The New International Trade

The “New” international trade refers to trade issues that are related to imperfect markets.

The Infant Industry Argument

The Argument:

In some industries, new firms cannot compete with established firms because they don’t have enough experience. According to this argument, the government should use import barriers to protect these infant industries.

The Learning Curve

Describes the relationship between historical output and current average cost of production.
Also called dynamic increasing returns-to-scale, learning-by-doing.
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The underlying economic assumption is that some production processes cannot be completely “learned” without actually producing. There are “tricks of the trade” that come only through experience.
Ex: Japanese auto industry

If an industry is characterized by learning-by-doing, then what is the proper policy response, if any?

If perfect capital markets

No policy response is necessary. Banks will finance the venture if it makes economic sense.

Why might the market not work?

Imperfect K markets

Not enough banks, not large enough banks, no international borrowing.

Gov’t has skills or information that the private sector doesn’t

What could the gov’t do?

Subsidize production to move down learning curve faster. Unlike an import tariff, this has no distortion on the consumption side.

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Lesson

Gov’t should use policies which distort as few decisions as possible.

Why might the gov’t still not want to do anything?

The costs of the policy may still outweigh the discounted benefits.
Political economy suggests that infant industries never grow up.

Creating Comparative Advantage: Agglomeration, External EOS & Trade

“Economies of Scale” (EOS)

When costs fall with the scale of an undertaking.

Internal EOS

AC falls with the firm’s output

External EOS

Firms’ costs fall as