Do Tariffs Protect an Infant Industry?

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Many support “Buy American” campaigns but don’t have compelling economic or moral reasons to do so. Buying exclusively within a specific geographic region impoverishes the local economy, whereas purchasing foreign-made goods helps lift the world’s poor out of poverty.

Some people suggest that protecting an infant industry with tariffs is a special exception. They argue that only mature industries can handle the global competition of free trade with their competitive prices. When these mature industries are foreign, supporters of the infant industry argument call for tariffs, a tax on foreign goods, to force the foreign price above the already higher price of the infant domestic goods.

They reason that younger industries need protection until they have developed the necessary knowledge and skills to compete. When they rise to the same level as the experienced producers, the tariffs will be no longer needed.

These arguments are some of the most compelling for protectionism. But economists who study the unintended consequences of tariffs conclude that even in this special case, tariffs do more harm than good.

Mature industries versus infant industries have three types of knowledge that give them a competitive edge. But in each case, tariffs are not the right solution.

First, mature industries may possess a trade secret or patented technique that efficiently gets them high quality. With affordable foreign goods on the market, infant industries may complain they have no way to compete. They are trapped in a catch-22. They need profits to buy the research that would garner profits. They need a tariff, so they argue, to have enough revenue to research the trade secret.

This argument overlooks a business loan, the already existing free market solution to the problem. It comes at the cost of the loan’s interest, but having the trade secret might provide a big payback that makes it worth the cost. Even if the extra profit to pay for it is not presently there, incentive exists for the owner to borrow today the money necessary to have the big payback in the future.

If the payback is not large enough to justify the cost of the loan, although a tariff will certainly help the business owner get his trade secret without any cost to him, the cost of the tariff is diversified across all of society. The cost the business owner wasn’t willing to take on is built into the now higher price of that industry’s goods.

The business owner wasn’t willing to pay the price for the research, so there is an economic loss to society by buying it at their expense. In this case, the high cost of the tariff in the industry’s prices is deadweight loss, making a tariff ultimately the wrong action.

The second kind of knowledge is public, information easily copied or obvious from looking at the product. To take a simple example, a blanket may be duplicated by anyone with sewing skills. This knowledge, although a source of business income, is also public.

In many cases such knowledge of mature industries poses no threat to infant industries, like how to make a Snuggie. However, in some cases, although the knowledge is public, the domestic infrastructure or environment cannot support the industry in the same way the foreign one can.

Some of these barriers will never relax. For example, there is no trade secret in growing bananas, but a specific environment is required that is not readily available in the United States. No amount of business capital can solve that problem.

Other barriers to infant industries may relax, like having access to high-tech machines, transportation or efficient processes. The infant industry argument will complain that, in such cases, if the businesses involved were just given extra profits through tariffing their foreign competition, they could pay for the labor necessary to create the infrastructure that would allow them to compete naturally without the tariff.

There is no incentive for one company to develop the infrastructure from which every other company will also benefit. After sinking a lot of capital into the project of building the shared resource, other companies will be able to set lower prices and undercut the first business out of its profits. It is a net loss for the company willing to take the risk, no matter how much profit is gained from tariffs protecting them from foreigners.

The tariffs allow even more inefficient firms to gather a profit in the protected industry. Firms that spend money to publicly advance the field may be priced out by firms continuing to use the inefficient methods or copying the improvements and undercutting the price.

These types of tariffs encourage this inefficiency as long as the state is willing to provide the protection. Many protected industries never quite fail. As they grow they use their political power to keep their protection intact.

Another problem with this argument for tariffs is that it overlooks another free market solution. Trade associations are organizations funded by groups of businesses within one industry. The projects of trade associations range from “Got milk?” ads to standardizing an electronic medical record.

Such associations were created to fund what will benefit the whole industry. Thus trade associations can develop the necessary infrastructure, even when tariffs cannot.

The third kind of knowledge infant industries lack is a trained workforce. Mature industries have an existing pool of trained employees, whereas infant industries still need to find or develop this workforce.

This is really just a more complicated example of a shared resource. Extra profit from a tariff won’t provide them incentive to train their workforce. Whichever firm sinks capital into training, another firm can pay a fraction of those costs to attract those skilled workers to their firm.

Where the market is willing to pay more for trained workers, the workers themselves will invest in higher education and training to compete for the higher wages.

Tariffs hurt consumers. The higher costs of one tariffed industry spill over into other industries and lower their productivity as well.

Other related government actions include subsidizing production or paying for industry-related research with public funds.

Production subsidies use government money to pay a producer and often result in rewarding inefficient or insolvent business methods. This is most frequently used when foreign maturity is thought to be due to a trade secret and suffers the same deadweight loss as a tariff.

Funding research, in contrast, is perhaps the most targeted money spent. It is often used when foreign infrastructure is believed to be the key to their success. The problem is that, if it was worth the money of the industry’s firms, they would eventually band together and strike an agreement in their trade association to get it done privately. The government is notoriously bad at targeting what has the best return on investment, but businesspeople are famously good at it.

Only the free markets offer constantly changing pricing to optimize the use of resources. Tariffs reward inefficiency and stupidity without providing any of the incentives to develop wisdom. Infant industries don’t need protection. They need savvy leaders who know how to find the optimal balance between risk and reward.

Photo by juhansonin used here under Flickr Creative Commons.

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