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Substitution Industrialization and Multinational Corporations Essay

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Import Substitution Industrialization

The import substitution industrialization is characterized by the creation of local industries to manufacture modest and low-cost consumer goods. The aim of import substitution industrialization is to safeguard local industries by forbidding the importation of traditional consumer products. The protective measure is achieved by imposing several measures such as direct government control, subsidies, exchange controls, and higher tariffs.

Therefore, the import substitution industrialization approach is costly since it is implemented by the public sector without consideration for efficiency or cost.1 Import substitution industrialization strategies were adopted by developing countries in South America, Asia, and Sub-Saharan Africa as a means of accelerating self-reliance and economic growth via the strengthening of the domestic market.

As stated earlier, import substitution industrialization is based upon extremely protective trade policies, subsidization of key industries such as electricity generation and agriculture, active government involvement in economic activities. However, the import substitution industrialization policy was replaced by structural adjustment programs (SAP) in the 1990s by developing countries as a precondition for accessing foreign aid from the World Bank and International Monetary Fund.

In an influential article, Werner Baer argued that import substitution industrialization was an economic strategy employed by third world countries to free their economies from world division of labor that began in the late 19th century and early 20th century.

Under this approach, most parts of Africa, Asia, and Latin America specialized in the importation of manufactured products from the United States and Europe while exporting raw materials and food. It follows that import substitution entailed the establishment of local manufacturing facilities to produce goods that were previously imported.

As a result, countries that achieved industrialization after Great Britain passed through the import substitution industrialization phase. In other words, these countries went through a phase where a substantial part of the investment in domestic industries was carried out to replace imports. The import substitution industrialization phase ended when considerable investments were directed towards building the capacity of the domestic industry.2

The wave of import substitution industrialization in the United States and Europe took place in the mid-19th century. It is highly acknowledged that the government played a key role in shielding and boosting the growth of infant industries during the formative phase of import substitution industrialization.

Another typical feature of the 19th-century import substitution industrialization relates to its national character. In spite of the fact that some countries acquired finance from abroad to invest in infrastructure, local industries were mainly owned by domestic investors. However, domestic industries relied on machines and skilled labor imported from England in the formative period of industrialization.3

Werner Baer asserts that the adoption of import substitution industrialization approach in many parts of Latin American was attributable to the occurrence of the Second World War and the Great Depression of the 1930s. The deterioration of non-military production in the U.S and Europe exacerbated by intermittent shipping resulted in acute shortages of imported manufactured products in Latin America increased relative prices of imports, and raised the profitability of import substitution industrialization ventures.

Further, the 1930s Great Depression led to increased shortages of imports. The declining foreign exchange income from export goods compelled most Latin American countries to reduce imports. The reduction initially led to the improved utilization of the productive capacity, which had largely remained idle in the early 20th century.

Later on, the decline in imports led to the establishment of new industrial capacity. It is worth mentioning that the depression induced import substitution industrialization took place mainly in the consumer goods industries with few exceptions, such as Brazil, where capital goods and steel industries grew on a fairly small scale.

On the contrary, the Second World War had a positive impact on import substitution industrialization. Shortages of exports stimulated the full employment of industrial capacity. For example, the importation of capital prompted investment in new capacity resulting in the export of some textile goods by Mexico, Argentina, and Brazil. 4

Whereas import substitution industrialization fashioned strategies for development during the first three decades after the culmination of World War II, the last three decades have been characterized by export-oriented industrialization.

By the mid-20th century, import substitution industrialization was creating two key economic inequalities that lend credence to the idea that import substitution industrialization was no longer a viable development strategy. The first inequality was noted in government budgets. The import substitution industrialization approach had a tendency to produce budget deficits since it advocated heavy government participation in the economy.

Given that the private sector was perceived to be inclined towards profit-maximizing objective hence would not invest in local industries that promoted import substitution industrialization, governments took it upon themselves to make such investments by creating state-owned enterprises or collaborating with private sector groups.

However, most of these state-owned enterprises were never economically viable. For example, a majority of these enterprises in third world countries had operating deficits that were roughly 4.1 percent of the gross development product in the late 1970s. Nonetheless, most governments used the state budget to keep these enterprises operational. As a result, the persistent injection of state resources to unproductive state-owned enterprises created huge and recurring budget deficits among developing countries.5

In his book, Thomas Oatley asserts that the recurring budget shortfall attributable to import substitution industrialization was further worsened by domestic politics. For example, many governments in developing countries relied on the urban population for political support.

Consequently, governments were compelled to subsidize basic services such as food, telephone services, electricity, and water to maintain this political support. This could only be achieved by using state revenues to bridge the gap between the price charged and the real cost of subsidized services.

In addition, the civil service was expanded to create employment opportunities for the urban population. A case in point is Benin, whose civil service budget increased by three-fold between 1961 and 1981 simply because the government wanted to secure political support.6 With a static revenue base, such expansionary strategies increased public expenditure, aggravating the already widening budget deficit.

