Import substitution, also referred to as import substitution industrialization (ISI), is a set of policies that addresses the developmental concerns of structurally deficient economic countries. As the name suggests, the ultimate goal of ISI is to promote a country’s economic industrialization by encouraging domestic production and discouraging imports of consumer goods.
The dependency theorists were the first to formally devise import substitution as a viable economic strategy. Inspired by Karl Marx and Friedrich Engels’s writings on imperialism, the dependency theorists characterize the international system as divided between countries of the core and those of the periphery. In contrast to the industrialized nations of the core, the peripheral countries are poor and lag behind technologically. Another trait of the countries of the periphery, according to this school of thought, is their inability to influence economic outcomes in the international realm. The asymmetry in power relations between core and peripheral countries is borne out of the unfavorable economic exchanges that developing countries have with the developed world. This theory asserts that developed nations utilize their economic superiority to influence, and often intervene in, the peripheral countries’ economic, diplomatic, and military interests.
The dependency theorists contend that developing nations are bound to experience balance of payments problems due to declining terms of trade; that is, their ability to use earnings from agricultural (or other primary) exports to pay for industrialized (and high value-added) imports from developed nations is likely to diminish (Hirschman 1971). Hence, they argue that developing countries can enhance their international strategic position by reducing, or eliminating, their trade dependence on wealthy nations if they substitute their industrialized imports for goods manufactured domestically.
Besides the theory that inspires ISI policies, past international crises have forged a consensus among developing countries for the need to promote their local industries. The Great Depression and the two world wars were devastating for developing countries, whose industrialized imports from the developed economies were drastically interrupted. The economic success of the Soviet Union during the first half of the twentieth century also inspired policy makers throughout the developing world, including proponents of capitalism, who were persuaded by the apparent efficacy of a centrally planned economy. Indeed, the political and economic elites of peripheral countries were convinced that the state had to lead the crucial task of promoting domestic industry. Policy makers believed that a well-conceived and coordinated state intervention in the economy would eventually enable peripheral countries to catch up economically to the developed nations, which had the historical advantage of being the first ones to achieve industrial development.
In a nutshell, import substitution is a governmentled, tightly staged economic strategy aimed at promoting industrialization by offering a package of subsidies to its local industries (which are oftentimes government owned) and by insulating infant industries from foreign competition. Two important tasks of a successful ISI strategy are to persuade domestic consumers to buy locally produced goods and to encourage domestic producers to participate in the country’s industrialization project. ISI policy tools include:
- High import tariffs on consumer goods
- Low or negative tariffs on imports of machinery and intermediary inputs
- Cheap credit (frequently at negative real interest rates) to industrial firms
- Preferential exchange rates for industrial producers
- Public investment in infrastructure (e.g., transportation and power) and in so-called basic industries, such as steel (Weaver 1980)
One important feature of ISI is the tendency to transfer income from agricultural exports to industrial development. Countries that adopt this economic strategy in effect penalize their agricultural sectors, even though most of these countries enjoy significant comparative advantages in agricultural production. Michael Lipton (1977) denounces this practice as “urban bias,” namely, policies that favor urban industrial producers and labor at the expense of farmers and workers in rural areas. Some of the policies that characterize urban bias are overvalued real exchange rates, which penalize the export sector; price controls on domestic sales of locally produced agricultural goods as a means to subsidize food consumption in urban centers; and heavy taxation on agricultural exports. Therefore, one could argue that import substitution results in economic autarky.
Despite widespread enthusiasm in the 1940s and 1950s, levels of economic success among governments that pursued ISI policies tend to vary across regions and countries. Nevertheless, a common pattern exists among the ISI countries that achieve material domestic industrialization: They all tend to have large domestic markets. In Latin America, for example, some of the countries with relatively successful ISI experiences include Argentina, Brazil, and Mexico, the three largest countries in the continent. Scholars believe that import substitution cannot succeed as a development strategy without the support of a fairly large domestic market. Such markets are necessary to encourage local production.
Unfortunately, import substitution has left a devastating legacy in Africa, where most ISI economies have experienced stagnant or declining production in their agricultural sectors. Since 70 percent or more of the African population earns its income from agriculture, the urban bias that characterizes import substitution has resulted in a reduction in the real income of those who are among the poorest in the region (World Bank 1981).
Some of the other economic problems attributed to ISI include:
- An increase in state bureaucracy and in administrative inefficiency, in part because of the government’s excessive intervention in the economy;
- Increased fiscal deficits, which are primarily caused by governmental investments in heavy industry despite the lack of public resources;
- Chronic real exchange rate misalignments resulting from the maintenance of overvalued exchange rates;
- A shortage of foreign exchange, mostly due to the countries’ poor trade performance;
- An increase in foreign debt because ISI economies tend to borrow heavily from international capital markets to finance their development strategies;
- An increase in income inequality, especially between rural and urban workers; and
- An increase in balance of payments problems due to poor export performance and the rise in the importation of heavy machinery by domestic industry.
Of all the problems associated with import substitution, arguably the latter is the most ironic. A reduction in trade dependency on developed nations is precisely one of the main objectives in the pursuit of ISI strategy. Since the late 1980s there has been little support for import substitution among scholars. However, the economic nationalism that motivated much of this economic strategy has not completely gone out of fashion.
SEE ALSO Balance of Trade; Economic Growth; Export Promotion; Industrialization; Infant Industry; Protectionism; Trade
Lipton, Michael. 1977. Why Poor People Stay Poor: Urban Bias in World Development. Cambridge, MA.: Harvard University Press.
Weaver, Frederick Stirton. 1980. Class, State, and Industrial Structure: The Historical Process of South American Industrial Growth. Westport, CT.: Greenwood.
Monica Arruda de Almeida