4 I Report No.7402-MAI Malawi Industrial Sector Memorandum December 14,1989 Industry andEnergy Operations Division Southern Africa Department FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may beused by recipients onlyin the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
Transcript
4 I
Report No. 7402-MAI
MalawiIndustrial Sector Memorandum
December 14, 1989
Industry and Energy Operations DivisionSouthern Africa Department
FOR OFFICIAL USE ONLY
Document of the World Bank
This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents may not otherwisebe disclosed without World Bank authorization.
ADMARC Agricultural Development and Marketing CorporationAES Annual Economic SurveyAREE Annual Report on Employment and EarningsCBM Commercial Bank of MalawiDEMATT Development of Malawian Traders TrustDFI Dcvelopment Finance InstitutionDRC Domestic Resource costINDEBANK Industrial and Development Bank of MalawiINDEFUND Investment and Development FundISIC International Standard Industrial ClassiflcationMDC Malawian Development CorporationMEDI Malawian Entrepreneurs Development InstituteMEPC Malawian Export Promotion CouncilMTIT Ministry of Trade, Industry and TourismMUSCCO Malawian Union of Savings and Credit CoopcralivcMVA Manufacturing Value AddedNA Not AvailableNBM National Bank of MalawiNSO National Statistical OfficeOGL Open General LicensePOSB Post ')ffice Savings BankRBM Reserve Bank of MalawiRTS Rural Trade SchoolSEDOM Small Enterprise Development Organization of MalaaiwiSITC Standard Industrial Trade ClassificationTFPG Total Factor Productivity Growth
FOR OMCIL USE ONLY
SYNOPSIS
The contribution of Malawi's industrial sector to economic growth, employment, andexports was negligible during the eighties. This performance stands in stark contrast to the sector's recordduring the sixties and seventies, when manufacturing output and employment outpaced GDP growth andthe sector attained its present 12 percent of GDP. This report examines the causes for the dramaticslowdown in the growth of industrial output and employment and offers policy recommendations to spurefficient manufacturing growth.
The report has two main findings. First, Malawi's industrial sector is among the mostefficient in sub-Saharan Africa, despite the facts that it is small, characterized by simple technologicalprocesses, heavily dependent on raw materials, and mainly geared to satisfy domestic demand. Second, thesector's efficiency and relatively high rates of growth during the sixties and seventies were the result of goodsectoral and macroeconomic policies. In general, sectoral policies have been market-oriented and relativelyneutral. Thus, the authorities have never used tax holidays to favor industrial investment, and have usedsubsidies only occasionally. Until the late seventies, protection was low and fairly uniform. Finally, theGovernment has not pursued industrialization through large investments in industrial concerns either. Theweak performance during the eighties was the result of exogenous factors and inappropriate policyresponse. Adverse changes in the terms of trade reduced domestic demand and the country's capacity toimport, triggering a slowdown in industrial output. The authorities' response--in particular, higher importduties and discretional allocation of foreign exchange--increased protection, led to a misallocation ofresources, and aggravated the economic slowdown.
To spur growth, the report recommends returning to the macroeconomic policies thatspawned Malawi's industrial sector. In particular, it advocates eliminating the foreign exchange allocationsystem and supports the authorities' flexible management of the exchange rate. The reports argues forreducing tariff-based protection by lowering the overall tariff level and reducing tariff spreads, but onlyafter access to foreign exchange has been fully liberalized. The report also recommends adopting policiesto place manufacturers in a free-trade-equivalent situation to spur industrial exports, listing duty drawbackschemes, and export processing zones as two possibilities.
With respect to financial policies, the report concluded that the institutions now operatingin Malawi cater mostly to prime customers and do very little, if any, term intermediation: their liabilitiesare mostly short-term and so is their asset base. This conservative bias falls particularly heavily on thesmall and emerging entrepreneur. The report argues that the instruments of monetary policy used by theauthorities are in large part responsible for this bias. In particular, the use of credit ceilings (enforced onan institution-by-institution basis) to control the money multiplier reinforces the market's oligopolisticstructure, raises collateral requirements, and displaces non-prime borrowers. When credit ceilings arebinding banks prefer to lend to their established client base and to prime clients with the best collateral;they also actively discourage savers by directing them to instruments with the lowest interest rates, makingtime deposits less attractive than other assets. The report recommends using open market operationsinstead of credit ceilings to control the money supply, and revising the legal framework accordingly.
This document has a restricted distribution and may be used by recipients only in the performance |of their official duties. It3 contents may not otherwise be disclosed without World Bank authorization.
MALAWI
INDUSTRIAL SECTOR MEMORANDUM
TABLE OF CONTENTS
Pae No.
EXECUTIVE SUMMARY.. ..................... .... . . I
Introduction ..Industrial Structure ... iIndustrial Efficiency ... iiThe Policy Environment and its Impact on Industrial Performance. iiiGrowth Prospects.vRecommendations.vFinancial Sector.vi
Institutional Setting.viPerformance.vii
Small Scale Industry.viiiInstitutional Arrangements.viiiCredit.ix
Gr wt Pr EOOMANTEspects ........................... .." _...... "...................................................
The Malawian Economy .1Recent Industrial Performance .. 2Industrial Structure .3Concentration .4Export Orientation and Import Dependence.SFinancial Characteristics.6
Rates cf Return and Pay-out Ratios.6
I1. PROTECTION AND INDUSTRIL EFFICIENCY.. .. .... ........... 7
Introduction.7Nominal Protection.8Effective Protection.9Industrial Efformany .11Sources of Inefficiency.12
Capacity Utilization and Foreign Exchange Allocatin .13Firm Ownership.14Import Content.15Capital Intensity.16
This report is based on the findings of an industrial sector mission that visited Malawi during October1987. The mission was composed of Pedro Belli (Chief and principal author), Vincent Rague (financialsector analyst), Richard Scobey (economist), Caroline Doggart (consultant, economist), Jorge Garcia-Garcia (consultant, economist), and Gradimir Radisic (consultant, economist). A draft report wasdiscussed with the Government of Malawi in May 1989.
Profitability and Economic Efficiency .............................................. 18Conclusions .............................................. 18
Ill. THE POLICY ENVIRONMENT AND) INDUSTRIAL PERFORMANCE.-..-. . .. . . ......... . .... 20
Introduction ..................................................... 20Key Stages in the Trade Regime ...................................................... 22Tariff Policy ..................................................... 22
Adjustment ..................................................... 24Foreign Exchange Allocation and Protection ..................................................... 25
Nominal Protection ..................................................... 25Increasing Protection and its Impact on Trade Ratios ..................................................... 26
Relative Prices ..................................................... 27Exchange Rate .................................... 27Nominal Minimum Wage and Real Wages .................................... 29
Sources of Growth in Manufacturing 1974-79 .................................... 31Employment, Labor and Total Factor Productivity .................................... 35
Employment ............................................. 35Labor Productivity .................................... 35Investment and Capital Stock Estimates .................................... 37Total Factor Productivity .................................... 37Sub-sectoral Total Factor Productivity Growth .................................... 39
IV. FINANCIAL INSTITUTIONS AND POLICIES ... .... .... . . .. ... ......... .40
The Reserve Bank of Malawi ..................................... 40Commercial Banks ..................................... 40Other Financial Institutions ..................................... 42
The Post Office Savings Bank ..................................... 42Finance Houses ..................................... 43The New Building Society (NBS) .43Development Finance Institutions (DFIs) .43Pension Funds and Insurance Companies .43
The Regulatory and Supervisory Framework ............................. 49
V. SMALLSCALE INDUSTRY IN MAlAVI ......... . .. . .................... .0.... s
Structure and Development .............................. 50Financing Small-Scale Industries .............................. 51Industrial Licensing .............................. 52Barriers to Entry and Growth .............................. 52Government Policy and Institutional Framework for SSIs ...................................... 52
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LIST OF TABLES
CHAPTER 1 Page No
1.1 Structure of the Manufacturing Sector, 1983 .......................... 31.2 Indices of Industrial Concentration. 41.3 Composition of Industrial Exports, 1976-84, Selected Years ........ 5.......... S1.4 Main Financial Indicators of Manufacturing Firms ..................... 6
CHAPIER 11
11.1 Firm Level Survey, Sample Coverage ................. 811.2 Estimates of Nominal Protection ..................... . 911.3 Estimates of Effective Protection ............... .................. 1011.4 Estimates of Industrial Efficiency .......... ....................... 1111:5 Distribution of Value Added According to DRC ........ ............. 1311.6 Estimates of Long-Run DRCs at Different Rates of Capacity Utilization .... 1411.7 Domestic Resource cost, Effective Protection and Ownership by Sub-Sector . 1511.8 Statistical Association Between Efficiency, Import Content
and Firm Ownership . . ......................................... 1611.9 Capital Intensity and Economic Efficiency by Sub-Sectors ..... .......... 1711.10 Firm St?;. and Economic Efficiency ............................... 1811.11 Industrial Concentration and Economic Efficiency
CHAPTER III
111.1 Annual Rates of Growth of fleal Gross Output ......... ............. 20111.2 Central Government Finance as a Proportion of GDP ...... ........... 23111.3 Average Import Duties on Selected Goods, 1974, 1978 and 1986 ... ....... 25111.4 Changes in Implicit Indirect Tax Rates ............................ 26111.5 Inflation Rates, 1973-86 Selected Years111.6 Nominal and Real Wages, 1973-86, Selected Years ........ ............ 30111.7 Sources of Growth in Manufacturing, 1974-79 ......... .............. 33111.8 Sources of Industrial Growth, 1979-83 ....... ...................... 34111.9 Sectoral Distribution of Manufacturing Employment, 1973/75-1981/83 ..... 36111.10 Factor Shares and Total Factor Productivity Growth Rates
in Manufacturing, 1973-83 .. 37111.11 Subsectoral Total Factor Productivity Growth ....... ................. 38
CHAPTER IV
IV.1 Comrnwtrcial Banks Comparative Analysis, 1985-86 ...... .............. 41IV.2 Distribution of Financial Sector Assets and Advances ...... ............ 42IV.3 Measures of Financial Depth . ................................... 44IV.4 Real Interest Rates, 1979-1985 . ................................... 47
CHAPIER V
V.1 Sub-Sectoral Distribution of Small-Scale Manufacturing, 1985 ..... ....... 51V.2 Industrial Investment Licensing . .................................. 53
EXECUTIVE SUMMARY
Introduction
i. The contribution of Malawi's industrial sector to economic growth, employment, and exports hasbeen negligible during the present decade. This performance stands in stark contrast to the sector's recordduring the seventies, when manufacturing output grew from about 9 percent to its present 12 percent shareof GDP and wage employment. Industry's strong performance during the late sixties and throughout theseventies was in large measure the result of good sector and macroeconomic policies. The downturn inindustrial performance has been in part the result of external events affecting the country at large--thesecond oil shock, disruption of traditional trade routes, drought, and the rise in international interest rates,These developments slowed the economy and the growth in demand for manufactured goods. But not allof industry's problems have been caused by exogenous events. When in the late seventies the externalsituation took a turn for the worse, the authorities at first did not adjust, but instead eased fiscal policy,reduced dependence on domestic savings, increased foreign borrowing on commercial terms, and boostedprotection. Later, attempts to adjust resulted in a progressive closing of the economy, with gradual tariffincreases in the late seventies and finally with the imposition of quantitative restrictions (QRs) in 1986through foreign exchange rationing. Higher tariffs and ORs deterred growth and investment by raising thecost of imported inputs and capital equipment at first and later by denying producers free access to thesegoods.
