Import Substitution and Export Promotion

Karim Qasim African Trade Organisation ( June 20, 2015)
IMPORT SUBSTITUTION AND EXPORT PROMOTION:
A CONTINUING DILEMMA FOR PAKISTAN
Relevance of Paper to Africa: How do you reconcile anticolonial sentiments and obediently
following recommendations of Bretton woods institutions such as the World Bank? Africans
today want to be independent not only in the political realm but also in economic spheres. This is
a feeling that often clouds our judgment when drafting trade and other economic strategies.
(African Trade Organization)

1
Introduction:
In the ever globalizing world of today, there is a dominating tendency of economic
experts to adopt a sharply marked and bounded understanding of trade-related economic growth
and development due to export promotion in opposition to import substitution. More often than
not this kind of stereotyping has put developing countries (LDCs) in a position of having to make
a choice between the two developmental strategies in their attempts to move their economies and
societies from a so-called "backward" orientation towards a more "modern" one.
For international agencies such as World Trade Organization, World Bank and IMF trade
liberalization has become the linchpin of policy reforms in many developing countries.
Economists in these organizations generally advocate outward-looking export promotion
strategies of growth and cite phenomenal success of adherents of this policy, the Asian Tigers,
China, Brazil and Malaysia. By contrast, the advocates of inward-looking growth policies
believe that the negative effects of trade liberalization outweigh the potential benefits and
therefore espouse more protectionist approach.1
This paper reviews the economic underpinnings of pursuing import substitution or export
promotion as desirable growth strategy. After delineating the exact contours of these apparently
antithetical policies, this paper aims to provide empirical analysis of both the policies in the
context of Pakistan’s economy. It makes no pretense to offer any policy guidelines but merely
tries to examine the issue connected with the formation of a suitable policy for Pakistan. Why,
after pursuing the policy of export-led growth for over two decades, there is a return to
1
Manu, Franklyn A. "Import Substitution and Export Promotion: a continuing dilemma for developing countries." Journal of International
Business and Economics (2009).

2
protectionist import substitution in Pakistan? This article will also try to shed some light on the
general trend in export performance in various regimes.
Comparing Import Substitution and Export Promotion for trade based growth:
During the first four decades of the post-World War II period, there was a strong sense of
proclivity in the developing countries towards inward-looking ‘import substitution’ (IS) – the
promotion of industries oriented towards the domestic market by using import restrictions,
through high tariffs, quantitative restrictions and overvalued exchange rates, to encourage the
replacement of imported consumer and manufactured goods by domestic products. This policy
choice was much in line with the ideological consensus in the economists of the day which
supplemented the strong nationalistic and anti-colonial sentiments of developing countries. The
developing countries’ production structure was the corollary of the colonial rule that was heavily
oriented towards production and exports of primary commodities.2
Because of the unstable
markets and low income and price elasticities of demand there was a formidable risk of export
earnings instability with primary-product export dependence. With this view, the advocates of IS
strategy emphasized the need for LDCs to evolve their own style of development through
“learning by doing” using technologies appropriate to the country’s own resource endowments.
They argued that primary-commodity products tend to suffer a secular (long-term) decline in the
terms of trade against imported manufactured goods and therefore, espoused planned
intervention by the governments to support infant industries to replace imports from abroad and
in this way save foreign exchange in order to improve trade balance and achieve greater self-
2
Prema-chandra Athukorala, Jayatilleke S. S. Bandara, Saman Kelegama (Eds). (2011). Trade Liberalisation and Poverty in South Asia, New York,
NY: Routledge Studies in the Growth Economies of Asia

