Adverse Selection in Credit Markets and Infant Industry Protection

This paper considers the role for infant industry protection when credit markets suffer from adverse risk selection. We show that asymmetric information about firm-specific risk leads to under-funding of the infant industry in a competitive credit market. A small amount of infant industry protection is shown to be welfare improving, and the optimal infant industry tariff is derived. Finally, an alternative government policy of production subsidies is considered under the assumption that the government shares private knowledge with infant industry firms. We argue that a tariff may dominate production subsidies as an entry promoting devise in this context.