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Report No. 1695a-PO
Manufacturing ExDort Industriesi n Portugaili' I btiree VOlHImSQ
Main ReportDecember 27, 1977
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CTJRRENCY EQUIVALENTS
Until 1971 1 US dollar 28.75 escudos1 escudo 0.035 US dollar
1972 (yearly average) 1 US dollar 27.25 escudos1 escudo = 0.037 US dollar
1973 (yearly average) 1 US dollar 24.67 esucdos1 escudo 0.041 US dollar
1974 (yearly average) 1 US dollar 25.41 escudo1 escudo - 0.039 US dollar
1975 (yearly average) 1 US dollar - 25.44 escudo1 escudo 0.039 US dollar
1976 (yearly everage) 1 US dollar 30.00 escudo1 escudo 0.033 US dollar
1977 (February 25) 1 US dollar - 32.92 escuido1 escudo = 0.030 US dollar
1977 (February 26) 1 US dollar = 38.73 escudo1 c] ,lildo = 0.026 US dollar
For c0olv8rsious for 1977 and su-bsequent years this Report usCs thle38. 73 rat.e. Since August 1977 the Escudo has floated; in earlyDecember the rate rVas about Escudos 40 per UJS dollar.
FOR OFFl,YIL USE ONLY
PORTUGAL
MANUFACTURING EXPORT INDUSTRIES
TABLE OF CONTENTS
Page No.
BASIC DATA .................................... iii
GLOSSARY OF ABBREVIATIONS ...................... iv
PREFACE ........................................ v
CHAPTER I: AN OVERVIEW OF MANUFACTURING INDUSTRY ........ I
A. The Relative Roles of the Private and
Public Sectors .......................... . 1
B. Small and Medium Sized Industry ........... 2
C. Output and Growth ........................ 3
D. Employment ..... ........................... 4E. Exports: Performance, Markets and
Prospects 5 ................................. 5
CHAPTER II: INTERNATIONAL COMPETITIVENESS AND THE FOREIGN
TRADE INCENTIVE SYSTEM ......................... 9
A. Wages, Productivity and Competitiveness 9
B. Tariff Structure .......................... 11
C. Bias Towards Import Substitution ........... 14
D. Tariff Reform ............................. 15
E. Import Surcharges, Prior Import Deposits
and Quantitative Restrictions ..................... 16
F. Drawback .................................. 17
G. Credit Subsidies .......................... 19
H. Exemption of Indirect Taxes on Inputs 20
I. Income Taxes .............................. 20
J. Export Promotion Fund (Fundo de Fomento
de Exportacao - FFE) ...................... 21
K. Summary of the Effects of Trade
Incentives .............................. . 21
L. Recommendations ........................... 23
CHAPTEP. III: REVIEW OF MANUFACTURING INDUSTRIES .............. 26
A. General ................................... 26
B. 14Ietal Working Industry ..................... 29
C. The Textile and Clothing Industries 34
D. Other Industries ...................... .... 42
This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.
TABLE OF CONTENTS (Continued) Page No.
CHAPTER IV: FINANCING OF MANUFACTURING INDUSTRY ............. 44
A. General Financial Conditions ...................... 44B. Measures to Increase New Investment 44C. Resources to Finance Manufacturing,
1977-1980 .............................. . .46
CHAPTER V: FOREIGN INVESTMENT ............................. 52
A. The Role of Foreign Investors .............. 52B. General Background ......................... 52
C. The Investment Code and ProposedRevisions . .................................. 53
D. The Foreign Investment Institute ......... 54
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lanulfacturing Sector - Basic Data
Recent Years Annual Rate of Growth(%)1970 1976 (1970-76)
GDP (bln. esc., 1970 pr.ces) 158.7 212.3 5.0Mantifactur4ng Induscrv Output
(billion esctudos) 53.9 76.6 6.0
GFCF as % cf GDP1970 1975
Gross Fi;:ed Capital FormationTotal (bln. esc., 1970 prices) 31.1 28.0 (1975) 19.6 13.4% in Manufacturing 31.3 29.2 (1974)
Manu factLring Output Annual Rate of Growth (%)(bln. esc., 1970 prices) (1970-76)Foodstuffs, Beverages, Tobacco 6.3 11.3 10.2Textiles, Apparel, Footwear 10.0 16.4 8.6Chemicals & Related Activities 6.3 9.7 7.5Non-metal Minernil Products 3.9 6.8 9.721etal Products, Mechanical,and
Electrical tlachinery, Trans-portation Equipment 16.1 18.9 2.7
Emplc.ybeneTotal (000) 3,180.1 3,1.02.0 -0.5Manufacturing Industry (000) 828.9 336.9 0.15(% of Labor Force) (25.4) (23.4)
Employment in Main Industries(% of Total in Manufacturing)
Foodstuffs, Beverages, Tobacco 7.4 6.3Textiles, Apparel, Footwear 33.5 33.8Cheoica's & Related Activities 3.7 3.7Nori-wetdl Mineral Products 6.3 6.0Metal Products, Mechanical and
Elecrrical Maclhinery, Trans-portation Equipment 21.9 22.7
Annual Rate of Growth (%)(current prices)
Exports 1963 1968 1973 ]975 1968-73(mln. USS, current prices)Total. Manufactured Exports(SITC 5+6±7+8-68) 240 466 1,283 1,356 22.5
Total M'anufactured Exportsincl. processed food(03+05J-,6) and wine (1121) 343 639 1,578 -1,637 19.8
Total Exports 418 761 1,862 1,940 19.6Maini Manufactured Items
Textiles, Apparel, &Footwear 111 217 549 562 20.4Chemicals 39 56 124 141 17.2Metal Products, Mfechanical,Electrical & Transporta-tion Equipment 23 62 303 334 37.3
Processed Food 62 102 169 150 10.6Wine 31 59 12& 131 16.8
Direction of Exports 1976- - - - $ million % of Total
World 1,826 100EEC 940 51.5EFTA 294 16.1U.K. 335 18.3Getmany Fed. 197 10.8Frauce 153 8.4Sweden 141 7.7Italy 68 3.7USA 123 6.7USSR 55 3.0Angola 29 1.6Mozambique 27 1.5
-iv-
GLOSSARY OF ABBREVIATI.ONS
EFN 'Banco de Fomento NacionalCIP .Confederacao das Industrias Portuguesas
(Confederation bf Portuguesce Industries)CGD Caixa Geral de DepositosCOSEC Companhia Seguro de Creditos
(Credit Insurance Company)DEC Development Finance CompanyEEC European Economic CommunityEPPI * Empresa Publica de Parques Industrisis
(Public Enterprise for Industrial Parks)EFTA European Free Trade AssociationEIB European Investment BankFFE .Fundo de Fomento de Exportacao
(Export Development Fund)GEBEI General Studies Unit, Ministry of IndustryGFCF Gross Fixed Ca'pital FormationtAPfEI Instituto de Apoio as Pequenas e Medias Empresas
Industriais (Institute *for the Support of Smalland Medium Industrial Enterprises)
IPE Instituto das Participacoes do Estado(institute of the State Participation)
lIE1 Instituto dos Investmentos Estrangeiros(Institute of Foreign Investments)
lINE Instituto Nacional de Estatistica(National Institute of Statisti-cs)
HIT Ministry of Industry arLd TechnologyPISEE Programa de Investimentos do Sector Empresarial
do Estado (Investment Program for Public SectorEnterprises)
PIMEs Pequenas e Medias Empresas(Small and Medium Enterprises)
.
- v -
PREFACE
This Report is based on the findings of a Mission which visitedPortugal to review export manufacturing industries in April-May 1977. TheMission Report is in three parts, the Summary Report, the Main Report and theStatistical Appendix and Annexes. The Summary Report states the major find-ings and recommendations of the Mission and contains mainly those points whichshould be brought to the attention of the Government. Detailed background andanalyses are presented in the Main Report. Information on Portugal's policiesand industrial position of use primarily to readers outside the Government ofPortugal has been placed in Annexes of the Main Report. In preparing itsReport, the Mission has drawn on (and sought not to duplicate) information inother IBDR Reports on Portugal, in particular, "Portugal: An Economy inTransition", (Report No. 1408a-PO, March 16, 1977) and "Appraisal of Banco deFomento Nacional, Portugal" (Report No. 1462a-PO, May 9, 1977). Since theMission was in Portugal the Government, in August 1977, took a number ofeconomic measures; the Report notes these measures and the recommendationsmake allowance for them.
The Mission was composed as follows:
Barend A. de Vries Chief of MissionRichard L. Storch Private Investment and FinanceSurendra K. Agarwal General EconomistDavid Morawetz (Consultant) Economist (Trade Incentives)Wilson Suzigan (UNIDO Consultant) Industrial EconomistFederico Tubio (Consultant) Industrial Expert
(Textiles and Clothing)Walter Oettinger (UNIDO-Bank CP) Industrial Expert
(Metal-Working Industries)Jacob Levitsky Industrial Expert
(Other Industries, TechnicalAssistance)
In addition Mr. Francis Colaco participated in part of the Mission'sfield work. Messrs. S. Rangachar, C. Gomez and Mrs. S. Craigmile assisted inthe preparation of the Report.
Messrs. A. David Knox and M.G.S. Aiyer and mission members discussedthe draft Report with the Government in November 1977.
CHAPTER I
AN OVERVIEW OF MANUFACTURING INDUSTRY
A. The Relative Roles of the Private and Public Sectors
1.01 This Report deals with the prospects and problems of Portugal's
exoort industries and with the measures wlhich can be taken to accelerate the
growth of output and employment in these industries. The Report concentrates
on the textile and clothing, metal, mechanical and electronics industries, as
well as food processing, footwear, furniture, cork, and paper and pulp. These
industries, with the exception of paper and pulp, are largely in the private
sector. As a result of measures taken in 1974-76, the public sector has in-
creased its role in manufacturing, but despite these measures private firms in
the manufacturing industry continue to dominate aggregate output and to employ
the bulk of the industrial labor force.
1.02 The measures effecting manufacturing in 1974-76 included the nation-
alization of the banking system, insurance companies and the power sectGr, and
the takeover by the Government of some of the large industrial groups in indus-
tries such as steel, cement, petroleum and petrochemicals and tobacco as well
as most modes of public transport, radio and TV. The formal steps were com-
pleted by September 1975. The nationalization of financial institutions gave
the Government varying degrees of participation in private sector enterprises.
There are different types of public enterprises: those which were in the
public sector prior to 1974, those which were nationalized, and those in which
the State has acquired shareholder participations. In addition, there are
about 80 enterprises in the manufacturing industry in which the Government
intervened because of their financial difficulties or labor problems. In the
manufacturing industry of the 130 firms with State ownership, 30 were public
enterprises (100% ownership), 55 were State controlled enterprises (more than
50% ownership), and 45 were enterprises with 20-50% State participation. These
enterprises now account for about 17% of value added, 34% of gross fixed cap-
ital formation and 12% of the labor force in the manufacturing industry.
1.03 Nationalization and Government intervention created uncertainties
for investors and industrialists. The Government has now taken a number of
measures to remove their uncertainties. First, the Government has announced
that there will be no more nationalizations. Second, the "disintervention"
process has started and is to be completed by July, 1977; however, due to the
complicated and serious difficulties of many intervened companies, this pro-
cess will probably take longer than planned. Third, the law concerning com-
pensation for nationalized assets has been approved and financial measures to
set troubled enterprises back on their feet have been instituted (see Chapter
IV).
1.04 The Republican Assembly in May 1977 agreed on the delineation of the
public and private sector and the principles to be followed in their opera-
tions. All public utilities, post and telecommunications, banking, insurance,
and transport will be public sector. In the manufacturing industry, the public
sector will include the armaments, oil refining, petrochemical, fertilizer,
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iron and steel, and cement industries. For these industries joint venturescould be authorized when the need justifies it, although the State wouldretain a majority interest. According to the law, the Government may handover to the private sector the small and medium size firms which were national-ized indirectly and are not in the above sectors, provided the workers do notopt for self-management or cooperatives.
1.05 With the implementation of all the measures mentioned above, businessconfidence, which has recently improved, will be given a further boost. Also,investment by the private sector should revive and is the essential key toincreased production and exports. The public sector will, however, remainimportant: the medium-term plan envisages that more than half of total produc-tive investment during 1977-80 is to be in the public sectors.
B. Small and Medium Sized Industry
1.06 Portugal's industrial structure is characterized by a large numberof very small enterprises. Of the 14,900 enterprises in manufacturing, in1974, 90% were small and medium sized firms (Pequenas e medias empresas orPMEs) employing up to 100 workers; 33.1% of all firms employed up to 10workers and 80.7% up to 50 workers. The predominance of PMEs is a markedfeature of all manufacturing subsectors as shown in Table I-1 below,
Table I-1: SIZE OF ENTERPRISES IN THE MANUFACTURING INDUSTRY(Number of Enterprises with Five or More Workers, January 1974)
101- 501- OverNumber of Workers 5 - 10 11 - 20 21 - 50 51 - 100 500 1000 1000 Total
Manufacturing Industry 4,931 3,781 3,314 1,388 1,268 148 70 14,900X of Total 33.1 25.4 22.2 9.3 8.5 1.0 0.5 100
of whichFood 446 364 321 156 199 10 2 1,498Textiles 250 276 402 217 286 44 25 1,500Clothing 77 78 40 18 15 1 - 229Footwear 803 460 425 158 113 6 - 1,965Metal products 599 386 337 148 103 9 4 1,586Machinery 257 143 156 86 65 9 8 724Transport equipment 631 382 224 85 62 7 5 1,396Miscellaneous mfg. 188 107 106 35 31 3 - 470
Source; Table 5.1.
1.07 There were only 218 manufacturing enterprises with more than 500workers. They were concentrated in food industry, textiles, clothing, chem-icals, non-metallic minerals, basic metals, and metal manufacturing industries.Of these only 70 employed more than 1,000 workers.
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1.08 Small scale enterprises are generally less capital intensive thanmedium and large scale firms. But many of them, in common with enterprisesof similar size in other countries, also have deficiencies in production,management, and marketing. These problems stem from the small size, familyownLership of most firms and limited access to finance. Until the revolutionin 1974 there was no Government agency to deal with the specific problems ofPMEs. These enterprises were, however, able to survive and remained profit-able often due to low laboc costs.
1.09 As a result of the establishment of a minimum wage, changes in laborconditions, and steep increases in raw material prices during 1974-76, PIMEstended to become trapped in lower profitability and losses and faced severeliquidity problems. To help PMEs overcome their problems, the Government in1975 set up IAPMEI (The Institute for Assistance to Small and Medium SizeEnterprises (see Annex III-4). Considering the short period of its operationsIAPI4EI has become an important organization which has helped PtlEs in overcomi-ing their liquidity crisis.
C. Output and Growth 1/
1.10 Manufacturing was a leading sector in Portuguese growth in 1963-73and exports were a key factor in this growth. Value added in manufacturinggrew at 10-11% p.a. and GDP at 7 percent. The metal products, machinery andtransport equipment industries increased their share in the total manufactur-ing output while textiles and clothing held their share and other traditionalsectors (food, beverages, wood and cork) declined. In 1973, manufacturingoutput contributed 35.5% to GDP.
1.11 Exports were particularly important in textiles, clothing, footwear,metal products, machinery and transport equipment. The dollar value of ex-ports increased relative to manufacturing value added in 1963-73 from 43.5%to 46.1%.
1.12 Portugal has become increasingly integrated with the world economy.The share of manufactured imports in domestic supply increased from 50.7% in1963 to 56% in 1973. The import content of manufacturing is relatively highwith imports accounting (directly and indirectly) for 25% of export production.Likewise, a relatively high proportion of intermediate inputs is imported,e.g., textiles (50.9%) and non-electrical machinery (54.1%). 2/ (Annex I-1,Table 4).
1/ For details, see Annex I-1.
2/ These percentages will now be much higher because of the worldwideincrease in prices and the loss of former colonies as chief suppliersof cheaper raw materials. No new recent data is available on the importcontent of Portugal's exports but it could be anywhere between 34-45%.
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1.13 The design of trade incentive policies must necessarily allow for
the open character of the Portuguese economy. Given the high import content
of manufacturing output, restrictions on imports will quickly have a restrain-
ing effect on productivity and competitiveness. Moreover, t'ie importance of
exports in manufacturing output means that acceleration of export growth is
essential for future growth of manufacturing output and employment.
