CHAPTER

64
Commercial Polic olicy Commercial Policy and Dev Economic Development
MEANING
Commercial policy plays an important part in the economic development of an LDC. Commercial policy may be defined as one that helps in accelerating the rate of economic development: (a) by enabling the underdeveloped country to have a larger share of the gains from trade; (b) by augmenting the rate of capital formation; (c) by promoting industrialization; and (d) by maintaining equilibrium in the balance of payments.

ARGUMENTS FOR AND AGAINST

Various arguments have been put forth in support of such a commercial policy which inevitably aims at the adoption of protection: 1. The Terms of Trade Argument. The increase in the gains from trade of an underdeveloped country is based on the terms of trade argument. A shift in the terms of trade in favour of an underdeveloped country is tantamount to an increase in its national income. If a country imposes a tariff that brings about a fall in import prices or a rise in export prices, it will result in improving its terms of trade. This will naturally help in financing economic development. For, its income will increase and it will be in a position to import larger quantities of capital goods.

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Its Limitations. On the face of it, this argument sounds logical, but it is not without certain reservations. First, an improvement in the terms of trade will have little relevance to capital formation, if the increased income is not saved but dissipated on domestic and imported goods. Mere saving is not enough. What is required is its investment in capital goods. Second, for such a tariff policy to be successful, the tariff imposing country should have sufficient monopoly or monopoly power. But this is not possible unless the underdeveloped countries act as a united economic group. In reality, such a policy is impracticable because of the small size of the domestic market for an importable commodity, and the ability of the developed countries to develop local substitutes for the natural products of such countries. Third, a tariff policy of this type is effective only if the foreign-offer curve is inelastic. But in the case of underdeveloped countries, the foreign-offer curve is usually elastic. As a result, they supply less exports and demand less imports as the price of imports rise. The higher is this elasticity, the greater will be the fall in the volume of trade as a result of the imposition of tariff. These price elasticities of supply and demand act as one of the important limitations to the terms of trade argument. However, discounting all these limitations, it is likely that the gain from trade would be only a short-term gain which would be eliminated quickly by retaliatory measures by other countries, changes in elasticities or by changes in the governments expenditures of customs revenue or an internal redistribution of income. 1 2. The Saving Ratio Argument. One of the principal sources of capital formation is an increase in the tempo of investment by stepping up domestic savings. Domestic savings can be stepped up by restricting the importation of consumer goods through direct controls or prohibitive duties. The consumption expenditure is thereby reduced which is equivalent to an increase in savings. This increase in savings is, in turn, utilized for importing capital goods. Thus for capital formation, the necessary condition is that a reduction in the import of consumer goods must be followed by an increase in the imports of capital goods of the same value. Its Limitations. But this argument is also not free from limitations. First, if the import restrictions do not result in reducing consumers expenditure, but lead to a shift of expenditure from imported to domestic consumption goods, the demand for the latter goods will rise in relation to their supply and there will be an inflationary pressure on prices and costs. As Nurkse puts it aptly, When the escape value of consumable imports is shut off, the pressure of the steam in the system increases, demand becomes excessive in relation to domestic supply and tends to push up the level of prices.2 Second, the increase in home consumption will also occur at the cost of home investment because increased consumption draws domestic factors away from capital construction or maintenance. Leaving aside an increase in voluntary savings, capital formation can, however, take place by purchasing imported capital goods through forced saving that results from inflation. Third, if the import restrictions on luxury consumption goods are not accompanied by similar restrictions on the domestic production of these goods, domestic savings will be sucked into non-essential channels. Thus the economy surrenders through the back-door what it secures by the front-door. It cannot be denied that economic growth does take place in this way, but it takes a needlessly painful and contorted form.
1. Meier and Baldwin, op. cit., p. 404. Italics mine. 2. Ibid., p. 112.

