Making a Mockery of Competitiveness

One of the few genuine innovations in South Africa's APDP, the motor industry support program that will replace the MIDP, is a requirement of a minimum scale of operations in order to qualify for the program's very generous financial benefits. Although the details of the program still have not been gazetted, we understand that in order to qualify vehicle assemblers will have to produce a minimum of 50,000 vehicles per year. The idea is to encourage international competitiveness by achieving some economies of scale in production.

The scheme does raise some questions.

1. Why is it necessary for the government to instruct global auto firms on efficient scales of production? (It is not; but under MIDP and APDP it is not necessary to be competitive in order to make big profits by producing in South Africa.)

2. Will production of 50,000 vehicles per year provide sufficient scale to compete with true international major league plants? (Generally not; competitive plants elsewhere produce at least 100,000 per year.)

3. And of course one might wonder how firms will try to get around the new requirement in order to continue to take advantage of the large subsidies made available by the government (and paid for through the "generosity" of South African vehicle consumers and taxpayers) without ramping up production.

But at least the new requirement appears to be a feint in the direction of encouraging some competitiveness on the part of the local industry.

An announcement by the government-operated East London Industrial Development Zone (ELIDZ) provides an answer to the third question. ELIDZ has told the press that it will soon announce the signing of several tenants in a new "multi-OEM assembly plant" it will build in the zone. What is the purpose of such a plant? To enable companies sharing the facility to produce at volumes of 10,000 vehicles per year, or even as low as just a few thousand and still qualify for the APDP benefits that are contingent on meeting the 50,000 per year volume target. It apparently will "work" as long as the total of all vehicles produced by all tenants reaches 50,000 per year.

How will this encourage increased competitiveness, the stated goal of the new policy? It will not. In fact it will simply replicate the highly inefficient pattern of small scale production of multiple models and other automotive products under one roof that was encouraged by protection in pre-MIDP days and by continued protection and MIDP benefits since then.

Another Industrial Policy "Success" Story

Volkswagen South Africa (VWSA) has won a contract worth about R30 billion to export South African-made VW Polos over the next 6 years. The company's Managing Director, David Powels, says that 685 new jobs will created. This will be viewed in many quarters as an early success of the latest incarnation of South African government support for the motor industry (APDP, formerly known as MIDP).

Powels has been reported separately as saying that producing cars in SA is up to 40 percent more costly than in competitor locations in Asia and Europe. If that is the case, how did VWSA win this contract? The answer -- subsidies under MIDP, APDP and other government programs are expected to compensate for this cost differential.

Suppose that the cars to be exported under the contract are only 35 percent more costly to produce than in the next best location. If this is so, VWSA must be counting on government subsidies of at least R10.5 billion (35 percent of R30 billion, the value of the contract). Otherwise it would make no sense for VW to source the vehicles in South Africa.

What is the size of the subsidy per job? Based on the VWSA estimate of 685 new jobs, the expected subsidy is R15.3 million per job over the 6 years of the contract, or R2.55 million per job per year. This is 25 times higher than the average annual wage in manufacturing in South Africa (about R100,000). Quite a success!!

More Protection for the SA Clothing Industry?

Following a request from SACTWU, the Clothing and Textile Workers Union, South Africa’s International Trade Administration Commission (ITAC) has reviewed the import duties on garments. Its report concludes that the duty should be increased from 40 to 45 percent, the maximum allowed under SA’s WTO commitments. For several items the current duty is only 20 percent, and yet they would still get the new 45 percent rate. The recommendation covers virtually all clothing used by South Africans from socks and underwear to shirts, jackets, suits, pants and skirts; for men, women, girls, boys and babies.

This follows another recent recommendation and government agreement to reduce the duties on a wide range of imported fabrics from 22 percent to zero.

ITAC argues that these measures will “provide significant encouragement and support to the industry while its extensive efforts to restructure to become more competitive are continuing;” and they will have little inflationary impact.

