Industrialization in Malaysia

Import Substitution and Infant Industry Performance

Rokiah Alavi

• Publisher: Routledge
• Year: 2006
• Print ISBN: 9780415144766
• eBook ISBN: 9781134760657
• Topic: Business
• Subtopic: Business General
• Index: Business

Some of the most successful growth economies in the Pacific Rim have combined protectionist Import Substitution Industrialisation policies with export-oriented policies. This study provides a systematic rethinking of relationships between strategies within the Malaysian context.

1

INDUSTRIAL STRATEGY: A FRAMEWORK FOR ANALYSIS

THE ISSUE

For the greater part of the postwar period developing countries have striven to diversify, and particularly to industrialise, their economies as the surest way to accelerate their economic growth (Helleiner 1992). However, economists and policy-makers alike have long disagreed on the policies best practised for successful industrialisation (Krugman and Obstfeld 1991). The form of government intervention in this area is the distinguishing feature of alternative development strategies. Broadly speaking, a developing country may pursue two kinds of industrialisation strategy:

1 import substitution (IS); or

2 export promotion (EP).

If more incentives are provided to IS than to EP activities, the strategy is considered IS or ‘inward-orientated’; otherwise, it is EP or ‘outward-orientated’ (Bhagwati 1988; WBDR 1987; Balassa et al. 1982). However, there is still a controversy on the definition of export-promotion strategy. This has been discussed extensively elsewhere (Liang 1992; Edwards 1989; Bhagwati 1988; Lall and Rajapatirana 1987; Chenery et al. 1986; among others). Which of these strategies can be pursued depends upon a number of factors: the economy’s resource endowment (both physical and human); its size (particularly of its domestic market); its international context, especially the rate of growth of world trade and the policies of transnational corporations (TNCs); and the attitude of the national government.

Traditionally, industrial strategies¹ have been defined along a bipolar spectrum with import substitution (IS) and/or ‘inward orientation’ at one end, and export promotion (EP) or ‘outward-orientation’ on the other (Liang 1992: 447). A sharp distinction between IS and EP, however, is impractical, as these two classifications are overlapping rather than fully independent (Liang 1992; Helleiner 1990, 1992; Kirkpatrick et al. 1984: 200). Helleiner (1992) asserted that ‘there is certainly far more to the analysis of trade policy than the dichotomous characterisations that have been so emphasised in much of the mainstream literature in recent years — in terms of so-called “inward” and “outward” orientation’. In fact, in some recent literature it has been argued that these two strategies are sequential rather than alternatives and they can be compatible rather than separate strategies (Helleiner 1992; Liang 1992).

The general pattern of industrialisation (with few exceptions) in developing countries has been of an initial emphasis on import substitution followed eventually by a shift to export-orientated industries (Gillis et al. 1987; Teitel and Thoumi 1986). It has been argued that virtually all successful exporters of manufactures, except Hong Kong, began their industrialisation with import substitution under significant protection (Helleiner 1990: 888). Thus, it has been argued that EP and IS should be seen as sequential rather than as alternatives (Helleiner 1992).

Singer and Alizadeh (1986) see EP and IS as ‘complementary rather than alternative strategies’ because IS is needed, not only for creating export ability, but also for providing the volume basis necessary for competitive exportation. Indeed, this is the core of the infant industry argument. Furthermore, in the presence of oligopoly and scale economies, import protection is not only compatible with, but may even be instrumental to export promotion (Krugman 1984).

Empirically this view has been supported by the success of South Korea in its policy of pursuing both EP and IS strategies simultaneously (Pack and Westphal 1986; Park 1991, 1981). Suh (1975) terms the Korean strategy as ‘export-oriented import substitution’ while Krugman (1984) terms it as ‘import restriction as export promotion’. There are numerous writings focusing on how the Korean industrial strategy shift from import substitution to export promotion has successfully taken place (Amsden 1989; Wade 1988; Luedde-Neurath 1986; Westphal 1981).

