Import substitution

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Import substitution industrialization (also called ISI) is a trade and economic policy based on the premise that a developing country should attempt to substitute products which it imports, mostly finished goods, with locally produced substitutes. The theory is similar to that of mercantilism in that it promotes high exports and minimal imports to increase national wealth.

The policy has three major tenets: an active industrial policy to subsidize and orchestrate production of strategic substitutes, protective barriers to trade (namely, tariffs), and a monetary policy that keeps the domestic currency overvalued. Hence import substitution policies are not favored by advocates of absolute free trade.

A major (theoretical) advantage touted by proponents, which grew out of the Great Depression was this. If most of an ISI-practicing country's industries were native - food, consumer goods like clothing, automobiles, electronics, and even industrial goods - that nation would only be affected slightly, if at all, in the case of another massive worldwide economic shock like that of 1929, being insulated by its self-contained ISI policies. This proves in practice to be economically - and practically - untenable.

1 Latin America
2 East Asia
3 South Korea
4 Perceived failure
5 Sources
6 See also

[edit] Latin America

Import substitution policies were adopted by most nations in Latin America in the 1930s and 1940s because of the Great Depression of the 1930s. In the 1950s the Argentine economist and UNECLAC head Raúl Prebisch was a visible proponent of the idea. Prebisch believed that developing countries needed to create forward linkages domestically, and could only succeed by creating the industries that used the primary products already being produced by these countries. The tariffs were designed to allow domestic infant industries to prosper.

ISI succeeded only in creating, in some countries, moderate growth, at best, often resulting in inferior, or mediocre substitutes for higher quality products that could more cheaply, and sensibly, be attained in the world market. For example, Brasilian small arms production is a result of ISI, though these goods could very easily, and at much lower cost, have be attained from any number of other manufacturing nations. As a result, Brasil now has a native weapons industry, even exporting such to countries as Venezuela, yet these weapons are of inferior quality to, as an example, German manufactured small arms. ISI was most successful in countries with large populations or high living standards, having already a more solid economic basis upon which to function. Latin American countries such as Argentina, Brazil, Mexico, and, to a lesser extent, Chile and Uruguay had the most success with ISI (Blouet and Blouet, 2002). Smaller and poorer countries such as Ecuador, Honduras, and Dominican Republic were not very successful in implementing ISI policies.

In Latin American countries where ISI was most successful, it was accompanied by structural changes to the government. Old neocolonial governments came crashing down to be replaced by more or less democratic governments. Banks and utilities and certain foreign-owned companies were nationalized.

The ISI strategy ultimately proved a failure for Latin America, being one of many factors leading to the so-called Lost Decade of Latin American economics. A lack of comparative advantage in many industries led to gross inefficiencies, not to mention that their domestic markets were not large nor strong enough. Government subsidies to support domestic production led to a lack of incentive for innovation and improving efficiency.^{[citation needed]}

[edit] East Asia

ISI was rejected by most nations in East Asia in the 1960s, and many economists attribute the superior performance of East Asia in the 1970s and 1980s to this difference in policies. Typically, import substitution policies resulted in inefficient industries.

In addition, the focus of import substitution in promoting industrialization typically resulted in policies which benefited industrial workers at the expense of farmers which made up most of the population of the nations involved. For example to reduce the cost of industrialization, the cost of food was often fixed at an artificially low level. In addition the licensing schemes required for an import substitution strategy led also to rent seeking behaviors which increased economic inefficiency.

In order to build up their manufacturing bases, many countries imposed high tariffs on manufactured goods, so that multinational companies would instead produce or assemble them locally. One example of this was in the motor industry, in which manufacturers exported vehicles in 'completely knocked down' (CKD) kit form, for local assembly. This often resulted in products that were of poorer quality and more expensive than those imported 'completely built up'. It also became increasingly inefficient for manufacturers to have identical products assembled locally in several countries in the same region, which only served to duplicate resources and reduce economies of scale.

[edit] South Korea

One strategy that Korea adopted to boost its competitiveness in the 1970s were export oriented and import substitution industrialization strategy. Investments were made into heavy and chemical industries, such as shipbuilding, steel and petrochemicals.

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From: http://hdr.undp.org/docs/publications/ocational_papers/oc24aa.htm

[edit] Perceived failure

The policy began to fail in the early 1980s, as a result of overspending by the governments involved, mostly from spending foreign exchange reserves trying to keep the currency stable. As the Latin American governments failed, they began to default on their debts and were forced to turn to the International Monetary Fund for help. The failure of ISI led to the rise of the Washington Consensus.

However, some economists have pointed out that the failure of import substitution should not necessarily be taken as an endorsement of globalization. They note that most East Asian countries while rejecting import substitution also maintained high tariff barriers. The strategy followed by those countries was to focus subsidies and investment on industries which would make goods for export. The focus on export markets allowed them to create competitive industries. Although these policies later created inefficiencies and other problems, as seen during the Asian financial crisis.

By the end of the 1990's, the Washington consensus was being questioned. Nevertheless, there has not been a return to import substitution as a developmental strategy.

[edit] Sources

Chasteen, John Charles. 2001. Born in Blood and Fire. pages 226-228.

Reyna, José Luis & Weinert, Richard S. 1977. Authoritarianism in Mexico. Philadelphia, Pennsylvania: Institute for the Study of Human Issues, Inc. pages 067-107.