AN EVALUATION OF INDUSTRIAL POLICY PERSPECTIVES IN THE SOUTH AFRICAN CONTEXT

AN EVALUATION OF CURRENT APPROACHES TO INDUSTRIAL POLICY FROM GOVERNMENT, BUSINESS AND LABOUR

Current South African trends in industrial policy

South Africa has never had a clear industrial strategy in the 1990s that could have led to a coherent set of industrial policy measures. Hence, the role of the Department of Trade and Industry, as well as the Industrial Development Corporation, has generally been used as a yardstick to assess current government thinking on industrial policy. Documents such as the section on industrial policy in the Growth, Employment and Redistribution (GEAR) document on macro-economic policy, as well as discussion documents from the DTI (see, for example, DTI 1998) were used as indicators for the thinking of government officials on the status and direction of industrial policy. The publication of the latest DTI discussion document (see DTI, 2001), goes some way to provide a point of reference.

Generally speaking, the industrial policy orientation shifted towards what the DTI called a supply-side orientation, where a model of import substitution industrialisation makes way for export-led growth. This movement is in line with the proposals of especially the World Bank, the Porterist and some of the elements of the post-Fordist perspective. Alongside a programme of import tariff reduction, the DTI put in place a general set of supply-side measures, including a tax incentive scheme and the provision of low interest loans to companies in industries undergoing rapid tariff reductions. Legislation governing competition was reviewed, and new agencies were created to support the development of small business. It also embarked on spatial development initiatives (SDI's) and industrial development zones (IDZ's) in order to attract investment to certain geographical regions (DTI 1998; see also Hosking & Jauch 1997; Newman 1998).

In the context of a policy of export-led growth, it is interesting to note in which sectors of the manufacturing industry jobs have been created. From 1996 to 2000, the highest growth rate in employment has been in plastic products, leather & leather products and wood & wood products (not including furniture). These sub-sectors of manufacturing each achieved annual average growth rates above 5%. In only three other sub-sectors (out of the 27 main sub-sectors in manufacturing) was employment in 2000 higher than in 1996.

Plastic products: Only a very small proportion of plastics products are exported. Apart from 'engineering plastics' niches, plastics are generally a medium to low technology product with technology being embodied in machinery bought 'off the shelf'. Competitiveness depends on building-up capabilities in using equipment, on access to feedstocks and on other factors such as labour costs, finance and infrastructure (Roberts, 2001). The largest market for plastics products (approximately half) is in packaging. The auto sector is also an important market, and the growth in plastics may be linked with the Motor Industry Development Programme (MIDP).

Leather products (and the Motor Industry Development Programme): This sub-sector is almost entirely oriented to providing seat-leather for cars. The evidence indicates that South African firms were not competitive in this area, but undertook it in conjunction with multinational companies specifically because of the major incentive provided by the MIDP. Now, after learning and skills development, there are indications that firms are becoming competitive in their own right although there is a shortage of raw hides as a result of expansion in this sector (which is itself an example of a co-ordination failure).

Wood & wood products: This sector also has a very low level of exports. It is essentially based on the processing of forestry products, in the form of logs, planks and products such as chipboard and veneer. It indicates the potential for growth based on local needs for housing etc. as well as the Department of Water Affairs and Forestry, DWAF's programmes promoting greater community participation in developing wood lots, etc.

Two of these sectors may have benefited from active government industrial policies - i.e. the MIDP. However, the argument that government should be more pro-active in the targeting of certain industries seems to have lost ground. Two reasons given for this is the perception that the DTI does not have the capacity to do this successfully, and the concern that some of these measures may not be admissible under the World Trade Organisation rules.

It is also important to recognise that the way in which the government's macro-economic policy was introduced, and the strict adherence to fiscal discipline, closed down some of the space provided in the RDP framework to couple supply-side measures with demand-side measures. Hence, an industrial strategy that could focus on economic growth through infrastructure development and the meeting of basic needs, became undesirable in the broader policy framework adopted by the government (Chang 1998; Marais 1998; Nkadimeng 1999).

The latest DTI discussion document does not attempt to provide "a detailed and comprehensive list of policies that government will inevitably follow." Instead, it attempts to map out a "broad trajectory or thrust" in order to anticipate the premises upon which government industrial policy over the next two decades will be based - i.e. the document is concerned with industrial strategy, not policy (DTI, 2001: 7).

It is interesting that the document immediately defines industrial strategy as a strategy to strengthen manufacturing (DTI, 2001: 7). Here, the author of the document draws strongly on the post-Fordist approach (see Table 1), but adds the dimension of the impact of information and communication technologies on manufacturing productivity.

