IMPORT SUBSTITUTION (IS) AND GOVERNMENT INTERVENTION
According to Bruton (1998), Import Substitution is substituting the imported goods with the locally produced goods in order to meet the internal demand.For this, a protection is needed. The institution that will make this protection is the government. In general words, this is a government intervention to the market. The government can do this not only via tariffs, quotas but also via exchange rate, prices of the factors of production and interest rate. All of these cause a profound bureaucracy that can be harmful for the market. In short, IS is a strategy that appreciates the local production via government intervention to the whole economy.
When starting an IS strategy is adopted, it should be temporary, because it is assumed that the protected industry will in turn progress and will able to compete with the foreign industries. In practice the results are opposite to this view. Nevertheless IS strategy is attractive for developing countries. The goal of the production in an IS strategy is to serve the internal demand.
Interventions in Import
A tariff is a tax on importing a good or service into a country, gathered by customs officials at the place of entry. Tariffs fall into two categories. A specific tariff is a money amount per physical unit of import. For example a $ per ton of textiles. An ad valorem tariff is a percentage of the estimated market value of the goods imported. For example a 25 per cent of the value of textiles imported. In general, as a result of a tariff consumers will end up paying higher prices, buying less of the product or both. A tariff brings gains for domestic producers who face import competition.
It is likely that tariffs of importing country result in retaliation from exporting country and both countries end up losing most of the gains from trade. Suppose we assume that the terms of trade of the nation imposing the tariff improve and those of the trade partner deteriorate. Facing both a lower volume of exports and deteriorating terms of trade, the trade partner’s welfare declines. As a result the trade partner is likely to retaliate and impose a tariff of its own. The volume of trade further declines. If the process continues, all nations end up losing most of the gains from trade. Cleary this hampers International Trade
Import Quotas and Voluntary Export Restraints
The government gives out a limited number of licences to import items legally and prohibits importing without a license. A quota gives government officials greater administrative flexibility and power. A quota is a shelter against further increases in import spending when foreign competition is becoming severe. The quota cuts the quantity imported and derives the domestic price of the good up above the world price at which the licence holders buy the good abroad.
The way in which a quota is allocated will have impact on consumer welfare. Competitive auction is the best way. The competitive auction is likely to yield a price for the import licences that roughly equals the difference between the foreign price of the imports and the highest home price at which all the licensed imports can be sold. In the case of a public auction, the quota system does not cost the nation any more than an equivalent tariff. Allocating quota on a fixed favouritism is the most illogical way. In this method the government allocates fixed shares to already established firms without competition. A third method is resource-using application procedures. This is considered the least efficient way and a non-price method of allocation. limited, this bids the prices up for that limited foreign supply. The world as a whole loses as voluntary export restraints limit trade between nations (Hill 1999).
The governments of importing countries levy antidumping tariffs against dumping. Dumping is a form of international price discrimination in which an exporting firm sells its product at a lower price in a foreign market than it charges in its home country market. Dumping is considered a method by which firms unload excess production in foreign markets. There are two types of dumping. Predatory dumping occurs when the firm temporarily discriminates in favour of some foreign buyers with the purpose of eliminating some competitors with the intention of later raising its prices after the competition is over. Persistent dumping occurs when price discrimination goes on forever. Dumping by an exporting country is often subject to retaliation by the importing country. The governments of importing countries levy antidumping tariffs. In a way, antidumping policies are designed to punish foreign firms that engaged in dumping. The objective is to protect domestic producers from so-called “unfair” competition. Usually domestic producers file a petition with the appropriate government agencies. An antidumping duty is likely to lower world welfare. It is possible uncompetitive domestic producers can call for antidumping duties from firms that may not be dumping. In a way this is an excuse for protectionism. In this case antidumping duties are like usual tariffs and generate costs to the world and to the importing nation as well.
Local Content Requirements
National governments can require firms to use a specific minimum proportion of inputs of a good to be sourced domestically. Kenya forced the radio and television stations to give a certain share of their airtime for local songs, shows and content. Developing countries frequently use this method as a device for promoting local manufactured products and components. By limiting foreign competition the producers of local content benefits. Restrictions on imports raise the prices of imported contents. Higher prices for imported contents raise the cost of the final products produced locally and in turn raise the prices. Overall, this scheme tends to benefit producers but not consumers.
Some times a range of administrative trade policies or bureaucratic rules can restrict imports and boost exports. The resulting delays due to bureaucratic rules can have direct impact on imports. Bureaucratic rules benefit producers and harm consumers by denying access to superior and lower cost foreign products.
Interventions in Export
Export interventions are export quotas, export tax and export subsidy. Export quotas are rarer, but tend to be more severe, than import quotas. For example to avoid national famines governments used to control exports in the past. In the extreme they can take the form of an export ban or export embargo, both refers to complete bans or economic sanctions. Export tax is common, which has effects that are symmetrical to those of an import tax. An export tax, in the face of a fixed world price, discourages exports and directs supplies back onto the home market, pushing down the domestic price. Exports are often subsidized. For example, governments use taxpayers’ money to give low interest loans to exporters, engage in advertising and export promotion on behalf of exporters and give tax relief based on the value of goods or services each firm exports. Lower prices of exports due to subsidy likely to benefit consumers and harm producers of importing countries. The governments of importing countries have a good reason to protect their producers from unfair competition. They do retaliate by imposing a tariff against exporters which is widely known as countervailing duties. Higher domestic prices of importing countries as a result of countervailing duties suppose to protect the domestic producers. GATT/WTO do proscribe export subsidies as “unfair competition” and allow importing countries to retaliate with protectionist countervailing duties. The net effect of the subsidy plus countervailing duty together determines the world welfare.
Advocates of strategic trade policy support granting subsidies to strategic industries/firms. This form of subsidy is different from the infant industry argument for protection. Countries may predominate in the export of certain products because they had firms that were foremost in technology and able to attain first-mover advantages in industries that would support only a few firms because of substantial economies of scale. Government should use subsidies to support promising firms in emerging industries and should provide this support until the domestic firms establish first-mover advantage in the world market. Both home market protection and export subsidies are advocated.
Government intervention in the form of foreign trade protection creates direct and indirect costs to the economy as a whole. The misallocation of resources in production and the reduction in consumer welfare because of the misalignment of domestic and foreign prices generate direct costs to the economy. Indirect costs derive from unproductive activities associated with protection such as evading tariffs, under capacity utilization and smuggling.