54 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Ninth Edition
Chapter 11
Trade Policy in Developing Countries
.1 nChapter Organization
Import-Substituting Industrialization
The Infant Industry Argument
Promoting Manufacturing Through Protectionism
Case Study: Mexico Abandons Import-Substituting Industrialization
Results of Favoring Manufacturing: Problems of Import-Substituting Industrialization
Trade Liberalization Since 1985
Trade and Growth: Takeoff in Asia
Box: India’s Boom
Summary
.2 nChapter Overview
The final two chapters on international trade, Chapters 11 and 12, discuss trade policy considerations in
the context of specific issues. Chapter 11 focuses on the use of trade policy in developing countries and
Chapter 12 focuses on new controversies in trade policy.
While there is great diversity among the developing countries, they share some common policy concerns.
These include the development of domestic manufacturing industries, the uneven degree of development
within the country, and the desire to foster economic growth and improve living standards. This chapter
discusses both the successful and unsuccessful trade policy strategies which have been applied by
developing countries in attempts to address these concerns.
Many developing countries pose the creation of a significant manufacturing sector as a key goal of economic
development. One commonly voiced argument for protecting manufacturing industries is the infant industry
argument, which states that developing countries have a potential comparative advantage in manufacturing
and can realize that potential through an initial period of protection. This argument assumes market failure
in the form of imperfect capital markets or the existence of externalities in production. Such a market
failure makes the social return to production higher than the private return. This implies that a firm will
not be able to recapture rents or profits that are in line with the contribution to welfare made by the product
or industry establishment of the firm. Without some government support, the argument goes, the amount of
investment which will occur in this industry will be less than socially optimal levels.
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley
55 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Ninth Edition
Given these arguments, many nations have attempted import-substituting industrialization. In the 1950s and
1960s, the strategy was quite popular and did lead to a dramatic reduction in imports in some countries. The
overall result, though, was not a success. The infant industry argument did not always hold, as protection
could let young industries survive, but could not make them efficient. The methods used to protect industries
were often complex and overlapped across industries, in some cases leading to exorbitantly high rates of
protection. Furthermore, protection often led to an inefficiently small scale of production within countries
by creating competition over monopoly profits that would not have existed without protection. By the late
1980s, most countries had shifted away from the strategy, and the chapter includes a case study of Mexico’s
change from import substitution to a more open strategy.
Since 1985, many developing countries have abandoned import substitution and pursued (sometimes
aggressively) trade liberalization. The chapter notes two sides of the experience. On the one hand, trade
has gone up considerably and changed in character. Developing countries export far more of the GDP
than prior to liberalization, and more of it is in manufacturing as opposed to agricultural or mining
sectors. On the other hand, the growth experience of these countries has not been universally good, and
it is difficult to tell if the success stories are due to trade or due to reforms that came at the same time as
liberalization. While countries such as the “Asian Tigers,” China and India, have experienced spectacular
rates of growth following trade liberalization, only part of this growth can be attributed to trade reform.
Furthermore, countries such as Brazil and Mexico that have also moved toward freer trade have not
experienced the same rates of economic growth.
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley