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Industrial Policy (including beneficiation policy)

Index

• Examining beneficiation
• Reconfiguring Industrial Policy
• South Africa's export predicament
• Understanding South Africa’s Economic Puzzles

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Examining beneficiation

Abstract

Beneficiation, moving downstream, and promoting greater value added in natural resources are very common policy initiatives to stimulate new export sectors in developing countries, largely based on the premise that this is a natural and logical path for structural transformation. But upon closer examination, very few countries that export raw materials also export their processed forms, or transition to greater processing. The quantitative analysis finds that broad factor intensities do a much better job of identifying patterns of production and structural transformation than forward linkages, which have an insignificant impact despite the fact that the data used is biased against finding significant effects of factor intensities and towards finding significant effects of forward linkages. Moreover, the explanatory power of forward linkages is even smaller in sectors with high transport costs, and in sectors classified as primary products or raw materials, which are the most common targets of such policies. Finally, the results are the same even when only considering developed countries, meaning that colonial legacy inhibiting transitions to natural resource processing are not to blame. These results suggest that policies to promote greater downstream processing as an export promotion policy are misguided. Structural transformation favours sectors with similar technological requirements, factor intensities, and other requisite capabilities, not products connected in production chains. There is no reason for countries like South Africa to focus attention on beneficiation at the expense of policies that would allow other export sectors to emerge. This makes no sense conceptually, and is completely inconsistent with international experience. Quite simply, beneficiation is a bad policy paradigm.

Introduction

The idea that moving from raw products into beneficiation is a logical progression to pursue, has always been popular in developing economies and policies encouraging that progression as a route towards accelerated growth, enjoy wide support.

However the basis for such downstream linkage-based policies is questionable, and mostly based on assumptions relating to the cost of transport to connect raw materials to markets, and the argument that high transport costs justify value addition at source. Other popular reasons given include the cost of raw materials close to the point of beneficiation, as well as the value of backward linkages to co-ordinate supply and demand.

Most beneficiation policies are based on logic, anecdotes, and what is taken as ‘self-evident truth” rather than systematic analysis. The paper aims to combine new methodologies to study international patterns of production and the process of structural transformation, with a highly disaggregated input-output matrix to consider the empirical relevance of forward linkages to cross-country patterns of trade performance over time.

The findings are that a factual analysis does not support the popular beliefs. Forward linkages play an extremely small role when compared to traditional determinants of comparative advantage. It further shows that forward linkages are often the weakest in the very sectors where popular belief would have it that they are the strongest (for example primary raw materials). Finally the article shows that there is no connection between the small effect of forward linkages, and colonialism and that the small impact of linkages is as true for industrialised countries as it is for developing countries.

Beneficiation is clearly the wrong approach for South Africa, and can only be achieved at the expense of missed opportunities from the entire set of “lateral” sectors that don’t currently exist. Furthermore, it is a bet against the whole international experience.

Literature review

Linkages jumped to prominence in development thinking in the 1960s with Hirschman’s ‘The Strategy of Economic Development’. In a postscript to the 1988 edition, he notes that “if a popularity contest were held for the various propositions I advanced in Strategy, the idea of favouring industries with strong backward and forward linkages would surely receive first prize.” Hirschman operated from an assumption that a clear theoretical model of economic growth did not apply to developing economies and that, therefore, development policy was simply a search for those policy levers or inducement mechanisms that had the highest marginal impact.

Hirschman’s ideas found appeal in Latin America in particular, where the notion of import substituting industrialisation (ISI) was pursued as a first logical strategy towards beneficiation. Tariff structures became part of the overall strategy to favour ISI. The second idea was the downstream beneficiation of raw materials, and this led to tariffs on the export of raw materials. Although many of these attempts led to stagnation and macroeconomic crises, they remain popular.

More recent work highlights the fact that Hirschman’s linkages never had any theoretical basis and lacked a clear definition of a market failure. Differences in manufacturing transformation are due to comparative advantage in factor endowments and technological differences.

The new economic geography literature (Ottavio and Puga) has brought more clarity to the role of linkages.

Methodology

Forward linkages, structural transformation and factor intensities are measured using a range of techniques and analytic instruments.

Results

The results of the analyses are tabulated in detail. It shows that less than one-third of raw material exporters in the sectors analysed, also export the next downstream product. Instead of following forward linages, countries that are good at exporting a raw natural resource like cotton are also good at exporting another raw natural resource like coffee, as well as a simple manufacture like garments, and not often a more complex manufacture like breakfast cereals.

