The Infant Industry Argument: Case Study on the Brazilian

Computer Industry
Pooja Thaker

ABSTRACT

Countries have always looked for methods to improve the conditions of certain industries in order to
increase their gross domestic production. Many have resorted to various trade protectionist policies in
the form of quotas and tariffs to drastically reduce imports to develop the domestic industry. This notion
of shielding a particular industry stems from the infant industry argument. This argument supports
protective policies to develop a particular industry. The argument is considered to be controversial as
economists are divided over whether to support the theory or not. This paper reviews the case of the
Brazilian micro-computer industry from 1971 to 1990. It studies the policies employed by the
government to reduce import dependency.

INTRODUCTION

Since the Second World War, most post-colonial developing countries had introduced high
levels of protection for newly developed industries. Such policies were introduced on the
grounds that the new industries were “infants” and that the dynamic factors would ensure
efficiency in time (Krueger & Tuncer, 1982). Protectionist policies stem from the infant
industry argument developed by Friedrich List, a German economist, whose core argument
was that newer industries do not have the same advantages of economies of scale as compared
to the older ones, and thus, need to be protected until they can achieve similar economies of
scale.

First articulated by Alexander Hamilton, the infant industry argument is a controversial topic
under the purview of international trade. In his Report on Manufactures (1791) he introduced
various tariffs to encourage domestic production and give subsidies to increase manufacturing
to make American enterprises more efficient. List, in The National System of Political
Economy (1841) stated that protectionist policies can be justified for an economy trying to
develop new manufacturing industries. He criticized countries like Great Britain for using
protectionist policies to develop their core industries and later insisting on pure free trade. He
said that such countries were “kicking away the ladder” for developing countries. More
recently, Ha Joon Chang, a South Korean economist, voiced a similar opinion that developed
countries are keener to promote free trade after they have benefitted from protectionism.

The argument put forth by List was that new industries face high startup costs relative to foreign
enterprises, they require some time to become competitive. If the industry were to develop, it
would become efficient enough to provide a reasonable return on initial investment and thus

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the infant industry requires a period of protection in order to lower its costs and prepare itself
for international competition (Krueger & Tuncer, 1982).

One of the main features of the argument made by List was that it was essential to protect infant
industries in order to enhance the ‘productive power’ of the economy. He was against Smith’s
invisible hand ideology and did not believe that the market could promote industrialization in
low-developed economies with free trade (Shafaeddin, 2000). Since the establishment of an
industry involves high costs and risks, manufacturers must be given some incentive i.e.,
protection from foreign competition in the early stages of its development. The eventual
creation of a monopoly would reduce the costs and the gradual introduction of domestic
competition would safeguard consumer interests. List gives great importance to development
of human capita or “invisible capital” and wants to achieve dynamic externalities by learning
(Shafaeddin, 2000).

Many economists argue that most countries have used protectionist policies to develop their
industrial base. However, it is still a controversial policy recommendation. This paper studies
the case of the Brazilian micro-computer industry to understand whether the infant industry
argument stands valid or not. The purpose of this paper is to study the literature available,
understand the opposing views of many authors and analyze the case of the Brazilian computer
industry.

THEORETICAL BACKGROUND

For a long time, economists have been divided over a particular aspect of international trade;
they are either supporters of free trade or they promote protectionist policies. But what is ‘trade
protectionism’? Protectionism occurs when countries introduce certain policies which restrict
the imports into an economy. This can be done with the help of tariffs, quotas, embargoes and
subsidizing domestic production. Regan (2006) defines protectionism as a regulation adopted
for improving the competitive position of some domestic economic actors, usually producers
who are competing with imports from foreign competitors. The principal argument put forth
by economists supporting trade protectionism is the infant industry argument.