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Fourth, this argument assumes that a policy of import restriction on consumption goods does not affect exports adversely. If import restrictions are placed to protect domestic importcompeting industries they are likely to attract resources away from the export industries. Then the exports will be adversely affected. It is also possible that the incentive to peasants to produce the exportable crops may be dampened by the denial of imported consumption goods. Fifth, a policy of import restrictions leading to an increase in domestic costs and prices may have an unhealthy effect on exports. Thus Nurkse observes: The simple idea that more capital can be got for the country merely by pinching and twisting the foreign trade sector is an instance of the fallacy of misplaced concreteness.3 3. The Foreign Investment Argument. Protection also acts as a source of capital formation by attracting direct foreign investment in the underdeveloped country. One of the methods is the setting up of tariff factories in the tariff imposing country by the foreign manufacturer in order to escape the import controls. The foreign manufacturer may set up a branch or subsidiary of his firm alone or in collaboration with local enterprise behind the tariff wall when the finished products are prohibited while raw materials and necessary parts are permitted duty free. Some of the foreign industrial investment in India, in recent years, has been of this type. But the main obstacle in the flow of direct foreign capital has been the small size of the domestic market for the restricted imports in the underdeveloped countries. A wide domestic market acts as a big incentive in attracting foreign capital. As Nurkse puts it bluntly: Tariff protection, if it can help at all, can only help the strong, it cannot help the weak.4 4. The Infant Industry Argument. The famous Listian infant industry argument in favour of protection gives enough inducement to underdeveloped countries in accelerating their pace of industrialization. There are some industries which can be fruitfully developed in underdeveloped countries provided they are protected from foreign competition. In the present, their costs of production may be more due to the lack of certain basic facilities, but in due course of time, after the initial difficulties are overcome, their products would cost less. The future fruits of industrialization would more than compensate for the sacrifice undergone in the form of higher prices in the present. Thus the argument is that infant industries need protection from foreign competition till they attain adulthood. The period between infancy and adulthood is generally characterized by a transition from the agricultural to the industrial stage. Myrdal has assigned four special reasons for industrial protection in underdeveloped countriesthe difficulties of finding demand to match new supply, the existence of surplus labour, the large rewards of individual investments in creating external economies, and the lop-sided internal price structure disfavouring industry.5 These reasons are interrelated and provide an infant economy case for protection to an underdeveloped country. Its Limitations. But it has its limitations too. First, according to Nurkse, infant industry protection alone is an ineffective instrument of promoting economic development because it overlooks the problem of capital supply. Second, infant industry protection should not be given before the industry has been actually set up. As Nurkse said, Infant creation must take precedence over infant protection. Third, tariff protection cannot create or increase the supply of capital required by the infant industry. If can, however, make a contribution on the demand side by increasing the inducement
3. Ibid., p. 115. 4. Ibid., p. 106. 5. G. Myrdal, An International Economy, p. 279

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to invest in the protected industry. But this argument is confined only to creating demand for import-substitutes. Fourth, it is also doubtful whether the stress on import-substitutes will be enough to lead to a balanced growth of the economy. For, without an overall growth of the economy, investment in the import-competing industries will be very small. Nurkse cautions that too much reliance on import restrictions should be avoided because the import-substitutes produced at home are costly and tend to reduce real income.6 Fifth, given that the infant industry has been created, it must satisfy a number of conditions for the policy of protection to be successful. It is essential that the industry would not develop without the help of protection and that eventually it would be able to stand on its own legs when protection could be removed. Above all, it should acquire enough skill and experience to produce at low costs. It implies that though in the initial stages there may be losses, yet in future the industry should be in a position to realize sufficient saving in costs. Sixth, it is also difficult to decide the amount and the period of protection to be given to the infant industry. For making these decisions Dr. Lakdawala stresses, It is necessary not only to know and forecast the domestic demand and supply conditions but also those of the rest of the world. An error of judgement may prove costly, as the possibilities of reversal are limited. Once a protected industry comes into existence, even if it does not grow out of its infancy, it has to be borne with, especially in countries where the employment problem presents concern. To minimize the chances of failure, it is necessary not only to insist on a competent impartial enquiry as a prior condition, but also the government has to act as watchdog to ensure the full efficiency and productivity of protected industries. Seventh, assuming that these requirements have been satisfied, the right selection of infant industries is somewhat uncertain because it is difficult to forecast changes in costs and the extent of external economies in future. It is, therefore, advisable to impose a uniform ad valorem duty on all the manufactured products, rather than heavy selective duties in order to encourage the development of particular industries.7 5. External Economies Argument. Another argument for protection is that the establishment and development of every new industry yields benefits in the form of external economies. These external economies result in a divergence between private profit and social benefit. And when such divergence arises, a case can be made for import restrictions or subsidization in order to lessen this divergence. Scitovsky8 maintains that the concept of external economies in the context of industrialization of underdeveloped countries is used in connection with the social problem of allocating savings among alternative investment opportunities. External economies are generally classified as technological and pecuniary external economies. They arise because of direct inter-dependence among the producers. Technological external economies exist whenever the output of a firm depends not only on the factors of production utilized by this firm but also on the output and factor utilization of another firm or group of firms.9 These technological external economies affect the firms output through changes in its production function. According to Scitovsky, Pecuniary external economies are
6. Nurkse, op. cit., pp. 105-08. 7. D.T. Lakdawala, Commercial Policy and Economic Growth in Trade Theory and Commercial Policy in Relation to Underdeveloped Countries, (ed.) A.K. Dass Gupta p. 31, n, 5. 8. Tibor Scitovsky, Two Concepts of External Economies in Aggarwal and Singh (ed.) op. cit., pp. 295303. 9. J.E. Meade, External Economies and Diseconomies in a Competitive Situation. Economic Journal, March 1952. 10. Scitovsky, op. cit.

