As mentioned above, each one reflects prevailing ideologies of its time; import substitution industrialisation was followed by many countries, especially in Latin America, from the 1930’s onwards, and came about as a result of the effects on inter-regional trade of the Great Depression of 1930’s US, and structuralist views of international trade. Export-led strategy gained in popularity when the successes a number of East Asian countries in developing not only a successful industrial base, but also reducing poverty, became clear in the 1970’s and 1980’s. This policy is supported by the World Bank and Western economists and prevails as the preferred route to development. Import substitution industrialisation concerns itself with the production of previously imported goods for the domestic market while export-led industrialisation promotes the production of goods for the international market. These are supported by appropriate monetary policies; import substitution industrialisation seeks to protect ‘infant industries’ by erecting barriers to foreign imports such as tariffs and quotas, while export-promotion strategies lower these barriers and encourage foreign direct investment and multinationals by setting up ‘export processing zones’ (EPZs). Proponents of import substitution industrialisation defend their protectionism by emphasising the dual objective of greater domestic industrial development and the ability to move towards exporting goods once they become internationally competitive, while supporters of export-promotion cite the growth benefits of accessing large world markets instead of narrow domestic ones, and the great successes in some of the East Asian economies. Each strategy has its advantages and disadvantages; what follows here is a more detailed analysis of import substitution industrialisation followed by one of export-led growth.
The ideologies and theories that evolved into structuralism and were applied through import substitution industrialisation have their origins in Latin America’s declining economic position after 1900. After independence, many Latin American countries had expanded commodity exports, such as coffee in Brazil, copper in Chile and sugar in Cuba, but over-production was having an impact on growth by the 1920’s. With the Wall Street Crash and subsequent depression in North America and Europe during the 1930’s, commodity prices crashed as demand fell, resulting in a decrease in foreign exchange earnings. This had two effects; one was a reduction in the amount of money available for industrialisation, and the other a reduction in the ability to import manufactured goods.
A number of economists began to look at this pattern of events in the context of the experience of Latin American trade, and ‘dependency theory’ was put forward. Dependency theory said that a country’s progress was not merely dependent on that country’s resources and endowments, rather the ‘core’ (industrialised) countries made the rules and the ‘periphery’ (LDC) countries were pawns in the international pursuit of profit. Dependency theorists, especially Andre Gundar Frank, felt that while the periphery was tied to the core, no sustainable growth would occur due to declining terms of trade controlled by the core. International trade was therefore seen as exacerbating inequalities, and it was clear that while trade with industrialised partners was slow, Latin American countries would have to become more self-sufficient and find another way to develop their economies. Paul Baran and Raúl Prebisch recognised the importance of local elites forming alliances with international capitalists as key in hindering long-term growth, with a relationship that had existed under colonialisation and persisted afterwards through the pattern of a few large-scale, rich landowners using a large amount of labour to farm extensively, while the smallholdings owned by poorer families were farmed intensively. Fernando Enrique Cardoso and Enzo Faletto saw active state policy as an enabler of development in the poor ‘periphery’; a change in government policy would see it acting in the country’s interests against these local and international elites to take the maximum benefit from available labour, land and mineral resources.
Dependency theory grew in popularity as a number of these prominent and politically powerful economists took on its ideas. Prebisch – an Argentine economist who had been the director of the National Bank before taking over as chairman of the Economic Commision for Latin America in 1948 – took the idea of dependency to the ECLA and led the analysis of Latin American economic performance, concentrating on a number of factors that had combined to produce poor economic growth. It looked at a number of factors that had contributed to the situation, including the volatility of primary products; declining terms of trade; low income elasticity for agricultural products; the fact that most technology was controlled by ‘core’ countries and the lack of ‘added value’ in primary products. They noted also the positive correlation between interruption of normal trade patterns with the ‘core’ countries, and strong internal growth in Latin American economies; and looking at how the economy was shaped by power and politics. The conclusion was that the free market had failed to achieve sustainable development in Latin America.
