ATC150508: Report of the Portfolio Committee on Economic Development on its Oversight visits to DCD Wind Towers, ASPEN Pharmacare, BMW and the Entities of the Economic Development Department– (02-06 February 2015), dated 17 March 2015

Economic Development

REPORT OF THE PORTFOLIO COMMITTEE ON ECONOMIC DEVELOPMENT ON ITS OVERSIGHT VISITS TO DCD WIND TOWERS, ASPEN PHARMACARE, BMW AND THE ENTITIES OF THE ECONOMIC DEVELOPMENT DEPARTMENT– (02-06 FEBRUARY 2015), DATED 17 MARCH 2015
 

1. Introduction and Objectives

 

The Portfolio Committee on Economic Development (PC) undertook oversight visits on 2 – 6 February 2015 to the Eastern Cape and Gauteng.

 

The Committee visited four (4) projects where government has directly funded and/or supported the projects through other forms of concessions. The identified projects are central to governments’ targeted sectors for industrial development, beneficiation and energy generation. The first project is a step towards responding to increasing the South African energy mix with particular focus on renewable energy, specifically wind energy.

 

The second project is one of the sectors identified as priority in the national industrial policy framework and in the industrial policy action plans. Beyond the social impact of manufacturing pharmaceutical domestically; the greatest sustainable value of this sector is the effect on the knowledge economy in the areas of sciences and technology.

 

Regional development is crucial in South Africa’s economic development. One of the important policy objective of special economic zone is to try and spread economic development across the country by exploiting each of the nine provinces’ competitive advantage. The third project being visited is one of the first differentiated economic areas aimed at achieving such regional development.

 

The last project to be visited is also at the centre of industrial policy, the automotive industry. The support of the South African motor industry started in the 1960s specifically targeted at local content development until the late 1980s. The support was for the development of the motor vehicle assembly and component industry.  Post 1995, the government instituted a much broader programme called the Motor Industry Development Programme (MIDP) which effectively ran until 2012. Replacing the MIDP with effect from January 2013 was the Automotive Production and Development Programme (APDP). The APDP is a production driven incentive for vehicle assemblers and automotive components manufacturers.

 

The oversight is part of the orientation of the Committee on the various projects the government has invested in. The second objective for the oversight is to assess the ‘value for money’ and ‘return of investment’ on the projects where government has invested. Government investment refers to direct financial support and other concessionary interventions.

 

The Committee also paid courtesy visits to the Economic Development Department (EDD) and its agencies, namely; the Competition Commission, Industrial Development Corporation (IDC), International Trade Administration Commission (ITAC) and the Small Enterprise Finance Agency (sefa).

 

 

1. Eastern Cape, 3 – 4 February 2015

The PC on Economic Development, jointly with the PC on Trade and Industry, visited:

 

 

Part A: DCD Wind Tower Facility

 

A background of the history of this project, developed by the PC on Trade and Industry, is attached as Annex 1.

 

Essentially this is a joint initiative between the IDC, Coega Development Agency and the DCD Group. The DCD Group is a manufacturing and engineering company focusing on energy, mining, rail and other engineering solutions. Located in the Coega IDZ, this R300 million investment in wind turbine production facility started operating in May 2013 with the aim of producing about 110 – 120 wind towers a year.

 

For the PC on Economic Development, beyond the physical assessment of the investment, are the following critical broader issues which require policy coordination between industrial policy and the Integrated Resource Plan (IRP) 2010 – 2030,

 

• The first issue, not policy related, is that of economies of scale. South Africa is said to require about 10 000 turbines for wind generated energy to be cost effective. The IRP projects a decreasing demand;
• However, there might be constraints to achieving the above as a result of the synergy deficit between industrial policy and the IRP. How does such an investment fit into the IRP (2013) projections? The IRP should ensure an effective wind energy production industry built on local demand; and
• Other issues for consideration as the Committee does oversight of the project include issues such as local content.

 

Findings

 

Very low local content in the production of the wind turbines

• Customer decides on design and type of steel (grade) to be used in production of turbine, and therefore all steel imported; and
• Cost of steel in certain cases importing finished steel products could be cheaper than purchasing the local material to manufacture the part from ArcelorMittal South Africa.

