Economic transformation, inclusive growth, and competitiveness:

Towards an Economic Strategy for South Africa

Prepared by Economic Policy, National Treasury

Abstract: The combination of low growth and rising unemployment means that South Africa’s economic trajectory is unsustainable. Government should implement a series of growth reforms that promote economic transformation, support labour-intensive growth, and create a globally competitive economy. We start by highlighting five fundamental building blocks of sustainable long-run growth and then identify a series of specific and detailed reforms to raise potential growth. These growth reforms are organized according to the following themes: (i) modernizing network industries; (ii) lowering barriers to entry and addressing distorted patterns of ownership through increased competition and small business growth; (iii) prioritizing labour-intensive growth in sectors such as agriculture and services, including tourism; (iv) implementing focused and flexible industrial and trade policy; and (v) promoting export competitiveness and harnessing regional growth opportunities. We estimate the economy-wide impact of the proposed interventions over time based on when they can realistically be implemented, and find they can raise potential growth by 2–3 percentage points and create over one million job opportunities. 1

Contents

Executive summary 3 i. Modernizing network industries to promote competitiveness and inclusive growth 3 ii. Lowering barriers to entry and addressing distorted patterns of ownership through increased competition and small business growth 5 iii. Prioritizing labour-intensive growth: agriculture and services 6 iv. Implementing focused and flexible industrial and trade policy to promote competitiveness and facilitate long-run growth 7 v. Promoting export competitiveness and harnessing regional growth opportunities 9 vi. Quantifying the impact of proposed growth reforms 9 1 Introduction 11 2 Modernizing network industries 18 2.1 Electricity: planning, pricing, and Eskom’s sustainability 19 2.2 Telecommunications: competition, spectrum allocation, and broadband roll-out 22 2.3 Transport: regulation, pricing, and competition 24 2.4 Water: infrastructure, regulation, and institutional models 26 3 Lowering barriers to entry and addressing distorted patterns of ownership through increased competition and small business growth 27 3.1 Lower barriers to entry to address distorted patterns of ownership 28 3.2 Promote the growth of small, micro, and medium enterprises 31 Leverage the role of public procurement 33 Reduce red tape 33 Broaden financing options 36 4 Prioritizing labour-intensive growth: the role of agriculture and services 36 4.1 The role of agriculture in promoting labour-intensive growth 37 Innovative joint ventures can boost agricultural production and promote agrarian transformation 37 4.2 Create an enabling environment for investment in agriculture 39 Implement innovative financing solutions required by farmers 39 Introduce adequate and affordable agriculture insurance 40 Improve extension services for smallholder and emerging farmers 40 Enhance trade promotion, market access, and access to water for irrigated agriculture 41 Invest in establishing innovative market linkages for smallholders 41 4.3 Harnessing a growing services sector to boost economic transformation 42 The importance of growing tourism for inclusive growth and transformation 42 5 Implementing focused and flexible industrial and trade policy 44 6 Promoting export competitiveness and harnessing regional growth opportunities 50 2

6.1 Implement cross-cutting interventions to boost the export competitiveness of firms 50 6.2 Leverage regional opportunities to promote export growth 52 6.3 Harness regional opportunities: transport, energy, and construction 53 7 Quantifying the impact of proposed reforms 54 7.1 Short-term scenarios 54 7.2 Medium-term scenarios 55 7.3 Long-term scenarios 58 7.4 Other considerations 59 7.5 Scenario results 59 References 62 3

Executive summary

South Africa’s current economic trajectory is unsustainable: economic growth has stagnated, unemployment is rising, and inequality remains high. The government should urgently implement a series of reforms that can boost South Africa’s growth in the short term, while also creating the conditions for higher long-term sustainable growth. These growth reforms should promote economic transformation, support labour-intensive growth, and create a globally competitive economy. The specific and detailed reforms outlined here demonstrate that the only way to raise South Africa’s potential growth is through the implementation of a series of deliberate and concerted actions across a range of fronts. However, any attempt to raise South Africa’s potential growth rate must include progress on the fundamental building blocks of long-run sustainable growth. These include:

• Improving educational outcomes throughout the educational life-cycle, with a particular focus on early childhood development (which presents the greatest return on educational investment) and enhancing the relevance of education systems by better aligning learning outcomes to labour market needs.

• Implementing youth employment interventions such as continued support for government programmes that incentivize job creation (e.g. learnerships) and apprenticeships that facilitate school-to-work transition based on close cooperation between institutions of learning and the private sector.