But IS and EP are not necessarily seen as complementary by all governments and may not be sequential either. Evidence from Thailand and Malaysia, for example, has shown that EP and IS have been separate strategies and the industrial structures have developed along dualistic lines (Jansen 1991; UNIDO 1990; Lee 1985; Ariff and Hill 1985; Edwards 1991; Shepherd 1980). In this case, the problem is that not only is there no sequencing of import substitution and exports, but EP and IS strategies have been treated as separate strategies.

Thus, while the recent literature has concentrated on the compatibility and sequencing of the two strategies, the existence of ‘dualistic’ industrial strategies in other developing countries has been overlooked. The objective of this chapter therefore is to highlight this issue by examining IS and EP industrial strategies in developing countries.

IMPORT-SUBSTITUTION INDUSTRIAL STRATEGY

Import-substituting industrialisation strategies have been adopted in developing countries mainly for two major reasons: to cope with external trade imbalances and to promote industrialisation.

The strategy started as an emergency measure designed to respond to the successive challenges presented by the restrictions in the external sector, restricting primarily inessential imports, and with no thought at first of encouraging the replacement of them by domestic production (Little et al. 1970: 38). Only gradually was the significance of restricting imports to encourage domestic production fully realised, and import restriction turned into a policy deliberately aimed at encouraging the establishment and expansion of domestic industry by the protection of the domestic market and the gradual exclusion of competing imports.

International circumstances prevailing in the period 1913–50 are the most commonly cited explanation for the emergence of import substitution as an industrial strategy in the least developed countries (LDCs). This was the case in Latin American countries, where the impetus for import substitution was provided by severely disrupted primary export markets. This arose because of the Great Depression of the 1930s, and subsequently because of the breakdown of commercial shipping during World War II (Gillis et al. 1987). Confronted by deteriorating terms of trade, relief was sought by reducing imports through domestic manufactured goods production.

Among the prominent supporters of IS using the argument of deteriorating terms of trade in developing countries were Prebisch, Singer and Myrdal. Prebisch (1950) and Singer (1949) seriously postulated the danger of dependence on primary commodity exports in the LDCs. The Prebisch—Singer presumption is that the income elasticity of LDCs’ demand for exports from the developed country (DC) is relatively high, whereas the price and income elasticities of the DC’s demand for LDC exports are relatively low.

The importance of the disparity between the elasticities of demand can be explained by the specialisation in producing primary goods in developing countries and manufactured goods in the developed countries (Baer 1971: 180). The terms-of-trade pessimism argument ran as follows: increases in productivity can lead either to increases in wages or falls in prices. In LDCs, because the surplus of labour is exerting a constant pressure on real wages, the latter occurs. Since the demand for primary exports from LDCs is both price-and income-inelastic, export growth is slow because price falls do not lead to greater export volume.

It has been argued that increase in productivity in LDCs lead to a reduction in export prices and therefore have a detrimental effect on their external terms of trade. An opposing argument is that technological progress, which leads to productivity growth in the DCs, results in increased wages, and this is transferred into the prices of manufactured goods. Hence, the gains from technical progress in the DCs will usually be kept in the DCs while some of the fruits of technical advance in LDCs benefit the DCs. Thus, the outstanding differences between the standards of living of the masses of the two regions are widened (Prebisch 1962: 5). Rosenstein-Rodan (1943), Nurkse (1952), Myrdal (1958) and Park (1977) all argue along these limes.

Thus, Prebisch emphasised the importance of import-substitution industrialisation for the developing countries to correct trade imbalances. A prescription for this problem is either that the rate of increase of demand for imports would have to fall by means of import substitution, or industrial exports would have to be added to the primary ones, or a combination of the two (Prebisch 1959: 254). The former was the policy chosen by most LDCs.

One might ask why a choice needs to be made. Why not encourage both import substitution and exports? At least three strands of thought led many development economists to advocate import substitution rather than exports of manufactures. The first reason was that developing countries were sceptical about the possibility of exporting manufactured goods because of the severe competition in the world market from the established producers in DCs. The second was based on the belief that developing countries’ comparative advantage lay in highly specialised, primary commodity lines, and that an open trade regime, therefore, would result in each country’s continuing specialisation in a few primary commodities. Therefore, a restricted trade regime was favoured. The third was based on the premise that developed countries had such a head start that ‘industrialisation’ would not proceed at a satisfactory rate in the absence of protection.

