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EXPORT PROMOTION VS IMPORT SUBSTITUTION

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					EXPORT PROMOTION
VS.
IMPORT SUBSTITUTION




HAKAN YILMAZKUDAY




W
            hy do some countries develop more than others? Do their
            strategies on international trade have a role on this? In
            this paper two different industrialization strategy, import
substitution (IS) and export promotion (EP), will be introduced. These
strategies will be compared. The advantages and the disadvantages
of these strategies on their development will be stated.


Then the relation between these strategies and growth will be
analyzed. Which strategy is better for higher growth rates, especially
in a globalized world structure?




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                   Export Promotıon vs. Import Substıtutıon




Why did some countries apply import substitution strategy until the
mid-1960s? According to which reasons such countries switched to
the export promotion strategy? Was it because of the changing
structure of the world, technology, or what?


Is the export promotion strategy best one, or does it have any
alternative except the import substitution? These questions are also
the concern of this paper.




STRATEGIES FOR INDUSTRIALIZATION



Countries, according to the structure of their international trade,
mainly   apply   two   different    industrialization    strategies:   import
substitution (IS) and export promotion (EP). Strategy means a
general model or approach; its scope is greater than a policy. A
specific strategy can be applied via appropriate policies assisting it.


In early developing countries, development comes into the picture via
substituting the imported goods by locally produced goods. In other
words, most of the countries have begun developing via import
substitution. This may be due to letting the less-developed industries
to reach a level at which it can compete with foreign industries in all
over the world. The evidence of this is that most of the less-
developed countries has shifted their policies to serve for an export




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                   Export Promotıon vs. Import Substıtutıon




promotion strategy after an import substitution strategy (Edwards
1993).


Generally,    import   substitution   strategies     start    with   producing
consumption goods that do not need a progressed technology,
because less-developed countries actually have industries for such a
production.


There are three sources that put growth of a country into motion:
import substitution, export and the increase in internal demand. First
two of these are related to international trade effects; but the third is
related to expenditures inside the country. As we will discuss below,
the main point of import substitution is that the locally produced
goods are replaced with the imported goods.


However, in an export promotion strategy, the external demand is
the source of activity. The main point of an EP strategy is to make
production for international trade and hence to increase exports.


The indicator of EP is the increase of the rate of exports in GNP. In
other words, in this model the main goal is to increase not only the
national income but also the rate of exports. The second goal is to
increase the rate of industrial goods in exports.


“There are two channels through which openness positively affected
growth. First, there are direct effects that operate via dynamic
advantages – including higher capacity utilization and more efficient
investment projects – and second, there are indirect effects that work




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                             Export Promotıon vs. Import Substıtutıon




through exports: more liberalized economies have faster growth of
exports and these in turn, result in more rapidly growing GNP.”
(Edwards 1993).




IMPORT SUBSTITUTION1,2 (IS)



Basically, import substitution is substituting the imported goods with
the locally produced goods in order to meet the internal demand.
(Bruton 1998). For this, a protection is needed. The institution that
will make this protection is the government. In general words, this is
a government intervention to the market. The government can do
this not only via tariffs, quotas but also via exchange rate, prices of
the factors of production and interest rate. All of these cause a
profound bureaucracy that will be harmful for the market.


In short, IS is a strategy that appreciates the local production via
government intervention to the whole economy.


In the early applications of IS strategy the governments used a fixed
exchange rate policy. In such a regime the government determines
the exchange rate. But after a while, the local currency appreciates
which in turn affects the balance of trade negatively. In general,
countries with a more volatile real exchange rate experienced poorer

1
    This sections mostly draws on (Bruton 1989).
2
    Also known as inward oriented strategy or inward orientation.




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                  Export Promotıon vs. Import Substıtutıon




overall performance than those nations that had managed to
maintain a more stable real exchange rate (Edwards 1993).


The interest rate is also determined by the government, and it is
determined under the market equilibrium level. By this way the
investment is promoted in order to support the firms. However the
interest rate puts savings into motion and diversifies investment
between different economic activities.


In outward oriented countries interest rate, inflation and exchange
rate are determined in the market. But in inward oriented countries
the government, which in turn destroys the resource allocation of the
economy, determines these values (Bruton 1998).


In short, the policies used in an IS strategy closes the country’s
economy to the rest of the world. The policies on price, interest and
exchange rate are repressive. Because of the high protection levels,
internal and external price levels differ so much in value. The absence
of competition with the foreign industries is tried to be remedied by
the government, but this in turn destroys the economy further and
further (Bruton 1998).


