58 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Ninth Edition
As seen in the previous chapters, activist trade policy may be justified if there are market failures. One
important type of market failure involves externalities present in high-technology industries due to their
knowledge creation. Existence of externalities associated with research and development and high
technology make the private return to investing in these activities less than their social return. This means
that the private sector will tend to invest less in high-technology sectors than is socially optimal. While
there may be some case for intervention, the difficulties in targeting the correct industry and understanding
the quantitative size of the externality make effective intervention complicated. To address this market
failure of insufficient knowledge creation, the first best policy may be to directly support research and
development in all industries. Still, while it is a judgment call, the technology spillover case for industrial
policy probably has better footing in solid economics than any other argument.
Another set of market failures arises when imperfect competition exists. Strategic trade policy by a government
can work to deter investment and production by foreign firms and raise the profits of domestic firms.
An example is provided in the text that illustrates the case where the increase in profits following the
imposition of a subsidy can actually exceed the cost of a subsidy to an imperfectly competitive industry
if domestic firms can capture profits from foreign firms. While this is a valid theoretical argument for
strategic policy, it is nonetheless open to criticism in choosing the industries which should be subsidized
and the levels of subsidies to these industries. These criticisms are associated with the practical aspects of
insufficient information and the threat of foreign retaliation. The case study on the attempts to promote
the semiconductor chips industry shows that neither excess returns nor knowledge spillovers necessarily
materialize even in industries that seem perfect for activist trade policy.
The next section of the chapter examines the anti-globalization movement. In particular, it examines the
concerns over low wages in poor countries. Standard analysis suggests trade should help poor countries,
and, in particular, help the abundant factor (labor) in those countries. Protests in Seattle, which shut down
WTO negotiations, and subsequent demonstrations at other meetings showed, though, that protestors either
did not understand or did not agree with this analysis.
The concern over low wages in poor countries is a revision of arguments in Chapter 2. Analysis in the
current chapter shows again that trade should help the purchasing power of all workers and that if anyone
is hurt, it is the workers in labor-scarce countries. The low wages in export sectors of poor countries
are higher than they would be without the export-oriented manufacturing, and while the situation of these
workers may be more visible than before, that does not make it worse. Practically, the policy issue is whether
or not labor standards should be part of trade pacts. While such standards may act in ways similar to a
domestic minimum wage, developing countries fear they would be used as a protectionist tool.
Anti-globalization protestors were by no means united in their cause. There were also strong concerns that
export manufacturing in developing countries was bad for the environment. Again, the issue is whether these
concerns should be addressed by tying environmental standards into trade negotiations, and the open
question is whether this can be done without destroying the export industries in developing countries.
Globalization raises questions of cultural independence and national sovereignty. Specifically, many are
disturbed by the WTO’s ability to overturn laws which do not seem to be trade restrictions, but which
nonetheless have trade impacts. This point highlights the difficulty of advancing trade liberalization when
the clear impediments to trade—tariffs or quotas—have been removed, yet national policies regarding
industry promotion or labor and environmental standards still need to be reformed.
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