The process of import substitution industrialization in Latin America

Introduction

Import substitution industrialization (ISI), development strategy focusing on promoting domestic production of previously imported goods to foster industrialization. Import substitution industrialization (ISI) was pursued mainly from the 1930s through the 1960s in Latin America—particularly in Brazil, Argentina, and Mexico— and in some parts of Asia and Africa. In theory, ISI was expected to incorporate three main stages: (1) domestic production of previously imported simple nondurable consumer goods, (2) the extension of domestic production to a wider range of consumer durables and more-complex manufactured products, and (3) the export of manufactured goods and continued industrial diversification.

The theoretical foundation for deliberate, government-promoted ISI emerged from critiques of the international division of labour, in which less-developed countries largely exported primary products and imported finished manufactured goods from Europe and the United States. In the 1950s, critics such as Argentine economist Raúl Prebisch claimed that this division of labour would ensure continued poverty for primary-product producers.

The process of import substitution industrialization in Latin America

Prebisch and others argued that developing countries must promote industrialization through practices that encourage domestic manufacturing. Promotion policies involved both protection of “infant industries” for imports and incentives to encourage capital and technology imports. Tariffs were often used in addition to exchange controls, exchange-rate manipulation, and import licenses for particular products necessary for manufacturing.

Key to the implementation of the policies was an alignment that emerged between three actors in these societies: the government, including state-owned firms; domestic private enterprises; and transnational corporations (TNCs). This “triple alliance” involved government investment in intermediate and capital-goods sectors to support industrial expansion, domestic production of import substitutes, and TNC production of high-tech goods needed for manufacturing that could not yet be produced domestically. Although promoters of ISI anticipated that this alignment would last only until access to capital improved and production spilled into additional industries, the interactions between these actors were often mutually reinforcing.

The process of import substitution industrialization in Latin America

By the 1960s, ISI strategies were seen to have significant drawbacks. Although results varied from country to country, general trends included production that often did not extend into industries other than consumer goods, slow employment growth, agricultural-sector decline, and minimal productivity growth. Social strife also emerged and was seen in part as resulting from increased internal migration and greater inequality. Although large countries such as Brazil and Mexico produced at least short-term growth with ISI policies, smaller countries, including Ecuador and Honduras, were less successful.

Critics within Latin America, particularly at the Comisión Económica para América Latina (Economic Commission for Latin America) and the University of Chile in Santiago, condemned ISI’s dependence on TNCs and its failure to promote egalitarian development. These scholars, and others in Mexico, often pushed for socialist models free of TNC participation

Promoters of free trade instead decried ISI’s protective measures, arguing that they created distortions in capital appropriation and prevented developing countries from pursuing their comparative advantage in international trade. New, protected industries and government planning were deemed inefficient in comparison with those encouraged through market-led development strategies. These critiques, supported in part by early observations of export-led growth in East Asia, produced a strong emphasis by economic and development agencies on export promotion beginning in the 1960s.

Experiences and interpretations

This section borrows its name from one of Werner’s seminal papers (Baer, 1972) which analyzed the process of Latin American industrialization in the 1950s and 1960s. In that paper, the nature of ISI, the results of the industrialization process, and the prospects for future development policies in the region were reviewed. Stiglitz (1987, p. 141) points out that there are two “conflicting paradigms for development strategies.” One emphasizes the importance of the principle of comparative advantage, preaching free market and export-oriented policies. The other highlights that “there is a natural path of development ... and that path, for most part, involved heavy industrialization.” This development strategy has been typically associated with interventionist trade policies and focus on fostering a domestic market via ISI.

In his evaluation of the ISI experience in Latin America, Werner Baer adopts an analytical approach that borrows from both paradigms. He presents ISI as “destiny” while criticizing the excessive attention to “efficient allocation of resources” that could perpetuate a focus on “myopic” comparative advantage (i.e. a static rather than a dynamic perspective). At the same time, he recognizes that “one-size does not fit all” in evaluating ISI experiences in Latin America. Accordingly, he underscores the relevance of some of the criticism coming from adepts of the “market-oriented” paradigm, while pointing out that some of this criticism applies much better to small economies (e.g. Chile) than to the larger Latin American economies (e.g. Brazil).

The process of import substitution industrialization in Latin America

The point of departure of his evaluation is the proposition that “all countries which industrialized after Great Britain, went through a stage of ISI; that is, all passed through a stage where the larger part of investment in industries was undertaken to replace imports” and that “in this early ISI process [in Europe and the United States in the nineteenth century] governments played an active role in encouraging and protecting the development of infant industries” (Baer, 1972, pp. 95–96). He goes on to attribute the delay with which Latin American countries embarked in this process to socioeconomic considerations: an elite focused on the high profitability of primary exports, supply-side bottlenecks (weak entrepreneurial classes, poor endowment of skilled labor, and inadequate infrastructure), as well as limited market size and pressures from external powers interested in the maintenance of liberal trade policies. His analysis of the historical path towards ISI in Latin America differentiates between ISI spurts induced from abroad (associated with external shocks such as the two world wars and the Great Depression) and ISI as a deliberate policy tool for economic development in the 1950s and 1960s. He points out that after World War II, most “of the larger countries of Latin America implicitly or explicitly accepted the ECLA analysis of the hopelessness of gearing their economies towards the traditional world division of labor” (Baer, 1972, p. 97).

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