Is Infant Industry in Vietnam A Good Idea - Essay Example

Infant Industry – A Good Idea? A Case Study of Vietnam Introduction Being the latest addition to the World Trade Organization (WTO), Vietnam is one of the numerous developing countries who intend to benefit from this pro-development effort. By being a part of the WTO, the country must be able to change some of its policies that is geared towards trade liberalization or also called free trade. Faced with the need to change its current economic policies as well as its present status as a developing country, Vietnam is faced with a dilemma as to whether it is willing to ease the entry of foreign investors while being able to protect its local business establishments1. International trade is deemed as one of the most essential step towards success in the global industry. It is also expected that trade liberalisation could alleviate poverty rate in the country. On the downside, there will always be an increasing demand from developed, First World countries towards excessive liberalisation of foreign imports and investment. In some cases, free trade has been helpful for China and Taiwan, albeit with some violations and tremendous criticisms. At the international forefront, it has received a tremendous setback such that the Doha trade talks had been stalled while governments block the acquisition of foreign companies2. Only a tip in of the iceberg, Vietnam is faced with the need to broaden and widen its free trade defences while maintaining its infant industry towards economic and improvement of rural development in the countryside. Infant Industry Argument Aimed at protecting an industry, or a country in this particular scenario, the infant industry is an argument claiming the need for, as well as allowing, small firms in underdeveloped or developing countries to have a protection mechanism or policies against large, well-established, and well-developed industries or countries. Because new firms, particularly in developing countries, are not yet capable to go on a head-to-head battle with well-recognised business establishments from developed countries, the infant industry argument allows a developing country to impose a protective tariff, or tax, to imported goods and products. When this occurs, imported goods are obliged to increase prices, thus making them less competitive as compared to those local businesses in developing economies. In return, local businesses are able to gain a strong footing in their local economy until such time that it could achieve a sufficient size and obtain a significant economy of scale3. It must be noted that international firms from developed countries have been in the business industry for quite some time. Other companies within the very same industry have respected their track record, thus they would have no problem adjusting their prices and cost of production to suit the needs of the locality. Furthermore, their capabilities also range from information and knowledge on the production process, as well as analysing the market capabilities, characteristics, and the labour market of the developing country. As a result, such companies are able to compete with local products at a much affordable price, but with high regard for quality4. On the other hand, firms producing the same product in a less developed country, more often than usual, do not have the equivalent capabilities to impose the same production technology as compared to the local ones. As a result, they tend to utilise greater cost of production, thus the need for a more competitive price in the market so as to regain capital and eventually give them the time to ‘grow up’ and be more efficient in producing locally produced goods. It is hoped that if local firms would be given enough time for them to grow up, the local government may be able to eventually eliminate tariffs and become of equal footing with international companies5. Infant Industry: Supply and Demand Curve6 Economically speaking, the infant industry can be explained by the demand and supply curves of a garment industry. Suppose that the supply and demand curves in the country are as shown in the adjoining diagram. Suppose initially free trade prevails and the world price of the good is P1. At that price consumers would demand D1 but the domestic supply curve is too high to warrant any production. This is the case then where domestic producers simply could not produce the product cheaply enough to compete with firms in the rest of the world. Thus the free trade level of imports would be given by the blue line segment which is equal to domestic demand, D1. Suppose that the infant industry argument is used to justify protection for this currently non-existent domestic industry. Let a specific tariff be implemented which raises the domestic price to P2. In this case the tariff would equal the difference between P2 and P1, i.e. t = P2 – P1. Notice that the increase in domestic price is sufficient to stimulate domestic production of S2. Demand would fall to D2 and imports would fall to D2 – S2 (referring to the red line segment). Through the aforementioned diagram, it is very evident that the government and the local producers are the ones who gain from this endeavour. For the producers and the local business industry, an increase in tariffs for imported goods would entail a significant increase in prices to P2 and would consequently bring about an equivalent decrease in demand to D2. With such cause and effect scenario, consumers have no choice but to make do with lower priced locally produced goods as compared to relatively higher-priced imported products. On the other hand, the government would also rightfully gain in an infant industry as high tariff rates mean more usable income and increased spending on local projects. More supply of imported goods mean more tariffs to be collected. The Downside of Infant Industry7 Despite the numerous benefits of the infant industry argument, the fact cannot be denied that the protection tit gives is likely to be a second-best policy rather than being a first-best policy. Furthermore, an increase in import tariff does not directly improve or provide solutions to any problems within the local market. Given that the government implements a production subsidy that is equivalent to the difference of P2 – P1. This enables the increase in the prices of local products by the amount of the subsidy to P2. In effect, domestic supply would rise to S2, domestic consumer prices would be maintained at P1, demand remains at D1, and imports would fall from D1 – S2. Production subsidy would also in effect cause production efficiency loss in exchange for an additional consumption efficiency loss. . If the positive dynamic gains in efficiency in subsequent periods are the same, then the production subsidy would generate the same positive stream of benefits but at a lower overall cost to the country. For this reason the production subsidy is the first best policy to choose in light of the dynamic production externality. The import tariff remains second best. Vietnam8 Being a communist country, Vietnam’s economy was, and has continued to be plagued with production inefficiency and intense corruption among various government activities. It was only in the last two decades that the country was able to encourage private ownership in its industries, commerce, and agricultural sector. From 1990 to 1997, it had achieved an 8% annual growth. The period of 2000 to 2005 Vietnam was able to maintain a 7% annual growth, thus making it the second-fastest growing economy in the world. Overall, the country is still poor, with a 2006 GDP of US$258.6 billion. With a 7.5% inflation rate, it had been observed in the recent year that public spending has increased.2 In transitioning into a market economy, Vietnam joined the World Trade Organisation (WTO) in July 2006 and was accepted in November 2006. Prior to its inclusion in the WTO, Vietnam has been very much successful in its use of the infant industry argument, from the garment industry into the iron and steel industry, as well as the recent introduction of the software industry.3 Current literature does not provide a critical and specific approach to which the country may have succeeded in the implementation of the infant industry argument, but by encouraging private ownership and increased local competition, the country has been able to rise out from high priced monopolisation of specific reigning industries. On the other hand its membership in the WTO may also help the country benefit from international trade through increased competition and broadened export market. Vietnam is obliged to implement changes in its current policies through increased free trade or international trade liberalisation, economic reforms, and basically more room for foreign investors. Like China, the Philippines, and India, it may also experience a sudden burst of labour pool demand from outsourcing and off-shoring industries that wants to take advantage of Vietnam’s cheap labour market. In terms of the agriculture industry, local producers in the country may definitely suffer from cheaper agricultural goods coming from China and Thailand, particularly in the aspects of poultry and rice production. Without the infant industry ‘protection,’ its communist government is required to be more open and welcoming to private foreign investors, increased level of market competition, and rapid rural to urban migration. Overall, the inclusion of Vietnam in the World Trade Organisation and the need to have freer, more liberal market policies tends to have some positive effects and negative setbacks. Whichever way the country goes, its approaches towards economic change is inevitable. Indeed, the experience of Britain or the United States, in implementing the infant industry argument, may not hold true for Vietnam, but the need to grow and expand its horizons still holds true for all nations. Note: please cite the references you gave in the paragraphs that do not have citation. Thanks. End Notes Read More