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Industrialization (ISI)
1. What is ISI
Industrial development program based on the protection of local infant industries through
protective tariffs, import quotas, exchange rate controls, special preferential licensing for
capital goods imports, subsidized loans to local infant industries, etc.
In the “old economic order”, the “international division of labor” was such that industrialized
, higher income countries specialized in the production of manufactured goods, while the low
income non-industrialized countries specialized in the production of “primary” (agricultural,
mineral, forests) products. In this way, it was reasoned, different countries specialize in the
production of those commodities with which each enjoys a “comparative advantage” i.e. an
abundant resource or factor endowment (e.g. labor, land, technology,). Countries then trade
those commodities they produce for those they consume but do not produce. This meant that
the low income countries would have to trade their own relatively low value-added primary
sector products for the more expensive, higher-value added products in which the
industrialized higher income countries specialized.
Two developments beginning around World War II made this international division of
labor untenable for the low-income developing countries. First, the War itself forced
the industrialized countries to shift production from a civilian consumer market to a
wartime military market. Tanks and guns were produced in place of automobiles and
bread toasters. This left many developing countries which had come to depend upon
foreign manufactured consumer goods imports vulnerable to shortages of those goods.
Second, a long-term trend of declining “real prices” (prices adjusted for inflation) for
primary commodities began after World War II. This development meant that low
income countries specializing in primary commodity production received less and less
“foreign exchange” (US$) through trade, and therefore had to pay relatively more for
the manufactured goods from trade with the industrialized countries. These
“deteriorating terms of trade” meant developing countries dependent upon the
manufactured imports from the industrialized countries had to spend more and more
money to purchase those imports. Both of these developments made many Third
World leaders, especially in Latin America, to decide to promote domestic
industrialization to reduce their country’s economic dependence and vulnerability to
the First World economies. ISI became the policy strategy they pursued to gain this
economic independence.
3. Logic Behind ISI.
(a) Forward and Backward Linkages in Industrialization Processes. The goal of ISI
was to promote native/local industries to replace the foreign produced
manufactured products that were consumed as imports. A few principles of
manufacturing need to be understood: First, every industrial or manufacturing
process involves several stages of production. The number of stages in the
production process is a reflection and function of the complexity of the final
product. For example, the manufacturing process that transforms alumina into soft-
drink containers entails about 5 stages. The manufacturing process that transforms
about 17 primary metals into the structure that ultimately becomes an automobile
requires over 120 stages. Note also that the “density” (number of stages) of the
manufacturing process also influences the “value added” of the final product, and
hence the final price that industrialized countries can secure for complex
manufactured products.
Generally, we classify these stages of production into 4 inter-related industrial goods sectors:
(4) Capital goods sector (e.g. blast furnaces, pressure molds, robotic assembly
devices).
The key to success in industrialization requires that individual factories achieve “economies
of scale” of production.
In most manufacturing processes a point of output is reached after which the cost
of producing every additional unit of output diminishes. Different types of
industries, given their different production functions (combinations of capital and
labor, etc.) obtain different scale thresholds or minimum levels of output
necessarily to begin accruing cost savings from large-scale output. For example, a
mechanical pencil factory may need to sell 5 million units of output (pencils) each
year before it can achieve economies of scale of production – efficient level of
production. An automobile industry may need to sell 100,000 units of output (cars)
to achieve the same level of efficiency.
Clearly, the more units of anything manufactured you can sell the better the
chances that your factories (consumer goods and intermediate, and ultimately
capital goods) will achieve economies of scale, efficient production.
(1) Complete vertical integration – All stages, all sectors (virtually impossible in
most countries over a reasonably 20-year industrialization time-line);
1. Tariffs: Ad valorem taxes imposed on imported products to make them relatively more
expensive than comparable domestically produced goods. Such taxes serve to protect local
companies from foreign competition in the domestic consumer market.
Two concepts of protection: nominal and effective rates of
tariff
(a) Nominal tariff rate: Percentage difference between the price of a
good with and without protection. We can calculated the nominal
tariff rate as follows:
e.g. p = 10, p1 = 12
(b) Effective tariff rate: When the nominal rates of tariff for a final
product and its component parts or inputs are different can effectively
increase the protection of the domestic product beyond the nominal
tariff rate. We calculate the effective tariff rate as follows:
Pw-Cw
100-50
While several of the large developing countries (e.g. Brazil, Mexico, India) were reasonably
successful in fomenting industrialization through ISI strategies, this approach did have several
negative impacts as well.
In all 3 decades when ISI was the prevailing national development strategy in Latin America,
the urban labor force increased at higher rates than urban industrial employment (new job
creation), due to combined effects of internal migration and use of modern capital-intensive
(and labor-saving) production technology .
Moreover, new heavy industries created new demand for industrial fuels,
especially petroleum, which for many countries had to be imported from
OPEC. Indeed, oil as a percent of total imports increased from 8.7% in
1960 to 27.4% in 1983 in Latin America. The oil shock in 1973 set in
motion the debt crisis of the 1980s. (see Sessions 18 and 19).
1960 13.2%
1970 18.1%
1980 26.6%
1982 48.2%
1960 13.2%
1970 18.1%
1980 26.6%
1982 48.2%