Does import substitution deserve its unsavory reputation?

It's hard to see why it does, in view of the numbers here. They reveal that import substituting industrialization (ISI) had a more-than-respectable productivity record. 

But there are two other objections that often surface in relation to ISI--and which were raised in the discussion that followed my earlier post. One is that ISI has an easy early stage, and then gets bogged down in its difficult later stage. The other is that the debt crises that Latin American and other countries succumbed to in the 1980s were the consequence of ISI. The first argument may be right, but is largely irrelevant. The second is almost surely wrong.

The "easy ISI" hypothesis has never been precisely formulated, as far as I know. I think I know that it can be done, but I strongly suspect that it would be a highly contingent argument rather than a general one. The typical formulations in terms of the ease of producing the first generation of light manufactures versus the difficulty of more sophisticated products is not very satisfactory, when one bears in mind the learning that takes place along the way. But the more telling point, in fact, is that countries like Brazil and Colombia were already pulling out of inward-looking regimes by the 1970s. So ISI was not just a static set of incentives. Countries did not necessarily get bogged down in some easy early stage.   

With regard to the debt crisis, the argument that gives ISI a causal role mixes up microeconomics with macroeconomics. ISI is about "distorting" relative prices and the sectoral allocation of production and investment. The debt crises were about mismanaging the relationship between aggregate expenditures and incomes. You can have as distorted a structure of relative prices as you want, but still run balanced budgets and zero current account deficits. Conversely, you can be extremely outward-oriented and have free-trade regimes, but still face currency and debt crises if your macro and exchange-rate policies encourage over-spending. (If this were a classroom, I would ask my students to fill the implied 2x2 matrix with real world country examples.)

Latin American countries ran into the debt crisis because they had expansionary fiscal policies and/or overvalued currencies, not because they had high trade barriers or directed credit. Incidentally, the country with the most overvalued currency of them all was Pinochet's free trading Chile. And Chile experienced the deepest collapse in the entire region in 1982-83 when capital inflows stopped. Its liberal economy and low trade barriers did not protect it.

But some myths die hard.

Comments

[Andrew]

Lesse...

Kazakhstan for import substitution and balanced books
Finland for free trade and balanced books.
Greece for import substition and unbalanced books.
America for free trade and unbalanced books.

[gallagher]

We should be clear that ISI is distinct from the export-oriented developmental states of the East Asian kind. ISI gave LAC nations a real nice bump into manufacturing that they would never had reached without it. And, there's a bit of a consensus that it wasn't ISI that failed (where the specific policies were microeconomic in nature) but the macroeconomic and fiscal policy decisions of the planners. So, it never failed but was thrown out with the bathwater after the crises in the early 1980s.

That being said it was a weaker model than the East Asian version because it did not deploy two things as well:

1) an equal focus on exporting. A lot of ISI policy was directed toward the domestic market (where in Mexico, Brazil, Colombia, Argentina of course was quite big) but not exports. That created lags in technology. East Asians had to export their protected products. So, for South Korea to get protection for cars they actually had to reliably drive down US highways and thus be close to the technological frontier. With ISI and a focus on domestic markets without competition, there was a built in technology haze.

2) East Asia better deployed recipricol control mechanisms that disciplined capital. They enforced performance requirements (you have to export 60 percent of product or you lose your tariff protection and subsidies kinda policies) whereas the folks in Latin America after a while got too cozy (yes rent seeking) with the protected firms and were softer on them.

ISI worked, East Asia developmentalism is a variant that worked better. China's current growth is a variant of East Asian developmentalism and seems to be working quite well. The problem for Latin America is that where China has the policy space to deploy some key performance requirements Latin Americans have traded them away in trade deals with the United States.