1.14 In recent years social and economic changes caused a decline in
growth with manufacturing growth decelerating to 2% in 1974 and output falling
by 5.6% in 1975. In 1976 output increased by 5.5 - 6% and once again surpassed
the 1974 level. The wood and cork, textile and machinery industries suffered
most, while pulp and paper, metal products and chemicals faired best. Capacity
utilization fell to less than 70% in 1976 compared with more than 80% in 1972-
74 (Table 4.1). Capacity utilization is particularly low in the textile and
clothing, wood and cork and metal manufacturing industries.
D. Employment 1/
1.15 Unemployment presents the country's economic management with problems
to which there are no quick solutions. In total some 452,000 or 12.7% of the
labor force is unemployed, and moreover there is considerable underutilization
of labor in the manufacturing industry. Of the total unemployed 137,000 are
looking for new jobs, 189,000 are looking for their first jobs and 126,000 are
returnees from the former colonies. Most of the unemployed are unskilled and
white collar workers. Only 25,473 out of a total of 207,545 unemployed regis-
tered with the National Employment Service stated their preference to work in
the manufacturing industry.
1.16 At the end of 1976 the manufacture industry employed 836,900 or 27%
of the labor force. "Export industries" 2/ play an important iole in employ-
ment. They provide employment for 710,500 persons, i.e., 84.9% of the total
employment in manufacturing and 22.9% of total employment in the economy.
About 250,000 persons are employed in the textiles and clothing industries
alone. Export industries are generally more labor intensive than industries
producing mainly for the home market (as chemicals, cement, fertilizer, and
basic metals); exceptions are the pulp and paper and certain mechanical indus-
tries. The former have a higher employment coefficient (number of workers per
value of output) and lower capital investment per worker than the latter (see
Annex I-1, Table 4 and Annex I-2, Table 4).
1.17 The Government's draft medium-term Plan for 1977-80 gives high
priority to improvement in employment. It envisages that 203,000 new jobs will
be created of which 34,000 would be In the manufacturing industry, i.e., 17%
1/ For details see Annex I-2.
2/ "'Export industries" in this Report include: food, beverages, tobacco,
textiles, clothing, footwear, wood and cork, furniture, paper and print-
ing, leather, metal products, non-electrical machinery, electricalmachinery, transport equipment, and miscellaneous manufacturing. Most of
the industries export more than 25% of their share added (Table 2.3).
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of the total new jobs. Thus industry would be a minor provider of new employ-ment and, in fact, the Plan appears to expect that most new manufacturingemployment will be created in capital intensive industries. According to thePlan construction, services and trade sectors will be a principal force forcreating new jobs during 1977-80.
1.18 At present, capacity utilization in manufacturing is low and thereis excess labor in most firms. These factors and the restructuring of thetextile, clothing and shoe industries, will tend to limit new job creationin the years immediately ahead. Many of the less economic smaller mills willneed to be consolidated through mergers or absorbed by the largest expandingfirms.
1.19 The total employment impact of the manufacturing industry will dependon several critical decisions ahead. Improvement and stability of labor condi-tions are crucial to create new jobs. Recognizing this, the Government hastaken a number of measures affecting labor rules. The assembly recently passedlaws concerning workers' committees, dismissals and strikes. Their implementa-tion should enhance certainty about work rules in Portugal. Discipline isapparently improving and labor conditions in general are better compared withwhat they have been dtiring 1974-76.
1.20 An accelerated export-led industrial growth with emphasis on laborintensive industries, which is well within Portugal's potential, would addnew jobs in 1979-80 and subsequent years well above those now in sight espe-cially when indirect employment benefits associated with such a strategy areincluded in the analysis. Employment and growth prospects are particularlypromising in clothing, footwear, wood, cork, furniture, glass and glassproducts, metal products, machinery, ship construction and ship repair 1/.
E. Exports: Performance, Markets and Prospects 2/
1.21 Exports (particularly of manufactured goods) expanded rapidly during1963 and 1973. Manufactured exports grew by 12% in real terms and some 45% ofthe manufactured output was exported. The leading export industries were tex-tiles, clothing, machinery, wine, fruits and vegetables (mainly tomato paste),fish, wood and cork, non-metallic minerals and chemicals. The industriesstudied by the mission account for about 80% of manufactured exports (includ-ing wine and processed food) and were 69% of total exports in 1973.
1/ Investment in the manufacturing industry will lead to a significantdemand for construction materials and thus create a large number ofjobs in construction materials industry.
2/ For details see Annex I-3.
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1.22 Portugal's membership in EFTA was an important factor in exportgrowth. Together with EEC countries, EFTA countries accounted for 68% of theexpansion of exports in 1963-73. Exports to EFTA countries accounted for 38%of the increase in the clothing exports in 1903-73 and 27% of the textileexports. Until 1974, the former African colonies provided sheltered marketsfor Portugal's exports. Angola and Mozambique accounted for 21% of Portugal'stotal exports in 1963 and 12% in 1973.
1.23 Exports declined sharply, however, following the events in 1974 dueto the loss of markets in the former African colonies, the unstable situationin Portugal, and the recession in the OECD countries to which Portugal exported78% of its total exports in 1973. Exports in constant dollar terms in 1976were 35% lower than in 1973. Exports to Angola and Mozambique declined to only3% of total exports in 1976.
1.24 The importance of manufactured exports to the Balance of Paymentsis illustrated by the difference between actual performance in 1976 and levelswhich could have been achieved on a "normal" trend. In 1976 manufactured ex-ports were, in current dollars, about $1.4 billion or slightly above the 1973level of $1.28 billion. Had Portugal kept pace with manufactured exports ofLDC's to OECD countries they would have increased by 40-50% or some $530 mil-lion more than was actually achieved. This would have constituted a netimprovement (after allowing for raw material imports) of some $400 millionover actual performance.
1.25 Prospects. Portuguese manufactured exports can be increased througha combination of cost reduction, productivity improvement and strengtheningof management and marketing (Chapter III). In several industrial branchesproduct quality and mix will need to be improved. The increase in exportvolume will make possible better utilization of labor and will tend to improvelabor productivity significantly. At the same time an increase in exports willhelp improve capacity utilization.
1.26 The medium term Plan (1977-80) projects growth of traditional exportsat 8.8% (textiles, clothing, wood, cork and paper and pulp) and 15.9% formachinery and basic metal products. Overall exports are projected to grow 12-13% p.a. The mission feels that if adequate incentive measures are providedand industrial management is improved as recommended in Chapter III, Portugalshould be able to expand exports of several manufactured items at a higherrate than those given in the Plan particularly in the later years of theperiod and after 1980. There are good possibilities to expand exports ofprocessed fishery products, fruits and vegetables, paper and pulp, clothing,footwear, furniture, metal manufacturing and machinery, consumer electronics(color TV sets), glass and glassware, and plastic products. Relatively favor-able growth rates estimated by the mission include textiles and clothing (11%for 1976-80), footwear (22% in 1974-81), cork (11.6% in 1977-81), pulp andpaper (23% in 1976-78), furniture (26% in 1976-80). In metal manufacturingand machinery Portugal's prospects for expanding exports are also particularlypromising (see Chapter III).
1.27 Portugal's export prospects are enhanced by the fact that at pre-sent its most promising products have only a minor share in its major markets.(Its share in the imports of the EEC and EFTA countries was only 0.7% in 1973.)This is true e-ven though for some of its exports it is subject to quota re-strictions. According to the 1976 Agreement between the EEC and Portugal,ceilings had been established on the quantities of several products whichPortugal can export to the EEC member countries. These restrictions refer tothe articles of natural cork, cotton yarn, woven fabric of synthetic fibers,twine ropes and cables, undergarments, and outergarments. There are also"voluntary" quotas on a number of -extiles and clothing items which Portugalcan export to the United Kingdom. However, the ceilings are set in metric tonswhich means that by upgrading products it should be possible to increase sig-nificantly the value of exports of these items. The Portuguese are clearlycorrect in anticipating that membership in the EEC will be advantageous totheir export growth. Such membership will, however, also imply that importrestrictions be kept low and trade incentives generally conform to the Europeanstandards.
1.28 With aggressive marketing efforts, Portugal could also exportto North Africa and the Middle-East, and East-European countries such asCzechoslovakia (metal-manufactures), Hungary (cork) and Romania (ship repair,cork, batteries). Portugal has already been successful in exporting footwearto USSR and prospects for textiles appear good; exports to USSR were 3% ofPortugal's total exports in 1976. There are also indications that Portugal'sexports to its former colonies (Angola and Mozambique) could improve in thenear future. Countries in Latin America could also be potential markets forPortuguese exports.
1.29 The Plan's growth rate of 7.9% p.a. for manufacturing output is wellbelow Portugal's potential and would be exceeded if Portugal takes appropriatemeasures and accelerates its export growth. The Plan's projected growth ratesappear low for the metal products, machinery and transport equipment industriesas well as the traditional export sectors. These are the sectors in whichPortugal should be able to utilize its comparative advantage and substantiallyexpand exports. Furthermore, these sectors have relatively low capital-laborratios and, therefore, a rapid export-led growth in their output can make asignificant impact on Portugal's present high unemployment rate. If appro-priate policies to expand exports, as discussed in Chapter II of the Report,were followed, manufacturing output could increase at a rate above that indi-cated in the Plan.
1.30 Investment. As discussed in Annex I-4, investment in manufacturingdeclined to Escudo 15.3 billion ($601 million) in 1975 and Escudo 16.5 billion($550 million) in 1976 compared with Escudo 19.6 billion ($767 million) in1974. In 1977 prices, investment in manufacturing in 1974 was around $1 bil-lion. Assuming that the Government is successful in reviving investment, 1978investment in manufacturing could reach once again the 1974 level, i.e., $1billion.
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1.31 The Mission has not made detailed projections of investment in themanufacturing sector. It seems possible, however, that accelerated export-ledgrowth could involve output growth for the sector as a whole of at least 10%per year and investment growth of 25% (see Annex I-4). Sustained export growthwill require the construction of new facilities after an initial period ofimproving capacity utilization. However, from the start significant investmentwill need to be made in plant modernization, re-equipping and restructuring.Investments by 1979 could rise to $1,265 million and in 1980 to $1,400 million(in 1976 prices). During 1977-80 the total investment in the manufacturingindustry would amount to some $4,400 million. The actual amount would, ofcourse, depend among other factors on the realization of plans for the steel,cement, and chemical industries.
1.32 In the early seventies, approximately 68% of the manufacturinginvestment took place in the "export industries" (see Table 3.1). This ratioimplies that out of a total of $4.5 billion some $3 billion investment shouldbe in export industries in 1977-80, leaving around $1.5 billion for otherindustries. The latter figure could be significantly exceeded if presentplans for heavy industry were to materialize. The substantial increases inmanufacturing investment will make necessary new planning and resource alloca-tion procedures so as to assure that sufficient resources are available tohigh priority export industries identified in this Report as well as projectsin heavy industry with a high economic return (paragraphs 4.09 and 4.10).
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CHAPTER II
INTERNATIONAL COMPETITIVENESS AND
THE FOREIGN TRADE INCENTIVE SYSTEM
2.01 This chapter analyzes the explicit and implicit incentives and dis-
incentives which currently influence the production of exports and import
substitutes in Portugal.
2.02 Portugal is suffering from a severe balance of payments deficit.
To reduce import demand and stem the deficit, the Government has taken a
number of measures:, import surcharge, prior import deposits and quantitative
restrictions. It has taken further steps directly to stimulate exports, e.g.
interest rate subsidies and tax exemptions. The mission has sought to analyze
the impact of these various measures on the allocation of resources and in
particular on the profitability of export industries. It has done so by
studying the incentive system as a whole and by reviewing ,ne system's impact
on individual export manufacturers, usually through interviews with firms.
2.03 The incentive measures must, of course, be seen against the back-
ground of increases in wage costs and changes in exchange rates and in produc-
tivity, both in Portugal and abroad. After discussing the changes in the com-
petitiveness of manufacturing industry since 1973, this Chapter analyzes the
incentive effects of the customs tariff; of the surcharges, restrictions and
advance import deposits and, finally, of other measures such as credit subsi-
dies and tax rebates.
A. Wages, Productivity and Competitiveness 1/
2.04 In examining Portugal's competitiveness it seems appropriate to com-
pare wage cost and productivity trends in Portugal with those in Portugal's
main trade partners and competitors since 1973. In 1973 the exchange rate for
the Escudo seems to have been adequate to maintain balance of payments equi-
librium at least in the short to medium term. (See Annex II-1 for details).
2.05 Data for Portugal on the one hand, and France, Germany, the U.K.
and the U.S. on the other, indicate that annual earnings in Portugal (adj'lsted
for exchange rate changes) increased in total about 4% more than wage earnings
1/ The analysis is relative to prices and exchange rates as of February 1977.
The floating of the Escudo since August 1977 has partly corrected for
domestic inflation since February.
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in its trading partners between 1973 and early 1977 1/. In addition, fringebenefits in Portugal have at least kept pace with, and may have been morerapid than those in Portugal's trade partners during 1973-77. Social securitycontributions by employers increased from 17% of wages in 1972-76 to 19% fromend-1976 onwards, while employers' contributions to the unemployment fund in-creased from 1.5% in 1973 to 3% in 1975. To the extent that these increaseswere more rapid than in the rest of Europe, the difference in the increase(at most 3.5%) should be added to the relative wage increase of 4%, makingPortugal's wage disadvantage (compared with its 1973 position) 7.5% in total.
2.06 Similar comparisons can be made between Portugal and its Europeancompetitors, e.g. Italy, Greece and Turkey. (See Annex II-1, paragraph 11).Since 1973, Portuguese wages have increased somewhat relative to those inItaly, (including an allowance for fringe benefits). Italy is an important"tcompetitor", particulaLly in exports of clothing and footwear. As discussedin Chapter III, Portugal has to improve its product quality and compete in thesame markets as Italy.
2.07 For the manufacturing sector as a whole, i.e. including both"export" and "heavy" industries, Portugal's wage disadvantage may be offset,in part, by a relative improvement in productivity. In 1973-76 total manu-facturing output improved somewhat (2%), while employment declined by 3.6%.Hence productivity measured as output per man-year improved by 5.8%. Thiscompared with an improvement in productivity in the U.S. and leading European"trade partners" of 3.4% on average (weighted by their shares in Portugal'sexports). Portugal's productivity improved by 2.3% in relative terms. Hence,after allowing for productivity changes the wage disadvantage for the manu-facturing sector as a whole, is 5.1%.
2.08 The improvement in Portugal's productivity in 1973-76 was caused,principally, by a decline in the work force and a completion of investmentsand an associated increase in output in certain industries, mainly the "heavyindustries" (e.g. pulp and paper, chemicals, oil and coal products). In 1973there were indications of excess labor in some industries and a decline inthe work force since then (and a decrease of 12.6% in total hours worked peryear) did not adversely affect output in all cases. However, the improvementin productivity is spread unevenly over the different industries. In manyexport industries, and especially the textile and clothing industries, outputdeclined more than employmeint, and productivity fell an average by 2.7% (AnnexII-1, Tables 2 and 3). According to available statistics the most severeproductivity declines occurred in non-electrical machinery (36%) and wood andcork (12%) and textiles and clothing (12%). The Mission's observations basedon plant interviews confirm that productivity (output per man-year) has
1/ This figure includes allowance for the fact that Portuguese salaries arenow naid for 14 months instead of 13 1/2 as previously. The wage-costdisadvantage is calculated relative to 1973 and should not be interpretedas an absolute wage disadvantage. Portugal's wages are well below thoseof the U.S. and the main European countries (e.g. see Chapter III, para-graphs 3.42 and 3.43).
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declined in certain export industries, with output per man-hour (allowing for
the decline in hours worked) having at best recovered to 1973 levels. (Annex
II-1, paragraph 10).
2.09 Thus for the export industries the effect of the wage disadvantage(7.5%) is enhanced by the deterioration in productivity - to an average of
10% for the export sector as a wiole and more for certain key industries:e.g. close to 20% for the textile and clothing industries.
2.10 The deterioration since 1973 in the relative competitive positionof Portugal's export industries will have to be overcome by a combinationof measures aiming at a reduction in costs and improvement in productivity.It is unlikely that real wages will decline and hence, other cost reducingmeasures will be necessary. Improvements in productivity will have to be
associated with an increase in output and exports and a number of measures
discussed in Chapter III, particularly improvements in management, the lay-out of plants, modernization of machinery and new plant investment.
B. Tariff Structure
2.11 From the viewpoint of the incentive system, two main features ofthe current Portuguese tariff structure should be noticed:
(a) Protection varies significantly and arbitrarily from sectorto sector; the uneveness of the tariff structure is worsenedby differentiation according to country of origin, (e.g.lowering of tariffs on imports from EFTA countries);
(b) The use of tariffs without offsetting export subsidies biasesthe allocation of resources away from exporting towards importsubstitution.
