Download January 25 INR SA Conference - National Foreign Trade Council

Daniel O’Flaherty Remarks at State Department Conference
“Assessing South Africa’s Future”
January 25, 2005
Let me first thank Rachel Warner and the State Department for organizing this
conference. Our assigned topic is “Assessing US Assumptions Made in the 1990’s.”
Since this conference will assess South Africa’s future, it is reasonable to begin by
looking back at our assumptions at the beginning of a new era, when sanctions were
removed and commercial relations were normalized. Ambassador Lyman has recalled the
political and diplomatic assumptions underlying US policy. My particular role in the
‘90’s was, and is, as director of the U.S.-South Africa Business Council, a trade
association of U.S. companies doing business in South Africa. South Africa had been
essentially off-limits to American business since the mid-1980’s. Those companies that
were not signatories of the Sullivan Principles, had similar corporate responsibility
requirements imposed on them by the Comprehensive Anti-Apartheid Act of 1986. Many
had left South Africa as disinvestment gained momentum. So by the time of South
Africa’s democratic transition, the question was how many would return and whether
investment flows would be large enough to help rebuild South Africa’s economy.
From 1994 to 2001, we were the private sector secretariat for the U.S.-South
Africa Binational Commission, co-chaired, as you will recall, by Vice President Gore and
Deputy President Mbeki. The BNC included a “Business Development Committee,” the
BDC, with a membership of 40 private sector representatives drawn equally from the two
countries. While the BNC covered a broad range of topics, from the environment to
defense, the BDC was, as then-DTI Minister Alec Erwin put it, “an important pillar that
supports our efforts to deepen trade and investment flows.” By 1996 Commerce
Secretary Mickey Kantor saw it as “accelerating the awareness by American firms of
South Africa as a positive place to do business by the creation of an internationally
competitive business and investment environment.”
While this is not the place to evaluate the BNC and the BDC, the objective of
increasing trade and investment remains a priority for both governments and business
communities. On the trade front, there has been a steady expansion of US imports from
South Africa. In 1994 the US imported $2.8 billion. In 2003 imports rose to $4.6 billion.
In the first 9 months of 2004 the US imported $4.3 billion, nearly as much as in all of the
previous year, partly as a result of the Africa Growth and Opportunity Act. US exports to
South Africa only rose from $2.3 billion in 1994 to $2.8 billion in 2003. So the US trade
deficit with South Africa has increased from $500 million in l993 to $1.8 billion ten
years later.
While US imports from South Africa have been an economic stimulus for South
Africa, US direct investment there has been a disappointment. Obviously, portfolio
investment responds to different variable than trade or FDI, and has lately been robust
due to interest rate differentials, partially explaining the sustained increase in the foreign
exchange value of the rand. But portfolio investment does not create jobs, transfer
technology, or expand the tax base. For that we need to look at FDI.
US FDI fell from its peak level in 1981 of $2.6 billion to $820 million by 1993
when sanctions were lifted. By 2003 the stock of US FDI in South Africa was $3.9
billion, l/10th the amount in Australia and about the same as in New Zealand (although
more than twice that in Russia). Between l984 and 1992, of the 440 US companies in the
country 334 withdrew during sanctions, leaving only about 106 US subsidiaries in the
country, many of them very modest in size. Of those that withdrew, fewer that 100 have
returned. Obviously, some companies went out of existence or merged during this period
and others learned to service the South African market from Europe. Dramatic
improvements in communications and transportation also have played a role in low FDI.
What is most striking about the pattern of US FDI since the end of sanctions is the
paucity of new, “greenfield” investment especially apart from sectors that were in their
infancy in the 1980’s. The best example is information technology, which comprises the
largest single category of US FDI, accounting for more than a third of the total. A recent
IMF study shows that between 1994 and 2002 South Africa lagged behind many other
middle-income developing countries in attracting FDI from the developed world
generally. The study found that in that period FDI flows accounted for only 1.5% of GDP
(and excluding two major transactions it was only 0.7% of GDP). At the same time, flows
into 16 other benchmark emerging economies averaged 3% of GDP. The last substantial
direct investment was Dow Chemical’s purchase of Centrachem in 1999.
What lies behind these statistics? Macro-economic policy has been the most
impressive achievement of the ANC government, sparking expected 4% GDP growth this
year on top of 3.4% last year, getting interest rates, government debt and inflation down
and encouraging a strong (some would say too strong) currency. These achievements
have been bought with considerable pain. Since 1994 the economy has lost a million jobs,
which exacerbates an already very high unemployment rate. Officials reasonably ask why
it is that having got their fiscal house in order, expected direct investment flows have not
followed.