The alternative to the free market was the development of import substitution industrialisation. It sought to develop industries in a protected environment, producing substitutes for technological imports and added value manufactured products. This would expand the local economy and feed into the development process, creating an expanding domestic market for finished goods. While industries were in their first stages, they could be nurtured by an active state that would bring in capital and investment for technology, encouraging capital investment by multinational companies (MNCs) in structurally important industries such as telecommunications, that would provide necessary technological hardware and know-how, while improving infrastructure for further industrial development. For instance, foreign ownership in Brazil’s industrial sector exceeded 50 per cent by 1970. Further, the sector could be developed through state-owned industries (SOEs), whose profits would feed back into the state that had supported their development.
Key to import substitution industrialisation was the idea of industrial linkages, both forwards and backwards. These were seen as crucial to maximise the development process - not only would the protected industry benefit from protection and support, but also its suppliers, transporters and finishers. Externalities are more important in industry than other sectors and this was seen as a great benefit. A classic example of industrial linkages is the development of the car industries in Mexico, Argentina and Brazil under import substitution industrialisation, where component manufacturers and suppliers of rubber, steel and glass benefited. In Argentina, the car industry and its linkages account for 22 per cent of employment.
In addition, import substitution industrialisation could not succeed without influence on the market by the state; popular support was therefore required not only to assure the wealthy elite with international links that the strategy would benefit them, but also the poor and working class, to ensure their cooperation. Latin American import substitution industrialisation therefore had a strong political element, with a tendency for the more inward-looking economies to have strong populist leaders such as Juan Peron in Argentina and Getulio Vargas in Brazil, who could mobilise support of the labour force and industrial elites to take on the changing policy.
As the strategy was developed in many Latin American countries through the 1950’s and 1960’s, there is no doubt that industry was able to flourish, but the policies followed by Latin American countries were not without inherent problems. State owned enterprises, including oil, petrochemicals, telecommunications, steel and aircraft, were developed. In Brazil, for instance, there was over 50 per cent state participation in transport, water, phone, electricity, mining, developmental services and chemicals by the mid-1970’s. These industries were backed by sovereign guarantees; although this meant that pressure to make a profit was relieved, it also tended to lead to a lack of expansion because there was no money to do so without seeking further funds from government or in the form of loans from abroad. As import substitution industrialisation progressed over time, borrowing by Latin American governments grew until it became unmanageable. Governments were able to negotiate the international transfer of technology through part of the multinationals’ involvement. Prices of inputs such as electricity and telecommunications, and finished goods, were kept artificially underpriced to support infant industries and enable the growing middle-class to access goods. SOEs had the power to recruit the most talented individuals, however, national pay scales tended to place a ceiling on skilled labour; additionally, political power over companies through government support led to over-employment as politicians were under pressure to secure jobs for burgeoning urban populations.
Protectionism served to insulate the economy from rival foreign firms dominating the market. This was provided to infant industries, especially manufactured goods, to give them the chance to develop new products and become self-sufficient. For instance, by 1970, a 168 per cent tariff over consumer and manufactured goods existed in Brazil, and similar tariffs exceeded 100 per cent in Argentina, Chile and Colombia. In Mexico, tariffs on chemicals up to 671 per cent were in place as the domestic chemicals industry developed. Tariff barriers and quotas were raised against foreign imports, and this further encouraged multinational involvement and investment; where protection was high, the best way for MNCs to access Latin American markets was to set up factories in the countries themselves to bypass prohibitive tariffs and quotas. Although this meant that control and profits were in the hands of MNCs, the situation nevertheless served to improve employment, skills and production levels and contributed to economic growth.
An artificially overvalued currency ensured that raw materials, capital and technological equipment necessary for rapid industrialisation were able to enter Latin America easily. SOEs and favoured industries were also given access to preferential interest rates, subsidies and tax breaks to increase and improve production. Once industries had developed sufficiently to achieve economies of scale and technological sophistication rivalling those in the ‘core’, the plan was that protection would gradually end and international trade could take off. Overvalued exchange rates meant, however, that products were not internationally competitive, thus the export sector – the second stage of import substitution industrialisation - did not develop in the way that was foreseen by the structuralists.