Infant industrial activities can be defined as those industrial activities that are being undertaken
for the first time in an economy (Bell, Ross-Larson, & Westphal, 1984). According to Sauré
(2007), developing countries face losses due to free trade by specializing in industries
according to their comparative advantage in sectors with dynamic learning externalities. The
argument can be categorized in two branches – the broader classical argument which treats the
term ‘infant industry’ as synonymous with “industrialization” and the narrower argument
which uses the term for a specific industry (Grubel, 1966). According to the broader argument,
the amount invested in an infant industry is insufficient as the private rate of return is lower

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than the social rate of return. Grubel (1966) states that there is a divergence in the private and
social rate of return due to trade protectionism and tariffs should be used to ensure that the
private rate of return eventually converges to the social rate. His narrow argument suggests that
with passage of time, the average cost of the industry will fall below the world price.

Being a controversial topic, there are varied views on whether protectionist policies should be
proposed to develop an industry mostly in low-developed countries. Some authors believe that
the benefits accrued by introducing restrictive trade policies outweigh their static costs
(Greenwald & Stiglitz, 2006). Succar (1987) discusses the validity of the infant industry
argument and also specifies the two conditions necessary for an industry to be considered
“infant”. First, the industry should be subject to dynamic, learning-by-doing (LBD) economies;
and second, the benefits of learning must be at least partially external to the firm. Through the
author’s generalized model of a small, open two sector economy it is demonstrated that the
optimal path of output subsidy in the presence of both intra and inter-industry LBD economies
lies above that when the latter economies are not present. The author gives significant
importance to development of learning opportunities especially in the production sector of
capital goods. The paper studies the industrialization process of certain less developed
countries and revealed that capital goods industries contributed majorly to growth by acting as
informal learning sectors for technical skills. Experience in production in these industries
generated a stock of different types of workers such as managers and engineers. This know-
how helped improve the organization of productive activity and provided the necessary
technical infrastructure (Succar, 1987). The study conducted by the author arrived at the
following three important results:

i. A uniform subsidy should be provided to those infant industries so that the discrepancy
between private and social rates of return can be eliminated.
ii. Protection of inefficient industries with strong forward and backward linkages is
justified even if the cost of learning exceeds the international price.
iii. If the nature of the learning process is such that a firm learns more from its own
experience, than from a comparable level of industry wide experience, the market will
be imperfectly competitive and direct firm subsidies are called for.

The author concludes by stating that trade based on comparative advantage is static and ignores
forward linkages and cannot guide the trade pattern asymmetric leaning opportunities. Thus, it
is important to promote those industries which generate substantial human capital formation in
low-developed countries.

Criticizing the infant industry argument has a long tradition. Baldwin (1969) convincingly
questions the required conditions on the learning process; some authors emphasize that the use
of a production subsidy is a more efficient instrument to induce learning externalities (Baldwin,
2003; Melitz, 2005). He also questions the effectiveness of tariffs in efficiently allocating

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resources to the industries that require them by suggesting that protectionism decreases social
welfare or at least fails to allocate the optimum quantity of resources to the infant industries,
thus, defeating its purpose. In contrast to Succar, the author trivializes knowledge gain by
stating that in a protected industry, the technological spill over cannot be trusted to induce firms
to incur the volume of learning costs as possessed by their foreign competitors. The author
points out that the infant industry argument grossly overgeneralizes the assumption that a tariff
can effectively induce investors or workers to obtain the required information for an efficient
use of their factor resources. Through his analysis, he concludes that duties on infant industries
distort consumption patterns and fail to achieve the efficient allocation of resources which leads
to a decrease in social welfare.

