In spite of South Africa’s significant political transformation, per-capita GDP grew at a slow rate (1.2 percent per annum). Both income levels and investment remained low and the country’s unemployment rate became one of the highest anywhere in the world – standing at 26 percent using the narrower definition of who is unemployed, and at 40 percent if one includes discouraged workers (Banerjee et al., 2006). Unemployment is concentrated among the young, unskilled, and the black population.
The high South African wages compared to real wage levels caused high unemployment. South African wages are high by the standards of countries at similar income levels while real wages have not increased much since the transition to democracy (Leibbrandt et al. 2005). The problem is also connected to the country’s inability to generate momentum as evidenced by the shrinkage of the non-mineral tradable sector since the early 1990s. The weakness of export-oriented manufacturing has hindered growth opportunities for South Africa. And unlike Malaysia, it was not able to pull its workforce into manufacturing.
Since non-mineral tradables (including manufacturing) are intensive in low skilled labor compared to services, shrinkage in manufacturing has caused a collapse in demand for relatively unskilled workers. Unemployment could have been evaded if only 1) a decline in real wages at the low end of the skill distribution could have compensated for the inward shift of the labor demand schedule and 2) the growing mass of job seekers could have been admitted into the informal sector. The second mechanism helped developing countries with similar labor market problems. However, for South Africa, although the informal sector grew rapidly, its level remained relatively low compared with other developing economies.
Why is South Africa not Malaysia?
South Africa and Malaysia are both medium-sized economies with deep racial segmentations, where an ethnic majority controls the state but economic power lies with an ethnic minority. In 1988, the economic structures of the two economies were very similar in terms of output per head, TFP, human capital levels, and their dependence on mining.
However, the two countries differed in that Malaysia underwent a process of industrialization, while South Africa de-industrialized. The proportion of the workforce employed in manufacturing increased in Malaysia, while the reverse ensued in South Africa. The expansion of manufacturing in Malaysia promoted both growth and equity. Meanwhile, although manufacturing in South Africa became more productive than the services sector, but it did not become productive as Malaysia.
Manufactures are the essential tradables, and the different accomplishments of the two economies are most evident in their trade performance. Around the mid-1970s, the share of manufacture exports in GDP was both around 6-7 percent. By 2004, this figure increased to more than 80 percent in Malaysia, but only to 12 percent in South Africa. Malaysia improved its manufacturing base and surpassed South Africa in terms of the “sophistication” of its export basket.
There are various reasons why the two countries had contrasting paths. Malaysia was in a neighbourhood that is conducive to an export-oriented strategy while South Africa had to contend with the debilitating effects of a trade embargo in the 1980s and heavy spending on defense industries. The Malaysian government also promoted manufacturing (and manufactured exports). Their policies used a mix of market signals and direct incentives through tax, trade, and labor market interventions. Some of the industries failed but the successes have been more than adequate to pay for the failures. Malaysia’s experience showed that the productive diversification required by economic growth is not an automatic process that well-functioning markets generate on their own; it requires an experimental, nurturing approach by the government in strategic collaboration with the private sector (Hausmann and Rodrik 2003, Rodrik 2004).
Patterns of employment and structural change in South Africa
During the 1990s, formal employment in South Africa has deteriorated despite economic growth since 1994 and the increase in labor force participation due to democratization and the end of the Apartheid era. A significant increase in the employment share of private non-tradables took place at the expense of tradables. Tradables decreased from more than 40 percent of employment in the late 1970s to around 30 percent. A decline in agricultural and mining employment was not compensated by an increase in manufacturing employment.
This pattern of structural change shows a big decline in the relative demand for low skill labor because the declining sectors constitute the least skill intensive parts of the South African economy. Skill upgrading spread across the whole economy and the share of low-skilled intensity fell. However, the tradable sectors remained the most low-skill intensive part of the economy.
For the South African government, the negative relationship between low-skill intensity and employment growth shows that skills (the lack of it) acts as a significant constraint on the country’s economic growth. However, higher levels of growth and employment creation require a different pattern of structural change—an expansion of low-skill intensive manufactures at the expense of skill-intensive non-tradables. With this argument, skills can no longer be viewed as a serious constraint on future growth.
It was also observed that capital substitution for labor is striking in tradable activities (including manufacturing). This trend is confined to tradables: capital-labor ratios have remained constant within the (private) non-tradable sector. Tradable activities use considerably higher capital per worker than non-tradable activities.
Shifts in the demand for labor (particularly low-skill labor) explain why unemployment has trended up and is so high in South Africa. A decrease in real wages for low-skilled workers was not politically possible in view of the democratic transformation in South Africa and the role played by unions in the anti-Apartheid struggle and the new democratic government. The informal sector also does not have the capacity to absorb the surplus labor supply because it does not present a large footprint due to restrictive regulations, high crime and the high reservation wage level set by social grants.
Explaining patterns of structural change
The fall in semi- and unskilled employment, from 1.0 million to 0.7 million, accounted for the decline in the formal employment in manufacturing. This trend can be explained by: the fall in the relative price of the manufacturing sector; greater competitive discipline due to openness to international trade; wage pressure.
