After the Bell: Steeling ourselves for change in South Africa’s industrial sector

What is it about the steel industry that attracts left-wing, “nation-building” politicians? Chinese communist dictator Mao Zedong famously championed backyard furnaces during the Great Leap Forward. This was the period between 1958 and 1962 when China took a great leap backwards. Reminds me of that joke: What’s the steel industry’s favourite type of comedy? Iron-y, obvs.

Because peasants were encouraged to prioritise iron and steel production over agricultural obligations, the backyard furnace project may have been a contributing factor in the severity of the Great Chinese Famine, in which between 15 million and 55 million people died. Not by chance, the famine overlapped almost exactly with the Great Leap Forward. Scarce fuel was burnt to keep the furnaces going; household implements were melted down for trivial amounts of iron ore; and labour better used for the harvest of bumper crops was eaten up by these schemes.

Some of the small blast furnaces succeeded, but most did not and were only able to create pig iron. The target was to make China the biggest steel producer in the world. Eventually, China did become the world’s biggest steel producer. Irony!

But the big increase took place only once China switched to a market system in the early 2000s. China currently accounts for more than half of the global steel output, producing about a billion metric tons. Before the market system was introduced, China was producing less steel than India does today.

The developmental notion behind steel production is simply that steel is a foundational building block at the base of the industrial system. Get that right, and the rest will follow. The argument is even more compelling for countries that produce iron ore in large quantities, as South Africa does. And yet it has led to perhaps the biggest policy misstep of the modern era in South Africa, something called the Price Preference System (PPS).  

It’s no accident that the system was supported by South Africa’s most left-wing trade and industry minister, Ebrahim Patel, who recently stood down. And because he has stood down, the question now falls to the new industry minister, Parks Tau, whether South Africa will continue down this benighted path. The topic of PPS is seldom discussed in South Africa because few people understand it, and it happens largely behind the scenes. 

But a recent report by Donald MacKay and Arista Nel from XA Global Trade Advisors takes apart the plan in some detail. The general idea was to artificially suppress the price of scrap metal and simultaneously encourage the development of scrap metal producers in order to reduce the price of steel in South Africa. The report finds that policies like PPS and export duties have led to artificial market conditions, benefiting a small group of mini mills and steel producers at the expense of broader economic efficiency. 

The PPS rules have been around since 2013. One of the things they do is deny scrap recyclers the ability to export unless they first offer their scrap to local consumers at a discount. The discounts range from 10% for non-ferrous metals to 30% for steel scrap, but the obstacles to export earnings don’t end there. If there are no local buyers, scrap recyclers can export – as long as they pay the export duty of between 10% and 20% depending on the metal in question, the report says.

A big part of the strategy was for the Industrial Development Corporation (IDC) to invest in mini mills, which process scrap metal, and that it did on an extraordinary scale. The introduction of PPS coincided with the IDC’s purchase of 75% of Scaw Metals (a steel industry supplier) for $430-million from Anglo American (R7.7-billion at today’s exchange rate; R3.4-billion at the time) and DHT purchasing the Cape Town Iron & Steel Company (Cisco) from Murray & Roberts for R80-million. Others followed. The sector is now the IDC’s most fragile investment by some margin.

All that has happened since is the amount of protection has increased. PPS was supposed to be replaced by export duties. Instead, both are now in place, and PPS has been extended to 2027. “The automotive industry receives R35-billion per annum in support. The scrap steel consumers alone receive a quarter of that in PPS discounts each year,” the report finds. 

And the job creation is minimal because mini mills are very capital intensive. XA does this interesting calculation:

The IDC has invested about R14-billion in scrap mills, which is only supporting about 3,000 jobs (R4.6-million in subsidies per job per annum). “Or if we only measure the R8.5-billion PPS subsidy, then around R2.8-million per job, about eight times as much as the automotive industry receives in subsidy per job and 60 times as much as clothing manufacturers, a labour-intensive sector, receives per job.”

It also costs jobs, because there are hundreds of thousands of waste pickers in South Africa, and the depressed price of scrap metal is an inadvertent cost to them too. And obviously it hurts Arcelor Mittal SA, which has always been the government’s bête noire.

It’s all just nuts. As the report says, “the mini mills industry, which South African factories, mines, SOEs and construction companies pour billions into each year, is the very definition of an industry with no comparative advantage. No matter how much money they are given, they will always need more. These are private sector companies receiving billions in bailouts each year.”

XA has a sensible suggestion: conduct an independent economic review of the scrap metal policy and make decisions based on evidence. That inevitably will mean phasing out PPS, and reallocating the funds to areas of comparative advantage and greater economic potential.

No irony there. Over to you, Mr Tau. DM