The applicability of a nation’s foreign economic policy in terms of developing countries, has been researched extensively e.g., Jung and Marshall (1985), Edwards (1992), Greenaway and Milner (1993) and studies of Rahman and Mustafa (1998), Gylfason (2001), etc. These studies suggest that major issues must be resolved by developing countries through international trade and they identify that the following two issues are of vital importance for developing nations to consider:
1. Do the developing countries use the open trade policy with smaller barriers for import, if it really plays any role?
24 2. Does the Government actively stimulate the trade by means of funding their export
sector? Or shall they limit the trade and perform the policy of increased self-sufficiency?
Generally, most countries are focused on dealing with solving these questions. However, the issues that are raised here tend to be more important for developing countries in terms of the types of raw materials and capital equipment that are involved, particularly those which are critically required for advancing the nation, and those that can be obtained only from overseas countries. Since the time when developing countries obtained their independence, there are occurring specific mechanisms of transitions in their respective foreign trade policy reforms, from one model of policy to another model, depending on the nature of their respective economic growth and associated policies. By tradition, trade strategies have been identified along a bipolar spectrum with import substitution (IS) or ‘inward-orientation’ at one side and export promotion (EP) or ‘outward-orientation’ at the other (Balassa (1982), World Bank (1987), Liang (1992), Bhagwati, in Balasubramanyam and Greenaway (1996)).
In terms of the nature of this particular research, it is important to understand what the main point is of these models and polices. In reviewing this question, it is noted that EP assumes the development of the national economy with an orientation directed towards foreign markets and exporting. In addition, Laux-Meiselbach (1989) defined export promotion as a “government policy with the affirmative intention towards increasing exports, thereby going further than just a laissez-fair approach”. Furthermore, Felder (1986) suggests that “import substitution” means protection applied to goods that are imported under free trade and ‘export promotion’ meaning protection applied to goods that are exported under free trade.
2.3.4 (b) Effects of Import Substitution and Export Promotion Policy to an economy In understanding the nature of the effects of import substitution and export promotion policy to an economy, Afzal (2006) points out that most developing countries pass through the stages of import substitution including “new industrialized countries.” Additionally, Chenery and Syrquin (1979) suggest that for Latino countries (Brazil, Argentina and Mexico) the strategy of import substitution plays a significantly positive role, by allowing the country to establish a diverse national economy, and to play a main role in the sphere of World production of key products.
Nevertheless, in reviewing earlier materials, Balassa (1971) considers that the above named countries could not create more stable assumptions in order to overcome their weaknesses in comparison with other industrialized countries, even though they may have more powerful economic potential than the “new industrial countries” of Asia. Moreover, research in the economic sciences has progressed since the 1960’s, and nowadays it is important to note that
the agenda has shifted and that there is a requirement for a distinct understanding of why protectionist measures and other tools of industrial policy can be successful.
Customs and other protection tools of national producers can be supplemented by supporting the nation’s exports, whereas in an export oriented industrial policy, without supporting exports, protectionism will ultimately lead to import substitution. Furthermore, protectionism has been used within the internal market, during both import substitution and export orientations. The main difference being that, without stimulation of exports the system can lead towards keeping inefficient production using protection with export stimulation, and this also helps to keep the inefficient production temporary, which subsequently makes the processes efficient. The external version of import substitution is a strategy of protection based on a nation’s own capabilities being directed towards producing goods inside the country. On the other hand, export orientation is a policy designed to create new industries, possibly from the very beginning but that absolutely must be competitive not only nationally, but also in the global market. Import substitution strategy development can be considered as the most common method used by the developing world in the post-war period. However, the effect of this strategy was mixed, and two issues appear to emerge as being of significant importance. Firstly, an import substitution strategy may bring about both benefits and damage to an economy, depending on the specific situation in each country. Krueger (1978) indicates that “both import substitution and export promotion, tend to increase capacity utilization, but such an effect under an export strategy is greater than that of an import substitution strategy” (Krueger, 1978 p153).
Hence, it should be borne in mind that an import substitution strategy can lead to faster growth - even just for a short period of time. Also, the implementation of this strategy can result in deviations, which can cause reduced efficiency and productivity growth (Syrquin, 1994).
