Terence Kealey uses the infant-industry argument to defend protectionism. Here’s what Mises has to say about the same argument:
Take, for instance, the infant industries argument advanced in favor of protection. Its supporters assert that temporary protection is needed in order to develop processing industries in places in which natural conditions for their operation are more favorable or, at least, no less favorable than in the areas in which the already established competitors are located. These older industries have acquired an advantage by their early start. They are now fostered by a merely historical, accidental, and manifestly “irrational” factor. This advantage prevents the establishment of competing plants in areas the conditions of which give promise of becoming able to produce more cheaply than, or at least as cheaply as, the old ones. It may be admitted that protection for infant industries is temporarily expensive. But the sacrifices made will be more than repaid by the gains to be reaped later.
The truth is that the establishment of an infant industry is advantageous from the economic point of view only if the superiority of the new location is so momentous that it outweighs the disadvantages resulting from the abandonment of nonconvertible and nontransferable capital goods invested in the already established plants. If this is the case, the new plants will be able to compete successfully with the old ones without any aid given by the government. If it is not the case, the protection granted to them is wasteful, even if it is only temporary and enables the new industry to hold its own at a later period. The tariff amounts virtually to a subsidy which the consumers are forced to pay as a compensation for the employment of scarce factors of production for the replacement of still utilizable capital goods to be scrapped and the withholding of these scarce factors from other employments in which they could render services valued higher by the consumers. The consumers are deprived of the opportunity to satisfy certain wants because the capital goods required are directed toward the production of goods which were already available to them in the absence of tariffs.
There prevails a universal tendency for all industries to move to those locations in which the potentialities for production are most propitious. In the unhampered market economy this tendency is slowed down as much as due consideration to the inconvertibility of scarce capital goods requires. This historical element does not give a permanent superiority to the old industries. It only prevents [p. 510] the waste originating from investments which bring about unused capacity of still utilizable production facilities on the one hand and a restriction of capital goods available for the satisfaction of unsatisfied wants on the other hand. In the absence of tariffs the migration of industries is postponed until the capital goods invested in the old plants are worn out or become obsolete by technological improvements which are so momentous as to necessitate their replacement by new equipment. The industrial history of the United States provides numerous examples of the shifting, within the boundaries of the country, of centers of industrial production which was not fostered by any protective measures on the part of the authorities. The infant industries argument is no less spurious than all the other arguments advanced in favor of protection.
At first glance, you could accuse Mises of being non-responsive to Kealey-type arguments. But on closer consideration, Mises’ answer is on point. It amounts to this: “So costs are high now, but will eventually be low thanks to learning by doing? Great! If you really believe that, I suggest that you start your business, then run it at a loss until the learning curve saves you. If the financials are really so clear-cut, investors will happily give you all the money you need during the start-up period, knowing they’ll be fully repaid once you know what you’re doing.”
While this may seem fanciful, this is standard practice in startups: You willingly lose money for a while – often years – until you hit stride.
The obvious objection is naturally: But investors rarely want to invest in projects like this. Indeed, most would-be investors will hastily shoo you out the door.
Why won’t they listen? Because in the real world, most business ideas that lose money for the first couple of years are going to lose money forever. Learning by doing will not save them. “Lose money, then make it all back and more” is the exception; “Lose money, then lose even more” is the rule. In the absence of strong, specific evidence, you should assume the worst. Kealey’s case amounts to urging Third World governments to take the empty promises of their native businesspeople as Gospel.
And one really shouldn’t do that.
READER COMMENTS
robc
Aug 26 2021 at 10:54am
Not really. If the investors wont invest, it must be a really bad idea.
My understanding of most VC is that they are fine with losing everything on 19 projects if number 20 returns 100x. They will happily invest in “We will lose money for a decade then produce outrageous profits afterward” knowing that there is a good chance the after never happens.
But they won’t invest in “We will lose money for a decade then produce 10% ROI afterward.”
