The effects that protectionism has had on the South ...

THE EFFECTS THAT PROTECTIONISM HAS HAD ON

THE SOUTH AFRICAN MOTOR INDUSTRY'S

COMPONENT SUPPLIERS

BY

KAREN JENNIFER VENTER

DISSERTATION

Submitted in partial compliance with the requirements for the

MASTER'S DEGREE IN BUSINESS ADMINISTRATION

Offered by the

TECHNIKON WITWATERSRAND, MANAGEMENT UNIT

Validated and conferred by the

UNIVERSITY OF WALES

SUPERVISOR: ANDREW PAMPALLIS

September 2001

ACKNOWLEDGMENTS AND DECLARATIONS

This research is not confidential and may be freely used by the University of Wales —

Bangor, the Technikon Witwatersrand, Johannesburg, South Africa and any other

interested party. The use of any data or information contained in the research must,

however, be properly acknowledged.

I wish to record my sincere thanks and appreciation to:

My Family and my husband, Allan for their continuous support and motivation;

Andrew for supervising me throughout the compilation of the dissertation;

Shatterprufe (Pty) Ltd. for allowing and supporting me in completing the MBA; and

My Creator through which none of this would have been possible.

I certify that the research is my own work, and that all references have been accurately

reported.

I CV 0-1\1-Q_Y-

Karen Jennifer Venter

September 2001

TABLE OF CONTENTS

PAGE

ACKNOWLEDGEMENTS AND DECLARATIONS

i

CHAPTER 1 INTRODUCTION AND SCOPE OF RESEARCH 1

1.1 BACKGROUND 1

1.2 AIM 2

1.3 OBJECTIVES 2

1.4 DEFINING CONCEPTS 3

1.5 LIMITATIONS 4

1.6 VALUE OF THE RESEARCH 4

1.7 METHODOLOGY 4

1.7.1 EXPLORATORY RESEARCH 4

1.7.2 SURVEY 5

1.7.3 EXPLANATORY STUDY 5

1.8 LAYOUT OF RESEARCH REPORT 6

CHAPTER 2 BACKGROUND TO THE MOTOR INDUSTRY 8

2.1 INTRODUCTION 8

2.2 THE TARIFF STRUCTURE OF THE MOTOR INDUSTRY 9

2.2.1 REBATES ON IMPORT DUTIES 10

2.3 OTHER NON-TARIFF TRADE RESTRICTING MEASURES 11

2.4 THE PROTECTIVE NATURE OF PHASE VI 11

2.5 THE EFFECTS OF THE PHASE VI PROGRAMME 12

2.5.1 THE PRICE EFFECT 12

2.5.2 THE DOMESTIC SUPPLY EFFECT 13

2.5.3 THE REVENUE EFFECT 13

2.5.4 WELFARE EFFECT 14

ii

6 MOTOR INDUSTRY DEVELOPMENT PROGRAMME 17

2.6.1 IMPORT DEBATE CREDITS 18

2.6.2 DUTY FREE ALLOWANCE 19

2.6.3 SMALL VEHICLE ALLOWANCE 19

2.6.4 MOTOR INDUSTRY TARIFF STRUCTURE 20

2.7 THE EFFECTS OF THE MIDP 20

2.8 MIDP MID-TERM REVIEW 22

2.8.1 MOTOR INDUSTRY TARIFF STRUCTURE 23

2.8.2 SMALL VEHICLE INCENTIVE 24

2.8.3 ASSISTANCE FOR EXPORTERS 24

2.8.4 PRODUCTIVE ASSET ALLOWANCE 25

2.9 CONCLUSION 25

CHAPTER 3 LITERATURE REVIEW 27

3.1 AN OVERVIEW OF TRADE POLICY INSTRUMENTS 27

3.1.1 INTRODUCTION 27

3.1.2 TARIFF BARRIERS 27

3.1.3 EXPORT TAXES AND SUBSIDIES 34

3.1.4 NON-TARIFF BARRIERS TO FREE TRADE 37

3.2 TRADITIONAL ARGUMENTS FOR PROTECTION 40


3.2.2 THE INFANT INDUSTRY ARGUMENT 41

3.2.3 THE TERMS OF TRADE ARGUMENT 42

3.2.4 TARIFF TO INCREASE EMPLOYMENT IN A PARTICULAR

INDUSTRY 44

3.2.5 TARIFF TO OFFSET FOREIGN DUMPING 45

3.2.6 TARIFF TO IMPROVE THE BALANCE OF PAYMENTS 46

iii

3 "NEW PROTECTIONIST" APPROACHES TO A TRADE POLICY

INTERVENTION 47


3.3.2 STRATEGIC TRADE POLICY 47

3.3.3 ECONOMIES OF SCALE IN A DUOPOLY FRAMEWORK 50

3.3.4 EXTERNALITIES - RESEARCH AND DEVELOPMENT AND SALES

OF THE DOMESTIC FIRM 54

3.4 CONCLUSION 56

CHAPTER 4 RESEARCH METHODOLOGY 58

4.1 INTRODUCTION 58

4.2 EXPLORATORY RESEARCH 58

4.3 EXPLANATORY RESEARCH 58

4.4 SURVEY 59

4.4.1 SAMPLE SELECTION 60

4.4.2 DATA ANALYSIS 61

CHAPTER 5 DATA ANALYSIS AND INTERPRETATION 63

5.1 INTRODUCTION 63

5.2 RESPONSES TO THE QUESTIONNAIRE 63

5.3 GENERAL CONCLUSIONS 86

5.3.1 GENERAL QUESTIONS 86

