Zambia - Industrial policy and performance

Report No. 4436-ZA Zambia ' LE kti Industrial Policy and Performance August 6, 1984 Industrial Strategy and Policy Division Industry Department Industrial Development and Finance Division Eastern Africa Projects Department FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  REPUBLIC OF ZAMBIA CURRENCY EQUIVALENTS 1 Kwacha (K) = US$ 0.625 1 US Dollar (US$) = K 1.60 The Zambir Kwacha is officially valued in terms of a basket of currencies for whi5h the US dollar is the intervention currency. Since July 1983, the Govern&ent has followed a flexible exchange rate policy, making periodic adjustments in the official value of the Kwacha. The rates expressed above are as of January 1984. The following are average annual exchange rates for selected years: 1970 K 1.00 = US$ 1.40 1975 K 1.00 = US$ 1.55 1976 K 1.00 = US$ 1.40 1977 K 1.00 = US$ 1.27 1978 K 1.00 = US$ 1.23 1979 K 1.00 = US$ 1.26 1980 K 1.00 = US$ 1.27 1981 K 1.00 = US$ 1.14 1982 K 1.00 = US$ 1.07 1983 K 1.00 = US$ 0.78 FISCAL YEAR Government: January 1 to December 31 ZIMCO: April 1 to March 31  FOR OFFICIAL USE ONLY ZAMBIA INDUSTRIAL POLICY AND PERFORMANCE This memorandum is based on the findings of three industrial sector missions which visited Zambia in May/June 1982, June/July 1983, and October/November 1983. The missions consisted of: May/June 1982 H. Koppen, Chief (East Africa, IDF Division) C. P. Cacho (East Africa, IDF Division) G. Gebhart (East Africa, Country Programs Division) N. Roger (Consultant) J. Wilton (East Africa, IDF Division) The mission benefitted from the presence in the field of Mr. H. Molina (World Bank/Unido Cooperative Program) and Mr. D. M. Gallagher (Consultant to UNIDO) June/July 1983 E. Sawaya, Chief (East Africa, IDF Division) C. P. Cacho (East Africa, IDF Division) C. Blitzer (Consultant) October/November 1983 J. M. Page, Chief (Industry Department, Strategy and Policy Division) W. F. Steel (Industry Department, Strategy and Policy Division) The mission drew on work by D. B. Keesing (East Africa, Office of the Vice President). The report was written by J. M. Page, Jr. and W. F. Steel. Assistance to the authors was provided in Washington by Deborah Bateman, Anne Milne, and Jon Evans. This report was discussed with the Government in June 1984. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   LIST OF ABBREVIATIONS CIF Cost, Insurance and Freight (border price of imports) CSO Central Statistical Office DBZ Development Bank of Zambia ERP Effective Rate of Protection FOB Free on Board (border price of exports) FY Fiscal Year GATT General Agreement on Trade and Tariffs GDP Gross Domestic Product GNP Gross National Product IDA Industrial Development Act INDECO Industrial Development Corporation LME London Metal Exchange NCDP National Commission for Development Planning NVA Negative Value Added (at world prices) PIC Prices and Incomes Commission S.G.S. Societe Generale de Surveillance SIDO Small Industries Development Organisation Tazara Tanzania-Zambia Railway TFP Total factor Productivity UNCTAD United Nations Conference on Trade and Development UNIDO United Nations Industrial Development Organisation ZCCM Zambia Consolidated Copper Mines ZEPC Zambian Export Promotion Council ZIMCO Zambia Industrial and Mining Corporation ZINCOM Zambia Industrial and Commercial Association ZNEC Zambia National Energy Corporation   ZAMBIA - INDUSTRIAL SECTOR BASIC DATA SHEET DATE: March 22, 1984 Gro-th Rates a/ 1983b/ 1983c/ 1970-80 1980-83 Wholesale Price Indices (1972-100) GDP Total ($ Billion) 3.32 1.1 1T. 1977 1982 Of which Manufacturing 0.61 0.14 2.3 4.2 Agri., Forestry, Fishing 165.2 382.3 Mining & Quarrying 0.51 0.37 -1.4 5.5 Manufacturing 252.6 492.0 Construction 0.07 0.04 -1,3 -16.4 Mining & Quarrying 120.1 154.0 Electricity, Gas & Water 0.06 0.08 17.0 4.7 Electricity 87.3 83.8 TOTAL INDUSTRY 1.25 0.63 0.4 3.3 All Co_odities 186.6 331.1 GFCF as 2 of GDP Domestic Energy Prices: Gross Fixed Capital Formation 1983b/ 1983c/ 1971/' 1983u/ Electricity, average revenue TOTAL ($ Billion) 049 09 28.0 S. per Kwh generated by sales to retail consumers during Sectoral GFCF as Percentages 1980-81 (+/Liter) 2.72 of Total GFCF (1965 Prices) 1972 Sectoral breakdown Marketers Consumers Comercial Agriculture 4.6 is not available Diesel oil (S/US gallon), 1982 1.36 2.63 Mining & Quarrying 32.8 after 1972. Fuel oil (S/US gallon), 1982 0.58 N.A. Manufacturing 12.5 Tranap. & Communication 10.0 Employment (000) Dec. 72 Dec. 80 Construction 2.9 TOTAL 367.9 379.4 Services 37.3 Of which Manufacturing 43.3 47.8 Mining & Quarrying 60.7 63.1 Domestic Credit (S Billion) 1982b, 1973b, 1982d, 1973dI Construction 72.3 43.8 TOTAL 3.12 0.58 0.66 0.50 Electricity & Water 4.5 8.0 Of which Claims on Govt. (net) 2.13 0.31 0.45 0.27 Total INDUSTRY 180.8 162.7 Claims on Private Sector .99 0.27 0.21 0.23 Agri., Forestry, Fishing 31.1 32.6 Lending Interest Rates 1977 1982 Feb.1983 Ocher Sectors 156.0 184.1 Nominal Rate 9.5 12.0 13.0 Percentage Increase in 1976-77 1981(II)-1983(II) Average Annual Earnings December 1980 Wholesale Price Index 19.8 13.4 of Employees (Kwacha) Non- Zambian Zambian Value Added of Subsectors Growth Rates a/ Agri., Forestry, Fishing 1,051 5,496 in Manufacturing (S Million) 1983b/ 1983c/ 1970-80 1980-83 Manufacturing 2,156 9,931 TOTAL 612 144 2.3 4.2 Mining & Quarrying 3,385 9,996 Of which Food & Beverages, Tobacco 273 75 1.6 5.9 Construction 1,634 7,286 Textiles & Apparel 85 26 9.3 5.6 All Sectors 2,301 8,715 Wood & Products 15 3 -2.0 -6.4 Paper & Products, Printing Industry Structure, 1980 Percentage Shares & Publishing 31 5 -3.4 16.2 Employees GDP Chemicals & Petroleum, Private 45.6 43.6 Plastic & Rubber Products 68 12 9.5 -4.8 Parastatal 43.4 49.5 Non-metal Mineral Products 52 10 -0.7 13.8 Public 11.0 6.9 Basic aad Fabricated Metal Produc,. 87 13 0.6 -5.0 Value Production Growth Rates a/ Minerals 1982 (K millions) ('000 m. tons) Merchandise Exports (S Million) 1982b1 1970-75 1975-80 1980-82 Copper, Electrolytic 716.7 584.5 TOTAL = 4 9.6 -12.0 Cobalt 45.3 2.4 Of which Copper 920 -5.3 8.2 -9.2 Zinc 27.6 38.5 Zinc 27 14.6 -5.0 4.0 Coal 22.3 603.9 Lead 7 5.1 -1.6 -5.8 Lead 6.0 14.7 Cobalt 44 4.5 46.2 -46.6 Energy (}TOE), 1981 Tobacco - 12.9 -16.6 - Production: llydro Power 2.21 Growth Rates a/ Coal 0.27 Merchandise Imports (S Million) 1981b/ 1970-75 1975-81 Net Imports (+Imp-Exp): TOTAL 1,047 13.3 2.2 Petroleum 0.75 Of which Electricity & Mineral Fuels 229 18.8 10.2 Coke 0.06 Food 58 5.3 0.8 Hydro Power -0.84 Crude Materials 15 14.7 0.2 Area Production Chemicals 143 23.9 3.1 Major Crops. 1980-81 ('000 ha) (000 m. tons) Manufactures, Classified by Maize 555.4 1,014.3 Materials 197 14.7 -1.5 Sunflower 38.7 18.9 Manufactures, Miscellaneous 34 0.8 -4.5 Groundnut 32.6 16.0 Machinery & Transp. Equipment 356 11.5 1.6 Cotton 27.0 23.2 Tobacco N.A. 2.6 Consumer Price Indices 1970 1975 1980 1982 1983e/ Exchange Rates ($/ZK) 1970 1980 1983 (198l - 100) 3ITT TT7 1 0 1.2 T=1 1.4000 1.2682 Q7800 a/ Growth rates are computed from values in 1970 Kwacha for GDP and Value Added of Subsectors in Manufacturing, and from values in current US dollars for Exports and Imports. These are simple average annual rates computed from the two end-years' values. b/ Converted into dollars at official exchange rate from figures in Kwacha in current prices. c/ Converted into dollars at official exchange rate from figures in Kwacha in constant 1970 prices. T/ Converted into dollars at official exchange rate from figures in Kwacha in current prices, and deflated by the GDP implicit deflator for gross fixed investment for the respective years with base year 1970-100. e/ Based on 2nd quarter statistics. SOURCES: 1. IMF, International Financial Statistics, Yearbook 1983 and March 1984, for Consumer Price Indices, Exchange Rates, and Domestic Credit. 2. Zambia: Issues and Options in the Energy Sector (Confidential), Report No. 4110-ZA, November 1982, for Energy Prices, Production and Imports. 3. Govt. of Zambia, National Commission for Development Planning, Economic Report, 1981, for Major Crops Area and Production 4. East Africa, Country Programs Department I, for Lending Interest Rates. 5. Govt. of Zambia, Central Statistical Office, Monthly Digest of Statistics, Oct./Dec. 1982, and Zambia: Country Economic Memorandum, Draft Statistical Appendix, 12/22/83, for data relating to other variables. (D-64c)   ZAMBIA INDUSTRIAL POLICY AND PERFORMANCE TABLE OF CONTENTS Page No. SUMMARY AND CONCLUSIONS i - x 1. INTRODUCTION: THE ECONOMIC AND POLICY SETTING ............. 1 2. THE PATTERN OF INDUSTRIAL DEVELOPMENT ...................... 5 A.. Introduction ............ ............................................. 5 B. Relative Size and Growth of Manufacturing .... ......... 5 C. The Structure of Production ........................... 8 D. Employment, Productivity and Wages ............... ..... 11 E. Investment and Capacity Utilization ................... 14 F. Total Factor Productivity Change .............. ......... 14 G. Import Intensity and Export Performance ....... ....... 19 H Conclusions ...... ....................... ............ ... 20 3. THE TRADE REGIME AND THE STRUCTURE OF INCENTIVES ........... 23 A. Introduction ..... ........................................... 23 B. The Structure of Tariff Protection .................... 23 C. Tariffs, the Structure of Incentives and Effective Protection ... ........ . . ............................. 26 D. The Foreign Exchange Control Regime ... ................ 32 E. Price Control ...................... .. * ..... 39 F. Domestic Resource Costs in Zambian Industry ........... 40 G. Obstacles to Industrial Exports ................... . ... 