3
reliance.3
Domestic industries, under government protection, were believed to harness economies
of scale and the external economies of learning by doing and eventually grow up to be
competitive in the international market. Thus IS became the hallmark of development strategy in
many developing countries.
In the late 1960’s there came an intellectual counter-current supporting the outward-
looking “export promotion”. It was observed that domestic industries growing behind protective
tariff walls had no incentive to become efficient in production. Infant industries also never grew
up. In addition, IS policies accompanied by exchange controls promoted the use of more capital-
intensive techniques of production. The exchange controls themselves resulted in a vast increase
in the rent-seeking activities, dramatically increasing the costs of protection.4
The infirmities of IS strategy and the success of Asian tigers that used export promotion
(EP) policy offered enough inducement for the developing countries to slash the distortionary IS
policy in favor of trade liberalization. This called for putting in place an economic system with
improved resource allocation on the basis of prices determined by free market forces; access to
better technologies, inputs and intermediate goods; an economy better able to take advantage of
economies of scale and scope; greater domestic competition; availability of favorable growth
externalities, like the transfer of know-how and promote entrepreneurial class which is more
conducive to generating sustained high economic growth in the long-run.5
Policies to expand
export included lowering of import tariffs and export taxes, removing quantitative restrictions on
3
Prebisch, R. (1950), The Economic Development of Latin America and its Principal Problems (New York, United Nations).
4
Grabowski, R. (1994). Import substitution, export promotion, and the state in economic development. The Journal of Developing Areas, 28(4),
535-554.
5
Dornbusch, R. (1992). The case for trade liberalization in developing countries. The Journal of Economic Perspectives, 6(1), 69-85.

4
trade and reducing barriers to international flows of capital. Governments also tried to get
exporters access to inputs at world price and followed prudent exchange rate policies.
The pattern of redirection for developing countries to EP varied amongst different
countries. This was mainly because of the different factor endowments of different countries and
correspondingly different comparative advantage in either labor-intensive primary products or
capital-intensive manufactured goods. Countries that were heavily dependent on primary-product
exports generally fared badly because of the demand and supply side impediments of primary-
product exports. The demand for primary products was constrained by the income and price
elasticity factors (discussed above), development of synthetic substitutes and distortionary
interventionist policies of developed countries. The supply side was marred by structural
rigidities of developing countries. Conversely, the LDCs that capitalized on their surplus labor to
expand export of manufactured goods ostensibly fared much better.5
Therefore, despite the
widespread support of EP in the economic circles as the ecumenical development strategy, the
varied experience of LDCs hindered its unanimous implementation. The choice of the IS or EP
for a developing country, therefore, was based on the economic and political reality of that
country and more often than not were adopted in tandem. We now turn our attention to the
experience of Pakistan with each of the two mentioned trade strategies.
Trade Regime: The Pakistani Experience
Pakistan has never had a consistent, coherent and well-articulated trade policy. Trading
patterns have closely followed a cycle defined by a major departure from and return to
protectionist import substitution policies.

5
The Idea of a single trade-based growth strategy:
At the time of independence in 1947 Pakistan’s industrial base was confined to a few
textile mills, some sugar mills and some cement factories, all totaling 34 units.6
The commodity
composition of Pakistan’s exports was dominated by low-value primary products that
precipitated severe balance of payment crisis and rapidly declining terms of trade. Pakistan
therefore, pursued a policy of import-substitution to protect its infant local industry against
imports and to expand its domestic industrial base. Thereafter, the government began to promote
export growth by taking a number of measures to reduce the anti-export bias of the trade regime
during the 1960s in order to promote industrialization. Firstly, the government introduced the
export bonus scheme in the late 1959, which were in effect a multiple exchange rate system
favoring manufactured exports.
Secondly, industries with export potential were singled out for special treatment such as
preferential access to foreign exchange. Thirdly, import liberalization was undertaken.6
Despite
this marginal liberalization, IS continued to be the seminal strategy whereby tariffs and non-tariff
barriers were used to regulate imports and fiscal incentives were used to expand low cost labor-
intensive manufacturing sector. During this time, the large-scale manufacturing grew at an
average rate of 13.4 percent per annum. The export bonus scheme which was tailored to provide
greater incentives to exporters of manufactured goods was instrumental in increasing the
manufactured exports by 11.4 percent per annum in current rupee term during the 1960s as
against 1.8 percent growth of primary exports and 7.0 percent growth of total exports.
6
Khan, A. H., & Ali, S. (1998). The Experience of Trade Liberalisation in Pakistan [with Comments]. The Pakistan development review, 661-685.