5.3.2 INTERNATIONAL COMPETITIVENESS 87

5.3.3 EMPLOYMENT 88

5.3.4 ECONOMIC GROWTH 89

5.3.5 BALANCE OF PAYMENTS 91

5.3.6 EFFECTS OF THE MIDP 92

5.3.7 RECOMMENDATIONS 92

iv

3.8 FUTURE OF THE MIDP

92

CHAPTER 6 CONCLUSION AND RECOMMENDATIONS 93

6.1 CONCLUSION 93

6.2 RECOMMENDATIONS 95

BIBLIOGRAPHY 98

TABLE OF CONTENTS ii

LIST OF TABLES vi

LIST OF FIGURES vii

APPENDIX I - QUESTIONNAIRE

LIST OF TABLES

PAGE

Table 2.1 Tariffs for CBUs and imported components 20

Table 2.2 Tariffs for CBUs and imported components 23

Table 2.3 DFA allowance for small vehicles 24

Table 2.4 Reduction of the import rebate 25

Table 4.1 Questionnaire groupings and the corresponding question

numbers 59

Table 4.2 Classification of NAACAM members 61

Table 4.3 Quantitative analysis performed per question 62

Table 5.1 Percentage of exports per country by component supplier 66

v i

LIST OF FIGURES

PAGE

Figure 2.1 The single market effect of a tariff on the motor industry 13

Figure 2.2 The welfare effects of a tariff on the motor industry 14

Figure 2.3 The effects of a small vehicle incentive (import subsidy) to

domestic producers 16

Figure 3.1 The single market effect of a tariff in a small country 29

Figure 3.2 The concept of consumer surplus 30

Figure 3.3 The concept of producer surplus 31

Figure 3.4 The welfare effects of a tariff on a small country 32

Figure 3.5 The single market effects of a subsidy to domestic producers 33

Figure 3.6 The impact of an export tax 35

Figure 3.7 The effects of an export subsidy 36

Figure 3.8 The imposition of an import quota 38

Figure 3.9 A tariff to improve the terms of trade 43

Figure 3.10 A tariff to extract foreign monopoly profit 48

Figure 3.11 Domestic firm and foreign firm's sales in a third-country

market 50

Figure 3.12 Domestic country protection and domestic firm sales through

economies of scale 52

Figure 3.13 Domestic country protection and domestic firm sales through

economies of scale 53

Figure 3.14 Domestic country protection and domestic R&D spending

and output 55

Figure 5.1 Percentage of supply to OEMs 64

Figure 5.2 Percentage of supply to each OEM 65

Figure 5.3 Percentage of exports generated by component supplier vs

that generated by OEM 67

vii

PAGE

Figure 5.4 Change in employees employed since 1994 70

Figure 5.5 Change in number of units sold to OEMs since 1994 71

Figure 5.6 Change in number of units exported since 1994 73

Figure 5.7 Change in the units sold to the local replacement market

since 1994 74

Figure 5.8 Change in profitability of markets from 1994 to 2000 76

Figure 5.9 Utilisation of company's capacity 77

Figure 5.10 Percentage of product which contains imported

materials/components 79

Figure 5.11 Change in units sold to OE, export and local replacement

market since 1994 90

viii

CHAPTER ONE

1. INTRODUCTION AND SCOPE OF RESEARCH

1.1 BACKGROUND

According to du Plessis et al., (1994:67), the history of protectionism in trade goes almost as

far back as that of trade itself. There are various arguments for the numerous benefits, which

can be gained from free trade such as, efficiency and welfare gains. But, despite these

benefits, governments have had counter arguments as to why protectionism is justified.

Examples of these traditional arguments for protection are, the infant industry argument, the

terms of trade argument, protection to increase employment in an industry, a tariff to offset

foreign dumping and a tariff to improve the balance of payments. All of these arguments