ii. A sustained improvement in eco'iomic performance will require a return to the policies thatnurtured Malawi's industrial sector. Industiial firms need to have access to foreign exchange as determinedby market forces, btit domestic competition must be complemented with foreign competition throughimports. Tariffs must be low and uniform in order to keep firms efficient within the sector as well as acrosssectors. To spur exports, industrial firms also need to be placed in a free-trade equivalent situation withrespect to the price of both inputs and output for exports. Attaining these objectives would requireeliminating foreign exchange rationing, lowering tariffs, reducing spreads, introduicing effective duty-drawbacks--or similar mechanisms--and adopting supportive macroeconomic policies.
Industrial Structure
iii. The pattern of industrial production in Malawi is typical of countries at an early stage ofindustrial development and relatively low levels of per capita income. The bulk of industrial productionstems from five sub-sectors, food, beverages, tobacco, textiles, and dothing and leather goods, which in1983 together accounted for 52 percent of gross output, 45 percent of MVA, 75 percent of industrialemployment, and 65 percent of the industrial wage bill. The value added share of these sub-sectors issimilar to those of Kenya (48 percent) and Zimbabwe (44 percent), but the total output of Malawi'sindustrial sector is only about 6 percent that of Zimbabwe, 10 percent that of Kenya, and 25 percent that ofTanzania.
iv. The small domestic market often cannot support more than one or two factories in a given sectorand as a result there is a good deal of industrial concentration. At the three-digit ISIC classification level,eight out of twenty-one sub-sectors have less than three firms. There is, moreover, an unusual degree ofconcentration of ownership. Three holding companies--Press Holdings, the Malawian DevelopmentCorporation (Ml)C) and the Agricultural Development and Marketing Corporation (ADMARC)--own asizable percentage of the sector's total equity. Finally, there are very close relations between industry andfinancial institutions: Press Holdings and ADMARC own 80 percent of the National Bank of Malawi and70 percent of the Commercial Bank of Malawi, the only two commercial banks in the country.
v. Malawi's landlocked position gives rise to high transport costs that provide natural protection butthat, by the same token, decrease the profitability of exports. In 1980 the CIF value of imports was 38
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percent higher than the FOB value. As a result of the virtual closure of the Mozambican trade routesduring the eighties, the CIF margin rose and is now about 67 percent. Such high transport costs markedlyreduce the profitability of industrial exports, especially those based on imported raw materials, and wouldrmnder domestic prices about 40 percent higher than exports even in a free trade situation. Consequently,the sector is heavily oriented towards the domestic market. Industrial exports as a percent of industrialsales are about 3 percent; the share of industrial exports in total exports is about 4 percent and of this tinyfraction textiles and clothing account for about two-thirds.
vi. Industry also has very few linkages within itself and with other economic sectors. Industrial firmstypically import about two-thirds of their raw materials and sell their product to the final consumer. Indus-trial imports of raw materials are about ten times as large as industrial exports, indicating that there is aconsiderable sectoral balance of trade deficit. Because Malawi is still predominantly agrarian--agriculturecontributes about two-fifths to GDP and wage employment--fluctuations in agricultural production heavilyinfluence domestic demand and hence industrial sales. Industry, then, relies on agriculture to stimulatedomestic demand and to generate the foreign exchange that it needs to import raw materials, fuel, andcapital goods. Consequently, industrial growth depends upon the performance of other sectors in theeconomy, particularly agriculture. The general downturn in economic conditions during the present decadeexplains to a large extent the relatively low growth of industry. If Malawian industry is to be less dependenton domestic conditions, it must seek to diversify its client base and penetrate foreign markets.
Industrial Efficiency
vii. About one-half of the country's export earnings are used to import raw materials for industry. Inaddition, industry imniorts fuel and capital goods. Considering that foreign exchange is likrely to he the mnostimportant growth constraint in the medium term, the efficiency with which industrial enterprises transforminputs into outputs is a crucial concern. Fortunately, the vast majority of Malawian firms are efficient froman economic view point. About ninety percent of the value added generated in the manufacturing industryis done under clearly efficient conditions and only less than three percent under clearly inefficient ones.This degree of efficiency places Malawi in a select group of sub-Saharan African countries that includesKenya and Zimbabwe. Although Malawi's industrial sector is based almost exclusively on importsubstitution and is heavily dependent on imported raw materials, the country's income and welfare is higherthan it would be if domestic production had not displaced imports. In this sense, the industrial sector playsa valuable role in the country's economy.
viii. At the time of the mission's visit, the main source of the little inefficiency that existed stemmedfrom low capacity utilization, itself the iesult of depressed domestic demand and foreign exchangerationing. In fact, higher capacity utilization would have reduced inefficiency in all but two of the one-hundred product lines surveyed. Inefficiency was also associated with a few parastatal manufacturing firms.
ix. The sector's efficiency can be explained in terms of macroeconomic and sectoral policiesimplemented by the authorities during the sixties and seventies. These policies avoided vices usuallyassociated with inefficient industrial development. Thus, special tax holidays for industry have never beenpart of industrial policies; industrial firms have not been favored with subsidies; the Government has notpursued industrialization through large invtstments in industrial concerns (parastatal firms account for only13 percent of total industrial sales valued at international prices), and high tariff protection has not been aninstrument of industrialization. Price controls and laws regulating industrial entry have been two of the fewareas where Government has intervened in an attempt to improve upon the workings of the market. Savefor vehicle spare parts and fertilizers, however, price controls on industrial products were eliminated in1985. By law, up to mid-1988, the Government was empowered to grant legal monopoly positions to firmson grounds of *public interest and in the interests of the efficient development of the industry concerned'for a period of up to five years, renewable any number of times. To this day, Government may deny alicense to a new entrant or to an established entrant seeking diversification. The Ministry of Trade,Industry and Tourism, however, has rarely granted monopoly rights--fertilizers, cement, and beer are theonly industrial legal monopolies in Malawi--and licenses are granted as a matter of fact: out of 136 requestssubmitted in 1985 and 1986, only 11 were rejected. Malawi has also had a liberal attitude towards foreign
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investment and at present about a third of total industrial sales (at international prices) are accounted forby foreign firms. In general, sectoral policies l'ave been largely market oriented and conducive to growthand efficient resource allocation. During the sixties and early seventies, the macroeconomic environmentwas also tavorable to fast industrial growth. LOw inflation, a market clearing exchange rate, market-de-termined allocation of foreign exchange, and low import duties all contributed to the good perfor-nance ofthe manufacturing sector.
The Policy Environment and Its Impact on Industrial Performance
x. The deterioration of the external environment and the authorities' policy response explain thesector's poor performance during the eighties. Domestic demand is by far the most important factoraffecting sales of industrial good. Consequently, the sector's performance has been intimately tied tooverall economic growth. Thus, while GDP grew at 5.7 percent per year between 1973 and 1979, MVAgrew at about the same rate. Between 1980 and 1987 the economy grew at 2.3 percent per year andindustry at 2.2 percent. The slowdown of domestic demand between 1980 and 1986, accompanied by a 9percent fall in per capita income, had a marked effect on the demand for industrial products.
xi. Trade policy in Malawi has gone through two main periods during the past fifteen years. Thefirst period, from 1973 to 1979 was one of substantially free international trade with virtually unimpededmovement of goods and fairly low and steady tariffs. The second period, from 1980 to the present, hasbeen one of rising protection via foreign exchange rationing and higher tariffs. From 1973 to 1979 theeconomy was relatively open, with an import to GDP ratio of about 35 percent and average import dutieson the order of 17 percent with a range of 0-70 percent. Unlike other sub-Saharan African countries,whose currencies underwent gross real appreciation during the seventies, the Malawian kwacha remainedstable in both nominal and real terms vis-a-vis a basket of currencies of Malawi's main trading partners. Asexpected from a country with an open economy and a stable exchange rate, domestic inflation was close tointernational inflation, namely about 8 percent per year.
xii. From 1974 to 1979 gross industrial output grew at about 7.2 percent per year of wv;i_h 55 pointswere accounted for by the expansion of domestic demand, 1.6 points by increasing market share (i.e.,import substitution), and the rest by a modest export expansion. Growth was aided by high savings andinvestment rates. The sector's present efficiency can be explained by the fact that throughout this period,indeed since independence, industrial firms faced active external competition through imports. Compe-tition kept prices down, and spurred efficiency. As is common at the early stages of industrial development,during this period growth stemmed from additions to the factors of production, not from productivity gains(i.e., growth was "extensive").
xiii. Malawi began experiencing severe balance of payments problems around 1978. Fallinginternational prices for export commodities, soaring oil prices, and a gradual disruption of traditionalexternal transport routes through Mozambique led to a deterioration of the terms of trade of some 28percent between 1978 and 1981. Drought reduced agricultural production and made it necessary to importmaize in 1980/81. The authorities mistook these shocks as temporary and tried to maintain aggregatedemand and the country's income level through deficit spending, the Central Government's deficit, financedto a large extent with external debt contracted on commercial terms, rose to 11.6 percent of GDP in1980/81 and the current account deficit of the balance of payments to 17.8 percent of GDP in 1978 and to23.8 percent in 1979. Inflation soared from 4.1 percent in 1977 to 19.0 percent in 1980 and GDP fell by 5.2percent in 1981.
xiv. To deal with the balance of payments and fiscal problems the authorities adopted several policiesthat resulted in gradual closing of the economy and deterioration of the economic environment for industry.Government attempted to close the fiscal gap by, among other things, raising import duties. The averageimport tariff rose from about 20.4 percent of imports in 1978 to 25.7 percent in 1980 and to 38.4 percent in1986. Tariff spreads also widened: the standard deviation increased from 20.2 in 1978 to 25.8 in 1V86.Higher duties and wider spreads increased nominal and effective protection, encouraging the domesticproduction of goods at costs increasingly higher than international prices.
