POL201Y1 Lecture Notes - Capital Flight, Foreign Direct Investment, Offshore Bank

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24 Nov 2010

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Politics of Development: Week 7 t October 25, 2010
Import Substitution Industrialization
- A strategy of economic development
o Other strategies: manufacture-export strategy (strategy of Britain), forced-capitalization
(other strategy of Britain during first years of Industrial Revolution), primary-product
export (strategy of countries in global South, up until mid 20th century)
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may just occur without being an orchestrated policy decision
- ISI occurs when you build up the manufacturing base by shutting down imports on
manufactured goods
o New manufacturing sector is able to take advantage of the domestic market by
producing the same goods that were formally imported
- History: first wave was generated by WWI
o Because of war, most developed country economies reoriented production towards
military needs and stopped exporting manufactured goods to developing countries
Shortages in developed and developing worlds as a result
Developing countries responded by either living with the shortage or by making
an attempt to produce those goods domestically
x Happened again during Great Depression and during WWII
o By decolonization starts, a lot of national liberation leaders
convinced of need to build up own independent manufacturing
base so not as dependent on developed world
Strategy forced on developing countries because of
changes in production in developed countries
Focus of ISI:
- Building up manufacturing enterprises to produce higher-value goods that were formerly
imported; reducing economic focus in primary resources
- Light consumer goods: textiles, processed foodstuffs, metallurgical products
- Heavy industry: iron and steel, heavy chemicals, automobiles
ISI is the solution to dependency: build up a manufacturing base by withdrawing from the global market.
- Condition of dependency is caused by unequal terms of trade, balance of trade between imports
and exports cannot be sustained, spending a lot of money on imports and not making a lot of
money on exports
o In order to break out, a country can withdraw from the global market
Two ways: stop importing secondary goods and stop exporting raw materials
x ISI solution to both
x Both involve developing own domestic manufacturing base
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o Two reasons: can stop importing expensive secondary goods as
can produce them yourselves, and can become an exporter of
manufactured goods (rather than raw materials)
Look like a core country rather than a periphery country
Reasons to Implement ISI:
- Volatility of primary commodity prices
o Prices for agricultural products fluctuate dramatically from year to year as vulnerable to
forces beyond developing countries capacity to control (e.g. overproduction in other
developing countries, changes in consumer preferences in importing countries,
technological advances, weather, tariffs)
- Declining terms of trade
o Demand and prices for primary goods decrease significantly over time
primary goods)
Structural changes: productivity gains in agricultural (cheaper and more efficient
- Safe way of developing and protecting infant industry
o Start manufacturing in areas or products where you already know there is a domestic
market, cut off imports, no external competition
o Protection of infant industry is a problem that Britain never had to contend with as was
no competition from other countries of the world
Could be inefficient and expensive for a period of time as no competition
After Britain, every other industrialized nation faced this problem and used
protectionist policies towards nascent industries
- Forward and backward linkages
o Invest in one industry, has spill over effects if has a lot of forward and backward linkages
E.g. Auto industry: supplier of raw materials t suppliers of components t
assemblers t center of pre-delivery t dealers
Create a number of industries at once
E.g. Real estate
o Investing in car manufacturing sector will drive other sectors of economy, economy will
spontaneously produce itself without the government having to do it all
- Balance of payments deficits
o Caused when countries regularly import more than they export, created by unequal
terms of trade
o In 1950s, this becomes major problem for many countries
o ISI promises to put an end to some imports, assist in balancing payments
Implementation of ISI:
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