Category: SA Economy

A key role in a growing economy is played by the start-up enterprise. They introduce new ways of doing business- supply new products and services – that challenge established business practices and so help make the economy a more productive one. They can start small but if they get it right, and execute  well they can become large and successful.

They do so by serving their customers better than the competition did or sometimes could not have imagined. They also have to satisfy the interests of their employees who could work elsewhere and they also have to meet the interests of other suppliers of services or goods to them, including those of the suppliers of capital, for which they have to compete with all other firms. Most important is that by by attracting custom and covering their costs they can provide their owner-managers with benefits and returns on their savings (capital) far superior to those they might have realised working for somebody else.

But their chances of such success are not good ones. The owner-managers of most start-ups, even most small businesses, do not realise well above average returns for their founders- ahead of what they might have earned elsewhere or from their savings plans. This means judged by past performance these true entrepreneurs are not deterred by the prospect of low average rewards but are inspired by the (small) chance of realising exceptional rewards. This makes them risk lovers rather than risk averse and society has every good reason to encourage their unusual appetite for taking on risk. And so not to impose regulations that favour the large firm. Those large enough to afford specialised human resource and legal departments that keep key managers out of the time consuming mediation procedures – and able to employ skilled accountants that can complete complicated tax and other returns.  Should it however be easy for new entrants into the market place to succeed? Easy pickings would reflect an undesirable lack of market efficiency. If the market is working well it should be difficult to beat the market.

Better than promoting or discouraging small over large or large and established firms over smaller rivals would be to ensure that all firms can contend freely and openly in the market place. The proverbial level playing feel serves the interests of all the consumers, workers and taxpayers who will always be far more numerous than the owners or senior managers or professionals who engage with them.  .

But such freedoms to compete will always be threatened by the established producers who have a large and easily measured economic interest in limiting the competition through laws and regulations favourable to them. In the old SA a minority of suppliers of goods or services enjoyed such protections. Most others, as consumers and taxpayers and workers suffered from import and capital controls and maize and banana boards etc. that put some producers and some white workers and professionals first in line for jobs to the disadvantage of their potential competitors and the customers who stood to benefit.

It needs to be recognised that the producer interests that now tilt the playing feel against consumers and workers and taxpayers in SA and against the interests of perhaps more worthy beneficiaries of government spending, are those of the owners of black businesses and skilled black professionals. They are being favoured with higher prices and rewards by affirmative action. As before it is the economic interests of a minority of producers that are being served by regulation and law. As before, the politics of such actions are easier to understand than their economic consequences. Though the low growth trap that has now caught the SA economy should concentrate minds on the costs and benefits of interfering with competition.

A power play unfolds before our eyes. Comedy as tragedy or farce?

Prospects for the SA economy early on Tuesday 11 October had improved significantly when we learned that SA’s first two independent privately owned coal-fired power stations (IPPs) had been given the go-ahead. Foreign interest in these projects, as suppliers of the equipment and technology and of the necessary capital, was welcomingly strong. Most important, the 863MW of additional electricity is to be delivered at an agreed wholesale price of 79 and 80 cents, plus inflation.

Alas later that morning a further very troubling scene in the opera buffo that has become SA’s fiscal affairs, was played out when Public Prosecutor Shaun Abrahams announced that he was charging Finance Minister Gordhan with fraud. The economic damage caused by a weaker rand, higher borrowing costs for the state and lower values for businesses that depend on the SA economy, was immediately registered, while firms with operations mostly outside SA gained rand value. The outlook for inflation deteriorated with the weaker rand and so the possibility of lower interest rates from the Reserve Bank has receded. The income and job prospects of SA households and their willingness to spend and borrow more, essential to any cyclical recovery in SA, has been undermined accordingly as has the willingness of SA business to invest more in meeting their demands and employment needs. Many billions, incalculable billions of lost economic opportunity, will have followed. Those responsible cannot possibly count the damage they cause.

The two announcements however are linked – perhaps in a way that can still produce a happy ending. Can we doubt that the fiscal power play has much to do with the prospect of nuclear power as opposed to power from coal or gas? The deal for nuclear energy, details of which are awaited and are to be reluctantly supplied, and about which the Treasury has had its serious reservations made well known, will be on a scale well beyond impressive sums now to be invested in additional coal fired capacity. Business Day referred to R40bn per private IPP. Capturing a chunk of this nuclear deal from the people of South Africa at the expense of their living standards is seemingly well worth fighting for.

