Colombia - Industrial competition and performance

mupout No. 7921-CO 2 Colombia Industrial Competition and Performance j ue29I19" Trade, Finance, and Industry Operations Country Departrent III Latin America J the Caribbean Region FOR OFFICIAL USE ONLY .,.f,* . Doammn of Us Wod Sa This documnt has a restricted distribution and may be used by recipienrt only in the perfonance of teir offcial duties. ls content may not odew ise 7~~~~~~~~~~~~~~~~~~~~~~ !  -,,,.l,,.,- ,* ,:, ,. _ - Abbreviations0(con ',S'~~~hg tat. '~1 \' ' ' im '' .' ,~ ~ ~ ~ ~ ~ ~~~~on. -. .. ,.. :, . I',Banco do la R*p;blica CAy! Corporacidi de Ahorro y Vivienda CDT Certificado de D.pg'ito a T4frm.ino CF Corporacidh Financiera dEC Companfa de Financiamiento Comercial Cn Corporaci6n Financier& Popular CIIU ClAsIficACId& Industrial Intemnacional Uniform. CR4 Four-firm (plant) concentration-ratio CONPES Coneejo de Politica, Kconamica y Social DANE Departamento Administrativo Nacional de Estad(utica DNP Departamento Nacional do Planeaci5n DTF Depdsito do Te6mino Fipo FCE Fondo do Capitalizacion Empresarial FFA,P Fondo Financiero Agropecuario FFI Fondo Financiero Industrial IFI Instituto do Famento Indu-strial INCOMEX Instituto do Comercio Exterior ISE Inversion Sustitutiva del En:aje NABANDINA Nomenclatura Bruselas Andina (tariff nomenclature) PROEXPO Fondo do Prom'oci'rm do Exportaciones QR ~~~~~Quantitative restriction SHE Small and medium scale enterprise TFP Total Factor Productivity  FOR OFFIIAL USE ONLY This report is based on the findings of a vork program on the industrial sector in Colombia, initiated in January 1988 anJ concluded in March 1989. The report was written by Kristin Hallberg (LA3TF). Much of the background work for the report was undertaken by consultants in Colombia, guided by the Government's Industrial Sector Working Group and funded by a grant from the Japaniese government. The consultants were Gabriel Misas A. (market structure), Rudolf Hommes and Alberto Villate (financial sector issues), Hanuel Ramirez (labor markets), Nohra Rey de Marulanda (tax incentives and price controls), and Jorge Ospina Sardi (institutional issues). Estimates of productivity change and their relation to internal and external competition were provided by Mark Roberts of Pennsylvania State University, as par.t of the World Bank research project *Industrial Competition, Productive Efficiency, and Their Relation to Trade Regimes' (RPO-674-46). Contributions to the financial sector chapter were made by Silvia Sagari (CECFP) and Felipe Saez and Ana Maria Llorente (Colombia Resident 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 Jisclosed without World Bank authorization.  COLWGIAs INDUSTRIAL COIPETITION AND PERFORMANCE Table of Contents * P~~~fso Pa. mcsmn suuY 1. INTRODUCTION 1 1.1 sconomic Recovery Since 1984 1 1.2 Indicators of Industrial Performance 2 1.3 Conclusions 21 1.4 The AnalyticAl Framework of the Report 23 L 2. TINDUSTRAL PERFORMANCE AND INTERNAL AND EXTZRNAL COMPETITION 26 2.1 Introduction 26 2.2 Trade Policy and the Degree of External Competition 26 2.3 Domestic Harket Structure and the Degree of Internal Competition 40 2.4 Trade Policy, Industrial Structure, and Performance 61 2.5 Tax Policy and Industrial Incentives 65 2.6 Legislation Governing Non-Campetitive Behavior 67 2.7 Conclusions and Policy RecoiAmendations 68 3. RESOURCE MOBILITY 71 3.1 Introduction 71 3.2 Patterns of Plant Entry, Exit, and Growth 71 3.3 Price Controls 76 3.4 Labor Legislation, Labcr Costs, and Labor Mobility 90 3.5 The Concordato as a Barrier to Exit 105 3.6 Conclusions and Policy Recommendations 106 4. THE FINANCIAL SECTOR AND INDUSTRIAL STRUCTURE AND PERFORMANCE 108 4.1 Introduction 108 4.2 Characteristics of Credit Markets 108 4.3 The Financial Behavior of Industrial Firms 116 4.4 Implications for Industrial Market Structure and Financial Sector Development 126 4.5 Conclusions and Policy Recommendations 132 5. THE DESIGN AND IHPLEMENTATION OF INDUSTRIAL AND TRADE POLICY 134 5.1 Introduction 134 5.2 The Institutional Framework for Macroeconomic, Trade, and Industrial Policy 134 5.3 Conclusions and Recommendations 139 BIBLIOGRAPHY 140 ANNEX 1: Industrial Performance and Internal/External Competition: Regression Results 144  LIST OF TABLES Table No. Pate No. 1.1 Manufacturing Output by Subsector 3 1.2 Manufacturing Output Growth 4 1.3 Share of GDP by Sector 5 1.4 Manufacturing Share of GDP: International Comparisons 5 1.5 Share of Manufacturing Output by Subsector 7 1.6 Share of Manufacturing, Output by Subsector, 19Fr5s International Comparisons 8 1.7 Manufactured Exports 9 1.8 Share of Manufactured Exports 9 1.9 Export Growth Rates, 1965-85 10 1.10 Total Exports, 1980-88 11 1.11 Composition of Minor Exports, 1985-88 13 1.12 ExpoLt Orierntation of Manufacturing 14 1.13 Export Orientation by 3-Digit Manufacturing Subsector 15 1.14 Total Factor Productivity Growth in Ma.nufacturing, 1977-87 19 1.15 Aggregate Total Factor Productivity Growth, 1950-86 20 2.1 Import Licensing Requirements, 1980-89 28 2.2 Frequency Distribution of Tariffs, 1989 28 2.3 Licensing Requirements and Average Tariff by Sector and Stage of Processing, 1989 29 2.4 The System of Import Licenses in 1989 31 2.5 Production Coverage of QRs by 2-Digit Subsector, 1989 32 2.6 Production Coverage of QRs by 4-Digit Subsector, 1989 33 2.7 Import Protection: International Comparisons 36 2.8 Imporc Penetration for Broad Product Groups 38 2.9 Import Penetration, 1977-86 38 2.10 Distribution of Plants by Size, 1977-85 41 2.11 Distribution of Plants by Age, 1977-85 41 2.12 Distribution of Plants by Major Metropolitan Areas,1977-85 42 2.13 Distribution of Plants by Departments, 1981-85 42 2.14 Distribution of Plants by Industry, 1977-85 43 2.15 Concentration of Production, 1968 and 1984 45 2.16 Concentration by Type of Industry, 1968 and 1984 46 2.17 Production Participation of the 100 Largest Industrial Firms 47 2.18 Measures of Concentration by 4-Digit Subsector 48 2.19 Concentration of Production: International Comparisons 52 2.20 Internal and External Competition by Manufacturing Subsector 57 2.21 Industries Ranked by Internal and External Competition 60 2.22 Price-Cost Margins by Manufacturing Subsector 63 3.1 Entry and Exit of Manufacturing Plants 73 3.2 Entry and Exit Rates by Manufacturing Subsector 74 3.3 Share of Manufacturing Output, Average Plant Size and Survival Rates of Entry Cohorts 75 3.4 Evolution of the Price Control System 79 3.5 Characteristics of Industries Subject to Pr_ce Controls 82 3.6 Annual Variations in Price Controls by Manufacturing Industry 86  Table No. PLae No. 3.7 Index of Prices for Major Subsectors 87 3.8 Profits of Major Firms, 1985-87 88 3.9 Statutory and Extra-Legal Non-Wage Benefits 92 3.10 Statutory Not-Wage Benefits 93 3.11 Vage and Non-Wage Paymento to Labor, 1970-86 93 3.12 Non-Wage Costs Int"rnational Comparisons 96 3.13 Real Remneration in Manufacturing, 1970-86 97 3.14 Real Wages in Manufacturing, 1970-86 98 3.15 Real Hourly Cost of Labors International Comparisons 99 3.16 Labor Share of Manufacturingt International Comparisons 100 3.17 Labor Turnover Rate, 1984-87 102 3.18 Informal and Temporary Labor, 1984-88 104 4.1 Credit by Ecovamic Sector, 1983-88 108 4.2 Directed Credit to Industry, 1984-88 110 4.3 Share of Directed Credit, 1984-87 111 4.4 BR Industrial Development Credit Terms, 1989 112 4.5 BR Industrial Development Credit: Resource Cost and Lending Rates 113 4.6 Interest Rates on Directed and Non-Directed Credit, 1981-87 114 4.7 Soutces and Uses of Funds of Private Corporations 117 4.8 Sources and Uses of Funds of Manufacturing Firms 118 4.9 Financial Indicators, 1971-85 119 4.10 Financial Indicators, 1983-85 120 4.11 Real (Ex-Post) After Tax Costs and Yields 124 4.12 Securities Markets Indicators, 1984-88 130 4.13 Selected Equity Market Statistics for Latin American Countries 131 LIST OF FIGURES Figure No. Page No. 1.1 Growth in Minor Exports and the Real Exchange Rate 12 1.2 Total Factor Productivity Growth and Total Input Growth: International Comparisons 22 2.1 QR Coverage and Concentration of Production 612  VZCUTIVZ SUMARY 1. This report assesses the performance of the Cclombian industrial aector, and examLnes the relationship between industrial performance and trade, regulatory, and financial policies. The report seeks explauations for the allepgd lack of dynamism of Colombian industry -- the failure of resourcec to move into areas of evolving comparative advantage, and a lack of ability to reduce costs and improve international competitiveness. Policy recomendations are focused on the objective of raising a-locative and productive efficiency, in order to increase international competitiveness and speed adjustment to changes in markets and technologies. The report is design d to provide analytical support to the Government's industrial strategy and a basis for industrial and trade policy discussions between the Government and the Bank. 2. In 1984 the Government adopted a macroeconomic program of stabilization with growth. The program emphasized fiscal and exchange rate policies as instruments to achieve internal and external balance. The results of the adjustment program were impressive -- the fiscal daficit was substantially reduced, and real GDP and manufacturiDg sector growth averaged 5Z during 1986-88. Strong growth in non-coffee exports -- particularly petroleum -- and the 1986 coffee boom improved the current account from a position of deficit equivalent to 62 of GDP in 1984 to a small surplus in 1987. 3. Despite the encoaraging recovery of GDP and manut c:uring following the adjustment program, a closer look at some irdicators ot 4.ndustrial performance suggests that the recent growth of the industri, sector, and indeed the experience of the sector since the mid-1970s, has - -rowth without change, and growth at high cost. A lack of structural ca.. we' is evidenced by the fact that the contribution of manufacturing to GDP has remained relatively constant, contrasting with the experience of some 3ther newly industrialized countries that have seen more dynamic manufacturing growth. The paze of diversification into intermediate and capital goods industries has slowed, and the share of nondurable consumer goods in Colombian manufacturing is now high comptred to much of Latin America and other newly industrialized countries. Raecent non-traditional export growth has been concentrated in a few products, and the value of minor exports has just now recovered to its pre-recession level. The export orientation of most industries is low and in many cases below that of the 1970s; exporting remains a marginal activity for most industrial firms. Thus, a fundamental shift in the structure and market orientation of industry does not seem to have occured. 