Which country adopted import substitution as a development model?

The Late Twentieth Century: Housing under the Washington Consensus

The ISI model was not without its internal weaknesses, including the serious inefficiency of the industrial sector that resulted from the heavy protectionism. Sheltered from external competition and with a secured domestic market, firms tended to maximise profits and minimise investments. Minimal capital investments in technology and almost no research and development resulted in a strong reliance on foreign technology, which, in turn, tended to increase production costs (Cornelius et al., 1989). Over time, Latin America’s industrial sector became increasingly obsolete and inefficient, unable to compete in international markets. Another weakness was the structural reliance on the importation of capital goods, which, together with a long-term shortage of capital, forced Latin American countries to borrow from international credit markets, ultimately accumulating unsustainable levels of debt. By the early 1980s, as most Latin American countries were struggling with mounting inflation, large public-sector deficits, and considerable debt-servicing obligations, there was increasing disillusionment with the protectionist policies. In this way, the conceptual model for development predominant in Latin America started to shift from one of heavy state interventionism to one of economic liberalisation reforms that emphasised a reduced role of the state, fiscal discipline, and financial and trade liberalisation. The forged agreement among Latin American leaders of the need to widely adopt neoliberal policies came to be known as ‘the Washington Consensus’ (Krugman, 1997; Williamson, 1997).

The economic crises of the 1980s and 1990s forced many Latin American countries to undertake economic reforms along the lines defined by the International Monetary Fund and the World Bank, implementing structural adjustment that emphasised macroeconomic reforms reflecting the thinking embedded in the so-called ‘Washington Consensus’ (Pugh, 1994, 1995). Against the backdrop of the free-market reforms that were being successfully implemented in most Latin American countries, the formulation and implementation of housing and urban policies became significantly internationalised, favouring the approaches formulated by the Washington-based development institutions, such as the World Bank and the Inter-American Development Bank. In this context, Latin America’s housing and urban agenda of the 1990s was conceived within the broader objectives of economic development and macroeconomic performance, seeking to maximise the positive ‘macroeconomic linkages’, or the potential of urban economies to contribute to a country’s macroeconomic performance through financial, fiscal, and economic links (Cohen and Leitmann, 1994; Jones and Ward, 1994; Lee, 1994; Pugh, 1995). With a central focus on the revalorisation of market mechanisms, sound housing and urban policies were defined as those aimed at eliminating barriers that restricted the productivity of urban economic agents, both formal and informal, so as to maximise their contribution to the national economy (Jones and Ward, 1994; Pugh, 1995). The role of the public sector was defined in terms of ‘enabling’ markets to work by providing the legislative, institutional, and financial frameworks in which firms and households could prosper (Pugh, 1995). Urban services, including water and sewer, electricity, roads, transport, and social services were now conceptualised as factors promoting urban productivity (World Bank, 1993). Even the potential productivity of the urban poor through the informal sector came to be recognised as an asset, which could contribute to the urban and national economies (World Bank, 1993).

The housing policies implemented in Chile from the early 1970s onwards anticipated the ‘enabling approach’ that was to be widely adopted in the region during the 1990s. These policies were adopted by the military government that took control in 1973 through a military coup and remained in power for 17 years. These policies were maintained after Chile returned to democratic rule in 1990, as the centre-left coalition that ruled the country between 1990 and 2010 sought to enhance poverty alleviation within the capitalistic free-market economic model adopted in the early 1970s. Thus, the housing policies implemented in Chile over the past three decades provide a good illustration of enabling housing policies as well as the weaknesses and challenges of the overall approach.

Chile’s preoccupation with housing dates back to 1906, when the progressive housing legislation – the Workers’ Housing Councils – was first enacted. However, despite the good intentions, the housing policies implemented in Chile until 1970 were deficient in ways similar to those of the other Latin American countries. Specifically, while the private sector succeeded in supplying housing to higher-income groups, a myriad of government programmes tried, unsuccessfully, to address the housing needs of lower-income sectors of the population. As a result, the housing deficit continued to increase. The democratically elected socialist government of Salvador Allende (1970–73) attempted to use housing construction as an engine of economic growth and employment. It sought to speed up public housing programmes through advanced technology and direct state construction. These initiatives, together with the decision to put an end to the indexation of mortgage repayments, brought fierce opposition from the construction and banking sectors. The socialist housing policies were abruptly disrupted when the military coup took place in 1973 (Gilbert, 2002).