2.12 S -ctoral Variation of Protection. The Portuguese tariff scheduleis currently set out mainly in "specific" rather then "ad valorem" terms.This means that without months of detailed analysis it is not possible todiscover even nominal let alone effective rates of protection.
2.13 The General Studies Unit (GEBEI) of the Ministry of Industry isputting together the available data to examine the 1977 pattern of effectiveprotection insofar as it can be ascertained. The results of this work are notyet available. In the meantime, GEBEI has produced an analysis of protection
based on 1970 tariff rates with the addition of the 1976 and 1977 surcharges(but excltuding prior import deposits and quantitative restrictions). These
data are summarized in Table II-1. In November 1977, when the report wasdiscussed with the Government, GEBEI, presented similar data based on the 1974tariff which are summarized in Table II-la.
Page 12
Table II-1 NOMINAL AND EFFECTIVE PROTECTION FROM TARIFFS AND SURCHARGES, 1977(IN PRACTICE, AFTER EXEMPTIONS - PERCENT)
Nominal ProtectionTariff 1970 Effectiveplus Protection
Tariff 1970 (Balassa Method)plus derived from
Input-Output Sector Tariff 1970 a/ 1976 Surcharge b/ 1977 Surcharge b/ Column 3 c/
1. Agriculture 9.5 16.6 19.1 232. Forestry 1.8 28.6 28.6 29
3. Livestock 2.2 2.7 2.8 0
4. Fishing and conserves 8.7 19.4 19.4 20
5. Mining - metallic 0.5 0.6 0.6 -5
6. Mining - non metallic 0.2 27.0 27.0 33
7. Meat and conserves 10.7 11.2 11.2 423
8. Milk products 63.6 83.3 83.3 4,453
9. Fruit conserves 13.5 43.0 43.0 39
10. Edible oils 12.5 12.5 12.5 -305
11. Animal feed 1.7 2.8 2.8 -38
12. Other food products 27.8 36.5 37.3 292
13. Beverages 329.2 355.0 355.0 278
14. Tobacco 66.9 106.0 106.0 133
15. Textiles - wool 19.8 39.1 39.1 118
16. Textiles - cotton 20.1 50.0 50.0 10517. Textiles - synthetic fibers 22.5 51.3 52.4 341
18. Clothing 24.4 54.9 54.9 65
19. Footwear 18.3 48.3 48.3 6320. Leather and products 17.8 49.3 49.3 173
21. Wood 4.5 35.5 36.2 60
22. Cork 8.6 33.5 47.8 13023. Furniture and upholstery 24.4 79.9 79.9 14824. Paper paste (pulp) 0.1 25.4 25.4 65
25. Paper, carton and products 10.6 31.0 31.7 39
26. Printing 16.5 28.2 28.7 45
27. Rubber and products 33.0 62.7 62.7 153
28. Plastic products 43.7 73.2 82.9 194
29. Basic chemicals 7.3 21.9 21.9 58
30. Resins 8.4 22.8 22.8 14531. Inedible oils; pesticides 15.3 15.3 15.3 -95
32. Paints, varnishes, lacquers 19.8 48.4 48.4 116
33. Other chemical products 21.1 44.7 44.7 123
34. Derivatives of petroleum and coal 7.8 7.8 7.8 54
35. Glass and products 32.3 56.4 62.7 119
36. Cement 11.4 41.4 41.4 65
37. Other non-metallic min. products 14.5 43.2 46.9 60
38. Iron and steel 16.4 24.9 24.9 67
39. Non-ferrous metals 2.7 15.1 15.1 5840. Metal products 19.0 45.6 47.7 75
41. Non-electrical machinery 9.0 26.2 26.5 2242. Electrical machinery and equip. 15.8 43.6 44.0 71
43. Shipping repairs and construction 11.7 39.5 39.5 5144. Tranbport equipment 22.3 30.7 31.0 135
45. Other manufacturing 13.2 38.8 41.5 72
Notes:
a! Calculated as: customs duty collections as percent of value of imports.
b/ Assumes that goods exempted from regular tariff are also exempted from surcharge.
c/ Based on input-output table for 1970 when wages, and hence value added were much lower than in 1977.No price comparisons' available.
Source: Unpublished data, GEBEI, Ministry of Industry
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Table II-la NOMINAL AND EFFECTIVE PROTECTION FROM TARIFFS AND SURCHARGES, 1977(IN PRACTICE, AFTER EXEMPTIONS - PERCENT)
Nominal ProtectionEffectiveProtection
Tariff 1970 Tariff 1974 (Balassa Method)plus 1976 plus ln77 derived from
Input-Output Sector Tariff 1974a/ Surchargeb/ Surchargeb/ Column 3 c/
1. Agriculture 7 13 15 202. Forestry 00 00 00 - L3. Livestock 1 1 1 - 114. Fishing & Conserves 1 63 23 305. Mining - metallic 00 00 00 - 46. Mining - non metallic 00 24 24 297. Meat & Conserves 2 2 2 18. Milk products 23 43 43 44079. Fruit conserves 9 28 28 15
10. Edible oils 8 8 8 -10311. Animal feed 1 2 2 - 2412. Other food products 10 13 13 13113. Beverages 65 94 94 84514. Tobacco 104 104 104 174015. Textiles - wool 10 30 30 5516. Textiles - cotton 15 42 42 9217. Textiles - synthetic fibers 8 38 39 12018. Clothing 6 36 36 2119. Footwear 19 50 50 13520. Leather & products 6 28 28 10421. Wood 3 33 36 7422. Cork 1 2 4 1023. Furniture & upholstery 14 68 68 13424. Paper paste (pulp) 00 00 00 - 325. Paper, carton & products 6 26 27 4026. Printing 7 19 19 2727. Rubber & products 15 37 37 8628. Plastic products 13 39 48 11529. Basic chemicals 1 8 8 1330. Resins 00 15 15 14231. Inedible oils; pesticides 00 00 00 -23432. Paints, varnishes, lacquers 8 37 37 9133. Other chemical products 3 9 9 - 334. Derivatives of petroleum & coal 7 7 7 192835. Glass & products 12 38 47 7736. Cement 9 58 58 17437. Other non-metallic min. products 7 39 42 5938. Iron & steel 1 5 5 1039. Non-ferrous metals 1 13 13 6040. Metal products 8 34 37 8941. Non-electrical machinery 3 15 15 1142. Electrical machinery & equip. 8 31 31 4843. Shipping repairs & construction 1 29 29 4744. Transport equipment 2 17 18 2245. Other manufacturing 6 24 27 33
NOTES:
a/ Calculated as: customs duty collections as Dercent of value of imDorts.b/ Assumes that goods exempted from. regular tariff are also exempted from surcharge.
cf Based on input-output table for 1074.
Source: Unpublished data, GEBEI, Ministry of Industry.
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2.14 The average nominal tariff rate for each sector has been estimatedby taking customs duty collections as a percent of the value of imports. Onthis basis, the average tariff rate for all industry (excluding surcharges)is about 22%. However, this method of calculation tends to underestimate theprotective effect of the tariff, in part because goods not produced inPortugal tend to bear low tariffs, and in part because goods with high tariffprotection are imported in small quantities.
2.15 Before the Revolution, tariff protection was generally granted toindustrialists on a tailor-made ad hoc basis, with little regard to the over-all pattern of effective protection that emerged. The results may be seenin the final column of Table 1: effective protection varies widely, from over200% in milk products, meat and conserves, synthetic fibers, other food prod-ucts and beverages to below zero for edible oils, inedible oils and pesticides,animal feed and mining (metallic). It should be emphasized that these effec-tive protection figures are built up on a number of simplified assumptions.For example, in the absence of hard data, it had to be assumed that goodsexempted from tariffs are also exempted from the surcharges. Equally impor-tant, the effective protection figures make use of the 1970 input-output table;but the pattern of wgages (and hence percent domestic value added) has alteredsignificantly since then.
2.16 Nevertheless, even if only the nominal tariff and surcharge figuresare used (Table II-1, columns 1-3), the essential arbitrariness of the currenttariff structure may be seen. For example, the average tariff rate on goodsin which Portugal has a comparative advantage varies from relatively low (non-electrical machinery: 9% or 27% including surcharge) to high (glass and glassproducts: 32% or 63% including surcharges). Similarly, there exist a numberof cases of raw materials and semi-finished goods bearing higher tariffs thanthe final product in which they are used. One of the most striking examplesconcerns the clothing industry: imports of "textiles used in producing cloth-ing" pay tarirfs of 30% (sub-sector not shown in Table II-1), which is greaterthan the protection for finished garments (24%).
2.17 The protection data based on the 1974 tariff (Table II-la) calcu-lated with the same method as those for 1970 show a number of changes. The(unweighted) average nominal tariff fell from 22% in 1970 to 9.6% in 1974.Reductions in nominal tariffs and nominal protection including the surclarge,took place in such items as non-electrical and electrical machinery, leatherand products, garments; but no reduction took place in footwear. Iitcludingthe 1977 surcharge (column 3) the (unweighted) average fell from 44.9% (TableII-1) to 28% (Table II-la). The calculation of effective protection (column4) is based on the same assumptions as the earlier data and does not incor-porate price comparisons. It shows that there continues to be a considerablevariation. For 1974 there is a larger number of items with negative effec-tive protection (e.g. mining-metallic, edible and inedible oils, animal feed,forestry, livestock, pulp and other chemical products). Certain categoriesof special interest for export development also show a reduction in effec-tive protection, as for example garments (65% in 1970 to 21% in 1974), non-electrical machinery (22% to 11%) and electrical machinery (71% to 47%).
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2.18 The unevenness and arbitrariness of the tariff structure is accen-
tuated further by the existence of differential tariff rates according to
the area of origin of the merchandise. Thus in 1970 goods originating in
the colonies and EFTA countries paid significantly lower tariffs than those
from other sources (see Table II-2). Portugal's increasing ties with the EEC
will further increase this source of variation.
Table II-2: NOMINAL PROTECTION FROM TARIFFS BY SOURCE
IMPORTS, 1970 (NOT INCLUDING SURCHARGES)
Theoretical tariff Tariff rate in practice,
rate, before exemptions after exemptions
Source of Imports (percent)- (percent)/
Overseas colonies 0.0 0.0
Mini-EFTA (Sweden,Austria, Switzerland,Finland) 7.7 6.5
"Adherents" (U.K.,Denmark, Norway) 13.6 10.8
EEC (thie original six) 18.8 13.1
Spain 17.5 15.1
Ireland 15.6 15.4
Other GATT 16.o 12.0
Other countries 1.4-17.4 1.2-15.9
TOTAL 12.9 9.7
/a Based on published tariff rates
/b Calculated as: customs duty collections as percent of value of imports
Source: Unpublished data, GEBEI, Ministry of Industry.
C. Bias Towards Import Substitution
2.19 The use of tariffs and other import restricting instruments without
complementary export subsidies has a tendency to bias new investments and
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hence production towards import substitution rather than exporting 1/. It isimportant to minimize the protection granted to import-substituting producers(and to reduce it gradually over time) to insure that industry does not becomecluttered up with a large number of high-cost (or high-profit) producers, ashas happened in the past in domestic appliances in many other countries, andin automobile assembly in Portugal 2/.
D. Tariff Reform
2.20 The Government is planning a revision of the tariff code to convertit from "specific" to "ad valorem" terms. Wholesale overhauls of the tariffschedule come but rarely; advantage should be taken of this opportunity toreform and systematize the entire structure. The new tariff structure shouldbe systematically designed to grant low nominal and effective rates of protec-tion, relatively equal across and within all sectors. There should not be toomuch "cascading", i.e. increasing rates of protection progressively as onegoes from capital goods and raw materials to intermediate and final goods.This would penalize the domestic intermediate and capital goods industries(e.g. metal manufacturing) and make for unduly high effective protection offinal products. At the sarte time, domestic intermediate and capital goodsproducers should not receive too much protection, otherwise users of theirproducts will be penalized. The surcharges should be excluded from the tariffstructure, and it should be emphasized that they are temporary measures only.
2.21 Portugal's increasing ties with the EEC make such a tariff reformespecially urgent at this time. The currently strong domestic demand iscausing resources to be diverted to import substitution. It is important thatthis should be efficient (not highly protected) import substitution, so thatonce the demand backlog has been fulfilled, the industries will be able to usetheir newly installed and expanded equipment to export, instead of being leftwith high costs and excess capacity.
1/ High tariff protection for import-substituting activities has attracteda number of investments by multinational corporations, as well as somefootloose industries.
2/ The way in which reducing tariff protection may be expected to stimulateexports is suggested by the following snippet of an interview which wehad with a Portuguese clothing manufacturer. This enterprise is currentlvemploying 250 persons and produces no fewer than 250 varieties of shirtsin cramped and poorly organized quarters in Lisbon. The firm is currentlycopying a shirt bought in a store in Switzerland for $21. The Lisbonall included production cost for this shirt is $6, and the quality of theproduct seems identical to the Swiss one. But the firm is not exportingthis or any other shirt because it can sell all its output comfortably inthe protected domestic market. When asked what he would do if he had toface competition from abroad, the entrepreneur answered that he would haveto specialize and start exporting to Europe.
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E. Import Surcharges, Prior Import Deposits, and Quantitative Restrictions
2.22 These measures all have the same effect as tariffs, the main
difference between the three being that for surcharges the percentage rates
are easily seen.
Table II-3: COVERAGE OF THE SURCHARGE, IMPORT DEPOSITS AND
QUANTITATIVE RESTRICTIONS (NOTIONAL, BEFORE EXEMPTIONS)
Structure of Percent of value of imports subject to:
Imports Import Quantitative
Type (percent) Surcharges Deposits /1 Restrictions /1
Consumption goods 14 80
Intermediate goods 56 22
Capital goods 15 58
Petroleum products 16 - - -
All Industry 100 31 10 5
/1 No breakdown available.
Source: Unpublished data, Ministry of Commerce.
2.23 About 31% of all imports of industrial products are subject to the
30% surcharge, while about 2.3% of such imports are subject to the 60% sur-
charge. Over half of the goods subject to surcharge are intermediate products
(see Table II-3), many of which are inputs into export industries; and many of
these and/or other finished goods are potentially exportable. For example,
the 30% list includes important inputs into the textiles, clothing, and foot-
wear industries (e.g. yarns, fibers, woven fabrics, leather, buttons, fasten-
ers) also chemicals, pig iron, copper foil, bearings, capital goods, stoves,
boilers, tools, machine tools for working wood and cork, utensils. The 60%
list includes mostly finished "luxury goods", bult some are products which
co'ild be exported (e.g. canned fish and shellfish, flowers, some wines, travel
goods, bags, glass products, wood manufactures, clothing, motor cycles).
2.24 Import deposits apply to about 10% of all industrial imports. They
are required mostly for finished products, but again many are exportable or
are used as inputs into exports (e.g. textile fibers, clothing, footwear,
furniture, glassware, jewelry, locks, safes, domestic appliances, motorcycles).
The cost-raising effect of the import deposits is about 3.5% of the value of
the finished product. (The deposit represents 50% of the c.i.f. import value
in non-interest bearing notes for six months, while the interest forgone is
14% per annum.)
2,25 Quantitative Restrictions which cover 5% of all industrial imports,
apply mostly to "luxury goods" like coffee, floor coverings and childrens'
mechanical toys. However, the list also includes a wide range of potentially
exportable domestic electrical and electronic appliances such as washing
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machines, stoves, refrigerators, radio and TV receivers and domestic sewingmachines 1/.
2.26 It is believed that, as of May 15, 1977, no licenses had yet beengranted to import goods which appear on the February 28, 1977 list of productssubject to quantitative restrictions. This is apparently because of bureau-cratic problems and delays involved in administering the system, and alsobecause of the discovery that some parts and pieces for machinery had uninten-tionally appeared on the list of goods subject to quantitative restrictions.
2.27 As is the case with tariffs, surcharges, prior deposits, and quanti-tative restrictions attract resources away from exporting and into import sub-stitution. Under Portugal's agreement with the EEC such restrictive measureswill not be permitted to remain for long, and all tariffs on industrial goodswill have to be substantially reduced by 1985. It would be useful to putindustrialists on notice that these changes are going to have to occur.
2.28 To the extent that the various types of import restrictions areintenided to limit consumption of luxury items rather then just import, theymight be converted to consumption taxes to avoid encouraging domestic produc-tion of the same goods. For imports, the consumption tax could be collectedat the point of entry into Portugal.
