In 1984 the value added in manufacturing totaled US$344 million, distributed approximately as follows: food and agriculture, 42 percent textiles and clothing, 11 percent chemicals, 8 percent machinery and transport equipment, 1 percent and other manufacturing, 37 percent. Manufacturing was almost completely oriented toward the domestic market manufactured goods accounted for a mere 2.5 percent of the value of exports of goods and nonfactor services. Production was concentrated in Panama City (over 60 percent of establishments), with smaller industrial centers at David (10 percent) and Colón (5 percent).

Industrial development has faced the serious constraints of the small size of the domestic market, lack of economies of scale, high labor and unit costs, and government policies of high protection against imports. The greatest growth in manufacturing occurred in response to import- substitution industrialization in the 1960s and 1970s. By the 1980s, however, the "easy phase" of importsubstitution industrialization was over a second phase, that of industrial deepening, was more difficult to carry out in such a small economy. The economy's obvious limitations in manufacturing have been partially offset by an educated labor force, highly developed internal and external transport and communication links, extensive financial facilities, the country's centralized location, and relatively few restrictions to foreign investment. The Panama Canal treaties provided additional space for expanding the CFZ, an ideal location for light industry and assembly plants.

During the 1970s, the public sector took the lead in manufacturing by building a cement plant, sugar mills, and iron and steel works. The structural adjustment program of the mid-1980s sought to reduce the state's role in the economy and to make the private sector the engine of manufacturing growth. The industrial incentives legislation of March 1986 encouraged manufacturers to be export-oriented by removing tax exemptions for those firms that produced for the domestic market. The legislation also provided for maintaining tax exemptions on imported inputs, income, sales, and capital assets for those firms that produced exports. The legislation also lowered import barriers over a period of five years in an effort to increase the productivity and competitiveness of local manufacturing. In addition, new companies were given tariff reductions of up to 60 percent for the first 7 years, and 40 percent thereafter.

Since the early 1970s, industrial expansion and job creation have lagged behind the growth of the labor force. In the 1960s, an average of 2,400 jobs was created each year in manufacturing. The rigidities of the industrial incentives law in 1970 and the labor code in 1972 contributed to a decline in manufacturing employment an average of only 530 new jobs were created each year in manufacturing during the 1970s. The changes introduced in the labor code in March 1986 sought to reverse the antiemployment bias in manufacturing. The slight reduction in the overall unemployment rate in 1986 may be partially attributed to 71c o the labor code revisions.

Despite government measures to stimulate manufacturing, Panama's becoming a major industrial center seemed unlikely. Under the CBI, some potential arose for the development of twin-plant operations, especially in association with firms in Puerto Rico, where labor costs were higher than in Panama. In general, however, Panama was unable to compete effectively with Mexico, given the latter country's low labor costs and proximity to the United States market. Also, the possibility existed that industries from East Asia, especially clothing manufacturers, might increasingly relocate to Panama, in an attempt to circumvent United States quotas. This possibility was limited by uncertainty over the United States response. The United States Department of Commerce had called for the reduction of United States imports from Panama, precisely in those products manufactured by Asian investors.

Data as of December 1987