Investment Incentives: briefing

Meeting report

TRADE AND INDUSTRY PORTFOLIO COMMITTEE
4 October 2000
INVESTMENT INCENTIVES: BRIEFING

Chairperson: Dr R Davies

Documents handed out:

· DTI presentation on Investment - measures to promote investment and Potential Growth Sectors - implications for DTI: text outline only (See Appendix 1)
· Manufacturing Sector Review (the first in a series of statistical reviews on the state of the manufacturing industry; email [email protected] for copy)

SUMMARY
Professor Dave Kaplan, Chief Economist in the Department of Trade and Industry presented a document outlining measures to promote investment in South Africa. The main theme of the presentation were investment incentives, which are proposed as a means of promoting domestic and foreign private investment in the employment and wealth creating industries. The new Small and Medium Enterprise Development Programme (SMEDP) expands the sectors eligible for support such as information and communication technology investments, tourism and other business services. Eligible projects receive an annual cash grant, paid over two or three years if a labour usage criterion is met. The grant is tax free. Another incentive programme, the Skills Support Programme, is a cash grant to the value of up to 50% of the training costs for new staff resulting from expansion or a new project.

[Note: The committee was incorrectly briefed that nothing below a R5 million investment qualified for an incentive grant. This was corrected in a letter from Prof Kaplan to the committee on 11 October 2000. Investments up to R5 million qualify for a 10% grant]

MINUTES
Briefing on Growth and Investment (refer to presentation document)
Comparative Growth and Industrial Performance
Prof. Kaplan said that if one has a look at Table 1 in the document, at this stage South Africa does not fare well with comparable countries.

Manufacturing, GDP and Volume Production
Looking at the relevant graph, the black line shows that South Africa is not much further advanced in terms of this sector.

Fixed Investment and Capacity Utilization
Essentially we have declining levels in terms of investment. We have to look for more investment growth than there is presently. We performed better in terms of the Growth Employment And Redistribution (GEAR) in the macro-economic level. We do expect that the figures will go up in the near future.

Annual Investment Grant awarded on a Regressive Scale
The Department has introduced an investment incentive, which was approved by Cabinet on September 6, 2000. The aim of this investment incentive is to elicit a higher level of domestic and foreign private investment in employment and wealth creating industries, to attend to the challenges of job creation and poverty alleviation through promoting sustainable economic growth and skills development.

By introducing this, the department hopes to make South Africa an investment destination. These incentives are meant to raise the rates of returns for investment. The idea is to look at how other areas and not only the manufacturing sector can be improved so as to promote new areas of economic growth. This is referred to as the 'New Economy' areas, that is an economy in which non-traditional sectors are looked at.
Prof. Kaplan indicated that these incentives might have a limited impact because some firms are looking at a long-term perspective, whilst these investment incentives are geared for shorter periods of two or three years. There are distortionary effects as firms can change their production trends. Other factors are:
- Firms tend to wait long periods before investing - they postpone investment. That is what South Africa is experiencing now.
- Some larger firms argue that crime is the problem, especially in places like Gauteng and Cape Town.
- Other firms are worried about the bureaucratic procedures involved.

The Annual Investment Grant awarded on a regressive scale is arranged as follows:
- For the first R5million investment -10% p.a.
- For the next R10m investment - 6% p.a.
(Above R5m up to R15m)
- For the next R15m investment - 4% p.a.
(Above R15m to R30m)
- For the next R20m investment - 3% p.a.
(Above R30m up to R50m)
- For the next R25m investment - 2% p.a.
(Above R50m up to R75m)
- For the next R25m investment - 1% p.a.

The Annual Investment Grant translates into the following cash grant amounts:
For the first R5 million investment: R5m @ 10% = R500, 000 (10%)

For an investment of R100 million (3%):
R5m @ 10% = R500, 000
R10m @ 6% = R600, 000
R15m @ 4% = R600, 000
R20m @ 3% = R600, 000
R25m @ 2% = R500, 000
R25m @ 1% = R250, 000
R3, 050, 000

These are annual cash grants available to all investors in the different categories mentioned, both domestic and foreign. Prof. Kaplan said it is important to note that this encourages a labor-intensive economic growth system and is based on capital expenditure. The department believes that this will be easy to administer given the resources and capacity that they have at their disposal.

Questions
Mr.D Lockey (ANC) asked why investors who invest below R5 million are not included. Prof. Kaplan replied that such investors are not catered for in this arrangement because they do not have the capital expenditure required.

A Democratic Party committee member asked whether any tax incentives are going to be introduced. Prof. Kaplan replied that the question of tax holidays is still under discussion. He said there are strong concerns around tax holidays.

Second Investment Incentive on the Skills Support Program (SSP)
These will be a cash grant to the value of up to 50% of the costs of training new staff, which results in an expansion or a new project. This grant will be paid on performance basis for up to three years, this will be capped at 30% of the annual wage bill and requires a Department of Labor-approved training program. A firm can claim money up to 30% of their annual income. This money will come from the Department of Trade and Industry.

Information Technology, Computer Software and Telecom Services Sector (ICT Sector) This is a major area for growth and investment, especially the Information Technology (IT) sector. The ICT Sector is defined in the following manner:
The industries that produce the products (goods and services) that support the electronic display; processing; storage and transmission information. They are divided into Manufacturing (Computer Hardware; Telecom Equipment) and Services (Information Technology Professional Services; Computer Software creation; Telecom Services)

Forecasts for Employment in the Telecom Sector
In terms of employment growth, Prof. Kaplan said jobs will be created but more emphasis will be put on Professional/Managerial and Clerical/Sales/Services skills. The overall growth for employment is lower than the output growth. Direct employment is skewed towards professionals and skilled workers, not to semi-skilled workers.

Policies in the 'New Economy'
Regulation, that is government intervention, will be very important because there is a lot of private and public enterprise involved in it.

Education
Prof. Kaplan said universities are not offering degrees that the Department of Trade and Industry would like them to offer, that is, degrees that will attract more foreign students. He said we have to attract a lot of foreign students here in South Africa. He students coming to South Africa for three to four years can make a good incentive for economic growth. The Department of Trade and Industry has to work very closely with other Departments e.g. Communication, Health and Education.

A Democratic Party member commented that whilst South Africa is losing some people, especially from the pharmaceutical sector, yet we are looking for new investors. He wondered why we do not focus on and keep our own investors.

Overview of 'Traditional' Areas of South African Manufacturing Industries
- Export growth has been satisfactory
- Imports grew as well, but not as much as exports
- Capital expenditure has increased
- Salaries have been pretty constant
- Fewer employees: employment has been declining at 2% per annum.

Concerning jobs, Prof Kaplan explained that jobs are not declining because investment is lacking. Employment is declining because the amount of capital per investment is too high. However, they hope to see considerable amount of growth in employment in the not so distant future.

African Growth and Opportunities Act (AGOA) - Rules of Origin
In the Textile industry South Africa has to move very rapidly, there are prospects of growth in this sector. He said export in this industry have been increasing at about 30%.
The number of jobs created in this industry are limited. That is why the Department is focusing on the development of the 'New Economy' sector. For instance South Africa can grow in the textile industry. We have the logistical capability to produce higher product quality. We can become one of the leading countries in this sector. He added that there are areas where firms need to grow and the Department has to look at that.

Ms Mahomed (ANC) asked how these investment incentives are going to be marketed. Prof. Kaplan said he was not sure how will this be marketed, he does not have a hands-on involvement on this issue. However there are recommendations from the Department on marketing.

Ms Connie September (ANC) said she thought that there would be an explanation in the presentation as to where do we want to be as a country - its vision. She wanted to know what would happen to GEAR, where are we going with GEAR from now? She asked whether this 'New Economy' is informed by the fact that too many jobs have been lost in the past years. Would this 'New Economy' absorb these people. Finally, what monitoring mechanisms are being put in place to ensure that employers engage in the training programs that they have agreed to do?

Prof. Kaplan agreed that the question regarding vision is very important. He said such a vision could give direction to firms on what the government would like to support in the future. The Department is working on a long-term industrial policy framework and a long-term vision will be looked at very carefully.