4. An esti -tion of total factor productivity growth, both for the economy as a whole and for the manufacturing sector, indicates that recent output growth has been costly, in the sense that it has been mainly due to expansion in tie quantities of resources used (primarily cap al) rather than  - il - increases in the efficiency of resource use. Low and frequently negative rates of productivity growth were evident not onlr during the recession of the early 1980s, when capacity was underutilized, but also during the economic expansion of the late 1970s and the recovery of the mid-1980s. These productivity estimates suggest that significartlv higher economic growth could havu boen achieved if productivity levels had merely stayed constants during 1977-87, the fall in productivity growth reduced the growth rate of manufacturing output from 6.1x to 4.9?, and improvementr in the efficioncy of resource use would have raised output growth above 6.11. For the future, the failure to increase productivity is problematic not only from the standpoint of Colombia's ccmpotitiveness in international markets, but also because continued output growth achieved by using ever gruater quant' ies of resources may be unsustainable. 5. The report focuses on the degree of competition facing industrial firms from both internal and external sources, and how this competitive pressure (or the lack of it) may explain the level of efficiency of different segments of the industrial sector. As in many developing countries, the small Mse of the Colombian market comb'ned with economies of scale in production encourage oligopolistic market structures and limited internal competitive pressure. The concentration of production in the industrial sector appears to have increased during the last twenty years, particularly in intermediate and capital goods industries. The historical tendency toward concentration of onnership and control via horizontal and vertical integration has become much more prevalent, implying more limitsd internal competition and more significant barriers to entry than are suggested by traditional measures of domestic concentration. 6. While the trade policy reforms undertaken in the 1984-86 adjustmenLt program eliminated a number of import restrictions, the reform program did not tundamentally alter the inward orientation of the trade regime. Imports continue to be restricted via prior license requirements for the majority of domestically produced goods, with little or no regard to price or Cquality differences. The coverage of local industry by quantitative restrictions, estimated at 841 of domestic production in 1989, is high by international standards: during comparable time periods. the coverage of domestic manufacturing by quantitative restrictions was 181 in Argentina, 412 in Brazil, 232 in Mexicu, and 482 in Venezuela, and more recent trade reforms in these countries have further lowered quantitative restrictions. While the degree of constraint of the licensing regime has been eased during periods of relative abundance of foreign exchange, the system introduces an element of uncertainty and lack of transparency for both consumers and producers. The anti-export bias of the trade regime continues to eesult in a low export orientation of industry and a lack of export diversification, further limiting competitive behavior among firms in export markets. 7. The empirical analysis of this report suggests that the low degree of internal and external competition have been factors causing the industrial sector's disappointing productivity growth and lack of international price competitiveness. The welfare losses of the imperfectly competitive domestic markets, reflected in higher price-cost margins, are reinforced by the lick of competition from imports. In thls sense the current trade regime, which  _ iii - grants nearly complete protection from imports to domestic producers, protects the ability of oligopolistic firms to earn excess profits. The price discipline eftects of higher rates of import penetration are greater in more concentrated industries where the ability to earn excess profits is higher, and the effects are greater for larger plants. 8. Both internal and external competition are also related to dynamic efficiency. Higher rates of total factor productivity growth are observed in industries with a more competitive domestic market structure. Higher rates of productivity growth are also associated -eith increased import penetration. Import discipline seems to have a greater efficiency-improving effect in more concentrated industries -- i.e., those that face little ,ompetition in the domaestic market -- implying that the efficiency benefits of trade liberalization would be higher in more concentrated industries. 9. The relationship between competition and performance clearly points to the need fcr aggressive pro competition policies, both internal and external. While competition policies on both fronts are important, and in fact may be complementary in many cases, there is an argument for making external competition policy the leading policy effort. First, by its very nature the trade regime restricts import competition across a wide range of domestic production, so that a general liberalization would be expected to promote efficiency improvements across many subsoctors. Second, in industries characterized by economies of scale or other natural barriers to entry, imports may be the only source of significant competition. Finally, the design of policies to increase internal competition, both as a complement to the trade reform and as a means to improve performance in industries in which a concentrated domi.stic market structure is the main cause of inefficiency, is more complex. The analysis of this report suggests that the focus of policies to incrpAse domestic competition and facilitate entry should be the financial sector. In addition, anti-monopoly legislation and regulations restricting non-competitive behavior will need to be strengthened and applied. 10. With respect to trade policy, a pro-competition stance requires a fundamental shift from past attempts to protect inf- industries from import competition that relied on the hope that the provisbn of a wide "marg.n of inefficiency, would give them the ability to mature and become more competitive. It must be recognized that while this import-protection strategy was useful during the initial stages of industrialization, it has become counterproductive. The trade regime has protected the position of inerficient incumbents, perpetuating their infancy. Trade policy must now focus on giving firms the incentive to become more efficient, by exposing them to the forces of international competition. 11. To bring international price pressure to bear on domestic industry, the trade policy reform should begin by changing the main instrument of protection from quantitative restrictions (import licenses) to tariffs and the exchange rate. To achieve greater neutrality across markets and industrial activities, the level and dispersion of protection must be reduced. This would imply reducing the number of tariff rates, the average tariff, and a substantial reduction in the maximum tariff, while at the same time reducing tariff exemptions granted to both public and private sector importers.  Greater relianco neods to be placed on the exchange rate as the min instrument of export promotion and officient import substitution. Further exchange rate adjustamets would *ncourage *zpansion of the traded goods sector. Reform in the iport regime should be accompanied by reductions in fiscal incentives (CZRTs) and subsidized crodit for exports, with export credit offered only at interest rates cospatible with those which prevail for domestic economic activity. Finally, the Governmat should continue its program of l proving the customs administration. 12. The Government has recently announced a plan of trade policy reform as an integral part of a five-year program to modernize the economy. The program is to begin by replacing quantitative restrictions by equivalent tariffs, followed by a reduction in the level and dispersion of protection. There would be an increase in the role of fiscal, monetary, and exchange rate policies to achieve external balance. The program would also include institutional reforms to encourage exports and discourage unfair trade practices. 13. The program represents a sigiiificant initiative on the part of the Government to increase the exposure of Colombian producers to import competition and to gradually reduce the anti-export bias present in the structure of trade incentives. A central issue now is the need to put the trade reform program in the context of the medium term macroeconomic framework, detailing policies to be taken to adjust to the balance of payments impact of the trade reform itself as well as other policies to improve the efficiencf of resource allocation and to maintain internal and external balance. In addition, it would be advisable to set (and announce) quantitative targets for the t-ansfer of products to the free import list and the structure of tariffs throu&nout the reform period. 14. 'urning to other industrial policies, the report finds that the tax regime, as a result of the 1986 :eforms, is basically neutral in its incentive effects across industrial subsectors. Thus tax incentives do not seem to be acting as a barrier to entry and competition, or biasing resource allocation across industrial activities, as they do in many developing countries. On the other hand, the function of the seemingly ad hoc system of price controls is unclear. The usual objectives sought by countries applying price controls do not seem to have been achieved by their use in Colombia. For example, it does not appear that price controls have been used to limit the ability of oligopolistic firms to earn excess pro'its, since not all industries with a concentrated market structure are so regulated. Neither do price controls seem to be used as a mechanism of providing basic necessities to lower income segments of the population, since they cover only a few items, and not necessarily the most important items, in the consumer market basket. In industries subject to price controls, the cost-based price adjustment mechanism may be disadvantageous for dynamic efficiency, as firms have little incentive for cost discipline. Though the Government has moved to redu.e the coverage of price controls, it would be recommendable to eliminate these controls altogether, in concert with trade policies to increase external competitive pressure and industrial policies to reduce barriers to entry and growth.  15. The report Investigate* the mobility of non-financial resources in the industrial sector, snd the extent to which cortain structural and policy factors act as barriers to resource mobility. In labor markets, high non- wage benefits contribute to the relatively high labor cCbt9 in Colombia relative to other developing countries, though to som extent non-wage benefits have substituted for wages in total labor compensation. While labor legislation has not been the only cause of high non-wage benefits, soe regulationa governing severance payments, in particular the retroactivLty of cesantia payments, are important contributlng factors. RegulatLons designed to protect workers from arbitrary dismissal increase the costs of layoffs to fLrms, thereby reducLng labor sobllity, but the sharp lncrease in required payments after an eployee's tenth year of service leads to premature layoffs before the tenth year. StrLngent labor regulations encourage evasion by fLrms, reflected in the frequtent use of temporary contracts and a large informal labor market. Labor legislation reforms should focus on eliminating the retroactivity on partlal withdrawals of the cesantia regima, replacing the vension-sancion with a more complete pension system that does not suffer from inflationary erosion, and converting the accion de reintearo system into an unemployment insurance scheme. 