Romania : restructuring to face the world economy

a UNDP-WORLD BANK TRADE EXPANSION PROGRAM COUNTRY REPORT 14 25404 February 1994 ROMANIA Restructuring to Face the World Economy This country report is a product of the joint UNDPIWorld Bank Trade Expansion Program which provides technical and policy advice to countries intending to reform their trade regimes. The views contained herein are those of the authors and do not necessarily reflect those of the United Nations Development Program or the World Bank. The Trade Expansion Program Mission visited Bucharest from December 6 to 18, 1992, at the invitation of the Ministry of Trade and Tourism. The mission was directed by L. Alan Winters, with the participation of Gabriel Castillo, Paul G. Hare, Patrick A. Messerlin, Morris Morkre, David MG Newbery, Carlos A. Rodriguez, and Wendy Takacs. Mission members thank Secretary of State Napoleon Pop, the staff of the Ministry of Trade, and the members of all the other ministries and organizations they visited for their hospitality and ready cooperation. This report sets out the mission's findings and recommendations on the efficiency of international trade management in the Romanian economy. The draft report was considered in July 1993 by Secretary of State Cristian lonescu and his staff at the Ministry of Trade and others in the Romanian government. Minor corrections of fact and interpretation were incorporated as a result of this review. The mission considered all policies that affect international trade and made recommendations on a far broader front than trade instruments. International trade is, however, the unifying theme. The information cut-off for the report is mid-December 1992-the date of the mission-but in a few cases more recent data are incorporated. Some of the major developments occurring between December 1992 and June 1993 are reported in notes. ROMANIA Restructuring to Face the World Economy Trade Policy Division Policy Research Department World Bank February 1994 Washington, D.C. The Trade Expansion Program Mission visited Bucharest from December 6 to 18, 1992, at the invitation of the Ministry of Trade and Tourism. The mission was directed by L. Alan Winters, with the participation of Gabriel Castillo, Paul G. Hare, Patrick A. Messerlin, Morris Morkre, David MG Newbery, Carlos A. Rodriguez, and Wendy Takacs. Mission members thank Secretary of State Napoleon Pop, the staff of the Ministry of Trade, and the members of all the other ministries and organizations they visited for their hospitality and ready cooperation. This report sets out the mission's findings and recommendations on the efficiency of international trade management in the Romanian economy. The draft report was considered in July 1993 by Secretary of State Cristian lonescu and his staff at the Ministry of Trade and others in the Romanian government. Minor corrections of fact and interpretation were incorporated as a result of this review. The mission considered all policies that affect international trade and made recommendations on a far broader front than trade instruments. International trade is, however, the unifying theme. The information cut-off for the report is mid-December 1992-the date of the mission-but in a few cases more recent data are incorporated. Some of the major developments occurring between December 1992 and June '1993 are reported in notes. Table of Contents Page No. Executive Summary 1 1 The Macroeconomic Environment 12 Inflation and monetary and credit policy 12 Interenterprise arrears 15 The foreign exchange market 16 Price controls and government subsidies 21 Global assessment and policy recommendations 23 2 International Trade Policy 25 The general import regime in 1992 25 Nonborder taxes 32 The general export regime in 1992 38 The Association Agreement with the European Community 46 Other topics 55 A summary of recommendations 56 3 Export Promotion and Foreign Direct Investment Policies 63 Trade promotion organizations 63 Foreign investment promotion in Romania 71 4 Trade and Industrial Policy 86 The industrial sector in Romania 86 Privatization in Romania 93 Trade policy and restructuring 98 Trade policy issues 99 Conclusions and recommendations 102 Appendix: The economic impact of export controls on raw material inputs 104 5 Romanian Industrial Competitiveness: A Numerical Exploration 121 Methodology and data 122 Competitiveness results for Romania 124 Comparison with other countries in Eastern Europe 126 Table of Contents (Continued) 5 Romanian Industrial Competitiveness: A Numerical Exploration (cont'd) Policy implications of the analysis 127 Summary and conclusions 128 Appendix: Competitiveness calculations and data 139 6 The Energy Sector 150 Sources and uses of energy 150 The impact of price changes on energy demand 155 Allocative problems of resource use 157 Energy policy and institutional reform 163 Conclusion 165 7 Agriculture 183 Production 184 Privatization 187 The interim role of ROMCEREAL 190 Controls on prices 191 Financing agriculture 194 Problems with fertilizer 195 Problems in the dairy sector 195 Export/Import companies 197 Import and export policies 198 The Europe agreement with the EC 200 Conclusion 201 Table of Contents (Continued) List of Tables Table Number Page No. .1.1 Monetary data 14 1.2 Monetization and dollarization 15 1.3 Gross interenterprise arrears, 1992 16 1.4 Fiscal costs of subsidies 22 2.1 The Romanian international trade policy; major texts, 1991-92 26 2.2 Tariffs and trade distribution in the old and new tariff schedule 28 2.3 Romanian statutory and applied tariffs by industry, 1992 30 2.4 Romanian tariff quotas 33 2.5 The discriminatory impact of nonborder taxes 35 2.6 Romanian export prohibitions and quotas, by industry 39 2.7 Textiles and apparel: Romanian export quotas to the EC, 1985-92 41 2.8 Iron and Steel: EC quotas on Romanian exports, 1989-91 43 2.9 The EC-Romania Association Agreement: main provisions on trade in goods 48 2.10 Romanian protection against EC goods 51 3.1 Number of joint ventures 81 3.2 Intended foreign investment 81 3.3 Incentives and restrictions on foreign investment in Romania 82 3.4 Incentives and restrictions on profits by sector 82 3.5 Comparison of foreign investment regimes 83 4.1 Industrial sector in Romania, 1990 87 4.2 Exports of the industrial sector, 1990 88 4.3 Origin and destination of major industrial imports and exports 89 4.4 Output statistics for Industry 91 5.1 Industrial competitiveness analysis 130 5.2 Average values by ISIC industry weighted by domestic output 132 5.3 Average values by ISIC industry weighted by domestic output 133 5.4 Correlations between different measures of competitiveness 125 5.5a Social profitability by industry and country, short run 135 5.5b Social profitability by industry and country, medium run 136 5.5c Social profitability by industry and country, long run 137 6.1 Historical energy balance and projections 172 6.2 Energy balance for Romania, 1989 173 6.3 Romania energy use, 1990 174 6.4 Shares in GDP 175 Table of Contents (Continued) List of Tables (Continued) Table Number Page No. 6.5 Shares in gross total output 176 6.6 Energy price movements 177 6.7 Projected energy demands 178 6.8 Structure of gas consumption, 1986-91 179 7.1 Supply and use of grains and crops, 1986-93 184 7.2 Supply and use of meat, 1986-93 185 7.3 Supply and use of meat products, 1986-93 186 7.4 Livestock 188 7.5 Monthly market prices, 1992 193 Table of Contents (Continued) List of Figures Figure Number Page No. 1.1 Real Exchange rate vs. the dollar 17 5.1 Distribution of social profit rates: Romania (original data) 138 5.2 Distribution of social profit rates: Romania (energy savings) 138 6.1 Production and trade, 1985-90 168 6.2 Trade in Energy, 1985-90 168 6.3 Sources of Energy, 1985-90 168 6.4 Uses of Energy, 1985-90 168 6.5 Energy intensities, 1989 & 1990 169 6.6 Energy intensity against competitiveness, 1990 169 6.7 Energy share against output share, 1990 169 6.8 Energy share against output share, medium run profit 169 6.9 Producer prices real energy price indices 170 6.10 Consumer prices real energy price indices 170 Executive Summary Foreign exchange and the macroeconomic situation Romania's transition to a market economy has not been easy. Though the government has made huge strides toward establishing a liberal market economy, many obstacles remain. Industry, which was generally energy intensive and technically inefficient, collapsed along with its major market-the members of the Council for.Mutual Economic Assistance (CMEA). Efforts to restructure are hampered by declining aggregate demand (output has fallen by 20 percent a year for the last three years), a flawed foreign exchange allocation process, high inflation and tight credit, and the continued state control over most industry. Inflation has been due in part to money creation to finance fiscal deficits, but other factors have probably been more important: price liberalization, declining economic activity, and the currency speculation, large devaluations, shortages of foreign exchange, and uncertainty about future exchange rates triggered by several reversals in exchange rate policy. Moreover, with inflation running at more than 10 percent per month and the fiscal deficit likely to grow in 1993, the economic outlook is not good, especially if the government does not address effectively the problems in the foreign exchange market. Foreign exchange allocation Export enterprises tend to hold onto their foreign exchange earnings, financing their activities through arrears to local suppliers-a clear indication that exporters expect capital gains on foreign exchange holdings to outpace interest payments on the arrears. But by withholding foreign exchange exporters reduce the supply, interfering with the ability of other productive sectors to import needed production inputs. Foreign exchange is allocated through official auctions in the interbank market, with transactions directed by a computer program that supposedly maximizes the number of - transactions made. But on a typical day, and despite injections of funds from the National Bank; buyers of foreign exchange receive less than half the amount they request. Despite such evident excess demand and clear inflationary pressures, the exchange rate remained fixed at 430 lei per dollar between October and December 1992, a clear sign that the auction is significantly less than competitive. The uncertainties created by the foreign exchange market's lack of price flexibility, transparency, and timeliness make it a formidable obstacle to the development of international trade. Devaluation alone is not the solution. Greater access to foreign exchange requires a stable and transparent allocation mechanism that inspires market confidence and encourages long-term decision making. The present system offers neither a self-regulating market allocation mechanism nor a minimally efficient system of quantitative rationing. A flexible exchange rate is needed to enable the transparent allocation of foreign exchange by price. Provided that the government exercises fiscal and monetary restraint and solves the problem of the interenterprise arrears, even full convertibility ExECUTIVE SUmmARY would not cause the exchange rate to rise to unsustainable levels. Policies to ensure that these conditions are met should precede any move to full convertibility, however. Confidence building measures Trade expansion requires not only an efficient foreign exchange allocation mechanism but also macroeconomic stability and clear market rules that inspire investor confidence. Because the process of privatization is far from complete and local capital is inadequate to finance the required industrial restructuring, the government should issue to the public shares in state enterprises that would be negotiable in a capital market. Also, to stabilize interenterprise arrears, the government must continue to send the clear message that arrears will not be refinanced. The practice of forgiving such arrears is incompatible with monetary stability and the development of a well functioning capital market. In December 1992 net interenterprise arrears were about 30 percent of the money supply (M2); they cannot be monetized without risking serious inflation. Once arrears are brought under control, a battery of instruments can be used to try to eliminate them. The bankruptcy law, though otherwise an important tool, will not help in the short term . because the courts are unable to process the large stock of arrears fast enough. The law needs to be supplemented by measures such as the resolution of late October 1992, which requires state enterprises to pay off their arrears, whether by liquid assets or by converting arrears into negotiable corporate bonds, perhaps with preferred access to dividends and yielding an indexed interest rate.' Monetary and fiscal policy The freeing of interest rates and deregulation of banks are major steps toward a sound monetary policy. But because of concern that high interest rates will discourage investment, the National Bank and other state banks have retained several lines of subsidized credit. Such subsidies will further distort resource allocation at a time when permanent and profitable investments are needed most. We recommend studying the possibility of indexing credit lines to relevant indicators, such as wages (for mortgages) or the export exchange rate (for export prefinancing); freeing prices; and removing subsidies as soon as possible, along the lines agreed to with the World Bank. On the fiscal side, we recommend that the government continue to exercise restraint during the difficult period of transition.? We note, however, that the nominal capital gains derived from the revaluation of gold in 1992 were monetized and treated as current government revenue. We urge that this action not be repeated in 1993, and that the gains from the revaluation be devoted to nonexpansionary activities, such as the capitalization of the National Bank or that the funds remain in a reserve account. International trade policy The recent changes in Romania's international trade policy have been dramatic: from a reliance on quasi-autarchic import controls and state monopolies to a reliance on tariffs. Though only moderately high in 1992 and the first part of 1993 at an average of 12 percent, tariffs were scheduled to increase substantially over the rest of 1993, to an average of 18 percent. The tariff levels vary widely, resulting in high effective rates of protection for certain activities. 2 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNOMY Avoiding the use of trade instruments that dilute the strength of recent trade policy reform is the most immediate challenge for Romanian policymakers. In 1992 Romanian trade policy showed signs of reversal, with the effectiveness of one reform-a six-step reduction in statutory tariffs during the first part of 1992-challenged by the subsequent introduction of import surcharges and excise taxes that are often higher on imports than on domestic products. In another action, the government in May 1992 adopted antidumping, antisubsidy (countervailing) and safeguard regulations; such measures have proven highly discriminatory and protectionist in other countries and seem at odds with the government's stated goal of avoiding excessive or improper trade policy instruments. The introduction of measures that negate the effect of recent reforms, combined with the inadequacies of the foreign exchange auction mechanism, inspire uncertainty instead of confidence. Stabilizing and liberalizing trade policy has become even more important following the recent agreement with the European Community (EC), which will afford Romanian exporters greater access to EC markets. It should be noted that the agreement has costs for Romania and that the size of these costs will depend on Romania's general tariffs-the higher the tariffs, the greater the costs. The agreement will create increasing discrimination between imports from the EC, which will face rapidly falling, and eventually zero, tariffs, and imports from the rest of the world, which will face unchanged and still substantial tariffs. Export policy is distorted by quotas on many exports: raw materials, foods that are subsidized at home, and goods restricted by import partners. These quotas are monitored through a rigid regime of licenses that links future allocations to current quota fulfillment and that prohibits the transfer of licenses. The potential exporter that has paid the 2 percent bank guarantee needed to get an export license cannot sell the license to another firm even if the buyer defaults. The system raises the expected cost of exporting and can result in lower export prices, as distressed exporters seek to fill their quotas, thereby driving prices down for everyone else. To consolidate the trade policy gains achieved so far, the Romanian authorities should: * Continue to impose the 1992 applied tariffs and to progressively eliminate export restrictions (at least, those restrictions not imposed by foreign countries). * Allow the resale of any remaining export licenses. * Eliminate (as announced) the import surcharges and the discriminatory impact of excise taxes on foreign goods. * Commit publicly to the moderate use of the antidumping regulations. Trade promotion Romania's trade promotion institutions are young and have much to gain from applying the lessons from the experience of counterpart institutions in developing countries. Most trade promotion institutions fail because they are wholly government operated and provide services free of charge. Successful institutions provide relevant and well targeted services; operate autonomously, free from interference by government and special interests; charge a fee for some services; receive financial support from the government; and enjoy the respect of the business community. Romanian promotional institutions offer some relevant services, but are in the midst of transformation. They provide services free of charge in many instances-a practice that deprives them of the financial means to expand programs and tends to discourage the supply of services by the private sector. EXECUTIVE SUMMARY 3 These public sector institutions, manned and financed by government, have difficulty attracting qualified people and retaining trained personnel, who often move on to the private sector, where the rewards are greater. The government should ensure that promotional activities operate on a commercial fee-for- service basis that covers the cost of hiring foreign consultants as well as other export costs. In addition to direct export promotion, the private sector appears enthusiastic about the proposed free trade zones, which will provide a tax free environment for export producers. The experience of other countries suggests that successful zones are operated and administered by the private sector under incentives that are not significantly different from those of the rest of the economy. Among trade promotion policies, the government should: * Strengthen the duty drawback and exemption scheme for exporters-for example by introducing transferable certificates and removing ambiguities in its application by customs. * Take steps to calculate the cost of current tariff exemptions. * Export promotion zones, if pursued, should be privately run. Foreign Investment Law The law on foreign investment falls short of international norms in many respects. Poland and Hungary, for example, have already stopped the mandatory screening of foreign investment and dismantled the apparatus used to discriminate by origin of sector of investment. Romania maintains this apparatus even though it does not use it. The law provides many tax concessions: capital goods are imported duty free when contributed by the foreign partner; imported raw materials, supplies, and components used in any new productive process enjoy a 2-year exemption from customs duties; and profits also enjoy a 3-5 year exemption from taxes. The law's restrictions on profit repatriation, and the difficulties of rasing foreign exchange for repatriating profits outweigh the tax advantages, however. These restrictions, combined with the general climate of economic uncertainty and concerns about bureaucracy and possible corruption, explain the low level of recorded direct foreign investment.4 The foreign investment law creates serious problems of equity and efficiency. Because there is no statutory minimum requirement on foreign participation, join venture companies can be created with as little as $1 of foreign capital and can then exploit the numerous tax advantages. Indigenous firms and state-owned enterprises, which cannot apply for the tax and customs duty exemptions, are at a competitive disadvantage. The broad coverage and randomness of goods qualifying for customs duty exemptions seriously undermine the transparency of the tariff structure and create room for corruption. Joint ventures also reduce the tax base, and their fiscal ramifications will only be compounded as former state-owned enterprises are privatized and more firms seek foreign participation. Tax holidays are temporary, but may be renewed quite easily by registering a new venture.- To improve the law, the government should: * Abolish the requirement to register foreign investments with the Romanian Development Agency. * Eliminate tax holidays for new joint ventures (restrictions were introduced July 1993). * Tighten the definition of in-kind imports qualifying for tariff exemptions so that it includes only significant joint ventures. * Abolish restrictions on profit repatriation (done in July 1993). 4 ROMANIA: RESTRUCTUliNG TO FACE THE WORLD EcONOMY Trade and industrial policy Under central planning, the structure of Romanian industry was determined by the structure of CMEA trade and emphasized heavy industry (metallurgy, chemicals) and machinery. Much of Romania's trade was based on barter arrangements in which Romanian received raw materials in return for industrial goods. During the last decade an export drive designed to pay off the country's foreign debt deprived domestic industry of investment in new technology and even of spare parts. Much of the capital stock is outdated and inefficient, especially in the use of energy. The collapse of the CMEA requires Romania to reorient trade toward western markets and to restructure its industry. Trade policy and industrial policy must work consistently toward this objective. In a market economy, economic activities and resources shift constantly as some enterprises fail and new investment is attracted to the most profitable sectors. Price signals guide this flow of resources on both the input and output side. The relevant prices are world market prices, which reflect the real cost to Romania of obtaining products from abroad and of consuming or using the goods internally rather than exporting them. As open and liberal trade policy introduces world market prices automatically. To ensure that market forces determine which activities are efficient and competitive, producers must have access to inputs at world market prices and maintain world market prices for outputs. Trade policy The transition to a market economy-the removal of explicit and implicit subsidies, the opening of the economy to foreign trade, the pricing of important inputs such as energy at world market prices-has put tremendous pressure on inefficient and noncompetitive enterprises. The government should continue to resist pressures to protect these sectors by imposing new trade barriers. Lax financial discipline has allowed nearly all enterprises to continue operating, however, preventing new enterprises from forming and discouraging successful ones from growing. The government must avoid wasting resources on propping up inviable firms. Producers of some finished goods, such as furniture, are protected by export controls on their raw material inputs, which provide an implicit subsidy to these producers, reduce foreign exchange earnings from raw material exports, and discourage their production. Export restrictions should be removed except on goods whose domestic consumption is subsidized, and the subsidies should be phased out as soon as possible so that internal prices reflect the true cost of the* goods at world market prices. (This process began to happen by July 1993.) Industrial policy and privatization A number of agencies will be involved in the development of Romanian industrial policy: the Ministry of Industry, the, State Ownership Fund, and the relevant Private Ownership Funds. The roles of each of these agencies and their relationships with each other are in a state of flux. It is important that the responsibilities of these agencies and the relationship among them be clarified so that there is a mechanism for shutting down uneconomic activities as soon as possible, particularly activities that have negative value-added at world market prices. ExECuTivE SummARY 5 Discussions with Ministry of Industry officials indicate that the ministry is developing a more active restructuring strategy in the context of the privatization process. One option designed to speed the pace of reform calls for the creation of four categories of enterprises: those to be privatized, those to be restructured and then privatized, those to be supported through "selective restructuring", and those to be liquidated or shur down. Viable firms would be placed in the first category and privatized very quickly. Enterprises selected for "selective restructuring" must not be supported by government measures in an attempt to improve the attractiveness of the sectors in which they operate. Government actions favoring one sector over another must be avoided. In particular, subsidies or protection must not be used to help sell off production enterprises. The industrial restructuring strategy of the Ministry of Industry also includes references to balancing foreign trade within the sector, subsector, or even enterprise. Licensing requirements on barter trade arrangements appear to force such balance by favoring exchanges of output for raw material inputs for the same industry. This licensing requirement locks trade into the previous barter trade patterns and prevents reorientation of activity toward new markets and activities. Enterprises should be allowed to engage in barter trade arrangements without the constraints of firm or sector balance and without requirements that particular products be received for the exported output. In a market economy, there is no need to balance trade within particular sectors. Excess foreign exchange earnings by one sector are transferred to sectors with foreign exchange deficits through the foreign exchange market. It is extremely important to improve the operation of the foreign exchange auction to allow enterprises access to foreign exchange at a realistic exchange rate so that enterprises can obtain imported raw materials and intermediate inputs and more efficient modem equipment from abroad. Industrial competitiveness and restructuring To assess the international competitiveness of Romanian industries, it is important to estimate their profitability at world market prices, free from price distortions and various taxes and subsidies that make domestic profitability measures unreliable. When borders are open and trade is unrestricted, this assessment is easy, but in the meantime poor analytical substitutes must be used. Using the 105-sector input-output table for Romania in 1990, with corresponding data on the world market prices of the output of tradable sectors, the profitability of Romanian industries at world market prices was investigated in some detail. The results are crude because of the inevitably poor and aggregated data they are based on. Nevertheless the results of the exercise are useful if only to challenge the pleading of special interests. According to this analysis, the most profitable sectors in 1990 were: agriculture (crops, edible and other vegetable oils); petroleum processing; abrasives and graphite products; and nonferrous metallurgy. The biggest losses were in gas and oil extraction, meat and fish products, canning, milling and bakery products, alcoholic drinks, textiles and knitwear, coke, rubber and plastic products, and construction and refractory material. Several industries identified as unprofitable appear to meet vital domestic demands. At present levels of inefficiency, the government should either close them down or develop a program of restructuring or modernization to bring them up to more acceptable levels of efficiency. In developing a restructuring program, the government must recognize the impossibility of encouraging some sectors to expand without encouraging others to cut back. Moreover, as domestic distortions are progressively eliminated, the market mechanism can be relied on to guide restructuring. In most cases detailed intervention by the government to promote restructuring 6 ROMANIA: RESTRUCTURING TO FACE THE WoRLD EcoNOMY should not be necessary, except in the sense of providing a favorable environment in which to conduct business. For sectors that look profitable, there is no need for active measures to promote them artificially. Restructuring efforts should be directed at enterprises rather than sectors, because even in unprofitable sectors, there will normally be some enterprises capable of successful restructuring. Given the difficulties of pricking winners at the firm level, the case for getting prices right and relying on markets as soon as possible is all the more compelling. Energy policy A rational energy policy requires that producer prices be set a world market price levels (plus distribution costs) and that the currency be convertible, so that inefficient foreign exchange allocation does not interfere with necessary energy imports. Pricing policy The contraction of Romanian output in the face of declining CMEA and domestic demand appears to have increased the energy intensity of the Romanian economy: operating many plants below capacity, rather than closing some of them, generates excessive energy-overhead. Restructuring guided by profitability at world prices seems unlikely to reduce- energy intensity by much. What is needed to reduce energy consumption is to improve efficiency within sectors. Because Romania imports all its energy needs, the way to encourage efficiency improvements is to set domestic energy prices for industry at economic prices-the import cost plus transport and distribution costs. Most of the adjustment in the dollar price of fuels (measured at the official exchange rate) occurred in 1991. Dollar prices decreased slightly until August, 1992-the date of the latest government decision setting domestic prices using the exchange rate of 360 lei per dollar-and dropped further as the exchange rate fell to 430 lei to the dollar. By late 1992 several fuels were priced well below their import price. For example, gas prices appear to be not much more than one- half import parity-even if transmission and distribution costs are ignored-and crude oil seems to be less than two-thirds import parity. There may be special circumstances arguing for a more gradual removal of consumer subsidies," but there are no good reasons for delaying the adjustment of energy prices for industrial users. Fuel subsidies for industry prevent rational decisionmaking on choice of fuels and hinder attempts to identify negative value-added activities. The underpricing of energy has led to the need for administrative rationing with all of its associated problems. To some extent these problems have been alleviated by allowing enterprises to import fuels at world market prices, if they can pay in foreign exchange. This would be satisfactory if the lei were convertible, but the present system of foreign exchange allocation creates considerable difficulties for enterprises producing for the domestic rather than foreign market. The costs of energy shortages caused by inefficient foreign exchange allocation and by the inability to import additional supplies can be very high. For example, if a fertilizer factory can be exported profitably at world market prices, there is a danger that a cut in fertilizer production would result in a diversion of fertilizer from domestic agriculture, where it could increase yields and hence reduce food imports. In that case the loss in foreign exchaige would be larger than the cost of additional gas imports. EXECUTVE SUMMARY 7 Electricity and gas The electricity industry's investment program needs careful planning, and rational investment decisions are possible only if prices for alternative fuels reflect true relative prices. Among the choices are whether to rehabilitate existing run-down plants, continue the nuclear program, or build high-efficiency combined-cycle gas turbines. The costs of some recent rehabilitations seem very high at $780 a kilowatt hour, and the true costs of the nuclear program, including the uranium processing and heavy water production, as well as any backend costs, are likely to be considerably above gas turbine costs, unless almost all the costs have already been sunk. Contracting for power imports may be cheaper, depending on the terms available. As a general rule, however, it is cheaper to move gas than electricity, so it seems unlikely that imported electricity contracts will be cheaper than domestic production in the long run. Concomitantly, however, the government should not expect to export significant amounts of electricity to neighbors that also have access to gas. Give falling domestic gas production, the Ministry of Industry's intention to restructure ROMGAZ-the state gas production company-and to separate exploration, production, transmission, and distribution is welcome. The plan to make the high-pressure gas transmission system a common carrier with regulated tariffs will facilitate correct gas pricing at different locations. This in turn will encourage gas exploration by foreign concerns, since a world price defined at each location can be used to assess royalties or rent taxes. Similar plans to restructure RENEL-the state electric company-should have similar beneficial impacts, though the larger range of options for restructuring means that careful planning is required. Privatization may encourage western firms to assist in the production and distribution of energy. Environmental policy Romania's environmental problems are acknowledged. Consideration must be given to the costs as well as the benefits of abatement policies, however. In particular, Romania should not be too anxious to adopt EC standards for motor vehicles, given Romania's much lower density of vehicles and more pressing problems with static sources of pollution. Charges, rather than regulation, are the preferred approach to abatement, so that pollution generators can choose efficiently between technologies. The possibilities of varying pollution charges according to environmental and climatic conditions may be considered-for example, burning cleaner but higher cost fuels only when conditions are bad. Agriculture Despite a rich endowment of fertile land, Romania's agricultural sector has been troubled for many years. Recently, however, there have been signs of a stabilization, if not an improvement. The problems stem at least partly from two mistaken attitudes toward agriculture: that Romania should be self-sufficient in most agricultural goods and that subsidies are necessary to protect the food security of the poor, or even of the population in general. Agricultural trade should be based on comparative advantage-the swapping of goods that can be efficiently produced for those that cannot. Food subsidies encourage waste. If poverty is a problem, income support is required, not subsidies. 8 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNoMY The turmoil caused by privatization of collective farms after the 1989 revolution appears to be over. Preliminary land certificates have been issued for more than 90 percent of the area to be returned to private ownership. As of the end of 1992, final certificates had been issued to 5 percent of the individuals entitled to agricultural land. By the end of 1993, this figure was expected to rise to 25 percent. Already, a nascent market is emerging in land, and advertisements offering to sell land appear in local newspapers. The development of an active market in agricultural land should be strongly encouraged. Peasant holdings are limited to a total of 10 hectares each, so peasants are forming voluntary associations to create 50 to 100-hectare fields for the efficient production of wheat, maize, sunflower seeds, and other traditional crops. Voluntary associations of peasants are a rational response to the problem of aggregating fragmented and scattered holdings into fields large enough to utilize large machinery (tractors, harvesters) efficiently. These associations are being encouraged by the Ministry of Agriculture and by ROMCEREAL. There are also signs that expectations are improving: peasants are constructing new and durable houses and existing housing is being refurbished. Fertilizer, a crucial input for achieving high crop yields, is used about half as much in Romania as in western Europe. Fertilizer prices are low, resulting in a need for rationing. To determine appropriate usage levels, the subsidy to domestic fertilizer producers should be removed. If agricultural producers cannot obtain sufficient fertilizer from the domestic industry at the new higher prices, they should turn to imports. If fertilizer use increases, yield improvements will boost production, which will likely lead to exports of grains. If the domestic fertilizer industry is inefficient by world standards it should be streamlined so that the 10,000 workers employed in this industry can be released to more productive activities. Agricultural prices and trade. Although Romania's recent export performance suggests otherwise, the country possesses a comparative advantage in agricultural and food products. It has a long history as an important exporter of these products. The upheaval since the revolution led to production declines in a sector already weakened by a plethora of controls from the previous regime and, in 1990, to a ban on exporting most agricultural products. Many government policies continue to cause distortions, especially the artificially low farmgate prices for wheat, milk, cattle, and pigs (compared to world prices). These have been accompanied by low and subsidized consumer prices for several basic food products, including bread and milk. Fully liberalizing domestic prices and eliminating bans and quotas on exports would remove the largest barriers to the rationalization of agricultural production and provide a stimulus to expand production and exports. Following these actions, the only remaining source of divergence between domestic and world prices would be tariffs. For these products, the tariff should either remained fixed or be reduced. Other measures, such as a variable tariff (or levy) on certain agricultural products, should be strongly discouraged. There is considerable evidence that a variable levy policy (as in the EC) causes excess production with accompanying inefficient employment of resources. For agriculture, the recent agreements with the EC and the EFTA countries are a mixed . blessing. The agreements provide access to these markets through annually increasing quotas and declining levies or tariffs, but in return Romania had to accept limits on the amounts it is allowed to export. These quotas-based on 1987-89 actual quantities-are considerably below levels that would EXECUTIVE SUMMARY 9 be reasonable, given Romania's comparative advantage and historical position in world agricultural trade. Notes 1. A law was introduced on June 19, 1993, that will levy an interest rate of 0.15 percent a day. 2. Since December 1992 fresh analysis has suggested that the fiscal situation is much looser than was apparent at the time of the mission: a fiscal deficit of 6 percent of GDP and an even larger deficit in the consolidated public sector accounts now seem reasonable estimates. 3. The coverage of export restrictions was reduced in June 1993. 4. Profit repatriation restrictions were lifted in June 1993. 5. In June 1993 concessions were restricted to joint ventures with over $10,000 of foreign capital accounting for at least 20 percent of total equity. 6. In May 1993 energy costs for households were increased substantially. in'f)M.A?A Summary of principal recommendations Main recommendations * Implement a stable and transparent allocation mechanism for foreign exchange, based on market-clearing prices-preferably full convertability. * Free prices and abolish subsidies along the lines agreed to with the World Bank (partially done). * Stabilize import duties at the level of 1992 applied tariffs rather than the higher statutory rates. * Abolish restrictions on profit repatriation (done). * Clarify the responsibilities of various government agencies for shuttifig down uneconomic enterprises, and prepare plans for dealing with political pressures arising from plant closures. * Set domestic energy prices for industry equal to import prices plus transport and distribution costs. * Iberalize domestic prices and eliminate quotas on exports of agricultural goods. Other important recommendations * Send a clear message that interenterprise arrears will not be refinanced. Existing arreArs should be securitized to stabilize them and create ndinentary capital market instruments. * 'Study the implementation of credit lines indexed to relevant indicators such as wages (for mortgages) or the export exchange rate (for export prefinancing). * Use the gains from the revaluation of gold stocks onl 'for noninflationary purposes. * Eliminate export quotas immediately wherever possible, and where not-for example, if import partners impose constraints or domestic prices are subsidized-make licenses tradable between agents (partially done), * Eliminate the import surcharges and the discretionary excise taxes, on foreign goods. * Consolidate the convention of a moderate use of the antidumping regulations that seems to have emerged from the first cases presented. * Ensure that trade promotion activities-such as,those provided through the Export-Import Bank-cperate only on a commercial fee-for-service basis. * Enhance the effectiveness of the duty drawback scheme by making certificates transferable and reducing ambiguities in the application of laws by the customs administration. * Put export processing zones -under private management, it they are established at all. * Calculate the cost of current duty exemptions schemes by, improving customs reporting procedures. * Abolish tax holidays and tariff concessions for new joint ventures (partially done). * Tighten the definition of *in dnd imports qualifying for. tariff exemptions and restrict them to significant join ventures. * Continue to resist pressures to protect inefficient sectors by imposing trade barriers. * Avoid actions to make firms artificially attractive during the privatization process. Subsidies or protection must not be. used to help sell off enterprises. * Allow enterprises to engage in barter trade without restrictions on the goods they import or requirements for sectoral or enterprise balance. * Do not count on exporting significant amounts of electricity to neighbors that also have access to gas. * Encourage Western firms tw assist in energy production by privatizing oil and gas companies and by developing a satisfactory regulatory framework for energy transmision and sales. * Develop an,active maiketin agiiculfturl land. * Abolish the subsidy to domestic fertilizer producers. EXECUTIVE SUMMARY 11 Chapter 1 The Macroeconomic Environment Since the overthrow of the communist regime in December 1989, Romania has made impressive efforts to transform its economy into a market-oriented, capitalist system, passing, among other reforms, a new constitution in November 1991 that guarantees property rights and declares Romania a market economy. Reforms also were made in the areas of privatization, land ownership, pricing, international trade, fiscal management, and exchange rate and monetary policy. The transition has not been easy, however, and the work that remains to be done looks daunting. Romanian industry, which is energy intensive and technically inefficient, collapsed along with its regional market-the members of the Council for Mutual Economic Assistance (CMEA). In the last three years industrial output has fallen nearly 20 percent per year. GDP fell by 5.8 percent in 1989, 7.3 percent in 1990, 13.7 percent in 1991, and was expected to fall 15 percent in 1992. The drop in GDP, due mainly to the collapse of the CMEA, has been accompanied by a sharp rise in unemployment, a problem unknown in the centrally planned economies. Efforts to restructure industry and to improve efficiency are hampered by declining aggregate demand, a flawed foreign exchange allocation process, high inflation, tight credit, and the state's continued control over most industry. The agents of macroeconomic instability-inflation, sharply falling output, and rising unemployment-are huge obstacles to structural adjustment, hindering Romania's ability to create and diversify trade, develop an industrial policy, privatize, and create a capital market. The authorities' effort to respond by tightening fiscal and monetary policy is being thwarted by the actions of market participants who assume that government will eventually bail them out. Strengthening the credibility of policy reform is therefore essential. Romania is plagued by the remnants of its centrally planned economy: a system of price controls and fiscal subsidies results in prices well below world levels, export quotas and prohibitions regulate subsidized products and other raw materials, and foreign exchange prohibitions interfere with capital account and current account operations. Foreign exchange controls are particularly destructive of macroeconomic stability, since they result in the hoarding of foreign exchange and the accumulation of interenterprise arrears to finance exports. These arrears are an endogenous source of credit that circumvents the monetary authorities' efforts to tighten credit and to fight inflation. Addressing these and other problems must be a high priority for the government: until they are brought under control effective restructuring and economic growth will remain elusive or impossible. Inflation and monetary and credit policy Following the dissolution of the centrally planned economies, inflation skyrocketed, mainly because of the currency overhang, price liberalization, drops in output, and monetary financing of the fiscal deficit. Money was issued to finance fiscal deficits that were running at about 6 percent of GDP and a whole range of quasi-fiscal expenses, including the debts of state enterprises and capitalization of state-owned banks. Other factors affecting inflation were the much needed (but phased) price liberalization, partial elimination of producer and consumer subsidies, and repeated reversals in exchange rate policy that led to currency speculation, large devaluations, shortages of foreign to ROMATA: REsTRUCtmRiNG To FACR THE WORLD RcoNoMY exchange, and uncertainty about future exchange rates. By any standards, direct credit to the private sector has been severely tightened. But tight monetary policy has been undermined by the pardoning of extremely large interenterprise arrears in late 1991. Because of the lack of a capital market and of well-defined property rights, the accumulation of arrears essentially creates an endogenous money supply that fuels inflation, a process observed in several episodes of the hyperinflation in Latin America. In 1991 and 1992, the treasury appropriated the proceeds of the revaluation of gold reserves to finance regular fiscal expenditures, an inflationary measure that should be discontinued. Future proceeds should be used to capitalize the National Bank of Romania (NBR), the procedure followed in most central banks in the world. Partly to compensate for the expansionary effects of the across-the-board forgiveness of state enterprise arrears in late 1991, a 10 percent reserve requirement was applied to all lei deposits of enterprises. This requirement was extended to households in late 1992 to compensate for the expansionary effects of using the gold revaluation account in capitalizing state banks. These measures represent the first use of reserve requirements as an instrument of monetary control. In addition to tightening credit, these measures helped finance other quasi-fiscal expenses. The authorities should avoid any further increases in reserve requirements for financial, fiscal, or quasi- fiscal purposes, however, because they quickly result in large bank spreads and further demonetization of the economy. The authorities should also note that the system favors foreign exchange deposits over lei deposits, because foreign exchange is not subject to reserve requirements. Despite a generally tight credit policy, the National Bank granted several lines of subsidized credit in 1992. Subsidized credits included a 100 billion lei line of credit for agriculture at 15 percent a year, a 10 billion lei loan at 20 to 40 percent interest for export financing, and a 73 billion lei loan at 15 percent for the energy sector. These subsidized credit lines are damaging because they expand central bank credit-which boosts the money supply and inflation. They also negatively affect the quasi-fiscal balance and reduce the National Bank of Romania's net wealth, and divert capital from nonfavored uses that generate higher returns than favored ones. Inflation accelerated sharply in late 1992 as consumer subsidies declined in September and the nominal exchange rate rose by 100 percent following the May liberalization (table 1.1). Monthly inflation was near 10 percent during September and October and 13 percent in November and December. A new boost to inflation was expected in May 1993, the target date for eliminating all remaining consumer subsidies. With subsidies amounting to 7 percent of GDP in 1992, the shock was likely to be large. From October 1991 to October 1992, the supply of local currency increased 91 percent in nominal terms while the consumer price index increased by 193 percent. This real value of the local currency holdings fell by 35 percent-which can at least partly be attributed to the 15 percent drop in real GDP expected during 1992. In addition, inflation has increased significantly since September 1992-a rise that may require a reduction in cash holdings as the public adjusts inflationary expectations upwards. Since dollar deposits offer higher real rates of return, dollarization may also be cutting demand for local currency. While lei deposits at the savings bank accrue annual interest of 18 percent for sight deposits and 50 percent for one year time deposits, dollar deposits get about 4 percent, plus the gains from devaluation. Since during October 1991-92 the devaluation rate in the interbank dollar market was 66 percent, dollar deposits were clearly more attractive than lei. deposits.' THE MACROECONOMIC ENVIRONMENT 13 Table 1.1 Monetary data (billions of lei, unless otherwise noted) Foreign Currency Etchange Local US Dollar Rate Price Monthly Total M2 Currency In lei equivalent USS:lei Level Inflation Dec. 1989 420,914 416,936 3,978 275 14.44 100.0 0 Dec. 1990 514,457 499,347 15,110 435 34.71 137.7 11.6 Jan. 1991 518,702 502,961 15,741 453 34.74 158.1 14.8 Feb. 1991 516,081 498,917 17.164 500 34.30 169.2 7.0 Mar. 1991 516,755 497,911 18,844 510 36.97 180.4 6.6 Apr. 1991 524,644 494,709 29,935 493 60.67 228.2 26.5 May 1991 568,415 535,174 33,241 551 60.35 239.8 5.1 Jun. 1991 567,449 531,714 35,735 576 62.05 244.5 2.0 Jul. 1991 594,903 557,152 37.751 621 60.77 267.7 9.5 Aug. 1991 599,866 562,734 37,132 605 61.38 297.6 11.2 Sep. 1991 601,712 560,010 41,702 699 59.77 319.4 7.3 Oct. 1991 671,708 631,855 39,853 660 60.36 352.6 10.4 Nov. 1991 814,708 768,327 46,381 252 184.0 391.1 10.9 Dec. 1991 1,033,266 992,856 40,410 214 189.0 444.5 13.7 Jan. 1992 1,065,679 1,022,903 42,776 216 198.0 531.2 19.5 Feb. 1992 1,048,017 999,107 48.910 247 198.0 597.4 12.5 Mar. 1992 1,082.517 1,036,593 45,924 232 198.0 657.3 10.0 Apr. 1992 1,072,641 1,029,026 43,615 212 206.0 688.0 4.7 May 1992 1,098,723 1,038,006 60,717 269 226.0 771.3 12.1 Jun. 1992 1,123,307 1,030,699 92.608 305 304.0 804.1 4.3 Jul. 1992 1,197,687 1,058.853 138,834 380 365.0 829.6 3.2 Aug. 1992 1,322,167 1,140,772 181,395 474 383.0 857.6 3.4 Sep. 1992 1,425,303 1.239,814 185,489 435 426.0 944.5 10.1 Oct. 1992 1,446,423 1,204,887 241,536 562 430.0 1,035.2 9.6 Source: National Bank of Romnania, Ouarterly Bulletins. Early in 1992 the government-worried about the inflationary effects of negative real interest rates-increased the annual rediscount rate from 28 percent to 80 percent. The move was not completely successful in raising interest rates because the savings bank-traditionally the largest retail bank and still state-owned-did not follow by raising its borrowing rate. Real interest rates offered to depositors by the savings bank, which behaves as a dominant monopolist since it has the largest share of the market, are now 25 percent for sight deposits and 50 percent for time deposits of one year maturity. This policy has kept interest rates negative in real terms and has probably contributed to the fall in demand for real cash balances and the increased dollarization rate (table 1.2). Real cash balances in local currency fell by about 50 percent during 1992 alone and the share of foreign currency deposits in total money supply (M2) quadrupled from 4 percent in December 1991 to 16.7 percent in October 1992. The rate of dollarization has increased sharply since the liberalization of the foreign exchange market in May 1992, allowing enterprises to retain their foreign exchange earnings in local banks. The deposits were partly financed by interenterprise arrears, which increased in gross terms by 600 billion lei between April and October 1992 (net arrears are believed to be about 200 billion lei). I4 ROMANTA. PqTYrTTvr-y *n VAr- trmr U yry - Table 1.2 Monetization-and dollarization Share offoreign currency deposits in Real value of local currency holdings M2 (percent) Dec. 1989 100.0 0.9 Dec. 1990 87.0 2.9 Jan. 1991 76.3 3.0 Feb. 1991 70.7 3.3 Mar. 1991 66.2 3.6 Apr. 1991 52.0 5.7 May 1991 53.5 5.8 Jun. 1991 52.2 6.3 Jul. 1991 49.9 6.3 Aug. 1991 45.4 6.2 Sep. 1991 42.1 6.9 Oct. 1991 43.0 5.9 Nov. 1991 47.1 5.7 Dec. 1991 53.6 3.9 Jan. 1992 46.2 4.0 Feb. 1992 40.1 4.7 Mar. 1992 37.8 4.2 Apr. 1992 35.9 4.1 May 1992 32.3 5.5 Jun. 1992 30.7 8.2 Jul. 1992 30.6 11.6 Aug. 1992 31.9 13.7 Sep. 1992 31.5 13.0 Oct. 1992 27.9 16.7 Source: National Bank of Romania, Quarterly Bulletins Interenterprise arrears Under the centrally planned economy enterprises had to meet strict quantitative targets, and any financial disequilibria were compensated by fiscal authorities once or twice a year. Enterprises received their supplies on credit from other enterprises, accumulating large interenterprise debt that was erased under "global compensations" arranged by the government. Under the compensation, such as the one in December 1991, cross-debts were written off and the resulting net debts were financed by new credit lines granted by the national bank. In December 1991 gross arrears reached 1.8 trillion-lei, about 80 percent of annual nominal GDP. The cost to the national bank of the global compensation scheme in 1991 was about 250 billion lei in the form of increased credit granted to debtors at a subsidized rate of 28 percent per year (during the next 10 months inflation reached 133 percent implying that the real interest rate was -47 percent for the 10 months between December 1991-October 1992). The amount of gross arrears cleared in the December compensation scheme is not available, but interenterprise arrears reached nearly one trillion lei by April 1992 and more than 1.6 trillion by the end of October (table 1.3). Current net interenterprise arrears (assuming they are about one-third of gross arrears) are about 38 percent of M2. They cannot be monetized without running the risk of substantial inflation, which is already at a two digit monthly level. THE MACROECONOMIC ENVIRONMENT 15 Table 1.3 Gross interenterprise arrears, 1992 (billion kei) April May June July August September October TOTAL 969 1121 1198 1321 1234 1236 1607 Industry 598 635 664 794 688 688 747 Domestic trade 97 124 128 127 130 132 379 Foreign trade 68 149 167 155 173 81 185 Other 206 213 239 245 243 335 296 Source: National Bank of Romania The lack of bankruptcy legislation fuels the growth of interenterprise arrears. A bankruptcy law is now under consideration in Congress, but it will not provide a short-term solution to this pressing financial problem because the courts would be unable to process the very large stock of arrears fast enough. The authorities must continue sending the clear message that they will no longer refinance arrears. Monetary authorities have been forceful on this issue, and if they succeed in at least stabilizing arrears, a piecemeal approach to eliminating them can be tried using a battery of instruments, such as bankruptcy procedures, government resolution 701 of October 1992, which requires state enterprise to cancel their arrears using their liquid assets, and conversion into negotiable corporate bonds. The government should consider securitizing the arrears, or at least part of them, by issuing corporate bonds with some preferred claim to dividends or privatization rights. These negotiable bonds should be issued at a competitive interest rate, possibly fixed in real terms at a low level (perhaps 1 to 2 percent a year), and with long-term maturity (ten years or more). Bonds of bad creditors will trade at a discount versus the bonds of those seen as good prospects by the market, sending enterprises the message that global compensation of arrears will not be used again and that lending to good customers pays off. In addition commercial banks could recognize these bonds as collateral for loans and thereby remedy a further severe constraint on current capital markets. In addition to losses from interenterprise arrears, the nonperforming debts of enterprises to banks were estimated at 120 billion lei in September 1992. Tax arrears to the treasury were also common until 1992, when the treasury started charging 80 percent per year on them. The rate was high enough to quickly diminish tax arrears. In another demonstration of resolve, the Ministry of Finance vowed to cut the electricity supply to enterprises that do not pay their bills and has organized a commission with the power to liquidate enterprises with large debts. The foreign exchange market Perhaps the most daunting obstacle to reform in Romania is the inefficiency of the foreign exchange market. Foreign exchange shortages are almost certainly the main bottleneck to economic recovery. Not only is foreign exchange scarce, but suppliers' attempts to protect against uncertainties in the exchange rate and the foreign exchange allocation mechanism drive up inflation. Exporters tend to retain foreign exchange earnings, financing their activities with arrears to local suppliers - a clear indication that they expect the value of the foreign exchange to increase by more than the interest rate on the arrears. But withholding foreign exchange strains other productive 16 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY sectors, which cannot obtain the imported inputs needed for production. Foreign exchange is officially auctioned in the interbank market. The price is determined by a computer program that supposedly maximizes the number of transactions, but in fact less than half the demand at the selected price is satisfied. Despite wide oscillations in the ratio of sales to demand at the selected price, and inflation rates of 10 percent in September and October 1992, the exchange rate remained fixed at 430 lei per dollar during October-December 1992, providing evidence that the auction is less than competitive. Importers report that the interbank market lacks price flexibility and transparency and that they sometimes encounter long delays (even months) in obtaining foreign exchange. Since they generate great uncertainties about access to foreign exchange, the auctions in the interbank market are a significant obstacle to the development of international trade. Devaluation alone will not improve the situation. What is needed is a stable and transparent mechanism that provides enough confidence for economic reforms to take hold. The current exchange system is neither an efficient market allocation mechanism nor an efficient system of quantitative rationing. The foreign exchange allocation mechanism has helped generate wide swings in the real exchange rate (defined as the ratio of the interbank market exchange rate vs. the dollar and the Romanian consumer price index (CPI)), which fell from almost 250 in March 1991 to an estimated 88 in November 1992 (figure 1.1). Figure 1.1 Real exchange rate vs. the US dollar REAL EXCHANGE RATE VS.US DOLLAR 260 co(Decrber 1991=100) 250 240 230 220 210 200 190- 170 160 150- 140 130 120 110 100 90 80 70 sotWrCh 1991 July v bfrch July Nov May Sep. Jan.1992 key Sep. Note: November inflation CPI is estimated at 12 percent. THE MACROECONOMIC ENVIRONMENT 17 The sharp nominal devaluation of May-July 1992 only temporarily reversed the falling trend in the real exchange rate. Since September 1992 the authorities have apparently intervened in the auction market to keep the nominal exchange rate constant, but with inflation near 10 percent in both September and October and expected to rise, the real exchange rate took a nose dive. Allowing these abrupt drops is a very dangerous policy because the market anticipates a large devaluation and withholds foreign exchange from the auction. Also, expectations of large devaluations increase the rate of return for holding foreign exchange and thus provide further incentives for ongoing dollarization. Government could create a much more transparent mechanism for allocating foreign exchange by allowing for exchange rate flexibility. The exchange rate would not increase to unsustainable levels, provided that simultaneously the government applied fiscal and monetary restraint and found a permanent solution to the problem of the interenterprise arrears Recent developments Unlike efforts in other aspects of the economic transformation, the authorities have not developed a clear objective on the organization of the foreign exchange market. After the December 1989 revolution, the government imposed a strict system for allocating foreign exchange, requiring the surrender of export proceeds at an officially established exchange rate, which increased gradually from 15 lei to 35 lei to the dollar until February 18, 1991, when a more liberal system was introduced. Under the new system, exporters were allowed to trade 50 percent of their earnings in the newly created interbank market at uncontrolled rates. A daily auction was conducted, and transactions were directed by a computer program designed to find the price that maximized transactions. With half of export proceeds still going to the National Bank of Romania, the government was able to supply cheap foreign exchange for priority imports of raw materials and energy. During the nine months this system lasted, the interbank rate for the dollar was between three and four times the official rate. On November 11, 1991, the government reinstated the original policy, ordering the surrender of all export proceeds at an official exchange rate, now unified at 180 Lei per dollar. All state . enterprises were forced to surrender their foreign currency deposits at this rate-a move the market viewed as an expropriation, even though it resulted in boosting the average rate available from 177 (half at the official rate of 60 lei and half at the blackmarket rate of 294 lei) to 189.. The retrenchment may also have damaged credibility in the stability of local financial institutions and the sustainability of any exchange rate arrangement. Dollar deposits in convertible currencies fell from US$660 million in October to US$213 million by December 1991. Following the restoration of the full surrender policy, export proceeds at first increased in December 1991, but fell sharply over the next few months. A full-fledged black market, probably fed by underinvoicing of exports, began to thrive. By May 1992 it was clear that the mandatory surrender at a fixed official rate had lowered exports and spawned a black market. The government reversed its policy again, allowing retention of all foreign exchange, provided that it was deposited at a local bank. The auction market reopened, and restrictions on enterprise holdings of foreign exchange accounts were lifted. The ability of the computer-run auction to simulate a competitive market was undermined by 18 RoMAmA- RES'TTTTTR r Tn Trr m WT-m uyrn m'n, restrictions on participation. Only offers to buy or sell within 5 percent of the previous day's fixing were accepted and, if the program could not find a market clearing price with 100 percent execution -of the accepted offers, the rate was set by fiat and purchasers were rationed. Since the authorities could choose the previous day's fixing, the excess demand could be perpetuated indefinitely. The market initially lacked confidence in the auction, which was in full swing by July 1992. It worked competitively during the first nine days for which information is available with an execution rate (the ratio of demand orders to supply orders at the determined price) of 100 percent. By July 23, however, the market fell into a state of chronic excess demand from which it rarely recovered, with the execution ratio on some days not even reaching 5 percent-meaning that only one dollar out of 20 demanded was obtained at the given price. The auction's flaws frustrate enterprises, which complain of an inability to obtain enough foreign exchange to purchase required imported inputs. With industrial production falling at the rate of 20 percent per year for the past three years, the scarcity of foreign exchange indeed may be exacting a high social cost. Moreover, the auction process may not be functioning as transparently as desired. Firms find difficulties in even getting into the auction at market rates because more banks are interested in representing suppliers of foreign exchange (exporters) rather than demanders (importers). Thus the latter must wait several months for an allocation whose price and quantity are uncertain. Obviously, this uncertainty makes planning for production all but impossible. As expected, a black market has sprung up to evade inefficiencies of the rationing. In December 1992, the black market premium stood at about 30 percent over the official rate. Foreign exchange houses sell dollars to households (up to the 100,000 lei limit) at a rate equal to the auction rate plus a 30 percent commission. Moreover, significant proceeds from underinvoicing of exports are believed to be held in foreign accounts, which are transferred between enterprises that cannot obtain enough foreign exchange through official channels to finance imports. At the center of this inefficiency was the government's failure to allow the price to settle at its competitive level. The 5 percent band regulation ensured that participants did not offer at any price other than the previous day's fixing, thus ensuring the persistency of that price. The rate rose substantially from May to July (this could explain the success of the early July auctions), but it barely changed during July and August. In September the rate was allowed to increase by 11.6 percent (inflation was 10.6 percent) and it remained at that level until December. The time path of the real exchange rate shows a consistent trend of real appreciation that is clearly inconsistent with excess demand unless rationing is taking place (figure 1.1). In October 1992 the foreign exchange allocation mechanism was changed for the fifth time since 1990. The pooling and clearing of all offers by the National Bank was replaced by decentralized foreign exchange clearing by individual banks. Each bank was to service its own demand for foreign exchange, using only the supply offers it presented to the auction. The National Bank of Romania still uses its computer program to determine the daily price, but execution ratios differ by bank now that excess demands or supplies are not cleared across banks. The move was intended to pass the burden of rationing to banks, which now have an incentive to achieve a high execution ratio to attract good customers. In practice, however, banks lure suppliers of foreign exchange by offering services such as credit at special rates. Demanders of foreign exchange that cannot promise a future supply of exchange are discouraged from applying by a variety of methods, including delays or difficulties in approving their import documentation. (Banks must clear the documents as a requisite for presentation at the auction.) Given the well functioning black market, it is quite likely that the THE MACROECONOMIC ENVIRONMENT 19 banks' offers of special services to exporters or the added costs they impose on importers amount to close to the market-clearing premium of 30 percent. Even worse, enterprise-level foreign exchange allocation is now more or less decided by private banks, which introduces an element of arbitrary behavior and uncertainty for firms trying to conduct business. Since the new rules were put in place the exchange rate at the auction has been fixed at 430 lei per dollar, despite of wide changes in the execution ratio for the market and across banks and inflation rates of 10.6 percent in September, 9.6 percent in October, and even higher expected for November. Demonetization has increased, and deposits denominated in foreign exchange have significantly increased, both in real and in relative terms. The only consistent aspect in foreign exchange policy is the prohibition against capital account convertibility of the currency. Romanians are allowed to purchase a maximum of 100,000 lei (about US$180) a year (raised to 200,000 in mid-1993). Foreigners can purchase foreign exchange only to the extent that they can show proof of previous purchase of local currency for that amount. Exports of local currency are strictly forbidden, and customs enforces this regulation, even with tourists. Special provisions apply to the repatriation of profits of foreign investors under the foreign investment law, which limits repatriation to 8 to 15 percent of capital invested (according to the type of activity) and requires investors to compete in the foreign exchange market for the foreign currency needed for remittances.2 The costs of this confusion in the foreign exchange market are most obvious in the current account, whose balances were negative throughout 1992, except in the third quarter when the short lived, free-market auction provided a boost. For 1992 the current account was expected to reach a negative balance of about $1.5 billion to be financed mostly through loans from multinational institutions, with a $180 million deficit remaining. Recommen&dtions Repeated swings in exchange rate policy have interfered with resource allocation and retarded structural adjustment in other parts of the economy, distorting access to imported inputs such as energy and discouraging the development of capital market activities. The black market alleviates some problems, but a dual exchange rate system is not conducive to long-term investment. Full convertibility for the lei should be a high priority. It would provide incentives for holders of foreign exchange to enter the market with the full assurance that they will be able to buy it back, if needed, at the market price. Under present rules, exporters selling foreign exchange through the auction have no guarantee of being able to repurchase. Full convertibility does not necessarily imply a rush for foreign exchange purchases. Households and enterprises presently purchase dollars at the black market price and deposit those dollars-with no questions asked-in any bank. Therefore, convertibility will encourage the supply of dollars, not reduce it, and will strengthen, not weaken, the lei. Of course, full convertibility is viable only at the market-clearing price which would be about the same as the black market rate, a 30 percent premium over the official rate. Two factors will determine the supply of lei in circulation and therefore the exchange rate: official credit creation for financing the fiscal deficit and endogenous credit creation through the interenterprise arrears. Fiscal stringency and a permanent solution to interenterprise arrears are basic conditions for a stable exchange rate once convertibility is restored. Sound policies to guarantee them are, therefore, ,)nRnMAVTfA. ~ Y 1 . -. *'-- - preconditions for introducing convertibility. Restoring only internal convertibility is not likely to work. If the rate is to be fixed, monetary authorities would need a stock of international reserves-and they don't have one. If the rate floats, capital flows will be necessary to stabilize the rate, which will naturally fluctuate in the course of the daily flows of international trade. As it stands, nobody would supply foreign exchange on a day in which supply is short of demand because of the inability to legally demand the funds when the situation is reversed. If full convertibility is restored, the rate in the interbank market should be freely floating after the initial devaluation, subject only to operations by the National Bank of Romania with its own reserves to stabilize the real exchange rate around its medium-term equilibrium path. Under no circumstances should the National Bank of Romania intervene to stabilize the level of the nominal exchange rate when inflation exceeds 10 percent per month, as it did in late 1992. That would result in the depletion of foreign exchange reserves and restoration of rationing. Price controls and government subsidies Under the centrally planned economy, subsidies covered a wide variety of producer and consumer goods and strict price controls held prices below their market equilibrium level. The basic structure of subsidies remains, though it has diminished in size. Not only do subsidies have a high fiscal cost and distort resource allocation, but they also provide a potential justification for export controls. There are currently four basic sets of subsidies, all administered by the Ministry of Finance: * Subsidies covering the losses of autonomous entities. These subsidies cover the enterprises' losses and are not associated with their output or level of costs. Presently, only autonomous entities engaged in mining, water transport, and train track construction and repair receive this subsidy. * Consumer subsidies, which apply to a wide range of price-controlled products and cover the difference between the unit cost and the controlled price. * Subsidies covering the losses of public institutions, which are small (3 percent of total subsidies) and are not related to price control. * Subsidies granted by local governments, mainly to energy and public transportation. Consumer subsidies are the most costly for the economy, covering a wide range of products that make up a large share of the consumption basket of the poor: electricity, burning gas, lignite, bread, school books, powdered milk, imported wheat, urban transport, oil, sugar, meat, salami, and several types of orthopedic products to name a few. A wide range of agricultural fertilizer is also subsidized. Of these, electricity exacts the highest toll: while a kilowatt hour (Kwh) is sold to enterprises at 22.5 lei (close to production costs) it is sold to households at 6 lei. In 1991 this subsidy amounted to 1.56 percent of GDP. All four types of subsidies were expected to total 9.5 percent of GDP in 1992-assuming actual subsidies from the local governments stay at the projected 136 billion lei (table 1.5). THE MACROECONOMIC ENVIRONMENT 21 Table 1.4 Fiscal cost of subsidies (billions of lei) 1991 1992 (estimated) 1993 (projected) Amount % of GDP Amount % of GDP Amount % of GDP Central Government Total 113.0 5.4 493.0 9.0 653.0 5.3 Autonomous entities 48.0 2.3 104.0 2.0 245.0 2.0 Consumer subsidies 65.0 3.1 389.0 7.1 408.0 3.3 Local Government Energy and transport 23.8 1.1 103.0' - - Total subsidies 136.8 6.5 492.0 - -- 'Values from the 1992 budget. Revised actual figures for 1992 are not available, but the projected subsidy of the local governments of 136 billion lei was 39.8 percent of the initially projected amount of 341 billion lei for the total subsidies of the central government. The central and local governments intend to eliminate all subsidies to the population on May 1, 1993-a most welcome step not only because the subsidy represented a significant budgetary expense but also because it maintained the relative price structure of the old centrally planned economy and fiscal balance.' This change will have broad implications for resource allocation and income distribution. Also, fiscal and monetary restraint will be essential to combat the initial inflationary shock of lifting the subsidies. Price controls must be eliminated at the same time, since it is the pervasive system of price controls that has given rise to the need for subsidies and rationing of many items, including foreign exchange and export quotas. It is assumed that subsidies and price controls will be eliminated simultaneously. Otherwise, some more costly (socially) system of rationing will have to replace the subsidies. Both the income distribution and the inflationary effects of the removal of price controls and subsidies will need to be taken into account however. Price control is widespread, with most products in the economy subject, in one way or the other, to some control. The prices of all products that are subject to subsidies are fixed by the government every few months. A wide range of consumer and producer goods made by state enterprises or in industries with fewer than three firms are also price controlled. There are three methods of control: * Direct determination of a maximum price (government decision 776 of 1991 establishes maximum prices for thirty-five products, mainly energy and fuels. This list has been modified several times.) * Approval by the Ministries of Finance, Industry or Agriculture of prices negotiated between suppliers and customers. The prices to be negotiated (defined by government decision 776) encompass a wide range of products, including raw materials, intermediate products, metals, fuels, transport equipment, medicines services, and food and agricultural products. Inflation ensures that the controls are not as strict as intended: negotiated prices can be adjusted every 22 ROMANIA: RESTRUCTURING TO FACE THE WORLD Ecnwnvv thirty days with approval of the relevant ministry, although approval is not automatic. All goods produced by fewer than three suppliers are also subject to price negotiation. * Commercial margins for all goods produced by state enterprises are approved by the Ministry of Finance. These approvals are nearly automatic, and this regulation is not actually binding. Electricity pricing demonstrates the distortions introduced by the system of price controls. Prices are set by the government. In September 1992, the government allowed the electricity company, RENEL, to adjust its price for the effects of the devaluation that took place between May and July that brought the exchange rate to 360 lei. No adjustment was allowed for the subsequent increase in the exchange rate to 430 lei. Energy is periodically rationed to industrial users, creating uncertainties and disruptions in production. For other products, long queues (gasoline) and the near disappearance of supplies (fresh milk) are evidence of the distortions created by the price control mechanism. Global assessment and policy recommendations Trade expansion requires a framework of macroeconomic stability and clear market rules; an efficient foreign exchange allocation mechanism is a necessary but not a sufficient requirement. Capital markets and interenterprise arrears Privatization is far from complete, and local capital is scarce. The pardoning of the interenterprise arrears once or twice a year is inconsistent with a market economy, development of a capital market, and monetary stability. The authorities must put an end to the arrears problem by forcing borrowers and lenders to accept responsibility for the arrears. The bankruptcy law can help prevent the creation of new arrears, but will be unable to deal with the large stock of inherited arrears. This stock should be securitized through the issuance of preferred corporate bonds, negotiable and yielding a positive real interest rate-a move that would not only make clear the authorities' unwillingness to monetize the arrears, but also provide instruments for nascent capital markets. Prices and interest rates Export quotas, temporary import surcharges, and selective price controls remain in place and add to the generally uncertain regulatory framework in which production decisions have to be made. Freely determined interest rates and competition among banks are welcome, but several lines of subsidized credit remain within the national bank and other state banks, which may further distort resource allocation at a time when permanent and profitable investments are most needed. Confusion surrounds the high level of the nominal interest rates, which may end up negative in real terms because of expected inflation. While predictions -of inflation at the aggregate level can be made, individual agents may not feel sure about increasing their own prices (or wages) in line with the general level of prices. Consideration should be given to indexing credit lines to relevant indicators such as wages (for mortgages) or the export exchange rate (for export prefinancing). THE MACROECONOMIC ENVIRONMENT 23 Fiscal restraints The authorities have shown great fiscal and monetary restraint despite the enormous social costs of the transition. They should stay the course since fiscal restraint helps avoid even higher inflation, which would compound the social costs and delay the adjustment. Currently, inflation is being fueled in part by such nonmonetary factors as price liberalizations and expectations of devaluation. In 1993 the nominal capital gains from the revaluation of gold should not be monetized and spent as in previous years, but rather be used for nonexpansionary purposes, such as the capitalization of the central bank. Foreign achange The current system allocating foreign exchange combines the worst aspects of a market- determined rate with those of rationing, without receiving the benefits of either system. The possibility of flexibility at a time when the authorities are interfering to keep the rate stable generates expectations of a devaluation, encouraging exporters to retain foreign exchange. The resultant scarcity of foreign exchange is very damaging to production at a time of severe economic slump. Since October 1992, the authorities have set the price of foreign exchange at a nonequilibrium level, passing the problem of rationing on to the commercial banks and the illegal black market. This does not solve the problem. Romania should consider the possibility of restoring full convertibility to the lei-for capital and current account transactions-in the context of a managed float, with the goal of keeping the real exchange rate along its medium-term equilibrium path. Full convertibility would restore confidence in the currency, encourage capital inflows, and provide exporters with incentives to sell their foreign exchange, thus helping to reduce shortages. Notes 1. In May 1993 interest rates were raised to 40 percent for sight and 65 percent for one year time deposits. 2. Repatriation restrictions have subsequently been relaxed, but unless firms have earned their own foreign currency they must still bid for it in the auction. 3. May 1993 saw a significant reduction in subsidies, but not their complete elimination, which should remain a very important objective of policy. 14 ROMANLA: RESTRITCTTTMr,re A (r 're Wnwr rt m,m Chapter 2 International Trade Policy During the 1980s, the Romanian economy became increasingly protected. Romanian policymakers hoped high barriers would blunt the effects of trade sanctions, particularly after 1987, when Romania renounced its most-favored-nation status with the U.S. This increase in protection is difficult to -measure because of shortcomings in the data, but the openness ratio (imports plus exports as a percentage of GDP) declined from 64 percent in 1980-81 to 37 percent in 1988-89. During the same period the ratio increased or was stable in other nonmarket economies of Central and Eastern Europe.' Since 1990 Romanian trade policy has been based on a series of regulations-most of them government decisions or ministerial orders that can be changed quickly with little debate (table 2.1). A significant number of them were temporary, applying only to 1992. These changing regulations have not created a stable foundation for trade policy. Frequent policy shifts are partly an inevitable product of the transition from a centrally-planned to a market economy, but there are also specifically Romanian causes: Romania has recently undergone a General Agreement on Tariffs and Trade (GATT) trade policy review and has yet to renegotiate its full status under the GATT; thus it has to wait for peer judgement before making definitive choices.2 Such volatility and potential reversibility is undesirable and leads to our first crucial recommendation: from now on there should be as few changes as possible to the trade regime, so that operators can work in a stable legal environment. This chapter examines Romania's general import and export policies for 1992, the first year under the new trade regime, describes the.Association Agreement with the European Community (EC), which was expected to come into force in May 1993, and assesses the agreement's potential impact on the general trade regime. The general import regime in 1992 Article 134 of the Constitution, which declares the economy a market economy and the state a guardian of competition, is the only text concerning trade policy that is a law. As of January 1993 important parts of the Foreign Trade Law of 1980, though not expressly abrogated, have been superseded by other laws, leaving Romania with no real foreign trade law. As a result trade policy relies exclusively on government decisions and ministerial regulations.' After a broad survey of Romanian import policy, this section examines in detail four major trade instruments: ad valorem tariffs, quantitative restrictions (import licenses and tariff quotas), nonborder taxes that discriminate against foreign goods, and antidumping, countervailing and safeguard provisions. The stability of the regime: an overview Since September 1991 the Romanian import regime has been dominated by two forces, one negative-policy initiatives pushing in opposite directions-the other positive-an absence of formal quantitative restrictions (table 2.1). INTERNATIONAL TRADE PoucY 25 Table 2.1 The Romanian international trade policy; major texs, 1991-1992 Date Status Number Focus" Regudation Observations 1990 December 8 government decision 1274 MI/X Drawback system 1991 law 35 M/X Foreign investment September 25 government decision 673 M Statutory tariff schedule 4o be enforced in 1993(?) December 6 government decision 812 M Tariff reductions for 1992 temporary December 27 government decision 852 M Tariff reductions for 1992 temporary 1992 government decision 3 M Custom valuation rules government decision 13 X Export credit and insurance government decision 15 M General prohibitions April 10 ministerial order 62 M/X License regime government decision 76 X Export promotion law 84 M/X Free trade zones July 31 ministerial order 120 M/X Prohibition and license regime August 28 ministerial order 130 M/X Prohibition and license regime government decision 134 M/X Tariff reductions for 1992 temporary November 11 ministerial order 151 M/X Prohibitions and license regime April 10 government decision 177 M Tariff reductions for 1992 temporary April 30 government decision 215 M/X Prohibition and license regime April 30 government decision 216 M Surcharges May 7 government decision 228 M AD, CVI) & safeguard provisions government decision 293 X Export insurance government decision 358 X Preferential export credit August 1 government decision 387 M/X Customs modernization tax August 20 ministerial order 127 M AD, CVD & safeguard working rules ministerial order 128 M AD, CVD & safeguard working rules August 26 government decision 489 M Tariff quotas temporary September 11 goverment decision 547 MIX Special rules (London Club) September 15 government decision 554 M Tariff quotas temporary government decision 884 X Export insurance Source: Romanian authorities. Notes: a) M: the regulation focuses on imports; X: the regulation focuses on exports. From mid-September 1991 to mid-September 1992 twenty-one texts were adopted on the import regime, some within only a few days of each other. Some of these regulations-the procedural ones-codified practices and generally improved the objectivity of trade regulation, while others dealt with the use of trade policy instruments. Those regulations moving in the direction of trade liberalization, such as the decision to use only tariffs and subsequent tariff reductions were adopted before April 1992. Since then measures restricting trade, including import surcharges, have prevailed. Since the changes in regulations involved a broad range of goods (for instance, the tariff reductions adopted in December 1991 involved half of the product codes of the Customs classification), they bave had a substantial impact on the level of protection. Ro A A ESTP=rDttrT rwt mlNG TO% IACE TW WORL EI comAv A trade policy based on frequent changes in regulations is undesirable for two reasons. First, frequent policy shifts induce traders to invest precious resources in attempts to influence future levels of protection. Resources spent on lobbying are better used in other, more productive, activities. Second, fluctuations in policy prompt businesses to base import and export decisions on guesses of what Romanian authorities will do next rather than on purely economic considerations. On a positive note, as of January 1993 the general import regime has been free from quantitative barriers on imports, such as import quotas or voluntary export restraints-a condition ensuring that changes in world prices are reflected in the Romanian economy, despite the relatively high tariffs. But this achievement requires caveats. One policy-a nonborder regulation that effectively blocks used-car imports by denying a first- time registration to anyone with a car eight years or older-amounts to a quantitative restriction." This measure is analyzed in detail below. This type of nonborder restriction will remain a threat to trade liberalization in Romania for as long as public firms with monopoly power rule the economy. The state's ability to affect prices-as seen in the case of the parastatals, which are open to considerable official pressure on pricing and procurement-weakens market discipline and undermines the trade regime. The privatization program and the decision to reduce the number and scope of the parastatals should reduce this threat. Also, as shown in chapter 1, by allowing some sectors more access to foreign exchange than others, the flaws in the foreign exchange market amount to a quantitative restriction on the availability of foreign currencies, and thus on the flows of goods for the constrained sectors. Tanif based protection Ad valorem protection in the Romanian general import regime consists of three instruments: a statutory tariff schedule, import surcharges, and temporary reductions or exemptions of import tariffs (initially only for 1992, some of these reductions or exemptions have been extended to the first quarter of 1993). In addition Romania has two preferential agreements-the Protocol of 16 and the Global System of Trade Preference among Developing Countries-but these are omitted in this chapter because their coverage is marginal: the eligible volume of imports under these two agreements represented- 3.1 percent of total imports for the protocol and 8.9 percent for the global system in 1991.5 Vested interests have prevented the full application of the statutory tariff schedule (Decision 673/1991), the basis of the current import regime. Initial discussions of the tariff schedule sought to balance two forces: those pushing for higher tariffs-producers seeking compensation for the removal of their previous myriad non-tariff barriers and policy advisors in search of ways to boost government revenue-and those pressing for lower ones-industrialists requiring imported inputs and consumers, who had suffered so much under the previous regime. The conflict resulted in a statutory tariff for 1992 that was, on average, approximately twice the height of the former tariff (see table 2.2), but that offered a series of temporary exemptions on most imports (see below). Offsetting high tariff rates with widespread exemptions-a practice noted in other countries'-undermines the revenue argument for the tariff. This fact, combined with evidence given below, suggests that protection, rather than boosting revenue, was the major motive for the new tariff. INTERNATIONAL TRADE PoLicY 27 In mid-1992 pressure to impose import surcharges came from several sources, including the National Bank of Romania. While ostensibly adopted to help with balance of payments, the surcharges were actually justified as safeguards. Thus the government decision No. 216/1992 establishing the surcharges refers to Article 19, paragraph 3 (sic in the English translation) of Government Decision 673/1991 (the Tariff Schedule), which states that "... in case certain imports, by quantity or condition, cause or threaten to cause serious injury to domestic producers of like or directly competitive products, temporary import surcharges may be established. These surcharges shall be applied until the adverse effects existing at their establishment, are eliminated." Table 2.2 Tariff and trade distribution In the old and new Romanian tariff schedule Number and frequency of product codes Average tarf Inport mua Old tarff New turff Old wrff New tariff Old ariff New wr Number Percent Number Percent Exemption 391 8.5 62 1.2 0.0 0.0 2586.7 524.6 I - 5 percent 619 13.5 322 6.4 4.0 3.1 652.3 1963.6 6 - 10 percent 2351 51.1 959 19.1 9.8 8.2 1269.8 832.6 11 - 15 percent 440 9.6 969 19.3 13.3 15.0 395.5 600.3 16 - 20 percent 274 6.0 1274 25.4 19.7 19.9 245.3 568.3 21 - 25 percent 181 3.9 925 18.4 24.3 25.0 63.3 700.2 26 - 30 percent 297 6.5 450 9.0 30.0 30.0 284.3 201.7 over 30 percent 46 1.0 54 1.1 43.9 40.3 70.9 177.1 Total 4599 100.0 5015 100.0 6.9 11.7 5568.5 5568.5 Source: GATT Trade Policy Review Mechanism, C/RM/6/32, page 39. Note: a) In million US dollars. For a small amount of imports (0.376 million) there is no defined duty in the old tariff. 28 ROMANIA RESTRUCTURING TO FACE THE WORTT) T7Prnvrwfy Clearly the safeguards justification is inappropriate. It is inconceivable that so many industries should suddenly be threatened simultaneously. Also, some of the surcharged goods were not being produced in Romania. Although the government originally intended to eliminate the surcharges by the end of 1992, the mission was told the surcharges would remain in effect, albeit somewhat modified, for some time." Turning to the actual rates applied, table 2.3 provides a global assessment of the evolution of tariff-based protection. It presents these data by sector defined at the four digit level of the International Standard Industrial Classification (ISIC)-slightly modified by aggregating a few sectors in order to be compatible with the Romanian Standard Industrial Classification (RSIC).' It suggests three conclusions. First, while the reduction or elimination of statutory tariffs led to changes in the level of protection across all sectors, new tariff measures were introduced, with some sectors-wood, furniture, pulp and paper, radios and TVs, and, above all, motor vehicles-subject to a broad array of trade policy instruments. Second, a comparison of the applied tariffs for 1992, which were modified throughout the year by reductions and exemptions and by import surcharges, with the statutory tariffs for 1993 reveals a significant rise in the average statutory tariff (table 2.3).' The unweighted average for applied tariffs in 1992 was roughly 13 percent; weighted by value-added, it was almost 15 percent. The average statutory tariff for 1993 is substantially higher, with an unweighted average of close to 18 percent and a weighted average tariff of close to 19 percent. These averages are high by the standards of the industrial countries, but about the same as those found in other semi-industrialized countries. Third, surcharges-though relatively few in number-tend to have a powerful impact on the level of protection. For instance, under the initial statutory tariffs, the level of protection of wine industries is 1.3 times the average level. Protection is 2.6 times higher after the introduction of surcharges. The same is true for the Radio and TV industry, which features a level of protection 1.2 times the average under the statutory tariffs and 1.4 times the average when surcharges are added. While protection for the car industry as a whole is roughly stable, particular subsectors face profound changes depending on engine power. While the situation is clearly more liberal than before 1990, the enforcement of the statutory tariff in 1993 represents a substantial increase in the level of Romanian protection relative to 1992. This rise, coupled with the surcharges, which increase the average tariff by almost 30 percent, represents a significant backward step in the battle to bring Romanian industry up to scratch. Regressivity of the tanif schedule The highest tariffs (both applied and statutory) tend to be concentrated in final-that is, consumer-goods, especially in those goods with low income elasticities of demand, such as food and tobacco products, shoes, textiles and apparel. Unweighted applied tariffs are roughly 9 percent for equipment goods, 10 percent for intermediate goods and 19 percent for consumer goods while those for statutory tariffs are 14 for equipment, 17 for intermediate goods and 23 percent for consumer goods. This feature suggests a strongly regressive fiscal impact from the import regime: poorer Romanians spend a larger share of their income on such goods than richer Romanians, and pay a disproportionately high proportion of the tariff revenues. INTERNATIONAL TRADE POUCY 29 Table 23 Romanian statutory and applied tariffs by industry, 1992 Number of product codes Average rariffs Effective tarip d Other barriers' ISIC Total under under under Stau- Applied Statu- Applied Non- Etport Industries Industries number 1992 Sur- tariff tory I in 1992 tory c in 1992 border restric- in 1992 changes charges quotes taxes ions 1000 Agriculture 301 83 19.1 14.8 19.5 15.4 2.6 2000 Mining 100 39 5.1 3.7 1.5 1.8 2.6 3111 Slaughtering 75 35 22.5 16.1 33.4 20.5 2.6 3112 Dairy products 21 13 22.6 12.1 33.8 2.5 2.6 3113 Fruit & veg. canning 72 5 24.4 23.3 40.5 46.4 3114 Fish canning 32 8 22.7 16.7 472.7 26318.6 3115 Veg. & animal oils 49 37 24.5 10.8 41.4 -4.4 2.6 3116* Food products nec. 159 56 24.1 18.4 28.1 21.6 2.5 2.6 3122 Prepared animal feed 4 1 22.5 16.3 31.5 22.9 3130** Wine industries 24 9 23.5 34.8 28.7 52.3 2.5 3140 Tobacco mfg. 6 6 60.0 33.3 65.7 36.7 2.5 3211* Textile products 520 35 21.1 20.3 23.3 25.5 2.6 3213* Apparel 277 5 29.2 28.8 37.4 37.7 2.6 3231* Leather goods 63 2 17.5 17.2 16.6 18.8 3232 Fur dressing & 7 19.3 19.3 18.7 23.3 2.5 dyeing 3311* Wood products 57 16 2 13.8 11.2 11.8 11.0 2.6 3320* Furniture 35 3 18.7 18.7 23.2 27.1 2.5 3410** Pulp and paper 114 67 1 13.3 7.4 11.1 4.1 2.6 3420 Printing & publishing 29 3 8.4 8.1 3.1 8.1 2.6 3511' Industrial chemicals 707 586 17.4 6.2 20.9 4.1 2.6 3512 Fertilizers 25 3 10.6 9.4 7.8 13.3 3513 Synthetic products 92 78 17.7 7.4 29.1 7.8 3521 Paints & varnishes 12 9 9.8 5.6 5.8 4.2 3522 Drugs & medicines 63 62 15.5 0.5 16.0 -12.0 2.6 3523 Cosmetics 30 2 1 16.4 15.7 16.3 20.5 3530 Petroleum refineries 10 8 9.8 3.9 63.8 5.3 2.6 3540 .Petroleum & coal 10 3 7.8 6.5 12.5 13.1 2.6 prod. 3551* Tire & tube industries 55 35 19.4 10.7 26.0 12.6 3610 Pottery & china 14 4 20.4 18.3 26.8 26.8 3620 Glass & glass prod. 52 11 1 16.3 14-5 17.0 16.8 2.5 3691 Structural clay prod. 14 4 11.8 8.9 11.3 9.6 3692 Cement, lime, plaster 9 12.2 12.2 10.3 13.5 3699 Nonmetallics nec. 59 23 1 10.8 7.8 8.3 8.3 3710 Iron & steel 205 190 17.6 3.6 20.3 4.0 2.6 3720 Nonferrous metal ind. 168 112 7.6 1.3 -0.2 -6.3 2.6 3811* Cutlery & hand tools 227 109 3 18.2 12.8 30.5 23.4 2.6 3813 Structural metal prod. 22 6 1 15.3 14.0 18.7 26.2 3821 Engines & turbines 22 12 13.4 7.0 10.6 3.3 3822 Agr. machinery 29 20 14.5 11.0 11.9 12.0 38230 Metal & woodwkg. 239 179 7 14.9 7.9 13.3 5.2 mach. 3825 Office machinery 34 16 3 16.5 11.3 16.9 11.4 3829 Machinery nec. 178 83 10 13.9 10.0 11.7 10.3 3831* Electrical industrial 142 74 3 13.3 9.2 9.9 4.7 mach. 3832 Radio, TV 84 39 9 4 21.1 18.4 23.2 20.8 2.5 3833 Electrical appliances 23 1 15.7 15.7 18.1 23.6 3841 Shipbuilding 21 4 19.0 16.4 23.3 23.2 3842* Transport equipment. 34 19 20.6 10.7 27.7 13.7 other 3843 Motor vehicles - 60 38 4 2 28.7 19.8 44.3 32.5 2.5 3844- Motorcycles 10 1 29.0 27.0 37.6 35.8 3845 Aircraft mfg. 25 12 8.8 5.6 1.5 -3.3 3851* Equipment, other 208 91 1 13.3 8.8 12.4 8.9 2.6 3900** Manufacturing, other 190 14 1 16.1 15.4 17.7 20.4 2.5 2.6 20 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Table 2.3 (continued) Number of product codes b Average tariffs Effective tariffs d Other barriers' ISIC Total under under under Statu- Applied Statu- Applied Non- Erport Industriesa Industries number 1992 sur- tariff tory c in 1992 torf in 1992 border restric- in 1992 changes charges quotes taxes tions sum sum sum sum avg. avg. avg. avg. count count The whole economy Product codes 5018 2258 23 45 I i 9 21 Unweighted average f 17.8 12.4 - - Unweighted average s 17.8 13.2 21.4 15.2 Weighted averageh 18.7 14.6 - - Source: Tariff schedule, National Accounts. Own computations. Notes: a) ISIC codes followed by an asterix are a group of industries: see Annex A for details. b) Number of product codes in the 1992 customs classification. C) Statutory tariffs as defined by the Tariffs schedule 673/1991. d) Expected tariff revenues are obtained by multiplying tariffs by imports (at the product code level). e) For details, see the Tables mentioned in these columns. f) Average based on tariffs by product code. g) Average based on tariffs by industry. h) Averages (based on tariffs by industry) weighted by industry value-added. i) Excluding industry ISIC 3114. Effective rates of protection That Romanian applied tariffs range from 0 to 40 percent (60 percent in the statutory tariff schedule) raises the question of the magnitude of the "effective" tariff rates, which measure the protection granted to domestic value-added by comparing the differences between tariffs on inputs used by domestic producers and those on outputs. The need to look at effective tariff rates is reinforced by the statutory Tariff schedule's eighteen different tariff rates, which offer evidence of a very complex tariff structure.'o The mission believes that four tariff rates are appropriate. Any more introduces complexity, non-transparency, and incentives to lobby for apparently marginal changes of band. Table 2.3 presents the estimated effective tariff rates at the level of the sectors defined by the RSIC (based on the 1992 tariffs and the 1990 input-output table provided by the Romanian authorities). Annex II describes the methodology used for computing these estimates. Effective rates are high for food products (particularly, for fish), basic consumer goods (apparel, cutlery and hand tools) and cars. The (unweighted) average effective tariff is high-more than 20 percent in the case of the statutory tariffs. The table illustrates the huge changes in effective protection that can be introduced by altering the schedule of nominal rates. Since effective rates determine resource flows, the possible costs of regime instability are obvious. Tariffs and foreign direct investment: a costly exemption? The law 35/1991 on foreign direct investment specifies that foreign investors are exempt from tariffs on equipment needed to set up operations in Romania. A similar exemption is granted for joint ventures between Romanian and foreign firms. INTERNATIONAL TRADE PoUCY 31 To gauge the extent of exemptions, it would be interesting to compare "expected" tariff revenues-based on recorded import values and the 1992 applied tariff rates, so that they do not take into account the tariff exemptions granted to foreign investors-with actual tariff revenues. But, surprisingly, Romanian customs could not help the mission obtain industrial or product level data on actual tariff revenues, making the estimate of the fiscal cost of the measure impossible. The difference is likely to reflect closely the fiscal cost of the tariff exemptions, which could then be compared with their economic benefits. Such a task should be undertaken as soon as possible both for itself and because it would provide a rudimentary check on fraud and mismanagement of individual Customs offices. Also, such a generous tariff exemption could generate incentives to subvert the law, for instance by inducing operators to create joint ventures for the mere purpose of avoiding tariffs. Auditing the foreign investment law is not part of the mandate of the Customs service; it should be handled by a central office such as the Ministry of Finance or the Prime Minister's office. Quantitative aspects of the general import regime As mentioned earlier, there are no quotas or voluntary export restraints in the Romanian import regime (as of January 1993). Moreover, barter trade agreements with former state-trading countries and certain other countries are rapidly declining in importance. As a result, quantitative aspects are confined to import licenses on a few goods-weapons, ammunition, explosives and military equipment (in particular, under COCOM rules), drugs and narcotics, toxic products, and renewable offal of any kind." The loose definition of these goods and the secrecy attached to the trade of some of them precluded us from estimating the import coverage of this first group of products, but it appears to be no greater than in most other countries. Also, tariff quotas are applied to a few product codes-representing less than one percent of the total Romanian imports. When imports rise above an established ceiling, tariffs are imposed. The ceilings are fixed in terms of U.S. dollars, and the goods concerned are concentrated in a few industries-wood, furniture, paper and machinery of different kinds (see table 2.4). Based on GAIT (1992b), table 2.4 shows that in 1992, the products subject to this procedure can be split into two very different groups: products with utilization rates (imports as a percentage of the available quotas) lower than 100 percent and products with rates higher than this threshold. The tariff-quota system has been operative for such a short time, however, that it is not possible to distinguish between the various possible explanations of this situation, which include a possible lack of information by the operators. We note, however, that in all cases the quota grants tariff reductions relative to the statutory tariff, and in this sense it is a force of liberalization. But attention must be paid to quotas' effects on effective rates of protection and the lobbying they may encourage to extend the right to import at reduced rates of duty. Nonborder taxes Discriminatory nonborder taxes, such as excise or value added taxes with higher tax rates on foreign goods, can indirectly protect industries. Regulation 5/1992 lists goods subject to high excise taxes ranging from 10 to 70 percent in ad valorem terms.n This list is not provided in terms of Customs product codes, but in terms broad enough to make assessing the potential discrimination against foreign goods difficult. More important, it is difficult to assess the discriminatory element of 32 RoMANIA: RESTRUCTURING TO FACE THE Wo LD EcoNmy Table 2.4 Romanian tariff quotas (by customs product codes and industry) ISIC Customs Quota Import Udtiza- Codes Product Products Values * Values ion Codes rates Tariff quotas granted on August 26, 1992 3311 # 4410.10 Particle board of wool 15 1367 9113.3 3311 # 4410.90 Particle board, other 50 355 710.0 3320 # 9406.00 Prefabricated kiosks 3950 69 1.7 3320 # 9405.60 Illuminated signs 20 33 165.0 3320 # 9405.92 Plastic parts for illuminated signs 70 6 8.6 3410 ## 4814.20 . Wall Paper 20 532 2660.0 3610 6911.10 Tableware and kitchenware 20 681 3405.0 3620 7011.10 Glass bulbs 50 896 1792.0 3699 6810.19 Floor tiles 165 0 0.0 3811 # 8205.90 Hand tool sets 1110 132 11.9 3811 # 8302.42 Furniture, certain mountings 50 1123 2246.0 3811 # 7307.22 Stainless steel, elbows, bands, etc. 30 17 56.7 3825 8470.50 Cash registers 15 603 4020.0 3825 8471.20 Digital automatic data processing machines 2130 8089 379.8 3825 8471.91 Complete digital processing units 400 4617 1154.3 3829 8415.82 Air conditioners 1350 900 66.7 3829 8419.81 Machinery for hot drinks and food 30 79 263.3 3829 8428.33 Belt type machinery 1350 26 1.9 3831 # 8504.40 Static converters 140 555 396.4 3831 # 8536.50 Other electrical switches 10 224 2240.0 3831 # 8539.39 Other discharge lamps 190 186 97.9 3832 8525.20 Transmission apparatus 1000 1424 142.4 3832 8526.10 Radar apparatus 6000 733 12.2 3832 8526.91 Radio navigational aid apparatus 1600 117 7.3 3832 8527.90 Other reception apparatus 1500 429 28.6 3833 8509.10 Vacuum cleaners 50 1099 2198.0 3843 8702.10 Public transport vehicles 2000 4315 215.8 3843 8703.33 Vehicles (diesel engines > 2500 cc) 380 76 20.0 3851 # 9030.39 Other instruments of measure 1000 76 7.6 3900 ## 8609.00 Containers for carriage by plane 300 4 1.3 Tariff Quotas Granted on September 15. 1992 3813 7309.00 Reservoirs and similar containers 1298 20 1.5 3823 # 8422.20 Machinery for cleaning bottles 228 383 168.0 3823 # 8422.30 Machinery for filling bottles 533 2636 494.6 3823 # 8422.40 Packing machines 15 1081 7206.7 3823 # 8435.10 Presses for making beverages 267 209 78.3 3823 # 8438.60 Machinery for the preparation of fruits 150 202 134.7 3823 # 8438.80 Other machinery 404 3599 890.8 3823 # 8438.90 Spare parts for other machinery 264 863 326.9 3829 8413.60 Pumps, rotary 67 33 49.3 3829 8413.82 Liquid elevators 22 48 218.2 3829 8415.81 Air conditioners 12 163 1358.3 3829 8418.61 Compression type refrigerators 246 82 33.3 3829 8419.89 Certain heating, cooking machinery 1360 266 19.6 3829 8421.22 Filtering and purifying machinery 655 486 74.2 3829 8428.33 Belt type machines 187 26 13.9 Source: Decisions 489/1992 and 554/1992. as reported by GAIT Secretariat (C/RM/S/32B/p.21). Notes: a In US$ million (quota values granted for July-December 1992). b In US$ million (import values granted for January-June 1992). c Import values in percent of quota values. INTERNATIONAL TRADE PoLICY 33 these taxes because it is sometimes difficult to know whether the Romanian goods competing with the foreign goods are similar enough to be also covered by the higher tax rates. As a result, table 2.3 merely signals the few industries touched by possibly discriminatory nonborder excise taxes in 1992, without giving a precise estimate in terms of Customs product codes covered. Table 2.5 tries to go further. It lists goods subject to special excise tax rates, and tries to identify the cases where a discriminatory impact is plausible. By comparing the excise taxes on imported varieties with those on the corresponding domestic varieties (where such a correspondence is obvious) it calculates the degree of discrimination involved.Table 2.5 suggest three conclusions. First, and most important, the degree of discrimination-the incremental tax rate for foreign goods-can be very large: from twice the applied tariff for cigarettes to three times for cars with engines of over 1500 cc or more (alcohols). Moreover, comparison with table 2.3 shows a high correlation between sectors (goods) subject to surcharges and products subject to high excise tax rates. Second, high excise taxes and surcharges have mostly been imposed on "luxury" goods-although the list of goods given by table 2.5 includes some "non-luxury" goods, such as coffee, beer, and basic consumer electronics. Discriminating against foreign luxury goods has a strong perverse impact: it generates incentives to produce luxury goods domestically, instead of importing them, and presumably to do so less efficiently than in foreign countries. A discriminatory policy against foreign luxury goods potentially increases the amount of domestic resources devoted to these goods. A better policy is to impose the same tax rate on domestic and foreign goods. Lastly, the car industry appears at the center of a web of protective measures: tariffs, surcharges, higher excise tax rates, and the nonborder measure effectively banning the import of used cars older than eight years. This last measure is said to have been introduced for safety reasons, but it does not apply to the vast majority of domestically produced eight year old cars. Antidanping, countervailing, and safeguard instruments These instruments are quite different from the instruments already examined for two reasons: they can be invoked at any time: thus, they introduce by their very nature an element of potential change in the Romanian import regime; and, they rely on the existence of complaints lodged by domestic firms or by domestic subsidiaries of foreign firms. These features reinforce the reversibility of the Romanian general import regime and tend to recreate or reinforce the links between the still state-owned enterprises and public authorities, slowing progress toward a competition-oriented market economy. At this early stage in the history of such policies, it seems reasonable to focus attention on two limited points: the antidumping cases initiated in 1992, and an examination of the basic regulations. Romanian antidumping cases in 1992 The Romanian authorities reported that in 1992 only three cases were handled on the basis of these provisions, although it is not clear precisely which provisions have been used. The case that seems most representative of future cases involves TV tubes imported from Ukraine and several A RANVIA: REPQTRUTCDThTr. TO 1PACE Tt WnRTD 1PnUV Table 2.5 The discriminatory impact of the nonborder taxes Ercise Ad tax valorem Discrimination Industies and products rates' equiv- lents Existence e Degree d 2000 Domestic crude oil 25.0 33.3 2000 Methane or natural gas 36.0 56.3 3121 Coffee beans 60.0 150.0 3121 Soluble coffee 60.0 150.0 3130 Distilled, technical alcohol 30.0 42.9 3130 Brandies and natural brandies 60.0 150.0 lik. 3130 Wines 40.0 66.7 3130 Spirits and liqueurs 60.0 150.0 3130 Whiskies 70.0 233.3 yes 83.3 3130 Gins 70.0 233.3 yes 83.3 3130 Rums 70.0 233.3 yes 83.3 3130 Drinks of wine origin 60.0 150.0 3130 Cognac brandies 70.0 233.3 yes 83.3 3130 Sparkling wines 30.0 42.9 3130 Vermouth 30.0 42.9 3130 Beer 30.0 42.9 3130 Canned beer 45.0 81.8 lik. 39.0 3140 Cigarettes and tobacco products 70.0 233.3 yes 133.3 3140 Romanian cigarettes 1 50.0 100.0 3140 Romanian cigarettes I f 40.0 66.7 3232 Garments of noble fur 50.0 100.0 lik. 3320 Sculptured furniture 40.0 66.7 lik. 3620 Crystal items 40.0 66.7 lik. 3832 Video-sets 50.0 100.0 lik. 3832 Color TV sets 10.0 11.1 3832 TV sets with remote control 40.0 66.7 yes 55.6 3843 Cars (including second hand) 10.0 11.7 3843 Cars with engines of over 1500cc 50.0 100.0 yes 88.9 3900 Jewelries of precious metals 30.0 42.9 All Unweighted average 45.7 105.4 81.3 Source: Decision 5/1992 Notes: a Rates are determined as percentages of the tax-inclusive prices. b Ad valorem equivalents are determined as percentage of tax-exclusive prices (as ad valorem tariffs). c Discrimination can be likely (lik.) or certain (yes). d Difference between the rates applied to domestic goods and the rates applied to foreign goods. e Trade marks: Top. Dacia. Record, Club, Pescarus, Snagov. f Trade marks: Marasesti, Carpati. Bucegi. other states of the former Soviet Union (FSU) during the summer 1992. This case was terminated without opening formal proceedings by the abrogation of the tariff reduction granted for 1992 (the applied tariff was 5 percent), and a return to the statutory tariff of 15 percent (October 21, 1992). This action looks moderate, but two caveats should be made." First, the decision taken seems based only on an injury test; that is, on price undercutting in the Romanian market, where import prices were half the prices of TV tubes produced in Romania. Whether TV tubes were sold on the Romanian market at lower prices than in the exporting FSU states was never carefully examined. Second, complications have led to an indirect increase of the level of protection. The INTERNATIONAL TRADE PoLICY 35 combination of the free trade agreement between Moldavia and Romania and of the "free" trade regime between Moldavia and the other FSU states led FSU producers to export TV tubes to Romania through Moldavia as soon as the statutory tariff was reintroduced on exports coming directly from the other FSU countries. As a result, the tariff of 15 percent was extended to TV tubes exported from Moldavia-illustrating the domino effect of discriminatory measures that tend to increase the costs of an initially moderate and limited measure. The two other cases of administered protection involved detergents and towels imported from Egypt under state-trading agreements designed to reduce the outstanding debt between Egypt and Romania. The import volumes of these two products declined rapidly, however, after the import surge that triggered the action. As a result, no official action was initiated and no measure taken. By July 1993 sixteen initial requests for protection have been received under these rules, usually with no specific grounds quoted; that is, no statement about whether the claim is for antidumping, countervailing or safeguards action. It is commendable that to date no formal procedures had been opened as a result of these inquiries. An analysis of the basic regulation The Government Decision 228/1992, which contains the basic provisions for antidumping, countervailing, and safeguard measures, has a relatively low legal status that will allow it to change rapidly if the contracting parties of the GATT, especially in the Antidumping Committee, express concern. The regulations have been submitted to a special committee for review. Three observations on the regulations can be made. First, although the decision follows the definitions of dumping and subsidy provided by the GATT texts, it does not mention injury as a necessary condition for action. GATT permits antidumping measures only when dumping causes or threatens to cause material injury to an established industry in the importing country. Second, the safeguard provision (Article 4) nakes no reference to crucial GATT conditions such as the existence of "unforeseen developments* and the exchange of concessions. This divergence between the Romanian regulations and the GAIT text invites decisions by Romanian authorities contrary to the GATT. The Romanian text allows safeguard actions as soon as "...the imports of some products in such quantity or under such conditions as to cause or threaten to cause a major injury to the domestic producers of similar or directly competitive products." Third, Article 6 of Decision 228 establishes a price office. This office's goal is to provide information on world prices to Romanian exporters, theoretically helping eliminate the risk that Romanian exporters will dump and then be caught in antidumping procedures or other types of retaliation by the importing country. One may have strong doubts about the capacity to get information accurate enough to be useful. Moreover, to estimate dumping would require the office to compare export and Romanian prices-not merely to look at export prices. As a result, the goal of the price office seems rather to eliminate "price undercutting" by Romanian exporters on foreign markets-a very difficult task for an administrative body and one that does not make -a lot of sense from an economic point of view. If the Romanian authorities are concerned by "excessive" price undercutting from Romanian exporters, a less expensive and better alternative would be to give to Romanian exporters detailed information on the risk of undercutting prices by "too much" in: markets protected by frequent antidumping actions. Such information could consist of summaries of 36 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY previous antidumping cases involving Romanian firms (in the EC or in the U.S.) that show the difficulties of escaping antidumping measures. The price office also provides information on the world prices of Romanian imports-a dangerous and potentially improper procedure. The danger comes from the difficulties of providing accurate, timely, and exhaustive information on world prices. This procedure will easily lead to abnormally frequent accusations of dumping based on average rather than observed prices. The action is potentially improper because GATT tradition requires that antidumping actions be triggered only by domestic firms. There is a host of reasons why domestic firms might not lodge antidumping complaints when foreign firms "dump", but an active price office-not constrained by any of these reasons-might become an administrative substitute for domestic firms, generating antidumping cases on an ex officio basis. The price office has not acted in this way to date, but there is apparently provision for it to do so-Article 5.7 of Order 128/24 of August 1992. Working rules for enforcement and administration complete Decision 228/1992. In many respects, these provisions follow the regulations enforced in the EC and other countries. Since the EC regulations are more carefully drafted than Decision 228, the Romanian working regulations appear to compensate for certain provisions of Decision 228. For instance, they make clearer the double condition of the existence of dumping (or subsidy) and of the existence of injury. Working regulations are not a satisfactory answer to the observations presented above, however, for two reasons. First, inconsistencies between regulations are dangerous and create uncertainty. A more appropriate reaction is to eliminate the offending provisions embodied in the basic regulation. Second-and more important-the working regulations do not include the two provisions of the EC regulations that would have maintained a healthier discipline in antidumping enforcement-if, that is, EC authorities had chosen to enforce them: the "sunset" clause, which imposes an automatic lapse of five years after the measures if there is no review of the cases, and the "interest of the Community" provision, which empowers the Commission not to impose antidumping duties if they will harm the economy overall. The Ministry of Trade considers the Government Decision and its two implementation orders as a single package - and GATT has also agreed to do so. For a short period while current policies persist this is perhaps acceptable. But a high priority should be given to specifying satisfactory procedures in legal form. Summary recommendations * Stabilize the import regime. It would be best to set protection at the levels of 1992 tariff schedule or even lower. If this is impossible we recommend scheduling and announcing now a return to the 1992 tariff structure in, say, 1996. * Eliminate the discriminatory elements of two nonborder measures: the "tariff-equivalent" tax implicitly included in the higher excise tax rates and the discriminatory quota on used cars. Romania agreed to drop the car quota in its arrangement with the EC. It should extend this policy to non-EC countries. * Redraft entirely the antidumping, countervailing duty and safeguard regulations following three principles. The regulations should follow the GATT texts more closely, include a sunset clause, which would end antidumping, countervailing, or safeguard measures taken after a period of five (or even three) years, and incorporate a provision about the -"interest of the national economy", which will discourage Romanian authorities from initiating antidumping, countervailing or safeguard measures (even if the GATT conditions are met) when the general costs of such protection are INTERNATIONAL TRADE PoucY 37 higher than their benefits to the domestic firms involved. 0 Undertake a careful analysis of the costs and benefits of the tariff exemption on imports that has been granted to foreign investments. The general export regime in 1992 The provisions relating to the general export regime were mostly introduced in April in 1992, through Government Decision 215/1992 (table 2.1). These provisions can be split into two very different groups: export licenses and export promotion measures, which include export credit, export insurance, and the drawback system. Export promotion is examined in chapter 4. Products under export licenses can be divided into two categories-those licensed under international agreements with powerful trading partners, such as the EC, the EFTA countries, and the U.S. (meat, textiles and apparel, and iron and steel), and those covered for domestic purposes (see table 2.6). There are two major rationales behind this second type of export quota: the conservation of natural resources, such as wood products, and the protection of the current low prices in Romania, such as for drugs and medicines. This section examines the issues raised by the goods under controlled prices and those raised by the goods for which export limits are imposed by trading partners. It also describes the existing licensing mechanism and shows its economic inefficiency. Export quotas imposed for domestic purposes In December 1992 the Romanian authorities maintained a long list of quotas for domestic purposes, ranging from quotas on raw materials, such as wood and raw hides, for which the conservationist rationale is dominant, to quotas on more sophisticated products-for example, drugs-for which low domestic prices constitute the main rationale. Romanian authorities are committed to reducing and eventually eliminating these export quotas through two international documents: World Bank programs and the EC-Romania Agreement. Indeed, the most recent Ministerial Order (151/1992) has relaxed the export quotas for certain drugs and medicines, and more action was expected for late December 1992 (during the stay of the mission in Bucharest).,4 Two general remarks are useful. First, restricting exports limits the capacity to import. Thus these policies are equivalent to limits on imports and, in the current situation, the cost of such limits may be high. Second, alternative instruments may achieve.the same objectives at a lower cost. For manufactured goods, such as drugs, Western products are likely to be expensive by Romanian standards, but "generic drugs" produced in Ireland or elsewhere might be competitively priced. Import competition from such generic drugs will help to keep down the prices of drugs and medicines in Romania more efficiently than state price controls. Moreover, import competition offers an efficient alternative to the long term inefficiency generated by controlled prices, which r'duce the supply of the domestic industry and its rate of innovation. For all these reasons, a better policy would be to subsidize the few drugs considered to be crucial for the health of the population in a non-discriminatory manner (whatever their origin may be)-and to liberalize trade in drugs and medicines. For natural resources, the auction of domestic timber in a non-discriminatory manner-opening Romanian timber to use by domestic or foreign industries-would be a more 38 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNOMY Table 2.6 Romanian export prohibitions and quotas, by industry Customs Prohibidons Quotas ISIC product Products Codes codes Permanent for 1992 Unit Amount - - # Belongings of N.C.P. b Yes - -- Electric power Yes - - Nonferrous and paper scraps Yes - - # Toxic products Yes 1000 1001/1009 Cereals (and seeds) Yes 1000 4101 Raw hides, bovine Yes 1000 4102 Raw hides, sheep and goat Yes 1000 5001 Silk cocoons Yes 1000 1701 Sugar Yes 2000 2701/2704 Coal, energetic and coke Yes 2000 2601 Iron ore Yes 2000 2515 Marble, unprocessed cub. a. 300 2000 2515 Marble, unworked Yes 2000 2503 Sulphur, technical Yes 3111 0102+0201 Meat, bovine I tons 10400 3111 0104/0204 Meat, sheep c tons 14600 3112 0405 Butter Yes 3112 0401 Milk for consumption Yes 3115 1507 Soya (and seeds) Yes 3115 1512 Sun-flower seeds Yes 3115 1507 Sun-flower and soya oil Yes 3116 1102 Flour Yes 3119 07 Seeds (potatoes, beans...) Yes 3211 # 50/59 Textile products ###see Table 7### 3213 # 57/63 Apparel products ###see Table 7### 3311 # 4400 Wood, beechtree parquet th. sqm 500 3311 # 4400 Wood, beechtree plywood cub.a 50000 3311 # 4400- Wood, chipboard th.sqm 800 3311 # 4400 Wood, doors and window-frames th. sqm 1000 3311 # 4400 Wood, for firewood, cellulose... Yes 3311 # 4400 Wood, logs, rafters, lumber, etc. Yes 3311 # 4400 Wood, panels th. sqm 1300 3311 # 4400 Wood, semi-fabs th.a3 300 3311 # 4400 Wood, timber . Yes 3311 # 4400 Wood, veneers (all kinds of wood). Yes 3311 # 4400 Wood, wooden cases for citrus cub.a 35000 3411 4701/4107 Cellulose and semi-cellulose Yes 3420 4820 Note-books tons 4800 3420 4820 Note-books Yes 3511 2926.10 Acrylonitryl tons 11000 3511 2902.20 Benzene tons 2000 3511 29 Dimethyl-terphathalate tons 3000 3511 2905.31 Ethylene-glycol tons 1000 3511 3102 Fertilizers, nitrogen and urea th. tons 980 3511 2902.30 Tholuene tons 9000 3522 3003/3004 # Drugs and narcotics Yes 3522 300313004 Medicines Yes 3522 3003/3004 # Medicines Yes 3522 3001/3006 Pharmaceutical products 3529 # 3601/3604 # Explosives Yes INTERNATIONAL TRADE POLICY 39 Table 2.6 Romanian export prohibitions and quotas, by industry (continued) Customs Prohibdons Quotas SIC product Products Codes codes Permanent for 1992 Unit Amount 3530 2710 Oil, benzines th.tons 1400 3530 2710 Oil, crude Yes 3530 2710 Oil, diesel tons 200000 3530 2710 Oil fuel, kerosene and heating Yes 3530 2710 Oil, naphtenic mineral tons 30000 3540 2704 Coal briquettes Yes 3710 7202. Ferro-alloys Yes 3710 7202 Ferro-alloys, chrome, silicon,... tons 12000 3710 72 Steel products ###see Table 8### 3720 7604 Aluminum in blocks Yes 3720 7601 Aluminum in blocks, Iry and 2ry tons 75000 3720 74 Bronze and brass secondary alloys tons 1600 3720 7402 Copper, electrolyzable tons 5000 3720 740717411 Copper, cables, insulated etc... tons 100 3720 74077411 Copper, wire and extruded bars Yes 3720 74 Copper-lead crusts tons 10500 3720 7479 Nonferrous metals (lead, zinc...) Yes 3720 7106 Precious metals, scraps Yes 3720 7106 Precious metals and stones Yes 3819 7302 Scrap iron, collected, used rails tons 250000 3829 # 93 # Military weapons Yes 3829 # 93 # Weapons and ammunition Yes 3851 9018 # Medical apparatus Yes 3851 9021 Protheses, orthopaedic products Yes 3901 710617111 Nonferrous, precious concentrates Yes 3909 2705+2711 Natural and liquefied gases Yes Source: Ministerial orders 62/1992, 120/1992, 130/1992 and 151/1992. Notes: H Harmonized System, at the 2, 4 or 6 digit level. N.C.P.: National Cultural Patrimony. Also to be classified to ISIC 1000. efficient way to satisfy the stated goal of conservation. Auctions generate prices that signal the degree of scarcity of the raw materials, thus furthering the goal of conservation. When property rights on land are firmly established, the auction of land to large enterprises able to regulate the stock of timber could be envisaged. These export restrictions are analyzed more closely in the Appendix to chapter 4. The impact of export licenses imposed by trade partners Export licenses focus on textiles and apparel, iron and steel, and meat. The major trading partner concerned is the EC. What follows provides a brief description of the situation during 1992 and a few years prior. Table 2.7 lists all the textiles and apparel groups of products covered by the MultiFibre Agreement (MFA) and by the bilateral agreement between the EC and Romania, which enforces the MFA provisions. It leads to three observations. First, EC quotas in 1992 increased by roughly 11 percent, but these increases were much more limited than those granted to Poland, the Czech and Slovak Republics, and Hungary, and they were concentrated in a group of less importance for 40 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNOMY Table 2.7 Textiles and apparel: Romanian export quotas to the EC, 1985-1992 Situation in 1985-1989 Evolution of the situation (1990-1992) MFA MFA categories groups Utili- Shipment Relative Quotas Util. Inc 'd OPT Quotas zanon shares b unit in rates quotas quotas increase rates valuesc 1990 d 1990 1992' 1992f in % eld Categories under EC MFA VERs la 1 Cotton yarn 0.4 0.0 79.9 1078 0.0 1156 7.2 la 2 Fabrics, cotton 46.9 3.7 128.8 4332 19.6 4568 5.4 a 3 Fabrics, synthetic fibers 65.5 1.5 109.2 1289 11.3 1385 7.4 lb 4 Shirts 27.1 2.0 49.8 2948 26.2 3110 160 5.5 Ib 5 Pullovers 106.3 9.0 50.1 2727 45.5 2847 252 4.4 Ib 6 M&B breeches 90.8 12.3 108.5 2739 82.7 2904 1988 6.0 lb 7 W&G blouses 267.1 3.7 113.2 140 205.9 151 464 8.0 Ib 8 Men's and Boys shirts 119.8 7.3 66.2 1512 67.0 1624 554 7.4 Ha 20 Bed linen 73.6 1.3 105.7 949 88.8 1098 15.7 IIb 12 Socks 63.6 3.2 79.3 1572 36.2 1688 251 7.4 IIb 13 M&B underpants 100.0 3.1 70.3 992 46.4 1081 953 9.0 IIb # 14 M&B overcoats 47.8 3.0 210.2 1312 1428 1462 8.8 IIb # 15 W&G overcoat .129.5 14.7 83.0 1804 2011 4010 11.5 Ib 16 M&B suits 56.4 8.9 85.1 2507 22.9 2695 784 7.5 Ib 17 M&B jackets 143.9 7.6 102.6 744 99.7 811 736 9.0 Ib 24 Pyjamas 66.2 2.5 75.1 1678 21.1 1877 83 11.8 Ib 26 W&G&l dresses 157.0 3.5 90.2 335 60.9 387 711 15.7 Hb 68 Babies' garments 16.2 0.2 69.2 662 17.8 771 327 16.5 IIb 73 Track suits 45.5 1.1 73.2 910 7.5 1010 397 11.0 IIb 78 M&B bathrobes 75.3 1.1 131.1 332 72.3 408 327 22.9 Illa 36 Fabrics, regen. fibers 0.8 0.0 172.8 490 604 23.3 IIa 37 Fabrics, regen: fibers 62.2 2.8 98.2 3718 20.5 4376 17.7 Illa 41 Yarn, synt. fibers 43.5 0.9 68.9 3879 18.0 4934 27.2 IIa 55 Synthetic staple fibers 16334 Ia 58 Yarn, synthetic fibers 1095 Illb 99 Fabrics, textile coated 960 Ilc 91 Tents 55.8 0.4 536 602 55 12.3 IV 117 Fabrics, flax 13.0 0.2 1011 1138 12.6 IV 118 Bed linen, flax 45.5 0.3 533 597 12.0 Summary by MFA group (for categones awer EC MFA VERs) avg sum avg sum avg sum sum g All groups 69.1 100.0 94.9 40728 48.5 63650 13514 11.1 Group I 75.9 41.9 88.2 16764 57.3 17745 3418 5.8 Group II 80.6 53.2 97.9 13797 47.4 15265 10041 10.6 Group I-IV 36.8 4.9 99.2 10167 19.2 30640 55 20.5 INTERNATIONAL TRADE POLICY Table 2.7 Textiles and apparel: Romanian export quotas to the EC, 1985-1992 (continued) Situation in 1985-1989 Evolution of the Situation (1990-1992) MFA Member groups MFA categories states involved Utili- Sipnent Relative Quotas Ufil. Inc'd OPT Queras zanon shares unit in rates quotas quotas Increase rates0 values # 1990d 1990 1992 1992f in % Categories under "Regional* MFA VERs i fIa 39 Table, Linen FRIT 23.8 0.3 100.1 645 5.7 711 10.2 fIb 18 M&B garments BNL 6.6 0.3 65.1 230 14.3 259 109 12.6 fIb 21 Parkas, anoraks IT 229.3 4.5 84.8 414 240.1 466 71 12.4 IIb 28 Trousers BNL,UK 19.6 0.1 47.5 232 70.1 269 67 16.0 fIb 29 W&G&I suits FR. IT 96.2 0.7 93.0 131 206.1 156 234 111.9 1IIb 69 W&G&l slips BNL, FR 26.5 0.1 84.2 140 54.7 156 21 111.3 Source: World Bank MFA Database. EC Official Journal. Author's computations. Notes: a Imports as a percent of quotas (averages for the period 1985-1989). b Romanian shipments of the category as a percent of Romanian total exports of textile and apparel goods to the EC (based on values in ECUs) and subject to EC MFA quotas. c Unit values (shipments in ECUs divided by exported quantities) of Romanian exports as a percent of unit values of all exports (subject to MFA restrictions) to the EC. d In tons or in ton equivalents. e EC increased quotas for 1992. f EC quotas granted to Romania under the *outward processing trade' (071) regime. g Quotas imposed on products for which there were no EC quotas in 1990 have been disregarded. h BNL: Benelux. FR: France. IT: Italy. UK: United Kingdom. i In percent of Romanian total (under EC and "regional' VERs) shipments. Romanian exporters (and for which EC producers are more competitive). Second, this increase does not take into account increases in the quotas granted under the form of "outward processing quotas" because-by their very nature-these quotas are defacto granted to EC producers rather than to Romanian producers. Third, utilization rates in 1990 were much lower than the average utilization rates of the period 1985-1989; they barely reached 50 percent on average, and they exceed 90 percent for only two MFA products-a rate that suggests exporters are close. to being constrained. It would be interesting to know whether this decline, which partly mirrors the general decline of the Romanian economy, has continued or has been reversed in 1991 and 1992. If there is no sign of reversal, low utilization rates-that is, non-binding quotas-should be a crucial criterion in the procedure for granting export licenses, see below. As of May, 1993, an additional protocol between Romania and the EC on trade in textiles and apparel increased export limits by 28 to 96 percent compared with 1992 levels. The agreement also substantially increased outward processing quota levels. The EC will eliminate quantitative restrictions on Romanian textiles and apparel by May 1, 1999. Table 2.8 gives a broad view of the so-called "autonomous" quotas that were imposed by the EC and by individual EC member states on steel exports from Romania and from the other Central and Eastern European countries. Since 1992, these quotas have been officially eliminated 42 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNoMY Table 2.8 Iron and steel: EC quotas on Romanian exports, 1989-1991 Limited Quantities ('000 tons) CEE CEE Yearo Grand total utiliz. Romania PT countries Other CEECs total exports rates %r quo. i. i total quo. lb. e total quo. lib. C total '000T Export program imposed by Germany 1989 0.1 93.9 94.0 439.9 470.1 910.0 112.9 38.3 151.2 1252.3 890.0 71.1 1990 0.1 96.8 96.9 439.9 484.6 924.5 112.9 39.5 152.4 1270.9 998.0 78.5 1991 142.0 99.8 241.8 643.0 499.6 1142.6 192.0 40.7 232.7 1617.1 1620.0 100.2 Export program imposed by Benelux (Belgium, Luxembourg, Netherlands) 1989 17.7 1.6 19.3 61.0 4.9 65.9 29.9 1.6 31.5 116.6 182.0 156.1 1990 20.9 1.7 22.6 72.0 5.0 77.0 35.4 1.7 37.0 136.7 178.0 130.2 1991 20.9 1.7 22.6 71.7 5.2 76.9 35.4 1.7 37.1 136.6 120.0 87.8 Export program imposed by Italy 1989 105.9 19.3 125.2 243.5 55.1 298.6 52.6 0.3 52.9 476.8 815.0 170.9 1990 125.4 19.9 145.3 303.5 56.8 360.3 59.8 0.3 60.1 565.7 1117.0 197.5 1991 125.4 20.5 145.9 283.5 58.6 342.0 59.8 0.3 60.2 548.1 946.0 172.6 Export program imposed by the other EC member states 1989 0.0 106.6 106.6 0.0 505.9 505.9 0.0 118.1 118.1 730.6 761.0 104.2 1990 0.0 109.9 109.9 0.0 521.5 521.5 0.0 121.8 121.8 7S3.2 833.0 110.6 1991 0.0 113.3 113.3 0.0 537.6 537.6 0.0 125.5 125.5 776.5 754.0 97.1 Export program imposed by the whole European Community 1989 123.7 221.4 345.1 744.4 1035.9 1780.4 195.4 158.3 353.7 2576.2 2648.0 102.8 1990 146.4 228.2 374.7 815.4 1068.0 1883.4 208.1 163.2 371.3 2726.4 3126.0 114.7 1991 288.3 235.3 523.6 998.2 1101.0 2099.2 287.2 168.3 455.4 3078.3 3440.0 111.7 Source: EC Official Journal [various years] and interviews. Author's computations. Notes: a Figures for 'liberalized' steel in 1989 and 1990 are estimated. b Quo.: EC export quotas for the Central European country involved. c Lib.: EC export program of *liberalized' steel for the Central European country involved. d The information on EC quotas imposed (in 1992) under the Association Agreement is not available. e Excluding EC quotas on GDR steel. f Including EC quotas on ODR steel. g Quotas granted to the former GDR in 1989 and 1990 are excluded (they were eliminated in 1991). INTERNATIONAL TRADE PoLICY 43 between the EC and Poland, the Czech and Slovak Republics, and Hungary, although EC antidumping actions initiated in December 1991 and safeguard actions brought under the provisions of the Association Agreement have imposed new constraints, in particular on Czech exports. EC import quotas on Romanian steel products were eliminated as of May 1, 1993 in the Interim Agreement between Romania and the EC. Though there is no systematic official data on the Romanian utilization rates of the EC steel quotas, observers generally agree that these rates were high in certain cases. EC quotas on Romanian exports of meat are limited to sheep and goat meat and to bovine meat. The mission was told that none of these quotas was fulfilled in 1991 and that the utilization rates have been close to 60 percent. The licensing mechanism The licensing procedure enforced in 1992 can be briefly described as follows. The Romanian authorities announce in Romanian newspapers the list of the Customs product codes.(or category of product codes) subject to export licenses, the quantities imposed for each product code (or category), the time span of the licenses (generally 6 months), and the time limit for getting them. Export licenses are provided on the "first come, first served" principle. When the available quotas are exhausted, the authorities stop granting licenses." This licensing procedure provides public authorities the chance to impose undesirable controls, though it seems that in 1992, such controls have not been frequent in Romania. For instance, the authorities may look at prices in the contracts to check whether these prices are close to world prices and/or to test the seriousness of the exporters. Such controls may be justified for quotas totally fulfilled by exporters. But they are not justified when export quotas are not binding-when utilization rates are lower than, say, 90 percent; that is, in almost all the textile and apparel quotas imposed on Romanian exporters, if the 1990 utilization rates shown by table 2.7 mirror the present situation. The second problem flows from the practice of awarding licenses without granting the right to sell and buy the license. The Romanian authorities explain their reluctance to grant so-called transferable licenses by the recent evolution of the licensing procedure. In the late months of 1991, export licenses were available free of charge. As a result, some Romanian operators requested more licenses than they really needed. Although licenses granted by the Romanian authorities could be larger than the available quotas, effective exports were smaller than the quotas. For instance, the mission was told that in 1991 even though the licenses granted for meat amounted to 120 percent of the quantities authorized by the quotas, the final utilization rate of the quotas was only 60 percent. In early 1992, the Romanian authorities addressed this problem by requiring applicants to deposit 2 percent of the value of the licenses but they continued to prohibit the sales of licenses between potential exporters. These decisions intermingle two objectives: to screen out "non-serious" applicants and to increase the final level of effective transactions. Imposing a financial cost on export licenses to weed out "non-serious' candidates does not necessarily ensure the achievement of the second goal-increasing the utilization rates of the available quotas. Screening out "non-serious" applicants merely increases the probability that owners of licenses will make the envisaged transactions. But even serious applicants can face unexpected difficulties and can be forced to scuttle their plans." 