Import Substitution Industrialization

Wouldn't it be fantastic if your country could manufacture almost everything in the world without the need to import it from other countries? Well, that's usually not the case. After World War II, many countries were trying to do the same. Countries were trying to manufacture everything on their own by creating import-substituting industries without even considering their long-term impacts on the economy. To learn about import-substituting industrialization, its features, advantages, and disadvantages, let's jump straight into the article.

Import Substitution Definition

Before jumping directly into the definition of import substitution, let's learn about trade policies. The set of agreements and policies that are formulated by the government to make sustainable trade practices with foreign countries is known as a trade policy. The primary reason for the government to develop a trade policy is to strengthen their economy.

Depending on the type of country, trade policy differs. A developed country might have a different trade policy whereas a developing country might employ another policy.

The policy that countries adopt is dependent on changing views of economic development. After World War II, there was a strong belief that the key to economic development is having a strong manufacturing industry. To create a strong manufacturing industry, the country tries to protect its domestic industries from international competition by undertaking numerous policies to reduce imports. Hence, imported goods are substituted by domestically produced goods and services.

Features of Import Substitution

Let us have a look at some of the features of import substitution. We know that import substitution is the strategy adopted by developing countries to improve their economic situation by promoting their domestic industries. Hence, the main feature of import substitution is to manufacture the goods domestically rather than import them.

One of the important features of import substitution is that the government tries to protect industries by imposing higher tariffs on imports. Likewise, the government might also put in import quotas to restrict the number of imports. Further, subsidized loans are also provided to local manufacturers to optimize their production capacity.

Methods of Import Substitution

The most important methods of import substitution used by the government are:

Infant Industry Argument

One of the most important arguments for import substitution is the infant industry argument. In this case, the infant industry refers to the new industries. According to the argument, the infant industry in developing countries cannot initially compete with the established industries of developed countries. In this case, the government must formulate policies that support the new industries until they are strong enough to compete at the international level.

To support those industries, the government can impose a high tariff on imported goods. This will result in expensive imports which can help consumer switch to domestically produced inexpensive goods. Likewise, the government can also impose import quotas that restrict the number of international products that can be imported into the country. This will in turn help domestic industries to capture a greater share of the market.

Fig. 1 - Methods of import substitution

Figure 1 illustrates the effect of import quotas on the economy. When there is no import quota, the quantity of imports ranges from Q₁ to Q₄ at the price level P. When the quota is imposed, the import range is restricted to the range of Q₂ to Q₃. This increases the price to P₁ and decreases the import, which helps the domestic manufacturers to gain more share of the market and earn higher profits.

• The government can support infant industries by using the following measures:- Imposing a high tariff on imported goods;- Limiting import by applying import quota.

Protection of Manufacturing Industries

Another important method of import substitution is the protection of manufacturing industries. The government tries to protect its existing manufacturing industries by providing them with subsidies. A subsidy is usually provided by the government in the form of cash or cash equivalents and some cases, they also provide tax breaks. This supports the existing infant industries and also encourages the new industries that can help in import substitution to enter the market.

Import Substitution Example

Now, let us have a look at the example of import substitution.

Advantages and Disadvantages of Import Substitution Industrialization

Table 1 - Advantages and disadvantages of import substitution industrialization

Let's have a look at the advantages and disadvantages of import substitution industrialization in more detail.

Import substituting industrialization is mostly used by developing countries to minimize their reliance on developed nations. One of the advantages of import-substituting industrialization is there will be the creation of new jobs. To substitute the imported products, the country must increase the number of industries. The increase in the industry in turn demands more labor force, creating new job opportunities. Further, this type of industrialization can make an economy independent and protect it from the influence of international industries.

Along with the advantages, there are some disadvantages of import-substituting industrialization. One of the disadvantages is that domestically manufactured products can have various costs and thus be more expensive while at the same time they could have been imported at a cheap rate from other countries. Further, it might also lead to inefficiency in the domestic industries due to the lack of competition.