Developmental Challenges: Export vs Import-Substitution Industrialisation in Developing Countries

By Kalim Siddiqui

Does a developing economy get to choose between Export-led or Import-Substitution industrialisation or are there factors that make one more successful than the other? Can a nation switch between these two without any negative consequences? These and more are what this essay seeks to answer.

During the first half of the twentieth century, after the two world wars and the long Great Depression, the European powers were economically weakened and were unable to keep tight control over their colonies. There was also a rise of anti-colonial movements against European rule in the colonies. By the end of the war, European powers moved from being top creditors to heavily indebted countries, while the US emerged as the world’s largest economy. The US also came out in support of ending colonies so that US capital would have a greater opportunity to exploit markets and resources in the newly independent countries.

After independence in the 1950s and 1960s, most of the developing countries opted for the ‘‘Import-Substitution Industrialisation’’ (ISI) policy as they realised that during the colonial period, ‘‘free trade’’ ruined their economies. Therefore, to achieve economic prosperity and improve living conditions, active state intervention was considered very crucial, and the ‘‘market’’ and promoting ‘‘exports’’ alone cannot solve the problems of mass poverty and unemployment. Hence, it was thought that ‘‘domestic industrialisation’’ is the necessary condition to modernise their economies and remove backwardness (Siddiqui, 2021a; Amsden, 1989).

However, the Protection of ‘‘infant industries’’ is nothing new and historically, the US had followed high protective policies in the 19th and early 20th century against European producers. Even during the post-war period, the US-funded research in pharmaceuticals and bioengineering, computers, semiconductors, the internet, the GPS and touch screen, were first developed through “defence research” programmes and without these important technologies, there would have been neither Silicon Valley nor giant companies like Intel, IBM, or Apple (Siddiqui, 2021b).

The idea of ‘‘Export-Oriented Industriali-sation’’ (EOI) growth had become discredited by the inter-war crisis of capitalism before it made a reappearance through neo-liberalism; with world capitalism confronting the crisis since the 1980s. In fact, the wisdom of pursuing a strategy of export-led growth has been discussed among mainstream economists for at least half a century, ever since the so-called East Asian “miracle” started being contrasted with the comparatively sluggish growth experience of countries like India and Brazil that were pursuing an “inward-looking” development strategy (World Bank, 1993). The EOI hypothesis postulates that export expansion is one of the main determinants of growth. It holds that the overall growth of countries can be generated not only by increasing the amounts of labour and capital within the economy but also by expanding exports.

In Korea and Taiwan, since the mid-sixties, agriculture has been sacrificed in favour of industries and primarily focused on exports. Following such a policy not only deprived agriculture of investments but also of technology and people, who left in large numbers to work in the higher-productivity manufacturing sector. In both countries, grain prices were kept low and made agriculture the ‘‘sacrificial lamb’’ for the industry to extract surplus and facilitate the manufacturing sector. The lax environmental regulations along with low wages to reduce costs were seen as an incentive for foreign investors in Korea and Taiwan. The success of the industrialisation of these two economies is largely attributed to the rapid adoption of technologies, low direct taxation, investment in infrastructure and well-functioning markets (World Bank, 1993). It has been argued that without the direction and commitment provided by the state policies and planning conducive to industrialisation and economic development, industrialisation would not have taken place so smoothly.

India’s ISI policy experience was not very different from other Latin American countries. The adoption of an ISI policy dates to the early 1950s. In the period prior to independence in 1947, India’s economy was characterised as feudal and semi-industrialised, dominated by British-owned industries. There was persistent mass poverty and illiteracy, and exports consisted of primary commodities. During the post-colonial period, an industrialisation strategy was adopted to develop local capabilities in basic and heavy industries such as power generation, steel, and machinery. The scope of ISI policy covered almost all large and key industries and this was backed by high import tariffs and quantitative restrictions. There is clear evidence that the IS policy helped the country build heavy industries including steel, electrical, machinery, tools and manufacturing goods. But later, in the 1980s, this strategy experienced a crisis and the balance of payment (BoP) crisis deepened. India had to approach the IMF in 1991 for a bailout and in return India accepted dismantling ISI policy and adopting a neoliberal, i.e., pro-market, policy also known as the ‘‘Structural Adjustment Programme’’.