The problem for advocates of nuclear power in SA, well intentioned or perhaps not, is the firm offer of 80 cents per kilo watt hour from the new IPPs. We have a strong recent indication of just how expensive nuclear power can be. Britain has just given the go ahead for the nuclear Hinkley Point Power Plant, that plans to deliver 3200MW of power at a “strike price” of, believe it or not, £95.5 per MW plus inflation after 2012, that is at current exchange rates only roughly, since these rates move around so much, the equivalent of R1660 per MW, or equally roughly twice the price tendered by the IPPs. The wholesale electricity price in the UK is now much lower, about £45 per MW leading the National Audit Office to estimate that electricity consumers in the UK having to spend an extra £29.7bn for the benefit. Similar calculations of cost per hour and extra spend that will have to be charged to pay for nuclear in SA cannot be denied. They have to inform the process.

There is a more important lesson to be learned about the business of capturing the state from the citizens who pay for the state and its failures – intentional or not. The opportunity for corrupting the state is only as big as the state itself. There is no good technical reason to place airlines, electricity or water production, ports and railways, toll roads, hospitals and schools in the hands of the state. The reason why the state as supplier, rather than private producers, is so strongly supported by the politicians, is because they can so easily be captured by the suppliers of all kinds to these organisations, at the cost of the consumers of the essential services and the taxpayers who pay for them. South Africans watching the stage unfold might wise up to these facts of life.

Is there a true public interest in employment retention, either at Optimum Coal Mine or anywhere else in the economy?

The controversy surrounding the purchase by Tegeta Exploration and Resources, a Gupta controlled company, of Optimum Coal Mine for R2.5bn from Glencore has been grabbing the headlines in the local media. Optimum Coal Mine supplies Eskom and enjoys a near 10% share of the Richards Bay coal export terminal.

Part of the controversy was about the alleged role of Mineral Resources Minister Mosebenzi Zwane. According to a report in Business Day by Natasha Marrion on 23 February: “Mr Zwane said his only interest in the deal was to ensure that no jobs were lost under the new owner.”

Business Day further reported “that the Competition Tribunal has cleared the way for the Gupta-controlled Tegeta Exploration and Resources to acquire Optimum Coal, on condition there are no merger-specific job losses. The approval comes as the Treasury is reviewing all of power utility Eskom’s coal and diesel contracts.”

There is heightened public interest in the terms of this deal, for many reasons. What is of interest in this instance though is that the Competition Commission and Tribunal however chose to interest themselves only in the employment implications of the deal, following their mandate to consider the public interest as well as the competition implications of any deal of this magnitude. As the Appeal Court indicated in its precedent making judgment in 2011 on the Massmart-Walmart merger, the task of Competition Policy is to determine:

1. Whether or not the merger is likely to substantially prevent or lessen
competition;
2. If the result of this inquiry is in the affirmative, whether technological,
efficiency or other pro-competitive gains will trump the initial
conclusion so reached in stage 1 together, with the further
consideration based on substantial public interest grounds, which in
turn, could justify permitting or refusing the merger; and
3. Notwithstanding the outcome of the enquiries in 1 or 2, the
determination of whether the merger can or cannot be justified on
substantial public interest grounds.
The legislature sets out specific public interest grounds in s 12 A (3):
“(3) When determining whether a merger can or cannot be justified on
public interest grounds, the Competition Commission or the
Competition Tribunal must consider the effect that the merger will
have on –
(a) a particular industrial sector or region;
(b) employment;
(c) the ability of small businesses, or firms controlled or owned by
historically disadvantaged persons, to become competitive;
and
(d) the ability of national industries to compete in international
markets.”
Clause 3d, “the ability of national industries to compete in international markets”, as well as clause 3b “employment” might well have also have been used to examine the contract. Clearly the competitive terms on which Eskom sources its coal will affect its costs and the prices it will ask the regulator to approve. The ability of all SA industry to compete effectively depends on the price and availability of electricity.

That the Treasury is apparently also investigating this Eskom contract, among other Eskom contracts, might be a reason for the competition authorities to have ignored this public interest in the terms of the contract. Be that as it may be, the Competition Commission’s determination of the mandated public interest as in 12a clause 3 of the Act, in employment retention, following that of the Competition Appeal Court judgment in the case of the Walmart Merger, and further pursued in the Tegeta case, needs to be seriously examined.

The case of the entry of WalMart to the SA economy. The welcome mat was not laid out.