Given these advantages and drawbacks, how did import substitution industrialisation perform? In terms of economic growth, there is no doubt that the strategy had widespread, if not universal, success (see Table 2), with growth peaking in the more successful economies in the 1970’s. Average annual growth rates in the region between 1950 and 1980 were 5.5%, and this figure exceeded all other regions apart from some areas of East Asia. GDP increased by five times between 1945 and 1980, while the population grew by three times. Chile was identified as ‘strongly inward oriented’ before 1973 but ‘moderately outward oriented’ after this time; its strongest period of growth was during the 1960’s so this would suggest that in economic terms at least it fared better under import substitution industrialisation than after a change in policy.
The strategy enabled widespread production of basic consumption goods, and specialisation in some countries. Some countries were more successful than others; in Brazil, for instance, imports as a ratio of GDP fell from 19 per cent in 1949 to just 4.2 per cent in 1964 while the production of manufactured goods increased by 266 per cent in the same period. This was undoubtedly supported by Brazil’s huge domestic market; many authors state that countries with much smaller populations did not benefit from this but evidence from Table 2 suggests that a number of smaller Central American economies fared better through this period than countries such as Argentina and Chile with larger populations. Without the development of a domestic market, the new industries were not able to reach a level where the economies of scale made products internationally competitive, and this was exacerbated in smaller countries. Import substitution industrialisation therefore became ‘exhausted’ due to small domestic markets for manufactured goods in many instances. This placed a limit on plant size, technology and specialisation, and meant that many products would not be of sufficient quality to compete if exported. Todaro (1992) argues additionally that the main beneficiaries of import substitution industrialisation were the MNCs, because they were able not only to access domestic markets but also benefit from the incentives, preferential interest rates and support that governments were offering to industry.
The policy of imposing tariffs on imports and the development of SOEs created balance of payments crises, as most countries were unsuccessful in reducing the ratio of imports to GDP. The first stage of import substitution industrialisation could not happen without large inflows of capital and technological components; the resulting imbalance of payments affected the funding of future protectionism, and often the only solution was large scale borrowing from private financial institutions in industrialised countries. This only served to worsen conditions over time as repayments had to be made using scarce foreign exchange earned from primary commodities, since manufactured goods coming from infant industries were either too expensive or not sufficiently technologically advanced to compete with products produced abroad.
The strategy was successful in enabling the development of an urban middle class, a labour union movement and a national business class. However, local elites that had been the dominant landowners were engaged and became the new industrial elites, thus not contributing to social cohesion, and corruption was widespread. There is a wealth of evidence to support the notion that inequality was worse under import substitution industrialisation, even though total GDP rose. Agriculture was neglected, and this led to an increase in food imports in some cases, and a bias towards urban development, which fed the influx of people to the cities where they would not always be able to find work.
Some would argue that the many inherent problems of import substitution industrialisation brought about its demise. Ultimately, it could not continue to remain viable when international financial markets no longer leant money to Latin American countries to finance shortfalls in balance of payments or resources for development. By the end of the 1970’s debts were spiralling out of control and some would argue that the resulting crisis of the early 1980’s had its roots in the policy followed in the region. Suddenly the emphasis of policy changed from one of development of domestic industry to the need to raise foreign exchange to make debt repayments; there was an urgent need to increase exports, which would not happen under prevailing economic policy. By this time, the shortfalls of import substitution industrialisation were also becoming clear, and the outstanding performance of East Asian ‘tiger’ economies following a more ‘outward-looking’ strategy had overtaken Latin America; this strategy of openness had become popular during the 1970’s among economists and at institutions such as the IMF and World Bank, who ensured that Latin American countries opened up their economies to repay loans through structural adjustment. Thus the era of import substitution industrialisation came to an end.
The discussion now turns to export-led industrialisation. It has already been mentioned that proponents of this ‘outward-looking’ strategy cite the successes of East Asian economies, particularly South Korea, Hong Kong and Singapore. By the mid-1990s, many economies in the region had become some of the most successful in the less developed world. They had consistently higher rates of growth than in Europe and North America – averaging 7% per year - and were delivering on human development. Particularly successful were Korea, Thailand, Indonesia, Malaysia, Singapore, Hong Kong and Taiwan. The main features of this ‘Asian miracle’ were sharp increases in GDP per capita income – a four times increase between 1965 and 1990. Table 3 shows the exceptional performance of a number of East Asian economies, which outweighed the growth in Latin America during the same period.
