Aug 10, 2021

South Africa's developmental model: The significance of state-owned enterprises

Occasional paper 4/2021

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Views expressed in this report do not necessarily represent the views of the Inclusive Society Institute or those of their respective Board or Council members or Members.

August 2021

Author: Isaac Matshego

BCom Hons, MCom

Introduction

The development model pursued in South Africa is neither a laissez-faire approach nor a state-controlled and dominated economy. The United States Congressional Research Service (2020:12) characterises the South African government’s development model as a fusion of pragmatic support for private sector-led growth with state-centric economic planning. The role of the state in economic development is encapsulated in the National Development Plan 2030 (NDP 2030) (RSA, 2012), which envisions the achievement of a ‘capable and developmental state’. This model of development, which places public entities at the core of developmental initiatives, was conceptualised by Johnson (1982). Johnson contrasted the Japanese industrialisation model with the private sector-centred approach adopted by the United States and the United Kingdom. He described the Japanese model as the ‘capitalist developmental state’, or ‘developmental state’ for short. In this model, public entities assume the principal role in planning and executing industrialisation and overall development programmes. This development model was replicated, with considerable success, by most East Asian economies and was particularly successful in Singapore.

Historically, South Africa has pursued a developmental state model. Before the democratic transition in 1994, state-owned enterprises (SOEs) played a leading role in electricity provision, steel production, road network management, and even the development of technology to refine coal to fuel. The privatisation programme that started in the late 1990s under the Growth, Employment and Redistribution Programme led to the steelmaker being sold off entirely to private investors on the one extreme, and the partial privatisation of the telecommunications operator, while Eskom and Transnet remained wholly state-owned at the other end of the extreme. Therefore, SOEs still play the leading role in electricity and water provision, as well as operating the rail network, among other functions.

This article analyses the challenges encountered on the development front in South Africa, focusing on the shortcomings posed by poorly run SOEs in helping to achieve the goals of the NDP 2030. Firstly, a brief synopsis of the current state of the economy and shortfalls in infrastructure development are presented. A discussion of the weak state of local SOEs is then followed by proposed measures to stabilise and strengthen the management and governance of these entities.

State of the economy

The South African economy can be characterised as having failed to facilitate the achievement of short-term economic targets and longer-term development goals, that would in turn have raised incomes and uplifted the livelihoods of citizens. Job creation has hardly kept up with labour market growth. Moreover, per capita GDP, an aggregate measure of personal income trends, has contracted since 2015. Even before the onset of Covid-19, indicators of the state of the economy were significantly lagging behind the targets set in the NDP 2030. The economic growth rate was below 2% a year since 2014 and has furthermore declined through the years to a meagre 0.2% in 2019, averaging only 1.7% per year since 2010.

Among others, the critical objective in the NDP 2030 is to boost employment. The goal was to reduce the unemployment rate to 14% by 2020 and to 6% by 2030. This target required an average annual economic growth rate of between 5% and 6% throughout the entire period of almost two decades to 2030. However, the 2020 target for the unemployment rate has been missed, and it is looking increasingly unlikely that the rate will be cut by more than half over the next nine years. In fact, the unemployment rate breached 30% in 2020 after it hovered at around 29% over the course of 2018 and 2019. It is also worth noting that these figures are based on the official, narrow definition of unemployment that counts only workers who are actively seeking employment. Once discouraged workers are included, the rate of unemployment is actually close to 40%.

South Africa records a mixed performance in the assessment of the quality of infrastructure development. InfraCompass is an initiative of the Group of 20 that assesses the quality of infrastructure development among 81 countries that account for 93% of global economic activity. South Africa is the top performer in Africa in terms of infrastructure development but ranks poorly among the upper-middle-income countries in the survey. In terms of positive indicators, South Africa ranks in the top 10 among all countries in terms of the quality of financial markets’ infrastructure, 12th in planning and 23rd in procurement. However, the country performs poorly in governance (35th), regulatory frameworks (46th), funding capacity (47th), permits (51st) and activity (61st). In the InfraCompass 2020 survey, it did poorly in the value of closed public-private partnerships (PPP) infrastructure deals (scoring just 5.5 points out of 100), which totalled only 0.03% of GDP, compared with the upper-middle-income country average of 0.3%, and in terms of value of closed infrastructure deals with foreign equity ownership, scoring only 7.1 out of 100. These low scores suggest a preference for traditional infrastructure models that are constrained by the capacity of the government and the SOEs to raise debt financing for infrastructure projects.

The state of South African SOEs

The significance of SOEs in infrastructure development and financing and mobilising private sector funds is elucidated in Amman et al (2016). The paper highlights the role of infrastructure investment in Brazil by reviewing hindrances to infrastructure development, highlighting regulatory constraints and the burden posed by poorly managed SOEs. These entities play a similarly significant role in South Africa. Ehlers (2014) analyses the challenges related to raising infrastructure finance across the world. Ehlers (2014) and Amman et al (2016) surmise that developing economies with poor records of economic development, limited domestic long-term capital markets and sub-investment grade credit ratings incur high capital costs. This situation ultimately limits their ability to build infrastructure at the lowest cost possible.

The difficulties engulfing local SOEs, which have resulted in their failure to be drivers of development in the country, are well documented. Most of the rot in the local SOEs appears to have set in over the past decade. Before then, the large SOEs paid dividends to the public treasury regularly. Eskom was a well-managed power utility that won global awards and had a better credit rating than the government in the early 2000s. Transnet secured concessions to operate rail ports in a few southern African countries. South African Airways (SAA) won several global awards, including for being the leading airline in Africa.

The extent of the current troubles in these entities has been laid bare at the Commission into Allegations of State Capture, commonly known as the Zondo Commission. Poor management, political interference in operational matters, high debt, weak balance sheets and a shortage of critical skills afflict the entities at the centre of the government’s developmental agenda. These factors have led to poor investment outcomes by these SOEs. Eskom’s generation capacity expansion programme, which started more than a decade ago, has bequeathed to the country poorly built power stations that cost much more than budgeted. In the meantime, power supply shortages remain a burden on the economy. The collapse of SAA is attributable to political and board interference in operational matters, while Transnet acquired rolling stock that is not suitable for the local railway network.

SOEs have been a significant burden on the fiscus. The National Treasury transferred a cumulative R232.3 billion to the large SOEs between 2008 and 2020, while another R42.2 billion has been budgeted for 2021 to 2024. The bailouts, most of which are for the power utility Eskom (Table 1), are contrary to the management guidelines set by the National Treasury. The policies dictate that SOEs should be well-managed entities with the capacity to raise developmental financing on the strength of their balance sheets (National Treasury, 2010:95).

Public sector corruption and the mismanagement of SOEs inhibit the development of economies, particularly those that have pursued a developmental state model. Mauro, Medas and Fournier (2019) elucidate how corruption diminishes public trust by encouraging tax avoidance and even evasion, which often results in spending on social functions (education, health and even security) being lower in countries with a high prevalence of corruption. Corruption in public contracts ‘distorts the activities of the state and ultimately takes a toll on economic growth and the quality of people’s lives’, with the aggregate ‘cost of corruption being greater than the sum of lost money’ (Mauro, Medas and Fournier, 2019:26). Corruption and the mismanagement of SOEs are not confined to South Africa or developing economies. Japan’s own ‘arms deal’ in the 1970s had government officials accepting bribes in return for approving contracts for the purchase of US military craft (Mauro, Medas and Fournier, 2019).

The positive news in the case of South African SOEs s is the excellent state of the development finance institutions (DFIs). The Industrial Development Corporation (IDC) plays a leading role in industrial financing in the country and facilitates the entry and expansion of previously disadvantaged industrialists. The Development Bank of Southern Africa (DBSA) has proven itself a world-class infrastructure financier in the domestic market and Southern African region. The Land Bank, despite its recent financial difficulties, also remains a significant partner for emerging farmers in particular. Other DFIs fill a critical financing void in ensuring funding for small businesses, an area of growth identified as crucial for job creation in the NDP 2030. The generally good state of the DFIs is additional proof that South Africa can have SOEs managed prudently and that they are facilitators of development in a capital-constrained economy.

The significance of SOEs in South Africa extends beyond their socioeconomic objectives of transforming the economy to a more inclusive one. They are at the centre of the government infrastructure build programme, with most of the government’s infrastructure megaprojects being planned based on cooperation between national departments and SOEs. The National Treasury (2021:157) shows that the rollout of the government’s R791.2 billion infrastructure development programme over the fiscal years ending in March 2024 will be driven by SOEs, accounting for 37% of the spending.

Stabilising and improving the management and governance of SOEs

Stabilising SOEs is, therefore, one of the critical components for improving the developmental objectives. Mauro, Medas and Fournier (2019:29) conclude that curbing corruption ‘starts with domestic political will, continuous strengthening of institutions to promote integrity and accountability, and global cooperation’. Progress has been made in stabilising local SOEs in recent years. New boards and management have been appointed at Eskom and Transnet, among others. Leadership at the entities that have historically operated efficiently, such as the Airports Company of South Africa, has been strengthened. The restructuring of Eskom into three separate entities will help to make it more operationally efficient. The establishment of the Transnet National Ports Authority as an independent subsidiary of the Transnet Group has also been announced.

Other positive developments include the establishment of the Infrastructure Fund. The fund is housed in the DBSA and will coordinate PPPs between public entities and the private sector. Additionally, ‘Operation Vulindlela’ aims to ensure the efficacy and coordination of infrastructure spending across the public sector. Some progress has therefore been achieved, but more is still to be done.