The paper recognises that policy bias in the real world skews the results of the analysis somewhat. This is evident from the logging sector, where more than half of the world’s log exporters also export sawmill output. However many developing countries have explicit policies preventing raw log exports in order to stimulate downstream industries.

The data also showed that there is more commonality of factor intensities (like labour and capital) between exports from a specific country, than downstream linkages. For example, what are the capabilities needed to export logs? Probably a mix of natural resource property rights, sufficient capital to harvest the resource, and simple rural infrastructure. This mix of national-level capabilities seems more relevant to fish exports than to pulp mills. Likewise, success at growing cotton is much more aligned with the requirements for growing other crops, than for cotton mills. The data, not surprisingly, show more exporters of cotton achieve success at other crops and more exporters of logs achieve success at fish exports, than with cotton and paper mills.

Heterogeneous linkage effects: transportation costs and natural resources

Forward linkage-based policies are often based on the following logic: shipping raw materials to a third country for processing before export to the final user of the processed good is not sensible, as it imposes additional transportation costs. If the source country of the raw materials were able to process them locally and export directly, they would have a cost advantage, as they could avoid these additional transportation costs. This argument is formalized in Venables’ model of agglomeration, and suggests that linkages will matter more for products with higher transport costs. When transport costs are low, production can disperse to countries with the lowest factor costs more easily, whereas if transport costs are high, there is a greater benefit to co-location.

The analysis finds that not only is there no positive correlation between transport cost and where beneficiation takes place, but the there is a significant negative correlation. That is, linkages matter less in determining international patterns of production among goods with high transportation costs, like cement. Therefore there has to be another linkage, such as high technological complexity, which makes forward linkages more important for structural transformation, for example microchips and computers.

Lastly, it is found that there is no economic significance in the analysis of forward linking of products in developed countries as opposed to developing countries and that the so-called colonial legacy does not offer any policy rationale for local beneficiation.

Conclusion

Beneficiation, moving downstream, and promoting greater value added are very common policy initiatives in developing countries, particularly among those that export natural resources. These countries are seeking to diversify their output away from volatile commodities, reduce unemployment, and help bring about structural transformation in their economies through a well-targeted ‘inducement mechanism’. But what is the basis for using forward linkages as a guide for stimulating structural transformation? Most policy documents suggest this is a natural and logical progression that other developed economies followed, and represents the lowest-hanging fruit given the local presence, and therefore low transportation costs, of the raw materials.

However the paper shows that a capabilities view of production, with characteristics as simple as broad factor intensities, does a much better job of identifying patterns of production and structural transformation than forward linkages. Forward linkages have an extremely small impact on which sectors are likely to emerge as export successes in a country. And this is despite the fact that the data sources are policy-biased against finding significant effects of factor intensities and towards finding significant effects of forward linkages. Moreover, the explanatory power of forward linkages is even smaller in sectors with high transport costs, suggesting that physical proximity of raw material inputs matters little. Similarly, sectors classified as primary products or raw materials, which are the precise targets of most forward linkage-based policies, are even less likely to be exported in the same countries as their processed versions.

These results suggest that policies to promote greater downstream processing are misguided. Structural transformation in exports favours sectors with similar technological requirements, factor intensities, and other requisite capabilities, not products connected in production chains. Government does not have limitless capacities and resources, so a focus on beneficiation is necessarily at the expense of policies that would enable other potential sectors to emerge. The data clearly show that this is a bad trade-off, as the better opportunities are more often ‘lateral’ than downstream. Quite simply, beneficiation is a bad policy paradigm.

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Reconfiguring Industrial Policy

I: Introduction

The paper builds on earlier writings to present an overall design for the conduct of industrial policy in a low- to middle-income country. The main purpose of industrial policy is to speed up the process of structural change towards higher productivity activities. The paper firstly distinguishes this approach from a traditional understanding of industrial policy. It then proposes a two-pronged “industrial policy in the small” and an “industrial policy in the large”. Lastly, it makes policy recommendations for South Africa.

