IMPORT SUBSTITUTION
I. Introduction
During the past 100 to 200 years, the countries of Western Europe, northern North America, and Japan have experienced more or less sustained increases in measured GDP per capita; while in the countries of Asia (except Japan), Latin America, and Africa the output of goods and services did not increase in this steady, regular fashion.
In the late 1940s, after the dust of World War II had settled, the world became acutely conscious of the fact that a relatively small number of countries and a small proportion of the world's population had access to a vastly larger quantity of goods and services per person than was the case in most other countries of the world. Even more fundamental was the fact that in most countries, a large proportion o Import substitution may be described as a development strategy that seeks to accomplish both of these objectives: to learn from, and in general gain from, the rich countries, and, at the same time, to so protect the domestic economy that the society can find its own way, can create its own form of development, and can redo its economy so that it can function on equal terms in the community of nations.
The idea is not so much a matter of the less developed countries catching up with the rich, although some catching up is part of the story. Rather, it is a matter of creating an economy that is sufficiently flexible, diversified, and responsive that it can weather shocks, can respond to and indeed create opportunities for growth, and can, on its own, generate continually increasing welfare for its people. The basic rationale of the import substitution strategy is that in order for the modern, less developed country to make over its economy in the image just described, it needs protection, for a while at least, from the might of the GDP-rich countries. This chapter is about that protection, its content and the instruments by which it is effected, and, of equal importance, what happens in the country while it is experiencing this protection. Finally, attention must be given to how import substitution ends or can be ended, once the country has accomplished the objectives that the protection was to make possible.
Thirty years ago there was virtually no manufacturing in third world countries. Today manufacturing in the third world especially in The Far East and South America is quite substantial. Many economists think that the industrialisation in LEDC is the fastest way to economic growth and social change.
II. The historical preview of worlds's trade
Pre-colonial Colonialism
Pre-1500 Pre-colonial: Maya Aztecs Incas
1500-1700 Trade Monopoly ; concentration of mineral extraction ,various forms of land tenure
1700-1810 Trade diversification : Decline of mineral extraction ; boom of agricultural exports, colonial phase of export oriented growth.
Political Independence
1810-1824 Wars of Independence : Oligarchical control, economic and political instability
1825-1870 Re-entry in Global Economy : Specialization in Raw materials , the UK is the main source of capital and trade
1870-1914 Golden Years : Second phase of dependent and subordinated export oriented growth.
Ø export booms, international peace and political stability,
Ø internal markets and foreign investment
Ø technological innovations (e.g. railroad, refrigeration) and education
Ø light industry (textiles, canneries, construction, etc.)
Ø urbanization, immigration policies
Transition to Import Substitution
1915-1930 Stalled Progress : UK transfers hegemony in LA to the USA : growth model faces unsourmontable constraints .
Ø World War I
Ø unstable commodities markets and export collapses,
Ø incipient capital goods sector
1930-1970 Import Substitution and Populism : Adoption of protectionist policies to foster domestic industrialisation , various modalities of populism and state activism
Ø drop in the availability of foreign exchange decreases imports
Ø social instability: government investment in industries to create new jobs
Ø protectionist barriers
Ø World War II:
Adjustment and Crisis
1980s The Depth Crisis Macroeconomic disequilibria and fiscal indiscipline
1990s Structural Adjustment : Liberalisation and state reform ,second phase of export oriented growth.
Late 1990s Financial Crisis : Currency and banking crisis due to institutional features, appreciated exchange rates ,excessive capital inflows, etc.
III. What is Import-Substitution?
It is a way to try and create a trade surplus is import substitution. This refers to the development of local industries to produce items that a country had been importing. These industries may receive state subsidies or tariff protection. On the surface, this would seems to be a good policy for reducing dependency while shrinking a trade deficit. But it is against the principle of comparative advantage and has not proven effective in most cases. Some scholars think that import substitution is a useful policy but only at a very early phase of economic development, after which it becomes counterproductive.
Or as an other definition import substitution is the replacement of goods and services
purchased outside a region with goods and services produced within the region. In this
sense, import substitution creates "growth from within," as local businesses receive
supply contracts and local residents earn wages and income.
