Government Failure: The Strongest Argument For Protectionist Policies

While it is well known that free trade promotes prosperity for all, as Krugman explained in his book, a less known theory and yet by far the strongest case for protectionism is the infant industry argument. That is, a new industry with high potential but lacks economies of scales must require temporary protection from international competitors until they become mature as well, able to compete with already matured industries. This article critically examines the theory and reviews the empirical evidence. The majority of the studies indicate that the infant industry policy does not work.

(update November 7th 2024: added Kim et al. 2022)

CONTENT

Theoretical flaws of the infant industry argument

Empirical evidence: Disproving infant industry

Empirical evidence: Ambiguous conclusions

Empirical evidence: Supporting the infant industry

Failures of untargeted protectionist policies

Theoretical flaws of the infant industry argument

The intervention is typically called Industrial Policy (IP). The justification for IP requires strong evidence of learning-by-doing, with accumulation of human capital as a by-product of learning specialized skills and producing high-tech goods. The goal is to transform a labour-intensive into a capital-intensive industry but it must show evidence of higher growth rates than the already matured competitors. The benefits of IP must exceed its costs, an assumption rarely tested in most studies. Econometric models must also show that a free trade model would perform worse than the IP model, an assumption rarely tested. If a country imposes trade barriers using quotas or tariffs, one must ensure that other countries will not retaliate in a way that erases the gains from protectonist policies.

The theoretical nonsense of the infant industry is not well appreciated by mainstream economists. Econometric models calculate the profits in those new infant industries but ignore that capital goods were already optimally employed by old industries.

In Human Action, Mises (1949, p. 506) argued that the infant industry can only be advantageous if the superiority of the new industry outweighs the disadvantages resulting from the abandonment of nonconvertible and nontransferable capital goods invested in already established industries and which could yet render services valued higher by the consumers. If the new industry was indeed superior, it can establish itself and compete without need of the government. Another point worth noting is that even if the IP speeds up the process of shifting the resources, it might still not be advantageous because those capital goods still had a purpose:

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 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.

In Strictly Confidential, Rothbard (2010, p. 250) explained that under free market, an infant industry could at the start be unprofitable until a portion of the existing capital goods in the old industries has been allowed to wear away. Even the few empirical studies which attempt to simulate a “free trade” model do not account for this phenomenon.

Often, the studies reviewed below do not estimate the cost-benefit ratio. Even when such analysis is provided, what is never discussed is the regulation cost (e.g., import licenses). This is typical with mainstream economists, since they assume that any kind of intervention is free. This article explains well why the cost of regulation is gigantic, with the pages of the U.S. Registry book increasing drastically over time:

Regulations incur several different types of costs: the cost of creating the regulations (a political process in the case of laws, and an administrative process in the case of regulations), the cost of publishing the books that contain them (hundreds of thousands of copies so that we all may be able to access it, since ignoratio iuris non nocet [in English, “the ignorance of the law is no excuse”]), and finally, in enforcing the laws and regulations (thousands of government agencies employ hundreds of thousands of people whose jobs consist of seeing to it that we live by those regulations).

The spillover problem is one major argument for protection. A new entrepreneur who incurs costs in order to discover the best production technique cannot prevent potential competitors from obtaining the knowledge and copying the technique before he can reap a high reward. No entrepreneurs would undertake investments in acquiring knowledge. As noted by Baldwin (1969) however, by increasing prices, the tariffs make investments in knowledge more profitable but also make competitors respond faster to market opportunities. Also, a tariff will not induce entrepreneurs to incur the initial cost of learning-by-experience if these costs are greater than what subsequent firms must pay to acquire a known technique. Another version of the spillover is worker training. The entrepreneurs will not finance on-the-job training due to fears that those workers, once trained, will quit and move to other employers. However, as Boudreaux (2008) noted as well, infant industry protection will exacerbate the problem by raising the price of the product (if tariffs are used). The best course of action is to ask why there was a market failure in the first place.

The spillover is similar to the free rider problem, which is used to justify intellectual monopoly. The evidence indicates that free markets can deal with the free rider and that intellectual monopoly did not improve innovation. Thus one would wonder why limiting foreign competition would erase the spillover problem or improve the free market solution. Because, unlike the infant protection, free trade improves growth through technological advancements in developing countries (Sauré, 2007).

Globalization makes IP more costly. Indeed, Baldwin (2010) argued that the developing nation’s comparative advantage in their low-cost labour-intensive activities would increase the cost of the infant industry protection in two ways. First, offshoring raised the domestic welfare costs of any given level of final good production by lowering its price worldwide. Second, if developing countries hoped to maintain their competitiveness, they must purchase components from the lowest cost source rather than favouring local parts makers created by infant-industry policies. Although Baldwin presented a strong case against protectionism, he also proposed a weird case. Tariffs could lower the price of domestically-produced parts and components, by stimulating local production, because these imports would become expensive for developing countries due to frictional barriers (coordination, communication). If imports were expensive to the point of being unprofitable, there would be no import. The contrary would mean that imports, despite frictional barriers, are still profitable. Instead of imposing import tariffs, one must ask why the frictional barriers are high and how these could be mitigated.

At EconLog, Bryan Caplan explained that the large majority of trade is domestic due to physical transportation costs and poorly connected social network which could act as barriers. Every country has indeed powerful natural trade barriers, yet those barriers failed to make the vast majority of poor countries rich.

But trade barriers policies are usually sub-optimal, as the proponents of infant industry argued, because the policies either use quotas or tariffs. They argue that subsidies are less distortionary because only the producers, and not the consumers’ surplus, are affected. As Harrison and Rodríguez-Clare (2010) noted, there are several reasons why countries have continued to use tariffs to promote domestic industry. The most direct policy instruments are frequently not available in countries with limited abilities to collect income, consumption, or production taxes. Import duties are easier to collect and enforce than other modes of taxation.

A pervasive effect of import restriction is to give rise to rent-seeking competition, which can take the form of bribery and corruption. This way, resources are devoted to competing for import licenses. Krueger (1974) explained that not only rents are large but “To the extent that rent seeking is competitive, the welfare cost of import restrictions is equal to the welfare cost of the tariff equivalent plus the additional cost of rent-seeking activities.” (p. 299).

Unsurprisingly, industrial policies (IP) are not motivated by generating positive externalities but by optimal tariff considerations, revenue generation, protection of special interests (Harrison & Rodríguez-Clare, 2010). This aligns with what Mises (1960) argued: “The fact that, nevertheless, protection is asked only against foreign, but not also against domestic, competition clearly points to the real nature of the motives behind the demand.” (p. 237). Even if they have incentives to promote growth, they lack the ability to identify externalities. One could object that governments, pretty much like markets, have a tendency to learn and optimize their strategies. Once again, governments are constrained by vested interests and lobbyists. Moreover, favoritism gives IP-targeted firms the incentive to focus on pleasing the government rather than the customers.

Pack & Saggi (2006) provide an extensive literature review on industrial policy (IP). They argue that private firms have often been successful in pursuing learning strategies. The East Asian miracle had nothing to do with IP. In China and Japan, IPs did not single out individual firms with high learning potential and spillovers (Beason & Weinstein, 1996), as the infant industry argument would have argued. In Korea, IPs were not correlated with Total Factor Productivity (Lee, 1995, 1996). In India, the development of the software sector expanded on Foreign Direct Investment without needing IP.

As several observers pointed out, once an industry is protected or subsidized, it is politically difficult to take away the protection. Interests become vested. As Fukasaku et al. (1999) indicated, there are innumerable cases in which the targeted industries remain in a state of perpetual protection. In The Theory of International Trade, Haberler (1936, pp. 281-284) noted:

Nearly every industrial tariff was first imposed as an infant-industry tariff under the promise that in a few years, when the industry had grown sufficiently to face foreign competition, it would be removed. But, in fact, this moment never arrives. The interested parties are never willing to have the duty removed. Thus temporary infant-industry duties are transformed into permanent duties to preserve the industries they protect. Even if a part of the industry does become able to stand upon its own feet, there will always be in addition less efficient concerns which have come into existence behind the shelter of the duty and which would disappear were the duty removed. Moreover, even industrialists who could survive quite well under Free Trade strongly oppose the removal of the duty, either because they wish to continue making monopolistic profits under its protection or because they feel they may need it if foreign competition becomes keener.

Haberler also argued that IP could only increase the social product if the reallocation of workers has come from employments where their marginal productivity was smaller. He stated:

Suppose that a duty is imposed and that this causes much fixed capital to be installed, buildings to be erected, means of transport to be provided … Then it is possible that, even if the duty is removed, the industry will continue to produce, since much of the equipment and so on may be too specific to be put to other uses. Nevertheless, capital will have been lost, and must be written down in value. In such a case the duty will not have been advantageous.

If such condition is met, it will translate into productivity growth. Yet, as Irwin (2000b) demonstrated, many of the links between tariffs and productivity are elusive. During the 19th century in the U.S. there were cases in which domestic industries improved their competitiveness relative to foreign rivals (but for reasons not necessarily due to tariff) and other cases in which industries remained inefficient. Even a positive relationship between tariffs (or its absence) and rapid output growth does not imply causation unless we could identify the causal mechanisms. Irwin concluded that none of the possible mechanisms (i.e., inter-sectoral resource shifts) by which tariffs could have influenced the economy could explain the 19th century U.S. growth. While capital accumulation would also promote the U.S. growth, the tariffs on imported capital goods harmed capital accumulation by raising its prices.

There is a moderating effect not well appreciated in most studies. Beverelli et al. (2017) use data for a sample of 57 countries at all stages of economic development and find that the impact of trade policies depend importantly on the quality of local institutions, which seems to operate through Foreign Direct Investment (FDI). Lower barriers to services trade have economically meaningful effects on productivity of downstream industries in countries with good institutions. The positive effect of lower services trade barriers disappears if institutions are weak.

A much less discussed problem with IP is the policy uncertainty. Caldara et al. (2020) showed in their firm-level analysis that increases in trade policy uncertainty decreases capital accumulation. Using a vector-autoregressive model based on uncertainty measures such as newspaper coverage and tariff volatility series, they found that uncertainty decreases aggregate investment.

Empirical evidence: Disproving infant industry

Harrison and Rodríguez-Clare (2010) reviewed numerous single-industry and cross-industry studies and concluded that most did not support the infant industry argument. Often, long-run growth was observed but net welfare losses could not be avoided. Worse, tariff protection is frequently granted to declining industries and those without increasing returns.

Irwin (2000a, Figure 5D & Table 3) examined the effect of the 1890 McKinley tariff on the U.S. tinplate industry, using data between 1869 and 1913. Probit regression showed that the tariff was valuable to domestic producers. Counterfactual simulations revealed that a tinplate industry would have established itself about a decade later in the absence of the McKinley tariff, and that the tinplate industry would have established itself about 20 years later in the absence of tinplate tariff. However, if the U.S. allowed the free importation of iron bars at the U.K. price, then the simulations showed that the probability of establishment of the tinplate industry would have been much higher, earlier, and for most of the 19th century. Irwin finally computed the welfare change, as the sum of the changes in producer profits, consumers’ surplus, and tariff revenue. For the periods between 1891 and 1900, the welfare values were all negative: the initial large loss of consumer surplus is not offset by the profits received by domestic producers. Therefore, even if the tariff accelerated the industry’s development, the cost did not justify it.

Irwin & Temin (2001) showed that the U.S. Tariff of 1816 were not essential to the survival and success of the early cotton textile industry. The Walker tariff of 1846 reduced the duties on cotton textiles from 70% to 25% with little change in domestic production, by 1%.

Harris et al. (2015) analyzed the impact of the 1879 tariff policy on Canadian manufacturing. Using difference-in-differences method, they found that industries receiving greater protection enjoyed faster growth in output and productivity. Targeted industries also exhibited greater returns to scale and faster learning rates. However, Harris et al. admitted their result do not include welfare effects. Alexander & Keay (2018) estimated that the 1879 tariff increased welfare by 0.15% of GDP, when accounting for general equilibrium effects. On the other hand, they estimated that a free trade policy (1877 tariff rates go to zero) would have improved welfare by 0.70%-0.98% of GDP.

Bell et al. (1984, Table 1) summarized results of various decades of research in infant industries across developing countries (Brazil, Argentina, India, Turkey, Zambia, Tanzania). Only half of these infant industries displayed a productivity growth in labor or capital greater than that of the same industry in developed countries. If any industries achieved high growth once, most failed to maintain it. The authors admitted it is difficult to agree upon the real sources behind the maturation process.

Rask (1994) examined the import substitution program on the Brazilan ethanol production between 1975 and 1987 for the five major sugarcane producing states in Brazil. The program was extremely costly, with no increase in returns to scale and no technical progress independent of the effects of factor price changes.

Thaker (2018) examined the growth of the Brazilian micro-computer industry which was heavily protected from foreign competitors between 1971 and 1990 and concluded it did not reach the expected potential. Main reasons are: 1) high cost of producing a processor due to oligopoly, 2) laws forcing domestic computer to obtain inputs resources from the government-maintained firms, 3) burdensome bureaucratic requirements to enter the industry, 4) entrance of new manufacturers hindered by sectoral policies.

