Can the ‘Infant Industry’ Protection Argument Help Egypt Overcome its Economic Crisis? | Egyptian Streets

It is no secret that Egypt is suffering an economic whirlwind creating difficult living conditions for many.

The most pertinent discovery in my personal opinion will be raw realization—coming to terms with the reality of Egypt’s longstanding structural imbalances and the fact that addressing them is the only way to sustainably move past an era of recurring crises and fragility in the face of external shocks. But it had best not come to that for the sake of the people, who are under immense pressure.

A fundamental change is needed in the way we view and organize our economy to focus on fairness and resilience as opposed to macroeconomic growth and capital gain. One step to consider is taking a good look at the ‘infant industry’ argument, taught to all economics students at some point, and seeing what lessons can be extrapolated and adapted to the Egyptian context.

The protection of infant industries—those not yet sufficiently strong and developed so as to keep up with foreign competitors—has long been studied and debated by economists.

The Original ‘Infant Industry’ Argument

Notions of protecting young and still-developing industries began, ironically, in the United States by founding father Alexander Hamilton, according to former senior economist at the United Nations Conference on Trade and Development (UNCTAD), Mehdi Shafaeddin.

In a paper on “What Did Frederick List Actually Say? Some Clarifications on the Infant

Industry Argument,” published by Shafaeddin for UNCTAD in 2000, the economist expounds the central tenets of the argument, clears up the misconceptions surrounding it, and evaluates whether it is still useful in the then-current economic context.

For Egypt, by catalyzing the development of nascent industries, new avenues would be open for investments and, crucially, exporting. Moreover, expanding the industrial base is an excellent way to create jobs, and in general spur the economy to action.

Accordingly and though written over two decades ago, Shafaeddin’s paper explaining the original infant industry argument still holds valuable insight for Egypt today.

The infant industry argument is “often made in the context of developing countries at early stages of industrialization” and “a significant challenge to the classical theory of international trade” which focuses mainly on comparative advantage, says Shafaeddin.

Though Egypt has comparative advantages in some areas, it would stand to gain much if it had a larger industrial base in key industries.

“With the exception of Hong Kong, no country has developed its industrial base without resorting to infant industry protection. Both early industrialized and newly industrialized countries applied the same principle, although to varying degrees and in different ways,” he adds.

Under former president Gamal Abdelnasser, Egypt intensified protectionism and heavily favored domestic industry production.

The infant industry argument, though first introduced by Hamilton, was articulated as a comprehensive theory by German-American economist Frederick List.

List believed in a linear approach to development, but he also believed that it cannot take place ‘naturally’ through the market. He saw that protecting infant industries was necessary if countries were in different stages of development. The economist stipulated that protection—tariffs, quotas, or other instruments—must be temporary and targeted; he did not advocate for blanket protectionism, and viewed free international trade as the endpoint of infant industry protection, according to Shafaeddin. Furthermore, protection should be gradually removed, List says.

Gradually, targeted and effective infant industry development will mean moving from labor-intensive manufacturing to high-value, capital-intensive production, as the current economic system—rather tragically—favors capital over labor.

Priority should be given to products that provide “linkages” to others and which require large capital, general knowledge, dexterity, and experience.

Shafaeddin brings to light a dimension of List’s infant industry argument that many have overlooked: according to the economist, List’s vision is about more than just placing tariffs or quotas on imported goods. It’s about increasing the productive power of a country.

The economist explains that one of List’s main motivations for protecting certain industries is so that they can build a solid foundation of education, industrial training, and experience—”development of invisible capital.”

This is “close to capability-building or, in a wider sense, to the theory of State-directed economic development.”

He explains that this is what ‘human capital’ in our modern terminology refers to, accumulated “by doing and achieving dynamic external economies of learning”.

Thus the infant industry theory, usually dismissed by economists for the misconceptions surrounding it, turns out to be originally envisioned as a tool for development, and a way to build human capital—in my opinion the most important type.

List’s theory is therefore not just a protectionist one, but it can also be seen as a “multidisciplinary theory of development,” according to Shafeddin.

This is crucial because investing in human capital is the most important investment to be made, in my opinion. Or, in less capitalistic terms, people’s wellbeing and empowerment. This investment must be both financial and non-financial. In terms of finance, it is a matter of priorities and budget allocation. In addition, projects in health, education, microfinance and encouraging small and medium sized businesses, and women’s empowerment may be easier to finance through grants than other projects such as construction, therefore not adding as much of a burden on the state’s finances in the future.

There is a well-established link between education and economic growth. An excellently-trained workforce would be able to handle the process from beginning to end, rather than paying large sums of money for external consultants and expertise—which is a completely acceptable thing to do, when needed.

Non-financial investments must be made in the form of policy overhauls in areas which develop human capital.