46 R. Conclusions: Trade Policy Bias ....................... 50 4. PARASTATAL MANAGEMENT AND PRICE POLICY ..................... 52 A. Introduction . ................... ...................... 52 B. Objectives ......... ........ 52 C. Relative Size, Structure, and Productivity .... ........ 53 D. Organization and Management ............. ....... 56 E. Financial Performance . ................ .. . ....... 58 F. Price Controls and Liberalization ............... .... 61 G. Investment Criteria .......... ............................ ... . 65 t  -2- Page No. 5. REGULATION AND PROMOTION OF THE PRIVATE SECTOR ........... .. 70 A. Introduction ........................................... 70 B. Background .................. .................................. 70 C. Incentives to Large Scale Firms Under the Industrial Development Act ........... ............... 71 D. Financial Incentives and Interest Rates .... ........... 77 E. Promoting Small and Medium Scale Manufacturing ........ 78 F. The Informal Sector and Village Industries .... ........ 81 6. THE STRATEGY OF INDUSTRIAL DEVELOPMENT ........ .. ........... 83 A. Introduction ........ .................................. 83 B. The Economic Setting .......................... .......... . 83 C. Some Strategic Issues ................................. 85 D. A Strategy for Industrial Development . ................ 89 7. PROPOSALS FOR POLICY REFORIM4 ............................... ... 97 A. Introduction ........... 97 B. Strengthening Existing Industries .................... 97 C. Improving the Foreign Exchange Allocation System ...... 98 D. Suggestions for Tariff Reform ..... .................... 100 E. Restructuring the System of Incentives . ................ 102 G. Export Promotion . ..................................... 105 H. Improving Public Sector Performance ....... ............ 106 I. Changing the Regulatory Environment . .................. 108 J. Wage and Interest Rate Policies ....................... 108 ANNEXES I. Statistical Tables II. The Foreign Exchange Allocation System III. The Domestic Resource Cost Estimates  ZAMBIA INDUSTRIAL POLICY AND PERFORMANCE TEXT TABLES AND FIGURES Table Number Page No. Chapter 2 2.1 Manufacturing Production and GDP at Constant Prices 1965-1983 (Selected Years) ............................. 7 2.2 Distribution of Gross Manufacturing Output and Value Added by Branch of Industry, 1965-1980 ........... 9 2.3 Manufacturing Employment, Output, and Value Added Growth by Period 1960-1980 .......... ............. 12 2.4 Capacity Utilization in Parastatal Manufacturing by Branch of Industry, 1972/73, 1974/75, and 1982/83 ... 15 2.5 Growth of Total Factor Productivity, Inputs and Value Added by Subsector, 1965-1980 ................. ......... 17 2.6 Trends in Growth of Total Factor Productivity and Value Added in Industrial Braaches, 1965-80 ......... ......... 18 2.7 Import Intensity in a Sample of Firms by Branch of Industry, 1981 ............. .... 20 Chapter 3 3.1 Implicit Rates of Duty by End Use Group, 1978 ............ 25 3.2 Average Ratio of Import Duties to Imports 1972-1978, Selected African Countries ................. . .......... 27 3.3 Effective Rates of Tariff Protection, 1975 .... .......... 29 3.4 Distribution of Imports by End Use Category ............... 35 3.5 Nominal Rates of Protection for Selected Commodities, 1981 . .................. ........... 36 3.6 Average DRC and DRC Range: Zambian Industry, 1980-81 ..... *.. *O *. . . . . .. . . . . . . 42 3.7 Frequency Distribution of DRC Ratios for Products ........ 44 3.8 DRC Ratios at Projected Full Capacity .................... 46 Chapter 4 4.1 Public/Parastatal Sector Share of Manufacturing GDP and Employment by Branch of Industry, 1972-1980 ...... 54 4.2 Summary of INDECO Group Financial Indicators . ...... 59 4.3 INDECO Subsidiaries' Price Increase Proposals and Approvals, January-September, 1983 ..... .... 63 4.4 Price Index Changes Before and After De-control ........ 64 4.5 Parastatal Share in Total Manufacturing Assets, GDP, and Employment, 1972, 1975 and 1980 .................. 66 4.6 Capital Intensity and Efficiency in Parastatal Firms ... 67  -2- Page No. Chapter 5 5.1 The Structure of Interest Rates, 1970-1983 .... ......... 78 5.2 Average Size of Recorded Manufacturing Firms, 1975 and 1980 ....... .,............................. 79 Figure Number Chapter 3 3.1 Distribution of Nominal Tariff Rates, 1983 .... ......... 24 3.2 Distribution of Effective Protection Rates, 1975 ....... 31 Chapter 7 7.1 Actual vs. Estimated Effective Protection Rates, 1983 .. 101  SUMMARY AND CONCLUSIONS At independence in 1964, Zambia ranked among the African countries with the highest levels of per capita income. Copper export proceeds, on which the relatively high income level was based, enabled the country to pursue ambitious investment programs to develop infrastructure, broaden the industrial base and improve social services. Beginning in the mid 1970s, however, copper earnings suffered a substantial decline as a result of adverse world price movements and increasingly difficult mining conditions. The decline in export earnings and national income has persisted; GDP per capita in constant (1970) prices declined by about 25 percent between 1974 and 1983. Faced with lower copper export earnings and with a growing external debt, the Government of Zambia has initiated a number of actions to restructure the economy. While trying to rehabilitate the copper sector, it has also recognized the need to adjust to an environment in which copper revenues will play a smaller role. After several years of discussion of adjustment programs, the government has taken significant steps to move away from controlled prices and a fixed exchange rate. While insisting on a leading role for the public sector, it has in practice maintained and supported a mixed economy. It has also acted to improve financial and budgetary control, and parastatal management. The industrial sector clearly has an important role to play in Zambia's futuire economic development. If the economy is to become more independent of both copper exports and imported goods, industrial and agricultural production must expand in a balanced, integrated way so as to meet a larger share of demand through efficient use of domestic resources and to generate new export revenues. The critical question at this point is what set of policies can lead the industrial sector in this direction. This report attempts to answer this question, first, by reviewing past policies and performance in the industrial sector, and second, by suggesting appropriate directions for policy reform. Industrial policy ii'Zambia has consisted of a set of measures and government actions designed to shift resources into industry, both directly via the budget, and more indirectly through the incentive system as determined mainly by tariffs, quantitative trade restrictions and exchange rate management. Both by design and by happenstance, industrial polices have intervened in three major areas: (a) Limiting the degree of competition, both internal and, particularly, external, to which the industrial sector was exposed; (b) Reducing the role of market mechanisms in guiding the allocation of resources in industry; and (c) Expanding the role of public investment in establishing both the level and composition of overall investment in the industrial sector.  - ii - Chapters 2 through 5 examine the consequences of these policy initiatives for industrial performance in Zambia. Zambia's manufacturing sector is relatively large compared to other sub-Saharan countries. The share of GDP in manufacturing (18 per- cent) is second only to Zimbabwe, and only Zimbabwe and Ivory Coast have higher levels of manufacturing GDP per capita. Chapter 2 discusses the size and structure of the manufacturing sector and presents evidence on factor intensity and total factor productivity. Manufacturing was the leading sector of the economy in the first decade after independence. From 1965 to 1970, manufacturing output (GDP) grew at 11 percent per annum in real terms. In the 1970s industrial growth continued at high rates until 1975 when, in response to the sharp fall in copper prices and earnings, industrial output declined by 12 percent. There was some recovery in the second half of the decade, but by 1980 industrial production had not reached the levels achieved in the early 1970s. Some recovery has taken place since 1980, but the general picture remains one of stagnant growth in iLndustrial output. Zambia enjoys a relatively diversified industrial sector for a country at its level of income. Production is primarily concentrated in consumer goods, but two sectors producing intermediate and capital goods - chemicals and metal products - stand out for their relatively large shares of manufacturing output. In the case of chemicals, this is due to the presence of two large-scale capital-intensive facilities, a refinery and a nitrogenous fertilizer plant. The metal products sector contains a rela- tively large number of small- and medium-sized firms producing engineering goods and metal fabrications linked to the mining sector. This concentra- tion of producers in engineering goods and fabricated metal products provides an unusually high level of technical competence for industry in sub-Saharan Africa. A major finding of Chapter 2 is that high rates of growth in industrial output after independenc:e were achieved at progressively higher costs in terms of factor use. Total factor productivity (TFP) - the over- all efficiency in the use of labor and capital - declined between 1965 and 1980 at a rate of 3.8 percent per year