When starting an IS strategy it is supposed that the protection is
temporary, because it is assumed that the protected industry will in
turn progress and will able to compete with the foreign industries. But
in practice the results are opposite to this view. Since the industries
to protect are not chosen via appropriate competition criteria, a need




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                   Export Promotıon vs. Import Substıtutıon




for a permanent protection appears. And this results in an undesired
ways.


Nevertheless IS strategy is attractive for developing countries. The
goal of the production in an IS strategy is to serve the internal
demand. But the competition with foreign industries is not such an
easy process because it requires high levels of knowledge, ability and
tentative. Moreover, there may be problems in returns to scale, such
as high production costs.


In able to compete with the foreign industries, firstly the price level
must be appropriate. However there is no need for an appropriate
price level in a closed economy.


In practice IS strategy is applied to consumption goods. This is not by
accident, because there is an interval demand for these goods.
Furthermore the firms that will produce such consumption goods are
the ones that do not need a progressed technology. This is the easy
part of the IS strategy.


Moreover it is believed that IS strategy involves alternative policies
such EP policies. That is to say, the local industries may develop in
order to compete with the foreign industries during an IS strategy.


It is thought that the most attractive part of the IS strategy is the
decrease in the foreign currency expenditures and hence the
decrease in the trade deficit.




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                    Export Promotıon vs. Import Substıtutıon




IS strategy is evaluated as the process of modernizing the local
economy and reaching the level of developed countries. As noted
above, IS strategy comes to the picture with consumption goods, and
then it enlarges by including intermediate goods. The aim of including
intermediate goods is to form a basis in producing high level of
technology. Because the countries that use IS strategy import
intermediate goods in order to produce high technology goods, which
in turn raises the level of trade deficit.


Since the internal industry is protected by the tariffs and quotas, IS
strategy is the foreign (importer) industries’ disadvantage. So these
foreign firms may want to reverse this disadvantage by producing
their final goods inside the countries that applies IS strategy. It is an
easy   way    because     there   are    approximately         no   barriers   for
intermediate goods. So these foreign firms may produce their
products without any quota. This is a foreign investment and some
may think that it must be appreciated, but it must be kept in mind
that these investments do not have a high level of contribution to the
country.


First stage of an IS strategy is to produce consumption goods inside
the country. There are two alternatives for the second stage: one is
the export promotion and the other is to upgrade the production
structure in able to produce intermediate goods.


Before introducing EP strategy some criticisms about the IS strategy
may be covered. Some of these were mentioned above.




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                  Export Promotıon vs. Import Substıtutıon




Beyond the barriers, there is high level of prices and low quality of
goods at the countries that apply IS strategy. The local produces,
which know the absence of competition, may not make any research
and development. Moreover there may be monopolizations in the
absence of competition, which is in turn harmful for the allocation of
resources.


We had mentioned that the IS strategy starts with the production of
consumption goods. This strategy reduces the import of final goods,
but the danger is that there appears the need for import of
intermediate goods in order to produce final goods inside the country.
This in turn makes the country dependent to foreign countries.
Moreover if the level of the import of intermediate goods becomes
large this in turn damages the trade balance, which is an undesired
result.


IS strategy has a negative effect on exporters. Since the exchange
rate appreciates in order to protect the internal industries locally
produced goods become relatively expensive for foreign countries.
This in turn damages the exports and worsens the trade balance.


Both the decreasing exports and increasing dependence on foreign
intermediate goods worsens the trade balance further and further.
This in turn leads the country (that applies IS strategy) to borrow
money in order to finance the trade deficit. This is a profound
problem.




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                              Export Promotıon vs. Import Substıtutıon




By the time inward oriented countries begins to produce high
technology goods, which in turn brings industrialization into the
picture. This means that the structure of the production function
changes through a capital-using model. Human capital is used less
which in turn leads to unemployment problem. A brief example of it is
the changing structure of a country’s production from agriculture to
industrialization.




EXPORT PROMOTION3 (EP)



Opposite to the IS strategy, EP strategy promotes only the industries
that has potential for developing and competing with foreign rivals.
Since the goal is to trade abroad, there becomes competition, which
in turn remedies the returns to scale. The main goal of the EP
strategy is to prepare the “potential” industries for competition with
the foreign rivals. So the industries at their childhood must be
protected for a while (Balassa 1989).


Exporters, facing the increasing competition, have to improve their
technologies, their quality continuously in order to compete with their
rivals. They have to make research and development studies (Bruton
1998).




