The Capital Goods Sector in LDCs:A Case for State Intervention?

SWP343WP C-r ''''!O ' L '.

World Bank Staff Working Paper No. 343

July 1979

FILE COPY

Prepared by Jayati Datta MitraCountry Programs DepartmentEast Asia and Pacific Region

Copyright © 1979The World Bank1818 H Street, N WWashington, D C. 20433, U.S.A.

The views and Interpretations in this document are those of the authot i001 S X e7

and should not be attributed to the World Bank, to its affiliatedorganizations, or to any individual acting in their behalf.

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The views and interpretations in this document are those of the author andshould not be attributed to the World Bank, to its affiliated organizations,or to any individual acting in their behalf.

WORLD BANK

Staff Working Paper No. 343

July 1979

THE CAPITAL GOODS SECTOR IN LDCs: A CASE FOR

STATE INTERVENTION?

A Background Study for World Development Report, 1979

This study examines the case for the state promotion of machineryproduction in LDCs. It begins by setting out the rationale for capitalgoods manufacture in a range of semi-industralized developing countries.

The study then delineates the principal features of machinery productionwhich distinguish it from the consumer goods or process industries, with aview to identifying the particular constraints to efficient operations in thecapital goods sector. The threefold typology of constraints which emergesfrom this examination underlines the case for, and suggests the modalitiesof, state intervention in the sector.

Prepared by: Copyright C 1979Jayati Datta Mitra The World BankCountry Programs Department 1818 H Street, N.W.East Asia and Pacific Region Washington, D.C. 20433

U.S.A.

TABLE OF CONTENTS

Page No.

SUMMARY AND CONCLUSIONS . . . . . . . . . . . . . . . . . i-ix

INTRODUCTION .. . . .*.* .* . . .*. . . . . . . . . . . . . 1

I. The Rationale for Capital Goods Production in LDCs . . 1Constraints on Imports . . . . . . . . . . . . . . . IIndustrial "Deepening" . .. . . . . . . . . . . . . 2Protectionist Trends . . . . . . . . . . . . . . . . 2Changing Comparative Advantage among LDCs . . . . . . 4Expanding World Trade in Capital Goods. . . . . . . . 4The "Appropriateness" Argument. . . . . . . . . 5Factor Endowments .... . .... . . . . . . . . . 7Considerations of Firm Size . . . . . . . . . . . . . 7Externalities .... . . . . . . . . . . . . . . . . 8

II. The Efficiency of Capital Goods Production: PossibleConstraints and Choices . . . . .. 10

Special Characteristics of the Industry. . . . 10Factors Affecting Static Efficiency . . . . . . . . 11

Labor .... . . . . . . . . . . . . . . . .. . 13

(i) Labor Productivity per Machine Task. . . . . 13(ii) Labor Productivity per Plant . . . . . . . . 14

Material Inputs . . . . . . . . . . . . . . .. . 15

(i) Steel .... . . . . . . . . . . . . . . . 15(ii) Castings, Forgings and Component Manufacture 16

Capital and Overheads . . . . . . .. . . . 17

(i) Scale Economies. . . . . . . . . . . . . . . 17(ii) Organizational Requirements. . . . . . . . . 19

(iii) Firm Size.. . . . . . . 20

Considerations of Dynamic Efficiency . . . . . . . 22

(i) Cost Reduction and Incremental Innovation. . 22(ii) Design Improvements and Product Develop-

ment .... . . . . . . . . . . . . . .. . 23The Case Against Foreign Technology Purchase 24The Prevalence of Foreign TechnologyPurchase: Possible Explanations . . . . . . 26

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Page PNo

1110 The C&ce foz State Intervention . 0 . . 0 0 0 0 . 0 27

(i) ERtn EcnBieo 0 0 o o 0 0 0 0 0 0 0 0 0 0 27

(ii) nf§nt Induty Support. 0 . 0 0 . . . o 0 o 0 31

(iMi) The educticn of Uncertainty 0 0 0 . 0 0 0 0 34

The Capital Goods Sector in LDCs:A Case for State Intervention?

Summary and Conclusions

1. This study explores three aspects of capital goods production indeveloping countries. Part I sets out the case for the development ofmachine-manufacturing industries in LDCs. Part II attempts to identify andevaluate the constraints which lower the current efficiency of productionoperations in LDC capital goods sectors, and which determine the dynamicefficiency of LDC machine manufacture in the longer term. Part III drawsup the case for state intervention in the sector.

Part I: The Rationale for Capital Goods Production in LDCs

2. The most general argument marshalled in support of capital goodsproduction in LDC economies where export inelasticities constrain capitalgoods imports, is that the expansion of domestic capital goods supply providesthe means for overcoming the problem of transforming savings into investmentand thereby serves to accelerate growth.

3. The second argument stems from the need to "deepen" the industrialstructure: in certain LDCs, e.g., the semi-industrial LDCs, such as Koreaand Brazil, the pattern and volume of final and intermediate goods manufacturehas proceeded to the point where considerations of scale no longer argueagainst backward integration into capital goods production.

4. Mlachinery production and export /1 may also be appropriate for suchmiddle income countries as Korea, Brazil and Mexico. Faced with thesituation of current (and possible future) increases in wage levels and theprospect of competition from LDCs which enjoy a larger (unskilled) wage advan-tage, these countries may be induced, unless productivity increases compensate,to move into the production of commodities which do not use unskilled laborintensively.

5. Further arguments for industrial deepening by selected LDCs areprovided by the move towards the adoption of protectionist regimes by certainindustrialized countries. The curbs on traditional LDC exports (textiles,footwear), which affect a wide range of LDCs, point to the need for restruc-turing export baskets and production both within and between LDCs. Thecapital goods sector provides one of the logical options for development:the sector's products are relatively unaffected by protectionist measures;LDC penetration of developed country markets is still at an early stage;moreover, LDC machinery exports by virtue of their relative skill intensity donot pose as large a threat (as do traditional exports) to the employment indeveloped countries of unskilled labor - the group which appears to enjoylittle inter-industrial mobility, and provides some of the most vociferoussupport for protectionist sentiment in DCs.

6. Recent trends in international trade do in fact herald the moveto greater LDC concentration on capital goods exports.

(a) The growth rate of LDC machinery exports outstripped the growth rateof LDC traditional exports over the period 1972-76.

/1 By virtue of their skill-intensity.

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(b) LDC machinery exports have been exploiting the largest/fastest-growing markets for capital goods, e.g., the US, Japan.

(c) Despite the large weight of relatively simple products such assewing machines, bicycles, etc., in LDC machinery /1 exports,the data (e.g., for Brazil, Argentina, the Republic of China)suggests that a beginning has been made in integrating back fromthese products into more diversified and complex lines of machinery.This was the historical pattern in the US.

(d) The most rapidly growing market exploited by LDCs is the combinedLDC market itself: about 45% of LDC capital goods exports wasabsorbed by developing countries in 1975/76.

7. One rationale for this faster growth lies perhaps in the alleged"appropriateness" of LDC exports to LDC needs. This is because: (a) incomelevels determine the type/quality of final products consumed, and the latterin turn determines the nature and quality of the capital goods which arerequired to produce the final products;/2 and (b) LDCs tend to produceequipment which is more in line with LDC relative factor endowments, morespecifically LDC skill endowments. 1

8. Certain middle-income LDCs are currently (and potentially) relativelywell-endowed with skilled labor, trained engineers and technicians; thisshould confer a relative advantage in the production and marketing of capitalgoods, both activities being relatively skilled labor-intensive.

9. Despite the emphasis on the exploitation of scale economies incapital goods production, certain equipment-producing sectors in the US,Japan and Germany are characterized by small-sized firms. Small-sized firmsapparently succeed in capturing scale economies and in exhibiting competitiveefficiency, where the product range is successfully restricted to one or afew products produced in large volume, or where the organizational require-ments of production militate against large size. In these sectors, therelatively smaller size of LDC firms /3 (conditioned in part by capitalconstraints, prevailing organizational practices, etc.), would appear toconfer an advantage.

10. Production conditions currently in existence in other LDC sectorsmay confer an externality on capital goods production; machine repair skillsand facilities already available in certain regions of LDCs may provide theseedbed for the start of production operations.

/I Defined as SITC 7.

/2 This is not, however, an argument for the encouragement of capital goodsof low quality per se, but for capital goods embodying simpler specifi-cations and performance levels.

/3 Relative to the average DC firm size.

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11. Similarly, the capital goods sector may transmit valuable externaleconomies to other sectors: (a) capital goods production activity may createpools of skilled labor proficient in repair work. This may increase efficiencyin the user industries: downtimes may be reduced, and the purchase of second-hand equipment /1 accommodated, thereby allowing LDCs to gain access to awider spectrum of available techniques; (b) the consequent increase inengineering skills may encourage the indigenous planning and setting up ofproduction (e.g., as in turnkey projects), and also accommodate an increasein the domestic procurement of capital goods by improving the economy'sability to translate and match equipment norms to indigenous productionconditions/capabilities; (c) capital goods production by facilitating theintroduction of modern technological/organizational systems of factorymanagement could influence the speed of innovation within the sector, and theefficiency of client industries.

Part II: The Efficiency of Capital Goods Production: Possible Constraintsand Choices

Factors Affecting Static Efficiency

12. Since the factors which determine the efficiency of capital goodsproduction have much to do with the special attributes which distinguish theindustry from the consumer goods and process industries, it is important topoint to these features at the very outset. These characteristics relate notmerely to the extreme diversity of products, or the varied production sequencesavailable for the manufacture of the same end-product, but also to the preva-lence of "interdependencies in capital goods production": the malleability inuse of each piece of capital equipment, the possibilities of grouping diverseend-products for processing on the same machine or in the same productionoperation, and the heightened scope for complementarities between specificfactors of production. The importance of these interdependencies derives inthe main from the typically lumpy nature of the equipment and skills used inmachinery production, and the consequent need to effect scale economies. Tofacilitate exposition, however, we shall deal with these interdependencies inLDC machinery production in terms of their influence on the major elements ofthe cost structure: labor, material inputs, and capital and overhead factors.

Labor

13. Current cost comparisons (for the same machine design) betweenLDCs and DCs reveal that the LDC comparative advantage in machine productiongenerally lies in labor use, despite the higher labor intensities of productionusually observed in LDCs. The advantage derives in general from the relativelylow LDC wage levels, rather than from high physical labor productivity, fordespite commendable levels of operator efficiency per machine task, plantoutput per man-hour in LDCs is usually lower than in DCs.

/1 Performance norms are sometimes difficult to re-establish after relocationof the equipment.

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14. Where labor productivity per machine task is observed to be low, itmay be due to the following reasons:

(a) the quality of skills available (even in middle-income LDCs) maynot be adequate for, or wholly appropriate to, the needs of capitalgoods production; and

(b) the lower performance standards may be due to poor training, andto the commonly observed predilection of firms to train only forspecific rather than for a wide range of machine tasks, a consequenceof the divergence between private and social net benefits.

15. Lower plant-wide worker productivity may be due to a number ofcauses outside the plant's control, e.g., poor raw material quality and supplyinelasticities, economy-wide incentive systems which militate against factorydiscipline, etc., but the available studies also document the effects of poormanagement - in terms of poor plant layout and flow of work, inadequate pro-duction scheduling, inventory control, and planning of auxiliary activities,etc. - on plant output per man-hour. However, it is important to point outthat the crude copying of DC management norms does not guarantee performancestandards in LDCs: adaptation of modern production-cum-organizational techniquesto the requirements (and qualities) of other complementary factors availablein LDCs appears to be crucial.

Material Inputs

16. The most common inputs consist of special steels, castings, forgingsand components.

17. Steel supply problems in LDC machine production usually stem fromthe poor quality of supplies, and from the limited range of specialty steelsavailable. They are exacerbated, however, by LDC attempts to effect importsubstitution in steel production: the application of a protective traderegime usually encourages prices to rise above international levels; attemptsto phase the steel sector's construction and production plans with those ofthe machine-building sectors often starve the capital goods sectors ofessential raw materials.

18. Castings, Forgings and Component Manufacture. The widely observedsupply inefficiencies in these areas are usually a consequence of poormaterial supplies (e.g., of pig iron, steel and sand used in foundry activities),inadequate technical standards and know-how, and organizational problems.The latter stem largely from decisions regarding the extent of subcontractingof component manufacture and the degree of specialization considered feasiblefor LDC foundry and forge operations. The problems associated with highrejection rates, the pooling of demands from disparate machinery producers(for the purpose of capturing scale economies), the scheduling of shipments,etc., which arise in the case of specialized component/casting production,are often so overwhelming that the decision to specialize (and therefore toexploit scale economies adequately) is often abandoned in favor of verticallyintegrated machine-building operations.

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Capital and Overheads

19. The efficiency of capital use in the equipment-producing industrieshinges on three related factors: (a) The first relates to the need to spreadindivisible investment capacities over large volumes of output. Scale economiesare, however, not so much a function of the total investment volume per plant,but of the capacity installed for the production of an individual product, andultimately of the length of run or "batch size" per individual mark ne. In theprogression of plant scale possibilities (from organization according to"one-off," through "series" to "mass production") efficiency tends to increasewhen the product range is limited and output per product increased, and whenbottlenecks/excess capacities are overcome through the subcontracting ofcomponent manufacture or through the adoption of specialization by process.(b) The organizational implications of production where scale economies aresought to be ensured are not trivial. Aside from the decision to specialize,the correct choice of equipment, the identification of common parts/sub-assemblies per machine operation, the possibilities for "capacity sharing,"the particular mode of production organization (e.g., according to whetherproduction is by "series" on general-purpose machines, or by "mass" onspecial-purpose machine tools arranged in continuous flow lines) have importantimplications for the requirements of labor skills, materials handlingcapacity, inventory scheduling, quality control, etc. (c) For an LDC settingup production, the complexity of the decisions, the imperatives of scale, theseductiveness of the "latest technology", and the bias towards capitalintensity induced by the pattern of tax and interest rate subsidies generallyprevalent in LDCs, usually tilt the investment decision in favor of newinvestments in large size plants, and against the alternative of upgradingexisting capacity. Inevitably, and as a further consequence, the range ofbuy-out decisions is restricted through the in-house installation of criticalcapacities. The large-sized capacities installed, the restricted use ofsubcontracting, and the inexperience of the new firm in production andcapacity scheduling, usually lead to decisions to extend the range of products(to exploit installed capacities). This reduces the range of output perproduct per firm in the restricted LDC market, and sets in motion a sequenceof developments which work against the logic of scale economies (by productline), and of specialization.

20. The available evidence for India, Brazil and Korea, for example,confirms the tendency towards large firm size, the prevalence of inadequatescales in individual product lines, and the existence of trends towardsproduct diversification as an answer to problems associated with capacityutilization.

21. To sum up, an appraisal of the factors which determine the currentefficiency of LDC capital goods production suggests that a number of simplebut carefully orchestrated measures taken at the shop floor level, toimprove labor skills, plant layout, quality of materials and parts inputs,operating and maintenance practices, tooling usage, product and materialstesting facilities, scheduling, etc., might serve to raise performancelevels and current capabilities in LDCs.

Capital and Overheads

19. The efficiency of capital use in the equipment-producing industrieshinges on three related factors: (a) The first relates to the need to spreadindivisible investment capacities over large volumes of output. Scale economiesare, however, not so much a function of the total investment volume per plant,but of the capacity installed for the production of an individual product, andultimately of the length of run or "batch size" per individual marklne. In theprogression of plant scale possibilities (from organization according to"one-off," through "series" to "mass production") efficiency tends to increasewhen the product range is limited and output per product increased, and whenbottlenecks/excess capacities are overcome through the subcontracting ofcomponent manufacture or through the adoption of specialization by process.(b) The organizational implications of production where scale economies aresought to be ensured are not trivial. Aside from the decision to specialize,the correct choice of equipment, the identification of common parts/sub-assemblies per machine operation, the possibilities for "capacity sharing,"the particular mode of production organization (e.g., according to whetherproduction is by "series" on general-purpose machines, or by "mass" onspecial-purpose machine tools arranged in continuous flow lines) have importantimplications for the requirements of labor skills, materials handlingcapacity, inventory scheduling, quality control, etc. (c) For an LDC settingup production, the complexity of the decisions, the imperatives of scale, theseductiveness of the "latest technology", and the bias towards capitalintensity induced by the pattern of tax and interest rate subsidies generallyprevalent in LDCs, usually tilt the investment decision in favor of newinvestments in large size plants, and against the alternative of upgradingexisting capacity. Inevitably, and as a further consequence, the range ofbuy-out decisions is restricted through the in-house installation of criticalcapacities. The large-sized capacities installed, the restricted use ofsubcontracting, and the inexperience of the new firm in production andcapacity scheduling, usually lead to decisions to extend the range of products(to exploit installed capacities). This reduces the range of output perproduct per firm in the restricted LDC market, and sets in motion a sequenceof developments which work against the logic of scale economies (by productline), and of specialization.

20. The available evidence for India, Brazil and Korea, for example,confirms the tendency towards large firm size, the prevalence of inadequatescales in individual product lines, and the existence of trends towardsproduct diversification as an answer to problems associated with capacityutilization.

21. To sum up, an appraisal of the factors which determine the currentefficiency of LDC capital goods production suggests that a number of simplebut carefully orchestrated measures taken at the shop floor level, toimprove labor skills, plant layout, quality of materials and parts inputs,operating and maintenance practices, tooling usage, product and materialstesting facilities, scheduling, etc., might serve to raise performancelevels and current capabilities in LDCs.

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could be garnered by the DC innovator through the medium of technologytransfer arrangements, as against those which could be secured through exportto the particular LDC as well as to the LDC's potential export markets.Moreover, in the case of a new innovation, technology transfer is usuallyaccompanied by prohibitions on LDC exports.

27. Third, the resource costs of technology tranfer, encompassing thephysical items which embody the technology (e.g. blueprints, tooling) as wellas the know-how in the form of support engineering and adaptive activities,are apt to be high for machinery technology transfer. The resource costs oftransfer are particularly high for "leading edge" technology which is charac-terized by "few applications, a short elapsed time since development, andlimited diffusion," and are determined closely by the size, and technical andmanagerial experience of the transferee. It is possible that the frequentadoption of the technology transfer route by LDCs is due in part to aninadequate appreciation of the magnitude of the associated transfer costs.

28. A large part of the explanation for the paucity of LDC designinnovations may lie in the joint operation of an array of factors such asthe general application of import substitution regimes, oligopolistic marketstructures, etc., which induce LDCs to opt for the stability of market sharesand for satisficing behaviour. It is only when competitors attempt to increasemarket shares that LDC firms attempt to counter with design improvements.In these circumstances foreign technology purchase appears to be a quickerand surer route to product innovation than indigenous R&D.

29. The small size of the market for the existing design provides yetanother explanation. The restricted LDC market limits learning, restrictsscale economies in research, and accentuates the divergence between theprivate and social benefits and costs associated with innovative effort.

Part III: The Case for State Intervention

30. The case for state intervention in the mechanical engineering )industries rests -on three factors: (a) The operation of externalities; (b) therelevance of infant industry arguments; and (c) the efficacy of planning inreducing uncertainty.

(a) Externalities

31. It was pointed out that individual LDC plants undertake lessthan the optimum degree of labor training to minimize losses induced by thepirating of labor by competing firms. This works against increases in "laborproductivity." There appears to be a strong case, therefore, for governmentprograms for direct vocational training, for the subsidization or organiza-tion of self-financed schemes of in-plant training, or for training throughthe operation of multiple shift work.

32. Part II pointed out that plant efficiency in labor use, materialsuse, and management arrangements for the exploitation of scale economiesthrough subcontracting, and the choice of systems of know-how and management

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which are appropriate to LDC factor endowments, could be improved signi-ficantly "if technical expertise on production were available to management."Large firms may possess resources for the hiring of such know-how but smallfirms generally do not. A case therefore exists for the organization of agovernment program for the dissemination of pre-investment technical know-how,for technical assistance in "best practices," and for the organization andsystematization of technical information. Similar gains are likely to resultfrom the organization of centralized engineering consultancy services,particularly for the conception, setting up, and operation of turnkeyplants. An associated need relates to the establishment of nation-widestandards for the mechanical engineering industries and for determining theappropriate timing for a switch to systems of standardized fasteners, tooling(and some types of parts) and for the production of these standardized partsand tools in specialized plants. These steps would confer benefits whichindividual plants acting atomistically would be unable to attain.

33. Private calculations of returns and risk restrict indigenousindustriai R&D and LDC export efforts in international capital goodsmarkets. The external economy argument therefore buttresses the case forgovernment support of R&D (through tax and other incentives, contractresearch, encouraging the pooling of private efforts, etc.) and Governments'attempts to organize or support large-scale marketing efforts for LDCmachinery exports.

(b) Infant Industry Arguments

34. Part II pointed to the need for large volumes of output for thespreading of overhead costs and for learning. In LDCs characterized by smallmarkets it is therefore important to reserve the domestic market for domesticproducers, and to enlarge the total market by encouraging exports. The firststep is usually sought to be ensured by outright prohibitions or quotas.However, since this introduces inefficiencies in the equipment-using industriesthrough the restriction of the choice set, more preferable policy toolsappear to be the imposition of tariffs or the direct subsidization ofproduction for limited periods (long enough for learning to be effected).Interest rate subsidies which are in use in certain LDCs are less appealingbecause they encourage the use of capital relative to labor. One variant ofthe interest rate subsidy is the provision of overhead services at subsidizedrates. Government programs to encourage exports (including the operation offree trade areas, joint LDC production facilities, etc.) would serve the dualpurpose of enlarging the market, encouraging quality improvements and ensuringinternational competitiveness.

35. Part II outlined the importance of learning and of the adoption oftechnologies and organizational modes which are in keeping with LDC factorendowments. Learning appears to be facilitated by the adoption of machinedesigns where the intrinsic properties of the machine (rather than itsspecial features) are important, and by high volumes of cumulative output.These learning effects are important to bear in mind for LDCs where foreigntechnology imports are monitored or where technical assistance programs areorganized to help small firms choose apprcpriate techniques. Again LDClicensing and investment monitoring authorities tend invariably to mistake

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large firm size for large individual product volume. It is importanttherefore, to ensure that individual machine markets are not fragmented bygovernment licensing policy, that government-subsidized funds flow to small(subcontractors) as well as to large-sized firms, and that funds flow notonly to the new but also to the old existing firms which, by operating largeruns, can exploit their accumulated experience.

(c) The Reduction of Uncertainty

36. The establishment of the lumpy investments which characterizemachinery production, the full utilization of equipment and the concomitantadoption of efficient forms of technical organization, subcontracting, etc.are predicated on the stability of demand for the LDC equipment sector'scurrent product mix. Therefore some degree of indicative macro planningappears to be warranted to ensure the availability of prior information onthe timing of investments in the domestic equipment-using sectors and theplanned phasing of the raw material-producing sectors with the mechanicalengineering industries.

37. The need for stable demand patterns translates itself into anargument for a stable rate of growth, since the growth of the mechanicalengineering sector is determined by the growth rate of the economy. Hencegovernments contemplating economy-wide stabilization policies must concomit-tantly draw up measures for the support of the engineering industriesif recession is to be averted.

38. An additional rationale for sector and subsector planning (whetherfunded by government or by private industry) derives from the very complexityof the production decisions involved in capital goods manufacture: equipmentproducers should have a better framework for determining trade-offs and forsharpening perceptions than their "traditional bookkeeping framework ofaggregate financial transactions." A related service would consist of theacquisition, processing and dissemination of international marketing informa-tion which is "critically important" for determining the optimum degree of"product differentiation" for exports.

The Capital Goods Sector in LDCs: A Case for State Intervention? /1

Introduction

This study attempts to explore three questions relating to thedevelopment of capital goods production in LDCs. Its first concern (elabora-ted in Part I) is to examine the case for setting up mechanical engineeringproduction facilities in developing countries. Part II attempts to identifyand evaluate, in the context of the available empirical evidence, the con-straints which mar the efficiency of capital goods production. Some of thesebottlenecks work against the full exploitation of a sector's current capabil-ities, thereby reducing the current static efficiency of capital goodsproduction; yet other constraints are important in the context of a dynamicframework where the ability to innovate is important for continued competi-tiveness. The study then attempts in Part III to draw up the case for govern-ment policies which might aid in nurturing the mechanical engineeringindustries in LDCs. The evidence which the study attempts to marshal isunfortunately somewhat anecdotal and sporadic in its coverage./2 This ispartly because the number of LDCs following self-conscious policies ofcapital goods industry development has till recently been fairly small.Moreover, the focus of discussions on industrial policies in even thesecountries has tended more to the general questions of import substitution andexport promotion than to the particularities of capital goods industries perse. This was true, for example, in India, Brazil and Mexico. Again, as in thecase of the genre of development literature relating to the issue of choiceof techniques in LDCs, the sparseness of discussion is due perhaps also tothe importance of, and the economists' unfamiliarity with, some of theengineering dimensions of capital goods production./3

I. The Rationale for Capital Goods Production in LDCs

Constraints on Imports. The most generally heard argument in favorof capital goods production in LDCs runs in terms of their contribution tothe growth process. In economies where balance of payments difficulties

/1 I am greatly indebted to Howard Pack. As the numerous footnotes indicate,I have drawn extensively on his unpublished paper "The Capital GoodsSector in LDCs: A Survey," 1978.

/2 I have attempted to illustrate the propositions set out in this study,by examples from the empirical literature on Brazil, India, Mexico,Argentina, and the Republics of Korea and China. I have also referredextensively to the experience of the Soviet Union during the period1927-37, when it was grappling with precisely the same sets of problemsas those LDCs which are currently attempting to establish capital goodsproduction.

/3 The Soviet Union, however, appears to be a striking exception. Theliterature on Soviet industrialization during the period 1927-37appears to display a very keen understanding of the economic cumengineering issues involved. Also remarkable was the Soviet-willing-ness to experiment with alternative modes of production organization(specialization by product and specialization by process) and concomi-tantly with series production and mass production.

impose limits on imports of capital goods, the expansion of domest,c capitalgoods production is seen as the means of overcoming the pcoolLfli of trans.forming savings into inveatment and accelerating growth0 Indeed, in severalLDCs the products of the machinery sector constitute the single mo5t importantcomponent of gross fixed capital formation (e.g. 41% in (orea in lS77), andat the same time contribute a very large share to th2 total import 'oill: 27%of total Korean imports in 1977 consisted of machinery and zquipme.a;capital goods contributed 49% to Indian imports of manufacturas in 1.976.Looked at sometThat differently, about 30% of world eN2porto /I Cf senineeringproducto in 1976 were absorbed by the developing countr.eo. CftZ eCm,e_AVAntindustrisz, thezefore, appear to be the logical focus of imr&'uL3oitutingactivities in LDC economies, hard pressed by balance of paynents d:.fficulties0

Industrii `Deepening"0 A second argaizent Xn favor of t, ho insti-tutiou of the equipment-producing sectozs is dicteted by tkn opzc4¢.,Ioc stageof development reached by particular LDCSO The aTgznsent for "a Eor, balancedindustrial development with special ap'piEziz on thRe local prodzzt-2on of rawmaterials, fuels and semi-finished goods, as opposed to t'he prodvrctz:on offinished goods only"/L2 translates itself with time into the need icr thelocal pyoduction of the basic industrial equipment needed for the oteel,petrochemical aad other mineral -extraction industries0 Ths time fcr backwardintegration was judged to be ripe in the early 1960s for a nczber of LatinA!ericma countries considered then to be "at the most aevanced staSe ofindusetrilipstion - Argentina, Brazil, Chile and Nexico'K Taff /3 writing in1968 on the capital goods sector in Brazil refers to the prominent placeaccorded the equipment-producing industries as the "leading sector` for Brazil'sfuture economic growth0 In this view, the grovvth of the ecosaowy in the1950o wao stimulated by the import substitution of contmuer durables, butdevelopment in "the next phase" was associated with the accelerated domesticprodZction of capital goods. Westphal,/4 tracing the pattern of 7X(oreanindustrial development since 1960, refers to the importance of celectiveiuport substitution in the equipment industries in deepen'ng Rorea½s industrialstructure through backward integration from semi'finished and finishedproducts3

Protectionist Trends. Recent events in the .,;';- of inte2rnationaltrade appear to have strengthened the arguRent for "industrial _,'Ig' inparticular LUCSo With the onoet of a worldwide recession in .74, a majorshift in the direction of restrictive import plicy wams e£fected by the

/1 SITC 7, as defined in United NTations, Bulletin of Statstoicos ca Wocrld Tradein Lngineeing Products, 1976 e York, l otevar, the c'tsatisticsfor 1976 e5zcluded Chile, Colombia, Lebanon, S. Africa and UM r on-members.

/2 United Nations, ECLA, The ilanufacture of Industrial EguijœiLe_ nd achineryin Latin America, hew York, 1963, po 10

/3 Leff, Hathanial H0: The Brazilian CpEital Goods Industry l92I 64,Usrvard University Press, CambridgC, HlYass, l9O P° 40

/4 WeStphal, LoEo, "Manufacturing in Korea: Policy Issuos fxor Long-TermDeveloelsnt, ed0 Hasan, P. and Rao, D0C., The Johns HopkinS UnivereityPrFes, Baltimore and London, 19790

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principal industrial nations: the European Economic Community, Canada, Japanand the United States. While one of the major avowed targets of thesemeasures was Japan, the concentration of the restrictive measures on textiles,clothing, footwear, shipbuilding, steel, electrical consumer goods, elec-tronics and other miscellaneous manufactures, has meant that the restrictivetrade measures will have quite far-reaching implications for a wide range ofdeveloping countries. Not only are the current exporters of these products3everely hit, the measures have also dealt a blow to those LDCs which weregearing up for the exploitation of potential comparative advantage opportu-nities in the affected sectors. Thus the resurgence of protectionism has hitnot merely the three major East Asian exporters - Hong Kong, the Republic ofKorea, and the Republic of China (ROC), which together account for about onethird of LDC manufactured exports and which market over 60% of their textileand clothing exports (comprising the bulk of their manufactured exports) tothe industrial countries - but also LDCs with somewhat more diversifiedindustrial structures: Brazil, India, Mexico and Argentina; the newlyemerging LDC exporters: Colombia, Pakistan, the Philippines, Thailand andTurkey; and even countries at relatively lower levels of development:Bangladesh, Indonesia and Sri Lanka. The curbs on traditional LDC exports(textiles, footwear) point to the need for restructuring export baskets andproduction, both within individual LDCs and between LDCs.

Indeed, the three major East Asian exporters are looking to theirmachinery industries to fulfill the role of leading sector in their futureexport strategies. Brazil, Mexico and India, though somewhat less dependenton exports of textiles and clothing (these export categories constitutebetween one quarter and one third of their total manufactured exports, asopposed to Korea's one third), are also attempting to rely on non-traditionalengineering products to register expansions in their manufactured exporttotals. For the newly emerging exporters (Colombia, Malaysia, Morocco,etc.) the expansion of their traditional exports will depend not only onmovements in their own wage-productivity indicators, relative to trends incompeting LDCs, but also on the degree to which the established exportersdiversify. They, too, will need to explore possible comparative advantageopportunities in the light engineering sectors, and to determine whether thetime is ripe for laying the groundwork for a more substantial development oftheir machinery industries in the future. The case for capital goods produc-tion is strengthened by the fact that mechanical engineering goods /1 exportsare not yet subject to trade restrictions; that developed country marketpenetration by LDCs is still at an early stage (if Korean penetration of theUS market can be considered a guide);/2 that LDC machinery exports by virtueof their relative skill intensity do not pose a threat to the continuedemployment in developed countries of unskilled labor - the group whichappears to enjoy little mobility between industries;/3 and finally that

/1 Save for electronics products, electrical household appliances, ship-building, which in the UN trade classification are grouped withcapital goods (i.e. in SITC group 7).

/2 See Tables 2A, 2B, 2C for Korean shares in imports of machineryinto the US, Japan and Germany (Federal Republic).

/3 But provides some of the most vociferous support for protectionistsentiment in DCs.

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within the category of LDC non-traditional exports, capital goods haveregistered one of the fastest growth rates in recent years.

Changing Comparative Advantage among LDCs. Though comparable dataare somewhat difficult to muster, recent economic trends in individual middle-income developing countries (Hong Kong, Singapore, Korea, Turkey, Yugoslavia,Argentina and Brazil) suggest that the process of LDC export diversificationmay receive an additional impetus from the potential loss of competitivenessin traditional export areas, which may have been induced by the sor whatrapid rise in wage rates in some of these economies. [Between 1972 and 1976,for example, the nominal wages for urban production workers and for manufac-turing workers rose by 254% and 288% respectively in Korea, compared toincreases of 126% and 145% in the Philippines (Manila and suburbs) andThailand, respectively./1] Unless the effects of wage increases are compen-sated for by increases in labor productivity (and/or declines in other inputcosts), the middle-income LDCs are likely to face severe competition from thenewly emerging exporters such as Colombia, Thailand, the Philippines andMalaysia.

Expanding World Trade in Capital Goods. Recent trends in LDCexports do in fact herald the move to greater concentration on capital goodsexports. While growth rates of traditional manufactured exports from LDCshave been remarkable over the period 1972-76 (clothing exports from developingmarket economies,/2 for example, have grown at the rate of about 32% incurrent terms), the performance of LDC exports of machinery (category SITC 7)was as remarkable. For the group of developing market economies the growthrate registered in current prices was about 35% over the same period. Thishas been responsible for the changing composition of LDC-manufactured exports.Exports of machinery and equipment from developing market economies /3comprised 19% of their total manufactured /4 exports in 1972; by 1976 theirshare had risen to 23%. Moreover, the share of developing market economiesin world trade in machinery also rose from 2.3% in 1972 to 3.4% in 1976 (seeTable 1)./5

- A further disaggregation of the LDC export picture by geographicaldestination suggests that LDC machinery exports have indeed beenexploiting the most important growth markets for equipment imports.Penetration of both the Japanese and US markets (the two largestimporters of capital goods) appears to have proceeded apace: theshares of developing market economies in total US and Japanese importsof machinery appear to have risen from 6% to 9% and from 4% to 16%

/1 For Manila and suburbs, the statistic refers to the trend in unskilledlabor wage rates in the period 1972-76; for Thailand, it refers to themanufacturing wage trend over 1972-75. These data are presented only toconvey a rough idea of wage trends; definitions, coverage and accuracymay vary widely'between countries.

/2 United Nations, Monthly Bulletin of Statistics, New York, June 1978./3 United Nations, Monthly Bulletin of Statistics, New York, June 1978.74 Defined as SITC categories 5, 6, 7 and 8, excluding 68./5 Admittedly the expansion of electronics exports played a large part in

the growth of LDC capital goods exports, but some degree of diversificationhas been taking place. See the following para.

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respectively, over the period 1972-76 (see Table 1). A look at thecommodity composition of LDC machinery exports to developed coun-tries /1 confirms that the bulk of the exports is concentrated inrelatively low technology/labor-intensive lines of manufacture, e.g.,office machines, telecommunications equipment, sewing machines andautomotive equipment. These are obviously areas in which DC compara-tive advantage is beginning to diminish because of the high laborcontent of production. The evidence does, however, point to someprogress in the diversification of LDC exports into more complex linesof industrial machinery. Despite the decline in world trade in 1975,Brazil registered exports of textile equipment, paper and pulp-makingmachinery, construction and mining equipment, and power transformersto the US and Europe; Argentina exported mechanical handling andpackaging machinery to Europe; India, machine tools and pumps to theUS and Western Europe; and Singapore, exports of ball and rollerbearings, construction and mining equipment, pumps and centrifuges,powered tools and mechanical handling equipment. Though these exportswere admittedly of low volume and somewhat sporadic (see Tables 2B, 2Cand 3), and despite the fact that some of the capital goods exports arein the nature of durable consumer goods and the production processesinvolved are either assembly operations or relatively simple technolo-gically, the data imply that a beginning has been made in production(and marketing) and that it may be possible either to integratebackwards from these end-products to more sophisticated lines ofcapital goods manufacture, or to expand the products available toinclude machines with more complex specifications or finer tolerances.The evidence suggests that the Republic of China, for example, integ-rated backwards from the production of sewing machines, agriculturalmachinery, bicycles and textile equipment, into the production ofmachine tools, while the Argentinian auto industry had a significantimpact on the development of the machine tool industry./2 This wasalso the pattern in the US, where the development of the machine toolindustry derived great impetus from the prior expansion of the smallarms, sewing machine, bicycle, and automobile industries./3

- An even faster growing market for LDC machinery exports has been thedeveloping countries themselves; the 1972-76 growth rate of exports todeveloping country destinations was about 39% compared to an overallLDC manufactured exports growth rate of about 35% (see Table 1, and alsoTables 4A and 4B).

The "Appropriateness" Argument. This faster growth rate is oftenrationalized in terms of the greater "appropriateness" of LDC exports inmeeting LDC needs.

/1 See Table 3. Here again, the rubric "capital goods" encompasses allmachinery listed under SITC 7.

/2 See Cortes, Mariluz: "Argentina; Technical Development and TechnologyExports to Other LDCs," IBRD Draft (Mimeo), March 1978, p. 34.

/3 Rosenberg, N: "Technological Change in the Machine Tool Industry,1840-1910," Journal of Economic History, December 1963.

- One variant of this idea is an offshoot of the hypothesis that incomelevels in LDCs determine the quality of final products consumed, andthe latter in turn determine the quality of the capital goods requiredto produce the final consumer goods, eog., the quality of 6teelutensils used in India does not require the use of special purposemachine tools of strict tolerances. The concept of "appropriateness"bears further elucidation however0 One concomitant cf the Idea(though it is difficult to substantiate TigoTously) is that :iDC demandschedules may be more sensitive to price than DC demsnd schedules forthe corresponding class of producto/1 This in turn suggests twoalternative norms for production. The equipment produced ir the LDCmay simply be an earlier or less sophisticsted or scaled-down version(though by no means inferior in performance for specific puTposes) ofa machine currently produced in the DCs (eogoD a straighlt sttchsewing machine , bicycles with no gears) or it may simply embody poorerquality specifications 0 In both cases costs and prices may have beenlowered relative to DC levels to achieve competitiveness in LDCmarkets0 It is important to emphasize at this point , however , thatthe latter route, the lowering of price vla the sacrifice of qualityspecifications to suit current LDC market requireme2ats , does notappear to be the appropriate route for growth0 Exports of low qualityLDC equipment are apt to be especially vulnerable to competition fromdomestic equipment of similar lot quality and produced in otherLDCs 0 /2 The market for such loaquality products tends to be income=inelastic , and is apt to diminish wyith the process of groith; further ,

the memory of low performance is difficult to erase in a martet inwhich , relative to consumer goods. quality is ultiDately an importantattributeO Thus3, as the ROC and Korean equipent industriesdemonstrate , it is the quality end of the asrket which holds out thepromiae of faster technological advance and faster growtho Consider-ations of dynamic efficiency therefore Ergue against the sacrifice ofqualityo

Within the clEas of capital goods , LDC firms tend aslo to producemachinery which ic more in line with LDC relative factor endowments0bmsden /3 cites the case of the successful exports of machinetools from the Republic of China to the Philippines 0 ROC equipmentminimized investment outlays in the short run; given the lazbor intensityof ROC equipment relative to that of the higher priced (higher quality)machine tools available from other sources1 R8C equipaent inimizedtotal costs over the life of the machine1 , as well0

Given that the type of machine equipment lnstalled determines the natureof the production process (eogo. , whether one-off1 , series or massproduction , to use a convenient classification) , the use of LDC

/ ]oth (price) intercept and slope may be lower0/2 At the low quality end of the machine tool markLnet, foreign

iaports were not able to compete on price terms against domestic equipmentin the Republic of China in the 1950s

/3 Amsden , Alice: "The Division of Labour is Limited by the Type of Market:The Case of the Taiwanese Machine Tool Industry1 , World Development1 ,Harch l977.

equipment is more likely to dictate production skill requirements(managerial, engineering, and labor) which are likely to be bettersuited to LDC skill availabilities. The Soviet /1 attempt to arriveat appropriate organizational norms in the metal-working industriesduring the First Plan provides an interesting case in point. Theplanners attempted to match labor demands to availabilities byadopting production organization techniques (i.e. continuous flowmethods) which would use semi-skilled labor intensively and economizeon the use of skilled labor. This need to observe the imperatives ofthe "appropriateness" concept is a theme which recurs later in yetother contexts.

Factor Endowments. An additional argument in favor of equipmentproduction is that the capital goods sector, even in DCs, is labor-intensive,specifically skilled-labor-intensive./2 A number of LDCs: the Republic ofChina, Korea, Hong Kong, particular regions in India, Brazil, Mexico, Argentinaand Malaysia have a substantial pool of skilled workers /3 and/or of trainedengineers and technicians. Unless the wage advantage is nullified by lowerlabor productivities, the wage costs in these countries should confer acompetitive advantage in machinery production and marketing./4 A corollaryof this argument is that the incidence of machine production as between LDCs(conditions with respect to other factors such as capital supply being equal)will largely be a function of the relative endowments of skilled and unskilledlabor of competing LDCs.

Considerations of Firm Size. The size structure of firms in thecapital goods industries of DCs also reinforces the case for machine productionin LDCs. The skeptics hold that. owing to capital supply constraints, prevailingorganizational practices and norms etc., equipment-producing firms in LDCsare typically small relative to DC firms. They point out further that equip-ment production is characterized by very large-scale economies deriving mainlyfrom the lumpy investments embodied in industrial machines, as well as thehigh set-up times for specific machine processes based on series operations:efficiency considerations therefore dictate the large-scale production of arestricted range of machine types per firm, and for each machine type, whenthe logic of specialization is carried to its limit, they also suggest thesubdivision of operations down to the point where the mass output of a singlemachine item or component is achieved on a single machine. This minimizesdown-times, and set-up times (via a high degree of tooling), reduces therequired amount of materials handling and even the need for frequent re-scheduling. Thus the logic of large-scale operations seems inevitably to

/1 Granick, David., Soviet Metal-Fabricating and Economic Development. TheUniversity of Wisconsin Press, 1967, Chapter 3.

/2 The literature on comparative advantage usually runs in terms of two fac-tors, labor and capital. This tends to obscure the fact that the ineffi-ciency of material input use often jeopardizes the competitiveness of LDCmachinery exports. We discuss this point later.

/3 See, however, Part II for the caveats to the arguuent about skilled laboravailabilities in LDCs.

/4 The marketing of machinery also uses engineering skills relatively inten-sively.

dictate the need for large firm size. The size structure of firms in rhe US,Japan and Germany in the machinery sector, however, 5how5 a suzprising degreeof coexistence of large and small firms (classified by s:ze of employment)0/lIndeed a close look at the product structure of fiL.bis across size classesseems to suggest that the efficiency of the macihitery industry requires thecoexistence of firms covering the whole Gpectrum o.- 5ize clasesO The

imperatives of scale (generated by the need to spread high volumes of outputacross large individual machine capacities) may hazv pzecipitated the breakingaway of individual machine operations under S2epratn or saller, r,. inization&l.entities: thus the subcontracting of parts and cowiponents ';o separ2t2 3UpplieT

firms, and the existence of small firms producing high volumes of output ofindividual items/products, may be a logical outcome of the nature of thetechnical operations involved in machine productioa. Pack /2 points out,further, that the established pattern of coerz½stence of smZafT and large fi£rmin the US and European capital goods sectors, conDsi_de red togethe r wlth thefact of similarity of labor productivities and wagS sates across irms ofdiffering size, implies (assuming competitive conditions) that the averagevalue product of capital, and therefore average total .'ec:or 9roducZ.'1vity,must be fairly similar across all size classes of -.rmso A corollary /3which suggests itself is that if the organizatlonz3 aspects of ProductLon /4are as important in the machinery sectoE as the tcchrical economies themselves(as the Soviet experiment with continuous flow product-on methods indicates),then a small-sized operation equipped with gooe ; aAilizy rgy Well

survive in LDCs in the face of competition frou DCger DZ a erprisas charac-terized by greater exploitation of technical :al on" .ieso Ue Faehl lochmore closely at the requirements of, and the scone for, e fACient maEeEnt

as it affects the use of labor, material inputs and capital5 , in ParT XI

Externalities. Further argumento fcr the developm2nt of cEaptralgoods production hinge on the existence Oe1shere _n t,n economy of eX saleconomies which might help lower cost curves :In the machinery oector. or onthe potential externalities which capital gooao p' eductioc. might confer onthe rest of the economy.

(a) The beginnings of a skill base -3 -ed ^$Z the productiOzh ofcapital goods may already be availc.D.e iu Žrtain LDCs which haverelatively proficient repair industzy en7aves :_ 7cUla-ly in

urban areaso- Machine tool productiov -n k..Ar3ntina sterted out asan offshoot of repair activites in somla. tjorkshcps./5 Th:_ pre-cursors of the capital goods producti`on actlqities now evident in

/1 See Table 5./2 Howard Pack , in his unpublished papez, docr.ents tofhe 5lŽXlaDty o wgse

and labor productivity levels across the wsole s ' ZS? of fims inparticular branches of the US capitzl goodo industry (see Table 5).

/3 This is buttressed by the conclusions draun by Lamya' Rhee and '!estphal intheir paper: "Factor Substitution,, T½:J:n to Scal'e, ard the Organizationof Production in the Mechanical Engineering Thdustc!es I1BRD (Draft),July 1978, p.o 56.

/4 Relating to decisions about specialazatior,D schedullvg of machine capacitie3to deal with a diversity of machine components, the tracking of lnventcryuse, shop floor management, etc.

/5 Cortes, M.: opo cit., po 26.

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Batala (Punjab, India), Coimbatore and Madras (in Tamil Nadu,India), or in Incheon (near Seoul, Korea) were in fact facilitiesfor the repair of machinery and of consumer durables.

(b) The skills generated in the process of capital goods production maybe useful in machinery-using sectors where the continuity ofmachine utilization may be jeopardized by the nonavailability ofrepair and maintenance personnel./l Further, greater acquaintancewith machine construction may increase the range of options avail-able for machinery purchase by LDCs: the repair of LDC machinesmay be more easily done by LDC repairmen familiar with LDC construc-tion norms, and this in turn may broaden the spectrum of machine de-signs which might be adopted, or the sources of LDC technology whichcould be tapped; the purchase of second-hand equipment may be morefeasible because start-up problems (performance norms are diffi-cult to reestablish /2 when equipment has been moved to a newenvironment) may be reduced due to the availability of adequaterepair and maintenance men familiar with the technology embodied inolder vintages of imported machinery.

(c) An associated type of skill which equipment production might help tofoster is the engineering skills required, not so much for production,but for the planning and setting up of production: the engineeringconsultancy groups which are required for the choice of technologyand equipment, the planning and phasing of construction (andoperation), the laying down of norms for the flow of work, inventorycontrol, etc., and to translate and match equipment norms toindigenous conditions/capabilities. The costs of such servicescould form a significant share of set-up costs for plants estab-lished in LDCs. A recent check on the cost components of Japaneseturnkey plant exports to the Middle East revealed that engineeringcosts, despite scale economies and considerable Japanese experiencein the field, were in the range of 10-15% for power generation,petrochemical and cement plants and for iron and steel mills./3

(d) A further externality which capital goods production in LDCs mightconfer on the rest of the economy, is related to the creation ofyet another form of intangible capital: namely a modern technologi-cal organizational system of factory management. -As we shall see inPart II, improved managerial efficiency is likely to affect not onlythe current costs of the equipment-producing sectors, but also toforco the pace of learning, and therefore the speed and quality ofimprovements/innovation in machine production. This, in turn, islikely to influence significantly the current as well as the futureefficiency of the equipment industry's client sectors.

/1 Cited by ECLA in support of their arguments for the setting up ofchemical equipment production in Brazil.

/2 Cooper, Charles and Kaplinsky, Raphael: Second-Hand Equipment in a D@voloping Country, ILO, Geneva, 1976. Pack also lays stress on this point*

/3 Westphal, Larry and Rhee, Yung W. "A Note on Exports of Technology fromthe RepublAcs of China and Korea," IBRD (mimeo) 1978.

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IIo The Efficiency of Capital Goods Production: Possible Constraintsand Choices

Special Characteristics of the Industry

Before we enumerate the principal factors which appear to determinethe efficiency of capital goods production in LDCs, it might be well todelineate those characteristics of mechanical engineering production ortechnology which distinguish it from consumer goods production, or ! omprocess industries./l The complexities of mechanical engineering goodsproduction are due not merely to the extreme diversity of products, or thevaried production sequences which may be adopted for the same end-product(these complexities also characterize some process industries), but alsoby the malleability in use of capital equLpment: each piece of mechanicalequipment can usually be used to produce multiple products0 Further, seeminglydiverse end-products may be broken down into component parts or subassembliesin such a fashion that it is possible to form groups of common componentswhich might be machined together on the same piece of equipment0 Alternativelythe production process Ltself can be broken up into subprocesses such ascasting or forging operations so that disparate end-products can bejointly processed in the same facility0 The importance of these so-calledinterdependencies /2 in mechanical engineering production arises from thetypically lumpy nature of the production equipment and the consequent needto effect scale economies. The production decision is further complicatedby the fact that the very "upiless" of the equipment may itself be afunction of the scale of outputo0 Another set of characteristicswhich are not entirely absent in particular consumer goods industries, butappear to apply with special force in the mechanical engineering gcodssectors, stems from the apparently greater interdependence between factorsof production: the efficiency in use of individual factors way besubject to wider dispersion depending on the efficiency of the complementaryfactors0 To put it differently, the scope for complementarities betweencertain types of productive factors appears to be larger: the efficiencyof material or capital use may depend quite crucially on the efficiency ofthe labor force, or the form of production organization; labor, material,and capital productivity may be determined very closely by the firm"s planningand management capabilitieso/3

/1 See also Rhee and Hestphal in Stoutjesdijlk, A0 and UJestphal, L0 ,"Industrial Investment Analysis under Increasing Returns," IBRD (mimeo)Sept0 178, Chapter 15.

/2 A convenient term because it highlights the singular nature of thesolutions adopted in capital goods production (as opposed to thoseadopted in the typical consumer goods production process) in ennuringscale economie30 Scale economies could of course be achieved for agiven piece of equipment without resort to joint production or sharing0

/3 As we pointed out in Part I, for example, differing managerial efficiencymay explain the co-existence of very large and small firms withinparticular sectors of capital goods industries in developed countries0

Factors Affecting Static Efficiency

In the section which follows, we will attempt to look beyond thosecomplementarities and to isolate for purposes of exposition the major elementsof the cost structure of LDC machinery production. While total cost (ortotal factor productivity) is obviously determined not only by the physicalproductivities of individual factors and the shares in unit cost of eachof the factors of production,/1 but also by the rentals of each factor, weshall concentrate on the determinants of the physical productivities ofindividual factors with an occasional nod at the determinants of factorprices and the financial elements in cost. To set the scene, as it were,we present here, data on the cost structure of a Swiss spinning machinemanufacturing firm and its Indian licensee. The comparison suffices both to

highlight the orders of magnitude involved in a breakdown of costs by factorsof production, and to point to the sources of the potential cost advantageswhich LDC firms might enjoy relative to DC competitors.

/1 The following analytical construct utilized by Salter and Pack isinstructive.

p = WI + Pmm + Pkk

where W, Pm' Pk are the prices of the inputs labor, materials andcapital; 1, m and k, are the requirements for labor, materials andcapital per unit of output; and P denotes average unit cost.

dp= (dW + dl) w (dm + dPm) m + (dk + dPk) k.p W 1 m Pm k Pk

where w, m, k are the shares in unit cost of labor, materials and

capital. Movements in dP may be taken to reflect changes in costs overtime for any particular producer or to represent the cost differential for

a particular capital good between two competing producers.

12

COST CODPARISOWS FOR A SINWNIDG YLACEXRd (lM74/)5)

Xa&ian ~ RlastivenorpanliRad to diffcSTanceo

Swiss a."n &i0 co¢ts (R)

P1rice 100.0 X0000 GS30 & 3 .O

Labor 1100 S27 tO2 03ORaw oazeriLl 400 4-G7 20.3 13 00verheads and capital 49.9 43 6 29 3C90

0verhead and non-production salaries 160O 12.2 7.3 S3oO

Salea empnsoes androyalties 7.0 10oO Go iR.00

Deprecistion 700 5.0 300 5530Interast 400 2.5 rL.5 G30.profits before tag 15.0 20O to2.0 20.0

xnaian Z2rica!ota: priee of Indian -Zchine normlig?d to 51loy Yioce 60

Swiss priceEath ceoponent of Indian cost 1iio ta Sis cost is EcTivedas followa O

Column (3) Coluian (12)9 GO

Sourceg IEoD: India: Suvey of the Tsotle Y,t D: ry *Im trv cbeT i75.,

It is evident that the largest soUreS CZ DO (IMdianM) coa aratived6ventn3e (see column 4 of Table on Cost .;9 LSa in Labor use (i.e.i3h productivity and/a IOtg 'owge Tate oc- :: _ a ooiWly Mi&eGr laborintensity /1 of prod'uction) and in lowez capfitL intznoity./2 Roue2reT thedat alsoo underline the importance of noni&,bor cooft (both aaterif2 andoverhead) in determining coost coepet t .veneO 3 e detezTin&nts oflabor and non-labor cots aTre discussed below0

/1 This is corroborated by the obaseTveZ§3no of3 rzCV. on the BZa2ilitan eqU'I.L:

uector0 The high share of labor wakes e o. a final price that insome sectors compares favorably with that o.f the core advanced industrialcountries 0

/2 Lower interest and depreciation charges -.-a it-'Le case of the Indfan spinningmachine manufacturer do not necezsarHly Imply thact the capital-labor ratiois lower in the Indian firm. The phsnouzaia may have been due to subsidized

interest rates charged on long-terna loans for equipment investment in India,differing accounting practicesS etc 0

/3 See columns (1) and (3)o

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Labor: The extent of the labor cost advantage is determined bylabor productivity. Two aspects are distinguished: (a) operator efficiencyper machine task or the number of units (machine components) produced peroperator-hour, at a given machine, and (b) plant output per man-hour. Theempirical evidence, presented in several unpublished IBRD reports on themachinery sectors of India and Korea,/l and by Leff on Brazil's capital goodsindustry, suggests that operator efficiency at a given task is fairly highand sometimes comparable to levels achieved in developed countries; plant-widelabor efficiency, however, is usually significantly lower./2 Moreover, therange and complexity of the factors which affect plant output per unit oflabor suggest that improvements in plant-wide efficiency may not be easyto ensure.

(i) Labor Productivity per task

Part of the lower labor productivity per machine task in LDCs maybe due: (a) to the fact that while, as in some middle income LDCs, pools ofskilled labor (skilled relative to the needs of the traditional consumer goodsindustries) do exist, the quality of skills are not sufficient for machineryproduction. The skills /3 needed run in terms of the ability to read machinedesigns, manipulate measurements, deal in trigonometrical concepts, etc./4.(b) Some of the low labor productivity is due simply to poor training. Trainingis often conducted with poor machine tool equipment. Complaints such as thiswere heard even in India's premier machine tool plant. They were common alsoin Korea. Again in the case of in-plant training, labor is often trained atone particular machine task in order to minimize the risk and magnitude ofloss from labor turnover; however, this reduces the flexibility of the labor

/1 These unpublished reports pertain to the textile machinery, tractor,commercial vehicle, steel forging, and foundry industries in India, andto the machinery sector in Korea

/2 Leff seems to suggest, however, that plant-wide efficiency was not lowerin certain segments of the Brazilian capital goods sector in the 1960s,relative to that in 'counterpart' DC factories.

/3 In other LDCs, where the available labor may possess a modicum of therelevant skills, the "proletarianisation" of labor may not yet havetaken root. Machinery producers in established industrial areas such asCoimbatore and Bangalore in India still complained in 1972 of therather significant turnover rates among skilled laborers, occasioned byreturn migration to rural areas or smaller towns.

/4 The 1927-37 Soviet experience appears to have run counter to this point.The employment of large numbers of relatively "raw" labor did notapparently pose any additional technical constraints to the achievementof productivity gains in the medium term. Indeed, there appear to havebeen fairly large gains in productivity (of the order of 75%) within thespace of 4-5 years even in the general purpose factories which werejudged to be relatively intensive in the use of highly skilled labor.However, it is important to point out that the recruitment of raw laborwas accompanied by extensive formal and on-the-job training, increase inthe number of work shifts, etc.

foras in switching between different tasks.Qe)The effects of poor trainingare often compounded by the fact that the senior engineering personnel insupervision jobs are unaware of the particular characteristics of theirmachines. The unpublished IBRD Korea machinery report details the lack ofknowledge of machine capabilities - the use of wrong cutting speeds,inappropriate cutting practices, poor tooling, the wrong use of machines,little use of jigs and fixtures - which undermine worker efficiency.

(ii) Labor Productivity per Plant

While lower plant-wide worker productivity may in certain LDCabe traced to causes outside the particular plant's control eOgOg, to hold-upsin the delivery of raw material supplies the poor quality of raw Emterials andeconomy-wide incentive systems *which militate against factory discipline (allof these characterized the Indian machine tool sector in 1972 in varyingdegrees)D part of the explanation often lies in poor management. The IBRD Koreamachinery report details instances of: (a) poor plant layout and flW of work(poor lighting, congestion, etco); (b) inadequate scheduling of production;(c) poor inventory control; (d) inadequate planning of activities consideredauxiliary to the main production activities), e.g., conveyor systems), etc.Similar problems appear to have characterized the Indian machine toolscctor in 19720 The overall productivity of PraEga Hachine Tools, for example,improved significantly following the adoption of a simple expedient: thebuilding of ramps to connect separate machine shops where the difference inelevations posed problems for parts tranofer0 Inattention to auxiliaryotrmetures, and the centralization of storage facilities for parts andCfQTRilo without adequate arrangements for regular materials delivery on apredtetrm3lned chedule, hampered regular production activities at the Stalin-grad tractor plant during the first half of the 1930so /1

However, while relatively simple remedial measures can indeed effectsignificant improvements in labor productivity at the margin, both at a givenmachine task and plant-wide, the Soviet experience in the metnl=workhingindustries suggests that considerable experience is necessary if the impactof specific technological-organizational systems of factory organizationon worker and overall plant performance is to be anticipated0 Soviet machineinductry planners of the 1930s believed that it was possible to overcomeskilled labor scarcities by pushing through the adoption of the most moderncontinuous flow mass production methods (practiced in the West) in which eachmachine tool and operator was kept at work on only one part, or a very smallnumber of partso Such a production organization, which reduced the compleuityof taeks per worker and increased the number of nachine units per supervisor,would, it was felt, economise on the use of highly skilled workers, supervisors,aud technical and engineering personnel, while shifting labor demand to semi-skilled workers with general education0 However), the experiment provedunsuccessful: there appears to have been a grave miscalculation of therequirements of supervision and production planning, and of the heightenedneed for stricter quality control at the level of each production operationand at interprocess transfer points so as to obviate the need for repeatoperations. These requirements appear to have been greetly increased for

/1 Granick, David, opO citO, Chapter 20

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tontinuous flow operations at least partly because of the "employment ofuntrained and relatively irresponsible workers" unused to factory disciplinewith inadequate ability to comprehend written instructions on technicalmatters, etc. In contrast, as already noted, the available evidence /1points to the fact that the growth of (plant-wide) labor productivity wasfairly rapid (of the order of 75%) in the older, more general-purpose factories.This suggests that the crude copying of the most modern organizationaltechniques does not necessarily guarantee performance standards; experienceindicates that modern production-cum-organizational techniques, when trans-planted to LDCs, require a considerable period of assimilation and adaptationon home ground./2 We deal with some of these questions later in the sectionson Capital and Overheads)and Dynamic Efficiency.

Materials Inputs: The material inputs which figure significantlyin machine production include special steels, castings, forgings andcomponents.

(i) Steel

Steel supply problems in LDCs usually stem from their poor quality.Consequently rejection rates are high and performance standards low relativeto those in DCs. A second area of difficulties, the limited range of specialtysteels available, is sometimes a mixed blessing. Performance specificationshave often to be downgraded, but this is not the whole story. The need topreserve performance norms in the face of materials inadequacy has inducedsome of the most valuable innovative work in LDCs; machine designs have beenmore closely adapted to the requirements of the job at hand, and the inttinsicproperties of the materials available have been better mastered. The operationof these externalities, however, does not suffice to take away from themagnitude of the supply deficiencies.

In part, these supply problems can be traced back in specificinstances to LDC attempts to set up steel production facilities in tandemwith the development of their machine industries, and also to their associatedattempts to encourage import substitution in the steel industry with the helpof a regime of quantitative restrictions and tariffs. The IBRD study of theIndian forging industry, for example, documents that at the start of the 1970sIndian steel prices, set at about 50-60% above world prices, were responsiblefor a 20-30% increase in the costs of Indian forgings. The problems ofphasing construction and production plans in indigenous iron and steel millswith the needs of machine production is compounded by long gestation lagsdictated by the very lumpy investments which are needed to ensure economiesof scale, or the adoption of the more modern production techniques in the

/1 The evidence on the "failure" of continuous flow production is indirect:Soviet management appears to have retreated from full-blown continuousflow operations to series production (and a wider product mix) in themid-1930s.

/2 This runs counter to the Gerschenkronian hypothesis that the "latest"production and organization techniques can be adopted efficiently by"backward" LDCs.

15

steel sector itself./1 The history of the Soviet steel industry provides aninteresting case in pointo Thus, the deliberate Soviet decision to scrapexisting steel mill construction projects in favor of building up-to-datecapacity ensuring specialisation and economics of scale in the steel industry,implied that the phasing of the Soviet eoi.t; :.c * b:ic_;-i!- sector fellcompletely out of step with the time schedule o£ the Soviet steel industry0The equipment industries were starved of their principal raw matezials0 Thiswas responsible not only for the Soviet declscion to monitor severely theallocations of scarce steel supplies, but also fcr the decision to alterradically the product mix in a series of equ touilding plants which hadoriginally been established to produce nonprl ority itewso The recult was anenormous waste of resources, as in the testile mEchinery sector0 The rawmaterial bottleneck also had other far-zeaching consequences: the inabilityto ensure a consistent quality of materials fneant, for example, that thehighly mechanized nature of production. in the agricultural equipment industryon the principle of drill-=based machinery operations was totally inappro-priate; more traditional lathe-based production techniques, which do notrequire materials supplies of such strIct specifications, might have provedmore suitable0 Here again the adoption of very specialized foms of produc-tion was based on an inadequate appreclation of the complementarity ofmaterial quality requirements and the organizational mode of production, andthis in turn reduced the possibilities of relatively facile reconversions ofplant to other types of product mix.

(ii) Castings, Forgings and Moan, z-: i4anufacture

Uhile the quality of pig iron, steel, sand, etc., available to thefoundry and forging industries is an im o-:;: determinant of the cost ofcactinge, forgings and couponents delivered to tZ.e fachine-building industries,it is significant that the technical staclaeds achieved in foundries andforges, even in LDCa with some history of founndy/forge operations, aregenerally low./2 In India, the IBRD mission wJas of the opinion that 65% ofIndian foundries would require more thfi five yezrs to produce castings ofinternational quality at competitive priceso/3 'Te Norea machinery reportdetails the problems: inadequate treatwent, cleaning and processing of sandfor molds, poor composition of sand, poor pl2nt layout, wastage of materialsat the forging stage which imposes costs at a later stage of machine finishing0

Finally, the organizational aspects of foundries, forges and componentmanufacture have exercised planners in several LDCs as well as in the SovietUnion0 This concern has stemmed from the possibility of setting up specialized

/1 Rhee and Uestphal in their paper, "Planning F'uture Import Substitutionand Export Expansion in Korea's Mechanica2 Engineering Industries,"stress the need to investigate "the interfaces between the plannedmachinery industry complexes and the planned metal industry complexes,"po 43.

/2 Recently confirmed by an IBRD mission reporting on the situation andprospects of Mexico's manufacturing sector0

/3 See Pack, opo clt., po j40

- 17 -

foundries and forges, and specialized facilities for the machining of alimited set of parts, to service a wide range of user plants/industries. Thisinvolves the principle that specialization by process can ensure scales ofproduction which would lie "beyond the bounds of possibility for verticallyintegrated factories producing a complete product." Thus the inefficienciesinvolved in the production of limited volumes of disparate final machineproducts (as is the case in LDCs) could be mitigated by the setting up ofcommon foundries to produce castings of roughly similar dimensions and degreeof design complexity.

The literature on machine-building industries in developingcountries does not, however, point to any successful experiments in special-ized foundries and forges. The difficulties of coordinating schedules withthe principal customers, of organizing timely shipments and of ensuringquality, appear to be too onerous for the successful functioning of separatelarge-scale foundry and forge facilities. The Soviet 1930s experiment withthe regional foundry set up in Moscow appears to have taken over 20 years toyield the expected cost economies, and even then it was probably achievedafter a narrowing of its role to a supplier of castings for machine toolsalone./l Suggestions for setting up centralized foundry facilities atChangwon, the new machinery industry complex in Korea, appear to have beenrejected in favor of vertical integration in individual large plants. InIndia, some amount of castings are produced for outside customers in foundryfacilities owned by large machine building plants, e.g. HMT, The Mining andAllied Machinery Corporation, etc., but these are necessarily ad hoc arrange-ments in the nature of jobbing./2

Capital and Overheads:/3 The efficiency of capital use in theequipment industries appears to hinge on three related factors: (a) the needto spread the high overhead costs associated with indivisible investments(and individual machine capacities) over large volumes of output; (b) theneed to evolve efficient forms of organization for planning the operationsand use of all three factors of production: labor, materials and capital; and(c) the need to undertake the upgrading of current capabilities in existingfirms and to check the uninhibited tendency (characteristic of certain LDCs)towards new investments in large-sized firms.

(i) Scale Economies

As we have discussed before, one of the distinguishing features ofequipment production is that it is subject to significant economies of scale.To elaborate a little, scale economies are a function, not so much of thetotal volume of investment concentrated in a single plant, but of the capacityinstalled per plant for the production of an individual product. Taking the

/1 Granick, David: op. cit., p. 154.

/2 Argentina appears to be a striking exception. Component manufactureappears to be well-established and to have attained a high degree oftechnical development. See Cortes, op. cit., p. 30.

/3 This section draws heavily on Granick, David: op. cit. Chapter 3.

- 18 -

argument a step further, a major determinant of the magnitude of scaleeconomies is the length of run per individual machine. This is why "lot" or"batch" size is so important for equipment production, which is organized onconcepts of "series productiono" Production according to series refers tothe organization of simultaneous operations on a number /1 or "batch" ofproduct units (or parts) of more or less identical designo The `bctch`refers to the number of units worked on in immediate succession by both laborand the given item of equipment. Normally each machine or worker w2oks oneach unit per batcho Obviously then, the larger the lot size1, the -ozeintensive the utilization of a given piece of equipment or specializedworker /2 (eog. highly skilled fitters, set-up men, etco) In more complexsituations, the products/parts to be machined or assembled may not be ofidentical designo However, processing in batch is possible because eitherdisparate parts require identical machining or common parts or subansembliescan be identified0 In the limit when the number of parts is very large,Dgseries production" might shade into "mass production" where both wnchineoand workers work permanently on identical products (and identical pazts ofproducts)./3

Thus both series and mass production require production 'li largevolume, and since scale economies are limited to the capacity devoted to anindividual product, efficiency may be furthered by limiting each plcnt to asingle product, or at the very least to a small range of products0 lowever,since the optimum utilization rate of individual machine capacitien is rarelyidentical, it follows that bottlenecks or excess capacities might be avoidedthrough the expedient of subcontracting a part or machining activity (whichis intensive in the use of the critical equipment) to a separate productionentity which can itself achieve economies of scale by pooling orders fromdiverse plants for the same component or machining activity0 Pushed to alogical extreme, specialization then involves specialization by proceessThus, as in the case of foundry/forge operations (see the section on MaterialInputs), individual plants concentrating component production through thepooling of technically similar orders achieve ranges of scale econoamieper process which a vertically integrated plant cannot0

/1 Any number greater than two0

/2 Lamyai Rhee and Westphal suggest in their paper: "Factor Substitution,Returns to Scale and the Organization of Production in the MechanicalEngineering Industry," IBRD Draft, July 7, 1973, that indivisibility oflabor skills is of at least as much importance as capital indivisibility0

/3 It is interesting to note, in a more historical context, that the superiorityof American factory organization relative to the British, noted by BritishGovernment Commissions during the years following the Great Exhibitionof 1851, was attributed primarily to the "adoption in most branchez ofindustry of the 'manufacturing principle,' the production in large numbersof standardized articles on a basis of repetition O the principle

lending itself "to the use of mechanical methods1 , particularly to thedevelopment of automatic 'special purpose' machines designed foz a singleoperation0" See Burn , Duncan L. "The Genesis of American EngineeringCompetition, 185070,," in Hughes , Thomas Parke , ed01, The Development of

Western Technology Since 1500, the Macmillan Co0 ,D New York, 19640

- 19 -

(ii) Organizational Requirements

The organizational implications of production which seeks to ensurescale economies are not trivial. Decisions have to be taken simultaneouslyon several fronts: the decision to specialize by product/process, thecorrect choice of equipment (given the scale of the market, the type ofraw materials and labor used, and therefore the sequence of productionadopted), the identification of common parts or subassemblies per machineoperation, the decision to "share" capacity between disparate parts whichrequire similar processing, the choice of a particular mode of organization(whether "one-off"/l "series" or "mass" or a mix of both) etc. All thesedecisions'>tturn, have rather important implications for the requirements oflabor skills, materials handling capacity, inventory scheduling, qualitycontrol, etc. Series production with general purpose machines, for example,may require significantly higher complements of highly skilled workers;however, continuous flow operations carried out with a newly industrializedwork force require a higher proportion of supervisors, technicians andengineers. Again, while mass production requires fairly close scheduling ofwork both within and between shops, once the schedule has been satisfactorilyworked out and enforced, production planning under continuous flow is farless complicated than under series production; however, since both workersand shops must produce on time under continuous flow operations, the schedulehas to be paced to the efficiency of the least efficient worker; a slowingdowr. throws the whole operation out of gear. Again, since efficiency dictatesminimisation of machine down-times, both series and continous flow requirecareful planning of inventories, materials flow and- maintenance; however, notonly are the requirements more onerous under continuous flow, the obligatory"freezing" of norms may even be inappropriate in the fluid conditions of anLDC where levels of efficiency, low to start with, are being upgraded withthe accretion of experience. Finally, the greater the need for accuracy intolerance limits, the greater the cost escalations resulting from the need toremachine parts in the event of shortfalls in quality.

While LDCs are on the whole less likely to opt for full-scale massproduction (except perhaps in the auto industry), the problems outlined aboveare not totally irrelevant. The distinction between series production andmass production is at best hazy: production in LDCs often adopts a seriesapproach to mass production: different parts from diverse end-products willbe run as a continuous flow operation or part of a plant's equipment may bearranged in continuous flow lines. A proper amalgam of the two, which involvesa shift away from the continuous mass output of a single part on a singlemachine, requires, if anything, a significant effort at redesign of parts andanalysis of the alternative operational possibilities of given machinecapacities in order to achieve a commonality of parts between machineproducts of different designs and to concentrate "machining operations intothe least possible number of working places".

/1 "One-off" refers to a production operation which turns out only one unitof a final product, e.g., one unit of steel plant equipment.

20 -

(iii) Firm Size

For an LDC setting up equiphisnt pro&uctioon, the complexity of thedecisions involved, the cost minimizing effects 0f scelae and the seductive-ness of the "latestt" technology, usually tilt the investment decisionagainst the upgrading of established plants, and i' favor of newi investmentsin large-sized plantso Apart from the scale TaetoT (uhich is sought to beensured from the start by the emphasis on lezeoo), D the decision to under-take new investment is based on the following rctioaslo. Thrzec i no need tocompromise with the historical complement c` eZ 1,.-` ;. Present i, an eaistingplant, to make judgments as to the technical obosslescence of the eizistingstock of machines, to plan the meshing of eniotli:g e capacity withthe new, or to grapple with performance no-ms twich have become ingrained0Further, tax and interest rate subsidies designed to 1nduce investment intonew areas of production usually encourage large o,e0 /2 Again the veryinexperience of new units, and the consequent high initial costs of Identi-fying and developing supplier networks, reinforces the tendency of new firmsto reotrict the range of buy-out decislons in order to reduce downtimes onmore regular capacity: critical capacities aze th efcore ? natalled in-house.But this in turn enlarges the problem of meshing i-3chinz csapacittecS and thedifficulties of production schedulingo The ual noESH@ to these dilemwas isto enlsrge the range of products produced wlithin each large plamt, setting intrain a sequence of developments which works a3nilnet the logic of specializa-tion by product and process, and which. u-,:diAuns t-he irison dnete for thesetting up of large firms0 The entry of the large firms generally into linesof product in which existing firms have i)roveno p tei profitability,

fragments an already small market, shrinks the raen o f op-erations of existingfirms, reduces the opportunity of building cn t>e erienee of =aotltngfirms, and diminishes the viability of the serl,Y nd aediu, firms which, ifallowed to specialize, could have operated as o plere to the large firms.This in turn leads to further attempts at pro6uct divareificnPtion by a largernumber of enterprises, accentuasting the problemse of cshort rune and precludingthose possibilities of learning and irnovsticn uw ch Tresult from o2zpoaure togrowing cumulative voluLmss of output witj "hin eCnh

WJhile cenosq data on the capitsl Gcono 3 uectcr in 'Je Dvailable

for say India, Dtore, BrzcEil, throw on ocscal.es of 9i pro Uction andproduct structure in LDC capitel goods seczor-s dt oaile studies of theorganization and e@ficienTcy of capitEa,l use i"n t'i:di.vducl plante ar.d at thelevel of the individual product are ro.aro The Krsan CesE us/SuTrvey of Hiningand N&nufcturFiagD the publicationo on licensed capacity put out by India'sDirQetoraee General for Technical D z:2.JLe>0 ecd ttVo, 2CLA worch o 3rarilpoint to the prevelence of rve:z scnleu L7?. idue?. product linesD andto the tendency of individual enterpTices to 2e,Rpend Into a divesT'ity ofproduct lines in order to exploit machine capsc:tL ;es 0 Kn nLdia, forc enample,yAyeore Irzlosalmr, one of the largesnt maEchine tool uehers, wa lieanoed to

pzoduce about eight different types of machine tools at t7he Thc|1 :-Br works in199 0 Capacities licensed for individual machine tool lines like capstanlathes were of the order of 250 per year0 Actiial production in 1372 was Hell

/I Corteo, Op. cit. po 34.

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below half that figure. It was no wonder then that the enterprise sought todiversify its product range. The Korean machinery report documents a similarfailure to "concentrate on a fairly small number of products," and the inabilityto achieve large cumulative output, as well as the inability to realizesufficient specialization through a complex subcontracting system. The IBRDstudy on the textile machinery industry in India noted that of the 250-280(textile machinery) component suppliers in India in 1975, only about 10 couldhave been said to have produced components of acceptable quality. Of 20plants visited by the mission, 10 had their own foundries.

While the available literature (e.g. the IBRD studies on the IndianFoundry, Forge, Textile Machinery, and Commercial Vehicle industries, and ofthe Korean Machinery Sector), identifies problems of inadequate plant layoutand operations, the weak management of materials, work-in-process and finishedproduct inventories, and the somewhat cavalier attitude towards machinemaintenance and quality control, there is little discussion, however, in theempirical literature of the complex interrelationships between modes ofproduction organization, types of labor demand, maintenance requirements,quality norms, inspection methods, planning and scheduling. Granick'saccount and evaluation of alternative modes of organization in the Sovietmetal-forming industry during the period 1928-37 constitutes an obviousexception. Moreover, recent experimental work by Rhee and Westphal onquestions of scale and interdependence in Korean mechanical engineeringindustries may also be seen as an attempt to bridge this gap./1 This is notto say that managers in LDCs /2 are totally unaware of the interdependence ofdecisions in these seemingly diverse areas. The setting up of separatebranches of Hindusthan Machine Tools in Hyderabad and Pinjore, and theshipping out of excess capacities from the main works in Bangalore, wereobviously designed both to achieve a greater balance of machine capacities byappropriate groupings of machine tools as well as to reduce productionscheduling problems at the Bangalore plant.

To sum up, even a brief tour d'horizon of the factors affectingstatic efficiency in the capital goods sector suggests that a number ofsimple but carefully directed measures taken at the level of the shop floormight serve to raise performance levels and current capabilities in LDCmachinery manufacture: measures designed to improve labor skills, plantlayout and flow of work, the quality of castings and components, operatingpractices, the maintenance of machines, tooling usage and auxiliary systems,product and materials testing, etc. These measures could serve to effectcost reductions of a once-and-for-all nature. For an LDC firm to effect a

/1 In Chapters 14-18 of Stoutjesdijk, A., and Westphal, L., "IndustrialInvestment Analysis under Increasing Returns," IBRD (mimeo), September1978.

/2 At the time of the author's visit to Praga Machine Tools, the management wasdebating the relative merits of organizing production by product line asopposed to organization according to process, for a group of its older,larger volume, product lines. Similar questions were discussed atCooper Engineering.

22

continuous lowering of its cost curve requires the repeated adoption ofimprovements by the management in the organization of the firm. NoweverTthis introduces issues which belong properly in the realm of dynamic effi-ciency.

Considerations of Dynamic Efficiency

Two routes are open to firms attempting to maintain competitivenessin the long run0 The first consists of continuous attempts at cost reduction;either through improvements in the utilization of input factors and changesin the manufacturing process, or through incremental product quality changes.The second route consists of major design innovations. Both require R and DoThe empirical literature suggests that little R&D is currently undertakenby LDC firms. Pack /1 surveying the available evidence concludes that thelittle R&D which is in fact undertaken is designed to effect cost reductionsrather than design innovations0

Cost Reduction and Incremental Innovation. The first route, thatof incremental innovation in product design and processes of manufacture,when pursued over the long term0 generally requires increasing specializationand economies of scale0/2 This is because, as the firm progresses doEn itslearning curve, the incremental benefits from cost reductions generally tendto become smaller,/3 and hence to be worthwhile must be reaped over largervolumes of oututo The successful adoption of such cost reductions thendepends on the efficiency with which such incremental innovations are inter-nalized; in other words0 successful cost reduction depends on the efficiencyof organization and managemento The literature on capital goods productionsuggests, however, that the achievement of optimal forms of technological andmanagerial organization poses problems of a different order from thoseinvolved in the once-and-for=all improvementS referred to above. Whilecertain solutions for relatively simple scheduling or for plant operationproblems can indeed be absorbed through interplant contacts and the employmentof consultants, domestic and foreign, the know-how required for the continuedadoption of optimum organizational arrangements of factors of production forpurposes of cost reduction appears to be more difficult to come by withoutin-plant RD&E. The literature seems to suggest that the adoption of these

/1 Pack: op. cit00 po 28.

/2 See Abernathy, WoJos and Utterback, J.M00 "Patterns of IndustrialInnovation0" Technology Review, Vol 0 80, No0 7D June/July 19730

/3 Conway, R°Wo, and Schultz, A0 , in their study of progress functions forelectric appliances with production already in the hundreds of thousands0nevertheless0 reported savings in labor requirements of as much as 8=12%when volume was doubled0 The corresponding decline for airframes andships was 20=30%. See "The Manufacturing Progress Function, DJournal ofIndustrial Engineering, Volo 1OD Jan.-Feb. 19599 PP. 39-540

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more innovative solutions is not necessarily ensured by the pressures ofcompetition or by more thorough arrangements for foreign technology transfer.The work of Rhee and Westphal, which utilizes rather complex programming

algorithms to arrive at utilization levels for indivisible labor and capital

and to study the implications of scale and interdependence for certain levels

of material costs, underlines the complexity of the decision-m-king processes

involved./1 DC firms have an edge in the identification and development of

efficient forms of technical organization because of their access to managers

with long experience. In LDCs, because of the novelty of the sector and the

occurrence of different operating conditions, this experience has to be

acquired deliberately through the working out of problems on home ground.

Managers in machine tool firms in India returned again and again to the

importance of accumulating indigenous experience and of committing enough

"mistakes" if a certain "know-how" is to be internalized, even after a

"successful transfer of foreign technology" has occurred.

Granick cites the case of the two Soviet tractor plants at Stalin-grad and Kharkov which provides a neat illustration of the "need for working

out technological processes on home ground." The Stalingrad plant, opened in

1930, was built with extensive help from American companies responsible for

the detailed engineering and design of individual shops and with thorough

arrangements for the large-scale training of Soviet engineers, foremen and

skilled workers in American factories as well as in the Soviet plant. The

Kharkov plant opened at the end of 1931, built on the Stalingrad model and for

the same output volume, but with fewer foreign technicians and workers and

with Russian-built equipment functioning according to the newly developed

norms of planning and scheduling worked out at the Stalingrad plant, was able

to exhibit superior performance. Apparently a great deal of information on

production design, the location of ancillary facilities, the requirements of

maintenance, etc., which "was not gleaned from observation abroad or from

foreign consultants could be learned from even a very brief period of opera-

tion of the first Russian tractor plant."

The importance of such learning, the necessity of working out solu-

tions to "mistakes," leads one back to the need to "experience" large volumesof cumulative output,/2 and to spread cost reductions over larger scales of output.

Moreover, if Alchian's insights into the behaviour of learning curves in airframe

production can be generalized, the stability of progress functions appears to

depend on the continuity of production./3

Design Improvements and Product Development. We have dealt so far

with the factors which determine the comparative advantage of LDCs in theproduction of a given machine design. However, in order to retain competitiveness

/1 See also Dzielinski, B.P., Baker, C.T., and Manne, A.S., "SimulationTests of Lot Size Programming," Management Science, 1963(a), pp. 229-58.

/2 Large scale, per se, does not necessarily ensure learning.

/3 Alchian, A. A., "Reliability of Progress Curves in Airframe Production,"

Econometrica, Vol. 31, No. 4 (October 1963) pp. 679-93.

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against DC competitors in export markets, and against iaported foreignequipment in the domestic market, and in order to ensure the competitivenessof the capital goods industry's client sectors (if an import-substitutingregime prevails), it is important that LDC machine vaanufacture be able tooffset the cost reductions which DC competitors are able to effect throughcontinuous d'-ign improvements./1 The question, of couiTse, arises as towhether it is necessary for an LDC to undertake expensive R!D eupenditureswhen it is possible to buy out new innovations in design as and when they areevolved in the DCso

(i) The Case Against Foreign Technoloy Purchase

First, design changes evc,ved in DCs are usually undertaakenas a response to a different set of preveailing factorpriceso They tend generally to be capital saving or to bebuilt on material specikications and standards hAich differconsiderably from those relevant to LDCs.

iu* Moreover, they are built for optimum utilization at scaleswhich may not be immediately within the --.% of LDC producers0Adoption of DC designs is therefore often based on aninadequate appreciation of the extent of the market open toLDCs (sales depend both on r,:;.E.1on and m , efforts)and of the costs of production incTrred for the adaptationof material specifications to local LDC evailabilities0This explains the concentration of LDC innovative ef0orts onmaterial input substitutionslo/2

It is arguable, therefore, that R&D opzrations undertatten inLDCs may tend in the directioa of design innovations whichbest exploit LDC factor availabilties0 indeed, if undertakenearly enough, it may be possible to u?grade LDC equiygentsufficiently to avoid a soltuation of technical dominancewhich an improved DC machine design is able to achieve,despite,the embodied labor"saving iwprovements, primarilydue to the extent of the reduction of equipment cost whichthe innovation is able to effect.0/3

the argument for foreign technology purchase also assumesthat licensors are continuzlly willing and able to transmitthe latest designs0 Obvicasly the willingness of DC firmsto license technology will depend on the expected payoff

/1 The accumulation of small process improve,dents for a given design may, ofcourse, add up to significant product development0

/2 See Pack, opo cit., for evidenceO

/3 Pack analyzes the conditions: (a) lnitial capital-labor ratios of DC andLDC equipment; (b) the relative factor prices; and (c) the relative ratesof reduction in all input prices equipment, labor and material - whichdetermine the point at which DC equipment e ill technically "dominate" LDCequipment, despite the labor-saving bias of innovation0

- 25 -

from technology transfer or license sales compared to theearnings from potential exports directed at the LDC seekingthe license, as well as at the LDC's own export markets.The DC producer's willingness is also conditioned by thedegree of competitiveness characterizing the internationalmarket for the particular equipment design and the innovativestage reached by its own competitors /1.

iv. Again if the technology transfer route is taken by the DCinnovator in the case of a new innovation (as could happenif the LDC market was subject to quotas), the transfer isusually accompanied by agreements restricting export./2

v, Even if DC licensors were willing to transmit the newesttechnology, the empirical evidence suggests that the resourcecosts of technology transfer can be fairly high, so that theability of DC licensors to transfer the technology and theability of LDC purchasers to absorb the technology may belimited. Teece, studying the resource costs of 26 technologytransfer arrangements carried out by multinational firms,concludes that the common view that "technology is nothingbut a set of blueprints that is usable at nominal cost toall," and that "the marginal cost of successive applicationis trivial compared to the average cost of research, develop-ment and application", is erroneous./3 Technology transfercosts include, apart from the cost of physical items such astooling, equipment and blueprints which embody the newtechnology, the costs of transferring the informationwithout which the hardware cannot be effectively utilized.They include the costs of pre-engineering technologyexchanges, engineering costs, R&D costs associated with thesolution of unexpected problems and the adaptation andmodification of technology during the transfer, the pre-start-up training costs, and the "excess manufacturing costsrepresenting the learning and debugging costs incurredduring the start-up phase" before the plant achieves per-formance specifications. It is these support activitieswhich constitute "the crux of the process of technologytransfer."

/1 For example, Brazil in 1963, was unable to negotiate royalty agreementsto manufacture cement plants with any existing internationally reputedproducer.

/2 See Frankena, M.: "Restrictions on Exports by Foreign Investors,The Case of India," Journal of World Trade Law, Sept./Oct. 1972, pp.575-593, and UNCTAD, Restrictions on Exports in Foreign CollaborationAgreements in India, New York, 1971.

/3 Teece, D.J., "Technology Transfer by Multinational Firms: The ResourceCost of Transferring Technological Know-How." The Economic Journal, Jote1977, pp. 242-261. For a critical review of Teece's book, The Multi-national Corporation and the Resource Cost of Technology Transfer,(Cambridge, Mass., Lippincott, Balinger, 1976), from which this artic is

drawn, see Christopher Bliss in Journal of Economic Literature, Vol. X%VINo. 4, December 1978.

26

Typically the costs of technology tT&nsfer cGooca4ted withmachinery projects appear to be higher than tha costo ascociatedwith process industries (chemicals and p cs-.m refining)0Whereas transfer costs averaged only 192 of total project costs forall 26 projects in the Teece sampleG theo uachinory project transfercosts ranged from 24% to 59% (the one aveeptina involved a 10%transfer cost share). The Teece study aloo uac@rlinad the criticalimportance of the transferor's own aaroEiAeTy with t'ne new tech-nology, the age of the technology , and thu mkbe of firms usingsimilar or competitive technology. The soot dfficult gnd hencecostly technology transfers are characteriaed "by few applications,a short elapsed time since developqant, and liuAted diff;3sion"./iThus °°leading edge"° technology is aPt tO a ino a snate eo flux;engineering designs will be subject to fietaont change, renderingtransfers difficult0 Further, the Teece study oeezerved that thesizeD and technical and managerial co-p: of the transfereewere also important determinants of the cooto of trankser0 Inter-estingly enough , the effects of the age of the teehnology9 thenumber of firms with identical technology and transferee sizeturned out to be significant for mschinaery /2 technology transfer0

The magnitude of the transfer costs and the importance of the diffusionprocCso (as well as the critical importance of e a -hsc n and size of thetransferee) suggest that at least for the l'L-'9 tora esnpSrienced LDC firmsit oight be in the firm's interest to undertalte Ladigenuou R&D to maintaindynamic competitiveness0 The author's interviteo with Indian machine toolfirms suggest that at least one explanation for the poucity of intrv=plantdesign innovations stems from the inaccurate forecaoting of the magnitude oftheDe trenefer costs./3 But obviously this is not tho whole explanation forthG coutinued purchase of foreign technology by largo mchix -building firmssueh as UiT.

(ii) The Prevalence of Foreign Technolo Purchaaa. lT.Z Explanations

A large part of the explanation piobebly lies in the joint operationof an array of factors which induce LDC fims to opt for stability of market

/R Each additional application enables the _:o ''0o to acquire additionalknouledge about the technology by obeerving the effects of differentoperating parameters on production, and also to transfer experiencedoperstors and engineers from older plants to the new plant to assiststarztup and training0 The age of the innovation determines the stabil-ity of engineering designs and the transferor0s hnowledge of manufactur-ing procezseso

/2 It is important to note, however, that the number of machinery-technologytransfer cases included in the total Teece sample of 26 was only 9. Con-sequGntly, the effects of sampling variability on his results may belargeo

/3 The Teece study does not report on the entent to which transfer costswere accurately foreseen by the transfereeo

- 27 -

shares, rather than for profit maximization. The rather general applicationof import substitution regimes in LDCs (Brazil, India, Korea) reduces the

threat of foreign competition, and the oligopolisitic /1 market structureusually characteristic of LDC equipment industries introduces an element of

stability which reduces the need for R&D. It is only when a competing

domestic producer attempts to increase its market share by undertakingresearch or the purchase of a foreign design license that domestic producers

are induced to retaliate. The usual option chosen to counteract the domesticcompetitor's headstart is to buy out a different foreign license./2 An evenmore important factor is perhaps the limited size of the current domestic

market for particular items of machinery,/3 which implies that the market forthe improved product, which is apt to cut into the market for the existing

design, is likely to be even smaller. The limited size of the market has

other pernicious effects: it limits the extent of learning, militates againstthe achievement of scale economies in research, and accentuates the force ofall those factors in the production environment of LDC firms which tend tocause a divergence between private and social benefits and costs.

III. The Case for State Intervention

The case for state intervention rests on three factors: (a) the

existence of external economies in the mechanical engineering sectors; (b)

the relevance of the infant industry (or increasing returns to scale) argument

for intervention; and (c) the efficacy of planning exercises in reducinguncertainty./4

(i) External economies which cause a divergence between private andsocial benefits and costs, appear to characterize mechanical engineeringindustry operations in a number of areas. We saw in Part II that, while LDC

comparative advantage in machinery production generally stems from therelatively low wages paid to labor (and the relative labor intensity ofproduction operations), the advantages of a low wage are sometimes nullified

/1 Though about 128 registered firms operated in the Indian machine tool

sector in 1972, the market was clearly dominated by three large firms.

/2 Pack has a comprehensive discussion of LDC satisficing behavior in the

unpublished piece referred to on p. 1.

/3 The low growth of the major user industries, e.g., general engineering,automobiles, etc., is usually cited as an important explanation forthe paucity of innovational effort in the area of precision machine

tools in India. See Business India, "Machine Tools, Narrowing theTechnology Gap," No. 26, March 5-18, 1979, pp. 51-52.

/4 In some areas of state intervention, arguments (a), (b), (c) may

coexist. While the effects of external economies and learning in infantindustries may be similar, in that both may lead to increasing returns toscale, the conceptual distinction is maintained here, because the secondphenomenon belongs properly in the dynamic context, while the first may

operate in a static framework.

- 28 -

by poor labor productivity0 One evident cause of low labor productlv4tywas found to be poor labor training0 It was pointed out also that individualplants undertook inadequate or partial laoor training in ozder to minimizelosses caused by the bidding away of labor by competing fi.rTs, after thelabor traini-N had occurred. The indivi6ual firm, faced with the possibilityof a loss of such investment in intangible capita.l preferred to undertakeless than the socially optimum degree of investment0 There appears to be afairly strong case, therefore , for the establisiment of government programs fordirect vocational training,L but more importantly, for the initiation andsubsidization of a scheme for in-plant training of labor, preferably on-the-job./2 Such a program of in-plant training might be self-financing, as inBritain, where a tax levied on firms in the mechanical engineering industriesis used to subsidise on-the-job training in those firms which have set upapproved programs.

A variant of on-the-job training which does not require subsidiza-tion , but is predicated on the existencz of' a substantial market for theoutput of the engineering sector1, is a deliberate policy of increasing thenumber of work shifts0 This route was pushed to some extent in the Sovietmetal-fabricating industry of the 1930so .Tts scope may, however, be limited:increased shift work generally gives rise to an increased demand for tech-nicians and supervisory personnel1 , a deuand which the Soviets , for example1 ,

were unable to meet adequately in the 1930s./3 Shift wozk also results insome loss of individual responsibility for worrk and for maintenance ofequipmento These losses might become untenable for an LDC intent on thesimultaneous development of factory discipline0

Part II also outlined the significant itprovements which could beachieved in plant layout, flow of work and operating practices generally ,"if technical expertise on production were available to management0

1 Largefirms might possess the resources for the hiring of domestic and foreignknow-how, but small firms usually do not:0 2owever , efficiency in the smallfirm may confer an externality on the rest of the sector via the increasedpossibilities of subcontracting0 Thus, a govern eat p2roagm for lechnicalassistance through "engineers and production people experienced in the 'bestpractices' in operations , use of machineoc flaoz of uork, could have an almostimmediate payoff in improved operationoi." The o-ganiEsation of technicalassistance arrangements has an additiongl rationale0 1.We found in 2?arts I andII that it is of overriding importance zo adopt sytams of know-how and

/1 This type of support was a significant feature of government policydesigned to accelerate the adoption of muOtEn Eachinery proceoces innineteenth century Prussia0

/2 Jacob Mincer's work on earnings differeacec, offers some intereatinginsights on the efficacy of on-the-job trsl1ningD as opposed to mereformal schooling , in explaining a lazge part of the variation Zn earn-ingso See his "On-The-Job TrainingC Costs, D eturns and Some `mplica-tions1,

t Journal of Political Economy , Oct. S962. ?art 20

/3 The experiment might not be inapprcpr!ate in s. country where engineeringskills are in surplus1 , if demand cEn be ensured0

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management which are in keeping with factor endowments in LDCs. However, theneed to adhere to the logic of "intermediate" (as opposed to the "latest")production and organization stages may not be immediately obvious, and therange of possible technical and organizational options may be unknown,particularly to small firms. It is here that a pool of engineering skillsorganized for the dissemination of pre-investment assistance would confer arange of social benefits which individual plants acting atomistically wouldbe unable to attain. Engineers conversant with "best practices" operating inthe West in the 1950s and 1960s, for example, might provide a useful startingpoint for particular LDCs. The idea of organizing technical data banks (anidea popular in certain "technology" circles) seems much less appealing, ifonly because, for successful application, the choice of technology has stillto be worked out by engineers with know-how capable of matching availabletechniques to specific LDC capabilities.

A similar gain is likely to result from the organization of central-ized engineering consultancy services, particularly for the conception,setting up, and operation of turn-key plants. In LDCs facing rapid expansionin sectors such as power generation, and petroleum refining capacity (i.e.,sectors which demand large volumes of plant equipment), the availability ofengineering personnel may represent a crucial bottleneck within individualplants. The demand for such engineering services, however, is apt to riserapidly at a time of significant increase in equipment demand, because of theneed to match the specifications stipulated in the technical designs beingadopted by the client sectors to the capabilities, both current and potential,of existing producers in the LDC equipment-building sectors./l While itmight not be possible for individual machine-building plants to carryengineers with the requisite skills on their permanent payrolls, it might bepossible for them to hire engineering services from a centralized pool as theneed arises.

Another lacuna, noted in Korea and India, in contrast to the bestrun Western machinery and metal-working establishments, relates to thenonavailability of "technical material available to the machine operator andfirst line supervisors": that is standardized technical material which helpsimprove the accuracy or quality of operator functions. The organization andsystematization of such information (in the form of condensed technicalhandbooks, wall charts, tabular materials, etc.) is usually outside thecapabilities of small machine-building firms in LDCs. The-requirements andusefulness of centralizing such information make it an appropriate functionfor a government institute associated with the mechanical engineering sector.

An associated need, identified in several LDCs starting out oncapital goods production (Brazil, India, and the Soviet Union, for example),relates to the standardization of materials and parts used by machineryfirms.

The opportunities for the purchase of foreign technology world-widemeans that there exist at any one time in the typical LDC mechanical engin-eering industry machine designs and operations based on disparate standards,

/1 See the ECLA discussion on pp. 21 and 65.

30

~EsaDentseystems and specifications0 Thver is, thersfore, some need forthe ooablishment of nation-ide standards for the mechanical enginearinginduozriesg otandardization ensures both ooEtlA11y and economies of scaleotzhils some form of standardization (materials and meaurement otardards)/hhave obvious economy-wide implications, other gorms of national standardiZa=tion (those relating to the standardization of nand subasoemblies) may,at least durzing the initial stages of developnent of a capital goodo industry,iop:oa too great a cost on the economy in terEm of currant pToduction fore°gone (due to delays while standards are being tworttsd out).o Howver: theremay em a point in the development of an LDCe capitsl goods sector when thecost to the nation of undertaking disparate, unet dardized production oftooling and fasteners to suit individual plant requirements wtill outueighthe private costs of a disruption in production caused during the process ofadoptiou of national standards. In other wordo, nzt gains t-yill accrue fromnationmidde standardization due both to the narrowing of the range of producttypes p@E achine in the equipment-producing firms and to the poosi,bilitiesfor undaertking the production of standardized fasteners and toolin3 inopcialigad plants 02 The appropriate timing for the introduction of normsfor atandardied tooling, etc., is then a function of the volume of nationala uipnEnt production, a factor uhich is unlikely to be psrceived by anindividual equipmant producer0/3 Hence, the need for state intetventionin dGtemininag the appropriate timing fEo the suitch to national standards,and Emor ipogteant, for state aid in esttblishing untional standards and fortidilng over the initial period when private losses zae incurred0

In PeaTt 1I, we pointed to the need for intra?lEs -: a&D for cost°cutting and product design development 0 However, pLrivats czlculations of thereturna=/riek attaching to R&D result in the restriction of industrial RED0Hence the need for State intervention to ansure >h- E sociel banefits0GovermQnt mid wight take the form of tau and other incentives for ancouragingindustrial PAD, the setting up of Institutions to undertaei contTact research

_i See ¢CLA, Leff and Granick, for the rEtionles for antional sXeaaue2etoyatens

J Thruechev complaineSd in 1962 that annual Soviet lessee from scatteredtoolingy production totelled twice the value of the fired capitan of thesopcielised tool plants then in eisitsence0

y3 Socs of ths sconomies of scale 'hich attend the pooling of fasesaer(or toolina) oTrdes derive from tho application of production techniques(Cg OO cold upsetting) which are not sconomical for veztically integratednmchine building operations producing fasteners ( 0 0 D with thge< help ofturrot lathes) for internal consumption0

- 31

for industry, and the channelling of R&D funding to development work (asopposed to basic and applied research)./L /2

Finally, the external economy argument supports the case forstate aid in the organization of marketing facilities for the export of LDCmechanical engineering equipment. The requirements for machinery exportsdiffer considerably from those for the export of traditional consumer goods./3Machinery is bought on specifications, quality, performance and reputation.Buyers often place orders incorporating special custom features: thisrequires a sales engineering capacity, incorporating design and technicalcapability. Buyers also require the assurance of a reliable service engineer-ing network. LDC governments might help ensure product quality by setting up(and possibly leasing the services of) centralized facilities for both mate-rials and final product testing. These services may otherwise be beyond thereach of individual machinery producers./4 Sales and service engineeringmight be taken care of by large-scale trading companies either set up orsubsidized by the state for the purpose of enlarging the ambit of exportactivity to cover smail and medium firms which would otherwise be deterredfrom export activity by the prospect of initially large overheads.

(ii) Infant Industry Support

The second set of arguments for state intervention derives from therelevance of the infant industry argument to the case of mechanical engineeringgoods production. We noted in Part II the importance of economies of scalefor machine-building activities. Large volumes of output were necessary forthe spreading of overhead costs (both capital, highly skilled labor and R&D),as well as for the accretion of learning (though in the case of learning large

/1 The IBRD's Korea machinery report documents the imbalance in KoreanR&D spending. Too little is spent on development work (compared to Japanand the US)(See Table 6).

/2 It is significant that in the electronics industry, which currently con-stitutes a "leading sector" in terms of the pace of technology changeworldwide, the major advanced semiconductor technology firms in the US,Japan and Europe are receiving a varied range of explicit and implicitsupport from their governments (R&D and production subsidies, theestablishment of R&D laboratories, availability of venture capital,conditions facilitating merger, etc.). I am indebted to Magdi Iskanderfor tais information. See also Far Eastern Economic Review, "The USWages Micro-War," March 16, 1979.

/3 See the discussion on pp. 17-19, in the IBRD's Korea Machinery Report.

/4 In Argentina, for example, such services are provided by the NationalInstitute of Agricultural Technology and by local universities. SeeCortes, op. cit., p. 48.

- 32 -

volhznes of cumulative output are more relevant),/1 end learning W5s found tobe important for the lowering of cost curves, as wall as fo.c the assimilationof the next round of new technology. However, LDCs are in general character-ized by a small domestic market. Hence it becomes important Lo reserve thisdomestic.market for domestic producers, as well as tc atrnmp£ to expand thesize of the market through exports. The first aim, the insulation of thedomestic market against foreign competitors, is usually z-1-.-;l throughoutright prohibitions on the import of `similars" or through oc.;: 0c./2However, since quantitative restriction measures reduce the choice set ofequipment designs available to machinery users by drastically llmlt;'.gforeign competition, they tend to encourage inef'Liciencies in the domesticmachine-building industries0 A more preferable pol:icy tco7. would be theimposition of tariffs /3 for a limited period of time (the o-).:.ocl b1ingannounced in advance) during which domestic producers cou:.d hope to takseadvantage of the domestic market to progress downm zhelz learning cu.rOveso Thepossibility of foreign import, though at a higher price, serves to retain asalutary element of competition0 Foreign imports could alwanys be resorted toif quality slipped badly in the domestic plant. Nowever, here too thsjudicious organization of centralized domestic enginering services (or offoreign consultancy services) by the state, of the sozt recoueadee InIII(a), in tandem with the application of protection, wsu.ole go some waytoward ensuring quality0 An alternative measure ewould be the 6irectsubsidization of production for a limited period0 Korea, for exanple,subsidizes the use of investment funds in the mechanical eLgineeszrn Industries(rates of return are hypothesized to be low in the wachInLsery industrzies,

particularly because of long gestation periods; mozeover r capl.tal marketis insufficiently developed)0 This, however, has the demerit that cm interestrate subsidy tends to encourage the use of capital reelative to labor0. Avariant of the interest rate subsidy would be the provislon of ovs2eheadservices (industrial site and service facilities) at subsldized ra 2eSo/4

/1 However, if the stability of the learning curve iu sought, to be ensured,stable output volumes are required, and thio Iln tur pcjintS to 'ahs needfor large scales of production, if a short leazrins period Is a L30

simultaneously desired0

/2 This also has the merit of not involving any budgetary operations0

/3 The height of the tariff should take adequate account of the inefficienciesof domestic subcontractors (if the government~ is also seeking t.o developthe supplier industries)O This was pointed oLt to me by ;i-2C*. :sLtander.

/4 Subsidies appear to have played an important part 1n stare pol:'cies forthe promotion of the engineering industries in Prus31a anc, Japn.0 Thefirst hydraulic press and steam engines in Germany were produced in statesubsidized factories, while in Meij1i Japan, government subsidles wereused to foster shipbuilding and marine engineering products. Sze U 000Henderson, "Peter Beuth and the Rise of Prussian Industry, 181C 45," inHughes, T0P0 ed0 , opo cit 0 pp. 113120, and Allen GoCo A Short EconomicHistory of Modern Japan, 1867-1937, Unwin University Books, Lordon, 1963o

- 33 -

Machine-building firms enjoying tariff protection might be moreeasily induced to strive for quality if the state were to use suasion as wellas incentives (subsidies and arrangements for centralized marketing) toencourage early export. Moreover, exports of domestic machines would alsohelp enlarge the size of the market facing the domestic producer./1 Themarket might be further enlarged if LDC governments were to conclude agree-ments for the setting up of free trade areas and planned production facilitiesfor LDC mechanical engineering products.

Before we move on to the third major rationale for state interventionin the capital goods sector, however, it might be well to explore a littlefurther the relevance of the argument for scale economies in two importantareas of policy and to tie in the concerns, voiced in Part II, about the sizestructure of LDC firms and the nature of the technology absorption and learningprocess.

As we saw in Part II, attempts to follow the Gerschenkronian routeof adopting the "latest" technology are sometimes self-defeating: in thesecases intermediate production technologies were judged to be more attuned toLDC capabilities. An additional argument for going the intermediate stages/2 route is the fact that the "latest" technology often delivers a sophis-ticated machine with a restricted LDC market. Moreover, a sophisticatedmachine with a wealth of features is not always the most appropriate designfor facilitating learning. Indeed, experienced machine toolmakers in Indiasuggested that a sturdy design with an assured high volume market was a moreappropriate vehicle for learning in LDCs. These learning effects may beimportant to bear in mind for LDCs where foreign technology licenses aremonitored,/3 or where engineering expertise is being set up to assist smallfirms in the choice of techniques [see Part III(a)].

A second area where policy needs to be appropriately designed totake account of scale economies is that of investment allocation in themechanical engineering industries. As we saw in Part II, the size of the

/1 Subsidies have additional merit. Since they are a strain on the budget,there is ultimately some pressure to get rid of them. Moreover, entryinto export markets may induce firms to maximize profits rather thanto satisfice (see Parts II and III(a)].

/2 Nota bene: this is not, however, synonymous with arguments for "reinventedintermediate technology." The "latest" technology might be relativelyeasy to assimilate if other complementary factors were available andindustry know-how internalized." The American foundry industry was ableto adopt the most modern German casting techniques in the latter half ofthe nineteenth century because immigrant German skilled labor and engin-eers were available to man the foundry shops. See D.L. Burn, in Hughes,T.P., op. cit. pp. 101-112.

/3 One school of thought contends that LDC royalty rates for foreigntechnology licenses are set too low to accommodate adequate technologytransfer.

- 34 -

plant required for the production of the individual m.echine line io w.aoreimportant for scale economies than the overall ci.ze of the cutpriecLDC licensing and monitoring authorities, howevern, .,.- lnv&2ri3y tomistake large firm size for large individual pro&3Ct voaf e. It is important,therefore, to ensure first, that individual ochinbz Qetiet,3 zs ey not fragmentedby delibezate government licensing po Lcy, seeoni that *ov nment oubsidizedfunds fRow to medium and small-sized firus and eotrectr; : i o'QU)?t?nRn la EI Tuns on individual product lies. eM thirdD that investmentfunds do not flow predominantly to the neWD larges , ern rmo bu': also toenterpTise wuith a history of production in tha c Do tnat th%e judiciousdistribution of investment, by eliminating bottlenecks iu tooling, D ixturesaEd maintenance equipment, will serve not only to r7ancF-ease the lsnczhs ofproduction runs, but alEo to concentrate volirec ca thaEzefore lex.a:i.ng oppor-tunities in firms with come accumiulated riene 0

(iii) The aeduction of Uncertainty

The final set of arguments for state atverives fro:mzoE theneed to reduce uncertaintieso The full utii2ntion of okue t a < illedlabor, the Stand&rdization of products, componento anm Žmbliso and theadoption of certcin forms of technical oT3rniEtZLOTa rpmzticularly o: equipment)is predicated on the stability of deEmad for he Lhc s ect:or "Scurrent product mia. Further, the lumpy nature of the ^n.mvestnts which areusually undertaken in the equipment industry0s client sectors (eog. turbinesof very Iage ceapacity, used for powde 'c : Or stel -',i: Zi.-- z that neu production facilities have either to is oat up in thedo-astic capital good asector or that oubetantiae. O.r. f ro0is:tingcapacity have to be planned. In either came, n%or inforustion on theplanned phsainA of investsent in the e4uipmentr"s, nqSrectosa wouid aid ther-(1i:~-d ajustmients in the capitEil goods sector and also help raise theproportion of equipEment that could ultisately be Coezestcically procuzred. Asimilar argument eiziot for the planned phsoin e the r aci producingsectors, eag. cteel, with the mechanical oc... sctors. O cth argumentspoint to the need for some degree of indicative 1iae'r pPLanning.

The first iosue, reacting to the need f$r hljeTa ieaind paitterns,translates itself into an argument for a stabLe rate - ' .-c Y Th.L;e mechanicalengineering sectors are distinguiohable from the -onasux er -.cc6z, industries inthat the growth of the sector is a function, not co much of the level ofnationiaml inoeD, but of the growth rate of the econouy. Uence it in importantfoe governments contempleting economywide yt-wll:. .on policos (rarticularlyin LECs where government purchasing pollicies are n .zc for tihc equipmentproducing soctorC) to draw up measures desiGned ft: uenfitc2:n cemanae formechanical engineering products (once the stabil.4at1on policioc tievetakeon effect-), if Erecesionary conditions are to be avoided 4.n the capitalgoods sectors. This was the rationale underlying the Indina Government'spromotion of enports of engineering goods following the onuet of recession in

So far we have referred to the need for EcrcTc planning0 The discus-sion in 1art I pointed to the need for upgrading the cuality of intra-plant

- 35 -

management in LDC equipment firms. Recent work by Rhee and Westphal haspointed to the payoffs involved in ensuring economies of scale (and to alesser degree from taking account of interdependencies)./I While the modelsutilized have not yet been tested operationally in LDCs, the complexity ofthe issues dealt with suggests /2 that "producers should have a betterframework for costing their products than the traditional bookkeeping frameworkof aggregate financial transactions" and that the industry should have accessto arrangements for "man-model-computer iterations" of mechanical engineeringprocesses, manned by teams of economists and engineers. Such arrangementsneed not necessarily be funded by government; they could equally well be setup and funded by private industry, but with access to government technicalinformation systems. A related service, which could be performed eithersingly or jointly by the private sector and government, concerns the acquisiton,processing and dissemination of international marketing information which is"critically important in determining the optimum product differentiation foran export market."

/1 See the conclusions set out in Chapters 16, 17 of Stoutjesdijk and Westphal,op. cit.

/2 As the authors themselves point out, in their earlier 1973 paper: PlanningFuture Import Substitution and Export Expansion in Korea's MechanicalEngineering Industries.

Table 1: WORLD TRADE IN MACHINERY AND TRANSPORT EQUIPMENT (SITC, Revised, 7)VALUES (In millions of US dollars, F.0.8.) AND SHARES (%)

Regions of Destination Regions of DestinationDeveloped Developing Centrally Developed Market Region Total Centrally Developed Developing Developed Miarket

World Market Market Planned Ecpnomies in World World Planned Market Market EconomiesYear Trade Economies Economies Economies Europe USA Japan Trade Trade Economies Economies Economies Europe USA Japan

REGIONS OF ORIGIN

World Trade1972 125,028 83,429 26,520 14,366 50,213 17,757 2,088 100.0 100.0 11.5 66.7 21.2 40.2 14.2 1.71973 164,289 108,798 35,167 19,194 67,480 21,819 2,746 100.0 100.0 11.7 66.2 21.4 41.1 13.3 1.71974 205,674 129,883 50,851 23,349 78,696 24,935 3,770 100.0 100.0 11.4 63.1 24.7 38.3 12.1 1.81975 244,455 141,138 70,709 30,898 88,486 24,328 3,146 100.0 100.0 12.6 57.7 28.9 26.2 10.0 1.31976 278,348 163,204 81,266 32,100 102,060 31,339 3,375 100.0 100.0 11.5 58.6 29.2 36.7 11.3 1.2

Developed Market Economies1972 108,729 80,814 23,664 3,611 48,973 16,600 1,985 86.9 100.0 3.3 74.3 21.7 45.0 15.3 1.81973 142,307 104,655 31,363 5,528 65,725 19,86S 2,529 86.6 100.0 3.7 73.5 22.0 46.2 14.0 1.81974 179,339 124,614 45,526 7,828 76,350 22,731 3,412 87.2 100.0 4.4 69.5 25.4 42.6 12.7 1.91975 212,665 135,283 63,958 11,768 85,357 22,380 2,787 87.0 100.0 5.5 63.6 30.1 40.1 10.5 1,31976 241,884 155,585 73,434 11,383 98,380 28,436 2,827 86.9 100.0 4.7 64.3 30.4 40.7 11.8 1.7

Developing Market Economies1972 2,829 1,664 1,112 26 348 1,138 85 2.3 100.0 0.9 58.8 39.3 12.3 40.2 3.01973 4,601 2,830 1,681 42 533 1,915 196 2.8 100.0 0.9 61.5 36.5 11.6 41.6 4.31974 6,581 3,633 2,831 33 817 2,160 334 3.2 100.0 0.5 55.2 43.0 12.4 32.8 5.11975 7,131 3,654 3,504 60 1,047 1,894 344 2.9 100.0 0.8 51.2 49.1 14.7 26.6 4.81976 9,469 5,128 4,208 66 1,334 2,836 531 3.4 100.0 0.7 54.2 44.3 14.1 30.0 5.6

Centrally Planned Economies1972 13,470 950 1,745 10,729 893 19 18 10.8 100.0 79.7 7.1 13.0 6.6 0.1 0.11973 17,381 1,313 2,123 13,894 1,223 35 21 10.6 100.0 79.9 7.6 12.2 7.0 0.2 0.11974 19,754 1,636 2,494 15,488 1,529 44 25 9.6 100.0 78.4 8.3 12.6 7.7 0.2 0.11975 24,659 2,201 3,248 19,069 2,083 54 15 10.1 100.0 77.3 8.9 13.2 8.4 0.3 0.11976 26,995 2,491 3,625 20,650 2,347 67 17 9.7 100.0 76.5 9.2 13.4 8.7 0.2 0.1

Source: UN, Monthly Bulletin of Statistics, June 1978.

I ~~~~~~~~~~~~~~~~- 37 -

Table 2A: SELECTED /a US IMPFORTS OF MACHINERY FROM9 KOREA AND DEVILOPIN COUNTRIES - CIDIENT VALUES AND SHARES, 1970-74

Shaer of principal Share of prin-Us imports (in US$ m1n 5) .. US imports Korean share Korean share Latin Amerlcan LDC cip.1 AaLan

1970 I 1974 from Cores of LDC of Us market exporter in IS LDC exporter InSITC Total LOCw -Tota O (inUS1, amnj erte'Z'ke c ,;- Sa-re / group ipr. hae i or. hae i7I7 190 74 1970 1976 19I199O 74

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)

7 Mah4the.ry end transport equipment 11,171.3 S.0 24,700.7 120.3 30.6 284.3 5.4 9.4 0.3 1.1 1.4(1) 3.7(1) 1.5(l) 1.6(1)71 Maihinery, non..lectric 3,017.3 2.6 6,432.5 5.6 0.4 24.9 0.5 6.9 0.0 0.4 1.1(1) 2.7(1) 0.6(1) 0.6(l)711 Pwovr mechinery, noelectric 792.0 1.4 1,531.3 2.6 0.1 0.3 0.0 1.3(1) 1.8(1) - 0.0(I)71. Piston engn, OnaIr 665.3 1.6 1,191.2 3.3 0.1 0.5 0.0 O.8(I) 2.2(l) - 0.0(1)711.6 Engines, NES 7.3 - 11.8 0.1 - - -7 12 Agritult.ral machine ry 263.9 0.6 742.7 1.3 0.1 1.2 0.0 0.0 0.2(1) 0.4(1) 0.2(2) 0.5(2)712.1 Cultivating nachinery 7.3 - 11.8 0.1 0.4(1) - -712.2 Harvesting ,s.thimes 126.3 0.4 304.5 1.2 0.2(1) 0.6(1) - 0.1(2)712.5 Tractors, nonroad 90.5 - 302.8 0.1 0 .1(2) --712.9 Agriculture machines, other then

cultivating 6 harvetingmathines, dairy fare equipmsntA tractors, .nonoad 9.6 9.4 41.7 14.3 2.1(3) 1.2(1) - 7.4(2)

714/b Office machines 504.6 10.9 1,020.5 21.3 0.3 19.6 0.7 9.1 0.1 1.9 4.0(1) 10.7(1) 3.6(1) 3.3(1)715 Metalworklng machinery 163.7 0.4 305.2 1.2 0 .2(1) 0.1(l) 0.1(7) 0.2(4)715.1 Machines tools for metal 134.6 0.5 273.7 1.3 0.2(2) 0.1(1) 0.2(7) 0.3(4)715.2 Metalworking mchinery. other

than sachine tools for metal 29.1 - 31.5 0.5 - - -- -717 Toxtile. leather macbinary 361.0 0.6 613.5 2.9 2.1 - 11.5 - 0.3 0.1(2) 0.5(2) 0.1(1) 0.2(1)717.1 Textils machinery 241.3 0.2 397.6 0.5 0.1(3) 0.2(2) --717.2 Skin, lesther working macblmes 6.5 - 6.8 0.2 - - -- -717.3 Sewing machines 113.2 1.5 209.1 7.6 2.0 - 12.6 - 1.0 0.2(4) 1.1(2) 0.2(1) 0.5(l)718 Nschimae for special ind-atries 205.7 0.5 433.4 1.6 0.3(l) 1.0(1) - 0.1(3)716.1 Paper, etc. mill machiosry 50.2 - 88.8 0.3 - - -718.2 Printing, bindimg machinery 64.3 0.2 104.8 0.6 0.5(1) -710.3 Pood machinery, eoodomsatic 20.3 1.0 43.7 2.4 0.5(1) - 0.5(4)718.4 Construction, minlng machinery 49.0 1.2 175.3 2.1 0.8(1) 1.8(1) -718.5 Crushing, etc. glees machinery 21.8 0.9 40.9 3.5 2.01) - 1.0(3)719 Other special mechinery 736.3 0.8 1,765.9 3.5 0.1 2.7 1.7 4.3 0.0 0.2 0.4(1) 1.8(1) 0.1(1) 0.3(31719.1 Heating, cooling equipment 66.2 0.5 121.1 6.4 0.1 1.3 - 0.1 0.3(3) 3.5(1) - 0.0719.2 Pumps, centrifuges 111.9 1.3 333.4 2.1 0.3 - 4.3 - 0.1 0.5(1) 0.8(1) 0.3(1) 0.4(1)719.3 Mechanical handling equipment 97.7 0.3 226.2 LI.1 0.1 2.1 - 0.0 0.2(1) 0.6(l) - 0.01)1719.32 Forklift trucka. etc. 22.2 0.9 64.5 2.6 1.7(2) - -719.4 Domatic appliancee. nonslactric 25.3 0.8 36.2 2.0 2.2(1) 0.6(0) 1.1(1)719.5 Powered tool. 81.1 0.5 208.0 1.9 0.3(2) 1.5(1) - 0.2(3)719.6 Nonalectric machines. Hi 39.0 0.8 88.8 5.2 0.2 - 4.3 - 0.2 1.441) 0.5(1) 2.1(1)719.7 6.11, roller, etc. bearings 79.9 - 216.6 1.3 0.3 - 11.4 0.1 0.101) - 0.87(3)718.8 Other machines, nonelectric 131.8 0.5 275.0 5.1 0.2 - 1.1 0.1 0.3(1) 3.2(l) - 0.3(I)719.9 Machine perts, accessories. MRES 103.6 2.2 260.4 5.0 1.4 - 10.6 0.5 1.7(l) 2.4(l) 0.1(1) 0.3(1)72 Zlectricsl machirary 2,271.9 20.9 5,416.9 45.4 30.1 248.1 6.6 10.1 1.3 4.6 4.7(I) 11.3(1) 6.2(1) 6.5(1)729.4 Aua,tootive electrical equipmsnt 57.7 0.9 143.3 4.6 0.1 0.5 0.1 0.7(2) 8.9(2) - 0.8(1)73 Ttransport equipment 5,682.0 0.5 12,851.3 1.7 11.4 - 5.3 - 0.1 0.2(1) 1.0(1) 0.1(1) 0.1(1)i3l Railway vehiclea 14.5 22.8 43.2 6.3 -22.1(l) 6.0(1) - -738.5 Psasseger cars, not Powered 3.9 82.1 … … … … … … … … … - - --

?17 Railway locomotive car parts.n18 10.6 33.0 37.5 7.2 6.9(1) -

732 Road motor vehiclex 5,479.5 0.3 11,830.8 1.0 0.3 0.3 - 0.0 0.2(1) 0.7(1) 0.0(1) 0.0732.1 Psasemagr motor vehiclee,

excluding bus". 3,913.3 - 7,635.9 0.4 0 .4(1) - 0.0(l)732.8 Motor vehicle part., MS5 891.5 1.1 2,586.6 2.7 0.2 - 0.0 0.3 1.0(I) 1.8(1) 0,0(1) 0.0(1)732.9 Motorcycles.. etc. parts 327.9 1.3 969.7 1.2 0.2(l) 0.0(1) 0.0(e)733 Road vehicles. neomotor 66.3 2.4 368.1 12.3 10.7 23.6 - 2.9 - 2.9(1) 0.5(l) 0.4(9)733.1 bicycles, somontor, parts 56.1 2.9 347.5 12.4 10.5 24.4 - 3.0 -3.8(1) 0.5(1) 0.5(1)733.3 Vehiles,m MS, noneutor.

trailer. 10.1 - 20.5 10.7 3.4(1) - -734 AIreraft 274.3 0.3 510.2 5.0 4.9(1) - -734.9 Aircraft parts 226.0 - 386.3 6.6 6.3(1) --735 Ships, boat. 47.4 17.5 99.0 25.8 0.4 1.6 - 0.4 3.6(1) 1.3(1) 12.5(l) 6.6(1)735.3 Ships & boats, nonovar 47.4 17.5 99.0 25.8 0.4 - 1.6 0.4 3.6(l) 1.3(1) 12.5(1) 6.6(l)

.Excludes SITC cat*anries which conatituts office machinery and electronics.76b SUTC category 714 io included under electronic. products in the UN definition.T_ The numbers In brackets are codas for the particular Latin AnericaQ deweloping countries whoase export shares are recor,dedin Columne (11) and (12).

Th. country codes are as follows: (1) Mexico, (2) Brazil. (3) Argentina. (4) Colo-bis. (5) Paama Em C.Z./d The numbers in brackets are codes for the principal Aai.n developing co-ntries whoa. export ehares are recorded in Colown. (13) and (14). The country

codes are on follows: (I) beng tong. (2) Malaysia, (3) Singapore, (4) Philippines.

* Note: The Republic of China in no longer included in Ulf trade statistic..

Sounce] UN Commodity Trsd. St.tiatics. 1970. 1974 Statistical Papern Series D; Vol. XX, No. 1-20. 9o1. XXIV, No. 1-28.

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Tablo 20- SELECTED /o JAPANESE IMtPOIRTS OF MACHINElY ROM KOREA AND DEVELOPING COUNTRIES - CURRENT VALUES AND SUARfS, 1970-75

Shoar ofJapaneoe Japaneoo Ioroan ohare Shore of principal principal Aofan

iporto (in aln dolloro. i) leporto Ilorcon oboro of Joponooo Lstin Aaoricon L3C LDC onportcer1970 197S Urea tEore, of LEC nork.t ceporter in Jopanooo in Jnponecc

SITC Total LUC Totol LDC (in ) ort (t Ic ( M .t /d 12)codo iuporto ohore laporto ohorc 1970 I175 I _ IIYO' ( 01975 1970 ) 1 1T

(1) (2) (3) (4) (5) (6) (7) (a) (9) (10) (11) (12) (13) (14)

7 t-chinnry cnd trenoport cquipocnt 2,132.4 1.9 3,823.5 10.2 5.5 148.5 13.9 39.0 0.3 3.4 0.0(3) 1.3(2) 0.4(1) 0.8(3)71 N.chincry, nonoloctric 1,262.5 0.3 2,054.8 6.6 0.3 14.2 7.5 10.5 0.0 0.7 0.0(3) 2.3(2) 0.0(1) 1.1(3)711 Pouar cschinory. nonclctric 154.2 0.1 306.4 0.5 - - - - 0.1(7)711.5 Pieton enginco, nonair 19.6 0.5 49.1 2.9 - - - - - - - - - 0.4(7)712 A3riculturol cechinory - - 88.3 0.7 - 0.6 - 100.0 - 0.7 - - -712.1 Cultivating c=chinary - - 3.2 18.8 - 0.6 - 100.0 - 18.0 - - -714/b Office cechinao - - … … … … … … … … … - - -715 Cutolmorlting ~chinory 167.9 0.2 136.8 1.5 0.1 0.3 25.0 15.0 0.1 0.2 - - - 0.3(3)715.1 Machinwo toolo for catol 159.0 0.2 122.3 1.1 - - - - - - - - 0.1(1) 0.3(3)715.2 rNtoltrorhina rxchinory. UIZS - - 14.5 4.8 - 0.2 - 20.6 - 1.4 - - -717 Toetile. leothor cechinary 113.4 0.3 92.5 3.5 - 1.9 - 59.4 - 2.1 - 0.2(1) 0.4(2)717.1 Tentile aechinory 102.2 0.2 74.2 1.0 - 0.6 - 46.2 - 0.8 - _ 0.2(1) 0.5(2)717.3 Se.ina cnchincs - - 13.8 14.5 - 1.3 - 65.0 - 9.4 - - -718 flochinee for special IndustrieS 105.8 0.3 175.1 0.7 - 0.6 - 50.0 - 0.3 - - - 0.1(3)710.1 Printing, binding c-chinory - - 62.9 1.0 - 0.6 - 100.0 - 1.0 - - -710.3 Pood c=chinory, nonda-oatic - - 16.5 0.6 - - -718.4 Conotruction, olninz cnchinory - - 39.2 0.5 - - - - - - - - - 0.5(3)718.5 Cruching. etc. glota cachinry 11.4 1.8 … … … … … … … … … - - -719 Other op-cil neehinery - - 751.5 6.0 - 8.7 _ 19.2 - 1.2 - 0.0(3) - 2.5(3)719.1 hooting, cooling oquipcent - - 96.5 14.9 - 0.1 - 0.7 - 0.1 - - - 14.5(2)719.12 Air-conditioning rzachinery - - 21.5 65.6 - - - 65.1(2)719.2 Pumpo, contrifugoo - - 164.5 7.7 - 0.4 - 3.2 - 0.3 - - 7.1(3)719.3 N2chanicol handling cquipcnt - - 85.2 1.1 - 0.4 - 44.4 - 0.5 - 0.4(3)719.32 Forklift tructs, etc. - - 1.8 5.6 - - -

719.5 Povorod teoao. UZS 32.8 0.6 47.4 1.9 - 0.5 - 55.6 - 1.1 - -

719.6 .onaloctric onchinao. lIES - - 71.8 3.6 - 2.2 - G4.6 - 3.1 - - 0.3(1)719.7 Del, roller, etc. baorinoo - - 25.2 29.8 - 0.9 12.0 3.6 - - 25.0(3)719.8 Other mechinno, nonelectric - - 126.4 0.7 - - - - - - 0.4(3)719.9 fachioe porto, occcocorieo, NES 80.9 0.4 131.5 4.3 - 6.3 76.0 3.3 - 0.1(1) - 0.2(2)72 Iloetrical cchinoary 463.7 6.0 1,004.5 23.7 5.1 132.0 10.2 55.6 1.1 13.1 - 10.4(1) 1.5(l) 1.0(2)720.4 tPtcaotive electrical oquip=ont - - 12.3 1.6 - - -

73 Tranoport equlpoont 406.2 1.9 764.1 2.4 - 2.3 - 12.6 - 0.3 - 0.3(l) 0.3(4) 0.4(3)731 Etaluly vahicloo - - 6.6 1.5 - - - - - -732 Load rotor vehicloc - - 297.0 1.4 - 1.0 - 23.S - 0.3 - 0.8(1) - 0.0(4)732.0 Kftor vehicle porte. 11218 - - 47.4 7.8 - 0.7 - 1G.9 - 1.5 - 5.3(1) - 0.2(4)732.9 tiXtorcycloe, etc. parto - - 5.6 7.1 - 0.3 - 75.0 - 5.4 - - -733 load vQhiclao. norcotor - - 7.3 41.1 - 1.3 - 43.3 - 17.8 - - - 20.6(3)733.1 licycloo, nonzotor, parto - - 4.7 63.8 - 1.2 - 40.0 - 25.5 - - 31.9(3)735 Shipe, bocto 60.6 12.2 87.9 12.4 - - - - - - - 1.5(5) 2.0(4) 1.6(3)735.3 Shipe 6 boato. nonvor 51.7 7.7 83.0 12.8 - - - - - - - 1.4 5) - 1.7(3)735.8 Voooolo for breahing up 0.8 30.6 2.4 8.3 - - - - - -_ _ 13.6(4) 4.2(4)

/a Encludoe SITC cotogorioa ehich conotituta offiao cechinory end aloctronito./b SITC cat°aory 714 ic includod tmdor olactronice producto in the UU dofinition.7;; Tho neellaro in brececto ore codco for the particular Latin A=ricon doveloping countrico ohoso ouport eharoc aro rccorCsd in CoI.ano (11) end (12).

The country coede ore co folloua: (1) Niraieo, (2) Sroanl, (3) Argentina, (4) Colocbie, (5) Penacao 9= C. Z./d Th ruz-boro in broceoto ara codoc for the principol laaon davolopin3 countrioa ehoce cport ohoroo ore rocordad 10 Colu=ao (13) and (14). Tho country

ce4oa ore ao followos (1) Rong Mona, (2) t;sloyoao, (3) lingoporo, (4) Philippinco, (5) Qatar, (6) Iran, (7) India, (0) Ozmn. (9) TurUay, (10) SaudiArabio. (11) Cypruo.

baoto Theo apublic of Chinao i no longor Included in Ub trcde etotiotico.

Source; 1l Co=,odity Trado StotiStSco, 1970, 1975 Statipticol Papara Soriao D; Vol. 121J, lI. 1-15, Vol. MlT, Ve. 1-4.

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Table 2C: SELECTED Is GERMAN (FEDERAL REPUBLIC) IMPORTS OF MACHINERY FROM KOREA AND DEVELOPING COUNTRIES - CURRENT VALUES AND SHARES, 1971-75

German Share of principal Share of prin-Germa ( ort(inm dollars '1 ) Lnports Koreanfshre L orean share Latin Anerican LDC cipal Asian

197 I 191_______ trom Korea of LDC of Gerum arkes expo rts In German LDC exports inSITC Trbtal LDC Total LDC (ln *ln _ xport (S) (1) market /c (2) Cer.market /d (X)code Imports share imports share 1971 1975 197it, 1975 7T 1971 1975 1971 1975

(I) (2) (3) (4) (5) (6) (7) (a) (9) (10) (11) (12) (13) (14)

7 Machinery and transport equipment 6,700.2 1.0 13,046.0 3.0 1.0 22.3 1.5 5.7 0.0 0.2 0.1(2) 0.4(2) 0.2(l) 0.6(1)71 Machinery, nonelectric 2,824.7 0.6 5.119.8 3.1 0.2 5.2 1.5 3.2 0.0 0.1 0.2(2) 0.6(2) 0.2(I) 0.7(3)711 Poamr achinery. nonelectric 263.2 1.8 644.4 8.4 - - - - - - 0.8(2) 3.8(2) 0.2(6) (.5(3)711.3 Stem engines, turbines 22.5 - 36.5 1.1 - - - - - - - - - 0.5(5)

711.4 Aircraft engines, lncl. jet 79.1 2.6 165.6 8.2 - - - - - - - - 1.8(6) 2.5(6)711.5 Piston engines, nonair 124.7 2.1 328.4 10.2 - - - - - - 1.8(2) 7.5(2) 0.1(7) 0.2(7)711.6 Cas turbines, nonnircraft 12.1 - 54.5 12.1 - - - - - - - - - 3.1(7)

711.8 Engines. hES and excludingnuclear reactors 8.5 - 22.6 0.9 - - - - - - - 0.4() - -

714/b Office machines 6h9.8 0.9 1,151.0 6.5 - 4.4 - 5.9 - 0.4 0.5(2) 0.1(2) 0.1(l) 2.5(3)715 Metalwtrking machinery 238.9 0.3 266.2 0.6 - - - - - - 0.0(2) 0.2(2) 0.2(7) 0.3(3)715.1 Rachines tools for metal 195.6 0.3 201.4 0.8 - - - - - - 0.1(2) 0.2(2) 0.2(7) 0.3(3)717 Te-tile. leather machinery 180.4 0.2 267.7 2.1 0.2 0.7 56.5 12.5 0.1 0.3 - 0.2(2) - 0.2(1)717.1 Te-tle machinery 145.6 0.1 202.1 0.5 - 0.3 - 27.3 - 0.1 - 0.1(2) - 0.1(3)717.3 Sewing machines 31.8 0.9 59.9 7.5 0.2 0.4 83.5 8.9 0.7 0.7 - 0.5(2) - 0.7(I)718 Machines for special industries 295.7 0.2 500.4 0.3 - - - - - - - 0.0(2) - 0.1(9)718.1 Paper, etc., mill machinery 33.9 - 61.3 0.5 - - - - - - - 0.3(2) - -718.2 Printing, binding machinery 50.6 0.4 95.3 0.1 - - - - - - - - - -718.4 Conatruction, mining machinery 155.1 0.1 255.2 0.1 - - - - - - -718.5 Crushing, etc. glass machinery 41.2 - 59.2 1.2 - - - - - - - _ - 1.2(9)719 Machines, NES. nonIectric 1,092.9 0.4 2,044.9 1.1 - - - - - - - 0.1(1) 0.2(7) 0.3(7)719.1 Heating, cooling equipment 156.7 0.2 240.7 1.0 - - - - - - - - - 0.7(9)719.2 Pumps, centrifuges 177.0 1.3 408.0 3.0 - - - - - - - 0.2(2) 0.9(7) 2.0(7)719.4 Domestic appliances. nonelectric 6.6 - 11.8 9.3 - - - - - - - - - 1.7(1)719.5 Powered tools, NES 76.9 0.2 133.1 0.5 - - - - - - - _ _ 0.5(3)719.6 Nonelectric machines, NES 81.0 0.3 156.6 0.6 - - - - - - - 0.2(3) - -719.7 Ball, roller, etc. bearings 71.8 - 162.7 0.4 - - - - - - - 0.2(3) - -719.8 Other machines, nonelectric 130.3 0.1 212.8 0.1 - - - - - - - 0.1(2) - -719.9 Machine parts. accesnriaes, NES 232.0 0.4 483.3 0.8 - - - - - - 0.1(1) 0.3(I) - 0.116)72 Electrical machinery 1,519.9 1.4 3,725.2 4.9 - 17.2 - 9.4 - 0.5 - 0.1(2) - 1.6(1)729.4 Automotive electrical equipment 31.7 0.7 92.9 1.2 - - - - - - - 0.3(2) 0.3(6) 0.5(6)73 Transport equipment 2,355.6 1.2 4,201.0 1.3 - - - - - 0.1(1) 0.4(1) 0.2(6) 0.0(6)731 Railway vehicles 28.7 0.5 61.5 0.3 - - - - - - - 0.3(4) 0.3(12) -732 Road motor vehicles 1,652.5 0.3 3,214.2 1.0 - - - - - - 0.2(I) 0.5(l) - 0.0(9)732.2 Buses 3.4 - 20.6 1.5 _ - - - - - - - - 1.0_)732.3 Lorries, trucks 57.5 - 154.4 0.1 - - - - - - - - - 0.1(10)733 Road vehicles, nomnotor 67.7 - 125.2 0.2 - - - - - - - - - 0.1(7)733.1 Bicycles, no.motor, parts 24.5 - 49.1 2.0 - - - - - - - - - 0.2(7)734 Aircraft 296.0 0.1 571.8 0.1 - - - - - - - - - 0.4(10)734.9 Aircraft parts 114.8 0.2 265.3 0.2 - - - - - - - - - 0.8(10)735 Ships and boats 310.7 7.8 228.2 7.0 - - - - - - - 0.2(3) 1.1(6) 1.1(11)735.3 Ships & boats. nonwr 283.4 8.4 215.4 6.3 - - - _- - - 2.0(5) 1.2(6) 1.2(11)735.8 Vessels for breaking up 0.9 29.8 2.7 74.1 - - - - - - - 7.4(5) 11.1(11)735.9 Ships ond boats., NES 26.3 - 10.0 5.0 - - - - - - - 5.0(3) - -

/A Excludes SITC categories which constitute office machinery and electronics./b SITC category 714 is included under electronics products In the UN definition.7T The nombers In bracket are codes for the particular Latin American developing countries whose export sh,re. re recorded in Col,ns (11) and (12).

The country codes are as follows: (1) Mexico, (2) Brasil, (3) Argentina, (4) Colombia, (5) Pana Ex C. Z./d The nucbers in brackets are -J.ies for the principal Asian developing countrisa whose export shares are recorded In Columns (13) and (14). The country

codes are as followa (I) Hong tong, (2) Malaysla, (3) Singapore. (4) Philippines. (5) Qatar, (6) Iran. (7) India, (8) Oman, (9) Turkey. (10) SoudiArabia, (11) Cyprus.

Note The Rep.blic of Chins is no longer included In UN trade statiatics.

Source Co= Trade Statistics, 1970, 1975 Statistical Papers Series D; Vol. XXI, No.1-10, Vol. XXV, No. 9-3.

40 -

Table 3: IMPORTS OF MbJJOR 14ACHINEIRY ITEMS BY SIX LEADINTGDEVELOPED COUNTRY 2IWONTERS FROM 0 IE LDCS AND

ifHE LLC ' SHAURE, I974(US$ miY.lion)

SITC descriptLion V'alue

71o Machinery9 7o0nelectrlc7114 Aircraft egingneso JECo jet 57.0 3097115 Piston eng-nes r3n,o r 00.7 2077129 Agricu.lture machinery, n.e.s. 6.3 3097141 Typewritevn, cinqve twr!ters 8o3 2.47141 Accounting azcchineo, computers 273.9 29o37143 Statisticc3. Machines 6300 2077149 Office machlines, nloCso 36.6 3o67151 Machine toois rczG Lastnl 13.7 R0

7173 Setving mL;ehines 2.309 6067191 Heating, cooing equipment 22.2 2007192 Pumps, centrifuges 36.3 201

7193 Mechanical handllr' equipwant X4.7 loO7194 Domestic appliances, nonelectric 3o3 3.67197 Ball, Yoile-, etc., bearings 12.2 1o87198 Other iiachines, nonelactric 18o3 1047199 Machine perts, accesGoriesD noe.so 36.3 201

72. Electrical Machinery7221 Electric power vachinery 12308 2Oo17222 Switchgear, etc. 142.6 9.47231 Insulated wire9 cgale 34.1 O.o77241 Television receivers 31304 27.47242 Radio broadcaES receivers 5R6o8 35047249 Telecommunication 2c, 'L,L - - noeoSo 4740o 21L0725 Domestic electrical equipment, noe0s. 32.2 5.77291 Batteries, Dccumu-!z&:oTo 207 9o07292 Electric lamp, b°rlba 37o3 23.47293 Transistors9 vD ves, t_co i9 072O 33057294 Automotive electrical equipment 2507 5047295 Electrical meacuriag, control equipment 27o9 20 7299 Other electzic¢l chimerZy 267M8 20oS

73. Transport Eu-pent7321 Passenger motor vehic1c, excludinS buses 4303 0037328 Motor vehicle pnFtsa D XLO0o OY6

7329 Motoz cyclec, ctzD 230 a 9

7331 Bicycis 9 n.onhictoiZ, D :Ec:f 56.3 2.2S3

7333 Vehi.cles, noe.S 0 9 iDoenotorp traiA.ris 15.2 4067349 Aircraft parts9 etc. 510O 3.67353 Ships znd boats, 45D5 4oJl

7358 Vessels for break.in3 up I7 9).3

7359 Ships and boatsD n.e.c0 2.4 o0O

Source: Kawag¢chf.D Y.: Yo zj.- Oeveloped Countriee' eIpo?. - of

Machinery from the LDCla, !BRD, 9 V.> 29779 Table 7D page 7.

- 41 -

Table 4A: SHARES OF DEVELOPING COUNTRIES IN TOTAL EXPORTS OF ENGINEERINGPRODUCTS FROM BRAZIL, INDIA, SINGAPORE AND KOREA, 1975

(In percent)

SITC Products Brazil India Singapore Korea

7 Total engineering products 66.8 76.4 44.8 24.071 Total machinery, nonelectric 60.9 77.2 51.6 20.072 Total electrical machinery 47.9 66.4 35.3 12.573 Total transport equipment 86.3 82.7 59.2 55.0711 Power generating machinery 27.9 69.1 39.4 -711.4 Aircraft engines 28.0 - 3.6 -

711.5 Other internal combustion engines 23.9 54.9 84.0 -

712 Agricultural machinery 97.3 - --712.1,2 Agricultural machinery for cultivating soil 96.8 - _ _712.5 Tractors 98.5 - - -

715 Metal working machinery 96.1 38.1 - -

715.1 Machine tools 95.9 36.0 - -717 Textile and leather machinery 70.9 94.9 - 28.6717.1 Textile machinery - 95.1 - -717.3 Sewing machinery 73.7 - - 21.6

718 Special industrial machinery 90.0 98.0 64.5 -718.4 Construction, mining machinery 91.4 - 62.2 -719 Other special machinery 85.3 77.8 69.1 24.7719.2 Pumps, centrifuges 78.8 79.4 47.7 -719.3 Mechanical handling equipment 93.2 - 91.9 -

719.7 Ball, roller bearings - - 57.7 -719.8,9 Appliances, parts and accessories 78.4 77.6 84.8 14.3731 Railway vehicles - 55.3 - 13.2732 Road motor vehicles 86.7 88.2 94.4 -732.1 Passenger motor cars 96.7 - 93.2 -

732.2,3,4 Buses, lorries, trucks 92.6 97.8 - -733 Road vehicles other than motor - 93.9 - 6.5733.1 Cycles - 93.9 - 5.3

734 Aircraft 75.7 - 76.6 0.0735 Ships and boats - - 36.2 69.9

Source: UN (Economic Commission for Europe): Bulletin of Statistics on World Trade inEngineering Products, 1975, New York, 1977.

Table 4B: REGIONAL SHARES (Z) IN EXPORTS OF ENGINEERING GOODS FROM BRAZIL, SINGAPORE AND INDIA - 1973, 1975

Country SITC 7 SITC 71 SITC 72 SITC 73of Engineering products Machinery, nonelectric Electrical machinery Transport equipmentorigin Destination 1973 1975 1973 1975 1973 1975 1973 1975

Brazil(1) Africa 7.7 12.1 3.9 4.8 1.2 1.7 20.4 28.6(2) North America 26.2 18.7 18.9 18.5 51.6 41.7 11.5 5.8(3) Other America 52.3 51.3 57.9 53.1 34.8 45.3 61.7 52.1(4) Oceania 0.9 1.0 1.8 2.0 0.2 0.1 0.0 0.0(5) Asia, Middle East 0.7 1.3 0.5 0.9 0.1 0.4 1.4 2.4(6) Asia, Far East 0.6 2.1 1.2 2.0 0.2 0.5 0.1 3.3(7) Europe 7.5 9.8 7.0 11.5 11.8 9.6 3.9 7.4(8) Japan 4.1 3.7 8.9 7.2 0.0 0.8 0.8 0.4

Total Developing Countries: (1)t(3)i(5)t(6) 61.3 66.8 63.5 60.8 36.3 47.9 83.6 86.4

Singapore(1) Africa 1.8 1.7 0.6 1.1 2.0 2.1 3.6 1.4(2) North America 39.1 27.5 30.0 7.8 55.0 40.7 12.1 24.2(3) Other America 0.5 1.2 0.4 0.8 0.5 0.5 0.6 3.8(4) Oceania 4.4 6.7 7.4 17.7 0.6 1.4 9.0 2.9(5) Asia, Middle East 1,0 4.6 0.7 6.1 1.0 2.9 1.6 6.8(6) Asia, Far East 36.2 37.3 38.9 43.6 24.4 29.9 64.3 47.2(7) Europe 15.1 17.9 17.8 16.1 15.5 21.1 8.4 12.0(8) Japan 2.0 3.2 4.2 6.8 1.0 1.6 0-4 1.6

Total Developing Countries: (1)i(3)i(5)1(6) 39.5 44.8 40.6 51.6 27.9 35.4 70.1 59.2

India /a(1) Africa 19.6 11.9 16.9 31.2(2) North America 1.2 2.0 0.4 0.8(3) Other America 1.0 0.9 0,5 1.6(4) Oceania 2.1 2.8 2.2 1.0(5) Asia, Middle East 20.4 19.5 26.2 17.5(6) Asia, Far East 35.4 45.0 22.8 32.4(7) Europe 19.7 17,6 30.7 15.6(8) Japan 0.6 0.2 0.3 0.0

Total Developing Countries: (1)1(3)r(5)f(6) 76.4 77.3 66.4 82.7

/a Data ondectinntionc not availablc for India for 1973.

Source: UN (Economic Commission for Europe): Bulletin of Statistics on World Trade in Engineering Products, 1975, New York 1977.

Table 5 -43

Value Added and Annual Remuneration Per Employee

By Size Class of Firm - U.S. 1967

(dollars)

Metal Cutting Dies, Tools, Jigs TextileSize of Firm Farm Machinery Machine Tools Fixtures MachineryNo. of Employees VA/L W/L VA/L W/L VA/L W/L VA/L W/L

1-4 13,556 5,333 19,750 8,250 17,933 7,933 15,333 7,000

5-9 11,364 5,636 16,000 8,000 14,557 8,658 12,800 7,000

10-19 11,484 5,581 19,957 8,217 13,612 8,481 10,400 6,100

20-49 11,551 5,694 13,581 8,163 14,214 8,988 10,447 6,237

50-99 11,284 5,716 16,000 8,904 15,031 9,503 9,667 6,190

100-249 12,524 5,707 15,593 8,321 15,102 9,398 10,952 6,476

250-499 14,028 6,413 16,736 9,632 14,646 9,104 11,030 6,597

500-999 16,200 7,467 17,928 8,245 11,674 9,391 10,660 6,489

1000-2499 16,500 7,596 15,333 8761 14,683 11,171 9,189 6,250

2500 and over 17,634 8,079 14,363 8,960 - -

Average 14,978 6,946 15,955 8,714 14,496 9,092 10,179 6,380

Source: IBRD Mission data

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