Production cost in the periphery: The case of Greece

~ngltle~~l~g

Costs and

285

Fr~du~~io~~~on5~ics, 20 ( 1990) 285-294

Elsevier

PRODUCTION

COST IN THE PERIPHERY: GREECE

THE CASE OF

Costas P. Pappis Unjversity

of

farras,

repayment

of ~ecbanjcal

Engjneeling,

26500

Rio, Patras,

Greece

ABSTRACT

The phenomenon of developmental polarization, that is uneven regional development, strongly affects the production cost in the periphery of a country. This, in turn, seriously affects a peripheral enterprise’s competitive posture and abiiity to su~ive. The increased transportation cost, the lack of j~iendly ~ndustrial environment and sufficient infrastructure, the manpower problem and the need for a centrally located branch of the enterprise are included among the most unfavorable factors for the production cost in Greek peripheral production units. An assessment of the production cost in such a unit showed an 18% increase due to

these factors. Measures to counteract regional unevenness include development incentives and creation of industrial estates. Nevertheless, such measures, unless they address the increased production cost problem in the long run, can only marginally iFnprove the regional distribution of prod~~ctive activities. The paper discusses the relation between production cost and location, analyzes the factors affecting the production cost in the periphery, describes the support given to peripheral enterprises in Greece and suggests policies which would relate this support to the operating cost of such enterprises.

I. INTRODUCTION

and apparent solution. Moreover, although often arising from quite similar causes and exhibiting the same symptoms in different countries, the problem presents unique characteristics and requires unique treatment in each country. The need for central planning and political support in order to reshape the regional economic (particularly industrial) structure has gained general recognition [ 11, as regional unevenness, in addition to regional crisis, may lead even to a crisis of the national state coherence [2,3]. In Greece, as elsewhere, one of the effects of uneven regional development is the urbanization of a large percentage of the population, which is concentrated mainly in the country’s

Uneven regional development is one of the main features characterizing particularly, but not exclusively, countries of the so-called “lessthan-well-developed” group, i.e. those immediately succeeding the economically advanced countries. This many-faceted problem may generally be defined as the phenomenon of considerable regional unevenness concerning, among others, population, income and employment, which is accompanied by an imbalance in the existing infrast~cture. It usually produces massive movements either within the country, towards more privileged areas, or towards other countries. It certainly has no easy 0167-l 88X/90/$03.50

0 1990-Elsevier

Science Publishers B.V.

286 capital and, to a lesser degree, in a small number of other cities. According to the I98 1 census, 3 1% of the total Greek population was concentrated in the urban area of Athens. Five other urban centers were inhabited by 12% and another 55, with more than 10,000 inhabitants, had 15% of the Greek population. Together with urbanization, the industrial polarization is another serious symptom of uneven regional development [ 41. Thus, the regional distribution of the industrial employment shows that there is a strong tendency for industrial activity to concentrate in a small number of the country’s regions. Such regions include either major urban centers or areas which lie near to such centers and have been privileged by development laws. Table 1 shows the distribution of industrial enterprises and respective employment over some of the industrially most important of the 52 regions (nomos) of the country. It can be seen that l/3 of the industrial enterprises and more than l/3 of the industrial employment are found in the capital’s area. The capital’s region (Attiki) counts for nearly half of the country’s population employed in industry. It is interesting to note that the 1969 and 1984 percentages remain practically unchanged, irrespective of the various incentives for industrial decentralization given by development laws.

The tendency for industrial concentration continues as shown by the new permits given for the establishment, operation and expansion of industrial enterprises. It can be seen in Table 2 that, as the most recent available data show, 42.6% of the permits given for the operation of new industrial enterprises concern the Attiki region. The corresponding figure for expansion permits is 5 1%. The reasons for Greece’s regional unevenness, which grew mainly during the first postwar decades, are quite complex. The problem may generally be attributed to policies which aimed at an industrial development “at any cost”, as well as to the civil war which hit Greece after the 2nd world war and resulted in the transfer, during and after the war, of masses of population from the provinces, where the main operations of the war took place, to the cities. The solution of the problem was declared to be a government’s priority for the first time in the “5-year 1960-l 964 economic development plan”. The basic element of the regional policy for the next plan for the years 1966- 1970 was the introduction of industrial estates as poles of industrial development in live cities. The incentive policy for regional development started essentially in the 70s with several laws being passed, which led to the Law 1262/82 which is in force today, having replaced all the others. The basic instrument of

