Import Substitution Industrialization
What is Import Substitution Industrialization?
Import substitution industrialization is a strategy of building domestic industry behind tariffs and quotas to replace imported manufactured goods.
The tools were tariffs and import quotas on finished manufactures, cheap directed credit, overvalued exchange rates that made imported machinery cheap, and state-owned firms in steel, chemicals and vehicles. The justification was the infant industry argument: a new industry cannot compete with established foreign producers at first, but with temporary shelter it will learn, reach scale and eventually stand on its own. Much of Latin America and parts of South Asia and Africa followed this route through the middle of the twentieth century, and it did generate real manufacturing growth for a while. The trouble was that domestic markets were small, protection was rarely temporary, and firms shielded from competition had little reason to cut costs. Foreign exchange shortages and debt problems followed, which pushed many countries toward export-oriented policies.
Import Substitution Industrialization: a worked example
A country imports cars at a world price of $8,000. It imposes a 100 percent tariff, so an imported car now costs $16,000, and a domestic assembler that can only build a car for $14,000 suddenly looks viable and starts producing. Buyers who used to pay $8,000 now pay $14,000, an extra $6,000 per car, and the assembler faces no pressure to close that cost gap because the tariff shields it. If the whole national market is 20,000 cars a year while exporters abroad build hundreds of thousands, the domestic plant never reaches the scale that would make it competitive.
The mistake students make with import substitution industrialization
The usual misreading is that import substitution means shutting out all trade. It targets specific imported manufactures, and countries following it kept importing machinery, inputs and technology, often heavily. The second misreading is that it failed instantly. Several countries recorded fast industrial growth under it for a decade or more; the problems came later, from small home markets, protection that never expired and weak productivity growth.
Import Substitution Industrialization questions
Why did import substitution fall out of favor?
Import substitution lost favor because protected firms in small domestic markets never became competitive. Without export sales they could not reach efficient scale, and without foreign rivals they had little reason to cut costs or improve quality. Foreign exchange shortages, budget strain and debt crises then pushed many governments toward export-oriented policies.
What is the infant industry argument?
The infant industry argument says a new domestic industry needs temporary protection because it cannot yet compete with experienced foreign producers. The claim is that costs will fall with experience and scale, so the industry becomes viable once it has grown. The practical problem is that protection is politically easy to grant and very hard to remove.
How is import substitution different from export-led growth?
Import substitution aims at the home market behind trade barriers, while export-led growth aims at world markets and accepts foreign competition. The first measures success by how few goods are imported, the second by how much is sold abroad. Export-led producers face constant pressure from world prices and quality standards, which is the discipline protected firms never got.
Formula / Example
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