Export Promotion Strategy Vs. Import Substitution Strategy

1. Introduction

It was the export promotion (EP) strategy that accounted for East Asian's states' success of economic development. Meanwhile, many other developing countries such as Latin America countries had committed to an alternative strategy, import substitution (IS). The IS strategy yielded disappointing results: most of these countries did not succeed in either industrialization or economic growth while export-oriented industrializations (EOIs) sustained fast economic development. Data from the World Bank (1993) showed that the real GDP of EOIs (7.6%) grew faster than IS countries (3%) during 1965-1990. There is no doubt that EOIs outperformed countries that adopted IS strategy in terms of economic development. However, are there any other aspects that EP is better than IS?

In this essay, the detailed comparisons between these two strategies will be discussed in three main parts: (1) industrial sector; (2) agriculture and service sector; and (3) international trade policy. Also, the merits of IS and the limits of EP will be mentioned.

2. Comparisons between EP and IS

2.1 Definition of IS and EP:

The IS strategy prescribed by structuralists such as Presbish (1950) and Myral (1957) favored expansion of the industrial sector in the domestic market to substitute for imports. The key idea is to protect "infant industries", especially heavy industries, by substituting the imported goods with the locally produced goods via government intervention to the whole economy. The structuralists believe protection is necessary for most developing countries to establish a strong base for domestic industry while it develops into a mature local industry. The government can make this protection not only via tariffs, quotas but also via exchange rates, prices of the factors of production and interest rate.

Opposite to the IS strategy, EP is a trade and economic policy aiming to speed-up the industrialization process of a country through exporting goods for which the nation has a comparative advantage. Export-led growth implies opening domestic markets to foreign competition in exchange for market access in other countries. Reduced tariff barriers, floating exchange rate (devaluation of national currency is often employed to facilitate exports), government support for exporting sectors and attracting FDI are all examples of policies adopted to promote EOI, and ultimately economic development.

2.2 Industrial Sector

In most IS countries, industrialization, particularly the industrialization of heavy industries such as steel, heavy machinery and automotive, was among the top priorities of the state plan. Various protection measures and incentives were provided to domestic industries. Typical practice included direct subsidies to tax exemptions, direct government investment in establishing new industries, preferential treatment in bank credits, as well as preferential treatment in imports. For example, in Turkey, the State Economic Enterprises (SEE), which was established for the purpose of industrialization, accounted for about half of the total value of industrial production. In Brazil, favored industries had access to long-term, low-real-interest rate (or even negative real rate) loans from BNDE (National Bank for Economic Development) and the Bank of Brazil. This type of subsidy represented 5% of total investment in the industrial sector during the 1952-1964 period. Furthermore, the losses of state enterprises were generally financed by Central Bank credits. Private industrial firms that were at the verge of bankruptcy were often consolidated to form a state firm.

At the beginning, they worked well to help the infant industries grow. The state acted as engine of development for the economy. It tried to set up the required infrastructure (roads, dams, electrification, communication system, energy etc.) to maintain the industry. Real GDP grew and unemployment decreased. However, 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 be able to compete with the foreign industries. But in practice the results are opposite to this view. Studies show that many industries could not reach maturity even after 20 years of protection. Moreover, according to Bell et al., even if some industries reached maturity in their technology, it seems that they soon lost it again.

This phenomenon indicates the failure in the application of infant industry theory and thus the failure of IS strategy. Under the IS strategy, the degree of government intervention was unprecedently high, rivaling that of the central planning economies. It would not be a surprise that an often-cited criticism of IS is misallocation (or distortion). The empirical evidences showed that in the long run IS strategy led to over-intrusive, bloated and inefficient state-owned enterprises (SOEs). Large SOEs and private sector companies operated as monopolies/oligopolies within a protected market. Also, the inefficiency and corruptness of the government bureaucracy limited the scope of action and reforms.

IS was aimed at replacing imports from abroad, but nevertheless in most Latin American countries the import of manufactured goods in fact increased. The terms of trade got worse, caused by low prices for exported raw materials and expensive imports. The industrialisation could not keep up with the technical and innovative development of the free world markets. As a result, new technologies and machinery had to be bought from transnational companies. Therefore, it can be concluded that while these IS policies have their merits in the short term, they cause great problems to the IS economies in the long run.

Under EP strategy, the goal is to trade abroad. There becomes competition, which in turn remedies the returns to scale. Exporters, facing the increasing competition, have to improve their technologies and their quality continuously in order to compete with their rivals. They have to make research and development studies. 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 the optimum. Finally, the increased efficiency, production capability and upgraded technology led to the success of EP strategy. At the time of the East Asian EOIs' economic take-off, they had an abundance of low-wage labour. Their industrial policy was to manufacture labour-intensive goods for exports. It is developed as a 'footloose' activity, with