Developing countries (LDCs) have adopted a number of approaches in
their attempts to move their economies and societies from a so-called
"backward" orientation towards a more "modern" one.
Crucial to this process was a desire to change from a rural-traditional
dominance to a more modern-industrial mode for the simple reason that
development was equated with industrialization. As a result, LDCs
pursued a policy of rapid industrialization primarily through a process
of import substitution. Some of the negative consequences of this
process led to what is considered to be an opposite approach to economic
development, the policy of export promotion. The literature, however,
still continues to offer a lot of debate (Razzaque and Raihan, 2008;
2. IMPORT SUBSTITUTION STRATEGY
In talking of import substitution, it is important to distinguish
between that which occurs "naturally" in the course of
economic growth and development, and that which forms the object of
governmental policy. "Natural" import substitution takes place
as domestic incomes rise and the range of products that can be produced
competitively for the domestic market increases. Goods that were
previously imported because domestic demand was too small to support
competitive local production are gradually replaced or supplemented by
locally produced goods. Import substitution in this paper refers, not to
this "natural" process, but rather to that which takes place
as a result of a deliberate governmental policy.
The primary incentive for initiating import substitution is the
prospect of industrialization and the economic gains associated with it.
Behind this incentive lies the desire to be rid of the chronic long-run
structural disequilibria in patterns of production and trade.
Specifically, import substitution has been based on the following
arguments: infant industry protection; instability of foreign market
earnings and the need-for self-sufficiency (Prebisch, 1962); savings for
investment, since industries are assumed to save more; a need to
conserve foreign exchange and improve balance of payments; additional
exports of primary products would turn the terms of trade against the
exporting country (Cypher and Dietz, 1997).
The policy instruments supporting import substitution regimes are
an assorted mix of tariffs, quotas, exchange controls and overvalued
currencies. Restrictions on imports protect domestic firms from
competition with producers from other countries and are measured using
the effective rate of protection (ERP). Empirical estimates by Balassa
(1971) and Lewis and Guisinger (1968) indicated an excessively high rate
of effective protection, and by implication, a heavy movement of
resources into manufacturing sectors. Another concept that provides a
measure of the "real" economic costs of production activities
that result from protective measures is that of Domestic Resource Costs
(DRCs). It gives an empirical estimate of the domestic marginal rate of
transformation by adjusting domestic prices for monopolistic rents and
factor market distortions, in order to reflect the opportunity cost of
producing various commodities. Krueger (1974, p. 218) interprets the DRC
as follows: "Thus if an activity has a DRC twice as high as another
the implication is that had the first activity not been undertaken and
had resources been employed in the second activity, these resources
would have produced twice as much foreign exchange earning or saving as
under the existing allocation."
There is a very large body of research on the effects of import
substitution regimes in developing countries. A major effect cited is
the discrimination against agriculture. This happens because protection
raises the prices paid for manufactures while depressing those for farm
produce. A difference is created in the domestic terms of trade between
industry and agriculture, and the external terms of trade, which show
the same price relations but at world prices. The net result is a
redistribution of income from agriculture to industry. Pakistan's
import substitution policy in the 1960s which caused the ratio of
manufacturing to farm prices to be twice as high as it was in world
markets, amounted to an 11-13% tax on farmers' incomes (Lewis and
Guisinger, 1968). Similar estimates by Diaz-Alejandro (1970) for
Argentina between 1947 and 1955 gave a tax on farmers of between 30 and
40%. A related effect has been the favoring of profits over wages within
the manufacturing sector with a resulting increase in inequity of income
distribution. Since import substitution initially focused on the
production of final consumer goods it created a demand for a variety of
new imports to be used in production processes. This led to an increase
in dependence on imports with even more serious consequences in the
event of foreign exchange shortages (Athukorala and Rajapatirana, 2000).
Now there would be effects on employment and capacity utilization
instead of there being only shortages of the formerly imported final
product. This kind of situation resulted in the difficulty of further
import substitution (Bruton, 1998). The net result was that import
substitution did not lead to economic self-sufficiency. As Sunkel (1973,
p. 15) indicated, "the transit from the primary export model to the
import substitution industrialization model does not mean that they have
become less dependent on the international economy, but that the nature
of dependence has changed."
