ENGINEERING FOR DEVELOPMENT

(First Draft)

E J Jefferies

March 1969

CONTENTS

PART 1 THE WORLD DEVELOPMENT PROGRAMME

Chapter 1 Introduction
Chapter 2 Closing the Gap
Chapter 3 Resistance to Change
Chapter 4 International Technical Assistance

PART II AN ENGINEERING APPROACH TO A PLAN FOR A COUNTRY

Chapter 5 Outline of the Approach
Chapter 6 Setting the Problem
Chapter 7 Basic, Concepts, Terms and Definitions
Chapter 8 Background Data Available
Chapter 9 The Starting Point for a Case Study
Chapter 10 Preliminary Calculations
Chapter 11 Patterns of Economic Growth
Chapter 12 Development Plan for Year 1
Chapter 13 Development Plan for Year 2
Chapter 14 Development Plan for Year 3
Chapter 15 Review of Changes During the Three Years
Chapter 16 The Control of Development
Chapter 17 Financing the Development

PART III THE IMPLICATIONS OF RAPID GROWTH

Chapter 18 Economic Growth and Technological Changes in Rural Communities
Chapter 19 The Influence of Agriculture on Industrial Development
Chapter 20 The Role of Manufacturing Industry
Chapter 21 The Contribution of Industrial Engineering to a Solution

PART IV DESIGNING FOR BALANCE IN DEVELOPMENT

Chapter 22 The Prediction of New Manufacturing Capacity Requirements by Product Group
Chapter 23 The Productivity of Labour
Chapter 24 The Growth of Productivity
Chapter 25 The Calculation of Appropriate Levels of Productivity in New Plants

CHAPTER 17

FINANCING THE DEVELOPMENT

Capital

Capital resources are an essential ingredient of any form of economic activity. Before a manufacturing operation can begin to generate an income from sales, it is necessary to acquire buildings, equipment and raw materials and to pay for a certain amount of labour. The decision to produce goods for consumption in the future depends on the diversion of some of today’s spending power into additional productive resources.

Capital formation arises from existing economic activities in the form of profits and deferred consumption.

In industrialised countries, capital formation is relatively high, commonly around 20% of national income. In countries in an early stage of development it tends to be low since nearly all productive effort goes into providing essential immediate consumption - food, clothing and shelter. In a country with a per capita GDP of US $2000, capital formation may amount to 20% or US $400 a head a year. But a country with a per capita GDP of US $200 rarely achieves more than 10% capital formation or US $20 a head a year, i.e. a twentieth of the absolute value achieved by the more advanced country. So it is very important in the early stages of development to put every penny of saving to work and to make it give its maximum return in new production. Equally it is important to make as much money as possible available for reinvestment. Since deferment of personal consumption is more difficult where standards of living are low, the major internal source of this money in an underdeveloped country is from profits ploughed back into business, or paid to government in taxes, and operation of businesses at an adequate profit margin is very important.

The low levels of capital formation reported by developing countries may give an unduly pessimistic picture both of actual and potential amounts available. To begin with, much economic activity is carried on in a very informal way. Money spent on wages and supplies used in actually making things is not separated, due to lack of adequate accounting systems, from time and materials used for making and installing equipment and tools, which are really capital goods. Secondly, due to underdevelopment of banking systems, much of the surplus income of households remains hoarded and hidden, either as cash or as readily saleable goods not subject to depreciation, particularly gold, jewellery and gems. Alternatively, these surpluses are spent on impermanent luxury and prestige goods, usually imported, of little immediate use to the buyer and little resale value.

This situation can only change through a change in attitude among the population at large and a change in their methods of handling money. The two most urgently needed changes are probably: the development of a habit of using banks, especially in rural areas; and the introduction of simple but effective book-keeping into all economic activities down to the smallest units.

Each form of economic activity has its own typical "capital/output ratio", i.e. the amount of capital usually needed to produce a given amount of net product, which is related to the level of technology and to the scale of operation. It might seem wise therefore in a situation where capital is scarce to engage only in those activities which produce a maximum return from a minimum of capital. This however is not possible since such activities alone would not add up to a self-sustaining or balanced economy. Generally speaking, retail trade is one of the lowest users of capital, but an economy in which everybody is engaged in retail trade and nobody produces the goods handled by the traders is obviously absurd.

In a situation where capital formation is low and unemployment (or underemployment) is high, it is desirable to keep the amount of capital used to create each workplace as low as possible. But this must not be taken to the extreme point at which (a) the unit cost of the product becomes too high; or (b) the productivity of labour becomes too low to permit the economy to advance; or (c) the required quality of product cannot be achieved.

Estimation of Capital Requirements for Projects

There are several bases upon which capital requirements in various types of manufacturing have been reported for various scales of operation. These "Performance Indicators" are, for example:

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• Value - added per unit of fixed assets.
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• Fixed assets per employee.
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• Capacity output coefficient (value of sales at estimated full production capacity, divided by total investment).

Tabulated values for these are given in Staley and Morse: "Modern Small Industry for Developing Countries", Tables 7-1 (page 201), 7-2 (pages 203-4), 7-3 (pages 205-6), 7-4 (page 207) for three countries, Pakistan, New Zealand and Australia, and many other sources give average figures for different industries in different countries. Data of this type has its uses, especially in the hands of the countries’ "planners" who need some generalised indication of the capital requirements of a proposed increase in industrial output. However, at the factory level, they can be very misleading. The performance of a specific factory is very largely in the hands of the industrial designers and managers who plan and operate it. These people, and they alone, are in a position to seek out the OPTIMUM and APPROPRIATE possible performance of the individual factory and it is up to them to do so. They should never be content with a design or project report or a year’s trading result merely because it produces "indicators" which lie within the average or range achieved by other factories in the past and in other circumstances (which is really all that the published tabulated figures give). The Project Report should not be finalised until it has been optimised against criteria appropriate to the specific situation. It is probable that the industrial engineer in the field whose ultimate objective is economic development through industrialisation will find it is more meaningful to work with a unit of "Productivity of Capital" defined as Value Added per year per unit of total capital employed.

Second-Hand Plant

One method of keeping down capital requirements of new factories in developing countries is the importation of second-hand equipment. This is claimed to have two advantages: (a) low cost; (b) a less advanced technology which is automatically more matched to the developing economy. It is often pointed out that the equipment of new factories in industrial countries consists largely of second-hand equipment¹⁰ whereas developing countries are often reluctant to release foreign exchange for second-hand plant, which may be considered something of a gamble.

There are several difficulties which must be faced in importing second-hand equipment:

However, given adequate conditions especially in respect of inspection and overhaul before purchase and in availability of performance data, imported second-hand plant could contribution greatly to industrial development in a developing country. What is probably more important is the fuller utilisation of existing idle plant in the country itself. Very little work has been done on the surveying of plant standing idle due to business failure and lack of maintenance and spares, or on the setting-up of mechanisms to put this tied-up capital back into productive use. A number of government are now operating equipment financing or hire purchase schemes which will help, especially if they can be backed by adequate workshops capable of repairing and redesigning work and out-moded machines.

The Cost of Capital

In many cases, capital is made available to a new project on specially favourable terms in order to foster a particular development. This cheap rate is used in calculating capital requirements and profitability. The same amount of capital, invested in some other undertaking, might be expected to earn a much higher return and its diversion from this higher yielding use may reduce its contribution to the country’s GDP. However, the diversion may be politically desirable where it leads, by extra employment of labour or in some other way, to the balanced development of the economy. It is suggested that in such a case the decision to invest should be based on the actual terms on which capital will be provided, but that the level of productivity of labour and capital of the project should be assessed on the prevailing "Opportunity Cost" of capital. This will provide an added safeguard against over-sophistication and against under-utilisation of capital.

The true cost of imported capital poses difficult questions. Whether it is imported as private risk capital of under bilateral aid or trade agreements, there is always the problem of repatriating the whole of the original capital as well as any interest charges. This creates an outflow of foreign exchange which can only be met by increasing exports. In most developing countries such exports are limited to primary products of agriculture, forestry or mining, with or without a little pre-processing. In practically all cases, the importation of capital to increase industrial production has to be parallel with increased primary production for export if the country’s balance of payments position is to be maintained. This is yet another confirmation of the dependence of industrial development on the development of primary production, and on the development of international trade.