SOUTH AFRICA ECONOMIC UPDATE INNOVATION FOR PRODUCTIVITY AND INCLUSIVENESS Edition 10 | September 2017 | World Bank Group Public Disclosure Authorized © 2017 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street NW Washington, DC 20433 USA All rights reserved Photos: Flickr, Shutterstock and World Bank. CONTENTS Contents i Acknowledgements iii Foreword iv Abbreviations v Executive Summary vii CHAPTER 1 CHAPTER 2 Recent Economic Developments 1 Innovation for Productivity and Inclusiveness 25 Global Economic Developments 2 The Role of Innovation in Meeting South Africa’s Real Sector Developments in South Africa 4 Economic and Social Goals 26 Labor Market Developments in South Africa 12 An Overview of South Africa’s Ecosystem for Fiscal Developments in South Africa 18 Innovation and its Performance 33 Inflation and Monetary Policy in South Africa 20 What More Can Be Done to Encourage Private External Sector in South Africa 21 Innovation in South Africa? 46 The Outlook for South Africa 22 Conclusion 54 References 55 FIGURES Figure 1.1: Global activity indicators 2 Figure 1.2: Global financial conditions 3 Figure 1.3: Growth in mining and agriculture, and major industry and services 5 Figure 1.4: Capacity under-utilization and investment in the manufacturing sector 7 Figure 1.5: Corporate, government, and household savings/dissavings 8 Figure 1.6: South Africa TFP gains and losses, within and between sectors 9 Figure 1.7: TFP growth within sectors 9 Figure 1.8: High-tech manufacturing investments in machinery and equipment in South Africa 10 Figure 1.9: Total factor productivity levels relative to the United States (1994 and 2014) 10 Figure 1.10: TFP growth in BRICS 11 Figure 1.11: Firm performance – micro to large enterprises 12 Figure 1.12: Unemployment by skills level, 2008–2017 12 Figure 1.13: Employment in the manufacturing sector 13 Contents | South Africa Economic Update 10 | i Figure 1.14: Nominal wages and unemployment in emerging markets 14 Figure 1.15: South African average monthly wages and employment creation by skill-set 15 Figure 1.16: Poverty duration and income source 17 Figure 1.17: Public debt and South Africa’s credit rating 18 Figure 1.18: Credit ratings downgrades and foreign-held debt 19 Figure 1.19: Revenue collection (fiscal year 2017/18) 20 Figure 1.20: Consumer price index inflation 20 Figure 1.21: South African exports to fast-growing economies 21 Figure 2.1: Growth in employment by occupation, 1979-2012 27 Figure 2.2: Impact of sectoral innovation on job creation and consumption by poorest households 28 Figure 2.3: Sectoral rates of return to capital 30 Figure 2.4: Uber trips in Johannesburg-Pretoria (2015, 2016) 31 Figure 2.5: Percentage of LinkedIn members per city that are active entrepreneurs 36 Figure 2.6: Percentage of LinkedIn network comprising entrepreneurs abroad 36 Figure 2.7: R&D expenditure in BRICS countries 37 Figure 2.8: Private R&D spending by sector in South Africa 37 Figure 2.9: Share of young firms in South Africa and other emerging economies 39 Figure 2.10: R&D intensity in the United States (1991–1995) and South Africa (2009–2014) 40 Figure 2.11: R&D intensity of top global, Chinese, and South African R&D spenders 42 Figure 2.12: South African exports (2005 vs 2015) 43 Figure 2.13: High-tech exports in BRICS countries 43 Figure 2.14: Technological content of exports per destination (2010-14) 45 Figure 2.15: Internal and external factors affecting innovation 46 TABLES Table 1.1: Contributions to GDP 6 Table 1.2: Sectoral determinations and the national minimum wage (2015 prices) 16 Table 1.3: Baseline annual growth forecasts 23 Table 2.1: Innovation and competitiveness indices 34 Table 2.2: Scientific production in BRICS countries 34 Table 2.3: Patent Cooperation Treaty top applicants 35 Table 2.4: R&D expenditure and intensity by sector 41 Table 2.5: Export value of different technology levels in South African total exports 44 Table 2.6: South Africa’s top five export products per technology group (2014) 45 Table 2.7: Median annual salary of selected jobs 49 Table 2.8: Skills in highest demand on LinkedIn, South Africa (2016) 50 BOXES Box 1.1: Addressing the youth employment crisis 13 Box 1.2: Incubating small businesses 24 Box 2.1: Pioneering carbon capture and storage in South Africa 32 Box 2.2: Using tax files data to assess private R&D patterns 40 Box 2.3: What does high-tech really mean? 44 Box 2.4: Adjusting migration policy to build the skills base 50 Box 2.5: Public programs to support entrepreneurship, technology absorption, and innovation 52 Box 2.6: Impact evaluations of innovation support programs 53 ii | South Africa Economic Update 10 | Contents ACKNOWLEDGEMENTS The 10th South Africa Economic Update was produced by a World Bank team comprising Yashvir Algu, Reyes Aterido, Wayde Flowerday, John Gabriel Goddard, Itzhak Goldberg, Marek Hanusch, Jemima Harlley, Charl Jooste, Gerard Kambou, Natasha Kapil, Mutoni Karasanyi, Mokgabo Molibeli, Helidah Ogude, Zandile Ratshitanga, Anna Reva, Jamele Rigolini, Mark Schaffer, Yirbehogre Some, Victor Sulla, Catherine Tovey, and Precious Zikhali, and led by Sébastien Dessus. It was internally peer reviewed by Smita Kuriakose and John Litvak, benefited from comments from Paolo Belli, Ejaz Ghani, and overall guidance from Mathew Verghis (Practice Manager, Macroeconomic and Fiscal Management) and Paul Noumba Um (Country Director for South Africa). Chapter 2 draws on the findings of a one-year research project with the National Treasury, which was led by Duncan Pieterse and Andre Steenkamp, and features initial results from a partnership with LinkedIn, coordinated by Paul Ko and Alan Fritzler, to develop diagnostics for policy makers based on LinkedIn data. The team is grateful to Imraan Patel from the Department of Science and Technology, Mlungisi Cele from the National Advisory Council on Innovation, and participants at a workshop in March 2017 for their valuable comments on the preliminary findings. It is also grateful to Catherine McLeod, Konstantin Makrelov, Mulalo Mamburu, Aalia Cassim, Ian Stuart, Trinish Padayachee (National Treasury), Godfrey Mashamba (Department of Science and Technology) and Mario Scerri, Rasigan Maharajh (Tshwane University of Technology), and for their constructive comments on an advanced draft of this report. The report was edited by Sandra Gain and Clarity Editorial, and designed by Cybil Maradza. Acknowledgements | South Africa Economic Update 10 | iii FOREWORD I am pleased to launch this 10th South Africa Economic Update which offers a review of the country’s recent economic and social developments and its outlook in the context of global economic prospects. It focuses on the role of innovation in fostering economic growth, creating jobs and reducing poverty in an environment in which more South Africans are getting poorer. Between 2008 and 2015, 4 out of 5 South Africans experienced poverty, some temporarily, some permanently. In recent years, two important vehicles of South Africa’s economic growth lost steam: high commodity prices and foreign direct investments, the latter being sanctioned in 2017 with the downgrade to sub-investment level. Meanwhile, South Africa diverged in productivity from main technological leaders, whereas private expenditure in research and development contracted. These developments highlight the pressing need to focus on innovation policy as an actionable tool for economic and social progress. Reviewing South Africa’s innovation strengths – academic excellence, entrepreneurial networks in large metros, a large array of operational public programs to support research and development, and weaknesses – a business environment insufficiently conducive to the emergence of innovative startups, a low skills base, a slow and expensive broad-band, high trading costs, the Update underlines the large untapped potential for innovation. Innovation can not only raise South Africa’s competitiveness and allow breaking into new markets and creating jobs. It can also significantly improve the life of millions of poor South Africans and their chance for economic participation, through the provision of better and cheaper goods and services, in health, transports, and e-government notably. Fundamentally, innovation can help South Africa diversify from its traditional commodity- based economic model which did not lead to the reduction of inequalities in last decades. The Update report builds on a solid research partnership between the Department of National Treasury, the Department of Science and Technology, the National Advisory Council on Innovation, Statistics South Africa, and the World Bank to better understand the drivers of innovation and how to maximize its social and economic impact. South African authorities are to be commended for making firms’ tax and export transactions data available to the research community, enabling a deeper investigation of the complex issues at stake. The Update’s findings also build on the ongoing cooperation between the national government, metros and the World Bank to improve the life of city dwellers, through better urban planning and management, and between Eskom and the World Bank to promote innovative energy solutions. As the World Bank, we stand ready to work with all stakeholders and support South Africa to fulfill its development agenda and contribute towards ending extreme poverty and promoting shared prosperity. It is our hope that South Africa will continue using the World Bank’s knowledge, global experience and convening power as a platform for peer-to-peer learning in the identification of evidenced based pragmatic solutions to reach the country’s National Development Plan’s goals. Paul Noumba Um World Bank Country Director for South Africa iv | South Africa Economic Update 10 | Foreword ABBREVIATIONS BRICS Brazil, Russia, India, China, and South Africa CO Carbon dioxide ² EMDEs Emerging markets and developing economies GDP Gross domestic product ICT Information and communication technology JSE Johannesburg Stock Exchange NT-SARS National Treasury-South African Revenue Service OECD Organisation for Economic Co-operation and Development PMI Purchasing Managers’ Index R&D Research and development StatsSA Statistics South Africa SMME Small, medium, and micro enterprise TFP Total factor productivity R South African rand Abbreviations | South Africa Economic Update 10 | v vi | South Africa Economic Update 10 | Executive Summary EXECUTIVE SUMMARY Global growth picked up in the second quarter of 2017, the insufficient innovation efforts of private firms, in reflecting improving conditions in advanced economies absolute terms and in comparison with peers in the and emerging market and developing economies last decade. Innovation is defined as the introduction (EMDEs), from pronounced weakness in the first half of new-to-the-world and new-to-the-firm goods, of 2016. Global growth is expected to increase from 2.4 services, business practices, and organizational percent in 2016 to 2.7 percent in 2017 and 2.9 percent methods. While not a perfect metric, the drop in private in 2018, as commodity prices and financial markets research and development (R&D) expenditures, which continue to stabilize. by some estimates is about 40 percent lower than in 2009, suggests a growing innovation gap relative to South Africa also emerged from recession in the second many peers. From a productivity standpoint, South quarter of 2017. This is good news, but this growth Africa is falling behind leaders in technology. is unlikely to restore positive per capita GDP growth in 2017, following negative per capita growth in 2015 Building on the examination of big data from tax forms, and 2016. Between 2011 and 2016, per capita incomes export transactions, and professional networks, this barely increased and more than 3 million people have 10th South Africa Economic Update underscores the joined the 30.4 million poor South Africans now living large untapped potential of innovation that could be on less than R1,131 per month (about US$2.9 a day). mobilized to advance South Africa’s economic and Between 2008 and 2015, almost 80 percent of South social development goals. Given the country’s medium Africa’s population experienced poverty, about half level of economic sophistication and diversification, permanently and the other half intermittently. there is wide scope for adapting foreign technologies, and turning private R&D into a more powerful driver of Insufficient economic growth is pushing South Africa corporate profitability and economic growth. Despite into a vicious circle: insufficient tax revenue raises the widespread fears that automation will result in a risk of public debt distress, which plays an important loss of jobs, our estimates suggest that greater R&D role in the downgrade of South Africa’s sovereign credit efforts are actually likely to create more jobs rather rating in early 2017. The credit rating downgrade in than shed jobs in net terms. The resilience of the South turn reduces investors’ appetite for South Africa, African high-tech manufacturing sector, at a time when where their investments would support much-needed lower-tech manufacturing sectors are shedding jobs, growth. Insufficient revenue and more complicated illustrates this point. Moreover, innovation can improve borrowing terms also limit the government’s capacity the lives of millions of people, particularly poor people, to support the economy and its citizens. by improving goods and services. Introducing disruptive technologies can lower barriers for competition and Apart from a drop in global commodity prices, domestic expand economic opportunities. factors such as drought, electricity shortages, logistical constraints, and difficult labor relations have To realize this potential, South Africa’s innovation contributed to South Africa’s poor growth performance strengths – academic excellence, and the concentration in recent years. Although authorities are working to and connectedness of centers of innovation in large address some of these factors, South Africa is today metros – need to be integrated more effectively with much less productive than it was before the financial the rest of the economy. Innovation can only have a crisis. With the same amount of economic resources strong economic and social impact if commercialized – natural resources, capital, and labor – South and brought to a large number of beneficiaries. This Africa produced 6 percent less in 2016 than in 2007. can be done in several ways, detailed below. A critical contributing factor to this deterioration is Insufficient economic growth is pushing South Africa into a vicious circle Executive Summary | South Africa Economic Update 10 | vii Foster a business climate conducive to innovation Nurturing South Africa’s entrepreneurs and innovative Access to finance is a major challenge for small companies requires a business climate that is more businesses. Their access to credit is constrained by conducive to the entry and growth of new firms, and to two factors – lack of suitable financial products offered risk-taking and experimentation. This requires reviewing by banks and inadequate capacity of small business product market regulations that favor incumbents and founders to present their funding needs to financial cutting red tape, which tends to disproportionately institutions. The government is working with banks to affect small and young firms where large innovation remove the risks of lending to small businesses and to potential lies. Legal reforms and peer learning among provide these enterprises with direct loans. It is important local governments could go a long way in improving to scale up these programs. Relative to the size of the the business climate. By combining the nine largest financial system, the venture capital raised by South metros’ best practices in obtaining construction Africa’s start-ups remains small, particularly in funding permits, getting electricity connections, and enforcing for new-to-the-world technology intended for global contracts, it would be possible to boost South Africa’s markets. To identify the growth drivers, further research relative performance to a level above the average in is needed into the types of early-stage companies that high-income Organisation for Economic Co-operation are obtaining funding. Then policy options need to be and Development (OECD) countries. Innovation itself can reviewed for growing equity investments into young play a major part in reducing costs and cutting red tape, high-growth firms. because e-government solutions can simultaneously improve services and stimulate growth in the information High and uneven ports tariffs discourage innovation. A and communication technology (ICT) industry. One- large share of innovation efforts are focused on goods, stop shops and electronic platforms for public service and innovative companies are more likely to export their delivery introduced in various emerging economies have products by sea than companies that do not innovate. reduced the time and cost of complying with government Although port costs have declined significantly since 2012, regulation and mitigate the risk of corruption. they remained 88 percent higher than the global average in 2016/17. Bringing down cargo and inland handling costs, Policy uncertainty needs to be limited. In the case of and improving port efficiency, can support innovation. innovation, delays and uncertainties surrounding the Furthermore, South Africa’s port tariffs continue to favor reform of the intellectual property rights regime have the transport of minerals over manufactured goods. This been a longstanding concern, and limit the usefulness increases the cost of technology absorption that occurs of patents granted in the country. Persistent uncertainty via the import of capital goods in the form of advanced regarding the future of power purchase agreements, technology. It also makes the country a less competitive the copyright amendment bill, and the ICT regulatory destination for export-oriented industries. framework may also deter investment in innovation. Nurture innovation ecosystems in cities Innovation happens in cities. In addition to striving to access to equipment and experts in the public research match the best business practices of international and education system, to creating centers of excellence metros, South African metros could build on their and encouraging collaborative research programs existing network of innovation programs and cluster between companies and research institutions. Some them further around innovation districts. Fostering of these partnerships can be started at city level, but partnerships with the private sector, particularly many would also require support and funding from between academic institutions and private companies national departments. From a national perspective, of different sizes, would leverage existing research consideration needs to be given to building on existing capacity. Programs could range from open data resources, networks, and partnerships in the largest initiatives that use information collected by cities to metros when allocating resources to spur innovation. develop commercial applications and improve service Although this prioritization could run counter to delivery, to projects providing start-ups and small, balanced development objectives, it will raise the medium, and micro enterprises (SMMEs) with better impact of public programs for innovation. viii | South Africa Economic Update 10 | Executive Summary Build the skills base Labor shortages in high-skilled sectors, such as ICT, to improve the skills supply is to encourage highly skilled severely limit innovation. Increasing the supply of the professionals to work in South Africa. Recommendations highly skilled will take time, requiring strengthened in the government’s current migration white paper could primary and secondary education, and adult education, have significant implications for filling high-skills gaps in vocational training, and entrepreneurship programs that the labor market. build skills and create employment. A complementary way Improve ICT infrastructure A knowledge economy requires fast and cheap broadband infrastructure, strengthen competition, and broadband to connect businesses with domestic and improve the quality and reduce the price of ICT services. international consumers, and to enable the efficient It should be a priority to ensure the policy independence delivery of public services. But South African consumers of the regulator and confirm its field of action, so that are paying more for broadband services of lower speeds stalled processes such as 4G licensing can be expedited. than many other emerging economies. Urgent reforms Ultimately, the importance of ICT lies in its role in are needed to increase investment in mobile and fixed facilitating innovation in the economy as a whole. Enhance the effectiveness of public programs and incentives for innovation Government support programs are a formidable funding and adequate staffing of the agencies strength of South Africa’s innovation ecosystem. implementing innovation and entrepreneurship But there is scope to improve their effectiveness support programs. by consolidating program objectives, budgets, and management arrangements. The multiplicity R&D tax incentives prioritize new products and of programs, along with limited budgets, may be services. Extending the eligibility criteria to include fragmenting and reducing the impact of public funding absorbing technology from elsewhere will make for private sector development. It is important to incentives much more relevant for the large number evaluate the effectiveness of these initiatives (including of domestic firms that are not working at the their targeting, cost-effectiveness, and economic technological frontier. In addition, simplifying the R&D impact), set standards (for incubators in particular), tax incentive process and allowing firms that are not and consolidate and scale up the best performing yet profitable to benefit from it can help boost the programs. It is also important to ensure predictable growth of young firms in South Africa. Executive Summary | South Africa Economic Update 10 | ix CHAPTER 1 Recent Economic Developments 1 | South Africa Economic Update 10 | Chapter 1 Global Economic Developments The global economy is recovering Global growth picked up in the second quarter of 2017, managers’ index (PMI)¹ and export orders remained reflecting improving conditions in advanced economies expansionary in July and August, suggesting continued and EMDEs following pronounced weakness in the first robust production and trade momentum in the third half of 2016. The global manufacturing purchasing quarter (Figure 1.1). Figure 1.1: Global activity indicators A. Global