for all manufacturing and in 14 out of 17 manufacturing sub-sectors. Deteriorations in total factor producti- vity of this magnitude over so long a period are of substantial concern. Since TFP declines are equivalent to increases in unit costs, these results show a major increase in the average costs of production for the manufac- turing sector, which is primarily attributable to declining productivity of investment. The pattern of industrialization in Zambia has positive aspects - relatively large size, diversification, and a base of technological competence - which are not found in many other African countries. Never- theless there are some problems which cannot be ignored. The overriding issues are growth, capacity utilization and productivity. The rapid growth of industrial capacity has been accomplished at high resource costs, as indicated by the rapid decline in the overall productivity of inputs. In  - iii - part this is due to deteriorating levels of capacity utilization in indus- try in response to the depressed levels of aggregate demand and imports, but it also indicates a more fundamental problem in selection and implemen- taton of efficient industrial projects. The structure, rate, and efficiency of industrial growth in Zambia were heavily influenced by the decision of the government to limit external competition faced by the industrial sector. Trade policy is the principal instrument used to limit external competition for industry. In effect the whole industrial sector has been treated as an infant industry and sheltered from competing imports by high and rising barriers to inter- national trade. Chapter 3 describes the trade regime, the current structure of incentives for industrial production, and the international competitiveness of a selection of firms in Zambia. The structure of trade protection is formed by the tariff system and the working of the system of foreign exchange control. Taken together, these two instruments of trade policy exercise substantial influence over decisions made regarding capacity expansion, new investment, production for domestic or export markets and the choice of technique. The present structure of protection in Zambia is characterized by high and extremely variable effective protection to value added. Effective protection measures the degree to which factors of production - labor, land, and capital - are permitted to earn returns in excess of those which would prevail if inputs and outputs were priced at international prices. High effective protection implies strong incentives for resources to enter a sector and a potential for high resource costs relative to those which would prevail in the absence of trade protection. The results of the protection studies in Chapter 3 indicate that both the tariff structure and the system of exchange control provide cas- cading effective protection. Consumer goods receive the highest levels of protection - often in excess of 100 percent - followed by light interme- diate goods, capital goods and heavy intermediates. In many intermediate and capital goods industries, there is substantial negative effective protection, indicating that resources are discouraged from entering those activities. One aspect of the tariff structure is particularly notable both for its impact on revenues and effective protection. There is a wide range of intermediate inputs and some capital goods on which no duty is charged. This amplifies effective protection to activities that produce final goods, discourages the local production of intermediate inputs, and reduces the revenue base of the tariff structure, particularly in the current situation of heavily restricted consumer goods imports. A major problem with the current structure of protection is that reliance on quantitative restrictions on imports to control foreign exchange use creates a situation in which protection varies in response to the level of imports and may vary among firms in response to changes in the allocation of import licenses. Thus, the incentive effects of the trade regime are not predictable and can vary over time, among sectors, and among  - iv - firms according to the decisions made by the exchange control authorities. Moreover, increases in protection can become automatic in the sense that with quota restrictions on imports the level of protection generally rises with increases in domestic production costs, providing little incentive for cost discipline. The high level and variance of effective protection implies that different industries and firms are permitted to use widely different levels of domestic resources to save a unit of foreign exchange. This is illus- trated in Chapter 3 by the results of domestic resource cost of foreign exchange (DRC) calculations for a sample of industrial firms. The DRC measures are based on the principle of international competitiveness and indicate the cost in terms of domestic factors - mainly labor and capital - of generating one unit of net foreign exchange (which represents value added at international prices). The results of the calculations indicate that industrial produc- tion in Zambia has not on the whole achieved a high level of international competitiveness. Food products is the only sector in which the average DRC is unambiguously acceptable. Of 48 individual products, only about half have DRCs which indicate that they are now, or could reasonably quickly become, internationally competitive. The results do confirm, however, that there are existing and potential sectors in which Zambia is internationally competitive. Among these appear to be food products, wood and wood products, some textiles, and fabricated metal products. They also suggest that past investments in such large-scale projects as fertilizers, paper, packaging materials, and automob:ile assembly have imposed high resource costs on the Zambian economy in terms of the opportunity cost of the net foreign exchange saved. The high levels of protection to import-substitution industries have created strong incentives for investment in these activities, and the absence of competing imports has permitted domestic prices to rise to levels well above those of traded equivalents. As a result, trade policy has been heavily biased against exports. Industrial exports account for less than one percent of total exports and have not grown in volume or number for over a decade. In addition, the structure of protection has encouraged excessive allocation of resources toward industry and away from mining and agriculture, which carry negative effective protection. The evidence on productivity change and domestic resource costs suggests that the period of easy import substitution has drawn to a close in Zambia, and that a new strategy is in order. The bias against exports and agriculture encourages the growth of an industrial sector which is not fully consistent with Zambia's comparative advantage. In the long run, encouraging further development of industries which have high resource costs can impose a substantial penalty on the economy in terms of the waste of resources and low productivity of industrial investment. The public/parastatal sector has come to play a leading role in industrial development. Purchase of controlling interests in existing firms, together with new investments, resulted in a major change in the  - v - structure of ownership in manufacturing between 1968 and 1972 from pre- dominantly private (and foreign) to one in which the parastatal enterprises accounted for more than half of manufacturing output and more than forty percent of manufacturing employment. Chapter 4 examines the organization, management, and performance of the public/parastatal manufacturing sector. Between 1970 and 1980 the public sector, represented primarily by the Industrial Development Corporation (INDECO), grew at rates exceeding those for the economy as a whole and those for private manufacturing. This growth was accompanied by deterioration in relative productivity both within individual industries (as compared with the private sector) and as a result of a shift in investment within the public sector toward lower productivity activities. The deteriorating productivity performance of the parastatal sector had its counterpart in deteriorating financial perform- ance - from an average gross return on fixed assets of 12 percent in 1969/70 to sizeable losses in 1978/79 and 1979/80. Since 1980, some recovery in financial performance has taken place, but the analysis of international competitiveness reveals that much of the public sector remains inefficient in saving and generating net foreign exchange. These indicators suggest that the public/parastatal sector suffered from a number of factors inhibiting good economic performance. Some of these, for example pricing and investment decisions, were the result of policy actions taken outside the firm, but poor performance was also related to management practices and the organization of the public sector. The details of recent policy changes in each of these areas are given in Chapter 4. In general, public sector organizational and management changes have been designed to reduce political interference in the operating decisions of firms and to increase the autonomy and accountability of individual firm managers. These efforts at decentralization of decision making were further reinforced by the decontrol of prices in 1982, which made individual enterprises, subject in some cases to approval by the parastatal holding companies, responsible for their pricing decisions. The management and pricing reforms have been partially successful in increasing the autonomy of individual enterprises, but they will require the support of skilled managers at the firm level to fully achieve the benefits of decentralization. A major area of concern for the public/parastatal sector remains the use of appropriate investment criteria for selection of new projects. Past public sector investments have been characterized by high (and fre- quently excessive) capital intensity and dependence on imports. These characteristics have contributed to the sector's relatively poor perform- ance in terms of the domestic resource costs of generating or saving foreign exchange, and indicate that more effective criteria for screening investment proposals must be implemented in the public sector. The govern- ment is moving toward establishing tighter economic and financial criteria for project selection and for the evaluation of the performance of existing firms. A critical need remains, however, to increase the capacity of the public/parastatal sector to evaluate investments.  - vi - Although stressing the role of the public sector, the government of Zambia has in practice maintained a mixed economy with a relatively large and dynamic private sector. Private industry in Zambia has grown up in an atmosphere of control and regulation, coupled with incentives to selected firms and sectors. Chapter 5 reviews the structure of incentives to private manufacturing industry conferred by the Industrial Development Act, the interest rate regime, and programs for small enterprise promotion, and examines the nature of the regulatory environment within which the private sector is constrained to operate. The Industrial Development Act of 1977 is highly regulatory in tone and arbitrary in nature; in this sense it may discourage rather than encourage investors in industry. The awarding of licenses and incentives is not automatic on the fulfillment of specific conditions, but depends heavily on the discretion of the Minister of Commerce and Industry. Licensing is a device to restrict competition. Although it may have had an appropriate role in establishing a leading position for the public sector in the post-independence period, it is not consistent with the current objectives of encouraging a more dynamic role for private investment and promoting internal competition. Exemptions from customs duties on interme- diates and capital goods have reinforced the biases of the protective structure away from production of these goods and in favor of import- and capital-intensive activities. A revision of the Act - which the government is committed to undertaking - should contain a clear statement of its objectives and scope and should be as unregulatory and non-discretionary as possible. Incentives provided under a revised Industrial Development Act should be limited to fairly narrow objectives for restructuring industry and should be focused as directly as possible at offsetting specific costs of distortions that inhibit private investors from pursuing those objec- tives. Generalized incentives to investors need not be of primary concern, especially in the current situation of widespread underutilization of existing capacity. Consideration should be given to providing any incentives in the form of grants or credits rather than as a long list of exemptions from (or rebates of) taxes. This would help to make the level of incentives explicit and would facilitate treating them as temporary assistance rather than as a quasi-permanent entitlement. Public policy in the financial sector, which is highly regulated, establishes an important set of incentives for private producers via the structure of interest rates. Over the period 1970 to 1983, nominal interest rates relative to the prevailing rate of inflation yielded persistently negative real rates on deposits and small positive real rates on loans of the banking system. This pattern of interest rates probably has led to some financial disintermediation. Moreover, beginning in 1983 lending rates turned strongly negative. Persistence of the current highly subsidized lending rates to the manufacturing sector will result in emerg- ing excess demand for credit and a need for further administrative controls on credit allocation, with corresponding adverse effects on the efficient use of financial resources.  - vii - Small- and medium-scale industries have received some recent attention, as the government has attempted to promote them as a vehicle for increasing Zambian ownership of industry and for upgrading entrepreneurial skills. The Small Industries Development Organization (SIDO) is addressing itself to many important constraints on the development of small and medium enterprises, but such organizations are not automatically successful. SIDO was organized on a model suited to relatively abundant high-level manpower, which is extremely scarce in Zambia. It needs, rather, to concentrate its efforts on types of assistance that fill immediate needs of small enter- prises, such as technical services and improving input supplies, rather than on identification and evaluation of new projects. Financial interme- diation by SIDO is probably not appropriate. On the basis of the analysis in Chapters 2 through 5, Chapter 6 proposes a strategy for industrial development. A common theme of the strategic recommendations for industrial development is the judgement that Zambia's capacity is limited to sustain: (a) a trade strategy which has emphasized import substitution supported by high levels of effective protection; (b) reliance on administrative mechanisms rather than market mechanisms in allocating economic resources; and (c) reliance on large scale, public sector investment as the leading edge of industrial development. The import-substitution strategy produced impressive gains in industrial development in the period before 1975, but evidence suggests that the past policy biases of this approach have been costly and that future gains may be difficult. The scope for further substitution for consumer goods imports is limited, and recent investment in the manufactur- ing sector has been achieved at high economic cost and decreasing overall utilization of capacity. An unintended consequence of trade policy bias has been to penalize not only manufactured exports, but also agriculture, two activities which will have to make significant contributions to the structural transformation of the economy. As the foreign exchange crisis has tightened, the authorities have been drawn almost inexorably into increased reliance on administrative mechanisms to control the allocation of resources, particularly foreign exchange. Although it is possible in theory to allocate resources efficiently in a centralized fashion, as a practical matter it has not worked well. The present system is heavily overloaded, provides substan- tial rents to individual producers, and is wasteful of skilled high-level manpower. It has reached the limits of its ability to function effec- tively. The public industrial sector has been the leading force in recent industrial development in Zambia. Public capital and management resources are limited, however, and the time has come to redefine the relative roles  - viii - of public and private actors in industrial development. For the foreseeable future, the government will probably wish to retain control over investment in large-scale, capital-intensive projects with economic benefits exceeding their financial returns. New investments in the public sector will require careful preparatiLon and sound economic appraisal, however, which will increase the managerial and administrative burden on the public sector. Since these resources are in limited supply, they should be focused on the areas in wh:Lch they have the highest potential returns. In more labor-intensive and less scale-sensitive activities, the private sector should continue to expand its role, regulated not by fiat but by internal and external competition. The proposed strategy of industrial development begins from the above three propositions and has the principal objective of reducing reliance on import substitution, administrative control, and public industrial investment. The overriding concern of a long-run development strategy must be to meet the need for more diversified and efficient production of tradable goods, including both industry and agriculture. Five specific objectives address this need: (a) Increased reliance on market as opposed to administrative mechanisms for the allocation of resources. (b) A structure of incentives which is both more uniform among producing sectors and neutral with respect to promotion of exports and import-substitutes. (c) Selective promotion of a limited number of new industrial activities. (d) Greater attention to the linkages between industry and agriculture. (e) Balance between public and private investment in industry. Each of these objectives is discussed more fully in Chapter 6. Of particular note is the suggestion that the government give careful consideration to replacing the existing system of administrative control of foreign exchange with a market-based system. A process of exchange rate adjustment is the most efficient strategy to achieve this, but it may be supported by a set of import surcharges and/or an auction of import licenses as transitional measures. In order to assure that decentralized decisions advance the goal of efficient development of the industrial sector, the chapter also stresses the need for parallel actions to reform the incentive structure by making effective protection more uniform, by lowering the effective protection to import substitution industries, and by promoting non-traditional exports. Chapter 