International Political Economy

What is Import Substitution Industrialization? What are its Problems?

Import Substitution Industrialization (ISI) refers to an economic concept, which recommends the replacement of foreign imports with domestic production. According to Cárdenas, Ocampo, and Thorp, the concept is grounded on the assumption that domestic production is healthy to an economy since it reduces overdependence on foreign goods.¹ While international trade is beneficial to an economy, trade imbalances may be harmful to a country. The concepts of import and export have gained root in the contemporary world where countries are seeking to spark economic growth. According to the lecture notes by Seay, in an international trade setting, countries usually export the goods that they produce in plenty and import the scarce ones. ²

However, a country must balance the imports and exports to realize positive economic growth. Under the ISI concept, the concerned country usually uses economic incentives and legislations to spark local industrialization. As Gereffi and Wyman reveal, a country may enact legislations that directly bar international trade to the extent that it becomes difficult to import particular products.³ On the other hand, the economic incentives include the subsidization of local production costs, tax exemptions, and the imposition of high exercise duties on imported goods. Such incentives facilitate the selling of local products at low prices to make them attractive to the customers. However, as the paper reveals, as much the concept may be beneficial to a country; it does have its problems, including violating the stipulation of the WTO.

Problems Associated with ISI

Hinders Free Trade

For any move to adopt the ISI to be regarded as lawful, it has to be in line with the legislations passed by the WTO to guide the way the concept should be carried out. However, despite the several benefits that come with ISI, including faster economic growth, industrialization, and the creation of employment to the locals, it is crucial to point out that the ISI goes against the provisions of the WTO and other similar trade agreements. As revealed in the lecture notes by Seay, the concept of ISI emphasizes capitalism where capital products are left in the hands of few private agents or companies, instead of being enjoyed by all people and businesses.⁴ Regional and bilateral trade agreements have greatly boosted international trade since they have led to business contracts that facilitate trade between countries. According to Matsushita, Schoenbaum, Mavroidis, and Hahn, the agreements mostly seek to eliminate barriers to international trades through the elimination of tariffs and other non-tariff barriers.⁵

The removal of such barriers contributes to the liberalization of trade, leading to specialization whereby the countries involved concentrate on the production of a certain line of products different from that produced by others. Consequently, the countries must trade to obtain whatever goods they do not produce. The evolution of international trade has led to the emergence of traders who specialize in the import and export of goods. By embracing the ISI concept, Jomo reveals that a country usually achieves industrialization by imposing export restrictions and subsidizing the locally produced goods at the expense of the imported ones.⁶ The free trade agreements require countries all over the world to refrain from imposing tariff and levy barriers to trade. Therefore, ISI is a major drawback towards achieving free trade in the backdrop of the rising need for countries to adopt it to achieve economic convergence.

It Leads to the Production of Inferior Goods

The other problem that is closely linked with ISI is the production of poor-quality goods in the end. The ISI concept usually discourages the import of goods into a country while protecting the local industries from international competition as a way of promoting industrialization, which goes against the Efficiency-Oriented Investment (EOI). The EOI theory states that companies tend to produce high-quality goods and services when competition is high. Given that the local businesses operate in an environment, which is free from competition whatsoever, it is apparent that the situation leads to the production of poor quality goods and services due to the unavailability of substitutes. Simachev, Kuzyk and Zudin argue that although competition may be harmful to the revenues of the concerned companies, it compels firms to embrace quality measures to achieve competitive advantage.⁷ In an environment without competition, businesses are motivated to produce more units of goods to make profits, irrespective of the quality of such products. Additionally, the local firms may be motivated to utilize the premium pricing strategy on their goods due to their monopolistic status. This move may reverse the benefits accruing from the adoption of the ISI economic policy.

Leads to Chronic Trade Imbalances and Inflation

There is strong evidence that ISI may lead to chronic trade imbalances and inflation for a country. The view is grounded on the fact that a country, which adopts the ISI concept may actually need to import more products to facilitate the local production. Theoretically, the ISI reduces the overall importation of goods into a country by promoting local industries. However, the restriction of imports may not stand in the end since a country will need to import raw materials from other countries around the globe for local production to be successful. As countries become industrialized, they are compelled to import goods from other nations. In the light of the highlighted view, a country with an operational ISI policy will need to import raw materials in addition to intangible assets.

In this context, intangible assets refer to the non-current material goods that a company must import to make production successful. Such goods include plant and machinery, production equipment, and other relevant items, which may be highly priced. Given that the ISI policy is highly against such importation, the acquired materials may be highly priced due to the heavy taxes imposed on imports. Additionally, a country might be compelled to outsource technical labor from the developed countries, which may be a costly endeavor. As revealed in the lecture notes by Seay, the issue of labor outsourcing is evidence by the Chinese movement to the US as early as during the 1820s.⁸ Many countries are known to have engaged the Chinese to undertake contractual works such as roads constructions and other structural works.

Conclusion

The concept of Import Substitution Industrialization has had its share of problems that many countries are battling with. The ISI policy advocates for Export Oriented Strategy (EOS), which denotes that a country must export more than it imports. In this case, governments must make substantial investments to subsidize the goods to make them affordable in the international market. The overall impact of the application of the ISI concept is that it leads to the devaluation of the currency and inflation, which may increase the prices of the exports further.

The Global Community’s Criticisms about the WTO’s Treatment of Developing Countries

Introduction

The World Trade Organization (WTO) is an agency, which brings together about 152 countries from different regions around the globe. The organization has its main offices in Switzerland. According to Narlikar, Daunton, and Stern, its chief goal is to promote free trade among the member nations.⁹ According to the lecture notes by Seay, the agency enhances the growth of small businesses.¹⁰ According to Hoekman, one of the requirements of the WTO is the elimination of discrimination based on tariffs.¹¹ The member countries are obliged to remove tariff and non-tariff barriers that may limit competitive business dealings. The organization requires that the levies charged by a country on imports be standardized so that each country is charged at the same rates. This section addresses the criticisms raised by the global communities concerning WTO’s treatment of developing countries. The paper will also comment on whether the criticisms are valid or not.

Criticisms

Developing countries have complained in a number of occasions that their interests have been sidelined and that they do not reap the benefits of the agreements. According to Eagleton-Pierce, the assertions led to the establishment of the Special and Differential Treatment provision that requires preferential treatment of developing countries.¹² However, according to Conconi and Perroni, as much as the rule exists, it is not clear concerning the extent to which such special treatment should apply.¹³ Consequently, world powers have abused the provision by causing it to work in the favor of developed countries. This situation has angered the global communities that claim that the treatment is against the wish of the non-industrialized nations. Developing countries have been compelled to withdraw about 90% of the tariffs to fit in the organization. The action is in the interest of the developed countries that have a wide variety of products to export to the developing ones.

Emerging economies have also complained that the WTO may cause food insecurity in the developing nations in the end. The key objective of the WTO is to promote free trade among all the member states in line with the lecture notes by Seay.¹⁴ To achieve the stated objective, WTO has established a set of rules that aim at mitigating conflicts arising in the course of conducting business internationally. One of the provisions of the WTO is that all member states should remove tariff and non-tariff barriers that hinder competition among companies in different countries. The removal of the tariffs extends to the agricultural sector where the developed and developing countries alike are required to remove all the hurdles. This provision has not been in the best interest of the developing countries since most of them are food insecure and hence the alarm from the global communities. According to Van Grasstek, subsidization of agricultural inputs for local farmers often leads to low production cost and poor product prices compared to the food items from developing countries.¹⁵ This issue has been criticized internally since it compromises the concept of free trade. This situation has often led to disputes since the developing countries often argue for preferential treatment from their developed counterparts.

The other controversy that has attracted criticism from the global community concerns WTO and other regional and bilateral agreements. Such treaties have led to the escalation of disputes among developing countries. Most bilateral agreements provide other special provisions regarding their engagement. In most cases, according to Elms and Low, the provisions contradict those of the WTO, thus causing disputes among the concerned states.¹⁶ As noted previously in this paper, the WTO has a special mechanism for solving disputes arising between member states. Such provisions cannot be applied to non-members to solve issues resulting from a secondary agreement.

The secondary agreement may also have a different dispute resolution mechanism dissimilar to that of the WTO. This disparity may present problems in solving the dispute. A case in point revolves around Canada and the US, which found themselves in the middle of a crisis, owing to contradictions of both agreements. The two countries are members of the WTO, but they also have a bilateral agreement, the NAFTLA. The US argued that under the NAFTLA, Canada did not have the right to protect its barley, egg, poultry, and dairy producers from the US exports through new or higher tariffs. However, the GATT protected the products, thus presenting controversies as to which agreement should prevail. Interestingly, the NAFTLA provides room for resolution of disputes involving member states without involving the WTO. The case illustrates the effect of the existence of other agreements in the WTO.

Another area in which WTO is said to discriminate against the developing countries is its provisions regarding agriculture. This discrimination has been a source of criticism from the global community. According to Matsushita, Schoenbaum, Mavroidis, and Hahn, the WTO Agreement on Agriculture (AoA) was implemented to liberalize the agricultural sector through the elimination of tariff and non-tariff barriers.¹⁷ The laws are effective in ensuring that exporters have minimal barriers to their business of exporting agricultural products, a move that enhances multilateral agreement on investment among the member countries. The laws allow any country to present its concerns about any barrier imposed, which is likely to affect its business in the concerned market. Therefore, it may be said that the laws act as a way of extirpating protectionism among the member nations.

Validity of the Complaints

Based on the arguments presented in this paper, it may be argued that the complaints from the global community are valid. To some extent, the WTO favors the developed countries at the expense of the developing nations. Firstly, developing countries are poor economically. As such, they need to be accorded special treatment concerning trade. This claim is in line with Seay’s notes on the need to allow small businesses to thrive in developing countries.¹⁸ The countries should be allowed to impose trade barriers in some sectors such as agriculture. The WTO’s regulations apply universally to all member nations, hence causing imbalance. However, although most WTO’s provisions tend to favor the developed countries, developing nations enjoy some degree of special treatment in the form of access to European markets, thus opening more market for their industrial goods. Additionally, developed countries usually give monetary and non-monetary benefits to their developing counterparts to boost their competitiveness in the international market without expecting such favors in return.