From 1977 onwards, the military government undertook a thorough reform of the housing sector according to the neoliberal principles that had been applied to the economy as a whole. Under the new paradigm, which has been maintained until today, the private sector was to be the main actor in the production and financing of housing, with the state playing a subsidiary role, boosting the purchasing power of low-income households with up-front subsidies financed by the central government. In addition, the new policies supported the development of capital markets as a whole, including the securitisation of mortgages, as a way to increase access to private long-term housing financing among higher-, medium-, as well as lower-income households. Additionally, urban land markets were deregulated in 1978, when many growth restrictions and land-use regulations were lifted, freeing massive amounts of new land for development (Rojas, 2001). Finally, the focus shifted away from the production of fully finished low-income dwellings and a stronger emphasis was laid instead on progressive self-help models aimed at providing minimal housing solutions that could be later incrementally improved by the beneficiaries themselves (Greene and de Dios Ortúzar, 2002).

While housing production has increased steadily and the private sector has played an increasingly important role in the financing and construction of housing, the strong role played by the state has been a critical factor in ensuring the ultimate success of Chile’s housing policies. The need for government intervention proved to be particularly urgent in the low-income segment of the market, as Chilean developers and banks showed no interest in building and financing houses for households earning less than US$200 per month. As a result, the government had to assume a more active role than originally envisioned and, to this day, it directly contracts the construction of low-income housing with private companies and assigns the houses to beneficiaries registered in a national list of applicants. Likewise, the government has been providing the supplementary loans required by low-income beneficiaries to pay for the homes because banks have not been interested in financing these loans (Rojas, 2001).

The Chilean experience is widely regarded as a success: the production of new housing since the 1980s has been above the rates of new household formation and replacement of the old housing stock, opening the possibility that Chile’s housing deficit will be soon eliminated (Rojas, 2001). Illegal land occupation has also been brought to an end. This is not a minor achievement, taking into consideration that, by the early 1970s, illegal land occupation had become common practice not only on the urban fringes but also on more valuable land located in the urban centres (Ducci, 2000). Moreover, the private sector now plays a leading role in the production and financing of housing for the middle- and higher-income households, which constitutes a significant achievement considering that in the 1970s most housing was built and financed by the state. Further, government assistance is reaching the poor in an effective manner and most public resources are benefiting low-income households (Rojas, 2001). There are, however, significant challenges still pending, such as the low quality of the housing and the concentration of poverty in low-income housing projects, which, in turn, are located at the urban periphery without sufficient access to jobs, services, and urban amenities. Moreover, chronically high levels of delinquent debt in government-provided low-income housing loans are still to be addressed systematically, as they are threatening the entire low-income housing system in Chile (Ducci, 2000).

Chile’s approach towards housing during the past two decades seems to have found a point of equilibrium between the minimalist and expansionary roles that were alternatively assigned to the state in the housing sector in Latin America during the twentieth century. At this equilibrium point, both the state and the private sector play an important and complementary role. While the Chilean experience has demonstrated that private markets can deliver efficient housing solutions and financial mechanisms for those segments of the population that can afford them, it has also shown that the vision of a housing sector mostly driven by the private sector is unattainable. Alternatively, Chile’s housing policies have underscored the need for the state’s continuous engagement to ensure the development of sound housing markets and to effectively respond to the housing needs of low-income households, as well as the persistent challenges that this task presents.

