Report No. 1695a-PO

Manufacturing Export Industriesin PortugalUIn Three VolImnes)

Summary ReporiDecember 27, 1977

Iil LLi4I( l II'It i'1)( )I 11 I l ' nd I iflll ITe l)ivi )

LIi ( )I t Nlid( ( FI' I f t I l(I Nortl Afri (a RegionFOR OFFICIAL USE ONLY

Document of the World Bank

Thik (( i( iiw'it ' iL s ci rwtii( 1ed diIrcld li)Ii and lliaV be: ;"cd 1 hy i v ( C I pie nyon)yI ' in tl wpi tOriindm( (ol thei(r- i)tlit Iii it ii(. Its ( -Itn' . 1iiV nII it

{ )d I(t'I% i91 I )Vd liS'. I(M9'd1 Wi ItII I I W 014dl( fid11 III, i tl A I n'.llo

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Manufacturing Sector - Basic Data

Recent Years Annual Rate of Growth(%)1970 1976 (197Q-76)

GDP (blno esc., 1970 prices) 158.71 212.3 5.0Manufacturing Industry Output

(billion!escudos) - 53.9 76.6 6.0

GFCF as Z of GDP1970 1975

Gross Fixed Capital FormationTotal (bla. esc., 1970 prices) 31.1 28.0 (1975) 19.6 13.4Z in Manufacturing 3 1 29.2 (1974)

ManufacturingOut Annual Rate of Growth (Z)(bln. esc., 1970 prices) (1970-76)Foodstuffs, Beverages, Tobacco 6.3 11.3 10.2Textiles, Apparel, Footwear 10.0 16.4 8.6Chemicals & Related Activities 6.3 9.7 7.5Non-metal Mineral Products 3.9 6.8 9.7Metal Products, Mechanical,and

Electrical r,ashinery, Trans-portation Equipment 16.1 18.9 2.7

EmploymentTotal (000) 3,180.1 3,102.0 -0.5Manufacturing Industry (000) 828.9 336.9 - 0.15(Z of Labor Force) (25.4) (23.4)

Employment in Main Industries(Z of Total in Manufacturing)

Foodstuffs, Beverages, Tobacco 7.4 6.3,Textiles, Apparel, Footwear 33.5 33.8Chemicals & Related Activities 3.7 3.7Non-metal Mineral Products 6.3 6.0Metal Products, Mechanical,and

Electrical Machinery, Trans-portation Equipment 21.9 22.7

Annual Rate of Growth (Z)(current prices)

Exports 1963 1968 1973 1975 1968-73(ml.n. US$, current prices)Total Manufactured Exports

(SITC 54-6+7+8-68) 240 466 1,283 1,356 22.5Total Manufactured Exports

incl. processed food(03+05+06) and wine (1121) 343 639 1,578 1,637 19.8

Total Exports 418 761 1,862 1,940 19.6Main Manufactured Items

Textiles, Apparel, &Footwear 111 217 549 562 20.4

Chemicals 39 56 124 141 17.2Metal Products, Mechanical,Electrical & Transporta-tion Equipment 23 62 303 334 37.3

Processed Food 62 102 169 150 10.6Wine 31 59 128 131 16.8

Directiou of Exports 1976_______________ million % of Total

World 1,826 100EEC 940 51.5ETA 294 16.1U.K. 335 18.3Germany Fed. 197 10.8France 153 8.4Sweden 141 7.7Italy 68 3.7USA 123 6.7USSR 55 3.0Angola 29 1.6Mozambique 27 1.5

GLOSSARY OF ABBREVIATIONS

BFN Banco de Fomento NacionalCIP Confederacao das Industrias Portuguesas

(Confederation of Portuguese Industries)CGD Caixa Geral de DepositosCOSEC Companhia Seguro de Creditos

(Credit Insurance Company)DFC Development Finance CompanyEEC European Economic CommunityEPPI Empresa Publica de Parques Industriais

(Public Enterprise for Induastrial Parks)EFTA European Free Trade AssociationEIB European Investment BankFFE Fundo de Fomento de Exportacao

(Export Development Fund)GEBEI General Studies Unit, Ministry of IndustryGFCF Gross Fixed Capital FormationIAPMEI Instituto de Apoio as Pequenas e Medias Empresas

Industriais (Institute for the Support of Smalland Medium Industrial Enterprises)

IPE Instituto das Participacoes do Estado(Institute of the State Participation)

IIE Instituto dos Investmentos Estrangeiros(Institute of Foreign Investments)

INE Instituto Nacional de Estatistica(National Institute of Statistics)

MIT Ministry of Industry and TechnologyPISEE Programa de Investimentos do Sector Empresarial

do Estado (Investment Program for Public SectorEnterprises)

PIEs Pequenas e Medias Empresas(Small and Medium Enterprises) --

PREFACE

Thts Report is based on the findings of a Mission which visitedPortugal to review export manufacturing industries in April-May 1977. TheMission Report is in three parts, the Summary Report, the Main Report andthe Statistical Appendix and Annexes. The Summary Report states the majorfindings and recommendations of the Mission and contains mainly those pointswhich should be brought to the attention of the Government. Detailed back-ground and analyses are presented in the Main Report. Information aboutPortugal's policies and industrial position of use primarily to readersoutside the Governmont of Portugal has been placed in the Annex Volume. Inpreparing its Report, the Mission has drawn on (and sought not to duplicate)information in other IBRD Reports on Portugal, in particular, "Portugal:An Economy in Transition", (Report No. 1408a-PO, Marh 16, 1977) and "Appraisalof Banco de Fomento Nacional, Portugal" (Report No. 1462a-PO, May 9, 1977).Since the Mission was in Portugal the Government, in August 1977, took a num-ber of economic measures; the Report noLes these measures and the recommenda-tions make allowance for them.

The Mission was composed as follows:

Barend A. de Vries Chief of MissionRichard L. Storch Private Investment and FinanceSurendra K. Agarwal General EconomistDavid Morawetz (Consultant) Economist (Trade Incentives)Wilson Suzigan (UNIDO Consultant) Industrial EconomistFederico Tubio (Consultant) Industrial Expert

(Textiles and Clothing)Walter Oettinger (UNIDO-Bank CP) Industrial Expert

(Metal-Working Industries)Jacob Levitsky Industrial Expert

(Other Industries, TechnicalAssistance)

In addition Mr. Francis Colaco participated in part of the Mission'sfield work. Messrs. S. Rangachar, C. Gomez and Mrs. S. Craigmile assisted inthe preparation of the Report.

Messrs. A. David Knox and M.G.S. Aiyer and Mission members discussedthe draft Report with the Government in November 1977.

ll ~e~

MANUFACTURING EXPORT INDUSTRIES IN PORTUGAL

SUMMARY REPORT

A. Introduction

1. The Industrial Sector Mission which visited Portugal in April-May

1977 had as its principal focus (a) the review of prospects and problems of

exporting manufactutiLng industries, (b) the policies affecting those indus-

tries, and (c) the administrative or managerial, financial foreign investment

and technical measures needed for the development of those industries. The

Mission also paid special attention to the employment creating effect of the

industries reviewed.

