Import Substitution Industrialization

Import substitution industrialization is an economic theory that advocates trade barriers. It is an attempt to substitute finished foreign goods with local goods. To achieve this, local producers need to be protected from foreign competition. The growth of local manufacturers also increases employment opportunities.

Potentially, this strategy could reduce a developing country’s dependence on developed nations. The theory was implemented in Africa, parts of Asia, and Latin America. But real-world results were poor. By the 1980s, most countries rejected this theory. The strategy failed because reduced competition only made local producers more complacent.

• Import substitution is an economic theory that recommends the imposition of trade barriers to protect domestic manufacturers and businesses from international competition.
• High tariffs and import quotas will reduce demand for foreign goods in the domestic market. Potentially this paves a space for domestic producers to scale up production.
• After experiencing poor results, most nations rejected this strategy; it was criticized vehemently.
• Reduced competition is not enough for domestic growth. Manufacturers need more investment to ramp up production. Innovation and technology stagnate when a country keeps imports out.

Import substitution is a foreign policy that combines foreign goods with domestic products. The government initiates such stances to support domestic and small-scale businesses. Import substitution can potentially protect local manufacturers from undue competition.

Sometimes international markets are flooded with products that are both affordable and quality. However, domestic manufacturers may be unable to produce such quality at affordable prices. This is when the government restricts imports by imposing trade barriers—tariffs and import quotas.

If import taxes are kept high, imported goods become significantly costlier than domestic products. As a result, the demand for imported goods in the domestic market falls. Like all taxes, import barriers are sources of revenue.

Import Quotas are imposed by a government restricting the quantity of the product. This limit is calculated in terms of the quantity of imports per year.

Again, the import substitution definition focuses on small businesses and their ability to compete in global markets. This theory states that markets in developing countries are flooded with foreign goods—domestic producers struggle to survive.

But it goes beyond just manufacturers. If local businesses go bankrupt, then the country’s citizens lose jobs. So import substitution should have a positive impact in theory. In practice, however, this approach has backfired terribly.

Import substitution in Pakistan is a recent example. However, economists question the move since it has yielded poor results with other countries.

Let us look at an import substitution industrialization example.

Over the years, Import substitution policies have failed in every country. Import substitution industrialization in Latin America failed miserably. Over decades, Argentina, India, and Zambia also showed poor results. In Brazil, import substitution industrialization attempts were made in 2012.

Brazil bullied Mexico out of the domestic market by restricting car imports. In tandem, Argentina also employed arbitrary import controls on Spanish-controlled energy companies. The import restrictions directly affected trading partners, and exports declined drastically. Experts predicted a loss of $18 trillion globally.

Following are the effects of import substitution industrialization.

• The results vary from country to country, but the expected effects are employment generation.
• An increase in domestic production elevates the business of small industries. However, in the 1960s, import substitution led to an agricultural decline in Latin America.
• Contrary to its advantages and theoretical significance, the strategy did not positively impact world economies.
• Only a few countries, like Ecuador and Honduras, implemented it successfully.
• Most countries implemented this policy in the 1940s. But by 1980, it was rejected by all.

Import substitution industrialization poses the following challenges.

• Developing countries face a lack of resources and government support.
• Developing countries end up becoming complacent when competition is reduced.
• Eliminating competition helps only in theory; in practice, only some countries have access to the required technology and equipment.
• Even after import substitution, domestic businesses struggle to scale up. As a result, they need investment to ramp up production. In most cases, demand rises, but supply cannot keep up.
• The sociopolitical relationship between developing countries and global market players plays a significant role. Before tariffs, local producers receive technological support from global players. But substitution industrialization isolates markets. Innovation slows down.
• Transport and lack of power supply are other drawbacks. Framing a political stance is easy, but it takes decades to build domestic infrastructure. Without the infrastructure, domestic firms can improve neither quality nor quantity.

Advantages

• Helps in the growth of local and small-scale businesses.
• Creates a void in the economy, which encourages investment.
• The growth of local industries creates more jobs for the country’s citizens.
• It can help create a balance between imports and exports. As a result, efficient local businesses get a massive boost and register exponential growth.
• Expansion of local business over time can lead to increased exports.

Disadvantages

• A customer interested in foreign goods will not buy domestic products. Nevertheless, consumer demands still need to be met in such scenarios.
• The absence of foreign competition might help producers, but consumers can pay the same amount for sub-standard goods.
• The excessive application of Import substitution will lead to overvalued exchange rates.
• This policy backfires so often because it creates monopolies within the domestic market. This further results in unfair income distribution.

This article has been a guide to what is Import Substitution Industrialization. We explain its effects, challenges, advantages, and disadvantages using an example. You can learn more about it from the following articles -

• Trade Liberalization
• Autarky
• Demand Theory