3
    Also known as export oriented strategy or outward orientation.




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                  Export Promotıon vs. Import Substıtutıon




Comparative advantage theory implies that a country must specialize
in the production that uses the mostly possessed factors of
production. By this way the structure of the overall industry is in
harmony with the country structure. If the country has advantage in
human capital then the EP strategy may be a remedy to the
unemployment problem (Bruton 1989).


The indirect effect of the EP strategy appears in the export values of
the countries. The increase in exports raises the foreign exchange
inflow. However, there may be an increase in import expenditures
due to the increasing income of the country, which in turn worsens
the country’s trade balance (Srinivasan 1999).




FROM IMPORT SUBSTITUTION TO EXPORT PROMOTION



As stated above most of the less-developed countries have begun
developing by an IS strategy, and then they have followed an
outward oriented strategy. Especially the countries, which have a
huge internal market, had advantage of the IS strategy during 1960s.
In practice the countries that apply IS strategy had to shift their
strategies to EP strategy due to heft economic crisis. After these
shifts these countries had developed faster than the others. However,
the process of this shifting is not simple (Srinivasan 1999).




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                    Export Promotıon vs. Import Substıtutıon




Countries, which apply traditional IS strategies, make appropriate
structural changes in order to trade. Some of these structural
changes had to be about the exchange rate. The most important
necessity for openness in trade is to have a flexible exchange regime.
By this way the appreciation of the local currency, which worsens the
trade balance, is prevented (Bruton 1998).


Nevertheless, some problems appear during shifting to an EP
strategy. In order to have trade openness these problems must be
solved. Some of these problems are introduced below.


Structural changes in exchange rate regime in not enough to promote
exports. Some structural changes in the real sector, such as
improving productivity, are also needed. Some other structural
changes may be about the choice of appropriate technology, the
human    capital,   the    appropriate     allocation     of   resources   and
institutional rearrangements (Srinivasan 1999).


Some other policies are used in order to terminate the discrepancy
between the IS and EP strategies. These include protecting the
exporters as much as the firms that produce substitutes for imports,
because exporters do not have enough power in the foreign
competition area especially at the beginning (Bruton 1998).


According to the IS strategy internal industries must be protected via
some subsidies. By the same analogy exporters must be promoted
too. However, this kind of a subsidy may cause some further budget
deficit, by the side of government.




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                    Export Promotıon vs. Import Substıtutıon




Tariffs, as a medium of protection, is always less harmful than
quotas. So the countries start trade openness by getting rid of
quotas. Beside this, the level of tariffs must also be decreased in
order to have an appropriate environment for trade (Bruton 1998).


Getting rid of (or a fall in) tariffs does not necessarily lead to
unprotected local producers. With a flexible (and probably high levels
of) exchange rate is the new way of protection for the local
producers.


Outward oriented strategies necessitate the absence of government
intervention to the price level, factors of production and exchange
rates. But an EP strategy can be successful only via government
support.


This government support may be the training of the exporters, the
promotion of the export goods in foreign countries or a direct
subsidy.   Moreover,    exporters     must     be   enlightened   about   the
qualities, norms and standards of the international goods. And getting
rid of bureaucracy may be the pushing force of the exports (Adelman
and Yeldan 2000).


Outward orientation is not only increasing the exports but also
opening all the goods and services to trade. Furthermore, structural
changes in capital movements must also be made. This is the only
way of globalization.




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                   Export Promotıon vs. Import Substıtutıon




There is still a debate that the EP strategy is the best one. Most of the
economists of the current time agree that IS is not an alternative for
EP strategy, but what is the alternative for EP? There is still a
discussion on this subject.


Consequently, as it was stated at the beginning of this section,
countries that have shifted their strategies from IS to EP have
developed faster than others. Multi-country studies and cross-country
regression analysis support this idea.




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                  Export Promotıon vs. Import Substıtutıon




References:


•   Adelman Irma and Erinc Yeldan 2000. Is this the end of economic
    development? Structural Change and Economic Dynamics 11: 95-
    109


•   Balassa B. 1989. Outward Orientations. Handbook of Development
    Economics II: 1645-1689


•   Bruton H. 1989. Import Substitution. Handbook of Development
    Economics II: 1601-1644


•   Bruton Henry J. 1998. A Reconsideration of Import Substitution.
    Journal of Economic Literature XXXVI: 903-936


•   Edwards S. 1993. Openness, Trade Liberalization, and Growth in
    Developing Countries. Journal of Economic Literature XXXI: 1358-
    1393


•   Srinivasan T.N. and Bhagwati J. 1999. Outward-Orientation and
    Development: Are Revisionist Right? Yale University, Center
    Discussion Paper 806




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