By Dr Ross Harvey, director of research and programmes at Good Governance Africa (GGA)
Late last year, a colleague – Pranish Desai – and I published a peer-reviewed journal article trying to identify whether southern Africa was afflicted by a phenomenon now known as “premature deindustrialisation”. A Harvard scholar, Dani Rodrik, had identified a pattern in developing countries of manufacturing decline sooner than their industrialised counterparts, and at lower levels of income.
In other words, developing economies were transitioning into low-value services before having utilised the manufacturing bandwagon to build a prosperous, broad-based economy. This is obviously concerning, as manufacturing has been the traditional channel through which to absorb labour and build a sustainable middle class empowered to hold its political and business elites to account. African countries are increasingly afflicted by growing youth unemployment and, given that Africa will be the only fertility-positive continent on the planet by about 2050, we are concerned about future employment prospects for young people.
In our paper, we did indeed find econometric evidence for premature deindustrialisation in southern Africa. “We find that there is good reason to believe that the SADC group of countries is emerging as a region where deindustrialisation in both employment and output terms is growing more distinct.” In our regressions – a statistically rigorous way of determining a potential causal relationship between two variables – we found that “a reliance on oil and mineral rents is negatively correlated with industrial employment and manufacturing output”, which suggests Dutch Disease. “This could be curbing industrialisation prospects in many oil and mineral reliant countries in both SADC and Africa as a whole”. Dutch Disease was originally identified in the Netherlands, where growing oil wealth was strangely correlated with manufacturing decline. Economists typically posit that the disease works as follows: The sale of a raw commodity increases the demand for that country’s currency, which then appreciates as a result. However, such appreciation renders the country’s manufacturing exports relatively more expensive in global terms, undermining their competitiveness. Concomitantly, the extractive industry sectors draw resources away from manufacturing sectors (especially during commodity price booms), which further impairs industrial competitiveness. There have been many wrong-headed attempts to address this phenomenon, many based on poor diagnoses or a naïve presumption about the actual causal mechanisms behind the disease. This is like treating cancer with TB medication. It won’t work.
So, we set out to establish whether in fact there was good evidence for Dutch Disease in South Africa. If so, what are its likely causal pathways or patterns, and what can practicably be done to address them? In a forthcoming paper, colleagues and I at Good Governance Africa show that there is actually good statistical evidence to suggest that Dutch Disease is afflicting South Africa. When we interact a South Africa dummy with mineral rents (to tease out country-specific effects in our sample of comparator countries), we find a strong negative effect on manufacturing output that is significant at a 90% confidence level. We also see a negative impact on industrial employment (as a share of overall employment) but no statistical significance there. In other words, that effect could be explained either by other variables in the model or variables outside the model.
Critics of models like the ones we’ve run typically suggest that it’s impossible to isolate and specify the impact of a country’s mineral rents and assert that they are primarily responsible for weak manufacturing performance. However, this is why we control for other factors that the economic literature suggests could also play a role in mediating the relationship. After controlling for institutional quality – typically the strongest explanatory factor in ascertaining why resource endowments often cause underdevelopment – we found that the effects still held. What we think is going on here is that South Africa’s mineral rents (despite a paralysed mining industry increasingly in crisis) have played a partial role in undermining the country’s institutional quality. This, in turn, has had a negative effect on manufacturing competitiveness through undermining the country’s overall investment-attractiveness.
Another possibility is that the electricity crisis, starting in 2008 and climaxing in 2023 (or may still yet peak after the May 29 elections) may be the primary factor explaining manufacturing decline. However, when we controlled for electricity consumption in the sample, the overall efficacy of the model deteriorated, probably because the variable’s effect was already being picked up in other factors we had controlled for. Another option is simply that globalisation has undermined South African manufacturing attractiveness – labour is cheaper elsewhere, and skills and electricity availability are stronger. We haven’t controlled for that in the modelling, so of course it remains an option. But all countries in the sample would have been affected by that, so we still can’t override what we’re seeing – mineral rents seem to be driving down manufacturing output in South Africa specifically.
So, what can we do about it? Two simple things (and two more difficult prerequisites). First, we need an industrialisation strategy that begins – perhaps ironically – with strengthening the investment-attractiveness of the mining industry. We need more money to flow into exploration and production expansion. Second, we need to ensure that a growing mining industry is integrally connected to green industrialisation that will generate broad-based development. This must serve as the foundation for a much more diversified economy. But, for any of this to happen, we need two other pre-requisites to be in place:
1) Improved political governance – we need electoral system reform, alongside parliamentary rule reform, to ensure greater accountability for our errant politicians and government officials. Moreover, we need radical strengthening of key institutions such as the Hawks and the National Prosecuting Authority to deepen deterrence effects to prevent corruption.
2) Improved fiscal transparency. South Africa needs to join the Extractive Industries Transparency Initiative, and it must expedite getting off the Financial Action Task Force’s grey list. The longer we stay on that list, the more expensive it is for us to service our debt and the less likely we are to attract investment.
