South Africa's industrial strategy helps the sector retain momentum

Among the manufacturing powerhouses of the continent, South Africa has a strong industrial tradition dating back 150 years. The past few decades have been difficult, with external and domestic factors weighing on the sector, but the government and industry leaders have been working to stoke growth and develop value-added industries. In doing so they can capitalise on the country’s industrial base, ample natural resources and rising position as an exporter to the fast-growing markets of Africa and Asia.

Major Contributor

Manufacturing makes up around 13% to South Africa’s GDP, according to Bloomberg, making it a vital driver of growth. It is also a major contributor to export and foreign currency earnings. Total manufacturing industry sales reached R1.8trn ($155.5bn) in 2014, according to Statistics South Africa. Overall manufacturing production grew 5.6% in the year to July 2015, the last period for which statistics were available at the time of research, according to a statistical release from Statistics South Africa in September 2015. This increase came despite a range of economic, political and social challenges faced by the sector over this time.

The single largest contributor to overall manufacturing growth was the metal and machinery segment, which rose by 17.4% year-on-year (y-o-y) and adding 2.9 percentage points to overall manufacturing production. The automotive and transport equipment segment increased even faster, surging 39.6% between July 2014 and July 2015, adding 2.6 percentage points. The figures achieved through July 2015 give some hope of a sector-wide recovery. Growth of manufacturing production has slowed y-o-y over the past half-decade, from 4.6% in 2010 to 2.8% in 2011, 2.2% in 2012, 1.3% in 2013, and just 0.1% in 2014.

Sector Breakdown

According to the current weighting used by Statistics South Africa, the single biggest segment of the manufacturing sector is food and beverage, contributing 24.44% to the total has production volume. It is followed by petroleum, chemical products, rubber and plastic products (22.13%); basic iron and steel, non-ferrous metal products, metal products and machinery (19.59%); wood and wood products, paper, publishing and printing (12.65%); motor vehicles, parts, accessories and other transport equipment (7.39%); glass and non-metallic mineral products (3.91%); furniture and other manufacturing (3.61%); textiles, clothing, leather and footwear (3.17%); electrical machinery (1.70%); and radio, television, and other communications apparatuses and professional equipment (1.41%).

Changing Dynamics

Historically, South Africa developed a strong manufacturing sector by capitalising on low-cost labour and strong technical education (at least for a minority of the population), supported by tariffs on imports. Until the end of the apartheid regime in 1994, the sector was dominated by a few large conglomerates and state-owned enterprises. Mining and infrastructure projects were a major focus, driving demand for construction materials and engineering. Mining in turn fed back into manufacturing through providing inputs. However, the apartheid regime failed to diversify manufacturing, a legacy which continues to have an impact today.

Parts of the manufacturing sector are highly geared to commodity inputs, with low value-added. However, other segments, including automotive, have flourished and become among the more productive and dynamic in the world, helping ease the effect of commodity price volatility on the broader economy.

Trade

South Africa’s traditional trading partners have been in Europe and North America. However, in recent years, Africa and Asia have become important destinations for South African products, as these’ economies have grown and trade ties have been strengthened. In the first eight months of 2015, South Africa exported goods worth R198.9bn ($17.2bn) to Asia, R197.1bn ($17bn) to Africa, R158.5bn ($13.7bn) to Europe, and R65.8bn ($5.7bn) to the Americas, according to the South African Revenue Service.

Emerging Destinations

Emerging markets have been on the rise at a time when developed countries have experienced sluggish growth or recession, and when South Africa has suffered shocks both to demand and the supply side. “The significant downward pressure on the manufacturing sector has been somewhat offset by the fact that our exports to Africa are rising quite significantly,” Garth Strachan, deputy director-general for industrial development policy at the Department of Trade and Industry (DTI), told OBG. “This is especially true for household consumables and agro-processing products as South African retailers have moved very significantly into sub-Saharan African destinations.” Strachan acknowledges that there are still strategic barriers to greater penetration of South African exporters in the rest of the continent, including infrastructure and trade barriers, but that these are easing over time.

