Import substitution industrialization (also called
ISI) is a
tradeTrade is the voluntary exchange of goods, services, or both. Trade is also called commerce or transaction. A mechanism that allows trade is called a market. The original form of trade was barter, the direct exchange of goods and services. Later one side of the barter were the metals, precious...
and
economicEconomics is the social science that studies the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
policyA policy is typically described as a deliberate plan of action to guide decisions and achieve rational outcome. However, the term may also be used to denote what is actually done, even though it is unplanned....
based on the premise that a
countryIn geography, a country is a geographical region. The term is often applied to a political division or the territory of a state, or to a smaller, or former, political division of a geographical region...
should attempt to reduce its foreign dependency through the local production of industrialized products. Adopted in many Latin American countries from the 1930s until the late 1980s, and in some Asian and African countries from the 1950s on, ISI was theoretically organized in the works of
Raúl PrebischRaúl Prebisch was an Argentine economist known for his contribution to structuralist economics, in particular the Prebisch-Singer hypothesis that formed the basis of economic dependency theory. He is sometimes considered to be a neo-Marxist though this label is misleading...
,
Hans SingerSir Hans Wolfgang Singer was a development economist best known for the Singer-Prebisch thesis, which states that the terms of trade move against producers of primary products. He is one of the primary figures of heterodox economics.-Biography:Singer was born in Elberfeld, Germany in 1910...
,
Celso FurtadoCelso Monteiro Furtado was an important Brazilian economist and one of the most distinguished intellectuals of his country during the 20th century. His work focuses on development and underdevelopment and on the persistence of poverty in peripheral countries throughout the world...
and other
structural economicStructuralist economics originated with the work of the Economic Commission for Latin America and is primarily associated with its director Raul Prebisch and Brazilian economist Celso Furtado. Key to structuralist analysis is the idea that the structural features of developing economies need to be...
thinkers, and gained prominence with the creation of the
United Nations Economic Commission for Latin America and the CaribbeanThe United Nations Economic Commission for Latin America and the Caribbean was established in 1948 to encourage economic cooperation among its member states. In 1984, a resolution was passed to include the countries of the Caribbean in the name...
(UNECLAC or CEPAL). Insofar as its suggestion of state-induced industrialization through governmental spending, it is largely influenced by Keynesian thinking, as well as the
infant industry argumentsThe infant industry argument is an economic reason for protectionism. The crux of the argument is that nascent industries often do not have the economies of scale that their older competitors from other countries may have, and thus need to be protected until they can attain similar economies of scale...
adopted by some highly industrialized countries, such as the United States, until the 1940s. ISI is often associated with
dependency theoryCategory:Uncategorized articles needing expert attentionDependency theory is a body of social science theories predicated on the notion that resources flow from a "periphery" of poor and underdeveloped states to a "core" of wealthy states, enriching the latter at the...
, though the latter adopts a much broader sociological outlook which also addresses cultural elements sought to be linked with
underdevelopmentUnderdevelopment is the state of an organization that has not reached its maturity.It is often used to refer to economic underdevelopment, symptoms of which include lack of access to job opportunities, health care, drinkable water, food, education and housing.-Overview:Underdevelopment takes place...
.
Definition
Even though ISI is a development theory, its political implementation and theoretical rationale are rooted in trade theory.
BaerWerner Baer is an American economist at the University of Illinois Urbana-Champaign and the Jorge Lemann Professor of Economics. He received his Bachelor's degree from Queen's College in 1953, and a Master's and a Ph.D. from Harvard University in 1955 and 1958 respectively...
contends that all countries which have industrialized after the
United KingdomThe United Kingdom of Great Britain and Northern Ireland is a sovereign state located off the northwestern coast of continental Europe. It is an island country, spanning an archipelago including Great Britain, the northeastern part of Ireland, and many small islands...
went through a stage of ISI in which the large part of investment in industry was directed to replace imports (Baer, pp.95-96). In his book
Kicking away the ladder, Korean economist
Ha-Joon ChangHa-Joon Chang is one of the leading heterodox economists specialising in development economics. Trained at the University of Cambridge, where he currently works as a Reader in the Political Economy of Development, Chang is the author of several influential policy books, including 2002's Kicking...
also argues, based on economic history, that all major developed countries – including the United Kingdom – used interventionist economic policies to promote industrialization and protected national companies until they had reached a level of development in which they were able to compete in the global market, after which those countries adopted free market discourses directed at other countries in order to obtain two objectives: to open their markets to local products and to prevent them from adopting the same development strategies which led to the developed nations' industrialization.
