4062 Ann Harrison and Andrés Rodríguez-Clare

outcome. If international agreements are not efficient in this sense, however, then
countries would evaluate the impact of IP on welfare while taking into account its
effect on international prices. Clearly, this could lead to a decline in global welfare.
For example, imagine that countries have committed to free trade. If IP for some good
X implies a reduction in the supply of some other good Y then the price of this good
would increase. If IP just barely makes the Home country implementing it better off,
then for the world as a whole (which necessarily sees a decline in TOT) this entails a
loss. Note, however, that this is a general feature of domestic policies implemented
by countries that affect international prices, and not something particular to IP.
Finally, we turn to the model where IP aims at promoting diversification. As in the
cases discussed above, the problem for global welfare may arise from the influence of IP
on international prices. Imagine that the cost of a policy to encourage “self-discovery”
just barely justifies the associated benefits. If such benefits include an improvement in a
country’s terms of trade (which would arise from the decline in the supply of the non-
diversified good), then the global efficiency would decline. Again, global efficiency
would necessarily increase from IP only if countries evaluate it while disregarding its
impact on international prices.

3. EMPIRICAL EVIDENCE ON INFANT-INDUSTRY PROTECTION

AND OTHER FORMS OF IP
Since the best known form of IP is infant-industry protection, we devote most of this
section to a critical review of the empirical literature on this type of IP. As discussed in
Section 2, the theoretical justification for infant-industry protection relies on the exis-
tence of Marshallian externalities. There is extensive evidence that these externalities
exist and are significant (Rosenthal & Strange, 2004). When such externalities exist,
temporary protection may help the country switch toward a better equilibrium, and
this may be welfare improving if the short-run costs are not too high. Protection
may also be welfare enhancing if the protected industry generates positive (interindus-
try) externalities to the rest of the economy.27
As we outlined in Section 2, such a policy would be welfare enhancing only if it
passes both the Mill and Bastable tests. Recall that the Mill test requires that the pro-
tected sector can eventually survive international competition without protection,
whereas the Bastable test requires that the discounted future benefits compensate the
present costs of protection. We emphasize in our review that very few studies of IP
have examined whether industries pass either the Mill or the Bastable test. Conse-
quently, even if we could show that protected sectors grow faster, this is not sufficient
evidence to claim that IP is welfare-enhancing.
Even if the conditions necessary for protection to increase welfare are satisfied, pro-
tection is not the most efficient policy. The theory of targeting (see Bhagwati &