Export Led Or Import Substitution?
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Published: Tue, 16 May 2017
The emphasis that Countries have placed in their development strategies in favor of either export led growth strategy or import substitution has influenced the evolution of current account balances and growth of output. In the case of import substitution, the costs of these strategies have often turned out to be far greater than expected. In particular, the methods used to shield domestic sectors from foreign competition such as those used in many western hemisphere Countries have in the event been more prone to produce distortions and resource misallocation than those used to favor exports as in certain Countries in Asia.
This essay will focus on discussing exports led growth strategy, import substitution policy, and the main differences between the two strategies and the most superior one. Those in support of the export led growth strategy usually do so on the basis that it is the normal and effective substitute to other strategies of development. Outward orientation and export led growth are argued to generate the necessary flexibility in shifting the economy’s resources to take account of the changing pattern of comparative advantage (World bank, 1987).
IMPORT SUBSTITUTION STRATEGY
Import substitution of one form or another prevailed in many developing Countries during the 1950’s and early 1960’s, and it was very popular in several developing Countries such as Argentina, Brazil and Mexico and some Countries still prefer it till today. The strategy believes in the protection of domestic producers from foreign competition by substituting domestic production of goods previously imported with domestic sources of production and supply and then substitute through domestic production for a wider range of more sophisticated manufactured items by the extensive use of trade barriers to protect domestic industries from import competition. The idea behind this is to raise the price for domestic substitutes for the imported goods. The increased price however provides greater incentives for production for the home market by domestic firms relative to production for foreign markets (exports). From a development perspective, the goal of such a strategy has been to promote the growth of the manufacturing sector and therefore transform the economy from an agricultural one to an industrial base. In the extreme, import substitution strategy could lead to complete self sufficiency.
The rationale behind import substitution arises as a result of the perspective of trade held by developing Countries. Most developing Countries assume they cannot export manufactured goods as they cannot compete with established firms of the developed Countries due to the fact that developing Countries maintain high trade barriers and since developing Countries have a need for economic growth, they are now faced with no option but to produce for themselves some of the goods they import (Carbaugh, 2008).
Import substitution appears logical, in one aspect, in the sense that if a good is highly demanded and imported, why not produce it domestically? But from an economist point of view, it may be more expensive to produce it domestically and cheaper to import it; and comparative advantage should decide which goods should be imported or exported.
ARGUMENT IN FAVOR OF IMPORT SUBSTITUTION STRATEGY
For about thirty years, starting from around the 1950s, import substitution was seen by a lot of people as the most important element for development, and protectionist policies were adopted in majority of the third world Countries. Those in support of these policies usually argued that for Countries to achieve economic growth, Countries had to protect the infant industries as the risks associated with establishing a home industry to replace imports are low since the domestic market for the manufactured goods exists already. Different developmental specialists often advised developing Countries that while there may be stagnant effectiveness losses linked with protection, the gain from increasing domestic production and moving down the cost curve would more than offset the stagnant ineffectiveness arising from protection (Lawrence, 1999).
The departures from uniform incentives under import substitution regimes are typically characterized by import tariffs, import quotas and prohibitions on the importation of certain commodities. Such measures have resulted in effective rates of protection for manufacturing industries that have high and variable between different sectors of the economy. These rates reached a peak in the late 1960s and early 1970s when in one western hemisphere Country for example the effective rates of protection were estimated to vary from -23% for one sector to +1140% for another, while in a large predominantly agricultural Asian Country, the range of variation was from -19% to +5400%. Although, import duties and restrictions are often utilized for reasons other than protection. For example, to raise budgetary revenue or to enhance national security, changes in the scope and average height of effective rates of protection are clear indications of whether a foreign trade strategy is being altered toward either greater import substituting bias or more uniform incentives (World economic outlook, 1985).
PROBLEMS ASSOCIATED WITH IMPORT SUBSTITUTION STRATEGY
The import substitution began to lose favor when it became clear that Countries pursuing the strategy were not competing with advanced Countries. In fact, some Countries lagged further behind advanced Countries as they developed a domestic manufacturing base. India became poorer compared to the United States in 1980 than it had been in 1950, the first year after it achieved independence (Krugman, 2008).
Neoclassical economists argue that free trade leads to an optimal allocation of resources both between and within Countries. Thus, all Countries benefit through trade and free trade would inhibit the industrial transformation of these Countries. However, newly established manufacturing firms in less developed Countries are not likely to operate at too small a scale and to lack complete understanding of manufacturing technologies. In other words, they are unable to benefit from the economies stemming from large scale operations and from learning by doing.
The objective of import substitution strategies would be to protect infant industries in developing nations. The protection would allow these industries to expand operations so as to achieve economies of scale, as well as to give them time to learn. Once this process is complete, these industries would be able to compete internationally without protection. Unfortunately, in much of the world these policies have failed. Economies of scale failed to materialize and little learning seems to have occurred. As a result, the protected industries have failed to become competitive. Even more importantly, the protected industries have used much of their resources to accumulate political power allowing them to gain significant control over policy making. This has been labeled rent seeking activities.
A further cost is the tendency of import restrictions to promote production at an inefficiency small scale. The domestic markets of even the largest developing Countries are only a small fraction of the size of that of the United States. Yet, when this small market is protected, say, by an import quota, if only a single firm were to enter the market it could earn monopoly profits.
