Eric Werker of the Harvard Business School speaks to Martha Lagace about a
paper to be published in December
How does South Africa challenge conventional views about foreign direct investment?
South Africa, since the end of apartheid and its first democratic elections in 1994, was doing everything right. It had liberalised the economy. It had enacted economic reforms that made it easy for foreign capital to flow in and out. It performed well on various surveys of competitiveness and the business environment. The economy was managed spectacularly, with inflation brought down to single digits relatively quickly, budget balances within a reasonable ability to pay, and political stability guaranteed by the ANC’s popularity.
They had undertaken all of these standard prescriptions that the World Bank or the International Monetary Fund would have advised for countries to receive more foreign direct investment. But interestingly, it was slow in coming.
And so the reasons for this can be many. I think one that might have been overlooked was, in fact, the very strength of the corporate climate in South Africa. Under the apartheid era, the economy was sheltered. Initially, in the 1920s, this had been under an import substitution strategy, but by the 1970s and 1980s, it was more of a self-defense mechanism. This led to South African corporations’ ability to expand and, once they had reached expansion within a particular industry, they would buy up companies in other industries.
Though South Africa is often classified as an emerging economy, it might be more correctly seen as having two economies.
It became a very concentrated corporate structure with basically well-run companies. They weren’t running at maximum efficiency because they didn’t have much competition from abroad, but given the environment within South Africa, the strongest ones had come to survive and existed in the form of large conglomerates.
When the economy opened up following the end of apartheid and the end of sanctions, these conglomerates shed their non-core assets — which left them cash-rich. What resulted was that industries remained fairly concentrated, but the companies weren’t necessarily the inefficient companies that had characterised the apartheid era.
So South African firms had money to invest. They also had a large market share within their industry; and this, of course, wouldn’t be a great environment for someone to go in and set up a new shop. If there are three or four firms sharing an industry, they are probably making money and if you were to come in and undercut on cost, for example, you would have to face the potential retaliatory measures of the stalwarts of the industry.
And with their cash from shedding the non-core assets, South African firms had begun themselves to look for new opportunities.
How is it to do business in South Africa now?
It’s complex. It would be an intimidating place for a foreign business — without experience in that type of environment — to enter and to prosper in. The crime rate is certainly one of the highest in the world, to the extent that it affects the everyday lives of people and managers. The HIV prevalence rate in South Africa is, like other countries in Southern Africa, among the highest in the world.
In addition, though South Africa is often classified as an emerging economy, it might be more correctly seen as having two economies — the normal economy of sophisticated consumers and firms that are investing all over the world, and the rural economy, which still contains many subsistence farmers or folks who are living off of meagre agricultural incomes and transfers from the state or their relatives in the big cities. So to compete with all of those site-specific issues would be a challenge. That’s not to say it hasn’t happened. Foreign direct investment (FDI) has gone into South Africa at a rate of about one-third of that flowing into Latin America or East Asia.
According to the statistics on FDI in your new case study, in ‘all countries’ FDI is 2,7% of GDP. South Africa is 1,5%.
Exactly. Another reason why the FDI numbers weren’t as high has to do with the financial market system. Johannesburg has a stock market as it has had for over a century, and business executives I spoke with said that you can get a future contract of 10 years on the rand/dollar exchange rate — which is extremely sophisticated.
So within financial markets that are pushing the envelope on offering products for an emerging market, the need to go in and set up a business or acquire your own company in order to have exposure to this area is lessened. What many firms or asset managers who want exposure to South Africa would do would be simply go through financial markets. Portfolio inflows that capture those financial market investments are much higher in South Africa than they are for other regions of the world.
Your case describes the complexities of good FDI and ‘bad’ (or at least not so good) FDI in South Africa. Could you tell us about that?
Most of that section is to generate class discussion. Take a country like South Africa where the domestic corporate scene is actually quite developed and creative, exporting ideas, exporting managers to the multinationals who work there. What sort of FDI are they likely to receive? Given the concentrated market structure and the high profits of the firms that would be among the several operating there, I think it’s not surprising that we should see investments into already successful companies rather than new firms setting up and potentially bringing a new technology or process to the country, except at the innovation frontier where we do see foreign companies setting up.
So even as many in South Africa would see the acquisition of a successful company as potentially not being the right kind of direct investment, the fact that it will occur is part of the savings and investment balance. If you don’t want that type of investment, you basically need a higher domestic savings rate.
I think the savings rate isn’t as high as in many developing countries because of the delay of gratification that has already occurred.
Its newly enfranchised black population didn’t have access to a lot of economic goods, let alone political power, and as they are acquiring a share in this economy, they are buying cars and houses, and credit is fueling a lot of the current boom. Many of these participants in the economy just have not had access to very basic things that not only make a middle-class existence more pleasurable, but, in fact, are required for it. I would see the savings rate rising, but not for a while because of all the fairly basic personal infrastructure purchases that are occurring.
How do you think the South African economy will evolve over the next five to 10 years?
A major test for South Africa is going to be World Cup soccer in 2010. It is not just because putting on this event will be a logistical challenge, but many in South Africa see it as almost a signal of the country’s ability to make the necessary infrastructure investments and to provide the necessary security to the foreigners who will be visiting South Africa for the World Cup.
I think that commodity prices will remain attractive enough that surrounding economies in Africa will continue to grow, at least in the medium term, and that will create some positive synergies with South African growth.
If South Africa is able to meet these infrastructural and security challenges, I think the five following years would bode very well.
Extracted from HBS Working Knowledge at www.hbswk.hbs.edu
Eric Werker is an assistant professor at Harvard Business School. Martha Lagace is senior editor at HBS Working Knowledge