Marc J. Melitz, on the other hand, considers the argument from the perspective of a government
planner. He states that for any industry to be considered as an ‘infant’ must fulfil two
prerequisite conditions – first, there must be dynamic learning effects external to the firms, and
second, protection must be temporary in nature and the industry must become self-sufficient
without protection. Policy choices for protection available to most planners are of three types
– tariffs, quotas or subsidy. The paper studies the viability of each type and suggests the one
which yields the highest welfare. Ideally, the policy maker should reduce the level of protection
as learning advances and do away with protection once learning has ceased. Melitz’s findings
suggest that subsidies and tariffs need to be regularly lowered over time periods and such
changes may not be viable in practice, whereas a fixed quota inevitably reduces its level of
protection as domestic costs fall. The fixed quota can also be chosen so as to become
nonbinding once learning ceases (Melitz, 2005). The author also lists certain drawbacks of
levying a quota on imports. He states that quotas generate less revenue as compared to tariffs
even when their rights are auctioned. Similar to tariffs, they also distort domestic consumption
patterns while subsidies do not. Lastly, binding quotas eliminate market discipline of tariffs
when firms have market power. Melitz concludes by clearly stating that he does not intend to
defend the infant industry argument, and especially does not intend to promote the use of
quantity restrictions on industries. He merely wishes to suggest a policy instrument which is
the least distorting if a government is looking to introduce protectionist policies. Similarly,
Herbert G. Grubel also considers a direct subsidy to be more efficient than a tariff. The reasons
are as follows:

i. The subsidy prevents the loss of consumer surplus caused by a tariff lowering the initial
cost.
ii. The continuous payment of the subsidy results in frequent reviews of the value of that
industry as it is a reminder to society that the protection of the industry is costing it
valuable resources.
iii. Changes in the global market influence the world price and directly the size of the
subsidy, making it likely to be deliberated while evaluating a project.

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The author also analyses the problems linked to subsidies faced by developing countries i.e.,
inability of governments to generate sufficient revenues as they can with a tariff. A proposed
solution was a scheme recommending a hybrid between a subsidy and tariff (Grubel, 1966).

The debate on the infant industry argument has remained mostly theoretical and very few
empirical tests have been conducted to verify the argument. Anne O. Krueger & Baran Tuncer
(1982) aimed to develop a test of whether the infant industry criteria are met and then apply it
to a developing country. The test developed is simple: in more protected economies, input per
unit of output must fall more rapidly. The test was then applied to Turkey as the government
had provided protection to a variety of industries, citing them as infant industries. Industries
such as transport equipment, basic metals, textiles, chemicals, paper and paper products, and
rubber products are some examples of protected industries. The results of the test suggested
that the protected Turkish industries did not experience a rapid increase in output per unit of
input. This was sufficient to prove that the protection for these industries was not justified.
However, this does not mean that there were no infant industries in the list. What can be
inferred is that the trade regime itself may have provided the wrong incentives. An alternative
incentive structure could have resulted in the output per unit of input to grow more rapidly in
some industries. The authors conclude by maintaining the view against the infant industry
argument; with the study on the Turkish industries as protection did not stimulate a growth in
output per unit of input which is the base of the claim for infant industry protection (Krueger
& Tuncer, 1982). A detailed analysis of the test conducted by Krueger & Tuncer revealed that
their study suffered from many limitations. First, no statistical tests were applied by them to
support their conclusion and simply stated that there was no systematic relationship between
productivity growth and protection. With the use of correlation on the same data set, it was
found that there was a statistically significant positive relationship between the level of
protection and the growth in productivity. In contrast to their conclusion, it can be shown that
the protected Turkish industries did achieve higher productivity during the sample period
(Harrison, 1994).

METHODOLOGY

This paper follows a case-based approach to understand the concept of the infant industry
argument and its validity. A case study helps obtain a well-rounded view of any
phenomenon by forming a connection with the theory and empirical data
(Eisenhardt, 1989). The case selected for this purpose is the Brazilian
micro-computer industry, since Brazil has suffered from “classical
dependency syndromes” and had aimed to reduce technological dependence on
other countries. The policies studied in this paper were implemented by the
Brazilian government from 1971 to 1990.

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 Secondary Research: This research paper uses secondary data to support its
claims. In secondary analysis, the available data is scrutinised again in
order to answer the original research questions (Glass, 1976). In this study,
the sources of secondary data are the various articles published on the topic
being analysed in renowned journals. A variety of views on the argument as
well as the case study were taken under consideration.

