1. Trade & Development I: Import Substitution Industrialization
International Political Economy
Prof. Tyson Roberts

2. Brief history globalization & development
Mercantilism (1500s-1700s)
Globalization through empire
Imperial goal: amass the most gold
Subsidize exports, tax imports
Classical liberalism (1800s– early 1900s )
Increasing free trade promoted by Britain hegemon
Continued promotion of trade within empires

3. How globalization helps developing countries according to classical liberalism 1st Age of Globalization
Free trade: poor countries specialize in comparative advantage (e.g., agriculture) & import other products (e.g., manufactures)
Free flow of labor: workers move from labor-abundant to labor-scarce economies => wages 
Free flow of capital: capital flows freely from capital-rich to capital scarce countries => investment, development

4. Example 1: Argentina in 1800s
Economically backward compared to Britain
Land abundant
Labor scarce
What should we predict regarding policy preferences of each group, and the resulting political coalitions?

5. Commerce and Coalitions 1st Age of Globalization (increasing free trade)
Labor scarce
relative to Land
Labor abundant
Capital rich
(Developed countries)
Capitalists & Landowners for trade
Labor against
Capital & Labor for trade Landowners against
Capital scarce
(LDCs)
Landowners for trade Labor & Capitalists against
Labor for trade
Landowners & Capitalists against

6. Commerce and Coalitions 1st Age of Globalization (increasing free trade)
Labor scarce
relative to Land
Labor abundant
Capital rich
(Developed countries)
Capitalists & Landowners for trade
Labor against
Capital & Labor for trade Landowners against
Capital scarce
(LDCs)
Landowners for trade Labor & Capitalists against
Labor for trade
Landowners & Capitalists against
Argentina

7. Brief history globalization & development
Mercantilism (1500s-1700s)
Globalization through empire
Imperial goal: amass the most gold
Subsidize exports, tax imports
Classical liberalism (1800s– early 1900s )
Increasing free trade promoted by Britain hegemon
Continued promotion of trade within empires
World Wars & interwar period ( )
Breakdown of free trade system, nationalist, fascist & communist movements

8. Crisis: WWI & Great Depression
War => increased demand for labor => increased power of labor in economics (unions) and politics (votes) (esp. in sovereign nations)
British Navy no longer strong enough to enforce free trade policies in developing countries
Rich and poor countries respond to crisis by imposing controls on trade, capital, immigration
Communists & Fascists extremely protectionist

9. Example 2: Argentina in 1930s
Economically backward compared to Britain
Land abundant
Labor scarce
What should we predict regarding policy preferences of each group, and the resulting political coalitions?

10. Commerce and Coalitions Depression of the 1930s (increasing protectionism)
Labor scarce
relative to Land
Labor abundant
Capital rich
(Developed countries)
Capitalists & Landowners for trade
Labor against
Capital & Labor for trade
Landowners against
Capital scarce
(LDCs)
Landowners for trade
Labor & Capitalists against
Labor for trade
Landowners & Capitalists against

11. Commerce and Coalitions Depression of the 1930s (increasing protectionism)
United States: New Deal
W. European Fasicism
Labor scarce
relative to Land
Labor abundant
Capital rich
(Developed countries)
Capitalists & Landowners for trade
Labor against
Capital & Labor for trade
Landowners against
Capital scarce
(LDCs)
Landowners for trade
Labor & Capitalists against
Labor for trade
Landowners & Capitalists against
South American Populism
Asian & East
European Fascism

12. Argentina 1940s-1950s
Juan Peron rises to power with support of labor, industrialists (import competing sectors) and military
Implements import substitution industrialization policies

14. Structuralist Critique of Economic Liberalism
Market imperfections in developing countries
Industrialization in modern era requires coordination
Complementary demand: need critical mass of wage workers to buy manufactured products
Pecuniary external demand: need related industries to invest simultaneously

15. Coordination Problem in Boom Town
Home construction firms
Build Homes
Don’t build homes
Restaurants
Invest in restaurants
10, 10
-5, 0
Don’t invest
0, -5
0, 0

16. Coordination Problem in Boom Town
Home construction firms
Build Homes
Don’t build homes
Restaurants
Invest in restaurants
10, 10
-5, 0
Don’t invest
0, -5
0, 0
Two Nash Equilibria

