Mozambique - The development of industrial policy and reform of the business environment

Report No. 7795SMOZ Mozambique Industrial Sector Study The Development of Industrial Policy and Reform of the Business Environment May 22, 1990 Southeem Africa Department Industry and Energy Operations Division FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in dhe performance of their official duties. Its contents may not odterwise be disclosed widout World Bank authorization.  'J CURRENCY EQUIVALENTS (AFRIL 1990) US$1 841 Neticais (MT) - April 1990 MT 1 - US$ 0.001 ABBREVIATIONS AND ACRONYMS AEPRIMO Association of Private Sector Entrepreneurs DM Banco de Mocambique BPD Banco Popular de Desenvolvemento BST Banco Standard Totta BSTH Banco Standard Totta de Mocambique CCADR Caixa de Credito Agrario e Desenvolvimento de Seguros CNP Conmissao National de Planc DRC Domestic Resource Cost EGA Custom Fees EPR Effective Protection Rate ERP Economic Rehabilitation Program GAPI Cabinete de Consultoria dos projectos da Pequena Industria GPIE Foreign Investment Promotion Bureau IDIL Instituto de Desenvolvimento da Industria Local MIE Ministry of Industry and Energy OER Official Exchange Rate SEILA Secretariat of State for light Industry SER Shadow Exchange Rate SME Small Medium Enterprise SNAAD System for Non Administered Allocation of Foreign Exchange SOCIEF Sociedade de Investimentos e Estudos Financeiros UCPI Coordination Unit for Industry Import Programs Fiscal Year Government and Publit Fiterprises: Calendar Year  FOR OFFICIUL USE ONLY MOZANBIqUE INDUSTRIL SECTOR STUDY PREFACE This report is based on a study of the business environment carried out by the IDA in conjunction with UNIDO and financed by UNDP. The study was submitted to the Government in July 1989, and discussions of its findings were held in Maputo in December 1989. A number of changes were made as a result of these discussions. as well as updating and ext.nsion. The initial study team consisted of Messrs. David Phillips (IDA and principal author), J. Weiss, D. Rhatigan, and H. Jackelen (Consultants). Contributors to the study in IDA included Mr. C. Frischtak (IENIN), who was lead advisor, and valuable assistance was received from AF6CO, AFTTF, and colleagues in AF6IE. The main mission spent four weeks in the field over the period November to December 1988, followed by a further visit in March 1989. In December 1989, during the discussions with the Government, the study was updated in preparation for this final report. The study serves as the policy basis for two current IDA investment projects, the Small and Medium Enterprise Development, and Industrial Enterprise Restructuring Projects, which are due to become effective in mid- 1990. It also complements the UNIDO Industrial Policy and Institutional Adjustment Project, which is notr under way. The discussion is concerned with the development of industry sector-wide, but, in accordance with its original terms of refereuice, it particularly focuses on small scale industry. The mission would like to express its appreciation for the help and guidance received from the Government, in particular H.E. Antonio Branco. Minister of Industry, Mr. 0. Mutemba. Vice Minister, and his staff, and staff of the Bank of Mozambique and the Ministries of Commerce and Finance, who participated in the study discussions upon which the report is based. We would also like to express our appreciation to Mr. Charles Larsimont, Resident Representative, UNDP, and Mr. Carlos Goulart of UNIDO, and many individuals in both the private and public sector and aid agencies, who gave up their time to assist the mission. 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.  NDZAMBIQUE INDUSTRIL SECTOR STODY TIE DEELOPMENT 0? INDUSTRIAL POLICY AND REFORM OF THE BUSIESS EIR01ONMENT TABLE OF COrTENTS Page No. PAI. BACKGROND, SUMRY AND RECOIHENDATIONS . . . . . . . . . . 1 A. Background and Objectives . . . . . . . . . . . . . . 1 B. Conclusions, and Reconmendations . . . . . . . . . . . 5 -Industrial Structure . . . . . . . . . . . . . . . I 5 -Economic Efficiency of Industries . . . . . . . . . . 6 -Industrial Sector Po.Acy . . . . . . . . . . . . 6 -Financial Sector Policy . . . . . . . . . . . . . . . 8 i II. ECONOMIC BACKGROUND AND INDUSTRIAL GROWN . . . . . . . . . 10 A. General Economic Background . . . . .. . . . . . .. 10 B. The Development of the Industrial Sector . . . . . . . 11 - ludustrial Development: Preindependence . . . . . . 11 - Industrial Declines Post-independence . . . . . . . 13 - Manufacturing Employment . . . . . . . . . . . . . . 16 - Export of Processed Goods . . . . . . . . . . . . . 17 C. The Structure of Industry . . . . . . . . . . . . . . 17 - The Composition of Industrial Output . . . . . . . . 17 - Industrial Location . .19 - Ownership Structure of Industry . . . . . . . . . . 20 D. Industrial Strategy and Planning 1977 - 87 . . . . . . 20 E. Small Scale Enterprises; Structure and Performance . . 21 III. TE CURRENT BSINESS ENVIRONHENT . . ...... . * . . 25 A. The Business and Investment Climate . . . . . . . 25 - Generl Background . .25 - New Investment and Company Formation . . . . . . . . 26 - Enterprise Pricing..... . . .28 - Marketing and Distribution . . . . . . . . . . . . 29 - Capacity Utilization . . . . . . . . . . . . . . . 30 - Current Industrial Output and Employment . . . . . . 30 - Manufactured Exports . . . . . . . e . . . . . . . . 32 B. The Demand for Industrial Products . . . . . . . . . . 32 - Long Term Demand . . . . ... . . . . . . 33 - Impact of Structural Adjustment on Purchasing Power 34 - Impact of Donor Aid on Production and Markets . . . 38  - ii - C. The Reform of Industrial Policy . . . . . . . . . . . 38 - Reforms Under the Economic Rehabilitation Program . 38 - Reforms and Medium Term Strategy for Industry . . . 42 IT. ESTIMATION OF THE ECONOMIC EPPiCIENCY OF INDUSTRY . . . . . 64 A. Industrial Efficiency Analysis . . . . . . . . . . . . 44 S. The Enterprise Survey, Industrial Efficiency Estimates 46 C. Results of the Survey; Industrial Efficiency Estimates 46 D. Conclusions ..... ... ..... , .49 V. TEE DEVELOPMENT OF INDUSTRUL POLICY . . . . . . . . . . . 54 A. Introduction . . . . . . . . .. . . . . . . . . . . 54 B. Exchange Rate Policy . . . . 55 _ Objectives of Exchange Rate Reform . . . . . . . . . 55 - Effects of Currency Devaluation on Efficiency and Exports . . . . . . . . . . . . . . .57 - Equilibrium Exchange Ratet . . . . . . . . . 58 C. Foreign Exchange Allocation . . . . . . . . . . . . . 59 - Channels of Foreign Exchange Provision . . . . . . . 59 - The Export Retention Scheme . . . . . . . . . . . . 60 - Donor Import Allocation Procedure . . . . . . . . . 61 - Guidelines for Donor Import Allocation System . . . 63 The Small-medium Erterprise and Market Fund . . . . 65 - Import Licenses . . . . .65 Revised Guidelines for Import Licenses . . . . . . . 66 - S-umary of Recommendations on Foreign Exchange Allocation . . . . . . . . . . . 67 D. Trade Tariff Reform 68 - The Current Reform Program. .. . 68 _ Tax Revenue Considerations . . . . . . . . . . . . . 69 - Designing the Tariff Structure . . . . . . . . . . . 70 - Income Distribution and Tariff Policy: Luxury Goods 72 - Tariffs and Long-run Protection . . . . . . . . . . 73 - Export Promotion and Tariff Policy . . . . . . . . . 75 - Summary of Tariff Reform Recommendations . . . . . . 76 E. Measures for Price Setting . . . . . . . . . . . . . . 78 - Conditional Prices . 78 _ Revision of Conditional Price Formula . . . . . . . 79 - Demand-based Pr cing. 81 - Summary of Recommendation on Conditional Pricing . . 81 P. Investment Incentives 81 - The Current System. . . ..81  _ iii - - Rationalization of Tax Exemptions . . . . . . . . . 82 - Employment Tax Credit . . . . . . . . . . . . . . . 84 - The Effects of the Turnover Tax (Imposto Ctrculacao) 85 - Access by Small Enterprises to Tax Incentives . . . 86 - Effects of P.oposed Tax Changes . . . . . . . . . . 86 - Summary of Recommendations on Taxation . . . . . . . 87 VI. THE WIKT.NG SECTOR AND TEE FIZWICING OF INDUSTRIAL . . . . 88 REHABILITATION A. The Role of the Financial Sector . . . . . . . . . . . 88 B. The Operation of Banking Institutions in Mozambique . 89 C. The Reform of the Banking Sector . . . . . . . . . . . 92 - Economic Stabilization: Credit Ceilings . . . . . . 92 - Structural Reforms in the Financial. System . . . . . 93 D. The Demand for Industrial Credit . . . . . . . . . . . 95 - Real Domestic Lending . . . . . . . . . . . . . . . 95 - Industrial Credit Survey . . . . . . . . . . . . . . 96 E. Enterprise Restructuring; Revaluation of Assets . . . 98 - objectives . . . . . . . . . . . . . . . . . . . . . 98 - Asset Revaluation: A Case Study . . . . . . . . . . 99 VII. TIE PROKMOTION OF INDUSTRIAL INVESTHENT . . . . . . 102 A. The Environment for Foreign Investment . . . . . . . . 102 B. Foreign Exchange Allocation; Export Retention Scheme 103 C. Debt Equity Swap Law; Effect on Investment Incentives 105 D. Industrial Promotion Infrastructure . . . . . . . . . 108 - The Role of the Unidades de DiregiLo . . . . . . . . 108 - The Promotion of Small Scale Enterprises . . . . . . 