Import Substitution Industrialization - Policy Regimes, Indian Economy | Indian Economy - B Com PDF Download

What is Import Substitution Industrialization?

While there are many variations of applications related to import substitution industrialization, the idea behind ISI is that countries that have been reliant on importing products (usually by more economically developed Global North countries) will instead decide to focus on their own production of products that they formally imported. This will not only make these countries less reliant on outside states’ finished products, but the goal is for them to also build their economy through industrialization.

Sanderatne says of import substitution industrialization: “What are import substitution policies? They are policies that attempt to reduce foreign dependency of a country’s economy through local production of food and industrial products. Import substitution policies advocate replacing imports with domestic production. It is based on the premise that a country should attempt to reduce its foreign dependency through local production of goods, mainly industrial products. Many Latin American countries implemented import substitution policies with the intention of becoming more self-sufficient and less vulnerable to adverse terms of trade.”

The belief is that there is a need to offer this protection, until there is additional knowledge development, as well as capital. While capital is often outside aid, for knowledge, this takes time to develop internally. And it often involves innovation, errors, successes, and continued work and efforts on the particular sector that the society is looking to import substitute. But the argument is that none of this can happen if that country has to continuously compete with international economic actors, many of whom may have had decades of experience and knowledge working on developing that said product (Bruton, 1989). As Bruton (1989) states, “Protection then is a means of inducing diversification and the learning upon which development is based. More accurately, perhaps, it is a means of creating a process of development that builds on search and learning…” (1605-1606).

How do you know when import substitution industrialization is happening? While it might be easy to answer this question, merely looking at government leader calls for the country to move towards substituting their imports for their own products, there would have to actually be a serious substitution to know that ISI was occurring. In order to understand whether a country is establishing an import substitution industrialization policy, this “import substitution industrialization is “measured” by a change in the ratio of imports to the total availability (imports plus domestic output) of a single product or category of products. If this ratio falls over time, then import substitution is said to take place in that particular sector” (Bruton, 1989).

The idea is that a great deal of income is being spent on products produced by foreign companies, which in turn, will send out money away from the local economy. Thus, “One way to prevent money from leaving the local economy is to connect local demand for goods and services with the local suppliers of those goods and services. Many of the things that individuals or businesses need can be found from suppliers within the area but, due perhaps to lack of adequate information or convenience, those things are often purchased from the outside. This represents another flow of capital leaving the system. By substituting demand for externally produced things with locally produced things, communities can retain capital for use within the community” (Basu, 2005).

 History of Import Substitution Industrialization

While much of the discussion on the topic of import substitution industrialization focuses on current (and more recent historical cases of ISI implementation), ISI economy shifts have existed at least since the 1800s. For example, a number of European states, along with the United States of America began to stop importing various goods, and instead, looked to begin producing their own products, which over time, led them to shift away from those imports. These countries were careful to ensure that their companies had a chance to keep with already established companies overseas, and thus, took it upon themselves to protect these domestic industries (Baer, 1972).

But while the United States and other European states industrialized through import substation, not all countries in the world did so. For example, many states in Latin America, Africa, and Asia did not follow similar import substitution industrialization patterns. The reason for this was that “Colonial policies of European countries provide much of the explanation for the former two cases, while socio-economic structure helps explain the Latin American case. The presence of attractive external markets for the region’s primary exports, which benefited the elites, meant that there was little political desire to change the structure of the economies” (96).

So, external actors–such as the role of Britain and their colonial control of many countries can help understand why a number of states could not follow their own import substitution industrialization; the colonial powers would not allow it. Along with this, according to scholars, another factor that did not lead to ISI or industrialization was that regions such as “Latin America did not have the entrepreneurial class, labor force, infrastructure, market size, or administrative capacity to cope with an extensive industrialization process. Also in the case of some countries, like Brazil, European powers had enough leverage to force governments to maintain free trade policies, thus in effect blocking any possibility of ISI (Baer, 1972: 96). However, the Latin American states were still looking at ISI policies, and attempted to implement these policies even before WWII, but continued to do so in the decades following the Second World War (Sanderatne, 2011).

