Critical evaluation of export substitution

By Priya Chetty on April 25, 2010

The three decades since 1965 witnessed rapid expansion in exports of manufactures from LDCs to the developed country markets. In the process, there was also increasing diversification in the manufactured exports. That is, the range of exports widened. The initial concentration around labour intensive, technologically standardised, older products (e.g. textiles—yarn and fabrics—clothing, footwear, toys, electronic assemblies, sports goods, bags, wood products, processed foodstuffs, etc.) was followed by new exports that were relatively more skill-intensive and capital intensive as well (e.g. ships, TV sets, parts, components and accessories of engineering products, steel, electrical machinery and other producer goods–machine tools–etc.).

An important question in the trade policy debate concerns the potential for future growth in exports of manufactures from LDCs to the developed countries. In other words, what is the scope for the transferability of the successful experiences of the East Asian countries to other LDCs?

The answer to this question, broadly speaking, can be presented by way of the views of the pessimists on the one hand and the views of the optimists on the other. While the pessimists refer to demand constraint, the optimists refer to the supply sided competitiveness.

Views of the pessimists

First, the pessimists argue that the progress in manufactured exports was largely concentrated in four East Asian nations (i.e. South Korea, Taiwan, Hong Kong, and Singapore). They together account for more than two-thirds of total LDC manufactured exports. In the rest of the Third World, primary products, which are the traditional mainstay, remain the predominant export.

Secondly, the pessimists argue that the success of the four Asian Tigers owes a lot to certain initial favourable conditions that they experienced which are not available to the newer LDCs trying to copycat the experience of the pioneers. These favourable initial conditions were as follows: (i)  favourable access to markets of developed countries characterized by rapid economic growth and trade liberalisation; (ii) increased and easy access to international finance from private capital markets; and (iii) increasing relocation of production by manufacturing as also trading multinational corporations in order to seek low-cost sources of supply, especially based on cheap labour in the Third World countries. As against these, the changing conditions of the world economy since 1973 through the 1980s and 1990s have been hostile to increasing exports of manufactures from the Third World. The counter-arguments of the pessimists are as follows: (a) The developed countries have been afflicted with a deceleration in growth or stagflation; (b) the governments of the developed countries have not let their ageing or ‘sunset industries’ to die economic death in the face of growing international competitiveness from the Third World, by granting them high effective rates of protection. Furthermore, the developed countries have resorted to ‘new protectionism’ in terms of non-tariff barriers (NTBs) which have discriminated most severely against exports of manufactures from the LDCs. The various NTBs are as follows: (a) import quotas; (b) voluntary export restraints—VERs—whereby the developed countries induce other nations to reduce their exports voluntarily, under the threat of higher all-round trade restrictions when those exports threaten an entire domestic industry in terms of dumping; (c) very stringent technical, administrative and other regulations–safety regulations (e.g. in automobiles and electrical equipments), red-tapism and harassment in customs procedures, health and sanitary regulations (e.g. in production and packing), environmental regulations, labelling requirements (showing origin and contents), labour standards, restrictions or ban on advertisements, etc.; (d) laws requiring the governments to buy from domestic suppliers (government procurement policies); (e) indirect taxes (imposed on imports while giving rebates for internal producers and exporters); and (f) export subsidies—direct payments or granting tax relief or subsidised loans to internal agents and granting low interest-bearing loans to foreign buyers (e.g. by the US Export-Import Bank). This is not all.  The pessimists further refer to the increasing adoption of the new flexible microelectronics based technologies in developed countries. This has had the power of undermining the comparative advantage of LDC producers and exporters based on cheap labour. The pessimists also emphasize the state of high external indebtedness of many LDCs and the increased importance of the IMF and the World Bank as their sources of external finance based on the conditionality of adopting stabilisation and structural adjustment programmes. Stabilisation involves a drastic reduction in imports which can result in deindustrialisation. Lastly, they argue that the growth of the manufactured exports from the LDCs will outpace the demand in the developed countries and if many newer LDCs reach the same high ratio of exports to GDP as in the case of the successful countries, then the market would be saturated and the terms of trade would deteriorate, making all countries worse off.

Views of the optimists

  1. The LDCs now supply only some 3 per cent of the manufactured goods consumed by the developed countries. Therefore, there is a large potential for greater penetration of the developed country markets.
  2. Overall, the penetration of industrial market economies by LDC exports in the 1980s grew more rapidly than penetration by other suppliers.
  3. Specifically, the successful case of Thailand through the 1980s as an exporter of clothing is a testimony against the views of the pessimists.
  4. The role of NTBs in thwarting the LDC exports is rather over-exaggerated by the pessimists. Evidence suggests that the trade adversely affected by NTBs is negligent or nil.
  5. The pessimists give too much emphasis on the external demand constraint. But even during the period of slower growth since 1973, the Asian Tigers have been able to expand exports at a highly credible rate. They could do so by remaining competitive on the supply side, thereby contradicting the commonly held belief that the export growth of LDCs depends on the income and demand growth in the developed countries. There are empirical studies to suggest that the export performance in most countries is relatively more sensitive to domestic factors, particularly the ability to compete in world markets.  The trade reforms and supply oriented policies of the successful cases have governed their growth rates which are higher than that of other LDCs without such policies or with half-hearted interventions in favour of outward-looking.
  6. There are empirical studies to show that intra-industry trade through horizontal specialisation (i.e. the exchange of differentiated products of the same industry or broad product group or industrial classification) has increased and the extent of this conducted by the developed countries with the LDCs has more rapidly grown than with that of other developed countries.
  7. It is a false understanding of the part of the pessimists that all countries would export at the same time at the same rate and with the same range of exports. Export of manufactures is characterised by more and more diversification in terms of the introduction of newer products and moving upmarket within product ranges. The everchanging structure of comparative costs allows a country to proceed up the ladder of comparative advantage, say from resource-intensive exports to unskilled labour-intensive exports to skill-intensive exports to capital intensive exports to knowledge-intensive exports. And as a country moves up the ladder, another country in the queue is able to follow it up by filling in the gap left by the former. Thus, as Japan rose on the ladder, the East Asian nations became major suppliers of the former exports of Japan. As the East Asian Tigers rose up the ladder, countries such as Thailand, Indonesia, Philippines and Malaysia are taking over the markets vacated by the Asian Tigers.

Priya is the co-founder and Managing Partner of Project Guru, a research and analytics firm based in Gurgaon. She is responsible for the human resource planning and operations functions. Her expertise in analytics has been used in a number of service-based industries like education and financial services.

Her foundational educational is from St. Xaviers High School (Mumbai). She also holds MBA degree in Marketing and Finance from the Indian Institute of Planning and Management, Delhi (2008).

Some of the notable projects she has worked on include:

  • Using systems thinking to improve sustainability in operations: A study carried out in Malaysia in partnership with Universiti Kuala Lumpur.
  • Assessing customer satisfaction with in-house doctors of Jiva Ayurveda (a project executed for the company)
  • Predicting the potential impact of green hydrogen microgirds (A project executed for the Government of South Africa)

She is a key contributor to the in-house research platform Knowledge Tank.

She currently holds over 300 citations from her contributions to the platform.

She has also been a guest speaker at various institutes such as JIMS (Delhi), BPIT (Delhi), and SVU (Tirupati).



2 thoughts on “Critical evaluation of export substitution”