have important gains for the protected economy but could be considered beggar-thy-

neighbour policies since they are at the expense of the unprotected economy. TECHNIKON WITWATERSRAND

LIBRARY

Various trade instruments are used by governments to intervene in its countries trading

activities. These trade instruments are categorised into, tariff, non-tariff barriers and export

taxes and subsidies. Both tariff and non-tariff barriers are used to interfere on the import side

of trade, whereas export subsidies and taxes are used to interfere with the free flow of

exports. Tariff barriers include specific tariffs, ad valorem tariffs, import subsidies,

preferential duties, most-favoured nation treatment and offshore assembly provisions. Non-

tariff barriers include import quotas, "voluntary" export restraints, government procurement

provisions, local content provisions, administrative classification and restriction on service

trade (du Plessis et al.,1994:67-70).

In recent years, "new protectionism" or "strategic trade policy" theories have emerged on

why a domestic country can probably benefit from a tariff or other trade instruments.

Examples of these "new protectionism" theories include, the strategic trade policy,

economies of scale in a duopoly framework and research and development and sales of the

domestic firm (Appelyard & Field,1995:220-222).

An example of a protected industry in South Africa is the motor industry. The initial

protectionist programmes used by the motor industry were characterised by local content

policies. These programmes resulted in a heavily protected motor and component industry. In

recent years, policymakers have attempted to reduce the level of protection in the industry

through the Motor Industry Development Programme (MIDP), in line with the General Trade

and Tariff Agreement (GATT). This programme is not only attempting to reduce the use of

trade instruments but, also to become globally competitive.

Despite the persuasive theoretical arguments showing the new welfare gains that result from

free trade, individuals and organisations continue to persuade government policymakers to

restrict imports or artificially magnify the size of the country's exports (Appelyard &

Field,1995:225). The expansion or contraction of international trade due to government

intervention has implications for income distribution and it is therefore important to

understand who the "winners" and "losers" are from protection policy (Lindert,1991:115).

Moreover, the identification of the winners and losers due to trade interference's is

important, to assess the economic and political desirability of alternative trade policies.

1.2. AIM

This dissertation attempts to evaluate the effects that protectionism, in the form of the Motor

Industry Development Programme, has had on the Motor Industry's component suppliers.

1.3. OBJECTIVES

To provide background to the Motor Industry and an overview of protectionism in the

South African Motor Industry, with special reference to the Motor Industry Development

Programme.

To discuss protectionism in terms of the trade policy instruments; the arguments for

protectionism and the strategic trade policy.

2

To conduct a quantitative study by means of a questionnaire of the effects of the Motor

Industry Development Programme on the local motor manufacturers and component

industry.

To evaluate and interpret the results of the research conducted on the Motor Industry's

trade policies

To provide conclusions and/or recommendations for the future trade policies in the Motor

Industry.

