Download economic policy changes, market structure and economic

Trade Policies, Market Structure, and Manufacturing Sector
Performance in Malawi over the period 1967-2002
Hopestone Kayiska Chavula
Macroeconomic Policy Division
United Nations Economic Commission for Africa
Addis Ababa
Ethiopia
[email protected]
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Abstract
The paper attempts to assess the impact of market structure and the
changes in trade policy regimes Malawi is envisaged to have gone
through since its independence on economic performance. We adopt the
widely accepted theoretical approach to structure–performance modeling
which follows the general classes of oligopolistic models by expounding
the Kaluwa and Reid (1991) framework. Following Baum (2001),
structural breaks are econometrically identified in relation to the
changing trade regimes. The results provide evidence that market
concentration has a positive impact on price-cost margins throughout the
trade regimes while factor inputs have negative impacts on performance.
Trade variables, imports and exports also exert a negative impact on
price-cost margins despite being insignificant during the SAPs period.
However, tariff rates have an insignificant impact across the regimes.
1.
INTRODUCTION
In the 1960s and 1970s, the Malawian economy went through periods of high economic
performance and periods of economic crisis as has been the case with most developing
countries in Africa, Asia, and Latin America. However, when one compares the country’s
economic performance over the decades since independence, the Malawian economy is
observed to have performed relatively better in the first fifteen years after independence,
1964 -1979 (Njolwa, 1982; Mulaga and Weiss, 1996; and Chirwa, 2003). This is supported
by the country’s performance in terms of the share of manufacturing output in gross domestic
product (GDP) which increased from 8 percent in 1964 to 12 percent in 1979, with the
overall GDP growth rate averaging 5.3 percent per annum over the period (Chirwa, 2003).
This early success is associated with the period when the Malawi Government implemented
the import substitution industrialisation and the protectionist economic policies, together with
the export led agricultural development strategy. Despite the adoption of structural
adjustment programmes (SAPs), with trade liberalisation as the main guiding policy
instrument, Malawi’s manufacturing sector has remained relatively small and
underdeveloped, and its performance remains dismal when compared to the period under
protectionist economic policies. It contributed about 14 percent of GDP in 1999 down from
17 percent in 1994, and dropped further to about 11 percent in 2003 (World Trade
Organisation (WTO), 2002; Malawi Government, 2004; NSO, 2006). These different trade
policy regimes with the existing domestic market structures could have played a significant
role in the performance of the sector.
The paper uses econometric analysis to evaluate the impact of changes in economic policies
and market structure on the performance of the manufacturing sector in Malawi. It
specifically investigates the impact of trade policy changes and market structure on the pricecost margins, using enterprise level data spanning over the period 1967 to 2002 in the
manufacturing industries involved in the annual economic survey by the National Statistical
Office (NSO). The study could not include data beyond 2002 due to unavailability of
consistent datasets after 2002. Despite a growing body of empirical literature on the effects of
trade policy changes especially tade liberalisation in most developing and emerging
economies, there has been no study, with regard to the author’s knowledge that has looked at
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the impact of changes in trade policy and market structure on mark-ups since the study by
Kaluwa and Reid (1991). This study is to some extent an extension of Kaluwa and Reid
(1991) covering the period 1969-1972, which falls within the period when the Malawi
Government was implementing the import substitution and protectionist trade policies. As far
as the author is concerned this is the first study to carry out such kind of analysis over the
different trade regimes Malawi is envisaged to have gone through. Also, despite having
knowledge of the periods when specific policies were put in place as stipulated in the
following section, this is the first study in Malawi to empirically carry out tests, such as the
Clemente-Montañés-Reyes unit-root test, with the aim of identifying the sector’s structural
breaks, as a result of the changing policy regimes and initiatives, despite having prior
knowledge of when the policies were actually put in place. This is believed to let the data
reveal the time when these policy prescriptions had effects on the manufacturing sector’s
performance, since it is possible to experience lags between the date a policy is announced
and the date of its actual implementation, as well as the adjustment by firms in terms of
changing their prices, costs, investment options etc. It is believed that the study results will
make a significant contribution towards the design and implementation of policies that will
have a significant impact on the development of the sector, especially with regards to its
contribution to the growth of the economy. The remainder of the paper is organised as
follows: Section 2 provides a brief overview of economic policies and reforms in the
manufacturing sector in Malawi. Section 3 reviews the theoretical and empirical literature
with the associated hypotheses. Section 4 describes the methodology and the data used for
estimation, and Section 5 presents empirical results while Section 5 provides policy
prescriptions and concluding remarks.
2. ECONOMIC POLICY REGIMES AND MANUFACTURING
PERFORMANCE
Domestic and international trade have mostly been influenced by macroeconomic policies
that have evolved over time since the country’s independence in 1964. This policy evolution
could easily be categorized into three distinct periods with regard to trade and economic
regime change. The early economic policies were motivated by the structuralist view to
development which advocated government intervention in the market. The first fifteen years
(1964-79) of independence were pre-occupied by import-substitution policies with associated
restrictive trade policies with limited emphasis on export-orientation. This period was
followed by a transitional regime (1980-93) in which Malawi, as was the case with most
African countries pursued a series of structural adjustment reforms which opened up various
sectors of the economy with emphasis on export orientation. The third regime (1994-2002),
was associated with trade liberalisation making international trade almost free. This is the
period of open trade with export promotion and democracy as the political regime moved into
the multiparty system of government.2
If we try to relate the different regimes to trade policy strategies, Table 1 shows that the
manufacturing sector experienced a significant decline in average growth rates in output in
relation to the different trade policy regimes. The table outlines the main policy actions
implemented by the Malawi Government, relating the trade policy actions to performance of
the manufacturing sector during the associated periods. The statistics in the table support the
thinking that the manufacturing sector in Malawi performed relatively better during the
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import substitution and protectionist policy period (i.e. the period 1964-80), than during and
after implementation of economic liberalisation policies.
Table 1: Trade policies and manufacturing performance
Period
Trade Policy Actions
Manufacturing Average
Growth rates
1964-1980
Import Substitution Industrialisation
 Overvalued exchange rate system – fixed peg
 Limited tariff protection
 Non-tariff barriers to trade e.g. import licensing and implicit foreign exchange
12.65%a
rationing.
 Malawi-Botswana reciprocal trade agreement in 1968.
 Active government involvement in manufacturing industries.
 Low and stable inflation and interest rates.
1981-1993
SAPs Period
 Periodic devaluation of the local currency and liberalisation of interest rates
 Liberalisation of output prices and limited entry
 Liberalisation into the manufacturing sector.
 Introduction of duty drawback system in 1988.
 Introduction of surtax credit system in 1989
2.87%
 Bilateral trade agreements
 Reduction in tariffs leading to a maximum of 75 percent in 1994.
 Elimination of quantitative trade restrictions and foreign exchange rationing.
 Abolition of exclusive monopoly rights
 Privatisation of state-owned enterprises
 Liberalisation of the financial sector and interest rates
1994-2004
Complete Open Economy Regime and export promotion
 Floatation of the local currency
 Introduction of Export Processing Zones (EPZ)
 Reciprocal bilateral trade agreement
-1.01%b
 Base surtax rate reduced to 20%
 Malawi joined the COMESA free trade area
 Privatisation of state-owned enterprises.
 Liberalisation of industry and output/input prices.
Source: Computed by author based on data from the Reserve Bank of Malawi Financial and Economic Review
(Various issues). a was calculated over the period 1973-1981 and b was calculated over the period 1995-2002
due to data unavailability during the time of the study.