General Views Among Import Substitution
As a Process; Import substitution, like many common economic development strategies, can be
considered both as a process and as a practice.
Import substitution is when goods and services previously purchased outside a region or not consumed due to high import costs are produced within the region. (Lee Huskey, 1987) To start the process, practitioners need to develop the Practice of import substitution:
Import substitution is identifying goods and services which local businesses and institutions plan to buy from outside the area and then determining which items can be competitively supplied by local businesses. (Alberta Bureau of Economic Development and Tourism, 1992)
Import Substitution versus Replacement
In her book Cities and the Wealth of Nations, Jane Jacobs distinguishes between import substitution and import replacement
Import substitution - is when a region replaces imports with goods it already produces.
Import replacement - is when a region replaces imports with goods it can now make for itself.
In other words, import replacement is distinguished by the start of local production tailored to the particular needs and preferences of the region. Jane Jacobs argues that import replacement is far superior to import substitution, in that the region develops the capacity to alter production qualities and creates inputs and products uniquely suited to local uses. She argues that, historically, cities or regions that have been able to engage in import replacement have retained their vitality, while other regions stagnated.
Practically, encouraging import replacement as opposed to import substitution may not be feasible. Deliberate policies are more likely to be able to effect import substitution. Some theorists suggest that import substitution will naturally lead to importsubstitution (e.g., see Sandro, 1995) These pages generally consider import substitution as an explicit economic development strategy, with the understanding that import replacement is likely preferable when feasible and may arise naturally from import substitution.
IV. TheTheory
Import substitution is a strategy that has enjoyed little explicit practice and limited academic study. The place of import substitution within economic development is typically as a justification for a program, and it may be only one of several justifications. The ways in which import substitution efforts may be carried out are varied and malleable. Import substitution strategies are rarely enacted in isolation, butt end to form one facet of a broader strategy, becoming inextricably linked with other development goals and programs such as economic self-sustainability, entrepreneurial
development, or location incentives. Quite commonly, the import substitution portion of a program or strategy remains implicit or even incidental - that is, import substitution is not acknowledged as an underlying basis for the economic development measure and in some cases may not even be considered as a potential justification.
In this environment, theory is the tool that allows us to separate import substitution from other goals and strategies and judge it in isolation. Theory allows the consideration of import substitution apart from the differing levels of enactment and enthusiasm present in the practice of economic development. This is not to argue that theory is sufficient to provide a thorough understanding of the topic and its application; rather, theory gives a starting place, from where it will be possible to consider import substitution examples in practice.
1- Economic Base Theory
Export-based theory comprises the major support for import substitution. To the question "how do regions grow?", economic base theory answers that exports fuel the economic growth of a region. Expenditures from outside a region on a region's exports stimulate local businesses, both through local supply chains (inputs to the exported production) and through the earnings and spending of local employees (payment for labor). These expenditures generate a chain reaction effect, termed the multiplier. Local industries buy inputs from local suppliers, which then pay local employees and buy further inputs from local suppliers, etc. Local industries also pay salary or wages to local employees, who then buy local products, further stimulating local businesses ,who pay their local employees, and so on. Thus, the effect of an expenditure on are gion's exports from outside the region is multiplied by these further rounds of local income and spending.
In this context, imports represent leakage from the system. Imports leak rounds of spending outside the region so that they contribute no further to the earnings and production of the region. The further rounds of income and spending are sent to the regions that produce the imported goods or services. Import substitution acts to prevent this leakage, essentially plugging up the system so that all the multiplier effects are contained within the region. By this theory, the replacement of one dollar's worth of imports with local products is as effective in generating regional economic growth and expansion as the creation of one dollar's worth of exports from the region.
The fact that import substitution inherently focuses on local-serving industries provides a further theoretical justification for import substitution. Hans Blumenfeld (1955) has argued that the important strengths of a regional economy are in the local sectors, that those firms and services which cater to local needs and desires promote the diversity and versatility of a region. In the long run, growth and development may owe more to local-serving industries than to those that focus on serving extra-local
needs. Much empirical support has accumulated for Blumenfeld's contention that regions with well-developed local-serving sectors are more adaptable to changing economic conditions and more resilient to economic downturns that interrupt external demand for a region's exports. In addition, the multiplier effects within diverse regions tend to be larger because there is more opportunity for businesses to source locally and for consumers to purchase local goods and services.
