Economic Offsets Estimation in recent Defence Procurement Programme: Hearings

Meeting report

TRADE AND INDUSTRY PORTFOLIO COMMITTEE
6 February 2001
ESTIMATION OF ECONOMIC OFFSETS FROM THE RECENT DEFENCE PROCUREMENT PROGRAMME: HEARINGS
 

Industrial participation, investment and growth: the case of South Africa's defence-related industry by Profs Batchelor and Dunne
Defence Procurement and Regional Industrial Development in South Africa: A Case Study of the Eastern Cape by Profs Dunne and Haines
ECAAR submission
SACOB submission
COSATU submission

Subsequent submission:
Department's response to queries raised in this committee meeting (see Appendix at end of minutes) OR DTI's response to questions raised at Hearings on Defence Procurement Programme's Economic Offsets

Chairperson: Dr R H Davies

SUMMARY
The committee was briefed by the Minister of Trade and Industry on the defence offset programme and the likelihood of it creating 65 000 jobs. Much of the discussion revolved around the specifics of the jobs to be created: in which sectors and in which geographical areas would these jobs be concentrated. A burning issue was whether these were skilled or unskilled jobs. If skilled, were preparations being made at tertiary level to provide for this? Questions also arose on the issue of the transparency of the projects and also on the lack of figures on specific jobs to be created in the various projects. The committee requested further information in this regard.

Academics from Middlesex University and University of Port Elizabeth explained the concept of 'offsets' and said that offset deals are an important part of the international trade in military equipment. As for benefits accruing from offset agreements the issue was complex and a country had to weigh its options. For small countries it was sensible to import arms rather than produce them locally. Regarding job creation, it was difficult to quantify government estimates of 65 000 jobs at R1.6 million per job. However, they suggested that the involvement of foreign suppliers in equity investments, joint ventures and export contracts will help to maintain jobs in the defence-related industry. Their case study of Port Elizabeth and the Coega Industrial Development Zone in the Eastern Cape explored the effects of defence procurement economic offsets on industrial and economic development at the local level. It was found that the defence offset projects are not linked to the Local Economic Development strategies in the region. It was concluded that the kind of investments that are based on offsets have proven not to be sufficient enough for industrial and economic development.

Economists Allied for Arms Reduction called on government to get its economic priorities right. He said the armaments deal was not one of them because defence offsets lead to job losses and corruption. He urged the portfolio committee to stop the government from pursuing this armaments procurement deal.

The South African Chamber of Business agreed that investment is vital to the economy, but had problems with the practice of counter trade and the government's lack of transparency in the process. SACOB said counter trade is inefficient, complicated and risky. They said it would have a negative effect on South Africa's own armaments industry and offers scope for corruption.

COSATU argued that, in terms of employment, the arms procurement deal would benefit white males in Gauteng, since the defence industry is centred in Gauteng and is dominated by skilled white males. It believes the deal is likely to aggravate existing economic and social divisions while exposing the economy to the risks inherent in the defence industry and diverting investment resources into what is already a capital-intensive sector. COSATU advocated growth in labour-intensive sectors instead.

In terms of the current arms procurement deal, COSATU recommended an assessment of the contracts to determine whether they are justified and, ultimately, a review of the contracts for flexibility and exit possibilities.

In closing, Minister Erwin stated very forcefully that the government of South Africa does not reverse deals it has made and that it will meet its contractual obligations.

He characterised counter trade as a viable instrument of industrial policy. He refuted the suggestion that this arms procurement deal bears any similarity to South Africa's earlier "ammonia" fertiliser deal, stating the country had learned from mistakes made in past counter trades. He asserted that the government of South Africa is not stupid and corrupt and resents the suggestion that it is.

MINUTES
Introduction by Committee Chairperson
Dr R Davies made the point that this committee is dealing with issues relating to the arms procurement programme as referred to them by the Standing Committee on Public Accounts (SCOPA). The committee's mandate is to look at the job creation estimates and to check on their validity of these estimates. Of particular interest to this committee is the estimated 65 000 jobs that would be created by the programme. Additionally, R104bn would be injected into the economy of which R14.7bn would be for defence offsets - Defence Industrial Participation (DIPS) programmes - and R89.4bn in non-defence offsets: the National Industrial Participation (NIPS) programmes. . He noted that the committee is not an investigating agency.

