113 CHAPTER FOUR PRODUCTIVE ADAPTATION IN IMEP AND …

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CHAPTER FOUR

PRODUCTIVE ADAPTATION IN IMEP AND METASA

INTRODUCTION

Chapter Four analyses patterns of productive adaptation within IMEP and METASA in

light of the specific pressures and constraints facing these firms. Part One briefly considers

the interrelationship between four categories of productive adaptation defined in the

analytical framework. Parts Two and Three present the results of the IMEP and

METASA case studies respectively. The conclusion summarises and compares the main

forms of productive adaptation in these two firms. These results are then related to the

role of the state in the Nicaraguan economy.

This Chapter discusses each firm separately for two reasons. First, the nature of the

research material lends itself to a discussion by firm rather than by issue. IMEP and

METASA faced a distinct set of production problems and responded to their external

environment in different areas. As a result, the structure of the argument and the data

generated for each firm are not always the same. Second, each case study views the same

processes of adaptation from distinct angles in light of foreign exchange considerations,

resource constraints, changing demand conditions and financial conditions in local

currency. By considering each firm separately, Parts Two and Three will show how these

external circumstances combined to generate specific forms of productive adaptation.

Chapter One outlined the basic research approach used in the case studies and underlined

its limitations.1 This approach included a review of company records, numerous

exploratory and structured interviews, and direct observation on the shop floor. Some of

its limitations stemmed from two characteristic features of this research environment.

First, Nicaragua did not provide the context for a controlled experiment in which all but

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one variable remain constant; rather numerous variables were changing simultaneously.

Second, IMEP and METASA were characterised by poor information systems which

resulted partly from the soft budget constraint and also from high inflation rates. These

firms were also run without systematic production records based on physical indicators.2

These conditions limited any attempt to trace the effectiveness with which firms carried

out specific processes of productive adaptation.

Nevertheless, this research approach did reveal clear patterns of productive adaptation to

external pressures and constraints. Specific research methods were developed in light of

existing information and the need to capture highly dynamic processes. Daily access to the

factories facilitated these efforts and allowed for the cross-referencing of numerous

information sources and interviews, as indicated in the endnotes. The case study findings

were interpreted in the light of the four categories of productive adaptation outlined

below.

PART ONE: CATEGORIES OF PRODUCTIVE ADAPTATION

Chapters Two and Three have confirmed the main premises defined in the analytical

framework. Based upon these findings, Part One now maps out the interrelationship

between its distinct categories in the Nicaraguan case, and thereby explains the

organisation of each case study. The first two categories are adaptation given foreign

exchange considerations and adaptation to resource constraints. Chapter Three stated that

the purchasing and investment decisions of Nicaraguan metalworking firms could be

expected to reflect adjustments carried out in light of a strict foreign exchange budget in

convertible currency and the availability of supplier credit lines.3 Each case study first

considers these forms of adaptation given foreign exchange considerations.4 The latter in

turn influenced the type of resource constraints confronting each production section.

Resource constraints were the main factor generating productive adaptation in the five

main metalworking firms. Kornai’s three basic forms of adjustment to resource constraints

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are therefore likely to be relevant as outlined below:

1. adjustment in the volume of production to current bottlenecks;

2. adjustment in output composition to available inputs; and

3. forced substitution of inputs and machinery.

In Kornai’s account, these types of adjustment tend to have negative consequences. The

first leads to an under-utilization of complementary resources in the plant, while the

second contributes to the production of an assortment of goods which diverges from

customer demand. Finally, forced substitutions are likely to entail higher costs, a decline in

product quality or other negative results.5

The case studies will attempt to trace the effects of specific patterns of adjustment to

resource constraints, and will interpret these findings in light of the particular

circumstances that gave rise to these forms of adjustment. In the Nicaraguan case, these

circumstances were somewhat distinct from that defined by Kornai. The soft budget

constraint on state institutions and enterprises did contribute to the demand for scarce

resources. Yet to some degree, resource constraints and supply uncertainty formed an

inevitable feature of the production environment, given the manufacturing sector’s high

import content and the international conditions facing Nicaragua in the 1980s. In this

context, we would expect to find a close interaction between the nature of external

finance, foreign resource allocation, adaptation given foreign exchange considerations, and

daily patterns of adjustment to resource constraints.

Demand-oriented adaptation forms the third category and includes the following types of

adjustment aimed at meeting current user needs:6

1. adjustment in output composition (including changes in the firm’s current product

mix, the introduction of new products, and product quality improvement);

2. changes in input usage or machinery utilization aimed at improving product

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quality or matching product specifications to buyers’ requirements; and,

3. adjustments in input usage or machinery utilization aimed at completing contracts

and meeting delivery dates.

The case studies will examine the extent and nature of demand-oriented adaptation as

influenced by the relative power of producer and user firms.7 Chapters Two and Three

confirmed the need to modify Kornai’s framework in two ways. First, Kornai analyses the

relation between state enterprises organised under a central plan. In contrast, this study

looks at exchange relations between state metalworking firms and customers organised

under diverse enterprise forms. Second, Kornai attributes the relative power of the

producer-seller versus the user-buyer to chronic shortages and the soft budget constraint

on state enterprises. This study also considers the impact of a broader range of

circumstances upon exchange relations.

In Kornai’s account, enterprises that do not face significant demand constraints generally

are not responsive to buyers’ requirements. Nicaraguan metalworking firms did not

confront significant demand constraints in several product lines. Nevertheless, other

constraints affecting their operations may have influenced the degree and the way in which

firms responded to customer demand, as illustrated by the following examples. First, the

central government exerts pressure upon the firm to meet a major state contract. The firm

may be responsive to these pressures because the central government controls access to

foreign resources, thereby determining its ability to overcome one of the main constraints

upon its operations. Second, in equipment production, the user firm generally supplies

product technology, thereby enabling the producer to overcome constraints upon its ability

to diversify output. Under these conditions, there is unlikely to be a seller’s market

wherein the seller dictates and the buyer must conform.

These examples are relevant both because Nicaraguan metalworking firms faced severe

foreign exchange and technological constraints and because the central government was

among their main customers. In addition to shortages and the soft budget constraint, this

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thesis will consider the impact of customer and contract type, foreign exchange and

technology considerations, and other circumstances upon the relative power of domestic

producer and user firms. Finally, demand-oriented adaptations are likely to cross over

with daily processes of adjustment to resource constraints. For example, pressures from

the customer may lead a firm to substitute inputs or machinery to meet delivery dates on a

particular contract. The case studies will consider these forms of adjustment under both

the second and third categories.

The fourth category is price-enforced adaptation. In Kornai’s account, the firm operating

under a soft budget constraint is not forced to adjust to prices in the productive sphere.8

Chapter Two argued that government foreign exchange, credit, and price policies provided

sufficient conditions to create a soft budget constraint on Nicaraguan enterprises. Chapter

Three then showed that price-enforced adaptation was not among the predominant forms

of productive adaptation in the main Nicaraguan metalworking firms. The case studies

will now consider the precise reasons why each firm was not forced to adjust to prices in

the productive sphere. Likewise, it will look at the specific impact of inflation upon their

investment and current production decisions. This will provide a further explanation for

the way in which firms adjusted to other external circumstances.9 In sum, Part One has

reviewed four categories of productive adaptation. Despite their close interaction, each

category brings to light distinct aspects of firm-level adjustment processes, as displayed

further in the case studies.

PART TWO: PRODUCTIVE ADAPTATION IN IMEP

Established in 1972, IMEP produced construction inputs on a small scale for the domestic

market, its main products including angles, beams, assembled steel structures, and water and

fuel storage tanks. The firm came under state administration in 1980 and reinitiated operations

based on the existing input stocks and machinery, obtaining contracts mainly for state

construction projects. In the 1981-87 period, IMEP initiated equipment and parts production

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for agriculture and agro-industry, while continuing to produce construction inputs.10 From year

to year, the firm varied output composition both between product lines and within the

equipment line in response to changing external circumstances. Likewise, it made adjustments

in input usage and machinery utilization. Part Two analyses this process of productive

adaptation with reference to four categories defined in the analytical framework.

1. Adaptation Given Foreign Exchange Considerations

Foreign exchange considerations shaped some of management's basic decisions regarding

inventories, product mix and investment in new machinery. Upon reinitiating operations in

1979, IMEP counted on sufficient input stocks to cover production requirements through

1980. Between 1982 and 1984, it imported raw materials from South Korea, France, Spain,

Austria and Brazil, confronting severe raw material shortages only in the latter year. From

1985 to 1987, IMEP met its raw material requirements mainly through a Soviet credit line for

steel imports.11

Sheet metal constituted the main raw material for angles, beams, structures and tanks, although

technical specifications differed according to product and building design. Likewise, IMEP

fabricated equipment parts from imported sheet metal and bar. After 1984, the firm ordered

raw materials on an annual basis due to the location of its new suppliers and the requirements of

centralised planning within their countries. It estimated the amount required to meet output

targets based on past production experience rather than input-output coefficients. From 1985 to

1987, it included a three-month buffer stock in its annual orders so as to respond to unforeseen

contracts, as well as delays in delivery of materials in the following year.

Even this buffer stock did not guarantee that IMEP would have adequate materials to meet

production orders. The firm received production orders throughout the year rather than on an

annual basis. Subsequent raw material requirements, particularly for the structures line, did not

necessarily match up with existing inventories.12 Annual ordering procedures limited the firm's

ability to reduce inventories and adjust these to changing demand conditions. As a result,

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IMEP maintained large inventories and faced occasional raw material shortages simultaneously.

Likewise, it continued to experience interruptions in the supply of inputs that could only be

purchased locally or with convertible currency.13 These inventory trends resulted largely from

the firm's growing reliance upon supplier credit lines to finance input purchases.

Foreign exchange considerations also influenced IMEP's decision to initiate equipment

production. Its capacity to increase production and invest depended largely upon access to

imports, as demonstrated in Chapter Three. Equipment and parts production required general

purpose machinery which could be obtained relatively easily through supplier credit lines.

Because entry into equipment production constituted a key aspect of government industrial

development strategy, equipment producers received priority access to imported inputs,

machinery and technical assistance. The future growth of the firm was therefore tied to the

introduction of the equipment line.

IMEP's investment programme evolved in response to import opportunities. The firm imported

cutting, bending and welding equipment and general-purpose machine tools mainly from

Czechoslovakia and North Korea, as shown in Chart 4.1. These were standard or universal

machinery and equipment whose operating features did not vary significantly between

countries. They formed part of larger import packages obtained through bilateral co-operation

agreements. Due to the nature of its production process, IMEP could install this machinery and

equipment piecemeal without causing downtime in other areas.

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Chart 4.1 IMEP: Description of Machinery Imports, 1982-1987

Year SystemDescription Fabrication Installation Source Mechan. Hydraulic Pneu-

matic

10 lathes 1982-1985 1984-1986 N. KoreaCzechoslovakia

X

2 millingmachines

1982, 1986 1984, 1987 N. KoreaCzechoslovakia

X X

2 radial drillingmachines

1980, 1984 1984 N. KoreaCzechoslovakia

X

1 drillingmachine

n.i. 1984 N. Korea X

1 gear cuttingmachine

n.i. 1987 Czechoslovakia X X

1 broachingmachine

1984 1986 Czechoslovakia X X

1 surfacegrinder


1 cylindricalgrinder

1984 1985 N. Korea X

3 universalgrinders

n.i. 1986 Czechoslovakia X X

1 guillotineshear

1984 1986 Czechoslovakia X

1 folding press 1983 1986 Czechoslovakia X

1 eccentricpress


2 sheet metalrolling equip.

1984 1986 Czechoslovakia X

1 equip. forcutting angles

n.i. 1986 Czechoslovakia X

1 shavingmachine

1985 1986 N. Korea X

1 universalplaning mach.

1984 1986 Bulgaria X X

Source: IMEP, Production department, machinery list and plant observation

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IMEP initially installed a small heat treatment oven to facilitate parts production. In 1987,

through a credit line with East Germany, it purchased four heat treatment ovens whose capacity

far exceeded the firm's own requirements. This investment led the state metalworking division

to develop its plan for a national heat treatment centre attached to IMEP to service other firms.

IMEP also imported electrical equipment which would increase the plant's voltage to support

the newly-installed capacity.14 Neither the heat treatment ovens nor the electrical system had

been installed by the close of the period under study.

Access to supplier credit lines propelled IMEP's investment in the development of equipment

and parts-production capacity, as well as the expansion of its physical plant.15 The firm

enlarged its installations between 1982 and 1987 to include the new equipment line, machining,

and heat treatment sections, as well as additional space shown in Chart 4.2.

