a presentation on import substitution policy

2. Introduction
'Import Substitution' (IS) generally refers to a policy that eliminates
the importation of the commodity and allows for the production in the
domestic market. The objective of this policy is to bring about structural
changes in the economy. The structural change is brought about by
creating
gaps in the process of eliminating imports and thus making investment
possible in the non-traditional sectors (Bruton, 1970).

3. -Meaning
-What are import substitution policies? They are policies that attempt to reduce
foreign dependency of a country's economy through local production of food and
industrial products.
Import substitution policies advocate replacing imports with domestic production.
It is based on the premise that a country should attempt to reduce its foreign
dependency through local production of goods, mainly industrial products.
Many Latin American countries implemented import substitution policies with the
intention of becoming more self-sufficient and less vulnerable to adverse terms of
trade.
-The import substitution strategy is often complemented with state-led economic
development through nationalization, subsidization of vital industries and
agriculture.
 Such regimes are characterised by highly protectionist trade policy. Many Latin
American countries adopted import substitution policies from the 1930s until
around the 1980s. Some Asian countries, especially India and Sri Lanka, pursued
such policies from the 1950s.
All major developed countries used interventionist economic policies to promote
industrialization and protected industries until they had reached a level of
development when they were able to compete in the global market.

4. Advantages and disadvantages
The major advantages claimed for import substitution are increases in domestic
employment and resilience in the face of global economic shocks such as recessions
and depressions.
The disadvantages are that import substitution industries create inefficient and
obsolete products as they are not exposed to international competition.
Other disadvantages include unemployment increasing internationally as World GDP
decreases through the promotion of inefficiency.
 Countries that adopted import substitution policies faced many undesirable effects
such as chronic problems with the balance of trade and payments.
 Although import substitution was supposed to reduce reliance on world trade, there
was a need to import raw materials, machinery and spare parts.
The more a country industrialized the more it needed these imports and import
substitution industrialisation (ISI) was strongly biased against exports.
Trade protection and overvalued exchange rates raised domestic prices and made
exports less competitive. Consequently, import substitution industrialising countries were
unable to export enough to buy the imports they needed.
The faster the economy grew, the more it needed imports; but exports could not keep
up with the pace of imports and so countries ran out of foreign currency.

5. In response, governments restricted imports to essentials. The currency was
devalued to raise the price of imports and make exports more attractive.
 Government subsidized industrial investments. Such spending chronically
outpaced government revenue and these budget deficits were usually covered by
printing more money.
The result was inflation which made domestic goods more expensive which in
turn reduced exports even further. Sri Lana experienced much of this during its
import substitution industrialising period in the 1960s and 1970s.

6. Success and failure in import substitution
While import substitution industrialisation was not successful, it must also be
recognised that some import substitution policies were a success and contributed to
increasing the country's production and economic development.
These were in agriculture, where protection afforded to agriculture contributed to
increased production of rice and other food crops.
 It was, however, not only protective import control policies that resulted in food
production increasing.
The import restrictions were complemented by guaranteed prices for farm produce,
research, extension services, marketing arrangements and subsidies in inputs.
This range of policies enabled the country to achieve impressive gains in food
production.
At the time of independence when the country had a population of only 7 million,
the country imported nearly half of her food needs. This includes rice, many
subsidiary food crops like chillies, onions, potatoes and poultry.
There were also high imports of sugar, wheat flour, milk and lentils (dhal). The latter
category remains one where domestic production is inadequate. Rice is perhaps the
most spectacular success as the country is able to feed its near 21 million population
with domestic rice and there has also been decreased consumption of imported
wheat flour that is being substituted by local rice.

7. Per capita rice consumption has increased from less than 100 kilograms per capita
to about 115 kilograms per capita, while per capita wheat consumption has reduced.
 In several other commodities too there has been significant substitution of local
produce for imported ones. These include maize, potato, poultry products.
The important lesson to be drawn from this experience is that the price support
given by import substitution policies contributed much to the increase in production.
However while such price support was important and necessary, it was not
sufficient. There were also several other support measures that make the import
substitution strategy work.
 Conversely there were crops where the lack of adequate resources, incentives and
other capacities where the import substitution strategy has not succeeded.
Sugar production is a good example of this. Although the country still imports about
80 percent of its milk requirements, there is evidence that the improved prices and
other incentives and institutional support is contributing to increased milk production.
The experience with respect to industrial import substitution was very different. The
reasons for failure were Sri Lanka's limited resource base, small domestic market
and investment capacity.