110 E. Development and Diversification of Industrial Financing 112 - The Environment for Equ ty Investment . . . . . . . 112 - Developments in Financial Service and Markets . . . 113 - Resources of Entrepreneurship in Mczambique . . . . 114 - The Industrial Labor Force: Share Participation Schemes . . . . . . . . . . . . . . . . . . . . . . 115 - The Role of Venture Capital . . . . . . 116 - Management Legal and Accounting Services .118 F. Mechanisms for Privatization/Transfer of Companies . . 119 G. Institutional and Management Considerations for Equity Financing ....... 121 H. Conclusions . . . . . . . . . . . . . . . . . . . . . 124  - iv _ TABES. * * e a * * a a * * a a a * a a *. * . v 2.1 Preindependence Growth of Enterprises and Employment . . . 13 2.2 Output Volumes: Power and Principal Manufactures . . . . . 15 2.3 Growth of Manufacturing Employment . . . a . . . . . . . 16 2.4 Processed Export Products 1973-87 . . . . . . . . a . . . . 17 2.5 Structure of Manufacturing Output . . . . . . . . . . . . . 17 2.6 Level of Manufacturing Value-Added (1973) Selected Low Income African Economies aa... 18 2.7 Ownership Structure of National Enterprises . . . a a 20 3.1 Foreign Investment Proposals Approved by GPIE . . . . . . . 26 3.2 Foreign Investment Approvals by Subsector . . . . . . . . . 26 3.3 New Enterprise Registrations in Small-Scale Manufacturing Processing and Repairs Maputo . . . . . . . . . . . . . . . 27 3.4 Capacity Utilization of Selected Companies a. . . . . . . 30 3.5 Output Growth - MIE Enterprises 1988-89 . . . . . . . . . . 31 3.6 Population and Consumption .. . . . . . . .. .. . . . 33 3.7 Consumer Price and Wage Index, End Year . . . . . . . . . . 35 3.8 Enterprises Reporting Demand Constraints . . . . . a . . . 37 3.9 Finished Goods Stocks; Selected Industries . . . . . 37 4.1 Domestic Resource Cost Ratios (Medium Term) . . . . a a a 48 4.2 Domestic Resource Cost Analysis (Short Runj Category A 45 Enterprise Survey . . a .. a ..... .. C.... 51 4.3 Dow3stic Resource Cost Analysis (Short Run) Category B 45 Enterprise Survey .*. . . a. . . .. ...... . .....a 52 4.4 Domestic Resource Cost Analysis (Short Run) 10 Enterprise Survey . . .a .. . a... ... .a.. .. 53 5.1 Foreign Exchange Allocation and Production MIE Enterprises 1989 62 5.2 Iliustrative Grouping of Branches by DRC Results . . . . 65 5.3 Trade Taxes in Total Tax Revenue: Mozambique and Other African Economies 1980s . . . . . . . . . . . . . . . . . . 70 5.4 Tariff Protection and Other Taxes and Subsidies . . . . . . 77 5.5 Increases in Conditional Industrial Prices 1986-88 . . . . 78 5.6 Comparative Output Price Ratios (Late 1988) . . . . . . . 80 5.7 Illustration of Effect of lO Turnover Tax . . . . a. . . 85 6.1 Banking System; Domestic Credit Ceilings and Utilization 92 6.2 Net Domestic Lending to the Economy . . . . . . . . . . . . 95 6.3 Survey Results - Summary Demand for Industrial Credit 1988 97 6.4 Asset Revaluation: Mabor de Mozambique . . . . . . . . . 99 6.5 Coefficients for Revaluation of Fixed Assets . . . . . . 100 FIGURES . * . * . . . . . . . . . . . . . . . . . . . 2.1 Index of Industrial Production . . . . a . . . . . . . . 14 2.2 Industrial Enterprise Employment: Economy-Wide 1973 . . . . 22 2.3 Industrial Enterprise Employment: Economy-Wide 1987 . . . . 23 2.4 Industrial Enterprise Employment: Maputo 1973 . . . . . . . 23 2.5 Industrial Enterprise Employment: Maputo 1987 . . . . . . . 24 5.1 Evolution of Exchange Rate and Prices . . . . . . . a. . . 56 6.1 Shares in New Lending by Banks . . . a . a a . . . . . . 91  1XVIL APEDICES Appendix 4.01. Domestic Resource Cost Measure of Economic Efficiency .. ...................... . 125 Appendix 4.02. Analysis of Efficiency of Industrial Subsectors . 134 Appendix 5.01. Calculation of Effective Protection Rates . . . . 145 Appendix 5.02 Effects of Changes In Tax Incentives . . . . . . . 148 Appendix 6.01 Operating Mechanism for Revised Export Retention Scheme * ........................... . . 151 Appendix 6.02. Company Privatizations Illustration of Porm of Management Contract and Company Transfer Process . . . . 152 AS= . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Summary Accounts of the Banco de Desenvolvimento and the Banco Standard Totta de Mozambique, 1984-89 . . . . . . . . . . . 154 2 Summary Accounts of the Bank of Mozambique, 1984-89 . . 155 3 Structure of Interest Rates, September 1989, Ministerial Orde. ...156 4 Distribution of Bank Credit to the Economy. . . . . . . . . 159 5 Legal Status of Enterprises . . .160 6 Maln Problems Affecting the Firms . . . . . . . . . . . . . 161 7 Import Tariff Rates - 1989 . . .162 8 Export Retention Rates . . . . . . . . . . . . . . . . . . 166 9 Fixed Consumer Prices 1980 thru April 1988 . . . . . 167 10 Produc-ion Data Ministry of Industry and Energy . . . . . . 168 11 Scale Distribution of Industry 1973 and 1987 . . .... . 169  mOzWMBIQUR INDUSTRIAL SECTOR STUDY THE DEVELOPMENT OF INDUSTRIAL POLICY AND REFORM OF THE BUSINESS ENVIRONMENT I. BACKGROUND. SUMMIARY AND RECOMMENDATIONS A. Background and Chjiectives of the Study 1.01 This report was conceived as a study of broad industrial policy within the context of the rapid chantS,. in the business environment brought about by the Economic Rehabilitation rr.gram, launched in January 1987. Its purpose is to identify important medium term options in a range of specific industrial trade and financial policy areas, rather than to carry out a comprehensive analysis of industrial activity and development per se, which has been the subject of other studies. 1/ 1.02 A series of recommendations and proposals are set out which are intended to assist the Government to initiate action and prioritize issues for more detailed study. Revisions and updating have been made following discussions held with the Government on the draft report. The current rapid momentum of policy change in Mozambique has already encompassed some of the recommendations made, while others are under consideration as part of the Government's own ongoing industrial policy formulation process. 1.03 The main co.lclusions are summarized as follows: Industrial Development: - for historical reasons the current pattern of industrial production is consistent with econcmic efficiency and future investment should maintain this broad structure. - existing industrial capacity, If fully rehabilitated from its currently poor condition, may exceed domestic demand in the medium-term. Thus rehabilitation must be selective, not comprehensive. - along with selective rehabilitation of major enterprises, new investment may be justified in expanding micro-enterprises which have shown apparent dynamism in adverse conditions. Industrial and Trade Policy: - foreign exchange allocation and import licensing should, during transition to more opera markets, be based on specific 1, E.g. UNIDO Industrial situation in Mozambique, Vols 1 and 2, May 1987; and Review of Agricultural and Industrial Enterprises, Vol 1 and 2, World Bank (Arthur D Little inc), July 1988. 'Mozambique; an Introductory Economic Survey' World Bank, June 6, 1985, provides an account of the industrialization process before independence.  - 2 - international competitiven%3s and price criteria, phasing out administrative control. - the import tariff and control system should continue to be reformed, using concepts of transparency and uniformity. monitored by a tariff commission. - the corporate tax system could be rationalized to improve incentives for existing businesses, while at the same time maintaining the level of Government revenue. Finance and Investment Promotions - the impact of investment promotion instruments must be continuously monitored to ensure effectiveness; the industrial promotion institutions should aim to move towards financial self-sufficiency through increased autonomy and provision of fee-based services. - banking reform must include continued interest rate reform, recapitalization, and establishment of lending guidelines and a regulatory system controlled by the Central Bank. - equity financing for industrial rehabilitation should be mobilized. probably by establishment of a specialized investment company 1.04 A principal aim of the study is to explain and elaborate key aspects of an enabling environment for business, and for industry in particular, in Mozambique. An enabling business environment is defined as one that permits business to operate within a manageable and comprehensible institutional and regulatory system, and with a supportive macroeconomic and incentive framework. This is the first effort to draw together the wide range of disparate issues and policy areas which are instrumental in defining the business environment in Mozambique and it is inevitably selective. 