What Is Import Substitution Industrialization (ISI)?

Import substitution industrialization (ISI) 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 approach 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, the process makes local economies, and their nations, self-sufficient.

Key Takeaways

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

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 comparative advantage concept that occurs when countries specialize in producing goods at a lower opportunity cost and export them.

The History of Import Substitution Industrialization (ISI) Theory

ISI refers to the development economics policies of the 20th century. However, the theory itself has been advocated since the 18th century and was 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, and encouraging nationalization and protectionist trade policies.

Nevertheless, developing countries slowly began to reject ISI in the 1980s and 1990s after the rise of global market-driven liberalization, a concept based on the International Monetary Fund and the World Bank's structural adjustment programs.

The Theory of Import Substitution Industrialization (ISI)

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 in economic analysis. That is, political, social, and other institutional factors.

A critical feature 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 in 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 in a report. That report became "the founding document of Latin American structuralism" (to quote one academic paper) and a virtual manual for import substitution industrialization.

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, and then expanded into durable goods, such as autos and appliances. Some nations, like 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 the insistence of these institutions, these countries had to drop their ISI protectionist policies and open up their markets to free trade.