Import Substitution Industrialisation

The strategy many Latin American countries followed from the 1930s to the 1980s of building domestic industry behind high tariffs, and why it ran into trouble.

For much of the twentieth century, many Latin American countries pursued import substitution industrialisation, or ISI. The idea was to replace imported manufactured goods with goods made at home, protected by high tariffs and government support.

Why countries chose it

The Great Depression of the 1930s and the Second World War cut Latin America off from imported manufactures and collapsed prices for its commodity exports. Many leaders concluded that relying on exporting raw materials was too risky.

The Argentine economist Raúl Prebisch, who led the United Nations Economic Commission for Latin America from 1950, argued that the prices of commodity exports tended to fall over time relative to the prices of manufactured imports. If so, countries that exported raw materials would keep falling behind. Building domestic industry seemed the way out.

How it worked

Governments used:

High tariffs and import quotas to protect domestic industries.
State-owned companies in steel, oil, electricity and other sectors.
Subsidised credit for favoured industries.
Overvalued exchange rates to make imported machinery cheaper.

The idea drew on the infant industry argument: new industries need temporary protection until they grow strong enough to compete.

Results

At first, ISI brought rapid industrial growth. Brazil and Mexico built large manufacturing sectors, and growth rates in the 1950s to 1970s were often high. But problems accumulated:

Protected firms often stayed inefficient, producing costly, lower-quality goods.
Industries relied on imported machinery and parts, so import bills stayed high while exports lagged.
Overvalued currencies hurt agricultural and other exports.
Countries borrowed heavily abroad to cover deficits, contributing to the debt crisis of the 1980s.

The expensive car

Under ISI, a country might ban imported cars and protect a local car factory. Local drivers must buy domestic cars at high prices, with little choice. The factory employs workers and builds skills, but with no foreign competition it has little pressure to improve. Decades later, it may still be unable to compete in world markets.

Comparison with East Asia

East Asian economies like South Korea also protected industries, but they required firms to export and compete in world markets, disciplining them to improve. Many economists see this export focus as a key difference in outcomes.

Thinking ISI was a complete failure

ISI did help build industrial capacity and skills in countries like Brazil and Mexico. Its problems came from keeping protection too long, neglecting exports and relying on foreign borrowing. The lesson economists draw is about how protection is used, not just whether it is used.

Key takeaways

ISI replaced imported manufactures with domestic production behind high tariffs.
Raúl Prebisch argued commodity exporters faced falling relative prices.
ISI brought early industrial growth but led to inefficiency, weak exports and debt.
East Asia's export discipline is often contrasted with Latin America's inward focus.