The growth and decline of import substitution in Brazil

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UNITED NATIONS

AFRICAN INSTITUTE FOR ECONOMie DEVELOPMENT AND PLANNING

DA KA R

THE GROWTH AND DECLINE OF U~PORT

SUBSTITUTION IN BRAZIL

by

ECLA: ECONOMIC BULLFJriN FOR LATIN ANERICA

(Vol. IX, No. l, March

1964)

REPRODUCTION/353

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JANUARY

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RCP110DUC 'l'ION/ 35 3 Page 1 •

THE GROVTTH AND DECLINE OF IMPORT SUBSTITUTION IN BRAZIL~

I - THE IMPORT SUBSTITUTION PROCESS VIE"\tŒD AS A MODEL OF RECENT DEVELOPMENT IN LATIN AMERICA.

A. CHANGES IN THE LATIN Aï.TERICAN DEVELOPMENT MODEL

1. Features of the export rnodel.

A cursory review of the salient features of the traditional ex- .. ·

ternally oriented Latin .Arnerican dovelopment modal will .make clear how it differs from the more recent deyeloprnent model described belo~.

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It is usual to stress the strong influence of tne external scctor in the primary commodi ty exporting countries ₉ wi th particular refe:c-ew~c

to the part played by the two basic variables~ experts, as an exo;, .. _1l•,_;J

factor responsible for the generation of a substantial shàre of the nation incarne, and for its growth, and imports, as the flexible sourc0

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of supply of the various typos of goods and services noeded to satisfy .::,n appreciable part of dornestic demand. However₉ this synthetic descriptio: .. does not bring out tho special significance. of these two components in the underdeveloped countries. Renee, if the external sector's role in those countries is to be fully gasped, it must be compared with the rolo

~ This paper represents the greater part of a study prepared by the Development Centre in Brazil, set up jointly by the Economie Com- mission for Latin JJ.merica (ECLA) and the Banco Nacional do :Uesenvol'- vimento Econônico (BNDE). The study is now-undergoing final revi-

<:Ùon A.nd will bo published in mid - 1964. Like all research of this type, it is the result of the efforts and observations of serveral workers. At the outset the work was directed by the economist Charles Rollins9 subsequently this task was taken over by the economist Maria Conceiçao Tavares, who is responsible for tbe text and arrangement of the present version. S?e was assisted by the senior staff of the Centre and also, as regards the gathering of background.

rnaterial, by Mr. Roberto Andrade and Kr. Elder Motta.

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REPRODUCTION/353

Pé:.é;O 2.

plnyuJ oy tl".::.t u.cctor in the econor.~ios of the "ountres".· This '.Till rovcal sor..o of the Li::'..in features of the model to be analysed.

In the European development process the external sector gènerally predominated, and essentially performed both the above- described functions. Nethertheless, even from a fairly abetract standpoint, it can be seen that there were substantial qualitative differences in the behaviour of the ext 3rnal sector in the two types of econcmy.

Let us first examine th~ part played by experts in bath cases. In the case of the industrial "central" economies, although experts were an important and dynamic factor in generating the national incarne, and essential to its expansion, the growth of the economy did not depend wholly or even primarily on experts. In fact, that

ex~ernal factor was combined with a highly important internal factor, namely, autonomous investment coupl ed with technological innovations. The combination of those two internal and external factors made it possible at the same time both tJ take -advantage of the opportnities

offered by the external market and to diversify and integrate production capaci ty.

In the Latin American countries, on the other band, not only were experts, virually the only autonomous source of incarne growth, but the export sector was the dynamic centre of the whole economy. Admittedly its effects in diversifying production capacity was necessarily limited, since the external sector rested on the narrow basis of only one or twn primary commodities; in addition

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its influence ,., on the rest of the system depended in practice en a series of factors, in particular the type of production.process

adopted, and whether or not the sector constituted an eclave ~f foreign ownership. In short, the degree to Phich export activities influen- ced the general economy of each country depended on the nature of the production process of these primary commodities, and the exent to which it multiplied and distributed income.

Generally speaking, the develepment of the export sector gave rise to a fairly intensive urbanizatien process, during which wh3.t are known as the "residentiary¹¹ industries (textiles, footwear, clothing, furni ture, etc) were established. These are, 8f course,.

traditional, low-productiïity industries that are f~und in nearly all tha Latin Amer:i,._c,an countries, and arose ~ut of the primary-export model itsel.

The pertinent fact, however, is that this small-scale industrial activity, combined with a subsistence agriculture, was insufficient to impart to the domestic economy a vigorous growth "f its own. Thus, economie growth remained essentially harnessed to the

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behaviour of external demand for primary commodities, and this is what has given the Latin American econnmics their pre-eminently dependent and vulnerable character.

Moreover imports, as well as being different in structure, played a different part in the econo~y. In the open economies at the centre of the system, the fun_qtien of imports was primarily to supply food and materials that cou.ld, .P.Qt, en the basis çf the . country' s . natural resources, e3.sily ·be produced d~mestically. In the Latin

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American economies, on the 0ther hand, impo.rts were required, in addition to meeting much the same needs, to supply whole ranges of

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finished consumer goods and pratically all the capital goods required

for the investtJent process induced by the exogenous growth nf the

national inco~e. Thus t~e role of the external secto~, as a means of filling the gap between demand and domestic production, is of ^d very different nature, which is largely responsible for the subsequent

ahange in the development model.

Essentially, thè problems of the outwardly directed growth that is typ.ical of the Latin American economies are clearly linked to the pattern of international "Clivision of labour that arose eut of the development process in th~ advanced economies and which for the peripheral countries led to a social division of labour entiraly dif-

ferent· from tha:Î prevailing in the centre countries •·

In the more advanbed countries there is ne-t, and never ha,s been, any clear dividing-line between two sorts of productio·n capa-·

city, one to meet domestic and another t~ meet external market needs. Tliere is no export sector as such: manufactured goods are both

exported and consumed in large quantities within the country and any specializat\on for the external market that existsis .'in terms '"'of dpecific products rather than of different sectors of production.