Minister of Trade and Industry's presentation
Mr Alec Erwin stated that the reason for his visit is to elicit feedback from the committee on the issue of the jobs to be created by DIPS and NIPS programmes. The majority of which would fall into the latter category. Mr Erwin stated that SCOPA insists on having clarity on the jobs to be created by the NIPS programme, failing which it could place the whole deal in jeopardy.

He proceeded to highlight some of the objectives of the programme. This programme was not merely an offset programme but rather a means to fast-track investments into SA. The strategy is to work hand in hand with the private sector so as increase foreign investment. NIPS is therefore an investment facilitation programme. Mr Erwin assured members that they have drawn up guidelines for the implementation of such programmes based on models from overseas countries such as Australia and Canada.

The Minister made three points about the NIPS programme:
- The decision to procure arms stands on its own merits. Government made this decision based on its Defence Review. The NIPS programme is only ancillary to the arms deal, it is not the reason for the arms procurement.
- The NIPS programme is also evaluated in terms of industrial policy. Specific projects are ranked from 1-25 according to their feasibility for implementing industrial strategies. Mr Erwin was adamant that the focus should be on strengthening our manufacturing industry such as steel, agriculture, titanium and gold.
- A 5% performance guarantee is the market standard. Mr Erwin stated that they would have been willing to accept the 5% norm but during negotiations the sellers agreed to 10% to which they readily agreed.

Mr Erwin stated that they had to decide whether their prospects of success with the NIPS programme were reasonable. They attempted to evaluate the success of actual projects in order to give them an indication of the programme's overall success.
For example, Dylan-Reed researched the stainless steel project. The results of the research showed that the stainless steel project is feasible but that the risk factors in the early years would be high. However the risk would taper out in later years. Mr Erwin added that in assessing the risks they had to look at the effects that the various projects would have on the growth rate.

The Minister pointed out that the decision to acquire the package was based on affordability. They had to answer many questions in this regard. Could the economy afford the expenditure? What is the fiscal risk associated with the deal?
Mr Erwin stated that none of the decisions were taken unilaterally and the negotiating team worked closely with the Department of Trade and Industry. Negotiations with the bidders are ongoing, as some of the projects were viable whereas others had to be amended. Even the corresponding obligations were intensely negotiated by interested parties. The Minister stated that they have six-monthly progress reports so as to facilitate the transparency process.

Mr Erwin stated that the real issue before the committee is the number of jobs to be created by the various projects. Research has shown that 45 000 jobs would be lost in various sectors of the SA economy. He believed that the projects would create direct employment of ± 8 000 jobs by 2003. Additionally, from 2004 onwards he expects ± 4000 construction and ± 1500 operating staff jobs to be created for each of the projects. Mr Erwin stated that the point is not whether these figures are accurate or not but rather whether these projects would emerge. The Minister also wished to make the point that the defence project is expected to create ± 65 000 direct and indirect jobs by 2010. He emphasised that the public should realise that these projects would be ongoing and not once off. The Minister stated that the process is well on track as 15% of the obligations had already been met in its first year.

Discussion
Mr F Beukman (NNP) asked how the 65 000 jobs would be distributed and which of the provinces would benefit. Minister Erwin stated that the main projects are located in Eastern Cape, Kwazulu-Natal, Gauteng and the Western Cape. He added that the projects are industrial in nature and would be focussed in industrial areas. For example, stainless steel plants are mainly found in Mpumalanga. However the venues for the projects might change over time.

Prof Ripinga (ANC) asked if it was correct to assume that the figure of 65 000 is merely an estimate and the figure be higher or lower. Mr Erwin stated that the 65 000 jobs to be created is a relatively optimistic scenario. He felt that they have a realistic chance of reaching this goal. He explained that the chances of the projects creating a knock-on effect is great and therefore spin-off jobs from projects are a reality. However, these are projections and the figures might not be exact. The Minister's main concern was whether exports and investment would impact on growth in SA.

Ms Taljaard (DP) stated that if their mandate does not include contractual validity, how are they to analyse these figures because clearly it does have a bearing on them. She asked how the issue of risk was communicated to Cabinet. She asked for particulars on the 15% target already reached and the 10% penalty provision.

Mr Erwin stated that Cabinet had full access to information regarding risks as reports had been sent to them on a regular basis. He explained that the arms procurement deal was a means used by government to leverage in growth and investment into our economy by way of industrial strategy. Normally penalty provisions for offsets are 5% but during negotiations they were able to secure 10%. The target of 15% which has already taken off comprised of jewelry, gearbox parts and steel projects.

