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Trade and Competition Policy

Index

• Competition and productivity growth in South Africa
• SACU Tariff Policies - Where should they go from here?
• South African trade policy matters

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Competition and productivity growth in South Africa

The article is quite dense in its presentation of the analysis of the data and the technical methodologies used, and does not succeed very well in building an ordinary-language argument to set out its findings, that could be followed by non-technically versed policy makers.

What is important to note is that the research was conducted using three different sets of panel data to (i) compare product market competition in South African manufacturing firms and sectors, to those in the corresponding sectors worldwide, and (ii) assess the effect of increasing product market competition on productivity growth and aggregate employment in South Africa.

The three data sets are:

1. industry-level panel data for SA and more than 100 countries since the mid-1960s, from UNIDO
2. industry-level panel data over the period 1970-2004 from the TIPS database
3. firm-level panel data since the early 1980s from public listed companies

The main findings of the research are as follows:

1. Mark-ups are significantly higher in South African industries than they are in corresponding industries worldwide, and this is consistent over three data sets. In particular, profitability margins are more than twice as large in South Africa than in other countries, and they show no decline over the recent period.
2. Higher past mark-ups are associated with lower current productivity growth rates and with lower current employment. A ten per cent reduction in SA mark-ups would increase productivity growth in SA by 2 to 2.5% per year, and also lead to an increase in employment.
3. The relationship between growth and competition is the same in South Africa as in the UK and other countries.

On higher mark-ups, the research found consistent evidence of pricing power in South African industry that is greater than international comparators, and which is non-declining over time. Results prove to be robust across:

• Three distinct data sets, covering both industry level data as well as firm-level evidence
• Two proxies of the Lerner index, given either by the differential between value added and the total wage bill as a proportion of output, or the difference between output and both wage and capital costs as a proportion of output
• Alternative measures of firm profitability
• The measure of mark-up of price over marginal cost of production
• The level of aggregation for industry, or firm size.

On the impact of pricing power, the research found it to be associated with lower productivity growth, and with lower employment in South African manufacturing. Results were found to be robust across:

• Three distinct data sets, covering both industry level and firm-level evidence
• Two proxies of the Lerner index, given either by the differential between values added and the total wage bill as a proportion of output, or the difference between output and both wage and capital costs as a proportion of output.

The above findings suggest that increased product market competition will have large positive effects on productivity growth and employment in the manufacturing sector in South Africa.

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SACU Tariff Policies - Where should they go from here?

Section 1: Features of the current tariff structures

Some features of the SACU tariff structure include measures of its restrictiveness, its effects on taxing exports, and its complexity. These are discussed in some detail.

From existing economic research the paper first develops a trade restrictiveness index (TRI). The TRI is a measure of the uniform tariff that, if applied to imports instead of the current structure of protection, would leave home welfare at its current level. The paper finds that the GDP weighted average Effective Rate of Protection (ERP) in manufacturing, for all final consumption goods, is 40 percent. Production for the domestic market is thus much more attractive than production for exports. In essence, South Africa’s trade policy continues to heavily favour import substitution rather than exporting.

Tariffs on inputs is also an inadvertent tax on exports, given that inputs are often intermediary goods in the manufacturing chain. Although provision is made for duty drawbacks and rebates for exporters under various different schemes, the effect is limited, and the process bureaucratic and cumbersome. This negative impact is despite the fact that there are two export incentive schemes in operation – one for the motor industry and one for clothing and textile exporters.

The paper uses Lesotho as an example of how input tariffs can impact exports, via its participation in the AGOA agreement with the USA. This means Lesotho receives duty-free access for clothing wholly assembled in Lesotho, regardless of the country of origin of the fabric used. This has been a considerable benefit to Lesotho, whose exports are growing rapidly and they are able to sell competitively to the USA market.

South Africa’s tariff schedule is also very complex, with 78 different ad valorem rates and 119 specific and mixed duties, for a total of 154 different rates.

Section 2: Is the current tariff structure justifiable?

The paper asks whether, despite the fact that the tariff structure provides considerable protection to some sectors, discourages exports, and is complex and opaque, these disadvantages are perhaps offset against benefits derived from the tariffs, for example through job protection, the nurturing of infant industries, or as income support for less-skilled workers.