An important case for competition law in SA, resolved in 2011 on Appeal to the Competition Appeal Court headed by Judge Dennis Davis, involved the purchase of a majority stake in a local JSE-listed retailer and wholesaler, Massmart, by the largest retailer in the world, Walmart. Approval of the deal was given by the Competition Tribunal because it was “common cause” – to quote the Judgment of the Competition Appeal Court, on the Tribunal – “that there was no threat to competition”. Indeed it was so conceded by the counsel for the parties contesting the approval of the merger in Court, to quote a report on the proceedings: “Paul McNally, who submitted closing arguments on behalf of the union… said his clients accepted that there would be lower prices as a result of the acquisition, but that these would come at the expense of local jobs.” ¹

Surely this common cause should have been sufficient to approve the merger and to extend a warm welcome to Wal-Mart, especially from SA consumers, who were bound to benefit from more competition for their spending power. Given the importance of foreign capital for the economy and its growth prospects, a warm welcome too might have been extended in recognition of the confidence that the world’s largest retailer was expressing in the SA economy. This friendly response to an important investor in the SA economy might well have encouraged more direct foreign investment that is very obviously in the broad public interest.

The Competition Tribunal however surrounded its approval of the deal with a number of onerous and complicated conditions. Such conditions were highly sympathetic to the arguments made by the trade unions interested in the merger, but costly to Walmart and therefore its ability to compete in the market place with other retailers and wholesalers.

The conditions required of the merged entity by the Tribunal included restrictions on retrenchments, preferences for previously retrenched workers when employment opportunities presented themselves and R100m to be invested in a programme to support local business, combined with a requirement to train local South African suppliers on how to do business with the merged entity and with Wal-Mart with the programme and its administration to be “advised by a committee established by it and on which representatives of trade unions, business including SMMEs, and the government will be invited to serve”.

However the merger was taken on appeal to the Competition Appeal Court by the concerned unions and Ministers of State who sought to have the merger disallowed on public interest grounds. The Appeal Court agreed to allow the merger but decided to largely support the Tribunal by surrounding the deal with the conditions as had been recommended by the Tribunal (somewhat modified) but clearly not to the advantage of Wal-Mart as a competitor.

This seems a very unhelpful and unlikely course to take for a body designed to promote competition. Mergers and acquisitions, friendly and especially hostile ones, are among the more important ways in which businesses realise economies of scale that allow them to become more efficient more profitable and by definition more competitive in the interest of its customers of whom they wish to win more over. Any synergies to be realised in a larger, combined entity almost inevitably involve retrenchments of staff. Indeed, the ability to avoid duplication of personnel and systems and to reduce operating costs and improve margins is often the prime motivation for any merger or acquisition.

A vibrant economy is one where, over time, workers and managers are continuously being allocated and reallocated to more efficient purposes. This requires that some firms will be reducing their complements of workers while others are increasing theirs and net employment gains are registered for a growing potential labour force. Without job losses, there would be far fewer job gains made possible. A system that made it very difficult to retrench workers is one that discourages hiring in the first place. It makes for a stagnant economy, with a feudal style labour market that treats jobs as an entitlement, not at all easily discarded and highly discouraging to job creation.

A flexible labour market, by contrast, gives firms a high degree of freedom to hire and fire and allows workers to freely choose their employers and move easily from one job to another. The favourable outcomes of such freedoms enjoyed over time can be observed in the US or UK, with a highly productive and well paid labour force and a significant rate of turnover of jobs.

The South African labour market, or at least the labour employed in the formal sector of the economy that provides the much prized, so-called “decent jobs”, is highly inflexible. Job retention, rather than job growth, has become the primary objective of labour market regulations and it would appear also competition policy. The prospect of an extended period of unemployment is an unhappily realistic one for many of those threatened with retrenchment.

This is a weakness of the labour market that policies for competition should be addressing, not reinforcing. The competition authorities, by their rulings on job retention, have made the economy less efficient and competitive than it could be. By setting these precedents, it also makes efficiency enhancing investments and acquisitions less likely and so the efficient use of capital and labour less likely.

There is a public interest in a more competitive and efficient market for goods and services and for labour. There is only a private interest in avoiding particular retrenchments. Competition policy misuses the public interest in employment. The public interest is in employment growth and a more productive labour force to which mergers and acquisitions can make a very important contribution.

¹ http://mg.co.za/article/2011-05-31-walmartmassmart-deal-approved-with-conditions

There is much anxiety about how much poor South Africans are paying in interest for the credit they receive. Newly shocking to observers is the fact that if a good is purchased on credit the monthly payments may amount to much more than the purchase price. For example, if a fridge had a face value of R10 000 to a buyer on credit, paying 25% p.a interest and repaying the capital sum over 10 years, the buyer would be making monthly payments of R227. And so over the life of the loan would have paid in interest and capital repayments an amount of R27 299 of which R17 299 would have been interest. Had the loan been a five year loan at the same 25% rate of interest, the monthly payments would have been higher, R294 per month, meaning lower total payments of R17 611 of which much less, R7 611 would have been the interest expense.