• Expanding effective, affordable, and integrated public transport systems and prioritizing targeted housing and urban development interventions to overcome spatial legacies. The latter includes mechanisms to facilitate the growth of resale markets in social housing, fast-tracking the provision of title deeds to beneficiaries and leveraging private sector finance for low-income housing developments.

• Addressing the skills constraint through a combination of short-term solutions (such as the easing of immigration regulations for individuals with tertiary qualifications from accredited institutions) and the long-term educational reforms discussed above.

• Delivering a capable state supported by a new compact between the government, private sector, and other social partners. Government’s commitment to the compact should prioritize strengthening the capability of the public sector and state-owned entities as well as achieving the right balance between policy progress and certainty to ensure the economy is able to attract investment. The private sector’s commitment must ensure that businesses seek government policies that are unambiguously in the public interest.

• A stable macroeconomic policy framework underpinned by a flexible exchange rate, inflation targeting, and credible and sustainable fiscal policy. Low and stable inflation and a more sustainable fiscal trajectory reduces uncertainty, lowers borrowing costs across the economy, anchors returns expectations for investments and increases business confidence—all of which boost productivity. Turning to the growth reform agenda, we draw on the National Development Plan to outline five themes and the contribution of growth reforms within each theme that prioritize economic transformation, inclusive growth, and competitiveness. i. Modernizing network industries to promote competitiveness and inclusive growth 4

Network industries such as energy, transport, and telecommunications, provide essential services that underpin the growth, productivity, and competitiveness of an economy. South African network industries face some challenges including the absence of efficient economic regulation, old and poorly maintained infrastructure, a lack of access to quality services, and poorly managed state-owned companies. To address these challenges, a number of interventions should be prioritized.

• Electricity: In energy planning, the base case of the Integrated Resource Plan (IRP) should be unconstrained so that all policy options can be compared relative to the least- cost option; the IRP should be updated regulary to reflect changes in economic conditions and technology; future electricity tariffs should be managed in a transparent and predictable manner; and the over-reliance of municipal budgets on electricity revenue needs to be corrected. An independent transmission company, to be created from the unbundling of Eskom, should buy electricity transparently from independent power producers. Consideration should be given to regulation that enables households and firms to sell excess electricity they generate.

• Telecommunications: Government should release spectrum through an auction with a small set-aside for a government-controlled network, and competition should be allowed in Telkom’s infrastructure that connects the local exchange to residential homes and businesses. Rapid deployment guidelines that accelerate the installation of telecommunications infrastructure should be finalized, and open access conditions should be imposed to minimize unnecessary duplication of telecommunications infrastructure. The Independent Communications Authority of South Africa’s (ICASA’s) proposed economic regulation component should be independent of line departments and directly funded from industry levies, as per international best practice. The state should leverage private-sector expertise in broadband roll-out, rather than relying exclusively on state- owned companies (SOCs).

• Transport: We need to finalize the Economic Regulation of Transport Bill; enforce separate accounting divisions or separate financial statements for the various operating divisions of Transnet to ensure subsidies across divisions are made explicit; grant third- party access to the rail network to encourage private sector participation; and introduce competition in ports and rail. Other interventions that can improve freight transport include facilitating the exchange of information and improving coordination between shippers and transport companies, and encouraging the shift from road to rail where practical and efficient. Public transport can play a significant role in overcoming historical spatial planning through the integration of modes by local government and the densification of cities in specific areas. Local governments should take responsibility for the integration of public transport and land use planning. We should consider a review of fuel price regulation and implement strategies to formalize the taxi industry.

• Water: The sector suffers from an infrastructure backlog and the current process to investigate appropriate institutional options for service delivery needs to be finalized. There needs to be a comprehensive management strategy for investment in water resource development, bulk water supply, and wastewater management; including applying lessons from the successful renewable energy independent power producers programme. An independent water regulator can improve the overall efficiency of water provision and improve price setting. The implementation of a national water conservation programme can reduce water waste and demand in urban areas.