7 builds on this strategic view by offering an agenda for policy reform in the near term. The major short-run goals are:  - ix - (a) To strengthen the existing industrial structure by increasing capacity utilization, by making firms more competitive at international prices through restructuring investments, by phasing out those that cannot operate economically, and by enhancing managerial skills and productivity. (b) To initiate reform of the incentive structure by replacing quantitative restrictions with tariffs and by selective changes in the tariff structure. (c) To promote industrial exports by providing incentives designed to offset the present bias in the protective structure against exports. (d) To limit new projects in the public sector and to exercise strict economic criteria in their selection. The first set of policy recommendations in support of these objectives deals with improving the foreign exchange allocation system. For better industrial planning and performance, import licenses must be issued regularly and must be backed by foreign exchange. To achieve this end the report recommends: (i) improving foreign exchange budgeting; (ii) eliminating the current overhang of import licenses not backed by foreign exchange; (iii) shortening the maturity of import licenses; (iv) separating allocations for capital goods from those for intermediates; and (v) introducing greater flexibility and responsiveness to users' needs in the allocation procedure. The report also suggests that the committee use imports selectively to enforce cost discipline on domestic producers. Suggestions for tariff reform include: (i) establishing a minimum tariff" concept by eliminating the zero-duty categories for capital goods and intermediate goods imports; (ii) shifting the tariff basis from FOB to CIF; and (iii) unifying domestic and import sales tax rates. These measures can be undertaken immediately. In the longer run the reform of the structure of incentives depends first on a shift from the system of quantitative restrictions on imports to one in which domestic prices are set by the exchange rate and tariff alone. The report recommends formation of a Tariff Commission with representation from the government and the producing sectors to oversee a comprehensive program of tariff reform, based on a study of effective protection. In order to facilitate the process of tariff and exchange rate reform the report suggests two interim mechanisms--a system of import surcharges and auction of import licenses--which can alleviate excess demand for imports and can be used to manage a gradual transition toward greater uniformity in the structure of protection. Export promotion is an important area for immediate policy attention. The report recommends that the following incentives for exporters be established: (i) an improved export retention scheme; (ii) an export revolving fund for purchase of imported intermediates;  - x - (iii) a workable duty drawback system; and (iv) a possible subsidy to value added. In addition, substantial effort is needed to improve institutional support for exporters, including credit and guarantee schemes and marketing assistance. The strategy for industrial development outlined in the report places heavy emphasis on improving the efficiency of investments. To this end, the report recommends that a capability for economic analysis of new projects and existing performance, using the principles enunciated in Chapter 3, be established in the public/parastatal holding companies. In addition, programs for restructuring or phasing out present capacity should be developed in cases where economic returns to existing firms are low or negative, and a program of technical consultancy should be undertaken. Greater balance between private and public investment can be facilitated by reform of the current regulatory environment embodied in the Industrial Development Act. The report recommends formation of a commis- sion to review and rewrite the current act along the lines suggested in Chapter 5, with technical assistance, if required. In order to regain the path of sustained economic growth, the Zambian economy will require improved incentives for efficient production of tradable goods, including agriculture, industrial exports, and competi- tive import-substituting industries. This growth can only be achieved in a more neutral trading environment in which the incentives for producers coincide with appropriate economic incentives, and in which decentralized economic decisions conserve the scarce administrative and managerial resources of the government. The data and analysis in this report indicate that the industrial sector has an important role to play in this process of structural transformation, provided that policy reform and efficient economic management receive political priority and broad-based support.  1. INTRODUCTION: THE ECONOMIC AND POLICY SETTING 1.01 At independence in 1964, Zambia ranked among the African countries with the highest per capita income, yet the development of its physical and human resources was still at an early stage.1/ Copper export proceeds, upon which the relatively high income level was based, enabled the country to maintain a large volume of imports and to pursue a substan- tial investment program geared to building up infrastructure, broadening the industrial base, and improving social services (particularly education, housing and water supply). A major objective of this development program was to reduce the degree of dualism that existed between rural subsistence agriculture on the one hand, and the "modern" sector on the other, consist- ing of mining, commercial farms, and high-wage urban industries and other activities. 1.02 Because Zambia is landlocked and relatively sparsely settled over a large area, much of its investment has had to be directed toward con- structing rail, road and pipeline linkages--both external and internal. Transport connections through Tanzania became especially important follow- ing Rhodesia's unilateral declaration of independence (UDI) in 1965. Sanctions against Rhodesia and the effort to reduce dependence on southern transport routes imposed heavy costs in terms of both reliance on higher- cost suppliers and transport delays and costs. 1.03 A major turning-point for the economy came in 1975 when the price of copper dropped by 40 percent, while higher prices for imported fuel had already raised import costs. Import controls--initially introduced to implement sanctions after UDI and to ration available transport capacity-- were used to adjust to the decrease in export revenues by virtually halving the level of imports, in real terms, between 1974 and 1978. The cut-backs in exports, imports and revenues, aggravated by the impact of drought on agricultural production, provoked a major financial and economic crisis. The public investment program was cut, foreign borrowing was increased, and economic activity generally slumped. GDP per capita in constant 1970 Kwacha declined by about 25 percent from 1974 to 1983. 1.04 The initial policy response to this situation was limited and aimed more at surviving a temporary disequilibrium than at fundamental economic restructuring. The result was an increasing degree of distortion in prices and the exchange rate. Price controls were used in an effort to hold down the cost of living in the face of both internal and external inflationary pressures, making it increasingly difficult for producers to cover rising costs of production, especially in agriculture. The official exchange rate--established on the basis of a prosperous mining sector-- diverged increasingly from the value of scarce foreign exchange to the economy, encouraging excess demand for imports and discouraging the expan- sion of new non-mineral exports. 1/ For further details on the general economic environment, see World Bank, Zambia - A Basic Economic Report, 1977, and Zambia - Country Economic Memorandum: Issues and Options for Economic Diversification. Report No. 5000-ZA, Eastern Africa Country Programs Department I, April 16, 1984.  -2- 1.05 With the continuing decline of the copper industry and with growing external debt, the Government; has been adjusting and reassessing its strategy. While insisting on a Leading role for public investment, it has in practice maintained a mixed economy with the private sector continu- ing to play an important role. While trying to rehabilitate the copper sector, it has also recognized the need to transform the economy for a future situation in which copper revenues are much less significant. After several years of discussion of adjustment programs, it has taken signi- ficant steps since late 1982 to move away from controlled prices and a fixed exchange rate. It has also acted to improve financial, budgetary and parastatal management. 1.06 Weak prospects for copper prices and the foreseeable depletion of Zambia's copper reserves make it impesrative to transform the economy toward less dependence on the mining sector--which previously provided a third or more of GDP and virtually all export earnings. The key to this transforma- tion will clearly be the expansion oE agricultural production, which has been adversely affected by past policies and which has significant poten- tial in the form of a large land area suitable for both crops and livestock and an already substantial commerciaL agricultural sector. Agricultural surpluses are important both as a possible source of export earnings in the short (as well as long) run and to support industrial expansion based on local materials, rather than on costly imported inputs. 