POLYTECHNIC UNIVERSITY OF THE

PHILIPPINES
SAN PEDRO CAMPUS

CASE STUDY:

SUBSTITUTION OF FOREIGN AND

DOMESTIC GOODS

Jommel C. Gayod Jr.

BSEM II-I

Prof. Lito Penaflor

SUBSTITUTION OF FOREIGN GOODS

Substitution of Foreign Goods involves extensive use of trade barriers to protect domestic
industries from import competition. The goal of production in import substitution is to
serve internal demand by substituting imported goods with locally produced goods; a
strategy that appreciates the local promotion via government intervention to the whole
economy.

One of the major advantages for developing countries is to able avoiding import tariffs: by
encouraging foreign (developed) countries to set-up their manufacturing plants/factories
in the country, domestic employment is increased. In addition, the protection of domestic
goods against foreign competitors is easier than forcing industrial countries to lower their
trade restrictions for their exported produce: this would provide low risks of establishing a
home industry to replace imports.
Import substitution is attractive for developing countries, it is challenging as high levels of
knowledge, ability and tentative are required to compete with other foreign (developed)
countries. Import substitution starts with the production of consumption goods, with the
aim to reduce the import of goods. However, if the level of demand for imported goods
required to produce final products in the country increases rapidly, the country will
become more dependent on other (foreign) countries on such imports; damaging trade
balance.

n addition, import substitution has a negative effect on exporters: as the exchange rate
appreciates, it will be relatively expensive to protect locally produced goods in the internal
industries. As a result, there would be damages in the exports, worsening trade balances.

Both the increase in dependence on foreign intermediate goods and decrease in exports
will worsen trade balance, it will result in the profound problem which causes the
developing country to borrow money to finance the trade deficit. Other disadvantages
would include low incentive for domestic manufacturers to increase efficiency, the market
being too small for economies of scale, restrictions on imports being hard to remove and
may breed corruption, and not having competitive advantage.

SUBSTITUTION OF DOMESTIC GOODS

In Substitution of Domestic Goods, external demand is the source of activity. Export

promotion focuses only on potential industries for developing and competing with foreign
rivals (countries). The main point of the export promotion strategy is to make production
for international trade and increase exports.

The advantages of substitution of domesti goods would be to provide developing

countries a remedy to the unemployment problem: developing countries are most likely to
have a comparative advantages such as labor-intensive manufactures, which will
encourage industries in developing countries to hire more people (labor) in the production
of labor-intensive products.

The export market also allows domestic producers to utilize economies of scale. There is
also a low level of trade restrictions that forces the domestic firms to remain competitive
so as to increase efficiency.

Although the growth of developing countries can be promoted via exporting, these
developing countries are dependent on the ability and willingness of industrial
(developed) nations to absorb the large quantities of manufactures from the developing
countries. It has become sensitive to the economic cycles and protectionist pressures in
the export markets. Countries emphasizing export promotion have tended to realize higher
rates of economic growth than countries emphasizing import-substitution policies.