Localisation and investment in the context of industrial policy

The sixth in a series of webinars focused on localisation in terms of South Africa’s approach to localisation in the context of industrial policy. Sponsored by Access Bank, the webinar was presented by Donald MacKay, CEO of XA International Trade Advisors and Paul Bondi, Co-head and MD of Rothschild & Co South Africa.

What is industrial policy?

Industrial policy is a government intervention to direct transactions better than they deem the market could. When considering the industrial policy model, we have to ask whether the people making these decisions have adequate information to do so. The problem is that decisions are ultimately made democratically by politicians rather than by a team of economists and industrial experts.

How does localisation factor in?

In South Africa, localisation is our industrial policy. A policy statement on localisation for jobs and industrial growth in South Africa from May 2021 states that, “A focus on localisation is…at the heart of Government’s strategy to create sustainable jobs for South Africa and build the economic base for long-lasting prosperity.”

There are three primary forms of localisation:

• Designation: a government directs that businesses procure domestically produced goods and services from domestically generated raw materials.
• Import replacement: applying duties as a mechanism to drive local procurement in the private sector.
• Export control of raw materials: keeping our important raw materials to benefit economy domestically, before considering export.

While creating sustainable jobs in our country is absolutely a crucial objective given our unemployment numbers, the jury is out on whether localisation is beneficial or sustainable for our economy.

Eskom is a state-owned entity that is starting to look more critically at whether localisation is a good idea. “Procurement rules are not as agile as they should be, including rules which say you cannot use suppliers that are not local,” says Eskom Director Mteto Nyati. “When the supplier of equipment is an international company…you have to use middlemen to satisfy the localisation rule.”

Balancing localisation with export growth

A major challenge with the typical localisation model is to maintain the balance between localisation (import replacement) and export growth. This is because the more you localise, the more you remove competition from the market. As you remove competition, you become less competitive, making exports ever more difficult. When you can’t export, you’re under increased pressure to sell your excess production locally, and because you aren’t locally competitive, you’re under increased pressure to remove global competitors. While localisation is certainly not unachievable, this balance must be considered. One of the prices you pay for any kind of localisation initiative is that it doesn’t naturally co-exist with competitiveness.

When we look more broadly at localisation or industrial policy, there are success stories that are often toted globally in places like China, South Korea and Singapore. However, China is currently an authoritarian government and South Korea and Singapore are both former authoritarian governments. It seems therefore that these successes are due to the ability to enforce policies without dealing with the democratic process where unpopular policies aren’t allowed to thrive. In contrast, it’s difficult in a democracy to get strict legal enforcement. In this context, we do have a problem in South Africa in that our industry is failing consistently and we are struggling to compete.

How do you balance the objectives?

Localisation and export competitiveness can’t naturally co-exist. South Africa’s competition law takeover regime has two components: on the one hand, pure anti-trust, and on the other hand, public interest matters. Public interest includes employment, BE-EEE, and localisation. There’s a natural tension between these three and anti-trust matters, but anything in the public interest that is governed by legislation needs to be considered when approving a transaction or not.

There are increasing commitments towards localisation in the form of prioritising procurement requirements, which can be useful in industries like agriculture and therefore are broadly positive. We’ve seen localisation become increasingly important in merger approvals under the public interest banner, but we’ve also seen a mixed bag of outcomes. What’s most important is that any localisation initiative in the context of merger approval needs to be based on sound economic or industrial logic. However with mergers, these commitments are invariably for the short term and won’t have long term benefits for industry.

When it comes to industrial policy, both buyers and sellers want certainty on an outcome. The problem is that competition authorities are implementing industrial policy through anti-trust processes, which takes away visibility for buyers and sellers and hinders their ability to deliver on those requirements.

In the South African context, it’s important that business owners are aware of localisation policies in their specific industries. This includes keeping a close eye on the pronouncements by the Department of Trade & Industry, as updates in localisation policy can have a major impact on their input costs. By staying abreast this, business owners can maintain the balance between the localisation policies currently in place and their export growth going forward.