Import Substitution Industrialization in Latin America: Experience and Lessons for the Future Carlos A. Primo Braga1 I.

Introduction Werner Baer’s contributions to the analysis of Latin American economic development occupy a well deserved place in the economic literature dedicated to the region. But Werner is an unusual scholar. He has been not only an influential thinker and researcher, but also he has “engineered” one of the largest informal networks of scholars interested in Latin American economics -- encompassing generations of his students (including myself) and collaborators at Vanderbilt University, the University of Illinois at Urbana-Champaign, the University of São Paulo, the Catholic Universities in Rio and Lima, etc. Accordingly, his impact on the debate of Latin America’s economic experience goes well beyond his writings. In this paper, I discuss his analyses of the pros and cons of import substitution industrialization (ISI) in Latin America, focusing mainly on the case of Brazil. I review a selected number of his many contributions to this literature and, in particular, I ask to what extent some of the questions posed by his earlier papers on ISI remain relevant to the contemporary debate on trade and development. Section II reviews the main insights and questions that can be extracted from some of his contributions to the literature. Section III revisits some of these questions from the perspective of the ongoing debate on trade and development. Section IV concludes.

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Carlos A. Primo Braga, Senior Adviser, International Trade Division, The World Bank. Paper prepared for a seminar in honor of Professor Werner Baer, held at the University of Illinois at Urbana-Champaign, December 1-2, 2006. The views expressed here are personal and should not be attributed to the World Bank Group, its Executive Directors, or the countries they represent.

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141) points out that there are two “conflicting paradigms for development strategies. ISI: Experiences and Interpretations This section borrows its name from one of Werner’s seminal papers (Baer 1972) which analyzed the process of Latin American industrialization in the 1950s and 1960s. Werner Baer adopts an analytical approach that borrows from both paradigms. In that paper. all passed through a 2 . the nature of ISI.e. for most part.” One emphasizes the importance of the principle of comparative advantage. The point of departure of his evaluation is the proposition that “all countries which industrialized after Great Britain.” This development strategy has been typically associated with interventionist trade policies and focus on fostering a domestic market via ISI. that is. a static rather than a dynamic perspective). At the same time.g. involved heavy industrialization. Stiglitz (1987. He presents ISI as “destiny” while criticizing the excessive attention to “efficient allocation of resources” that could perpetuate a focus on “myopic” comparative advantage (i. preaching free market and export oriented policies. Chile) than to the larger Latin American economies (e. The other highlights that “there is a natural path of development … and that path. went through a stage of ISI.. he recognizes that “one-size does not fit all” in evaluating ISI experiences in Latin America. p.. he underscores the relevance of some of the criticism coming from adepts of the “market-oriented” paradigm. Brazil).g.II. In his evaluation of the ISI experience in Latin America. while pointing out that some of this criticism applies much better to small economies (e. the results of the industrialization process and the prospects for future development policies in the region were reviewed. Accordingly..

g. the mix of trade and macroeconomic policies adopted in this phase typically involved trade barriers and exchange rate controls. He points out that after World War II. taxing export activities and fostering import substitution. pp. as well as limited market size and pressures from external powers interested in the maintenance of liberal trade policies. most “of the larger countries of Latin America implicitly or explicitly accepted the ECLA analysis of the hopelessness of gearing their economies towards the traditional world division of labor” (Baer. In many countries this was complemented by a complex mechanism of preferences for strategic imports (e. capital goods and industrial raw materials). He goes on to attribute the delay with which Latin American countries embarked in this process to socio-economic considerations: an elite focused on the high profitability of primary exports. supply-side bottlenecks (weak entrepreneurial classes. 1972. His analysis of the historical path towards ISI in Latin America differentiates between ISI spurts induced from abroad (associated with external shocks such as the two world wars and the Great Depression) and ISI as a deliberate policy tool for economic development in the 1950s and 1960s. 1972. It is worth noting. 97). p. and inadequate infrastructure). however. the direct participation of the state in the economy (via state-owned enterprises) and cheap credit for “strategic” sectors.stage where the larger part of investment in industries was undertaken to replace imports” and that “in this early ISI process [in Europe and the United States in the XIX century] governments played an active role in encouraging and protecting the development of infant industries” (Baer.. that foreign capital was often an important partner in this process “by transferring know-how and 3 .95-96). In most countries. poor endowment of skilled labor.