In most Latin American cou.1tries, on the other hand, thoro is a clear social division of labour be"tween the external and internal sectors of the economy. The export sector was, and still is, a well- defined sector of the economy, usually with a· high level of producti- vi ty, specializing in one or two ·commodi ties of which only a small proportion is consumed wi thin the C')unt(lry

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^{The iht}^ernal se.Jtor,

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^One ^of ^the few exc.eptions is Argentina where this division is not so clear and. a substantial part of the ouput of its two chief export commodi ti es is co.1sumed in the country. However ~ the basic character of the xport sector is the same, as regards speciaLiza- tion, and the remarks that follow also supply.

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on the contrary, with its low productivity l evel, w~s primarily a subsistence sector, and met only part of the food, clothing and hous- ing needs of that section of the population whose consumption was within the monetary economy.

Moreover, the high concentration of 01mership of natural rcsources, especially capital, in the more productive e~~ort sector gave ri

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^t^{o :1n} ^extrein^{ely un}equal di stri bu ti ~n of i ncome. TJus, while tbe in.:::orne of the bulk of the population was sr lovr 1,S vil·t~;éJ_-

ly to '3Xclude them from the monetary economy, the high-inccme groups maintained lovels and pattern·s of consumption similar to those prevailing in the large European centres, based largoly - ~ i~~crts.

The combina tian of this dual pattern of di vi sj_o:1 cf lé:_, v.~·

wfth a marked inequali ty in personal income dis tri but::.o:1 •n ~ th,::-'>

fore rcsponsible for the great difference betwocn the ut:::'· Gturu "'~

production and the composi tian of inte.rnal demand, which ·ms marie good by foreign trade. This, in the last analysis, is the most ::.rnpo:r ·· tant feature of the primgry-export madel for an understanding CJf tt.e post-Depression change.

2. Collapse of the traditional madel and transition to a neu one.

From 1914 to 1945 the Latin American economies underwent successive foreign-trade crises as a result of twenty years of war and/ or depression. The long Depression of the thirties, however , may b~ taken as the critical point at which the primary-export madel broke down. The sharp decline in export receipts caused an immediate drop of 50 per cent in the importing capacity of most cf the Latin American countries, and broadly speaking this capacity never, even after its recovery, regained its pre-crisis levels

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See the many ECLA studios on this subject, in particular the En-·- nomic Survey of Latin America 1959 (E/CN,.'12/ 164/Rev.1) . United Nations publication. Sales N°:51 .II.G.I .

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Despite the severe impact of the Depression on the external sector of the Latin American economies, they did not ramain in a prolonged state of depressicn like the more developed economies. The extGnt of the external imbalance impelled most Latin American G"varnments to take measures to pr~tect internal income, thus anti- cipa-ting the oconom~.c policy of compensation that was only later advcnated b;r the "contre" countries. The measures con si sted prima-

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rily in import restrictions and controls, the raising ~f exchange

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rates and the purchase of financing of surplus output, and were aimed more at protecting tho country ag-'3-ints external desiquilibrium th<:-,1 at stimulating internal activi tv. Nev::œtheless, the ir:d'lStriali zD- tion which the began c-ras undoubtedly buttressed by thG rnainter:=tnC:•-3 of internal incarne resulting from that policy.

Let us now consider briefly, and in general tcrrrts, ho•;-T t~t>J

new internally oriented developmont modcl came into being.

Since the ex~sting level of demand remainded at virtually the same leval, while tho capacity to import was sharply reduced, it was no longer possibl e to make ari ex ante adjustment between the structures of production and of domestic demand by means of foreign trade. An ex post adjustment was made through a substantial increase

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in the relative priees of imports, which provided a sharp stimilus to domestic import-substitution production. By making full or even excessive use of the existing production capacity, it was possible to replace a proportion of the goods formerly imported. Later on, by a re-allocation of factors, especially the foreign exchange that vms in su':)h s2ort supply, the availabke capaci ty to import was used for external purchases of the capital goods and raw materials needed to establish new production units and thus continu8.the import sub•

stitution process.

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A lengthy description of the dynamics of this process is unnecessary, since it is dealt with in detail below. 3ut the imper-

tan~ fact that it represents the emergence of a new development modal .

The first point to be noted is the change in the economy's growth factors. There was a decline in the external sector's contribution to the national incarne and an increase in the contribution

Jf domestic production, and in its growth rat e.

The external Browth factor, exports, yielded first place ·' to the internal factor, investment, and the arnount and C'O"llposi ti "'rJ of investment were what determinGd the continuation of the development pr,?cess.

This does not mean that the external sector no longer played a major part in the Latin American countries, but merely that i ts :fui.lCtion changed: instead of being directly responsi ble for incarne growth, through increased exports, it became the decisive factor in diversifying the structure of production, through imports of equipement and intermediate goode.

This explains how it is possible to achieve a reasonable rate of investment, and consequently of gro~vh, despite a tempor~ry

stagnation or decline of the purchasing power of _e::ports, provided that the composition ~f imports can be altered by reducung non- essential imports in favour of capital and intermediate goods •

. l There are other points that need to be made clear, for a better understanding of Latin America's new deve:opment ·model.

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In the first place, the changes in the structure of production were virtually.confined to the industrial sector and to allied activities, and had little or no effect on t~e situation of the primary sector - including, of course, the traditional export lines. Renee, two circumstances to which there will be occasion to refer later. One ·is the persistance of a precarious and undynamic export base, which is one of the causes of the chronic external bottleno0k:

the ether is the incomplete nature of the transformation of tho eoo·- nomic system, and the consequent emergence of a new type of dual economy.

Secondly, there is the well-knbwn fact that the new dynamic sectors are established and expand wi thin the narrow fra"1ework of the domestic market, which imposes a "closed" character on the new model .

