Import Substitution Policy And Export Led Growth Strategy Economics Essay

In the last half of the century Development strategies of the Third World have been the subject of extensive debate and controversy among the different schools of thoughts in economies. The neoclassical school reformulated the Ricardo’s theory of comparative advantage to defend Thirds World’s’ export of raw materials and primary goods in exchange for the manufactured commodities of advanced capitalist economies. On the other hand, there been an extensive debate on economies theories which may challenge the above Neoclassical Theory. Dependency Theory, Structuralism School and the World System theory are the most important.

The above theories have somewhat proposed the strategy of Import-Substitution (IS) industrialization even though they vary from their methodological outlook. As a response, neoclassical economists during the 1970s and 1980s adopted export led industrialization.

Industrialization is intended for a number of reasons, because of a war a country’s supply of imports could be suddenly interrupted and the government might respond by promoting domestic-import replacing industries. On the other hand, industrialization can take place “naturally” as income rise in response to growth of exports .Alternatively; an industry will develop as part of a planning strategy.

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The developing countries must accomplish a transformation of their economies -from non-growth to growth- in an environment dominated by well-off and growing economies .The developing economy must protect itself from a number of struggles that are created by wealthy nations. Import substitutions main aim is to achieve the above objectives: to learn from the rich countries, and at the same time protect their domestic economies while avoiding balance of payment difficulties and generating demand for the growth of employment. This particular trade related strategy “substitutes domestic production of previously imported simple consumer goods (first stage IS) and then substitute through domestic production for a wider range of more sophisticated manufactured items (Second stage IS)-all behind the protection of high tariffs and quotas on these imports” (Todaro M, 2000)

If the foundation of an Import Substitution is to protect an infant economy while it matures where it can perform satisfactorily in the world economy then the society while protected can create an environment in which learning occurs .It’s been argued that this strategy contributes to industrialization through “learning by doing”. This policy is in favour of government intervention, which can create distortion because new actions may be inconsistent with economy’s factor endowment .One unfavourable effect was that cost that added to the income distribution problem which punished the self employed and small farmers while on the other hand it was beneficial to capital owners, domestic or foreign. Another unfortunate consequence was that in order to encourage local manufacturing through the import of intermediate goods or cheap capital, exchange rates are often overvalued artificially thus raising exporting prices and lowering import prices in relation to local currency.

Protection imposes short-run costs on the whole economy as the implementation of this kind of strategy requires large investments. Availability of goods and services is expected to be less at the beginning of an Import Substitution strategy in comparison with free trade policy. The shorter the period of Import Substitution used as a development strategy, the less its costs and the higher the return on the investment .Furthermore the substitution of imported finished goods by domestically produced goods may require the importation of a considerable volume of raw materials and intermediate products, if they need more inputs to produce given output than foreign industries.

Import substitution may not be as successful in saving foreign exchange, or resolving a balance of payment problem as the export promotion policy. Import Substitution could still be defended as a tool to achieve a high rate of domestic savings and investments. Domestic manufactures are protected by tariffs, quotas, licenses and other restrictive instruments from international competition, facilitating to obtain higher profits by raising their prices and lowering the quality of their products. In addition, these protective devices have been employed by a number of developing countries in order to meet balance of payment difficulties.

A common drawback of import substitution is that it penalizes exports. Exports can prevent balance of payment difficulties by enabling the importation of the capital goods necessary for investment .It enables the importing capital as a means of increasing the productivity of accessible resources. The comparative disadvantage of local in comparison with foreign entrepreneurship it’s not reduced by the use of protection of promoting substitution of local for foreign production, in contrast, induces foreign firms to set up local production facilities to satisfy the demand previously satisfied by exports from their home country. It encourages the development of subsidiaries or affiliates of foreign firms, with headquarters in the US and Europe, giving rise to political anxieties about foreign “control” and “domination of the economy”.