The industrial policy has essentially been based on two planks:

• non-targeted, functional 'supply-side' measures and incentives
• trade liberalisation

Although different parties disagree about the effectiveness of these policies, there is little doubt that the performance of manufacturing industry has been poor in terms of output, employment and investment. The performance in manufacturing is in line with that of the overall economy illustrated in Figure 1 below.

Figure 1.Non-agricultural employment and production (indices)

Source: Calculated from South African Reserve Bank data

While it may be believed by the DTI that manufacturing is not going to be the major generator of jobs in the future, the output and investment performance has also been very weak, especially from 1997, and large numbers of jobs have been shed. This forms the backdrop to the different attempts to address the fundamentals of an industrial strategy.

The different approaches of the constituencies are briefly outlined, with the main focus being on the DTI document. The implications of different approaches for a series of issues at the heart of any industrial strategy are then explored. These include:

• production capabilities and technology
• employment and skills
• knowledge and information
• investment
• business confidence and expectations
• competition, and competitiveness
• international trade and production

The DTI approach

Overview

The DTI discussion document, Driving competitiveness: Towards a new integrated industrial policy for sustainable employment and growth (2001) identifies two major areas at the heart of its 'integrated strategy for sustainable employment and growth': (a) the need to move to a knowledge-based economy which recognises the decline in old modes of competitiveness, and (b) competition and effective regulation.

This is based on an earlier analysis of changes in markets, and the need for a set of rules (to be established and enforced in an industrial strategy) to ensure markets function effectively and to address market failures. Competition rules are the main thing identified as necessary for the effective functioning of markets. In the DTI document various boxes on Black Economic Empowerment, SMMEs and Employment are inserted to indicate that they are areas of concern.

The changing nature of competitiveness and the increased emphasis on a 'knowledge basis' underpins the strategy. As a result, the document highlights the need to develop backward and forward linkages of information and communication technology (ICT) with production, and the use of capacities in knowledge driven activities to realise lower production costs, economies of scale, and integrated regional production systems.

Human resources and telecommunications are identified as two key constraints for the realisation of a 'knowledge driven economy'.

The approach outlined by DTI leads to suggestions of 'indicative policies' around skills development, technological development, innovation, ICTs, networks etc. Government will pursue these policy objectives across Departments, while DTI itself will have an emphasis on Business and Consumer regulation.

Commentary on DTI approach

Few could disagree with the aims of human resource development or having better telecommunications. But, what are the relationships with 'knowledge intensity', and how are they to be brought about?

Knowledge is largely developed by firms. In other words it is to do with their decisions and responses to opportunities. An important part of it is experiential, developed on-the-job. In other words, rather than developing the knowledge and then competing, firms respond to demand for their products and, if they take a longer-term perspective, invest time and resources in building their productive capabilities. It is not surprising that South Africa has strong production capabilities in technologically sophisticated products such as parachute material and yachts, as these both represent responses to the historical orientation of demand (to the defence sector and the wealthy white elite). Workers in these firms do not necessarily have a particularly high level of education, but the workforce is very stable, enabling skills to be built up. It is well established that firms under-invest in training where there is a higher turnover in labour. Capabilities are generally based on the domestic market, with the ability to draw on international sources of technology (through processes of adaptation, copying and reverse engineering) being more important than product exports.

Trade liberalisation suggests a reorientation of production, which requires investment and the ability to respond to different opportunities in international markets. In South Africa, the low levels of investment and contractionary environment mean that instead of capabilities being built, there is the danger that existing experience has instead been lost.

The need to develop capabilities and therefore earn higher rents is not a new phenomenon. The product life-cycle hypothesis associated with Vernon describes how in the early stages of a new product the research and development activities are crucial, meaning that production is located in a multinational's home country (Vernon, 1966). As the product becomes mature, competitive pressures increase reducing the returns from production, and the firms seek low cost locations for the production. Analyses of relationships between firms in value chains have also highlighted the importance of firms' capabilities and bargaining positions if the benefits of improved linkages in the value-chains are to be shared.

The industrialisation in countries such as South Korea depended on the development of production capabilities in order for firms to move into higher value products. Government policies, including the provision of finance were based on an understanding of the requirements of selected sectors. Competition was an important disciplining force on large companies to prevent them from abusing their position and focusing on short-term rent extraction rather than longer-term investment in productive capabilities. But, competition was combined with support and government monitoring. Competition policy was not implemented in the form of an independent regulatory body, but was an integral component of industrial policy, addressing the behaviour of large firms in its position within the powerful Economic Planning Board (until 1994) (see Amsden & Singh, 1994; Amsden, 1997; Wise, 2000).