If those characteristics are cxamined fr~m a brJad standpoint, it can be asserted that the orange in the division of labour (nr resources) in a country resulting from the industrialization

process typical of the region was not accompanied by any 00rresponding change in the international division of labour which remained basi- cally the same, at least as regard the special functions of the in industrial and the under-developed economies in world trade. In fact, the only appreciable changes that took place were in tha trade Withir.

the group. of "cent::-al" nations.

In essence, many current aspirations and movements, such as those relating to the regional integration of Latin America rr the United Nations Conference on Trade and Develorment, are based on or imply new patterns for the internaticnal division of labour (or resources), in line with internal changes and with the need to acce- lerat e the growth rate of developing countries by expanding their foreign trade.

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To sum up, the import ^subs~ituti^eⁿprocess may be inter- prcted as a:1 incomplete and "closed'' development process which represented an attempt, in responsJ tn foreign trade restrictions, to

repro4Mc~ in an accelerated form the industrialization carried out in tha past by the more devaloped countries, but in 3ntirely different conditions.

3.

Nature and

evo l~ti o n

ôf^thê êxtê^rnal^bottl^3necks

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Since a decline in the dynamism of the external secto~ iG one of the dominant features of y he import aubsti tu ti rn mnd c:l 9 ^<:1-'".

is actually founcl in naarly all the Latin American .econom:i_os, i t deserves to be ex~mined in sorne detail.

First, a distinction c~n usefully be drawn between the tw) main types of external bottle:1eck, namel..;r, the "absolute" form, rep~r--

senting a stationary or declining capacity to-:-import, and the "relative" fr-rm, representing a capacity to import that increase more slowly than the product . The first type of bottleneck is ussually related to contractions of international trade in primary commeditios, and the second to long-term trends in primary commodity experts.

Although there is FO shortage of matorial on the vicissitu- des and behaviour of the Latin American external sector, for the purpose of. subsequent analysis it is useful to recapitulate brio:ly

the main features.

Up to the end of the Second World War neithqr the volume nor the purchasing power of experts h1.d regained their p~o- .Deurc..csi 1.

levels. After the war the pnrchasing power of exports rose in at so-- lute terms, because of the increased vnlume exported ~nd a terr:t)" ~ 1 .. •

j}~he data used in this se tion were )btained from tho fnl~' wing · ^{t r ·} ces: ECLA' s Economie Sùrvey of Latin Amercia 1949; "In·:"latio: c.:1i gr()wth: a summary of experience in Latin America", in the Econ ·11i.c Bulletin for Latin America, vol.VII (1962), pp.23, et seq.,and

Towards a dynamic development policy for Latin _",.merica (E/CN. i2,f6GO).

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improvement in th·-3 t rr.1s of trade batween 1949 and î 954. Since 1954 the purchasing power ~f axports from all the Latin American countries (except Venezuela) has remained at a standstill, and in recent years has even tended to decline because of the deterioration of the terms of trade.

A comparison of the evolution of fer capita incarne and the par· capi t::1 purch::1sine powe:r of exports, shelds sorne light on tb.o

external 88ctor' s fJ..ilure to r.:;cover in relative t•3rns. Frî:c 19'".:8· ·2) to 1960, while tho regi cr"' s average per capi. ta income rose by 8Ver 60 per cent, the pel' capi ta purchasing po1.;er of eJqJorts fe.ll by over 50 per cent. Even in 1950-51, the most favour:1ble pos-3--war y.:oacs for Latin America exports, their per ci;::i ta purc~.aE';.nc; roc,rt::.' r~.-tE'J' ne·_

23 per cent below the pre-Depression lev:ll.

This external bottleneck and the consequa~t fa~rl~ i~t0~Ei~c

import substi tutiC'n process w~re reflectad i.n a re(LUcti.on in ^t ^JH ^c.^·. ^·- ficient of the Latin American economies.

The proportion of Latin Amer1'!ca¹s total incomo absnrbed by imports, which before the Depression was 28 per cent, has in recent yeJ..rs fallen to tha rdlatively low level of 12 per cent, and as early as 1945-49 i t was only in the region of 15 per cent .

In establishing the relation between thases changea in the external sector and the various forms of import substitution, it is helpful t~ consider thrae seperate periods that reprsent changes in the nature of this relation.

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In the first period. extending from the Depressinn to the end of the Second World War, there were sharp reductions in the . .., capacity to import, either over-all ~r specifie according to the individual situation. Consequently this was a period when restrictions ir:.

the external sector were "absolute", and called for vigo;rous import substitution in nearly ~ll the Latin American countries, which lBS

reflected in a substantial decline in the general import coefficient. This first phase was characterizeù above all by substitutien in

respect of non-durable final consumer goods. In sorne of the larger countries - including Brazil, as we ehall see later - the process was extended to intermediate and capital goods as well.

In the second period, or the first decade after the war, the capacity to,.,import was less restricted. The increase purchasing power of exporta, though insufficient to restore the external sector to its former relative level, nevertheless-permitted a considerable accelaration of the growth rate of the economy thro~gh the expansion . of domestic production combined with improved conditions in the

export sector.

During this period, most of the Latin American countries reverted in practice ta an externally rather than an 1internally

oriented growth, based on a higher purchasing power of exporta rat~eT

than on import substitution. In a few countries, however, such as Brazil, full advantage was taken of this relatively favourable si tu::.- tien in the external sector to expand the industrializativn process. Thus import substitution made considerable progress, and sorne categories of durable consumer goods, were embarked upon, while production of other lines, including capital goods, continued.

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Of'\ the three decad9s under consideration this was the period nf greatest growth for Latin America as a whole

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speaking, it was made possible solely ~y a rapid incre~se in the purchasing power of exports, although this increase was slower than that of the product. (This means that the limitations deriving fTom ttJ.e external sestor were only of a relative nature).

Fr~m 1954 .'on, external conditions were once more wholly restricti•re (except in the petroleum producing countries) and the region ¹s capaci ty to import again approached stagnation. }~oi:3t of the countries w~re unable to maintain their rate of development by means of import substituti,.n. Mexico and Brazil were practically the only countries able to proceed with industrial expansion at a rapid p:1ce. Brazil even succeeded in increasing its growth rate through a number of circumstances dealt with in the section on Brazil be¹_ow, but only at the oost of considerable increasing i ts balance- of-payments deficit.

