Libya’s Central Bank(s): Between a Rock and a Hard Place

Libya_Inflation_20082013

Source: EIU

The Central Bank of Libya (CBL) is interesting insofar as such an institution resists to some extent the partitioning of the country. It and the Libyan Investment Authority (LIA), the holder of much of the state’s frozen assets, have tried to treat both governments equally while also ignoring their requests for termination of various staff. This independence held until the House of Representatives (HoR) in Tobruk opened their own office in the city of Bayda and decided two days ago to print their own currency. Not a separate currency, but instead decided to go ahead with the money printing the financial committee at HoR believes is needed. The UN-designated Presidential Council disapproved of the maneuver but then after meeting their competing partners in the HoR they reversed course.

Looking at the graph above, M2 percentage change is negative since 2015. One should note that the Economist Intelligence Unit, and for that matter most data sources I reviewed do not have reliable data on Libya since 2014 (the official start of the current crisis). From 2014 the data above is noted as an estimate by analysts but it does seem to match the internal estimates of the CBL here and here. Nonetheless, I think it’s crucial to see the precarious situation that the CBL, HoR and Presidential Council is placed in with regards to Libyan monetary affairs.

For one, culturally in Libya households have held on to money since depositing cash into commercial banks would limit spending since banks are limiting withdrawals due to cash shortage. This has been a way of life for most Libyans I know. In Tripoli, since 2015, cash withdrawals have been limited to varying degrees. As of recently at major commercial banks it is 500 dinars per customer. The driving factor is both poor economic performance and money hoarding in Libya. In particular, the money supply (generally across all measurements) has been ‘flat’ since 2014 but inflation has crept. Driven by turmoil in the country (likely a supply-side shock). This brings in to question, should the central bank print no matter the consequences to alleviate the cash shortage that effects every day lives or wait for a political solution to occur.

The reason I mention the political solution, is that a large amount of Libyans earn an income from the state, especially young people who traditionally in Libya got their first job working for the government (quick read on the post-revolution economic situation for youth here). However, public revenues have fallen considerably. This has dramatic effect on the aggregate demand of the economy. That and a fall in the productive capacity due to the fall in oil production and increased private sector rigidity really leave the central bank, and more importantly the government(s), in a variable situation.

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Source: Central Bank of Libya, Economic Bulletin 2015Q2

In my opinion, I would bite the bullet and print the money. I don’t think Libya will have sky rocketing inflation due to general low exchange of hard currency due and it’s supply-side constraints that are tied up in politics and war. It is worth it only because it would breath life into the business sectors in Tripoli, Misrata and Benghzai, where idle businessmen can’t pullout their own funds to do work with.

This recommendation and much of the analysis is mired with poor data. Employment information is limited as most sources have the same unemployment rate for Libya over the last 5 years, ranging from 20-35% with not enough detail to compare with other indicators. But the public sector spending fall is clear. In a country that only went through limited privatization before 2011, there is a lot of dependence on the state (health, education, utilities). The current partition is the source of the majority of economic woes in Libya, be it the cash shortage, medical shortage, education delays,  or miscellaneous subsidy delays. In the end, nothing can improve without proper institutions. This is a bit of a cop-out but it remains a true fact about Libya.

Focal Point in the Libyan Civil War?

The current developments between the various parties in Libya, especially following Hafter’s recent interview and the Vienna conference on the 16th of May, have been interesting to say the least. In the variety of analysis on the solutions in Libya, including those editorials endorsing certain figures, there is a lack of understanding where each party stands in bargaining for a position of power.

To simplify the conflict I will do away with the smaller tribal conflicts in the south and the pervasive new crime wave across Libya. The reason is that compared to the other features I will mention they won’t determine the future of Libya, in other words their weight on any future state is negligible. I also don’t think it is important to analyze arms control when one wants to understand why some parties logically don’t give up. Yes, some groups receive weapons through the porous borders and banana republicans in the middle east, the weapons aren’t more useful or effective than brigade size. In the end it’s just bullets and Ak-47s. The technologically threshold has been maximized for almost all belligerents.

There are two sets of conflicts. This is reached by crude simplification of individual conflicts, and the web of allegiances can be bundled together to determine the aggregate conflict (Fajr vs. GNA vs. Dignity).

