When and How Should Infant Industries Be Protected?

Citation:

Melitz, Marc. 2005. “When and How Should Infant Industries Be Protected?” Journal of International Economics 66: 177-196.
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Abstract:

This paper develops and analyzes a welfare maximizing model of infant industry protection. The
domestic infant industry is competitive and experiences dynamic learning effects that are external to
firms. The competitive foreign industry is mature and produces a good that is an imperfect substitute
for the domestic good. A government planner can protect the infant industry using domestic
production subsidies, tariffs, or quotas in order to maximize domestic welfare over time. As
protection is not always optimal (although the domestic industry experiences a learning externality),
the paper shows how the decision to protect the industry should depend on the industry’s learning
potential, the shape of the learning curve, and the degree of substitutability between domestic and
foreign goods.
Assuming some reasonable restrictions on the flexibility over time of the policy instruments, the
paper subsequently compares the effectiveness of the different instruments. Given such restrictions,
the paper shows that quotas induce higher welfare levels than tariffs. In some cases, the dominance
of the quota is so pronounced that it compensates for any amount of government revenue loss related
to the administration of the quota (including the case of a voluntary export restraint, where no
revenue is collected). In similar cases, the quota may even be preferred to a domestic production
subsidy.

Last updated on 11/30/2020