1. Import Substitution Policy and Export Promotion Policy

2. 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

3. 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.

4. 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

5. 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.

6. Nominal and Real Price Indexes Industrial Commodities, 1862–1999

7. 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.

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

9. Performance of ISI (per capita growth rate)
Country
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

10. 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

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

12. 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

13. 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.

14. 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.

15. Effective Rate of Protection

16. 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

17. Low Productivity Growth
GDP growth
TFP
(2)/(1)
(1)
(2)
Argentina
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
5.3
1.5
Korea
9.7
42.3
Hong Kong
9.1
4.3
47.0
Source: world bank

18. 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”.

19. 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?

20. 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.

21. 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.

22. Performance
Source: World Development Report 1987

23. Export and growth

24. 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.

25. Additional Evidence

26. 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.

27. Convergence among open countries

28. 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?

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