Trade, Foreign Investment, and Industrial Policy for Developing Countries 4067

most likely to succeed on world markets in Indonesia were in fact penalized by restrict-
ing their access to import licenses.
There are a number of other areas where additional research is needed. To properly
test the type of model presented in Section 2, we would expect initial output and produc-
tivity gains from the imposition of tariffs; later removal of these tariffs would generate no
effects. We are not aware of any studies that test for these asymmetric effects of imposing
protection and later removing tariffs through trade reform. Nor do existing empirical stud-
ies address the many other reasons why infant-industry protection may not work. Domes-
tic demand in LDCs may lack the level of sophistication that would induce firms to meet
the quality standards necessary for penetrating richer markets (Porter, 1990). Porter also
argues that weak competition in small protected markets may not provide the incentives
that firms need to upgrade their technologies and increase their efficiency. Small markets
may also fail to reach a critical mass where Marshallian externalities are fully exploited.
Moreover, as mentioned above, industries that use simple production methods may
expand without the generation of any externalities, even if those same industries do exhibit
strong Marshallian externalities in rich countries (Baldwin, 1969; Rodrı́guez-Clare, 2007).
Firms may believe that protection will fail to create a cluster, and so they may decide not
adopt the production methods that lead to externalities. In other cases protection may
actually favor the use of backward technologies that do not contribute to the generation
of higher industry-level productivity (Sauré, 2007).
The realization of Marshallian externalities is a much more complex process than
what the model in Section 2 suggests. As argued by Rosenthal and Strange (2005),
“there are many different aspects of a location that may matter to firms. A well-
intentioned policy could easily fail because it failed to attend to one or two of
these . . . it may not be possible to duplicate elsewhere the circumstances that led to a
successful agglomeration in another place. . . This is not to say that government policy
has never contributed to the formation of clusters. It certainly has, but the formation of
clusters has been a side-effect rather than the primary goal of the policy . . .” (p. 19). In
other words, the econometric evidence regarding Marshallian externalities may in fact
be telling us that agglomeration may be necessary but not sufficient for increased produc-
tivity. If a certain factor, policy or institution is necessary for geographic concentration
of an industry to lead to higher productivity, then we may observe Marshallian extern-
alities taking place in advanced countries, but not in LDCs. To put it crudely, subsidiz-
ing the software sector may not generate a Silicon Valley in a developing country.

3.3 Cross-country studies

There are a number of cross-country studies evaluating the success of IP. These can be
grouped into (1) testing for an association between protection and country performance
and (2) qualitative case study evidence. Within the first group, recent studies emphasize
the importance of the pattern of protection in understanding possible linkages between IP