On the lowest level there are militias that protect regional interests. These interests are the cities they are from, usually they were the militia that removed Gadaffi loyalists in 2011 from said city. The have local support and political support from similar groups that view them as fellows in the fight against Gadaffi. Some groups are multi-city troops. For instance Hafter’s 2014 insurgency against Islamist militias was formed from anti-islamists militias and military units reformed by the General National Congress (GNC) and National Transitional Council (NTC). In the need to keep this analysis broadly about the general conflict, suffusive to say most of the Operation Dignity’s political support comes from Eastern Libya, due to figures from there supporting Hafter and Hafter’s reciprocal support for some of their military figures. In the west, Misratan militias have almost full support in Misrata and contain unique centralized leadership tied to the municipal government of Misrata. Again, due to the war in 2011 the Misrata faction receives political and regional support. This for Misrata extends weakly from Misrata all the way to Zawiyah and the Nafusa mountains. There is a inverse relationship between the distance from Misrata and the acceptance of Misrata based security forces. With the GNA, it seems Misrata may enjoy extended support if it becomes the “LNA” for the Government of National Accord (GNA). There are similar groups in Tripoli, Nafusa Mountains, Zintan, Zawiyah and Sabratha.

The groups mentioned above have alliances amongst each other. In the case of the non-LNA party they have allegiances formed due to cooperation in the revolution and subsequent cooperation to lobby (more accurately threaten) public officials of the first GNC to give out contracts to militias and ban Gadaffi-era officials from military posts amongst other positions. The dignity operation is the formed from former Gadaffi brigades who revolted at sometime in the war, a minority consisting of “new” army trained by the NTC, Zintani city militia and tribal militias From the Northeast.

In the Zintani and GNC government militias conflict, it is a proxy for the general Fajr (Misrata, Tripoli militia alliance)-Dignity conflict. For the last few months there has been a cease fire with territorial control centred around the Gheryan. The point of consideration here is that Gheryan is geographically a focal point. The road to Gheryah from Azziyah leads to the mountain pass to the city and then to much of the Nafusa mountains. Thus behind Geryhan is an expectation that one’s enemy will plan primary checkpoints around the city depending on their geographical starting point.  Much like a river is a common retreat point for armies. It is an equilibrium solution if both parties decide that eventually they prefer to concede (for a limited time), assuming they know each other’s expectation. This same focal point ceasefire is seen going west from Gheryan to the Tunisian border and down to Sebha. Both parties here have not confused their intentions. All parties have it in their best interest to avoid incidents like the Tripoli Airport conflict.

This is not observed in the more political and aggregate conflict. There is no focal point between Hafter and GNC (now GNA). The main reason is information. There have been no clichés, incentives or any informational clues that can solve the tacit bargain for seat of power in Libya. One important consideration is that in any war in which there is tacit limited conflict the consideration of focal points can help parties find some resolution since the war is not zero-sum. Misrata and LNA don’t face each other in conflict at all. There is no way to understand what plan they have as a contingency when they fail. Or what is is the “second” best result. There is clearly here confusion in the conflict. There is no river, no mountain pass, no Nash equilibrium in this limited war.

Moreover, my main argument is that in fact the confusion that leads to the institutional lack of focal point is that inside theses parties, in any of their parts, there is a lack of information on leadership, structure, and goals. Consider Hafter, he was decried by the newly elected parliament before its official formation in Tobruk. Then he was accepted, since then he has yet to appear in front of parliament to report on advancements in their fight against the Shura Council in Benghazi, a militant jihadist group. This lack of communication between a military general and the government makes the door to political reconciliation difficult to open. There is no focal point politically if the goals of Hafter are not known. He may be a rogue general, it is nearly impossible to make an educated guess.

The internal communication issues exist in the alliance between the Libyan Revolutionaries Operations Room (LROR) and Misrata. Besides a few skirmishes in eastern Tripoli that I remember being reported only faintly (only because it was common in Tripoli to attack groups who arrest your militia members for crimes), the alliance is weak. They don’t form a proper operations room or military. They don’t share a point of command in any government. Thus, they don’t share a plan or strategy. The formation of an operations room by the new UN-supported GNA from Misrata brigades and their closest allies is trying to fill this gap by having the Presidential Council become the point of decision making for all militias so that they can eventually organize themselves into a structured command without relying on Gadaffi-era members.  Regardless, they are independent operations with self-involved goals. This makes it unknown to the parliament, the UN, and Hafter what is their internal logic and expectations from the conflict.