R. THE V_\.RIOUS MKUHNGS GIVEN TO THE T'SRM

"IMPORT SUBSTITUTION"

The term. "import substitution" is often used in a simple and literal way to denot3 the reduction or eliminatio~ nf certain imports and their replacem-,nt by domestic products. This interpretation obscures the real nature of the ifuport substitution process · described above, and even gives rise to a false notion of ~ts dynamicè.

In actual fact, the term "import substitu+;ion", which has been adop+;ed to denote the new process of development takin place in the under-developed countries, is unsatisfactory because it gives the impression that this process consists simply and solely in the removal

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^See ^The ^e^conomie development of Latin America in the post-war period (E/CN.12/659).

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diminution of components of the import structure and their replacem:nt by national products. It m:lght be assumed by extension that tt6 nQtural goal would be to eliminate imports altogether, in ether YOi'ds, t,., ac hi eve self -,sufficiency

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Nothing, how<=.ver, could be further from the truth. In the first place, the substitution process is not intended to reduce the over-all impC'\rt quantum. Such a reducti•n, when it •ccurs, is the Gutcome

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of restrictions in the external ser-tor rather than an aim

in itself. It is those restrictions, whether absolute or relativo₉ ttat make it necessary to produce in the country goods formerly imported. But the place of the ousted goods is taken by others, and as the process g?.the:rs m0mentum i t genera tes an increase in deri vod demand for imports of intermediate and c~pital goods which may lead tn greater dependenco on the external sector than dt~ing the earlier stages of the substitution prccess.

Now that attention has been drawn to this possible misap-

~"lrehenr:ion, the n0xt step is a mrre detailed examinatien ef the c.n'.l.ly+ic3.l problews that may arise when import substi tuti0n is under- stood in its rcstricted sense, th~t is, as an absolute or ·relative

·lecreaso in cartain groups of products in the import structure. For trj s iJU'~poEe7 sorne e--:amples ar8 given below in which r:o such decrease

~cc:.l~f', c.:r, if i t doos, i ts real nature is masked by the "apparent"

'l.~:e .Li:>:st cxample that might lte considered is the extreme case r·were no ckmge takes place in the composition of imports in absolute or rel~tive terms, that is, neither the quantum nor the

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Incidentally, this point of view has b0en advanced by sorne theore- tists, such as Professer R)ttonberg of Chicago, to emphasize th0

"danger" inh2r0nt in a policy of import substitution. See Sinon Rottenberg, Reflexiones sobre la industrializatien y el desarrollr econcmic••, Cath0:ic University, Santiago, 1957.

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respective proportions of the principal commodity groups in the

i~port structure undorgo any modification. In such an event there would be no "app3.rent" or "visible" substitution, Gven though a vigorous and effective process ;f substituti8n might actually be taking

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place through an increase in domestic industry's contribution to an exvmding domestic supply, which be reflected in a reduction cf the economy's. import coefficient.

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An thor kind of problem is posed by the emergence ~f new products on the world market, which m3.kes it difficul to undertake

a compar~tive analysis of the pattern of imports in different perioùs. For instance, after the Second World War, new durable consumer goods made their appearance which bore no resemblance to the typo of p~o

duct imported previously. Consequently the development of a dr~o~tic

industry producing such goods cannat be described, stri tly spoaking,

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as "substitution" in terms of pre-war imports. It is cbviousl;y -, continuation of the general process described above; that is, it involves a realignment of the factors of production corresponding to a change in the pattern for the division of labour in tho economy.

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Another common occurence in Latin America, particularly during the last decade, is a decline in imports of non-essential goods (cortain kinds of durables and non-durables) as the result of discriminat0ry exchange policies aimed at reconciling the over-all level nf imports wi th the re::.l cap;1ci ty to import.

The affect of those restrictions has beon to stimulate domestic production. Obvi

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ously, in these circumstances the "real"

substitution takes place after the "apparent" substitution di SCEŒni- blo in the pattern of imports. But it may well be that sorne products are not actually replace (because the market i~ not large enough,

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and/or the resources for produoing them locally are lacking), and that their reduced share in the import structure is entirely attri- butabl e t~ import controls. Once these have eased imports of Ruch goods -vrill automatically begin to climb a:gain, possibly in ceompany with those of ~ther goods that cannet be produced locally ~n a competitive basis without the protection afforded by very high tariffs or other discriminatory measures.

Lastly, there is a point which, while obvious enough, is

not al ways~"~ clearly grasped; "real" substitution is usually much less

tha the "apparent" substitution manifested in the reduction of certain imports. For instance, when import substituti0n takes place in end goods, there is a. rise in demand for basic inputs and materials (not all necessarily produced locally) , payments have not be made in respeGt of technical s<Jrvices and capital, and so forth. In reality, the production of a particular article replaces only part of the value added which used to be generated outside the economy. As pre- viously indica.ted, the re sul t may be an increase in the deri ved demand

for imports that exceeds the saving in foreign exchange achieved by domestic production.

These brief remarks are not intended solely to indicate the risks inherent in a narrow interpretation of the term "import

substitution~ but to draw attention to sorne features of the process itself that are masked by that designation and sometimes even ap_e1r to be in conflict with it.

An analysis follows of the d.ynamics of what will continu.e to be called "the import substitution process", since this is the accepted term in the literature of economie development in Latin

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America, and in ECLA studies in particular . Nevertheless it should be u-nderstood that in the rest of this study this t erm will be used in a broad sense, to designat€ an internal development procesè that arises out ef and takes its direction from external restrictions, and is evidence ~ainly in the expansion and iversification of industrial production capacity.

C. THE DYNAMICS OF THE I~œORT SUBSTITL~ION PROCESS

The object of this section is to make a highly theoretical analysis of the main features of the dynamics of what is meant by

"import substitut ion '¹9 in the broad sense₉ and of the external and internal problems that arise as this process develops.

