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dk econ 116 - EconTutor 116 Session 2 2.19.08 1 Infant...

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EconTutor 116 Session 2 2.19.08 1) Infant Industry - Concern: new industries will get destroyed by foreign competition if they are not protected during initial learning period. - Argument for Intervention - Positive Externality - New Industries generate: Their product, Knowledge (public good) - Human Capital of country - Non-excludable so it passes from one firm to another - Social Benefit exceed private benefit - Market Failure - Government should intervene - Argument Against - Government intervention may be hard to get rid of… - Firm grow larger, get more political support. Fight for continued protection. - Hard to measure “positive externalities”, Little empirical support 2) Dutch Disease - Manufacturing sector is the engine on growth - If the country has abundance of natural resources, this diverts factors of production (labor, capital) away from manufacturing toward production of primary products. - Industrialization - Government efforts to push economy away from specializing in export of primary products - Motivation for: - PIS => Primary Import Substitution 3) Stages to Import Substitution - Stage 1: Primary Import Substitution - Develop light industry - Consumer non-durables - Not very capital intensive - Low minimum efficient scale - (see graph 1) - occurs at relatively low levels of output - PIS - Continues until you replace imported non-durables with domestic non-durables - Stage 2 : Critical Choice between PES or SIS - Develop non -durable, light industry base - Choice: - Exporting non-durables - Switch from import substitution (protect industries from foreign competition) to liberalization (lower trade barriers) and export. - Primary Export Substitution (PES) - Promote secondary industrialization - Heavy Industries - Consumer Durables - Large minimum efficient scales - More protections - Secondary Import Substitution (SIS) Probable Outcomes - SIS: Relies on more protection (i.e. trade barriers), Closed Economy, Less competition, Higher prices, Fewer consumer choices, Less efficient firms, Trade Deficits, Foreign exchange problems, Need to import capital for heavy industry but you are exporting less, Too much government interference! - Latin American experience of 1970-80’s, Not Good! - PES: More open economy , More competition, choices, greater efficiency, Trade surplus, Exporting => collect foreign reserves, Fund future industrialization. - East Asian experience of 1970-80’s, Very Successful! 8) Reaching the second stage of import substitution
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- To reach SIS, (1) you have to successfully complete PIS, well developed light industry focused on non-durables - (2) SIS focus on relatively expensive durable goods and this strategy only makes sense if you have a large domestic middle class which can afford to buy these goods.
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