Import substitution is also considered in general to have been
unable to save foreign exchange. This was partly due to imports for
production processes discussed above. In addition, the growth of income
resulting from the policy had the effect of increasing leakages into
other imports; it was mostly urban dwellers with a high import component
of demand that benefited most from this "modernization."
Furthermore, it was unable to create enough jobs for the masses in the
urban areas nor was it able to change the emphasis on exports of primary
goods (Sunkel, 1990).
The major defect of import substitution policies, according to
Bhagwati and Krueger (1973), has been their inevitably indiscriminate
nature in influencing the behavior of individual firms. The inability to
distinguish between low cost and high cost activities led to a roughly
proportionate expansion of all firms in a given industry, with little
competition among them, ensuring the growth of efficient and inefficient
ones alike. This difference in efficiencies can be attributed in large
part to the haphazard building of manufacturing capacity, a
proliferation that made more difficult the exploitation of whatever
economies of scale were potentially available. Still another criticism
of import substitution is that it eliminates the gains from trade by
favoring production for domestic use over exports. This happens because
of over-valued exchange rates that mean a producer will earn a lower
amount of domestic currency equivalent by exporting than by selling in
the home market. Thus there is a bias against exports. In addition the
protective-regimes further penalize exports by tariffs on their inputs
and thereby raising the costs of production as well as prices, leading
to international non-competitiveness. These effects have been
well-documented by Little, Scitovsky and Scott (1970), Balassa (1971)
and Anderson et al. (2002) among others.
A final (within the scope of this paper) set of effects has to deal
with the lack of linkages between import substitution and other sectors
of the economy. This effect cannot be blamed on the policy for it
depends on the degree of articulation within an economy.
3. EXPORT PROMOTION STRATEGY
As a result of these criticisms of the policy of import
substitution a number of economists e.g. have proposed export-led models
of development (Caves, 1970). Export expansion is important for it is
almost nearly a necessary condition for sustained growth and development
over any lengthy period. Exports are viewed as an "engine of
growth", and increases in exports stimulate domestic investment
through an accelerator effect. The increase in investment has the
consequence of increasing the internal demand while at the same time
expanding productive capacity and productivity. If money wages are
assumed to increase at the same rate in other trading countries, then
the rise in productivity will result in relative price stability and an
improvement in international competitiveness. So long as exports keep
increasing there will be a self-reinforcing tendency for a country to
maintain its competitive position and to continue its economic growth.
Exports then make possible the benefits from trade, pay for the imports
required in development both directly and indirectly (by adding to
borrowing and debtservicing capacity).
Policies to promote export expansion have included the following:
subsidies, realistic exchange rates, and trade agreements. Export
expansion may generally take two forms: primary commodity export
expansion; and manufactured goods export expansion. Export expansion is
however not necessarily easier. Todaro (1977) identified factors
militating against rapid expansion in exports of primary products,
especially agricultural, to the developed countries. On the demand side
he cites the following: low per capita income elasticity of demand for
agricultural foodstuffs and raw materials; developed country population
growth rates at or near replacement levels; low price elasticity of
demand for most non-fuel primary commodities; development of synthetic
substitutes; growth of
In addition to these factors, there are also supply side
considerations in the form of structural rigidities that work against
rapid expansion of primary product earnings. Examples of such rigidities
are limited resources, antiquated rural institutional, social and
economic structures and non-productive patterns of land tenure.
The goal of expanding manufactured exports was given impetus by the
"success" stories of such LDCs as Taiwan, South Korea and
Brazil during the 1960s and 1970s. In recent times, however, growing
protection in developed countries has again dampened the viability of
this kind of expansion. This outward-looking strategy of development
based on export promotion is generally considered to be a better one
than that of import-substitution in the literature (Weiss, 1999;
Krueger, 1998). The leading examples of the success of this approach,
subsequently dubbed the "Gang of Four" are Hong Kong, South
Korea, Singapore, and Taiwan. Taiwan's export expansion was based
to a great extent on exports of processed imported materials. Exports of
industrial products rose from $12 million in 1957 to $280 million in
1966 (50% of total exports). These exports accounted for about 66% of
the total increase in exports from Taiwan over the period. Exports of
certain processed foods based on domestic produce such as pineapple,
asparagus and mushrooms also increased substantially. This growth in
industrial products did not come at the expense of exports of primary
products. Taiwan's exports of bananas, for example, rose from 3.2%
of total exports in 1962 to 9% in 1966. While Taiwan's success was
in part due to external factors such as external aid and the Vietnam war
which increased the demand for some of her exports, i.e. metals and
building materials, credit must also go to the economic policies
followed. These policies included the removal of import restrictions,
the maintenance of "realistic" exchange rates, and the
provision of export finance and insurance.