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invoked whenever the profits of one producer are affected by the actions of other producers. He explains further that with an expansion in the capacity of an industry as a result of investment, prices of its products fall and the prices of the factors used by it rise. The lowering of product prices benefits their consumers and the rising of factor benefits their suppliers. When these benefits accrue to firms in the form of profits, they are pecuniary external economies. 10 Its Limitations. The external economies argument has the following limitations: First, if production costs of firms in other industries are lowered as a result of expansion in the capacity of the protected industry, due to emergence of technical or pecuniary external economies, the private profitability understates its social desirability in this situation. As a result, the production of commodities will be less than optimal. In other words, investment decisions will be less than optimal, if investment in the protected industry increases the profitability of an another industry. Thus protection granted to a range of complementary industries is socially more profitable whereas in the case of isolated industries, it might be less profitable. As Scitovsky emphasises, Only if expansion in industries were integrated and planned together, would the profitability of investment in each one of them be a reliable index of social desirability?11 Second, Myrdal is of the view that greater external economies are realizable in the export as well as the import-competing industries.12 Third, in reality, one must count only the net external economiesthe external economies minus diseconomiesaccruing to domestic nationals and leave out of account the pecuniary external economies accruing to foreign buyers from the expansion of export industries and the diseconomies inflicted on foreign competitors by the expansion of import competing industries. Accordingly, investment in export industries, concludes Scitovsky, is always less and that in import competing industries, is always more desirable from the national point of view. 6. Factor Re-distribution Argument. It is contended that in an under developed country the gap in prices and costs between agriculture and industry is so wide that it hampers the development of industry. This view was first of all put forth by M. Manoilesco13 who advocated protection for industry since industry was more productive than agriculture. Lewis14 and Myrdal have restated the argument in recent years. In overpopulated underdeveloped countries, the money wages of labour in industry exceed the social cost of labour in alternative uses. Due to the existence of the extended family system and underemployment in the rural areas, wages tend to be low in agriculture and high in industry. An underemployed or unemployed worker in the rural area will not be prepared to accept a job in the town unless the wages offered exceed his share of the family income. From the point of view of the society, the value of the workers output is smaller than what he is prepared to accept in an alternative job in the town, since his marginal product is negligible or zero as he is underemployed or unemployed. Thus a policy of protecting industries is called for in order to compensate for this gap in money and social costs and also to provide viable employment opportunities for the surplus labour force. Myrdal states that in an under developed country the span between wages in manufacturing industry and in agriculture tends to be particularly broad. This will hamper industry if it is not given protection to a corresponding degree. Moreover, the social costs for labour in industry are actually lower than money costs. And
11. Ibid. 12. Ibid., p 227. 13. M.Manoilesco, Theory of Protection and International Trade, 1931. 14. W.A. Lewis, in Aggarwal and Singh, op. cit.

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protection will compensate for this gap in labour costs between agriculture and industry.15 It is maintained that since agriculture is less productive than industry, real income can be raised by factor redistribution through a policy of protection. Its Limitations. This argument is also not free from limitations. First, this argument is not cogent when applied to the problem of disguised unemployment existing in underdeveloped countries. If a portion of surplus working force (whose marginal productivity in agriculture is zero) is withdrawn from agriculture and gainfully employed in industry, it will raise the real income of the country. For this purpose industries are to be protected against foreign competition. Second, we have already discussed the various aspects of the problem of disguised unemployment. Given that disguised unemployment does exist, should protection be given in order to transfer surplus labour force from agriculture to industry? Nurkses solution to this problem is not through industrialization but by employing surplus labour in capital projects. The problem is not one of protecting industry but of stimulating labour mobility by removing the various social and institutional barriers. Third, this superiority of industry argument is, however, untenable in the context of economic growth. A country is poor not because of the agricultural bias of its economy but due to low agricultural productivity. In fact, for rapid economic growth agricultural development must keep pace with industrial development. Agricultural productivity should continue to increase in order to provide food to a growing population, to supply raw materials to expanding domestic industries, to earn more foreign exchange, and above all to accelerate the rate of capital formation. Too much emphasis on industry is, therefore, likely to adversely affect agriculture and exports. Thus primary production cannot be regarded as a cause of poverty. It is an associative characteristic of poverty, but not a causative characteristic.16 7. The Balance of Payments Argument. One of the principal objectives of commercial policy in an underdeveloped country is to prevent disequilibrium in the balance of payments. Such countries are prone to serious balance of payments difficulties to fulfil the planned targets of development. An imbalance is created between imports and exports which continues to widen as development gains momentum. This is due to increase in imports and decline in exports. To establish economic infrastructure like power, irrigation, transport projects, etc. and directly productive activities like iron and steel, cement, electricals, etc. underdeveloped countries have to import capital equipment, machinery, raw materials, spares and components in large quantities, thereby raising the import content of their foreign trade. Another cause of the rise in imports is the growing demand for foodgrains necessitated by a rapidly growing population. For instance, India had been importing on an average 3 million tonnes of foodgrains every year till a few years ago. So food imports are an important factor in creating an unfavourable balance of payments in underdeveloped countries. Apart from foodgrains many essential consumer goods are imported to meet the domestic demand because it cannot be met adequately by indigenous production. This equally applies to capital equipment needed by the private sector of the economy. Another important factor responsible for growing imports of such countries is the policy of import substitution. It requires the establishment of such industries within the economy which ultimately replace imports. This policy, in itself, necessitates the import of large quantities of
15. Ibid. 16. Meier and Baldwin, op. cit, p. 400.

