Report No. 4093-CO F ECe Colombia ~~ Manufacturing Sector Developments and Changes in Foreign Trade and Financial Policies (In Two Volumes;) Volume 1: Summary Report January 21, 19B3 Projects Department Latin America and the Caribbean Regional Office FOR OFFICIAL USE ONLY Document of the World Rank This document has a restricted distribution and may be used by recipients only in the performance of their official duties Its contents may not otherwise be disclosed without World Bank authorization CURRENCY EQUIVALENTS 1/ Currency Unit = Colombian Peso (Col$) US$1.0 = Col$70.11 Col$1.0 = US$.0143 Col$1.0 million = US$14,164 GLOSSARY OF ABBREVIATIONS ANDI Asociacion Nacional de Industriales (National Association of Manufacturers) ASOBANCARIA Asociacion Bancaria (Banking Association of Colombia) BR Banco de la Republica (The Central Bank) CAF Corporacion Andina de Fomento (Industrial Financing Agency of Andean Common Market) CAT Certificado de Abono Tributario (Tax Rebate Certificate for Non-traditional Reports) DANE Departamento Administrativo Nacional de Estadistica (National Statistical Office) DNP Departamento Nacional de Planeamiento (National Planning Office) CDTs Certificados de Deposito al Termino (Certificates of Deposit) CEPAL Comision Economica para America Latina (United Nations, Economic Commission for Latin America) CFs Corporaciones Financieras (Investment Banks) ECOPETROL Empresa Colombiana de Petroleo (National Petroleum Company) FEDESARROLLO Fundacion para la Educacion Superior y del Desarrollo (Economic Research Institute in Bogota) FFI Fondo Financiero Industrial (Industrial Financing Fund) FIP Fondo de Inversiones Privadas (Private Investment Fund) IFI Instituto de Fomento Industrial (Official Industrial Development Bank) IFS International Financial Statistics, Published by the Inter- national Monetary Fund (IMF) 4 INCOMEX Instituto Colombiano de Comercio Exterior (Colombian Foreign Trade Institute) PROEXPO Fondo de Promocion de Exportaciones (Export Promotion Fund) PV Plan Vallejo (Import Drawback Device for Exporters of Non-traditional Products) UPACs Unidades de Poder Adquisitivo Constante (Indexed Investments Issued by Savings and Loan Associations) I/ December 31, 1982 FOR OFFICIAL USE ONLY TABLE OF CONTENTS VOLUME I SUMMARY REPORT Page No. I. Summary and Recommendations. .......................... 1 II. FOREIGN TRADE INCENTIVES AND MAJOR SECTOR VARIABLES A. Patterns of Trade and Industrial Growth............... 3 B. The Foreign Trade Incentive FramewoAk ................. 5 C. Export Development: Structure and Rissponse to Incentives ........................... ............ 11 D. Foreign Trade Incentives, Industria'L Development and Policy Options ...*..... 0........................ , 15 III. FINANCIAL POLICIES AND INDUSTRIAL DEVELOPMENT E. Financial Policies, Interest Rates and Resource Mobilization ............... .....I*................ , 21 F. Industrial Finance: Problems and Prospects... ......... 24 IV. INDUSTRIAL SECTOR DEVELOPMENTS AND SPECIFIC ISSUES G. Investment, Productivity, Wages and International Competitiveness ..... ........... ,, .. ... 29 H. Textiles and the Problem of Import liberalization ..... 32 I. The Metal Mechanical Industries ....................... 36 This report Ls based on the findings of a mission which visited Colombia in September 1981. This mission comprised Messrs. J.P. Wogart (L(JPI2); J. Hanson (IND);; A. Sandig (IND); D. Von Stauffenberg, (CLI); D. Morawetz, J. Escandon, and C. Velez (Consultants). This document has a-restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization, I. SUMMARY AND RECOIMENDATIONS 1. During the last decade, Colombian industrial development has been quite successful in terms of growth of output, employment, and exports of manufactured products. Since 1980 however, various external and internal factors have been slowing down development. Thus, it appears an opportune moment to assess industrial strategy for the decade of the 1980s. The Industrial Sector Mission that visited Colombia in August/September 1981 focussed principally on: (a) reviewing the manufacturing sector's problems and prospects, with particular emphasis on the current state of international competitiveness of some major subsectors; (b) analyzing foreign trade policies and, the impact they have on the performance of the manuf acturing sector; (c) examining financial policies and thEir relation to the financial structure and needs of marLufacturing enterprises; (d) identifying technical and financial measures to improve the manufacturing sector's performance in the years to Come . The mission's review was concerned particularly with the relationship between changes in the external sector incentive framework and their impact on manufacturing sector development. In addition., an attempt was made to analyze the fiLnancial structure of firms in manufacturing and to evaluate the impact of recent financial sector reforms on industrial financing and on investment. Subsector analysis concentrated on two branches wh:ich were among those most affected by the changes in the export incentive system and the move toward imnport liberalization, viz. textiles and garments, and the metal-mechanical industries. 2. The report explores the links between foreign trade incentives and major variables in the manufacturing sector: output, prices, exports and employment. It finds that changes in these variables have been significantly influenced by Colombia's foreign trade strategy, and it suggests that improvements iin trade policies should lead to improvements in manufacturing sector performance. The manufacturing sector has generally been able to maintain its iinternational competitiveness in operational terms during the late 1970s, suggesting that further import liberalization can be undertaken with some conf-idence provided that an appropriate exchange rate regime prevails. Analysis of two principal subsectors which have already faced strong competition from imports supports this view. 3. The recent slowdown in growth and the accompanying difficulties encountered by the sector have led to renewed protection measures and - 2 - increased credit at below market rates. While a more inward-looking policy with increased interventions might help to stimulate production in the short run, it is suggested that a more forceful orientation towards an open economy is desirable from the medium and long-run perspective. In order to achieve higher growth, enlarge employment opportunities, and stabilize export earn- ings, the general recommendation of the mission is to remove progressively the most important distortions in trade and financial systems as part of a carefully phased medium-term program. More specifically, the report suggests: (i) to give greater incentives to exporting via maintenance of a real effective exchange rate, which makes manufactured exports more profitable than currently. This policy is even more necessary than in the early 1970s, given the changing conditions in international markets and the prevailing recessionary conditions. The changing composition of manufactured exports regarding subsectors and countries of destination as well as the difficulty of predicting future exports suggest that concentrating on specific export incentives would be less effective than maintaining on a favorable exchange rate (paras. 22-24, 31-34). (ii) to expand imports along with exports, in order to limit inflation and to take full advantage of specialization. This would require rationalizing import protection by gradually lowering tariffs on most consumer goods, while raising the effective protection on capital goods by reducing the numerous special exemptions from tariffs. More importantly, it would require a renewed attempt to liberalize the prior licensing process. This rationalization process would be facilitated by a more favorable real exchange rate. Evidence from the recent import liberalization attempts points towards a positive impact, in terms of increased output and lower inflation, on those sectors where imports entered more freely (paras. 28-30, 35-36). (iii) to follow through with a more outward directed policy within the Andean Common Market; this would be in line with Colombia's recent attempts to set the integration movement on a new course. Colombia has greatly increased trade with its Andean Group neighbors, but the expansion of its manufactured exports appears to be largely unrelated to the specific trade preferences of the Andean Common Market. Since regulations for foreign investment and integrated industries seem to have had a dampening effect on industrial investment and output, the report suggests that current regulations be revised and that greater private sector participa- tion be stressed in new directives for regional development (paras. 25-26). (iv) to relax limitations on external capital inflows and to reduce forced investments and reserve requirements of the financial system in order to lower interest rates. To dampen potential inflationary consequences of these measures, import restrictions must be eased and the fiscal deficit controlled (paras. 51-52). - 3 - (v) to consider the gradual phaseout of the subsidy elements of the special lines of credit, since their impact on industrial concen- tration seems to be significant. It would also be beneficial to adjust the corporate accounting and tax systems to recognize more fully the role of inflation and reduce distortions (paras. 48, 53). The proposed measures are likely to: (a) stimuLate relatively more labor intensive industries and with it increase employment in manufacturing and related sectors; (b) reduce inflation through enforcing increased competition in highly protected sectors; (c) diversify the export base of the country and with it stabilize export receipts and expand ilts import capacity; and (d) help to increase the GNP growth rate above whal: it otherwise would be. While a detailed projection of the recommended policies' results will require more information than that examined in this report, there is a strong presumption that reverting to protectionism wi;Ll have a negative impact on the major macroeconomic and sectoral variables. 4. Implementation of the various recommendations made in this report will require careful planning and phasing in view of their macroeconomic significance and interrelationships. While the recommendations in organiza- tion and procedural areas, such as the streamlining of the import drawback mechanism and adjustment in accounting procedures, could be implemented quickly, the major recommendations will need to be implemented progressively over two to three years, following extensive consultations among the different branches of Government and the private sector. The phasing of the external tariff simplification and unification program is of special importance. Removal of the anti-export bias of Colombian manufacturing requires a careful coordination of exchange rate, export promotion and import liberalization measures. Similarly, the remova.l of distortions in financial markets as they affect industrial activities have to be introduced in sequence and in coordination with the trade policies. II. FOREIGN TRADE INCENTIVES AND MJOR SECTOR VARIABLES A. Patterns of Trade and Industrial Growth 5. In the last 20 years, Colombia has been transformed from a predominantly rural and agricultural economy to a more urbanized and industrialized economy, with a labor force which is increasingly employed in services and manufacturing activities. Interdependence has growl between Colombia and the fully industrialized centers of the world economy, and it is increasing with the neighboring countries of the Andean region. While econo- mic growth has fluctuated over the last 30 years, it has general:Ly been strong, averaging about 5% p.a. in real terms. Manufacturing has been one of the leading sectors, with its rate of growth consistantly outpaci.ng GDP growth by approximately 1% per year since 1950. 6. Since! import substitution and export promotion policies have had a major impact oln promoting the manufacturing sectors in developing countries, researchers have attempted to measure the contribution of each st:rategy to economic growth and employment. Table 1 links the growth in the Colombian manufacturing sector for the 1953-79 period to the various sources of demand - 4 - changes. 1/ Up to 1967 Colombia pursued an import substituting growth strategy (ISI), with the ratio of industrial imports to gross output falling continuously. As is usually the case, most of the measured growth occurred in the early years, when increased local production in such traditional ISI type investments as steel and chemicals came on stream at protection inflated prices. Over the latter portion of the period (1963-67), import substitution slowed substantially in the manufacturing sector, although the foreign exchange crises of 1965 and 1967 and their accompanying quantitative restrictions produced a further decline in the ratio of total imports to GDP. The easy stage of import substitution had passed, with capital and import intensive sectors dominating an industrial development suffering from foreign exchange scarcity. The fall in coffee exports also depressed the domestic demand, which, together with lack of inputs, generated excess capacity in industry. This latter stage of the import substitution strategy coincided with the lowest average rate of aggregate growth between 1953 and 1980. Table 1: SOURCES OF INDUSTRIAL OUTPUT GROWTH 1950-66 1967-74 1974-79 Real Annual Growth in Manufacturing Value Added 6.2 7.6 6.4 Percent Growth due to Import Substitution 22 -4 2 Percent Growth due to Export Diversification 7 10 4 Percent Growth due to Domestic Demand Expansion 60 ) ) Change in Input-Output Coefficients 11 ) 94 ) 94 SOURCE: H.B. Chenery, Interactions between Industrialization and Exports, American Economic Review (May 1980) and Table 8, Vol. II. 7. In contrast to the early 1960s imports grew faster than domestic output during 1967-74. Thus, import substitution's contribution to growth became negative for the economy as a whole as well as for the manufacturing sector. The most striking characteristic was however the rapid growth of exports. Stimulated by favorable world economic conditions and a number cf monetary and fiscal incentives, as well as a more realistic exchange rate policy, export growth accounted for an increased fraction of growth in domestic output. Manufactured exports rose from US$25 million in 1967 to US$400 million in 1974, climbing rapidly from 3% of industrial production in 1970-71 to close to 10% in the mid-1970s. While less important than the strong expansion of internal demand, exports of manufactured goods were a driving force behind the high rate of industrial growth, which averaged 7.6% between 1967 and 1974. At the same time, manufacturing firms increased employment by over 20,000 per year, increases many of which were created in the export intensive branches of industry. 1/ For an explanation of the analysis and a more complete discussion, see Vol. II, Chapter III. -5- 8. The export drive lost much of its impetus after 1974. Manufacturing exports expanded modestly, with both their share in world exports and GDP declining from the peak reached in 1974. At the same time imports of indiustrial goods were held down--at least until 1979--with their nominal and rieal share declining as a percentage of GDP. Manufacturing output nonetheless continued to grow at an average of 5.5% between 1975 and 1980. This was made possible by the rise in coffee prices, and to a lesser extent by the drug boom, which stimulated domestic demand in a captive market between 1976 and 1980. While gains in output growth, improvements in real wages, and reLatively low unemployment were positive signs, the rate at which the manufacturing sector generated new jobs in 1975-79 was only about half of that during 1970-74. 9. In early 1980, the economy began to slow down. The fall in export growth and high interest rates lowered the growth in real aggregate demand and forced the manufacturing sector to contract. Sluggish aggregate demand led industrial enterprises to reduce capacity utilization by 10 percentage points, rendering new investment unprofitable. More recently, high interest rates and low profitability have also added to industry's relucl:ance to undertake investments. Foreign investment, which had contributed significantly to the import substitution phase of industrializal:ion in the 1950s and 1960s, had already slowed down in the 1970s. Even the increased foreign investment applications during 1979/80 barely went beyond the needs for maintaining the real value of the capital stock. 10. Struck by the first serious recession in over 15 years, the manufacturing sector as a whole and a number of important branches in particular have requested and received higher protection and favorable credit conditions. During the first semester of 1982, the most important trade and financial measures included the complete prohibition of textile imports and the opening of new credit lines at below market interest rates for capital goods. Currently, an increased number of imports are shifted from free to previous license, and import tariffs are to be raised by 20%. While it is too early to measure the impact of these policies, it can be expected that they will be of some benefit to industrial producers in the short run. On the other hand, it is likely that they will also have an inflationary effect on the economy. In the medium run, even the positive effects can be expected to disappear, once the distortionary effects of increased protection and credit subsidization divert significant: amounts of resources from the rest of the economy. B. The Foreign Trade Incentive Framework 11. Colombian imports have been restricted by a combinaticin of select- ive licensing, tariffs, prior deposits and exchange controls. The prior license has remained the most important form of protection. Until 1981 the percentage of tariff code classifications subject to licensing was steadily falling from over 95% in 1971 to 66% in 1975 and to about 31% in 1980. Prior licenses continued to be used for some agricultural products and. to protect the textile and wood products industry. Although almost 90% of requests for permission to import were approved in 1980, the likelihood of being rejected for such reasons as overly high prices (possible overinvoicing), overly low prices (dumping), or excessive requests relative to historic levels of imports or to local supplies, inhibited many potential imports. Nominal Colombian tariffs averaged 26% (unweighted) following the revision of protection in mid-1979, according to the most recent estimates. This average level was close to the Andean Pact's common minimum tariff, which has not presented a barrier to cuts. The tariff schedule showed substantial dispersion around the average, the standard deviation was 17.7%, and the distribution was skewed toward higher levels, with some tariffs being as high as 150%. In addition to tariffs, imports were subject to prior deposits (consumer goods and inputs) and to a 5% fee to finance PROEXPO loans. The rise in this fee offset much of the cut in average tariffs between 1970 and 1980. 12. No current study is available of effective protection estimates based on comparisons of local and world prices of importables. Using only the legal import tariffs and the input-output tables, average (unweighted) effective protection was computed to be 44% in the second semester of 1979. The standard deviation was 40% and the distribution was sharply skewed, with maximum rates of 400% and minimum rates of -46%. The highest nominal and effective rates apply to consumer goods and transport equipment, with average effective rates of protection being more than double the nominal rates (see Table 2). Average effective rates are 30% to 50% higher than nominal rates in other industrial sectors. The consumer goods sector is also subject to prior deposits, which are not included in these estimates of effective protection. While the machinery sector shows the next highest effective rates, the estimate neglects the Global License Facility and public sector purchases, which allow imports of capital goods at only a 5%, or even a zero, nominal tariff rate. Mission estimates indicate that the machinery sector faces mxLch more international competition than implied by Table 2; in some cases it experiences negative effective protection (see Vol. II. Chapter III). Finally, primary products are shown to have the lowest nominal and effective rates of protection, although direct price estimates for a few products indicate that their actual protection was quite high because of the effect of prior licenses. Table 2: IMPORT PROTECTION OF MANUFACTURING 1975 AND 1979 Nominal Protection Effective Protection Items Under Prior License 1975 1979 1979 1975 a/ 1979 % % % % 0' Primary Products 19 15 24 53 20 Consumer Goods 47 39 81 48 49 Intermediate Products 24 20 29 43 18 Machinery 28 27 39 66 30 Transport Equipment 40 34 75 89 91 All Imports 36 26 44 66 40 a/ Information of first three items under prior license are for 1978. SOURCE: Statistical Appendix, Table 12. -7- 13. In order to lower inflationary pressures, which began in the early 1970s and became stronger with the export and foreign exchange surplus after 1974, successive governments have started rather hesitantly to open up the economy to international competition. On average, nominal and effective protection declined after 1975, although these cuts were partiaLly offset by the rise in PROEXPO fees and the re-imposition of prior deposit:s. The percentage of imports on the free list rose after 1974, the delays in responding to import requests were cut, and the proportions of approved requests for licensed imports were maintained at roughly 90% of applica- tions. Prior deposits, which were cut in early 1982, already had a lower average cost in the second half of the seventies than in the first half. However, the average ratio of legal imports to GDP was actually lower in 1975-79 than in 1970-74, and rates of effective protection are still uneven, with a number of consumer goods enjoying rates of 60% or more, while many capital goods suffer from negative effective rates of protection. 14. In [980, imports did rise sharply as a percentage of GDP, but 70% of the increase was composed of petroleum and petroleum products, capital goods, and transport equipment. Increased world prices and subsidized internal prices combined to raise petroleum imports; government imports under the Public Investment Plan (PIN) and the use of the Global License Facility, particularly by petroleum companies, increased demand for foreign machinery and equipment, a liberal interpretation of import prohibitions by INCOMEX temporarily aLlowed vehicles to enter the country. Some of the 1980 rise in imports may also have resulted from speculation that the liberal treatment of requests for iimports and the favorable exchange rate would soon end because of the unfavorable current account. Thus, most of the recent increase in imports has been due to special factors and policies, which have already been reversed,, and to specific types of liberalizations, usually in areas which do not compete with imports. 15. Colombia's shift from import substitution to export promotion in the late 1960s was stimulated by various policies and incentives, including tax rebates (CAT), import drawbacks (Plan Vallejo), low interest, rate credit, and most importantly, a crawling peg system for the exchange rate. The CAT is a tax certificate valued at a given percentage of the value of exports that is issuecl to the exporter, who may sell it at a market-determined dis- count rate on the stock exchanges or use it to pay domestic taxe!s and duties at maturity. The cash value of the incentive is determined by t:he percentage of export value granted as CAT, the market discount rate, and the marginal tax rate of the owner. As the total volume of CATs cost the Treasury about US$90 million in 1974, the tax rebate was reduced from 15% of export value to 1% for most agricultural and mining products, 5% for a large portion of industrial products, and to 7% for other nontraditional products, leading to a weighted average CAT for all nontraditional exports of about 3.9% of export value during 1975 and 1976. In 1977 and 1978, the CATs were raised in an attempt to compensate for the lagging exchange rate devaluation, and four different rates were established, with some industrial products receiving 12%. Between 1977 and 1981, further changes oE CAT percentages were imple- mented, which raised the weighted average CAT to 7% with some industrial products receiving 12% of export value. FinalLy in 1982, CATs for - 8 - agricultural products were raised significantly to compensate for low international prices. As a consequence, the average weighted export tax incentive was about 11% for all nontraditional export products in late 1982. 2/ 16. A number of reasons for the implementation of the above changes in the level and structure of CATs have been given by the authorities. These reasons have changed over time and have not always been consistent with each other or with the actual CAT system. The most important reason for the introduction of CATs was the objective of providing exports with an overall compensation for an overvalued exchange rate; consequently, an across-the-- board CAT was established for all nontraditional exports. The drastic reduc- tion in CAT rates in 1974, on the other hand, was based on the objective of reducing the budget deficit. After 1974, the strong differentiation of CAT percentages and their frequent changes reflect the desire to use the CATs as a more finely tuned instrument of export promotion. The authorities attempted to stimulate exports with high domestic value added, labor intenr- sive exports, and products coming from less developed regions of the country; on the other hand, exports with insufficient or variable domestic supply or with good potential in foreign markets were granted a low CAT. 17. When the CAT incentives were curtailed in 1974, the supply of sub- sidized export credit from PROEXPO was expanded, and new credit lines were added. Between 1974 and 1978 credits to industrial exports rose from US$101 million (26% coverage) to US$416 million (78% coverage). The expansion of PROEXPO credit was made possible by increasing the import surcharge from 1.5% to 5%, representing about 20% of total tariff revenues. Export credits are granted through three major lines, including short and medium-term pre- shipment credit in national currency established in 1972 and 1974, and a short-term post-shipment credit line in US dollars that was established in 1975. The increasing coverage of PROEXPO credit has provided liberal provi- sion of export credit financing. While the authorities' monetary policy has aimed at restricting the expansion of domestic credit since inflation acceLe- rated in 1967-77, the increasing availability of credit from PROEXPO contri- buted to relieve the tight credit situation faced by the industrial sector. As the authorities consciously attempted to compensate for the lagging exchange rate movement with more favorable lending terms, the differential between PROEXPO interest rates and the interest rates charged by commercial banks have become wider. In 1980, the level of the PROEXPO credit subsidy reached 7.5 cents for every dollar of exports. Since the subsectoral distri- bution of PROEXPO credit was quite similar to the actual percentage composi- tion of exports by product categories, the interest rate subsidy operated as an across-the-board incentive. 18. The import duty drawback system known as Plan Vallejo constitutes the oldest instrument of export promotion for manufactured exports. Under this scheme, export manufacturers establish contracts with the Goverment Eor 2/ For a detailed analysis of these and other export incentives see Vol. II, Chapter I. -9- the import of inputs and machinery free of import duties and ot'her import charges. Nearly half of all nontraditional exports in 1977-78 benefited from duty-free imports under Plan Vallejo, compared to a little over one-third in 1974-75. By providing access to inputs at international prices, Plan Vallejo reduces the costs of exporting enterprises that might otherwise be forced to use domestically produced inputs at higher prices. It is estimated that the cost reduction achieved by Plan Vallejo users during the period 1972-76 averaged about 6.5 cents per dollar of exports. Given the recent differences in external and domestic price trends, it is likely that the cost reduction in later years was somewhat higher. Plan Vallejo has thus provided a benefit to nontraditional exports by reducing the disincentives inherent in the import protection system. Moreover, the benef'its provided under Plan Vallejo have been quite stable over time. However, the complicated administrative procedures involved have tended to favor large enterprises, and the delays inherent in the scheme have reduced its value to exporters. 19. Nominal exchange rates are usually changed when domestic and inter- national infliation rates differ significantly. This has been the case in Colombia for many years. When examining movemtents in the real exchange rate, which measures the extent to which the rate of devaluation of the peso has offset the difference between the rate of increase of prices in Colombia and abroad, two different sets of data are usually calculated in CoLombia: peso-US dollar, and peso-weighted average-basket-of-currencies ("peso-weighted average"). The real peso-dollar exchange rate rose consis- tently from 1967 through 1971, fluctuated around the 1971 level in 1972-75, and then fell by 20-25% in 1976-81, with the largest single decLine (15-16%) occurring in 1977. The relationship between the Colombian peso and a basket of foreign currencies showed a similar trend, although the increasing exchange rate fluctuations among major currencies caused annual differences to widen. During 1967-72, the real peso-weighted average exchange rate rose continuously and reached a peak in 1975-76, but then declined until June 1981, when it was 13% below what it had been in 1971, and 20% below what it had been in 1975. 20. The computation of the effective value of fiscal and credit export incentives (CAT + PROEXPO credit) is presented in Graph 1, which indicates their increasiLng importance since the mid-1970s (from 12% to 20%' of export revenues between 1975 and 1980). At the same time Colombia's real exchange rate fell by about 20%, after it had climbed steadily during the late sixties and early seventies. Fiscal and credit incentives as well as the real exchange rate increments are combined in the index of the real effective exchange rate. That index fluctuated less because of the counterbalancing movements of exchange rate and fiscal-credit policies. Nevertheless, its 1980 level was more than 5% below the 1975-76 level, and by mid--1981 it had fallen to 10% below the earlier peak. Moreover, the increased use of the fiscal and credit incentives had the potential to accelerate iniflation and to invite countervailing measures from abroad. e8e PIW a8/8at We3 ISt 9o/L96l ,/ (saAIIuasUI Ajelau°WV/ pue leosi= Buipnpoui) 5 aOe8 86ueq3x3 t / \ / ~~~~~~~~~~~~~~~~~~~~(OOL =LL60) A;s ~~~~~~~~~~ ' S ~~~~~~~~O /ue4ODx3 \ "-"' / -00l 9 81%~~~ - ~~ v ~ a6ueusx13 le88 .~ ~ ~ ~~~~ -9t was PIW 0i8SS Le 9z8 .....,,''., - , .. . . . .. . . . .. . . . .. . . . .. . . . .. . . . . ................................................................................ .... '., ... . - . . .. . . " ' " ' " . . .. . .. . . .. . . ' ' " .. . .. . . .:...,.,..,..'......:" ..............."........................... .... '',''.i,1I .'...............'.......................... ........... .... liJW..............-...... ............... \~~~~~~~....................... ii I i1lw\.. ,... -.................u \ .. ...............................................................L.... ......................................................... .....pu.e les .wX3021u1.. . .. . .. 1v:]-~- SZ 3EfilM 'lN3S38d '1Std s S3AI1N3ONI( lPSO OdX -~~~QXO1 01- - ~~~~~..........................I .......'..Yci *S.AIL.3N I J.IO d .. . . . . . . . . . . . . .. ..I .H. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 11 - C. Export Development: Structure and Response to Incentives 21. Colombia's exports of manufactured goods in dollar terms increased almost sevenfold during 1970-75, but less than doubled during 1975-79. While export growth of manufactures from other developing countries also slowed down during t'he second part of the seventies, some of them realized substan- tially higher rates of expansion of sales in external markets. Manufactured exports of some East Asian countries (Korea, l'aiwan, Hong Kong and Singapore) experienced average annual growth rates of 35% between 1970-75 and 15% in the 1975-80 period in real terms. In contrast, Colombia's annual exports of manufactures increased by 17% in real terms during 1970-75, but rose by only 4% a year between 1975 and 1980. The growth and subsequent stagnation of Colombia's manufactured exports are reflected in a number of ratios. Manu- factured exports rose from around 3% of industrial output in 1970-71 to about 10% in 1974-75, but then gradually declined to about 7% in 1980. As a percentage of GDP, they rose from about 1.4% during 1970-71 to about 5% in 1974-75, but then declined gradually to about 3.6% in 1980. Similarly, Colombia's share of total LDC manufactured exports rose from 0.69% in 1971 to 0.88% in 1973, but then fell back slightly to 0.85% in 1975-77 and 0.75% in 1978-79. 22. Statistical analysis indicates that there was a strong positive correlation batween the improvements of Colombia's real effective exchange rate and manufacturing export growth between ]967 and 1974. W'hen the real effective exclhange rate declined in the mid-1970s the value of real manufac- tures exportedi also fell. The relationship between export performance and exchange rate policy is more difficult to trace after 1978. Paradoxically, manufacturing exports reached their highest le!vel in 1979, at the same time as the index of the real effective exchange rate fell. When export incen- tives improved in 1980, real export revenues declined. In part, this contradictory behavior can be explained by fictitious exports, which industrialist; undertook to import or repatriate capital in 1979. If registered rather than customs reported exports are considered, the relation- ship between exports and the real effective exchange rate shows a continua- tion of the positive correlation trend, with the export-output ratio for 1979-80 being approximately three percentage points below the same ratio in 1974-75 at the same time as the real effective exchange rate index fell by approximately 8%, as illustrated in Graph 2. 23. The impact of changing trade incentives on the pattern and destina- tion of Colombian exports is less visible. Venezuela has becomea the most important marlcet for Colombia's manufactured products. That country, with a comparatively limited size but relatively higb per capita incomea now takes about 40-50% of Colombia's total industrial exports. Total offLcial industrial exports to Venezuela increased front US$4 million in 1970 to US$281 million in 1980. Four sectors--textiles and clothing, metal manufactures, transport equJipment and cement--have consistently made up about half of these exports, with the other half spread quite widely across the industrial spectrum. The main reasons behind the growth of manufactured exports to Venezuela were the rapid rise of Venezuelan incomes (between the oil price increases of 1973-74 and the price stabilization attempt in 1980-81), and the emergence of the Margarita Islands since 1975 as an important Venezuelan free port. After Venezuela, the second most important market for CoLombia's - 12 - GRAPH 2 REAL EFFECTIVE EXCHANGE RATE INDEX AND MANUFACTURING EXPORT INDICATORS 12- REAL EFF. EXCHANGE RATE its HANUFACT EXPORTS/ANUF . OUTPUT MANUFACT EXPORTS/P E x ~~~~~~~~~~~~~~~~R p E R A T L s 8E I F N F E x 95c T a I F V 4- E 0 E T u 2-~ ~ ~ ~ ~ ~ ~ ~~~~~~~~8 1978/1 1974/5 1979/88 manufactured exports is the United States, which took 21% of official manufactured exports in 1977. Colombia's manufactured exports to the U.S. are highly concentrated: few items, such as non-metallic mineral products followed by clothing, yarns and fabrics as well as leather goods, suitcases and bags, accounted for 60-65% of total manufactured exports in 1970 and 1974, and for three-quarters of such exports during 1978-79. Exports to each, the Andean Group (except Venezuela), Central America, the Caribbean, and the E.E.C. are of equal importance as markets for Colombia's manufactured exports after Venezuela and the U.S. This diverse group of countries tend to take 10-15% each of such exports, with the rest of Latin America taking most of the remaining 5%. 24. While exports to neighboring markets tend to be more capital and skill intensive, Colombia has exported relatively labor intensive goods to - 13 - the U.S. and the E.E.C during the 1970s. Exports to the other Latin American nations are concentrated in chemicals, metal products, and non-metallic minerals, whereas the U.S. and E.E.C. markets are of major importance for leather goods and shoes, as well as textiles and clothing. The trend is also visible on an intra-industry basis. Clothing exports to the U.S. and the E.E.C. tend to be made to buyers' specifications and sometimes require only low cost labor, whereas exports of clothing to neighboring markets are mostly to Colombian manufacturers' designs and specifications and include all phases of the operation. More recently, Colombia also has been exporting some more capital intensive items to the advanced countries, including yarn, fabrics and some paper and paper products; thus, the export diversification is moving beyond the stage of specialization in natural resource and labor intensive products. In view of the weakening of the Venezuelan market, which has been consuming almost half of Colombia's manufactured exports, further efforts in export market diversification appear to be desireable. 25. An important issue regarding Colombia's diversification of manufac- tured exports relates to the effects of the ArLdean Common Market (ACM).3/ A recent study undertaken by Colombia's Planning Department showed that Colombia appears to have been the principal beneficiary of liberalization policies, with its exports to ACM countries rising from US$51.9 million to US$652.7 million between 1970 and 1979, with imports from those countries increasing even faster from US$17.8 million tc US$174.5 million. But while the increase in Colombian imports from other ACM countries is largely attri- butable to the preference given to them, Colombian exports to ACM countries received very little preference (Graph 3). Thus, Colombian exports to ACM countries can be attributed mainly to their proximity, general export promotion policies, and the rapid rise in per capita incomes and increasing overvaluation of the exchange rates in Venezuela and--until recently--in Ecuador. 26. The Andean Pact countries have been and are expected to remain an important market for Colombian manufactured pr oducts. This explains in great part why Colombia actively participates in a nmulti-country market agreement, which has been firmly committed to an import substitution strategy. There is now a growing awareness of the costs to each country of buying high priced goods from its ACM partners, rather than importing cheaper prodacts from third countries. In the November 1981 meeting of ACM Ministers of Industry, Colombia asked the other members to face up tco these problems and set the Andean Group on a new course, which would consist of the following changes: (a) increased emphasis on export promotion; (bi) adjustments in existing Industrial Programs; (c) additional trade liberalization and decreased emphasis on industrial programming; (d) renewed efforts to achieve a common external tariff; and (e) less discrimination against agriculture and mining. 3/ The Andean Group was formed by Bolivia, Chile, Colombia, Ecuador, and Peru in 1968. Venezuela joined in 1971, and Chile withdrew in 1974. A more detailed analysis of the Andean Market is currently undertaken by a separate mission of the World Bank. - 14 - GRAPH 3 ANDEAN MARKET INTEGRATION AND COLOMBIAN EXPORTS 1970 EDPERU E3 ECUADOR LJ i3OLXVZA 1979 Non-oil exports from Colombia to the countries of the Andean Common Market increased from US$35 million to US$300 million between 1970 and 1979. However, most products had no special trade preference within the Andean Common Market. 1978 PRODUCTS WT NO PREFERENCE LW PRODUCTS AUTOMAT=CALLY EXEMPT COMMON LtST PRODUCTS 1978 NON COMPETING EXPORTS - 15 - D. Foreign Trade Incentives, Industrial DeveLopment and Policy Options 27. While it is not too difficult to trace the impact of the import substitution strategy and the move toward export promotion on industrial imports and exports, industrial output and employment depend on many more variables than foreign trade strategies. This is particularly true for a country in which exports and imports are less than 25% of GDP and where the exports of the manufacturing sector, while reaching over 30% of total exports, averaged only 10% of total industrial production during their best years. Nevertheless, it seems that Colombian manufacturing development in general and that sector's employment growth il particular went through different development stages, which correspond rather closely with changes in trade strategies. These were discussed in paragraphs 5 to 8. Graph 4 provides a summary review of these relationships, demonstrating the substan- tial differences in manufacturing exports and employment growth during the three different time periods. During the last: seven years of the import substitution period (1960-67), manufacturing exports hardly grew. Only 4,300 jobs per year were created in manufacturing during that time. Those develop- ments contrasted with the growth pattern in 1967-74, a period which was characterized by strong export incentives. Not only did manufacturing exports shoot up, manufacturing value added did better than during any other period, and employment gains were five times the earlier job increases. However, once the boom of traditional and illegal exports led to lower incentives for nontraditional export products, manufacturing export reacted negatively, output growth slowed down and the number of new jobs created fell from 21,000 to less than 8,000. In sum, there seemed to be a positive response of the Colombian economy to export-oriented policies, creating a momentum for production and employment by manufacturing, which has not been sustained in more recent years. 28. During the second half of the 1970s and increasingly aso since 1979, Colombian policy makers have lowered import barriers. As a consequence, import penetration has increased in several irdustries. In genesral, it seems, that the higher imports did not prevent growth from occurring, while they did contribute to dampen price increases during the last fLve years. Regression analysis suggests that monetary expansion and rises in the local price of imports were the two principal factors contributing to inflation in 1960-80, with weights of .7 and .3 respectively. 4/ This analysis also shows that the local prices of imports have been inversely related to output growth over the same period. Lowered protection, while perhaps hurting some sectors, on balance seems to have lowered costs and inflation, without reducing aggregate growth of the Colombian economy. 29. At the industry level, a comparison of seven major manufacturing sectors shows that those branches which depended more heavily on import sub- stitution for their expansion experienced lower than average growth and 4/ For a detailed analysis of this and the following paragraphs, see Vol. II, Chapter III. - 16 - GRAPH 4 OUTWARD ORIENTED POLICIES BETWEEN 1967 AND 1974 LED TO: 1. Rapid Increase in Manufactured Exports 50 40 32.3 _ 30_ 20 - 0, @ 35- 6.0 0:X- i7 g _ -._- <::~~~~ ~ I 1lll 1960/67 1967/74 1974/80 2. Substantial Gains in Industrial Value Added 10 8.- 7.6 =03 6 5.6 5.5 '-20. < 0 - 4 2 0- 1960/67 1967/74 1974/80 .3. And a Surge in Industrial Employment 40 a o 30- 0) - ~~~~~~~~20.7 C ! 20