F. Drawback
2.29 The drawback system, to the extent that it is in fact used, servesto remove one of the distortions - high costs of raw materials and intermediateinputs - introduced by the, use of tariffs and other import restrictions withoutcompensating export subsidies. However, the drawback itself does nothing tooffset the second tariff - induced distortion - the fact that protected linesof production become more attractive; nor does it compensate for the cost -disadvantage of Portuguese manufacturers vis-a-vis competitors.
2.30 The drawback system as currently operated suffers from a number ofdefects. Judging from the comments of some plant managers, the drawback pro-cedure tends to be rather cumbersome in practice, involving excessive datarequirements, discretionary decision-making and long delays, and hence is notalways used 2/. Even drawback users often have to pay the customs duty in
1/ When originating in the EEC and EFTA imports of non-liberalized industrialprodtucts are free of quantitative restrictions, except for certain pro-tected products such as steel and automobiles.
2/ Decree Law No. 75-L/77 of February 28, 1977 goes part of the way to solvethis problem by increasing the length of time during which a drawback canbe claimed, but much of the red tape remains. A series of detailed sug-gestions on simplifying custom procedures, were made by a working groupof 27 firms in Northern Portugal. (Braga, Report of Working Group ofIndustries in the North, February 1977).
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advance, and the duty is sometimes returned only after 12-24 months instead ofthe 6 laid down in the law.
2.31 Furthermore, the drawback system as currently operated discriminatesagainst small firms and in favor of large ones. Small firms do not alwayshave the detailed cost informLation required by the drawback administration,and their managers cannot always afford to spend the time required to negotiateand shepherd the drawback application through the various official channels.
2.32 The drawback as currently operated also discriminates in favor of in-tegrated and against horizontally specialized enterprises. Thus an integratedspinning-weaving-garment-making firm which exports its final products can claimthe drawback on raw materials or intermediate inputs imported at any stage ofthe production process; whereas an otherwise identical spinning and weavingfirm which sells its output to an otherwise identical garment manufacturer (whoexports his final product) cannot claim the drawback 1/. A possible solutionto this problem which has been used successfully in other countries (e.g.Israel) is to allow the drawback for indirect exports too. For example, a firmmanufacturing metal cans which are sold to food processing plants and used intheir exports would be eligible for drawback benefits.
2.33 The OECD apparently currently permits Portugal to apply a drawbacksystem - permission was initially granted for a year and has since beenrenewed. The drawback is permitted under the GATT. But the EEC and similarlyEFTA, is prepared to accept such a system only if it is operated in a "bonafide" manner. In practice this means that it is acceptable if (a) the rawmaterials and intermediate inputs exempted from duty come from EEC countries;or (b) if they come from other countries (especially including Japan) domesticPortuguese value added must be "relatively high". Hence, beyond certain limits(depending on the commodity), duty-free importation of components from coun-tries other than those in EEC (EFTA) for use in exports to EEC (EFTA) countriesis generally not permitted.
2.34 Drawback schemes may encourage the use of imported inputs in placeof domestically produced items. In Portugal this is avoided by the ruling thatthe inputs must be bought in Portugal if local supplies "of satisfactory priceand quality" are available 2/. But this ruling, in turn, introduces problems.Government bureaucrats are not well equipped to judge a producer's claim thatthis or that raw material or intermediate product is not exactly what it needsto be able to export. And the addition of an element of judgment makes theprocess of applying for drawbacks slow and cumbersome. It would be preferableto raise the exchange rate, lower tariffs (which would be that much lessneeded) and grant to exporters automatic drawbacks of the by-now low tariffs.
1/ This discrimination is especially serious now that the 30% surcharge isin force on many textile inputs.
2/ See e.g. Article 17 of Decree Law No. 288/76 on Export DevelopmentContracts.
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This would minimize the difference in incentives to different firms created bythe variation in applicability of the drawback system, lighten the governmentsalready-too-heavy administrative burden, and speed up and simplify the wholeprocedure, thus increasing the likelihood that it would be used.
G. Credit Subsidies
2.35 The interest rate structure in Portugal fixed by the Government hasbeen at a level below the rate of inflation over the past five years or more.In 1977 inflation is projected at approximately 30%, but hopefully it willsubside to about 20% in 1978. The highest interest rate currently chargedfor a short-term loan is 16.5%, while for a term loan it is about 18.5%.Thus, during 1977, borrowers were paying zero interest and, in addition, werereceiving a subsidy on capital of at least 12%. If a real positive interestrate of 5% is used as the point of comparison, (that is, a 35% nominal ratewhen, inflation is 30%), then the actual subsidy is at least 17%.
2.36 In addition, the Government has introduced interest rate rebatesrunning from 2 to 9%, for one to four years, to be available on the following:export credit, investment credit for agriculture, forestry, livestock, fish-eries, tourism, mining and manufacturing; and credit for the restructuirng ofviable enterprises currently in difficulty. 1/ This raises the actual subsidyanother step, to the 19 to 26% range. Furthermore, it is necessary to dis-count to present value the subsidy on term loans (negative interest rate plusrebate); this comes to 3 to 5%. Total actual subsidy is now 22 to 31% on bor-rowings, assuming credit is evenly split between short and long-term.
2.37 If the inflation subsidy is omitted, the net incentive is 5 to 14%.The amount of this subsidy has to be adjusted in accordance with the incre-mental capital-output ratio (ICOR). If the ICOR is 0.5, the interest ratesubsidy (inflation adjustment excluded) becomes 2.5 to 7%. If, as in heavyindustry, the ICOR is 2.0, then the value of the subsidy quadruples to10 to 28% 2/.
1/ In the range from 2 to 9%, there is a cost per jobs cut-off point ofEsc. 750,000 ($18,750). This is quite high in the Portuguese contextand ways to circumvent it are being found by loan applicants.
2/ Initial investment = 100; annual production = 200; interest savings = 21to 27% p.a. Effective output subsidy - (21 to 27%)/200 = 10.5 to 13.5%.Estimated direct capital-output ratios in industry at about Portugal'slevel of development vary from 0.5 (printing and furniture) to 1.9(fertilizer). Total (direct and indirect) capital-output ratios vary from1.0 (shipbuilding) to 3.4 (fertilizer). Total capital-output ratios forthe export industries are 1.29 (Lextiles and clothing), 1.41 (furniture),1.26 (shipbuilding), 1.35 (machinery), 1.63 (wood and cork), 1.67 (metalproducts), 1.83 (food processing), and 1.85 (paper). Joseph J. Stern,"The Employment Impact of Industrial Investment", World Bank Staff WorkingPaper No. 255.
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2.38 A credit subsidy of the magnitude indicated above provides a strongincentive for capital-intensive labor-saving investment, even though thisis contrary to Portuguiese policy to encourage employment creation.
2.39 Exporters can get an interest rate subsidy of 5% to finance sales orproduction for up to two years. This is not very significant in view of theoverall interest rate structure and the relatively short period for which thesubsidy applies. The discrimination of the interest rate regime in favor ofCxports is rather negligible, and the main effect of the set of implicit andexplicit credit subsidies is to lower the cost of capital quite substantiallyacross the board, regardless of whether manufacture is export oriented or not.
H. Exemption of Indirect Taxes on Inputs
2.40 As in most countries, Portuguese exporters are exempted from payingindirect taxes on inputs used in production. In the absence of detailedinformation, the mission assumed that this exemption guarantees equal treat-ment with foreign firms rather than granting any net advantage to exporters.It may of course, put export firms in a better position vis-a-vis importsubstitution firms.
I. Income Taxes
2.41 The current Export Development Contract law permits discretionaryreduction or temporary abolition of corporate income tax payments (Article 13).This may be challenged by Portugal's trading partners in Europe - GATT rulesare ambiguous on the point 1/. More likely to be acceptable are the existingprovisions which relate to accelerated depreciation allowances, which in theend have a similar effect (Articles 13, 15). Again, these should be madeautomatic rather than discretionary. Further, the industrial corporation taxcan' be reduced by an amount up to 5% of export value (see para. 4.06 (g)).
2.42 Depending on exemptions, loopholes, etc., the rate of corporateincome tax is approximately 20-30% on income. If income taxes are waived,firms earning 2% on sales (assuming all sales are value added), would receivebenefits equivalent to an output subsidy of 0.4 to 0.6%; for a firm earning
1/ Ireland regarded by the EEC as a less developed region, has been allowedto retain such tax exemptions. But the U.S. may impose countervailingduties.
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as much as 15% on sales the output subsidy would be 3 to 4.5%. 1/ If valueadded is 50% sales, the percentage (subsidies) would be doubled.
J. Export Development Fund (Fundo de Fomento de Exportacao - FFE) i
2.43 The FFE provides a number of useful services to exporters describedin Annex III-5. It has 130 representatives at various strategic locationsabroad, organizes participation in trade fairs, finances missions and trips byprospective buyers and sellers, hires and finances consultants to do marketresearch, and is in charge of signing and implementing the Export DevelopmentContracts discussed in Annex III-5.
2.44 Although these are useful services it has not been attempted to cal-culate what "percentage incentive" they represent for exporting firms. TheFFE has been useful in opening up new markets, and in the future it is expectedto play a key role in providing marketing and other export development assis-tance (paragraph 2.52).
K. Summary of the Effects of Trade Incentives
2.45 The effects of the various trade incentive measures on productionfor export on the one hand and production of import-substitutes on the otherare summarized in Table II-4. The table does not include credit subsidieswhich apply to both export and import substitution industries. In the absenceof the necessary detailed calculations the Table does not present averages butinstead ranges of price incentives.
2.46 Two conclusions may be drawn from the table:
(a) Export firms receive subsidies well below those received byfirms producing import substitutes. The former receive asubsidy averaging 2% (or 0.5% - 5%) of output value (andwhen the drawback does not operate, an additional penalty of10% as against a protection of 13 - 80% for import substitu-tion firms. According to mission calculations for individualfirms, the calculations showing the incentive effect as a per-centage of value added would show a similar bias in favor ofimport substitution and against exports. Thus, the observa-tions made about the import substitution bias in paragraph2.19 above is true generally for the incentive system as a
1/ The top corporations in the U.S. earned an average of 4.6% net on sales(after tax) in 1976. (Fortune, in Time, May 16, 1977, p. 52). The taxadvantages are spelled out in detail in the new draft export incentivebill. (Law No. 42177 of June 18, 1977 specifies that the industrialcorporative tax liability can be reduced by up to 5% of export value.)The law also permits acceleration of depreciation and other tax benefitswhich the Mission did not discuss with the authorities.
2/ Recently renamed "Portuguese Institute for Export Probiotion".
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whole. Between 1970 and 1974 there was a reduction in tarifflevels (cf. para4 2.17), but since then several instrumentswere added which in effect intensified the imports substitutionDias.
(b) Moreover, the subsidy element received by the export manu-facturer [averaging 2%, and 10 percentage points less whenthe drawback is not operating] is insufficient to overcomethe deterioration since 1973 in competitive advantage (causedby changes in wages, productivity and exchange rates) vis-a-vis producers in Portugal's OECD trade partners. As discussedin paragraph 2.09 this deterioration was at least 10% on aver-age and substantially more for certain industries.
2.47 It is true that in the short-run there may be quite a deal of scopefor import substitution, especially because of the effects of the post-1974income redistribution and the arrival of the retornados. However, in themedium to long term the small size of the Portuguese market and the tariffreductions required by Portugal's agreement with the EEC limit the amount ofimport substitution that may profitably be done. Therefore, it is importantto ensure that the current catch-up phase of import substitution is efficient,so that once it is spent the capacity built up will be useable for export.
Table II-4: SUMMARY OF THE PORTUGUESE FOREIGN TRADE INCENTIVE SYSTEM
Incentive for:Measure Exports Import Substitutes
--------- (% of value of output)-------
/a1. Tariffs Average of +10%
or more with widevariation
/a2a. Surcharges +30% for 31% of
imported goods;+60% for 2.3% ofimported goods /b
/a2b. Prior import deposits +3.5% for 10% of
imported goods /b
2c. Quantitative import Strongly positiverestrictions for 5% of imported
goods /b
3. Drawback /a Net effect zero(it simply removesdisincentives fromtariffs, surcharges,etc. on imported inputs)
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Incentive for:Measure Exports Import Substitutes
--------- (% of value of output)-------
4. Exemption of indirecttaxes on inputs (Simply equalizes tax
treatment with thatof foreign firms)
5. Income taxes +0.5% to +4% increasingwith the rate of profit
6. Export Development Small positiveFund
TOTAL 0.5% to 5% Varies widely from13% to 80% andhigher (see TableII-la, column 3)
CONCLUSION: There is a clear bias in favor of import substitution and againstexports.
/a See drawback below. When the drawback does not operate (e.g. for smallfirms), tariffs and/or surcharges and/or prior deposits have to be paid,and the subsidy to exporters is lowered correspondingly. E.g. a 10%penalty results when imported inputs are subject to the 30% surcharge andaccount for a third of total cost. The penalty will be even greater than10% if there are tariffs and prior import deposits to be paid.
/b The positive incentive is lower to the extent that exemptions are granted.;
L. Recommendations
2.48 The steps to be taken fall into three categories: (a) have a generalreduction in the cost structure of Portuguese industries to overcome the deter-ioration in competitive advantage since 1973 and lay the basis for accelerationof exports of manufactures; (D) remove the present import substitution bias ofthe incentive system; and (c) improve the effectiveness or remaining elementsof the system, e.g. the tariff, the drawback and the operations of the ExportDevelopment Fund. Once the measures have been taken and a program of actionhas been agreed, it is essential that the system will be maintained in a stablemanner so as to give full opportunity to export manufacturers to make thenecessary investments, develop products and enter new markets.
2.49 Improvement in cost-competitiveness. The mission stresses the needfor across-the-board measures, in particular a general reduction in relativecost which has an even effect on all industries. Portugal is faced with asituation of crucial structural adjustment in which it is extremely difficultto determine a priori precisely which export industries and products will do
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well in foreign markets and which existing production lines must be adopted tonew conditions and markets. Estimates for the necessary improvement in cost-competitiveness of export industries range between 10 and 20% and higher (para
2.09). These estimates however, probably are less than the over-all cost re-ductions required when account is taken of the adjustments which industry mustmake if it is to contribute sufficiently to Portugal's balance of payments. Asa result of structural changes affecting the balance of payments, manufacturedexports will have to make a substantially larger contribution to Portugal'sforeign exchange earnings than they did before 1973. Thus, even if on a 1973basis Portuguese export industry would have been fully cost-competitive inFebruary 1977, further cost reductions would have been necessary if exportgrowth is to speed up sufficiently. The manner and timing of the necessaryacross-the-board cost reducing measures will very much depend on the progresstoward achieving domestic price and wage stability and improvements in produc-tivity. The measures called for will have to be part of a broad program ofdomestic price-cost stabilization, and improvements in industrial management,efficiency and productivity discussed in Chapter III.
2.50 A sufficient general reduction in relative cost-levels will makepossible removal of the import substitution bias of the present restrictivesystem. This will require dismantling - or setting up a timetable for theelimination, of the system of surcharges, prior deposits and quantitativerestrictions, as well as a reduction in tariffs. This is necessary in orderto avoid attracting resources away from exports into high cost import substi-tution industries which will be a burden once Porgual's EEC agreement forcesimport restrictions to be lowered.
2.51 The Mission also recommends that the Government consider additionaldirect export subsidies. P6rtugal already has various means of assistingexport industries and the Mission is recommending improvements in them, espe-cially in the operations of the Export Development Fund. Failing adequategeneral measures to reduce relative costs (and accompanying reduction in importsurcharges and tariffs) there would be a case for subsidies to overcome thedeterioration in competitive position and remove the import substitutica biasof the present incentive system. The subsidies should preferably be based ondomestic value added, be simple to administer and be confined to a transitionalperiod pending more basic measures and a strengthening of manufactured exports.Portugal would need approval of the EEC and EFTA for such subsidies, presumablyfor a limited period.
2.52 Further steps are:
(i) Take advantage of the present unlikely-to-be-repeatedopportunity to rationalize the entire tariff structureduring its conversion from "specific" to "ad valorem"terms. In general protection should be relatively lowand tend to have similar levels of effective rates acrossand within all sectors.
(ii) Simplify and speed up procedures involved in the draw-back.
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(iii) Extend the drawback to apply to indirect exports (e.g.exempt from duty yarn used to weave cloth whtich is soldto a garment-maker who exports his products).
2.53 A special role is to be played by the Export Development Fund:
(a) Rationalize the operations of the Export Development Fund, andespecially attempt to increase its degree of contact withPortuguese industry. The Fund would make sure that exportfirms receive all the benefits available, and follow-up on thevaricus phases of development of new export projects.
(b) Have the Export Development Fund issue the firms which exportmore than a minimum percentage of output (say 30%) with theequivalent of an Exporters' Card - this may be the revampedExport Development Contract - which would automatically andquickly entitle him to exporters' privileges - drawback taxreductions, etc.
(c) Simplify and speed up the procedures for signing of theExport Development Contract as suggested in Annex III-5.
2.54 The effects of the incentive system should be kept under review.Once economic recovery gets under way the entire system might profitably bestudied with a view to rationalizing it further.
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CHAPTER III
REVIEW OF MANUFACTURING INDUSTRIES
A. General
3.01 Portugal's comparative advantage in manufactured exports rests onits natural resources, its labor and engineering skills and its location.
Natural resources yield a variety of agricultural, fishery, and forestry prod-ucts which have provided the basis for an expanding volume of resource-specificexports. Skilled manpower is relatively abundant, both for engineering andproduct design and for machine operation. Despite the sharp post-1973 wageincrease, Portuguese wages are still only one-fourth to one-half those of itsEuropean trading partners. This means that Portugal has a comparative advan-tage not in the simplest, most labor-intensive goods (in which it cannot com-pete with East and South Asia), nor in the most capital-intensive products (inwhich it cannot compete with the lower capital costs of the OPEC and OECDcountries), but in the large range of goods between the two extremes - andespecially in those which tend to be more skill-intensive. 1/ Portugal'slocation - close to other European markets and relatively close to the NorthAfrican and Middle Eastern members of OPEC - gives it an advantage in goodswith an intermediate weight to value ratio: not so high as to bar all trade,but high enough to gain an advantage over East Asian and Latin American com-petitors. For similar locational reasons, Portugal has an advantage in prod-ucts with high sensitivity of value to fast delivery.
3.02 Since many potential manufactured exports are produced in the pri-vate sector in Portugal, the Government can be effective by reducing uncer-tainties to a minimum (especially those concerning labor relations, anddomestic economic policies and plans), ensuring that incentives are roughlyequal between and within all sectors for exporting and import substitution(see Chapter II), and letting private firms decide which products to export.It should lend assistance in consoliaating the smaller sized firms into moreviable export units so as to make marketing, purchasing and transfer of tech-nology more effective.
3.03 The ways in which Portugal can best utilize its comparative advan-tage is described on an industry by industry basis. Portugal will have toovercome a number of obstacles which at present are hampering the realizationof its potential. First, as is discussed in paragraph 2.45, the current biasof the incentive system against exports and in favor of impo2t substitutionwill have to be redressed. Second, major efforts need to be made to reducethe uncertainties facing industry, especially those concerning future laborrelations. Third, training for middle-level management, need to be started orstrengthened, with particular emphasis on skills which seem to be lacking in a
1/ The discussion in Annex 1-3 suggests that a 1968-73 exports of productswhich are still labor-intensive tended to grow relatively more rapid thanothers.
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wide range of plants throughout Portuguese industry; production management,
cost accounting, shop-floor supervioion, and human and employee relations.
Fourth, the transport and communications networks need to be improved. In the
area of sea transport - 93% of exports and 96% of imports are moved by sea at
present - the port of Leixoes was widely criticized as being congested and
high-cost. Road connections are mainly through Madrid, while for rail there
is a change in gauge between Spain and France. It would be useful to improve
transit arrangements with Spain to cut down on customs delays at the border.
Finally, it will be necessary to make export marketing more aggressive to
hasten the adjustment away from Portugal's traditional markets in the colonies
(and to a lesser extent the U.K. and EFTA) and towards the EC, U.S. and oil
exporting countries in the Middle East, North Africa and Latin America.
3.04 In the next five to ten years the structure of Portugal's industry
will undergo several changes in response to the shifts in demand confronting
it. Besides an increase and change in the composition of exports other factors
causing structural changes are: (a) higher levels of private consumption,
(often of relatively inexpensive products) associated with higher real income
and a more equitable income distribution; (b) an increase in public infra-
structure investment; (c) higher levels of residential, business and public
construction; and (d) those resulting from efforts to overcome regional dis-
parities. In addition, the structure of industry will be affected by the com-
pletion of the Government's heavy industry plans, including parts of the SINES
complex.
3.05 The Government, through IAPMEI, EPPI and special programs is attempt-
ing to consolidate small uneconomic and obsolescent firms into larger and more
economic units; this is particularly important in the textile, clothing, foot-
wear and food processing industries 1/. In restructuring industry, the objec-
tive of employment creation should be a key consideration. The industrial
estates program (EPPI, Annex III-3) should make an essential contribution,
supported by the promotional activities of IAPMEI. The latter Institute will
need to be strengthened and decentralized (Annex III-4) in order to make a
more effective contribution to the reequipping of small firms, the establish-
ment of industrial centers, helping consolidate smaller units into larger ones
and to further closer links between large and small firms. A sectoral approach
(e.g. concentrating on particular industries such as footwear or food process-
ing) would be most effective in IAPMEI's various programs.
3.06 The definition used for IAPMEI's program of assistance to small
industries is too wide and does not lay sufficient stress on the employment
aspect. IAPMEI's role should be limited to assisting firms with between 10
and 100 employees and with fixed assets in plant and equipment not greater
than Escudos 10 million for a merger project involving a number of small
ftrms. While there is a strong case for limitLng the size of individual
small firms being assisted, it is unwise to maintain - as at present - too
1/ Other industries in need of restructuring are: wood and cork, furniture,
paper, resins and glassware.
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low a ceiling on the size of the guarantee to a project resulting from amerger of a group of small enterprises.
3.07 The Institute for State Participation (IPE), which is under theMinistry of Planning and Economic Coordination, supervises many small enter-prises in which the Government owns a majority of shares. One of the IPE'sfunctions is to encourage mergers and improvement in organization. The IPE isalso working towards the consolidation of ownership, e.g. transfer of sharesof the nationalized banks in enterprises to the IPE. The IPE has only recentlystarted operations and is not yet adequately staffed. It will have to play akey role in makLng the operations of firms with State participation more effi-cient and profitable; one way to do this will be through management trainingunder IPE auspices. It is essential to have experienced competent managementin these enterprises and to permit scope for independent action.
3.08 Management. Much can be done to improve the status and remunera-tion of professional managers in Portuguese industry, especially (but notexclusively) in branches dominated by family-owned business. Besides manage-ment training - a longer-term proposition - immediate action appears requiredin abolishing present government-imposed limits on pay. Remuneration can beimproved in various other ways, e.g. stock options or profit sharing. Moreprofessional management of labor relations appears especially urgent in lightof the changed roles of labor unions and the excessive time spent on theserelations by top management. Production management has a special role toplay in the improvement of plant lay-out and utilization necessary in severalbranches, but especially machinery, clothing and food processing industries.The IPE has a program for training managers for state controlled industries.There is need for a wider program to train and upgrade managers for theprivate sector as well. Business studies should be introduced as courses ininstitutions of higher learning. CIP should be encouraged to initiate thecreation of a Portuguese Institute of Management.
3.09 The M.I.T. is already engaged in various types of technical assis-tance to industry. Some additional areas where technical assistance is calledfor at this time are: (a) preparation of a program for developing the capitalgoods industry, preferably by contracting a group of engineers and technolo-gists; (b) a center for dissemination (possibly associated with a PortugueseUniversity) of technical information and documentation to industry; IAPMEI'sservices in this field to PME should be expanded; (c) more support for R&D inindustry; and (d) a study of the utilization of trained high level industrialmanpower (engineers, accountants, computer specialists, etc.), to clarify withindustrial management how better use can be made of engineering talent avail-able in the country. Finally, much technical help can be obtained throughknow-how and licensing agreements with foreign firms.
3.10 Export marketing should be strengthened in several industries. Inthis area the Export Development Fund will have to play a central role (AnnexIII-5). Portuguese embassies could render more expedient services in helpingfirms to become aware of opportunities and respond to invitations for inter-national competitive bidding, e.g. in the heavy engineering industry.
,.S .. , < ,, ;~~~~. .Et.. O . . v. . .?.
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B. Metal Working Industry
3.11 The mission visited the plants of some 15 firms and held discussionswith their managements, covering recent trends, prospects, operations (manu-facturing, finance, marketing, labor relations) and where applicable productdesign, licensing and technical assistance needs (see Anrnex III-6 for pointscovered in interviews). The plants visited produced a wide range of items,and probably represented the better firms in the industry 1/. The principalfindings from individual plant visits are indicated in Annex III-7.
3.12 Production Trends. The original orientation of the Portuguesemetal-working industry was primarily toward the domestic market and the colo-nies, supplying material for the development of infrastructure, includingrailways, ports, electrification schemes, etc. The consumer-oriented market(household appliances, office machinery, electronics, etc.) depended on im-ports and received little attention. In-between, some companies producedmedium-weight goods, including a few basic machine tools, some textile machin-ery, motorcycles, and so forth. None of these have really become very suc-cessful,
3.13 In the 1960's a few foreign companies established plants for themanufacture of specialty items which were needed by the parent company, eitheras components parts or as directly saleable items. The establishment ofplants of this type was based on relatively low wages, which in conjunctionwith "paced" production lines resulted in low production costs. These werefurther enhanced by incentive measures (exemptions from duties, remission ofcertain taxes, simplication of some of the administrative procedures). Wit'the loss of the colonies, a slowing down of infrastructure development inPortugal, and the widening of the consumer market (due to a rapid rise inthe workers' wage levels) some companies are cautiously considering thepossibilities of producing consumer goods, such as cooking stoves, washingmachines, kitchen appliances, etc.
3.14 The companies specialized in the heavy goods field, faced withrestricted sales opportunities at home, are becoming more active in exporting.Some well established companies have in fact been exporting for several years.The metal-working industry can be expected rapidly to take advantage of oppor-tunities once the prospects are considered favorable in relation to the in-herent risks. Given proper support in incentive policies and financing, andthe identification of export opportunities, the Portuguese metal-workingindustry can quickly increase its exports.
1/ Items produced by the firms visited included: Heavy Mechanical Equipment(cranes, vessels, heat exchangers, turbines, hydraulic gates and rollingstock); Heavy Electrical Equipment (transformers, motors, alternators,switchgear, elevators); Internal Combustion Engines; Machine Tools;Munitions; Ships; Wires and Cables; Metering Instruments; HouseholdAppliances; Consumer Electronics; Automotive Spare Parts; ElectricalComponents; Plastic Parts; Non-ferrous Extrusions; Fasteners; Stampings;and Castings.
- 30 -
3.15 Since early 1976 the mechanical industries, as other branches ofmanufacturing, have experienced improvements in output, exports and laborconditions. Many companies may show a profit in 1977 for the first timesince 1974. Some firms actually continued expanding output despite thetroubled conditions in 1974 and 1975. The managements of several firms havebecome more optimistic and are making new investment plans. Generally, how-ever, the attitude toward new investment is quite cautious. lWhile plans arebeing developed in many enterprises, firm decisions will probablv not be takenuntil there is greater certainty about tae Government's policies.
3.16 In management the areas generally deserving most urgent attentionare those of production management and marketing. Many plants can increasetheir efficiency on the factory floor. While Portugal has a good engineeringprofession, it will need special and more formal training for productionmanagement - including training abroad. Marketing will require a specialeffort for many engineering products: the present emphasis on exports israther new. In engineering, management concentrates on product testing andquality control; but it largely relies on foreign design inputs, especiallywhere effort at the conceptual level is needed. Much more ought to be donein engineering research, which at present is absent at levels above thesimplest product and process development work.
3.17 Labor costs hLave risen substantially, as in other industries, butare still considerably below those in more industrialized countries. Quiteproperly, many metal-working plants use more labor-intensive methods thanwould be economical in most other European countries where wages are higherand skilled labor is often scarce. The more sophisticated Portuguese firmsare carefully seeking low product cost levels by continually examining therelative advantages of additional investment in productive equipment versususing more labor which in many cases, due to governmental policy, is largelya fixed cost. The relatively few companies which have adequate cost informa-tion feel that they have no difficulty meeting costs experienced elsewhere,except in cases where the (generally much larger) foreign firms have advan-tages of scale, particularly in the area ou materials purchasing. (Compari-sons are often difficult because Portuguese manufacturing industry has a highdirect labor content due to the absence of a sub-contracting industry commonin more inriuCtrialized countries).
3.18 1-l,:ices of material inputs used by the metal working industry seemto be in line with the world market, regardless of whether the inputs areimported ot: procured domestically. All heavy steel plate, most structuralsteel shapes, all non-ferrous metals, and many other materials (such asraw rubber Eor cable insulation) is imported. Portugal has a few metal-transforming plants producing certain intermediaries (e.g. structural steelshapes in srmll sizes; thin gauge cold-rolled steel sheet; 8 mm copper wiremade from iUnported "wire bar", etc.).
3.19 Plant utilization in the industry is well below capacity, produc-tion being about two-thirds of what could be accomplished with the same laborforce (working with effective incentives). Generally, a single-shift opera-tion is the rule. Multiple shifts are uncommon, and are worked only in
31 --
situations where certain specialized machines are used, or where there are
temporary bottlenecks or the zompany wants to a-void new investments whosejustification, in the long run, seems unassured. In many of the plants, the
working pace is quite leisurely in an apparent attempt to spread the work over
the available working hours, given a fixed work force.
3.20 A low level of orders is the usual cause of low capacity utlization.
The heavy mechanical industry, particularly, is dependent on the level of
public investment (railways, electricity); and construction of the SINES
complex. On the other hand, the plants with shorter production cycles, e.g.
consumer electronics, relays and a recently opened modern foundry, have been
performing at higher levels of capacity utilization.
3.21 Exports. Opportunitties for foreign sales lie primarily in four
product areas:
(a) custom-made heavy equipment (cranes, pressure vessels,
electric sub-station equipment, etc.); orders are mostly
placed by Governments or their agencies, frequently after
international competitive bidding;
(b) contract supply of "commodities", such as small diesel
and gasoline engines, standard machine tools, medium size
electric motors, wire and cable; also shipbuilding and
repair;
(c) component parts manufacture in sub-contract (such as raw
castings, machined castings, stampings, plastic parts,
etc.), and
(d) machine-paced operations with relatively high labor content.
3.22 Custom-built heavy equipment would probably be the best product
group in which Portugal's combined advantages of relatively high manufacturing
sophistication and low labor costs could be applied. "Commodities" produced
in quantity would very likely also offer possibilities, provided the products
are chosen wisely. Relatively heavy duty engines (prinicipally kerosene or
diesel fueled) might be suitable for production in Portugal. They are usually
preferred for agricultural irrigation purposes and also find use on tillers
and industri,al fork lift trucks. Several firms have already had experience in
such equipment. Similarly, medium-size electric motors, say from 20 to 500 kw
ratings, particularly where such motors are not run-of-the mill induction
motors, but special (including geared) types, might offer possibilities; the
production quantities of such equipment are usually not so large as to attract
interest by companies focusing on high-quality capital-intensive production.
While Portugal may not have special natural advantages for wire and cable pro-
duction, it doeF¢ have experience in their manufacture and efficient manufac-
turing facilities which are currently largely idle. Hence, work for these
facilities should be sought, even thouggh there is some question as to whether
further substantial investments in this product area should be made.
- 32 -
3.23 The Portuguese heavy mechanical industry is able to meet specified
quality standards and can expand exports under present circumstances. It is
able to make speedy deliveries in particular because of low capacity utiliza-
tion. Profits are, however, low and over the longer term, corrective steps
are necessary. Export prices are in certain cases below those charged for
domestic sales, mostly to the Government or its agencies. As capacity util-
ization improves delivery time and prices would come under greater pressures.
3.24 Portugal seems to be able to fulfill supply contracts at a profit
for smaller items e.g., speciality castings, automotive precision spare parts.
The industry needs to apply greater and more effective marketing efforts,
searching out potential customers abroad. Since only a few of the very largest
firms can economically undertake the necessary information and promotion activ-
ities, a central role will have to be played by the Expct Development Fund
(see Annex III-5).
3.25 Most promising production items. Portugal's industry has achieved
a high level of technical sophistication. The country has good engineers in
design offices as well as on the shop floors. Hence, it is well advanced
relative to many countries which are currently endeavoring to compete inter-
nationally, but which are still -in a much earlier stage in their efforts at
industrialization. On the other hand, wages in Portugal are relatively low,
generally less than half of comparable ones in the more highly industrialized
countries. Hence, the country should do well in product areas which require
a combination of sophistication in conjunction with a high labor input.
3.26 Products could include a great variety of items, ranging trom heavy
electrical equipment over electronic assemblies, locomotives, ship repair and
rolling equipment to the manufacture of high-precision automotive spare parts.
Conversely, at present wage levcls, products which are simple to make, or
whose production depends more on the availability of highly efficient (and
expensive) special-purpose machinery would not seem to offer equal promise.
With regard to consumer products principally made for the domestic market
(e.g. cooking stoves), the present designs are rather unsophisticated, while
acceptable in Portugal and lower income countries, would not be saleable in
the more affluent countries. Hence, design improvements, possibly in sub-
contract with foreign firms, will be necessary if exports of these products
are to become important.
3.27 Portugal should also be able to develop in the longer run a machine
tool industry for export. In the next few years it would be hard to enter
foreign markets under Portuguese brand names. At least one firm is already
supplying tools to a well-known U.S. firm selling machines under its own
name. Arrangements of this type would at present seem advantageous provided
the Portuguese manufacturer does not become excessively dependent on one
single foreign customer. Domestic machine tool brands are not popular in the
Portuguese market and Portuguese brands would find little acceptance abroad.
Initially it would, therefore, seem best to export components (e.g. gears or
lead screws) or sub-assemblies (e.g. drive heads).
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3.28 With present sales prospects new investment in equipment is justi-fied at present where existing equipment is no longer economic (because ofobsolescence, higher real wage costs or increases in output) or where wouldameliorate an otherwise unbalanced situation. Investment is also desirablewhere plants are arranged inefficiently and should be laid out anew to improvethe work flow. Much of the new investment would consist of modernizing build-ing (better lighting; ventilation; distribution of power, light, compressedair, gas); moving production machinery in accordance with the new lay-outs.Where new plants are to be constructed, the Government may want to considerwhether administrative or physical consolidation of smaller units would befeasible. In the immediate future the requirements are less in the areasof updating equipment as in the updating of skills. At least in most of theplants vLsited by the mission there appears to be no lack of up-to-date equip-ment. But frequeniLly the skills inherent in the most modern machines are notfully utilized, partly due to the lack of properly trained production plannersand operators.
3.29 Over the medium-term (say starting in 1979) investment needs can beexpected to increase significantly as capacity utilization improves, exportscontinue to grow and domaestic demand firms up or increases. Provided doinesticsupplie-s receive adequate finance, demand for products of the metal workingindustry is expected to increase as Portugal proceeds with construction of newplants (e.g. cement, oil refining, petrochemical), infrastructure investmentis stepped-up (hydro and thermoelectric plants, road and port construction)and residential construction continues at a high level.
Recommendations on Action for the Metal-Working Industry
3.30 A Stable Real Exchange Rate Policy (i.e. moving the exchange ratewith the excess of domestic inflation over inflation abroad) is particularlyimportant to the heavy mechanical industry in maintaining competitiveness,preparing cost estimates and planning production (frequently with a lead timeof two or more years). (The August 1977 measures are a step in this direc-tion.) The heavy mechanical industry would benefit from demand emanating froma well defined and stable long-term Government investment prograLm, (partic-ularly electric power, and heavy industry in the public sector). Greater stab-ility in domestic demand will help the industry cope with fluctuations iyiexternal demand.
3.31 Market Intelligence. Information on export opportunities should becollected continuously and in a systematic fashion. It should then be madeavailable to industry on a regular basis. Particular emphasis should beplaced on major "projects", world-wide, which require heavy mechanical and/orelectrical equipment; and also on possibilities - which should be activelysearched out - of supplying castings, component parts, sub-assemblies, etc. toforeign OEM's (Original Equipment Manufacturers). This activity might best beundertaken by FFE assuming, of course, it will be strengthened as recommendedin Chapter II (see paragraph 3.35).
3.32 Technological Support. Many of the smaller firms could use help inmaking technological decisions relative to products, processes, availability
- 34 -
of specialized equipment and of licenses, etc. Reliance on the "friendly
advice" of equipment salesmen - always readily available - is bad practice.
Government, perhaps with help from bi- or multi-lateral assistance agencies
could set up an office staffed with a small number of specialists available to
industry upon request (the service could certainly charge a fee and thus beself-financing). This work is within the purview of IAPMEI; but there is some
question of its effectiveness at the present time.
3.33 Quantity Purchasing. Even the largest Portuguese metal-working
enterprises are considerably smaller than their principal foreign competitors.
The former, therefore, with regard to purchasing, suffer an important dis-advantage of scale. The Government may want to consider establishing a buying
office for the Portuguese metal-working industry, concentrating on metallic
raw materials, semi-finished products and components. The administrative
costs would doubtlessly be outweighed by the lower purchase prices obtainable
In this way.
3.34 Production Management. Production management includes inventory
planning and control, warehousing, manufacturing process selection, machine
loading, tool engineering and many other functions which are as yet not gener-
ally recognized in Portugal as separate and important management responsibili-
ties. More training opportunities should be provided for personnel instru-
mental in production, includLng specialized training courses, professional
society conferences for the exchange of relevant information among enterprises,
"fellowships" in applicable foreign plants, etc.
3.35 Export Sales Promotion. Smaller firms have usually little back-ground in promoting their wares abroad; and they can, individually, hardly
justify the cost. It may be desirable to establish, with the assistance of
FFE, trading firms, which would become actual participants in the trading
process, without themselves being manufacturers. The Japanese firms could
serve as examples.
3.36 Long-range Planning. Portugal's metal-working industry has few
"natural advantages" beyond skills and relatively low wages. The economic
situation, within and without the country, should constantly be monitored
with a view toward opportunities, short-range as well as long-range, where
the industry's advantages can be brought to bear.
3.37 Consolidation: The Government should consider encouraging the con-
solidation of small and medium sized metal-working firms into larger more
viable export units. This will facilitate the implementation of the recommen-
dations under paragraphs 3.31-3.33. Further it would be justified undertaking
a more detailed study of the intensive development of the capital goods indus-
try.
C. The Textile and Clothing Industries
Introduction
3.38 The mission visited eighteen mills in the textile and clothing
industry and received assistance from the Ministry of Industry, and Grupo
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Intervencao a Industria Textil and various associations 1/. The textile andclothing industries are of critical importance to a Portuguese industrialdevelopment program emphasizing exports and employment. They provided some41% of total manufactured exports in 1973 and 39% in 1975. Exports of cloth-ing items grew by 28% (in current dollars) in 1968-73, considerably more rapidthan total manufactured exports (22%) and textiles (17%). Further, in 1976the textile and clothing industries employed 248,000 workers, almost 30% ofthe labor force in manufacturing. Capital invested per worker is relativelylow, especially in the clothing industry (around $2,000 per worker); in spin-ning and knitting it is around $30,000. Given its relatively low wage levels(even after recent increases), the considerable past investments in the indus-try and its know-how and marketing contracts, Portugal has a comparativeadvantage in certain textile and clothing items. In order to make use of itscomparative advantage it will have to upgrade its product mix and quality.Portugal has a competitive advantage in European markets in middle levels ofproduct quality, while its present exports rely mainly on lower quality items.Further, it would not appear to have a clear advantage in cotton yarns forwhich it has to import all of the raw material. Provided appropriate incen-tive policies are adopted and management is improved as recommended in thisChapter, both industries can raise product qualities and increase exportswith, at least initially, comparatively small new investments.
3.39 The former colonies and the U.K. and other EFTA countries were impor-tant customers of these industries - these markets accounted for 38.1% of tex-tile exports and 43% of clothing exports in 1974. Exports were concentratedin relatively few items, generally low quality; mainly cotton and polyester/cotton goods and in the make-up field, shirts, trousers and knitted underwear.These are items which require little technical effort, and in which competi-tion from East Asian. countries is strong. In recent years (1974-76) quality,fabric design, apparel models and level of service have not improved, and infact frequently have deteriorated. In this respect Portugal has not developedits competitive potential, given its technical proficiency.
3.40 Since 1973 exports to the colonies have fallen - e.g. in 1976 wovengarmen-ts exported to the ex-colonies were 33% of i973 and yarns only 10%.However, a number of Portuguese producers are maintaining contacts with Africaand exports could again increase, or be replaced by local production byPortuguese-owned mills (e.g. a private Portuguese spinning mill with AngolanGovernment participation).
3.41 Size of Firms. There are rather few large-sized plants and an exces-sive umbler, of small plants in both the textile and the make-up industries (seeAnnex III-8, Tables 1 and 2). Most exports originate in the larger plants.For the tr,,o industries combined, the size distribution (1974) of firms was asfollows3n
1/ N-Elonal Federation of Textile Manufacturers; the National Associationof Cotton and Spun Fibers Textile Industries; and the Portuguese Associa-tion of Knitting Industries.
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Number of workers per firm Number of firms
more than 1,000 20500 - 1,000 43200 - 500 144less than 200 1,518
Total 1,725
3.42 Wage Costs and Productivity. Wage and fringe benefits have increasedsubstantially since 1973 and, as discussed in Chapter II, after allowing forexchange rate changes have increased in relation to those in other OECD coun-tries. Output per worker in the textile and clothing industries has alsodeteriorated, especially in 1975, but is now recovering. Productivity varies,of course, between plants, with the better managed mills showing better laborperformance and lower absenteeism.
3.43 Even after the wage increases since 1973, wage earnings per hour inabsolute terms, are still well below those in the U.S. and European countries(see Annex III-8, Table 14). In fact, 1976 Portuguese wages in the textileindustry are 33% of U.S., 21% of German and 28% of Italian wages. On theother hand, output per operator hour in the best-managed Portuguese textileand weaving mills are well below those in the U.S. Germany and Italy (AnnexIII-8, Table 12). (Portuguese productivity is somewhat ebove that in Greeceand Turkey where wages are also relatively low.) The net effect is that inthe best Portuguese spinning and weaving mills certain standardized productshave labor cost per unit of output below those in the U.S. and European coun-tries, except that Portuguese weaving costs are above those in the U.S. (AnnexIII-8, Table 15) 1/. Cost comparisons of this kind are necessarily rough,limited to a few standardized items and do not allow for quality differences.The data referred to are based on performance of the "best" mills - the pro-ductivity of the poorer mills is considerably lower (in fact, less than halffor the '"poorest" spinning mills). Comparisons of this kind have been madefor only few textiles lines and the mission does not have comparable estimatesfor the clothing industry. They nevertheless confirm the observation thatPortugal has a good base on which to expand textile and clothing exportsthrough improvements in quality and management. At the same time they do notcontradict the conclusions about a deterioration in Portugal's relative com-petitive position since 1973, as discussed in Chapter II.
3.44 Industry Performance. Output declined more than 20% in 1975, a yearin which many firms encountered serious production and financial problems (seeAnnex III-1 for description of the problems of a Portuguese textile and cloth-ing firm). By the end of 1976 output was still 13% below 1970-73 (Annex I-1,Table 2), and 1976 exports, in volume terms, were 31% below 1973 levels (Annex
1/ The computations were for 1975 productivity and wages. Using 1976wages produces similar results.
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III-8, Table 4). Capacity utilization is well below "normal", some estimates
putting it as low as 50% in 1976 (Annex I-1, Table 5); other estimates suggest
that actual production in 1975 was at 70-85% of capacity. In 1973 and earlieryears companies tended to over-hire because of low wages. Under present legis-
latLon they are not able to lay off workers despite lower output levels and
the work force tends to be excessive. Productivity in the textile anld clothing
industries (output per man-year) was in 1976 still below 1973 (Annex II-1,
Table 2). An increase in shifts and a corresponding 29% increase in hours
worked (from 130 hours per week at present to 168 hours), would make possible
more efficient plant utilization 1/. This would also require improvements in
plant lay-out and modernization of machinery, and would, of course, have to be
accompanied by higher output and more exports particularly.
3.45 Further, there appears to be an imbalance between the spinning indus-
try on the one hand and the weaving and knitting industry on the other. The
spinning industry capacity exceeds the capacity of the weaving and knitting
mills and not all of the potential excess spinning output is exported 2/.
3.46 Imports. The industry imports a significant portion of its rawmaterial needs, including all raw cotton. The import content of intermediate
inputs is 51% for the textile industry and 32% for clothing (see Annex I-1,Table 3). Fabric imports include velvet, corduroy and heavy denim and alsolimited quantities for higher quality clothing. Limited imports of knittedgoods from Hong Kong and Macau are allowed. While manufacturers are gener-
ally permitted to import needed raw materials and accessories, they do haveto pay surcharges and the drawback system is not fully effective especiallyfor smaller and non-integrated mills (see paragraphs 2.29 and 2.30). Further,manufacturers urged that the present six month limit on raw material finan-
cing should be extended to twelve months to permit adequate inventories; theyalso need more flexibility in obtaining credit guarantees to permit purchasesof raw materials when prices are low.
Exports: New Markets and Products
3.47 In expanding its exports Portugal should develop higher quality prod-ucts, with a higher value added component. This would enable it to lessen the
1/ See Annex ITI-8, Table 17 for an example of improvements in productivity
and output of an individual firm.
2/ The installed spinning capacity for soft fibers comprising cotton,artificial and synthetic yarns is estimated at a yearly output of around177,000,000 kgs of an average count 22. The weaver room capacity for thesame fibers is estimated at around 115,000,000 kgs/year. The estimated
spinning capacity for the wool industry including all mixtures with arti-ficial and synthetic fibers is around 41,000,000 kgs per year, while theweaving capacity for the same sector is figured as being about 13,800,000kgs/year. The knitting industry capacity is estimated as being around
32,000,000 kgs per year.
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reliance on lower quality items in which the East Asian countries have a com-
petitive advantage.
3.48 Cotton yarn, exports have been declining in recent years and thePortuguese should make efforts to increase productivity and maintain costsat competitive levels. Competitivity could be enhanced through the sale ofyarns with a higher value added component such as mercerized, gassed, dyed,
etc., which are also needed for finer articles in the domestic market, andeventually replace exports of yarn with fabrics and garments. There are goodopportunities for export of some acrylic yarns and mixtures of artificial andsynthetic yarns. Portugal could also produce corduroy and velvet for export
to European markets.
3.49 Men's shirts, trousers, knitted underwear and T-shirts, have been
traditional exports, but little has been done about more fashionable goodsfor ladies and girls, such as jackets, suits, blouses, sport clothes andgeneral knitting and woven outerwear, as well as women's underwear. Theladies' clothing market is much more demanding in terms of fashion anddesign, but with the right help the Portuguese manufacturers are competentto begin on a medium-quality basis, eventually leading to a better qualitywithin the volume segment of the market. The Portuguese can also fruitfullycater to the market for baby clothes, which has a wide variety of fashiongoods which creative designs are able to promote.
3.50 The upgrading of the quality of export products will enable Portugal
to increase sales to European markets (and switch away from ex-colonial mar-kets) and, within Europe, to more demanding markets where higher quality, up-to-date fashions and better designs are important. Portuguese exporters havein the past concentrated too much on EFTA countries. Efforts should be madeto try to open up new markets and to sell other types of models, designs and
qualities which up to now have been neglected. The markets deserving primaryattention are Germany, Belgium, the Netherlands, Denmark and in addition, theU.S. and Canada. It is assumed that Portugal will continue close relationswith existing EFTA markets. Portugal should exploit its proximity to theEuropean countries, Sales personnel should travel more to visit clients andbe in closer contact with them through telex and telephone. They should con-centrate on giving better service and consider promotion expenses a good in-
vestment in building up new markets.
3.51 In all, exports of textile and clothing items combined could in-
crease by some 11% per annum in volume terms in 1976-80, with growth ratesfor woven garments considerably higher (23%) (Annex III-8, Table 18). Onthis basis the volume of garment exports would substantially exceed 1973levels. As a result of the upgrading of product quality the constant dollarvalue of exports would, of course, grow more rapidly than the volume. Up-grading of product quality would enable Portugal to increase exports to EECmarkets. However, EEC quota adjustments would be required although themission has not calculated the precise composition of exports to individualcountry markets. Present EEC quotas on ladies and babies clothing wouldseem particularly low.
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Improvements in Management and Training
3.52 Upgrading of product quality and expansion into EEC markets andCanada will require a strengthening of management in production, designmarketing, finance and labor relations, at both top and middle levels.
3.53 The plants visited by the mission showed a combination of problemsand shortcomings: lack of adequate control of inventories; lack of produc-tion planning; lack of appropriate quality control systems; lack of costsystems; lack of preventive maintenance programs; low production efficiency;low productivity; scarcity of new designs and models meeting market demand;high waste percentages; high percentage of end-breaks in spinning and weaving;high absenteeism in certain enterprises; low discipline; and poor marketing.