7.1 The Washington Consensus

In world history, the 1980s will remain the decade of three world leaders: Thatcher, Reagan, and Gorbachev. Together they demonstrated the importance of personal leadership for the future of nations and for humanity at large. The liberalization and deregulation policies they initiated and pursued launched a new course in international affairs: the era of globalization. With the collapse of the Soviet empire and the disintegration of the former Council for Mutual Economic Assistance that had been founded in 1949 as an alternative to the Marshall plan for the Soviet satellite states in Eastern Europe, the bankruptcy of the Soviet state-regulated socialist economic system became apparent to everybody. Under the aegis of the United Nations (UN), the newly independent countries joined the large family of international institutions, embarking on a process of accession to the World Trade Organization's General Agreement on Tariffs and Trade (GATT) to be able to benefit from the fruits of open global markets. Inspired by the triumph of market-oriented economic theories over theories advocating government ownership or control, a widespread process of privatization, deregulation, liberalization, competition, and agreements to lower trade barriers commenced globally.

The relationship between globalization and development has been one of the most challenged issues in economic policy in recent decades. The Washington Consensus as formulated by the British economist John Williamson (1990) refers to a set of broadly free market economic ideas such as free trade, floating exchange rates, free markets, and macroeconomic stability. At the time, the consensus expressed the general economic philosophy of prominent economists and international organizations in Washington DC including the IMF, the World Bank, and the US Treasury. The underlying assumption of the consensus was that trade openness is beneficial and indeed essential for the growth and development of a developing country. In order to open such economies to favorable development, it was suggested that they liberalize their imports and orient production toward exports to ensure faster growth.

The term was coined in 1989 in a background paper presented by Williamson for a conference that the Institute for International Economics convened to examine the extent to which old prescriptions of development economics that had governed Latin American economic policy since the 1950s, were being swept aside by a new set of ideas that had long been deemed appropriate within the OECD. Williamson presented a list of 10 groups of policy interventions (10 commandments) that he believed practically everyone in Washington agreed were needed to be implemented in Latin America. This, then, was the Washington Consensus. By implication, senior members of the Congress, the administration, the international financial institutions in Washington, the economic agencies of the US government, the Federal Reserve Board, and the think tanks would all subscribe to these ideas.

The policy reforms aimed at initiating industrialization and import substitution. According to Williamson, the original conception of the consensus was founded on three big ideas: a market economy, trade liberalization and openness to the world, and macroeconomic discipline. The 10 reform agenda items are:

fiscal discipline to eliminate public deficits;

a change in the priorities of public spending: withdrawal of subsidies and increased spending on health and education;

tax reform: broadening tax bases and reducing tax rates;

positive real interest rates determined by the market;

exchange rates determined by the market guaranteeing their effectiveness;

liberalization of trade and opening of the economy (remarkably, however, Williamson did not include the liberalization of capital flows);

no restrictions on foreign direct investment;

privatization of public enterprises;

deregulation of economic activity;

a solid guarantee of property rights.

Elaborating on these points, Williamson later (2008) made the following additional observations:

Fiscal discipline: At the time, almost all countries in Latin America had run large government deficits leading to balance of payments crises and high inflation. As a result, considerable capital flight to abroad was occurring, deepening domestic levels of poverty.

Reordering public expenditure priorities: This suggested switching public spending patterns toward policy measures that would both stimulate growth and alleviate poverty, from nonmerited subsidies to basic health care, education, and infrastructure.

Tax reform: The aim would be a tax system combining a broad tax base with moderate marginal tax rates.

Liberalizing interest rates: Recognizing the importance of financial liberalization but saying very little about the necessity for prudential supervision of banks and financial institutions.

Competitive exchange rates: Asserting that exchange rates should be left free and without interventions from the central bank.

Trade liberalization: This was clearly one of the key principles of the policy recommendations. Only scant attention was given to the issue of how quickly borders should be opened up and trade be liberalized.

Liberalization of inward foreign direct investment: Under this heading Williamson never included comprehensive capital account liberalization, believing that it did not or should not command a consensus in Washington.

Privatization: An originally neoliberal idea that at this time seemed to have won broad acceptance within the Washington community.