1.4. DEFINING CONCEPTS

Motor Industry

The Motor Industry refers to the local motor manufacturers/assemblers and components

suppliers. There are seven motor assemblers in South Africa namely: BMW, Daimler-

Chrysler, Delta, Ford, Nissan, Toyota and Volkswagen. These motor assemblers source

components (parts) from local and overseas component supplier and then assemble these

components into a locally manufactured motor vehicle. These motor vehicles are then sold

locally or in some instances, exported.

Protection

According to the Fowler's Oxford Dictionary (1984:594), protection is defined as "protecting

or being protected; person or thing that protects; system of protecting home industries".

Protectionist trade policies

Trade policy refers to the various instruments that governments can use to affect international

trade and capital movements, in other words the balance of payments (Mohr &

Fourie,1995:497). These trade instruments can take the form of tariffs, non-tariff barriers,

export taxes and subsidies.

3

1.5. LIMITATIONS

This dissertation will be limited to the South African component suppliers who are members

of the National Association of Automotive Component and Allied Manufacturers

(NAACAM). Since, NAACAM is the most recognised association in the motor industry for

the component suppliers to belong to. In addition, this dissertation will be limited to the

available theory on the Motor Industry and protectionism.

1.6. VALUE OF THE RESEARCH

With a growing number of industries experiencing changes to their level of protectionism.

This dissertation will assist these industries and companies going through the change process

with lessons learnt.

1.7. METHODOLOGY

Three main research design methods will be used namely: exploratory research, survey and

explanatory studies. Each of these research design methods and the reason for making use of

it will be discussed below.

1.7.1 EXPLORATORY RESEARCH

According to Saunders et al., (2000:97), exploratory studies are used to establish what is

occurring; seeking new insights and assessing new phenomena in a new light. Thus, it is

beneficial when the understanding of a problem requires clarification. Literature reviews are

a useful tool when conducting exploratory research. The focus is initially on the broad issues

and then the focus becomes consecutively narrower as the research continues (Saunders et

al . ,2000: 97).

The exploratory research method is very applicable to objective one and two were firstly, a

background of the Motor Industry will be given with special reference to the Motor Industry

4

Development Programme (MIDP). This will be followed by an overview of the various types

of protectionist policies and the relevant arguments for them.

1.7.2 SURVEY

According to Saunder et al., (2000:94), a survey grants the collection of a sizeable quantity of

data from a large population in a highly economical method. Most often questionnaires are

made use of and the data collected is standardised and thus allows for easy analysing. This

method of research is also perceived to have authority by the majority of people. The reason

for this is because it is easily understood and it also allows for more control over the research

process. The disadvantages of this method is that it is time consuming in terms of drawing up

the design of the questionnaire, piloting it and then analysing the results. The data collected

by means of the survey method may not be as broadly scoped as those collected by

qualitative research, since there are only a limited number of questions that a questionnaire

can obtain and this is dependant on the reliability of the respondent (Saunders et al.,2000:94).

Despite some of the drawbacks with the survey method, a questionnaire will assist in

achieving objective three, which is to conduct a quantitative study of the effects of the Motor

Industry Development Programme on the component industry.

1.7.3 EXPLANATORY STUDY

According to Saunders et al., (2000:98), an explanatory study is used to establish casual

relationship between variables. Therefore the situation or problem is studied in order to

explain the relationships between variables. This method will be used to evaluate whether

there is a relationship between the reduction of protectionism and the financial performance

of the component suppliers.

The data collected will consist of primary and secondary data. The primary data collected

will be by means of a questionnaire. The secondary data will be obtained from textbooks,

journals and periodicals.

5

The total population of local component suppliers which belong to NAACAM is one hundred

and sixty four. A cluster probability sample of seventy-nine component suppliers will be

selected as the sample size and questionnaires will be sent to the Financial

Directors/Managers of these companies.

1.8. LAYOUT OF RESEARCH REPORT

Chapter Two begins by providing a background to the South African Motor Industry.

Attention is then focused on protection used in the motor industry. Particular attention is paid

to the effects which protection has had on consumers, producers and the government under

the previous Phase VI local content programme to the current Motor Industry Development

Programme (MIDP) and mid-term review.

Chapter Three consists of a literature review of protectionism. This is conducted by firstly

providing an overview of trade policy instruments and the impact of these instruments.

Secondly, the traditional arguments for protection will be discussed by presenting the

argument as to why protection should be applied. The arguments are usually given from a

national perspective or an individual industry perspective or from the worldwide perspective.

The validity of protection argument is evaluated and the question is asked whether there are

alternative policy instruments, which may be able to achieve the objective of the restrictive

trade policy. Lastly, the "new protectionist" theories on the possible benefits of protection

will be evaluated. The analysis of the "new protectionist" theories is sub-divided into three

sections. The first section discusses a theoretical situation in which a domestic country's

tariff results in the transfer of some of the profit of a foreign monopoly firm to the domestic

country. This argument is also referred to as the strategic trade policy. The second section

uses a duopoly framework to evaluate the effects of a domestic tariff on realising economies

of scale and larger exports for the protected country. Lastly, a two-firm framework (one

domestic firm and one foreign firm) will be used to evaluate the possible beneficial impact of

protection on research and development.

6

Chapter Four discusses the methodology used in order to conduct the research. Three forms

of methodology were used to conduct research namely exploratory research, survey and an

explanatory study. Each of these methods will be defined and their application in conducting

the research discussed.

Chapter Five focuses on the analysis of the research conducted on protectionism in the Motor

Industry. Particular attention will be paid to the results of the questionnaires completed. This

chapter will also include the interpretation of the results obtained from the completed

questionnaires.

Chapter Six makes use of the empirical evidence of the Motor Industry Development

Programme in order to conclude what effects this programme has had on the South African

component suppliers. This chapter also suggests further possibilities for the role of

protectionism in the motor industry.

7

CHAPTER TWO

2. BACKGROUND TO THE MOTOR INDUSTRY

2.1. INTRODUCTION

The South African motor industry is a significant player in the economy since it contributes

approximately 5.4% of the gross domestic product (GDP). It employs 32 500 people in the

assembly industry, 48 600 people in the component industry and 175 000 people in the motor

trade. Further people are indirectly employed by the motor industry, supporting the vehicle

carpark of approximately 6.2 million vehicles, of which many are older than 10 years

(AIDC,26 July 2001:2).

Over the past 70 years, the South African Motor Industry has used import substitution as a

method of protection, which has created an inward-looking industrial base (Holden,1992:26).

The first development of a Local Content Policy (LCP) for the motor industry was based on

the principle of import substitution. According to Julius (1995:88) the main reason for the

LCP was to provoke economic growth in South Africa and to reduce the demands of the

motor industry on the country's foreign exchange resources. Prior to the LCP, the motor

industry made use of imported vehicles and components at the expense of equivalent local

firms.

The motor industry LCP came into operation on 1 January 1961 and it implied placing high

tariff duties on the imports of Completely Built-up (CBU) cars and completely Knocked-

down (CKD) packs (imported vehicle components) so as to create a gradual but ongoing

increase in the local content of cars. Since, its inception, the LCP was amended to meet the

ever-changing needs of the South African motor industry. Six amendments have been

realised starting with Phase I through to Phase VI. One principle that has remained is the

importance of local content — emphasis is thus placed on import substitution (van Zyl &

Kotze,1994: 27-28).

8

In this chapter the tariff and non-tariff barriers used by the motor industry will firstly be

discussed. Since Phase I through to Phase VI all follow the principle of local content, only

the most recent local content programme will be discussed namely Phase VI. The Phase VI

local content programme will be evaluated by discussing the effects that it has on consumers,

producers (local vehicle assemblers and local content manufacturers) and the government.

The current motor industry development programme (MIDP) which was introduced in

September 1994 will then be discussed. In addition, the mechanism and effects of the MIDP

will be discussed and evaluated. This will be followed by a brief discussion of the future

changes to the MIDP as outlined in the Mid-term Review of 1998.

2.2. THE TARIFF STRUCTURE OF THE MOTOR INDUSTRY

Two broad categories of import duties where used in the motor industry namely, customs

duties and fiscal duties. Custom duties included ad valorem duties, specific duties or formula

duties. In the case of formula duties, the duties were based on a particular formula calculated

for each specific imported good. These various forms of duties were used to protect the local

production against foreign imports. Fiscal duties included surcharges on imports and other

exercise duties. These fiscal duties were used for fiscal and balance of payment purposes, in

order to curb the quantity of imported goods (Van Zyl & Kotze,1994:27-28).

