# _Product market issues_

Most arguments for vertical policies focus on externalities on the production side and give short shrift to demand side considerations, in particular, rents. Krugman’s classic Airbus/Boeing discussion was precisely about industrial policies to shift rents arising from increasing returns to scale toward the home country, however this is the exception that makes a critical point.<sup>8</sup> In general, it is preferable to be in goods where some market power is enjoyed and where countries are not locked in ferocious competition over tight margins. This offers an immediate caution to strategies seeking to emulate the success of established leaders or rich countries. By definition, rich and very competitive countries are already producing those goods and hence entry will be difficult. A classic example here is that of Nokia in the 1980s when the government sought to push it into television production- the market was already saturated and the firm nearly failed.

Harrison and Rodriguez-Clare (2010) raise a related and fundamental point about the general equilibrium effects of identifying externalities. If the World Bank were able to reliably estimate and then publish the magnitude of externalities of all goods on _http:/worldbank/externalities.com_ , then many countries would choose to enter those same sectors to capture those same externalities. But this would then drive down the world price, potentially to the point of eliminating the benefit. This leads them to argue that countries should only enter goods in which they have a deep comparative advantage, beyond the assumed market failure, which will be better registered by market signals. This argument is mitigated somewhat if there are _inter-_ industry externalities, that is, the spillovers accrue to the economy as a whole and hence are not being registered in the goods price.<sup>9</sup> Further, to the degree that developing countries have more to gain in learning than advanced countries, they may extract a net benefit.<sup>10</sup>

> 8 The focus on these price considerations raises the issue of market structure and the desirability of reaping rents where the international product price lies above the cost of production.  Though “rent seeking” carries negative connotations, in principle rents are part of value added and desirable.  Such rents can arise where industries have increasing returns to scale, as Krugman pointed out in the work that won him the Nobel Prize.  Both Boeing and Airbus, if they could dominate the market for airframes, would reap large rents. Since increasing returns to scale implies that moving first and fast due to large sunk costs of production acting as a barrier to entry is potentially more critical than “deep” parameters of comparative advantage, governments may engage in strategic subsidies to guarantee that their champion wins the market.

> 9 These were the arguments forwarded by Tyson (1992) in _Who’s Bashing Whom_ for defending the semi-conductor industry in the U.S.

> 10 For instance, the first Intel plant in Costa Rica may teach important economy-wide lessons about the importance of tolerances (precision), the nature of international marketing networks, the best way to spin off new firms from old, and how to provide on time quality inputs to a global supply chain.  Arguably, introducing a new type of chip-driven product to Silicon Valley would have little additional learning effect there.

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