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Import Substitution Industrialization (ISI)

The development of domestic industries and the reduction of reliance on manufactured foreign imports

What is Import Substitution Industrialization (ISI)?

Import substitution industrialization (ISI) is an economic policy that favors the development of domestic industries and the reduction of reliance on manufactured foreign imports. ISI was a prominent policy in the 20th century for developing countries seeking to reduce their dependence on developed countries, with the goal to reach industrialization and eventually become self-sufficient. However, the policy lost its momentum in the latter half of the century.

 

Import Substitution Industrialization (ISI)

 

Summary

  • Import substitution industrialization (ISI) is an economic policy that favors developing domestic industries and reducing reliance on manufactured foreign imports.
  • ISI was a prominent policy adopted by developing countries in the 20th century to create a self-sufficient internal market.
  • ISI is achieved through government subsidization of vital industries, protectionism, nationalization, and increased taxation.

 

Understanding Import Substitution Industrialization

Development economists such as Raúl Prebisch argued that developing countries could not progress without industrialization. Developing countries rely heavily on manufactured imports from developed countries due to inadequate domestic industries, locking them into a primary goods export model.

Import substitution industrialization seeks to reduce this dependency by protecting and building up domestic industries until developing countries can create a self-sufficient internal market. ISI is achieved through:

  • Government subsidies for vital industries: State-induced industrialization is the foundation of import substitution industrialization.
  • Protectionism: Enforcing tariffs and quotas to make foreign imports more expensive and inaccessible. Revenue collected from tariffs can be injected into industries
  • Nationalization: Transferring private industries into state control
  • Increased taxation: Generating funds to subsidize industrial growth

 

ISI Example – Latin America

The most prominent example of import substitution industrialization adoption is throughout Latin America. The Great Depression in the 1930s severely hurt Latin America’s export market. They realized that their heavy reliance on natural resource export was not sustainable and made them vulnerable to the international market.

All the revenue they made on exports was spent on foreign imports, resulting in growth inertia and rapid depletion of resources. Furthermore, Latin American countries suffered from weak domestic markets as a result of small local industries run by elites, leading to high levels of unemployment.

Import substitution industrialization became the obvious solution to such problems. Many Latin American countries adopted ISI by investing heavily in key local industries. Private industries were nationalized to strengthen state control. Tariffs and quotas were put in place to decrease imports, and taxes were increased to support the policy.

However, the policy implementation was met with mixed results. Countries such as Argentina, Brazil, Chile, Mexico, and Uruguay were successful in adopting ISI due to their investment in technology and meticulous planning. They experienced moderate industrialization and a reduction in unemployment.

On the other hand, countries such as Peru, Bolivia, and Ecuador were unsuccessful. Their failure can be partially attributed to their inability to reach consensus, as well as resistance from elites to invest in technology. In such cases, the countries failed to develop key industries and subsequently reverted back to exporting natural resources.

Overall, even successful implementation of industrial substitution industrialization came with its respective triumphs and shortcomings. Indeed, industrialization and economic growth were favorable outcomes. However, ISI also unintentionally created unforeseen problems.

For example, the increased role of state control encouraged corruption, and the excessive protection of industries led to an absence of competition and, therefore, unproductivity. Most importantly, ISI was a costly policy to maintain, and the long-term implementation resulted in high public debt.

By the early 1980s, many countries defaulted on their sovereign debt, effectively known as the Latin American debt crisis. The International Monetary Fund (IMF) and World Bank stepped in to intervene by making structural adjustments. A precondition for their help was to abandon their import substitution industrialization policies for neoliberal policies. Thus, ISI quickly lost its influence in Latin America.

 

Additional Resources

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Imports and Exports
  • International Monetary Fund (IMF)
  • Tariffs
  • Unemployment

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