The idea of import substitution industrialization as an economic policy began to take hold much more following World War II. Part of the reason for this was related to the time of decolonization, and the related nationalist movements that not only called for state and political independence, but the leaders also were also advocating economic independence from their colonial powers. Thus, many countries began to look for ways to protect domestic industries while they strived to industrialize economically.

Interestingly, this notion of economic independence was not only adopted by colonized countries, but also some Global North states as well. As Basu (2005) writes, “The notion of import substitution was popularized in the 1950s and 1960s as a strategy to promote economic independence and development in developing countries (Bruton 1998).This initial effort failed due in large part to the relative inefficiency of 3rd world production facilities and as a result their inability to compete in a globalizing marketplace. Since then, those countries and the rest of the world rely a great deal on foreign-produced products and, as globalization trends suggest, an export oriented approach has became the norm. Despite this, in the 1970s, import substitution came into the U.S. consciousness as a means to promote national (Buy American campaigns) and regional development and the debate continues as to its effectiveness.”

Benefits of Import Substitution Industrialization

There are a number of reasons why governments might want to consider import substitution industrialization policy for their economies.

One of the main reasons that a government would consider import substitution industrialization policy is if the society was highly dependent on foreign exports, and because of this, they have not established a domestic industrialized economy. Because of outside dependency, the states do not have their own economy that can produce whatever product they are importing. By focusing on ISI, these governments can move to more self-sufficiency. They can begin to move off reliance for outside products, and instead, can begin to produce them domestically. This will also help build their own economy, provide domestic jobs, and help the overall economic growth of the state.

Furthermore, by shifting to import substitution industrialization, they might also be affected by external price shocks. For example, if they are heavily reliant on outside products from one particular country, any increases in the cost or production of that product might affect the importing country who still will need to purchase those products, particularly since they do not have their own production possibilities. This could happen if there was a problem with the production, if there is conflict in that state, or for a number of other reasons. By import substitution, the importing state will now be less effected by that external shock to the price of those goods.

In terms of examining where ISI policies may have been effective, “ISI had some positive effects on the larger economies of Latin America. It was responsible for periods of high growth rates during which the economies underwent some profound structural changes. After a while, however, it also caused some severe imbalances, threatening the continued growth and socio-economic stability of a number of countries”. (W. Baer & L. Samuelson, 1977) (in Rojas, 1993).

Thus, while there are a number of benefits to ISI policies, it is necessary to also look at some of the challenges in effectively implementing import substitution industrialization policies within a country. 

Criticisms of Import Substitution Industrialization

While there are arguments for the benefits of import substitution industrialization, there have also been criticisms related to state-adopted ISI policies. For example, one of the biggest critiques is that with ISI, the state often nationalizes companies, and then protects them from the international markets. While this can be seen as a positive as it pertains to allowing those companies to grow and develop, one drawback is that “import substitution industries create inefficient and obsolete products as they are not exposed to international competition” (Sanderatne, 2011). With governments protecting domestic products, their willingness, or need to ensure a top quality product are not necessarily ensured, given that they no longer have to keep on an even playing field. By being protected with high import tariffs into the country, local products will have an easier time being sold, even though the same products might be inferior to international products.

Another concern that scholars have pointed out is the belief (which may not be a correct assumption) that if just given some time, the domestic protected products will be just as good as the external, foreign products, and will be able to compete with them internationally. The assumption is that their markets, while needing to be protected at first, would over time get strong enough, and the products be good enough, to give competition to the same/similar products produced elsewhere (Bruton, 1989). However, there could exist a number of reasons as to why this may not happen immediately (if ever). For example, if the new country does not have the sufficient technology, or if their technology is outdated, whereas other countries’ technologies to make that said product are always updating, the first county may always be at a competitive disadvantage. Moreover, even if they did have the technology, because of no competition (due to high import tariffs on foreign products), there may be less motivation to produce the best product, particularly if there are some within the state who don’t mind only selling the product domestically.

This is why effective import substitution industrialization requires conditions that promote innovation and new thinking, so that the product can continue to improve (Bruton, 1989).