1.07 The industrial sector also has an important role to play in Zambia's future economic development. If the economy is to become more independent both of imported goods and of copper exports, industrial and agricultural production must expand in a balanced, integrated way so as to meet a larger share of demand from domestic sources and to generate new export revenues. Prospects for industrial exports other than through processing are somewhat limited--by the high cost of imported inputs imposed by Zambia's landlocked nature, by the lack of past export expe- rience, and by competition from other industrial exporters in the region. The domestic market also is limited--by small size (population under 6 million, GDP just over $3 billion) and by declining income per capita in recent years ($527 in 1983). 1.08 The critical question for the industrial sector at this juncture is what set of policies can induce the industrial sector to expand in a manner consistent with national objectives and in such a way as to become more competitive and less dependent on imports. This report attempts to answer this question, first, by reviewing past policies, performance and structural changes, and, second, by analyzing the present policy environ- ment and appropriate directions for policy reform. 1.09 Industrial policy in Zambia has consisted of a set of measures and government actions intended to shift more resources into industry, both directly through the budget and more indirectly through the incentive system as determined mainly by tariffs, quantitative trade restrictions and exchange rate management. In establishing the policy environment within which industrial development would take place, policy makers in Zambia have been primarily concerned with three interrelated issues:  - 3 - (a) The appropriate degree of competition, both internal and external, to which the industrial sector should be exposed. (b) The extent to which market allocation mechanisms could be relied upon to achieve the necessary levels of industrial investment and the desired degree of diversification of industrial activity. (c) The extent to which industrial development should be based on public as opposed to private domestic or foreign investment. 1.10 Trade policy has been the primary tool used to control the degree of competition faced by industrial producers. In effect the entire indus- trial sector has been treated as an "infant industry." High protective barriers were created behind which industry grew as an import substituting activity, oriented towards the domestic market with primary production providing the foreign exchange needed for imports. Chapter 2 describes the structure, characteristics and trends of manufacturing production. Chapter 3 analyzes the pattern of protection created to manage external competition and the costs of this generalized protection. Within the industrial sector, the major instrument used to manage competition among domestic producers has been investment licensing. Chapter 5 reviews the current structure of investment licensing in the industrial sector and evaluates its impact on private industrial investment. 1.11 The need to respond rapidly to difficult economic adjustments, particularly in the market for foreign exchange, coupled with an underlying reservation on the part of many policy makers in Zambia concerning the efficacy of market forces in allocating investment and in enforcing cost discipline led to progressively greater reliance on administrative mechanisms for allocating economic resources. Recently, however, the Government has begun to move away from direct intervention in some markets, as for example with the recent decontrol of most final goods prices. Administrative control of foreign exchange and prices is analyzed in Chapters 3 and 4. 1.12 Public sector investment has been a major factor in guiding the growth and structure of the Zambian industrial sector. The motivations for public investment in industry were basically two. First, there was a concern that market incentives, even in a highly protected trading environ- ment, would not generate sufficient entrepreneurial response to meet the desired targets for growth of a Zambian-owned industrial sector. Second, public enterprises were seen as a mechanism for guiding investment into key industrial sectors, and for balancing the interests of consumers with the objectives of industrial development. Thus, substantial investments have been made in parastatal industrial firms across a wide range of sectors. The size of the parastatal sector in Zambia means that the performance of parastatal firms is a crucial determinant of the performance of the indus- trial sector as a whole. Chapter 4 reviews the structure and performance of parastatal industry.  - 4 - 1.13 Zambia has now arrived at a crucial turning point in industrial policy. The explicit and implicit resource cost of protecting and subsi- dizing the industrial sector as a whole has become excessive. Traditional export revenues and foreign capital Lnflows are insufficient to cover the growing import needs of industry and the demands related to infrastructural and agricultural development. There is, therefore, a critical need to improve the efficiency of the industrial sector, to enhance its level of international competitiveness, and to begin the process of developing manufactured goods exports. These issues are addressed in Chapter 6. Chapter 7 contains some specific recommendations for short-run policy change.  2. THE PATTERN OF INDUSTRIAL DEVELOPMENT A. INTRODUCTION 2.01 The preceding chapter reviewed the general economic and policy setting relevant to the development of the industrial sector in Zambia. This chapter reviews the main statistics that describe the growth of industry as a basis for subsequent chapters, which analyze in greater depth the relationship between policies and the pattern of industrialization. The emphasis is on the changes in growth, structure and productivity that have occurred in response both to external factors and to industrial policies. This chapter examines the industrial sector as a whole; statis- tics on the role and performance of the public sector are presented in Chapter 4. B. RELATIVE SIZE AND GROWTH OF MANUFACTURING 2.02 Zambia's manufacturing sector is relatively large compared to other sub-Saharan countries, contributing over $600 million to GDP in 1982 and employing nearly 60,000 workers in the modern sector. The 18 percent share of manufacturing in Zambia's GDP is higher than any other country (for which data are available) except Zimbabwe, and only Zimbabwe and Ivory Coast have higher per capita GDP originating in manufacturing (Annex Table I-1). Although Zambia ranks only nineteenth among sub-Saharan countries in population and twelfth in total GDP, its manufacturing output ranks sixth. This relatively high ranking may be attributed in part to the demand generated by mining activity (both for inputs and for consumer goods for wage earners) and to the natural protection afforded by its landlocked position. 2.03 The contribution of manufacturing to GDP has tripled since independence in 1964, when it was about 6 percent.l/ Manufacturing was the most dynamic component of GDP in the first decade of independence, although it was too small to be able to offset stagnation in other sectors. From 1965 to 1970, manufacturing GDP grew at over 11 percent per I/ This ratio applies to GDP in current prices. Measured in constant 1970 prices, the 1983 share was 12.5 percent (rather than 18.6 percent), or about double the 1964 share (see Table 2.2). Besides being influenced by changing relative world prices, the difference between the current and constant price ratios reflects increasing price distortions during this period, i.e., rising effective protection to manufacturing value added. This tends to overvalue the contribution of manufacturing relative to that of mining and agriculture, whose contribution would be higher if valued at world prices. Although this distortion also affects the comparison to the share of manufacturing in GDP in other countries, similar distortions are found in most of them as well.  annum, but falling agricultural production (in real terms) together with negligible growth in the contribution of mining resulted in a decline in real GDP per capita (Table 2.1). Growth picked up in other sectors and in GDP per capita during 1970-74, with manufacturing continuing to lead, though at a slightly reduced rate of over 8 percent per annum. 2.04 In 1975, the price of copper fell by 40 percent, copper produc- tion by 9 percent, and the contribution of the mining sector to GDP (in 1970 prices) by 10 percent (Table 2.1). The impact was severe on both the balance of payments and the economy in general, and particularly on manufacturing output, which fell by nearly 12 percent in 1975.2/ This decrease can be attributed largely to the drop in demand, both in the aggregate and in the mining sector in particular. The largest drops in output in 1975 (about 25 percent) were registered in the wood and basic metals industries, which depend more heavily on mining demand than other branches. 2.05 Both mining and total GDP remained lower in 1979 than in 1975 (in constant prices), while manufacturing, agriculture, and services (excluding trade) were able to show only a slight increase over 1975-79.3/ The supply of imported inputs was a problem during this period, following the closure of the Rhodesian border and hence of rail shipments from the south in 1973, and subsequent congestion in the Dar-es-Salaam Port. Imports were also cut back sharply in response to falling foreign exchange earnings, with a negative impact on industrial production (see Annex Table I-4 for annual changes in the index of industrial production by subsector). 