The second significant issue is the variety of experience in different countries, where some countries followed an industrialization process entirely dependent on an import substitution strategy. Consequently, they suffered from the damage caused by the protectionist policies which were connected to this strategy. According to Yanikkaya (2003), strategies in the area of import substitution industrialization dominated during most of the 20th century in developing countries. The author points out that, while developing countries in Latin America that followed IS strategies experienced relatively lower growth rates, when East Asian countries adopted EP policies they outperformed other countries. On the other hand, during the post-war period, a few countries (mainly the Asian economies) have been successful in import substitution and promptly turned towards an outward orientation strategy. This led researchers to question that if import substitution policies were so unfavorable to the economic development of LDCs, how could so many economists get it wrong during the post war period? On this matter, Baldwin (2000) proposed two explanations. The first explanation is related to that of knowledge
26 acquisition by the protected industry. An import duty does not guarantee that individual entrepreneurs will undertake additional investment in knowledge acquisition for the betterment of firms, particularly as this incurs cost for the said investment. He also proposes that what could have been done here was the introduction of a subsidy to the initial producer in order to support the discovery of new production techniques. The second point is about their lack of concern for macroeconomic implications of a nation’s import substitution policies. It was the resultant macroeconomic crisis associated with unsustainable import deficits, unmanageable government budget deficits, and runaway inflation, which caused these Asian countries to abandon their respective import substitution policies, rather than an understanding of the serious resource allocation effects of these policies (Baldwin, 2000 p.8).
2.3.4 (c) Influences of Import Substitution and Export Promotion Policies to an Economy and Associated Consequences
Unfortunately, in the opinion of Arystanbekov (2002) many people confuse the definitions of import substitution and export promotion policy, and evidence suggests that the promotion of both import substitution and export promotion in Kazakhstan takes place at the same time over a very long period. Generally, simultaneous implementation of import substitution and export orientation policies is impossible. Greenaway and Milner (1987) and Liang (1992) indicate that a government may attempt to promote both import substitution and export promotion policy activities simultaneously, however the above mentioned policies tend to contradict and offset each other because a country cannot effectively provide a ’true protection’ for both import substitution and export orientation activities. In this connection he notes the “protection of import- competing activities in isolation “disprotects” exporters, while the subsidization of exports in isolation “disprotects” import substitution activities” (Greenaway & Milner, 1987 p.208).
In order to understand this, the following example is used where there are two types of products being produced in an economy. One product is being produced and partially used by satisfying domestic demands and partially exported. Another product is produced and partially imported for satisfying the needs. Also, export orientation policy considers that when performing industrial policy, the respective government provides a flow of resources from the import substitution branch to the export orientation branch.
In this connection Hout (1996) cites the research of Edward and emphasizes as follows:
“Many scholars have argued that the direct effect of an export- oriented strategy on economic growth is positive, whereas the effect of import substitution is thought to be negative. Export orientation can be seen as an impulse for economic growth
because it will spur the demand for the goods produced in a developing country. In those cases where import substitution is introduced, growth figures will generally be lower because of the less efficient allocation of production factors that can be expected under such strategy” (see Hout, 1996 p.605).
This point of view was shared by Zestos & Tao (2002), who suggest that “one of these reasons is that expansion of the export sector allows countries to attain economies of scale by specializing in production, which is important for smaller countries”. Small countries have small national markets and allow small specialization. Also “development of the export sector permits countries to have access to higher levels of technology and technology rich capital”.
(Zestos and Tao, 2002 p. 860).
In contrast, the import substitution policy assumes that through the involvement of the government in the market allocation of the resources, it stimulates the flow of resources from export-oriented to the import substitution branch. As far as the resources are limited, their flow can be stimulated to either of the branches. Hence, Kusainov (2003) emphasizes that it is impossible to stimulate two trends simultaneously.
On the other hand Jingbo (1998) finds it necessary to combine ingredients of the IS and EP strategies. He cites as an example East Asian countries. So, Korea and Taiwan used government forces to control the process of import substitution and then changed their strategies to the export promotion. According to Jingbo (1998) the main goal of the import substitution strategy is to improve the domestic productivity, to replace imports, to protect domestic infant industries and then to encourage rapid industrialization.
In 1987 the World Bank report discussed the respective successes of import substitution - and export oriented strategies, which highlighted two categories of countries - inward oriented and outward oriented (with two sub-groups in each case). Laux-Meiselbach (1989) suggested that these findings were incomplete and that inward oriented nations showed a significant lower rate of growth in industrial production than outward oriented nations. Additionally, prior to this, Alexander (2001) emphasizes that “sooner or later the import substitution strategy of development reaches a point of exhaustion” (Alexander, 2001 p.305). In view of the following adverse effects:
(a) Corruption, uncertainty and delays which interfere with private initiatives due to excessive bureaucratization associated with government regulations;
(b) Under-utilization of capacity due to lower tariffs on capital goods, and cheaper credits for installing machinery;
(c) Under-utilization of labor due to relatively cheaper capital goods;
28 (d) Higher import dependence;
(e) Bias against exports due to overvalued exchange rates;
(f) Bias against agriculture because of the relative price advantage for manufactured goods; and
(g) Limited scope for further expansion as LDCs run out of import substitution possibilities soon.
