The Main Attractions of an Import Substitution Strategy - Assignment Example

Topic: A) What are the main attractions of an import substitution strategy? B) How do you explain that several developing countries have not succeeded to deepen the process of import substitution into its second and third phase? 1. Introduction: This paper seeks to discuss import substitution as strategy by analysing its attractions and its defects as far as its implementation is concerned. The paper starts with discussion of the concept of import substitution and then followed by the experiences of developing countries in adopting the import substitution strategy. 1.2 Definitions Before one knows what are the main attractions of import substitution are, one must know first what is import substitution as strategy? US Library of Congress (n.d.) give another definition of import substitution as: “An economic development strategy that emphasizes the growth of domestic industries, often by import protection using tariff and nontariff measures. Proponents favour the export of industrial goods over primary products. The strategy may be adopted as a matter of economic policy and to attain industrialisation. In such context, Wikipedia (2006) said: “Import substitution industrialization (also called ISI) 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 is similar to that of mercantilism in that it promotes high exports and minimal imports to increase national wealth.” It further said, the policy has three major tenets: (1) an active industrial policy to subsidize and orchestrate production of strategic substitutes, (2) protective barriers to trade (namely, tariffs), and (3) a monetary policy that keeps the domestic currency overvalued. Hence import substitution policies are not favoured by advocates of absolute free trade. 2. Analysis and Discussion 2.1 What are the main attractions of an import substitution strategy? Having introduced with definitions, we could now answer the question: “What are the main attractions of an import substitution strategy?” Based on the above definitions, the main attractions therefore of the strategy may include the following: 1. It will promote industrialization by an attempt to substitute products which developing country imports, with locally produced substitutes. 2. It will also promote high exports and minimize imports to increase national wealth. 2.2 How do you explain that several developing countries have not succeeded to deepen the process of import substitution into its second and third phase? The failure of several developing countries of not having succeeded to deepen the process of import substitution into its second and third phase could be attributed to the defect of the strategy as determined by results. The experiences of several developing countries are thus cited below to explain the failure. We will start with the Latin American countries, followed by East Asia and then we will discuss the cases of Malaysia and the Philippines. The case of Latin America Wikipedia (2006) said: “Import substitution policies were adopted by most nations in Latin America in the 1930s and 1940s because of the Great Depression of the 1930s. In the 1950s the Argentine economist and UNECLA head Raúl Prebisch was a visible proponent of the idea. Prebisch believed that developing countries needed to create forward linkages domestically, and could only succeed by creating the industries that used the primary products already being produced by these countries. The tariffs were designed to allow domestic infant industries to prosper.” Wikipedia further said: “The policy was very successful from the 1950s to the 1970s in creating economic growth in Latin American countries…. ISI was most successful in countries with large populations or high living standards. Latin American countries such as Argentina, Brazil, Mexico, and, to a lesser extent, Chile and Uruguay had the most success with ISI (Blouet and Blouet, 2002). Smaller and poorer countries such as Ecuador, Honduras, and Dominican Republic were not very successful in implementing ISI policies.”. It further reported that in those Latin American countries where ISI was successful it was accompanied by structural changes to the government. Old neocolonial governments came crashing down replaced by more or less democratic governments. Banks and utilities and certain foreign owned companies were nationalized. Wikepedia (2006) however admitted that the ISI strategy ultimately failed for most countries and it attributed the lack of comparative advantage (Culpepper, and Finegold, 1999) in many industries (Morrison, 1990) which led to gross inefficiencies (Bell, and Henry, 2001), not to mention that their domestic markets (Lansing, Gabriella, 1993) were not large nor strong enough. Based on the foregoing the lack of comparative advantage in many industries led to gross inefficiencies. This is a very logical result since it would be very difficult for these countries to sell their