Export Promotion & Import Substitution

By: Fakhar Bokhari & Mansoor Ahmed

The article is based on the critical study of two industrialization strategies that is Import Substitution and Export Promotion.

Basically, import substitution is substituting the imported goods with locally produced goods in order to meet the internal demand. It is done through government intervention through tariffs, quotas, exchange rate, prices of the factors of production and interest rate. In short, Import Substitution is a strategy that appreciates the local production with the help of Government intervention to the whole economy.

Since 1950’s and 1960’s, Pakistan adopted import substitution strategy as its trade regime. This strategy was adopted because after the independence, Pakistan’s economic conditions were very vulnerable. In early developing countries, development comes into the picture through substituting the imported goods by locally produced goods.

Most of the less-developed countries have begun developing by an Import Substitution strategy in order to reach a level at which it can compete with foreign industries in all over the world.

Later on they have followed an outward oriented strategy. Especially the countries, which have a huge internal market, had advantage of the Import Substitution strategy during 1960s. Practically the countries that pursue Import Substitution strategy had to shift their strategies to Export Promotion strategy due to heft economic crisis. After these shifts these countries had developed faster than the others. Due to this reason, Pakistan switched to export promotion strategy in 1970’s.

This strategy is adopted in order to prepare the “potential” industries for competition with the foreign rivals. Exporters, facing the increasing competition have to improve their technologies and their quality continuously in order to compete in the International market.

The Export Promotion strategy may be a remedy to the unemployment problem if the country has advantage in human capital. Furthermore, foreign direct investment (FDI) as a growth-enhancing component has received great attention of developed countries in general and less developed countries in particular in recent decade. It has been a matter of great concern for many economists that how FDI affects economic growth of the host country.

The investments are financed solely from domestic savings in a closed economy having no access to foreign saving. In contrary, open economy investments are financed both through domestic savings and foreign capital flows, including FDI. Foreign direct investments facilitate investment-receiving countries to achieve investment levels beyond their capability to save.

Now the questions arise:

Why do various countries develop more than others?

Is there any International trade strategy playing a role on this?

IMPORT SUBSTITUTION MAIN STRATEGY TOOLS:

    TARIFFS

A tariff is a percentage that is applied to the value of an imported item with the resulting sum of money going to the government. A tariff raises the effective price of a commodity above international levels.

Assumptions: (Implicit)

·        Competitive markets

·        P* (World price) is independent of domestic strategy.

Suppose that a tariff of t% is imposed. It will have an effect of increasing international price (as perceived by buyers) to the level

P*(1+t/100)

EFFECTS:

1.     Demand falls to point D.

2.     Domestic supply is larger, at the level C.

3.     Import falls to CD from AB.

4.     Buyer’s loss: they pay higher Prices.

5.     Sellers gain: they obtain higher prices.

6.     The government obtains tariff revenue.

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    QUOTAS

(Often combined with tariff) A quota is the stipulation of a maximum quantity on a particular good, above which no more of that good can be imported into the country.

For the purpose of comparison with tariffs we are going to impose a particular quota. Recall that the amount imported after the tariff t, was CD. Let us choose precisely this quota.

EFFECTS:

1. The equilibrium domestic price is the same as with the tariff.

2. The domestic production levels are the same as well, 

    and so is the amount of imports.

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COMPARING TARIFF AND QUOTA

 

EFFECTS:

1. Tariffs and quotas are equivalent in this example.

2. Except that they allocate purchasing power 

    differently to the buyers and the Government.

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After conducting a detail study over import substitution and export promotion, we are able to conclude that the development of any economy depends on the utilization of both foreign and local resources. Import substitution has proved as a successful strategy in past because in early developing countries, development comes into the picture through substituting the imported goods by locally produced goods. This strategy was also followed by the vetos as this is the only way through which the local industry could grow and prosper. Most of the less-developed countries have begun developing by an Import Substitution strategy in order to reach a level at which it can compete with foreign industries in all over the world.

Later on they have followed an outward oriented strategy, especially countries having a huge internal market. Due to this reason, Pakistan switched to export promotion strategy in 1970’s. This Strategy is adopted in order to prepare the “potential” industries for competition with the foreign rivals.

After working on this area we recommend that the government should create a mix strategy in order to increase growth and development of our country.

To increase the production and the quality of the products they should give incentives in the form of reductions over the imports of plants, equipments, machinery and other raw materials. In this way, local market would flourish as the domestic consumers would opt for the products that are locally produced.

They should focus over export promotion strategy because this strategy expands trade beyond market-determined limits. This strategy lumps together under the classification of outward orientation, in contrast to inward orientation that is used to describe import substitution strategy.

We should also focus over such trade regime that encourages foreign direct investments as unfortunately in the recent years due to economic instability we had lost a number of investors which were ready to invest in some big projects planned by the Govt. of Pakistan.

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Article dated: August 2009.