The Pitfalls of Protectionism: Import Substitution vs. Export-Oriented Industrial Policy

IMF Working Papers, April 26, 2024

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Canonical URL: The Pitfalls of Protectionism: Import Substitution vs. Export-Oriented Industrial Policy

Authors: Reda Cherif, Fuad Hasanov
Publication date: April 26, 2024
Document type: IMF Working Paper (Working Paper No. 2024/086)
Core proposition: Industrial policy with export orientation outperformed import substitution across successful Asian cases; trade protectionism is neither necessary nor sufficient and is likely counterproductive.

Industrial policies pursued in many developing countries in the 1950s-1970s largely failed while the industrial policies of the Asian Miracles succeeded.
A key factor of success is industrial policy with export orientation in contrast to import substitution.
Exporting encouraged:
- competition,
- economies of scale,
- innovation,
- local integration,
- and provided market signals to policymakers.
Even in a large market such as India, import substitution policies in the automotive industry failed because of micromanagement and misaligned incentives.
While state interventions may be needed to develop some new capabilities and industries, trade protectionism is neither a necessary nor a sufficient tool and will most likely be counterproductive.

Export orientation produces stronger market discipline and clearer market signals for policymakers compared with import substitution.
Exporting facilitates:
- intensified competition from global markets,
- realization of economies of scale through access to larger markets,
- faster innovation driven by external competitive pressures,
- deeper local integration of supply chains.
Import substitution tends to create environments where micromanagement and misaligned incentives can entrench inefficiencies.

Even with a large domestic market, import substitution in the automotive sector failed.
Failure drivers identified:
- micromanagement by policymakers,
- misaligned incentives for firms and intermediaries.

The paper analyzes risk tradeoffs across various industrial policy strategies.
Implication: State interventions can be warranted to develop new capabilities but should avoid reliance on broad trade protectionism as a primary tool.
Trade protectionism is characterized as likely counterproductive for modern industrial policy objectives.

Favor export-oriented industrial policies when aiming to:
- foster competition,
- achieve economies of scale,
- stimulate innovation,
- integrate local suppliers into global value chains.
Use state intervention selectively to build specific capabilities and industries rather than resorting to generalized trade protectionism.
Design incentives to align firm behavior with productivity and export performance rather than shielding firms from competition.