Mr Jassat (ANC) asked how many jobs would be highly skilled and how many would be unskilled jobs. Minister Erwin stated that offhand he would not be able to give an accurate breakdown, as one would have to look at specific projects. He did however state that they would be relatively skilled jobs.

Ms Mahomed (ANC) asked what assurances does the committee have that poor communities would be used in outsourcing programmes. Mr Erwin replied that they are well aware of black empowerment programmes. He added that negotiations are ongoing as projects go along.

Ms September (ANC) asked for more detail on the various ongoing projects and also what difficulties were experienced in each. She wanted to know if the job creation would go into new establishments or existing businesses such as Iskor.

Mr Erwin replied that SA is the fifth largest producer of stainless steel in the world. It is for this reason and many others that the projects would take place in sectors where they are feasible. He added that the department is negotiating with big companies in SA to foster a climate of co-operation.

Ms Dudley (ACDP) asked if the expenditure is justified compared to the number of jobs to be created. She also asked whether these jobs are sustainable or whether they are once-off jobs related to the construction of factories for projects.

Mr Erwin said that whether the money has been well spent is not the object of the debate in which they are currently engaged. He emphasised that the decision to purchase has already been taken. They are only engaging in projects that create sustainable jobs and he has full confidence in the choices that they have made.

Ms Taljaard asked what economic growth rate was built into the model. She stated that in the USA they have a specific commission dealing with offsets. She suggested that such a commission would be useful in reporting back to Cabinet.

The Minister replied that they take projections of economic growth from their budget forecasting. They would report to Parliament so as to be transparent on issues relating to defence offsets disclosure. He added that SA could not be compared to the US. They are large arms sellers whereas SA is only trying to increase its industrial capacity.

Mr Lockey (ANC) asked whether the initial cost of the arms deal had escalated from $30bn to $43bn and if so what variables caused it to increase.

Mr Erwin replied that the figures were the result of a cash-flow projection. It does not reflect the actual cost, it is only a projection. He emphasised that exchange rates and interest rates would affect the final cost.

Ms Mahomed (ANC) asked whether networking is being done to prepare South Africans for the jobs. Mr Erwin stated that they have started to restructure programmes at technikons and universities to be in line with the jobs to be created by the various projects. The Minister did however point out that not all of the 65 000 jobs would be skilled jobs. It is likely that only ± 12 000 would be skilled, the rest would be varied.

Mr Bruce (DP) stated that much talk has been on rand cost, but no mention is made about dollar cost. He also asked for particulars on the names of advisors and members of the negotiating team.

Mr Erwin stated that the dollars/euro cost is a separate financing agreement. He added that provision has been made for escalation clauses relating to the rand/dollar exchange rate. The Minister assured the committee that the names of advisors and members of the negotiating team are freely available.

The Chair requested the Minister to make available the following information:
- Direct job estimates for both DIPS and NIPS
- Exact figures for jobs in specific projects
- Particulars on the 15% target that had been reached and the breakdown of the jobs that had been created within it.

Middlesex University and University of Port Elizabeth: presentation
Professor Paul Dunne noted that most of what he wanted to say has been covered by the Minister of Trade and Industry. As such he narrowed his presentation to two aspects: the economics of defence offsets and job creation.

In procuring defence equipment, countries can choose either to produce the equipment locally or to purchase it from a foreign supplier.

Direct offsets involve goods and services in exchange for the equipment the purchaser is buying and indirect offsets are goods and services unrelated to the specific equipment, and can include foreign investment and countertrade. Offset deals are an increasingly important part of the international trade in military equipment, especially in the aerospace industry.

However while official publications herald offset agreements as beneficial to the purchasing country, the issue is much more complex. He said that if a country with a local defence industry decides to procure new weapons system, then it has to decide whether to produce the weapons locally or to purchase from a foreign supplier. Imports without offsets tend to be the cheapest option, while local production is likely to be the most expensive and the technology may not be available. Evidence however suggests that maintaining a local defence industry is expensive and uneconomic for a small country. Prof Dunne said that importing arms without offsets may be more sensible, especially as there is usually a premium attached to offsets, with the result that the purchase price is normally higher.

In the case of South Africa the decision has been made to procure the weapons, and the emphasis has been placed on offsets rather than price. While there are clear opportunity costs particularly with respect to the local defence industry, considerable efforts have been made to implement offset policies that reflect the experience of other countries, such as the UK.

On job creation Professor Dunne said that despite a 10 percent expansion in real output since 1994, formal employment in the non-agricultural sectors of the South African economy has continued to decline, creating a situation of 'jobless growth'. He said that currently unemployment is estimated at 37.6 percent of the work force and the need for 'labour demanding growth' has become imperative.