growth B. Global industrial production and goods trade Percent volume growth Percent, quarter-on-quarter annualized 8 5 6 4 4 3 2 2 0 1 -2 16Q1 16Q2 16Q3 16Q4 17Q1 16Q1 16Q2 16Q3 16Q4 17Q1 0 2012 2013 2014 2015 2016 2017 2018 2019 Industrial production Trade World Advanced Economies EMDEs World 2012-16 average C. Global manufacturing PMI D. Commodity prices Index, 50 += expansion US$ nominal, 2010=100 54 54 140 140 120 120 52 52 100 100 8080 50 50 6060 48 48 4040 2020 46 46 00 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14 Jul-14 Dec-14 May-15 Oct-15 Mar-16 Aug-16 Jan-17 Jun-17 2010 2012 2012 2013 2014 2015 2016 2017 2018 2019 Manufacturing PMI Export orders Energy Metals Agriculture Sources: Haver Analytics, World Bank, CPB Netherland Bureau for Economic Policy Analysis. Notes: A. Aggregate growth rates calculated using constant 2010 U.S. dollars GDP weights. Shaded areas indicate forecasts. B. Last observation is 2017Q1. C. 3-month moving averages. Last observation is August 2017. D. Shaded areas indicate forecasts Activity is picking up in advanced economies, with the first quarter of 2017, growth in the United States investment and exports regaining momentum after recovered in the second quarter, to 3 percent (quarter-on- subdued growth in 2016. Following a slowdown in quarter seasonally adjusted annualized rate), supported 1 PMI is an indicator of the economic health of the manufacturing sector. A rating above 50 indicates expansion in the sector. A reading below 50 signals contraction. A reading of 50 indicates no change. Chapter 1 | South Africa Economic Update 10 | 2 by renewed strength in consumer spending. High- recovering from deep recessions in 2016. Nigeria frequency indicators point to robust third quarter growth recorded positive growth of 0.6 percent (year-on-year) in personal consumption, equipment investment, and in the second quarter. Growth in Russia accelerated export growth. The growth outlook for countries in the from 0.5 percent (year-on-year) in the first quarter of euro area has strengthened. Growth has also picked up the year to 2.5 percent in the second quarter. In Brazil, in Japan, supported by a recovery in external demand. gross domestic product (GDP) expanded further in the second quarter. In commodity-importing EMDEs, Among EMDEs, growth remained steady in China at accommodative policies are supporting domestic 6.9 percent (year-on-year) in both the first and second demand and a recovery in global trade is fueling quarters of 2017. EMDE commodity exporters are export growth. Figure 1.2: Global financial conditions A. Corporate bond spreads B. Commodity-exporting EMDE bond spreads and exchange rates Basis points Basis points Index, 100=Jan. 2016 600 500 130 500 400 120 400 300 300 110 200 200 100 100 100 0 0 90 2012 2013 2014 2015 2016 2017 2015 2016 2017 Global Emerging markets Bond spread Exchange rate (RHS) C. EMDE international bond issuance US$ billions 70 60 50 40 30 20 10 0 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Sovereign Corporate Sources: Bloomberg, Dealogic, International Energy Agency, World Bank, Haver Analytics. A. Spread between yields on non-sovereign debt with at least 18 months to final maturity and U.S. Treasury yields of equivalent maturity. Individual bonds are weighted by market capitalization. Dotted lines indicate the median values since 2005. Last observation is May 24, 2017. B. Medians of a nine-country group of EMDE commodity exporters are shown. Exchange rates are bilateral against the U.S. dollar, with upward movement showing an appreciation. Last observation is May 24, 2017. C. Last observation is September 5, 2017. 3 | South Africa Economic Update 10 | Chapter 1 Commodity prices continue to stabilize After averaging US$53 per barrel in the first quarter per barrel less than January forecasts, and to stabilize of 2017, oil prices fell below US$50 per barrel in early around US$54 per barrel in 2018. Metal prices have May. Oil production declined in early 2017 as a result surged from their late-2015 lows due to strong demand of agreed cuts by members of the Organization of the and tightening supply as China imposed environmental Petroleum Exporting Countries and some non-member restrictions on aluminum and zinc mines and processing oil producers. However, these cuts were partly offset plants. Agricultural prices have weakened, reflecting by stronger-than-expected shale oil production in the well-supplied key grain and oilseed markets after a United States. Oil prices are expected to average US$53 better-than-expected harvest. per barrel in 2017, up 24 percent from 2016 but US$2 Financial market volatility remains generally low Global financial conditions have been benign since the re-pricing of risk. In an environment of low market start of 2017 (Figure 1.2). Shortly after the U.S. elections volatility and robust risk appetite, emerging market of November 2016, the country’s long-term yields rose bond spreads³ have narrowed and equity prices have sharply, similar to their surge during the mid-2013 taper recovered. Bond spreads have narrowed most notably tantrum.² But, unlike the taper tantrum, the late-2016 among commodity exporters, while their currencies increase reflected market expectations of strengthening have generally strengthened. Overall, capital inflows growth and higher inflation in the United States, and to EMDEs have been strong in the first half of 2017, with was not accompanied by a sudden and sustained EMDE bond issuance activity increasing at a record pace. The global outlook is favorable From a post-crisis low of 2.4 percent in 2016, global expected to increase from 0.9 percent in 2016 to 1.8 growth is expected to increase to 2.7 percent in 2017 percent in 2017, while growth in commodity importers is and 2.9 percent in 2018, mainly driven by stronger projected to remain broadly stable at about 5.7 percent. growth in EMDEs. As the cyclical impulse wanes and Growth should rebound in Sub-Saharan Africa, but the monetary policy becomes less accommodative, placing recovery is expected to be slow, as some commodity upward pressure on interest rates, growth in advanced exporters – South Africa in particular – struggle to adjust economies is expected to gradually moderate. to low commodity prices. In contrast, robust growth is expected to continue in EMDE regions with substantial EMDE growth is expected to increase to 4.2 percent numbers of commodity-importing economies, such as in 2017, from 3.7 percent in 2016, reaching 4.6 percent East Asia and Pacific, and South Asia. in 2018/19. Growth in EMDE commodity exporters is Real Sector Developments in South Africa South Africa emerged from recession South Africa’s GDP growth slowed from 2013 to accommodation. The largest drag on growth in the 2017. Between the first quarters of 2013 and 2017, last three years came from agriculture, especially finance, real estate, and business services made the during 2015 and 2016 as a result of drought; largest contribution to growth, followed by general electricity, particularly in 2015 due to supply government services and trade, catering, and bottlenecks; and gas and water. Mining production ² Taper tantrum refers to the 2013 surge in U.S. Treasury yields, which resulted from the Federal Reserve’s gradual reduction (or tapering) in the amount of money it was feeding into the economy. In response, investors drew their money out of the bond market rapidly, which sharply increased bond yields. ³ The cost of raising funds outside the domestic market reflects two factors: the risk-free rate, which is accepted as the interest rate on a U.S. Treasury security with the same maturity; and a spread to reflect the greater risks that investors perceive as being associated with the issue or issuer. Chapter 1 | South Africa Economic Update 10 | 4 also fell as commodity prices declined, production In the first quarter of 2017, South Africa entered a was disrupted by strikes and infrastructure technical recession, defined as two consecutive constraints, and policy uncertainty and lower quarters of negative economic performance: GDP fell commodity prices limited expansionary investment. by 0.7 percent in the first quarter of 2017 (quarter- Manufacturing showed little movement, with on-quarter seasonally adjusted annualized rate), production stagnating. The slowdown in GDP following a contraction of 0.3 percent in the fourth growth is even more pronounced when measured quarter of 2016. It was the country’s first recession in per capita terms: since 2015, the country’s GDP since the global financial crisis and the associated grew more slowly than its population, leaving South economic downturn in 2008 and 2009. And, for the Africans worse off on average. first time since 1994, all sectors except mining and agriculture contracted in the first quarter of 2017. Figure 1.3: Growth in mining and agriculture, and major industry and services (Sectoral value added, seasonally adjusted annualized rate, 2015 Q1=100) 105 105 Joint share in GDP: 10.9% 100 100 95 95 90 90 Joint share in GDP: 55.0% 85 85 2015 Q1 2015 Q3 2016 Q1 2016 Q3 2017 Q1 2015 Q1 2015 Q3 2016 Q1 2016 Q3 2017 Q1 Agriculture Mining Finance Trade Manufacturing Source: Statistics South Africa (StatsSA) and World Bank staff calculations In the second quarter of 2017, South Africa emerged in summer crops and maize in particular. Maize from recession, led by agriculture and mining. Jointly, production is estimated to more than double from 7.8 these sectors account for 10.9 percent of GDP. World million tons in 2016 to 16.4 million tons in 2017, with Bank staff calculations suggest that multiplier effects the largest production increases in the Free State, from higher growth in the agriculture and mining Mpumalanga, Limpopo, and North West Province.⁵ sectors are low compared to other South African Higher production supports falling food prices, one sectors.⁴ But, given the magnitude of their growth of the main reasons for the drop in inflation in 2017. performance (agriculture alone grew by 21.1 percent This has left more disposable income in the pockets in the first quarter and 33.6 percent in the second of consumers and thus also supported sales in the quarter), the two sectors have been the main drivers retail sector in the second quarter of 2017, especially of growth in the first half of the year. in relation to food and clothing. Drought continues to affect some parts of South Africa, The mining sector also strengthened in the first half notably the Western Cape, but it has lifted in other of 2017 as a result of rising commodity prices and parts, boosting agriculture. Accordingly, the agriculture, fewer supply disruptions, such as at the Richards forestry, and fisheries sector has rebounded in the Bay coal terminal. But production remains depressed first half of 2017 (Figure 1.3), with bumper harvests by historical standards and, given weak investment ⁴ Multiplier effects measure the impact of higher growth in a given sector on the demand for goods and services from other sectors. ⁵ Source: http://www.sagis.org.za/CEC-Aug2017.pdf. Note: summer crops are harvested between May and August. 5 | South Africa Economic Update 10 | Chapter 1 in the sector, it is unlikely to become an engine board in the first quarter, moderate growth returned of growth in South Africa in the near term. The – except for in government services and construction. new Mining Charter remains a point of contention Manufacturing grew by 1.5 percent. Electricity, gas, between the South African Chamber of Mines and and water grew by 8.8 percent, supported by energy the Department of Mineral Resources. Uncertainty demand from factories and mines, and easing water around the details of the charter keeps investment in constraints. Manufacturing has been particularly the sector at bay. According to the Fraser Institute’s driven by food and beverages, cars and automotive 2016 survey of mining companies, South Africa ranked parts, and accessories and transport equipment. 91st in the category of “Uncertainty Concerning the Retail and wholesale supported growth of 0.6 percent Administration, Interpretation, and Enforcement of in the trading sectors. Finance, real estate, and Existing Regulations” among the 104 countries and business services grew by 2.5 percent, largely due jurisdictions surveyed. Less than a fifth of participating to greater financial intermediation, insurance, and mining houses felt satisfied regarding policy certainty trading in global financial markets. Improved private and political stability. consumption has supported activity in these sectors in the second quarter. Performance in industry and services was mixed in the first half of the year. Following a contraction across the Table 1.1: Contributions to GDP (Percentage point contributions to quarter-on-quarter seasonally adjusted annualized rate growth, expenditure approach) Gross Private Public Private Public Change in Exports of Imports of Domestic Consum. Consum. Gross Fixed Gross Fixed Business Goods & Goods & Product Expend. Expend. Capital Capital Inventories Non-Factor Non-Factor Formation Formation Services Services 2013 Q1 1.9 0.9 0.6 1.3 0.5 0.0 1.0 -2.6 2013 Q2 5.0 1.4 1.3 2.1 0.2 2.9 1.6 -4.4 2013 Q3 0.9 0.2 -0.1 1.7 0.5 -3.2 1.8 0.0 2013 Q4 5.6 -0.3 0.4 0.5 0.5 -3.4 1.4 6.5 2014 Q1 -2.5 0.0 0.4 -1.9 0.1 -2.3 4.4 -3.2 2014 Q2 1.0 0.4 0.1 -0.4 0.3 5.6 -7.9 2.8 2014 Q3 2.0 1.5 -0.3 1.4 -0.1 -1.4 3.3 -2.5 2014 Q4 4.5 1.4 0.0 0.9 0.0 0.0 4.6 -2.5 2015 Q1 1.8 1.2 -0.1 -0.7 1.4 6.1 -0.4 -5.6 2015 Q2 -2.7 0.0 0.3 -1.0 0.6 -8.5 2.7 3.2 2015 Q3 0.4 1.4 0.5 0.2 0.9 -0.7 -0.8 -1.1 2015 Q4 1.6 0.9 0.6 -0.7 -0.3 2.3 0.2 -1.3 2016 Q1 -1.7 -0.9 0.3 -1.9 -0.4 -1.1 -1.4 3.6 2016 Q2 3.6 0.7 0.6 -0.3 -0.3 -4.6 4.8 2.7 2016 Q3 0.4 1.3 0.4 -0.7 0.0 6.2 -7.1 0.3 2016 Q4 -0.1 1.3 0.1 -0.2 0.5 -3.5 3.4 -1.8 2017 Q1 -0.7 -1.7 -0.4 0.1 0.1 3.0 -1.0 -0.9 2017 Q2 2.4 2.8 0.2 -0.5 -0.2 4.1 -3.9 Source: StatsSA and South African Reserve Bank. Chapter 1 | South Africa Economic Update 10 | 6 Household expenditure contracted in the first quarter of Exports had a weak start to the year, contracting by 2017, but increased to 2.8 percent growth in the second 3.2 percent in the first quarter of 2017, led by mineral quarter. While lower inflation has undoubtedly supported products, vehicles, and transport equipment. The household budgets, South African consumers continue second quarter saw a rebound of 14.4 percent growth in to face considerable challenges. The Bureau of Economic exports, reflecting the good performance of the mining Research consumer confidence indicator remains and automotive manufacturing sectors. Mining exports negative, falling from -5 in the first quarter of 2017 to drew on both strong production in the second quarter and -9 in the second quarter. Household spending power is inventories built up in the first quarter. The automotive also constrained by low real wage growth and slowing sector accumulated inventories. Yet, in spite of such credit extension. Total compensation of employees grew temporary improvements, comparing the first halves by only 1.1 percent in the first half of 2017 (year-on-year of 2016 and 2017, export growth was zero, suggesting in real terms), with wage growth below inflation since that overall the manufacturing response to opportunities 2012. Private consumption grew at the same rate in that in global markets remains timid. The PMIs of 42.9 and period. While private consumption was the strongest 44.0 in July and August respectively do not point to any expenditure category (other than imports) in early 2017, significant increase in activity (values below 50 indicate it is barely enough to keep up with population growth. pessimism in the manufacturing sector). South Africa may be missing opportunities from strengthening global Credit conditions remain tight, lending little support to demand and a depreciated rand, which is still about 16 household consumption. In real terms, credit extension percent below its peak in December 2010 in real, trade- to households remains negative. Slowing credit helps weighted terms. Imports, on the other hand – supported reduce household dissavings – that is, spending by improvements in private consumption and the import exceeding income – with dissaving dropping from 2.3 of capital goods – outgrew exports in the first half of 2017 percent of disposable income in the second quarter in real terms. of 2013 to 0.3 percent in the first quarter of 2017. This lowers the financial vulnerability of households and Weak overall demand results in low capacity utilization brings down their indebtedness. However, unsecured rates (Figure 1.4). This means South Africa’s installed credit and overdrafts have been among the fastest- industrial capacity and resources are not being growing categories of household credit. Mortgage used and its potential economic output is not being advances – that is, credit to build household assets and realized. Capacity under-utilization in manufacturing is more permanently strengthen households’ wealth – have significantly higher than before the global financial crisis grown more slowly, both in May and June 2017. Corporate (increasing from 14.5 percent in 2006 to 18.1 percent in credit continued to grow above the inflation rate, at 9.0 2016, and climbing even further at the beginning of 2017), percent in May and 10.1 percent in June in nominal terms. largely due to insufficient demand. Figure 1.4: Capacity under-utilization and investment in the manufacturing sector (Capacity under-utilization in percent and investment in million rand, constant 2010 prices) 120,000 25.0 100,000 20.0 Under-utilization Millions, Rands 80,000 15.0 60,000 10.0 40,000 20,000 5.0 0 0.0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Under-utilization: raw materials (RHS) Under-utilization: skilled labor (RHS) Under-utilization: semi/unskilled labor (RHS) Under-utilization: insufficient demand (RHS) Under-utilization: other reasons (RHS) Machinery investment Total investment Capacity under-utilization Source: World Bank staff calculations based on StatsSA, Quantec (2017) 7 | South Africa Economic Update 10 | Chapter 1 Excess capacity and low demand mean that there is high capital intensity of the economy, 14 percent of limited need to expand existing production lines. This GDP are savings simply required to maintain existing is one reason for weak private investment. Year-on- capital stock. This leaves 2 percent of GDP for new year, fixed investment fell for a seventh consecutive investments. quarter in the second quarter of 2017; it contracted by 1.1 percent in the first half of 2017. As both households and government spend more than their income, corporate and foreign savings have While there is little appetite to expand existing been financing South African investment (equivalent production facilities, new opportunities could be to 19.6 percent in 2016). South Africa’s National sought both domestically – in new technologies (see Development Plan targets investment of 30 percent Chapter 2) – and by expanding into global markets. of GDP to accelerate growth to the national target of But domestic savings are too low to finance additional an average of 5.4 percent. But, given low savings levels investment. South African gross savings were and investor concerns about policy uncertainty and equivalent to 16 percent of GDP in 2016. Given the growth prospects, this target is far from being realized. Figure 1.5: Corporate, government, and household savings/dissavings (Savings in percent of GDP) 20% 15% 10% 5% 0% -5% 2009 2010 2011 2012 2013 2014 2015 2016 Corporate net savings Household net savings Government net savings Consumption of fixed capital Total gross savings Total net savings Source: South African Reserve Bank Growth has been dragged down by protracted productivity losses since 2008 South Africa’s protracted growth deceleration has of foregone GDP growth every year on average been underpinned by negative growth in total factor between 2008 and 2016 (Figure 1.6). The decline can productivity (TFP). TFP measures how efficiently labor largely be attributed to productivity losses within and capital are used in the production process. Negative rather than between sectors. Between-sector losses growth indicates that South Africa has produced less reflect the change in aggregate TFP resulting from the over time with the same amount of labor and capital. reallocation of labor and capital to sectors with lower TFP reflects the market mechanisms in place and the productivity levels. Poor allocative efficiency of capital effectiveness of public institutions, but, in its broadest was highlighted in the 9th South Africa Economic sense, productivity growth is about innovation, as Update,⁶ and labor seems to exhibit the same pattern discussed further in Chapter 2. of not necessarily moving to sectors where it can be most productive. TFP in South Africa has declined since the financial crisis, costing the equivalent of 0.7 percentage points ⁶ World Bank (2017d). Chapter 1 | South Africa Economic Update 10 | 8 Figure 1.6: South Africa TFP gains and losses, within and between sectors 6% 1.50 5% 1.45 4% 1.40 1.35 3% 1.30 2% 1.25 1% 1.20 0% 1.15 -1% 1.10 -2% 1.05 -3% 1.0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Within (LHS) Between (LHS) TFP level, index 1993=1 (RHS) Source: World Bank staff calculations based on Quantec (2017) Figure 1.7 shows TFP trends by sector. Growth in particular, mining, footwear and textiles, fiber and rubber manufacturing has decelerated significantly in recent products, electricity and water supply, construction, years, although these sectors have fared better than transport, and non-financial private services recorded the primary, other secondary, and tertiary sectors. In large and sustained drops in TFP levels since 2008. Figure 1.7: TFP growth within sectors 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% Low-tech Med - Low Tech Med-High Tech High-tech Primary Other Tertiary Manufacturing Manufacturing Manufacturing Manufacturing Secondary 1994 - 2007 2008 - 2016 Source: World Bank staff calculations based on Quantec (2017). Note: Unweighted TFP growth averages across sectors groups. Several factors could have contributed to this trend In the manufacturing sector, where innovation efforts of within-sector productivity losses in South Africa are typically concentrated, the deceleration in TFP since 2008. growth could result from a decline in capital-embodied 9 | South Africa Economic Update 10 | Chapter 1 innovation (that is, the acquisition of equipment that African high-tech manufacturing sector after 2008 would drives innovation). Adler et al. (2017) suggest that the support this claim. After stagnating from 2009 to 2013 at decline in capital-embodied innovation cost about 0.2 about two-thirds of its 2008 level, high-tech investment percentage points of foregone GDP growth in emerging regained strength in 2014, but did not quite return to the economies annually in 2013 and 2014. The decline in level and share of GDP recorded in 2008 (Figure 1.8). machinery and equipment investment in the South Figure 1.8: High-tech manufacturing investments in machinery and equipment in South Africa 5,500 0.2% 5,000 4,500 Millions 4,000 0.1% 3,500 3,000 2,500 2,000 0.0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Investment (LHS) Share of GDP (RHS) Source: World Bank staff calculations based on Quantec (2017) Another potential reason for the decline in within-sector the same model also suggests that South Africa’s productivity is the reduction in spillover effects from capacity to absorb foreign technology has been low, technological leaders in advanced economies. Adler et and is insufficient to compensate for domestic factors al. (2017) suggest that the slowdown in TFP growth in the hampering TFP growth. As a result, South Africa’s TFP United States since 2008 could have cost other advanced levels have diverged from that of the United States economies up to 0.2 percentage points of TFP growth. since 1994 (Figure 1.9). This strongly contrasts with other BRICS countries, such as India and China, which Viewed through this lens, the deceleration in U.S. TFP have managed to sustain high TFP growth rates since growth since 2008 could have cost South Africa 0.4 the early 1990s, including through the financial crisis percentage points of annual TFP growth.