Neo-liberalist theory underlines the importance of the free market; that a strong role for the state should be discouraged because it does not result in the optimal allocation of resources for development. Indeed some of the drawbacks of import substitution industrialisation would have been overcome through a more liberal approach. Obvious examples include the fact that Latin American industries, through the protection provided, were never designed to be internationally competitive, and that under normal market conditions they would have altered or simply shut down. However, critics of neo-liberal theory cite its tenuousness, and indeed most of the literature on neo-liberalism tends to focus on the experiences of individual countries rather than outlining the thought behind its assertions.
How did the policies followed in some East Asian countries differ from import substitution industrialisation? The development model followed during and after the post-war boom focussed on achieving economic growth through the promotion of exports. While the theory behind import substitution industrialisation had evolved from the ideas of unequal exchange and at a time of depression in North America and Europe, export-led growth acknowledged the growing international integration and globalisation of production, along with better and quicker transportation, and used these global developments to maximise growth. Between 1965 and 1990, Asian economies boosted their global trade share by 6%, largely by promoting manufacturing industry for foreign markets. A high level of investment in education and training, coupled with government incentives including preferential interest rates, reductions in tariffs and tax concessions, succeeded in attracting a level of foreign direct investment equal to 5-7% of GDP.
In addition, the comparative advantage enjoyed by the region in terms of lower wage costs and investment in new technology facilitated a move from agriculture towards labour-intensive manufacturing industries such as textiles, sportswear and microchips, especially encouraging MNCs through the setting up of EPZs where foreign companies could enjoy benefits such as tax breaks and exemptions from labour laws and minimum wages. Although different from those advantages put forward in Latin America, these resulted in the same kinds of benefits for MNCs in producing at a lower price and passing on this saving as profit or to Western consumers. By the mid-1990s, for instance, Thailand’s most important export product had become textiles, bringing in more revenue than more traditional commodities such as rice, rubber and shrimp. Governments in the region also encouraged private domestic investment through low tax, low inflation and high real interest rates so that domestic savings and investment grew to 35-40% of national income. They recognised that developing manufacturing industry had to be accompanied by improved agricultural efficiency and support so that development occurred across urban and rural sectors.
As time went by, the liberalisation of financial systems in the region enabled a move from labour- to capital- intensive industries as technology and productivity improved through the 1980s and 1990s. Between 1990 and 1996, growth rates accelerated still further. Indonesia, Malaysia, Thailand and Vietnam all enjoyed GDP growth rates of at least 7% each year; figures in Laos, Singapore and Mayanmar approached these rates. The region’s nine main industrialising economies’ global share of trade in the manufacturing sector rose from 12% to 17% in this period.
However, those economists who refer to the region as the model of the success of capitalist free markets ignore that macroeconomic policy was designed to support industrialisation. The most widely cited model of economic growth through reliance on the free market, South Korea, actually started its industrial process in the 1950’s through import substitution industrialisation, with the establishment of the state-owned Chaebol industries producing for the domestic market. US aid played a crucial role in establishing and maintaining this industrial base; without the foreign exchange receipts provided by aid, Hewitt, Johnson and Wield (1992) argue that the limited domestic market would not have been able to support the development of industry, and indeed that the transfer from import substitution industrialisation to export-promotion was necessary as aid declined.
On the other hand, many studies point to a combination of factors that left many Asian countries vulnerable to rapid breakdown, in the same way that import substitution industrialisation had resulted in the build-up of unmanageable foreign debts. The IMF World Economic Outlook Interim Assessment (December 1997) asserts that the successful performance of most of the economies concerned, which was both a result of, and a contributing factor in, the rapid growth of net capital inflows to the region, brought with it policy challenges that were not met by the countries concerned, and helped to bring about the Asian Financial crisis of 1997. The export-led policy the region followed enabled a huge influx of capital into the region that was not controlled by the state the way it had been in some Latin American countries – when the market changed, this money flowed out again, helping to cause and exacerbate problems.