TABLE 1” Percentage distribution

Industrial enterprises

Region

1. Athens area 2. Thessaloniki 3. Magnesia 4. Larissa 5. Heraklion 6. Eubia 7. Messinia 8. Seres “Source:

of industrial enterprises and employment

[ 51.

in several regions Manpower employed (O/o)

(%)

1969

1973

1978

1984

1969

1973

1978

1984

32.9 10.2 2.1 2.2 2.6 2.0 1.7 1.9

35.3 9.3 2.1 2.4 2.7 1.9 1.8 1.7

36.7 10.1 1.9 2.2 2.7 1.7 1.5 1.9

32.9 11.2 1.9 2.3 2.8 1.8 1.6 2.0

46.9 11.8 2.0 1.7 1.8 1.6 1.2 1.2

46.3 11.7 1.8 2.2 1.4 1.7 1.1 1.0

42.0 12.3 2.2 2.2 1.4 2.2 1.1 1.2

36.8 12.6 2.2 2.3 1.8 2.4 1.1 1.4

287 TABLE 2” Permits for new plants and extensions

New plants Extensions

( 1987)

Total country

Attiki region

Number of permits

Total power installed (HP)

Number of permits

Total power installed (HP)

3,689 1,040

83,987 111,087

1,572 531

11,743 33,482

“Source: Ministry of Industry.

the incentive policy for regional development is the subsidization, mainly in terms of direct grants and tax allowances, of new private enterprises. Among the most important criteria for the magnitude of the support is the region where the enterprise is to be located. Such a support is expected to promote the regional evenness and to contribute seriously to the economic and social development of the country. 2. PRODUCTION COST AND LOCATION The increased cost of the productive inputs is a major result of, but also a serious reason for, uneven regional development. This cost is affected in many ways by developmental polarization, whether it refers to enterprises located in industrially well-developed or in underdeveloped regions of the country. In turn, the increased production cost feeds the developmental polarization in a vicious circle. The cost of a product includes the cost of the inputs to the production process, such as materials, labour, energy, machinery and equipment, information and technology [ 61. It also includes all other costs related to the product, from the initial design stage up to the moment it is met by the customer. It includes, therefore, the R&D cost, the general expenses and also the transportation and distribution costs. The market share, the competitiveness and the ability of an enterprise to survive depend on this cost, which is sensitive to locational fac-

tors. This led to the formulation of several models and theories concerning the location problem, i.e., the problem of selecting the site to install new facilities so as to minimize the production cost (e.g., [ 7- 15 ] ) . In such models, apart from quantitative parameters such as those described above, qualitative ones such as community and labour market characteristics have also been considered and the decision proposed is almost exclusively conditioned to the set of these two parameter categories. The above parameters and the respective production cost elements, while influenced by regional unevenness, have in turn a strong impact on the latter, by creating or strengthening the terms for regional unevenness to increase further. Existence of a well-developed productive structure in a region creates employment opportunities, attracts skilled labour, induces creation of services and further development of technical and economic infrastructures and, generally, helps the productive structure to grow and the region to further develop. On the contrary, lack of a well-developed productive structure has the opposite effects, which act as counterincentives for new productive structures to be located in the region by simply increasing the production cost (e.g., because of lack of skilled labour or services supporting the production process). Thus, while developmental polarization in a country results in unfavorable production cost in the regions of the periphery, the latter in turn helps the gap between well- and not-well-developed regions to become wider. However, along with this a continuous process of productive restructuring is taking place, favored by external factors such as international capital movement and state intervention [ 161. 3. FACTORS AFFECTING THE PRODUCTION COST IN THE PERIPHERY

The cost of the productive inputs in the periphery of Greece, which includes the less developed regions of the country, is negatively