II: The policy problem

The paper sets out to avoid the traditional, and often stale, arguments about the pros and cons of industrial policy, by presuming that in developing countries market failures are not a rarity, but rather a rampant feature of the landscape. Market failures that require intervention by means of industrial policy, take three forms in particular:

1. Self-discovery externalities: Learning what new products can be produced profitably in an economy, and how, is an activity whose social value greatly exceeds its private value.
2. Coordination externalities: New economic activities often require simultaneous and lumpy investments upstream, downstream, and in parallel forks, which decentralized markets are not good at coordinating.
3. Missing public inputs: Private production typically requires highly specific public inputs – legislation, accreditation, R&D, transport and other infrastructure specific to an industry – of which the government has little ex-ante knowledge.

These externalities lie behind slow structural transformation, and hence slow growth. However no-one knows exactly where these externalities are, and therefore a feature of the proposed policy process, is to “organise searches” to identify and respond to them.

The nature of these externalities are such, that they cannot be addressed by traditional economic subsidies or money transfers, because they reflect multiform missing markets or public inputs like infrastructure, skills, regulations, property rights and social norms, and the required solutions would involve a portfolio of measures or activities, like building infrastructure, passing laws, regulating certain markets, and providing services, which then translate into abilities, for example the ability to transport and sell fresh meat into foreign markets.

What a country produces, is indicative of the kind of co-ordination problems it is able to solve, just as the things it is not producing are indicative of the know-how that it does not have. It is difficult to coordinate in advance, the creation of capabilities for activities that do not yet exist, and therefore productive transformation needs to happen through the incremental shift towards “nearby” goods, i.e. goods that can be produced with skills similar to those skills that already exist. These shifts need to provide constant feedback into public inputs.

These processes are ongoing, and exchange of information between government and the private sector is therefore an important challenge that an industrial development policy must address.

III. From principles to policies

Traditional industrial policy is often quite clear about the market failures, policy instruments, and industries identified as the beneficiaries of the policy. However this paper puts the emphasis on getting the strategic collaboration between the state and the private sector which directs policy, to work right. It focuses on the processes and procedures for selecting (and correcting selections) of both policy and industries, rather than recommend specific policy instruments or sectors.

It therefore proposes industrial policy around two different axes – a local axis (policy in the small) to improve the performance of existing industries in a stepwise manner (in the hope that this will facilitate “jumps” to adjacent trees in the forest), and a global axis (policy in the large) through strategic bets on new industries whose success depends on bigger capacity leaps.

1. Industrial policy in the small

This would entail improving the provision of public inputs to existing activities towards higher productivity and better quality of existing activities in the hope that “nearby” products will emerge. The sources of information for such policy inputs would be existing firms. For this approach to work government needs to overcome a threefold problem. Firstly, an information problem of not knowing what public inputs to provide; secondly, an incentive problem of weak rewards for officials to take the appropriate actions; thirdly, a resource problem in that government does not have a “market mechanism” for resources to move to fill identified needs.

The paper proposes a policy intervention involving four elements:

1. A mechanism to promote, under public auspices, systematic discussion among firms with the aim of identifying, and proposing solutions to, specific coordination failures.
2. A new budgetary procedure to increase the responsiveness of the public sector to the requisite actions.
3. A new monitoring procedure to discipline project selection while diffusing the lessons of its successes.
4. A set of operating principles. A list of possible operating rules is also proposed.

2. Industrial policy in the large: strategic bets

Whereas industrial policy in the small may lead to productivity and quality improvements that could enable firms to jump to nearby “trees” in the forest of productive activity, government is not expected (and would not be able) to predict what these adjacent trees are. By contrast, industrial policy in the large implies thinking of an industry or activity one would want to see develop, and then backing up all its public input needs plus some subsidies to stimulate private participation. This requires more centralisation, and calls for a second set of institutions that can range much wider in its exploration along the frontiers of the production space. This could work along the principles of a venture fund but, unlike private venture capitalists who compete for the best of the many deals presented to them, in this proposal the venture fund would operate along more monopolistic lines, not unlike a development bank. There needs to be clear benchmarks or criteria for success and failure and there needs to be room for experimentation, with a clear strategy to let losers go, more so than to pick winners. The objective should be not to minimise the risk of mistakes but to minimise the cost of mistakes.

IV. An application to South Africa

The acid test for an industrial policy framework is whether there exist institutions that engage policy officials in an ongoing conversation with the private sector; whether the government has the capacity to respond selectively, but also quickly, and using a variety of policies, to the economic opportunities that these conversations are helping identify; and finally whether there are monitoring and evaluation procedures to ensure the policy process is self-correcting.

