JAKE MORRIS: Import substitution works for other countries, but somehow not for SA

Localisation bashing is in vogue. For those unfamiliar with the subject, localisation policy aims to promote local manufacturing over imports in targeted industries, often through the use of import tariffs.

The anti-localisation argument is that SA’s market is too small and stagnant to justify an import replacement strategy for industrial growth. Instead, we are told, we must focus on exports. And the only way to become competitive in global markets is to expose local manufacturers to unfiltered international competition in the domestic market.

The reasoning is that import tariffs, which have the effect of raising market prices, remove local manufacturers’ incentive to improve productivity and become more competitive. If the sting is taken out of international rivals, local manufacturers will laugh all the way to the bank, SA consumers will pay the price and the country won’t grow. 

The argument’s trump card is that however compelling the localisation narrative might be, the data show it simply hasn’t worked. Indeed, manufacturing’s contribution to GDP has been in slow decline since the turn of the century.

Dangerous assumption

There are some points in this argument that are easy to agree with. SA manufacturing is indeed struggling and needs a reboot. And we do need to increase exports if we are to grow our industrial base and make a real dent in poverty, unemployment and inequality.

There are also cases where localisation policy probably doesn’t make sense. Specifically, where local monopoly suppliers of critical raw materials receive protection against cheaper imports this raises the costs for downstream manufacturers who rely on those raw materials as inputs.

This may be problematic because often those downstream manufacturers possess more growth and employment potential than the upstream raw materials supplier, so compromising their competitiveness and growth may leave us worse off overall. 

However, beyond this the anti-localisation narrative becomes dangerous. This is mainly due to its reliance on the assumption that exposure to sharper international competition will make our firms more competitive. 

If this were true we should observe that the fastest-growing emerging economies are those with the lowest levels of protection against imports. As it turns out, the opposite is true.

The International Trade Barrier index (TBI) measures the level of protectionism for 88 countries, accounting for both tariff and non-tariff barriers to trade. SA is ranked 39th and is in the least protective half of the index. 

A 2018 study by McKinsey identifies the fastest-growing emerging economies over the past 50 years. Ten of these appear in the TBI. Two of them, Singapore and Hong Kong, are some of the most open economies in the world. But they are city-states with not much choice but to be open, and therefore anomalies that bear little relevance to SA. 

The other eight are all more protective than SA. Malaysia is the closest to us at 45 out of 88, while the rest are essentially the most protective economies in the world. India is at 88, Indonesia 86, Thailand 85, China 78, Vietnam 77, Kazakhstan 76 and South Korea 71.

The message is clear — the fastest-growing emerging economies are also the most protective. This immediately casts into doubt the suggestion that import substitution, as a general principle, is the source of our economic troubles. If anything, this evidence raises the question as to whether we are protective enough. 

But what’s most interesting about these protective emerging economies is that they are export powerhouses. This tells us that localisation policy and export-orientated policy should be complements, not substitutes. The question is not which one to choose, but how to intelligently engage in both. 

Thailand best practice 

To see how this is done, let’s zoom into Thailand. We have a lot to learn from the country as it’s a similar size to us (population 71-million versus our 61-million), has a far larger manufacturing sector (25% of GDP versus our 13%), is one of the top seven fastest-growing emerging economies over the past 50 years and has an unemployment rate of only 2%.

Much of its economic success is attributable to its automotive industry. In 1999 SA and Thailand produced about the same number of vehicles. Since then, while our production increased marginally and has remained flat since 2006, theirs has more than quadrupled. Why?

The Thai government recognised that to be globally competitive its automotive manufacturers first needed economies of scale and time to build their productive capabilities in the local market. So it imposed an import duty of 40%-80% (our equivalent is now 25%). It also offered multinational vehicle assemblers corporate tax breaks and duty exemptions on imported raw materials on condition of investment in local manufacturing plants and research & development facilities. Thailand became the Southeast Asian hub of vehicle manufacturing and the 10th largest vehicle producer in the world. 

This raises the question: if import substitution has worked for other countries, then why not for us? The answer is that competitiveness is complex and depends on more than import tariffs. Factors such as economies of scale, labour rates, productivity, skills availability, public infrastructure and other government trade and industrial support play a major role. 

For example, beyond import protection the Thai government used consumer tax incentives to promote certain types of vehicles over others to create industry specialisation and further scale in the domestic market. It invested in a high-functioning port and reliable electricity supply. It allowed for a standard six-day work week to improve productivity.

It prioritised attracting investment, without concern for local ownership or the creation of local industrialists. And it nurtured a long-term partnership with Japan, paving the way for numerous joint ventures between Thai and Japanese firms that brought technology and skills transfers.

We haven’t done these things. And the reality is that the same constraints that stifle import substitution will stifle export-orientated policies. Except it will be even worse, because out there in the global market our firms won’t be able to fall back on lower freight costs, avoidance of import duties and deep knowledge of the local market. 

Lessons for SA 

So where does this leave SA? For starters, we should nuance the localisation criticism. Rather than being axiomatic, it should be reserved for specific industries and specific stages in those value chains, for example upstream processing versus downstream manufacturing. 

Then we should not be shy to leverage import substitution for selected strategic industries, with the ultimate goal of achieving export competitiveness. It needs to be done better and smarter though, applying lessons from successful comparator economies such as Thailand. 

And finally we must get the basics right and fix the handbrakes on competitiveness that plague our firms in both local and international markets. The inconvenient truth is that if our firms can’t be competitive at home, they have no chance abroad. 

• Morris is COO at BMA, a management consulting company focused on manufacturing value chains.