ECON 3601 Lecture 10: Lecture 10 – Chapter 11

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28 Jun 2018

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Lecture 10 – Chapter 11

Introduction

•Which countries are “developing countries”?

•The term “developing countries” does not have a precise definition, but it is a name

given to many low- and middle-income countries.

Import-Substituting Industrialization

•Import-substituting industrialization was a trade policy adopted by many low- and

middle-income countries before the 1980s.

•The policy aimed to encourage domestic industries by limiting competing imports.

•The principal justification of this policy was/is the infant industry argument:

•Countries may have a potential comparative advantage in some industries, but

these industries cannot initially compete with well-established industries in

other countries.

•To allow these industries to establish themselves, governments should

temporarily support them until they have grown strong enough to compete

internationally.

Problems with the Infant Industry Argument

1. It may be wasteful to support industries now that will have a comparative advantage in

the future.

2. With protection, infant industries may never “grow up” or become competitive.

3. There is no justification for government intervention unless there is a market failure that

prevents the private sector from investing in the infant industry.

Infant Industries and Market Failures

•Two arguments for how market failures prevent infant industries from becoming

competitive:

1. Imperfect financial asset markets

–Because of poorly working financial laws and markets (and more generally, a lack

of property rights), firms cannot or do not save and borrow to invest sufficiently

in their production processes.

–If creating better functioning markets and enforcing laws is not feasible, then

high tariffs would be a second-best policy to increase profits in new industries,

leading to more rapid growth.

2. The problem of appropriability

–Firms may not be able to privately appropriate the benefits of their investment

in new industries because those benefits are public goods.

–The knowledge created when starting an industry may not be appropriable (may

be a public good) because of a lack of property rights.

–If establishing a system of property rights is not feasible, then high tariffs would

be a second-best policy to encourage growth in new industries.

3. Import-substituting industrialization in Latin American countries worked to encourage

manufacturing industries in the 1950s and 1960s.

4. But economic development, not encouraging manufacturing, was the ultimate goal of

the policy.

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Document Summary

The term developing countries does not have a precise definition, but it is a name given to many low- and middle-income countries. Import-substituting industrialization was a trade policy adopted by many low- and middle-income countries before the 1980s. The policy aimed to encourage domestic industries by limiting competing imports. The principal justification of this policy was/is the infant industry argument: Countries may have a potential comparative advantage in some industries, but these industries cannot initially compete with well-established industries in other countries. To allow these industries to establish themselves, governments should temporarily support them until they have grown strong enough to compete internationally. Two arguments for how market failures prevent infant industries from becoming competitive: Because of poorly working financial laws and markets (and more generally, a lack of property rights), firms cannot or do not save and borrow to invest sufficiently in their production processes.

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Competition police crossing continents

Competition authorities are increasingly reaching beyond their country's borders

Feb 22^nd, 2014

WHEN TWO AMERICAN presidents, Theodore Roosevelt and William Howard Taft, embarked on a trustbusting mission a century ago, they were taking government into a new policy area: competition. Industrialization was still relatively new, and any monopolies that had emerged, such as the British and Dutch East India companies, had been created by governments.

The robber-baron companies of the late 19th century were accused of using their industrial muscle to drive competitors out of business. Private monopolies, the argument ran, diminished the benefits of capitalism; by definition, the existence of a monopoly made it impossible for a free market to operate.

Since then, governments have generally had some kind of competition policy, though not necessarily a coherent one. Politicians have tried to juggle several different priorities, among them putting the government in control of "strategic" industries (a category that has always included defense but often also a range of other industries, from airlines to car manufacturing, power generation, and telecoms); shielding domestic businesses from foreign ownership or competition, and protecting consumers from price-gouging.

In the past two decades, a new concern has emerged: that monopolies may be restricting innovation. The technology industry seems to have been particularly prone to creating near-monopolies, from Microsoft in software to Amazon in retailing and Google in an internet search. This is due to network effects. Consumers gravitate to the dominant technology, either because it offers more products or because many of their friends are already using the network concerned. These monopolists, it is feared, will be slow to introduce new technologies that might cannibalize their existing business; and they will be so entrenched that new competitors will find it hard to get a foothold.