The dynamics of the process of development through import substitution may be regarded, t~ put is shortly, as a series of responses to·successive challenges presented by the restrictions in the external sector, as a result of which the economiy 5radually becomes less quantitatively dependent on external sources, and also effects a transformation in the nature of this dependence. Thrcughout this process, which gives rise to a nnmber of structural modifications in the economy, "•the basic contradiction betwwen development requirements and the barrier represented by the capacity to import manifests itself in a series of differents forms. The aim here i s t~ show how sorne of the difficulties can be surmonted₉ but the conclusion re~cheJ

is that external and internal problems tend to accumulate to the point where they act as a brake on the dynamism of the process.

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REPROL~CTION/353 Po.ge 17. ·

Rusponsos to the ch-:ül.::mgo of externo.l disoquil ibrium

The boginning of the import subst i tut ion process is his- toric2.lly linked wi th tho worLi Depressi on of tho thirtics but for analyt ic:-::.1 purposvs tto start ing-point chosen ^L'J,Y üo any l!:.stin.:.;

extern::tl disoc_uilibrium that clisrupts the baln.nco0 be-t'N<:J.Jn J.Lr.~·.y-, L r .. : ^L

production, as described nbove :.n deé1l ing ~;ith tb:; trnii-tic,j:-.1 ^{• r} o,:t madel.

Thus

9 during its f irst phese tho o j· .. is to sc.tisfy cu.L·~·, ü~ domestic dem<'.nd v<hich is not nffoctecl by tho crisis in the u-c"o::· b sec tor , and mr:.y or may not be rr.nintained by govorument <.lc ion.

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r:'hcre c.ro throe possible ways of exp;::.nding J.omestic supply 9

n-:.r.'ely: be tt er utiliz~ t ian of existing inst2..l lod proluction cap:::.ci ty~ tho pr oduction of g')ocls and services relo.t ively indepondont of tlH;

external scctor (e.g. goverument services); and the establishment of product ion units to repl~co former imports.

The f irst ::tl terna t ive com0s to an end when util.iz:::. ti on of iJle c:::.pucity existing in thû economy reaches saturat ion point. Pr:.rt . of the EL>vonl al"':;ernat ive is closely tound up 1rith the tl:::ird9 ancl

together t hey form tho be.ckbone of the inward- oricnted development process known as import substitution.

Substitution usually bE,gins in tho casiest n.:r:-ea, th8 pro}.1 e:t~. ·:1 of f inished consumer goods, partly bec"use the tcchnology is gene... :::'..1:· less complicated and less c<'-pi tu.l- intensive₉ but r. cinly bec:: use t.Lu:.·o is a larger unt;::.ppGd market for goods of this kind, ei th er alroadj- existing, or brought into be ing as a re sul t of the foreign trr·. :Lo policy adopt ed as a defensive mensure.

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There now follows an explanation of how the vory oxpJ.nsion of internal production that characterizes th0 first phase imposes the need to press on with the development process.

In tho first placo₇ the establishement of industrial plants to produce internally final consumer goods formerly imported tendù to onlarge the home market for such goods, not only because of tho hieh0r income that results fro:n the investment process

.§{

^b^ut ^also

b0cavso of the absence of int0rnal restrictions of the kind ir!lposeJ.

on aqvivalcnt i·nprrts. Secondly, domestic production, as we s...:on, r8pl1-ce-:; 'Jnly ,3 l)art of the VQ.lue added thq,t was proviou::ly GC'nor?..tc._l

cutsiù~ tho economy. Consequently, derived demand for imports of raw materials and othcr inputs climbs rapidly and tends to outstrip the supply of foreign exchilngc.

This, the, is the first manifestation o one ph&-:;,) r f i ·

above-mentionod internal contradictior" oot1v0en-tha ai..m

>vhich is to expand the product (and, consequently, imp0rtr·, 1-t J.~. - to sorne extent), and the limitations of the CQ.pacity to im)c~t.

'rhe response to this. challenge is a fresh 1vave of substi- tutions, which means that sorne of the less essential imports have to be eut to release the foreign exchange required for the establishment and operation of new production units. Once more there is an increase in the product and in income, and the phenomenon described above then repeats itself₇ to a greater or l esser extent.

The mainspring of the import substitution process is the constant struggle to resolve these contradictions. Theoretically, the process could continue, though a rigously selective use of foreign

/" 1

2.1 Ho1-r f:u consumption expands in relation to the growth of incomo is essentially a question of the income-elasticity of the products in question.

•

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exchange, to that point in the international division of labour where utilization of existing domestic resources reaches its maximum

1{

But in practice, as the substitution process salves the problems successi vely posed by tl1e "ext.Jrnal barrier", i ts progress becomes increasingly difficult and costly, not simply for internal reasons, such as market size; technology, etc., but also because, as a result of the limitations of the 8ap~city to import, the import structure tends to become extremely rigid before the development process has required sufficient independance in terms of divers:i.fi-

catio~ of production.

The intornal factors are analysed in the nextsection, which deals in more detail the ways in which the dynamic& of substitution affect the structure of imports, and what the implication€ a~e for the continuity of the process.

2. Changes in the structure of imports and the·

substitution·mechanism.

In t·he first phase of the substitution process the choico of new lines of production is based o~ tho existing domestic demand for those items, in the import structure that were easiest to manufacture, to wit, as alreaày indicated, finished consumer goods.

This change in the orientation of domcstic activity is reflected in the import structure by a reduction in the proportion of finished consumer goods and an increase in the proportion of intermediate products.

1/

^The ^lack of sorne of the natural resources required rules out even the academie possibility of progressing towards self-sufficiency

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REPRODUCTION/ 353 Page 20

However, once the initial stage of industrialization is completed₁ the persistance of a structure of imports lP.rgely unchanged as regards the relative position of the three main groups (consumer goods₁ intermediate products and capital goods) may maan that substitution is being effected in several categories at the same time₁ although the emphasis on particular groups of products will vary according to the indi vidu<Ù circumstances of each country and the stage of development it has attained.