Currently direct employment in the defence-related industry is estimated at 25 000 jobs (15 000 in the public sector and the rest in the private sector). Indirect employment (e.g. suppliers, subcontractors) accounts for a further 35 000 jobs. Putting this in perspective, more than 60 000 jobs in the defence industry have been lost since the 1980s.

Professor Dunne said that job creation estimates which were presented by government in September 1999 suggest that R104 billion worth of industrial participation (IP) will create approximately 65 000 jobs - this amounts to R1.6 million per job. He said this figure is extremely high. In 1997 the cost per job in the public sector defense industry was R93 722, while in the private sector it was slightly lower at R82 838. In 1997 turnover per employee in the public sector defence industry was R231 898 while in the private sector it was R464 633. Based on these figures, the estimated R14.5 billion worth of potential Defence Industrial Participation (DIP) activities could create, or sustain, approximately 40 000 jobs (based on R350 000 per job) in the local defence-related industry. However, Prof Dunne conceded that it was difficult to quantify these estimates. He however said that local purchases by the foreign suppliers, equity investments, joint ventures and export contracts will help to maintain jobs in the local defence-related industry, and prevent further retrenchments.

Professor Richard Haines (Head: Development Studies, University of Port Elizabeth) noted the interim academic paper prepared by himself and Prof Dunne on the effect of defence procurement economic offsets on industrial and economic development at the sub-national and especially local levels. It involved a case study of Port Elizabeth and the Coega Industrial Development Zone in the Eastern Cape. He said the kind of investments that are based on offsets have proven not to be sufficient enough for industrial and economic development. Further the defence offset projects are not linked to the Local Economic Development strategies in the region. International experience has shown that defence offsets are always problematic.

A recent study conducted in Saudi Arabia found that instead of a proclaimed 75 000 local jobs, the various programmes generated only 2000 jobs. The defence industry normally requires highly skilled labour. This means the majority of poor unskilled people will remain unemployed despite the job estimates.

Application of the offsets investment projects comes when South Africa's industrial policy is being revised. The offset projects in the Eastern Cape are directed largely at the Coega Industrial Development Zone (IDZ) and does not involve the Local Economic Development strategies. As a result local economic and industrial development strategies are inadequately conceptualized and implemented to take suitable advantage of the offset possibilities. The province would not benefit in structural terms from these offset projects.

Despite focussing on the Defence Industrial Participation strategy, Prof. Haines said local industrial policy and development in the province needs to be rethought. There should be a shift from industrial development based mainly on manufacturing. Eastern Cape has an abundance of natural capital resources which should be utilised in order to create both urban and rural jobs. There is a great need of infrastructural development in the Eastern Cape, and more funds should be deployed in improving infrastructure. The Eastern Cape government is beginning to address the above concerns and is currently formulating a macro development strategy which it would like to workshop widely with stakeholders throughout the province.

The Director General of Economic Affairs and Tourism in the Eastern Cape stresses the need to diversify offsets from orthodox large industry projects. However the major concern is that projects seem to remain mere promises despite the advancement of the procurement contracts. The main problem is that development alternatives which allow for labour-intensive employment and sustainable use of natural resources for agri-tourism appear to be dismissed without due consideration

Discussion
Mr. Bruce (DP) wanted to know the magic formula the government was going to use to create such jobs when foreign investment was not forthcoming. Are we trying to use defence offsets and counter-trade to create jobs as was used by the former Soviet Union? Why should we have to arm ourselves to the teeth in order to create jobs?

Prof. Dunne said there was no magic formula, even the British government subsidizes arms production for its military establishment. South Africa could do the same but in Professor Dunne's opinion It should buy arms directly without offsets and negotiate prices down without tying that to defence offsets.

Mr Lockey (ANC) wanted to know if there was emperical proof that buying arms directly without offsets was a better option. Professor Dunne replied that very few studies had been done on the costs and benefits of offset deals. He felt that purchasing the arms outright without offsets is a better alternative. He did state that under the circumstances DTI has done a good job to get the best deal out of this defence procurement programme.

Mr Zita (ANC) wanted to know if the scale of the arms procured was warranted.
Prof. Dunne felt that these procured arms were unnecessary for Africa and were more suitable for defence by countries such as the United States or France. Such arms will be used by South Africa for peacekeeping initiatives in Africa. He believed that South Africa should obtain less high-tech arms that are suitable for the economy.

