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Import substitution industrialization (ISI) is a trade and economic policy that advocates replacing foreign imports with domestic production.[1] It is based on the premise that a country should attempt to reduce its foreign dependency through the local production of industrialized products. The term primarily refers to 20th-century development economics policies, but it has been advocated since the 18th century by economists such as Friedrich List[2] and Alexander Hamilton.[3]

ISI policies have been enacted by countries in the Global South with the intention of producing development and self-sufficiency by the creation of an internal market. The state leads economic development by nationalization, subsidization of vital industries (agriculture, power generation, etc.), increased taxation, and highly-protectionist trade policies.[4] ISI was gradually abandoned by most developing countries in the 1980s and after the fall of the Soviet Union because of its failure in providing development[5] and, thereafter, the insistence of the IMF and World Bank on their structural adjustment programs aimed at the Global South.[6][7]

In the Todaro & Smith fourfold category, Import Substitution is a "secondary inward" approach to development. Countries that suppress imports as a policy might have to keep exchange rates high and eventually to create an indirect tax on exports as well. It can lead to rent-seeking activities by local industries.[8] On the other hand, an outward-looking developmental policy encourages free trade and the flow of capital along with movement of workers, students, and enterprises. Some countries also take a selective approach by using ideas from both inward- and outward-looking approaches and target some sectors.[9]

In the context of Latin American development, the term "Latin American structuralism" refers to the era of import substitution industrialization in many Latin American countries from the 1950s to the 1980s.[10] The theories behind Latin American structuralism and ISI were organized in the works of Raúl Prebisch, Hans Singer, Celso Furtado, and other structural economic thinkers and gained prominence with the creation of the United Nations Economic Commission for Latin America and the Caribbean (UNECLAC or CEPAL). The theorists behind ISI or Latin American structuralism were not homogeneous and did not belong to one particular school of economic thought, but ISI and Latin American structuralism and the theorists who developed its economic framework shared a basic common belief in a state-directed centrally-planned form of economic development.[11] In promoting state-induced industrialization through governmental spending by the infant industry argument, ISI and Latin American structuralist approaches to development are largely influenced by a wide range of Keynesian, communitarian, and socialist economic thought.[12] ISI is often associated and linked with dependency theory, but the latter has traditionally adopted a much broader Marxist sociological framework in addressing what are perceived to be the origins of underdevelopment through the historical effects of colonialism, Eurocentrism, and neoliberalism.[13]

Trade policy, exports and growth in European countries

ISI is a development theory, but its political implementation and theoretical rationale are rooted in trade theory. It has been argued that all or virtually all nations that have industrialized have followed ISI. Import substitution was heavily practiced during the mid-20th century as a form of developmental theory that advocated increased productivity and economic gains within a country. It was an inward-looking economic theory practiced by developing nations after World War II. Many economists then considered the ISI approach as a remedy to mass poverty by bringing a developing country to a developed status through national industrialization. Mass poverty is defined as "the dominance of agricultural and mineral activities – in the low-income countries, and in their inability, because of their structure, to profit from international trade" (Bruton 905).

Mercantilist economic theory and practices of the 16th, 17th, and 18th centuries frequently advocated building up domestic manufacturing and import substitution. In the early United States, the Hamiltonian economic program, specifically the third report and the magnum opus of Alexander Hamilton, the Report on Manufactures, advocated for the U.S. to become self-sufficient in manufactured goods. That formed the basis of the American School in economics, which was an influential force in the country during its 19th-century industrialization.

Werner Baer contends that all countries that have industrialized after the United Kingdom have gone through a stage of ISI in which much investment in industry was directed to replace imports (Baer, pp. 95–96).[14] Going further, in his book Kicking Away the Ladder, the South Korean economist Ha-Joon Chang also argues based on economic history that all major developed countries, including the United Kingdom, used interventionist economic policies to promote industrialization and protected national companies until they had reached a level of development in which they were able to compete in the global market. Those countries adopted free market discourses directed at other countries to obtain two objectives: to open their markets to local products and to prevent them from adopting the same development strategies that had led to the industrialization of the developed countries.