⁷ However, of 2008/09 (Figure 1.10). Figure 1.9: Total factor productivity levels relative to the United States (1994 and 2014) (Purchasing power parity index: U.S.=1) 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 Mauritius Switzerland Finland South Republic of Brazil Kenya Russian Nigeria China Africa Korea Federation USA 1994 2014 Source: World Bank staff calculations based on Penn World Tables, Center for International Data (2017) ⁷ In comparison with a scenario in which the U.S. TFP would have grown from 2008 at the pace recorded over the period 1994–2007. This conclusion is obtained by estimating a leader-follower econometric model, whereby South Africa’s TFP growth would depend positively on U.S. TFP growth and the difference between U.S. and South African TFP levels. Chapter 1 | South Africa Economic Update 10 | 10 Figure 1.10: TFP growth in BRICS (Annual, %) BRICS China India Brazil Russia South Africa Percent 3.5 1 -1.5 -4 1990-2000 2001-2007 2008-2009 2010-2016 Source: World Bank staff calculations based on Penn World Tables, Center for International Data (2017) A loss of skills may also have contributed to in anticipation of a rebound in global prices).⁸ productivity losses in recent years. According to • The long time needed for mega-investment LinkedIn data, South Africa is losing more professionals projects to become operational (in the electricity than it is gaining. This is mostly driven by emigration to sector, for example). OECD countries such as the United States, the United Kingdom, and Australia. These individuals tend to be Finally, analysis by the National Treasury and skilled in business, information technology, or health World Bank staff⁹ suggests that since 2009 large, care. According to the OECD (2017), about 19,000 skilled less productive firms (as measured by value South African nationals emigrated to OECD countries added per worker) have grown faster in terms of in 2015. Conversely, most of the skills South Africa has employment than small, more productive firms. gained have been through the migration of individuals This misallocation of resources within sectors may from neighboring countries, as well as BRICS and be partly attributed to the difficulties small firms Scandinavian countries, although at a slower pace. experience in attracting skilled workers (who are interested in the professional development and job Additional factors contributing to (within-sector) security prospects offered by larger firms), and in productivity losses include: complying with tax and regulatory obligations when • Reduced use of installed productive capacities as a exceeding some economic activity thresholds.¹⁰ result of lower demand (notably in mining sectors, South Africa is losing more professionals than it is gaining. ⁸ Adler et al. (2017) suggest that TFP cycles of commodity exporters can be correlated to commodity price cycles, which indeed seems to be the case in South Africa. ⁹ Aterido et al. (2017). ¹⁰ See Boonzaaier et al. (2016), for a discussion on the response of small firms to tax schedule discontinuities. 11 | South Africa Economic Update 10 | Chapter 1 Figure 1.11: Firm performance – micro to large enterprises A. Value-added per worker of micro to large firms B. Firms performance by size with respect to micro ratio by country -12 -10 -8 -6 -4 -2 0 2 4 6 8 2.0 10-19 1.5 20-49 Ratio 1.0 50-249 0.5 250-499 500+ 0.0 ZAF-2009-2014 MDA-2009-2014 VNM-2009-2014 CIV-2007-2012 PER-2007-2012 PRY-2010 AFG-2009 UGA-2010 Employment Growth TFP Wages Size for Employment Growth regression refers to Micro Firms: size 1 to 9 “average” size in the growth period. Large Firms: size 100+ ZAF: South Africa; MDA: Moldova; VNM: Vietnam; CIV: Cote d’Ivoire; PER: Peru; PRY: Paraguay; UGA: Uganda. Source: National Treasury and World Bank staff calculations based on SARS and National Treasury data Labor Market Developments in South Africa The economy remains too weak to reduce high unemployment rates Since 2008, 3.5 million people have entered the are included. Including these discouraged workers, labor force, but only 1.6 million additional jobs have South Africa’s unemployment rate is 36.6 percent. been created. The unemployment rate has risen Of those looking for employment, 3.5 million (57.1 from 22.5 percent in 2008 to 27.7 percent in the percent) have not worked in the past five years first half of 2017. (Figure 1.12). This number has increased by nearly 1.2 million since 2008. There are far more unemployed Nearly 6.2 million people are unemployed, or 9.3 low-skilled and semi-skilled workers than there are million if those who have stopped looking for work unemployed skilled workers. Figure 1.12: Unemployment by skills level, 2008–17 (Unemployment by skills level and duration of unemployment) 6,000 5,000 4,000 Thousands 3,000 2,000 1,000 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 H1 Unemployed who have not worked in the past 5 years Low-skilled unemployed Semi-skilled unemployed Skilled unemployed Total Unemployed Unemployed who worked in the past 5 years Source: World Bank staff calculations based on StatsSA Chapter 1 | South Africa Economic Update 10 | 12 Only high-tech manufacturing sectors have managed to keep employment relatively stable between 2010 and 2016 (Figure 1.13). Figure 1.13: Employment in the manufacturing sector (Change in number of employees by sector, 2016 compared to 2010) High-technology manufacturing Medium-high-technology manufacturing Medium-low-technology manufacturing Low-technology manufacturing Total manufacturing -80,000 -70,000 -60,000 -50,000 -40,000 -30,000 -20,000 -10,000 0 10,000 Source: World Bank staff calculations based on Quantec (2017) Growth in the labor force was the main contributor to 31,000 jobs were created. Economic growth is too low the 14-year peak in unemployment in 2017, as 427,000 to generate sufficient jobs, especially in light of the new job-seekers joined the unemployed, but only country’s maturing youth bulge (Box 1.1). Box 1.1: Addressing the youth employment crisis Entrepreneurship, training, and active labor market cannot generally be expected to address the mismatch programs are essential components of a jobs strategy, between the quality of the education system and the but cannot be expected to solve the youth employment needs of the job market. But, despite their limitations, challenge alone. some programs show encouraging results. For example, livelihood and entrepreneurship programs that provide Kluve et al. (2016), reviewing a large set of interventions the self-employed with training and seed capital have, across the world, show that most employment on average, more of an impact. So do comprehensive programs have a relatively small effect on beneficiaries’ programs that complement training with other earnings. Part of the challenge lies in the nature of components, such as internships, capital injection, these programs. A few weeks or months of training certification, or labor insertion support. Box 1.1 figure 1: Impact on earnings outcomes across categories of youth employment programs (Standardized mean differences, percentage) 0.2 0.1 0.0 -0.1 Total Skills Entrepreneurship Employment Subsidized Comprehensive training promotion services employment Standardized mean differences Confidence interval at 95% Source: S4YE (2015) 13 | South Africa Economic Update 10 | Chapter 1 Given the costs involved, it is important to rigorously improve and become more cost-effective. The National evaluate and continuously improve the performance Treasury’s ongoing evaluation of employment tax of entrepreneurship, training, and active labor market incentives is a good step in this direction, as discussed programs. South Africa is spending billions of rands a in the 9th South Africa Economic Update. year on such programs. The Jobs Fund has facilitated more than 70,000 jobs over five years, the Expanded In addition, programs should adapt to the diversity of Public Works Program employs more than half a beneficiaries and adjust to different educational and million people on a short-term basis, and in 2014/15 skills levels.¹¹ One-size-fits-all programs are bound the Employment Tax Incentive Program supported close to have little impact: understanding the profile of to 700,000 jobs with a budget of more than R2 billion. beneficiaries is essential. In South Africa, labor centers Despite these massive efforts, it remains unclear how could take the lead, directing beneficiaries to the right many net jobs these programs have generated overall. programs. Finally, effective coordination must be based These programs need to be closely monitored, and their on integrated information systems to design, monitor, performance assessed against objectives so they can and evaluate programs. South Africa’s unemployment rate is high compared growing faster than productivity in many sectors. to other BRICS countries and emerging markets • Living costs are high in South Africa, requiring (Figure 1.14). Wage levels are also comparatively high wages to be above a certain level to be attractive for several reasons: for workers. Reducing living costs would allow for more competitive wages without hurting worker • Skilled, productive labor commands a high wage welfare. Costs can be further reduced through given the country’s skills shortage. greater competition policy¹² or better spatial • Collective bargaining arrangements yield higher planning¹³ that lowers transportation costs. wages for unionized workers, resulting in wages Figure 1.14: Nominal wages and unemployment in emerging markets (2013-2015 averages, US$; and percent) 3,000 30% 2,500 25% Nominal wages, US$ Unemployment, % 2,000 20% 1,500 15% 1,000 10% 500 5% 0 0% il a a n a a . ico ia a ub az ric si in an di io s ex ay ne In p Ch at Br Af w Re er M al do ts h M d b Bo ut In Fe a So Ar an t, yp i ss Eg Ru Nominal wages (US$) Nominal wages (US$, PPP) 2015 Unemployment rate (RHS) Sources: World Bank staff calculations based on International Labour Organization (2016) and World Bank (2017a) The average wage in South Africa masks the country’s (Figure 1.15). The income inequality is even clearer when high wage inequality. The average skilled worker earns considering that the top 10 percent of income earners nearly 7.5 times more than the average low-skilled worker make 66 times that of the bottom 10 percent. ¹¹ In South Africa, Harambee, an organization supported by the Jobs Fund, has shown that less than two months of targeted training could significantly improve the employability of unemployed youth. ¹² World Bank (2016c). ¹³ World Bank (2016a). Chapter 1 | South Africa Economic Update 10 | 14 Figure 1.15: South African average monthly wages and employment creation by skill-set (Mean monthly earnings in 2015, ZAR, left panel, job creation 2016 H1 – 2017 H1 in thousands, right panel) 18,000 250 15,000 200 12,000 150 Thousands 9,000 100 6,000 50 3,000 0 0 -50 Total Professional Plant/machine operator Elementary Other Manager Elementary Plant & machine operator Domestic worker Other Clerk Professionals Managers Technicians Clerks Craft & related trades Sales & Services Skilled agriculture Skilled Semi-skilled Low-skilled Craft & related trade Skilled agriculture Sales & services Technician Semi-skilled Low-skilled High-skilled Wage National average wage National minimum wage Source: International Labour Organization (2016) The R20 per hour national minimum wage announced percent and 90 percent respectively), with both sectors in February 2017, equivalent to just under R3,500 per reaching 100 percent two years after implementation. month, is expected to take effect by May 2018. This The national minimum wage will improve the welfare will affect more than 5 million workers who currently of many workers, but it is also anticipated to increase earn less than R3,500 a month. A National Minimum unemployment in the short term for low- and semi- Wage Commission will be set up to assess its effect skilled workers in sectors where the minimum wage is on poverty, inequality, and unemployment, and make greater than the current sectoral determination wage recommendations on adjusting wages accordingly. To (Table 1.2).¹⁴ This will be especially true if economic minimize adverse effects on employment, domestic growth does not generate additional income to be and agricultural workers will receive lower rates (75 passed on to workers through wages. ¹⁴ Bhorat and Stanwix (2017). 15 | South Africa Economic Update 10 | Chapter 1 Table 1.2: Sectoral determinations and the national minimum wage (2015 prices) Sectoral Lowest National National minimum Covered Determination sectoral minimum wage less Workers determination wage ¹⁵ lowest sectoral determination Agriculture R2,607 R2,678 R71 668,048 Forestry R2,607 R2,976 R369 38,710 Domestic Work R1,813¹⁶ R2,232 R419 1,131,424 Private Security R2,067¹⁷ R2,976 R909 523,870 Wholesale & Retail R2,514¹⁸ R2,976 R462 1,382,320 Taxi R2,113 R2,976 R863 253,358 Hospitality R2,761 R2,976 R215 333,656 Contract Cleaning R2,8447¹⁹ R2,976 R132 743,723 Avg. / Total R2,522 R2,846 R430 5,075,109 Source: Bhorat et al. (2016). Notes: Wages are in monthly terms, and the sample has been restricted to employees who earn less than the Basic Conditions of Employment Act earnings threshold. The extent and duration of poverty is strongly linked to location and labor market status In its most recent report on poverty trends, StatsSA the total population increased across all poverty lines (2017) shows that the proportion of poor individuals in between 2011 and 2015: UPPER-BOUND LOWER-BOUND FOOD POVERTY LINE POVERTY LINE POVERTY LINE R1,138 R758 R531 per person per month per person per month per person per month Using the upper-bound line, the proportion of poor following individual households over the period 2008 individuals rose from 53.1 percent of the population to 2015²⁰ distinguishes transient poverty from chronic in 2011 to 55.5 percent in 2015. Analysis conducted poverty. It suggests that 78 percent of the population by StatsSA and the World Bank on a large dataset experienced upper-bound poverty at some point over ¹⁵ The national minimum wage is agreed to be instituted by no later than May 2018 at a nominal rate of R3,500 per month. Assuming a constant five-year average inflation rate, the real figures in 2015 prices are presented in the table above for comparison purposes. ¹⁶ Domestic workers who work fewer than 27 hours a week are excluded from this calculation. ¹⁷ This figure only includes private security guards. ¹⁸ This figure excludes the legislated wages for a manager, assistant manager, supervisor, and trainee manager, which are far above the other legislated wages in the wholesale and retail sector. ¹⁹ The contract cleaning sectoral determination only specifies a minimum hourly wage. To convert this hourly wage to a monthly wage, it was assumed contract cleaners work for 8 hours a day for 21.6 days a month. ²⁰ National Income Dynamics Study panel survey carried out four times between 2008 and 2015 used to assess the extent of chronic poverty in South Africa. The survey collects a wide range of information about households and individual wellbeing following the same households over time. Chapter 1 | South Africa Economic Update 10 | 16 the period – about half were permanently poor, while have an average of seven members, which is more than the other half either fell into poverty or escaped from twice the size of households in the wealthiest quintiles. it during the period (Figure 1.16). Only 22 percent of Chronic poverty particularly affects children, with every the population did not fall below the poverty line over other child below age 15 growing up in chronic poverty. this period. Chronic poverty is most dominant in rural areas with traditional villages and communally owned land. StatsSA and the World Bank also assessed the factors Accordingly, chronic poverty is overly concentrated in associated with a household’s probability of escaping KwaZulu-Natal, followed by the Eastern Cape, while chronic poverty.²¹ Large families, children, and people those resilient to poverty predominantly live in Gauteng in rural areas are especially vulnerable to chronic and the Western Cape. Race is strongly associated with poverty. The chronically poor live in households that the incidence and duration of poverty. Figure 1.16: Poverty duration and income source 45% 39% 100.0% 40% 90.0% 35% 80.0% 5.5% 26.7% Poor at least once: 39% 70.0% 54.4% 30% 60.0% 25% 22% 50.0% 20% 20% 40.0% 79.3% 64.9% 30.0% 15% 10% 9% 20.0% 37.5% 10% 10.0% 5% 0.0% 0% Never At least Always Poor 1 2 3 Poor poor once poor poor never Sometime poor (# of spells) always Labor market income Subsistence agricultural Remittance income income Investment income Other income from Government grant income government Source: StatsSA and World Bank staff calculations There is a strong relationship between education and More than half of those experiencing chronic poverty the incidence and persistence of poverty. Of those who rely on government grants as the main source of did not experience a single poverty spell, 93 percent income (Figure 1.16, right panel). Unsurprisingly, the lived in households where the household head had chronically poor also tend to lack access to basic goods attained at least secondary schooling. Poverty tends to and services. Of the chronic poor, only 21 percent had be a temporary phenomenon for higher earners in the access to electricity, flowing water, a flushable toilet, labor market. Those who have remained out of poverty and formal housing, while close to 77 percent of those between 2008 and 2015 live in households where the who had never been poor had access to all of the above. head is more likely to actively participate in the labor market. Those who remain out of poverty generally This analysis suggests that protracted economic have a household head who is formally employed with growth deceleration in recent years mostly affected a permanent work contract. In contrast, half of the the 22 million people vulnerable to transient poverty. household heads in chronic poverty are self-employed A rebound in economic growth is unlikely to directly in the informal sector, in casual employment, or work affect the chronic poor, which include another 22 as farmers on their own plot or food garden. million people. ²¹ Based on panel regression. The dependent variable of the panel regression is the probability of the household to get out of chronic poverty and not fall back into poverty. The explanatory variables included a set of demographic characteristics, location, labor, education, and skills variables, as well as changes in these variables. 17 | South Africa Economic Update 10 | Chapter 1 Fiscal Developments in South Africa South Africa lost its prized investment grade credit rating Minister of Finance Pravin Gordhan tabled the 2017 Budget Minister Gordhan was replaced by Minister Malusi Gigaba in Parliament in February 2017. The Budget focused on in a Cabinet reshuffle on 30 March 2017. Markets strongly broad-based transformation through inclusive growth, reacted to this event in anticipation of a downgrade of focusing on the following five areas set out in the 2012 South Africa’s credit rating. The following week, Standard National Development Plan: and Poor’s downgraded South Africa’s long-term foreign currency credit rating from BBB- to BB+, moving it from 1. Education and skills development. an investment-grade rating to a sub-investment (or junk) 2. Stronger competition law to reduce barriers rating. Fitch followed suit shortly after, also downgrading to entry and allow for more inclusive product South African debt to sub-investment grade both on the markets and corporate ownership. foreign and the local currency rating—and given that only 3. Increased private sector participation in state- 10 percent of South African public debt is denominated owned enterprises. in foreign currency, the local currency downgrade was 4. Support and incentives to labor-intensive sectors, noteworthy and adds additional urgency to avert further such as agriculture, agro-processing, and tourism. downgrades by Moody’s or S&P (on the local rating). Both 5. Strengthened cities as growth and employment S&P and Fitch stated that governance concerns were hubs. central to their decisions. Consequently, the rating agencies also downgraded South African banks and other corporates. The Budget recognized a weaker-than-expected growth With the S&P and Fitch downgrades in April 2017, South outlook and proposed both expenditure containment Africa ceased to be an investment-grade-rated country for and new revenue measures to ensure continued fiscal the first time in 18 years (Figure 1.17). consolidation. The aim is to stabilize the debt-to-GDP ratio within three years, as public debt has increased significantly This was followed by significant bond disinvestment since 2009. The spending ceiling was lowered by R10.2 by institutional investors, as the downgrades resulted billion (0.2 percent of GDP) for 2017/18 and by R15.9 billion in the automatic exclusion of South African government (0.3 percent of GDP) for 2018/19. The Budget thus continued bonds from JP Morgan’s Emerging Market Bond Index and a policy of five years of fiscal consolidation, where the Government Bond Index. This prompted estimated outflows government managed to reduce the primary deficit from of US$1.5 billion, according to NKC African Economics. Capital 2.3 percent of GDP (and a consolidated deficit of 5.0 percent) outflows saw yields on 10-year Treasury bonds increase in 2012/13 to 0.5 percent (and consolidated deficit of 3.9 by 40 basis points, while the rand depreciated by 5 percent percent) by 2016/17—a notable achievement, especially in within days. This was broadly in line with World Bank an environment of low growth. simulations in the 9th South Africa Economic Update. Figure 1.17: Public debt and South Africa’s credit rating (Gross public debt in % of GDP and South African credit rating [average of S&P, Fitch, and Moody’s]) 60 12 50 10 Average rating 40 % of GDP 8 30 6 20 4 10 2 0 0 1994 1997 2000 2003 2006 2009 2012 2015 Gross debt (% of GDP) Average rating (RHS) Sub-investment grade Investment grade Source: National Treasury, Bloomberg, and World Bank staff calculations Chapter 1 | South Africa Economic Update 10 | 18 The situation normalized shortly thereafter, with other emerging markets. This helps explains the both yields and the rand stabilizing closer to levels increase in South African debt held by non-residents seen before the downgrades. Minister Gigaba quickly following the reshuffle (Figure 1.18). Although bond committed to implementing the Budget that had yields have settled somewhat since April, they remain been proposed by Minister Gordhan, which helped higher than before the reshuffle. This suggests that calm markets. At the same time, global investors’ investors consider South African long-term debt to appetite for emerging market fixed income remained have become riskier and wish to be compensated for strong, especially as yields on South African long- this risk with higher yields. term bonds continue to be attractive compared to Figure 1.18: Credit rating downgrades and foreign-held debt (10-year Treasury bond [R186] yield (spread over selected emerging markets), LHS, and cumulative acquisition in South African debt held by foreigners, RHS, January 1, 2017 = 0) 4,500 2.2 4,000 2.0 3,500 3,000 1.8 Yield % 2,500 $ millions 1.6 2,000 1,500 Post-downgrade 1.4 1,000 Pre-downgrade average spread 1.7 average speed 1.5 percentage points 1.2 500 percentage points 0 1.0 -500 1.3.2017 2.3.2017 3.3.2017 4.3.2017 5.3.2017 6.3.2017 7.3.2017 8.3.2017 9.3.2017 Cummulative debt South Africa 10-year T-bond spread relative to emerging markets* (RHS) *Brazil; China; Colombia; India; Indonesia; Malaysia; Mexico and Turkey are included in emerging markets T-bond yield Source: IIF, Haver Analytics, and World Bank staff Maintaining fiscal consolidation remains important Revenue Service, tax revenue collections were R13.1 for South Africa’s creditworthiness – not least as billion below estimate between April and June alone, Moody’s continues to rate South African debt as equivalent to 0.3 percent of forecasted annual GDP. investment-grade, a rating that could be at risk if there is fiscal slippage – i.e. deviations from what Under-collection is consistent with a weaker economy was announced in the 2017 Budget. Yet tax collections than anticipated in the Budget. It will likely require an appear to have been falling behind in June and July announcement of further fiscal effort in the Medium (Figure 1.19), making it more difficult to attain the Term Budget Policy Statement of October 2017, collection target set out in the Budget. This is driven with additional revenue measures and expenditure especially by taxes on income and profits, and cuts expected. This in turn will weigh on growth, as to an extent by taxes on goods and services and discussed further in the outlook section. international trade. According to the South African 19 | South Africa Economic Update 10 | Chapter 1 Figure 1.19: Revenue collection (fiscal year 2017/18) (Estimated cumulative deviation from Budget tax collection target, and contributions by tax category) Cummulative tax collection % 0.4 0.2 0.0 -0.2 deviation -0.4 -0.6 -0.8 -1.0 April May June July Direct tax Indirect Tax Source: National Treasury, SARS, and World Bank staff. Note: Calculated as deviation from monthly collections required to meet 2017/18 Budget tax revenue target, accounting for typical monthly collections (5-year average tax collection as percentage of total collection). Inflation and Monetary Policy in South Africa Inflation has fallen back into the target range, resulting in looser monetary policy Consumer price inflation accelerated in 2015, breaching are well within the 3-6 percent inflation target range the South African Reserve Bank’s 6 percent upper (Figure 1.20). target in January 2016. This was largely due to the depreciating currency and rising food prices as a result With inflation falling within the target band since April 2017 of drought. As the rand strengthened and the drought and lower inflation expectations in the mid-term, in July lifted, inflationary pressures eased. Headline inflation 2017 the South African Reserve Bank reduced the policy fell to 4.6 percent in July 2017, helped significantly rate by 25 basis points, to 6.75 percent – to the surprise of by food prices: food inflation fell from a high of 12.0 many analysts. A relatively low inflation environment in a percent in December 2016 to 6.8 percent in July 2017. weak economy, and a healthy banking sector with a low Core inflation also declined to 4.5 percent in 2017. incidence of nonperforming loans at 3.2 percent, mean that Inflation expectations for 2017 and subsequent years further monetary easing is possible in 2017. Figure 1.20: Consumer price index inflation (Consumer price index inflation in percent, year-on-year) BER 8 7 MPC 6 5 4 3 % 2 1 0 -1 -2 2017F 2018F 2019F 2013 2014 2015 2016 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 July 2017 inflation Core inflation (headline excl. food and NAB, fuel and energy) Fuel expectations Electricity and other fuels (energy) Food and non-alcoholic beverages Headline inflation Repo rate (average) Source: StatsSA and South African Reserve Bank. Inflation expectation by Bureau of Economic Research. Chapter 1 | South Africa Economic Update 10 | 20 The External Sector in South Africa The current account is improving but its financing is reliant on volatile portfolio flows South Africa’s current account deficit has narrowed since percent. When comparing the first quarters of 2016 and a high of 5.0 percent of GDP in the first quarter of 2016. It 2017, they improved by 7.1 percent. stood at 2.0 percent of GDP a year later. The trade balance has been the key driver: it was net positive between Significant opportunities exist for South African exports February and July 2017, and reached a high of a R10.6 abroad. More than a quarter of South Africa’s exports billion trade surplus in June. In value terms, exports rose go to fast-growing economies, and more than half go 4.4 percent year-on-year between January and July 2017, to economies that grow faster than the global average compared to 2.2 percent growth in imports. This is largely (Figure 1.21). It is easier to penetrate growing markets than due to more favorable terms of trade, a consequence of to gain a share in stagnant ones. South African exporters both higher commodity prices and a somewhat stronger tend to be better at seizing opportunities from growing rand (although still low by historical standards). Between markets than obtaining competitiveness gains associated the fourth quarter of 2016 and the first quarter of 2017 with currency depreciation. Yet the export response to alone, the South African terms of trade improved by 2.6 these opportunities has been relatively limited. Figure 1.21: South African exports to fast-growing economies (Percentage share of South African 2015 merchandise exports to countries [sorted by growth rate]) 30% World-growth Fast-growing (2.8%) 25% 20% 15% 10% 5% 0% >0% 0% - 1% 1% - 2% 2% - 3% 3% - 4% 4% - 5% 5%< Average forecasted growth rates 2017-19 Source: Comtrade and World Bank staff calculations Given the positive trade balance, the main reason financial account is dominated by portfolio investment. for a large current account deficit continues to be Following the downgrade earlier this year, South Africa a relatively sticky negative income balance on the experienced some capital flight, including disinvestment balance of payments. The overall narrowing current by institutional bond investors tracking JP Morgan’s account deficit is good news because it reduces South investment grade sovereign bond indices. However, as Africa’s vulnerability to international capital flows. discussed earlier, these flows have somewhat reversed Given weak foreign direct investment, South Africa’s since then, although yields remain higher. 21 | South Africa Economic Update 10 | Chapter 1 By September 2017, South Africa faced uncertainty around Africa would also be excluded from the Citibank World two rating decisions: whether Moody’s would downgrade Government Bond Index if both agencies downgraded, from two notches above sub-investment grade to junk which could result in outflows of between US$6 billion status, and whether Standard and Poor’s would downgrade and US$9 billion. The estimates suggest that the amounts the local currency rating to junk, with the risk of exclusion affected by these downgrades would be considerably from additional bond indices. Either downgrade would larger than that of the April downgrades and could place result in South Africa being excluded from the Barclays additional pressure on the rand and bond yields. The Global Aggregate, which NKC African Economics estimates current account deficit continues to remain an external could result in capital outflows of up to US$4 billion. South vulnerability for the country. The Outlook for South Africa The economy remains too weak to meaningfully reduce poverty The South African economy improved in the first half of others – the net effect remains unclear. 2017, largely due to one-off effects in agriculture and mining. By the second quarter of 2017, agricultural output Investment is likely to remain weak, except perhaps was back at 95 percent of production levels before the in automotives. Uncertainty around the future of the drought struck, suggesting that the significant rebound is Mining Charter is expected to continue weighing on unlikely to last throughout the year. Agriculture added 0.5 investor confidence, and no significant additional percentage points to headline growth in the first half of investment is expected in mining. Given excess capacity the year, but this performance is unlikely to be sustained. in manufacturing, little investment is expected in that In mining, favorable terms of trade effects are expected to sector either. Public investment may decelerate as have largely been seized in the first half of the year. it tends to be more discretionary than consumption spending, such as civil service wages, and may therefore Capacity under-utilization in the manufacturing sector is be cut as the government attempts to stick to its fiscal likely to limit investment. Unless South African companies consolidation goals. seize opportunities from the global economy, there is unlikely to be an increase in demand. The automotive Generally, given the performance of revenue, little sector is a shining light in manufacturing: although 2017 support to growth can be expected from the Budget going will see a temporary drop in vehicle production (by an forward. Additional revenue measures and expenditure estimated 20,000 cars, compared to 2016), this is largely cuts will likely be needed to control the budget deficit and due to the scheduled phase out of the BMW 3 series (to demonstrate to foreign investors and South Africans alike be replaced by production of the new X3 model) and a a commitment to the country’s creditworthiness. This is scheduled reduction in the Mercedes Plant in East London. likely to be a further drag on growth. A ramp up of production in BMW, Volkswagen, Nissan and Mercedes in 2018 is expected to result in 633,000 vehicles A timid recovery is still expected in the next three years, produced, an increase of 20 percent, with another 10 but the economy is anticipated to grow barely faster than percent increase expected in 2019. Automotives are thus the population. The World Bank forecasts growth of 0.6 expected to provide some boost to exports in 2018 and percent in 2017, with a moderate increase in 2018 and 2019. 2019. But overall, South African manufacturing needs to look to the world for demand, and tailor its exports Although downside risks to the outlook have lessened accordingly. Greater innovation, as discussed in Chapter somewhat, they remain considerable throughout the 2, will be required for this. forecast period. One is fiscal policy: fiscal slippage is a risk given signs of revenue under-collection; and the general On the expenditure side, easing inflation has helped South election in 2019 may put pressure on public expenditure African consumers, supporting private consumption. South in anticipation. Moreover, contingent liabilities in State- Africa is an arid country and the risks of drought increase Owned Enterprises (including South African Airways and with climate change and global carbon dioxide (CO2) Eskom) could delay the fiscal consolidation course. Fiscal emissions. Barring further periods of drought, inflation is slippage would likely result in additional downgrades by likely to remain contained and household consumption is international credit rating agencies. This would increase expected to grow modestly. Household consumption may the cost of public debt, crowding out other expenditures. be further supported by somewhat easier credit conditions Downgrades could also result in significant international in light of potential cuts to the policy rate. The minimum capital movements, putting pressure on the exchange wage may raise consumption further in 2018, although the rate and inflation, and in turn on household budgets and boost to wages for some may be offset by job losses for consumption. Political confidence shocks can have similar Chapter 1 | South Africa Economic Update 10 | 22 effects on the exchange rate, as could a shift in global shedding, which was previously a considerable bottleneck, investor demand for emerging market assets, for example, is not presently limiting output. from tighter monetary policy in developed economies. More broadly, there needs to be predictability to secure South African growth is diverging from global growth private investment, which has driven innovative, nimble, and the country risks falling behind its peers. This would and cost-effective solutions such as the independent be to the detriment of South Africans, particularly the power producer initiative. Reducing uncertainty around poor, for whom a growing economy is necessary for power purchasing agreements will therefore be vital. The jobs, decent wages, and a sustainable system of social February 2015 Cabinet decision that all bills and regulations grants. Structural reforms could offer value for money, should include a socioeconomic impact assessment especially in an environment where the national budget could better demonstrate possible trade-offs between is constrained. Fostering growth in TFP is particularly investment and equity imperatives, and facilitate informed important to put South Africa on a higher growth trajectory. debates on proposed policy orientation. Innovation policy, discussed in Chapter 2, is one key area of focus here. At the current rate, growth is likely to be insufficient to significantly reduce poverty. Both 2017 and 2018 are It remains crucial to limit policy uncertainty. An agreement expected to have negative per capita growth, which on the Mining Charter that is acceptable to all relevant means poverty rates will remain fairly consistent with 2016 parties is needed to encourage investment in mining levels. By 2019, 15.7 percent of the population is expected – including in innovative production methods, where to remain below the US$1.9/day poverty line (purchasing South Africa has a good record. It will also be important power parity) and 33.7 percent under the US$3.1/day line. to consolidate previous achievements. Electricity load Policies for growth are crucial for South Africa’s poor. Table 1.3: Baseline annual growth forecasts 2014 2015 2016 2017f 2018f 2019f Real GDP growth, at constant market prices 1.7 1.3 0.3 0.6 1.1 1.7 Private consumption 0.7 1.7 0.8 1.0 1.9 2.0 Government consumption 1.1 0.5 2.0 -0.2 0.3 0.5 Gross fixed capital investment 1.7 2.3 -3.9 -1.2 1.6 2.3 Exports, goods, and services 3.2 3.9 -0.1 0.4 2.4 1.7 Imports, goods, and services -0.5 4.5 -3.7 2.1 1.7 1.9 Real GDP growth, at constant factor prices 1.8 1.3 0.4 0.6 1.1 2.7 Agriculture 6.9 -6.1 -7.8 15.0 5.8 2.4 Industry 0.1 1.1 -1.3 0.2 1.1 1.6 Services 2.3 1.6 1.3 0.3 0.9 1.7 Inflation (consumer price index) 6.4 4.6 6.3 5.7 5.8 5.9 Current account balance (% of GDP) -5.3 -4.4 -3.3 -2.6 -2.9 -3.0 Fiscal balance (% of GDP)¹ -4.3 -4.1 -3.9 -3.8 -3.7 -3.5 Debt (% of GDP)¹ 46.6 49.4 50.7 52.7 53.8 53.4 Primary balance (% of GDP)¹ -1.3 -1.0 -0.5 -0.4 -0.2 0.1 Poverty rate ($1.9/day 2011 purchasing power 15.6 15.7 16.0 16.0 15.9 15.7 a,b,c parity terms) Poverty rate ($3.1/day 2011 purchasing power 33.6 33.7 34.1 34.2 34.1 33.7 a,b,c parity terms) Source: World Bank staff calculations. Notes: f=forecast; 1/Fiscal year; a/calculations based on 2010-IES survey; b/ Projection using neutral distribution (2010) with pass-through = 0.87 based on GDP per capita constant PPP; c/ Projections are from 2013 to 2018. 23 | South Africa Economic Update 10 | Chapter 1 Box 1.2: Incubating small businesses Elias Makhubu (45) owns the Black Star Coffee Bar, a start-up designer beverages company. His company is one of 332 businesses in an innovative Riversands Incubation Hub near Diepsloot in the north of Johannesburg. Owned by Century Property Developments, the hub was founded by a family, who saw an opportunity to help small businesses and entrepreneurs in a densely populated and marginalized area of the city with limited economic prospects. Diepsloot residents often have to walk long distances to work or spend a disproportionate amount of resources and time on transport (World Bank, 2014). By creating jobs close to Diepsloot, the businesses in the hub help residents cut their transport costs and raise their economic participation. The hub is supported by the Jobs Fund in a 50/50 joint venture, as part of a government initiative launched in 2011 to co-finance projects by public, private, and nongovernmental organizations that create jobs. The hub aims to contribute to the Gauteng government’s efforts to integrate the township economy into the mainstream economy. incubation process, with training and mentorship “We are an enabler and we offer tailor-made support programs on all stages of setting up and running a for businesses and interventions, with a very low business. In fact, the training programs are considered barrier to entry,” says Tracy Henley, the hub’s director. an on-site practical business university. The hub takes in entrepreneurs at different stages of developing their business. It houses 152 businesses The proximity of the hub to upmarket residential and on campus and about 180 off campus. The businesses commercial development centers presents excellent range from farming, textiles, bakeries, and restaurants, opportunities for SMMEs. Elias, for example, caters legal, engineering, ICT, technical services to cleaning to surrounding businesses as well as to functions services, uniform makers, carpentry, and construction. held at the hub. The surrounding area is undergoing extensive mixed development construction, providing For Elias and many entrepreneurs who benefit from the a market for products and services from the SMMEs. hub, the affordable rental is one of the main drawcards. The hub also provides easy access to and from the An engineer by training, Elias arrived at the hub about Johannesburg-Midrand-Tshwane corridor. two years ago looking for premises for his construction business and spotted an opportunity to feed people. Being housed under one roof also provides an This led to the opening of his coffee bar, which also opportunity for entrepreneurs to network and learn serves light meals. He has a portfolio of four business from each other. Businesses can work together to come concerns housed at the hub, and employs at least 40 up with innovative collective solutions to challenges people, mostly young, and 99 percent of whom are they face. Elias hosts “coffee conversations”, which from Diepsloot. “I am scared of poverty, I know that provide a platform for peer-to-peer learning at his world and that is why I have diversified my portfolio so coffee bar. much so that I can always stay afloat. But I also know it is not just about me. I am responsible for other people True to the hub model of incubating businesses to too and therefore I cannot be reckless”. the point where they are able to expand and compete in a mainstream business environment, Elias will be In addition to subsidized rentals, the hub offers a opening a branch of his coffee bar in the neighboring comprehensive mentorship and support program to upmarket suburb of Dainfern. The Riversands SMME the SMMEs. The hub’s screening program determines Incubation Hub makes a clear case for public-private whether a business can be incubated, indicating partnerships that can help create jobs, stimulate the viability of the envisaged business. Thereafter, activity in marginalized areas, and contribute to businesses go through a structured three-year economic growth. Chapter 1 | South Africa Economic Update 10 | 24 CHAPTER 2 Innovation for productivity and inclusiveness 25 | South Africa Economic Update 10 | Chapter 2 The Role of Innovation in Meeting South Africa’s Economic and Social Goals South Africa has a long history of embracing science, an assessment of the strengths and weaknesses of technology, and innovation. But its innovation, in terms the science and innovation ecosystem, we focus on of productivity, may be losing ground. the take-up and impact of R&D investments (seen as inputs to the innovation process), and on the Innovation, defined as the introduction of new-to-the- technology content of exports (seen as outputs of world and new-to-the-firm goods, services, business the innovation process) to better assess innovation practices, and organizational methods,²² can play a trends, and their possible determinants. This is significant role in supporting the country’s pressing made possible by the availability of the South African economic and social priorities. Revenue Service-National Treasury (SARS-NT) tax dataset from 2008 to 2016, which allows for the first This chapter focuses on analyzing the opportunities economy-wide investigation of private innovation of for private innovation to become a more central part all formal firms in the country. The chapter ends with of South Africa’s shared growth model. It begins with a discussion of policy implications, both in terms of the an overview of how innovation can boost economic enabling environment and the public instruments that growth and help address social challenges. Following support private innovation. Making the economy more competitive for job creation and poverty reduction South Africa’s commodity-based growth model A recent World Bank²⁴ study focusing on developing exacerbates the volatility of exports and output, with economies provides some useful nuance in this debate. knock-on effects on domestic revenue mobilization Using a survey sample of 15,000 firms across Africa, and the funds available for critical social transfers and Eastern Europe, Central and South Asia, and Middle East public investment. High wage levels make it difficult for and North Africa, the study suggests that: South Africa to compete in low and medium-tech goods markets where cost is the deciding factor. In this context, • Innovation, when successful (leading to innovation can boost productivity in existing industries. It increased sales), generates additional can also promote diversification in new manufacturing employment, even if entailing more capital- and service sectors with good job-creation potential, intensive production processes. and where the country can build long-term competitive advantages. For example, sharply decreasing ICT costs • Product innovation (a new or better quality are improving cross-border communications and reducing product) creates more jobs than process (such the minimum scale needed to enter global markets. This as automation) innovation or organizational creates tremendous growth opportunities for existing (such as outsourcing, or changes in management firms and new entrants alike.