1.05 The idea that the central issue of industrial strategy in a developing country should be the creation of an enabling environment is quite different from the conception of the strategies for industrial development which were formulated in the post-independence period of the 19609 and 1970, in many African countries. The latter traditional" approaches were more concerned with establishing what was conceived as the industrial base. This involved in many African (and other) countries direct state involvement in what were identified as key industries, particularly essential consumer goods and heavy industries, and a concomitant demphasis on the private sector. In particular, private foreign investment and ownership was in many cases considered to be inconsistent with the development of an appropriate industrial base, inter alia because of its supposedly short-term horizon, its perceived monopolistic tendencies and its reluctance to reinvest profits and transfer technology within host countries. To support the state-sponsored industrialization effort it was necessary to develop: (i) an investment and production planning system, often on a five-year basis, and; (ii) a trade protection and internal regulatory system which would permit infant public enterprises to operate profitably. The formulation of an incentive system for  private business was of secondary importance, and the international competitiveness of local industry was subordinated to the principal concern of choosing priority industries and setting up pro'uction plants. The competitiveness of industry was assumed to be achievable as a result of a learning process which would reduce infant industry costs over time. 1.06 The experience of the past twenty years has shown that, despite some initial gains in terms of industrial growth, usually of an import- substitating type, the state planning and investment approach has not been succassful in many countries, and, rather than laying an industrial base, it has resulted in many cases in economically inefficient, high cost, capital and import-intensive enterprises, often unprofitable without sustained protection, and highly vulnerable to foreign exchange shortage without contributing adequately to foreign exchange savings. In fact the decade of the 1980s has been one of deindustrialization in parts of Africa; the earl!er gains in industrial growth have been reversed so that in 1987 the ratio of manufacturing tc GDP in the lower income economies of SubSaharan Africa was the same as it had been in 1965, at the start of the industrialization drive. 2/ 1.07 As stated above, an enabling environment is one that involves a combination of sound macroeconomic policy, price incentives, and a supportive institutional and regulatory framework. More precisely the business environment msy be defined inter alia by: (i) the nature of the price system - the exchange rate, interest rate, wage rates, and input and output price determination; (ii) the trade policy regime - import and export tariffs, subsidies, trade-related goods taxes, and quantitative restrictions, including licensing regulations etc; (iii) the corporate tax system and the system of fiscal incentives; (iv) the financial system - its solvency, liquidity, lending regulations, supervision, capacity to provide industrial finance (debt and equity), and system of monetnry incentives; (v) the role of the state, ownership and reservation policy for industrial assets and land; (vi) corporate and labor law and its enforcement, particularly as regards entry and exit regulations for industry; (vii) the institutional and economic infrastructure (promotion and technical services, power, transport etc). An improvement in the business environment, in the context of a controlled economy with nonfunctioning distorted markets, involves freeing of prices accompanied by removal of quantitative restrictions in foreign exchange, capital, labor and goods market. Physical controls are replaced where necessary and appropriate by transparent price-related measures (e.g. taxes and tariffs rather than licensing controls). Producers are then able to make autonomous buying and selling decisions based on rational price signals. Reforms in the regulatory and incentive system should complement price reforms, aiming at encouraging efficient investment and production. 1.08 Over the past three years, since the announcement of the Economic Rehabilitation Program, a series of policy initiatives has affected the business environment in Mozambique, in the area of exchange rate management, planning, pricing, distribution, public expenditure, credit, investment 2/ This is discussed in SubSaharan Africa: From Crisis to Sustainable Growth, The World Bank, Washington, 1989.  -4- incentives, enterprise avnership. These initiatives have entailed a broad series of changes, notablys (a) the opening up of access to f.: .gn exchange, with improvements in competitiveness of industrial production through exchange rate changes, and modification of the tariff structure to substitute for quantitative controls, and to reflect more the requirements of industry for protection; (b) an increase in enterprise management autonomy and accountability after 10 years of central planning of pricing, distribution and procurement of larger e- erprises with few major decisions taken by management; tc) improvement in financial discipline as a result of the cessation of the use of the banks as a channel for financing the central plan, credit and interest rate reform, redefinition of the role of the Central Bank, restructuring of bank finances, and decentralization of lending; (d) some revival of the private sector through changes in ownership policy, investmen incentives, increased interest by foreign and local investors, and increased emphasis on the development of swall enterprises. 1.09 At the same time great efforts are still needed to inter alia rationalize enterprise ownership, rehabilitate and increase utilization of capacity and improve management, as well as continue exchange rate, price and wage reform, and rehabilitation of the banking system. As the central planning of production, prices and distribution is dismantled, the role of Government in industry has to become one of more regulation and oversight. This requires creation of the right conditions for industry to flourish, and implies the need to construct an incentive framework which channels production and investment, both in skills and fixed assets, in ways that are consistent with economic priorities. 1.010 The study examines the following specific policy areas relating to medium term industrial strategyt (P) industrial structure and growth and short to medium tern industrial efficiency in terms of international competitiveness; (b) the efficient allocation of resources and appropriate policy in the areas of foreign exchange allocation, licencing, prices, trade tariffs and taxes, corporate taxation and fiscal incentives; (c) analysis of the financial sector, the reform process and future developments, and aspects of industrial investment policy, including the export retention scheme, asset revaluation, debt-equity conversion, and promotional infrastructure;  -5- (d) t.e requirements for industrial investment financing and possible instruments for private sector participation, with emphasis on equity financing, and their role and effectiveness in industrial promotion. 1.11 The enterprise data-base for the study was a sample of about 60 enterprises visited in Maputo, Beira, and Nampula, and 10 enterprises included in a detailed enterprise restructuring study. 3/ In addition a credit survey of 120 companies was used as the basis for estimating demand for industrial finance. B. Conclusions and Recommendations Industrial Structure 1.12 The industrial sector in Mozambique inherited from the colonial regime was relatively diverse, and large in terms of output per capita, by comparison with other Subsaharan African countries; there are few obvious instances of misallocation of past investment, most of which took place prior to 1975, during a period when Portugal opened the economy to multinational ivestment; potentially many enterprises could probably be rehabilitated to =come economically efficient. However, industry as a whole is import- Spendent and has an ageing capital stock some of which was second hand at istallation; the state of plant and equipment in many enterprises is very )or and is a constraint on efficient production. However, over 1987-89 _idustrial production has increased following a steep decline from 1981 to 1986. The increases are due mainly to increased provision of materials and spare parts through donor support, allowing fuller capacity utilization, and initial steps in rehabilitation of enterprises. Donor support however brings with it problems of production planning, procurement tying, and lack of coordination. Effective further recovery depends on major rehabilitation where feasible, but it may also face a depressed market for some manufactures, due to the decline in real purchasing power of certain sections of the population, and dislocation of others as a result of the security situation. Manufacturers of discretionary consumer goods have faced market constraints. 1.13 The general trend of declining output has been countered in the case of the micro-enterprise sector, those of 10 workers or less, which, according to available data have shown an increase in production and employment over 1973-1987, especially in metalwork, wood products and garments industries. Thia sector, if economically efficient, may also be a source of future growth, and it is also likely to be a source of entrepreneurial learning. A focus of future credit and promotional activity ihould be in this sector, in conjunction with the effort to rehabilitate existing larger enterprises which account for the majority of employment and capacity. 