Challenges to SADC Regional and Global Integration

I was asked recently to give an assessment of progress and possible future directions for economic integration in the Southern Africa Development Community (SADC). The resulting paper and presentation summarize my views on some of the main challenges facing the region.

The Importance of SADC Integration

Trade policy is one of many tools for improving productivity, increasing competitiveness and promoting long-term economic development. It is about far more than tariff negotiations. Similarly, SADC is about much more than implementing and extending the Trade Protocol. Great progress has been made; but much more could be done to achieve more meaningful and productive economic integration—globally and in the region. Despite substantial reform trade in SADC remains costly (see Table 2 of my paper) and continues to be hampered by well-intended initiatives whose unintended negative consequences for the region’s development are insufficiently appreciated.

SADC is economically small; for most internationally traded goods regional markets are too small and fragmented to provide a base for globally competitive operations. To focus primarily on products in which firms rely on protection to compete locally and regionally is of limited value and often harmful. The focus must be on creating an environment in which investors can think about competing internationally. When this happens, SADC growth will accelerate and the SADC market will eventually merit real attention. But growth based on global markets must be the primary concern.

SADC is also geographically large, and the resulting hard and soft logistical infrastructure challenges are among the main constraints to effective global integration of the region.

A SADC Customs Union?

Early plans called for formation of a SADC customs union by 2010. This deadline will not be met. A SADC customs union could reduce the need for intra-regional border controls, especially those related to enforcing rules of origin. Against this, however, must be weighed several considerations.

1. Rules of origin are not the only barriers to regional integration in SADC. Dealing with the other barriers is of great economic importance; and many of them can be dealt with independently of a customs union.

2. Based on experience to date, a number of countries are simply not ready for a customs union, or even for complete intra-SADC free trade. A customs union in which members insist on restricting intra-regional trade for economic development purposes would be futile, as would a union in which poorer countries are too dependent on customs revenue to contemplate reducing import duty rates. There are even more basic issues such as rules and guarantees on transit trade that can and should be dealt with long before a customs union or even completion of the SADC FTA.

3. A customs union requires agreement on overall tariff policy—not only on common external tariffs but also on future preferential and MFN-based tariff negotiations as well as antidumping, safeguards and other contingent protection. Member States are far from united on these questions. Mauritius plans to eliminate all MFN import duties and become a duty-free island. South Africa, on the other hand, sees import tariffs as a key tool of industrial policy. Agreement on a common tariff would require either undoing substantial reforms that have already taken place in some countries, or forcing others to move more swiftly on MFN tariff reform than they are prepared to do.

4. Differences in approach to trade and economic development policy might make it difficult and maybe even inadvisable to move too quickly towards a SADC customs union. Allowing for different approaches permits countries to experiment and to learn by themselves and from other SADC partners. A “lowest common denominator” approach, which might result from moving in unison towards a customs union now, could hold back more progressive and ambitious countries. Countries like Mauritius can “raise the bar” for all SADC Member States in setting targets for tariff, trade and industrial policies.

Is SACU a Model?

As the oldest customs union in the world, and one that includes five SADC Member States, the Southern Africa Customs Union (SACU) might be thought of as a model for a SADC customs union. However,

1. In some respects SACU is a customs union more in name than in fact. Use of the infant industry protection clause, for instance, has resulted in significant intra-SACU trade barriers aimed at achieving industrial policy goals of questionable value. All intra-SACU imports are subject to complete customs control by each country, with intra-SACU trade being subject to inspection and documentation on each side of all borders.

2. The current SACU Agreement calls for joint decision-making on all MFN tariff decisions. Until now no SACU wide tariff body has been set up, and South Africa continues as de facto arbiter on tariff policy. The Economic Partnership Agreement (EPA) negotiations with the EU revealed potentially serious differences among SACU members.

3. The SACU revenue sharing formula is viewed by poorer SADC Member States as a potential model for a SADC. This is primarily because it allocates a disproportionate share of customs revenues to the four smallest members. This is not replicable on a SADC-wide basis, nor should it even be thought of as a possible model.

There certainly are lessons to be learned from SACU. But it is unlikely to be an appropriate starting point or model for a SADC customs union, at least in its present form.

Monitoring SADC Performance

The approach to monitoring progress in SADC so far has been largely “legalistic”—focusing on intra-SADC trade and the extent to which countries are meeting agreed liberalization commitments. This is important. But it is also critical not to lose sight of the broader purpose of SADC integration—it is part of a much larger project to improve productivity and competitiveness of SADC Member States so that they can integrate more effectively into the global economy.

