The South African launch this week of the Organisation for Economic Co-operation and Development Centre’s new report on the role of industrial policies is very useful in moving the dialogue beyond high-level and often unproductive entrenched positions in relation to industrial policy.
The report, titled “Perspectives on Global Development 2013 – Shifting up a Gear: Industrial Policies in a Changing World”, highlights many challenges South Africa and other African countries are grappling with in the current global context. Most importantly, it raises the issue of how to achieve a structural shift from natural commodities to manufacturing in resource-abundant economies, recognising that manufacturing has been the driving force in all historic episodes of high and sustained growth.
In this context the global commodity boom has been a mixed blessing. On the one hand, it has been a key source of export demand, particularly as the traditional growth poles of the US and EU have experienced crisis and stagnation.
On the other hand, the commodity boom has shifted relative prices against manufacturing competitiveness across many economies, including South Africa.
A critical element of the continent’s industrialisation must involve exploring how African countries can leverage access to their mineral and agricultural endowments in exchange for investment and trade relationships. These links will help them add value to this endowment as well as attract entirely unrelated manufacturing activities, both for domestic consumption and intra- and extra-regional exports.
The report demonstrates that sectoral choices are unavoidable. Effort and resources need to be deployed to shift countries into more dynamic sectors: demand dynamic in the sense of meeting rapidly growing domestic and international demand and supply dynamic in the sense of sectors that have prospects for significant upgrading and productivity gains.
This is best addressed explicitly, particularly where market-neutral policies can often have the unintended consequence of channelling resources into relatively less productive, unsustainable and sometimes unstable speculative activities.
In South Africa, the confluence of a global commodities boom and macroeconomic and financial sector policies have shifted relative prices against tradeable sectors towards an unsustainable credit-fuelled consumption boom directed towards various non-tradable sectors.
The report provides a useful checklist of pitfalls to avoid in the design of industrial policy. Arguably the most important challenge is to design incentive structures that build in conditionalities that promote the continuous upgrading of processes, products and people.
An important innovation of the report is its explicit recognition that sectors chosen and incentive design need to be compatible with country-specific conditions if they are to be successful. One challenge South Africa needs to face is how to increase the presence of black-owned firms in manufacturing.
South Africa provides examples of how built-in conditionalities can induce effort.
One of these is the steady tariff phase-down of levels of support to the automotive sector that has induced greater vehicle output per unit of support. Similarly, our more general Manufacturing Competitiveness Enhancement Programme provides support to specific investments in the upgrading of processes, products and people across a range of sectors.
Tariff policy has been more strategically deployed to support value addition and employment creation on the one hand, and tariff reductions focused on lowering the costs of intermediate inputs on the other. This is particularly in sectors that have high levels of domestic market power like steel and polymer inputs.
An important insight of the report is that broad educational attainment does not automatically translate into the vocational skills necessary for industrialisation and rapid employment growth. For countries like South Africa, which face numerous challenges and backlogs in education that will require long-term solutions, there is a high premium on vocational training that can reorient funding and people to address core skills demanded by industry and away from the oversupply of training in areas that provide limited employability and upgrading opportunities.
The infrastructure section highlights the complexity of co-ordinating new investment and adequate maintenance expenditure in infrastructure that supports diversification and upgrading, in particular. Decades of little or no investment in infrastructure has led to electricity shortages and rapidly rising energy prices.
South Africa is a useful example of how the demands of established interests can trump long-term structural change. A significant amount of rail and ports infrastructure serves the export of bulk commodities and has been historically cross-subsidised by exporters of value-added manufactured goods. A significant success of our industrial policy work has been to work with the ports regulator to scale down these cross-subsidies and lower the costs for value-added exporters.
Periodic technological waves provide extremely important but time-bound opportunities for countries to diversify and upgrade. The massive growth in the penetration and use of cellphones in Africa has been widely celebrated.
What has been overlooked is that countries that have grown most rapidly are the countries engaged in the production of these new technologies rather than simply being users of and, at best, service providers to the technology of others.
Renewable energy represents such a technological wave. South Africa has committed to one of the largest renewable energy programmes in the developing world and seeks to leverage this investment to build a component production presence in this sector.
Industrial financing is correctly identified as a major constraint. However, the focus on small, medium and micro enterprises masks broader problems with the provision of finance to productive sectors. In addition to matters of the cost of financing, South Africa has seen a shift to the increasingly short-term tenure of private finance available. This is due to a mismatch between sources and uses of funds.
For instance, large short-term capital inflows have been deployed to household credit expansion rather than long-term investment. Development banks have a critical role to play, not just to lower the cost of capital but to make long-term funding available. South Africa’s Industrial Development Corporation has significantly re-oriented itself to take on this role.
The report is innovative in highlighting the leverage of public and private procurement with important – and sometimes counterintuitive – learnings in the process. A major inhibitor of domestic supply into infrastructure procurement has been weak long-term planning. One of the “unintended consequences” of requiring localisation is positive pressure on public procurement planning to better understand the detail of what is being procured, and standardisation of componentry to promote economies of scale through greater long-term certainty of repeat demand.
Another focus of the report – regional economic integration – is a major priority for South Africa. Colonialism divided Africa into 54 countries. This limits consumption and economies of scale at a country level. South Africa is working actively to negotiate a trilateral “grand” free trade area (FTA) between the Southern African Development Community, East African Community and Common Market for Eastern and Southern Africa.
The grand FTA is a key step in integrating 26 countries representing a market of 600 million people.
However, lowering trade barriers is entirely insufficient to generate meaningful regional integration through diversification and upgrading. This is because of the low complementarity between export supply (typically raw or semi-processed resources) and import demand patterns: for finished goods. This requires massive investment in manufacturing and supporting infrastructure.
Nimrod Zalk is an industrial development policy and strategy adviser.