Clearly₁ this does not maan that there is no alteratiun in the structure of imports; on the contrary₁ it will undergo changes

within each group, at a speed determined by the pace of the substitution process. However₁ if the process is to continue, substitution activities must be so co-ordinated as to prevent any coincidence of peaks of demande for imports that might give rise to a persistent

internal bottleneck. The behaviour of the.various historical series for imports could therefore be expected to appear in a graph as a series of dephsed parabolas that represent the alternate appearance and di sappearance of new products in the import structm:e.

The possibility of maintaining sorne degree of flexibility in the structure of imports, when the capacity of import is limited, depends on forgoing as soon as possible certain links in the chain of production which are of strategie importance for furthering the process. In other words, the possibility of proceeding with substitution depends upon the types of substitution already effected.

If, for example, substitution were confined to final consumer goods, the import schedule might be virtually limi ted to the ··

imports needed t-o ma:intain current 1Yroductio'rl, · wi·th ·no ·m:lr·gin-·left for the entry of new products and, in particular, .of the capital goods

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·. REPRODUCTiON/353 Page 21.

eesenticl for the expansion of production c~pncity. To prevent this happening it is imperative to embark promptly on substitution in respect of ~ddition2.l cC!.tegories, ospecially of intermediate products and capital goods, before an excessively rigid import structure jeo- pnrdizes the very continua fion of th~:.: procoss.

A notable ad.v['.,nta.ge of substitut ion in respcet of soiT!i- processed ma teri2.ls and other intermedia te products, from the stand.- point of internal restrictions, is that imports noede.d to maint.ün existing output are relatively ~odàst. T.here are two :-1ain reason for this. The first is that some of the raw matcrials noeded for the -manufacture of such goods can be found within the country itself, and-the proportion imported consists of rav1 or simply procE:ssed

JT_,_ terircls of lOir unit value. The second is thc.t the ir domestic Elarket,

èl.nlike the intornnl market for consumer goods, does not tend to expand sharply meroly because production vdthin tho country is under- t:::lmn. In all probability tho main outlay of foreign oxch~nge m2.de Gnoo anl for nll will ·be the purchase of the equipment needed for the ir:stallc.tion of produotion-units.

ln this intermediate production sector, however, there is a consi,lerablo tiE1e lag betwoen t he decis~on to invest in a given branch n.ctivity and entry into 6peration. Consequently, if import substitution is not envisaged until these products hc.ve already bE:- come important items in the import structure9- almost cer~~.inly the rise in deriv~ demand; combined with the timo lag in the domestio supply, will result in a substantial incre::1.se in such imports wbiuL may exceed the .country' s foreign exchange rosourcos.

__ l:lh~_t_ tlô:_s _beensai~ a~_ov_e , __ <:l~P_ec.icll~_Y.. ~n- th_o precee~?-ng paragroph about the production of intérmediate goods also applies to sorne extent to certn.in types of capital goods. In additio~ tho earli~~t

: .. ·ï:O :;.:J.::•

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possible start on their production has the strategie advantage of giving the domestic development process sorne degree of independence in relation to external restrictions.

To sum up, i t can be asserted that, given the conditions of the import substitution model, it is pratically impossible for tho industrialization process to proceed from the base to the apex of the production pyramid, thàt is, to start with the more simply pro- cess3d consumer goods and progress gradually until it includes capital goods. The substitution process might be regarded as a building of which overy storey must be erected simultaneously although the degree of concentration on each varies from one period to another.

It is plain that this undertaking gives rise to a series of problems of all kinds whose solution requires a conjunction of favourable conditions. Two such problems, one int,,rnal anè_ th-.; othcr external, meri t special attention.

The first relates to the choice of product categories for substitution purposes. Clearly, in view of what has been said abrwc:? such a choice cannot be made in th

•

e light of a static conception

either of the domestic market or of the import structure at a given moment,. or of both. In the first place, this means that not all investment can b0 induced only by existing demand, and secondly, it calls for a deeree of foresight and ability to make autonomous decisions that can be looked for only from the State, or occasionally f::oom the very few entrepreneurs of the "innovating" type

~

8/The cerm is used in the Schumpeterian sense. Thus, although it is

::o~sognized that in sorne of the Latin American economies there is a considerable bod;y of able entrepreneurs capable of responding adequa-

tely to m:J.rket stimuli or decisions of government eoollt.owic policy₁ or both, t'1e "innova ting" and far-sighted type of entreprenuer, capable oc:

sedking out the opportunities implicit in the opening-up of new lines of productive activity, may fairly be considered a rarity.

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"

It will be difficult for what are termed the b<'1sic invostrJonts~

for oxcwple, to be effected soon enough except through governmer:t decisions, eit~er to undertake direct promotion of private enter- prise or to stimulate and protect it by financial and other measures.

Of the market-induced investments themselves, 1nany are in no v;ay "spontaneous".z< since they are due largely to economie policy decisions, especially on foreign trade (exchango and tariff policy), which by causing changes (sometimes very abrupt) in relative priees, deliberately or otherwise determine changGs in production capacity.

The second type of problem that arise with import substitution relates to th~ nature of the limitations of the external sector. Naturally, if there is an "absolute" stagnation of the capacity to

import, it is hardly possible for industry to expand sufficiently to maintain a rapid growth rate. If the high rates of capital formation and the composition of investment needed for the rapid d1versification and integration of the production mechanism are to be achieved, the limitations of the external sector must e.t 1wrst be relative, i.e. there must be sorne import expansion, even if it tnkes place at a lower rate than the growt:1 of the product. This can be

achieved by an increase in the purchasing p01o1er of oxports, wi th or wi th out an autonomous or compensa tory inflow of foreign cc pi t2,l.

As explainod below in the Section on Brazil, in recent times fairly satisf[>,ctory solutions have been found for the two problems referred to.

2/

^In^th^e sense of resulting from the free pl~y of market forces.