Economists Allied for Arms Reduction (ECAAR)
Mr Terry Crawford-Browne, Chair of the South African affiliated ECAAR (ECAAR has affiliates in twelve countries and is accredited to the United Nations) began his presentation by posing the question: what were South Africa's economic priorities? He doubted they were armaments acquisitions. He said fighting the scourge of HIV/AIDS and other diseases was a priority and yet the South African government spent more on arms - double the figure it spent on Health and triple that it spent on Education as depicted on the National Budget projections for the period 1999-2003. He said offset deals had been discredited in the international arena as shown by the European Union and the North American Free Trade Agreement prohibiting defence offsets in civilian trade. He traced the origins of defence offsets to the Soviet Union and its Comecom partners which had resulted in bankruptcy and their demise as a result of such offset deals. He also traced such deals in South Africa to the Botha era in an attempt to avoid sanctions. More recently they recurred in 1994/95 with Spain, when that country offered to sell South Africa four corvettes whose offsets would have been the creation of 23,000 jobs. Mr Crawford-Browne said that studies of the deal show that instead of creating 23,000 jobs that deal could have cost the South African fishing industry 85,000 jobs.

Mr Crawford-Browne said the contribution of the military industry to the economy has been meagre: about 0.5 percent on total exports and 0.17 percent on the GDP. Since the 1970s the South African economy was driven by the military establishment resulting in higher unemployment rates and the devaluation of the rand. He said the South African economy has been the worst disaster story in the world.

He made an assertion that instead of being productive the armament industry was destructive and gave an example of an arms deal between Britain and Saudi Arabia whose offsets were to create 75,000 jobs. He said instead of reaching that figure the deal created only 1,600 jobs, 300 of which went to Saudi citizens and the rest to foreign expatriates. Parliamentary investigations were carried out but that the British establishment in higher places suppressed that investigation.

He said the military establishment connives with politicians and illustrated his point quoting the highest office in the country. An ANC member objected to this, prompting the Chairperson to remind Mr Crawford-Browne that such assertions should be made to the Standing Committee on Public Accounts. Mr Crawford-Browne conceded and produced a Financial Times which showed former French Foreign Minister Mr Dumas on trial for corruption related to an arms deal with a company with which South Africa had dealings.

He said the projections of creating 16,500 jobs through the German submarine deal at Coega have now being scaled down to 1,000 jobs only. He doubted whether these jobs will benefit the local community. He predicted they will benefit skilled personnel as such projects required. This was in addition to potential damage to the environment. He said the armaments industry was a "killing business" and asked would those in this business be brave enough to confront a mother in this country, India, Rwanda, Angola or Congo whose child had been killed by a bullet or shell that created one job? He said the church and the NGO community were opposed to arms exports to Africa since 90 percent of the casualties were civilians.

Mr Crawford-Browne said defence offsets were a "scum" and called on the government to pursue "ethical" economic policies that included education, health, transportation and communication and urged the portfolio committee to stop the government from going ahead with this armament procurement madness.

No questions were asked and the committee meeting broke for lunch.

South African Chamber Of Business
Mr Ken Daly focused on the shortcomings of counter trade and the principles under which such transactions should be conducted.

The recent South African armaments deal falls into the "offset" category of counter trade. This means the seller guarantees it will purchase goods and services from the buyer country.

SACOB said counter trade distorts markets and is inefficient, complicated and risky.
- Inefficient: A 1986 World Bank study of Indonesia's counter trade policies showed that only 12% of commissions found its way back to Indonesian business. Counter trading thus becomes an unprofitable way to trade.
- Complicated: Often the only people who profit from the transaction are the intermediaries.
- Risky: The commodity price can move considerably before a buyer can be found.

Thus SACOB sees counter trade as a last resort measure to be adopted under conditions of extreme economic duress. This is not the case in the South African context.

In any counter trade transaction one should look at the impact it will have on the South African industries affected. For example, in the 1982/83 ammonia/maize barter there was much discontent among farmers who were given no choice but to use ammonia as fertilizer. Similarly, one can argue that South Africa's own armaments industry was allowed to collapse in favour of procuring from the outside.

A prerequisite for counter trade transactions is proper and transparent supervision by government. Officials and politicians have to account to the public. Opportunities and policies arising from the procurement have to be even-handed and based on principles of equal opportunity.

Discussion
Ms September (ANC) stated that the ammonia/maize example is not comparable to the present situation. She asked why SACOB believed that South Africa's own armaments industry is likely to collapse if government procures from the outside.