Theoretical basis
As a set of development policies, ISI policies are theoretically grounded on the
Singer-Prebisch thesisThe Singer-Prebisch thesis is the observation that the terms of trade between primary products and manufactured goods tend to deteriorate over time...
, on the
infant industry-See also:*Infant industry argument*Industry...
argument, and on Keynesian economics. From these postulates it derives a body of practices, which are commonly: an active industrial policy to subsidize and orchestrate production of strategic substitutes, protective barriers to trade (e.g.
tariffA tariff is a duty imposed on goods when they are moved across a political boundary.-History:...
s), an overvalued currency to help manufacturers import capital goods (heavy machinery), and discouragement of
foreign direct investmentForeign direct investment in its classic form is defined as a company from one country making a physical investment into building a factory in another country. It is the establishment of an enterprise by a foreigner. Its definition can be extended to include investments made to acquire lasting...
.
In many cases, however, these postulates did not apply: on several occasions, the Brazilian ISI process, which occurred from 1930 until the end of the 1980s, involved currency devaluation as a means of boosting exports and discouraging imports (thus promoting the consumption of locally manufactured products), as well as the adoption of different exchange rates for importing capital goods and for importing consumer goods. Moreover, governmental policies toward investment were not always opposed to foreign capital: the Brazilian industrialization process was based on a tripod which involved governmental, private, and foreign capital – the first being directed to infrastructure and heavy industry, the second to manufacturing consumer goods, and the third, to the production of durable goods (such as automobiles). Volkswagen, Ford, GM and Mercedes all established in Brazil in the 1950s and 1960's.
The major and unifying postulate of ISI can thus be described as an attempt to reduce foreign dependency of a country's economy through local production of industrialized products, whether through national or foreign investment, for domestic or foreign consumption. It should be noted, as well, that import substitution does not mean
import elimination: as a country industrializes, it begins to import other kinds of goods which become necessary for its industry, such as petroleum, chemicals, and the raw materials it may lack. The real objective of import substitution is therefore not to eliminate trade, but to lift it to higher stage – that of exporting
value-added products, which are not as susceptible to economic fluctuations as raw materials, according to the
Singer-Prebisch thesisThe Singer-Prebisch thesis is the observation that the terms of trade between primary products and manufactured goods tend to deteriorate over time...
.
Outward and inward development
Conceptually, ISI could be outward-looking in that it promotes exports (like in Asia, especially South Korea) or inward-looking without significant links to world markets (like in Latin America). The decision to adopt one or another perspective is frequently determined by external factors. The industrialization of
South KoreaSouth Korea, officially the Republic of Korea and often simply referred to as Korea, is a country in East Asia, located on the southern half of the Korean Peninsula. It is neighbored by China to the west, Japan to the east, and North Korea to the north. Its capital is Seoul, the second largest...
and other Asian Tigers, for example, was in line with the United States's geopolitical strategy of building a "contention belt" of capitalist countries around China and other communist states in Asia, which involved the granting of incentives for these countries to export to the United States. In contrast, Latin American countries, which were outside the main areas of geopolitical concern, did not receive these incentives – despite requests that they be extended to them, for example in the Pan-American Operation proposed by Brazilian President Juscelino Kubitscheck. Consequently, Latin American countries concentrated on producing for their domestic markets, or on building expanded areas which could absorb scale-production, such as the Latin American Free Trade Association (ALALC) and the
Latin American Integration AssociationThe Asociación Latinoamericana de Integración is a Latin American trade integration association, based in Montevideo. Its main objective is the establishment of a common market, in pursuit of the economic and social development of the region...
(ALADI), which were never fully implemented.
Both in inward and outward-oriented ISI, however, external competition by imports in the markets of the targeted industries are discouraged, by tariffs, devalued currencies and other factors. Hence, policies to pursue ISI have a strong protectionist component and are not favored by advocates of absolute
free tradeFree trade is a type of trade policy that allows traders to act and transact without interference from government. According to the law of comparative advantage the policy permits trading partners mutual gains from trade of goods and services....
