16 May 2013

The Motor Industry, Industrial Policy and SA's Trade Deficit

South Africa's motor industry alone accounts for about 40 percent of the country's trade deficit. In a recent post I suggested that this is evidence of the sector's lack of international competitiveness. The industry is able to survive in SA only as a result of massive subsidies, ranging from import taxes and controls, to tax incentives, and direct cash handouts.

But focus on the trade deficit asks not about the underlying competitiveness problem but rather what would happen to sectoral imports and exports if government support were reduced. This looks at the trade deficit as a sectoral issue rather than a broader macroeconomic phenomenon.

One of my early reports on MIDP illustrates the risk of this approach by showing that replacing imports or increasing exports through subsidized domestic production is a very costly way to earn foreign exchange.

I estimated that in 2005 vehicle exports were being subsidized at a rate of about 30 percent of domestic value added and production for domestic sale at a rate of at least 60 percent. At these rates, each R100,000 of vehicle exports was costing South Africa R130,000 of domestic resources. That is, earning $100 of foreign exchange through vehicle exports was costing South Africa $130. Similarly each $100 of foreign exchange saved through sourcing vehicles domestically rather than through imports was costing at least $160.

Reducing the trade deficit through subsidies to a non-competitive motor industry is very costly indeed.

Is the APDP any better? I have estimated that in the final year of MIDP vehicle exports were being subsidized at a rate of 17.3 percent of local value added and production of vehicles for domestic sale at a rate of 62.5 percent. By my estimates the APDP has increased the export subsidy to 27.7 percent and the import substitution subsidy to 71.7 percent. At these increased rates we might hope to see some reduction in the motor industry trade deficit. But the cost will be even higher than it has been in the past.

What does the dti make of this? Viewing everything from the perspective of its industry clients, it looks at the trade deficit and most other longer term development problems as sectoral issues. Rather than examining and dealing with underlying structural and regulatory barriers to development, it asks its industry clients how large and what type of subsidy they require to overcome the problems of investing and producing in South Africa.

At my last count, the government was giving subsidies of well over R10 billion per year to a few auto firms, and imposing a cost on consumers of close to R20 billion per year. Over its first decade MIDP subsidies came close to R100 billion. The government continues to "negotiate" with the big auto firms about improving their competitiveness. The dance goes on and the subsidies continue. We will certainly see new forms of support. This has not produced a competitive industry and it has not solved any real or imagined trade deficit problems.

Unfortunately the motor industry is not an isolated case. The textile and garment industry receives large subsidies, mostly paid for by consumers, even as much of it disappears or migrates to Swaziland and Lesotho. The dti has recently revived a failed policy from decades ago by releasing a list of 10 "special economic zones," defined by product and province, that it wishes to support.

The lesson for investors is that success in South Africa is enjoyed by cozy monopolies and those with access to generous government support in the form of subsidies and barriers to competition. This is good for some investors, but not for South African development. Longer term growth depends on the creation of an environment in which investors can and do compete, domestically and internationally.

02 May 2013

The Malaysian Model and its Relevance for South Africa

Malaysia has had a strong allure for South Africa and other countries in the region. Of particular interest have been its policies aimed at redressing racially-based economic imbalances and its willingness to question the merits of conventional macroeconomic and industrial policy advice from international financial institutions.

Like South Africa, Malaysia has been ruled since independence by a single coalition dominated by the interests of the majority ethnic group. An election this Sunday will provide a real possibility of political change. The occasion calls for a realistic assessment of what has come to be regarded as the "Malaysian model."

My own view is that a) the divergence of Malaysia's macroeconomic policies from conventional "best practice" has been greatly overstated, b) whatever the merits of "bumiputra" affirmative action policies, the costs have also been large and by now certainly outweigh the benefits, and c) key features of targeted industrial policies have impeded rather than promoted the country's economic growth.

These views are echoed concisely in a Financial Times opinion piece. According to the columnist, David Pilling, failures of past policies make political change a real possibility.

"There is huge anger at entrenched corruption and buddy-buddy crony capitalism. Many Malaysians have come to the conclusion, almost certainly correct, that affirmative action has outlived its purpose and is holding the country back.