products in the world market if the production cost of finished goods are not comparatively low as those who have better capitalization. The failure to sell outside their country would necessarily forcing them to sell their products locally which may not be capable of absorbing the excess production which was not a result of local demand study on the first place. Since the one of the objectives of import susbtitution is to promote export too by encouraging domestic production, the government support resulting to a lack of incentive for innovation and improving efficiency is also not surprising. This is consistent with the principle of management of human behaviour theories since motivation producing effiency comes from a healthy competition that drives the human spirit for excellence. The case of East Asia Wikepedia (2006) said: “ISI was rejected by most nations in East Asia in the 1960s, and many economists attribute the superior performance of East Asia in the 1970s and 1980s to this difference in policies. Typically, import substitution policies resulted in inefficient industries.” It added that the focus of import substitution in promoting industrialization typically resulted in policies which benefited industrial workers at the expense of farmers which made up most of the population of the nations involved. It gave as an example that fact that to reduce the cost of industrialization, the cost of food was often fixed at an artificially low level. Wikepedia (2006) further observed that in addition to the licensing schemes required for an import substitution strategy, the same also led also to rent seeking behaviors which increased economic inefficiency. (Paraphrasing made) Particularly describing the fact many countries imposed high tariffs on manufactured goods so that multinational companies would instead produce or assemble them locally in order to build up their manufacturing bases, Wikipedia (2006) used the motor industry as example. It noted that manufacturers exported vehicles in completely knocked down (CKD) kit form, for local assembly which has often resulted in products that were of poorer quality and more expensive than those imported completely built up. Thus, it inferred it “became increasingly inefficient for manufacturers to have identical products assembled locally in several countries in the same region, which only served to duplicate resources and reduce economies of scale.” (Paraphrasing made) The case of Malaysia Malaysia was one of the countries in East Asia that really adopted import substitution. In a study involving Malaysia, Clarke, R. et. al (2004) said: “One attraction of ISI coupled with FDI1 in the case of Malaysia is in terms of technology acquisition where there is a strong link between technological modification and the technology transfer process (Clarke et al. 2002).” The authors also said that this may be encouraging for the Government since it suggests that technological development and transfer will take place, in addition to other, initial, benefits of FDI. They further said that equally there is evidence that even the smaller foreign owned plants, while not engaging in R&D; do engage in other forms of technological effort. The authors did not fail to mention that the literature on the benefits of FDI to developing countries makes much of the “technological gap” that exists between foreign and local firms, and the extent to which this “gap” hampers technology transfer. The fact that the smaller foreign subsidiaries are engaging in the more basic forms of technological effort is likely to be an important part of the technology transfer process.” It must be observed that in the case of Malaysia, ISI was combined with FDI so that the investment in manufacturing coming from foreign sources constituted a great part of its economy. This is supported by the conclusion Clarke, R. et. al (2004) when they said: “Foreign direct investment has been a major feature of the industrial development of Malaysia. Following independence in 1957, the Malaysian government has made major efforts to increase and widen the industrial base in Malaysia. An important part of this process has been the encouragement of FDI. The industrial sector as a whole accounted for 35 per cent of Malaysian GDP in 1998 compared to just 13 per cent in 1970. The EE industries themselves accounted for 13.2 per cent of manufacturing employment and 3.8 per cent of total employment in Malaysia.” Clarke, R. et. al (2004), in their conclusions paper have identified two key issues that need to be properly addressed and acted upon if Malaysia is to maximise the benefits of inward FDI. The authors said that firstly, the apparent weak linkages in the EE industry and that despite the impressive growth and development of the manufacturing sector, most of it is MNE driven. With the exception of a few, involvement of local firms has been mostly restricted to supplying low value added components and services to MNEs. Secondly, the