Theoretical basis

As a set of development policies, ISI policies are theoretically grounded on the Prebisch–Singer thesis, on the infant industry argument, and on Keynesian economics. The associated practices are commonly:

By placing high tariffs on imports and other protectionist, inward-looking trade policies, the citizens of any given country by using a simple supply-and-demand rationale substitute the less expensive good for a more expensive one. The primary industry of importance would gather its resources, such as labor from other industries in this situation. The industrial sector would use resources, capital, and labor from the agricultural sector. In time, a developing country would look and behave similar to a developed country, and with a new accumulation of capital and an increase of total factor productivity, the nation's industry would in principle be capable of trading internationally and of competing in the world market. Bishwanath Goldar, in his paper Import Substitution, Industrial Concentration and Productivity Growth in Indian Manufacturing, wrote: "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 continued 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 i

ISI policies have been enacted by countries in the Global South with the intention of producing development and self-sufficiency by the creation of an internal market. The state leads economic development by nationalization, subsidization of vital industries (agriculture, power generation, etc.), increased taxation, and highly-protectionist trade policies.[4] ISI was gradually abandoned by most developing countries in the 1980s and after the fall of the Soviet Union because of its failure in providing development[5] and, thereafter, the insistence of the IMF and World Bank on their structural adjustment programs aimed at the Global South.[6][7]

In the Todaro & Smith fourfold category, Import Substitution is a "secondary inward" approach to development. Countries that suppress imports as a policy might have to keep exchange rates high and eventually to create an indirect tax on exports as well. It can lead to rent-seeking activities by local industries.[8] On the other hand, an outward-looking developmental policy encourages free trade and the flow of capital along with movement of workers, students, and enterprises. Some countries also take a selective approach by using ideas from both inward- and outward-looking approaches and target some sectors.[9]

In the context of Latin American development, the term "Latin American structuralism" refers to the era of import substitution industrialization in many Latin American countries from the 1950s to the 1980s.[10] The theories behind Latin American structuralism and ISI were organized in the works of Raúl Prebisch, Hans Singer, Celso Furtado, and other structural economic thinkers and gained prominence with the creation of the United Nations Economic Commission for Latin America and the Caribbean (UNECLAC or CEPAL). The theorists behind ISI or Latin American structuralism were not homogeneous and did not belong to one particular school of economic thought, but ISI and Latin American structuralism and the theorists who developed its economic framework shared a basic common belief in a state-directed centrally-planned form of economic development.[11] In promoting state-induced industrialization through governmental spending by the infant industry argument, ISI and Latin American structuralist approaches to development are largely influenced by a wide range of Keynesian, communitarian, and socialist economic thought.[12] ISI is often associated and linked with dependency theory, but the latter has traditionally adopted a much broader Marxist sociological framework in addressing what are perceived to be the origins of underdevelopment through the historical effects of colonialism, Eurocentrism, and neoliberalism.[13]

ISI is a development theory, but its political implementation and theoretical rationale are rooted in trade theory. It has been argued that all or virtually all nations that have industrialized have followed ISI. Import substitution was heavily practiced during the mid-20th century as a form of developmental theory that advocated increased productivity and economic gains within a country. It was an inward-looking economic theory practiced by developing nations after World War II. Many economists then considered the ISI approach as a remedy to mass poverty by bringing a developing country to a developed status through national industrialization. Mass poverty is defined as "the dominance of agricultural and mineral activities – in the low-income countries, and in their inability, because of their structure, to profit from international trade" (Bruton 905).

Mercantilist economic theory and practices of the 16th, 17th, and 18th centuries frequently advocated building up domestic manufacturing and import substitution. In the early United States, the Hamiltonian economic program, specifically the third report and the magnum opus of Alexander Hamilton, the Report on Manufactures, advocated for the U.S. to become self-sufficient in manufactured goods. That formed the basis of the American School in economics, which was an influential force in the country during its 19th-century industrialization.

Werner Baer contends that all countries that have industrialized after the United Kingdom have gone through a stage of ISI in which much investment in industry was directed to replace imports (Baer, pp. 95–96).[14] Going further, in his book Kicking Away the Ladder, the South Korean economist Ha-Joon Chang also argues based on economic history that all major developed countries, including the United Kingdom, used interventionist economic policies to promote industrialization and protected national companies until they had reached a level of development in which they were able to compete in the global market. Those countries adopted free market discourses directed at other countries to obtain two objectives: to open their markets to local products and to prevent them from adopting the same development strategies that had led to the industrialization of the developed countries.

Theoretical basis

As a set of development policies, ISI policies are theoretically grounded on the Prebisch–Singer thesis, on the infant industry argument, and on Keynesian economics. The associated practices are commonly:

By placing high tariffs on imports and other protectionist, inward-looking trade policies, the citizens of any given country by using a simple supply-and-demand rationale substitute the less expensive good for a more expensive one. The primary industry of importance would gather its resources, such as labor from other industries in this situation. The industrial sector would use resources, capital, and labor from the agricultural sector. In time, a developing country would look and behave similar to a developed country, and with a new accumulation of capital and an increase of total factor productivity, the nation's industry would in principle be capable of trading internationally and of competing in the world market. Bishwanath Goldar, in his paper Import Substitution, Industrial Concentration and Productivity Growth in Indian Manufacturing, wrote: "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 continued 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 that (Goldar 148).