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xv. In 1981, the Governiimnt launched a broad-based structural adjustment effort geared to restoringmacroeconomic stability and removing structural constraints. This program was supported by threeStructural Adjustment Loans (SALs), an Extended Fund -:ility and successive stand-by operations withthe IMF. With the help of these programs Malawi managed to reduce domestic and external imbalanceswhile resuming GDP growth in 1982-85. The current account deficit declined from 20.7 percent of GDP in1980 to 8.2 percent in 1985, the Government budget deficit from 11.7 percent in fiscal 1981/82 to 6.4percent in fiscal 1984/85, and GDP grew at annual rate of about 4.6 percent between 1982 and 1985.Progress, however, was cut short. Continuous disruption and final closure of direct rail links toMozambican ports increased transport costs and caused an advcrse shift in the terms of trade of 18 percentand an 8 percent loss of GDP in 1982-85. Deterioration of export crop prices exacerbated balance ofpayments pressures, and large unbudgeted expcnditures on displaced persons from Mozambique, plusrising interest rates on the external debt, aggravated the external balance of payments deficit. To balancethe external accounts, inter alia, the Government tightened the rationing of foreign exchange to the privatesector, further increasing protection through quantitative restrictions (QRs).
xvi. As a result of higher import duties and transport costs and the imposition of ORs, the domesticmarket for industrial goods became much more profitable than exports, accentuating the already strongdomestic orientation of industry and indeed of the economy at large. Between 1973-75 and 1984-86 thetrade ratio declined from 58 percent to 45 percent of GDP, and imports from 35.7 percent to 22.5 percentof GDP. By late 1987, competing industrial imports had been effectively banned from the domestic marketand the market share of firms was being determined by the Reserve Bank of Malawi (RBM) through itsforeign exchange allocations. The closing of the economy together with expansionary fiscal policies pushedinflation to double digits, with a peak of about 28 percent in 1987. Quantitative restrictions on inputsreduced industrial output, while QRs on finished goods left firms with an uncontested domestic market,removing the principal downward pressure on prices and a major inducement for efficiency. Also, byincreasing the profitability of the domestic market relative to exports, QRs further discouraged potentialexports of industrial products. Higher import duties also reduced the volume of trade, accentuated theanti-export bias of the trade regime for industry, and turned the terms of trade against the exportablesector, namely agriculture. Higher taxes and higher nominal interes4 rates also contributed to makingc-pital more expensive than labor, discouraging investment.
xvii. The performance of the manufacturing sector reflected these changed conditions. First, as aresult of the general economic slowdown, domestic demand for industrial products fell by about 16 percentduring 1979-83. Industrial production would bave normally fallen at about the same rate, but the relativeclosing of the economy--owing to higher import duties and QRs--enabled local producers to displaceimports from the domestic market and to hold the fall in domestic output of industrial goods to only 4.3percent. There is a strong presumption that the import substitution of the eighties was less efficient thanthat of the seventies because it took place in conditions of higher protection. Although this trend may nothave been too damaging during the eighties because there was not much investment in the period, it couldbecome a serious problem if the policy environment continues to encourage inefficient import substitution.Second, the higher cost of capital both in absolute terms and relative to labo-, contributed to lowering theinvestment growth rate during the eighties, from MK 9.3 million per year in 1973-79 to MK 2.9 million in1980-83 (both at 1978 prices). Lower investment rates and lower production redounded in negligibleemployment creation: while from 1973 to 1978 industrial employment rose at an average annual rate of 6.8percent, from 1979 to 1983 (the last year for which there is comparable data). it remained virtuallyunchanged. Finaliy, labor productivity, which stagnated during the seventies, actually fell during theeighties, suggesting that manufacturing firms maintained redundant workers on their payrolls despitesagging sales. The pressures of a growing population on a stagnant labor demand, however, were reflectedin lower average real wages in manufacturing: by 1985 the average real wage was only two-thirds as high asin 1974.
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Growth Prospects
xViii. Despite its lackluster performance in recent years, manufacturing is capable of contributing tofuture growth of output, emplejment, and exports, albeit modestly. At the beginning of the decade,industry's slow growth merely reflected Malawi's economic recession, but since 1986 rationing of foreignexchange has been the main growth constraint. Growth prospects wilH depend upon the reactivation of theeconomy at large and higher inflows of foreign exchange. In the short run, growth is unlikely to come fromexport expansion or import substitution. Industry is not yet geared to export goods that can profiteblyovercome present transport costs; aside from textiles and clothing, exports of industrial goods are likely tobe insignificant in the near future. Import substitution, also, is unlikely to be an important source of growthbecause opportunities for further efficient import substitution are rare, as the "easy' ones have already beenexploited. In the short run, then, industrial output wili expand to meet domestic demand.
xix. More liberal access to foreign exchange will allow firms to expand production and satisfy thegrowing markets needs. Because capacity utilization is low, in the short run growth can be sustained withminimal investment. To increase their competitiveness with impores and avoid financial distress in aliberalized environment, a few firms may have to restructure product lines or manage them more effi-ciently, but in view of the sector's efficiency, a major restructuring of industry is not necessary.
xx. In the medium term exports can also become an important source of industrial growth, but asustained export drive will require substantial investment in new lines of production and deeper policychanges. Malawi's wages are among the lowest in the world. Consequently, Malawian industry has a clearadvantage in labor-inteusive processcs and could increase its exports even if only to the region. Withappropriate training of the labor force and the right equipment, the potential for diversifying and increasingindustrial exports would be considerably enhanced. Growth, especially export-led growth, however, willrequire higher investment rates to replace obsolete equipment and augment installed capacity. The policyenvironment also will require modifications. In particular, it will be necessary to place domestic producersin a free-trade equivalent situation so that they pay international prices for their inputs and receive interna-tional prices for their exports.
Recommendations
xxi. Government, in collaboration with the Bank and IMF, has developed a comprehensiveadjustment program to implemeat macroeconomic and sector policy reforms that would address most ofthe concerns raised in this report. These reforms were broadly outlined in the Government's 'Statement ofDevelopment Policies, 1987-1996" and are now being implemented under an IMF stand-by arr-ngementapproved in March 1988, the Industrial and Trade Policy Adjustment Credit, approved by the Bank in June1988, and a recently approved IMF Enhanced Structural Adjustment Facility (ESAF). The program'smacroeconomic objectives include raising the rate of real GDP growth from 15 percent in 1988 to about 5percent by 1992; restoring fiscal discipline consistent with balance of payments targets; and reducing thear.ual inflation rate from 26 percent in 1987 to international levels by 1989. The program's backbone istrade liberalization complemented by flexible exchange rate management, tight fiscal management, and taxreform. Trade liberalization includes removal of foreign exchange rationing and import prohibitions, andrationalization of the import tariff structure. The adjustment program also includes measures to supportdevelopment of small-scale enterprises and increase financial sector efficiency.
xxii. The sequencing of the liberalization of foreign exchange rationing is especially important forindustry. The rationing of foreign exchange in recent years has been a double-edged sword for industrialfirms. On the one hand it hindered access to imported inputs, raised costs, and lowered capacity utilization.On the other hand, it restricted imports of competing goods. If through liberalization foreign exchange ismade freely available to import raw materials and capital goods, but not competing goods, manufacturerswill be tempted to charge monopolistic prices without fear of losing market share, thus increasingmonopoly rents. Liberalization, therefore, should include final goods from the outset to spur efficiency inthose product lines where importation of raw materials and intermediate goods is no longer subject toforeign exchange rationing.
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xiii. The medium-term viability of th- liberalization program depends or. Malawi's ability to increaseexports. Exceptional balance of payments fmancing will provide essential external resources to support theinitial liberalization steps, but the economy's ability to sustain economic growth with a liberalized regimewill rest on the expansion and diversification of Malawi's export base. It is important to recognize that thepresent combination of transport costs, exchange rate, and tariffs render most industrial exports unprofit-able. Government has taken steps to reduce transport costs by improving alternate routes, such as theNorthern Cor7idor, and by attempting to rehabilitatv, the Nacala route. Second to reducing transport costs,the most important export promotion policy for manufactures would be the removal of the anti-export biascreated by tariffs, exchange rate overvaluation and, lately, QRs. In most countries the gestation period foran export drive after removal of anti-export bias is between 5 and 10 years. In Malawi it might take longerand be more difficult because of high transport costs. Previous experience shows that the main ingredientsof successful export drives include:
o an efficient system for providing inputs at international prices to exporters;
o appropriate institutional mechanisms that provide a catalyst for implementing anexport policy.
xxiv. Inputs can be provided at international prices even in the presence of import tariffs in at least twoways: by providing duty drawbacks, or by allowing manufacturing in bond. At present, unless specificallyexempted, all imports to Malawi are subject to import duties. Industrial duty drawback regulations allowmanufacturers to claim all tariff duties paid on imported raw material used for the manufacture of goodswhich are to be exported, but the scheme is ineffectual. The authorities are revising the scheme in thecontext of the tax reform now in progress and a new efficient system is expected to be in place shortly.Manufacturing in bond has been a standard ingredient of successful export strategies of East Asiancountries and has also been successful in the Dominican Republic, Mexico, and Mauritius. The Malawianauthorities are also experimenting with in-bond manufacturing and some firms are already exporting underthe scheme.
xxv. A strong partnership between business and Government helps set common goals needed tocompete in world markets. Quasi-official trading corporations have been used to provide coordinationbetween Government and business, economic policy advice, export policy administration, and trademissions. Their most effective roles have been in general policy matters and lobbying for export interestswithin the bureaucracy. In the early stages, the corporations have also played a role in disseminating in-formation about markets and trading opportunities. The Malawi Export Promotion Council (MEPC) hasthe legal mandate to provide a variety of functions to support export development. In practice, MEPC hasnot performed these functions to the satisfaction of its constituency and most firms visited by the missiondid not consider that it provides a useful service. To be more effective, the MEPC needs to concentrate onanalyzing markets, designing and developing individual promotional programs to open new markets,introducing new products, and eliminating domestic bureaucratic bottlenecks.