Deregulation: This focused specifically on easing barriers to entry and exit, not on abolishing regulations designed for safety or environmental, nor to govern prices in a noncompetitive industry.

Property rights: This was primarily about providing the informal sector with the ability to gain property rights at acceptable cost.

The 10 categories of recommendations of the Washington Consensus can be organized into two mutually reinforcing groups of policies: stability through fiscal adjustment and market orthodoxy (commandments i, ii, iii, x); and liberalization through a dramatic reduction of the role of the state in the economy (iv, v vi, vii, viii, ix).

6.3.1 Precatching-up Stage

The precatching-up stage is characterized by the import-substitution policy phase during the 1960 and 1970s. Brazil had a highly regulatory system for controlling foreign firms and the import of goods and services. During this period FDI grew to attend to the needs of a highly protected market, benefiting from market and trade restrictions. The government provided significant investments in basic infrastructure to sustain industrialization in the largest and traditional locations in the Southeast (São Paulo).

This precatching-up stage in Brazil corresponds to a period that can be identified as Stage 2 in the investment development path (see chapter: Determinants of Foreign Direct Investment: Theoretical Approaches (Dunning and Narula, 1996). Because of the policies adopted by the government, the country starts creating some location-specific advantages. This will mean the beginning of a process of FDI increase, driven by the growth of the domestic market in terms of size or purchasing power. At the beginning of Stage 2, MNCs’ FDI strategy is a direct reaction to the import-substitution policies adopted by the government. That is, FDI will be stimulated by the government’s application of tariff and nontariff barriers to protect domestic industry or any particular sector of the national economy.

Trade Liberalization

After the great depression, the Mexican government followed a strategy of import substitution industrialization (ISI). Under ISI, the Mexican government instituted a series of policies and regulations to protect domestic industries from international competition. This approach installed not only high import tariffs, but also nontariff barriers on the importation of foreign goods, and provided subsidies to aid Mexican industries. Under this model, the country's producers had no incentive to export manufactures because they enjoyed a captive domestic market with little or no competition. The Mexican model of development, based on ISI, continually ran into trouble in the 1970s and 1980s. Except for auto manufacturers and maquiladoras, companies operating under the ISI model did not export much and it was hard for them to get enough foreign exchange to pay for imported capital equipment and intermediate goods. Moreover, severe shortages of foreign exchange jeopardized the foreign debt service of the Mexican government, generating damaging exchange rate crisis. In fact, the country had a balance-of-payments crisis, that is, had to devalue its currency, in 1954, 1976, and 1982.

Between 1979 and 1981, the Federal Reserve Board raised interest rates in the United States to record levels to contain inflation in that country, with European central banks also raising rates simultaneously. This interest rate increase perversely affected Mexico and other developing countries across the board and was even more damaging because it was accompanied by a rapid decline in commodity prices (Cardoso and Helwege, 1992). This combination of external shocks led to the decline in export receipts, an increase in the cost of servicing debts denominated in foreign currencies, and pressures over the exchange rate. In August 1982, the administration of José López Portillo (1976–82) announced a moratorium on Mexico's foreign debt service and started a process of renegotiation that was not finalized until 1989, under President Carlos Salinas de Gortari. Moreover, as Mexico suspended payments, investors around the world panicked, leading to an increase in interest rates that pushed other countries in Latin America to also suspended payments on their debts. The crisis led the countries in distress to request financial support from the International Monetary Fund (IMF) and the World Bank (Stallings and Robert, 1989). These institutions, rather than just bailing out the countries, made loans and technical support contingent on a series of economic reforms. The reforms were aimed at achieving macroeconomic stability, reducing government intervention in the economy (i.e., promoting privatization, deregulating, and strengthening the protection of private property), and liberalizing the economy to international trade and capital.

