Boost manufacturing for prosperity

COMMENT

Throughout history, manufacturing has been the pathway to the development of nations. From the Netherlands in the 17th century, England in the 19th century and the United States, Germany and Japan in the 20th century to China, Korea and Taiwan today, manufacturing has been fundamental to national development and prosperity.

But South African manufacturing is in a perilous state. Manufacturing’s contribution to South Africa’s gross domestic product (GDP) has fallen from 24% in the early 1980s to 13% today, and the number of people employed in the sector has declined by more than 25% over the same period, according to Statistics South Africa’s quarterly employment statistics.

Various dynamics have contributed to South Africa’s deindustrialisation. This goes back almost a century, when the country adopted a policy of import substitution as a vehicle for economic development in the 1920s. Complicated tariff structures, high tariff walls, duties and quantitative restrictions were enacted to protect and nurture domestic industries, according to the International Trade Administration Commission.

Our isolation under apartheid made things worse and, by the end of the 1980s, according to nonprofit research body Trade and Industrial Policy Strategies, South Africa had the most tariff rates, the widest range of tariffs and the second-highest level of tariff dispersion among a range of developing countries.

Decades-long trade protectionism left many companies bloated and inefficient. Post-apartheid trade liberalisation exposed these inadequacies as businesses found it hard to adjust to a more open economy. Since the 1990s, the performance of manufacturers has been cyclical and patchy, subject to the whims of exchange rates, commodity prices and foreign demand.

A confluence of long-standing and recent challenges has made the past few years particularly painful. Unfolding against a backdrop of already weak infrastructure spending, these issues reinforce themselves through a negative feedback loop.

• Administered prices: Between 1980 and 2007, electricity prices rose by 9% a year, or 1% less than inflation. Since 2007, electricity prices have risen by 17% every year, or 11% more than inflation. Water, sanitation and municipal charges have increased in some years more than electricity prices, and our port charges are among the highest in the world.
• Productivity: Workforce management company Adcorp estimates that, collectively, labour productivity has fallen by almost a third since 1967. A back-of-the-matchbox calculation indicates that labour productivity in the manufacturing sector has lagged the rest of South Africa’s labour productivity by as much as 35% over a similar period.
• Industrial action: According to the South African Reserve Bank, the average annual number of workdays lost between 2008 and 2014, excluding 2010, owing to the public sector strike, amounted to 5.1-million, compared with an annual average of only 1.8-million for the 13 years from 1994 to 2006. In 2014 the platinum strike alone resulted in a greater loss in wages than all 114 strikes in 2013 combined.
• Infrastructure bottlenecks: Coal, iron ore and manganese production and exports are constrained by the country’s rail capacity limitations. An ageing water pipeline is holding up mining activity in the Northern Cape Kalahari Basin. South Africa’s port and road congestion is infamous, and rolling blackouts have introduced further uncertainty.
• Policy uncertainty: There is confusion about black economic empowerment codes, property rights, minimum wages, labour reform, the importing of rare skills and domestic beneficiation. Rumours of further state involvement – such as the mooted establishment of a five million tonne greenfield steel plant by the Industrial Development Corporation and a Chinese consortium – are further fuelling private sector insecurity.
• External factors: The weak global recovery following the 2008 financial crisis has simultaneously lowered the demand for South African exports and increased import competition. Research by the Steel and Engineering Industries Federation estimates that intermediate inputs imported by South Africa’s metals and engineering sector have risen from about 22% 20 years ago to more than 35% currently. A volatile exchange rate has made long-term projections, budgets and planning difficult.

There is no easy cure for South Africa’s manufacturing sector woes. Some issues will ebb and flow; some are permanent. For example, real electricity price increases will remain higher than their historical averages for a long time. It is equally difficult to imagine wages rising by less than inflation. Manufacturers seem to agree. Where labour can be substituted with capital, one response has been to accelerate the rate of mechanisation to do more with fewer workers.

Across the board, from steel to packaging, employee numbers in listed manufacturing businesses have fallen, often by more than 30%, over the past few years. According to Hosken Consolidated Investments, low-return manufacturing businesses are closing down and major parts of certain industries are disappearing altogether. More than 80 000 jobs have been lost in the clothing and textile industries alone since 2002.

The desire of South African businesses to grow offshore is more fervent than ever. From the smallest manufacturers to industrial giants, capital is being redirected to other parts of the world. Our outward-bound foreign direct investment grew 17% in 2014, but foreign investment into South Africa is falling by 23% a year. Foreign direct investment into developing economies rose by 4% in 2014, as shown by Reserve Bank data, indicating we are batting well below the average.

These trends do not bode well. South Africa needs an environment that will facilitate more capital investment. We need to increase our investment in fixed or productive assets such as factories, infrastructure and agriculture to remain globally relevant.

Improving our infrastructure would be one way to start breaking the vicious cycle that plagues South African manufacturing. The sector is important, given its upstream links to mining and downstream links to the infrastructure, construction and automotive sectors. Innovation that reduces cost and improves efficiency is inevitable, but can be complementary with labour employment. South Africa needs both.

Simon Raubenheimer is a portfolio manager and a director of Allan Gray Investment Services.