Why not complement existing monitoring efforts with a new and possibly much less “coercive” attempt to monitor progress in improving international competitiveness? Benchmarking success stories and identifying ways in which they can be extended and generalized could be very useful to all Member States.

At the risk of oversimplification, SADC appears to operate now at two different levels. At one level it is dominated by high level political visionaries guided by dreams of and plans for developing a greater southern Africa and ultimately a more unified and successful African continent. On a day-to-day basis, however, it is dominated by trade negotiators, who see “concessions” on the use of tariffs, non-tariff barriers (NTBs) and other economic instruments as a surrender of sovereignty. They tend to view their main goal as to achieve openings in external markets. They do not see trade liberalization as part of a strategy to promote economic development by improving global competitiveness.

This is not uncommon. Trade negotiations are often driven by a mercantilist fiction, that imports are an evil to be avoided and that trade is a zero sum game.

In fact most of what trade negotiators deal in are issues that can best be resolved through domestic, unilateral trade policy reform. Most of what is needed to improve any country’s business environment and international competitiveness can be done at home. It does not have to be “negotiated” with other countries.

Of course, pursuing domestic reform through international negotiations can help overcome domestic resistance by using the fiction that reform is part of the price to pay for obtaining similar “concessions” by foreign partners. However, negotiators need to see through this fiction and recognize domestic reform as a means of enhancing development through improved competitiveness.

Unfortunately, negotiators more often see themselves as representatives of domestic interests that might be negatively affected by trade reform; they see their main “stakeholders” as existing investors and producers that benefit from current trade restrictions, and not those that compete in world markets or future investors, producers, workers and consumers that will benefit from improvements in the business environment arising from trade reform.

This might be changed by some broadening of the focus of SADC itself—working together not so much to promote trade reform and trade negotiations as goals in themselves, but rather to identify and deal with the real constraints to growth. This does not necessarily require all Members to move at the same pace. Countries that wish to fast track certain reforms can do so, and in the process provide valuable information and maybe even a model to partner countries. Some issues will be more important and/or more amenable to change in some countries than in others.

This is not to denigrate past accomplishments or ongoing initiatives. It is to suggest, rather, the value of complementing past successes with a greater emphasis on monitoring and improving competitiveness in the region. A first step might be to complement annual trade audits and ongoing NTB monitoring with annual competitiveness audits. The purpose would not be to “name and shame” individual countries or to enforce negotiated agreements, but rather to highlight lessons that can be utilized by any Member and to identify areas and mechanisms for independent action and regional cooperation for the mutual benefit of the citizens of all Member States.

Follow the Money

This strays a bit from my usual range of economics issues. But it certainly is about following the money.

Thailand's fugitive former PM Thaksin recently hired a Canadian lawyer, Robert Amsterdam, who flew over to Bangkok last week to visit the red-shirt leaders. CNN obliged by giving him an incredibly soft interview and international sound bite on his client's behalf. Much better was an interview he did with an Al-Jazeera reporter from Kuala Lumpur. She asked some good questions and he sidestepped almost all of them.

Amsterdam seems to have quite an international reputation. He has been written up in recent articles in a Bucharest magazine and Belgrade newspaper of all places.

Canada's Globe and Mail also did an interview with him last week. See the article and some interesting comments.

Making a Mockery of Competitiveness

One of the few genuine innovations in South Africa's APDP, the motor industry support program that will replace the MIDP, is a requirement of a minimum scale of operations in order to qualify for the program's very generous financial benefits. Although the details of the program still have not been gazetted, we understand that in order to qualify vehicle assemblers will have to produce a minimum of 50,000 vehicles per year. The idea is to encourage international competitiveness by achieving some economies of scale in production.

The scheme does raise some questions.

1. Why is it necessary for the government to instruct global auto firms on efficient scales of production? (It is not; but under MIDP and APDP it is not necessary to be competitive in order to make big profits by producing in South Africa.)

2. Will production of 50,000 vehicles per year provide sufficient scale to compete with true international major league plants? (Generally not; competitive plants elsewhere produce at least 100,000 per year.)

3. And of course one might wonder how firms will try to get around the new requirement in order to continue to take advantage of the large subsidies made available by the government (and paid for through the "generosity" of South African vehicle consumers and taxpayers) without ramping up production.

But at least the new requirement appears to be a feint in the direction of encouraging some competitiveness on the part of the local industry.