The solution is clearly a third party mediator. Sadly the UN has been involved aggressively throughout the process. But when comments by Hafter reveal distaste for UN intervention and LROR threatens to fight a UN-endorsed government one begins to see that mediation is a point of contention amongst the parties.

So, the focal point is non-existent in the Libyan war. The Vienna talks might reveal a new focal point if it pushes the parliament in Tobruk to accept the GNA, causing concessions between groups as a communication channel opens. However, if Hafter remains difficult with the media (and public officials who govern him from Tobruk) and the Tripoli based militias lack internal control then the rising confusion leads to no general political focal point for Libya. Simple symbolic signals are important too. LROR and Misrata brigades don’t have the same uniforms, not between both groups or within each one separately. This further makes Libyans and their opponents skeptical of their current efforts anywhere.

It may seem the details I have discussed here are unnecessary for the conflict resolution. Certainly this thesis of confusion in the game of war is never discussed by any articles I have read on Libya. Articles focus on ideology of groups, which is important when discussing the ISIL, Ansari Alshari, and Shura Council of Benghzi. However, there is little to no use in islamist or liberal labels to explain the rest of the war. To put it bluntly, the most anti-Hafter city is Misrata due to the fear of rogue generals. The experience of Misrata in 2011 is dreadful and the city arguably will need another decade to recover, politically and economically. Same in Benghazi, where militias who use the word “revolutionary,” to excuse their assassinations and murder recked, havoc and killed a beloved ambassador. This experiential perspective of two unique cities in the conflict started the issues we face today. To solve it, some communication must happen so that at least both sides get systemic access to each others true expectations. This seem frightfully simple, and supposing this is the solution I won’t be surprised by the hindsight laden article in any publication noting that dialogue was a solution all along. Dialogue may seem simple in hindsight, but dialogue is hard to do and many individuals are preoccupied with ISIL sleeper cells and new governments. Hardly do they have time to revisit the structure of their command completely and commit to rationalizing the expectations of their enemy.

There is more to discuss about the conflict. In fact, as I noted in one of my previous posts, I find the conflict ripe for the type game theory analysis that deals with information asymmetry and reputation, likely with  multiple equilibria. The question becomes, in which “solution” is Libya a democracy and can one predict it. There is no focal point in Libya and if there is no focal point I can’t adequately predict a resolution.


Sources on militias: http://www.bbc.com/news/world-middle-east-19744533

More updated source: http://www.ecfr.eu/mena/mapping_libya_conflict#cap0

Note: All sources on militias completed by foreign or local sources is bound to be incomplete, like I noted the structures intra-militias isn’t always well defined due to lack of proper leadership and anarchic banditry.

PS I highly recommend Chapter 3 and 4 from Thomas Schelling’s great book, The Strategy of Conflict. There are a lot of great Libyan writers and journalists. Mohamed Eljarh is great. Also, this site  run by Jason Pack, a History PhD at Cambridge University, is wonderful.

 

Lloyd Shapley (1923-2016)

In March Lloyd Shapley sadly passed away . His paper with D. Gale, “College Admissions and the Stability of Marriage”, is fascinating. I am unsure if Shapley set out in 1962 to answer questions in economics explicitly. I say this because this paper really does speak like an economics paper.  Supposing you are matching pairs of people (i.e. marriage), stability is defined as a position in which any person from at least two pairs can leave the pairing for another also willing to leave. A stable position leaves no more room for ordering. Similar to Pareto optimality, you can’t make another person better off without making some else worse off.

The stable marriage problem and the solution to gain optimality and stability is surprisingly easy to understand. Shapley and Gale wrote the paper in very clear English. In fact, they comment on their use of plain English and precise definitions in the concluding remarks:

Most mathematicians at one time or another have probably found themselves in the position of trying to refute the notion that they are people with “a head of figures,” or that they “know a lot of formulas.” At such times it may be convenient to have an illustration at hand to show that mathematics need not be concerned with figures, either numerical or geometrical. For this purpose we recommend the statement and proof of our Theorem 1.

Many more results from this seemly simple problem and their solution to it have been discovered, some in fact very simple but only recognized a few years after the paper. The stable marriages problem algorithm is commonly summarized as:

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Result 1: For any equal number of men and women, the algorithm terminates

Simple Proof:

No single man can be rejected by every single woman. This is because that would mean that all the women are married. But since there are equal numbers of woman and men, this is impossible.

