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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.