SACOB replied that when the government made the decision to purchase ammonia fertilizer the farming community was left with no choice but to use ammonia. As they were unable to purchase other fertilizers cheaply, it meant that there was a limitation on free enterprise. In addition, South Africa will now import aircraft, whereas they had exported aircraft a few years ago.

The Chair referred to the statement by the Minister that where the government spends ten million rands or more, it should be used as an opportunity to attract investment. He asked what SACOB thought about this.

SACOB replied that one should look at whether the expenditure is justified. Any investment in South Africa will benefit the economy, as South Africa needs the inflow of capital and employment opportunities. The question however is whether counter trade is the way to achieve this.

The Chair asked whether the estimates of the jobs to be created by the procurement are, according to SACOB, reasonable or not.

SACOB said it suspected this was a loaded question. Job creation is inevitable, but the process has to take place in an open-handed manner. Very little detail has been made available to the public to date.

The Chair asked whether SACOB was aware that a few of the projects arising from the procurement had already been implemented. He stated that he found it surprising that the business community was unaware of these investments and were unable to comment on the estimates, which had in fact been the purpose of the hearings.

SACOB responded that the responsibility of justifying these estimates lies with the government. It was impossible for SACOB to express a view as they lacked the means to either confirm or deny it.

The Chair referred to SACOB's view that an offset is not the ideal way of transacting and stated that no one had argued that it is. He asked whether SACOB agreed that the government should maximise its benefits through industrial participation and negotiations, given that there is going to be a large expenditure in any event.

SACOB stated that government should make an effort to build the economy and agreed that investment is the answer. SACOB however has a problem with the way this is being done. It stated that although the transaction cannot be undone at this point it should at least be transparent and should be seen to provide the advantages which were promised. He reiterated the view that counter trade is not the ideal basis on which to make acquisitions and investments.

SACOB stated that the Minister had referred to the high risk involved in the procurement. SACOB is not opposed to risk if the transaction takes place with circumspection. In addition, proper monitoring and transparency are also necessary for any industrial participation programme to be acceptable.

In answer to Ms September's reiteration that the ammonia/ maize deal cannot be compared to the arms deal, SACOB stated that this example illustrated the effect of counter trade in both cases: a lack of choice. It stated that there were many other examples illustrating this.

Ms September also commented that it appeared as if SACOB was hearing about the finer details for the first time. She asked what preparation SACOB had done in the areas in which these jobs are to be created.

SACOB stated that it had not been privy to the details of the deals as it had been a security matter and had therefore been private. Thus, in the absence of detail they had therefore been forced to deal with principles. It was in SACOB's interests that the economy flourish and that a strong manufacturing industry is built. This should however be done openly and should not be kept under wraps.

In addition, counter trade is an indication of a failing economy. SACOB said this is not true of South Africa, which is a buyer's market. One can therefore transact on a normal basis where deals are straightforward and open.

Confederation of Trade Unions of South Africa (COSATU)
COSATU's presentation focused on the broader economic impact of the arms procurement programme, rather than the specific implications of industrial participation programmes, looking specifically at the "opportunity costs" of the programme. This refers to the benefits of creating jobs through the arms procurement programme compared to expenditure on alternative projects.

The submission took the view that the benefits of the arms procurement deal would go primarily to the defence industry and noted:
- that the investment is capital intensive;
- that the industry is located mainly in Gauteng, is skill intensive and dominated by white males; and
- the impact of the depreciation of the Rand against the US dollar.

COSATU asserted the deal is likely to aggravate already existing economic and social divisions in South Africa, while exposing the economy to the risks inherent in the defence industry and diverting investment resources into what is already a capital-intensive sector.

The presentation concluded that, in light of the opportunity costs, the arms deal cannot be justified in terms of job creation. COSATU advocated growth rather in labour-intensive sectors. In terms of the current arms procurement deal, it recommended a review of the contracts for an assessment of whether they are justified and, ultimately, a review of the contracts for flexibility and exit possibilities.

Discussion
Dr Davies, Chairperson (ANC), asked the presenters if they had any comment on the estimates of the numbers of jobs the deal would create. He wanted to know if COSATU had perceived any distortions in the figures that might actually indicate a loss of jobs.

COSATU responded that there was not enough information for it to be able to look in detail at the estimated 65 000 jobs the deal would create. In terms of the possibile distortions in the expected results of the deal, COSATU responded that it was taking a broad view of the effects of the deal on the economy.