Electricity Supply

• Electricity load shedding does not affect the Coega IDZ. Load shedding in the IDZ is an option of last resort as per a memorandum of understanding between the management of the IDZ, CDC, and the Nelson Mandela Bay Metropolitan. In addition, there is construction of the DEDISA Peaking Power Plant which will provide additional electricity + back-up where demand exceeds supply and as a result of load shedding respectively, in the IDZ.

Skills shortage and development

• There are particular skills not available in the area and therefore the company has to import such skills from other provinces such as Gauteng;
• Although CDC has instituted a program of skills development for purposes of supplying industries invested in the IDZ, there is a time-lag between training and the uptake by industry. The time lag affects both parties in that when a skilled individual has been trained but not hired by an industry in the IDZ seeks opportunities elsewhere and therefore a loss to both IDZ and industry. On the other hand, when a particular skill is needed by the industry at a particular time, yet such skill is still being developed through training by the CDC, industry is then compelled to import such a skill; and
• It was of concern to the Committee that the industries in the IDZ itself have not engaged beyond the CDC skill development programme, such as engaging local institutions of higher learning to collaborate in skills development.

 

Policy challenges

 

The Renewable Energy Independent Power Producer Procurement (REIPPP) programme is key for the development of this sector. However the uncertainty related to the next window in the programme and access into the Eskom grid has a negative effect on potential investment in wind renewables. There also has to be a significant domestic depart for wind energy which currently does not exist.   The net effect of these uncertainties are questions on the economic viability of manufacturing parts locally.

 

 

Part B: Aspen Pharmaceuticals

A detailed background document on the pharmaceutical industry in South Africa developed by the Department of Trade and Industry is attached as Annex 2.

 

Aspen South Africa is a subsidiary of the fifth largest global pharmaceutical company. Aspen South Africa has three manufacturing facilities; in Port Elizabeth, in East London and another in Cape Town. They each specialize in pharma-production. Aspen South Africa is over 16 years old and its growth has been largely through acquisitions.

 

Local pharmaceutical production has had a positive ripple effect on prices of medication and access to the necessary medicine. The industrial policy prioritization of pharmaceuticals does not only concern itself with investment and production. This is especially because of issues of economies of scale and market size in South Africa and the rest of the continent. The domestic and continental markets are considered relatively small from a global market perspective.

 

For the PC on Economic Development, the greatest benefit of the sector to economic development are in the areas, central to the NDP and NGP:

• Research and Development – this is the most critical area of the pharmaceutical industry; and
• Linked to the above are issues of Indigenous Knowledge that may be developed to be commercially viable and Intellectual Property.

 

 Findings

 

Local procurement of drugs

Aspen expressed dissatisfaction with how government procures drugs. Aspen argues only a few local drug producers benefit from government procurements even where price differential is marginal between the local and international drug producers. Although the pharmaceutical industry is a designated priority sector in the industrial policy, such expected preferential procurement is not exercised by government.

 

Special designation

Aspen argued the current designation as sez does not work for them. This is because, they argue, their investment in the current location is prohibitively high to be able to uproot and reinvest in a designated IDZ/SEZ. They have begun work lobbying government for a ‘factory specific sez/sector development zone/ Export Oriented Units (EOU)’.

 

Incentives policy flexibility

Flexibility of government incentive policies constrains Aspen. The 12i, a tax incentive on capital expenditure incentive, is too rigid in its application and does not allow for sector-specific nuances. Primarily the issue is that the incentive does not place as much weight to future job creation/employment as a result of capital expenditure. Rather consideration is placed on current/immediate employment created. This therefore reduces the current benefit that the company would ordinarily enjoy from the incentive.

 

Committee Conclusions/Recommendations

 

1. Access to affordable drugs versus industrial policy. Aspen presented government procurement decisions on drugs as conflicting its industrial policy priorities. Essentially it argues that government should procure drugs from local producers despite costs because government has designated the sector priority for industrial development. The Portfolio Committee’s approach to addressing this has been to schedule a closed briefing involving all relevant stakeholders including the Department of Health. This is so that a comprehensive solution is found to the issues raised by Aspen.
2. Aspen further lobbied the Committee to consider putting pressure on the departments of trade and industry, and the EDD, to consider designation of the factory as an EOU or sector development zone or factory specific special economic zone (sez). There is need to explore the pros and cons of the request. The initial reaction is that it has the potential to create precedence, especially for large factory investments, to leverage such investment and therefore demand such treatment. The net effect is that this will dilute the whole objective of designation of areas as sez, diluting the value derived from clustering such as economies of scale. However, the dti and EDD should explore this arrangement particularly where such investment preceded the designation.
3. The request to consider future employment from capital investment instead of immediate employment created may create fiscal difficulties. The rebate operates in such a way that National Treasury budgetsor allocates funds based on the current/immediate employment benefit from investment. The proposal by Aspen is that such commitment of funds should be made prior to actual employment benefit being achieved from investment.