In addition, “Other disadvantages include unemployment increasing internationally as World GDP decreases through the promotion of inefficiency. Countries that adopted import substitution policies faced many undesirable effects such as chronic problems with the balance of trade and payments. Although import substitution was supposed to reduce reliance on world trade, there was a need to import raw materials, machinery and spare parts. The more a country industrialized the more it needed these imports and import substitution industrialisation (ISI) was strongly biased against exports” (Sanderatne, 2011).

Sanderatne (2011) goes on to say that “Trade protection and overvalued exchange rates raised domestic prices and made exports less competitive. Consequently, import substitution industrialising countries were unable to export enough to buy the imports they needed. The faster the economy grew, the more it needed imports; but exports could not keep up with the pace of imports and so countries ran out of foreign currency. In response, governments restricted imports to essentials. The currency was devalued to raise the price of imports and make exports more attractive. Government subsidized industrial investments. Such spending chronically outpaced government revenue and these budget deficits were usually covered by printing more money. The result was inflation which made domestic goods more expensive which in turn reduced exports even further. Sri Lana experienced much of this during its import substitution industrialising period in the 1960s and 1970s.”

Import Substitution of Industrialization in Russia

In 2015, Russian leaders were pushing the idea of import substitution as a domestic economic policy. Russian leaders have called for less economic dependence on outside states, and outside products. Much of this is related to the political developments in recent years. Not only has Russia had political differences with the United States, but they have also squared off with the European Union. For example, there has been concern by Russia about the rising expansion of NATO post-Cold War. Moreover, one of the main reasons that the Ukraine conflict happened was because both the EU, and Russia each wanted to establish economic relationships with Ukraine, which led to a cancelled EU agreement, a moving towards Russia, which then led to a revolution, followed then by Russia’s annexation of the Crimea, and their support of rebels in Eastern Ukraine. During this time, there have been sanctions placed on Russia (although many have considered them weak, and not able to significantly harm the leaders). However, these sanctions, along with low oil prices in the international market, has reduced Russia’s economic power.

As a result, they are looking to develop their own industries, not only for economic wealth and diversification, but also to ensure that they are less reliance on foreign states and products.

Here are a couple of news video discussing Russia’s import substitution industrialization programs, as they pertain to sectors such as food, as well as medical products.

Here is another video further discussing Putin’s import substitution industrialization program.

Others have made a similar argument, saying that Russia’s import substitution industrialization is not working right now. For example, writing in October of 2015, Adomanis (writing in Forbes) points out that imports have declined greatly following the economic sanctions levied against Russia. Thus, from there, he asks whether Russia has adjusted towards their import substitution industrialization model, asking: “Has Russian business stepped into the space vacated by Western goods that are no longer affordable to many Russian consumers? So far, at least, the answer is a definite no. Official Rosstat data show that through the first half of 2015, Russian manufacturing actually shrunk by about 2.8%. The only sectors of the economy to show any growth were agriculture (up 2.4%), natural resource extraction (up 2.4%), and public administration (up 0.7%). The areas of the Russian economy where private business predominates, particularly consumer retail, have been absolutely walloped, with the overall retail sector shrinking by almost 9% over the past six months.

He goes on to say that “So far, then, the crisis has not made Russia’s economy any more flexible, entrepreneurial, or dynamic. It has instead made it even more dependent on the old growth model, which was based on government and natural resources. One of the few areas of agreement in Russian society is that the old model is exhausted and in desperate need of replacement, but exactly the opposite is occurring right now: it is being further bolstered and institutionalized. Russian business isn’t rushing to fill the space left by Western firms, it’s suffering amid a broad-based downturn in virtually all areas outside of oil, gas, and government.”

Again, these programs do take time, and so, one cannot write off this program yet. However, as we discussed, they also take a sound policy that is committed to long-term domestic growth, and a government willing to set up conditions to help this import substitution industrialization process. But, there continues to be a concern that Russia can transform their economy through domestic industrialization, in part because of “weak property rights and a general aversion to investment” (Adomanis, 2015), which continue to hinder economic growth.