44 RoMAIuA: RESTRUCTURING TO FACE THE WORLD ECONOMY Indeed, the deposit requirement is likely to have a perverse impact: the more risk-averse the applicants are, the more they are induced nt to request licenses-with the consequence that only risk-loving Romanian exporters will continue to operate. It is necessary to reform the existing export licensing procedure. The core of the reform is to make licenses "transferable" by allowing resale between operators, ensuring that the whole stock of licenses is always available for potential exporters. A system of transferable licenses will encourage risk-averse operators to participate, even if a deposit is still mandatory, because they will be able to get their money back by selling the licenses. A system of transferable licenses will require additional rules in order to work properly. As shown in more detail in figure 2.1, the need for such rules depends on the degree to which the available quotas bind. For products under non-binding quotas (low utilization rates), Romanian authorities can continue to award licenses on a "first come, first served" basis because licenses for these products are not scarce (available quotas are larger than the licenses requested and used). To eliminate the possibility of "inside information", authorities must merely check that public information about licenses is freely available and that artificial scarcity of the available licenses does not occur. The problem is more complex when products are under binding quotas (when utilization rates are higher than a threshold-for instance, 90 percent). In this case, the "first come, first served" principle awards licenses to operators who are the best informed on the licensing procedure, but who may or may not be the most efficient. Indeed, the practice favors operators who specialize in the administrative process of granting licenses and penalizes those who focus on foreign markets. Under binding quotas, a better procedure is to grant licenses based on past performances of Romanian exporters. This past performance criterion is frequently used in Romania. While better than "first-come-first-served", it tends to favor well-established exporters and to penalize new competitors. Romania has addressed this problem by reserving 10 percent of the quota for newcomers. If the existence of new firms hurts exports of a given product an alternative solution, such as auctions for licenses could be tried." In this case, exporters for whom licenses have the highest value-those able to extract the highest value from the products exported-will be eager to buy them. License auctions require sophisticated managerial skills from the public authorities, who must make sure that auction markets will be efficient. Since this last condition is not a simple matter, authorities often award a certain proportion of licenses based on the past performance and auction the rest, blending the two principles. In any case, the precondition for an optimal use of the past performance principle or of the auction mechanism is transferability. If the utilization rates in textiles and apparel are still close to the low level of 1990, then allowing the resale of licenses will be the only immediate action at Romania's disposal. In early 1993 Order No 2/1993 introduced new rules for issuing licenses, permitting their issue on "first-come-first-served" basis, past performance, and on the basis of tenders. No details on tenders are given and they have not yet been used. The past performance criterion is the most commonly used because it provides a quota for newcomers, but requires exporters to have used about two-thirds of an initial allocation (20-30 percent of the total annual quota covering approximately three months) before qualifying for further allocations. The unused portion is reclaimed for use by other exporters. Resale is forbidden ostensibly to avoid profiteering that could arise when not all firms know when quotas are issued, but this seems unconvincing because under INTERNATIONAL TRADE PoLicY 45 the present arrangement ignorant firms miss out altogether. The mission continues to recommend permitting resale. Summary of the recommendations 0 Allow-as quickly as possible-the resale of licenses needed for exporting goods under quotas imposed by foreign trading partners. For goods under*binding quotas (when utilization rates are high) this action should be complemented by the use of the principle of past performance and, if the Romanian authorities feel confident of their capacity to promote efficient auction markets, by the .introduction of an auction system. * Eliminate, as quickly as possible and in a non-discriminatory way (that is, afford non-EC and EC countries the same treatment) export quotas that are imposed for domestic purposes, and implement more efficient policies for addressing social goals, such as the conservation of natural resources or minimal social equality. The Association Agreement with the European Community On February 1, 1993, Romania signed an Association Agreement with the EC. Like the Agreements between the EC and Czechoslovakia, Hungary, and Poland, the terms of the agreement dealing with trade issues were implemented in an interim agreement, which requires only a vote at the European Parliament before coming into force, whereas the Association Agreements need ratification by the twelve Parliaments of the EC Member States. The trade component Agreement went into effect on May 1, 1993. In accordance with Article 126 of the Association Agreement (Article 52 of the Interim Agreement), 1993 will be considered as the first year of enforcement of the Agreement. Romania has also signed an Agreement with the EFTA states-a move that parallels the trade relationships between Romania and the EC. Hence it will not be examined in detail. The structure of the EC-Romania Association Agreement is very similar to that of the other "Europe Agreements." This section focuses on the reductions in the barriers to trade in goods and on a few other essential topics related to trade in goods, such as factor movements and services. Before doing so, however, it is worth observing that the Europe Agreement is much more than a trade agreement: It forms the centerpiece of Romania's effort to re-integrate into the democratic, market-economy, world. The EC is Romania's largest western trade partner and a natural focus for its political aspirations. Thus the agreement must be. judged on more than just trade clauses-indeed on more than just all its written clauses. Its influence is widespread. For example; the agreement's mere existence reduces the probabilities of political recidivism and, on a concrete level, reduces the likelihood of a reversion to the semi-autarchic trade policy. But it would be inappropriate to judge the agreement on political criteria alone, because it is supposed to foster the development of the Romanian economy toward western standards of affluence, and, while clearly a huge advance on the previous regime, it equally clearly has limitations in this regard. 46 RoMANIA: RESTRUCTURING TO FACE THE WORLD EcoNOMY Trade barriers in goods Table 2.9 reports the commitments of both parties under four major headings: industrial products, agricultural products and fisheries, textiles and apparel, and iron and steel. It makes clear the long transitional period before Romania has to liberate all its imports and the rather faster liberalization of access to most EC markets. What are the net gains for Romania of the preferences granted by Romania to EC products? Any preferential agreement generates benefits and costs. Benefits flow from the trade created by the removal of trade barriers previously faced by efficient (i.e. low cost) firms of the signatories of the agreement. Costs flow from trade diversion-when a signatory is induced to buy imports from the signatory partner rather than from the rest of the world. Preferences granted by the agreement give an edge to inefficient (i.e. higher cost) firms in the signatory partner. A simple analysis of this issue is presented in figure 2.2.18 Since EC producers are not among the most efficient world producers for all the goods covered by agreements, it is likely that Romania will suffer from some trade diversion. This possibility affects Romania more than other Central European countries because Romanian tariffs on non-EC goods are substantially higher (figure 2.2). An assessment of the net gains for Romania of the Association Agreement-the benefits of the agreement minus the costs flowing from trade diversion-requires more information and time than are available. But, table 2.10, which makes a first guess at the extent of the problem by estimating the scheduled decline of average Romanian tariffs by industrial sector, shows that one condition for diversion (the extent of preferences) will be quickly met: by 1996, preferences for EC goods will exceed 5 percent-a level that gives an edge to EC firms. The agreement has also obliged Romania to adopt a more disaggregated tariff nomenclature-it must shift from a six digit to an eight digit tariff classification. As mentioned earlier, a uniform tariff is generally preferable to multiple tariffs for a country without market power on world markets. An increase in Customs product codes creates the potential for a more complex tariff structure. The shift from the optimal (uniform) tariff structure is roughly mirrored by the number of new product codes created by the Romanian authorities in the Association Agreement. These new product codes are unevenly distributed among sectors: for a dozen, the number of product codes created is higher than the number of existing product codes, whereas for another dozen there is no change (table 2.10)."1 The introduction of the new headings has so far been a purely technical issue-the new 8-digit codes all carry the same statutory tariff as their 'parent' 6-digit codes. . But preferences for EC goods vary between 8-digit codes from the same 'parentage', and a tariff system with eighteen different rates and a tradition of lobbying clearly offers room for exploiting the finer classification. Evidence from other countries suggests that tariff classifications for manufactures tend to be most disaggregated in the most sensitive and thus tariff-prone products. Industrial products Table 2.9 presents the time schedules for reducing barriers against EC exports. Under Article 11:4 tariffs will decrease by 20 percent three years after the start of the agreement-supposedly in 1996. After a pause during the fourth year, Romanian tariffs will decline INTERNATIONAL TRADE POLIcY 47 Table 2.9 The EC-Romania Association Agreement: main provisions on trade in goods 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 INDUSTRIAL GOODS (except textiles & apparel, iron & steel) Romania General T 100 80 60 50 35 20 0 Q Elimination of all quantitative restrictions at the entry into force. EXP Elimination of all restrictions at the entry into force. Annex IV T 0 Annex V T 80 40 0 Annex VI T 80 70 60 40 20 0 T 100 0 60 40 20 0 Annex VII T Reduction of tariffs (as for General) for imports above the quotas. Q Annual increase (10%) of the initial (1993) quotas of 20,000 units. Annex VIII Q Elimination of all restrictions on second-hand (8 years old) cars in 2000. Annex IX EXP Elimination of all these restrictions between 1993 and 1998. European Community General T 0 Q Elimination of all quantitative restrictions at the entry into force. EXP Elimination of all restrictions at the entry into force. Annex Ha T 50 0 Annex Ib T 80 60 40 20 0 Annex II Ta 85 70 55 40 25 0 Q Annual increase (20%) of the initial quotas or ceilings. AGRICULTURAL PRODUCTS (non-processed) and FISHERIES Romania General Q Elimination of all quantitative restrictions at the entry into force. Annex XIII T Reduction of tariffs between 1993 and 1997. Annex XV T Reduction of tariffs in 1993. European Community General Q Elimination of all quantitative restrictions still subject to EC Reg. 342083. Annex XIa T Reduction of levies by 50 percent.4 Q Annual increase (10%) of the quotas. Annex XIb T Reduction of tariffs. 48 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Table 2.9 The EC-Romania Association Agreement: main provisions on trade in goods (continued) 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 AGRICULTURAL PRODUCTS (non-processed)and FISHERIES (cont.) Annex XHIa Reduction of tariffs and levies (20% in 1993, 40% in 1994, 60% after 1994). Annex XIIb Q Annual increase of the quotas. Annex XIV T Reduction of tariffs in 1993. SPECIAL PROTOCOL 1: TEXTILES & APPAREL Romania T Tariff reduction in accordance to above-mentioned provisions on industrial goods. European Community Td 71 57 43 29 14 0 T Elimination of tariffs on Romanian exports under 'outward processing' rules. Q Increase of the quotas (to be negotiated). SPECIAL PROTOCOL 2: IRON & STEEL' Romania General T 100 80 60 50 35 20 0 Q Elimination of all quantitative restrictions. Annex Ila T 0 Annex Ilb T 80 40 0 European Community T 80 60 40 20 10 0 Q Elimination of all quantitative restrictions. Source: The EC-Romania Association Agreement [1993]. Notes: a Suspension of tariffs for imports within the quotas. b Products subject to quantitative restrictions. o Products subject to minimum prices. d (missing) e (missing) rapidly to 0 percent between the fifth and the ninth years. The general rule includes two other provisions: the elimination of all import quotas and of all restrictions on exports not examined in other parts of the agreement. The EC seems to have requested those provisions as a legal guarantee, since no such barriers exist in Romania, as mentioned earlier. In addition to this general provision, Romania has accepted six other tariff commitments specified in the annexes of the agreement. Annex IV, which lists the goods for which tariffs will be abolished when the agreement comes into force, covers 1,433 products-many of them corresponding to newly created product codes. Annex V enumerates the 644 goods subject to a more rapid elimination of tariffs than those covered under the general rule. Annex VI lists the few goods (automobiles) with a slightly different time path for reducing tariffs. Annex VII specifies the INTERNATIONAL TRADE PoLICY 49 commitments in terms. of quantities for the few products which operate under a tariff-quota system in Romania: quotas granting zero tariffs will be increased by 10 percent every year (and tariffs for quantities outside the quotas will be reduced under the general rule). Annex VIII specifies that the only known Romanian quantitative restriction-the "safety regulations" on foreign used cars-will be eliminated eight years after the entry into force of the agreement, that is, by the year 2000. Lastly, Annex IX specifies the goods subject to Romanian export bans and restrictions and which restrictions shall be "progressively reduced and eliminated at the latest by the end of the fifth year after the entry into force." (Much of this has already been achieved.) Table 2.10 provides a crude estimate of the global impact of all these provisions. At the start of the agreement, the unweighted average tariff on EC goods for the whole Romanian industrial sector will decline by 15 percent. In 1996, it will represent two-thirds of the average statutory tariff enforced compared with the rest of the world, one half in 1998, and one quarter in 2000. . At a first glance, EC commitments seem more generous: their general rule consists of a zero tariff from the start, and even their exceptions to the general rule represent a faster reduction of the tariffs than Romania has committed to. These differences have generated the concept of "asymmetry", which implies that the EC opens its markets faster than Romania. This impression erodes, however, when the list of EC exceptions for "sensitive" products-agriculture and fisheries, textiles and apparel, iron and steel, all of which represent a major proportion of Romanian exports to the EC-is examined. As was pointed out to the mission by officials of the Ministry of Trade, the EC "philosophy" of trade policy claims special privileges for such sectors and Romania alone could not overturn that philosophy. Thus it is not surprising that access continues to be restricted in such sectors. This does not alter the fact that continuing to protect such sectors reduces the benefits of the Europe Agreements to Romania and imposes costs on EC consumers. Agricultural products and fisheries Reductions in agricultural trade barriers are limited in terms of product coverage and tariff reductions (table 2.10). Romanian concessions are twofold: the elimination of quantitative restrictions-again a legal guarantee for the EC since there are apparently no such Romanian restrictions-and a list of products for which tariff reductions are granted by Romania to EC products between 1993 and 1997. There are no commitments for the years after 1997. Commitments on fisheries are similar to those on agricultural products: tariff reductions are modest and limited to less than 20 products. The limited Romanian concessions mirror the limited concessions that the EC has been offered. They also reflect the fact that the Romanian authorities may want to introduce a "Romanian agricultural policy," a concept mentioned in Article 21:5 of the Association Agreement although this Article does not define the concept.2 Certain Romanian officials told the mission that they were considering a "harmonization" between the EC and Romanian farm policies (a statement in accordance to the Article 21:6 of the Agreement) and that they were working on the introduction of variable levies. It is crucial, therefore, to emphasize that the EC Common Agricultural Policy generates extremely high costs for both the EC budget and the EC consumers. For instance, EC food prices are twice world prices; equivalently, the ad valorem tariff equivalents in agriculture range from 100 50 RoMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Table 2.10 The Romanian protection against EC goods: survey and estimates of the Romanian concessions in the Association Agreement ISIC Romanian protection vis-a-vis EC goods Sectors Initial situation New items Tarrff imposed on EC goods QL.r c Number Statut. A-4 A-5 Other 1993 1996 1998 2000 of p. tarffs codes INDUSTRIAL GOODS 1000 Agriculture 59 6.8 58 4 3.2 2.5 1.8 1.1 2000 Mining 100 5.1 35 3 7 3.5 2.7 2.0 1.2 3111 Slaughtering 1 10.0 10.0 8.0 6.0 3.5 3121 Food Products nec 3 8.3 8.3 6.7 5.0 2.9 3211 Spinning & weaving 390 19.1 53 18.3 14.6 11.0 6.4 3212 Textile goods 52 29.0 1 28.5 22.8 17.1 10.0 3213 Knitting mills 139 29.4 29.4 23.5 17.6 10.3 3214 Carpets & rugs 27 35.6 35.6 28.4 21.3 12.4 3215 Cord & rope industries 11 25.0 11 19.0 15.2 11.4 6.6 3219 Textile nec 36 20.9 30 13.2 10.5 7.9 4.6 3220 Wearing Apparel 138 28.9 2 28.6 22.9 17.2 10.0 3231 Tanneries 22 5.0 38 1.0 0.8 0.6 0.3 3232 Fur dressing & dyeing 7 19.3 1 10 13.9 9.9 5.8 3.4 3233 Leather products 17 22.6 22.6 18.1 13.6 7.9 3240 Footwear 24 25.4 4 22.5 18.0 13.5 7.9 3311 Sawmills 39 10.7 38 2 9.2 7.2 5.3 3.1 3312 Wooden containers 5 27.0 27.0 21.6 16.2 9.5 3319 Wood & cork products nec 13 18.2 6 15.1 12.1 9.1 5.3 3320 Wooden furniture 15 20.0 20.0 16.0 12.0 7.0 3411 Pulp, paper, paperboard 64 12.0 25 2 10.4 8.2 6.0 3.5 3412' Paper containers 8 15.0 15.0 12.0 9.0 5.3 3419 Paper products nec 42 15.0 10 3 13.9 10.8 7.8 4.6 3420 Printing & publishing 29 8.4 7 17 7.6 5.4 3.2 1.9 3511 Industrial chemicals 515 17.0 113 166 14.2 10.6 7.0 4.1 3512 Fertilizers 25 10.6 10.6 8.5 6.4 3.7 3513 Synthetic products 92 17.7 14 12 16.0 12.3 8.6 5.0 3521 Paints & varnishes 12 9.8 6 9.5 7.3 5.1 3.0 3522 Drugs & medicines 61 15.2 25 17 12.9 9.6 6.3 3.7 3523 Cosmetics 28 15.8 4 12.9 10.3 7.7 4.5 3529 Chemicals nec 115 16.8 68 23 11.3 8.9 6.5 3.8 3530 Petroleum refineries 10 9.8 5 5 8.4 6.0 3.6 2.1. 3540 Petroleum & coal products 10 7.8 4 6.0 4.8 3.6 2.1 3551 Tire & tube industries 13 30.0 3 26.5 21.2 15.9 9.3 3559 Rubber products nec 42 16.1 18 1 12.7 10.1 7.5 4.4 3560 Plastic products nee 63 20.0 17 17.6 14.1 10.6 6.2 3610 Pottery & china 14 20.4 20.4 16.3 12.3 7.1 3620 Glass & glass products 52 16.3 16 13.8 11.1 8.3 4.8 3691 Structural clay products 14 11.8 1 10.7 8.6 6.4 3.8 3692 Cement, line, plaster 9 12.2 12.2 9.8 7.3 4.3 3699 Nonmetallics nec 59 10.8 30 9 7.9 6.1 4.2 2.5 3710 Iron & steel 205 17.6 26 14 57 16.0 12.7 9.1 5.3 3720 Nonferrous metal industry 168 7.6 134 30 5.5 4.1 2.7 1.6 INTERNATIONAL TRADE PotCY 51 Table 2.10. The Romanian protection against EC goods: survey and estimates of the Romanian concessions in the Association Agreement (continued page 2) ISIC Initial Romanian protection vis-a-vis EC Goods Sectors Situanon a New items b Tariffs imposed on EC goods QLjc Number &atu. A-4 A-5 Other 1993 1996 1998 2000 of p. rartfs codes INDUSTRIAL GOODS 3811 Cutlery & hand tools 81 23.6 16 11 20.6 16.0 11.3 6.6 3812 Metal furniture 20 17.8 6 15.3 12.2 9.2 5.3 3813 Structural moral prod. 22 15.3 2 5 13.8 10.9 8.0 4.7 3819 Metal products nec 146 15.2 35 30 13.4 10.3 7.2 4.2 3821 Engines & turbines 22 13.4 9 16 10.8 8.4 6.0 3.5 3822 Agricultural machinery 29 14.5 14.5 11.6 8.7 5.1 3823 Metal & woodwkg. mach. 99 15.7 23 4 13.3 10.5 7.7 4.5 3824 Industrial machinery 140 14.3 55 11 10.0 7.8 5.5 3.2 3825 Office machinery 34 16.5 29 8 10.9 8.4 -5.9 3.4 3829 Machinery nee 178 13.9 104 32 9.7 7.6 5.5 3.2 3831 Electrical industrial mach. 106 13.0 48 42 10.3 8.0 5.7 3.3 3832 Radio, TV 84 21.1 70 30 12.0 8.8 5.6 3.3 3833 Electrical appliances 23 15.7 5 15.1 11.5 7.8 4.6 3839 Electrical machinery nec 36 14.3 9 12.4 9.9 7.5 4.4 3841 Shipbuilding 21 19.0 3 19 17.8 13.5 9.1 5.3 3842 Railroad equipment 23 20.0 3 19.9 15.7 11.6 6.8 3843 Motor vehicles 60 28.7 14 2 18 25.6 20.3 15.1 9.0 3844 Motorcycles 10 29.0 29.0 23.2 17.4 10.2 3845 Aircraft manufacturing 25 8.8 33 4.0 3.2 2.4 1.4 3849 Transport equipment nec. 11 21.8 21.8 17.5 13.1 7.6 3851 Scientific equipment 91 10.1 94 10 4.9 3.9 2.8 1.6 3852 Photo & optical equipment 62 12.6 31 27 7.9 5.4 2.8 1.6 3853 Watches & clocks 55 19.6 3 18 18.0 13.2 8.3 4.9 3901 Jewelry 31 11.5 18 8.9 7.1 5.3 3.1 3902 Musical instruments 23 20.0 7 15.1 12.1 9.0 5.3 3903 Sporting goods 21 22.6 7 21 15.5 9.8 4.1 2.4 3909 Manufacturing industries nec 111 15.0 20 41 13.0 9.8 6.6 3.9 Unweighted average 16.9 14.4 11.3 8.1 4.7 Total number 4312 1433 658 82 52 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNoMY Table 2.10. The Romanian protection against EC goods: survey and estimates of the Romanian concessions in the Association Agreement (continued page 3) ISIC Initial Romanian Protection vis-vis- EC Goods Sectors situation a New ites b Tarrffs inposed on EC goods Q1 Number Statur. A-4 A-5 Other 1993 . 1996 1998 2000 of P. tarif codes INDUSTRIAL GOODS 1000 Agriculture 242 22.1 108 21.2 21.0 17 3111 Slaughtering 75 22.5 6 22.4 22.3 3112 Dairy products 20 23.3 66 22.3 22.4 41 3113 Fruit & vegetable canning 72 24.4 46 24.1 23.8 3114 Fish canning 32 22.7 12 20.8 20.7 3115 Vegetable & animal oils 49 24.5 7 24.3 23.9 3116 Grain mill products 45 24.7 16 24.6 24.5 16 3117 Bakery products 10 24.0 24.0 24.0 3118 Sugar refining 5 24.0 2 23.7 23.2 3119 Confectionery 15 23.0 3 22.9 22.7 3121 Food products nec 81 24.2 18 24.0 23.6 3122 Prepared animal feed 4 22.5 22.5 22.5 3131 Distilling industries 8 23.1 23.1 23.1 3132 Wine industries 9 23.3 23.3 23.3 3133 Malt & salt liquors 3 23.3 23.3 23.3 3134 Soft drinks & water 4 25.0 25.0 25.0 3140 Tobacco manufacturing 6 60.0 60.0 60.0 3211 Spinning & weaving 4 15.0 15.0 15.0 3511 Industrial chemicals 5 24.0 24.0 24.0 3522 Drug & medicines 2 25.0 25.0 25.0 3523 Cosmetics 2 25.0 25.0 25.0 3529 Chemicals nee 9 25.0 25.0 25.0 3909 Manufacturing industries nec 4 25.0 25.0 25.0 Unweighted average 23.5 23.0 22.8 Total number 706 _284 74 Source: The EC-Romania Association Agreement. Author's computations. Notes: a. P.codes: product codes (in Customs classifications). b. A-4: Annex IV. A-5: Annex V. Other: Annexes VI to VIII and Protocol on steel. c. Quantitative limits introduced in Annex XIll. to 175 percent. Total transfers required by the EC Common Agricultural Policy from the public budget and the EC consumers' budgets are roughly estimated to be two-thirds of the value-added of the EC agricultural sector-perhaps 3 percent of EC GDP." These extremely high costs have exacerbated-rather than calmed-social tensions, as illustrated by the frequent and violent actions of EC farmers. Indeed, the main beneficiaries of the EC Common Agricultural Policy have been land owners and owners of other essential inputs used in agriculture. The current absence of a clear and stable regime of land ownership in Romania will make a Romanian agricultural policy similar to the EC policy even more costly. Lastly, the emerging consensus between the EC and the U.S. on farm issues in the Uruguay INTERNATIONAL TRADE POuCY 53 Round negotiations (the so-called Washington Compromise of November 1992) gives a strong incentive for Romania to avoid an agricultural policy similar to the EC policy and to stick to tariff protection coupled with public investment in rural infrastructure, as suggested in chapter 7. Textiles and apparel Textiles and apparel are covered by Protocol 1 of the Association Agreement and they offer an interesting counter-example of the "asymmetry" mentioned above. Article 2 of the Protocol states that by 1998 EC tariffs will be 15 percent of the 1993 tariffs, whereas table 2.9 shows that Romanian tariffs will still be 55 percent of the 1993 tariffs. But the article maintains the principle of EC quotas on Romanian exports introduced under the MultiFibre Agreement (MFA), because Article 3:1 exempts the EC alone from the general obligation, embodied in Article 26 of not imposing quotas after the start of the Agreement.' The exemption leaves open the possibility that EC quotas could become smaller and/or more numerous in future. In the near future, there is an additional aspect of the EC protection to be taken into account. According to the Romanian authorities interviewed by mission staff the EC has introduced a new procedure for granting import licenses in the MFA quota regime that is related to the post- 1992 program of "communitarization" and that grants textile and apparel quotas at the EC level (without a systematic breakdown by EC Member State, as previously). This procedure may be more restrictive than the previous one because it introduces a consultation clause if foreign exports are "too concentrated" in one EC "regional" (Member State) market. This procedure can be analyzed as equivalent to an Article 115 procedure on an er ante basis. It generates risks for Romanian exporters, thus inducing them not to enter an EC regional market or to restrain themselves. Both the consultation noted in the previous paragraph and the general safeguard provision seem to be governed by Article 3.3 of the Protocol, which guarantees that any negotiated "mechanism shall not be globally more restrictive than the safeguard mechanism provided for" in previous agreements (signed in 1986 and amended in 1991). Neither the benchmark nor the term "globally more restrictive" suggest great liberalism, although it was suggested to the mission that perhaps a more liberal side-understanding prevents safeguard action or consultation from reducing Romanian exports in any category below the previous year's level. Iron and steel Protocol 2 of the Association Agreement is another illustration of the fact that asymmetry is more limited than is often supposed. Although the initial tariff cuts are greater in the EC than in Romania, the special safeguard provision (Article 5 of the Protocol 2) represents a threat to the Romanian producers--especially in light of the recent dispute between the EC and the Czech and Slovak Republics. This provision, which does not exist in the first Europe Agreement with Poland, Hungary, and Czechoslovakia, is particularly drastic: "if, during a period equal to the derogation of subsidies (...), imports of specific steel products originating in one party cause or threaten to cause serious injury to domestic producers of like products or serious disturbances in the steel markets of the other Party, both Parties shall enter into consultations immediately to find an appropriate solution." The loose wording of this first portion of Article 5 should be underlined: "specific" products are not defined nor "serious disturbances"; the plural for steel markets suggests that any 54 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcONOMY causal relationship envisaged is very loose. Moreover, the article authorizes the importing party to take "immediate action" in the form of "quantitative restraints or other solutions" on an unilateral basis in cases of "exceptional circumstances". These converging provisions lead to the conclusion that the EC-Romania steel trade liberalization cannot be considered a serious commitment.3 Other topics Romania's Agreement with the EC is the same as the other Association Agreements in terms of disciplines to be enforced during the transition period.' We examine them only briefly under four headings. First, there is a profusion of "safeguard" clauses for monitoring trade in goods. These clauses are often loose, their GATT consistency is not ensured, their procedures are designed to favor secrecy and hidden agreements, and their economic basis is weak. It is understandable that for political reasons governments may want to minimize the number and magnitude of changes in market conditions, but competition demands market changes. ' Second, the "infant industry" clause raises the same types of questions. The infant industry argument has little or no economic justification, and trade policy is not an adequate instrument for supporting new industries. The restriction of the infant industry provision to Romania may be seen as an example of asymmetry. But safeguard actions, which are available to both parties and are likely to be used more intensively by the EC than by Romania, are likely to be used more frequently and have a more powerful impact than infant industry protection. Third, labor movement between the EC and Romania is not seriously enhanced by the Association Agreement. Migrant workers are guaranteed a no less favorable treatment than the treatment each signatory gives its own workers in terms of insurance, pensions, family allowances, etc. These guarantees merely confirm existing provisions, however, and no additional access to the EC labor markets is granted to Romanian workers. Lastly, the issues of establishment, cross-border trade, and "approximation" of laws are addressed in the agreement, particularly in the context of services. Establishment is generally granted on a "no less favorable treatment" basis, trade liberalization in services is envisaged-although with exceptions, like transport, and the approximation of laws is encouraged. The general approach of all these issues is merely to encourage the introduction of Community laws in Romania. By requiring Romania to adopt the same legal restrictions on economic activity as it has itself, the EC undermines many of the comparative advantages that Romania has in the short and medium run. For instance, to require the same rights for Romanian workers as for EC workers increases labor costs in Romania. A time span of ten years looks much too short for transferring most of EC law to Romania. As a result, Romanian authorities could be well advised to focus first on the approximation of competition laws, particularly in manufacturing and key services for export activities (for example, banking, insurance, and transport) and for import activities, such as wholesale distribution or retailing, so that Romanian consumers will reap the benefits of lower prices brought about by trade as quickly as possible. INTERNATIONAL TRADE POLICY 55 A summary of the recommendations The Association Agreement is an important first step toward normal trade relations on a market economy basis. But it is only a first step and it requires additional measures to be fully beneficial. * Tariffs on imports from non-EC countries should be reduced along with those on EC imports. At a minimum the target should be 1996, when trade liberalization between the EC and Romania will begin to be substantial. * Make clear that the infant industry provision will not be used without a full investigation into the costs and benefits for the whole Romanian economy of such an action. * "Approximation" of laws should focus on a single priority exercise, namely the introduction of competition law and regulations in Romania. These laws should be enforced in key sectors related to foreign trade: industrial sectors, banking and insurance, transportation, and distribution. Such focus on increased domestic competition should prepare the groundwork for long run goals: a better educational system to improve the skills of Romanian labor; better financial structures that will allow the abolition of exchange rate controls; and the establishment of free movement of capital. These are necessary conditions for structural change in Romanian comparative advantage in the long run. 56 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Figure 2.1 SB Price SA X E B H A P ZZ D Y 0 60 80 100 Ouantity Figure 2.1 represents two Romanian producers who would export 100 units each to the EC at a given price p. The supply curves of the two firms are shown by SA and SB (for simplicity's sake, the firms are assumed to have equal sales at the price p).- If the EC imposes a quota larger than Romanian exports (for instance, 240 units), the quota is not binding and the licenses that the EC may request from the two Romanian exporters have a zero price. This looks the case for most of the EC quotas on Romanian textile and apparel exports. The situation differs radically, however, if the EC restricts Romanian exports to less than 200 units - say 160 units - as shown by the three following cases. First, the effect of granting licenses on the basis of the "first come-first served' principle (and prohibiting the transferability of licenses) on the Romanian welfare depends from which firm comes first and gets the authorization to export its full capacity (100 units whereas the other firm gets only the 60 remaining units). If firm A comes first, Figure 1 shows that the Romanian welfare declines by the producer surplus lost by the firm B, that is, by AXY. If firm B comes first, the Romanian welfare declines by the smaller producer surplus lost by the firm A (AXZ). Second, granting licenses on the basis of the past performance (and prohibiting the transferability of licenses) eliminates the volatility of the previous procedure. In this example, the past performance principle would grant 80 units to both firms. Figure 1 shows that Romanian welfare declines by a stable amount: the sum of the A's surplus (area ABC) and of the B's surplus (area ABD). Third, allowing transferable licenses further reduces the welfare cost. If A agrees to sell EB units of its licenses to B, it exports EB units less and loses a surplus equal to BEFC. As a result, B can export BH (= EB) units more and gains a surplus equal to BHGD.2 This would allow B to compensate A (BHJI=BEFC) and to keep a residual gain illustrated by IJGD. In sum, the EC quota imposes a cost on Romania equal to the sum of A's uncompensated surplus (area ABC) and of the B's surplus (area ABIJG). In other words, the area IJGD represents the gain from making licenses transferable. INTERNATIoNAL TRADE PoLiCY 57 Figure 2.2 P,o , a o P b a d P 0 Let us assume that the supplies of foreign trading partners are perfectly elastic (an acceptable assumption since Romania is a small country with respect to the EC and world economics). Moreover, let us consider the case where EC suppliers are less efficient than the suppliers located in the rest of the world - implying that p (the world production cost and price) is lower than p' (the EC production cost and price). Finally, let us assume that Romania imposes statutory tariffs t on imports from non-EC sources -r implying that the prices to final purchasers of imports from the rest of the world is p", equal to p(1 +t). The Association Agreement with the EC allows Romanian consumers to benefit from lower prices (p' instead of p"). The gross increase of Romanian consumers' surplus is illustrated by the area (a+b+c+d). However, part of this gross gain is a transfer from Romanian producers (the area a) and from Romanian Treasury (a portion of the former tariff revenues shown by the area c). As a result, the net increase of the Romanin consumers' surplus is the area (b+d) - a positive consequence of the trade created between the EC and Romania by the Association Agreement. However, the Association Agreement has a last consequence. At p', EC producers eliminate foreign producers - the whole trade between Romania and the rest of the world. By doing so, the tariff revenue which would have been levied on imports from non-EC countries is lost. A portion of this loss (the area c) is now part of the consumers' surplus. But the rest of this loss (the area e) constitutes an additional cost to be taken into account. In sum, the net gain from the Association Agreement is the algebraic sum of the net consumers' gain (b+d) and of the Treasury's loss (the area e) - a figure which can be positive or negative. Figure 2.2 deserves two more remarks. First, a non-preferential decrease of the statutory tariff (such that p' would be the price prevailing in Romania for imports from all sources) would have provided a higher gain for Romania (the area b+d, since the tariff revenue c would have been levied) than the Association Agreement. Second, the more efficient the EC firms are (the closer p' is to p) and/or the lower t is (the closer p" is to p), the lower the additional cost c is. As the Romanian authorities have no impact on the efficiency of the EC firms, the unique way to minimizt the risk and extent of trade diversion is to lower the Romanian statutory tariff. 58 RoMANIA: RESTRUCTURING TO FACE THE WoRLD EcoNoMY Notes 1. Source: The World Bank, 1991, Romania: The Challenge to Transition, Volume 1, page 22. 2. In December 1992, Romanian trade policy was subject to the GATT TPRM. Our mission has benefitted greatly from the information provided by the resulting Report (in two volumes) and would like to express its gratitude to the Romanian authorities for having provided an advanced copy of their section. Both their report and the GATT commentary were published in May 1993. 3. The Ministry of Trade (in July 1993) reports its intention to embody Romanian trade regulations in a law or laws within the next few years. It argues, however, that until practices become relatively stable and well understood, writing the law will be difficult and the debate surrounding it uninformed and potentially dangerous. The mission urges as early as possible a codification of trade law as is consistent with these constraints. 4. It is considered as a quantitative restriction in the EC-Romania Association Agreement. 5. The Protocol of 16 (relating to trade negotiations among developing countries) and the GSTP cover 88 and 110 CCCN product codes, respectively. For the first half of 1992, their respective coverage is estimated at 1.6 and 4.4 percent of total Romanian imports [GATT Report, C/RMIG/32, pages 19 and 20]. 6. See Pritchett L and Sethi G. 'Tariff Rates, Tariff Revenue and Tariff Reform,' Working Paper 1143. Policy Research Department, The World Bank, May 1993. 7. See GATT Country Report, page 42. 8. The 1992 tariff schedule is established at the six-digit level of the Harmonized System. Tariff data were available at this level [Ministry of Trade and Tourism, Utilization Guide of the Romanian Import Tariff Schedule. December 1991]. The product correspondence between the tariff classification and ISIC sectors is based on the correspondence supplied by the World Bank Sintiat Program. The correspondence between the ISIC and the RSIC sectors is shown in Annex I. 9. A sizable proportion of the 1992 applied tariffs have been extended to the first trimester of 1993. 10. While Pritchett and Sethi show, for example, that prior to their tariff reforms, Pakistan had fifteen rates; Kenya thirty-three; and Jamaica ten, the mission's view is that perhaps four rates is appropriate. 11. These goods can be split in two groups: when domestic sales are authorized by the Romanian authorities, imports are subject to licenses. When domestic sales are prohibited, imports are banned. 12. Excise taxes were revised in June 1993 through Law No. 42/29 and now range from 13 to 200 percent. 13. As no official action was initiated, these observations rely exclusively on interviews. 14. Romania has not eliminated all such export controls as required under the World Bank's Structural Adjustment Lending conditions, but it has taken further steps towards doing so. In July 1993 quotas existed for copper alloys, mineral oils and chemical fertilizers; coal and certain mineral ores cOuld be exported only if subsidies were repaid; and export bans covered wheat, dairy products, crude oil, oil products, natural gas, blood serum, vaccines, precious metal scraps, iron ore, semi-finished steel, some copper alloys, other copper, and non-ferrous metal scrap. 15. The special procedures for licenses on textiles and apparel exports to the EC are described below, when the Association Agreement is examined. 16. In the current system, the Romanian authorities feel obliged to help aserious" applicants facing unexpected difficulties - opening a new source of public interventions in an environment where state bodies can be easily abused and captured. 17. The use of the auction solution is closely related to the extent to which entry is a crucial problem in the products considered. For instance, new entrants can be numerous in apparel, but few in the textile industry. INTERNATIONAL TRADE POLICY 59 18. Trade diversion is possible even when EC and third country goods are not perfect substitutes: for example, reducing the price of EC cars by, say, 10% will divert demand from Japanese cars even though some consumers will continue to choose the latter despite their facing higher taxes. That the Europe Agreement is ostensibly consistent with (the extremely weak) Article 24 of the GATT in no way implies that it avoids trade diversion or other economic costs. 19. Table 10 is based on the ISIC classification. However, it respects the approach of the Association Agreement, by separately identifying agricultural products tariff (Chapters 1 to 24) and industrial goods tariff (Chapters 25 to 99). As a result, nine ISIC sectors (1000, 3111, 3121, 3211, 3511, 3522, 3523, 3529, and 3909) are listed under both the headings of industrial products and agricultural products. 20. It is interesting to note that Article 21:5 uses an exactly similar wording for the EC and for Romania: "rules of the .agricultural policy.* Article 21:6 reinforces this similarity by introducing the concept of harmonization of the agricultural -policies. 21. From the Australian Bureau of Agricultural Economics. 1985. Agricultral Poicies in the EC. Australian Government Publishing Service. 22. The 'counterpart' of this exemption is the EC 'concession' not to use the safeguard provision of Article 31. 23. The text was written in early 1993. Subsequent developments in the EC's steel trade relations with Eastern Europe suggest that the mission's concern over formalities was misplaced, but that its conclusion that liberalization would not occur was quite correct. The Romanian authorities re-iterated in July 1993 that they will regard EC sensibilities in this area of trade; thus we believe that iron and steel have effectively fallen outside the Europe Agreement for the indefinite future. 24. For an analysis of the other Association Agreements, see L. Alan Winters, 1992, The Europe Agreements: With a Little Help from Our Friends, in CEPR, The Association Process: Making It Work, Centre for Economic Policy Research, Occasional Paper No 11; and Patrick A. Messerlin, 1992, The Association Agreements between the EC and Central Europe, in John Flemming and J.M.C. Rollo, Editors, Trade, Payments and Adiustment in Central and Eastern Europe, Royal Institute of European Affairs and EBRD. 25. Indeed, it is hard to imagine that the EC would have been the success it is, if such types of 'safeguard' clauses were included in the Treaty of Rome. 26. We would like to thank J. de Melo for his suggestion of this figure. 27. Transfer occurs until the margifial costs of the two firms are equalized. 60 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNoMY Annex I. Correspondence between ISIC and RSIC Industries ISIC items Romanian SIC items 7)pes of goods Agriculture 1000 1 2 3 4 5 6 Intermediate Mining 2000 7 8 9 10 13 14 15 16 17 Intermediate Slaughtering 3111 18 Final Dairy products 3112 22 Final Fruit & veg. canning 3113 20 Final Fish canning 3114 19 Final Veg. and animal oils 3115 21 Final Food products, others 3116 3117 3118 3119 3121 23 25 Final Prepared animal feed 3122 24 Intermediate Wine industries 3131 3132 3133 3134 26 Final Tobacco mfg. 3140 27 Final Textile products 3211 3212 3214 3215 3219 28 Intermediate Apparel 3213 3220 29 Final Leather goods 3231 3233 3240 31 Final Fur dressing and dyeing 3232 30 Intermediate Wood products 3311 3312 3319 32 Intermediate Wooden furniture 3320 3812 77 Final Pulp and paper 3411 3412 3419 33 Intermediate Printing & publishing 3420 34 Final Industrial chemicals 3511 3529 3560 43 Intermediate Fertilizers 3512 39 Intermediate Synthetic products 3513 44 Intermediate Paints & varnishes 3521 38 40 Intermediate Drugs & medicines 3522 41 Final Cosmetics 3523 42 Final Petroleum refineries 3530 36 37 Intermediate Petroleum & coal products 3540 35 Intermediate Tire & tube industries 3551 3559 45 Intermediate Pottery & china 3610 48 Final Glass & glass products 3620 47 Intermediate Structural clay products 3691 49 50 53 Intermediate Cement, lime, plaster 3692 51 52 Intermediate Nonmetallics nec 3699 54 Intermediate Iron & steel 3710 11 59 60 Intermediate Nonferrous metal industry 3720 12 58 Intermediate Metal products, others 3811 3819 55 57 Intermediate Structural metal prod. 3813 56 Intermediate Engines & turbines 3821 61 62 Equipment Agr. machinery 3822 63 Equipment Metal & woodworking mach. 3823 3824 64 Equipment Office machinery 3825 68 Equipment Machinery, other 3829 65 66 Equipment Electrical industrial mach. 3831 3839 67 Equipment Radio, TV 3832 70 Final Electrical appliances 3833 69 Final Shipbuilding 3841 73 Equipment Transport equipment, other 3842 3849 74 Equipment Motor vehicles 3843 72 Final Motorcycles 3844 76 Final Aircraft mfg. 3845 75 Equipment Equipments, other 3851 3852 3853 71 Equipment Manufacturing, other 3901 3902 3903 3909 78 46 Final Sources: For ISIC classification: United Nations, ST/STAT/SER.M/43/Rev.1,1971. For Romanian classifications: Romanian authorities. INTERNATIONAL TRADE POLICY 61 Annex II Effective tariff rates Table 2.3 reports the effective tariff rates by industry. They do not include subsidies so they are not effective protection rates.'The calculations are based on the Romanian Input-Output Table (1990) and thus rely on domestic value-added figures. The effective tariff rate of the industry j can be written as follows: [1] E(t, - A)/(1 - B) where [2] A = E Ojts and [3] B = Et %4 where ag are the input-output coefficients (the share of the value of input i in the production j), 0 = (1 +t)/(1 +t) and where t1 and t are the (unweighted) nominal tariffs computed by industry and provided by Table 3. The original Romanian Input-Output Table has been rewritten in terms of the 78 industries defined in Annex I. The computations of the As, Bs and ETRs have been done in Lotus. 62 ROMANIA: RSTRUCTURING TO FACE THE WORLD EcONOMY Chapter 3 Export Promotion and Foreign Direct Investment Policies In central and eastern Europe the collapse of a traditional export market-the members of the Council of Mutual Economic Assistance (CMEA)-has exacerbated the strains caused by fundamental economic reform and the transition to a market economy. For Romania, embargoes on two major customers, Iraq and Yugoslavia, have made matters worse. To stop the fall in output, stimulate growth, and generate foreign exchange, Romania and others are focusing on export promotion and foreign investment. Romania's resolve to expand international trade is evident in its recent international agreements. Romania, a member of the GATT since 1971, is renegotiating its Protocol of Accession to reflect the new market economy and recent changes in the tariff code. It has signed the Black Sea Economic Cooperation Declaration-a regional trade agreement with Turkey, Greece, and other former centrally planned economies, including Albania, Bulgaria, Moldava, Ukraine, Russia, Georgia, Armenia, and Azerbaijan-and it has negotiated an Association Agreement with the EC. These developments have been bolstered by incentive programs designed to boost exports and encourage foreign investment. This effort involves national legislation and the creation of various promotional institutions. This chapter focuses on Romania's trade promotion organizations, which are undeveloped and have much to learn from their foreign counterparts. The usefulness of these organizations depends critically on their ability to achieve greater autonomy from government. The chapter also examines the role the Romanian Development Agency plays in investment promotion, comparing Romania's incentives and regulations for direct foreign investment with those of others in the region. For a number of reasons, Romania's present policies fail to attract a significant volume of foreign investment and give rise to serious distortions, inequities, and inefficiencies. Trade promotion organizations The principal objective of any trade promotion organization is to boost exports by providing ancillary services and persuading firms to "go" global. At first glance, this appears a simple enough objective with an equally simple solution, yet many developing countries have tried and failed. Assessing the faults inherent in promotional organizations is simple; the challenge is designing more effective organizations. Lessons from other developing countries Three pitfalls should be avoided in the design and implementation of trade promotion organizations.' First, promotion organizations should never substitute for sensible economic policies. Macroeconomic instability accounts for the ineffectiveness and ultimate failure of many trade promotion agencies, which, at best, complement. the conditions necessary for export success: political commitment, economic stability, and policy continuity. These conditions are best achieved through a realistic exchange rate, an absence of price controls, adequate credit facilities and physical EXPoRT PROMOTION AND FOREIGN DIRECT INVESTMENT PoucIES 63 infrastructure, duty/tax-free access to imported inputs, and prudent labor regulations. In this respect, the reform program of Romania is progressing toward a more suitable economic environment for the recovery and expansion of exports. Second, trade promotion organizations should not provide export services free of charge. An argument can be made for temporary and partial subsidies for the purchase of export services, however. At first exporters tend to underestimate the benefit of such services and grants or subsidies are needed to entice them to use promotion organizations, at least until they learn that, "Firms with substantial capacity and export potential, but still at the learning stage, often derive very large benefits-many times what they pay for services, even at the full market rate-from effective support services of international quality."2 These subsides should be partial, lasting only as long as needed to whet exporters' appetites for the services and spur demand. Free services retard the development of private competition in the provision of export services. Exporters who receive grants or subsidies for export services must be free to choose among trade promotion organizations, private domestic firms, or international consulting firms as suppliers. Third, government and bureaucrats should not run or control trade promotion organizations. Purely public organizations systematically fail to understand their objectives or meet the needs of exporters. They tend to assume regulatory and administrative roles, adopt the wrong attitudes and strategies, become rigid on matters related to expenditures and staffing, and-in their struggle for bureaucratic survival-avoid criticizing government policies. But strictly private promotion organizations, such as chambers of commerce or membership associations, are not a panacea either, since they are inclined to service only the short term needs of their constituencies. Successful promotion organizations are typically privately managed but publicly supported, like those in Hong Kong, Singapore, the Republic of Korea, and Taiwan (China). The handful of successful trade promotion organizations share three important characteristics: Relevant export services. Successful organizations focus exclusively on promotional functions and on administering targeted loan, subsidy, or grant programs to the most promising exporters. Promotional services include on-line commercial and marketing information, advice on transportation and the development of export plans, group promotion events, and, most important, a convenient facility, in the organization or elsewhere, for processing all port, customs, and government clearances, for both exports and the imports required for exports. At the same time, successful trade promotion organizations recognize differences among exporters, provide their services carefully, and adjust to changing conditions. Specialized export services are best provided by the private sector rather than the trade promotion organization. If demanded and allowed to develop without constraints, services will -eventually reflect all the various stages in the export process: identification and development of products and markets; adaptation of export supply, such as production technology, cost control, inspection, procurement, packaging, and packing and shipping; and final marketing, such as obtaining orders, selling abroad, and designing and implementing prompt delivery systems. Competition among private firms should be used to improve the quality of these services. Autonomy from government in an atmosphere of trut. A trade promotion organization must not become involved in government regulatory functions. Successful promotion organizations operate autonomously, but receive financial support from the government. The needs of exporters are top priority.' The government trusts the trade promotion organization, provides adequate funding, and does not expect short-term miracles. The organization, in turn, earns the confidence of the private 64 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY sector by providing useful services and by avoiding the stereotype of bureaucratic control or prohibition associated with the public sector. A law punishing trade promotion organizations that leak information to the government or to competitors would inspire further confidence. Officials of successful trade promotion agencies command the respect of the business community, are internationally experienced in commercial matters, and receive competitive remuneration. Overseas representatives must be experienced and aggressive salesmen and receive performance-based remuneration. Adequate financial support and carefid targeting. Providing effective assistance for exporters, tracking local exporters and their products, matching buyers with exporters, retaining qualified personnel, and designing programs all require money. Promotional organizations' funds come from membership fees, direct charges, government grants, and/or direct levies on trade, which resemble the h percent fee charged on both exports and imports for modernizing the customs service.' Such fees may eventually become illegal on imports, since import duties of a "fiscal nature" would conflict with Articles 6 and 13 of the EC-Romania Association Agreement. Given the scarcity of grants, subsidies, and loans, trade promotion organizations must choose to help only the most promising export firms-a formidable task. Public trade promotion organizations must resist spreading-their resources so thin that they become ineffective or practicing a misguided evenhandedness with businesses, particularly with those in the same industry. At times, a promotion organization will have to favor one export product over another, concentrating its efforts on the products and firms with the best export prospects. Such judgements must be based solely on commercial criteria. How should trade promotion organizations select which firms to target? The current industrial structure provides few clues as to Romania's long run comparative advantage, since many firms developed out of subsidies or by the design of central planning. An unbiased initial assessment of the country's export potential is needed, one that provides the following information: * Structure of effective protection by industry. * Actual pattern of exports to reveal strengths. * Flow of foreign investment into industrial or export sector. Some of the background work for this research is contained elsewhere in this volume, and the data on foreign investment collected by the Romanian Development Agency are analyzed below. The Ministry of Trade has the capability and the detailed information required to identify the sources of export strength.' Also, to narrow the list of candidates, foreign marketers or purchasing managers can be asked to review factories or inspect product lines. At this stage, only the most promising export firms should be offered a subsidy or matching grant, administered by an independent financial institution, for the purchase of foreign consulting services (discussed below). Charging for part of the consulting services is necessary to determine a business' willingness to pay and to generate a demand for quality services. The trade promotion organization's loan scheme can foster firms' expansion plans by financing the necessary export-oriented investments. EXPORT PROMOTION AND FOREIGN DiRECT INVESTMENT PouciEs 65 Some considerations for Romania The rapid pace of transformation has placed a premium on information. Collecting information from international markets, chambers of commerce, membership astociations, and other sources is probably too expensive a task for individual firms. But strong trade promotion organizations can capture economies of scale in gathering information and can help organize the market for information, charging a small fee for the service so as not to discourage private competition. A trade promotion organization can play a catalytic role in transmitting market information, redirecting the basis of industry and exports, and selectively identifying, targeting, and encouraging the most promising export firms.' A trade promotion organization can also help shift the focus of production and exports from unprocessed products and export to CMEA markets to manufactured goods and more stable Western markets. Unprocessed products tend to decline in price on international markets, become scarce, and spawn a host of environmental and health problems. Economic circumstances have already launched this transformation. Imported oil is no longer subsidized by Russia, and the reform program has phased out most industrial subsidies. Exports of manufactured goods are not constrained by the availability of resources, since inputs may be imported duty/tax free from other nations, and these goods may be sold in the lucrative and more stable Western markets. Such sales are the main source of convertible currencies and offer a wider scope of learning opportunities for exports than CMEA. Exporters stand to learn a great deal from finicky foreign purchasers about customizing product lines "ready for the shelf" and adjusting to the frequent changes in design, specification, demand, and fashion. "Most manufacturing enterprises in developing and former socialist countries are unaware how far they lag behind the best practices in advanced market economies in such crucial areas as systems engineering, productivity, quality control, response time for meeting orders, and other aspects of production."" Trade promotion organizations' matching grant scheme enables Romanian firms to learn about markets abroad by hiring foreign consultants, whose comparative expertise is in resolving a wide range of export problems such as: * Improving input usage (curtail redundant labor, reduce output rejection rates). * Rearranging plant layout and work flow. * Detecting problems in the configuration, design and safety of products. * Introducing new management techniques for inventories, cost control, procurement, and sourcing. * Identifying and certifying the enterprise's quality control system. * Upgrading and designing new product lines. * Targeting high income high price markets. A good consulting firm will tailor its recommendations to the needs of each exporter. Even if the precise nature of the problem is not evident to Romanian enterprises, experienced consultants could help. The priority role of government in export promotion remiains trade facilitation. A trade promotion organization-perhaps aided by foreign consultants-may serve as an effective ginger group for monitoring improvements in communications systems-telephone, facsimile, and postal services-transportation, and customs. AOq ~ ~RnVAVTA - 'PrCrTrTTr r) PA(-C rtyr WnDT re-mi,f Promotional organizations and incentive schemes The government of Romania promotes international trade under an umbrella of national legislation that various promotional institutions implement. The legislation features a streamlined tariff regime, 100 percent foreign exchange retention in domiciliary accounts, a customs duty drawback/exemption regime, and a free trade zone regime. Promotional organizations, such as the Export-Import Bank and the Chamber of Commerce, implement the legislative framework and administer incentives to increase the supply of exports. Domiciliary accounts. These special accounts allow exporters to retain 100 percent of foreign exchange earnings in commercial banks and to use the funds for any legitimate current account transaction, such as importing finished goods, raw materials or other inputs, traveling, hiring international consultants, or paying commissions, royalties or distribution costs. Duty drawback and exemption scheme (DDES). These programs attempt to boost exports by either reimbursing exporters for duties paid on imports used in export production or exempting them from duties altogether. While duty drawback and other exemption schemes provide incentives to export and help exporters become more competitive, they are not without flaws. A drawback system that works well in a few developing countries consists of a published list of standard duty drawback rates for each manufactured product based on technical coefficients that relate inputs to outputs. Rates are adjusted periodically for price and exchange rate developments, and firms have the option of presenting supporting documentation for larger refunds. But duty drawback schemes take a long time to implement and are notoriously difficult to administer. Their incentive effect is lost unless the refund is received upon application. The Romanian duty drawback regime (Decision No. 1274/8.12.1990) provides partial or complete refund of customs duties collected on imported inputs embodied in a subsequent export. Effective since January 1, 1991, customs officials may administer guarantees, which waive payment when reexport occurs within a prespecified period, or duty drawbacks. The drawbacks are far from automatic: firms must apply for reimbursement when filing the import declaration form and working capital remains tied-up until cistoms officials receive the clearance documents. There is no provision for negotiable or transferable drawback certificates for indirect exporters-the domestic producers of intermediate goods used in export production. The transfer of drawbacks between producers would in part reduce the anti-export bias arising from high effective rates of protection in the economy. This is particularly important since such a large proportion of Romania's imports are intermediated by trading companies. Duty drawbacks amounted only to US$116.6 million out of US$5,532.6 million in imports, or 2.1 percent in 1991. In sum, Romania has a drawback framework, but it is not implemented with vigor. A duty-exemption scheme is more efficient and easier to administer than a duty drawback. Used throughout the world, these are often called temporary admissions, duty-waivers, or suspensions of duties. While providing an incentive for exporters, they also introduce distortions, since some of the export firm's output is destined for the domestic market, putting other producers at a competitive disadvantage. The Law on Foreign Investment (see below) also grants customs exemptions on imported capital goods, raw materials, and components to foreign-owned and joint venture companies. The arbitrariness of imported goods that qualify for this treatment severely undermines the otherwise transparent tariff code and creates a distortion similar to the one mentioned above. Drawback schemes fail in providing exporters with a "special' incentive, since virtually any firm can register EXPORT PROMOTION AND FOREIGN DIRECT INVESTMENT PouCIEs 67 as a joint venture company and enjoy even broader customs and profit tax exemptions. The government was unable to provide an estimate of the revenue impact of the exemption regime (see chapter 2), but it is believed to be significant. * We recommend greater uniformity in the customs treatment of different producers. The government is advised to * Strengthen the Duty Drawback Scheme for exporters. * Phase-out firm-specific customs exemptions. * Introduce permanently lower tariffs on capital goods and raw materials directly into the tariff code. * Consider spreading out the payment of customs duties on imported capital goods over a longer time period. Export processing zones This scheme also allows for the duty free exchange of goods and services with the rest of the world, but here only in designated, fenced-in, industrial parks called export processing zones (EPZs). The experience of other countries suggests four forces that drive this type of proposal: the demands of exporters who use imported inputs intensively; the desire to attract foreign investment; pressure from geographic special interest groups; and a politician who makes it a pet project. Only one of these-exporters who use imports-is a satisfactory basis for establishing EPZs. The second force is contrary to the best policy of treating all investment including joint ventures uniformly and refraining from case-by-case negotiation of concessions. The last two motives are wholly unacceptable for obvious reasons. Romania's Law for Free Zones Regime (No. 84/21.07.1992) envisions many EPZs in the vicinity of "maritime and river ports, along the Danube-Black Sea Canal, other navigable canals and in the neighborhood of frontier checkpoints." The oldest among these is the Port of Sulina, where the River Danube meets the Black Sea. Storage, transshipment, and manufacturing may take place there, duty free, upon application. Although Sulina once attracted Austrian and Hungarian tourists on cruise ships, the port facilities have deteriorated markedly, and the channel requires dredging that is prohibitively expensive and may have a deleterious environmental impact on the Danube Delta. So, the most promising EPZ site is the Port of Constanza, Romania's single largest investment on port infrastructure. The original plan for this port remains incomplete, but it is nonetheless modem, currently underutilized, and better connected to the Danube than is Sulina. The Ministry of Transport has planned an EPZ at Constanza and two multinationals have reportedly expressed an interest in the facilities. Entrepreneurs appear enthusiastic about the prospects of a perpetual tax holiday and the ability to effect all transactions within the zone in hard currency. The principal shortcoming of this incentive scheme is that it benefits only a handful of firms that are completely export oriented. Potential or occasional exporters, as well as firms producing for the domestic market, will not benefit from these incentives. These EPZs will be managed by their current administration reorganized as a Regies Autonomes (Article 8) and financed with taxes on operator licenses and rent income from the facilities (Article 21). But experience elsewhere suggests that successful EPZs are privately managed. The question of whether to invest further in port facilities and EPZ infrastructure is 68 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Chamber of commerce and industry of Romania The Chamber of Commerce and Industry has a 125-year history and has regained its autonomy from government as a private promotional organization by Law No. 139/11.4.1990. The organization is composed of seven departments: domestic relations, foreign relations, economics, press and information, professional training, Publicom, and Rominvent. Some of its services include disseminating information on business laws, maintaining the Trade Register, lobbying or litigating, researching or designing business plans, offering professional training courses-such as foreign languages, accounting, broker and stock exchange-organizing seminars and conferences, and coordinating fairs, expositions or foreign travel itineraries for or on behalf of its members. Unlike other organizations the Chamber of Commerce and Industry of Romania charges members a fee for its services and must continuously prove its usefulness to survive. Official export promotion organization A consultant provided by the UNDP to the Ministry of Trade has proposed an institutional approach for the promotion of exports. Exporters under this scheme would receive free services, including the use of a library, on-line data/information on international prices of goods and services, export contacts through the Romanian embassies, occasional trade fairs, and a large permanent staff of specialized consultants on trade regulations and opportunities in various sectors of activity. The recent statement of the Governing Programme (March 1993) also alludes to trade promotion, stressing the free provision of market information, the extension and simplification of drawbacks and the strengthening of EXIMBANK. It also envisages establishing a "National Centre for Foreign Trade subordinated to the Ministry of Trade". As clear from the above, the successful implementation of such plans is difficult. Recommendations Most promotional institutions in developing countries fail because they are government operated and provide services free of charge. Successful ones provide relevant and well targeted services, operate autonomously from government and special interest pressures, charge a fee for some services, receive financial support from government and respect of the business community. Romania's trade promotion organization's offer some relevant services but are still in the midst of transformation. Services often are provided free of charge, depriving the institutions of the financial means to expand useful programs and discouraging the supply of services by the private sector. Mostly staffed and financed by government, these institutions face problems in attracting and retaining qualified personnel, who receive better remuneration in the private sector. The government often pressures the institutions to support unviable firms that it considers important. Such practices drain their limited financial resources. The institutions are engaged in a constant struggle for greater autonomy from government in objectives, activities, and finance. 