Why then would anyone borrow for a longer rather than a shorter period if it costs so much more? One could however ask an even more obvious question. Why would anyone buy on credit rather than pay cash, especially when the cash price is very likely to be a lower discounted one? The answer should be obvious. They buy on credit because they do not have the wherewithal to pay cash.

Without access to credit they would be denied the essential services of the fridge. Further saving the R294 minus R227 (R67) per month might mean a fridge fuller with essential food. The value of the fridge to the household borrower is in fact what they are willing to pay for it, the R227 or R294 per month. They are consuming the services of the fridge for which they are clearly willing to pay. For the lender, shorter repayment periods, higher monthly payments and less interest accrued becomes a less risky transaction, one they otherwise might wish to encourage. Borrowers however have to be judged as credit worthy enough to enjoy extended credit terms. The choice of extending the repayment period, paying more interest, may in fact be a limited one- unfortunately.

The cash buyer will not be paying interest, but nevertheless will be foregoing the opportunity to earn interest or dividends on the cash they have allocated to a particular asset. It might well be a good decision for them to rent or lease an asset rather than pay cash and put the cash to better use elsewhere. For example, to rent rather than buy a home and do something much more valuable with the cash invested, perhaps even to pay the deposit on a house bought to rent with a mortgage loan.

As with the fridge, somebody buying a home on credit pays out a lot more in interest and capital repayments than the purchase price of their home. A R1m home bought on mortgage credit at a low 10% per annum paid off over 20 years, will mean a monthly payment of R9 650 and will accumulate total payments of R2 316 052 – more than twice the purchase price paid. But the proud home owner would have saved rental payments over the period and the home will have a market value after 20 years, unlike some household appliance.

The house bought on credit will have provided a flow of services, accommodation services, similar in nature to the services provided by a fridge or TV – benefits that are received in exchange for interest and principal paid. Also, such leverage may prove to be a very good financial deal if the house more than maintains its after inflation value. Access to such credit provides a rare opportunity for salaried homeowners to add to their wealth through leverage. Such lending and borrowing on terms agreed to by borrowers and lenders surely deserves every encouragement, even if, as is bound to be the case, interest paid apparently means a more expensive house over time.

Household appliances do not provide the lender with anything like the same protection against losses should the borrower default – hence the higher charges required by lenders competing for the business. These charges reward the dealer who incurs the costs associated with the bundle of goods and services associated with any transaction concluded on credit. Charges that will be intended to cover the interest costs of supplying credit, the costs of goods supplied with the credit, and the services associated with the goods, for example the rent paid for trading space and the working capital invested in an inventory of goods from which customers can choose. This bundle of benefits – goods and services including credit services supplied to a customer – may come with a single charge, for example for a dress bought on credit at a given price to be paid off over time. Yet the price of the dress is very likely to incorporate a very high, but unknown to outsiders, profit margin intended to cover all the associated costs including the risks of non-payment. There is fortunately very little comment about regulating gross profit margins on goods supplied on credit.

There is much comment however about the apparent inequity when the terms of the transaction are in a mix of separately itemised charges – some combination of listed price, interest charges, delivery and insurance charges etc. may be specified. And complained about if one or other of the charges, considered alone, appears exorbitant. But what will matter to all buyers paying a single charge or multiple charges is how much they will be required to pay each month and whether or not it is worth making the monthly payment. And what will matter to the seller of the mix of credit and goods supplied, is whether the revenues they collect – perhaps is a variety of itemised charges – will cover their costs, including a return on capital invested appropriate to the risks incurred. If the returns exceed the required returns, more competition to supply goods and credit can be confidently expected. But if some of the charges made are controlled on an apparent cost-plus basis, such as insurance charges, any loss of revenue will have to be made up in one or other of the other charges (if the goods and credit are to be supplied in the same volume and variety). If the loss of revenue cannot be made up, less credit will be supplied.

The SA government has however decided not to leave the outcomes in credit markets to be determined by market forces. They have regulated the terms of the contracts by more than what willing lenders and equally willing borrowers might otherwise agree to. Loans, including mortgage loans, may be forced to be limited to some proportion of wage incomes and the terms of the loan, including the interest rate agreed to or charges for insurance arrangements, may be subject to regulation.

Treating borrowers in this way, as less than capable of looking after themselves, as adults managing their credit affairs, has consequences. So too has not trusting potential lenders to compete with each other with loan facilities that will compete away excess risk adjusted returns in providing credit. Such interventions in the credit market mean less credit supplied. It means fewer fridges, TVs, computers and furniture in homes, less clothing in the wardrobe, all understandably very important to the household. It also means fewer houses owned by the occupier.