Tariff lines can be defined as the number of ad valorem tariffs, specific tariffs and formula

tariffs, which are applicable to particular goods or industries. Under the South African tariff

structure, 336 tariff lines are applicable to the motor industry and related items. Of these 336

tariff lines, 197 carry ad valorem duty (approximately 59 percent) and 96 have a formula

duty (approximately 28 percent). The balance 13 percent of motor vehicle and related tariff

lines also carry a surcharge. This surcharge is charged over and above the import value and

the applied duty and is used as a further mechanism to protect the domestic industry against

imports (van Zyl & Kotze,1994:29).

According to du Plessis et al.,(1994:302), the ad valorem duties and formula duties used in

the motor industry are known as the nominal rate of protection. The basic assumption of the

9

theory of nominal tariff protection is that the imposition of an import tariff on a particular

good enables local manufacturers of that good to raise its price. Thus, the size of the import

tariff is regarded as the degree of protection given to local manufacturers, by the way that

production has been encouraged by the increase in price (du Plessis et al.,1994:302).

But, the theory of effective tariff protection raises two criticisms on this point of view. The

first criticism is that it is not the price increase, which has caused production to expand.

Instead, the tariff causes extra remuneration for factor services used for the production of the

good and therefore production will increase. The second criticism is that it ignores the cost-

increasing effects of tariffs on manufactured inputs. As a result, large discrepancies can exist

between nominal and effective rates of protection. Thus the theory of effective protection

states that in order to determine the protective effect of a tariff, the size of the nominal tariff

is not important. Instead, the proportionate change in the value added of the protected good,

as a result of the imposition of the tariff needs to be evaluated (du Plessis et al.,1994:304-

305).

2.2.1. REBATES ON IMPORT DUTIES

Motor vehicle assemblers (also known as Original Equipment Manufacturers (OEMs)) can

make use of vehicle components in two instances namely, original equipment (OE) or for the

replacement market. When the component is used for original equipment, this implies using

the particular component for the local assembly of the motor vehicle. A local example of this

is, using a locally manufactured component (a Shatterprufe windshield) in a Volkswagen

produced car (a Citi Golf). The distinguishing feature between original equipment

components and replacement market components is that, once the local motor vehicle has

been sold with the original equipment component and this component subsequently becomes

faulty, it will be replaced (in the replacement market) by a replacement component. Thus, the

market or use determines whether the component is original equipment or replacement (van

Zyl & Kotze,1994: 27).

10

Where motor vehicle assemblers import components for the use of original equipment local

production, they will receive full rebates on the import duties applicable and be excluded

from paying a surcharge on the imports. But in the case of components being imported for

replacement purposes, the full imported duty price is paid. In certain instances, component

manufacturer may also qualify for a rebate on the import duty. The instances when this is

applicable are:

When the component is supplied to the local vehicle assemblers for the use of original

equipment;

When the component is supplied to the local vehicle manufacturers for the replacement

market;

When the component is sold to dealers in, or users of, parts and accessories;

When the component is exported (van Zyl & Kotze,1994:27-28).

2.3. OTHER NON-TARIFF TRADE RESTRICTING MEASURES

Non-tariff barriers have been a distinguishing feature of the South African trade policy for a

long time (van Zyl & Kotze,1994:27). Since the lifting of sanctions by the world, the South

African government has replaced non-tariff barriers with tariffs. This was done in preparation

of South Africa possibly being pressurised in abandoning its non-tariff barriers in order to

comply with the General Agreement on Tariffs and Trade (GATT). The regulations of the

Phase VI local content policy constitutes a non-tariff trade barrier (van Zyl & Kotze,1994:27-

28).

2.4. THE PROTECTIVE NATURE OF PHASE VI

The Phase VI local content programme was introduced in 1989. Through this programme,

local vehicle manufacturers enjoyed protection of 115 percent (a 100 percent ad valorem

tariff and a 15 percent surcharge). The local content programme was used to protect the local

component industry from foreign imports. It was calculated in such a way that, if an Original

Equipment Manufacturer (OEM) maintains a local content of 55 percent, the local

component manufacturers would have a 22,2 percent advantage over imports and this

1 1

percentage (22,2 percent) would decrease in proportion to the increase in local content.