2.1
Import substitution period
During the import substitution and protectionist policy period more emphasis was placed on
the need for private, competitive and profitable firms, which were regarded to be the engine
of growth in the manufacturing sector. More industry protection instruments were employed
which emanated from both commercial policy and non-policy or natural barriers. The main
objective of policies during this period was to diversify the economy away from the
agricultural sector through increased import-substitution industrialisation, thereby generating
sustainable employment opportunities (Malawi Government, 1971). This was emphasized
through the Government Development Plans (1961-64 and 1965-69), the first Statement of
Development Policies (1971-80), the Industrial Development Act of 1966 and the Control of
Goods Act of 1968. The development plans and the Acts enforced heavy industrial regulation
making incumbent firms enjoy protection from competition in the domestic market. Trade
policy was central in pursuant of this import-substitution strategy (Mulaga and Weiss, 1996).
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During this period, especially between 1973 and 1980, as shown in Table 1, the
manufacturing sector had an average growth rate of 12.65 percent, which is relatively the
highest growth rate when compared to the other periods in the table.2 It is observed that the
economy became more restrictive especially in the late 1970s, which is suggested to have
mainly been motivated by the government’s revenue needs to finance the budget. However,
this period is characterized by good financial discipline imposed on public sector enterprises,
good macroeconomic management leading economic growth and favourable balance of
payment (BOP) position. The growth rate in real GDP was relatively higher in the 1970s than
any other period in the post-independence era (Chirwa and Zakeyo, 2003).
2.2
Structural reforms period
The second regime is the reform period between 1981 and 1994 in which the Malawi
Government actively implemented SAPs under the auspices of the World Bank and the
International Monetary Fund (IMF). This was due to the worsening BOP position of the
country’s economy as a result of the oil crisis, acute deterioration of the terms of trade and
exacerbation of excess demand for imports originating from deficit financing of public
expenditure, and increased external transport costs due to the civil war in Mozambique,
which led to the influx of refugees into the country exacerbating the situation further. Partly
these developments led to the rise of both the current account and fiscal deficit in the
country’s economy.4
The adjustment programs were aimed at diversifying the economic base, ensuring appropriate
price and incomes policy, increasing efficiency, improving the policy environment for
manufacturing and trade, and restructuring of fiscal budgetary allocation and expenditure
(Chirwa and Zakeyo, 2003). It is argued that Malawi went through two phases of policy
reforms during this period. The first phase is the period between 1981 and 1986, in which
more emphasis was placed on domestic trade policy including fiscal and external
stabilisation, restructuring of major state-owned and private enterprises, periodic increases in
interest rates and agricultural output prices, limited liberalisation of prices and limited
liberalisation of entry into the manufacturing sector (see Ahsan et al. 1999; Mulaga and
Weiss, 1996). However, towards the end of this period the economy experienced
macroeconomic instability arising partly from increases in international transport costs due to
the intensification of the Mozambican civil war and the influx of refugees into the country.
These developments are believed to have increased the current account deficit to 13 percent
of GDP in 1986 from 7 percent in the previous year (Chirwa, 2003). During this period
(1981-1986) the manufacturing growth rate significantly declined to 2.6 percent, which is
much lower as compared to the import substitution and trade protectionist policy period
discussed earlier.i The second phase, during the same reform period was the one between
1987 and 1994, which was characterised by hesitant liberalisation of trade and tariff policies
manifested in high macroeconomic instability and poor sequencing of policies. Economic
policies during this period were more inclined towards liberalisation of international and
domestic trade. Trade orientation was more in favour of exports through an export promotion
strategy as stipulated in the Statement of Government Policies (1987-96). This was
accomplished through a continuous reduction in import tariffs as a result of the lowering of
trade taxes (Milner and Zgovu, 2003). During both the pre-reform and reform periods, trade
policy was central in the design and implementation of economic policies, with more
emphasis on the growth of the economy. In this period there was a concerted effort on
domestic economy liberalisation, especially with respect to agriculture and the financial
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sectors. In 1987, through the Agriculture (General Produce) Act, the marketing of
smallholder agricultural produce was liberalized allowing the participation of private traders
in domestic and export markets. This was followed by the liberalisation of prices for
agricultural produce with the exception of maize, cotton and tobacco. In 1990, the marketing
of agricultural inputs, that was being done by the Agricultural Development and Marketing
Corporation (ADMARC), was deregulated and the phased removal of fertiliser subsidies was
completed by 1991. It has been argued that reforms in the agricultural sector were
characterized by poor sequencing, with markets being liberalized before deregulation of
prices during the period (Chirwa, 2003). With regard to the financial sector, interest rates
were liberalised by 1988 and entry into the financial sector was liberalized in 1989, allowing
entry of new banks into the sector. These developments are believed to have had a significant
impact on the performance of the manufacturing sector since most of the industries were
agricultural based, as well as benefits to firms through an increased access to banking and
financial services after the liberalisation of the financial sector. Furthermore, entry into
manufacturing was also liberalised in 1991 after completion of the phased decontrol of
prices.5 However, Table 1 shows that the manufacturing sector experienced a significant
decline in performance as measured by growth in manufacturing output shown in Table 1
over the whole 1981-1993 period. The manufacturing sector grew by 2.9 percent on average
during this period, which is much lower when compared to manufacturing growth during the
first fifteen years after independence.
2.3
Open economy regime
The third policy regime is the post-reform period after 1994 in which the economy became
more open to domestic and international trade through tariff reductions under multilateral,
regional and bilateral trade agreements. This period is characterised by policy refinements
with more emphasis on removing the constraints and rigidities facing, especially, the
manufacturing sector. The government eliminated the authority to grant exclusive product
rights, revised the duty draw-back system and reduced the scope of industrial licensing
requirements to a short list of products during this period. Domestic policies continued to
focus on the liberalisation of the agricultural sector as the government removed restrictions
that prevented smallholder farmers from producing and marketing high value crops such as
burley tobacco in 1995. This was followed by the liberalisation of prices for all agricultural
crops except maize in 1996, the year in which the government also reduced the base surtax
rate from 25 percent to 20 percent. The government also continued the privatisation of state
owned enterprises through the National Privatisation Programme from 1996, despite its
suspension in 2001 due to lack of tangible benefits.
This period is also associated with the strengthening of regional integration and trade
openness within regional blocs, which included the introduction of manufacturing in the
Export Processing Zones (EPZ) schemes, and the signing of several bilateral, regional and
multilateral trade agreements especially those related to the Southern African Development
Community (SADC) free trade area and African Growth and Opportunity Act (AGOA).6
Also, since February 1994, Malawi adopted a managed float exchange rate regime, which led
to further devaluation of the exchange rate. The floatation of the exchange rate was designed
to improve the country’s export competitiveness, to provide an efficient foreign exchange
allocation mechanism and to dampen speculative attacks on the domestic currency which
were eminent and became predictable due to the frequent devaluations during the time. This
floatation was also designed to restore investor and donor confidence, since it became very
difficult for the country to do business with the rest of the world due to the low levels of
foreign exchange reserves at that time (Reserve Bank of Malawi, 2006).