Even though ineptitude and non-competitiveness are virtually taken for granted by the infant’s industry argument for protection it assumes that in time and with the increase in experience, unit costs will gradually fall. As an example in Ghana during 1964, despite the local government’s substantial protection, 22 out of 31 state industries failed to make a profit with an overall net loss of the state industries of 15 million on a capital investment of 30 million

A policy of import substitution if unlikely to transform an underdeveloped country into a major industrial power, competitive in the world market for manufactured products.Instead such a policy is likely to transform it into a miniature replica of the economies of the advanced countries, though less efficient and technologically laggard to an extent depending on the size of the domestic market and the degree of protection employed. From the point of view of economic welfare of the underdeveloped country this result may nevertheless constitute an improvement at least in the longer run, especially if the country attracts FDI. It will necessarily prove beneficial in the long run by giving the country a share in technical progress in the industries involved.

Through to the mid 1970s development policy was based on Import substitution model which encouraged countries to develop their own domestic manufacturing capacity and substitute domestically produced goods for imports. There has been a remarkable change in the position of development policies in the last two decades. Due to the economic troubles that appeared in the 1970s there was a move away from Import substitution towards the Export Promotion. (Palley T, 2002)

The growth advantage of free trade and competition, the significance of substituting large world markets for constricted domestic markets, the deforming price and costs effects of protections are related with the efficiency of Export promotion of both primary and manufactured goods. It is argued that Export promotion contributes by “learning through trading”, transfer of knowledge and technology, thus it is the standard model of development that the IMF proposes to all its clients countries.

The centre theoretical criticism is that Export promotion supposes that all countries can mature by relying on demand growth in other countries, the model suffers from a misleading notion of composition. There is a risk of a beggar-thy-neighbour outcome, when export promotion is applied globally in a demand-constrained environment. This leads to excess supply and deflation as everyone try to develop on the backs of demand expansion in other countries. In relation, it is not exporting per se that it is the issue but rather main exports the focus of development. Exporting should be well organized in order to maximize its input to domestic development and not viewed as an end itself, because countries will still require to export to pay for their imported capital and intermediated goods needs. In terms of a Keynesian economics viewpoint export promotion suffers from an intrinsic myth of composition whereby one country’s effort to enhance domestic aggregate demand by rising exports, results in a fall of domestic aggregate demand in the country it is exporting to.(Palley 1990 and Blecker 2000)

Export promotion development strategy affects the terms of trade, it worsen the long standing trend weakening in developing country terms of trade by prompting countries to transfer even more output onto global markets. Furthermore, export promotion impacts financial instability. Developing countries borrow in hard currency and as their terms of trade deteriorate it turns even harder to earn the currency needed to service their debt. As countries seek to export their way to growth, export promotion results in an unintended creation of excess capacity in the manufacturing export sector. Ertuk (1999) argues that an over investment boom may have took place in East Asia with the initial success of their tiger economies attracting more and more export oriented production capacity in Thailand , Malaysia and Indonesian. This resulted in an over capacity which undermined the financial soundness of investments. From this point of view, Asia financial crisis was not just the result of financial speculation but a fundamental cause situated in the real economy.

From the two developments strategy discussed above none of the two could be look upon as more superior. However, export promotion and Import substitution could be regarded as “complementary rather than alternative strategies” the rationale for that, is that Import Substitution is required for providing the volume basis necessary for competitive exportation and generating export ability. (Singer and Alizadeh 1986) .South Korea’s success it’s attributed by some scholars (Bhawati 1988, Rhee 1985) to the lack of anti-export bias, rather than the presence of export incentives. The key to Korean achievement is neutrality between Export promotion and Import Substitution biases or “free trade position”. The “dual policy” of following both Export promotion and Import Substitution strategies simultaneously its featured the Korean success(Pack and Westphal 1986)

In conclusion, developing countries experience rigorous problems in the event of a serious trouble in the flow of intermediate and capital goods imports, for both import substitution and export promotion. A social, economic or political occurrence that detaches the economy from its main supplies of productive capital could hugely damage its performance. Both Import substitution and export promotion are associated with the internationalization of the course of industrious capital, two stages in the same vibrant process. In the Import substitution industrialization the circuit of money capital is terminated in the domestic market while in the case of Export promotion the route happens in the world market through the understanding of the value of domestically produced manufactures.