Import Substitution Policy Versus Export-Led Growth Strategy

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Import Substitution Policy versus Export-Led Growth

Strategy
Import substitution industrialization (ISI) is an external economic policy, which advocates
replacing imported goods with domestic production. ISI is based on the premise that a country
should attempt to reduce its foreign dependency through the local production of industrialized
products. Thus, ISI implies a tendency towards closing an economy from the outside world.
Export-led Growth Strategy (EGS), on the other hand, is a trade and economic policy, aiming
to act as a catalytic factor to accelerate the process of industrialization of a country by exporting
goods for which the nation has a comparative advantage. Export-led growth implies opening
up of domestic markets to foreign competition in exchange for market access in other countries.
Given this backdrop, the present study will make a comparative analysis between Latin
American strategy of ISI and the East Asian EGS.
1. Terms of Trade (ToT) is defined as:
ToT= (Index of Export Prices)/(Index of Import Prices)
As noted in the preceding paragraph that ISI makes an economy inward oriented by
focusing on the domestic industrialization policy which produces substitutes for
imported commodities. For over two decades, from 1950 to 1970, Latin America
pursued the policy of ISI. As a result, Latin America was marked by export pessimism,
where each unit of exports would earn a declining unit of imports. However, with the
implementation of ISI policy led to a secular decline in the ToT in Latin America. The
reason behind this secular decline in ToT can be attributed to the famous Prebisch-
Singer thesis. According to this thesis, exports in primary commodities (eg.,
agricultural and allied products) will, over time, experience a secular decline in prices
relative to the prices paid for the manufactured products. It is a well known fact that
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developing countries (LDCs) mainly export primary goods, while, developed countries
export manufactured goods. Thus, in terms of Prebisch-Singer thesis, the ToT will
gradually deteriorate for LDCs vis-a-vis DCs. Latin American economy, being mostly
agricultural, experienced a deterioration in ToT after the implementation of ISI.
2. ISI policy has failed miserably to achieve the goals of industrialization and economic
growth. On the contrary, Latin America experienced a stunted economic growth
followed by the huge debt crisis in the 1980s. This outcome can be attributed to a
number of reasons. First of all, because of ISI, the government allocated more resources
towards the domestic import substituting industries. As a result, less resources were
relatively channelized to the export. This caused a misallocation of resources in the
economy, which ultimately affected the economic growth in Latin America. Secondly,
exchange rate was overvalued by the monetary authority. This led to increase in the
prices of exported goods in the international market. Thirdly, policies were too much
biased in favour of urban areas in relation to its rural counterparts. Thus, there were
wide regional disparities which led to growth imbalances in Latin America. Fourthly,
ISI trade and competition policies were heavily protectionist in nature. This resulted in
the concentration of industrial power by creating domestic monopolies. This adversely
affected the competitive environment among the domestic industries. Fifthly, ISI
fostered rent-seeking and corruption on a larger scale. Finally, ISI led to
macroeconomic instability in Latin America. As a result of all these reasons, ISI policy
was abandoned ater 1970s.
3. East Asian Economies, often termed as the High Performing Asian Economies
(HPAE) by the World Bank have followed an Export-led Growth Strategy (EGS) in
order to achieve high economic growth. The stable macroeconomic policy, which
played a key role in accelerating the overall economic growth through EGS in HPAE,
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can hardly be overlooked. This stability had mainly come from high saving rates
matched by high investment rates. This had, in turn, resulted in low inflation and rapid
income growth. In addition, the HPAE were going through the final phase of
demographic transition, where both death and birth rates were falling. Coming to the
external front, it can be observed that by 2000, HPAE exports had become a major share
of world exports. Further, HPAE kept budget deficits and foreign debt within the limits
of the ability of the government to finance without having to print or borrow excessive
money. This had, in turn, resulted in low rate of inflation. This enabled a stable interest
rate, which allowed the firms to take a long term view of their investment. The
institutional environment was made conducive to make the production process more
efficient and productive. There were well-defined property rights coupled with a
competent bureaucratic system, which enabled enforcement of contracts and access to
relevant information. Regulation of government are clear and well publicized. Fiscal
discipline and business-government relation were maintained on a one-to-one basis.
Governments of HPAE strictly intervened in the market to discourage the practice of
rent seeking. Thus, a stable macroeconomic setup had worked as a catalytic factor for
HPAE to embark on a higher growth trajectory.
4. According to World Bank, a sound industrial policy can be implemented if thee
government intervenes in three common areas:
 Targeting of specific industries
 Directed credit
 Export promotion
Going by the World Bank guidelines, the HPAE had targeted six key tool:
 Restriction on imports
 Direct credit
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 Subsidies
 Infrastructure construction
 Research and Development (R&D) funds
The industry-specific targeting was given by the government as long as the industries
can meet the specific export target. The government had given top priority to
macroeconomic stability over industrial policy. As a result, more export earnings
fostered higher GDP growth in HPAE.

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Import Substitution Policy versus Export-Led Growth

Import substitution industrialization (ISI) is an external economic policy, which advocates

to act as a catalytic factor to accelerate the process of industrialization of a country by exporting

American strategy of ISI and the East Asian EGS.

1. Terms of Trade (ToT) is defined as:

ToT= (Index of Export Prices)/(Index of Import Prices)

focusing on the domestic industrialization policy which produces substitutes for

Singer thesis. According to this thesis, exports in primary commodities (eg.,

agricultural, experienced a deterioration in ToT after the implementation of ISI.

growth. On the contrary, Latin America experienced a stunted economic growth

relatively channelized to the export. This caused a misallocation of resources in the

the concentration of industrial power by creating domestic monopolies. This adversely

fostered rent-seeking and corruption on a larger scale. Finally, ISI led to

was abandoned ater 1970s.

competent bureaucratic system, which enabled enforcement of contracts and access to

discipline and business-government relation were maintained on a one-to-one basis.

Governments of HPAE strictly intervened in the market to discourage the practice of

HPAE to embark on a higher growth trajectory.

4. According to World Bank, a sound industrial policy can be implemented if thee

government intervenes in three common areas:

 Targeting of specific industries

 Research and Development (R&D) funds

macroeconomic stability over industrial policy. As a result, more export earnings

fostered higher GDP growth in HPAE.

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