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Independent regulators such as the National Energy Regulator (NERSA), the Ports Regulator, and ICASA regulate sectors that are dominated by one or more large entities to ensure more efficient outcomes. Several unregulated areas that are dominated by large state-owned entities or the government (e.g. rail, road, port terminals, and water) should have their economic activities regulated by independent agencies. Where regulators exist, the government needs to ensure they have the capacity to effectively perform their functions. Regular reviews of regulated prices and their underlying formulae need to become the norm to ensure these are updated to reflect the latest available information and international best practice (e.g. the Ports Regulator recently reviewed the port tariff methodology).

ii. Lowering barriers to entry and addressing distorted patterns of ownership through increased competition and small business growth

Barriers to entry distort product markets and reduce the incentives for productivity and innovation, which directly inhibit growth. Large and old firms continue to dominate the economy as well as employment dynamics. New firm entry and effective rivalry among existing firms can generate significant consumer welfare benefits.

Several cross-cutting interventions can lower barriers to entry across a number of sectors:

• Competition and market structure issues should be considered in the drafting of new legislation, policies, and regulations.

• Development finance should be made more accessible to new entrants by the Industrial Development Corporation and others. A small business and innovation fund is being created to focus on the ideation and start-up phases of a business where the market failure in small business finance is most binding.

• Government support, in the form of incentive programmes, needs to be better communicated and simpler to apply for, especially for small business. There are a variety of other interventions that would support the growth and entrance of rivals in specific industries.

• The regulatory provisions in network industries such as telecommunications and banking should be changed to favour rivals provided these do not harm financial stability—for example, conditions for banking licences can be made less onerous and banking regulations should be more flexible to new developments, such as the growth of mobile money in the rest of Africa.

• Addressing exclusive leases is critical to create more competition among supermarkets. The Competition Commission is working to ensure that existing supermarkets do not enter into leases with exclusivity clauses. The Competition Commission should reduce the duration and scope of these clauses in instances where such leases have already been entered into. Municipalities should tackle exclusivity directly through planning policies.

• Switching costs could be reduced by instituting a regulated switching process with mandatory timelines in banking and telecommunications. The South African Reserve Bank should exempt consumers from interest, penalty fees, and other charges incurred due to delays in switching bank accounts. Clear guidelines to facilitate mandatory sharing of Financial Intelligence Centre Act information can also ease switching. 6

While large businesses have the resources to navigate their way in a variety of circumstances, the combination of impediments such as a high regulatory burden, inflexible labour markets, and high levels of concentration present significant obstacles for small business. The costs of compliance with red tape (e.g. obtaining black economic empowerment (BEE) certification, applying for a tax incentive, or accessing a learnership through a sector education and training authority (SETA)) is the same across companies, making it much more expensive in relative terms for smaller companies.

• Lower barriers to entry can be facilitated by reviewing red tape around licensing and municipal servitudes and introducing a ‘silence is consent rule’ for licensing procedures that have low associated risks.

• Small businesses should be supported through public procurement: late payments by government to small business should be addressed (perhaps by allowing for automatic addition of interest on outstanding balances after a certain period). Governments and state-owned entities need to, where possible, draft tenders to create greater opportunities for small business. Acting as a sub-contractor to a large firm is one way for a small business to enter global value chains and to get into longer-term contractual relationships that can unlock access to credit—a dispute resolution mechanism in the Chief Procurement Office or a separate ombudsman can improve oversight and monitoring of subcontracting relationships.

• A commitment to a reduction of red tape can unlock opportunities for small businesses. The Red Tape Impact Assessment Bill, which was rejected by parliament on procedural grounds, could be revisited. The proposed bill requires all departments and self-regulatory agencies to reduce red tape by 25 per cent over five years. The government should consider full or partial exemptions for small businesses from certain kinds of regulation (e.g. the extension of bargaining council agreements) can assist small businesses (and other new market entrants)—special economic zones can be used as potential places where these types of interventions can be piloted. iii. Prioritizing labour-intensive growth: agriculture and services In a skills-constrained economy, the bias towards skills-intensive employment driven by technological advancement has the unintended consequence of raising wage premiums, which further entrenches inequality and contributes to rising unemployment. Agriculture and services, especially the tourism sector, are conduits for labour-intensive growth. Several features of agriculture make it important in the pursuit of inclusive, labour-intensive economic growth: rural linkages, ability to absorb less-skilled labour, large multipliers due to extensive links with the rest of the economy, globally competitive labour productivity, and importance for export-led growth. Despite these advantages, the sector continues to experience low growth and declining employment. Innovative joint ventures have shown to boost agricultural production and promote agrarian transformation and should therefore be supported. This requires creating an enabling environment for investment in agriculture including:

• Improving access to financing for farmers: Farmers have unique financing requirements, typically demanding high levels of debt to offset uneven revenue streams. Concessional agricultural credit (e.g. declining subsidized interest rate loans) can play an 7

important role in targeting export-oriented and labour-intensive commodities and support various developmental objectives.

