Infant Industry Theory
What it is:
Infant Industry Theory promotes an economic policy that protects young industries in less developed economies until they become established, financially stronger, and capable of withstanding competitive pressures.
How it works (Example):
Just as an infant is defenseless and vulnerable upon its entry into the world, young or “infant” industries are weak and vulnerable to a variety of market challenges and economic pressures. For example, they usually lack a skilled workforce, efficient production processes, experienced managers, and established sales channels and market share even in their own domestic markets. During this start-up phase for new industries, young firms often find it difficult, if not impossible, to compete with the established international competitors.
In practice, governments use a variety of tools, such as tariffs, quotas, and duty taxes, to keep international competitors from being able to match or beat the prices of a new or infant industry. These tariffs and taxes have the effect of increasing the costs to the competitor and giving the infant industry the chance to build an efficient operation and establish its presence in the market. During this period, the new firm or industry is given a chance to grow up.
For example, Infant Industry Theory was the basis of U.S. trade policy after gaining its independence from Britain. At that time, the well-established British and other European products were familiar and sought by the U.S. consumers but were made more expensive by tariffs and duties, giving a chance for U.S. firms to take hold in their own domestic marketplace. Years later, in the late 19th and early 20th centuries, the U.S. steel industry was granted protection from international competition through tariffs and quotas that kept other steel producers out of the U.S. market, allowing the U.S. steel industry to dominate its own domestic market and to compete effectively in international markets.
Why it Matters:
Infant Industry Theory recognizes that a level playing field (i.e. free trade) provides benefit to the stronger competitor and that may not always be beneficial to infant domestic industries. Using protective tariffs and taxes adds cost for the foreign competitor sales process, and while it may give the infant industry a chance to get started, it also tends to disrupt the economics of production and pricing as the industry grows.
At the same time, if tariffs are left in place too long, similar “protectionist” trade policies may be instituted by foreign governments, thereby limiting opportunities for growing firms to expand into those markets. As a result, Infant Industry Theory recognizes that these protections must be scaled back so these new industry adapts itself to produce, compete and survive on a level playing field in the international market.