Brazil’s huge domestic market

As the strategy was developed in many Latin American countries through the 1950's and 1960's, there is no doubt that industry was able to flourish, but the policies followed by Latin American countries were not without inherent problems. State owned enterprises, including oil, petrochemicals, telecommunications, steel and aircraft, were developed. In Brazil, for instance, there was over 50 per cent state participation in transport, water, phone, electricity, mining, developmental services and chemicals by the mid-1970's14. These industries were backed by sovereign guarantees; although this meant that pressure to make a profit was relieved, it also tended to lead to a lack of expansion because there was no money to do so without seeking further funds from government or in the form of loans from abroad.

As import substitution industrialisation progressed over time, borrowing by Latin American governments grew until it became unmanageable. Governments were able to negotiate the international transfer of technology through part of the multinationals' involvement. Prices of inputs such as electricity and telecommunications, and finished goods, were kept artificially underpriced to support infant industries and enable the growing middle-class to access goods. SOEs had the power to recruit the most talented individuals, however, national pay scales tended to place a ceiling on skilled labour; additionally, political power over companies through government support led to over-employment as politicians were under pressure to secure jobs for burgeoning urban populations.

Protectionism served to insulate the economy from rival foreign firms dominating the market. This was provided to infant industries, especially manufactured goods, to give them the chance to develop new products and become self-sufficient. For instance, by 1970, a 168 per cent tariff over consumer and manufactured goods existed in Brazil, and similar tariffs exceeded 100 per cent in Argentina, Chile and Colombia. In Mexico, tariffs on chemicals up to 671 per cent were in place as the domestic chemicals industry developed.

Tariff barriers and quotas were raised against foreign imports, and this further encouraged multinational involvement and investment; where protection was high, the best way for MNCs to access Latin American markets was to set up factories in the countries themselves to bypass prohibitive tariffs and quotas. Although this meant that control and profits were in the hands of MNCs, the situation nevertheless served to improve employment, skills and production levels and contributed to economic growth. 

An artificially overvalued currency ensured that raw materials, capital and technological equipment necessary for rapid industrialisation were able to enter Latin America easily. SOEs and favoured industries were also given access to preferential interest rates, subsidies and tax breaks to increase and improve production. Once industries had developed sufficiently to achieve economies of scale and technological sophistication rivalling those in the 'core', the plan was that protection would gradually end and international trade could take off. Overvalued exchange rates meant, however, that products were not internationally competitive, thus the export sector – the second stage of import substitution industrialisation – did not develop in the way that was foreseen by the structuralists.

Given these advantages and drawbacks, how did import substitution industrialisation perform? In terms of economic growth, there is no doubt that the strategy had widespread, if not universal, success (see Table 2), with growth peaking in the more successful economies in the 1970's. Average annual growth rates in the region between 1950 and 1980 were 5.5%, and this figure exceeded all other regions apart from some areas of East Asia. GDP increased by five times between 1945 and 1980, while the population grew by three times. Chile was identified as 'strongly inward oriented' before 1973 but 'moderately outward oriented' after this time; its strongest period of growth was during the 1960's so this would suggest that in economic terms at least it fared better under import substitution industrialisation than after a change in policy16. 

The strategy enabled widespread production of basic consumption goods, and specialisation in some countries. Some countries were more successful than others; in Brazil, for instance, imports as a ratio of GDP fell from 19 per cent in 1949 to just 4.2 per cent in 1964 while the production of manufactured goods increased by 266 per cent in the same period17.

This was undoubtedly supported by Brazil's huge domestic market; many authors state that countries with much smaller populations did not benefit from this but evidence from Table 2 suggests that a number of smaller Central American economies fared better through this period than countries such as Argentina and Chile with larger populations18. Without the development of a domestic market, the new industries were not able to reach a level where the economies of scale made products internationally competitive, and this was exacerbated in smaller countries. Import substitution industrialisation therefore became 'exhausted' due to small domestic markets for manufactured goods in many instances.