Prof Kaplan said that with 'New Economy' areas, it is true the capital investment can be small. Those firms with low capital expenditure will be looked at in the future. They hope to reach as many firms as possible across the economic spectrum. A range of firms in which infrastructure has been created will be encouraged because this will attract more investors. Infrastructural backlogs will need to be addressed because they are very important.

He noted that GEAR is a macro-economic framework and though very important, the macro-economic framework alone is not enough. It should be accompanied by sound industrial policies. On its own it is neither a necessary nor a sufficient condition for economic growth.

The monitoring of the Skills Support Program would be the responsibility of the Department of Labor - they will liaise with the Trade and Industry Department.

A NNP committee member expressed concern at the cost of the total package of incentives. You say it is an approach for growth? We must not simply accept this. Even GEAR was said to bring growth, but it has not.

Mr Lockey (ANC) raised again the issue of a minimum capital investment of R5 million to qualify for the cash grant. He asked why this minimum amount is not lowered as it would be difficult for people from disadvantaged backgrounds to raise R5m.

On the question of black entrepreneurs being left out, Prof Kaplan agreed that not everyone can afford to raise that money. But this has been discussed at great length in the Department. In the discussions it was realised that it is difficult to administer smaller firms. Special arrangements should be made for small firms.

Mr Lockey said that there are smaller computer firms that can administer that. This is not an excuse, in fact what is happening here is that the wrong people are being empowered. Another ANC committee member added that there are firms that are still growing but this will sideline them.

Prof. Kaplan said these comments would be taken forward to the department.

An NNP member noted that parliamentarians would be very suspicious of possible tax incentives because this is not transparent and open to the public. If there are risks, they should be identified and also be quantified. Any risk should be compensated. South Africa is not comparable with countries such as Britain and Japan because of the neighborhood it has.

Prof. Kaplan agreed that tax incentives lead to non-transparency and that is always the case, they cannot help it. Some people will get tax incentives and some will not. On risks, he said that they have talked about this. The investment incentives are also meant for domestic investors. It is to the local investors' advantage to use this opportunity. If domestic investors sit by, foreign investors will overtake them. So if foreign investors see risk in putting their money in South Africa, local investors might see it differently, hence they can use this to their own advantage. He said what is important is to increase productivity in all sectors of the economy.

In conclusion the Chairperson pointed at the issues that he felt were important from the presentation. He said these issues would be looked at in the following meeting:
- The broader issue of Industrial Policy,
- Monitoring of the Skills Support training Program.

Appendix 1:
Presentation
Focus
Investment - measures to promote investment
__________________________________________
- Economic Background
- Investment Incentives
- New Economy - ICTs
- 'Traditional' Manufacturing - clothing

South Africa Comparative Growth & Industrial Performance
% change on year earlier· · Potential Growth Sectors - implications for DTI

	GDP		Industrial Production
Hong Kong	10.8	Q2	-0.7	Q1
South Korea	9.6	Q2	19.3	Jul
Malysia	8.8	Q2	20.1	Jun
China	8.3	Q2	12.8	Jul
Singapore	8	Q2	11.3	Jul
Mexico	7.6	Q2	7.2	Jun
Russia	6.7	Q2	8.5	Jul
Hungary	6.6	Q1	21.1	Jun
Chile	6.1	Q2	4.4	Jul
Egypt	6	1999*	9.7	1999
Poland	6	Q1	7.8	Jul
Israel	5.9	Q1	10.6	Jun
India	5.8	Q3	4.9	Jun
Turkey	5.6	Q1	2.4	Jun
Taiwan	5.4	Q2	6.9	Jul
Thailand	5.2	Q1	1.4	Jun
Philippines	4.5	Q2	14.3	Jun
Czech Republic	4.4	Q1	6.1	Jun
Indonesia	4.1	Q2	34.8	Q4
Brazil	3.9	Q2	7.6	Jun
Greece	3.7	1999	6.2	May
Venezuela	2.6	Q2	na
South Africa	2.4	Q2	10.2	Jun
Colombia	2.2	Q1	12.5	Jun
Argentinia	0.9	Q1	0.9	Jul

