Import Substitution and Trade Policies Explained

A nation’s development rests largely on the shoulders of its industrial sector. Notably, the industrial sector serves as a source of more stable employment opportunities when compared to the agriculture sector and improves a nation’s living standard. Regardless, at the time of India’s independence industrialists were not equipped with enough capital and resources to expand or improve their production capability. Resultantly, the government had formulated a suitable trade policy to promote industrialization in India. It was done to tap into the nascent production capability of the nation.

Keeping this in mind, let’s proceed to find out more about such trade-oriented policies like the import substitution in India.

What is Trade Policy?

Trade policy can be described as the set of norms, regulations, goals, and standards, which tend to control the flow of goods and services between countries. The primary objective of trade policies has always been rapid economic growth and the promotion of self-reliance. Such policies are formulated by the public officials of a country and are specific to its industries. Notably, such plans also include taxes on exports and imports, tariffs, quotas, and taxation on inspection.

Now, it must be noted that post-independence and until the ’80s the Indian government imposed new foreign trade policies and mandated import substitution in India. Typically, international trade policy can be defined as a set of rules and regulations that bind the exchange of goods, services, and capital across countries.

Nonetheless, in the late 80’s such impositions were relaxed, and by the early ’90s emphasis was shifted to privatization, liberalization, and even globalization.

Indian Trade Policy

The Department of Commerce is charged with making India a prominent player in global commerce and assuming a leadership position in international industry associations commensurate with the country's rising significance. In the medium term, the Department develops commodity and country-specific strategies, and in the long run, it creates a strategic plan/vision and India's Foreign Trade Policy.

The Foreign Trade Policy of India establishes the policy and strategic framework for encouraging exports and trade. It is updated regularly to keep up with domestic and international environmental changes.

Multilateral and bilateral commercial contacts, special economic zones, state trading, export promotion and trade facilitation, and the development and regulation of specific export-oriented businesses and commodities are all responsibilities of the Department.

What is SEZ?

In India, special economic zones provide incentives to local enterprises. SEZs often provide competitive infrastructure, duty-free exports, tax breaks, and other incentives to simplify doing business. As a result, many multinationals, particularly exporters, are flocking to India to invest in SEZs.

While SEZs in India are comparable to those in other regions of Asia, business executives considering establishing an SEZ in India should research how SEZs operate in India. Each SEZ is distinct. Before undertaking site visits, many company executives conduct market entry studies assessing sites, resources, tax incentives, and expenses.

What is Trade Protectionism?

A country's measure and purposeful move to control imports while encouraging exports are known as trade protectionism. It is done to raise the country's economy above all others.

Tariffs that charge imports are the most prevalent protectionist technique. Imported items' prices spike as a result. This strategy is most effective in nations with many imports, such as the United States.

Advantages of Trade Protectionism

• Protects new industries in a nation against the outside competition:

• Tariffs will shield a country against foreign competition if it seeks to develop a new industry. 

• Creates jobs for domestic employees temporarily:

• Tariffs, quotas, and subsidies preserve domestic company's ability to recruit domestically. Once other nations reciprocate by constructing protectionism, this benefit will vanish.

Disadvantages of Trade Protectionism

• Domestic items will eventually deteriorate in quality and become more expensive than those made by competitors from other countries.

• Jobs are outsourced due to this: Job outsourcing is a result of the United States' losing competitiveness. Competition has dwindled because the United States has not invested in education for decades. This is especially true in high-tech, engineering, and science. Increased trade expands the number of marketplaces where enterprises may offer their goods.

Test your Knowledge 

1. What do you mean by the globalization of an economy? Pick the correct option from these:

a) expanding business abroad b) Getting rid of import of substitution c) limiting restrictions on trade policies

What is an Inward Looking Strategy?

As a means to boost India’s industrial sector and trade, on the whole, the government adopted the inward-looking or the import substitution policy, which was applied to all major economic sectors. As per this policy, imported goods and services were to be substituted with domestic production to protect consumer goods produced in India against international competition.

These two trade barriers were extensively applied to provide adequate protection to the domestic market –

1. Tariffs: To regulate the flow of imported goods, high tariffs were imposed on them. It makes the cost of imported goods quite expensive and encourages consumers to switch to domestically produced goods and services. 

2. Quotas: This move limited the flow of import significantly as only a restricted number of imported goods were allowed.  As it limited the availability and variety of foreign products in India, the local producers found the opportunity to cater to the untapped demand for growing consumer goods in the country.

Resultantly, these measures turned out to accelerate both production and sale of domestic products quite impressively.

Test your knowledge 

1. Which of these attracts the excise duty?

a)Export  b)Import   c)Production of commodities  d)sale of commodities

Impact of Import Substitution Strategy

Here are some of the most profound impacts of an inward-looking trade strategy concerning the domestic industry.

1. The industrial sector contributed significantly to the economy’s GDP.  For instance, between 1990 and 1991, it contributed 24.6% to the economy, which was noted as a drastic improvement from the previous contribution of 11.8% made towards the GDP between 1950 and 1951.

2. India’s industrial sector expanded beyond jute and cotton textile. There was significant diversification of the industrial sector, and there was a noticeable growth in small-scale industries.

3. The protected market pushed the demand for domestically produced goods and also helped to lower foreign exchange.

4. Indigenous sectors like automobile industries, electronics, etc. also flourished during this time.

5. Significant growth was noticed in the public sector. Industries like defense, railway, telecom, and airway came into prominence and established dominance in the country.

Besides benefiting the public sector in general, there were other notable advantages of import substitution. However, economists argue that the import substitution industrialization was flawed and did not benefit the Indian economy as hoped. 

Test your Knowledge

1. India’s Public Sector dominates in which of these?

a)Transport industry b)Steel production c)Commercial banking d)Organized financial institutions.

Criticism of Inward Looking Strategy    

The following pointers highlight that the effects of import substitution industrialization were short-lived and flawed.

1. The Indian economy did not undergo any massive growth or witness sustainable development due to import substitution in India.

2. Lack of competition in the domestic market reflected poorly on both the production capacity and efficiency of public and private firms.

3. This closed market structure led to the growth of inefficient public monopolies in the country.

4. There was a massive clash amidst the industrial sector owing to Permit License Raj.

5. Owing to the negligible market competition, producers stopped paying much attention to the demand and requirements of consumers. Also, the quality of products and services all degraded to a great extent.

6. Several public sectors incurred huge losses. Nonetheless, they continued to operate to avoid the hassles of closing them permanently. Similarly, competent private enterprises found it challenging to enter and sustain in such an oppressive setup.

To conclude, import substitution industrialization did not prove useful in strengthening the export sector of India. Resultantly, reformative foreign trade policies were introduced in 1991. However, it must be acknowledged that a balance between domestic trade and international trade is a must to ensure sustainable economic growth and development.

Refer to Vedantu’s compact study materials to learn more about trade policy meaning and improve your hold on import substitution example-related concepts as well. Also, by registering for our free online classes, you would be able to clear your doubts effectively. In turn, it will benefit your board exam preparation to a great extent.

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