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case for import substitution?
issue with my conclusion in the May 22 column that the Indian industry
needs further trade liberalisation, labour-market reforms, an end to the
small-scale industries reservation, effective bankruptcy laws and
privatisation to catch up with China, my friend Professor Dani Rodrik of
Harvard University writes in a personal note:
of the countries of Latin America did all of that, and the result was a
rate of industrial growth (and TFP expansion) that is way below the levels
experienced under ISI [import-substitution industrialisation]. The least
that India can do is to learn from this experience and not assume that all
the good things will follow as soon as trade liberalisation, deregulation
and privatisation takes place.”
is among a handful of thoughtful critics of trade liberalisation and
deregulation who ground their views in serious scholarly research.
Therefore, one cannot summarily dismiss his advice.
how does one respond to Rodrik? To begin with, there are serious limits to
applying the Latin American experience to India. Since early 1970s, Latin
America has been repeatedly subject to devastating macroeconomic crises.
The worst India has seen is the balance-of-payments crisis of 1991.
place this contrast in perspective, while a 20% inflation rate is
synonymous with the absence of inflation in Latin America, it defines the
absolute upper limit of tolerance in India.
Four years ago, insufficient appreciation of this difference landed
the then chief economist of the World Bank, Joseph Stiglitz, into hot
water at a conference in Colombo.
on research based principally on Latin American data, Stiglitz argued
forcefully that the additional benefit from fighting inflation was zero
once it had been brought down to 20%.
That sent the South Asian policy makers present at the conference
into fury: how could Stiglitz not know that in South Asia 20% inflation
was equivalent to death for the poor!
leave this qualification aside and examine the case for ISI made out by
Rodrik in his recent book, Making Openness Work.
He presents evidence showing that the years 1960-73 define the
golden period of growth for developing countries with 30 countries growing
at 3% or more in per-capita terms. In contrast, growth rates plummeted
during 1973-84 and 1984-94. The decline was especially pronounced in Latin
America (columns 2 and 3 of the accompanying table) and Africa.
Growth Rates in the Latin American Countries that Grew 3% or More During 1963-73*
* Barbados and Panama also grew at rates exceeding 3% in per-capita terms during 1963-73 but had to be omitted from the table due to unavailability of export data.Source: Rodrik, Dani, Making Openness Work for growth rates of GDP and author’s calculations for growth rates of exports.
argues that ISI policies during 1960-73 “spurred growth and created
protected and therefore profitable home markets for domestic entrepreneurs
to invest in. Contrary to received wisdom, ISI-driven growth did not
produce tremendous inefficiencies on an economy-wide scale.”
the debacle that followed 1973, including the failure of ISI during the
rest of 1970s, Rodrik points to macroeconomic instability as the villain.
For the instability itself, he blames external shocks including “the
abandonment of the Bretton Woods system of fixed exchange rates, two major
oil shocks, various other commodity boom-and-bust cycles, plus the Volcker
interest-rate shock of the early 1980s.”
is wrong with this story? For starters, during 1960-73, industrial
countries grew far more rapidly than during 1973-94 and they progressively
opened their markets. Both factors helped spur growth in developing
countries. While the more open economies of East Asia benefited more, the
less open economies of Latin America also benefited from the open and
growing markets in industrial countries (column 4 of the table). But this
is not all.
ISI is to be credited with stimulating growth in Latin America, at the
minimum, we must be able to establish this persuasively for Brazil, by far
the largest economy of the continent. To be sure, Brazil did register the
second highest growth of the continent during 1960-73. But evidence hardly
credits ISI for it. Thus, during 1960-73, Brazil’s exports and imports
grew at the impressive annual rates of 7.8 and 8.9%, respectively, in real
terms. More importantly, trade policy specialists on Brazil describe the
period 1965-73 as one of “cautious outward-looking trade policy
liberalisation” and 1974-80 as one of “renewed inward-looking
policies.” During the former period, Brazil corrected the
real-exchange-rate overvaluation, introduced several export incentives to
reduce the anti-export bias, and lowered average legal tariff for
manufacturing (including surcharges) from 99 to 57% and for agriculture
from 53 to 34%.
case for ISI as the key to growth in Latin America during 1960-73 is,
thus, seriously undermined. But we are still left with Rodrik’s
criticism that trade liberalisation and privatisation during 1980s did not
produce significant growth response there. To address this concern, we
must once again begin by recognising the role of the slow growth in
industrial economies and its impact on Latin American exports (column 5 of
beyond that, Rodrik’s own explanation for why ISI failed to deliver
during 1970s — macroeconomic instability — must be invoked. If ISI is
to be rescued from culpability during 1970s by appeal to macroeconomic
instability, symmetry demands that trade liberalisation and privatisation
be acquitted of the charge of ineffectiveness during 1980s as well since
the same macroeconomic instability prevailed then.
critical question one must still answer from the policy perspective,
however, is why the East and South Asian economies escaped macroeconomic
instability during 1980s while Latin American economies fell prey to it.
Here the principal villain would seem to be short-term capital mobility,
which the latter had largely embraced by early 1980s while the former had
not. The collapse of the fixed exchange rates and oil crises affected all
oil-importing economies symmetrically but the Volcker interest-rate shocks
impacted Latin America asymmetrically.
that India enjoys the necessary macroeconomic stability and is some
distance from embracing short-term capital mobility, the prediction that
good things will follow trade liberalisation and privatisation is a safer
bet than the alternative.
Economic Times, September 25, 2002