Government has reduced tariffs over a wide range of goods without considering the broader consequences for industry, writes Charles Millward
In January 1943, a commentator in The Times of London noted: “Next to war, unemployment has been the most widespread, the most insidious, and the most corroding malady of our generation: it is the specific social disease of Western civilisation in our time.”
High levels of unemployment threaten a society’s political stability. Even the most determined opponents of a market-based system are likely to mute their criticism in the face of rising levels of income and employment; when the opposite is happening, democratic governments become vulnerable to attacks from the right and left.
Present South African employment trends are disturbing. The latest statistics show 40 000 job losses in the first quarter of this year alone. Over the past year some 100 000 jobs have been lost in the formal sector.
Sactwu, the clothing and textile workers union, has blamed tariff reductions for massive job losses in this sector. The job losses were contrasted with the projections under the government’s growth, employment and redistribution (Gear) plan suggesting that more than 200 000 jobs should be created this year.
Government has put a brave face on the statistics, and officials have suggested that Gear simply needs more time to work. As the benefits of government’s commitment to lower deficits and steadily reducing tariffs become evident, South African industry, after several years of streamlining to become internationally competitive, will gradually begin to re- absorb labour.
There are two problems with this approach. First, the benefit of deficit reduction, which will supposedly reduce interest rates as “crowding out” of private investment by the state diminishes and thereby kick-start investment, is not happening.
In fact, the empirical evidence underlying this proposition is tenuous and in any event interest rates are deliberately managed at high real levels by the Reserve Bank, which is pursuing completely different objectives.
Second, there is no evidence that government’s programme of tariff reduction will have the desired effect of making South African industry internationally competitive.
The idea of reducing tariffs and thereby reducing the cost of primary and intermediate inputs to internationally competitive levels is, of course, a good one, provided it achieves its objective.
The problem in South Africa is that the suppliers of primary inputs such as steel and chemicals are near monopolists.
Using such tariffs as remain and the natural barrier of high transport costs on items like steel, companies such as Iscor practise import parity pricing, which generally means domestic steel prices are some 50% higher than in the rest of the world.
This phenomenon was recently highlighted by a senior executive of engineering group Dorbyl, Iscor’s largest domestic client. He demanded to know why Iscor sells steel overseas at prices more than 25% lower than domestically.
Furthermore, he noted that Iscor’s record on timeous deliveries was appalling – worse than 60% – and the quality often sub- standard. The executive queried how South African manufacturers were supposed to become world-class in these circumstances.
And herein lies the rub. Government is reducing tariffs over a wide spectrum of products ranging from clothing and footwear to industrial transformers and telephone handsets.
Indeed, tariffs on the latter two items have been reduced beyond even the required World Trade Organisation levels of 20% to a mere 5%.
This almost certainly spells the end of manufacturing in these categories, and no doubt the factories concerned will close in due course.
In the haste to reduce tariffs, the capacity of local industry to become world- class, given the constraints that downstream manufacturers face, is often not considered.
The cost disadvantage to a local manufacturer using local inputs can be up to 20% of turnover compared with one in the United States or Japan. While there can always be management problems in specific companies, the collapse of a large part of South Africa’s white goods manufacturing capacity in recent years must be laid at the door of the inflated input costs paid.
Rates of profit in manufacturing are such as to make it one of the least attractive businesses.
Returns on assets in manufacturing (pretax and pre-interest income divided by total assets) are generally less than 20% throughout industry.
Indeed, some of the better engineering
companies will return about 20%, but in sectors such as clothing and the motor industry, returns are often 10% or less. Compare this with returns among some of the large retailers of 30% or more.
It is no accident then that the stock market is taking such a jaundiced view of the manufacturing sector as a whole. Compare the price earnings (p/e) multiple of a textile manufacturer such as Da Gama at six, or a motor manufacturer such as Toyota at seven with average p/es in the retail or hotels and leisure sectors of 20.
Better still, consider the 35 times multiple accorded to the banks and financial services sector (in no small measure thanks to the relentlessly high real interest-rate regimen engendered by the Reserve Bank).
Essentially the stock market does not believe in the future of South African manufacturing. At p/es of five or six it is basically expecting the sector to disappear in a few years.
Companies are often capitalised by the market at break-up value or less. Yet it is precisely in industries like motor and clothing that most South African manufacturing jobs are found. The social implications of these industries disappearing are horrific.
What is clearly called for is a Korean- style intervention in industry by government with the specific aim of increasing profit rates in certain industries to make them attractive from an investment point of view – the Koreans massaged returns on assets in targeted industries up to nearly 50% in some cases.
Even the US, a supposed paragon of neo- liberal economics, has always pursued an active industrial policy at state level through a combination of tax incentives and subsidies to industry, not to mention outright protectionism when it suits.
In its own interests the government needs to become more actively involved in industry and start ensuring that it works. The imperfections of the South African market are too great to be resolved without determined government intervention.
Charles Millward is an executive director of the National Union of Metalworkers’ Investment Company. The views expressed are his own