It was the export promotion (EP) strategy that accounted for East Asianâ€™s statesâ€™ 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 â€œinfant industriesâ€, 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 EOIsâ€™ 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 â€˜footlooseâ€™ activity, with very few linkages to pre-existing industrial bases. Hence, the EOIs did not need to invest heavily.
Despite these great advantages of EP over IS, there are also some limits to EP. Since the EOIs are specialized in manufacturing labour-intensive goods, EP is often criticized for its lack of product diversity, which makes the economies potentially unstable. Moreover, the export-partner concentration makes EOIs very dependent on U.S. and Japan economy which is mostly criticized by the structuralists.
2.3 Agricultural and Service Sector
As the industrial sector was heavily subsidized and protected, the agriculture and service sector were neglected and heavily taxed. The idea of promoting industrialization at the cost of agriculture was widely accepted in almost all developing countries, not only in IS countries. However, the taxation and actual detrimental effect on agriculture was greater in IS countries. A study by Schiff and Valdes shows that the average tax on the agriculture sector (direct or indirect) is around 35% in 16 sample IS countries. Two major policies that harmed agriculture were the over-inflated exchange rate and the tax on some major agricultural exports. According to Balassa, the polices of IS economies discouraged their primary export, resulting in losses of market share in agricultural products and finally causing harm to the economy. For example, Argentinaâ€™s world market share of beef and wheat dropped by half form the mid-1930s to the early 1960s.
However, the experience of the worldâ€™s fastest growing economies last century, Japan and the four Asian Tigers gives rise to the question of whether a comparative disadvantage in agriculture was a factor in their growth. These economies are all poorly endowed with natural resources and, in particular, have very little arable land per capita. By contrast, among the slowest growing of the more industrialized economies have been land-abundant Argentina and other agrarian economies of Latin America and Sub-Saharan Africa.
It suggests that EP strategy is more suitable to countries that are lack of natural resources or perhaps the only choice for them.
2.4 International trade policy
International trade policy was also geared toward protection of domestic industries. The degree of protection is had to measure due to numerous non-tariff restrictions on trade. For example, one of the most restrictive trade barrier is â€œpositive import listâ€, which is a list of products that are allowed to be imported. In many countries, certain laws were established to protect domestic industry from foreign competition. For example, the Law of Similar requires that once a domestic firm is able to produce a product that was formally imported, this product would be no longer imported. While tariff allow some competition from foreign firms, the practice of prohibition of imports simply removes all threats from the outside word increasing the likelihood of inefficient production.
Again, it is the lack of competition that leads to the failure of IS strategy and it is competition that results in the success of EP strategy.
This brief comparison between IS and EP suggests that IS may promote short-term growth but with very large long-term costs. Evidence also suggests that IS countries tended to have low growth of total factor productivities, low level of technology and low efficiency of the SOEs. This also suggests that the inconsistency between infant industry theory, which predicts that protection would promote technology progress, and the implementation of IS.
In contrast, EP strategies smartly used the countriesâ€™ comparative advantages to promote economic growth. The efficiency and productivity are high in the context of international competition. However, there are also some limits to EP strategy such as lack of productivity and dependence.
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