Export-led VS import-Substitution Industrialisation

The annual high growth rates of 7-10% during 1960-1990 in Korea, Singapore, Taiwan, and Hong Kong were seen to vindicate the mainstream prescription of export-led growth and close integration with the world economy (Balassa, 1988). While on the other hand, India, Brazil, and Mexico are seen as failures of ISI policies. Such arguments ignore the different political domestic appliances in the two different regions. I find that state autonomy played an important role in the transformation of the economy in East Asia. The pursuit of policies such as land reform, keeping wages low, raising interest rates, subsidies and protection to firms engaging in exports was key to achieving higher growth. The East Asian experience suggests that policy reform may demand autonomy from dominant as well as subordinate social groups (Jones and Sakong, 1980).

The Korean War (1950-53) resulted in the death of more than three million people and afterwards, the country was divided into two – North and South Korea. War is the reflection of politics. Here I will focus on the economic policy of South Korea and hereafter I will call the country Korea. After the war, in the mid-1950s, Korea’s developmental strategy began through land reforms and land distribution. As a result, big landowners were eliminated. The Confucian philosophy produced a society where the state commanded the moral high ground and drew on the best talents. The Confucian belief that the state is a legitimate social institution seems to be an important factor in making state intervention a positive role in the country (Amsden, 1989).

Rapid socio-economic transformation took place under President Park Chung Hee who ruled Korea from 1961 to 1979, leading the country through a period of rapid economic development. His government introduced a series of economic reforms that eventually led to the swift expansion of manufacturing, now known as the East Asian miracle, giving the country one of the fastest-growing national economies during 1960-1980. Moreover, the Park regime’s nationalisation of all the banks in the country the harsh punishment against corruption, and the imprisonment of many prominent businessmen on the charge of accumulating illicit money from undeclared sources, helped in effecting this. Jones and Sakong (1980: 296) note that military coup in Korea rationalised economic policy independent of political elites: “Under Rhee [in the 1950s] Korea was the familiar “soft” LDC in which economic regulations were seldom enforced. Under Park, it became the prototype of the “hard” development model with the ability to impose obligations via compulsion and the ability to direct administrative discretion towards economically durable ends.”

Korea heavily relied on indirect taxes to discourage consumption and the government heavily controlled consumer prices. Strict control was placed on foreign exchange, and imports of ‘‘luxury goods’’ and imported cars and foreign holidays were banned until 1989. Korea’s Hyundai Motor Company is a major part of the country’s conglomerate ‘‘Chaebols’’ (industrial groups). The company’s growth is an interesting story. Hyundai’s main business was originally construction and began to move into the auto sector in the late 1960s. It started its first automobile with joint ventures with UK’s Ford to assemble the Cortina car, using mostly imported parts, in 1966. But by 1972 the company developed a conflict with Ford over its joint venture plans and the production of vehicles in Korea. The joint venture talks failed, and then it decided to develop its model, which was known as Pony. The government then fully supported Hyundai against Ford and extended financial and technical support to the company to become a major car manufacturer (Chang, 1983).

However, given the small size of domestic markets, it was difficult for Hyundai to increase car production and achieve economies of scale, and hence exports became its major long-term objective to become a successful vehicle producer. In 1973, Hyundai severed relations with Ford and started to produce local cars— the Pony. In 1976, Hyundai produced 10,000 cars, which was 0.5% of what Ford produced that year. Then Korea was known to produce wigs, garments, and toys, low-value manufactured goods that require little capital and cheap labour. However, in 2010, Hyundai produced more cars than Ford did. There were several reasons behind this success including visionary entrepreneurs like Chung Ju-Yung, the founder of this business, and workers who worked for long hours. Most importantly, the government banned imports of all automobiles until 1998 to create space for Hyundai and other car producers to establish, and subsidised and prioritised credits to auto-producers.

The phenomenal growth of the Korean economy began with the transition from an ISI to an EOI or export-led growth policy in the late 1980s. However, in 1965, the government adopted crucial economic policy changes including cuts in tariffs, substantial increases in real interest rates and the introduction of realistic exchange rates by making exports more profitable. The government emphasised using cheap labour by following comparative advantage in labour-intensive industries and reaping the benefits from trade. The increased interest rates helped to mobilise domestic savings then. As Chang (1993: 137) notes: “The Korean state prescription for private firms to invest in heavy and chemical industries in the 1970s was a proscription against investing in less risky and often more profitable consumer goods industries. The best example in this regard is the shipbuilding industry, which has grown literally from scratch to the world’s second biggest in less than a decade. The Korean shipbuilding industry was set up in direct response to a personal ‘‘command’’ from then-President Park Chung Hee, against the will of the Hyundai group, the boldest of the Korean business groups, … In a country like Korea where private firms depend heavily on the state-run banking sector for their investment funds, the states’ channelling of money into public enterprises can have a very visible impact on private initiative.”

