International Economics Study Set 9

Business

Quiz 9 :
Arguments for and Against Protection

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Quiz 9 :
Arguments for and Against Protection

The specificity rule is a guide to government policy that tries to enhance economic efficiency by addressing incentive distortions or market failures. It states that it is more efficient to use a policy that is closest to the source of a distortion separating private and social benefit or cost. It is also useful as a guide to government policy that tries to achieve a noneconomic objective with the least economic cost. For a noneconomic objective, it is least costly to use a policy that acts directly to achieve the objective.

The infant industry argument states that a country can benefit by shielding an industry (the infant) that is currently uncompetitive against foreign rivals, if that industry can lower its costs over time and become competitive in the future. It is potentially a valid argument for the government to do something to assist the infant industry, because the future benefits can be larger than the current costs of doing so. But, it has a number of weaknesses. First, even if some form of government assistance is appropriate, the specificity rule indicates that the best form of assistance is not a tariff or other barrier to imports. Rather, a subsidy to initial production or to whatever is the source of cost reductions over time is usually the best policy. Second, if the industry is so promising, it is often the case that no government assistance to the initial firms is needed. Instead, these firms should borrow from private lenders to cover their initial losses and repay these loans from future profits. Third, the argument is subject to abuse, because it is speculative. Will the industry really grow up-lower its costs to become competitive over time

The national defense argument states that the government must limit imports during peacetime to ensure that the country can meet its needs for defense goods during times of war. While the need to provide for the national defense is clear, the specificity rule says to think clearly about what the actual problems are, and then use policies that act directly on them. If the need is for production capabilities for a product, then the government should subsidize production capacity. If the need is for materials that can be stockpiled, then the government should build the stockpiles. If the need is for access to depletable mineral resources, then the government should forego domestic production during peacetime, but have production capability ready if needed. Barriers to imports would achieve some of these objectives, but at a higher economic cost. In fact, imports during peacetime may be part of the solution, for building stockpiles or acquiring depletable resources so that domestic supplies are not used up.