17. Coordination Problem Electricity Firm Invest in Dam Don’t invest
Manufacturer
Invest in factory
10, 10
-5, 0
0, -5
0, 0

18. Coordination Problem in newly-independent Ghana
Electricity Firm
Invest in Dam
Don’t invest
Manufacturer
Invest in factory
10, 10
-5, 0
0, -5
0, 0
Two Nash Equilibria

19. Solution to coordination problem: “Big Push” by Government
Volta Dam, Ghana
Major electricity producer
Valco aluminum smelter
Major electricity user

20. Structuralist Critique of Economic Liberalism
Market imperfections in developing countries
Industrialization in modern era requires coordination
Declining terms of trade
Imported manufactures prices rise
Export commodity prices fall
Result: core country real incomes rise, periphery country real incomes fall

21. Solution to Declining Terms of Trade Problem: ISI
Easy ISI:
Promote local production of consumer goods
Sufficient local demand to enable economies of scale
Sufficient local labor for labor intensive production
Necessary technology available for import (in part in form of foreign capital: machines, etc.)
Benefits: wage-based employment, human capital

22. Solution to Declining Terms of Trade Problem: ISI
Easy ISI
Second step options
Secondary ISI
Move up to consumer durables (cars, etc.), intermediate inputs (steel, etc.), and capital goods (machines, etc.)
Common in Latin America, South Asia, etc.
Export substitution
Expand consumer good production for export
Common in some East Asian countries

23. ISI Policies Government planning (5-year plans, etc.)
Government investment
Roads, rail, electricity, telecom, etc.
State-owned & mixed-ownership enterprises
Trade barriers
Tariffs (on manufactured goods)
Import quotas (on manufactured goods)
Overvalued and/or multitiered exchange rates to enable import of capital goods

24. Sources of funds for investment
Foreign aid
Foreign borrowing
Taxes on agricultural exports (marketing boards)
Tariffs on imports

25. $2 $1 $1
Pictures from

26. Winners & Losers from ISI Policies
Workers & firms in import-competing industries
Higher market share & prices for produced goods
Government
Jobs, opportunities for rent-seeking
Urban residents
Subsidized government services
Export-oriented farmers
Lower producer prices => reduced production
Consumers
Higher prices for manufactured goods
Manufacturers in export-oriented industries (if any)
Overvalued exchange rates increase price of exports, etc.

27. Assume the world equilibrium price for cocoa is $2
Assume the world equilibrium price for cocoa is $2. How much would Ghana cocoa farmers be willing to produce?
Price of cocoa SC 3 2 DC 1
Quantity of Ghanaian Cocoa 2 4 6

28. Assume the world equilibrium price for cocoa is $2
Assume the world equilibrium price for cocoa is $2. How much would Ghana cocoa farmers be willing to produce?
Price of cocoa SC 3 2 DC 1
Quantity of Ghanaian Cocoa 2 4 6

29. How would cocoa farmers respond if the government sets the producer price at $1?
Price of cocoa SC 3 2 DC 1
Quantity of Cocoa 2 4 6

30. How would cocoa farmers respond if the government sets the producer price at $1?
Price of cocoa SC 3 2 DC 1
Quantity of Cocoa 2 4 6

31. ISI policies successfully promoted industrialization & GDP growth in 60s & 70s
GDP/capita growth
1960s & 70s
Latin America
2.3%
Sub-Saharan Africa
1.4%
Middle East & N. Africa
3.7%
East Asia
5.2 %
South Asia
1.2%
Southeast Asia
3.1%
But for most countries (all but East Asia), those growth rates would not prove sustainable…

32. Conclusions
International and domestic developments and new belief systems => ISI Policies
World Wars & Depression strengthened relatively scarce factor owners
Political changes strengthened workers, domestic industrialists, urban voters, etc.
Marxism, Structuralist critique of economic liberalism, etc.

33. Conclusions
ISI policies increased industrialization & GDP growth, but …
Urban workers & industrialists benefitted to detriment of export-oriented farmers
Governments (esp. in “weak states”) took advantage of rent-seeking opportunities to over-extend protection of inefficient manufacturers
Budget & trade deficits left countries exposed to global downturn