Import Substitution Policy and Export Promotion Policy

Export Promotion versus Import Substitution Export promotion: looking outward and seeing trade barriers primary-commodity export expansion expanding manufactured good exports Import substitution: looking inward but still paying outward tariffs, infant industries, and protection

Historical Background of ISP Import substituting industrialization was a trade policy adopted by many low and middle income countries before the 1980s. The policy aimed to encourage domestic industries by limiting competing imports. It was often accompanied with the belief that poor countries would be exploited by rich countries through international financial markets and trade.

Historical Background of ISP Latin America Independence~1930: Free trade based on specialization. 1930~1945: Difficulties due to the Great Depression and Second World War. 1950~1970: Import Substitution Policy 1960~1980: Regional Integration and Some Liberalization Efforts 1980~1990: ‘lost decade’ and protectionism 1990~ Trade reform

Arguments in Favor of ISI Volatility of primary commodities prices Declining terms of trade Infant industry Linkages: spillover effects Dynamic nature of resource endowments: concentration in labor-intensive exports would simply trap workers in low wage industries.

Nominal and Real Price Indexes Industrial Commodities, 1862–1999

Infant Industry Argument The principal justification of this ISP was/is the infant industry argument: Countries may have a potential comparative advantage in some industries, but these industries can not initially compete with well-established industries in other countries. To allow these industries to establish themselves, governments should temporarily support them until they have grown strong enough to compete internationally.

Instruments of Protection Non-tariff barriers Tariffs (level and dispersion) Exchange rate control Export tax State-owned enterprises Targeted credit, subsidy

Performance of ISI (per capita growth rate) Country 1941-49 1950-59 1960-69 1970-79 Brazil 1.6 3.6 2.8 6.1 Ecuador 4.1 2.4 1.8 7.0 Mexico 3.7 3.1 3.5 3.2 Dominican Rep. 3.0 3.4 1.4 4.6 Panama -2.2 4.8 1.9 Costa Rica 4.7 2.2 3.3 Colombia 2.1 Peru 2.5 1.2 El Salvador 9.3 Guatemala 0.3 0.5 Paraguay 0.6 -0.7 1.1 5.0 Argentina 2.3 0.8 1.3 Honduras 1.5 -0.1 Chile Uruguay 1.0 Nicaragua 4.2 -2.5 Bolivia -1.7 Venezuela 6.7 2.9 0.0

Lower Dependency (Imports of goods and services as % of GDP)   Argentina Brazil Chile Colombia Mexico 1928 1938 1948 1958 18 12 11 6 7 31 15 10 8 14 9

Consequences of ISI Overvaluation Decline of agriculture Fiscal deficit and inflation Dependency on imports of essential inputs

Criticism of ISI Uneven protection Overcapacity effective rate of protection Overcapacity Low productivity growth Agriculture Budget deficits Low interest rates capital-intensive, low savings rate Labor: dual economy, don't make the most of the abundant labor

Problems With the Infant Industry Argument It may be wasteful to support industries now that may or may not have a comparative advantage in the future. With protection, infant industries may never “grow up” or become competitive. There is no justification for government intervention unless there is a market failure that prevents the private sector from investing in the infant industry.

Effective Rate of Protection If tj=ti, then ERPj=tj If tj>ti (tariff escalation), then ERPj>tj Average nominal protection over consumer and manufactured goods 1960: Arg:313, Bra:168, Chi:138 ERP: Mex: 671 for fertilizer and insecticides, 206 pharmaceuticals, 102 automobiles.

Effective Rate of Protection

Overcapacity In late 1960s, Latin America had ninety firms producing 600,000 cars, or an average annual output of just 6,700 cars. Production of cars in LA: 1968 Annual production number of firms Highest Lowest Argentina 180,976 10 41,280 1,093 Brazil 279,564 9 154,972 949 Chile 18,042 6 - Peru 10,115 2,346 92

Low Productivity Growth GDP growth TFP (2)/(1) (1) (2) Argentina 1960-74 4.1 0.7 17.1 Brazil 7.3 1.6 21.9 Chile 4.4 1.2 27.3 Mexico 5.6 2.1 37.5 Peru 1960-70 5.3 1.5 Korea 1960-73 9.7 42.3 Hong Kong 9.1 4.3 47.0 Source: world bank

Export Promotion Policy Instead of import substituting industrialization, several countries in East Asia adopted trade policies that promoted exports in targeted industries. Japan, Hong Kong, Taiwan, South Korea, Singapore, Malaysia, Thailand, Indonesia and China are countries that have experienced rapid growth in various export sectors and rapid economic growth in general. These economies or a subset of them are sometimes called “high performance Asian economies”.

Export Promotion Policy Neutral incentives elimination of the anti-export bias Static gains from trade Economies of scale Advanced technology and innovations Competition and efficiency Self-correcting policies Q: Was Korea more open than Latin American countries? Wasn’t HCI promotion policy an ISP?

Export Promotion Policy It is debatable to what degree these economies established “free trade”. Although evidence suggests that these economies did have less restricted trade than other low and middle income countries, some trade restrictions were still in effect during different times. Some observers content that it is also unclear whether the high volume of exports and imports caused rapid economic growth or was merely correlated with rapid economic growth.

Political Economy of ISI Primary constituencies urban working class domestic industrialists middle class Why not direct transfer? Latin America vs. East Asian Countries Latin America countries are land-abundant whereas East Asian countries are labor-abundant. Labor-abundant countries opened faster as governments tend to be more responsive to the interest of labor over landowners.

Performance Source: World Development Report 1987

Export and growth

Example: Openness and growth Sachs and Vial Significant changes Faster convergence among countries Openness became more relevant for growth Reliance on natural resources for exports is more of a disadvantage than before.

Additional Evidence

Convergence theory and openness Nonconvergence: The rich tend to grow richer as a result of increasing returns to scale. Convergence club: convergence applies only among countries with a sound human capital base for using modern technology. Conditional convergence: currently poor countries have a low long-term potential income level, though countries do tend to converge to this. New convergence club? The open countries display a strong tendency toward economic convergence.

Convergence among open countries

Demand Side High growth rate of industrialized economies and market access Growth in world trade Why do the recently liberalizing countries have poor performance compared to early Asian liberalizers? Why do exporters of primary products have poor performance?

Alternatives Trade reform Regional integration Expansionary policy and stronger ISP (?)