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Figure 1: Price-cost margins and manufacturing output growth rate trends – 1967-2002
40
0.7
Manufacturing grow th rate
Price-cost margin
0.6
0.4
10
0.3
Growth rate %
0.5
20
0
19
6
19 7
1968
6
19 9
1970
7
19 1
1972
7
19 3
7
19 4
1975
7
19 6
1977
7
19 8
1979
8
19 0
1981
8
19 2
1983
8
19 4
1985
8
19 6
1987
8
19 8
1989
9
19 0
1991
9
19 2
9
19 3
1994
9
19 5
1996
9
19 7
1998
9
20 9
2000
01
Price-cost margin
30
-10
0.2
0.1
-20
0
Source: Calculations by the author and Reserve Bank of Malawi
However, despite all these policy initiatives, the manufacturing sector registered a further
significant decline in average manufacturing output growth rates during this period. Table 1
shows that the sector grew at the rate of -0.90 percent, indicating a further decline despite
further liberalisation of the economy which was mainly aimed at, among other things,
improving the performance of the manufacturing sector. To sum up, by looking at Figure 1, it
is observed that manufacturing performance measured by price-cost margins was relatively
higher during the import substitution period before dropping in the 1980s during the reforms,
before rising again in the 1990s, the period associated with a significant reduction in
manufacturing growth rates.
3.
REVIEW OF THE LITERATURE AND HYPOTHESES
3.1
Theoretical and empirical literature
Economic theory and industrial experience suggest that structural features of an industry
influence the competitive conduct of its constituent firms, the outcome of which has
important consequences on resource allocation. Scarce resources are allocated most
efficiently when the output of each industry is such that long-run selling price is equal to
long-run marginal cost of production (Beng and Yen, 2002). In a related theoretical
development, price theory has traditionally held that the degree of competition in a market is
related to the number and size distribution of competing firms. The smaller the number of
competitors and the more skewed their size distribution, implying increased market
concentration, the lower the probability that there will be aggressive competition (Adenikinju
and Chete, 2002). Usually active competition exists in situations where there is more efficient
allocation of resources, mostly due to the opening up of the domestic economy. Since the
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Cowling and Waterson’s (1976) seminar work, there has been a well-established rationale for
expecting industry price-cost margins to be positively related to the level of market
concentration. Theoretically trade liberalisation reduces monopolistic power and this
enhances efficiency due to the reallocation of resources, which stimulates competition hence
reducing prices and profits. It removes barriers to trade and altering of the incentive structure
in favour of tradable goods. However, it has been argued that this enhances competition
hence compel domestic firms to improve their production and management, and firms may
benefit from new imported technologies and knowledge transfer, hence increase competition
which may improve product quality and firm efficiency both of products and processes and
provide a positive impetus to firm profitability (Kambhampati and Patikh, 2003). Thus, there
is as yet, no consensus regarding the impact of reforms on the efficiency or performance of
firms. Therefore, in a small open economy like Malawi, a complete specification of the
structure-performance model would have to include the influence of changes in trade
policies, especially international trade on domestic profitability. To some extent Kaluwa and
Reid (1991) incorporated import and export extensity which captured to some extent the
impact of trade policies on manufacturing sector performance in Malawi. However, their
study covered the period 1969-1972, which is the period when the country practiced import
substitution and trade protectionist policies. In this study we employ an analysis period of
1967-2002 which spans through three different and distinct trade regimes, making it plausible
to assess to what extent the different regimes influenced the performance of the sector in
terms of profitability.
The protectionist as well as import substitution strategies are theoretically envisaged to
enhance inefficiency in production, as explained by the neo-classical theory which rejects
protection as a viable alternative on grounds of intra-industry effects due to imperfect
competition. Since barriers to entry and absence of foreign competition allow domestic
producers to acquire monopoly power and enjoy supernormal profits thereby failing to
achieve economic efficiency (Tybout et. al., 1991; Hossain et. al., 2004). The economic
transition effects from autarky (the closed economy characterized by protectionist and import
substitution policies) to the open economy is that exposure to trade induces an increase in
productivity levels and average profits per firm. This process is mostly associated with the
new trade theories which incorporate innovations like market imperfections, strategic
behaviour and the new industrial economics, new growth theory and political economy
arguments (see Jenkins (1995), Karunaratne and Bandara (2004) and Hossain et al. (2004).
The theoretical trade literature offers conflicting predictions about the evolution of
firm-level performance following the trade liberalisation episode, especially in cases where
imperfect competition and firm heterogeneity are taken into consideration. It has been argued
that trade has both enhanced the growth opportunities of some firms while simultaneously
contributing to the downfall and even exit of other firms in the same industry. On one hand,
trade openness exposes domestic producers to foreign competition, reduces the firms’ market
power, exploitation of economies of scale, delivers gains in productivity and efficiency,
which arise from specializing according to the principle of comparative advantage for the
global market, as a result firms expand output leading to reduction in average costs and
increase in profitability. The production for an enlarged global market generates increasing
returns to scale, market share reallocations and other dynamic benefits resulting in sizeable
cost reductions due to efficiency in production (Karunaratne, 2001; Pavcnik, 2002; Melitz,
2003). It is believed that domestic firms enlarge the stock of domestic knowledge as they
increase their interaction with foreign markets and it is also shown that exporting activities
have some learning externalities that decrease through time and increase with the level of
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exports (Melitz, 2003; De Hoyos et al., 2007). It has also been observed that, if foreign
markets are characterized by a higher degree of competition than domestic markets, then
exporters will be put under very competitive pressures than non-exporters, therefore,
increasing their incentives to innovate and be more efficient in order to survive. Hence
exporting firms would exhibit higher long term productivity and profitability growth than
non-exporters. However, on the other hand, gains from scale economies are not very likely in
developing countries like Malawi where increasing returns to scale are usually associated
with import-competing industries, whose output is likely to contract as a result of intensified
foreign competition, hence negatively affecting productivity levels (Tybout, 2001; Pavcnik,
2002). This has been supported by some empirical studies such as Jenkins (1995),
Karunaratne and Bandara (2004) and Hossain et al. (2004), where trade openness was found
to have led to an increase in technical inefficiency although theoretically a positive
relationship is expected.
In models involving heterogeneous firms, international trade is found to be a catalyst for
inter-firm resource reallocations within an industry, and how these reallocations affect
industry performance. Since protection is reported to shelter inefficient firms, these models
reveal that due to exposure to trade, firms that are less productive are forced to exit the
industry, and those that are more efficient and productive, self-select themselves into the
export market and become even more efficient as they get exposed to competitive pressure
from foreign firms (Tybout, 2001; Melitz, 2003). This is supported by the findings of the
study by Baldwin and Gu (2004), on the Canadian manufacturing sector, in which it is
revealed that as trade barriers fell during the period under consideration, more Canadian
plants entered the export market which led to higher productivity growth through increases in
plant specialisation, learning by exporting and exposure to international competition as firms
were able to exploit economies of scale and became more efficient in production. As
international trade leads to faster diffusion of technology, and hence higher productivity
growth, there are also the spillover effects due to ‘learning by doing’ gains and better
management practices triggered by the new technology leading the firms toward the best
practice technology (Krugman, 1987). To empirically assess the effects of the different
arguments postulated above, a number of market structure and trade related hypotheses have
been tested in explaining variations in price-cost margins in developing economies. These
hypotheses are outlined in the remainder of this section.
3.2
Price mark-ups, trade and market structure hypotheses.