16. The structure of financial markets and the incentive effects of financial policies affect industrial performance directly, through their impact on the availability and cost of financial instruments, and indirectlv through their effects on industrial market structure. The report finds that financial sector inefficiency and the distortionary effects of some financial policies have had significant effects on the financial behavior of industrial firms, and have reinforced the concentrated structure of industrial markets. 17. The oligopolistic structure of the financial sector and, until recently, restrictions on the entry of foreign-owned banks have reduced pressure on financial institutions to minimize costs. The high operating costs of financial institutions have been one cause of large intermediation margins. The other major factors, explaining an estimated half of intermediation margins, are the high reserve requirements and mandatory investments required of financial institutions. In turn, high intermediation margins affect industrial performance by increasing the cost of credit and encouraging an industrial market structure conducive to interfirm credit transactions. 18. The subsidized directed credit system has distorted relative costs in favor of debt rather than equity financing, resulting in a highly leveraged financial structure of industrial firms. The availability of subsidized directed credit may have also led firms to choose more capital intensive methods of production, contributing to the capital-using pattern of industrial growth of the industrial sector. 19. The existence of subsidized directed credit also has pernicious effects on the structure of financial and industrial markets. In financial markets, though directed credit has been intended to be a partial solution Lt the pro-lem of market failure for private long term credit, the fact that directed credit offers a cheaper alternative to other financing options may have been part of the reason that private long term credit markets failed to  - vi - develop. The notable decline in the importance of securities markets and underdeveloped capital markets in general has been partly a result of the effects of tax incentives and directed credit on financing choices cf firms. Finally, subsidized directed credit has provided a source of low-cost funds that has encouraged the growth of the interfirm critit maket. 20. In the industrial sector, the distribution of directed credit reinforces the imperfectly competitive structure of indastrial u.arkets. Since intermediation margins on directed credit are fixed, credit tends to be allocated to larger and more well-established incumbents (except for the special SHE window). This works to the disadvantage of medium-scale firms, those wviti higher risk (such as new firms or firms financing non-traditional activitiec), and those without a close relationship with a financial institution. For this reason the system of subsidized directed credit with fixed intermediation margins can also be seen as a barrier to entry, growth, and change in the industrial sector. The desire to obtain subsidized directed credit also leads firms to form industriallfinancial conglomerates. 21. Recent financial policy reforms have addressed some of these problems: the burden of reserve requirements and mandatory investments has been reduced; a law has been passed to allow greater competition from foreign banks; the volume of directed credit to industry has declined; interest rates on most directed credit lines have been made variable and brought closer to market levels. The analysis of this report points to the need to continue financial policy reforms in these directions. Efforts to increase competition in financial markets should go beyond encou.-aging entry of foreign banks, to reducing barriers to entry of new domestic competitors and harmonizing regulatory requirements across different types of financial institutiorAs. The subsidy element of directed credit should be eliminated and intermediation margins freed, maintaining voltme only transitionally for the purpose of term transformation. The reform of directed credit would need to include the elimination of the subsidy element of PROEXPO financing, in line with a trade program that uses the exchange tate as the principal instrument of export promotion. These reforms will allow a reduction in the burden of mandatory investments, the main source of funds for directed credit. Moze aggressive efforts will be needed to encourage the development of capital markets. 22. The report is organized as follows. The first chapter provides factual background on the composition of manufacturing production and trade, and indicators of industrial performznco- The second chapter explores the relationship between industrial performanc;, and internal and external competition. The following chapter focuses on the mobility of non-financial resources in the industrial sector, and the extent to which certain structural and policy factors act as barriers to resource mobility. Chapter 4 examines patterns of industrial finance, and attempts to identify financial sector conditions and policies that have a negative impact on industrial structure and performance. The final chapter analyzes the institutional framework within which industrial and trade policies are designed and implemented.  CHAPTER 1: INTRODUJCTION 1.1 Economic Recovers Since 1984 1. The economic adjustment program initiated in 1984, which included a drastic reduction of the fiscal deficit, major devaluation of the peso, and modest liberalization of external trade, restored internal and external balance in th_ economy. The fiscal deficit was reduced sharply from a peak of 6.82 of GDP in 1984 to 1.42 in 1987 and 2.21 in 1988. After a perio.d of recovery, the economy grew strongly at 5.82 in 1986 and 5.3Z in 1987, before slowing to 3.7Z in 1988. The unemployment rate fell by about four percentage points to around 102 by December 1987, and remained at about that level during 1988. Investment growth (mainly private investment) was a dominant component of the growth of domestic demand, contributing 302 to the increase in total demand. The restraint in public consumption and investment also made possible a strong recovery in the growth of private consumption. 2. A distinguishing feature of the 1986-87 economic recovery was the impressive growth of the industrial sector. Real industrial output grew 6.0Z in 1985, 11.31 in 1986, and 6.31 in 1987; the manufacturing sector (including coffee) registered growth rates of 3.0Z, 5.92, and 5.02, respectively. It should be noted that some of the swift recovery in manufacturing outptut was possible because of an increase in utilization of existing capacity, evidenced by a decline in the incremental capital-output ratio during 1985-87. In 1988, industrial and manufacturing growth slowed to 2.22 and 2.3Z respectively. 3. By late 1984, the pace of exchange rate depreciation increased to a rate greater than the differential between domestic and foreign inflation. Between the last quarLer of 1984 and the last quarter of 1986, the exchange rate depreciated by 392 in real terms. Exchange rate policy since December 1986 has been to maintain the real exchange rate attained in that month. In spite of the 1987 decline in coffee prices, the current account balance improvee from a deficit of 6.02 of GDP in 1984 to near balance, and internacional reserves recovered to above 5 months of imports of goods and services by end-1987. Non-traditional export growth was particularly strong: non-coffee exports grew 242 in 1986 and 572 in 1987 in U.S. dollar terms. 4. Colombia's impressive macroeconomic and industrial performance in the mid-1980s seems inconsistent with claims by some that the industrial sector lacks a certain 'dynamism' -- that resources continue to fail to move into areas of evolving comparative advantage, and that industry lacks competitiveness in international markets. To provide information on the dynamism and efficiency of the industrial sector, the remainder of this chapter looks back over a longer period of time and in more detail. at some indicators of industrial performance -- the share of manufacturing in GDP and composition of manufacturing production, the growth and diversification of  - 2 - manufactured exports and the export orientation of domestic producers, and productivity change. 1.2 Indicators of Industrial Performance 1.2.1 Growth of the Manufacturina Sector 5. The 1967-74 period was characterized by significant g owth and diversification of Colombian industry, both as a result of import substitution and export expansion. Manufacturing output grew by 8.6Z per year in real terms (Tables 1.1 and 1.2). Thereafter, the macroeconomic problems associated with a boom in world coffee prices in 1975 led to an actual contraction of the manufacturing sector which, together with low growth in 1977, gave the 1975- 79 period an average annual growth rate of 4.11. With the end of the coffee boom of the late 1970s, and a macroeconomic policy framework generally unfavorable to industrial development, manufacturing output fell by an average of -0.5Z per year during 1980-83. However, the decline in Colombian industry ir the early 1980s was less than in other Latin American countries. 6. As noted above, the years 198" to the present represent a period of impressive macroeconomic recovery and in.ustrial growth. Manufacturing output recovered more quickly in Colombia than in the rest of Latin America. However, the manufacturing growth rates of the 19809 recovery have not yet reached those of the late 1960s and early 19709. 7. The share of manufacturing in GDP has remained relatively constant since the late 1960s. In 1987, non-coffee manufacturing comprised 192 of GDP, compared to 17Z in 1967 (Table 1.3). Small variations around this level followed the output trends described above: the share of manufacturing increased during 1 67-74, declined during 1975-83, and rose somewhat during the adjustment pexiod beginning in 1984. Agriculture has declined in importance, from 26.6Z in 1967 to 21.62 in 1987, and the services sector has expanded. 8. The importance of industry in Colombia has been and continues to be lower than in other Latin American countries and newly industrializing countries (NICs). In 1985, the industrial share of GDP was 28.92 in Colombia compared to 39.12 in Latin America and 37.12 in NICs; in developed market economies, the share was 35.62. Correspondinglf, the share of services in Colombia was larger than in the rest of Latin America and NICs. The stagnation of manufacturing's share of GDP in Colombia contrasts with the experience of some other NICs (e.g., Korea, Indonesia, Thailand, the Philippines, Turkey, and Mexico) that have seen more dynamic manufacturing growth (Table 1.4).  -3- TAKE 1.1: Mlaufacturing u uwt y Sbseetor (19N5 Col WII lea1t) 1966 1V, 1_ 1is 1617 TOTAL 132.7 336.' MK. go.6 6.7 NMe-urable Consumer Good. 6.7 125.1 1n.