/ 19 March 2015

Customs union inhibits development

Flaws: Botswana earns more revenue from the customs union than from diamonds.
Flaws: Botswana earns more revenue from the customs union than from diamonds.

In a recent commentary about tax proposals for the 2015 South African budget, accounting firm PwC slammed the revenue-sharing formula agreed to by the Southern African Customs Union (Sacu), arguing that “a more equitable sharing of the customs revenue pool would see South Africa entitled to at least 80% of the pool. The cost to South Africa is therefore at least R30-billion.”

An accountant’s view
The 105-year-old customs union agreement between South Africa and the neighbouring states of Botswana, Lesotho, Namibia and Swaziland (BLNS) distributes revenue collected on import duties and excise based on a number of criteria. The import duty revenue is collected on all imports coming into the customs union from outside.

Excise duties are distributed by country based on the share of the gross domestic product of the countries involved. The excise revenue goes mostly to South Africa, which is by far the largest economy, but import duties are the problem, being distributed based on a formula that calculates each country’s portion based on its share of intra-Sacu imports.

This results in the bulk of the revenues going to the BLNS countries because they export almost nothing to South Africa and import almost everything from South Africa. In 2014, South Africa exported R132-billion to the four countries, but imported only R28-billion. So the R104-billion surplus formed the basis for what is, in effect, a massive export subsidy to the BLNS.

According to PwC, if the revenue share was based on share of trade then 80% of the customs revenue would go to South Africa and the balance to the BLNS and not the other way around. Thus, the current loss to South Africa is about R30-billion.

For several years now the members of the customs union have been quietly negotiating to achieve a new formula that would be fairer, but agreement has been hard to achieve. The reason is simple. The BLNS countries have, over the years, become dependent on the revenue flow from Pretoria and, rather than treating it as transitory, all treat it as permanent, spending it every year.

Although Botswana and Lesotho have generated what appears to be a budget surplus, their position, like the other countries, is unsustainable.

An economist’s perspective
The end of apartheid changed nothing about the transfers from Pretoria to the BLNS states.

What most South Africans do not know is that a deal was made in the 1967 renegotiations, called the secret protocol because it only became known when apartheid ended in 1994. Under the provisions no BLS state (no Namibia then) could ask Pretoria to use the external tariff for protecting a local industry if that industry could not produce 60% of customs union production. For the tiny BLS states this was impossible and hence the Faustian bargain made with the apartheid regime was: you give us revenue and we will agree not to develop competitive industries.

Despite the post-apartheid renegotiations in 2002, the relationship between Pretoria and the BLNS did not really shift – in fact, the dependence worsened. The BLNS was supposed to form a tariff board at which all countries would, in theory as equals, together set the tariffs for the customs union.

But the BLNS know that if they try to interfere with South Africa’s monopoly on tariff policy the South African government would consider it a step too far and tear up the customs union agreement. As a result the BLNS still sit in an apartheid-era time warp where tariffs are unilaterally set by Pretoria and the BLNS are rewarded with stagnant economies but bloated budgets.

Put another way, the BLNS get a major subsidy, equivalent to 30% of net exports from South Africa. South Africans get the jobs and the BLNS get the revenue. Or, alternatively, the BLNS are paid a subsidy whenever they create jobs in South Africa by importing South African products. At the same time they are being subsidised to keep their own children unemployed.

From a revenue standpoint the customs union revenue-sharing formula is heaven-sent for the BLNS, but from a developmental standpoint it is disastrous.

Cesspit of economic distortion
Almost every sector you look at in the BLNS is distorted by the customs union and its revenue implications.

The BLNS all import electricity from Eskom and yet South Africa does not have enough for itself. The reason is Botswana pays for a small portion on contract but the bulk is imported at spot market prices, which are, according to engineers in Gaborone, at astronomic levels. Eskom would be in an even worse financial hole without the prices paid by Botswana. But Botswana is subsidised under the revenue-sharing formula for every rand of electricity it buys from South Africa.

South Africa can unilaterally raise the subsidies it pays to its automobile producers at will because it knows that the subsidies are based on customs duty rebates, 83% of which is paid by the BLNS states.

Botswana signed an agreement with De Beers to relocate diamond aggregation to Gaborone from London and that means the diamonds from South Africa, Namibia and Lesotho are sold to Botswana. As its imports rise so the level of South African revenue transfers increase. The list goes on and on.

But by far the worst distortion is that the BLNS cannot maintain their living standards and balance their budgets without customs union transfers from Pretoria and will do whatever it takes to defend these transfers. Botswana now earns more government revenue from the customs union than from diamonds.

The biggest distortion is the effect customs union revenue sharing has on African development. In 2011 the South African Development Community (SADC) was supposed to form a customs union. There can only be one external tariff and one customs union and the SADC negotiations collapsed because the BLNS, which are also members of SADC, were opposed to the move. The BLNS knew that it would lose revenue if it was shared with all SADC members.

The SADC timelines receded into oblivion and we are left with a tripartite free trade area instead. Everyone is kicking SADC integration further down the road to avoid dealing with this intractable problem. But the consequence is that a larger SADC economy cannot develop because the commercial union revenue-sharing formula stands in the way.

Avoiding economic disaster
The customs union is an excellent building block for the Southern African region but the revenue-sharing formula is an economic disaster with continental consequences.

It retards African integration and continues an apartheid-era relationship that should have ended two decades ago. Although R30-billion is a lot of money for some, it is peanuts to a South African government that expects tax revenues of R1.1-trillion in 2015 and needs no more Zimbabwean-style basket cases on its border.

South Africa will bear the cost of customs union revenue sharing because removing it would result in an economic catastrophe for its neighbours. The revenue-sharing formula will only really be reformed when South Africa can no longer afford the luxury.

These are the views of Professor Roman Grynberg and not necessarily those of any institution with which he is affiliated