/ 5 December 2016

South Africa must tackle dominant firms to achieve better wealth distribution

An uncertain future: The plight of the poor is compounded by
An uncertain future: The plight of the poor is compounded by

The focus on “state capture” in South Africa has tended to divert attention from a deeper question. How can the distribution of wealth and control over the economy be changed in material terms?

There is an implicit justification for corruption and other rent-seeking activities, namely that this is the only way to do it. The argument runs that the rules of the game are stacked against the majority and so the only option is to break the rules.

It can be further asserted that nobody who has “made it” actually did so playing by the current rules anyway. Under apartheid obviously, different rules created wealth for the few. Indeed, the example of coal contracts in the public protector’s report mirrors the accumulation of wealth by Afrikaner business groups under apartheid, using the state utility Eskom’s procurement as a lever.

But this narrative keeps the country trapped in the past. A radically different path needs to start from the premise that markets are intrinsically skewed to historic privilege. And then move from this to develop strategies to reshape market outcomes. This must include direct redistribution measures and changes to how markets work.

It cannot simply be a process of “correcting” discrete failures.

The structure of markets and the overall distribution of wealth is maintained by barriers that protect incumbent interests and lock out new entrants. A lack of competition means entrenched businesses can continue to earn high profits with low levels of investment and little effort and innovation. The result is that returns continue to go largely to the wealthy.

Wrong policy choices

Over the past two decades, South Africa has made important choices that have undermined its ability to change the shape of the economy. These include a relatively conservative competition regime which emphasises mergers and enforcement against cartels. But the regime makes it very difficult to address abuses by dominant firms.

The premise is that if we stop mergers which will increase concentration, and penalise cartels, the problem of concentration will be solved. This suggests that there is nothing wrong with the current market structure as long as the entrenched businesses do not combine with each other.

But this is not the case. The failure to change course or to take alternative action means that the long-established trajectory continues. Contestation is simply over who gets the rents.

South Africa needs to revisit the paradigm: to rethink market outcomes themselves, in terms of who participates and how they compete. The country’s policies have been fundamentally naïve to assume that change will come from a structure which remains essentially the same while accommodating a few new faces.

It is time to change the rules. The alternative is that they are simply ignored. It is also helpful to consider the range of alternative approaches to fostering competition and growth which exist internationally.

Countries which have fundamentally changed their industrial structure have addressed the position of large companies in ways that appear heretical to an orthodoxy that has largely been accepted in South Africa. Take South Korea. It has explicitly pursued balanced growth as part of its competition policy objectives. Its competition authority was given the job of monitoring the conduct of the largest chaebols (the big conglomerates), to ensure they don’t skew the playing fields in their favour and that they treat their subcontractors properly.

Germany’s competition regime is permeated by economic values of fair competition which ensure large companies have special obligations.

Barriers to entry

Our recent in-depth studies highlight the extent of the barriers faced by entrants and smaller firms in South Africa. These firms are up against well-entrenched incumbents, many of which derive their position from privileges obtained under apartheid.

Entrants may have fantastic products but find their routes to market are blocked in many ways.

For example, incumbents can control distribution systems and retail space. Exclusive lease agreements between incumbent supermarkets and owners of shopping malls mean that new supermarket chains have to invest in finding vacant land and building freestanding stores. This was evident in the case of Fruit and Veg City.

Another factor is consumer inertia and brand loyalty. New entrants have to spend large sums on advertising before sales volumes and scale can be achieved.

And then there is the issue of established players putting up strategic barriers to new entrants. As mobile operator Cell C entered the market the large incumbents increased call termination rates. This contributed to Cell C’s slow growth and sustained higher mobile prices for consumers.

The studies also note the general importance of economies of scale and scope. If a new player wants to build a competitive business it needs access to substantial, and patient capital. This raises issues around access to inputs or the need for entrants to invest in businesses at different levels of the supply chain – all at the same time.

New and creative businesses can bypass some of the roadblocks. But they can be undermined at one level preventing them from unlocking the markets at another. Another point we highlight is the significance of learning-by-doing. Successful entrants learn by making mistakes. Fruit and Veg City entered into retail in 1994 and took 22 years to develop its business model and build a footprint of just more than 100 stores.

The case of Capitec also offers useful insights. The fact that a leading financial services group, PSG, was one of its shareholders and provided equity finance gave it a considerable advantage. But it still took about a decade to reach the scale required to be an effective competitor.

These examples show that the only way new entrants can survive is if they have backing through their early years. This again suggests that businesses with inherited wealth behind them have a substantial undue advantage.

Things need to be done differently

South Africa needs to do things differently if it wants to open up its economy.

Routes to market must be opened up to new entrants and rivals. This can be done by securing commitments from supermarkets to lower the barriers to smaller suppliers, as a key route to market for all consumer goods. Urban planning can facilitate a diversity of retail formats.

Regulation of network industries such as telecommunications, banking and electricity transmission should be done with increased participation and competition in mind to ensure that entrants are given the chance to grow and effectively challenge incumbents.

In addition to a greatly expanded role for development finance institutions, sources of venture capital need to be identified for rivals in concentrated markets. It involves more “patient capital” with a longer repayment horizon to give entrants time to build the capabilities they need. One source of finance for these investments would be if all competition fines were paid into a development finance fund for competition.

But the package requires more than finance. It requires support to build the financial, management, and other skills needed to establish successful businesses. Businesses are bound to fail if support for new entrants, including black industrialists, continues to happen at one level without addressing the dynamics across the entire value chain.

Ultimately facilitating entry strengthens the competitive process and opens the economy to wider participation. This rewards innovation and creativity rather than incumbency and historical advantage.

Genuinely addressing the concentration of wealth and ownership and creating the ground for black industrialists to thrive requires such a programme for change.

And, for a meaningful change in the distribution of wealth, tackling the way in which inherited market power is exerted must be complemented by taxing historically acquired wealth.

Simon Roberts, Professor of Economics and Director of the Centre for Competition, Regulation and Economic Development, University of Johannesburg and Tamara Paremoer, Senior Researcher, Centre for Competition, Regulation, and Economic Development, University of Johannesburg

This article was originally published on The Conversation. Read the original article.

The Conversation