The preoccupation of developing countries’ development strategy with the encouragement of manufacturing as opposed to other sectors of the economy is also, to some extent, a result of the symbolic importance of manufacturing as a sign of national development. Most advanced countries are mainly exporters of manufactured goods, while poor nations are usually exporters of ‘primary’ products such as agricultural produce and minerals. Thus, countries seeking to demonstrate their strength and independence often want to have conspicuous domestic industries such as steel or petrochemicals. Industrialisation has been seen as an important strategy for raising income levels through a number of mechanisms, including particularly foreign exchange savings or earnings, and the generation of externalities and linkage effects.

Gradually, the import restriction turned into a policy deliberately aimed at encouraging the establishment and expansion of domestic industry by the protection of domestic markets and the gradual exclusion of competing imports. This was particularly the case in the 1950s and 1960s, when the new politically independent developing countries began to view industrialisation as a road to development. Industry² was seen as a key to wealth accumulation and the engine of growth. This view was influenced by theoretical writings on the importance of the manufacturing sector in stimulating economic growth in DCs. List (1885: 133) for example remarked that industry possesses ‘the power of producing wealth’. Along the same perspective, many other economists demonstrated, using theoretical and empirical analysis, the superiority of the manufacturing sector as against the agricultural sector as an engine of growth.

Singer (1949), Park (1977) and Prebisch (1979) argued that the manufacturing sector leads to technological knowledge and has a higher tendency to create a dynamic and resilient economy. This idea was supported by Maizels (1963), Batchelor et al. (1980) and Kaldor (1966) using empirical data. Manufacturing industries were also argued to have greater ability to produce externalities and linkage effects, and therefore would generate a diversified, broad-based and integrated economy. Industrialisation is also argued to have a higher capacity to absorb labour (Rosenstein-Rodan 1943: 245) both in industry itself, and in services (Park 1977: 125). The scope for labour absorption through output expansion and diversification is said to be much greater in manufacturing than in the primary sector.

However, even though there does not appear to be a particularly close relationship between industrialisation and the level or the rate of growth of per capita income in developing countries, the presumption remains that sustained economic growth in the longer run requires industrialisation (Nixson 1990: 329).

The general nature of import substitution

The immediate approach of an IS policy is to replace imports of specific products with domestic production. Without a doubt, the simplest way to do this in a market economy is to impose limitations on imports. This limitation on imports has a variety of impacts (Power 1966). It creates gaps in the economy that make for obvious investment opportunities in non-traditional activities of the economy, usually manufacturing. Resources are directed into new industrial sectors and expected profits may lead to an increase in the saving rate and to further increases in investment (Bruton 1970). There are two crucial questions related to industrial promotion which arise here:

1which product to produce, or which industry should be promoted, and

2what is the appropriate and effective policy tool or industrial strategy which should be applied to ensure successful promotion?

Which industry should be promoted?...

Table of contents

• Cover
• Half Title
• Routledge Studies in the Growth Economies of Asia
• Full Title
• Copyright
• Contents
• List of figures
• List of tables
• Preface
• Introduction
• 1 INDUSTRIAL STRATEGY: A FRAMEWORK FOR ANALYSIS
• 2 MALAYSIAN INDUSTRIAL DEVELOPMENT: 1957-1990s
• 3 THE STRUCTURE OF TARIFF INCENTIVES IN MALAYSIA
• 4 THE INFANT INDUSTRY ARGUMENT: A THEORETICAL ANALYSIS
• 5 PROTECTION AND PRODUCTIVITY GROWTH
• 6 HAVE THE INFANT INDUSTRIES GROWN UP?
• 7 CONCLUSIONS AND POLICY RECOMMENDATIONS
• References
• Index