Decomposing remuneration into skill-upgrading and wage-push components
Changes in real sectoral remuneration can be decomposed into a part due to changes in skill composition (skill upgrading) and a part representing the skill-adjusted wage (wage push). After running a regression across nine one-digit sectors over the 1980-2004 period with a full set of year and sector dummies, it was found that: the estimates of the skill premium are positive and statistically significant; and there was no increase in the economy-wide skill premium post-1990.
After real remuneration was split into skill upgrading and wage push, results show that: once the effect of skill upgrading is taken out, labor costs in manufacturing appear to have become less burdensome in the 1990s than they were in the 1980s. This makes it very unlikely that wage-push factors can account for the reduction in manufacturing employment during the 1990s.
The econometrics of structural change
Assuming that output and employment in each sector of the economy responds to relative prices, labor costs, skill-biased technological change, and total factor productivity growth, a panel regression was run for the following three dependent variables: output; total employment; and semi and unskilled employment. The panel consisted of eight one-digit sectors—I exclude SIC 9, government services—over the 1980-2004 period. Each regression included a full set of fixed effects for sectors and years.
Results show that where output is concerned, manufacturing shows no difference from other sectors: a decrease in its relative prices reduces output in manufacturing by the same amount to that in other sectors on average. On the other hand, there are strong differences when it comes to employment. Total employment and unskilled employment are significantly more sensitive to changes in relative prices in manufacturing than they are elsewhere. Also, while skill upgrading and labor costs are not strongly associated with changes in output, they have a strong influence on employment. Lastly, it was found that productivity growth has asymmetric effects on output and employment. These results show that patterns of structural change in South Africa can be explained using a parsimonious framework.
To study the decline in manufacturing employment since the democratic transition in 1994, a regression was run and a “causal” decomposition of employment changes since 1994 was undertaken. It was found that the decline in relative price of manufacturing is the predominant cause of the fall in manufacturing employment. This factor accounts for more than 100 percent of the employment reduction. Skill-biased technical change is the second most important contributor.
The decline in the terms of trade of manufacturing shows up in a variety of relative prices. Standard economic variables explain manufacturing’s relative price, although a significant component of the decline remains unaccounted. While measured markup rates throw out some important puzzles, the picture that one obtains after considering these various indicators is a consistent one: a post-1994 investor considering an investment in South Africa would have been far less likely to commit resources to manufacturing, compared to banking, insurance, or other services oriented towards the home market.
Understanding the decline in manufacturing’s relative price
To explore the factors that caused the decline in relative profitability in manufacturing in the 1990s, the (log of the) value-added price of manufacturing divided by the GDP deflator (lnp_pgdp) was regressed on variables such as trade, the real exchange rate, import penetration, and a time trend. It was found that import penetration enters with a negative and statistically significant coefficient. The estimated coefficient on the real exchange rate is negative and significant as well, indicating that a real appreciation worsens the relative profitability of manufacturing confirming that the level of the real exchange rate is a significant factor of the health of manufacturing. The regression indicates that there is a strong decreasing time trend in manufacturing’s relative price even after we control for these other influences. When decomposition is done, the bulk of the decline is explained by the time trend.
After examining the effect of international trade on manufactures, it was observed that an increase in import penetration has a strong negative effect on a manufacturing subsector’s relative price, while an increase in exports has a statistically significant positive effect. These results confirm at a more disaggregated level that manufacturing’s profitability is strongly linked to trade competition and performance. They also confirm that the causality runs from trade to prices, rather than vice versa. Furthermore, it was found that that import penetration has adverse effects on employment while exports have a positive effect.
Concluding remarks
The poor performance of the South African economy is a consequence of the under-performance of its non-resource tradables sector, especially manufacturing. Had the South African manufacturing sector expanded rapidly, economic growth would have been higher and more jobs would have been created for the relatively unskilled. The health of the formal manufacturing sector is important to the strategy of shared growth.
Prices, costs, and productivity are the main drivers of manufacturing production and employment. Increasing the share of manufacturing will require a lot of work on these variables. It will require reversing the decline in relative profitability.
At the macro level, it requires a combination of monetary and fiscal policies that will allow the South African Reserve Bank (SARB) to run a modified inflation targeting framework which allows considerations of competitiveness to affect its decision-making. Without a relatively stable and competitive exchange rate, it will be difficult to persuade entrepreneurs to make investments in manufacturing.
On the micro level, the need is for more coherent and better coordinated industrial policies targeted at “self-discovery” (Hausmann and Rodrik 2003). Private investment and entrepreneurship in new areas where South Africa can develop comparative advantage must be encouraged. Greater discipline in targeting policy interventions on plausible, identified sources of market failures must be set. Political leadership and coordination at the top, and strategic collaboration at the bottom must be instituted must be established through a better institutional structure (Rodrik 2004).
The objectives of macroeconomic stability, economic growth, and social equity all require the same essential structural shift in the South African economy: a developed non-resource tradables sector.
Source:
Rodrik, Dani, “Understanding South Africa’s Economic Puzzles” paper prepared for the Harvard University Center for International Development Project on South Africa (2006).
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