3/ This study was carried out for the IDA Industrial Enterprise Restructuring Project.  -6- 1.14 Tht-re are indications of increased local and foreign investor interest in the country in a number of sectors of industry and commerce. The Government has started to improve investment incentives with reforms of the tax and tariff system and provision of investment codes, ationalization of company ownership, and financial restructuring of enterprises and the banking system. In addition major macroeconomic reforms such as currency realignment have had beneficial effects on industrial competitiveness. However, the prospects for both foreign and local invet-ment depend to a significant extent on the resolution of the security situation. Economic Efficiency of Industries 1.15 Currency devaluation has generally lowered wage costs as a proportion of total costs so that enterprises are more competitive in terms of international prices. In the short run, taking into account direct costs and ignoring plant replacement costs, most industries are able to produce efficiently in economic terms. This means that they are generating net foreign exchange and doing this efficiently enough to justify the commitment of resources for short-term support. Enterprises which are not economic in the short run appear to include sugar, glass, tire tubes, and metal pipes. which are not covering their direct operating costs in the present difficult operating conditions. 1.16 Taking account of long term costs of production including plant replacement costs, with their present setup many industries are probably uneconomic. This is due to (a) shortage of materials, inadequate repair and maintenance and lack of technical and management skills, which lead to capacity underutilization, (b) operating inefficiencies such as overmanning and excessive material wastage and (c) demand constraints resulting from dislocation the population and economic adjustment. However, rehabilitation of these industries, and the sector in general, with complementary increases in productivity in the workplace and good management, could in principle restore economic profitability to many enterprises in the long run. The rehabilitation of industry will firstly require identification of industries which are economically viable, and, secondly, improvements in labor and material productivity in those industries. Case-by case cost-benefit studies are essential if a viable restructuring program is to materialize. Industrial Sector Policy 1.16 Foreign Exchange Allocation and Licensing. The current export retention scheme is an effective short to medium-term instrument for mobilizing exports, although it may create certain longer term investment and production biases. The operation of the scheme could be clarified in order reassure investors that they do not face significant foreign exchange risk. In this respect some benefit may be derived by setting up special overseas accounts for eligible companies which would provide guaranteed access to foreign exchange, unaffected by exchange rate changes. 1.17 Prior to the opening up of the foreign exchange market, the Government should institute a foreign exchange allocation system based on a measure of the efficiency of production of enterprises, as a substitute for the current more arbitrary priority lists. The suggested measure is the DRC ratio which is already known to the authorities. A method for systematic  prioritization of foreign exchange applications from enterprises using efficiency criteria should be introduced. 1.18 Prior to the opening up of the foreign exchange market, the policy of non-issuance of import licenses when domestic suppliers are available should be amended in order to ensure that lecal products are not isolated from international prices. In order to achieve this a specific percentage margin of domestic price preference for local suppliers could be introduced. This would assist the transition towards the use of tariff and exchange rate instruments to control foreign exchange demand, which is preferable to licencing. 1.19 Trade Tariffs and Pricing. By international standards tax revenue in Mozambique is relatively highly dependent on domestic taxation, with trade taxes comprising a relatively low proportion. Quantitative controls are used to restrict imports. However such controls do not produce tax revenue but instead transfer monopoly rents to traders. In addition controls obscure the relationship of domestic to world prices. The use of tariffs would restore the sensitivity of domestic prices to changes in world prices, and is therefore preferable on trade efficiency gremnds. In addition it would boost Government revenue. The tariff system should be designed for a) uniformity, and b) transparency. The study recommends the following. 1,20 A tariff commission should be formed within Government to monitor the issue of protection of industry (and other sectors) and advise on changes. The role of the CoDmission will be to: (a) estimate and set a minimum uniform tariff on all goods based on trade and exchange rate considerations, and revenue needs; (b) identify nonessential consumer goods which qualify for either higher tariffs or special excise taxes, on distributional equity grounds; (c) identify possible industries which qualify for infant industry/rehabilitation protection or protection in terms of employment or expected long run productivity gains; (d) examine the possibility of setting up an indirect duty drawback to exporters to compensate for high cost tariff protected domestic inputs. 1.21 In order to move towards a rationalized system, of protection, capital equipment and industrial materials should not be exempt from tariffs. 1.22 Prior to general decontrol of prices, and assuming that demand will sustain the prices set, the conditional pricing system should be modified and based on import price plus a margin, rather than the existing cast-plus- markup formula. This is to ensure sensitivity of prices to international competition. The margin proposed would be linked to that for 'domestic preference'. Enterprises setting prices within the agreed margin would, as at present, set their own prices with reference to the authorities ex-post.  - 8 - 1.23 Corporate Taxation and Investment Incentives. Tax holidays should be generally restricted in length. However, flexibility in negotiating with investors is important in order to maintain the current momentum of investor interest. Profits tax should be further reduced over time and the depreciation allowance incentives should be curtailed. 1.24 The Government should start looking into ways of substituting the Imposto de Circulacao (turnover tax), which currently tends to operate in favor of imports, by an alternative such as a value added tax or consumption tax. 1.25 The access of small-scale enterprise to fiscal incentives may be restricted because of lack of information; it is recommended that a study is made to letermine whether this is a constraint on development. 1.26 The above combination of tax proposals would increase the present value of Government revenue while restructuring the system of incentives to give greater incentive to existing producers, and maintaining a satisfactory level of new investor incentives. Financial Sector Policy 1.27 The financial system, and industrial investment promotion. There is considerable unsatisfied demand for long term rehabilitation finance from potentially economically viable enterprises. In order to effectively meet this demand continuing structural reforms in the financial sector are desirable. (a) The Banking system requires reorganization in order to strengthen its competitiveness and operations, and to increase productive savings, investment and growth. This involves inter alia institutional diversification (including redefinition of the role of the Central Bank), clearing of lending arrears, recapitalization, and reestablishment of bank performance criteria and a regulatory framework for commercial bank operations. The revaluation of enterprise assets, currently under way, is an essential requirement for the revival of sound commercial lending as well as regularization of company taxation. (b) The foreign investment legislation is in general beneficial to new investors, although some refinements may be advisable. General clarification of corporate law is important, p&rticularly in areas such as ownership and transfer of companies, industry entry and exit, and labor legislation. The debt-equity swap law appears relatively restrictive, especially concerning reversion of companies to the state and remittance abroad of principal. Clarification may be necessary if this scheme is to be effective. (c) If the former Unidades de Direccao are reconstituted as holding companies, it is important to establish them as self- financing entities independent of Central Government, and to  remove certain functions, such as foreign exchange allocation, in order to prevent conflicts of interest. (d) In order to maximize effectiveness of small enterprise promotion, the Government, through IDIL and other appropriate agencies, should ensure a) clear identification of needs of small businesses, b) cost effectiveness of assistance measures, and c) cost recovery through generation of revenue, where possible. 