Cogs, wheels and pistons: Manufacturing and industry account for nearly one-third of GDP

Industrial activity plays a central role in the South African economy, accounting for around 31.6% of GDP in 2011, and employing a large portion of the population in labour-intensive processes. The nation’s comparatively well-established legal framework and well-developed infrastructure have enabled it to become Africa’s largest industrial base, as well as a gateway to the rest of the continent. However, like many comparable economies, recent decades have seen the nation’s economic activity tilt away from traditional industry towards a more service-based economy. Mining and quarrying, manufacturing and agriculture have all seen relative declines in their contribution to GDP since 1993, while areas like financial services, communication and trade have seen their contributions rise. Ensuring that South Africa’s industrial base is not further eroded is a government priority, but in doing so it faces several salient challenges.

A Government Strategy

The Department of Trade and Industry (DTI) plays the primary role in developing South Africa’s industrial policy, and over recent years it has produced a number of complementary policy frameworks aimed at the twin goals of national economic expansion and job creation. The National Industrial Policy Framework (NIPF), launched in 2007, provides the broad outline of the nation’s industrial ambition, the government’s general industrial policy and planned areas of intervention over the coming years.

However, the details of the government’s industrial strategy are to be found in the Industrial Policy Action Plan (IPAP), which is launched each year by the DTI on a three-year rolling basis with a 10-year outlook. The various iterations of IPAP represent a flexible approach to policy making which has allowed South Africa to respond to changing economic conditions, particularly those that have affected both the domestic economy and export markets since the global economic downturn in 2008. The current IPAP, 2013/14-2015/16, is the fifth in the series and details significant interventions to build value-added production and improving the regulatory structure. Regulatory measures detailed in the fifth IPAP include reforms designed to bring tariffs and standards in line with World Trade Organisation (WTO) treaty obligations and a variety of other bi- and multi-lateral trade agreements, as well as reduce port charges and rail inefficiencies. It also targets several “clusters” for industrial investment.

A single cluster comprises several sectors that were grouped in the first IPAP. These have been subject to government attention ever since: automotive and components; clothing, textiles, footwear and leather; plastics, pharmaceuticals and chemicals; bio-fuels; forestry, paper, pulp and furniture; creative and cultural industries; and business process services. A second cluster is made up of areas of focus identified for the first time in the current IPAP, including: metals fabrication; capital and transport equipment; agri-processing; and green and energy-saving industries. The final cluster identified by the IPAP is made up of sectors determined to have the potential to develop in the longer term: nuclear; advanced materials; aerospace and defence; and the electromechanical and ICT sectors.

Sector Focus

While the NIPF and IPAP between them represent the government’s industry-wide policy framework, two segments in particular have been the subjects of a sector-specific strategic approach. The rapid expansion of South Africa’s automotive industry since the introduction of the Motor Industry Development Programme (MIDP) in 1995 is widely regarded as the most successful instance of government intervention in the industrial sector. The programme, which was built around a number of investment incentives and a tariff regime that encouraged exporting activity and reduced the cost of inputs, was replaced in 2013 with the Automotive Production and Development Programme (APDP). The new scheme provides similar tariff and investment incentives, but it incentivises value addition (see analysis), rather than exports. The clothing and textile industry, meanwhile, has been targeted for development by the DTI through its Clothing and Textile and Competitiveness Programme (CTCP) and its core funding mechanism, the Production Incentive. Launched in 2010, the CTCP’s main objective is to support upgrades to processes, products and people, and re-position them for competition at home and abroad.