Result 2: When men propose all the men have the best pairing they can get in any stable matching, and women have the worst possible

Simple Proof:

Suppose after the first execution of the algorithm, by contradiction, you create a set of pairs so that any man prefers w’. In the original execution this means he was rejected by w’ in place for m’. So in the arbitrary matching there is no stable position for (m’,w’) as both rather be together. Thus in the executed algorithm, and not the contradictory one, not only does giving each man his best possible stable match give the only stable match for the same set over and over but it is also the best the man can do, assuming they are proposing.

For the women’s choice, supposing again a contradictory set of matchings, M’, but compared to the algorithm’s results the woman prefers the m (from the algorithm) matched to her to m’ matched to her. This means that m, w cause M’ to be unstable unless in the initial algorithm (which we know to be optimal for the man) he prefers the match in M’ to w, which contradicts the fact found in the first part of proof, as the man always prefers the outcome from the algorithm (assuming men propose).

There are various other results, and lots of interesting literature by economists (particularly Alvin Roth) discussing stabling matching algorithms applied to various problems. For instance, matching residences to medical students. Also, there is even more literature in computer science on matching.

Some extra reading on Shapley’s influence can be found here and another piece of mathematics he completed to further economics (with Folkman) can be found here.

For detailed proofs (precise in the way Shapely discusses), and a video worth watching discussing some of the theorems.

Escalation of Commitment in Libya

I should disclose that a lot of topics in economics dealing with political economy and growth theory that I am motivated by come from interest in the affairs of Libya.

Nonetheless, I currently acquired a copy of Thomas Schelling’s The Strategy of Conflict . My interest in the game theoretic nature of the Libyan civil war has occupied my day dreams and detached thoughts for weeks now. In particular, there are two elements of the “game” in Libya I find particularly interesting. First, it is escalation of commitment brought by a sunk cost fallacy and tribalism. The tribalism is essentially a sunk cost fallacy but I think there is a dimension to Arab tribalism that is almost a mapping of what someone thinks the hive mind behaves like.

For instance, in a discussion with a relative, they were oblivious about what was happening in Benghazi or in Sirte or in Derna. Areas where substantial and unusual islamist radicals have flourished. The individual was reasoning because his local area’s leaders have said it doesn’t exist then no one thinks it exists. This is different from the presumption I had that people tied to groups because they were attached to their identity then followed their deeds, but in Libya it is like the group is a short cut to normal thinking. A secondary dimension is added.

Secondly, the proxy war in Libya can exist even when it doesn’t through rumours. While the interests of various Arabic parties and Turkey are murky it doesn’t stop the discussion between militia leaders from divulging into lumping a proxy onto another militia. At times with negligence. Tribalism plus false narrative can certainly fuel the “game”.

The two governments in Libya almost ask to be modelled into a paper. Leaving me to wonder if a game with sunk cost fallacy or escalation of commitment exists and whether simple “narratives” can be reconstructed in a game. I’ll certainly try and find out while the weather is cold this weekend.

Democracy & Oil

Common conjectures on oil rich nations is that they have rampant despotism, militarism and general lacking of democratic institutions. This is mostly due to the examples set by Iraq, Saudi Arabia, Venezuela, Iran, Qatar, and Libya to name a few. But there are some rich countries with what can be seen as good governmental forms that are rich in oil. For example, one can just look at the US, Canada, and Norway as examples. Frequently conflicts amongst the former list of nations surrounds natural resource. This leaves one to wonder if their lack of democratic reform and general economic develop is linked to the abundance of oil.

Analyzing any data could create issues of endogeniety. This mostly comes from what are the expected tenures of despots, how their organization is structured, level of economic freedom within the country, whether the state extracts the oil or not, the rate of oil exploration, war in neighbouring countries, etc. Any of these can in many ways create issues when analyzing panel data of oil extraction, conflict, oil reserves, oil revenues, and so on.

Interestingly enough the general result on democracy and oil from panel data, from Robert Barro, shows a negative correlation between democracy and natural resource production. Which is dummied by oil.

Ross (2001) is even more interesting since it really brings the question of whether “Oil Hinders Democracy” directly to the headline. My conjecture on how the hindrance of democracy occurred relied on the simplification of dictatorial regimes as bandits. Supposing a bandit found a source of wealth to extract from but didn’t want to break enough law to get removed. The existence of oil would attract bandits to government, wherein they would “unjustly” extract the oil for themselves until no profits are to be gained. Essentially, dictators stay in power until a revolution or the profit to be earned is non-existent.