288 affected by factors related to material transportation, the production environment, the existing infrast~cture, the manpower and the need to establish a branch (possibly the headquarters) of the enterprise in the center (most likely the country’s capital). More specifically, transportation of materials to a peripheral factory implies an increase of the production cost corresponding to the cost of tra~spo~ation. Similarly, the cost is increased because of the transpo~atio~ of finished goods to consumer centers, the main ones of which are situated in the more developed regions of the country. The transpo~ation cost is affected by the condition of the tra~spo~ation network which, in Greece, is characterized by the inefficiency of the railways, narrow and often badly maintained roads, a small number of airports and a lack of adequate sea and land facilities at sea ports [ 171. For example, the mean hourly speed developed by trains transporting merchandise is 35-40 km,, while 95% of the railways have one single line [ lS]. In addition, the production cost is indirectly affected by problems created as a result of the factory’s dependence on distant sources of procurement. Such dependence often makes production planning and scheduling a difficult task and has costly consequences (e.g., stops or alterations in production plans). Lack of a ~r~~~c~~o~friendly e~v~ro~~e~t is another impo~ant factor which causes increases in production cust. Such an environment, if it exists, provides technical and technological services to an enterprise. Such services include repair of production machinery and equipment, construction of jigs, stamps, calibres, fixtures and special pu’rpose instruments and machinery, quality assurance and testing and other services provided by specialized laboratories, research institutions and consultants, transpo~ati~~ and, in general, services which facilitate production planning and control and support the production function of an enterprise. Lack of production friendly environment is characteristic of the

Greek periphery and contributes considerably to production cost increases. ~e~~~ica~~~~ast~~t~~e, which is also part of an enterprise’s environment, includes traffic, water, energy and communication networks, sewage and pollution treatment facilities, firstaid, fire fighting, gas and oil stations, bank branch offices, etc. Such infrastructure, though necessary for smooth production, is generally degraded in the Greek periphery, Electric power stoppages take place more frequently, while communication is more difficult and expensive compared with the center. Existence of pollution treatment facilities in big urban centers favors the production operation and the respective cost in enterprises situated there, In general, the substandard condition of the technical infrastructure results in increased production cost in peripheral production units in comparison to those situated in the center. ~a~po~)er is also a factor which differcntiates peripheral from central production units. Periphery is characterized by lack of cadres and special skills and poor op~~unities for training and education. Characteristic is also the phenomenon of the “peasant-worker”, referring to land-owner workers who, apart from their occupation in the factory, spend part of their working time in rural activities, This exclusive characteristic of peripheral production units is combined with high absenteeism, especially during peaks of rural activities, and negatively affects the execution of the production plan, the quality of the products and, finally, the production cost as, among other things, the enterprise is obliged to keep an increased number of personnel. Last but not least of the factors which contribute to increased production cost in the periphery is the need for some activities of the enterprise to be undertaken by a bramh located in the center. Sometimes it is the headquarters which are centrally located. Such activities either are exclusively assigned ‘to the branch or duplicate the activities of the peripheral unit, Usually they include sales, war-

289 ehouses, accounting, public relations, customs declaration, etc. In the case of headquarters located in the center, their activities include also planning and general management. Thus, the enterprise also bears the cost of the centrally located operational unit as well as the cost related to coordination and communication between the two units. Table 3 gives an analysis of the production cost increase due to the location of an enterprise in a less privileged region. The analysis is based on an assessment made in a papermill situated at the northeastern part of Greece. The total increase of the production cost, which is assigned to factors related to the enterprise’s location, is estimated to be 18% over the respective cost of a similar enterprise located in a central region, e.g., Attiki. The data of Table 3 were derived from relevant data concerning each element contributTABLE 3” Production cost increases due to location Reason Isolation from consumer centers and production decrease in case of bad weather or calamity Strikes in transportation Energy stoppages because of damage or supply stoppages Communication with central offices and double record keeping Increased stock of repair items Transportation of finished goods to consumer centers Strict environmental pollution regulations Keeping higher number of cadres, higher salaries, etc. Keeping higher number of personnel to cope with absenteeism during peaks of rural activities Mobilization of personnel during military exercises Low “industrial quality” of personnel, lack of specialization, need for a central branch, travel expenses of management executives Total “Source: Thrace Papermill.