The success of the government’s sector-specific policy approach has fed back into the planning of its more general industrial strategy. The latest iteration of IPAP sets out the new Manufacturing Competitiveness Enhancement Programme (MCEP), which is in effect a complementary policy designed to generate greater confidence among manufacturers after a period of economic uncertainty. Announced in Finance Minister Pravin Gordhan’s 2012 budget speech, the MCEP incorporates lessons learned in the successful interventions into the automotive and textile sectors, and accounts for a number of measures through which the government hopes to create a more competitive manufacturing environment: finance grants, by which firms can upgrade facilities, processes and people; support for capital investment, working capital and pre-shipment finance, feasibility studies; product development and process improvement; value chain localisation and supplier development; energy efficiency and logistics. As a general principle, the MCEP will exclude sectors already benefitting from dedicated support, such as the automotive industry, as well as capital-intensive sectors. Likewise, firms shown to have a history of anti-competitive behaviour will also be excluded. Elsewhere, it will seek to maximise employment and the value-added potential in strategic sectors set out in the latest IPAP.

Beyond its general strategy and sector-specific policy frameworks, the government has over recent years introduced a wide array of subordinate policy initiatives aimed at incentivising all or parts of the nation’s industrial arena. These include the Capital Project Feasibility Programme (CPFP), Co-Operative Incentive Scheme (CIS), Critical Infrastructure Programme (CIP), Export Marketing and Investment Assistance (EMIA), Incubation Support Programme (ISP), the Isivande Women’s Fund, Section 12I Tax Allowance Incentive (12I TAI), Seda Technology Programme (STP) and Support Programme for Industrial Innovation (SPII).

Primary Industry

As a result of the South African Reserve Bank’s (SARB) methodology of dividing local economic output into primary, secondary and tertiary sectors, South Africa’s industrial arena is often spoken of as possessing a primary tier, made up of agriculture and mining, and a secondary tier comprised of manufacturing, which incorporates a range of activities such as automotive and chemicals.

South Africa’s primary agriculture sector only accounted for 2.2% of GDP in 2012 – but the industry is responsible for around 7% of formal employment and is a significant source of foreign exchange (see Agriculture chapter). Like agriculture, South Africa’s mining industry is a major earner of foreign exchange for the nation, with primary mining exports accounting for 38% of its total merchandise exports in 2011, according to the Chamber of Mines of South Africa. It is also a major driver of job creation, providing 16.2% of the total formal non-agricultural employment, as well as accounting directly for 5.2% of GDP in 2012, according to Statistics South Africa (Stats SA), The industry’s contribution to economic activity is still greater when the supplier and downstream industries are taken into account: using this wider measure the Chamber of Mines estimates that in 2010 mining and quarrying activity helped to generate 18.7% of GDP. While the industry’s direct contribution to GDP has decreased in percentage terms since the 9.7% recorded in 1993, the potential of the sector is underwritten by the nation’s sizable mineral resources (see Mining chapter) MANUFACTURING: According to Stats SA, the second-tier industrial activity of manufacturing comprised 15.4% of GDP in 2012, making it the second-largest single contributor to the national economy, behind finance, real estate and business services. Manufacturing activity also plays an important role in job creation, directly employing around 1.7m people, according to the Manufacturing Circle, an industry body. It is among the top three sectors in terms of value addition, job creation, export earnings and revenue – producing R1.13 ($0.14) of value added for every R1 ($0.12) invested.

Manufacturing quarter-on-quarter % change, 2009-Q3 2012* AUTO: Manufacturing activity encompasses a diverse array of industries. As the principal beneficiary of the government’s sector-specific policy reform, the automotive sector is the largest single source of manufacturing activity, and accounted for 6.8% of GDP in 2011, according to the National Association of Automobile Manufacturers (NAAMSA). Seated in Gauteng, the Eastern Cape and KwaZulu-Natal, the industry has expanded its exports from a negligible amount in 1995/96 to 277,893 units in 2012, while in value terms the nation exported around R4bn ($490m) per year at the start of the programme, compared to R86.9bn ($10.6bn) for 2012. Players that were attracted by the DTI’s regulatory regime to establish operations include BMW, Volkswagen, Ford, Mazda, Mercedes-Benz, Nissan, Renault, Toyota and General Motors. Between them they export to every continent, with the largest market being Germany, followed by the US, Japan, the UK, Algeria, Spain, France, Poland, Austria, Belgium and Zimbabwe.