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Chart 4.2 IMEP: Construction of New Plant Installations 1982-87

1982existing plant

new 1983 1984 1985 1986 1987

Cutting and bending section 765

Structures section 99

Maintenance workshop 462

Machine tools area 638

Heat treatment area 162

Equipment line section 2,160

Storage room 864

Painting section 144

Tanks section 205

Heat treatment section 816

New maintenance section 363

Source: Calculated from plant blueprint included in IMEP, Investment Report forthe National Financial System (1987).

Because it built its own structures, its investment in new plant was not limited by production

capacity in the domestic construction sector. The equipment section was the largest installation

built during this time. It was constructed under rush work so as to be ready before the

machinery arrived to port. The firm continued to expand its installations until it ran up against

the constraints imposed by its location. At the close of 1987, it was looking into possibilities of

purchasing additional property.

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1.a. Sub-conclusion

By introducing equipment and parts production, IMEP gained priority access to imported

inputs, machinery and technical assistance, guaranteeing both current production and the future

growth of the firm. The central government used its control over access to foreign resources to

promote the development of the equipment line, thereby shaping this form of adaptation given

foreign exchange considerations. Entry into equipment and parts production required general-

purpose machinery on offer through supplier credit lines. The firm could incorporate this new

machinery piecemeal without major disruptions to production and without the need for

balancing found in a line layout. Investment timing depended upon these import opportunities

rather than the planning of a phased investment programme at enterprise level. Finally, both the

firm's choice of inputs and the management of its inventories may be seen as forms of

adaptation given foreign exchange considerations. This partly explains the nature of resource

constraints on current production and associated forms of productive adaptation, as discussed

further below.

2. Adaptation to Resource Constraints

This section examines IMEP's response to resource constraints: it considers both adjustment in

output composition and the forced substitution of inputs and machinery. IMEP showed a

positive output trend from 1980 to 1987, at the same time that it varied annual output

composition between product lines, as shown in Table 4.3. The angles and beams line showed

a positive growth index in every year except 1984, both when 1980 and 1982 are taken as the

base year. This line registered the sharpest variations in annual output and its share of total

production ranged from 16 per cent to 46 per cent. The combined output of assembled

structures and tanks also showed a positive growth index. Within the structures and tanks

section, the share of each product line in their combined output varied from year to year.

These changes in output mix partly reflected the firm's efforts to adapt to resource constraints. '

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We have four sections, each with a distinct production process, product mix, and set of

customers. If we encounter production problems or shortages in one section, we can always

increase output in the other sections,' explained enterprise director Julio Valladares.16 The

firm's production processes enabled it to adjust output among its product lines according to

available inputs and machinery.17 The cutting and bending section produced angles and beams

to customer orders, as well as supplying materials to other product lines. Production

programming in this section therefore involved trade-offs between outputs in the distinct

product lines. The production process was similar in the tanks and structures line. After

receiving materials from the cutting and bending section, workers assembled and welded the

parts in an adjacent section prior to carrying out finishing work and painting. This section was

organised on a workshop basis and the same workers and equipment were employed in both

product lines, resulting in a trade-off between structures and tanks.

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Table 4.3: IMEP: Changes in Output Composition between Product Lines, 1980-1987 Metric tonsa

Product line 1980 1981 1982 1983 1984 1985 1986 1987

Angles, beams 226 561 409 532 201 681 598 782 Annual % of Change

n.a. 148 -27 30 -62 239 -12 31

Index 1980=100 100 248 181 235 89 301 264 345 Index 1982=100b n.a. n.a. 100 130 49 167 146 191

Share in total % 31 46 32 35 16 38 32 39

Structures 337 428 497 539 579 746 561 671 Annual % of change

n.a. 27 16 9 7 29 -25 19


Share in total % 47 35 39 36 45 42 30 34

Tanks 156 175 215 304 292 128 368 211 Annual % of change

n.a. 12 23 42 -4 -56 188 -43


Share in total % 22 14 17 20 23 7 20 11

Sub-total: struc.& tanks 493 603 711 843 872 874 930 882 Annual % of change

n.a. 22 18 19 3 0 6 -5


Share in total % 69 50 56 56 67 49 50 44

Equipment 0 47 143 134 221 229 325 338 Annual % of change

n.a. n.a. 204 -6 64 4 42 4

Index 1982=100b n.a. n.a. 100 94 154 160 227 236

Share in total % n.a. 4 11 9 17 13 18 17

Total 720 1,211 1,263 1,510 1,293 1,784 1,853 2,001 Annual % of change

n.a. 68 4 20 -14 38 4 8


Notes: a. Calculations are based on one decimal place figures. b. This table also includes a 1982 index so as to

measure growth trends after the initial reactivation period. n.a. signifies not applicable.

Source: Based on output figures from IMEP, production department.

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IMEP used the angles and beams line as a buffer in adjusting to raw material inventories,

machinery availability in the cutting and bending section, and pending production orders in the

other areas. This partially explains the wide fluctuations in output in this product line (see

Table 4.3). Faced with material shortages, IMEP gave priority to assembled structures. For

example, management responded to a severe raw material shortage in 1984 by reducing output

and sales of angles and beams in favour of supplying the structures line. Annual output in the

angles and beams line fell by 62 per cent from 1983 levels, while increasing 7 per cent in the

assembled structures line.

Adjusting its product mix to available inputs, IMEP still produced to customer orders. In the

above example, it met contract obligations in the structures line, maintained employment, and

maximised both labour and machinery utilization given available input stocks.18 However, the

firm did not meet orders in the angles and beams line during this period. From IMEP's

perspective, this did constitute an effective form of adjustment to resource constraints, enabling

the firm to minimise slack within its own production process.

When major contracts were at stake, management showed a greater reluctance to alter the

firm's output mix according to available inputs and machinery. IMEP often continued work on

priority contracts, even when it would have been more effective from the firm's point of view to

shift temporarily to other product lines. In these cases, it carried out forced substitutions of

inputs and machinery.19 For example, IMEP worked on a contract to produce water and fuel

tanks for the army in 1986. At the same time, it faced interruptions in the local supply of

oxyacetylene, which it used for cutting circular and irregular shapes, including circular tank

tops.

The production department continued working on this contract, rather than shifting temporarily

to production orders in the other product lines which did not require this input. It substituted

the guillotine shear for oxyacetylene equipment, cutting straight lines at various angles until a

circular shape was produced. 'It was slow, exhausting work, but the army needed these items,

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and so we did what we could,' recalled Manuel Baltodano, production worker in the cutting

and bending section.20 IMEP met this contract, but only at the cost of an inefficient utilization

of labour and machinery.

The launching of the equipment line augmented daily supply difficulties in IMEP. Initially, the

firm subcontracted out parts production to small workshops which often did not meet quality

standards or delivery dates. As the firm shifted to in-house parts production, it often faced

disparities between required and available materials. Finished products required items such as

belts, ball bearings and motors which could only be purchased with convertible currency. The

firm imported machinery for the equipment line from North Korea, Czechoslovakia and East

Germany. The distance between Nicaragua and its new suppliers led to delays in the supply of

items such as machinery lubricants, gaskets and electrical parts; IMEP waited several weeks for

items which would have been available within a few days from sources closer to home.21

How did IMEP respond to these supply difficulties? Individual machines remained down due to

delays in the arrival of electrical parts and other supplies. Customers often provided motors or

other items for the finished product. The shift to in-house parts production formed a key aspect

of IMEP's adjustment process and may be viewed as a form of forced input substitution. IMEP

moved gradually from subcontracting arrangements to in-house parts production in response to

local supply problems, as well as to state strategy and the availability of foreign finance.22

Chart 4.4 illustrates this shift by comparing parts production for two standard products in 1983

and 1987. In 1983, the firm still subcontracted several parts which required cutting and

bending sheet metal, machining and/or heat treatment processes. By 1987, these operations

were carried out in-house, while the firm continued to subcontract out casting processes.

Chart 4.4: IMEP: Parts Production for Two Standard Products, 1983 and 1987

1983 1987Subcontract In-house Subcontract In-house

128(a) (b) (a) (a) (b) (a)

Hammer Mill (MM-10)

Axles x xNuts X xcoupling flanges x xlock gates x xbelt pulleys x x x(c)metallic cores x xventilator disks x xhammer disks x xcutting blade disks x xpile hammers x xcutting blades x xseparators x x

Corn husker

axles x xnuts x xwedgers x xbelt pulleys x x x(c)shank pins x xcoupling flanges x xventilator disks x x

Notes: a. This refers to parts fabricated from imported sheet metal or bar,utilising cutting and bending, machining and/or heat treatmentprocesses.

b. This refers to casting processes.c. The parts are cast outside the firm and machined within IMEP.

Source: Based on information provided by IMEP, production department

The firm began to develop its own machining capacity and installed the small heat treatment

oven in response to problems with subcontractors' performance in terms of product quality and

delivery dates. These problems were related to the low levels of technological development in

the small shops supplying IMEP. 'Our dependence upon local parts suppliers was becoming the

biggest bottleneck in the equipment line, affecting our ability to meet delivery dates,' stated

enterprise director Herzán García. 'At the same time, there was an opportunity to import

Korean machine tools.'23 Entry into parts production formed part of IMEP's investment drive,

as well as constituting a response to constraints on current production. There was not

sufficient information with which to measure the consequences of this form of forced

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substitution in terms of costs and product quality.

Subcontracting arrangements are generally thought to provide equipment producers with

greater flexibility in responding to the demand for a wide variety of output while maximising

machinery utilization. Yet this assumes the existence of a reliable network of suppliers

specialised in different processes. The absence of these suppliers has led larger firms in

developing countries to incorporate in-house capacities in areas such as machining, heat

treatment, foundry and forging. Likewise, state socialist enterprises have tended to integrate

backwards to control supply sources in the face of chronic shortages. By incorporating

machining and heat treatment processes, IMEP displayed a form of adaptation to resource

constraints which is commonly found in both developing countries and resource-constrained

economies.24

The machining section also ran up against immediate resource constraints. Because of constant

changes in product mix within the equipment line, it could not programme its supply

requirements, and often faced a mismatch between required and available materials. In some

cases, this led to forced substitution with negative effects on performance. For example, faced

with a shortage of cylinder bars in 1987, the machining section occupied three lathes to cut

cylinder parts from square, rectangular and hexagonal parts. It supplied the required parts to

the equipment line, but only by inefficiently utilising labour, machinery, cutting tools and raw

materials.25

2.a. Sub-conclusion

IMEP did tend to adjust its output mix between product lines according to available inputs and

machinery, thereby contributing to positive growth trends from 1980 to 1987. However,

output maximization did not constitute the sole objective guiding product mix decisions

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between angles, beams, assembled structures and tanks. The firm carried out work on major

state contracts, even when this required highly inefficient forms of forced substitution, which

affected total output figures negatively.

IMEP ran up against a new set of resource constraints upon initiating equipment production. It

shifted to in-house equipment parts production in response to local supply problems, as well as

opportunities to import machine tools. The machining section in turn often lacked the raw

materials required to supply the equipment line. In some cases, this led to forced material

substitutions, resulting in an inefficient utilization of labour, raw materials and machinery.

IMEP's efforts to overcome resource constraints only partially explain its adjustment process.

The former do not fully account for changes in output composition, input usage and machinery

utilization. Changing demand conditions also influenced the nature of productive adaptation, as

discussed further below.

3. Demand-Oriented Adaptation

The following two sections document the extent and nature of demand-oriented adaptation.

The first considers changes in IMEP's output composition between product lines, while the

second looks at adjustments in product mix within its equipment line and associated changes in

input usage and machinery utilization.

3.a. Changes in Output Composition Between Product lines

IMEP established direct relations with a wide range of customers who displayed varying

degrees of relative bargaining power. It varied output mix between product lines in response to

pressures from its main customers, given resource constraints. These changing demand

pressures had a greater impact upon its production decisions than the government output plan.

From 1984 to 1986, its annual output plan called for only slight changes in the share of each

product line in total output from year to year, the latter varying by four percentage points or

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less. Greater variations in output composition therefore represented departures from the plan,

as shown in Table 4.5. Once again the angles and beams line provided the main source of

flexibility. In this line, annual output as a percentage of the plan ranged from a low of 77 per

cent in 1984 to a high of 296 per cent in 1985.26

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Table 4.5: IMEP: Annual Output as Percent of Plan by Product Line,1984-1987

metric tons*

Product line 1984 1985 1986 1987

Angles, beams

annual output 201 681 598 782 annual plan 260 230 290 393 output as % of plan 77 % 296 % 206 % 199 %

Structures


Tanks


Sub-total: Struc. & Tanks


Equipment


Total

annual output 1,293 1,784 1,852 2,002 annual plan 1,415 1,406 1,491 1,609 output as % of plan 91 % 127 % 124 % 124 %

Note: * Calculations are based on one decimal place figures.

