A stage by stage look at import and export substitution and the effectiveness of this practice.
Describe import substitution (Inward looking) developmental strategy, clearly outlining the differences between the first and second stage. Assess its effectiveness in promoting economic development. Compare inward looking and outward looking strategies and discuss the assertion that the latter is superior. The First Stage of Import Substitution: All present day industrial and developing countries protect their manufacturing industries for the domestic markets. While the industrial countries of today rely primarily upon the usage of relatively low tariffs, developing countries apply high tariffs or quantitative restrictions which either limit or completely exclude competition from their imports. Protection like that – high protection – discriminates against exports through the explicit/implicit taxation of the export activities. Explicit taxation can take the form of export taxes whereas implicit taxation occurs as a result of the effects of protection on the exchange rate. As your protection level increases, your exchange rate level will decrease in order to ensure the necessary equilibrium of the balance of payments and the lower the amount of domestic currency exporters receive per unit of foreign exchange earned. There is no need for high protection at the first stage of import substitution in the replacement of the imports of non-durable consumer goods (clothing, shoes, household goods, textile fabrics, leather, wood and other types of inputs) since these commodities exist in the developing countries that are at the initial frontier of industrialization. The commodities I mentioned are intensive in unskilled labor, the scale of output is relatively low, and costs do not rise substantially at lower output levels. The production of the commodities do not involve the use of sophisticated technology or highly educated workers and suppliers for parts, components, materials and accessories are not necessary for highly efficient operations. An argument for infant industry protection and promotion is made for the “easy” stage, that being the first stage of import substitution because even though the domestic production of the commodities generates external economies in the form of labor training, entrepreneurial development and the spread of technology, there is a viable argument for infant industry protection because without the shielding from larger, more sophisticated companies, these infant industries will be crushed and overwhelmed by exceeding costs, non-competitiveness due to the lack of highly skilled laborers and the simple fact that these infant industries are technologically incompetent. The Second Stage of Import Substitution: I see the first stage of import substitution as a temporary requirement because the domestic production rises since it not only provides for increases in consumption but it also replaces imports. The rate of this growth however will decline as soon as the process of import substitution is completed. The maintaining of these high industrial growth rates necessitates the turning to the exportation of manufactured goods or moving to second stage import substitution. Second stage import substitution involves the replacement of intermediate goods and consumer durables by domestic production. These intermediate goods are highly capital intensive and are subject to important economies of scale. The margin of processing is very small and organizational and technical inefficiencies may contribute to high costs. Due to the scarcity of physical and human capital in developing countries that complete the first stage of import substitution, they tend to be at a disadvantage in the manufacture if highly physical capital intensive intermediate goods and skill intensive producer and consumer durables. By limiting the scope for the exploitation of economies of scale, the relatively small size of their national markets also contributes to high domestic costs in these countries.