Manufacturers also cater to the South African consumer. In 2012 an estimated 47.5% of passenger cars and 44.2% of light commercial vehicles were retained for domestic sales. The MIDP, introduced in the mid1990s and credited with turning around what had become a dormant industry, was replaced in January 2013 with the APDP. The new regime offers similar tariff reductions and investment incentives to its predecessor, but with a greater emphasis on in-country value addition rather than the incentivisation of export activity that had characterised the MIDP (see analysis).

Steel

The success of the automotive industry has helped to drive the growth of South Africa’s steel manufacturing. According to the most recent annual rankings from the World Steel Association, South Africa was the world’s 21st largest crude steel producer in 2011, and the approximately 7.5bn tonnes that emerged from its foundries made it the biggest producer in Africa – accounting for 47% of the continent’s output. The sector includes a primary stainless steel producer, ArcelorMittal South Africa, which has plants in four locations, and four carbon steel producers: Cape Gate in Vanderbijlpark, Columbus Stainless in Middelburg and Mpumalanga, Evraz Highveld Steel and Vanadium in Witbank, and Scaw Metals Group in Germiston.

Chemicals

The chemicals industry is the largest and most complex on the continent, incorporating a wide Estimated manufacturing sales by industry, 2012 range of manufacturing activities from fuel processing to plastics fabrication and the production of pharmaceuticals. Between them, petroleum, chemicals and rubber and plastic products contributed R318bn ($38.8bn) to national GDP in 2011 and accounted for around 23% of total manufacturing sales. South Africa’s isolation from global markets during the apartheid era compelled it to seek innovative solutions to meet its energy needs, and the synthetic coal and natural gas-based liquid fuels and petrochemicals processes which developed during this era continue to dominate the sector. The low grade of the nation’s coal, meanwhile, has resulted in it becoming one of the most cost-efficient producers of ethylene and propylene in the world.

A small number of players dominate the primary and secondary segments, including Sasol, AECI and Dow Sentrachem. The plastics segment, however, shows a higher degree of fragmentation due to the relative ease of entry to it. Plastics manufacturing accounted for around 0.6% of GDP in 2011. While the pharmaceuticals market accounted for only 0.35% of GDP in the same year, South Africa’s status as the world’s largest market for anti-retrovirals has resulted in considerable opportunity for domestic and foreign firms. However, despite the significant investment seen in recent years, the nation remains a net importer of chemicals: in 2011 South Africa shipped R37.8bn ($4.6bn) worth of chemical products overseas, while its chemical imports ran to R65.3bn ($8bn). Reducing this imbalance has, therefore, become a government priority, with the issue being addressed both in terms of policy formation and public sector investment (see analysis).

Textiles

South Africa’s textiles and clothing industry accounts for around 14% of manufacturing employment and, according to international credit insurer Coface, is the nation’s second-largest source of tax revenue. Significant industry sub-sectors include apparel textiles, technical and industrial textiles, and home and lifestyle textiles, each utilising a range of product groups, which include fibre, yarn, fabric (knitted, woven and non-woven) and home-made textiles. Government intervention and financial incentivisation of the sector has encouraged some development over recent decades, although the rise of China and India within the global textiles market has resulted in an overall decline in production levels. In 1999, seasonally adjusted real values of combined sales of textiles, knitted or crocheted products and apparel totalled R41.7bn ($5bn), but by 2009 this figure had decreased to less than R34bn ($4.1bn) in real terms, according to Stats SA. Nevertheless, the industry remains an important component of the economy, directly employing around 230,000 people, as well as a further 200,000 in dependent industries, such as transport and packaging, according to South Africa’s Industrial Development Corporation.

In 2002, the National Bargaining Council for the Clothing Manufacturing Industry was established as a forum to reach agreements on increased wages. However, the decisions of the council placed upward pressure on wages just as China was entering the market. As a result, many South African textiles manufacturers have repeatedly failed to comply with the salary levels and often lay off staff when pressured to do so.