²³ structures) innovation. But innovation is also perceived as a threat to social • The farther the country/sector is from the progress, given that it often leads to automation, production frontier (the most innovative product/ eliminating unskilled or lower-skilled employment. The process), the more innovation generates jobs (as consequences of innovation are hotly debated in both opposed to replacing jobs with robots). developed and developing economies. ²² Similar to the OECD/Eurostat (2005). New-to-the-world services and products have not been introduced to the world before, nor are they derived from existing products or services. New-to-the-firm refers to products or services that a particular firm has begun to offer, which they had not done previously. ²³ World Bank (2016b). ²⁴ Cirera and Sabetti (2016). Chapter 2 | South Africa Economic Update 10 | 26 Figure 2.1: Growth in employment by occupation, 1979-2012 (Percentage change in employment) Advanced Countries Developing Countries Leg. and Managers Professionals Technicians Operators Crafts Clerks Skilled agricultural Service workers Elementary occ -1 -0.5 0 0.5 1 1.5 -1 -0.5 0 0.5 1 1.5 Source: Comtrade and World Bank staff calculations Job creation in South Africa is often deemed to benefit A measure above 1 (the average impact) indicates that from product innovation, including the adaptation and innovating in this sector will have a higher impact on, adoption of innovation developed elsewhere. Yet the respectively, job creation and the consumption of the impact of innovation on employment creation varies poorest 40 percent of households than the average by sector. Innovation can directly reduce production for all sectors. costs within a company. It can also indirectly reduce the cost of production in sectors using intermediate Results suggest that innovation in any sector creates inputs that benefited from innovation. jobs and raises the consumption of the poorest 40 percent of households at the aggregate level,²⁵ with The magnitude of the impact depends on growth and results varying by sector. Innovation in gold, machinery, job multipliers, and the response in domestic and and housing, for example, has a pronounced impact international demand to changes in prices. In turn, as a result of higher exports, cheaper investments, poverty and inequality will be affected by the impact and strong multiplier effects. Innovation in coal, that innovation has on creating jobs for the poorest other mining activities, and government services, in sections of the population and on the price of goods contrast, has a less pronounced effect on jobs creation. consumed by these households. Similarly, innovation by sector has different effects on the consumption patterns of poor households. The World Bank measures these effects using a This reflects, to a large extent, the lack of capacity in computable general equilibrium model for South the poorest households to supply skilled labor. One Africa, comprising 55 sectors and four labor types implication is that innovation mostly influences the differentiated by skill level. The model considers welfare of low-income households by reducing their substitution possibilities between labor types, and cost of living, as opposed to increasing their revenue. between labor and capital, allowing for the progressive As a result, innovations in public transportation, automation of productive systems. It simulates the electricity, food, footwear, beverages, and agriculture impact of generating an additional R1 of output using have the largest positive effect on poor households. existing factors of production in each sector – a gain Innovations in gold mining (given its use of unskilled in TFP resulting from innovation. labor) and social housing combine high job creation and pro-poor impact. These results illustrate the different Figure 2.2 displays the relative impact of innovation channels through which innovation can play a role in in a given sector on net job creation and the real reducing poverty and creating jobs. consumption of the poorest 40 percent of households. ²⁵ Simulating a productivity increase equivalent to 1 percent of GDP across all sectors generates a 0.2–0.25 percent increase in the number of jobs (and a 0.9–1.8 percent increase in real wages), depending on whether innovation is embedded in capital or labor. 27 | South Africa Economic Update 10 | Chapter 2 Figure 2.2: Impact of sectoral innovation on job creation and consumption by poorest households (Relative impacts of sectoral innovation on jobs creation and the consumption of the poorest households) Gold & uranium ore mining Social housing Machinery & equipment Television, radio & communication equipment Metal products excluding machinery Electrical machinery Finance Insurance Business services Furniture Wood & wood products Non-metallic minerals Coke & refined petroleum products Plastic products Glass & glass products Motor vehicles, parts & accessories Basic iron & steel Public transportation Paper & paper products Agriculture, forestry & fishing Communication Electricity gas & steam Printing, publishing & recorded media Other transport equipment Other transports Building construction Wearing apparel Textiles Beverages & tobacco Other chemicals & man-made fibres Leather & leather products Food Basic chemicals Other non-government services Rubber products Non-government: Health Footwear Wholesale & retail trade Government: Defence Professional & scientific equipment Government: Water & sanitation Government: Social Other industries Non-government Education Basic non-ferrous metals Government: Education Government: Law and order Government: Infrastructure Government: General administration Government: Health Government: Economic Catering & accommodation services Non-government: Water & sanitation Coal mining Other mining 0 0.5 1 1.5 2 2.5 3 Bottom 40% consumption Jobs creation Source: World Bank staff calculations Chapter 2 | South Africa Economic Update 10 | 28 Providing better goods and services to poor households Innovation is often perceived as a policy area with little Swaziland and Eastern Cape. He realized that the bearing on poverty, creating products affordable only distance and lack of specialists in rural areas kept to rich households. Yet rapid technological progress many people blind despite the existence of medical has made it possible for most of South Africa’s poor to treatments. This inspired him to develop a mobile purchase mobile phones and take advantage of mobile app. “Vula” means “open” and was taken from the applications, leapfrogging advanced economies where name of the eye clinic Vula Amehlo – Open Your consumers only 10 years ago spent considerable amounts Eyes in Swaziland. The app enables primary health of money on fixed broadband and desktop computers. care workers to fill in a standard questionnaire, Similarly, health outcomes have dramatically improved take photos, do a basic medical test, and send it as a result of the availability of new medicines, the to the on-call specialist. The response time is 15 outreach and quality of education is improving through minutes and the doctor can see other patients online platforms, and public services are gradually while waiting for the advice of the specialist. Along coming online. with subsequent treatments, the app has helped restore the vision of hundreds of people living The private sector can be a powerful player in addressing in rural areas. Now Vula has expanded beyond the needs of the poor by developing affordable products ophthalmology and covers about a dozen different and services, and creating opportunities for the fields, including dermatology, HIV, cardiology, and unemployed. Sometimes these efforts come from the oncology, benefiting more than 1,000 patients a large incumbent firms, but more often than not they are month. In addition to direct health benefits for the the creation of social entrepreneurs. patients, Vula has also resulted in cost savings as more patients receive care by primary doctors Two recent examples show how local companies are rather than specialists. In addition, rural health using digital technologies to increase low-skilled workers benefit from the continuous support of employment and improve the provision of social services: specialists. • Job matching: SweepSouth is a start-up that These two examples demonstrate the way new connects domestic workers with potential technologies developed by entrepreneurs with a clients. The primary aim of the company is to social vision are transforming people’s lives. There is provide flexible working opportunities at a fair a mass of potential customers, patients, employees, wage for those in this less-skilled segment and suppliers, which until recently was largely of the population. The company has already untapped because of distance to markets and limited helped more than 3,000 individuals who were access to information and finance. Improvements in previously unemployed or underemployed to the logistics infrastructure in rural areas, and the find full-time work. roll out of ICT networks, are creating opportunities • Health care: Vula was founded by an to change this. ophthalmologist who volunteered in rural areas of Reinforcing competition through disruptive technologies Economic competition is low in South Africa. This is competitiveness, and a high cost of goods and services notably reflected in the large dispersion of returns to sold to the poor. World Bank staff analysis suggests capital across sectors (Figure 2.3). Low competition that progressively halving mark-ups resulting from is likely to result in suppressed demand for capital dominant market position could create 300,000 and labor in these firms and sectors, reduced price additional jobs and lift 600,000 people out of poverty. Local companies are using digital technologies to increase low-skilled employment 29 | South Africa Economic Update 10 | Chapter 2 Figure 2.3: Sectoral rates of return to capital (Gross operating surplus over capital stock, 2006-15) Building construction Civil engineering & other construction Other manufacturing Television, radio & communication equipment Wholesale & retail trade Catering & accommodation services Leather & leather products Footwear Professional & scientific equipment Other services Wood & wood products Beverages Machinery & equipment Electrical machinery & apparatus Non-metallic minerals Food Medical, dental & veterinary services Furniture Wearing apparel Rubber products Other chemicals and man-made fibers Basic non-ferrous metals Other producers Other transport equipment Metal products excluding machinery Communication Plastic products Paper & paper products Transport & storage Basic iron & steel Agriculture, forestry & fishing Coke & refined petroleum products Textiles Business services Weighted average: 17.5% Basic chemicals Finance & insurance Water supply Glass & glass products Motor vehicles, parts & accessories Electricity, gas & steam Printing, publishing & recorded media General government services 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 110% 120% Source: World Bank staff calculations based on Quantec (2017). The causal relationship from competition to innovation Uber revolutionized conventional passenger transport is not straightforward. Market dominance may be systems by establishing a digital marketplace required to innovate when intellectual property rights that matches suppliers (drivers) with customers are insufficiently protected. But lack of competition (passengers) for an efficient, generally safe, and may prevent the emergence of innovative new firms. affordable service to commuters around the world. Lack of competition in key enabling sectors, such as Since its launch in 2009, Uber has expanded into more ICT, may also deter innovation in other sectors, as than 600 cities in over 77 countries on six continents. discussed in the sections below. Globally, there are more than 65 million monthly active Uber riders and over 2 million driver partners. The impact of innovation on competition is clearer. The introduction of disruptive technologies can play South Africa is one of Uber’s fastest growing an important role in strengthening competition. The markets globally, highlighting a gap in the existing rapid success of the e-hailing platform Uber surprised transport market. The company has joined with many observers because of the regulatory constraints drivers in the country that come from a wide range and vested interests in the traditional taxi industry. of occupational backgrounds. Chapter 2 | South Africa Economic Update 10 | 30 Figure 2.4: Uber trips in Johannesburg-Pretoria (2015, 2016) (Uber trips over time) Data from Johannesburg and Pretoria over the course of one week in May 2015 and 2016. Completed trips only. Routes are generated using an automated routing process. Trip end points have been jittered for privacy. 2015 2016 Johannesburg and Pretoria, South Africa Source: Uber (2017) The introduction of Uber had various spillover effects Tailoring this technology to the South African market into other segments of the transport industry. It has (especially lower-income earners) has the potential inspired the entry of other firms and even greater to multiply the impact of this type of innovation. Uber competition. Taxify is a platform that followed the Uber requires the end-user to have access to a smartphone model, and adapted it worldwide – further increasing (between 37 percent and 45 percent of South Africans), efficiency and competition within the market. The South while Afta Robot only requires the user to have an African-born company Afta Robot has inserted itself Internet-enabled phone (about 86 percent). By being into the minibus taxi sector, which generally serves able to access the service for only 20 cents to the Rand lower-income South Africans and accounts for about (1.5 U.S. cents) per dial, the average South African 70 percent of daily commuters. commuter can afford to be connected to the transport grid in a way that they could not before. Improving the management of public goods New technologies can contribute to addressing jobs. The International Labour Organization estimates environmental issues. Faster adaptation and that South Africa can create 462,000 additional jobs diffusion of clean technology²⁶ products and services by 2025 through investments in the green economy, throughout the household and corporate sectors can including in clean energy generation, energy efficiency, create opportunities for more efficient and sustainable pollution control, and natural resource management.²⁷ water and energy use while creating thousands of new South Africa can create 462,000 new jobs by 2025 through investments in the green economy ²⁶ A product or service that reduces negative environmental effects. ²⁷ World Economic Forum (2017). 31 | South Africa Economic Update 10 | Chapter 2 Box 2.1: Pioneering carbon capture and storage in South Africa As one of the 20 largest emitters of fossil fuels globally, the optimal geological sites for large-scale carbon South Africa has committed to reducing its carbon storage. Several universities, the Council for Scientific footprint. Accordingly, it is exploring the potential of and Industrial Research, and the World Wide Fund for innovative climate change mitigation technologies, Nature have also been actively involved. notably piloting the capture and storage of carbon. A five-year demonstration program is under way to Carbon capture and storage involves the integration capture and store carbon at scale. This includes the of three processes: the separation of CO2 from other design, construction, and operation of a CO2 capture gases and its compression into a dense state; transport plant at Eskom’s Kusile power plant, with the goal of of the CO2 to an appropriate site; and the injection of providing a testing and learning facility for industry CO2 into an underground geological formation where it and academia across Southern Africa and beyond. can be safely stored and monitored. Integrated carbon Explorations are also under way to identify a site capture and storage is a new and rapidly evolving within the Zululand basin for the injection, storage, technical area. Globally, only 15 large integrated carbon and monitoring of up to 50,000 metric tons of CO2. capture and storage projects were in operation by the The successful completion of this demonstration end of 2015. program will pave the way for commercial carbon capture and storage. The first investigations into the viability of carbon capture and storage in South Africa began in 2004. The uptake of this technological innovation will likely Following the establishment of a South African depend on changes in the regulatory environment. Centre for Carbon Capture and Storage in 2009, the The proposed national Carbon Tax Bill, by providing South Africa Council for Geoscience together with for carbon offsets, would help incentivize companies to Sasol, Eskom, PetroSA, Anglo-American, and the invest in greenhouse gas and CO2 mitigation projects to South African National Energy Development Institute reduce their carbon tax liabilities, including accelerating jointly developed a comprehensive atlas, identifying the use of capture and storage technologies. Big data collected through various platforms can WhereIsMyTransport is using big data to provide also reduce coordination costs and facilitate the solutions in local informal transport networks. development of evidenced-based policy. Labor By capturing data on routes, commute times, and matching, traffic congestion, and identifying skills costs, the company can optimize travel plans for shortages (using LinkedIn data, for example) can all commuters for a cost-efficient journey.²⁸ This project be improved with big data. has already been rolled out in five major cities, and has led to a partnership with local government – a Agriculture, transport, health care, education, and crucial element of big data operations. The use of big poverty are among the areas that can benefit from data is most effective when there is both private and big data, particularly when it is open data that can public cooperation, creating a space for new ideas be used to develop new services. South African firm and research. Leveraging innovation for inclusive growth The government’s recognition of the role innovation innovation (especially for under-served communities) plays in advancing social goals is reflected in the is also recognized in the private sector, as discussed Industrial Policy Action Plan of 2017. The Department of in previous sections. Science and Technology’s forthcoming white paper will also look at the contribution science and innovation can South Africa already has a sophisticated research system. make to the country’s development, and will shape the It boasts well-recognized universities and a tradition of future of public policies in this area. The importance of academic excellence. It has also invested in world-class ²⁸ The Guardian (2016). Chapter 2 | South Africa Economic Update 10 | 32 science facilities, including the fastest computer on Google and Microsoft. South Africa continues to be the continent and one of the largest telescopes in the the top foreign direct investment destination in Sub- world. It has powerful role models who can inspire young Saharan Africa and is ranked 25th globally on the people to study science and engineering, become social 2017 A.T. Kearney investor confidence index.³⁰ entrepreneurs, and develop careers in the innovation sphere. From the first heart transplant to the first digital But competitive pressures have increased dramatically. laser, South African advances in science and technology Emerging economies, particularly fast-growing have reached far beyond the country’s borders. Ubuntu, countries in East Asia, and more recently in South Thawte, and Paypal have more in common than meets Asia, are making massive investments in education the eye: not only are they are all pioneering software in and skills, ICT infrastructure, technology upgrades, the modern age of computing, but they were all created and national R&D systems. As underlined in Chapter by South Africans.