Cost increase (O/O)

2 2 2 0.5 1 2

I 3

1 2

1.5 18.0

TABLE 4” Energy stoppages in a peripheral enterprise Year

Number of stoppages

Total duration of stoppages (hours)

1984 1985 1986 1987

38 47 29 33

114 181 123 152

“Source: Thrace Papermill.

ing to the production cost increase. For example, data concerning energy stoppages were translated in terms of total idle time for the production unit due to such stoppages per year. As Table 4 shows, the stoppages recorded, for example, in the year 1987 resulted in a total of 152 hours idle time. This is nearly 2% of the yearly working hours of a papermill and causes a serious drop in production volume as well as in productivity. Such stoppages are mainly due to weather conditions and take place in the less or ill-mainprivileged (i.e., less protected tained) areas of the periphery rather than in, say, the Athens area. Another example refers to the cost increase due to mobilization of civilians during military exercises. Such mobilization, while taking place quite regularly in the papermill’s area, would very rarely happen in, say, the Athens area. It was estimated that 60 persons from a total personnel of 300 of the enterprise are mobilized twice a year, each time for up to two weeks. This gives a loss of labour time equal to 240 manweeks per year. Compared to 14,400 manweeks per year theoretically available in the papermill, this corresponds to a 1.7% loss of labour time and to at least a 2% increase in production cost. The latter is the result of the loss in labour time as well as of the organizational and other side effects of the interruption of the productive process incurred by the mobilization.

290 4. ADVANTAGES OF SELECTING A PERIPHERAL SITE LOCATION

Obviously, the cost increase referred to in the above would not be tolerated unless some considerable local advantage exists or some compulsory technical requirement is satisfied. In fact, some of the above mentioned factors, instead of increasing the production cost in a peripheral unit, may actually result in some cases in a reduction of this cost. This is the case, for instance, for the transportation cost element in production units located close to either a peripheral source of raw materials or a primary customer. A bottling enterprise exploiting a nearby situated source of mineral water is a characteristic example of low transportation cost of the main raw material, resulting in a reduction of the production cost. Peripheral location of small production units supplying big enterprises located in the periphery is another example, In this case, the production cost of the satellite unit is reduced as a result of its location close to its main or exclusive customer. As a matter of fact, some industrial branches, including food, paper, wood and mining industries, tend to select peripheral site locations in order to take advantage of the closeness to a primary raw material source. Most of these industries are characterized by productive processes resulting in significant weight reduction of the product processed. Moreover, quite a few big enterprises tend to distribute their productive activities among sites, each one of which is characterized by one or more comparative advantages. Apart from the transportation cost, other factors may also favor site location in the periphery of a country (or in a country of the periphery, as in the case of international corporations). Such factors may refer to technical requirements of the production process. This is the case, for example, for water of either a special quality, required in some chemical processes, or of adequate quantity, as in the case of the paper industry. Such is also the case for

perishable goods, e.g., dairy products, fruits and vegetables, for which there is a technical requirement for in-time processing or packaging. In addition to the above considerations there are also the macroeconomic advantages in decentralizing the industrial structure. As noted earlier, the developmental polarization, which goes along with the industrial concentration, tends to feed itself in a vicious circle. This has a destructive effect on a country’s infrastructure. Indeed, the latter tends to deteriorate in the less privileged regions while the infrastructure developed in the more privileged areas tends to become less effective, having to function under congestion conditions. Therefore, as a consequence of developmental polarization, the center suffers also, particularly if, as in the case of Greece, it has not been planned as to bear the whole burden of the productive structure. Finally, the developmental polarization, apart from its economic repercussions, has a very important social justice as well as national coherence aspect. 5. SUPPORTTO PERIPHERAL ENTERPRISES IN GREECE

In order to cope with the tendency for uneven development, incentives and counter-incentives have been introduced, in the framework of either development laws or other regulations. The development law 1262, in particular, introduced in 1982 and amended as to further improve the incentives, is the general framework purported to tackle the polarization phenomenon and direct new investments to all regions of the country, especially the less privileged ones. Thus, new investments are subsidized according to the law on the basis of several criteria, such as the size and nature of the investment, a main one being the location of the new productive unit. The country has been divided in four areas in accordance with the level of their economic and regional development and the incentives are

