Competitive manufacturing sector can solve issues in SA

Tariff protections are necessary, but it’s important to optimise their impact, writes Henk Langenhoven.

Tariff protections are necessary, but it is important to optimise their impact and minimise their unintended consequences. A loud and persistent concern has been expressed by various stakeholders about the manufacturing sector’s decline and the concomitant de-industrialisation.

When mention is made in the same breath about the government’s focus on manufacturing as a way to create jobs to solve the unemployment problem, often the reaction is that of disbelief. Yet the latest version of the Industrial Policy Action Plan (Ipap) boasts about several achievements regarding industrial policy.

South Africa is not de-industrialising, but manufacturing is changing. The manufacturing sector is today 15 percent bigger than it was 10 years ago, 51 percent bigger than 20 years ago, and 64 percent bigger than 30 years ago. However, employment numbers have declined alarmingly: 14 percent fewer people are employed today than in 2005, 23 percent fewer than in 1995 and 27 percent fewer than 1984.

Diminishing share

Confusion arises when the size and share of the economy is mentioned in the same breath. Manufacturing constitutes a diminishing share of the economy simply because other sectors, primarily services, have been growing faster over the same period. According to the SA Reserve Bank, manufacturing’s contribution to the economy has declined from 19.7 percent in 1995 to 13.7 percent last year.

At the end of the second quarter of this year, renewed weakness is evident in manufacturing and the metals and engineering sector. Incidentally, the latter sector is 6 percent larger than in 2005 and 53 percent larger than in 1995. However, the sector is still producing at 30 percent below the 2007 peak, with grave concern that a renewed downward cycle has been entered.

These trends pose several dilemmas for industrial policy.

The fact that manufacturing has been growing over the last decades positively answers the question whether it should be supported at all. The more relevant question is whether South Africa is spending its scarce fiscal resources on the right industries in the sector.

Manufacturing is essentially made up of five large industrial groups including agro-processing (24 percent), metals and engineering (23 percent), chemicals (22 percent), wood, paper and printing (13 percent) and the automotive sector (7 percent). It is not simple to analyse the complex mixture of trade facilitation, investment incentives and competitiveness enhancement programmes run for the manufacturing sector in South Africa, as a review of these policies by the Trade and Investment Policy Strategies research institute revealed in 2010.

That study revealed the focus of incentives by sub-industry between 1994 and 2008, shifting the debate to whether support should be simplified and focused on these large groupings to enhance their growth and potential. It is clear that an in-depth evaluation of the effectiveness of support measures should be undertaken again to inform policy formulation. This is a critical exercise following the 2007/8 financial crisis and its aftermath.

Owing to the small and open nature of the South African economy, each of these industrial groups is characterised by a small number of large, usually internationally competitive companies and many small companies that are almost solely dependent on the domestic market.

This creates a huge conundrum for policymaking.

The large companies earn the country’s foreign exchange, but may show monopolistic tendencies in their pricing behaviour, whereas the small, secondary group creates most of the employment, but needs protection and intermediary products from the upstream companies. This is well demonstrated by the outcry from secondary steel companies following the introduction of tariff protection for the primary producers.

It is important that balance between the interests of the two groups is found. Industrial policy literature often excludes the automotive and clothing industries. That essentially indicates two different approaches to the debate: a sectoral or cluster process versus other approaches.

Pipeline approach

In the case of the metals and engineering sector, a “pipeline approach” has been followed. Until now, it has been based on the idea of extracting “developmental prices” for inputs from upstream industries, hoping to leverage input cost advantages, and incentives for downstream manufacturers. The latter has clearly not been successful compared with the successes achieved in the clothing and auto industries. The latest version of the Ipap seems to put more emphasis on the second approach.

Conceivably there is a third approach which must focus on creating an environment conducive for hundreds of small- and medium-size manufacturers operating mainly out of small towns. Companies are confronted daily by uncertainties, which should be distinguished from risks that can be mitigated against.

Despite claims to the contrary, electricity interruptions are realities in many rural towns and city areas due to maintenance issues and neglect. Water shortages in many towns have a similarly disruptive effect on companies that need water in their manufacturing processes or to cool down plant and equipment. Failing local authorities in terms of rates and tax administration, road maintenance and crime prevention often have fatal consequences for companies, especially when compounded together.

The impact of more macro policy issues on the business environment is of more significance, but is often far removed from smaller and medium-size companies. Increased political and policy uncertainty have been highlighted by the Quarterly Manufacturing Survey conducted by the Bureau for Economic Research over many years, and has recently reached its highest levels since 1987.

The reality of the government’s fiscal constraint and the need to consolidate spending have a direct bearing on the manufacturing sector. Firstly, incentive programmes such as the Manufacturing Competitiveness Enhancement Programme have been curtailed. Secondly, massive savings must be made on public procurement spending, including capital expenditure which, although necessary, will also curtail the government stimulus to the manufacturing sector and the economy.

Monetary policy is almost in chains due to the need for stability in a highly volatile international environment and the SA Reserve Bank has very little room to manoeuvre to stimulate the economy. The impact of the unstable international monetary situation has been compared to a wrecking ball due to its destabilising effect on emerging market exchange rates, which influence the earnings of half of metals and engineering production and up to 40 percent of input costs.

Another impact is the setting of standards and specifications, which is vital to enhance the quality of local products.

Domestic demand

The increasing institutional uncertainty regarding the areas of authority and the execution of this role between the SA Bureau of Standards and National Regulator for Compulsory Specifications (NRCS) is a cause for great concern. This has become an issue with testing of parts or complete products and the drive by the Department of Trade and Industry to ensure local content of products to enhance local procurement and stimulate domestic demand.

Despite a court ruling against the NRCS, little progress has been made to date to clarify the issues and, in the process, clear the bottlenecks.

The stimulation of domestic demand or the reservation of more of the domestic market for local producers is one policy option open to South Africa. In the case of the metals and engineering sector, the local producers’ share of the market has shrunk from 68 percent in 2002 to 48 percent last year, which is a staggering R114 billion worth of production forfeited or 70 000 job opportunities lost.

Trade and industrial policy intersect clearly, but need the support of institutions such as the SA Bureau of Standards, NRCS, the Treasury and the SA Revenue Service. Designation of products is another way, but needs implementation and co-ordination from all. Tariff protection is the sharp end of trade and industrial policy, and we cannot always rush to it for solutions.

A huge effort is needed to optimise the impact and minimise the unintended consequences of this instrument. It is vital that feedback loops are created among departments and between the government and business to achieve the optimum outcome.

Manufacturing has a place in solving South Africa’s economic problems, but it has to be able to survive the cold winds of international competition. It needs synchronised efforts from all involved domestically. This remains a very complex and dynamic challenge.

* Henk Langenhoven is the the chief economist of the Steel and Engineering Industries Federation of Southern Africa.

* The views expressed here do not necessarily reflect those of Independent Media.

BUSINESS REPORT