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machinery, capital equipment, spares, raw materials, etc., to set and operate such industries. Almost all underdeveloped countries have emerged as independent nations after a long spell of colonial rule. They, therefore, prize their hardwon independence above everything. For this, they prepare themselves to ward off any external invasion and internal rebellion. This had led to heavy imports of defence equipments. Another important cause of the balance of payments difficulties in such economies is inflation. As the economy moves on the path to development heavy investment expenditure flowing from deficit financing lead to strong inflationary pressures. Rise in domestic incomes, costs, and prices encourage imports and discourage exports. This makes the balance of payments position serious. Further, balance of payments disequilibrium arises when a developing economy needs foreign exchange to service foreign borrowings. Such economies have to pay back the principal and interest on borrowings from the developed economies. Besides, they have to make payments for the services of invisible items, i.e., transportation and insurance charges on imported goods. All these require larger foreign exchange which, being already scarce, accentuates the balance of payments position. On the other hand, exports lag behind imports. Exports of underdeveloped countries lack variety and resilience. These countries produce primary products, mainly raw materials and agricultural commodities. Hence their markets are limited and highly competitive. Moreover, they are unable to export more on account of increased domestic consumption of exportable products due to rising income and increase in income elasticity of demand for consumer goods. Another problem is their high cost of production due to inflationary pressures. In the face of highly competitive international markets, high cost is a big hurdle to exports. Again, tariff barriers, quota restrictions and regional economic groupings also keep down the exports of underdeveloped countries. Lastly, bad quality of exportable goods and the absence of proper credit facilities to sell goods in foreign countries have been instrumental in keeping their exports low. Thus the above factors have tended to keep exports down and imports high thereby creating a perpetual problem of balance of payments in underdeveloped countries. Measures to Overcome Balance of Payments Difficulties. The gap between imports and exports can be bridged by increasing exports and cutting down imports. For this purpose, complete government control over exports and imports is essential in order to push exports to the maximum and to cut down imports to the essential minimum. We discuss these two objectives in detail. 1. Export Promotion. Export promotion is indispensable for overcoming disequilibrium in the balance of payments. As a first step, comprehensive commodity surveys should be made in developed countries to determine potential markets. On the basis of these surveys, production of commodities with export potentialities should be increased. Exports of non-traditional items should be encouraged for they are needed both by the developing and developed countries. Myrdal observes in this connection that it is not in the interest of underdeveloped countries to continue with their traditional exports. He, therefore, suggests that they should rather take good look at the composition of these exports and at their prospects in the world market and then make up their minds about which exports they should try to increase and which, exports they should rather leave alone or reduce. They should seek out for themselves the dynamic commodities with using demand trends and with high income and price elasticities and try to get away from those with a doubtful future.17
17. G. Myrdal, op. cit., p. 854.