6
Consequently, the share of manufactured exports in total exports increased from 43 percent in
1960 to 67 percent in 1970. 6
However, multiplicity of exchange rates and trade and fiscal
incentives for industrialization led to distortions in resource allocations and encouraged rent-
seeking activities and an industrial structure that was heavily dependent on the protection
provided by the government. As a result, the industrial base remained weak, inefficient and
concentrated which also affected the competitiveness of exports.7
On the Path to being “Open” to the world:
After the separation of East Pakistan in 1971, the government tried to launch more
reforms to further liberalize trade and divert the exports from the protected markets of former
East Pakistan to other countries. The Export Bonus Scheme was abolished, restrictive licensing
system was removed and devaluation measures were undertaken. These measures proved
successful as manufactured exports increased at a compound growth rate of 26 percent per
annum in current rupee term in early 1970s. 6
Pakistan’s terms of trade reached its all-time high
of 257.99 index points in 1973 (Fig. 1). Nationalization of economy, however, did not help the
cause. The net impact of the mentioned reforms was inadequate as disparaging anti-export bias
in the face of export taxes persisted (Fig 2) and the terms of trade eventually declined in the later
part of the decade (Fig. 1).
In 1980s, the process of denationalization was started. The government sought to reverse
the protectionist IS policies of earlier decades to reduce burden on government and encourage
private sector. Under this regime, the country moved to a floating exchange rate system, a
7
Lewis, S. (1971). Pakistan: Industrialization and Trade Policies, OECD: Paris

7
number of non-tariff barriers such as import quotas on non-capital imports were removed and
negative import system was adopted. In addition, a number of tariff reforms were undertaken.
Maximum tariff rate was reduced from 225 percent in 1986/87 to 125 percent in 1988/98 though
the dispersion of tariffs remained the same.6
Export policy was launched that emphasized the
need to generate exportable surplus by increasing domestic production in the agriculture and
industrial sector, with focus on export-oriented industries. Despite these policy reforms, the anti-
export bias persisted because of high tariff rates (Fig. 2 and Table 2) and terms of trade
incessantly declined (Fig. 1).
Pakistan finally announced a shift away from the IS development strategy in the late
1980s towards more outward-oriented EP. It embarked on programs of stabilization and
structural reforms to reduce market intervention in order to improve efficiency of resource use
and the competitiveness of the economy. The tariff structure was simplified: maximum tariffs
were lowered from 80 percent in 1993 to 45 in 1997 and to 25 percent in recent years and the un-
weighted i.e simple average statutory tariff fell from 45.61 in 1998 to 14.78 percent in 2009
(Table 2).8
Simplification and rationalization of tariff rates, the elimination of controls and other
quantitative restrictions and abolishing the negative list have been the important policy reforms
undertaken in the last two decades. At the same time, Pakistan also undertook some export
promotion measures such as export finance scheme, export credit guaranteed scheme etc. 6
These measures evidently brought tremendous export growth. Export earnings showed
substantial growth, increasing from $ 6.7 billion in 1990 to $ 24.7 billion in 2010 (Table 1).
8
Mahmud, M. (2010). A Strategy for Reversing Pakistan's Dismal Export Performance.

8
However, we will see later that this figure is not as impressive as it may seem. The liberalization
reforms also provided strong base for private sector development and foreign direct investment
which is complementary to export promotion.9
As a result, resource allocation improved and
Pakistan experienced an increase in annual average growth of 6 percent (Fig 3).
Despite these achievements, economic growth and export expansion in Pakistan have
lagged far behind East and Southeast Asian countries and even its South Asian neighbors.
Pakistan’s share of world exports has actually declined 17 percent since the early 1990s while
that of Malaysia, Thailand and India increased on average by 185 percent (Table 3). Even
Bangladesh has showed significant improvement since its separation from Pakistan.8
The gains in
terms of exports to GDP remains at a modest 13 percent, very much below the range of 30-50
percent of GDP in successful East Asian countries.
It is generally believed that lower competitiveness and lack of access to the other
countries are the major reasons for the slow progress in export expansion. Despite significant
chance in composition of exports with share of manufactured goods in total exports increased to
77 percent in 2007 from 56 percent in 1990, there is still a high concentration around a few
products like rice and textile. As a corollary of this the terms of trade have continued to be
dismal (Fig. 1).2
It is also important to note here that while there was substantial trade
liberalization during last two decades, there has been an increase in tariff dispersion.8
As a result
trade regime continues to have anti-export bias which is holding Pakistan back from developing
its full trade potential. Further reductions in tariffs have been hampered due to its significant
9
Hasan, P. (2007). Role of the State in Pakistan's Economy: Assessing the Past and Exploring Future Challenges. Economic and Political Weekly,
1623-1630.

