Chapter 10 Notes

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University of Toronto Scarborough
Economics for Management Studies
Garth Frazer

Chapter 10 Trade Policy in Developing Countries Notes Import-Substituting Industrialization The Infant Industry Argument • according to the infant industry argument, developing countries have a potential competitive advantage in manufacturing, but new manufacturing industries in developing countries cannot at first compete with well-established manufacturing in developed countries • to allow manufacturing to get a toehold, governments should temporarily support new industries, until they have grown strong to meet initial competition; thus it makes sense to use tariffs or import quotas as temporary measures to get industrialization started • the infant industry argument seems highly plausible, and in fact it has been persuasive to many governments • economists have pointed out many pitfalls in the argument, suggesting that it must be used cautiously 1) it is not always good to try to move today into the industries that will have a comparative advantage in the future 2) protecting manufacturing does no good unless the protection itself helps make industry competitive 3) more generally, the fact that it is costly and time-consuming to build up an industry is not an argument for government intervention unless there is some domestic market failure • the imperfect capital markets justification for infant industry protection is as follows: if a developing country does not have a set of financial institutions (such as efficient markets and banks) that would allow savings from traditional sectors (such as agriculture) to be used to finance investment in new sectors (such as manufacturing), then growth of new industries will be restricted by the ability of firms in these industries to earn current profits • the first-best policy is to create a better capital market, but protection of new industries, which would raise profits and thus allow more rapid growth, can be justified as a second-best policy option Export-Oriented Industrialization: The East Asian Miracle • from the mid-1960s onward, it became increasingly apparent that there was another possible path to industrialization: via exports of manufactured goods, primarily to advanced nations • moreover, the countries that developed in this manner—a group that the World Bank now refers to as the high performance Asian economies (HPAEs)—achieved spectacular economic growth, in some cases at more than 10% per year Summary 1. Trade policy in less-developed countries can be analyzed using the same analytical tools used to discuss advanced countries. The particular issues characteristic of developing countries are, h
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