What Is Import Substitution Industrialization – ISI?

Import substitution industrialization is a theory of economics typically adhered to by developing countries or emerging-market nations that seek to decrease their dependence on developed countries. The theory targets the protection and incubation of newly formed domestic industries to fully develop sectors so that the goods produced are competitive with imported goods. Under ISI theory, this process makes local economies, and their nations, self-sufficient.

Understanding Import Substitution Industrialization – ISI

The primary goal of the implemented substitution industrialization theory is to protect, strengthen and grow local industries using a variety of tactics, including tariffs, import quotas, and subsidized government loans. Countries implementing this theory attempt to shore up production channels for each stage of a product's development. 

ISI runs directly counter to the concept of comparative advantage, which occurs when countries specialize in producing goods at a lower opportunity cost and export them.

Key Takeaways

  • Import substitution industrialization is an economic theory adhered to by developing countries that wish to decrease their dependence on developed countries.
  • ISS targets the protection and incubation of newly formed domestic industries to develop sectors fully, so the goods produced are competitive with imported goods.
  • Developing countries slowly turned away from ISI in the 1980s and 1990s.

A Brief History of Import Substitution Industrialization – ISI Theory

The term "import substitution industrialization" primarily refers to the development economics policies of the 20th century, although the theory itself has been advocated since the 18th century and supported by economists such as Alexander Hamilton and Friedrich List.

Countries initially implemented ISI policies in the global south (Latin America, Africa, and parts of Asia), where the intention was to develop self-sufficiency by creating an internal market within each country. The success of ISI policies was facilitated by subsidizing prominent industries such as power generation and agriculture, as well as encouraging nationalization, greater taxation, and protectionist trade policies.

However, developing countries slowly turned away from ISI in the 1980s and 1990s after the rise of global market-driven liberalization, a concept based on the structural adjustment programs of the International Monetary Fund and the World Bank.

Theoretical Basis of Import Substitution Industrialization – ISI

The ISI theory is based on a group of developmental policies. The foundation for this theory is composed of the infant industry argument, the Singer-Prebisch thesis, and Keynesian economics. From these economic perspectives, a group of practices can be derived: a working industrial policy that subsidizes and organizes the production of strategic substitutes, barriers to trade such as tariffs, an overvalued currency that aids manufacturers in importing goods, and a lack of support for foreign direct investment.

Related to and intertwined with ISI is the school of structuralist economics. Conceptualized in the works of idealistic economists and financial professionals such as Hans Singer, Celso Furtado, and Octavio Paz, this school emphasizes the importance of taking into account structural features of a country or a society—that is, political, social and other institutional factors—when undertaking an economic analysis of it.

Chief among these is the dependent relationship that emerging countries often have with developed nations. Structuralist economics theories further gained prominence through the United Nations Economic Commission for Latin America (ECLA or CEPAL, its acronym in Spanish). In fact, "Latin American structuralism" has become a synonym for the era
of ISI that flourished n various Latin American countries from the 1950s to the 1980s.

Real-World Example of Import Substitution Industrialization – ISI

That era kicked off with the creation of ECLA in 1950, with Argentine central banker Raul Prebisch as its executive secretary. Prebish outlined an interpretation of Latin America's burgeoning transition from primary export-led growth to internally oriented urban-industrial development, a report that became "the founding document of Latin American structuralism" (to quote one academic paper) and a virtual manual for import substitution industrialization as well.

Inspired by Prebisch's call to arms, most Latin American nations went through some form of ISI in the ensuing years. They expanded the manufacturing of non-durable consumer goods, like food and beverages, first; then expanded into durable goods, like autos and appliances. Some nations, such as Argentina, Brazil, and Mexico, even developed domestic production of more advanced industrial products like machinery, electronics, and aircraft.

Although successful in several ways, the implementation of ISI did lead to high inflation and other economic problems. When these were exacerbated by stagnation and foreign debt crises in the 1970s, many Latin American nations sought loans from the IMF and the World Bank; at those institutions' insistence, they had to drop their ISI protectionist policies and open up their markets to free trade.