The Modern World Economy - Essay Example

The modern world economy The infant industry argument claims that in certain circumstances government support for an industry may be justified on a temporary basis to permit it to mature to the position where it can stand on its own feet. The gist of the argument is that the present (static) cost of protection is accepted for the sake of future (dynamic) benefits, where under protection, the infant will experience faster productivity growth and could eventually compete in the domestic and world market (Kiggundu, 2002, p. 114). The experience of West Germany, the United States, Japan and South Korea suggests that governmental support in promoting infant industries did assist efficient industrialisation processes to some extent. However, the experiences of other countries, mainly the developing countries, seem to suggest that protection policy has been frequently abused. Therefore, it is not surprising to find a large body of literature which exhibits considerable scepticism concerning the success of infant industry protection in developing countries. The effective rate of protection has been high for most import-competing industries for a long time and export performance has been poor, with most of them being orientated towards the domestic market. This implies that no sequencing from into exports has taken place and protection in most cases has been given indefinitely. One of the major reasons for the apparent failure of the IS (import substitution) part of industrialisation strategy is because IS and EP (export promotion) strategies have not been linked together. As a result of this, IS industries continue to produce for domestic markets with no incentive to produce for overseas markets. Recent writings in the theory of international trade suggest that IS and EP industrial strategies are not mutually exclusive. For example, Krueger (1995, p. 207) have argued that these two strategies are sequential rather than being alternatives and they can be compatible rather than separate strategies. They have further asserted that IS is needed not only for creating export ability, but also for providing the volume basis necessary for competitive exportation. Indeed, this is the core of the infant industry argument. Empirically this view has been supported by South Koreas success in its policy of pursuing both EP and IS strategies simultaneously (Trebilcock, 1990, p. 92). However, IS and EP are not necessarily seen as complementary in all countries; and may also not be sequential either. Evidence from many developing countries has shown that EP and IS have been separate strategies. A good example is the Malaysian industrialisation experience. The problem is, not only has there been no sequencing of import substitution and exports, but EP and IS strategies have been treated as separate strategies. The separation of IS and EP strategies has been an obstacle to the efficient development of the Malaysian manufacturing sector. Protected infant industries in Malaysia seem to produce almost entirely for the small domestic market and are therefore isolated from competitive global business (Alavi, 1996, p. 24). The separation of IS and EP and the existence of high and restrictive trade controls (with their indiscriminate and almost permanent protection) in many developing countries has been used as evidence against infant industry protection or import-substituting industry (ISI) strategy. But this is a biased and prejudiced view. The failure of many import-competing industries in developing countries should not be used as an argument against ISI strategy or protection policy. This is because protection policy, like any powerful instrument, can be used either effectively or ineffectively and there is evidence which shows that protection does not necessarily suppress the performance of import-competing (infant) industries. Recent literature on East Asian economic success, particularly written in the late 1980s and in the 1990s, provides supportive evidence of successful implementation of IS strategy. These studies have shown that the East Asian economies have successfully practised selective import controls, where most of their import-competing industries experienced rapid penetration into the world markets. The study by the World Bank, The East Asian Miracle, also acknowledges this fact by emphasising that selective promotion to firms (infants) was limited for a time and subject to export performance (cited in Gianturco, 2001, p. 24). In this case, infants were not just promoted but they were forced to grow up – to be internationally competitive, and their performance was under strict scrutiny, where failure meant penalties and withdrawal of advantages. This demonstrates that IS strategy can be successful and useful in developing and creating exporters, and that it is the management of protection policy which matters in ensuring the success. Thus, IS and EP can be complementary and sequential with proper management of industrial policy. Due to the apparent failure of IS strategy, there has been increasing pressure from the World Trade Organisation (WTO, formerly GATT) and many regional trade groupings for discontinuation and termination of protective barriers provided to the ISIs. The rationale of this move is, liberalisation would sharpen the competitive edge of ISIs and position them to be better able to exploit emerging global business opportunities. Countries, which continue to protect the domestic industries, were threatened with the risk of falling behind world competitors. The argument goes on that protecting infant industries will merely enable their competitors to strengthen their capabilities and pull further ahead (Chalmers, 1993, p. 40). In theory, the case for free trade is undebatable, given the assumptions of perfect competition. However, market failures are prevalent, significant uncertainties are involved in trading, varying learning costs are incurred over time, and many other factors may distort the economic welfare effects of free-trade policy as suggested in theory. There is no clear empirical evidence showing the advantages of free trade. Given the unclear and unestablished evidence of the advantages of free trade, moves towards a rapid and sudden trade liberalisation may have a detrimental effect on the ISIs (Belderbos, 1997, p. 80). There are many import-competing firms and industries in developing countries which can compete given time and support; but they may not be ready for full international competition. There is evidence that trade liberalisation has been introduced too rapidly in some countries and may have destroyed potentially viable manufacturing capacity, i.e. in Africa and Latin America under the structural programmes (ibid.). This, however, does not mean to suggest that protection should be given for an indefinite period of time. What is required is to develop and push these viable import-competing industries to become international competitors through domestic