An announcement by the government-operated East London Industrial Development Zone (ELIDZ) provides an answer to the third question. ELIDZ has told the press that it will soon announce the signing of several tenants in a new "multi-OEM assembly plant" it will build in the zone. What is the purpose of such a plant? To enable companies sharing the facility to produce at volumes of 10,000 vehicles per year, or even as low as just a few thousand and still qualify for the APDP benefits that are contingent on meeting the 50,000 per year volume target. It apparently will "work" as long as the total of all vehicles produced by all tenants reaches 50,000 per year.

How will this encourage increased competitiveness, the stated goal of the new policy? It will not. In fact it will simply replicate the highly inefficient pattern of small scale production of multiple models and other automotive products under one roof that was encouraged by protection in pre-MIDP days and by continued protection and MIDP benefits since then.

Another Industrial Policy "Success" Story

Volkswagen South Africa (VWSA) has won a contract worth about R30 billion to export South African-made VW Polos over the next 6 years. The company's Managing Director, David Powels, says that 685 new jobs will created. This will be viewed in many quarters as an early success of the latest incarnation of South African government support for the motor industry (APDP, formerly known as MIDP).

Powels has been reported separately as saying that producing cars in SA is up to 40 percent more costly than in competitor locations in Asia and Europe. If that is the case, how did VWSA win this contract? The answer -- subsidies under MIDP, APDP and other government programs are expected to compensate for this cost differential.

Suppose that the cars to be exported under the contract are only 35 percent more costly to produce than in the next best location. If this is so, VWSA must be counting on government subsidies of at least R10.5 billion (35 percent of R30 billion, the value of the contract). Otherwise it would make no sense for VW to source the vehicles in South Africa.

What is the size of the subsidy per job? Based on the VWSA estimate of 685 new jobs, the expected subsidy is R15.3 million per job over the 6 years of the contract, or R2.55 million per job per year. This is 25 times higher than the average annual wage in manufacturing in South Africa (about R100,000). Quite a success!!

More Protection for the SA Clothing Industry?

Following a request from SACTWU, the Clothing and Textile Workers Union, South Africa’s International Trade Administration Commission (ITAC) has reviewed the import duties on garments. Its report concludes that the duty should be increased from 40 to 45 percent, the maximum allowed under SA’s WTO commitments. For several items the current duty is only 20 percent, and yet they would still get the new 45 percent rate. The recommendation covers virtually all clothing used by South Africans from socks and underwear to shirts, jackets, suits, pants and skirts; for men, women, girls, boys and babies.

This follows another recent recommendation and government agreement to reduce the duties on a wide range of imported fabrics from 22 percent to zero.

ITAC argues that these measures will “provide significant encouragement and support to the industry while its extensive efforts to restructure to become more competitive are continuing;” and they will have little inflationary impact.

ITAC does not show its estimates of the amount of support this will provide. My own calculations show that before any of the recent recommendations, i.e. with tariff rates of 40 percent on clothing and 22 percent on most fabrics, SA garment producers were being subsidized at a rate of about 94 percent of value added. In non-technical terms, this means that the tariff structure allowed them to produce garments at a cost 94 percent higher than foreign competitors and still compete in the local market. This is a very high level of support, higher than in just about any other industry in South Africa.

Under the proposed new measures, the subsidy will increase to 114 percent for garment producers that are still subject to the 22 percent fabric tariff. And for those that are able to take advantage of the new rebate that lowers the fabric tariff to zero, the subsidy will be 180 percent. They will be able to produce at almost three times the cost of foreign competitors and still be able to “compete” in the domestic market.

Does this encourage restructuring and increased competitiveness? No, it subsidizes high cost producers, and enables them to survive despite much higher costs than international competitors, with no need to adjust or to improve their competitiveness.

On top of this, the government is mulling even further subsidies to the industry. No details have been made available, but under proposals that have been mentioned publicly I estimate that the rate of subsidy could be over 300 percent.

It is difficult to imagine how firms that require this kind of support could be transformed into internationally competitive producers.

What, then, is the real goal of government support? It seems to be to protect vulnerable and/or a privileged subset of the country’s workers. But is subsidizing continued production and further investments in training and equipment to sustain existing jobs in non-competitive firms or industries the best way to do this? The cost is high. Clothing and footwear account for 5 percent of consumer expenditures in South Africa. For lower income households the percentage is much higher. A 40 or 45 percent tax on such a basic consumer good is a cruel and regressive tax indeed. While an increase in the tariff might provide further short-term relief for garment workers, it will be at the much greater expense of all workers and consumers in the country, and especially the poor.