Ross uses a similar concept to the one from my conjecture. He defines “Rentier States” as states that depend on rents from oil. I suppose one can describe dictators as bandits, which is a stone’s throw away from “Violent Rentier”. The “Rentier State” is tested by Ross by adding to his model taxation and government consumption. This is to see if the government itself depends on regular taxation or extraction of oil profits.

The overall results Ross shows are fairly strong and seem to be replicated by Tsui (2011). Ross also finds, similar to Barro, that generalizing from oil to natural resources by including mineral resources shows that indeed they too can impede democracy. Cases like Chile, Angola, and Cambodia ring true. Broadly, the hindrance of democracy is far more common in poor states, after controlling for developed Western states Ross’s results show that oil rich poor states are especially in danger. In Ross’s testing he considers the change in regime if oil worth $10 Billion is discovered (figure 2). The results are chilling in a sense, as clearly seen a country like Canada or US with ~45,000 in income per capita sees no fall in democracy.Screen Shot 2016-01-26 at 1.27.36 PM

What if any implications does this have? I certainly am stumped. One could thank years of good economic institutions for the democracy in OECD nations. Much of growth literature over the years has been surrounding the institutions left over after the colonialism and WWII. The MENA region for this reason may continue to suffer from escaping rentier dictators if the rents are easy to take hold of.

 

Pseudo Dichotomy in Positive Economics

‘What ought to be’ and ‘What is’

The two statements above are clearly equatable with normative economics and positive economics, respectively. This comes to us by Hume, Samuelson and Friedman. These terms I believe are less appreciated outside the glossary list of day one of economics 101 at various institutions. However, more than this I always felt another dichotomy existed. Specifically within positive economics. This secondary dichotomy is not so much a strict split, nor does it muddle the differences between normative and positive economics. There still remains a very distinct difference between what is and what ought to be.

Consider theoretical work on optimal decision making in any specific decision faced by an agent. Now let’s assume the work is game theoretic in nature and the suggestion by the economist is whether a certain decision is the optimal condition. Or rather claims multiple conditions based on multiple parameters are the most optimal. This still is a positive analysis. What is the best is clearly a ‘what is’ statement with no value added of the implications outside the paper for the claims, still that leap could be made easily in this hypothetical case. Though other positive economics statements are sometimes purely empirical and reached through economic tools and econometrics. Saying that “consumers in the tinplate industry faced gains due to increased international trade in the industry” is an empirical positive claim. The dichotomy, existing mostly between empirical and theoretical positive claims, exists only in partial form and is unnecessary to make note of. There are situations when claims by people recently introduced to behavioural economics or any sort of criticism of economic theory, such as expected utility theory come to believe because a purely or mostly theoretical paper using a rational actor is unrealistic it means that it is useless. To borrow Richard Thaler’s phrase for the rational actor, Econs, people who view a positive paper on Econs assume it is replicating reality rather than finding optimality or analyzing choices for the sake of analyzing choices. While there are sometimes gaps in descriptive analysis that behavioural economics has filled in, the pejorative of Econs doesn’t completely apply as a critique of positive economics.

Description isn’t the only acceptable form of economic science. Finding truth and knowledge is. And that can be found even in the strictest and unreal of assumptions. It may seem incredibly unintuitive for an individual who enters economics without any experience. However, if one ponders a research idea or is intrigued by a problem to solve then the economist becomes an engineer in a sense and those “unrealistic” foundations of some models in positive analysis becomes useful guides and benchmarks to normative science. This is why Milton Friedman’s writing on methodology, no matter how brash at first his statements for some on assumptions may seem, the insight into positive analysis in economics is very unique and not a diametric balance between unrealistic (bad/biased) and realistic (good/unbiased) assumptions. The assumptions economists make can be abused similarly to novel cases of p-hacking. However, science is hard and novel examples of unintended or intentional abuse of unrealistic assumptions shouldn’t discredit a field.

So, is the dichotomy I mentioned in positive economics that creates a secondary ‘what ought to be’ and ‘what is’ level of analysis real? Not fully, only a in a crude matter to non-economists like myself. But discussing this crude dichotomy may help some detractors, whether from unorthodox fringe schools of economics or media, understand the scientific method in economics.