.
Latin America
Import substitution policies were adopted by most nations in
Latin AmericaLatin America is a region of the Americas where Romance languages – particularly Spanish, Portuguese, and variably French – are primarily spoken. Latin America has an area of approximately 21,069,501 km² , almost 3.9% of the Earth's surface or 14.1% of its land surface area...
from the 1930s until the late 1980s. The initial date is largely attributed to the impact of the
Great DepressionThe Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
of the 1930s, when Latin American countries, which exported primary products and imported almost all of the industrialized goods they consumed, were prevented from importing due to a sharp decline in their foreign sales. This served as an incentive for the domestic production of the goods they needed.
The first steps in import substitution were largely untheoretical and based on pragmatic choices of how to face the limitations imposed by recession, even though
PopulistPopulism is a political discourse that juxtaposes "the people" with "the elites." Populism may comprise an ideology urging social and political system changes and/or a rhetorical style deployed by members of political or social movements...
governments in Argentina (Perón) and Brazil (
VargasGetúlio Dornelles Vargas served as president of Brazil from 1930 to 1945 and from 1951 until his suicide in 1954.-Background:...
) had the precedent of Fascist
ItalyItaly , officially the Italian Republic , is a country located on the Italian Peninsula in Southern Europe and on the two largest islands in the Mediterranean Sea, Sicily and Sardinia. Italy shares its northern, Alpine boundary with France, Switzerland, Austria and Slovenia...
(and, to some extent, of the
Soviet UnionThe Union of Soviet Socialist Republics was a constitutionally socialist state that existed in Eurasia from 1922 to 1991. The name is a translation of the , tr. Soyuz Sovetskikh Sotsialisticheskikh Respublik, abbreviated СССР, SSSR. The common short name is Soviet Union, from , Sovetskiy Soyuz...
) as inspirations of state-induced industrialization. Positivist thinking – which sought a "strong government" to "modernize" society – played a major influence on Latin American military thinking in the 20th century. Among the officials – many of whom rose to power, like Perón and Vargas – industrialization (specially steel production) was synonymous of "progress" and was naturally placed as a priority.
ISI only gained a theoretical foundation in the 1950s, when
ArgentineArgentina, officially the Argentine Republic , is the second largest country in South America, constituted as a federation of 23 provinces and an autonomous city, Buenos Aires. It is the eighth largest country in the world by land area and the largest among Spanish-speaking nations, though Mexico,...
economistAn economist is an expert in the social science of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
and UNECLAC head
Raúl PrebischRaúl Prebisch was an Argentine economist known for his contribution to structuralist economics, in particular the Prebisch-Singer hypothesis that formed the basis of economic dependency theory. He is sometimes considered to be a neo-Marxist though this label is misleading...
was a visible proponent of the idea, as well as
BrazilBrazil , officially the Federative Republic of Brazil , is a country in South America. It is the fifth largest country by geographical area, occupying nearly half of South America, the fifth most populous country, and the fourth most populous democracy in the world. Bounded by the Atlantic Ocean...
ian economist
Celso FurtadoCelso Monteiro Furtado was an important Brazilian economist and one of the most distinguished intellectuals of his country during the 20th century. His work focuses on development and underdevelopment and on the persistence of poverty in peripheral countries throughout the world...
. 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
tariffA tariff is a duty imposed on goods when they are moved across a political boundary.-History:...
s were designed to allow domestic
infant industriesThe infant industry argument is an economic reason for protectionism. The crux of the argument is that nascent industries often do not have the economies of scale that their older competitors from other countries may have, and thus need to be protected until they can attain similar economies of scale...
to prosper.
ISI was most successful in countries with large populations and income levels which allowed for the consumption of locally produced products. Latin American countries such as
ArgentinaArgentina, officially the Argentine Republic , is the second largest country in South America, constituted as a federation of 23 provinces and an autonomous city, Buenos Aires. It is the eighth largest country in the world by land area and the largest among Spanish-speaking nations, though Mexico,...
,
BrazilBrazil , officially the Federative Republic of Brazil , is a country in South America. It is the fifth largest country by geographical area, occupying nearly half of South America, the fifth most populous country, and the fourth most populous democracy in the world. Bounded by the Atlantic Ocean...