The role of competition and market structure in firm and industry performance has been an
issue of considerable debate in both theoretical and empirical industrial economics, however,
there are no doubts that variations in market structure will lead to different performance
results in firms and industries. One of the most widely used indicators of market power in
economic literature is the Herfindahl-Hirschman Index (HHI) of concentration in domestic
production. According to oligopoly theory, the strength of mutual interdependence in price
and output behaviour among competing firms depends on the number and size distribution of
firms in a particular market. The higher the value of HHI, the higher the monopoly power,
and the greater the probability of successful collusion (either implicit or tacit) between firms
assuming a large share of industry output is produced by a few firms. Since the analysis in
this study is being done at firm level, HHI is emerging as a better measure of market
concentration compared to other measures such as the concentration ratio which only covers
a number of firms in a specific manufacturing sector, while HHI involves all the firms in an
industry.
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In addition to monopoly power, another dimension of market structure involves barriers to
new competition. This measures the difficulty of entering an industry due to the size of the
plant required for efficient operations in the industry. Theoretically, a number of issues have
been identified as the main sources of barriers to entry which include economies of large
scale, product differentiation and absolute capital requirements (Bain, 1951). Economies of
scale pose a significant source of entry barrier if the minimum efficient scale of new entrants
constitutes a substantial proportion of the industry sales, and the average cost of production
increases substantially below optimal scale. Entry at optimal scale would lead to excess
capacity and price war while production at below optimal scale results in high costs. Hence,
the larger the minimum efficient scale for an entrant relative to the industry output, the higher
the entry price. Profits and output performance can be expected to be positively related to the
level of scale economy.
Another component that could also act as barrier to entry is capital intensity, since a greater
percentage of capital is imported by developing countries like Malawi. The positive
relationship could exist if capital-intensive firms embody the most advanced technology.
However, in a developing country like Malawi where labour is the abundant factor of
production, capital intensity is expected to be negatively related to output hence profitability,
supporting the factor endowment theory (Kumar and Siddharthan, 1993; Chirwa, 2000). In
the traditional Heckscher-Ohlin-Samuelson model based on perfect competition assumptions,
it is argued that trade reflects the interaction between the characteristics of countries and their
technology. The proposition that emerges is that countries will export goods whose
production is intensive in the factors in which it is abundantly endowed. Capital intensity
could also be negatively related to performance if it captures the levels of sunk costs which
may create barriers to entry or exit. However, the differing technological characteristics of
each industry mean that each industry will operate with a different ratio of capital to labour.
This will affect both the rate of return on capital and the rate of return on labour.
With the Malawian development context input availability to the manufacturing process is of
paramount significance in determining the performance of the industry or firm as they
directly influence pricing behaviour. A principal contribution that Kaluwa and Reid (1991)
brings to the analysis in developing countries is the inclusion of both output demand and
input supply elasticities in the analysis. It has been argued that for a firm that is oligopolistic,
the responsiveness of variations in output to variations in factor prices depends on both
demand and supply of output and inputs respectively. Hence in a development context, factor
scarcities should generally not be ignored. For Malawi, the study cites the relevant input
scarcity variables like skilled labour, imported raw materials and working finance capital, to
have a significant impact on firm’s pricing behaviour. The other characteristic that is deemed
to have impact on profitability is the rate of growth of demand. In a growing market it is
easier to make profits than in a stagnating one. The demand is continually shifting to the
right, thus raising the equilibrium price, and it takes time for supply to increase through entry
of new firms or the expansion of capacity of existing firms, however, during that time higher
profits are made by existing firms in the industry. Holding other things equal, the growth of
industry sales exerts a positive influence on profit. Firms in industries having a rapid increase
in sales are less likely to feel competitive pressure than those in industries with stagnating
demand. It is argued that an industry with higher growth rate of demand will be under less
pressure from competition due to higher profits encored (Yoon, 2004). In capital intensive
oligopolistic industries, where overhead costs are high relative to total costs, excess capacity
resulting from declining demand tends to cause a breakdown in established price discipline,
leading to lower price-cost margins Beng and Yen, 2007).
10
In countries like Malawi, foreign producers pose the most immediate threat to entry and exert
a lot of influence on the pricing behaviour of domestic firms. To the extent that actual or
potential import competition keeps domestic firms from reaping monopoly profits. With low
tariff rates, imports from efficient producers abroad would enter the domestic market when
selling price substantially exceeds their transportation costs. It has been argued that under
reasonable assumptions, a foreign entrant faces lower overall entry barriers than a domestic
entrant, despite the additional tariff barriers imposed on foreign producers (assuming no
import quotas). As such, foreign producers may pose the most “immediate” or potential
threat to entry and exert the strongest influence on the pricing behaviour of established
domestic firms. To the extent that actual import competition keeps domestic firms from
reaping monopoly gains, leading to lower price-cost margins due to competition from
imports. Import intensity is negatively associated with the price-cost margins especially as a
result of both openness of the market and market share of imports which affect market
performance as imports promote competition within the domestic market. Imported goods
will naturally cause more severe competition in the domestic economy, hence negatively
affecting the price-cost margin, supporting the “imports-as-market-discipline” hypothesis
(Levinsohn, 1993). The hypothesis is also supported by Lopez and Lopez (2003) where
imports are found to have a negative impact on price-cost margins or a disciplining effect in
the US’s food processing industries in 1992. However, it is argued that an increase in imports
will lead to a decrease in price and demand for the domestic good. This decrease in demand
will lead to a decrease in the domestic quantity supplied. With the lower amount supplied,
there is a countervailing positive effect on price and a decline in marginal costs if there are
diseconomies of scale, both of which exert pressure to increase price-cost margins (see Lopez
and Lopez 2003).
The existence of a competitive export market tends to compel monopolists (oligopolists) to
be more competitive in pricing. A monopolist selling only in a protected domestic market
will be able to set the selling price above the international price levels, however, when export
opportunities exist, and if he cannot discriminate between domestic and foreign markets due
to trade liberalisation, the monopolist becomes a price-taker in both domestic and world
markets. In such cases price-maximisation will lead to the expansion of domestic production,
hence exports resulting in the reduction of domestic prices to international levels. It is also
argued that oligopolistic sellers tend to encounter greater difficulty in achieving tacit
collusion with foreign sellers than with their local counterparts, largely because of
differences in market environment and problems of communication. Consequently they are
forced to adopt competitive pricing strategies when selling in international markets (Yoon,
2004). Exports are expected to be negatively related to the price-cost margin or performance
due to either price discrimination between domestic and foreign markets or better capacity
utilisation (Lopez and Lopez, 2003).
Tariff rate is employed as a policy variable to capture the level of openness or height of entry
barriers faced by foreign competitors and the level of protection to local industries or the
level of competitiveness the local industries are confronted with in the changing market
environment. Tariff rate together with the dummy variables would help to answer the
question of whether liberalisation enhances the competitive atmosphere of the manufacturing
sector and hence affect price-cost margins. Reduction in tariff is expected to reduce
protection and expose the local firms to competition hence reduction in output and profits.
However, a positive relationship between tariff rates and performance could exist especially
if tariff reduction led to the importation of relevant technologies that lead to improvements in
efficiency and output hence an increase in price-cost mark-ups.
11
4.
METHODOLOGY AND DATA
To analyse the influence of market structure, and changes in trade policies on economic
performance, we adopt the widely accepted theoretical approach to structure–performance
modelling which follows the general classes of oligopolistic models as suggested by Kaluwa
and Reid (1991), Smirlock (1985), Lloyd-Williams et al. (1994) in which an industry-level
equation of the following form is suggested:
y  f MC,  X ,  B, e, p …….(1); where
where y is the price-cost margin capturing the firms’ performance (see Domowitz et al.