In fact, the paper comes to the opposite conclusion. While the current tariff structure does support some jobs at relatively low costs, many tariffs preserve jobs at a considerable total welfare loss to consumers (as much as R2 million per job).

Liberalisation, on the other hand, would have an offsetting effect on employment in that it would stimulate job-creation via three avenues: Firstly, through improving profitability and raising output; secondly, through improving export profitability and boosting exports through a reduction in anti-export bias; and thirdly through growth in services in response to lower input costs.

In sum, the current tariffs serve to preserve some jobs in particular sectors, but they do so at a cost to society at large and at a considerable cost to consumers and in particular poor consumers, who spend the majority of their income on tradable goods (that are subject to tariffs) while those in wealthier deciles spend proportionally more on services that are not subject to tariffs. This means that import tariffs are a regressive tax and poor households bear a disproportionate share of the tariff burden relative to their income.

What about infant industry protection? The paper looks at products with a high income value (PRODY), the density of the of the product space, in particular how close the product currently not being exported, is to the export basket, and thirdly strategic value. It is assumed that trade-offs may exist between these three measures.

Overall, the paper finds a wide variation in the association between measures of productive capabilities and protection. There is very little linearity in the trends analysed, suggesting that both nominal tariff protection and effective rates of protection are relatively HIGH in sectors with LOW PRODY, strategic value and (to a lesser extent) density. This means that the sectors that are being given protection are not those which are likely to enhance competitive capabilities in the future.

The tariff structure remains quite protectionist, discouraging of exports and complex and opaque. It does not appear to be a cost-effective approach to job preservation, it has a regressive impact on income distribution and it does not appear to reflect a coherent infant industry orientation. Instead, it is poorly focused and clearly the result of numerous ad hoc decisions based on historical and political pressures rather than strategic behaviour.

The paper then asks the question whether a simpler tariff structure will perform better. The argument in defence of the existing tariff structure is that it enables the government to protect specific industries that require such protection. The paper chooses an arbitrary tariff (35% for mangoes, but zero for berries, dates and figs) to show how such arbitrary incentives lead to perverse outcomes. The most adverse effect is the fact that such differentials in tariffs misallocate scarce resources in the economy, and reduce economic welfare by giving the most protection to the activities in which South Africa is the least efficient economically, and the most organised politically.

There appears to be no consistent relationship between competitiveness and the tariff structure. By imposing a tariff, the government is creating incentives to put more farmland, capital investments, farm labour, water and fertilisers into mango growing and less into growing other fruit. Over long periods this is counterproductive.

As to the merits of a complex tariff structure, government simply does not have detailed knowledge of production and consumption of over 6000 product lines, and to the extent that it actually scrutinises the existing tariffs, it has to rely heavily on data and arguments provided by the industries themselves. This information asymmetry makes it highly susceptible to capture.

In sum, tariffs reallocate resources towards producing more of the product that is being protected and away from being used to produce all other products.

Section 3: Economic effects of alternative trade reform scenarios

The authors argue that the benefits of trade reform are many-fold and that the paper illustrates these benefits using a variety of scenarios.

At the same time, the lowering of trade barriers can cause dislocation and, given the South African context of high unemployment, this concern may prevent the government from adopting policies that could actually stimulate long run growth and employment. This means that a way has to be found to facilitate adjustment to a new dispensation, over time.

Firstly, the adjustments can be phased in. Secondly, consideration can be given to programmes that can aid in adjustment of industries, workers and communities. In the event that an adjustment causes disruption that had been underestimated, protection that is sufficient to offset the injury could temporarily be re-imposed. Such an approach could include the establishment of a SACU adjustment assistance programme to assist dislocated workers and communities, following a procedure to understand the cause of the dislocation. Finally, communities or municipalities experiencing job losses and plant closures due to trade liberalisation, could be given adjustment grants.

Section 4: Regional trading arrangements

The paper looks at two groupings with a significant impact on South Africa, i.e. SACU and the SADC. The focus is on SACU because of the tariff reform under consideration.

