Measuring the Impact of Trade Protection on Industrial Production Size

• Published date: 01 May 2014
• Author: Wei Tian,Miaojie Yu
• Date: 01 May 2014
• DOI: http://doi.org/10.1111/rode.12081

Measuring the Impact of Trade Protection on

Industrial Production Size

Wei Tian and Miaojie Yu*

Abstract

Trade theory has no clear prediction on how import protection affects an importing sector’s relative size. In

this paper, we estimate the impact of US trade protection on industrial production relative size based on a

translog GDP functional system. Using an industrial panel data set and controlling for factor endowments

and technology improvement, we f‌ind empirical evidence that trade protection does not help much increase

a sector’s relative size. Such f‌indings are also robust to both the inclusion of the role of political economy

and the coverage of various non-tariff measures as proxies of industrial protection.

1. Introduction

When a government imposes an instrument of trade policy on its imports, it has a

direct impact on both producers and consumers. An import tariff on a small country

pushes up its domestic import price which in turn leads to higher domestic production

and less consumption on the import. Without a doubt, a very small country bears a

deadweight loss owing to both production and consumption distortions. In contrast, a

large country might improve its national welfare owing to extra gains from terms of

trade. This is because the terms of trade, its world relative price of exports relative to

imports, would increase as a result of the change of the relative demand and supply of

the import. Regardless of a country’s size, an import tariff clearly raises both the

import price and the quantity produced; yet the industrial relative size for the import

sector does not necessarily increase since the tariff could indirectly change the sizes of

other sectors as well.

Therefore, whether strong protection in an industry leads to high output share

remains an empirical question. In fact, one can easily f‌ind opposing evidence for dif-

ferent industries. For example, in the 1960s, the USA abandoned high trade protec-

tion on its footwear industry. As a result, the output in the footwear industry

decreased dramatically (Cassing and Hillman, 1986). Conversely, the story of the

garment industry shows another side of the coin. Traditionally, the garment industry

is one of the most highly protected sectors by the US government, yet its output share

relative to the gross domestic product (GDP) shows a decreasing trend over the years.

In this paper we therefore estimate the effect of trade protection for an industry on

its output share. Our paper contributes to the literature from two important perspec-

tives. First, we extend the seminal work of Harrigan (1997) by considering the role of

trade protection in a neoclassical trade specif‌ication model which believes that the

* Yu: China Center for Economic Research, National School of Development, Peking University, Beijing

100871, China. Tel: +86-10-6275-3109; Fax: +86-10-6275-1474; E-mail: mjyu@ccer.pku.edu.cn. Tian: School

of International Trade and Economics, University of International Business and Economics (UIBE),

Beijing 100871, China. The authors thank Robert Feenstra and Xiaopeng Yin for their very full comments

for this project. However, all errors remains those of the authors.

Review of Development Economics, 18(2), 231–253, 2014

DOI:10.1111/rode.12081

© 2014 John Wiley & Sons Ltd

pattern of international specif‌ication and trade is jointly determined by technology

difference alàthe Ricardian model and factor endowment difference alàthe

Heckscher–Ohlin–Vanik model. In contrast to an ideal free-trade setup, our empirical

specif‌ication is closer to reality by allowing various trade protections such as import

tariffs and non-barrier barriers such as import quota or export subsidy. We f‌ind strong

evidence that trade protection plays a role in determining industrial size for some

manufacturing industries.

Second, our empirical f‌indings themselves also enrich the understanding of the

effect of trade protection. It is a conventional wisdom that an industry could grow

faster under import protection. For more than a century policy makers and even some

economists believe the idea of “infant industry protection” as a favorable argument

for trade protection. Our empirical f‌indings instead cast doubt on such a theoretical

conjecture. After controlling for factor endowments and technology improvement, we

f‌ind empirical evidence that trade protection does not greatly help increase a sector’s

relative size, measured by its industrial output share over GDP.

The objective of this paper is to see how an import tariff imposed on an industry

can change production sizes of itself and other related industries particularly in the

USA. It is important to emphasize that a change in industrial production size could

occur for reasons other than the change of an import tariff. First, the change of indus-

trial output share could be due to factor endowment changes caused by a movement

of international factors or other reasons. For example, consider a standard

Heckscher–Ohlin model, in which labor is migrated from the foreign country to the

home country. The home country’s labor-intensive sector will expand according to the

Rybczynski theorem.

Second, it might be because of the export-biased technology improvement. The

advanced technology used in export-biased industries causes the expansion of export-

able. Accordingly, resources will shift toward the exporting sectors from the import-

ing sectors, which in turn causes the shrink of the importing sectors. As known as

the “Immiserizing growth” initiated by Bhagwati (1958), for a large country, if the

exportable-biased growth reduces the output of the importable good, and if the

foreign demand for such an importable good is inelastic, then its national welfare

would be reduced, in large part, because of the deterioration of its terms of trade.

Third, nontradable sectors grow very fast today. For example, according to the

reports from the Bureau of Economic Analysis (BEA), the weight of professional ser-

vices related to the GDP in the USA reached 20% in 2006. Such a quick move would

make tradable sectors shrink relatively, which in turn also leads to a relative decline

of import-competing tradable sectors. In addition, other domestic industrial policies

such as a production subsidy on import-competing commodities could also make sizes

of importing sectors shrink.

Finally, factors from the demand side could affect the industrial output share as

well. For instance, an increase in the price of substitutable commodities for an

industry could push the industrial demand curve shift right, since consumers will

substitute commodities in the industry for their substitutable goods. Accordingly,

both the equilibrium price and output increase, given others constant. In other

words, an increase in the price of substitutables for an industry could affect its

industrial output share.

Therefore, to estimate the effect of trade policy on production size for each indus-

try, we need to control for other factors affecting industrial production size such as

factor endowments, technology and price changes from other industries. We adopt a

functional form of translog GDP system to handle this task for two reasons.

232 Wei Tian and Miaojie Yu

© 2014 John Wiley & Sons Ltd