3.54 There are very few firms without any of these shortcomings. Eventhe better firms could benefit from management training in some specificareas. Of the 18 firms visited, roughly 20% have fair to good management,35% have poor management in need of training and 45% have poor to very poormanagement.
3.55 There is a shortage of trained managers and supervisors, in admin-istration and technical fields, as well as in the financial and commercialareas. Some companies have Portuguese technicians that studied abroad dueto lack of facilities in Portugal. In some of the more advanced companies,this problem has been partly overcome by encouraging personnel to take partin special courses (company paid), seminars, and sometimes through visits toestablishments in other countries. The lack of management know-how has inmany cases resulted in inertia and deficiencies in the organization as wellas in the lack of proper procedures.
3.56 Several steps are required to overcome present management weakness:training of new qualified managers, technicians and even skilled workers;getting the correct fashion appeal of products offered, up-dating fashiontrends on more sophisticated markets; getting good apparel design throughmodelists trained in the importing country; and giving the best level of ser-vice regarding deliveries, quality and prices.
3.57 Management training is of crucial importance in improving theindustry's performance, increasing productivity and reducing costs, as wellas finding new markets for exports. The training should be undertaken withthe help of professional colleges or through seminars to improve the skillsof present managers. The bigger companies may send managers for courses orseminars and organize visits to mills abroad. For lower level supervision,overseers and shift heads, some kind of official school is needed to teachcorrect approaches in transmitting orders to workers, human relations, thebasics of mechanics, electricity, techiical matters, technical calculations,proper action in case of accident or fire, etc.
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Investment, Modernization and Restructuring
3.58 Present investment intentions are weak, pending improvements in laborlegislation and other factors (paragraph 4.02). Yet, if the industry is torecover it will have to make new investments in plant modernization, upgradingof product mix and quality and restructuring of the industry, making possibleelimination of uneconomic plants.
3.59 In 1977 and 1978 an increase in exports - say some 20-25% in realterms - could be achieved through improved utilization of capacity. However,to achieve improvements in capacity utilization often requires some investmentoutlays. Further, continued and accelerating growth will require more substan-tial investments and it will, therefore, be necessary to plan for new invest-ments immediately.
3.60 Most of the larger mills visited (i.e. over 200 employees perplant) have modern machinery, although not always fully utilized. In theperiod immediately ahead, most of the mills with less than 200 employees,will need to install more modern machinery if they are to improve productivityand output. The need for modernization of machinery is greater in the cloth-ing industry than in the textile mills. Further, many mills (especially thosewhich are family-owned) have grown rather haphazardly in the past and needto improve their plant lay-outs and rationalize present production lines,enabling them to increase output per article, improve fabric utilization andcontrol costs.
3.61 New plant investment is needed in certain finishing mills, e.g.corduroy and velvet. New plants in the industry should be of sufficientlylarge size and they should provide an opportunity to absorb part of the laborforce in the less economical smaller plants. Of the smaller textile mills(accounting for at least 75% of the total number of plants), only a few canat present be regarded as economical. It is estimated that the minimumeconomic size for a new integrated textile operation is 25,000/30,000spindles and 400/500 automatic looms. Except for special products, aminimum sales volume of some $20 million is necessary to maintain efficientmanagement and staff services. Thus it seems essential to develop a policyunder which smaller mills are combined into larger units or absorbed intonew units. In some cases spinning and weaving plants can be combined, orseveral spinning and weaving units can be grouped together to feed into afinishing plant. Finally, there is some indication that part of the presentspinning capacity is redundant and should be eliminated as part of the in-dustry's restructuring.
3.62 The textile and clothing industries would benefit from a clarifica-tion of Government policies towards the industries especially in the areasof labor, the priority of investments, restructuring and finance. As seen bythe mission, Government policy should take the following key considerationsinto account:
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(1) The industries would benefit from a stable real exchangerate. Incentives should encourage exports more effectively.Until surcharges on raw material inputs are eliminated, thedrawback should be made to work more effectively, especiallyin the case of smaller and non-integrated mills. Textilemills also need an extension of credit terms from six totwelve months for the financing of raw material imports;
(2) The industry should be assisted in a process of modernization,restructuring and improvement in productivity. This will in-volve new investment, management training and reequipping andrestructuring of the older and smaller uneconomic mills. Thesesteps are essential in the process of upgrading product mix andqutlity which should provide the basis for export recovery andexpansion;
(3) Investment is needed for the acquisition of new machinery inthe smaller mills, particularlv in the garment industry. Manymills also require new plant lay-outs. There may be a casefor encouraging the largest and most efficient plants to expandtheir operations. New plants should be on a minimum economicscale and preferably integrated. The largest mills should beable to supplement finance available domestically by direct bor-rowing abroad.
(4) Many of the smaller plants can no longer expect to operateeconomically, especially in the spinning sector. They willneed to be consolidated through mergers with other smallfirms or absorbed by the largest expanding firms. Hence,their work force will need to be reemployed by the expandinglarger mills or be deployed in new industrial estates. TheIAPMEI and EPPI have to play key roles in this process;
(5) Portugal will need to increase exports of higher quality prod-ucts, particularly to EEC and EFTA markets, U.S. and Canada.As part of its expansion and rehabilitation program, Portugalwill need to negotiate larger import quotas in EEC markets forhigher quality products; and
(6) The improvement in management training can essentially beundertaken by the industry. However, the Government willhave to play an important role by expanding present manage-ment assistance programs (paragraph 3.08).
(7) These measures would be helped by a more detailed study of thelong range development of the industry, giving special atten-tion, inter alia, to rationalization, restructuring, manage-ment training, prospective markets, expansion of selectedlines and productivity improvement.
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D. Other Industries 1/
3.63 The footwear industry can expand its output to 28 million pairs by
1981, with some 15.5 million for export (more than 3 times the 1976 level),
mostly in the medium price range ($10.00 per pair). Additional exports of
this magnitude would make a relatively important contribution to Portugal's
balance of payments, but would be small in relation to the exports of Italyand Spain (only less than 10% and 20% respectively). The major new marketscould be West Europe and North America. The industry still has low laborcosts and steps to improve productivity include additional mechanization,guarantee of high quality and price of leather supplies, development of the
component industry, incentive pay and increased marketing efforts. The indus-
try, with two-thirds of firms employing less than 20 workers and only oneplant more than 500 would benefit from restructuring.
3.64 The food processing industry registered an indirect increase inemployment (5%) in 1974-76 (to 78,000) to meet high domestic demand. In-adequacies of supplies (especially fish) is a major obstacle to increasing
exports. The industry is in need of some $100 million investment in newequipment and additional cold storage facilities and modernization of thefishing fleet. Productivity can be doubled by mechanizing processing lines,improving materials handling equipment and introducing incentive pay. The
industry would benefit from new research and development, with Governmentsponsorship, and is also in need of restructuring into more medium sized or
larger units. Exports of canned fish, meat products and some other canned
and frozen vegetable items can be expanded; exports of tomato paste shouldcontinue the improvement started in 1976 and early 1977 after a sharp dropin 1974-75; in all, exports could reach $150 million in ].981 (compared with
around $120 million in 1976) 2/.
3.65 The cork industry can expand employment by 5,000 jobs and exportsto $200 million in 1981, compared with 1976 employment of 15,000 and 1977exports of $130 million. Steps required are:
a. installation of new and improved machinery, with investmentincentives and government assistance for the smaller factories;
b. a government sponsored program of searching new and wider usesof cork - capitalizing on the present trend of widening the corkmarkets;
c. raise the productivity of cork "stripping", with organizationof labor to ensure a more regular supply.
1/ For details see Annex III-9.
2/ These figures exclude such items as wines (and other beverages) which
accounted for over $130 million exports in 1976.
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3.66 The pulp and paper industry comprises several modern and large pulpmills (four have more than 500 employees each) which export more than 60% oftheir output, and supply the needs of some of the country's paper mills, mostof which are small and use old equipment. With improved operating and market-ing and the expansion already underway, pulp and paper exports are expected toincrease from about US$100 million in 1976 to some $150 million in 1978. Fur-ther expansion and improvement must wait for carrying out feasibility and mar-ket studies and arranging for financing. Plans to install a new plant to pro-duce corrugated material both for exports and for the domestic market (mainlyfor packaging for export products) have high priority. The most serious issuein the future development of the sub-sector lies with the economic exploita-tion of existing pine and eucalyptus plantations and the carrying out of acarefully planned forestration program. Pulp and paper are capital-intensiveindustries but substantial additional employment could be generated in linkedactivities, both upstream (in forestry exploitation and wood transportation)and downstream (in the paper conversion and printing industries).
3.67 The furniture industry can become an export industry, using itsadvantages of good local timber supplies, familiarity with African woods,skilled labor, good design and location. Exports have been small ($2 mil-lion) but, with marketing assistance of FFE, could expand to $5 million ormore by 1980. Increased local demands and exports could create 5,000 newjobs by 1981.
3.68 In addition to the foregoing export industries, a major expansionis called for in the production of construction materials, including cement,which will call for substantial investments. Parallel expansion will beneeded in such items as building hardware, ceramic accessories, electricalfixtures, etc., to meet the large needs of residential construction as wellas investment projects in the public and private sector. Output in thisindustry is likely to increase well over 10% annually to meet domesticrequirements.
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CHAPTER IV
FINANCING OF MANUFACTURING INDUSTRY
A. General Financial Conditions
4.01 Manufacturing industry enjoys a favored position in the Portuguese
financial system, compared to other sectors 1/. First, because they are gen-erally more modern in outlook and more profitable than other businesses inPortugal, manufacturing firms are considered more creditworthy and are prefer-
red customers of banks. The interest rate structure has heavily subsidizedworking capital and term loans in recent years, and the manufacturing sectorhas benefitted most because of preferential rates and the longer term loansavailable to it. The inflow of foreign-capital to manufacturing has also been
a source of financing not generally available to other sectors, except realestate and hotels. The low taxation rate enhances the cash generation capab-ility of manufacturing firms to re-invest. There has been a banking bias tolend to foreign multi-national corporations and to exporters. The overallconclusion to be drawn is that, except for problems arising from the economicturmoil of 1974-1976, the manufacturirng sector has had ample financial re-sources available on very favorable terms. Thus, finance has not been a con-straint to the development of manufacturing in Portugal under normal condi-tions. The particular financial problems of manufacturing firms createdduring the 1974-1976 period and measures to solve them are described in detailin Annex IV-3.
B. Measures to Increase New Investment
4.02 From 1974 to 1976 the behavior of manufacturing firms was affectedby 'the conjuncture of economic recession in the OECD countries, political un-certainty, social change, and high inflation: in short, firms borrowed asmuch as possible, made no new investment unless absolutely necessary, and evendisinvested and exported capital in a number of cases. The establishment of
political stability and the recent signs of economic recovery now make it pos-
sible to address the problem of how to revive investment in the manufacturingsector. Confidence has slowly started to return among Portuguese investors,
and there are signs of interest among foreign investors. Strong and sustainedgrowth will be a key factor in enhancing and maintaining investor confidence.Further, there are a number of issues needing Governiment action which, ifhandled satisfactorily, will further strengthen confidence. Described beloware some of the issues on the national agenda where implementation measures
are called for:
(a) The basic division between public and private sector industryhas been decided upon by the Republican Assembly (Chapter I,para. 1.04). However, certain details have yet to be elabo-rated. For example, there is uncertainty because small andmedium sized firms nationalized indirectly "but outside the
1/ For details, see Annex IV-1.
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basic sectors of the economy may be reintegrated into the pri-vate sector provided that the workers do not opt for a self-management or cooperative system". Also, the demarcationbetween public and private is not clear in a number of cases 1/.
(b) The Government was supposed to reach a decision on the disposi-tion of the over 300 intervened companies by April 28, 1977, butthe deadline was extended. This is admittedly a difficult taskbut, until it has been completed, these intervened companies,which constitute a significant share of the private sector, willbe unable to function normally, restructure finances, exploitcapacity and plan for future investment. In the industrialsector, out of some 60 companies intervened, about 35 have al-ready been returned to private sector control.
(c) The law on indemnification of shares held in nationalized com-panies has been passed. However, assessment of the value ofthese shares will take time to complete. Until indemnificationis made through the issuance of bonds, a very large amount ofprivate sector assets are frozen. Obviously, the distributionof these bonds would have a widespread impact on the economyand the financing of the transaction would have to be fittedinto the Government's monetary program.
(d) The valuation of shares in nationalized companies is linked tothe problem of managing the equity participations in existingprivate sector companies held by the nationalized banks, insur-ance companies, industrial groups and others. This categoryof assets is still frozen and is to be under the management ofthe Institute for State Participation (IPE), which is not yetfully operational. The IPE could raise revenue for the Govern-mernt by selling shares from the portfolios of nationalizedcompanies, when appropriate, to the private sector and to for-eign intvestors. A secondary benefit of this kind of divesti-ture would be to revitalize the stock market. In any case,where the Government has a controlling interest, the restruc-turing of such private sector enterprises cannot take placeuntil the IPE is playing an active and decisive role.
The new law excludes the private sector from banking and insurance, yetit permits the private sector to operate savings banks, farm loan banks,regional development associations, parabanking activities (specificallyinvestment associations), and mutual or cooperative insurance firms. Theextent of private participation in the armaments industry is also notclear. Finally, some enterprises which have been nationalized can beoperated and managed by private entities, though not permanently. Allof the foregoing are to be clarified by Governmental decrees or regula-tions yet to be issued.
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(e) The National Council on Prices and Wages needs to take actionon the control of wages and salaries and the relationshipbetween the highest and lowest permissible compensation in anenterprise. The current controls are a hindrance to incen-tive and performance of managers and professional staff. Theyinvite evasion through non-monetary compensation, perquisites,and other abuses.
(f) Although all the Portuguese owned banks are nationalized, theystill operate in many respects as they did prior to the revo-lution. More mergers, further rationalization of functions,and some specialization with regards to sectors and types ofbusiness are being discussed, but action has not yet beentaken. Just how extensively the Government intends to controlthe banks is unknown. This creates an atmosphere of uncer-tainty which inhibits bankers from developing new business.
4.03 The Government is working on the implementation of this nationalagenda as speedily as political realities allow. The heart of the problemlies in the conversion of an economv which was predominantly private sectorin its orientation into a mixed economy. Private and public ownership isintermingled and in many cases needs to be disentangled, while in othersthe delineation of responsibility between public and private interests inthe same enterprise needs to be worked out. A new set of relationships mustbe established between labor and management and between public and privatelyowned entities.
4.04 In view of the present high unemployment, Portugal has a specialinterest in stimulating investment in employment intensive industries. TheCentral Bank has taken direct steps to subsidize labor intensive investmentin the manufacturing industry. New investments with a cost of less thanEsc. 750,000 ($18,750) per job created will be given rebate on interest onterm loans amounting to 9% in the first year, 7% in the second, 5% in thethird, and 3% in the fourth year. These subsidies, however, are conditionedon at least 60% local procurement in the invrestment project; such a fixedcut-off point does not, of course, consider the overall economic effects of aproject, and may therefore be arbitrary in some cases. In addition to thisinterest rate subsidy for labor intensive investment, the Government mightconsider a wage subsidy of Esc. 2,250 per month (one-half of the minimumwage and equal to the current level of unemployment benefits) for new laborintensive projects for the first two or three years of opierations. Thisshould apply selectively to export and labor-intensive industries with a lowcapital-labor ratio. Such a wage subsidy would initially be equivalent tothe present unemployment compensation and could be phased out in two orthree years.
C. Resources to Finance Manufacturing, 1977-1980
4.05 Portugal's banking system has ample liquidity at the present time,since demand for borrowings has not increased in relation to deposits. The
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commercial banks' ratio of excess reserves to total deposits was 7.9% at end
1976, compared to 3.2% in 1974 and 1.9% in 1975 (in fact, for the first nine
months of 1975 the excess reserve position was negative). Savings institu-
tions are even more liquid. In addition, the banks and specialized institu-
tions have substantial uncommitted foreign lines of credit available for fi-
nancing imports on both a short and medium term basis. Part of foreign aid
resources (which total $615 million commitments in 1977) is available to manu-
facturing industry 1/. Finally, there are new refinancing mechanisms avail-
able to manufacturing industry resulting from laws and regulations recently
passed and listed in Annex III-2. Clearly the banking system should have no
difficulty meeting the demand for credit in the immediate future, The problem
is how to stimulate demand and that, to a large measure, is a matter of restor-
ing confidence, as discussed above. The financial position of manufacturing
enterprises and their ability to undertake new investments is improving with
recovery of domestic and export demand, the stabilization of labor conditions
and the establishment of a more viable relationship between wage cost and
prices.
4.06 Near-Term Prospects. The re-financing and restructuring necessary
to salvage manufacturing firms currently in difficulty, to continue existing
operations, and to exploit unused capacity raise a number of issues. Some
specific comments on the current system for financing manufacturing over
the next 18-24 months are in order, as follows:
(a) Given the estimated rate of inflation for 1977 of 25-30% the
interest rate structure now in effect is substantially nega-
tive (see Chapter II). The result of subsidizing borrowed
capital is that it constitutes a bias towards capital inten-
sive investment, which is counter to the Government's stated
policy of employment creation. The heart of the matter isthat the interest elasticity of the demand for credit is verylow, in spite of the negative real cost of borrowings. There-
fore, the interest rate structure slhould be brought into line
with inflation in order to eliminate the capital-intensive biasand lay the basis for a more liberal regime of capital movements
conducive to investments in Portugal. The Bank of Portugal has
begun to move toward greater interest rate flexibility by link-ing the yield in Treasury Bills to its own discount rate.
(b) Financing operations in the private manufacturing sector arefrequently delayed by slow processing of transactions in the
Central Bank. Credit available for essential imports and
exports cannot be utilized in a timely orderly way because of
administrative delays and difficulties. Alleviation of this
situation is urgently needed and is especially imp'wtant for
the export expansion of the heavy mechanical industry.
1/ See Annex IV-2. This $615 million is in addition to a $750 million
consortium loan to be committed for use in 1977 and 1978.
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(c) Companhia Seguro de Creditos (COSEC) is performing a vitalfunction in guarantying domestic and export trade credit. Itis self-supporting and profitable. Its business doubled in1976, with export credit insurance amounting to 61% of itsoperations. Complaints and criticisms about COSEC's perform-ance have several origins. First, despite an extensive publicinformation campaign, the clientele of COSEC is still notthoroughly familiar with the procedures and standards ofcredit insurance. Secondly, although COSEC's relations withthe Government's Credit and Credit Guaranty Commission havegenerally been smooth, this has not always been the case withcertain other Governmental bodies which have on occasion in-hibited and retarded COSEC's operations. Thirdly, becauseof the rapid increase in its business volume and staff, COSEChas understandably had growing pains. COSEC has alreaaygained acceptance outside Portugal, which is of course cru-cial for its success 1/. COSEC deserves the Government'sfull-fledged support while, at the same time, maintaining itsoperational independence. In monitoring COSEC's performance,the Government should pay particular attention to the totalcost of credit insurance to COSEC's clients, to see that itis not higher than the insurance cost of foreign firms com-peting with Portuguese exporters; for example, the 27.5%"additional charge" levied by the State on top of COSEC'sfees should be eliminated if it jeopardizes export sales.
(d) Establishment of a special foreign trade bank does not seemnecessary, given the capabilities of the existing bankingsystem. The problems are not institutional but environmental.
(e) Perhaps the most sweeping measure available to Portugueseenterprises to restructure their financial condition is theLaw on Revaluation of Assets passed in April 1977 (for summary,see Annex IV-3). The great improvement in debt/equity ratioswhich can result from the application of this law will enhancecreditworthiness and facilitate increased borrowings to stimu-late production and investment. The danger is that the Govern-mental approvals necessary to bring about the revaluation ofassets may take too long to grant. Ways should be found toexpedite the process.
(f) The above observation also applies to the law on ViabilityContracts, passed April 1977, which permits the re-scheduling
COSEC has been able to reinsure a large portion of its portfolio withleading foreign institutions, and it is expected to become a memberthis year of the Berne Union and the International Credit InsuranceAssociation.
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of debts for up to ten years (see Annex IV-3 for a summary).In addition, with regard to Viability Contracts, the proceduresand paper work required are so extensi-ve and detailed that theywill inhibit applicants and delay the very assistance so urgentlyneeded. Ways should be found both to simplify and to speed upthe process.
(g) The law to promote exports (June 18, 1977) permits, among otherthings, the reduction of the industrial corporation tax by anamount equal to 5% of the total value of exports. This provi-sion might well be refined so as to apply to the increase inexports above an average base period, in order to provide anincentive for existing exporters to expand their sales abroadrather than to reward them for what they are already doing.As for the 5% interest rate subsidy available to financeexports for 90 days, the term may appropriately be extendedto one year; annual ceilings may best be fixed for exportersso that the subsidy can be granted automatically withoutadministrative delays.
(h) There re complaints about the length of time and the proce-dures involved in obtaining term loans from BFN and the Caixa.Both institutions need to make greater efforts in expeditingapplications, and in maintaining closer contacts with industrygroups about their investment plans and prospective needs.They also need to educate their customers on the economicdifference between short term and medium/long term credits.The-former can be backed with liquid collateral and the riskminimized. The latter cannot ordinarily be collateralizedby stocks, bonds, personal guarantees and so forth. Instead,they must be supported by mortgages on land, buildings, andcapital equipment; and this security is not quickly or easilyliquidated. Fundamentally, of course, the only real securityagainst the higher risk of a term loan is the profitabilityof the project being financed. An important reason for thelength of time needed to complete term loan formalities is thatthe Ministry of Justice takes so long to register mortgages,and the Government should seek ways to speed up the registra-tion process.
(i) Industrial investment can often be expedited by more adequatepreparation of project studies. In a number of cases industrycan usefully be assisted in the preparation of studies. Tosome extent this can be done through more effective promotionefforts by the BFN and CGD 1/. A more systematic effort should
The BFN has made a special effort in the case of selected industries,e.g. the heavy mechanical industry (BFN, Dinamizacao das Exportacoes daIndustria Metalmecani-a Pesada, January, 1977).
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be made to utilize existing Portuguese consulting engineering
resources, where necessary with foreign help. The Government
should consider establishing a project preparation facility
which will improve the use of available engineering and
economic talent and, where justified provide finance for
feasibility studies.
(j) Supervision of the banking system, even though banks are
nationalized, is still very relaxed. Authorities merely
review periodic reports submitted by banks without any real
inspection or auditing. There is, therefore, ample scope
for using moral suasion to influence banking practices. For
example, some banks prefer to lend to multi-national corpora-
tions rather than Portuguese companies, because they believe
there is less risk. However, in certain cases (see Ch. V)
foreign investors in Portugal should be required to reduce
their borrowings from Portuguese Banks and to import more
funds. This would result in greater resources being made
available to Portuguese companies.
(k) The Foreign Exchange Risk Fund of the Central Bank needs to be
broadly publicized and fully explained. It has only recently
started to operate, and experience will probably result infurther elaboration of its provisions (for summary see Annex
IV-3). If adequate personnel are not available, the Fund
could end up being another impediment to economic recovery,
instead of being the incentive to foreign borrowing as designed.
4.07 With a view to encouraging investment in manufacturing the Govern-
ment may consider taking some further measures in addition to the revaluation
of assets ad the rescheduling of debts. In special cases where financing is
an obstacle to implementation of economically justified projects, the Govern-
ment may be able to provide risk capital, e.g. through the CGD taking equity
participation. An alternative would be for the Government to finance the
construction of new plants and lease them to industry until the firm is able
to purchase the plant.
4.08 Medium-Term Prospects. Some rough estimates of involvement and fi-
nancial requirements of manufacturing industry are given in part. 1.31 and
Annex I-4. The outlook for the next 18-24 months discussed above focuses on
the financial needs of restructuring, improving plant lay-out, replacing
uneconomic machinery and exploiting the unused capacity of existing manufac-
turing firms; of course some investments in new ventures is also anticipated,
but actual disbursements are likely to lag. The major problem after 1978 will
be how to mobilize sufficient domestic capital for investment in increased
manufacturing capacity and in new facilities. Portugal's gross domestic
savings, in relation to GDP, fell from a 10.7% annual average in 1968-73 to
a -1.1% in 1975. Furthermore, by setting interest rates on Treasury bills
above those paid on savings accounts, financial savings were channeled into
these bills. This policy will have to be modified if domestic savings are
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to regain former levels and funds are to be made available to the privatesector. Also, the authorities should foster the creation of additionalsavings instruments, to supplement deposits and Government bonds which havetheir limitations. Self-generation of funds by firms will depend primarilyon the state of the economic recovery.
4.09 In the allocation of resources, there is a danger that large capitalintensive projects will crowd out medium F.nd small export and more laborintensive industries. In addressing this problem, the Government will alsohave to decide how to apportion capital between the competing interests ofindustry and other sectors and, within inidustry, between heavy and light,and exporting and import substituting investments. Ensuring the mobiliza-tion and allocation of equity capital will be a particular problem. Besidesreviving the stock markets of Lisbon and Oporto, there are some other mecha-nisms which could be used. For example, some commercial banks and specializedinstitutions have very few equity investments, and they could be encouragedor required to invest a certain percentage of their capital in the shares ofPortuguese industries. Alternatively or additionally they could hold a cer-tain percentage of assets in term loans for export industries. Another pos-sibility is the provision of risk capital by the Government (see para. 4.07).Further, the National Development Fund could put Government capital at thedisposal of specified banks for investment purposes 1/. Although this Fundhas been discussed for some time, it has not been established as yet. Itdeserves careful study and formulation since it might be needed in one or twoyears time if the economic recovery surges forward. In fact, the biggest taskin the medium-term as far as capital investment is concerned is its relation-ship to savings (quote is from the 1975 Annual Report of the Banco de Portugal,p. 165):
to analyze the relationship between investment and investment financ-ing i.e. the national saving capacity; the obtaining of,externalcredit; and the role of the financial system as a link between saverand investor. However, a study of this type is seriously impairedby the almost total absence of statistical data which could providean overall and coherent view of the behaviour of the Portuguese fi-nancial system.
1/ The National Development Fund could work in a variety of ways. Throughselected institutions like BFN and the Caixa, the Fund could make out-right grants, for the most serious cases, and capital subscriptions, inmost cases. The latter could be preferred stock which the firm could buyback from the Government at a later date, or which could be convertedinto a term loan once the firms' financial condition has improved.
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CHAPTER V
FOREIGN INVESTMENT
A. The Role of Foreign Investors
5.01 Clearly the inflow of foreign investment capital should not besought just because of its favorable impact on the balance of payments. Thebest reason why a country at Portugal's stage of economic development shouldstrive to attract foreign investment is that the particular foreign investorcan bring greater benefits to the domestic economy at a lower cost than aPortuguese investor can. Thus, the impact of new technology to manufacturenew products should be an important criteria (the Foreign Investment Codedeals extensively with this point). Also, the benefit of foreign managerialskills, particularly in plant management, should not be overlooked. Knowledgeof and access to foreign markets is another important consideration, sincePortugal's exporting industries have relied on relatively few traditionalbuyers. Perhaps the most important unquantifiable benefit of foreign invest-ment is the demonstration effect it can have on those manufacturers who havebeen complacent and unimaginative, because they lacked the stimulus of com-petition and a growth oriented approach to business.
B. General Background
5.02 The trend of recent foreign investment and financing of manufactur-ing industry in Portugal is shown in Annex V-1. In 1976 a detailed question-naire was sent to all foreign investors asking for information about theirholdings and operations. Although over 90% responded, the answers have notbeen compiled. Consequently, the Government does not have figures on thetotal amount of foreign investment in the country, number of firms withforeign participation, their financial position, the number of employees, oreconomic data such as value added or exports generated. The only figuresavailable are the rather notional calculations of the foreign chambers ofcommerce in Portugal which indicated that in 1975 there were at least 1,020firms with foreign capital of Esc. 19.9 billion and 142,610 employees. Thepreferred sectors are manufacturing, the wine industry, and real estate. Themost highly visible investments are those of the multi-nationals which areprimarily in Portugal to produce and sell to the domestic market rather thanto export. When EEC membership becomes a certainty, the interest of multi-nationals producing import substitutes will undoubtedly decrease because inmany cases, it will be more profitable simply to sell in Portugal from plantsalready existing in EEC countries. The biggest foreign exchange earninginvestments are in wine, f,ollowed by real estate (hotels, retirement andholiday homes). In order for the Government to form a long-term strategyabout foreign investment, obviously an effort must be made to compile andanalyze information on existing foreign investments and its costs and bene-fits to the economy.
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C. The Investment Code and Proposed Revisions
5.03 The Foreign Investment Code of April 6, 1976 has attracted 141 ap-plications from industries since its effectiveness to May 1, 1977. Only 26of these applications were for new undertakings. Of the remainder, two-thirdsinvolved an increase in capital of existing firms (through the conversion ofcapital surplus and excess reserves), and one-third involved the purchase ofshares in existing companies by foreigners. The number of applicationsapproved was 128 and their total amount was Esc. 615 million ($16 million).After deducting Esc. 417 million for one very large investment which was ajoint venture in the Sines development, those remaining amounted to Esc. 198million (about $5 million) and averaged about Esc. 5 million ($130,000) perapplication. This small flow of foreign investment over a 12 month period,compared to the much higher levels prior to 1974, is primarily a result of theclimate of uncertainty which inhibited the interest of foreign companies toinvest in Portugal. However, recent stability and Lmprovement has brought acorresponding increase in investor inquiries, though this has yet been re-flected in a higher level of applications. Assuming the atmosphere continuesto improve, the major constraint will shift to the deficiencies of the ForeignInvestment Code.
5.04 On August 24, 1977 a new Foreign Investment Code was promulgated(Decree-Law No. 348/77), accompanied by five regulatory decrees amplifyingvarious articles of the new code. The new code is a decided improvementover the previous version. However, it still raises some problems, andthese should be resolved to the extent political realities permit.
(a) Article 17 suspends the transfer of dividends, profitsand proceeds of sale or liquidation whenever (i) thereis a serious disequilibrium in the balance of payments,or (ii) the amount involved would provoke serious economicand financial upheavals in the country. In such cases,the amount to be transferred per year could be as littleas 20% of the total involved. 1/ Ideally, there should beno limits on the transfer of profits or the repatriation ofcapital. At the minimum, the restriction on transfer ofprofits should be eliminated in order to provide an assuredincentive to foreign investors and in order to bring thecode closer to OECD and EEC requirements.
1/ With regard to the transfer of dividends and profits, Article 17 statesthat as little as 20% of the amount may be transferred each year. How-ever, this is in contradiction with Article 13, para 2 which says trans-fers of dividends and profits "may be spread out for a period of neverlonger than one year".
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(b) The reference to a serious disequilibrium in the balanceof payments as a condition for restricting the transfer ofprofits or repatriation of capital is both sweeping andvague. If it cannot be eliminated, it should be made moreprecise in its terms. In fact, the decision to admit for-
eign investment should be based on the assumption that the
resulting benefits to the economy are such that the balance
of payments can and should accommodate remittance of profitand repatriation of capital.
(c) Article 20 appears on the surface to be satisfactory inpermitting branches of foreign companies and companies with
foreign investment to have access to Portuguese institutionsfor short-term credit. However, given the roll-over prac-
tices of Portuguese commercial banks, short-term creditbecomes in fact disguised term credit. This means that
foot-loose foreign investors can still exploit thePortuguese banking system by undertaking heavy borrowingsand then, when profits have been transferred abroad andnecessity dictates, they can simply pull up stakes and
default on their loans to local banks.
(d) Article 21 has to be read in conjunction with the centralbank's order No. 536/77 which simply repeats the same term
credit allocations set forth in Article 21 of the old code.
These provisions on term credit are too generous to foreigninvestors; instead, they should be required to bring in a
higher proportion of borrowed funds from outside sources.The same risk with foot-loose industries of course exists,
as described above.
(e) The Government has been asked to renew the investmentguaranty agreement with the U.S. and to conclude similaragreements with Germany and Switzerland. It is in Portugal'sinterest to have such agreements if it wishes to attractforeign investment.
D. The Foreign Investment Institute
5.05 The comparative advantages of Portugal and the economic and political
environment are what will attract new foreign investment to the country. The
incentives available under Portuguese law and in the new code are sufficient
to bring the foreign investor to a favorable decision. However, realization
of the investment could fail or be delayed if bureaucratic procedures are
too cumbersome. The Foreign Investment Institute (FII) has been established
in order to provide the foreign investor with one central organization forhandling the investment application and attendant procedures. The Statues of
the FII are appropriate and appear to endow it with the proper functions and
competence. Success of the FII will now depend not only on the staff and
resources allocated to it but on the attention and importance which the Gov-
ernment accords to it in order to see that it can work effectively.
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