Sector targeting: Strategic Trade Policy and Infant Industry Protection

The Primary aim: Give examples of models of industrial policy that have emerged out of controversies over Industrial Economics

• Building barriers to entry trough protectionism and subsidies

New Sector Policies

Under certain conditions ‘sector targeting’ (trade-protection, subsidies) is consistent with a social optimum

This property has been used in normative models of politics directed to high-technology sectors

Difficult for governments to know when these circumstances apply

Invite to lobbyism Comparative advantages are created through politics (not

inherited)

Premises for the analysis:

• Analysis in two steps1) National governments do not coordinate their policies2) A government expects reaction from other governments

• In the spirit of Japanese ip: Division between pioneering countries and latecomers

• Industries with a potential for technological change

• Technology diffusion through imitation

Infant Industry Protection Argument (IIP):

• Perfect competition

• In “latecomers” (“laggards”), a protectionist trade-policy is temporarily legitimate in terms of a social optimum if it is followed by ‘learning-by-doing’ reducing production costs to the same level as in “pioneering countries”

 • We think about ‘Learning-by-doing’ as “Dynamic Economies of

Scale” or “Economies of Time”

Infant Industry Protection is an appropriate policy if:

• The subsidy, in combination with Dynamic Economies of Scale, generate a producer surplus > 0 (Mill’s criterion)

• The present value of the future income the costs of the subsidy (Bastable criterion)

• Intervention by a public policy agency if there are externalities implying that those firms, that carry the costs, do not also gain from the policy (Kemp´s criterion)

• In the case of a large country, the Bastable criterion has to

be modified in order to take account of consumer surplus (Negishi criterion)

 

Implications for the Social Welfare:

• Small countries – producer surplus

• Large Countries - producer and consumer surplus

Strategic Trade Policy:

Export subsidy: Cournot’s duopoly - imperfect competition

”Domestic”

”Foreign”

”OtherCountries”

Strategic Game – Cournot’s Duopoly

• The firms set no prices – they accept the price “set by the market”

• At each period in time, the firms choose a production plan

• Equilibrium when the firms maximize profits, given no expectations about changes in the production plans

Description of the process:

• The subsidy induces “Domestic” to increase production

• “Foreign” believes it is a permanent increase and reduces its production

• This reduction implies that “Domestic” increases its profit beyond the subsidy – “Strategic effect”

Implications for Social Welfare (SW)

• “Domestic” – increased SW (redistribution through taxes)

• “Foreign” – SW decreases • “Other countries” – lower prices imply that SW increases

  

International policy-coordination - intergovernmentalism:

A country can gain from protective policies if all the other countries do not respond actively

  Total gain is maximized if all countries cooperate to ‘not to

protect’

Favorable strategy for both countries: Long periods of cooperation in combination with punishment of defection.

  

International policy-coordination:

Country A Cooperate Defect

Cooperate 400, 400 50, 500

Defect 500, 50 100, 100

Country B

Trigger strategy: Cooperate as long as the opposite party cooperateTit for tat: Cooperate from the beginning. Afterwards, choose the strategy the opposite party has chosen in the previous pariod