A government official recently told me that one of the main problems with the SA garment industry is that the equipment is very old. The unwillingness of firms to invest in upgrading this equipment, despite current high levels of protection, would be a rational response to their view that much of the industry will never be able to compete.

I asked about the age of workers in these factories. The answer: “about the same as the equipment.” This might also reflect a rational response by young workers who see no future in this industry. It also reduces the costs of any necessary adjustment if industrial support is gradually withdrawn. An increase in support might not only impose higher immediate costs on taxpayers and consumers, but might draw new workers into the industry and increase future adjustment costs.

What is the bottom line? The government needs to move out of the box that views subsidies to non-competitive producers and industries as the best way to help the country’s workers, taxpayers and consumers. Let's deal directly with what is essentially a social welfare problem – assisting workers in declining firms – and free the government to think more creatively about an industrial strategy that points to the future rather than the past.

Health for Empowerment and Growth

Promoting empowerment of disadvantaged groups through incentives to broaden ownership of capital has had mixed results in terms of social justice and long-term growth. Experience in Malaysia and South Africa for instance shows that such schemes have certainly enhanced the wealth of a select few of the “previously disadvantaged.” But broader trickle-down effects to the poor have been much harder to find. And the costs have been high, with serious questions about the extent to which they might have impeded longer-term productivity growth as a result of implicit taxes on wealth and creation of a rent-seeking business society. As a result, there is growing pressure in Malaysia to abandon the “bumiputra” policy. Some of the loudest voices belong to those who were supposed to be the beneficiaries of the program.

These countries should take note of some new research findings from the US. A recent report by Chay, Guryan and Mazumder shows the startling and large effects of improvements in basic health care for black infants in the 1960s arising from hospital integration. They show that better infant health care explains substantial improvements in educational achievement, independently of other causes such as school integration and changes in family backgrounds.

The lesson for countries like Malaysia and South Africa is clear. If you want to promote empowerment of disadvantaged groups, use basic health and education to tackle the root causes of inequality and the real barriers to economic opportunity. The resulting improvements in human capabilities will pay additional dividends in the form of higher long-term productivity growth as well.

A "New" Program of Auto Industry Support

It's been a long time coming. But in early September the dti finally announced the general architecture of its revised MIDP, now called the Automotive Production and Development Program (APDP). The official announcement is sketchy. Public support of the industry will be extended until at least 2020; the program will be "production neutral" (i.e. it will subsidize both exports and production for the local market) and so will be more WTO-compatible. 

Other than that, the details, magnitude and impacts of the program will be very difficult for most observers to fathom. Two major studies commissioned during the three-year review process have not been released for Parliamentary or public scrutiny. The Industrial Development Corporation (IDC) conducted a "cost-benefit analysis" of the proposals for the dti, but that is also being kept under wraps.

Of course there will be few mysteries or surprises for the motor industry. The program was designed in close consultation with them by two teams of dti consultants and by the dti itself. This is what the dti calls "stakeholder consultations." But what about other important stakeholders -- Parliament and the consumers and taxpayers they represent, and who ultimately pay for these and other industry support programs?

Broader stakeholder discussion and understanding require much wider dissemination of information and analysis. Justin Barnes and Anthony Black, who have been involved with the MIDP since its beginning, shed some light on the thinking behind the new program in an opinion piece. 

This was the cue for a short article of my own, in which I draw out some implications of their observations and fill in a few blanks with my own estimates of the costs and magnitude of the subsidies provided under both the old and the new programs. The costs have been and almost certainly will continue to be high; catalytic converters -- canned platinum -- have received as much export support as automobiles; despite an apparent decrease in some of the rates, overall rates of subsidy for both exports and locally sold production will increase rather than decrease under the new program; the new incentives are likely to create a barrier to entry for new producers.

At least some of these consequences are unintended. But whether intended or unintended, appreciated or not appreciated, they are certainly not what has been advertised by industry advocates. 

When policy design and assessments are done behind closed doors, in consultation primarily with only the direct beneficiaries of the programs, questions are bound to be raised. From the information available in this case it appears either that the industry is uncompetitive and is unlikely to become so, at least for a very long time; and/or that consumers and taxpayers are being taken for a ride by giving unnecessary subsidies. In either case the argument for continued support appears to rest on very weak foundations.

A box in a recent OECD report on South Africa singles out the dti's support of the motor industry to illustrate the dangers of the "capture" of policy makers in the design and implementation of industry-specific industrial policy programs.

