Industrial Development Strategy

Import Substitution Strategy

During the 1950s and 1960s,
developing countries experienced a
decline in world markets for their
primary products and growing BOP
deficit on their current accounts
Given a general belief in the magic
of industrialization, they turned to an
IS strategy of urban industrial
development
Definition
IS entails an attempt to replace
commodities that are being imported,
usually manufactured consumer
goods, with domestic sources of
production and supply
The typical strategy is first to erect
tariff barriers or quotas on certain
imported commodities and then try to
set up the local industry to produce
these goods.
Typically, this involves joint ventures
with foreign companies, which are
encouraged to set up their plants behind
the wall of tariff protection and given all
kinds of tax and investment incentives
Tariffs, Infant industries and the theory of
protection
A principal mechanism of IS strategy
is the erection of protective
tariffs( tariffs on imported goods) or
quotas
The basic economic rationale for
such protection is the infant industry
argument
Ways in which the infant industry is
protected
There are three most common methods
are
1) Tariffs
2) Trade Quota
3) Provision of subsidies
Tariffis a tax that is levied on imported
products.

Forms of tariff:
a) Ad valorem
b) Specific
c) Compound tariff
Ad valorem duty – is a fixed
percentage of the value of the
commodity, as when imported cars
are taxed at 25%
Specificduty – is a fixed amount of
money per physical unit of a
commodity, say 50,000/- per
imported commodity
Compound duty – is the combination of
the two as when a car is taxed at 50,000/
plus 5% of value
An immediate effect of a tariff is to
raise prices, thus inducing consumers
to reduce their purchases of their
tariffed good
Quota
Is the establishment by a government of a
physical limit on the quantity of a good
that that can be imported over a given
period
A quota may be expressed in
physical, value or market share terms,
but all imply that when a given
quantity has been imported no more
of that good will be allowed into the
country
Subsidization of domestic industries
Subsidy is a negative tax.
This is an attempt of the government
to promote certain lines of production
Subsidies have the effect of
protecting domestic industries
(producers) against foreign
competition
This is because subsidies enable
domestic producers to produce at a
relatively low cost compared to
foreign competitors
Advantage of ISI
The market for industrial product
already exists, as evidenced by
imports of the commodity.
So risks are reduced in setting up an
industry to replace imports.
Employment Creation – through
establishment of industry within the
country the rate of unemployment will be
reduced because an industry needs skilled
and unskilled labour in its operations
Sources of Government revenue
The IS industrialization Strategy and
Results
Most observers agree that the IS
strategy of industrialization has been
largely unsuccessful
Specifically, there have been five
undesirable outcomes:
First, secure behind protective tariff
walls and immune from competitive
pressures, many IS industries(both
publicly and privately owned remain
inefficient and costly to operate)
Second, the main beneficiaries of the
IS process have been the foreign
firms that were able to locate behind
tariff walls and take advantage of
liberal and investment incentives
After deducting interest, profits and
royalty and management fee, most of
which are remitted abroad, the little
that may be left over usually accrues
to the wealth local industrialists with
whom most foreign manufacturers
cooperate and who provide their
political and economic cover
Third, most IS has been made
possible by the heavy and often
government- subsidized importation
of capital goods and intermediate
products by foreign and domestic
companies
In the case of foreign companies,
much of this is purchased from parent
and sister companies
There are two immediate results:
◦ Capital- intensive industries are set up, usually
catering to the consumption of the rich while
having a minimal employment effect
◦ Far from improving the LDCs BOP
situation and alleviating the debt
problem, indiscriminate IS often
worsens the situation by increasing a
need for imported capital goods and
intermediate products while a good part
of the profits is remitted abroad in the
form of private transfer payments
Fourth, a fourth detrimental effect of
many IS strategies has been their
impact on traditional primary –
product exports
To encourage local manufacturing
through the importation of cheap
capital and intermediate goods,
exchange rates have often been
artificially overvalued
This has had the effect of raising the
price of exports and lowering the
price of imports in terms of the local
currency
The net effect of overvaluing
exchange rates in the context of IS
policies is to encourage capital
intensive production methods still
further and to penalize the traditional
primary – product export sector by
artificially raising the price of exports
in terms of foreign currencies
This overvaluation, then causes local
farmers to be less competitive in
world markets
In terms of its income distribution
effects, the outcome of such
government policies may be to
penalize farmers and the self –
employed while improving the profits
of the owners of capital both foreign
and domestic
Fifth,IS, which may have been conceived
with the idea of stimulating infant
industry growth and self – sustained
industrialization by creating “forward”
and “backward” linkages with the rest of
the economy have often inhibited that
industrialization
Many infants never grow up, contend to
hide behind protective tariffs and
governments are reluctant to force them to
be more competitive by lowering tariffs