$ 157.1 172.4 Food5 U.1 37.1 115.$ 121.1 182.6 Othr food products 46.3 63. 90.1 4.7 In.& s.ora.e 6.6 14.6 21.7 22.2 24.6 Tocco 2 3.6 4.4 1.7 4.3 4.1 ToKti lea, Clothing, Loather 22.6 6.9 09.6 ".0 49.4 Durabl- Consumer A Intermediate Go*o 44.8 91.1 13 7 114.5 13.6 Wood Indu telte & Furniture 2.9 4.2 4.4 4.2 5.2 Paper Products to rinting 6.2 14.6 16.9 29.4 23.6 Chemlcal. A Rubber Product. 16.5 6 7.0 44.4 46.9 54.6 Petrolem Refining Product. 6.5 10.4 11.1 14.9 13.6 Mon-Metal Mineral Products 4.6 7.9 10.6 11.1 13.3 Basic Metals 8.2 16.5 19.1 17.9 29.6 Capital Goods 5.7 13.6 23.3 24.7 25.9 Machinery A Equipmnt 3.7 9.6 12.8 12.3 13.7 Transport Equipment 2.9 6.2 11.9 12.4 12.2 Other Industries 1.6 2.5 C .3 3.6 4.6 Source: DANE, National Account.  -4- TANA 1. 2 Menufacturig Output Greoth 1#7-74 1974-79 1979-0 11081-1 TOTAL O.OX 4.1X -8.5X 4.0X Nes-Durablo Consumer Goeods 6. 4.83 4.5 8&.8 Food 6.OX 5.82 1.83 2.8X Other teod product. 5.73 5.4X 1.2X 2.51 Beverages 7.6x 6.3x 1.83 S.1s Tobacco 6.1X -4.09 1.2X 4.8X Textiles, Clothing, Leather 7.73 2.5X -5.7X 4.0X Durable Consumer A Intero Gd 10.7X 3.03 0.23 5.9X Wood Industries A Furniture .4X *.2X -1.83 O.9X Paper Products A Printing 18.2X 4.7X 0.7X 6.1X Chemicals A Rubber Product. 12.6X 8X.x -S.a S.4X Petroleum Refining Products 7.1X 0.83 5.9X 8.9X Non-Metal Mineral Products 8.53 .6ex 1.4X 5.3X Basic Metals 10.73 3.6X -8.3X 65.X Capital Goods 15.13 6.83 -4.OX 7.83 Machinery A Equipment 15.1X 5.6X -8.63 6.3X Transport Equipment 28.1X 6.83 -4.5X 9.0e Other Industries 7.9X 4.8t 4.X 7.1X Source: DANE, National Accounts. Notes: Growth rates are simple avorage of annual growth rates. Growth of Manufacturing Output in 1975 Colombian Pesos.  -5- TAKLE 1.8 $ hre of W by Secor 9117 1174 11 11 4 11 1416 PhIY 16.6N 18.11 ".X 22.11.21 11.13 21.83 Agriviter., Fishing, Forestry 26.6X 28.11 22.71 22.23 2 l. 21.311. SECOUAR (DOUSUM 1.4X 119.6 23.x3 21.0 80.4X 8.21 MimIng 21.3 1.7X 1.81 1.73 4.21 4.21 Manufacturing 21.1X 2.53 221.81 21.21321.43 11.11 Coffee 8.6 2.61 8.811 J." 2.61 2.81 Other 17.83 12.71 16.1 16.213 1U.S1 16.8X E IetrIcIty, Gas, Water 6.7x 9.sx1 1.1X 1.1 1.1X 1.1X Construction 8.71 8.61 8.41 4.13 8.731 8.6 TERTIARY (SEICES) 42.5 44.6X 46.4.61 47.6X 48.n Commere s.2x 18.8 11.73 12.83 11.6X 11.61 Transport, Storage, Communications 7.3X 3.5X 9.8X 9.61 6.61 o.7x Financial Estabi ahmentn 14.11 18.7X 14.6 14.4 14.13 14.2X Community, Social, Pereonal Services 14.21 11.9X 12.7X 1t.2X 18.8X 18.3 Minus Imputed Bank Service. -2.8X -2.6X -2.73 -2.73 -2.15 -21.1 VALUE ADDED 97.1 97.71 96.6X 97.13 07.2X 07.x Indiroect Taxes 2.5a 2.8X 8.41 2.sx 2.61 8.61 CROSS DOMESTIC PRODUCT 116.61 11.61 1wX .X 16.13 1.01 1S.13 Source: DAVE, National Accounts. TABLE 1.4 : Manufacturing Shere of OP: Intornational Comprliono Country Manufacturing Share of COP 1#67 1917 Colombia 1o1 19X Koreo 1x UNX Ind'neoi a BX 14X Thailand 143 24X Philippines 2X 26X Turkey 16x 26X Maxico 26X 26X Source: World Bank, Wor1J Development Report 1169.  -6- 1.2.2 The Comosition of Manufacturina Output 9. The structure of Colombian industry diversified rapidly in the first two decades following World War II, from predominantly traditional consumer goods (851 of manufacturing value added in 1945) toward intermediate products, reflecting the strategy of import subatituting industrialization. Growth was particularly evident in steel, chemicals, petroleum refining, and paper. By 1966, intermediate goods accounted for a larger share of manufacturing value added (432) than was the case for other newly industrializing countries S371). 10. During the 1967-74 period of export-led growth, expansion of capital goods industries, at almost 18Z per year, exceeded the 81 annual growth of non-durable consumer goods and capital goods, and was also greater than in other NICs. The pace of 4iversification into capital goods slowed after 1974, and the concentration in chemicals and basic metals which Colombia had developed relative to other NICs disappeared by the 1980s. 11. In 1987, ncndurable consumer goods (food products, textiles, clothing, and shoes) accounted for over half of manufacturing output, a proportion that has remained fairly constant over the last ten years but is below the proportion that prevailed in the mid-1960s (Table 1.5). Durable consumer goods and intermediate goods accounted for 402 and capital goods 82. International comparisons show that the share of nondurable consumer goods in Colombia is now high compared to other Latin American counLries and NICs. In 1985, food products accounted for 38Z of manufacturing value added in Colombia, compared to 30% in Latin America, 152 in NICs, and 14X in developed markat economies (Table 1.6). Durable consumer goods were 40Z of manufacturing value added in Colombia, the same as in Latin America and NICs, and capital goods accounted for 7t, compared to 152 in Latin America, 261 in NICs, and 402 in developed market economies. Thus, a notable characteristic of the structure of Colombian industry is the stability of the share of nondurable consumer goods since the mid-1970s, and the prominance of these industries in Colombia compared to other NICs.  -7- TALE 1.5: SMre ol Maufaeberim Output by Sub eesr 197 1174 low 1i4 1337 TOT 1.11 111.4 11.41 1.11 1. Nen-Durable Coenmer Geood 4c.11 5u.ns 5.43 U.4X 0.3S Food 43.711 6.3X n.7rs 41.41 n.es Other ooed produst 34.6X 23.73 81.11 31.61 S 11.0 s.wergr 6.73 6.23 7.41 7.41 7.23 Tobacco 2.23 1.91 1.3S 1.43 1.23 Textilee, Clothing, LeAther 17.13 16.lX 13.73 12.11 11.9 Durable Consumer A Intermoeiato Goode 88.7X U.51 37.33 X 8.2S 41.11 Wood Industries A Furnituro 2.2X 1.63 1.51 1.43 1.53 Paper Product. A Printing 4.7X 6.13 6.5X 6.31 7.6S Cheicals A Rubber Products 12.43 1S.9X 15.3X 16.63 16.1X Petroleum Refining Products 4.93 4.43 3.93 4.7X 5.5S Non-Metal Mineral Products 8.43 8.3X 3.6X 3.7X 3.9X Basic Metals 6.2X 7.3X 6.6X 5.96 6.3X Capital Goods 4.3X 7.6X 6.2X 6.2X 7.73 Machinery A EquIpment 2.6X 4. 1X 4.4 4.1X 4.0X Transport Equipment 1.65 3.5s 3.61 4.13 3.63 Other Industries 1.2X 1.1X 1.1X 1.33 1.4X Source: DANE, National Accounts.  .9...~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ TAKE 1.6 : 1hare o Maufacturing Value Added by Subeseter, 1666 Intereatilel Ceperleoe DM Nice LAC CI. MAMUFIJACTU11N VALUE AD=S 11.11 I1.11 16.6 X .6 81 Foed, e*eraee A Tobacc 14.13 15.131 81.6 7.53 81 Textiles, Apparel * Leatber 6.43 16.63 18.61 12.73 8U Wocd a Wed Preduets 8.83 8.1X 6.1 2.2X 84 Paper A Paper Produtct .7x 4.2X 2.2X 1.93 85 Chmicals, Petroleum Products 16.9X 17.63 16.1X 21.tX 86 Nor-Metolic Mineral Product. 5.13 6.63 5.63 5.6x 87 Basic Metal InduW4.;os 6.63 9.3X 8 .X 5.23 Metoal Products, Mach, Equip 89.53 26. x 15.43 7. X 89 Other Man 'acturing 1.43 2.13 6.8X 21.X Not.: OMEs a Developed Market Economle NICn * Newly Industrialized Countries LAC a Latin America and the Caribbean Col a Colombia 1.2.3 Export Growth and Export Composition 12. The predominance of coffee as Colombia's main export has leclined since the late 1960s, from over half of total goods exports to an average of 421 over 1984-88. Manufactured exports grew and diversified, particularly with the increase in exports of petroleum products (Tables 1.7 and 1.8). The growth of manufactured exports was higher during the late 1960s and early 1970s than it was during 1975-85, partly due to a reversal of export growth over 1978-83. Garcia-Grrcia (1987) shows that manufacturing exports grew 13- 16Z during 1965-74 (depending on whether the definition of manufacturing includes all manufacturing, excludes agricultural-based manufacturing, or excludes agricultural and petroleum refining), compared to -1lZ to -57 during 1978-83 (Table 1.9).  ~~~-9 TARLE 1.7: Mbnufactured Exports CUS M Ion) 1974 1906 1964 1967 19m TOTAL 656.9 1199.9 1196.9 1002.6 1744.2 Non-4urable Consume Goods 3. 608.4 *7.4 514.6 65.6 Food, Bev, Tobacco 189.6 515.6 161.1 196.4 246.4 Textiles, Clothing, Leather 161.4 3.6 146.5 815.6 416.6 Durable Conumer A Intormdltoe Goods 273.2 n79.7 793.9 924.2 366.6 Wood Industries A Furniture 36.6 14.9 7.7 17.9 11.3 Paper Products & Printing 14.0 71.9 71.4 128.4 111.6 Chemicals, Rubber, Petrol Products 198.3 217.0 664.8 648.6 511.5 Non-Metal Mineral Products 25.6 71.5 84.5 55.3 58.1 gasIc Metols 6.P 3.6 76.6 64.6 160.6 Capitol Goods 52.6 187.9 55.7 1in 5 106.4 Metal, Machinery, Transport 52.6 137.9 55.7 I"6 6 106.4 Other Industrioe 26.1 76.9 *909 68.3 15. 2 Source: DANE. TABLE 1.8: Share of Manufactured Exports 1974 1966 1964 1967 196 Ti nAL 166.61 166.61 16.61 1006.61 106.61 Non-Durable Conumer Goode 46.7X *. 1X 25.9X 82.11 36.11 Food, Bev, Tobacco 21.2X 26.2X 18.61 12.41 14.?'A Textiles, Clothing, Lether 25.61 24.1X 12.81 19.71 2 9X Durable Conouer A Inter-dist. Goods 41.5 1 .81 e 6. 91 57.7X 49.1 Wood Industrie2 A Furniture 4.61 1.21 6.61 1.11 6.71 Paper Prod...t. A PrintIlg 2.11 6.61 6.11 7.7x 6.41 Chemicals, Rubber, Petrol Product. 29.41 16.21 56.91 46.21 26.8X Non-Metal Mineral Products 8.0X 5.9X 2.9X 8.51 8.*X Basic Metal.* 1.2X 6.ax 6.41X .2X 10.4X Capital Goods 6.61 11.5X 4.tX e6.a1 6.1 Met l, Machinery, Transport 3.X 11.5X 4.71 6. 8X 6.6 Other Industries 4.6X 6.6x 2.5X 4.61 6.61 Source: DANE.  - I0 - TAU 1.0 a aport Growth Et., 1665 165-74 1P446 1P43 136-5 q~~~~~~~~~~$S -.S - - - s._1_ Nee-Ceffe. Aylister.l (1,3) 6.5 -eel -4.1353 _I_mrnetemls I (0-11, U-IS) 14.13 6.13 -5.43 . MIfecurlrw It (15-13 13.3 1.13 -.65 6J.7 me"feeterlas II (1W1, 011-1) 15.61 J."3 -W.0 0.1s Geds (1-1) l." 1.65 -1.6 4.03 seeldN sd elose 5.1 3.65 -1.43 4.4X Se": Garcla @arch, (IS) Table S. Nu*mer In perenthese retfr to ee_te setore as dredl by DANE. 13. Since the beginning of the adjustment program in 1984, non-coffee exports have increased, and had particularly impressive growth rates in 1986 and 1987 (Table 1.10). In 1986, non-coffee exports grew 24Z in U.S. dollar terms; in 1987, though coffee exports declined 402 with the fall in the price of coffee, non-coffee exporta grew 57S. A decline in petroleum exports associated witL guerilla activity contributed to 1OS decline in non-coffee exports in 1988. 14. A closer look at the export data shows that even the significant expansion in non-coffee exports in 1986-87 did not represent a significant diversification of exports nor a fundamental shift in the export orientation of the industrial sector. The majority of the increase in ron-coffee exports during the economic recovery was due to growth in exports of petroleum, coal, and nickel. 'Minor exports', including agroindustrial, industrial, and mining products, increased at lower rates of 21Z in 1986 and 141 in 1987 and 1988. In 1988, minor exports amounted to US$l.780 billion, only 72 more than their 1980 value of US$l.668 billion. The increase in minor exports during the recovery period was largely explained by the significant real devaluation of the peso that was a cornerstone of the adjustment program (Figure 1.1).  