291 provided on a scale rising from area A, which includes the center, i.e., mainly the Athens and Thessaloniki areas, to area D including mainly areas situated close to the borders of the country. The law provides five types of aid and the prospective investor may select either of the following, mutually exclusive, combinations: (a) Grant, reduced tax rate, interest subsidy and increased depreciation rates, or (b) Tax allowances and increased depreciation rates. Table 5 shows the aid given in the case of industry, which includes manufacturing and small craft industries. Aid is also provided to tourist investments and mining operations. Thus, a new productive unit planned to be located in area D will get either combination (a, b, c, e) or combination (c, d) of the following aid items: W A grant of up to 50% (but not less than 20%) of the value of the investment excluding the value of land. @I Interest rate subsidy up to 50% but not less than 20%, provided for the first three years of a loan’s service. Increased rate of depreciation (50%, 100% and 150% for 1st, 2nd and 3rd shifts worked, respectively) applied to the part of the investment for which no grant has been given. TABLE .5a Aid to manufa~tu~ng Law 1262/82

and small craft industries according to

Area

Ab

B

C

D

Grant Interest subsidy Increased rates of depreciation Tax allowances % of the investment % ofthe profit Reduced tax rate

-

lo-25% lo-251 20-80%

15- 40% IS- 40% 35-120%

20- 50% 20- 50% 50-150%

-

55% 40% 75% 60% 391 (for fisted) or 44% (for non-listed)

-

*Source: [ 191. bOnly for special investments.

70% 90%

Tax allowances applicable to the profits of the first accounting period, transferred to subsequent years if no profits were made. The allowance is 70% of the investment cost and applied to 90% of net annual profits, i.e., those resulting after deduction of ordinary reserve and distribution profits. Reduced tax rate of undistributed profits (39% for firms listed on the stock exchange and 44% for those non-listed, as against 49% of the ordinary tax rate). Characteristic of the law, however, is that it is mainly directed to helping the investor to cover the expenses related to the new plant installation or to its initial period of operation but not to its production cost in the long run. Another measure acting as an incentive to attract new investments to the periphery is the creation all over the country of industrial estates (VI.PE.), i.e., sites with facilities specially designed and equipped with the infrastructure necessary for the installation and operation of modern industrial units [ 191. A VI.PE. usually offers a complete road network, water and power supply, sewerage, telephone lines and waste treatment facilities. Units installed in a VIPE. may be served by banks, first aid stations, etc. Apart from offering such infrastructure, a VI.PE. should normally be selected for reasons such as: selling price of land lower as compared to similar sites in outside areas, possibility for a higher acreage to be built up, no requirement for permits for establishing or expanding a unit, possibility for a firm installed in a VLPE. and getting the grants of law 1262 to receive the aid applicable to the next most favorable (in terms of incentives) area, reduced expenses for loans and notary transfer fees, etc. Such estates, however, like development law 1262, can only marginally contribute to the solution of the increased production cost problem which characterizes productive units Iocated in the periphery. It is, indeed, the initial

292 installation and operation cost rather than the production cost in the long run which is favored in the case of a unit located even in a VI.PE. in the periphery of the country. 6. RELATING SUPPORT TO PRODUCTION COST As said earlier, development and other laws tend to introduce incentives in order to attract investments in the periphery which, however, are proven to be less effective than expected. A main reason for this is that the increased production cost in the periphery is practically ignored in such measures. Thus, enterprises selecting a peripheral site location after some years of operation often realize a non-competitive cost, which threatens their profitability and even their existence. In order to cope with this, appropriate policies to support the peripheral enterprise’s production cost should be designed if the objectives of decentralization are to be promoted. More specifically, the support may take the form of either direct subsidization of the cost elements affected by the location of the enterprise or indirect subsidization of its productive activity. In the first case, i.e., direct subsidization, each cost element may be subsidized separately. The subsidization may be based on averaged measurements of the actual percentage increase due to the peripheral enterprise’s location. Thus the electricity, personnel, transportation and other bills may be directly subsidized (i.e., the enterprises are charged with lower amounts, the rest-being covered by the government). This may be done also by reducing accordingly the enterprise’s yearly taxation amount. Some cost elements, such as the increased stock of repair items, may be indirectly subsidized, by increasing the subsidization of other cost elements, e.g., personnel. In the second case, i.e., indirect subsidization of the enterprise’s productive activity, the exact subsidization amount may be based on:

