The of policy at its core in an attempt

The
relationship between trade policy and rapid industrial development has
fascinated nations across the global since the publication of Adam Smith’s “An
Inquiry into the Nature and Causes of the Wealth of Nations” in 1776. In the
two centuries following Smith’s publication, many economists including David Ricardo
and Paul Samuelson, acknowledged that the potential bridge between free trade
policy and rapid industrial development was the most beneficial for all
countries trading in this manner. In contrast, non-economists have continued to
remain deeply sceptical about the virtues of free trade and promote a restrictive
trade policy in an attempt to promote domestic industries. The notion of free
trade was based on the country’s ability to compete. Competition can be defined
as a country’s ability to gain superiority over other nations and is the root
from which a country’s status stems and economic well-being can blossom.

 

The end of World War II began an
economic expansion that excelled until the mid-1970’s, which seen GDP growth in
OECD member countries reach approximately 4.5% on average and the standard of
living in those countries improve drastically. This rapid industrial
development, known as the “Golden Age”, was captured perfectly by the former
Prime Minister Harold McMillan, who in his 1957 speech stated that, “Let us be frank about it: most of our people
have never had it so good. Go round the country, go to the industrial towns, go
to the farms and you will see a state of prosperity such as we have never had
in my lifetime – nor indeed in the history of this country.” Harold
McMillan’s 1957 speech was relatable across the globe, from Eastern Asia, to the
United States and Western Europe, all of which were rebuilding their nations from
the devastation which the war had caused.

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During this time of rebuilding, many countries
devastated by the war used an Import Substitution (IS) policy. This trade
policy had the protectionist type of policy at its core in an attempt to
promote internal industrialisation through placing restrictions on imports and
producing substitutes at home behind a ‘protective wall’. In practise, Import
Substitution Industrialisation (ISI) was put in place from the Great Depression
in 1929 to World war II in 1945 to protect a nations resources and to project
power that they could produce goods of similar quality in times of uncertainty.
The idea of ISI had three main components; firstly, the need for industrialisation.
This component highlighted the importance of a country to industrialise to
ensure sustainable productivity. Prebisch, one of the founding fathers of IS, believed
that poor countries could not just specialise in primary products because they
are declining the terms of trade for commodities, meaning the ratio of export
prices to import prices is falling which leads to a national trade deficit. In
addition, Nurske said that a slowdown of trade in these primary products would
result in unsustainability and limited benefits in the long term for poorer
countries. Secondly, the need for import substituion was exaggerated during
this time due to the restrictive markets in which countries where trading their
goods due to the political alliances. In the case of Italy, an ally of Germany in
World War II, who held comparative advantage in Europe for wine for the last
century, had their marketplace stifled as a result of their stance on the Nazi
regime and this resulted in France amongst others applying the IS idea to
produce their own wine to meet the demand in their country and ultimately compete
globally in the future. The thrid component was the need for protection. Nurske
said that balanced growth is needed to break through poverty but normal market
forces would not facilitate this so a triggering mechanism was essential, which
in this case was protectionism. Furthermore, Prebisch suggested that the
differences in productivity between developed and developing countries is too
high and therefore these developing countries need protection or their infant
industries would be victimised by the same industry in more advanced countries.
In other words, infant industries require protection from those countries which
avail of economies of scale as a result of comparative advantage due to
technical advancements or financial savings. A country can perform this
protectionist trade outlook through either a tariff on imports or a quota on
the level of goods permitted to be imported on an annual basis. This will
reduce the number of foreign goods in the economy which will result in less
money exiting the economy and an increase in the buying of substituted goods
which are manufactured domestically. This guarantees a certain level of demand
for infant industries which in turn generates sales and potential profit margin
which can then be used for reinvestment and expansion to the maximum level
under this protectionist umbrella. It is apparent that ISI is the cornerstone
on which rapid industrial development can be built. However, as IS interferes
with free trade, it causes an inefficient allocation of resources which leads
to slow growth. Furthermore, IS increase the price of imports as it creates an artificial
scarcity in the market which results in a gap between the artificially high
price of imports and the normal market price, also known as the scarcity rent. Subsequently,
importers compete to control this rent by trying to gain an import license to
the country, which can be costly for an importer to obtain. In addition, trends
illustrate that IS based trade has rapid initial growth in the short term but
is stifled after few years due to the saturation of their domestic market.
Moreover, although the tariffs and quotas decrease the amount of consumer lead imports
into the country, the country will increase it importation of foreign machinery
to produce the substituted product for the domestic market, so imports remain
higher than the theory would suggest and certain industries will remain infant
in the long term. In the case of IS, exports are a contributing factor to the
slow growth in the long term. Once the maximum level of expansion is reached
and the market is saturated, there is a lack of incentive to produce as the
level of exports is low under the IS model, as other countries will place
tariffs and non-tariff mechanisms to neutralise the restrictions they face. On
the whole, IS policy contradicts the theory of comparative advantage by Heckscher-Ohlin,
which suggests that the developing nation should specialize and produce the
good that they hold comparative advantage and trade these goods to other
nations for goods that the developing nation has higher opportunity
costs. 