Although there are a number of departments, parastatals and development agencies in South Africa engaged in industrial policy initiatives of some kind, the authors do not believe current industrial policies pass the above acid test. Although aspects of a proposed new policy exist, there is a significant disconnect between government and the private sector, with a number of programmes that have outlived their usefulness. In some cases current arrangements are so disorganised that it would make sense to create institutions with overlapping mandates, as a measure to create competition for public input. The paper then proposes a number of initiatives to improve the framework conditions within which industrial policy takes place.

1. A new budgetary procedure to elicit information on missing public inputs and pay for them

The proposal is to allocate 4% of the economic cluster departmental budgets to a central fund, for which bureaucrats compete based on their ability to generate productivity enhancing public inputs. The applications would be vetted by a fund secretariat. Applications would come from firms or groups of firms and would identify absent public inputs that, if supplied, would enhance their productivity.

2. Reorienting the IDC towards self-discovery activities

The IDC is ideally positioned to undertake self-discovery activities, and in exceptional cases it has done so, but its large asset base and low leverage and turnover base provides it with plenty of room to expand and engage in strategic bets. Rather than avoiding project failure risk, it should take on more project risk and strengthen its monitoring activities to be able to recognise and get out of failures.

3. A revamped Motor Industry Development Plan focused on strengthening the supplier base

At the time of the paper’s publication, the MIDP was still in force, and the paper proposed a ‘two-window” approach to improve the MIDP and refocus it towards the supplier base of the motor manufacturing industry. Firstly, a standard incentive as a subsidy on the wage bill or capital cost for new capacity in the supplier industry, and secondly, support that depends on the specific needs of the firms in question. Firms would have to choose between the two windows. Once again the support taken, would enable government to learn about the obstacles faced by investors in the industry. It was anticipated, at the time, that not all firms would be prepared to continue manufacturing if they had to give up the lucrative Import Rebate Credit Certificates in favour of a scheme that favours the supplier base, and this would give the proposal the added feature of acting as a screening process to sift out those who did not see a long term future beyond rent seeking.

4. Improving the Customised Sector Programme processes of the DTI

Ideally, the kind of policy advocated above for the auto industry would have come out of the CSP process for the sector in the DTI. In principle, the CSP consists of a deliberation forum at the industry level and would function along the lines sketched in the earlier discussion of industrial policy in the small. Elements of such a deliberation forum have indeed been sponsored under the umbrella of the MIDP, most notably the benchmarking club of assemblers. Though neither this club, nor any other forum or oversight body created in connection with what is, after all, South Africa’s single most significant and conspicuous industrial policy programme, managed to articulate a reorientation plan that most key actors would regard as reasonable – despite strong incentives to do so (the need to issue new regulations because of the MIDP’s inconsistency with WTO rules and the expiration of the present scheme).

This failure to engage key suppliers in a discussion seems especially troubling and revealing, and points to a failure of execution and monitoring in the government’s efforts to organize policy collaboration with industry. Similar disjunctions were found in other sectors.

It is therefore concluded that the CSP is not a systematic programme with characteristic advantages and disadvantages at all, but rather it is a collection of very disparate industrial policy initiatives grouped under a common rubric.

5. Avoiding forced beneficiation

The paper makes a strong argument that downstream beneficiation in the mining sector should not be pursued, because the expertise involved in mining diamonds, for instance, is very far removed from the expertise to polish them. Rather, the mining sector has proven expertise in a number of fields that has application outside mining, like the design and production of high performance pumps and valves and other capital equipment for the mining industry. What is more, the cost of beneficiation is likely to be measured less in the poor investments it compels than in the opportunities it obscures, and depends on legacy thinking that beneficiation has a higher value than extraction. Such thinking frustrates the open-ended search for possibilities that this proposed industrial policy is designed to encourage.

V. Concluding remarks

Industrial policy assists firms in their search and discovery processes for new lines of comparative advantage, but the implementation of industrial policy itself is a process of discovery about the appropriate institutional practices that will bring the desired results about. Continuous benchmarking, monitoring, and experimentation are important. It is therefore a mindset that rejects a big bang approach in favour of experimentation, and gradual but transformative change of self-correction for problems in the system.

