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# Illustration of the quantity effects of x-inefficiencies

28. In view of the significant levels of NEPR available<sup>to some of the</sup> synthetic fibers and heavy chemicals industries in India (Cf. para. 22), the question arises whether Indian planners may have tried to<sup>estimate product-</sup> specific protection rates to cover not only the price<sup>effects of NPCk but also</sup> the quantity effects of x-Lnefficiencies (the choice of uneconomic capacity sizes below the MES required for international competitiveness in subsectors /product groups characterized by significant economies<sup>of scale; and/or the</sup> unability, for market or technical reasons, to reach a satisfactory<sup>rate of</sup> capacity utilization) stemming from India's self-sufficiency and licensing policies. The primacy of self-sufficiency in Indian industrial<sup>policy has</sup> generated protection policies which permitted the financial<sup>viability of</sup> markedly undersized plants satisfying small, or very small,<sup>domestic markets.</sup> In addition, the traditional regulations for licensing of entry<sup>and domestic</sup> competition have limited in each product group the output of<sup>each plant to a</sup> prescribed share of the market, and thus constrained the<sup>capacity utilization</sup> of new entrants. As mentioned in para. 16, these<sup>factors can distort upwards</sup> the unit investment costs. It is shown in Annex 1 that,<sup>similarly to the price</sup> effects of the factor NPCk, the quantity effects of x-inefficiencies on financial profitability correspond to an effective protection<sup>rate providing</sup> international level returns, denominated XEPR and computed<sup>as follows:</sup> XEPR - (1 - s).(x - 1), where the factor x is inversely related to the capacity utilization rate k and the ratio of capacity size to MES.

Moreover, Annex 1 shows that, for the actual EPR<sup>to cover both the price</sup> and quantity effects, then NEPR should be greater than XEPR.

29. Typical industries characterized by significant economies of<sup>scale are</sup> those producing synthetic fibers and chemicals, particularly<sup>petro-chemicals.</sup> Project-specific data on some of these products from the sample, as shown in Table 4, indicate the presence of uneconomic capacities, sometimes<sup>coupled</sup> with low capacity rates. The table shows that NEPR is higher<sup>than XEPR in 4</sup> cases, and lower in 5 cases. This tends to invalidate the<sup>assumption, raised</sup> in para. 28, that the levels of actual protection granted to<sup>such products</sup> could have been estimated to cover both the price and quantity<sup>effects of</sup> policies for capital goods protection, self-sufficiency and licensing.

TABLE 4: X-INEFFICIENCY EFFECTS ON EFFECTIVE PROTECTION

|Product|MES/Capacity|Capacity|Factor x|CEPR<br>|NEPR<br>|<br>XEPR<br>|
|---|---|---|---|---|---|---|
||Ratio|Utiln(%)||----|--(in %|)-----|
|EPM Rubber|2.000|90|1.320|32|89|26|
|ABS|5.000|75|2.284|12|74|35|
|SBR|2.414|90|1.423|41|102|35|
|PFY|1.667|81|1.364|35|54|28|
|MA|1.429|70|1.483|33|28|41|
|NBR|4.167|85|1.874|43|25|75|
|NTY|1.456|87|1.201|58|-5|<br>18|
|POY|5.556|90|1.986|70|20|86|
|Alpha Olefins|<br>2.000|85|1.397|37|-12|<br>36|