Development Economics II ECON 415

1. Kniivilä, M., 2007. Industrial development and economic
growth: Implications for poverty reduction and income
inequality. Industrial development for the 21st century:
Sustainable development perspectives, 1(3), pp.295-333.
1. Import Substitution (IS) Strategy
 Definition: Replacing imported goods with domestically produced goods through
protectionist measures such as tariffs, quotas, and subsidies.
 Mechanism:
o Protective tariffs on imports.
o Encouragement of local production (e.g., manufacturing of radios and bicycles).
o Joint ventures with foreign firms for local production.
Arguments for IS:
o Reduces dependence on imports.
o Protects "infant industries" to help them grow.
o Promotes self-reliance and industrialization.
Key Findings (from research studies):
 Industrial Inefficiency:
o Many IS industries remained costly and inefficient due to lack of competition
(Kabelwa, 2004).
o Example: Tanzania - South African companies had the potential for technology
transfer but domestic industries failed to develop efficiently.
 High Tariff Structures and Protection Measures:
o Nominal Protection: Raised domestic prices above world prices.
o Effective Protection: Increased cost of inputs and discouraged diversified growth.
o Example: Pakistan and Uruguay had >300% effective protection rates, leading to
market distortions.
 Adverse Impact on Agriculture:
o Overvalued exchange rates discouraged agricultural exports and hurt rural
development (Athukorala & Jayasuriya, 1988).
o Example: Sri Lanka (1981) - Protectionist policies led to a decline in agricultural
competitiveness.
 Failure to Achieve Long-Term Growth:

2. o Many industries failed to “grow up” and remained dependent on protectionist
policies.
o Foreign firms often benefited more than domestic producers (Busjeet, 1980).
o Example: Mauritius and the Philippines - Export Processing Zones (EPZs) had mixed
results.
2. Export Promotion (EP) Strategy
 Definition: Encouraging industries to focus on producing goods for international markets
rather than relying on domestic consumption.
 Mechanism:
o Export incentives such as tax breaks and subsidies.
o Foreign investment in export industries.
o Flexible exchange rate policies to maintain competitiveness.
Key Findings (from research studies):
 Economic Growth and Efficiency Gains:
o EP strategies promoted competition, efficiency, and higher growth rates (Rodrik,
2006).
o Example: South Korea and Taiwan successfully transitioned from IS to export-
oriented growth.
 Technology Transfer and Upgrading:
o Export-oriented industrialization led to rapid technological advancements.
o Example: China and India - Governments actively supported innovation and
technology absorption.
 Role of Government in EP Strategies:
o South Korea’s model:
 Used targeted industrial policies to promote high-tech exports.
 Provided subsidies and credit incentives for exporters.
o Chile’s model:
 Focused on agriculture and resource-based exports, achieving sustained
growth.
 Challenges of EP Strategies:
o Market volatility: Relying on exports makes economies vulnerable to global demand
fluctuations.

3. o WTO trade rules: Some government support mechanisms may violate international
trade agreements (Rodrik, 2006).
3. Key Comparisons: IS vs. EP
Aspect Import Substitution (IS) Export Promotion (EP)
Economic Impact
Initial growth, but long-term
inefficiencies
Sustained growth with higher
efficiency
Government Role High protection, subsidies Targeted support for export industries
Employment Capital-intensive, few jobs More labor-intensive, job creation
Market Competition Weak due to tariffs Strong due to global markets
Examples Latin America (1950s-1970s), Africa East Asia (South Korea, Taiwan), China
Conclusion
 Import substitution was widely used in the 20th century but often led to inefficiencies and
reliance on protectionist policies.
 Export promotion has shown better long-term results, especially in East Asian economies.
 Successful development strategies require a balance between IS and EP, ensuring domestic
industry growth while remaining globally competitive.
2. Foreign Aid: Good or Bad?
IMF Survey: Foreign Aid – Good or Bad?
Authors: Andrew Berg (IMF Research Department) and Arvind Subramanian (Peterson Institute for
International Economics, former IMF economist)
Key Themes of the Debate
1. Effectiveness of Foreign Aid
o Supporters argue aid enhances healthcare, infrastructure, and investment, leading
to poverty reduction and economic growth.
o Critics claim there is no strong evidence linking aid to long-term economic growth,
and aid may even hamper domestic investment.
2. Potential Benefits of Aid (Andrew Berg’s Perspective)
o Boosts growth when efficiently invested and aligned with good policies.
o Can fund healthcare, education, and infrastructure, laying a foundation for future
growth.

4. o Example: Tanzania and Mozambique – Countries that implemented institutional
reforms received significant aid and showed development progress.
3. Challenges and Risks of Aid (Arvind Subramanian’s Perspective)
o Weakens institutional development:
 Governments become dependent on aid rather than strengthening tax
collection and governance structures.
o "Dutch Disease" effect:
 Aid inflows appreciate local currency, making exports less competitive.
 Evidence suggests that countries receiving more aid tend to export less,
leading to slower growth in the long run.
o Example: Sub-Saharan Africa – Countries with high aid dependence often struggle
with institutional reforms and economic diversification.
4. Alternative Approaches to Aid (Proposed by Subramanian)
o Funding Global Public Goods:
 Investing in R&D for health and technology (e.g., Green Revolution).
o Improving Governance:
 Enforcing transparency in foreign bank accounts to prevent corruption.
o Increasing Market Access:
 Reducing trade barriers for developing countries instead of just providing
aid.
Conclusion
 Aid can support development if well-targeted, but it should not replace the need for
domestic institutional reforms.
 Countries must balance aid dependency with policies that promote self-sufficiency and
sustainable economic growth.
 Future discussions should shift from government-to-government aid toward broader
economic reforms and capacity-building strategies.