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Import substitution: what can we learn from East Asian countries?

“Even if they do not explicitly say it like this, it seems foreigners who come to Ethiopia [with capital] would say to the Ethiopian people as follows: the reason why we have come to Ethiopia is to take the wealth of your country. However, since the land is yours, you will not let us work on it and take what is in it. [But] if you let us [do this], we will not bring workers from our country as the cost of labor would be high. As the wages of your labor are extremely low, let you yourself do the work and give us [the output]; we shall pay you small amount of money for your exertions. But, with this small amount of money we pay you, do not buy the equipment and machinery that is required to manufacture the clothing and other items that you need for your consumption; and never produce them by yourself. From now on, do not manufacture shema (cotton garment produced by Ethiopian traditional textile industry), swords and all the things that have been locally produced. Buy everything from us. Return to us the money we have given you immediately with large amount of interest.”

This is a translation of a quotation from a great Ethiopian Economist Gebrehiwot Baykedagn (1886-1919). (Gebrehiwot, Baykedagn. 1995. The State and Economy in Early 20th Century Ethiopia by Gebrehiwot Baykadgn. Translated by Tenkir Bonger)

Countries develop in a myriad of ways. Some states pursue an export-oriented philosophy, trying to produce the goods and services that can be competitive in the global market. Some others focus on protectionism and import substitution – supporting businesses and industries that can manufacture goods and provide services to replace imports. More often than not, this policy is described as import substitution industrialization. For years, it was a defining feature of economic development in East Asia. Today, some developing countries readily embrace its advantages in an attempt to strengthen their economic position and hasten their economic growth. Although import substitution has a good promise to promote economic and trade development in Ethiopia, the main lesson from East Asia is that this policy is extremely state-centered. Therefore, the country should decide if it is willing to continue with import substitution industrialization or switch to a different strategy for continuous economic development and more effective development and trade ties.

Import substitution is a policy of economic development, when developing or emerging economies take a step to relieve their dependence on richer countries and markets (Segal, 2019). That is, developing or emerging countries choose to replace the products and services imported by their more developed trade partners in an effort to become more economically independent. Import substitution implies that states and countries build protectionist policies to support domestic industries and reduce imports (Segal, 2019). They can use different instruments to accomplish this purpose: Ogujiuba, Nwogwugwu, and Dike (2011) list import quotas, tariffs, preferential licensing, and exchange rate controls. Countries may choose to provide subsidies or cheap loans to infant industries (Ogujiuba et al., 2011). In any case, import substitution is a policy of protectionism. That said, states take an extremely active part in import substitution policies and processes.

Import substitution used to be a distinctive feature of economic development policies in East Asia. Sugihara (2019) writes that China and India were among the key adopters of the import substitution industrialization framework. The intent was to gain political and economic independence from industrialized countries. It was a matter of politics; it was also a matter of economic growth for these countries. Import substitution was also a policy embraced by the Asian Tigers. However, beyond simply imitating and replacing imported goods and services, East Asian countries also learned from their experiences; they sought to innovate and outperform their former suppliers. Consumer goods were the primary target for import substitution industrialization in East Asian countries: it was expected that the growing demand for locally manufactured consumer items would launch a chain reaction, fostering the development of other supplemental and intermediate industries (Ogujiuba et al., 2011). To a large extent, East Asian countries successfully fulfilled their import substitution tasks, turning into leaders of the local, regional, and global economy. As such, it is not surprising that other countries, including those in Africa, are willing to take the same path.

Ethiopia is also tinkering to some extent with import substitution. Xinhua (2017) reports that Ethiopia is saving billions of dollars manufacturing local goods and producing services to substitute imports. Between 2012 and 2017, nearly $2.3 billion was saved due to import substitution (Xinhua, 2017). Some of the key substituted products included vehicles, vehicle spare parts, elevators, and steel products (Xinhua, 2017). All these products come from resource- and labor-intensive industries. Xinhua (2017) writes that the Ethiopian government expects that local companies will substitute imported cement, textile, vehicles, sugar, and heavy-duty trucks. This policy has its advantages, but it also has drawbacks.

East Asian countries teach a lesson of success in import substitution. Countries that adopted the policy were able to create a robust industrial base and a comprehensive manufacturing infrastructure. Both serve as a foundation for continued economic growth and sustain countries’ competitive advantage in the global market. With more local manufacturers involved in industrial and economic processes, countries will be less vulnerable to external market volatility, relying on internal resources and providers instead. At the same time, Ethiopia should not forget that import substitution industrialization is a state-centered and state-oriented policy. It can thus limit the true functioning market forces. Furthermore, Ethiopia cannot cut its ties with the global world; nor can it substitute all products and industries.

The pros and cons of import substitution and its implications for the Ethiopian economy should be clearly evaluated and analyzed. Significant savings certainly create a promising and positive climate, but everything is good when it is balanced and moderate. Import substitution should also follow this rule. Ethiopia may want to substitute imports in the most competitive industries, leaving the most resource-intensive products to more experienced foreign traders. The country may also want to look more thoroughly into the failures or negative legacy of import substitution in East Asian countries. In any case, short-term savings should not blind Ethiopian authorities in its striving to acquire and retain a strong manufacturing advantage. The Ethiopian government must think several steps ahead to realize the advantages and disadvantages of import substitution industrialization in the long run.

Ed.’s Note: Samuel Alemu is a partner at the ILBSG, LLP. His partner at the ILBSG, LLP, Praveen C. Medikundam, contributed to this article. They are both admitted to the bar associations of New York State, United States Tax Court, and the United States Court of International Trade. Samuel can be reached at [email protected]. You can follow Samuel on twitter @salemu.

Contributed by Samuel Alemu