lecture 22 isi

8/12/2019 Lecture 22 ISI

1/19

International Political Economy #22

Import Substitution Industrialization

William Kindred Winecoff

Indiana University Bloomington

November 19, 2013

W. K. Winecoff | IPE #22: ISI 1/19
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An Aside

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Defining ISI

Import substitution industrialization is a state-led development strategy

in which industrialization occurs by substituting locally-producedmanufactured goods for products currently imported.

ISI intentionally works againstcomparative advantage, and tries to

cultivate new comparative advantages.

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The Macroeconomic Logic of ISI

Need investment for growth: increase I > increase GDP.

Harrod-Domar model: savings is endogenous.

We can only grow if we can save, but savings is limited by lowincomes.

We can borrow from the rest of the world, using debt to

finance investment.

Conclusion: we need the state to intervene in markets, and force

investment via forced domestic savings and foreign borrowing.

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The Microeconomic Logic of ISI

Development requires shifting of resources out of low productivity

sectors e.g. agriculture into high productivity sectors e.g.

manufacturing.

Markets dont allow this, so we need to work against markets:

Tariffs on imports, subsidies to domestic producers.

Over-valued exchange rate, to make importation of inputs for

production cheaper.

Create state-owned industrial sector.

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The Two Stages of ISI

Primary ISI: consumer non-durables.

Off-the-shelf technology available, at low capital cost.

Low skills required, so easy transition for labor.

Large domestic market that can be easily captured.

Secondary ISI: consumer durables.

Tech still available, but at higher capital cost.

More complicated production, so higher skills needed.

Hope that large domestic market emerges, or exportationpossible.

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7/19

The When and Where: ISI in Practice

Classic ISI:

Latin America first (1930s).

South Asia post-independence (esp. India).

Middle East and N. Africa (modernizers)

Sub-Saharan Africa post-independence (kind of).

East Asia in the postwar era (for awhile).

Extreme ISI: Above plus elimation of private property and price

mechanism, state control of entire economy.

The Soviet BlocChina

In varying forms and places from 1920s-1985 or so.

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8/19

The Why: The Politics of ISI

Global developments make self-sufficiency attractive:

Great Depression

No global trading system

No global lendingNo currency convertibility

Colonial systems, imperial preference, and autarky

This makes development difficult, b/c developing countries cant get

manufactured goods they want, or technology they need.

Urban labor emerges as important political force.

Coming out of WWII, Bretton Woods constructs institutions/rules in

the interests of the Core.

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10/19

The Why: Ideas

Structuralism provides intellectual support for state-led development(see previous lecture).

Development requires a big push that only targeted state

intervention can provide.

GATT is a rich country club, biased against the interests of

developing nations.

Development impossible, because infant industries will never

be competitive globally.

Secular decrease in terms of trade means that Gap is locked

into peripheral status by structure of the system.In general: markets wont reallocate the globes distribution of

resources, so states had to.

The Soviet model backwards agrarian economy to industrial

powerhouse in just a few decades is very attractive.

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11/19

The Consequences of ISI

Rapid economic growth and development of manufacturing during the

1950s-1960s.

ISI generates large budget deficits, inflation, and foreign debt asbyproducts.

Heavily reliance of state investment/ownership (SOEs):

Capital-intensive (i.e. expensive)

Not efficient enough to export.

Couldnt achieve economies of scale at home.

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The Consequences of ISI, con.

The goal of ISI was to develop industry through protection, then removeprotections when local industry was competitive internationally.

SOEs were not profitable, and no incentive to make them so.

If they become competitive, they will face international

competition.

Because they dont face competition now, no incentive to beefficient. They have a captive local market and collect rents

from the state.

ISI does not lead to exports, but does increase reliance on imports (esp.

of inputs).

This leads to large deficits (remember S-I = X-M).

Print money to pay debt > skyrocketing inflation.

Example: In Argentina, local currency equivalent of $1 billion

in 1960 was worth 1/13 of one cent by 2000.

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13/19

The Consequences of ISI, con.

State control of resources creates myriad opportunities for corruption.

Centralized corruption: Central govt over-taxes and

distributes rents for political support; leaders treat states

resources as their private property.

Decentralized corruption: Everyone (that can) collects rentsrather than work efficiently.

Corruption leads to massive misallocation of resources (estimated at

5-7% of GDP on average).

Talent in society goes towards capture scarce resources via control ofstate apparatus rather than increasing the size of the pie.

Entrenched interest groups organize politically to prevent reforms which

would kill their golden goose.

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The Hegemons Role

High inflation and low growth in the U.S. during the 1970s

(stagflation).During the 1970s inflation becomes a central campaign issue.

In 1979, Paul Volcker appointed as Chairman of Federal Reserve with

the goal of getting inflation in line.



16/19

The Volcker Recession

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The Hegemons Role

In order to get inflation in line, Volckers Fed causes a recession,

intentionally.

Higher interest rates means banks no longer have access to easy cash.

As a result, banks have to charge higher rates to borrowers. This makesit more expensive for indebted ISI countries to roll over their debt.

They cant pay it back.

A series of a sovereign defaults in the 1980s in Latin America; leads to

banking crisis in the U.S.

U.S. responds by mobilizing IMF to Latin America (more later), andenacting new banking regulations (which are forced upon rest of world

so U.S. firms wouldnt lose competitiveness).



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Lessons

Difficult to avoid shocks from the global economy.

A new development strategy is needed, but what? If ISI doesnt work

that doesnt mean that a markets-only approach works any better thanit did before. Particularly if you still think structuralism is right.

The emergence of export-oriented industrialization (EOI), which well

cover next, and the birth of neoliberalism, under the aegis of the

Washington Consensus.

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lecture 22 isi

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