Bowman & Kulkarni (2015) reviewed several studies on the Nigeria experience pointing out the mistake of policies protecting capital-intensive industries. This is because capital is expensive in Nigeria, which means capital-intensive industries will have to compete with labour-intensive industries where a small amount of capital goes much further in producing the desired effect because of the low cost of labour in Nigeria. Furthermore, the learning rate of capital-intensive industries is likely much slower. Overall, the situation could have been different if the labour-intensive industrial sector already materialized. Other studies suggested that developing nations like Nigeria mostly need foreign direct investment (FDI) but that industrial protectionism does not encourage FDI. Still others concluded that trade liberalization would bring improvements to the economy and negate the negative impact of tariffs. Corruption was the reason Nigeria was deaf to trade liberalization.

Barwick et al. (2021, Tables 5-6 & C5) examined China’s nascent shipbuilding industry during the 2000s. They found no evidence of learning-by-doing, as the marginal costs tended to increase. The subsidies boosted China’s world market share but their gross-profit gains were modest, as the output expansion was largely fueled by the entry of inefficient firms (due to entry subsidy). Welfare benefits were modest since employment in shipbuilding accounted for less than 0.1% of national employment. Performance of subsidies varied by type and timing. Subsidies overall generated more profits during a downturn than during the boom. Counterfactual simulations show that 82% of production subsidy, 68% of investment subsidy, 49% of entry subsidy are allocated to firms that are more efficient than the median firm. Kalouptsidi (2018) estimated that China’s subsidies reduced shipbuilding costs by 13-20% between 2006 and 2012. But because China increased its market share at the expense of Japan, subsidies shifted production away from the low-cost Japanese shipyards towards the high-cost Chinese shipyards, the industry now producing at a much higher average cost net of subsidies. Subsidies indeed caused a negative reallocation effect.

Ohyama et al. (2004, Table 1) compared 19 government-selected and 63 market-selected firms in the Japanese infant cotton spinning industry between 1867 and 1896. They found that government-selected firms (who enjoyed subsidies) were 3 times more likely to go out of business. Half of these died before 1900 and only 1 of the initial 19 firms survived at the beginning of the first World War. Accumulated experience (or learning-by-doing process) does not impact the hazard rates among government-selected firms. The firms whose entrepreneurs were not subject to market selection were well below the sizes of the firms whose entrepreneurs had to pass the market test.

Mustafa (2020) provides a literature review regarding Proton, the first automobile industry in Malaysia. In the 1980s the government introduced tariffs for foreign vehicles to promote the market share of Proton. There were also massive subsidies to create economies of scale, quotas to restrict quantities of imports, forbiddance of foreign companies to sell its production locally. The government tried to enhance R&D by linking research and consultancy firms with public universities to encourage university-industry collaboration in R&D. The industry still could not develop enough to compete worldwide. In 2017 the welfare loss was massive. Astonishingly, in the 1990s, a new automobile industry was established, Perodua. It did not receive any protection but developed a more efficient system. After 20 years of protecting Proton, the government started to lose hope and remove protection tools gradually.

Kim et al. (2022, Figure 2) studied the Korean industrial policy of the 1973 heavy and chemical industry drive during the 1967-1987 period. They use a difference-in-differences (DiD) model, comparing industry-region pairs with a targeted industry in a targeted region versus non-targeted industry in a non-targeted region. The DiD model uses a dichotomy variable indicating whether the industry and the region were treated or not, as well as industry, region and year fixed effects. They calculate Total Factor Productivity (TFP) of industry-region pairs by averaging plant-level TFP with value-added (defined as real gross output minus real intermediate input) as weights. They found that while both output and input grew significantly more for the targeted industries/regions, the TFP at the industry-region level did not change relative to that of the non-targeted ones, and that the unweighted average in the targeted industry-region pairs increased significantly more than in the non-targeted ones while the weighted averaged decreased. The latter finding is a strong indication of resource misallocation. Their variance decomposition also showed that the plants that entered during the policy period have disproportionately worsened the misallocation.

One argument put forth is that protection could help growing firms to innovate. Bagayev & Davies (2017) used data on 4756 firms across 13 developing countries to test the hypothesis that protection of infant industries via tariffs or non tariff measures (SPS and TBT which are often geared towards a better reallocation of production) could increase innovation in either products or processes. Their linear probability models, which control for labour productivity and firm’s characteristics (size, age, exporter, importer, etc.), showed no such relationships.