Strachan, as well as others in the public and private sector, place considerable stock in the Tripartite Free Trade Agreement (TFTA) signed on June 10, 2015. This brought together three existing trade partnerships – the East African Community, the Southern African Development Community (SADC, of which South Africa is a member), and the Common Market for Eastern and Southern Africa – theoretically creating a trade bloc with a population larger than either the EU or the North American Free Trade Agreement.

The 26 potential signatory states of the TFTA have a combined population of more than 600m and account for 58% of the continent’s GDP, according to international press reports. Strachan said the TFTA presents “enormous opportunities” for industries, and a chance for some African countries to break out of the “resource curse” by developing downstream manufacturing, while admitting that barriers remain. He said that, over the longer term, the TFTA could expand to include other African countries, as well.

However, the implementation of the TFTA is expected to take time, given the need for its ratification by national parliaments, and African countries’ historic support for domestic industry over free trade. Currently, only 10% of South Africa’s trade is within the continent, compared to around 60% in Europe and Asia. Nonetheless, the consensus is that Africa is likely to become a more important market for South African manufacturers in the future.

“Our established export markets in the US and eurozone remain important as they are long-standing relationships that come with technology and knowledge transfer and offer markets that are not without further possibilities,” Coenraad Bezuidenhout, executive-director of Manufacturing Circle, an industry association, told OBG. “However, Africa is where most opportunities lie, thanks to demographic pay-offs, technological innovations and energy developments.”

Government Policy

In 2007 the government launched its first Industrial Policy Action Plan (IPAP). This was an important moment for the sector, indicating a new willingness in the government to drive industrial development forward, partly though interventions. Nimrod Zalk, industrial development policy and strategy advisor at the DTI, argued at a conference in 2014 that this helped the sector to ride out the global financial crisis that hit the following year. The IPAP is reviewed and updated on an annual basis.

The government sees manufacturing, including heavy industry, as central to creating jobs in a country in which the official unemployment rate is around 25% and the population is increasing at a rate of 1.3% a year, according to the World Bank. Industrial growth also has benefits elsewhere in the economy, from primary extractive industries which produce inputs for manufacturers, to retailers – in recent years, South African retailers have flourished around Africa, taking affordable domestically produced fast-moving consumer goods (FMCGs) with them.

In recent years, the government has emphasised orienting exports towards the fast-growing economies of sub-Saharan Africa, where South Africa has the advantages of geography and trade agreements. As in many middle-income emerging markets, adding value to manufacturing exports is also a priority.

Growth Drivers

Strachan identified five key drivers of industrial growth on which the DTI is focusing in 2015: first, supply-side moves to support sectors and companies that can compete in foreign markets; second, developing public procurement policies that support local manufacturers, but with conditionality to ensure that quality is not compromised; third, working with other departments to continue the development of infrastructure to support economic growth, including ports and railways; fourth, development of maritime industries – from offshore oil and gas to aquaculture; and finally, better use of South Africa’s mineral wealth in manufacturing, including improved utilisation of resources like iron ore.

The government’s industrial approach is not universally praised. While the DTI is seen as supportive to the sector, alignment between different industrial and national development policies is not always as close as might be hoped. Some critics think the government’s interventions in favour of certain sectors are not as effective as a broader strategy. Implementation of policies can be patchy, while some well-meaning legislation, including in the domain of labour relations, has proven counter-productive by hampering growth of a sector that can provide jobs and generate revenue for social development.

Recent Performance

The first half of 2015, like much of 2014, was a difficult period for many manufacturers in South Africa, reflecting an overall slump in business confidence. However, there are some industries bucking the trend, including automotives and FMCGs, and the sense remains that the South African industrial sector has a number of underlying strengths that can be expected to reassert themselves in the medium to long term.

A number of factors have been affecting the sector, including the volatility of the rand, difficulties with electricity supply, labour relations and industrial action, and lower commodity prices. In its Manufacturing Bulletin quarterly review for the second quarter of 2015, Manufacturing Circle reported that its members cited a range of challenges weighing on their performance, including high labour costs, skills gaps, and shortages of raw material. Some 73% of manufacturers surveyed by the organisation said that business conditions were either fragile or poor, up from 67% who gave those responses a year earlier.

With pressure on margins from cost increases and sluggish growth, many manufacturers have been looking to reduce costs, including on labour, energy usage and inputs, and while this has been something of a shock for some firms after years of leveraging low energy and labour costs, operations as a whole are becoming leaner and more efficient, making firms better suited to competition on the global market.

Challenges

The manufacturing sector’s performance has been closely linked to that of the broader economy for several decades, Bezuidenhout told OBG. This has been the case for the sector’s recovery since the 2008 global financial crisis, with GDP growth of around 2-2.5% a year allowing manufacturers to maintain capacity and continue investing to improve competitiveness, without providing the impetus needed for strong expansion of industry.

Labour

Labour issues are a particularly tricky stumbling block. The five-month stoppage of platinum mines in 2014 bit both manufacturing supply, and demand as the real economy took a substantial hit from the loss of mining revenues. The situation was exacerbated by a four-week strike in the metals and engineering industries. Bezuidenhout warns that further strikes in 2015 are not out of the question, and that they often start in upstream segments before spreading to manufacturing.

Solving South Africa’s labour problems is likely to prove difficult. The country has a robust history of labour participation, in part as a corrective following decades of disempowerment of workers under apartheid. Unions, including the Congress of South African Trade Unions, an umbrella of several large unions across a number of sectors, have a strong voice in the current government, with a long history of working alongside the African National Congress (ANC) as part of the ruling coalition.

There are a number of existing tools used to encourage dialogue between labour, business and the government, such as National Economic Development and Labour Council, but their impact thus far has been muted. As a result, strikes are a common occurrence. Not all industrial action is on the same level as the 2012 Marikana strikes that resulted in violence and a number of deaths, As of mid-2015, reforms were on the drawing board that would somewhat curb industrial action through audited strike balloting and tighter law enforcement on strikes, which were viewed unfavourably by unions. Meanwhile, minimum wage increases that could feasibly be used as a bargaining counter were opposed by business.

Infrastructure

The second issue is the supply of energy and water, which has become less consistent in recent years as infrastructure has come under pressure. While these shortages are far more modest than those seen in some other African countries, they have had an impact on industry. “Stage 3” outages, when “load shedding” of up to 3000 MW occurs, became all too frequent in early 2015, coming at a time when industry was looking to recover from the effects of the strikes. Aside from the immediate impact of having power shut off, much heavy industrial equipment, such as smelters and furnaces, works less efficiently when switched on and off regularly.

Pressure on power and water supply is already easing, with new supply coming on-stream, including the Avon and Dedisa independent power producer peaking projects, the Ingula pumped storage scheme and the first unit of the Medupi Power Station. Moves are also under way to improve the capacity of the state power company, Eskom, while series of renewable independent power projects should supply needs (see Energy chapter). However, it will take a year or two before the changes are felt.

Currency Concerns

Another issue affecting manufacturing has been the fall in global commodity prices caused by oversupply and softening demand. The mining industry is an important customer for heavy industries and capital goods manufacturers. This has been one of the factors behind the slump in the steel industry, for example. The slide in the value of the rand has had a mixed effect on manufacturing. In late September 2015, the currency dropped to all-time lows against the dollar and euro, decreasing a total of 18% against the greenback from the beginning of the year, and continuing a steady fall that has lasted several years. Causes of the slide include South Africa’s domestic weaknesses outlined above, as well as global factors including the strengthening dollar, the recovery of the euro, and concerns about emerging markets and particularly China.