Source: Based on data provided by IMEP, production department, annual production reports, 1984-87.

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The relative position of user firms in relation to IMEP differed between product lines and

customer types. The structures line worked on large contracts, about 90 per cent of which

were in the state sector. Under production for construction contracts, there is generally a close

interaction between producer and user firms regarding quality, product design and delivery

schedules. IMEP's contracts included high priority projects within public investment and

defence programmes. The central government often placed considerable pressure on IMEP to

speed up delivery dates for these contracts. Success in meeting these obligations became a

more important performance indicator than plan fulfilment by product line.

Production orders in the tanks line ranged from individual orders for one storage tank to large

contract orders for numerous items. The latter included high priority projects within the state

sector. Product mix within the structures and tanks section depended on the relative power of

its customers to exert pressure on the firm. State priority projects could influence product mix

decisions in their favour.27 In this case, changes in output composition did represent a form of

demand-oriented adaptation. In the angles and beams line, production orders were generally

for small quantities of materials. Its customers included businesses and homeowners who

wished to repair or expand their physical installations. The firm was fairly unresponsive to

these buyers and maintained a long backlog of unfilled orders in the angles and beams line.

Management used this line to provide some flexibility in coping with other circumstances.28

3.b. Adjustments in Product Mix within the Equipment Line

IMEP introduced about 38 new products from 1981 to 1987, mainly in response to buyers’

requirements. This represented the predominant form of demand-oriented adaptation in the

equipment line. Although it set aggregate output targets, the government neither planned the

demand nor organised marketing channels for equipment produced by IMEP. Rather

management sought out the first customers for this line. Its main buyers were rice, livestock

and basic grains producers in the private and state sectors whose scale of operations ranged

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from peasant production to large agribusinesses. These customers were concerned primarily

with IMEP's ability to produce the required item and meet delivery dates.29 Their demand for

locally-produced equipment stemmed from their ample access to credit in local currency and

limited access to foreign exchange. Likewise, the US trade embargo interrupted their former

commercial links with US equipment suppliers.

IMEP's customers were dependent upon it to resolve immediate bottlenecks. They paid in local

currency which had reduced significance given the soft budget constraint on both producer and

user firms.30 In this respect, the relation between the producer-seller and user-buyer resembled

that described by Kornai in his account of the seller's market. Yet there were also a number of

key differences which explain the firm's responsiveness to customer demand. IMEP had to

seek out customers in a relatively small market which had traditionally been supplied by foreign

firms and now faced temporary import constraints. Its customers compared its products to the

imported items, even when the latter were no longer readily available. Its ability to enter into

equipment production depended upon customer acceptance of its initial products.

The equipment line introduced new products in response to specific buyer requirements; it

received both instructions and feedback directly from the user firm rather than through formal

planning networks. It introduced several new products based on the copied manufacture of

imported equipment provided by the customer. From 1984 to 1987, the design department

also introduced new products based on technical information supplied by the customer.31

IMEP's customers provided credit in local currency and often agreed to supply motors and

other items for the finished product which could only be purchased with convertible currency.

These conditions generated greater interplant communication and interdependence than that

found under centralised planning.

IMEP's product mix evolved from its response to immediate user needs. From 1981 to 1984,

the firm built up the equipment line around a highly varied product mix, introducing about

twenty-two products in this period alone, as shown in Table 4.6.

135Table 4.6 IMEP: Number of New Products Introduced Each Year, 1981-1987

Year 1981 1982 1983 1984 1985 1986 1987 Total

Number of newproducts

3 3 8 8 3 11 2 38

Source: IMEP, production department, work order books 1981-87,and quarterly production reports 1984-87.

Its first major contracts were in the rice sector and included equipment utilised in rice drying

plants. From 1982 to 1987, it also produced equipment for basic grains and livestock

producers, and one-off items for the coffee, cotton and mining sectors. From 1985 to 1987,

both management and the state metalworking division questioned the viability of further

product diversification in the equipment line. 'We want to specialise in twelve standardised

products, and complete rice, coffee and animal feed processing plants,' stated enterprise

director Julio Valladares in 1987, voicing a position backed by the metalworking division.32

The processing plants would incorporate a number of standard products.

Despite these objectives, the firm continued to accept production orders for a wide range of

products in this period. The equipment line introduced sixteen additional products from 1985

to 1987, only two of which were in its standard product range, and produced chemical

processing tanks for two state investment projects. In 1987, it worked on a defence contract,

as well as a major contract for the structures line. Both were government priority projects,

demanding rush work and the temporary suspension of work on other production orders.

Output composition fluctuated from year to year, even within the standard product range.

Among the latter, the equipment line did not produce any one item in the four years between

1984 and 1987.33 It continued to produce mainly one-off items under pressure from those

customers who arrived at the factory gate.

In 1986-87, the firm introduced internal orders for twenty to fifty units of a few standard

136

products to avoid price re-negotiations in the inflationary period. It received large orders for

three items from the state distributor of agricultural machinery and the Union of Agricultural

and Livestock Producers (Unión Nacional de Agricultores y Ganaderos: UNAG). The

equipment line began to assemble and weld these products in batches of around ten. According

to workers and the area supervisor, small-batch production facilitated efforts to reduce worker

hours per unit and improve product quality. Yet finished goods such as the hammermills,

which required items purchased with convertible currency, remained in stock due to

shortages.34 In this case, resource constraints blocked the benefits of small batch production.

Although management's intention was to narrow its product range, external circumstances

continued to push the firm in the direction of a broad product mix.

Under these circumstances, IMEP's engineers and workers developed the capacity to produce a

wide range of equipment involving varying degrees of technological complexity. We classified

this equipment according to the degree of complexity involved in its production. The

equipment line included two processes corresponding to the static and dynamic parts of the

finished product. The static part refers to the equipment body. Its manufacture involved

cutting, bending, rolling and/or perforating sheet metal; assembling the static parts to form the

equipment body; and welding this semi-finished product. The dynamic part refers to

mechanical parts such as axles and gears.

To classify this equipment, we used two criteria: 1) whether it included only static parts, or

static and dynamic parts; and 2) the number of static and dynamic parts. We also considered

the degree of precision required to produce each item.35 Because the fabrication of dynamic

parts required machining and heat-treatment processes, the equipment containing these parts

were classified as more complex. Likewise, the manufacture of equipment with numerous parts

required a wider range of production skills, as well as more complex decisions regarding

material usage and machine programming. IMEP produced equipment ranging from least to

most complex, as shown in Chart 4.7.

137Chart 4.7 IMEP: Classification of New Products According to Technological Complexitya 1981-1986

Product and Year of Introduction System Number of Parts

static dynamic static Dynamic

Simple: x - 4-140 0hopper (1981), tractor implements for ricesoil preparation (1983), animal feeder(1984), gasometric tank (1984), moulds(1986), silos (1986)

Moderate: x x 46-81 5-70screw conveyer (1981), hammermill-MM3b (1983), corn husker (1983),hammermill-MM10 (1984), grain mixer(1984), pasture cutter (1986)

Complex: x x 2-4,000 20-120grain dryer (1982), cube elevator (1982),radial ventilator (1983), hammermill-MM30 (1984), speed divider (1986)

Notes: a. In addition to the two criteria illustrated here, we also considered the degreeof precision required to produce each item

b. IMEP introduced three models of the hammermill (MM3, MM10, MM30)

Source: Based on information provided by IMEP, production department

Initially, IMEP obtained the dynamic parts through subcontracting arrangements and assembled

them in-house. By 1987, it had incorporated machining and heat treatment, and only continued

to subcontract out casting processes. Among its most complex products were the grain-drying

equipment which contained numerous static and dynamic parts and the speed divider which

required a high degree of precision.

3.c. Limits to Demand-Oriented Adaptation in IMEP

The equipment line did adjust its product mix according to customer demand. Yet there were

limits to this adjustment process which became increasingly apparent as the firm obtained a

wider range of customers. This could be seen in the areas of materials usage, production

organisation and product quality. IMEP consistently gave priority to meeting changing

138

demand pressures over maximising usage of materials. This was particularly evident in the

cutting and bending section.36 Due to its broad product mix, the equipment line required

numerous parts of varying sizes and dimensions which were cut from sheet metal. Supply

requirements fluctuated in the face of constant changes in product mix. The area supervisor

showed considerable initiative in attempting to minimise wastage under these circumstances.37

Yet management did not develop an effective information and feedback system between the

import, design, production and sales departments regarding material usage.38 This blocked the

firm's ability to improve its record in this area. Inefficiencies in the utilization of sheet metal for

the equipment line did not become readily apparent due to buffer stocks.

From 1985 to 1987, the firm did not seek out contracts that would enable it to improve its own

performance regarding productivity, utilization of installed capacity, reduction of work-in-

progress and ability to meet delivery dates. Rather, it continued to shape its product mix

around the demands of those customers who arrived at the factory gate, and to interrupt work-

in-progress to meet priority contracts.39 As a result, the machining section faced problems in

programming machinery utilization and materials supply.40 This became one of the main causes

of machinery downtime, while also leading to forced material substitution in some cases. The

equipment welding and assembly section also faced difficulties in production programming

which were aggravated by rush work on priority contracts. The firm accumulated large work-

in-progress inventories. At the same time, IMEP began to maintain a backlog of unfilled orders

for the equipment line. The main complaint of IMEP's customers concerned delayed delivery

dates and the accompanying increases in product prices during the inflationary period.41

Management, engineers and shop-floor personnel did display a concern for product quality,

which depended significantly on workers' skills in machining, welding and equipment assembly.

IMEP promoted in-house training to raise quality standards, as discussed further in Chapter

Six. However, the firm did not record the performance data required to facilitate learning and

allow for ongoing improvements in this area. The equipment line fabricated parts from sheet

metal and bar which were imported from various sources between 1982 and 1987. There was

no materials testing department to indicate how the technical characteristics of the raw

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materials affected product quality. By 1987, the machining section still relied on visual quality

control and had not yet implemented norms regarding precision, tolerances and finishing

surfaces. The equipment line carried out quality control on selected items but did not compile

records in this area.

IMEP gave priority to introducing new products versus improving the quality of existing

models. This trend was evident both in the design department and on the shop floor. The

design department continued to introduce new products throughout the period under study,

giving less attention to design improvements on existing models.42 On the shop floor, workers

stated that small-batch production allowed greater room for improvement in product quality.

Yet this line continued to produce mainly one-off items. Only five products were produced in

quantities of twenty or more within a given year.

These limits to demand-oriented adaptation may be explained in light of the following

conditions. IMEP did not have to compete with either domestic or foreign producers. Its

customers depended upon equipment supplied by IMEP to overcome bottlenecks in the face of

import constraints. The majority of its customers operated under a soft budget constraint in

local currency and were willing to purchase its products despite the dramatic increase in sales

prices, as discussed further below.43

3.d. Sub-conclusion

IMEP did carry out demand-oriented adaptation. The firm varied output composition between

product lines in response to pressures from its main customers, given resource constraints.

Likewise, it introduced about 38 new products within the equipment line mainly in response to

buyers' requirements. It focused upon these forms of demand-oriented adaptation, despite

market conditions characterised by shortages and the relatively passive role of domestic money.

This may be explained in light of three key differences between the seller’s market, as defined

by Kornai, and demand conditions facing IMEP.44 First, the state had a more important impact

on current production decisions in its role as user firm than as planner of output targets, and

140

could pressure IMEP to meet its product requirements. Second, there was greater interplant

communication and interdependence than that found under centralised planning. Third, the

demand for domestic equipment stemmed from temporary import constraints within a small

market that had traditionally been supplied by foreign firms. In this case, the relative power of

the user-buyer in relation to the producer-seller was far greater than that envisioned in Kornai's

account of the seller’s market.

Nevertheless, limitations inherent in this process of demand-oriented adaptation became

particularly apparent in the 1985-87 period. The equipment line continued to introduce new

products rather than improve its ability to respond to customer demand for its current product

mix by improving both quality standards and its record on meeting delivery dates. Problems in

integrating production programming and sales led to large work-in-progress inventories and

delayed delivery dates. This pattern of productive adaptation may be explained in light of the

soft budget constraint on both producer and user firms, as well as the absence of competition

from other equipment producers.