Similarly, there is a focus on telecommunications in the DTI document, but the gains from more effective integration of firms' operations will depend on appropriate business models for the co-ordination of activities across firms. There is also little evidence that independent regulation is the best way to achieve better and wider access to telecommunications which would form part of a more integrated economy. Instead competition is likely only in the high-income and big business markets.

The experience of the USA indicates that government has to play a major role in ensuring broader access to telecommunications and investment in high-speed ISDN lines. For example, the city of LaGrange, about 70 miles from the city of Atlanta, could not attract companies because of the lack of high-speed telecommunications infrastructure. The private telephone company declined to provide it because of insufficient demand. After the council established a public utility and provided the infrastructure from 1996, companies were attracted to locate, which increased demand and the metropolitan council earned an estimated rate of return of 15% on their investment (i.e. earning a profit over and above covering all its costs). The economic development programme was also linked with training and education programmes at high schools and technical institutions to provide training in the skills required by the telecommunication intensive firms that were to be attracted (Youtie, 2000).

The provision of transport infrastructure, electricity and telecommunications are all things which make economic activity easier, and influence its nature and development. Transport and electricity are not mentioned by DTI as being significant parts of a strategy for industrial development. The complex and interdependent nature of physical investment, education and skill-development, and firms' organisation of production require appropriate co-ordination and planning. Indicative planning in itself involves influencing expectations and thereby the investment decisions of firms. To do this, it requires specification of objectives and mechanisms at a sector level that can be readily understood by firms. For example, in the USA the growth of production capabilities in semi-conductors followed a concerted programme which identified the key requirements for the USA to regain leadership in this field. This linked the activities of national institutions, universities, the Semiconductor Research Consortium, the Semiconductor Industry Association and regional government in areas such as 'Silicon Valley' in California and Route 128 in Massachusetts (Best, 2001).

In conclusion, the discussion document fails to develop an adequate understanding of how the South African manufacturing industry links into other sectors of the economy. An in-depth study of how some of the key commodity chains operate might yield such an understanding. Also, the focus on the role of information and communication technologies is appropriate and valuable, but partial. Other key elements of industrial strategy are excluded as a result.

Labour's approach

The labour position paper is essentially a section-by-section critique of the DTI document. It particularly emphasises the need to base a strategy on analysis of South African conditions and social needs. It starts from the high levels of inequality and the implications that this has for patterns of domestic demand.

While labour argues that the 'world class' strengths in mining and some parts of agriculture have to be built on, there is the risk of ignoring capabilities which already exist in areas of manufacturing. South Africa is one of the lowest cost producers of iron & steel in the world. It also has particular production strengths on some chemical products due to the production capabilities of Sasol. Other areas include products aimed at the defence sector.

International relationships are also important for improved technological capabilities. Integrating into international buyer chains is also necessary in sectors such as clothing, if potential gains from the African Growth and Opportunities Act (AGOA) are to be realised. Similarly, strategy in sectors such as automobiles must recognise that they are governed by multinationals. Indeed, in sectors such as paper & pulp and chemicals South Africa has major multinationals such as Sappi and Sasol.

The Business submission

The submission analyses industrial policy options from an initial discussion of comparative advantage, competitive advantage and dynamic comparative advantage. It argues for a competitive advantage approach along the lines of Porter (see Table 1). It also proceeds from a proposition that an enterprise strategy focused at microeconomic reforms affecting all (not only industrial) enterprises is the appropriate scope for consideration. Business also argues that sufficient detail is required in such a strategy on the various factors affecting investment, including the cost of capital, market access, infrastructure investment and skills availability.

The distinction between comparative and competitive advantages

The discussion of comparative advantage and competitive advantage identifies the first as operating at the industry level and the second at the firm level. It seems to identify comparative advantage with resource endowments rather than factors of production (land, labour and capital) as it argues that countries such as Japan, Taiwan and Singapore had little comparative advantage. The point about the theory of comparative advantage is that there are win-win gains to be had from specialisation (and the division of labour) and exchange through markets. This applies to international markets just as to domestic markets. For example, it may hypothetically be easier to both grow maize and provide financial services in Gauteng than in the Northern Province. The relative advantage in financial services is much greater, while the advantage in growing maize is only slight. This means that land costs rise as office blocks are built in Johannesburg and financial services supplied to the nation, while maize will not be grown, but be imported to Gauteng from other Provinces.

