We are locked in this zero-sum-game scenario because we are asking the wrong questions. The reality is that the sector is diverse. It does not consist individually of the basic ferrous industry and the rest or downstream industries. Analysis should be focused on the dynamics of the component sub-industries, with sustainable solutions devised that will revive them individually. In time, this holistic approach would, in turn, put the sector as a whole on a growth trajectory.
To break it down, the overall South African market for metals and engineering products consists of production by local producers, minus their exports to the world, plus imports into the country. This aggregate market kept on growing and peaked in 2013 – higher than in 2008. It has since fluctuated somewhat, but is estimated to be at virtually the same level as in 2008.
For each sub-industry, this situation differs due to its unique dependence on exports and the dynamics of its own domestic market. Since 2000, for example, the domestic markets for rubber products grew by 33%, ferrous products by 66%, metal products by 18%, machinery by 56%, electrical machinery and equipment by 54% and other transport equipment by 73%.
Why, then, is the sector production languishing at 30% below the 2007 peak levels? Part of the answer lies in export markets being important, at around 50% of production, but weak. This weakness is coupled with depressed export prices in tandem with commodity price trends. The other side of the coin is that domestic producers continued to lose market share in their own market, from about 50% in 2013 to only 43% this year. The opportunity cost is a massive R50 billion worth of production forfeited and an estimated 40 000 jobs not created (going by the current sector employment multipliers). Again, the numbers differ widely for each sub-industry.
When one looks at the current job losses in isolation, the situation looks dire, especially due to an apparent acceleration in jobs lost recently. Alarmingly, jobs are shed slower than current production declines, indicating that the worse may still come. Over the last 12 months (middle 2015 to mid-year 2016), an estimated 25 000 people lost their jobs in the sector, from a total of 400 800 employees to 375 000 at the last count (mid-2016).
The cost, in terms of company closures and value destroyed, makes for equally bad reading. At an average company size of 50 employees, these numbers translate into 500 companies closing down during the year. (The losses differ again per sub-industry.) However, in the context described above, a set of different questions should be asked.
Surely, in-depth analyses of what each individual sub-industry is exporting to which countries, and what competing products are being imported will yield an array of answers and options of what could be done to regain South Africa’s product share in the domestic market, and larger export successes. To look at the overall sector and attempt one-size-fits-all solutions seems unproductive.
The issue of the sector’s inability to compete with cheap imports is often thrown in the fray willy-nilly. Almost in the same breath, the perceived benefit of a weaker exchange rate comes up, and the fact that exports are not rising concomitantly is then used as further evidence of lack of competitiveness.
Instead, questions must be directed at how to regain domestic market share in niches where the sub-industries can compete and improving efficiencies through modernisation and fixed investment where they are lagging. Recovery in each of the mining, construction and auto sectors is crucial for demand growth. World-class cost effectiveness and moral suasion will ultimately attract private sector demand. Stimulation and redirection of domestic general government procurement demand towards domestic metals and engineering producers is a policy measure over which South Africa has control.
The net result of losing domestic market share is, of course, lower production (-4,5% over the last 12 months) and lower capacity utilisation (-2,4%). At 77% capacity utilisation (against a benchmark of 85%), it means that fixed cost of production could be up to three times higher than at full capacity. Variable production costs have also shot up dramatically during the last two years. The combination of labour costs (20% weight), dollar-based prices (40% weight), administered prices (15% weight) and other costs (25% weight) increased by 12% during the year, while producer and merchant prices increased by only 10% and 3% respectively. The continued pressure on profits is obvious.
Mitigating against some of these variable costs seems critical. A “labour partnership for growth” will have to be formed. The reciprocal damage caused by industrial disruptions (autos, mining, construction and metals) in the past is something to be avoided. The exposure to international prices for inputs makes exchange rate movements a double-edged sword. It helps with export earnings, but simultaneously pushes input prices up. The situation is different in the case of administered prices, over which the country has control.
The debate about the costs of energy (and Eskom’s flier that it may sell electricity cheaper when in surplus) and carbon taxes, for example, is critical for the survival of the sector.
It cannot be over-emphasised that each sub-industry in the metals and engineering sector has unique circumstances and has to be treated individually and policy designed to support growing and successful entities and mitigate against the constraints each may experience.
It seems as if the structural shifts in market dynamics have not sunk in for companies, with some still viewing it as a cyclical downturn, and policymakers who are largely stuck on the “pipeline” construct of how to focus policy. The result of these tendencies is that the wrong questions are asked and the changing of course on a new path of efficiency and competitiveness is delayed.
Henk Langenhoven is the Chief Economist of the Steel and Engineering Industries Federation of Southern Africa.