Appendix: A note on the economics of the MIDP and IRCCs

In this note the MIDP is subjected to a brief economic analysis showing that there are arguments in support, as wells as arguments for the scrapping of the MIDP, in particular when counterfactual considerations (such as the impact on the fiscus) are brought into the calculation. The scheme has had a positive impact on export, but the import of new vehicles (import penetration) remained largely unchanged and therefore consumers have not benefited from lower prices of locally manufactured vehicles. What is more, the OEMs are mostly foreign owned and therefore the IRCCs accrue to foreign companies. These transfers are too large to make much of a difference to the bottom line.

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South Africa's export predicament

Abstract

The paper explores export performance in South Africa over the past 50 years, and concludes that a lagging process of structural transformation is part of the explanation for stagnant exports per capita. Slow structural transformation in South Africa is found to be a consequence of the peripheral nature of South Africa’s productive capabilities. The authors apply new tools to evaluate South Africa’s future prospects for structural transformation, as well as to explore the sectoral priorities of the DTI’s draft industrial strategy. They then discuss policy conclusions, advocating an “open-architecture” industrial policy where the methods applied herein are but one tool to screen private sector requests for sector-specific coordination and public goods.

Section 1: Does South Africa face an export predicament?

Analysis of export data for the period 1960 to 2004 shows that South Africa’s export performance has remained stagnant and that although exports have grown in absolute terms, the per capita value of exports was at the same level in 2004, as it was in 1960. This makes South Africa a complete outlier among peers, ranking 50th out of 56 comparable countries in terms of export per capita. The main reason is that mining faces a fixed endowment in a country where population has been rising. Additionally, the lack of growth in mining output was not offset by growth in other manufacturing output, which only rose in the 1960s and ‘70s, but remained stagnant thereafter. Rising output of other export goods have been offset by even more imports of the same goods (like vehicles, machinery, food, leather etc.).

The article finds that exports are not only lagging in amount but also in sophistication. “Rich countries produce rich country goods” and this leads to growth in GDP per capita as well. In this regard South Africa only experienced marginal improvement in its export basket but this has been offset against a stagnation of per capita GDP over the 30 years preceding 2004.

Section 2: Structural transformation in South Africa

In standard trade theory, structural transformation is a passive consequence of changing factor endowments. South Africa had a large endowment of mineral resources, and therefore its export basket was concentrated in such goods. As population increased, the mining endowment per capita fell and endowments of unskilled labor and capital rose. Theory would predict that this new endowment mix should automatically manifest itself in a different export mix. However, there are many reasons why structural transformation may be more complicated than this picture suggests. Several factors may create market failures such as industry-specific learning by doing or industry externalities. There may also be technological spill overs between industries. Alternatively, the process of finding out which of the many potential products best express a country’s changing comparative advantage may create information externalities as those that identify the goods provide valuable information to other potential entrepreneurs but are not compensated for their efforts.

Producing new things is quite different from producing more of the same, as each product involves highly specific inputs such as knowledge, physical assets, intermediate inputs, labour training requirements, infrastructure needs, property rights, regulatory requirements or other public goods. Established industries somehow have sorted out the many potential failures involved in assuring the presence of all of these inputs, which are then available to subsequent entrants in the industry. But firms that venture into new products will find it much harder to secure the requisite inputs. For example, they will not find workers with experience in the product in question or suppliers who regularly furnish that industry. Specific infrastructure needs such as cold storage transportation systems may be non-existent, regulatory services such as product approval and phyto-sanitary permits may be underprovided, research and development capabilities related to that industry may not be there, and so on. In short, structural transformation may be held back if the current product mix is very different from other products a country might produce.

The probability that a country will develop the capability to be good at producing one good is related to its installed capability in the production of other similar, or nearby goods for which the currently existing productive capabilities can be easily adapted.

Using different tools to analyse South Africa’s positioning in the product space, the paper argues that much of the country’s structural transformation predicament boils down to its placement on the periphery of the product space. The view is then postulated that the tools to overcome this predicament likely lie in the area of trade policy and industrial strategy.

Section 3: the trade-offs in industrial strategy

In considering the products that South Africa could move to, the authors identified a particularly important dimension: contribution to open forest, or what they refer to as strategic value. In addition to strategic value, they were also able to measure the distance of any good from the country’s current export basket.