Financial Sector
xxvi. Effective financial intermediaries are an essential ingredient in the development of industry.Rarely, if ever, are industrial firms able to generate in their normal operations the resources needed tofinance capital expansions or working capital. A smoothly functioning financial system can provide therequired resources in a timely fashion and at adequate cost. Failure to do so raises production costs,fosters inefficiency, and retards growth. This report provides a brief review of financial policies andinstitutions, focusing on those issues that affect industrial performance and growth.
Instititional Setting
xxvii. Malawi's financial system, like that of many other sub-Saharan African countries, is small and hasonly a limited variety of institutions and services. The main financial institutions are the Reserve Bank
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(RBM), two commercial banks, two finance houses, a building society, three development financeinstitutions, the Post Office Savings Bank, a number of insurance companies and the Malawi Union ofSavings and Credit Cooperatives. Financial assets held by the public are essentially limited to currency anddeposits. There is no inter-bank market and the capital market is limited to Government local registeredstock (LRS), treasury bills, and private placement of share issues. Malawi also has an informal financialsector that cannot be readily quantified for lack of data, but that reputedly plays a significant role in creditallocation outside the officially registered financial institutions.
xxvimi. Partly by design, partly because of its small size, the official financial market is fragmented andoligopolistic. The market for financial services is segmented on both the deposit-taking and lending sides.The two commercial banks control 81 percent of financial system savings, they have close ties to oneanother and to the two main holding companies that dominate the industrial sector. As mentioned before,Press Holdings and ADMARC own 80 percent of NBM and 70 percent of CBM. Standard Chartered Bankof the United Kingdom has the remaining 20 percent equity holding in NBM. The Government is animportant actor in the financial sector, with 30 percent equity share of CBM and 51 percent share of theNew Building Society--a joint venture between Government and foreign private sector interests. Malawidoes not allow free entry into or exit out of the fnancial industry and no new commercial banks have beenestablished during the past sixteen years. Rather than fostering competition, the authorities have opted forestablishing specialized institutions (INDEBANK, NBS, INDEFUND, SEDOM) to fill perceived gaps infinancial services, or to cater to specific segments of the economy, thus intensifying market segmentationand cartel-like arrangements.
Performance
xicx. Malawi has not done poorly in terms of domestic resource mobilization and financial deepening.Although compared to other countries with similar income levels voluntary holdings of financial assets werelow at the beginning of the eighties, they have more than kept pace with the growth of nominal GDP sincethen and their composition has shifted in favor of time deposits. Yet, the Government's expansionary fiscalpolicies have had an important impact on the performance, composition, and size of the fmuancial sector.As a result of large public sector deficits, financial institutions have been called upon to buy public debt,increasing Government debt as a share of accumulated financial savings and the RBM's share in totaldomestic credit. The share of private credit in total credit, and of industry in particular, has fallen. Partlybecause the expansion of commercial bank credit has been restricted, the growth of the banking system hasbeen stunted and its potential for resource mobilization curtailed.
xxx. Despite the reduction in industry's share of credit, there is no evidence of substantial crowdingout. However, the primary reasons for the coexistence of a large public sector borrowing requirement andthe absence of crowding out were, initially, depressed domestic demand and lately, the foreign exchangeallocation system, which reduced the demand for loanable funds. In 1986, industrial firms were drawingvery lightly on the financial system, using internally generated resources to finance their working capital. Ifproductive investment is to rise--as it must if the sector is to grow--the demand for credit by themanufacturing sector would also recover and a reduction in public sector borrowing would be necessary toavoid crowding out of the private sector via credit rationing or significantly higher interest rates. The firstorder of the day, then, is a drastic reduction in the flow of domestic credit to the public sector.
XKxi. The Government recognizes this need and its adjustment program envisions an initial reduictioitof the Central Government's indebtedness with the banking system, with minimal recourse thereafter, untilat least 1992. This is expected to provide the private sector with sufficient resources to finance itsanticipated expansion.
xxxi. In addition to reducing the public sector deficit, however, a number of measures may berecommended to improve the instruments of monetary control and to foster competition. Credit ceilingsfor commercial banks have been enforced periodically to slow down monetary growth. Credit ceilings arean effective way of controlling the money multiplier, but it is doubtful that they have been effective incontrolling aggregate demand, as they do not affect investment or consumption financed with non-bankcredit, be it cash balances, retained earnings, or informal sector finance. Continuous access to RBM credit
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by Government and the restrictions imposed by RBM on overall growth of domestic credit have shifted thedistribution of credit towards the official sector. Moreover, because they are enforced on an institution-by-institution basis, using existing market shares as the benchmark, they have effectively reinforced themarket's oligopolistic structure. Cretit ceilings have also encouraged (i) tightening of commercial banks'credit standards, (ii) raising collateral requirements, (iii) displacing non-prime borrowers, especially small-scale, to the informal market, and (iv) disintermediation. When credit ceilings are binding, banks naturallyprefer to minimize their risks and lend to their established client base and to prime clients with the bestcollateral. Because there is not even an incipient inter-bank market, and legal impediments prevent otherinstitutions from tapping excess funds, overly-liquid commercial banks have opted for financing theGovernment (through investments in treasury bills), or for placing their deposits with the RBM itself in in-terest-bearing accounts. Faced with excess liquidity and no lending opportunities, commercial banks havehad little incentive to mobilize additional resources; in fact, in mid-1988 they were turning down longer-term deposits, forcing the public to hold larger than desired liquid balances, thereby stimulatingconsumption and the demand for real assets and durable commodities. Private enterprises with surplussavings are circumventing the financial system and lending to deficit enterprises directly, leading todisintermediation.
xxxiii. An alternative control mechanism might focus on reducing not the money multiplier, but themoney supply itself either by introducing open market operations, or adopting a monetay program thatplaces ceilings on the RBM's credit to both the Government and the private sector. Adoption of openmarket operations would have to be accompanied by substitution of the cash ratio for the liquidity ratio toeliminate treasury bills' role as interest-bearing financial system reserves. In addition to giving the RBM apowerful and sensitive tool for controlling the money supply, it would force the Central Government to paya market-determined interest rate on its domestic debt. Interest rates wou!d become the key variable in thecontrol of the money supply, exerting a restraining salutary influence on Government expenditures.
xxxiv. One possibility for fostering competition within the financial sector would be to modify the by-laws of development finance institutions (DFIs) to enable them to mobilize domestic resources and engagein a greater variety of financial services, including merchant banking, and unit trusts. This would not onlyincrease competition, but also spur financial institutions to serve the needs of non-prime as well as primeborrowers. The authorities might also consider establishing money and capital markets, unit trusts, andpossibly an equity market.
Small Scale Industry
xxxv. The growth of off-farm, small-scale industry (SSIs) in Malawi has been slow, primarily due tolimited entrepreneurial experience and limited access to financing for working capital and investment. Atpresent, there are only 156 registered small-scale industrial establishments, defined as those with 20 orfewer workers, which employ a total of 1,370 people. While there are a number of financial and technicalassistance institutions that support small enterprise development, these groups are inadequately capitalizedand lack effective outreach and training programs.
Institutional Arangements
xxxvi. Technical assistance is needed for the development of new entrepreneurs by expanding theprogram of basic business administration courses and project preparation assistance. These functions arecurrently performed by the Development of Malawian Traders Trust (DEMATT) and, to a lesser extent, bythe Malawian Entrepreneurs Development Institute (MEDI), the Rural Trade School, the Polytechnic andthe Nasawa Technical Training School. Existing entrepreneurs would benefit from more and betterbusiness administration courses and technical assistance is needed particularly for the training of trainers.
xxavu. Zoning legislation which forbids the setting up of small workshops in residential areas and/orrequires existing workshops (e.g., tailors, small bakeries, repair shops) of a certain size to move out whenthey are considered to have grown too big, is a major obstacle to both new enterprises and the growth of
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existing ones. Revising it would be advisable. It would also be advisable to allow very small craftenterprises to operate in popular housing zones.
xxxviii. The investment licensing system is not seen as a disincentive to small-scale industrialization.There is strong evidence, however, that the system is now being used to block Asian and other non-Africanmanufacturing investment. As African Malawians are not picking up investment opportunities denied toother Malawians and non-Malawians, the net result is a loss of new investment, and eventualy of industrialgrowth potential. Meanwhile confidence among the expatriate community is being undermined, which mayencourage the flight of capital and skills. Experience with industrial development legislation elsewhere hasshown that it is SIost effective where there is least room for discretionary or arbitrary interpretation. Itwould be advisable either to remove the wide discretionary powers of the Industrial Development Actgranted under Section 10(d) or to provide for a judicial appeal system.
Credit
xxxix. At present, SSIs have practically no access to domestic commercial bank credit. The creation of acredit guarantee scheme for small enterprises might help to overcome local bankers' reluctance to lend tonon-prime borrowers. Experience in other countries, however, has shown that a credit guarantee scheme isuseful where non-availability of finance has been a serious constraint to the growth of small businesses andthe commercial banking system is ready to participate in such a scheme. Although neither of theseconditions was evident in Malawi at the time that the mission was in the field in late 1987, the introductionof market-determined interest rates in 1988, together with modifications to the management of the moneysupply outlined above, would improve incentives to lend to non-prime borrowers, including SSIs, andcommercial banks might be more inclined to entertain such schemes. In parallel with the modifications tothe financial system, the authorities might consider introducing credit guarantee schemes for SSIs.
I. THE ECONOMY AND THE SECTOR
The Malawlan Economy
1.01 During the fifteen years following independence in 1964, Malawi presented one of the majordevelopment success stories in Africa. Although the country is landlocked and has little trained manpower,during these years total GDP more than doubled, per capita GDP increased by almost two-thirds, savingsrates rose from 4 to 18 percent of GDP and investment rates from 16 to 26 percent, while inflation ratesaveraged about 8 percent per year, virtually the same as in the industrialized countries. Also, agriculturalproduction expanded and Malawi's industrial base broadened and deepened, illiteracy fell and lifeexpectancy increased. Exports grew rapidly and the major roads for the integration of the country werebuilt. The key to this success was the ability of the Government to formulate economic developmentpolicies that emphasized agriculture, exports, a fairly open economy with moderate protection, minimalGovernment intervention, and a major role for the private sector.