8 percent in 1947 to 28 percent by 1968. as governments tried to stimulate economies amid growing signs that the growth dividend of the “easy” ISI phase was gone. Industrial growth became the main driver of Latin American economies over these two decades. the pendulum began to swing back to a much more open economic model. especially external ones. By the 1970s.” This characterization can be extended to other Latin American 4 . p. however. the ISI model was already reaching its limits. in which barriers to foreign trade and capital flows were substantially eased. Not only the size of Latin American domestic markets constrained the opportunities for further industrialization.1 percent).6 percent) and 1967 (24. These actions paved the way to the growing external debt and balance-of-payment crises experienced by Latin American countries in the 1980s. ISI led to significant structural changes in the Latin American economies in the postWorld War II era. Over the last two decades.organizational capabilities” while benefiting from the rents associated with protected markets. Structural change was particularly significant in the case of Brazil were industry increased its share in the economy from 19. Werner points out that macroeconomic “pressures. In a paper co-authored with Don Coes (Baer and Coes. were the major forces in bringing this phase [ISI] of Brazilian economic history to an end. but also the accumulation of distortions associated with the panoply of government interventions imposed a growing “drag” on the growth prospects of these economies. especially in the 1990s. monetary and fiscal profligacy often became the macroeconomic companions of ISI. which focuses on Brazil. 2002. 862). with the manufacturing sector expanding its share in GDP between 1950 (19. Moreover.

It can be argued that these issues (Baer. (2) could Latin American countries adopt the Asian model (of manufactured-based outward orientation)?.” growth over the last two decades has remained elusive. 1984) provide a useful reference to judge the extent to which policy options adopted in the 1980s and 1990s have paved the way for a sustainable model of economic integration for Latin American economies. as pointed out in Zagha. In this paper. An answer to the chances of recidivism (particularly with respect to protectionist trade policies) has to address not only economic considerations.9). “although nearly every country in Latin America and the Caribbean has pursued economic reform. Revisiting the Trade and Development Nexus One possible characterization of Baer’s extensive review of the key challenges faced by Latin American policy makers in the aftermath of the ISI phase can be summarized by the following three questions: (1) can trade policy be an effective instrument for a pro-active industrial policy?. III. the inevitable question is to what extent can the pendulum once again swing back towards a more interventionist and closed model of development? After all. At the same time.economies. the fact that “reform fatigue” has become a common-denominator in the region is not surprising. 1972. and (3) can the trade regime be reformed in a 5 . p. I will limit myself to the economic aspects that Baer identified as major challenges for policy-makers dealing with the implications of ISI in the 1970s. but also the evolving political environment in Latin American countries. Nankani and Gill (2006. Against this background.

and World Bank (2005).2 At the core of this debate is the proposition – see Baer (1972. the importance of “self discovery” – i. But the “eternal” debate about the pros and cons of industrial policy (and trade protectionism) has taken a new format in the last few years.. for example. (2006). the knowledge generated by firms that invest in “experiments” to identify what they are good 2 See Rodrik (2004).g.way that helps poverty alleviation and fosters a more equitable distribution of income? The answers to these questions are explored below. reflecting the contributions of authors such as Rodrik and Hausmann and reviews of the lessons from the 1990s. 6 . the reduction of the anti-export bias brought by comprehensive trade liberalization in Latin America did not generate enough incentives for steering these countries into an export-driven growth path. These critics emphasize.. In other words. According to this perspective. the dismantling of trade interventions will not necessarily pave the way to a new model of export-driven development. some analysts felt confident enough to argue that “It is generally believed that import substitution at a minimum outlived its usefulness and liberalization of trade is crucial both for industrialization and economic development. to what extent the costs of resource misallocation and rent-seeking behavior surpassed the benefits of diffuse externalities associated with technological progress and learning-by-doing. From this perspective.e. The revival of interest in industrial policy By the late 1990s.” (Krueger. p.that there is no easy economic method to evaluate if the costs of ISI-related “inefficiencies” dominated “the modernization or development” brought by ISI. Hausmann and Rodrik. Some (e. Rodrik 2006) argue that the focus on static efficiency gains does not amount to a growth strategy.110) -. 1997. p.1). The answer to this question remains controversial.

South Korea. Export Pessimism? Baer (1984. p. Singapore. many of the questions posed by Werner Baer in the 1970s remain relevant to the debate about how best to implement trade policy as a lever to a growth-oriented strategy. The revival of interest in policy activism illustrates the currency of many of the points raised in his earlier contributions. and Taiwan. China) to all developing countries and argues that the “fallacy of 7 . China.at producing and exporting – arguing that unless there is a pro-active governmental policy to stimulate these “experiments” this type of entrepreneurship tends to be undersupplied. In sum. although the debate on the Latin American experience with respect to ISI has converged to the recognition that “wholesale” trade protection is not conducive to sustained economic growth. The Cline experiment focus on the implications of generalizing the manufactured-exports intensity achieved (1976) by the “Gang of Four” (Hong Kong. etc. the political economy of market access in industrialized countries.) has often been at the very core of inward-oriented strategies of development.” Export pessimism in its different formats (secular decline of terms of trade for commodity exporters. 133) poses the question “[could] the world have accommodated a situation where many Latin American countries would have emulated the East Asian superexporters?” He goes on to quote Cline (1982) suggesting that if most developing countries were to follow this model this “would have resulted in untenable market penetration into industrial countries. inhibiting the process of economic diversification and growth.

