Import Substitution Policy Versus Export Led Growth Strategy

The Countries conduct two different strategies for industrialization; import substitution and export promotion for their international trade. Whether to adopt import substitution or export promotion trade strategy is controversial issue throughout the years for the countries. This issue forms a debate between “Trade Optimists” who support outward looking development policy, which envisages the free trade and free movement of goods and the “Trade Pessimists” who believe that the company must write its own destiny, and do not cooperate with other countries [Tadora, (2006) p621]. In 1950s and 1960s import substitutors are outweigh this debate by becoming popular in most of the developing countries but after the late 1970s export promoters become more powerful.

The both policies have advantages and disadvantages. In this report, I will firstly give some information with respect to these two policies and then critically analyze advantages and disadvantages of these two policies.

Import Substitution

Low-income countries must industrialize to become more developed; but as they could not compete with already industrialized markets, firstly they have to protect themselves from the imports, which came from already industrialized and highly productive economies and concentrate on their production in order to achieve this goal. [Bruton, (1997) p904]. They have to reach a level, which make them compete with foreign industries in all over the world.

Import substitution policy could be defined as putting various barriers to the importation of foreign goods to reduce the countries’ foreign dependency and providing these goods by producing them domestically [Ray, (1998) p657].

The import substitution policy could be varied among the goods. The capital good and consumers’ goods are treated differently. Consumer goods had been imported more strictly with the reason the consumer goods could be produced with less cost and the production of the capital good requires more intense capital and more complex technology. [Bruton, (1997) p908]. So mostly developing countries put bans on importation of consumer goods but not capital goods.

As stated above, in order to provide import substitution, a protection is required. This protection could be supplied by government intervention. There are several ways to restrict the importation. Firstly, it could be provided by tariffs and quatos. Tariff is the percentage that is applied to the value of and imported item with the resulting sum of money going to the government. In the presence of tariff, the potentials import has been substituted by domestic production [Ray, (1998) p657]. Whereas the quato gives the maximum quantity on a particular good. Above that limit, no more of that good can be imported into the country.

The other instrument, which restricts import, is the exchange rate. If the domestic currency will be overvalued, the price of the imported will be high and domestic good will be low [Bruton, (1997) p912]. When the exchange rate is higher, it will be more expensive to purchase foreign product imports. If for example, the government wants to “overvalue” its currency to make the foreign imports more expensive in domestic market, it may keep the currency from circulation. For example, if we assume that there is a demand of 1 million US Dollar but only the 500 thousand US Dollar has been issued to economy by government. This directly increases the price of US Dollar.

It is believed that the import substitution encourages the learning of new techniques of production (as they are afforded with this protection) and the labors skills are improved with the experience, which provides increase in productivity of the firm [Ray, (1998) p669]. Besides this, import substitution strategy in a single industry can also be beneficial in other industry by creating additional demand that shall increase the employment and income. In conformity with these advantages, as per the data obtained by Maddisson (1995), there is an overall positive development (in terms of GDP growth rate, investment rate) in the countries that conduct import substitution policies.

However starting from 1960, the negative consequences of import substitution starts to show itself and today it is mostly accepted that import-substituting strategy becomes unsuccessful in most of the countries.

In the light of the information gathered from Bruton [(1997) p917]. and Tadora [ (2006) p631], the negative effects of import substitution could be summarized as follows:

First of all, the import-oriented industries remain inefficient and costly to operate, as they are not competing with international industries and they do not need to make any research and development. So it is not incorrect to argue that industrialization has been inhibited with this strategy. Since there is inefficiency, the unemployment will automatically will increase within this respect. Secondly, although some industries were conducted with import substitution policy, most of them acquired by foreign companies and they transfer their profits abroad rather than investing them in the domestic industries. Thirdly, the newly established domestic industries specialized for production of consumer goods created a demand for importation of intermediate goods, but the danger is that there appears the need for import of intermediate goods in order to produce final goods inside the country and significant part of the profit transferred to the foreign countries. In addition to this, as the local currency is overvalued, -which increase exports’ price and decrease the imports- the local farmers become less competitive in the international market. Besides this, since it does not have any interactions with other countries, the country will be less affected in case of global economic crisis.