(1986)); MC is a measure of market concentration, e is the industry elasticity of demand;
while  and  are conjectural elasticities with respect to incumbent firms and potential
entrants respectively. X is a vector of factors determining conjectures amongst incumbent
firms such as input factor scarcities (e.g. the availability of raw materials, skilled labour
force, working finance capital and levels of technology) as they influence how firms behave
towards each other in maintaining their competitiveness on the market. B is a vector of
variables which determine the conjectures made by incumbents about potential entrants
categorised as barriers to new entry or competition. These include variables such as scale
economies, and cost disadvantage ratio (CDR), while p represents the policy variables. Note
that due to unavailability of data and insignificant number of firms to come up with a good
measure, variables such as those capturing the effect of advertising and the CDR
respectively, were not included in the analysis. Therefore, based on equation (1),
MC  f (hhi, exp, imp) ;  ( X )  f (rms, skill , fink ) ;  ( B)  f (klr, mes) , e  f (dem) and
tariff as a policy variable. Following Kaluwa and Reid (1991) model framework, the
following extended econometric model specification is formulated:
yit   0   1 hhiit   2 imp kt   3 exp kt   4 rmtrsit   5 skill it   6 fink it
  7 klit   8 meskt   9 demandit   10tariff t   11 DU mt   it
…(2)
where the subscripts, i and t , indicate the observation for the i -th firm and i  1,2,..., N
where N is the number of firms in year t , where t is corresponding to the period between
1967-20027, while k identifies the industry level variable. y is captured by the price-cost
margin, hhiit is a measure of market concentration or monopoly power, meskt is a measure
of scale economies, klit is the capital-labour ratio capturing capital intensity, skill it is a
measure of skilled labour, rmtrs are the raw materials as a measure of barriers to entry,
dem is the growth of demand, exp kt is export intensity, impkt is the import intensity or
competition, fink it is a proxy for working finance capital, DU mt are dummy variables
representing the different economic policy regimes the country is envisaged to have gone
through since independence in 1964, to be identified by structural breaks during analysis,
while  it is an error.
DU mt is the dummy variable where DU mt  1 for t  Tbm and 0 otherwise, for m = the
number of structural breaks over the period 1967-2002. Tbm s’ are break points to be located
by grid-search following Baum (2001). The breaks are expected to capture the effects of the
policy processes described in the three identified period in Section 2. To control for the
changes in the general economic policy environment, many studies have used dummy
variables to capture the effects of the different economic policy changes. However, it is
12
possible to experience lags between the date a policy is announced and the date of actual
implementation of the policy, as well as the adjustment by firms in terms of changing their
prices, costs, investment options etc. Because of these set backs, in this paper we try to
control for these lags by carrying out tests for structural breaks despite having the knowledge
of when the policies were put in place in the country. This will let the data reveal the time
when these policy prescriptions had effects on the manufacturing sector’s performance.
The study uses firm level panel data obtained from the questionnaire responses administered
by Malawi’s NSO annually under the census of industrial production survey. This survey
covers both large and medium scale profit making establishments over the period 1967-2002.
Gross manufacturing output is deflated by the GDP deflator and, capital stock for each firm is
estimated by the conventional perpetual inventory method and has taken into account the
book value of all fixed capital assets composed of land, buildings, other constructions and
land improvements, machinery and other equipment, transport equipment, gross additions
and depreciation (except for land) during the year. The data set is comprised of a total of 141
firms covering the 14 four digit ISIC industries. The data relate to the period 1967-2002 and
summary statistics describing the data are presented in Table 2 below. Capital was deflated
by the price of capital which was approximated by the price of imports into the country, since
a greater percentage of capital into the sector is imported. Export intensity and import
intensity are measured at industry level because of the scarcity of data at firm level. The firm
level data on imports and exports was very scanty and made it difficult to be used for the
analysis, hence we used import and export data from the various publications of the Annual
Statement of External Trade for various years from NSO. The data from these publications
was categorized and linked to the three-digit ISIC classification used by NSO based on the
Foreign Trade Classification - Malawi (1984), which establishes the relationship between the
International Standard Industrial Classification (ISIC), Standard International Trade
Classification (SITC) and HS codes or the Customs Co-operation Council Nomenclature
(C.C.C.N.).
Table 2: Summary Statistics
Variable
Obs
Mean
Std. Dev.
Min
Max
pcm
2672 -6457.17
169357 -5331050
1.00
hhi
2686
0.0928
0.1979
-0.005
1.36
imp
2695
0.5389
1.3393
0.00
18.10
exp
2695
0.1237
0.4597
0.00
7.80
Rmtrs
2676 609173.3
5839267 -9181537
135000000
Skill
2665 15901.34
42528.37
0.00
514285.7
fink
2671
34.9873
490.02
0.00
18954.03
Mes
2695
35.57
19.95
3.01
100.00
klr
2674
125.86
1242.68
0.00
53462.76
dem
2523 5997235 301000000
-100.00 15100000000
tariff
2695
79.18
51.49
20.57
188.23
Source: Malawi National Statistics Office and the Reserve Bank of Malawi
Considering the relationship that exists between price-cost margins, trade related variables,
market structure and performance variables, it is worthy examining the correlation between
evolution of these variables. Table 3 reports the corresponding simple correlation
coefficients. The correlation results show that in terms of variables capturing the level of
market concentration, there is a positive correlation between price-cost margin and the
13
concentration ratio (hhi), while having a negative correlation with export and import
intensity. In terms of factors determining conjectures amongst incumbent firms, the
correlation results show that there is a negative correlation between price-cost margins (pcm)
and raw materials (rmtrs), however there is a relatively high correlation between raw
materials and concentration ratio, which could be indicating the level of input factor
scarcities since a greater percentage of raw materials is imported. The results also show a
positive correlation of 0.17 between price-cost margin and the capital-labour ratio (klr) which
to some extent measures the skill level in relation to capita utilisation. Growth of demand
(dem) and scales economies (mes) show a positive correlation with price-cost margins while
tariff exhibits a negative correlation. It is also important to note the relatively higher and
positive correlation that exists between market concentration and raw materials, between
import intensity and minimum efficient scale, and between working finance capital and
capital-labour ratio.
Table 3: Correlation coefficients for performance, trade and market structure variables
pcm
Hhi
Imp
Exp
Rmtrs
Skill
Fink
mes
Klr
Dem
Tariff
hhi
imp
exp
rmtrs
skill
fink
mes
klr
0.1244
-0.0311 0.3167
-0.0372 -0.0189 -0.2196
-0.1992 0.5796 0.0254 0.0853
0.0554 0.0773 0.2374 -0.1419 0.0977
0.0062 0.2277 0.2386 -0.1830 0.1524 -0.1642
-0.0865 0.1371 0.4657 0.3608 0.1512 0.3355 0.3603
0.1732 0.3319 0.1214 -0.1828 0.2953 0.3401 0.5905 0.1930
0.0120 0.1172 0.0571 0.0252 0.0515 -0.0494 -0.0273 -0.0112 0.0175
-0.0205 0.0092 -0.0882 -0.1588 0.1492 0.1087 0.0520 0.0147 0.1716
Source: Malawi National Statistics Office and the Reserve Bank of Malawi
5.
dem
-0.1122
EMPIRICAL RESULTS
Table 4 presents panel regression results on the factors affecting Malawi’s manufacturing
sector performance which is captured by the price-cost margins. As indicated in the
methodology section, before carrying out the regression analysis we first, following Baum
(2001), carried out the Clemente-Montañés-Reyes unit-root test with double price-cost
margin’s mean shifts, in order to establish the time when the sector experienced structural
breaks in its performance. These breaks could be attributed to the effects of the different
policy prescriptions under the different policy regimes, outlined in Section 2, could have had
on the manufacturing sector’s performance. Appendix Figure 1 presents the results of these
tests and they show that Malawi’s manufacturing sector performance experienced significant
structural breaks in the years 1982 and 1991. From the Figure it is not surprising to note that
the most significant structural breaks occurred during these periods. The break in 1982 could
be related to the long-run effect of the economic instability before the country adopted the
structural adjustment programme strategies initiated since 1981 by the Malawi Government.