70 ROMANIA: RESTRUCTURING To FACE THE WoRLD EcoNoMY important, and at present, our estimate is that a better use of scarce government funds would be to improve the duty drawback and exemption scheme and its administration, which uniformly benefits all exporters regardless of location. Export-Import Bank of Romania Export-Import Bank or EXIMBANK (established by Decision No.189/22.3.1991) promotes exports by financing, guaranteeing, and insuring small and medium sized exporters and potential exporters of manufactured goods. Its initial capital subscription of 30 billion lei was divided equally between domestic and hard currency funds, with the government maintaining a 51 percent stake in this state bank. The bank has no stated policy for reaching a specific clientele. By default, its clients consist primarily of large state-owned enterprises plus the handful of private export firms that stumbled upon Export-Import Bank services themselves. To be more effective, the bank must design and implement a policy for identifying/targeting services to firms with the best export prospects. One of the bank's useful functions is helping firms draw up workable export and financial plans, which are necessary steps in channelling available credit and foreign exchange to exporters. This service is free with the costs covered by commissions and interest from other financial products. The bank offers insurance for insolvency, political risk, default, and the non-acceptance of delivered goods, but as of December 1992 it had issued only one policy. The low demand for insurance is consistent with the experience of other countries, since exporters at the early stages of development rarely choose insurance coverage. For now, the bank should abandon the insurance program and focus its resources on expanding the more sought after programs. The Export-Import Bank either guarantees commercial bank loans or extends direct credit for up to 85 percent of the value of export contracts or imports of technology. The credit terms for exporters and small to medium sized manufacturing firms are 25 percent for 60 days, 40 percent for 60-180 days or 50 percent for 180-360 days of the National Bank of Romania's refinance rate. With the recent National Bank of Romania's rate of 80 percent, the subsidized borrowing rate for exporters translates into 20 percent, 32 percent, and 40 percent depending on the maturity. The availability of credit and foreign exchange is more important than subsidizing the borrowing rate for the development of Romania's export potential, however. Many countries have followed an ill- advised policy of rationing credit for some users and making it artificially cheap to others. The IMF, for instance, recently proposed the elimination of subsidized credit facilities in Romania not only to encourage exporters to sell foreign exchange to finance their domestic needs, but also to eliminate potential distortions such as the incentive to roll-over other loans at the subsidized rate of interest. About 20 percent of EXIMBANK's loan portfolio is at present nonperforming, which compares favorably to the 40-60 percent estimate for other Romanian banks, but is nonetheless disturbing since EXIMBANK opened its doors to the public only two years ago. As part of a the World Bank's Industrial Development Project, EXIMBANK will administer the Export Finance Fund to provide working capital in the form of a revolving foreign exchange fund and partial/full coverage of exporters' preshipment finance needs. The Term Lending Fund facility was designed to finance export-oriented investments or the purchase of machines for export firms with an approved market development plan. Given its institutional infrastructure, EXIMBANK could also design and administer a grant/subsidy program to finance the use of foreign consultants. EXPORT PROMOTION AND FOREIGN DIRECT INVESTMENT POLIlEs 69 The mission recommends that the government pursue the following measures: * Replace firm-specific customs exemptions with a strengthened duty drawback system for exporters. * Consider spreading the payment of customs duties on imported capital goods over a longer time period. * Consider transferable or negotiable drawback certificates for indirect exporters. * Consider the private management of EPZs through concession or lease. * Require EXIMBANK to target and actively seek promising exporters as clients, charge fees for all services, scrap programs with little or no demand, adopt pay-scales in line with the private sector, and extend its loan scheme to include some grants and to cover the purchase of foreign consulting services. * Offer trade promotion organizations financial support with "no strings attached", particularly with respect to the use of funds. Foreign investment promotion in Romania The former partners of the CMEA now are engaged in a fierce intraregional battle to attract foreign investment, and the countries are continually changing their legislative and promotional policies in hopes of gaining the upper hand.' Romania has transitional programs similar to those of the Czech Republic, Hungary, and Poland and offers the same proximity to the European markets, low wages, and relatively skilled labor forces as the others. Romania has not fared as well as the others, however. Hungary offered much the same incentives, registered as many joint venture companies, but recorded thirty times more net direct foreign investment than Romania."o Its success stems from a better macroeconomic outlook, a liberal investment regime, and the lifting of all bans on foreign ownership of property, including land. The Czech Republic attracted 15 times more foreign investment and Poland attracted seven times more. The government recognizes the important complementarity between trade and investment in fostering economic growth. Romania's miserable performance in attracting foreign investment is caused by distortions generated by the investment regime and a binding limitation on profit repatriation, not by a lack of generous incentives. This section analyzes investment promotion, the principal provisions in Chapter III of the Law on Foreign Investment (No. 35/3.4.1991), and compares Romania's regime to that of its peers in the region. Qfficial investment promotion organization - The Romanian Development Agency implements the legislative framework and promotes a favorable climate for foreign investment. The agency also gathers statistical information on, and ultimately must approve, foreign investment applications. Approval is automatic if the agency fails to respond within thirty days." The one-stop agency assists investors who might otherwise become discouraged by Romania's bureaucratic maze. The intermediate steps include notarizing the articles of incorporation, announcing the partnership in the Official Gazette, and signing the Commercial Register-far fewer steps and delays than ever before. Moreover, although empowered to do so through its bylaws, the Romanian Development Agency apparently does not discriminate by type of EXPORT PROMOTION AND FOREIGN DIRECT INVESTMENT PoLiciEs 71 foreign investment, intervene in the private choice of technology, or negotiate concessions on a case-by-case basis. All this is commendable. The lessons on promotional organizations mentioned earlier apply in equal measure to the development agency. First, promotional measures typically fail when deep and supportive economic reform or adequately defined property rights are missing. A liberal business climate is a precondition for luring foreign investors. Second, screening for the financial soundness of investment proposals is not warranted," and in fact it is almost sure not to work well because the government staff that would do such screening will not have the time, the expertise, or the access to sufficient accurate data to do the job well."l2 Recognizing this, the Czech Republic and Hungary recently dismantled their mandatory screening and approval process for foreign investment and with them the means to discriminate by the origin or nature of investment. In Poland, foreign investors must still obtain approval and/or a permit for certain activities on a short negative list, which includes port facilities, defense, real estate, legal council, trade in consumer goods, or the assets of a former state-owned enterprises. By contrast Article 17 of the Romanian Foreign Investment Law reserves the right to grant sector-specific incentives for priority activities identified by the Romanian Development Agency. This represents a legal basis for the provision of discriminatory, sector-specific incentives that tend- to distort the allocation of capital. The Article has only been used once-to promote investment in the oil and gas sector (Law 66/92)-and has yet to be formally approved by Parliament. Moreover the development agency undertakes no detailed screening of incoming investment. Overall, then, it seems desirable to bring the law into line with liberal practice and allow Article 17 to die a natural death. Investment should be controlled, if at all, only in a few sensitive sectors as published on a short negative list. The pattern offoreign investment An examination of the pattern of inward foreign. investment helps identify industries that foreigners consider profitable. The percentage of investment that settles in an export sector may be particularly useful in revealing the location of comparative advantage. The data on registered foreign investment projects gathered by the Romanian Development Agency are, however, of only limited use in generating descriptive statistics or analyzing possible patterns of comparative advantage on a sectoral basis. There are two problems with the data. First, the Romanian Development Agency counts the stated intention of a foreign firm as a foreign investment, a practice that inflates the figures. Net foreign investment recorded in the balance of payments since the December 1989 Revolution amounted to US$65 million, while Romanian Development Agency reported US$537 million of intended foreign investment for the same period. Joint ventures tend to overstate the contribution of a foreign partner to secure the approval, further twisting the data. The accuracy of the data is also questionable because of the failure to verify the source of funds, the value of in-kind assets at the time of registering capital, or if the investment was ever carried-out." Second, the joint venture partners on average claimed active involvement in five different sectors out of fourteen possible choices on the registration form." Thus, even the most rudimentary descriptive statistics are impossible and no meaningful way exists to distribute intended foreign investment by sector. The Romanian Development Agency database would have been more useful had the questionnaire asked for a primary sector of activity or investment. 72 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Despite the shortcomings, it is instructive to compare the start-up capital contributions of intended foreign investors and their domestic counterpart." The data are strongly skewed in terms of the number of firms and the amount of foreign investment. The number of newly registered joint ventures increased from only a handful before the 1989 Revolution to 20,400 by December 1992 (table 3.1). Of these, the foreign partners of 10,937 companies (or 54 percent of the total) contributed less than US$1,000 and those of 15,943 (78 percent) less than US$5,000. By contrast, only 1,328 (6.5 percent) companies registered foreign contributions in excess of US$25,000. When the same classification is performed on the amount of intended foreign investment, the data reveal even more striking patterns (table 3.2). During the same period, the foreign partners expressed the intention to invest a total of US$537.5 million. The top 100 companies in terms of foreign contributions to startup capital (i.e. those in excess of US$500,000) account for 72 percent of all intended foreign investment, and the top 374 companies (in excess of US$100,000) for 83 percent. By contrast, the remaining 19,972 companies (98 percent of the total) account for only 17 percent of intended investment. Overall, the tables suggest an inordinate number of joint ventures, typically small in terms of both foreign and domestic contributions to startup capital, and that a minority of companies account for the bulk of intended foreign investment. The framework of incentives The preferential treatment of foreign investment has been justified in many countries on the basis of spillovers in technology and in management and marketing skills, or, if the exchange rate is unavoidably distorted, increased foreign exchange. The government views foreign investment as the catalyst in the transition toward a market economy. But the present legislative and institutional framework generates serious distortions, inequities and inefficiencies, falls short of international norms in several respects, and fails to attract a significant volume of foreign investment. Romania has succeeded in registering many joint ventures, some formed for the obvious tax and tariff advantages, and others for not-so-obvious opportunities to evade taxes and launder hard currency. This section traces many of these distortions to chapter III of the Law on Foreign Investment, which not only provides a package of special customs and profit tax incentives for, but also imposes important restrictions on foreign investors and joint venture companies. Dates of Romanian policy appear in tables 3.3 and 3.4, and comparisons are drawn between the regimes of Romania and its peer group. Customs duty incentives. Foreign investors and joint venture companies benefit from two customs incentives (table 3.3). The first of these, contained in Article 12 of the law, grants a perpetual exemption on imported capital goods to the extent they represent an in-kind contribution by the foreign partner. Capital goods are loosely defined to include personal automobiles, furniture, appliances, machinery, equipment, and other production goods.16 Second, Article 13 specifies an automatic 2-year exemption from customs duties on all imported raw materials, supplies, or component parts. The firm need only convince customs officials that the end-use of these goods is for production. The customs exemptions do little, if anything, to promote foreign investment. On the contrary, the incentives undermine the trade regime, generate distortions, and are easily abused. The principal shortcoming of these incentives is their breadth. Vagueness in the law bestows considerable EXPORT PROMOTION AND FOREIGN DIRECT INVESTMENT POLICIES 73 discretionary authority upon customs officials, who must discriminate among consumers, importers, and producers by end-use, determine the firm's legitimacy, and ultimately decide whether to grant the exemption. The broad coverage and the randomness of the goods qualifying for firm-specific exemptions, in turn, severely undermines Romania's otherwise transparent tariff code. Although protected sufficiently by the tariffs on their outputs, the main beneficiaries of the exemptions are joint ventures that produce primarily for the domestic market. The exemptions raise their respective effective rates of protection and contribute to the economy's anti-export bias. For example, Article 13 may encourage firms to import components for the assembly of goods with low or even negative value added at world prices. Vagueness in the law coupled with discretionary power also begets corruption. Importers attempt to bribe officials to redefine the "fine line" between the imported goods that are exempt and those that are not. Even exporters no longer find it worthwhile to apply for duty drawback treatment when it is easier to register as a joint venture to benefit from a wider array of customs and profit tax incentives. Perhaps the most afflicted, however, are indigenous firms and state owned enterprises that find themselves at a competitive disadvantage compared with joint ventures because they do not qualify for similar exemptions. Every other country in the region has moved recently to limit both the range and the duration of customs exemptions (table 3.5). The Czech Republic was the most far-reaching in revoking all future customs exemptions. New laws in Hungary and Poland specify that only in-kind contributions of imported capital goods, held for at least three years, remain exempt. This exemption is perpetual in Hungary and lasts for three years in Poland. None of these recent legislative changes rescinds the incentives already promised to existing firms and foreign investors, but they do remove the elements that contributed to arbitrariness. Based on these considerations, the mission recommends three policy changes to achieve a more equitable treatment of all firms: * Abolish firm-specific customs exemption to remove distortions in the trade regime. * Lower tariffs on both imported producer and capital goods to a uniform level of, say 10 percent, for the benefit of all firms.' * Consider the deferred or installment payment of customs duties on imported capital goods to free-up the working capital of producers. Although not recommended, customs exemptions, if provided at all, should be written directly into the statutory tariff code for the benefit of all firms or strictly limited to export firms that must compete in foreign markets. The profit tar exemption/reduction incentive. All new Romanian firms benefit from a holiday/reduction period before the imposition of the standard profit tax schedule. Article 14 specifies an automatic 2 to 5 year holiday from the tax on profits (table 3.3). The length of the holiday varies by sector of activity (table 3.4). Thereafter, Article 15 stipulates an additional period of tax reductions for firms that fulfill certain performance requirements-reinvesting profits, increased investment, exporting, spending on research and development, or creating additional employment. But the scheme contains some penalties. Article 18 compels foreign investors to repay the full value of profit tax concessions enjoyed under Article 14 in the event of an early liquidation." This event is defined as occurring before twice the period for which exemptions had been granted, somewhere between 4 to 10 years depending on the sector of 74 ROMANIA: RESTRUCTURING TO FACE THE WORLT Frn vxv activity. Designed to curb short-term foreign investments, similar restrictions exist in the peer group with the exception of Hungary. *The tax holiday/reduction incentive does little to help promote foreign investment. Instead it gives rise to distortions. The differing lengths of tax holidays tend to distort the allocation of capital. Also, the exemption period is too short to provide an adequate, much less an attractive, incentive. The gestation period between the initial investment and the realization of production, sales, and profits frequently exceeds three years. Legitimate firms in the early stages are in a tax- loss situation, and Romanian laws allow the carry-forward of losses but not incentives.18 Existing enterprises find themselves again at a competitive disadvantage relative to joint ventures because they do not qualify for the same exemptions. Finally, since the tax exemptions deprive the public sector of the fastest growing component of the tax base, they force government to raise taxes elsewhere or adopt inflationary finance to bridge the revenue gap. To compound the distortions, the World Bank's Foreign Investment Advisory Service (FIAS) finds that "the tax holidays do not provide incentives for the behavior that they were originally enacted to encourage. They reduce taxes on all income earned by a company in which a foreigner invests, including activities underway before the investment. '9 Second, important benefits do accrue to local businessmen from the tax holidays-they can practice income-expenditure switching to evade taxes. That is, revenues are switched to the newly registered tax-exempt joint venture company, while expenditures are transferred for the purpose of deductions to an already existing tax-liable company. Presumably each firm's tax holiday eventually expires, but they may be renewed quite easily by registering a new joint venture. The Romanian Development Agency database indicates that at least 325 local partners had registered more than one joint venture company, with one partner accounting for as many as twenty-seven registrations. The 325 figure surely underestimates actual multiple registrations: firms were identified by their local telephone numbers-some could have two or more phone numbers, some 15,000 telephone entries were missing in the databank, data processing errors could cause numbers to differ, and even the 2-year exemptions have not yet expired for most firms. Thus, the problem of multiple registrations for the purpose of tax evasion seems likely to become more acute over time. Foreign investors in the peer group receive slightly shorter tax holidays (table 3.5). The Czech and Slovak Republics offer only an automatic 1-year tax holiday. Hungary repealed its automatic 5- year holiday with the possibility of a 5-year tax reduction based on the absolute level of startup capital, foreign participation, and sector of activity. Investors registered prior to January 1994 will benefit from a 2-year holiday and none thereafter. Similarly, Poland's law on foreign investment, which took force on June 14, 1991, also repealed an automatic 3-year holiday, 3-year extensions based on the sector of activity, and tax reductions based on the share of exported output. Their tax holidays now are very specific and only for investments registered prior to January 1994.2 Perhaps the most significant change sweeping the region is the abolition of tax holidays, which will end discrimination and reduce the international competition for foreign investment. In shifting to their new regimes, however, the peer countries gained credibility by honoring the incentives promised to foreign investors prior to reform. Since there exists no rational basis to justify the profit tax exemption/reduction incentives, which give rise to distortions and discrimination, the government is advised to abolish all firm-specific profit tax exemption/reductions. Alternatively, the government might choose to ignore this recommendation, preserve the special incentives, and hope to circumvent the distortions by accurately targeting the group of beneficiaries. EXPORT PROMOTION AND FOREIGN DIRECT INVESTMENT POLICIES 75 But a moment's reflection on these policy options suggests their inadequacy. First, some countries limit incentives to joint venture companies with some minimum level of foreign capital. Table 3.1 appears to suggest that a limit as low as US$5,000 eliminates 16,000 (or 78 percent of the) beneficiaries, but a limit this low would only be circumvented, which is why Poland limits incentives to firms with at least 2 inillion European Currency Units (ECUs) in foreign capital participation. Other countries have used the rate of foreign participation in startup capital for much the same purpose. As shown on Table 3.2, the foreign participation rate of 17,040 joint venture companies (or 84 percent of the total) exceeds the oft-used threshold of 30 percent, but these firms together accounted for 93 percent of all intended foreign investment. In other words, such threshold ratios are not a viable policymaking option since they fail to distinguish between firms on a rational basis. A combination of these, say a US$10,000 limit and a 20 percent participation, also misses the point, because fundamentally there is no justification for incentives that discriminate on the basis of size. Nonetheless, this is the policy introduced by the government in July 1993. It is probably better than doing nothing, but a complete abolition of tax holidays should remain a high priority. A country may attempt to link the value of the incentives directly to the foreign participation ratio, rather than providing the exemptions in full. Under this scheme, a joint venture company with foreign participation at say 30 percent would be entitled only to a 30 percent exemption from profit taxes. This approach theoretically rewards foreign investment without the distortionary side-effects of the present system, but it would be extremely difficult to implement, requiring a number of administrative changes, the diligent verification of ever-changing participation ratios, and strict enforcement given firms' dishonest reporting practices. Undoubtedly, these alternatives would generate new distortions and even greater uncertainty among foreign investors. For these reasons, we recommend that the government abolish all firm-specific profit tax exemptions and consider offering all firms more generous depreciation allowances to encourage investments in new productive assets. 2 Profit taxes Given a particular level of gross profitability, potential foreign investors will compare the tax treatment of profits in different countries over the expected lifetimes of their investments. After the initial tax holiday/reduction period, firms operating in Romania revert to a standard corporate tax schedule, which is contained in the Tax on Profit Law (No.12130.1.1991) and its recent amendment. As part of a cumbersome process of monthly reporting, a company may deduct from taxable income the cost of goods sold, wages, and other operating costs, such as other taxes paid, research and development expenditures, commissions, carryover losses, charitable contributions, and . entertainment, advertising and promotional expenditures within limitations established by the Ministry of Finance. One million lei (or roughly US$2,325) serves as the dividing line between the tax rates of 30 percent and 45 percent on nominal profits. The repatriated portion of profits and dividends are taxed an additional 10 percent, which raises Romania's maximum effective marginal tax rate on foreign investors to 50.5 percent.m On a purely technical basis, the monthly reporting requirement is both time consuming and costly for firms, and the tax on nominal profits and the high rates of inflation now experienced in Romania tend to erode the capital stock. On a comparative basis, the maximum rate of 50.5 percent compares favorably to the confiscatory rate of 77 percent that prevailed during the last FIAS (1991) review. It is broadly in line with the tax structures of peer countries-the effective marginal tax rates on foreign investors is -Y,e ROMANTA: RESCTRUTTUTRTNG Tn PAC THE WORT nECnOmy 59 percent in the Czech Republic, 52 percent in Hungary, and 49 percent in Poland (table 3.5). Although Romania's maximum rate of 50.5 percent is about average for Eastern Europe, it remains high enough to encourage tax evasion by domestic firms, and is high relative to corporate tax rates in advanced Western countries: 34 percent in the United States and averaging 39 percent in the European Community and 26 percent in the European Free Trade Area (EFTA). The relatively higher tax rates in Romania tend to discourage foreign investment.3 Based on these considerations, the government is advised to reform its present structure of profit taxation in at least three ways. The government should: * Replace the requirement of monthly reporting by firms with yearly reporting. * Make allowances for inflation so as to tax only real profits. * Choose a single rate of profit tax, somewhere between 30 and 35 percent, and not based on whether profits are repatriated. Profit repatriation Countries successful in attracting foreign investment also offer the snag-free repatriation of profits. Although there are no restrictions on the repatriation of profits earned directly in convertible currency,2 Article 16 in Romania's law limits the repatriation of profits earned in lei to only 8 to- 15 percent of startup capital, actually 8 to 12 percent for the important sectors (table 3.4). This restriction is problematic for a number of reasons. First, the currency denomination of the limit is crucial because of the high rate of inflation and exchange rate depreciation now experienced in Romania. For example, an exchange rate depreciation of the order of 100 percent a year reduces the 8 to 12 percent lei-denominated limit to 4 to 6 percent in dollar terms within only one year of the initial foreign investment. Although Romania Development Agency officials confirmed verbally that the restriction is dollar-denominated, the present wording of Article 16 remains ambiguous and, in the minds of would be investors who seek assurances, subject to interpretation. 2 Second, joint ventures may be, overstating the foreign partner's contribution as a means of getting around this restriction. The eight-fold overstatement of foreign investment discussed earlier relaxes the 12 percent limitation of Article 16, allowing profit repatriation in full (8.3 x 12% = 100%). The failure to verify the source of investment funds, or if the investment was carried-out, or the value of in-kind assets at the time of registering capital, creates an ideal opportunity for the local partner to launder hard currency funds from the black market for future capital flight through official channels. Third, no peer country currently has restrictions on repatriation. Article 19 of the Polish Law initially limited repatriation to 15 percent of profits derived from domestic sales. But, this restriction was abandoned in 1991. Romania's peers have progressed more rapidly toward internal and external convertibility and allow the full, unrestricted repatriation of profits, dividends, and proceeds from the liquidation of assets, after the payment of taxes and at the official rate of exchange. The statutory limit on profit repatriation probably explains Romania's poor performance in attracting foreign investment, undoubtedly outweighing any of the temporary tax advantages. Legitimate foreign investors simply are not interested in an uncertain 8 to 12 percent annual return on capital, especially considering the political, economic, and exchange risk or the long waiting period necessary to convert lei profits into foreign currency through official channels. Such a return EXPORT PROMOTION AND FOREIGN DRECT INVESTMENT PoLIcIEs 77 on capital is inferior to-the low-risk, high yielding government bonds currently available in parts of Western Europe, or the riskier but high reward investment opportunities in the more liberal regimes in Central and Eastern Europe. For these reasons, the mission recommends the abolition of Article 16, which would in all likelihood attract a volume of foreign investment that more than compensates for the annual, unrestricted repatriation of profits. Recommendations The Law on Foreign Investment fails to treat Romanian and foreign investors equally and to attract foreign investment. The incentives represent an enormous tax loophole for firms that register as joint ventures with as little as $1 of foreign. capital, and generate serious distortions, inequities, and inefficiencies. Potential for further revenue erosion is enormous given the problem of multiple joint venture registrations and that foreign investors will participate in the imminent privatization of former state-owned enterprises, which traditionally accounted for the bulk of business taxes.' Overall, the regulatory framework disrupts the economy and encourages black market activity and tax evasion by businesses. Indeed, such problems are evidently not restricted to business, for a number of officials identified the corruption, bureaucracy, and uncertainty now endemic in Romania as the primary deterrent of foreign investment. The government is advised to reexamine the legislative framework and to close the tax loopholes enjoyed by bogus joint venture companies. The hemorrhage may be contained simply with an amendment to abrogate all the special incentives (and restrictions) contained in Chapter III of the Law on Foreign Investment. A far more equitable treatment for all firms as regards customs duties involves a low uniform tariff on imported producer and capital goods, of say 10 percent, with the possibility of deferred (or installment) payments for capital goods. A uniform profit tax rate between 30 and 35 percent serves as a far better promotional device-free from initial tax holidays and limits on profit repatriation. The government may also wish to offer accelerated depreciation allowances, as a means of promoting legitimate investments in new productive assets, to all firms. Romania has so far fared miserably in the international competition to attract foreign investment, especially when compared with the Czech Republic, Hungary, and Poland. Foreign investors simply are not interested in an uncertain 8 to 12 percent a year nominal return on capital, especially considering the political, economic, and exchange risks or the long waiting period necessary to convert lei profits into foreign currency through official channels. Notwithstanding the other recommendations, the government must abolish Article 16 that limits profit repatriation if it ever -hopes to attract legitimate foreign investment. A final caveat: Incentives and other promotional schemes always fail in the absence of deeper and supportive reforms or adequately defined property rights. Once the reforms are complete, foreign investors will discover Romania's potential. The mission recommends that Romania pursue the following measures: * Abolish the legal basis for discrimination in the provision of sector-specific incentives (Article 17). * Abolish the requirement of bureaucratic approval of foreign investors and replace it if necessary with a short negative list. * Abolish firm-specific customs exemptions (Articles 12 and 13). * Replace the requirement of monthly tax reporting with yearly reporting by firms and make allowances for inflation so as to tax only real profits. 78 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNoMY * Abolish firm-specific profit tax exemptions (Articles 14, 15 and 18), replace them with a uniform profit tax rate between 30 and 35 percent. Do not base the rule on whether both are repatriated. Consider accelerated depreciation allowances to promote investments in new productive assets, for the benefit of all firms. * Abolish the limit on profit repatriation (Article 16). This has now been done (July,1993). Notes 1. This section benefitted from conversations with Donald Keesing and draws heavily on the existing literature contained in Keesing et.al. (1988, 1990) and Hogan et.al. (1991). 2. Keesing et. al (1991), p. 27. 3. Trade Promotion Organizations in Korea and Taiwan, China have become involved in recent years in import promotion to balance the economies' export success. 4. Donald Keesing (1988) reports that direct levies of 0.04 percent on Korea's imports, 0.05 percent on Hong Kong's exports and non-food imports, and 0.0625 percent on Taiwan's exports were earmarked for Trade Promotion Organization budgets. 5. Undertaking this research is not the proper role of a Trade Promotion Organization. 6. This section benefitted from conversations with Sonja Brajovic-Bratanovic and draws extensively on a recent paper by Donald Keesing (1992). 7. Keesing (1992), pg 22. 8. It is said that Ceausescu envisioned competing directly with Rotterdam for maritime traffic originating at the Suez Canal and destined for cities along the Danube and the Rhine, such as Bucharest, Sophia, Belgrade, Zagreb, Budapest, Vienna, Munich, and Frankfurt. 9. The countries concerned include Albania, Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland and. Slovak Republic as well as the former USSR countries of Azerbaijan, Belarus, Kazakhstan. Moldava, Russia, Turkmenistan, Ukraine and Uzbekistan. 10. That is, net foreign investment in the balance of payments was US$1,462 million for Hungary and US$37 million for Romania in 1991. 11. Large joint ventures are referred to the Ministry of Industry for approval. 12. FIAS (1990a), pg. 17. 13. RDA and the NBR are currently (July 1993) discussing issuing a periodic questionnaire to foreign-owned and joint venture companies to elicit more precise information on such details. It will be voluntary. 14. Firms appeared to respond to the inquiry as if the failure to list a sector on the initial form would preclude their ever operating in it. 15. The IMF database on exchange rates was merged with RDA's on joint ventures, according to the date of initial registration, to compare the dollar and lei counterparts of startup capital. 16. In July 1993 this exemption was extended to capital purchased out of a JV's foreign capital contribution. 17. Otherwise, the proceeds of liquidation may be repatriated within one year but in three installments. EXPoRT PROMOTION AND FOREIGN DIRECT INVESTMENT POuCIES 79 18. Although not recommended, Russia recently announced tax holidays that become effective only after a company turns profitable. 19. FIAS (1990a), pg. 13. 20. Incentives are provided on a case-by-case basis, for an uncertain duration, and only for firms fulfilling certain performance requirements (i.e. when the foreign investment exceeds 2 million ECU and involves either a production facility where there is structural unemployment, for new technologies, or for exports of at least 20% of output). 21. The World Bank's FIAS has recommended similar measures in the past for both Hungary and Poland. 22. This assumes zero transaction and opportunity costs of waiting for foreign exchange through official channels. 23. Boadway and Shah (1992) also argue against setting rates below that of advanced countries, the vast majority of which allow credits for any taxes paid abroad by foreign investors. A profit tax too low may tend to encourage foreign investment but at the expense of a revenue transfer from the Romanian to the foreign treasury. 24. See the provision in Chapter II, Article 9, Section c. of the Law on Foreign investment. 25. In July 1993 all repatriation restrictions were abolished, although, of course, non-dollar-earners are obliged to obtain the necessary foreign exchange through the official auction. 26. The Czech Republic recently incorporated a safeguard that precludes privatized companies from the benefit of tax holidays and Poland carefully scrutinizes investment projects that involve the assets of a former SOE. 80 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Table 3.1 Number of joint venture companies itended Foreign Contribution to Startup Capital (in US$ 7housands) Participation 0-1 1-5 5-25 25-50 50-100 100-500 Fl > 500 ALL % ALL Ratio 0 to 0.1 460 104 57 10 6 7 2 646 3.2 0.1 to 0.2 608 187 106 15 6 6 4 932 4.6 0.2 to 0.3 986 433 239 29 8 27 6 1,728 8.5 0.3 to 0.4 3,159 1,525 1,004 203 109 77 40 6,117 30.1 0.4 to 0.5 3,500 1,759 1,158 250 128 90 28 6,913 34.0 0.5 to 0.6 2,105 780 350 82 48 31 7 3,403 16.7 0.6 119 218 161 34 26 34 15 607 3.0 ALL 10,937 5,006 3,075 -623 331 272 102 20,346 % of ALL 53.8 24.6 15.1 3.1 1.6 1.3 0.5 Table 3.2 Intended foreign investment Intended Foreign Contribution to Startup Capital (in US$ Thousands) Participation 0-1 1-5 5-25 25-50 50-100 100-500 Fl > 500 ALL %ALL Ratio 0 to 0.1 82 192 585 361 369 1,450 2,397 5,436 1.0 0.1 to 0.2 173 353 1,027 491 390 1,194 3,005 6,632 1.2 0.2 to 0.3 321 830 2.597 1,015 499 6.023 11,972 23,257 4.3 0.3 to 0.4 1,147 2,878 10.911 6,563 6,895 16,760 138,525 183,679 34.2 0.4 to 0.5 1,379 3,680 13,220 8,312 8.734 17,713 71.957 124,995 23.3 0.5 to 0.6 908 1,451 3,678 2,826 2,955 5.658 51,212 68,687 12.8 0.6 72 439 1,761 1,159 1.808 7,583 111,999 124,822 23.2 ALL 4,081 9,823 33,779 20,726 21.650 56,382 391,067 537,508 100.0 % of All 0.8 1.8 6.3 3.9 4.0 10.5 72.8 100.0 Sources: Romanian Development Agency and International Financial Statistics database. EXPORT PROMOTION AN FOREIGN DIRECT INvEsTmEN POuCIEs 81 Table 3.3 Incentives and restriction on foreign investment in romania Article Description Exemptions from Customs Duties Article 12 Permanent for imported capital goods constituting the contribution of the foreign partner. Article 13 A 2-year exemption for imported raw materials, supplies or component parts used in any productive activity. Exemptions from Profit Taxes Article 14 Full exemption for 2-5 years by sector (See Table 3.4) Article 15 Reductions following initial tax holiday of 50% for reinvestment and/or 25% if half of inputs are imported, output exported, or domestic machinery or equipment purchased. 10% expenditure on R&D. or created 50 new jobs in each year the performance requirements are meet. Restrictions/Discretion Article 16 Profit repatriation limits by sector (See Table 3.4) Article 17 *Additional Incentives could be granted by law upon Government proposals for investments effected in the fields" of special interest as identified by the RDA. Article 18 Repayment of exemptions in early liquidation prior to twice the period specified by Article 14. Table 3.4 Incentives and restrictions on profits by sector Repatriation Limit on Length of Exemptiond lei-Profitsf Sector (years) (percent per year) Anti-pollution technologies 5 15 Agriculture, construction and industry 5 12 Comm. transp and res. exploration 3 12 Banking and insurance 2 10 Retail,wholesale,import or export trade 2 8 Source: Romanian Development Agency (1992) I As specific in Article 14 k/ As specific in Article 16 R7 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNoMY Table 3S Comparison of foreign investment regimes Romania Czech & Slovak Republic Hungary Poland GDP in USS 11.0 Billion (1991) 33.2 Billion (1991) 32.9 Billion (1990) 63.9 Billion (1990) Population 23.2 Million (1991) 15.6 Million (1991) 10.3 Million (1990) 38.1 Million (1990) Foreign investment USS 37.0 Million (1991) 586.0 Million (1991) 1,462.0 Million (1991) 300.0 Million (1991) Internal convertibility Incomplete Achieved Achieved Achieved Foreign investment framework Approval Required None None Some sectors require approval or permit. Equity limitations Full ownership Full ownership, with None Full ownership, sectoral restriction in defence and former SOE sector. limitation. Profit taxes Standard rate of corporate 30 percent < Lei I Billion Uniform 45 percent Uniform 40 percent and Uniform 40 percent tax 45 percent > Lei 1 Billion profit reinvestment fully exempt Incentives period and Automatic 2-5 year Automatic 1-year holiday Automatic 2-year holiday Case-by-case basis and restrictions holiday with possible for all companies, except after 1/1/92 and none after none after 12/31/93. extension (Tables 3.3-3.4) if privatized former SOE 12/31/93. Repatriation of profits Tax rate Uniform additional 10 Uniform 25 percent tax on Uniform 20 percent tax on 15 percent on repatriated percent dividends whether or not dividends whether or not dividends. repatriated. repatriated. Method Limit 8-15 percent (Tables Unrestricted repatriation Unrestricted repatriation, FOREX purchases from 3.3-3.4) of capital at from own FOREX FOREX from own account banks at official rate, officially determined rate. accounts at officially or purchased at official possible MOF audit. determined rate. rate. FOREX accounts illegal. Early liquidation Full repayment of benefits Full repayment of benefits No penalty Full repayment of benefits if within 4-10 years of if liquidation within 3- if liquidation within 2- holiday's expiration. years of holiday years of holiday expiration. expiration. '4ormal liquidation In full within a year but in In full with no restrictions In full with no restrictions In full with no restrictions three installments :stons duties ncentive period and Perpetual duty free imports None Perpetual duty free imports A 3-year duty free import estrictions of in-kind foreign of in-kind capital and of in-kind capital held for contribution and 2-year spare parts by foreign at least 3-years. exemption for producer partner, If held for 3- goods. years. ources: WB, UN Economic Commission for Europe, BNA's Eastern Europe Reporter, and Prentice Hall Law & Business EXPORT PROMOTION AND FOREIGN DIRECT INVESTMENT PoLiCIEs 83 References Birenbaum, David E. 1992. Business Ventures in Eastern Europe and Russia, 2nd Ed. Prentice Hall Law & Business Boadway, Robin and Anwar Shah. 1992. "How Tax Incentives Affect Decisions to Invest in Developing Countries" in Policy Research Working Papers, WPS 1011 The World Bank, Washington, D.C. Bureau of National Affairs. 1992. Eastern Europe Reporter. Cuthberson, A.G. (1992). "Trade Expansion Program Mission to Mongolia: Export Policies" World Bank, Washington, D.C. Foreign Investment Advisory Service. 1991. "Romania: Framework for Foreign Direct Investment". The World Bank, Washington D.C. April. 1990a. "Foreign Direct Investment Policy in Hungary". The World Bank, Washington, D.C. July. 1990b. "Foreign Direct Investment in Poland". The World Bank, Washington, D.C. April. Grey, Cheryl W. with Rebecca J. Hanson and Peter G. Ianachkov. 1992. "Romania's Evolving Legal Framework for Private Sector Development." in Policy Research Working Papers, WPS 872. The World Bank, Washington, D.C. March Keesing, Donald B. 1988. "The Four Successful Exceptions: Official Export Promotion and Support for the Export Marketing in Hong Kong, Singapore, The Republic of Korea and Taiwan, China" United Nations Development Program, Trade Expansion Program Occasional Paper #2 The World Bank, Washington D.C. September. Keesing, Donald B. with Andrew Singer. 1990. "How Support Services can Expand Manufactured Exports: New Methods of Assistance" Working Papers Series #544 The World Bank, Washington, D.C. November. 1992. "Trade Policy for a Small Former Socialist Country" Division Working Paper draft, The World Bank, Washington, D.C. August. Hogan, Paul with Donald Keesing and Andrew Singer. 1991. "The Role of Support Services in Expanding Manufactured Exports in Developing Countries" in EDI Seminar Series The World Bank, Washington, D.C. Mintz, Jack M. and Thomas Tsiopoulos. 1992. "Corporate Income Taration and Foreign Direct Investment in Central and Eastern Europe" in Occasional Paper No. 4 Foreign Investment Advisory Service, Washington D.C. Romanian Development Agency. 1992 Law Digest for Foreign Investors Bucharest: Romanian Development Agency, February. ROMANIA: RESTRUCTURING TO FACE THE WORLD EcONOMY United Nations Economic Commission for Europe. 1991-92. East-West Joint Ventures, various issues. World Bank 1991 "Export Processing Zones", Industry Development Division, Industry and Energy Dept., Trade Policy Division, and Planning and External Affairs. (Wash. D.C.: World Bank, June) EXPORT PROMOTION AND FOREIGN DIRECT INVESTMENT POLICIES 85 Chapter 4 Trade and Industrial Policy This chapter examines the links between international trade policy and industrial policy in Romania. Trade policy, which refers to the policy instruments governments have at their disposal to control, restrict, or encourage international trade, can be used to carry out or complement industrial policy goals. "Industrial policy" refers to government policy toward the industrial sector, including direct and indirect subsidies, preferential credit, and measures affecting the price and availability of raw materials and energy. Since trade liberalization and the collapse of traditional export markets in formerly centrally planned economies will cause some sectors to grow and others to contract, and since industrial policy can subvert these pressures and undermine the potential benefits of liberalization, trade and industrial policies must be consistent-industrial policy must facilitate trade policy by fostering industrial entry and exit. Two major factors influence the current formulation of Romanian industrial policy: the inherited industrial structure based on central planning and Romania's role within the Council for Mutual Economic Assistance (CMEA), and the current transition to a market economy, including the privatization program. The industrial sector in Romania The structure of the industrial sector During the era of central planning the government pursued rapid industrialization, emphasizing oil refining and petrochemicals, metallurgy, and machinery and equipment. As a result, the industrial sector became the major sector of the Romanian economy, accounting for 37 percent of total employment and 48 percent of GDP in 1990. Machine building and metal working constitute the largest sector in terms of output and employment, followed by fuels, chemicals, textiles, and wood products. (See table 4.1) The industrial sector also plays an important role in Romania's foreign trade, providing approximately 80 percent of exports. The most important export industries in the industrial sector in 1990 were machinery and transport equipment, petrochemical products, metal products, apparel, and furniture (table 4.2). The most export-oriented sectors are furniture, petroleum refining, and apparel. Romanian exports to the convertible currency area differ from those to former CMEA countries. Western Europe is a relatively important market for textiles and apparel, furniture, leather products and footwear, and fuels. Exports in these sectors show capacity for future growth. The former CMEA countries remain important markets for copper, machinery and transport equipment, and fuels, but they offer less promise of expansion. Non-European market economies are major markets for ferrous and-some nonferrous metals, machinery and transport equipment, other manufactured goods, and fuels. (See table 4.3) 86 RoMANIA: REm UCURING TO FACE THE WORLD ECONOMY Table 4.1 Industrial sector in Romania, 1990 Percent of Average no. industrial Number of Total number Percent of total employees per Percent of electricity Sector enterprises, of employees industrial employment enterprise industrial output consumption Industry - total 2,241 3,701,856 100.0 1,652 100.0 100.0 Fuels '80 204,770 5.5 2,560 14.4 15.2 Ferrous metallurgy' 36 177,434 4.8 4,929 6.1 15.7 Nonferrous metallurg 23 96,009 2.6 4,174 2.3 8.8 Machinery and metalworking 366 1,225,155 33.1 3,347 25.8 13.0 Chemicals 97 215,467 5.8 2,221 9.6 15.9 Building materials 68 89,715 2.4 1,319 3.2 4.0 Forestry and woodworking 9 291,060 7.9 3,270 3.7 2.6 Pulp and paper 17 35,307 1.0 2.089 1.3 2.6 Olass and ceramics 33 60,732 1.6 1,840 0.9 0.7 Textiles 221 350,507 9.5 1,586 6.6 2.8 Leather goods, furs and footwear 44 92.329 2.5 2,098 2.0 0.2 Food 335 214,818 5.8 641 12.0 3.0 Printing 17 17,318 0.5 1,019 0.3 0.1 Others 815 631,035 17.0 774 11.8 15.4 1. Including mining of ferrous ores. 2. Including mining of nonferrous ores. 3. End of year. Source: Romanian Statistical Yearbook, 1991. TABLE 4.2 Exports of the industrial sector, 1990 Percent Ratio of of Total Exports to Sector ExportsO Exports Utilization Textiles 6923 4.83 7.59 Apparel and Furs 9994 6.97 21.93 Footwear. Leather 3381 2.36 14.64 Goods Refinery Processing 21235- 14.80 25.61 Chemical Products 10270 7.16 9.44 Glass, Ceramics, and 5263 3.67 11.25 Concrete Metallurgical Products 18016 12.56 12.26 and Steel Construction Materials Machinery and 10412 7.26 7.01 Machine Tools Electrical Machinery 4827 3.36 9.11 and Materials Transport Equipment 13221 9.21 18.44 Furniture Production 9371 6.53 43.25 o Exports reported in millions of lei. Source: Romanian input-output table, 1990 Recent performance of the industrial sector Since 1989 the Romanian industrial sector has been hit hard by external shocks and by the government decision to convert the centrally planned economy into a market-oriented one. The primary external shock was the collapse of the CMEA trading system and its associated economic and payments problems, which have seriously constrained exports to that region. Other international political events have also hurt Romanian exports. United Nations' embargoes against Yugoslavia and Iraq have effectively eliminated two important markets for Romanian industrial products. The liberalization of the trade regime beginning in January 1990 also subjected Romanian industry to increased competition from imported goods. In addition to the loss of markets for exports and increased import competition, many enterprises have had difficulty obtaining inputs of raw materials and intermediate goods needed to maintain their production levels. Although the Ministry of Industry (MIND) has discretionary power over the allocation of some important inputs, such as energy in times of emergency shortages, it no longer directs the activities of enterprises-enterprise managers now must act independently and autonomously with respect to their productive, financial, and commercial activities. This and the external shocks have disrupted the traditional patterns of commerce and industrial production in Romania. 99 ROmANIA: RESTRUCTURING TO FACE THE WORLD EcomoMY Table 43 Origin and destination of major Industrial Imports and exports, January-October 1992 Value of Exports Percent of Percentage Exported To: Value of Imports Percent of Total Percentage Imporied from: Sector (thousands of US$) total Exports CMEA Europe Other (thousands of US$) Imports CMEA Europe Other Fuels 384621 11.5 29.1 42.1 28.7 1297627 29.9 34.4 20.2 45.4 Leather products and footwear 70211 1.4 17.1 61.9 21.0 84842 1.5 6.6 65.6 27.9 Textileslapparel 336353 6.8 6.6 69.3 24.2 247479 4.4 3.9 79.2 16.9 Ferrous metals 447422 9.0 15.8 35.5 48.7 114937 2.1 23.5 54.9 21.7 Copper and Articles thereof 9331 0.3 91.7 1.9 6.4 11451 0.3 30.2 61.7 8.1 Aluminum and Articles thereof 116606 3.5 7.2 46.6 46.2 6948 0.2 6.5 77.1 16.4 Other nonferrous metals 4288 0.1 7.0 16.0 77.0 30582 0.5 20.0 55.0 25.0 Machineryltransport equipment 745938 15.1 38.6 18.2 43.2 769377 13.8 9.8 67.9 22.3 Furniture 265270 7.9 18.0 78.7 3.3 11443 0.3 4.2 75.7 20.2 Miscellaneous Manufactures 155814 3.1 6.9 40.2 52.8 239344 4.3 38.3 44.5 17.2 Total Exports 3345406 100.0 20.1 42.3 37.6 4339203 100.0 20.1 48.7 31.2 Source: Data provided by the Ministry of Trade Industrial production has fallen drastically since 1989: by about 18 percent in 1990, about 20 percent in 1991, and by a further 24 percent during the first six months of 1992. (See table 4.4). But since July 1992 there have been signs that industrial production is leveling off and that a moderate recovery has begun. The decline in industrial production from 1990 through mid-1992 was spread across virtually all subsectors of industry. The sectors least affected (in which production in June 1992 exceeded half the 1989 level) were petroleum and gas extraction, food and drinks, leather and footwear, woodworking, machinery and equipment (including electrical), and furniture. The hardest-hit sectors included electronics (radio, TV, and communications equipment and computers), pulp and paper, rubber and plastics. Problems of the industrial sector in Romania One of the major problems of the industrial sector in Romania is the inherited structure of industry, which was formed during the industrialization push of the central planning era. Planning and investment decisions reflected a strong bias toward producer goods industries, such as steel, nonferrous metallurgy, machinery, oil refining, and chemical production, at the expense of consumer goods and services. This structure does not necessarily correspond to Romania's current comparative advantage in the world economy. The depletion of natural resource reserves has led to falling production of petroleum, natural gas, and coal and to an increased dependence on imports of raw materials in a number of industrial sectors. The breakdown of the CMEA trading system cut demand for many of Romania's export products, particularly machinery and transport equipment. Part of this decline may be temporary due to the economic disruptions of the transition process in those economies and shortages of foreign exchange, but it is highly likely that a significant part is permanent, now that Romania faces competition from Western producers of like or similar products. A second major problem facing Romanian industry is the obsolescence of its capital stock. This resulted from decisions to curtail new investment, and even imports of spare parts, during the 1980s to pay off Romania's external debt. Not only did this preclude physical investment, but it also cut off Romania from new technology and ideas. It. isolated Romanian industry from changes in world prices, in particular the rise in energy prices during the 1970s. For Romania, isolation and the absence of new investment meant that industry did not adopt new energy-saving technologies, with the result that production is extremely energy intensive, both in the sense that the structure of production is heavily biased toward energy intensive heavy goods production and in the sense that the technologies currently used within each industry -are also very energy intensive. For example, much of basic steel capacity is open hearth furnaces, and cement is produced by the relatively energy intensive "wet" process. The energy intensity of production in Romania is estimated to be about 5 times that of the Organization of Economic Cooperation and Development (OECD) countries. Energy demand by the industrial sector is discussed in more detail in chapter 6. Romania's economy is characterized by a preponderance of very large firms (table 4.1). For example, one garment factory was reported to employ more than 10,000 workers, compared with an average employment level per establishment in the garment industry in the United States in 1990 of forty-one. The small number of large enterprises facilitated the planning process and the high employment levels disguised underlying problems. But the highly concentrated structure poses a problem because privatization of the existing enterprise structure would create private monopolies on ROMANA: RESTRUCTURING TO FACE THE WORLD EcoNoMY Table 4.4 Output statistics for industry (Percentage of 1989 output, unless otherwise noted) 1990 1991 1992(1) 1992(2) 1992(3) 1992(4) 1992(5) 1992(6) 1992(7) 1992(8) 1992(9) 1992(10) Sector name (% 89) (% 89) (% 89) (% 89) (% 89) (% 89) (% 89) (% 89) (% June) (% July) (% Aug.) (% Sept.) TOTAL INDUSTRY 82.2 66.1 57.3 63 59.4 54.6 55.5 50.4 86.3 102 105.5 102.6 Coal mining and preparation 65.3 57.4 60.1 68.2 69 68.6 72.3 65 98.8 104.4 98.6 98 Petroleum and gas extraction 87.9 75.1 71.4 72.9 73.3 73.1 70.6 71.3 100.8 99.6 101.2 99.4 Iron ores mining and preparation 73.1 59.3 43.3 53.3 54.3 61 69.1 58.1 93.4 101.2 100.8 88.8 Other extraction 101.3 78.9 48.2 53 60.1 63.6 55.7 48.8 103.8 106 91.4 103.2 Food and drinks 87.5 73.7 56.3 58.7 57.7 56.3 61 60.7 94.4 104 109 108.8 Textiles and textile fabrics 85 74.6 61.8 70.2 61.9 53.5 56 46.7 86.3 98.2 113.9 104.6 Fabrics, furs and leather goods 80.9 75.6 74.2 81.8 67.9 63.7 56.2 48.2 84.2 88.6 105.6 109.2 Leather and footwear 88.2 78 67.3 72.4 65.9 57.9 61.3 54.7 77.1 102.7 111.9 104.3 Wood working 78.9 62.9 51.3 63.8 66.2 58.7 60.2 52.4 91.6 100.3 101.8 107.9 Pulp, paper and cardboard 71.7 50.1 41.4 42.5 42.9 37.3 35.7 30.4 101.7 117.1 114 96.5 Oil processing 76.8 49.2 45.5 54.8 44.4 42.3 36.6 44.8 97.6 71 118.9 118.5 Chemicals,.Incl. synthetic fibers 79.5 59.2 53 56.8 62.6 54.4 48.3 45 88.7 92.4 101.2 92.2 Rubber and plastic processing 79.1 60.2 42.2 55.1 49.8 47.2 45.1 40.1 89 95.7 114.1 100.2 Other non-metallic mineral products 63.6 49.1 34.8 43.2 46.3 44.7 42.6 41 99.5 91.3 108.2 95.2 Metallurgy 78.1 57.9 45.2 45.7 45.8 42.7 44.2 45.5 80.2 102.5 -93.6 98.1 Metal products 68 59.5 52.2 58.4 48.5 46.4 46.5 44.8 70 116.1 100.8 100 Machinery and equipment 97.8 67.9 59.6 69.3 61 57.2 59.6 53.9 83.6 91.7 107.8 98.9 Computers, etc. 80.4 51.9 49.1 29.4 42.3 49.8 36.8 34.7 96.1 118.3 66.6 104 Electrical machinery and equipment 110.2 82.1 73.8 79.9 74.6 56.6 60.2 53.8 77.6 94.6 101.4 93.6 Radio, TV and communications equipment 72.9 67.9 56.3 64 71.5 59.9 43.8 28.7 72.4 153.9 125.2 95.8 Medical and optical instruments 72.5 61.4 64.2 68 63.3 60.8 67.8 43.6 73 90.2 98.3 97.9 Means of road transport 81.5 64.7 57.7 55.4 43.5 . 41 52.5 45.7 37.8 227.5 122.9 107 Other means of transport 77.2 60.9 59.2 56.3 61.9 63.4 55.8 44.8 89.1 144.2 72.8 107 Furniture, other industrial activities 95.9 94.9 106.9 127 103.2 73.8 77.3 65 84.5 108.9 104.3 104 Electricity, gas, hot water 76 63.3 72.9 75 69.5 57.2 50.6 47.3 101.6 94.9 109.7 115.5 Source: National Commission for Statistics: Monthly Bulletin, various issues and monopsonies. Moreover, even within the "marketization" phase the highly concentrated structure has led the government to regulate prices in many industries to prevent firms from exploiting their potential monopoly power. Some degree of regulation is justifiable under the circumstances, but the regulation of prices may interfere with the desirable adjustment of prices toward world market levels. The large average size of enterprises also complicates industrial restructuring. Closing a large firm is likely to create greater political pressure than an equal-sized diffused lay-off. Previous attempts to spread industrial employment by dispersing industry throughout the country means that in many cases an enterprise is almost the sole source of employment for a town or city. Another problem is that enterprises have previously operated in highly distorted price and incentive settings. These distortions are being reduced as prices are liberalized and adjusted toward international price levels, but a number of important distortions remain. Raw material and energy prices remain artificially low due to subsidies for the mining and energy sectors' (see chapter 6) and to export controls on certain raw materials. Extensive price controls remain: the Ministry of Economy and Finance regulates prices in sectors with fewer than three producers; prices are negotiated under the auspices of the Ministry of Industry between certain enterprises and the users of the enterprise's output, and prior notification is needed for price increases.2 Although they help avoid monopolistic pricing practices in sectors where import competition is insufficient to maintain competitive pricing behavior, measures to regilate prices may prolong pricing distortions in Romanian industry. All of the above problems imply that the inherited structure of Romanian industry is not viable in the long run, given new international circumstances, the transition to a market oriented economy, and international competition. Many enterprises will not be competitive in international markets so there is a clear need for industrial restructuring in Romania: markets and raw materials available in the past will not be available in the future, and competitiveness based on subsidized energy inputs is not sustainable in the long run. These realities suggest that entire sectors may not be able to operate profitably in an open market environment. It is important to note that the long-term viability is difficult to determine until prices are set by the market and individual enterprises are allowed to adjust to those prices. Current performance and the analysis of the competitiveness of sectors at world market prices (see chapter 5), however, suggest that the industrial sectors most at risk in Romania include parts of ferrous and noAferrous metallurgy, and parts of the chemical sector. These sectors must undergo extensive restructuring. In some tradable goods sectors, particularly capital intensive ones, restructuring will involve phasing out production, shutting down some or perhaps all enterprises, and scrapping capital equipment that cannot be used in unrelated sectors. In other sectors, particularly those in which economies of scale are.important, restructuring would imply shutting down some enterprises to allow the remainder to achieve a viable size. In most sectors, given the general age of the capital stock, "restructuring" will occur through the replacement of outdated technology with new equipment, changes in product design and mix, changes in management practices, and the shedding of excess labor. In virtually all sectors, new investment is necessary to increase efficiency, particularly energy efficiency. A massive amount of investment funds will be needed to update and replace the capital stock-so much that it will be impossible to innovate across the board. Consequently, difficult decisions must be made with respect to shutting down enterprises that are not profitable and are unlikely to become so at world market prices. In a market economy in which all industry is 92 RoMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY privately owned, unprofitable firms cease operations when they can no longer finance their operations through internally generated funds or obtain additional credit through financial markets. They are liquidated through bankruptcy procedures. Since industrial enterprises are still state-owned in Romania, closure involves decisions at political or bureaucratic levels. Privatization may resolve some of these difficulties. To explore its role in Romanian trade and industrial restructuring policy, we turn now to a basic description of the privatization process and the agencies involved in the formulation of industrial and trade policy. Privatization in Romania Before 1990 the Romanian economy was centrally planned, with very little participation by the private sector.3 Immediately after the May 1990 elections, the government adopted a privatization plan to transfer existing state-owned enterprises to the private sector and to encourage the establishment of new private enterprises. In July 1990 the Romanian Parliament passed Law No. 15/1990 transforming all Romanian state- owned companies into "commercial companies"-joint-stock or limited liability companies to be privatized-or regies autonomes or RAs which are to remain under state control and ownership. The approximately 6,300 commercial companies accounted for about 53 percent of the value of assets and the nearly 900 regies autonomes about 47 percent. Some eighty-six RAs fall under national administration. These will remain under the Ministries of Industry, Transport, Environment, National Defense, and Health for the indefinite future.4 The remaining sectors are under local authority. Excluding mining activities, there are only six industrial regies autonomes: three in the wood products sector, engaged in the primary forestry operations, and three in the chemical sector. Law 15 also created the National Agency for Privatization, the government body that coordinates and guides the privatization process. The agency reports directly to the Prime Minister, but it is soon expected to report to the National Council for the Coordination of Strategy and Reform (CCSR), a consultative body set up by Romania's newly elected government. The agency steered the privatization law through parliament, developed procedures for the sale of shares and assets, and established procedures for privatization. Its role now is to publish information and provide technical advice related to privatization. Privatization is proceeding along three tracks: * Sales of assets, the parts of commercial companies that can be organized and operated independently. * "Early privatization" of a small number of selected commercial companies by selling shares through direct negotiation with buyers, sealed bid, open auction, or public offering. * "Large scale privatization," which will involve first transferring the shares of the commercial companies to six funds that will hold and manage the shares during a transitional period in which privatization will take place. Sales of assets are conducted by the National Agency for.Privatization. Assets normally are parts of enterprises that can be operated independently, such as equipment, shops, restaurants, hotels, or storage facilities. Enterprises can register assets for sale by auction through the privatization agency to raise funds for new investment or to pay debts. As of December 1992, approximately 6,000 assets had been registered for sale and 1,258 had been sold.s TRADE AND INDUSTRIAL POLIcY 93 Early privatization consists of the pilot privatization of selected companies. Of the approximately 200 enterprises that expressed interest in being privatized, the privatization agency selected, with foreign technical assistance, sixteen small and medium sized companies for pilot privatization. As of December 1992, five of the sixteen privatizations had been finalized.' Large scale privatization is designed to privatize the remaining commercial companies over a 7- year period by first transferring the ownership of the shares of these companies to six funds. One, the State Ownership Fund, will initially receive 70 percent of the shares of each commercial company. Each year the state fund will propose a plan to privatize at least 10 percent of its initial allocation of shares, which may be sold to any investor, domestic or foreign. Under the privatization plan for 1993, the state fund had selected by July 5, 1993, 422 commercial companies, sixty-six of them in the industrial sector, which will be privatized by management/employee buy- out. The selected companies cover ten industrial sectors: twenty-seven commercial companies from leather and textiles, nine from wood working, eight from electronics, electrotechniques and fine mechanics, six from machine building, six from chemical and petrochemical products, three from materials recycling, two from metallurgy, two from energy, two from mining geology, and one from petroleum and gas. The remaining 30 percent of the shares will be distributed to one of five Private Ownership Funds. The companies will be allocated among the five private funds using a combination of regional and sectoral criteria." Every Romanian citizen 18 years or older as of December 31, 1990 will receive five certificates of ownership, one for each Private Ownership Fund. These certificates of ownership can be exchanged for shares of companies or sold to other Romanian citizens. After five years the private funds will act much like mutual funds and any owners of certificates of ownership that have not exchanged them directly for shares will receive shares in the respective private fund. It appears that in the initial years at least, the private funds do not intend to pay dividends because it would be too costly and administratively complex to do so. Instead the private funds will use the dividends for restructuring, reinvestment, and other activities related to privatization. It appears at least possible that private fund resources could be used to shift funds from profitable to unprofitable firms. The operational procedures of the state and private funds will need careful monitoring to avoid such socially wasteful uses. Another concern is that the management boards of the state and the private funds are dominated by members of Parliament and senior officials and include few individuals with business experience. This does not bode well for the performance of the funds. If the proposed schedule is accomplished, the privatization process will take approximately seven years. During this period the State Owned Funds will gradually privatize their share of the ownership of Romanian companies, and owners of certificates in the Private Ownership Funds will exchange these for shares. Developing an industrial policy for Romania As of December 1992, Romania had not yet formulated a clearly defined industrial policy or restructuring strategy. Existing policies and programs are .designed to encourage new investment, especially foreign investment, but these are very general and do not target particular industrial subsectors. The de facto policy the government appears to follow is to keep almost all enterprises operating by issuing credit to cover their arrears. As of December 1992, the government was 94 RoMANIA: RESTRUCTURING TO FAcE THE WORLD EcoNoMY discussing an industrial restructuring policy, but the roles the various government agencies will play were not clear. At some point officials will have to choose which enterprises to liquidate and which ones to spare. Several agencies have an interest in matters of industrial and/or trade policy. These include: Ministry of Trade (formerly Trade and Tourism) Ministry of Industry (MIND) National Agency for Privatization Social Ownership Fund Private Ownership Funds Romanian Development Agency Chamber of Commerce and Industry Others such as the Ministry of Finance, with its tax and banking power could be added to the list. The Ministry of Trade has broad responsibility for Romania's trade policy and was heavily involved in negotiations on GATT and on the Association Agreement with the EC. The Ministry of Industry helps devise general policies for industrial restructuring and develops programs for specific sectors of industry. The agencies concerned with privatization-National Agency for Privatization, Social Ownership Fund and Private Ownership Funds-implement industrial policy and are thus directly and indirectly, through advice to the government, likely to be very influential. The Romanian Development Agency, a relatively independent agency, answers to the Prime Minister, but soon expects to report to the recently formed National Council for Coordination of Strategy and Reform. The agency's role in industrial and trade policies is indirect with its main objective the promotion of foreign direct investment (see chapter 3) and also the administration and allocation of financial assistance reaching Romania under the EC's Polgne-Hongrie Aide A la Restructuration Economique (PHARE) program. Under present arrangements the agency approves all foreign investment and helps guide foreign investors through the minefield of bureaucratic delays and corruption. It plays an advisory role in relation to all aspects of government policy that might affect direct foreign investment and joint ventures. At present the agency emphasizes direct foreign investment likely to raise exports, and is also keen on the development of small and medium-sized enterprises. The Chamber of Commerce and Industry, (included here for completeness, but not further discussed) with its national office in the capital and forty regional chambers, provides services to businesses and also lobbies the government on behalf of business. Like the Romanian Development Agency, it helps potential foreign investors, partly by providing information about business practices in Romania, and partly by helping to bring Romanian and foreign firms together. Several of these organizations have overlapping responsibilities. They all, in different ways, have an interest in trade and industrial policy. The extent and nature of these overlaps is examined below. Romanian industrial policy to date has not favored one industrial sector over another. Individual enterprise managements are allowed a high degree of autonomy in their production, financing, investment, and restructuring decisions, and the government has not yet identified priority sectors, other than the regies autonomes and commercial companies classifications. Given that regies autonomes could have access to continued government subsidies, while commercial companies will not, those sectors with many regies autonomes, such as the energy, mining and transport sectors, TRADE AND INDUSTRIAL PoucY 95 may be implicitly favored under the current designation. This implicit favoritism could extend to the few regies autonomes in the forestry and chemical sectors. . Within the commercial sector general policy has not discriminated much between subsectors. -There are two exceptions, however, but there is not much evidence that they were used in a consistent fashion. First, in times of energy shortage-primarily during 1991-the Ministry of Industry engaged in a form of ad hoc industrial policy through its decisions on the allocation of available energy resources across factories. Second, some licensing requirements for counter-trade activities may act to support particular subsectors. Otherwise, the government has tried to keep all enterprises afloat by issuing credit to cover arrears. According to the Ministry of Industry, very few factories (approximately 30-40 in 1992) had shut down because of lack of finance to continue their activities. There were policies in effect in December 1992 designed to encourage investment, but these were very general and did not target particular industrial sub-sectors. New investment in industry was encouraged by longer tax holidays. New investments in the industrial sector, as well as in agriculture and construction, are granted exemption from profits taxes for five years from the beginning of productive operations, whereas profits from natural resources, communications and transportation receive three years, and trade, tourism, banking, and other services two years. The government is currently developing an industrial restructuring policy with the help of various agencies. The Ministry of Industry, the Social Ownership Fund, and the group of Private Ownership Funds could each have a major influence on industrial policy if they devise a coherent strategy and pursue it single-mindedly. But none has: the Ministry of Industry tends to