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Essay/Term paper: Import substitution

Essay, term paper, research paper:  Economics

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Import Substitution

Describe import substitution (Inward looking) developmental strategy, clearly
outlining the differences between the first and second stage. Assess its
effectiveness in promoting economic development. Compare inward looking and
outward looking strategies and discuss the assertion that the latter is superior.

The First Stage of Import Substitution:

All present day industrial and developing countries protect their
manufacturing industries for the domestic markets. While the industrial
countries of today rely primarily upon the usage of relatively low tariffs,
developing countries apply high tariffs or quantitative restrictions which
either limit or completely exclude competition from their imports. Protection
like that - high protection - discriminates against exports through the
explicit/implicit taxation of the export activities.
Explicit taxation can take the form of export taxes whereas implicit
taxation occurs as a result of the effects of protection on the exchange rate.
As your protection level increases, your exchange rate level will decrease in
order to ensure the necessary equilibrium of the balance of payments and the
lower the amount of domestic currency exporters receive per unit of foreign
exchange earned.
There is no need for high protection at the first stage of import
substitution in the replacement of the imports of non-durable consumer goods
(clothing, shoes, household goods, textile fabrics, leather, wood and other
types of inputs) since these commodities exist in the developing countries that
are at the initial frontier of industrialization.
The commodities I mentioned are intensive in unskilled labor, the scale
of output is relatively low, and costs do not rise substantially at lower output
levels. The production of the commodities do not involve the use of
sophisticated technology or highly educated workers and suppliers for parts,
components, materials and accessories are not necessary for highly efficient
An argument for infant industry protection and promotion is made for the
"easy" stage, that being the first stage of import substitution because even
though the domestic production of the commodities generates external economies
in the form of labor training, entrepreneurial development and the spread of
technology, there is a viable argument for infant industry protection because
without the shielding from larger, more sophisticated companies, these infant
industries will be crushed and overwhelmed by exceeding costs, non-
competitiveness due to the lack of highly skilled laborers and the simple fact
that these infant industries are technologically incompetent.

The Second Stage of Import Substitution:

I see the first stage of import substitution as a temporary requirement
because the domestic production rises since it not only provides for increases
in consumption but it also replaces imports. The rate of this growth however
will decline as soon as the process of import substitution is completed.
The maintaining of these high industrial growth rates necessitates the
turning to the exportation of manufactured goods or moving to second stage
import substitution.
Second stage import substitution involves the replacement of
intermediate goods and consumer durables by domestic production. These
intermediate goods are highly capital intensive and are subject to important
economies of scale. The margin of processing is very small and organizational
and technical inefficiencies may contribute to high costs.
Due to the scarcity of physical and human capital in developing
countries that complete the first stage of import substitution, they tend to be
at a disadvantage in the manufacture if highly physical capital intensive
intermediate goods and skill intensive producer and consumer durables. By
limiting the scope for the exploitation of economies of scale, the relatively
small size of their national markets also contributes to high domestic costs in
these countries.


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