 

· · For the next R10m investment - 6% p.a.
(above R5m up to R15m)
· For the next R15m investment - 4% p.a.
(above R15m up to R30m)
· For the next R20m investment - 3% p.a.
(above R30m up to R50m)
· For the next R25m investment - 2% p.a.
(above R50m up to R75m)
· For the next R25m investment - 1% p.a.
(above R75m up to R100m)

The Investment Incentives:
1.Why have we implemented them?
The short answer - to give a spur to private sector investment.
Calculations were done on the risk premium that investors will consider that they face in SA. Tried to develop a level of incentives that would make SA on a par or better as an investment destination by comparison with other countries - industrial and industrializing.
What they do is they impact upon the rate of return investors will receive in the initial few years after the investment (3 years). Allows investors to realize their initial capital investment more quickly. Makes it more likely that they will survive - since the attrition rates for firms is far higher in the earlier period of their lives.
2. What are the problems encountered?
May not be very effective.
· Firms are in it for the long haul - may only influence their decision at the margin.
· Deadweight loss - inevitable that some firms will get the incentives who would have invested anyway.
· Distortions - firms will change their investment decisions so as to maximize their gains form any incentive package.
· In a period of considerable uncertainty, firms will tend to wait before investing. Incentives are likely to be less effective.
· This is where, unfortunately SA is currently at. The National Survey; World Bank Study of industry in Gauteng.
3) How will they work?
· Three allowances.
· SMEDP Incentives
· The skills support programme
· Critical infrastructure programme

· Annual Investment Grant awarded on a regressive scale

The Small and Medium Enterprise Development Programme (SMEDP)
· An idea of the extent of the incentive. It is large for smaller cos. And progressively less as companies get larger. - Note the absence of incentives for very large investments - still under consideration. - SMEDP.
· Note that is only for 3 years maximum.
· In fact, the third year is only given if the ratio of labour remuneration/value added is more than 30%.
b)The skills Support Programme
· Cash grant - up to 50% of training of new staff resulting from an expansion or a new project. Must be based on a Dept. of Labour approved training programme.
· Payable for 3 years.
· Maximum annual grant 30% of annual wage bill.
· A firm can access both incentives simultaneously. Features to note:
· Favours smaller firms
· Favours labour intensive firms
· Favours firms that train new workers
By contrast with the old incentives, which were solely for secondary manufacturing, for the first time these are extended to new areas - and indeed areas outside of manufacturing all together - tourism; ICTs; high value agricultural products, agro-processing, recycling, bio-technology and aqua culture industries.

Defining the ICT Sector
New Economy Areas
ICTs
Worthwhile dealing with this sector in some detail, since it is so important. Mot merely because of its own size and growth, but because of its impact on manufacturing and all other business activities.

[PMG Editor's Note: diagram not included]

Current SA & International Growth Rates for ICT, by Segment

	South Africa	International
Computer Hardware	12%	6,9%
Telecom Services	20%	8,8%
Computer Software	20%	14%

 

· Overall growth in employment is limited - far slower than growth in output.
· Direct employment gains are overwhelmingly in skilled and professional occupations. Very minor in unskilled/semi-skilled.
· Scoping and looking for new areas for potential development. Breaking the mould - looking for new areas of opportunity for investment and employment and output growth. We have to be more imaginative. This is not to denigrate our traditional extractive and secondary industries - there is plenty of growth possibilities there - but the employment and output growth is happening and will increasingly happen in the tertiary-services sectors. What is clear is that the traditional measures of industrial policy are not appropriate.
· Let me take the equivalent of poetic licence. Foreign students…What will be the key here - promotional and publicity activities; English foundation courses - require state support; ease and expense of issuing visas (one year - four year visas).
· To reiterate, this is an illustrative example - not a chosen target, at this point in time.
· Don't take it to literally - Illustrative -
· An area of potential; Requiring state-private partnerships; Requiring new areas of policy; Requiring policy coordination across departments - education, home affairs, DTI;
· The DTI has begun such a process of identifying new areas for development and the constraints and blockages to development and then asking how can DTI play a role in promoting - ICTs tomorrow.
· Synopsis on the New Economy
· We will be looking at this sector far more closely.
· Co-operation with other departments.
· Brings in new policy measures. Regulation and Human Resource Development in particular. Not a panacea for everything.
· NB- Developments here will impact upon all areas of activity - including traditional areas- examples: mining, clothing.