The balance-of-payments crisis of 1982 led to a radical transformation of the Mexican government's development model. Miguel de la Madrid, president of Mexico (1982–88) for the Party of the Institutionalized Revolution (PRI in Spanish), became one of the leading reformers in Latin America. He adopted policies to deregulate many industries, started a massive program to privatize numerous government-owned enterprises, and began to liberalize trade across the board. For example, his administration unilaterally decreased the maximum import tariff from 100 to 20% and lowered other tariff and nontariff barriers. The administration also lifted restrictions on foreign investment in many sectors – in particular, allowing foreigners to own 100% of manufacturing businesses outside of major cities.

After 1988, President Salinas, also of the PRI, continued with economic reform and trade liberalization. In particular, his administration negotiated the NAFTA with the United States and Canada. Under this trade agreement, the government lowered tariffs even below the levels required for most-favored nation status, or eliminated them altogether, for trade within North America. NAFTA also opened up the country to foreign direct investment in most sectors (except sectors considered strategic, such as banking and energy) and developed a series of treaties to enforce transnational investment and trade contracts (Iyer, 2005 and Lederman et al., 2005).

Models of Endogenous Development I

Theories of dependency led to an emphasis on infant-industry protectionism, import substitution, and autocentric development. These ideas were reflected in the emergence of a more general emphasis on the relative merits of self-centered and locally controlled development. Two factors underpinned this change of emphasis. The first was the impact of the economic crises of the 1970s on exogenous or externally controlled investments in many economically under-developed areas. The second was the wave of productive decentralization that these crises precipitated, the subsequent identification of industrial districts (especially in southern Europe) as drivers of regional economic development, and the yet later observation of the dynamics of new technology industries.

In many cases, these areas of industrial growth were dense concentrations of interdependent small- and medium-sized firms (SMEs) in a single sector and in auxiliary industries and services. These districts were interpreted as the result of two sets of forces. The first was a set of economic forces that included: (1) scale economies that result from a high degree of specialization and division of labor; (2) external economies that arise from the existence of shared infrastructures, services, and information; and (3) the availability of special skills and the pooling of the workforce. The second were the interactions between the economic and social system that generated a social atmosphere and communities of firms and people conducive to industrial development, whose consideration opened the door to models dealing with the social, cultural, political, and institutional foundations of the district model, including analyses of social norms and values, political subcultures, associationalism, good governance, institutional density and performance, conventions, trust, social capital, and entrepreneurship.

These theoretical developments were associated with some important shifts in the models that dominated regional development strategy thinking. On the one hand, strategies of self-reliance, autocentric growth, and development from below were advocated as an alternative to development from above. On the other hand new engines of regional economic growth were identified: instead of the consumer and intermediate goods sectors that had dominated growth, attention switched in developed countries to investments in human capital and information and communications technologies (ICT) and the commodification of knowledge to produce informational goods. More generally, emphasis was placed on innovation and learning, investment in research and development, the diffusion of knowledge and its social, cultural, and institutional determinants.

Sri Lanka

Upon independence Sri Lanka, like the rest of South Asia, turned to import substitution policies and centralized planning and saw little economic growth or poverty reduction. Starting in 1977, moves began towards a more liberalized economy, but the payoffs have been slow in coming. However, the country's garment industry has profited from this openness and accounts for most of the country's manufactured exports. Sri Lanka was more affected by the recent global economic downturn than other countries in the region (Van Horen and Pinnawala, 2006: 315; Carrasco et al., 2010; Ranjith and Widner, 2011).

Sri Lanka's economy has rebounded from its recent low point in 2009 and is experiencing increasing investor confidence and numbers of tourists as the long-running civil war has come to an end. Around 60% of the economy is in the service sector, which along with the agriculture sector has shown a good recovery. Inflation has been moderate and while public debt growth has slowed it is still high. Investment, both domestic and foreign, continues to be limited. A major reduction in ‘red tape’ and a more business-friendly environment along with a more efficient financial sector might be necessary to increase levels of private investment which are needed for increased growth (Asian Development Bank, 2011a: 173–6).

III Export-Led Versus Import Substitution

One debate on growth and development is the alternative strategies of export-led versus import substitution industrialization (Kruger, 1985, 1990bKruger, 1985Kruger, 1990b; Krugman, 1984). Latin American countries in their industrialization process adopted import substitution, while East Asian economies followed an export-led strategy in most cases. Among the four East Asian economies, the South Korean and Taiwan economies are bigger than the economies of Singapore and Hong Kong. However, in terms of GDP per capita, Singapore and Hong Kong have a higher GDP per capita than both South Korea and Taiwan. Hong Kong and Singapore have taken up economic openness and an export-led strategy has been adopted. For a short while in the early 1950s, South Korea and Taiwan did follow the import substitution strategy. But soon, both realized that their economies were not growing as rapidly as Singapore and Hong Kong. Hence, beginning from early 1960s, South Korea and Taiwan changed and adopted the export-led approach. The Asian experience shows that economies adopting an export-led strategy had been more successful than countries adopting the import substitution strategy.

Import substitution is popular in economies with a large domestic market. For large economies, promoting local industries provided several advantages: employment creation, import reduction, and saving in foreign currency that reduced the pressure on foreign reserves. Furthermore, if the locally produced domestic goods are successful, the economy could even increase its exports. Hence, it can produce a “virtuous economic cycle” of increase in employment, output, income, exports, and foreign reserve, and a decrease in imports, giving an overall improvement in the economy’s balance of trade and payments. Why did economies adopting import substitution not succeed in growth and development? The answer lies in the initial stage of the strategy. To promote local industries, capital and investment was needed. In economies with a shortage of foreign reserves and unattractive to foreign investment, the alternative would be government subsidies. The problem started from the fact that large government subsidies were given to establish the “infant industries,” hoping that once the industries have “matured” government subsidies would no longer be needed. Hence, the initial phase of government subsidy was meant to provide an initial injection of capital.

When any development involves government subsidy, it would mean government intervention and interference, especially if officials were involved in the management. And since government subsidy was provided free, the manufacturing plant could experience loss, which would persist or even expand. Furthermore, the “loss-making” enterprise might not be market-oriented and with weak management, inefficiency, and ineffectiveness, the goods so produced might not be of good quality, or even might not inspire local confidence. Hence, even if the goods were manufactured locally, sales would be low and the protected firm would face losses. There could be more unfavorable consequences. Firstly, the government subsidies might end up causing fiscal deficit and national debt if the economy had not been growing, or a heavy welfare burden might erode the economy’s fiscal ability. Secondly, in the process of producing locally, imports of raw materials and machinery would be needed. Hence, total imports might not fall, as import of the final goods was replaced by imports of intermediate goods. Thirdly, if local consumers did not have confidence in locally made manufactured goods, imports of the final goods would continue. In aggregate, the economy could even face an increase in imports in both final and intermediate goods. The increase in total imports could end up with a fall in foreign reserves, thereby adding pressure on the exchange rate to depreciate.

The “vicious cycle” began with government intervention in the form of subsidy. The problem with “infant industry” was firms were protected and losses were accepted. Relying on subsidies, the management may not be cost-minimizing, and “profit” would reduce the provision of free subsidy. In other words, once subsidy is provided, the “infant” firm may prefer to remain in the “comfort zone” so as to escape from competition. The worst would be that the uncompetitive firm might not be allowed to close, as that could have other undesirable consequences, such as rise in unemployment, political spillover, and so on. Eventually, these uncompetitive enterprises were maintained and subsidies continued. The economy was trapped in the weak side of the strategy.

