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Import Substitution Definition
Before jumping directly into the definition of import substitution, let's learn about trade policies. The set of agreements and policies that are formulated by the government to make sustainable trade practices with foreign countries is known as a trade policy. The primary reason for the government to develop a trade policy is to strengthen their economy.
Depending on the type of country, trade policy differs. A developed country might have a different trade policy whereas a developing country might employ another policy.
A trade policy is a collection of agreements and guidelines developed by the government to ensure sustainable trade practices with foreign countries.
The policy that countries adopt is dependent on changing views of economic development. After World War II, there was a strong belief that the key to economic development is having a strong manufacturing industry. To create a strong manufacturing industry, the country tries to protect its domestic industries from international competition by undertaking numerous policies to reduce imports. Hence, imported goods are substituted by domestically produced goods and services.
The import-substituting policy was mostly adopted by developing countries to limit their imports and accelerate their domestic manufacturing sector. The major agenda behind adopting such trade policy in developing countries is to decrease the income gap with the developed countries.
Import substitution is a broadly applied policy by developing countries to minimize their reliance on developed countries by limiting imports and encouraging domestic manufacturing.
You've come this far learning. Great Job!
Now, to further strengthen your understanding of trade policies,
do not hesitate to check out the following articles:- Trade Policies
Features of Import Substitution
Let us have a look at some of the features of import substitution. We know that import substitution is the strategy adopted by developing countries to improve their economic situation by promoting their domestic industries. Hence, the main feature of import substitution is to manufacture the goods domestically rather than import them.
One of the important features of import substitution is that the government tries to protect industries by imposing higher tariffs on imports. Likewise, the government might also put in import quotas to restrict the number of imports. Further, subsidized loans are also provided to local manufacturers to optimize their production capacity.
Import substitution industrialization can also have a detrimental impact on the country. When one country seeks to optimize its manufacturing business by adopting certain policies that reduce or eliminate imports, it affects the exports of another country. So, other countries may also stop importing products from your country, potentially resulting in a trade war in the long run. As a result, market inefficiencies arise.
Want to learn more about the government policies that help in protecting domestic industries from international competition? Do check out our article: Protectionism
Methods of Import Substitution
The most important methods of import substitution used by the government are:
- Infant industry argument;
- Protection of manufacturing industries.
Infant Industry Argument
One of the most important arguments for import substitution is the infant industry argument. In this case, the infant industry refers to the new industries. According to the argument, the infant industry in developing countries cannot initially compete with the established industries of developed countries. In this case, the government must formulate policies that support the new industries until they are strong enough to compete at the international level.
To support those industries, the government can impose a high tariff on imported goods. This will result in expensive imports which can help consumer switch to domestically produced inexpensive goods. Likewise, the government can also impose import quotas that restrict the number of international products that can be imported into the country. This will in turn help domestic industries to capture a greater share of the market.
Fig. 1 - Methods of import substitution
Figure 1 illustrates the effect of import quotas on the economy. When there is no import quota, the quantity of imports ranges from Q1 to Q4 at the price level P. When the quota is imposed, the import range is restricted to the range of Q2 to Q3. This increases the price to P1 and decreases the import, which helps the domestic manufacturers to gain more share of the market and earn higher profits.
- The government can support infant industries by using the following measures:- Imposing a high tariff on imported goods;- Limiting import by applying import quota.
Indeed, the infant industry of a developing country needs to be supported in its initial stages by the government. Why not check out our article that covers this topic in detail: The Infant Industry Argument
Protection of Manufacturing Industries
Another important method of import substitution is the protection of manufacturing industries. The government tries to protect its existing manufacturing industries by providing them with subsidies. A subsidy is usually provided by the government in the form of cash or cash equivalents and some cases, they also provide tax breaks. This supports the existing infant industries and also encourages the new industries that can help in import substitution to enter the market.
A tax break is a government-provided deduction that helps an individual or a business to save its income.
A subsidy is a government-provided benefit in the form of money or tax breaks to support existing industries and encourage new industries to enter the market.
Import Substitution Example
Now, let us have a look at the example of import substitution.
Suppose, a developing country (Nepal) imports packaged chips from India. Packaged chips are highly consumed in Nepal but guess where it's manufactured? In India. Now, Nepal decides to stop the import of packaged chips and produce them domestically. Hence, Nepal is looking forward to building an import-substituting industry.
Likewise, for this strategy to work seamlessly, the government of Nepal adopts various policies (high tariffs on imports, import quotas) that supports domestic manufacturers and drives out foreign competition.
Similarly, to meet the domestic demand for packaged chips, the government also tries to encourage new manufacturers. To encourage new manufacturers to join the packaged chips manufacturing, the government decides to provide subsidies.
Advantages and Disadvantages of Import Substitution Industrialization
Some of the advantages and disadvantages of import substitution industrialization are:| Advantages | Disadvantages |
| 1. Increase in the number of industries creates employment opportunities. | 1. The domestically manufactured product can be expensive. |
| 2. Can make a country independent and have protection against the influence of international industries. | 2. Might lead to inefficiency due to the lack of competition in the market. |
Table 1 - Advantages and disadvantages of import substitution industrialization
Let's have a look at the advantages and disadvantages of import substitution industrialization in more detail.
Import substituting industrialization is mostly used by developing countries to minimize their reliance on developed nations. One of the advantages of import-substituting industrialization is there will be the creation of new jobs. To substitute the imported products, the country must increase the number of industries. The increase in the industry in turn demands more labor force, creating new job opportunities. Further, this type of industrialization can make an economy independent and protect it from the influence of international industries.
Along with the advantages, there are some disadvantages of import-substituting industrialization. One of the disadvantages is that domestically manufactured products can have various costs and thus be more expensive while at the same time they could have been imported at a cheap rate from other countries. Further, it might also lead to inefficiency in the domestic industries due to the lack of competition.
To learn more about international trade, do check out our following articles:
- International Trade
Import Substitution Industrialization - Key Takeaways
- A trade policy is a collection of agreements and guidelines developed by the government to ensure sustainable trade practices with foreign countries.
- Import substitution is a broadly applied policy by developing countries to minimize their reliance on developed countries by limiting imports and encouraging domestic manufacturing.
- The government can support infant industries by imposing a high tariff on imported goods and limiting imports by applying import quotas.
- A subsidy is a government-provided benefit in the form of money or tax breaks to support existing industries and encourage new industries to enter the market.
- Import substituting industrialization can lead to a trade war in the long run, which can cause inefficiencies in the market.
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Frequently Asked Questions about Import Substitution Industrialization
What is import substitution on industrialization?
Import substitution on industrialization is a broadly applied policy by developing countries to minimize their reliance on developed countries by limiting imports and encouraging domestic manufacturing.
What are the problems with import substitution?
The problems with import substitution can lead to a trade war in the long run, which can cause inefficiencies in the market.
What is the importance of import substitution?
The importance of import substitution is that it makes a country self-sufficient and helps in the creation of new jobs.
What is the difference between import-substitution industrialization and export-oriented industrialization?
Import substitution is a method for reducing a country's dependency on other countries by limiting imports and increasing domestic manufacturing. On the other hand, export-oriented industrialization is one in which the country invests more in developing industries to export a product that has a comparative advantage in the worldwide market.
What is an example of import substitution?
For example, country A imports packaged foods from country B. Now, country A decides to open an industry to manufacture its own packaged food which it will not have to import from country B. Hence, country A is shifting towards import-substituting industrialization.
What country uses import substitution?
After World War II, import substitution was widely used by Latin American countries - Argentina, Brazil, and Uruguay.
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