authors emphasized that the low technological capability of local firms which probably offers some explanation for the weaknesses mentioned above. This after they found out that low technological capability is also evident on a national level as highlighted in various official documents. (Paraphrasing made) The case of the Philippines Chamarik, S. and Goonatilake, S. (2004) cited that during the period 1949-1969, the Philippines annual average growth of manufacturing was an impressive 8.5 per cent. The author however said: “However this was mostly illusory industrialization, because there was negligible enhancement of local technological capability. Furthermore, the policy merely favored the manufacture of import-substituting consumer goods and discriminated against the manufacture of capital goods and exports.” The authors then found that the early exuberant growth of manufacturing in the Philippines in the 1950s was not sustainable because it was not self-reliant growth. They concluded that the growth not based on local technological capability, and it did not rely on local innovation and international competitiveness for growth. It was simple import-substitution with most of the capital goods and technology imported. Comparing the case of Malaysia and the Philippines is the reality of growth not being based on local technological capability (Shan, and Song, 1997) which denied sustainability (Kenny, and Meadowcroft, 1999) and therefore not a true growth (Pitchford, 2002). 3. Conclusion: Import Substitution appears to be a good strategy as the first glance but as we have seen, it actually led to inefficiency. Developing countries, in their desire to develop their economies in the past, have chosen the import substitution as strategy but it experiences confirmed that there are really draw backs in adopting the same and some of these include making the local manufacturing industries inefficient and dependent and the necessary loss of economies of scales. Loss economies of scale mean higher cost. Said experiences were contradictory to the countries original plan for more wealth. In the nature of things, deciding to adopt a strategy just to stop importing what may have been efficiently done by other countries could just not work as well to developing nations simply because of the incapacity to sustain the requirement of subsidy or the inefficient result of too much dependency for support. In a global scale, the issue of productivity and efficiency may still be properly managed by the market. It means that in real sense, prices of products will dictate the product cost. For government to subsidize one industry as the expense of one industry, of which it could be strong in one angle, is just like a born singer but is trying it hard to become a dancer, simply because dancing seems to be the craze or fad. What that country needs to realize it that it is more beneficial to venture more on where it finds its competitive advantage over other nations in the same way that being born as singer is an artist’s talent which would giving him the advantage than forcing himself to dance when there is much to pay and sacrifice. Bibliography: 1. Bell, S. andHenry, J.(2001), Hospitality versus Exchange: The Limits of Monetary Economies, Review of Social Economy, Vol. 59 2. Chamarik, S. and Goonatilake, S. (2004), Technological independence - The Asian experience: S&T policy and Rhetoric and reality, {www document} URL http://www.unu.edu/unupress/unupbooks/uu04te/uu04te0l.htm, Accessed as of June 25,2006 3. Clarke, R , N. Driffield, and Mohd Noor, H.(2002)Technological effort of MNEs in developing countries: evidence from the electronics and electrical industry in Malaysia, mimeo as cited by Clarke, et. al (2004) 4. Clarke, R. et. al (2004) Inward Foreign Direct Investment and the Industrial Development of Malaysia, {www document} URL, www.lums.lancs.ac.uk/publications/viewpdf/000055/, Accessed as of June 25,2006 5. Culpepper, P. and Finegold D. (1999) ,The German Skills Machine: Sustaining Comparative Advantage in a Global Economy, ; Berghahn Books, 1999 6. Kenny, M. and Meadowcroft, J. (1999), Planning Sustainability; Routledge, 1999 7. Lansing, P. and Gabriella, J. (1993) , Clarifying Gray Market Gray Areas, American Business Law Journal, Vol. 31 8. Morrison, A. (1990), Strategies in Global Industries: How U.S. Businesses Compete, Quorum Books 9. Pitchford, J. (2002), Trevor Swans 1956 Economic Growth Seminar and Notes on Growth, Economic Record, Vol. 78 10. Shan, W. and Song, J. (1997), Foreign Direct Investment and the Sourcing of Technological Advantage: Evidence from the Biotechnology Industry, Journal of International Business Studies, Vol. 28, 1997 11. US Library of Congress (n.d.) , Glossary , {www document} URL http://countrystudies.us/south-africa/91.htm, Accessed as of June 25,2006 12. Wikipedia (2006) , Import Substitution, {www document} , URL http://en.wikipedia.org/wiki/Import_substitution, Accessed on June 25,2006 Read More