9
contribution to the country’s revenue and because of rent-seeking behavior of special interest
groups that benefit from this protection.10
While Pakistan pursued significant liberalization policies, the recent success in export
performance can hardly be accredited to that. Exports only picked up because of accompanying
depreciation of the real exchange rate and due to high international commodity prices as
observed by the Planning Commission of Pakistan.11
This did not happen because of quality
improvement, value-addition and globally competitive prices or efficiencies in the export-
oriented industries. Furthermore, free trade spurred vicious pre-capitalist mercantilism that had
set a process of deindustrialization, kept agriculture stagnant and led to a growth bubble.
Finding the “right mix”:
Global financial Crisis threw a spanner in the process of liberalization complemented
with high current and fiscal account deficits. Pakistan once again introduced heavy protectionism
in the late 2000s, although the regulations were compatible with WTO’s guidelines.11
While IS
served to correct imbalances, it re-introduced major distortions in the trade system. There are
now at least nine standard normal statutory tariffs compared with just four in 2003-04. From the
list of 906 manufactured items that enjoy tariff exemptions, 91 per cent of the listed products
benefit only a single local monopoly producer and five per cent benefit only two producers,
while other producers of the same good, especially the small and medium producers, do not
receive the same treatment. The extremely high protection slows down the development of
efficient and competitive industries and promotes rent-seeking behavior. While this is true,
10
Bashir, Z., & Din, M. U. (2003). The Impacts of Economic Reforms and Trade Liberalisation on Agricultural Export Performance in Pakistan
[with Comments]. The Pakistan Development Review, 941-960.
11
Planning Commission`s strategy paper, “Pakistan: Framework for Economic Growth May 2011.”

10
selective curbs on imports are inevitable to correct widening trade imbalances in the present
stage of country`s industrialization. A judicious blend of import substitution and export growth,
therefore, can help reduce heavy foreign dependence more rapidly. 12
Conclusion:
The suitability of trade policy – IS or EP- for growth and development still remains a
moot question for Pakistan. After pursuing import substitution in the late 1950s and in 60s,
Pakistan switched to export promotion policies in 1970s and 1980s. IS was considered sine qua
non for industrialization. While it created bias against exports, Pakistan was able to develop a
sound industrial infrastructure particularly in power generation and specialized textile sectors
because of IS.13
Disappointingly, however, it accentuated several economic vices, viz.,
inefficiency in resource allocation, pervasive corruption and growth of inefficient monopoly
houses. Trade liberalization started with partial dismantling of trade barriers in 1980s but it was
only in 1990s when Pakistan initiated a decisive break away from IS and towards outward-
oriented EP, following a massive balance of payment crisis (Fig. 4), which severely constrained
its ability to continue with past policies. While limited protectionism persisted, improvement in
balance of payments following foreign capital and financial inflows between 1995 and 2002, and
a steady growth in exports proved EP as a better choice for growth. A thorough examination of
economic variables, however, proved otherwise. As mentioned earlier, marginal increase in
exports was not due to quality improvement, globally competitive products or efficiencies in the
12
Protectionism and the lure of mercantilism (2011, June 19). Dawn. retrieved from http://beta.dawn.com/news/637874/
13
Reza, S., Thuraisingam, G. (Eds). (1998). Export-led Growth Strategy for South Asia, Kuala Lumpur, Malaysia: Asian and Pacific Devevlopment
Centre

