Import Substitution versus Export Promotion

by Juan

January 1, 2015 2 minutes • 346 words

Import substitution is an economic policy that replaces imports with local manufactures. It was popularized by Argentina in the 1970’s and subsequently spread around the world. Its main goal is to lower a country’s expenses.

Adam Smith would categorize it as a policy by poor and austere societies:

Adam-Smith

In every civilized society which has the distinction of ranks, there were always two systems of morality: the strict or austere which is generally admired and revered by the common people, and the liberal or loose system which is commonly adopted by people of fashion. The vices of levity is apt to arise from great prosperity. It leads to the excess of gaiety and good humour… The vices of levity are always ruinous to common people. A single week’s thoughtlessness and dissipation is often sufficient to undo a poor workman forever, and drive him to commit enormous crimes.

Export promotion pushes local production to manufacture for foreign markets. It is meant to increase a country’s revenue. Adam Smith would categorize it as a policy by rich and liberal societies.

Usually, countries with abundant natural resources stay in import substitution because it provides quick return at less effort. For example, Indonesia sells palm oil to buy equipment for local infrastructure for local needs, such a high speed train.

In contrast, countries with few natural resources often go for export promotion which needs a bit more time and effort. Japan imports steel, minerals, and equipment from overseas to process them for overseas markets which is a much bigger market than at home. In time, it learns to make those equipment itself and churns out both manufactures and equipment.

Countries that do export promotion are richer than those that do import substitution because the global market is much bigger than the local market. China has a natural advantage in export promotion because it has both a huge local and external market.

In the case of the Philippines, its error was staying too long in import substitution in the 1970’s instead of transitioning into export promotion. Its economist Cesar Virata explains: