There's concern among many economists that Import Substitution is again becoming popular among developing countries as well as developed countries like the US.
IMO however, this conflation of the US situation with those in developing countries, misleads the debate. 1/9
It is true that in many developing economies in the past, IS and purely inward looking policies have led to disustrous growth consequences.
This is mainly becoz the political economy in these countries allowed IS to provide a carrot to the pvt. sector, but not hold a stick. 2/9
All east Asian miracle economies, including China, however, implemented this carrot and stick policy successfully.
It allowed these economies to transform themselves technologically, from labour intensive to skill and tech-intensive economies. 3/9
Thus for developing countries, this carrot and stick policy, which economists call industrial policy (IP), is the only historically proven strategy for rapid transformation and growth. 4/9
However, the biggest weakness in developing countries that may derail such industrial policies, remains the old problem.
It's the rent-seeking politics that turns IP into a protectionist racket. 5/9
Thus for developing countries, the gain from IP is technological, the constraint is political.
This is exactly the opposite of the US case, where the gain is political, the constraint is technological.
Let me explain. 6/9
The objective of Import Substitution in the US is not to be technologically transformative. It's already the world leader in technology.
The objective is political. It is to provide jobs to satisfy a vote bank that can change the fortunes of either political party in the US. 7/9
OTOH, their main constraint is not political, but technological.
It's the advent of automation, which has ensured that even if domestic demand in the US is catered solely by domestic production, it may not create many jobs. 8/9
As @DevashishMitra_ tweeted recently, it'll create jobs (mainly) for robots.
To sum up, the issues of Import Substitution and Industrial Policy are very different for developed and developing countries. Conflating these is unhelpful in understanding either of them. 9/9
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The disruptions caused by Covid-19 and the lockdowns may make the work of macro policy more complicated than usual, simply by worsening the short-run tradeoff between growth and inflation.
Let me explain.
1/6
A major factor behind the growth-inflation tradeoff is that in any economy close to full capacity, there is excess capacity in some sectors, while others face capacity constraints.
2/6
Increasing aggregate demand in such a situation lead to more growth in the excess-capacity sectors but also more inflation in the sectors facing constraints.