1.28 Financial Instruments and the Mobilization of Equity Funds. The rehabilitation of industry requires equity as well as debt financing. An environment more conducive to equity ownership should be developed, encouraging resources of entrepreneurship to come forward. The Government should examine institutional options in this area, building up on existing experience in the banking system and new institutions such as GPIE, and SOC7EF. Financial instruments should be introduced to permit transfer of control of state or intervened companies while, where appropriate, preserving the essential interests of the Government. Among a number of available financing techniques, appropriate instruments may include nonvoting preferred shares, and a form of management agreement with enterprise investors, which would allow independence to investors while safeguarding Government shareholdings. 1.29 For enterprises which have been rehabilitated, the possibility of worker share participation schemes should also be examined, as an incentive to higher productivity and as a redistribution device, building on the experience of generally constructive worker- management relations in Mozambique since independence. The success of such schemes however depends on the implementation of reforms in the business environment. 1.30 Considering the large number of industrial enterprises currently under state control, the Government should examine the possibility of forming a type of investment company, possibly with its own capital, which would mobilize equity investment, and other sources of finance, for industrial rehabilitation, and would provide services in the preparation and packaging of company restructurings, transfers and new investments. Initial financing of such an institution could probably be identified from sources such as international donors, and the private sector.  -10 - II. ECONOMIC BACKGROUND AND INWUSTRIAL GROWNH A. General Economic Backgron 2.01 At independence the economy of Moz..smbique was built around four main activities - subsistence agriculture, processing of agricultural commodities for export, migrant labor, and transit/tourism services. The external account depended on merchandise exports (principally cashew nuts, prawns, cotton and tea), transit trade (from South Africa, Zimbabwe and Malawi) and tourism, and mino workers remittances, (largely from the South African coal mines). The ue from remittances and services was usually sufficient to offset its on the merchandise trade account, which ranged between 202 and 352 bport value over 1960 to 1973. The industrial sector expanded rapidly a low base in the 10 years preceding independence, following the opening 'the economy to private foreign investment. Because of the relative ess of the economy over 1965 - 70 new industries needed to be --tionally competitive and therefore the sector does not exhibit obvious cation of investment; however, much equipment was second hand and all ent and skilled labor was foreign. The increase in industrial ------ent also assisted the build up of external debt, which by 1974 was US$640 million, or approximately 702 of GDP. 2.02 Following independence a series of major setbacks occurred. These included the departure of 902 of the settler population (about 200,000 people), and virtually all skilled manpower over 1974 -77, which obliged the Goveranment to take over control of numerous industrial enterprises in order to maintain production. The emigration also had particularly severe effects on plantation agriculture, rural distribution and the railways and ports, In 1974 foreign exchange reserves were almost fully depleted. The overall situation was aggravated by the diversion of transit trade by South Africa, reductions in mine labor and remittances, and fall off in tourism earnings. 2.03 Apart from the problems inherited at independence, in 1980 serious difficulties arose with the breakdown of the security situation; combined with a major flood and drought this led to a 602 reduction in exports over 1980-84. This was compounded by deepening economic management problems resulting from the central control of prices and production, which resulted in major exchange rate and price distortions in the production and financial sectors, with diversion of goods on to parallel markets. In 1986 the parallel market price for foreign exchange rose to a level twenty times the official rate. The shrinking of the tax base which had resulted from the dejarture of the settlers, and the price controls with consequent operating losses of many enterprises, assisted the growth of the fiscal deficit which reached a peak of 17.72 of GDP (before grants) in 1986. Concurrently, by 1986, total external debt reached US$3.0 billion and the debt service requirements exceeded 2002 of exports of goods and services, largely bilateral public debt, of which 202 was in arrears. Since 1987 the balance of payments gap has been met by donor assistance amounting to 80-852 of Mozambique's foreign exchange inflows. As a result of the fundamental problems facing the economy GDP per capita is estimated to have declined by 82 per annum in real terms between 1973 and 1983.  - 11 - 2.04 The industrial sector contribution to GDP rose to a peak of 12.5Z in 1980 but fell steadily over the period since. The decline in the services sector (which was the largest contributor to GDP in 1973) paralleled industry up to 1984, reflecting the collapse of transit trade and tourism. The manufacturing contribution to rDP in the years 1973 and 1980, was greater than of many other Sub Saharan African economies; however the 1985 level was well below comparable economies. reflecting serious disruption of industrial output and high level of excess capacity. 2.05 In January 1987 an Economic Rehabilitation Program was initiated. Overall details of the ERP are set out in Government documents such as the Policy Framework Paper, and its relevance to industry and banking is discussed in the remainder of this report. In overall terms the ERP introduced major macroeconomic changes designed to address the serious economic problems facing the country. Economic stabilization measures centered on credit controls and public expenditure cuts, while structural adjustment measures focussed on the exchange rate, pricing, trade and distribution of goods, taxes and tariffs, and a series of other measures related to these. The state Central Plan, in force since 1978, has been reduced in scope to more of a review function. As a result of the ERP measures, and major international financial support, including foreign debt service renegotiation, real GDP is estimated to have risen by about 42 per annum over 1987 and 1988. 2.06 The major source of growth has been the family and private commercial farm sector which responded to improved price incentives and probably also to the increased availability of consumer (incentive) goods. In addition industrial production turned round in 1987 and has expanded by over 252 up to 1989. A recovery of 302 in merchandise exports occurred from the low point of US$79.0 million in 1986 to an estimated US$103 million in 1988. Inflation and fiscal deficit targets have been met, the exchange rate target has been partly met and has settled at around 40 to 502 of the parallel rate, implying a considerable realignment of internal and external prices. The impact of the ERP has to be seen in context however; production levels still remain well below 1980 levels and the serious problems of security remain, along with those of inadequate skilled manpower and rundown capital stock. B. The Development of the Industrial Sector Industrial Developments Pre-independence 2.07 The current industrial situation in Mozambique is the outcome of ,everal decades of relatively drastic political and economic change, alongside changes that were also occurring in Portugal. In the early 20th century, industry was confined to a few agroprocessing plants such as sugar and sisal; manufacturing growth originated at the start of the industrialization of Portugal itself, in the 1930's, when Portugal turned its attention to its colony as a source of raw materials. From about 1930 smaller scale manufacturing began to emerge in Mozambique - including cement, bricks,  -12 - soap, beer and cigarettes, and a market for these industries was provided partly by the settler community which at that time numbered about 20,000. At the same time certain industries were curtailed in the colony, in order to ensure that markets were open to Portuguese exporters. This was the case with the Portuguese textile industry, based on Hozambican cotton exports which rose fourfold between 1939 and 1946. 