"There is increasing recognition, too, that economic performance is not all it might have been....Manufacturing exports have been stalled for years and attempts to build an indigenous steel and car industry have flopped. It has been easier for cosseted businessmen to jostle for lucrative state contracts than to compete internationally."

Pilling's view is that there is a "need to roll back a system based on race and patronage in favour of one based on competition and merit."

Whether political change happens, and whether it will result in meaningful policy reform remain to be seen. But discussions in South Africa and elsewhere need to be informed by a realistic view of the nature and impacts of the "Malaysian model." Otherwise the dti and others will continue to copy Malaysia's failures rather than learning the real reasons behind its successes.

09 April 2013

SA's Motor Industry—Once Again

The release of the dti's latest Industrial Policy Action Plan (IPAP) has put the motor industry in the spotlight once again. The dti continues to claim the industry as its greatest industrial policy success. However a recent news report draws attention to IPAP data showing that this sector alone accounts for about 40 percent of the country's trade deficit, and asks what this means for the success of the dti's policies. If government support has created an internationally competitive motor industry, as claimed, why does it show such a large trade deficit?

The implicit answer, supported by a number of online reader comments, is that the industry is not internationally competitive. This is consistent with my own analysis over the years—the ability of MIDP and other government policies to attract investment and promote exports reflects, not the industry's competitiveness, but rather the value of government incentives. 

The MIDP was recently replaced by the APDP. This tweaked some of the details of public support for the industry—production subsidies are now given to domestic sales as well as exports; the dti can now hand out cash investment incentives on a more discretionary basis. But the magnitude of public support has not diminished; and it is determined largely in consultation with the major firms who tell the government how much support they require to overcome the high costs of investing and producing in SA. In other words, the type and magnitude of public support depend on how uncompetitive these firms are in SA.

The danger now is that the dti will seek to solve this sectoral trade deficit "problem" in ways that will  increase the burdens on consumers and taxpayers, and further diminish SA's manufacturing competitiveness. A simple "solution," for instance, would be to impose local content requirements on the industry and restrict imports through higher tariffs or other measures—in other words, return SA to the bizarre and highly costly policies of the Apartheid era.

The government could, and almost certainly will, employ more subtle subsidies and incentives to serve its motor industry clients. A tender document just released by the DPE, for instance, solicits advice on how Transnet and Eskom can be used to increase motor industry profitability. Reducing Transnet and Eskom costs would certainly be good for the entire economy. But to give special privileges to the motor industry (which already benefits from special Transnet pricing deals on its exports) would perpetuate the failures of the current policies that seek to improve competitiveness by subsidizing uncompetitive firms and industries.

25 March 2013

Subsidies, Bailouts and Markets

I read with relish the report of Leon Louw's recent blast at the never-ending bailouts of South African Airways (SAA). Mr. Louw, Executive Director of South Africa's Free Market Foundation (FMF), demonstrates how these subsidies distort competition, raise costs and prices, divert resources from more efficient and growth-promoting activities, and are especially burdensome to the poor, from whom the bailouts divert public support. The FMF performs a great public service through well-reasoned commentaries of this sort.

Of course, it is not just state companies and agencies that benefit from public subsidies. Direct government support and regulation are viewed by some as necessary for South African industrial development. The consequences of this approach can be similar to the effects of bailouts of state enterprises.

In this regard, Mr. Louw's remarks reminded me of a brilliant commentary by another FMF member, on the impacts of industrial policy in South Africa's motor industry. In a prize-winning letter to Business Day in 2005 Jim Harris explained how the MIDP (Motor Industry Development Program, recently rechristened as APDP) supports a few companies, but punishes consumers and retards the country's long-term economic development. His remarks were controversial and attracted fierce reactions from some fellow FMF members—at least those associated with the motor industry.

Mr. Harris' letter signalled the start of a vigorous public debate about MIDP that, if nothing else, clarified the nature and magnitude of the subsidies enjoyed by the industry. As with the bailouts of SAA, the MIDP and related subsidies protect a few heavily dependent companies at the expense of consumers, jobs and the poor.

I have been unable to find any follow-up on the FMF website to Jim Harris' early foray into South Africa's most important industrial policy. It would be useful for the FMF to complement the comments on bailouts to state enterprises (and on the US bailout of General Motors) with a discussion of the massive and continuing subsidies to firms in the South African motor industry and other selected sectors.