illustrating that an outward-oriented strategy can be successfully pursued by Latin American countries. however.composition” holds – i. the reason for this has less to do with the absorptive capacity of industrialized countries than with macroeconomic variables (e. But as EAP countries performance illustrates. government effectiveness. in particular.e. the main implication of implementing trade reforms that eliminate the anti-export bias of ISI practices is to allow private actors to explore unforeseen export opportunities. if all developing countries were to adopt an export-oriented strategy the results would be quite different from the experience of the super-exporters. In the mid 1980s. with respect to opportunities for intra-industry trade. control of corruption). It remains true.. not to mention a distorted structure of production inherited from reliance on extreme ISI.g. By 2004. that Latin American and Caribbean (LAC) countries have lagged behind East Asia & Pacific (EAP) countries in terms of their integration into the world economy. Moreover.g. The absorptive capacity of import markets is often underestimated.. contesting new markets that are impossible to predict ex ante. have significantly expanded their export volumes (and value-added) in the last decade.. for example. both regions had similar trade to GDP ratios. Mexico and Chile. In short. the region as whole has remained an underperformer in terms of trade expansion in spite of significant trade reforms in the last two decades. 8 . The reality of the expansion of China’s exports in the last two decades. LAC’s trade to GDP ratio was 40 percent below that of EAP. underscores that the scope for expansion of manufactured exports from developing countries was much bigger than “export pessimists” believed. frequent reliance on overvalued exchange rates as monetary anchors) and institutional factors (e. however.

He points out that although “ISI helped diversify the economies of the region and neo-liberalism increased efficiency by opening the economies to more trade and foreign investments none of the regimes effectively solved the region’s distributional problems” (Baer. Werner Baer’s skepticism about the impact of trade liberalization – a usual backbone of neo-liberal reforms – on poverty and inequality is warranted. Sustained economic 3 For a detailed analysis of the evidence on the links between trade liberalization and poverty see Winters. the nature of the reform. p. for example. 2002.3 Analyses of the linkages between trade and growth. and how they sustain themselves. 309). tend to confirm a positive association. McCulloch and McKay (2004). After all. including initial conditions of the country undergoing reform. both cross-country analyses and country-specific studies. but the ultimate outcome will depend on many other factors. who the poor are.” Baer (2002) contrasts neo-liberal policies followed by most Latin American countries in the 1990s with the ISI era. there are no examples of countries sustaining long-term growth without being open to trade. p. 178). even though the magnitude of such a relationship is controversial.Trade and Poverty Another theme often addressed in Werner Baer’s work is the interaction between trade regimes. it is important to recognize that trade liberalization can be a force for poverty reduction. the difficulties in pursuing redistributive efforts in the post-ISI era to the extent that the “profile of the productive structure which resulted from the ISI process reflects the demand profile [often based on quite unequal income distribution] which existed at the time when the process was started. He highlights (Baer 1972. poverty and income distribution. After all. 9 .

for example. in turn. trade liberalization can increase income inequality and this underscores the importance of complementary governmental policies to deal with its side effects. Moreover. world prices have been differentially transmitted on a regional basis. protection is often higher on relatively skill-intensive goods. But it is much more difficult to shift from being an unskilled worker. imperfections in the price transmission mechanism are often present in developing countries where markets are characterized by high transaction costs and are poorly integrated into the international economy. 10 . is typically associated with improvements in the minimum standard of living and poverty reduction over time. It is also important to recognize that income effects of trade reforms are relatively more important for the poor than consumption effects.growth. In other words. depending on distance from the border and nature of the traded good (Nicita 2005). As a consequence. it is often possible to consume less of it. In developing countries. The wage rate of unskilled labor remains the key variable in determining if the poor gain more or less than the average in the process of trade reform. Trade liberalization can contribute to this process not only by promoting growth. In modeling 4 Note that this is not necessarily the case in LAC as pointed out by Perry and Olarreaga (2006). but also by changing the relative prices of the products that are relevant to the poor. If the price of one commodity increases significantly. Households with little access to credit or that are located in remote areas where subsistence farming is prevalent may not benefit from the process.4 Thus trade liberalization can benefit the poor over those better-off via its impact on prices. however. It is well known. that trade liberalization generates both winners and losers. In Mexico. Northern states can expect more reduction of poverty associated with trade liberalization than Southern ones. to being a skilled worker or to become an entrepreneur.