2.08 Between 1946 and 1961 limited industrlal growth occurred largely to supply consumer goods, and to provide inputs to the export processing sector. Total employment grew from 25,000 to 90,000. The emerging industrial sector diversified from primary processing into consumer and intermediate manufacturing, including food products, garments, footwear, furniture, glass, metal products and light engineering. The first textile factory was permitted to start production in 1952, and cement production rose from 26,000 tons in 1946 to 200,000 tons by 1960. Nevertheless the most important subsector (in terms of employment and investment) remained primary processing; i.e. tea, sugar, sisal fibr, cotton ginning, and edible oil. 2.09 Over the period 1957 to 1970, according to the available index of industrial production, the rate of growth of industrial output averaged between 6 and 72 per annum, with an acceleration to over 102 during the period 1965 -69, as Portugal opened up the economy to foreign investment, particularly from South Africa. The 'open door' polic. for foreign investment included a series of incentives such as tax holidays, a. 1 profit repatriation entitlement; previous regulations requiring financial participation by Portuguese firms were dropped. In one sense the legacy of this period has been helpful to industrial viability, because the open door policy forced new enterprises to be internationally competitive and would therefore have resulted in the establishment of economically efficient operations. However, these enterprises tended t3 be highly dependent on imports, and were often equipped with second hand machinery; their reliance on foreign management and technicians was also a potential weakness. 2.10 The domestic market was boosted by a surge in colonization, with the number of settlers rising to about 240,000 by 1970, largely residing in the urban centers. The most rapid growth by subsector was in the metals and engineering industry which recorded an increase of 30? per annum in the latter period (1964-70). The restrictions on the textile industry were lifted, although only one additional plant had opened by independence. Intermediate and capital goods production expanded, including engineering, and metals, a petroleum refinery, chemicals, fertilizer, paints, etc. Import substitution manufacture increased its share of total industrial output steadily, from approximately 37? in 1955 to 61? in 1972, while the share of export processing activities declined proportionately. There was also extensive South African investment in cashew nuts with backward linkages to tin can manufacture and gas supply, both servicing cashew exports. By 1973 Cashew processing comprised about 25? of organized industrial employment (over 20,000 workers), and the industry was a major world supplier. 2.11 Summary data on enterprises and employment in manufacturing and processing over the period prior to independence in 1975 are as follows.  - 13 - Table 2. 1: MOZAHIQUE - PREINDEPENDENCE GROWTH OF ENTERPRISES AND EMPLOYHENT 1962 1967 1969 1970 1972 1973 No of enterprises 1283 1602 1802 1904 1488 1418 Employment 59090 68653 73044 85050 95810 99503 Sources Estatisticas Industriais; various years; Instituto Nacional de Estatistica 1973. In 1973 total manufacturing value-added per capita in Mozambique was estimated to be the sixth largest in SubSaharan Africa. 1/ The share of manufacturing in GDP was also higher than that of many Subsaharan Countries. Industrial Decline: Post-independence 2.12 Following independence in 1'75, the large-scale exodus of Portuguese settlers over the 3 years 1974-77, caused a serious disruption in production. The settler community had all but monopolized managerial and skilled jobs, largely because of the lack of educational facilities for Africans. This situation necessitated the "intervention" by the Government in numerous enterprises, many of which were by then in a state of neglect, and in some cases with heavy debt arrears. The coal mines were taken over after 2 serious accidents. Formal nationalization however only occurred in the case of petroleum refining and a shipping company. The banks (except for Banco Standard Totta which remained private) were either closed or merged under state control. The state also set up a network of overseas and domestic trading companies to take over commercial operations necessitated by closure of Portuguese firms. In 1975 specific criteria were laid down for intervention. These included a 60-day delay following the publication of a statutory notice during which owners of abandoned units or their representatives could oppose. In 1977 it was further decreed that intervened enterprises could be taken into state ownership if necessary, subject to various provisos. A total of approximately 300 enterprises were intervened initially, including many small distribution outlets which were after 1980 returned to the private sector. In 1987 a total of 140 manufacturing and processing enterprises were listed as intervened. It appears that the Government has returned numerous enterprises to private ownership, mainly in the small scale distribution sector, but increasingly in manufacturing. 2/ 1/ See UNIDO Handbook of Industrial Statistics, UN, 1984, Table 1. 2/ A notable example is Habor Tyres, where the Government renegotiated agreements with General Tyre. Similar initiatives have been taken in other csinponies.  - 14 - 2.13 A partial index of industrial Vioduction for 1973-Z9 is shown in figure 2.1. Figure 2.1 INDEX OF INDUSTRIAL PRODUCTION P0VISILGA C1SS0 * 100) 140 130 - 120 110 100~ soX_ j 70. 60 -- 50 20 10 1973 1975 1980 198 1984 199 1987 1988 1989 YEAR 2.14 The index of production is tentative. It excludes certain subsectors, and applies to nationally registered enterprises (approximately 50 workers and above). Estimates for 1987 and 1988 are based on reported year to year increases. 1989 projection is based on MIE figures only. 2.15 The rapid decline in output after independence which is shown in the table was partly reversed by 1980. In 1981 however sabotage of infrastructure by armed bands began. This was combined with external economic difficulties associated with the world recession, and the lack of skills and management capacity. The centralized control of production, distribution and pricing also prevented enterprises adapting to adverse conditions. As a result there was a steep decline in industrial output over 1981-85 with 1986 output at less than half its 1V80 level for the above group of industries, and 30X of the pre-independence peak production. Sabotage was responsible for the decline of electric power distribution from 11.3 GWH in 1980 to 0.4 GWH in 1986. Petroleum refining was halted in 1985 and major output reductions occurred in a number of other manufactures, as shown in table 2.2.  - 15 - 2.16 As a result of donor import-financing and the start of rehabilitation, a turnaround in production occurred in 1987 when output rose in real terms by 7.0X; this was followed by an estimated 9.7Z increase in 1988, and about 7.6Z in 1989 according to partial results. The extent of disruption of industrial production is shown by the fact that, despite the three years of expansion, 1989 estimated output would still be little more than 5O0 of tha; achieved in 1980, and below 40? of 1973 levels. Over 1985- 88 output recovered irn a wide range of industries, but continued to decline in clothing. leather, footwear, furniture, and metals. 2.17 The steep decline in output volume in principal subsectors is shown in table 2.2. Table 2.2: MOZAMBIQUE - OUTPUT VOLUMES: PONER AND PRINCIPAL MANUFACTURES 1980 1981 1982 1983 1984 1985 1986 1987 Electricity GWHOOO 11.1 3.6 3.0 6.0 .4 (J.5 0.4 0.5 Textiles (mn mts) 6.0 10.1 9.5 8.4 8.8 6.1 5.2 7.2 Garments (mn pcs) 7.6 0.8 7.1 8.9 0.2 6.7 4.7 4.8 Paints (mn liters) 1.0 0.6 1.0 0.9 0.7 0.4 0.2 0.3 Tyres,tubes (000) 197.0 301.0 228.0 195.0 89.0 162.0 123.0 a/ Glass cont (m pcs) 24.0 121.9 19.9 16.5 20.6 9.3 6.9 a/ Oils,Soap (000 tn) 36.8 47.5 40.6 34.1 21.4 12.6 13.2 17.3 Flour (000 tons) 98.4 109.5 95.0 82.0 74.4 73.6 55.5 89.1 Cement (000 tons) 236.0 261.0 270.0 188.0 105.0 77.0 73.2 73.1 Timber (000 cu mt) 164.0 140.0 92.0 62.0 74.0 68.0 72.0 a/ al Statistics -were reclassified in 1987, and these categories are not directly comparable with 1986 data. Sources Estimated from Informacao Estatistica 1986, 87 (Conmmissao Nacional de Plano), 2.18 In the case of agroprocessing even larger declines occurred in marketed production, exacerbated by demonetization resulting from the general shortage of consumer goods in rural areas. In 1987, 6 ort of 14 cashew processing plants were non-operational, either closed down or sabotaged, according to the FAO, 31 with output at 15-20Z of 1973 levels. The industry has been decimated by a combination of a) neglect of plantations, b) drought, fire and pests, c) breakdown of the grading system in the field d) poor product quality and e) lack of transport vehicles, and attacks on rail freight. 2.19 Capacity utilization of industrial plant is estimated to have fallen to less than 30? in 1986 in many industries. (However the measurement of utilization is problematic). The most seriously affected industries were sugar (62 utilization), cashew, and oils and soaps (10Z) because of their '$/ Sources Study of the cashew nut industry in Mozambique. FAO, 1987.  - 16 - reliance on domestic materials and transport subject to sabotage. In manufacturing the most seriously affected were containers and paints (both estimated at 8Z), while only batteries and radio assembly recorded higher than 50. 2.20 Despite the dramatic decline in industrial production, industrial investment since independence took place to a limited extent in cereals processing, ship repair, bus assembly, timber processing, farm implements, vegetable oil, and textiles. In 1987 a total ef 20 textile-related projects operated in the formal sector, emplopying 12,000 workers. Industrial investment financed by the state reached a peak in nominal and real terms of 251 of total public investment expenditure over the period 1981-83, averaging about Mt 4.0 bn per annum. However, since then there has been a decline to the 1986 level of Mt 1.30 bn, accounting for just over 10 of public investment which was itself well below the 1981-83 levels. Over 1987-89 public investment in infrastructure and health services has increased, with the proportion of investment in industry and energy declining to a projected 61 in 1990. Manufacturing Employment 2.21 Industrial employment suffered along with output, although labor laws over the period prevented a steep reduction in factory manning. There have been a number of surveys of employment in industry, leading to conflicting estimates. Table 2.3 sets out the probable levels over time. Table 2.3: MOZAMBIQUE - GROWTH OF MANUFACTURING DIPLOYMENT 1973 a/ 1984 bl 1988 c/ 1988 d/ (revised) Total 99,868 83,533 116,989 88,553 a/ Source: Estatiaticais Industriais 1973: all enterprises, with possible underreporting of microenterprises. h/ Source: UNIDO: (1987) p 56t national level enterprises only. c/ Sources data supplied by Commissao Nacional de Plano (CNP): national level enterprises plus a proportion of local enterprises. d/ Source: amended CNP data. 2.22 The 1988 estimate is adjusted to exclude sugar and cashew estate workers which were included in the manufacturing employment data supplied by CNP. A survey by the Ministry of Labor for 1987 estimated 66,500 for all manufacturing, including microenterprises, which is inconsistent with the UNIDO and CNP estimates based on only national enterprises. The Ministry of Labor estimatii probably underreported employment outside Maputo. From the statistics avdilable it appears that there was a significant fall in employment, but not of the scale of the output decline.  - 17 - Exports of Processed Goods 2.23 Exports suffered from the decline in production of traditional products, particularly sugar and cashew nuts, whose export volumes in 1988 were 12.5Z and 41.7Z, respectively, of the 1980 level. The composition of processed export products has been primarily the following: cashew kernels and oil, ginned cotton, sugar and molasses, and tea. In addition, in the past occasionial exports have occurred of cement, tires, fabricated metal products and other manufactured goods. This is shown in table 2.4. Table 2.4: MOZWMBIQUS - PROCESSED EXPORT PRODUCTS 1973-87 Year (US$ million) Year (US$million) 1973 138.4 1983 79.0 1975 93.2 1984 47.1 1980 202.8 i985 33.4 1981 184.4 1986 42.4 1982 148.6 1987 50.6 Source: Informacao Estatisticais, various years. C. The Structure of Industry The Composition of Industrial Output 2.24 The following table shows the structure of employment and value added by 2 digit ISIC subsector, for 1973 and 1988 over all manufacturing and processing. Table 2.5: MOZAMBIQUE - STRUCTURE OF MANUFACTURING OUTPUT (Subsector Shares at Domestic Prices) 1973 1988 ISIC code Employment Value Employment Value added added . A . Food products 311-312 42.1 29.6 35.9 20.7 Beverages, tobacco 313-314 4.2 14.3 2.8 20.8 Textiles, garments, 32 leather, fibre 16.9 15.8 26.3 23.0 Wood, paper, printing 33 -34 16.0 10.3 11.6 8.2 Petroleum, chemicals, rubber, plastics 35 4.1 8.8 5.7 10.7 Nonmetal. mineral prods. 36 4.7 7.0 5.4 4.5 Basic Metals 37 1.1 1.2 1.9 1.2 Metal products, equipment 38 10.5 12.3 9.9 10.8 Other industries 39 0.4 0.5 0.4 0.1 Total 100.0 100.0 100.0 100.0 Sources Based on Estatistical Industriaw.s, 1973 , Ministry of Labor, 1987, and mission estimates.  - 18 - 2.25 The estimate of value-added for 1988 is provisional, based on mission estimates. 4/ Subsector shares measured at World prices would differ from those at market prices. 5/ Despite the externally dependent situation of the economy (in terms of trade, technolog> and finance), in 1973 the level of industrial capacity was relatively significant. As stated, manufacturing value-added per capita was the sixth largest in Subsaharan Africa. Value- added per capita for three major industrial branches was as follows: Table 2.6* MOZAMBIQUE - LEVEL OF MANUFACTURING VALUE-ADDED (1973): SELECTED LOW-INCOME AFRICAN ECONOMIES (Per capiti in US$ at 1975 prices) Total Food, drink Textile, garments Metal products Tobacco Leather, footwear Equipment (31) (32) (38) Ethiopia 11 3 4 0.2 Kenya 29 8 3 7 Madagascar 29 7 12 3 Tanzania 18 5 4 2 Zaire 15 3 3 3 Zambia 86 9 10 27 Zimbabwe 138 17 22 33 Mozambique 48 21 7 6 Source: UWYDO (1984); Op Cit, and Estatisticas Industriais. 4/ Value-added statistics have not been officially compiled. For this study estimates of manufacturing value added were made by applying separate value-added to gross output ratios for each three-digit branch of manufacturing, based on international data and derived by estimating the average ratio for individual branches for a sample of developing countries. Source: Industry in a changing World UN, New York, 1984, p.215. S/ Measured at world prices, the structure of output would differ if effective rates of protection are variable across branches. Shares of domestic resource-intensive industries (foods, textiles, wood, building materials etc), would tend to rise relative to import-dependent industries (petroleum, chemicals, plastics, rubber) which are generally more highly protected. Effective protection is difficult to measure in Mozambique because of extensive trade restrictions. (See chapter 5.)  - 19 - 2.26 In 1973, in terms of industrial structure, the dominant subsector was food, drink, and tobaccc, implying a colonial economic orientation (i.e. dominated by the processing of agricultural raw materials). The largest single industry in terms of value added contribution was sugar, and the largest in terms of employment was cashew processing. The dominance of foods resulted in relatively modest shares for textiles, metals and other branches. However the metal products and equipment subsector was larger in absolute per capita terms than that of four other countries illustrated, aithough considerably lower than that of Zambia and Zimbabwe. The textile industry group was also larger in terms of value-added per capita than that of several other countries. The split between consumer, and producer (intermediate and capital) goods production was approximately 67 s 33 in terms of value added. The direct export sector comprised about 20X. Overall average scale of production was 70 workers per establishment. Despite the relatively high level of industrial activity in relation to population, there were built-in problems, par%. -larly because a proportion of plant was second hand when installed, and tne skilled labor force to maintain it and operate industrial enterprises was almost exclusively foreign. 2.27 The 1988 estimates show that the structure of industrial production has shifted significantly towards the textile and apparel subsector, with a major decline in the case of food products; in the textile industry there was a high rate of investment in the 1970s, and as a result absolute declines in production were lower than in other industries; in the case of foods the decline has been mainly due to low capacity utilization and deterioration of assets because of security-related problems. This also applies to nonmetallic mineral products, in particular the cement industry which is still producing at less than 30Z of its 1981 level. In the case of metal products and equipment the decline has been more due to technical problems (lack of skilled manpower) and scarcity of imported inputs. The 1973 structure of output may be closer to that which would obtain if enterprises were currently operating nearer their capacities. Industrial Location 2.28 In 1973 Haputo (Lourenco Marques) province accounted for 442 of employment, and 51? of industrial value added. Beira and Maputo together accounted for 60Z of employment, and 71? of value added. The most widely distributed industries were cereals milling, cotton ginning, sisal, and timber which were located largely outside Lourenco Harques/Maputo province. In general the food and fibre processing industries, as expected, were widely distributed, while manufactured goods such as rubber, plastics, chemicals, paints, and metal products were heavily concentrated in the two major towns. 