Michal Lehuta
May 16, 2006
Internal economies
Internal economies of scale arise at the firm level due to falling average total costs (increasing returns) in certain specific good production. The result for the domestic economy is imperfect competition (concentration). Internationally, according to this theory, countries become perfectly specialized as a result of falling opportunity costs. Van den Berg (2004), however, comes to a slightly different conclusion - that of explaining the intra-industry trade (Note: I did not get this argument).
Despite the small ambiguities, increasing returns coupled with free trade provide for a combination of both efficiency in terms of low prices as well as variety thanks to new brands of goods coming from abroad. Compared to Ricardian trade theory, internal economies are rather indefinite about the impetus starting an international exchange. For this reason, the theory is incapable of predicting a trade pattern, leaving the outcome to be determined by history or chance.
External economies
External economies are said to take place at the level of a whole industry due to positive externalities arising from the concentration of specialized suppliers, labor market pooling, knowledge spillovers, and the learning curve (dynamic increasing returns). Their effects include possible non-optimal lock-ins in country specialization, this being the core of the so-called infant industry argument for protection.
Nevertheless, the theoretical situation of a path-dependent free-trade failure are very difficult to identify in practice. In order to substantiate the argument for strategic trade policy, Van den Berg (2004) cites five necessary preconditions. The first, John Stuart Mill test, stipulates that the protected industry has to eventually become competitive and thus gain a comparative advantage. Second, Charles Bastable test requires that the benefits of an industry’s protection outweigh the opportunity costs related to it. Third, a clear evidence of a market failure preventing private individuals to invest in the prospective industry has to be provided. Fourthly, the decision maker has to be granted an assumption of perfect information about the effects of an action taken or withheld. Lastly, no retaliation from other states leading to a non-cooperative (Prisoner’s Dilemma) equilibrium should be expected.
Laura Tyson’s Arguments
Writing in 1990, after a decade when Japan seemed to overtake the US in technological supremacy, Laura D’Andrea Tyson’s main thesis is that a "managed trade" is more sensible for American policy regarding high-tech industry, basing her arguments on external economies of scale. The appropriate response for her would require, in particular, establishing international ‘rules of the game’ of what is allowed and what not in the business, as well as negotiating the economic outcomes when necessary (Tyson 1990, pp. 168-183).
The normative case rests on arguments to promote the US high-tech industry’s competitive strength (assuming external economies), reasons of responding to other governments’ intervention, helping the current account imbalance, or deflecting growing demands for protectionism. Nothing can be criticized about the claim that more specific anti-protectionist rules are to be established for the high-tech industries under the (then) GATT framework. A lot else in the author’s reasoning can be disapproved of, however.
I consider Tyson’s arguments flawed on several grounds. First, the author’s reasoning fails to substantiate when confronted with the five assumptions of Van den Berg (2004). Although Tyson makes an effort to address these, she admits that her proposals represent a "policy gamble" (p. 160), stating literally that "individual [here: government] choices are more a matter of faith, pragmatism, and policy experience rather than a matter of pure theory and empirical evidence" (p. 162). I simply do not accept this approach from a social scientist.
Secondly, Tyson’s text is hypocritical and often contradictory. On the one hand, the author calls for a strategic protection for domestic industries, on the other she insists on fighting for access on foreign markets. This is of course a self-defeating policy when applied by all states (and as such conspicuously resembles obsolete mercantilism). Similar argument holds for her advocating of subsidies vs. rejection of dumping. Her proposed restrictions on FDI in high-tech industries go against the logic of positive spillover effects due to geographic concentration. That is, Americans could benefit from a foreign company’s presence in the country, but they are not allowed to under Tyson’s framework.
Lastly, the text mistakenly uses the concept of current account deficit. Tyson assumes that import restrictions automatically translate into improvements in trade balance, not taking into account the necessary coupled reduction in imports.