Research Question: The research question of this paper is understand the

rationale behind the infant industry argument and prove its validity in the
case of the Brazilian computer industry. The analysis of the policies
implemented by the government and their effects have also been included in
this paper. Solutions to the problem of the infant industry argument have
been suggested.

Scope and Significance of the study: This paper predominantly focuses on the
Brazilian computer industry and tries to identify the several policies
implemented by the government and their effect on the industry. This topic
has been selected as it is imperative to understand how to develop those
industries which are lagging especially in developing countries.

CASE

Until 1990, the Brazilian government strongly protected the domestic producers of the
electronics industry, including the micro and mini-computer industry. Many observers note the
failure of this industry to come to par with its foreign competitors. These policies and their
consequences reveal important lessons about how protecting high-technology industries may
fail.

In 1977, the Brazilian military government imposed the national informatics policy initially to
protect the micro and mini computers but was gradually extended to a variety of data-
processing hardware and their inputs. The policy was implemented to gain technological
autonomy and was characterized by the almost absolute exclusion of foreign companies, which
differed from the previous policies of import substitution. The effectiveness of the law for
different types of microcomputer buyers led to the emergence of a large black market in the
industry. Large businesses and public sector buyers could not evade the trade restrictions as
they were easy targets for the enforcement agencies and in contrast smugglers dominated the
market for small purchases. The majority of buyers resorted to illegal means as those imports
were technically better. By 1991, smuggling accounted for around 65% of the total personal
computer market (Luzio & Greenstein, 1995).

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Since the domestic firms did not produce for exports, they solely produced for public sector
buyers and large domestic firms. The firms specialized in clones of the American firms and
clones using every type of hardware became available, for instance, those using CP/M
operating systems, IBM PCs using MS-DOS and clones of Apple’s designs. Similar to the
United States, clones of IBM PCs with Intel chips became the dominant player in the market
by the mid-1980s.

Table 1: Quantity produced and Value (Millions of Real CR$) of Microcomputers Produced

Source: Luzio & Greenstein (1995)

The table above (Table 1) presents the market share of 8 and 16-bit designs from the mid 1980s
to 1990. The real values have been computed based on the data available from the Secretariat
of Informatics (SEI) (1989).

Brazilian Computer Policies

In 1972, the government of Brazil introduced a new body responsible for gathering data on
computer equipment and coordinating data processing activities known as the ‘Coordinating
Commission for Electronic Data Processing Activities’ (CAPRE). By 1977, CAPRE had
implemented an import regulation policy which required authorization of all imports of
computers, parts and accessories in order to reduce imports. The overall objective was the
establish a self-sufficient economy and support a national computer industry without remaining
dependent on foreign raw materials and technology.

By late 1977, a council was established included CAPRE, the military Chief of Staff and
officials from economic ministries. They ensured a government-maintained oligopoly of three
franchises concerning production of small computers. They also regulated imports of
minicomputers through quotas and exceptions were granted only by CAPRE. Computer
component manufacturers also received a similar status with regard to import restrictions. The
council followed a strong nationalist policy by denying foreign companies like IBM and
Burroughs the right to manufacture computer components in Brazil, as COBRA (a national

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firm) had agreements with Ferranti (a UK company) to purchase technology and Sycor (USA)
that provided transfer of minicomputers, parts and technical know-how (Westman, 1985).

The SEI had decreed the micro-computer industry as vital to national security in 1981. A
process of tightening of regulations for the components industry ensured the formation of
another oligopoly. Two Brazilian firms were chosen as manufacturers of components. To lead
the micro-electronic technology industry, the SEI established a R&D centre, the Institute for
Microelectronics. Such developments displayed the government’s commitment to developing
the domestic computer industry.