Though the education system has been changed in the past few years, responses by parents and observers were not always positive. In addition to the system being severely underfunded compared to Egypt’s population, the changes were imposed by the ministry of education in a top-down, blanket manner by the whose effect in the classroom and the household did not appear to be sufficiently studied. Bottom-up approaches pivoting on research and case studies should be attempted in favor of a unilateral vision.

What Could Egypt Do About it?

Through this approach, developing countries can slowly stand on their feet when it comes to trade and manufacturing. Rather than only being exporters of raw materials and certain agricultural products, and confined to labor-intensive manufacturing when local industries begin exporting, developing countries can now diversify their outputs and move towards higher-value products.

Therefore, the workforce of a country like Egypt must not be looked at as ‘cheap labor’ that allows Egypt to set competitive prices for its products internationally, but as a force of potential human capital. Such an endeavour requires investments in knowledge, health, and wellbeing to get high returns in the form of technological advancements, increases in productivity, increasing demand as wages go up and people live longer as health improves, and increased societal stability.

Supporting infant industries would also create jobs for Egyptians in the formal sector. The informal sector currently makes up about half of Egypt’s economic activity and the government has recently been attempting to bring it into the formal economy through various efforts such as digitization of payments and getting businesses to register with tax and insurance authorities.

Though suffering from the devaluation and constant inflation themselves, it may be possible to support infant industries in Egypt by providing tax breaks, streamlining bureaucratic processes, building capacities, and investing heavily in human capital.

In terms of tax breaks, the government may consider allocating certain key industries a zero-tax status for a limited time period in exchange for price controls agreed upon beforehand. Pricing should be sufficiently low to alleviate pressures on consumers as well as attract high demand compared to foreign goods, but sufficiently high to generate the needed revenue to grow the industry in question.

As these two considerations clash when it comes to pricing, all factors must be taken into account when one is inevitably favored over the other, even if slightly. Consumers may not be affected by a less than ideal price if the good or service in question is substitutable or non-essential, but at the same time that may mean demand decreases, so a thoroughly-studied pricing strategy must be adopted.

In fact, all economic decisions, and all policy in general, must be backed by evidence and science. Special interests must be removed from the equation. A fair, healthy, and sustainable work and business environment is a prerequisite for infant industry development to succeed.

Moreover, for a country like Egypt that imports much more than it exports, growing the industrial base will mean both the reduction of the import bill and increasing export receipts, which would do wonders for its USD -3.7 billion (EGP -114.5 billion) negative balance of trade where exports are more than double imports in value.

However, while trying to manufacture may increase exports, it may also increase imports amid a dollar shortage as Egypt also imports machinery, plastic, iron and steel, electrical and electronic equipment, amid other things used to manufacture.

Conveniently, List argues that industrial inputs, both raw materials and capital goods “should be exempted from duties, or should be subject to a low level of duties,” Shafaeddin says. This is exactly the policy Egypt should adopt when it comes to importing materials for manufacturing until the balance of trade stops leaning to one side.

Accordingly, it would be prudent to develop the industries which manufacture the components needed for wider manufacturing, such as electrical and electronic equipment and others listed above—adhering to List’s recommendation for having linkages to other industries.

A Unique Case

However, Egypt is in economic crisis. Record-high headline inflation surpassing 38 percent in July combined with a US dollar shortage, widespread uncertainty about the state of the economy, and outside pressures force policy to be both highly specific and highly dynamic.

Due to the complexity of the Egyptian context, which also includes a large and rising population, its unique geographical position, and the politics surrounding the region at large, the infant industry argument cannot be applied as is without creative adjustment.

Placing or increasing tariffs on imports would be disastrous for Egyptian consumers already reeling from non-stop inflation with salaries that are not keeping up by a long shot.

Domestic industries in Egypt already have an indirect form of protection in the form of Egypt’s devalued currency, which has translated to a price increase on all foreign goods. Accordingly, this is a golden opportunity to propel Egypt’s industries forward.

The Final Stage

After developing infant industries for the domestic market, Shafaeddin explains that the next stage of List’s theory involves orienting these industries to be exporters.

For Egypt, this would be a boon as it would bring in valuable foreign currency, helping to stabilize the exchange rate, build up reserves, and ultimately curb inflation. It is likely that, today, Egypt would rather develop industries directly for exporting. This is a policy choice to make, though I believe some supply should be allocated for the domestic market even if there are alternatives, to promote competition.

However, before exporting, the targeted industries must be developed. List’s work on infant industry protection and Shafaeddin’s interpretation of the German-American economist’s trade theory as a multifaceted theory of development may provide a roadmap for economic policymaking during Egypt’s era of successive crises—hopefully as a way out.

The opinions and ideas expressed in this article are the author’s and do not necessarily reflect the views of Egyptian Streets’ editorial team. To submit an opinion article, please email submissions@egyptianstreets.com.

Subscribe to the Egyptian Streets’ weekly newsletter! Catch up on the latest news, arts & culture headlines, exclusive features and more stories that matter, delivered straight to your inbox by clicking here.