Deloitte (2019) stresses critical tenets for the efficient and effective operation of SOEs:

Clarity of purpose. SOEs play a significant role in extending economic and social services that the private sector cannot provide at reasonably affordable costs to consumers. In this case, the mandate of SOEs and the justification for their participation in such activity must be elucidated to avoid conflict with the role of the private sector.
Management of SOEs. A clear separation of the roles of management, the board and the shareholder help to inhibit interference in operational matters by those appointed to fulfil fiduciary and oversight functions. The government, as the shareholder, must act boldly to address mismanagement where such measures are justifiable.
Importance of capital management. In pursuing their developmental mandate, SOEs commit to strategic projects that are predominantly funded through long-term debt. Therefore, capital management should be divorced from the whims of those in power, who are often influenced by short-term political and pecuniary goals.
Fiscal health. Prudent management of the SOEs that shields them from the influence of the executive arm of the government contributes to building well-run entities that become dividend payers to the fiscus instead of relying on bailouts. To this end, establishing an independent board to oversee policy implementation and enforce proper governance and management of SOEs is necessary. At the same time, the government department under which the SOE falls fulfils an additional governance role. Singapore established Temasek Holdings in 1974 as its SOE-holding company, and the company has been transformed into the country’s sovereign wealth fund with stakes in various industries across the globe. China has successfully housed its SOEs in the State-owned Assets Supervision and Administration Commission, which is accountable to the State Council (the Executive arm of government), since the 2000s.

Implementing these measures will set local SOEs on a path to better financial positions and improve their contribution towards achieving the country’s developmental goals. Better managed SOEs with solid balance sheets will improve the credit ratings of these entities and enable them to raise capital in local and international markets under favourable terms.

Conclusion

South Africa continues to pursue a developmental state model. Consequently, SOEs are central to the government’s developmental plan. South Africa’s socioeconomic fabric is similar to Brazil’s, and the country is similarly highly dependent on SOEs for the rollout of national economic and social infrastructure. Therefore, the need to strengthen local SOEs and improve their contribution to development objectives is of paramount importance. Well-functioning SOEs will facilitate the NDP 2030 objectives of strong economic growth and the significant reduction of unemployment and poverty.

Measures have already been implemented to improve the management and governance of key SOEs. The government has also put in place policies and entities to facilitate closer cooperation between the public and private entities involved in infrastructure development. The establishment of an overseeing authority of SOEs, in the form of a holding company made up of retired executives from both the public and the private sectors, will help to cushion them from political interference. The management of the SOEs must be aligned with the long-term objectives laid out in the NDP 2030.

These steps will help lift confidence, facilitate greater cooperation in fixed investment by the public and private sectors, boost economic growth, ultimately stimulate job creation, ensure reliable energy supply, and eradicate logistical bottlenecks that constrain the country’s export capacity.

Table 1: Summary of recapitalisations and bailouts of state-owned companies

Source: National Treasury

References

Amman, E., Baer, W., Trebat, T. E Lora, J.V. 2016. Infrastructure and its role in Brazil’s development process, The Quarterly Review of Economics and Finance, 62:66−73.

Congressional Research Service. 2020. South Africa: Current Issues, Economy, and U.S. Relations, Congressional Research Service, R45687, September. [Online] Available at: https://crsreports.congress.gov/product/pdf/R/R45687 [accessed: 27 July 2021].

Deloitte. 2019. Gearing for Growth: Restructuring SOEs for improved governance and performance, in Gearing South Africa for Growth. Johannesburg: Deloitte.

Ehlers, T. 2014. Understanding the challenges for infrastructure finance, BIS Working Papers No 454. Basel: Bank for International Settlements.

InfraCompass. N.d. Infrastructure Futures Report. [Online] Available at: https://infracompass.gihub.org/ [accessed: 27 July 2021].

Johnson, C. 1982. MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925 – 1975. Stanford: University Press.

Mauro, P., Medas, P. & Fournier, J-M. 2019. The Cost of Corruption, in Finance and Development. Washington: International Monetary Fund.

Republic of South Africa (RSA). 2012. National Development Plan 2030. [Online] Available at: https://www.gov.za/issues/national-development-plan-2030 [accessed: 27 July 2021].

National Treasury. 2010. Budget Review. [Online] Available at: http://www.treasury.gov.za/documents/national%20budget/2010/default.aspx [accessed: 27 July 2021].

National Treasury. 2021. Budget Review. [Online] Available at: http://www.treasury.gov.za/documents/national%20budget/2021/default.aspx [accessed: 27 July 2021].

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This report has been published by the Inclusive Society Institute

The Inclusive Society Institute (ISI) is an autonomous and independent institution that functions independently from any other entity. It is founded for the purpose of supporting and further deepening multi-party democracy. The ISI’s work is motivated by its desire to achieve non-racialism, non-sexism, social justice and cohesion, economic development and equality in South Africa, through a value system that embodies the social and national democratic principles associated with a developmental state. It recognises that a well-functioning democracy requires well-functioning political formations that are suitably equipped and capacitated. It further acknowledges that South Africa is inextricably linked to the ever transforming and interdependent global world, which necessitates international and multilateral cooperation. As such, the ISI also seeks to achieve its ideals at a global level through cooperation with like-minded parties and organs of civil society who share its basic values. In South Africa, ISI’s ideological positioning is aligned with that of the current ruling party and others in broader society with similar ideals.

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