The Case for Protecting Infant Industries

Shielding young companies helped the U.S. economy flourish once. It wouldn’t hurt to revisit the idea.

Him again.

Source: stock montage/getty images

I must say, it’s been almost breathtaking to see how fast the acceptable terms of debate have shifted on the subject of trade. Thanks partly to President-elect Donald Trump’s populism and partly to academic research showing that the costs of free trade could be higher than anyone predicted, economics commentators are now happy to lambaste the entire idea of trade. I don’t want to do that -- I think a nuanced middle ground is best. But I do think it’s worth reevaluating one idea that the era of economic dogmatism had seemingly consigned to the junk pile -- the notion of infant-industry protectionism.

This idea is usually applied to developing countries. Poor nations, the argument goes, benefit from having high-tech, high-value industries that produce positive spillovers -- local supply chains, an expert workforce, innovative ideas. But because poor countries have little capital, their high-tech industries can’t compete with huge multinational behemoths. So it makes sense to shield these young, promising companies behind protectionist walls for a while, letting them play in the sandbox of the domestic market until they gain the size and know-how to go out and compete in the world.
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The first known proponent of this idea was Alexander Hamilton. He suggested subsidies -- which he called “bounties” -- as the best tool for helping young manufacturing industries, as opposed to tariffs. Casual observation would suggest that Hamilton’s strategy worked well, or at least didn’t hurt too much, as the U.S. became an industrial powerhouse. However, in the middle of the 20th century, the doctrine came under attack from economists. Studies of industrial policies in places like Turkey showed disappointing results. Productivity in the shielded industries didn’t even go up. Infant-industry protection was broadly rejected along with other economic heresies.

This dismissal was premature. Arguments from theory can break down in any number of ways. And examples like Turkey’s aren’t true random experiments -- for example, countries might try to use protectionism to shore up industries that were uncompetitive to begin with, and which had little hope of ever flourishing. Policy decisions don’t just drive economic conditions, they’re also driven by them. To really know whether infant-industry protection is effective, we’d need some kind of random event that affected the competitive environment.

Economist Reka Juhasz, of Princeton and Columbia, combed through the historical record to find such a random event. And she found one: the Napoleonic Wars. It seems doubtful that Napoleon’s conquest of Europe was an elaborate scheme to protect failing French manufacturing industries, so it’s probably safe to consider its effects as akin to an act of God.

During his wars with Britain, Napoleon tried (unsuccessfully) to bring his island nemesis to its knees by cutting it off from European markets. The move protected industries within the sprawling Napoleonic domains that competed heavily with Britain. The prime example was mechanized cotton spinning, a very high-tech industry for its time, and a locus of intense competition between early industrial nations like Britain and France. With detailed historical records, Juhasz was able to identify how much different regions saw their trade costs with Britain go up as the result of Napoleon’s embargo, and to see whether cotton spinners in those areas flourished. 

They did. Juhasz found that in the short term, profits of protected cotton spinners rose, and their size and productivity increased more in the long run. Decades later, these regions were exporting more, relative to less-protected regions, showing that companies in the shielded areas were eventually able to compete in global markets -- just as the infant-industry argument would predict.

This study, though clever and carefully executed, is just one example -- if the infant-industry argument is going to become widely accepted, it will need a lot more evidence. But this paper suggests that it might be worth taking a second look at the idea.

There’s also the question of whether developed countries like the U.S., Europe or Japan, which already have high-tech industries and competitive multinational companies, should consider infant-industry strategies. It seems to me that in general the answer is no, but in some cases it might be appropriate. For example, there are high-tech industries like batteries in which the U.S. lags behind countries like South Korea. Depending on how excited researchers and scientists are about the possibility for big technological and supply-chain spillovers from batteries, the U.S. might consider a Hamilton-style program of subsidies for this industry, or similar ones.

In an era where all of the received wisdom on trade is being called into question, infant-industry protectionism seems like an interesting heresy to revisit.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.