1.02 Malawi's economic performance began to weaken in the mid-seventies and entered into severeproblems at the beginning of the present decade. Fiscal policies became highly expansionary in the lateseventies and early eighties, as the authorities responded to a series of external shocks. Fallinginternational prices for export commodities, soaring oil prices, and a gradual disruption of externaltransport routes through Mozambique led to a deterioration of the terms of trade of some 28 percentbetween 1978 and 1981. Drought reduced agricultural production. Government mistook these shocks astemporary and tried to maintain aggregate demand and the country's income level through deficit spending.The fiscal deficit, financed to a considerable extent with extemal debt, rose to 11 percent of GDP in fiscal1980/81. Despite the injection of foreign exchange and the stimulus to domestic demand, the GDP fell by5.2 percent in 1981.
1.03 With the help of adjustment programs guided and supported by the Bank and the IMF, Malawimanaged to reduce domestic and external imbalances while resuming GDP growth in 1982-85.Deterioration of export crop prices and high external debt-service payments virtually depleted internationalreserves in 1986, forcing the Government to ration foreign exchange to the private sector, leading to a 2.8percent growth in GDP in 1986.
1.04 Despite its early record of growth, Malawi is still one of the poorest countries in the world, with a1987 per capita GNP of US$ 160 that placed it seventh from the bottom among the countries listed in the1989 World Development Report. The country is still predominantly rural and its economy primarilyagrarian. Agriculture accounts for about two-fifths of GDP, nine-tenths of exports, and nearly half of theemployed labor force. Production is based on two types of farming, smallholder, under which 70 percent ofthe arable land is cultivated, and estates which covef about 5 percent. The former accounts for nearly 80percent of agricultural production, but the estates are the major foreign exchange earners. Tobacco, tea,and coffee account for about three-quarters of total exports.
1.05 At this juncture, Malawi faces some daunting development problems. Population growth rate--one of the highest in Africa--is creating a fast-rising demand for food, energy, and social services.Smallholder agricultural productivity is declining and more than one-half of the rural population facesseasonal food deficits and low nutrition levels. The country has relatively undeveloped human resources,with exceedingly poor education, literacy, health, and mortality levels. Poverty is worsening and incomedifferences are widening. The young and fast-growing labor force is putting pressures on labor marketabsorption; and the limited export base is making Malawi extremely dependent on balance of paymentssupport.
1.06 Restoration of real per capita growth is the Government's paramount concern. The key sector inthe Government's strategy is small holder agriculture, where the potential for increasing productivity ishigh. Government plans to increase production through increased fertilizer use and adoption of higher-
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yielding maize varieties. The Government is also introducing measures to increase productivity and laborabsorption in estate agriculture, where land utilization rates are quite low. Growth in this sector will beimportant in raising export earnings, as much of the increase in smallholder production is expected to beconsumed domestically. Government also expects significant increases in the industrial sector. Asdiscussed in Chapter 2, manufacturing firms have been operating at about one-half of their capacity and theshort-term need is to increase this rate significantly to levels that have been achieved in the past. Also, asdiscussed in Chapter 6, investment will be needed *n the medium term for future growth. Development ofsmall and medium-sized industries by Malawian entrepreneurs is a key element in positioning the sector forfuture growth and expansion, and will be necessary to help absorb the rapidly growing labor force and helpthe development of rural areas.
Chart 1.1Malawi--Growth Rates of Manufacturing Industry, 197487
1.07 Industrial growth during the eighties has been only half as fast as during the seventies, when itaveraged about 5.6 percent per year. Industrial performance in both decades, however, has been subject towide fluctuations, with differences as large as 21 points fron one year to the next, as illustrated in Chart I.1.As discussed in Chapter 3, industrial performance has been very closely tied to the performance of theeconomy at large and to the authorities' policy reactions to the successive external shocks that afflicted theMalawian economy in the late seventies and early eighties. Industrial employment generation also feil withthe slowdown of manufacturing growth. Whereas during the seventies industrial employment increased by
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6.8 percent per year, during the eighties it has remained virtually stagnant. At present, manufacturingcontributes about 11.2 percent to GDP and about an equal share to wage employment.
Table 1.1Malawi-Structure of the Manufacturing Sector, 1983
(Percentages)
Employ- Wage Value InputslSub-sector Output ment bill added output
Beverages 11.8 4.2 4.9 11.2 78.4Tobacco manufacture 5.9 8.9 8.3 6.6 75.9Textile, netting & blanket manufacture 11.9 13.1 11.9 17.3 66.6Clothing, leather goods and footwear 3.7 5.8 4.3 1.7 89.8Sawmill and wood products 3.4 5.6 4.7 5.5 63.5Packing materials, printing and publishing 7.4 3.6 5.6 11.3 65.2Chemicals and fertilizers 6.0 0.8 1.6 4.2 84.2Pharmaceuticals, paints, soaps & cooking oils 12.1 2.2 6.7 11.2 78.9Tyre retreading and plastic products 2.8 1.4 2.5 4.4 64.1Non metallic mineral products 4.0 4.4 3.1 4.9 72.1Metal products other than machinery 5.2 3.6 5.6 7.5 67.0Machinery and motor vehicle assembly 1.7 1.4 2.5 1.5 79.7All other manufactures 5.2 1.9 2.9 5.0 78.1
Totals 100.0 100.0 100.0 100.0 77.2
Source: NSO, Annual Statistical Survey, various issues; mission estimates.
Industrial Structure1
1.08 The pattern of industrial production in Malawi is typical of countries at an early stage ofindustrial development. The bulk of industrial production stems from five sub-sectors, food, beverages,tobacco, textiles, and clothing and leather goods, which in 1983 together accounted for 52 percent of grossoutput, 45 percent of MVA, 75 percent of industrial employment, and 65 percent of the industrial wage bill,as Table I.1 shows. The value added share of these sub-sectors is similar to those of Kenya (48 percent)and Zimbabwe (44 percent), but the total output of Malawi's industrial sector is only about 6 percent that
The analysis of the structure and performance of the industrial sector is based on two sources of data.The analyses of historical performance and present structure are based on information from theNational Statistical Office (NSO) in Zomba. The efficiency and protection analyses are based on adetailed survey of 40 firms covering 100 activities conducted by the mission with cooperation from thestaff of the Ministry of Trade, Industry and Tourism in mid-1987. The survey is based on 1986 data.
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of Zimbabwe, 10 percent that of Kenya, and 25 percent that of Tanzania (value of output measured atinternational prices in all cases).
Concentration
1.09 With a population of only 8 million and a per capita income of only US$ 160, Malawi's domesticmarket is too small to support profitably more than one or two firms in many sub-sectors and as a resultthere is a great degree of industrial concentration. The mission calculated the Herfindahl-Hirschmannindex of concentration for three years. This index has an upper bound of one-thousand for puremonopolies and a lower bound of zero for perfectly competitive industries.; As Table I.2 shows, industrialstructure in Malawi is characterized by a high degree of oligopoly. In fact, concentration is higher than inKenya, another country where the Bank carried out a similar study. Firms selling in what may becharacterized as highly competitive markets account for only 11 percent of total sales, whereas in Kenyathey account for 36 percent. The proportion of firms working under oligopolistic conditions is much higherin Malawi (86 percent) than in Kenya (49 percent). On the other hand, Malawi has about the sameproportion of pure monopoly firms as Kenya, but their sales are only 3 percent of total sales, compared to15 percent in Kenya.
Table 1.2Malawi: Indices of Industrial Concentration
Source: NSO, direct information; mission estimates.
1.10 Data on concentration were available for only thret; years, precluding an analysis of changes overa long period of time. During the three years for which data were available there did not seem to havebeen major changes. From 1981 to 1982 there was a doubling of the share of firms working under highlycompetitive conditions, from 7 percent to 14 percent, but it declined to 11 percent in 1983.Correspondingly, the share of firms working under oligopolistic conditions fell, while the share of sales ofthe monopolistic firms remained constant.
2 The formula for the index is H = 1000(V2 + 1)/N, where V stands for the coefficient of variation ofsales and N for the number of firms in the sub-sector.
1.11 The high degree of industrial concentration is neither surprising nor necessarily bad for a countrywith a small domestic market and low per capita income. On the contrary, the high degree of concentrationis probably symptomatic of good investment decisions in the past. Domestic firms cannot be expected toprovide a wide range of goods at reasonable cost because efficiency often requires long production runs.The size of the market then dictates concentration on those product lines that can be produced atreasonable cost. However, concentration implies that domestic competition cannot be expected toengender pressures to reduce costs and improve quality; these pressures must come from importedproducts. Imports are also needed to complement domestic production of those goods that cannot beproduced domestically at costs close to international levels.
Table 13Malawi-Composition of Industrial Exports, 1976-84, Selected Yearsa
Memorandum Items:Ind. exports as % of total exports 3.3 6.4 7.7 5.5 3.8 2.7Imports of raw materials forindustry as % of total exports 38.6 49.1 50.5 49.1 47.1 36.5
Sources: NSO, Annual Statement of Extemal Trade, various issues; mission estimates.
Export Orientation and Import Dependence
1.12 Owing to its landlocked position, Malawi's transport costs are very high and provide a naturalbarrier of protection against imports, but also a formidable obstacle against exports. In 1980 the CIF valueof imports was 38 percent higher than the FOB value. As a result of the virtual closure of the Mozambicantrade routes, the CIF margin is now about 67 percent. Such high transport costs markedly reduce theprofitability of industrial exports, especially those based on imported raw materials, and render domesticprices about 40 percent higher than exports even in a free trade situation. High transport costs havecontributed to keeping exports down. At present, industrial exports account for only about 3-8 percent ofall exports. Of this tiny fraction, about two-thirds are textiles and clothing--products that are primarilybased on domestic raw materials and whose value-to-weight ratio is high.
1.13 Industrial firms typically import their raw materials and sell their product to the final consumer:there are few linkages within industry and with other sectors, as Table 1.3 shows. These figures suggest aconsiderable sectoral balance of trade deficit, for raw materials account for only part of total industrialimports; fuel and machinery and equipment are also imported. An excess of induistrial imports over exportsis not necessarily bad, in Malawi's case it underscores the dependence of industry on agriculture.Agriculture is important in two ways: first, to stimulate domestic demand, and second, to generate theforeign exchange that industry needs to import raw materials, fuel, and capital goods. This double reliancerenders industry extremely vulnerable to fluctuations in agricultural production. Given that industry uses
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more than 40 percent of total export earnings, the efficient use of these resources is a major concern. Thenext chapter of the report explores this topic.