 

In
addition to the IS strategy, another strategy that is considered in the rapid
development of countries throughout the world, was Export Orientation (EO). The
EO is a trade strategy which promotes the production of goods for the export
markets in competitive conditions. Export orientated strategy came in light of World War II ending during the global
consensus that countries foresaw their benefits only in working together. The
General Agreement on Trade and Tariffs 1947 was established to promote free
trade and generate exports to promote economic growth between partnering
countries. In contrast to IS, EO has a neutral incentive for exports. EO
conducts on the principal of low tariffs on all goods and services with no
other non-tariff mechanisms, which allows EO to promote economic prosperity
through efficient allocation of resources to promote free trade and
subsequently helps competition between domestic companies in a competitive market
which increases productivity due to incentives such as bonuses rely on profit
margin of the company. Furthermore, with little to no restrictions on trade,
there is no maximum level on trade unlikely the IS strategy so foreign
investment is more likely due to the greater return on investment. In recent
times, countries such as China and Indonesia have seen rapid industrial development
as EO trade allows labour intense countries to use comparative advantage which
increases demand of the product at a cheaper price and subsequently stimulate
growth resulting in job creation and an improvement in living standards. However,
unlike IS, EO strategy achieves allocative efficiency but not necessarily the
rapid export growth experienced with IS. Bhagwati, an advocate of free trade,
suggests that EO promoted openness which caused growth, but not in terms of exports.
In other words, he believed that EO strategy enabled markets to be open which
resulted in an increase in the exporting and coincidently the importing of
goods. Following studies conducted by Dollar and Edwards gave further backing
to Bhagwati, by showing that the more open an economy, the faster it grows. The
most notable of which was the free trade zone for European Union (EU) members.
The European Economic Area Agreement 1994, allows for all 28 member states to
trade freely to promote prosperity and good-will between all member states. However,
as suggested by the IS scholars, the EU free trade zone is saturated with
developed countries due to the benefits of integrated technology and skilled
labour which means it is difficult for developing countries access the market
due to a lack of financial stability as they compete with member states on the
majority of goods.

 

It is apparent from the arguments
made that ISI and EO have a range of benefits and limitations that can be used
to aid industrial development in developing countries. The first most notable
fact is that ISI and EO are not unconnected, they are the bridge that need to
be crossed to achieve a developed economy. ISI is a cornerstone to rapid industrial
development and acts as the foundation to further slow growth through EO as the
infant industries develop and no longer need protection as they are able to
compete. The first example of this transition working was the growth of the
four Asian Tiger economies, also known as the Asian Miracle. The first step was
the implementation of ISI by substituting goods in the foreign markets for domestic
goods. The steps that follow integrate the next level of sophisticated trade or
integrated the other strategy to meet the last level of trade e.g. moving from
simple IS trade of manufacturing to the substitution of heavy industries and
the exporting of the goods manufactured (ISI and simple EO). This type of
integration continued with the substitution of high-tech manufacturers and the
exporting of simpler manufacturing (high level ISI and secondary EO). Through
this type of trading, the Four Asian Tiger economies of Hong Kong, Singapore,
Taiwan and South Korea shifted from developing to developed due to the
industrialisation and competitiveness of their economies over a relatively
short period of time and moving from IS to EO once it was deemed appropriate. In
the case of South Korea, who came out of Japanese rule following World War II
and then had the Korean civil war from 1950-53, ISI was implemented to
protected the remaining industries that made it through the wars. Under ISI,
30% of GNP and aid going towards agriculture. South Korea then transitioned to
export orientated growth by gaining comparative advantage due to cheap labour
under the Rheaa era, which led to rapid economic growth. During this time,
South Korea’s government where still protecting growing economies through
tariffs and subsidies from the international market. However, the government
understood that this growth, of 10% in the early 1960’s was unsustainable and
that further trades strategies had to be implemented to stabilise the growth.
The government used the balance surplus as a result of increased exports to
invest in more advanced industries such as chemical and pharmaceutical. Foreign
capital sparked growth in exports of 39.2% in the 1970’s which seen investment
in education and infrastructure which accounted for a massive spike in
industrial output in the decades that followed.

 

In spite
of the ideal transition South Korea has made to industrial development, other
developing countries at that time of rebuilding did not transition in such a
smooth manner. During this time, many countries followed the ISI strategy
similar to that of the Four Asian Tiger Economies, however got stuck using the
strategy after the rapid growth caused an illusion of sustainable growth
through these means or a poor ISI foundation so the transition was made more
difficult. Nonetheless, by sticking with the ISI strategy, countries in Latin
America for example soon declined or plateaued after the growth as they had
reached the maximum level of ISI growth. In the case of Argentina, Prebisch an
Argentinian economist, believed that countries who operate on a basis of free
trade had unequal power and had little say on the market price of exports.
Prebisch continued by suggesting that developing countries could only prosper
by creating industries that used the primary products that Argentina manufacturer
domestically and implement tariffs to protect their infant industries to allow
them to grow. This diminished Argentina’s reliance on exports as they no longer
had to sell their primary goods for low prices to obtain foreign industrial
goods. Subsequently, this resulted in an increase in income for the majority of
the population as it became a labour abundant economy that operated by selling
labour intensive goods. This strategy was implemented throughout Latin America
and seen growth rates of 6% per year from 1945-75, which subsequently came to
an end due to the inability to transition to EO growth. This was a result of
countries such as Argentina not being able to specialise in those goods that
they held comparative advantage on an international scale and the saturation of
their own market resulted in an inefficient allocation of resources and the
growth ceased.

 

Import
Substitution (IS) strategy and Export Orientation Strategy (EO) are the pathway
to bridge the gap between the developing and the developed, however it is
important to note that the success of a country ultimately depends on their
governments ability to plan and implement IS effectively to ensure that the
transition between the two strategies takes place without difficulties or the
country may find itself falling further behind as a result. ISI will provide a
country with the short-term rapid industrial development needed to spark the
transition, however if not followed by EO the growth will be deemed worthless
as seen in Latin America.