Similar economic policies are believed to have contributed in no
small measure to the rapid expansion of fish meal exports from Peru and
raw cotton from Central America. South Korea embarked upon an
export-promotion strategy in the early 1960s after several years of very
slow growth. The growth rate rose by over 40% per annum as a result of
bias towards exports provided by the economic system. The rate of growth
of GNP that was 6.1% in 1965 averaged 10.3% from 1966 to 1972. Brazil
also experienced similar success after shifting to an outward-looking
strategy in late 1967. Export earnings, which showed virtually zero
growth from 1954 to 1967, showed an average annual increase in excess of
25% from 1967 to 1973. The average annual rate of growth of real GDP
from 1962 to 1967 was 3.7% but averaged 10.2% from 1968 to 1973.
Much of the literature deals with these two strategies as either/or
propositions but it is doubtful whether this should be the case. While
traditional approaches to import-substitution create a bias against
exports it is believed this bias can be removed by other policies, as
has been the case in Taiwan and Pakistan. Included in these policies are
export subsidization and the case of multiple exchange rates. Such an
approach would decrease some of the distortions arising from
import-substitution to change the structure of the economy. The strategy
to discourage primary commodity exports is fully consistent with efforts
to reduce traditional patterns of dependence. However, a country cannot
export manufactures without building the capacity to produce them and
capacity cannot be built without import substituting. This is because
the ratio of imports to domestic production of manufacturers in many
LDCs is so high that attempts to create domestic capacity is bound to
take the form of import substitution. There is thus an implication of a
sequence from primary specialization, to import substitution, to exports
of manufactures. Findlay (1973) showed that this sequence is attained
either by sufficiently large increases in productivity in manufacturing
sectors, or through an increase in the propensity to save out of
profits. Ahmad (1978) also indicated that the growth of import
substitution in manufacturing is positively correlated with the growth
of exports. Thus, sectors that showed a high growth of import
substitution were also the ones that had a relatively high rate of
export growth. The Brazilian experience indicates that significant
exports of manufacturers arise only in industries where large scale
import substitution has been successfully accomplished. As Chenery
(1975, p.505) pointed out "Although Brazil is on its way to
becoming an efficient exporter of automobiles and machinery, a period of
apparently inefficient import substitution may well have been necessary
to structural change in both production and exports". Green (1995)
documented how the strategy advanced Latin America's economic
development. In the 1960s domestic production provided 95% of
Mexico's and 98% of Brazil's consumer goods and from 1950 to
1980, Latin America's industrial output rose six times.
Although countries that have built their development efforts around
import substitution have experienced grave problems it is still possible
to pursue the policy in a more satisfactory manner. The problems arose
as a consequence of the kinds of activities selected and the methods
adopted to bring about their development. As Bruton (1970, p. 124) put
it, "to implement their import substitution policy, countries have
chosen instruments and techniques that seem, in effect, to prevent that
very policy from being successful."
What is necessary then is a different approach to implementing the
policy of import substitution. At the same time there is the need for
export promotion. In effect there is a need for a twopronged approach
for the two policies need not be mutually exclusive (Jha, 2008). As
Masina (2006) indicated, the East Asian countries that became
economically successful used a combination of selective import
substitution and export promotion policies tailored to their national
industrial strategies. In particular, protection against imports in the
form of tariffs and quotas was constrained by limited duration or export
obligations for the specific industry. It is therefore clear that the
debate continues and will provide challenges for policy-makers and
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Franklyn A. Manu, Morgan State University, Baltimore, MD, USA
Dr. Franklyn A. Manu earned his Ph. D. from the Stern School, New
York University. Currently he is a professor in the School of Business
and Management, Morgan State University, Baltimore, MD, USA and recently
completed a sabbatical at the GIMPA Business School in Ghana where this
paper was written.
agricultural protection in developed
countries in the form of tariffs quotas, and
non-tariff barriers such as sanitary laws.