These consequences were relative to the key policy features of the import substitution strategy high tariff rates, strict import quotas and the over-valued exchange rate(s), and the institutional settings associated with these policies. The imposition of tariffs and import quotas tends to reduce the demand for foreign exchange. However, this can cause an appreciation of the domestic currency, which increased the export costs, thereby making imports cheaper. In this connection, Krueger (1985) gives some significant explanations, where, if import barriers remained high for consumer goods but relatively low for intermediate goods, resources would be directed to import-competing sectors. Basically, an import substitution strategy was initially intended to reduce external trade because the ideological belief of self-reliance undermined the role of foreign trade development. Nevertheless, import substitution could take a long period as far as newly expanded industries lacked an appropriate technological basis to rationalize the production; hence, growth of import substitution industries tends to increase as well as the related imports of capital goods.
An alternative explanation given by Todaro (1995) advises that it is important to understand that import substitution or export orientation must be considered as not the type of produced product - but how it is produced, i.e. what tools are supporting the development of the respective sector of the economy. Indeed, with regards to their comparative efficiency, the experience of South-East Asia and other countries showed that an export-oriented policy was the most efficient policy. One of the dominant factors was that, when choosing an export-oriented policy, governments establish high level expectations for national manufacturers who should compete in the foreign market. Such strict competitive conditions encourage them to maintain high efficiency in production, and also, producing companies have some possibilities to reduce their expenses by means of economies of scale.
Alexander (2001) points out that during the promotion of import substitution policy there can be an increase in many of the so-called non-production costs, where funds and efforts are spent for lobbying interests, and this is particularly poignant during the creation of overprotective conditions for specific branches, departments or companies. Here, it causes the following effects:
(a) A decrease of stimulus for improvement and for the implementation of technologies;
(b) To reduce the expenses and production costs and permanent renewal of the product ranges;
(c) An improvement of product quality, based on demands and needs of the consumers, etc.
It is also important to consider that governments use widely indirect methods during promoting an export orientation policy, while direct tools of economic policy are used for promoting an import substitution policy. During promoting a policy of import substitution, resources are usually directed to those branches which are not competitive at that particular time. However, such branches have the potential for further development and can become competitive in the foreign and domestic market. Moreover, Massimo (1993) observed that the level of import protectionism was not too high, and suggested that it was necessary to maintain specific levels of competition, so that any of the branches should not be overprotected and monopolize the market. Unfortunately, such expectations are not always efficiently justified. For example, Clifford and Kohli (1994) noticed that Japan used an import substitution policy to protect and promote certain industries such as steel making and ship building, through trade barrier regulations. However after some period of time, it turned out that those industries did not create any competitive advantage for the country. Consequently, the import substitution stage can be considered as the period of directing the formation of the national producers, especially if the industry has been recently created and cannot stand against foreign professional competitors. In such cases, it is only possible to keep incentives for the development of, and not for lobbying, the interests for supporting monopoly positions. Similarly, if the branches are being supported by implementing higher levels of protectionism at the introductory stage, then it is required to establish a program for each liberalization period. As a result, companies could predict and plan their growth if they have to compete with importing products, and such approaches allow minimizing structural expenses during the liberalization period of the trade regime in regards to that specific branch.
Criticisms
Some economists (Schydlowsky, 1967; James & Fujita, 1989; Zestos & Tao, 2002), do not support the view that import substitution is positive for all conditions and all exports, but only advocate support for exports which give the most externalities and external profits.
Furthermore, this tends to occur when public efficiency from investments to the specific type of activities is higher than income for the particular firms, which directly addresses this type of activity. Consequently, for the government, there exist important external effects from the development of education, healthcare and fundamental sciences. Therefore, governments should support such branches, in order to reach their development level to the optimum level. Recent research (Jayanthakumaran, 2000; Manu, 2009) also indicates the existence of externalities from the development of complex high technology exports where they lead towards the growth of the whole economy. If society obtains externalities from technically complicated and high
30 technological branches, then there is an implication that export specialization in these spheres, will lead towards having maximum efficiency. It also indicates that the idea of import substitution is always a rational kernel and this is true in the following cases:
(a) it is required to develop the progressing industries which absolutely do not exist in non-developing countries and not to rely on natural and already existing comparative advantages;
(b) it is necessary to uninterruptedly increment the level even if the level is successfully high, otherwise it would not be possible to establish new records.
This suggests that if governments do not try to export - and keep working just for the internal market - it would not be possible to establish a competitive sector. But if they try to export only oil and other raw materials, then it would not be possible to continuously maintain high growth perspectives. In this connection, the structure of Kazakhstan’s exports must keep improving by making transition from less high-technology goods to more technically advanced and processed products. Moreover, when promoting industrial policy, another difficulty can occur when choosing high priority branches. On this note it is important to understand the nature of the criteria for defining “high priority branches.” For stimulation of the economy branches, it is not enough to just provide protection from exported products and different types of subsidies, but it is also important to set up conditions where industry is given a high priority, will be steadily growing and will become competitive in the foreign and internal markets.