South Africa’s regional policies have two aims, i.e. to facilitate the export of its goods and services and direct foreign investment by South African firms, and secondly to stimulate regional economic development as part of an overall desire to create larger market for South African goods and services. Although the paper focuses only on tariffs, it is acknowledged that other policies also matter, for example physical infrastructure, but also institutional infrastructure like financial markets and services, regulations and competition.

South Africa needs to find a balance between holding its partners to agreements that prevent discrimination against South African products, while allowing them policy space, preference and financial assistance.

Fear in the region about South Africa’s dominance leads to an expectation that South Africa should bear a disproportionate cost associated with cooperation, and it reflects in the generous regional agreements entered into by South Africa, that have a strong compensatory element, but result in less than full reciprocity.

SACU has a common external tariff, but revenue distribution is beneficial to BLNS countries and costly to South Africa. While South Africa accounts for 90% of SACU’s GDP and 97% of extra-SACU imports, it only receives 20% of the tariff revenues. There are numerous other problems with the revenue sharing formula and the paper lists them.

The paper argues that renegotiating the revenue sharing formula faces a number of obstacles and that a change in the tariff policy could provide an alternative context for reforming the RSF.

Radical reform of the tariff structure would benefit BLNS because they consume a lot but do not produce a lot, but at the same time it would impact substantially on their share of the revenue derived from the RSF. BLNS would bear 80% of the implications of tariff reductions. SA should consider some other form of compensation through an explicit SACU development programme and fund. This would amount to aid rather than revenue sharing. This would also acknowledge South Africa’s de facto status as a donor country.

To summarise: Using simple tariff structures that have a zero and just one or two tariff bands the paper shows that it is possible simultaneously to provide benefits to consumers, limit employment dislocation by conferring a reasonable degree of effective protection on finished goods, reduce export taxes, improve transparency and provide a norm against which industrial policy priorities can be set. The long run goal would be a globally competitive SACU region that provides producers with access to inputs at world prices.

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South African trade policy matters

The paper takes as its point of departure the Accelerated and Shared Growth Initiative of South Africa (ASGISA) and highlights the fact that trade performance per se is not identified in ASGISA as a growth constraint, suggesting that it is seen as an external constraint, that is, a constraint which is not within the control of policy makers.

It argues that trade policy does matter as a growth constraint. In order to do so, it demonstrates that South Africa’s weak trade performance is a self-inflicted wound resulting from the import substitution policies of the 1970s and 1980s which not only blocked imports but also discouraged exports.

An important aspect of the argument is to show that given the policy constraints, public investment always translated into an increase in imports, thus impacting the trade balance negatively. It is only the trade liberalisation of the mid 1990s which allowed exports to grow faster than imports and improved the balance of trade.

The authors point out that their views are not uncontroversial and that other researchers have tried to argue that protection has not had a negative impact on exports, and that, rather, protection enabled the diversification of industry. The authors argue that protection has rather led to the creation of manufacturers that are unable to function without state assistance, and that, by contrast, firms that become globally competitive enjoy the unlimited potential of the world market.

Section I: South African Trade Performance – a tale of two periods

The paper compares South African trade performance before and after the mid-1980s. Prior to 1987 trade behaviour is completely stagnant. Although trade performance started to improve after 1991. South Africa missed out almost completely on two decades of globalisation. Between 1991 and 2001 trade volumes increased substantial for the first time, with export outstripping import, but after 2001 export became sluggish although imports continued to grow rapidly, and the trade balance declined from a surplus of 3.9 percent of GDP in 2001 to a deficit of 1.5 percent of GDP in 2005.

The question is then posed as to what explains these trade performance patterns: Is it simply a story of external forces such as trade sanctions, commodity price fluctuations and exchange rate movements, or have trade policies played an important role? The paper argues that trade policy has made an important contribution to the trade outcomes.

