffee. (William R Cline, 1994) History It is said that this strategy was adopted by countries such as America and Germany during the rapid industrial development which took place before the 20th century. Both had extremely high import tariffs during the industrial revolution periods. These protected the infant industries from competition from the more advanced firms in Britain and may have been the main reason for the great economic growth which took place in both countries. It is believed that these policies was first formulated by an American Finance Minister "Alexander Hamilton" whose picture is on the $10 Bill. The US shifted to protectionism after the Anglo-American War in 1812. However, going even further back in history we find that even these policies had been motivated by ones formed in Britain by Robert Walpole during 1720s. This was industrial development programmes depending on subsidies and high tariffs. Therefore we can see that many of the great nations today have become successful only because of this protection. They seem to forget that now and have moved against tariffs, subsidies, public enterprises, regulation of foreign investment and permissive intellectual property. Both the history of rich countries and developing countries prove the fact that economic growth depends on all forms of protectionism. Without this no one can climb the ladder of success. (Chang, 2007) International Policies United States emerged as a great industrial prominence during the nineteenth and early twentieth century due to the strong tariff based policies incorporated in its economic policies. On the other hand Japan recovered from the World War II, and became the second largest economic country taking its strength from the protectionist policies. However, we can also observe some bad examples for instance by the end of cold war the Soviet Union, Eastern Europe and much of Latin America adopted the protectionist policies; but their domestic economies were not observed to improve, in fact they showed a relatively downward turn. Even though Britain adopted a free trade policy, it was incurring a heavy trade deficit during the early twentieth century. These historical experiences have now provided a base for forming economic policies. They guide us into correctly applying the infant industry argument. It showed us that trade policies can not stand alone but should be incorporated into economic policies and that a protectionist policy is not the cause of poor economic factors. It depends more on how it is implemented rather than just the implementation. Countries like United States and Japan were able to benefit from this because dynamic domestic competition existed with in them. Therefore these "infant industries" had to grow if they wanted to survive. They did not remain stagnant, the policies had given them grounds to flourishes. It was more of a push rather than embracing the industry in the arms and protecting it from the whole world. However in countries like Britain these policies were merely implemented on the basis of protection and had little to do with providing incentives for growth. If all the trading partners adopted the protectionist policies and followed them then only economic growth can be achieved. (Schaefer, 1995) Economic policies like tariffs, production subsidies, quotas and consumption taxes are used to bolster non economic objectives which are: 1. Infant Industry Protection 2. Minimum level of production 3. Minimum level of economic self sufficiency 4. Regulation of employment level Therefore we can conclude that many economic policies are formed, on the basis of protection given to infant industries, however they might be used for other purposes as well. Thus a detailed analysis of all the effects should be done before any policy is finally accepted. (Taku, 1999) Works Cited 1. Diamond model - Michael Porter. Retrieved on 15th March 2008 from http://www.valuebasedmanagement.net/methods_porter_diamond_model.html 2. William J Baumole, (1997) Economics: Principles and policies. 3. Steven M Suranovic, (2002) International trade theory and policy. Retrieved on 15th March 2008 from http://internationalecon.com/Trade/Tch100/T100-4.php 4. Encyclopedia Britannica (2008). International trade. Retrieved March 15th, 2008, from Encyclopedia Britannica Online: http://www.britannica.com/eb/article-61705 5. Ha-Joon Chang, (July 23 2007). Infant Industry Argument. Retrieved on 15th March 2008 from http://darwiniana.com/2008/02/25/the-infant-industry-argument/ 6. William R Cline (1994), International Economic policies in the 1990 7. Howard G Schaefer, (1995) International economics Trend Analysis. Retrieved on 15th March 2008 from http://books.google.com.pk/books'id=TACQEtotTgkC 8. Thomas A. Taku (1999). Frame work of industrialization in Africa. Retrieved on 15th March 2008 from http://books.google.com.pk/books'id=shbBMbm051gC 9. Harry G. Johnson, http://links.jstor.org/sici'sici=0021-9398(196807)41%3A3%3C392%3AEPTLDC%3E2.0.CO%3B2-9 10. Robert Schenk. Barriers to Trade. Retrieved on 15th March 2008 from http://ingrimayne.com/econ/International/Barriers.html Read More