Import Substitution

Import substitution is an economic policy that involves producing domestically goods that were previously imported. This strategy aims to reduce the share of imports in total domestic supply by replacing them with local production, thereby narrowing the foreign trade deficit. When import substitution occurs in an economy, it leads to foreign exchange savings alongside an expansion of domestic production capacity. This strategy is typically implemented both as an industrialization policy and as a balance of payments policy.

The fundamental objective of import substitution policies is to transform the economy’s dependence on imports, reduce external dependency, and strengthen the domestic production infrastructure. Implemented through the coordination of industrialization and foreign trade policies, import substitution has been regarded as an instrument of economic development.

Historical Background and Implementation

The import substitution strategy was advocated by economists such as Alexander Hamilton in the United States and Friedrich List in Germany during the 19th century and regained widespread popularity in the mid-20th century, particularly after World War II. In Latin America, economists such as Raúl Prebisch and Celso Furtado argued that sustainable development in developing countries could only be achieved through industrialization based on import substitution. The strategy was adopted by many developing countries after 1945.

During the 1950s and 1960s, import substitution became widespread in many countries, especially in Latin America and Asia. Under this strategy, state-supported industrial investments increased, with production of consumer goods receiving priority. However, after the 1980s, export-led growth strategies were promoted in developing countries under the leadership of the IMF and the World Bank, leading to the decline of import substitution practices.

The import substitution strategy was implemented with two primary objectives:

• Addressing Foreign Payment Difficulties:

While export revenues failed to grow, import expenditures continued to rise, creating foreign exchange shortages. Developing countries turned to import substitution to conserve foreign exchange, reduce the need for external borrowing, and narrow the trade deficit. To this end, imports requiring foreign exchange were restricted, while domestic production of goods that could be manufactured locally was encouraged.

• Economic Development and Industrialization:

Import substitution was also used as a development strategy. In its initial phase, the goal was to produce final consumer goods domestically; in the second phase, the aim was to establish industries producing intermediate and capital goods to support this production. Within this framework, the substitution strategy was adopted to increase production to meet domestic demand in the short term and, in the long term, to reduce dependence on imports and build an industrial base oriented toward exports.

Policy Instruments and Implementation Methods

The import substitution strategy was supported by various economic instruments and interventions, including high customs tariffs, import quotas, exchange controls, currency subsidies, low-interest loans, and state-supported industrial investments. The state incentivized private sector investments aligned with the strategy and established large-scale public industrial enterprises in sectors where the private sector proved insufficient.

In directing industrial investments across sectors, the criterion of foreign exchange savings was decisive. The foreign exchange required to import goods that could be produced domestically was compared with the foreign exchange needed for local production; sectors with higher foreign exchange-saving potential were prioritized.

Import Substitution in Türkiye

In Türkiye, the import substitution strategy began to be systematically implemented from 1945 onward. It was adopted with the goals of reducing the foreign trade deficit, accelerating industrialization, and decreasing external dependency. The following measures were implemented under this strategy:

• Exchange rate regimes and fixed exchange rate policies provided industrialists with a favorable low exchange rate advantage.
• Interest rates were kept below inflation levels to encourage industrial investment.
• Import quotas and high customs duties were applied to specific products.
• The state established large public economic enterprises in strategic industrial sectors.

In the 1970s, import substitution practices became more difficult due to rising crude oil prices and increasing inflation. The fixed exchange rate policy encouraged imports of consumer goods while discouraging exports; low interest rates reduced savings and created financing constraints. Domestic production quality remained limited due to insufficient domestic competition and the absence of external competition.

Limitations of the Strategy and Transition Process

For import substitution to achieve long-term success, production must advance to the second stage, involving the manufacture of intermediate and capital goods. However, in many countries the strategy remained stuck in the first stage, focusing exclusively on consumer goods and resulting in resource waste. Productivity remained low, exports failed to develop, and a competitive, open external structure could not be established.

After 1980, many countries including Türkiye shifted toward export-led growth strategies. Import substitution practices were abandoned, and policies emphasizing openness to the outside world and market liberalization gained prominence.