2. The Mission obtained its information from discussions with Minis-

tries, Government Agencies, institutes and banks which were coordinated by

a group of officials chaired by the Ministry of Industry. In addition, the

Mission visited a number of industrial plants and held talks with management

of these plants as well as other firms, arranged by the Ministry of Industry,

assisted by the Banco de Fomento Nacional (BFN) and, in some cases, by

Confederacao das Industrias Portuguesas (CIP). In line with its objectives,

the Mission's review was concerned principally with the metal-working and

textiles and clothing industries, and, in lesser detail, food processing,

shoes, furniture, glass, paper and pulp and cork. These industries, referred

to in this Report as "export industries", account for the bulk of Portugal's

manufactured exports, 85% of manufacturing employment and 75% of manufacturing

output. The firms and plants visited by the Mission directly account for

about one-third of manufactured exports. The capital labor ratio for the

export industries studied ranged from less than $1,500-2,000 in footwear

plants and clothing plants to around $15,000-20,000 in the metal-mechanical

industry and $30,000 in spinning and knitting. Capital per job created

is $27,000 for new projects in the paper industry and $130,000 in the pulp

industry. In size the firms ranged from about 50 workers (as in some clothing

and shoe plants) to 2,500-4,000 (certain integrated textile-clothing plants,

TV and radio production, ship repair, metal-mechanical plants). The Mission

did not study the "heavy industries", e.g. steel, chemical, petrochemical,

fertilizer and cement because they are not export oriented and because they

have a high capital labor ratio (in some cases it reached $200,000 or more);

also, the SINES complex, where much of new investment in heavy industry

is to take place, has been the focus of a separate World Bank mission.

3. The Mission's principal recommendations concern the following:

(1) Focus of industrial investment and policies on labor

intensive export industries (Section B of this Summary

Report);

(2) Changes in the incentive system to overcome the deter-

ioratLon since 1973 in the competitivreness of export

industries, and to remove the present bias in favor

of import substitution and against export development

(Sections C and D);

-2-

(3) Measures to strengthen export industries and raise theirproductivity:

(a) management, training and technical assistance(Section F);

(b) modernization, restructuring and new plant investment(paragraph 30 and sections dealing with individualindustries);

(c) marketing (paragraph 34);

(4) improvement .in investment climate; steps to increaseinvestment and channel resources to high priority projects(Section J);

(5) Interest rate policy (Section K);

(6) Measures to encourage Foreign Investment and help orientit toward high priority industries (Section L); and

(7) Coordination of Industrial Policies and allocation ofFinance (Section M).

Sections G, H and I, respectively, deal with the metal working, textile andclothing, and other export industries: their present and prospective con-tribution to export development, with recommendations for specific industryactions to improve their productivity, output and export performance.

The Economy and Industry

B. Macro Economic Considerations

4. The prospects of the industrial sector are irmproving considerably:(a) the mea.ures of February and August 1977 and particularly the adjustmentsof the exchange rate were steps in the right direction; (b) the labor situa-tion has improved; productivity has increased and work stoppages are much lessfrequent; (c) fears of turther nationalization are subsiding; and (d) themeasures toward decontrol of prices will help improve the financial positionof industrial firms and put them in a stronger position to invest. There aremany signs of improving investor confidence, particularly among the better,more aggressive industrial managers. Further measures will, however, benecessary if the Government is to lay the basis of a more dynamic develop-ment program for manufactured exports. Basic to a sustained revival inindustrial investment is the achievement of workable understanding betweenGovernment, labor and management. This will require implementation of legis-lation in five areas: labor laws, compensation for nationalized property,division between State and private industry, a revised foreign investmentcode, and agrarian reform. Progress has been made by agreement in principleon the division between State and privately owned manufacturing activitiesand the transfer of management of companies to the private sector in most

-3-

cases in which the Government had intervened. Further progress will have toawait the adoption of agreed work rules (particularly as to dismissal andincentives). Compensation will take time to work out since the transferpayments involved are large and will have to be accommodated by the Govern-ment's overall finance program.

5. In the years ahead the Portuguese economy will have to adjust toseveral post-1973 changes: the higher cost of labor, the increase in consump-tion levels, the elimination of preferred trade relations with the ex-colonies,the slow-down in emigration and remittances, and the progressive integrationwith Europe. Manufacturing industry will have to make a greater contributionto Portugal's external position than it did before 1973. Other considerationsstressing the importance of export manufacturing industries are: (a) theobvious need for reducing the Balance of Payments deficit; (b) the possibili-ties of exports to the EEC and North America and the much larger size of theseexport markets compared with production for the home market; (c) the abilityof export industries to attract foreign investment and private capital in aperiod when internal investment resources do not meet the demand for capital;and (d) the high productivity and growth possibilities of export industrieswhich can make an indispensable contribution to an economy beset with highunemployment and low agricultural productivity. A strategy of rapid, highlyproductive manufacturing for export should be combined with measures directlyaimed at the country's unemployment problem, including in particular education,and technical-managerial and vocational training. While the basic problemsof improving Portugal's employment situation will necessarily involve publicexpenditures and make quick reduction or elimination of the public sectordeficit very difficult, development of the export sector is, from a nationalview point, self-financing and will actually help strengthen the financialposition of the public sector. Furthermore, accelerated growth of manufacturedexports - say in the range of 15-20%. per year - would have employment effectson the economy as a whole well above those foreseen in the Plan estimates inthe years immediately ahead. In short, rapid export-led growth can make asignificant impact on Portugal's present high unemployment rate.

6. Unemployment of 452,000 or 12.7% of the labor force presents thecountry's economic management with problems to which there are no quick solu-tions. In addition, in many industries there is considerable under-utilizationof labor. Analysis of the employment effects is essential to any industrialpolicy and investment recommendation. The Government's draft Plan gives highpriority to improvement in employment, and envisages that in 1977-80 some203,000 new jobs will be created of which 34,000 would be in the industrialsector - i.e. 17% or less than the 27% share of manufacturing industry intotal employment at present (837,000 out of 3.1 million). However, the Planappears to stress capital intensive industries which will have a lower employ-ment effect (even after allowing for indirect effects) than expansion of morelabor intensive export industries.

7. The Mission recognizes that the major sources of employment creationare outside the manufacturing sector, in particular, construction and services.It has not been possible to undertake a thorough analysis of the employment

- 4 -

effects of a comprehensive industry program. However, from its own, admit-tedly tentative, review of the employment effects of export manufacturing, theMission concludes that new jobs created in industry may, at least in certainindustries, be well above those given or implied in the Plan (e.g. the foodprocessing, furniture, cork and metal working industries). The Plan appearsto underestimate the possible growth for several labor intensive exportindustries (see Ma-in Report paragraph 1.26). On this basis, new manufacturingjobs could be above those given in the draft Plan, even after allowing for theloss of jobs which would result from the restructuring of the textiles andfootwear industries.

8. The total employment impact of the industrial sector will depend onseveral critical decisions in the period ahead:

(a) There is a need to give proper emphasis to labor-intensiveexport industries. The Mission has focussed on industrieswith relatively low capital-labor ratios which should beable to increase output rapidly without major investmentassistance from the public sector. The MAission recommendsthat sufficient policy and financial emphasis be given tothese industries to enable them to grow as rapidly as possible.

(b) Analysis of the employment created by industrial investmentmust consider the linkage effects on other sectors, especiallyagriculture and services. The Mission recommends that forthis reason, special attention be given to the food process-ing, fish canning, paper and pulp and cork industries. Apartfrom their employment linkage effects, these industries usemainly domestic raw materials. Clearly any industrial programwill need to be coordinated with measures in forestry, fishingand agriculture.

(c) Over a period of three to four years, adequate attentionshould be given to the job-creation effects of the start-upof new plants (as against expansion of existing plants).This will include large new plants (for which a specialfacility to prepare new projects may be needed) as well assmall plants such as those accommodated by Industrial Parks.

9. In order to increase the employment effect of industrial investmentthe Mission recommends (a) priority be given to financing of new projectswith a low capital per job ratio; (b) subsidization of investment in laborintensive projects; and (c) consideration of a wage subsidy of some Esc. 2,200per month for new labor intensive projects (e.g. with a capital-job ratiobelow $15,000). Such a subsidy would initially be equivalent to the presentunemployment payment and it could be phased out in two to three years. Theemployment effects of industry can further be enhanced by special assistanceto small labor-intensive firms (through IAPMEI) and industrial developmentoutside the main centers (through EPPI) (see para. 30).

-5-

10. The Mission recognizes that not all export industries are laborintensive such as the pulp industry and certain textile and heavy mechanicalindustry branches. A country in Portugal's stage of development can profit-ably expand production of intermediate and basic goods, often capital inten-sive, especially where it complements present industrial activities and/orstrengthens the utilization of local resources (notably agriculture) or otherhigh priority activities. Some of the more capital intensive industries mayfacilitate the rapid growth of export industries - which given Portugal'spresent structural and financial problems clearly deserve high priority. Inpreparing for industrial investment activities, special attention ought to begiven to indirect and linkage effects and competitiveness and, recognizingPortugal's present foreign exchange and labor situation, use should be madeof shadow prices in project appraisal.

C. Wages, Productivity and Competitiveness

11. Labor conditions have altered in many respects since 1973. Produc-tion was disturbed in 1975, but the situation has become more stable now. In1976 there were few strikes and output improved in most of the export indus-tries, although it was still well below 1973. Several different aspects ofwork rules still need to be settled, particularly questions of incentivepayment schemes, dismissal, shifts and even limitations on output per worker(e.g. as in certain clothing plants). Management will need to adapt to themore participatory role of labor, and special effects are needed to introducemodern procedures in labor-management relations. In the more progressivefirms, labor relations have obviously proved less of an obstacle to improve-ments in productivity, output and investment.

12. Wages almost doubled in 1973-76 and, allowing for extra year-endpayments, annual workers' earnings actually had increased by 116% as ofDecember 1976. In real terms, annual earnings in 1976 were up 19% over 1973,but in 1977 they declined once again. The February 1977 exchange rate adjust-ment brought the increases in real wages, since 1973, closer in line withthose in Portugal's trade partners.l/ Calculations in Annex II-1 for Portugalrelative to France, Germany, the U.K. and U.S. suggest that Portugal's rela-tive wages were on average still 4% above 1973 levels. In addition, employers'contributions for unemployment and social security assistance are up by 3.5%of the wage bill. Thus, since 1973 Portugal's wage cost advantages havedeteriorated by some 7.5% in relation to France, Germany, the U.S. and the U.K.

13. Portuguese wages (excluding fringe benefits) are compared with 1973on average 8% below those in its OECD competitor countries, Italy, Greece,and Spain. They are, however, in line with wages in Italy, and some 3% aboveItalian wages when allowance is made of employer's contributions. Italy isan important "competitor", particularly in clothing and footwear; in theseproduct lines, Portugal will have to upgrade its quality and sell in the samemarkets.

1/ The floating of the Escudo since August has partly corrected for thedomestic price increases since February. The subsequent analysis isrelative to prices and exchange rates in February, 1977.

-6-

14. Improvement in productivity could help overcome all or part of the

deterioration in wage competitiveness. Preliminary overall data suggest that

productivity in Portugal's manufacturing sector as a whole has improved by

5.8% since 1973, compared with an average 3.4% for the U.S. and leading

European countries. The improvement in Portuguese productivity was caused

by a small decline in the work force and the completion of investments and

associated increases in output, mainly in the heavy industries. However,

productivity in the export industries has deteriorated - overall data suggest

by an average of 2.7% and considerably more in certain key industries, such

as textiles and clothing (12%) and electrical machinery (36%). The Mission's

observations based on plant visits confirm that productivity (output per man-

year) has declined in certain export industries, with output per man-hour

(allowing for the decline in hours worked) having at best recovered to 1973

levels.

15. Thus, the net deterioration in the competition position of export

industries - i.e. changes in total wage costs plus productivity changes - is

an average of at least 10% for export manufacturing, and more for certain key

industries, e.g. 20% for the textile and clothing industries.

16. The deterioration since 1973 in the relative competitive position

of Portugal's export industries will have to be overcome by a combination

of measures aiming at a reduction in costs and improvement in productivity.

It is unlikely that real wages will decline and hence, other cost reducing

measures will be necessary. Improvements in productivity will have to be

associated with an increase in output and exports and a number of measures

discussed in Chapter III, particularly improvements in management, the layout

of plants, modernization of machinery and new plant investment.

D. Industrial Policies - The Incentive System

17. In the decade before 1974, Portugal's exports, particularly to EFTA

and other European countries, increased rapidly. The import share of domestic

supply of manufactured goods also increased. Portugal's economy was relatively

open. Its trade policies were rather mixed. On the one hand, open policies

permitted the textile-clothing industries, metal working, and other traditional

industries to expand, using the advantage of relatively cheap labor. On the

other hand, special protection (prices, access) was granted to trade with the

colonies, from which the clothing as well as the engineering and heavy con-

struction industries benefitted. Effective tariff protection varied widely

and arbitrarily from sector to sector. Protection was granted on an ad-hoc

basis, with little regard to the overall pattern that emerged (see Chapter II).

18. In recent years, and particularly in 1976, Portugal has had to place

special emphasis on restraining imports. This has been done primarily through

import surcharges of 30 and 60% (depending on the commodity) quantitative

restrictioris, and advance import deposit requirements; these measures were

introduced in 1975 and 1976 and intensified in February 1977. The additional

import taxes were superimposed on an already arbitrary customs tariff. While

the emphasis on import restriction was justified in the circumastances, the

7

Mission has focussed its analysis on the medium and long-term consequencesfor resource allocation and the effect on Portugal's ability to adjust to thestructural changes in the Balance of Payments.

19. The principal effects of the incentivz system are:

(a) Taken together, the subsidies received by export producersadd up to about 5% of their output value or less, while firmsproducing import substitutes for the home market receiveprotection varying widely from 13% to 80% of output value(see Table 2-4, Chapter II). I-f the "drawback" is not used,the export subsidy is reduced by about 10% of output value(i.e. becomes negative). Hence, the system has a strong biasin favor of import substitution and against export promotion.

(b) The above mentioned subsidy received by export firms is notsufficient to overcome the deterioration of 10-20% since1973 in competitive advantage which Portuguese exportersstill suffer vis-a-vis their competitors in OECD marketcountries.

20. The 30% surcharge and quantitative restiictions apply to manyimported inputs used for export production. The "drawback" system (whichreturns to export firms the taxes paid on imported inputs) often does notwork for small firms or even for larger firms (e.g. integrated clothing-textile plants) which find it difficult to separate their export and domesticoperations and to cope with the administrative problems of actually obtainingthe drawback refund. In many cases drawback payments are made only afterconsiderable delays. In addition, the surcharges - 30 and 60% - and quanti-tative restrictions apply to several products which can often be exported(e.g. clothing, motorcycles, glass, and leather ware), hence, encouragingdomestic sales at a 30-60% premium over exports (sometimes even higher, whenallowance is made of the customs tariff).

21. The customs tariff is, for many products of marginal significancein comparison with the effect of other import taxes and restrictions. It isat present specific and needs to be converted to an ad valorem basis. Pro-tection should be low and relatively equal across and within sectors, withtariffs on capital goods and material inputs not beiag high relative to thoseon finished goods. The surcharges should continue to be regarded as temporaryand not be incorporated into the tariff.

E. Recommendations

22. The steps to be taken fall into three categories: (a) have ageneral reduction in the cost structure of Portuguese industries to overcomethe deterioration in competitive advantage since 1973 and lay the basis foracceleration of exports of manufactures; (b) give export industries at leastthe same incentive as industries producing for the domestic market, i.e.,remove the present import substitution bias of the incentive system; and

-8-

(c) improve the effectiveness of remaining elements of the system, e.g. the

tariff, the drawback and the operations of the Export Development Fund. Once

the measures have been taken and a program of action has been agreed, it is

essential that the system will be main-ained in a stable manner so as to give

full opportunity to export manufacturers to make the necessary investments,

develop products and enter new markets.

23. Improvement in Cost-Competitiveness. The Mission stresses the need

for a general reduction in relative costs which has an even effect on all

branches of industry. Portugal is faced with a situation of crucial struc-

tural adjustment in which it is extremely difficult to determine a priori

precisely which export industries and products will do well in foreign markets

and which existing production lines must be adopted to new conditions and

markets. In this type of situation, different industries and products should

be given the same opportunity. This is because it is not just a question of

which brancheL of industry should be encouraged. It is because within any

given branch of industry the efficient firms should be given the opportunity

to survive and expand, rather than be inhibited by policy measures which dis-

criminate against that particular branch. Estimates for the necessary improve-

ments in cost-competitiveness of export industries range between 10 and 20%

and higher. These estimates, however, probably are less than the overall cost

reductions required when account is taken of the adjustments which industry

must make if it is to contribute sufficiently to Portugal's balance of pay-

ments. As a result of structural changes affecting the balance of payments,

manufactured exports will have to make a substantially larger contribution to

Portugal's foreign exchange earnings than they did before 1973. Thus, even

if on a 1973 basis Portuguese export industry would have been fully cost-

competitive in February 1977, further cost reductions would have been neces-

sary if export growth is to speed up sufficiently. The manner and timing

of ,the general cost reducing measures will very much depend on the progress

toward achieving domestic price and wage stability and improvements in produc-

tivity. The measures called for will have to be part of a broad program of

domestic price-cost stabilization, and improvements in industrial management,

efficiency and productivity discussed in Chapter III.

24. A sufficient general reduction in relative cost-levels will make

possible removal of the import substitution bias of the present restrictive

system. This will require dismantling - or setting up a timetable for the

elimination of the system of surcharges, prior deposits and quantitative

restrictions, as well as reduction in tariffs. This is necessary in order

to avoid attracting resources away from exports into high cost import sub-

stitution industries which will be a burden once Portugal's EEC agreement

forces import restrictions to be lowered.

25. The Mission also recommends that the Government consider additional

direct export subsidies during a transitional period in which manufactured

exports should gain momentum. Portugal already has various means of assisting

export industries and the Mission is recommending improvements in them, espe-

cially in the operations of the Export Development Fund. Failing adequate

general measures to reduce relative costs (and accompanying reduction in sur-

charges and t;ariffs) there would be a case for export subsidies to overcote

-9-

the deterioration in competitive positLon and removal of the import substitu-tion bais of the present incentive system. The subsidies should preferablybe based on domestic value added, be simple to administer and be confined toa transitional period, pending more basic measures and a strengthening ofmanufactured exports. Portugal would need approval of the EEC and EFTA forsuch subsidies, presumably maintained for only a limited period.

26. Further steps are:

(i) Take advantage of the present unlikely-to-be repeatedopportunity to rationalize the entire tariff structure(paragraph 21).

(ii) Simplify and speed-up procedures involved in the drawback.

(iii) Extend the drawback to apply to indirect exports (e.g.exempt from duty yarn used to weave cloth, wlhich issold to a garment-maker who exports his products).

27. Ilanufacturing firms exporting more than a minimum percentage (30%)of output should receive advance exemption of surcharges and other importmeasures applicable to their inputs and be automatically eligible for exportincentives (interest rate subsidies, tax benefits). This measure can be admin-istered by the Export Development Fund whose operations should be rationalizedand made more effective (paragraph 34).

Export Industries

F. General Considerations

28. Most manufactured exports are produced in the private sector inPortugal. The Government can be most effect-ive by reducing uncertainties toa minimum, ensuring that incentives are roughly equal within all sectorsfor exporting and import subsitution and letting private firms decide whichproducts to export.

29. Portugal's comparative advantage in manufactured exports rests onits natural resources, its labor and engineering skills and its location. Inorder to realize its manufactured export potentials, Portugal will have toovercome a number of obstacles. First, as is discussed in paragraph 18 and19, the current bias of the incentive system against exports and in favor ofproduction for the domestic market will have to be redressed. Second, majorefforts need to be made to reduce the uncertainties facing industry, espe-cially those concerning the real exchange rate, future labor relations, andthe role of workers' commissions. Third, training for middle-level management,need to be started or strengthened, with particular emphasis on skills whichseem to be lacking in a wide range of plants throughout Portuguese industry:production management, cost accounting, shop-floor supervision, and humanrelations. Fourth, the transport network needs to be improved. In the areaof sea transport - 93% of export and 96% of imports are moved by sea at

- 10 -

present - the port of Leixoes was widely criticized as being congested and

high-cost. Road connections are mainly through Madrid, while for rail there

is a change in gauge between Spain and France. It would be useful to improve

transit arrangements with Spain to cut down on customs delays at the border.

Finally, it will be necessary to make export marketing more aggressive to

hasten the adjustment away from Portugal's traditional markets in the colonies

(and to a lesser extent the U.K. and EFTA) and towards the EEC, U.S. and oil

exporting countries in the Middle East, North Africa and Latin America.

30. The Govc:nment through IAPMEI, EPPI and special programs is attempt-ing to consolidate small uneconomic and obsolescent firms into larger and more

economic units; this is particularly important in the textile and food process-

ing industries and also the footwear and clothing industries. In restructuring

industry, the object-ive of employment creation should be a key consideration.

The industrial estates program (EPPI, Annex III-3) should make an essential

contribution, supported by the promotional activities of IAPMEI. The latter

Institute will need to be strengthened and decentralized (Annex III-4) in

order to make a more effective contribution to the reequipping of small firms,

the establishment of industrial centers, the consolidation of smaller units

into larger ones and forging closer links between large and small firms. A

sectoral approach (e.g. concentrating on particular industries such as foot-

wear or food processing) would be most effective in IAPMEI's various programs.

31. Management. Much can be done to improve the status and remuneration

of professional managers in Portuguese industry, especially (but not exclu-

sively) in branches dominated by family-owned business. Beside management

training - a longer-term proposition - immediate action appears required in

abolishing present government-imposed limits on pay. Consideration should

be given to profit sharing, stock option or bonus schemes. More professional

administration of labor relations appears especially urgent in light of the

changed roles of labor unions and the excessive time spent on these relations

by top management. Production management has a special role to play in the

improvement of plant lay-out and utilization necessary in several branches,

but especially machinery, clothing and food processing industries. The IPE

program for training managers for state controlled industries - with ILO

assistance should be widened to help train and upgrade managers for the

private sector as well. Business studies should be introduced as courses in

institutions of higher learning. CIP should be encouraged to initiate the

creation of a Portuguese Institute of M4anagement.

32. The M.I.T. is already engaged in various types of technical assis-

tance to industry. Some additional areas where technical assistance is called

for at this time are: (a) preparation of a program for developing the capital

goods industry, preferably by contracting a group of engineers and technolo-

gists; (b) a center for dissemination of technical and market information and

documentation (IAPMEI's services in this field to PME should be expanded);

(c) more support for R&D in industry; and (d) a study of the utilization of

traLned engineers in induistry to clarify with industrial management how better

use can be made of engineering talent available in the country. Finally, much

technical help can be obtained through know-how and licensing agreements with

foreign firms.

- 11 -

33. Export marketing should be strengthened in several industries.In this area the Export Development Fund will have to play a central role.Portuguese embassies could render more expedient services in helping firmsrespond to invitations for international competitive bidding, e.g. in theheavy engineering industry.

34. The Export Development Fund 1/ has carried out a number of veryusefuil functions, including the organization of industrial fairs, explorationof new products and markets, publicity, training, design and assistance ofPortuguese businessmen going abroad. However, several steps seem to benecessary to make the Fund more effective and play a central role in a manu-factured export development program (see Annex III-5 for details):

(a) The Fund management should be strengthened, the targets forits activities be more clearly defined and its achievementsevaluated regularly. Its activities should become moreclosely attuned to Portugal's present situation and policies.

(b) The Fund's activities are spread out over too many marketsand products. It would be better if it were to concentrateits activities on fewer markets with high potential for newexport expansion, as for example the U.S. and Germany (aswell as Venezuela, and to certain Middle Eastern countries),giving less emphasis to several countries where Portugueseproducts are already well introduced or have little additionalpotential. Its product concentration should be on thoseindustries where marketing efforts have been weak, and/orwhere Portugal's comparative advantage can realistically beexploited more fully (e.g. clothing, shoes, furniture, metalmechanics).

(c) The Fund can be more effective in furthering subcontractinglinks between large firms and small firms producing componentsfor exports. It should maintain close contacts with IAPMEIin the interest of increasing exports by small and mediumindustry.

(d) The Fund should play a more positive Lole furthering exportdevelopment contracts. Thus far very few contracts have beenexecuted and most persons and firms contacted by the Missionhave not heard of their possibilities. The procedures forprocessing these contracts can be simplified considerably. TheFund should equip itself to assist in the execution of thesecontracts. Thus, besides, identifying new possibilities, theFund would involve itself in the various phases of new productor investment proposals: feasibility study, investment, finan-cing, marketing and operation (including the effectiveness ofincentive measures, in particular the drawback).

1/ Recently renamed "The Portuguese Institute for Export Promotion".

- 12 -

(e) The Fund should exercise an economic intelligence function,

identifying opportunities not fully utilized, new products

in which Portugal is gaining a comparative advantage and

evaluating Portugal's manufactured export performance. In

doing this the Fund will necessarily have to keep abreast

of cost developments in the economy, as well as new invest-

ment proposals. In carrying out its functions, it should

act as an advisor to top officials in Government, industry

and labor interested in Portugal's export performance.

(f) These recommendations would entail a redeployment of staff

under dynamic leadership. They need not involve an increase

in budget outlays which at present are over $10 million

equivalent.

G. Metal Working

35. The original orientation of the Portuguese metal-working industry was

primarily toward the domestic market and the, colonies, supplying material for

the development of infrastructure, including railways, ports, electrification

schemes, etc. The consumer-oriented market (household appliances, office

machinery, electronics, etc.) received little attention. In-between, some

companies produced medium-weight goods, including a few basic machine tools,

some textile machinery, motorcycles, and so forth; none of these have really

become very successful (Chapter III, Section B).

36. The companies specialized in heavy equipment, faced with restricted

sales opportunities at home, are becoming more active in exporting. Some well

established firms have in fact been exporting for several years. Given proper

support in incentive policies, financing and the identification of export

opportunities, the Portuguese metal-working industry can quickly increase its

exports.

37. Plant utilization in the industry at present is well below capacity,

production being about two-thirds of what could be accomplished with the same

labor force (working with effective incentives). Generally, single-shift

operation is the rule. A low level of orders is the usual cause of low

capacity utilization. The heavy mechanical industry, in particular, has

suffered from cutbacks in public investment (railways, electricity); the

problems would have been worse in the absence of construction of the SINES

complex. On the othe- hand, the plants with shorter production cycles, e.g.

consumer electronics, relays and a recently opened modern foundry, have been

performLng at higher levels of capacity utilization.

38. Opportunities for exports lie primarily in four product areas:

(a) Custom-made heavy equipment (cranes, pressure vessels,

electric sub-station equipment, etc.);

(b) Contract supply of "commodities", such as small diesel

and gasoline engines, standard machine tools, medium

- 13 -

size electric motors, wire and cable; and ships andship repair;

(c) Component parts manufacture in sub-contract (such asraw castings, machined castings, stampings, plasticparts, etc.); and

(d) Machine-paced operations with a relatively high laborcontent.

39. The Portuguese heavy mechanical industry is able to meet specifiedquality standards and should be able to expand exports substantially. It isable to make speedy delivery in particular because of low capacity utilization.Profits are, however, low and corrective steps are necessary. Export pricesare often below those charged for domestic sales, mostly to the Government orits agencies. As capacity utilization reaches more normal levels deliverytime and prices would come under greater pressure.

40. Portugal seems to be able to fulfill supply contracts at a profitfor various items (e.g., specialty castings, automotive precision spare partsas well as large castings and gates for hydro electric plants). The industryneeds to apply more effective marketing efforts, searching out potentialcustomers abroad.

41. Products could include a. great variety of items, ranging from heavyelectrical equipmeilt over electronic assemblies, locomotives and ship repairto the manufacture of high-precision automotive spare parts. Conversely,products which are simple to make, or whose production depends more on theavailability of highly efficient (and expensive) special-purpose machinerywould not seem to offer equal promise. Portugal should also be able to developa machine tool industry for exports. Initially it would seem best to exportcomponents (e.g. gears or lead screws) or subassemblies (e.g. drive heads)to foreign firms who market the product under their own brand name.

42. The attitude toward new investment has until recently been cautious.While plans are being developed in many enterprises, firm decisions will prob-ably not be taken until there is greater certainty about the Government"spolicies. Given the favorable sales prospects, new investment in equipmentis justified where existing equipment is no longer economic (because of obso-lescence, higher real wage costs or increases, in output) or it would amelioratean otherwise unbalanced situation. Investment is also desirable where plantsare arranged inefficiently and are laid out anew to improve the work flow.Much of the new investment would consist of modernizing building (betterlighting; ventilation; distribution of power, light, compressed air and gas);moving production machinery in accordance with the new lay-outs. Where newplants are to be constructed, the Government may want to consider whetheradministrative or physical consolidation of smaller units would be feasible.

43. Over the medium-term (say starting in 1979) investment needs can beexpected to increase significantly as capacity utilization -improves, exports

- 14 -

continue to grow and domestic demand firms up or increases. Provided domesticsuppliers receive adequate finance, demand for products of the metal-workingindustry is expected to increase as Portugal proceeds with construction of newplants (e.g. cement, oil refining, petrochemical), infrastructure investmentis stepped-up (hydro and thermoelectric plants, road and port construction)and residential construction continues at a high level. The heavy mechanicalindustry would, in particular, benefit from a well defined and stable Govern-ment program in electric power and the heavy state industries.

44. Recommendations on Action for the Metal-Working Industry

(a) Market Intelligence: Information on export opportunitiesshould be collected continuously and in a systematic fashion.It should then be made available to industry periodically,and, where appropriate, on an ad hoc basis. Particular em-phasis should be placed on major "projects", world-wide,which require heavy mechanical and/or electrical equipment;and also on possibilities - which should be actively searchedout - of supplying castings, component parts, sub-assemblies,etc. to foreign OEM's (Original Equipment Manufacturers). Thisactivity might best be undertaken by FFE assuming, of course,it will be strengthened as recommended in paragraph 73.

(b) Technological Support: Many of the smaller firms could usehelp in making technological decisions relative to products,processes, availability of specialized equipment and oflicenses, etc. Reliance on the "friendly advice" of equip-ment salesmen - always readily available - is bad practice.Government, perhaps with help from bi- or multi-lateralassistance agencies could set up an office staffed with asmall number of specialists available to industry uponrequest (the service could certainly charge a fee and thusbe self-financing). Tlis work is within the purview ofIAPMEI; but there is some question of its effectiveness atthe present time.

(c) Quantity Purchasing: Even the largest Portuguese metal-workingenterprises are considerably smaller than their principalforeign competitors. The former, therefore, suffer an im-portant disadvantage of scale in purchasing. The Governmentmay want to consider establishing a buying office for thePortuguese metal-working industry, concentrating on metallicraw materials, semi-finished products and components. Theadministrative costs would doubtlessly be outweighed by thelower purchase prices obtainable in this way.

(d) Production Management: Production management includes in-ventory planning and control, warehousing, manufacturingprocess selection, machine loading, tool engineering andmany other functions which are as yet not generally applied

- 15 -

in Portugal as separate and important management responsibi-

lities. More training opportunities should be provided for

pc:rsonnel instrumental in production, including specialized

training courses, professional society conferences for

the exchange of relevant information amongst enterprises,

"fellowships" in applicable foreign plants, etc.

(e) Export Sales Promotion: Smaller firms have usually little

background in promoting their wares abroad; and they can,

individually, hardly justify the cost. It may be desirable

to establish, with the assistance of FFE, trading firms,

which would become an actual participant in the trading

process, without themselves being manufacturers. Lhe

Japanese trading firms could serve as examples.

(f) Consolidation: The Government may well want to encourage

the consolidation of small and medium-sized metal-working

firms into larger more viable export units; it is already

doing so in the public sector. This will facilitate the

implementation of the recommendations under (a), (b), and

(c). Further, the Government would be justified under-

taking a more detailed study of the intensive development

of Portugal's capital goods industry.

H. Textiles and Clothing

45. These industries are of critical importance to Portuguese industrial

development emphasizing exports and employment. Given its relatively low wage

levels (even after recent increases) and the considerable past investment in

the industry, its know-how and marketing contacts, Portugal has a comparative

advantage in better quality textile clothing items. In order to make use of

its comparative advantage it will have to upgrade its product mix and quality.

It should have a competitive advantage vis-a-vis competitors in European

markets. However, at present its present exports rely excessively on lower

quality items. Further, it would not appear to have a clear advantage in

cotton yarns for which it has to import all of the raw material. Provided

appropriate incentive policies are adopted and management is improved, both

industries can raise product qualities and increase exports with, at least

initially, comparatively small new investments (Chapter III, Section C).

46. In the past the former colonies and the U.K. and other EFTA coun-

tries were important customers of these industries. Exports were concentrated

in relatively few items, generally low quality; which require little technical

effort, and in which competition from East Asian countries is strong. In

recent years (1974-76) quality, fabric design, apparel models and level of

service have not improved, and in fact frequently have deteriorated. In this

respect Portugal has not developed its competitive potential, given its tech-

nical proficiency.

- 16 -

47. The industry imports a significant portion of its raw material

needs, including all cotton and certain fabrics. However, present raw mate-rial financing is limited to six month credit and should be extended to

twelve months, in order to permit manufacturers to carry adequate stocks.

48. Cotton yarn exports have been declining in recent years and thePortuguese should make exports to increase productivity and maintain costsat competitive levels. Competitivity could be enhanced through the sale ofyarns with a higher value added component such as mercerized, gassed, dyed,etc., which are also needed for finer articles in the domestic market andeventually replace exports of yarn with fabrics and garments.

49. More has to be done for exports of higher quality garments; thismarket is much more demanding in terms of fashion and designs, but with theright help the Portuguese manufacturers can start exporting medium-qualityproducts, and eventually also better quality items within the volume segmentof the market.

50. The upgrading of the quality of export products will enable Portugalto increase sales to European markets (and switch away from ex-colonialmarkets) and, within Europe, to more demanding markets where higher quality,up-to-date fashions and better designs are important. The markets deservingprimary attention are EEC, EFTA and North America. To make full use of itspotential, Portugal will need to obtain higher quotas in the EEC market.

51. Upgrading of product quality and expansion into EEC markets andCanada can only be achieved through a strengthening of management: produc-tion, design, marketing, finance and labor relations, at both top and middlelevels.

52.r Several steps are required to overcome present management weakness:training of new qualified managers, technicians and even skilled workers;getting the correct fashion appeal of products offered, up-dating fashiontrends in more sophisticated markets; getting good apparel design throughmodelists trained in the importing country; and giving the best level ofservice on deliveries, quality and prices.

53. Management training is of crucial importance in improving theindustry's performance: increasing production and productivity and reducingcosts, as well as finding new markets for exports. The training should beundertaken with the help of professional colleagues or seminars to improvethe skills of present managers. The bigger companies may send managers forcourses or seminars, and organize visits to mills abroad. For lower levelsupervision, overseers and shift heads, some kind of official school isneeded to teach correct approaches in transmitting orders to workers, humanrelations, the basics of mechanics, electricity, technical matters, technicalcalculations, proper action in case of accident or fire, etc.

54. New investment is needed primarily in certain finishing mills,e.g. corduroy and velvet, and for installation of automatic equipment in theclothing industry. In 1977 and 1978 an increase in exports - say some 20-25%

- 17 -

in real terms - could be achieved through improved utilization of capacity.However, continued and accelerating growth will require more substantialinvestments. Some of the largest mills have strong management capable ofexecuting substantial new investments.

55. In the period immediately ahead, the smaller mills, in fact themajority of the mills with less than 200 employees, will need to install moremodern machinery if they are to improve productivity and output. The need formodernization of machinery is greater in the clothing industry than in thetextile mills. Further, many mills need to improve their plant lay-outs andrationalize present production lines.

56. Only few of the smaller textile mills - accounting for at least75% of the total number of plants - can be regarded as economical. As partof Portugal's modernization and expansion program, smaller mills should becombined into larger units or absorbed into new units. Finally, there issome indication that part of the spinning capacity is redundant and shouldbe eliminated as part of the industry's restructuring.

57. The textile and clothing industries would benefit from a clarifica-tLon of Government policies towards the industries especially in the areas oflabor, the priority of investments, restructuring and finance. As seen by theMission, the Government policy should take the following key considerationsinto account:

(a) Textile mills need an extension of credit terms from six totwelve months for the financing of raw material imports;

(b) The industry should be assisted in a process of modernization,restructuring and improvement in productivity. This will in-volve new investment, management training and reequipping andrestructuring of the older and smaller uneconomic mills. Thesesteps are essential in the process of upgrading product mixand quality which should provide the basis for export recoveryand expansion;

(c) Investment is needed for the acquisition of new machineryin the smaller mills, particularly in the garment industry.Many mills also require new plant lay-outs. There may be acase for encouraging the largest and most efficient plants toexpand their operations. New plants should be on a minimumeconomic scale and preferably integrated. Financing for therestructuring program could be provided by existing investmentbanks (CGD and BFN). The largest mills should be able tosupplement finance available domestically by direct borrowingabroad;

(d) Many of the smaller plants can no longer expect to operateeconomically, especially in the spinning sector. They willneed to be consolidated through mergers with other small firms

- 18 -

or absorbed by the largest expanding firms. Hence, their workforce will need to be reemployed by the expanding larger millsor be deployed in new industrial estates. The IAPMEI and EPPIhave to play key roles in this process;

(e) Portugal will need to increase exports of higher qualityproducts, particularly to EEC and EFTA markets, U.S. and Canada.As part of its expansion and rehabilitation program, Portugalwill need to negotiate larger import quotas in EEC marketsfor higher quality products; and

(f) The improvement in management training can essentially beundertaken by the industry. However, the Government willhave to play an important role by expanding present manage-ment assistance programs (paragraph 3.07 of Main Report).

(g) These measures would be helped by a more detailed study ofthe long-range development of the industry, giving specialattention inter alia to rationalization, restructuring,prospective markets at home and abroad, expansion of selectedproducts and productivity improvement.

I. Other Exporting Industries

58. The footwear industry can expand its output to 28 million pairs by1981, with some 15.5 million for export (more than three times the 1976 level),mostly in the medium price range ($10.00 per pair). Steps to improve pro-ductivity include additional mechanization, guarantee of high quality andprice of leather supplies, development of the component industry, incentivepay and increased marketing efforts. The industry, with two-thirds of firmsemploying less than 20 workers and only one plant more than 500, would benefitfrom restructuring (see Chapter III, Section D).

59. For the food processing industry inadequacies of supplies (espe-cially fish) are a major obstacle to increasing exports. The industry is inneed of some $100 million investment in new equipment and additional coldstorage facilities. Productivity can be doubled by mechanizing processinglines, improving materials handling equipment and introducing incentive pay.The industry would benefit from new research and development, with Governmentsponsorship, and is also in need of restructuring into more medium sized orlarger units. Exports of canned fish, meat products and some other cannedand frozen vegetable items can be expanded; exports of tomato paste shouldcontinue the improvement started in 1976.

60. The cork industry can expand employment by 5,000 jobs and exportsto $200 million in 1981, compared with 1976 employment of 15,000 and estimatedexports oL $130 million for 1977. Steps required are: (a) installation ofnew and improved machinery, with investment incentives and government assis-tance for the smaller factories; (b) a Government sponsored program of search-ing new and wider uses of cork, capitalizing on the present trend of wideningthe cork markets; and (c) raise the productivity of cork "stripping", withorganization of labor to ensure a more regular supply.

- 19 -

61. The pulp and paper industry comprises several modern and large pulpmills (four have more than 500 employees each) which export more than 60%of their output, and supply the needs of some of the country's paper mills,most of which are small and use old equipment. With improved operatingand marketing and the expansion already underway, pulp and paper exportsare expected to increase from about US$100 million in 1976 to some $150million in 1978. Further expansion and improvement must wait for carryingout feasibility and market studies and arranging for financing. Plans toinstall a new plant to produce corrugated material (mainly for packaging forexport products) have high priority. The most serious issue in the futuredevelopment of the sub-sector lies with the economic exploitation of existingpine and eucalyptus plantations and the carrying out of a carefully plannedforestation program. Pulp and paper are capital-intensive industries butsubstantial additional emploment could be generated in linked activities, bothupstream (in forestry exploitation and wood transportation) and downstream (inthe paper conversion and printing industries).

62. In addition to the foregoing export industries, a major expansionis called for in the production of construction materials, including cement,which will call for substantial investments. Parallel expansion will beneeded in such items as building hardware, ceramic accessories, electricalfixtures, etc., to meet the large needs of residential construction as well asinvestment projects in the public and private sector. Output in this industryis likely to increase well over 10% annually to meet domestic requirements.

Finance and Organization

J. Domestic Financing of Investment

63. Investment in the manufacturing sector was low in 1975 and 1976. In1975 labor conditions were unsettled and exports suffered from interruptionsin production as well as the external recession. The ability of companies toundertake and finance investment deteriorated sharply. Management was weakened.As noted in paragraph 4, significant improvements are now taking place. Con-tinued improvement will in part depend on the restraint exercised in limitingwage increase in 1977, which the Government is seeking to keep to 15%. Com-panies' ability to finance investment is also being strengthened by measuresnow under way to revalue assets, reschedule debts and cover the exchange riskson foreign borrowings (Chapter IV of the Main Report).

64. Demand for investment funds has been low, and the banking system hasample resources, both domestic and foreign, for financing industry. In theshort-term, availability of financing would, therefore, not seem to be anobstacle to increasing investment. Also, as is clear from the review of in-dividual industries, it will be possible to increase output (and exports) ofmany products without substantially increasing total investment in the manu-facturing sector. Idle capacity and better use of labor on the job shouldmake such increases possible in the months immediately ahead.

65. If Portugal moves towards the right policy mix of export incentives,as recommended in Section E, output and exports can be expected to rise to

- 20 -

such an extent that investment requirements will increase substantially. Overa period of three or four years the Mission foresees a steadily rising trendin investment. Even at present - as noted in the sections on individualindustries - technology and equipment needs to be modernized. Plant lay-outs need to be improved, for example in many metal mechanic and cloLhingindustries - if firms are to make better use of existing machinery and improvelabor productivity within the rules agreed to with the labor unions. Improvedmanagement and production techniques are also needed. The restructuring ofthe textile industry will require new machinery and the same is true for theclothing industry. Furthermore, present demand and cost conditions in severalexport industries warrant expansion of production facilities and the start-upof new plants, as is evident from the plans to expand production of paper andpulp, color TV's and proposals to start production ofL utomobile engines forexport.

66. While the expansion of labor intensive and export industries deserveshigh priority, Portugal will also have to proceed with a number of more capitalintensive projects producing intermediate goods. As investment in manufacturingincreases, it is likely that financial resources, and especially public funds,will become increasingly scarce. This may actually occur at a time when thefinancial conditions in the economy will be tightening. It is, therefore,advisable that Portugal adopt criteria for resource allocation in the manufac-turing sector, with due recognition of the objectives of acceptable economicreturn, employment creation and export growth. It will be important that,within available resources, sufficient funds are specifically set aside tomeet the investment needs of export industries. Overall estimates of tleinvestment needs of export industries and the other manufacturing sub-sectors(including the SINES projects) should be prepared as soon as possible toguide the allocation of budget and credit resources. The Mission understandsthat the Ministry of Industry is preparing such overall investment estimatestor both public and private sector manufacturing.

67. The following steps can be taken to increase investment and channelresources to high priority projects:

(a) Expedite the measures to re-value capital assets andreschedule debts. In addition, in selected cases wheretight financial conditions impede the execution of highpriority investments, the Government may wish to make riskcapital available (e.g. through the National DevelopmentFund or by having the CGD and BFN provide equity funds)or through a new facility, whereby the Government wouldbe able to finance plants directly and lease them to newindustries, enabling them to purchase the plant later.

(b) Revive the stock exchanges in Lisbcon and Oporto as a firststep in creating a real capital market.

(c) Increase the responsiveness of the BFN and CGD to theinvestment needs of industry and establish a better under-standing among industrialists of the policies of the BFN

- 21 -

and CGD. In attaining these improvements these banks mayusefully carry out a dialogue with selected industry groups,and provide a more careful explanation of the role andstandards of Investment financing.

(d) Assist industry in the preparation of projects for considera-tion by the investment banks. This can be done through morepromotion efforts by these banks. A more systematic effortshould be made to utilize existing Portuguese consultingengineering resources. The Government should consider estab-lishing a project preparation facility which will improve theuse of available engineering and 2conomic talent and, wherejustified, provide finance for feasibility studies; such afacility would utilize existing Portuguse engineering/management firms, supplemented by external help.

(e) Improve the process of selecting projects in the banks andthe Ministries of Industry and Planning by economic evaluationmethods, using shadow prices for foreign exchange and labor.Public credits and concessionary terms should be confinedto projects with high economic return as distinct from thegrcnting of public resources to inefficient industrial plants.

K. Interest Rates

68. Real interest rates are deeply negative, even after the adjustmentsmade in August. The special interest rate subsidies for investment projectsare small compared with the inflation subsidy. The present levels of interestrates tend to discourage investors from committing funds to projects InPortugal. At the same time demand for funds is rather inelastic with respectto interest rates. A progressive adjustment in interest rates to positivereal levels would encourage industrial investment over the longer term andprovide an Incentive for more efficient resource allocation and, in particular,employment-intensive production. The achievement of an adequate level ofinterest rates will, in time, depend on progress made in abating domesticinflation. For the present, a time period of some two years would, however,seem realistic. More immediately, it seems essential to introduce an elementof flexibility as is being done by linking the rate on Treasury Bonds to theCentral Bank discount rate. Meanwhile, interest rate subsidies under existingregulations should only be granted for economically justifiable projects witha favorable employment effect.

69. A realistic interest rate policy is also essential for establishinga more liberal regime of international capital movements. Higher real interestrates will make it more attractive to keep capital in Portugal and encourageinvestment in Portugal provided exchange rate policy is also regarded asrealistic and stable. Hence, policies on interest rates and the exchangerate will have to be closely in tune with each other.

- 22 -

L. Foreign Investment

70. Foreign investment should play an important role in the expansion of

Portugal's export industries. Assistance provided in connection with direct

investment, often by smaller foreign enterprises, could be a key factor inimproving production management and in strengthening marketing efforts. The

technical assistance associated with the foreign investment may often be at

least as important, if not more important, than the financial contribution.It is important that Portugal's policy encourage foreign investments, partic-

ularly those which contribute to the twin objectives of export expansion and

employment growth.

71. The new Foreign Investment Code promulgated in August 1977, is a

decided improvement over the 1976 version. However, it still raises someproblems, and these should be resolved to the extent political realities

permit.

(a) Article 17 suspends the transfer of dividends, profits

and proceeds of sale or liquidation whenever (i) thereis a serious disequilibrium in the balance of payments,or (ii) the amount involved would provoke serious economicand financial upheavals in the country. In such cases,

the amount to be transferred per year could be as littleas 20% of the total involved. Ideally, there should be no

limits on the transfer of profits or the repatriation ofcapital. At the minimum, the restriction on transfer ofprofits should be eliminated in order to provide an assuiredincentive to foreign investors and in order to bring thecode closer to OECD and EEC requirements.

(b) The reference to a serious disequilibrium in the balance

of payments as a condition for restricting the transfer ofprofits or repatriation of capital is both sweeping andvague. If it cannot be eliminated, it should be made more

precise in its terms. In fact, the decision to admit for-

eign investment should be based on the assumption that the

resulting benefits to the economy are such that the balanceof payments can and, should accommodate remittance of profit

and repatriation of capital.

(c) Article 20 appears on the surface to be satisfactory in

permitting branches of foreign companies and companies with

foreign investment to have access to Portuguese institu-

tions for short-term credit. However, given the roll-over

practices of Portuguese commercial banks, short-term creditbecomes in fact disguised term credit. This means that

foot-loose foreign investors can still exploit the Portuguesebanking system by undertaking heavy borrowings and then, when

profits have been transferred abroad and necessity dictates,they can simply pull up stakes and default on their loans tolocal banks.

- 23 -

(d) The provisions on term credit (Article 21) are too generous

to foreign investors; instead, they should be required tom

bring in a higher proportion of borrowed funds from outside

sources. The same risk with foot-loose industries of course

exists, as described above.

(e) The Government has been asked to renew the investmentguaranty agreement with the U.S. and to conclude similar

agreements with Germany and Switzerland. It is in Portugal's

interest to have such agreements if it wishes to attract

foreign investment.

M. Coordination, Planning and Execution

72. Industrial planning and policy, and execution of investment projects

is widely dispersed among Ministries and agencies. The Ministries of Planning

and Coordination, Industry and Technology, Commerce, Finance as well as the

Bank of Portugal all get involved in critical phases of industrial planning,

finance and implementation. Key agencies and the Ministries under which they

resort are the Export Development Fund (Ministry of Commerce); the Institute

.for Small and Medium Industries (IAPMEI), and the Public Enterprise for

bIndustrial Parks (EPPI), (Ministry of Industry); the Institute for Foreign

Investment and the Institute for State Participations (IPE), (Ministry of

Planning). The Ministry of Industry supervises State enterprises in the

industrial sector, in consultation with the Ministry of Planning which in turn

also supervises the SINES complex. The Ministry of Finance is represented on

the board of the two iinvestment banks (BFN and CGD) which will have to finance

more than half of industrial investment in the next few years.

73. The Mission recommends that the Government prepare overall estimates

for investment in both heavy industries and export industries and determine

economic criteria for the financing of projects deserving priority. It would

seem desirable that a top-level Government coordinating group, chaired by the

Minister of Industry, be set up to formulate the investment plan and' monitor

its financing and execution. The key Ministries, the Central Bank and the

investment banks would participate in this group and, as far as the export

industries are concerned, staff work could be undertaken by the Export

Development Fund.

74. Several of the agencies will need to be restructured or strengthened

if they are to play an effective role in the reorientation of Portuguese in-

dustry toward employment creation and export. The IAPMEI and the EPPI have to

play a central role in the restructuring and relocation of the textile, shoe

and clothing industries (reequipping, mergers, industrial estates) as well as

the essential strengthening of links between small and large sized firms. To

carry out its task, the IAPMEI will need to be strengthened and decentralized

(see Annexes III-3 and III-4). The IPE has only recently started operations

and will have to play a key role in making the operations of firms with State

participation more efficient.

- 24 -

75. The Mission has made recommendations in several fields of industrialpolicy (paragraph 3 lists these major areas). These recommendations arecl,sely interrelated. For example, the steps to be taken to improve produc-tivity in export industries, such as those recommended for individual indus-tries in Chapter III, of the Main Report, will be mo e effective if they arepreceded by policies to improve price incentives favoring these industries.Conversely, policies to give greater incentive to exports must, to have a fulleffect, be accompanied by modernization in plant and management, by technicalassistance to selected industries and by a strengthening of marketing assis-tance. Both the rationalization of export incentives and the improvement inproductivity will need to be bolstered by new investment and the mobilizationof finance for high priority projects. Clarification of and prompt implementa-tion of Government policies (e.g. in distinguishing between public and privateactivities) and labor policies are essential for reviving investor confidence.

76. Although it is difficult to pin-point priorities among the measuresrecommended by the Mission, certain ranges of priority can be discerned. Thepolicies recommended to provide the right incentives clearly are basic toa program for stimulating export industries. Under this category fall thegeneral reduction in export costs, elimination of the import substitutionbias of the incentive system, additional export subsidies, and the raisingof interest rates. The Mission recognizes that these measures may requirea one or two year period to become fully effective. Another group of toppriority measures deserving immediate attention are (a) the formulation ofa comprehensive industrial investment program and coordinated arrangementsfor monitoring credit allocation and for execution of private and publicinvestments; (b) provision of financial assistance to viable industries,a more active role of the investment banks (BFN and CGD) and assistancein project preparation; and (c) institutional steps to strengthen marketingassistance (FFE).

77. A further range of priority measures are those concerned withstructural reform which will extend over a longer period; for example (a) therestructuring of the textile and clothing and other industries and the con-solidation of firms into larger more viable export units, (b) the assistanceto small industry; and (c) regional industrial development. Some of thesemeasures require the strengthening of selected institutions (IAPMEIE, EPPI andIPE). The Mission specifically recommends more detailed studies be undertakenof the restructuring and modernization of the textile and clothing industries,and the more intensive development of the capital goods industry. Parallelwith these measures are the recommended improvements in the Foreign InvestmentCode and steps taken to attract an increasing flow of external investment andcredit.

78. The Report has focused on the substance of desirable measures, andhas not always indicated who should adopt and implement the measures. Theresponsibility for undertaking many measures are, however, clear - as forexample the role of the Ministry of Finance and the Bank of Portugal inimproving the incentive system and interest rate policy, and the functionof specialized institutions in their areas of specialization (e.g. assistance

- 25 -

to small industry and restructuring and regional development: IAPMEI, EPPI,SINES; export marketing: FFE; foreign investment: IIE; industrial investmentallocation: BFN and CGDC The Ministry of Planning has responsibility forintroducing improved project appraisal methodology especially in the publicsector (along with the BFN), greater emphasis on employment creation measuresand foreign investment policy. The Ministry of Industry and Technology hasa key role in restructuring, preparing selected industry programs (along withindustry associations), preparing investment estimates for the manufacturingsector as a whole, modernizing management (with IPE, industry associationsand the CIP), providing technical assistance (in part through IAPMEI), andconducting selected studies (textiles and clothing industries, and capitalgocds). The Ministry of Commerce has responsibility for increased assistancein export marketing. Clearly many of these measures will need close collab-oration among different institutions, both private and public, particularlyin the area of management modernization, restructuring of industry, and theintroduction of more effective labor-management relations.