The benefits of localisation are overstated while the costs are dramatically understated

In recent months the government has articulated an approach to economic recovery and growth that can be encapsulated in the phrase “industrialisation through localisation”. This envisages growth of output and industrial capabilities flowing from policies that seek to redirect demand away from imports towards locally produced goods.

In this regard, the Department of Trade, Industry and Competition (DTIC) has designated nearly 30 products/product categories that government agencies must purchase either solely or in the main from local producers. At the same time, the “social partners” have reached an agreement at the National Economic Development and Labour Council that they will reduce South Africa’s non-petroleum imports by 20% over the next five years by redirecting spending to local manufactured goods.

Proponents of localisation argue that the switching of demand from foreign to domestic products has the potential to increase GDP, expand employment and sow the seeds for the development of increased industrial capability.

A new report by the Centre for Development and Enterprise, The Siren Song of Localisation: Why localisation policy will not lead to industrialisation, disputes those claims. It argues that the benefits of localisation are overstated while the costs are dramatically understated.

The case for localisation rests on the idea that protection of, and support for, specific industries will allow firms located in those industries to develop rapidly and become exporters. However, there is no evidence that the DTIC’s approach seeks to discriminate between industries in which comparative advantage might be developed and those in which this is not possible. As with much of the department’s industrial policy, every industry appears to be treated as a priority. Its decision to designate a product for local procurement by government agencies appears to be made on the basis of “evidence indicating that the government buys [the] product which is under distress caused by imports which displace local production and jobs.” This indiscriminate, one-size-fits-all approach to protectionism is a misguided, inefficient and expensive development strategy.

Localisation policy restricts government procurement decisions to the products made by local firms. Such a requirement is unnecessary unless, in its absence, the purchaser would have chosen to procure an imported product. It is reasonable to conclude, therefore, that the local product must be more expensive than the comparable import and/or of inferior quality. Requiring that a more expensive and/or an inferior good must be purchased raises the cost of doing business and the costs of delivering services. In either case there are negative implications for those who use products designated for localisation, and it is consumers, taxpayers or businesses who must ultimately foot the bill.

Proposals for localisation feature prominently in the industry master plans that the DTIC has been developing in conjunction with organised business and labour in a number of sectors over the past few years. A common feature of the master plans is their blindness or indifference to the implications of their proposals for the rest of the economy. When local content targets are included in master plans, the effect is often higher costs for consumers or downstream users of the industry’s products. The oft-repeated argument that master plan processes can help address bottlenecks in local value chains needs to be balanced by an awareness that there is a clear risk that the process serves to protect incumbent firms from further competition.

Apart from imposing higher costs, the DTIC’s quantity-based localisation restrictions, which stipulate that a certain percentage of designated goods must be sourced locally, reduce incentives on firms to become more efficient and innovate new products. Their market is guaranteed, and firms can secure a share of the market without having to become more efficient or to innovate.

The net effect is that one of the risks of localisation is that policy ends up supporting very inefficient firms – a risk that is especially acute when markets are dominated by a small number of players.

Another localisation-related cost is incurred when technical and design differences between a local product and the comparable imported item require that changes must be made to the design parameters of an entire project. A local pump or local piping, for example, might have technical specifications that are different from the design parameters of the most appropriate product, resulting in cascading changes elsewhere that will raise costs of production and/or maintenance or will affect overall operations.

Raising costs and/or lowering the quality of their goods obviously has implications for firms’ ability to compete in export markets, suggesting that an entirely plausible effect of localisation policy will be a reduction, rather than an expansion, in exports.

The DTIC justifies localisation policies by claiming that South Africa has an “over-propensity” to import. It argues that GDP would rise by five percentage points if non-petroleum imports were reduced by 20%. They report having secured agreement with business and labour to achieve this goal within five years.

There are several problems with the DTIC’s reasoning.

First, the data do not support the DTIC’s claim that South Africa devotes a disproportionately large share of its GDP to imports. South Africa’s imports as a share of GDP are very much in line with other countries.

South Africa’s poor economic performance has nothing to do with an “over-propensity” to import, and everything to do with a range of well-known and self-inflicted policy and governance injuries. The claims made on localisation’s behalf are simply not credible.