The weakness of the rand theoretically helps boost South Africa’s export competitiveness, as well as improving domestic manufacturers’ competitiveness on the local market, as prices of imported goods have risen. However, only certain sectors have been able to benefit. Some firms have been less able to take advantage of their edge, as the rand’s fall has made investment in capacity (often including the import of capital goods) less attractive. A stable exchange rate would make the country more appealing to investors.

Productivity

According to reports collated by the University of South Africa in early 2014, output per worker per unit of capital in South Africa has declined from R7297 ($630) to R4924 ($425) a year since 1967, a drop of 32.5%. Productivity peaked in 1993, and has since fallen by 41.2%, to its lowest level in 46 years.

Bongani Coka, CEO of Productivity SA, an organisation linked to the Ministry of Labour that works to promote the country’s productive capacity, told OBG he identifies four overlapping factors that constrain productivity in South Africa: labour relations, education, communication, and remuneration. The first comprises an “adversarial relationship between management and labour”, as evidenced by the World Economic Forum’s (WEF) 2014-15 “Global Competitiveness Report”, which ranks South Africa 144th out of 144 countries on employer-labour cooperation. The Commission for Conciliation, Mediation and Arbitration states that referrals have risen by 25% in the last five years. That the ANC government includes communists and is linked to militant trade unions is one source of friction. On the other hand, many feel that companies that flourished under apartheid, and employers as a whole, have a role to play in promoting social justice through better conditions and wages.

Productivity SA’s observations on communication and remuneration feed into this. It argues that a disconnect between management and employees on goals, vision and ethos is detrimental to relations. The link between poor pay and lack of financial incentives is an obvious one, with the country ranked 136th in terms of pay and productivity in the WEF report. Finally, poor educational standards have ramifications for the workforce and labour relations. South Africa ranked 140th out of 144 countries for the quality of its education system, with both the poor quality of teaching and a disconnected attitude of pupils cited as reasons. However, human resource shortages could be reduced in the short term if the visa regime were less restrictive. While companies are able to bring in expatriate workers, it is challenging, and obtaining visas for family members can be problematic.

As Coka points out, productivity is not about working harder, but working smarter, including production of higher-value products. Promoting productivity can be achieved by cultivating innovation, opening industries to greater competition, strengthening quality, developing a supportive policy environment and attracting foreign talent. South Africa is making some progress in all these areas, but there is still work to do.

Steel 

Steel production accounts for 4.7% of South African manufacturing output, according to international press reports. The industry is seen as an important bellwether of the broader manufacturing sector, as it feeds into other major segments including automotive and white goods production.

Steel production fell 9.4% in the first quarter of 2015 to 1.6m tonnes, according to the World Steel Association (WSA). The drop was due partly to supply-side shocks, particularly electricity disruptions, but sluggish demand was a major factor. Bold public infrastructure projects took longer than expected to implement, depressing the market. Capacity utilisation stood at 85% as of mid-2015, below benchmark.

According to Kaizer Nyatsumba, CEO of the Steel and Engineering Industries Federation of South Africa. The country exports around 50% of its steel, of which two-thirds goes to Africa. As with other sectors, steelmakers could benefit from growing demand across Africa, particularly if the domestic market remains sluggish. The World Steel Association (WSA) forecasts that steel consumption in Africa will rise 7.4% to 40m tonnes in 2015, having grown 4.2% in 2014 – already a healthy rate. The continent’s demand looks set to continue to outstrip that of the global average, with the WSA forecasting an increase of 0.5% in 2015 and 1.4% in 2015.

“Africa is a ray of sunshine for us,” said Nyatsumba. “There are many places where there is enormous scope for infrastructure development and which are growing at much higher rates than South Africa.”

Outlook

The manufacturing sector has had a difficult few years, but by autumn 2015, some of these were easing, with industrial action coming to an end and new power and water infrastructure coming on-stream. Structural issues remain in labour legislation and education, which will take time to address, but the government’s industrial strategy has helped the sector maintain momentum. Incentives and cooperation with investors have offset downside risks to a degree. Over the longer term, manufacturers can look to the future with more confidence, particularly from the rise of Africa to support higher sales.