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This policy, in turn, necessitates the adoption of the following measures: (i) An essential precondition for the fulfilment of the export programme is the realization of the production targets set in the agricultural mineral and industrial sectors of the economy; (ii) Restrain-ing the growth of domestic consumption of commodities through fiscal or other measures in order to create adequate export surplus; (iii) Maintenance of reasonable internal price stability; (iv) Modernisation of export-oriented industries; (v) Timely import of raw materials and capital equipments needed for the production of exportable goods and even supplying them at subsidized prices; (vi) Relaxation or removal of export restrictions on exportable goods; (vii) Provision of credit, insurance and transport facilities to exporters. In India, credit facilities to exporters are provided by the Reserve Bank of India, the State Bank of India, and the Refinance Corporation. Besides, there is the Export Credit and Guarantee Corporation which insures all export risks, furnishes guarantees to banks on behalf of the exporters for credit facilities and provides supplementary credit facilities for export promotion. While the Indian Railways provide cheap and preferential transport facilities; (viii) Tax concessions to exporters using imported raw materials, semi-processed goods or components in the manufacture of exportable commodities; (ix) Stabilisation of prices of exportable goods; (x) Measures for the introduction and enforcement of quality control and compulsory preshipment inspection of various exportable commodities. In India, the Export Inspection Council performs these twin functions; (xi) Establishment of a commercial intelligence service for the compilation and dissemination of information to guide exporters and foreign importing firms; (xii) Establishment of a trading company to represent business interests of exporters in foreign countries having branches in key centres of the world; (xiii) Promotion and participation in industrial and trade fairs abroad and to arrange visual commercial publicity for the purpose of export promotion; (xiv) Setting up export promotion councils for major export goods. In India there are Export Promotion Councils in the case of major exportable commodities which perform both advisory and executive functions. They have been set up to secure the active cooperation of growers, producers and exporters in the countrys drive for export promotion. Some of the councils have opened regional centres at important places in India and abroad; (xv) Conclusion of bilateral trade agreements with developed countries; (xvi) Cooperation among developing countries in the sphere of foreign trade. Since most of the underdeveloped countries export almost similar types of products, they enter into competition with one another which is detrimental to them. Nurkse, Myrdal and others have, therefore, suggested cooperation among them in the field of international trade. It may be cooperation in a particular region or the creation of a common market among countries of the same character. This is the only way to boost up the trade of underdeveloped countries by increasing their bargaining strength in the world market. The Says Law of Market, so to say, will have a wider application among various countries of the underdeveloped region than within one country itself. The supply of one country would meet the demand in the other, and vice versa.18
18. M.S. Khan, Indias Economic Development and International Economic Relations, 2nd ed.

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2. Import Substitution. Another important method to overcome the balance of payments difficulties has been the import substitution. The strategy is to cut down import of consumer goods and produce them at home. As Myrdal has pointed out, The danger on the foreign exchange front provides a reason for directing investments in industry towards production of commodities that are substitutes for imports.19 According to Hirschman, there are four impulses of import substituting industrialization. They are the balance of payments difficulties, wars, gradual growth of income, and deliberate development policy. The first leads to a bias in favour of non-essential industries and the last is likely to produce exactly the opposite bias. The two motivating forces of industrialization by import substitution in developing countries have been balance of payments difficulties and deliberate development policy. The measures which are adopted in pursuance of these two impulses are import duties, quotas and import of exchange surcharges and multiple exchange rates as price-protective devices, while tax exemptions and subsidies are used to reduce costs in import-competing industries. Import substitution necessarily begins with the manufacture of durable consumer goods at the final stages of production. The country imports many converting, assembling and mixing plants and turns out finished consumer goods that were previously imported and then moves on, more or less rapidly and successfully, to the higher stages of productionto intermediate goods and machinery through backward linkage effects.20 Case for Import Substitution. The case for import substitution rests on the grounds that trade had operated historically as a mechanism of international inequality to the disadvantage of backward countries. They are, therefore, justified in adopting the strategy of industrialization by import substitution for the purpose of achieving self-sufficiency in the long run and to save foreign exchange by substituting imports by home production. The experience of advanced countries is also cited in support of import substitution. H.B. Chenery has shown on the basis of historical studies of some countries that not only the share of industrial output rises with development, but also the growth of industries based on import substitution accounts for a large production of the total rise in industrial production.21 One of the principal arguments for the policy of import substitution is that it avoids the uncertainties and risks involved in finding markets for the import substitution industries because when the imports are shut off, an already established market is secured for the new industries. Another argument is based on the contention that the demand of a developing country for industrial imports increases much more rapidly than the foreign demand for its exports. Such countries export primary products which have a sluggish foreign demand and are therefore unable to import industrial products sufficiently in exchange for exports. Thus the need arises for producing industrial goods at home to meet the domestic demand. Again, it is argued that import-substituting industrialization augments the rate of domestic savings and investment. When the state uses restrictive devices like tariffs, licences, quotas, etc., to protect import-substituting industries from foreign competition, the producers are able to raise the prices of their products and thus earn high profits. When these profits are saved and reinvested, development gains momentum. Moreover, it is argued that protection to import substitution industries will turn the terms of trade against the unprotected sectors and thus change the distribution of income in such a manner that savings and investment are encouraged in the economy.
19. G. Myrdal, op. cit. 20. A.O. Hirschman, The Political Economy of Import Substituting Industrialization in Latin America. QJE, February, 1968. 21. H.B Chenery, Patterns of Industrial Growth, AERL, September, 1960.

