Some countries have not tried to follow the export led strategy, whether based on manufactures or staple exports. They have, on the contrary, formulated the import substitution strategy. This involves, in the initial phase of planned economic growth, setting up domestic industries especially in the capital goods sector, to replace imports. India has followed this strategy almost up to 1970. The necessary conditions for the success of the import substitution strategy are:
1. Existence of large domestic market. Most capital goods industries require a minimum plant size for economic efficiency and may not be viable in the absence of a large domestic demand.
2. Setting up of import substituting units would require substantial amount of foreign exchange resources to finance initial imports of machinery and capital equipment.
3. Adequate tariff and non-tariff measures have to be introduced to protect these infant industries from global competition.
The basic advantage of this strategy is that it is less risky than export led strategy. Since production capacity is being created to cater to the needs of the domestic economy, the risk elements are less compared to a position where the outputs are to be marketed abroad. Another advantage of the strategy is that identification of the industries is easier inasmuch as demand profile of the respective products is evident from the existing volume of imports.
The principal drawbacks of this strategy are:
1. Industries which would operate within a high protective wall would become inefficient and create a high cost economy.
2. The strategy can work only for a finite period. Once the domestic economy is saturated, the strategy would cease to work.
Import substitution strategy, therefore, can work basically in the short and medium term. In the long run, the economy would be getting more benefits through integration with the world economy, by specializing on the basis of its dynamic comparative advantage.
There is, however, no reason to assume that the two strategies are mutually exclusive. Many countries have for some years a followed the import substitution strategy and then shifted to export promotion strategy. In fact, most industrial exports from India today originate from industries which were established earlier as import substitution nits. Simultaneous pursuit of both the strategies is also possible. A country may try to promote exports of those industries in which it has comparative advantage, while going for import substitution in those sectors which are perceived to be crucial for the economyâ€™s strength and viability in the long run.
Benefits of foreign trade: The greatest advantages of foreign trade had been identified centuries back by Adam Smith:
Advantages of Export-led Strategy:
There are certain advantages in following the export led strategy:
1. The country has to become internationally competitive for the strategy to be successful. This puts tremendous pressure on the exporting firms to become price and quality conscious.
2. The exporting firm can ignore the constraint of the small domestic market. It can plan its production on the basis of world demand and thereby reap the benefits of economics of scale to the maximum.
3. The technological up-gradation of the production structure becomes inevitable because in its absence the firms would not be able to compete in the global markets.
4. The country would not suffer from balance of payments problems and therefore, would have greater freedom in pursuing the planned process of economic development.
There are, however, several undesirable effects as well:
1. If the country has to import in very large quantities inputs for export production, the net benefit to the country may not be substantial.
2. When large scale production facilities are created solely to cater to exports markets, any fluctuations in those markets directly destabilize the domestic economy.
3. Export production tends to become more uncertain than domestic production because of sudden because of sudden and drastic changes in national trade policies which may close or restrict market access.