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REPRODUCTION/353 Page

24 3 .

^Internal ^conditions affecting the process

So far the development model of the Latin Amorican economies has been examined from the angle of the growth of import substitution as regards the various types of problems and responses arising from external limitations.

We now turn those determining factors of the process th~t

stem from certain internal limitations. There are three types of factors which eventually be come serious problems ~ as economie ₁ d,;vo···

lopment through import substitution proceeds~ and which, morJover, are among the causes of the distortions to which the process has been subject in the Latin American countries in the past . These are the size and structure of the domestic markets, the nature of technological development and the constellation of productive resources. The three factors are, of course, closely interrelated in many respects, and only a thorough and systematic analysis of their interaction would make possible an over-all yet dotailed view of the complex of economie development problems in the Latin American countries.

(a) The first step is to analyse the problems arising from the size and structure of the domestic market .

As already noted, the industrialization process in Latin America was on a strictly national scale, because of the situation with respect to the international division of labour which prevailcd when the process began, and which has changed little since. To overcome this obstacle, the larger countries could rely on their domastic markets and superimpose on their old structure of primary producti.on a modern secondary sector, èy readapting and modernizing tho servicoR sector formerly directed towards export activities. However, the

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size and diversification of the new sectors was determined by the scale and composition of deomestic demand and by i ts sub.sequent de-

~elopment. These, in turn, necessarily depend on the existing and future level and distribution of incarne.

As axesult of the income distribution existing when import substitution began, th8 productive system had to be directed primarily to meeting the unsatisfied imptrt demand of the high-income

sectors .•. Al though this encouraged industrial diverisfication, beacuse of the varied demand of those sectors, it entailed obvious disadvan- tages in tarms of oost structure and concentration of production.

Since thô absolute size of the domestic market was relatively small to bein wi th ¹

~

^{i t is}^easy^{to imagin}^e ^{what i t} ^;neant ^fr^n·::1

the standpoint of economie saales of production~ to have to satisfy a whole range of requirements of goods and services, each one of which represented only a minute fracti~n of the total market •

•

This fact explains the inevitable trend towrads concentration of economie activities, since it was inconceivable that a large number of enterprises could be established, on a competitive yet profitable basis, to fight for single-product markets that were so very small (with the exception cf the markets for certain consumer goods) .

Moreover, these problems tend to become.more serious as the industrialization process extends to new and more complex categories of production, since to embnrk on·G certain type of mo~al-tT~nsforming

1..Q/ According to the ECLA study, The Latin American Common Market (E/CN.12/531, United Nations publication, Sales N°59.'II.G.4), in 1959 the largest dom0stic market ·in Latin Jimor:i!ca had an annual purchasing power of sorne $13,200 million, while the United States' motor vehicule market e:.bovo roprosonted a purrch<'.lllint; power of approxirmtively ~: 7,200 mil·- lion. The absolute size in the thirties was obviously smaller, but the relative disproportion must have been the same.

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P:S~-'RODUCTION/ 353 Pggo 26

industry or intermediate-goods industry, for example, requires a very large scale of production in relation to the size od the market.

Let us now see how the davelopment of the industrialization process through import substitution gives rise to expansion of tho

domestic market itself~ and what is the nature of this expansion.

Sinoe import substitution was effected'in categories of non-durable consumer goods, or in certain intermediate and capital goods frn >'l'hi ch the technology adopted required a low capital den si ty, tho pattern of invcstmant, basides raising income, tanded to increase employment sh~rply. Thus the market expanded in two ways: through the increase in the income of the higher brackets, and through incor- poration of the workers employod in the new dynamic sectors, who naturally received higher wages, in the market for industrial and alliad goods and services. However, as import substitution progres- ses, and espocially when it ambraces categories rf dura•le consumer goods, the relative market growth b8comes mainly vertical, that is, it is based on the purchasing power of the high-income sectors. This is due to two main factors: (1) the high capital density per unit of output precludes the large-scale absorption of labour; (2) the high unit value of the goods produced permits the entry int0 the consumer markets of only small sectors of the population.

Thus,although the establishment of new sectors of production makes the economy very dynamic in terms of incarne growth, and accole- rates the import substitution process, it also introduces a serious disproportion between the production oapacity nf enterprises or sac- tors established on a scala in line with the requirement s of tho mass markets in the d<-veloped countries, on the one hand, and on the othor, the g,ctual size of the market in an under-developed country.

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REPRODŒ TION/353 Page 27 •

(b) The next step is to cond_der tho problems posed by tho nature of modern technology in relation to the import substitution process.

On.~ point often stressed is that the developing countries adopt teyhniques originally conceived for the "centre" economies, in line with their own constellations of resources, which are totally different from those of the developing countries. The need to import such techniques is due to the substitutive nature of this incus-

tri~lization process in the latter countries and tho difficulty of working out new techniques better suited to their own individual

circurnstance~.

The general drawbacks are G.lso fairly well known, and may be summarized as follows: the amount of capital required in arder to substi tute dornes tic produc.tion f or a given volume of output is very large, while the colurne of employment generated is relative:y small. This means in terms of growth that economie expansion en- tails a high level of cnpital accumulation coupled with insufficient absorption of the grow~ng numbers who an?~ally join the labour

force. Attempts to improve the absorption rate must involve increasing the rate of investment~ as long as tho basic featur~s of the technology adopted remain unchanged.

In addition to the foregoing general consideration of

the rpoblem of ' employment and of the growth rate of the Latin American

economies ïn very broad terrns, it is useful to give sorne thought also to the obstacles that impede the continuation of the process when it becomes necessary to embark on substitution in types of production wher·e the problems of saale and technological complexi ty bec orne increasingly acute. Tb us, the actual divers if ica ti0n e.nd

integration of the industrial production machinery tend to slcw down

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in so far as the amount of capital needed combines with the size of the domestic market and with questions of technical know-how in impeding access to a series of sectors wherc even a small-scale production unit is too large for the real capacity of the economy.