TAKS 1.19: Tsl i-rl, 1_1" i1 lo 1904 i* am so9_ am IWAL 4# 11 am am gm mm C f_ an 1s 1784 im 14 19 10 NO*-Co efs gm 170 IK Ml MlW 46 11 Pebrle1_ in 1s1 441 460 1141 1911 Coal 19 .4 8 13 U US 8 Nickel 0 a a 4U 70 1in Mi or xwert. s6n 1171 *O 1126 I8" 1567 170 Gold 1s 1 1245 Su t 792 419 Souroe. Benco de I Rqwubileo, ftvlta 1S. With4n the category of minor exports, agroindustrial exports grew at an average annual rate of 18Z during 1987 and 1988, and industrial exports grew at an average annual rate of almost 21Z. Accounting for most of the growth of agroindustrial exports were three products: bananas, flowers, and cotton (Table 1.11). For industrial goods, the leading performers were textiles, garaents, leather, and shoes industries (402 average annual growth in 1987 and 1988), followed by industrial chemicals (22Z), and paper and printing (llZ). Remaining industrial exports had growth rates below 1OZ per year in nominal dollar terms. In other words, the recent diversification of exports into minor exports was not generalized across a wide range of prc.'ucts.  Figure 1.1 Growth In Minor Exports and the Real Exchange Rate 'U~~~~~~~~~~~~~~~~~~~~~~~3 '/ 0 t_l ~ ~ ~ ~ ~ ~ ~ ie t ut_ | RER (12186-100) -- Growth in Minor SourRe (12/86-100)cExports (%/yr.) Source: Banco de la Republics,.  TANA 1.11: CempOolti. of Milser 9xperW, 186646 (as X of Tot., ft"ort) 1ifS 1967 11 _ AOROINUThAL M.4 a7.1 M. so oft Agroidustriala 664178. Bananas 111.0 41.7 F Flowers 8.2 27.4 30.8 Cettoft 18.6 6.6 9.4 Shellfish 6.2 7.9 5.8 mot 1.5 4.8 1.5 Tobacco t.2 8.J 2.6 Cocoa 1.5 2.9 8.0 Frults and vogotablos 6.9 1.7 1.2 Other 6.1 2.8 11.0 INDUSTRIAL 57.6 58.6 55.1 as X of Industrial: TextilIs, garments, loather, shoos 27.8 81.9 84.5 Industrial chemicals 21.9 23.7 17.6 Food product. 13.6 12.5 6.5 Paper and printing 11.4 15.4 11.1 Motel products 11.9 6.J 7.8 Construction m0terlels 658 6.9 7.9 Wood and furniture 2.6 1.0 7.9 Other 1.5 1.8 7.9 MINING 3.4 4. a.c as X of Mining: Precious stones 61.3 981 8.8 Other 86.7 1.9 16. 7 Source: Banco do Is Ropublics, Revists.  1.2.4 Import Orientation 16. The export orientation of the industrial sector r maIns low sanufactured exports were 6.32 of do ntic production in 1966, below the ratio of 7.53 in 1975 (Table 1.12). The largest decline in export orientation was lc ao-durable con uer goods (.1 In 1975 to 5.11 In 1986), ccpepnated somwhat by the increased export orientation of the petroleum sector (increasing fro- 32.61 Iu 1975 to 69 72 in 1986). Non-petroleum non-durable consumer goods and intoimdiate goods increased from 6.91 to 8.21, and capital goods declined soewhat from 3.31 to 4.31. At a more disaggregated level, export orientation in 1966 was not significantly different than it was in the late 19703 for *may of the products that have ezperienced significant export growth (e.g., textiles, industrial chemicals, paper) (Table 1.13). The only non-petroleum, non-mineral industry to register significant growth in export orientation was the leather industry (from 241 in 1977 to 322 in 1986). TABLE 1.12: Export Orlentation of Maunw icturing (1 of Production Exported) 1975 1906 1964 1906 Total oxcl. petroloe 7.5 7.C 4.8 6.3 Non-durable consumer gooda .1 7.2 4.4 5.1 Durabl, conumer 2oods and 19.1 1.4 11.7 16.4 Intermediate goods R fInod petroleam 32.6 31., 52.6 69.7 Other 6.9 7.9 6.9 8.2 Capital goods 5.3 6.7 2.1 4.9 Othor 0.4 16.7 5.4 7.2 Source: Banco do Io RepubiIco, Rev Ieta.  - i5 - TABLE 1.13: Expert OrleaUtles by -O4git ManufeoUring Sub eeetr 1077 1976 1979 1DU lN" 166 I11 food Producte 5.2S 5.61 X .3 6.71S 4.11 41.7 313 0eversge 6.0 6.6 6.63 X.6x 6. S X.23 314 Teowo 6.23 6. 6.711 6.61 06.4 6.5311 321 Textilso 7.1X 7.33 7.53 S J.3 95.0 7.7X 322 Apparel 1.41 14.6 23.63 1 1.3X 1609. 17.0 323 La4thr 23.6J 23.63 19.2S 15.2X 26.71 32.63 324 Shoes 12. S11 l. 1 X 11.3 11.1 9.4X 14.43 331 Wood 16.03 11.23 16.4X 11.71 14.33 17.X 332 Wood Furniture 1J16S 1323 160JX 4.1 6. 7X 13.5X 341 Paper 4.43 8.4311 4.4 6.4 3.411 5.11 342 Prlnting 186.S 25.5 16.15 11.2% 3.aSE 18.?X 351 ChomTcal Pr*ducts 4. S 4.3J 4.91 S.2N 5.61 S. . 353 Patrol R@fti 18.9% 27.71 19.7X 8.4X A#.4X 32.61 354 P.trol, Coal 14.EX 6.41 1.2X 90.91 5.61 12.63 355 Rubber 3.61 1.9X 1."? 2.63 1 .5 2.2X 856 Plastic 1.61 2.51 2.91 2.91 2.1N 2.21 361 C.re.tics 11.53 ,86X 26.63 1.03U 5.13 6.6X 3J2 Ole* 11.5X 6.7X 9.4X 16.86 4.5X 4.6X 369 Other non-metal 10.1X 9.2X 1.61X 9.43 5.1X $5.X 371 Iron Steel 1.2X 6.0X 6.43 *.X 10.9X 16.7X 372 Non-Sorrowe metals 2.9X 1.9X 1.43 2.6X 16.5X 13.33 301 Fab Metal Prodte 6.33 6.6x 9.6X 7.6X 4.1X 5.45 382 Nonelec Machin 13.6X 16.6X 15.1X 13.3X 7.06 7.3X 363 Eloc Machinery 3X 2.73 4.6X 3.1X 3.5X 9.23 364 Transport Equip AX 2.7X 2.13 3.1X 1.2X 3.23 385 Scilntif Equip 2t.OX 14.3X 39.7X 17.1X 9.3X 0.6x 390 Other Manut 27.6X 16.6X 6.53X 68.6X 20.9X 27.2X TOTAL 6.61 8.61 6.81 7.33 7.4X 7.5X Sources: Boletin do Eatedistica, Oct-Doc, 106; Colombia Estadistica 1987; DANE, 1977-1906. 17. During the last twenty years, the chief source of growth in demand for manufacturing output has been domestic demand. Exports have been only a modest source of growth, rarely contributing more than 102 to annual output growth in any subsector. In contrast, the typical NIC derived significant advantages for growth and structural change from international market expansion, particularly during the late 1970s. During that period, with the real appreciation of the peso, Colombia lost out to competitors in export markets and to imports in the domestic market. 18. The data is consistent with anecdotal evidence that suggests that exporting is a marginal activity for most industrial firms: exports expand during short-run episodes decline in domestic demand, but most firms do not have a long-term commitment to sell in external markets. This Lack of commitment to export is partly due to the greater risk and initial information costs involved in selling in external markets, but probably mostly explained  - 1G- by the anti-export bias of the trade regime, which makes sales to the domestic market significantly more profitable than exporting. In addition, the low export orientation suggests the existence of dynamic inefficiencies that result in a lack of competitiveness in international markets. 1.2.5 Total Factor Productivity Growth 19. The level of output produced in an industry depends on the amounts of inputs used (labor, capital, and materials) and on the manner in which these inputs are used. An increase in output may come about by increasing the amount of inputs and/or by using a given amount of inputs more efficiently. Total factor productivity (TFPI growth refers to the latter: it is the residual component of output growth after the share of output growth attributable to input changes has been netted out. TFP growth is meaeured as the growthi rate of output minus the ccst share-weighted growth ratos of all prcduction inputs. Equivalently, it is the percentage reduction in the average cost of production, sdjusted for the share-weighted percentage change in input prices. 20. In general, technical change, scale econumies combined with output growth, and/or increases in capacity utilization can lead to reductions in average cost and hence positive rates of productivity growth. Even without any change in technology, TFP growth can result from a more efficient use of inputs by the firm. In fact, this last source of productivity growth is probably the most important one for developing countries.1 21. Roberts (1989) measured TFP growth for each of 28 3-digit manufacturing industries for each of ten years, 1977-78 through 1986-87, averaging the growth rates for three subperiods: 1977-80, 1980-83, and 1983- 87.' The results are shown in Table 1.14. Beginning with a look at the lNishimizu and Page (1987). 2The growth rate of total factor product'-rity in industry i between years t-l and t is measured as the growth rate of real output minus the share weighted growth in labor, capital, and materials using the Tornquist index number formula: l in TFPit - [ ln Qit - ln Qit_l ] - I SL (ln Lit - ln Lit.1) + SK (ln Kit - ln Kit_1) + SM (ln Mit - ln Mit_,) ] Real output Qit is measured as the nominal value of output in industry i in year t, deflated by an industry price index Pit for domestic industry output. The inputs are labor Lit, measured as the number of employees in the industry; capital input Kit, measured using the perpetual-inventory method; and materials Mit, measured by deflating the value of industry material purchases by an industry-specific material price index. The share weights SL, SK, and SH are the average expenditure shares of labor, capital, and materials in the value of output in years t-l and t.  - 17 _ recession of the early 1980s, reflected in negative manufacturing output growth averaging -1.3Z per year during 1980-83, TFP growth averaged -2.62 per year across all manufacturing. In other words, the decline in output vas mainly due to a loss of efficiency of resource use. The results suggest that output would have declined even more than -1.32 but for increases in the quantities of resources used. Equivalently, if productivity had stayed constant, manufacturing output would actually have increased, at 1.32 per year, during the early 1980s. Productivity growth was negative in fully 23 of the 28 industries (the exceptions were rubber products, glass products, non- ferrous metals, non-electric machinery, and scientific equipment). Of the 23 industries with negative TFP growth, 11 experienced output growth. 22. It is interesting to note that low and frequently negative rates of productivity gro'th in the manufacturing sector were found not only during the 1980-83 recession, but also during the prior and sutbsequent periods of output expansion. During the 1977-80 tibperiod, average TFP growth in manufacturing wss negative, at -0,72 per year, even though real output grew at 7.9? per year. This saggests that if productivity had merely stayed constant, manufact.1ring output would have increaspd by 8.6? per year instead of 7.9?. Of the 28 industries, 14 had negative rates of productivity growth; of these, the majority (10) had experienced positive output growth. During the economic recovery of 1983-87, when output growth averaged 7.4Z annually, productivity declined on average by -0.5? per year, with 13 of 28 industries buffering negative TFP growth. These results suggest that the negative productivity growth estimated for the early 1980s did not merely reflect low rates of capacity utilization, since even during the 1977-80 and 1983-87 periods of increasing capacity utilization and strong output growth, TFP declined. 23. Despite the fact that productivity growth was negative in virtually all industries in 1980-83, nine of the industries actually had higher (i.e., less negativre) rates of productivity growth in that period than in the 1977- 80 period. At the same time, of the fourteen industries with positive TFP growth in 1977-80, all had lower rates of growth in 1980-83. This indicates that the decline in the average TFP growth rate between the two time periods is not characteristic of all industries. Rather, the decline in productivity growth of the initially high-growth industries more than offset the increases in productivity of the initially low-growth industries. During 1983-87, though the majority of industries experienced improved productivity performance, nine (including many chemicals and basic metals industries) deteriorated. Over the entire 1977-87 period, the two-digit industrias with the lowest rates of productivity growth were basic metals (averaging -3.7? per year), paper and printing (-3.3Z), and chemicals (-3.1?). The only industry with positive TFP growth over the whole period was nonmetallic minerals (1.2Z). 