By 1990, the informatics laws were being perceived as a costly barrier to productivity in export-
oriented industries, especially those using numerically controlled machinery. The informatics
law enforced by the military junta did not receive much support. Thus, the next government
formed by a democratic election in 1990 promised to phase out the laws by 1992. After
ascending the post of President, Fernando Collor de Mello put the plan into effect giving almost
immediate results. The removal of import restrictions resulted in a dramatic decline in sales
faced by the domestic firms as buyers curtailed their purchases of domestic products in
anticipation of an easier access to better foreign goods. This dramatic decline led to an increase
in the unemployment rate of Brazilian engineers and those who remained eventually became
sales representatives of joint ventures formed with multinational firms.

ANALYSIS AND DISCUSSION

Despite fifteen years of a protectionist policy, the Brazilian computer industry had failed to
grow to its expected potential. The domestic industry failed at the infant industry arguments’
main objectives – technological autonomy and internationally competitive prices. Many
reasons have been offered for the same, some of them as follows:

i. The main parts of producing a processor were costly to obtain. The chips were mostly
imported whereas the peripherals produced domestically were priced higher (Luzio &
Greenstein, 1995). Since the domestic industry was an oligopoly of three main
companies, the prices charged by them were higher than that of the multinational
companies based outside Brazil. The industry depended on Sycor for sharing
technological know-how which resulted in an increase in dependency. The profits were
remitted back to the foreign countries (Westman, 1985). Most industry specials were
critical of the higher prices and inferior quality of the domestically produced peripherals
(Rocha, Christensen, & Paim, 1990).

ii. The informatics law forced the domestic computer manufacturers to procure inputs
from domestic suppliers. The SEI had compelled all manufacturers to purchase

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 resources from the government-maintained firms. This policy of import substitution
was implemented to ensure growth of the micro-computer industry. However, the
industry faced an adverse effect. The quotas on imports separated Brazil from the world
economy leading to a rise in production costs (Westman, 1985). Since the market prices
were controlled by the government, the cost of the basic micro-electronic inputs were
around 2 to 5 times the international prices (Luzio & Greenstein, 1995).

iii. The bureaucratic requirements to enter the micro-computer industry were burdensome.
Local firms could only join if they received an invitation from the SEI. They were then
asked to submit their proposals for production of super mini-computers. The
manufacturers found the nature of the invitation ambiguous as it specifically allowed
licensing of technology but at the same time limited the type of licensing (Evans &
Tigre, 1989). The SEI was worried that the super-minis would surpass the Brazilian
market, which is why they encouraged local producers to take up production by
allowing licensing. However, the ambiguity of the licensing policy resulted in the
producers being divided on the issue. The government wanted to achieve “technological
autonomy” and thus did not allow licensing of certain proprietary technology such as
those of DEC and Data General.

iv. The sectoral policies hindered the entrance of new manufacturers, thus limiting
competition. Legal restrictions were imposed on transnational companies prohibiting
them from directly entering the market. Only national firms were allowed to
manufacture computers and peripherals. The definition of a national firm as stated by
the SEI was a firm with headquarters in Brazil and whose control is permanently and
exclusively in the hands of people or companies in Brazil. The SEI had stated that all
manufacturing firms must ensure that 70% of capital ownership was by Brazilians along
with 100% of the voting rights (Rocha, Christensen, & Paim, 1990). This lead to a
tremendous increase in the national firms in the industry, and an overall increase in the
employment level. This policy of nationalization of the computer industry lead to the
Brazilian market being separated from the world market.

After analysing the protectionist policies implemented by the Brazilian government under the
stance of the infant industry argument, it can be concluded that the industry had failed to
develop to its full capacity. Though the industry had witnessed significant growth since 1971,
it had still not reached international standards by 1990. It had become dependent on the import
policy, government financing and the demand from the domestic firms (Westman, 1985). It
was found that the Brazilian computer industry had advanced at a rate equivalent to that of
international standards of technological advance but the legal prices of Brazilian PCs had
stayed higher than that of their international competitors.