4. Productive Adaptation and Financial Conditions in Local Currency

From 1984 to 1987, IMEP faced high inflation rates and operated under a soft budget

constraint in local currency. To what extent and how did these financial conditions influence its

current production and investment decisions? IMEP showed positive profit margins

throughout the period under study, but faced occasional liquidity problems. One of the firm's

main financial concerns was to maintain a positive cash flow in the inflationary period as it

introduced new products, carried out a major investment programme, and worked on large

contracts requiring several weeks to complete. Yet high inflation rates did not generate price-

enforced productive adaptation. The firm adjusted to inflation outside the productive sphere,

securing a positive cash flow in two ways.

First, it adjusted contract prices upon project completion to take into account the effect of

inflation on each cost item.45 Second, IMEP relied upon customer advance payments of

141

between 20 and 40 per cent of the final price to finance current operations. In some cases,

customers financed 100 per cent of the costs of introducing new products in the equipment line.

IMEP also borrowed directly from its customers when faced with liquidity problems.46

Because it could respond to rising input prices through these two avenues, IMEP was generally

not forced to adjust in the productive sphere. This is one of the main consequences of the soft

budget constraint cited by Kornai.

Profit criteria generally did not determine IMEP's product-mix decisions. In 1986-87,

management intended to introduce financial criteria in local currency when setting output mix in

the equipment line. Yet it did not begin to draw up a cost structure for individual products until

the end of 1987. These efforts were hampered by constant fluctuations in product mix, as well

as abrupt changes in input prices in the inflationary period.47 The latter undermined the ability

of domestic prices to guide adjustment in the productive sphere.

We only found two examples in which financial considerations in local currency affected

current production decisions. First, orders for angles and beams could generally be met in less

than 15 days as compared to a few months for the other product lines. The firm increased

output and sales of angles and beams to obtain quick cash following a devaluation, a wage

increase or major investment expenditure. It carried out this form of price-enforced adaptation

to overcome immediate liquidity problems.48 Second, IMEP introduced internal orders for

select equipment so as to maintain a small stock of finished goods, thereby avoiding price

renegotiations in the inflationary period. Price renegotiations entailed administrative costs and

began to encounter customer resistance, particularly in the case of delayed delivery dates.49

A small firm, IMEP imported machinery and equipment valued at just over two million dollars

from 1984 to 1987; a period in which Nicaragua faced a growing trade deficit.50 Operating

under a soft budget constraint, it did not carry out pre-investment studies in local currency.

Efforts to calculate the present value of an investment had little practical significance in a period

of hyperinflation and distortions in relative prices. IMEP attempted to invest profits

immediately because of the low costs of imported machinery in local currency, and the effect of

inflation on savings given interest rate policy.51

142

Yet interest rates were not the main factor determining its investment capacity. IMEP had

access to credit in local currency to cover investment expenditures and did not risk bankruptcy

or closure if the investment failed. Under these conditions, Kornai points out that the primary

issue is price responsiveness rather than interest rates. IMEP's investment behaviour reflected

the soft budget constraint on its operations in local currency. Finally, because of the

government's decision not to revalue machinery in the inflationary period, machinery costs were

not reflected in product prices in local currency. Delays in the start-up phase or an inefficient

utilization of the new machinery were not reflected in product prices, even though the latter

were based on cost-plus pricing policies.

4.a. Sub-conclusion

IMEP came under pressure to maintain a positive cash flow in the inflationary period. It

responded to these pressures primarily outside the productive sphere, increasing product prices

and drawing upon customer credit and advance payments. Price-enforced adaptation did not

constitute a predominant form of productive adaptation. Output mix decisions generally were

not shaped by financial considerations in local currency, except in the two cases noted above.

Likewise, investment decisions were not determined by profitability criteria. Negative interest

rates, combined with the low cost of imported machinery in local currency, encouraged IMEP

to reinvest profits immediately. Yet its investment timing was determined by the availability of

imported machinery.

The soft budget constraint explains to some degree IMEP's ability to expand its physical

installations, purchase new machinery, and develop the equipment line around a broad product

mix in the inflationary period. The soft budget constraint on both IMEP and its main user firms

also explains the absence of price-enforced adaptation. High inflation rates reinforced one of the

main consequences of the soft budget constraint; that is, a loss of control in production. This

was aggravated by constant changes in product mix within the equipment line.

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PART THREE: PRODUCTIVE ADAPTATION IN METASA

METASA was the country's first metalworking firm to be established on an industrial scale.

Founded in 1958 by the US company, United Steel, and Nicaraguan private capital, METASA

soon formed part of the incipient manufacturing sector developed under the Central American

Common Market. In 1976, United Steel sold its assets to INFONAC (Instituto de Fomento

Nacional: National Development Institute), the Somoza-controlled bank. The Sandinista

government nationalised the firm, bringing it under state management in the 1980s. The

following provides an overview of the enterprise prior to focusing upon productive adaptation

within the pipe section.

METASA had three main production sections, each based upon distinct technological

processes. The structures section processed imported sheet metal to manufacture, assemble

and install building structures and liquid and gas tanks. It included cutting and bending

processes as well as assembly and welding. The iron rod section consisted of a rolling mill

wherein imported steel billets in a hot state were reduced into iron rods. The pipe section was

based on a cold roll forming process to form pipes, angles and beams from imported sheet

metal. The pipes were then galvanised in an adjoining section.

The firm installed most of its machinery in the early 1960s. Mainly of US origin, its fabrication

dates ranged from 1945 to 1961. In the 1980s, the firm imported machinery and equipment

from Czechoslovakia, Bulgaria and North Korea for its structures section and maintenance

shop. The iron rods section and pipe section continued to operate on the basis of existing

installed capacity.52

METASA depended upon imported raw materials, chemical inputs, tools, spare parts, and

machinery supplies. In the 1970s, it purchased raw materials from the United States,

Venezuela and Japan and could obtain machinery supplies and other inputs at short notice from

US companies. Both foreign exchange constraints and the US trade embargo led the firm to

diversify import sources in the 1980s. From 1980 to 1987, it imported these items from 23

countries. Nevertheless, it continued to face frequent interruptions in the supply of both

144

imported and locally purchased inputs. The latter were affected by foreign exchange

constraints on the local supplier firms.

The firm had always worked on contracts for large construction and infrastructure projects for

both domestic and export markets. In the 1970s, METASA was one of the main Nicaraguan

manufacturing firms exporting to the Central American market. Between 1975 and 1978, its

annual exports represented between 20 and 36 per cent of its total annual sales measured in

production volume.53 In contrast, annual exports dropped to 5 per cent or less of total annual

sales in all but one year between 1981 and 1987. Higher export figures in 1983 were due to

two major export contracts to build a hotel and bridges.

In the 1980s, METASA produced mainly for the Nicaraguan state infrastructure and agro-

industrial investment projects and defence. The state and military sectors represented over

two-thirds of total sales from 1984 to 1987.54 Domestic demand for construction inputs

produced by METASA exceeded domestic production capacity during the period under study.

The defence sector required products traditionally produced by METASA (such as assembled

structures and water and petrol tanks) and generally did not generate a demand for products of

a higher technological complexity.

145

Table 4.8: METASA: Foreign and Domestic Sales, 1980-1987

metric tonsa

Product line 1980 1981 1982 1983 1984 1985 1986 1987

Foreign salesb 3,077 561 165 2,784 377 0 444 844Domestic sales 8,436 16,374 14,511 17,102 18,490 16,163 17,826 15,509Total sales 11,513 16,935 14,676 19,886 18,867 16,163 18,270 16,353

% DivisionForeign sales 27 % 3 % 1 % 14 % 2 % 0 % 2 % 5 %Domestic sales 73 % 97 % 99 % 86 % 98 % 100 % 98 % 95 %

Notes: a. Calculations are based on one decimal place figures. b. METASA exported to the Central American Common Market.

Source: Based on data provided by METASA, sales department.

Table 4.9 shows annual output measured in volume from 1980 to 1987. These output trends

reflect the firm's efforts to adjust to import constraints and domestic demand pressures. In

1980-81, METASA lowered output in response to raw material shortages, utilising less than 50

per cent of installed capacity. Faced with a decline in output, management gave priority to

domestic contracts associated with state investment in the social and economic infrastructure.

Output increased in the 1982-84 period as the firm obtained better access to raw materials. In

1983, it began working on the installations for a new state-owned sugar mill financed by Cuba.

Pressures to complete this project, combined with access to raw materials, led to an increased

utilization of installed capacity.55

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Table 4.9: METASA: Annual Output by Product Line, 1980-1987

metric tons*

Product Line 1980 1981 1982 1983 1984 1985 1986 1987

Structures 2,893 4,830 4,615 5,550 4,182 3,934 4,077 5,653

Annual % of change n.a. 67 -4 20 -25 -6 4 39 Index 1980=100 100 167 160 192 145 136 141 195 Share in sub-total 28 42 29 30 26 30 28 45

Pipes, angles, beams 5,108 5,066 7,800 8,840 7,698 6,434 7,421 4,455

Annual % of change n.a. -1 54 13 -13 -16 15 -40 Index 1980=100 100 99 153 173 151 126 145 87 Share in sub-total 50 45 49 48 47 49 50 35

Iron rods 2,270 1,475 3,523 3,996 4,434 2,757 3,267 2,511

Annual % of change n.a. -35 139 13 11 -38 18 -23 Index 1980=100 100 65 155 176 195 121 144 111 Share in sub-total 22 13 22 22 27 21 22 20

Sub-total 10,271 11,371 15,938 18,386 16,314 13,125 14,765 12,619

Annual % of change n.a. 11 40 15 -11 -20 12 -15 Index 1980=100 100 111 155 179 159 128 144 123

Galvanised sheet metal 1,425 0 0 0 20 3,568 5,722 6,342

Annual % of change n.a. n.a. n.a. n.a. n.a. 17,740 60 11 Index 1980=100 100 0 0 0 1 250 402 445 Share in total 12 0 0 0 0 21 28 33

Total 11,696 11,371 15,938 18,386 16,334 16,693 20,487 18,961

Annual % of change n.a. -3 40 15 -11 2 23 -7 Index 1980=100 100 97 136 157 140 143 175 162

Note: * Calculations are based on one decimal place figures

n.a. signifies not applicable

Source: Based on output figures from METASA, production department

147

Higher annual output figures from 1985 to 1987 were due largely to the reopening of the

corrugated roofing line. Concerned solely with cutting and bending processes, this line

represented between 21 and 33 per cent of annual output measured in volume in this period,

but was far less significant in terms of value added. When this line is excluded, average annual

output in the 1985-87 period is lower than that of the previous three years. From 1985 to

1987, the firm continued to produce for major state contracts and attempted to regain export

markets in the latter year. Yet input shortages and machinery-related problems continued to

interrupt production.56

Output trends in the pipe section responded to this same combination of pressures and

constraints. This section lowered output and utilization of installed capacity in 1980-81 in

response to raw material shortages. Output in pipes, angles and beams reached its highest

levels in 1983 as the firm obtained major state contracts and gained access to raw material

supplies. Machinery-related problems constituted one of the main factors limiting output from

1984 to 1987 and was the main factor explaining the drop in output in the latter year.

From 1983 to 1987, the firm attempted to maximise output based on an increased utilization of

installed capacity. In doing so, it continually ran up against resource constraints, forcing it to

adapt in the area of inputs and machinery. The following sections will analyse this process of

productive adaptation in the pipe section with reference to the four categories outlined in the

analytical framework.

1. Adaptation Given Foreign Exchange Considerations

METASA diversified import sources and shifted to supplier credit lines in response to foreign

exchange constraints and the US trade embargo. This enabled the firm to avoid severe raw

material shortages in the 1983-87 period. Yet the pipe section continued to face input

shortages and often could not obtain vital supplies for its machinery park. These supply

148

conditions influenced inventory trends, as well as the firm's response to machinery-related

problems.

Raw materials accounted for a large share of inventories due to annual ordering procedures,

and the firm's efforts to maintain buffer stocks as a shield against delays in delivery of materials

in the following year. The pipe section attempted to keep buffer stocks between the different

production phases so as to facilitate the continuous cold roll forming process and guarantee

materials supply to the galvanization section. Frequent input shortages and machinery failures

reinforced this concern.57 Finished goods represented a relatively small share of total

inventories due to the demand for domestic construction inputs, as discussed further below. 58

METASA's response to machinery-related problems represented a form of adaptation given

foreign exchange considerations. This applies to management's purchasing and investment

decisions, as well as shop-floor initiatives. Foreign exchange was required to overcome the

basic problems in this area. At least three types of expenditure could have contributed to that

end:

• the purchase of spare parts and machinery supplies required to guarantee an adequate

maintenance of the existing machinery park;

• the replacement of select machinery and equipment in the pipe section; and

• investment in machinery and equipment for the maintenance section to facilitate spare-

parts production.

The first type of expenditure depended largely upon the amount of foreign exchange which the

Central Bank allocated to METASA. Spare parts and accessories represented less than 5 per

cent of total annual foreign exchange disbursements to the firm for raw materials, spare parts

and accessories. These figures included foreign exchange in convertible currency and in the

form of credit lines. Spare parts purchases for the existing machinery park required convertible

currency whereas raw materials were obtained primarily through credit lines. METASA also

bought a limited number of parts, using export earnings in convertible currency and foreign

149

exchange obtained on parallel markets.59

The firm did not purchase new machinery and equipment for the structural mill area during the

period under study. This area utilised specialised equipment which was not available through

larger import packages, and for which there were fewer opportunities to negotiate special

projects. Likewise, the utilization of select new equipment would have depended upon the

performance of other machinery and equipment in the plant which were purchased second-hand

in the 1960s.60 Nor did METASA invest in new equipment for the galvanization area, despite

frequent problems with the furnaces and auxiliary equipment. Technical failures were

associated with the age and state of this equipment, as well as shortages of imported spares,

lubricants and other supplies. METASA received priority status within state strategy precisely

because its existing installed capacity and technical know-how could be used to meet current

production objectives.61 A major investment in the replacement of its machinery park would

have had to compete with other public investment priorities at the national level.

Yet machinery performance could have been improved significantly through investment in new

auxiliary equipment, as well as spare parts and other machinery supplies. By the end of 1987,

METASA and the state metalworking division had identified those investments which would

have improved utilization of existing installed capacity in the structural mill area. This included

purchases of new condensers, direct current motors, rectification and velocity control, a new

set of dies, and spare parts and accessories for the structural mill. Investment costs were

estimated at US $281,500 and would have required convertible currency.62

METASA did invest in new machinery for its maintenance section. Initially, this section utilised

US machine tools whose fabrication dates ranged from 1945 to 1961. From 1985 to 1987, it

installed newly imported lathes, a milling machine, drills, and other machine tools to facilitate

spare-parts production. Machine tools were available through supplier credit lines based on

bilateral government arrangements with Bulgaria, Czechoslovakia and North Korea. These

import packages included standard machinery whose technical characteristics did not vary

significantly between countries.63

150

Shop-floor personnel responded to foreign exchange constraints by carrying out minor

improvements to the existing production process. For example, they mechanised the transfer of

materials in the galvanization area, thereby improving working conditions and increasing the

pace of production. The shop-floor supervisor implemented changes in chemical usage, leading

to improved product quality and a reduction in material wastage. This section recovered zinc

powder from the galvanization process, which was then exported to obtain both foreign

exchange and imported goods through barter trade. The extraction of this powder also

improved working conditions.64 These changes were not forced by immediate resource

constraints; nor did they represent optimal solutions to current production problems as

compared to alternatives that would have required foreign exchange and/or access to US

suppliers. Rather these shop-floor initiatives constituted a form of adaptationgiven foreign

exchange constraints. Chart 4.10 lists minor changes to the production process, distinguishing

between the above improvements and forced substitutions.

151

Chart 4.10: METASA: Pipe Section, Galvanization Area Minor Changes to the Production Processa

1980-1987

Process Description of Change ForcedSub-stitution

Improve-ment

Results

Hydrochloric acid tank Input saving change x Process required more time/Productquality declined

Galvan-ization

Ammonia tanks Input saving change x Reduction of zinc wastage/Lowerproduct defect rates

Ammonia tanks Input substitution x Improved product quality

Heat furnace Equipment reconstruction x The heat furnace retained itsoriginal operating features, exceptthat fuel consumption increased

Materials transfer Mechanization ofmaterials transfer

x Eliminated strenuous and hazardousjobs

Galvanization furnace Equipment reconstruction x The galvanization furnace retainedits original operating features

Galvanization furnace Mechanization of workprocess

x Eliminated strenuous and hazardousjobs

Galvanization furnace Utilization of byproductsb x Improved working conditions/Thefirm exported the zinc powder,obtaining both foreign exchange andimported goods through barter trade

Materials transfervapour cleaning

Mechanization of workprocess

x Eliminated strenuous and hazardousjobs/Reduced time required forthese operations/Improved productquality

Materials transfer Input substitutionc x Foreign exchange savings

Notes: a. See appendix to Chapter Four for a more specific description of thesechanges.

b. The plant supervisor designed an extractor and cyclone system to recoverzinc powder.

c. In-house production of gearing chains to replace imports.

Source: METASA, Interview no. 19 (April 1988), Alejandro Aguilar, production departmentdirector (1980-1987); Interviews no. 21 (April, May 1988), with workers in eachphase of the cold roll forming process; and Interview no. 25 (April 1988), ManuelMayorga, galvanization area supervisor (1980-1987)

152

1.a. Sub-conclusion

METASA's response to machinery-related problems was characterised by the absence of

investment in the replacement of select machinery and equipment and low expenditure on spare

parts and other machinery supplies. At the same time, METASA imported machine tools to

facilitate spare-parts production and other repair work. Its purchasing and investment decisions

were shaped by the foreign exchange constraint in convertible currency, the US trade embargo, and

the availability of supplier credit lines tied to specific import packages. Within the pipe section,

shop-floor personnel carried out minor improvements to the existing production process in the face

of constraints on the firm's ability to replace equipment. Finally, METASA's inventory policy

reflected its growing reliance upon supplier credit lines, as well as its efforts to adapt to supply

uncertainty.

2. Adaptation to Resource Constraints

METASA's pipe section included cold roll forming and galvanization processes. Due to the nature

of its production processes, this section was often forced to adjust its output volume to current

bottlenecks. Supply interruptions and machinery-related problems could bring the entire plant to a

halt. The firm carried out forced substitutions of inputs and machinery (including equipment

reconstruction) in an effort to keep the plant in operation.65 This section will now describe the

production process, identify the main bottlenecks in each stage, and document cases of productive

adaptation.

2.a. The Structural Mill Area

The structural mill area consisted of a cold roll forming process which included three stages:

1) the sheet metal was cut into strips according to the dimensions specified for a given type

153

of pipe, angle or beam;

2) the strips were flattened out and welded into a continuous strip which was transferred

along a mechanical roller system to the structural mill;

3) in the structural mill, the strip passed through three roll-forming dies which gave

preliminary shape or form to the metal. This material then passed through a second group of

roll-forming dies which gave the product its final form. Finally, the product passed through

saw cutting discs attached to a moving car synchronised to the velocity of the transport

system.

Diagram 4.11 illustrates this cold roll forming process.

154

Diagram 4.11

155

This area utilised both standard and specialised machinery and equipment based on mechanical,

hydraulic and pneumatic systems. Besides the structural mill itself, this section included equipment

for carrying out those processes illustrated in Diagram 4.11; additional materials transfer equipment

such as forklifts and a travelling overhead crane; and other auxiliary equipment such as electrical

motors, an air compressor and a steam boiler.66

In each phase of production, resource constraints caused frequent work stoppages or delays as

shown in Chart 4.12.67

Chart 4.12 METASA: Causes of Downtime in Each Phase of the Cold Roll Forming Process, 1980-1987

Process Factor

General lack of raw materials

electricity shut-downs

electrical surges, damaging machinery parts

lack of imported spares and electrical parts forthe forklifts, resulting in frequent breakdowns

1st Stage: Materials preparation lack of cutting blades

resetting of cutting blades for product changes

2nd Stage: Preparing the metal strips material shortages due to problems in previousstage

3rd Stage: Cold roll forming machinery breakdowns due to mechanical orelectrical failures and lack of replacement parts

change rolling dies for product changes

interruptions in flow of lubricants, causingoverheating of rolling dies

frequent wearing down of contacts

shortage of cold roll forming dies

shortage of saw cutting discs

problems with hydraulic pump

Source: METASA, Interview no. 19 (April 1988), Alejandro Aguilar,production department director (1980-1987); and Interviews no.21 (April, May 1988), with workers in each phase of the coldroll forming process; plus direct observation.

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The firm was often forced to lower output in the face of raw material shortages and electricity shut-

downs. In 1980-82, the lack of raw materials was one of the main factors explaining

underutilization of installed capacity. Machinery-related problems, aggravated by shortages of

spare parts and other supplies, represented the main source of downtime in the 1983-87 period.68

The structural mill area carried out repair work in an effort to keep the plant in operation. The

machinery and equipment were organised in a line layout according to their intervention in the

production of a narrow range of products. When there were technical failures in a particular

machine, this section could not change its output mix or the utilization of its machinery to by-pass

this constraint. Machinery-related problems meant downtime in both the immediately affected area

and those dependent on it for materials supply. Maintenance and repair activities became an

important determinant of this section's ability to maintain output in the face of import constraints.

Maintenance work continued to be corrective rather than preventive during the period under study.

The structural mill area did not define comprehensive preventive maintenance procedures.

Attempts at preventive maintenance were limited by the lack of spare parts, as well as the absence

of technical documentation. 'Even when we had information regarding the parts that needed to be

replaced periodically, we could not acquire these parts through import channels, nor did we have

the capacity to produce parts for stock,' stated Milton Icaza, technical department director.69

METASA's mechanics were reluctant to take apart the machinery when there were no spares in

stock.

Once the machinery was down due to a damaged part, the maintenance section made a replacement

part, at the same time producing an extra spare to keep in stock. Therefore, repair time often

included the time required to produce a replacement part. Several factors, both internal and

external to the firm, affected in-house spare-parts production. The firm lacked adequate raw

materials, particularly speciality steels, required for many of the parts. The absence of a materials-

testing department affected the quality of parts produced in-house, as did the lack of heat treatment

capacity. The maintenance section carried out quality control only on a visual basis. As a result,

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replacement parts produced in-house lasted about one-third of the time of an imported spare.70

From 1980 to 1986, the maintenance department did not keep records of parts produced in-house

or repair work carried out on individual machines. It focused on solving immediate problems

rapidly, but did not begin to develop an information base by which to judge the effectiveness of

maintenance and repair work until 1987.71 External constraints, as well as the lack of technical

documentation for its machinery, reduced the room for improvement in maintenance and repair.

This may partly explain why the firm was slow to develop an effective feedback system in this area.

Yet the absence of maintenance records also reflects a more general trend. While its administrative

offices spent considerable time compiling information for central government, the firm lacked

adequate data systems in areas crucial to production.

In sum, maintenance and repair work involved various types of forced substitution simultaneously.

The firm carried out maintenance and repair work on a production process which could not be

replaced or upgraded through investment in new equipment. Shortages of spare parts and

machinery supplies hindered these maintenance and repair activities. METASA began to produce

spare-parts on a one-off basis to overcome these import constraints. Unable to import speciality

steels for spare parts production, the firm was forced to utilise inadequate raw materials. Poor

information systems, the absence of a materials-testing department, and inadequate quality control

procedures posed internal constraints on the firm's ability to improve in-house spare-parts

production and maintenance and repair work under these circumstances.

By carrying out these forced substitutions, METASA was able to keep the structural mill area in

operation. However, this pattern of productive adaptation eventually wore down production

capacity. By 1987, production capacity in the structural mill area had declined to about 45 per cent

of 1978 levels, according to estimates of a local consulting firm.72 This area encountered its most

severe machinery-related problems at the close of the period under study. Table 4.13 shows

downtime due to technical failure as a percentage of work hours programmed for the first six

months of 1987.73

Table 4.13 METASA, Structural Mill Area: Downtime due to Technical Failure as a Percentage

158of Programmed Work Hours, January-June, 1987

Month Jan. Feb. Mar. Apr. May. June

67% 50% 26% 28% 11% 18%

Source: METASA, production department

Problems with the pipe-welding equipment also limited pipe production from October to December

1987. This in turn affected the supply of materials to the galvanization area.

2.b. The Galvanization Area

The galvanization area was frequently forced to adjust its output volume to current bottlenecks.

This area also carried out forced substitutions and minor improvements to the production process.

The galvanization area included three stages:

1) The chemical cleaning process removed heavy oils, grease and dirt from the pipes' surface

and consisted of soaking the pipes in a series of tanks containing chemical substances and

water.

2) The pipes were soaked in an ammonia tank, then passed through the heat furnace and

were subsequently introduced into the galvanization furnace. Vapour cleaning was used on

the pipes' interior surface before the pipes were cooled in a water tank.

3) Screws were cut into one pipe end and a cap was placed on the other. Diagram 4.14

illustrates this process.74

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Diagram 4.14 METASA, Pipe Section: Galvanization Process(Source: METASA, direct observation)

STORE ROOM

CAUSTIC SODA TANK

WATER TANK

HYDROCHLORIC ACID TANK

HYDROCHLORIC ACID TANK

WATER TANK

WATER TANK

AMMONIA TANK

HEAT FURNACE

GALVANIZATION FURNACE VAPOUR CLEANING

PIPE SCREW CUTTING

STORE ROOM

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This area depended upon pipe-production levels and could be brought to a halt due to problems in

the structural mill area. For example, the galvanization area faced interruptions in the supply of

materials from July 1986 to May 1987. Chart 4.15 identifies causes of downtime in each phase of

the galvanization process.75

Chart 4.15: METASA: Causes of Downtime in Each Phase of the Galvanization Process 1980-1987

Process Factor

General lack of pipes to be galvanized due to workstoppages in cold roll forming process

electricity shutdownsa

Chemical cleaning lack of chemical inputsb

technical difficulties with overhead travellingcrane

Galvanization lack of chemical inputs

mechanical failure in the air compressor due tolack of spare parts

reconstruction of the heat furnace due todeterioration

breakages in the furnace hearth due to the ageof the galvanization furnace, requiring itsreconstruction

Screw cutting lack of cutting blades

Notes: a If the electricity is cut off for more than five hours, this begins to damage thegalvanization oven insofar as it affects the chemical properties of the fire clay bricksand hearth. This augments the frequency of breakdowns.

b METASA faced interruptions in the supply of both imported and locally-producedchemical inputs as import constraints also affected local chemical plants.

Source: METASA, Interview no. 19 (April 1988), Alejandro Aguilar,production department director (1980-87); and Interviews no.26 (April, May 1988), with workers in each phase of thegalvanization process; plus direct observation.

This section carried out forced substitutions of inputs and machinery. For example, faced with

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shortages of locally-supplied hydrochloric acid, this section processed double the amount of pipes

with the same amount of chemical inputs. While it saved on hydrochloric acid, the process required

more time and product quality declined. The breakdown of the heat and galvanization furnaces

resulted partly from a lack of imported parts required for their maintenance. This brought the plant

to a halt on two separate occasions in 1987, forcing the section to rebuild the equipment. To

reconstruct the galvanization furnace, the firm utilised scrap fire clay bricks in the face of import

constraints on this item. The rebuilt furnaces retained their original operating features, except for

an increase in fuel consumption in the heat furnace. The main cost was in production lost during

the period in which the plant had been shut down to allow for reconstruction.76

In 1987, production capacity in the galvanization area remained at 1978 levels, despite the lack of

investment and numerous import constraints on maintenance and repair work. This was partly due

to minor improvements to the existing production process such as the mechanization of materials

transfer.77 Likewise, shop-floor personnel were able to reconstruct the furnaces while maintaining

their original operating features. This area was less affected than the structural mill by shortages of

spare parts and machinery supplies.

2.c. Sub-conclusion

Because of the nature of its production process, METASA’s pipe section was often forced to

adjust output volume to the current bottleneck. In Kornai's terms, shortage and slack appeared

simultaneously. The structural mill area aimed to overcome machinery-related problems quickly so

as to minimise slack. Maintenance and repair work in this area involved various types of forced

substitution simultaneously. The galvanization area carried out forced substitutions to overcome

current bottlenecks, as well as a series of improvements not dictated by immediate circumstances

(see Chart 4.10). This pattern of adaptation developed in the face of foreign exchange constraints

on the firm's ability to rehabilitate or upgrade its machinery park.

As a result, the pipe section remained in operation despite severe import constraints. Yet this

adjustment process could not overcome the basic trend identified by Kornai. In the face of constant

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shortages, other resources in the same plant remained unutilised due to complementarity between

inputs. Efforts to mitigate this problem through forced substitutions were effective only in the short

run. In the structural mill area, forced substitutions plus the absence of preventive maintenance

eventually wore down the machinery park, resulting in downtime and a corresponding decline in the

volume of output. This circle could have been broken through a relatively minor investment in

auxiliary equipment, as well as the purchase of select spare parts and accessories. Yet this would

have required changes in central government decisions regarding the allocation of hard currency.

3. Demand-Oriented Adaptation

3.a. Output Maximization

Adjusting both input usage and machinery utilization, METASA maximised output, given resource

constraints. Production, with forced substitutions, increased until it came up against bottlenecks

caused by shortages that the firm could not overcome. To what extent was this adjustment process

driven by demand conditions and/or the government output plan? This section consistently lagged

behind the plan in all three product lines. Even with forced adjustments, output targets could not

be met. Since the state metalworking division set these targets and allocated raw material imports,

it was not in METASA's interest to lower output targets. At the same time, input shortages and

machinery breakdowns held output and sales below the level permitted by available raw materials.

Quantitative output targets tied to import quotas constituted one factor encouraging the firm to

produce up to the level determined by resource constraints.

Yet immediate pressures on production came from the firm's main customers, who were primarily

in the state sector. This demand was not planned on an annual basis. From 1980 to 1986, both

state and private customers placed production orders throughout the year, thereby requiring

constant readjustments in production programming. The central government exerted considerable

pressure on METASA to speed up work on major contracts.78 These demand conditions led to

taut capacity utilization in the pipe section, requiring forced substitutions of inputs and machinery.

This adjustment process can be further understood as demand-oriented adaptation insofar as it

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responded directly to pressures from the firm's main customers, particularly the central government.

In this case, the relative bargaining strength of the state as user firm explains the degree of demand

responsiveness displayed by METASA.

Contract type also influenced exchange relations between METASA and its main customers, partly

explaining why the firm continued to meet quality standards on major construction and

infrastructure projects throughout the period under study. Under production for construction

contracts, the producer-seller has to meet engineering norms for the design supplied by the user-

buyer, leaving little room for a decline in product quality. This stands in contrast to exchange

relations between producers and users of basic consumer goods in a shortage economy. METASA

thus pursued quantitative output increases and maintained quality standards simultaneously, albeit

at the cost of high rejection rates. The latter, together with increasing downtime, signalled limits to

its process of demand-oriented adaptation. These limits became particularly apparent as the firm

attempted to regain export markets in 1986-87.

3.b. Export Trends and Limits to Demand Oriented Adaptation

Table 4.16 shows annual output and export figures for pipes, angles and beams from 1980 to 1987.

Table 4.16: METASA, Pipe Sections: Annual Output and Exports of Pipes, Angles and Beams, 1980-1987

metric tons*

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Product line 1980 1981 1982 1983 1984 1985 1986 1987

Total Output 5,120 6,771 4,131 8,840 6,184 6,435 7,422 2,812

Annual % of change

n.a. 32 % -39 % 114 % -30 % 4 % 15 % -62 %

Index 1980=100 100 132 81 173 121 126 145 55

Total Exports 2,200 343 91 1,369 483 0 537 298

Annual % of change

n.a. -84 % -73 % 1404 % -65 % -100 % n.a. -45 %

Index 1980=100 100 16 4 62 22 0 24 14

Note: * Calculations are based on one decimal place figures. n.a. signifies not applicable.

Source: Based on data provided by Nicaragua, Ministry of Economy, Industry and Foreign Commerce, 1980-1987.

These figures show similar export trends to total figures for METASA from 1980 to 1986. These

trends correspond to a combination of import constraints and domestic demand pressures facing

METASA, as described in the above overview.

METASA shifted to the domestic market in response to direct pressures from the central

government to meet state contracts in the face of resource constraints. This interrupted the firm's

long-standing relations with a number of Central American customers. In 1986-87, the state

metalworking division pressured METASA to recover export markets, and participated directly in

efforts to obtain contracts in the other Central American countries. At the same time, the firm

continued to face pressures from other government ministries to supply the domestic market.

These direct pressures from the state had a greater impact upon the firm's marketing decisions than

export promotion schemes.79

What was the relation between export trends and efforts to respond to domestic demand pressures

within the pipe section? Quality standards on domestic contracts were similar to that of export

markets. METASA’s pipe section did not face the problems encountered by the industries that

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changed the material composition or other technical characteristics of their products in response to

changing domestic demand pressures. For example, the textile and clothing industry faced

difficulties recovering export markets after having carried out product changes to supply basic

consumer goods, military uniforms and other items for the domestic market.

Chapter Three pointed to two additional aspects of productive adaptation in Nicaraguan

manufacturing firms that affected their ability to re-enter export markets. First, several firms

utilised existing installed capacity to maximise output for the domestic market in the face of

numerous constraints, without adequate investment in maintaining, rehabilitating or upgrading the

plant. This did occur in METASA’s pipe section. Taut capacity utilization, entailing a series of

forced substitutions, eventually wore down its machinery park. Frequent technical failure in the

machinery and consequent plant shut-downs compounded ongoing difficulties in production

programming. Under these circumstances, METASA could not recover previous export levels,

while guaranteeing delivery dates. In 1987, the combined exports of pipes, angles and beams

dropped to 14 per cent of 1980 levels.

Second, the process of adjustment to resource constraints often had a negative impact on product

quality. METASA did not have severe problems in this area relative to other firms which were

forced to adapt to inadequate raw materials.80 Some of these firms exported a lower-grade

product, reducing product prices accordingly. In METASA’s case, inadequate maintenance

affected product quality negatively, contributing to scrap rates of about 5 per cent in the 1986-87

period. This compares to an acceptable rate of about 2 per cent for this production process,

according to the state metalworking division.

More precise information on the state of the machinery and its effect upon product quality were not

available. 81 Quality control was carried out on a visual basis. The supervisor decided when to

reject materials, parts or semi-finished products, and also classified final products into two quality

grades, but did not keep written records of rejection rates or final product quality performance.

Quarterly and annual production evaluations did not include data on changes in quality performance

over time. Rather, these reports focused on obstacles to quantitative output increases and the steps

taken to address these problems.82

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In the galvanization area, minor modifications to the existing production process did have a positive

impact upon product quality. In the ammonia tank, changes in input usage and production

technique resulted in quality improvement, with the latter also leading to reduced material wastage.

The mechanization of materials transfer and the vapour cleaning process improved working

conditions and product quality simultaneously.83 (See above, Chart 4.10) In very general terms,

these improvements given foreign exchange constraints also formed part of METASA’s process of

demand-oriented adaptation. Nevertheless, they could not reverse the main trends noted here.

Machinery-related problems, stemming from import constraints, continued to limit this section’s

capacity to meet delivery dates and lower scrap rates.

3.c. Sub-conclusion

Pressure from the state as METASA's main customer, combined with quantitative output targets

tied to import quotas, led to taut capacity utilization in the pipe section. This involved constant

adjustments in input usage and machinery utilization to overcome resource constraints. This

adjustment process may be further understood as a form of demand-oriented adaptation insofar as

it responded to direct pressures from customers to complete major contracts. As customer, the

central government had considerable influence over METASA's current production decisions. In

this case, the power of the user-buyer relative to that of the producer-seller exceeded that

envisioned in Kornai's account of the resource-constrained economy. Likewise, contract type

influenced the capacity of user firms to enforce quality standards.

Nevertheless, limits to METASA’s process of demand-oriented adaptation became particularly

apparent as the firm attempted to regain export markets. METASA continued to maximise

capacity utilization under severe resource constraints without a corresponding investment in

maintenance and repair. A series of forced substitutions eroded production capacity in the

structural mill area, thereby undermining its ability to reduce scrap rates, meet delivery dates, and

re-enter export markets. These findings underline the need for resource allocation to be finely

tuned to firm-level adjustment processes and co-ordinated with demand-side pressures exerted by

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state institutions in their role as user firms.

4. Productive Adaptation and Financial Conditions in Local Currency

To what extent and how did the soft budget constraint in local currency and high inflation rates

influence METASA’s current production and investment decisions? When documenting specific

instances of adaptation in each phase of the cold roll forming and galvanization processes, we did

not find cases of adaptation to changing input prices in local currency. The firm's ability to augment

its product prices in line with rising costs provides sufficient explanation for the absence of this type

of price-enforced adaptation. Profits as a per cent of sales were high in this period largely due to

cost-plus pricing policy.84

Likewise, price did not determine output levels. From 1980 to 1982, the margin of contribution did

not cover fixed costs largely because of low capacity utilization in the face of resource constraints.

In the inflationary period, the margin of contribution exceeded fixed costs due to pricing policy.85

In other words, product prices were adjusted to cover the costs of maintaining these output levels

despite resource constraints. Neither the state metalworking division nor METASA calculated the

domestic costs of exports. Such calculations were virtually impossible given arbitrary prices.

In the 1985-87 period, the firm came under direct state administrative pressure to reduce costs in

local currency as rising costs for construction inputs constituted a major source of inflation.86 Yet

even when the firm was motivated to reduce costs, this did not generate productive adaptation in

the pipe section. The same conditions that contributed to the soft budget constraint, plus the

uneven effect of inflation on different cost items, undermined any effort to evaluate performance or

take production decisions based on financial indicators in local currency. Under these conditions,

domestic prices were unable to guide adjustment in the productive sphere.

Inventory policy and raw material usage generally constitute important areas in which costs may be

reduced. Yet in METASA's case, the costs of imported raw materials remained low relative to

other items due to government exchange rate policy.87 METASA's large buffer stocks were not

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reflected accurately in figures on raw material inventory turnover due to the low costs of raw

materials relative to other items comprising cost of sales. Likewise, the declining share of raw

materials in total variable costs did not reflect lower scrap rates or other changes in raw material

usage.88

Indirect costs increased dramatically both in absolute terms and as a percentage of variable costs

because these items were purchased locally.89 The firm could not switch to foreign sources for

these items insofar as this would require convertible currency. Volatile price changes in this area

hampered METASA's efforts to draw up a cost structure for its main products and identify areas

where costs could be reduced.90 Annual labour costs as a percentage of total costs reflected

government wage policy in the inflationary period rather than changes in labour productivity.

Financial costs were minimal from 1985 to 1987 as high profit margins enabled the firm to finance

an increasing portion of its own operations.91 Likewise, the firm counted on customer advance

payments to finance current operations. Also, interest rates on bank loans were negative in the

inflationary period. The increase in maintenance and repair costs reflected the purchase of spare

parts locally, an almost complete reliance on corrective rather than preventive maintenance, and

often suboptimal solutions to machinery-related problems, given import constraints. Finally,

administrative expenses accounted for a major part of rising operating costs. The above factors led

to a breakdown in the mechanisms by which prices may guide adjustment in the productive sphere.

The soft budget constraint in local currency further explains the firm's investment behaviour.

METASA did not carry out pre-investment studies nor attempt to calculate the profitability of

investment in new machinery and equipment. It had access to credit in local currency to cover

investment expenditures and did not risk bankruptcy or closure if the investment failed. At the

same time, foreign exchange constraints curbed the firm's investment capacity. Under these

conditions, METASA operated with existing installed capacity, invested in machine tools for the

maintenance section, and fabricated spare parts in-house. Management did not carry out financial

calculations in local currency regarding these decisions which shaped the nature of productive

adaptation in the structural mill and galvanization areas.

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4.a. Sub-conclusion

The soft budget constraint in local currency explains why rising input prices did not generate price-

enforced adaptation in the pipe section. The soft budget constraint, plus high inflation rates and

their uneven effect on different cost items, led to a breakdown in the mechanisms by which prices

may guide adjustment in the productive sphere. The resultant loss of control in production was as

serious as motivational issues associated with the soft budget constraint. Finally, METASA's

investment decisions were shaped by the availability of foreign finance rather than by financial

considerations in local currency. The soft budget constraint explains why METASA could

continue to operate the pipe section without further investment in maintaining and upgrading the

plant.

SUMMARY AND CONCLUSION

This conclusion summarises and compares patterns of productive adaptation in IMEP and

METASA, and briefly relates these findings to the role of the state in the economy. Foreign

exchange considerations determined each firm’s decision to invest or operate with existing

installed capacity. Import opportunities offered by supplier credit lines propelled IMEP’s

investment in equipment and parts production capacity. The central government used its

control over foreign resources to promote the development of IMEP’s equipment line, thereby

shaping this form of adaptation given foreign exchange considerations. In contrast, METASA

faced severe foreign exchange constraints on its ability to replace select machinery and

equipment within the pipe section, despite its priority status in state strategy. The nature of

their production processes further accounted for contrasting patterns of investment between

these two priority firms. IMEP employed general-purpose machinery organised on a

workshop basis, while METASA utilised specialised equipment in a continuous production

process. The former facilitated the ability of Nicaraguan metalworking firms to shift to new

suppliers in the face of foreign exchange constraints in convertible currency and the US trade

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embargo.

Foreign exchange considerations also influenced their choice of inputs and management of

inventories. Both firms maintained large raw material inventories and faced constant input

shortages simultaneously. These firms did hold buffer stocks to guard against shortages.

Annual ordering procedures, required by socialist country suppliers, also limited their ability to

reduce inventories and adjust these to changing domestic demand conditions. Consequently,

these firms had little room within which to develop the type of capabilities in inventories

management required to secure long-term competitiveness.

Kornai’s three basic forms of adjustment to resource constraints are relevant in the case of

IMEP and METASA. Both firms adjusted output volume to the current bottleneck with

consequences similar to that outlined by Kornai. Other resources in the same plant remained

unutilised due to complementarity between inputs. METASA’s pipe section was often forced

to carry out this form of adaptation due to the nature of its production process. In contrast,

IMEP adjusted output composition to available inputs and machinery, thereby minimising

slack within its own production processes. This form of adjustment contributed to positive

growth trends from 1980 to 1987, even as the firm continued to produce to customer

demand.92

IMEP and METASA implemented forced substitutions of inputs and machinery. Within

METASA’s pipe section, maintenance and repair work involved various types of forced

substitution simultaneously. These adjustments enabled the pipe section to remain in

operation despite severe import constraints. Yet this pattern of adjustment eventually wore

down its machinery park, leading to more frequent technical failure and additional downtime.

IMEP did not depend upon this form of adjustment to remain in operation. Rather, it resorted

to forced substitutions to complete work on major state contracts. These two distinct patterns

of forced substitution each involved an inefficient use of resources.

Both firms also carried out forced substitutions capable of saving foreign exchange and

contributing to technological development. IMEP initiated equipment-parts production, while

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METASA shifted to in-house spare-parts production. These specific instances of forced

substitution derived their significance from the country’s traditional dependence upon foreign

suppliers for these items, as well as their potential role in the government’s technological

development strategy. However, these efforts could only be as effective as the overall

adjustment processes characterising each enterprise.

Both IMEP and METASA carried out demand-oriented adaptationdespite market conditions

marked by shortages and the relatively passive role of domestic money. Their responsiveness

to customer demand may be explained in light of three key differences between the seller’s

market, as defined by Kornai, and demand conditions facing these enterprises. First, the state

as user firm had a more important impact on current production decisions than the state as

planner of output targets. Second, there was greater interplant communication and

interdependence than that found under centralised planning. Third, in IMEP’s case, the

demand for locally-produced equipment stemmed from temporary import constraints within a

small market that had traditionally been supplied by foreign firms. IMEP’s customers

compared its products to the imported items even when the latter was not currently available.

As a result, IMEP’s output mix evolved in response to buyers’ requirements. The firm

developed technical capabilities in equipment construction and machining processes, while

responding to immediate user needs in agriculture and agro-industry. METASA met major

state infrastructure and construction contracts despite severe import constraints.

Nevertheless, limitations inherent to these adjustment processes became increasingly apparent

over the period under study.

Kornai’s concept of the soft budget constraint is useful in explaining the absence of price-

enforced adaptation in both firms, their room to manoeuvre in adjusting to other external

circumstances, and some of the main limitations associated with these adjustment processes.

The soft budget constraint, combined with the uneven effect of inflation on different input

prices, made it virtually impossible to evaluate performance or take production decisions based

on financial indicators. This loss of control in production was as important as motivational

issues associated with the soft budget constraint.

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How do these results relate to the role of the state in the economy? The nature of external

finance curbed the state’s capacity to implement its industrial strategy based upon its control

over foreign resources. Within these constraints, the central government influenced the nature

of adaptation given foreign exchange considerations, as well as daily patterns of adjustment to

resource constraints. By using foreign exchange allocations as its main planning instrument, it

was able to mobilise and direct resources towards key objectives, but was less effective in

securing their efficient use. Resource constraints and supply uncertainty remained among the

main sources of inefficiency throughout the period under study. The case study findings

underlined the need to redirect and strengthen the capacity of enterprises to adapt to

immediate resource constraints.

As user firm, the state generated processes of demand-oriented adaptation and shaped their

nature to a significant degree. The case study findings indicated the need for closer co-

ordination between industrial policies implemented on the supply side and those state policies

and purchasing decisions that affected the demand conditions facing enterprises. The goal

would be to enable and enforce forms of demand-oriented adaptation that were closely tied to

buyers’ requirements and that could be sustained in the long term.

As regulator of economic activity, the state influenced the nature of the budget constraint

upon enterprises in both foreign exchange and local currency. In Kornai’s terms, the case

study findings called for a ‘hardening’ of the budget constraint. This would have to be

combined with positive measures aimed at improving adaptive capacity within enterprises.

Otherwise several enterprises, operating under severe import constraints, would be unlikely to

meet strict financial criteria, leading to unresolvable tensions between these criteria and social

transformation goals. The challenge would be to encourage forms of adaptation that would

gear limited resources towards social transformation goals, while enhancing the capacity of

enterprises to generate value added in foreign exchange. Based upon the findings presented in

Chapters Two to Four, the conclusion to this thesis will look more closely at these issues

pertaining to the nature of productive adaptation and the role of the state in the economy

during the 1980-87 period.

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174

NOTES

1 For a more detailed account, see appendix on case study methodology.

2 In IMEP and METASA, I began my research by reviewing administrative files within eachdepartment. In this way, I ensured that information constraints were characteristic of the context under studyrather than the result of poor access to data.

3 Kornai discusses inventories in the context of the seller’s market. In the Nicaraguan case, rawmaterial inventory policies were likely to be shaped by foreign exchange considerations.

4 This category also includes technical initiatives aimed at improving performance given foreignexchange constraints, as discussed in Chapter One.

5 See Kornai (1980), Chapter Two, p.l21-48.

6 Demand-oriented adaptation is first considered independently of price, as stated in Chapter One.

7 In developing this approach, we drew upon Kornai’s acccount of the seller’s market, although thiswas not directly applicable to the Nicaraguan case. See Kornai (1980), Chapter Six, p.109-125.

8 See Kornai (1980), Chapters Thirteen and Fourteen, p.299-351.

9 For example, IMEP developed the equipment line around a broad product mix in response toimmediate user needs. The soft budget constraint in local currency explains its ability to carry out this form ofdemand-oriented adaptation, as well as some of the main limitations of this adjustment process.

10 This study focuses upon productive adaptation within the factory and therefore will not discuss on-siteinstallation of steel structures.

11 IMEP, imports department, imports records (1982-87).

12 IMEP, Interview no.1 (July 1987), Julio Valladares, director (1985-87).

13 IMEP, Interview no.1 (July 1987), Valladares.

IMEP, office of the director, list of input requirements which could not be met in 1987.

14 IMEP, office of the director, investment report (1980-87) for National Financial System.

15 Victor Thomas, production and technical department head, described IMEP's investment process in thefollowing manner.

"We sought out investment opportunities by obtaining the catalogues of foreign country suppliers who were signingco-operation agreements with the government. When credit lines were on offer, we arrived at the meeting with a listof the machinery we required which could be obtained through these channels.” Interview no. 2 (September 1987),Victor Thomas, production department director (1983-86) and technical department director (1986).

16 IMEP, Interview no.1 (October 1987), Valladares.

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17 IMEP, Interview no.1 (October 1987), Valladares; Interview no.2 (September 1987), Thomas; Interviewno.3 (October 1987), Ricardo Barbieri, technical department director (1987); Interview no.4 (September 1987), NoelGarcía, production department director (1987).

Interviewees were asked to explain variations in annual output shares between product lines, as shown in Table 4.3.

18 This also required forced input substitution. The sales department modified the building designs for itsthree main contracts in the structures line to accommodate for the material in stock.

19 There was not sufficient information to calculate the frequency with which IMEP carried out forcedsubstitution.

20 IMEP, Interview no.5 (October 1987), Manuel Baltodano, production worker, cutting and bending section.

Workers were asked to describe changes in production methods which had occurred in their area and to identify thereasons for these changes. This information was confirmed by Noel García, production department director(Interview no.4).

