SA cannot afford its costly localisation policy

September 8th, 2023Latest News, Op-ed

To achieve growth we must move towards greater global integration, not greater self-sufficiency.

Everyone wants to see SA’s economy grow, for it to attract more foreign investment, for new firms to be started and existing firms to grow, and for all of this to generate many more jobs.

All the evidence suggests that if we are to achieve growth and create the jobs we need, we must move towards greater global integration, not greater self-sufficiency.

Why then, when we so desperately need faster growth and jobs, is the government committed to a policy of localisation when it is clear that its actual effect is to be a brake on investment and growth? And why is organised business endorsing this approach, as it did when it was party to a National Economic Development and Labour Council (Nedlac) agreement that, while unenforceable, envisages a 20% decline in non-fuel imports over a five-year period?

The Centre for Development and Enterprise’s (CDE) most recent report, “The Seven Sins of Localisation: Can SA afford this costly policy?”, is based on a recent round table with experts and stakeholders to assess the case for localisation policies.

Localisation should be understood as an enforceable requirement or economic incentive that domestically produced goods be purchased in preference to imports. This applies both to the state and the private sector. It is reflected in preferential procurement rules for government and industrial master plans.

At the CDE round table there were strong voices in favour of localisation, and people who were earnestly looking for ways to make the policy work in the difficult circumstances in which the country, especially the manufacturing sector, finds itself.

However, from the discussion as a whole it was difficult to escape the conclusion that the way localisation is being implemented in SA ensures that the policy is having a detrimental economic impact. There are growing concerns — even from people who largely favour it — that localisation is imposing significant costs on a cash-strapped state and is slowing growth. For example, Transnet CEO Portia Derby has spoken up about the costs localisation imposes. She claimed that local procurement obligations impose an extra cost of 10%-30%, making it impossible for Transnet to be competitive.

The Zondo state capture commission expressed the view in its 2022 report that “the primary national interest is best served when the government derives the maximum value for money in the procurement process”.

In the CDE’s view, localisation policy as currently practised in SA is guilty of seven sins that undermine its ability to achieve its goals. The first is the lack of transparently produced data and research relating to localisation. Some of the figures used by the government do not seem based on reality at all — in some cases there are local content requirements despite a complete lack of local industrial capacity to meet them.

For example, under the original terms of bid window 5 of the Renewable Energy Independent Power Producer Programme (REIPPP), the localisation requirement for solar panels was 100%, even though SA only had two solar panel producers which were in no position to cope with demand.

Second, additional costs, delays and inefficiencies resulting from this policy negatively affect investor confidence. By forcing private bidders under the REIPPP to commit to local content requirements, the costs of bidders are raised, as is the overall cost of energy generation, with major knock-on effects for the entire economy.

Research by DNA Economics suggest that “local content requirements have increased the cost of production in SA’s renewable energy sector by at least 10%”, while for some firms production costs rose by as much as 60%. Though firms may apply to the department of trade, industry & competition for exemptions if the required volumes of inputs are not available to source locally, these are considered on a case-by-case basis and often cause long delays.

A third problem is that localisation strategies result in the deployment of tariffs to raise the costs of imports and channel demand to local producers, which require protection from foreign competition. These tariffs act as a tax on SA exporters, which must use more expensive inputs, making them less competitive in global markets. Contrary to the department’s aims, the nature and scope of SA’s protectionist policies hamper our ability to export manufactured goods.

Another consequence of localisation is that it restricts competition and raises prices for all. If it serves to artificially keep domestic manufacturers in business, one is left with inefficient firms that likely would not survive on a level playing field. Such firms will pass on inefficiencies to consumers in the form of higher prices, lower-quality products or both.

In addition, localisation, as applied by the state, reduces incentives for firms to innovate and find new markets. When producers are protected from foreign competitors they tend to find it overly difficult, and often unnecessary, to enter new growth areas. This lack of incentive to innovate and expand means countries that adopt these policies are liable to lag behind more entrepreneurial places in a fiercely competitive global marketplace.

The sixth problem with SA’s basket of localisation policies is that they appear to be in violation of the country’s international legal commitments, including those of the World Trade Organisation’s General Agreement on Tariffs & Trade, the EU-Southern African Development Community economic partnership agreement, and the African Continental Free Trade Area agreement.

Ultimately, the question we need to answer as a country is the one posed by University of Cape Town economics professor David Kaplan: “Do we want our future to be inward-looking or do we want to be integrated with the global economy, learning from others, increasing our export footprint, growing our economy, and providing the jobs and inclusion we so desperately require?”

The answer is obvious. Rather than trying to compel local manufacture of products, the government should be working to shape a business environment that attracts and rewards investment as a result of strong competitive pressures. SA cannot afford this expensive policy.

Bernstein is head of the Centre for Development and Enterprise. This article is based on the report “The Seven Sins of Localisation: Can SA afford this costly policy?”

Article published by the Business Live

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