Although one of the oldest regional development theories, economic base theory remains integral to the practice of economic development. It provides the support for a number of common economic development strategies in addition to import substitution, including export promotion, location incentives, natural resource development, and place marketing. Economic base theory is intuitive, comprehensible, and relatively easy to apply. Additionally, though it receives much theoretical criticism, many of the strategies that have arisen from economic base theory have been remarkably successful.
2-Entrepreneurship Theory
Import substitution also is supported by entrepreneurship theory. The relevant question here is "how do individuals stimulate regional development?" The answer provided by the theory is that entrepreneurs act in situations of uncertainty to fill available niches in the economic landscape. Where there is incomplete or asymmetric information, unconnected markets, or uncertain market forces, entrepreneurs act to expose information, connect markets, and reveal needs in the local economy that can be filled by local businesses.
As niche-fillers, entrepreneurs typically engage in import substitution. Niches are available because there is a local need for certain products, services, or information that is not being supplied locally. The relationship between import substitution and
entrepreneurship is two-sided: entrepreneurs often engage in or further the cause of import substitution, whereas the process of import substitution helps make a region more diverse economically, which creates opportunities for and attracts entrepreneurs.
Entrepreneurship theory is gaining popularity in economic development practice in the United States and around the world. It is, however, not the only way in which import substitution can be enacted. Established businesses or new large firms can practice import substitution effectively as well. In many cases, what is needed to encourage import substitution is merely the establishment of a link between existing local suppliers and local producers.
V. In Practice
To answer the question of "what scale is appropriate for Import Substitution? " , we must see the levels of trade in worldwide;
Import substitution is practiced at several different levels:
a) International
At the international level, import substitution is normally aimed at reducing economic dependency. International import substitution uses tools that are not available to regions: tariffs, quotas, fiscal and monetary policy, and exchange rates.
b) Large, Diverse Regions
Here is where it is most cost-effective to begin local production involving significant economies of scale. Diversity tends to attract entrepreneurs and entrepreneurial capital.
Heavy Importers
Regions that import a large percentage of their goods and services are prime candidates for import substitution. These regions include frontier, peripheral, and underdeveloped areas.
The implementation of the import substitution industrialisation (ISI) strategy in Turkey ;
During the two decades preceding the adjustment program of 1980, Turkey had pursued an inward-oriented development strategy, combined with extensive involvement by the public sector. Macro planning and import substitution became synonymous, as the import substitution industrialisation (ISI) strategy was institutionalised under the First Five Year Development Plan introduced in 1963.
Judged on the basis of the growth rate of industrial production and overall output, the performance of the 1963-1977 period was impressive. The average growth rate of GNP was recorded as 7%, while the average growth rate of industrial production was 9%. Several factors exercised a favourable influence during the 1970s and helped to sustain the momentum of rapid growth established during the preceding decade. Such forces deserve special emphasis. The primary commodity boom was instrumental in the rapid increase of Turkish exports during the early 1970s. Significant inflows of workers' remittances and short-term capital inflows from the Euro-currency market also performed a key role in resolving the foreign exchange problem and maintaining high rates of economic growth.
These forces, however, helped to disguise the principal problem of the Turkish economy, namely an excessive dependence on imports of intermediate and capital goods, with unsatisfactory ability to increase export earnings to finance the necessary import bill. A pattern observed in many developing countries was repeated in the Turkish context.
The ISI strategy had rendered the economy more vulnerable to external shocks as a result of increased
dependence on imported inputs. In contrast, the share of exports in GDP remained constant at around 4-5 % throughout the decade.
In Turkey, the reaction of policy-makers to such structural problems following the oil shock of 1973-1974 had been to press ahead with the import substitution strategy. The crisis of the late 1970s, which was precipitated by Turkey's inability to meet her external commitment in 1977,was the combined outcome of domestic and external economic environment.
By the end of 1979, the inward-looking, approach had been discredited as a viable option and the administration was converted to the view that a major shift in policy was necessary.