subordinate the development of broad strategic vision to detailed sectoral analysis and special pleading; and the Social Ownership Fund and Private Ownership Funds lack manpower, experience, and a political base. The main effort to define and design an industrial restructuring strategy has taken place within the Ministry of Industry, possibly in consultation with the other agencies concerned. The Ministry of Industry formulated a preliminary Industrial Restructuring Strategy and published in English in March 1992 a synthesis of this strategy that identified three stages of restructuring. The first task-to halt the decline in production by boosting output in a few sectors, such as textiles, leather, building materials and wood processing, and closing persistent loss-makers. While the decline in production has been arrested and output in some sectors has recovered sharply, the gains did not occur in the sectors just listed (table 4.4). So far, not many firms have been forced to close. The second stage covers the year's 1992-95, during which GDP is expected to return to 1989 levels, branch growth rates are expected to be 5 to 15 percent per year, and output of consumer goods should grow 2 to 5 times faster than that of capital and intermediate goods. Thereafter, in the third stage, steadier and slower growth is expected, as Romania becomes more integrated with the EC. The objectives are very ambitious and include such items as smaller firms, the use of information technology and new fuel-efficient production technologies, environmental protection, and a shift away from industry to infrastructure and services. The document foresees layoffs of 30 to 40 thousand per year. This estimate seems optimistic. Far more than 40 thousand jobs were cut in 1992; layoffs are likely to continue at this pace for some time to come. In terms of policy instruments, the strategy is not so much optimistic as imprecise, containing many possible policies-for example, agreements with foreign firms, better trade deals, discriminatory credit lines, and price stabilization-but not directions on how they are to be used. 0< ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Not surprisingly no policies had been implemented by December 1992. According to representatives of the Ministry of Industry's industrial strategy division, current thinking favors subsidized long- term credits at low interest rates with 2-year grace periods to finance new private investment, especially in export-oriented activities and other activities of "national interest", and a differential taxation scheme with lower rates for firms that start new activities. With respect to industrial strategy, the Ministry of Industry does not have any policy to encourage any sector over another. The specific programs that the Ministry recommends, such as subsidized credit, are aimed at encouraging new private investment. Recently, to assist in attracting foreign investment to the industrial sector, the Ministry of Industry has compiled lists of potential investment projects to upgrade technology. These were developed mainly by the enterprises' management themselves and MIND published them with no indication of particular priorities or favoritism toward any particular sector or subsector. Thus these schemes appear to be aimed at encouraging new private investment across the entire industrial spectrum.! Discussions with Ministry of Industry officials also indicated that the Ministry is now defining a new restructuring approach. One option under consideration separates enterprises into four categories: enterprises to be privatized, enterprises to be restructured and then privatized, enterprises to be supported through "selective restructuring", and enterprises to be liquidated or shut down. "Selective restructuring" includes possible protection of the internal market to improve the attractiveness of the sectors in which the enterprises operate. This suggestion is discussed in more detail below. Some sectors and types of enterprises are much easier to privatize than others. Easier sectors include most small and medium-sized firms, services, light industrial activities oriented toward the consumer market, parts of the housing stock, and rural land. For progress to be palpable these areas should be privatized first, as rapidly as possible, regardless of other industrial strategy considerations. Romania has made progress in some of these areas through programs developed by the National Agency for Privatization and the Ministry of Agriculture, but the whole privatization program could gain enormous momentum if private ownership were quickly extended to the others. The success of the privatization policy will depend on finding solutions to two problems. First, unlike other countries in eastern Europe, Romania has not yet passed a restitution law. A draft law is still under discussion in the Parliament. Depending on the final terms, such a law could either undermine the budget (if compensation is financial) or damage privatization (if the original assets are returned). The best solution may be similar to one adopted in Hungary, where most compensation takes the form of vouchers that can be used to buy shares in companies being privatized. Second, citizens' ownership certificates in the Private Ownership Funds are not negotiable. The likelihood that the values of shares in private ownership funds will vary makes finding a satisfactory trading arrangement difficult. Even though people eventually will be able to convert their shares in Private Ownership Funds into shares in individual firms, considerable uncertainty remains concerning the value of firms' assets at the time of privatization. Given the absence of a clearly articulated industrial policy or restructuring strategy it is perhaps not surprising that there is, as yet, no clear designation as to which government branch or agency is to make the difficult decisions to shut down, phase out, or restructure enterprises, subsectors, or even sectors. All the agencies involved foresee a shift in industrial structure, but there appear to be no policies in place to foster or prompt that shift or to deal with the ramifications of shutdowns of large enterprises. TRADE AND INDUSTRIAL PoucY 97 The bylaws of the State Ownership Fund appear to give the fund responsibility for privatization and for restructuring (including liquidation) and providing corporate guidance to all Romanian companies. The state fund owns 70 percent of the shares of each commercial company, and so in principle it could act as majority shareholder and take charge of decisions on the disposition of each enterprise. Yet discussions with representatives of the State Ownership Fund and a Private Ownership Fund indicated that the two agencies intend to share equally in decision-making. Moreover, the state fund does not intend to become a large bureaucracy. It views its role as the owner of the commercial companies, a role distinct from management. Representatives of the state fund indicated that they did not have the staff or the technical expertise to deal with 6,000 companies. Consequently much of the practical work of assessing firms and determining restructuring plans will have to be developed within the relevant branch ministries, by private firms specializing in such work, or by the enterprises themselves. It is important to clarify the responsibilities of these agencies and their relationships with each other so that some agency can take charge of shutting down uneconomic activities relatively quickly, particularly activities that have negative value-added at world market prices. While the market- based, non-sector-specific stance of the agencies concerned is commendable, this approach exists in an environment of easy credit for loss-making firms, one in which stock accumulation and interenterprise arrears amount to alarming levels, and in which firms are obliged to continue to produce for "social reasons". This amounts to an industrial policy of a very damaging and inefficient sort, with little regard for competitiveness or anything else to do with economic efficiency. The sooner this stops the better. In addition the government needs to address the problems of the industrial environment by removing rationing, developing accounting standards, and reforming the banking system so that legitimate and profitable activities have access to credit. Even the intention of the Ministry of Industry to classify firms according to competitiveness among other indicators will come to nothing if enterprises are not compelled to behave as if they had hard budget constraints. If firms do not behave this way, resources that could have been used for profitable restructuring will be wasted on inefficient firms that have no future. There is also a terrible danger that political and other pressures faced by the institutions set up to implement Romania's privatization program will urge the preservation of old economic structures rather than serious restructuring and modernization to save firms and jobs. In this context, the blurring of lines of responsibility and the interpenetration of the new institutions with existing governmental structures through the appointment of senior staff and boards of management are not helpful. Trade policy and restructuring During the transition to a market economy and restructuring of domestic industry it is extremely important to use international prices as a guide to competitiveness. An open and liberal trade policy accomplishes this goal automatically. With relatively low tariffs, no nontariff trade barriers, ready access to foreign exchange, and freedom to export, the prices of tradable inputs and products in Romania will not deviate very much from the prices of the products in the world market. On the import side, world prices of tradable goods reflect the true cost of obtaining products or intermediate inputs. If the domestic market is protected from import competition, consumers of final products or users of intermediate inputs are forced to pay higher prices. It is especially important to allow producers access to inputs at world market prices so that potential export industries can be competitive in world markets. Imports also provide a discipline on pricing. Romanian industries are ROMANTA: RESTRUCTURING TO FACE THE WoRLD EcoNoMY highly concentrated, but import competition can prevent even monopolies from exploiting monopoly power and thus act as a substitute for a competition policy or direct price controls by the government. On the export side, the international prices of tradable goods reflect the true opportunity cost of consuming the goods at home or using them as inputs in production; that is, the amount of foreign exchange that could be earned by exporting them. It is important to force producers to pay for inputs at world market prices, and to maintain world market prices for outputs so that market forces determine which activities are efficient and competitive. Trade policy issues An industrial policy is based on a set of particular programs and policies, including tax policy, credit policy, price regulation, and trade policy. This section discusses issues of trade policy. Generally, any policy that taxes, subsidizes, or controls imports or exports hurts some groups while benefiting others, and will involve net losses or costs to the economy. Such interventions may accomplish other specified policy objectives, but it is important to bear in mind the costs and be sure that they do not outweigh the benefits. The costs of protection arise from distortions of production and consumption decisions. Import barriers increase the prices of imported goods and therefore encourage or allow production of domestic substitutes, but at a higher cost than the price of imports. Consumers are hurt because goods are more expensive, and enterprises using imported raw materials or intermediates as inputs become less competitive because their production costs increase. Enterprises producing goods that compete with restricted imports will enjoy higher profits. On balance, there are net costs because extra domestic resources are used up producing goods that the country could have imported at a lower cost, and consumers are discouraged from buying imported goods that could have been imported at low cost. Export controls keep the domestic prices of controlled goods low, which hurts producers of those goods but helps consumers, provided the controlled goods are final consumer goods, or industries that use controlled raw materials or intermediates. Artificially low prices encourage increased consumption or use of inputs that is of less social value than what would have been earned from exporting. Also, lower prices reduce production that could have been profitably exported. The protection of domestic industries (by either artificially increasing their output prices or decreasing their input prices) reduces the pressure on the enterprises to achieve maximum efficiency. Moreover, where industrial concentration is high (as in virtually all sectors in Romania) .reducing competition from imports or competition from foreign buyers of inputs may allow Romanian enterprises to exploit their monopoly or monopsony power. Groups benefiting from trade barriers will naturally attempt to urge the government to impose or maintain the barriers that benefit them. Enterprises interested in increasing their profits and workers intent upon preserving their jobs or increasing their salaries will understandably pressure the government to impose import controls on their enterprise's outputs and export controls on its inputs. The government must take a broad perspective and consider the welfare of all enterprises and citizens when formulating trade policy. The remainder of this section discusses specific trade policy issues in Romania, focusing on the use of trade policy measures in keeping unviable industries afloat, attracting foreign investment, increasing the attractiveness of recently privatized companies, and ensuring availability of raw TRADE AND INDUSTRIAL POuCY 99 materials for industrial activities. Protection to keep unviable industries afloat The transition to a market economy, the removal of explicit and implicit subsidies, and the adjustment to world prices have put tremendous pressure on enterprises that are not efficient and competitive. The government should resist pressures to protect these sectors by imposing or increasing trade barriers. Once granted, protection is difficult to remove because of political pressure from the interest groups that benefit from it. Moreover, given the commitment to remove barriers on trade with the EC over the next ten years, an increase in trade barriers with the rest of the world would increase the costs of trade diversion raising the incentive to import higher priced goods from the EC rather than lower priced-goods from the rest of the world (see chapter 2). Protection to attract foreign investment The industrial restructuring strategy calls on enterprises to develop their own restructuring plans without intervention from the Ministry of Industry. The ministry has provided advice to enterprises and compiled lists of projects for potential foreign investors. The government has encouraged foreign investors and joint ventures to establish new enterprises and finance the renovation or replacement of technologically outdated and worn-out equipment. In some other countries with policies of actively attracting foreign investment, governments have given concessions to foreign firms, including the imposition of trade barriers to provide the investor a protected domestic market. The emphasis on technological upgrading in the restructuring plan and the activities to attract foreign investment to help innovate raise concerns that concessions may be demanded by and granted.to foreign investors. Where the enterprises produce for the domestic market, the temptation may be to increase protection to make potential investments appear more attractive-a costly endeavor because it draws factors of production out of other sectors and into sectors that cannot survive at world prices. There is evidence that this type of pressure from potential foreign investors has been applied in Romania. The French automobile producer Renault is reported to have expressed interest in investing in the Dacia plant in Pitesti, which produces under a license from Renault dating from the 1970s, provided that the government would protect the domestic market. This request for protection was, quite appropriately, turned down by the government. The government should continue to avoid increasing trade barriers as a means of attracting foreign investment in industries producing for the domestic market. Protection for privatization As discussed above, recent thinking within the Ministry of Industry focuses on the relationship between restructuring and the privatization process. The Ministry is developing guidelines to classify enterprises as immediate candidates for privatization, enterprises that will be "restructured" and then privatized, and enterprises that will be shut down. The preliminary document in English setting out this approach to industrial restructuring mentions methods to be used to make enterprises more attractive for privatization, including enhancing the attractiveness of the sector -in which the firm operates. One method mentioned for improving the attractiveness of the sector is protection of the domestic market. This has essentially the same costs as offering protection to foreign direct 100 ROMANIA: Esm UCTURING TO FACE THE WORLD EcoNoMY investors. Government actions that favor one sector over another to make firms attractive during the privatization process would have an adverse effect on other sectors and consumers, and they should be avoided. Export controls to protect processing activities Producers of some finished goods, such as furniture, are protected by export controls on their raw material inputs. Export controls on raw material inputs often are motivated by a desire to promote output and employment in the domestic processing industries by ensuring adequate raw material supplies at low cost or to increase export earnings by exporting higher value-added products. Export controls on raw materials provide an implicit subsidy to enterprises using those raw materials as inputs, reduce foreign exchange earnings from raw material exports, and discourage production of raw materials. If the processor of the raw material is a monopsony (a single buyer), export controls on raw materials will not necessarily achieve the intended objectives. Output and employment in the processing activity may fall, and foreign exchange earnings may be decreased. Appendix 4.1 develops a simple model to illustrate the impact of export controls on raw material inputs under both competitive and monopsonistic market structures. It shows how economic welfare and-depending on the circumstances-export earnings are reduced by such restrictions. Applying this model to data from Romania's wood and furniture industries suggests that in the long run the export bans on wood could reduce export earnings by 10 billion lei, or even more if adequate competitive control is not exercised over the using industry. The export quotas on raw materials amount to a policy of encouraging industries that process domestic raw materials over all other activities, with the associated distortions and costs. These quotas should be eliminated as soon as possible so that prices internally reflect the true cost of the goods at world market prices. Export controls are not an adequate policy for conservation of raw material supplies. If the government's goal is to prevent excessive exploitation of natural resource endowments-forestry resources-the appropriate policy would be to directly control the harvesting of trees, not the exportation of wood products. Use of barter trade licensing requirements for protection In some industrial sectors, such as chemicals and ferrous metallurgy, various forms of barter trade still dominate international trading relationships. For example, the former state trading organizations METALEXPORTIMPORT and METANEF still account for approximately 90 percent of trade in steel products; some trade is now paid in convertible currencies, but most is still in the form of barter trade arrangements with traditional trading partners. Difficulties and delays in obtaining foreign exchange have also given rise to countertrade arrangements in which individual enterprises exchange inputs for products with a foreign firm. For example, a Romanian company will obtain cold rolled bars from a foreign firm, make wire from them, return an agreed portion of the wire to the foreign firm, and retain a portion to sell internally or export itself. Similar arrangements are found in the fertilizer sector, where foreign companies purchase and provide natural gas to Romanian fertilizer producers in exchange for a proportion of the fertilizer output. These countertrade transactions are subject to license. The Ministry of Industry reportedly uses TRADE AND INDUSTRIAL POLICY 101 this licensing requirement in an effort to ensure raw material inputs for the metallurgy sector. Licensing policy decisions encourage the sector to exchange steel products for raw material inputs for the steel sector and prevent it from trading for unrelated goods. The licensing requirement for countertrade purchases has reportedly also been used to encourage the use of domestic rather than foreign intermediate goods. For example, the ministry could use licensing to force a company to opt for domestic bars to produce sheet rather than use foreign ones in a countertrade arrangement. The existence and apparent viability of these countertrade arrangements and of "in lohn" processing-cash payment by foreign firms for processing activity-suggests that certain Romanian fabricating industries would be competitive at world market prices provided that they had access to intermediate steel products at world market prices. The industrial restructuring strategy of the Ministry of Industry also includes references to balancing foreign trade within the sector, subsector, or even enterprise. Licensing requirements on barter trade arrangements appear to encourage such balance by favoring exchanges of output for raw material inputs for the same industry. They tend to lock trade into the previous barter trade patterns and prevent reorientation of activity toward new markets and activities. Enterprises should be allowed to engage in barter trade arrangements without requirements that particular products be received for the exported output. In a market economy, there is no need to balance trade within particular sectors. Excess foreign exchange earnings by one sector are transferred to sectors with foreign exchange deficits through the foreign exchange market. In this regard it is important to improve the operation of the foreign exchange auction to allow enterprises to exchange domestic for foreign currencies at a realistic exchange rate, so that they can obtain imported raw materials and intermediate inputs and more efficient modern equipment from abroad. Conclusions and recommendations Governments can use international trade policy instruments to carry out or complement industrial policy goals. A country's trade policy and industrial policy should be internally consistent, with the costs of using trade policy to-achieve industrial policy goals made clear. Trade barriers can be used to encourage production in particular sectors, but they also implicitly discourage and disadvantage production in other sectors and impose costs on consumers. Even if intervention is required-which is rarely the case-trade policy instruments should be used only very cautiously as a means of carrying out an industrial policy. There is a clear need for industrial restructuring in Romania, but formulating an industrial restructuring policy is complicated by the difficulty of determining the long-term viability of sectors when prices are not yet set by the market. Restructuring the industrial sector in Romania will entail phasing out production in some sectors, shutting down some enterprises in sectors where economies of scale are important to allow the more viable enterprises to survive, and-in most sectors-restructuring at the firm level by acquiring new capital equipment, redesigning product lines, changing management practices, and shedding excess labor. Industrial restructuring in Romania will coincide with the privatization process, which if it remains on schedule, will privatize much of Romanian industry within seven years. The . privatization program is being conducted through transitional agencies, the Social Ownership Fund and five Private Ownership Funds that in principle own the enterprises until they are privatized. These institutions should be made independent of government in their day-to-day operations. They should be able to make commercial decisions in the context of government policy but should be free 102 ROMANIA: REsmucTuRINo TO FACE THE WORLD ECONOMY from all direct political control, even via their boards of management. The policy of the Romanian government toward the industrial sector has allowed individual enterprise management a high degree of autonomy in production, financing, investment, and -restructuring decisions. Commendably, industrial policy to date has not favored one industrial sector over another. In the absence of a clearly defined industrial strategy, however, the de facto policy that the government appears to be following is to keep almost all enterprises operating by issuing credit to cover their arrears. This is not commendable. Difficult decisions about the relative viability different sectors and enterprises will have to be made at some point through some mechanism. The government is currently developing an industrial restructuring policy, but the roles of the various government agencies that will be involved in formulating and implementing the industrial restructuring policy had not been clearly defined by December 1992. The Ministry of Industry has taken the lead in formulating industrial restructuring strategies, but specific policies have not been implemented to achieve the broad objectives of the restructuring program. As the ministry continues to develop a restructuring strategy in the context of privatization it will be important to clarify the responsibilities of the various agencies involved and the relationships among them, in order to create a mechanism for shutting down uneconomic activities. Trade policy plays an important role in the transition to a market economy and in restructuring domestic industry because international prices serve as a guide to competitiveness. An open and liberal trade policy on both the import and export side allows international prices to guide the restructuring process. On the import side, world prices of tradable goods show the true cost of obtaining products or intermediate inputs. On the export side, international prices reflect the true opportunity cost of consuming goods at home or using them as inputs in production. It is important to force producers to pay for inputs at world market prices, and to maintain world market prices for outputs so that market forces determine which activities are efficient and competitive. Given the tremendous difficulties of the industrial sector during the past three years, it is noteworthy that the government has, to a large extent, avoided the use of trade restrictions to try to aid industries in difficulties. This is commendable and the government should continue to avoid raising trade barriers to help particular sectors, to attract foreign investment, or to make enterprises more attractive for privatization. Export controls on raw material inputs provide an implicit subsidy to enterprises that process the raw materials, reduce foreign exchange earnings from raw material exports, and discourage production of raw materials. Export controls are intended to promote output and employment in the processing industry, but where processing is controlled by one or a few users of the raw materials, an export quota or ban may lower output and employment and reduce foreign exchange earnings. Export restrictions should be removed except for goods restricted by bilaterally negotiated agreements, or for goods subject to consumption subsidies. In this latter case the subsidies should be phased out as soon as possible so that prices internally reflect the true cost of the goods at world market prices. License requirements on barter and countertrade transactions have apparently been used to encourage the use of domestic intermediate goods rather than foreign, or to attempt to ensure raw material supplies for particular sectors. Licensing requirements for barter transactions should not be used in a way that locks trade into previous patterns, prevents the reorientation of trade toward new markets and activities, or discourages the exploitation of new opportunities. Enterprises should be allowed to engage in countertrade transactions without requirements that particular imports be received for export goods. TRADE AND INDUSTRIAL POLICY 103 Appendix: The economic impact of export controls on raw material inputs This appendix examines the economic impact of export controls on raw materials and develops a method for estimating the magnitude of the costs and transfers that result from those export controls. The analysis is first developed in terms of an export quota because this approach allows the identification of the potential rents to traders who receive export licenses. The analysis first assumes competitive markets for the raw material, that is, a large number of independently acting buyers and sellers. Under this assumption the model is then applied to the case of Romanian export controls on wood products. The competitive assumption is then dropped to explore monopsony power on the part of a single domestic buyer. Raw material export controls with competitive markets Suppose that a raw material input, I (such as timber) is used as in input into the production of a final product, F (such as furniture). Following Corden (1973), to ease graphical presentation and link the markets for inputs and outputs, define units of input so that one unit of input is required to produce one unit of output.' The perfectly competitive processing industry is willing to process more inputs into output the higher the value-added per unit in processing: (4.1) S where Qs is the quantity of final product processed, PF is the price of the final good, P, is the price of the raw material input and PF-P, is the value-added per unit. Suppose that the quantity of the final good demanded within the country (QO) depends upon the price: (4.2) Qj - D(P,) Net exports of the finished product will be the difference between the quantity supplied and the quantity demanded: (4.3) S D XF -Q - Q; Suppose that the raw material is produced by a perfectly competitive input industry and that the quantity of the raw material input supplied depends on its price: (4.4) S, (P,) 104 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcONOMY Suppose that the raw material is not demanded in the domestic market except as an input to the final goods processing industry. This assumption, along with the definition of the "units" of input, implies that: (4.5) D S Q2, = QF Exports of the raw material will be the difference between the quantity supplied and the quantity demanded as inputs by the domestic industry: (4.6) X, = Q ,s S,(P,) -Q,D The equilibrium in this model under free trade is shown in figure 4A. 1. If there were no trade restrictions, the domestic prices of both the final good and the raw material would be equal to the prevailing world market prices. The supply curve of processing as a function of the value-added is shown in the upper panel of figure 4A. I by the curve S(V). The height of the curve is the value- added per unit of final good produced, V. The processing industry's supply curve of the final product under free trade, SF*, would lie above S(V) by the raw material input costs per unit P''. The demand curve for the product is DF. The upper panel of figure 4A. 1 shows the market equilibrium for the final product under free trade. If the world market price of the final good were PI', the world market price of the input were PT, and there were no trade restrictions, the quantity demanded would be DF*, the quantity supplied by the processing industry would be QF*, and QF*-DF* (= XF*) would be exported. The market for the raw material is shown in the lower panel of figure 4A. 1. The units along the horizontal axis measure the quantity of "packages" of inputs, where each "package" represents the inputs needed for one unit of output. The price measured along the vertical axis is likewise the price per "package" of inputs. The domestic raw material industry supply curve is shown by S1. If the price of the raw material in the world market were PI', the domestic raw material industry would produce an output Qj*, the domestic final goods processing industry supply curve would be SF*, -the output of final goods would be QF*, and the demand for raw materials on the part of thedomestic processing industry would be Dl*. The quantity exported would be Xj* (=Q,*-D,*). Export earnings from final goods exports would be PWXF* and export earnings for raw materials exports would be PwX,*. Suppose that the government now controls exports of the raw material by imposing an export quota that allows no more than a maximum amount to be exported, and that this system is enforced through an export licensing system. In terms of the model, the domestic price of the raw material will no longer necessarily equal the world market price because producers are not free to export. Instead, if the quota restriction were binding, the quantity of exports would be given and the domestic price would be determined by equation 4.6. The domestic equilibrium price under the export quota system would be the price at which the difference between the quantity of raw material supplied and the quantity demanded would equal the maximum amount allowed to be exported. TRADE AND INDUSTRIAL POLICY 105 MIURE 4A1: Final good and raw materials market&: no rade restritIons ppw fl(V) 0 x8 pfl 0 0 X6lf 106 Rom~NA REmTucrumING To FAcE THE WoRLD EcoNomy Given that the quantity demanded depends upon the output of the processing industry, and given that the position of the processing industry supply curve depends upon the price of the raw material, the new equilibrium would be determined jointly in both markets. As the raw material input price falls due to the export restriction, input costs of the processing industry fall and the processing industry supply curve shifts downward, or to the right. At a constant final product price, output of the final product (and therefore the quantity of the raw material demanded by the processing industry) increases. Figure 4A.2 illustrates the new equilibrium after an export restriction limiting raw material exports to X,' is imposed. The price of the input will settle at P', where the quantity demanded, which is equal to the quantity of final good supplied at the world market price PF and input price P? plus X1', equals the quantity of input supplied along Si. The lower equilibrium raw material price will reduce raw material production from Q1* to Q1'. In the final goods market, output increases from QF* to QF'. The raw material export restriction hurts producers of the raw material and discourages raw material production and exports, but increases profits of the processing industry, as well as production and exports of the final good. The gains of the processing industry and the losses to the raw material producers, as well as the net efficiency losses from the restriction, can be identified and estimated. In the market for raw materials, producer profits fall because of falling prices. The loss in profits is usually identified as a loss in "producer surplus" equal to area adge in the lower panel of Figure 4A.2. The height of the raw material supply curve shows the marginal cost of producing each extra unit. When price falls to PI,, revenues decrease by area adrsge but costs decrease by only gdrs, so net income declines by area adge Part of this loss (area abfe = area hijk) consists of a transfer from raw materials producers to the processing industry in the form of higher profits because of lower input costs. Another part (area bcgf) represents a transfer from raw materials producers to the recipients of import licenses, who are able to buy the raw material on the domestic market at P, and sell abroad at P11. The remainder (area cdg) is an efficiency loss because the extra units of raw material Ql*-Q,', which would have been exported to earn P'' in the absence of the export restriction, would have only cost an amount equal to the height of the supply curve to produce. With the export restriction, these extra units of the raw material will not be produced and sold abroad for more than the cost of producing them. Area cdg thus represents a net efficiency loss to the country. These transfers and efficiency losses can in principle be measured. The loss to producers of the raw material equals area adge: Area adge =dP, Q, + dQ dP1 2 (4.7) 1 dPs dQ, P, Qr dP, (4.7) P rpJQ + .1d1P Q1L l p P, 2 P, dP, Qs P, Pr SsCV + ' eX2V ' 2 el V where e=(dQ/dP)(P/Q) is the elasticity of supply of the raw material, 7r is the percentage change in the raw material input price due to the export control, and V, is the value of raw material TRADE AND INDUSTRIAL PoLIcY 107 FIGURE 4A.2: Final good and raw materials markets: export control on raw material PSW F . FF 0 x F F 0 0 0 O 0 0 0 0 b d 0. 0 D* vge d 0 P0 108~ p ..-o-- m~:- . RE = N oFAE.EWRL CNM fl f fl f pw E fl b e r 108 RoMANLA: RESTRUcTURING To FACE THE WORLD EcoNOMY production. The second term of equation 4.7 is the efficiency loss in the raw materials market, area cdg. The part of the loss to raw material producers that is transferred to export license recipients is area bcgf: (4.8) Area bcgf =dP, X, x where Y is the value of raw material exports. In the market for the processed good, the processing industry gains area hiki. The industry marginal cost curve shifts downward from SF* to SF' which reduces costs for each unit previously produced and therefore increases profits by area hnkl. Profits also increase by the difference between revenue and costs for the extra units produced, area nik. From the point of view of the country, however, the increase in domestic processing of the raw material creates an efficiency loss equal to area min because the artificially low raw materials price encourages the processing industry to expand output beyond the point at which the price in the world market equals the true cost of producing the final good, including the opportunity costs of exporting the raw material. Since SF* is parallel to Sr', but below it by (P, -PI), area min = area ijk. This part of the transfer from the' raw material producers is not a gain to the processing industry, but is simply lost due to higher processing costs. Again, these transfers and costs can be measured. The gain to the processing industry is area hikl: Area hik = QF dPs - . dQ, dP, (4.9) 2 ( )dPs P 1 dPr dQ. v Q, 1P, 17 2P, dy QF V where v is the value-added per unit of final product. Let es be the elasticity of supply of processing with respect to the value-added per unit, 4=PI/PF equal the ratio of raw material cost to the price of the final product, and VF = PFQF be the value of final good produced. With the final product price unchanged, dv=-dP,, so (4.10) area hiki V,# 7 - F2 yY 2 1- The efficiency loss due to higher-cost domestic processing (area Uk = area min) is the second term of equation 4.10. Export controls on raw materials are often justified by the desire to increase earnings of foreign exchange by encouraging exportation of higher value-added processed goods rather than raw TRADE AND INDUSTRIAL PoLicy 109 materials. It is therefore of interest to investigate the impact of the raw material export controls on total export revenue. Foreign exchange earnings from final goods exports increase by PF(QP'-QF*). Raw material exports fall from Xj* to Xj', and export earnings fall by Pw(X,*-X,'). Export earnings from exports of final goods increase, but export earnings from raw material exports decrease not only because of the diversion of exports to the domestic industry, Dj'-Dj* (=QF'-QF*), but also because the low price decreases production (and therefore exports) by Ql*-Q,'. The net impact of the raw material export restriction on total export earnings is ambiguous. The change in total export earnings due to the export control on raw materials would be the difference between the increase in the value of final good exports and the decrease in the value of raw material exports. Given that XI=Qs -QD and QD = Q1, the decline the value of raw material exports would be: dlPjX = P [dQI - dQI] = P [F,QZI - -(-79) (4.11) S S = eVXl + ) + E V 0, (1 + 7)7 = g(1 + 7)[eV, + E Y,( )] 1-4 The first term in square brackets captures the decline in raw material exports due to the fall in production; the second captures the decline in exports due to the diversion to domestic processing. Holding domestic demand for the final good constant, and allowing for free exportation of the processed good at an unchanged world market price, the export restriction on raw materials would increase exports of the final good. Given that value-added per unit would increase by the decline in raw material cost per unit, the magnitude of the increase in final good export earnings would be: (4.12) P,'dX. V, s4 Therefore total export earnings would change by: (4.13)P,wdXF,- PIM =X f- VT 4 7-w9(1+7C)[e1SV + e V )] (4.13) V1- 1 1 1!V4 1-4 Total export earnings will increase if equation 4.13 is positive but decrease if it is negative. The first term reflects the increase in export earnings from diverting raw material exports to the processing industry and exporting higher-priced processed goods instead of raw materials. The second term is the loss in export earnings from reduced raw material production due to lower 110 ROMANIA: RESTRUCTUING TO FACE THE WORLD ECONOMY domestic prices. The raw material export control is more likely to increase export earnings the greater the value-added in processing at world market prices (the smaller is 4), the greater the elasticity of supply of the processing industry, and the smaller the elasticity of supply of the raw material. Application to Romanian timber and wood produces export restrictions Romania has prohibited the exportation of certain wood products that are inputs into the furniture industry and imposed export quotas on others.10 Equations 4.7 through 4.13 can be used to calculate estimates of the magnitude of the transfers and net costs associated with these export restrictions. The values for the variables in those equations, and an explanation of the sources and reasoning behind them, appear in table 4A. 1. The estimated impacts of the wood products export controls appear in table 4A.2. The estimates in table 4A.2 are designed to be illustrative rather than definitive. No information is available on the actual elasticities of supply in the wood products and furniture industries in Romania, so the estimates are based on a range of assumed values for these elasticities. Romania currently imposes restrictions on cutting of timber to protect the environment and allow rebuilding of the timber stock. These restrictions can be interpreted as implying a zero elasticity of supply of timber (and therefore wood products) in the short run. However, in the long run additional planting and harvesting of timber would be possible, so estimates are presented using both a short-run scenario, in which the elasticity of supply of raw material inputs is assumed equal to zero, and the elasticity of supply of value-added in furniture production is assumed equal to one, and alternative long-run scenarios, in which the elasticity of supply of raw material input is assumed to be positive. To illustrate the sensitivity of the results to assumptions about the elasticities of supply of wood product material inputs and furniture, the results of two alternative "long-run" scenarios are presented, one assuming that both elasticities of supply equal one, and a second assuming a low elasticity of supply of wood products of 0.5, but a higher elasticity of supply of furniture production of 5. The results indicate that the export controls on wood may impose severe losses on the wood input industries. The estimated decreases in profits range from about 8 to 10 billion lei per year. If there is a nonzero elasticity of supply of wood, there are also efficiency losses in the wood market, estimated here between 1 and 2 billion lei per year. The gain in terms of increased profitability of the furniture industry is about 1.5 to 2.3 billion lei, while the estimated efficiency losses from increased furniture production amount to 200 million to approximately 1 billion lei. The result of the wood inputs export controls are ambiguous and depend crucially on the elasticities of supply in the two industries. In the short-run scenario in which wood inputs production cannot respond to price changes, the export controls increase total export earnings by approximately 2 billion lei. However, in the first long-run scenario, assuming equal elasticities of supply of wood products and furniture, the discouraging effect of the export controls on wood production and the diversion of wood exports to furniture production decreases wood input exports by almost 14 billion lei, while furniture exports increase by a much smaller amount. The net result is a decrease in total export earnings from wood products and furniture of over 10 billion lei. These calculations are far from definitive, but they do indicate that the wood export controls, under reasonable assumptions of elasticities of supply, may transfer significant amounts of profits TRADE AND INDuSTRIAL POLICY 111 from the wood products industry to the furniture industry, and could result in a substantial decrease in Romanian export earnings in the long run. Raw material export controls with monopsonistic processor The structure of Romanian industry in 1992 is extremely concentrated. The centrally planned economy resulted in an industrial structure in which there is often only one (or a few) producers of particular products. When the inputs into the production process are used only by that single user, the single processor is an example of monopsony, a single buyer of a product. Even where there is more than one producer, the large market shares or local monopsony position may give each producer some degree of potential control over local input markets. Whether a monopsony is able to exercise monopsony power depends crucially on the international trade policy in effect. If the raw materials processed by these firms can be freely exported, then these processors may not be able to effectively exercise monopsony power. They will have to compete with potential exporters of the raw materials and will be forced to pay the world market prices for their inputs. On the other hand, if the inputs cannot be exported or if exports are limited to predetermined quantities, then the processors will be able to control the price of the raw materials through their purchasing decisions. The determination of prices, production, and exports of raw materials and processed products in the case of a monopsonistic market structure in the absence of any export restriction is illustrated in figure 4A.3. As in the previous figures, the upper panel represents the market and production conditions for the final product and the lower panel the market and supply conditions for the raw material input. In the upper panel D represents the demand curve for the final product and MC(V) represents the marginal cost for factors of production other than the raw material input. The extra cost of an extra "unit" of raw material input must be added vertically to MC(V) to obtain the marginal cost of production curve MC. If the world market price of the input is P1', and exporters are free to export at this price, the processor will also have to pay P, and the marginal cost curve for the processor will be MC as shown in the upper panel of figure 4A.3. If the world market price of the final product is PFv, then the processor would maximize profits by producing at an output level of QF*."1 The quantity of the final good exported would be XF* the difference between QF* and DF*. The value of export earnings from final product exports would be the area abcd in figure 4A.3. In the input market, the processor would demand D1* units of input, the producers would supply Q1* at the price P*, so the quantity exported would be X1* (=Q,*-D,*). Earnings from exports of the raw material would be PwX,*, equal to area efgh. Compare this outcome with the resulting prices, production and export earnings if exports of the raw material are limited by some form of quantitative export restriction, such as a restrictive licensing system, an export quota, or an export ban or embargo. The analysis is developed in the form of an export ban because it is the simplest to illustrate and because export prohibitions have been imposed on many products by the government of Romania. The results would be similar with other forms of quantitative export restrictions.1 A ban on exports of the raw material input implies that -the single processor faces the upward sloping supply curve of the raw material input S1. The greater the output of the processor, the more raw material purchased, and the higher the resulting market price of the raw material. Because the processor would drive up the market price for all unit of the inputs used, not just the last unit 112 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcONOMY bought, the extra cost of an extra unit of input to the processor will exceed the market price. A curve showing the extra cost of extra units of input, labeled MC, in the lower panel of figure 4A.4, can be derived from the input supply curve S1.13 After the restriction on the exportation of the input, the marginal cost of the final good would be MC'. It is derived by adding MC, to MC(V). The monopsonistic processor can still sell in the world market at PwF, so the processor's profits would be maximized at Qr' the output level at which the world market price equals the marginal cost of production. In the case illustrated in figure 4A.4, this would be at a lower output level than without the export ban. The processor reduces output because lowering output reduces the demand for the input and reduces the equilibrium price in the market for the raw material inputs. As shown in figure 4.A.4, when only one profit maximizing processor buys a raw material on the domestic market, an export ban on the raw material eliminates exports of the raw material, and can decrease production and exports of the final good. In this case, total export earnings from both the final product and the raw material must decrease. Figure 4A.4 illustrates the case in which total export earnings fall, but this result is not unambiguous. If exports of the raw material are large relative to production of the final good, output and exports of the final good may increase. As in the competitive industry case analyzed first in this appendix, the export ban will reduce real income or profits of the raw material producers and increase the profits of the processing industry. Revenues of the raw material producers fall from efgh to Ukh. Revenue from raw material exports will fall by 1.f.g.k. Of this reduction in export revenue, If represents a net loss to the country because it is the difference between export revenues lost and the incremental cost of producing the quantity that would have been exported in the absence of the export ban. Area elji represents a transfer from raw materials producers to the processing firm. TRADE AND INDUSTRIAL POLICY 113 NGURE MA3: Single processor, r trade mc ba w 00 OM 0 0 DD 0uS fl fl 114 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcONoMY 勾 TRADE AND INDUSTRJ誦工POUCY 1 15 Table 4A.1 Data for Estimation of Impact of Romanian Wood Export Controls V1 16,959 Value of output of woodworking industry. (millions of lei) Data are from the 1990 Romanian input-output table for the woodworking sector (sector 32) VF 20,868 Value of furniture output (sector 77 of 1990 input-output table) (millions of lei) VX t 230 Value of exports under quota of plywood, laminated board and chipboard, all potential inputs for the furniture industry (millions of lei) 0.24 PI/PF, calculated from ratio of value of inputs of woodworking industry into the furniture industry to value of output of furniture industry from 199D input-output table. ir 0.5 (Pw, -P,)/P,. the percentage difference between the world and domestic price of raw material inputs due to the export controls on raw materials. A study of the Romanian wood-based industries by the Swedish consulting firm Jaakko Poyry (1992) estimated that the prices of wood material input costs for the furniture industry were far below the prices in other countries. Input costs were less than half the costs in the next-least expensive country, Poland. Costs of half the world market price would imply a cost differential as a percentage of the domestic price of 100%. Romanian critics of the Jaakko Poyry study argue that it overestimates the wood price diffemntial, and that 50% would be a better estimate. The 50% figure is used here, but the estimates of the costs and transfers would be even larger than those calculated if the actual price differential is larger. es.es F 1 0 to 5 Assumed elasticities of supply 116 RomANIA: RsnucTuRYNG TO, FACE T14F WOPTn'Pf-n',Jn1kFv Table 4A.2 Estimated impact of Romanian wood export controls (millions of lei) Short run Long run of=0;A = 1 e l= 1; 1e=0.5;e=5 Loss to wood industries 8,480 10,599 9,539 (area adge) Efficiency loss in wood industries 0 2,120 1,060 industry (area cdg) Transfer to export license 115 115 115 recipients (area bcgf) Gain to furniture industry 2,306 2,306 1.516 (area hik) Efficiency loss in furniture industry 198 198 988 (area Uk) - Decline in wood exports 1.186 13,905 12,291 Increase in furniture exports 3.294 3,294 16,475 Change in total exports 2,108 -10,610 4,184 TRADE AND INDUSTRIAL PoLicY 117 Notes 1. GATT Trade Policy Review Mechanism: Romania, Draft Report C/RM/G/32 (16 November 1992) p. 73. 2. See Chapter 2 above and GATT. Trade Policy Review Mechanism: Romania, C/RM/G/32, p. 24 and Annex 6. 3. In 1989, private sector participation accounted for 6% of industrial production, 2% of construction and 22% of retail trade. (Rumanian Development Agency, 'Privatization in Romania") 4. In July 1993 it was reported that partly in response to World Bank insistence the future of the RAs was under review, with a view to reducing their number and scope dramatically. The review will consider the possibility of hiving off many of the 'internal service' and subsidiary operations undertaken by most nationalized industries as well as of commercializing entirely the RAs covering, for example, mineral water bottling, government catering and regional airports. 5. Only five of these assets (one shop, one food store, and three hotels) had been sold to foreign investors. 6. Two enterprises were privatized with participation by foreign investors. VRANCO (a clothing factory) was privatized through a sale of 51% to an Italian company and the remainder to the employees and managers of the company, with the employee and management purchase financed by the Italian company through loans in lei. URSUS-CLUJ (a brewery) was privatized through a public offering of 51% of the shares, with the remainder sold to Brough & Brunin, a German company. Three enterprises (IPCT, a design institute for machinery; ARTAGRAFICA, a printing company; and INDUSTRIA CARNII, a meat processor) were privatized through employee/management buyouts. 7. The Private Ownership Funds are located in five different towns. Each private fund receives 30 percent of the shares in most companies located in the surrounding judets, except for companies in the sectors allocated to specific Private Ownership Funds. For example, the private fund located in Bucharest receives all shares of commercial companies in and around Bucharest, except those in certain sectors designated as the sectors specific to other private funds (such as, fishing, naval transport, textiles, leather, nonferrous metallurgy, and electronics). But the Bucharest Private Ownership Fund receives all the POP shares of all commercial companies in building materials, glass manufacturing, and cosmetics and medicines, regardless of where they are located in the country. There is some danger that allocation of all of the shares of all CCs in a particular sector to one POF may lead to excessive concentration of ownership and maintenance of monopoly positions. 8. A MIND Document prepared for the G-24 in February 1993 sets out later intentions for restructuring. It stresses the role of foreign capital and recognizes the need for closing inefficient plant. It does not specify the mechanisms for achieving the latter, however, and in policy terms lays more emphasis on the stimulation and support of particular sectors. It is not yet clear that MIND have formulated a realistic assessment of the degree of adjustment required. While the new document suggests the existence of a greater depth of information than existed during the missions's visit, it regrettably does not convey the impression that the hard decisions have yet been confronted. 9. Suppose that the processing industry uses a inputs to produce one unit of output Then each "package' of a inputs would be a 'unit* of inputs. For example, if 2 square meters of plywood were used to produce a piece of furniture, then a 2 square meter piece of plywood would be one "unit" of input. If the price of asquare meter of plywood were $1.00, then the price of a 'unit' of input would $2.00. 10. Order No. 120 of 31 July 1992 prohibited the export of logs, rafters, lumber, railway sleepers, Christmas fir trees, firewood, wood for cellulose, fiberboard, timber, wooden pallets and veneers, and imposed the following quotas: Product Quantity Beech-tree plywood 50,000 m3 Panels 1.300,000 me Beech-tree parquet 500,000 ml Chipboard 800.000 m2 Timber and semifabs 300,000 m2 of resinous woods, beech and softwoods Door and windowframes 1.000,000 M2 118 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY 11. This analysis presumes that the behavior of the processing firm is to attempt to maximize profits. In a transitional economy such as Romania, it is not clear what the objective of firms that are still state owned actually is. As these firms become privatized and thus presumably become responsive to the shareholder's desire for high dividends or growth in share value, firms will presumably shift their objectives to profit maximization. The shift in behavior will also increase efficiency in resource allocation throughout the economy. 12. It is important to note that discouraging exports through an export ta will not give the monopsonistic processor control over the domestic market price. The export tax will lower the input price, but exporters will still be free to export as long as they pay the tax, so price will fall no lower than the world market price minus the tax. The export tax system will also yield revenue for the government, rather than profits in the form of quota rents to exporters who are able to obtain licenses. 13. The marginal cost curve of the input will lie half-way between the supply curve S, and the vertical price axis. See Ferguson and Maurice (1978) pp. 459463 or virtually any other intermediate level microeconomic theory textbook for an explanation of the analysis of monopsony. TRADE AND INDUSTRIAL POLICY 119 References Corden, W. Max (1973). The Theory of Protection. New York: Oxford University Press. Ferguson, C.E. and S.C. Maurice (1978). Economic Analysis: Theory and Application. Homewood, Ill.: Richard D. Irwin. Jaakko-Poyry (1992). Romania-Private Sector Development and Enterprise Reform Project: Study on the Wood-based Industries of Romania. Stockholm (November 6) Jones, Ronald, and Barbara Spencer, 1989. 'Raw Materials, Processing Activities, and Protectionism' Canadian Journal of Economics. 22:469-486. 120 ROMANIA: RESTRUCTURING TO FACE THE WORT n) Prnmnmv Chapter 5 Romanian Industrial Competiveness: A Numerical Exploration Improving the efficiency of production and trade is among the most urgent tasks facing the government of Romania. In an ideal world, market signals would stimulate enterprises to lower costs, improve their product mix, and reorient their foreign trade in accordance with their comparative advantage. While market signals are an essential part of industrial restructuring, several preconditions must be satisfied before market mechanisms function effectively. 0 Domestic prices and international trade should be liberalized so that transaction prices truly reflect world market prices. Tariffs should be either removed altogether or transformed into a simple structure with low and more or less uniform rates across commodity groups. Economic agents must have ready access to foreign exchange, allowing. them to carry out their desired transactions. * In the domestic economy, production in most branches should be reasonably competitive-there should be several firms, entry should be relatively easy for new firms, and there must be effective bankruptcy procedures to force out firms that perform badly. * Production should take place in an environment in which the rules governing business conduct are clearly defined, uniformly applicable, and generally enforced, property rights and private business contracts enjoy legal protection, and information about business performance and conduct is widely disseminated. * Financial mechanisms are necessary to move funds from savers to investors, and investors must be required to demonstrate the profitability of their proposed projects. Financial institutions, therefore, must have the skills associated with project assessment. Investors should not assume that their mistakes will result in some form of financial rescue. * Stable government with a prudent and firm macroeconomic policy is necessary to foster the conditions in which profitable, legitimate business can flourish. While these conditions are not fully satisfied anywhere in the world, they remain a distant goal in much of Eastern Europe. Although significant liberalization has occurred, many distorting taxes and subsidies remain, as do many situations of near monopoly. The continued lack of financial discipline associated with weak financial institutions and weak governments has not forced firms to act as if they face hard budget constraints (see Kornai, 1980, 1992). Left to themselves market forces cannot he expected to generate the most direct route to long-term efficiency. For the various reasons outlined in this report it is evident that Romania does not yet satisfy the RoMANLAN INDuSTRIAL CoMPETmrVENEss: A NuMEICAL EXPLORATIOR 121 conditions guaranteeing optimal outcomes from market processes. It is equally plain, however, that with hugely depressed output, high unemployment, and a balance of trade deficit, Romania must embark on a process of industrial restructuring as soon as possible. No clear alternative to market signals exists, but it seems worthwhile to explore whether there is another means of evaluating the profitability/viability of firms and industries. Moreover, given the probable importance of stimulating exports and the obvious advantage of building an industrial structure on the notion of comparative advantage, it is desirable that any such measure stress the issue of international competitiveness. This chapter explains a number of possible measures, based on previous papers by Hughes and Hare and their collaborators (see Hughes and Hare, 1991, 1992a, 1992b; Thomas et al, 1992; Senik-Leygonie and Hughes, 1992), and applies them to Romanian data. The results derived here are at best indicative. They are not a guide to which sectors to promote or contract, but rather a tentative prediction of how the market might react when conditions settle down-a benchmark against which to compare detailed industry and enterprise level analyses, and a challenge to special pleading from particular sectors. Statistical analyses can be no better than the data on which they are based, and it takes little experience to know that those used here-while meticulously collected and prepared by the National Commission on Statistics-are subject to many qualifications. Thus we most certainly do not advocate discriminatory industrial policy based on these, or indeed on any other, results. We do believe, however, that formal analysis of the kind presented here is a useful contribution to the debate about industrial restructuring and policy, especially in a context from which major interest groups might try to tilt the political arguments in their own favor. Methodology and data Methodology The real opportunity costs of producing the different tradeable goods and services in Romania are indicated by the world market prices to which the country is exposed. Romania is a small country in world market terms and must therefore, for all practical purposes, behave as a price taker in its international transactions. Even though the world market itself is distorted in various ways, Romania has no choice but to adapt itself to these distortions since it is powerless to change them. Therefore, production and trade should be organized to maximize the value of the country's GDP evaluated at the prevailing world market prices. Starting from this simple idea, it follows that the economic value of a given branch or enterprise should be based on an estimate of its value added measured in world market prices. It is then interesting to compare that value added with the domestic resources of labor and capital used to generate the output concerned. This gives rise to the well known domestic resource cost (DRC) measure, defined as follows: DRC, = (Value added in domestic prices), I (Value added in world market prices), This indicator attempts to measure, for each branch, the cost in domestic labor and capital of earning a unit of foreign exchange. Aside from a caveat about domestic value added noted below, low values of DRC correspond with the more competitive branches, and high values correspond 1101~A~YaP~"~~ - . with uncompetitive branches of the economy. The least competitive of all are those branches with negative value added at world market prices. As we shall see, this case arises in several branches of the Romanian economy. Value added is measured as the value of output at domestic producer prices less the value of intermediate inputs used in production at world market prices. For the denominator of the DRC indicator, this is fine, but for the numerator it can prove unsatisfactory if distortions in the domestic price system-a very low domestic price-result in an apparently negative value added at domestic prices. This can occur if there are highly distorting taxes and subsidies in the domestic price system. A more appropriate numerator, therefore, may be the direct value added in the branch concerned, measured as labor costs plus capital costs. An alternative approach is to sidestep this particular difficulty by calculating a somewhat different indicator, or set of indicators, namely measures of social profitability under various conditions. The problem with DRC itself other than the possibility that it may sometimes be ill- defined, is that it is essentially a short-run measure, maximizing GDP in world market prices while treating both capital and labor as fixed factors. But measures of social profit can cope with different circumstances. A short-run measure of social profit can be defined as value added at world market prices per unit of sales at world market prices (SPR'), which is substantially equivalent to the original DRC indicator.' But in addition, by accounting for the shadow costs of labor and capital at world market prices, medium term and long term measures can be defined. Thus if labor is regarded as a variable factor in the sense that it can be shifted between sectors, then a medium term measure of social profit (SPRI) can be defined by subtracting from value added at world market prices the shadow cost of labor, again dividing the result by the value of sales at world market prices. Furthermore, when capital is also treated as a variable factor, we can obtain a long-run measure of social.profit (SPR) by subtracting an estimate of the shadow value of capital costs per unit of sales from the previous estimate of medium term social profit. Naturally, any branch with negative value added at world market prices looks even worse in the medium and longer term. But some sectors that appear viable in the short run earn insufficient surplus to cover the shadow costs of labor and/or the shadow costs of capital. These have to be accounted for in terms of their productivity elsewhere in the economy. Such activities might be kept going for a time, but eventually they must either improve their efficiency enough to earn positive profits, or they must close and release their labor and capital to sectors that can contribute toward positive value added. The technicalities of the calculations and their interpretation are discussed in the appendix to this chapter, along with the details of the data. The three indices of shadow profitability and the DRC indicator provide a clear basis for discussing industrial restructuring. All sectors must be required to generate a positive long-run shadow profit rate on new investment, with immediate attention devoted to value-subtracting sectors, which must either improve their performance or be closed as rapidly as is politically possible. These measures are not predictions that industries will lose money-ultimately industries have to cover their long-run average costs. Rather the measures show what would happen if techniques of production and efficiency are not improved, and thus reflect the pressure that will build up on particular branches as the economy evolves toward world prices. Heavy pressures on less profitable sectors may be met by contraction and/or by technical change, and may or may not be caused by policy, but those issues are essentially beyond this chapter. In short, one might regard the results of this chapter as illustrating the extent to which current practices are untenable. ROMANIAN INDUSTRIAL COMPETTIVENEss: A NUMERICAL EXPLORATION 123 Data .Two kinds of data are required to implement the calculations here-an input-output table and information on world to domestic price ratios for tradeable branches of the economy. The National Commission for Statistics provided a 105-sector, input-output table for 1990, conforming to SNA conventions.' Based on trade data for 1990, seventy-three sectors were classified as tradeable, twenty-eight sectors as non-tradeable, and four showed zero output levels. The pricing data were also obtained from the National Commission for Statistics and consisted of tables of imports and exports to the dollar and ruble areas, which show the effective price in lei of earning a dollar or a ruble of foreign exchange. Dividing the official exchange rate used to compute the input-output table by these ratios then gives the required world-to-domestic price ratios. As far as possible, the dollar export price ratios defined in this way were used as the basis for determining the world to domestic price ratios, but for some branches it was necessary to use dollar import prices. For just one branch, the ruble import price had to be used.' Determining the value of labor and capital for use in calculating the rates of social profitability is a complicated and imprecise matter. The value of labor is based on the cost of producing the average consumption bundle absorbed by all employees, while the value of capital inputs is based on US data for 1977. If Romanian industry is profitable using these capital inputs we may safely presume that it is profitable using its own actual techniques of production. Competitiveness results for Romania Social rates of profit were calculated for Romanian industries based on the theoretical approaches outlined above. These social rates of return were defined for the short run, when they are substantially equivalent to DRCs, for the medium run-which accounts for shadow costs of labor-and in the long run, which considers both labor and estimated capital costs. The results for Romania's tradeable sectors are summarized in tables 5.1, 5.2 and 5.3, with the distributions of short, medium, and long run social rates of profit being shown in figure 5.1. Table 5.1 ranks branches of industry according to their short run, medium run, and long run competitiveness as defined in the previous section, table 5.2 presents actual measures of social profit rates for the seventy-three tradeable branches of Romanian production aggregated into thirty-nine broader ISIC sectors, and table 5.3 gives the full results for individual branches. Although the whole set of results is of interest, most policy attention should be focused those branches in which one or more of the competitiveness indicators turns out to be negative. Since the conceptual underpinnings of the DRC indicator and the social rates of profit are rather similar, it is useful to show how closely they are related. This can be done by presenting a simple table of rank correlation coefficients between the rankings obtained using different measures of competitiveness, including the simplest measure of all which would merely adjust domestic value added using the world market price of output, making no adjustments at all on the input side. The results are shown in Table 5.4. 