Three major explanations are givens: (1) the reduced propensity of US firms to
invest abroad generally in recent years; (2) the distance of South Africa from the US and
the resulting high transportation costs; and (3) the size of the South African market,
which even with an expansion to a Southern African Customs Union through a US free
trade agreement, remains small. Another clue lies in the trade statistics. Since much FDI
follows exports, the relatively slow rise of US exports means that many companies do not
see the need to produce locally.
It is interesting to look back at the joint communiqués from the Gore-Mbeki BNC
in the mid-l990’s. The July, 1996 communiqué “encouraged aggressive restructuring of
state assets, privatization and removal of exchange controls.” While there was lively
interest in the l990’s in buying privatizing parastatals, the pace of privatization has
slowed and with it that source of FDI. The communiqué also advocated concluding a
bilateral tax treaty, which was achieved, and a bilateral investment treaty, which has not
been, lending importance to the investment chapter of the FTA currently under
negotiation.
Another major constraint on FDI is rigidity in the labor market and the relatively
high cost of labor in South Africa. The average manufacturing wage in South Africa is
about $5.75, which is comparable to that in South Korea where productivity is seven
times what it is in South Africa. This, along with a perceived over-regulation can make
South Africa seem less competitive than other countries as an investment destination.
Beyond these relatively straightforward criteria for foreign investment decisions,
company executives frequently cite a less precise concern: “policy uncertainty,” or the
extent to which present policies can be projected into the future, particularly a reasonably
certain future for to cover amortization of the investment. Despite South Africa’s evident
political stability and the negligible prospect of the ANC losing power, there is
uncertainty about who will succeed Mbeki and what the profile of the next generation of
leadership will be, i.e. those who have come to maturity since l994. Will they continue
the current internationally approved macro-economic policies or will they be more
attracted to populist policies? Will they be more or less likely to pursue policies of
reconciliation? Will they be more or less friendly to multinational corporations? Will they
be more or less aggressive in pursuing “transformation” policies? I will leave these
questions to my colleagues, with the caveat that long-term investors seeking answers
have far less information to go on than those of you in the US government. As a result,
their gut instinct may be skewed toward caution.
That 1996 communiqué went on to say that “black economic empowerment
should be an urgent priority in South Africa.” That is no less true in 2005 when the South
African government has made BEE a major priority. Obviously, implementation of the
policy has been controversial within South African with figures such as President
Mandela, Bishop Tutu, and ANC Secretary General, Kgalema Motlanthe, as well as
COSATU and the Communist Party criticizing the concentration of wealth that has
resulted. Indeed, South Africa’s Gini coefficient, measuring income disparities, is higher
today than it was in 1994. American companies agree with the importance of BEE, but
have been specifically concerned about the equity transfer obligation that appears to
require 25.1% of a subsidiaries’ equity to be held by an empowerment group. It is
impossible for some companies to meet this requirement, on which qualification for
government procurement and licenses depends. Everything hangs on what the DTI
guidelines on equity, now expected in the spring, will require. Presently there is a
patchwork of company reaction and practice and a great deal of uncertainty about what
they will ultimately be required to do. In December the Minister of DTI issued BEE
guidelines for many areas of corporate operations, but not for the key issue of equity.
Since uncertainty is the greatest enemy of investment decisions, the sooner the guidelines
are finalized, the better. The present situation is a disincentive to new investment.
The matter of FDI into South Africa is more than a business issue for those of us
who care deeply about South Africa and the success of its young democracy. The
domestic rate of savings and investment at 15% of GDP is too low to launch the economy
on a higher growth path that would impact unemployment, whether measured at the
official rate of 25% or the broader measurement of about 40%. The experience of other
developing countries is that a domestic saving and investment rate on the order of 25% is
required to grow at the 6-8% which South Africa would require to begin to affect
unemployment. Unemployment is a key reason for worries about political stability and
continuity. The investment gap can only be made up through increased FDI, and the US
is the largest potential source, given the fact the Europeans did not disinvest in the 1980’s
and Asian investment, as we all know, is often short-term. Recognizing the importance of
these flows, Alec Erwin, now Minister of Public Enterprises, recently set a target of FDI
at 2% of GDP. Last year FDI from all sources was 0.5% of GDP.
In closing it is safe to say that many of the ambitious goals of the Clinton
Administration in the 1990’s were indeed met in the new commercial framework that has
emerged. Most important among these is the rule of law and a truly first rate court system
on which investors can rely. The importance of completing the agenda to increase
investment cannot be overstated.