• Providing adequate and affordable agricultural insurance: Many agricultural producers in South Africa are not insured against the negative impacts resulting from natural disasters, such as drought, mainly due to the high costs associated with agricultural insurance. The Land Bank should take an active role in expanding the range of agricultural insurance products to support business continuity, ensure food security, spur rural economic development, and modernize the sector.

• Improving extension services for smallholder and emerging farmers: Intensive and high-quality extension support in partnership with industry associations is required for smallholders and emerging farmers to transition to higher-value agricultural commodities and can play a major role in reducing poverty and strengthening rural development.

• Enhancing trade promotion, market access and access to water for irrigated agriculture is crucial to unlock investment in labour-intensive crops such as apples, table grapes, citrus, avocados, and macadamia and pecan nuts. Export growth in these crops will come from improved market access, which must be supported by the availability of water.

• Investing in establishing innovative market linkages for smallholders: Contract farming and strategic government procurement, for example, can play an effective role in helping smallholder farmers achieve greater productivity, scale, access to inputs and markets, and ultimately facilitate graduation to emerging and commercial status. The services sector has proven to be resilient in downturns relative to other sectors, is highly localized and supportive of industrial production and therefore key to enabling inclusive growth and economic transformation. The tourism sector, in particular, is characterized by low barriers to entry as most tourism businesses are small, providing services such as accommodation, tour guiding, day tours, and taxi services.

• Greater budgetary support for tourism agencies is required and measures should be introduced to protect their budgets from the negative impact of currency fluctuations given their impact on marketing in foreign destinations.

• The Department of Tourism should increase the level of support to tourism firms to navigate the highly regulated business environment.

• South Africa’s visa regulations should be amended to ensure a better balance between security concerns and growing the tourism sector.

• Adopting proposals for the reintroduction and enhancement of the Tourism Safety Initiative, with highly visible policing in tourist hotspots can address the perception of South Africa as an unsafe destination.

iv. Implementing focused and flexible industrial and trade policy to promote competitiveness and facilitate long-run growth

High value-added sectors such as manufacturing promote productivity growth (which underpins long-run economic performance), diversifies exports, and is an important contributor to the 8

country’s skills base. Increasing competition in global value chains has forced domestic manufacturers to increase their competitiveness through investments in new technologies and up- skilling their workforces. There is scope for improving South Africa’s industrial policy in the following ways:

• Developing metrics to assess industrial policy interventions that are not punitive but encourage a process of learning and improvement: monitoring and evaluation must be a critical component of the incentive design process. There must be an emphasis on ensuring that adequate and accurate information is collected through the programme’s life-cycle so that independent evaluations can be conducted periodically.

• Allowing flexibility for South Africa’s industrial policy interventions to incorporate experience from implementation over time while maintaining policy certainty: Incentive adjudication committees should be allowed the flexibility to incorporate learning from their experiences. A clear set of criteria to determine which changes to programmes can be instituted will increase the transparency of programmes and ultimately improve accountability.

• Increasing experimentation and piloting of industrial policy options: this allows the agency or department in question to identify possible constraints or flaws in the programme design and will highlight procedural and system issues that need to be addressed while limiting policy uncertainty. Special Economic Zones can be used to experiment with policies on a small scale, before rolling them out to the wider economy

(if it makes sense to do so).

• Leveraging public procurement to support industrialization: the government’s status as a big buyer of goods and services through public procurement allows for this buying power to be leveraged to provide critical demand-side support to industry. This approach is effective if it is informed by evidence in selecting the products and industries that will meaningfully be assisted by this type of support. This can be achieved by: o Creating a repository of data on government procurement spending to allow evidence-based government-led product selection for designation; o Aligning and enforcing procurement processes at all levels of government; o Capacitating the South African Bureau of Standards to ensure that it is able to conduct local content verifications;

o Collecting information on procurement spend across all levels of government to improve the targeting of public procurement as an industrial policy tool; and o Monitoring and enforcing designations to ensure that they are being adhered to by all organs of the state.