2.29 In 1987 the pattern was altered by the considerable increase in the share of Maputo province. This may partly reflect underreporting elsewhere. However, absolute employment in manufacturing and processing in Haputo Province, according to the Ministry of Labor Survey, shows an increase from 43,000 in 1973 to 46,400 in 1987. Maputo and Beira continue to dominate the sector in terms of employment and output. There are advantages in this  - 20 - in terms of economies of concentration and security considerations for those enterprises not dependent on materials from upcountry. However, against this in the longer term is the issue of income distribution and regional balance. Ownership Structure of Industry 2.30 As stated, following independence the ownership of industry ehanged radically as a result of the decision by the state in 1975 to tervenel abandoned or commercially sabotaged enterprises. After an tial intervention in about 300 enterprises the 1977 law permitted various nges, including full state ownership, or reversion to private ownership, ending on the circumstances. (See para 2.12.) In 1984 the structure of uw..ership of 575 nationally registered enterprises was as follows: Table 2.7s 7 HOZBIQUE - OWNERSHIP STRUCTURE OF NATIONAL ENTERPRISES state 114 intervened 140 private 294 mixed and cooperative 27 total enterprises 575 Source: UNIDO (1987) 2.31 State control over the manufacturing sector, partly forced on the Government by circumstances, is relatively extensive, and possible options for divestment are under continuous consideration. Evaluation and Sales Committees were set up following the law of May 1989, responsible for overseeing the disposal of intervened assets and the Government recently announced its intention to establish a bureau of enterprise divestment. This is discussed further in chapter 3. D. Industrial Strategy and Plannings 1977 - 87 2.32 In the period immediately after independence strategic issues had to be shelved as the Government concentrated on short term measures to offset the effects of the departure of skilled manpower. By 1980 however, prospects had improved, with partial recovery in production and favorable political developments in Southern Africa. As a result the Government decided to launch a 10 year development plan for 1981 - 90, with the aim of eradicating underdevelopment in a decade. The plan was extremely ambitious, calling for 17Z per annum increases in GDP, with parallel large increases in all sectors, with emphasis on large scale projects, state farms, and heavy industry, including iron and steel, aluminum, natural gas, chemicals and cement, plus expansion of consumer goods such as textiles.  -21 - 2.33 The financing and implementation demands of the plan however forced its abandonment, prior to formal publication and it was substituted by a more modest three year plan for 1982 -85. This in turn was upset by the rapidly developing economic difficulties of the country, and in 1983 at the 4th party congress a new policy was adopted emphasizing the increase in utilization of existing capacity, rehabilitation, and acceleration of existing project implementation. The previous emphasis on large projects was also substituted by support of small scale industry and liberalization of restrictions on private distributors. 2.34 The current industrial policy environment has to be seen in the context of the controls dictated by the Central Plan over 1979 - 1986. The plan, coordinated by the Comissao Nacional de Plano (CNP) was applicable to the nationally registered enterprises, accounting for about 60Z of industrial employment. Targets were passed down from the CNP through the Government departments and the "Unidades de Direccao" to enterprise level. Annual plans, submitted by enterprises, went back up to the CNP and a process of material balancing took place so that by the end of the year the CNP provided finalized targets to enterprises. 2.35 By 1983 it was accepted by Government that a greater degree of flexibility had to be introduced into the system. Over the past two years the role of central planning has been diluted; the current situation is that the Unidades de Direccao are still expected to provide production data through Ministries to the CNP but the plan is now based on 'bottom up' submissions of production price and shipment figures rather than the 'top down' instructions of the CNP. Nevertheless, business behavior in the industrial sector is still inevitably constrained by the effects of controls - e.g. there is little procurement or marketing experience, nor experience of actively seeking opportunities for profit making. This applies to both the public and the private sector enterprises. E. Small Scale Enterprise: Structure and Performance 2.36 As stated above, the role of small-medium enterprises in the economy has only become a focus of Government concern relatively recently, and information on the sector has not been systematically compiled. The prospects for this sector are however of importance, and an attempt has been made to process some of the available data. The economy-wide scale structure of industry in 1973 and 1987 is shown in figures 2.2 and 2.3, and Anne._ 11. 2.37 The data for both of these figures contain omissions and underreporting. For example, small scale garment making is underreported in 1973, and activity outside Maputo is probably underrecorded in 1987. In addition Zambezia province was not surveyed in 1987. Bearing this in mind the scale structure still seems to have shifted decisively towards microenterprises (under 10 workers), with llZ of 1987 employment compared with 2Z of 1973 employment in this category. 1987 employment in microenterprises doubled compared to 1973. The total micro and small scale sector, defined as enterprises with below 100 workers, comprised 252 of total employment in 1973 and 31Z in 1987. At the other end of the scale, for  - 22 - enterprises of over 500 employees, the 1973 share of 401 of employment has fallen to 29%, largely because of the semi-closure of industries such as cement, cashew processing and sugar. 842 of enterprises were in 1987 at the microlsmall scale level; extending the category to 'medium' scale (under 200 workers) would capture 95Z of enterprises with 46Z of total employment. By subsector the smallest average scale is in the wood products and textile (garment) industries (average 15 workers). The food sector also has a relatively large number of micro and small enterprises but also contains the largest (e.g. sugar), (see Annex 11). Figure 2.2 2.38 The overall 1973 estimate of 252 of employment in all recorded enterprises of INOUSTRIAL ENTERPRISE EMPLOYtEINT under 100 workers 9"Le Som 6, am." 59*9n a p p e a r s comparatively low; this could be 10-4B 2* accounted for by the known history Soo. /29.m Co.////of rural Mozambique (3955 S O* C9.mbefore independence where a combination of migrant labor and plantation \ / \ / agriculture may have distorted MD-4W C" M downwards the contribution of rural industry. The 312 estimate for 1987 however reflects the low c a p a c i t y utilization of larger enterprises as well aq a switch towards the smallest scale of production. 2.39 In the case of Maputo province alone (figures 2.4 and 2.5) employment increased between 1973 and 1987, from 43,000 to 46,400. Since the surveys of Maputo are likely to be more complete than those for other provinces, an analysis of the situation in Maputo province may shed more light on the issue. (See also Annex 11). 2.40 The figures confirm that in Maputo the only sector to exhibit significant growth, contrary to the overall trend, has been microenterprises with under 10 employees. There is also an increase in employment in the largest scale categories, which is principally explained by the establishment of textile spinning and weaving in Maputo province during the early 1970's. The structure of microenterprises in Maputo in 1987 was dominated by the garment industry, (consisting of 210 separate enterprises with 422 of total microenterprise employment). The next most  - 23 - Figure 2.3 m p o r t a n t activities were engineering and metal products INDOJSTRIAL ENTERPRISE EMPLOYMENT (ssmall repair shops), and wood swA &AM ot -asc 7 products. 2.41 The small- medium enterprise sea. C29.2% 93 < { 10-49 CO. a s#ector, with or without the microenterprises, constitutes a significant subsector in terms of enterprises and 00\ 1t 9 C15.0 employment. 200-499 C24.Se However, the evidence of relative dynamism in the smallest f irms is not easy to interpret; given the quantitative restrictions on trade, and the Figre 2.4 shortage of foreign exchange and skilled manpower, it is possible that the micro- I NDUSTR iAL ENTERPR I SE EMPLOYIMENT-MAPUTO enterprise sector, >so" KRSammW wn w i t h 1 o w e r dependence on 10-9 C~W)imports and technical skills, SeW (2) 4 ///// 8gained market share even with products so-s l4090.m t h a t w e r e uneconomic (with high relative economic cost in relation to q u a 1 i t y ) . 2 \ Nevertheless, the apparent fact of solid growth in this sector is consistent with international experience and it is likely that micro/small scale  - 24 - iagure 2.5 enterprises are . ~~~~~~~~~~g e n e r a 1 1 y potentially economic as a result of their INOLSTRIAL ENTERPRISE EYE-MAUT ability to utilize capacity more CS.%IW ~~fully, and their more appropriate lIIIj' g