[hari]

During my professional life import substitution was the way forward to development and finding jobs for school leavers.
Qualitative/quantitative trade analysis showed us that the primary drawback of our policy framework was lack of capacity building and efficient administration.
Now, they're providing technology transfer for "production mini-plants in mobile containers" on turnkey basis including one-third equity provision to get it started from scratch. So, I'd argue that in terms of comparative (trade) advantage, it'd be imperative to compare cost effectiveness of import substitution in a globalized world market.
Moreover, product development and value added has become more important for capturing market segments. But I know govts are still issuing licenses for imports to disadvantage of domestic infant industry.
This is a difficult industrial development policy area, and some countries may still benefit from import substitution due to population density/profile and other domestic disadvantages.

[Celo]

Gallagher:

Your comment #1 is spot on, and I think it should be read twice by everyone here:

[quote]1) an equal focus on exporting. A lot of ISI policy was directed toward the domestic market (where in Mexico, Brazil, Colombia, Argentina of course was quite big) but not exports. That created lags in technology. East Asians had to export their protected products. So, for South Korea to get protection for cars they actually had to reliably drive down US highways and thus be close to the technological frontier. With ISI and a focus on domestic markets without competition, there was a built in technology haze.[/quote]

The ISI problem isn't so much that the government is pushing for greater industrialization. That is a laudable goal since it pushes the country towards higher value added activities. But the dyanmic effects need to be planned for as well, through proper incentives.

I have a problem when governments try to dictate where the market should go (Brazil producing computers was a funny concept that I lived through). But I support government action to provide incentives for the market to find solutions in higher value added activities, and while maintaining the need for competition.

The failure of many ISI models, IMO, has to do with the infant industry protection argument that never allowed those industries to leave the nest. And this is widely expected as economic interests that exist because of government protection don't want to be dropped from the nest to learn how to fly.

"ISI" as it is understood by us all, looks great on paper, but implementation is the key.

PS: it would be great to have the ability to do Italics, Bold, and Quotes.

[srp]

The above commenters are surely right that the export yardstick, combined with support conditioned on performance against that yardstick, works a lot better than straight protection of domestic firms. But the type of politcal equilibrium needed to get the better policy into place is not easy to come by.

The other drawback is that the non-tradeables sector of the economy may end up becoming the regulated, low-productivity employer of last resort, used by the politicians as a buffer against the shocks created by the dynamism of the export sector. Richard Katz has argued that Japan got caught up in this dynamic during its "lost decade." And the McKinsey global productivity research in the 1980s and 1990s confirmed the extremely low productivity in Japan of retailing, food processing, etc.

[paine]

i'm a big fan of ISI

ITS ROLE IN FOREX FIDDLES NEEDS MORE ATTENTION

in particula the domestication
of more and more links in the value added chain
that gets flung over seas
to compete with
world market quality rivals

point:

a sub par exchange rate
ain't just a tax on tradeables
and a subsidy to exports

its a subsidy
to import subs too

[paine]

srp

and what's so wrong about an ad hoc
full employment policy ???

non trabeables is exactly where you'd stash the
latent surplus
if you were able
so long as u hold
down imports
by smoke and mirror NTBs

and more to the point
you can't honestly suggest
thatpolicy
was a cause
of japan's 90's
great belly flop
to nowhere

to me the full lessons of the yen reaching par
vis a vis north currencies
and the massive switch
by japanese firms
to capital export
is under retold

while japan's
fabled policy merlins
obsessed
about retaining
a trade surplus
choaked off imports
unable to stimulate
export growth once
(post plaza )
heavy handed
currency fiddles
became gauche

[A]

Hi there. little out of my depth here but I've long since been wondering about ISI in South Africa during Apartheid. From my understanding the country was forced into it and it proved to be successful for only one reason: Popular demand. For instance, if there is strong demand for Mars bars pre-IS, then there will be strong demand for it during IS. This means that the government has to provide the goods or risk disorder (if Mars bars are a rioting point, or the demand for Snickers and Mars bars together make a case for government overthrow).

These are all just assumptions! And I don't like the South Africa example for obvious political reasons. But does anybody have any reactions to this? Any suggested readings?

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