24. These productivity estimates suggest that the main source of manufacturing output growth has been expansion at the extensive margin (the use of greater quantities of resources) rather than at the intensive margin (more efficient use of inputs). In fact, negative TFP growth even during times of output expansion implies that resource use is expanding at an even higher rate than output. Over the entire 1977-87 period, the contribution of  - 18 - TYP growth (-1.21) to real output growth (4.91) was -24S--in other words, the fall in productivity reduced the growth rate of manufacturing output by 241. Equivalently, the fall in productivity increased the growth of production costs, after adjusting for changes in input prices, by 242. 2S. The productivity estimates for manufacturing are consistent with recent estimates at the aggregate level for the economy as a whole. Garcia- Garcia (1988) finds that TIP growth averaged -0.2S per year over 1975-86, while real output grew at 3.61 annually (Table 1.15). In other words, real output growth was the result of a weighted average increase of 3.8Z per year in the quantities of resources used, which more than compensated for falling efficiency of resource use. Since 1950, aggregate economic growth has been derived primarily from increasing inputs of labor and capital and secondarily from productivity increases. Of the average economic growth rate of 4.81 per annum over 1950-86, TFP growth accounted for about 27Z. The contribution of TFP growth to aggregate economic growth rose during the 19509 and 1960s, peaking at nearly 50 during 1967-74. Since the mid-1970s, TFP growth has fallen, both in absolute terms and as a proportion of output growth. A malor contributing factor has been the declining pioductivity of capital, reflected as well in an increasing capital-output rat3o.  - 19 - TAKLE 1.14t TOTAL FACTOR PROOUCTIVITY GROWTH Di WANUFACTIDO,G 1977-1967 PRCPJCTIVITY GROWTH S I ,~ ~ ~ ~ ~~~~~~~L LOP 81 P00, WEV, TOSCCO - .428 -4.42 0.61 9.978 9.11 0.e2 811 Peed products -9.138 0.191 41.067 9.69 0.024 01.604 812 Food Prdt., n.o.n. -.. -4.942 *.967 C.2e 9.42 9.122 818 oveorage 9.916 -4."S -4.919 *.117 0.916 6.023 814 Tobeeo -4.115 -4.9S4 9.602 0.827 9.U87 - .025 82 TEXTILES, LEATHER -.0.6 -4.941 9.929 9.942C 40.0 91.14 821 Texti I.a -04098 4.957 .1.01 _d.4. -4.128 9.976 822 Apparel 6.078 -0.00 6. ON 9.906 4.681 0.114 828 Lather Products 9.036 -. 61 -.676 9.940 -0.061 6.as6 824 Footwear 6.945 -0.641 -O.025 6 *119 0.911 *0.77 I8 WOOD PRODUCTS .6os -O.649 0.025 9.074 9.191 0.977 881 Wood Products -O.03O -J.632 6.914 6.061 6.671 *.641 382 Wood FurnIture O0.71 -4.074 6.941 0.098 -0.976 *.13S 84 PAPER, PRINTINH -0.64 -o.e65 -o.eee .623 -OU4 *96C2 841 Pulp, Paper -.17 -4.056 6.029 .640 -4.019 *.e6c 342 Printing -0.995 -0.655 -.965 -0.916 0.027 -0.01 85 CHEMICALS, PETROLEUM -o.640 -4.16 -o.087 .698 -J.920 6.663 351 Industrial Chemicals O.643 -4.915 0.026 o099 0.027 *.121 852 Drugs, Cometics -0.018 -.064 -4.926 9.087 -4.19 *.161 854 Petroleum Prdta, Refin -0.166 -4.668 -0.112 9.2&4 -4.e24 *.eee 856 Rubber Products -4.O40 0.002 -4.027 *0.12 -4.652 9.616 86 Plastic Products -0,025 -4.8 -0.090 6.166 .626 6. fz 86 NONMETALIC MINERALS *.078 -o.o33 -4.eo5 9. 1SC .60 9 .os6 861 Pottery, C*eramics .075 -4.665 9.S" *.14 -4.079 0.126 862 Olass Products 9.931 0.001 6.weo 0.119 0.098 0.074 #89 Nonmtl Products nos. 0.092 -4.064 -4.919 0.142 0.024 0.081 87 BASIC METALS 40.9s8 -o.eo4 -4.019 -9.562 o.9n S.Ob 871 Iron Steel Beaic ktl -4.669 -4.618 -4.926 -4.42 0.118 0.074 372 Non-ferrous Metals -4.113 0.64 0.925 -4.108 -J.07 6.115 36 METAL PRODUCTS, MACHINERY 9.011 -4.022 -4.018 9.e6 -9.oen 9.687 861 Fabricated Metal Prdt. -4.e25 -0.024 -4.920 9.O66 -4.6 O.686 $82 Nonelectric Machinery 0.090 6.684 -4.66 a.me3 9.al -4.681 S83 Eloctrical Machinery 6.698 -0.036 6.98 6.140 -0.656 o.o8 S84 Transport Equipment O.615 -6.982 -0.028 8.064 -J.126 6.169 a83 Sciontific Equip_mnt 9.6" 9.e909 0.077 0.265 -4.09 6.162 89 OTHER MANUFACTURING 0.020 -C.es 9.689 6.064 -4.9W6 *.116 890 Other Manufacturing 9.020 -4.9os 9.o.6 . G4 -o.oe3 6.116 AVERAGE -4.O7 -4.026 4.065 6.079 -4.18 .974 Notes: 2-Digit CIIU averages weighted by 1986 8-Digit producclon. Shore of TFP Growth In Output Growth calculated as Productivity Growth/Real Output Orowth. Source: 'The Structure of Production In Colombian Manufacturing Industries 1977-19605; Mark J. Roberts, May 1909 (updated by Roberts, March 1990).  - 20 - Table 1.15: Agyegt Total Petre Productlvty G o, 196646 (averane"I grew"h rot.") low-1T 4.0 6.8 2.5 1.1 14.6 1166-" 4.9 *.9 2.4 1.9 89.6 1167-74 6.4 4.1 2.6 8.1 49.6 1974-4 5.5 4.9 4.1 1.0 16.0 196146 2.7 4.2 2.6 -4.6 -22.0 19t 166 4.6 4.8 2.0 1.8 17.9 1967-86 4.6 4.4 8.2 6.9 19.5 197-1116 4.3 4.4 8.2 6.9 16.6 197&-4 8.6 4.7 8.2 -4.2 - 5.0 Source: J. Gercie4Qrcla, Macroeconomic Crtmm .aero.conoalc Pollies! and Lon-Run Growth: Pert Ii, The Colombian Exprernce 1956-, Bogota, July 106. 26. This analysis of productivity change puts the recently-achieved economic growth in a new light, for it suggests that macroeconomic and manufacturing growth has been very costly, in the sense of being very resource-using. If the productivity decline had been avoided, these resources could have been used to produce significantly more output and a higher standard of living. 27. International comparisons of economic growth and productivity change suggest that countries can be broadly c'.assified into three groups distinguished by the rate of TFP growth and the contribution of TFP growth to output growth.3 Industrialized countries other than Japan are characterized by low rates of factor accumulation and TFP growth, but the latter accounts for about one-half or more of cutput growth. 'Typical' developing countries exhibit somewhat faster growth rates of both inputs and TFP than industrialized economies, but TFP growth accounts for less than 20Z of output growth. 'Atypical' developing countries -- including newly industrialized countries such as Hong Kong, Israel, Taiwan, Korea, Spain, as well as Japan - - have high rates of input, TFP, and GDP growth. As in the case of the typical developing countries, however, TFP growth plays a relatively less prominent role in output growth than in industrialized countries. 28. The TFP, output, and input growth estimates for Colombian manufacturing can be compared with similar data for 17 other countries (13 LDCs) covering various periods during 1960-81 that were compiled by Nishimizu and Page (1987). Figure 1.2 shows TFP growth and share-weighted growth in capital, labor and material inputs for each of these countries (using 1977-83 3Chenery (1986).  - 21 - averages for Colombis); the series of 45 degree lines represents increasing rates of output growth. The three rays from the origin show the combinations of TVP growth and input growth that give the share of TFP growth indicated. Countries that ad manufacturing growth rates similar to Colombia's during the period of study (e.g., Argentina and Chile) had higher rates of TFP growth, and thus a higher contribution of TFP to output growth. Those with similar ratoe of input growth (eg.., ggypt and Mexico) combined this with highor TIP growth to achieve higher rates of output growth. With Zambia, Colombia stands out vith its strongly negative rate of productivity change. 1.3 Conclusions 29. In 1984 the Government initiated a major economic adjustment program designed to restore internal and external balance, using mainly fiscal and exchange rate policies as instruments. In 1986-87, the improvement in the fiscal deficit and the trade balance, and growth in real GDP and manufacturing, all evidenced the success of the stabilization program. 30. Despite the encouraging recovery of both GDP and manufacturing, a closer look at some indicators of industrial performance suggests that the growth of the industrial sector since the adjustment program, and indeed the experience of the sector since the mid-1970s, has been growth without change, and growth at high cost. The contribution of manufacturing to GDP has remained relatively constant, in contrast to the increased importance of this sector in other newly industrializing countries. Recent non-traditional export growth has been concentrated in a few products (petro'eum. coal, nickel, and some agroindustrial and industrial products), and the value of minor exports has just now recovered to its pre-recession level. The export orientation of most industries remains relatively low and in many cases below that of the 19709; exporting remaini a marginal activity for most industrial firms. Thus, a fundamental shift in the structure or market orientation of industry does not seem to have occurred. 31. An examination of total factor productivity growth, both for the economy as a whole and for the manufacturing sector, indicates that output growth has been costly, in the sense that it has been mainly due to expansion in the quantities of resources used (primarily capital) rather than increases in the efficiency of resource use. The contribution of TFP growth to output growth has been low, and frequently negative. In manufacturing, negative rates of productivity growth were evident not only during the recession of the early 1980s, when capacity was underutilized, but also during the economic expansion of the late 1970s and the recovery of the mid-1980s. These productivity estimates suggest that significantly higher economic growth could have been achieved if productivity levels had merely stayed constant. For the future, the falling productivity of industry is problematic not only from the standpoint of Colombia's competitiveness in international markets, but also because continued output grnwth achieved by using ever greater quantities of resources may be unsustainable.  - 22 - Total Factor Productivity Growth and Total Input Growth: International Comparisons 16. 16- 30I -2~ ~ ~ ~~~~~~~~~~~0 yX=s~~~~O -2 0 2 * * S 10 U12 14 6 1 Tota Fadw hdo Growth Country Codes: 1. Sweden 10. Korea 2. U.S.A. 11. Turkey J. Finland - 12. Phillipines 4. Japan 13. Thailand 5. Yugoslavia 14. Egypt 6. Argentina 15. Zambia 7. Chile 16. Indonesia 8. Mexico 17. India 9. Hungary 18. Colombia, 1977-83 Source: Page (1988).  - 23 - 1.4 The Analytical Framework of tb. Rioort 32. The sections above presented data on the composition of industrial output, the growth and diversification of industrial exports, and productivity change that brought into question the dynamisa of the industrial sector. Dynaism refers to both the ability of the industrial sector to move resources into areas of evolving comparative advantag, and to its ability to r*ducw costs and improve international competitiveness. In other words, there are two aspects to industrial efficiencys the efficiency of allocation of resources across industries (inter-industry efficiency), and the efficiency of use of resources within industries (intra-industry efficiency). In a dynamic sense, inter-industry efficiency refers to the ability of resources to move to their most valuable uses in response to changing market conditLons, and intra- industry efficiency refers to reductions in production costs achieved vith the adoption of technological improvements, better organization and management techniques, etc. 33. The focus of this report is on the degree of competition faced by industrial firms, and how competitive pressure is related to inter- and intra- industry efficiency. It examines the relationships between industrial structure, performance, and public policies -- trade and industrial regulatory policies, and labor and financial sector policies. In addition to looking at competitive pressure and the resulting incentives pushing firms to move into new activities or reduce costs, the report questions whether there exist barriers to resource mobility that affect efficiency. 