8. Most industries must industrialise on an export-led strategy. There is a need to
attract foreign investors who would not only bring in capital but also modern
technology, management skills, technical expertise and assured markets.
 The value addition in Sri Lanka, employment opportunities and technology
transfer would add much to the country's economic development.
 Industrialisation based on import substitution of imported goods will fail as in the
past.
 The country has made important strides in industrial production for export in such
as areas as textiles and garments, ceramics, rubber manufactures, electrical goods,
solid tyres and boats.
These are not import substitution industries but export led industry.
This does not mean that there are no possibilities for import substitution industry.
Good examples of possibilities are in the food processing field, where with
adequate production of fruit and vegetables, there are possibilities of expanding
food processing industries to both substitute for imports as well as export to
especially Middle Eastern markets.
Pragmatism, as President Mahinda Rajapaksa rightly said, should be the guiding
principle of economic policies.

9. Studies on Estimation ofImport Substitution in Indian Industry
The sources of output growth in Indian industry have been analysed by Ahmed
(1968) using the Chenery framework for the first three five year plans 1950-65. The
major conclusions are, IS accounted for 33 per cent of industrial output growth in the
First Planand a major share came from capital goods and intermediates. In the
Second Plan, IS accounted for 13 per cent of the output growth and this was
contributed by paper, newsprint, petroleum products and electrical machinery. In the
Third Plan, IS was 25 per cent of output growth and capital goods accounted for a
major share. For the whole period 1950-51 to 1965-66 IS accounted for 23 per cent
ofoutput growth and capital goods accounted for half of it21.
Desai (1970) has analysed the IS pattern and performance in terms of three major
groups of industry, consumer goods, intermediates and investment goods, for the
period 1951-61 and 1951-63 and two sub-periods 1951-57 and 1957-63. She has
used the absolute, relative and Chenery measures and an aggregate measure to
determine IS. The data on production and imports were taken at market prices. So
the effect of change in prices as well as internal taxes onproductionand imports are
included while measuring IS.

10. (i) Supply side analysis:
The chief critics of India's strategy of Industrialisation -
Bhagwati, Desai, Srinivasan and Ahluwalia have highlighted
the supply side constraints to be the cause for low long run
growth of the Indian economy. Ahluwalia (1987) has summed
up its main defects as under:
(a) Indiscriminate and indefinite protection given to domestic
industry from foreign competition22.
(b) Administrative burdens in a system of physical controls.
(c) The adverse effect on enterpreneurship by providing
incentives for rent seeking rather than long term corporate
planning23.
(d) Little or no incentive for technological upgradation24.
(e) High cost inefficient industries25.
In the view ofthe critics, there is a precise link between the
industrial strategy and deceleration in industrial growth, which
is demonstrated by increase in the capital-output ratio and
reduction in the growth rates of labour
Phases

11. (ii) Demand side analysis:
Economists who have highlighted the demand side constraints of India's
industrialisation strategy are Bagchi (1988), Chakravarthy (1979), Patnaik (1987)
and Ghosh (1988). In the late sixties, during the period of recession, capacity
utilisation was seriously affected and some economists started to talk about the
limits of ISI. Since, despite improvements in food
production during 1967-71, industrial production did not respond. It was then
realised that the ability ofthe agricultural sector to generate a surplus, though
crucial to sustain growth, was not a sufficient condition in a private enterprise
economy. It was at this juncture that the problem of demand deficiency was
highlighted.
The terms of trade had adversely affected agriculture which has had a bearing on
industry. They argue that a squeeze28 on agriculture erodes the availability of
resources for industrial development, leading to an over production of home
produced industrial goods (Patnaik, 1987). So, they
advocate redistribution of income (Bagchi, 1988) and not export-oriented