11
export-oriented industries but only because of depreciation of the real exchange rate and high
international commodity prices.
There is a widespread belief that Pakistan has not been able to reap much benefit from
export-led growth strategy due to both product and market concentration. Given the inelasticity
of import basket, only viable option available for the government is to diversify exports.
Manufacturing sector, which is regarded as the engine of growth of economy, has historically
been neglected except for the ones owned by the country’s powerful rentier class. It must be
noted here that significant exports of manufactured goods in past two decades happened in textile
industry where the large-scale IS has been successfully accomplished. It would be wrong,
however, to blame trade liberalization policies for the poor performance of industries. The
unstable political environment, poor infrastructural facilities, lack of discipline of the labor force,
its skill and quality, and lack of backward-linkages have all contributed in the poor export
performance of a country. It is in this context that the policymakers in Pakistan have been
ambivalent about pursuing more liberalization.
The global financial crisis in 2008-09 complemented with high current and fiscal account
deficits, changed the entire economic scenario of Pakistan and brought import substitution back
on the policy map. Much emphasis was given for IS in agriculture industry in which Pakistan has
historically enjoyed comparative advantage. Although the recent trade policy package released
by the Planning commission 2012/13 pays lip-service to the need for continuing liberalization,
the fact remains that the policy-making in Pakistan has reeked of myopic vision, lack of

12
governance structure and patronization of the powerful business class by the government. As a
result, Pakistan still faces intractable problems in finding the right trade-based growth strategy.
Bibliography:
1
Manu, Franklyn A. "Import Substitution and Export Promotion: a continuing dilemma for developing countries."
Journal of International Business and Economics (2009).
2
Prema-chandra Athukorala, Jayatilleke S. S. Bandara, Saman Kelegama (Eds). (2011). Trade Liberalisation and
Poverty in South Asia, New York, NY: Routledge Studies in the Growth Economies of Asia
3
Prebisch, R. (1950), The Economic Development of Latin America and its Principal Problems (New York, UN).
4
Grabowski, R. (1994). Import substitution, export promotion, and the state in economic development. The
Journal of Developing Areas, 28(4), 535-554.
5
Dornbusch, R. (1992). The case for trade liberalization in developing countries. The Journal of Economic
Perspectives, 6(1), 69-85.
6
Khan, A. H., & Ali, S. (1998). The Experience of Trade Liberalisation in Pakistan [with Comments]. The Pakistan
development review, 661-685.
7
Lewis, S. (1971). Pakistan: Industrialization and Trade Policies, OECD: Paris
8
Mahmud, M. (2010). A Strategy for Reversing Pakistan's Dismal Export Performance.
9
Hasan, P. (2007). Role of the State in Pakistan's Economy: Assessing the Past and Exploring Future Challenges.
Economic and Political Weekly, 1623-1630.
10
Bashir, Z., & Din, M. U. (2003). The Impacts of Economic Reforms and Trade Liberalisation on Agricultural Export
Performance in Pakistan [with Comments]. The Pakistan Development Review, 941-960.
11
Planning Commission`s strategy paper, “Pakistan: Framework for Economic Growth May 2011.”
12
Protectionism and the lure of mercantilism (2011, June 19). Dawn. ( http://beta.dawn.com/news/637874/)

13
13
Reza, S., Thuraisingam, G. (Eds). (1998). Export-led Growth Strategy for South Asia, Kuala Lumpur, Malaysia:
Asian and Pacific Devevlopment Centre
Appendix A: Tables
Table 1. Exports Receipts & Imports Payments and Balance of Trade. (In Millions U.S. $)
Period Exports (BOP) Imports (BOP) Balance of
Value Growth Rate Value Growth Rate Trade
a c a-c
1970-71 683 -- 1,187 -- -504
1971-72 625 -8.6 954 -19.6 -329
1972-73 766 22.6 889 -6.8 -123
1973-74 1,020 33.1 1,493 67.9 -473
1974-75 978 -4.1 2,114 41.6 -1,137
1975-76 1,162 18.9 2,139 1.2 -977
1976-77 1,132 -2.6 2,418 13 -1,286
1977-78 1,497 32.3 3,174 31.3 -1,677
1978-79 1,644 9.8 3,816 20.2 -2,172
1979-80 2,341 42.4 4,857 27.3 -2,516
1980-81 2,799 19.6 5,563 14.6 -2,765
1981-82 2,316 -17.2 5,771 3.7 -3,455
1982-83 2,627 13.4 5,618 -2.7 -2,991
1983-84 2,665 1.5 5,990 6.6 -3,325
1984-85 2,458 -7.8 6,017 0.4 -3,559
1985-86 2,943 19.7 6,000 -0.3 -3,057
1986-87 3,488 18.5 5,793 -3.5 -2,305
1987-88 4,361 25 6,917 19.4 -2,556
1988-89 4,628 6.1 7,201 4.1 -2,573
1989-90 4,924 6.4 7,414 3 -2,490
1990-91 5,894 19.7 8,387 13.1 -2,493
1991-92 6,761 14.7 9,000 7.3 -2,238