The second important point about international trade is that it is an exchange. South Africa can only import goods in US$ if we export goods to earn those dollars. Conversely, the foreign currency earned from exporting will mainly be spent buying imports (it could also be used to buy foreign assets, through capital outflows). Being more competitive in one type of good (and increasing exports of it) means importing more of other types of goods, and so being less competitive in them. Improvements in overall competitiveness means better production capabilities and productivity - through better skills, technological capabilities, machinery and infrastructure, regardless of which products are exported and which are imported.

Dynamic comparative advantage recognises that patterns of comparative advantage depend on the capabilities and capital already developed. Previous decisions over skill development determine the relative abilities to produce today. In other words comparative advantage is not only about the quantities of factors of production and their prices, but about the nature of the factors. In addition, there are sectors in which the production processes themselves are developing rapidly such that participation in these sectors means improving skills and producing higher value and more advanced products. For example, producers of computers have rapidly developed their capabilities as the product has changed, and have benefited from greater returns from the products. Agricultural producers have not experienced such gains, except perhaps in niche products. Abilities to produce more sophisticated products in which there are ongoing improvements are part of the reason for industrialisation.

Lastly, in most industrial products there are many stages of manufacture, from the processing of the raw material through to the assembly of the products and the packaging and distribution. The competitiveness depends on operations of firms all the way along the chain. Firms' capabilities are also often learned or copied from similar firms. In many countries, competitive advantages in industries have been built up through networks of firms engaged in similar activities.

Traditional and new policy measures

The Business submission largely agrees with the DTI document on the need for information and communication technologies, human capital development, innovation and research, black economic empowerment and small and medium enterprises. These are to be added to the traditional measures of macroeconomic stability, trade liberalisation and privatisation. There is little detail on areas such as SMME development, black economic empowerment and innovation and research. The emphasis is placed on 'internationally competitive' tax rates and the need not to penalise large South Africa companies. The low returns made by such companies with a capitalisation of more than $5bn is used as a argument that profits are too low for investment to be made. There are only 8 such companies in South Africa, and some have made very good returns. The more fundamental question is why returns have been poorer. With lower corporate tax rates, it is difficult to see this as the main reason.

Essentially much of the Business submission argues for a smaller role for government, without suggesting ways forward on many of the particular policy areas identified. There are also conflicts between the need to improve infrastructure and tax levels. The lack of investment by Transnet and high wharfage charges of Portnet are traceable to the government's orientation to privatisation and profitability on the part of parastatals along with the inherited pension fund deficit and high interest rates which have prevailed. Similar factors may be driving the very high prices charged on local flights where there is no competition. The assertion that 'a significant amount of the input costs of the average business are provided by SOEs in uncompetitive markets with non-market determined prices...' therefore needs further investigation, especially when for many businesses the largest input cost after labour and capital is electricity, where we have one of the cheapest supplies in the world. Most firms also use road transport, a sector with competition, but with increased toll charges.

Interestingly, international experience has shown that growth and trade liberalisation have been accompanied by a larger role of government rather than a reduced one (as asserted by Business). Lower tax rates and less government are also not necessarily the best way to attract FDI. Evidence suggests that FDI follows rather than leads growth. A more central question is therefore why South African companies (a number of whom are themselves truly multinational) are not investing? The Business submission suggests that most internationally successful companies have been launched off the back of a strong domestic market base. In this regard, it is unclear what is being suggested by Business on the dominance provisions of the Competition Act. The Act only addresses the behaviour of dominant firms, abusing their position, and does not address size as such. In any event, the abuse of a dominant position such as through charging very high prices may hinder the long term growth of a company as it will render the downstream users of their product uncompetitive and contribute to the stagnation of the local economy.

There is also a need for further examination of the links between labour costs and economic strategies. A competitive advantage or dynamic comparative approach does not place emphasis on lower and lower wage rates, or on the ease of hiring and firing. Rather, the development of productive capabilities rests on the organisation, management and training of the workforce in order to compete on quality, design and delivery aspects and not narrowly only on price.

Skills development, research and innovation are all clearly critical areas in which performance has been relatively poor. It would be useful to have a better understanding of the nature of skill demands and projections of how these might constrain growth so that interventions could be designed in the appropriate areas rather than a general aspiration to improve education and training.

The role of government in supporting 'Enterprise Development' requires addressing a range of issues constructively and in some detail. The performance of programmes which have been relatively successful, such as the Motor Industry Development Programme, might also be examined in order to understand exactly how government policies impact on the decisions and growth of firms.

The Business submission also argues that a 'fairly comprehensive literature review' reveals that government interventions were not the main cause of growth in successful Asian economies. In fact, many, if not most, analyses of the east Asian experience reveal that government measures certainly played a constructive role. For example, the high savings rates in countries such as South Korea, Taiwan and Malaysia were accompanied by far-reaching and selective interventions in the financial system, both on the side of savings through pension funds etc. and in the allocation of finance to industry.