The deficit spending adopted by most developing countries stems from Keynesian economics, which was propounded by John Maynard Keynes. He suggested that deficit spending can be a good thing and that money lying idle in a bank should be injected back into the economy via government deficit spending.

In order to accomplish this task, he suggested that the government should print more money as well as release idle money in the national bank into business to bring them back to life. He believed if this was done in moderation, this would create a surplus. This theory has been adopted by several advanced countries such as South Korea, which gives incentive money to businesses to spur economic growth.7

The second imbalance generated by import substitution industrialization was known as frequent current account deficits. It is important to mention that the current account is used to record goods and services that are either imported or exported in or out of the country. Thus, a deficit in the current account implies that the country is a net importer since the value of imports is higher than that of export.

It is against this background that import substitution industrialization resulted in the increase in current account deficits, given that it produced substantially reduced the value of exports and at the same time, increased demand for imports.

Thus, import substitution industrialization relied on import goods to work. For industrialization to take off, countries had to import essential machines and skilled manpower to operate them. Further, there was a need for the continued importation of spare parts for use in repairing the already installed machines.8 This means that imports continued to grow as developing countries pursued the industrialization approach.

There are two reasons advanced to explain the decline in export growth in developing countries. First, domestic industries that came into existence via import substitution industrialization could not compete effectively in the global market. The local markets in the majority of third world countries were not big enough to enable local industries to achieve economies of scale.

This wastefulness was exacerbated by surplus capacity attributed to the formation of additional production capacity relative to what the local market could absorb. As a result, the new production industries found it difficult to export their goods to the global market.

Secondly, the policies adopted by governments to spur industrialization destabilized agricultural activities, especially in Sub-Saharan Africa, where severe taxes were imposed on farmers. The heavily taxed farmers were less motivated to produce; hence, the growth rate in agricultural activities declined substantially. For example, the declining price of cocoa in Ghana was a disincentive for farmers to invest and improve the production of cocoa. 9

Multinational Corporations

Multinational corporations (MNCs) are firms that are heavily involved in international activities. Although multinational corporations exhibit diverse characteristics, they can be defined as a firm that operates and manages manufacturing plants in two or more countries. In essence, a multinational corporation owns several manufacturing plants in various countries, which are managed by a single corporate unit.

However, the definition does not encompass all activities that a multinational corporation engages in. For instance, it is common knowledge that multinational corporations are engaged in diverse activities such as cross-border investment, international trade, and economic production. A case in point is the General Electric Company, based in the United States, which is considered among the biggest multinational corporations in the world.

The Company operates over 248 plants which are spread in approximately 25 countries in Asia, Europe, North and South America. The majority of products manufactured by General Electric transcend national borders either as intermediate goods or final consumer products.10

The inception of MNCs can be traced back to the early 15th and 16th centuries when European firms began to shift their business operations to different parts of the world.11 For instance, the Royal African Company, Hudson’s Bay Company, and British East India Company were former by British traders with the aim of trading with Africa and America. These firms were the precursors of the modern-era MNCs.

Following the culmination of the Second World War in the mid-20th century, the structure and scope of MNCs have evolved at a phenomenal pace, with the international petroleum industry preceding this modern development.12 As noted earlier, a typical MNC usually operates with the head office based in a single country. Some multinational corporations may establish assembly operations to reduce transportation outlays and avoid tariff barriers.

The role of multinational corporations in the world economy has grown tremendously as the number of MNCs increases. For example, the United Nations has projected that MNCs account for approximately 30 percent of world exports with a human resource base estimated at 76 million people worldwide.

Further, approximately 8 percent of the entire foreign MNC’s assets are owned by 100 largest multinational corporations. In total, the 100 largest MNCs account for an estimated 4.1 percent of the global GDP, with a substantial part of this share taking place between foreign firms and multinational corporations. Based on this information, there is no doubt that multinational corporations play a significant role with respect to the present-day world economy.13

Even though multinational operations are concentrated in developed countries, there is mounting evidence that suggests that similar MNC’s operations have increased considerably in developing countries in the last three decades. This has been achieved through two main approaches.

First, as history shows, third world countries have hosted multinational investments, although the volume of foreign direct investments has been somewhat insignificant. For example, the share of foreign direct investments in developing countries rose from 25 percent to 50 percent of the total global investment from 1981-1998, amounting to about $189 billion.

However, this amount increased substantially in absolute terms to about $618 billion by 2008. It is important to note that the distribution of FDIs was skewed in favor of some Latin American and Asian countries. For example, Asia accounted for approximately 60 percent of all foreign direct investment inflow.

Similarly, China received about 30 percent of all foreign direct investments, while Latin America’s share increased by 5.9 percent of the total foreign direct investment in 1989 to 9.1 percent in 2008.14 This means that the share of foreign direct investment channeled towards Sub-Saharan Africa was negligible to have the desired economic impact.

