LESSON

7: A STATE-CENTERED APPROACH TO TRADE POLITICS

As the Airbus versus Boeing case shows, there might be situations where it is good that
governments give subsidies to some industries. Thus, the society-centered approach is not enough
and we need to consider a new one.

STATES AND INDUSTRIAL POLICY

Industrial policies are based on two assumptions. The first one is that protectionism, under
certain circumstances, can raise social welfare (not only harm it because of reduced gains from
trade, as standard theory claims). Moreover, governments can act relatively unconstrained from
interest groups and pursue the goals of national policy makers. They do so through tariffs,
production subsidies and other policy instruments we will explain later on.

This theory has its foundation on the infant-industry case.

INFANT-INDUSTRY CASE

The infant industry theory describes targeted governmental intervention. In the standard
model, government intervention is bad because it doesn’t allow factors to shift to industries
where they will generate more gains. However, this theory states that this is not always the case:
sometimes, newly created firms (infant) will not be initially efficient but could be in the long run if
they are given time to mature. There should be a short period of tariff protection/subsidy until the
firm is competitive enough to enter the market. Then, this measure would be removed and the
firm would capture a lot of rent (extreme gains). When is this the case:

1. Economies of scale: where the cost of production varies with the size of output. The unit cost of
production falls as output increases. An example is commercial aircraft. 


2. Economies of experience: where an efficient production requires skills that can only be
developed while producing (managers, skilled workers and reliable suppliers). 


These measures help improve welfare because after they are removed the industries
generate a lot of revenue. This was first applied in the context of British hegemony by the USA; or
in the time of US hegemony by Japan regarding manufacture.

Thus, our industrial policy concept establishes the policies that governments have adopted
to promote the development of infant industries through tax policy, subsidies, traditional
protectionism and government procurement practices (to channel resources away from some
industries and direct them towards those industries that the state wishes to promote).

STATE STRENGTH

State strength is the degree to which national policymakers are insulated from domestic
group pressures. Strong states are highly insulated, they are centralized, there is a lot of
coordination among state agencies and access to societal actors to influence policy is limited. A
good example of this is Japan. Meanwhile, weak states have a decentralized authority, a lack of
coordination among agencies and large number of channels for interest groups to influence
economic policy.

It is easier for a strong state to formulate long-term plans of national interest that remove
protections and implement distributional measures. This has been the case for Japan and France
(the first with more success than the latter), but even a weak state like the USA has managed to
enact such long-term plans.

STATE-CENTERED APPROACH

It argues that:


State policymakers can use industrial policy to improve social welfare.

Factors cannot move automatically, so government intervention with tariffs or subsidies

can encourage movement into industries.

On the long-run, welfare gains are higher than losses.
The ability to succeed is strongly

influenced by the institutional structure of the state.

Industrial policy is now being applied to high technology industries because they are the

ones that generate the highest contributions to national income, that is, the industry that

produces rents.

STRATEGIC-TRADE THEORY

Thus, we have seen that governmental intervention can help domestic firms achieve

economies of scale and experience to become efficient and competitive in global markets. The

strategic-trade theory helps explain why this is particularly useful for high technology industries.

This approach states the same as the infant-industry approach, but it has a decisive difference: the

market it takes into account is not perfectly competitive, but oligopolistic (such as the one for high

technology).
 The economic dynamics of an oligopoly (an industry dominated by a small number of
firms) are different from perfectly competitive markets. Firms earn excess returns, and thus pay
higher wages. This is why they are wanted by governments (it is a zero- sum competition).

In theory, the firm that enters first (first-mover advantage) earns the rent. However,
government intervention can help to enter established high-tech to challenge it:

The government may provide financial assistance and pay for the costs of research and
development, reducing the upfront investment a firm must make to enter the industry.
Governments may guarantee a market for the early and more expensive version of the
firm’s products through tariffs, quotas or subsidies.

When firms made economies of scale, they could compete against established firms in
international markets, like semiconductors in Japan or aircraft in Europe. These subsidies can even
help bring out already-established firms. The strategic-trade theory has been a source of conflict
between many countries (such as the case of the USA and the EU with Boeing and Airbus).

WEAKNESS OF OUR MODEL

Provides little justification for its central assertion that states will regularly act in ways that
enhance national welfare. Statal actors have also many incentives to act in benefit of their
own interests. Why does the national interest prevail?
The assumption that states make policy independently of a domestic interest group
pressure is misleading, since even in the most centralized countries businesses have
influence and establish parameters for policies. There is a need to fit both the society- and
the state- centered approach, to see how this is exactly shaped.
It produces strong conclusions only under a relatively restrictive set of assumptions, since
there is no real evidence of its assumptions.
Moreover, this model is very difficult to translate into policy.