Regulations of this kind may protect some less than responsible borrowers and lenders from borrowing and lending more than they should have. Yet by imposing regulations on the potentially credit worthy, as judged by willing lenders, they frustrate the plans of potentially worthy borrowers to gain access to credit that is valuable to them, credit that might be supplied to them on terms they would be willing to agree to. In the absence of credit from established businesses with reputations to protect and repeat business to encourage, desperate borrowers may well be forced into the clutches of the informal payday lenders and their ilk. Lenders who will charge much higher rates of interest for loans of typically very short duration, with repayment secured violently if necessary.

The regulators appear only aware of the costs of poor credit decisions, rather than the benefits of many more good ones made, under the discipline of market forces. Access to credit has played a very important role in improving the standard of living of many South Africans with improving income prospects but little wealth to draw upon. It is in reality a South African success story.

The self- regulatory capabilities of a market place, including those of a credit market, receive too little respect in South Africa. The costs – intended and unintended – of the flood of additional rules and regulations that prevent agreements between willing sellers and buyers, willing borrowers and lenders, are too easily ignored by an ambitious bureaucracy. These ever growing regulatory burdens on market participants are an important part of the reason why the SA economy is stagnating.

The SA government seems determined to press ahead with a national minimum wage (NMW). This is apparently with the agreement of organised business and labour, though the minimum levels themselves are still in dispute. It however appears likely that the NMW will be set close to the incomes that define “the working poor”, those who earned less than about R4000 per month in 2015 for a 35 hour working week.

Not much poverty relief at R4000 per month, you may think. Yet the problem is that most of those with jobs in SA earn much less than this while a large number of potential workers are unemployed and earn no wage income at all. According to a comprehensive recent study of the Labour Market in SA¹ , even after adding 40% to wage incomes to compensate for “underreporting” in the Labour Force Surveys undertaken by Stas SA, 48% of all wage incomes representing 5m workers fall below R4000 per month and 40% earn less than R3000 per month, about 2.7m workers out of a total employed of about 13m. The proportion of those employed who fall below R4000 are much higher in the rural areas, higher in agriculture (nearly 90%) and domestic services (95%). At the other end of the spectrum is mining, where 22% of the work force earn less than R4000 per month. Even in the comparatively well paid and well skilled manufacturing sector, about 48% of the work force are estimated to earn less than R4000 per month.

Unless the laws of supply and demand for labour can be repealed, it seems obvious that were the NMW to be made effective, the consequences for currently low paid workers would be very serious. Many will lose their jobs, while many more young workers hoping to enter the labour market will find it even more difficult to gain entry to formal employment. Some excluded from formal employment may find work in the unregulated informal sector and many others will be required to work fewer hours, as employers seek to make their work force more efficient, to compensate for an artificially higher hourly rate. This trend is already well under way, according to the study. Other employment benefits provided by employers, such as pensions, health, housing and food, may be reduced to compensate for higher take home pay.

Why then would the government wish to push ahead with such a predictably disastrous initiative, imposed without regard to labour market fundamentals? Can the government and its advisors truly believe that wages have little to do with employment or that some miracle of economic growth or currently unrealised productivity gains will come to raise the demand for labour? Surely not, though the support of trade unions and large businesses for an NMW, expecting less competition for jobs from low paid workers or firms able to hire them, is entirely rational self-interest at work. Unions attempt to maximise the wage bill they can draw member dues from and business seeks to maximise profit, not employment. Robots can replace workers very easily especially at higher wages or rather improved employment benefits.

The case for an NMW must be a political one. It cannot be an economic one. If an NMW, proclaimed at levels well above market determined wages could cure poverty, the economic problem of poverty in SA and everywhere else would have been solved by decree a long time ago. The government must believe that fewer but better paid, so called decent jobs, will mean more support for it at the ballot box. Nobody would thank a government for employment at wages that do not provide an escape from poverty, even if the alternative more poverty for now and more dependence on government hand-outs of cash and housing.

Our labour market regulations and interventions have long been pushing employment and employment benefits strongly in this direction. Fewer well paid private sector formal jobs have been provided – relative to GDP – and many people have joined the ranks of the unemployed or the informally employed, the latter not fully captured in GDP estimates.

NMW may be a recipe for political survival but is not a cure for poverty in SA. It will retard the rate of economic growth in SA that is the only long term cure for poverty. Economic growth, sustained at a rate well above population growth, would gradually lift all incomes in SA, including those of the worst paid, as well as skilled workers. Achieving higher growth rates demands a more flexible labour market. Unfortunately SA continues to move in the other direction.