“Import substitution as implemented failed, and the Justifications for out ward orientation are being increasingly undermined” – Guy Bentley From World War II until the sass’s many developing countries have attempted to accelerate their development by limiting imports of manufactured goods, in an attempt to foster a manufacturing sector to serve the domestic market. This paper will follow the structure of Henry J Burtons’- A reconsideration of import substitution by first examining the theory of import substitution, as a method of manipulation foreign exchange.
I will then look at the Justifications for the failure of this implemented policy by looking at the example of 19th century Japanese trade liberalizing. Succeeding that, I will describe the dramatic policy transition from inward looking strategies to outward orientation whilst examining the example of Taiwan and Korea. Finally I will examine the reasons why certain individuals undermine this development strategy, in an attempt to pursue the most effective and appropriate combination of policies to promote economic development.
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During the last few decades there has clearly been an unprecedented integration of national economies where globalization has been driven by constant Technological advances. This has eased the movement of goods and information by lowering barriers to trade thus stimulating a change in the economic policy which countries choose to pursue. However before the sass’s the global situation was completely different, with protectionist policies such as tariffs, voluntary export restraints and anti-dumping duties, inhibiting the free flow of trade and factors of production.
Import substitution (IS) was one of these policies and stemmed from the need to protect an economy from imports of developed countries allowing them to concentrate on producing an array of manufactured products domestically rather Han importing them. Burton argues that IS occurred as a result of a rejection of free market solutions as the need for comprehensive planning and accumulation of physical capital came to surpass any trust held in Adam Smith’s invisible hand.
The primary Justification for IS was based on the infant industry argument; which stated that initially inefficient developing countries could have a potential comparative advantage in manufacturing. However they can’t compete with the well-established manufacturing sectors present in developed countries that already reap the benefits of economies of scale. History supports this theory as the US and Germany both had excessively high tariff rates on manufacturing in the 19th Century equally Japan had extensive import controls until the sass’s (Grumman).
Other arguments that Justify this means of protectionism include the profitability argument which governs an innovators ability to capture profits generated by new entrance into a market (Grumman). The idea is that innovative firm should be rewarded for their entrance into a new industry with some sort of tariff protection offsetting the initial sunk costs. If this was not in place, isomorphism from other firms may exist where they could allow the innovator into the new industry without paying the sunk cost.
Finally Burton explains Tanat IS was uses In countries winner ten mostly capital goods market was relatively small and the need for physical capital to promote productivity and growth was substantial. One way of solving this was to encourage investment by maintaining an exchange range that kept capital’s domestic price low by constantly overvaluing the currency. However this created balance of payments pressures which consequently led to the erection of tariffs, quotas and other restraints in an attempt o combat these pressures.
Grumman, Obsolete, Maurice and Emilie highlighted a few counterpoints to the infant industry argument in their book International Economics: Theory and Policy. Firstly protection doesn’t help unless it makes the industry itself competitive. For example certain poor countries lack skilled labor, entrepreneurs and minimum capital requirements. Therefore a tariff, or import quota, will allow inefficient sectors to survive by supplying them with temporary shelter.
In certain cases the domestic market may not even have the magnitude to reap economies of call and therefore, despite the intended protection, it will never be in a position to compete globally. Furthermore a phenomenon called a “pseudoscience industry’ may occur which is where a net cost or unrelated success takes the guise of an infant industry success. Pakistan and India are a good example of this as they have protected their manufacturing sectors for decades and have recently begun to develop significant exports of manufactured goods.
However these goods are light manufactures for example textiles and not the heavy manufactures that were benefactors from the protective measures. Certain scientist state that IS not only holds back the country that is implementing the policy but also has adverse effects on other developing countries. Dollar and Collier carried out a study in 2001 that concluded that the cost to poor countries of rich countries protectionism was recorded at $100 billion per year, a figure that is twice as large as foreign aid from rich to poor.