Consequently, the new Economic Stabilisation Programme was announced in January 1980. The main objectives of the programme were a reduction in government involvement in production activities, an increased emphasis on market forces, the replacement of an inward looking strategy with an export-oriented strategy of import substitution and the attraction of foreign investment.
An Example of Import Substitution Strategy : Mexico
World War II reduced trade among nations, therefore Mexico, as many other less developed countries (LDC's) who had been dependant on imports from developed countries, was forced to cover its national demand with its own production, stimulating the import substitution scheme. During this period, the Mexican industry grew at an annual rate of 7% and the GDP grew at a rate of 6% per year. Associated to this economic boom, a growth in employment and productivity was observed.
With the import substitution scheme (1940-1958) two main goals were to be accomplished: a) obtain national growth; b) decrease the dependence on imports. The Mexican state began to play a key role, implementing strategies which supported the industrialisation process. This, through public investment and an industrial protectionism policy. The Mexican government as active promoter, justified its investment, which represented 40% out of the total investment. It concentrated itself in strategic sectors providers of infrastructure, such as oil, electric energy, roads and agriculture.
During World War II, protectionism was given to the new born Mexican industry. However at the end of the war, the government had to devaluate its currency in order to maintain its protectionism policy, which also included tariffs and import regulations. In addition to the commercial policy, there were other incentives given by the government which enhanced industrial investment, these were tax exemptions and credit facilities. Machinery and equipment were allowed to be imported under a duty free tariff in order to increase productivity. During this period it was established that cars destined to the Mexican market ought to incorporate national auto parts up to 60% of the automobile's cost, a clear example of the excessive protection given to national producers. The excessive protection given to the Mexican industry originated a considerable gap between the domestic and the international
goods' quality and prices.
Thus, in the mid 1980's Mexico began to move toward an economic liberalisation , which was evidenced by the adoption of an strategy of structural change designed to remove the instability which characterised economic activity during the preceding years. This program contemplated four fundamental issues: fiscal discipline and austerity, federal deregulation, privatisation of state-owned entities; and trade liberalisation "This four dimensional process of adjustment was an unavoidable response to the populist policies of domestic industrialisation via massive expansion of the state sector and import substitution protectionism. In the period between 1970 and 1982, the paraestatal sector grew from 300 companies under state-run control to an outrageous 1,555." (Salinas Leon, 1994, p.3) By the end of 1993, the government had desincorporated a total of 909 entities, which generated more than $21 billion in new income for the state.
VI. History
A simplified timeline of import substitution:
1700s-1800s
European cities grow through "natural" import substitution, as
local businesses form without government intervention or
encouragement to supply local production needs.
1850s
Several American trade-based or natural-resource-based
towns grow and develop through import substitution, with
little or no public sector intervention. Examples include St.
Louis, Chicago, and Cincinnati.
late 1940s,
early 1950s
After World War II, war machinery factories in Los Angeles
are converted to motor vehicle assembly and production.
This is the first import substitution involving automobiles in the
American West.
1950s-1960s
Import substitution receives attention as a strategy for
international development, to counter dependency and
lingering effects of European colonialism. The idea is to
protect and promote home-grown industries in former
colonies, but by most accounts, the strategy is a miserable
failure. Third world industries are hampered by pervasive
inefficiency, domestic disorder, and international competition
(despite explicitly protectionist trade policies).
Underdeveloped nations continue to rely almost exclusively
on imports for manufactured and high-technology goods.
1970s - present
The practices of industry targeting and location incentives give
encouragement to import substitution at the regional level in
the United States, as a means of identifying which firms and
industries to pursue.
1990s
Some argue that import substitution is out of date in the
modern, globally-integrated economy; regions should
concentrate on the goods and services they can produce
most efficiently. Others answer that import substitution yields
income gains across the board, allowing regions to increase
both exports and imports while gaining the capacity to choose
which goods and services to import and which to produce
locally.
VII. How Well Does Import Substitution Work?
It is difficult to assess the success of import substitution strategies, for a number of
reasons:
Until relatively recently, regional import substitution strategies were not studied explicitly.
Import substitution strategies are rarely practiced or considered on their own, rather they normally form a portion or segment of a broader strategy or set of programs. Thus it is hard to attribute successes to import substitution. Changes or successes might have happened without the program - it is nearly impossible to separate what would have happened anyway from the effects of the program.