Finandal Characteristics
1.14 The aggregate balance sheet of Malawi's industrial sector, like that of Kenya's and Zimbabwe's, isrelatively strong. Based on the industrial sample, the mission analyzed the balance sheets and incomestatements of 38 firms whose value added amounted to about 80 percent of MVA in 1985 and 1986. Thissample shows that Malawian industrial firms draw lightly upon financial institutions and are onlymoderately indebted. Their leverage ratio (total liabilities to equity) in 1985 was only 1.08, compared to2.17 for Kenya and a very conservative 0.68 for Zimbabwe.3 As economic conditions worsened in 1986,their indebtedness ratios increased to 1.23. Because the fnancial system is not geared to long-term lending,as discussed in Chapter 4, most of the debt is short-term and long-term leverage ratios are low. Lowlong-term leverage ratios are a common feature of industrial firms in all three countries.
Rates of Retum and Pay-out Ratios.
1.15 Nominal returns on equity declined by almost thirty percent between 1985 and 1986, whilereturns on total assets feli by almost forty percent. As discussed in Chapter 2, economic conditionsworsened in 1986, and consequently returns on assets and equity fell. The dividend pay-out ratio, however,increased in the two years, suggesting that as profits declined, firms sought to maintain the dividend streamconstant.
Table 1.4Malawi-Main Financial Indicators of Manufacturing Firmsa
1985 1986
Malawi Kenyab Zimbabwec Mala)W
Pre-tax Profit as % of Sales 10.2% 10.4% 7.5% 7.4%After-tax Profit as % of Sales 55% 53% 5.4% 3.2%
Return on Equity 18.5% 12.0% 10.3% 13.2%Return on Total Assets 63% 3.8% 6.1% 3.8%Effective Tax Rates 46.1% 49.2% 27.9% 56.2%Dividend Pay-out Ratios 52.7% 62.4% 37.9% 61.3%
aBased on responses of firms that participated in the Industrial Sector Survey 1986, carried out by theWorld Bank in July-September 1987.
bBased on consolidated financial statements of 29 firms publicly trade on the Kenya stock exchange.
cBased on consolidated financial statements of 52 publicly traded in the Zimbabwe stock exchange
Source: Industrial Sector Survey 1986; IBRD, Zimbabwe: An Industrial Sector Memorandum, Report No.6349-ZIM; and Kenya. Industrial Sector Policies for Investment and Growth, Report No. 6711-KE; missionestimates.
3 The Kenya and Zimbabwe ratios are based on published returns of publicly held companies traded intheir respective stock exchanges. They may not be, therefore, representative of their respective sectors.
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II. PROTECTION AND INDUSTRIAL EFFICIENCY
Introduction
2.01 The policy environment profoundly affects the performance and efficiency of the manufacturingsector. Protection from both imports and domestic competition may leave producers with an uncontestedmarket that leads to monopoly rents and inefficiency, as entrepreneurs invest in the more protectedactivities, or neglect to obtain the maximum output for given inputs. It is important, then, to assess theincentives inherent in the policy regime and to measure their impact on economic efficiency. The missionundertook a thorough analysis of the pattern of protection and industrial efficiency in Malawi, usingnominal and effective protection ratios as a measure of protection and Domestic Resource Cost (DRC) asa measure of efficiency.
2.02 The nominal protection rate (NPR) is the ratio of the value of output measured at domesticprices to the value of output measured at international prices4. This ratio indicates how much higher (orlower) ex-factory domestic prices are compared to what they would be under free-trade conditions. If theratio is above one, domestic prices are higher than they would be under free trade conditions, andconversely if the ratio is below one. The difference in prices may be due to import duties, quantitativerestrictions on imports, or to the degree of competition present in the domestic market. The effectiveprotection rate (EPR) is the ratio of value added measured at domestic prices to value added measured atinternational pricess. An EPR greater (or lower) than one implies that value added is higher (lower) thancould be obtained if output and inputs were valued at international prices. Since value added consist ofprofits, wages, and taxes, EPR greater than one implies that either one or more of these components ishigher than under free-trade conditions by virtue of the protective system.
2.03 DRC ratios measure the cost of domestic resources used in the production of a good per unit offoreign exchange saved or earned. Firms use both domestic and imported resources in the production ofany good and in the process they either save foreign exchange through import substitution, or earn foreignexchange through exports. As discussed in Chapter 1, most Malawian firms substitute imports and hencesave foreign exchange. The amount of imported resources that firms save is given by the differencebetween the value of their output (measured at international prices) and the cost of their imported andpotentially exportable ("tradeable") inputs (also measured at international prices). In most cases, the valueof the output exceeds the cost of the "tradeable" inpuis, but in some cases firms may be so inefficient thatthe value of their current inputs may be higher than the value of their output, i.e., they generate negativevalue added at international prices. Such firms are not economically beneficial to the country, they surviveonly because they are heavily protected. In a less protected environment such firms would encounterfinancial difficulties and would have to be either thoroughly restructured, or shut down altogether.
2.04 A firm's efficiency depends not only on the amount of foreign exchange saved, but also on theamount of domestic resources used. If in saving one unit of foreign exchange a firm uses more than oneunit of domestic or "non-tradeable" inputs, it is not an efficient saver of foreign exchange. Only those firmsthat use one unit or less of domestic resources per unit of foreign exchange saved may be consideredefficient. These are firms with DRC ratios of one or less; they use less than one unit of domestic resourcesper unit of foreign exchange saved. Converse!y, activities with DRC ratios higher than one are consideredinefficient. The country maximizes the net foreign exchange earnings from exports and the net foreign
4 International prices in this report are defined as the CIF price net of duties for comparable imports andFOB price, net of subsidies, for exports.
s For imports, international prices are defined as the CIF price, net of duties, for comparable importedproducts; for exports, the international price is defined as the FOB price, net of subsidies.
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exchange savings from import substitution per unit of domestic resource used by stimulating activities withDRCs lower than one. Based on the industrial sector survey, the mission calculated DRCs, nominalprotection and effective protection ratios. A detailed report of the methodology and findings appears inTechnical Appendix I. Table IJ.1 provides a summary of the samplk coverage.
2.05 At the time that industrial sector survey was undertaken, Malawi's average tariff level was about38.4 percent--moderate by developing country standards. The tariff level, however, did not fully reflect theextent of nominal protection, nor the variations in protection between sub-sectors because imports weresubject to QRs, giving domestic manufacturers the opportunity to raise prices without fear of losing marketshare. Under the circumstances, directly comparing domestic with international prices provided a bettermeasure of protection. The two estimates turned out to be rather close, with direct price comparisonsindicating a slightly lower protection level. The results of the survey (Table II.2) shcw that on averagedomestic prices for products were 36.4 percent higher than international prices, with some groups of goodsbeing as much as 73.9 percent higher (leather and footwear) and others only 13.3 (food processingactivities).
2.06 On the input side, nominal protection was substantially lower, ranging from 4.4 percent for inputsused in food pi oducts, to 16.9 percent for inputs used in beverages and tobacco products, with an average of9.7 percent. The difference in nominal protection rates between output and inputs indicates that, onbalance, the trade regime benefits the manufacturing industry by allowing firms to have a higher valueadded than under free-trade conditions. But this result has not come without costs. Malawian consumershave had to pay higher prices and exporting firms have had to compete with the handicap of higher costs.
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For exporting firms, protection given to import substitution activities has been the equivalent of levying atax on exports. This has been the case with the garment industry and agriculture, for example.
Table 112Malawi-Estimates of Nominal Protection
Protection onProduct Inputsa Output
Food Processing 4.4 133Beverages and Tobacco 16.9 27.2Textiles and Clothing 7.9 33.3Leather and Footwear 11.4 73.9Wood and Paper Products 7.7 31.5Plastic and Pharmaceuticals 11.6 36.8Chemicals and Fertilizers 10.9 49.4Cement and Glass 7.0 70.3Steel Products 12.5 61.2Misceilaneous Products 12.4 11.1
Averageb 9.7 36.4
aNominal protection on inputs used to produce a particular item is the ratio of the total cost of the inputsvalued at domestic prices to the total cost valued at international prices, minus one.
bFor inputs, protection coefficients are weighted by the share of inputs for a particular product in the totalvalue of inputs for all products. For outputs, the protection rate is weighted by the activity's share in thesector's value of output.
2.07 The industrial survey indicates that on average industrial value added for firms engaged inimport-substitution activities was about 140 percent higher than under free trade conditions and that therewere wide variations according to the product, ranging from 574.9 percent for cement and glass to 39.0percent for food products and nil for miscellaneous products, as Table 11.3 shows. Effective protection raybe the result of different tariff rates for inputs and output or of different degrees of scarcity. Two firmsmay pay the same duty rates on their inputs and their produrts may also be protected to the same extent bythe tariff schedule, but if the product of one firm is more scarce than that of the other on account of ORs,the price of the more scarce good may be higher, relative to the border price, than that of the moreabundant good. This disparity accounts for the higher rate of effective protection. To the extent that thevariations were due to scarcity, the liberalization program presently under way will tend to reduce thedifferences in effective protection among the different activities. But to the extent that they arise from thetariff schedule, they are likely to remain unchanged. The only way of ensuring that all activities enjoy thesame effective protection is to adopt a uniform tariff rate.
2.08 It is obvious that the policy regime has favored import-substitution, as every activity had equal orhigher value added under the existing policy regime than under free-trade conditions. The policy regime,moreover, works against exports. Exporting firms must pay duties on the inputs used to produce goods forexports. Although Malawi has had a duty-drawback scheme in operation, it has been ineffectual; the costsof exporting firms have been higher than under free trade condiW ons and their value added lower, i.e., theireffective protection has been negative. The mission calculated the effective protection for the few productsthat are exported. In all cases effective protection was negative, as shown in Table 11.3.