Strength of the Infant Industry Argument

In my last blog post I noted that infant industry argument is one of two serious academic attempts at discrediting international trade liberalization. I referred to “race of the bottom” as empirically unfounded as seen by referring to the literature and intuitively makes no sense. The infant industry argument though has some history of being valid policy focus advocated by Alexander Hamilton and John Stuart Mill, especially with the messy analysis of trade policies at the turn of the century. The free trading British Empire and protectionist United States complicate discussion with confusing anecdotal evidence. So, this means to get a good idea you have to look at current evidence and past evidence, specifically look for natural experiments.

To a large extent there is such a thing as an infant industry. Some level of soon to be realized comparative advantage. Take for instance differences in industrialization between European countries and North America between the 20th and 19th. Defining infant industries has always made me hesitant, and in past I considered the argument to a large degree unfounded mostly because I couldn’t picture how a planner could go around determining missed potential in industry. I think the best way to see infant industries besides the traditional definition (industries with costly learning curves compared to established foreign completion) is an industry requiring temporary protection to produce at competitive international prices until economics of scale set in. Further, in academic fields, previously (and in some cases today), using New Trade Theory arguments that increasing-scale-of-returns industries are the preferred industries to protect. Some have used this viewpoint and data from 1800s-1900s to explain two opposing arguments using natural experiments.

I am not an economist (won’t be for a couple of years) and at this point I haven’t take an international trade field elective yet, so this obviously means I am not up to date on New Trade Theory or New New Trade Theory. So, my views will/may change as I continue this blog. So, I guess take this as a disclaimer. My motivation for writing anything is that it is enjoyable. Let’s hope no planner, for the sake of society, reads this.

International trade isn’t as much of a monolith as I thought it was, I think Paul Krugman puts very nicely in his Nobel lecture. Probably as a detriment of macro 101, one assumes that international trade ends with Ricardo. The comparative advantage model explains a lot, specifically why different countries are good at specific things but New Trade Theory (NTT) fills underlying theoretical gaps and shows even in similar countries why different industry grow out. However, sometimes a few people reason from NTT that this means that any country should at any cost recreate Alexander Hamilton’s world and protect firms (preferably new firms) in industries of increasing returns. However, the insight of NTT is that increasing returns in countries of differing capacities or similar capacities is that both exporter and importer benefit. Protection reduces the win-win situation of free trade. There can be protection tools that can assist in the learning of firms in infant industries but as I mentioned in my last post some individuals hold onto infant industry argument as the end all be all of international economics. It is not.

A recent paper by Canadian economists on manufacturing between 1870-1913 uses learning-by-doing models to show that protection increases productivity, market size, output and price reductions. Specifically, ‘National Policy’ during that era, which was Canada’s mirror of the ‘American System’. Critics of national policy are common and certainly are recognized by Harris et al. However, it should be clear that even they noted in a footnote on the second page that tariff protection is not costless. Which again brings me back to insight of NTT. That is that trade liberalization can bring greater positive welfare effects than infant protection, a win-win situation. They do find that using Krueger and Tuncer’s (1982) focus on output of infant-industries, however applied to a large number of industries shows that in fact one can find evidence of infant-industries improving. With increasing returns, some Canadian industrial firms reduced prices. But remember tariffs have a cost. The alternative is cheaper goods from abroad at a lesser cost. And certainly the mixed evidence in other countries, like Turkey in Kreuger and Tuncer (1982), shows that this isn’t a hard and fast rule, one doesn’t have to always and everywhere protect new industries. Plus, Canada’s National Policy wasn’t a huge positive for the general growth of the country in that time period.

Another historical analysis during the turn of the century is by Douglas Irwin, unlike Harris et al (2015) opposes infant Industry argument which is actually quite difficult to do in an absolute sense empirically. Consider the ‘National Policy’ paper. A show in positive output growth that matches a learning-by-doing industrial organization model is a clear result, one has to show an empirical counterfactual to counter the case.

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R. Harris et al. / Explorations in Economic History 56 (2015) 20

Showing the counterfactual is far more difficult empirically. There is a puzzle that can leave one agnostic about infant industries as a whole. Consider that Irwin notes that “Learning by doing had only a modest impact on costs”. He modelled a counterfactual and simulated pricing alternatives. It was clear the tinplate industry didn’t have to create completely new practices. They adopted other practices and technologies, from the far more free trading UK. Irwin’s paper is fairly well cited and it’s findings make the case for protectionist USA as the best USA possible at that time questionable. Learning-by-doing is a large defence of infant-industry but learning isn’t always expensive just because an industry is new.