Implications for industrial policy

• Investment:

  Investment in expanded production capacity depends on the expectation that it will yield a return greater than the cost of the investment or the alternative that could be earned from investing the money elsewhere. Profitability depends on markets for the products at a good price, which can cover the costs of production. Lower tax rates, or other incentives can only be considered once the fundamental conditions for the investment are in place. Demand factors and supply factors (costs of inputs, of labour and skills, availability of infrastructure) are critical. Government potentially plays a role in all of these. Infrastructure shapes the environment within which economic activity takes place. The delivery on government's own investment plans is also an important part of building-up confidence in growing markets. For example, government investment in infrastructure and housing has direct impacts on demand for metal products, bricks and cement, machinery, asphalt etc. The shift by government to a significant programme of investment provides major opportunities which can be addressed through industrial policy.

• Technology and production:

  Original technological capabilities can be developed through research and development, but more important is the application and adaptation of technologies in the production process. Funding for research is only one aspect. Firm strategies must be geared to learning about new technologies, especially those being developed internationally. This suggests attention to international relationships (e.g. technology licensing and participation in multinational networks) and developing networks of firms in South Africa to ensure the diffusion of technologies throughout an industry or sector.

• Knowledge and information:

  This is closely linked to technology. Firms will often under-invest in knowledge because other firms can copy them and reap the gains for free. There is therefore an important role for government in funding the generation and dissemination of knowledge and information through institutions such as universities, technikons, the Council for Scientific and Industrial Research (CSIR) and the Human Sciences Research Council (HSRC). It can be utilised by all firms, and also plays a crucial role in influencing firm expectations. The knowledge-base of an organisation such as the IDC is a crucial part of its successful financing programmes which shape the South African economy. Wider dissemination of information linked to sectors with great future potential could be a key focus area for DTI.

• Employment, skills and capabilities:

  Low wages and the 'race to the bottom' has been rejected by all groups. In any case, recent evidence suggests that the high levels of unemployment have pushed significant numbers of people to work for very low wages which are not even enough to move themselves and their families above the poverty line. While everybody supports skill development, it is important to have better understanding of the kinds of skills most required. It is also necessary to place employment within the broader issue of developing production capabilities. Much of people's capabilities are developed on-the-job. Skills development initiatives support the ongoing training of staff, but skills on their own are not likely to create growth in the absence of other conditions.

• Competitiveness:

  South Africa has historically built up competitive capabilities in heavy industries linked to natural resources. A main challenge, identified in the submissions is to build on these, rather than to reject them. While reduced import-tariffs do increase competitive pressures on these industries, and there are signs of improved quality and delivery as a result, firms can continue to charge 'import-parity plus' prices (which take advantage of transport and other costs necessary for one to import). This earns profits for the upstream firms in sectors such as iron & steel and chemicals, but does not build constructive linkages along the South African value-chain. Programmes of rebates and 'export-parity' pricing could be further explored to increase the international competitiveness of downstream firms in metal products and plastics that rely on South African industry for their key inputs. There are major opportunities now with the improved capabilities of South African producers in sectors such as iron & steel and chemicals.

• Regulation and the role of government:

  Rather than a simple dichotomy between privatisation and state-ownership, it may be useful to acknowledge that it is necessary for the state to be effective and responsive to the development needs of the economy. It needs to ensure efficiency at the economy wide level in the framework established, whether this framework governs managers of a state-owned enterprise such as Eskom or regulation of firm behaviour in the telecommunications sector. International experience demonstrates that ongoing privatisation and liberalisation does not mean that the state's role as regulator declines over time. Rather it has tended to increase if it is to be effective. The recent South African experience coincides with international evidence that privatisation and regulation is not a panacea. For example, in sectors such as rail transport state-owned operators have been more successful, where managers are subject to clear objectives and accountability mechanisms.

• Trade liberalisation, exporting, and production growth:

  Exports only add to overall production if there is not a matching increase in imports. The more important aspects of trade and growth relate to other dimensions of the gains from integration into the international economy which accompany trade. Exporting can be a disciplining force on firms. Competition in international markets is a powerful force for firms to develop capabilities and to draw on international sources of technology. This means that the gains from globalisation require effective action by government, amongst other role-players, in the areas of technology, knowledge, skills and competitiveness if they are to be realised. A focus on trade to the exclusion of other factors is unlikely to reap these gains.

'Joined-up government' requires bringing these areas together for effective government policies aimed at growth and broad-based development.