The Structural Transformation:
The Industrialization Process
Cypher and Dietz,
Ch. 9 & 10
What type of economic policy
for industrialization?
protective import-substitutionist
industrialization
(infant industry protectionist)
versus
liberal export-lead growth
What type of economic policy
for industrialization?
A third way:
protective import-substitutionist
industrialization within a limited time
frame
Strategy switches between
protective import-substitutionist
industrialization
and export lead growth (export substitution)
the rationale for infant industry
protection
• If domestic producers’ unit cost > foreign competitor’s
unit cost,and
• domestic country opens borders to international trade,
then
↓
likely to lead to domestic producers closing down due to
price competition from foreign countries.
• “transitional inefficiencies”: competitive disadvantage
of less-developed countries’ young firms vis-a-vis
existing, more mature foreign firms.
Why transitional inefficiencies in
the firms of developing countries?
• Lack of finance for investments due to
imperfect markets in banking and finance
• Lack of technology
• Few trained entrepreneurs
• Lack of learning by doing
How can firms of developing countries become
internationally competitive?
• In order for domestic producers to reach internationally
competitive levels of productivity, they need to decrease
their unit cost.
How?
↓
through technological change
and experience-based learning
• Yet such technological change and experience based
learning entails high costs that necessitates financing
until domestic producers become competitive.
The rationale behind ISI
Import-Substitution Industrialization
Government protection enables the
overcoming of transitional inefficiencies of
domestic firms by allowing them the time
required to initiate the production process,
invest in technology and engage in
learning by doing.
Infant Industry Protection as a form of finance
to raise productivity and reach international
competitiveness
• a protective tariff tax on imports → prices of imported
goods increase → domestic goods are able to
compete better in domestic markets
• as domestic demand for domestically produced goods
increases, domestic producers slide down the ATC
curves
• also domestic producers have a chance for learning
by doing
Also other policy tools for Infant Industry Protection :
• tax incentives, low interest rate credit, direct subsidies
to lower cost of production
• undervalued exchange rates
• creation of para-state firms
Opponents of ISI:
infant industry protection
as an internal barrier to development
No motivation for domestic producers to invest in
technology and learning
↓
• Productivity remains low; unit costs high
↓
• Consumers suffer from high prices and low quality.
• Overextended protection can lead to a few domestic
firms benefiting from rents at the expense of consumers.
↓
• Corrupt interest relations formed between bureaucrats
and industrialists leading to factional state.
↓↓
Eventually long-term growth and development process
is inhibited.
How can firms of developing countries become
internationally competitive?
• they need to decrease their unit cost.
How?
↓
through technological change
and experience-based learning
• This entails high costs that necessitates
financing until domestic producers become
competitive.
The rationale behind ISI
Import-Substitution Industrialization
• Government protection enables the
overcoming of transitional inefficiencies of
domestic firms by allowing them the time
required to
– initiate the production process,
– invest in technology
– engage in learning by doing.
• workers, managers and entrepreneurs can
improve efficiency in the process of actually
producing
Infant Industry Protection:
a form of finance to raise productivity &
achieve international competitiveness
• a protective tariff tax on imports
→ prices of imported goods increase
→ domestic goods are able to compete in domestic
markets
• as domestic demand for domestically produced goods
increases, domestic producers slide down the ATC
curves
• also domestic producers have a chance for learning
by doing
Impact of infant industry tariff
Prior to tariff consumer
surplus: PFfPM
Producer surplus: P0aPF

Higher
efficiency
With the tariff, CS:
PTdPM

PS: P0bPT
loss in CS: PFfdPT
government tariff
revenues: bcde
additional PS: PFabPT
deadweight loss:
PFfdPT– PFabPT – bced
= abc + def
After efficiency increase:
g
CS: PFPMf
PS: PFfg (larger)
dynamic welfare gains
13
Source: Cypher & Dietz (2004): p. 263
Additional policy tools for
Infant Industry Protection
•
•
•
•
•
tax incentives,
low interest rate credit,
direct subsidies to lower cost of production
undervalued exchange rates
creation of para-state firms
infant industry protection
with a timetable for phasing out
• Government announces a clear timetable at the
beginning of ISI.
• Domestic firms can anticipate the end of tariff
protection;
• hence they do not become complacent;
• instead they take advantage of the protectionist
period to prepare themselves for international
competition when the tariff is phased out.
ISI protection measures should not become a
permanent feature of the economy.
Long-term Industrialization Policy:
suggested sequence of ISI
Easy (primary) ISI (consumer non-durables)
↓
Strategy switch: export substitution
↓
Need for increasing import of complex, intermediate inputs
domestic vertical integration
↓
Secondary ISI (consumer durables and intermediate
goods → capital goods)
↓
Strategy switch: export substitution
export lead growth
Long-term Industrialization Policy:
important guidelines
• Using infant industry protection, a country can create its own
comparative advantage; but such protection can also lead to
negative consequences.
Hence:
• protection should always take place within a clearly defined
timetable
• it should end whenever enough time has been allocated for
domestic suppliers achieving international competitiveness.
↓↓
Long-term aim is integration into international markets but with a
carefully planned strategy for industrialization.
How long to protect?
No precise answer yet experience shows it
depends on the average learning curve of the
industry :
• Non-durable consumer goods have relatively
short learning curves: protection approximately
5 years
• More complicated products have longer learning
curves, hence protection might be longer.
ISI strategies in Latin America & India,
versus in South Korea & Taiwan
LA & India followed easy ISI prematurely with secondary ISI.
This failed because:
1. Secondary ISI industries need advanced technology and
sophisticated proprietary knowledge & skills;
•
to meet this need, they had to invite TNCs;
•
this shortcut the growth process of local entrepreneurs.
2. Lack of competitive pressures on domestic industry → few domestic
firms earn economic rents →
•
culture of vested interests and corrupt state
•
also little technical dynamism in technology and human capital.
3. Secondary ISI is less labor intensive than easy ISI (or easy export
substitution) → labor absorption slows down → unemployment
ISI strategies in Latin America & India,
versus in South Korea & Taiwan
In South Korea & Taiwan;
• easy ISI lasted only for about a decade (1950s into 1960s), and
then the strategy switch to export substitution.
• This lead to a more dynamic export pattern, dominated by
manufactured goods.
• Hence no prolonged protection for domestic industrialists; domestic
firms felt competitive pressures from international firms;
• and became more adept at making necessary technological and
human capital investments.
• Also use of “contests” → a performance based allocation system
where the state imposes rules, rewards and referees for private
firms wishing to gain access to protection.