34. Public policies can affect inter-industry and intra-industry efficiency directly, through their effEcts on relative prices, or indirectly, through their effects on market structure and firm competition. An example of the former is the effect of import protection on the price of import substitutes relative to exports and nontradeable goods, which affects performance by biasing resource allocation. Tax policies and price controls also affect performance directly through their effects on relative prices. As an example of the indirect impact of policies on performance through their effects on structure and competition, import protection may encourage excess entry and result in a market structure characterized by firms of suboptimal scale. This in turn can produce the performance result of technical inefficiency as firms fail to realize economies of scale. Import protection can also affect performance through its impact on managerial behavior, as firms are not forced by external competition to minimize pr,duction costs. Financial pollcies can affect performance directly (through, e.g., their effects on interest rates) and indirectly: for example, a system of administered credit can reinforce the position of oligopolistic firms. 35. Conceptually, it is useful to think of competitive pressure on domestic producers as coming from three sourcess from other producers in the domestic market (internal competition), from foreign producers selling in the domestic market (import competition), and from foreign exporters competing with domestic exporters in third markets (export rivalry). The competitive pressure may come from existing firms, or from potential entrants (i.e., from  - 24 - the threat of competition in contestable markets).4 All three types of competitive pressure can lead to a 'challenge-response' mechanim whereby domestic firms are induced to adopt new technologies, cut waste, allocate resources more efficiently, and generally reduce costs. In addition, competition can be a force for industrial restructuring as firms shed outdated operations, introduce new product lines, and search for new markets. 36. Increases in internal and external competition can improve both inter-industry and intra-industry efficiency. For example, the efficiency improvements of a trade liberalization that increases import competition may arise from a more efficient allocation of resources among sectors (as resources are reallocated to sectors more in accordance with. comparative advantage, what is usually thoight of as the efficiency effects of a trade liberalization) and intra-industry efficiency effects -- increased scale economies as firms expand into export markets, reductions in prices in oligopolistic industries as firms are faced with higher !import competition, and improvements in X-efficiency. 37. In some industries, and for some types of efficiency, it may be that policies prc,oting external competition and internal competition can be thought of as substitutes -- alternative ways of achieving efficiency gains. For example, promoting external competition via import liberalization or internal competition via reducing barriers to entry could be seen as alternative ways of reducing excess profits in oligopolistic industries. In other cases, there may be less substitutability between internal and external competition policies. For example, in some industries, the small size of the domestic market combined with potential economies of scale raise natural barriers to entry and imply that, in an efficient equilibrium, the domestic market will be served by a few large firms. Regulation of the industry to promote internal competition may be a less feasible alternative than openi.,g the market to competition from imports. 38. Internal and external competition may be actually couaplementary in several important ways.5 First, while each dimension of competition is likely to improve both resource allocation and firm-level efficiency, they may have relatively stronger or weaker effects on different types of efficiency. For example, it is thought that domestic competition has a particularly strong effect on improved managerial (X-) efficiency, as managers are forced to cut down on waste and use resources more effectively. Import competition is thought to have the greatest impact on inter- and intra-industry resource allocation, creating incentives for firms to restructure or shed inefficient operations, and to expand output along more specialized lines. Export rivlary can help bring major dynamic efficiency gains, giving firms a sustained incentive to continuously adapt their production and marketing organization in response to rapidly changing market requirements. 4See Frischtak (1989). Sibid., Annex 2.  -25- 39. Second, internal and ezternal competition often act in synergy, utually reinforcing each other. In particular, an increase In either domestic or Import competition has a positive impact on export rivalry in the medlum to long run, even though the short run impact of import competitlon on exports may be negative. Third, each of the three forces of competition faces barriers, and barriers to one dimnsion of competition can prevent firms from behaving competitively along another dimnsion. For example, import liberalization may fail to achieve its expected efficiency effects if domstic markets for distribution of imports are imperfectly copetitive. 40. The next chapter will begin by examining the degree of internal and external competition felt by domestic industry, and how coWpetition has changed over time. Next it addresses how the degree of internal and external ccopetition affect certain measures of inter- and intra-industry efficiency. Finally, the effects of the tax regime on the inter-industry allocation of resources are considered.  - 26 - CHAPTER 2: LIDUSTRIAL PERFORMANCE AND INTERNAL AND EXTERNAL COMPETITION 2.1 Introduction U1. This chapter explores the relationship between trade and industrial policies and t4e structure, conduct, and performnce of the industrial sector. It questions whether trade and industrial policies have introduced significant biases in the allocation and efficiency of use of resources by altering iDrentives, both directly via their impact on relative prices, and indirectly through their influence on market structure. With respect to trade policy, the chapter focuses on the import regime (tariffs and quantitative restrictions). With respect to industrial policy, the focus is on price controls, with some reference to tax policy, policies govelning asset restructuring and receivership, and anti-monopoly legislation. 2.2 Tr&de Polic? and the Degree of Extetnal Competitiori 2.2.1 The 1984-86 Trade Policy Reforms 42. External sector policies over the last twenty years have been tied to the macroeconomic management of cycles in agricultural exports, particularly coffee. Rather than relying on macroeconomic policies to smooth out aggregate expenditure in response to external payments deficits or coffee booms, import and foreign exchange controls have been alternately tightened or eased. The use of trade policy as a stabilization device, combined with a conscious strategy of industrialization through import substitution, resulted in a lack of international coimpetitiveness and stagnant growth of industrial exports. 43. The 1984-86 macroeconomic adjustment program included measures to rationalize and liberalize the trade regime. The program broke new ground in stressing the roles of macroeconomic policies for stabilizi'ng the economy and trade reforms for promoting long-term export growth and diversification. The principal elements of the program were the maintenance of a competitive exchange rate; reduction of import and export restrictions; reduction of the levels and dispersion of tariff rates; and changes in export incentives. 44. A recent Bank report reviews the accomplishments of the program and describes the characteristics of the trade regime as it existed in 1988.1 It cites the maintenance of a competitive exchange rate as one of the major accomplishments of the adjustment program. However, despite the substantial real depreciation of the peso, the decline in the value of the peso was not 1"Colombia: Commercial Policy Survey", Report No. 7510-CO, December 15, 1989.  - 27 - fully translated into changes in the domestic torms of trades the prices of traded goods relative to nontraded goods remain below those prevailing in the mid-1970s.2 45. The adjustment program accoWplished a significant reduction in both the levels and dispersion of tariff rates, the average tariff rate fell from 61S to 30Z, and the standard deviation was cut in half between 1985 and 1988. Howevr, tariff surchargeo were introduced in 1985 at a uniform rate of 101 and increased to 182 in 1987. 46. The 1984-86 trade reforms achieved the reaoval of some items from the prohibited and prior license categories and a concomitant expansion of the free import list. Unrestricted tariff positions as a proportion of total tariff positions increased from 0.S2 to 38? during the reform program, and the coverage of domestic manufacturing by import restrictions fell from 10O in 1984 to 822 in l988.3 The value of imports enteririg under free pocitions increased less then 3Z of total imports in 1984 to 44? in l9e8. While these reforms were important, it should be noted that they resulted in a systrm in. which the number of unrestricted and prohibited positions had approximately returned to the levels prevailing in 1981 (Table 2.1). Ir uther words, the reforms of the licensing system mainly reversed the p:otvctionist trend of the early 19809. In addition, the items which were liberalized were mostly noncompeting inputs for locally manufactured gooda, so that external competition for domestic industry was not significantly increased. The previously cited Bank report concludes that the recent trade reform progrrm did not fundamentally alter the inward orientation oi productive incentives. 2'ibid: However, the report also warns that the pr4.re indices used in the calculations may need to be reviewed carefully to confi=r the empirical findings. 3ibid. The c-overage of domestic manufacturing by import rest.