(a)

the linal results of the productive activities, e.g., sales, and (b) the averaged total production cost increase resulting from the location of the enterprise. In this case, the subsidization may be effected by subtracting an amount corresponding to the percentage of cost increase from the value added tax of the products sold. This would encourage the enterprise to develop its productive activities and present results (while facilitating tax collection). Evidently, such a form of subsidization would provide support to active productive units rather than to enterprises basing their profitability on state protection. Though a realistic definition as well as the actual measurement of the “averaged total production cost increase” in the periphery would present certain difficulties, approaches such as the ones presented in the case of Thrace Papermill would be quite helpful. In either case, i.e., direct or indirect subsidization, this should be based on realized results, e.g., actual costs incurred or actual sales, and not on budgeted or nominal figures, such as productive capacity. It should last as long as the causes of regional unevenness and industrial centralization are present. Apparently, the subsidization based on the final results of the productive activity has certain advantages. First, it is simple and easier to apply as, having specified the subsidization percentage figure, the enterprise is subsidized with an amount equal to that percentage figure times sales (or production cost). And second, what is subsidized is actual production rather than cost of productive inputs. However, a policy including both forms of subsidization may prove more effective. Such a policy should take into account the fact that, in some cases, peripheral site location favors a reduction of some cost element, as is the case for enterprise situated close to a primary supplier or customer. The subsidization policies discussed above may be integrated into a strategy for industrial

293 and regional development, which would also include some other elements, such as the differentiation of subsidization in accordance with regional categories. Regions needing more support would be subsidized accordingly, using higher coefficients. Another such element would be the differentiation of subsidization reflecting a differential treatment of industrial branches. Thus, the subsidization policy may give priority to specific industrial branches for some reasons, including the cont~bution to the improvement of the productive structure of the country. The above considerations, while giving an idea of the issues arising, need to be further elaborated in order for an effective decentralization policy to be designed. In Greece until the end of 1986 the subsidization policy also included support to the operational cost of peripheral enterprises, particularly those situated close to the borders of the country. Thus, the labour cost was subsidized by reducing the amount by which the company covers part of the employee’s insurance cost. The government was paying 50% of the company’s participation, which resulted in a 1520% decrease in the labour cost. The value added tax was also reduced in the case of such enterprises by 75%, which corresponded to 7.5% of the sales value. Finally, export activities were encouraged by granting export grants ( 1O-20% of export value). This policy was abandoned and the operational cost of peripheral enterprises was no longer subsidized until April 1988, when a new policy was implemented. According to this policy, the government subsidizes the labour cost of enterprises situated close to the borders of the country by granting 6% of the minimum labour wages and 10% of the salary of new cadres (employees with higher qualifications). The policy includes also preferential treatment of the products of such enterprises in governmental procurements.

7. CONCLUSIONS In the preceding discussion an account was given concerning the various factors affecting the production cost in peripheral productive units in Greece. The increased transportation cost, the lack of friendly industrial environment, the inefficiency of the industrial infrastructure, the manpower problem and the need for a centrally located branch of the enterprise are considered to be probably the most important of such factors. An assessment of their effect in terms of percentage increases of the production cost has shown an indicative 18% total increase. It is argued that such increases in the production cost, while stemming from the phenomenon of developmental polarization, result in further deterioration of this phenomenon. Measures to counteract these effects include incentives given in the framework of development laws in order to attract new investors to the periphery of the country. They also include creation of industrial estates all over the country, which provide facilities, similar to those normally offered in central regions. Such measures, however, have not produced the expected results as they are restricted to providing support to new industrial units at the installation and initial operation stage. They do not cope with the increased production cost in the long run. It follows that, for an effective regional development policy to be designed and implemented, the production cost and the factors affecting it in the periphery of the country also have to be taken into account. Until such factors are cancelled, measures to counteract their effect are necessary. Such measures include support of the productive activities in the periphery, by directly or indirectly subsidizing specific cost items (e.g., labour, energy) as well as by improving their environment in terms of infrastructure, educational and training opportunities, etc. Without such measures, industrial and, generally, regional unevenness

294 will probably deteriorate to the detriment not only of the country’s periphery but of the center and, finally, the national economy also.

ACKNOWLEDGEMENT

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2, 1989; accepted

in revised form