trade protection. Certainly, protection has to be reduced gradually and eliminated ultimately, but it should not be done without proper planning or in haste. The protected industries must be ready to face harsh and intense competition in the global markets. What is needed is to exercise, manipulate and manage protection policy to create international competitors. In the long run, developing ISIs to be internationally competitive is the only efficient way of integrating IS and EP strategy. Serious moves towards liberalisation at the global level and awareness of the fact that there are many industries not performing well in a protective environment, provides a clear direction for the future of ISIs. The only way to survive is to become internationally competitive through learning, technological and human resource development, and improving marketing strategy. This means a study on the impact of protection policy on the dynamic performance (over time) of ISIs is crucial. This requires not only studies of effective rates of protection levels, but what goes on behind the protective barriers – their dynamic performance (Hope & Maeleng, 1998, p. 70). Detailed evaluation of their performance in terms of achieving international competitiveness and productivity growth is imperative because the South Korean experience shows that constant evaluation and monitoring is the key to their successful implementation of protection policy. There are various studies which assess the implications of export-promotion versus import-substitution strategies in developing countries. Balassa (1978) summarises a large World Bank project that focused on eleven countries – Argentina, Brazil, Chile, Colombia, Mexico, Israel, Yugoslavia, India, South Korea, Singapore and Taiwan – for the period 1960–73 (cited in Krueger 1995, p. 110). First, he analysed whether export incentives fostered export growth, and in the second stage he investigated the effects of an expansion of exports and output growth. In the first stage of the analysis, Balassa makes use of two proxies for quantifying export incentives: the rate of growth of manufacturing exports and the change in the export– output ratio in manufacturing. He found that these variables were consistently higher in those countries that followed sustained export promotion policies (ibid.). However, studies on trade liberalisation programmes in Latin American countries show that export performances were not encouraging. In Chile, Argentina and Uruguay, despite the declared intention of boosting the export sector and thus moving away from an inward-looking development strategy, the real value of the exchange rate actually appreciated significantly, thus reducing the incentives to export and discouraging the production of traded as compared with non-traded goods (Chalmers, 1993, p. 56). Alavi (1996, p. 59) argued that the market liberalisation programmes of Argentina and Chile in the 1970s were intended to improve industrial efficiency and hasten the transition from ISI to industrial exporting. But the outcomes were surging consumer imports, higher unemployment, partial deindustrialisation and financial bubbles that collapsed with devastating repercussions. In contrast, the export performances of the South East Asian countries were impressive after the introduction of export promotion policy. Kiggundu (2002, p. 75) show that the share of manufactures increased dramatically in all ASEAN countries except Indonesia between 1962 and 1982. In both the Philippines and Thailand the share rose about tenfold, while in Singapore it almost doubled from an already substantial base. In Malaysia, the Philippines and Thailand the share began to rise sharply in the 1960s or early 1970s, more or less coinciding with the first sustained attempts to promote manufactured exports (ibid.). However, the significant increase in the manufactured exports in these countries consists of labour-intensive products, mainly electronics and electricals, and textiles and clothings, which are produced in the EPZs. Thus, exports were not generated from previously IS industries. Gianturco (2001, p. 17) argued that the export performance of IS industries was not significant. He argued that the sequencing from IS to exports did not materialise in developing countries, except in South Korea, despite the export promotion policy. He asserted that this is because no export targets were imposed on IS industries. He further pointed out that there were no export targets in Hong Kong, Singapore, and Taiwan, all of which had an export performance comparable to that of South Korea (Kiggundu, 2002, p. 88). And export targets hardly played a role at all in the expansion of exports in the Latin American countries, where export obligations were imposed on firms in only a few cases (such as automobiles in Mexico). There is also no evidence of such a policy in any other South East Asian countries (with the exception of the export targets on Proton – the public-owned automobile industry in Malaysia). Thus, it can be concluded that export promotion policies in developing countries, except in South Korea, did not facilitate the sequencing of IS to exports. Hence, many IS industries in developing countries remain producing for highly protected markets despite the implementation of an export promotion policy. IS a development strategy by which a technologically backward economy tries to accelerate industrial investment, primarily for the home market, through heavy reliance on government manipulation of market prices, barriers to entry and access to imports and finance. IS is viewed as a transitional strategy, to be superseded, as the industrial sector matures technologically, by a lowering of import barriers and industrial exporting. Therefore, IS and EP should be seen as a sequence and complementary to each other. References Alavi, R. (Ed.). (1996). Industrialization in Malaysia: Import Substitution and Infant Industry Performance. New York: Routledge. Belderbos, R. A. (1997). Japanese Electronics Multinationals and Strategic Trade Policies. Oxford: Clarendon Press. Chalmers, H. (1993). World Trade Policies: The Changing Panorama, 1920-1993; a Series of Contemporary Periodic Surveys. Berkeley, CA: University of California Press. Gardner, B. (1996). European Economye: Policies, Production, and Trade. New York: Routledge. Gianturco, D. E. (2001). Export Credit Agencies: The Unsung Giants of International Trade and Finance. Westport, CT: Quorum Books. Hope, E. & Maeleng, P. (Eds.). (1998). Competition and Trade Policies: Coherence or Conflict. London: Routledge. Kiggundu, M. N. (2002). Managing Globalization in Developing Countries and Transition Economies: Building Capacities for a Changing World. Westport, CT: Praeger. Krueger, A. O. (1995). Trade Policies and Developing Nations. Washington, DC: Brookings Institution. Trebilcock, M. J., Chandler, M. A., & Howse, R. (1990). Trade and Transitions: A Comparative Analysis of Adjustment Policies. London: Routledge. Read More