International Trade - Theory and Policy, 2010a

prices, then the gross domestic product (GDP) will fluctuate along with the prices. Some years will be very
good, and others will be very bad. Although a wealthier country may be able to smooth income by
effectively using insurance programs, a poor country might face severe problems, perhaps as severe as
famine, in years when the prices of their comparative advantage goods are depressed.
In addition, many people argue that the management and organizational skills necessary to produce
agricultural goods and natural resources are not the same as the skills and knowledge needed to build an
industrial economy. If true, then concentrating production in one’s static comparative advantage goods
would prevent the development of an industrial economy. Thus one of the reasons for protecting an infant
industry is to stimulate the learning effects that will improve productive efficiency. Furthermore, these
learning effects might spill over into the rest of the economy as managers and workers open new
businesses or move to other industries in the economy. To the extent that there are positive spillovers or
externalities in production, firms are unlikely to take account of these in their original decisions. Thus, if
left alone, firms might produce too little of these types of goods and economic development would
proceed less rapidly, if at all.
The solution suggested by the infant industry argument is to protect the domestic industries from foreign
competition in order to generate positive learning and spillover effects. Protection would stimulate
domestic production and encourage more of these positive effects. As efficiency improves and other
industries develop, economic growth is stimulated. Thus by protecting infant industries a government
might facilitate more rapid economic growth and a much faster improvement in the country’s standard of
living relative to specialization in the country’s static comparative advantage goods.
An Analytical Example
Consider the market for a manufactured good such as textiles in a small, less-developed country.
Suppose that the supply and demand curves in the country are as shown in Figure 9.2 "An Infant Industry in
a Small Importing Country". Suppose initially free trade prevails and the world price of the good is P 1 . At
that price, consumers would demand D 1 , 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, D 1 .
Figure 9.2 An Infant Industry in a Small Importing Country
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