Empirical evidence: Ambiguous conclusions

Krueger & Tuncer (1982, Table 1) examined the import substitution policy using data from Turkey, a developing country, between 1963 and 1976. They computed the effective rates of protection and rates of growth of output/input for each infant industries and discovered there was no correlation between the two variables. Harrison (1994, Table 3) criticized their study on the grounds that they reported raw data instead of conducting statistical test. Results from firm- and industry-level data provide evidence of positive relationship between protection and productivity growth but only when three sectors were excluded on the grounds that they are outliers. Harrison did not provide any explanation as to why they have to be removed from the analysis (e.g., bad data). The all-sectors analysis reveals no clear relationship.

Head (1994) analyzed the effect of the import tariff on the U.S. steel rail industry between 1865 and 1915, which was one of the major manufacturing sectors in the post bellum U.S. The counterfactual simulations of a free trade policy reveals that the tariff raised both short- and long-run market share of the domestic steel rail producers and lowered its long-run prices. However, Head rightly pointed out that an import restraint that only encouraged inefficient production will not increase welfare. The difference in welfare levels calculated in the simulations of tariff and free trade policies showed a positive but small net impact of the tariff on domestic welfare.

Hanlon et al. (2019) studied the impact of temporary input cost advantage on production patterns between the U.S. and Britain for the period 1871-1912. Their results show that the U.S. shipbuilders were unable to compete with the British producers even after Britain’s initial advantage in input prices (i.e., costs) disappeared after 1890. The finding shows that the timing of intervention is crucial. IP may be less useful once producers in another country are already established. British shipyards did not lack skilled workers, while the U.S. shipyards used more capital goods as substitute for their unskilled worker. But capital cannot truly compensate for lower skill levels.

Lee (1997, Table 2) analyzed the growth of 29 industries (12 being classified as infant) in South Korea for 8 observed years between 1970 and 1990. It was found that 8 infant industries favored by subsidies had faster growth than other categories. According to the author, this refutes the free trade hypothesis. However, among the 12 infant industries, there were 3 ones not favored by subsidies and they also matured just as well in 1980. It is unknown whether the benefits exceeded the costs. The fact that favored industries became profitable amounts to a post hoc fallacy because, after a decade of rapid growth, one would expect Korea to become more labor-scarce and capital-abundant. Dollar & Sokoloff (1990) indeed identified lower productivity in targeted industries during the 1970s, relative to labor-intensive sectors.

Lane (2022, Tables 5 & D2) studied the impact of tariffs IP on the heavy and chemical industry (HCI) in South Korea between 1973 and 1979. This investment-focused interventionism shows evidence that HCI-targeted firms expanded on absolute terms and more than non-targeted firms. There was improvement in employment, exports, and learning by doing. Downstream sectors with strong linkages to HCI firms enjoyed higher growth, invested in more capital goods. However, among HCI firms Lane showed that cuts in intermediate input tariffs are positively associated with industry growth and output protection negatively associated with industry growth. Oddly, HCI-targeted industries enjoyed lower tariffs rates with respect to output and input. And nothing is known about cost-benefits.

Charles (2017) uses Granger causality test to examine whether the Average Tariffs Rates (ATR) would cause exports flow, for each targeted, existing industry in Switzerland over the period 1886-1913. It should be noted that Granger test is merely testing the null hypothesis of no Granger cause, which was rejected. Although export growth could be a sign that the industry is successful, we don’t know if there were welfare benefits. And even this analysis says nothing about the causal mechanisms (Irwin, 2000b).

Hinton (2013, Figure 1) examined the National Tariff of 1859 and 1879 in Canada and showed that the growth rate of Cotton Mills’ accelerated in the late 1850s right after a huge drop but not during the period following 1879. It was concluded that the superior productivity growth (using Total Factor Productivity) of Canada’s Cotton Mills during the 1889-1910 period compared to 1869-1890, and the superior growth of Canada’s cotton industry in 1869-70 and 1909-10 compared to the U.S., should be seen as a success for the infant industry argument. Not only the analysis is susceptible to omitted variable bias, Hinton failed to understand that a real test of the infant industry hypothesis must test for various assumptions, especially the cost-benefit ratio. Although Hinton et al. (2014, Tables 2-3) confirmed that the post-1879 period experienced lower growth than pre-1879 period, they still failed to show evidence that the pre-1879 growth was mainly due to the 1859 Tariff.