However, the tremendous expansion of multinational corporations in the last three decades has brought to the fore the discussion about globalization. As a matter of fact, every facet of globalization has been synonymous with the operations of multinational corporations. Some scholars critical of globalization have argued that subsidiaries of multinational corporations in the developing world have been involved in the organized exploitation of employees in the host countries.15

Some critics have argued that the ability of multinational corporations to shift manufacturing bases wherever they desire has systematically weakened government regulations that seek to safeguard the environment, consumers, and employees.16

It is imperative to appreciate the positive contributions of multinational corporations to the host country. For instance, multinational corporations provide avenues for shifting savings between countries. It is worth mentioning that investment in both physical and human capital is a precondition for economic growth. However, a country requires substantial savings to undertake any form of investment required to achieve the desired economic growth.

Thus, MNCs provide means to channel foreign investment into the host country and enable it to accelerate economic growth than it would have achieved under a narrow base of domestic savings. Furthermore, given that multinational corporations undertake investments through foreign direct investments and the creation of local subsidiaries, it effectively allows the host country to control external debt.17

In addition, the host country can benefit from the managerial expertise and advanced technology brought about by the multinational corporations. Given that these firms manage intangible resources based on advanced skills, they usually facilitate the transfer of specialized knowledge to domestic firms in the host country.

A case in point is Motorola Malaysia, which shared advanced technology with a local Malaysian firm that enabled it to produce circuit boards. Such knowledge transfers have the potential of creative considerable positive externalities with immense effects on economic development.

Multinational corporations can also facilitate the transfer of managerial skills to domestic firms. The managerial knowledge is usually shared with the local managers in the host country, thus enabling them to operate in an efficient manner. Local managers working in these MNCs subsidiary firms are able to learn new managerial skills and use them to operate local firms.

In this manner, the multinational corporation is able to impart managerial expertise to the host country. In addition, local producers can benefit from the marketing networks of multinational corporations. This usually occurs when local firms and subsidiaries of a multinational corporation are assimilated into the global production and marketing chain of multinational corporations.

As a result, local producers can benefit from the global market chain, which would have been nonexistent in the absence of the multinational corporation. A case in point is a Malaysian firm which began manufacturing new electronic parts after acquiring knowledge from Motorola.18

In spite of the apparent benefits of multinational corporations to the host countries, there is a need for sound regulations to mitigate the negative externalities of such conglomerates. For example, multinational corporations may resort to borrowing capital from the domestic money market, thereby crowding out local investments.

Further, multinational corporations may resort to repatriate generated income to their home country in the absence of government regulations on the matter. As a result, the surplus income ends up in the home country of the multinational corporation, which, in effect, denies the host country funds that could be channeled into productive economic activities.

The need for government regulation is further underlined by the fact that multinational corporations have a solid financial base and advanced marketing knowledge, which they can apply to drive local firms out of operations.19

For example, if the multinational corporation possesses advanced technology that allows it to produce goods at a comparatively lower cost than domestic firms, the former will start to experience declining sales and eventually grind to a halt.

Thus, it is imperative that the government plays an active role in the economy by putting in place regulations to control the operations of multinational corporations and ensure fair play. This will safeguard the small domestic firm from imminent collapse.

Bibliography

Akanebu Ben, “The impact of multinational oil corporation on the Nigerian economy: An empirical analysis.” European Journal of Social Science, Arts, and Humanities 2 (2014): 21-15.

Lee Tan, “Technology Transfer, FDI and Economic Growth in the ASEAN Region.” Journal of the Asia Pacific Economy 11 (2006):394-410

Odunlami Samuel, “Multinational Corporations and Economic Development in Nigeria.” American Journal of Environmental Policy and Management 1 (2015): 16-24.

Teofilo Daquila, The Economies of Southeast Asia: Indonesia, Malaysia, Philippines, and Thailand (New York: Nova Science Publishers, 2010), 68.

Thomas Oatley, International Political Economy (New York: Pearson Longman, 2010), 134.

Werner Baer, “Import Substitution and Industrialization in Latin America: Experience and Interpretations.” Latin American Research Review 7 (1972): 95.

Footnotes

1 Teofilo Daquila, The Economies of Southeast Asia: Indonesia, Malaysia, Philippines, and Thailand (New York: Nova Science Publishers, 2010), 68.

2 Werner Baer, “Import Substitution and Industrialization in Latin America: Experience and Interpretations.” Latin American Research Review 7 (1972): 95.

3 Baer, 96.

4 Ibid.

5 Thomas Oatley, International Political Economy (New York: Pearson Longman, 2010), 134.

6 Oatley, 135.

7 Oatley, 135

8 Ibid.

9 Ibid.

10 Ibid.

11 Akanebu Ben, “The impact of multinational oil corporation on the Nigerian economy: An empirical analysis.” European Journal of Social Science, Arts, and Humanities 2 (2014): 23.

12 Odunlami Samuel, “Multinational Corporations and Economic Development in Nigeria.” American Journal of Environmental Policy and Management 1 (2015): 17.

13 Oatley, 162

14 Oatley, 164

15 Lee Tan, “Technology Transfer, FDI and Economic Growth in the ASEAN Region.” Journal of the Asia Pacific Economy 11 (2006): 394.

16 Ibid.

17 Oatley, 173.

18 Oatley, 174.

19 Oatley, 175.

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