,
MexicoThe United Mexican States , commonly known as Mexico , is a federal constitutional republic in North America. It is bordered on the north by the United States; on the south and west by the Pacific Ocean; on the southeast by Guatemala, Belize, and the Caribbean Sea; and on the east by the Gulf of...
, and, to a lesser extent,
ChileChile, officially the Republic of Chile , is a country in South America occupying a long, narrow coastal strip between the Andes mountains to the east and the Pacific Ocean to the west. It borders Peru to the north, Bolivia to the northeast, Argentina to the east, and the Drake Passage in the far...
,
UruguayUruguay , is a country located in the southeastern part of South America. It is home to 3.46 million people, of whom 1.1 million live in the capital Montevideo and its metropolitan area. An estimated 88–94% of the population are of mostly European and/or mixed descent.Uruguay's only land border is...
and
VenezuelaVenezuela , officially titled Bolivarian Republic of Venezuela , is a tropical country on the northern coast of South America. It is a continental mainland with numerous islands located off its coastline in the Caribbean Sea...
, had the most success with ISI (Blouet and Blouet, 2002). This is so because while the investment to produce cheap consumer products may pay off in a small consumer market, the same can not be said for capital-intensive industries – such as automobiles and heavy machinery –, which depend on larger consumer markets to survive. Thus, smaller and poorer countries, such as
EcuadorEcuador , officially the Republic of Ecuador , literally, "Republic of the equator") is a representative democratic republic in South America, bordered by Colombia on the north, Peru on the east and south, and by the Pacific Ocean to the west. It is one of only two countries in South America that...
,
HondurasHonduras is a republic in Central America. It was formerly known as Spanish Honduras to differentiate it from British Honduras...
, and the
Dominican RepublicThe Dominican Republic is a nation on the island of Hispaniola, part of the Greater Antilles archipelago in the Caribbean region. The western third of the island is occupied by the nation of Haiti, making Hispaniola one of two Caribbean islands that are occupied by two countries...
, could only implement ISI to a limited extent.
PeruPeru , officially the Republic of Peru , is a country in western South America. It is bordered on the north by Ecuador and Colombia, on the east by Brazil, on the southeast by Bolivia, on the south by Chile, and on the west by the Pacific Ocean.Peruvian territory was home to the Norte Chico...
implemented ISI in 1961, and the policy lasted through to the end of the decade in some form.
To overcome the difficulties of implementing ISI in small-scale economies, proponents of this economic policy – some within UNECLAC – suggested two alternatives to enlarge consumer markets: income distribution within each country, through agrarian reform and other initiatives aimed at bringing Latin America's enormous marginalized population into the consumer market, and regional integration through initiatives such as the Latin American Free Trade Association (ALALC), which would allow for the products of one country to be sold in another.
In Latin American countries where ISI was most successful, it was accompanied by structural changes to the government. Old
neocolonialNeocolonialism is a term used by post-colonial critics of developed countries' involvement in the developing world. Writings within the theoretical framework of neocolonialism argue that existing or past international economic arrangements created by former colonial powers were or are used to...
governments were replaced by more or less democratic governments. Banks and utilities and certain foreign-owned companies were nationalized or transferred ownership to local
businesspeopleA businessperson is someone who is employed at usually a profit-oriented enterprise, or more specifically, someone who is involved in the management of a company, or even an entrepreneur...
.
Many economists contend that ISI failed in Latin America, being one of many factors leading to the so-called
lost decadeThe Latin American debt crisis was a financial crisis that occurred in the early 1980s , often known as the "lost decade", when Latin American countries reached a point where their foreign debt exceeded their earning power and they were not able to repay it.-Origins:In the 1960s and 1970s many...
of Latin American economics. Other economists contend that ISI led to the "
Mexican Miracle," the period that lasted from 1940 to 1975 in which economic growth of 6 percent or more.