This was significantly due to the worsening BOPs position of the country’s economy as a
result of the global oil crisis, acute deterioration of the terms of trade and exacerbation of
excess demand for imports originating from deficit financing of public expenditure, and
increased external transport costs due to the civil war in Mozambique, which led to the influx
14
of refugees into the country exacerbating the situation further. Partly these developments led
to the rise of both the current account and fiscal deficit.ii The structural break identified in
1991 could have been due to the accumulation and continued effects of these SAPs strategies,
in particular, Malawi being an agricultural based economy, this could have been due to the
concerted effort on domestic economy liberalisation especially with respect to the
liberalisation of the agricultural and the financial sectors in the late 80s and early 90s. This
encompassed the liberalisation of the marketing of smallholder agricultural produce in 1987,
the liberalisation of prices for agricultural produce and marketing of agricultural inputs, and
also the deregulation and the phased removal of fertiliser subsidy which was completed by
1991. With reference to the financial sector, interest rates and entry into the financial sector
were liberalised by 1988 and 1989 respectively (Chirwa, 2003; Chirwa and Mlachila 2004).
It is also important to note that the government was implementing these financial reforms
amidst a very unstable macroeconomic environment characterised by high rate of inflation
largely due to structural rigidities within the economy and devaluation of the currency, large
budget deficits, increased borrowing from the banking sector and BOPs instability (Chirwa,
1999). These developments are believed to have had a significant impact on the performance
of the manufacturing sector since most of the industries were agricultural based, as well as
through increased access to banking and financial services due to the liberalisation of the
financial sector. Furthermore, entry into manufacturing was also liberalised in 1991 after
completion of the phased decontrol of prices.5 These policy strategies could have had a
significant contribution to the economy’s structural break identified in 1991.
Among the results in Table 4, Model 1 is based on the total sample observations 1967-2002,
Model 2 is based on a subsample representing the import substitution/protectionist period
(1967-1982), while Model 3 is based on the sub-sample representing the period of structural
reforms (1983-1991), and Model 4 represents the post-liberalisation period (1992-2002).
Despite the historical trade regimes stipulated in Section 2, these analysis periods are based
on the results of the analysis above which led to the identification of the two distinct
structural breaks in the manufacturing sector performance over the period under
consideration. The Hausman test was used for the choice of the models and suitability of the
random effects over the fixed effects model in all the models reported in Table 4. In all the
four models the Hausman test led to the rejection of the null hypothesis favouring the fixed
effects models as the random effects models were rejected except in Model 4. However, the
diagnostic test results for Model 1 and 3 revealed the presence of first order autocorrelation
(AR(1)) since we reject the hypothesis of the absence of first order autocorrelation in the
models using the Wooldridge test, and also the cross-sectional data revealed the presence of
panel heteroscedasticity using the Wald test. This led to the use of the Feasible Generalised
Least Squares (FGLS) to estimate both models 1 and 3. The FGLS allows estimation in the
presence of AR(1) autocorrelation within panels, and cross-sectional correlation and
heteroskedasticity across panels to obtain consistent and efficient estimates. FGLS is deemed
an efficient estimation method if time period (T) is greater than the cross-sectional units (N),
which is the case in these Models as the data covers longer periods (Beck and Katy, 1995).
However, models 2 and 4 revealed the presence of groupwise heteroscedasticity without the
presence of first order autocorrelation, hence prompting the use of the statistical software
STATA’s Robust command to obtain robust estimates.
15
Table 4: Panel Data Regression Estimates of the Structure and characteristics on
Performance in Malawi’s Manufacturing Sector
Variables
Hhi
Imp
Exp
Rmtrs
Skill
fink
Mes
Klr
Dem
Tariff
Dummy83-91
Dummy92-2002
Intercept
Hausman test
Wooldridge test
(AR1)
Wald test
Breusch & Pagan LM
test
Observations
Groups
Model 1
1967-2002
FGLS
0.128***
(0.000)
-0.044***
(0.000)
-0.006
(0.528)
-0.225***
(0.000)
-0.031*
(0.065)
-0.073***
(0.001)
-0.013
(0.748)
0.129***
(0.000)
-0.008
(0.566)
0.008
(0.835)
-0.005
(0.927)
0.154**
(0.031)
1.727***
(0.000)
47.09***
(0.0000)
6.729**
(0.0109
1.3e+05***
(0.000)
-
Model 2
1967-1982
FE(Robust)
0.175***
(0.000)
-0.330***
(0.000)
-0.064***
(0.006)
-0.488***
(0.000)
0.038
(0.565)
-0.096*
(0.106)
0.090
(0.525)
0.081*
(0.100)
-0.008
(0.750)
0.058
(0.314)
Model 3
1983-1991
FGLS
0.091***
(0.000)
0.014
(0.425)
0.025
(0.174)
-0.186***
(0.000)
0.019
(0.644)
-0.165***
(0.001)
0.090
(0.362)
0.255***
(0.000)
-0.013
(0.650)
-0.074
(0.401)
Model 4
1992-2002
RE (Robust)
0.157***
(0.000)
-0.086**
(0.021)
-0.055**
(0.019)
-0.241***
(0.000)
-0.081**
(0.015)
-0.062
(0.226)
0.274**
(0.017)
0.084**
(0.029)
0.0001
(0.997)
-0.198
(0.144)
2.958***
(0.000)
27.19***
(0.0000)
0.652
(0.4223)
1.6e+05***
(0.000)
-
0.924
(0.183)
50.19***
(0.0000)
3.423*
(0.0693)
1.5e+05***
(0.0000)
-
2.234**
(0.047)
15.34
(0.1202)
17.230***
(0.0001)
-
1583
132
678
88
442
88
109.46***
(0.0000)
463
94
Notes: The values in parentheses are p-values and the coefficients with *** denote level of significance at 1%
level; ** denote significance at 5% level; and * denoting significance at 10% level.
The models in Table 4 present regression results of performance measured by the price-costmargin on variables in Equation (2). The results show that the variables related to the role
market concentration plays in influencing price-cost mark-ups, hhi , is positively associated
with performance, with the coefficient of the variable being statistically significant at below 1
16
percent level in all the four models. This is in support of the relationship exhibited by the
correlation coefficient between these variables in Table 3, and it also renders support to
Bain’s (1951) hypothesis, arguing that there exists a positive correlation between market
concentration and performance measured by the price-cost margin. However, the result is in
contrast to the findings of Kaluwa and Reid (1991), where the concentration variable was
found to be insignificant and with the wrong sign, which could be suggested to be because of
the period under consideration in their study (1969-1972), which is much shorter as
compared to the period in this study. Also, the period considered by Kaluwa and Reid (1996)
was characterised by entry restrictions to the manufacturing sector and price controls on
certain lines of products where planned price increases had to be notified to the Ministry of
Trade and Industry for approval, which would only be justified by exogenous cost increases
(Kaluwa, 1986), hence the insignificant impact in their results.