Conclusion

However, as much as the WTO’s rules have been effective in eliminating trade barriers, developing countries may not achieve full benefits from the arrangement because of the prevailing capitalism as presented in the lecture notes by Seay. It is important to note that most people in developing countries obtain food from agriculture. Therefore, the governments of such countries must subsidize the agricultural inputs to guarantee food security in their respective countries. Therefore, the abolition of subsidies is not in the best interest of the developing countries and hence the criticism from the global community.

Bibliography

Cárdenas, Enrique, Jose Ocampo, and Rosemary Thorp. An Economic History of Twentieth-Century Latin America: Volume 3: Industrialization and the State in Latin America: The Postwar Years. Berlin, Germany: Springer, 2016.

Conconi, Paola, and Carlo Perroni. “Special and Differential Treatment of Developing Countries in the WTO”. World Trade Review 14, no. 1 (2015): 67-86.

Eagleton-Pierce, Matthew. Symbolic Power in the World Trade Organization. Oxford, UK: Oxford University Press, 2013.

Elms, Deborah, and Patrick Low. Global Value Chains in a Changing World. Geneva, Switzerland: World Trade Organization, 2013.

Gereffi, Gary, and Donald Wyman. Manufacturing Miracles: Paths of Industrialization in Latin America and East Asia. Princeton, NJ: Princeton University Press, 2014.

Hoekman, Bernard, and Petros Mavroidis. World Trade Organization (WTO): Law, Economics, and Politics. London, England: Routledge, 2015.

Jomo, Kwame. Industrializing Malaysia: Policy, Performance, Prospects. London, England: Routledge, 2013.

Matsushita, Mitsuo, Thomas Schoenbaum, Petros Mavroidis, and Michael Hahn. The World Trade Organization: Law, Practice, and Policy. Oxford, UK: Oxford University Press, 2015.

Narlikar, Amrita, Martin Daunton, and Robert Stern. The Oxford Handbook on the World Trade Organization. Oxford, UK: Oxford University Press, 2012.

Seay, W. “The Origins of Political Economy.” Lecture, the University of Virginia, Charlottesville, VA, February 3, 2017.

Simachev, Yury, Mikhail Kuzyk, and Nikolay Zudin. “Import Dependence and Import Substitution in Russian Manufacturing: A Business Viewpoint.” Foresight-Russia 10, no. 4 (2016): 25-45.

Van Grasstek, Craig. The History and Future of the World Trade Organization. Geneva, Switzerland: World Trade Organization, 2013.

Footnotes

1. Enrique Cárdenas, Jose Ocampo and Rosemary Thorp, An Economic History of Twentieth-Century Latin America: Volume 3: Industrialization and the State in Latin America: The Postwar Years (Berlin, Germany: Springer, 2016), 32.
2. W. Seay, “The Origins of Political Economy” (lecture, the University of Virginia, Charlottesville, VA, 2017).
3. Gary Gereffi and Donald Wyman, Manufacturing Miracles: Paths of Industrialization in Latin America and East Asia (Princeton, NJ: Princeton University Press, 2014), 76.
4. Seay, The Origins of Political Economy.
5. Mitsuo Matsushita et al., The World Trade Organization: Law, Practice, and Policy (Oxford, UK: Oxford University Press, 2015), 56.
6. Kwame Jomo, Industrializing Malaysia: Policy, Performance, Prospects (London, England: Routledge, 2013), 11.
7. Yury Simachev, Mikhail Kuzyk and NikolayZudin, “Import Dependence and Import Substitution in Russian Manufacturing: A Business Viewpoint,” Foresight-Russia 10, no. 4 (2016): 26.
8. Seay, The Origins of Political Economy.
9. Amrita Narlikar, Martin Daunton and Robert Stern, The Oxford Handbook on the World Trade Organization (Oxford, UK: Oxford University Press, 2012), 12.
10. Seay, The Origins of Political Economy.
11. Bernard Hoekman and Petros Mavroidis, World Trade Organization (WTO): Law, Economics, and Politics (London, England: Routledge, 2015), 103.
12. Matthew Eagleton-Pierce, Symbolic Power in the World Trade Organization (Oxford, UK: Oxford University Press, 2013), 45.
13. Paola Conconi and Carlo Perroni, “Special and Differential Treatment of Developing Countries in the WTO,” World Trade Review 14, no. 1 (2015): 68.
14. Seay, The Origins of Political Economy.
15. Craig Van Grasstek, The History and Future of the World Trade Organization (Geneva, Switzerland: World Trade Organization, 2013), 21.
16. Deborah Elms and Patrick Low, Global Value Chains in a Changing World (Geneva, Switzerland: World Trade Organization, 2013), 56.
17. Matsushita et al., The World Trade Organization, 45.
18. Seay, The Origins of Political Economy.