In Korea, chaebol is a family-controlled handful of conglomerates that dominate the country’s economy. Among the largest chaebols are Samsung, LG, Hyundai, and SK Group. In 2020 the chaebols produced about two-thirds of Korea’s exports and attracted the greater part of the country’s foreign capital inflows. The relationship between the government and the chaebols is close cooperation. It helped the country achieve high growth and economic transformation from a primarily agrarian economy to industrial development within twenty-five years. However, this policy led to the development of monopolies and the concentration of capital in a few businesses (Amsden, 1989).

Taiwan was another successful example of economic transformation in the second half of the twentieth century. In the country, rapid growth was accompanied by the expansion of manufacturing in the late-1950s. Taiwan became known for its cheap manufactured exports produced by small enterprises bound together by flexible sub-contracting networks. The US was very keen to see the successful rapid economic growth in Taiwan due to the tension with China and its policy of containing communism. Taiwan has become an important US partner in trade and investment, education, health, semiconductor and other critical supply chains, investment screening, science and technology, education, and advancing democratic values (Siddiqui, 2016).

And in the 1980s Taiwan moved to capital-intensive and knowledge-based industries. A high rate of savings, rising labour productivity, privatisation, astute government planning, considerable foreign investment, and trade all propelled Taiwan’s rapid economic expansion. At present, Taiwan has a dynamic and export-oriented economy that ranks among the largest in Asia. Taiwan is also known for its high-tech industry, particularly in the fields of semiconductors, electronics, and information technology. Taiwan’s main exports consist of electronics, basic metals and metal products, machinery, chemicals, plastics, and rubber.

In Latin America, Brazil’s industrialisation followed the ISI strategy from 1940-1980. This process led to the establishment of many industries such as steel, automobile, and transportation. The first Vargas government (1930–1945) was significant for Brazilian industrialisation. It obtained technology from the US for the construction of the steel Industry. The ISI strategy was an attempt by less-developed countries to break out of the ‘‘international division of labour’’. It consists of establishing domestic production facilities to manufacture goods that were formerly imported. The Great Depression and World War II forced Brazil to work towards the expansion of domestic industries due to deteriorating terms of trade and declining exports, the country decided to adopt ISI policies. However, in the 1980s, the debt crisis and subsequent IMF ‘‘structural adjustment programs’’ ended the ISI policy (Siddiqui, 2022).

Brazil’s success is largely due to states’ active role in influencing and directing industrial, financial, trade policies and state provisions of finance and infrastructure including investments in power generation, roads, health, and education, and law enforcement, along with tight labour control, keeping lower wages for higher profits. As Saad-Filho (2010: 8) notes: “Economic intervention was legitimised by a nationalist ideology, according to which the ‘‘nation as a whole’’ would progress only through industrialisation. In this developmental discourse, insufficient industrialisation was associated with backwardness and the political and economic power of the traditional landed elites, which should be overcome through state action that fosters economic progress. The relationship between nationalism, statism, and developmentalism tended to become especially pronounced when private capital lacked the capacity or interest to invest in strategic areas such as oil, steel, electricity generation, or transport links. In these cases, a provision often depended on extensive state intervention, either through nationalisation of the industry or through the provision of subsidies for private capital.”

Industries grew rapidly in the 1960s-1970s in Brazil but began to face a crisis by the early 1980s due to a rise in external debts and inflation. Its manufacturing is still not fully developed and is ‘‘immature’’ in Kaldorian terms i.e., where a large supply of labour remains in low-productive sectors. Countries can only attain the “maturity phase” when productivity levels become aligned between all sectors of the economy. Brazilian firms have not been able to compete in international markets. They have not yet completed the industrialisation process, in the meantime, they adopted neoliberal policy, which has exposed them to external competition without internal defence mechanisms by following the economic opening according to recommendations of the Washington Consensus and as a result, its economy is deprived of defence mechanisms (such as tariff barriers, subsidies for exporting manufactured goods, capital controls, among others) (Siddiqui, 2015).