124 ROMANIA: RESTRUCTURING TO FACE THE WOVY n r'^A' -s Table 5.4 Correlations betiveen different measures of competitiveness (Spearman correlation coefficients) WVA DVA SPRS SPRM SPRL PLUMB WVA 1.00 0.51 0.98 0.94 0.82 0.74 DVA 1.00 0.59 0.38 0.22 -0.06 SPRS 1.00 0.92 0.78 0.66 SPRM 1.00 0.89 0.78 SPRL 1.00 0.75 PLAMB 1.00 Note: WVA is value added in world market prices; DVA is value added in domestic prices; SPRx is the social profit rate for period x (x- S, M or L), and PLAMB is the world to domestic price ratio. To investigate a particular issue of concern to Romanian policymakers, the entire series of calculations was repeated on the assumption that energy input coefficients in the input-output table for 1990 were uniformly reduced by 25 percent, implying that any sector using any kind of energy input would be able to save a quarter of its energy input relatively easily. (The sectors whose intermediate use was reduced in this way were the following: coal mining, refinery processing, other fuels, electric power, gas power, and thermal power and hot water.) The reason for estimating social rates of return under these conditions was to determine whether such energy savings substantially changed the relative profitability ranking of sectors in the Romanian economy or merely improved the profitability of everything with little or no effect on the rankings. The principal results of the energy saving variant of the calculations are presented in Appendix tables 5A. 1 and 5A.2, and are illustrated in figure 5.2. The energy saving variant does cause a shift in the distribution of profitability toward higher rates, though the shift is most noticeable for the short-run profit rates. (figures 5.1 and 5.2). The rankings are not greatly changed by the possibility of energy savings, with food processing branches remaining among the least competitive (lowest rank), and agriculture, parts of engineering, chemicals and electronics being among the best (highest rank) (tables 5.1 and SA.1). Indeed, for the short run indicator (SPR'), the correlation coefficient between the rankings obtained using the original data and in the energy saving calculation exceeds 0.95. A comparison of tables 5.2 and 5A.2, reveals that in the short-run analysis, two sectors' have negative value added (negative SPR') in each calculation. Looking at the medium-run results that account for shadow wage costs (SPRm), the least profitable sectors on the basis of the original data (table 5.2) are: coal mining, meat and fish products, canning, edible oils, milling and flour products, textiles, furniture production, ceramic products, glass products, cement, concrete products, and nonferrous metals. This list raises concern because several of the products are among Romania's important exports, an implication that productivity must be improved quickly if these exports are to be efficient. The same list of unprofitable sectors appears in the energy-saving calculation, though of course the actual levels of loss are lower. Te strongest sectors of the Romanian economy can be identified by looking at sectors that, even in the long run, appear capable of earning positive profits at world market prices (positive SPRL). Using either set of data, these sectors are: agriculture (crops), extraction, tobacco, fur and fur ROMANIAN INDUSTRIAL CoMPETvIVENEss: A NUMERICAL ExPLoRATION 125 products, footwear and leather goods, wood working, publishing and printing, part of chemicals, coke, synthetic rubber, clay brick and stone, machinery, vehicles, medical instruments, and other industry. It appears that substantial parts of Romanian industry are already potentially profitable, and it is to be expected that their export potential will be exploited. Apart from the specific issue of energy saving, the study of other forms of resource saving was also of interest. In particular, in view of the poor performance of the food industry, it was useful to investigate the effect of reducing the inputs from agriculture into the food industry. Accordingly, competitiveness indicators were estimated on the assumption that these inputs would be reduced by 25 percent. In the input-output table, this means that inputs from rows one and two of the input- output table (crop production and livestock production) columns eighteen to twenty-seven (meat and meat products, fish and fish products, tinned vegetables and fruit, edible oils, dairy products, milling and flour products, prepared animal feedstuffs, other food products, beverages, and tobacco) are reduced in this proportion. A similar exercise considered the effects on competitiveness of economizing the use of certain basic materials. The chosen materials were all products of the extraction sector except for other than the energy products mentioning above. The relevant materials occupy branches eleven to seventeen of the 1990 input-output table; they are: ferrous extraction, nonferrous extraction, mining of building materials ores, sand and clay quarrying, extraction for the chemicals industry, extraction and preparation of salt, and other nonmetallic extraction. Input coefficients corresponding with the use of these materials in all sectors of the Romanian economy were reduced by 25 percent, and revised competitiveness indicators calculated. Neither exercise induced significant change-the correlation coefficients between the new and the original rankings shown in table 5.1 exceeded 0.95. The fundamental point is that, on the basis of the analysis reported in this section, substantial parts of Romanian industry require restructuring if they are to operate successfully in competitive world markets. Although some sectors are already highly profitable at world market prices, many are not, and they will only be able to survive with new investment, modernization and reorganization. It is unlikely that Romania can muster the resources to restructure every sector and doubtful that the government can keep loss-makers in business indefinitely through the provision of subsidies. Given this, it is of interest to investigate whether the changes that have taken place in Romanian industry in the last two to three years reflect these findings about competitiveness. To this end we compare the changes in output shares by industry based on table 4.4 and in exports over the same period with those predicted by the profitability calculations here. Both sets of data required some reclassification, but they seem to suggest some modest gains in competitiveness. There is a small, positive correlation between the estimated competitiveness indicators and the observed changes in output and trade, but the structural change so far is quite small. Comparison with other countries in Eastern Europe The competitiveness results for Romania obtained in the previous section do not conflict with the findings of Hughes and Hare (1992b) for other countries of central and eastern Europe. These findings are summarized in tables 5.5a, 5.5b, and 5.5c, which show short-run, medium-run, and long-run social profit rates for broadly defined ISIC sectors in Bulgaria, Czechoslovakia, Hungary, and Poland. These are contrasted with Romania in the last column of each table. Like Romania, the other countries have weak food processing sectors. While doubtless a reflection of real inefficiencies in the food processing sector, the poor performance is also partly a I ~~~6 ROMANJTA' P- In CAr., r ", reflection of the transportation and distribution problem. Although the main input into food processing is the output of the agricultural sector, it appears that in eastern Europe transportation of food from the farms and distribution to food processors are included in the input-output food processing sector. Statistics from several countries show that this transport and distribution system accounts for large losses and waste of food-a result of inefficiently long hauls, poor refrigeration facilities, poor storage facilities, the ravages of pests, and to some extent theft. In the input-output tables, this appears as large coefficients of the input flows from agriculture to different branches of the food industry. A further complication is that agriculture is not particularly disaggregated: in most countries it is a single sector. In Romania it is broken into only two categories-grains and other plant products and livestock products. Even with this disaggregation, several branches of the food industry are treated as if they received identical inputs from agriculture, associated with identical prices. In practice this is not, of course, correct, and a better treatment should decompose agriculture into several subsectors, while also separating out the distribution activities already discussed. Aside from this common feature of poor food processing performance, all the countries, Romania included, have reasonably complementary industrial structures: each country has sectors in which it has a competitive advantage. This bodes well for integration into the European economy and for the eventual reestablishment of regional trade. Such trade must be allowed to grow naturally, without either unnatural barriers or unnatural stimulation or planning. Policy implications of the analysis This analysis has several implications for Romania's policy toward industry and trade. First, since the calculations were based on 1990 data and a static model, one should not conclude that loss-making sectors identified in the calculations should close immediately. These sectors do require urgent attention from policymakers, since it is neither feasible nor desirable to subsidize them for long and since the government undoubtedly has bettei uses for its resources. The reported results can be used to indicate how far particular sectors have to improve, in terms of cost reductions, in order to remain competitive. Indirectly the results inform the decision on whether temporary support is warranted. Even in a model with 105 sectors, however, many sectors contain subsectors or branches with different technologies and probably different competitive positions. For instance, nonferrous metals appear uncompetitive, but this sector includes both copper and aluminum-two categories whose technologies and prospects are widely different. It would obviously be unwise to make firm decisions about restructuring without carefully looking at such subsectors. By the same token, it will often be necessary to examine the competitiveness of individual firms-including their managerial skills-rather than simply assuming that results at broad sectoral level apply to all the firms in the given sector. Second, one of the least competitive sectors, food processing, is clearly not going to be closed. To become more competitive it must be modernized and restructured as quickly as possible. Given the apparently huge divergences between efficiency in Romania and Western Europe in this sector, parts of the food processing sector may prove attractive targets for foreign investment, as has happened elsewhere in the region. ROMANIAN INDUSTRIAL COmPETmVENESS: A NUMERICAL EXPLORATION 127 Third, the modest but realistic energy savings allowed for in the second calculation reported above did not greatly affect the main findings about competitiveness. The proposed saving may simply have been insufficient, since Romania apparently uses two to three times as much energy per unit of GDP as many OECD countries. So in principle there is scope for improvement in energy that was not captured in this examination and that may change the rankings of sectors. Such improvements are unlikely to be achievable, however, without very large scale and prolonged investment. Therefore, it would be naive to believe that simple improvement in energy efficiency will save ailing sectors. Fourth, the Romanian results confirm a conclusion reached in Hughes and Hare (1992a)-that the central and eastern European countries would gain from finding ways of trading efficiently within the region. At present, each country tends to seek trade agreements with western partners, but this in itself does little to ensure that trade within the region is conducted according to GATT principles. This finding should not be interpreted as support for preferential and managed trade relations in Eastern Europe. Finally, despite its obvious crudity, the competitiveness analysis presented in this chapter can play a useful role in identifying problem sectors. But to be useful some agency or institution must adopt it as its game plan. The natural body would be the State Ownership fund and/or the Private Ownership funds, since they will actually implement much of the restructuring that occurs, but as indicated in chapter 4, they appear reluctant to take on this responsibility. While the Ministry of Industry has the capacity to provide useful technical advice on restructuring, it is not clear that it should assume the leading role. The analysis of competitiveness could also be made available to banks and other financial institutions as their investment appraisal skills develop. But wherever it might be used, it can only make a difference to Romania's competitiveness in the context of a sound economic policy and clear institutional responsibilities. Summary and conclusions This chapter has set out and implemented a methodology for illustrating the potential profitability of Romanian industries at world market prices. The analysis was carried out using 1990 data for a 105-sector decomposition of economic activity. Results were obtained for four cases, but the precise ranking of branches according to their profitability did not vary dramatically by case. In all cases, several branches turned out to be highly profitable, while others made very large losses. The unprofitable sectors call for very urgent attention from policymakers. In terms of the Romanian institutional setting, it probably makes most sense for analysis of the sort discussed here to be located in the agencies with most immediate responsibility for implementing restructuring, namely the State Ownership funds and the Private Ownership funds, drawing on the expertise of Ministry of Industry and other agencies for technical support. But as indicated in the previous chapter, it is very important that the lines of responsibility for industrial policy in Romania be clarified, since there are several agencies that could play a role. But most of them appear to insist that the principal responsibility resides elsewhere. 128 ROMANIA: RESTRUCTURING TO FACE THE WORLD Frnvwv It is important to stress to whoever uses the analysis that the results obtained here should not be used without qualification. There are several ways in which they might require modification and refinement: * Update the basic input-output data * Improve the estimates of world-to-domestic price ratios * Extend the analysis to subsectoral and enterprise level * Adapt the analysis to account for finer details of trade policy Any analysis of this kind must be supplemented by additional considerations, such as managerial skill, careful market research, the development of appropriate products, etc. The analysis is only a poor substitute for market signals. Liberalization, competition, macroeconomic stability, financial structures, and sound institutional structures will allow the market to stimulate and determine the nature of industrial restructuring with only a gentle nudge from policymakers. ROMANIA 1NDUSTRITTAL C_OMPTITIVFwS A NUMErRIAL EYPILATION 170 Table 5.1. Industrial competitiveness analysis: Romania, original data ranking of sectors by social profit rates Social groft rare ranking OBS Sector ISIC Sector Name Short Medium Long term term term I 1 110 Plantgrowing 64 60 38 2 2 110 Livestock Breeding 60 67 72 3 4 120 Forestry 68 55 27 4 7 210 Coal Mining and Preparation 30 19 12 5 8 220 Extraction of Crude Petroleum 66 62 28 6 9 220 Natural Gas-Extraction Industry 73 73 57 7 11 290 Ferrous Extraction 29 40 37 8 12 290 Non-Ferrous Extraction 50 35 31 9 13 290 Mining of Building Materials Ores 69 68 69 10 14 290 Sand and Clay Quarrying 72 70 70 11 15 290 Extraction for the Chemicals Industry 49 30 19 12 16 290 Extraction and Preparation of Salt 71 71 67 13 17 290 Other Non-Metallic Extraction 70 66 61 14 18 301 Meat and Other Meat Products 2 3 6 15 19 301 Fish and Fish Products 4 2 2 16 22 301 Dairy Products 1 1 1 17 20 302 Tinned Vegetables and Fruit 10 6 10 18 21 303 Edible Oils 9 21 21 19 23 304 Milling and Flour Products 20 15 17 20 24 306 Prepared Animal Feedstuffs 19 22 22 21 25 306 Manufacture of Other Food Products 39 42 45 22 26 313 Beverages. Alcoholic and Other 22 33 35 23 27 314 Tobacco Industry 62 69 73 24 28 321 Textiles 25 17 23 25 29 322 Clothing 36 27 32 26 30 323 Fur and Fur Products 41 41 48 27 31 324 Footwear and Leather Goods 46 41 48 28 5 331 Forestry Operation and Wood Working 67 64 42 29 32 331 Wood Working 54 54 56 30 77 332 Furniture Production 15 8 9 31 33 341 Paper and Paper Products 24 32 29 32 34 342 Publishing and Printing 63 65 64 33 38 351 Basic Chemicals . 5 11 7 34 39 351 Fertilizers and Pesticides 42 50 54 35 40 351 Paints. Varnishes, Etc. 13 24 25 36 44 351. Synthetic Fibres and Yarns 12 14 18 37 41 352 Pharmaceuticals 6 5. 3 38 42 352 Soap. Detergent and Cosmetics Products 65 72 71 39 43 352 Other Chemical Products 38 46 47 40 36 353 Refinery Processing 11 26 30 41 35 354 Manufacture of Coke 45 53 60 42 45 355 Synthetic Rubber Products 34 44 50 43 46 356 Plastic Products 32 37 36 44 48 361 Ceramic Products Production 23 23 20 45 47 362 Glass and Glass Products 31 20 13 46 51 363 Fabrication of Cement. Lime 14 10 4 47 49 364 Clay Products 16 7 5 48 50 364 Bricks and Other Construction Materials 40 38 33 49 53 364 Cutting. Shaping and Finishing of Stone 61 58 62 50 52 369 Concrete Components, Etc. 17 9 8 51 54 369 Other Mineral Non-Metallic Products 43 49 SI 52 55 371 Ferrous Metal Products 8 13 15 53 56 371 Pipes 44 SI 55 54 57 371 Other Metallurgical Products 7 12 14 55 59 371 Iron Casting, Steel Foundry 21 18 24 56 58 372 Non-Ferrous Metals Production 3 4 11 57 60 381 Steel Construction Equipment 33 29 39 58 61 382 Engines and Turbines 58 61 66 Table 5.1 (continued) Social profit rate ranking OBS Sector ISIC Sector Name Short Medium Long term term term 59 62 382 General Purpose Machinery 53 52 53 60 63 382 Agricultural Equipment 47 47 52 61 64 382 Fabrication of Machine Tools 48 43 44 62 65 382 Other Special Purpose Machinery 37 36 41 63 67 382 Household Machinery and Equipment 27 25 26 64 68 383. Computing and Office Equipment 59 63 68 65 69 383 Electrical Machinery and Equipment 18 16 16 66 70 383 Radio, TV and Communications Equipment 35 34 40 67 72 384 Motor Vehicles 26 28 34 68 73 384 Shipbuilding and Repairs 55 57 65 69 74 384 Locomotives and Rolling Stock 28 31 43 70 75 384 Aircraft Construction and Repair 52 48 59 71 76 384 Motorcycles and Bicycles Production 56 56 58 72 71 385 Medical Instruments. Clocks Production 51 45 49 73 78 390 Other Branches of Industry 57 59 63 Source: Author's calculations a) Sector number is the number in the Romanian 105 sector input-output table for 1989; sectors are ordered by their ISIC category, and in order of sector number within any category. b) Low numbers indicate poor performance, high numbers are relatively favourable values of the profitability indicators. ROMANIAN INDUSTRIAL COMPETITIVENEss: A NUMERICAL EXPLORATION 131 Table 5.2. Average values by ISIC industry weighted by domestic output (original data) Social profit rates Sector Name ISIC FREQ World Domestic PLAMBb Long Medium Short Value Value Term Term Term Added Added 73 0.417 0.394 1.108 0.008 0.207 0.376 Agriculture 110 2 0.930 0.673 1.318 0.275 0.547 0.705 Forestry 120 1 0.740 0.789 0.971 -0.159 0.383 0.762 Coal Mining 210 1 0.371 0.175 1.308 -0.383 -0.073 0.283 Oil and natural gas 220 2 0.739 0.811 0.959 -0.049 0.614 0.770 Other extraction 290 7 1.204 0.283 2.075 0.169 0.389 0.580 Meat, fish and dairy products 301 3 -0.328 0.188 0.941 -0.580 -0.429 -0.348 Canned foodstuffs 302 1 0.028 0.194 0.850 -0.435 -0.258 0.033 Edible oils 303 1 0.021 0.178 0.865 -0.222 -0.065 0.024 Milling and flour products 304 1 0.152 0.245 0.914 -0.271 -0.098 0.166 Other food products 306 2 0.298 0.307 0.992 -0.077 0.094 0.300 Beverages 313 1 0.158 0.382 0.764 -0.048 0.104 0.206 Tobacco 314 1 1.063 0.668 1.496 0.510 0.653 0.711 Textiles 321 1 0.156 0.432 0.651 -0.214 -0.095 0.240 Clothing 322 1 0.237 0.431 0.643 -0.071 0.056 0.369 Fur and fur products 323 1 0.385 0.408 0.958 0.053 0.173 0.402 Footwear and leather goods 324 1 0.401 0.415 0.952 0.068 0.187 0.421 Timber products 331 2 1.107 0.512 1.830 0.125 0.395 0.605 Furniture 332 1 0.085 0.416 0.818 -0.442 -0.231 0.104 Paper and paper products 341 1 0.278 0.299 1.170 -0.096 0.101 0.237 Publishing and printing 342 1 1.435 0.508 1.974 0.319 0.565 0.727 Basic chemicals 351 4 0.106 0.137 1.063 -0.217 0.002 0.100 Pharnaceuticals and household 352 3 0.594 0.339 1.283 0.152 0.366 0.463 chenicals Oil refining 353 1 0.043 -0.025 1.079 -0.091 0.024 0.040 Coke 354 1 0.739 0.126 1.773 0.249 0.343 0.417 Synthetic rubber products 355 1 0.379 0.291 1.089 0.075 0.213 0.348 Plastic products 356 1 0.287 0.352 0.904 -0.043 0.150 0.318 Ceramic products 361 1 0.174 0.408 0.836 -0.265 -0.047 0.209 Glass and glass products 362 1 0.291 0.449 0.915 -0.326 -0.065 0.318 Cement 363 1 0.077 0.314 0.899 -0.503 -0.173 0.085 Clay products, bricks and stone 364 3 1.034 0.519 1.706 0.151 0.358 0.606 Other non-metallic mineral 369 2 0.147 0.367 0.850 -0.368 -0.125 0.172 products Ferrous metallic products 371 4 0.294 0.220 1.252 -0.063 0.102 0.235 Non-ferrous metal products 372 1 -0.305 0.040 1.206 -0.412 -0.300 -0.253 Steel sections and girders 381 1 0.329 0.400 1.022 -0.031 0.080 0.322 Machinery 382 6 0.551 0.418 1.202 0.101 0.264 0.459 Electrical equipment 383 3 0.247 0.425 0.843 -0.093 0.070 0.293 Vehicles 384 5 0.448 0.310 1.189 0.085 0.199 0.376 Instruments, clocks, etc. 385 1 0.516 0.491 1.062 0.073 0.22 0.486 Other industry 390 1 0.929 0.525 1.434 0.282 0.463 0.648 a) FREQ denotes the number of 1-0 sectors in the given ISIC category. b) PLAMB is the average world to domestic price ratio for the given ISIC category. Table S.3. Average values by ISIC industry weighted by domestic output (original data) Social profit rates Sector ISIC Sector Name Output World Domestc Long Medium Short (millions Value Value Term Term Term of lei) Added Added 1 110 Plantgrowing 140877 0.738 0.773 -0.035 0.474 0.727 2 110 Livestock Breeding 122735 1.149 0.559 0.491 0.599 0.690 4 120 Forestry 4744 0.740 0.789 -0.159 0.383 0.762 7 210 Coal Mining and Preparation 10311 0.371 0.175 -0.383 -0.073 0.283 8 220 Extraction of Crude Petroleum 20110 0.719 0.774 -0.153 0.525 0.736 9 220 Natural Gas-Extraction Industry 10219 0.776 0.883 0.165 0.800 0.840 11 290 Ferrous Extraction 5705 0.424 0.098 -0.039 0.175 0.277 12 290 Non-Ferrous Extraction 4415 1.095 0.038 -0.083 0.134 0.469 13 290 Mining of Building Materials Ores 6878 1.788 0.517 0.407 0.617 0.766 14 290 Sand and Clay Quarrying 668 2.191 0.550 0.462 0.660 0.812 15 290 Extraction for the Chemicals Industry 469 0.535 0.472 -0.266 0.089 0.468 16 290 Extraction and Preparation of Salt 267 2.659 0.442 0.386 0.695 0.810 17 290 Other Non-Metallic Extraction 668 1.466 0.621 0.252 0.578 0.777 18 301 Meat and Meat Products 78421 -0.281 0.195 -0.491 -0.345 -0.282 19 301 Fish and Fish Products 2092 -0.215 -0.038 -0.845 -0.592 -0.211 22 301 Dairy Products 16176 -0.567 0.184 -1.178 -1.018 -0.863 20 302 Tinned Vegetables and Fruit 11624 0.028 0.194 -0.435 -0.258 0.033. 21 303 Edible Oils 6298 0.021 0.178 -0.222 -0.065 0.024 23 304 Milling and Flour Products 2331 0.152 0.245 -0.271 -0.098 0.166 24 306 Prepared Animal Feedstuffs 21758 0.159 0.185 -0.220 -0.056 0.163 25 306 Manufacture of Other Food Products 32774 0.390 0.387 0.015 0.191 0.389 26 313 Beverages, Alcohol and Other 38359 0.158 0.382 -0.048 0.104 0.206 27 314 Tobacco Industry 13859 1.063 0.668 0.510 0.653 0.711 28 321 Textiles 79260 0.156 0.432 -0.214 -0.095 0.240 29 322 Clothing 36447 0.237 0.431 -0.071 0.056 0.369 30 323 Fur and Fur Products 3660 0.385 0.408 0.053 0.173 0.402 31 324 Footwear and Leather Goods 20042 0.401 0.415 0.068 0.187 0.421 5 331 Forestry Operation and Wood Working 4026 1.638 0.540 -0.001 0.528 0.750 32 331 Wood Working 16959 0.981 0.505 0.163 0.356 0.562 77 332 Furniture Production 20868 0.085 0.416 -0.442 -0.231 0.104 33 341 Paper and Paper Products 13523 0.278 0.299 -0.096 0.101 0.237 34 342 Publishing and Printing 6991 1.435 0.508 0.319 0.565 0.727 38 351 Basic Chemicals 21990 -0.102 0.101 -0.480 -0.163 -0.113 39 351 Fertilizers and Pesticides 8438 0.717 0.115 0.158 0.297 0.402 40 351 Paints, Varnishes, Etc. 6507 0.064 0.273 -0.205 -0.016 0.080 44 351 Synthetic Fibres and Yarns 9685 0.074 0.144 -0.269 -0.111 -0.075 41 352 Pharmaceuticals 6192 -0.041 0.280 -0.571 -0.275 -0.061 42 352 Soap, Detergent and Cosmetics Products 5533 1.812 0.418 0.488 0.697 0.731 43 352 Other Chemical Products 15258 0.409 0.335 - 0.056 0.255 0.373 36 353 Refinery Processing 71428 0.043 -0.025 -0.091 0.024 0.040 35 354 Manufacture of Coke 8728 0.739 0.126 0.249 0.343 0.417 45 355 Synthetic Rubber Products 10540 0.379 0.291 0.075 0.213 0.348 46 356 Plastic Products 26744 0.287 0.352 -0.043 0.150 0.318 48 361 Ceramic Products Production 2309 0.174 0.408 -0.265 -0.047 0.209 47 362 Glass and Glass Products 6546 0.291 0.449 -0.326 -0.065 0.318 S1 363 Fabrication of Cement, Lime 7047 0.077 0.314 -0.503 -0.173 0.085 49 364 Clay Products 426 0.099 0.526 -0.495 -0.247 0.105 50 364 Bricks and Other Construction Materials 589 0.443 0.428 -0.060 0.171 0.397 53 364 Cutting. Shaping and Finishing of Stone 1783 1.452 0.548 0.258 0.457 0.697 52 369 Concrete Components, Etc. 26192 0.103 0.372 -0.453 -0.202- 0.129 54 369 Other Mineral Non-Metallic Products 2967 0.527 0.328 0.095 0.294 0.407 ROMANIAN INDUSTRIAL COMPETITIVENESS: A NUMERICAL EXPLORATION 133 Social profit rates Sector ISIC Sector Name Output World Domestic Long Medium Short (millons Value Value Term Term Term of let) Added Added 55 371 Ferrous Metal Products 19902 0.016 0.181 -0.298 -0.118 0.014 56 371 Pipes 28862 0.641 0.218 0.159 0.325 0.415 57 371 Other Metallurgical Products 6821 -0.007 -0.019 -0.309 -0.118 -0.006 59 371 Iron Casting, Steel Foundry 18488 0.163 0.352 -0.213 -0.082 0.170 58 372 Non-Ferrous Metals Production 22199 -0.305 0.040 -0.412 -0.300 -0.253 60 381 Steel Construction Equipment 51729 0.329 0.400 -0.031 0.080 0.322 61 382 Engines and Turbines 1.130 0.453 0.345 0.516 0.651 62 382 General Purpose Machinery 28901 0.701 0.455 0.153 0.334 0.532 63 382 Agricultural Equipment 21089 0.566 0.354 0.142 0.275 0.431 64 382 Fabrication of Machine-Tools 11467 0.457 0.455 0.015 0.200 0.447 65 382 Other Special Purpose Machinery 52531 0.387 0.416 -0.002 0.149 0.371 67 382 Household Machinery and Equipment 5922 0.228 0.347 -0.181 0.019 0.252 68 383 Computing and Office Equipment 4878 0.923 0.613 0.390 0.527 0.680 69 383 Electrical Machinery and Equipment 26474 0.118 0.365 -0.277 -0.096 0.143 70 383 Radio, TV and Communications 17897 0.254 0.462 -0.029 0.116 0.348 Equipment 72 384 Motor Vehicles 26576 0.252 0.256 -0.049 0.077 0.245 73 384 Shipbuilding and Repairs 9767 0.917 0.387 0.321 0.405 0.563- 74 384 Locomotives and Rolling Stock 12459 0.293 0.249 0.001 0.095 0.261 75 384 Aircraft Construction and Repair 3682 0.575 0.458 0.192 0.289 0.528 76 384 Motorcycles and Bicycles Production 4314 0.931 0.513 0.190 0.385 0.639 71 385 Medical Instruments, Clocks Production 23739 0.516 0.491 0.073 0.225 0.486 78 390 Other Branches of Industry 9485 0.929 0.525 0.282 0.463 0.648 a) FREQ denotes the number of 1-0 sectors in the given ISIC category. b) Output data is at domestic prices in millions of lei. in 1990. lid ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Table 5.5a. Social profitability by industry and country, short run. Industry Bulgaria CSFR Hungary Poland Rumania All traded sectors 21.7 21.7 23.4 41.6 14.8 Agriculture 110 39.8 19.4 44.3 33.8 58.5 Forestry 120 69.3 -349.3 67.3 62.2 Coal mining 210 54.0 63.6 61.8 71.6 19.9 Oil and gas production 220 94.5 18.6 54.0 36.6 -1.7 Other mining 290 36.9 48.0 24.9 33.6 Food processing 300 6.8 -19.9 1.2 -0.3 -55.7 Drink and tobacco 310 17.3 -16.5 11.2 76.4 -29.1 Textiles, footwear 320 14.8 17.3 28.9 47.5 7.2 Wood products 330 39.6 19.9 22.0 43.3 31.8 Paper and products 340 14.7 24.4 24.2 52.0 10.1 Chemicals 350 23.7 -9.1 4.3 32.8 9.9 Non-metal mineral products 360 9.2 26.5 31.9 38.9 -0.8 Metallurgy 370 24.1 24.6 -1.9 19.2 16.9 Engineering 380 18.3 28.8 32.4 46.6 15.3 Other manufacturing 390 8.7 38.0 45.0 51.6 -21.1 Percent of total outpu from traded sectors valued at world prices Sectors with social profit rates < 0% 8.2 11.1 16.9 2.7 31.0 Sectors with social profit rates > 50% 14.9 17.9 13.2 48.3 5.9 Social profi rates (percent) for quartiles of total output valued at world prices Lower quartile 11.2 18.6 22.0 31.0 Median 22.1 25.9 36.5 47.9 Upper quartile 35.9 38.7 44.3 67.4 Wage bil of sectors with social profit rates < 0 in Ohe total wage bill of: All traded sectors 8.0 6.1 10.0 2.6 All sectors 5.4 4.1 6.6 1.5 ROMANIAN INDUSTRIAL COMPETITIVENESS: A NUMERICAL EXPLORATION 135 Table 5.5b. Social profitability by industry and country, medium run. Industry Bulgaria CSFR Hungary Poland All traded sectors 8.7 10.9 6.5 28.6 Agriculture 110 -2.5 -10.4 19.3 26.6 Forestry 120 41.3 -373.3 42.0 Coal mining 210 37.9 56.6 40.7 50.3 Oil and gas production 220 90.6 13.8 47.7 31.6 Other mining 290 19.3 35.6 -17.1 Food processing 300 -1.3 -26.6 -8.9 -14.7 Drink and tobacco 310 9.1 -27.6 -0.9 73.4 Textiles, footwear 320 -1.0 2.5 10.8 29.5 Wood products 330 25.2 7.4 -0.0 25.7 Paper and products 340 6.6 13.6 12.5 37.2 Chemicals 350 19.6 -13.1 -2.9 21.8 Non-metal mineral products 360 -6.9 14.6 15.2 21.4 Metallurgy 370 18.6 20.0 -12.8 12.0 Engineering 380 8.4 18.8 14.8 30.4 Other manufacturing 390 -10.3 24.3 1.6.5 22.2 Percent of total outpurfrom traded sectors valued at world prices Sectors with social profit rates < 0% 24.2 25.4 20.6 3.5 Sectors with social profit rates > 50% 7.4 16.5 2.4 25.8 Social profit rates (percent) for quariles of total output valued at world prices Lower quartile 2.1 -1.8 8.0 16.9 Median 11.6 20.6 19.3 31.6 Upper quartile 26.1 25.5 19.3 50.3 114 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Table 5.S.c. Social profitability by industry and country, long run. Industry Bulgaria CSFR Hungary Poland All traded sectors -9.1 -8.2 -22.6 6.5 Agriculture 110 -37.2 -59.3 -31.4 -4.6 Forestry 120 -12.5 -430.5 -22.7 Coal mining 210 11.0 31.7 10.5 19.5 Oil and gas production 220 58.7 -19.1 -4.5 17.0 Other mining 290 -4.8 9.0 -52.1 Food processing 300 -18.0 -42.9 -26.5 -36.4 Drink and tobacco 310 -21.6 -48.8 -24.3 55.1 Textiles, footwear 320 -11.7 -8.1 -3.8 14.9 Wood products 330 8.4 -9.2 -21.2 6.5 Paper and products 340 -9.6 -2.9 -4.6 17.0 Chemicals 350 6.3 -27.6 -20.2 -0.7 Non-metal mineral products 360 -27.7 -4.2 -6.0 -2.4 Metallurgy 370 8.6 11.4 -24.1 0.6 Engineering 380 -7.0 2.8 -2.9 11.3 Other manufacturing 390 -28.2 6.9 -6.2 -0.1 Percent of toal ourpu from traded sectors valued at world prices Sectors with social profit rates < 0% 61.1 42.2 72.2 29.8 Sectors with social profit rates > 50% 0.1 8.2 0.0 4.2 Social profit rates (percent) for quardles of total oaput valued at world prices Lower quartile. -23.5 -18.9 -31.4 -3.3 Median . -7.3 3.4 -15.5 10.7 Upper quartile 10.1 14.9 3.6 19.5 Source (for Tables 5.5.a. 5.5.b. and 5.5.c): Calculations reported in Hughes and Hare (1992b). RoMANIAN INDUSTRIAL COMPETITIVENESS: A NUMERICAL EXPLORATION 137 Figure 5.1 Distribution of Social Profit Rates: Romania (original data) Percent of Total Manufacturing Output 50 4 0 ...................... ... ... ... ... ... ... ... ... ... ... ... 0A < -0.25 -0.25-0.0 0.0-025 0.25.-0.5 > 0.5 Domestic Resource Cost E Short Run 0 Medium Run E Long Run Figure 5.2 Distribution of Social Profit Rates: Romania (Energy saving) Percent of Total Manufacturing Output 50 40 ..................-... ........-........-......----..-.---....----. 30 .........-............ ....... .-.---- .-.--..-.- ......--- 20 ......... ....--- --.....-... - -- -- 10 --ij-- - .--- -- -- ---- L -- < -0.25 -025 - 0.0 0.0 - 0.25 0.25 - 0.5 > 0.5 Domestic Resource Cost EShort Run E Medium Run 0 Long Run 138 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Appendix: Competitiveness calculations and data This appendix summarizes the method of estimation of DRC and profitability measures more formally, drawing on Hughes and 'Hare (1991) and (1992b). The calculation of value-added at world prices in an industry producing traded goods is based on the following equation: (5.1) p = ; - X 7r - at - YA T where p is a row vector containing the ratios of value-added at world prices to the domestic output price by sector, X is a row vector containing the ratios of world to domestic prices by sector (for tradeable sectors only, therefore), p is a row vector containing the direct and indirect cost at world prices of traded goods used per unit of output of non-traded items (relative to domestic prices), and - is a row vector of conversion factors applied to imported intermediate inputs. Thus y reflects the fact that the prices and exchange rates used to convert dollar and ruble intermediate imports into domestic prices do not correspond with the world to domestic price ratios embodied in the vector X6. The partitions of the input matrix A are indicated by the superscripts T for traded goods, N for non-traded goods and services and I for imported inputs. Thus the original nxn matrix, A, of intermediate input coefficients is partitioned into the form: (5.2) A7UA Nr Ahw where A*" is an mxm matrix of traded inputs into the production of traded goods, A7 is an mxk matrix of traded inputs into the production of non-traded goods (where m+k=n, of course), and so on. Ar and A' are matrices of import coefficients. In most instances they are simply of dimension 2xm and 2xk respectively, the two rows representing hard currency (dollar) and ruble imports. For non-traded items we obtain: (5.3) AAI IA NN +yA JN Solving for p yields: (5.4) p =A(I - A"r - A m[y - An"-tAN ) y ( Aff + Am[I - ANIl"'AN ) The equivalent ratio of domestic value-added to the domestic output price is denoted by the row vector O which is obtained by setting all of the elements of the vectors X and y to 1 in equation 5.4. This substitution means that we accept domestic prices for tradeables, and make no adjustment to the values of dollar and ruble imports, simply accepting the way in which they were ROMANIAN INDUSTRIAL COMPETITIVENESS: A NuMERICAL EXPLORATION 139 valued in the original input-output tables. The vector of domestic resource costs is then obtained from: (5.5) DRCj = 41.lp, For comparisons across countries it is necessary to express value-added at world prices relative to the world output price which gives: (5.6) *1 P1 / 1 Going beyond the simple, and essentially short-term DRC indicator, the problem of assessing the competitiveness of industries in economies in transition has strong analytical links to the appraisal of investment projects in developing countries. The basic welfare economics is the same, but there are crucial differences arising from the nature of the starting points to which the analysis must be applied. In developing countries it is assumed that the typical decision concerns a new investment on a green field site. At this stage, governments in central and eastern Europe are primarily concerned about whether they should provide support for industries or enterprises that are effectively bankrupt. As the short term merges into the medium and longer term, further decisions about the allocation of factors (initially labor, but later investment resources) must be addressed, so that any approach must try to integrate short and longer run criteria. Three questions then arise in attempting to rank the claims of industries for short term assistance: What is the burden imposed on the economy of supporting bankrupt or loss-making enterprises or industries? How might a fixed quantity of resources for such support best be allocated across industries so as to meet some social objective-for example, minimizing the level of open unemployment? What are the prospects that current loss-makers might improve their performance sufficiently to recoup the support that is provided? As the transition progresses, the answer to the first question changes, reducing the importance of the other two questions. Initially, it is reasonable to act as though the opportunity cost of employing factors in subsidized industries is effectively zero since constraints on labor mobility and the fixity of capital mean that there is only limited scope for reallocating factors between sectors. This assumption becomes decreasingly appropriate as time passes since the industries will be making some investment while labor could be retrained and transferred. The burden of support rises and enterprises failing to improve their performance must be closed. Finally, the stage is reached when all factors may be considered mobile and the analysis becomes identical to project analysis in developing countries. The key to ranking industries in terms of their short-term claims on resources and longer-term competitiveness is the shadow prices that must be applied to inputs of goods, services, and factors?. For traded goods, as we assumed in the above analysis of DRCs, the standard rule that the opportunity cost or value of domestic consumption or production is equal to their border price is appropriate for the economies studied since they are all, in European trade terms, relatively 'small'. Non-traded goods and services may be treated as bundles of traded goods and factors, so that their shadow prices are determined as weighted averages of the shadow prices for traded goods and factors, where the weights are the total direct and indirect -requirements of traded goods and factors per unit of output. These simple points form the basis of the calculation of shadow profit rates (SPRs), which we now explain more formally'. udn ROMANIA: RESTRUCTURING TO FACE THE WORLD EcONOMY In this more general -setting, equations 5.1, 5.3 and 5.4 above need to be replaced as follows. First, the shadow profits for all traded activities may be written as: (5.7) = - XA T - yAr - oBr The factor input matrix, B, is partitioned into inputs into traded and non-traded activities (hence Br, B); the vector a = (aL , aK ) is the vector of shadow prices for labor and capital inputs, respectively. Second, for non-traded items we obtain: (5.8) P LA7m + pN + yAm + oBN Solving for r yields: (5.9) X { I - _ r - _ w[I - ANJ -'A ) - yi Ar + Am[I - A "I-A' B 7 + KI-n AN Note that this specification attributes all intermediate profits in non-traded sectors to the traded sectors which use their output, as did the equivalent equation for DRCs. The corresponding formulae for profits at domestic prices may be obtained by setting all of the conversion factors, i.e. the vectors X, - and a, equal to 1. To make comparisons across industries and between countries it is convenient to calculate shadow profit rates relative to the world market prices of output. This gives, as an extension of (5.4): (5.10) ~1 Three measures of competitiveness and shadow profitability have been calculated; they are designed to reflect the differences in perspective outlined above. A. Short run profit at shadow prices, denoted by SPRs, which is the net value-added at world prices produced by the activity. It is obtained by setting the shadow prices for labor and capital in equation (5.9) equal to zero and it reflects the contribution of the sector to total value-added at world prices on the assumption that the short run opportunity cost of employing factors is effectively zero. Any sector which produces negative value-added at world prices (which corresponds, of course, to a negative DRC indicator, too), so that its SPRs is negative, is clearly uncompetitive on this criterion since national income at world prices could be increased simply by closing down the activity. This does not necessarily mean that countries should immediately close down all such 'value-subtracting" sectors since accepting a temporary loss might be justified if the prospects for improving a sector's performance are good enough. However, the presumption must be that there are better ways of using scarce investment and management resources. ROMANIAN INDUSTRIAL COMPETriVENESS: A NUMERICAL EXPLORATION 141 B. Medium run profit at shadow prices, denoted by SPRI, is based on net value-added at world prices less the shadow cost of any labor employed in the sector. In this case the shadow price of labor is positive, whereas the shadow price of capital is still zero. Immediately after the adoption of a reform program, when unemployment is rising rapidly, it may be reasonable to act on the basis that the opportunity cost of employing labor is effectively zero. However, once the initial contraction of economic activity has stabilized it is no longer appropriate to assume that the opportunity cost of employing workers and paying wages is zero. Labor is heterogeneous, so that - with sufficient information - we should use shadow wage rates which reflect the average marginal product of the workers employed in each sector. Instead, we have estimated the average opportunity cost of employing additional workers over the economy as a whole. Ignoring differences between marginal and average consumption patterns, this implies that the shadow price of labor divided by the wage rate will be equal to the cost at shadow prices of one unit of domestic currency spent on the average consumption basket. On this criterion a sector may be judged to be uncompetitive if it is unable to generate sufficient net value-added at world prices to cover the potential value of employing its labor force in services or similar employment. The implication is that such sectors should contract in order to release labor for employment elsewhere, unless, as above, there is a good prospect of a rapid improvement in their performance. C. Finally, in the longer run we must take account of the shadow cost of the investment that will be required to maintain output. This yields the long run profit rate at shadow prices, SPRL, for which both the shadow prices of labor and capital are positive. The computation of the shadow prices for capital is complicated by the difficulty of measuring the capital stock currently employed for each sector in the countries studied. Instead, we have adopted a forward-looking approach which is described below, when we discuss data issues. Data Two kinds of data are required to implement the calculations referred to above-an input-output table and information on world to domestic price ratios for tradeable branches of the economy. For Romania, we obtained from the National Commission for Statistics in Bucharest a 105 sector input- output table for 1990, conforming to SNA conventions'. Based on trade data for 1990, seventy- three sectors were classified as tradeable, and twenty-eight sectors as non-tradeable. In addition, the input-output table showed zero production levels (and zero intermediate use) for four sectors, namely mining of radioactive ores, other fuels, munitions, and services related to transport. In the case of the mining of radioactive ores and munitions sectors, this omission was presumably for security reasons. For other fuels, it is simply assumed in what follows that relevant inputs and outputs were assigned to the prevailing sector-refinery processing. Services related to transport are assumed to be included in other services (sector 101). The pricing data were also obtained from the National Commission for Statistics. The data consisted of tables of imports and exports to the dollar and ruble area (the two markets, of course, still functioned according to very different 'rules of the game' in 1990), showing the effective price in lei of earning a dollar or a ruble of foreign exchange. Dividing these ratios by the official exchange rate used to compute the input-output table then gives the required world-to-domestic price ratios. As far as possible, the dollar export price ratios defined in this way were used as the basis for determining the world to domestic price ratios, but for some branches it was necessary to use dollar import prices; for just one branch, the ruble import price had to be used. 142 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcONOMY All the input-output and price data refer to 1990 and hence up to this point we have been able to construct a fully balanced and consistent view of that year. In one regard, however, some extrapolation was necessary. In order to obtain the corresponding -y's with which to revalue imported inputs from the dollar and ruble areas, we would have preferred to follow the practice of other studies carried out by Hughes and Hare; see Hughes and Hare (1991). Since the objective of the whole analysis is to assess the competitiveness of Romanian industries in the world market, which means, in effect, the dollar market, what is required is to value imports at whatever they would have cost in the dollar market. Accordingly, for imports already coming from the dollar area, the appropriate value of y could be taken as unity (implying that no revaluation was required), whereas for the ruble imports it was necessary to estimate what these imports would have cost if brought in from the dollar area. By comparing the prices of similar products imported from the dollar and ruble areas, it was possible to arrive at an average value for the - to be applied to ruble imports: for Romania in 1989, this value was 1.58, but a similar calculation has not been completed for 1990. Nevertheless, as a first approximation, -y = (1,1.58) is what we should have used. However, the available input-output table for 1990 was presented in a form in which the transactions table included not only domestically produced inputs, but also imported inputs; domestic and imported inputs were not separately identified. The only way around this difficulty was to make use of import ratios taken from the 83 sector 1989 table originally provided by the Statistical Commission, since this did contain a separate row for imported intermediate inputs'o. It was then assumed that for each sector the ratio of imports to total supply was the same as it had been in 1989, and this ratio was applied to the intermediate flows in the transactions table to estimate the domestic flows. Since the import regime was rather more relaxed in 1990 than it had been in 1989, this probably understates the scope for imported -inputs in Romanian production, though the theoretical relaxation may have been offset to some degree by Romania's difficult access to convertible currency credits; in any case, the above assumption is the best available approximation. Suitable adjustment had to be made to deal with the very different sectoral classifications employed in the 1989 and 1990 tables. The result, too, was that y had to be treated as a simple scalar, assumed to equal unity, since no distinction was made in the data between imported intermediate goods from the ruble and dollar areas. It would, of course, be straightforward to repeat the calculations with a different assumption. Fortunately, the detailed results are not terribly sensitive to the precise assumptions made about imported intermediate inputs, though it would obviously be better, in subsequent work, to assemble fuller information sufficient to permit a more adequate treatment. In the analysis of social rates of profit, it was also necessary to estimate wage costs in each branch in world market prices. This was done by taking the vector of household consumption from the input-output table, revaluing it at world market prices (using the X's for traded sectors, and the p's for non-traded sectors), and calculating the ratio between consumption valued at world market prices and consumption valued at domestic prices; the resulting ratio was applied to wage costs for each sector in order to estimate medium and long term social rates of profit. Finally, the long run rate of profit also required information on capital costs. In the absence of reliable and detailed information on capital costs per unit of output for each sector in Romania, and in line with other studies (e.g. Hughes and Hare, 1992b), we made use of capital costs taken from US sources, specifically, the US input-output table for 1977, with 79 sectors." The costs of capital included here included an allowance for depreciation, a normal return on capital, and additional ROMANIAN INDUSTRIAL COMPETITIVENESS: A NUMERICAL EXPLORATION 143 earnings attributed to capital, such as royalties and other fees. The total was expressed in the form of an annual capital cost per unit of (gross) output in each sector. If sectors of the Romanian economy are shown to be profitable (in the long run) using this measure of capital costs, we can be reasonably confident that these sectors would be profitable with the types of investment-probably involving somewhat less capital intensive production-actually likely to occur. 144 ROMANIA- RESTRUCTURNG TO FACE THE WORLD ErOvOMY Table 5.A.1. Industrial competitiveness analysis: Romania, Energy saving, original data, ranking of sectors by social profit rates Social profir rate rankinp OBS Sector ISIC Sector Name Shorr Medium Long term term term 1 1 110 Plantgrowing 65 60 40 2 2 110 Livestock Breeding 60 67 71 3 4 120 Forestry 67 54 27 4 7 210 Coal Mining and Preparation 33 23 11 5 8 220 Extraction of Crude Petroleum 68 64 28 6 9 220 Natural Gas-Extraction Industry 73 73 56 7 11 290- Ferrous Extraction 29 40 38 8 12 290 Non-Ferrous Extraction 49 36 31 9 13 290 Mining of Building Materials Ores 69 68 69 10 14 290 Sand and Clay Quarrying 72 70 70 11 15 290 Extraction for the Chemicals Industry 50 33 18 12 16 290 Extraction and Preparation of Salt 71 72 68 13 17 290 Other Non-Metallic Extraction 70 66 60 14 18 301 Meat and Other Meat Products 2 3 4 15 19 301 Fish and Fish Products 4 2 2 16 22 301 Dairy Products 1 1 1 17 20 302 Tinned Vegetables and Fruit 8 5 6 18 21 303 Edible Oils 6 16 21 19 23 304 Milling and Flour Products 19 11 17 20 24 306 Prepared Animal Feedstuffs 17 17 20 21 25 306 Manufacture of Other Food Products 39 42 45 22 26 313 Beverages, Alcoholic and Other 22 31 33 23 27 314 Tobacco Industry 62 69 73 24 28 321 Textiles 25 13 23 25 29 322 Clothing 36 27 29 26 30 323 Fur and Fur Products 40 38 46 27 31 324 Footwear and Leather Goods 41 39 47 28 5 331 Forestry Operation and Wood Working 66 63 41 29 32 331 Wood Working 55 53 55 30 77 332 Furniture Production 13 8 7 31 33 341 Paper and Paper Products 27 34 30 32 34 342 Publishing and Printing 63 65 63 33 38 351 Basic Chemicals 10 22 12 34 39 351 Fertilizers and Pesticides 45 51 59 35 40 351 Paints, Varnishes, Etc. 12 24 26 36 44 351 Synthetic Fibres and-Yarns is 19 22 37 41 352 Pharmaceuticals 5 6 3 38 42 352 Soap, Detergent and Cosmetics Products 64 71 72 39 43 352 Other Chemical Products 38 46 48 40 36 353 Refinery Processing 11 26 32 41 35 354 Manufacture of Coke 53 59 66 42 45 355 Synthetic Rubber Products 35 45 50 43 46 356 Plastic Products 31 37 37 44 48 361 Ceramic Products Production 23 21 19 45 47 362 Glass and Glass Products 34 20 14 46 51 363 Fabrication of Cement, Lime 20 15 10 47 49 364 Clay Products 14 7 5 48 50 364 Bricks and Other Construction Materials 42 41 36 49 53 364 Cutting, Shaping and Finishing of Stone 61 57 61 50 52 369 Concrete Components. Etc. 18 9 8 51 54 369 Other Mineral Non-Metallic Products 43 49 54 52 55 371 Ferrous Metal Products 9 12 15 53 56 371 Pipes 43 49 54 54 57 371 Other Metallurgical Products 7 14 16 55 59 371 Iron Casting, Steel Foundry 21 18 24 56 58 372 Non-Ferrous Metals Production 3 4 9 57 60 381 Steel Construction Equipment 30 29 39 58 61 382 Engines and Turbines 58 61 65 59 62 382 General Purpose Machinery 52 50 53 60 63 382 Agricultural Equipment 44 47 SI 61 64 382 Fabrication of Machine Tools 46 43 44 62 65 382 Other Special Purpose Machinery 37 35 42 63 67 ' 382 Household Machinery and Equipment 26 25 25 RomANaN INDUSTRIAL. COMPETITIVENESS: A NUMERICAL EXPLORATION 145 Table 5.1 (Continued) Social grofit rate ranking OBS Sector ISIC Sector Name Short Medium Long term term term 64 68 383 Computing and Office Equipment 59 62 67 65 69 383 Electrical Machinery and Equipment 16 10 13 66 70 383 Radio, TV and Communications Equipment 32 32 35 67 72 384 Motor Vehicles 24 28 34 68 73 384 Shipbuilding and Repairs 54 56 64 69 74 384 Locomotives and Rolling Stock 28 30 43 70 75 384 Aircraft Construction and Repair 51 48 58 71 76 384 Motorcycles and Bicycles Production 56 55 57 72 71 385 Medical Instruments. Clocks Production 48 44 49 73 78 390 Other Branches of Industry 57 58 62 Source and notes: same as for Table 5.1 ROMANA- RESTRUCTURTNG TO PACE THE WORLI EcoNoMY Table 5.A.2. Average values by ISIC industry weighted by domestic output (energy saving) Social profit rates ISIC FREQ World Domestic PLAMS' Long Term Medium Short Term Value Value Added Term Added 73 0.438 0.412 1.108 0.032 0.228 0.396 110 2 0.943 0.685 1.318 0.289 0.559 0.716 120 1 0.742 0.791 0.971 -0.152 0.389 0.764 210 1 0.469 0.255 1.308 -0.304 0.005 0.358 220 2 0.763 0.831 0.959 -0.019 0.641 0.796 290 7 1.243 0.316 2.075 0.193 0.410 0.599 301 3 -0.322 0.193 0.941 -0.572 -0.423 .0.342 302 1 0.035 0.200 0.850 -0.422 -0.248 0.041 303 1 0.031 0.187 0.865 -0.206 -0.052 0.036 304 1 0.163 0.254 0.914 -0.254 -0.083 0.178 306 2 0.308 0.316 0.992 -0.061 0.107 0.311 313 1 0.163 0.386 0.764 -0.039 0.112 0.213 314 1 1.065 0.669 1.496 0.512 0.654 0.712 321 1 0.165 0.439 0.651 -0.194 -0.078 0.254 322 1 0.241 0.434 0.643 -0.060 0.064 0.375 323 1 0.391 0.413 0.958 0.063 0.181 0.408 324 1 0.405 0.418 0.952 0.075 0.192 0.425 331 2 1.124 0.527 1.830 0.139 0.407 0.614 332 1 0.097 0.426 0.818 -0.421 -0.213 0.118 341 1 0.314 0.332 1.170 -0.053 0.134 0.268 342 1 1.441 0.513 1.974 0.324 0.569 0.730 351 4 0.207 0.225 1.063 -0.100 0.100 0.195 352 3 0.615 0.359 1.283 0.174 0.384 0.480 353 1 0.084 0.012 1.079 -0.047 0.063 0.078 354 1 0.974 0.323 1.773 0.386 0.476 0.549 355 1 0.407 0.315 1.089 0.110 0.240 0.374 356 1 0.306 0.367 0.904 -0.019 0.172 0.338 361 1 0.201 0.432 0.836 -0.219 -0.013 0.240 362 1 0.329 0.484 0.915 -0.261 -0.020 0.359 363 1 0.176 0.401 0.899 -0.357 -0.060 0.196 364 3 1.056 0.538 1.706 0.169 0.373 0.619 369 2 0.184 0.398 0.850 -0.312 -0.078 0.216 371 4 0.325 0.246 1.252 -0.032 0.128 0.260 372 1 -0.245 0.085 1.206 -0.359 -0.251 -0.203 381 1 0.344 0.413 1.022 -0.011 0.097 0.336 382 6 0.564 0.429 1.202 0.116 0.276 0.469 383 3 -0.252 0.429 0.843 -0.084 0.078 0.299 384 5 0.459 .0.319 1.189 0.098 0.210 0.386 385 1 0.525 0.499 1.062 0.086 0.236 0.494 390 1 0.935 0.530 1.434 0.290 0.469 0.652 a) FREQ denotes the number of 1-0 sectors in the given ISIC category. b) PL.AMB is the average world to domestic price ratio for the given ISIC category. ROMANIAN INDUSTRIAL COMPETmVENESS: A NUMERICAL EXPLORATION 147 Notes 1. In terms of the notation introduced later on, DRC, = 4,/p,, and SPRs = p/X,. Thus both are negative when the value added at world prices is negative, so that they identify the same branches as the most uncompetitive. 2. All data were obtained from the National Commission for Statistics, Bucharest, with the help of Mrs. Clementina Ivan Ungureanu, Head of the Input-Output Table Department. We are extremely grateful for the assistance we received in this work. The only input-output table for 1989 that has been published is a more aggregated MPS table with thirty-six sectors; the corresponding forty sector SNA table for 1989 exists, but has not been published. No tables for 1990 have been published yet. 3. In some cases the implicit exchange rates used in these calculations apparently have been adjusted by production subsidies to exporters. Unfortunately, the data to correct for this were not available when the mission visited Bucharest, and so no adjustment was made. It seems unlikely that many sectors are seriously distorted by our inability to adjust the data in this way, but checking this assertion would be an obvious step if the data ever were made available. 4. Meat and fish products (ISIC 301) and nonferrous metals. 5. Note that it might have appeared more natural to start with a set of equations for the prices. But equation (1) is easily derived from such equations by transferring value added to the left hand side, and dividing through each equation by the corresponding domestic output price. This yields the ratios with which we continue the analysis. 6. Sirictly speaking, one may wish to use vectors of adjustment factors on the imports side, too, with different vectors for rouble and dollar imports, corresponding to the vector X used on the output side. In deed, in some of the countries studied by Hughes and Hare, we have been able to obtain matrices of adjustment factors, with different vectors available to re-price imported inputs into each sector of the economy. Such data were not, however, available for Romania. 7. There is no generally agreed method of defining shadow prices in these or other circumstances. In the developing countries literature, there is a distinction between shadow prices calculated according to simplified (partial equilibrium) formulae and those obtained from full general equilibrium models. For practical reasons we have followed the partial equilibrium approach. It is very difficult to assess either the direction or the magnitude of any biases which may be introduced by neglecting general equilibrium interactions. 8. For fuller analysis, including the treatment of- shadow pricing and other issues beyond the scope of the present paper, see Brent, 1990; Little and Mirrlees, 1969 and 1974; UNIDO, 1973; La, 1974. 9. All data were obtained from the National Commission for Statistics, Bucharest, with the help of Mrs Clementina Ivan Ungureanu. Head of the Input-Output Table Department. We are extremely grateful for the assistance we received in this work. The only input-output table for 1989 that has been published is a more aggregated MPS table with 36 sectors; the corresponding 40 sector SNA table for 1989 exists, but has not been published. No tables for 1990 have been published yet. I0.This is different from the 105-sector input-output table for 1989. which, we understand, is also in circulation. The latter does not contain the imports row which we require. 11. Some experimentation with input-output tables for EC countries adjusted by Eurostat to a common 58 sector classification showed that the estimated capital inputs would not have been greatly different using European data. IdQ ROMANIA: RESTRUCTURTNG TO FACE THE WORLD ECONOMY References Brent, R.J. 1990. Project Appraisal for Developing Countries, Hemel Hempstead: Harvester Wheatsheaf. Hare, P.G. and P.Fomin. 1992. "Industrial Competitiveness in Romania", paper prepared for ACE workshop, Sofia, December, mimeo. Hughes, G. and P.G. Hare. 1991. "Competitiveness and Industrial Restructuring in Czechoslovakia, Hungary and Poland." European Economy, Special edition No.2, Brussels: Commission of the European Communities. 1992a. "Industrial Policy and Restructuring in Eastern Europe." Oxford Review of Economic Policy, 1:82-104. 1992b. "The International Competitiveness of Industries in Bulgaria, Czechoslovakia, Hungary and Poland." Oxford Economic Papers. forthcoming. 1993. "Market Forces and Restructuring in Eastern Europe." paper prepared for Economic Policy panel, April. Kornai, J. 1980. Economics of Shortage. 2 vols, Amsterdam: North Holland. 1992. The Socialist System. Oxford: Oxford University Press. Lal, D. 1974. "Methods of Project Analysis: A Review." Washington, DC: The World Bank. Little, I.M.D. and J.A. MirrIees 1969. "Manual of Project Appraisal in Developing Countries." Paris: OECD. 1974. Project Appraisal and Planning for Developing Countries. London: Heinemann Educational Books. Michael, T., R6v6sz, T., P.G. Hare and G. Hughes 1992. "The Competitiveness of Hungarian Industry." Budapest, mimeo, forthcoming in Acta Oeconomica. Ministry of Industry 1992. "Industry Restructuring Strategy: Synthesis", Bucharest: Romanian Ministry of Industry. Senik-Leygonie, C. and G. Hughes 1992. "Industrial Profitability and Trade Among the Former Soviet Republics." Economic Policy. United Nations Industrial Development Organization 1973. "Guidelines for Project Evaluation", New York: United Nations. World Bank 1991. "Romania: The Challenge of Transition", 2 volumes, Report No. 9497-RO, Washington, DC: The World Bank. ROMANIAN INDUSTRIAL COMPETITIVENESS: A NUMERICAL EXPLORATION 149 Chapter 6 The Energy Sector Energy is a crucial sector in Romania's international trade: about half of all imports are energy sources. Domestic output of energy is falling rapidly, putting further pressure on imports. Exports contain a high proportion of energy-intensive goods, and Romanian industry and households are notoriously energy inefficient. With the exception of lignite, all of Romania's fuels are internationally traded, including electricity, so that the central policy issues facing the country are moving domestic energy prices to import parity levels and ensuring that the currency is adequately convertible, which would enable energy imports to be secured as required. Many fuels are underpriced, creating shortages in the domestic market. Industries lacking foreign exchange cannot turn to foreign markets to meet their needs. This would not occur if foreign exchange were freely convertible, but foreign exchange, and hence many fuels, are rationed, with gas allocation in particular displaying many features of the old system of central planning. The distorted relative prices of fuels lead to inefficient patterns of demand. Given Romania's heavy dependence on fuel imports, there is a need to shift demand toward domestically supplied energy sources, the most salient of which are lignite and nuclear power. The economics of increased reliance on domestic energy looks questionable, but the current pattern of prices and subsidies distorts the picture. The first part of this chapter examines the extent to which Romania might reduce its energy use, and its dependence on energy imports. The second part looks into microeconomic issues of fuel choice and the extent to which it is distorted by price signals. The main conclusion: structural changes resulting from the collapse of trade with members of the former Council for Mutual Economic Assistance (CMEA) and the reorientation toward Western markets will not in themselves lead to large energy savings. The main gains will come from improved efficiency in energy use and more appropriate choices of fuels. Price reform, careful investment analysis, and investment to replace inefficient technologies are the key ingredients on the demand side. On the supply side, to stop the rapid drop in domestic production of oil and gas, Romania must reform its institutions, enact transparent prices and regulations, and create a well-defined petroleum law to secure foreign participation in exploration and production. Sources and uses of energy Romania has diverse sources of energy supply, including oil, gas, coal, and hydropower. It also has access to internationally traded gas and electricity, in addition to the normally traded fuels of oil and coal. Less than two-thirds of total primary energy is domestically produced. The balance is imported (table 6.1; see end of chapter for tables). Romania imports two-thirds of its crude oil requirements and about one-third of its coal, but exports oil products, and has a small net surplus in transformed energy, exporting refined petroleum products ip exchange for electricity. The balance between the different fuels in total primary energy is shown in figure 6.3. Overall, net imports of final and transformed energy are about one-third, but a further quarter of primary energy is lost in transformation (see figure 6.4). 