[PMG Editor's Note: Table not included]

Exports and Imports
Seen significant export growth overall - and this export growth has been shared across the different sectors.
Imports have been rising too - but generally not as fast as exports (partly this reflects low rates of investment.)

[PMG Editor's Note: Graph not included]

Production & Sales
Output has also performed quite well - although on 5 years not that well.

[PMG Editor's Note: Graph not included]

Capital Expenditure
Capital Expenditure - over 5 years a decline of 2% per annum - shared unevenly. Some sectors have grown and some have declined.

[PMG Editor's Note: Graph not included]

Gross Salaries
Salaries - pretty constant - low growth over 5 years

[PMG Editor's Note: Graph not included]

No. of Employees
Employment - this is the depressing part of the story. Declining at 2% per annum and declines are almost universal across the sectors.
Not just that investment rates are low, new investment is much less labour demanding. Or, if you like, the amount of investment per job is constantly rising.

[PMG Editor's Note: Graph not included]

AGOA - Rules of Origin
Textiles - excluded (except hand-loomed)
· · Apparel - duty free no limitations - using US fabric or thread
· Apparel - duty free with limitations - using African fabric or yarn spun in Africa or US.
- Maximum = 1.5% of US imports apparel
+ 0.25% p.a. 1.5% of 62b = $2.4b
3.25% Current exports 250m

· Apparel - duty free with limitations - countries with per capita income less than $1500, using 3^rd country cloth - first four years duty free
· Some Apparel - without limitations - using fabrics not available in the US eg. Silk, cashmere.

Clothing and textile summit held at end of August in Durban (summit grew out of the Job Summit.)
Two developments are important here. The SADC Protocol on Trade and the African Growth and Opportunities Act.
2. Stainless Steel
Seen sustained growth of 13% per annum in fabricated products - 2X world average.
Exports growing at 40% per annum.
3. Motor Industry
Motor Industry Development Programme (MIDP) for light vehicles has been implemented from July. Extended now to 2007.
Exports have increased 46.5% from 1998-1999 in Rand terms. Component exports growing at 30% per annum.

 

SA growth is very high - and considerably higher than the international average. Looking at about a 17% annual growth rate. This is far higher than for any other industry segment.

Exports, Imports & Trade Balance of Office, Accounting & Computing equipment (ISIC3000)
Exports are growing - particularly to Africa - but off a low base and the bulk is imported. Major adverse terms of trade in this area.

[PMG Editor's Note: Graph not included]

The Telecom Sector
-Forecasts for Employment by Broad Occupation (1998 and 2003)
Two things to note - of equal importance.
a) Investment R5m
R5m @ 10% = R500,000

Investment R100m
R5m @ 10% = R500,000
R10m @ 6% = R600,000
R15m @ 4% = R600,000
R20m @ 3% = R600,000
R25m @ 2% = R500,000
R25m @ 1% = R250,000
R3,050,000
We are performing poorly. Industrial production is doing much better but still not a great performance.

Manufacturing GDP and Volume Production
Manufacturing investment declining for 8 quarters - revived at end of 1999 and first quarter of this year - then fell off again.

[PMG Editor's Note: Graph not included]

Fixed Investment & Capacity Utilisation
The situation is worse with respect to public sector investment, but I will leave that aside.
Macro framework in place. Exports doing well - rising primary product prices. Actually expect our growth rate to quicken - if the rate of growth of the world economy goes on as it has done. A question mark over oil.
But the key is that investment rates are much lower than we we would like. Currently at a little over 14.5% - looking for 24-25%. GEAR envisaged 23%.
Result - to spur private sector investment, we have developed a number of investment incentives. Further incentives are under discussion.

[PMG Editor's Note: Graph not included]

Annual Investment Grant awarded on a regressive scale
For the first R5m investment - 10% p.a.