Brazil is one of the most unequal societies in the world in terms of access to wealth, and income. The ISI policy reinforced these inequalities because, despite the rise of manufacturing, it failed to create enough jobs, and unemployment remained high which resulted in compressing wages low due to abundant labour supply and the absence of land reforms and land ceiling, rural inequality continued unabated. Brazil’s state and bureaucrats were unable to coordinate industrial policy, essential for the success of the ISI model. Despite the success in a few crucial industries such as auto, steel, aircraft, and defence, it was less successful in other key industries such as textiles, processed food, beverages and so on. Thus, despite the initial success of the ISI model in Brazil’s state intervention policy, the institution was not ready to meet the challenges. With the structural constraints and adverse external shocks in the late 1970s and early 1980s, Brazil witnessed increasing fiscal deficits, oil shocks, and an external debt crisis worsening the balance of payment situation. The government decided in 1989 to accept the IMF’s loan in return for neoliberal economic reforms. The neoliberal reforms strategy included trade, financial and capital account liberalisation (Siddiqui, 2012b), which was justified to achieve efficiency and bring down inflation. And the public industries were privatised, and companies were persuaded to form alliances with foreign companies. The long-term goals of self-sufficiency were shunted to short-term goals of quick returns and integration with the global economy.

The difference between East Asia and Brazil as far as export promotion is concerned, is that in Brazil exports were promoted after the development of local markets, while in Korea exports were promoted from the beginning. Korea launched its auto manufacturing in the early 1970s when the government closed various small-unit industries and encouraged only four firms to produce vehicles. Effective intervention needs a higher degree of autonomy of the state from the dominant class, which allows the state to focus on key objectives rather than serving and protecting the narrow interests of small groups or short-term interests. In 1973, the government announced its prioritisation of the Heavy and Chemical Industry and its long-term industrialisation included promoting the auto vehicle sector. The aim was to achieve about 90% local materials and contents for domestic car production and move towards a major exporter by 1982 (Siddiqui, 2012a; also, 2010).

The successful examples in East Asian countries show how governments established close cooperation with producers and with the economically vulnerable sections of rural society to manage crop distribution. The strategy proved to be feasible and ensured the transition from poor economies in the 1950s to middle-income status economies in the 1980s, for example, in Korea and Taiwan. In the East Asian economies, the government intervened because the Cold War created more favourable external linkages as they were seen to be more crucial allies. The Cold War offered these countries better access to Western markets and technologies than those available to any other developing country. Such experiences tell us that the right kind of government intervention could be crucial to foster industrialisation in developing countries (Siddiqui, 2021d; also, 2018a).

There were several benefits to adopting ISI as a developmental strategy for developing nations in their quest to industrialise. ISI policy aims to shield domestic industries from external competition to provide a nurturing environment for their growth and development. The primary objective of ISI, economic self-sufficiency, is of foremost importance in promoting economic stability and security. By reducing dependence on foreign goods, ISI policy reduces vulnerability to external economic shocks such as fluctuations in global prices and changes in trade restrictions. Additionally, other benefits included improving the balance of payments, enhancing economic resilience, and reducing the current account deficit. The resulting stability and security can stimulate investment, encourage economic growth, and benefit the wider society.

In India, the ISI strategy was launched soon after India gained independence. During the pre-independence, India relied on exporting primary commodities, and well-established industries such as textiles were dismantled and operated only to benefit British misrule. Through the ISI programme, the government aimed to industrialise and achieve self-sufficiency. To achieve self-sufficiency, the government invested heavily in infrastructure development such as power generation, irrigation, and industrial expansion while imposing high tariffs and quotas on foreign goods to encourage domestic production capacity. The adoption of modern technology and machinery through ISI facilitated an increase in productivity while enhancing Indian goods’ competitiveness (Siddiqui, 2018b).

The critiques argue that India’s industrialisation lacked emphasis on overseas markets which in turn meant that the goods produced would be uncompetitive in global markets. Consumers had to withstand rising prices, limited product variety, and substandard quality due to the emergence of virtual monopolies because of industrial licensing, high tariffs, and quantitative import restrictions. This was due to a lack of pressure on domestic producers to manufacture efficiently by the government and subsequent failure to increase competition within industries. This was evident in the automobile industry as there was a lack of innovation within the Indian auto industry with one or two producers monopolising the market (Siddiqui, 2019).