Phil H
Aug 26 2021 at 12:56pm
“They will happily invest in…”
They do, and that model has been fabulously successful, at least in some cases. But I think this model is very new, and only exists because of the great stability of US law, and abundance of capital there. In the past, this kind of very long-term investment was much less. (Landowners would invest in their land, but that was about it.)
If we believe both of the things I said in the paragraph above (long-term investment can be very successful; it’s historically been rare), then there is an opportunity for governments to invest, either in the form of money (subsidies) or policy (protectionism). Because their investment could well be successful, but the institutions that would allow capital to invest successfully are lacking.
And the East Asian catch-up countries seem to offer a good example of how this can work. Relative stability of government still seems to help a lot.
Nicholas Weininger
Aug 26 2021 at 12:11pm
FWIW, one of the more thoughtful recent pieces on manufacturing in the US advocates investment subsidies, rather than protectionism, on the claimed basis that there are long-term good investments (“good” in an overall social return sense) which investors aren’t willing to fund for time-horizon reasons:
https://www.theatlantic.com/science/archive/2021/08/america-into-the-worlds-factory-again-industrial-finance-corporation/619793/
Philo
Aug 26 2021 at 12:24pm
Protection of “infant industries” is most obviously uncalled for in industries that are expanding. If new factories are having to be built, and inexperienced workers hired and trained, this will be done in the most propitious settings without any interference from governments. (And industries in decline are less likely to be championed for protection.)
Note that if some other government is committed to subsidizing certain of its domestic industries, thus “distorting” the market–still, from an outsider’s point of view, that does indeed add to such a country’s propitiousness as a site for that industry.
Mark Z
Aug 26 2021 at 2:25pm
Playing devil’s advocate, what if the cost of investing enough in an infant industry to make it profitable in a long time is so high that no one firm has enough capital to invest (or it would be such a large gamble that if they turn out to be wrong, it would bankrupt them)? Combine that with externalities. E.g., if I start investing in manufacturing cell phones and training more skilled employees, they’ll be poached by competitors, maybe even in other industries that are profitable now, so it’s against the interests of each individual firm to be the first to invest in cell phones, even if everyone would be better off if a bunch of firms did so simultaneously, making the spillover effects more mutually beneficial. In this scenario, only the state may be willing to make this good investment, since only it has enough capital and insulation from risk, and the ability to overcome the prisoner’s dilemma created by externalities.
Frank
Aug 26 2021 at 2:36pm
Copy from earlier post:
A contemporary version of the Infant Industry Argument relies on a [non-capital] market failure. There must be learning; the learning must be by doing; the benefits of the learning must accrue outside the firm; the tariff must be the only way of fixing the externality; and the tariff must eventually come off.
Accrue outside the firm: Airplane production would not count even though there is great learning by doing, for the workers who learnt could not benefit from the learning if they left the firm [except all of them together].
The conditions for the validity of the argument are stringent. It is difficult to empirically test for them in the numerous cases for which the argument has been invoked. Except for one condition — the tariff must come off! It never does.
Adam Allen
Aug 26 2021 at 4:14pm
The state cannot invest. The state often behaves as an owner by making decisions about assets and industries. But it is not an actual owner of assets and doesn’t behave as such. The state can subsidize and give away favors, but it does not engage in actual investment. Actual investment requires potential beneficial ownership of profits for individuals making decisions.
Knut P. Heen
Aug 27 2021 at 11:03am
Correct. Although you could make the point that it is more correct today than it was at Mises’ time because of the development of venture capital (equity financing).
Strictly speaking you need perfect financial markets for the NPV-criterion to hold (unlimited access to cash at the market rate of return). If access to cash at the market rate of return is limited, the manager has to be more picky than the NPV-criterion tells her to be. She cannot invest $10 million if she has $1 million even if the NPV-criterion tells her to do so. In such cases, the manager may resort to using some version of the pay back time criterion to rank the projects with positive NPV, and infants may not do well in such a ranking.
Basically, the infant industry argument says that the consumers should finance the corporation by overpaying for the good during the infant period (the protection period) without getting an ownership stake in the firm. It is a free lunch for the stockholders. It is unclear whether the consumers benefit.
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