150 'ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY In financial terms, fuel imports have reached nearly 50 percent of total imports, and although fuel exports are about one-sixth of total exports, the ratio of net imports of energy to the value of total exports has been about one-fifth, except for 1990 when the collapse in exports pushed net imports of energy to more than half total exports (figure 6.2). Clearly, Romania depends on trade for satisfying its energy requirements, and energy forms a large fraction of both imports and exports. Like most Soviet-type economies, Romania traditionally underpriced energy and was very energy intensive. Seventy-eight percent of energy available for consumption was used by industry and only 9 percent by the domestic sector (figure 6.4). Within the industrial sector, the emphasis was on energy-intensive heavy industry, and the result was that the energy intensity of GDP in 1990 was roughly five times that of OECD European countries. Thus the energy intensity in Romania in 1990 was 1.9 metric tons oil equivalent (TOE) primary energy per US$'000 of GDP (in 1985 U.S. dollars) compared with 0.65 metric tons oil equivalent/$'000 in Portugal, 0.77 in Turkey, and the EC average of 0.40. Turkey and Portugal are probably appropriate countries for a comparison, having lower per capita incomes than the EC average, though Romania is more heavily industrialized than either country. Making these adjustments, Romania's energy-intensity could be about twice that expected for a country of its level of GDP and degree of industrialization. Reducing energy intensity might enable Romania to reduce net imports of energy, which would allow it to finance imports of other scarce goods, including investment goods. Romania can reduce its overall energy intensity in three ways: improve the efficiency of transformation of primary energy into transformed energy, primarily electricity; improve the efficiency of energy use in the consuming sectors, especially in the industrial sector; and - probably most important - change the balance of sectoral demands in overall GDP. Improving efficiency of transformation and energy use probably require substantial investment, but the potential returns to increased efficiency are large, and the Romanians estimate that in some sectors energy intensities could be reduced by 50 percent. The main reason for the low level of energy efficiency, apart from the previously low energy prices, was the isolation of Romania from the rest of the world since the 1970s. Most Industrial processes and power station technologies date from the 1960s and have been subsequently replicated in Romania,.often using inferior local materials and inappropriate qualities of fuels. Simple plant-level comparisons between Romanian and western techniques will quickly show what is feasible, and, given the investment costs and market prospects, what is desirable. The process of reducing energy use through structural change is under way. The collapse of export markets in the former members of the CMEA and trade and price liberalization have revealed some energy-intensive sectors to be uneconomic at world prices. Three questions need to be addressed: * Has this trade collapse reduced energy intensity? * Are the less profitable industries at world prices the more energy intensive? * Is the reduction in the share of industry itself likely to be a major source of energy savings? The effect of trade collapse on energy intensity It is not unreasonable to expect that a contraction in demand for many industrial products and for fuels would have forced the most inefficient plants to close and led to an improvement in overall THE ENERGY SECTOR 151 energy efficiency. It would have been rational to close the least efficient plants first and then concentrate production on the most efficient plants. But this has not happened. The energy intensity of the economy actually increased between 1989 and 1990. There are several explanations. * The first is that industrial plants in Romania, like those in other Soviet-type economies, are extremely large, regionally dispersed, and frequently constitute the major source of employment for a town or village. Romanian officials have scaled back production fairly uniformly, to avoid concentrations of unemployment in particular locations. As a result, plants have been underutilized rather than shut, and often energy overhead use means that the overall energy efficiency has decreased rather than improved. Second, the fall in demand for electricity might have been expected to force inefficient generating plants to run fewer hours per year. But most electricity generation in Romania combines heat and power, supplying district heating to the domestic sector. This introduces considerable inflexibility in the scheduling of plants, as well as creating priority demands for oil and gas to supply district heat. Clearly, it may not be possible to close an inefficient plant if it is a district's sole source of heat during a cold period. Finally, the hypothesis that the least energy-efficient plants were the least profitable may not be true. This possibility is examined in the next section. Identifying the energy-intensive industries If we knew the amounts of energy used per unit of gross output of each industry, we could compare the change in implied fuel demand at unchanged energy intensity given the decrease in output between 1989 and 1990 with actual energy demands. If we had reliable energy balance data for the two years, this would be reasonably straightforward. But satisfactory energy balance tables are not available. Those published by the Romanian authorities differ considerably from the World Bank's attempt to construct an energy balance table for 1989 (see table 6.2). The statistical basis for energy studies is relatively weak, and there are considerable difficulties in identifying the sectoral fuel demands. The energy balance suggests that the chemical sector is the largest user, consuming 22 percent of total final consumption, followed by the iron and steel sector. Twenty-two percent of final consumption has not been allocated, however, and most of the oil and coal could not be adequately accounted for. An alternative way of examining the change in energy intensity is to use the input-output tables for 1989 and 1990, which measure financial expenditure on fuels rather than physical inputs. Comparisons between the two years and across industries make the possibly unwarranted assumption that relative fuel and output prices did not change, and that different industries paid the same prices for their fuels. Ideally, energy prices might more accurately measure the quality of energy inputs and be therefore superior to physical inputs measured by metric tons of oil equivalent, but given the highly distorted price structure prevailing in Romania, one cannot rely on this assumption. Prices were liberalized only in the fourth quarter of 1990, and reached highly distorted levels. During this period, coal, gas, and electricity were underpriced, and the prices of different oil products varied - heavy fuel oil was subsidized while lighter products were taxed. Thermal heat was underpriced, at least during periods when additional top-up heat was required. With these qualifications, the appendix tables rank sectors by the amount of total energy use, and by different fuel consumption levels, as well as by overall energy intensity. In each case, the 105 sector input-output table was reduced to 101 sectors by eliminating null columns and rows, and 152 ROMANIA RESTRUCTURING TO FACE THE WORLD EcoNoMY the two sets of data were compared by scaling 1989 levels to the 1990 level of gross output (somewhat lower than in 1989). There are striking differences in the overall energy intensities and fuel intensities by sector (table 6A.3). Table 6A.3 shows the sectors that together account for 80 percent of total energy by expenditure. The average of energy intensity in 1990 is 20 percent higher than in 1989 despite the fall in output. The coal intensity fell by 30 percent, presumably as a result of supply difficulties, while electricity and gas intensities increased by 40 percent. The straight averages of the ratios of the sectors identified (unweighted) are somewhat higher than the weighted averages for the whole economy, and the standard deviations are also high, suggesting considerable instability in fuel intensities, possibly reflecting the changes in fuel supplies and the differential impacts of the collapse in demand on different sectors. Figure 6.5 compares the energy intensity (measured by total expenditure on energy over the value of gross output) in 1989 with intensity in 1990. The 1990 energy intensities are typically higher than those in 1989 except for the most energy-intensive industries, where the fit is reasonably close. In the appendix, Lorenz curves for energy use in 1989 and 1990 show that 1989 energy use was slightly more unequal than in 1990. The impact of structural changes on energy demand If liberalization proceeds as planned, the Romanian industrial sector will shortly be exposed to international prices for inputs and outputs, and as a result some sectors will collapse. The competitiveness analysis in Chapter 5 using the 105-sector, input-output table for 1990 identifies those sectors that - without significant improvements in efficiency - are likely to be unprofitable at world prices in the short or medium run. In each case the cutoff is taken as a small positive profit (<0.1) at world prices, though the unprofitable sectors with negative social profitability can be identified from column six of table 6.3. In the short run, the seven least profitable sectors would make a loss at world prices, and the twenty-four least profitable would make a loss in the medium run allowing for labor costs. The top section of table 6.3 suggests that in the short run if all unprofitable industries close (rather than improve their efficiency), total energy expenditures would drop 10 percent, electricity use would decrease by 16 percent, and gross output by 7 percent. Taking the entire set of short-run unprofitable and marginal industries, total energy drops by 24 percent, close to the drop in oil and electricity consumption, and considerably higher than the drop in output of 14 percent. This appears to suggest that the unprofitable industries are energy intensive. In fact, there is no correlation or rank correlation between energy intensity and competitiveness, taking all industries (either in the short or medium run), as figure 6.6 shows.. The three most energy-intensive unprofitable industries are nonferrous metal production (largely aluminum), basic chemicals, and other metallurgy. Ironware, edible oil, synthetic fibers and yarns, paints and cement are also energy-intensive and on the margins of adding negative value. Figure 6.7 shows the cumulative share of total fuel used by the industries ranked by their short run social profitability. If all industries were equally energy intensive, the graph would be a 450 line. The two most unprofitable industries have very low energy intensities, but the third, nonferrous metal products, is very energy intensive, so the graph of total fuel share crosses the 45* line and then remains above it until an output share of 50 percent. Nevertheless, the slope of the graph of total THE ENERGY SECTOR 153 fuel share is approximately 450 for most of its range, showing that there is little relation between energy intensity and competitiveness. The same is true for the other fuel shares. A strong correlation between energy intensity and uncompetitiveness would appear as a concave relationship, but except for electricity, such a relationship does not appear in the graph. In the medium run, if labor shifts from less to more profitable industries, and if industries failing to cover their wage bills are closed, then expenditures on total energy would fall by 31 percent, oil demand by 15 percent, electricity consumption by 35 percent, and gas demand by 21 percent. Total output would fall by 21 percent, again suggesting that the more energy-intensive industries are unprofitable, though again considering all industries, there is no overall correlation between social profitability and energy intensity. Declining demand for electricity would affect total fuel consumption. The collapse of inefficient industries would influence demand for other goods, and thus affect demand for energy. Without a clear sense of the export prospects for other sectors it is hard to compute the general equilibrium consequences of these shocks, but to a first approximation the fall in energy consumption is likely to be no greater than the fall in output. In the medium run, the list of more energy-intensive unprofitable industries includes non-ferrous metal production, concrete components, cement, basic chemicals, other metallurgy, ironware, synthetic fibers and yarns, textiles, iron-casting and steel foundry, glass, and paints and varnishes. Coke is also energy intensive, and is not distinguished in our calculations (being amalgamated with coal). But it too appears unprofitable in the medium run, assuming that it is tradeable. Taken as a whole the metallurgical industries and basic chemical sector would seem set for a decline. And demand for energy would decline with them. Again, there is little relationship between energy intensity and social profitability in the medium run, (see figure 6.8). The sectors with more energy intensity occur where the graph is steeper than 45*. Industries in this range are interspersed with less energy-intensive industries, so that over wide ranges of industries, the average slope is about 45*. The absence of any correlation between energy intensity and competitiveness demonstrates that restructuring within the industrial sector would not, by itself, affect overall energy intensity (assuming no change in energy efficiency or input-output coefficients in this short run). The initial impact of the decline in demand actually had an adverse impact on overall energy intensity. That leaves the balance between the size of the industrial and non-industrial sectors as a possible determinant of overall intensity. Table 6.4 measures the contributions of different sectors to GDP and to energy usage. The first three columns give the shares of different sectors in GDP for 1985-88 average, and for the two successive years. Sectoral shares were moderately stable until 1990, when the industry's share dropped by 6 percentage points. The final four columns give the energy shares and the relative energy intensities (the ratio of the energy share to the GDP share) for the averages of 1985-88, and again for 1990. Industry, which excludes the energy consumed in the energy sector, has a normal energy intensity of 1.2, rising to 1.6 in 1990. The energy intensity of the other sector is unreliable because it is derived as a residual. Table 6.5 gives the shares in total gross output, material input, and net material product, following standard centrally planned economy conventions. These figures suggest that the gross output energy intensity of industry was not particularly high until the fall in output in 1990, though the energy intensity of net material product was higher. Agriculture and construction always appear as relatively less energy intensive according to measure. A decline in the share of industry in total GDP should result in a drop in overall energy intensity, though the size of this fall would be difficult to estimate. The energy intensity of industry would probably appear higher if all inputs and outputs were measured at world prices. Then the measured share of industry in GDP might decrease somewhat. It would then be important to distinguish between changes in the real share of industry and changes in the method of valuation. The evidence that structural change will itself reduce energy intensity and hence energy imports is not particularly strong, and relatively more will therefore depend on improvements in efficiency, induced by price changes, improved management, and access to better technology. The impact of price changes on energy demand Prices play a key role in determining energy usage, regulating the exchange of goods and providing a signal to agents, who attempt to boost profit and reduce costs. Romania has lacked price signals for most of its recent history. Just at the time that profit maximization and improved efficiency became prime targets, access to energy became problematic for many industries. In principle, as all fuels are importable, enterprises are free to meet unsatisfied demands, either by direct import, as in the case of gas for fertilizer production, or indirect import by paying RENEL in hard currency for electricity or fuel imports. In practice, this option is readily available only to exporters who earn foreign exchange directly. Other enterprises either have to bid for an allocation of energy or for the foreign exchange to buy imports of energy. Neither of these two items is automatic. To the extent that current prices are not scarcity prices, price increases and the abolition of rationing may not lead to the reductions in energy demand predicted by assuming normal price elasticities. But energy use decisions may be made more carefully as budgets, become more constrained. Prices for household energy are still between 10 to 20 percent of 'economic cost' - the cost of buying at import parity and transforming and delivering the final energy to the household (table 6.6). Romania plans to free these prices by the end of 1993, but meanwhile subsidizing them puts significant strains on the budget - in 1992 the estimated fiscal burden for household electricity subsidies alone was 57 billion lei, or approximately US$ 283 million. Subsidies to RENEL for thermal heat are expected to be a further 22 billion lei or $110 million (Romania: Energy Sector Study, Paras 4.21-23). Moving energy prices to international prices will therefore affect not only efficiency but also the budget deficit, and in turn the trade deficit. 2 Gas is most heavily subsidized, at 52 percent of its economic cost. Electricity import prices have varied between $52/megawatt hour (MWh) in November 1991, and $35/MWh in 1992. Transmission and distribution costs might increase these import values by 50 percent for large users and even more for smaller users, so electricity prices are still below economic cost. Lignite is somewhat overpriced on a calorific value basis, though production is still heavily subsidized. Heavy fuel oil is underpriced while lighter products are overpriced, which favors heavy industry. Industrial energy price increases of between 50 and 100 percent might still be required, perhaps more if the exchange rate were to move to market-clearing levels. Although this might not affect the relative prices of outputs to energy inputs in the traded sector, it should affect the non-traded sectors. The producer price index has moved up sharply in various months each year and then gradually eroded as inflation proceeds apace (figure 6.9). Indexing on the import price would seem to be more THE ENERGY SECTOR 155 logical than these periodic large adjustments. The domestic prices of energy do not seem to be adjusted to maintain their real price level, except for the adjustment in May 1992. Even this failed to restore the October 1990 parities, let alone move toward the true economic cost (figure 6.10). The effect of price increases on energy intensity can be speculated, bearing in mind the caveats mentioned above. If the medium-term price elasticity of industrial energy demand is -0.3, and prices are increased by 66 percent on average, industrial energy intensity of production should fall by 15 percent. A demand elasticity is -0.5 might lower energy intensity by 22 percent. It is important to realize that, as a derived demand, the demand for energy depends on conditions in product markets. If monopolistic producers can pass on all energy price rises (the regulators of prices are no doubt sympathetic to cost increases as a reason for raising prices), energy demand is driven more by consumers' substitutions than by substitution between inputs at the industrial level. This is particularly true for periods of rapid and uneven price change, for industrialists may be unwilling to invest in the equipment or adaptations necessary to exploit different relative input prices. Domestic energy demand elasticities may be even lower than industrial ones, since most energy is not metered at the household level, though higher prices will provide incentives to improve accountability and metering. If prices quadruple and the elasticity is only -0.2, energy demand might fall by 25 percent, and by 43 percent if the elasticity were -0.4. Higher elasticities would be appropriate if the large income effect of the price increases were not offset by increases in money incomes to hold real incomes constant. Projected energy demands, supplies, and imports The World Bank (1993) study, Romania - Energy Sector Strategy, provides preliminary demand forecasts for energy to the year 2005. The report considers two scenarios based on two alternative assumptions for GDP growth and overall energy efficiency, reproduced in the top block of Table 6.7. The pessimistic scenario assumes sluggish recovery, delayed restructuring, and a slow pace of energy efficiency improvements. In this scenario, GDP in 2000 is 20 percent below the 1990 level in real terms, and energy intensity decreases by 20 percent in the year 2005 compared to 1990. The more optimistic scenario has the economy starting to recover from 1994 and rate of growth between 1996 and 2000 of 4.7 percent a year leading to a GDP in 2000 of 104 relative to 1990. Energy intensity falls faster, but the assumed GDP elasticity of energy demand is taken as 1.3, and the slight increase in GDP has some impact on energy demand. These scenarios are then used to construct sectoral level energy demands. To arrive at primary energy requirements, final consumption was adjusted for conversion, transmission, and distribution losses, which are assumed to decline from 26 percent in 1990 to about 15 percent of total primary energy in 2000. The middle section of table 6.7 gives the projections for fuel demands. The next step in projecting import demands is to project domestic energy supplies by fuel. The World Bank study projects a continuing decline in gas production until the end of the decade. Production was 32 million metric tons oil equivalent (mtoe) in 1986, 23mtoe in 1990, and is projected to fall by more than half to 11 mtoe by 2000. 1 Total domestic oil production is projected to fall by an additional one-third between 1990 and 2000, from 7.9mtoe to 5.3mtoe, about the same proportional decline as between 1980 and 1990. Peak coal production was reached in 1989 when 53.1 million metric tons of lignite (10mtoe) and 11.5 million metric tons of hard coal (7.1mtoe) were produced. In 1990 production dropped by 156 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcONOMY about one third. In 1991 production dropped by an additional further 15 percent, and the decline is projected to continue. About one quarter of lignite is mined from underground mines that are almost certainly uneconomic. All hard coal is underground mined, and probably uneconomic. The labor productivity of hard coal mining is about 5 percent of that in Western Europe. The production of lignite will be constrained by demand for electricity generation, which is projected to be stagnant. Much will therefore depend on the fuel mix of generation, which, in turn, depends on the outcome of a cost-benefit analysis pitting refurbished lignite generation stations against either new Combined Cycle Gas Turbine stations or nuclear power stations. The implicit assumption in the projections is that the fuel mix in generation will move away from lignite. Given projections of domestic supply and demand, the balance then translates into quantities of imports. What is striking is that despite the continued rapid decline in domestic energy production, import volumes of all fuels are projected to be lower in 2000 than in 1990, except for gas, which may double. The share of exports in GDP is assumed to stay roughly constant, in which case the projected share of (net) fuel imports to export revenue might remain at its historical level of 15 to 20 percent. The actual level of gross energy imports will depend on the extent of toll processing of oil into products in refineries, and of gas into fertilizer. In the past, gross energy imports were between 37 to 47 percent of total imports, though it is the net imports of 15 to 20 percent that are relevant for determining the burden placed on the balance of payments. Allocative problems of resource use A large fraction of Romania's energy problems centers on the availability and cost of gas. If gas is available for import at a world market price, its price will determine the value of lignite for electricity generation and the profitability of large fractions of the chemical industry, especially fertilizer. The Department of Chemical and Petrochemical Industry in the Ministry of Industry (MIND) explained that the collapse of the CMEA had less effect on demand for chemicals than for other products because chemicals are tradeable. The production declines were caused by problems of securing raw materials, with the main problem being access to energy, especially gas. The volume of export sales was not adequate to cover the import bill, and difficulties of access to foreign exchange may have caused the fall in capacity utilization, though in some cases where the process was unprofitable at world prices the factory stopped production (acetylene,. carbide, some caustic soda and some ammonia). Gas allocations are rationed. One criteria used in allocating gas is profitability. In the case of fertilizer, cutbacks in gas allocation worsened the industry's financial performance, which, in turn, apparently resulted in smaller allocations. The profitability signals were misinterpreted. It is believed that the fertilizer plant would have been profitable at full capacity. The Ministry of Industry appears to have the authority to exercise a proactive industrial policy, even though overall policy is still very much under the control of Ministry of Finance. During energy shortages of 1990-92 industries were allocated energy based on demands, but prioritized by financial viability of the proposed market (export vs domestic, currency vs barter), and the urgency, for example, on technical grounds, to prevent irreversible damage to furnaces. This appears to grant the Ministry of Industry the same powers it had under the former system of planning, but one THE ENERGY SECTOR 157 difference is that the industries are free to produce what they like, rather than meet targets. This might be more apparent than real, however, because success in satisfying the criteria for the initial allocation - the production of critical supplies, or the earning of foreign exchange - would doubtless be expected to affect subsequent allocations. The main difference is that financial profitability is now a necessary condition for allocations of energy. The system might be described as a surrogate for long-term contracts for energy supply - a common method for dealing with natural gas, electricity, and other sectors where lumpy investments are required to satisfy a durable demand. Finally, any enterprise is allowed to import gas provided it has access to foreign exchange or to engage in processing of foreign-owned gas. . Energy may be denied to enterprises unable to pay for it, or, more generally, to those that are considered insolvent. In such cases, however, Law 76 requires that a commission of State Ownership Funds, Private Ownership Funds, lending banks, Ministry of Finance, Ministry of Industry, and Ministry of Social Protection be set up to consider all aspects of closing the enterprise. The commission conducts a feasibility study to recommend restructuring, privatization, or closure. The supply and allocation of gas Gas is currently imported through a single link from Russia in eastern Romania, at a price set unilaterally by Russia. The capacity of the pipeline is 10 billion cubic meters per year (bcm/y) at 35 bar. ' Until 1985, imports ran at less than 2 bcm a year, but in 1989 they rose to 7.3 bcm a year, or 20 percent of total consumption. Not only is the price beyond Romania's control, but supplies are vulnerable to interruption. The import price in 1992 was reported to be $94 per thousand cubic meters (kcm) - higher than the $80 per kcm for Russian gas delivered to Western Europe. If Romania were willing and able to sign indexed contracts backed by secure foreign exchange, then the price of gas might fall to levels charged in hard currency markets. Prospects for alternative sources of supply are not promising in the medium run. Liquid natural gas into Adria would deliver gas at $140kcm (equivalent to $25/bbl crude oil), but this option is unlikely because of the political turmoil in Yugoslavia. ROMGAZ is discussing the possibility of building a S bcm a year pipeline of 60km that would tap into the transit pipeline Ukraine uses to deliver gas to Eastern and Western Europe. The gas would probably remain the property of Russia until it reached the border, in which case it does not help diversify the sources of gas, though it might reduce interruptions arising from technical failures in the eastern link. More remote prospects might involve participation in the multi-country proposal to import gas from Iran to the Ukraine via Azerbaijan, Georgia and Russia, which would allow Romania to import from the Ukraine, presumably on a take-or-pay contract. If gas is in inelastic supply, then its value will be its netback value in its most valuable marginal use, that is, the highest value that the using industry could afford to pay and still remain viable. Electricity generation and fertilizer production are the two leading users of gas (table 6.8). Energy efficiency in fertilizer production is low, and might be improved by 40 percent (Romania: Energy Sector Strategy. para 7.21). Elsewhere in the industrial sector, estimates suggest that energy savings of 10 to 25 percent could be made at modest cost through improved energy management practices and better standards of insulation, and through modest investments to reduce gas consumption. Substantial savings requiring only modest investments could be made in the residential 158 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcONOMY sector, where heat losses in the district heating systems are reported to be high due to poor standards of insulation, and where incentives to conserve energy are reduced by a failure to meter individual consumption. A considerable part of the fertilizer industry will remain competitive, providing it has-access to imported gas at reasonable prices, because it is currently successfully exporting under toll- processing arrangements. The critical issue will be gas use in power production. Gas contributed 43 percent of thermal generation in 1985, but only 37 percent in 1991. Some plants designed for gas burning were converted to fuel oil. The economics of this switch in terms of foreign exchange saved can be computed, on the assumption that additional gas can be imported if foreign exchange is available - the price of HFO/metric ton would have to be less than 1.24 times the price of imported gas per thousand cubic metres (kcm), assuming it could be burned at no lower thermal efficiency. Since gas was imported at the high price of $94 per kcm, the import price of HFO would have to be less than $116/metric ton. The average price of high sulphur (3.5 percent) HFO fob in Western Europe over the past six years has been about $80/metric ton, so HFO is preferable, unless the thermal efficiency were degraded by 30 percent an improbable amount, or the resulting environmental costs were too great.- At a price of HFO of $80/metric ton, the saving might be as large as 25 to 35 percent.6 The reason for the failure to substitute the economically cheaper HFO for gas is that gas is underpriced, sold to industry for $47/kcm while the equivalent amount of HFO was sold at $68/metric ton. This practice makes HFO appear more expensive. Electricity generation - an area where fuel substitution is often easy - provides a clear example of the potential costs of failing to set relative prices of fuels at import parity. Choice of generation fuel is distorted in favor of gas, requiring quantity allocations to achieve the desired result. At present gas is used in lower efficiency conventional steam raising plants, rather than much higher efficiency combined cycle gas turbines (CCGT). The reported thermal efficiencies of RENEL's condensing plant vary from 23.6 percent for 200MW Czech units to 33.2 percent for the 200MW Mintia station burning hard coal. The efficiency of a Frame 9F gas turbine can be as high as 53 percent (NCV), equivalent to 47.7 percent Gross Calorific value.' Comparisons are complicated by the prevalence of co-generation units operated by RENEL. Seven Gigawatts (GW) or almost one-half installed thermal capacity is designed for co-generation and 40 percent of annual energy production is from co-generation plant. If combined cycle gas turbines are to replace existing co-generation and are to meet the steam or hot water requirements, their electrical efficiency will be downgraded, though their overall thermal efficiency will still be substantially above that currently achieved. Demands for process steam are likely to fall with the scaling back of many industrial activities, making combined cycle gas turbines look attractive, especially when compared with the option of rehabilitating existing base-load condensing plant. 8 The comparison is simple. New combined cycle gas turbines currently cost about US$700 per kilowatt (Kw) installed capacity and have low non-fuel running costs of about $50 to $70/kW capacity per year or 0.7 to 0.9 US cents per kilowatt hour (KWh) on base-load. Total non-fuel costs (capital expenditure plus running costs) might be 2.35c/kWh, to which must be added the fuel costs. At $94/kcm these would be 2.1 C/kWh, while at the West European import price of $80/kcrn they would be 1.8c/kWh, giving a total base-load price of power from gas turbines of 4 to 4.5C/kWh, or $40 to $45/MWh. I This may be compared with the import price of power of $52/MWh in November 1991 (and of $35/MWh in 1992) both described above. THE ENERGY SECToR 159 The import price of electricity is the logical reference price, since 1990 imports (mainly from Russia via the Ukraine) amounted to 10 percent of total consumption, though this has fallen with the decrease in domestic demand. In 1992, electricity imports were down and were confined to the first half of the year. Looking ahead, if combined cycle gas turbines are widely installed in East and Central Europe, and if adequate gas supplies from Russia can be ensured, other countries closer to the source of the gas are likely to be installing combined cycle gas turbine technology, so some convergence between the import price of electricity and domestic production costs could be expected. Since it is cheaper to move gas than electricity, (once the pipeline is in place), Romanian electricity prices should move below import parity, unless Romania strikes unfavorable bargains over the price of gas. Plans to export electricity to countries with access to cheaper gas are unlikely to be profitable. The main unknown in this calculation is the feasibility of installing and operating the relatively sophisticated combined cycle gas turbine technology, compared to maintaining modern jet engines in complexity. It may be that the earlier and smaller vintages, which were relatively straightforward translations of tried and proven jet engines operating at lower thermal efficiencies (47 to 49 percent GCV) would prove more robust and reliable, but it may require substantial organizational changes within RENEL to ensure reliable operation. Supposing that combined cycle gas turbine technology is feasible, will it displace lignite burning stations at gas import parity, which might expand gas imports considerably? Many lignite stations need rehabilitation, and if it is economic to do this, rather than close them and replace them with gas, then it is clearly wise to retain existing stations that need no rehabilitation. The calculation needed to answer the question of the desirability of rehabilitating lignite or coal-burning plants are reasonably straightforward. Lignite is purchased at the same price per Kilocalorie (Keal) or gigajoule (GJ) as imported coal, and its production is subsidized, though these subsidies are expected to drop. Given these costs (possibly $45/metric ton coal equivalent c.i.f, plus $7/metric ton transport to the station), and the assumed level of thermal efficiency after rehabilitation, perhaps 30 percent, the margin between operating costs (fuel costs and other non-fuel avoidable operating costs) and the electricity price determines the maximum return available to the rehabilitation. If the avoidable non-fuel operating costs are taken to be the same as for combined cycle gas turbine - they may well be higher since staffing levels and maintenance costs will be higher - and the utilization rate rises to 70 percent for base-load (the average capacity factor in 1991 was 30 percent), then the margin between the total cost of new CCGT generation and the avoidable cost of lignite would be 1.3c/kWhr or $80/kW of capacity per year. If the interest and depreciation of the cost of rehabilitation is 20 percent per year, then it would not be economic to spend more than $400fkW of capacity. Figures cited in Romania - Energy Sector Study (para 9.58) suggest that RENEL's estimated rehabilitation cost might be as high as $780/kW - clearly uneconomic, though the rehabilitation of the Turceni power station cost only $165/kW. - Should the first stage of the nuclear power station at Cernavoda be completed? The latest estimate of the incremental power production cost of completing the first unit is $34/MWh, assuming the use of imported rather than local fuel and heavy water. Local inputs would increase the cost above this level. 'o In addition, Cernavoda would not contribute any district heating, so that the comparison with cogenerating stations (either lignite or gas) is not straightforward. If thermal output froi a rehabilitated lignite station is ignored, then completing Cernavoda at 160 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcONOMY $35/MWh would be preferable to either combined cycle gas turbine or lignite rehabilitation unless the rehabilitation costs can be reduced to less than $165/kW, the breakeven margin when the incremental cost of alternative power is as low as $35/MWh. The conclusions of this very rudimentary cost analysis is that the economics of gas, lignite, and completion of the first stage of the nuclear station are sufficiently finely balanced that more careful studies will be needed. " Put another way, new combined cycle gas turbine stations, and hence large increases in gas use for power generation, are not so attractive in the short to medium run, when no new capacity is needed, that they should command special access to scarce imported gas. In the long run as generating plant need to be replaced, the economics of new gas generation become very attractive, since the costs are now compared with the total cost of alternatives, not just the avoidable and rehabilitation cost. A further implication is that any arguments for the nuclear station in order to provide an profitable export surplus of electricity must be considered fanciful, since in the near future importing countries are likely to be generating their own electricity from gas-based combined cycle gas turbine at a lower local price, allowing for transmission losses. The Department of Energy in the Ministry of Industry has optimistic plans to finance the second stage of the nuclear plant out of sales of electricity to Bulgaria and the Ukraine, where concerns over unsafe reactor design may precipitate an electric capacity shortage. This casts doubts on whether prices would ever be high enough to cover the costs of completion. Even if increases in gas use in electricity generation were ruled out in the short term, the fall in local production still means that gas imports will be required. In this context, the Ministry of Industry's intention to restructure ROMGAZ and to separate exploration, production, transmission, and distribution, is welcome. The plan to make the high pressure gas transmission system act as a common carrier with regulated tariffs will facilitate the correct pricing of gas at different locations. This in turn will encourage foreign exploration for additional gas, since there will be a world price defined at each location within the country that can be used for the assessment of royalties or rent taxes. Plans to restructure RENEL should have similar beneficial impacts, though the range of options for restructuring is larger and will require careful planning. Lignite Mining Lignite mining relies on the electricity industry for its demand and presents an interlinked and difficult set of problems. The first step, of selling lignite at the calorific value of imported coal, has already been taken. This ensures that RENEL faces the correct incentives to burn lignite. But this does not solve the whole problem, especially if lignite causes more environmental damage than imported coal. 12 The next step is to ensure that rail transport costs are rationally set, so that the delivered and pithead prices of lignite are appropriate. The natural way to achieve this is to find locations where hard coal and lignite are both used, find the delivered price of hard coal there, and then netback the price of lignite by subtracting transport costs from the pithead. Railway freight haulage costs are not simple to compute because they involve track maintenance costs and congestion costs, but methods exist for their calculation. It may well be that some haulage of lignite is demonstrated to be uneconomic (several power stations currently receive lignite after haulage of more than 500km). The mining industry must be restructured to concentrate production in lower cost surface mines. The final step will adjust the size of the mining industry to domestic demand, given that lignite THE ENERGY SECTOR 161 cannot profitably be exported. At present lignite supply is less than potential demand for thermal generation, but if electricity demand continues to fall, and if hydro, nuclear, and gas generation look more economic to expand than lignite power, then the market may contract, and with it, the size of the mining industry. This should in turn reduce average costs and lessen the subsidy burden. The fate of the lignite industry depends very much on the comparative economics of different fuels, as well as on the speed with which costs can be reduced to justify pricing at import parity. Enviromnental Policy Romania currently has a set of environmental standards for the concentration of various air pollutants such as sulphur dioxide and nitrogen oxides released by large combustion plants. In due course Romania expects to meet European standards for transboundary pollutants after a transition period of perhaps 10 years. New plants will have to meet quite stringent limits from now on, but old plants cannot reasonably be treated with the same rigor. One complication in dealing with local excess pollution levels is that closing offending stations would have serious effects on local industry and the population. This was the case for a station in the Jiu region, which burned both lignite and High Sulphur HPO (from Iraq, with a sulphur content in excess of 4 percent). The logical alternative of using a lower sulphur alternative fuel such as gas was ruled out on economic grounds. " Economic realities obviously constrain pollution abatement from existing plant. The least-cost solution is to stock or ensure access to low polluting fuels for use during periods of local environmental stress, such as temperature inversions, and to burn the polluting fuels when the damage they do is less pronounced or more acceptable. While the approach for new industrial investments and the realism guiding the enforcement of standards for existing plant seems sensible, there is a danger that inappropriately costly and rigorous EC standards will be accepted for purely domestic concerns - for example, automobile pollution limits. These may well constitute a form of protection, forcing Romania to import or assemble vehicles to a higher technical specification than would be justified by the standard of living of the population. Given the relatively lower level of vehicle ownership, automobile standards could well be set at much less stringent levels without serious local health hazards. Pollution from heavy vehicles, especially particulate emissions from poorly tuned diesel engines, will almost certainly command higher priority on health grounds than NO. and other emissions from automobiles. As a general rule, the costs of reducing pollution from large stationary sources is lower per metric ton of pollutant than from small mobile sources, such as vehicles, making automobile standards arguably the least pressing. " Thus volatile hydrocarbons released from refineries and petrochemical plants are likely to be cheaper to reduce (per metric ton of pollutant) than tightening standards for vehicles. Chapter 4 of the new environmental law currently under discussion contains provisions for levying charges or penalties on the release of pollutants, and this principle has already been approved for waterborn pollutants and waste disposal. Water charges are paid into a water fund that is used to finance water treatment. Waste disposal charges currently cover only the cost of transport and disposal, but not treatment. Past toxic and other environmentally damaging waste constitutes the most pressing environmental problem facing the country. These waste dumps were not properly lined, and waste leaches into the ground water aquifers. Higher charges should ensure that the costs of adequate treatment are met, while providing incentives to reduce waste or provide for treatment 162 ROMANIA: RESTRUCTURING TO FACE THE WOR.LD EcoNoMY at the factory where this is cheaper. As a rule, charges for emissions are economically superior to standards, since they allow overall standards to be met at least cost, provided the polluting firms operate in a competitive market economy. For example, in electricity generation, the company has a choice of plants to operate (the merit order) and hence which fuel to burn (low or high sulphur, coal, lignite or gas), whether to install expensive abatement such as flue gas desulphurization, whether to build new low polluting stations such as combined cycle gas turbine, hydro or nuclear, or whether to import electricity, which pollutes outside the country. If each station has to meet the same standards regardless of location and period of operation or total quantity of pollutant released, the result is likely to be substantially more costly than leaving the choice to the company, guided by emissions charges. Sulphur taxes will have an adverse effect on domestically mined high sulphur lignite and coal, whose costs will be raised by the tax on resulting emissions, unless they are burned in stations with FGD or other abatement technologies (such as fluidized bed combustion with limestone). ' Energy policy and institutional reform A rational energy policy requires that producer prices be set at world price levels and that the currency is adequately convertible so that energy imports can be secured as required. Institutions then need to be reformed to ensure that they respond appropriately to market price signals. Problem sectors like lignite and nuclear power will need careful economic analysis to determine their viable scale of operation, and may need transitional financial support (or debt write-offs) to reach this scale. Finally, market failures such as environmental pollution and imperfect incentives for conservation will need to be addressed, ideally by market mechanisms such as emissions taxes and charges, and by providing the relevant information for efficient decision making. For conservation, this means installing the appropriate metering for publicly supplied heat, power and gas, as well as energy labelling, and the provision of efficiency audits where expertise is lacking. 16 Conservation policies will require institution building and are likely to evolve over longer periods of time, but Romania is receiving advice and assistance in this task. The absence of appropriate pricing policies and enterprise reform will hamper conservation, so these areas are top priority. Pricing policy Since all energy inputs are currently imported, domestic energy prices for industry should be set at import prices plus transport and distribution costs. Romania is fortunate that all its energy inputs and outputs, with the possible exception of lignite, are tradeable. Oil, gas, coal, and electricity can be imported at well-defined prices payable in hard currency. Most of the energy-intensive industries produce outputs that can be sold for hard currency, and the swiftest way of eliminating activities that add negative value is to introduce world prices for inputs and outputs. The government plans to adjust producer prices towards import parity by the end of 1993 and should then approach economic cost, but at the moment there is an apparent reluctance to peg prices to movements in import prices. (figure 6.9). Full convertibility would cause little trouble for traded energy, requiring only that domestically produced fuels be sold at wholesale prices that match imported prices plus distribution to ensure satisfactory pricing. With the present system of essentially administered pricing and THE ENERGY SECTOR 163 inconvertible currency, the government should ensure that prices are adjusted quickly in response to movements in the exchange rate. There may be special circumstances that argue for a more gradual removal of consumer subsidies if it is difficult to compensate consumers at low incomes for the required price rises, though it would be preferable to index social security payments to reflect changes in energy (and other essential) prices. There are, however, no good reasons for delaying the adjustment of energy prices for industrial users. Delays prevent the rational choice of fuels and hinder attempts to identify negative value-added activities. To some extent these problems have been alleviated by allowing enterprises to import fuels (oil, gas, coal, and electricity) at world market prices, if they can pay in foreign exchange. This would be satisfactory if the lei were convertible, but the present system of foreign exchange allocation creates considerable difficulties for enterprises supplying the domestic market. The costs of energy shortages caused by inefficient allocation and the inability to import additional supplies can be very high. If fertilizer factories cannot obtain gas, then the production of fertilizers will drop. Since fertilizer can be exported profitably at world market prices, (they are currently toll- processing imported gas for that purpose) there is a danger that it would be diverted from domestic agriculture, where it could increase yields and hence reduce food imports. The resulting savings in foreign exchange of this indirect trade would be high - larger than the cost of the additional gas imports. Institutional reform Enterprises in the energy sector are currently constituted as regies auonomes (RAs). They are weak, poorly managed, and in urgent need of restructuring. The role of the state as regulator of energy needs to be separated from its role as owner. The country urgently needs a petroleum law to facilitate foreign exploitation of oil and gas resources. The government might consider stripping RENEL of the nuclear power sector, which would make the costs of the sector clearer. The reforms needed in the gas industry have already been described, and, together with the need for a petroleum law, are top priority. As a simple rule, natural monopoly elements of the energy industry, specifically the gas and electricity transmission and domestic distribution systems, should remain in public ownership until the regulatory institutions dealing with competition policy have been established and proved successful without political interference. Only then might it be worth contemplating privatizing transmission systems under regulation, and even then the case for privatization is weak. Gas production and electricity generation might be privatized, since they are potentially competitive industries. Gas privatization might reassure foreign investors that they will not be discriminated against in securing access to the publicly owned grid. Electricity privatization is more problematic because it requires the creation of a satisfactory method of coordinated dispatch (assuming the grid remains under separate ownership). It would encourage a more commercial approach to investment and operations, though much can be done by taking the necessary first steps of commercializing the RAs while still in state ownership. That and the creation of a separate regulatory regime with a clear mandate to encourage efficiency in operation and energy allocation are the most pressing reforms required. 164 ROMANIA: RESTRUCTURING TO FACE THE WoRLD EcONOMY Conclusions Romania is an energy-intensive economy. Although it currently produces all fuels, Romania remains heavily dependent on imported fuels. Over the next decade, domestic production of all fuels is projected to decline, either because reserves are becoming exhausted, or the economics of current exploitation is unattractive, as in the case of coal. It is therefore necessary to reduce the energy intensity of production to prevent energy imports from becoming a serious strain on the economy. This is entirely feasible, providing Romania adjusts fuel prices to economic levels, and makes prudent investment decisions in improving energy efficiency and reducing the losses in energy transformation. The declining importance of some of the more energy-intensive heavy industries will automatically reduce energy intensity, though not by as much as might have been expected. There is very little correlation bet*een energy intensity and profitability at world market prices, so that the reorientation toward the more profitable sectors will not in itself lead to much change in overall energy intensity. The greater scope for improvement in efficiency comes from firm level investments, rather than changing the relative balance of industrial outputs. Romania is connected to the East European electricity grid, but this should not tempt it to embark on a program of surplus electricity generation for export. The economics of such a program is dubious. The least cost method of generating electricity is to transform gas using modern high efficiency combined cycle gas turbine generation. Given a pipeline infrastructure, it is cheaper to move gas than electricity, and Romania's neighbors would, in the long run, be better advised to import gas and generate their own electricity rather than importing electricity generated from imported gas. Obviously the economics of exporting electricity to gas-exporting neighbors like the Ukraine and Russia is even less attractive. It is difficult to see how completing the proposed nuclear power program will reduce the cost of generation below that of gas-fired stations, and given the heavy investment requirements needed to complete that program, any justification based on export sales is doubtful. The highest priority must be given to improving domestic fuel supplies by encouraging Western firms to prospect for additional reserves. Privatizing the oil and gas industry and creating a satisfactory regulatory and pricing framework for gas and oil transmission and sale will help lure Western firms. Notes 1. Most of the figures in the table come from the draft report 'Romania - Energy Sector Study' table 4.2 (World Bank, 1992). Much of the study has been superseded by the Yellow Cover Report 'Romania - Energy Sector Strategy* (World Bank, 1993), though some of the earlier data, and these data in particular, are not reproduced in that volume. To complicate matters, where similar tables are available in both reports, the figures often differ. The assumption is that the later figures are more accurate, and that caution should be exercised in relying on the earlier data. 2. In the latest revisions (May 1993) prices for household consumption of gas, liquid petroleum gas and thermal energy have risen by factors of 4.5 to 6 in dollar terms. This price reform brought liquid petroleum gas and thermal energy to 90 percent and 100 percent of economic cost, but gas prices remain only about 45 percent of economic cost. Industrial prices have not generally increased in dollar terms so that domestic crude and natural gas are still significantly under-priced. 3. Romanian sources give gas in thousands of cubic meters (kcm). Ikcm is equivalent to 0.86toe, and lbcm - 0.86mtot. There are discrepancies of 3 to 6 percent in the various sources for gas production which may be attributable to different conversion factors. THE ENERGY SECTOR 165 4. One billion cubic meters = 0.86 million tonnes oil equivalent. Thirty-five bar is thirty-five atmospheres pressure. 5. Romania: Energy Sector Strategy 9.17 reports the difficulties experienced in the switch to HFO, and notes the energy needed to preheat the oil and the loss of efficiency in heat exchangers; it does not, however, quote a figure for the -degradation in efficiency. 6. MIND reported in July 1993 that internal studies suggested that the costs of sulphur emission and sulphur-based wear and tear on equipment made low-sulphur HFO a better deal than high sulphur HFO. 7. NCV is net calorific value, which for natural gas is 0.90 of the Gross Calorific Value (GCV), the basis on which gas is sold. Coal is conventionally sold on NCV. Note that RESS 5.33 claims 53.8% net thermal efficiency, which is based on a confusion of gross and net. 8. MIND currently (July 1993) have studies of the economics of CCGT in hand. 9. This is considerably above the claimed (and rather suspect) figure of $25-30/MWhr cited in Romania: Energy Sector Sh(dy, para 5.30, which would require a gas price of $65/kcm and non-fuel operating costs of less than $20/kW capacity. It may result from confusing GCV and NCV efficiencies. 10. Romania: Energy Sector Study para 529 estimates that the cost of locally processing uranium might be 3 to 4 times the cost of imports. while the domestic production of heavy water would place a heavy drain on electricity supplies, needing about 50MW of capacity. 11. Current studies (July 1993) within MIND are said to favor the first phase of Cernavoda but the mission has not examined these. 12. Lignite has somewhat less than 1 percent sulphur and a calorific value of 165OKcal/kg, equivalent to perhaps 4 percent sulphur content for hard coal of 7000Kcal/kg, and therefore very high. Imported coal of 0.6 percent sulphur is available at about $50/tonne. 13. Gas would have to be have been purchased for foreign exchange, which RENEL lacked, though they have on occasion sold additioial electricity to exporters at the price of imported electricity in dollars. In this case they had no obvious client with access to foreign exchange able to purchase the gas, nor probably would any consumer have been willing to pay dollars just to meet an environmental standard. 14. Except perhaps for high vehicle ownership levels in cities with serious temperature inversion problems or with valuable cultural buildings (such as Athens). 15. MIND is currently examining the environmental impacts of electricity and mining in a World Bank funded study. 16. Labelling and standards programs are now under way, but the capital costs of installing meters present a significant problem. 166 ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNoMY References World Bank (1992) Romania - Energy Sector Study, Draft report, Industry and Energy Division, EMENA Technical Department. World Bank (1993) Romania - Energy Sector Strategy, Report no. 11541-RO; Jan. 5, 1993 THE ENERGY SECTOR 167 ROMANIA 1985-90 ROMANIA 1985-90 Production and trade Trade in Energy Million tonnes oil equivalent US$ ml1ons 100 15 15 80 ---.-.... ... .t0 -10 60so. . 5 - , 5 40 - . . . --0 0 20- -5- - -5 0 -10 --10 -20 4 I- -15 1985 1986 1987 1988 1989 1990 1985 1986 1987 1986 1989 1990 NProduction MImports fuel MTotal exports Menergy exports U Imports transformed 0Exports transformed @Total imports Menergy imports ReomwHabal Jen R0 BomCeMatradez Jan R Figure 6.1 Figure 6.2 ROMANIA 1985-90 ROMANIA 1985-90 Sources of Energy Uses of energy mill tonnes oil equiv million tonnes oil equivient 100 s 00M 80 ...... -- ...-...-.-. 60 - - - 40 60- 20 20-1 0 -1** --*** -**--** - -------*-- 1985 1986 1987 1986 1989 1990 1985 1986 1987 1988 1989 1990 *3Oil 0Gas ELosses 0exports trans energy BLignite Eard Coal WIndustry BACriculture OHydro NImports trans energy EDomestic BOther RmOwltsalal Ja to R**uahab.* Ja 28 Figure 6.3 Figure 6.4 168 ROMANIA: RESTRUCTURING TO FACE TF Wr)pT n renNirv Energy intensities ROMANIA 1990 Romania 1989 and 1990 Energy Intensity against competitiveness 1989 energy/gross output relative energy intensity 100 10 to- + + +* + 4+ 01 + * 0.1 .+0 .4* +44+ + . +. + + 0.01 II 0.01 I ' I I 0.01 0.1 1 10 10 -0.8-0.6-0.4-0.2 0 0.2 0.4 0.6 0.8 1990 energy/gross output Short run socist profit Figure 6.5 Figure 6.6 Energy Share against Output share Energy Share against Output share Romania 1990 Romania 1990 Fuel share X Fuel share X 70 . 70 60 80- 50- 60- 40- 40 - 30- -' 30- 20- - 20- 10 - 10 - . 0 10 2030 40 60 60 70 0 10 20 30 40 50 -60 70 Output share 2 Output share I -Total Fuel share -Oil share -Total fuel share -oil share ..Elec share *Gas share -Electricity share -*Gas share Ranked by shortrun profit Ranked by medium run profit Figure 6.7 Figure 6.8 THE ENERGY SECTOR 169 Romania Producer Prices Romania Consumer Prices Real Energy Price Indices Real Energy Price Indices Index October 1990 = 100 Index October 1990 = 100 300 120 250 100- 200 - 80 N A50 60- 150 ... 60- ' R00 - ./'40 -' 50 - 20 -' 40 : Octv0 Jan 1 Apr Ju Oct Jan 92 Apr Jul Oct g Oc9m 9t Apr 3uly Oct Jan 92 Apr Ju'l Oct pp PIcoal "Ppi Oil & gas - PPI Elec &heat CPl fuels CP1 Elec - - CP[ Gas & CH Romeem\eaprice 27Jan93 HaRmeem\enprice M7an93 igure 6.9 Figure 6.10 Energy Lorenz Curves Romania 1989, 1990 Cumulative output share % 100 80 - 40 - 20 - 01 0 10 20 30 40 50 60 70 80 90 100 Cumulative energy share % - 1990 1989 THE ENERGY SECTOR 171 Table 6.1. Historical energy balance and projections 1988-90 million metric tons oil equivalents (mtoe) averages shares in total final Projections consumption Primary Energy 1985 1986 1987 1988 1989 1990 percent 1990 1995 2000 Oil Domestic 10.4 9.8 9.2 9.1 .8.9 7.7 16.5 7.9 6.9 5.3 Import 14.2 16.5 21.3 20.3 21.2 15.6 36.7 16.1 7.9 11.2 Total crude oil 24.6 26.4 30.5 29.4 30.1 23.3 53.2 24.0 14.8 16.5 percentage imported 57.7 62.7 69.8 69.1 70.4 66.9 Gas Domestic 31.8 32.1 30.5 29.5 26.4 22.8 50.6 22.8 15.2 10.8 Import 1.5 2.0 2.6 3.2 5.9 5.8 9.5 5.8 2.6 9.0- Total natural gas 33.3 34.1 33.1 32.7 32.3 28.6 60.2 28.6 17.8 19.8 percentage imported 4.4 5.8 7.8 9.7 18.2 20.3 Lignite Domestic 6.7 6.7 7.5 8.9 9.5 6.0 15.6 6.0 4.2 4.7 Import 0.1 0.3 0.3 0.5 0.5 0.7 1.1 0.7 Total lignite 6.8 7.0 7.9 9.4 10.0 6.7 16.8 6.7 4.2 4.7 Hard Coal Domestid 3.4 3.4 3.7 3.7 3.3 1.8 5.6 1.8 1.0 0.5 Import 3.9 3.9 4.4 4.0 3.7 3.3 7.1 3.2 1.6 2.6 Total hard coal 7.2 - 7.4 8.1 7.7 7.1 5.0 12.7 2.7 3.0 3.0 rotal Coal Domestic 10.0 10.1 11.2 12.5 12.8 7.7 21.3 Import 4.0 4.3 4.8 4.6 4.2 4.0 8.2 Total Coal 14.0 14.4 16.0 17.1 17.0 11.7 29.5 percentage imported 28.5 29.6 30.0 26.8 24.9 33.9 ydro 3.0 2.7 2.8 3.4 3.2 2.7 6.0 )al Prinary Energy 74.8 77.6 82.4 82.6 22.6 66.4 148.8 67.0 42.4 47.1 Total imported 19.6 22.8 28.6 28.1 31.3 25.4 54.4 25.8 12.1 22.8 Percent imported 26.2 29.4 34.8 34.0 37.9 38.2 0.1 38.5 28.5 48.4 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Table 6.2 Energy balance for Romania, 1989 (in thousand metric tons of oil equivalents) Sector Coal Crude Peholeum Gas Hydrolo £ee- TherMal Total Share Of oil products ther ticity 000 TOE total primary energy Supply (TPES) Industry Sector Iron and steel 2979 3070 776 6825 10.0 Chemical 7 10248 1055 11310 16.6 Non-ferrous metal 1 542 543 0.8 1Hon-metal minerals 76 31 107 0.2 Transport equipment and machinery 73 73 0.1 Machinery 757, 757 1.1 Mining and quarry Food and Tobacco 22 150 172 0.3 Paper pulp printing 147 147 0.2 Wood and wood products 2 99 101 0.1 Construction 4 230 234 0.3 Textile and leather 4 160 164 0.2 Light industry Non-specific industry 2263 2665 6096 271 11295 16.6 Total industry 5431 0 2665 19414 0 4218 0 31728 46.5 Transport sector Air 256 256 0.4 Road 2836 2836 4.2 Rail 450 450 0.7 Internal navigation 0 Non-specific transport 7 251 258 0.4 Total ansport 7 0 3542 0 0 251 0 3800 5.6 Other sectors Agriculture 22 1197 842 359 2420 3.5 Communications and Public Services 382 382 0.6 Residential 593 314 2158 369 6447 9881 .14.5 qcn-specific other 62 98 160 0.2 foral other sectors 677 0 1609 3000 0 1110 6447 12843 18.8 Ion-energy use 211 1928 2139 3.1 oral uses 6326 0 9744 22414 0 5579 6447 50510 74.0 irce: Romania - Enery Secor Sady (World Bank 1992) THE ENERGY SECTOR 173 Table 63 Romania energy use 1990 (ranking by social profitability) Sector SR MR SR soc. cunulative fuel shares (in percent) energy relative no. ISIC sector rane rant prof. Fuel Oil Elec- Gas Gross (million energy ricity lei) intensity Ranked by short run loss 22 301 milk products 1 1 -0.86 0 0 0 0 1 262 0.2 18 301 tin meat 2 3 -0.28 1 0 1 0 5 750 0.1 58 372 non-ferrous metal 3 4 -0.25 3 1 8 1 6 4738 2.4 19 301 tin fish 4 2 -0.21 3 1 8 1 6 33 0.2 38 351 basic chemicals 5 11 -0.11 9 9 14 9 7 11038 5.7 41 352 pharmaceuticals 6 5 -0.06 9 9 14 9 7 442 0.8 57 371 other metallurgy 7 12 -0.01 10 9 16 10 7 1129 1.9 SS 371 ironware 8 13 0.01 15 10 19 11 8 9523 5.5 21 303 edible oil 9 21 0.02 15 10 19 11 9 191 3.0 20 302 tin vegetables 10 6 0.03 15 10 19 11 9 242 0.2 36 353 refining 11 26 0.04 21 23 21 13 13 10085 1.6 44 351 synthetic fibre 12 14 0.08 22 24 23 14 13 1798 2.1 40 351 paints, varnishes 13 24 0.08 22 25 23 14 13 652 1.1 51 363 cement 14 10 0.09 24 26 25 17 14 2504 4.1 Ranked by medium run loss 22 301 milk prod 1 1 -1.02 0 0 .0 0 1 262 0.2 19 301 tin fish 4 2 -0.59 0 0 0 0 1 33 0.2 18 301 tin meat 2 3 -0.35 1 0 1 0 5 750 0.1 58 372 non-ferrous metal 3 4 -0.30 3 1 8 1 6 4738 2.4 41 352 pharmaceuticals 6 5 -0.28 3 1 8 2 6 442 0.8 20 302 tin vegetables 10 6 -0.26 4 1 9 2 7 242 0.2 49 364 clayware 16 7 -0.25 4 1 9 2 7 31 0.8 77 332 furniture 15 8 -0.23 4 2 9 2 8 713 0.4 52 369 concrete components 17 9 -0.20 5 2 12 4 9 2574 1.1 SI 363 cement 14 10 -0.17 7 3 14 7 9 2504 4.1 38 351 basic chemicals 5 11 -0.16 13 11 20 15 10 11033 5.7 57 371 other metallurgy 7 12 '0.12 13 11 21 15 11 1129 1.9 55 371 ironware . 8 13 -0.12 19 11 25 16 11 9523 S.S 44 351 synthetic fibre 12 14 -0.11 20 12 26 17 12 1798 2.1 23 304 milling, flour 20 15 .0.10 20 13 26, 17 12 73 0.4 69 383 electrical machinery 18 16 -0.10 20 13 27 17 13 535 . 0.2 28 321 textiles . 25 17 -0.10 21 13 29 18 17 2086 2.6 59 371 iron/steel 21 18 .0.08 23 13 31 19 18 3677 2.3 7 210 +35 coal+coke 30 19 -0.07 30 14 34 20 19 12057 7.2 47 362 glass 31 20 -0.07 30 14 34 21 19 942 1.6 21 303 edible oil 9 21 -0.07 30 14 34 21 20 191 3 24 306 animal feed 19 22 -0.06 30 14 35 21 21 194 0.1 48 361 ceramics 23 23 -0.05 30 14 35 22 21 224 1.1 40 351 paints. varnishes 13 24 -0.02 31 1s 35 22 21 652 1.1 67 382 household machines 27 25 0.02 31 15 35 22 21 163 0.3 36 353 refining 11 26 0.02 36 28 38 24 25 10085 1.6 29 322 clothing 36 27 0.06 37 28 38 25 26 433 0.1 72 384 motors 26 28 0.08 37 28 39 25 28 665 0.3 60 381 steel contruction 33 29 0.08 38 29 41 26 30 2235 0.5 15 290 chemical ore 49 30 0.09 38 29 41 26 30 53 1.3 Notes: a. Least profitable sector - 1. b. Ranking ignores capital and labor costs. c. Ranking ignores capital costs but not labor costs. The numbers in the first column are the sector numbers from the 105-sector breakdown used for the energy intensity calculations, those in the second column are ISIC codes, allowing comparison with western sectoral classification. The rankings by profitability ar indicated as SR (for short run) and MR (for medium rm). SR Soc. prof. is short rn profit as shadow prices (and MR is again medium run), defined as net value added at world prices. 174 Romw: RESTRUCTURING TO FACE THE WORLD ECONOMY Table 6.4. Shares in GDP Shares in GDP at constant prices Energy Relative Energy Relative shares energy shares * energy intensity intensiy Average Average 1985-88 1989 1990 1985-88 1985-88 1990 1990 GDP (mp) 100.0 100.0 100.0 100.0 1.0 100.0 1.0 Industry 54.8 53.9 47.6 68.1 1.2 75.3 1.6 Agriculture and Forestry 13.0 13.5 16.6 5.0 0.4 4.5 0.3 Construction 5.8 0.8 6.2 2.2 0.4 1.7 0.3 Transportation and 7.0 7.4 7.3 4.7 0.7 5.4 0.7 Teleconununications Trade 4.9 6.1 8.0 0.7 0.1 0.9 0.1 Other 14.5 12.9 14.3 19.4 1.3 12.3 0.9 Note: a. Other energy taken as domestic and the residual, total excludes energy sector use. TlE ENERGY SECTOR 175 Table 6.5. Shares in gross total output. Shares in total gross output. material Energy Relative Energy Relative energy input and net product shares' energy shares' intensity intensity Average Average 1985-88 1989 1990 1985-88 1985-88 1990 1990 Indusny Gross output 66.4 66.8 64.7 68.1 1.0 75.3 1.2 Material input 70.2 71.0 70.7 Net product 59.5 58.1 53.5 68.1 1.1 75.3 1.4 Agriculture Gross output 11.8 11.3 14.9 5.0 0.4 4.5 0.3 Material input 10.2 9.4 10.1 Net product 14.6 15.2 20.6 5.0 0.3 4.5 0.2 Construction Gross output 9.0 8.8 7.2 2.2 0.2 1.7 0.2 Material input 9.4 9.6 7.4 Net product 8.3 7.1 6.9 2.2 0.3 1.7 0.2 Transporzation Gross output 4.2 4.4 4.3 4.7 1.1 5.4 1.3 Material input 3.7 3.8 4.1 Net product 5.0 5.6 4.7 4.7 0.9 5.4 1.1 Other Sectors Gross output 8.7 8.8 10.0 13.9 1.6 13.2 1.3 Material input 6.5 6.3 7.7 Net product 12.6 13.9 14.2 13.9 1.1 13.2 0.9 Total Economyl Gross output 100 100 100 100 1 100 1 Material input 100 100 100 100 Net product 100 100 100 100 1 100 1 Notes: a. Material sector only. b. Net material product (national income). c. Other energy taken as domestic and the residual, total excludes sector use. 176 ROMANIA: RESTRUCTURING TO FACE THE WORLD )FNnV Table 6.6. Energy price movements Prices in US$ Prices in constant lei: index numbers Nov 1990 = 100 Nov Nov May Jan as % of Nov Nov May Jan 1990 1991 1992 1993 econ. 1990 1991 1992 1993 cost Energy product Crude oil (price/ton to refinery) Domestic (ton) 117 134 96.4 96 62 100 186 94 Imported (ton) 117 154 103.2 159.7 103 100 - 214 101 66 Petrol products (price/ton) Premium gasoline 342.5 508.4 324.2 475.3 209 100 241 108 169 Regular 337.8 441.5 286.1 436.5 200 100 212 97 157 Diesel 263.2 342.3 223.3 290.7 139 100 211 97 134 LPG (households) 46.7 15.6 11.2 27 is 100 54 27 70 Fuel oil (price/ton) From domestic crude (I% sulphur) 66.7 91.4 65.8 91.3 74 100 222 113 167 From imported crude (3.3% sulphur) 66.7 91.4 65.8 81.6 74 100 222 113 149 Natural gas (price/'000c.m.) Industry 46.7 59.2 46.8 44.8 52 100 206 115 117 Households 16.7 5.6 14.8 8.4 10 100 54 101 61 Lignite (price/ton) 7.1 15.2 10.9 18.4 127 100 347 175 315 Thermal coal (price/ron) 7.1 35 30 35 100 100 800 483 600 Electricity (price S/Kwh) Average 0.024 0.052 0.038 0.038 100 352 181 193 Industry 0.025 0.05 0.036 0.036 100 325 165 175 Households 0.011 0.0036 0.015 0.014 100 53 156 155 Thermal energy (price/gcal) Industry 7.8 4.2 9.5 14.5 100' 100 87 139 226 Households 3.7 1.2 3.5 2.3 16 100 53 108 76 Exchange rate lei/USSb 35 180 250 440 CPI October 1990 - 100 123.4 391.0 771.3 1274.8 Source: Romania - Energy Sector Study (World Bank 1992). Table 6 RomanialEnprice Notes: a. As percentage of marginal fuel cost. b. November 1990 taken as 35 (not 60) lei/USS The exchange rate shown in the source (Romania: Energy Sector Satdy, Table 6) for November 1990 is actually 60, but the prices ar consistent with the official exchange rate of 35. and this is the figure shown. THE ENERGY SECTOR 177 Table 6.7 Projected energy demands (millon metric tons oil equivalents) Actual Scenario I projections Scenario II projections 1989 1990 1991 1995 2000 2005 1995 2000 2005 108.3 100 81 80 86 104 124 GDP (index numbers) Energy: million tonnes oil equivalent Total primary energy consumption 76.4 70.4 64.2 40.7 43.9 49.2 42.4 47.1 53.8 Total final energy consumption 54.8 47.8 47.5 32.5 37.3 41.9 33.9 40.1 45.7 Difference 21.6 22.6 16.7 8.2 6.6 7.3 8.5 7.0 8.1 Industry 42.8 37.2 37.1 23.7 26.1 29.2 23.0 25.3 27.4 Services 4.8 4.2 4.1 3.9 5.0 5.9 4.5 6.0 7.3 Agriculture 2.3 2.0 2.0 1.9 2.2 2.5 2.6 4.3 6.0 Households 5.1 4.4 4.4 3.0 4.0 4.2 . 3.8 4.5 5.0 Balance -0.2 -0.0 -0.1 0.0 -0.0 0.1 -0.0 0.0 0.0 Primary fuel demands (million TOE) 1989 1990 1995 2000 Crude oil 31 24 14.8 16.5 Natural gas 23.3 28.6 17.8 19.8 Lignite 10.4 6.7 4.2 4.7 Coal 7 5 2.6 3.1 Hydropower 3.2 2.7 3 3 TOal 74.9 67 42.4 47.1 Trade in energy lSS millions except where stated Projections 1985 1986 1987 1988 1989 1990 1995 2000 Total imports Sm 8402 8084 8313 7643 8438 9114 10000 12500 Fuel, mineral, raw materials 4753 4095 4721 4078 4727 4339 Energy imports from 3500 3000 3800 3600 4000 4000 1154 2189 Percentage fuels (in %) 42 37 46 47 47 44 12 i Total exports Sm 10174 9763 10492 11392 10487 5870 10000 12500 Fuels, minerals, raw materials 3067 2462 2824 3198 3370 1978 Energy exports (ESS) 2000 1300 1700 1600 1900 1000 0 0 Percentage fuels (in %) 20 13 16 14 18 17 Net exports USSm Fuels, mineral, raw materials -10174 -9763 -10492 -11392 -10487 -5870 Energy (ESS p66) -1500 -1700 -2100 -2000 -2100 -3000 -1154 -2189 Percentage energy/total exports -18 -21 -25 -26 -25 -33 -12 -18 Source: MOINR; Romania - Energy Sector Stdy (World Bank 1992) Table 2 178 ROMANIA: RESTRUCTURING TO FACE THF WOPT.T Pr-nmer-Rv Table 6.8 Structure of gas consumption, 1986-1991 Year 1986 1987 1988 1989 1990 1991 Power Industry * 12.8 12.2 11.9 11.8 10.8 10.0 *Fertilizer 12.8 12.7 13.1 12.8 9.6 5.5 -Metallurgical 3.9 3.8 3.7 3.8 3.4 2.7 -Building Materials 2.7 2.7 2.7 2.6 2.6 2.2 -Machinery and Electro technical 1.7 1.7 1.7 1.6 1.6 1.3 -Other industry 3.0 2.9 3.5 2.9 2.9 2.4 Residential 2.8 2.8 2.6 2.7 2.7 3.1 Others 2.1 1.8 1.6 1.8 1.9 1.6 Total 41.8 40.6 40.8 40.0 35.3 28.8 Source: ROMGAZ a Excludes natural gas consumption for import processing. THE ENERGY SECTOR 179 Tablе 6А.1. ROmaaia energy use 1989 frOm 105 sесгог 10 eиpendituPes Од flaads In milll0д 1ei Ran+tгd Ьу тгrду иsг (f7 (F/1� SmFrSm У У 5тУ/5тУ пlalive лгг Тога! Encrgy Grm елггgу Grots Gurг ouryur глгr$у ирогг Scaors ' Сооl+coke Oi! Еlеалс Gat Хгы Eлergy оигриг rhon 5ь оигриг shan R, гцеллry оигрт т а . 79 Nearicrry 11008 2772 1946 , 8Э49 19 24096 S9 14 40802 2 7.8 -8 81 hец Э086 2911 4)Э 5329 1139 1Э558 70 22 19506 Э 9.2 0 ЭЬ rctwurд 0 8109 994 96Э 1SB4 11620 13 29 82729 7 1.7 Э3 Э8 ра'иц 211 as9s 2Э13 з178 1262 11580 4з 36 289п 8 3.7 l8 7.Э3 ooal+coke 9587 212 614 38 64 10516 SO 82 116Э3 8 12.0 -18 3S conyre 8321 !58 1168 4Э4 l80 10480 40 48 26467 9 3,2 � 1�+ 620 3221 1706 1612 2434 9583 9 33 109343 14 1.2 0 �°0�од 306 420Э 2630 420 484 809Э S S8 133829 21 0.7 1 �� 0 4672 464 g6 19 5210 11 61 45373 2Э 1.S 0 38 °°°�� 97S 376 2981 4ЭЭ 3 4969 19 64 26178 24 23 4 1� �т 129 ц01 482 491 7S9 4361 10 ё5 4398Э 86 I.3 0 s9 ;гоу,� 2311 78 взо s76 16а 3968 !7 69 226sь а7 а.з .1 �� 49 1701 lоrз в1 2за з137 1Э 7о аазаа 28 1.7 4 3��' • 30 2344 б78 23 9 3885 13 72 3167C 29 1.8 0 36 wbea 1312 111 483 79Э 82 3783 8 74 Э9800 31 1.1 1 �� 20 362 1202 768 Эб4 2615 9 75 Э0341 32 1.1 0 S1 enneat l4 4S7 833 130Э 1 2610 31 77 8490 32 4.1 9 ���� Э08 276 1102 S60 Э32 ц97 4 7В 9174Э 33 O.S ) ��'m+ch� 283 187 883 932 308 2415 4 $0 67784 36 03 -Э Э9 latiliar 7 936 971 Н47 3Э1 339Э 2t1 81 11817 39 2.9 -2 �>� +� 30 731 617 99 437 1992 30 82 9548 39 8.В 86 ЭЭ оергг 0 367 д47 9;D1 142 1657 82 83 flS889 80 1.S 1 ��� рп� 0 831 . 60Э fl68 Р� l692 6 1зд 37660 41 0.8 9 t3 otЬetdu� 109 В23 S� б$7 � 1322 U $,$ 18Z26 42 fl.1 -S �8 глиllе 17 186 719 330 26�1 1SЗб 2 _ 86 884ц 46 0.2 % g �Уи ryЬЬ�г 0 279 Э31 143 дб4 131В 9' 87 1Э550 47 Н.2 13 7 оФа тааl ! 80 60 ' 46( 248 >НЬ 10Э4 9 t3'9 14731 47 0.9 86 S tood 100 134 228 311 Н98 969 3 88 32164 SO 0.2 .S t e9uip fог tго1. 9S BBS Эб4 818 119 9ЗI Э !19 30818 S1 О.В -10 о$ 0 3l8 Э38 Н70 6 td32 l €19 58186 S3 0.2 -70 )� 1 78S 23 0 О 8б9 8 89 10291 Sб 1.0 Н8 ' гадlаттwl 11 187. 447 69 68 782 7 Qд 12004 S4 0.9 -fl1 81ass 0 33 163 S70 !д 764 11 90 6895 SS 1.3 S2 � !2 131 298 10 309 780 19 91 00Э0 3S a.S 0 о'�д 11 182 226 105 22@ 933 3 91 22613 S6 0.4 fl1 глоwгп 1l 71 434 193 92 942 8 92 416Э3 38 0.8 9 мtег 9 37 484 9g 3$ 6g4 2,2 92 Э047 38 3.0 ® �lргодt 98 399 173 б9 $ 699 ВП 9Е 3705 38 3.6 -8 Wгmnm В 118 308 8гS9 ?9 �дб8 8 . 9Э 27383 S9 0.3 89 Fuqueг 0 482 4А 4S б1 �31 10 99 6392 60 1.3 9 кроп о/ тФоагед еопtу оГ fiпc 20 seaors: кport.ot eaboidea eaerDr оГ iod�trial веаоr. 3цg toel ригеЬака: 40784 49154 7041Ф 93319 14868 171939 13 �д11 2273861 1.0 8 �г�еаевпв. �wnппввr.п.тлвn п.. Р............ •тr__' _ ^______ _- Table 6AI. Romania: energy intensities from 1990 101 sector 1-0 Table Panked by energy use (millions of lei. unless othetwise noted) F FIY SmFrSm Y Y SMY/SMY rela6w Total Energy Cum ene Gross Cum ourp energy fro, Secrors Coal+coke Oil Ejeanc Gas Hex Energy output rhareT output share twewdy ou:; 79 electricity 7274 4143 3609 13944 32 29001 71 16 40989 2 9.1 81 heat 2057 3875 741 7519 1630 15623 70 24 22294 3 8.0 36 relining 0 6741 1017 896 1439 10085 14 43 71429 8 1.6 2 38 paint 82 4052 2530 3132 1241 11038 50 37 219W 5 5.7 7.35 8134 264 1055 155 156 12057 133 31 19D39 4 15.2 -8 coal+coke 55 ironware 7320 IS2 1391 467 193 9S230 48 48 19902 9 5.5 .1 I Crops 171 2004 1316 1121 1689 6302 14 55 140677 22 83 construction 105 3261 2547 366 421 6721 5 51 126478 is as raw 0 5298 653 70 24 60" 13 58 44840 24 1 58 notifer mew 746 483 3100 406 3 4739 21 61 22199 25 102 admin 51 2246 337 494 759 4067 9 65 4720D 26 1.0 C 59 ironisteel 1915 71 936 587 165 3677 20 69 19486 31 2.3 -2 97 rail - 24 1865 1459 265 3731 is 67 24612 30 1.7 0 3 as am 20 3235 818 36 14 4123 14 63 30612 27 0 56 tubes 614 104 564 936 67 2205 8 76 28962 39 0.9 0 i2 co 8 223 1269 729 345 2574 10 71 26192 32 1.1 10 .1 cement 6 397 976 M4 1 2504 36 72 7047 33 4.1 10 ,0 steel ccinstr 109 221 IM 500 313 2235 4 73 31729 38 0.5 3 5 other mach 117 173 1013 776 317 2306 5 73 SUM 35 0.5 -11 9 iertilizer 3 760 979 133 300 2175 26 77 8438 39 2.9 -35 4 syn fibre if 631 661 74 421 1796 19 82 9685 31 2.1 7 1 paper 0 306 463 340 132 1742 13 83 13523 52 13 -2 i ardibre prod 0 669 610 153 90 1523 6 94 267" 53 0.7 - I i other chem 33 285 251 so 72 1143 7 as ISUB 55 0.9 -17 textile 9 218 3051 435 373 2066 3 79 79260 43 0.3 2 other metal 120 60 $75 278 97 1129 17 36 6821 56 1.9 58 food 60 182 385 472 296 1395 4 95 32774 54 0.5 -27 equip for Uals 36 179 486 263 1" 1110 4 v 28901 57 0.4 -10 oil 0 643 8" 313 13 logs 9 81 20110 31 1.1 -261 marine 1 1833 6S 0 1 1900 22 to 9659 50 2.3 0 nonfer metal 746 483 3100 406 3 4736 21 61 22199 25 7 traft 6 156 439 13 410 1025 29 87 61351 60 0.2 0 Livestock 105 326 1432 43 142 2048 2 79 122735 49 0.2 .1 wctej 5 47 751 137 111 1020 26 68 3874 60 3.0 0 rish 0 950 14 0 0 964 30 as 3223 60 3.4 0 .pon of embodied energy of fim 20 sectors: -6%3 .poft of emboided energy of indiistrial licictor -992U luel Pachuca: 29565 51040 435M 41 W7 14710 182963 9 200 2091816 -3 1 TmE ENERc;Y SECTOR I& ТяЬk бАЭ. Comparison 1990 aidh 1489 Raлkca Ьу uurgy иrг � Rопмiа елегgу ше Rыго to ппатаliгед /989 глпgу шг 1990 те�у рпвсh¢гц mi!/ lei l990/1989 ust солrпгдJов оиryш ehaлge ртсhагг oJmrrgy produar С90/С89 Ио. poezl�У е�дг еоаl oi1 еlацiе eas Ьаt се � та1 oi1 еlеа пи ак� m�i�uc 89 79 �;а rna аlаз эбо9 139а4 эа г9оо1 о.7 1.в 2.о ь.а 1.з 1.о 81 ддt YOS7 3675 741 7519 16Э0 13623 О.б 1.4 1.7 1.б 1.3 1.1 38 Wmt 82 4052 цЭ0 Э132 1241 11038 0.4 !.0 1.2 1.1 1.0 0.8 36 пfщi� 0 6741 1017 888 14Э9 10085 0.9 1.1 1.0 0.9 0.8 3S eoke 6062 12 349 154 136 6743 1.2 2.8 Э.4 2.9 1J 0.8 8Э оогоwпiоо 105 Э281 2547 366 421 6721 0.4 0.9 1.1 1.0 0.9 0.8 1�Ps 171 2004 1Э16 1121 16В9 6302 0.3 0.7 0.8 0.8 0.7 1.9 88 rotd 0 5298 653 70 24 бОб4 1.2 13 !.4 !.3 1.0 �+У м� 20 Э235 д18 ЗЬ 14 41Z1 0.7 1.3 1.9 1.7 1.6 1.4 �� �Ф 51 2246 S37 494 7S9 4087 О.д 1.0 1.У 1.1 1.0 1.1 s8 °т►'lerrmen! 4 483 Э100 406 3 Э995 Ф.4 0.9 1.1 1.0 1:1 0.8 �► � 24 l865 t439 99 285 3731 O.S 1.2 13 1.3 1.3 1.0 7� 2072 222 707 0 20 3020 OS 1.2 1.5 1.4 0.7 03 2�ыг� 8 22Э 1269 729 34S 7574 0.4 0.9 1.2 1.0 1.1 0.9 1�tiи б зе7 87б 123а 1 as0a о.4 0.9 1s • 1д 1.1 о.е 5 оФатиhФ�s 117 17Э 1013 77В Э17 2Э98 0.4 1.0 1.Э 1.1 l.1 O.R S гголмп 189 132 1391 467 19Э 2392 O.S 1.1 l.3 1.2 Ъ.1 0.8 3 пде! оо>uv 109 22! 1092 S00 313 22З3 0.4 0.9 1.1 1.0 0.9 0.7 а(е+ti4кя Э 760 979 13Э ' 300 2173 0.4 0.9 l.1 1.0 1.0 0.7 t ге:дk 9 218 1D51 434 37Э 2086 0.б 1.Э 1.6 1.4 1.3 0.9 • аЕе: 487 104 S64 836 д7 2078 0.3 1.0 !.3 1.2 0.9 0.8 1n'епогх 105 Э26 1432 4Э 142 20�8 д,3 10.8 13.4 12.0 1 L6 1.4 msтine ! 1837 6S 0 1 1900 1.1 2.6 3.2 2.6 0.8 oi1 0 643 848 383 l3 186В 2.2 2.8 2.3 2д 0.� syn ГЬп 11 631 661 74 421 1798 0.4 0.9 1,2 1.1 1.0 1.0 Авеrце of above сагiа:: 0.ТS 1.64 2.03 1.7В 1.бЭ 0.89 SD ot вЬоrв rwos: 0.85 1.9К 2.40 2.19 2.09 0.24 Arente га[ia 90/89: 0.7 !.1 1.1 l.4 1.2 0.91 �nt i� en в. DСвтnвrnтввлпвi. тn L' . г+.-. п.�. TTf..... .. в-•.....'_. ,.. Chapter 7 Agriculture Agriculture is traditionally a major sector in the Romanian economy. Currently it accounts for about 19 percent of the country's GDP and 29 percent of its workforce.' Romania has about 10 million hectares under cultivation-40 percent of the country's total land area-of which approximately 3.2 million hectares are equipped with irrigation facilities. An additional 4.7 million hectares are devoted to pastures, meadows, and forage. Prior to the 1989 Revolution, there were 395 state farms, 3,784 cooperative farms and I million small, privately-owned farms. The state farms, which have now been converted into joint stock companies, control 1.5 million hectares. 