Import intensity is found to be negative and highly significant at conventional levels of
significance in the overall model (Model 1), import substitution period (Model 2) and in the
post-liberalisation period (Model 4), revealing that an increase in imports led to a reduction
in price-cost margins of the domestic firms, which is in line with the findings of Kaluwa nd
Reid (1991). The results are consistent with the imports-as-market-discipline hypothesis,
since under the pressure of imports, it is expected that price-cost margins would decrease
especially for the firms that have market power (Lopez and Lopez, 2003; Culha and Yalcin,
2005). However, there is a relatively significant reduction on the impact of import intensity
on price-cost margins in the post liberalisation period as compared to that in Model 2 (the
import substitution period), which could imply some improvements in the performance of the
sector as the costs of production were significantly reduced. Another conjecture is that
domestic firms may not be able to compete with better quality and sometimes cheaper foreign
goods and may therefore experience reduction in price-cost margins as they reduce prices in
order to remain competitive. As we pass from the import substitution industrialisation period
to the post-liberalisation period, the significant change in the size of the coefficient of the
import intensity variable shows that imports had a relatively significant impact on price-cost
margins during the import substitution period.
Export intensity appears with the correct sign, with its increase leading to the lowering of
price-cost margins in models 1, 2 and 4, however, it is significant at conventional levels of
significance only in Models 2 and 4 supporting the findings by Kaluwa and Reid (1991). The
negative sign for the coefficients is consistent with the findings of House (1973), Lopez and
Lopez (2003) and Culha and Yalcin (2005), accounting for the fact that, as firms become
more export oriented, they are in a better position to exploit economies of scale and operate
on smaller price-cost margins. This could also be suggesting that Malawian firms to a greater
extent adopted competitive pricing strategies existing on the international market hence
negatively affecting their price-cost margins. Meaning that Malawian exports have not been
competitive enough to have significant control or influence over prices on the international
market, especially in the post-liberalisation period.
Among the variables that relate to the scarcity of factor inputs which include raw materials,
that skilled labour and finance capital, raw materials are found to have a negative and highly
significant influence on price-cost margins at below 1 percent level of significance
throughout the 4 models estimated, while having a relatively greater influence on price-cost
margins during the import substitution period (Model 1). This negative impact could be
attributed to the scarcity of raw material inputs most of which are imported hence leading to
higher production costs (Kaluwa, 1986). Skilled labour captured by average earnings is found
17
to be positively related to price-cost margins in Models 2 and 3 but statistically insignificant
at conventional levels, however it is found to be negative but highly significant at 5 percent
level in the post-liberalisation period. This could be suggesting that there might have been a
lot of labour movement due to liberalisation hence leading to a reduction on wages and
easing the pressure on price-cost margins for the manufacturing sector in the country. The
other variable which is a proxy for the availability of working finance, is found to have a
negative and significant influence on price-cost margins at conventional levels of
significance in all the models except in the post-liberalisation period (Model 4). The findings
are in contrast to Kaluwa and Reid (199), as they found working capital to have a positive
and significant impact. This could imply the effect of the competitive financial market
especially during the liberalisation period (Model 3), where the financial sector and lending
rates were liberalised, hence enhancing the availability of working finance leading to a
reduction in price-cost margins.
With regard to the variables representing the barriers to entry, the minimum efficient scale
variable, mes , is positive and statistically significant at 5 percent level in Model 4. This
means that, on average, economies of scale constituted a significant source of entry barriers
to new entrants especially in the post-liberalisation period. To a greater extent this could
imply that firms enjoyed economies of scale due to the opening up of the economy as a result
of liberalisation. The coefficient of capital-labour ratio (taken as a measure of firms’
technological levels), which is a scarce resource in many manufacturing firms in the country,
is found to be positive and statistically significant at conventional levels across all the
models. The same result was obtained when the capital-labour ratio was replaced with the
variable used in Kaluwa and Reid (1991), the capital-sales ratio, as a measure of capital
intensity. This result is not in support of the results in Kaluwa and Reid (1991) and Chirwa
(2004), where their results are against the factor endowment theory, where capital intensity is
found to be an insignificant determinant of price-cost margins. However, in our findings, the
size of the coefficient of the capital intensity variable is relatively higher during the structural
reforms period with regard to its impact on price-cost margins. Since most of the capital
goods are imported, liberalisation of the economy especially through devaluation of the
exchange rate, led to an increase in the cost of imported capital goods for domestic firms,
hence leading to an increase in the price-cost margins. To some extent this could also be
supporting the notion that capital intensive firms embody the most advanced technology, and
due to liberalisation of the economy the flow of technology and knowledge is enhanced,
especially in Malawian firms as they would have been starved of technological flow to the
country due to the protectionist regime that preceded the liberalisation of the economy. It
could also be argued and suggested that due to the scarcity of skilled labour force in countries
like Malawi, increase in labour absorption takes place much slower than the expansion of
capital accumulation, hence leading to an increase in capital-labour ratio intensity, leading to
an increase in price-cost margins.
The proxy for the rate of demand in all the models’ results appear with the expected sign only
during the post liberalisation period, but insignificant at conventional levels across the
models. Hence, growth in demand does not seem to play a critical role in enforcing price-cost
margins during the period understudy. The only policy variable included in the analysis is
tariff rate. In the total sample model, tariff rates have a positive but insignificant impact on
price-cost margins while it has a negative but also insignificant impact across the rest of the
models, signifying the minimal influence of tariff rates on price-cost margins in the sector.
18
The dummy variables capturing the impact of the revealed structural breaks in the sector’s
performance and representing the effects of the different policy initiatives undertaken by the
Malawi Government during the identifies periods in Model 1 (dummy83-91, dummy92-2002)
are found to have a negative and insignificant impact on price-cost margins over the period
after 1982. However, the structural break after 1991 (Dummy92-2002) is found to have a
highly significant positive impact on price-cost margins, at below 5 percent level of
significance.
Comparing the models 1 with dummy variable capturing the effect of the structural breaks
after 1982 to Model 3, without the dummy variable (since to some extent they are capturing
the effect of policy initiatives based on almost the same period of analysis), the results show
that if the dummy variables are not included, the structure-performance model may result into
biased coefficients of the variables. It is observed that the coefficient of market concentration
and raw materials increase from 0.09and 0.19 in Model 3 which is without the dummy
variable, to 0.13 and 0.23 respectively when the dummy is included (i.e. in Model 1).
Similarly the coefficients of working finance and capital-labour ration decrease from 0.17
and 0.26 respectively in Model 3 to 0.07 and 0.13 respectively when the dumy variable is
included (in Model 1). However, the inclusion of the dummy variable leads import intensity
and skilled labour from being insignificant without the dummy variable (in Model 3), but
becomes highly significant when the dummy is included with a value of 0,04 and -0.03
respectively.
Since the structural break captured by Dummy93-2002 is associated with the period captured
by Model 4, the effect of the policy strategies during this period captured by the dummy
variable, led to the reduction in the size of the coefficients of the market concentration
measure, import intensity, raw materials and skilled labour from 0.16, 0.09, 0.24 and 0.08 in
Model 4 (without the dummy) respectively, to 0.13, 0.04, 0.23 and 0.03 in Model 1
respectively. However, the inclusion of the dummy variable led to an increase in size of the
coefficient for capital-labour ratio from 0.08 in Model 4 to 0.13 in Model 1, as well as
rendering export intensity and economies of scale measure insignificant. To some extent
could be suggesting that some of the policy strategies implemented during the said period
rendered the sector’s exports uncompetitive on the world markets, hence having no impact on
domestic prices. While making financing capital significant in Model 1, despite Chirwa and
Mlachila (2004) arguing that despite liberalisation of the financial sector, banks continued
using their monopoly power in determining interest rates making them les favourable for the
depositiors and borrowers. Form the results in Model 2 it is worth noting that the size of the
coefficients for market concentration, import and export intensity, and raw materials were
relatively larger compared to the size of these variables’ coefficients in the other models in
Table 4. Suggesting that during this period in which trade protectionist and import
substitution strategies were practiced, these variables had a relatively higher significant
influence on price-cost margins.
