How Does Import Substitution Policy Affect GDP Growth - Research Paper Example

How does Import Substitution policy affect GDP growth? Introduction Most of the nations of the world are engaged in international trade in order to gain a competitive advantage over the other nations. A country may export the goods which it can produce with an advantage as compared with the other nations. On the other hand the country would import the goods which it would find cheaper to buy from the other nations than to produce using the resources of the country itself. However too much of import would result in the flow of the local currency from the home country which would have an adverse effect on the currency value of the nation. Thus free trade may not be the policy the government of a particular nation would encourage. Various types of protectionism policies are imposed on the exporters and importers to discourage the amount of trade with the imposition of trade barriers like tariffs and quotas. The country on the other hand has to promote the policy of import substitution so that the industries located in the home country are encouraged to produce more of the products in the domestic markets so that the demand of the buyers for the foreign products get reduced. Theoretical Background Since the government has a dominant influence in the implementation of the trade policies as well as in the international relations, the ISI concept can be attributed as an economic as well as a political theory. In common parlance the theory of import substitution can be attributed as the theory of development economics and had been reflected in the writing of the Keynesian economists. In the free market in the international scenario most of the economies that have a dominant position in international trade would take advantage of their position and would tend to dominate the developing nations (Corden 42-59). This in turn forced the under-developed nations to become self sufficient and to set up their own industries to stop this level of exploitation. The infant industry argument was based on the Prebisch- Singer hypothesis, which states that the terms of trade between the primary goods and the industrial goods would worsen with the passage of time (North 359-368). Thus with the process of development being on the move the developing countries would import less compared to what they would export. This happens mainly because of the fact that the demand for the manufacturing goods would increase more compared to the primary goods as the GDP or the per capita income of the economy increases. This was an observation which was particularly noticed by the economists with the use of the time series data of various countries (Grossman 1261-1283). From this theory it follows that the developing countries would take the path of an import substitution policy in order to encourage the development of the country and to add to the Gross Domestic Product. With import substitution in a country, the products that would otherwise be imported from the foreign countries at a premium price would now be produced it in their domestic markets (Edwards 1358-1393). Thus the aggregate demand in the country would increase as a result of this increase in production. The increase in output would add to the GDP of the nation. Empirical implications of each theory The GDP as well as the export and import data prove that the theories put forward by various economists on the import substitution strategies are true for most of the developing countries. The qualitative as well as the quantitative analysis of the following sections prove that the theories are true and most of the economies are engaged in such activities. Qualitative Analysis The developing countries have been considered in the following section especially the Latin American countries like Brazil and Argentina. The policy of import substitution was mostly successful in these countries. This was in the post Great Depression phase when the countries like Brazil and Argentina used to import most of the industrial products and export the primary products (Bruton 903-936). The Latin American countries like Argentina Mexico and Brazil adopted this policy more vigorously and the other countries like Chile and Uruguay followed on with the popularity of the theory posited by the economist from Argentina, Raul Prebisch. It was also found that the government of these countries underwent changes in the structures which made the counties adopt this protectionist policy. The short run creation of jobs and the dominance of the domestic producers over the foreign producers have supported the fact that the ISI policy contributed to the rise in the GDP of these countries. Quantitative Analysis First of all in case of Argentina it is seen that the terms of trade have fluctuated over the periods that have been considered. The deterioration of the terms of trade is the reasons for adversity in the trade balances in the economy. The reason behind it is the technological progress in the manufacturing sector and the effect of the technological innovation affects the developed countries more compared to the developing countries. Source: Trading Economics 1, 2013 Since Argentina is a developing nation with the growth of the import substitution in the country and the growth in the domestic industries the country has started exporting more and more to the foreign countries. As a result of this the export of the nation has steadily increased and has taken a big leap during the years 1997-98. Source: Trading Economics 2, 2013 In case of imports during the phase of 1997-98, there is a decline in the imports which shows that the Source: Trading Economics 3, 2013 Similarly, the terms of trade of Brazil have fluctuated over the period under consideration. The deterioration would have the same implication as that in Argentina. The fluctuations that the country went through would lead to an adverse condition on the BOP of Brazil. Source: Trading Economics 4, 2013 During this phase the GDP of Brazil has shown a steady rise which indicates that the country had been moving in the path of development. Thus the decline in the imports and the increase in the exports have resulted in the rise in the GDP of the economy. Source: Trading Economics 5, 2013 Source: Trading Economics 6, 2013 From the quantitative analysis provided above it is clear that the countries which have adopted import substitution policies have experienced greater increase in the GDP as the growth of the domestic industries have added to the aggregate output and the employment generation in the economy. Figure 1: Growth of the employment in agriculture in 1870-1913 Source: Irwin 36 From the figure it becomes clear that the countries which reported a rapid growth in the phase 1870 and 1913 are the ones in which the growth of the employment in the agricultural sector declined to a large extent. Thus there is an unconditional form of correlation between these two variables (Baer 95-122). Thus the mobility of the labor from the agricultural tot eh industrial sector is the reason for the shift in the employment manufacturing sector. The main reason for the shift is the industrialization in these countries. As a result of this the import of the foreign goods would suffer a decline and the export of the goods produced in the domestic markets would increase. Figure 2: Growth of the employment in industry in 1870-1913 Source: Irwin 36 Conclusion Thus from the qualitative and quantitative analysis it is clear that the industrial growth in the home country in order to promote the policies of import substitution has been proved to be valid. Through free trade is conducive for the countries from the point of view of globalization, protected trade policy would promote the economic development of the country with the generation of more employment opportunities. Works cited Bruton, Henry. “A Reconsideration of Import Substitution.” Journal of Economic Literature, 36(2) (1998): 903-936. Print. Grossman, Gene M. and Elhanan Helpman. “Product development and international trade.” Journal of Political Economy, 97 (1989): 1261-1283.Print. Baer, Werner. “Import substitution and industrialization in Latin America: experiences and interpretations.” Latin American Research Review, 7(1972): 95-122. Print. Edwards, Sebastian. “Openness, Trade Liberalization, and Growth in Developing Countries.” Journal of Economic Literature, 31(3) (1993): 1358-1393. Print. North, Douglass C. “Economic Performance through Time.” The American Economic Review, Vol. 84(3) (1994): 359-368. Print. Corden, W. Max. The theory of protection. Oxford: Clarendon Press. 1971. Print. Irwin, Douglas A. “Did Import Substitution Promote Growth in the Late Nineteenth Century?” National Bureau of Economic Research 8751(2002): 36. Print. Read More