Import Substitution Industrialization - Theoretical Basis

Theoretical Basis

As a set of development policies, ISI policies are theoretically grounded on the Singer-Prebisch thesis, on the infant industry argument, and on Keynesian economics. From these postulates, it derives a body of practices, which are commonly: an active industrial policy to subsidize and orchestrate production of strategic substitutes, protective barriers to trade (such as tariffs), an overvalued currency to help manufacturers import capital goods (heavy machinery), and discouragement of foreign direct investment.

Due to the exploitation the laissez-faire market indirectly performs third world countries began to self-rely on themselves. To fight mass poverty of the respected country, ISI was an implement for the infant-industry argument. To compete in the world market with first world countries, third world and/or developing countries would protect their "infant" new industries until a sufficient amount of knowledge, capital and comparative advantage is accumulated. Henry J. Burton in his paper ‘A Reconsideration of Import Substitution’ states: "The very idea of import substitution implied this: keep out that which is now imported from the North and produce it at home," (Bruton 910). That is the North developed and industrialized markets will not be a factor or a source for resources for the undeveloped and developing south.

By placing high tariffs on imports and other protectionist, inward-looking trade policies the citizens of the respected country by simple supply and demand rationale will substitute the lesser expensive good for the more expensive. The primary industry of importance would gather its resources such as labour from other industries in this situation; the industrial industry would use resources, capital and labour from the agricultural. In time a third world country would look and behave similar to a first world and with the new accumulation of capital and comparative advantage, and the increase of TFP (total factor productivity) the nation's industry will be capable to trade internationally and compete in the world market. Bishwanath Goldar in his paper ‘Import Substitution, Industrial Concentration and Productivity Growth in Indian Manufacturing’ writes: "Earlier studies on productivity for the industrial sector of developing countries have indicated that increases in total factor productivity, (TFP) are an important source of industrial growth," (Goldar 143). He continues that "a higher growth rate in output, other things remaining the same, would enable the industry to attain a higher rate of technological progress (since more investment would be made) and create a situation in which the constituent firms could take greater advantage of scale economies;" it is believed that ISI will allow this (Goldar 148).

In many cases, however, these postulates did not apply: on several occasions, the Brazilian ISI process, which occurred from 1930 until the end of the 1980s, involved currency devaluation as a means of boosting exports and discouraging imports (thus promoting the consumption of locally manufactured products), as well as the adoption of different exchange rates for importing capital goods and for importing consumer goods. Moreover, governmental policies toward investment were not always opposed to foreign capital: the Brazilian industrialization process was based on a tripod which involved governmental, private, and foreign capital, the first being directed to infrastructure and heavy industry, the second to manufacturing consumer goods, and the third, to the production of durable goods (such as automobiles). Volkswagen, Ford, GM and Mercedes all established in Brazil in the 1950s and 1960s.

The major and unifying postulate of ISI can thus be described as an attempt to reduce foreign dependency of a country's economy through local production of industrialized products, whether through national or foreign investment, for domestic or foreign consumption. It should be noted, as well, that import substitution does not mean import elimination: as a country industrializes, it begins to import other kinds of goods which become necessary for its industry, such as petroleum, chemicals, and the raw materials it may lack. The real objective of import substitution is therefore not to eliminate trade but to lift it to higher stage, that of exporting value-added products, not as susceptible to economic fluctuations as raw materials, according to the Singer-Prebisch thesis.