The ability of lesser developed countries to efficiently absorb unemployed or underemployed manpower into their industrial sectors during the development phase is examined. The poor record of industrial labor absorption in LDCs is discussed from a historical and policy perspective. The different nature of the innovation process in LDCs is described, and a theory to account for the innovation process is proposed. This theory is examined in relation to favorable policy conditions by reference to historical Japan and contemporary Korea and Taiwan. It is concluded that a typical developing country can expect, through manipulation of appropriate policies, to change from import substitution to export substitution. This transition will involve movement from pure technological transplantation to reliance upon labor-using innovations. Such a transition will accelerate the current slow and uneven trend toward economic liberalization.