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Further, there is the employment argument in support of industrialization by import substitution. It is contended that import-substituting industrialization is necessary to provide gainful employment to the existing underemployed, to absorb surplus manpower arising from increase in agricultural productivity through the use of modern labour-saving techniques and to engage the growing labour force as population increases. Another argument for import-substituting industrialization is from the point of view of the economic welfare of the underdeveloped country in the long run. If the policy of importsubstitution is carried through, substantial amounts of direct foreign investments, as is usually the case, the country benefits from modern industrial techniques and know-how. By directly participating in the technological know-how of the advanced countries, it is in a position to accelerate its rate of capital accumulation. Lastly, the ultimate aim of industrialization via import substitution is two-fold: (i) to achieve self-sufficiency in the production of finished consumer goods, intermediate goods and machinery; and (ii) to export them to developing and developed countries. Case Against Import Substitution. The policy of import substitution being followed in India, Pakistan and in many Latin American countries has not been smooth. Rather, it has tended to disrupt the economies of underdeveloped countries thereby making their process of industrialization a costly one. Santiago Macario, a Latin American economist, writes in this connection that anxiety to relieve the chronic shortage of foreign exchange has induced many Latin American countries to pursue an industrialization policy essentially geared to import substitution; and that the substitution process has not been effected gradually, in accordance with a plan, and in anticipation of development requirements but in makeshift fashion, frequently to meet emergencies, and on the basis of excessive and indiscriminate protection. Consequently, in many instances it has been carried a good deal beyond the economically advisable limits, with the result that serious distortions have been introduced in the economic structure in the countries concerned and the development of more efficient and productive activities has been adversely affected to the special detriment of export possibilities.22 These observations equally apply to India, as will be shown later. We discuss arguments against import substitution in the light of merits of this policy as given above: The principal objective of the policy of import substitution aimed at saving foreign exchange has been frustrated. The industries established have not been those that might have saved foreign exchange. In fact, the established industries have failed to produce any real savings, rather they have resulted in dissaving of foreign exchange. Underdeveloped countries lack in raw materials, intermediate goods and capital equipment to start import substitution industries. So the need for imports is much greater in this policy than otherwise. Thus, the direct savings of foreign exchange may be less than the indirect expenditure of foreign exchange on inputs and capital goods needed for import substitution industries. It may even lead to dissavings because the value of the inputs imported for the new industries may far exceed the value of goods replaced by domestic production. The historical evidence adduced by Chenery in support of industrialization via import substitution may not hold good in the case of all the developing countries. It is contended that the rise in industrial production has taken place through the growth of imports. The import of raw materials, intermediate goods and capital equipment help in the establishment of the domestic industry in an underdeveloped country. In fact, the imports help in using the
22. S. Macario, Protectionism and Industrialization in Latin America, Economic Bulletin for Latin America, March, 1965.

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underemployed resources productively, in creating demand, and in encouraging entrepreneurial activities within the economy. It is the imports which ultimately pave the way for the establishment of import substituting industries by creating a base for them. The argument that import substitution industrialization is essential to meet the domestic demand for industrial goods secured by shutting off imports overlooks the need for larger imports. According to Prof. Hirschman, The bulk of new industries in developing countries are in the consumer goods sector and as they are undertaken in accordance with known processes, on the basis of imported inputs and machines, industrialization via import substitution becomes a highly sequential, or tightly staged, affair.23 The policy of import substitution thus creates demand for a variety of imports and defeats the purpose for which it is adopted. Moreover, the tendency for import substitution to create demand for further imports has important consequences. (i) instead of reducing, it increases the economys dependence on imports. (ii) sometimes the economy may be unable to import raw materials, capital equipment and spares due to shortage of foreign exchange or its insufficient allocation to imported materials and spares. Consequently, this leads to under-utilization of manufacturing capacity resulting in work stoppages, unemployment and fall in income. (iii) import substitution has a tendency to shift the distribution of income in favour of the urban sector and the higher income groups, whose expenditure pattern typically has the highest component of imports which tends to increase further the demand for imports. Thus the extension of import substitution to a wider range of goods generates or increases the demand for further imports with bad effects on the economy. John Power has argued that import substitution of finished consumer goods tends to lower rather than raise domestic savings and investment. The stress on the production of consumer goods for domestic use tends to raise their consumption and thus penalise exports and backwardlinkage import substitution. Such a policy leads to adverse effects on economic and technical efficiency thereby reducing income, profits and saving. John Power, therefore, advocates investment in capital goods and export sectors rather than into the consumer goods sector to augment the rates of national income, saving and investment for further growth.24 The argument that the establishment of import-substituting industries tends to absorb surplus labour in underdeveloped countries has not been borne out by facts. Firstly, There is no denying the fact that import substitution expands output in the manufacturing sector but it has failed to create jobs for growing labour force in such countries. Griffin and Eros have shown that the growth of employment in manufacturing is not in the least comparable to the growth in output. In fact, employment seldom increases unless manufacturing output is growing by about 4 per cent per annum. Secondly, industrial employment grows less rapidly than the population.25 For instance, over the period 1960-70 the average annual growth rate of output in Chile was 5.5 per cent while the growth rate of employment was 1.4 per cent. Similar was the case with Philippines where the growth rate of employment was only 2.1 per cent as against 6.7 per cent in output. This proves that industrialization via import substitution fails to create jobs so as to absorb redundant labour. Further, the use of the strategy of import substitution as a means to achieve self-sufficiency in industrial production has led to malallocation of resources and a very bad effect on industrial productivity. In their enthusiasm to attain self-sufficiency, underdeveloped countries have
23. Ibid. 24. J. Power, Import Substitution as an Industrialization Strategy, Philippines Economic Journal, Vol. V, no. 2, 1966. 25. Planning Development, 1970.