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The Brazilian PC industry is an example of a failed attempt at protection under the infant
industry argument. Even after fifteen years of protectionism, the industry was still
technologically dependent on American companies. To say that there were only negative
outcomes of the protectionist policies would be erroneous. The industry did experience a
broadening of the research and development base of the electronics and computer industry. The
policies implemented warranted formation of joint ventures between multinational companies
and Brazilian firms, a strategy which multinationals had avoided previously.

SOLUTIONS AND RECOMMENDATIONS

The infant industry argument has been rejected by many economists as it is believed that
protection of an underdeveloped industry by import substitution is not the best policy choice.
Since the key element in the argument is the positive externality of dynamic production, it is
assumed that this production causes learning which improves the efficiency of production in
the future. It is also assumed that this learning creates a spill over effect in other economies as
well and improves those economies’ productive efficiencies. In the case of the Brazilian
computer industry, this spill over learning was generated to an extent with the formation of the
research and development centres mandated by the SEI. Domestic production of peripherals
increased and were used as raw materials in the personal computer and micro-computer
industries. Nevertheless, import quotas are not considered the best policy as it does not address
the problem of market distortion directly. Economists have suggested that in the case of a
production externality, a subsidy granted to the producers of the targeted industry is a more
effective policy to implement.

An important point to be considered when discussing the infant industry argument is that the
policy implemented for the same should be temporary in nature. This point was specified by
Friedrich List while constructing the argument. According to him, the industry under
consideration should be placed under protection for definite period of time during which it can
grow to international standards. During this tenure, the government encourages domestic firms
to produce in this industry by restricting imports from foreign competitors. This was
implemented in Brazil by the SEI when they placed quotas on imports of personal and mini-
computers. Since manufacturers had to use domestically produced components, the peripheral
industry grew. When the nationalist policy was finally removed in 1990, market analysts
noticed that although the Brazilian industry had grown significantly, but was still below global
benchmarks. A major shortcoming of the infant industry argument is that an accurate time
period for the implementation of the policy cannot be identified. Many argue that the protective
policy failed in the context of the Brazilian computer industry as it was employed for a
prolonged period of time. The national firms were unaccustomed to competition and therefore
did not charge internationally competitive prices. Their cost structures were also higher as

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compared to the foreign players. This higher price and resultant inferior quality lead to the
failure of the policy.

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CONCLUSION

The problem of underdeveloped industries is prevalent in most developing countries. Before

the Second World War, most of these countries were dependent on the European countries for
their technological resources. They mostly imported the capital machinery to fulfil their
requirements. Most of the post-colonial countries did not have high capital-intensive industries.
In order to develop them, the governments employed policies of import substitution on the
basis of the infant industry argument. The case study of Brazil revealed that the argument does
not stand valid as the micro-computer industry failed to develop up to its potential i.e., it was
not at par with the international market. Even though the industry had developed since 1971,
the legal prices of peripherals and computers were still higher than international standards
making the industry less competitive. It was found that the opportunity cost faced by the
Brazilian government to follow this policy rather than opening up to the international market
was around US $716.4 million. This was roughly a third of the total expenditure incurred on
micro-computers produced domestically (Luzio & Greenstein, 1995). By studying the positives
and negatives of the infant industry argument and analysing the case of the Brazilian computer
industry, it can be concluded that employing protectionist trade policies creates market
distortions which ultimately do not bring about an increase in national welfare.

FUTURE RESEARCH DIRECTIONS

Extensive research has been conducted in the theoretical field of the infant industry argument.
Most authors disagree with the arguments put forth by List and state that protectionism has
more negative than positive effects on an economy while other authors defend the argument
on the grounds that the developed countries had also followed protective trade policies while
developing their capital-intensive industries. Further research can be conducted in comparing
the opportunity cost of implementing protective policies and opening up the industry to the
market economy. Studies could be conducted to understand the efficiency of import
substitution policies and which particular costs it affects in the industry. Other policies to
encourage domestic production may have lower costs and reviewing the same would be helpful
for future government decisions.

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