There is a trade-off between the two dimensions of distance and strategic value: countries are more likely to move successfully to goods that are close to what they currently produce, because such goods require similar capabilities. Yet, such goods may or may not have much strategic value. They may be in a sparse part of the product space or may be so close that the move does not imply the development of new capabilities that can be redeployed in other directions. So the trade-off is between moving closer, which is easier, or moving further away, which may be more valuable in terms of future structural transformation.

There may also be a trade-off between a product’s attractiveness (price) and distance. Products closest to the current export package may not be the most sophisticated, and therefore would not have the highest prices.

When considering industrial strategy, the three fundamental characteristics of product value (income), proximity and strategic value can be used when prioritising the provision of public goods and the resolution of co-ordination failures that are sector- or product-specific.

Performing such an analysis, the article finds a rather heterogeneous mix of sectors. There are very diverse types of machinery, agricultural products, pharmaceutical products, and mining and processed commodities, in addition to a significant number of products that fall into other sectors.

Industrial strategy is further complicated by the other pressing goals in South Africa, relating to the labour market. South Africa has a large pool of underutilised unskilled labour, in addition to high levels of capital. Correcting further for these two factors, the products essentially fall into two categories: agriculture, food and animal products, and clothing and textiles. Of these, and in terms of distance and strategic value, agriculture, animals and food products are much nearer to South Africa’s current productive structure and are also of a higher strategic value for South Africa when compared to clothing and textiles.

The analysis suggests that a sectoral approach to South Africa’s industrial strategy may offer some useful information. Yet, it is also clear that when considering the economic objectives achieved by successful penetration of various products, there are very attractive targets in a rather diverse set of sectors. This suggests that a sectoral approach to South Africa’s industrial strategy may discard some products of great value and prioritise others of little value.

Section 4: The DTI’s industrial strategy

The DTI’s National Industrial Strategy focuses on 14 priority sectors but not on products. An analysis shows that the targeted sectors include 70% of the goods in the product space in South Africa. An analysis of the 30% products that are not covered, fall inside an efficient frontier, which means they lie far away from the current productive structure and they offer little in terms of providing capabilities valuable for future structural transformation. On face value the omissions seem quite sensible.

The paper plays with a number of different permutations in analysing the chosen sectors with a view to identifying sectors or products with a high potential to facilitate future structural transformation of the economy. The sectors that emerge with the highest potential for this outcome, are sectors like agriculture, machinery, basic chemicals, and refined products, whilst sectors that score low are clothing and textile and aerospace.

Section 5: Policy implications

General policy conclusions

The paper generally favours a sector-neutral promotion strategy that is concentrated on overcoming market and government failures, wherever they may be, instead of choosing specific sectors. However it acknowledges that the SA Government may have limited options in terms of the choices it is able to make, and therefore proceeds by using the insights gleaned from the analyses performed on the SA product space, to highlight the potential of four specific sectors. At the same time the paper suggests that the government should institute a “general window” through which suggestions could be made for intervention in sectors or activities requiring intervention. A set of principles is suggested to guide this process of self-selection.

Sector-specific conclusions

Analysis of the product space highlights four sectors for specific attention: agriculture, machinery and equipment, pharmaceuticals, and other chemicals. The research informing the paper did not include the services sector.

Agriculture

Agriculture faces a number of limitations, including distance ot market, climate, and property rights issues and the availability of arable land. Yet, comparisons with international data show that countries with similar constraints achieve much more in terms of agricultural output, which suggests that there is much unexploited potential for a more ambitious strategy in agriculture.

Machinery and equipment

Machinery is positioned in one of the densest parts of the product space and the distance to other similar strategic opportunities is smaller. What interventions are required from the public sector, needs to be identified through the policy process. There is an additional gap for government to exploit a loophole in the WTO rules due to the fact that it has not signed the WTO procurement protocol and could therefore use the public investment programme to subsidise learning-by-doing with a view to bolstering the export competitiveness of local suppliers.

Pharmaceuticals

A number of factors favour pharmaceuticals as a growth product. These are: the global market, African growth forecasts, donors in health care, and the specificities of the African market, like tropical diseases and the prevalence of HIV-AIDS. Finally there is the large donor interest in research and development, as exemplified by investments by the gates Foundation. There is already a manufacturing base in generic drugs, but, due to regulatory challenges surrounding pharmaceuticals, also a requirement for active public input.

Chemicals

Chemicals occupy a dense area of the product space, with high income and strategic value. In addition, SASOL is an important anchor for the chemical industry. Challenges include regulatory and intellectual rights issues, as well as the fact that SASOL is state owned and therefore offer limited diffusion unless it actively seeks joint ventures in other fields.