East Asia
The inward-looking variant of ISI was rejected by most nations in
East AsiaEast Asia or Eastern Asia is a subregion of Asia that can be defined in either geographical or cultural terms. Geographically and geo-politically, it covers about , or about 28 percent of the Asian continent, about 15 percent bigger than the area of Europe, though some categorize Tibet, Xinjiang,...
in the 1960s, and some
economistAn economist is an expert in the social science of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
s attribute the superior performance of East Asia in the 1970s and 1980s to this difference in policies. Indeed, East Asian policies are most commonly not referred to as ISI, even though some would argue the rationale and execution of policy design largely followed those recipes.
Most
East AsianThe term Four Asian Tigers or Asian Tigers refers to the highly developed economies of: Hong Kong Singapore South Korea TaiwanThey are also known as Asia's Four Little Dragons in Chinese, as these countries and territories have at various points in history been under the Chinese cultural sphere of...
countries, while rejecting the inward-looking component of classical import substitution policies, 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, and not to attempt to undervalue the local currency. In pursuing this and to boost its competitiveness in the 1970s,
South KoreaSouth Korea, officially the Republic of Korea and often simply referred to as Korea, is a country in East Asia, located on the southern half of the Korean Peninsula. It is neighbored by China to the west, Japan to the east, and North Korea to the north. Its capital is Seoul, the second largest...
made large investments into heavy and chemical industries, such as shipbuilding, steel and petrochemicals. This focus on export markets allowed them to create competitive industries.
It should be contended, however, that outward-looking development did not pose as a choice for many countries. As mentioned before, for geopolitical reasons, many East Asian countries received open market policies and incentives for industrialization from the United States government, as a means of creating a "contention belt" of capitalist countries around communist nations in Asia. For instance: from 1953 until 1960, the United States financed 70% of South Korea's imports of commodities, which allowed it to rise from a rural producer to an exporter of manufactured goods in just seven years (Hong & Krueger,
Trade and Development in Korea. Seoul: Korea Development Institute, 1975). With such a clear path for development laid out, South Korea naturally invested in educating its population to meet the needs of its exports-driven industry.
Advantages and disadvantages
The major advantages claimed for ISI include: increases in domestic employment (reducing dependence on labour non-intensive industries such as raw resource extraction and export); resilience in the face of a global economic shocks (such as recessions and depressions); less long-distance transportation of goods (and concomitant fuel consumption and greenhouse gas and other emissions). The disadvantages claimed for ISI is that the industries that it creates are inefficient and obsolete, and that the focus on industrial development impoverishes local commodity producers who are primarily rural.
In most manufacturing processes a point of output is reached after which the cost of producing every additional unit of output diminishes. Different types of industries, given their different production functions (combinations of capital and labor, etc.) obtain different scale thresholds or minimum levels of output necessarily to begin accruing cost savings from large-scale output. For example, a mechanical pencil factory may need to sell 5 million units of output (pencils) each year before it can achieve economies of scale of production – efficient level of production. An automobile industry may need to sell 519, 001 units of output (cars) to achieve the same level of efficiency.
Clearly, the more units of anything manufactured you can sell the better the chances that your factories (consumer goods and intermediate, and ultimately capital goods) will achieve economies of scale, efficient production.
In a free market global economy, industries that produce inefficiently (without obtaining economies of scale of production) under the protections of ISI have been subject to criticism from more efficient foreign industries – a force driving the neo-liberal campaign for open markets.
What determines whether a country obtains efficiency – economies of scale in production? Market size (number of consumers, population) and purchasing power (usually but unreliably indicated by GNP/capita). Hence, larger, richer economies were more likely to make ISI succeed efficiently, whereas smaller countries with lower per capita incomes were less likely to succeed with ISI.
From: http://hdr.undp.org/docs/publications/ocational_papers/oc24aa.htm
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.
See also
- International trade
International trade is exchange of capital, goods, and services across international borders or territories. In most countries, it represents a significant share of gross domestic product . While international trade has been present throughout much of history , its economic, social, and political...
- Commanding Heights for an exposition of the effects of ISI on Latin American economies
- Singer-Prebisch thesis
The Singer-Prebisch thesis is the observation that the terms of trade between primary products and manufactured goods tend to deteriorate over time...
- Export-oriented industrialization
Export-oriented Industrialization sometimes called export substitution industrialization or export led industrialization is a trade and economic policy aiming to speed-up the industrialization process of a country through exporting goods for which the nation has a comparative advantage...
- Export substitution industrialization