Is neo-liberalism, then, more of a reaction to the difficulties that Latin America experienced than a viable policy for industrialisation? Was import substitution industrialisation inherently flawed or did it simply outlive its usefulness as domestic and international conditions changed? What is clear from this analysis is that although East Asian economies have been more successful in terms of economic growth and industrialisation than Latin American ones, there is less difference between the policies followed in each region than advocates of neo-liberalism suggest. Both have drawbacks as well as advantages, and both have, in various ways, contributed to financial crises: in Latin America through the build-up of debt and in East Asia through insufficient management of incoming capital. At face value, export-led growth has done more to alleviate poverty and improve social indicators than import substitution industrialisation; but this has less to do with the policies themselves and much more to do with the attitude of the state towards supporting social development through education and health provision.
Would the remarkable development of South Korea been possible without US aid (from which Latin America did not benefit) and a period of import substitution industrialisation before 1960 where the basis for industrialisation was laid? It should be remembered that the ideas behind import substitution industrialisation ultimately involved the opening up of markets – it was never envisaged as a permanent policy, rather as a stage in the development process of LDCs which was necessary to be able to catch up with the industrialised countries. Hong Kong, one of the three countries used as an exemplar of neo-liberal success, had strong British ties up to 1997, with capital, technology and labour investment all contributing to its economic success. What seems clear is that the countries that have succeeded in transforming the make-up of their economies from a bias towards agriculture towards industry have become more outward-oriented over time. The reasons for the World Bank’s and IMF’s promotion of outward-oriented development is hinged not only in the belief of market forces in achieving development, but also in the need for them to ensure that LDCs make debt repayments, which is not possible if a country does not seek to promote exports. Perhaps then, if import substitution industrialisation is time-limited and seen only as a means to achieving growth through promotion of exports, it is still viable for the future.
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Appendix
Table 1
GDP composition by sector and level of development for selected LDCs (from The World Fact Book 2003 www.ci and World Bank www.worldbank.org)
Table 2
Percentage Annual Growth in GDP per Capita in Latin America 1950-1980 (from Franko, 2003)
Table 2
Percentage Annual Growth in GDP per Capita in some East Asian Countries (1975-2000) (from World Bank, 2002, Correspondence on GDP per capita annual growth rates. March. Washington, DC. At )
* 1980-2000 calculated from total GDP growth
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World Fact Book 2003 www.ci
Kitching (1982) in Hewitt, Johnson and Wield (1992)
Mulhearn and Vane (1999) explore this ‘state versus market’ discussion further
Statistics from The World Fact Book 2003
See for instance Hewitt, Johnson and Wield (1992 pp 139)
For more on the neglect of agriculture see Pomfret (1997)
Statistical information from Hewitt, Johnson and Wield (1992 pp 158)
See Hewitt, Johnson and Wield (1992 pp 70-71)
See Hewitt, Johnson and Wield (1992 pp 71)
From Franko (2003, pp 68)
From Evans (1979), in Franko (2003, pp 58)
Statistics from Franko (2003, pp 65-6)
Classification by the World Bank Development Report, 1987 (in Todaro, 1992, pp 371)
All statistics from Franko (2003, pp 64-65)
Reasons for this dichotomy may well include the nature of the differing political regimes during the period; Costa Rica and Panama, which fared better than Argentina and Chile, both arguably had a more stable state during the period, and support from industrialised countries (Panama especially had a resident US population that would have provided a domestic market for manufactured goods). Argentina on the other hand went through dictatorship and military rule and Chile underwent a number of turbulent regimes under Allende and Pinochet. However, this is not the focus of this essay.
See, for instance, Hewitt, Johnson and Wield (1992).
These three countries were the only ones identified as ‘strongly outward oriented’ by the World Development Report 1997 (From Todaro, 1992, pp 371)
Hewitt, Johnson and Wield (1992, pp 193)
Statistics from various sources including Henderson (1998) and Hoekman (1998)