2.09 Negative effective protection for exports is common in countries that pursue industrializationbehind protective barriers--while import substitution is encouraged, exports are discouraged, introducing ananti-port bias. The degree to which the policy regime increases valued added in import-substitutioncompared to exports is given by the anti-export bias ratio. If the policy regime increases value added byequal percentages in both import substitution and exports, the ratio is equal to one. If the policy regimeincreases value added relatively more in import substitution, the ratio is greater than one. In all of thecases examined in Malawi, the anti-export bias ratio was greater than one, with an average of 1.8. Thisaverage ratio indicates that the policy regime increased value added by 1.8 times as much in importsubstitution than in exports, providing a strong incentive to engage in the latter and neglect the former.
2.10 Negative effective protection on exports is the direct result of levying import duties on inputs andit can be eliminated only by fully rebating import duties paid on inputs used in production for exports, or bynot levying import duties on such inputs at all. In-bond manufacturing and free-trade processing zones aretwo alternative ways of placing exporters in a free-trade equivalent situation. The anti-export bias,however, is the result of higher protection on import substitution than on exports. Elimination of the anti-export bias would require a combination of lower import duties and higher subsidies on exports.
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Industrial Efficiency
2.11 Effective protection rates as high and variable as those present in Malawi often lead toinefficiency. By increasing value added, the policy regime stimulates investment and expansion of the moreheavily protected activities. This does not seem to have happened in Malawi. The survey results suggestthat the industrial sector is working efficiently. As Table HA.4 shows, short-run DRCs were above one inonly two sub-sectors, cement and miscellaneous products. The value added of these sub-sectors was only2.8 percent of the sector's value added, indicating that the vast majority of the sector's value added wasbeing produced efficiently, i.e., at DRCs below one. This means that most industrial activides were usingless than one dollar in labor costs for each dollar of foreign currency that they save through importsubstitution (or exports). These results compare favorably with results obtained in the Bank's industrialsurveys of Tanzania and Kenya, where similar short-run DRCs were estimated at 0.93 and 0.69respectively.6
Table IIAMalawi-Estlmates of Industrial Efflcency
Short-run Long-run Longrun DRCProduct DRCa DRCa at Shadow Prces
Food Processing 0.73 1.86 1.59Beverages and Tobacco 0.15 0.63 0.56Textiles and Clothing 0.67 3.66 3.44Leather and Footwear 0.53 1.36 1.16Wood and Paper Products 0.80 1.64 1.37Plastic and Pharmaceuticals 0.33 1.22 1.09Chemicals and Fertilizers 0.95 1.98 1.64Cement and Glass 1.47 3.22 2.70Steel Products 0.93 1.94 1.60Miscellaneous Products 1.13 2.25 1.86
Aveage 0.49 1.6S 1.48
aMeasured at observed capacity utilization and official exchange rate.
2.12 Short-run DRCs tell us whether a firm is efficient if capital costs are treated as sunk costs. In thelong run machinery must be replaced, an estimate of capital cost should be used to reflect normal wear andtear of buildings and equipment and ascertain whether a firm is worthwhile replacing when its capital isworn down. To this purpose the mission also estimated long-run DRCs. As Table II4 shows, at observedcapacity utilization (using the official exchange rate to convert domestic and foreign costs into a commoncurrency) the sector's long-run DRC was 1.65, indicating that for every dollar of foreign exchange saved
6 DRCs for Tanzania are calculated at shadow exchange rate; the others at official exchange rates.Tanzanian estimates, then, are not strictly comparable and give the impression that its industry is moreefficient.
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industrial firms were incurring US$ 1.65 in labor and capital costs. The sector, however, was using only 47percent of its attainable capacity.7 If industrial firms were to work at attainable capacity, their capital costsper unit of output would fall. Mission estimates indicate that the efficikncy gains would bring their long-runDRCs down to 0.90. In other words, if Malawian firms had to start ail over again and worked at or nearattainable capacity, the country would gain from theii establishment. Even under observed conditions,however, the sector's short-run DRC was on the ordcr of 0.49, indicating that for every dollar of foreignexchange saved, the sector used the equivalent of fifty cents of recurrent domestic resources, excludingcapital costs. As discussed later in Chapter 3, rationing of foreign exchange is the main reason behind lowindustrial output; to the extent that this constraint becomes less binding, industrial firms will becomeincreasingly efficient. Nevertheless, despite the low rate of capacity utilization, a considerable proportion ofindustrial value added was being produced efficiently. Fifty-two percent of value added was being producedat a long-run DRC lower than one; 67 percent at long-run DRCs of less than 1.5; 12 percent at DRCsbetween 1.5 and 2.0, 5 percent at DRCs between 2 and 3; and 15 percent at DRCs above 3, as Table 11.5shows. It should be emphasized that these DRCs were estimated at the official exchange rate and thattherefore they are conservative estimates of efficiency. Nevertheless, because the DRC methodology is ex-tremely sensitive to the estimates of output and input prices, both subject to a considerable degree ofvariance, the results should be taken as indicative rather than as conclusive.
2.13 DRC ratios inevitably require converting domestic and foreign currency costs into a commoncurrency, making it necessary to use an exchange rate. The official exchange rate, however, does notnecessarily reflect the value to the economy of using, or generating, one unit of foreign exchange. Importduties, for example, raise the cost of imported goods to the consumer; an average tariff rate of 30 percentimplies that for the consumer the effective exchange rate is 30 percent higher. Similarly, overvaluation ofthe official rate biases the results upwards if the official rate is used to convert all costs to a commonmonetary unit, making activities appear less efficient than they really are. To overcome these problems a"shadow" exchange rate that takes into account such things as effects of import duties, export subsidies, andovervaluation of the exchange rate is useful to compensate for these biases. For purposes of this report, itwas assumed that the "shadow' exchange rate is about 1.4 times the official rate, or roughly the officialexchange rate adjusted for the nominal protection coefficient. Using this "shadow" rate, the averagelong-run DRC becomes only 1.48, as Table II.4 shows. This figure is in between those obtained in Kenya(1.53) and Zimbabwe (1.27), but vastly lower than that for Tanzania (4.70).8
2.14 If DRCs are adjusted for both exchange rate and capacity utilization, the average long-run DRCfalls to 0.64. These findings strongly indicate that Malawi's industrial sector is potentially very efficient.
Sources of Inefficiency
2.15 A measure of overall efficiency is useful for providing a summary view of the sector, but forpurposes of improving the policy environment it is also important to examine the sources of inefficiency.To this end the mission analyzed the relationship between efficiency on the one hand and capacityutilization, ownership, import content, firm size, profitability, market concentration, and nominal rates ofprotection on the other. The results show that low capacity utilization is the main source of inefficiency andthat parastatals are less efficient than private-sector firms. Other than these two variables, there was noclear relationship between inefficiency and any of the other variables, as might be expected in a country likeMalawi where high protective tariffs are of recent vintage and imposed to deal with balance of paymentsproblems, not to favor investment in particular sub-sectors.
I See Technical Appendix I for a definition of attainable capacity.
8 DRC calculations in these countries also used "shadow" exchange rates. These measurements, however,shbo*ld be taken with a great deal of caution, as international comparisons are fraught with manythe&retical and practical difficulties.
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Table 11SMalawi--Distributlon of Value Added According to DRCa
(Percentages)
Short-Run DRC Long-Run DRC
Value Added as Value Added asPercent of Percent of
Total Value Added Total Value AddedDRC at Border Prices at Border Prices
Less than 1.00 90.2 51.6
1.00 - 1.25 1.6 10.6
1.25 - 1.50 3.0 4.9
1.50 - 2.00 2.7 12.3
2.00 - 3.00 1.3 5.3
More than 3.00 1.2 15.3
Total 100.0 100.0
aValues calculated at official exchange rate and actual capacity utilization.
Capacity Utilization and Foreign Exchange Allocation
2.16 Underutilization of capacity is at present the major source of inefficiency. Full capacityutilization would reduce long-run DRC below one in all but three sub-sectors, fertilizers, textile andclothing, and cement and glass. Full capacity utilization in textile and clothing and cement and glass,however, would reduce long-run DRCs to only 2.1 and 2.2 respectively, as Table 11.6 shows. In the fertilizersub-sector, the only one with product lines that generate negative value added at international prices, highercapacity utilization would lead to higher inefficiency. Ironically, the inefficient firms in these three sub-sectors are among the largest in the country and had been able to obtain enough foreign exchange to workat close to full capacity, while efficient firms in these and other sub-sectors had been starved for foreignexchange. Thus, sub-sectors where capacity utilization was high were food processing products (70percent), textile and clothing (72 percent), and cement and glass (77 percent). In all three sectors thelong-run DRC was higher than the industrial average, but it was particularly high for textile and clothing(2.1) and cement and glass (2.2). Other inefficient sub-sectors where capacity utilization was higher thanaverage were chemicals and fertilizers (capacity utilization of 59 percent and unmeasurable DRC) andwood and paper products (capacity utilization of 56 percent and DRC of 0.7).
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Table 11.6Malawi-Estimates of Long-Run DRCs at Diffeent Rates of Capadty UdUzation
Food Processing 159 0.91Beverages and Tobacco 0.56 0.34Textiles and Clothing 3.44 2.11Leather and Footwear 1.16 0.37Wood and Paper Products 1.37 0.74Plastic and Pharmaceuticals 1.09 0.71Chemicals and Ferilizersb 1.64 0.84Cement and Glass 2.70 2.18Steel Products 1.60 0.35Miscellaneous Products 1.86 0.35
Average 1.48 0.80
8Measured using shadow exchange rate
bExcludes product lines with negative value added at international prices
2.17 Of the six firms analyzed in the textile and clothing sub-sector, only two were operatinginefficiently, one because it was working at only 33 percent capacity, the other because its capital costs wereextremely high. In fact, in every one of the product lines of the latter firm, capital costs were higher thanthe value of output measured at international prices. As a result, short-run DRCs were low, but long-runDRCs were extremely high. This difference suggests that as structured the firm was too capital-intensive.
2.18 The cement and gass sub-sector consists of only one firm that at the time of the survey wasworking at 77 percent capacity. Like the textile firm, the cement factory was too capital-intensive; its short-run DRC was only 0.85, but its long-run DRC was 2.2-capital costs were higher than the internationalvalue of its output.
2.19 The fertilizer factory is also heavily protected, with 36 percent nominal protection andunmeasurable effective protection. Moreover, it is also one of the few Malawian firms that are protectedby law from domestic competition. In principle, there is no technical reason for the inefficiency of the fer-tilizer factory. Its production process is simple and does not enjoy increasing returns to scale. Inefficiencyprobably stems from waste. As presently structured, these firms have no comparative advantage and thereis no economic justification for protecting them from external competition.
