Import Substitution

Import substitution and protectionism

Import substitution and (import) trade restrictions

A few interesting links to start with:
https://opentextbc.ca/principlesofeconomics/chapter/34-3-arguments-in-support-of-restricting-imports/
https://www.yourarticlelibrary.com/trade-2/5-major-types-of-import-quotas-proactive-trade-devices/26248
https://wir-en.s3.amazonaws.com/wp-content/uploads/2012/09/Identifying-Import-Restrictions1.pdf
https://www.investopedia.com/articles/economics/08/tariff-trade-barrier-basics.asp

There are several ways to restrict imports:

Import Tariffs:
Tariffs are an easy way to make imported goods more expensive, but can run counter to WTO agreements.

Import Quotas:
Quotas can be imposed on certain products or countries.

Subsidies:
Local industries are supported by the government, so it makes local products cheaper.

(Import) Licensing requirements:
Foreign companies must "buy" import certificates in order to sell into market. This allows a government to tightly control imports.

Standards:
Special standards and certifications are required, so importers must spend time and money to get certified in order to sell their goods or in some cases, completely change the product.

Anti-Dumping duties
Foreign countries or companies can be designated as "dumpers" for a type of goods, so special duties are applied in order to "protect" local industries.


The Sovereign Economic Model supports such measures in order to limit imports.

But all the above measures should only be surgically used in order to really improve the local economy and local companies. In cases where local companies are competitive to foreign ones, these measures can be applied. If the local companies are much inferior to foreign ones, trade restrictions can make the local economy sector even less competitive. A minimal amounts of imports should always be allowed, to keep the local companies on their toes especially if they conquered a large majority of market.

Import substitution and sustainability of localized parochialist economy



One of the benefits of import substitution is that a country produces and consumes its own goods.

Even on a regional level within a country, import substitution leads to increase localization and sustainability as local consumers buy increasingly local products.
As large international players are removed from a  market, and thus competition, local companies can take over. For example, instead of buying a foreign brand of beer, a consumer can buy beer from a local brewer.
The local product, especially if it relies on local ingredient or historic local know-how, can be competitive in price as the transport costs are much lower,the product "fresher", more tailored to local tastes, than something sourced from far away or from abroad. This also makes the product and the business model more sustainable.
This leads to money flows remaining within a region and helps to the region's development. Therefore the regional authorities and businesses should push for "parochialism economics" to make consumers aware of local goods, and to send the message that by spending on locally produced goods, money will remain locally and their local communities will improve economically.
Within a country, healthy competition between neighbouring regions stimulate the overall efficiency of the economy. One example would be Irish vs Scottish whisky, which are neighbours,  if they are not strictly regions within the same state.

Best Practices for Import Substitution


Recently I was researching import substitution by looking at import data of various countries. And I hatched a generic plan.

First of all 3 questions:

1) which imported items can be easily displaced?
Examples could be:
- Agri-food, light industry(FMCG) where capital expenditure is minimal and technology low

2) which are the most imported items (by value) ?
Often relatively simple chemical raw materials are a big item in the import basket. Things like plastics or base chemicals for cleaning products.

3) which items are more strategic for the market or industry?
Examples could be one or more priorities:
-goods whose production has multiplying effect on jobs
-strategic goods where unavailability stops whole industries
-linkage to related industries
-processing of local resources


This analysis needs to be further drilled down, for each industry, and an analysis of imported good needs to be donein order to know which goods have a very big money value.

Financial incentives and GDP for Import Substitution vs Foreign Buy


Let’s suppose a large order for 100.000 USD for personal care products (shampoo).

Bought from abroad: 100K USD —> 100% GDP


Bought internally with import substitution: 100K USD –> 180% GDP


Additional local GDP:

5 % taxes(assuming 20% corporate taxes)

25% personnel (payslip + taxes/social)

25% operating and production cost

25% ingredients(base chemicals) costs

20% net profits for company

Import substitution and the importance of localization

This is a post in English of a post written in Russian: http://www.sovecomo.ru/2021/01/25/Импортозамещение-И-Важность-Локализации.aspx

Import substitution is a pillar of a sovereign economy: it is important for industrialization, developing skills and new technologies, generate direct and indirect jobs and profits for the local communities, and add money to state budgets through taxes.
Ideally, in such a business cycle the money is kept inside the country, if the production is fully localized.

Total or very high localization means that components, ingredients, materials, tools and related services are also produced inside the country. Which unfortunately is often not true.

I will try to layout an approximate schema:

There are different types of suppliers:
Foreign companies which sell items produced abroad: almost 0% of money stays inside the country
Foreign companies which sell items assembled inside the country but with components produced abroad: up to 25% of money stays inside the country
Foreign companies which sell items assembled inside the country and with localized components: up to 50% of money stays inside the country
Local companies which sell items produced abroad: up to 25% of money stays inside the country (mainly profits)
Local companies which sell items assembled inside the country but with components produced abroad: up to 50% of money stays inside the country
Local companies which sell items assembled inside the country and with localized components: up to 100% of money stays inside the country

As we see there are 3/4 main factors, which determine on how much money stays inside the country:
-Localization of labour(jobs)
-Localization of supply chain
-Taxes
-Profits

Summing them up even more, we can say that both the Tax residency of company(and main investors) and localization determine how much money stays inside the country. Especially the localization will keep the money inside the country, if the business is labour and manufacturing intensive e.g. industrial goods like car, ships, airplanes.

That why the Sovereign Economic Model whitepaper advocates the de-taxation of small-medium manufacturing businesses, in order to manufacture locally as much as possible, and therefore retaining the money inside a country.

Build vs Buy:What is best for import substitution ?

Build:

1) Self Development
If there is a large base of capabilities such as research, prior knowledge(from USSR), tools and talented people, a business can be self developed and build.

2) Joint Venture
If there are only partial knowledge and capabilities, the best way is to form a joint venture with a foreign firm and build together.

Buy

3) Buy a company:
Often it is easier to buy a company, in order to fill a gap in the local market.Ideally it should be as mall company with excellent products and technical know-how.
In this case an acquired company could serve as a template to kickstart a national business sector,by replicating R&D and production in the country.

4) Buy IP - Intellectual Property rights:
In some cases, where specific processes are covered by IP, it might be useful to buy a license.

5) Hire specialists
Specialists are best hired either as technical leaders (if previous experience) or business process consultants: they can help replicate a type of business model and bring much needed experience.


Any of the above solutions can be mixed and matched, in order to improve the Value Creation and Industrialization of a country.