Economies that take up the export-led strategy are usually small, knowing that the domestic market cannot support large industrial production, and export is the only alternative. Similarly, given that a small economy might not have sufficient funding in its initial development, to attract foreign capital, the economy would pursue business-friendly policies. Hence, from the start, the economy is prepared to provide a competitive environment, including a healthy fiscal framework, and allow maximum potential for investors. The advantage is that foreign investments often lead to exports. Thus, the export market would automatically be taken care of. And since foreign investors know what is demanded in their home country, exports from host countries would have no problem in locating foreign markets. Over the years, as income in host economies rose, local industrialists could also be nurtured. The more established pool of local industrialists would in turn venture into the foreign market by gradually building up brand names, lifting industrial production to a higher technological scale. In short, an export-led strategy produces a “virtuous cycle” that begins with the attraction of foreign investment, promotion of domestic industries, rise in employment, outcome, and exports. Trade surplus improves the exchange rate and international reserves. There can also be drawbacks in the export-led strategy. Firstly, the economy could become dependent on foreign investment and markets. Although exports are “guaranteed,” economic recessions in foreign market could create economic volatility. Secondly, development of local industries may be discouraged, especially in the area of research and development (R&D). Hence, the economy may lag behind technologically, as the economy depends on imported technology.

Nonetheless, the export-led strategy of industrialization explains the success of the East Asian economies. Industrialization, however, has produced different results among the four economies. South Korea is probably the most successful in manufacturing industries, and development has passed the stages from light manufacturing to technologically intensive, to capital-intensive industries. For example, the production of such heavy industries as shipping and motor vehicles, and the use of technology in such manufacturing as mobile phones and household appliances has caught up considerably. South Korea has followed Japan’s style of establishing brand names and design in technological products. Indeed, after the 1990s, when Japan experienced the “lost decade,” some South Korean brand names have rapidly achieved a global status and competed with Japanese products.

Textiles and clothing are the traditional light manufacturing in all East Asian economies, but production has spread to other light manufacturing, such as toys, wigs, watches and clocks, and plastic flowers. One feature among these light industries is that they are not land-intensive industries, and production is possible in small factories. By the 1980s, electronics has increasingly become the dominant industry in the four East Asian economies. Similar to South Korea, Taiwan has also established brand names in computer production. However, small- and medium-sized enterprises constitute the largest group of enterprises in Taiwan, Singapore, and Hong Kong. Both Singapore and Hong Kong concentrated mostly in the production of electronics components and subcontracting. The flourishing electronics industry among East Asia economies has made the Asian region a primer in the market for electronics products.

3.1.4 Protectionist measures

In recent times, protectionist measures aimed at bolstering infant industries or providing an incentive for import substitution have generally been proscribed through international trade agreements. While it is generally accepted that countries would seek to support and promote domestic industries, doing so by shielding them from domestic competition from imports or financing their competitive struggles with foreign firms was prohibited as being inconsistent with the general principle of free trade. Even if some merit might exist for supporting infant industries, as many countries have done historically, implementing this support through protectionist measures would complicate trade governance by blurring the boundary between mercantilism and efforts at industrial promotion.

Acceptance of this argument is by no means universal. In the context of this chapter, the pivot of the controversy is the assumption that the prohibited actions are either ineffective or redundant to other policies that would be similarly effective. This assumption is supported to the extent that knowledge is a global public good or that the available processes of knowledge generation and distribution, that is, ones that do not contravene agreements (such as thematic funding), will suffice to allow entry into new areas of production or commercial activity. The assumption is contradicted if these conditions do not hold. While it is straightforward to find examples of countries entering new industries, contradicting a strong version of the infant industry argument, it is possible, although nearly impossible to establish, that prohibitions of protectionist measures have prevented entry into “important” industries (a broad counterfactual) or created “weak” entrants (for which there may be many other reasons).

The same problems apply to the analysis for historical examples where it is claimed that protectionist measures were of critical importance in supporting domestic technology development. While the fact of such measures is undisputed, the counterfactual claim of what would have happened in their absence is largely speculative. For example, in the case of the United States, domestic pig iron-making capacity was aided by protectionist measures in the nineteenth century with greater effect prior to the Civil War than following—however, in neither period is it likely that the industry would have disappeared without the tariff (Davis and Irwin, 2009; Irwin, 2000). The counterfactual (without protectionist measures) international division of labor in steel making in the latter half of the nineteenth century, during the most active period of American industrialization, is thus a matter of pure speculation.

