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Lifting the Veil

Lifting the Veil

How does a country built industrial capacity? And how does it lose it, indeed actively destroy it? The veil on SA efforts was partly lifted recently when SEIFSA chief economist Henk Langenhoven expressed in a few simple phrases the very intricate processes involved.

His focus was on the steel and engineering complex, but his analysis can easily be extended to other industry entities, both large and small.

Henk's analysis concentrated on what we call the metals and engineering, plastics, electrical machinery and equipment industry, incorporating a very diverse range of economic activities.

This diversity is a function of the origin of each of the bits and pieces.

Combined annual turnover (2013) is R444bn of which half (R220bn) exported. The sector employs 387 000 people and retains only about half of the domestic market, with imports having captured the other 50%.

Domestically, this sector represents 30% of SA manufacturing and 5% of GDP. The bulk of the sector's production sold in SA is intermediate products supplied to the motor sector (8%), mining (10%), construction (10%) and machinery and equipment manufacturers (45%).

Now a funny fact. Some 150 years ago, nearly none of these industries were in existence. There were a few simple local manufactures catering navy supplies, building and transport supplies and merchant supplies, the latter mostly to farmers. But that was it.

The great push came with Cape Colony and West Transvaal diamond fields being discovered. Most equipment and materials had to be imported at great cost from overseas from known suppliers. As a proven local market came into being, with rising quantities sold, local manufacture could be attempted where it was cheaper to do so, considering high import transportation costs.

As mining activity spread, and local goods and service markets came into being, local supply was stimulated. In waves, this also invited foreign suppliers to open local outlets, to get nearer the action, cut out middlemen and transport costs.

In this manner, hundreds of foreign companies acquired a local SA foothold, alongside outright SA businesses, in the process adding to the diversity of SA industrial capacity and sophistication, as technical higher-skilled jobs came into being, and were filled by local labour.

The modern SA economy progressed in this manner in a number of "waves", the first being the Kimberley diamond and Witwatersrand goldfields, but followed soon by spreading urban construction, infrastructure construction, Boer War reconstruction, the stimuli from WW1 local shortages, and new mining waves in platinum, coal and eventually iron ore.

The 1920s and 1930s saw major efforts at poverty relief and infrastructure additions. WW2 brought more stimuli, both for military supplies and because of war shortages. After the war, the Free State goldfields were opened up, and the government further boosted infrastructure investment.

Henk's modern reference period is the mid-1970s to mid-1980s, which was at the end of the previous commodities supercycle (or mining boom), which had for decades ridden on the back of post-WW2 reconstruction in Europe and Asia, and modern wars (Korea, Vietnam). Locally, that period had seen sustained state investment in road, rail and water infrastructure. It was followed by a long period of public corporation investment in power stations, nuclear energy, oil refineries, heavy industrial expansion and the arms industry.

All this industrialization effort was partly market-driven, but also politically inspired, with the country seeking greater self-sufficiency through import replacement as foreign trade became more politically isolated and sanctioned.

All these growth drivers resulted in a rich diversity, depth and scale of activity unheard of before, protected by "double glazing", namely the sanction shortages created by the rest of the world and our own import trade tariff protection, between them along with infrastructure development the main drivers for inward SA industrialization.

But then a high watermark was reached. The infrastructure scaling up efforts of decades came to an end in the mid-1980s as growth slowed and excess capacities mushroomed while the state ran out of financing options. Also, the protective import tariff walls came down during the early and mid-1990s.

Ever since, the engineering industrial complex has been driven by its exposure to imports from an integrated world dominated by low-cost manufacturing from the East. It has lost out on the latest global commodities super cycle for mining, its motor industry clients have become heavily integrated into international supply chains and markets, and have taken strain, and the construction sector appears to have entered a new infrastructure-led stagnation phase.

Recent years have also shown this industrial complex to be highly exposed to the state of each other's labour relations. Consecutive strikes in mining, construction, transport and motor industry have created "perfect storm" reciprocal demand disruptions for each of these sectors, causing production to be curtailed and scaled down, and even complete closure of plants.

The domestic impact of these events have been widely highlighted. Yet the more pervasive impact for these industrial sectors is actually far more serious. For they export 50% of their output. Also, a large proportion of supplies to the domestic motor sector is also destined for exports through car manufacturers.

The global supply chains at the heart of these operations are highly complex and driven by global cost optimization pressures. It is something SA needs to adapt to rather than that it can prescribe. Price taker rather than price maker.

Domestic cost increases (electricity, logistics, labour, regulatory demands) cannot be passed on to global markets due to severe competition, intensified by the present decade or two of sluggish global demand in the aftermath of major global financial crises.

Besides price and quality, security of supply is often as important in securing global export contracts. Most of these supply contracts recur in cycles (3-5 years) requiring new capacity and tooling investments.

If price disadvantages increase due to costs getting out of hand, and the security of supply is in doubt, chances of winning business in the next supply chain cycle diminish substantially. Adding insult to injury, losing the price competitive edge domestically also increases the opportunities for importers to make yet greater inroads and fill any voids left by local capriciousness.

These micro economic and trade effects have yet bigger consequences. As also emphasized by the SARB, output losses, lower exports and larger balance of payments deficits, as well as tax revenue implications due to lower company profits, all feed through to investor confidence risks.

Thus the positive reinforcing boosts of previous decades and the spreading industrialization in its wake has become reversed in recent years into a progressive de-industrialization, undoing the economic foundations built up with great effort and in the face of many challenges over a century.

Arresting this by now galloping drift will take more than just the recasting of labour laws and labour negotiation regimes. For far more is at issue, and not only for the industrial complex described here in some detail.

Metals and engineering activities need to be globally competitive. Besides labour costs, input costs generally are at issue, from basic metals through to the many administered prices, from the failing of local business support services to the lack or inadequacy of logistical infrastructure.

All dimensions of value-adding dynamics, from quality skilled labour, old production capacity (fixed capital stock) and need to invest in new technology are important. The cultivation and expansion of export markets are important.

All this goes well beyond only labour, and these many negative dynamics need to be reversed if our industrial capabilities are to be retained.

Reference

Henk Langenhoven, Chief Economist SEIFSA "Crafting a solution to industry woes goes beyond labour cost" BusinessDay 5 August 2014