What is the Infant Industry Argument?
The infant industry argument, a classic theory in international trade, states that new industries require protection from international competitors until they become mature, stable, and are able to be competitive. The infant industry argument is commonly used to justify domestic trade protectionism.
The infant industry argument was initiated by Alexander Hamilton in 1791 when he argued for the protection of industries in the United States from imports from Great Britain. Later on, Friedrich List published his book, National System of Political Economy, in 1841, which helped refine, formulate, and provide a comprehensive overview of the infant industry argument.
What is an Infant Industry?
An infant industry is a term used in economics to describe an industry that is in its early stages of development. In other words, an infant industry is a newly established industry. Therefore, infant industries lack the experience and size to compete effectively against established competitors abroad. An infant industry is characterized by a lack of efficiency, competitiveness, and a high vulnerability to sudden market changes.
Consider a country that traditionally imports cars from overseas and has no domestic production of cars. The creation of a domestic automotive industry would be an example of an infant industry.
Rationale Behind the Infant Industry Argument
The main rationale behind the infant industry argument is that new industries require protection because they lack the economies of scale that competitors possess. Infant industries lack the capabilities to leverage their existing production and require protection until they can acquire similar economies of scale.
In addition, there are various other reasons behind the infant industry argument:
- To encourage and stimulate domestic production
- To promote national security and reduce reliance on production from abroad
- To be a source of government revenue once the infant industry reaches maturity
- To attract foreign investment
- To create employment and develop the domestic market
- To encourage the consumption of domestically produced goods
- To prevent trade dumping
Arguments Against Infant Industry Protectionism
There are several criticisms of the infant industry argument:
- Infant industry protectionism may encourage industries to be inefficient. Developing industries that have protection may lack the incentive to be efficient and competitive.
- Infant industry protectionism may result in retaliation from other countries.
- Once an industry gains government protection, it may be politically difficult to remove the protective measures later on due to vested interests.
- It is difficult for a government to choose industries to protect – what is the rationale behind protecting one industry over the other?
- Infant industry protectionism decreases consumer surplus as it results in consumers having to pay higher prices for goods that would have otherwise been cheaper if imported.
How is an Infant Industry Protected?
There are a number of ways to protect an infant industry. The three most common methods are:
An infant industry can be protected by imposing tariffs on imports. A tariff is a tax or duty on the volume of imports. Tariffs can either be (1) a fixed dollar charge for each unit imported or (2) a percentage tax levied on the value of the imported good. The Smoot-Hawley Tariff of 1930 is a famous example of tariffs aimed at protecting the U.S. agriculture industry from European agricultural imports.
2. Production subsidies
An infant industry can be protected by imposing a production subsidy for domestic production. A production subsidy is a payment made by the government to producers; production is subsidized by the government. Similar to tariffs, production subsidies can either be (1) a fixed dollar subsidy for each unit produced or (2) a percentage subsidy on the value of the produced good.
3. Quotas on imported goods
An infant industry can be protected by imposing a quota on imports. A quota is a limit on the number of goods that can be imported within a specific time period.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)® certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful: