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Industrial restructuring in developing countries: The need and the means

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
December 1985
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Anil Sood and Harinder Kohli

There is nothing fundamentally new about industrial restructuring. It is a natural phenomenon associated with economic growth and change and can proceed with or without the involvement of government. What is new is the magnitude, suddenness, rapidity, and complexity of the industrial restructuring necessitated by a much changed global economic environment over the past decade. The intensified pressure for change and its economic and social implications have increasingly led governments of all economic persuasions to play a more active role in inducing and facilitating effective restructuring so that international competitiveness can be improved or regained.

Restructuring becomes necessary when mounting losses, declining productivity, or diminishing market shares indicate an actual or potential decline in international competitiveness or in the ability to deliver required products at a competitive quality and price. Restructuring embraces all dimensions of structural change, including modifications in the efficiency and relative size of industries; the start-up, closing, growth, or shrinkage of enterprises; and alterations in product mix and technology. It calls for the movement of resources—labor, capital, and technology—from one part of the economy to another, and sometimes across countries.

Restructuring can occur on an enterprise, individual industry, or industrial sector-wide level. It can likewise take place for different reasons. It may be “defensive,” that is, in response to a threat already present, or it may be “positive,” if change is pursued to build a stronger competitive position for the future. The dominant type of restructuring that advanced European countries have attempted to assist declining industries such as steel or shipbuilding is of a defensive nature. Efforts by a number of countries, for example, France, Germany, and Japan, to accelerate the development of emerging industries, such as electronics and information technology, provide examples of positive restructuring.

This article notes some of the key factors that have recently increased the need to restructure; it looks specifically, however, at circumstances in developing countries and the policy and institutional reforms that can form the basis of effective restructuring programs there. Particular attention is paid to the roles of government and industry in the various levels and types of restructuring. For its recommendations, which are primarily of a general nature, this paper draws heavily on the Bank’s analysis of past restructuring efforts and its own research, policy, and operational work in this field. (See list of related Bank publications.)

Pressures to restructure

The increasing need to restructure has a number of complex and interacting causes. Some are specific to developing countries and are discussed later, but four developments stand out as fundamental explanations. First, changing consumer tastes, market saturation in many products, and changes in technology and in the relative costs of factors of production have dramatically reduced demand worldwide for the major industrial products, such as steel, that traditionally fueled growth and development.

Second, the world economy has been unable to sustain the very high growth rates of the 1950s and 1960s. While growth rates are expected to recover somewhat from the depressed levels of the past decade, most economists expect them to reach only moderate levels in the immediate future. This increases prospects for continued excess capacities, intense international competition, and poor profitability in many industries. Third, the pace of change in technology, design, and production processes has quickened tremendously; increasingly product life cycles are shorter and, because of increased efficiency, manufacturing costs are dropping. Fast changing consumer tastes and the emerging technological revolution are likely to accelerate this trend, making the competitive environment even more dynamic and uncertain.

Fourth, as a result of these changes, technological development, product design, marketing, and distribution—rather than manufacturing itself—account for an increasing proportion of a product’s value. For more than a decade now, the service sector has been the leading sector of the world economy, not only in OECD countries, where the bulk of world GDP originates, but also in some major developing countries, such as India.

…in developing countries

Although much discussion of industrial restructuring has focused on developed countries, restructuring is equally relevant for developing countries, and arguably more urgent. The fundamental pressures to restructure industry in LDCs stem from the same causes but have been exacerbated by additional external and internal factors. The debt crisis and declining terms of trade for major commodities, combined with slower domestic growth and limited potential for further import substitution, have put tremendous pressure on developing countries to increase their manufactured exports. For most, this will mean restructuring their industries to make them more internationally competitive.

Increasing protectionism in the OECD countries has also necessitated, for example, rapid restructuring of the textile industries in Hong Kong, Korea, Taiwan Province of China, and Turkey toward products with fewer restrictions and higher value-added content. In other industries, such as steel and shipbuilding, even very competitive developing country producers have been compelled to diversify their products. Korean shipbuilders, for example, are diversifying into the manufacture of industrial plants. Also, recent technological breakthroughs in many industries, ranging from leisure footwear to electronics, have reduced the labor intensity of production and have eroded the competitive advantage that developing countries had enjoyed from lower wage rates. Where fast changing consumer tastes put a premium on rapid response, such as in textiles, production closer to the dominant markets in developed countries is favored even when manufacturing costs are marginally higher.

Various internal factors in developing countries compound these pressures. Market distortions and constraints caused by past government policies have often promoted inefficient investments, while reducing and sometimes eliminating internal and external competition and providing little incentive to improve productivity. Trade protection measures, including tariffs and unrealistic exchange rates, have led to high and fluctuating inflation and interest rates, restrictive labor and wage policies, state monopolies and regulatory restrictions on private investment, price controls, and subsidies. Not only inefficient, these policies are also increasingly untenable; governments have been unable to sustain the large subsidies required to continue them.

The significant—often virtually monopolistic—role assigned to public enterprise in key industrial sectors also requires special attention. In many countries poor management and disappointing operating performance have placed a heavy financial burden on already strained government resources. Inefficiencies in the heavy capital-intensive industries—for example, steel, capital goods, and chemicals—that supply inputs to other industries also seriously undermine the competitiveness and performance of the entire industrial sector.

Other key factors relate to the stage of a country’s development. The most significant is a lack of adequate institutions and infrastructure, which can hinder efficient operations and timely movement of capital, labor, and technology from inefficient to efficient parts of the economy. The absence of efficient financial markets is a serious obstacle to the normal market-based restructuring that takes place through decline or bankruptcy of inefficient firms and the movement of capital to profitable ventures. Inadequate infrastructure—and here infrastructure includes “software” elements such as management, marketing know-how, distribution networks, and so on—is also a constraint.

Strategies for restructuring

Given the urgent need to restructure and the additional obstacles developing countries face, what strategies offer the most effective means of restructuring? And what can be the most effective roles of government and industry in this process?

Past restructuring efforts and the findings of recent World Bank work yield some useful lessons for developing countries. First, there is no universally applicable model. Industrial restructuring strategies and programs must be based on an in-depth understanding of the fundamental causes and nature of the particular restructuring efforts. Second, restructuring requires complementary, rather than contradictory, actions on the part of government, industry, labor unions, the financial system, and individual enterprises. Third, a mix of self-reinforcing policy reforms, institutional changes, and direct measures at the individual industry and enterprise level is needed to facilitate sustainable industrial restructuring. Effective restructuring requires improvements not only in the physical plant facilities but also changes in the behavior and motivations of enterprises, managers, and workers. The exact mix of such measures depends very much on the nature of the restructuring, the economic and social system of the country, and the ability of individual enterprises to respond in a timely manner to the changed policy environment.

The role of government must be one of fostering an appropriate policy and business environment that facilitates restructuring. Rather than intervening in the decision-making process at the enterprise level, governments must concentrate on eliminating policy distortions, promoting efficient institutions, and strengthening market mechanisms. Direct restructuring measures should normally be determined and implemented by individual enterprises—public and private. Governments may, however, have an important role in working with industry to develop and support the implementation of desirable restructuring strategies.

Policy and institutional reforms

Policy reforms are a necessary, and often the most crucial, condition for sustained restructuring in most developing countries. The basic objectives of these reforms, akin to those of the overall structural adjustment of economies, should be to increase competition, improve market discipline, and facilitate movement of capital, labor, and technology. Such reforms normally include measures to remove distortions in trade, pricing, interest rate, taxation, labor, and wage policies. It is also important to examine the respective roles of the public and private sectors in industry, degree of competition, constraints on direct foreign investment, corporate legal framework, and regulation and supervision of industrial and financial institutions. The specific measures needed will depend on the nature of existing distortions and sociopolitical and institutional settings in different countries.

In a Bank-assisted effort in Hungary aimed at improving the efficiency and structure of the entire industrial sector, policy and institutional reforms have been designed to enhance internal and external competition, resource mobility, and the market-responsiveness and financial discipline of enterprises—the three aspects identified as fundamental for effective restructuring in that country. On the other hand in Turkey, where the Government has already implemented major economic reforms and the private sector plays an important role in the economy, the highest priority is being accorded to removing policy distortions at the subsectoral level (e.g., price controls, ad hoc subsidies and taxes, and distribution restrictions in the fertilizer industry), restructuring and privatizing major public enterprises, and re-examining the relative roles of government and managers of those remaining in the public sector. Minimal direct government intervention is anticipated at the level of individual private enterprises.

The development of efficient financial markets—banking systems and capital markets—and institutions promoting the accumulation and dissemination of technology, management, and marketing know-how is a critical supplement to policy reform, particularly for less developed countries, where efficient markets and institutions are not yet available. In addition, specific institutional measures, including the dismantling or reorienting of regulatory agencies and the strengthening of legal and accounting systems, are usually necessary to strengthen market mechanisms.

When are policy reforms sufficient and when are direct measures, aimed at individual enterprises and institutions, whether supported by governments or other outside agencies, justified? Much depends on the urgency and the magnitude of the restructuring, the financial and social costs, the ability and willingness of the sectors or enterprises to move on their own and, in general, the extent of constraints on the movement of resources that must be overcome through direct intervention.

Industry-wide policy actions may often need to be supplemented by parallel efforts in major enterprises and institutions to ensure expeditious response to changing circumstances. In defensively motivated restructuring, selective direct government support may be justified at the subsector and enterprise levels, particularly where sharp cutbacks in capacity and jobs are likely to result in high social costs and meet substantial resistance. Government support in these instances should include steps to ameliorate short-term social costs, such as temporary unemployment. Government intervention to eliminate uncompetitive capacity is also necessary in industries dominated by public enterprises.

An industrial sector dominated by large monopolistic public enterprises, as is the case in many African and centrally planned countries, requires much more direct intervention than one composed of numerous profit-oriented companies operating in an open, competitive environment as in Korea and Mauritius. Experience in developed countries with positive restructuring suggests, however, that industry-wide incentives and temporary market-support measures are generally preferable to providing public financial support to specific products or enterprises over extended periods. The appropriateness of direct interventions also varies with the level at which restructuring takes place, the type of industry, and whether it is publicly owned or private.

Direct measures

Enterprise restructuring. Ultimately all industrial restructuring programs rely on actions at the enterprise level. These actions include “hardware” elements relating to plant and equipment, improvement of existing products, and the introduction of new varieties, as well as “software” such as corporate strategy, organizational structure, improvement of management and labor skills, financial systems and controls, and marketing and distribution. The software elements are particularly critical to building the organizational and management capability needed to maintain and enhance competitiveness. In the restructuring program for Gecamines, the major copper producer in Zaïre operating in a fiercely competitive international market, such software elements are the most crucial part of the package and took some three years to develop.

The design of enterprise restructuring programs should start with the formulation by management of a well-defined strategy for the business (or portfolio of businesses, where appropriate) based on a thorough analysis of competitive position and the specific measures required to enhance it. At this stage it is important to identify which activities are economically justified, which operations should be closed down, and what opportunities exist for changes in the basic business. A complementary analysis should identify the specific software areas that should be strengthened to support the selected corporate strategy. The most difficult challenge is to increase the overall organizational ability to operate in a changing and competitive environment.

Financial restructuring is often also essential where enterprises face liquidity problems that result from sudden increases in inflation, very high nominal or real interest rates, and large devaluations that increase debt-service obligations in local currency terms. In these instances conversion of foreign exchange debts into local currencies, rescheduling of debts, provision of guarantees, and infusion of equity through different mechanisms may be justified. However, liquidity problems are often symptomatic of basic problems in a company’s overall business strategy, competitive position, and management capabilities. Financial restructuring, therefore, normally needs to be coupled with the more fundamental restructuring measures discussed above. In any case, a critical assessment of the underlying viability and competitiveness of the enterprise is vital before proceeding with any major financial restructuring.

When restructuring public enterprises, additional issues merit attention. These include commercial and social objectives; institutional relationships between government and enterprises; financial discipline and viability; personnel policies; and managerial appointments, autonomy, and performance evaluation. A solution to the interrelated problems of restructuring and mounting fiscal burdens of public enterprises increasingly being considered by many developing countries—ranging from Turkey to Togo and Uganda—is that of “privatization.” Privatization includes not only a transfer of equity ownership but also other means of enhancing private sector involvement in management and operations, such as leasing and management contracts. These latter arrangements may be of particular relevance to developing countries where it seems impracticable to attract significant amounts of private capital at this time. (See Samuel Paul’s “Privatization and the public sector” on page 42 of this issue.)

Restructuring specific industries. Restructuring at the level of a subsector, industry, or segment of industry best takes place in the context of a well-defined strategy based on a rigorous analysis of its current and potential international competitiveness in different markets and product-groups. In most instances, governments need to take the initiative to work with private and public enterprises to carry out the required analyses of industries; industry associations, where they exist, can also play a leading role. It is important to distinguish here between industries consisting of relatively homogeneous commodity groups (such as fertilizer, mining, steel, and cement) and segmented industries (such as textiles, electronics, and engineering industries), which typically involve many more producers operating in numerous distinct segments within the industry.

Industries producing bulk commodities frequently comprise few enterprises; these are large in size and—particularly in developing countries—often state-owned. Capacities and the manufacturing and distribution costs of competitors can generally be estimated with reasonable accuracy so that international competitiveness can rather readily be determined. Relatively deterministic restructuring strategies can thus be designed; measures such as plant closures, production linkages and rationalization between producers, and investments to reduce costs can be readily identified. Specific policies, where appropriate, and implementation assistance can be directed toward the few key enterprises.

Restructuring programs were recently developed and implemented on such a basis for the fertilizer industry in Spain where, based on a management consultant’s study, the Government, the private sector, and trade unions agreed to close some plants and merge companies; similarly a major physical and financial restructuring of the petrochemical industry in France was decided between the major companies and the Government in order to reduce financial losses and meet increased import competition. In Turkey, the Government and the private sector are following a similar approach to restructure the cement and fertilizer industries with World Bank assistance. In both efforts, a combination of policy and direct measures at the company and plant level is anticipated. At the policy level, pricing, entry and liquidation of firms, labor policies, product distribution and marketing, technology and product import policies, and energy conservation issues are critical. Restructuring programs will include industry-wide capacity rationalization as well as specific actions for state-owned enterprises, including the reorganization and possible partial “privatization” of some.

Industries involving a large number of segments, by contrast, are marked by differences in products, markets, geographical location, and consumer base, and in most cases a much larger number of plants and enterprises. The requirements for competitiveness and success vary substantially in different segments. The analytical work and the formulation of a restructuring strategy must differentiate between these segments, and are thus more complex than for commodity industries. Government efforts are best concentrated on developing an overall industry strategy, general policy actions, and provision of infrastructure. Development of appropriate technology and marketing infrastructure is critical to support the restructuring efforts of the small-and medium-sized enterprises in such industries. But actual investment and other business decisions are best taken and implemented by individual enterprises in response to market signals and the new policy and institutional environment. Some direct support at the enterprise level, however, may be necessary where a few large enterprises play a dominant role and are unlikely to restructure on their own.

The restructuring of the textile industry in France was developed in dose cooperation between government and private sector organizations. A similar approach is being used in the Bank-assisted efforts to restructure the plastic processing industry in Hungary and the textile industry in Turkey. The program in Hungary will encompass industry-wide measures such as the development of technological infrastructure, promotion of small-and medium-sized companies, and improved access to materials and technology. Detailed restructuring programs to upgrade the product-mix and organizational capabilities of the five largest enterprises, which account for over half of industry’s output, are to be implemented concurrently. The program for the textiles industry in Turkey, which accounts for around one third of the country’s manufactured exports, focuses on developing a viable product and export market strategy for the future. It will cover the restructuring needs of key enterprises in the different segments of the industry and related policy and institutional measures. Reorganization and possible partial “privatization” of the large state-owned enterprise, if appropriate, will be an integral part of this program.

Conclusion

In considering the strategy and role of developing country governments in industrial restructuring, it is important to recognize the constraints imposed by the current scarcity of resources and limits of effective state intervention. The emphasis should be on low-cost investments with high returns to improve the utilization and efficiency of existing assets rather than on the creation of much new capacity, which characterized past structural change under an environment of high economic growth and expanding resource availability. While hardware investments, such as for equipment upgrading, will inevitably be required, the returns from software investments are expected to be far more significant.

Though restructuring strategies will need to be tailored to specific circumstances, past experiences nonetheless highlight some important general lessons. Industrial restructuring is a complex process with significant, sustainable results likely only over the medium term. It can entail substantial social costs and is likely to meet with opposition from many sources. Firm commitment on the part of government, private sector, and enterprises is a prerequisite for success. Appropriate phasing of actions, early “successes” that provide a valuable demonstration effect, and specific attention to meeting transitional social and financial costs are essential to sustaining commitment and enhancing prospects for success. The design of effective industrial restructuring strategies must rely on an appropriate balance of policy, institutional, and direct support measures that take account of country and industry circumstances.

In response to increased requests from member countries, the World Bank has substantially increased its research, policy, and operational activities related to industrial restructuring. It is now assisting over a dozen countries in the design and implementation of comprehensive restructuring programs and strategies both at the industry and enterprise level, and is well placed to assist other member countries.

Related World Bank publications

    ChadLeechorHarinderKohli and SujinHurStructural Changes in World Industry: A Quantitative Analysis of Recent Developments Industry and Finance Series1983.

    BarendA. de Vries and WilliamBrakelRestructuring of Manufacturing Industry: The Experience of the Textile Industry in Pakistan Philippines Portugal and Turkey Staff Working Paper No. 5581983.

    AlanR. RoeIndustrial Restructuring: Issues and Experiences in Selected Developed Economics Industry and Finance Series1984.

    GillesMichel and Peter A.PetriWorld Industry 1966-1982: Growth. Competition and Structural Change (forthcoming).*

    MiekoNishimizu and John M.PageJr.Country Strategies for Industrial Restructuring: An Analytical Framework and Applications (forthcoming)*.

    *Mimeograph copies available from the World Bank’s Industry Department.

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