Import Substitution Industrialization

Import substitution industrialization (ISI) is a government strategy designed to encourage domestic industry to supply markets previously served by foreign imports. The goal is economic growth along with a measure of political and economic self-reliance. ISI policies aim to create and nurture infant industries to substitute for imports, as the phrase itself suggests. These new domestic industries may be locally owned (public or private) or foreign owned. The latter, foreign direct investment, usually requires a series of incentives to attract foreign firms to set up production facilities within national boundaries. ISI has been especially significant at one time or another in large economies such as China, India, Japan, Brazil, Mexico, and Argentina. As an inward-oriented strategy, ISI sometimes is contrasted with export-oriented industrialization, although the two are not mutually exclusive and many countries' policies combine elements of both.

ISI originated in Latin America, partly as a result of the twin shocks of the Great Depression and World War II and partly as an innovative and sophisticated set of policy prescriptions. ISI policies involve a complex mix of strategies, including the use of relatively high import tariffs, quota restrictions on imports, and controlled access to foreign exchange. Such protectionist measures to encourage domestic production usually are combined with disincentives to exporters. The idea is to increase industrial capacity and complexity over time by starting with simple consumer goods such as clothing, processed foodstuffs, and pharmaceuticals. ISI theorists prescribed four stages in this process. As firms gained stability and the nation became self-reliant in simple consumer goods, the country would move to more complex products such as stoves, radios and television sets, and automobiles—known as consumer durables. Countries at this second stage that did not have the capacity to manufacture every part of a given product, such as a stove or an automobile, were allowed by Latin American ISI theorists and planners to import the needed components. Thus, the importation of industrial parts was permitted, but that of assembled manufactured goods was not. With the industrial foundation gained during the second stage, nations would concentrate on the third stage, the production of intermediate goods, which specialized in the manufacture of the parts and components for consumer goods. The fourth and final stage emphasized the production of capital goods (e.g., machines to make parts and components), including steel and chemicals needed in the manufacture of heavy machinery. ISI theorists suggested that industrial self-sufficiency would be accomplished during these four stages.

To succeed at industrialization, ISI theorists advised national governments to protect local industry during its formative period from foreign competitors that, because of their head start, were capable of underselling local manufacturers. Latin American countries used several techniques to protect their new industries, including the establishment of import quotas that limited the number of competing foreign goods allowed into the country, the imposition of very high tariffs or duties on those products that were permitted into the country, and the maintenance of overvalued currencies that had the effect of discouraging sales of industrial raw materials abroad. Another common government response—and one that created some political fallout—was the outright nationalization of public utilities, airlines, railroads, mines, steel mills, and other basic industries.

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