Burton argues that the overvaluation of domestic currency to keep the domestic price of capital low simply made it difficult to experience any export led growth as productivity failed to grow because of the foreign exchange pressures. Furthermore the work of Formability, Sunset and Slow on the sources of growth made it clear that simply an accumulation of physical capital alone was not sufficient for sustained economic growth; instead the productivity of resources had to be increased. The example of Trade liberalizing in Japan during the 19th Century epitomizes the failures of import substitution extremely effectively.
In the 12 years after Japan ended its self-imposed economic isolation in 1858, whereby tariffs and voluntary export restraints severed the free flow of trade with the rest of the globe, the value of Japanese trade rose by a factor of 70. It is estimated to have raised Japanese real income by 65% over the two decades (Well). There are numerous examples which support the adverse effects of tariffs, for example the US Smooth- Hawley tariff, which contributed directly to the severity of the sass’s Great Depression.
One study estimated that agreements, under the Uruguay Round of tariff reduction (a set of negotiations that begun in 1986 and were completed in 1994) raised world purchasing power by $73 billion which is equivalent to 0. 2% of current world GAP (Well). I will now turn my attention to Outward orientation. Burton defines outward orientation as “keeping the domestic economy open to foreign competition and foreign capital to ensure exports aren’t penalized.
This would lead to structural changes according to changes In ten Allocates AT comparative advantage Tanat are assumed to occur. ” The central notion for outward orientation is a return of confidence combined with a strong commitment to exporting non- traditional products. In Chile’s case this was achieved through the liberalizing of their imports. During the sass’s import restrictions were removed by a new military government who placed complete trust in the free market having seized power.
As the country started to recover from the world debt crisis in 1986 Chilean economic performance started to outpace its Latin American neighbors, as there was a successful shift from its dependence on production of the raw matter copper to off season fruits and increasingly high quality wine. This allowed them to achieve average GAP growth of 4. 74% between 1986-1998 (Francisco Galleon, and Norman Locally), with a peak of 12. 2% in 1992. Chile was not alone as a success story for outward orientation; Taiwan and Korea benefited from increases in GAP from 6. 5%-10% and 4. 4%-9. 1% respectively during the period from, 1950-1960 (Burton).
This was because they had marked policy changes in the late sass’s and early sass’s that actively reduced distortions and encouraged firms to export. Throughout the sass’s Taiwan had used numerous protectionist measures such as; trade and exchange rate policies, tariffs, ERRS (effective rates of protection) and multiple exchange rates which were constantly overvalued. The adoption outward orientation policies meant that Taiwan implemented a single exchange rate at a realistic level encouraging exports which, coupled with, the rapid rate of growth of world trade, led to successful development.
Burton argues that Korea succeeded because they were not only able to absorb the collective learning passed on from Japanese control before 1950, but also because they benefited from the institutional developments which had been put in place for example the Bank of Korea. Furthermore foreign aid allowed for further learning for example US army engineers teaching many of the locals in the sass. Though these successes created a blue print for development whereby exports could facilitate employments, economies of scale and solve balance of payments problems, outward orientation has received a few criticisms.
Firstly the role of exports as a sufficient mean to promote development has been critiqued because of the lack of interactions between exporting and domestic learning. Studies of knowledge accumulation, especially the ideas of tacit knowledge, on the Job learning and learning by doing, combined with studies of technological change in individual firms and institutions, offer evidence that exporting is not a substitute for a strong indigenous learning process (Burton). Additionally the contribution of Trans National Corporations (Tan’s) has been criticized as it doesn’t contribute to strong indigenous learning capacity for cantonal firms.
These Tens are profit maximizing and often fail to create any sustainable development in the area where they set up business. It seems that the basic objective should not be to simply attract this foreign investment, but to create a social and economic environment which promotes knowledge. Finally the simplistic nature of the blue print for Taiwan and Korea has come under fire. Other countries with differing initial conditions, such as a lack of skilled labor, will face different challenges and barriers to development. Burton concludes that IS failed as it scourged learning as a result of countries isolation.