• Rationalizing the Industrial Policy Action Plan (IPAP) to improve its efficacy: the latest iteration of IPAP focuses on thirteen sectoral areas with numerous interventions under each (in addition, there are eight transversal focus areas). IPAP may have a greater impact if it targets fewer areas where the greatest gains can be made. Trade policy is a key component of South Africa’s industrial policy package: South African trade policy is currently administered by the International Trade Administration Commission

(ITAC) which considers trade measures on a case-by-case basis through applications. This means that trade policy evolves on a piecemeal basis through applications to ITAC, which lends the process to an inherent bias towards larger, more organized firms. ITAC should be capacitated 9

so that it conducts broader value chain analysis of the impacts of submissions and is proactive in addressing the current biases of trade policy. There should be consistent monitoring and evaluation of industrial policy interventions, possibly through a multi-stakeholder monitoring body enhancing coordination between government departments and institutions. v. Promoting export competitiveness and harnessing regional growth opportunities Export orientation and sophistication are key drivers of long-run economic growth. South Africa needs to promote export competitiveness and actively pursue regional growth opportunities in order to leverage global and regional value chains for export growth. Technologically sophisticated exports, in particular, are crucial to structural transformation as they enable the economy to move from low- to high-productivity activities.

• The quality of and access to infrastructure can be improved through the promotion of competition and private sector participation in infrastructure.

• New and re-negotiated preferential trade agreements with growing markets are required for key export products.

• Government needs to collaborate with the private sector to set up an automated licensing system for key export documentation; and review border control procedures, plant, and animal health standards.

• There is a need to increase awareness of South African export products abroad. Incentives such as the Export Marketing and Investment Assistance Scheme may need to be focused on specific sectors.

• Export credit and bridging finance to finance large projects should be provided at internationally competitive rates. Export credit insurance and investment guarantees should cover political and currency risk.

Recent changes in South Africa’s trading patterns, both the nature of the products as well as their destinations, have important implications for how we think about South Africa’s export strategy. Between 2008 and 2014, manufacturing exports to the Southern African Development Community (SADC) more than doubled. Regional growth opportunities should be harnessed to promote export growth.

• Improving intra-regional logistics requires joint action across a range of areas including border controls, standards, storage facilities, and increasing competition and investment in infrastructure.

• With potential sources of energy spread across the region, institutional models of power generation and distribution need a regional perspective.

• Construction services exports into the continent can be expanded by pursuing a common or harmonized procurement framework for SADC; harmonizing of border processes; and enhancing the export promotion schemes run by the Department of Trade and Industry (dti).

vi. Quantifying the impact of proposed growth reforms 10

The bulk of the interventions are realistically executable in the medium term, and include reforms in the telecommunications, agriculture, services, and transport industries. Short-term interventions are important as they lay a foundation for other reforms, while long-term interventions address competitiveness. In the long term, the combined scenario (taking into account short, medium, and long-term interventions) can add as much as 2.3 percentage points to gross domestic product growth and create over one million job opportunities. This is dependent on the successful implementation of the short-term reforms as well as complementary policies in place to address the constraints currently faced by the economy, including insufficient skills and capital availability. The contributions of the primary and secondary sectors are expected to moderate as services’ growth accelerates. Insufficient availability of skilled workers and capital can hasten this shift, as the constraint causes a reallocation of resources from the primary and secondary sectors, to the services sector.

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1 Introduction

South Africa’s key economic challenges are well documented. Real gross domestic product (GDP) per capita has declined since 2015 (SARB 2018); productivity growth has been slow and appears to be slowing (Kreuser and Newman 2018; Aterido et al. 2019); the unemployment rate has recently been increasing from already high levels (Statistics South Africa 2017a); and inequality remains very high (Wittenberg 2017). The current state of the South African economy is unsustainable. Low economic growth entrenches poverty and inequality. High income inequality aggravates social fragmentation (Putnam 2007) and poses a risk to economic growth. Inequality contributes to extremely divergent views, which make compromises difficult—the resulting stalemate and policy uncertainty can contribute to economic weakness. Addressing our economic challenges requires an immediate focus on policies that will raise South Africa’s potential growth.1 Recent estimates of South Africa’s potential growth indicate that South Africa’s growth rate is low and has been slowing.2 Therefore, a sustainable trajectory for the South African economy is one where a series of reforms are implemented to raise South Africa’s potential growth rate.

A growth-oriented policy agenda must be accompanied by interventions that change how the benefits of growth are distributed and fundamentally transform the systems and patterns of ownership and control that govern our economy. Initiatives that transform the economy must meet the dual tests of sustainability and

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