This is not to deny the role or importance of industrial policy. But industrial policy needs to be based not just on the influence of powerful industry lobby groups or on the inclinations or dreams of policy makers; it needs to be based on sound economic analysis. To avoid the dangers of capture, it also requires institutions and processes that are transparent and accountable. Policy reviews need to be made public; alternatives need to be presented and properly assessed in terms of their overall economic impacts. And industrial policy needs to be based on a recognition of the capabilities of the policy-making authorities to do the ongoing monitoring and assessment that are represented as a key part of the dti's own Industrial Policy Action Plan.

Unsafe at any Speed: MIDP and SACU

In three articles headed the wheels may come off South Africa's Mail and Guardian draws on a recent paper by Matthew Stern and myself to explain problems with customs revenue sharing in the Southern Africa Customs Union (SACU).

The articles cleverly explore the links between SACU's new revenue sharing formula, South Africa's Motor Industry Development Program (MIDP) and the recent boom in car sales in South Africa, to illustrate how the new formula turns all previous interests in SACU trade policy on their heads. By fattening the government budgets of the four small and less developed SACU members (Botswana, Lesotho, Namibia and Swaziland—the "BLNS countries" in SACU-speak) the formula has turned these countries into avid supporters of a program designed to subsidize South African motor industry producers at the expense of South African and BLNS consumers. The cost of the program to BLNS consumers is now dwarfed by the (far more than) offsetting revenue transfers to BLNS governments (to the tune of 23 percent of GDP in the case of Lesotho and 12 percent in Swaziland). And now poor South African consumers/taxpayers are saddled not only with high priced motor vehicles but also with the burden of huge fiscal transfers to the BLNS.

South Africa's National Treasury, quite naturally, is bemoaning not only the size of the revenue transfers, but also the difficulties they will create in reaching agreement on badly needed rationalization of the SACU tariff structure. Under the new SACU arrangement, tariff rate decisions are meant to be decided collectively by all members. Having been turned into the greatest supporters of South Africa's protectionist trade policies, the BLNS countries are unlikely to favour tariff reductions that threaten their fiscal windfalls. Before complaining too much, however, South Africa should look at its own central role in promoting agreement on this new revenue formula.

Among the cutest parts of the M&G articles is an illustrative calculation of the amount of revenues transferred to the BLNS whenever a South African buys a new imported car. Based on an import duty rate of 25 percent and an assumed transfer of about half of these revenues to the BLNS, the article shows that the purchaser of a new "Volvaru" that cost a dealer R200 000 would pay just over R25 000 to the BLNS, of which about R5 000 would go to the government of Swaziland and R4 100 to Lesotho.

In fact the numbers are much worse than that. The import duty on cars is now 30 percent, not 25 percent. And, according to our estimates of last year, the share of duty collections going to the BLNS is about 88 percent, not 50 percent. This means that a South African buyer of the above-mentioned "Volvaru" would contribute about R52 000 to the BLNS, of which over R11 000 would go to Swaziland and R7 400 to Lesotho (and greater amounts to the governments of Botswana and Namibia).

This tale leaves South African consumers and taxpayers with much to ponder. The consequences of the MIDP and of the new SACU arrangement are surely much different than whatever might have been expected by those who designed them; and their combined impact is far worse than either of them individually. Two bad policies do not make a good one.

South Africa's MIDP

South Africa's Motor Industry Development Program (MIDP) has been one of my favorite topics recently. The Department of Trade and Industry (DTI) and the motor industry have been remarkably quiet as the country awaits the release of the MIDP Review (due sometime last year) and the government's future policy framework for this industry.

However, an industry representative was reported yesterday as saying that government support of the industry is "below par" relative to other countries and will have to be improved in order to make the industry competitive.

How much support has the MIDP given the industry? Answers to this basic question are difficult to obtain. I have estimated that typical subsidies to motor vehicle and/or components manufacturers range from 260 to over 650 percent of the size of MIDP-supported investments.

Support to the motor industry from export subsidies and import duties has almost certainly exceeded R100 billion over the life of the program so far. The cost to consumers has been similar. How can an industry that relies on such levels of support expect to become "competitive"? Surely the solution is not to give even more subsidies.

Australia, after whose program the MIDP was initially modelled, is entering the final phase of its "Automotive Competitivness and Investment Scheme." This program provides modest production and investment-linked subsidies and a phase down of its import tariff from 10 percent at the moment to 5 percent in 2010. The South African tariff is still 30 percent—a long way to go before encouraging competitiveness.

For more on this, including a link to the news story in question, see the Features page of my website.