Report No. 6714MOR Morocco: The Impact of Liberalization on Trade and Industrial Adjustment (In Three Volumes) Volume Il: Main Report March 15, 1988 Europe, Middle East & North Africa Country Department l! Country Operatiions Division FOR OFFICIAL USE ONLY .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Dmvamd of the %*rld Unk0- 4, ,~~~~~~~~~~~~~~~~4 O ..~ ~ ~~~~~~~~~~. .})~~~~~~~~~~~~~a '0 -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. 0 * 4 )- 0 TNs repot hasa rstricte ditrbtio anea eueyrcpet .~~~~~~~~~ , Do~ien oo th Wol BnO only in the performance of their official duties. Its con'tents may not otherwise' be disclosed without World sahk cluthorization. 4,~~~~~~~~~~~~~~~~ 0 O~~~~~~~~~~~~~~~~~~~ 1 KINGDOM OF MOROCCO CURRENCY EQUIVALENT Currency Unit: Dirham (DH) Official Exchange Rate: Dfrham (DH) per US Dollar 1975 4.053 1981 5.172 1976 4.419 1982 6.023 1977 4.503 1983 7.111 1978 4.167 1984 8.811 1979 3.899 1985 10.062 1980 3.937 1986 9.104 1987 8.359 FISCAL YEAR January 1 - December 31 GLOSSARY OF ABBREVIATIONS BNDE = Banque Nationale pour le D6veloppement Economique (National Bank for Economic Development) BTN 2 Brussels Tariff Nomenclature CAP 2 Common Agricultural Policy CCCN Customs Cooperation Council Nomenclature CGE Computable General Equilibrium Model CIH = Cr6dit Industriel et H6telier (Housing Finance) DRC = Domestic Resource Cost GATT = General Agreement on Tariffs and Trade IBP = Corporate Income Tax IHS = International Harmonized System ITPA = Industrial and Trade Policy Adjustment Loan MC = Domestic Market Regime MCIT Ministere du Commerce, de l'Industrie et du Tourisme (Ministry of Commerce, Industry and Trade) MFA = Multifiber Arrangement MFN = Most-Favored Nation NTB = Non-Tariff Barrier ONT = Office National du Transport PERL 2 Public Enterprise Rationalization Loan PMIs Petites et Moyennes Entreprises (Small- and Medium-Scale Firms) QR Quantitative Restriction SAL 2 Structural Adjustment Loan SIT Special Import Tax TA = Temporary Admission Regime TFP - Total Factor Productivity TPS = Taxe sur les Produits et les Services (Turnover Tax) VAT = Value-Added Tax VER = Voluntary Export Restraint FOR OMCLIL USE ONLY TABLE OF CONTENTS Page No. L DNl1ODUCTION ....................................... I IL STABILIZATION, ADJUSTMENT, AND THE MACRO-ECONOMY 4 A. Macro-economic Developments since the Financial Crisis of 1983 .............................. 4 B. The Interaction of Stabilization and Adjustmeiit ........ 8 Budgetary Impact on Savings and Investment Behavior .. 9 Internal Consistency of Macro Policies ... ........... 12 Budgetary Effects of Structural Measures ............ 15 C. The Social Impact of Adjustment ......, ................ 18 IlL THE EVOLUTION OF TRADE POUCY REFORM IN MOROCCO . 21 A. The Political Economy of Trade Reform in Morocco ...... 21 B. Changes in the Instruments of Trade Poliny ............ 22 Import Policies ..... ......... ....................... 23 Export Policies ..................................... 25 Accession to the GATT ....... ........................ 26 C. The Impact of Trade Policy Reform on the Structure of Incentives ............................. 28 IV. THE IMPACT OF LBERALIZATION ON EXTERNAL TRADE PERFORMIANCE ......................... 36 A. Export Performance Under Liberalization ............... 37 Export Diversification ......... ................... . 37 Exchange Rate Policy and Export Response ............ 39 Market Penetration of Moroccan Exports .............. 39 B. Import Performance Under Liberalization ............... 41 Global Import Trends ........ ....... ................. 41 Policy Change and Import Behavior ................... 43 Import Performance by Economic Regime ............0... 45 C. Direction of Trade .................................... 45 The Structure of Morocco's External Markets ......... 45 Effects of Foreign Trade Practices on Moroccan Market Access ..... .................... .... 46 Market Diversification: A Strategic Issue for the Future ................................. 48 This document has a resticted distdbution and may be used by recipients only in the prfomo of thir official duties. Its contents may not otherwise be discled without World Bank auhodzation. - ii - Page No. V. THE DIPACT OF INDUSTRIAL AND TRADE POLICIES ON THE STRUCTEURE AND PERFORMANCE OF INDUSTRY ............. 50 A. Structural Characteristics of the Industrial Sector ... 51 The Evolution of Moroccan Manufacturing ............. 51 Outward-Orientation and Patterns of Sectoral Growth . 51 Industrial Concentration ............................ 55 B. Industrial Promotion Policies and Sectoral Constraints 57 The Structure of Fiscal and Financial Incentives .... 57 The Regulatory Environment ....... ................... 58 Labor Mobility ...................................... 60 e,onstraints to Industrial Performance . ..a....................... 60 C. Productivity and Sources of Industrial Growth: The Micro-economic Effects of Adjustment .............. 62 International Comparisons of Productivity Growth .... 62 Components of Productivity Growth ................... 64 The Impact of Stabilization on Industrial Productivity 68 International Competitiveness in a Dynamic Context .. 69 VIL A FRAMEWORK FOR FURTHERING TRADE AND IIND)USTrUIAL POIICY REFORMf .............................. 73 A. Conclusions ..... . .......... ................. . ........ 73 B. Issues for Future Policy Reform ....................... 75 C. Recommendations ....... ................... ............. 77 D. Policy Simulations ...... .............................. 79 - 1 - L INTRODUCTION 1.01 The events leading up to the balance-of-payments crisis of 1983 have been well documented in a number of World Bank reportsX' and will be only sunu_rized by way of introduction. In the early 1970s, Morocco's terms of trade benefited from a sharp increase in the price of phosphates, the country's primary export, which more than compensated for the first oil shock. At this time, the Government adopted a strategy of accelerated growth through high levels of public investment spending in a protected domestic market. The phosphate boom was short-lived, however, and the Government sought to supplement dwindling foreign exchange earnings through increased recourse to external borrowings on highly attractive terms-'. Despite a 7.6X average rate of GDP growth p.a. in 1974-79, the inability to control public expenditure (partly a result of the increasing defense efforts in the Western Sahara) and diversify exports left the economy highly vulnerable to the second oil shock in 1979-80. 1.02 Sporadic attempts to stabilize the economy beginning in 1978 met with limited success, and the Government embarked upon a second round of expansionary public investment in 1981. Rather than adjust to the changing external environment, the abundance of foreign financing opportunities with little loan conditionality prompted Morocco to borrow more, thereby aggravating the country's indebtedness. At the same time, Morocco's ability to service its massive debt was becoming increasingly impaired. International interest rates began their unanticipated rise, while a combination of inexpedient public investments and unfavorable external factors, viz. a severe drought in 1980-84 which reduced agricultural and hydroelectric production, led to a marked deterioration in the productivity of investment. The ICOR increased from 3.9 in 1975 to 7.4 in 1983. 1.03 By 1982, the budget deficit had grown to 12.3% of GDP and the current account deficit had reached 13.32 of GDP. The stock of total foreign debt outstanding had risen from US$1.8 billion in 1975 (09.6% of GDP) to US$11.2 billion in 1983 (84.22 of GDP and 2902 of exports). The structure of Moroccan debt had changed, moreover, with 40S of outstanding liabilities owed to commercial banks compared to nil a decade earlier and over 60% at non-concessional rates. In mid-1983, the economic situation had become unsustainable. Foreign exchange reserves virtually disappeared prompting the Government to impose emergency import restrictions and to effect draconian cutbacks in public expenditures. Official and commercial creditors acceded to the request by Morocco for debt rescheduling. Concomitantly, a new Government, appointed to confront the economic crisis, sought the assistancei of the IMF and World Bank to design a program with dual objectives: (i) to stabilize the economy in the short-term by reducing aggregate demand and the size of the Government budget deficit; and (ii) to transform the economy into V/ See Morocco: Medium-Term Adjustment Policies and Prospects, World Bank Report 5785-MOR, August 1985 Morocco: A Framework for Medium-Term Adjustment, World Bank Mimeo, March 1986 Morocco: Issues for a Medium-Term Structural Adjustment Program, World Bank report 6608-MOR, January 1987. 2/ Interest rates on Moroccan debt were negative in real terms, averaging -13.31 during the period 1973-80. -2- an efficient producer of goods and services in the medium-term by reforming the underlying structure of key economic and social sectors. 1.04 In order to attain these objectives, the Government launched a program of stabilization and structural adjustment supported by a series of standby arrangements and sectoral adjustment loans. Restrictive fiscal and monetary policies were employed to provide for an orderly elimination of the imbalance between aggregate domestic demand and resource availability. At the same time, structural reforms were initiated in the trade and industrial sector to promote increases in productivity and export potential by improving the allocative efficiency of resource use and attenuating the existing bias against exports. The Bank supported these objectives with two consecutive Industrial and Trade Policy Adjustment (ITPA) loans, which included measures to reduce barriers to external and internal trade, liberalize the financial sector, and. streamline administrative procedures. It was recognised from the outset that the appropriate mix of stabilization and adjustment policy instruments was critical to enable the country to service its massive debt while maintaining a socially acceptable rate of economic growth. 1.05 Following the release of the second and final tranche of ITPA II, a Bank economic mission visited Morocco in December 1986 to study the impact of the liberalization program on trade and industrial development and to update the stock of knowledge-' in order to confirm preliminary results and to Justify further efforts in this area. The mission attempted to evaluate the extent of liberalization which has taken place to date and assess the capacity for future industrial adjustment. In this vein, an industrial survey of forty firms was carried out to elicit the reactions of industrialists to the program and provide a framework in which to interpret analytical findings. The interaction between stabilization and adjustment was evaluated, as was the compatibility of expected macro-economic developments with further liberalization efforts. The effects of changes in trade and industrial policy instruments on the structure of incentives were analyzed. The reaction of the economy to a more efficient trade and industrial regime as manifest in the behavior of the external sector and changes in the international competitiveness of Moroccan industry was examined. Finally, in preparation of a proposed structural adjustment loan (SAL), a set of policy measures for future reform was evolved and its impact on the economy assessed. 1.06 The report is organized as follows. Chapter II analyzes the effects of stabilization and adjustment on the evolution of the macro-economy. The discussion focuses on the budget deficit and associated strategies of financing. It is demonstrated that the increased recourse of the Treasury to domestic savings in order to finance unsustainably large budget deficits has led to rising real interest rates; this has served, in turn, to discourage domestic investment and dampen industrial adjustment at the sertoral level. 1.07 Chapter III reviews progress achieved in implementing trade policy reforms and evaluates the resultant structure of incentives. It is argued that although the economy has been increasingly exposed to international 1/ The last industrial sector report is based on information collected from 1978 to 1982. -3- market forces, further efforts in this direction are necessary. Political economy aspects of trade liberalizati'a are first developed, followed by an analysis of import and export policies. The chapter concludes by assessing the implications of Morocco's accession to the GATT on future trade relations. 1.08 Chapter IV examines the impact of liberalization on external trade performance. The response of exports and imports to variations in trade policy, the exchange rate, and external factors is analyzed at both a general and disaggregate level. It is shown that exports have reacted positively to relative price movements and changes in the structure of incentives. This has led to a significant shift in the composition of exports toward non-traditional products. Morocco has maintained its share in traditional markets principally because of an active exchange rate policy and bilateral agreements with the EEC which secure market access. It is concluded that the preferential arrangements from which Moroccan exports benefit may be eroded in the future as a result of quota limits and the upcoming Uruguay round of multilateral trade negotiations. Consequently, Moroccan efforts to diversify products and markets should be encouraged through further trade policy reform. 1.09 Chapter V traces the evolution of the industrial structure and assesses the potential for structural adjustment. Recent changes in industrial policies were shown to affect relative factor use in line with Morocco's natural comparative advantage. Certain features of the regulatory environment were identified as potential obstacles hindering industrial adjustment. Detailed analysis at the subsector level indicates improvements in the productivity of capital and labor; however, the effects of macro-economic imbalances which are presently being felt at the firm level have attenuated the degree of efficiency gains. From an international comparative framework, it is concluded that further adjustment of industry is necessary. The scope of adjustment, however, will be conditioned by the extent and pace of stabilization. 1.10 Chapter VI presents the general conclusions of the report. The outstanding issues for continued liberalization of the trade and industrial sectors are identified and recommendations for future policy reform adduced. The chapter concludes with a simulation of the effects of policy measures on the budget and 4alance of payments. The link between liberalization and macro-economic policy is established analytically, leading to the judgment that a strengthening of stabilization efforts is a sine qua non of further adjustment in the areas of trade and industrial policy. -4- IL STABILIZATION. ADJUSTMENT. AND THE MACRO-ECONOMY 2.01 The purpose of this chapter is to analyze macro-economic developments which have taken place since 1983 as they relate to stabilization and liberalization objectives. In particular, the impact of the budget deficit and the associated financing strategy on broad macro-economic aggregates such as savings and investment will be assessed, as will the effect of trade policy measures on the budget. In this context, an attempt will be made to reconcile the sustainability of the budget deficit with the structural transformation of the economy. The chapter concludes with an evaluation of the costs of adjustment in terms of employment and income. A. Macro-eeonomic Developments since the Financha Criss of 1983 2.02 Stabilization in Morocco during the period 1983-87 took the form of a package of expenditure-reducing measures to decrease Government absorption. On the other hand, adjustment was induced through expenditure-switching policies which sought to promote the tradables sector. The macro-economic program concluded with the IMF emphasized contractionary fiscal and monetary measures, rather than the restrictive trade policies of the past as the means to alleviate the acute foreign exchange shortages which beset Morocco at the time. This approach implicitly recognized the importance of an appropriate macro-economic environment in which liberalization could take place. As the experience of the Southern cone countries demonstrates1', inconsistent macro-policies could serve to undermine the liberalization program, provoke a financial crisis, and erode credibility for future reforms. 2.03 With the onset of stabilization, the overall budget deficit fell from 12.22 in 1983 to 6.02 in 1987 on a commitment (accruals) basis. The favorable trend which has characterized the evolution of the budget deficit since 1983 nevertheless belies a number of structural weaknesses. Tax pressure from traditional sources of revenue has declined nearly two percentage points from 19.1S of GDP in 1983 to 17.42 of GDP in 1987. The increase in total revenues in 1986/87 was principally due to the excise tax levied on petroleum, which kept the price facing domestic consumers at US$28/bbl equivalent. Proceeds from this source alone represented nearly 152 of total fiscal receipts. Notwithstanding a fall in international interest rates and a reduction in outlays on consumption subsidies which served to contain the growth of current expenditures, most of the fiscal adjustment was due to a substantial decline in the public investment budget from DR 9.3 billion in 1983 to DH 5.6 billion in 1986. This resulted from a notable lack of progress in mobilizing public savings: the current budget deficit on a commitment basis fell only from 2.42 to 2.1% of GDP from 1983 to 1986'*. During this period, there have also been wide discrepancies between budgetary commitments and cash payments 1/ See especially "Liberalization with Stabilization in the Southern Cone of Latin America", World Development, August 1985. 2/ This trend has been reversed somewhat in 1987 with public investment expenditures rising by DR 9.6 billion and the current budget registering an estimated 0.71 surplus with respect to GDP. leading to a substantial buildup of domestic payment arrears. At end-1987, the outstanding stock of arrears owed by the Treasury totaled DR 10.5 billion or 7.71 of GDP, indicating that the Government has continued to consume beyond its means over the period in question. 2.04 The exchange rate was a major policy instrument used to forestall a deterioration of the balance-of-payments position with the onset of liberalization. By dismantling quantitative restrictions on imports and reducing tariff barriers to external trade, Moroccan policy makers sought to attenuate the bias against exports inherent in the existing system of incentives and induce structural adjustment at the sectoral level. In order that liberalization of the external regime not stoke balance-of-payments pressures, a depreciation of the real exchange rate was critical. In Morocco, bilateral real exchange rates have fluctuated significantly despite the relatively frequent adjustments of nominal rates. In addition, the real exchange rate has tended to appreciate in periods of relatively high protection as was the case in the late 1970a (Table A.II.1). Since September 1983, however, the Moroccan government has pursued an active exchange rate policy which has served both to restrain domestic demand and support trade liberalization measures (Table 2.1). The real effective exchange rate on a trade-weighted basis has depreciated by 26.01 since end-1982. This reflects a downward crawl vis-a-vis a basket of international currencies attendant on a number of discrete devaluations which has more than offset inflation Table 2.1: REAL EXCHANGE RATE INDICES A& (1980 = 100) OF THE DIRHAM AGAINST THE CURRENCIES OF MOROCCO'S MAJOR TRADING PARTNERS, 1980-1986 Nominal French Saudi Spanish German Italian U.S. Real Year Effective Franc Riyad Peseta Mark Lira Dollar Effective Rate Rate Rate k 1980 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 1981 93.7 97.1 112.9 100.3 96.9 98.2 122.0 92.3 1982 92.5 92.9 115.1 98.3 99.3 97.6 129.3 90.3 1983 89.6 95.8 124.9 94.6 105.3 105.0 144.0 84.3 1984 82.8 99.2 131.9 103.3 106.0 109.1 160.7 79.5 1985 78.4 105.5 129.3 109.9 109.2 112.4 166.7 74.2 1986 72.6 70.9 1987 72.7 69.2 a/ A decrease indicates a depreciation for effective exchange rates whereas an increase indicates a depreciation for bilateral exchange rates. b/ Basket with multilateral trade weights based on the geographical pattern of trade including third market effects. Source: Mission estimates based on IMF statistics -6- differentials between Morocco and its principal trading partners. To the extent that exchange rate depreciation has been used to offset reductions in quantitative restrictions and tariffs, and in particular, the special import tax (Annex IV), inflationary pressures linked to devaluation have been kept to a minimmv' 2.05 The sustained real depreciation of the exchange rate and contractionary macro policies resulted in a gradual improvement of the trade balance (Fig. 2.1). Certain categories of price-elastic exportables registered strong growth1', which served to offset the decline in demand for phosphate rock and derivatives, Morocco's principal export. Import demand was contained during this period by four factors. First, the depreciation of the exchange rate limited imports of consumption goods recently subject to liberalization to sustainable levels. Second, the higher cost of capital which resulted from reforms undertaken as part of the liberalization program (para. 5.14) served to dampen investment demand. Third, increased domestic agricultural production led to a major decline in the volume of grain imports. Fourth, the sharp decline in international petroleum prices reduced the value of oil imports by 452 in 1986. Abetted by a favorable external environment, the program of stabilization with adjustment thus led to a narrowing of the resource gap by increasing the share of external trade in overall economic activity rather than by solely compressing imports. 2.06 The downward movement of the exchange rate had salutary effects on the balance of services as well. Net tourism proceeds, in particular, reacted strongly, increasing by 322 p.a. in dollar terms since 1984. Continued growth of worker remittances and the decline in net investment income payments abroad, in line with the easing of international interest rates, contributed further to this trend. As a result, the evolution of the current account deficit was even more favorable than that of the trade balance and fell from US$2.0 billion (13.3Z of GDP) in 1982 to an estimated US$222 million (1.62 of GDP) in 1987 before debt relief. 2.07 Despite this impressive progress, the current account deficit has not been narrowed as rapidly as would have been required by the evolution of the capital account. Structural weaknesses of the capital account linked to low autonomous loan disbursements and high amortization payments (before debt relief) have given rise to financing gaps over the past few years. These gaps have been financed, in turn, by the virtual depletion of foreign exchange reserves and the buildup of external trade arrears. At various times in the past, the level of reserves was equivalent to only two days worth of imports and the outstanding stock of external arrears reached US$540 million. In consequence, Morocco is presently experiencing an acute shortage of foreign exchange which has had serious repercussions on the adjustment process. For example, importers have experienced delays of up to 120 days in obtaining foreign exchange, which has raised intermediation costs, increased the level of uncertainty in the tradables sector, and made foreign suppliers more reluctant to extend trade credits to Morocco- . The disequilibrium in the 1/ The rate of inflation as measured by the consumer price index declined from 12.5Z in 1983 to 2.42 in 1987. 2/ The magnitude of these relative price effects are analyzed in Chapter IV. 3/ The impact of this liquidity constraint on industrial activity is analyzed in greater detail in Chapter V. EXTERNAL ACCOUNTS AND EXCHANGE RATE MOVEMENTS 1 0.8 A 0.6 0.4 iF 0.2 00 -0.2 -0.4 -0.6 ID ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~CD 1~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~t -1.44w -1.6 -1 .8 -2--- 1980 1981 1982 1983 1984 1985 1986 1987 O Trade 8al + Cur Acet O Real Exch Rate -8- foreign exchange market could well reflect the failure to adjust the exchange rate in order to compensate for the reduction in import barriers which occurred in early 1986^'. B. The Interaction of Stabilzation and Ad3ustment 2.08 It is useful at this juncture to segregate the relative macro-economic effects of the stabilization-cum-liberalization policies which have been pursued since 1983. While reductions in the Government budget deficit are unambigously contractionary, exchange rate devaluation, in theory, can induce either economic expansion or recession depending on a number of factors (e.g. levels of capacity utilization, elasticities of tradables, rigidities in factor mobility). The use of a computable general equilibrium (CGE) model to simulate alternative policy scenarios can provide insight in this area. 2.09 In the case of Morocco, devaluation alone can be shown to improve the balance of payments and raise GDP growth as well1'. On the other hand, a reduction in public expenditures and/or an increase in taxation inevitably results in a significant slowdown in economic activity1'. In effect, the deflationary impact of demand management policies pursued since 1983 appears to have been cushioned by the downward movement of the exchange rate. By attracting resources to the tradables sector, devaluation has stimulated both efficient import substitution and export growth, and has thereby contributed to the favorable evolution of the balance of payments. This, in turn, has mitigated the fall in aggregate demand and income that would have ordinarily obtained from traditional stabilization policies alone4'. 2.10 The results of two alternative policy simulations support these conclusions. In the case of a pure stabilization package comprised of a 101 increase in import taxes, a 52 reduction in Government consumption, and a 202 cut in public investment, GDP decreases by 1.52 with imports and exports falling by 4.52 and 0.32 respectively. The budget and balance of payments improve by DE 2.2 billion and DH 1.7 billion respectively with employment falling by 3.6% in the formal sector. The impact of an outward-oriented, stabilization-cum-adjustment policy package was subsequently evaluated. As a result of a 51 reduction in Government consumption, a 10% cut in public investment, and a 10% devaluation, GDP decreases only by 1.2% and employment by 2.41. Imports are reduced by less than in the absence of devaluation, 1/ The modest decline in the real effective exchange rate in 1986/87 was insufficient to offset the implicit appreciation resulting from the reduction of the maximum nominal tariff rate from 60% to 451 and the elimination of quantitative restrictions on certain consumption goods with a relatively high level of notional demand. 2/ A 10% devaluation without any nominal wage adjustment reduces the current account deficit by about US$200 million or 221 of the 1985 level and raises GDP by 1.31. 3/ A reduction in Government expenditure of 101 leads to a fall in GD? of 4.11, whereas an increase in commodity taxation of 101 results in a 2.31 decline in GDP. 4/ The economy has grown at an average annual rate of 4.1% since 1983. - 9 - whereas exports grow at 5S compared to a 0.3% decline in the previous scenario. As a result, the DR 2.5 billion improvement in the balance of payments is substantially greater, as is the DR 2.9 billion reduction in the budget deficit. 2.11 In order to isolate the relative effects of stabilization and structural adjustment policies on the performance of the Moroccan economy since 1983, a macro-econometric model was employed. The simulations show that most of the improvement on the current account over the past three years can be attributed primarily to a reduction in domestic absorption and to a number of favorable exogenous factors. Of the US$1.1 billion decline in the current account deficit, US$630 million derives from the reduction in domestic absorption, linked in large part to the narrowing of the Government budget deficit, devaluation, and the increase in interest rates; US$310 million results from a combination of the positive shock to agricultural production (para. 2.05) and the improvement in the terms of trade, the drop in oil prices more than compensating for the decline in phosphate demand; and US$160 million can be attributed to the supply-side response of the economy to the more rational structure of incentives. The limited effect of the liberalization program on the balance-of-payment adjustment is not surprising in view of the relatively limited share of non-traditional manufactures in total exports which prevailed at the onset of the program, as well as the lags associated with supply-oriented reforms. In the medium-term, it is expected that the relative impact of structural policies on the current account would increase, thereby reducing the degree of required disabsorption. 2.12 Budsetary impact on Savings and Investment Behavior. The medium-term development strategy of Morocco is predicated on the appropriate use of trade and industrial policy to enhance international competitiveness and expand the production of tradable goods. An increase in aggregate domestic supply is likely to entail an initial rise in the level of domestic investment as well as major shifts in resource allocation. An important cnponent of structural adjustment in Morocco is the substitution of the dynamic private sector for the State in commercially-oriented economic activity. An analysis of the relationship of the budget deficit to savings and investment behavior indicates that slippages on the stabilization front are beginning to constrain the potential for future adjustment. 2.13 The macro-economic environment in Morocco has been characterized in general by an expansionary fiscal policy combined with relatively contractionary monetary policy. Prior to 1983, foreign borrowings financed nearly 60% of the Treasury deficit. When Morocco's access to external funding was abruptly reduced in 1983, Central Bank borrowings rose on an exceptional basis as shown in Table 2.2. Insofar as the monetary authorities have been firmly committed to eschew sustained inflationary financing, there has been a concerted effort to mobilize additional domestic savings for the Treasury. As part of a broader financial sector reform supported by the second ITPA loan, measures have been taken to deepen the money and capital markets/'. 1/ See Morocco: Second Industrial and Trade Policy Adjustment Loan, World Bank, Report P-4075-MOR, May 6, 1985. - 10 - Table 2.2: SOURCES OF TREASURY FINANCING (In Millions of Dirhams) 1981 1982 1983 1984 1985 1986 1987s' Treasury Deficit1' 11148 11322 10643 10623 11346 6819 6198 Source of Funds Foreign Borrowingko 6761 6503 4466 5071 3772 -225 155 Borrowing from Central Bank 1332 1182 3382 1325 917 952 n.a. Borrowing from Domestic Banks 2510 839 2962 841 3573 3683 22251' Other Domestic Sources&' 176 37 -539 -28 1731 2953 5001 Net Flow of Arrears 369 2761 372 3414 1353 -544 -1183 a/ Commitment basis after debt relief. b/ Net of debt relief on interest payments. c/ The figures for 1985-86 reflect the recent issue of Treasury bonds to the uon-financial private sector (para. 2.14). d/ Provisional. e/ Including borrowings from Central Bank. Source: Ministry of Finance and Mission Estimates. 2.14 This strategy has yielded some short-term benefits. The steady increase in both nominal and real deposit rates (Table 2.3) has been associated with a major shift in portfolio composition away from currency holdings toward bank deposits and especially time deposits, as witnessed by the stronger growth of Mz (541) relative to Mi (33S) since 1984. The ceiling on credit to the economy has ensured that a significant proportion of the increased financial resources of commercial banks would be channeled to the Treasury. The recent issues of high interest-bearing, tax-exempt Treasury bonds to the non-financial private sector have further contributed to financing the deficit. These factors have thus contributed to the reduction in the share of Central Bank finincing from 31.8X in 1983 to an average of around 101 in 1985-86, as well as the decline in the rate of inflation from 12.51 in 1983 to 2.41 in 1987. Table 2.3: THE EVOLUTION OF INTEREST RATES IN MOROCCO (percentages) Nominal Rates Inflation Rate1' Real Rates Year Borrowing&' Lending'' Borrowingi Lending' 1974 3.0 6.5 14.4 -11.4 -7.9 1976 3.5 8.0 13.4 -9.9 -5.4 1981 6.0 10.0 13.2 -7.2 -3.2 1983 6.5 12.0 12.5 -6.0 0.5 1985 10.5 14.0 10.0 0.5 4.0 1986 10.5 14.0 4.4 6.1 9.6 1987 10.5 14.0 2.4 8.1 11.6 a/ Rate paid on six-month time deposits at year end. b/ Rate paid on medium-term rediscountable loans at year end. c/ Annual percent changes in the consumer price index from December to December. Source: Bank of Morocco and Mission Estimates. - 11 - 2.15 Despite the positive results achieved to date, further analysis reveals that the present financing strategy entails significant medium-term costs which run counter to the objectives of structural change and may be unsustainable in the future. Despite considerable success in mobilizing additional savings, borrowings from traditional domestic sources were still insufficient to finance the budget deficit. As a result, the Treasury resorted to forced savings from domestic private suppliers and public enterprises in the form of payment arrears, which have financed up to 322 of the budget deficit since 1983. There is also an increasing danger of crowding-out, as shown by the recent evolution of monetary indicators. Between 1980 and 1985, total domestic credit to the Government from the consolidated banking sector increased at an average annual rate of 14.82, whereas M2 grew only by a yearly rate of 8.91 over the same period. As a result, the share of total domestic bank credit to the Government in the money supply rose from 62.61 in 1980 to 81.8% in 1985. Interest rates1' have risen by approximately 19.5 percentage points since the mid-1970's in order to mobilize the private resources necessary to compensate for the comparative lack of foreign and public savings-'. 2.16 The rise in interest rates attendant on the elimination of accelerated depreciation allowances for fiscal purposes in the context of the 1983 investment code (para. 5.14) resulted in a significant increase in the cost of capital-' as shown in Table 2.4. In relation to both the industrial wage and manufacturing value-added, the co8t of capital has exhibited a clear upward trend. This suggests that investment demand was negatively affected by the increase in the cost of capital as a result of both the substitution effect (by making capital more costly with respect to labor) and the output effect (by raising the real cost of capital). An analysis of gross fixed capital formation in the industrial sector shows that after reaching a peak in 1982, real investment expenditure in manufacturing has subsequently declined (Table 2.4). To this effect, medium-term rediscountable and BNDE1' loans, the two main lending instruments for industrial investment, registered a decline in their share of total credit from 37.4% in 1982 to 35.5% in 1985 (Table A.II.3). 1/ Although not excessively high (101 in real terms) compared to some other developing countries, real interest rates, if they continue to rise, could lead to a situation whereby the successive rise in rates, interest payments, and the outstanding stock of public debt eventually culminates in an explosion of the budget deficit. In 1986, for example, the ratio of interest payments on outstanding Government debt to the overall budget deficit was 1.07 before debt relief. 2/ Although the average saving propensity of the Moroccan private sector has increased in line with real interest rates (Table A.II.2), no causal link could be established econometrically. In the Moroccan context, the rise in real interest rates is likely to have affected investment. 3/ The methodology used to calculate the cost of capital in Morocco is presented in Annex I. 4/ Banque Nationale pour le D6veloppement Economique, the national development bank. - 12 - Table 2.4: MANUFACTURING INVESThENTS AND RILATMVE COST OF CAPITAL FOR MOROCCAN INDUSTRY (In thousands, at 1980 constant DR prices) I n v e s t m e n t Relative Cost of Capital tot Year Agro- Textile & Chemical Electrical & Manufacturing _ industry Leather Mechanical Labor Value-Added (In thousands at 1980 constant DR prices) (1980.100) 1979 107.0 75.1 151.9 79.9 78.91/ 76.7k' 1980 160.2 155.5 227.7 100.2 n.a. n.a. 1981 89.6 123.6 144.8 92.2 110.3 108.8 1982 221.2 113.8 360.8 87.2 n.a. n.a. 1983 208.0 85.2 142.4 80.8 157.5 173.3 1984 112.3 145.7 135.5 118.5 170.8 191.8 1985 120.4 140.4 126.6 71.0 173.3 203.0 a/ For the year 1977. Source: Ministry of Industry and mission calculations. 2.17 The evolution of the relative cost of capital is determinant in explaining investment behavior in Morocco. It shows also how the policy reforms implemented to date have succeeded in substantially reducing, if not eliminating, the previous bias against labor. In the second half of the 1970's, increasing real wages and low capital costs, due mostly to the biased structure of trade and industrial incentives, oriented both sectoral and technical choices towards a relatively high level of capital intensity. The recent decline in investment must therefore be viewed in the context of shifting relative factor prices which act to correct previously existing distortions. More importantly, growing investment in the relatively labor-intensive, export-oriented sectors indicates that the economy is moving steadily toward a sectoral pattern of production more in line with its natural comparative advantage. 2.18 A detailed analysis of the sub-sectoral distribution of investment within manufacturing reveals that industries which have succeeded in maintaining a steady level of capital accumulation are those which have derived maximum benefit from the increasing export orientation of the economy. This is reflected, moreover, in the evolution of the relative demand for credit in manufacturing. Whereas the share of manufacturing in total credit barely changed during the 1982-85 period, the relative share of export credits increased, reflecting the more dynamic performance of exports and the exemption of export lending from credit ceilings. 2.19 Internal Consistency of Macro Policies. The past financing strategy which succeeded in lowering inflation by depleting net foreign assets and building up arrears appears to be unsustainable, as witnessed by the recent foreign exchange shortages and intermittent work stoppages in publicly financed projects. An analysis of the structural budget deficit1' (i.e. the 1/ The derivation of the structural deficit is presented in Annex II. - 13 - public deficit corrected for the effects of inflation, cyclical variations in revenues and expenditures, and Government net worth) reveals, moreover, a fundamental inconsistency with inflation targets in the medium-term. This is shown using an analytical framework developed by Sargent and Wallacel'. It is based on a simple accounting identity which relates the budget deficit to possible sources of financing] '. The relationship between the change in the monetary base and the primary deficit is directly linked by constraining certain variables. In the case of Morocco, financing the budget deficit through increased borrowings or further depletion of foreign exchange reserves must be ruled out at this time in view of the unsustainably high debt burden and present liquidity crisis-'. Its small country status renders world interest rates and proportional changes in the terms of trade exogenous. The domestic interest rate in Morocco is closely linked to the world interest rate adjusted for inflation differentials and expectations with regard to future developments in exchange rates. As such, the ability of the monetary authorities to adjust domestic interest rates in real terms to accomodate 1/ See Sargent, T. and Wallace, N. (1982), "Some Unpleasant Monetarist Arithmetic", Federal Reserve Bank of Minneapolis Quarterly Review. 2/ The excess of Government expenditures over revenues can be financed by domestic borrowings, foreign capital inflows, money creation, or running down the stock of foreign exchange reserves, yielding the public sector budget identity: G + i D + ei* D* - T - M + D + e D* - e R p p _ _ _ _ where G is the level of total Government expenditures, T is real taxes net of subsidies, i and i* are the nominal domestic and international interest rates respectively, D and D* are the outstanding stock of domestic and foreign public debt respectively, R is the level of official foreign reserves, e is the exchange rate, M is the nominal stock of high-powered money, and P is the domestic price level. 3/ Setting the present debt to GDP ratios at maxima for both domestic (d) and foreign (d*) borrowings and setting the official reserves to GDP ratio at a minimum, the following relation between inflationary financing and the real budget deficit as a proportion of GDP obtains: S= - - 6 + ( r - gy) d + (r* + g. - gy) d* Py where S is the real seignorage the Government has to extract by printing money, 6 is the real primary deficit (i.e. the overall budget deficit less interest payments), r and r* are the real domestic and international interest rates respectively, gy is the rate of growth of real GDP, and gc is the rate of deterioration in the terms of trade. The omission of a term corresponding to the change in official reserves is predicated on the assumption that the level of reserves with respect to GDP is at a minimum and the cost of accumulating additional reserves in the near future is deemed too high. - 14 - Treasury borrowing requirements is limited-". Apart from an increase in the rate of growth of GDP which improves the debt servicing capacity of the economy and relaxes the Treasury's borrowing constraint1', a reduction in the primary deficit by some combination of tax increases and/or expenditure cuts is the only way in which the Government can limit its recourse to seignorage. 2.20 The internal consistency between budget deficit and inflation targets was evaluated for Morocco on the basis of projected revenue and expenditure levels, domestic and external interest rates, GDP growth rates, and domestic and international inflation rates. The primary structural deficit was estimated to be approximately 1.71 of GDP in 1986. In view of the underlying assumptions on borrowing constraints and exogenous developments, a seignorage level of 3.41 of GDP is required to finance the budget deficits'. This would generate, in turn, a rate of inflation on the order of 202, significantly higher than the rates recorded in the past4'. The Government's increasing reluctance to devalue even nominally would induce an appreciation of the real exchange rate, placing the liberalization program in jeopardy and fueling speculative capital flight. 2.21 Developing countries resort more often to seignorage as a source of deficit financing than do industrialized countries1'. The former typically exhibit a lower velocity of circulation of high-powered money which serves to broaden the inflation tax base, allowing more revenue to be captured for a given inflation tax rate. The relative dependence on seignorage as a source of Government revenue in selected developing and developed countries over time is depicted in Table 2.5. As expected, the level of seignorage in relation to GDP is much higher in the developing countries. I/ Artificially lowering rates on Treasury borrowings or forcing banks to absorb more Government assets than they would ordinarily choose to hold at a given lending rate effectively constitutes a tax on bank holdings and can be considered as another form of seignorage. 2/ For a more thorough treatment of the relationship between debt, economic structure, adjustment, and growth see M. Selowsky and R. van der Tak, "The Debt Problem and Growth", World Bank, mimeo, 1986. 3/ The algebraic derivation of this relationship is presented in Annex II. 4/ Seignorage as a proportion of GDP is equal to the rate of change of high-powered money times the inverse its velocity of circulation, or S dM/M x 1/V. The rate of change of the monetary base is thus equal to the level of seignorage with respect to GDP times the income velocity of circulation of the monetary base, estimated at between six and seven in Morocco. The quantity equation of money, MV a Py, demonstrates that with a level of seignorage equal to 3.41 of GDP with V and y held constant, the rate of change in the price level will surpass 201. Clearly, the budget deficit must be reduced, or alternatively, a higher rate of economic growth achieved if inflation is not to accelerate in the future. 5/ This results from a relatively lower degree of financial intermediation and a limited array of financial instruments in the case of the former. - 15 - Table 2.5: SEIGNORAGE AS A PERCENTAGE OF GDP IN SELECTED COUNTRIES Year Germapy France Japan USA Morocco Philippines EAypt Tunisia Korea 1975 0.292 -2.272 0.39% 0.462 1.892 0.74% 3.601 1.602 2.95% 1978 1.312 0.901 1.282 0.711 2.022 1.35% 5.85% 1.611 3.042 1980 -0.381 0.90% 0.572 0.342 0.741 0.712 14.28% 1.051 -0.59% 1981 -0.161 0.292 0.24% 0.182 1.851 0.561 8.432 2.11S -0.941 1982 0.481 1.042 0.54% 0.342 0.921 0.31% 10.971 2.071 1.931 1983 0.511 0.301 0.481 0.33% 1.791 2.44% i0.28% 1.681 0.441 1984 0.352 0.631 0.752 0.332 1.581 1.08% 5.561 1.011 0.221 1985 0.301 0.351 n.a. 0.511 1.01% 0.811 6.45% 0.87% 0.091 Source: International Financial Statistics. 2.22 It is noteworthy in the case of Morocco that the level of seignorage required to finance a primary deficit of 1.71 of GDP would be significantly above the historical trend. With the onset of financial sector reforms and the elimination of artificial barriers to private financial intermediation, the demand for money at a given level of income tends to fall. This increases the income velocity of circulation as individuals seek to rid themselves of excess cash balances which reduces, in turn, the inflation tax base. If the same level of seignorage is to be maintained, the inflation tax rate, that is the rate of growth of the monetary base, must increase and with it the rate of inflation. If the inflation target is to be respected in a country undergoing a major financial sector reform, then the budget deficit must be correspondingly lower. This conclusion is particularly relevant to the case of Morocco which, under the ITPA program, has adopted a series of significant measures to promote financial deepening. The link between stabilization policies and the successful implementation of structural reforms is thereby reinforced. 2.23 Budgetary Effects of Structural Measures. The trade liberalization program was expected to have both a negative direct effect on budgetary revenues in the short run, which was to be offset by specific compensatory measures, and a positive indirect effect over the medium-term. Rationalizing the structure of protection and reducing the bias against exports by lowering the rate of international trade taxes, were expected to lead to shortfalls in budget receipts. On the other hand, a number of compensatory measures, such as an across-the-boardr increase in the rates of indirect taxes which do not discriminate against eiKternal trade1' and an active exchange rate policy serving to broaden the taxable base, were identified to neutralize the decline in revenues. Finally, the increase in general economic activity, particularly in the industrial and exporting sectors, resulting from a more efficient allocation of resources in line with Morocco's comparative advantage, was expected to increase tax revenues in the medium-term. 1/ The introduction of a value-added tax in Morocco in April, 1986 precluded this option. The authorities first wanted to be sure that the VAT was functioning properly before proceeding to a modification of rates. - 16 - 2.24 Table 2.6 shows the evolution of trade tax receipts in absolute terms and as a share of total import value. Global proceeds from trade taxes in current prices excluding the turnover tax have steadily increased up to 1982 and fallen slightly thereafter. In accordance with the liberalization prosram", the special import tax (SIT) rate (para. 3.04) was reduced from 151 in 1983 to 52 in 1987, accounting for a significant loss in revenues. The SIT in overall import tax revenues fell from 34.81 in 1982 to an estimated 14.01 in 1987. This trend was cushioned to some extent by an increase in receipts from customs duties, which continued to grow despite a series of reductions in the maximum nominal tariff rate in 1984-86. This finding can be explained by the relatively low share of heavily taxed items in the overall import basket, the majority of which remain subject to quantitative restrictions (para. 3.26); and by the shift in the composition of imports away from zero-duty goods in 1985-87'. This explains the increase in import tax revenues as a proportion of total import value in 1986, despite a continual decline in the share of trade taxes in total tax revenues since 1984. Table 2.6: EVOLUTION OF TRADE TAX REVENUES (In Millions of Dirhams) 1982 1983 1984 1985 1986 1987 Total Trade Tax Revenues Excluding turnover tax 5792 5262 5627 5771 5600 5640 S of total tax revenues 37.82 29.01 29.51 27.31 23.32 21.5% Including turnover tax 8611 8138 9251 9866 9926 10039 1 of total tax revenues 56.2% 44.91 48.51 46.61 42.51 38.21 Import Tax Revenues Customs Duties 1703 1598 1885 2245 2373 3059 Special Import Tax 2994 2631 2533 2221 2033 1402 Stamp Tax 849 810 913 972 970 996 Total 5546 5039 5331 5438 5376 5457 Percentage of Imports 21.31 19.71 15.51 14.12 15.51 15.6S Source: Annex Table A.II.4. 1/ For a discussion of the panoply of trade taxes in Morocco and the way in which they have been affected by the liberalization of the trade regime, see Annex IV and Chapter III (paras. 3.09 to 3.10). 2/ The relative share of wheat and petroleum imports, both of which are imported duty-free, declined dramatically in 1985-87 as a result of high domestic agricultural production and the fall in world oil prices; this, in turn, freed up import capacity for dutiable items. - 17 - 2.25 Export taxes have been virtually abolished in keeping with the liberalization program (para. 3.11), except for a levy on mineral exports. The latter does not constitute a bias against exports insofar as it applies in general to phosphate rock where Morocco enjoys considerable market power and is tantamount therefore to an optimum tariffl *. The 1987 level of trade taxes (excluding VAT proceeds from imports) is estimated at 21.51 of total tax revenues, reflecting both structural measures (i.e. the elimination of the statistical tax on exports and the reduction in the maximum tariff rate) and cyclical ones, notably a fall in tax revenue from phosphate exports link'd to the recent decline in world demand for phosphate rock and derivatives. 2.26 Tax expenditures which result from the various incentives embodied in the investment and export codes (paras. 5.13-5.15, 3.15-3.17) have contributed to budgetary strain. Whereas much progress has been realized in limiting the scope of investment incentives, Treasury revenue foregone under the export code remains considerable (Table 2.7). This fiscal loss amounted to an estimated DE 600 million in 1986 or nearly 10 of total direct tax revenues. Table 2.7: REVENUE FOREGONE DUE TO GRANTING OF FISCAL INCENTIVES (Value in Millions of DR) 1976 - 1985 1976 1979 1983 1984 1985 Export Code 16.3 25.9 66.4 131.6 447.0 Investment Code 113.0 139.2 20.8 54.0 69.4 Total Revenue Foregone 129.3 165.1 87.2 185.6 516.4 Memo Items Central Government Tax Revenue 8,322 13,802 18,943 20,971 23,161 % Tax Revenue Foregone 1.5 1.2 0.5 0.9 2.2 Source: Ministry of Industry and Mission Estimates 2.27 This analysis has shown that the effect of tariff reductions on budgetary revenues was not a major cause of macro-economic disequilibrium. These measures were necessary, moreover, to reduce distortions in the structure of incentives and promote a more efficient allocation of resources. In contrast, the fiscal incentives provided under the export code may prove increasingly costly as trade liberalization proceeds and resources are increasingly allocated to export-oriented activities. With exporters exempt 1/ For a discussion of how a large exporting country can pass on the costs of an export tax to the importing country, see H. Johnson, "The Gains from Exploiting Monopoly or Monopsony Power in International Trade", Economica, May 1968. - 18 - from virtually all forms of taxation-', the expansion of exports will be accompanied by declining tax receipts, that is, the income elasticity of fiscal revenues will decline with the structural transformation of the economy. This could result in a worsening of the already precarious budgetary situation, casting considerable doubt on the future of trade liberalization in Morocco. If the progress achieved under the liberalization program is not to be undermined, the sectoral reforms must be complemented and strengthened by an array of macro-policies that raises the rate of investment and reduces the ratio of debt service to total savings, while containing aggregate demand and inflation. C. Ibe Sooa ImIact of Adjustment 2.28 After rising steadily until 1979, real wages have declined significantly. This behavior parallels that of the real exchange rate which, as noted earlier (para. 2.04), had been appreciating until the end of the 1970. and depreciating thereafter. It is probable that the devaluation of the nominal exchange rate would have led to much less of a real depreciation, had it not been for the decrease in real wages3'. 2.29 The negative impact of the real depreciation of the dirham on the purchasing power of wage earners was to some extent limited by the fact that consumer prices increased at a slower rate than producer prices. As a result, the product wage decreased more than the real wage in consumption goods. The disparities in the movements of the CPI relative to the producer price index indicate, moreover, that the "internal" real exchange rate (i.e. the relative price of domestic tradables to non-tradables) also tended to depreciate. 2.30 The behavior of employment has been significantly affected by the evolution of real wages. In view of the general scarcity of labor statistics in Morocco, the analysis of the effects of the adjustment program on employment was confined to the manufacturing sector1'. Table 2.8 traces the evolution of permanent and total employment in the manufacturing sector since 1976. Employment stagnated until 1979, while real wages increased at an average annual rate of 7.71 over the same period. With the subsequent decline in real wages, the employment response was swift, rising from 197,300 workers in 1979 to 296,953 in 1986. Unlike investment, employment exhibited a common upward trend across sub-sectors, with no one industry significantly outperforming the others (Table A.II.5). 1/ Exporting firms are required to pay the National Solidarity Tax (PSN), introduced in 1980 to finance the defense effort in the Western Sahara. The PSN rate of 10% is applied to the marginal rate of profits tax (481) yielding an effective tax rate on export profits of 4.82 Results from the industrial survey, however, indicate a significant compression of profit margins which served to reinforce the impact of the devaluation. 3/ In view of the linkages between industry and other sectors of the economy, formally respresented by intersectoral employment multipliers, the global employment effect is presumably greater. - 19 - Table 2.8: INDUSTRIAL EMPLOYMENT (Number of employees, in thousands) Total Seasonal Real Wage Employment Employment (1980u100) 1976 190.0 29.4 89.0 1977 194.0 22.1 99.1 1978 176.9 14.7 108.9 1979 197.3 21.3 111.2 1980 222.1 27.9 100.0 1981 223.0 26.3 98.7 1982 NA NA NA 1983 239.3 29.5 97.3 1984 255.6 31.1 94.3 1985 271.3 42.7 94.2 1986 297.0 55.2 Source: Ministry of Industry, Les industries de transformation. 2.31 The employment effect was greatest in the food processing sector, where labor demand surged at an average annual rate of 5.5%, most likely in response to a marked decline in real wages in that sector (more than 20X since 1980). Employment growth in textiles, however, was less impressive (3.61 per annum) as a result of the rise, however modest, in real wages (0.61 per annum). Wages in the textile sector remained only 75.8% of the average industrial wage in 1985. This result is not surprising insofar as textiles is a relatively unskilled labor-intensive sector. 2.32 The social costs of lower real wages, and hence reduced purchasing power, was partly compensated by a positive employment effect, as production shifted to more labor-intensive exporting activities. At the same time, however, the composition of employment has changed somewhat, with part of the increase coming from seasonal workers (Table 2.8). It is clear from Table 2.9 that the social costs of adjustment in Morocco have been moderate in relation to other comparator countries. On the other hand, ther. are signs that the labor market is still going through a difficult phase of readjustment. According to Government estimates /, urban unemployment has steadily increased in the last few years from 11.9% in 1981 to 18.4% in 1984, declining to 14.51 in 1985. 1/ Report prepared by the Government of Morocco for presentation at the Consultative Group in March 1987. - 20 - Table 2.9: COMPARATIVE SOCIAL INDICATORS 1982-1985 (average anDual percentage change) GDP Employment in Manufacturing per capita Manufacturina Real Wase Argentina -1.22 2.3% 12.6% Brazil 1.0% -0.22 -2.42 Chile 1.0% 5.72 -5.1S Mexico -2.31 -2.8% -12.1% Morocco 1.21 A" 5.52 -1.41 Peru -4.61 -4.22 -15.9% Turkey 2.51 3.52 -5.01 aJ 1982-1986. 2.33 In Morocco, employment is a politically more sensitive issue than wage levels given the high rates of unemployment and underemployment. The rapid growth of the civil service despite the relatively depressed level of public sector salaries is but one manifestation of this. The positive employment effect in the manufacturing sector is an encouraging development which may render the continuation of the adjustment program more palatable politically. - 21 - TIL THE EVOLUTION OF TRADE POUCY REFORM IN MOROCCO A. The Poltical Eeonomy of Trade Reform In Morocco 3.01 Two primary considerations have been instrumental in shaping Moroccan trade policy in the past. The first was the desire to protect the nascent industrial tissue by shielding domestic import-substituting activities from international competition. The second was the desire to resort to trade restrictions as a means of addressing external disequilibria and shortfalls in fiscal receipts. Exchange rate policy was formulated independently to control inflation. The tendency of the exchange rate towards overvaluation, however, aggravated the balance of payments which stoked pressures to restrict the trade regime. 3.02 The barriers to external trade and the regulatory apparatus governing international transactions generated a strong anti-export bias. The combination of relatively high tariffs and binding quantitative controls resulted in a gradual shift in import demand away from finished goods and towards intermediate products and capital equipment. Pressure from industrial groups to reduce tariff rates on the latter categories led the Government to introduce an extensive array of tax exemptions embodied in the various Investment codes (paras. 5.13-5.15). This artificially depressed the cost of capital and discriminated against labor-intensive activities, an area in which Morocco enjoys a natural comparative advantage. As customs revenues deteriorated, the reaction of policy makers was to introduce new layers of trade taxes. This, in turn, led to higher levels of dispersion in tax rates which further aggravated the distortions in the system of protection. Scarce resources were misallocated to highly protected and/or inefficient sectors with the result that the international competitiveness of Moroccan industry deteriorated. 3.03 Ackaowledging the importance of a more neutral incentives regime, Morocco embarked on an extensive program of structural reform required to restore a viable balance-of-payments position and a sustainable growth path in the medium-term. The objectives of the program were defined and internalized by the Ministry of Trade and Industry in the context of a joint research project with the World Bank on the structure of industrial incentives. The results of this studyV 'were used both to establish a substantive policy dialogue between the Bank and the Government and to gain the necessary support for reform from Moroccan industrialists. This involved prolonged discussions with firm owners to explain the objectives, timing, and sequencing of liberalization measures. Studies were carried out on the impact of specific measures on individual sub-sectors. This reassured industrialists that the Government was sensitive to their concerns and marshaled support for the program. 1/ Morocco: Industrial Policies and Export Promotion, World Bank Report 4893-MOR, January 1984 - 22 - 3.04 The liberalization strategy adopted was predicated on the graduated and simulataneous reduction of both non-tariff and tariff barriers, the flexible management of the exchange rate, and continued progress in stabilizing the economy. The notion of the "compensated" devaluation was considered vital to provide appropriate price incentives to exporters and to offset the economic and financial effects linked to trade liberalization measures. Quantitative restrictions were to be reduced on a yearly basis and eliminated by 1989. Protection afforded by the tariff structure was to be rationalized by the so-called concertina approach, consisting of progressive reductions in the maximum nominal tariff rate such that no tariff would exceed 251 by 1989. The special import tax (SIT), an across-the-board, uniform surtax, was to be abolished by 1986. The underlying rationale for targeting the relatively non-distortionary SIT was that its elimination would reduce effective protection equally across sectors. The putative advantage of this approach was the equitable distribution of burden-sharing, which enhanced its political acceptability. The budgetary impact of the program was meticulously analyzed and measures were proposed to offset the fiscal shortfall. The need to lower the overall budget deficit was recognized as an independent but complementary objective to liberalization!". The program was launched in 1984 in response to the March 1983 balance-of-payments crisis, which required that generalized quantitative import restrictions be applied to contain imports and defuse the foreign exchange crisis. As the subsequent analysis shows, much has been accomplished to date. 3.05 The determinant factor conditioning the success of the liberalization program, however, has been the sustained commitment of the Government to trade policy reform and the astute management of the bargaining process with industrialists. The six years which have elaspsed between the onset of the joint research project and the implementation of the liberalization program, although seemingly lengthy, were necessary to induce the requisite attitudinal changes throughout the economy. According to the results of an industrial survey of forty firms, carried out by a World Bank mission in December 1986a', all industrialists interviewed at the time were fully aware of the program's objectives. The commitment of the Government to eliminate quantitative restrictions by 1989 and reduce levels of protection to a maximum of 251 was frequently cited by firm managers in the course of the discussions. The annual liberalization program for 1987 had already been discussed with the relevant industries, which underscores the Government's intention to proceed with liberalization even in the absence of a specific Bank policy loanz-L. I. CbanRes in the Instunts of Tade Policy 3.06 The liberalization of the external trade regime is reflected by reforms of both import and export policies. A description of the different features characterizing the import and export regimes in Morocco is presented 1/ Morocco: Industrial Policies and Export Promotion, op.cit. 2/ A full description of the survey methodology, including criteria for sample selection, is given in Annex III. 3/ All loan conditions having been satisfied, the second tranche of ITPA II was released in November 1986. - 23 - in Annex IV. This section will therefore focus on documenting the major changes in trade policy that have occurred since 1983. 3.07 Import Policies. Progress achieved in dismantling quantitative restrictions can be observed in Table 3.1. Following the generalized control of imports in March 1983, products have been steadily transferred from lists B and C to list AL'. As of February 1986, list C was formally abolished with the result that list A accounted for 671 of all tariff positions and 86S of total import value. With the transfer of 332 products in the context of the 1987 General Import Program, List A now accounts for over 701 of all tariff positions. Table 3.1: CHANGES IN IMPORT REGIME 1983-1986 (percentages) Tariff Position"' Import Value 1983k' 1984 1985 1986 1983 1984 1985 1986 List A 49.9 52.5 58.5 66.7 38.5 84.7 86.7 86.3 List B 32.1 37.7 41.2 33.3 61.3 15.2 13.3 13.7 List C 18.0 9.8 0.4 - 0.2 0.1 - - 100 100 100 100 100 100 100 100 al Six digit CCCN tariff codes. b/ February of each year. Does not reflect the closure of the economy in March, 1983 where all goods in list A were temporarily shifted to list B. Source: SINTIA Customs Files and Ministere du Commerce et de Ilndustrie 3.08 Recourse to the system of floor prices has been effectively abolished for all industrial goods. The reference price, a more transparent albeit imperfect instrument, has been intermittently invoked as a safeguard measure against what is perceived as unfair trading practices by foreign producers. The use of reference prices has been limited primarily to ceramic tiles, end-of-series and second-hand clothing, and used auto-parts. In these instances, reference prices are reportedly being used to counteract dumping from abroad and are generally based on international price comparisons. Moroccan authorities justify the use of reference prices to counter unfair trade practices in that they are less visible and hence, less likely to invite retaliation from abroad. 3.09 Measures have been taken to compress the range of trade taxes and reduce dispersion in the tariff structure. Prior to the onset of liberalization, customs duties were subject to wide variations both between 1/ Goods on list A can be freely imported without prior authorization, those on list B require that a license be obtained, and imports of products on list C are prohibited except in special circumstances. - 24 - and within sectors with rates ranging from 0% to 400S. Similar products often received different rates of nominal protection. An analysis of the 1982 composition of imports by tariff levels indicates the extent of these distortions. For example, twelve out of 20 sectors had tariffs ranging from 01 to over 751. Once those items benefiting from tariff exemptions (i.e. temporary admission, investment codes, products taxed at a zero duty rate) are excluded, the mean unweighted tariff"' varied from 8.41 to 150% depending on the sector. This analysis does not take into account the effect of quantitative reatrictions which serves to increase the implicit nominal rate of protection for many goods. At end-1983, total duty and tax rates for 70% of all products averaged over 301. 3.10 In January 1984, the special import tax (SIT) was lowered from 151 to 101 and the maximum customs duty rate was reduced to 601 in July 1984 with a view to decreasing tariff redundancy, import smuggling, and the high costs of protection. Sectors affected by this measure included plastics (mean tariff 681), glassware (mean tariff 881), beverages (mean tariff 125X), and footwear (mean tariff 1422). Rationalization of the tariff structure progressed further with the SIT being reduced to 7.5X in January 1985 and the maximum customs duty falling to 451 in early 1986A'. This combination of measures brought the unweighted average cumulative rate of trade taxes to 35.9% down from 58.4% and the maximum protective rate to 62.3% down from 466.31 (Table 3.2). The dispersion of rates across the 8050 positions of the Moroccan tariff code was also significantly reduced. The standard deviation of customs duty rates decreased from 40.5 to 15.4. Table 3.2: TARIFF STATISTICS (percentages) Rate of Cumulative Customs Duty Trade Tax Rate A/ 1983: Minimum 0.0 0.0 400.0 466.3 Average 36.1 58.4 St. Deviation 40.5 46.0 Coeff. of Variation 112.2 78.9 1986: Minimum 0.0 0.0 maximum 45.0 62.3 Average 23.4 35.9 St. Deviation 15.4 17.7 Coeff. of Variation 65.8 49.3 a/ Including special import tax and stamp duty; excluding the value-added tax. Source: SINTIA Customs Files and Ministere du Commerce et de l'Industrie 1/ All references to mean tariffs in this section include only the customs duty rate. The SIT was reduced to 51 in January 1987. - 2.5 - 3.11 Export Policies. The active promotion and diversification of Moroccan exports have been key components in the liberalization program. Since 1983, several important reforms were introduced to eliminate barriers to exports, reduce existing disparities between exporting and import-substituting activities, and simplify administrative procedures in the area of external trade. Export licensing requirements, which proliferated during the early 1980s to secure supply for the domestic market, have been abolished on virtually all industrial, agricultural, and mining productsL'. The sole remaining levy on exports, the statistical tax which was applied at a rate of 0.5S, has been repealed. 3.12 The centerpiece of Morocco's export promotion policy has been the temporary admission scheme which functioned even during the financial crisis of 1983. This is clear evidence of the Government's continued commitment to the promotion of exports. The benefits of this regime have since been expanded and made more attractive in the context of the liberalization program. For example, both direct and indirect exporters (i.e. local suppliers to exporters) are now able to import all inputs duty-free, without having to obtain a license for those products on lists B or C. The only major exception was packaging materials where domestic suppliers were given priority. As a condition of the ITPA loans, these products were liberalixed and the "negative" list for industrial products abolished. 3.13 Other measures taken since 1983 to improve the temporary admission scheme include an allowance for wastage; on-site customs clearance for imported inputs and exported products; the introduction of global, annual guarantees to cover possible payment of duties on temporary admission imports in the case where goods are not re-exported; and the decentralization of the prior export scheme ("exportation pr6alable"). Under this procedure, when goods originally produced for the local market are exported, manufacturers may import duty-free those inputs which were not imported under the temporary admission regime (and hence required payment of import duties) but which were subsequently exported. Progress was also achieved in reducing the average processing time for customs clearance by 50X from 12 to 6 days. In order to improve the flow of information and eliminate institutional constraints pertaining to international trade transactions, the Moroccan Government established a Committee for the Simplification of Foreign Trade Procedures under the auspices of the Prime Minister. 3.14 Preferential financing arrangements for exporting activities have been broadened and made more attractive. Ceilings on pre-shipment export credits have been raised and the maturities of post-shipment financing have been extended. A medium-term credit facility to finance the export of capital goods has been established. The preferential terms on credit extended to exporters for working capital have been increased. Exporters receive rates of 91, compared to short-term rates of 14% on regular commercial credit. Only a fraction of the value of exports, however, is being financed on preferential 1/ Remaining exceptions include barytine, charcoal, hides, and leather. - 26 - terms. For the manufacturing sector as a whole, it has been estimated that the amount of loans outstanding as a proportion of exports is 6.62 and 11% respectively for pre-shipment and post-shipment credits. Therefore, a crude approximation of the interest rate rebate as a proportion of f.o.b. export value is 1S (i.e. 52 times 17.61), or more than twice the level which prevailed in 1983. 3.15 Significant fiscal and financial incentives granted to exporters are embodied in the Export Code, which extends and qualifies many of the advantages governed by the Industrial Investment Code (para. 5.14). Promulgated in 1973, the existing export code exempts profits of industrial and artisanal exporting activities from the corporate income tax (IBP) for ten years in the case of new firms and until 1983 for firms existing prior to 1973. Parliament has been renewing this incentive yearly for existing firms since 1983. The benefits of the temporary admission scheme, moreover, are formally grarled to exporters in the context of this code. 3.16 A revised export code has recently been submitted to Parliament. The main features of this code include an extension of benefits to exporters for fifteen years, followed by an additional ten years if profits are reinvested, and the establishment of parity of incentives between direct and indirect exporters. The scope of the code will also be broadened to include agricultural, fishing, and mining exports as well as the export of construction services and public works. Finally, the turnover threshold of trading companies for inclusion under the code has been reduced from DH 10 billion to DH 2 billion. 3.17 The export code exhibits several weaknesses which serve to exacerbate existing distortions in the economy. For example, certain fiscal incentives discriminate against labor in favor of capital. This encourages the adoption of relatively capital-intensive technologies in which Morocco may not enjoy a clear comparative advantage. The set of fiscal and financial incentives may invite retaliatory action by industrial countries in the form of countervailing and anti-dumping duties. In addition, these incentives might have potentially serious consequences from a macro-economic perspective (para. 2.27). In view of the remaining net anti-export bias in the structure of incentives (para. 3.29), and the increasing reluctance of policy makers to use the exchange rate,as an instrument of export promotion, continued reliance on fiscal and financial incentives, although to a lesser degree, appears justified. 3.18 Accession to the GATT. Morocco became an official contracting party to the GATT on June 1, 1987. In acceding to the GATT, Morocco reaffirms its commitment to the principles of free trade. The binding1' of 157 tariff lines consolidates the gains achieved thus far in liberalizing the trade regimes'. An examination of the relevant characteristics of these bindings 1/ In binding a tariff line, the contracting party is prohibited from raising the corresponding customs duty rate unless concessions are made to the relevant trading partner. 2/ The analysis of tariff bindings is .based on preliminary information provided by the Ministry of Commerce and Industry. Except for minor changes, the analysis presented does not deviate significantly from the agreements which enmpt se Moroceo's protocol with the GATT. - 27 - by BTN section4' shows that out of the 157 bound tariff rates, 99 (or 63X) were granted in four sections of the BTN (Table A.III.1). Of these, 42 were in electrical machinery and equipment (Section XVI), 21 in textiles (Section XI), 18 in chemical and allied products (Section VI), and 18 in paper and paperboard (Section X). 3.19 Tariff bindings are more meaningful when they apply to products not subject to quantitative controls. In these cases, the tariff is the sole instruments of protection and may not be increased without reducing protection elsewhere. The majority of the items bound in terms of both tariff lines and import value (62X) figures on list A, including certain sensitive products such as textiles (Section XI), machinery, mechanical appliances and electrical equipment (Section XVI), and chemical products (Section VI). The average rate at which these products are bound ranges from 28% to 37.5S, significantly below the maximum nominal rate of the present tariff structure. It is noteworthy that the tariffs of certain sensitive import-substitutes in list B have also been bound. Two sections - machinery, mechanical appliances, electrical equipment (Section XVI) and vehicles and transport equipment (Section XVII) - account for around 601 of the total value of tariff-bound imports in list B. With the anticipated elimination of quantitative restrictions, the potential for protection will be limited by the tariff bindings. Finally, the import value of tariff-bound items was US$1,160 million in 1985, or around one third of total imports. The extent of tte tariff bindings is significant and can be taken as evidence of Morocco's firm commitment to trade liberalization. 3.20 An analysis of tariff bindings by country reveals that tariff concessions were granted solely to industrialixed countries (Table A.III.2). This is not suprising given the relatively low participation rate of developing countries in past trade negotiations. For example, the US received the majority of tariff bindings both overall (531) and in virtually every section. The second country that benefited from Morocco's bindings oddly enough was Switzerland, where most were concentrated in textiles (Section XI) and machinery and mechanical appliances (Section XVI). 3.21 Morocco stands to gain from its accession to the GATT in several ways. First, agreements negotiated within the GATT will confer greater stability on Moroccan trade policy. This results from the fact that previously agreed import barriers cannot be increased without compensating trading partners if the latter's exports have been hurt. Second, Morocco can invoke international trade agreements as part of the GATT to resist political pressures from special interest groups for higher protectionA". Last, any further liberalization of the trade regime can be used by Moroccan policy makers to extract concessions in the form of increased access to other countries' markets. This feature takes on particular significance in view of the upcoming Uruguay round of multilateral trade negotiations. 1/ The available information on tariff bindings is presented at the BTN 4 digit level in Table A.III.1 In some cases, only a subset of the tariff lines at the BTN 4 digit-level was bound. This difference is not reflected, however, in the second column. 2/ This was a major factor in Mexico's decision to join the GATT. - 28 - C. The.hdofTadePoHlyRformomthe Struo of e-vs 3.22 A major objective of the liberalization program was to effect a generalized reduction in effective protection through the elimination of quantitative restrictions and the lowering of tariff rates. During the initial phase, the substitution of tariff barriers for quantitative controls in selected subsectors constituted a parallel aim. Finally, the program sought to convince entrepreneurs of the Government's comuitment to liberalization, as a prerequisite to inducing structural reform in industry. This section assesses the progress achieved in attaining these objectives. 3.23 Reductions in the coverage of quantitative restrictions by tariff item and import value have been sipificant (para. 3.07). A low share of imports under QRs, although indicative of protection, does not by itself indicate the openness of the trade regimeL'. A more accurate measure of the extent of deprotection which has taken place to date is the share of domestic production which remains subject to non-tariff barriers. Table 3.3 depicts the changes in the sectoral coverage of quantitative restrictions by tariff line and import value since 1983 as a function of domestic production. In addition, the average customs duty rate (unweighted) for the subset of tariff positions under QRs is shown. According to a more detailed sub-sectoral analysis (Table A.III.3), a growing proportion of local industry is being Iable 3-.: QUANTITATIVE RESTRICTIONS (1983-86) Subsectoral Coverage of B/C Lists Share of Sector Position a/ Average Customs Duty Share of Sector IUorts VI in 8/C Lists Unweighted in 5/C Lists Sector (ISIC) (X) (%) (X) 1932 19*4 1933 1931i 1951 1954 1983 1956 12931 19*4 1933 tam6 Agriculture 67.0 61.5 57.6 £1.7 16.0 21.8 27.7 24.5 82.8 14.0 12.8 10.4 (Net of Wieat) 59.S 44.2 31.8 19.0 1ining 90.0 73.4 73.4 13.7 6.9 17.2 12.5 12.9 99.4 0.3 0.3 0.1 (net of Oil) 56.1 36.4 43.8 5.6 Manufacturing 47.0 45.6 39.0 31.8 43.3 49.3 40.1 35.1 38.9 22.8 20.0 15.8 A/ 6-digit CCCN Codes of the Tariff. hv Iports for the domestic market only (regime MC) with the exclusion of imports under temorary aidmssiOn or investmnt code. Jicn: SINTIA Customs Files (tariff and NTBs) and Ministry of Industry. S951S P.14 1/ In certain cases, an increase in the value or share of imports not subject to licensing could reflect a more restrictive regime. In the extreme case where the import of all items are banned, save one, the share of freely importable goods in terms of value would be 100% in spite of a highly restrictive regime. Similarly, a significant share of tariff lines under QRs is equally ambiguous. A reduction in the number of restricted lines has no real significance in terms of liberalization and deprotection if these products are not produced locally or are not in demand. On the contrary, a small share can be highly binding and distortionary in the case where the few specific goods covered, reflect a high notional import demand or account for a significant share of local production. In the Moroccan context, the evolution of these two indicators is strongly correlated, providing some evidence, however tenuous, of a liberalizing trend. - 29 - subjected to increased competition from abroad. Nearly one-quarter of total industrial production has been completely liberalized, including paper products, printing and publishing, glass, and plastics. Restrictions on sectors such as mining, leather, ceramics, metal products, electrical appliances, and chemicals have been attenuated. Quantitative controls remain, however, on basic consumer goods. For example, imports of processed foods, beverages, textiles, clothing, footwear, and transport equipment (car and truck assembly) are still limited for both protection and balance-of-payments considerations. 3.24 In order to quantify variations on the extent of protection afforded by QRs, a production-weighted index was calculated on the basis of sub-sectoral data for the period 1983-1986. The results show that a significant portion of domestic production has been liberalized since 1983. Before the generalized application of quantitative controls for balance-of-payments reasons, the share of domestic manufacturing subject to QRs was 602 and 451 as a function of tariff line and import value respectively. These ratios fall to 401 and 152 in 1986. 3.25 Another indication of the degree of liberalization is the administrative flexibility in managing the licensing regime. It appears that the commitment of the authorities to easing restrictions on foreign trade is manifest at the implementation level, as shown in Table 3.4. The number of requests for import licenses received by the Ministry of Trade and Industry declined from around 54,000 in 1984 to 16,000 in 1986. At the same time, the proportion of license requests approved has steadily increased, reaching 84% In 1986. There has also been a significant decline in the time necessary to process license applications for certain products. For example, the number of processing days has dropped from six to three for pharmaceutical products, from 19 to 11 for chemical products, and from 20 to 11 for those items which come under the jurisdiction of the Department of Foreign Trade. For other types of goods, the number of processing days has remained relatively unchanged at an acceptably low level1/. 3.26 The extent of liberalization is also evident from an analysis of the structure of tariff protectionI'. The lowering of the maximum nominal tariff rate over the period 1983-86 attendant on the reduction of the SIT has 1/ One possible interpretation of these results is that they reflect a wide discrepancy between actual and notional demand. This occurs when would-be importers do not even bother to submit a request for an import license given the high rate of refusal in the past. The self-censoring process which takes place leads, in turn, to a downward bias in the number of requests actually received, and thus an upward bias in the proportion of requests granted. This interpretation was not confirmed, however, by the results of the industrial survey in which importers emphasized the increasing flexibility of the authorities in their application of administrative procedures. In any event, a decline in notional demand would be expected from the elimination of binding QRs. 21 This analysis excludes all products benefiting from a special regime. - 30 - Table 3.4: ADMINISTRATION OF THE LICENSING REGIME Number of Import Proportion Year Licences Accevted 1984 53,796 741 1985 30,221 82X 19861' 15,951 842 a/ Includes information until December 12, 1986. Source: Minist&re du Commerce et de l'Industrie led to a decline in the import-weighted mean tariff to 17.51 compared to an unweighted value of 35.9% (Table 3.5). This result obtains from the high share of imports (approximately 502) which enter at a zero tariff rate, notably petroleum and wheat, and the fact that no trade was recorded in approximately 3200 out of 8050 tariff positions. In addition, most items which are taxed at the upper range of the tariff schedule are also subject to quantitative restrictions. If the latter are binding, a reasonable assumption, this would introduce a downward bias in the calculation of the trade-weighted mean tariff. The same statistic based on estimates of notional Table 3.5: AVERAGE TRADE TAX RATES BY SECTOR (1983-86) Import Weighted1' Unweightedk/ Sector (X) (S) 1983 1984 1985 1986 1983 1984 1985 1986 Agriculture 4.9 2.7 3.4 3.6 57.4 49.4 37.0 32.6 (Net of Wheat) 14.5 11.6 11.8 8.2 Mining 17.4 4.2 9.1 9.2 35.2 26.2 20.9 19.9 (Net of Oil) 21.1 16.4 12.1 11.7 Manufacturing 30.6 25.0 22.6 21.6 58.9 49.3 40.2 36.5 Overall 23.6 15.3 16.1 17.5 58.4 48.9 39.6 35.9 (Net of Wheat & Oil) 29.4 24.1 21.9 20.7 -a/ Customs Duty rates are weighted at the 6-digit CCCN level with imports in MC regime (domestic market use). b/ Customs Duty rates are simnly averaged according to the number of occurrences in the Tariff Cede for that sector. Sources: SINTIA Custom Tariff Files, Office des Changes and Ministry of Industry - 31 - demand would be presumably higher4L. Excluding wheat and crude oil, one tenth of imports are tariff exempt while over half fall within a reasonable tariff bracket of 52 to 252 (Table A.III.4). 3.27 In order to estimate variations in the amount of tariff protection granted to Moroccan industry during the period 1983-1986, a production-weighted tariff index was derived. The reduction in the mean tariff was substantial, declining from 66.4X in 1983 to 38.7% in 1986 Much of this decline can be attributed to the reduction in the maximum nominal tariff since 1983 which has lowered protection in sub-sectors such as beverages, wearing apparel, footwear, paper products, plastics, and some metal products, accounting in toto for some 202 of domestic manufacturing production. These items were formerly subject to prohibitive tariff rates, as was the case with most consumption goods. The production-weighted mean tariff on items subject to quantitative controls also decreased from 79.1% to 49.92 over the period in question. These results reflect the trade liberalization strategy adopted by Moroccan policy makers, which consisted of a parallel reduction in tariff and non-tariff barriers to trade. 3.28 Although changes in effective protection have not been explicitly calculated, the concertina approach (para. 3.04) to tariff reductions enables some preliminary conclusions to be drawn. Effective protection has fallen by at least 112 across-the-board on products which are not subject to licensing1&', by virtue of the decline in the SIT rate and its incidence on the stamp duty. The compression of the tariff structure from above (Figure A.III.1) has dramatically limited the potential for effective protection. In 1983, effective protection could have ranged from negative to over 1500X$/. In 1986, the range of effective protection would have been narrowed to 1802 under the same conditions. 3.29 The trade policy reforms introduced since 1983 have led to a substantial reduction in the anti-export bias inherent in the structure of incentives. Prior to liberalization, the financial profitability of producing for the domestic market was found to be over 502 greater than exporting. The reduction in the SIT attendant on the abolition of the statistical export tax has narrowed the profitability differential between local and foreign sales by over 202. An active exchange rate policy has served to further attenuate the existing bias against exports (para. 2.04), particularly given the depressed state of domestic demand during the past few years. 1/ This conclusion is supported to some extent by an unweighted analysis of the tariff structure as a function of import regime. Although tariffs ranged in 1986 from zero to 60.7% for both list A (freely importable) and list B (subject to licensing), the unweighted mean tariff for the former is 29.8% as opposed to 47.92 for the latter. The standard deviation of the tariff structure for lists A and B is 13.1 and 14.7 respectively. 2/ This corresponds to 602 or 852 of domestic production, depending on whether tariff line or import value is used as a weight. ]/ This result obtains in the not improbable case where tariffs on inputs and output are at the extremes of the range and value-added at international prices represents 252 of the price of the final good. - 32 - 3.30 In addition to the parallel reductions in tariff and non-tariff barriers to trade, there has been the substitution of price restrictions for quantitative ones. In some subsectors, QRs were removed while customs duties were simultaneously increased in order to mitigate the shock of deprotection. Tariffs on these industries were to be subsequently reduced in accordance with the agreed schedule. In the pulp and paper industry, for example, pulp and several grades of paper were transferred from list B to list A, while corresponding custom duties were raised by 10-202. Similarly, in the plastic industry, the transfer of all products in Chapter 39 of the nomenclature from list B to list A was accompanied by setting the custom duty rate at the maximum level of 45S. In other subsectors, such as the ceramic tiles industry, quantitative and tariff restrictions were both reduced and a dirham-denominated floor price was introduced to counteract what was perceived to be unfair trade practices for these products. The floor price has not been adjusted since its establishment in 1984 and has therefore lost its effectiveness as a protective device, as a result of world inflation and the depreciation of the dirham. These examples illustrate that the liberalization program induced a major shift from non-tariff to tariff restrictions as well as a decline in the rate of effective protection for most subsectors since 1983. 3.31 Although considerable progress has been achieved in reducing both the level and dispersion of effective protection, the present system of protection exhibits certain characteristics which indicate the need for further reform. Final goods, for example, are more highly protected by both tariff and non-tariff barriers than are inputs, resulting in a cascading structure which reinforces rates of effective protection. An analysis of QR coverage by end-use shows that it is heavily weighted towards final goods, with intermediate inputs for the most part being freely importable (Table 3.6). Table 3.6: COVERAGE OF QUANTITATIVE RESTRICTIONS BY END-USE (percentages) Tariff Position Import Value 1983 1984 1985 1986 1983 1984 1985 1986 Consumer Goods 80.0 79.2 74.6 67.5 25.0 15.3 13.1 15.8 Intermediate Goods 33.0 28.5 19.1 9.5 46.0 25.8 17.7 14.5 Capital Goods 30.0 27.3 21.5 17.5 46.0 22.8 27.7 16.9 3.32 Over two thirds of all tariff positions corresponding to consumer goods were still subject to quantitative restrictions in 1986 and accounted for only 162 of total import value. Conversely, 66% of all items on list B are consumer goods. Remaining restrictions on intermediate and capital imports are relatively narrower in scope and apply equally to each category of goods. 3.33 The existing tariff structure also reflects this cascading effect. An analysis of tariffs by product use shows intermediates, capital goods, and consumer items to have mean tariffs of 27.9S, 31.71, and 50.11, respectively, - 33 - on an unweighted basis in 1986 and 20.41, 21.22, and 26.51 when weighted by Import value (Table 3.7). The sharp decline in the average tariff for consumer goods since 1983 reflects the reduction in the maximum nominal rate, applied for the most part to finished products. Table 3.7: AVERAGE TRADE TAXES BY END-USE (1983-86)&' Import Weightedk' Unweighted1' (%) (2) 1983 1984 1985 1986 1983 1984 1985 1986 Manufacturing Consumer Goods 33.8 30.1 27.7 26.5 94.5 70.2 59.5 50.1 Intermediate Goods 30.2 23.0 20.1 20.4 37.8 31.7 28.1 27.9 Capital Goods 29.7 24.9 23.4 21.2 44.4 38.2 33.2 31.7 Total Manufacturing 30.6 25.0 22.6 21.7 58.9 49.3 40.2 36.5 a/ Includes the Customs Duty, Special Import Tax, and Stamp Duty. Excludes the direct incidence of the VAT. b/ Customs Duty rates are weighted at the 6-digit CCCN level with imports in NC regime (domestic market use). c/ Customs Duty rates are averaged according to the number of occurrences in the Tariff Code for each type of product. 3.34 The cascading of tariffs and quantitative restrictions thus appears to be mutually reinforcing and can exacerbate the dispersion of effective protection across sectors. Disparities have also been found across sectors (Table 3.5), with mining having the lowest mean tariff (19.92) in 1986, followed by agriculture (32.6X) and manufacturing (36.5%). When weighted by Import value, all means are significantly reduced and the rank order is modified somewhat once wheat and oil are excluded. Agriculture exhibits the lowest trade-weighted mean tariff (3.61), followed by mining (9.21) and manufacturing (21.61). Within manufacturing, basic metals are characterized by the lowest mean trade-weighted tariff (11.91) after tobacco which enters duty free (Tables A.III.5 and A.III.6). 3.35 An international comparison of Morocco's 1986 cumulated trade taxes with those of immediate competitors (Turkey, Egypt, Hungary, Yugoslavia) and comparable economies (Philippines) reveals the need for further rationalixation of the tariff structure (Table 3.8). The reforms implemented thus far have focused on the level of tariff rates. The Moroccan tariff nomenclature, however, remains unduly detailed, reflecting historical attempts to "fine-tune" protection on a tailor-made, firm-specific basis. The cascading of rates and the potential for relatively high levels of effective protection ultimately result from the complexity of the tariff nomenclature. - 34 - Table 3.8s CROSS-COUNTRY COMPARISON OF TARIFFM STRUCTURES^' Moroccok Turkey Egypt1' Hungary Yugoslavia Mexico Philippinea Minimum 0 0 0 0 7 0 0 Maximum 62.3 200 110 180 32 45 60 Mean 35.9 36 30.3 15.1 11.5 22.2 27.9 Std. Deviation 17.7 31 30.7 13.7 5.6 14.2 15.1 No. of Codes 8050 8016 1799 3167 5997 8255 2291 a/ 1986 or most recent year bi Excludes VAT e/ Excludes 21 items with tariffs ranging from 160 to 3000 percent, as well as customs consumption tax. 3.36 Taking the number of tariff codes as an indicator of the flexibility and firm specificity of protection1', Morocco is second only to Mexico, which has an even more complex structure. This is particularly the case for such consumer goods as food, beverages, tobacco, and textiles. In comparison, the Philippines, Egypt, and Hungary manage a comparable or even more complex foreign trade structure with one-third the number of codes. Despite the decrease in the SITs Morocco has the highest mean taxation of the selected countries along with Turkey. Agriculture, mining, paper, printing, petroleum and chemicals are the most extreme examples (Table A.III.7). The variance of taxation is also relatively high, calling for further adjustment. 3.37 The results of the industrial survey indicate that further trade policy reforms are in the offing. The reaction of industrialists to the liberalization program, for example, has generally been positive. More than 801 of the firms interviewed stated that they fully agree with the basic principles of liberalization and free trade, while about 602 of the firms also approve of the specific policy reforms implemented in Morocco to date. On the other hand, 151 of the enterprises believed that liberalixation was completely inappropriate for the country at this particular juncture on the grounds that Moroccan industry is still at an early stage of development and cannot compete on an international scale. About 40% of the enterprises noted that the speed of implementation of the program has been too rapid to allow a smooth adjustment to the new policy environment. 3.38 Despite some variation in their level of certainty, virtually all enterprises who responded to the questionnaire viewed the liberalization program as permanent. After observing the strong commitment of the Government during the first two years of the program, none of the enterprises anticipated I/ If a firm needs protection, the Customs administration is often asked to create new codes in the nomenclature in order to differentiate taxation according to the firm's needs. - 35 - a reversal of this policy. They remain convinced, moreover, that further reductions in protection will be implemented as scheduled. Although the rate of deprotection is perceived by approximately 80Z of the firms as unacceptably high, the majority of these firms stated that if introduced more gradually with sufficient time allowed for adjustment between each phase, liberalisation should be pursued. - 36 - IV. THE IMPACT OF LIBERALIZATION ON EXTERNAL TRADE PERFORMANCE 4.01 The adjustment program launched by Morocco in late 1983 was expected to increase the share of foreign trade in overall economic activity. In contrast to traditional stabilization policies, external balance was to be achieved in part by an increase in the value of exports as opposed to a compression of imports. The level of foreign trade was thus expected to rise under a more liberal structure of incentives, as buoyant export growth would sustain a relatively higher level of imports. The estimates in Table 4.1 are presented by way of introduction to the analysis of Morocco's trade performance. Notwithstanding a downward bias in the trend of export values which results from Moroccan accounting conventions in reporting trade statistical', the figures show that the importance of trade flows has increased significantly after 1983. Table 4.1: INDEX OF OPENNESS, 1981-87 ' (percentage of GDP) Year Exports Imports Total Trade 1981 15.4 29.3 44.6 1982 13.7 28.8 42.5 1983 15.7 27.0 42.7 1984 18.2 32.8 51.0 1985 18.1 32.3 50.5 1986 24.4 31.7 56.1 1987X" 24.3 28.9 53.2 a/ Exports are expressed as f.o.b. values and imports c.i.f. b/ Provisional Source: Bank of Morocco and Mission estimates. 4.02 This chapter provides a detailed analysis of the effects of the policy reforms recently introduced on the evolution of Moroccan trade. In addition, trade performance will also be linked to exchange rate movements and indicators of comparative advantage. The chapter begins by an analysis of recent Moroccan trade performance at a disaggregate level, focusing on the growth and changing structure of Moroccan exports and imports respectively. In addition, the structure of imports by economic regime (i.e. temporary admission, investment codes, general regime) will also be evaluated. The 1/ Subcontracting arrangements, whereby firms process imported intermediate inputs and re-export the final product, are recorded under services. As discussed later (para. 5.08), exports of these services have increased dramatically since 1980. - 37 - chapter concludes with an assessment of the changes in the direction of trade. The effect of other countries' trade policies on Morocco's trade performance will also be reviewed. A. Ezvort Performree Underiberalizion 4.03 Expwrt Diversification. The trade policy reforms initiated in 1983 have served to expand the relatively limited base of manufactured exports and reduce reliance on traditional, natural-resource based (NRB)L" activities as a primary source of foreign exchange earnings. This structural transformation stood the economy in better stead to absorb the sharp decline in external phosphate demand which occurred in 1985-86. Traditional NRB exports reached their peak in dollar terms in 1980 when they represented 53.12 of total exports; however, they have since declined by around 101, accounting for only 39.41 of exports in 1987 (Table A.IV.1). This can be explained primarily by the fall in the nominal export value of phosphates and derivatives from US$1,006 million it. 1980 to an estimated US$945 million in 1987 (Table 4.2). Overall, the decline in the value of phosphate rock exports has been partially compensated by an increase in phosphoric acid and fertilizer exports. Among the remaining traditional exports, salted and shellfish have exhibited particularly dynamic growth, with export value rising from US$15 million in 1980 to US$211 million in 1986. Fresh fish exports, moreover, have recently surpassed the exported value of citrus fruit, which has traditionally been the most important agricultural export (Table A.IV.1). Table 4.2: MERCHANDISE EXPORTS (FOB) (Millions of Current Dollars) 1978 1980 1982 1983 1984 1985 1986 1987 Agriculture 534 762 546 576 538 603 792 842 Energy 21 119 88 82 86 84 62 74 Minerals 588 943 683 592 626 565 486 462 Phosphate Rock 488 765 572 497 524 479 412 385 Manufactures 360 627 748 848 919 908 1088 1401 Semi-Finished a/ 150 344 442 531 582 525 546 695 Finished 210 283 306 317 336 383 542 706 Total Exports (Customs Basis) 1503 2450 2065 2099 2169 2160 2428 2779 a/ Includes phosphoric acid and phosphate-based fertilizers. Memorandum: Phosphates and Derivatives 585 1006 913 925 1010 909 839 945 Non-traditional Manufactures 387 380 407 419 434 478 654 841 1/ Phosphate rock, phosphoric acid, phosphate-based fertilizers, and citrus. - 38 - 4.04 While not completely inelastic to changes in the trade regime, traditional export flows are determined chiefly by exogenous factors like weather (for agricultural goods) and world market conditons (for phosphates). This has been especially true during the past few years. The impact of trade policy is most likely to be felt on manufacturing exports. As the following analysis shows, trade policy reform, together with the evolution of the international economy, was a major determinant of Morocco's export performance in the manufacturing sector. 4.05 The evolution of manufacturing exports for Morocco is shown in Table 4.3, together with a measure of the real exchange rate for exports and the level of manufacturing imports in OECD countries as an indicator of world demand. Despite the depressed level of international markets, manufacturing exports fared relatively well in 1981 and 1982, prcbably as a result of the lagged effects of a depreciating real exchange rate-'. The 1983 balance of payments crisis left Morocco poorly positioned to take advantage of the International recovery, because the need to indiscriminately reduce import flows took its toll on 1984 export performance as well. The growth of overall manufacturing exports in 1985-86 was dampened by declining world demand for phosphate derivatives; however, induced both by a depreciating exchange rate and the international recovery, exports of finished manufactures rose by over 11 p.a. on average during the period 1983-86, compared to an annual average of about 2X in 1980-83. This trend continued in 1987 with exports of finished manufactures growing by over 201 in real terms. Table 4.3: DETERMINANTS OF MANUFACTURED EXPORT PERFORMANCE 1980 1981 1982 1983 1984 1985 1986 Exports of Manufactures Total (Millions of 1980 dollars) &' I' 627.2 766.2 983.4 1158.6 1221.6 1256.4 1398.2 Finished Manufactures '' 283.2 287.8 308.9 327.9 354.9 399.6 477.6 Real Exchange Rate for Exports ' 100.0 98.4 99.3 95.1 90.4 87.5 85.3 0ED Manufacturing Imports (Billions of 1980 dollars) 726.6 684.8 679.6 715.3 827.0 889.2 964.8 a/ Until 1983, deflated with the manufacturing unit index for Morocco. For 1984-86 deflated with global MUV. b/ Including phosphoric acid and phosphate-based fertilizers. c/ Excluding phophate derivatives and other semi-finished products. d/ Based on export-weighted average of manufacturing wholesale prices; a decline in the index indicates a depreciation, or alternatively, an increase in the competitiveness of Moroccan exports. 1/ The real exchange rate for exports depreciated by approximately 51 between 1978-80. - 39 - 4.06 Performance has varied considerably, however, across individual industries (Table A.IV.2). Whereas the value of ?rocessed food exports has declined between 1980 and 1985, chemical products- , rubber and plastics, electrical machinery, and clothing, for example, have exhibited particularly robust growth in both current and constant terms in recent years. An analysis of 1986 estimates reveals that, in addition to clothing, other relatively important sub-sectors which have registered strong export performance in value terms include textiles, leather and footwear, paper products, mechanical equipment, and electrical and electronic products. 4.07 The considerable growth of manufactured exports since 1983 has compensated the decline in important traditional exports. Exports of phosphates and derivatives have remained nearly constant in value since 1983, owing to a stagnation in volume and a decline in price. In contrast, non-phosphate based manufactured exports grew by nearly 651 in volume and 351 in price since 1983, leading, in turn, to a reduced dependency on natural resources and natural-based manufactures. At present, non-traditional manufactures (i.e. excluding phosphate derivatives) account for over 301 of total exports, compared to approximately 201 in 1983. The share of phosphates and derivatives has fallen from 452 to 341 over the same period. These findings underscore the extent of export diversification which has occurred since 1983* the relatively limited base of non-traditional manufactures notwithstanding. 4.08 Exchange Rate Policy and Export Response. The strong performance of price-elastic exportables may be explained, in part, by the active exchange rate policy which has been pursued since 1983. To test this hypothesis and provide a basis for quantitatively assessing the impact of further liberalization on trade, export demand decisions for the manufacturing sector were examined in the context of an econometric model-'. The results of this simulation indicate that trade policy significantly affects export demand of manufactures: the 101 improvement in the price competitiveness of Moroccan goods induced by devaluation during the period 1983-86 led to an increase in real exports of manufactures by 81 in the short-run and 162 in the steady state. 4.09 Market Penetration of Moroccan Exports. Exchange rate movement is not the sole determinant of export response; international demand can also play a prominent role. To differentiate the effects of the real exchange rate from the fluctuations in international demand, Morocco's ability to gain market shares abroad was examined. During the 1970's, Morocco's share in EEC manufacturing imports steadily decreased: the only exceptions were clothing and footwear. Table 4.4 shows the evolution of Moroccan exports as a percentage of EEC imports since 1980 for agriculture, total manufacturing, and clothing and footwear. The general tendency is for Morocco's share of manufacturing exports to iLacrease until 1982, remain constant or even in decline in 1983-84, and rise thereafter. This is the case not only for total manufactures, which is heavily influenced by the performance of phosphate derivatives, but also for exports of clothing and footwear. 1/ Primarily phosphoric acid and fertilizers which can be classified as a NRB manufactured good. In 1986, the dirham value of phosphoric acid exports continued its decline with the drop in international prices. The methodology and model specification underlying this analysis are described in Annex V. - 40 - 4.10 One factor conditioning Morocco's export performance is the differential rates of economic recovery among the industrialized countries over this period. In its initial years, the recovery was led by the United States, which has never constituted a significant market for Moroccan exports. In contrast, traditional outlets for Moroccan products in Europe had not as yet joined fully in the global recovery during the period 1983-84. As such, the recovery-induced increase in international demand did not significantly affect Moroccan manufactures until 1985. As can be observed from Table 4.4, variations in market share over time exhibited a similar pattern across both product type and country groupings. Morocco generally incurred a loss in market share of manufacturing exports in 1984, followed by substantial gains in France, Germany, and the EEC as a whole. Table 4.4: SEARE OF MOROCCAN EXPORTS IN IMPORTS OF MAJOR TRADING PARTNERS (in percentages) 1980 1981 1982 1983 1984 1985 1986 EEC Agriculture 2., 2.3 2.1 2.1 1.8 2.1 2.3 Manufactures 1.2 1.1 1.5 1.5 1.5 1.7 1.9 Clothing & Footwear 1.7 1.6 2.3 2.3 2.6 3.2 3.4 France Agriculture 8.2 7.6 6.9 6.8 6.3 7.6 7.1 Manufactures 4.2 4.2 5.9 6.2 6.2 7.2 7.5 Clothing & Footwear 10.8 10.0 13.2 14.4 14.9 15.7 16.1 Germany Agriculture 2.0 1.5 1.4 1.3 1.0 1.2 1.2 Manufactures 1.0 1.0 1.1 1.1 1.0 1.1 1.4 Clothing & Footwear 0.5 0.6 0.9 1.0 1.1 1.3 1.5 OECD Agriculture 1.6 1.4 1.4 1.3 1.2 1.4 1.4 Manufactures 0.5 0.4 0.5 0.5 0.4 0.5 0.6 Clothing & Footwear 0.7 0.6 0.9 0.8 0.8 0.9 1.1 Source: United Nations Trade System 4.11 The competitiveness of Moroccan goods with respect to other developing countries constitutes a second factor which may have influenced Morocco's penetration into foreign markets. It is generally acknowledged that Moroccan exports compete mostly against other LDCs for industrial country markets; this relation is captured only to a limited extent, however, in the 41 - standard measure of the real exchange rate1/. As a result, bilateral real exchange rates between Morocco and its presumed competitors within the developing world were calculated. Table 4.5 presents bilateral rates for Tunisia, Turkey, and Greece, all of which actively compete with Morocco for its traditional market outlets. The dirham depreciated significantly against the currencies of all three competitors in 1983. Noting that exports only react with a lag to exchange rate variations, the depreciation in '983 may partially explain the subsequent gain in market shares as a result of improved competitiveness. It is probable that the degree of substitution between Moroccan exports and those of other LDCs is significantly greater than between Moroccan goods and those of industrial countries. In this light, the deteriorating or unchanged competitive advantage of Morocco relative to other close competitors since 1983 could well restrain the future growth of Morocco's market share in developed countries. Table 4.5: BILATERAL REAL EXCHANGE RATES £L OF MOROCCO'S COMPETITORS (1980 100) TUNISIA TURKEY GREECE 1980 100.0 100.0 100.0 1981 104.7 103.6 94.0 1982 101.9 110.2 94.5 1983 94.2 106.6 92.1 1984 100.6 105.8 .94.8 1985 89.0 106.4 98.4 1986 96.2 127.3 97.6 a/ An increase indicates an appreciation of the Moroccan dirham. B. Import Petformance underIwberi2ation 4.12 Global Import Trends. The cyclical variations of major macro-economic aggregates attendant on the introduction of trade policy reforms have significantly influenced import flows. In 1982, the appreciation of the real exchange rate for imports (Table 4.6), together with the relaxation of import controls and a buoyant economy, led to a significant increase in import demand. Sweeping quantitative controls precipitated by the external payments crisis (para. 1.03), the depreciation of the real exchange rate, and the slowdown of domestic economic activity all served to restrain import growth in 1983. Since then, import demand has been conditioned by a combination of stronger economic growth, further real depreciation of the exchange rate, and the implementation of trade liberalization measures. I/ The usual measures relate the competitiveness of Moroccan exports to that of the importing countries' goods. Even when third country effects are allowed for, the relative importance of other developing countries is minimal, insofar as industrial countries trade mainly among themselves. Only if real exchange rates were defined at a sufficiently disaggregated level would they be able to capture inter-LDC competitiveness. - 42 - Table 4.6: REAL EXCRANGE RATE FOR IMPORTS A (1980 - 100) 1981 1982 1983 1984 1985 1986 100.3 102.7 98.1 92.3 88.2 84.2 a/ A decline in the index indicates a depreciation or, alternatively, an increase in the relative price of imports. 4.13 The value and structure of imports since 1978 are displayed in Table 4.7. As can be observed, imports in current dollars have declined from US$4.3 billion in 1982 to US$4.2 billion in 1987, or by approximately 32. In constant values, imports have grown on average by less than 1X. Global import performance has been recently conditioned by the decline in international oil prices and the strong domestic harvest. As a result, the share of food and petroleum in total imports fell from about 42% in 1984-85 to 291 in 1986-87. After some initial restocking following the generalised import controls imposed in 1983, most import categories have registered modest growth. One notable exception is the import of consumer goods, which has nearly doubled since 1984. Table 4.7: VALUE AND STRUCTURE OF IMPORTS (Millions of Current US Dollars) 1978 1980 1982 1983 1984 1985 1986 1987 Food, Beverages, Tobacco 481 720 580 534 660 507 476 499 Fuel 428 1006 1173 988 1021 1074 596 719 Raw Materials & Intermediates 992 1400 1307 1144 1252 1339 1442 1611 Machinery & Equipment 813 805 953 683 733 649 906 885 Consumer Goods 304 334 301 249 237 274 381 467 Total Imports (customs basis) 3017 4266 4315 3599 3904 3844 3801 4181 Sources: Banque du Maroc 1985 Report; 1986 data provioed by the Office des Changes; Table A.IV.3. - 43 - 4.14 Policy Change and Import Behavior. From the analysis of global import performance, it would appear that the combined impact of contractionary macro policies and the active management of the exchange rate has served to contain import growth. In order to evaluate the respective effects of macroeconomic and trade policies, an analysis of import demand by end-use waa carried out (Tables 4.8-4.10). Consumption and investment expenditures were found to be significantly correlated with their corresponding import flows, while demand for intermediate imports was to a large extent a function of industrial production. These relationships are obscured, however, by changes in trade policies and/or relative prices. The third and fourth columns of Tables 4.8-4.10 track respectively the restrictiveness of the trade regime, proxied by the share of imports subject to licensing, and the variation in relative prices for each import category over time. The relative price variable allows for the effect of variations in the special import tax (para. 3.04). Table 4.8: DETERMINANTS OF CONSUMPTION GOOD IMPORTS Real Domestic QR Coverage Relative Imports Private Ratio Pricesa' (1980=100) Consumption (1980=100) (1980=100) 1980 100 100 .61 100 1982 118 106 .60 112 1983 93 111 .77 94 1984 92 113 .60 90 1985 105 118 .55 88 a/ Import-adjusted GDP deflator divided by unit value of consumption goods imports. Table 4.*9: DETERMINANTS OF INVESTMENT GOODS IMPORTS Real Domestic QR Coverage Relative Imports Fixed Ratio Pricesx/ (1980.100) Investment (1980-100) (1980-100) 1980 100 100 .63 100 1982 145 114 .24 102 1983 90 103 .68 72 1984 97 103 .25 65 1985 85 102 .21 60 al Import-adjusted GDP deflator divided by unit value of capital imports. - 44 - Table 4.10: DETERMINANTS OF INTERMEDIATE IMPORTS Real Industrial QR Coverage Relative Imports Production Ratio PricesA' (1980-100) (19804100) (1980'100) 1980 100 100 .32 100 1982 109 103 .29 105 1983 107 107 .39 114 1984 113 107 .27 108 1985 113 108 .13 104 a/ Price of manufacturing value-added divided by unit value of semi-finished imports. 4.15 The behavior of all three import categories and their determinants were fairly synchronous in 1982. An increase of both consumption and industrial production together with a surge in investment expenditure coincided with a generalized real appreciation of the exchange rate and an easing of QRs. This stimulated import demand in all three cases. In 1983, industrial production and the real exchange rate for intermediate products continued to increase. The expansionary effect on intermediate import demand, however, was offset by tighter quantitative controls. For investment and consumption goods, the depreciation of the real exchange rate combined with the tightening of QRs to reduce import demand. The effect on capital goods imports was compounded, moreover, by a major decline in investment expenditure. From 1983 to 1985, activity levels for intermediate and investment goods remained more or less unchanged and the depreciation of the real exchange rate served to compensate for the partial lifting of quantitative restrictions. During this period, the import of consumption goods was fueled by rising consumption demand and liberalization of non-tariff barriers to trade, a modest devaluation notwithstanding. 4.16 Econometric methods were used to estimate the effect of trade and exchange rate policies on import flows by product type-V. Results indicate that import flows are highly responsive to changes in both trade restrictions and relative prices. For example, a 101 real devaluation led to a reduction in consumption good imports by an equal amount. Even investment goods and intermediate imports, for which substitution possibilities would appear to be limited, were sensitive to movements in the real exchange rate, decreasing by 7.41 and 3.0% respectively in the long run. 4.17 The results of this analysis provide a framework in which to interpret import estimates for 1986. Imports of machinery and equipment, for example, rose sharply. In particular, airplanes, ships, and agricultural machinery registered the strongest growth, with airplanes accounting for 61l of the overall import growth of capital goods. It is unlikely in this instance that movement on the exchange rate would have curbed import demand, insofar as the majority of these items reflected public investment priorities either directly (e.g. self-sufficiency in agriculture) or indirectly in the 1/ Annex V presents the results of the estimation of a set of import demand functions for a rationed consumer/producer where quantity restrictions cover only a subset of a given commodity category. - 45 - form of public enterprise purchases (e.g. Royal Air Maroc, the national airline). In contrast, failure to adjust the exchange ratel' to offset the reduction in tariff levels and quantitative controls, led to a consequent rise in aggregate consumer imports in 1986. From this analysis, it can be concluded that private import decisions are clearly responsive to changes in trade and exchange rate policies. 4.18 Import Performance by Economic Resime. The temporary admission scheme constitutes a major export incentive in Morocco. An analysis of temporary admission imports provides a basis for detecting changes in the relative importance of this regime (Table A.IV.4). First, temporary admission (TA) imports have grown quite rapidly. Between 1983 and 1985, for example, products imported under the TA regime rose by more than 1001 in current dirhams, while total imports increased by only 51S. Efforts to improve the functioning of the TA regime have thus been successful, as witnessed by the increase in the ratio of TA to total imports from 9.12 in 1983 to 14.2% in 1986. 4.19 The composition of imports by economic regime was analysed at a disaggregated level. In general, food, beverages and tobacco, and fuel account for a limited share of TA imports (less than 21), whereas raw materials and intermediate goods account for the largest share. The major raw materials imported under the temporary admission scheme include edible oils, lumber, paper pulp, cotton, sulphur and synthetic fibers, accounting in toto for nearly three-quarters of TA imports. Chemicals, plastics, paper and cardboard, synthetic yarns, metal rods, and hides and skins are the semi-finished products which have experienced considerable growth under the TA regime, doubling in value since 1983. There has been a dramatic rise in the import value of intermediates, as well as certain categories of consumer goodst'. Most of these imports are used as inputs in the production of labor-intensive items and, as such, parallel the rapid expansion of non-traditional exports. C. Dfrotion of Trade 4.20 The Structure of Morocco's External Markets. An analysis of the structure of total and manufacturing exports by destination (Table A.IV.5) reveals that France has remained the most important market for Morocco's exports during the past ten years, accounting for approximately 25% of total export value. Although the relative importance of the European Economic Community (EEC) has not changed significantly between 1983 and 1986, importing over 501 of total Moroccan exports, the share of other developing countries in the export of Moroccan manufactures has risen during this period. The market share of the EEC in Moroccan manufacturing exports, for example, declined from 521 in 1982 to 431 in 1985 while the relative shares of the most important 1/ The real effective exchange rate remained virtually constant from December 1985 to December 1986. 2/ These include natural-fiber and synthetic fabrics which, although classified in the Moroccan nomenclature as final consumption goods, are actually intermediates. - 46 - developing country markets (i.e. India, Libya, Turkey, Indonesia) rose from 26% to 36% over the same period. These results demonstrate that some degree of market diversification with respect to exports has occurred since the liberalization program was launched in 1983. Finally, it is important to note the small and stagnant share of the United States (less than 2X). The openness and size of the United States provide Morocco with an excellent opportunity to diversify markets, particularly in view of the significant increase in US imports during the 1980s. This is an important issue, where increased marketing efforts could yield high returns, given the increasingly binding constraints on Moroccan exports in the EEC (paras. 4.27-4.29). 4.21 The structure of Moroccan imports by origin was also examined (Table A.IV.6). Again, the relative importance of France is evident, supplying on average over 20% of Moroccan imports. In view of their role as principal suppliers of oil and wheat, Saudi Arabia and the United States accounted for an average of 13.52 and 9.4% respectively of total Moroccan imports. In general, the structure of imports by origin has remained relatively stable, however, indicating at this level of aggregation that trade liberalization policies have had little impact on sources of import supply,. 4.22 Effects of Foreign Trade Practices on Moroccan Market Access. The structure of Morocco's external markets is determined by a number of factors, not the least of which are natural comparative advantage and trade policies. Exchange rate movements, the structure of protection in the foreign country, bilateral and multilateral trade agreements, and tariff conventions all serve to influence the market orientation of supplying countries. The purpose of this section is to provide an overview of those factors which could potentially affect Morocco's access to foreign markets in the future. 4.23 The EEC constitutes Morocco's primary trading partner (para. 4.20). In consequence, trade policies such as the Common Agricultural Policy (CAP)# the Common Fisheries Policy, certain regulations regarding textiles, and special bilateral arrangements can significantly influence prospects for certain categories of Moroccan exports. According to 1983 datal', 662 of EEC import value from Morocco qualified for preferential treatment (Table A.IV.7). Goods not qualifying for preferential treatment were limited to only two BTN sections, namely mineral products (Section V) and paper making material (Section X). Excluding these sections, it appears that 931 of EEC imports from Morocco paid preferential tariffs. Most of those items qualifying for special treatment enter duty-free compared to a weighted Tokyo-round average tariff of 7.61 and a weighted Tokyo-round upper bound of 15.81. 1/ The pursuit of country-specific discriminatory trade policies by Morocco could also have an impact on the structure of Moroccan imports. On the basis of available data, however, it would appear that the share of preferential imports in total merchandise imports is extremely low (less than 1). Nearly all Moroccan imports are subject to the most-favored nation (MFN) principle and the use of non-tariff barriers to trade does not discriminate against specific countries. 2/ More recent data are not available at present. However, information gathered during a recent mission to Morocco suggests that the 1983 findings are still applicable. - 47 - 4.24 Certains productsL', however, are subject to import quotas as a result of bilateral arrangements between Morocco and members of the EEC1'. These include pants, shirts, blouses and dresses. As can be observed from Table 4.11, the value of EEC imports of these products from Morocco increased from about US$230 million in 1982 to US$354 million in 1985, that is by 5414'. This has enabled Morocco to increase its EEC market share for these products from 0.602 in 1982 to 0.74% in 1985. Table 4.11: VALUE OF EEC IMPORTS FROM MOROCCO IN QUOTA-RESTRICTED ITEMS 1982-1985 A/ 1982 1983 1984 1985 Product Value Share Value Share Value Share Value Share Pants 43,722 1.94 39,802 1.80 51,583 2.22 74,987 2.80 Shirts 5,359 0.63 5,832 0.82 5,498 0.80 6,730 0.75 Blouses 18,858 2.32 19,350 2.50 18,087 2.11 28,199 2.69 Dresses 10,414 1.06 13,326 1.42 16,880 1.99 e1,489 2.66 Total 230,161 0.60 239,030 0.63 255,089 0.65 353,866 0.74 I/ In thousand of US dollars. Source: Data prepared by the International Economics Research Division of the World Bank. 4.25 Import quotas granted to Morocco by the EEC were analyzed for 1985 and 1986 (Table A.IV.8). EEC quotas were found to vary both by country and by type of import. The size of the quota depends on whether or not the import was produced as part of a subcontracting arrangement. The figures show that in terms of units, pants are by far the most important product, representing over 601 of total import quotas granted by the EEC to Morocco. Quotas on pants, moreover, have increased by nearly 101 in 1986, three times that of all other items subject to the multifiber arrangement. The figures also show that France held the greatest quota share for this item, accounting for more than half of the community-wide quota. 1/ The Multifiber Arrangement (MFA) is one of the few exceptions to the GATT MIN principle. According to the MFA, industrial countries are allowed to restrict the amount of imports entering from selected developing countries. Although Morocco is not a participant in the MFA, it nevertheless faces import quotas on some textilv products in the EEC. 3/ These quotas are the result of a bilateral agreement signed between the EEC and Morocco in January 1985. This restriction could be classified as a voluntary export restraint (VER). 3/ Export figures shown in Table 4.11 are higher than those presented in Table A.IV.2. One possible explanation of this discrepancy is the omission of subcontracting activities in Moroccan merchandise trade statistics. - 48 - 4.26 Now efficient has Morocco been in fulfilling its EEC import quota? It appears that Moroccan exports of textiles and clothing were not effectively restricted until 1983. Low levels of production in the years previous to 1983 explained the underutilixation of quotas. Since then, Morocco has achieved a high rate of quota fulfillment. In 1986, for example, the rate of fulfillment was 862 for pants, the only item subject to a community-wide quota. This rate is considered relatively high by international standards. 4.27 Market Diversification: A Strategic Issue for the Future. Despite the incipient rise in Moroccan exports to developing countries, the EEC remains the primary trading partner. Unless Morocco intensifies efforts to diversify export markets, continued reliance on the EEC may prove costly over time for several reasons. First, Morocco's preferential tariff treatment in the EEC may suffer as a result of the upcoming round of multilateral trade talks. A comparison of the preferential tariff rate with the simple average Tokyo Round tariff rates that would have been levied on Moroccan exports in the absence of preferences indicates that the EEC's preferential imports from Morocco are significant (Table A.IV.7). The preferential import margins enjoyed by Morocco could be eroded by a general reduction in tariff rates agreed in the context of the Uruguay round of trade negotiations, thereby weakening the export opportunities of Moroccan products in the future. 4.28 Second, the existence of quotas on certain categories of Moroccan exports to the EEC militates in favor of diversifying markets over the medium termL'. Although Morocco has been assured by Community officials that it will continue to benefit from preferential quota treatment for some time in the future, these allotments will not be forever negotiable upwards, particularly in view of the recent enlargement of the EEC1'. 4.29 Table 4.12 shows changes in the unit values of EEC imports from the rest of the world and from Morocco over the period 1983-85 for the set of quota-restricted textile products that are exported by Morocco. Although no clear pattern is discernable In 1983-84, it is evident that a process of product upgrading has begun to take place in 1985 when Morocco's unit values in dollar terms rose by 152. In comparison, world unit values increased by only 61. The figures also show that above average increases in unit values took place in all quota restricted products. What form has this upgrading process taken? What are the implications for employment? What are the limits to upgrading for these products? These are the kinds of questions which merit further study, particularly in view of the Government's continued commitment to trade liberalization and export-led growth as a stimulus to employment. 1/ Preferential trading arrangements may have unintended, adverse effects on productivity growth (paras. 5.48-5.49). Bilaterally negotiated import quotas, for example, obscure the link between export performance and international competitiveness, and thereby constitute a disincentive to improving economic efficiency. 2/ Empirical analysis suggests that a process of product upgrading begins when exporting countries reach their quota ceilings. Since there are no limits imposed on the value of shipments, product upgrading can serve to increase the value of exports in the face of quota restrictions. - 49 - 4.30 As the potential for expanding exports to the EEC becomes increasingly constrained, Morocco should direct its efforts towards identifying now marbets. International agreements have been signed which facilitate Morocco's exploitation of new markets. The Arab League and the Lagos Plan of Action, for example, call for common markets to be established among Arab and African states respectively. Trade between Morocco and these regions is presently limited, however, such that any preferential treatment of Moroccan goods in this context is presumably small. Table 4.12: YEAR-TO-YEAR PERCENTAGE CHANGE IN UNIT VALUES IN EEC QUOTA-RESTRICTED PRODUCTS FOR MOROCCO AND REST-OF-WORLD IMPORTS 1983-85 1983 1984 1985 Goods Morocco World Morocco World Morocco World Pants 4.3 5.3 6.0 13.5 10.8 6.4 Shirts -12.0 2.9 -4.1 5.0 17.0 1.4 Blouses 13.6 4.1 6.0 11.6 9.0 6.6 Dresses 7.4 2.8 6.7 4.0 13.1 7.8 TOTAL 7.2 2.4 8.3 9.5 15.0 5.8 Sources International Economics Research Division. 4.31 A market with enormous potential for Moroccan exports is the United States. As previously noted, (para. 4.20), Morocco's export share to the US is negligible, in part because the latter is Morocco's main competitor in the international phosphate market. It is interesting to note that despite the rapid expansion of its labor-intensive exports, Morocco has failed to benefit from the growth of US imports of shoes (692) and textiles (30S), for example, between 1981 and 1984. This finding is even more surprising in view of the fact that Morocco faces very low import barriers in the US. This is true not only for non-tariff barriers but also for tariffs as well. For example, the US imported a total of US$28 million frmn Morocco in 1983 of which US$16 million worth of merchandise entered duty free, the result mainly of the Generalized system of Preferences. The simple average Tokyo Round bounded tariff rate for these products was 5.8S whereas the average tariff level on all Moroccan exports to the US was only 8.31. In view of the rapid export growth of certain categories of Moroccan manufactures and the relatively low level of US import barriers faced by these products, greater penetration of North American markets is warranted. This should be an integral part of Morocco's trade strategy in the future. - 50 - V. THE IMPACT OF IDUSTRIAL AND TRADE POIUCIES ON THE STRUCTURE AND PERFORMANCE OF INDUSTRY 5.01 Industrial policy, when broadly defined, encompasses not only industrial incentives per l. It also includes measures adopted for reasons other than the regulation of industry but which nevertheless strongly influence its development. In Morocco, for example, the trade policy regime has been one of the primary tools used to regulate the degree of external competition faced by industrial producers. The industrial policy regime on the other hand has traditionally served to limit the degree of internal competition, while using fiscal and other incentives to promote investment, employment, and exports, Industrial policy has thus served to condition the incentives of the trade policy regime and, in consequence, has exerted substantial influence on the structure and efficiency of industrial development. 5.02 The development strategy pursued by Morocco to date can be characterized as one of inward-oriented import-substituting industrialization in an environment shielded from external competition. The generalized and indiscriminate granting of fiscal and financial incentives in support of industrial development has been supplemented by direct government investment in selected sectors. The recent reforms in the area of trade and industrial policy constitute a watershed in Morocco's drive toward industrialization. They demonstrate, moreover, that the policy environment has a direct impact on the supply-side conditions that underlie the process of industrial growth and productivity change. At this juncture, the Government is faced with the pressing need to formulate industrial policies which will complement the efforts of trade liberalization by facilitating the adjustment of the industrial sector to a more open, competitive environment. 5.03 The purpose of this chapter is to analyze the interaction of past industrial and trade policies, evaluate their impact on industrial structure and performance, and assess the potential for future adjustment and growth of Moroccan industry. Insofar as trade policies have already been analyzed in great detail (Chapter III), this chapter will focus on the supply-side consequences of these policies. This chapter begins by delineating the structural characteristics of the industrial sector, linking their evolution to past industrial and trade policies. The effects of industrial policies, factor mobility, and the regulatory environment on firm behavior will then be evaluated and existing constraints to the adjustment of industry identified. In addition, the effects of the past and present policy environment on factor productivity and the efficiency of resource allocation will be examined. In particular, the impact of liberalization at the enterprise level will be assessed based on the findings of a recent industrial survey (para. 1.05). This will provide insights into the process by which macro-policy changes affect individual enterprises. The changing competitiveness of Moroccan industry will be discussed in a comparative international framework. - 51 - A. S al Caracteristis of the IWdstri Sector 5.04 The Evolution of Moroccan Manufacturing. Although the development of the industrial sector has been a Government priority, the contribution of manufacturing to GDP growth has not increased significantly over the course of the last twenty years. One possible explanation is that industrial growth may have been stunted by the Dutch disease contracted during the phosphate boom of the mid-1970s. The overvaluation of the exchange rate and the resource pull towards the phosphate sector slowed the expansion of other industries. As a result, the share of manufacturing output in GDP stagnated at approximately 16.52 throughout the 1970s, rising thereafter to about 17S. This led, in turn, to an extensive pattern of industrial growth in which output expansion was fueled primarily by the growth of inputs, especially capital (para. 5.30). Capital accumulation was encouraged, in part, by the granting of investment incentives, which resulted in a lower cost of capital relative to other factors of production. 5.05 Outward-Or4entation and Patterns of Sectoral Growth. Moroccan industry can be categorized into two groups: the modern manufacturing sector which employs nearly one half of the industrial labor force and has traditionally generated about three-quarters of manufacturing value-added; and the handicrafts sector which employs the other half of industrial workers and accounts for the remaining one quarter of total manufacturing value-added. In 1984, the manufacturing sector contributed about 17TL' of gross domestic value-added or about US$2 billion and employed nearly half a million workers (Table 5.1). The diversification of Morocco's industrial base took place following Independence and continued until the mid-1970's. The past orientation of Moroccan manufacturing towards consumer goods has given way to the production of intermediate and capital goods, which represents an increasing share of industrial output. As a result of strong growth in chemicals (primarily phosphate derivatives) and machinery, heavy industry now accounts for about the same share in total manufacturing output (about one-third) as food processing. In addition, light intermediates such as wood, paper, and light chemicals have outperformed the overall average rate of industrial growth by nearly twofold (9.81). 5.06 An analysis of the relative performance of individual industrial sectors from 1977 to 1985 reveals an apparent correlation during the latter part of the period between the change in output share and the orientation of the sector, with outward-oriented industries growing at relatively higher rates than import-substituting industries. This finding is clearly linked to the export promotion policies which have occurred since 1983. Those subsectors which increased their output share significantly during 1981-86, viz. wearing apparel, basic metals, machinery and equipment, and precision instruments, also experienced strong export growth, as witnessed by the change 1/ A cross-country trend analysis of industrialization, proxied by changes in the share of manufacturing value-added as a function of per capita income, reveals that Morocco deviates significantly from the norm. For a country like Morocco with a per capita income level of US$600, approximately 25% of output should originate in the industrial sector. - 52 - in export shares (Table 5.2). Whereas some of these industries have previously exported a relatively high share of productiou, others have undergone a significant shift in market orientation (Table 5.3). An analysis of export performance as a function of relative factor intensities of production techniques reveals that industries characterized by high export-output ratios also appear to be the most labor-intensive. Table 5.1: SELECTED MANUFACTURING INDICATORS 1984 Morocco Braxil Indonesia Korea Turkey Tunisia Manufacturing Value-AddedA' 1984 US$ billion 2.1 59.4 10.0 23.7 12.2 0.9 Per capita 98.1 448.0 62.9 591.0 252.1 134.4 Share of Mfg Value-Added in total GDP 16.9 28.4 12.5 28.4 24.3 11.8 X Share of Mfg Output: Food, beverage & tobacco 29.2 12.2 16.8 17.1 19.5 31.0 Textiles & leather 15.2 12.1 9.4 21.6 15.5 21.0 Chemicals 18.2 21.5 38.2 19.4 24.0 14.6 Machinery 15.3 28.6 14.5 22.9 19.0 14.4 Growth of Mfg Value-Added 1966-1984 (2 p.a.) 4.9 5.1 11.2 15.9 6.6 8.4 Growth of GDP per capita 1966-1984 (2 p.a.) 2.5 4.2 5.0 6.6 2.6 3.7 Share of Mfg exports in total Mfg outputk' 17.1 12.0 11.8 36.9 11.1 20.5 i' Manufacturing activities are classified according to the International Standard Industrial Classification. Both the modern manufacturing and handicrafts sectors are included in manufacturing output and value-added figures. it/ The share of manufacturing exports in total manufacturing output declines to 8.12 once phosphoric acid and phosphate-based fertilizers are excluded. Source: INDSP Data Base - 53 - Table 5.2: OUTPUT GROWTH AS A FUNCTION OF EXPORT ORIENTATION IN SELECTED INDUSTRIAL SUBSECTORSA' Annual Annual Share of Percentage Share of Percentage Gross Output Change Total Exports Change 1981 1985 1981-85 1981 1985 1981-85 Wearing Apparel 1.8 2.4 7.1 7.5 12.0 11.8 Leather and Footware 2.0 2.3 2.9 3.4 4.9 9.3 Basic Metal Industry 1.6 3.4 19.3 0.1 2.0 68.7 Electrical Machinery, Electronics 3.2 3.7 3.6 1.1 2.1 17.2 Precision Instruments 0.1 0.2 19.7 0.0 0.6 44.8 Beverages 8.8 6.2 -8.8 0.9 0.4 -17.3 Construction Materials 7.7 6.6 -3.9 1.8 0.6 -26.4 al Data for all eighteen industrial subsectors are presented for the period 1977-85 in Tables A.V.1 and A.V.2. Source: Ministry of Industry Table 5.3: PERCENTAGE OF EXPORTS AS A SHARE OF MANUFACTURING AND FACTOR INTENSITY CHARACTERISTICS Share of Exports in Total Output by Subsector Capital/ Industry 1981 1985 Labor Ratio" Beverages 4.0 1.2 80.7 Paper and Printing 8.6 8.9 73.1 Food 8.1 11.0 60.7 Non-metallic Mineral Products 2.1 1.7 57.5 Rubber and Plastics 1.2 3.6 47.0 Textiles 21.8 23.7 43.4 Chemicals 33.8 39.5 36.4 Transport Equipment 2.4 6.5 25.4 Basic Metals and Metalwork 5.0 10.7 25.1 Electrical Machinery 1.9 12.1 24.2 Wood and Furniture 6.0 17.4 22.1 Leather and Shoes 16.5 41.1 9.9 Wearing Apparel 54.7 83.7 7.1 Precision Instruments 2.1 7.5 6.2 a/ Ratio of total capital stock to employment (in thousands of dirham per worker). Source: Ministry of Industry and Foreign Trade, World Bank Report No. 4893-MOR. - 54 - 5.07 These results are confirmed by a recent micro-economic study which shows that firms servicing the domestic market only are highly capital-intensiveL' compared to those which sell on both local and foreign markets (Table 5.4). In addition, there is a positive correlation between labor intensity and export-orientation in industries with diversified market destinations. The most labor-intensive sectors (carpets, garments, knitwear, and leather) employed a relatively higher number of unskilled workers, in that the average wage for these industries was 502 lower than the sample mean. Table 5.4: INDUSTRY-SPECIFIC CHARACTERISTICS OF SELECTED SUBSECTORS CLASSIFIED BY MARKET DESTINATION, 1985 Number of Value-Added/ Wage Bill/ Market Served Firms Exports Output Employment Export/ Worker Valued-Added (CH Sillaon) (Thousandsl Output (DH'0O0) (Pereent&ago Domestic only 3,247 - 32.2 115.1 - 76.0 37.1 foreign & Domestic 762 11.4 27.5 109.0 .41 57.0 45.4 (Excl. Phosphate Derivatives) 752 7.0 21.7 103.9 .32 54.5 4G.7 Carpets 33 2.9 3.6 6.0 .79 12.5 71.5 Garments 189 1.4 1.6 21.5 .88 19.2 S7.2 Leather 79 0.6 0.9 6.7 .61 31.8 65.9 Yarns & Fabrics 7S 1.0 3.3 19.7 .29 43.9 22.4 Paper & Pulp 14 0.2 1.0 2.0 .20 126.0 29.8 Phosphate Derivatives 10 4.4 5.9 5.1 .75 114.0 33.0 Smwree: Tables A.V.3 and A.V.4. $S518 P.16 (04.16.7) 1/ Taking value-added per worker as a proxy for capital intensity, the ratio of this variable between inward- and outward-oriented firms is 1.33. - 55 - 5.08 As previously stated (para. 4.01), merchandise trade figures in Morocco do not include exports of goods produced through subcontracting arrangements. These exports often coastitute pure value-added and are highly labor intensive. Table 5.5 shows that the real value of these exports increased by 822 from 1983 to 1985, with above average growth rates recorded for garments. Assuming that the ratio of value added to gross value of production is 302 for subcontracting activities, the gross value of these exports is estimated at DH 130 million and DH 1.5 billion in 1980 and 1985 respectively. Subcontracting activities thus increased their share of total merchandise export value from 1.31 to 6.9S between 1980 and 1985. Together, these findings indicate that the structural adjustment process initiated in 1983 has led to a significant increase in the relatively narrow base of those manufactured exports in which Morocco could be expected to possess a natural comparative advantage. Table 5.5: VALUE OF EXPORTS OF SUBCONTRACTING SERVICES BY COMMODITIES, 1983 PRICES (Millions of DH) Commodity 1983 1984 1985 Leather Goods 1.9 1.5 3.4 Knitwear 40.2 67.6 68.8 Garments 58.5 88.6 136.4 Shoes 4.9 1.9 2.2 Electronic Goods 44.8 52.9 _ Others 7.4 8.7 9.5 Total 157.7 221.2 287.4 Source: Office des Changes; Mission Estimates 5.09 Industrial Concentration. The sizes' distribution of industrial firms by number of workers in Morocco in 1985 appeared similar to that of 1/ Firm size is most commonly measured by the number of workers. In industrial countries, small-scale often refers to enterprises employing less than 200-300 workers. In developing countries, however, the average plant size is smaller and 'small' is taken to mean 1-49 workers. Size in the 1983 investment code is measured by capital employed. Small- and medium-size enterprises (PMIs) are those which show less than DR 5 million worth of capital net of taxes at the moment of creation or investment extensions. Because of data limitations, firm size in the present context is defined on the basis of the number of workers. - 56 - other market economies like Korea and Japan (Table 5.6). Although output, employment, and exports are primarily concentrated in a limited number of large enterprises (Table 5.7), a diversified distributional pattern is found at the subsector level. In the food processing sector, fruit and fish canning production is equally distributed among small, medium, and large size firms. Beverages and tobacco on the other hand are dominated by a small number of large firms. In textiles, spinning and weaving is dominated by large spinning units and integrated mills, while garments and footwear exhibit relatively equal output shares across different firm sizes. A similar output distribution is observed in machinery and equipment with relatively few large assemblers and several medium-size manufacturers. In capital intensive industries such as chemicals and transport equipment, production is dominated by larger firms with small firms acting as component or intermediate input suppliers. Table 5.6: SIZE DISTRIBUTION OF INDUSTRIAL ENTERPRISESA (Number of (P e r c e n t a g e s) Workers) US Japan S.Korea India China Yugoslavia Hungary Morocco Firm Size (1977) (1972) (1981) (1977) (1982) (1981) (1981) (1985) 5-33 56.4 80.2 70.7 51.7 52.9 6.6 2.2 68.0 34-75 20.3 10.7 14.4 35.3 19.5 15.8 4.8 15.1 76-189 12.4 6.1 9.2 7.8 12.2 32.1 18.7 10.6 190-243 3.8 0.8 1.5 0.8 8.5 12.0 9.2 1.4 244 + 7.1 2.1 4.3 4.4 0.6 33.5 65.1 4.8 a/ Includes all industrial firms having at least five employees. Source: The World Bank Table 5.7: MANUFACTURING OUTPUT, EMPLOYMENT, AND EXPORTS BY FIRM SIZE IN MOROCCO - 1985 Number of Firms Output Employment Exports Firm Size less than 34 2727 8.8 14.3 7.4 34-75 604 13.0 13.5 7.3 76-189 426 18.6 22.2 13.8 190-243 58 5.0 5.5 4.4 244 + 194 54.7 44.5 67.1 Total 4009 100.0 100.0 100.0 - 57 - 5.10 The need to increase welfare and reduce disparities in income distribution has been a major objective of recent industrial policy. In order to absorb a large and growing pool of unskilled labor, Moroccan policy makers have introduced a number of fiscal and financial incentives to promote the establishment of small-scale enterprises (PMIs) and the adoption of labor-intensive technologies. Evidence on industrial efficiency as a function of firm size is generally unfavorable for small- and medium-size enterprises, when size is defined by the number of employees. PNI performance is more satisfactory, however, when size is measured by capital. 5.11 Insofar as efficiency, rather than size, ultimately determines the success of industrial policy, it must be demonstrated that small units, on average, use factor inputs more productively than their larger counterparts. In Japan, for example, small firms are either closely integrated with the activities of larger concerns, or highly specialized; as such, they tend to be highly efficient. In Korea where subcontracting arrangements are rare, small firms are 'dominated' by their larger counterparts, that is, they use both more labor and capital per unit of output. Unless the industrial efficiency of these types of firms improves, it is unlikely that a shift of resources towards smaller enterprises would yield the desired increases in output and unskilled labor demand. B. bndstria Promotion Policies and Sectoal Constrints 5.12 Industrial policy can be defined as the set of measures and government actions designed to influence the allocation of resources both between industry and competing sectors and within the industrial sector itself. Fiscal policy, financial incentives, export promotion efforts, and factor market regulations are important areas of industrial policy that, through their direct impact on the structure of relative prices and the allocation of productive factors, have influenced industrial performance. Within this context, the following section reviews the investment codes and the immediate regulatory environment in which industry operates. An understanding of the structure and impact of the incentives regime and regulatory environment is essential for evaluating the success of industrial policy against stated Government objectives. Existing constraints on industrial development are also identified. 5.13 The Structure of Fiscal and Financial Incentives. For almost three decades prior to the introduction of the ITPA reforms, the cornerstone of industrial policy in Morocco has been a set of investment codes and trade policies designed to channel resources toward modern manufacturing and protect the sector from both external and internal competition. The investment codes have been reriodically revised in response to changing Government objectives- . In contrast to the past where large firms have been the principal beneficiaries of fiscal incentives, the most recent initiative attempts to reconcile regionalization objectives with the need to attenuate the inherent bias towards capital-intensive technologies and to promote employment by supporting the creation and expansion of small- and medium-size firms (para. 5.10). 1/ An account of the historical evolution of the investment codes and their salient features is presented in Annex VI. - 58 _ 5.14 These objectives are reflected in the latest Investment Code of 1983. Corporate tax and import duty exemptions as well as employment and land subsidies are selectively granted for investment in three designated industrial regions outside the Casablanca-Mohammedia area. Allowances for accelerated depreciation have been eliminated for firms in the major industrial centers, thereby serving to increase the cost of capital. An important financial incentive, the 2% interest rate rebate included in the original version of the 1983 code, was eliminated in early 1987 for the industrial sector. 5.15 The present scheme of fiscal and financial incentives has not been entirely successful in reallocating resources in line with regional priorities (Table 5.8). Investment data for 1985 confirm that the distribution of benefits to enterprises according to zone r--s remained roughly proportional to the present regional structure of industry. On the other hand, much has been achieved in the way of limiting the cost of budgetary revenues foregone by the Government budget and reducing distortions in factor prices. The rollback of investment and employment subsidies under the 1983 Code indicates an increasing recognition by Government that it can no longer afford such largesse. A lower wage-rental ratio should shift the allocation of resources towards activities in which Morocco enjoys a natural comparative advantage. This will result, in turn, in increased employment opportunities in the formal sector and thereby limit the growth of the underground economy, estimated at present to represent some 40X of the labor force. Investment and employment objectives are often better served by factor prices which reflect their true scarcity value, a notion which this Code appears to implicitly recognise. Table 5.8: REGIONAL DISTRIBUTION OF INVESTMENT (by Investment Code Zones"/) 1979 - 1985 1979 1983 1985 Zone I 50.1 22.5 9.0 zone II 4.5 29.4 41.0 Zone III 39.4 38.4 35.7 Zone IV 6.1 9.8 14.1 Zones I and II 54.6 51.9 50.0 a/ The country is divided into four zones: I - Casablanca-Anfa; II - Mohammedia, Ben-Slimane; III - Rabat, Sale, Kenitra, Fes, Marrakech, Meknes, Safi, Tanger, Ictaran; and IV - all other provinces. Source: Ministry of Industry and Mission estimates 5.16 The Resulatory Environment. The dynamic process of growth and structural change in industry occurs fundamentally through the folloving two processes of competition, both conditioned by profits and losses: first, the entry of new, the growth of existing and the exit of moribund enterprises; and second. the entrance into, expansion of, and departure from different branches - 59 - of activity by existing enterprises. Major de iur regulatory barriers to the exit and entry of firms do not exist in Morocco. However, discretionary application of corporate, banking, and labor laws may at times impede factor mobility, which could retard the dynamic process towards greater efficiency. 5.17 In an environment characterized by high levels of unemployment and underemployment, one major concern of the Government has been job creation. As a result, temporary or permanent closures of firms in Morocco are generally discouraged and subject to administrative approvals. While bankruptcy provisions exist, only a small number of cases is reportedly being handled each yeari'. In contrast to small firms, exit is relatively difficult for large firms. In view of the more politically visible repercussions which redound from closure of the latter, the Government haa tried to rehabilitate large ailing units through injections of capital or, in some cases, partial reductions of labor. Although takeovers or mergers of enterprises experiencing financial difficulties are legal, they rarely occur at the medium- and large-size firm level. In this context, entrepreneurs and the banking system, respectively, may become increasingly risk-averse in their investment and lending plansa'. 5.18 Barriers to the entry of firms derive in practice from the behavior of administrative authorities and the banking community. The ambiguity of land titles, the issuing of construction permits, and the byzantine nature of zoning regulations, all constitute potential impediments to the creation of new firms. Construction licenses, for example, have been subject to substantial delays, averaging between six to eighteen months from the time of request. In general, these delays can be traced to a lack of coordination between central and local governments. Another potential barrier to entry derives from the relatively oligopolistic banking sector, which is often capricious or arbitrary in its selection criteria for investment financing. Financial barriers to entry may be particularly important in the Moroccan context since access to bank credit for new and small enterprises is quite limited1'. Finally, the entry of foreign firms has been circumscribed until 1983 by the 50 Moroccan partnership requirement which was applicable to all industrial activities and restricted the expansion of companies already existing in Morocco. This restriction still applies, however, on activities such as canning which remain subject to the 1973 Moroccanization law. 1/ Insofar as bankruptcy is deemed socially undesirable in Morocco, entrepreneurs tend to continue operations and gradually liquidate fixed assets until "involuntary" closure is unavoidable. 2/ Exit barriers can act as a deterrent to entry to the extent that they convert investment outlays that would normally be recoverable, into additional sunk or irretrievable costs - a situation that can reduce the expected rate of return on investment and thus lower overall investment activity. 3/ A description of the Moroccan financial sector and the sources of industrial finance is presented in Annex VII. - 60 - 5.19 Labor Mobilit1'. Although stringent in theory in some respects, Moroccan labor legislation is applied flexibly in practice. The regulations in force and the existence of trade unions, however, have a differential impact on the functioning of the labor market. They apply for the most part to the largest firms, especially those in the public sector. In general, labor laws can limit the firm's capacity to layoff workers or retrench by attrition. 5.20 In the case of what is called "collective layoffs", with or without the closing of the plant, the employer is required to request an authorization from the Governor of the province where the plant is located. Decisions are taken on a case by case basis and often depend on the bargaining power of the parties involved. Whereas some companies have reported minor delays in obtaining the authorization, others have reported delays of up to eight months. The interests of investors and creditors, moreover, are sometimes in conflict with considerations of regional employment and potential public disturbances. On the other hand, individual layoffs are permitted in principal on the basis of the "operational needs of the enterprise". The only requirements are an advance notice, generally one week to one month, and severance pay to the worker, which varies from six to fifteen days of wages depending on the worker's seniority. As the ultimate arbiter of what constitutes the operational needs of the enterprise, the Government does, albeit infrequently, block dismissals. 5.21 Reducing employment through attrition is formally prohibited by Moroccan law. Retiring workers, for example, must be immediately replaced by new recruits. In practice, management negotiates with employees about to retire, to resign shortly before the agreed date of retirement, insofar as replacement is not mandatory in the case of resignation. Alternatively, entrepreneurs resort to temporary and part-time contracts, even in the modern sector, in an attempt to optimize employment and reduce labor costs. 5.22 Constraints to Industrial Performance. Industrialists have identified a number of factors which are presently hampering the adjustment of enterprises to the new trade and industrial regime. One set of constraints is financial in nature whose source can be traced to macro-economic imbalances. The most commonly quoted bottleneck has been the long delays in obtai.ing foreign exchange for imported inputs. Because of Morocco's balance-of- payments difficulties, eighty percent of the import-substituting firms in the sample and a small percentage of the exporting firms (20X) have experienced delays of up to 90 days in purchasing foreign exchange to pay foreign suppliers. Delays have increased, moreover, during the past nine months. First, virtually all firms must hold stocks of imported inputs at higher levels than would otherwise be necessary. Second, Moroccan importers are currently required by foreign suppliers to open letters of credit confirmed by correspondent banks. As a result of the foreign exchange shortage, firms are required to take actions which increase financial costs in order to cope with the present climate of uncertainty and avoid disruptions in operations. Unlike large enterprises with high creditworthiness and good relations with commercial banks and foreign suppliers, smaller or less well-established firms 1/ A description of the labor market in Morocco is provided in Annex VIII. - 61 - often experience difficulties in obtaining confirmed letters of credit. Third, the Central Bank has recently introduced a 25l deposit requirement in October 1986 (subsequently raised to 501 in January 1987) for all importers in order to control the availability of credit to the economy. Insofar as commercial banks have required deposits from enterprises ranging from zero to 1001 of the transaction in the past, foregone interest earnings have differed across enterprises. Similarly, while some foreign suppliers have subjected Mbroccan firms to high finance charges for delayed payments, others have tried to accommodate their customers. The Central Bank has recently authorized exporting firms to seek lines of credit abroad to pay their foreign suppliers, with the possibility of servicing these lines of credit directly from the proceeds of their foreign exchange earnings. However, it appears that only medium-to-large exporting firms would be able to obtain foreign exchange financing by these means. 5.23 The pervasiveness of Government payment arrears, also a symptom of fiscal disequilibria (para. 2.15), has caused liquidity problems for some industrial firms visited in the course of the survey. The extent of this problem, however, was found to vary according to the type of firm. One example of a liquidity-constrained firm was a manufacturer of office-supply equipment which received a large Government contract and was still awaiting payment after one year. 5.24 The high cost of fuel was also cited as a major constraint by firms producing textiles, paper products, ceramics, and electrical appliances. As discussed previously, the need to mobilize additional fiscal revenues in the interests of stabilization led to the introduction of a windfall tax on petroleum. If maintained as a permanent fixture of the Moroccan fiscal system, this tax could result in a suboptimal allocation of real resources and a loss of competitiveness for exporting activities. Its replacement by a more trade-neutral mechanism is therefore highly desirable. 5.25 The high cost of electricity in Morocco was repeatedly cited by more than one-third of the 40 enterprises visited as a factor which has significantly eroded industrial competitiveness-'I. This situation reflects the windfall tax on oil, which is passed on to the user in the form of higher electricity tariffs, as well as the existing rate structure. Morocco is one of the few countries where electricity tariffs on industrial use (high voltage) are several times higher than tariffs on household consumption (low voltage) (See Annex IX). The issue of electricity pricing will be examined in the context of the Public Enterprise Rationalization Loan (PERL). The recommendations of that study will provide the basis for pricing policy reforms in the energy sector. 5.26 Almost all enterprises mentioned one or more of the service sectors as responsible for the declining efficiency and competitiveness of Moroccan industry. Sectors mentioned most often include banking, transport, and insurance. The oligopolistic structure of the commercial banking sector, the highly regulated nature of the domestic transport system, and the lack of I/ This position is strongly shared by the Department of Industry. - 62 - alternative export inst -ace schemes are all perceived as barriers to the continued structural ad)4stment of industry. The extent and kinds of problems linked to the "non-competitive" nature of these non-tradables, however, varied widely across firms. 5.27 Rising lending rates linked to deficit financing (para. 2.15) and large bank margind were unanimously identified as the source of depressed investment demand in Morocco. At the same time, the fiscal pressure on industrial activity was considered excessive and inequitable from an intersectoral point of view. Problems linked to the highly regulated domestic transport sector also varied in function of the size, marketing structure, and distribution channels of the firm. The State transport monopoly (ONT), for example, constitutes an impediment to the efficient functioning of smaller firms outside the Casablanca area which are prohibited from delivering goods directly to wholesalers. Finally, some industrialists mentioned the cost of export insurance as a potential constraint which might become increasingly binding as the structure of Moroccan industry continues its export-oriented shift. At this point, several firms have chosen not to carry insurance and simply incur the risk themselves. A medium-size firm producing footwear has been exporting 95S of its output to Europe without insurance, thereby avoiding a high additional cost relative to the value of its exports. C. RPoductivity and Sources of ndu5stri Growth: The Nicroeconomic Effects of Adjustment 5.28 In a number of countries, a close relationship has been observed between productivity and the market-orientation of industrial activity: export-oriented activities exhibit high rates of productivity growth. In Morocco, industries which have grown increasingly outward-oriented as a result of liberalization could thus be expected to experience increases in productivity. In view of the relatively short period of time which has elapsed since the onset of liberalization in Morocco, it is still too early to draw definitive conclusions on the outcome of the program. There are indeed certain structural aspects of the industrial adjustment process which will be manifest only in the medium-term. On the other hand, a preliminary assessment of the structural adjustment process will be attempted on the basis of information collected in the context of the annual industrial census and changes in the productivity of Moroccan industry. This section analyzes the sources of industrial growth in Morocco at a disaggregated level of 17 subsectors, and draws comparisons with other developing countries at a similar stage of industrialization in order to identify sources of dynamic comparative advantage. 5.29 International ComDarisons of Productivity Growth. Growth at the economy-wide or firm level is determined both by the expansion of productive Note: The analysis and empirical work underlying this section have benefited from the substantial comments and contributions of Deborah Bateman and Mieko Nishimizu of INDSP. - 63 - resources employed and the rate of total factor productivity growthl'. TFP growth is equivalent to the weighted average of capital, labor, and material productivity growth. Depending on the substitution possibilities available to producers, any combination of positive and negative productivity growth can occur among these three partial productivities. As long as the combined impact on production results in the improvement of total factor productivity, there would be a net gain to the economy. 5.30 The importance of TmP as a source of economic growth differs, however, across countries, time periods, and from the aggregate down to the firm level. A normal pattern of growth is characterized on average by approximately 20-302 of growth owing to increases in TmP. An intensive pattern of growth is said to occur when the contribution of TIP growth to output growth significantly exceeds the "normal" range. This type of pattern, for example, has been observed frequently in Korean and Japanese industries. At the other extreme is the extensive pattern of growth where the contribution of TFP growth is significantly below the "normal" range. The extensive pattern is characteristic of industries in countries such as Yugoslavia, Hungary, Egypt, India and Zambiat'. 5.31 The pattern of growth for the Moroccan modern manufacturing sector between 1977 and 1985 can be characterized as extensive: growth in inputs accounted for virtually all of the growth in manufacturing (93.22), with only a small fraction (6.81) attributable to TFP growth. A normal-to-intensive pattern of growth was found during the 1977-81 periodt', before the eruption of major macroeconomic problems which affected practically all sectors in Moroccan manufacturing. An extensive pattern of growth for the sector as a whole subsequently emerged, as a result of the sluggish material productivity 1/ The estimation of total factor productivity change is based on the economic theory of production and cost. A production function relates the maximum feasible amount of output to each level of inputs. TIP is the total change in output net of the change which derives from the rate of growth of inputs, both expressed in constant prices: 1 change in TIP s change in output - (output elasticities x S change in inputs). Alternatively, if production costs are specified as a function of input and output levels, TFP change can be measured as the change in unit costs of production net of input price changes: X change in TP - s change in unit costs + (2 change in input prices * cost elasticities). Note, therefore, that a 31 increase in TIP implies a 32 decrease in unit costs of production, after having taken into account all changes in input prices. A detailed description of the methodology used for calculating total factor productivity growth is presented in Annex X. 2/ See, for example, M. Nishimizu and John M. Page Jr. "Total Factor Productivity Growth, Technological Progress and Technical Efficiency Change: Dimensions of Productivity Change in Yugoslavia, 1965-1978". The Economic Journal Vol. 92, 1982. 3/ TFP growth accounted for between 23.71 to 67.91 of output growth depending on the industrial sub-sector. - 64 - performance of the later yearsV. The average annual rate of change in total factor productivity between 1977 and 1985 was 0.52 and in seven out of the 17 sectors was negative. The range of annual TFP growth for the period fell between -3.51 per year for non-mtal minerals to 3.7f per year for chemicals. During the 1980s, TFP performance ranged between 2.81 for precision instruments to 4.9% for non-metal minerals. A sub-sectoral analysis of changes in TFP growth (Table A.V.5) indicates that sectors which have been subject to foreign competition, including processed foods, machinery, and electrical appliances, exhibit relatively greater increases in productivity growth than sectors which remain highly protected. 5.32 Subsectoral rates of TFP change in Morocco and a number of comparator countries are related over the 1977-85 period in Figure 5.1. Individual countries are ranked according to their level of per capita income. By international standards, Morocco's average productivity performance has been similar to that experienced in the Philippines and Yugoslavia; however, it is well below that of high performing middle income countries, such as Korea and Turkey. 5.33 The variability of TIP growth rates in Morocco closely parallels those in countries at similar income levels. The coefficient of variation, which measures variability and is indicative of structural adjustment, is small. In the latter part of the period, however, variability in performance increased significantly in Morocco, reflecting change and incipient structural adjustment in industrial subsectors. 5.34 Components of Productivity Growth. An industry or enterprise can grow only as fast as the rate of expansion of its inputs plus the rate of total factor productivity growth. The impact of stabilization on the supply-side was to limit growth by restraining domestic demand; in addition, the foreign exchange constraint limited the supply of intermediate inputs and capital goods. The industrial policy reforms reduced investment incentives and brought the price of capital closer to its market price. In the face of tighter resource constraints, therefore, higher productivity performance becomes the principal conduit by which to alleviate the supply side constraint and achieve growLh with sttuctural change. In order to assess the potential for structural adjustment and growth in Moroccan industry, it is important to determine the initial effects of policy reforms on productivity performance. 5.35 The first indication of the reform's positive influence can be discerned in the substantial increase in capital and labor productivity (Table 5.9). Almost all of the seventeen sectors exhibit higher capital and 1/ As discussed in the following section, the deterioration in material productivity served to negate the significant growth of capital and labor productivity over the 1981-85 period. TOTRL FACTOR PRODUCTIVITY GROWTH IN INDUSTRY coutRY (Mean;Standa A U.u4D4nn) YURK miVTA K _ (0.40;1.49) (0.76;0.98?% (0.66;1.114) s0 " S " _ " ; f o~~~~-~0 0 (4.52;1.83) et, (1.60;1.52) . _ (0.52;2.22) 0 o (-.13;2.01) et (2.06;4.04) . ~~I I I ' I I | -8 -6 -4 -2 a 2 4 6 8 10 12 14 TOTRL FACTOR PRODUCTIVITY GROWTH NDTa amir owINT DIU M Ras - 66 - labor productivity growth after 1981-. These trends were confirmed at the enterprise level by the results of the industrial survey. Domestic firms which previously enjoyed considerable market power due to limited competition from abroad were induced by liberalization to increase the efficiency of factor use. For example, about 802 of the import-substituting enterprises in the sample had grown increasingly cost-conscious, as a result of having had to slash profit margins over the past two years in order to maintain their market shares. Specific industries which exhibited a more efficient use of capital at the enterprise level include food processing, paper, textiles, electronics, and machinery, as witnessed by the increased performance of capital productivity. Continued profitability of these industries, despite the reduction of fiscal incentives and the increase in the price of capital, is consistent, moreover, with the improved performance of capital. Table S.9: SOURCES OF INDUSTRIAL GROWTH, 1977-85 (in percent) Total TFP/ Gross Output Factor Output Materials Labor Capital Growth ProductivitY Growth Productivity Productivity Productivity Consumer Goods 1977-81 5.9 1.4 23.7 2.3 1.6 -4.3 19A1-8S 5.8 -1.3 -22.4 -2.1 0.2 0.8 1977-85 S.8 0.0 0.0 0.1 0.9 -1.8 Light Intermediates 1977-81 10.3 4.7 45.6 4.4 4.9 5.5 1981-8S 7.9 -0.2 -2.5 -2.1 4.9 6.1 1977-85 9.1 2.2 24.2 1.2 4.9 5.8 Heavy Intirmediates 1977-81 5.6 3.8 67.9 7.7 1.2 -12.9 1981-85 13.2 -1.S -11.4 -S.O 9.6 6.8 1977-85 5.8 0.2 3.5 1.2 1.9 -5.6 Capital Goods 1977-81 2.3 0.8 34.8 3.2 -3.0 -11.3 1981-85 1S.7 O.S 3.2 -3.0 11.2 10.9 1977-85 9.0 0.6 6.7 0.1 4.1 -0.2 Total Industry 1977-81 S.1 2.0 39.2 3.8 0.3 -7.1 1981-85 9.6 -0.9 -0.9 -3.0 S.0 5.2 1977-85 7.3 O.S 6.8 0.4 2.7 -1.0 5.36 In a number of subsectors such as plywood, ceramic tiles and bathroom fixtures, where performance is linked to the growth of the housing and construction industries, there was additional downward pressures on profit margins due to stabilization policies and reduced domestic demand. Indeed, 1/ Although the ITPA reforms were introduced only in 1984, changes in firm behavior are presumably significant enough to affect TFP estimates in the period 1981-85, thereby distinguishing it from the 1977-81 period. The reforms have not been in effect long enough to constitute a statistically separate time series. New estimates, however, should be calculated on the basis of future data to evaluate more fully the impact of liberalization on productivity growth. - 67 - firms in these activities were experiencing great difficulties in adjusting to liberalization, as it came at a period of particularly depressed economic activity. 5.37 Increasing competition from abroad also led to improvements in labor productivity. Many firms sought to economize on labor costs during business cycle fluctuations by substituting seasonal for permanent employment. Manifestations of labor productivity gains were observed, for example, in the electronics, machinery, and transport equipment sectors. These results were concretized during a visit to an ailing truck assembly firm which had recently been restructured. The realignment of the wage-rental ratio was an important factor underlying the labor and capital productivity gains which have taken place in Moroccan manufacturing since 1981. On the basis of these results, policy reforms should be pursued which stimulate structural adjustment through supply side strategies. 5.38 Material productivity growth in industrialized and newly industrialized countries is found to average between 12 to 2% per year'. Given the large share of materials in total cost, the gain or deterioration in material efficiency is one of the key determinants of TFP performance growth in the manufacturing sector. There is evidence from firm visits of more efficient material resource allocation, particularly the use of energy, where high costs induced conservation efforts throughout the manufacturing sector. In most subsectors, however, there was a major decline in material productivity growth between 1981 and 1985. This deterioration was financial rather than physical in nature1' and can be traced to the macro-economic imbalances of the past few years, most notably the severe foreign exchange shortages. Firms interviewed in the course of the survey had incurred considerable financial costs in their purchase of imported inputs as a result of the long delays in obtaining foreign exchange and the depreciation of the dirham. This was cited as a primary cause of waning competitiveness. The buildup of the country's commercial arrears in the 19809, for example, led foreign suppliers to require exorbitant risk premia ranging from 0.11 to 12 per day in exchange for confirmed letters of credit. Small and medium size firms with high imported content, for example, experienced a tripling and in several cases quadrupling of financial costs. In order to hedge against 1/ M. Nishimizu and S. Robinson, "Trade Policies and Productivity Change in Semi-industrialized Countries" Journal of Development Economics vol. 16, 1984. 2/ The decline in real productivity of material use appears to reflect a statistical artifact in the TFP calculations. The rise in input stocks which results from the liberalization of intermediate imports and the climate of uncertainty regarding access to foreign exchange should translate into a decrease in capital productivity. However, the data did not permit a reallocation of variations in inventory to changes in the capital stock, thereby leading to an upward bias in the productivity of capital and a downward bias in material productivity estimates. In addition, increased financial charges linked to foreign exchange shortages were captured as a residual in the cost of material inputs. By excluding the attendant financial costs, the material input deflator introduced an upward bias in the estimation of real input use, leading, in turn, to a decline in material productivity. - 68 - foreign exchange shortages and devaluation in the future, firms report a rapid accumulation of inventory. This attempt to minimize risk on the part of entrepreneurs is associated with the higher cost of imported inputs and the resultant decline in material productivity from a financial point of view. 5.39 The Impact of Stabilization on Industrial Productivity. Estimates of productivity change over the business cycle are associated systematically with procyclical tendencies. A slowdown in output growth tends to be accompanied by a dampening of productivity, while economic recovery is associated with an acceleration of productivity gains. This tendency is usually attributed, in part, to the inability of producers to adjust inputs fully to short run fluctuations in output, which themselves derive from variations in demand. 5.40 In Morocco, capacity utilization was also found to be an important factor conditioning TFP growth. In the course of the industrial survey, enterprises were identified in a number of sectors whose sluggish productivity performance was symptomatic of low levels of capacity utilization. Declines in capacity utilization can be attributed to changing market and demand conditions in some cases and to mounting foreign exchange shortages in otherss'. 5.41 The performance of certain firms, for example, was aggravated by the sharp increase in competition brought on by liberalization. Two import-substituting firms producing aluminum goods and rubber and plastics respectively, reported declines in productivity as a result of excess capacity linked to depressed domestic demand. Shortly before liberalization, certain manufacturers of small batteries, ceramic tiles, and wood products undertook large investments to expand capacity, based on demand estimates which assumed continued protection for their respective sectors. A syringe manufacturer was newly established in anticipation of continued tariff protection. As the only producer of syringes in Morocco, the firm invested in a plant with a capacity of one million units per year. With liberalization, market size and demand conditions deviated quite significantly from the levels projected by these firms. For example, with the slump in domestic demand as a result of the stagnant construction sector, the ceramic tiles industry had to compete with cheap "end-of-series" and second-hand imports from Europe. In small batteries, the market was flooded by lower quality products from China which sold at a fraction of the domestic price. In this case, liberalization put an end to a monopolistic structure whereby the local firm, with its two plantst was the sole supplier of small batteries. All of these firms were left facing a situation of low demand, excess capacity with capacity utilization rates as low as 30% to 40S, and high amortization and financial costs. Similarly, the syringe manufacturer was denied continued protection and a monopolistic position could not be secured. At present, this firm has huge excess capacity (80%) and very low productivity with the result that imports, being more competitive and cheaper, have captured a substantial share of the domestic market. The manufacturer of wood products, which exports 35S of its production, has had to face excess supply conditions abroad as well as keen competition from Korea and Indonesia, adding further to its difficulties. 1/ An analysis of the relationship of capacity utilization, output growth, and TFP growth is presented in Annex XI. - 69 - 5.42 All of these firms were financially profitable at the outset but lacked the necessary flexibility to adjust to the changing policy environment associated with liberalization. Other enterprises were already in poor financial health before 1984 as a result of deep structural problems. A company producing electrical appliances and light bulbs, for example, was financially insolvent before the trade policy reforms were introduced. In consequence, the company filed for bankruptcy in 1985. The reasons for failure lie in an inefficient structure of productionL, low quality of output, and high wastage as witnessed by a defective rate of over 501. An agro-industrial firm specializing in the manufacture of chocolates has been losing its market share in the last few years and has been experiencing continuous declines in capacity utilization since the late seventies. The sector was subject to liberalization, with quantitative restrictions reduced and tariff rates lowered marginally. The firm's management, however, identified smustling as the main source of its difficulties, rather than the liberalization program. Interestingly enough, smuggling activities seem to have shifted from alcoholic beverages to other luxury goods following the liberalization of the former. 5.43 In contrast, another group of firms demonstrated marked productivity growth as well as rapid expansion of output. Two of the firms interviewed, one in paper and abrasives, the other producing cotton yarn and textiles, are examples of dynamic firms which have achieved full capacity utilization, efficient use of inputs, and output expansion. Both enterprises produce high quality products. While the former is a new, small, export-oriented firm with modern technology, the latter produces for the domestic market and has recently launched an investment program to renew its technology. The firm is understood to be internationally competitive in terms of cost and quality. 5.44 A rapidly growing new exporting firm producing wearing apparel reveals a different picture. The firm has doubled its productive capacity and exports during the last few years, however, without accompanying high productivity growth. This may arise from the fact that the firm is operating at a high enough level of efficiency which makes its products competitive on an international scale. 5.45 To summarize, there are important indications of structural adjustment and the positive impact of reform efforts. For the industrial sector as a whole, the negative TFP growth in the 1980s is essentially the result of large declines in material productivity that offset the impressive capital and labor productivity gains. The uniformly negative growth in material productivity may dissipate once the underlying macro-economic causes are addressed, thereby enabling TFP growth and structural change to proceed apace. 5.46 International Competitiveness in a Dynamic Context. The comparative advantage of Moroccan industry is a reflection of the level of international competitiveness at a specific point in time, depicted by the Domestic Resource 1/ The manufacture of light bulbs requires high production runs and large markets given the massive economies of scale which characterize this industry. - 70 - Cost (DRC) ratio-V, and the relative change in competitiveness over time, indicated by the differential rates in TFP growth between Morocco and the rest of the world. Although a country has little control over the productivity performance of competitors, it can increase its own productivity growth. In Morocco, the issue of adjustment and growth for the future is how to maintain or engender a dynamic comparative advantage in manufacturing. 5.47 The relationship between international competitiveness and productivity performance is mapped in Table 5.10. Manufacturing activities are classified horizontally, according to the level of international competitiveness in 1982, and vertically according to productivity performance on the basis of average annual rates of TFP growth. The range of competitive, uncertain, and not competitive reflects possible biases due to aggregation problems, exchange rate imbalances, and levels of capacity utilization (see Annex XII). Activities that were estimated as not competitive in 1982 show improvements in their productivity performance, possibly as a result of increased import competition (or a perceived threat of competition) in electrical machinery, food products and metal products. Where the industrial policy and trade regime governing the sector has not changed, performance is Lagging. Table 5.10: COMPETITIVENESS AND PERFORMANCE OF MANUFACTURING P T _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __ .__ _ _ _ _ _ _ _ _ R 0 D Not competitive U Competitive in 1982 Uncertain in 1982 in 1982 C DRC < 0.8 0.8 < DRC < 1.2 DRC > 1.2 T I ___ _______ I V 32 < TFP < 2% Metal Products I Food T y 21 < TFP < 01 Beverages Electrical P Machinery R_ F Construction Transport Textiles and 0 Materials Equipment Knitwear R TFP < 01 Preserved Fruits Machinery M & Vegetables Paper A Wearing Apparel Chemicals and N Leather Goods Plastics Note: TFP growth for 1981-85; DRC 1978. / Annex XII describes the use of the DRC ratio to form a static impression of Morocco's competitiveness. - 71 - 5.48 Now then can Morocco's strong export performance in textiles, for example, be reconciled with the declining competitiveness of this subsector? The answer may lie in the bilateral arrangements with the EEC, which guarantee market access to exports of Moroccan textiles at the expense of lower-cost competition such as Korea. Exporting to a foreign market which confers a certain degree of preferential treatment is similar to producing for a protected domestic market. Moroccan producers who enjoy bilateral arrangements in protected EEC markets are able, for example, to transcend trade barriers and receive higher prices. The higher prices paid for Moroccan imports that enter the protected foreign market constitute a transfer to the Moroccan producer. The size of the rents captured by exporters would depend on the restrictiveness of the foreign market, the competitiveness of the domestic producer, and the distribution of these rents. Manufacturers that are not competitive by international standards might thus appear competitive in a protected foreign market. 5.49 The weak productivity performance of manufacturing activities which were competitive in 1982 suggests a possible loss of comparative advantage. Evidence from the industrial survey indicates, however, that this trend may soon be reversed. In the face of rising competition, expectations of further liberalization, and gradually diminishing levels of protection, improving economic efficiency has become a priority for individual firms. More than 50% of the firms interviewed have planned investments over the next two years to reduce energy consumption, improve management of personnel and inventories, and upgrade quality standards. About 20% of the firms have already undertaken similar efficiency-improving investments within the past two years which may not have given rise to productivity gains as yet. Producers of chemicals and pulp and paper, for example, have invested in electricity-saving measures resulting in a 20% to 302 reduction in electricity consumption. Some textiles and garments producers have invested in new equipment to improve and standardize the quality of their exportables. Similarly, a manufacturer of metallic cans has invested in a new technology to produce snap-top containers for indirect export. 5.50 The findings of the industrial survey also reveal a trend towards greater integration with world markets. A new awareness of movements in international prices and an outward-looking attitude among industrialists f'or example, has become increasingly visible. Firms which were 100% domestically oriented as late as 1985 have started seeking foreign markets with the intention of gradually shifting to exports. A company manufacturing wool-blend yarns exported 25% of its output in 1986 for the first timem, and an electronics firm producing televisions exported approximately 351 in order to circumvent the problems of depressed domestic demand conditions and saturated local markets. Firms specializing in the production of chemicals and office furniture also number among those enterprises "experimenting" in international markets. 5.51 The Moroccan manufacturing sector is presently subject to both changes in world prices and the political economy of trade restrictions in the EEC, Morocco's major trading partner. The mapping of competitiveness and performance shows, for example, that export industries such as textiles, wearing apparel, food processing and leather, might be losing in terms of - 72 - international competitiveness. If declining productivity attendant on high protective barriers persist, these industries may experience a sudden reversal of output and export growth. The enlargement of the EEC and the upcoming round of multilateral trade negotiations, moreover, could alter Morocco's ties to its traditional imarkets. 5.52 It is therefore essential that export industries strengthen their productivity performance so as to attain clear international competitiveness on the supply side. Trade policy should be used to encourage increased competitiveness by alleviating import barriers, and in particular, access to foreign exchange. The foundation for future gains in performance has been laid by the recent reforms, and the potential for further policy movement exists. At the same time, demand-side considerations are equally important. The likelihood of finding growth markets at home and abroad is greater with competitive market structures and a stable macroeconomic environment. The industrial and trade policy reforms of the future, as well as those recently implemented, will determine the scope of structural adjustment and economic growth in Morocco over the years to come. - 73 - VI. A FRAMEWORK FOR FURTHERING TRADE AND INDUSTRIAL POLICY REFORM A. Con s 6.01 Since the financial crisis of 1983, Morocco has successfully implemented an ambitious and extensive program of policy reforms which has initiated, in turn, a significant transformation of the underlying economic structure. The various analyses have shown that Morocco appears to be in the midst of a period of deep structural adjustment, manifest globally in the shift of the economy towards a more outward-looking and liberal orientation. The increasing importance of foreign trade in overall economic activity attendant on the diversification of exports should improve the country's ability to service its massive debt and withstand exogenous shocks, such as the recent decline in world demand for phosphates. The restructuring of Moroccan industry in line with a more market-oriented system of incentives should result in increasing international competitiveness and lay the basis for further industrialization and sustained economic growth in the future. 6.02 An evaluation of the impact of the liberalization program to date shows that the extent of adjustment has not caused excessive strain on the economy. From a macro-economic standpoint, liberalization does not appear to have unbearably exacerbated pressures on the balance of payments or government budget. This result is by no means fortuitous but resulted from judicious macro-economic management by Moroccan policy makers. Restrictive demand management and favorable exogenous developments combined with an active exchange rate policy to ensure that the liberalization of the trade regime did not provoke an unsustainable increase in imports. The importance of a flexible exchange rate policy to stimulate industrial exports and contain import demand, moreover, was demonstrated by econometric analysis. 6.03 On the other hand, the effect of tariff reductions on the budget served to reduce fiscal revenues in the short term and make stabilization targets more difficult to achieve. The liberalization program as originally conceived, however, anticipated these negative effects on the budget and proposed a set of compensatory measures to offset the shortfall in trade tax receipts. For various reasons (para. 2.23), the Moroccan authorities have been unable to implement the proposed or other measures to wean the fiscal system from its dependence on trade taxes. This was again evident in the decision to raise customs duties by 2.5 percentage points on all items whose tariff rate was less than 42.52, in order to compensate the Treasury for the loss in revenues which resulted from the reduction of the special import tax (SIT) from 7.52 to 51 in January 1987 mandated under ITPA II. It is clear from these actions that the fiscal impact of future trade policy measures must be evaluated carefully and deemed fully compatible with stabilization objectives before their implementation can be entertained. 6.04 The liberalization program appears to have the requisite support among the various constituent groups, not the least important of which is industry, which bodes well for future policy reform. The objectives of the program have been recognized and internalized by the relevant economic actors and many are already taking the necessary steps to prepare for the increased - 74 - competition expected to ensue from the further reduction in trade barriers. The successful outcome of an economic reform program is predicated on the ability to alter individual behavior by changing expectations. Reversals of programs already underway, however good the reasons, tend to erode Government credibility and increase the lag between the announcement of future policy reforms and the sollicited change in economic behavior. For this reason, it is essential to maintain the momentum of policy reform in Morocco. The intention of the Ministry of Industry to stay the course is manifest in the promulgation of the annual import liberalization program for 1987 and in its dealings with its constituents, most of whom expect future policy reforms to be implemented on schedule (para. 3.05). 6.05 Liberalization of both the trade and industrial sectors is having a significant impact on economic activity in Morocco. The extent of the reforms can be appreciated not only from the policy measures actually implemented (e.g. reductions in tariff and non-tariff barriers to trade) but also from the change in the structure of incentives. Narrowing the scope of fiscal and financial incentives in the 1983 investment code indicates a growing awareness by the Government that industrial promotion policies cannot be undertaken independently of budgetary concerns. Furthermore, it is evident that Government administrators are not attempting to vitiate these reforms in the course of their implementation. In fact, many of the firms interviewed during the industrial survey recognized the significant efforts on the part of the authorities to simplify trade procedures and expedite the international flow of goods and services, while emphasizing the need for additional progress, particularly in the area of Customs administration. 6.06 There is major evidence of the impact of liberalization at the macro, sectoral, and micro levels. For example, the increasing openness of the Moroccan economy is manifest in the growing share of foreign trade in economic activity. The reduction of the anti-export bias is evident from the strong manufactured export growth of the past few years and the increasing outwardness of industrial firms, many of which are exporting for the first time. As a result of trade policy reforms, the share of domestic production subject to quantitative restrictions has been reduced and temporary admission imports have grown substantially. Morocco's accession to the GATT places the Government's commitment to liberal trade policies in an international and enduring framework. Alleviating distortions in factor markets and realigning relative prices of capital and labor in accordance with factor endowments have led to a reduction in the bias towards capital-intensive activities. The strong performance of labor-intensive activities, particularly in exporting, and the gains in the productivity of both capital and labor in the industrial sector are important signs of structural change. The results of the industrial survey indicate the ways in which adjustment is taking place at the firm level, notably by shifting market orientation abroad, reducing profit margins, upgrading product quality, and increasing specialization. This process is leading to an increasingly diversified structure of industrial output and exports in line with Morocco's natural comparative advantage. 6.07 Finally, the Government has been able to implement difficult policy reforms without straining the social fabric of Moroccan society. With the onset of the financial crisis of 1983 and the evaporation of external sources of financing, it became clear that stabilization and adjustment could no - 75 - longer be postponed. The choice facing Moroccan policy makers was whether to take the lead in initiating the process on the basis of a well-conceived masterplan or to leave the economy to adjust on its own. They chose the former. Although structural adjustment entails some transitional social coats, the magnitude of these in the Moroccan context appears to have been tolerable. The fall in real wages was offset to some extent by a positive employment effect. The reduction in the anti-labor bias which has occurred since 1983 takes on particular significance in view of Morocco's relatively high rate of population growth. This constitutes an important structural change which will stand the economy in good stead over the medium-term to absorb the growing labor force. At the firm level, little evidence was seen of major bankruptcies and massive layoffs, indicating that the social costs of adjustment have been kept to a minimum. B. Issue for Putiure Pofliy Reform 6.08 It is clear that further liberalization of the trade and industrial regime can only proceed in an environment of macro-economic stability. Uncertainty as to the pace of stabilization and the ability to make use of the full range of trade policy instruments, most notably the exchange rate', casts some doubt on the extent to which liberalization can take place in the future. In 1986, the real effective exchange rate depreciated only marginally despite the removal of quantitative restrictions and the reduction of tariff barriers. The rise in import demand was absorbed owing only to a number of fortuitous external developments such as the dramatic fall in petroleum prices and the record domestic cereal harvest. The negative impact of the eventual elimination of quantitative controls on the trade balance should be counteracted by movement on the exchange rate. Insofar as most of the remaining items under quantitative restrictions are consumption goods which show a high level of notional demand (para. 6.21), failure to adjust the exchange rate to offset the, implicit appreciation linked to liberalization could have serious repercussions on the balanc3 of payments. 6.09 The worrisome fiscal situation, however, constitutes the greatest obstacle to structural change. The inability of the Government to mobilize fiscal revenues is at the root of the buildup of domestic payment arrears and the acute foreign exchange shortages that have plagued industrialists in their operations. If the speed at which the budget deficit can be narrowed proves to be incongruous with available sources of financing, then either inflation will mount or real interest rates will rise further. In the first case, price instability and balance-of-payments pressures linked to expansionary monetary policy will aggravate the climate of uncertainty in which industrialists operate, preclude further liberalization of the trade regime, and eventually require considerable movement on the exchange rate. In the second case, the massive recourse by the Treasury to domestic financial markets would begin to crowd out domestic investment. Rising interest rates fueled by high fiscal 1/ The political unpopularity of the dirham's downward slide was formally recognized in a speech by the King to Parliament in September 1985. - 76 - deficits have been cited as a major constraint to industrial adjustment, insofar as they impede the reallocation of resources from contracting to expanding activities and thus serve to frustrate structural change. Interest rates, however, cannot be adjusted independently of inflationary expectations or the underlying supply and demand conditions in the domestic credit markets. Rather, measures to increase public savings would serve to alleviate upward pressures on interest rates and is more in keeping with the Government's medium-term development framework, which is based on a strategy of private sector led growth and on a gradual withdrawal of the State from most couercially-oriented economic activities. 6.10 A favorable macro-economic environment is a necessary though not sufficient condition for additional structural reform. The potential for further trade liberalization and industrial adjustment is considerable. Trade barriers are still widespread and industry has not as yet been burdened with insurmountable adjustment costs in the form of extensive closures and mass unemployment. In addition, many enterprises are undergoing major restructurings in anticipation of further policy reform. To realize this potential, however, will require renewed efforts to rid the incentives structure of existing distortions. Although much progress has been made in liberalizing the trade regime, high levels of protection persist in important sectors, several of which are experiencing declines in productivity. Progressively exposing these industries to competition from abroad can induce higher rates of productivity growth in areas where a comparative advantage exists. The exit of sunset industries should not be hampered, so as to release productive resources to internationally competitive activities. The Government should nevertheless ensure that transitional costs are not socially unacceptable by facilitating the mobility bf factors and alleviating periods of temporary hardship. 6.11 Another isaue relates to the political economy of future industrial reform. There is a general consensus among industrialists and ministry officials alike that industry is bearing the brunt of adjustment, while sectors such as mining, agriculture, transportation (owing to internal regulations), and banking face little incentive to become more competitive. Industrialists consider the inter-sectoral fiscal burden inequitable in view of the high legal tax rates on domestic corporate profits compared to the broad fiscal exemptions granted to agriculture. The oligopolistic nature of the banking sector, for example, has reportedly led to higher than normal margins which, in turn, serve to keep lending rates high. It is becoming increasingly evident that support by industry representatives for further trade and industrial policy reform in Morocco will depend on the perceived extent of adjustment efforts in other major economic sectors. 6.12 At this juncture, it may be concluded that the determinant of future liberalization efforts is more likely to be the speed at which stabilization can proceed rather than the capacity of industry to adjust. In this vein, efforts to bring the budget deficit into line with available resources and to increase the availability of foreign exchange must be intensified in order for liberalization to proceed. At the same time, the timing and sequencing of liberalization measures take on added importance. The impact of policy reforms on both the budget and balance of payments should be carefully assessed to ensure consistency with macro-economic considerations. There is - 77 - still some scope for introducing measures which will have positive resource allocation effects without causing excessive pressures on the budget. However, these measures imply continued recourse to a flexible exchange rate policy. 6.13 One final strategic consideration is the need to structurally reform the budget so as to enable the use of tariffs as the principal instrument of trade policy and industrial protection. As previously discussed, the fiscal system remains overly dependent on trade taxes. To reduce this dependence, the structural reform of the fiscal system must continue and more neutral sources of revenue vis-&-vis foreign trade be identified. Modification of value-added tax rates to compensate for shortfalls in trade tax revenues is but one possibility. Closing loopholes and reducing exemptions to prevent a further erosion of the tax base will increase the buoyancy and equity of the fiscal system, while providing a more stable source of revenues. Fiscal authorities have recognized the structural weaknesses in the tax system and are presently working with the Bank to resolve these issues1'. C. R m 6.14 In view of the uncertain fiscal situation, the following sequencing of future trade policy reform is recommended. The Government should proceed with the complete elimination of all quantitative restrictions as rapidly as possible but no later than end-1988 as originally agreed under ITPA. This will entail the transfer of all products from List B to List A, thereby effectively abolishing the import licensing regime. Agricultural goods are being handled separately in a parallel operation. The tariffs on these liberalixed items should be correspondingly adjusted within existing bounds to provide the requisite interim protection in anticipation of the generalized tariff reform. 6.15 The substitution of quantitative barriers by tariffs has a number of generally recognized advantages. First, the use of a tariff rather than a quota serves to maintain a constant rate of protection in spite of changes in world technology. Domestic industry is therefore prodded to increase factor productivity in line with improvements in international competitiveness in order to compete at the given level of protection. From the survey, it was evident that the impact of both the reduction in protection and the substitution of price restrictions were strongly felt at the enterprise level. Second, the tariff can be used to afford just the amount of protection deemed necessary to enable domestic industries to compete. Unlike quantitative controls, the tariff does not sever the link with shifts in world demand and supply conditions. To this effect, it is a more appropriate instrument than the quota which provides an indeterminate amount of protection and usually more than the industry needs. Third, protection which is afforded by quantitative restrictions rather than by tariffs deprives the State of an important source of revenue which is most likely captured by the importer. The loss of Treasury revenues which derives from the quantitative control has served to aggravate the budget deficit and contribute to macro-economic disequilibria in Morocco. 1/ For a comprehensive discussion of fiscal issues in Morocco, see Morocco: Public Finance and Economic Growth, World Bank mimeo, March 1986. - 78 - 6.16 There exists enough scope in the present tariff structure to afford sufficiently high levels of protection to most industries which have yet to be liberalized. In specific instances where tariff protection is inadequate, exceptional measures could be envisaged provided the rationale for additional protection is justified and a timetable for its eventual elimination is agreed. Such an approach is not without risks, however, and might give rise to political pressures for reference prices and surtaxes. This could, in turn, erode Government credibility and undermine the reforms already in place. The transfer of certain items may result in an increase in import demand by virtue of a fall in the notional price of the good. If the higher deuand cannot be offset by an upward adjustment of the tariff within the limits of the tariff structure, then movement on the exchange rate will be necessary to preserve balance-of-payments equilibrium. 6.17 The layering of the various trade taxes and the cascading nature of the present tariff structure militate in favor of a thorough rationalization of the trade tax structure. First, the myriad taxes on international trade should be homogenized into a single levy. Ideally, the special import tax and the stamp tax should be integrated into the customs duty, which would heretofore constitute the sole instrument of protection. Flexibility should be shown concerning movement in the present structure of tariff rates, Including eventually a temporary suspension of the maximum nominal rate, to enable a complete integration of the tariff structure in the immediate without provoking a fiscal backlash. Second, the tariff nomenclature should be substantially simplified. The Moroccan tariff code is one of the most detailed in the world; its degree of complexity is unwarranted in practice insofar as more than one third of the tariff lines shows no evidence of trade. Simplification of the tariff code is awaiting ratification of the International Harmonized System (IHS) by certain members of the industrialized world. In the meantime, Customs authorities should begin to streamline the nomenclature to avoid delays in implementation once the IRS is adopted. Third, the degree of nominal, and hence effective, protection should be rationalized with a view to eliminating the cascading nature of the present tariff structure and reducing dispersion. A provisional tariff structure should be prepared that is consistent with the objective of establishing a 252 maximum level of protection. Fourth, there should be no special regimes other than the temporary admissions scheme that grant exemptions of customs duties on imported goods. This will increase the transparency of the tariff structure, reduce dispersion among rates, and help ward off pressures from special interest groups. In the future, the relative tariff rate structure should be adjusted in response to trade and industrial policy concerns rather than being driven primarily by fiscal considerations. The revenue impact of changes in individual tariff rates induced by protection considerations, however, should be fully taken into account. On the other hand, short-term panaceas to shortfalls in Government revenues, such as instituting a minimum tariff without regard to its effect on incentives, should be avoided. Such measures limit the room for maneuver in the future within the structure of protection, distract attention from the underlying structural problems of the fiscal system, and increase uncertainty among industrialists and traders. 6.18 A need for technical assistance and material support has been identified to ensure the smooth implementation of future trade and industrial policy reforms. In the context of the ITPA program, a committee for the - 79 - simplification of trade procedures was established to identify ways in which to facilitate the international exchange of goods and services at all levels. This includes computerization of data interchange, an enhanced role for the banking community in operations involving international trade, and further improving the efficiency of Customs operations. In addition, technical assistance should be made available to Customs authorities to expedite the preparation of a provisional target tariff structure and to the Ministry of Industry to identify and implement safeguard measures that are appropriate to the Moroccan context. An independent commission representing the national interest should be established to rule on allegations of dumping and exceptional requests for protection. This kind of institutional arrangement will reduce discretionality and ensure that the adopted safeguards are not abused by special interest groups. The regulatory environment in Morocco warrants further study to ensure that adjustment is not being hampered by constraints on internal trade-'. Finally, careful monitoring of the impact of future trade and industrial policy reforms is clearly warranted. The staff of the statistical unit in the Ministry of Industry, although competent in statistical techniques, lack the necessary manpower and material support to process the large amounts of data collected in the context of the annual industrial census. To fully evaluate the impact of liberalization on total factor productivity growth, for example, the data base created for the present study should be routinely updated and subject to future analysis. It is therefore recommended that Industry staff be equipped with micro computers and trained in economic data collection and processing in order to carry out the monitoring and evaluation of structural change on the economy. D. Policy Simatio 6.19 The Model of the External Sector. A small model of the external sector was constructed to estimate the effects of hypothetical changes in policy variables on the balance of payments and Government budget. The results of the external sector model were integrated into the medium-term framework of the Moroccan economy developed in the context of the March 1987 Consultative Group meeting''. All policy simulations were based on a five-equation econometric model3' comprised of three import demand functions for consumption, investment, and intermediate goods respectively; one export demand function for manufacturing goods; and a partial trade balance identity for the aforementioned categories. The base year for all simulations is 1985, the latest period for which the requisite information was available. The primary objective of the policy simulations was to estimate the movement in relative prices necessary to maintain a constant trade balance in the face of further liberalization. The fact that 1985 cons'.itutes the base year is not problematic, however, insofar as the real exchange rate remained virtually constant in 1986 with respect to the previous year and simulation results will be presented in terms of changes rather than levels. 1/ The influence of the regulatory environment on the activities of the leather sub-sector was recently investigated in a forthcoming Bank report on industrial organization in Morocco, viz. Morocco: Enterprise Development Study, World Bank Mimeo, January 1988. . 2/ See Morocco: Issues for a Medium-Term Structural Adjustment Program, 6608-MOR. 3/ This model is fully described in Annex V. - 80 - 6.20 Simulation-related Assumptions. The policy simulations are based on a number of underlying hypotheses. The growth rates of the activity variables in the three import equations, via. ag£regate consumption, aggregate investment, and industrial productions , have been taken from the medium-term framework assumptionsk'. The growth of world demand, the activity variable in the export demand equation, is based on World Bank projections of the global economic outlook. Changes in quotas and relative prices reflect exogenous policy assumptions. Goods outside the functional categories used in the model are considered to be exogenously determined in the simulationso consequently, they are not affected by variations in the real exchange rate or changes in non-tariff barriers to trade. In sum, the impact of variations in the real exchange rate on agricultural and raw material imports on the one hand and non-manufacturing exports on the other is assumed to be negligible. 6.21 Elimination of Non-tariff Barriers. The effect of the complete removal of all quantitative restrictions was estimated for 1987. There is no impact on manufacturing exports and imports of intermediate goodslV. The import of capital goods increases by DR 158 million (1976 constant prices) in 1990, a 6X increase with respect to the base case. On the other hand, the repeal of QRs on all consumption goods results in a significant rise in imports: DE 1,099 million by 1990 or an increase of 751 compared to the base year. The overall trade balance for those items simulated worsens by US$329 million (1986 dollars). Trade tax revenues rise by approximately 222 in nominal terms. 6.22 Compensatory Devaluation. The trade balance is fixed at its 1985 level. The trade regime is as it was in 1985. The compensatory devaluation required to maintain the trade balance constant following the abolition of quantitative controls was then calculated. Insofar as the devaluation affects certain categories of exports in addition to import demand of liberalized items, the magnitude of the devaluation which leaves the trade balance unchanged is less than that required to offset the increase in imports resulting from the elimination of quantitative controls. Results show that an initial 11.71 devaluation is necessary to maintain a constant trade balance, rising to 14.2% by 1990. The devaluation is particularly felt on exports, which increase by DR 173 million or 211, compared to the simulation where quotas sre lifted with a constant real exchange rate; and on the import of consul,ir goods, which decreases by DH 288 million or 131. Trade tax revenues increase by over 171. 6.23 Tariff Reduction. The effect of eliminating the special import tax and the itamp duty was simulated independently of changes in non-tariff barriers. The deterioration in the trade balance was found to be approximately DH 645 million w4th respective increases of 1.5%, 3.71, and 10.51 in the import of intermediate, capital, and consumption goods, with 1/ Imports of semi-finished products have been taken to exclude fertilizers which are related to agricultural production. Demand for other semi-finished products is mostly a function of industrial production. I/ RMSM high-growth scenario #21 V/ See Annex V. - 81 - tariff revenues falling by 1B% A compensatory devaluation of approximately 7-8% would be necessary to leave the trade balance unchanged. This is less than the 10% change in relative prices which derives from the tariff adjustment as a result of the export response. 6.24 Tariff Increase and Comoensatory Devaluation. In view of the reluctance to pursue an aggressive exchange rate policy by the Moroccan authorities in the immediate future, the use of tariff increases to mitigate the extent of the devaluation required to offset quota removals was considered. The trade balance was fixed at its 1985 pre-quota elimination level. The compensatory devaluation was exogenously set at 5%. Results of the simulation indicate that an across-the-board tariff hike of 8% in 1990 would be necessary to maintain the trade balance constant after a 5% depreciation of the real exchange rate. In this simulation, a wedge is driven between the real exchange rate for exports and that of imports, As a result, the increase in exports by 1990 is much less pronounced (7.5%), while the decline in the import of consumption goods is now equal to 18%. In this scenario, tariff revenues increase by over 30% in view of the higher import tax rate.