Finn Ownership
2.20 The survey also shows a clear relationship between ownership and efficiency. Firms wereclassified in three groups, private local, private foreign and parastataL On average, parastatals were themost protected and inefficient. The rate of effective protection (measured at actual capacity utilization atthe shadow exhange rate) for the parastatals group is 278 percent, compared to 146 percent and 93percent, respectively, for private local and private foreign. Long-run DRCs in turn were 2.16 for paras-tatals, 124 for private local and 0.87 for private foreign firms (See Table II.7). Not one parastatal firm was
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operations were present among foreign and locally owned firms without any discernible pattern, in fact insome sub-sectors locally-owned firms were as efficient or more efficient than foreign-owned firms.
Table 11.7Malawi-Domestic Resource Cost, Effective Protection and Ownership
2.21 The survey data failed to indicate a direct relationship between import content and economicefficiency. In fact, sub-sectors with both high and low import content showed high levels of inefficiency.Sub-sectors with low import content and high long-run DRCs were food processing (import content of 34percent and DRC of 1.86), textiles and clothing (import content of 34 percent and DRC of 3.66) andcement and glass (import content of 54 percent and DRC of 3.22). Sub-sectors with high import contentand long-run DRCs were wood and paper products (import content of 91 percent and DRC of 1.64),chemicals and fertilizers (import content of 95 percent and DRC of 1.98), steel products (import content of96 percent and DRC of 1.94) and miscellaneous products (import content of 96 percent and DRC of 2.25).As mentioned before, full capacity utilization would increase efficiency in all but two sub-sectors, textilesand clothing and cement and glass, both of which have a relatively low import content (34 percent and 54percent respectively).
2.22 Statistical analysis was consistent with these observations. DRCs measured at actual capacityutilization at the shadow exchange rate were higher for parastatals than for private firms, but the differencewas not statistically significant. The difference became significant, however, if DRCs were measured atattainable capacity. The difference in results is explained by the fact that parastatals were working at 68percent capacity, whereas private firms are working at only 44 percent. If capacity utilization were to in-crease, both types of firms would become more efficient, but private sector firms would gain relatively morethan the parastatals and the difference in efficiency would become not only more pronounced, butstatistically significant. This suggests that private firms were more deeply affected than parastatals by boththe scarcity of foreign exchange and the foreign exchange allocation system.
2.23 The statistical analysis was carried out using two regressions of the form:
LRDRC = a + bP + cI + e
where LRDRC stands for the activity's estimate of long-run DRC measured at the shadow exchange rateand actual capacity utilization in case one and attainable capacity utilization in case two; P denotes whetherthe firm is private (P = 1) or a parastatal (P = 0); and I denotes the activity's import content; a stands for aconstant, and e for a random variable. Case three attempts to measure whether as capacity utilizationincreases the difference in the estimates of DRCs becomes statistically significant. A statistically significant
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difference would imply that firms would become more efficient with higher capacity utilization. Theregression equation for case three was of the form:
DDRC = a + bC + e
where DDRC denotes the estimated difference in DRC for the activity in question as capacity utilizationincreases; a denotes a constant; C denotes the degree of capacity utilization, and e a random variable. Theresults appear in Table 11.8. The quantities in parenthesis are the standard errors of the estimates.
Table 11.8Malawi-Statistical Associaton between EMciency, Import Content and Firm Ownership
Case Esdmate of a Estimate of b Estimate of c R2
One 3.1922 -1.5539 0.1713 0.02(1.0185) (1.0269 (0.6737)
Two 2.4213 -1.0764 -0.7592 0.10(0.5220) (0.5263) (0.3453)
Three 2.3817 -2.2090 NA.a(0.3664) (0.70717) NA.a
aThis parameter is not applicable to this c quation.
2.24 In case one all of the standard errors were high relative to the coefficient, indicating that atactual capacity utilization there was a weak correlation between import content and efficiency, andownership and efficiency. At attainable capacity, however, the standard errors were low, suggesting thatprivate firms were more efficient that parastatals and that activities with lower import content were moreefficient. In case three, the estimate of b was statistically significant at the 5 percent level of confidence,suggesting that higher capacity utilization would result in higher efficiency. The coefficient is negativebecause for activities with high capacity utilization the gain in efficiency would be negligible. Conversely,firms with low capacity utilization would gain the most. There was then a negative relationship betweenefficiency gains and capacity utilization.
Capital Intensity
2.25 The most capital intensive sub-sector in Malawi--chemicals and fertilizers--is the second mostinefficient. The second most capital intensive sub-sector--beverages and tobacco--is the most efficient, asTable II.9 shows. The correlation between economic efficiency and capital intensity measured as valueadded per worker is only -034. Low correlation between capital intensity and inefficiency is to be expectedin a country where protection, as discussed later, has been triggered by the need to raise revenues and notto promote particular activities. In many developing countries the promotion of large capital intensiveprojects has often resulted in inefficient ventures and substantial welfare losses. This is not the case inMalawi. However, if continued, the present foreign exchange allocation system may generate the pattern ofinefficiency commonly found in other countries, with higher protection for more capital intensive and largerindustries.
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inefficiency commonly found in other countries, with higher protection for more capital intensive and largerindustries.
Table 11.9Malawi-Capital Intensity and Economic EMciency by Sub-sectorsa
CapitalIntensity
Number (ValueAddedl Short Longof Employee Run Run
Sub-sectors Fims 000 K) DRC DRC
Food Processing Products 5 46 0.73 1.86Beverages and Tobacco 4 94 0.15 0.63Textile and Clothing 5 26 0.67 3.66Leather and Footwear 1 18 0.53 1.36Wood and Paper Products 4 32 0.80 1.64Plastics and Pharmaceuticals 7 63 033 1.22Chemicals and Fertilizer 6 179 0.95 1.98Cement and Glass 1 8 1.47 3.22Steel Products 6 89 0.93 1.94Miscellaneous Products 1 2 1.13 2.25
TOTAL 40 557 OA9 1.65
Public 4 24 1.31 3.02Private Local 22 289 0.40 1.70Private Foreign 14 244 0.45 1.22
aDRC measured at actual capacity utilization and official exchange rate.
2.26 There was no clear pattern between firm size and economic efficiency either. Information onfirm size and economic efficiency presented in Table 11.10 showed that among five categories of firmsclassified by number of employees, the smallest firms were the more efficient and the largest ones the leastefficient. But the three middle groups were equally efficient, with the group of the second largest firmsbeing the second most efficient.
Maket Concentration
2.27 The Herfindahl index of concentration was also calculated for each sub-sector of the industrialsector survey. This index was calculated with values of output measured at international and domesticprices, with very little difference in the results. Table 11.11 presents information on the value of theHerfindahl index, domestic resource cost and effective protection for each sub-sector of the sample. Again,
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(Herfindahl index of 036) was also compatible with both efficient (Beverages and tobacco) and inefficientsub-sectors (Steel products).
Table 11.10Malawi-Flrm Size and Economic Efficlency
Domestic Protection Rate Domestic Resource CostValue ofOutput Nominal Effective Short Long
Size of Finns (000 MK) Run Run
Up to 20 Employees 71,892 32% 84% 032 0.90Between 20 and 49 61,417 43% 307% 0.63 1.56Between 50 and 100 45,842 35% 156% 0.53 1.47Between 101 and 200 11,357 61% 200% 0.48 1.10Above 200 Employees 47,081 31% 171% 0.82 439
2.28 There was no clear relationship between profitability and economic efficiency. This is probablythe result of the fact that protection has not been granted in Malawi under a defined pattern. Thus, high fi-nancial rates of profit can be found in higbly inefficient and efficient sub-sectors. In fact, the correlationcoefficient between ERP, NRP, and rate of profit was only about 0.48 in both cases.
Conclusions
2.29 Malawi's industrial sector, althoughpotentially efficient, is presently operating with only moderateefficiency, with a long-run DRC of 1.48. Estimated at the official exchange rate and at actual capacityutilization, all sub-sectors except beverages and tobar zo have long-run DRCs above one. One very positivefeature is that only two out of 100 activities surveyed generate negative value added at international prices.The main source of inefficiency stemmed from low capacity utilization, measured at only 47 percent ofattainable capacity as of 1986. This conclusion was based on 1986 data. The shortage of imported rawmaterials became more acute in 1987, but with the liberalization program undertaken since 1988, mostfirms are now producing at or near full capacity-, it is almost certain, then that efficiency has increased.
2.30 The high degree of potential efficiency implies that, except for few enterprises, the sector canwithstand international competition effectively. Opening the economy should not be a serious problem tothe performance of the sector because most firms would be able to compete with imports in the domesticmarket. In fact, opening the economy and making foreign exchange available would increase efficiencybecause the shortage of foreign exchange has been one of the important factors contributing to low capacityutilization and high unit costs.
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because the shortage of foreign exchange has been one of the important factors contributing to low capacityutilization and high unit costs.
Table 11.11Malawi-Industrial Concentration and Economic Efficiency
Numberof Short Long Herfindahl Index
Obseiva- Run Run Domestic Intemationaldons DRC DRC Prices Prices
Sub-sector
Food Processing Products 5 0.73 1.86 031 0.31Beverages and Tobacco 4 0.15 0.63 0.36 0.33Textile and Clothing 5 0.67 3.66 0.67 0.68Leather and Footwear 1 0.53 1.36 1.00 1.00Wood and Paper Products 4 0.80 1.64 0.46 0.45Plastics and Pharmaceuticals 7 036 1.22 0.17 0.17Chemicals and Fertilizer 6 0.95 1.98 0.41 0.40Cement and Glass 1 1.47 3.22 1.00 1.00Steel Products 6 0.93 1.94 030 0.27Miscellaneous Products 1 1.13 2.25 1.00 1.00
231 The liberalization program adopted by the Malawian authorities will address most of theproblems discussed in this chapter. In particular, protection arising from QRs will be eventually eliminatedand tariffs will become the main source of protection. To even protection between sub-sectors, a moreuniform tariff will be required. To eliminate the anti-export bias, it would be necessary for the policyregime to increase value added for exports as much as it does for import-substitution. This goal wouldrequire either no tariffs on imports, or a form of subsidy to exports. Since the former might not be feasibleand the latter might contravene GAIT rules, a second best solution might be to concentrate on eliminatingnegative protection for exports through an effectual duty-drawback scheme, or in-bond manufacturing.