Nevertheless, there are some indications of success:
Most programs involving import substitution facets have been considered successful enough to be continued or renewed. Import substitution, in the long run, is a relatively cost-effective strategy for economic development, creating jobs and economic growth for far less monetary cost than most other economic development strategies. Areas with a ready supply of capital and willing entrepreneurs tend to have more success with import substitution.
Some theorists argue that the long-term vitality of certain cities and regions, and the stagnation and depression of others, can be attributed to the success or failure of import substitution efforts. Some regional and industry factors that improve the chances of a successful
outcome are:
Ø An adequate regional supply of capital
Ø Existing businesses or entrepreneurs willing to engage in import substitution
Ø Sufficient local or regional market demand
Ø Relatively high industry transportation or import costs
Ø Relatively small gains from economies of scale in the industry
Ø Purchasing decisions made locally
VIII. Familiar Issues
Strategies Versus Import Substitution
Export-led Growth
In recent years more and more states have shifted to a strategy of export-led growth,
which is the strategy used by the NICs. This strategy seeks to develop industries that
can compete in specific niches in the world economy. The chosen industries may
receive special treatment such as subsidies, tax breaks, and protected access to local
markets. Exports from these industries generate hard currency and create a favorable
trade balance. The state can then spend part of its money on imports of commodities
produced more cheaply elsewhere.
Export Promotion
...As a Tool of Economic Development Policy in State and Local Government Planning
Export promotion has been a popular strategy for promoting economic development growth in state and local economies since the 1930's. Particularly at the state level, public officials have sought to raise the profile of a region in international trade networks and global emerging markets with programs of trade assistance and business support to local businesses, usually in multiple sectors of the economy. The enhancement of a firm's competitiveness promises in the best cases to contribute to area employment and income growth, with associated linkages to related supplier and product companies, area infratructure and educational institution growth and so on throughout the economy. In less success fulinstances, such programs fall prey to accusations of political favor, and the instability of the whims of succeeding directors.
Trade assistance programs tend to be in part targetted to the small and medium-sized firm, following the theory that larger firms tend to already have the resources, personnel and aggressiveness to explore
their export potential on their own. The extent of industry and regional analysis determines the goals and focus appropriate for an export assitance program.
IX. Comments on Import Substitution
Henry Bruton from Williams College Asks ; Why does the difference in per capita output prevail? And its corollary: Can the GDP-poor countries so modify their economies that output, and welfare, increase as a consequence of the routine functioning of the economy?
One answer to the latter question was at once evident: make over the GDP-poor countries in the image of the GDP-rich countries. The rich countries, therefore, offered an example to be followed or, more specifically, to be learned from. The existence of rich countries offered something else: they created a world environment significantly different from that which prevailed while they were getting rich. Earlier, there were no equivalent rich countries that could be copied or that created a volatile world environment in which the then developing countries had to find their way. The modern developing countries, however, must achieve the metamorphosis of their economies - from non-growth to growth - in a world dominated by a relatively small number of already rich and still growing economies. The developing country must recognize this fact, it must seek to learn from the already rich countries,
even while protecting itself from a number of problems that the existence of rich countries creates.
Import substitution is then a matter of two transitions. The first transition is that from a system characterized by lack of growth to a flexible, responsive system in which social welfare is continually rising. This takes place behind some form of protection. The second is the transition from protection to participation on a more equal footing in the world economy. Between these two transitions lies the process by which the economy achieves its metamorphosis.
It may be noted, as well, that the two strategies have much in common. Both are intended to induce learning and productivity growth, and both emphasize that economic strength requires resilience and the capacity to carry through continuous adjustments in response to changing circumstances. Most (not all) proponents of both strategies also acknowledge that our understanding of productivity growth is still quite primitive. This matter of similarity isreferred to again in the final section of this chapter, the section on policies.
Bela Balassa, Anne Krueger, and many others have accumulated a great deal of statistical and qualitative evidence that show many advantages to an outward looking, export oriented strategy. Balassa reports on their studies in Chapter 31 of this Handbook. Although the evidence that is offered in Balassa's chapter (and elsewhere) is
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