Costa Rica. reflecting its potential impact on agriculture and related industries in the poorest parts of the country. “the evidence on trade liberalization and wage inequality remains inconclusive. education policies and social “safety nets” are important complements to trade reform as far as the final distributive impacts of trade liberalization are concerned. Perry and Olarreaga (2006) argue that in the case of Latin America relative factor endowments (relative richness in natural resources). dynamic effects of trade (leading to skill-biased technical change). As pointed out in World Bank (2005. Actually. and a prereform structure of protection biased towards unskilled labor intensive sectors explain increases in the overall income inequality in LAC in contrast with the experience of other developing regions. Werner Baer’s concerns remain valid and underscore the complexity of addressing these issues in the post_ISI era. Measures to facilitate trade and market integration. however. 151). Summing up.trade liberalization in the case of Brazil. In this context. Brazil. IV. for example. and Mexico. it is clear that trade liberalization is not a “silver bullet” to deal with poverty and income distribution problems. In Argentina. p. Concluding Remarks 11 . this can lead to a relative increase in the demand for skilled labor. leading to more inequality. as well as labor market reforms. Ferreira Filho and Horridge (2005) show that multilateral trade liberalization could improve income distribution in Brazil. the industries that are most exposed to international competition pay the highest wages. the Dominican Republic.” To the extent that adoption of new technologies could be fostered by trade openness.

” The Quarterly Review of Economics and Finance (42): 853-63. Andrew and Anne Krueger (2002). “Neo-Liberalism in Latin America – a Return to the Past?” Financial Markets and Portfolio Management 16 (3): 309-15. who have benefited from Werner’s intellectual leadership and friendship. Werner (1984). Baer. Baer. Baer.As illustrated by this brief review of some of Werner Baer’s contributions to the literature on economic development in LAC. William R. many of the questions raised in his seminal work remain relevant to the modern debate on trade liberalization and models of development.” paper presented at the 2002 Annual Bank Conference on Development Economics. Growth and Poverty.” Latin American Research Review vol. “Trade. Cline. For those like me. 7 (Spring): 95122. 12 . mimeo. this is both a reminder of the relevance of his contributions to the economic literature and a reassurance that North-South academic collaboration can make a difference. “Can the East Asian Model of Development Be Generalized?” World Development 10 (2): 81-90. “Industrialization in Latin America: Successes and Failures. Werner and Donald V. Werner (1972). “National sovereignty and consumer sovereignty: Some consequences of Brazil’s economic opening. (1982). Werner (2002). Berg. References Baer.” Journal of Economic Education (Spring): 124-35. “Import Substitution and Industrialization in Latin America: Experiences and Interpretations. Coes (2002).

Rodrik.” in Thomas W. Guillermo and Marcelo Olarreaga (2006).. Krueger. Stoneman. forthcoming. Perry. D. Hertel and L.Ferreira Filho. Hertel and L. Alessandro (2005) “Mexican Households: The Effect of the Doha Development Agenda. Primo Braga. mimeo. “The Policy Coherence Agenda: Connecting Debt and Trade. eds. Joaquim Bento de Souza and Mark Horridge (2005). Ricardo and Dani Rodrik (2003). (2005). “Economic Development as SelfDiscovery. “Outward-Orientation and Development: Are Revisionists Right?” mimeo Stiglitz. Hello Washington Confusion?” Journal of Economic Literature. Anne (1997). “Trade Liberalization.” in Thomas W. and Regional Inequality in Brazil.: World Bank and Palgrave McMillan). localized learning and technological progress.” Paper presented at ABCDE Conference. Inequality and Poverty Reduction in Latin America. San Petersburg.N. Economic Policy and Technological Performance (Cambridge: Cambridge University Press). Dani (2006) “Goodbye Washington Consensus.. “The Doha Round. Srinivasan.. T. Poverty.C. Alan Winters.: World Bank and Palgrave McMillan). and Jagdish Bhagwati (1999). Hausmann. Nicita. “Learning to learn. D. eds. Poverty & the WTO: Impacts of the Doha Development Agenda (Washington. eds. Poverty & the WTO: Impacts of the Doha Development Agenda (Washington. Carlos A.” in P. Alan Winters. 13 .” American Economic Review 87(1): 1-22. Joseph (1987).C.” Journal of Development Economics (December). Dasgupta and P. “Trade Policy and Economic Development: How We Learn.” in Debt and Trade: Time to Make the Connections (Dublin: Veritas Publications).

and Andrew McKay (2004). Gobind Nankani. D. L.” Journal of Economic Literature XLII (March): 72-115. Economic Growth in the 1990s: Learning from a Decade of Reform (Washington. Alan. “Rethinking Growth. “Trade liberalization and Poverty: The Evidence So Far. Neil McCulloch. and Indermit Gill (2006).Winters. Zagha.: The World Bank).” Finance and Development 43 (March): 7-11.C. Roberto. 14 . World Bank (2005).

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