Dr Davies asserted the deal would also create many jobs outside of the defence industry, a fact COSATU had overlooked. COSATU responded that, while it is in favour of jobs in other sectors, it does not want this to occur in an ad hoc manner. Rather, it advocates specific and coherent sector growth.

Minister Erwin's Closing Remarks
The Minister acknowledged the arguments he had heard were resoundingly against the deal but noted it is not the responsibility of the Trade and Industry Portfolio Committee to determine whether the deal is a good one or not. He asserted very forcefully that the government of South Africa does not reverse deals it has made and that it will meet the contractual obligations resulting from deals it enters into. Any criminal corruption will be dealt with by due process of law.

Minister Erwin said the government will make the procurement, which is part of the implementation of policy decisions made in 1997. He added, however, that government is not blind to the problems of the deal. In response to statements by some of the presenters that counter trade is a "last resort" entered into by countries in desperate economic straits, he asserted the deal is not a desperate move and South Africa is not a desperate country. He characterised counter trade as a viable instrument of industrial policy. He refuted the suggestion that this arms procurement deal bears any similarity to South Africa's earlier "ammonia" fertiliser deal, stating the country had learned from mistakes made in past counter trades.

The Minister said the current deal offers an opportunity to see how counter trade deals will work in an industrialised country. He said it was a conscious decision to enhance certain sectors of the defence industry as South Africa acknowledges it cannot sustain a massive defence industry. It is not possible to produce aircraft in South Africa and the government has taken a clear decision not to attempt this. Instead, it wants to enhance those industries that are competitive internationally.

Minister Erwin emphasised that this arms procurement deal is not a deal with arms dealers but, rather, one entered into with multi-national companies. He asserted strongly that the government of South Africa is not stupid and corrupt and resents the suggestion that it is. He identified the deal as part of a clear policy decision to re-think industrial policy.

He said, contrary to some suggestions, the offset programme in the Eastern Cape is working and said the project will not affect the nearby elephant and aloe parks, since each project's financing mechanism is different. There will therefore be no crowding out of investment and infrastructure.

The Minister chastised SACOB for saying the deal has "irregularities". He asked SACOB to point out any irregularities in the contracts, saying government had responded to all queries and allegations. Therefore, he concluded, there are no irregularities in the contracts. He said the deal was not made under duress and added this is not a programme for defence deals only.

Minister Erwin asked why, if COSATU is against the purchase of arms, it has not raised this formally with the government. He invited COSATU to do so.

The meeting was concluded.

Appendix:


MINISTRY: TRADE AND INDUSTRY
REPUBLIC OF SOUTH AFRICA
Private Bag X274, Pretoria, 0001. Tel (012) 322 7677/8/9, Fax: (012) 322 7851
Private Bag X9047, Cape Town, 8000, Tel: (021) 481 7191/2/3, Fax; (021) 465 1291

SUPPLEMENTARY SUBMISSION TO THE PORTFOLIO COMMITEE ON TRADE AND INDUSTRY ON PUBLIC HEARINGS ON THE ESTIMATION OF ECONOMIC OFFSETS FROM THE RECENT DEFENCE PROCUREMENT PROGRAMME

1. INFORMATION ON THE NEGOTIATION TEAM.

In response to the questions asked by Mr. Bruce the following information is provided:
1.1. Members of the Director General's Oversight Committee:
Ms. M Ramos Director General : Finance.
Dr. Z Rustomjee Director General : Trade and Industry.
Mr. M Netsianda Acting Director General : Defence.

1.2. Members of the International Offers Negotiating Team. (IONT)
Mr. J Naidoo Chief Negotiator
Mr. S Shaik Department of Defence: Chief of Acquisition
Mr. R White Department of Finance: Chief Budget Officer
Mr. P Jordan Department of Trade and Industry: Deputy Director General
Mr. V Pillay Department of Trade and Industry: Director Ind. Participation
Mr. L Swan ARMSCOR : CEO

1.3 Consulting Firms used by the IONT and fees paid.
Warburg Dillon and Read. Fees Paid: R 8.821 Million
White and Case. R 4.720 Million

2. Projections of Job Creation in the NIP.
The projection of job creation from investments is inherently imprecise. This is even more the case in a complex investment facilitation exercise such as the Non-Defence Industrial Participation (NIP). These notes therefore provide information as to how the various estimates were made and the significance of the jobs created.