Moreover, by the mid-1980s, macroeconomic balances were threatened as public-sector deficits widened leading up to a balance-of-payments crisis in 1991 and foreign debt increased from US$ 20 billion in 1981 to US$ 82 billion in 1991 when the deficit reached 8.3 percent of GDP. Despite these challenges, the pro-business policies of the 1980s laid the groundwork for India’s economic growth. India fell to two drawbacks namely bureaucratic paralysis and capitalist rent-seeking. The Indian capitalist class did not support the idea of a ‘‘developmental state’’. Also, the capitalist class did not support disciplinary planning. The capitalist class reluctantly supported ISI as they had little capital to invest in various crucial areas. The Industrial Bill of 1949 allowed the state to regulate the flow of private investment in exchange for the protection of domestic industries and high returns. The Indian capitalist opposed the Bill, which was soon replaced by the industry’s self-regulation.

The mainstream economists criticised ISI for the following reasons: it prevents comparative advantage and specialisation, and this leads to rent-seeking and misallocation of resources, creates inefficient industries, and undermines economies of scale. Over-expansion of public sector employment raises fiscal deficits and public spending, increases dependency on government funds and support, and transfers resources from agriculture to the industrial sector. Other critiques came from dependency theorists, who criticised ISI that it increases rather than decreases the degree of economic dependence because of greater financial, technological and market reliance on foreign companies. And it creates new patterns of inequality by promoting further concentration of incomes into skilled workers and bureaucrats.

Moreover, with the collapse of the Soviet Union in 1990 and the rise of a unipolar world led by the US, most countries joined globalisation and adopted trade liberalisation as recommended by the US and international financial institutions. As a result, global trade and service increased sharply as indicated in Figure 1 and Figure 2. In 2021, the global trade value of goods exported throughout the world amounted to approximately 22.3 trillion US dollars at current prices. This figure stood at around 6.45 trillion US dollars in 2000. The rise in the value of goods exported around the world reflects developments in international trade, globalisation, and advances in technology.

Conclusion

We must distinguish between two cases among countries such as China, Korea and Taiwan pursuing an EOI strategy, where it has earned large current account surpluses and thereby built up their foreign exchange reserves. Others, like India, Brazil, and Mexico, had run current account deficits to address their balance of payments crisis through private financial inflows, and even when they built up foreign exchange reserves these were financed through borrowings, including from private financiers. In such cases if there was a widening of the current account deficit because of some exogenous reason, whether a pandemic-induced reduction in tourist earnings (as in the case of Sri Lanka), a Ukraine War-induced increase in import prices, or a world recession-induced fall in export earnings, its impact on the economy could expand because of the behaviour of private capital and banks. With the widening of the current account, the deficit needs more private financial inflow, but the widening could cause a huge financial outflow.

The ISI and EOI generate distinct capital accumulation strategies. Under the ISI model, the capitalists were under little competitive pressure to modernise and technologically upgrade their operations. While with the EOI policy, the firms must consistently adapt to vigorous competition. Korea made a successful transition from ISI to EOI because the unique international environment i.e., Cold War and global tension in the Korean peninsula favoured Korea and the country assumed the role of a front-line nation in the Cold War. Japanese firms also supported industries in Korea to access US markets. Japanese trading companies provided their marketing and sales contacts to promote Korean goods in the US markets (Siddiqui, 2009; Johnson, 1982). However, in return for US markets under US pressures Korean government allowed imports of agricultural commodities from the US as a condition for keeping US markets open for Korean manufactured goods.

The contrast between Korea’s success and India’s failure was striking. Both countries used the protection of domestic manufacturing, yet the orientation of India’s policies was inward-looking and anti-competitive, while that of Korea initially followed ISI policy, but local competition and government pressure to perform were much more visible, while in India, the government protected local car producer, Tata, but no pressure was put to them regarding their performance and innovation. Domestic market competition was encouraged in the Indian auto sector until 1991, therefore, rather than competition, monopoly emerged.

The study finds that successful industrialisation requires bureaucratic commitment and coordination, which involves building deep ties with the industrial sector. Mainstream economists and international financial institutions are mostly concerned with competition, efficiency, and free trade. However, they disregard other factors such as the international environment, institutions, history, culture, and the role of the state. The success in East Asian countries proves that these factors appear to have played a crucial role in the economic transition.

About the Author

Dr. Kalim Siddiqui is an economist specialising in International Political Economy, Development Economics, International Trade, and International Economics. His work, which combines elements of international political economy and development economics, economic policy, economic history and international trade, often challenges prevailing orthodoxy about which policies promote overall development in less-developed countries. Kalim teaches international economics at the Department of Accounting, Finance and Economics, University of Huddersfield, UK. He has taught economics since 1989 at various universities in Norway and the UK.

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