2.06 Since 1980, Zambia has had some degree of recovery (or at least no further major decline) in the principal economic sectors-/ and in total GDP, which had returned to its 1974 level by 1983. The independence of Zimbabwe in 1980 helped ease the transport problems, although foreign exchange availability remained constrained. Manufacturing output increased over 1979-83 at an annual average cf 3 percent measured in value terms and 1 percent according to the physical index (Table 2.1). 2/ Measured in physical terms by the index of industrial production, the 1975 fall in manufacturing output was somewhat less, at under 5 percent. 3/ See World Bank, Cnyconomc Memorandum, 1984, Annex Table 2.02. 4/ The principal exception was construction, which declined continuously after 1975 to only 42 percent of its 1974 real contribution to GDP. GDP per capita also fell in 1982-83, to 25 percent below its 1974 level in constant 1970 kwacha. ITn dollar terms, GNP per capita fell steadily by a total of 59 percent from 1974 to 1983. (See World Bank, Zambia Country Economic Memorandum, 1984, Annex Table 2.02).  -7- Table 2.1 MANUFALTURING PRODUCTICN AND GDP AT WONSEANE PRICES 1965-1983 (SELFCJXD YEARS) 1965a/ 1970 1974 1975 1979 1983 A. Index of Industrial Production (1973 = 100) n.a 81.8 110.6 105.5 96.2 99.3b/ B. Manufacturing GDP at Constant 1970 Prices: 1. Value (Kwadia million) 75.0 129.2 178.9 157.6 163.0 184.5 2. As % of GDP at market prices. a. Constant 1970 prices 6.8 10.2 12.1 11.0 11.9 12.5 b. Current prices 6.8 10.2 12.6 15.8 17.0 18.6 0. Total GEP at Corstant 1970 prices: 1. 'alue (Kwacha million) 1103.0 1268.5 1473.9 1438.1 1370.1 1479.1 2. Per capita (Kwacha) 325.9 305.0 313.6 296.8 250.2 236.5 D. Growth (% per an8xm at constant prices)C/ 65-70 70-74 74-75 75-79 79-83 1. Ind. production index n.a. 7.8 (-4.6) (-2.3) 1.1 2. Manufacturirg GEP 11.4 8.5 (-11.9) 0.8 3.1 3. Mining GDP 0.4 0.8 (-9.8) (-2.2) 4.7 4. Agricultural GaP (-2.1) 2.5 4.3 0.5 1.8 5. Total GDP 2.8 3.8 (-2.4) (-1.2) 1.9 6. GOF per capita (-1.3) 0.7 (-5.4) (-4.2) (-1.4) a/ Fonmer national accowantig methxdology. b/ 1982 figure. c/ Campound growth betwen end points. Source: Zambia, CSO, !Mktl Digest of Statistics; World Bank, Zambia - Country Economic Memorandum, 1981, Table 2.02, and 1984, Table 2.02.  -8- C. STRUCTURE OF PRODUCTION 2.07 Industrial production in Zambia has become increasingly diver- sified over the years, moving from predominance of consumer goods to a greater share of output in intermediate and capital goods and with increas- ing contributions from previously negligible branches of industry. Half of gross manufacturing output in 1965 was in food, beverages and tobacco, with an additional 9 percent in textiles, wearing apparel and leather (Table 2.2). The heavier industries (ISIC categories 35-38: chemicals, mineral products, metal industries and products, machinery and equipment) accounted for less than a third of gross output--still a reasonably large share relative to other sub-Saharan countries in the early 1960s. Ten years later, in 1975, the share of food, beverages, tobacco, textiles, wearing apparel and leather combined (ISIC categories 31-32) had fallen below 40 percent, while categories 35-38 had reached 49 percent of gross output.5/ 2.08 The 1975 fall in mining prices and production and in aggregate demand had differential effects on different branches of industry, as did the subsequent cut-backs in foreign. exchange available for imported inputs. The fall in output was most severe in wood products, basic metals, and metal products--i.e., those branches most closely allied to mining sector demand (Annex Table I-4).6/ Basic metals production recovered somewhat over 1976-78, but has declined since. 5/ The major decreases in shares (but not in level of production) were in beverages and tobacco and food products (Annex Table I-7). The most significant gains were in non-industrial chemical products and trans- port equipment. In terms of value added, the trend toward a greater share of production in "heavy" industries is not as clear as for gross output. The principal difference between the value added and gross output portions of Table 2.2 is that the share of food products is considerably higher for gross output than for value added, so that food, beverages and tobacco accounted for only 33 percent of value added in 1965 (as against 50 percent of gross output). The value added share of ISIC categories 35-38 therefore rose less sharply from a higher initial level of 44 percent in 1965 to a peak of 54 percent in 1975, falling back to 49 percent in 1980. 6/ The only "heavy" industry not to fall in 1975, and indeed to achieve substantially higher levels of production during 1975-79 than before, was non-metallic mineral products. This result is perhaps surprising in view of the slump in construmction during this period, although there may have been some substitution of locally-manufactured for directly imported building materials. During 1980-82, however, the index of non-metallic mineral production dropped below the 1970 level.  - 9- Table 2.2 DISIBUTICN OF GROSS MANUFAC1URING CUWIT AND VAUE AIDED BY BRANCK (F INC USITY, 1965-1980 (percentage cf total) ISIC Gross Output Value Added Code Industry Branch 1965 1970 1975 1980 1965 1970 1975 1980 31. Food, Beverages & Tobacco 49.9 46.1 27.4 30.0 33.3 52.5 21.8 22.0 32. Textiles, Wearirg Apparel 8.9 9.9 12.5 16.2 10.1 8.7 12.4 18.4 and leather 33. Wood, Wood Products anh 5.3 3.7 5.2 2.5 7.0 3.8 4.9 4.2 Furnibure 34. Paper & Printing 3.9 3.4 5.5 4.7 5.6 3.5 5.9 5.7 35. Cbemicals and Chemical 3.8 14.7 20.2 18.8 4.7 9.8 22.4 19.0 Products 36. Non-iitalUlc Mineral 8.7 5.3 5.0 5.9 16.7 6.5 6.7 6.6 Products 37/38 Basic Metals & Metal 19.1 16.6 23.6 21.5 22.2 14.9 25.1 23.7 Products 39. Other Mairfacturing 0.4 0.2 0.5 0.3 0.5 0.3 0.7 0.4 TUL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Note: Details may fail to add to totals because of roundirg. Source: Annex Tables I-7 and I-.  - 10 - 2.09 The only branch of industry to continue growing steadily after 1975--in fact, the only branch with a higher index of production in 1982 than in 1973--is textiles and clothing, which grew at an average of 7 percent per annum from 1975 to 1982 (Annex Table I-4). Textile and clothing manufacturers consist of t'he large vertically-integrated state firm that dominates production of printed cotton cloth and over 100 smaller firms that are more oriented toward synthetic fabrics and wearing apparel. By 1980, textiles had reached 8 percent of gross manufacturing output, making it the third largest branch of industry after food products and non-industrial chemical products (at the 3-digit ISIC level; see Annex Table 1-7). 2.10 The food sector is dominated by the milling of maize to produce mealie meal, the staple of the Zambian diet--although the contribution to GDP of the largely state-owned grain mills was negative in both 1975 and 1980, due largely to price controls. The other major activities in this sector are sugar (public sector) and baking (mostly private, plus two large public sector bakeries and several smaller ones). The principal component of non-industrial chemical products is the production of soap and deter- gents. In terms of GDP, however, t'he largest contribution from an individual manufacturing activity is from the state-owned breweries-- although most of this contribution is in the form of taxes. 2.11 Besides non-industrial chemical products, the most important activity in industries 35-38 over the years has been fabricated metal products (just under 8 percent of gross output in 1980). This subsector grew up on the requirements of the mining industry (especially for con- struction), but today can meet a wide range of demand for metal products and services, such as office furniture, agricultural equipment, and vehicle rebuilding. Both public and private firms are active. A related industry, transport equipment, had contributed substantially to the growth of the heavier industrial subsectors, although it consists largely of assembly rather than local manufacture. 2.12 The shift in industrial production toward intermediate and capital goods reflects the pattern of investment. Whereas categories 35-38 accounted for only 38 percent of fixed capital formation in 1965, they rose quickly to 71 percent in 1968 and exceeded 45 percent of new investment in all years except one from 1967 to 1980. This investment pattern is evidence of the government's emphasis on basic industries of major significance to the economy, with the Industrial Development Corporation (INDECO) playing a leading role beginning in the late 1960s. The branch of industry receiving the largest share of new fixed capital formation during these years was basic industrial chemicals. 2.13 As a result,-industrial chemicals had a significantly higher share of total fixed assets in 1975 and especially in 1980 than of value added, implying relatively capital-intensive operation. This is due primarily to the large fertilizer factory, which has a ratio of net fixed assets per worker over ten times that of parastatal manufacturing as a whole and which has operated at high cost due to start-up problems, failure to achieve technical specifications, and low utilization of capacity.  Other branches of industry with higher shares of fixed assets than value added in both years were non-metallic mineral products, food, and wood products. Industry branches with particularly low ratios of fixed asset share to value added share were transport equipment, machinery, wearing apparel, and furniture. 