Thread by @ChayuDamsinghe

Following import substitution, self-sufficiency, and local production didn't work out for Sri Lanka in the last 2 years. My longest 🧵yet to explain - promise it's worth it!

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#SriLankaCrisis #SriLanka #lka (#GotaGoGama #GoHomeGota #GoHomeRajapakshas #අරගලයටජය for reach)

Now, these ideas are often "common sense". It sounds good - if we have a forex problem, lets stop importing and make it ourself! Lets be self-sufficent, why depend on others?

But econ ISN'T common sense - so let's go through my view on why these don't work.

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The main idea behind these is basically - produce goods locally, ideally goods we currently import, and sometimes, hope to export later.

So 3 broad benefits spoken of

1. Save/grow forex
2. Increase GDP
3. Have a backup if global trade fails

Lets go through all of these

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A big issue I see with import substitution is that it fails to realise that even to make something domestically, we still need to import. We need raw materials, we need machinery, we need electricity, - which means the import cost is the same.

https://twitter.com/ChayuDamsinghe/status/1510916459765317635

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Not always the case, but lets take 3 hypothetical examples to show this.

Example A - Trains. Assume import cost of finished train as $ 100, iron/steel cost $ 80 to import, machines to make trains cost $ 15, and fuel costs is $ 15

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Example B - Nails. Assume import cost of finished nail is $ 100, assume iron/steel cost $ 60, machinery $ 20, energy $ 10.

Example C - Steel wire. Assume import cost of finished wire is $ 100, iron/steel cost $ 20, machinery $ 10, energy $ 5.

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In these three examples, compared to a $ 100 import cost if we just imported the final good, "local production" gives us $ 110, $ 90, $ 45 import requirement anyway.

In both A and B, it's really high!

Problem #1 - import substitution and local production needs imports

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Lets take example C then, where there DOES seem to be a big saving.

If there's a huge saving and we can make the same product for cheaper, why wasn't this done before?

Often, if it makes financial sense, no need to incentivise. Profit minded company will do it.

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What often happens is that the product quality is actually inferior, because we don't have the knowledge, skills, experience to compete with the global product. I'll give the example of making Marutis in India instead of importing Toyotas

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Now wait - making Marutis was bad? I thought India car companies are now doing well!

See, that CAN be possible if we have a large enough market that people will buy this product AND there's enough space for competition locally.

SL is too small for that.

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A great example for this is our tile sector, which has been protected and doing this import substitution/local production for ages now. But because our market is small, it's basically just 1 set of players, and they have no incentive to improve their product.

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In any case, it still needs consumers to use low-quality products, often with no other choice, for a while - and often at a higher cost (explained in problem #3).

Problem #2 - low-quality products

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The other issue is that even outside of the import components, there are other costs. Lack of experience, economies of scale, existing supply lines all mean that there are added costs to producing things locally.

Also profit margins.

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So many examples of this. Rice, tiles, corn, and more all have this

A big reason is that some countries, due to a combination of factors, simply can produce things better and cheaper than others.

Concept of "comparative advantage"



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All this can lead to a situation where locally produced items are often more expensive for whoever is buying than if the item was just imported.

Problem #3 - more expensive products

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However, the issue goes beyond this. Remember, resources are limited. This is true for money, but also for human resources, time, and just support the financial sector can provide too.

IMO we want things that grow sustainably long term, and also earn forex

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But when consumers pay more AND get a low quality product in return (meaning value of benefit is lower, costs of maintaining etc higher), they'll likely have less money left over overall. Meaning simply, they're likely to be poorer.

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It seems obvious to me that a poorer consumer has a smaller growth potential, and adding that over the years likely weakens the country's potential growth, since you're diverting resources to inefficient industries.

Problem #4 - weaker growth than otherwise

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But because resources are limited, this also means less labour and money for export industries to access. So not only is there problem #1, where there's anyway forex usage, but now -

Problem #5 - weaker exports

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Finally, that point about "backup" if global systems fail. As all above show, it's really difficult to do local production, especially for a small population, WITHOUT a global system already working.

Nevermind that the global system will punish us if we try and isolate.

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That means that there's no real "safety" or "removed dependance" from other countries either. Like it or not, the modern world has a highly interlinked economic system. Running away harms us more than being part of it.

Problem #6 - isolation is harmful

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So we have these 6 problems - import costs use forex anyway, low quality products, high cost products, poorer consumer=weak growth, weak exports, harmful isolation.

There are also others that come from the WAY we can do this- explained elsewhere

https://twitter.com/ChayuDamsinghe/status/1512668955579908097

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So what am I saying? Don't produce?

Not at all! I'm saying primarily focus on producing things that avoid these issues, especially things you can immediately export. Again, going back to doing what you're good at.

In the meantime, use those savings well.

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2 things needed in my view are -

1 - upskilling labour - so they can actually produce high-value items in the future
2 - RnD - so that high tech production (that is efficient) is possible in the future

An example of the numbers here

https://twitter.com/ChayuDamsinghe/status/1513101861590822913

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There are also other things that ALREADY fit this that we can do. Eg - SL is probably very well placed for mineral sand production and solar energy is a high-tech solution that's already here

Main reason this doesn't happen in my view, is harder to be corrupt with these

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Now there's another thing. Lets take those 6 problems again.

You CAN grow a domestic production economy, possibly into a good long term export one as well, IF you are okay with those 6 problems.

This means being okay with poorer population with worse QoL.

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A lot of examples that built up local production followed this path. My view is that we need to do BETTER than the mistakes of the past, especially when there's a viable alternative - export promotion, with proven benefits across the world.

https://twitter.com/ChayuDamsinghe/status/1512668992041029632

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Even banning vehicle imports is like that. Quality of life for Sri Lankans is worse as a result, and since we can't produce locally, whatever is already here goes up in price, bringing us the other issues

But again, IF that is an okay bargain, one can decide to go ahead

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There's a final way in which I personally think import substitution etc is desirable DESPITE the economic consequences - and that is if there are other benefits that outweigh the costs.

Eg - food security for local food production, labour banks for factories

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In the end, whenever we talk about these measures, we need to be aware of what they really mean. I believe import substitution has all these issues, and especially in the presence of an alternative, why go for something that just doesn't work?

Lets do what works :)

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