4 Structural Adjustment and Economic Liberalization

The first and second oil shocks of 1973 and 1979 forced many developing countries to abandon the state-led import substitution industrialization model and undertake far-reaching economic liberalization programs. Oil rents allowed most countries in the Middle East and North Africa to avoid instituting painful structural reforms. The earliest reformers, Jordan, Morocco, Tunisia, and Turkey, were all countries with limited oil revenues. The collapse of oil prices in the 1980s forced the other countries of the region to introduce drastic cuts in public investments, reduce public sector hiring, and curtail safety nets, with a few, such as Egypt and Algeria, adopting wide-ranging macroeconomic stabilization, structural adjustment, and privatization programs (Hopfinger 1996, Harik and Sullivan 1992, Harik 1997, Niblock and Murphy 1993, Celasun 2000).

A further impetus for pursuing economic reforms comes from prospects for greater trade liberalization and exposure to international competition as a result of accession to the World Trade Organization and the implementation of the Euro–Mediterranean partnership agreements. These agreements that 12 countries in the region have either negotiated or are in the process of negotiating with the European Union, emerge from a Euro–Mediterranean conference held in Barcelona in 1995. The partnership aims at creating free trade areas for all industrial products between the countries of the region and the European Union. The partnership agreements would also significantly increase aid flows to the region to facilitate the introduction of structural reforms. The prospects of intensified international competition and more open economies in the region has spawned an active literature on the consequences of these developments on the region's economies (Galal and Hoekman 1997, Handoussa and Reiffers 2000).

The MIRAB phase

Following the independence of some of the Oceanic territories, the economic model that was first espoused was that of import-substitution industrialization (ISI). This largely failed in all of the cases although it was only ever half-heartedly applied. Aid from the former colonial powers often funded these attempts at modernization. A major social revolution occurred in the 1960s and 1970s in those countries that were newly independent, involving the migration of large numbers of Pacific Islanders to cities on the Pacific Rim – especially those in New Zealand and Australia and also in the USA. This led to the establishment of proportionally highly significant flows of remittances from the new homes back to the islands. This combination of factors led to the development of what have been termed MIRAB economies.

The acronym MIRAB was coined to refer to countries where migration (MI), aid (A), remittence (R), and government-employment (bureaucracy) play a major role. It was first applied to the Oceanic region in study from 1985 which noted that living standards in the Pacific Island region were much higher than productive economic measure predicted. It was argued that the postcolonial migration of large numbers of islanders established transnational corporations of kin through which remittances flowed. These remittances, as subsequently argued, show little tendency to deteriorate even in third- or fourth-generation migrants – as such the attachment to home (sometimes among people who had ever actually been to such territories) was considered large. Aid was also large in some economies (although the relative importance of aid and remittances was seen to vary between countries and subregions) and this was initially the case for strategic reason but latterly due to postcolonial obligations. The government sector often became the major employer and small island nations had inherited colonial bureaucracies, and there was a minimum-efficient scale for governmental functions. The model varies in its applicability across the region and there is fierce debate as to whether it applies today.

Today, it is certainly the case that remittances and aid maintain their roles. In Niue, for example, over 50% of gross national produce (GNP) is in the form of aid. Remittences account for up to 40% of Samoan income, and in Fiji remittances are now the single-largest foreign-exchange earner, above both tourism and sugar. Indeed, there is little evidence for any long-term downward trend in remittances – in fact during times of conflict and natural disasters, which arguably characterizes the present, they have tended to rise. Notwithstanding, there is no doubt that until recently at least aid levels have been rationalized – and there has been a downward trend with a general shift to project, tied and targeted rather than budgetary aid. Migration controls, especially in the USA and also in Australia and New Zealand have tightened. The neoliberal models that regional trustees are seeking to apply to the region have insisted on governmental reform which reduces the bureaucracy (B) in MIRAB. Having said this, recent work has shown that the model still remains robust in many places although patterns continue to shift. Most notable, some have added a T for tourism to the acronym, making TOURAB. Proponents of the MIRAB analysis insist that it still represents a rational and sustainable method of obtaining development.