2.14 The spatial structure of Zambia's industry is unusual in Africa because it is not concentrated in the administrative/commercial capital. Rather, about half the (recorded) establishments and employees are located in cities in the Copperbelt, along the line of rail, with only around a third in the Central Province, which includes Lusaka (Annex Table I-13). Five of the eight provinces, however, have less than 3 percent of the firms and less than 1 percent of employment. Although further diversification of the regional distribution was one objective of industrial policy, this structure remained virtually the same in 1980 as in 1972, except for a slight increase in the share of employment in the Southern Province at the expense of the share of the Copperbelt. D. EMPLOYMENT, PRODUCTIVITY AND WAGES 2.15 Manufacturing employment grew at the relatively rapid annual rate of 11 percent during the 1960s (Table 2.3), accounting for about 10 percent of total recorded employment in the mid-1960s and around 12 percent since 1972.7/ The "elasticity" of employment growth with respect to value added7output growth was around 0.9, a relatively high ratio implying few gains in terms of economies of scale and labor productivity. Growth continued at a slower pace of under 6 percent per annum during 1970-74, with an employment/production growth "elasticity" of 0.6-0.7--more nearly what would be expected for an African country in the early stages of industrialization. V 7/ Based on data reported in the Monthly Digest of Statistics (CSO). These data increasingly diverge after 1970 from those reported in the Census of Industrial Production (CSO), the former showing declines in 1976, 1978 and 1979 and a 1980 level of 47,760, while the latter show positive growth in all years and a 1980 level of 58,909. The discrepancy arises from differences in coverage, definition and reference date. The Industrial Census data are used in this report for comparability and production data, except as otherwise noted. 8/ Norman Uphoff, "The Expansion of Employment Associated with Growth of GNP," The Economic Bulletin of Ghana 2.4 (1972), pp. 3-16.  - 12 - Table 2.3 MANUFACTURING EMPLOYMENT, OUTPUT AND VALUE ADDED GROWTH BY PERIOD 1960-1980 (percent per annum) 1960-65a/ 1965-70 1970-74 1974-75 1975-80 AVERAGE ANNUAL PERCENTAGE GROWTH Employment 11.2 11.4 5.6 3.3 1.1 Value Added at Constant Prices 13.3 13.0 9.1 -16.2 -0.4 Gross Output at Constant Prices 17.6 12.6 8.3 - 6.1 -5.7 1972-74 Public/Parastatal/Sector Employment n.a. n.a. 10.2 5.4 5.5 GDP at Constant Prices n.a. n.a. 2.0 -6.6 2.5 Private Sector Employment n.a. n.a. 9.1 2.1 -3.2 GDP at Constant Prices n.a. n.a. 9.5 -7.0 -3.0 RATIOS OF GROWTH RATES Employment/Value Added 0.85 0.88 0.62 * * Employment/Gross Output 0.64 0.91 0.68 * * Employment/GDP: Public/Parastatal n.a. n.a. 5.07 * 2.19 Private n.a. n.a. 0.96 * ** * Positive employment growth but negative growth of value added, gross output or GDP. ** Both employment and GDP growth are negative (ratio = 1.07). a/ Includes motor vehicle repair. Source: Annex Tables I-3, 1-14 and 1-15. The implicit GDP deflator for manufacturing is used for periods after 1965; the aggregate GDP deflator for 1960-65.  - 13 - 2.16 Although the recession of 1975 led to a severe drop in the value of manufacturing output that year, and to a lesser extent in the years that followed, employment continued to grow, albeit at only 1 percent per annum over 1975-80 (Table 2.3). This trend was maintained through public/ parastatal sector employment policies, with employment growing over 5 per- cent per annum during 1975-80, more than twice as fast as the sector's contribution to GDP. In the private sector, however, both employment and real GDP fell at about 3 percent during this period. 2.17 As a result of efforts to maintain a high rate of employment growth, labor productivity in manufacturing has declined steadily since 1973 (Annex Table I-3). Value added per worker in constant 1970 prices had risen at an annual average of 3.5 percent from 1965 to 1973, but dropped at an annual average of 11 percent over the next two years as employment continued to rise while capacity utilization fell. From 1975 to 1980, value added per worker continued declining at an annual average of 1.5 percent, while employment grew at 1 percent in spite of a decline in the number of firms recorded.9/ 2.18 In accordance with the government's policy of Zambianization, employment gains were entirely of Zambian workers, with the number of non-Zambians declining steadily to 1,900 in 1980, about half the 1965 figure.10/ In 1965, Africans accounted for 87 percent of the manufactur- ing work force. By 1972, 92 percent of manufacturing employees were Zambian, rising to 96 percent in 1980. 2.19 Real wages in manufacturing rose substantially during the post- independence boom period, but have followed a declining trend since 1973. Real wages of Zambian workers grew over 1966-70 at an annual average of nearly 8 percent in manufacturing and in all recorded employment (Annex Table I-18). Over the next five years, however, wage increases barely kept pace with price changes in manufacturing, and then showed a net decline over the period 1975-80, at an average annual rate of 2 percent. 2.20 Wages in the formal manufacturing sector are below average for Zambians (but above average for non-Zambians, since 1970; Annex Table 1-18). Wages have generally been higher in the mining sector (by more than 9/ Since the substantial decrease in number of establishments in the 1980 Census (539) as against 1975 (717) may have been at least partly a matter of response rate rather than a reduction in the number of firms operating, comparisons between 1980 and 1975 based on the industrial census must be taken with caution. In particular, it appears that smaller firms may be underrepresented in 1980, so that branches of industry in which smaller firms predominate may be similarly underrepresented. 10/ Figures in this paragraph are based on CSO, Monthly Digest of Statistics.  - 14 - half again as much as manufacturing in 1980) and to a lesser extent in transport and communications, with services also slighly higher than manu- facturing. These figures, of course, represent broad averages without regard to skill structure or fringe benefits. E. INVESTMENT AND CAPACITY UTILIZATION 2.21 Investment in manufacturing rose rapidly in the late 1960s and early 1970s, quadrupling in real terms over 1965-72 and doubling its share of total investment to reach 13 percent in 1972 (Annex Table I-11). Over 45 percent of total manufacturing investment from 1965 to 1975 was in chemicals and non-metallic mineral products, concentrated heavily in a few large projects such as the fertilizer plant, refinery, brick factory, and cement plant expansion. One consequence of the substantial public investment in larger, capital-intensive industries was a rise in the incremental capital/output ratio (ICOR) from 2 or less in 1966-67 to 3.5 in 1971-72 (Annex Table I-11). 2.22 The industries that received the most investment over 1965-75 also had the highest (or negative) ICORs: chemical and petroleum products with an overall ICOR of 5.5; food products with 8.6; and non-metallic mineral products with a negative ratio (Annex Table I-12). The former two branches continued to have the largest share of new capital formation in 1980, implying that the overall ICORL most likely has risen in recent years. 2.23 High ICORs are attributable to underutilization of capacity as well as to capital-intensive investment. Underutilization has been due to delays in bringing new investments into full production, especially in the early 1970s, and to scarcity of foretign exchange available for imported inputs and spare parts since 1975. In seven firms for which data are available since 1972, average capacity utilization rose from 46 percent in 1972/73 to 65 percent in 1974/75, but then fell to 60 percent in 1982/83 (Table 2.4). 2.24 Although annual investment in manufacturing fell by half in real terms between 1975 and 1980, capacity and the capital/labor ratio continued to rise. Fixed assets per worker in manufacturing averaged almost K11,000 ($8,500) in 1980. In spite of capital deepening, however, real GDP per worker fell in the public/parastatal sector and in total manufacturing during 1975-80 (Annex Table 1-17). F. TOTAL FACTOR PRODUCTIVITY CHANGE 2.25 Deterioration in labor productivity accompanied by an increase in the capital-labor ratio is symptomaltic of a deterioration in total factor productivity (TFP)--the level of output which is obtained from all factor  Table 2.4 CAPACITY UTILIZATION IN PARASTATAL MANUFACTURING BY BRANCH OF INDUSIRY, 1972/73, 1974/75 AND 1982/83 (percentage of capacity) Utweighted, 9ubsample a/ Ubweighted Weighted, Subsample a/,c/ Weighted, ISIC Industry Branch All Firms b/ All Firms b/,c/ Code 1972/73 1974/75 1982/83 1982/83 1972/73 1974/75 1982/83 1982/83 31. Food, Beverages and Tobacco 45.5 67.0 60.0 55.6 45.5 57.7 55.3 65.8 32. Textiles, Wearing Apparel and Leather 67.0 79.0 80.0 80.0 67.0 79.0 80.0 80.0 33. Wbod & Wood Products n.a. n.a. n.a. 47.4 n.a. n.a. n.a. 57.4 35. Chemicals & Chemical Products 43.5 64.5 33.0 52.8 30.1 70.6 37.7 54.0 36. Nbn-metallic Mineral Products n.a. n.a. n.a. 54.6 n.a. n.a. n.a. 60.2 38. Jetal Products, Machinery & Equipment 27.1 73.4 44.0 34.1 27.1 73.4 65.2 46.6 ALL FIRMS 42.7 69.5 51.7 50.9 46.2 64.5 59.5 64.1 a/ Subsample consists of eight firms for the unmeighted average and seven for the veighted average; the eight represent 22 percent of value added in all INDECO industrial firms in 1982/83. b/