Scratch a South African industry, it seems, and expose excessive prices over and above what companies would earn in a competitive market.
In fuel, cement, cars, life insurance, telecommunications (both fixed-line and mobile), steel, chemicals, sugar and now banks, this familiar story has emerged in recent months. The companies involved generally report handsome profits over and above their international peers, while their products are uncompetitively priced, hurting exports, jobs and growth.
Excessive pricing has been in the spotlight in recent months as part of the government’s drive to create higher levels of sustainable economic growth.
Examples of high South African prices include cement, which is the fourth highest of 31 countries (Merrill Lynch); Internet line costs, which are 400% higher than the average price of 15 developed and developing countries, according to the South Africa Foundation (SAF); cars, on average, are 14% more expensive than in Europe; steel, which is 25% above international prices; and telecommunication interconnect fees, which have increased by 635% during the past decade.
In fuel, the government has initiated an inquiry into Sasol’s windfall profits. Sasol’s domestic profits dwarf those of its multinational peers. Its chemical operations are in the government’s sights as part of a wider crackdown on import parity pricing (IPP).
A report for the Competition Commission last week found that bank charges have no relation to costs. The commission will now mount a formal investigation, one commission official indicating that an independent adjudicator may be set up.
Such an arbitrator for the pensions industry, Vuyani Ngalwana, has brought massive redress and reform to the life industry as part of the government’s attempts to encourage savings.
High prices are most often associated with companies that have dominant or monopoly positions in the economy.
Market power, in some cases, was built up under conditions of capital flight during the dying days of apartheid. Local companies were able to buy assets cheaply and build dominant market positions while the government had its hands full trying to put out fires rather than implement sound economic practices.
The new government concentrated on creating macroeconomic stability rather than facilitating sectoral reforms. In at least one case, Telkom, it disastrously allowed for its monopoly to be extended by five years in exchange for agreeing to roll out services to previously dis-advantaged areas.
But users preferred cellphones and did not use their landlines, leading to services being terminated. The failed roll-out programme cost R17billion, according to the SAF, but also handed Telkom a chequebook to write its own profits to the detriment of the rest of the economy.
In three cases — Sasol, Iscor (now Mittal) and Telkom — privatisation in the absence of competition created powerful entities with private rather than national agendas.
South Africa’s geographic isolation from other markets has contributed to excessive pricing.
Suppliers of products such as steel and plastics use IPP, notional transport costs contributory adding hugely to their profits. This means that South African-produced steel, for instance, can be bought more cheaply in competing markets offshore than at home.
South Africa is a low-cost sugar producer, but these benefits are not passed on to domestic consumers and industry. The Sugar Act allows the industry to use cartel powers to charge international prices.
Pressure for change may come now that the government sees sugar as a key, competitively priced feedstock for its ambitious plans to develop an indigenous biofuels industry.
Merrill Lynch, in a report on monopoly pricing released in March, lists three reasons for insufficient competition, monopolies and oligopolies in South Africa.
First, services such as electricity, water and fixed-line telephony have historically only been provided by the state. When the entity is then privatised without the introduction of competition, experience has shown that prices tend to increase substantially.
Second, with a gross domestic product of $200billion, the South African market is relatively small on a global scale. It may be too small to allow for more than one large player in industries that require large capital investment and large economies of scale.
Third, economic growth has been far faster than expected, leaving demand outstripping supply. This is a temporary problem that will be alleviated when further supply comes on stream. “Until then,” says Merrill Lynch, “we expect prices will remain high.”
The report says the government is focusing on monopoly pricing at present because the Accelerated and Shared Growth Initiative (Asgisa) programme has identified excessive pricing as one of the major obstacles to growth.
“Motor vehicle manufacturers, general manufacturers and mining companies have complained about the high cost of steel in South Africa.
“Harmony has stated that Mittal’s pricing will inflate its costs by R1,7billion over the remaining life of its mines.
“Similarly, nascent service businesses, such as business process outsourcing and call centres, have cited Telkom’s relatively high costs, and often poor service as the single largest obstacle to their development.”
Merrill Lynch says international comparisons have continually highlighted that South Africa’s input costs are relatively high. “The government’s decision to address these is therefore understandable.”
It says many of these sectors are making large profits. “The bulk of the industries under scrutiny have seen spectacular profit growth in recent years, buoyed by the very strong domestic economy. And often they are sitting on cash piles with no obvious investment opportunities within South Africa. That makes them easy targets.”
Merrill Lynch says the government can use the competition authorities, but “IPP alone does not result in excessive pricing”.
Where regulators exist, they can be used to push down prices but, “unfortunately, this sounds a lot easier than it is in practice. For example, the communications regulator, Icasa, recently looked at addressing the high interconnection fees between operators.
“The industry responded by pointing out that benefits were unlikely to be passed on to consumers, it could result in less investment and it was likely to result in higher pre-paid tariffs as this business was reliant on incoming calls.”
Merrill Lynch also says the government can use incentives to encourage more competitive pricing. It sees the government’s current investigation into Sasol’s windfall profits possibly to be in response to Sasol spending only R2billion of its current R16billion investment programme in South Africa.
“When companies are making large investments, government often provides inducements to companies in the form of favourable pricing of services (electricity, water, et cetera) or tax incentives. There seems to be a growing belief in government that there has not been enough demanded of corporates in return for these incentives.”
Encouraging competition would be the ideal solution, says Merrill Lynch. “Increased competition reigns in excess profits and limits government intervention. And this has been the government’s preferred method of dealing with high prices in the telecoms industry. Unfortunately, entrenched monopolies, high barriers to entry and the small size of the South African market make the entry of new competitors difficult.
“And the government’s suggestion that they will provide financial support to Sentech, at the expense of the second network operator, may destabilise the competitive environment in this space.”