6. CONCLUSIONS
The paper has tried to assess the relationship between trade policy changes, market structure
and manufacturing sector performance in Malawi using firm level panel data. We have
observed that policy changes and strategies led to two significant structural breaks in the
manufacturing sector performance in 1982 and 1991, mainly attributed to the country’s
economic crisis in the late 1970s and early 1980s, and due to the accumulation and continued
19
effects of the SAPs strategies, in particular, the liberalisation of the agricultural and the
financial sectors in the late 80s and early 90s respectively. Based on the econometric
analysis we can assert with some confidence that price-cost margin increases with the degree
of market concentration in an industry. In particular, it has demonstrated the relevance of
industrial organisation as a tool for analysing problems associated with performance in
Malawi’s manufacturing sector. The results lend support to the hypothesis that firms in a
market protected from competitive pressures by high entry barriers exploit this position and
earn an excessive rate of return on capital. One possible explanation is that x-efficiency that
arises from the inefficient use of resources failed to outweigh the effect on profits of the
excess prices charged in the monopolistic firms. We find barriers to entry created by
economies of scale to be in support of this understanding especially in the post-liberalisation
period while they are negative in the pre-liberalisation period.
Imports and exports are found to have a negative and significant impact on the firms’
performance in line with economic theory especially during the import
substitution/protectionist and post-liberalisation periods. Despite showing this negative
impact, the dummy variable capturing the economic liberalisation after 1994 is found to have
a positive and significant impact on the price-cost margin, signifying some positive
improvements on the price-cost margins. This could imply that opening up the economy led
to improvements in the performance of the manufacturing sector as the firms became more
efficient as they faced more competitive pressures. Firms were able to import capital goods
and the latest technology hence increase efficiency as signified by the impact of capitalintensity, and also liberalisation increased firms access to wider markets hence taking
advantage of the economies of scale to reduce costs.
My analysis has some implications on policy aimed at creating a competitive industrial
environment and maximising the firm’s profits. The study has identified key structural
variables that could lead to an improvement in the sector’s performance if taken into
consideration by policy makers. International trade has considerable impact on domestic
profitability looking at the effects of import and export intensity. Import intensity led to
reduction price-cost margins due especially to competitive pressures from better quality and
sometimes cheaper foreign goods due to liberalisation, leading to reduction in price-cost
margins as firms reduce prices in order to remain competitive. Export intensity results have
indicated that Malawian exports have not been competitive enough to have significant control
or influence over prices on the international market, especially in the post-liberalisation
period, leading to reductions in profitability. Policies aimed at enhancing export performance
(in high quality products) in the country could be the most effective policy measures to
promote more competitive market conduct. Import discipline is crucial in small domestic
markets like the one in Malawi where concentration seems inevitable if excess capacity is to
be avoided. Emphasis should be placed on technological transfer through importation of
emerging technologies, the associated knowledge and expertise which could enhance
technological innovation and hence lead to the production of high quality commodities that
could be competitive hence raise profits for domestic firms on the global market. This should
be accompanied by putting in place tax measures aimed at enhancing the performance of the
sector especially with regard to technological imports. The effectiveness of imported
technologies and the associate knowledge and skills will depend on Malawi’s existing
technological capacity to acquire, assimilate and utilise these technologies. This calls for
emphasis on the development of science, technology and innovation skills in the country’s
education system. As stipulated in Kaluwa and Reid (1991), availability of factor inputs play
a significant role in determining a firms profitability in Malawi. This calls for deliberate
20
efforts by the government enhance the availability of factor inputs such as raw materials for
manufacturing, skilled labour and financing capital for businesses, as well as increasing
access to loanable funds for start-ups, choice and enhancing access to appropriate
technologies. More emphasis could also be placed on mechanisms to reduce scale barriers to
entry in order to enhance entry and competition in the different industries within the
manufacturing sector, with greater emphasis on export promotion which would accelerate
growth and also improve efficiency in the manufacturing sector.
Notes
1.
2.
3.
4.
5.
6.
7.
8.
9.
See Mulaga and Weiss (1996), Chirwa (2003) and World Bank (1989) for more
details on Malawi’s trade policies.
The growth rate is calculated for the period 1973-80 due to the unavailability of data
for the other years before 1973. However, Chirwa (2003) reports a manufacturing
value-added growth rate of 6.7 percent over the same period.
See Njolwa (1982); World Bank (1989); Mulaga and Weiss (1996); Ahsan et al.
(1999).
See Ahsan et al. (1999) for a detailed analysis on this issue.
See Chirwa and Zakeyo (2003).
See Chirwa and Zakeyo (2003) for more details.
Note that there were 141 firms in total involved in an unbalanced panel as some of the
firms could not make it into the NSO Annual Economic Survey sample due to poor
performance and some gained entry to the sample as their performance improved over
the years under consideration.
See Chirwa (2004) for more details.
Darwin empasised the process of entry and exit of firms as they get more exposed to
international trade
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APPENDIX:
Appendix Figure 1: Clemente-Montañés-Reyes unit-root test with double price-cost
margin’s mean shifts, AO model
Clemente-Montañés-Reyes double AO test for unit root
-2.5
-2
lpcm
-1.5
-1
-.5
Test on lpcm: breaks at 1982,1991
1970
1980
1990
2000
1990
2000
Year
.5
0
-1 -.5
D.lpcm
1
1.5
D.lpcm
1970
1980
Year
Optimal breakpoints :
1982 ,
1991
AR( 1)
du1
du2
Coefficients:
-0.27724
0.40382
t-statistics:
-2.198
2.968
P-values:
0.036
0.006
Note: lpcm is the log of the price-cost margin
24
(rho - 1)
const
-1.07667
-0.85374
-5.512
-5.490 (5% crit. value)
Appendix Table 1: Variable Definitions
Variables Description
pcm
Price-cost
margin
hhi
HerfindahlHirschman
Index (HHI)
Definitions
The ratio of the difference between value added
and payroll to total sales.
The measure of concentration in domestic
production measured at the four digit international
standard industrial classification (ISIC) level.
imp
value of imports to total industry sales ratio
exp
skill
klr
ii
value of exports to total industry sales ratio
mes
Minimum
efficient
scale
Average earnings
Obtained by dividing capital by labour. Labour
refers to the number of persons engaged in each
firm, which includes the workers directly involved
in the production process.
Average employment of firms accounting for 50%
of total industry employment as a percentage of
total industry employment
fink
Working
finance
capital
Product of the estimated minimum efficient scale
and the ratio of capital (net book value of fixed
assets) to industry output.
rmtrs
Raw
materials
Demand
Import tariff
rate
Total cost of raw materials deflated by the GDP
deflator.
Percentage change in sales
Calculated by dividing total import duties by the
volume of imports
dem
tariff
i
Import
intensity
Export
intensity
Skill level
Capitallabour ratio
The growth rate during the period is based on the author’s calculation.
See Ahsan et. al (1999) for a detailed analysis on this issue.
25