Helping Infant Economies Grow: Foundations of Trade Policies for Developing Countries

Conventional wisdom has it that trade enhances economic efficiency and thus promotes growth. At least since Robert M. Solow’s (1957) pioneering work, however, technological progress has been recognized as the dominant factor in determining the rate of growth. This is presumably even more true for developing countries, for which the possibilities of closing the knowledge gap with advanced industrial countries offers especially large growth potential. We examine the impact of trade restrictions in economies in which technological spillovers within countries and across industries are fundamental to the process of growth (see Kenneth J. Arrow, 1962a, 1962b; Paul M. Romer, 1986; Stiglitz, 1987). Since that work, it has been clear that markets, by themselves, do not necessarily, or in general, lead to overall dynamic efficiency; and that there are often trade-offs between static inefficiencies (e.g., associated with patent protection) and long-term growth. We find, here in particular, that the dynamic benefits of broad trade restrictions may outweigh their static costs. Our analysis provides the basis of an infant economy (as opposed to an infant industry) argument for protection. This paper develops a simple two-sector model with an industrial (modern) and a traditional (craft or agricultural) sector. There are four key features to the model: (a) there are spillovers from the industrial sector to the craft sector, for which firms in the industrial sector are not compensated; (b) such spillovers are geographically based, that is, it is only productivity increases in the industrial sector in the developing countries that affect productivity increases in the traditional sector; (c) innovations are concentrated in the industrial sector; and (d) size is among the important determinants of the pace of innovation in the industrial sector. Earlier critiques of trade policies encouraging the development of the industrial sector in developing countries ignored these spillovers. They argued, in effect, that Korea would always have a comparative advantage in growing rice; therefore, it was foolish for it to try to restrict imports of industrial goods, even if by so doing productivity in the industrial goods sector was increased. It could never catch up, so the protection would have to be permanent. Year after year, the country would have been better off if it simply specialized in its own comparative advantage, growing rice. Korea could, and did, catch up, however, at least in certain areas. If catch-up is possible, then dynamic comparative advantage differs from static comparative advantage. But even if Korea’s comparative advantage remained in agriculture, industrial protection might be desirable, because by supporting it, one might have a more dynamic agricultural (traditional) sector. Trade restrictions enhance the size of the industrial sector; the benefits spill over to the rural sector; and national income grows at a possibly far faster pace. After presenting the model, we explain why the underlying hypotheses are plausible and argue that the model is broadly consistent with historical experience and empirical evidence.