Those who criticize the import substituting strategy also argue that it has aggravated other problems, such as income inequality and unemployment (Krugman, 2008)
EXPORT LED GROWTH STRATEGIES
Export led growth strategies refers to Government efforts to increase exports on the assumption that they can improve not only foreign exchange earnings but also increase productivity and growth.
The export led growth strategy is outward oriented as it links domestic economies with the world. Instead of trailing growth by protecting domestic industries lacking comparative disadvantage, the strategy involves promoting growth through the export of manufactures goods.
In the post war period, export promotion in Europe and Japan sought to overcome the severe foreign exchange constraints associated with reconstruction. Japan pioneered a new model of trade policy that combined relatively restrictive policies towards imports and inward foreign investment with aggressive promotion of export industries.
Initially, developing Countries did not show a strong interest in promoting exports as dependence on the export of raw materials was seen as increasingly vulnerable to international fluctuations and multinational fluctuations and multinational corporations (MNCs). While developing Countries did pursue efforts to increase productivity in export industries and stabilize earnings through international commodity agreements (ICAs), the main thrust of the policy turned away from exports towards the development of domestic industrial capacity.
Export promotion efforts also included the formation of export- processing zones (EPZs) and the encouragement of export oriented FDI. Free trade enclaves provided foreign investors with infrastructure and logistical support for export oriented manufacturing. The EPZ model was pioneered in Korea, Taiwan and along the Mexican border with the United States, but rapidly spread elsewhere from Ireland to Bangladesh.
ARGUMENT IN FAVOR OF EXPORT LED GROWTH STRATEGIES
Abstracting from such factors as initial level of economic development, population size and natural resource endowment, developing Countries that have pursued strategies based on export led growth strategies have tended to achieve greater success in terms of real GDP growth, than those Countries that have sought to achieve growth based on import substitution and domestic demand. This result may be partly due simply to the gains from trade, but seems also related to the tendency for Countries with export led growth strategies to maintain more uniform incentives among activities and therefore to develop more efficient production structures than Countries with a strong bias toward import substitution. This is especially true when the export promotion strategy has been accompanied by a policy of allowing international trade prices to be adequately reflected in the domestic price structure through maintenance of a realistic unified exchange rate.
The export led growth strategy has been implemented most successfully in East Asia where seven Countries Hong Kong, Singapore, South Korea, Taiwan which are known as the newly industrializing Countries and Indonesia, Thailand and Malaysia (South East Asia) have set the pace for the rest of the developing world such as Latin America and Africa in using outward looking strategies to stimulate rapid growth and industrialization.
The newly industrializing Countries are primarily exporters of manufactured goods while the three South East Asian Countries are still moving from their primary export bases toward greater reliance on manufactured exports.
For the past thirty years, these NICs standards of living have approximately doubled every ten years, and China is the newest Country to have joined.
Brazil changed from an import substitution strategy to an export led growth strategy and saw increased economic growth. By the 1970s, their economic growth was in double digits, much higher than previous years. There was also a dramatic change in Columbia as well but the most dramatic change was in South Korea which began in the 1970s from a change from an import substitution strategy to one relying on trade and export growth.
More Countries have started changing their economic policies from inward looking to outward looking based on the experience of Brazil, Columbia and South Korea. Mexico also lowered it imports in the 1980s and joined the US and Canada in a free trade area in the 1990s.
Also, they encourage industries in which developing Countries are likely to have a comparative advantage such as labor-intensive manufactured goods and by providing a larger market in which to sell domestic manufacturers greater scope for exploiting economies of scale.
PROBLEMS ASSOCIATED WITH EXPORT LED GROWTH STRATEGY
IMPORT SUBSTITUTION VERSUS EXPORT LED GROWTH STRATEGIES
Most literature on industrialization has attempted to discuss import substitution and export led growth mainly as a substitute route to industrialization. In both situations, it is argued that learning would contribute to industrial development however, import substitution advocates argue that import substitution contribute to industrial development through learning by doing while export led growth advocates argue that trade contributes to the transfer of knowledge and technology. The major difference among the two is mainly that the first group favors Government intervention while the second group argues in favor of free trade and market- oriented development (Shafeddin, 2007).
Export-led growth strategy introduces international competition to domestic markets which encourages efficient firms and discourages inefficient ones, by creating a more competitive environment they promote a higher productivity and hence faster economic growth. On the other hand, since import substitution policies rely on trade protection it tends to switch demand to products produced domestically. Exporting is then discouraged due to the increased cost of imported inputs and the increased cost of domestic inputs relative to the price received by exporters (Carbaugh, 2008).
The main reason for the failure of the import substitution strategy was the fact that it created an environment that discouraged learning. On the other hand, the outward oriented strategy fails to appreciate that learning requires conditions that are essentially internal and dependent on the basic characteristics of the society. This failure however, means that outward orientation needs adequate qualification and redirection (Bruton, 1998).
ARGUMENT IN FAVOR OF MIXED POLICY
The overvalued exchange rates and protectionist trade policies associated with these efforts had the unintended consequence of determining exports. As a result, a number of developing Countries particularly in Latin America supplemented their ISI efforts with various subsidies to exports.
COUNTRY PERIOD TRADE STRATEGY GROWTH RATE
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