Industrial Zones

Industrial activity has traditionally been focused around Johannesburg, the economic centre of the country; Cape Town, the key regional economic hub In the Western Cape; and Durban, the country’s busiest port. More recently, the government has moved to create specialised industrial development zones (IDZs), which are purpose-built for duty-free production of exports. Currently, South Africa has three IDZs, located in Richards Bay, KwaZulu-Natal; East London; and Coega, near Port Elizabeth. A fourth IDZ, near the OR Tambo International Airport in Johannesburg, has yet to be made operational. Established in 2001, between the 2002/3 and the 2010/11 financial years they attracted some R11.8bn ($1.44bn) in investment from 40 financiers, according to the DTI, although their performance is generally viewed as mixed. Inadequate incentives and competition from locations with similar initiatives, like Tanzania, China and Singapore, have subdued investment levels and the departure of some firms that invested during the initial phase of the projects. In response, the government released a draft special economic zone (SEZ) policy and SEZ bill for public comment in early 2012. In the 2013 budget, the government promised to negotiate tax incentives for businesses in the SEZs, as it endeavours to make them a one-stop shop for greenfield investment. Among the incentives discussed are a tax deduction for low-paid workers and an accelerated depreciation allowance for buildings. However, the package of incentives with which the SEZ will be marketed was still a work in progress when OBG went to print in mid-2013.

The new bill reveals a desire to move away from the narrow focus on IDZs and towards the establishment of a more diverse set of SEZs “in accordance with the changing national economic development priorities”. While comprehensive details regarding SEZ incentives have yet to be published, in February 2013 Finance Minister Gordhan indicated that he would authorise tax incentives after consultation in the DTI, while the National Treasury has proposed a 15% corporate tax rate in the new areas. Government support also plays a significant role in creating a favourable environment for industrial activity, not just in the policy initiatives laid out in the IPAP and sector-specific initiatives, but also in terms of financial assistance. The Industrial Development Corporation (IDC), established in 1940, is a state-owned national development financial institution with a mandate to promote entrepreneurship by investing in promising enterprises, either through acquiring equity stakes in projects or via financial grants. For the financial year ending in March 2012, IDC funding activity reached R13.5bn ($1.7bn), a 55% year-on-year increase and the organisation’s highest level of investment in the domestic economy ever. The number of funding approvals for the year rose by 33% to reach 293, and helped to create or sustain around 45,900 jobs.

South Africa has also established a wide array of trade agreements which industrial enterprises operating within its jurisdiction might take advantage of: it is a member of the Southern African Customs Union; it has free trade agreements with the 12-member Southern African Development Community and the EU; and it has preferential trade agreements with the South American Common Market and Zimbabwe.

Key Challenges

The work of the IDC is important in the context of South Africa’s modest provision of financial instruments by the private sector. The nation’s advantages are also limited by other challenges. Cost pushes and rand volatility are a threat to many businesses, particularly those engaging in manufacturing activity. Between 2002 and 2012 the rand grew in value by 23%, while costs, based on the Producer Price Index and electricity tariffs, rose between 81% and 231%, according to the Manufacturing Circle. Over the same period, manufactured imports have soared; imports from China were negligible in 1994, but had expanded to over R100bn ($12.9bn) in 2011. Laurent Langellier, the CEO of Air Liquide, told OBG, “Electricity tariff increases and rising labour and logistics costs are impacting heavily on overall industrial activity.” The labour market, meanwhile, is characterised by low flexibility, with considerable constraints on hiring and firing employees. Wage determination is rigid: despite the instances of multi-year agreements, most wage negotiations take place on an annual basis and occasionally result in work stoppages. In 2012, the mining sector was affected by wildcat strikes and 50 people were killed as a result of strike-related violence.

Outlook

The challenges facing the industrial sector will persist in the medium term. Strikes in both the agricultural and mining sectors occurred in early 2013, and in late 2012 the state electricity provider, Eskom, sought approval for a 16% increase in electricity tariffs for the next five years, from $0.61 per KWh in 2012/13 to $1.28 per KWh in 2017/18. However, industry has shown a considerable resilience in the face of adversity. If the government can create and maintain an environment attractive for private investment, this will underwrite the continued development of the sector.