Section II: Explaining Imports

The paper finds that the import-substitution trade policies were especially important in suppressing import demand in the 1980s and causing it to accelerate in the 1990s. The paper finds a consistent relationship between import volumes and GDP, investment, protection and relative prices. In the period after 1991 the big story is again trade policy. Over the period as a whole, relative prices do little to explain import growth. In other words the exchange rate and international price shifts do not play a major role. Trade liberalisation accounts for over half the import growth in this period, increasing import demand by 2.9 percent per annum. Furthermore, the data show that the ASGISA growth model would result in import growth of more than 6 percent for a GDP growth of 6 percent. This would require export growth to exceed 6 percent in order for the trade balance not to deteriorate.

Section III: Explaining Exports

The data again show that growth in exports between 1987 and 2003 is related to trade liberalisation. There seems to be little response to real exchange rates and labour costs. This means that once again trade policy is the missing element in exports. The reason for this is that exporters rely heavily on inputs, both imported and domestic, and particularly when it comes to deciding which markets to serve. Relative profitability of exports to domestic sales will also play a role. Exports responded sluggishly to exchange rate depreciation. This is probably due to more expensive import prices offsetting the possible export advantage of a lower Rand. The paper suggests that tariffs have no direct effect upon exports, but indirectly affect exports through their impact on domestic prices or costs. The research found that a rise in tariffs raises domestic prices, which in turn reduces the profitability of exports supply, and hence lowers export volumes. A 1 percent tariff rise lowers export volumes by 0.31 percent.

With regard to exports, the paper finds that tariff protection affects exports negatively, a real exchange rate depreciation has a positive impact on export volumes, while nominal exchange rate shocks have a small effect on exports in the long run, as domestic price increases erode the improved profitability of export supply.

Section IV: Export Taxes

Tariffs affect export performance in two ways. Firstly, tariffs raise the price of intermediate inputs and therefore reduce the profitability of export production. Secondly, nominal tariffs raise the relative return to production for the domestic market causing firms to shift production out of the export market and into the domestic market. These variables have a significant impact on trade flows, and this implies that it is not simply factor endowments that are responsible for the patterns of export specialisation in South Africa. In fact policy has contributed to the patterns.

Analysis of available data shows that trade policies were partly responsible for South Africa’s weak manufacturing export performance, particularly during the 1970s and 1980s. Not only did the trade regime penalise non-commodity exports more than commodities, but since non-commodity supplies are relatively more responsive to these penalties, the impact of these policies was magnified. The growth in exports, particularly non-commodity manufactures, during the 1990s, is in large part due to the reduction in anti-export bias brought about through tariff liberalisation.

Section V: Explaining the trade balance

Although the argument thus far indicates that trade liberalisation has both raised exports and imports during the 1990s, the net effect on the trade balance is ambiguous. Although many studies of developing countries in general find that trade liberalisation worsens the trade balance, the paper argues differently. Looking at various measures of protection, it finds a large positive and significant impact of surcharges on the manufacturing trade balance. However, higher nominal output tariffs, effective protection rates and the implicit tax on exports all worsen the trade balance. The paper finds that the stimulus to non-commodity export growth from liberalisation exceeded the increase in imports.

Conclusions

The paper finds that if South Africa were to boost its investment relative to GDP, then, at a constant exchange rate, import growth would outpace output growth. On average, one percent increase in gross domestic expenditure would lead to a similar growth in import demand.

In the apartheid period, trade protection seriously impeded both exports and imports. South Africa developed a comparative advantage in capital-intensive primary and manufactured commodities partly because of its natural resource endowments but also because the pattern of protection was particularly detrimental to exports of non-commodity manufactured goods. High and opaque tariffs seriously impeded export growth. At the same time surcharges were effective in reducing imports. By contrast, trade liberalisation in the 1990s not only increased imports but, by reducing both input costs and the relative profitability of domestic sales, also boosted exports. In fact, the growth in non-commodity manufactured sectoral exports as a result of liberalisation was faster than sectoral imports.

In addition to tariffs, both non-commodity exports and aggregate imports are responsive to changes in the real exchange rate. This evidence suggests that South African entrepreneurs are not inherently biased against exports but instead respond rationally to the incentives that they face.. This points to the importance of policies that afford them access to inputs at world prices as well as a competitive real exchange rate. It also suggests that additional trade liberalisation could well be part of the strategy to enhance export diversification.