Microsoft bundled its Internet Explorer browser with its dominant Windows operating software on personal computers. America's Department of Justice saw this as an attempt to force Netscape, a rival browser, out of the market. In a long court case that began in 1998, Microsoft was initially ordered to break itself in two. This ruling was overturned on appeal and a less onerous settlement was arrived at.

At the time many commentators felt that the authorities had overreached themselves. Internet Explorer was provided free of charge, so it was hard to see how consumers were being harmed. But this is a tricky area. On the one hand, rapid technological change can cause once-dominant companies to lose their position very quickly if they do not adapt; look at Nokia's and BlackBerry's mobile-phone businesses. Some argue that if the market is capable of such adjustment, governments should not get involved. The fact that some consumers make the wrong decision some of the time is not the basis for intervention, as long as all consumers are not being ripped off, says Simon Bishop of RBB Economics, a consultancy. On the other hand, such rapid change makes it hard to tell whether monopoly positions are being exploited, or whether a more competitive market would have produced more innovations.

Competition authorities have also had to rethink their role in cross-border deals. If one multinational takes over another, that might not create a monopoly in the country where the two groups have their headquarters, but it could do so in another country. A proposal for a merger between General Electric and Honeywell, announced in October 2000, was cleared by America's Department of Justice but blocked by the European Commission the following year. That objection appeared to herald a new era of transatlantic takeover disputes; in fact, it remains the only deal so far to have been cleared in America but blocked on the other side of the Atlantic.

However, there have been other instances of transatlantic disputes. In 2009 the European Commission imposed a 1.06 billion ($1.4 billion) fine on Intel, a chipmaker, after a complaint brought by an American rival, AMD. The ruling seemed to suggest that multinationals faced the prospect of double jeopardy because of inconsistent international rules.

We do it our way

There are some philosophical differences between Europe and America. Europe has a long tradition of state ownership of industry; even after privatization, many such companies retain dominant positions, at least in their national markets. In America, by contrast, market leaders have got there the hard way, by having superior technology or being more efficient. In Europe competition policy tends to be rules-based, with the European Commission issuing guidance for future mergers to follow; in America merger decisions tend to be hammered out in the courts, establishing legal precedent.

But multinationals also have to deal with competition policy in emerging markets. China is a particular challenge. The Chinese use competition policy to achieve other ends to keep out foreign firms or attack existing foreign businesses says, one expert. Latin American countries have tended to adopt the American model of competition policy, whereas eastern Europe has followed the example. Merger authorities from different countries have set up the International Competition Network to share the experience. Such efforts may reduce the double-jeopardy problems in international mergers, if only because rules may be applied more consistently.

In the longer term, the question is whether national competition policies will prove adaptable enough to cope with a globalized economy. It may make economic sense for global companies to exploit economies of scale and bring down prices for consumers, but national governments may be reluctant to accept the loss of control involved. In air travel, for example, fares have been reduced under pressure from low-cost airlines, but these newcomers are still being held back by policies that favor flagship carriers. If regulators in rich countries were to prove more zealous than their counterparts in emerging markets in restricting the size of multinationals, Western firms might be put at a competitive disadvantage.

New concerns for competition authorities are emerging all the time. Chris Walters, the acting chief economist of Britain's Office of Fair Trading (OFT), cites the practice of pay-for-delay, whereby a firm that holds a drug patent pays a generic manufacturer not to launch a rival drug to preserve the patent-holders monopoly profits. And David Currie, the chairman of the Competition and Markets Authority (which will take over from the OFT in April), recently pointed to a vast new potential problem, which he described as the growing collection, processing, and use of consumer-transaction data for commercial ends. This is proving an increasingly important source of competitive advantage; we need to be alert to the possibility that it will be an increasing source of consumer detriment.

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ECON 3601 Lecture 10: Lecture 10 – Chapter 11

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