²⁹ 1, these pressures are reflected in faster TFP growth in many countries compared with South Africa. As a In addition, South Africa’s private sector is one of result, South Africa’s companies are squeezed on two the most dynamic and diversified on the African fronts (World Bank, 2011). They must compete with continent. Domestic companies are active across developed economies that dominate the global market a number of sectors – from mining and minerals to for knowledge-intensive products, but they also face electronics and clean technologies. Recognizing the strong competition from Asian economies with much size and potential for growth in the South African lower labor costs. This means that South Africa will market, and the country’s strategic position as need to invest in innovation (including technological a finance hub, several multinational companies absorption) or it will face the threat of falling further established their offices in the country, including behind its peers. An Overview of South Africa’s Ecosystem for Innovation and its Performance South Africa ranks relatively high on the international small, has been able to adapt some global platforms metrics for innovation and competitiveness (Table 2.1). and create innovative local applications. However, This is attributable to the generally positive business declining private sector R&D investment, relatively environment, good intellectual property framework, a weak performance in high-tech and new industries, and tradition of excellence in public research institutions, a lack of new high-growth firms, threaten the country’s history of manufacturing, and an ICT sector that, while longer-term competitiveness. South Africa needs to invest in innovation or fall further behind its peers. ²⁹ Mark Shuttleworth was not only the first South African in space, but also the founder and developer of technologies such as Ubuntu (a Linux operating system) and Thawte (a secure payment technology). These technologies have (in part) created the world of secure online payments and open-source computing. South African-born Elon Musk is the founder of PayPal, Tesla, and Space-X. Continually pushing the boundaries of clean and space technology, Musk has been hailed as an icon of innovation. Young South African scientist Siyabulela Xuza has had a planet named after him in honor of his work in developing a record-breaking rocket and more energy-efficient rocket fuel. ³⁰ A.T. Kearney (2017). 33 | South Africa Economic Update 10 | Chapter 2 Table 2.1: Innovation and competitiveness indices Country Global Innovation Index 2016 Global Competitiveness Index 2016-17 Ranking (1-128) Score (0-100) Ranking (1-138) Score (1-7) South Africa 54 35.85 47 4.47 BRICS Brazil 69 33.19 81 4.06 China 25 50.57 28 4.95 India 66 33.61 39 4.52 Russia 43 38.50 43 4.51 Knowledge economies Finland 5 59.90 10 5.44 South Korea 11 57.15 26 5.03 Switzerland 1 66.28 1 5.81 United States 4 61.40 3 5.70 Other African economies Kenya 80 30.36 96 3.90 Mauritius 53 35.86 45 4.49 Nigeria 114 23.15 127 3.39 Source: WEF (2016), Cornell University, INSEAD, and the WIPO (2016) The innovation system can rely on a strong tradition of academic excellence One of South Africa’s areas of strength is the tradition The standard indicators of science impact also show of excellence in academia and public research. This an above-average performance (see Table 2.2). The can provide a foundation for strengthening innovation international collaboration on publications is also more activity in the private sector. Three of South Africa’s widespread than in other BRICS countries, indicating universities – the University of Cape Town, the University deeper integration in the global scientific community. of the Witwatersrand, and Stellenbosch University – Furthermore, public research institutions traditionally are ranked among the world’s 500 best universities.³¹ account for most of South Africa’s patents (Table 2.3). Table 2.2: Scientific production in BRICS countries Country Normalized citation impact index: International collaboration among 2003–2012 institutions (% of documents): 2003–2012 Brazil 0.77 24.9 China 0.66 15.0 India 0.71 17.4 Russia 0.50 30.9 South Africa 1.10 42.7 Source: OECD (2015a) ³¹ Based on Times Higher Education (2017a, 2017b). Chapter 2 | South Africa Economic Update 10 | 34 Table 2.3: Patent Cooperation Treaty top applicants (publication year 2015) Applicant Publication Stellenbosch University South African Sugarcane Research Institute 18 University of Cape Town 10 University of The Witwatersrand 9 Detnet South Africa (Pty) Ltd 8 University of Pretoria 8 CSIR 7 Sasol Technology (Proprietary) Limited 5 Stopak (Pty) Ltd 5 Discovery Limited 4 NCM Innovations (Pty) Ltd 4 Source: WIPO (2017) South African researchers have produced a number of of international consortia. For example, the Council globally important innovations over the years – including for Scientific and Industrial Research introduced the CAT scan, the tellurometer (the first successful the fastest supercomputer on the African continent microwave distance measurement device), the digital in 2016, opening new possibilities for conducting laser, and genetically modified disease-resistant crops world-class research projects. The Southern African suitable for African soil. A strong intellectual property Large Telescope in Sutherland is the largest single rights regime plays an important role in protecting optical telescope in the southern hemisphere. The domestic inventions. Square Kilometer Array project, which is under way in collaboration with 11 other countries, will bring foreign South Africa also continues to make major investment into the country and create jobs. investments in “big science” facilities, often as part Entrepreneurs and innovative activities cluster in a few cities Cape Town is home to the largest number of information LinkedIn data also suggest that the percentage of technology-based companies on the African continent, members who are active entrepreneurs in the South including between 700 and 1,200 active start-ups. African metros is closely associated with the capacity Johannesburg has between 200 and 500 active start-ups. of the universities in the same cities to produce LinkedIn data show that Cape Town, Johannesburg, and entrepreneurs and the capacity of the cities to retain Pretoria have a large base of active entrepreneurs that skilled migrants. The share of immigrant start-up outstrips that of similar cities in other countries (Figure founders of 18 percent in Cape Town and 17 percent in 2.5). The Global Startup Ecosystem Report 2017 ranks Johannesburg is comparable to the global average of Cape Town and Johannesburg relatively high for their 19 percent. However, start-ups in both cities experience availability of experienced software engineers.³² Even difficulties with bringing in foreign employees – the visa at the lower end of the spectrum, Durban, Port Elizabeth, success rate is 36 percent in Cape Town and 20 percent and Bloemfontein have more active entrepreneurs than in Johannesburg.³³ As a result, most start-ups focus the upper-middle-income city average. Taken as a whole, on the domestic market. Foreign customers comprise the results support the view that South Africa is an only 14 percent of clients for start-ups in Cape Town attractive environment for entrepreneurs, and is building and 11 percent in Johannesburg, compared to the global a steady pipeline of entrepreneurship-related skills. average of 23 percent. ³² Startup Genome (2017). ³³ Startup Genome (2017). 35 | South Africa Economic Update 10 | Chapter 2 Figure 2.5: Percentage of LinkedIn members per city that are active entrepreneurs Upper Middle Income High Income City Average City Average Istanbul, TR Cape Town, ZA Johannesburg, ZA Kuala Lumpur, MY Pretoria, ZA Bangalore, IN Mexico City, MX Durban, ZA Port Elizabeth, ZA Bloemfontein, ZA 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6% 1.8% 2.0% 2.2% % of Members in City that are Active Entrepreneurs Source: World Bank staff calculations based on LinkedIn data, 2017 The success of entrepreneurs is often closely linked to seems to be international connectedness, where the support systems and networks available to them. most South African cities, bar Cape Town, lag behind Large metros in South Africa are relatively good at comparable cities and global benchmarks (Figure 2.6). building local entrepreneur support communities such This may contribute to South Africa’s limited capacity to as meet-ups, incubators, and accelerators. But more catch up with global technological leaders. could be done in smaller cities. The bigger opportunity Figure 2.6: Percentage of LinkedIn networks comprised of entrepreneurs abroad Upper Middle Income High Income City Average City Average Kuala Lumpur, MY Cape Town, ZA Istanbul, TR Mexico City, MX Bangalore, IN Johannesburg, ZA Durban, ZA Pretoria, ZA Port Elizabeth, ZA Bloemfontein, ZA 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6% 1.8% 2.0% 2.2% % of Network Comprised of Entrepreneurs Abroad Source: World Bank staff calculations based on LinkedIn data (2017) Overall R&D intensity in South Africa is low R&D spending is essential for the public and private South Africa has declined over the past decade, while sector to identify and assimilate innovations generated it increased in BRICS and OECD economies. At 0.73 elsewhere, and to produce new products and services. percent, the R&D-to-GDP ratio in South Africa is the R&D expenditure is therefore a common metric for a lowest among BRICS countries (Figure 2.7). country’s innovation capabilities. R&D spending in Chapter 2 | South Africa Economic Update 10 | 36 Figure 2.7: R&D expenditure in BRICS countries (Percentage of GDP) 2.5 2.0 1.5 1.0 0.5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Brazil China India Russia South Africa Source: World Bank (2017a) Although the private sector accounts for most of South also behind comparable countries like Estonia and Africa’s R&D spending, it is also the main contributor to Slovenia. As most innovations are brought to the market its decline since 2008. At 0.8 percent of gross sales of by firms, low and declining R&D spending by South medium and large firms,³⁴ South Africa lags far behind Africa’s private sector may have negative consequences top performers such as South Korea and Finland, but for the competitiveness of the economy (Figure 2.8). Figure 2.8: Private R&D spending by sector in South Africa (billions, in 2010 rand values) 16 14 12 10 8 6 4 2 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Government Science Councils Higher Education Business Not-For-Profit Source: HSRC (2017) The decrease in private R&D spending may signal capture and storage have contributed to progress on a growing disconnect between the capabilities and climate change mitigation (see Box 2.1). The South focus areas of public research institutions and the African government has established several programs activities of the private sector. If true, the impact of to promote technology transfer and collaboration public investment in science can be multiplied by between public research institutions and industry, putting in place mechanisms for industry collaboration. some of which are described below. However, these For example, public-private partnerships on carbon programs have not yet been systematically evaluated. ³⁴ SARS-NT dataset. 37 | South Africa Economic Update 10 | Chapter 2 Mining, manufacturing, and ICT innovation South Africa’s mining industry has historically been However, with a few exceptions, South Africa is far behind a major contributor to intellectual property. South OECD and emerging economy champions in these fields. African producers received global recognition for ICT capabilities have become particularly important: their expertise in deep mining and related services. innovation across different sectors is increasingly driven Many local mining equipment manufacturers compete by digital technologies and the new business models they successfully with multinational companies in global enable. The average allocation of global R&D spending markets. South Africa’s leadership in mining technology for software and services increased from 54 percent to is also reflected in its large number of high-quality 59 percent between 2010 and 2015, and is expected to patents.³⁵ Strong expertise in mining is an important grow to 63 percent by 2020, according to a study on the asset that can be leveraged to diversify into other sectors 1,000 most innovative companies.³⁶ of the economy. South Africa has benefited from the global spread of The manufacturing sector has traditionally relied information technologies. The increasing rates of Internet on reverse engineering and manufacturing “clones” access and the nearly universal access to mobile phones of products developed elsewhere. Most locally have laid a foundation for delivery of basic e-services, manufactured products fall in the medium-tech online job platforms, and the spread of e-commerce. category. Although there are some pockets of It has also enabled the adaptation of digital platforms excellence in high technology, they remain fairly invented elsewhere. Although there are several success disconnected from each other, with no strong clusters stories in financial technology (such as Snapscan and or inter-industry linkages. They also find expression Yoko), education (GetSmarter and Snapplify), e-health in the regional (rather than global) value chain: (LifeQ), online job platforms (Giraffe, SweepSouth, South Africa has emerged as a hub for exports of Domestly, OfferZen), and other fields, the information manufactured goods into other African countries. technology industry in South Africa remains relatively small. It contributes less than 3 percent of GDP and 17.5 New industries such as ICT, biotechnologies, and clean percent of service exports, compared to 55 percent of technologies have emerged and grown over the years. service exports in Brazil and 40 percent in China.³⁷ Where have “gazelles” and “unicorns” gone? Globally, young high-growth firms, known as “gazelles”, also low, suggesting that less productive firms stay in are playing a leading role in innovation. Young firms business, limiting the reallocation of resources, such tend to be responsible for a higher share of patents as skilled labor, towards more productive firms. Given and to hold patents for more radical inventions.³⁸ South the transformative role played by gazelles around the Africa has the lowest share of young firms among world, South Africa’s small and diminishing cohort of emerging economies for which data are available, and young firms is a concern. this share has been declining over time. Exit rates are Most South African startups operate at a small scale ³⁵ World Bank (2011). ³⁶ PricewaterhouseCoopers (2016). ³⁷ World Bank (2017a). ³⁸ OECD (2015b). Chapter 2 | South Africa Economic Update 10 | 38 Figure 2.9: Share of young firms in South Africa and other emerging economies A. The share of young firms (age<=5) in South B. The share of young firms (age <=5) is declining Africa is lower than in other emerging economies over time Employment Distribution by Age Distribution of Firms by Age 100 80% Young Old 80 60% 60 40% 40 20% 20 0% 0 ZAF-2009-2014 MDA-2008-2014 CIV-2007-2012 CPV-2014 PRY-2010 UGA-2010 XKX-2009-2014 BGD-2013 SLE-2016 VNM-2009-2014 ZMB-2010 PER-2007-2012 AFG-2009 BFA-2008 TJK-2014 2009 2010 2011 2012 2013 2014 1 2-5 6-9 10-19 20-29 30+ Young Firms: age 1 to 5 Old Firms: age 10+ ZAF: South Africa; MDA: Moldova; CIV: Cote d’Ivoire; CPV: Cape Verde; PRY: Paraguay; UGA: Uganda. XKX: Kosovo; BGD: Bangladesh; SLE: Sierra Leone; VNM: Vietnam; ZMB: Zambia; PER: Peru; AFG: Afghanistan; BFA: Burkina Faso; TKJ: Tajikistan Source: National Treasury and World Bank staff calculations based on SARS-NT data Most South African start-ups operate at a small Elevation Holdings concludes that the problem is not scale; few have international customers or ambitions the absence of unicorns, but the shortage of young to enter global markets. Lack of outward orientation high-growth firms.³⁹ may have contributed to the absence of a “unicorn” in South Africa – a start-up with a stock market Factors that stifle the emergence of gazelles include valuation of about US$1 billion. Some smaller nations business environment constraints, the skills shortage, have been more successful in producing high-value and inadequate ICT infrastructure. Furthermore, start-ups: Sweden, with a population of 10 million, has although there are several public programs that aim five unicorns, Poland has two, and Portugal has one. to promote private innovation, they tend to be poorly In contrast, South Africa is not creating and retaining coordinated and underfunded. new businesses valued at a quarter of this amount. Private sector R&D expenditure levels are low despite large returns The availability of SARS-NT tax files data (covering conducted by authorities (Box 2.2). It also allows for about 600,000 firms each year) provides an opportunity improved comparison with countries such as France to comprehensively assess patterns of private R&D and the United States, where the same type of data and and usefully complement regular R&D surveys analytical frameworks were used.⁴⁰ ³⁹ Elevation Holdings (2017). ⁴⁰ Hall and Mairesse (1995, 1996). 39 | South Africa Economic Update 10 | Chapter 2 Box 2.2: Using tax files data to assess private R&D patterns Most studies of private innovation conducted in developed countries are more likely to report innovation developing countries rely on surveys involving interviews activities than firms in higher-income economies because with top executives from a sample of firms. This of different perceptions about what constitutes a approach offers some advantages in the breadth and significant improvement (World Bank, 2017c). depth of issues that can be covered. However, as with all methodologies, there are shortcomings. The approach used by this report uses a tax administrative dataset, which avoids the issues mentioned above. Questionnaire size and interview duration have been However, that does not mean that this analysis does found to have a significant impact on the quality of not have its limitations: changes in tax reporting forms responses, and it is not uncommon for self-reported present a significant problem as the consistency across financial information to be skewed. Surveys frequently the panel of data is limited in certain aspects; only formal, target larger firms or firms in sectors where R&D is registered firms are captured by such a database, and so concentrated, which means the activities of a vast number the informal section of the economy is not represented; of SMMEs go unreported. Micro and small firms are more finally, there is no straightforward measure of innovation likely to report marginal improvements as innovations, and, as a result, this study made use of proxies such as while large firms tend to report only new-to-the-market R&D expenditure and the export of products with high or new-to-the world innovations. Similarly, firms in less technological content embedded in them. Descriptive firm-level findings using the SARS- The intensity of R&D (sales weighted ratio of R&D NT dataset reinforce some of the issues already expenditure divided by gross sales in percent) is much identified in R&D surveys,⁴¹ but they also provide new smaller in South Africa than in France and the United information. Specifically, the data show that only a States (Figure 2.10 left panel). Manufacturing firms small percentage of predominantly old and large active in this space have an average R&D intensity of firms invest in R&D and they tend to do it on an ad 0.4 percent, compared to 2.9 percent and 2.3 percent hoc basis rather than through regular R&D programs. for U.S. and French firms respectively.⁴² Figure 2.10 About 4 percent of medium and large South African (right panel) shows that about 80 percent of South firms invested in R&D between 2009 and 2014. Among African firms have an R&D intensity ratio of less than the active R&D firms, only 4.9 percent reported R&D 0.5 percent over the 2009 to 2014 period, compared to expenditure in every financial year over the same only 10 percent in a sample of R&D active firms in the period, while about a third reported R&D expenditure United States from 1991 to 1995. in a single year only. Figure 2.10: R&D intensity in the United States (1991–95) and South Africa (2009–14) A. US 1991-95 B. SARS 2009-14 Distribution of R&D/S (weighted) Distribution of R&D/S (weighted) 15 60 10 40 Percent Percent 5 20 0 0 0 2 4 6 8 10 0 2 4 6 8 10 R&D/S in % R&D/S in % Source: Compustat and SARS-NT panel. Note: R&D intensity ratios weighted by sales ⁴¹ Department of Science and Technology (2017). ⁴² Hall and Mairesse (1996). Chapter 2 | South Africa Economic Update 10 | 40 Manufacturing accounts for most of the R&D, most likely to invest in R&D (Table 2.4). R&D intensity followed by mining and the business services in manufacturing is low compared to advanced subsector (finance, insurance, and real estate). economies, apart from aircraft and boats, where Within manufacturing, the pharmaceuticals, the R&D intensity exceeds that of the United States. chemicals, and electrical machinery subsectors are Table 2.4: R&D expenditure and intensity by sector (Medium and large firms) Sector South Africa (2009–14) % of firms with R&D expenditure by Weighted mean R&D to sector sales ratio Paper and printing 3.47 0.16 Chemicals 11.19 0.29 Rubber 6.41 0.19 Wood and miscellaneous 7.15 0.48 Primary metals 5.51 0.19 Fabricated metals 4.88 0.33 Machinery 5.67 0.88 Electrical machinery 9.78 0.27 Autos 3.04 0.37 Aircraft and boats 3.9 4.22 Textiles and leather 3.94 0.33 Pharmaceuticals 17.24 1.57 Food products 7.83 0.22 Computers and instruments 9.01 0.82 Oil products 4.05 0.45 Manufacturing 6.02 0.39 Agriculture 5.06 1.08 Mining 5.12 0.31 Electricity, gas, and water 6.16 0.26 Construction 1.4 0.1 Services 2.79 0.22 Total 4.02 0.32 Source: World Bank staff calculations based on SARS-NT data A comparison of South Africa’s top R&D spenders to software, computing, and electronics. The R&D listed on the Johannesburg Stock Exchange (JSE) intensity of these international companies is also much with world leaders and top Chinese companies also higher on average than that of the top 10 JSE-listed suggests a concentration in traditional activities, R&D spenders (Figure 2.11). such as finance, mining, and minerals, as opposed 41 | South Africa Economic Update 10 | Chapter 2 Figure 2.11: R&D intensity of top global, Chinese, and South African R&D spenders (Percentage of R&D spending over gross sales, 2012–16) Toyota Motor Corp Johnson & Johnson G Novartis AG L Roche Holding AG O Microsoft Corp B Intel Corp A L Alphabet Inc Amazon.com Inc Samsung Electronics Co Ltd Volkswagen AG SAIC Motor Corp Ltd China Railway Construction Corp Ltd C Tencent Holdings Ltd H Lenovo Group Ltd I CRRC Corp Ltd N Baidu Inc A China Railway Group Ltd PetroChina Co Ltd ZTE Corp Alibaba Group Holding. Ltd British American Tobacco Adcock Ingram Holdings S A Anglo American Plc O F Reunert Ltd U R Allied Electronic Group T I ArcelorMittal SA Ltd H C A Nedbank Group Ltd Sasol Ltd Barclays African Group Ltd Anglo American Plat Ltd 0% 5% 10% 15% 20% 25% Source: World Bank staff calculations Low economic returns for R&D could explain South specification. This is higher than the results⁴⁵ for France Africa’s low private investment levels. However, our and the United States, where the R&D rate of return is research, using a methodology⁴³ linking firms’ economic estimated between 28 percent and 78 percent depending performance (measured by sales) to their cumulative on the type of estimation used, and significantly higher R&D spending (as a proxy for innovation capacity), than the estimated rate of return of between 8 percent suggests otherwise.