 

 

Part C: Coega Development Corporation (CDC)

The Industrial Development Zone (IDZ) programme is a construct of Section 10 of the Manufacturing Development Act of 1993 as amended. The Coega IDZ was established in 2000 and received its operating permit in 2006. It is wholly-owned by the Eastern Cape Provincial government and managed by the Coega Development Corporation (CDC), a subsidiary of the Eastern Cape Development Corporation.

 

In 2014 the government enacted the Special Economic Zones Act of 2014 which principally expands the concept of industrial development zones extending the benefit of differential investment treatment. The SEZ ensures more comprehensive benefits beyond infrastructure and services concessions, and customs administration to include tax benefit as well.

 

There are essentially four primary objectives for the creation of IDZs, as conceptualized by the government; which were to:

(a) Attract Foreign Direct Investment;

(b) Provide an environment for increased production and technology development in manufacturing;

(c) Establish linkages between industrial zones based industries and domestic based industries; and

(d) Facilitate development of industrial infrastructure.

 

The Coega IDZ is in line to converting itself into an SEZ in line with the new structure as prescribed by the SEZ Act of 2014.

 

For the PC on Economic Development, the CDC oversight comes at an opportune time after the visit to the Kalagadi Manganese Project on the Northern Cape in late November 2014.

• The CDC has recently publicly (Financial Mail, 22 January 2015, Coega IDZ: incentives raise hope) identified the Kalagadi Smelter as one of two key investments. These have the potential to unlock major job creation. The Kalagadi Smelter, the third phase of the Kalagadi Manganese Mine, will be located in Coega. However, delaying the smelter are finance equity constraints. The PC made funding proposals in the late November 2014 oversight report. What role does the CDC see itself in raising finance for the smelter. Would the CDC consider such options? 

 

Findings

 

1. Transition from IDZ to SEZ: The CDC expressed concerns about the transition from an IDZ to a SEZ. Mainly the issue is that the new legislation establishing IDZ requires a split between the licensee and the operator of the sez. Currently these are the same in the IDZ statute.
2. Revenue and Opex funding: The greatest and immediate challenge for the CDC are its revenue and operation costs. The current funding arrangement with the dti and province is such that it does not fund operational costs. Rather such funds are restricted for use only in capital expenditure. The current problem is that even with a projects conversion rate of over 60% revenue from such does not cover the operation costs of the CDC.
3. The CDC also expressed concern with the fact that the Kalagadi Manganese Smelter which was supposed to have been constructed in the IDZ has stagnated. This is considered a crucial investment by CDC and therefore its failure to progress will have a serious dent on the prospects of the zone in relation to employment creation.

 

Recommendation

 

In collaboration with the dti, the EDD should investigate the financial troubles being faced by the CDC. Close to R2bil have been invested in the IDZ since its formation. At a regular interval it has operated and been constantly on the brink of financial collapse due to insufficient opex funding.

 

The Committee will engage the EDD, and state DFIs, with the goal to find out what seems to be the problem in implementing some of the massive infrastructure requirements that would include rail, energy which are catalysts to projects such as the smelter.

 

 

1. Gauteng, 5 – 6 February 2015

The PC on Economic Development visited one other project in the automotive sector, BMW in Roslyn, Pretoria North, and further paid courtesy visits to the national Department of Economic Development (EDD) and its regulatory agencies; the Competition Commission, the International Trade and Administration Commission (ITAC), IDC and sefa.

 

Part D: BMW South Africa

Very succinctly, the MIDP was an export-based incentive scheme where exporters of vehicles and automotive components earned Import Rebate Credit Certificates (IRCCs). Within the MIDP is the Productive Asset Allowance (PAA), which will be phased out at the end of 2015.  The PAA is a rebate credit benefit that accrues to vehicle assemblers for investments in productive assets used in the manufacture of vehicles and automotive components. BMW South Africa (SA) has participated and continues to benefit from these incentives.