But what about areas with strong learning effects, larger than the tinplate industry. Keith Head (1994) discusses steel rail industry and the costs of the protection of the industry in the U.S at the turn of the century. Like Irwin, here is a relatively successful attempt at simulating the counterfactual. In fact, I would argue that the counterfactual of free trade is even important to the pro-infant industry argument even though it is generally lacking. Anyways, Head simulates a free trade policy and finds a net negative effect from the infant-industry protection. In this case the learning by doing effects are existent and yet the policy is no good. He mentions Baldwin’s 1969 paper on the Infant-industry tariff protection. It is very clear that tariffs are a very blunt tool. Baldwin suggests input subsidies as an alternative second best policies that aren’t net negatives on welfare of the public.

I think it is pretty clear the common historical argument that supports early tariffs in the US and Canada is weak, if not false. The counterfactual is rather more rosy about free trade. But tariffs are a blunt instrument, the effect of subsidies I would assume from reading Head and Irwin’s writing are not terribly negative but unnecessary, especially if the learning-by-doing means nothing to the models of NTT. In a blog post, Krugman noted that people in love with the tariff protections mention their arguments as capturing NTT very well. However, he notes that:

[…] that was not at all the point of New Trade Theory, which ended up suggesting that concentration of production due to increasing returns is generally beneficial to importers as well as exporters of increasing-returns goods, that it generally reinforce the case for open trade, rather than undermining it.

I don’t know what I would say considering export subsidies, usually subsidies are a counter argument against the knock down of the ‘American System’ and Canada’s ‘National Policy’. The growth of Asian countries in the last quarter century I believe are due to high savings rates and open markets. I think it is okay to consider in the case of South Korea that industry subsidies not necessarily protected industries that wouldn’t have existed without subsidization but possibly increased their production after the Korean war as part of its own development. Again, what I am trying to emphasize isn’t that there is no such thing as an infant industry, but rather that protecting infant industries through tariffs is a net negative and pointless. Open trade achieves greater gains. Subsidies may as well be industrial policy, with greater domestic effect developmentally than an effect on balance of trade. South Korea captured a level of comparative advantage when it comes to labor for a long time.

I think this also applies to modern developing countries. With increasing foreign direct investment, through free trade many developing countries have increased living standards and through that human capital. I wonder if free trade has reduced the need to protect infant-industries in any way in poor countries, because of the general sharing of technology and resources (specifically inputs).

On other protection methods such as quotas, I’ll refer to Marc Melitz’s paper that discusses a welfare positive model for infant-industry protection through quotas. Melitz is probably one of the most influential international economists out there. Relating to my discussion of subsidies he summarizes to an extent my views on the matter (views that aren’t necessarily my own but rather the consensus of international economists, I believe):

The economics literature has subsequently developed formal models with dynamic learning externalities demonstrating how protection can potentially raise welfare. This literature has also shown that the protection provided by production subsidies is preferable to that provided by tariffs or quotas, as the latter additionally distort consumption. Nevertheless, production subsidies may not be feasible due to government fiscal constraints and distortions associated with raising the needed revenue.

This leads into his research and modelling that concludes with the second best policy of quotas, a quota that depends on the learning curve. It is really interesting and I really don’t have much to say about it. Not that I am knowledgable enough to say much about the others but I found it rather important as I was attempting to gather a perspective on infant industry when no surveys were available online.

There is a lot to infant-industries and I found that it has a lot more to do with industrial organization than a way for developing countries to improve or proof of the incompetence of free trade. Tariffs as I noted are useless, at least according  evidence that considers both output statistics and market analysis (papers that considered welfare implications and costs of tariffs on top of learning benefits). Subsidies I am unsure of, though I conjecture that they don’t explain South Korea entirely (a possible post topic if I get time to do some research) or China’s industrial sectors. Quotas, like subsidies I am not sure of. Something I didn’t really research that I would assume many economists have considered is the market power considerations. I am interested in seeing what the effects of giving market power to infant industries under any artificial conditions are like. Now I only wish this was made easier through some published survey on like this one on infant-industry. Many discussions I found considered infant-industry in parts, not within some generalized trade policy, with a few (Irwin, Head, Baldwin) considering the policy as a whole.