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resorted to indiscriminate protection for the development of inefficient and low priority industries. As a result, raw materials, intermediate goods and equipment obtained at a high cost have been misused. Thus such a policy has led to the establishment of inefficient industries with high production costs under extreme protection. This has been the experience of India in the field of import substitution. According to V. V. Desai, the self-sufficiency goal led to the impression that whatever substituted imports good for the economy. As a result, substantial amounts of spare resources were used up. in the production of such commodities as could be considered low priority consumption items. He estimated that the growth of such non-essential production resulted in the loss of potential savings to the tune of about Rs. 800 crores during 1954-55 and 1963-64'26 Further, this resulted in inadequate planning of the industrial structure and systematic under-estimation of the foreign exchange requirements of the programme for import substitution. It also resulted in the need for foreign exchange exceeding availability, thereby forcing many industries to operate below capacity. He concludes that the misdirection of substantial investment into low priority industries and the ever growing foreign exchange requirements have failed to achieve the goal of self-sufficiency in the industrial sector through import substitution.27 The same story has been repeated in the majority of Latin American countries. Besides, according to Raul Prebisch,28 excessive protectionism in such economies has generally insulated national markets from external competitions. This has tended to weaken and even destroy the incentive to improve the quality of their products and to lower costs. High cost of production has necessitated recourse to excessive protectionism. This has, in turn, adversely affected the industrial structure because it has encouraged the establishment of small uneconomic units, weakened the incentive to introduce modern techniques, and slowed down the rise in productivity. Thus a vicious circle has been created as regards exports of manufactured goods. These exports encounter great difficulties because internal costs are high because, among other reasons, the exports which would enlarge the markets are lacking. Thus import-substituting industrialization has failed to encourage exports of developing countries. Conclusion. In conclusion, it seems that the policy of import substitution has failed to conserve foreign exchange. However, in certain cases it has intensified the shortage. The emphasis on import substitution on consumer goods has not been successful in increasing real output, saving and investment. It has failed to bring the economy anywhere near the goal of self-sufficiency in industrial production. Neither has it succeeded in creating sufficient employment opportunities to absorb the growing labour force, nor has there been the progressive growth of the export sector. But countries like India which have established industries for the manufacture of sophisticated machinery and equipment have achieved significant progress in import substitution. It has helped the country lay reasonably good foundation for self-reliance in respect of the future investment programmes and defence capability. There has been spectacular achievement in respect of basic industries like iron and steel, crude petroleum and products, fertilisers, heavy chemicals, aluminium and a variety of machinery, besides a number of durable consumer goods like bicycles, fans, sewing machines which the country also exports. India now produces about three-fourths of the capital equipment required for its development programmes through the policy of import substitution.
26. V.V. Desai, Import Substitution and Growth of Consumer Industries, Economic and Political Weekly, 15 March, 1969. 27. V.V. Desai, Pursuit of Industrial Self-sufficiency, Economic and Political Weekly, 1 May, 1971 and Neglect of Implications of Self-sufficiency Goal, Ibid., July, 1971. 28. Raul Prebisch, Towards a New Trade Policy for Development, 1964.

