The Economics of Industrialization

Import Substitution Industrialization (Inward looking strategy)
• In the 1950s, it was thought that the problem of development was a structural problem in that developing countries relied too heavily on the primary sector and did not have manufacturing sectors. The creation of an industrial base to substitute domestically produced manufactured goods for import, became known as import substitution industrialization.
• Non-durable simple manufactured goods (e.g.: textiles).
• Trade barriers will be erected to protect the newly established domestic firms.
• The barrier would stay in place until the firm grew sufficiently in size and acquired the necessary know-how to lower the average cost.
• Trade barriers were reduced when they were able to compete with imports and survive within the domestic market.

Evaluation:
• The problems associated with an inward oriented strategy include:
o Due to protectionism, the domestic industries had their own ‘captive’ market, so it was never forced to become efficient. A captive market has no competition. In some cases, poor quality, expensive goods were produced.
o The strategy in some developing countries created a domestic pleat which became more and more powerful as the industry sector grew.
o The protected trade barriers, in many cases, were never removed.
o The established industries, were often ‘capital intensive’, employing ‘inappropriate’ technologies, and creating minimal employment benefits.

Outward looking strategy (Export-oriented growth and development)

• Structural changes brought about by ISI was followed in some East-Asian countries (Korea, Taiwan, Singapore, Hong Kongfour tigers). By an attempt to export these simple, non-durable, manufactured goods they had been producing for their domestic market. These, and later other developing countries, adopted an ‘outward orientation’.
• In this process, the role of the state varied between countries, but in all of them, it played a significant, complementary role. It provided guidance and assistance to the private firm, but only if they achieved specific performance standards typically associated with export targets. These firms were thus forced to produce low price, high quality goods, in order to continue to enjoy any state subsidies and loans to banks.
• Export promotion is not sufficient to promote development and to ensure the sustainability of the process. The state in these countries investing heavily in education, slowly creating a most productive workforce, with higher skills. The state also ensured the fruits of economic growth were enjoyed by all. These countries thus avoided the cost associated with rising income inequalities. The first Asian countries to initiate such an approach to growth and development was Japan, followed by the four East Asian ‘tigers’, then Malaysia, Thailand, and Vietnam. China and India are the current stars of export-oriented strategy.

Evaluation (advantages):
• Focusing initially on the production and exporting of simple, manufactured, non-durable goods changes the structure of these economies. Employment opportunities increased for the rural migrants, as these industries were more labor intensive.
• The export earnings alleviated balance of payments problems, as they were used to finance the importation of necessary intermediate and capital goods. There was less danger of the economy running into foreign exchange and foreign debt problems.
• Rising export increased aggregate demand and fueled growth in output and income. Focusing on the large export markets forced firms to grow in size and acquire scale economies. This is especially important in small nations.
• Firms were forced to learn more about manufacturing their products more efficiently. The international competition provides the stimulus. The state also invited technical assistance from abroad, but it usually limited contracts to no more than 3 years, forcing the domestic firms to learn the necessary technology.
• Operating successfully in the world market permitted firms to acquire marketing, financial, managerial, and most importantly entrepreneurial skills. Exposure to the world competition promotes a local entrepreneurial class to evolve and mature.
• Through varying degrees of state guidance these economies slowly shifted the comparative advantage and production to more sophisticated and complex manufactured products, and later to knowledge-based and technology-intensive products. The strategy facilitated economic diversification, which decreased the risk of exporting and created a variety of positive spillover effects for the economy.

Evaluation (disadvantages)

• Such growth depends on how fast the rich economies are growing. A recession in the US or Europe will slow down the process, if the domestic demand is weak.
• It must successfully overcome the hurdles that protectionism in developed countries create.
• It may lead to worsening income distribution as the rural sectors may be left behind.
• The drive to produce cheaply for export market may lead policy makers to ignore the cost of environmental degradation.
• It forces policy makers to maintain the exchange rate artificially undervalue to provide an extra competitive edge to their exports, risking not only rising protectionist sentiment abroad, but also inflation at home.
• It may lead to policy makers to postpone the creation of a social safety net that would include state pension and health insurance as the growth process does not rely on the ability of the population to spend on domestic goods and services.

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