Ann Bernstein says policy limits government purchasing decisions to products made by local businesses
The benefits of localization are overestimated while the costs are significantly underestimated
November 17, 2021
The argument for localization is based on the idea that protecting and supporting specific industries will allow companies located in those industries to grow rapidly and become exporters. However, there is no evidence that the approach of the Ministry of Trade, Industry and Competition seeks to distinguish between industries in which a comparative advantage could be developed and those in which this is not possible.
In recent months, the government has articulated an approach to economic recovery and growth that can be summed up in the phrase “industrialization through localization”. This envisions growth in production and industrial capacity stemming from policies that seek to shift demand from imports to locally produced goods.
In this regard, the Directorate of Commerce, Industry and Competition (DTIC) has designated nearly 30 products / product categories that government agencies must purchase either exclusively or mainly from local producers. At the same time, the “social partners” have reached an agreement at the National Council for Economic Development and Labor that they will reduce South African non-oil imports by 20% over the next five years by redirecting spending towards products. local manufactures.
Proponents of localization argue that shifting demand from foreign to domestic products has the potential to increase GDP, increase employment, and sow the seeds for the development of increased industrial capacity.
A new report from the Center for Development and Enterprise, Localization Sirens Song: Why Localization Politics Won’t Lead to Industrialization, challenges these claims. He argues that the benefits of localization are overestimated while the costs are significantly underestimated.
The argument for localization is based on the idea that protecting and supporting specific industries will allow companies located in those industries to grow rapidly and become exporters. However, there is no evidence that the DTIC approach seeks to discriminate between sectors in which a comparative advantage could be developed and those in which this is not possible. As with much of the ministry’s industrial policy, each industry appears to be treated as a priority. Its decision to designate a product for local purchase by government agencies appears to be made on the basis of “evidence that the government is buying. [the] product that is in distress caused by imports that displace local production and jobs. This blind and unique approach to protectionism is a flawed, ineffective and costly development strategy.
The location policy limits government purchasing decisions to products made by local businesses. Such a requirement is not necessary unless, in its absence, the buyer has chosen to procure an imported product. It is therefore reasonable to conclude that the local product must be more expensive than the comparable and / or lower quality import. Requiring that a more expensive and / or inferior good be purchased increases the cost of doing business and the costs of providing services. Either way, there are negative implications for those who use tracking products, and it is consumers, taxpayers, or businesses who ultimately have to foot the bill. Localization proposals feature prominently in industry blueprints that DTIC has developed in collaboration with businesses and organized workers in a number of sectors over the past few years. A common feature of blueprints is their blindness or indifference to the implications of their proposals for the rest of the economy. When local content goals are included in master plans, the effect is often higher costs to consumers or downstream users of industry products. The oft-repeated argument that blueprint processes can help remove bottlenecks in local value chains needs to be balanced with a realization that there is a clear risk that the process will serve to protect businesses. in place of increased competition.
In addition to imposing higher costs, DTIC’s quantity-based location restrictions, which stipulate that a certain percentage of designated goods must be purchased locally, reduce incentives for businesses to become more efficient and innovate new ones. products. Their market is guaranteed and companies can gain market share without having to become more efficient or innovate.
The net effect is that one of the risks of localization is that policy ends up supporting very inefficient firms – a risk that is particularly acute when markets are dominated by a small number of players.
Another localization cost is incurred when technical and design differences between a local product and the comparable imported item require changes to be made to the design parameters of an entire project. A local pump or piping, for example, may have technical specifications different from the most suitable product design parameters, resulting in cascading changes elsewhere that will increase production and / or maintenance costs or affect overall operations.
Rising costs and / or lowering the quality of their products obviously have implications for the ability of firms to be competitive in export markets, suggesting that a highly plausible effect of trade policy. localization will be a reduction, rather than an expansion, of exports.
The DTIC justifies localization policies by asserting that South Africa has an “over-propensity” to import. He argues that GDP would increase by five percentage points if non-oil imports were reduced by 20%. They say they have reached an agreement with companies and workers to achieve this goal within five years.
There are several problems with the reasoning of DTIC.
First, the data does not support DTIC’s claim that South Africa spends a disproportionate share of its GDP on imports. South Africa’s imports as a percentage of GDP are very similar to those of other countries.
Second, a quick glance at the data reveals that there is a very close relationship between the value of countries’ imports and the value of their exports. The reason is obvious: Global supply chains are complex and exporters must import intermediate goods, components and capital goods in order to export their production to the next link in the supply chain. Higher import levels are a sine qua non for increased exports. This is most evident in the sector which accounts for the largest fraction of industrial exports to South Africa: motor vehicles.
Third, the intimate link between imports and exports means that the possibilities of increasing GDP by reducing imports are illusory. Imports of intermediate goods and equipment are essential inputs to production and are associated with higher value-added South African firms. The competitiveness of exporting companies, especially of manufactured goods, also depends on access to high quality intermediate inputs at competitive prices. Since localization will restrict access to competitively priced imports and lead to higher production costs, the policy is, in effect, an anti-export strategy. It will also have the indirect effect of reducing competitiveness and production in downstream industries that use protected goods as inputs in production.
An argument put forward in favor of localization is that it is necessary to protect infant industries from international competition so that they have the time, space and markets to develop the required capacities and know-how. Supporters of this argument point out that protectionist policies under apartheid led to the emergence of Sasol and Iscor (now ArcelorMittal). Infant industry protection can be successful in fostering globally competitive businesses, but often it is not. In any case, the existence of these companies does not justify protection of the nascent industry leading to greater competitiveness and advantages for the local economy: the competition investigations with both Sasol and ArcelorMittal have sought to show that the import parity prices charged by these companies increased production costs for local industries.
Evidence that protectionism helps to develop industries is also contradicted by the clothing industry, which operates behind high tariff barriers and yet has experienced a continuous decline in production and employment, including a decline in 10% of jobs between 2015 and 2019.
South Africa’s poor economic performance has nothing to do with an “excessive propensity” to import, and everything to do with a series of well-known and self-inflicted political and governance wounds. Claims made in the name of localization are simply not credible.
The DTIC seeks to justify the localization policy by focusing on ad hoc success stories, and its approach has been supported by the beneficiary companies. The broader costs of the policy, which will be borne by the government, South African consumers, laymen and exporters, have been ignored.
Protection, import substitution, and localization industrialization all have an uneven track record as promoting development, with far more failures than successes. On the other hand, exports are an integral part of successful development everywhere. By increasing costs, these policies also directly contradict promises to lower the cost of doing business in South Africa.
South Africa’s future growth will also depend heavily on export growth – especially non-traditional exports. Seeking to replace imports is not a substitute for building export capacity. Excessive focus on locating and banning imports will weaken our export capabilities since we will not have the intermediate and capital goods necessary to manufacture goods at competitive prices for world markets.
Localization should be called what it is: an anti-export strategy, a strategy that will only further restrict our future development.
Ann Bernstein heads the Center for Development and Enterprise. This article is based on a new CDE report, Localization Sirens Song: Why Localization Politics Won’t Lead to Industrialization.
* This article first appeared in the Daily Maverick