Commercial Policy and Economic Development

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EXPORT PROMOTION VS. IMPORT SUBSTITUTION A pertinent question is: as between export promotion and import substitution which policy should be adopted by an underdeveloped country? Both policies have one common aim, i.e., to overcome balance of payments difficulties. We have discussed above the disadvantages of the policy of import substitution. Instead of saving foreign exchange, it has tended to increase the demand for imported machinery, parts and equipments. Extreme protection has led to the establishment of inefficient units with high production costs and sub-standard products thereby acting as severe handicaps for the growth of exports. The country is thus required to pay heavy price for industrialization via import substitution. Therefore, the policy of export promotion is called for. But import substitution can be an effective instrument provided it can be done without creating over-protected, inefficient and high-cost industries. On the other hand, an economy which lays stress on export development is likely to create conditions favourable for efficient production, because sustained growth of exports, involving international competition, calls for greater cost and quality consciousn29 For the purposes of discussion, let us divide the developing countries into two categories: (i) countries not suffering from acute population pressures; and (ii) overpopulated countries. Countries in the first category should try to maintain and expand their traditional exports. They should make improvement in primary production by using more capital and better technology. They should replace such imports the production of which absorbs more labour relatively to capital. The process of import replacements should be gradual and in collaboration with foreign enterprises. On the other hand, overpopulated countries like India should concentrate on manufactured products both for home consumption and export. This is essential because the markets for traditional exports of India like tea, jute manufactures, and cotton textiles have become either stagnant or have been expanding very slowly. Expenditure elasticity of demand for commodities like tea being constant, their exports are not likely to expand. Commodities like jute manufactures are losing their foreign market due to the development of synthetic materials. Even the market for cotton textiles is shrinking because of the development of man-made fibres like terylene. Another reason is stiff competition among the developing countries because every new country starts with cotton textile industry. Keeping these factors in view, it is imperative for developing countries to promote the export of those durable consumer goods which are in great demand in the developed countries. Such commodities are cars, scooters, tape recorders, air-conditioners, refrigerators, TVs, cameras etc. The classical example is of Japan which has captured the Australian, New Zealand, American, and Canadian markets despite stiff competition from the domestic producers of these commodities. But the greatest handicap in this field for developing countries like India is high cost of production and low quality. So, for the purpose of developing the markets for such non-traditional items, developing economies should adopt export promotion measures enumerated in the earlier page. But the export of non-traditional items to the developed countries are beset with strong protective barriers which the developing countries will have to overcome. In this context, Harrods advice merits consideration. He writes, whatever the policies of the mature countries, developing countries should aim at expanding their output of exportable manufactures at prices so competitive as to be able to surmount the protective barriers of those countries.30 The argument requires simultaneous establishment of intermediate goods and machirtery industries which are dependent on the economies of scale. This refers to industrialization via import substitution in an intensive manner. Thus a developing country like India should combine the export
29. Pitambar Pant, No Room for Complacence in Export Promotion. Yojana, 31 May, 1970.

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promotion policy with intensive import substitution to overcome balance of payment difficulties and accelerate the pace of development. CONCLUSION Regulation of foreign trade is the fundamental principal of commercial policy. For, without a strict regulation of its foreign trade, an underdeveloped country cannot proceed on the road to economic development. Protection then becomes a necessity in order to increase the rate of capital formation, promote industrialization, and remove balance of payments disequilibrium. Opinions, however, differ whether underdeveloped countries should follow a restricted or a liberal trade policy. Myrdal is of the view that import restrictions in underdeveloped countries are simply a shift of import demands for some commodities to others and generally to goods needed for economic development. They do not imply a diminution of total imports. Their import restrictions and export subsidies do not, therefore, decrease total world trade.31 At another place he is more explicit when he says that the advice underdeveloped countries are now often gratutiously given to abstain from interfering with foreign trade is tantamount to giving up their development policy. A strict regulation of their foreign trade is a necessity but these regulations will not generally decrease world trade. He further believes that the underdeveloped countries have rational grounds for asking the developed countries to liberalise their trade unilaterally. They need to be staunch free traders, but preserve for themselves the right to give export subsidies and restrict imports. And they have valid agruments against anyone who could call this attitude of theirs logically inconsistent. 32 Another view is held by Meier and Baldwin who argue that protective commercial policy will interfere with the optimum pattern of world trade and may lead to uneconomic productive practices and inhibit the flow of foreign capital. A liberal trade policy, on the other hand, can be a vital force in determining the rate at which a country develops. Thus an underdeveloped country foregoing the benefits of international trade may only be perpetuating its poverty.33 This argument is based upon the presumption that the adoption of a policy of protection necessarily paves the way to autarchy. But a well devised protective policy leads to fuller utilization of idle resources so as to expand and diversify the economy, ultimately leading to the expansion of foreign trade. If, however, an underdeveloped country were to choose between economic development and foreign trade, it will always choose the former. And commercial policy appears to be the easiest way to accelerate economic development. As Nurkse has said, When it is a matter of stimulating employment, shutting off imports is a very simple method. When the problem is to collect taxes for the government revenue, tariffs are not difficult to establish and have been very popular in the less developed countries. When protection is wanted for infant industries restricting imports is again easier than raising funds with which to pay direct subsidies to the protected industries. Commercial policy is the line of least resistance in these cases, not the most effective or equitable line. Similarly, commercial policy is easier than keeping domestic consumer demand in check by measures of, say, fiscal policy, but it does not go to the root of the problem. It is perhaps the best that can be done; the root of the problem may be insoluble.34
30. R. Harrod, Economic Development and Asian Regional Cooperation, Development Review, Spring. 1962. 31. Ibid., p. 283. 32. G. Myrdal, Economic Theory and Underdeveloped Regions, pp. 94-97. 33. Ibid., p. 409. 34. Nurkse, op. cit., pp. 118-19.