Import Substitution (IS) does economically mean the satisfaction of a greater proportion of a country’s total demand for goods, i.e. production plus imports through its own domestic production. Import substitution refers to a government policy aimed at protecting local businesses in developing countries like Ethiopia from being overwhelmed by foreign firms.
The Ethiopian Herald interviewed Meskerem Tolcha, an economist working for a private entity as an expert with a view to having reliable information from professional point of view.
She said, “IS refers to a policy that reduces or eliminates entirely the importation of the commodity, and hence leaves the domestic market exclusively for domestic producers. Measures of IS that are based on changes in the ratio of imports of specific products to their total domestic absorption are of course concerned with this definition. A policy that reduces the proportion of the quantity of a product that is imported.”
As to her, historically, import substitution industrialization has been the instrument through which governments of developing countries bolstered the transformation from an agricultural-based economy to an industrial-based one.
She further said that, the idea of import substitution is to initially close to a country from imports which will allow local firms in new ‘infant industries’ room to grow and then eventually, as the local firms grow strong enough in the protective environment, markets would be opened to competition.
As to her, this policy involves initially closing the country from imports to allow local firms in new industries to grow, and then gradually opening up the markets to competition once the local firms become strong enough. Agricultural goods and import substitution on manufacturing goods often from imported materials and parts of products that were once purchased from abroad.
Import substitution has focused on domestic production through industrialization and required high import content. The machinery, technology, skills and processes requisite for installing high value production assets are often not developed and produced within Ethiopia, she opined.
Most of the industries targeted by Ethiopia’s import substitution policies are heavy duty industries with resource intensive outlay necessitating large volumes of foreign exchange, consequent transfer pricing and negative value-added found that manufacturing activities in the country were net users rather than net savers of foreign exchange.
She said, “The principal industries are food processing, textiles, brewing, and other related sub-sectors. Production of cement, clothing, footwear, tires, batteries, and bottles takes place in that line, too. However, import substitution programs have shown limited success in promoting economic growth and poverty reduction, and have often led to insufficient and slower growth compared to more outward-looking strategies.”
She further stated that, the primary goal of the implemented substitution industrialization theory is to protect, strengthen, and grow local industries. This is accomplished through a variety of tactics including tariffs, import quotas, and subsidized government loans.
The issue can be put into an understandable framework by identifying the objective of IS policies that are aimed at reducing imports of specific commodities. Part of the rationale of the structural change objective is that the existing structure makes the economy undesirably dependent on matters outside its own control.
The scheme aims at ensuring the supply of energy sources and resources from abroad, increase the investments in overseas exploration and development of energy sources and resources, improve the economic, trading, political and diplomatic relations, she said.
A possible way to achieve the target of import substitution is pursuing a strategic plan of industrialization, due to the positive correlation between industrialization and economic growth. It is in these circumstances that inward-looking development policies established themselves in different countries’ trade strategies, recalling protectionists’ features of covering national industries by introducing barriers to imports to promote self-reliance through the substitution of imports with domestic products and sources, involving initially manufactured consumer goods.
This means that import substitution it is not only connected with a decrease of the total level of products and resources imported, but also with the application of trading policies aiming at reinforcing the current industrial base or protecting new industries.
She said the process of import substitution often relied on a large amount of imported intermediate goods which were funded by subsidies of the government to the local companies. Basically, companies that succeeded in settling themselves behind protective barriers have been the ones that took advantage the most from this policy; indeed, these businesses used to transfer abroad their earnings in the form of private transfer payments instead of reinvesting these capitals to improve their efficiency as they were supposed to act.
The Ethiopian government policy, which has often been tried to protect small local businesses from being overwhelmed by large foreign firms, is the use of the concept of import substitution. The idea of import substitution is to initially close a country from imports which will allow local firms in new ‘infant industries’ room to grow and then eventually, as the local firms grow strong enough in the protective environment, and markets would then be opened to competition.
After time to grow and develop, it has been claimed the local firms would be mature enough to compete on an equal footing with foreign competition. However, these programs have rarely resulted in strong home-grown industries and the programs have done more to retard poverty intensification.
The economies of developing nations like Ethiopia did start to see economic growth and poverty reduction gain speed as the shift away from import substitution to more open policies became more common.
True, Meskerem said implementing an import substitution strategy that has made many countries rich and well developed ones, while there are a few cases of growth being correlated with import substitution strategies.
As to Meskerem, import substitution is an economic tool designed to complement exporting, to provide a more balanced and integrated approach to local economic development and sustainability. A community focusing on import replacement would seek to produce goods and services that are currently imported in order to keep money circulating locally. By developing local production, the country would increase its capacity to meet the economic, social, and cultural needs of the people from within.
Import substitution is not a replacement for exports, but a way of decreasing a country’s vulnerability to external pressures. Homegrown industries diversify and expand the local economy and they naturally begin to look toward regional, national, and global markets as they expand and grow. While the export model has dominated politics, public policy, and economic development discourse, this alternative complementary model has slowly been gaining recognition as ‘the other side of the coin’ – this complementary model is import substitution.
Import substitution can function as a strong incubator for exporting – as local capacity is built up through the successful displacement of imports, this naturally leads to exporting. From a local economy’s point of view, an export is any good or service sold outside of that local economy. Hence, a sale to a neighboring community, region or economy constitutes an export – it does not necessarily have to be an international export.
A positive change in productivity could be the most significant factor in lifting economic growth, and the prosperity that goes with it.
However, as consumers can choose among more varieties, they also become more sensitive to price. An often overlooked aspect of open trade is the added competition imports create in the domestic market. If not for imports, domestic producers would have a higher degree of market power. This lack of competition could allow them to set higher prices, give them less incentive to innovate, and result in lower quality goods and services being supplied to the market place.
She said, “Foreign exporting companies are thus usually world-class producers, offering leading-edge, high-quality, or innovative goods and services, while others offer lower-cost goods from countries with more abundant labor. The very presence of foreign competitors compels domestic firms to seek out efficiencies and cost savings and to offer higher-quality goods at the same or lower prices. This, in turn, makes domestic firms leaner, more efficient, and more competitive, thus benefiting consumers.”
Although additional competition may force some domestic firms to exit the marketplace, this is more than offset from the productivity growth as more efficient producers take over, and the resulting gains are passed on to consumers, she added.
In a nutshell, IS policies should focus on small scale manufacturing industries as the country could benefit much out of it. These are capital intensive and lead to a lot of importation of capital equipment, cost outlays, technology and skills importation and massive repatriation of earnings. Focusing on small scale industries provides a better value proposition for IS, as the economies of scale, competitive advantage, strategic capabilities and flexibility favor the industrialized countries more in terms of high-value, large scale manufacturing installations.
BY MENGESHA AMARE
The Ethiopian herald September 1/2024
