Import Substitution (Grade 12 NSC Matric Economics): Revision Notes

Import Substitution

What is import substitution?

This policy has a positive effect on the balance of trade. When a country imports less and produces more locally, it helps to improve the difference between what the country sells to other nations (exports) and what it buys from them (imports).

Why do countries use import substitution?

There are several important reasons why South Africa and other developing countries choose to implement import substitution policies:

Diversification is a major driving force behind this policy. When South Africa starts producing goods locally that were previously imported, the country's manufacturing sector grows stronger. This expansion means the economy becomes less dependent on other countries for essential goods, making it more stable and self-reliant.

Promoting industrialisation is another crucial reason. By encouraging the development of new industries that can produce goods previously imported from abroad, the government can increase tax revenues from these new businesses. Additionally, these new industries create employment opportunities for South African workers, which stimulates economic growth.

Balance of payment problems also motivate import substitution policies. When South Africa's balance of payments shows a deficit that's too large, meaning the country is spending much more on imports than it's earning from exports, reducing imports through local production can help correct this imbalance.

Trade limitations present another challenge that import substitution addresses. Many developing countries rely heavily on their natural resources as the foundation for economic growth. However, this dependence can actually limit their ability to grow further. When these natural resources are processed locally into finished goods and services instead of being exported raw, or used domestically rather than sold abroad, the potential for economic growth increases significantly.

How is import substitution implemented?

Governments use various restrictive measures to limit the amount of imports entering the country whilst supporting local industries. These measures help reserve the domestic market for local manufacturers:

Tariffs represent one of the most common methods. These are customs duties or import duties - essentially taxes placed on goods coming into the country from abroad. Tariffs can be calculated based on the value of the imported goods (ad valorem) or as a fixed amount for specific types of goods.

Quotas work by putting strict limits on the quantity of specific goods and services that can be imported. This reduction in supply benefits foreign enterprises only if the demand for their products remains high, as it allows them to maintain higher prices for their limited quantities.

Subsidies help level the playing field by providing financial support to domestic enterprises. These payments enable local businesses with relatively high production costs to compete more effectively against more efficient foreign companies in the domestic market.

Exchange control involves government intervention in foreign currency markets. By reducing the amount of foreign exchange available to those who want to import goods, the government effectively limits the country's ability to purchase foreign products.

Physical control represents the most extreme form of import restriction. This involves imposing a complete ban or embargo on importing certain goods from particular countries, completely blocking these products from entering the domestic market.

Diverting trade includes various bureaucratic obstacles designed to make importing more difficult. These might include requirements for large monetary deposits before importing, time-consuming customs procedures, and demanding high-quality standards that many foreign products might struggle to meet.

Benefits of import substitution

Import substitution policies offer several advantages for developing economies like South Africa:

Increased employment is perhaps the most immediate benefit. When local industries expand to produce goods that were previously imported, they need to hire more workers. This job creation stimulates the broader economy as employed workers have money to spend, and overall GDP increases as a result of this increased economic activity.

More choice in how to use foreign exchange becomes available when import substitution succeeds. The foreign currency that was previously spent on importing certain goods can now be redirected towards importing other essential items, giving the government and businesses greater flexibility in their international trade decisions.

Diversification strengthens the economy by reducing vulnerability to external shocks. When South Africa produces a broader range of goods locally rather than relying on imports, the country becomes less susceptible to foreign economic problems, trade disputes, or sudden changes in international market conditions.

Drawbacks of import substitution

Despite its benefits, import substitution also presents several challenges for the local economy:

Capital and entrepreneurial talent drain can occur when resources that might have been used more productively elsewhere are redirected towards industries where the country doesn't have a natural competitive advantage. This misallocation of resources can reduce overall economic efficiency.

Technology borrowed from abroad may not always be suitable for local production conditions. When developing countries adopt foreign technology and production methods, these might not be the most appropriate or efficient approaches for their specific economic environment, labour skills, or resource availability.

Competitiveness of certain sectors decreases when they become overly protected from foreign competition. Industries that don't face competitive pressure may become complacent and less innovative, ultimately becoming less efficient than they could be.

Import substitution leads to demand for protection creates a problematic cycle. Industries that provide inputs to local manufacturers often begin demanding their own protection from foreign competition, which can lead to an ever-expanding web of protectionist policies that may harm overall economic efficiency.