Latin American Import Substitution

Latin American Import Substitution
Latin American Import Substitution

The term import-substitution industrialization (ISI) refers to the economic development strategy implemented by several Latin American governments in the period between the Great Depression and the debt crisis of 1982. Intended to encourage the growth of domestic industry, ISI emphasized an active role for the state in subsidizing and orchestrating the production of domestically produced goods.

State-owned enterprises were formed in such large-scale industries as petrochemicals, telecommunications, aircraft, and steel. In addition, high tariff walls and trade restrictions, including import licensing requirements, were imposed in order to protect infant industries from foreign competition.

At the same time, the governments of the developing Latin American countries imposed foreign exchange controls to promote the import of intermediate products deemed critical to the industrialization process while restricting the quantity of nonessential imports.

The origins of the ISI model can be traced back to the late 1920s and 1930s. Prior to that time the Latin American economy depended on exporting raw materials to—and buying manufactured products from—the more industrialized nations in Europe and North America.

With the stock market crash of 1929 and the onset of the Great Depression, Latin America's export markets were greatly diminished. The collapse of commodity prices undermined the export-oriented economies and led economic strategists to search for a strategy that would render Latin American countries less susceptible to the future fluctuations of the world market.

Arguments for a change in policy were strengthened during World War II, when a shift to wartime production in industrialized nations left developing countries vulnerable to shortages in consumer goods. In the years following the war, declining real prices for primary commodities further disadvantaged developing countries and led many third world leaders to search for an alternative to export-led economies.

The theoretical underpinnings for a policy of inward-looking development were articulated above all by Argentine economist Raúl Prebisch. As head of the United Nations (UN) Economic Commission for Latin America (ECLA), Prebisch greatly influenced Latin American economic policy in the 1950s.

He and other dependency theorists posited an inherently unequal relationship between the "center" (industrialized nations) and the "periphery" (developing nations) and argued that unfettered international trade would consistently work to the disadvantage of the periphery. Proponents of ISI therefore advocated an active state policy to counteract the natural tendencies of the international market.

State intervention was deemed justified by the apparent failure of market forces to produce sustainable growth in Latin America during the first several decades of the 20th century. Economic nationalists, eager to reduce dependence on the international market, turned to the state as the only economic actor with sufficient resources to compete with powerful multinational corporations.

The overarching goal of ISI was to develop domestic industries capable of producing substitutes for manufactured imports. State-owned enterprises proliferated in the three decades following World War II, particularly in industries that required heavy capital outlay.

In some cases, rather than full state ownership, Latin American governments offered industrial incentives in the form of direct payments or tax breaks for firms engaging in import-substitution production. In addition, states used a combination of tariffs, quotas, and import licensing requirements to facilitate the industrialization process.

The effectiveness of ISI strategies varied considerably from one country to the next within Latin America. In general, countries with larger populations and at least some degree of industrial development in place had more success with ISI.

In Mexico and Brazil, for example, the economies during the ISI period experienced rapid growth and diversification. Relatively poorer countries with smaller populations, on the other hand, often lacked a sufficient domestic market to support the profitable production of certain manufactured products, such as automobiles.

Even in relatively successful cases, the ISI model carried with it a number of interrelated problems, including overvalued exchange rates, inadequate export growth, and a large foreign debt. Dependence on imported consumer goods was simply replaced with dependence on imported capital goods such as heavy machinery.

Trade deficits continued and in some cases even worsened as exchange controls created disincentives for exports. In addition, the lack of competition in a protectionist climate fostered inefficient enterprises.

ISI also failed to remedy unemployment, and the rapid urban growth that resulted from industrialization created additional burdens on increasingly interventionist states. When governments responded by printing more money, rampant inflation resulted. One by one, Latin American countries abandoned the inward-looking strategy of ISI in favor of "neoliberal" economic policies.