Nishiwaki (2007) conducted a counterfactual simulation using data on automobile industry in Japan during 1955-1965. Historically, the Japanese government restricted import cars but also imposed tariffs. With this policy, Japanese makers became competitive enough against foreign counterparts. Yet welfare must be estimated. Under counterfactuals of a flexible subsidy model, in which the subsidy levels adapt in response to the marginal cost reduction, both consumers’ and producers’ surplus increased compared to the model of historical tariffs. Despite consumers being more harmed under the tariff model, it is unknown whether the situation would improve under free trade.

Empirical evidence: Supporting the infant industry

Hansen et al. (2003) evaluated the impact of subsidies on the Danish windmill industry between 1983 and 1998. Results show strong learning-by-doing productivity growth and high gain for shareholders. Even without accounting for the environmental benefits from green electricity for calculating the cost-benefit ratio, the firms’ market value far exceeded even the most pessimistic estimation of the costs. The authors noted that the costs are estimated with some degree of uncertainty.

Juhasz (2018) relied on the Napoleonic Blockade in France in the early 19th century as a quasi-natural experiment of temporary protection on the cotton industry. The blockade serves as a proxy for trade costs with Britain. Using difference-in-differences estimation, this temporary protection had a large impact on the adoption of mechanized cotton spinning technology, which was in turn related to industrial growth. The model was robust to confounds potentially affecting the trade cost shock. Placebo tests showed that the decrease in import competition (i.e., higher trade cost) was the only mechanism driving the technological change. Although there is no estimation of the cost-benefit ratio, French exports increased relative to British exports and the transformation of the French cotton industry was unmatched by other Continental countries in the early 19th century. Unlike many other papers, this research accounts for endogeneity effect about government selecting an industry which would have become competitive even without the protection.

Failures of untargeted protectionist policies

Because governments enacts IP on the basis of political concerns rather than economical ones, it is justified to evaluate the impact of IPs as a whole, regardless of industry targeting. The other rationale is that governments don’t know which industries could eventually display a comparative advantage.

Block (2011) reviewed studies conducted in the 1980-90s, showing that protectionist policies resulted in a loss/gain ratio in jobs much larger than 1. Coughlin et al. (2002, pp. 308-309) reviewed studies on trade restrictions conducted in the U.S. during the 1980s which overall reached a firm conclusion that there are large consumer losses associated with protected industries. One study (Hickok, 1985) even found that low-income families are more negatively affected than high-income families. Coughlin (2002, Table 1) reviewed studies from the 1990s showing that free trade would exert a positive impact on income. One important study (Hufbauer & Elliott, 1994) has generated estimates of the potential net national gains by industry if protection were removed, resulting in huge consumer gain per job lost in those protected industries by either tariffs or import quotas.

Blonigen (2016, Tables 4-6) emphasized that protection policies must exhibit positive effects as well among downstream industries, and not just upstream ones, to be deemed successful. Blonigen compared major steel-producing countries and found that industrial policies (IP) had harmful net effect on the export competitiveness of downstream sectors after controlling for both country-sector and country-time fixed effects, particularly for less developed countries (LDCs). The effect of IPs on both developed countries and Asian countries (Japan, South Korea, Taiwan) was unclear, especially because of the large standard errors despite the large sample size. The most harmful IPs are export subsidies and government ownership. The IPs typically raise prices of the protected sectors, hurting the competitiveness and development of the downstream sectors that use the protected sectors’ products as inputs. The results are consistent with the hypothesis that downstream sectors are facing highly competitive export markets, as the steel IP effect is estimated to be a small positive increase in export price and a decline in export quantity.

de Souza & Li (2022, Table 13) found that the anti dumping policy in Brazil increased employment by 0.06%. Tariffs shift the demand for protected goods from overseas to the national market, which increase employment at the national producer and decrease it at downstream firms. Because the downstream effect is not strong enough, aggregate employment and GDP both increase. The policy decreased real income by 1.3% and welfare by 2.4%. They found that using tariffs to maximize employment can increase employment by 2.8% but decrease welfare by 15.9% while using tariffs to maximize welfare will increase employment by 0.01% but decrease welfare by 1.46%.

Criscuolo et al. (2019) analyzed the impact of investment subsidies in a major program called Regional Selective Assistance (RSA) in the United Kingdom. The program aimed to maintain and expand employment in low-income, high-unemployment areas. By investigating policy rule changes in the program, they can test for a possible causal impact. Their analysis shows that while the positive effects on investment and employment exist solely for small firms, there was no improvement in Total Factor Productivity (TFP). Why large firms did not benefit from employment growth could be explained by their ability to “game” the system (p. 6). Overall though, there seems to be no causal impact of IP on industrial growth.

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