14
1992-93 6,782 0.3 10,049 11.7 -3,267
1993-94 6,684 -1.4 8,691 -13.5 -2,007
1994-95 7,776 16.3 10,298 18.5 -2,522
1995-96 8,311 6.9 12,015 16.7 -3,704
1996-97 8,096 -2.6 11,236 -6.5 -3,140
1997-98 8,434 4.2 10,301 -8.3 -1,867
1998-99 7,528 -10.7 9,613 -6.7 -2,085
1999-00 8,191 8.8 9,602 -0.1 -1,411
2000-01 8,934 9.1 10,202 6.2 -1,268
2001-02 9,140 2.3 9,434 -7.5 -294
2002-03 10,889 19.1 11,333 20.1 -444
2003-04 12,396 13.8 13,604 20 -1,208
2004-05 14,482 16.8 18,996 39.64 -4,514
2005-06 16,553 14.3 24,994 31.6 -8,441
2006-07 17,278 4.4 26,989 8 -9,711
2007-08 20,427 18.2 35,397 31.2 -14,970
2008-09 19,121 -6.4 31,747 -10.3 -12,627
2009-10 19,673 2.9 31,209 -1.7 -11,536
2010-11 25,355 28.9 35,872 14.9 -10,517
2011-12 24,696 -2.6 40,461 12.8 -15,765
2012-13 24,744 0.2 39,801 -1.6 -15,056
Source: State Bank of Pakistan (http://www.sbp.org.pk/ecodata/index2.asp#external)
Table 2. Tariff rate, applied, simple mean, all products (%)
Year 1995 1998 2001 2002 2003 2004 2005 2006 2007 2008 2009
Value 50.09 45.61 20.16 17.17 16.81 16.17 14.61 14.79 14.9 14.08 14.78
Source:World Bank (http://data.worldbank.org/indicator/)
Table 3. Exports as a Percentage Share of World Exports
Year Pakistan India Bangladesh Malaysia Thailand
1974 0.14 0.56 0.04a
0.55 0.32
1980 0.15 0.43 0.04 0.74 0.37
1990 0.18 0.57 0.05 0.94 0.74
2000 0.15 0.7 0.09 1.61 1.13

15
2008 0.15 1.32 0.10b
1.43 1.25
a
-1977, b
-2007
Source: Mahmud, M. (2010). A Strategy for Reversing Pakistan's Dismal Export Performance.
(http://www.creb.org.pk/)
Appendix B: Figures
Fig 1. Pakistan’s Terms of Trade (index points with base of 100)
Source: World Bank Data. (http://www.tradingeconomics.com/pakistan/gdp-growth)

16
Fig 2. Anti-Export Bias in Pakistan from 1969/70 to 1996/97)
Source: Khan, A. H., & Ali, S. (1998). The Experience of Trade Liberalisation in Pakistan [with
Comments]. The Pakistan development review, 661-685.
Fig 3. Pakistan’s GDP growth Rate (annual %).
Source: World Bank Data (http://www.tradingeconomics.com/pakistan/gdp-growth)

17
Fig. 4. Pakistan’s Current account balance (BoP; US dollar)
Source: World Bank Data (http://www.tradingeconomics.com/pakistan/gdp-growth)

Import Substitution and Export Promotion

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