International Relations

At the beginning of the twentieth century underdeveloped countries began to look for the ways to diminish their dependency on agricultural exports and to bring on an industrial revolution. The situation which evoked this need was critical. The problem was that the underdeveloped countries developed mainly the policies of supporting primary commodity exports. Transportation policy was used in the infrastructure for delivering the export crop to the harbour.

The research institutions specialized in agriculture worked only on improving crops for export, for example, sugar cane, coffee, cotton, etc.while crops for domestic consumption, for instance, beans or manioc corn, potatoes, left with little or even without expenditure. As a result some of the underdeveloped countries had to follow the policy of import substitution to induce industrialization. Import substitution industrialization will be the goal of study of this paper. This economic policy will be investigated in the frames of an economic term with the necessary characteristics and also in a wider meaning as the experience of the countries of East Asia and Latin America.

In the process of research different points of view, both pro and contra, will be cited in order to shed the light on positive and negative aspects and cover the field broadly. In the conclusion of the paper the main findings will be summed up. The term of import substitution can be defined as an economic process and as a policy strategy.

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As a process import substitution relates to the situation “where regions (more precisely, existing or new economic activities within regions) take up the production of goods or services which formerly were imported, but, for whatever reasons, now can be viably produced within the region (e.g. as a result of population increases leading to increases in demand or as a result of productivity increases resulting in greater competitiveness. ” As a policy strategy import substitution can be used to achieve the following goals: to utilize the capacities which are underused;  to fight unemployment in the regions;  to protect infant industries.

The policy of import substitution industrialization, according to the definition provided by the encyclopaedia, is “a trade and economic policy based on the premise that a developing country should attempt to substitute products which it imports, mostly finished goods, with locally produced substitutes. ” The theory of import substitution has much common with the theory of mercantilism. Both the theories promote minimal imports and high exports as the means of inducing the growth of national wealth. In order to implement the policy of import substitution industrialization, the following three main tenets must be pursued:

• protective barriers to trade, which can be set up in the form of tariffs. Tariffs or custom duties are applied to the goods which are imported and in this way they artificially protect domestic industries from competition with foreign companies;
• a particular industrial policy, which orchestrates and subsidizes production of the substitutes;
• a monetary policy, which will keep the domestic currency overvalued.

Monetary policy is implemented by setting reserve requirements and changing some interest rates directly or indirectly. The chief tools of monetary policy are operations in open market. In open market money circulates through the selling and buying of deferent foreign currencies credit instruments, or commodities. Such sales or purchases create a certain base currency which leaves or enters market circulation. Usually open market operations are aimed at achieving a specific short term interest rate target. However, monetary policy may also target a certain “exchange rate relative to some foreign currency or else relative to gold. ” Equally important is to note that import substitution as economic protectionalizm can have negative outcomes.

Stutz pointed out that "This form of economic protectionism helped some countries industrialize in the past but involves economic risks. " The risks of import substitution meant by Stutz are potential inefficiencies and higher prices. Successful implementation of this policy as a rule needs massive expenditure on infrastructure. Additionally, import substitution is accompanied by the establishment of state firms in the areas of industry which are thought to be too risky or too large for the private sector (or example, steel, aircraft) or estimated to be too important to be owned by foreign firms (or instance, oil).

The policy of import substitution industrialization was argued by the advocates of absolute free trade theory. Generally, free trade becomes possible when the flow of services and goods between countries is not taxed. In particular, the economists who supported free trade policy stated that economic strategy would become successful only under the following conditions:

1. international trade in services must be without trade barriers, or tariffs;
2. international trade of goods must not be free from any possible tariffs (namely taxes on imports) or trade barriers (for example, quotas on import);
3. the free movement of international labor;
4. the free movement of international capital;
5. the absence of any economic protectionalizm, implemented by trade-distorting policies (for instance, subsidies, regulations taxes, or laws), which gives an advantage to domestic firms, factors of production, and households over foreign ones.

Thus, it becomes obvious that free trade proponents advocated the policy which totally contradicted the fundamental tenets of import substitution industrialization. On the other hand, free trade proponents suggested that a foreign subsidy should be considered as another of comparative advantage and consequently domestic barriers should not be imposed on the purchase of goods produced overseas. Free trade economists pointed out that unlimited imports will be beneficial for domestic consumers which overweighs the loss of domestic producers.

Thus, the lower prices of foreign subsidies can be considered as net positive. Therefore, the domestic society where any import restriction is applied becomes “a whole worse off than it would be with unlimited imports. ” Anyway, the viewpoints of the both theories - import substitution industrialization and absolute free trade - were checked in the process of their implementation and in real life experience. In the period from 1930 to 1940 the policy of import substitution industrialization was adopted in many underdeveloped countries of Latin America.

The driving force which precipitated the acceptance of import substitution idea was the Great Depression which took place in 1930s. According to article Concern with Policy-relevance in the Latin American School of Economics authored by Bianchi, “Import substitution was a necessary condition for peripheral growth, in association with structural reforms in the economy. The focus should be placed on the strenghtening of the domestic market, which was seen as the crucial element of an inward-looking model of development.

” Later on, in the 1950s Raul Prebisch, the prominent Argentine economist, expressed his belief that the only way to succeed for developing countries was to build forward linkages domestically and to create industries which would work on primary products already produced by the countries themselves. The policy of tariffs would help the domestic industry to prosper. By implementing the policy of import substitution industrialization in the period from 1950 to 1970 a number of Latin America countries, in particular Mexico, Brazil, Argentina, Chile, Uruguay, attempted to reach positive results and to increase their national wealth.

The success of the policy in these countries was based on either high living standards or large populations. However, poorer and smaller countries, for example, Dominican Republic, Ecuador, Honduras, were not successful in adopting import substitution policy. Also it is notable that the countries which succeeded in import substitution industrialization managed to change the structure of their governments. Thus neo-colonialism collapsed and was replaced by democratic way of governing. Nationalization turned banks and utilities into public property and returned to nation some of the companies previously owned by foreigners.

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