JOHANNESBURG – Industry representatives and stakeholders were relieved with the announcement by President Cyril Ramaphosa in his State of the Nation Address that the government will champion initiatives aimed at replicating the so much lauded motor industry development programme (MIDP) for key sectors, including the diverse iron, steel and metal fabrication clusters.
The initiatives – which align with interventions aimed at re-igniting domestic growth – are consistent with previous suggestions by captains of industry aimed at boosting demand and supply-side initiatives, increasing efficiency and strengthening the case for more local content in production processes.
Moreover, the announcement came at a time when the rest of Africa holds promising trade potential, with the recently launched African Continental Free Trade Area agreement. Mirroring the MIDP would, therefore, add impetus for an increased volume of broader manufacturing output, support agro-processing activities and enhance export competitiveness to the rest of the continent, with positive spill-overs on employment, poverty and income inequality.
Given the difficult operating environment for local businesses, poor high-frequency data, confidence, expectations and trade data, the timing of the statement is apt.
Our first-quarter (Q1) 2019 Review of the State of the Metals and Engineering Sector Report reveals that the sector’s total real exports to the rest of the world contracted by 8.6 percent quarter-on-quarter (Q-o-Q) between Q4, 2018, and Q1, 2019, and by 1.98 percent on a quarterly year-on-year (Y-o-Y) basis.
The overall subdued performance, despite a comparatively weaker rand, was largely due to well documented challenges, as indicated at the beginning of 2019. Disconcertingly, the poor performance was further explained by low exports to other African countries both on a Q-o-Q basis (-14.3 percent) and a Y-o-Y basis (-6.1 percent).
Encouragingly, annual exports to Asia and the US at the end of Q1, 2019 were resilient (despite existing steel and aluminium tariffs imposed by the US on SA exports), providing some promising prospects.
The contraction of 8.8 percent in broader manufacturing output and the corresponding dip in African exports by the important cluster of industries in Q1, 2019, highlight the need for proactive thinking in order to reverse the negative contribution of 1.1 percent made by the sector to gross domestic product (GDP), enabling an uptick in economic growth.
However, although a strong GDP growth is necessary to reinforce the demand side dynamics of manufacturing and the rest of industrial production, with extended benefits to the fiscus and economy, the GDP numbers should be interpreted with caution. In fact, an exclusive focus on the GDP measure alone can be quite misleading – and industrialists are well aware of this.
Practically, with GDP measured by production, when newly produced stainless, alloy or carbon steel (an intermediate product) is manufactured, its market value is estimated and immediately counted as part of GDP in one quarter, irrespective of whether the product gets sold in the next quarter.
Suppose that the product was manufactured in November 2018, adding R200 000 to the GDP of Q4, 2018 but is subsequently sold in Q1, of 2019 it is only counted in the GDP of Q4, 2018 in order to avoid double counting.
Value added is, therefore, counted only when goods are produced rather than when they are sold.
This is a red flag when interpreting GDP statistics to gauge the health of the economy, as high GDP may only mean that a lot of intermediate or finished products are being produced and stored as inventory, and not necessarily that companies are selling the goods.
GDP can, therefore, be high in one quarter, underpinned by higher production and value add, but the economy can be about to go into recession in the following quarter because inventories are piling up and clogging production, and managers are contemplating cutting back on production in order to get inventories down back to target levels. Therefore, the dip in GDP for the next quarter will be mainly due to poor inventory turnover rather than poor productive capacity.
This explains why quarterly GDP numbers are very volatile as opposed to longer-term readings, and highlight the need concomitantly to monitor inventory levels in order to assist businesses with policies aimed at increasing demand for their products, instead of solely playing the GDP numbers game.
While GDP growth is important, it is not a panacea for South Africa’s socio-economic challenges.
Although it is good to pursue GDP growth as it measures how fast the economy is growing, higher GDP doesn’t always guarantee an improving per-capita income (especially given the relatively higher population growth in absolute terms), a better standard of living or that happiness is increasing.
On the contrary, GDP may increase when floods destroy a large section of a city or when a natural disaster occurs.
GDP is sometimes a corollary of bad things, as it will go up when re-construction begins and lots of new output is produced to replace what was destroyed.
Similarly, higher GDP may be possible in certain situations only if the government has tolerance for more pollution, greater income inequality, poor leisure time or dirtier environments as well as more crime and service delivery protests, because some people are getting richer much faster than others.
Although policies that raise GDP are generally beneficial for society, there are trade-offs and costs involved since GDP numbers on their own don’t reflect these negative conditions or externalities.
Instead, policies aimed at reducing businesses’ intermediate and operational input costs should be implemented in order to boost manufacturing’s share of real GDP consistently, with sustained benefits to the economy.
Additionally, initiatives aimed at boosting outward demand for South Africa’s local industrial goods should be complemented by efforts aimed at increasing inward demand from both the private and public sectors, perhaps through a mechanism to monitor and enforce designation requirements, in order to improve local content and promote import substitution.
Dr Michael Ade is the chief economist of the Steel and Engineering Industries Federation of Southern Africa.