Import substitution (IS) entails the reliance on domestic production by a country. In this case, the exports tend to be greater than the imports with the imports being minimized to restrict competition with local goods. It is a mechanism mostly deployed by emerging economies that for long periods have been dependent on developed economies. Exports and imports are essential economic tools for growth but an imbalance due to over reliance on imports is harmful to the economy. Substitution of imports favors locally produced goods over the external ones (Cypher, 2014). Therefore, this essay seeks to discuss the advantages and disadvantages of an economy employing an import substitution technique.
It promotes the initiation and growth of local industries. Restriction on imports creates increased demand for the products. This, in turn, generates a gap in the economy which calls for investment within domestic boundaries. Hence, local resources are redirected to the production of such services and goods leading to the formation of new industries. In addition, profits arising from such investment would transfer to increased saving rate, investment and capital formation (Cypher, 2014).
IS protects infant industries against competing with well-established international companies and markets. Competition would lead to the closure of such industries due to international entities having a competitive advantage over the local industries in terms of pricing and supply. IS technique serves to incubate the evolving industries to grow and have the capacity to compete in the international markets. Hence, it aids in making local economies self-sufficient, grow and reduce collapse of start-ups.
Employment generation due to domestic industrialization. IS enhances the demand for labor intensive industries that create job opportunities. This, in turn, reduces the unemployment rate in the economy. Further, livelihoods get improved that would reduce the percentage of individuals living in poverty. Moreover, an economy becomes more resilient to global economic shocks thus building economic stability and sustainability.
Reduces the cost of transportation from long distances to confined home boundaries. The focus shifts to developing home products and the cut-transportation costs to investing in industries. Moreover, IS does not limit the importation of machinery and equipment necessary for industrialization.
IS facilitates urbanization through the expansion of industries.
Lack of external competition affects the efficiency of the infant domestic industries. Hence, this would negatively affect growth. Also, the restriction such as physical, import licenses, guarantee deposits, and tariff walls would hinder trading across nations. Inefficiency reduces total output that leads to reduced growth rate.
Failure to meet consumer demands by the growing domestic industries may result in the development of ‘black markets’. Financial leakages take effect reducing government revenue and the overall capital base of the economy.
Trade protection due to IS may lead to overvalued exchange rates that cause a rise in domestic prices. Moreover, it forces governments to spend more to subsidize industrial investment. Inflation takes place causing exports to be less competitive. Also, it causes high budget deficits. An example is Sri Lanka during the 1960s and 1970s (Cypher, 2014).
The small sized domestic markets may not exploit the economies of scale from the home production. In such a case, it hinders production and growth thus, the collapse of the same industries. An example is a Brazilian economy. Brazil abandoned the use of IS on computers in the 1990s as the policy was a failure.
The presence of polarized internal income distribution. The ownership of the means of production will be monopolistic creating an extended gap between the rich and poor. This results in high inequalities within a country.
In conclusion, the essay has analyzed the import substitution mechanism. There are pros and cons to the IS methodology but its adoption would be viable based on country-specific factors. This is to ensure the economy remains in balance without any threat to growth and economic stability.