In many cases, however, the assertions did not apply. On several occasions, the Brazilian ISI process, which occurred from 1930 to the late 1980s, involved currency devaluations to boost 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, government policies toward investment were not always opposed to foreign capital: the Brazilian industrialization process was based on a tripod that 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 production facilities in Brazil in the 1950s and the 1960s.

The principal concept underlying ISI can thus be described as an attempt to reduce foreign dependency of a country's economy by the local production of industrialized products by national or foreign investment for domestic or foreign consumption. Import substitution does not mean eliminating imports. Indeed, as a country industrializes, it naturally imports new materials that its industries need, often including petroleum, chemicals, and raw materials.

Local ownership import substituting

In 2006, Michael Shuman proposed local ownership import substituting (LOIS), as an alternative to neoliberalism. It rejects the ideology that there is no alternative.[15] Shuman claims that LOIS businesses are long-term wealth generators, are less likely to exit destructively, and have higher economic multipliers.[16]

Latin America

Import substitution policies were adopted by most nations in Latin America from the 1930s to the late 1980s. The initial date is largely attributed to the impact of the Great Depression of the 1930s, when Latin American countries, which exported primary products and imported almost all of the industrialized goods that they consumed, were prevented from importing because of a sharp decline in their foreign sales, which served as an incentive for the domestic production of the goods that they needed.

The first steps in import substitution were less theoretical and more pragmatic choices on how to face the limitations imposed by recession even though the governments in Argentina (Juan Domingo Perón) and Brazil (Getúlio Vargas) had the precedent of Fascist Italy (and, to some extent, the Soviet Union) as inspirations of state-induced industrialization. Positivist thinking, which sought a strong government to modernize society, played a major influence on Latin American military thinking in the 20th century. The officials, many of whom rose to power, like Perón and Vargas, considered industrialization (especially steel production) to be synonymous with "progress" and naturally placed as a priority.

ISI gained a theoretical foundation only in the 1950s, when the Argentine economist and UNECLAC leader Raúl Prebisch was a visible proponent of the idea, as well as the Brazilian economist Celso Furtado.

Prebisch had experience running his country's central bank and started to question the model of export-led growth.[17] Prebisch came to the conclusion that the participants in the free-trade regime had unequal power and that the central economies (particularly, Britain and the United States) that manufactured industrial goods could control the price of their exports.[17] The unequal powers were taking the wealth from developing countries, leaving them with no way to prosper.[18] He believed that developing countries needed to create local vertical linkages and that they could not succeed except by creating industries that used the primary products already being produced domestically. Tariffs were designed to allow domestic infant industries to prosper. In doing so, Prebisch predicted many benefits: dependence on imports would lower, and the country would not be forced to sell agricultural goods for low prices to pay for industrial goods the income rate would go up, and the country itself would have a strong growth.[18]

ISI was most successful in countries with large populations and income levels, which allowed for the consumption of locally-produced products. Latin American countries such as Argentina, Brazil, and Mexico (and to a lesser extent Chile, Uruguay and Venezuela) had the most success with ISI.[19]

While the investment to produce cheap consumer products may be profitable in small markets, the same cannot be said for capital-in

Mercantilist economic theory and practices of the 16th, 17th, and 18th centuries frequently advocated building up domestic manufacturing and import substitution. In the early United States, the Hamiltonian economic program, specifically the third report and the magnum opus of Alexander Hamilton, the Report on Manufactures, advocated for the U.S. to become self-sufficient in manufactured goods. That formed the basis of the American School in economics, which was an influential force in the country during its 19th-century industrialization.

Werner Baer contends that all countries that have industrialized after the United Kingdom have gone through a stage of ISI in which much investment in industry was directed to replace imports (Baer, pp. 95–96).[14] Going further, in his book Kicking Away the Ladder, the South Korean economist Ha-Joon Chang also argues based on economic history that all major developed countries, including the United Kingdom, used interventionist economic policies to promote industrialization and protected national companies until they had reached a level of development in which they were able to compete in the global market. Those countries adopted free market discourses directed at other countries to obtain two objectives: to open their markets to local products and to prevent them from adopting the same development strategies that had led to the industrialization of the developed countries.

As a set of development policies, ISI policies are theoretically grounded on the Prebisch–Singer thesis, on the infant industry argument, and on Keynesian economics. The associated practices are commonly: