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Infant-Industry Protection and
Trade Liberalization in
Developing Countries
SUBMITTED TO
USAID/Washington
SUBMITTED BY
Nathan Associates Inc.
TCB Project
UNDER CONTRACT NO.
PCE-I-00-98-00016-00
Task Order 13
RESEARCH REPORT
MAY 2004
2101 Wilson Boulevard, Suite 1200 • Arlington, VA 22201
tel 703.516.7700 • fax 703.351.6162 • www.nathaninc.com • www.tcb-project.com
RESEARCH REPORT
MAY 2004
Infant-Industry Protection and
Trade Liberalization in
Developing Countries
SUBMITTED TO
USAID/Washington
SUBMITTED BY
Nathan Associates Inc.
Support for Trade
Capacity-Building Activities
Arlington, Virginia
PREPARED BY
Matthew J. Slaughter,
Tuck School of Business,
Dartmouth College
UNDER CONTRACT NO.
PCE-I-00-98-00016
Task Order 13
Sponsored by USAID’s Bureau of Economic Growth, Agriculture and Trade (EGAT) and implemented by
Nathan Associates Inc., the Trade Capacity Building (TCB) Project, 2001–2004, helps developing countries
assess their trade constraints and prioritize their trade-related technical assistance needs. The project provides
trade experts for short-term technical assistance in developing countries and assists USAID Missions in
designing, implementing, monitoring, and evaluating technical assistance that will stimulate economic growth
and reduce poverty. Electronic copies of reports and materials related to trade needs assessments, resource
guides, and trade training workshops are available at www.tcb-project.com. USAID Missions and Bureaus may
seek assistance and funding for activities under this project by contacting John Ellis, USAID/EGAT, TCB
Project Task Manager at jellis@usaid.gov.
For further information or for hardcopies of publications, please contact
Erin Endean
Nathan Associates Inc.
Chief of Party, TCB Project
eendean@nathaninc.com
This report was made possible through support provided by the United States Agency for International Development under the
terms of Contract No. PCE-I-00-98-00016-00. The opinions expressed herein are those of the authors and do not necessarily
reflect the views of the United States Agency for International Development.
Contents
Executive Summary iii
1. The Infant-Industry Argument 1
Static Arguments 1
Dynamic Arguments 2
Counterarguments 3
2. Empirical Record for Infant-Industry Protection 5
Inhibited Gains 5
Unintended Political-Economy Consequences 7
Foregone Comparative Advantage 8
Conclusion 9
3. Liberalization and Firm Performance 11
Access to Technology 11
Access to Capital 13
Competitive Pressures 15
Global Production Networks 16
Conclusions 17
4. Benefits of Global Engagement—the Information and Communication
Technology Industry 19
Global Engagement and ICT Firms 19
Developing Countries and ICT Globalization 22
II
Contents (continued)
Damaging Impact of ICT Infant-Industry Protection—Brazil 25
Benefits of ICT Global Engagement—Malaysia and Costa Rica 27
5. Conclusions 31
References 35
ILLUSTRATIONS
Figures
Figure 3-1. Relative Importance of FDI in Developing Country Net Capital Inflows 14
Figure 4-1. Share of U.S. Sales in ICT Industries Accounted for by U.S. Parents of
Multinational Firms 20
Figure 4-2. Share of Worldwide ICT Employment of U.S. Multinationals Accounted for
by Foreign Affiliates 21
Tables
Table 4-1. Export Activity for Product Groups with the Fastest Growth in
World Exports, 1980-1998 23
Table 4-2. World Trade Patterns in ICT Industries, By Product Group, 1998 24
Exhibits
Exhibit 3-1. Chile’s Liberalization Drives Export Growth and Diversification 18
Executive Summary
Many argue that firms in developing countries cannot compete against foreign counterparts
without the protection afforded by tariffs and non-tariff barriers. At least in theory, protection
gives “infant industries” the opportunity to prepare for freer trade by becoming more
productive through “learning by doing,” facilitating local supplier networks, investing in
physical capital, and undertaking research and development. Eventually, vigorous rather
than vulnerable firms can welcome freer trade. Though this argument remains widespread
and convincing in many developing countries, it cannot stand on theoretical grounds alone,
but must be checked against empirical evidence. Recent and ongoing research conducted at
the level of countries, industries, and individual firms has given rise to a growing body of
evidence, much of it suggesting conclusions precisely the opposite of the infant-industry
argument.
In checking the validity of the infant-industry argument against empirical evidence we find
that infant-industry trade protection often fails because of three complications. First, firms in
developing countries often do not achieve the best-practice productivity that protection is
intended to afford. Learning-by-doing for a largely domestic market can be insufficient;
capital investments can be misdirected; and research and development can be unproductive.
Second, even if protected firms do become efficient, perverse political-economy incentives
often compel them and other beneficiaries to seek more protection or longer periods of
protection than might be warranted. For protected firms, the highest-return activities can be
political lobbying. Third, protecting certain industries often incurs opportunity costs of
foregone comparative advantage. Even if a protected sector expands, aggregate national
welfare can still be lowered because the resources used in expansion might have been more
productively used by other firms in other sectors.
Indeed, protection against trade, as well as foreign direct investment (FDI), is found to inhibit,
rather than develop, the competitiveness of firms in developing countries. Exposure to global
best practice induces better performance via access to technology, access to capital, and
competitive pressures. The investments in capital and technology necessary for
competitiveness are more likely with engagement in global product markets, especially the
global production networks of multinationals.
IV INFANT-INDUSTRY PROTECTION AND TRADE LIBERALIZATION
A high and rising share of world trade is mediated on at least one side by a multinational
firm. On many dimensions, multinational firms operate differently—and on many measures
“better”—than do their purely domestic counterparts. This means that issues of trade policy
are also issues of FDI policy. Thus, the infant-industry argument involves questions not just of
the cross-border flows of goods and services but also of multinational capital. History offers
substantial variation on the relative importance of trade (both exports and imports) and FDI
(both outward and inward) under the umbrella of the term “global engagement.”
Of course, the fact that firms in developing countries can benefit from global engagement
through trade and FDI does not necessarily mean that they will. Openness may be necessary