The question arises whether, with the exception of those sectors with relatively specifie tcchnical patterns of production, it would not be possible to adopt a technology entailing lowcr capital density which would be more in line with the plentiful labour and land resources typical of the Latin American economies. This is a strictly academie question, however, at least as regards the adop- tion of such methods by private entrepreneurs within the dynamics of the import substitution model, particularly in the second poriod of development which took place after the war.

There now follow an explanation of why such a solution w~s

not really feasible in the actual conditions under which industrialization took place in the Latin American countries.

In the first place, tho ter.dency to use more capital and l ess manpower, in proportions difforing widely from those dictated by the relative availability of the two factors, is due to the fact that there is no relation between the real (opportunity) oosts of those factors and their monetary costs. Thus the minimum wage, for example, is virtually the same in all parts of a country, though the opportunity oost may be zero in areas where thore is unemployment of unskilled manpower . On the other the priee of oapital goods, which are mostly imported, was gcnerally reduced artificially by means of preferential exchange rates, in arder to promote industrial development .

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- - - -- - - - · - - - -

RBP~ODUCTION/353 Page

29

Furthormore; most import substitution activi ti es I.Yere basod on direct foreign investment_ (sometimos in association with national entrepreneurs) which involved the use of foreign tGchniques as well

~2 foreign capi tal.

These factors, allied to the fact that somG of the new v mtures -vero in SGctors wher3 tradi tional enterprises wGre already

ostablished, were conducive to a rapid deprecatior:i of 'the latter ' s .::;q_u::_"Çlmont on grounds of obsolescence , and the total effect was to .wastG œ~isting capital, impose a higher level of capitalization on

-l:;ho e;o~ooy Ftnd deprive unskillod labour of employment.

(c) As regards the constellation of prod~ctive resources, its most notable featuro is recognized . to be the disproportion behrsu1 thG supply of the various factors: that i s, natur.al resou~ces and unskilled manpowor are rel a ti ve-ly abundant, while skilled ma:>:1powc'~

and capital are scarcG. Consequently, thG ideal ·macro-economie p<, G·- terns of production which would bo more in keeping wi th such Sl;pr..~.i:.JG

of resources are completely different from those resulting from the sum of the micro-economie patterns actually adopted b~ entrepreneurs

.. ···-- . --^.·-. ·---·- -----^·-· ... ---·-

in tho import substitution process, on the basis of the existing system of rel~tive priees.

The disproportion tends to widen as the process advances, in that increasing quantities of scarce factors are used (often was- tefully) in the secondary sector, and. the structure of the primary sector romains unaltered 1

~

^This situation is largely responsible for tho serious structural unemployment of unskilled manpower and for that potentially productive reserves are left idle.

1J)

This does not mGan that any change in the structure nf the primary sec tor would automatically modify that trend. If, for ~xamtü.e, 3S<tl.ch a chango entail3d adopting a high-cap.i tal-densi ty t echnology, the -trend- would --like1y be--accentuated:, at- J:oast ·in ·tho_ ·sho-rt -run;

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REPROilUCTION/353 Page 30

Other problems arising in the Latin American economies relate to the fact taht r·elative abudance of natural resources does not always mean thàt thoir composition is what is nGoded for the growth of the industrialization process. In oarly stages of this process tho two basic rGquirements from the standpoint of natural rosources are: (1) thG existGnce of an agricultùral sector that can expand, either through increasing the area under cultivation or i:hrough more intensive land use with increased productivity, thus rnaking possible a fairly elastic food supply; ( 2) the existence of raw materials to supply the traditional consumer goods industries.

In the ensuing phases, however, there must be, in addition to those resources, a series of sources of energy (petroleum, coal, water rosources), and other mineral resources, and possibilities of exploiting them. But those resources are not evonly distrihutad tb.roughout Latin America, and in oaarly every country sorne cf the·~· y

often essen·tial items, are lacking, and thi·S consti tutes a soriovP obstacle in view of the restricted capacity to import.

Il. CRITICISM OF LATIN.AMERICA'S INilUSTRIALIZATION PROCESS.

In analysing the difficulties deriving from the external sector that have conJ.itioned the development process in the Latin Ameican countries it is commonly recognized that they represent ex- t ernal factors on which the individual action of the country concerned can have very little effect . On the other hand, thore is much sup- port for th.;; view that the reason why industrialization has generally led to insufficïent absorption of labour, largely uncompetitive

market structures and high production- costs₁^· in conjunct-ion wit-h -the

mainte~aace of an extremely uneven distribution of income, is the fai- lure to adopt E·ui table economie· :policy measures

~

ii!

^{By sorn}ê ^t^hêse ârê ^têrmêd ^sⁱ^mply "errors of government", and by others, in more t echnical or up-to-date terminology, "..Lnadeqt-:.ate programming".

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In this connection, it is hepful to present sorne comments that bring into clearer perpective the analysis in the preceding section of the structural factors that govern the dynamics pf the process, However, a prior general proviso is needed, pointing out that these governing factors can operate differentlT'in different

countries~ and have a favourable or restrictive effect according to actual conditions in each country, and the period at which the

various stages of its development take place. The degree of freedom of action resulting from the possible permutations of external and internal structural factors allows economie policy more or less roorn for manoeuvre, but once this policy has been adopted it, too, 1ecom€s a basic factor determining how far good use can be made of the economy's potential resources, or at least how far the obstacles to development can be overcome.

This should make it clear that the prsent analysis does not start with any arbitrarily deterministic interpretations, however, -it must be recognized that within the basic parameters of the import substitution model the industrialization prooess could hardly have led to radically different results frcm those actually produced. Tnere does not seem to be any point, moreover; in attempting to

rewrite history by discussing the theoretical viability of sorne other dovelopment model ·nased on such completely different parameters as a less unequal structure of ownership or distri~ution of the product, which would in the last analysis lead to entirely different goneral functions of production.

1. The problem of high costs and lack of competition.

A commonly crit;Lcizea fault of the industrialization process in Latin America is the high costs of the goods producedt a fact usually ascribed to lack of competition.