21 IMEP, Interview no.1 (July 1987), Valladares; Interview no.2 (September 1987), Thomas; Interview no.3(October 1987), Barbieri; Interview no.4 (September 1987), García; Interview no.6 (October 1987), Jesús Tercero,maintenance department director (1983-87); Interviews no.7 (September, October 1987) with workers in each phaseof the production process, equipment section (1987).

The enterprise director and department directors were asked to identify external factors affecting annual and quarterlyoutput and sales. The maintenance department director was asked to list factors affecting each machine and the stepstaken to address these problems. Production workers were asked to identify factors affecting performance in theirareas. This information was confirmed through direct observation in the plant.

22 As stated above, the state metalworking division strategy included the build-up of machining capacity inIMEP. This facilitated its access to imported machine tools through donations and/or supplier credit lines based onbilateral government arrangements.

23 IMEP, Interview no.8 (July 1987), Herzán García, enterprise director (1980-85).

24 On developing countries, see, for example, Mitra (1979), p.18-20; Katz (1986); and Sabel (1986), p.45-47. On socialist economies, see Murray (1990).

25 COIP, state metalworking division, technological evaluation of IMEP's machining section, internal report.

26 Quarterly output figures in the angles and beams line showed even greater differences from the plan. Output as a percentage of plan targets ranged from 21 per cent in the second quarter, 1984, to 399 per cent in the firstquarter, 1986.

27 This partly explains why management gave precedence to work on major state contracts when faced withresource constraints, even when this meant opting for a less efficient production method involving forced substitution.

28 IMEP, sales department, sales orders records (1980-87); production department, monthly work orderrecords (1984-87).

IMEP, Interview no.1 (October 1987), Valladares; Interview no.2 (September 1987), Thomas; Interview no.3

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(October 1987), Barbieri; Interview no.4 (September 1987), García; and Interview no.12 (July 1987), Saddy Castro,sales department director (1985-87).

Interviewees were asked to explain the firm's product mix decisions and record on completing work orders on aquarterly basis in the different product lines.

29 IMEP, Interview no.1 (July 1987), Valladares, and Interview no.2 (September 1987), Thomas.

30 Payments in local currency had reduced significance as compared to their expected role in transactionsbetween firms operating under a hard budget constraint. However, IMEP was dependent upon its customers tomaintain a positive cash flow in the inflationary period, as discussed further in the section below.

31 Of the 38 products fabricated in the equipment line, 34 were introduced based upon the copiedmanufacture of equipment provided by the customer or based upon technical information or designs obtained throughthe customer.

32 IMEP, Interview no.1 (July 1987), Valladares; and COIP, Interview no.13 (March 1987), WilibaldFriedersdorf, technical department director, state metalworking division.

33 IMEP, production department, monthly work order records (1984-87); and sales department, sales orderrecords (1980-87).

34 IMEP, Interview no.14 (September 1987), Danilo Perez, equipment line production manager; andInterviews no.15 (September, October 1987), with workers in the equipment line. Plus direct observation of finishedgoods in stock.

We attempted to trace changes in batch size for two standard products over the period under study and to compare thenumber of worker hours required per unit of equipment in each case. However, this proved to be impossible due toinadequate records in the latter area.

35 We selected these criteria together with IMEP's director, Julio Valladares.

36 Based upon guillotine shears and folding presses, the cutting and bending section supplied the firm's mainproduct lines. Equipment parts were also fabricated in the machining section.

37 IMEP, Interview no.9 (September 1987), Carlos Castro, area supervisor, cutting and bending section(1980-87).

The interviewee was asked to describe his job and how it had changed during the period under study. We alsoobserved the work process directly so as to identify the different kinds of shop-floor initiatives and decision- making.

38 IMEP, Interviews no.10 (September, October 1987), production department staff; Interviews no.11(September, October 1987), technical department staff, including foreign technical advisors; Interview no.12 (July1987), Castro.

Through these interviews, we traced the steps taken on work orders within each department and analysed the degreeof information flow between departments in areas such as raw material usage.

39 IMEP, sales department, sales order records (1985-87); production department, monthly productionreports and work order records.

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IMEP, Interview no.12 (July 1987), Castro; and Interview no.4 (September 1987), García, on process and criteria bywhich sales order were accepted by the firm.

40 COIP, state metalworking division, technological evaluation of IMEP's machining section, internal report(1987).

41 IMEP, Interview no.2 (September 1987), Thomas; and Interview no.16 (September 1987), CamiloMurillo, area supervisor, equipment section, on production programming.

IMEP, production department, work order records; and direct observation of work-in-progress inventories. Salesdepartment, sales order books.

IMEP, Interview no.1 (October 1987), Valladares; Interview no.12 (July 1987), Castro, on customer complaints. Weinitially intended to interview IMEP's main customers from 1980 to 1987. This proved to be impossible due tologistical constraints and also high labour turnover in government ministries and state businesses.

42 There was one main exception to this general trend. IMEP introduced two new designs of its windmillsafter its initial model was rejected by customers due to poor product quality.

43 Some of IMEP's customers began to show resistance to product price increases in the 1985-87 period. Yetthis was not sufficient to alter the basic pattern of productive adaptation described in this section.

44 Kornai states that the producer operating within the seller’s market is slow to adjust supply to demand andoften produces goods which do not meet buyers' requirements.

45 IMEP, sales department, review of methodology used to revalue contracts and examples of the latter.

46 IMEP, Interview no.17 (August 1987), Luis Saravia, financial department director, with reference toannual financial statements (1980-87).

47 IMEP, Interview no.1 (October 1987), Valladares; and Interview no.17 (August 1987), Saravia.

48 For example, the firm increased output in the angles and beams line to 49 per cent of total output in thefirst quarter of 1986 to obtain cash to cover investment costs following a devaluation.

IMEP, Interview no.1 (October 1987), Valladares, on factors affecting annual and quarterly output figures.

49 IMEP, sales department, sales orders (1984-87); and Interview no.1 (October 1987), Valladares, withreference to above records.

50 IMEP, office of the director, list of machinery imports and respective prices.

51 IMEP, Interview no.1 (July 1987), Valladares; Interview no.2 (September 1987), Thomas; and Interviewno.17 (August 1987), Saravia.

52 METASA, maintenance department, machinery records compiled in 1987; and direct observation in theplant.

53 CONSULTEC (1989), based on Central Bank records.

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54 METASA, sales department, annual reports (1984-87).

55 In 1983, output as a percentage of installed capacity was at 65 per cent in the structures section, 92 percent in the pipe section, and 83 per cent in the iron rods section.

METASA, production department; and CONSULTEC (1989), based on Central Bank estimates of installed capacityin 1978.

56 METASA, Interview no.18 (June 1987), Herzán García, enterprise director (1985-87); and Interviewno.19 (April 1988), Alejandro Aguilar, production department director (1980-87); on factors affecting quarterly andannual output figures.

57 METASA, Interview no.20 (April 1988), Antonio Vanegas, area supervisor, cold roll forming process.

58 Disaggregate figures on inventories were only available in local currency. From 1982 to 1986, rawmaterials represented between 56 and 71 per cent of annual inventories, while the share of work-in-progress rangedfrom 14 to 29 per cent. These figures tend to understate the share of raw materials, which were purchased at anartificially low exchange rate. Figures on work-in-progress included the installation of assembled structures. We donot have figures specifically on work-in-progress in the pipe section.

CONSULTEC (1989), based on METASA’s annual financial statements.

59 METASA, Interview no.22 (April 1988), Milton Icaza, technical department director.

60 METASA purchased second-hand US machinery and equipment for the structural mill area in the early1960s. It incorporated additional West German and Canadian equipment in the 1960s and early 1970s.

61 COIP, Interview no.23, (March 1987), Ronaldo Bermúdez, state metalworking division director, oncriteria for selecting priority firms.

62 COIP, state metalworking division (1988), technical report on METASA's cold roll forming process.

63 METASA, maintenance department, machinery records compiled in 1987.

COIP, state metalworking division, list of machinery imports (1984-87).

64 METASA, Interview no.25 (April 1988), Manuel Mayorga, galvanization area supervisor; and Interviewsno.26 (April, May 1988), with workers in each phase of the galvanization process, on changes carried out in eacharea of the galvanization process.

Human resources department, list of innovations (1987).

65 METASA occasionally suspended production of specific product lines due to inadequate dies andother machinery-related problems. However, this did not constitute the predominant form of adjustmentwithin the pipe section.

66 Based on COIP, state metalworking division, technical description of cold roll forming process inMETASA, internal document (1988); and direct observation.

67 METASA, Interview no.19 (April 1988), Aguilar; Interview no.20 (April 1988) Antonio Vanegas; and

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Interviews no.21 (April, May 1988), with workers in each phase of the cold roll forming process.

Interviewees were asked to identify factors causing work stoppages or delays in their area.

68 METASA, Interview no.19 (April 1988), Aguilar; Interview no.20 (April 1988), Antonio Vanegas;and Interviews no.21 (April, May 1988).

Product changes provided the third source of downtime following machinery-related problems and inputshortages. The structural mill produced pipes, angles and beams of different dimensions and had to reset forproduct changes. The firm did not keep records of the frequency of these changes and the length of productionruns.

69 METASA, Interview no.22 (April 1988), Icaza.

70 METASA, Interview no.22 (April 1988), Icaza; and Interview no.24 (May 1988), Agustin Vaughn,maintenance department director (1987).

71 METASA, Interview no.24 (May 1988), Vaughn, on activities carried out within the maintenancedepartment; and review of maintenance records.

72 CONSULTEC (1989).

73 METASA, production department.

Quantitative evidence on downtime and its causes was only available for the first six months of 1987.

74 METASA, direct observation.

75 METASA, Interview no.18 (June 1987), García; Interview no.25 (April 1988), Mayorga; and Interviewsno.26 (April, May 1988).

Interviewees were asked to identify factors causing work stoppages or delays in their area.

76 METASA, Interview no.25 (April 1988), Mayorga; and Interviews no.26 (April, May 1988), on changescarried out in each area of the galvanization process.

Human resources department, list of innovations (1987).


78 METASA, Interview no.18 (June 1987), García.

79 The latter determined firms’ export earnings in local currency and the percentage that could be obtained inforeign exchange. Enterprises had to apply for the use of these dollars and applications were often turned downbecause dollars were not available, as noted in Chapter Two.

METASA, Interview no.18 (June 1987), García, on factors affecting annual export and domestic sales figures (1980-87).

80 In one case, the galvanization area doubled the amount of pipes chemically cleaned with the same

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amount of hydrochloric acid. This type of forced substitution did affect product quality negatively, as noted inthe above section on adaptation to resource constraints.

81 METASA, Interview no.18 (June 1987), García; Interview no.19 (April 1988), Aguilar; Interview no.22(April 1988,) Icaza; Interview no.20 (April 1988), Antonio Vanegas; Interviews no.21 (April, May 1988); Interviewno.24 (May 1988), Vaughn; Interview no.25 (April 1988), Mayorga; Interviews no.26 (April, May 1988); andinformal interviews with imports and sales department staff.

Through these interviews, we attempted to identify the degree and type of information exchange between the shopfloor and the different departments in areas such as raw material usage and product quality. These interviews did notprovide evidence of an effective information and feedback system between the shop-floor and administrative andtechnical offices aimed at lowering scrap rates and improving quality performance continuously.

82 METASA, Interview no.20 (April 1988), Antonio Vanegas; and Interview no.25 (April 1988), Mayorga,on quality control procedures.

METASA, production department, annual and quarterly production reports (1984-87).

COIP, state metalworking division, quarterly evaluations based on information provided by enterprises.

83 METASA, Interview no.25 (April 1988), Mayorga; and Interviews no. 26 (April, May 1988).

84 Profits as a percentage of sales were registered at 27 per cent in 1984, 31 per cent in 1985, and 56 per centin 1986 and 1987.


86 COIP, Interview no.23, (June 1988), Bermúdez.

87 CONSULTEC (1989), for METASA's annual financial statements.

88 The share of raw materials in variable costs fell from 81 per cent in 1980 to 24 per cent in 1987.

89 Indirect costs rose from 9 per cent of variable costs in 1980 to as high as 58 per cent in 1987.

90 METASA, Interview no.27 (March 1988), Armando Bermúdez, financial department director (1985-87),on efforts to draw up a cost structure.

91 Financial costs as a percentage of fixed costs fell from 42 per cent in 1980 to 3 per cent in 1987.

92 Kornai states that forced adjustments in output mix tend to lead to the production of an assortmentof goods that do not meet buyers’ requirements.

Documents

113 CHAPTER FOUR PRODUCTIVE ADAPTATION IN IMEP AND …