7be cooperative farms have been disbanded and the land they controlled, approximately 8 million hectares, is being privatized and returned to former owners. The privatization of land formerly controlled by cooperative farms is the most significant step in the return of agricultural sector assets to private ownership. As the privatization process continties, agricultural policies and perceptions must change to allow private owners and operators of agricultural land and other assets to realize the sector's potential. These changes include moditring expectations of what a market-oriented agricultural sector can achieve and changing pricing policies and international trade policies. Romania has been an important exporter of a variety of agricultural products, in particular wheat. Before World War I half of the country's wheat production was exported.' In the past few years the sector has fallen far short of realizing its potential and has been obliged to make emergency imports of wheat and other products to meet domestic consumption requirements. While an important pin of current difficulties can be attributed to recent adverse weather conditions, there are also significant ways in which policy reform can improve the short term situation and, more important, pave the way for a resurgence in the long tem. An important underlyipg basis for current policy problems is the perception that the country should be self-sufficient in many if not most food products.' This view reflects a misconception about how a country can realize its economic potential when it has a reasonably well operating market system. With such a system a country will find it beneficial to specialize in those activities in which it. has a true comparative advantage. Under this doctrine, it is to be expected that Romania will expand certain agricultural activities but phase out others. Unfortunately, current conditions are so distorted by policy that it is impossible to predict which specific parts of agriculture would expand and which would contract, if not disappear altogether. Another perception that guides current policy is the notion that food prices must be kept low for consumers, who spend a large share of their household budgets on food (about 56 percent) The resulting price controls and export bans benefit some consumers but harm others. 71ey also reflect a lack a confidence in consumers ability to respond to higher prices by rearranging consumption patterns, to substitute cheaper goods for more expensive goods. Price controls encourage excessive waste and spoilage, sending the message that low prices mean low value. As a result consumers, distributors, and producers do not exercise proper care of artificially low priced goods. Controls also retard supply response and exacerbate the problems faced by consumers because quantities AGPJCULTURE 183 available in the market are reduced. Attempts to remedy supply deficiencies by providing subsidies to producers or by securing emergency imports may provide partial redress, but they introduce other problems, aggravating the government's budget problems in particular.5 Romania does appear to have considerable potential in agriculture, but policies that promote food self-sufficiency or protect consumers impede efforts to realize this potential. Production Historical performance Increased production of major agricultural products in the interwar period continued after World War II, accompanied by increases in yields of principal grains. During the 1920s average annual output of wheat was 2.5 million tons while maize output was 4.1 million tons. During the period 1930-1938 wheat output averaged 3.1 million tons and maize output 5.2 million tons.' By the end of the 1980s (1986-90) average wheat output had risen to 7.2 million tons and maize to 7.8 million tons (table 7.1). Wheat yields rose from 0.85 tons per hectare in the early 1920s (1920-1924) to 3.02 tons in 1986-90. Increases in yields of nongrain crops were arrested in the latter half of the 1980s, however, and grain yields fell to even with other countries in the region. In the early 1920s, wheat yields were 0.85 tons/hectare in Bulgaria and 0.91 tons/hectare in Hungary, but by the end of the 1980s, Bulgaria's yields had increased to 4.16 tons/hectare and Hungary's to 5 tons/hectare. Table 7.1 Supply and use of grains and crops, 196q1993 Grains and Area Producdon Impons Expors Consaumption craps harvested (000 Tons) (000 Tons) (000 Tons) (000 Tons) (000 Ha.) 1986-90 (Average) 2,388 7,188 201 160 7.229 1991 2,217 4,990 352 0 5,342 1992 (Estimated) 1,475 3.053 726 0 3,779 1993 (Projected) 2,257 6.164 - - - Maize 1986-90 (Average) 2,685 7,838 525 206 8.157 1991 2,578 9,018 0 0 9,018 1992 (Estimated) 3,087 5,572 0 0 5,572 1993 (Projecied) 2,915 9.280 - - - Sunflower 1986-90 (Average) 454 605 1 6 600 1991 470 535 31 0 566 1992 (Estimated) 600 708 17 0 725 1993 (Projected) 616 965 - - - Sugar 1986-90 (Average) - 426 163 88 501 1991 - 338 200 0 538 1992 (Estimated) - 250 200 0 450 1993 (Projected) .- 420 - - Source: Ministry of Agriculture and Food. ROMANIA: RESTRUCTURING TO FACE THE WORLD EcoNoMY In addition to this erosion in agricultural performance, recent results have deteriorated sharply. In 1992 this was attributed primarily to a drought that severely reduced grain production. Wheat and maize outputs declined sharply in 1992, both falling nearly 40 percent from 1991 to 1992 (table 7.1). Wheat output in 1992 was 58 percent below the 1986-1990 annual average while 1992 maize output was 29 percent below average during the same time span. The livestock sector suffered after the 1989 Revolution, with the stock of bovine animals falling from 6.3 million in 1989 to 4.5 million animals in 1992. One explanation for this decline is that the cooperatives maintained excessively large stocks of animals, particularly too many older and infirm animals, (GATI (1992-R), p.69), but there were also problems arising from privatization, which are discussed later. The pig population has also declined since the Revolution, but its decline was more modest because pigs are easier to keep on small farms. Moreover, the estimated size of pigs at slaughter has also increased to 150 kilos. It's a bad sign since the optimum weight for slaughter is 105 kilos, any higher and the pigs are considered excessively fat. The effect of the decline in wheat production on consumption was ameliorated by increased imports. But with maize, the drop was not offset by imports and as a consequence feed for animals was cutback. Table 7.2 shows that domestic meat output, of beef and veal, pork, and poultry, declined in 1992 relative to both 1991 and the annual average 1986-1990. Domestic milk and egg output also declined in 1992 (table 7.3). Table 7.2 Supply and use of meat, 1986-1993 Producion Inports Exports Consumption Type of meat hou, tons) fthou. tons) fthou. tons) (thou. rons) Beef and Veal 1986-90 (Average) 249 12.6 87 174.6 1991 342 5 5 342 1992 (Estimated) 246. 2.1 0 243.9 1993 (Projected) 208 - - - POrk 1986-90 (Average) 760 62 121 701 1991 770 0 26 744 1992 (Estimated) 746 0 50 696 1993 (Projected) 720 - - - Lamb and Muanon 1986-90 (Average) 70 0 37 33 1991 78 0 0 78 1992 (Estimated) 73 0 0 73 1993 (Projected) 60 - - - Poultry Meat 1986-90 (Average) 408 14 83 339 1991 410 0 0 410 1992 (Estimated) 349 S.6 0 354.6 1993 (Projected) 230 - - - Source: Ministry of Agriculture and Food. AGRICULTURE 185 Projection Projections by the Ministry of Agriculture suggest a mixed picture for 1993. The land area planted in 1992 with winter wheat is 2.3 million hectares, up by more than 50 percent from 1991. Absent a repeat of bad weather in 1992, wheat output should increase significantly in 1993, to 6.2 million tons, more than double the 1992 crop, if the projections are correct. Although the area planted in maize is not expected to change appreciably in 1993 compared to 1992, maize production is projected to increase through higher yields to 9.3 million tons, 67 percent higher than the 1992 crop. But 1993 projections for domestic production of meat and dairy products suggest little improvement from 1992. For example, 1993 milk production is expected to total 4,1 million liters, modestly above the 4,050 million liter level of 1992. The projections for meat production suggest further declines in 1993, particularly for beef and poultry meat. For example, beef output is projected to decline from 246 million tons in 1992 to 208 million tons in 1993. Poultry meat output is projected to decline sharply, from 349 million tons in 1992 to only 230 million tons in 1993. Table 7.3 Supply and use of meat products, 1986-1993 Product Production Imports Exports Consumption Eggs (millions) 1986-90 (Average) 7,650 40 442 7,223 1991 7,177 100 0 7,277 1992 (Estimated) 6.670 200 0 6,870 1993 (Projected) 6,675 - - - Milk (nil aters) 1986-90 (Average) 4,348 0 0 4.348 1991 4,100 0 0 4,100 1992 (Estimated) 4,050 0 0 4,050 1993 (Projected) 4.100 - - - Butter (thou tons) 1986-90 (Average) 43 10.6 16 37.6 1991 41 5.4 0 46.4 1992 (Estimated) 40 7.5 0 47.5 1993 (Projected) 40 - - - Cheese (thou tons) 1986-90 (Average) 85 1 12 74 1991 86 0.7 0 86.7 1992 (Estimated) 84 0.1 0 84.1 1993 (Projected) 82 - - - Source: Ministry of Agriculture and Food. 186 ROMANIA: RESTRUCTURING TO FACE THE WORLD ECONOMY Potential * According to officials in Romania, potential grain output, assuming good weather and reasonable application of fertilizers' and pesticides, is approximately 22 million tons. Assuming total grain consumption is 12 million tons, this would leave 10 million tons for export. In addition, grain storage and handling equipment at the port of Constanza is apparently able to handle this volume of annual exports, but this would be operating facilities at full capacity.' Privatization Romania has been privatizing physical property in the agricultural sector since the 1989 Revolution. It has made substantial progress on agricultural land but only limited gains on other major farm assets, such as tractors and harvesters. Other state-owned assets and state-run operations, especially the cereal trading Regie Autonome or autonomous state entity (RA), ROMCEREAL, remain under state control even though there is no traditional economic rationale for this situation. The turmoil in the aftermath of the spontaneous privatization of collective farms following the 1989 Revolution appears to be over. The disruption was considerable, resulting in the destruction of equipment and facilities in some cooperative farms as the members divided up conveyable assets. Its effects are revealed in the substantial increase in slaughter of beef cattle and milk cows in 1991. The number of bovine animals slaughtered in 1991 was 2.11 million-34 percent higher than the average number slaughtered. during the five-year period 1986-1991 (table 7.4). (The distinction between beef cattle and milk cows is less precise in Romania than in other countries-for example, the United States, because a large share of beef meat comes from milk cows.) That many of the animals slaughtered were inilk cows is indicated by the decline in annual milk production from 1986-1991 to 1992, from 4,348 to 4,050 million liters. This reflects the dispersal of animals from the large dairy herds in cooperatives (350 to 750 milk cows) to 1 to 2 cows per farmer and the failure of individual farmers to accommodate all of the animals they.acquired. That the worst of the turmoil is over is suggested by signs that expectations are improving. Recent long-term investments are an useful indicator of an improvement in expectations. In farming areas near Bucharest, peasants are constructing new and durable houses and existing housing is being refurbished. Apparently these investments are being paid for in cash by farmers who have achieved handsome earnings producing vegetables for sale in Bucharest. Land The privatization of agricultural land has proceeded in stages, beginning with spontaneous efforts after the Revolution, then proceeding to formal efforts to grant preliminary and subsequeitly final certificates of title. The formal efforts, which implement the new land laws, allow for a maximum of 10 hectares to be returned to individual peasant families. The law also sets a limit of 100 hectares on the holdings by individuals. AGRICULTURE 187 Table 7.4 Livestock, 1986-1993 Total inventory at beginning of year (thousand head) Total slaughter (thousand head) Cattle 1986-90 (Average) 6,532 1.576 1991 5,381 2.110 1992 (Estimated) 4,355 1,250 1993 (Projected) 4.500 1,150 Hogs 1986-90 (Average) 13,619 10,100 1991 12,003 10,150 1992 (Estimated) 10,954 11,000 1993 (Projected) 9,800 10.000 Sheep 1986-90 (Average) 16.610 9.500 1991 14.062 8,600 1992 (Estimated) 12,879 7,800 1993 (Projected) 12.350 7.300 Poultry 1986-90 (Average) 122,860 520.000 1991 121,379 410.000 1992 (Estimated) 106,032 400,000 1993 (Projected) 115,000 330,000 Source: Ministry of Agriculture and Food Preliminary land certificates accounting for more than 90 percent of the area to be returned to private ownership have been issued. By the end of 1992, final certificates will have been issued to 5 percent of the individuals entitled to own agricultural land. By the end of 1993, this was scheduled to increase to 25 percent. A market is slowly emerging to buy and sell agricultural land. Since the sale or transfer of land requires a final certificate, and since few of these certificates have been issued, it is not surprising that transactions in agricultural land are limited. Advertisements are appearing in local newspapers offering to sell land, however, and for sale signs are being posted in front of some land plots. Reliable data have not been collected for land prices, but initial impressions by an official in the Ministry of Agriculture is that the price is approximately 3 to 4 million lei per hectare of nonirrigated land (US$6,800 to US$9,100 per hectare), which if true suggests that the potential productivity of land is expected to be relatively high. But this estimated price may be inflated if the land is near a village and could be used for residential or commercial purposes. The development of a market in agricultural land should be strongly encouraged, but efforts to do so are hampered by rigidities in the financial/banking system and by restrictions on land transfers imposed by the land law. Under present law, agricultural land cannot be used as collateral in securing loans from banks. A purchaser can use land as collateral f6r a mortgage to purchase land, but terms are onerous: the interest rate is 70 percent and the maximum term of the loan is only 5 years with an 18-month grace period.'0 188 ROMANIA: RESTRUCTUmING TO FACE *Fm WnPT rN v Equipment In addition to efforts to privatize land, the government is also trying to privatize other state- owned assets in the agricultural sector, such as tractors, harvesters, and other major agricultural equipment and machinery. Much of the equipment is controlled by organizations called "Agromecs." The total stock of tractors has declined in recent years, from 185,000 in 1985 to 132,000 today, because of exports and a failure to replace machinery. There has been a consequent aging of equipment. The current stock of tractors is distributed as follows: Agromecs, 72,000; state farms, 30,000; private, 30,000. Prior to the Revolution Agromecs primarily supplied mechanization services to the agricultural cooperatives. The 570 Agromecs and their 3,200 substations are scattered throughout the country. They employ 150,000 to 200,000 workers and own 72,000 tractors and 34,000 combines. Since the Revolution, private farmers have bought tractors from Agromecs and other sources, but the total number of tractors in private hands is still only 30,000. The Ministry of Agriculture plans to accelerate the privatization of Agromec equipment, hoping that by end of 1993 the number of tractors owned by private farmers will be the same as the number owned by the Agromecs. These plans include a proposal for a 156 billion lei "soft" loan program in 1993 under which private farmers can purchase equipment and a plan to transform Agromecs into private companies. Under the soft loan program, which should not restrict farmer choices to Romanian produced equipment as currently proposed, private farmers would be able to obtain a loan for up to 10 years term, with a 2 year grace period, at 10 percent interest with 10 percent down payment. Currently, peasants may obtain soft loans for 6 years (with a 1 year grace period) at 15 percent interest with 15 percent down payment." The proposal to transform Agromecs calls for shares to be sold to employees. What is not clear is who will organize and direct the resulting enterprises. To be successful, privatization will need to encourage entrepreneurship, and it is not clear that individuals with entrepreneurial skill will emerge from the existing Agromec workforce. Accordingly, it is recommended that non-Agromec individuals be allowed to acquire an interest in the resulting enterprises. The sales price of the machinery is set in terms of agricultural products instead of cash. For example, Agromec workers want to buy a tractor to work on wheat fields and the current price of wheat is 40 lei per kilo, the price of a 5 year old 65 horsepower tractor is about 800,000 lei, based on valuation methodology established by the Ministry of Finance. Therefore, in terms of wheat, the price of the old tractor would be 20,000 kilos of wheat. This financial proposal is an interim solution to financing the sale of state-owned agricultural equipment and no doubt provides a solution to a severe financing problem for Agromec workers. These workers earn only 22,000 to 25,000 lei per month (US$50 to US$57).12 Part of the Ministry of Agriculture plan to boost private sector ownership of tractors focuses on new tractors. Romania is expected to manufacture 40,000 to 45,000 tractors in 1993. The Ministry of Agriculture expects that 20,000 of these will be sold on the domestic market and that 10,000 to 15,000 will be exported. The prices of new tractors are: 2.4 million lei for a 65 horsepower tractor (US$5,500) and 1.7 lei for a 45 horsepower tractor (US$3,900). Of the 20,000 tractors expected to be sold on the domestic market, the Ministry of Agriculture predicts that 10 percent will go to Agromecs, 10 percent to state farms, and 80 percent to private farmers. AGRICULTURE 189 The interim role of ROMCEREAL For the short and medium term the state-owned organization ROMCEREAL has an important role in facilitating an increase in the country's grain production. ROMCEREAL is an regie autonomie or autonomous state entity that serves as a middleman for agricultural crops by purchasing grains from farmers, providing storage, and arranging distribution. While ROMCEREAL is a state enterprise, it is apparently self-sufficient financially and claims to have considerable independence from the Ministry of Agriculture, which selects only one of the fifteen members of ROMCEREAL's Board of Administrators.13 ROMCEREAL operates throughout the country and has subsidiaries in each of the country's 41 judets or counties. Each subsidiary in turn has a considerable degree of independence and also has its own governing board. ROMCEREAL currently employs 14,000 workers, down from 20,000 before the Revolution. By comparison, there are only 1,600 employees in the Ministry of Agriculture." Immediately following the Revolution, ROMCEREAL played an important role, facilitating the transition from the former cooperative system to the present system based on private ownership of land. The process of granting land titles has taken longer than anticipated and the consequent uncertainty over ownership could have lead to serious reductions in area planted and in harvests. ROMCEREAL and the Ministry of Agriculture actively encouraged the formation of voluntary associations of peasant land owners. These associations, which are freely entered into by peasants, do not require final land certificates. Even with preliminary certificates, peasants have formed voluntary associations in order to create 50 to 100 hectare fields for more efficient production of wheat, maize, sunflower, and other traditional crops. Individual peasant holdings are limited to a total of 10 hectares and are typically scattered in small holdings surrounding a village. Voluntary associations of peasants are a rational response .to the problem of aggregating fragmented and scattered holdings into efficient sized fields to utilize tractors, harvesters, and other large machinery. The typical peasant land owner apparently not only has scattered land-holdings, he also belongs to two or more voluntary associations, and may also keep some of his holdings out of association arrangements to operate them independently. The associations typically comprise five or six peasant families. For example a peasant may use some of his land to form a large wheat field with some of his neighbors (50 to 100 hectares). Then, with land in a different part of the country, he may join another group, forming a large field that is planted in maize. Finally, he might- use the remaining land as part of another field (and association) on which sunflowers are planted.3 ROMCEREAL not only encourages the formation of voluntary associations of peasant landowners, but it also contracts with each association to provide various inputs and services, for example, seeds, fertilizers, and fungicides." Currently, ROMCEREAL has approximately 20,000 to 30,000 contracts, about 500 per judet. The specific details of each contract vary, some-for example-with respect to use of fertilizers. The contracts often call for one or two of the farmers to provide labor services to unload material. As a side arrangement-outside the ROMCEREAL's contract-the peasants who agree to work in the field are compensated by the other members of the association. In some cases, especially when the farming area is close to a major town, city, or factory, several members of the association may have full time jobs outside fanning. ROMCEREAL is therefore concerned that some members of the association devote time to tend the fields. ROMCEREAL also provides machinery services through the local Agromec, and, after harvest, buys the crops. Formerly, ROMCEREAL would set the procurement price for major crops, with approval of the Ministry of Agriculture. More recently, ROMCEREAL monitors prices on the free market and adjusts the acquisition price toward the free-market level. ROMCEREAL's prices do not appear to have been sufficiently attractive to compensate farmers for increased prices of inputs, however. Consequently, farmers have chosen to maintain large inventories of grain in 1992. According to one estimate, private sector holdings were nearly half of the country's total grain stocks.'7 Controls on prices The most apparent part of a pervasive system of price controls in agriculture and food is rapidly being dismantled. Overt or direct price controls were removed from several kinds of beef and pork, edible oil, and sugar on September 1, 1992," and now apply only to the retail prices of four food products: bread, butter, milk, and milk powder. These were scheduled to be removed in May 1993, and to lessen the impact of expected increases in the price of these food products, the government planned to raise wage rates at the same time. While it is important that the remaining price controls be removed, there is an even greater concern about indirect price controls. Prices of many products, while not covered by overt controls, are nonetheless subject to-control by other methods. These indirect controls are more problematic because they are less transparent but can be just as distortionary. Direct price controls A desire to protect consumers is usually the justification for price controls on major food products. Officials believe that consumers benefit from low prices for food necessities because they are provided with more money to spend on other goods and services. But, if price controls are effective, with consumers paying lower than the market price, controls invariably cause shortages. At least some consumers cannot buy as much as they would like at the controlled price. It is accordingly necessary for the government to ration. Rationing inevitably discriminates against some consumers, often by segregating consumers into groups and restricting each group to a different type of retail outlet, varying quantities delivered by area or region (e.g., urban/rural), or delivering to retail outlets at particular times. Consumers in the less favored group, living in the region with relatively small deliveries, or unable to shop at times that deliveries are made, are discriminated against. Even viewed as a short run policy intended to protect consumers, price controls invariably harm those they seek to help. As well as inducing discrimination price controls cause a variety of costly distortions that adversely affect many if not most consumers-for example, time lost waiting in long queues, or facing a limited selection. But the longer run effects of price controls are even more adverse for consumers because price controls diminish supply response by producers and cause reductions in supplies. To reduce the consequent shortages and increase the incomes of farmers, the government grants subsidies to boost output. This raises additional problems by placing strains on the national budget. The bread industry illustrates some of the problems of price controls." The retail price of a standard loaf of white bread (500 grams) is set at 20 lei in state shops (in December 1992). Most of AGRICULTURE 191 the bread consumed in the country, 85 percent to 90 percent, is sold by state shops, with the remainder sold by private outlets at a considerably higher price of 50 lei per loaf. The disparity between the price of bread at state and private outlets and early morning queues in front of bread shops, even in front of private outlets (at least on weekends), are strong indications of shortages.0 The government also provides sizeable subsidies to the wheat-bread sector. The subsidy is paid by government directly to state bakeries to reflect the difference between the fixed retail price of bread (with allowance for retail margin) and cost of wheat flour. In 1992, the amount budgeted for subsidies to bread was 39.1 billion lei, or 12 percent of total subsidies granted by the government-336.3 billion lei." These data presumably do not incorporate the effect of the recent production subsidy granted for grains in the amount of 9 lei per kilo. This new subsidy was announced and implemented in the fall of 1992. A comparison of the prices of wheat and bread reveals the importance of the subsidy to the sector. The retail price of bread is 40 lei per kilo. Coincidentally, the farmgate price of wheat was also 40 lei per kilo. To bake a kilo of bread requires approximately 1.07 kilos of wheat.= Therefore, based on the prices given above, each 20 lei loaf of bread incorporates a quantity of wheat for which the farmer received 21.4 lei. In other words, all of the costs of handling and processing wheat, wheat flour, and bread are forgiven consumers and absorbed by the government. Indirect price controls Officials are concerned about monopolies and about the effects of monopoly pricing, rightly so given that under the former regime many state-owned enterprises exercised monopoly power. Many of these enterprises probably continue to wield considerable market power. There is still no antitrust or competition policy law and, although there will apparently be such a law soon, it will take considerable time to form and train a staff to properly administer it. In the interim, the government has adopted the following rule: intervention in pricing is justified in situations where there are fewer than three domestic producers or where state-owned or regie autonome are selling goods or services'. The underlying presumption is that when there are three or more competitors, competitive forces are sufficiently strong to prevent collusion. This presumption is a reasonable rule of thumb for several markets,2 particularly for traded goods (goods that are exported or imported) that have been liberalized (see below). For agricultural and food products there are several instances, involving significant products, where government may intervene to regulate price. As of the fall of 1992, these products-in addition to the four products subject to direct price controls-included: sugar, edible oil, various meat and meat products, hen eggs, and autumnal potatoes.2 Thus, state ownership of most food processing plants allows the government to guide if not control prices, even though a product may be liberalized. As long as this situation continues it is unlikely that affected price levels will, on average, reflect all the costs involved in producing and distributing goods. Moreover it is not even known whether average prices are too high or too low, let alone if they respond to market forces. This reinforces other arguments to expedite efforts to privatize state-owned assets in agriculture and food processing. These efforts need to be done in such a manner that fosters competition. Liberalization goals and accomplishments When are prices not only liberalized but also free of discretionary influence by government? One convenient test applies to traded goods-goods that are imported or exported-and involves comparing prices of domestic products with border prices of comparable traded products.2 (This test also involves a test of the significance of barriers to import or export, which are discussed in a later section.) If the two prices are equal, the domestic price is fully liberalized. However, domestic and foreign traded products typically are not identical, because there are many dimensions of quality and it is likely that in at least one or more of these dimensions there will be significant differences .between domestic and foreign products. Even if domestic prices are fully liberalized there can be a difference between domestic and traded prices. An alternative test is to examine the behavior over time of domestic prices and comparable traded good prices. If two prices are highly correlated over time it is likely that domestic price is fully liberalized. With these qualifications in mind, table 7.5 provides information on the ratio of domestic to border prices for eight products in September 1992.? The data suggest that the price of maize and eggs is very close to world price levels. But prices of potatoes and broilers are high, while prices of wheat, young beef, hogs, and milk are low. These price ratios suggest that the influence of direct and indirect price controls or regulations distorts prices but that the direction of bias is not the same across all products. This implies that as liberalization proceeds,. relative prices across products will change, altering the mix of products produced in the country. Assuming producers are free to respond to market incentives, they will expand output of a product whose relative price increases and cut back production of a product whose relative price falls. However, the relative price data in table 7.5 are too preliminary to provide guidance.28 Table 7.5 Monthy market prices, 1992 (percentage of September 1992 border price) Producr February March April May Jmne July Augus September Wheat 49 44 54 51 - 59 63 64 73 Maize 60 60 66 66 78 92 87 102 Potatoes 138 139 201 137 274 190 123 129 Young Beef 34 37 47 46 60 55 50 56 (liveweight) Hogs 43 46 56 50 61 64 62 66 (liveweight) Broilers 120 114 104 114 122 126 130 120 (liveweight) Cow milk 41 43 46 46 67 55 49 55 Eggs 88 82 60 64 78 81 92 106 Source: World Bank, 'Romania: Agricultural Prices, Subsidies, and Marketing Review,' Nov. 3. 1992 (Yellow Cover Report). Report No. 11350-RO, Agricultural Operations Division, Country Deparmnent 1. Europe and Central Asia Region. AGRICULTURE 193 Proposed commodity exchange There is currently a proposal to form a commodity exchange in Slobozia, the site of the former -commodity exchange that began operation in 1924 and was closed after the second world war. This is a significant development because the potential effect of such an exchange in facilitating the shift to a market-oriented system for agriculture is considerable. If a commodity exchange were in operation for major agricultural products, prices of the products covered would escape government influence. There would be no role for government procurement prices. Even large enterprises seeking to purchase grains, such as ROMCEREAL, would find it less costly to place at least some of their orders through the exchange and to use exchange prices in arranging other purchases. Several major organizations are supporting the new exchange, including the former foreign trading companies Agroexport and Fructexport, as well as ROMCEREAL. The 1 billion lei cost of setting up the exchange would be financed by the supporting organizations and by one or more private banks. The EC Phare program has also promised technical help and money. Although Government financing is not contemplated, technical support from the Ministry of Agriculture will be needed." Under one plan, the new exchange would initially start with agricultural crops, including wheat and maize, and also include some forestry products, for example, mushrooms. A draft law has been prepared and circulated and some expect the new exchange could start operation in mid-1993. The prospective opening date of the exchange is probably optimistic. Establishing a reputable and financially sound commodity exchange takes time and should involve individuals knowledgeable about the operations of existing exchanges. The commodity exchange in Budapest started cautiously and modestly in 1989. It was open only one day a week and offered only futures contracts (in forint). It has since gradually grown and is now scheduled to expand operations to two days a week.30 Financing agriculture The Agrobank is the traditional source of financing for agricultural enterprises. Since the Revolution this bank has diversified and become a universal bank, engaging in all kinds of activities, including retail, wholesale, and foreign trade. Its strategies are to expand its retail business (deposit taking) and to seek out new business in area such as tourism and services. These efforts help diminish barriers to saving-investment flows across sectors, thereby improving the allocation of capital in the country, and should be encouraged. The Agrobank's 222 branches and agencies are spread throughout the country and employ 7,000 workers. The Bank has also been aggressive in expanding its client base, growing from 10,000 clients before the Revolution to 150,000 clients today. Of these, 143,000 are private customers. The Agrobank has also reduced its dependence on the National Bank, which prior to the Revolution provided 90 percent of Agrobank's resources and now provides 27 percent. Agrobank's main activities are still tied to agriculture: 90 percent of its loans are to this sector. Moreover, most of its loans. 80 percent, are short term, one year or less. Its major customer is still ROMCEREAL, which accounts for 60 percent of its loans? The bank also administers "soft" loans for the agricultural sector on behalf of the National Bank. In 1992 there were five soft loan programs, all but one of which were for short-term loans to obtain materials such as seeds, feeds, and fertilizers for growing and nurturing crops and livestock. These loans were granted at 15 percent interest in a credit situation where market interest rates increased from 30 percent at the beginning of 1992 to 80 percent in May. Rates subsequently settled at 70 percent by year end. Not surprisingly, these loan programs were oversubscribed. For example, the 23 billion lei soft loan program that began in September had applications totalling 250 billion lei. The Agrobank administers these loans and it is not known how its staff decides to allocate funds among the applicants. The need to grant subsidized loans to the agricultural sector will diminish as prices are liberalized. Indeed, the elimination of concessional credits is one aspect of full liberalization. Current high market interest rates reflect macroeconomic instability, a problem best dealt with in a broad stabilization program that sloVvs inflation. Problems with fertilizer Romanian grain production has long been characterized by low yields, about one-half the size of those in western European countries. This is attributed partly to low application of chemical fertilizers. In 1986, the rate of fertilizer application in Romania was about one-half the levels in western Europe. Since 1986, it has fallen sharply, and in 1992 was approximately 30 percent the 1986 level. At first blush this situation is peculiar since Romania has the ninth largest chemical fertilizer industry in the world. But the domestic fertilizer industry, which was heavily dependent on subsidized imports of natural gas from the former Soviet Union, has suffered since the breakup of the CMEA trading system. To encourage farmers to use fertilizer the government provides substantial subsidies to the industry. Domestic prices of fertilizers are about one-tenth the level of world prices. But output of the domestic fertilizer industry cannot meet domestic demand because the industry faces a shortage of energy. Recently the industry has been operating at less than 20 percent of capacity. The domestic energy shortages and problems of the fertilizer industry should discourage Romania from pursuing higher rates of fertilizer usage. The importance of raising the use of fertilizer is illustrated by a simple case." Suppose that all domestic demand for fertilizer was met by imports. Romania will require 3.12 million tons (active ingredient) of fertilizer to match the usage rate of western Europe. Based on September 1992 border prices of fertilizer, the import cost would be 435 billion Lei. The consequent level of grain output would be at least 22 million tons, possibly as much as 30 million tons. Of this total, 10 million tons could be exported. Again based on September 1992 border prices of wheat and maize, the value of these exports (assuming half wheat and half maize) would be 519 billion Lei. Thus, even if the output of the domestic fertilizer industry is ignored completely, the country has a net gain in foreign exchange earnings by increasing fertilizer usage. Admittedly this example does not consider the additional domestic costs of transporting and distributing the imported fertilizer. But then it does not consider the 450,000 ton output of the domestic fertilizer industry's 10,000 workers either. Problems in the dairy sector Problems in the dairy sector became even more glaring following the 1989 Revolution. The most visible symptoms were shortages of fresh milk and an increased reliance on fresh milk/powdered AGRICULTURE 195 milk blends. Consumers reportedly start forming lines in front of retail outlets as early as 4 am waiting for fresh milk to be delivered from dairy processing plants. While there is nc formal limit on the amount of fresh milk a single consumer may purchase, custom limits purchases to 2 liters per customer to avoid violence. Milk is so scarce that some parents have resorted to flying in fresh milk from other countries. The shortage is caused by several factors, including adverse weather in 1992 that reduced forage, and land holdings ill-suited for dairy production. But the major source of problem is government price controls on retail milk. Indeed, pricing distortions in dairy and milk operations are more severe than in the wheat and bread sectors. In the case of milk-dairy operations, there is also evidence of considerable wastage. The dairy processing industry is comprised of forty-eight commercial societies with state capital that operate in forty-one judets. The societies have a capacity of 8 million hectoliters of . consumption milk and 5 million hectoliters of fresh product for cheese and butter. Milk powder capacity is 60,000 tons per year, butter 81,000 tons per year, and cheese 120,000 tons per year. The dairy equipment, most of which was imported, is old, with an average age of 15 to 20 years. Until 1990 Romania exported a significant portion of its output of butter, 37 percent, and cheese, 14 percent, (see table 7.3). After the Revolution, the only exports were small consignments, under barter arrangements, to import inputs and equipment for the dairy sector. This decline dates from the mid 1980s. Currently milk processing plants are operating at only 30 to 40 percent of capacity. A substantial portion of the excess capacity is attributed to excessive optimism with respect to the output of forage. Even in the mid 1980s capacity utilization was not appreciably greater than 50 percent. The recent decline in capacity utilization was caused by lack of forage and the dissolution of the large dairy farms formerly run by the cooperatives, which sharply reduced output. Milk yields, however, have increased steadily between 1989 and 1992, from 1,800 to 2,450 liters per cow per year. (By contrast, milk yields are greater than 5,000 liters in the U.S.) Ministry of Agriculture officials attribute the increase in domestic yields to privatization, claiming that farmers have improved the care and maintenance of milk cows. Some large dairy farms remain state farms, but they only account for a small part of total milk production, about 15 percent. A considerable quantity of domestic milk production appears to be wasted. Based on the above capacity and capacity utilization information, the annual quantity of milk processed by domestic dairies is about 500 million liters (equal to capacity of 13 million hectoliters times capacity utilization of 40 percent). However, domestic milk production is more than 4,000 million liters. While some of this vast difference, roughly 3,500 million liters of milk, reflects excessive consumption and usage by farmers (as fluid milk, for making butter and cheese, and to feed livestock), the magnitude of the difference suggests that an enormous quantity of milk production is lost through spoilage. Spoilage is due mainly to problems with collection and transportation of fresh milk from the farm to the dairy. Farmers typically deliver their milk to local collection tanks, which hold 1,000 liters, but the cooling equipment at the collection points have problems. Moreover, in some cases dairy trucks collect milk from individual farmers who typically do not have refrigeration equipment. Transport from collection points to dairy involves substantial waste, especially in the summer months because even though the trucks in the dairy fleet-which is comprised of approximately 1,600, 2 to 4 ton trucks-have stainless steel tanks, none are refrigerated. The state-owned dairies pay farmers 55 leilliter for fresh milk. Although the free market price of fresh milk is considerably higher, 100 leilliter, sales by farmers to the free market are small Prixg,% km& - Prr"TyrrTmmr.3 rnr,& r-r' rur 117f'rr% rm because state dairies also provide forage to the farmers. The retail price of processed fresh milk is 16 leilliter. The difference between the retail and farmgate prices is covered by government subsidies. A recent development is the attraction of a Dutch firm, which has established a dairy processing plant near Bucharest. The plant now has 250 milk cows and will eventually have 500, all imported Holsteins. Romania contributed shelter, land, and forage, while the Dutch partner contributed the cows, processing technology (including plastic packaging equipment), and milking machinery. The target output is 10,000 liters of milk per day. The Ministry of Agriculture hopes to eventually have ten of these joint venture dairies. For perspective, dairy milk consumption of Bucharest is 250,000 to 300,000 liters per day. To achieve that total it is necessary to transport milk from more than 400 km away from the city. Foreign joint ventures in dairy operations are a possible source of marginal improvement in the milk-dairy industry, but an assessment of these investments requires information about the subsidies they receive (which was not available in this study). The more fundamental solution to the problems of the sector lies in the privatization of dairy assets and price liberalization. These moves are strongly recommended. Based on the massive waste that appears to exist in the milk-dairy sector there are substantial opportunities for profitable investment in items such as refrigeration equipment. To provide incentive to elicit these investments, market prices must correctly reflect the values and input costs of producing and distributing milk. Further, private enterprises are needed to provide the proper degree of response to these opportunities.3' Export/import companies Since the revolution there has been significant improvement in the regulation of imports and exports. Previously, all export and import transactions were monopolized by official state Foreign Trade Companies. While these companies continue to operate, the competitive environment that has evolved suggests that, for the most part, concern aboult monopoly power of state companies is not warranted. Extreme measures, such as dissolution of the state trading companies, are not appropriate because they would not improve performance in the trading business. It is relatively easy for a company, new or existing, to begin export or import activities. All that is required is that the company formally indicate its plans to engage in trading, notify the Chamber of Commerce and the Ministry of Trade, and have a bank account. The entire application process takes about one month. Although -precise data are lacking, there has been a tremendous increase in the number of trading companies-in particular importing companies-since 1990. There are also reports that a major part of this expansion can be atttibuted to former employees of the state trading companies, who left their old firms and helped found new trading companies, some of which have become successful-for example, Romagra, which trades in fruits and vegetables, and Semrom which trades in seeds. Private trading companies are also successful in terms of gross value of business transacted. Currently, the private sector accounts for 27 percent of the value of total exports and 30 percent of the value of total imports (separate data are not available for agricultural and food exports and imports). Moreover, the private sector is continuing to take business away from the state trading enterprises at a rapid rate. Currently, the private sector is reportedly gaining an additional 1 percent share each month. AGRICULTURE 197 Since the removal of their state monopolies, the traditional foreign trading companies have been forced to adjust their operations, having to not only compete in their traditional lines of business, but like everyone else try to diversify and engage in new lines of business. One form of adjustment by state trading companies to the new competitive climate is downsizing. Although information is limited, since the revolution employment at one foreign trading company declined from 230 to 150 workers, while at another the workforce declined from 120 to 70. These cuts occurred at the same time as companies were expanding the scope of their activities and entering new fields. For example, the traditional state trading company for dairy products now imports and exports all types of goods and agricultural products. But at the present time its major interests are still imports of milk powder and butter, because of shortages of these products in the domestic market. Similarly, the state companies' whose traditional product line was fruit now also imports potatoes, meat, and live animals. And one of the first and largest agricultural foreign trading companies has not only diversified its trading activities outside grains to include milk products, sugar, meat, and coffee, but it now also owns five bakeries and has acquired a pig farm near Bucharest. All three companies are reportedly profitable, and pay monthly salaries (gross of salaries tax) of 50,000 lei or more, double the salary level of professional staff in the Ministry of Agriculture. Import and export policies The liberalization of trade has eliminated the state's monopoly of foreign trade, removing restrictions on companies that wish to import or export goods. Unfortunately, liberalization has not been extended to all agricultural and food products. Restrictions on trade in agriculture are an important component of a program that ostensibly attempts to protect consumer interests, or support domestic producers." IMports An important advance was achieved in April 1992 when licensing requirements for imports were removed for most goods, but problems remain in three areas.' The first area concerns tariffs, the second, the manner in which emergency imports are administered, and the third-and most important-the problems traders face in obtaining foreign exchange. Firms seeking to import must generally obtain foreign currency. From information obtained from several governmental officials and traders in the private sector, permission to hold foreign currency is not automatically granted." The granting of foreign exchange for imports was depicted as a decision by the banking system based on unspecified priorities. Several first hand examples described how applicants for foreign exchange had to wait as long as six months before securing approval to execute their import orders and spend foreign currency." In some instances, the long delay resulted in the cancellation of import contracts. The problems experienced in securing foreign exchange poses a serious obstacle for traders. From their standpoint the procedures adopted by the banking system to allocate foreign exchange are cloaked in mystery, and rumors circulate about special arrangements being used by bankers to discriminate against ordinary businessmen in favor of special interests. This must be rectified quickly, not merely to remove a barrier to imports but to avoid undermining confidence in the banking system. Tariffs are relatively high but, more important, they are currently not bound under the GATT.39 It is important that current negotiations with the GATT to establish bound tariffs be successfully concluded as soon as possible. Room for discretionary behavior to protect domestic producers not bound exists when statutory tariff rates are relatively high and not bound. There is the potential, in effect, for a variable import tariff policy, a policy resembling the enormously costly variable levy of the European Community's Common Agricultural Policy (CAP). One indicator of the scope for discretionary behavior is suggested by the difference between the current statutory tariff rates and the average tariff rate actually applied. Based on data for the first half of 1992,'0 the (weighted) average statutory tariff rates for four broad categories of agricultural and food categories were as follows: live animals and animal products-21.72 percent; vegetable products-21.91 percent; animal, vegetable, or prepared fats and oils-24.94 percent; prepared foodstuffs and beverages-28.93 percent. The corresponding average tariff rates actually applied were: 5.41 percent, 3.30 percent, 9.25 percent, and 16.73 percent. Part of the difference between statutory and applied tariff rates for 1992 is explained by the waiver of duty rates in special circumstances, namely the shortage of supply in 1992 and the consequent program of emergency imports for some products. Tariff policy for agriculture has also been characterized as an instrument to stabilize domestic prices and markets.41 As a general issue, the flexible approach to tariff rates should be replaced by fixed rates, fixed preferably at lower rates than current statutory rates. The second area of concern is the opaque and excessively costly policy used to administer emergency imports of certain agricultural and food products. The shortage of certain products has forced Romania to import some goods. Moreover, since domestic prices of some major products have been kept artificially low, the government has been obliged to subsidize imports. For example, during 1992 the former foreign trading companies Nutricomb was authorized to import soya bean meal cake at 90 lei per kilo when the domestic price was 60 lei per kilo. The Government paid a subsidy of 30 lei per kilo to Nutricomb-to compensate it for the excess of import price over domestic price. When emergency imports are deemed necessarily, the government notifies four former traditional foreign trading companies and requests them to submit 'offers" specifying import price, specific type and grade of product, and proposed delivery dates.' Only if none of the four foreign trading companies.expresses interest in importing the goods sought by government does the government contact other trading companies. Private traders believe the emergency import program is reserved for the state trading companies, which derive a covert subsidy.'3 If the emergency import program continues, it should become more transparent and open so that imports are secured at lowest cost and that the program has a minimal impact on the Government's budget. Exports The major issue for export policy is bans. There is also a problem with export quotas on agricultural products. Export bans exist for many agricultural and food products, including the major grains (wheat, maize, and also flour), milk and butter, and sunflower oil and seed. These bans, which are supposed to be temporary, are related to controls on domestic prices." Proponents argue that bans are needed to ensure adequate quantity for domestic consumers. But many domestic firms would find it more profitable to export their output. AGRICULTURE 199 The major problem with export bans is that they completely insulate the domestic market from the world market, distorting producer and consumer decisions through artificially low domestic prices. In particular, export bans retard domestic supply response and cause shortages. This can be offset to some degree by granting subsidies to producers, such as the government's recent direct production subsidy to grain farmers at 9 lei per kilo. But production subsidies prompted by domestic shortages do not address the information problem caused by export bans. Price controls and export bans should be abolished together. If the bans are not removed they will constitute an indirect mechanism to restrict domestic price. Export quotas (if effective), like export bans, cause a rift between domestic and world market prices. But with export quotas domestic producers are permitted to legally access the world market and potentially earn excess returns-quota rent on export sales. Export quotas are only applied to sheep and sheepmeat and cattle and beefmeat. It is not clear how effective the two export quotas have been. Utilization rates, which are available only for 1991, were only 65 percent for sheep and sheepmeat and 84 percent for live cattle and beefmeat. Under the current export licensing system administered by the Ministry of Trade, licenses are allocated on a first-come, first-serve basis and require a deposit of 2 percent of value of the licenses requested.4s Recipients of licenses must use them within a fixed period of time generally 6 months and are prohibited from transferring or selling them to others. If the export quota is not binding-if exports would be smaller than the quota limit in the absence of licensing system-the current system serves primarily to monitor exports. But if the demand for exports increases, the system would ensure compliance with the quota ceiling. The current system does not state clearly whether the quotas are binding. It is likely that the present system retards exports and foreign exchange earnings through the 2 percent deposit, which may be too costly for exporters to forfeit if they do not complete the export transaction with a foreign buyer. The exporter is a middleman whose income is normally only a fraction of the gross value of the exports. The 2 percent deposit is small compared to the gross value of exports but not necessarily small relative to the exporter's income. For example, if the exporter's income is 10 percent of the value of imports, the 2 percent deposit represents an up front commitment of 20 percent of his expected income. Since the licenses must be used within a fixed time period and cannot be transferred the regulations would discourage newer, smaller, or risk adverse exporters from applying for licenses. The remedy to this problem is to permit transfers of licenses. Transferability introduces flexibility. If initial recipients are unable, for any reason, to use their allocation they can sell their licenses to others and recover their deposit. Transferability of export licenses is strongly recommended. The Europe Agreement with EC The recently concluded trade agreement with the EC offers only limited market opportunity for Romanian agricultural exports. Romania will have to find other markets if it reaches its full production potential. * The overall structure of the EC's agreement with Romania is comparable to the agreements the EC signed recently with Czech and Slovak republics, Hungary, and Poland. The main elements include tariff quotas for a wide variety of products. These quota quantities are allowed to increase by 10 percent per year for five years. The initial quotas are based on actual Romanian exports to the EC during the reference period 1988 to 1989. Moreover, during the first three years the EC will reduce tariffs or variable levies on within-quota quantities by 20 percent per year. Exports in excess of the quotas will be subject to full duties or levies. Since Romanian shipments during the reference period were generally low, prospective additional export revenues will be relatively modest. Romanian agricultural and food exports to the EC averaged only US$ 114 million in 1988-89. Furthermore, the administration of quota quantities will be controlled by the EC allowing the EC to capture, at least in part, any possible rents." The terms of the EC trade agreement for agriculture, particularly the tariff quotas on specific product categories, are disadvantageous to Romania because they are based on export performance during a period when the country's pricing structure was highly distorted. Thus, the pattern of exports to the EC in 1988-89 is not expected to coincide with the optimal export pattern, which will be gradually revealed as domestic prices become liberalized. Therefore, if total value of exports to the EC cannot be changed, Romania should at least press the EC to allow for the modification of the pattern of exports within the aggregate constraint on total exports. A potentially serious concern is Romania emulating the essential features of the EC agricultural policy by introducing variable levies on imports. Variable levies are a key component of the EC's costly common agricultural policy (CAP). The high budgetary costs and substantial economic distortions caused by the CAP are well known.' Adoption of such a policy by Romania would be a major setback and would conflict with the economic reforms and liberalization that are under way. Romania's intentions as far as variable levies go could not be confirmed in our discussions with government officials. A variable levy policy should be strongly discouraged. Conclusion Romania has the potential to export significant quantities of grains, at least the medium term. To accomplish this goal and to discover the other products that will be important export earners, several policy actions need to be taken. Fortunately, several of these actions are underway, but they need to be reaffirmed to ensure their credibility. The most important includes the move to full liberalization of prices and extensive privatization of physical assets. To realize full grain production potential, increased amounts of fertilizer must be secured and applied. If the problems with the domestic fertilizer industry cannot be solved quickly, export and import companies should be allowed to import fertilizers without restraint. There appears to be massive waste and inefficiency in the milk-dairy sector. A major improvement should not be expected in the short term. Privatization and gradual price liberalization will eventually provide strong incentives to undertake profitable investments, particularly in refrigeration equipment, in the long term. With respect to trade policy, the most important action needed is to remove export bans and quotas, except where required by agreements with trading partners. Export licenses must be made transferable. Quantitative barriers prevent domestic prices from providing correct signals of resource costs, which are crucial to improvements in efficiency and reductions in waste. The government should not impose variable levies on agricultural exports or imports. Notes 1. Data are for 1991 and also include forestry. General Agreement on Tariffs and Trade (1992), Trade Policy Mechanism, Romania, CIRM/G/32. Geneva. p. 77. Subsequently this report will be cited GATT (1992-R). AGRICULTURE 201 2. I.T. Berend (1985), "Agriculture," in M.C. Kaser and E.A. Radice (eds.), The Economic History of Eastern Europe, 1919-1975, Clarendon Press, Oxford, U.K., p. 151. Subsequently this is cited Berend (1985). 3. This is reflected by the following statement by the Romanian government. 'A study is now being elaborated for the development of agriculture in the next years. This study includes analyses of prices, production structure, supply and sales demand, credit possibilities etc. in order to secure food self-sufficiency in the domestic market. GATT (1992-R), p. 66. 4. The exact percentage was 56.5 percent in the first half of 1992. GATT (1992-R). p. 77. 5. There apparently is a consensus among certain policy makers in Romania that there is a need to subsidize agricultural producers. GATT (1992-R), p. 81. 6. The historical data in this section is from Berend (1985). 7. U.S. Department of Agriculture, Economic Research Service (1993), *Agricultural Policies and Performance in Central and Eastern Europe, 1989-92", Report No. 247, p.47. 8. This assumes chemical fertilizer application of approximately 2 million tons (active substance). This is considerably higher than the estimated amount applied in 1992, 0.45 million tons, but considerably below the capacity of the domestic fertilizer industry, which is 4.1 million tons. There are, however, major problems with the domestic fertilizer industry. These are discussed in a subsequent section. Note that in recent years, 1986 recorded the highest rate of use of chemical fertilizers in Romania, 1.56 million tons or about 156 kg/ha. But even this rate of fertilizer application was only one-half the usage rate in western Europe, and also considerably less than the usage in other countries in Eastern Europe. World Bank (1992), "Romania, Agricultural Prices, Subsidies and Marketing Review", Report No. 11350-RO, p. 27. 9. This is the estimate for the old port of Constanza, which is estimated to have a capacity to handle 67 million tons of cargo a year (present traffic is 40 million tons) and can handle vessels up to about 80,000 tons. An export trading company. Agroexport, owns the storage and handing equipment for grains in Constanza. This includes three berths, a 100,000 metric ton concrete silo, and pneumatic pumps to load/unload grains onto/from cargo vessels. The silo is old, but was upgraded in 1977. Wastage is reported to be less than 0.5% of volume handled. 10. There appears to be some confusion amongst governmental officials whether agricultural land can legally serve as collateral for mortgages. The Ministry of Agriculture believes that it can; the Agricultural Bank believes that it cannot Presumably this reflects the newness of the land law and the lack of applications for mortgages. 11. See subsequent section on the activities of the Agrobank. 12. To qualify to be a tractor driver in an Agromec the worker needs to obtain a license and does so by attending a 3-year training course. However, for private farmers the Ministry of Agriculture is arranging training programs that last 7 months. Presumably such programs will be stretched out over several months but only involve meetings a few days a month at times that do not interfere with farming operations. If by contrast the programs are planned to be contiguous they would be excessively long and take farmers away from normal activities for much too long a period. Note that comparisons with other countries are complicated by the fact that most farmers grow up on farms and gradually learn how to handle mechanized equipment in childhood without much if any need for formal training. 13. It was not clear to us, however, who controls ROMCEREAL. 14. However, the Ministry of Agriculture also employs an additional 50,000 workers in engaged in various agricultural support activities for example, providing sanitary and veterinary services. General Agreement on Tariffs and Trade (1992), 'Trade Policy Review Mechanism, Romania", Report of the Secretariat, Vol. A (Text), p. 73. Subsequently this document is cited GATT (1992 -SI). IS. One of the problems seen by Romcereal with respect to the new land system concerns crop rotation. Formerly, under the cooperatives, crop rotation was managed by the central organization of the cooperative. Apparently, with the substantial increase in number of decision makers under the new system, transactions costs are very high when it comes to securing agreements of all land owners to vary over time crops planted on particular fields. 202 ROMANA: RESTRUCTURTNG TO FACF TRF Wrv n Pr-nvn,v 16. ROMCEREAL is not the only organization that arranges contracts with associations of peasants. Farmers may also choose to enter into contracts with groups such as Agroexport (discussed below), which, among other services, supplies maize to farmers that raise pigs. * 17. U.S. Department of Agriculture (1993), 'Agricultural Policies and Performance in Central and Eastern Europe, 1989- 92", Report No. 247, p. 23. 18. General Agreement on Tariffs and Trade (1992), "Trade Policy Review Mechanism. Romania%, Report of the Secretariat, Vol. B (Tables and Appendices), pp. 39-40. GATT (1992-S2). 19. Reportedly it has become uncommon for housewives to bake bread at home. There are said to be problems in obtaining yeast and securing ovens. There are also energy shortages. 20. Apparently state shops are only open Monday through Friday. Private shops are also open weekends. 21. GATT (1992-SI), p. 76 and GATT (1992-S2), p. 39. 22. The amount of wheat flour required per kg of bread is 768 grams. The amount of wheat required per kg of wheat flour is 1.4 kilos. Therefore the quantity of wheat incorporated in a kg of bread is .768 x 1.4 = 1.075 kg. 23. GATT (1992-S2), pp. 36-37 and GATT (1992-R), p. 24. 24. This was reportedly also Nobel Laureate George Stiger's presumption about competition and monopoly. 25. GATT (1992-S2), p. 37. 26. Note that the data presently compiled by the Ministry of Trade on international prices could serve as a starting point to obtain the data needed for this test. However, it appears that present efforts by staff in MT do not include determining comparable domestic and traded products. This is essential for the test discussed here. 27. Due to difficulties in compiling data, world prices are only available for September 1992. 28. A more complete assessment of likely supply responses across products would also need to consider and adjust for price distortions of raw materials and other productive inputs. 29. It appears that the Ministry of Agriculture is supporting the new exchange only reluctantly. Apparently the Ministry believes - correctly - that it would be more difficult to control agricultural and food prices if there were an exchange. 30. For recent discussion of the Budapest commodity exchange, see Ronald W. Anderson and Andrew Powell (1992). 'Markets, Stabilization and Structural Adjustment in Eastern European Agriculture,' in L Goldin and L. A. Winters (eds.), Open Economies: StructuraoAdjusment and Agriculture, Cambridge Univ. Press, Cambridge, U.K., pp. 203-219. 31. ROMCEREAL is also close to the Bank's borrowing limit, which specifies that no more than 20 percent of the Bank's capital can be lent to any one company. 32. The one exception was a small, 6 billion lei, loan for (mainly new) agricultural equipment. Most of this went to private borrowers. 33. The following example is based on the following. The amount of fertilizer applied is 3.12 million tons and comprised of 2.28 million tons of urea (46 percent N), 0.684 million tons of TSP (46 percent P), and 0.152 million tons of MoP (60 percent K). The border prices (September 1992) are: urea - 140,000 lei/ton, TSP - 150,000 Leilton, MoP - 90,000 Leilton, wheat - 55,440 Lei/ton, maize - 48.300 Leilton. The 3.12 million, tons estimate and the border prices are from 'Romania: Agricultural Prices. Subsidies and Marketing Review.' November 3, 1992, Report No. 11350-RO, Agriculture Operations Division, Country Operations 1. Europe and Central Asia Region, pp. 27 and Appendix I. p. 1. 34. This sector is currently being examined in a major project sponsored by the EC Phare program. Their report has scheduled to be completed at the end of February 1993. AGRICULTURE 35. We do not take up the special issues raised by trade with EC and the recently agreed EC trade agreement. They are discussed in Section XI. 36. GATT (1992-R), p. 43. 37. Several of the complaints reported here probably occurred before the introduction of the current auction arrangements. Even though the existing exchange arrangement may have reduced problems in securing foreign exchange, the complaints are a warning of the consequences of failing to address foreign exchange rationing adequately. 38. In one example, a Romanian trading company sought to import a fertilizer product. It applied at its bank for USI million in January 1992. Approval was granted by the National Bank in March. But the trading company's bank account was not credited with the US dollars until May. Further, it was not allowed to draw on the dollar credit until later, one-half in September and one-half in October. During the entire period the company earned no interest on the amount of lei needed to purchase US dollars or on the US dollars credited to its account. The interest rate on lei denominated loans is 70 percent per annum. In another transaction, a trading company that had been able to import goods was forced to return them when it could not obtain foreign currency after waiting for approval for several months. 39. Romania currently has bound tariffs for approximately 850 6-digit tariff headings, of which 163 are for agricultural products. 40. The tariff data reported below are from GATT (1992-Si). pp. 93 and 97. 41. The assessment of one Romanian expert is as follows: '...customs duties [are] annually adjusted according to the domestic situation of resources and the demand and supply on both domestic and external markets.* "Overview of Agricultural Policy and Trade Developments in Romania in 1991-1992,* OECD, Directorate for Food, Agriculture and Fisheries, Committee for Agriculture, Draft 21 May 1992, p. 9. 42. Prior to contacting the foreign trading companies, the Ministry of Agriculture estimates the deficit between production and consumption and requests authorization from the government (involving the National Bank and Ministry of Finance) to emergency imports. 43. In one instance, involving emergency imports of wheat, the extent of the subsidy was reportedly over 30 percent. This is based on the difference between the import price actually paid by the authorized FTC compared to the lower import price that could have been paid had the transaction been undertaken by a private trading company. 44. GATT (1992-R). pp. 53 and 103. 45. The Ministry of Trade indicates it has considered auctioning quota licenses, which has certain potential advantages over the current allocation method. For a discussion of auction quotas, see C. Fred Bergsten, Kimberly Ann Elliott. Jeffrey J. Schott, and Wendy E. Takacs (1987), Auction Quotas and United States Trade Policy, Institute for International Economics, Washington, D.C. 46. The manner in which the quota will be administered is as follows. Romania will first grant export licenses to Romanian exporters. Second, the targeted EC country will request the EC Commission to issue import licenses to EC importers. Third. Romania will issue a certificate of origin. Since licenses are issued by both Romania and the EC, if there are quota rents it is not clear how the rents will be distributed between the Romanian exporter and the EC importer. 47. For a discussion of the CAP and its costly effects see, for example, A. Stoeckel et. al. (1985), Agricultural Policies in the European Community, Their Origins, Nawre and Effects on Production and Trade, Bureau of Agricultural Economics, Commonwealth of Australia, Canberra. 'InA ROMANIA: RESTRUCTURING TO FACE THE WORLDECONOMY