ITAC does not show its estimates of the amount of support this will provide. My own calculations show that before any of the recent recommendations, i.e. with tariff rates of 40 percent on clothing and 22 percent on most fabrics, SA garment producers were being subsidized at a rate of about 94 percent of value added. In non-technical terms, this means that the tariff structure allowed them to produce garments at a cost 94 percent higher than foreign competitors and still compete in the local market. This is a very high level of support, higher than in just about any other industry in South Africa.

Under the proposed new measures, the subsidy will increase to 114 percent for garment producers that are still subject to the 22 percent fabric tariff. And for those that are able to take advantage of the new rebate that lowers the fabric tariff to zero, the subsidy will be 180 percent. They will be able to produce at almost three times the cost of foreign competitors and still be able to “compete” in the domestic market.

Does this encourage restructuring and increased competitiveness? No, it subsidizes high cost producers, and enables them to survive despite much higher costs than international competitors, with no need to adjust or to improve their competitiveness.

On top of this, the government is mulling even further subsidies to the industry. No details have been made available, but under proposals that have been mentioned publicly I estimate that the rate of subsidy could be over 300 percent.

It is difficult to imagine how firms that require this kind of support could be transformed into internationally competitive producers.

What, then, is the real goal of government support? It seems to be to protect vulnerable and/or a privileged subset of the country’s workers. But is subsidizing continued production and further investments in training and equipment to sustain existing jobs in non-competitive firms or industries the best way to do this? The cost is high. Clothing and footwear account for 5 percent of consumer expenditures in South Africa. For lower income households the percentage is much higher. A 40 or 45 percent tax on such a basic consumer good is a cruel and regressive tax indeed. While an increase in the tariff might provide further short-term relief for garment workers, it will be at the much greater expense of all workers and consumers in the country, and especially the poor.

A government official recently told me that one of the main problems with the SA garment industry is that the equipment is very old. The unwillingness of firms to invest in upgrading this equipment, despite current high levels of protection, would be a rational response to their view that much of the industry will never be able to compete.

I asked about the age of workers in these factories. The answer: “about the same as the equipment.” This might also reflect a rational response by young workers who see no future in this industry. It also reduces the costs of any necessary adjustment if industrial support is gradually withdrawn. An increase in support might not only impose higher immediate costs on taxpayers and consumers, but might draw new workers into the industry and increase future adjustment costs.

What is the bottom line? The government needs to move out of the box that views subsidies to non-competitive producers and industries as the best way to help the country’s workers, taxpayers and consumers. Let's deal directly with what is essentially a social welfare problem – assisting workers in declining firms – and free the government to think more creatively about an industrial strategy that points to the future rather than the past.

Health for Empowerment and Growth

Promoting empowerment of disadvantaged groups through incentives to broaden ownership of capital has had mixed results in terms of social justice and long-term growth. Experience in Malaysia and South Africa for instance shows that such schemes have certainly enhanced the wealth of a select few of the “previously disadvantaged.” But broader trickle-down effects to the poor have been much harder to find. And the costs have been high, with serious questions about the extent to which they might have impeded longer-term productivity growth as a result of implicit taxes on wealth and creation of a rent-seeking business society. As a result, there is growing pressure in Malaysia to abandon the “bumiputra” policy. Some of the loudest voices belong to those who were supposed to be the beneficiaries of the program.

These countries should take note of some new research findings from the US. A recent report by Chay, Guryan and Mazumder shows the startling and large effects of improvements in basic health care for black infants in the 1960s arising from hospital integration. They show that better infant health care explains substantial improvements in educational achievement, independently of other causes such as school integration and changes in family backgrounds.

The lesson for countries like Malaysia and South Africa is clear. If you want to promote empowerment of disadvantaged groups, use basic health and education to tackle the root causes of inequality and the real barriers to economic opportunity. The resulting improvements in human capabilities will pay additional dividends in the form of higher long-term productivity growth as well.