 

With effect for 2013 the APDP replaced the MIDP.  This scheme is a production driven incentive for vehicle assemblers and automotive components manufacturers. The aim of this incentive is to grow the sector to be able to produce 1.2 million vehicles in South Africa by 2020. BMW SA currently earns two types of rebate credits under the programme, namely; the Production Incentive (PI) and the Volume Assembly Allowance (VAA).

 

Since January 2013 up to 31 Dec 2014, according to the Department of Trade and Industry (DTI), only one AIS project was approved for BMW (Rosslyn). The approval was based on an estimated investment of R2, 2 billion and an estimated AIS incentive of R664, 5 million as was approved by the AIS Adjudication Committee. This approval was based on projections provided at application stage. However the qualifying investment by BMW was less than anticipated and a total amount of R443 million was paid out over the AIS Incentive period to date.

 

For the PC on Economic Development, and for purposes on this oversight, it is important that it assesses:

1. Ratio of employment vs. investment (in the last 18 months BMW has made an investment of about R2billion in Roslyn);
2. Current production levels vs. future production projections – within the context of a national target of producing over 1miliion cars 5 year;
3. Procurement, local content and establishing of value chains issues – beyond the domestic considerations but also regionally (as part of regional integration) – i.e. building value chains is one of the priorities in the 5 point plan of the Southern African Customs Union (SACU); and
4. Corporate social responsibility – Pretoria North and the surrounding communities (Brits, Soshanguve, Hammanskraal etc.) are predominately poor.

In the long-term, this oversight provides an opportunity for the Committee, as custodians of economic policy oversight, to lead discussions on broader issues on state intervention in sectors such as the automotive sector. Literature on the assessment of the previous scheme, the MIDP, acknowledges the success of the incentive in the automotive sector. However, at a broader analysis level, in terms of economic benefits and costs, there is little work done by policy makers. This includes issues of:

1. Market access – how much of the local market (Africa broadly) has the South African automotive production captured and is sustaining?;
2. Comparatively, in BRICS, have we bench-marked in terms of the various concessions offered to the sector. Is there a threshold in terms of concessions offered – are we below or above – to the sector?;
3. The APDP Production Rebate Credit Certificates (PRCCs) introduces sliding scales of declining rates of benefit through the lifespan of the scheme. This introduces a competitiveness consideration in future benefits; and
4. Linked to the above is the question of economies of scale.

 The above are wide policy discussions that the PC can lead in its economic policy coordination function.

 

 

Findings

 

1. Conditions of Service – BMW claims that it offers comprehensive coverage of all medical needs of employees, has developed an in-house pension scheme and offers competitive remuneration,
2. BMW SA raised two policy challenges that concerns it the most:
   1. Uncertainty with the renewal of the Africa Growth and Opportunities Act (AGOA) post 2015 – BMW exports over 40% of its production to the United States; and
   2.  What happens post 2020 where the Automotive Production and Development Programme (APDP) ends. – For BMW SA, the discussion on the country’s policy direction after the next five years should start now. They feel that discussions should not be left to close to the end the programme. This will allow industry to properly adjust to any significant changes to policy.
3. Skills shortage and development – BMW SA is involved and keen on further collaboration with government of private – public partnership for skills development. It acknowledges there is still much work required to find ways of addressing the skill shortage in the country;
4. Energy and transport infrastructure challenges - BMW SA raised concerns about the energy shortage and has invested in some alternative sources to mitigate the impact of the country’s energy constraints. The same concerns apply to logistics wherein the unreliability of rain puts pressure in their transport costs. Over 60% of production is exported and rail is the cheapest method of transporting the cars to the harbour than road; 
5. Labour instability – in 2013 the country experienced one of the longest labour strike in its history. The impact on the automotive industry was very significant. The industry is very sensitive to inefficiencies with severe impact on time-bound contracts. The reputation, as it relates to its ability to deliver on time, of the organisation in the global auto industry is affected by such unrest and
6. Lastly, BMW SA raised concerns related to cost competitiveness with regards to import duties imposed on some automotive components, the referred logistical costs and inefficiencies on local suppliers.