This placed a limit on plant size, technology and specialisation, and meant that many products would not be of sufficient quality to compete if exported. Todaro (1992) argues additionally that the main beneficiaries of import substitution industrialisation were the MNCs, because they were able not only to access domestic markets but also benefit from the incentives, preferential interest rates and support that governments were offering to industry.

The policy of imposing tariffs on imports and the development of SOEs created balance of payments crises, as most countries were unsuccessful in reducing the ratio of imports to GDP. The first stage of import substitution industrialisation could not happen without large inflows of capital and technological components; the resulting imbalance of payments affected the funding of future protectionism, and often the only solution was large scale borrowing from private financial institutions in industrialised countries.

This only served to worsen conditions over time as repayments had to be made using scarce foreign exchange earned from primary commodities, since manufactured goods coming from infant industries were either too expensive or not sufficiently technologically advanced to compete with products produced abroad.

The strategy was successful in enabling the development of an urban middle class, a labour union movement and a national business class. However, local elites that had been the dominant landowners were engaged and became the new industrial elites, thus not contributing to social cohesion, and corruption was widespread. There is a wealth of evidence to support the notion that inequality was worse under import substitution industrialisation, even though total GDP rose. Agriculture was neglected, and this led to an increase in food imports in some cases, and a bias towards urban development, which fed the influx of people to the cities where they would not always be able to find work.

Some would argue that the many inherent problems of import substitution industrialisation brought about its demise19. Ultimately, it could not continue to remain viable when international financial markets no longer leant money to Latin American countries to finance shortfalls in balance of payments or resources for development. By the end of the 1970's debts were spiralling out of control and some would argue that the resulting crisis of the early 1980's had its roots in the policy followed in the region. Suddenly the emphasis of policy changed from one of development of domestic industry to the need to raise foreign exchange to make debt repayments; there was an urgent need to increase exports, which would not happen under prevailing economic policy.

By this time, the shortfalls of import substitution industrialisation were also becoming clear, and the outstanding performance of East Asian 'tiger' economies following a more 'outward-looking' strategy had overtaken Latin America; this strategy of openness had become popular during the 1970's among economists and at institutions such as the IMF and World Bank, who ensured that Latin American countries opened up their economies to repay loans through structural adjustment. Thus the era of import substitution industrialisation came to an end.

The discussion now turns to export-led industrialisation. It has already been mentioned that proponents of this 'outward-looking' strategy cite the successes of East Asian economies, particularly South Korea, Hong Kong and Singapore20. By the mid-1990s, many economies in the region had become some of the most successful in the less developed world. They had consistently higher rates of growth than in Europe and North America – averaging 7% per year – and were delivering on human development.

Particularly successful were Korea, Thailand, Indonesia, Malaysia, Singapore, Hong Kong and Taiwan. The main features of this 'Asian miracle' were sharp increases in GDP per capita income – a four times increase between 1965 and 1990. Table 3 shows the exceptional performance of a number of East Asian economies, which outweighed the growth in Latin America during the same period.

Neo-liberalist theory underlines the importance of the free market; that a strong role for the state should be discouraged because it does not result in the optimal allocation of resources for development. Indeed some of the drawbacks of import substitution industrialisation would have been overcome through a more liberal approach. Obvious examples include the fact that Latin American industries, through the protection provided, were never designed to be internationally competitive, and that under normal market conditions they would have altered or simply shut down. However, critics of neo-liberal theory cite its tenuousness, and indeed most of the literature on neo-liberalism tends to focus on the experiences of individual countries rather than outlining the thought behind its assertion.

How did the policies followed in some East Asian countries differ from import substitution industrialisation? The development model followed during and after the post-war boom focussed on achieving economic growth through the promotion of exports. While the theory behind import substitution industrialisation had evolved from the ideas of unequal exchange and at a time of depression in North America and Europe, export-led growth acknowledged the growing international integration and globalisation of production, along with better and quicker transportation, and used these global developments to maximise growth.

Between 1965 and 1990, Asian economies boosted their global trade share by 6%, largely by promoting manufacturing industry for foreign markets. A high level of investment in education and training, coupled with government incentives including preferential interest rates, reductions in tariffs and tax concessions, succeeded in attracting a level of foreign direct investment equal to 5-7% of GDP22.