The role of foreign investment

The paper concludes by highlighting the importance of Greenfield foreign investment to accelerate the process of structural transformation, with an active investment promotion entity being an important element of the strategy. In addition, a strategy to raise the presence and visibility of South Africa in the eyes of foreign corporations may be useful, in attracting the interest of major global players to complement a development strategy.

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Understanding South Africa’s Economic Puzzles

Abstract

South Africa has undergone a remarkable transformation since its democratic transition in 1994, but economic growth and employment generation have been disappointing. Most worryingly, unemployment is currently among the highest in the world. While the proximate cause of high unemployment is that prevailing wages levels are too high, the deeper cause lies elsewhere, and is intimately connected to the inability of the South African economy to generate much growth momentum in the past decade. High unemployment and low growth are both ultimately the result of the shrinkage of the non-mineral tradeable sector since the early 1990s. The weakness in particular of export oriented manufacturing has deprived South Africa of growth opportunities as well as of job creation at the relatively low end of the skill distribution. Econometric analysis identifies the decline in the relative profitability of manufacturing in the 1990s as the most important contributor to the lack of vitality in that sector.

I: Introduction

The political transition in South Africa could have gone the way of populism. Instead, the policy choices of the ANC government have largely been exemplary. If the world were fair, the South African Government’s political restraint and economic rectitude would have been rewarded with a booming economy and near full employment.

However, per capita growth remained low and unemployment is among the highest in the world.

Despite high unemployment, wages are also high, not so much in real increases, but rather that unions have succeeded in preventing wages from falling due to a surplus in the supply of labour.

The real reason for high unemployment, however, is the inability of the economy to create jobs.

High unemployment and low growth are due to the shrinkage in the non-mineral tradeable sector (agriculture and manufacturing) since the early 1990s. In South Africa this sector is intensive in low skilled labour.

Normally this high unemployment could be offset by lower wages, and absorption into the informal sector. Lower wages did not, however, lead to absorption due to social expectations, and absorption into the informal sector did not happen due to the legacy of apartheid laws, which prevented an informal sector from developing in urban areas.

By implication, expansion of the non-mineral tradeable sector (this paper deals mainly with export oriented manufacturing) will be good for growth as well as for employment of unskilled labour, and this will result in inclusive growth.

II. Why is South Africa not Malaysia?

Rodrik chooses Malaysia as a country with an economy and socio-political challenges similar to that of South Africa. In the 1970s the two economies were comparable in structure and scale, but went in opposite directions. Malaysia industrialised successfully. This was due to smart government policy, and close co-operation with the private sector. Although some initiatives failed, it was more than compensated for by the successes achieved.

III. Patterns of employment and structural change in South Africa

The South African economy experienced structural changes that led to a decline in the demand for labour, in particular as a result of a decline in the profitability of manufacturing. Between the 1970s and 1990s employment in the tradeable sector declined from 40% to 30%. The decline in employment in the mining and agricultural sectors was not compensated for by absorption into the manufacturing sector. Instead, skilled labour went into the non-tradeable (services) sector and low skilled employment remained stagnant.

IV. Explaining patterns of structural change

The patterns of structural change in the economy is explained by a close correlation of the decline in manufacturing output with job losses. Three causes of the fall in the price or value of manufacturing are identified. These are: rigid profit margins, import replacement, and a volatile exchange rate and terms of trade.

The paper discounts wage-push as a main reason for the decline in manufacturing employment. The real reasons are found in the econometrics of structural change in the economy.

V. Concluding remarks

The disappointing trajectory of the South African economy is due mainly to the under-performance of manufacturing. Therefore a healthy manufacturing sector is at the core of a shared growth strategy. This has macro- and microeconomic implications.

In terms of macroeconomic policy, monetary and fiscal policies need to allow for modified inflation targeting, with a shift of focus towards a stable and competitive exchange rate over the medium term to aid export-orientated manufacturing.

At the microeconomic level, a more coherent and better co-ordinated industrial policy that focuses on “self-discovery” rather than on meaningless objectives like beneficiation, is needed.

The paper concludes by emphasising that the good news of this analysis is that an expanded non-resources tradeable sector will serve the objectives of macroeconomic stability, economic growth and social equity (inclusivity) all at once.