Also, import substitution strategy has a negative effect on exporters. As the exchange rate increases, domestic goods, which are produced in internal industries, become expensive which will detrimentally affect the export. Both the decreasing exports and increasing dependence on foreign intermediate goods makes the trade balance worse. This cycle leads countries to borrow money to overcome their trade deficit.

Import substitution strategies were conducted most nations in Latin America from the 1930s until the late 1980s. Over the period, 1949-1964, the total demand in manufacturing was growth significantly [Ray, (1998) p675]. however when the world economy went into recession in the 1970s and 1980s, Latin America went into worst economic crisis because of its foreign debt and it also changed its policy towards export orientation.

Export Promotion

As the distortions and failure of the import substitution policy is recognized, the export strategy gains importance for the countries. The case of Taiwan and South Korea is significant in this respect [Bruton(1997) p920]. They started to export the goods in 1960s and they remarkably increase their growth from that period.

Import substitution is sharply contrasted with outward (export) oriented approach. In the export promotion, primary attention is given to the foreign trade and exports. [Bruton(1997) p904]. Basic goal is to maintain domestic economy to open the foreign capital. Export oriented approach has become popular in last 15 years and many countries has changed their policy from import to export oriented. [Bruton(1997) p905].

Generally rather than the exporting primary products, manufactured products are encouraged by governments of developing countries to be exported. The most of the developing countries have a comparative advantage in such primary products and they do not want to be dependent to other countries [Ray, (1998) p678].

Unlike import substitution, the tariffs and quotas on imports are reduced for exporters in order to encourage exportation. In addition to this, the banks are providing more easy and flexible terms to exporters. Governments can also make some payments to specific products to encourage the export of goods cheaper to foreign consumers and give some exemptions and incentives for those who want to export. According to Bruton [(1997) p924-925], the export-oriented strategy helps Taiwan and South Korea to overcome their balance of payment problems, increase their employment, and improve the knowledge of technology and quality of the product.

One obvious benefit of the export promotion is that it provides more visible gains [Ray, (1998) p677]. Because as there is competition in the international market, the goods are provided more cheaply. The allocation of resources could be done more efficiently and the cost of the production will be much more less (Salvatore, Hatcher, 1992). It also increases economic growth and it generates required foreign exchange that can be used to import goods [Tadora (2006) p640]. As the exporters are in the competitive market, they have to improve their quality and they have to conduct research and development studies within this respect.

It is argued that although import substitution has more immediate positive effects on economy on the short term, the export promotion has more long run positive effects. [Tadora (2006) p640].

Outward oriented strategy helps country to use its capital for progress by not facing any barriers in relation to payment of debt. As it is stated in above, inward oriented policy is a significant reason why Latin America have faced with debt issue. (Dollar 1992)

Although there are significant numbers of empirical result, which proves that there is a correlation between outward oriented strategy and growth rate, as it is more dependent to external factors and foreign countries economies, it can create unexpected results. The success of the export-oriented policy is dependent to foreign demand. In order to form a successful export oriented policy, it is crucial to envisage future demand of such market, the ability of any government to forecast is not totally possible as the information with regards to supply and demand can be vary easily in relation to external factors.

In the light of the above information, it is correct to argue that both of the strategies are totally not perfect. The success of the strategy depends fluctuations in the world economy. When the world economy is growing significantly in the period 1960 to 1973, the countries who applied export promotion have more advantages but when the world economy slowed down between the period 1973 to 1977, the countries having import oriented strategy get less effected. It is widely accepted that export oriented economies are more effective when the external demand is high. Besides, the success of the export strategy is changing from country to country. While China benefited from this strategy, Thailand, Indonesia faced a lot of difficulties. In addition to this, it is stated by Todora (2006) that even the most successful East Asian export promoters have pursued import substitution strategy in some of its industries. In other words, export promotion or import substitution policies could not be implemented entirely to all industries.