In order to understand how the estimates are calculated certain basic issues have to be taken into account.
The NIP is a process that will develop as the projects are assessed and then implemented. The initial agreements are based on the magnitude of the NIP obligation calculated by means of the National Industrial Participation Program (NIPP) credit system. The individual projects that would then fulfil this obligation are assessed and approved. The projects must also be assessed over time as the credits relate to the performance and sustainability of the projects. Accordingly in the first two years of the NIP it is possible for individual projects to change even though the total obligation will not change. This will impact on the precise employment effect.

The contracts were only concluded when it was clear that a credible initial portfolio of projects did exist. So the initial base for projections is the business plans for these projects. However, it has to be borne in mind that the projects commence over a period of time so that the projection that is made is one of attempting to assess what the employment effect will be over the seven to ten year period where the obligations have to be fulfilled.

In the main the estimates relate to new investment but they also include jobs that will be retained because of new market opportunities opened by the NIP and DIP. Estimates have also been made of the employment effects on existing investments of increased export orders.

There are three separate estimations that have all been used to provide the basis for the announced projection of about 65 000 jobs.

The first is based on the business plans of known projects where the direct employment is then increased by the indirect employment effect. This is set out in Appendix A. A slightly different exercise is set out in Appendix B that links revenue generated to the likely jobs that will be created. These estimates will be different depending on the time they were done as pointed out above and a simplifying assumption is made as to how projects start.

The IONT and its technical team of economists also had access to a study done by consulting economists for one of the bidders. This study worked on the business plans and did more detailed sectoral analysis. In addition it assessed the likely impact on the income of workers. The study was done fairly early in the final negotiations but it provides some important insights. It points out that although the impact of the NIP projects on overall employment is small, the impact on net job creation is significant - especially once its sectoral composition is taken into account. The impact on the growth of employment incomes in manufacturing is particularly significant, as a result of the high value added of the NIP projects.

In the projects assessed the number directly employed on the projects was estimated to average 6,264 over the first ten years, representing just over one-tenth of one percent of total non-agricultural employment of 5,95 million in 1998. Taking into account the fact that all of employment directly generated by the projects is within the manufacturing sector, the proportion is half of one percent of 1998 manufacturing employment, rising to almost one percent by year ten.

The contribution of the NIP projects to net job creation is, however, significant - even without taking account of indirect employment generated by the projects. This contribution can be seen both in relation to recent trends in employment and in relation to expected growth in employment over the next five years.

It was projected that the impact on net job creation of the NIP projects would be even greater in the second five years, when a further 6,200 new manufacturing jobs are created. On the projections of the business plan the average growth rate in direct employment generated by the projects is 16.2 percent per year - a rate at which the number of new jobs created more than doubles every five years. This compares with an average contraction in manufacturing employment in South Africa of -0.8 percent per year between 1993 and 1998 and of -3.8 percent per year between 1996 and 1998.

Again using the business plans and allowing for sectors the contribution of the NIP projects to the growth of incomes is even more significant, as a result of the high value added of the constituent manufacturing projects. The effects on employment incomes provide a better indication of the economic impact of the projects than employment numbers alone. They also provide a good indicator of the magnitude of the indirect employment effects of the projects by capturing the spending power that the projects would generate. It was estimated that the domestic salaries directly generated in the NIP projects by year five would be equivalent to 3 percent of total salaries and wages in the manufacturing sector rising to more than 6 percent in year ten.

An analysis done by the same economists on the exports generated indicates that they are concentrated in the higher value sectors and that they constitute an increase over current trends. This along with the information on the income effects points to a relatively high multiplier effect. An analysis of projects in the current NIPP program outside the NIP has shown a 1 to 10 direct to indirect employment ratio can be achieved.

In the final affordability study the economists also made estimates that were done to ensure that they were conservative. These came to some 9400 workers in all projects by 2008 with 4000 construction workers involved in construction of steel mills and then some 1500 permanent workers in the mills. A multiplier of 1 to 4 can be applied on the figure of 9400 or 11900 or 14900 depending on how one assumed the projects would unfold. This would give a range from 37400 to 59600.

In summary then the figure of 65 000 jobs is based on one of these exercises (Appendix B) and is in the upper range of estimates but in the light of the supporting studies, the unfolding of further projects and reasonable multiplier coefficients of direct to indirect employment based on the sectoral patterns of investment it is not an unrealistic estimate.

3. Report on Progress to Date.
Industrial Participation First Performance Report: February 2001
Performance report indicates all projects that have commenced to date, their relevant investment values and export values, included is the total value of the project over the projected life of the project.

BAE/SAAB

AGUSTA

THYSSEN

THOMSON

FERROSTAL