⁴⁴ and 35 percent in Taiwan.⁴⁶ Results obtained based on all South African firms Low investment in R&D despite high returns is common declaring R&D spending over the period 2009 to 2014 in developing countries and has been recently described suggest that the R&D rate of return in South Africa is high, as “the innovation paradox”. As argued by Schumpeterian ranging from 118 percent to 294 percent depending on the economists, countries further from the technological ⁴³ Results were obtained using an econometric methodology similar to that used for France and the United States (and to our knowledge, never applied to any developing country before South Africa). ⁴⁴ See Schaffer et al. (2017) for detailed results. ⁴⁵ Hall and Mairesse (1995, 1996). ⁴⁶ Wang and Tsai (2003). Chapter 2 | South Africa Economic Update 10 | 42 frontier can achieve strong gains from technological human capital and management capabilities may result catch-up and should have higher rates of return. Griffith in a situation when firms are not able to identify the best et al. (2004) find that the return to R&D in OECD countries technological solutions and organizational practices increases with distance to frontier, and extrapolation of relevant for their business. Restrictive labor laws and these results to developing countries shows a potential policy uncertainty also reduce the appetite for risk rate of return of between 200 percent and 300 percent.⁴⁷ associated with innovation. Distortions in capital and However, developing countries invest much less in R&D product markets can reduce firms’ returns to R&D. In the as a share of GDP than developed economies. case of South Africa, policy uncertainty, red tape, the skills shortage, and logistical bottlenecks (in transport and ICT, Globally, a number of framework conditions and for example) likely contribute to this trend. contextual factors contribute to this pattern. Weak Innovation is concentrated in medium-tech products Weak innovation in the private sector is reflected in the total manufacturing exports compared to other BRICS lack of export diversification over the past two decades, countries. However, there has been some improvement with high-tech exports constituting a small share of since 2010 (Figures 2.12 and 2.13). Figure 2.12: South African exports (2005 vs 2015) $50.6 bn $79.7 bn 2005 2015 Source: Haussman et al. (2017) Figure 2.13: High-tech exports in BRICS countries (As percentage of manufactured exports) 35 30 25 20 15 10 5 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Brazil China India Russian Federation South Africa Source: World Bank Group (2017); Comtrade Database ⁴⁷ World Bank (2017c). 43 | South Africa Economic Update 10 | Chapter 2 The availability of firm-level transaction data provides Following the OECD methodology, South African a more detailed view of how product innovation is export products are classified into four categories: low affecting the export basket. South Africa is one of the technology, medium-low technology, medium-high first developing countries to conduct such a transaction- technology, and high technology. Box 2.3 describes these level analysis. groups of products from a qualitative perspective.⁴⁸ Box 2.3: What does high-tech really mean? Low technology: These products tend to have stable, well- Medium technology: This technology makes up the diffused technologies. The technologies are primarily bulk of skill- and scale-intensive technologies in capital embodied in capital equipment, with relatively simple goods and intermediate products, forming the mainstay skill requirements in terms of the labor employed. Many of industrial activity in mature economies. They tend to traded products in this category are undifferentiated and have complex technologies with moderately high levels therefore rely on price structures to be competitive. As of R&D, advanced skill needs, and longer learning periods. a result, labor costs present a significant consideration This category is further broken down into medium-low for firms operating at this level. Scale economies and and medium-high technology. barriers to entry are generally low. Developing countries tend to express great interest in this technological area, High technology: Products with advanced and fast- and as a result place greater focus on price competition changing technologies, with high R&D investment, and than quality competition. The majority of goods produced an emphasis on product design. Advanced technologies within this technological band have moved from high- often require sophisticated infrastructure, specialized income to low-income countries. technical skills, and close interactions between firms, as well as between firms and research institutions. Using these definitions, high-tech products accounted A detailed review of the export trends from 2010 to 2014 for only 7 percent of the South African export basket in shows growth in both low- and high-tech products. 2014, while “other” and medium technologies comprise There has been a gradual decline in the share of the bulk of exports (Table 2.5). This is not surprising medium-tech and resource-based products, which were given that South Africa is known for its exports of arguably South Africa’s most competitive manufacturing minerals and resource-based products – all of which industries. Unlike many other developing nations, South make up the category of “other”. This indicates that Africa is not trapped in low-technology exports, and has South Africa mostly operates in the medium-tech space, the capacity to further upgrade its technologies and which typically involves complex technologies, with compete on quality and price. moderate to high levels of R&D investment. Table 2.5: Export value of different technology levels in South African total exports (As percentage of manufactured exports) Country 2010 2011 2012 2013 2014 Low technology 11.7 11.0 11.3 12.9 13.0 Medium-low technology 27.7 22.0 23.3 24.1 24.9 Medium-high technology 22.4 24.8 23.9 22.6 22.0 High technology 5.1 5.8 6.1 6.0 7.1 Other 33.2 36.4 35.4 34.4 33.0 Source: World Bank staff calculations based on SARS-NT data ⁴⁸ See Lall (2000) for a detailed discussion on the technological content of goods, and Flowerday et al. (2017) for an application to South Africa’s exports. Chapter 2 | South Africa Economic Update 10 | 44 The findings of Flowerday et al. (2017) show that a are investing in R&D are more likely to be high-tech. 1-unit increase in R&D intensity⁴⁹ results in a 2.7 Limited private R&D is reflected in slow diversification percent increase in the probability of the firm being of new products: the main exports per technology group high-tech. In addition, sectors such as transport remain the same. The five-year period under analysis and storage; electricity, gas, and water; ICT; and showed little movement in the top five products per professional technical and scientific activities show technology classification. Table 2.6 reports the top five the greatest likelihood of having high-tech firms.⁵⁰ exports per technology group in 2014. The results suggest that industries (and firms) that Table 2.6: South Africa’s top five export products per technology group (2014) High Technology Low Technology Engines for aircraft Wine Turbo-jets Wood pulp Telephones for cellular networks Wood Aeroplanes and other aircraft Diamonds Ammunition Coin Medium-High Technology Medium-Low Technology Acyclic hydrocarbons Petroleum oils Alcohols Metals; platinum, unwrought or in powder form Machinery; for filtering or purifying gases Metals; platinum, semi-manufactured Machines for sorting, screening, separating, washing,Metals; palladium, unwrought or in powder form crushing, agglomerating, shaping or molding Vehicle parts and accessories Ferro-alloys Source: World Bank Group (2017); Comtrade Database Limited diversification is also reflected in the technological Saharan Africa slightly, in both high and medium-high tech composition of exports according to their destination, markets and low and low-medium tech markets. South which remained almost unchanged between 2010 and Africa can enjoy a steady client-base, but has not been 2014. South Africa increased its export share in Sub- breaking into many new markets through innovation. Figure 2.14: Technological content of exports per destination (2010-14) High and Medium-High Low and Medium-Low 60% SSA 40% Increased share SSA Increased share 50% 40% 30% MENA+ECA 2014 2014 30% Decreased 20% EAP+SA 20% NA+LAC MENA+ECA Decreased share 10% 10% EAP+SA NA+LAC share 0% 0% 0% 10% 20% 30% 40% 50% 60% 0% 10% 20% 30% 40% 2010 2010 Source: World Bank Staff calculations using SARS-NT data. Notes: SSA: Sub-Saharan Africa; EAP: East Asia and Pacific; SA: South Asia; ECA: Europe and Central Asia; MEN: Middle-East and North Africa. NA: North America; LAC: Latin America and Caribbean. ⁴⁹ Either by increased R&D, decreased sales, or a faster increase in R&D expenditure than the increase in sales. ⁵⁰ When using the mining industry (the original backbone of the South African economy) as the basis for comparison. 45 | South Africa Economic Update 10 | Chapter 2 What More Can Be Done to Encourage Private Innovation in South Africa? Innovation activity is influenced by a range of internal young and small firms. While the quality of the higher and external factors, as shown in Figure 2.15. South education and research system compares well to that of Africa’s business environment lags behind that of fast- other emerging economies, it cannot resolve the highly growing knowledge economies. Policy uncertainty, red uneven distribution of skills across the population alone, tape, expensive trade logistics, and limited competition and migration data points to a large-scale net skills loss in key product markets hinder the entry and growth of towards more advanced economies. Figure 2.15: Internal and external factors affecting innovation Factors that influence firm growth and innovation External Internal Business climate Capabilities of the founder and staff Supply of education and skills supply Managerial practices of the firm ICT infrastructure R&D investment Public programs to support innovation The government has put in place a sophisticated firms. However, the design of some of the programs system to support entrepreneurship, technology can be improved to make them more targeted to the absorption, and innovation in the private sector. Few needs of the domestic private sector. Furthermore, upper-middle-income economies have developed the multiplicity of programs, combined with relatively such a wide range of instruments – including small budgets, fragments public efforts to support incubators, matching grant schemes, employee R&D, industrial development, and entrepreneurship. training, tooling centers and tax incentives – to encourage entrepreneurship and innovation. The Below we discuss some of the factors that influence availability of public support programs is a clear innovation activity and outline policy considerations benefit for entrepreneurs, no less than for established that could improve the environment for innovation. Foster a business climate that is conducive to innovation Nurturing South Africa’s entrepreneurs and innovative Cutting red tape is important to reduce regulatory companies requires a business climate that is more compliance costs, which tend to affect small and young conducive to the entry and growth of new firms, and firms disproportionately. South Africa ranks 74th in to risk-taking and experimentation. the world for ease of doing business – the fourth- best performance in Sub-Saharan Africa (based on Reviewing product market regulations that favor the World Bank’s Doing Business 2017 Report). But incumbents is a priority that was discussed in detail in it is far behind knowledge economies. SMMEs need the 8th South Africa Economic Update. A level playing to go through seven procedures and spend 43 days field that creates competitive pressures for incumbents just to register a business. It takes on average 141 could stimulate investments in technological upgrades, days to get a construction permit and 84 days to get and lead to the exit of less productive firms, enabling an electricity connection. Hindering regulations and resources to be put to better use. policies were recognized as the second most important Chapter 2 | South Africa Economic Update 10 | 46 constraint after skills deficit by SiMODiSA, a South agreements, the copyright amendment bill, and the African nongovernmental organization that promotes ICT regulatory framework (discussed below) may also entrepreneurship.⁵¹ deter investment in innovation. One avenue to enhance the business environment is Although South Africa has a well-developed and through legal reforms, but there are many areas where sophisticated financial system, access to finance is a short-term improvements can be made through major constraint to small business growth.⁵⁴ In fact, peer learning among subnational governments. a survey in 2010 revealed that less than 5 percent of This is one of the main findings of the Sub-National small businesses relied on formal financial institutions Doing Business 2015 Report: ⁵² by combining the for funding.⁵⁵ Their access to credit is constrained best practices from the nine largest metros in by two factors – lack of suitable financial products obtaining construction permits, getting electricity offered by banks and inadequate capacity of small connections, and enforcing contracts, South Africa’s business founders to present their funding needs to relative performance could be boosted to a level financial institutions. The government, through its above the average in high-income OECD countries. Small Enterprise Finance Agency, is working with The City Support Program at the National Treasury, banks to de-risk small business lending and provide with support from the World Bank, is rolling out direct loans to these enterprises. It will be important several initiatives to foster regular dialogue, identify to scale up these programs. regulatory best practices, and share experiences between municipal authorities. Relative to the size of the financial system, the venture capital raised by South Africa’s start-ups remains As mentioned in Chapter 1, policy uncertainty is a likely small, with a recent report estimating that in 2016, reason for the observed drop in investment. In the case 28 start-ups received $98 million, putting the country of innovation, delays and uncertainties surrounding in second place in the region behind Nigeria (to put the reform of South Africa’s intellectual property rights this into perspective, Austrian start-ups raised a regime have been a longstanding cause of concern, and similar amount in 2016, whereas start-ups in Russia limits the usefulness of patents granted in the country. and Finland raised up to four times more in total).⁵⁶ This translated into a slippage on global reviews of Experts from the industry have commented that intellectual property policy: in the International the venture capital deals in South Africa are helping Property Rights Index, the country’s score stagnated to connect global investors with domestic start- from 2007 to 2016, and its ranking dropped from ups focused on deploying clones of digital business 25th to 46th place. Similarly, the Global Intellectual models in the local market, but point to the scarcity Property Center (2017) highlights weaknesses in the of venture capital funding for new-to-the-world intellectual property rights regime, particularly in the technology from South Africa that aims to reach global area of patents. Disagreements about the direction markets. To identify growth drivers, further research is of the reform⁵³ have left researchers, entrepreneurs, needed into the types of early-stage companies that and companies having to operate in an environment are getting funding. Policy options for growing equity with a legal framework that is two decades out of investments into young high-growth firms then need date. The government relaunched the consultation to be reviewed. on intellectual property rights reforms last year and Cabinet has approved the draft Intellectual As discussed earlier, a large share of innovation efforts Property Framework. This is an important milestone. are concentrated in goods. Innovative companies are The reform has received positive reviews for its more likely to export their products compared to those phased introduction of a substantive search for and that do not innovate. Most South African products are examination of patents, as well as its alignment exported by sea. Although port costs have declined with the Agreement on Trade-Related Aspects of significantly since 2012, they remain 88 percent higher Intellectual Property to promote policy goals in spheres than the global average in 2016/17.⁵⁷ Bringing down the such as health, industrialization, and the environment. cargo and inland handling costs, and improving port Uncertainty regarding the future of power purchase efficiency, can support innovation. Apart from the high ⁵¹ SiMODiSA (2014). ⁵² World Bank (2015a). ⁵³ As in many countries, one particularly contentious issue is how to strike a balance between protecting domestic inventions and ensuring affordable access to pharmaceuticals developed in the rest of the world. ⁵⁴ SiMODiSA (2016) and SME Survey (2015). ⁵⁵ Finmark (2010). ⁵⁶ Sources: https://www.linkedin.com/pulse/vc-funding-raised-african-tech-startups-totals-record-cyril-collon; https://blog. dealroom.co/wp-content/uploads/2017/01/2016-European-Venture-Capital-Report.pdf. ⁵⁷ Ports regulator of South Africa (2017). 47 | South Africa Economic Update 10 | Chapter 2 cost relative to rival ports in emerging and developed in various emerging economies have reduced the time countries, South Africa’s port tariffs continue to favor and cost of complying with government regulation and the transport of minerals over manufactured goods. This mitigate the risk of corruption. For example, coordinating increases the cost of technology absorption that occurs e-government solutions and spatial data infrastructure via the import of capital goods in the form of advanced could improve the property registration process, because technology. Importantly, port costs make the country programs are currently running in parallel without a less competitive destination for export-oriented common standards and clear interoperability. Cities are at industries. different stages of automation and of updating records, but most would benefit from putting in place an online Innovation itself can play a major part in reducing costs tracking system for checking the progress of registering and cutting red tape, because e-government solutions deeds or a simple online database that links the deeds can simultaneously improve services and stimulate the registry and the Surveyor-General’s Office and includes growth of the domestic ICT industry. One-stop shops and information about associated mortgages, restrictions, electronic platforms for public service delivery introduced and other encumbrances. Nurture innovation ecosystems in cities Around the world, the growth of cities has gone hand- awareness, building capacity and skills, encouraging in-hand with economic progress and social change. community involvement, boosting public and private Competitive cities provide an enabling environment for sector innovation, and creating fundamental linkages firms and industries to create jobs, raise productivity, between all stakeholders. and increase the income of urban citizens. The World Bank’s report on competitive cities shows that 70 South Africa’s three largest metros – Johannesburg, percent of cities globally outperformed their countries Cape Town, and Durban – have emerged as hubs in productivity.⁵⁸ Several South African metros are of innovation and magnets for talent, spurred by already hubs for innovation, and are actively attracting the excellence of their academic institutions, the entrepreneurs and putting in place policies that will quality and cost of living, and overall agglomeration help them grow their businesses and create local jobs. economies.⁵⁹ In addition, these cities already have As already noted, simply scaling up the best practices many of the critical building blocks for an innovation of the top performing cities can significantly improve system, such as incubators, co-working spaces, the local and national business environment. fabrication labs, technology transfer offices, and technical and vocational education and training Cape Town and Johannesburg have received regional colleges. This is a fertile ground on which to grow. recognition for the quality of their entrepreneurial Interviews with city stakeholders (public, private, and ecosystem. Their municipal governments are taking civil society) suggest several opportunities: active measures to support entrepreneurship. For example, Johannesburg hosted 180 start-up events • Developing city-level strategies for innovation in 2016 and was the first African city to host the and entrepreneurship, focusing on putting in prestigious 2017 Global Entrepreneurship Congress. place programs that tie together the network Both city governments invested in incubators and of fragmented initiatives already in place, and accelerators to provide financial and mentoring encouraging research and innovation facilities to support for start-ups and have taken steps to improve be co-located to create real “innovation districts” public infrastructure and the business climate. Cape that bring more global recognition and capitalize Town ranks better than other South African cities on on existing strengths. The development of these the quality of its business environment, as measured strategies would also help to put the concepts by the Sub-National Doing Business 2015 Report. of innovation and entrepreneurship closer to the center of the economic development agendas of Other cities in South Africa are also working to improve municipal governments, mobilize bigger volumes the environment for innovation. InnovateDurban has of funding, and improve resource allocation. recently been established by the eThekwini Municipality and other key partners to create a common platform for • Fostering partnerships between the public and the innovation in the city. The entity will focus on creating private sector, and particularly between academic ⁵⁸ World Bank (2015b). ⁵⁹ Agglomeration economies originate from the geographical concentration of economic factors, notably human capital, which facilitates intellectual and commercial exchanges. Chapter 2 | South Africa Economic Update 10 | 48 institutions and private companies of different sizes, of these partnerships can be started at city level, but to further leverage existing public research capacity. many would also require support and funding from Programs that stakeholders mention range from national departments. open data initiatives that would use data collected by cities to develop commercial applications and From a national perspective, consideration needs to improve service delivery, to projects enabling be given to building on existing resources, networks, better access by start-ups and SMMEs to experts and partnerships in the largest metros when and equipment in the public research and education allocating resources to spur innovation. This may system, to creating centers of excellence and contradict balanced development objectives, but it will encouraging collaborative research programs effectively raise the impact of public programs aimed between companies and research institutions. Some at encouraging innovation. Building the skills base: Invest in technical and entrepreneurial skills, and encourage the migration of skills to South Africa Skilled labor is crucial to maintain the competitiveness may threaten the competitiveness of knowledge- of traditional sectors and develop new industries. intensive sectors. Overall, the average return for an Although South Africa’s share of university graduates additional year of schooling in South Africa is the has increased, it remains low by international second highest in the world after Rwanda.