-ictions was calculated as follows: A concordance was constricted between the tariff nomenclature (NKABANDINA) and the industrial classification system (International Standard Industrial Classification, or CIIU). The mapping related each four-digit CIIU category to a group of eight-digit NABANDINA categories. For each four-digit CIIU, the coverage of domestic production is defined as the proportion of NABANDINA positions in that category that are either prohibited from import or subject to prior import licenses. For higher levels of aggregation (three- or two-digit CIIU) the coverage ratio is a weighted average of the four-digit coverage ratios, where the weights are production shares.  -2- T.blo 2.12 leert Leligg Iqir_ , 1_ (membr at tariff "wiless) 1ow 1P 1on 1o i"4 low is" in? 1io ioW a/ Prolbibted a a 6 6 61 of U U a Prier Lies. 1 MS aI 8716 4671 41 NO6 11 Ml 8181 1125 Free 876 1614 167 4 as nu mm Ion 198 178 TO. I HtON 4778 4864 NU 1ll Ull 1M U42 042 $11 S15L of July Soure: 'Coioabi. Commercial Polley Survey", Reprt WN. 7616, Dsembe 15, I1; alk Aremel de Adua es, July 1M. 2.2.2 The 1mort Regime in 1989 47. Tariffs. Under th* tariff code prevailing in 1989, there Are 23 tariff rates ranging from 01 to 200Z. The majority of tariff positions (881) have tariff rates less than or equal to 402 (Table 2.2). Tne highest tariff rates, 1001 and 200Z, are assigned to motor vehicles. The tariff structure exhibits the usual cascading structure, with ala average tariff of 401 for manufactured consumer goods, 222 for intermediate goods, and 211 for capital goods (Table 2.3). Across two-digit industrial subsectors, average tariffs are highest for food and beverages, textiles, and, to a lesser extent, wood and paper products. Rates are lowest for mining and petroleum, agricultural products, and chemicals. Table 2.2: Froquecy Distribution Of Tariffs, 199 Tariff Rate X of Tariff Positions -16X 14X 11-263 X4X 21-89 19!: 81-4eX 213 41-56X 4X 51-66 53 61-76X ax over 76 6.4X Source: Arancel de Aduanas, July 1989.  - 29 - Table 2.5: Lieewimg Reuirements and Average Taritf by looter a Sta of Pro..eaIng, 1909 MBR OF PRIOR AVE SECTOR POSITIONS P1011DrrED LICEISE PRE TARIFF Ubel. Rcoao 5 151 is o1S 9S m Aelriclture 276 a 6on 84! 122 # nine 79 29X 713 14S MamfteUrlng 4796 1X 62X sox ns Ceesurnr Goode t1496 S Us lOX 40 Imtrmsdiate Goods m2 48X 521 221 Capital Gooed 1162 63X 571 21S By StaeX of Prosesin: Rev Mat Livo Anl mI, Agr .Prod. 525 soX 421 191 Intoermeate Semi-Proc Inputs 1647 54X 661 18X Procese Food, Agric. 396 41 79X 17X !SX Proessed Food W/Additives 177 20X 76X as 653 harcmaouticals 61 71X 291 14X Other Intermediate Inputa 827 761 28X 31X Capital Equipment 86s 6an 40X 191 Transport Equip_mt 169 791 21X 341 Finishe Products: Producer 279 83S 17X 40X Fialuhi Products: Consumr 423 9a3 71 46X Source: Arancel de Aduanas, July, 1989. 48. Actual tariffs paid are! reduced by an extensive system of exemptions, covering about half of all tariff positions. In 1984, the trade-weighted average tariff was 212, while actual collections (without surcharges) were estimated at 10. Tariff surcharges are set at a uniform rate of 182, and are less widely exempted than customs duties. In addition, some imports are subject to a sales tax. 49. Imort licenses. The foreign exchange budget is fixed by the Junta Monetaria and rationed among importers by INCOMEX through its import licensing system. Each item in the NABANDINA tariff code belongs to one of three categories: free, for which INCOMEX must grant import licenses; prior license, for which INCOHEX has discretion to refuse licenses; and prohibited, for which INCOMEX will grant licenses only under unusual circumstances. 50. The distribution of tariff positions across these three categories is shown in Table 2.4. The characteristics of the products in these categories are as follows: (a) Free: generally intermediate inputs, raw materials, and capital goods that do not compete with local production. In 1988, this group represented 39Z of tariff positions and 442 of the value o$ total imports.  - 30 - (b) Prior Licenses camprising 602 of tariff positions, these are items over which INCOMI has discretion. The volume of these goods which are granted irport licenses depenas on the availability of foreign exchange and on the degree to which the import competes with domestic production. In general, INCOMEX does not approve imports which compete with local production, with little consideration given to price and quality differences. (c) Prohibited: this third broad category includes items prohibited for health and safety reasons, and others considered to be luxury items and therefore politically difficult to allow to be imported in a system with foreign exchange rationing. In 1988, this group represented 12 of tariff positions (and 02 of import value). 51. In the practice of considering applications for licenses, INCOMEX separates items in the prior license category into three sub-groups: (i) Previa-libre: non-competing imports that are de facto freely importable during periods of relatively abundant foreign exchange, but for various reasons (the desire to retain the ability to tighten restrictions during periods of relatively scarce foreign exchange, the fear of dumping) the Government does not want to pass to the free list. In 1988, these imports comprised 62 of all prior license items and 132 of the value of prior license imports. (ii) Previa-previa: items for which national production exists but may be insufficient; or items categorized in a tariff code that contains both competing and non-competing importables. This last point needs some explanation. The level of disaggregation of the NABANDINA tariff code is not high enough to assign a unique code to each functionally distinct product. Within a given eight-digit tariff code, there are often one or more non-competing importables as well as one or more competing importables. For example, the eight-digit code assigned to 'metal valves, may include both copper valves, for which sufficient national production exists, and aluminum valves, which are not domestically produced. In these cases, INCOMEX approves import licenses on a case-by-case basis, again using the criterion of national production. In 1988, 662 of prior license items (872 of the value of prior license imports) were in this subgroup. (iii) Previa-prohibida: de facto prohibited imports, due to competition with domestic production. In 1988, this group represented 272 of prior license items (as.d zero import value).  - 33. - TAKS 2.4: The Syem Of Ump.st Lli..... 1. 1 1, Pos1Xo X In Iwor Vs I o (a) Pr. Ion IS WI 2121 44f (b) Prier Lie.ao N 2,665 sU (X) Pevia-libre (M) (U (372) (13) (11) Prewim-prevl. (2945) (G1M) (2,498) (gm1) (1Ii) Prewis-prebibid (SU) (271) (a) (U) (c) Prohibited 64 lox a Ox TOTAL 5132 1661 USS 5,091 16X Source: the Government'. draft trade roform progra. There are minor diffrencew between thee flgure. and those of the Bank report on comercial polIcy In Colombia. 52. Estimates of effective protection for the 22 major sectors of the national accounts in 1986 suggest that there was no correlation between average tariff rates and nominal protection calculated on the basis of domestic and international price comparisons, nor was there correlation between the effective protection implicit in the tariff rates and effective protection as measured by price comparisons.4 It therefore appears that the tariff structure has not been the main determinant of protection or of imports; instead, tariffs merely place a minimum bound on protection for items for which licenses are the binding constraint on imports. It should be noted, however, that tar'ffs tend to be higher for commodities that are more highly restricted by import licenses, capturing some of the rents enjoyed by the recipients of import licenses (Table 2.3). 4Recall that estimates of nominal protection can be calculated in two ways: (i) the percentage tariff on the imported product, and (ii) the percentage difference between domestic and international prices for the product. Similarly, estimates of effective protection can be based on tariffs for the final good and its inputs, or on price comparisons. If quantitative import restrictions are the binding constraint on imports of final goods, nominal and effective protection calculated on the basis of price comparisons would be expected to be greater than protection calculated on the basis of tariffs.  _ 32 - 2.2.3 The Dearse of Imort Couaetition 53. Production coveraae. Tables 2.5 and 2.6 show the coverage by import licenses of domestic manufacturing at the industrial classification level. The largest percentages of freely importable itse are in intermediate smi- processed inputs, raw materials, and capital equipment. On the other hand. the most tightly restricted groups are finished goods and food and agriculturil products. TAKLE 2.5: Production Coverage of IP* by 2-Diglt Subsector, 1969 PRODUCTION COVER40E OF QR* VALUE 7OF PRODUCTION, 1965 PRIOR (000 PsOJ) FREE LICENSE PROHIUTED 31 Food, Bev, Tobacco 799,516,166 6X 9gX 5X 32 Toxtil- ,Leather 291,125,169 9X 91X 38 Wood Product. 21,416,240 56 963 84 Paper,Printing 169,029,623 aox ?OX 35 Chamicals,Pstrol. 573,773,844 33X 67x 36 None_t. Mlnerals 105,983,646 15X 65X 87 Basic metals 79,265,976 223 78X 86 Metal Prod,Mach. 296,298,976 13 X 2X 39 Oth Manuf. 20,962,991 EX 96X TOTAL 2,844,371,685 17X 623 2S Note: Value at 2-digit level are weightod average of 4-digit values, using 1985 production wolghte. Source: Coloebl Coas_rclal Policy Survey", Report No. 7516-CO, Tho World Bank, February 28, 1969; and Arancel de Aduanas, July 1969.  - 33 - TABLE 2.6: Production Covoego of 1ts by 4-Digit Subeotr, 190 VXLUE OF PRODUCTOWI CON !RAU OF S PRODUCTION 1995 PRIOR SECTOR (on Pe;s) FPR! I.CENSE PROHSIBTD 311 FOOD PRODUCTS 47,134,726 ex so 5x 32.1 M.at Preration 85,451,573 19X 643 17X 3112 Dairy Products 53,142,714 131 97X 3113 Frt/Vog Canning 4,418,971 21 9NS 8114 Flh Canning 3,61,442 46X 521 3115 Veg/Anel Olso 91,499,524 1X 99X 3116 Grain Will Prod 162,892,193 ON 92 3117 Bakery Products 37,290,657 75X 25X 3118 Sugar Refining 59,379,449 16X 3119 Confectlonery 29,701,20J 41 1ix 15X 312 FOOD PRODUCTS, N.E.S. 133,177,447 Is on 3x 3121 Food Proc n.s. 47,358,166 1X 75X 7X 3122 AnimI Foed 66,619,211 16X 313 BEVERAGES 219,203,996 9nx 7x 8131 Distilled Spirits 45,766,118 651X 35 3132 Wine Industrieo 2,656,961 13X 3133 Molt Bovoerae 116,724,653 1OOX 31Z4 Soft Drinks 64,127,263 1JOX 314 TOBACCO 3140 Tobacco 133X 57X 321 TE.ATILES 186,717,273 7X 93X 3211 Spinning,Waving 32,683,110 12X 88X 3212 Textile. 2,602,968 sx 97X 3213 Knitting Mille 32,144,571 13OX 3214 Carpets, Rugs 3,090,527 1OO1 3216 Cord and Rops 1,304,956 l1OX 3219 Textile. n.e.s. 115,191,121 eX 92X 322 APPAREL 3220 Wearing Apparol 65,S62,535 2X 98X 323 LEATHER PRODUCTS 21,204,772 59X 41X 3231 Tanneriso 16,007,416 76X 24X 3232 Furs, Dyoinq 1,298,341 133X 3233 Leather Prod 3,999,618 9X 91X 324 FOOTW 8240 Footwear 17,360,689 1331 331 WOOD PRODUCTS 12,932,929 ex 92X 3311 Sawmills 11,697,252 71 93x U312 Wood Containers 79,806 160X 3319 Wood, Cork n.s. 1,155,672 17% 63X 332 WOOD FURNITURE $320 Wood Furniture 6,462,311 l60 341 PULP, PAPER 196,638,96 $3S 671 3411 Pulp, Paperboard 62,446,971 53X 47X 3412 Paper Container 29,123,674 1iOX 3419 Paper Prod ns.a.- 14,246,461 lOX 04X  - 34 - TAILE 2.6 (cs.t.): Produetlea Coversg of We by 4-4ig1t Submseeer, 1692 M ODUCTDON AOVERAOE OF US VALUE OF PRODVCTION, 19St PIOR SCTOR ( PeeL) I UWK NIDI $42 PRINTING 3429 Printing