 

Committee Conclusions/Recommendations

 

1. The concerns raised by BMWSA are legitimate. The government has recognised all the issues as important to the extent that it has instituted specific programmes to address such issues as labour relations, energy constraints, and market access concerns to the USA:
   1. An energy war-room has been established at the presidency involving all necessary state and none-state institutions,
   2. Lobbying the USA Congress and relevant parties, to the extent that the US Whitehouse has acknowledged the importance of AGOA in Africa - USA relations.
2. The policy uncertainty concerns with regards to post 2020 of the APDP are also legitimate.
   1. The Committee shall pass such concerns to its counterparts in the Portfolio Committee on Trade and Industry to engage the Department of Trade and Industry.
3. As part of the national infrastructure programme, the Department of Economic Development needs to engage such companies as BMW with regards to how plans on transport infrastructure development.

 

Part E: EDD, Competition Commission, ITAC, IDC and sefa

Chapter 4 of the Constitution of South Africa sets out one of the major functions of Parliament, and specifically the PC on Economic Development, is to ensure oversight over the executive (Department of Economic Development). Section 5 of the Money Bills Amendment Procedure and Related Matters Act No. 9 of 2009 empowers the Committee to assess the performance of each Department of Economic Development and its agencies. It is within this constitutional and legal context that the courtesy visits to the Department and its various agencies are held.

 

Part F: Aerosud

The Committee paid a visit to Aerosud. This is an aviation components Construction Company located in the Centurion Pretoria. Aerosud was formed in 1990. It focussed, primarily, on high engineering manufacturing and highly specialised aviation components of low production volume. The company restructured in early 2000. This led to the expansion of the company’s production capability and capacity. In mid 2000s Aerosud won an international tender for the supply of components for Boeing, and subsequently other tenders supplying Airbus. This led to, in September 2014, the Industrial Development Corporation (IDC) getting an equity stake of about 26% of Aerosud Holdings and its subsidiaries, Aerosud Aviation and African NDT. The company has an annual turnover of close to R1billion and an order book in excess of R5billion.

 

Major highlights for the Committee in its oversight were:

 

Findings

1. Obvious construction (buildings) as part of the expansion of the company and a result of the IDC equity stake;
2. The components assembled are for the aviation industry and therefore require very high engineering skills. However there is very little local content in the product inputs – including in the plastics/polymers sector that has been identified as priority in the various industrial policy action plan;
3. Collaboration between the Aerosud research and development division with other public enterprises such as Denel has led to the wholly developed multi-use/function light aircraft that has found market in the USA and Europe;
4. The choice of location for the company is also a result of the area designated at an aerospace cluster – Centurion Aerospace Village (CAV). The CAV is supposed to be a cluster village of OEMs in the aviation/aerospace industry. This arrangement has a positive economies of scale effect and cost reduction especially in relation to transportation of components; and
5. Since 2010/11 financial year, the DTI  investment in the CAV has stagnated to the extent that Aerosud has had to move production of the light aircraft away from the Aerosud to elsewhere. 

 

Committee Conclusions/Recommendations

1. The Committee will encourage EDD to engage the dti with the aim of assisting the fast tracking the implementation of the CAV;
2. There appears to be very minimum local content even in products that are identified in the industrial policy action plan as priority and strategic. There is need for the EDD to further engage such investments with the objective of determining the reason behind this (could be a pricing issue of inputs such as polymers, or skills issue in value addition of the abundant inputs to produce the final product or a variety other reasons); and
3. The EDD should assist in investigating why a wholly developed South Africa aircraft that has received international accolades does not find domestic market.

 

Committee Conclusions

 

The Committee met with the various agencies of the Department of Economic Development. The meetings were essentially aimed at introducing members to the functions of the agencies and how they report to the Department. The briefings were followed by a tour of the offices of the agencies. The Department received introductory briefings from the Competition Commission and Tribunal, ITAC and sefa.

 

The Committee noted the challenges of inadequate office space which face some of the entities and will continue to engage the Minister on the matter at an opportune time.

 

As the Committee continues to perform its oversight function, it has further noted through these visits, areas on which the Department and the entities could be empowered by its support, especially on issues related to legislation. These will form part of the formal conversations with the Department and the entities throughout the year.

 

 

1. Conclusion

The Committee requests that the Minister of Economic Development (the Minister), where applicable, ensures that the recommendations made herein are considered and due consideration is  given to their implementation. The Minister should further ensure that responses on recommendations’ feasibility and/or implementation are submitted to Parliament, within one calendar month of the adoption of the report by the National Assembly (NA).

 

Report to be considered.