Objective: industrialize producing manufactured
goods via governmental support and economic
• Gov policies to promote & protect infant industries:
1. International Trade
2. Industrial Policies
3. Monetary & Fiscal
ISI - INTERNATIONAL TRADE POLICIES
Impose international trade restrictions via import tariff to protect
national industry from international competition
Protective shield give time INFANT INDUSTRY to develop without
the competition of large multinational firms.
Temporal protective wall until factories could produce final
manufacturing goods (previously imported).
Anchored in the formation of State Owned Enterprises
(SOEs) state active role in production
What type of enterprises?
SOES ECONOMIC RATIONALE
Railroads, ports, telecom ..... Public Value
increase the well being of the whole society.
This infrastructure was thought public responsibility.
SOEs had larger time horizon for investment returns hard
to afford for a private enterprise.
SOEs economic rationale?
▪ Public externalities: Gov had access to international
financial markets to borrow and invest in large
▪Role of the government as negotiator in international
Goal of SOEs promote growth of local industry by
producing and selling SOE goods & services to local
private factories at prices below its cost lowering
cost of private industrial production.
Example of SOEs
• Public transportation creating the incentives for workers to
mobilize from rural to urban more industrialized areas.
• Industrial parks, etc.
Prices of SOEs final products and services were determined not
by the market forces but by the government
Prices were set up below market level
Implicitly governments subsidized industry
Over time SOEs became underfunded
Gov got loans (via international savings). Used to fund SOEs (monopolies). SOEs produced key goods & serv.
Since SOEs subsidized the industrial sector, SOEs ran
into deficits that limited its own re-investment.
Over long time, SOEs ran deficits that
needed constant international lending.
LAC Exchange rates were fixed and established by the
local Central Bank or Federal Reserve.
Industrialization needed to import technology - physical capital
A change in the exchange rate offer a viable method to affect trade flows
LAC Central Banks overvalued their exchange
rates to make imports relatively cheaper to buy
foreign currency cheaper (to pay w/less domestic
HOW DO EXCHANGE RATES WORK?
• Mexico Federal Reserve announces ER P/$=1
Mexico peso = 1
USA = $1
If in reality: the
common basket of goods
USA = $1 but in Mexico = 5 pesos
The real exchange rate should be:
ERP/$ = 5pesos/1dollar or 1peso/$.2
If the official ERp/$=1p/1dollar
The ER is overvalued relative to the
dollar because the true value of 1 peso
Overvaluing ER creates strong
DISTORTIONS OF OVERVALUED ER
• Overvalued currency is "too strong" in the
international market, making:
• Imports cheaper to local industries but
• Exports more expensive to foreigners.
▪Undervalued currency is "too weak" in the
international market making
▪ Exports cheaper to foreigners and
▪ Imports more expensive to locals.
ISI - MONETARY POLICY
• During ISI: LAC governments offered preferential
overvalued exchange rates to infant industries so
they could import even cheaper technology and inputs from
▪Soft credits w/preferential interest rates were
given to key industries (low interest loan rates and
long term payments).
▪National developmental banks were created
to target and facilitate industrial investment in the economy.
• To finance the technological transfer
ISI, making imports cheap.
▪To contain local inflation.
ER, Buys foreign
from abroad, Cheaper tech &
Devaluate ER (Paying more Pesos for $1, Imported Technology, Production Costs become higher (intermediate goods more expensive), Increasing Domestic Prices, Inflation (higher prices for manufactured goods, makes foreign currency more desirable), Forces deeper devaluation, More inflation, Correct Overvalued ER, Devaluate ER (Paying more Pesos for $1)
ISI - FISCAL POLICY
• Tax credits given to industries to promote
innovation and higher capital accumulation.
▪Gov taxed Agro EXPORTS to finance SOEs and
subsidize the industry
▪ Deterring investment on agriculture/mining sector to
promote reallocation of resources and structural change into
the industry (moving resources from traditional to modern
▪ ISI had a distinct anti-export agro bias