⁶¹ Salaries standards.⁶⁰ University graduates receive high returns in several knowledge-intensive occupations are higher on education; only 1.9 percent are unemployed. The than in other emerging economies (Table 2.7). skill premium in some occupations is so high that it Table 2.7: Median annual salary of selected jobs (As of March 24, 2017) High Technology South Africa, USD India, USD Malaysia, USD Software developer 20,090 6,052 12,848 Software engineer 24,911 6,724 12,327 Senior software engineer 41,356 11,259 20,240 Systems engineer, IT 19,734 5,395 12,808 Project manager, IT 32,629 20,454 27,021 Senior project manager, IT 55,561 28,151 42,850 SAP consultant 25,793 9,183 21,699 Electrical engineer 26,860 5,419 11,546 Senior electrical engineer 59,311 8,850 28,037 Mechanical engineer 26,532 5,231 10,961 Senior mechanical engineer 53,997 9,658 19,507 Chemical engineer 23,117 6,576 10,446 Environmental scientist 18,060 n.a. n.a. Pharmacist 30,895 3,091 15,352 Production manager, manufacturing 27,059 11,117 21,766 Structural engineer 26,857 7,544 16,144 Source: Payscale (2017). Notes: Payscale does not provide similar data for Brazil, China, Russia, and Turkey; n.a. = not ⁶⁰ StatsSA (2016). ⁶¹ Montenegro and Patrinos (2014). 49 | South Africa Economic Update 10 | Chapter 2 Meeting the needs of high-skilled sectors, such as ICT, is Table 2.8: Skills in highest demand important for economic transformation and productivity on LinkedIn, South Africa (2016) growth, because it can trigger a multiplier effect on employment and incomes through value chains or consumption.⁶² For example, in the United States each 1 Statistical analysis and data mining ICT job generates 4.9 jobs in other sectors. ⁶³ LinkedIn 2 Java development data show that nine of the top 10 skills in highest demand in South Africa are in ICT-related fields (Table 3 Network and information security 2.8). These occupations are also considered scarce 4 Mobile development skills according to the list compiled every year by the Department of Labor. 5 Perl/Python/Ruby 6 User interface design Increasing the supply of the highly skilled is a long- term agenda that is about both the quality and quantity 7 Middleware and integration software of resources. It will involve strengthening primary 8 Web architecture and development framework and secondary education to equip school graduates with better skills and increase the pool of qualified 9 Mac, Linux and Unix Systems candidates for tertiary education. It will also entail the 10 Public policy and international relations design of sustainable funding mechanisms to allow more students from low- and middle-income families to enroll in universities, and incentives for students to Source: LinkedIn, 2017 major in fields that are in high demand. In the short to medium term, adult education, Migration policy is another potential mechanism to vocational training, and entrepreneurship improve skills supply. Creating incentives for South development programs can upgrade skills and Africans who moved abroad to return and apply their generate employment. Evaluating and scaling up acquired knowledge domestically, as well as reforming successful programs can support innovation and migration policy to facilitate immigration of the highly create new jobs. skilled, can help build the country’s skills base (Box 2.4). Box 2.4: Adjusting migration policy to build the skills base The National Development Plan recognizes the potential determine the eligibility criteria for long-term of well-managed migration for the development of residence visas; using a long-term residence visa to the South African economy. Within this context, it attract investors and skilled migrants; granting critical recommends the “adoption of a more open immigration skills and business visas that cater for family members; approach to expand supply of high-level skills”. allowing international students who graduate in critical It is against this backdrop that the Department of Home skills occupations to apply for a long-term residence Affairs is making changes to South Africa’s International visa; and introducing a differentiated skills transfer Migration Policy (1999). Among the proposed changes mechanism to cater for different working conditions. in the White Paper on International Migration (March 2017) are recommendations that could have significant Although the South African economy does enjoy the implications for filling high-skills gaps in the labor market. interest of qualified professionals from throughout The white paper notes that the current policy is inadequate the region and beyond, it should not be assumed for attracting and retaining international migrants with the that the specifics of the new migration policy will requisite skills and capital to invest in the country. spontaneously attract potential candidates. A proactive and wide-reaching communication strategy needs to The white paper proposes several key interventions, be implemented to ensure the success of the initiative including: introducing a points-based system to in attracting high-skilled labor. Source: Payscale (2017). Notes: Payscale does not provide similar data for Brazil, China, Russia, and Turkey; n.a. = not ⁶² World Bank (2017b). ⁶³ World Bank (2016b). Chapter 2 | South Africa Economic Update 10 | 50 Improve ICT infrastructure A modern economy requires fast and cheap ICT 4G mobile services have still not been licensed in infrastructure to connect businesses with domestic South Africa, even though such services are thriving and international consumers, and to enable efficient elsewhere in Africa. delivery of public services. Urgent reforms are needed to increase investments in mobile and fixed broadband These costs take a toll on the development of infrastructure, strengthen competition among Internet e-commerce and the overall competitiveness of service providers, and improve the quality and reduce the economy. Already, South African firms that rely the price of ICT services. on e-commerce are more successful in overcoming distance constraints. Firms that trade on eBay reach South African consumers are paying more for an average of 30 different markets, while traditional broadband services of lower speeds than other exporters reach only five. Newcomers to this online emerging economies in Africa and other regions.⁶⁴ A platform (firms with no sales in the previous year) recent survey of prices across Africa concluded that account for 27 percent of sales; the respective figure 1GB of mobile data in South Africa costs five times for traditional firms is 2 percent. Data from eBay more than in Egypt.⁶⁵ South Africa’s high prices for also show that the concentration of sales among the Internet transit also negatively affect the market in top 5 percent of South African sellers is 33 percent, its landlocked neighbors, such as Botswana, Lesotho, compared to 90 percent for traditional firms.⁶⁶ and Zimbabwe. By one measure, the ICT Development Index collated by the International Telecommunication Furthermore, South Africa’s relatively high tariffs, low Union, which is a multidimensional index of sector broadband penetration, and slow Internet speed are performance, South Africa’s ranking worldwide has directly affecting the poorest households. High Internet fallen from 77th in 2002 to 88th position in 2016, during costs constrain the growth of the ICT industry and a period when other African countries were making contribute to the slow development of e-government big gains. applications, which makes it more difficult and costlier for citizens to access government services. The underlying constraint does not seem to be lack of capital for investment by the private sector, Ensuring the regulator’s policy independence and or lack of interest from foreign companies in the confirming its field of action should help expedite South African market. Instead, the constraint is stalled actions such as 4G licensing. Ultimately, the attributable to outmoded regulatory approaches and importance of ICT lies in its role in facilitating innovation the lack of competition among telecommunications in the economy as a whole. A more liberal approach to service providers (as discussed in the 8th South spectrum management and price competition would Africa Economic Update). A particular failing is that support these objectives. Increase the effectiveness of public instruments to support innovation and entrepreneurship The government has put in place many financial Availability of public support programs for and non-financial instruments to support private entrepreneurship and innovation is one of the innovation, promote technology transfer, facilitate strengths of South Africa’s innovation ecosystem collaboration between public R&D institutions and compared to that of many other emerging economies. industry, and encourage entrepreneurship. These In fact, the range and type of support programs programs are implemented by the Department of offered in South Africa resemble those in advanced Science and Technology, the Department of Trade and OECD economies (Box 2.5). There is scope, however, Industry, the Ministry of Small Business Development, to improve the effectiveness and targeting of these the Department of Public Enterprises, the Industrial support mechanisms by consolidating program Development Corporation, and city governments. objectives, budgets, and management arrangements. ⁶⁴ Banda et al. (2015). ⁶⁵ Research ICT Africa (2017). ⁶⁶ eBay (2013). 51 | South Africa Economic Update 10 | Chapter 2 Box 2.5: Public programs to support entrepreneurship, technology absorption, and innovation Technology Innovation Agency: The South African seems to prioritize development of new-to-the-world government created the Technology Innovation Agency products and services over technological catch-up. in 2009 to accelerate research commercialization and This can give a boost to top innovators, but, given that the creation of science-based firms. The agency supports most South African firms are small and far behind the technology development and pre-commercialization, technological frontier, the incentive applies to a very and enables and supports innovation. This covers a narrow range of firms. broad range of interventions, including providing access to technology stations to improve entrepreneurs’ access Administration of tax credits is also important. to modern equipment; implementing a youth technology Complex procedures and long waiting times discourage innovation program that provides young people with applications, particularly from small companies. different services from mentorship and business Measures introduced in 2012 may have resulted in support to risk funding; and providing seed-funding greater quality control and reduced fraudulent claims, grants for universities and SMMEs. but they have also made the application process more complex, and increased uncertainty about decision As a relatively young organization, the Technology making and waiting times for application approvals. Innovation Agency faced several challenges. Initially, it encountered difficulties in attracting the right set The share of firms recording R&D activities more than of proposals because many applicants lacked the halved following the reform, and this decline was capacity to develop bankable projects. Following the concentrated among smaller companies. South Africa’s establishment of a seed fund, the number of successful Davis Tax Committee⁷⁰ has partnered with the World applications to the agency’s main funds increased Bank to launch a full-scale impact evaluation of the R&D significantly. The Technology Innovation Agency has tax credit scheme in the near future. struggled to commercialize a large share of its portfolio of early-stage technologies through licensing, technology Department of Trade and Industry programs: The transfer to industry, or spin-out companies. This is largely department runs over a dozen programs intended attributable to the overemphasis on technology readiness to support industrial R&D, technology upgrade, and levels as a primary measure to assess opportunities. To exports. There are both sector-specific and horizontal mitigate this problem, the agency has recently introduced programs. For example, the Support Programme for market and business readiness levels as additional Industrial Innovation provides financial assistance for measurements to assess applications. the development of innovative products and processes. The department also supports sector-specific programs The Technology Innovation Agency also suffers from to increase competitiveness in the agro-processing, institutional constraints. As part of successive budget clothing and textiles, and automotive industries.⁷¹ cuts across government, the agency’s budget has been Recent evaluations of these programs are not available, reduced by 30 percent since 2014.⁶⁷ Overall, its allocation so their reach and effectiveness is unclear. for 2015/16 was R460 million, which accounted for 8.6 percent of the Department of Science and Technology’s Incubators: Soft assistance to SMMEs to improve total funds for that year.⁶⁸ The agency also experiences business and managerial practices is an important high staff turnover.⁶⁹ mechanism to support the growth of less established businesses.⁷² The results of a randomized control study R&D tax incentives: South Africa provides tax incentives of 852 small firms in South Africa that received a 10- for R&D expenditure. Companies can deduct 150 percent week marketing or finance training confirm this finding. of their operational expenditure on qualifying scientific Such programs can be a cost-effective way to increase and technological R&D. The design of the tax incentives sales and profitability, and create more jobs.⁷³ ⁶⁷ Urban-Econ Development Economists (2016). ⁶⁸ Department of Science and Technology (2016). ⁶⁹ Urban-Econ Development Economists (2016). ⁷⁰ The committee’s objective is to assess South Africa’s tax policy framework and its role in supporting the objectives of inclusive growth, employment, development, and fiscal sustainability. ⁷¹ For more information see the financial assistance section of the Department of Trade and Industry website http://www.dti.gov.za/ financial_assistance/financial_incentives.jsp?subthemeid=25 ⁷² World Bank (2017c). ⁷³ Anderson et al. (2016). Chapter 2 | South Africa Economic Update 10 | 52 advantage of the Standard Bank Incubator since 2015. South Africa has 142 capacity development providers And South Africa’s Raizcorp Incubator serves more than (of which more than 55 are government funded) in 3,000 entrepreneurs per year and was named by The the area of entrepreneurship, according to the Aspen Economist as the only incubator on the continent that Network of Development Entrepreneurs.⁷⁴ Some of is profitable without grants.⁷⁵ them hold promise for enhancing business skills and entrepreneurship. For example, the Jobs Fund supports However, many South African incubators are not a corporate vocational skills training and placement equipping entrepreneurs with the skills they need to initiative that benefits youth with no education beyond succeed in the global economy. Elevation Holdings matric. Several private initiatives have emerged as well. (2017) concluded that South Africa has too many For example, more than 6,000 entrepreneurs have taken incubators and too many of them are of poor quality. The multiplicity of government programs combined with and economic impact, see Box 2.6), and consolidate limited budgets may be fragmenting and reducing the and scale up the best performing programs. It is also impact of public funding for private sector development. vital to ensure predictable funding and adequate It is important to evaluate the effectiveness of these staffing of the agencies implementing innovation and initiatives (including their targeting, cost-effectiveness, entrepreneurship support programs. Box 2.6: Impact evaluations of innovation support programs Rigorous impact evaluation of South Africa’s major Two more recommendations emerging from innovation support programs would provide better evidence these evaluations are worth considering for other on the quality of the additionality, and help policymakers programs: First, shortening the time for the approval to decide which programs and incentives to scale-up, and of applications, as long delays can discourage the top which ones should be reformulated or eliminated. companies from applying as their project cycles are shorter. For example, the Support Program for Industrial As part of the national effort to strengthen evaluation, Innovation took close to 6 months from the submission two evaluations were commissioned by the of the application to the approval/rejection, whereas the Department of Trade and Industry looking at its Support global good practice would be to have a turnaround that Program for Industrial Innovation⁷⁶ and its Technology is 60-90 days. In recent years, this issue has been noted and Human Resources for Industry Program.⁷⁷ The in the case of the R&D tax incentives, and DST has put results suggested both programs remained relevant in place several measures to bring down the approval and should continue to be funded as they met their time while preserving quality. Second, evaluations had stated objectives, and demonstrated sufficient several limitations related to data, which restricted the additionality in terms of innovation outcomes, job impacts that could be assessed and/or policy questions impact, and other metrics. They also suggested that that could be addressed. The main reason is that the grant programs with matching were more effective evaluations had been commissioned ex post, and this as an instrument to incentivize firms, which is in line meant that follow-up reporting was not sufficiently with the conclusions of largescale studies in Israel. At detailed or spanned a long enough period to generate the same time, the evaluations concluded that these robust conclusions. A toolkit published by the Inter- programs could be better designed to meet the user American Development Bank on evaluation of science, needs and government objectives and that there was a technology and innovation programs provides good need to review similar programs run by TIA, Seda, and practices and pointers on how to strengthen impact other agencies to avoid duplication. evaluations.⁷⁸ ⁷⁴ Aspen Network of Development Entrepreneurs (2017). ⁷⁵ The Economist (2017). ⁷⁶ Genesis Analytics (2014). ⁷⁷ Business Enterprises (2015). ⁷⁸ Crespi et al. (2011). 53 | South Africa Economic Update 10 | Chapter 2 One final point is that impact evaluations generally a wealth of information about the pros and cons of do not aim to provide a sense of the alternative different approaches (e.g., tax credits vs. enhanced approaches, and to fill this gap it would be useful allowances, type of novelty requirements, carry-over if South Africa’s programs could be benchmarked provisions, etc.). Using this framework to assess against global and regional examples. For example, South Africa’s program would provide policymakers the European Commission commissioned a very with pointers about options to align with international comprehensive benchmarking and review of R&D good practices. incentives across many countries, which provides The design of the fiscal incentives for investment and tax lawyers. The majority of OECD countries have a one- R&D can be improved to better account for the needs of stop online application procedure. It would be good the economy. For example, reorientation of investment practice to limit the time for government officials to incentives from mining toward industrial sectors can issue decisions on the applications, and for this period help create jobs at no additional fiscal cost. R&D tax to not exceed a year. Some OECD economies provide incentives currently prioritize new-to-the-world an option of an immediate refund to small companies products and services; extending the eligibility criteria that tend to be more financially constrained.⁷⁹ to include investments in technology absorption will make the incentive much more relevant for the A review of the activity and best practices of the large number of domestic firms that are far from the incubation programs can help identify the models that technological frontier. work best in the South African context. The government can also play a role in setting the minimum quality Simplifying the R&D tax incentive administration standards for incubators and facilitating the sharing process can further encourage R&D activity, particularly of good practices among them. among smaller firms that cannot afford the services of Conclusion This report argues that South Africa’s has a large immigration, trade facilitation, competition in ICT, and untapped innovation potential. Harnessing this potential easier access to R&D tax incentives would significantly through improved business climate for startups, skilled help creating jobs and reducing poverty. ⁷⁹ European Commission (2014). 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