Therefore the local content programme is more favourable than the case of a normal ad

valorem duty which would have remained at the initial level of say 30 percent (van Zyl &

Kotze,1994: 34).

At a 75 percent or higher local content level a local vehicle manufacturer (OEM) has no

further incentive to buy local components and therefore the local component manufacturers'

protection is reduced to zero (van Zyl & Kotze,1994:33). In addition, the small vehicle

incentive (SVI) was also available, in the form of an import subsidy. This SVI increased the

rebatable proportion of the local vehicle manufacturers' excise duty operating below the 75

percent local content level. This resulted in a lower "import penalty" and a further reduction

in the incentive to buy local components. Therefore, the minimum local content requirement

of 55 percent (including exports) and the rebate incentive to increase local content, can be

viewed in addition to the protective wall behind which the local industry operates (van Zyl &

Kotze,1994:33-34).

2.5. THE EFFECTS OF THE PHASE VI PROGRAMME

The Phase VI programme will be evaluated with the aid of the theory on tariffs in Chapter

Three (see section 3.1.2.1). Phase VI has had effects on prices, domestic supply, revenue,

consumption and the welfare of the community. A partial equilibrium analysis will be

undertaken as the local content policy effects will be confined to only one market and

therefore the subsequent secondary effects are ignored (de Wet & Oosthuizen,1990:84).

2.5.1. THE PRICE EFFECT

In Figure 2.1, by imposing either ad valorem duties or formulae duties in the motor industry,

the domestic price of imported motor vehicles increased from PO to P1. The domestic price

of imported motor vehicles has increased as much as 115 percent ( a 100 percent ad valorem

tariff and a 15 percent surcharge). The cost of this increased domestic price for imported

motor vehicles has been passed on to domestic consumers (de Wet & Oosthuizen,1990:85).

12

The domestic price of locally manufactured motor vehicles also increased. But, this was not

due to the effects of the tariff per se. Instead, the local content programme resulted in local

Original Equipment Manufacturers (OEMs) using local components which where in certain

instances 50 percent more expensive than the imported component equivalent. This increase

in the domestic price of locally manufactured vehicles was also passed on to domestic

consumers.

Figure 2.1 — The single market effect of a tariff on the motor industry (de Wet &

Oosthuizen,1990:85)

2.5.2. THE DOMESTIC SUPPLY EFFECT

Since, the import duties caused increases in the domestic price of imported vehicles, the

quantity of imported motor vehicles declined from (QDO — QS0) to (QD1 — QS1) in Figure

2.1. As a result of the price increase of imported motor vehicles from PO to P 1 , the domestic

quantity supplied of locally manufactured motor vehicles and local components increased

from QD1 to QDO (de Wet & Oosthuizen,1990:85).

2.5.3. THE REVENUE EFFECT

In Figure 2.1, for each foreign motor vehicle imported the South African government collects

a duty of POP1. The revenue effect is the sum of these duties collected over the quantity of

13

100 120 160 190 Quantity

Price

6 (111

5.00

: AL IIIVANk .

Pint (l+t)

Pint

imports QD0Qp1, which is the rectangular area r (in other words the tariff times the quantity

of imports) (Ellesworth & Leith,1984:175).

2.5.4. THE WELFARE EFFECTS

In order to determine the costs and the benefits accruing to those effected, the concepts of

consumer surplus and producer surplus are used (see section 3.1.2.1) and illustrated in Figure

2.2.

Figure 2.2 — The welfare effects of a tariff on the motor industry (du Plessis et al.,1994:292)

Since, the imposition of an import duty has increased the domestic price of imported motor

vehicles, the producer surplus has increased by the area ABCJ in Figure 2.2. At the same

time, additional revenue was collected on the new level of imports — the area KCFG

represents the total receipt. The losers from this tariff on the imported motor vehicles are

consumers. Since, they not only paid higher prices for imported vehicles (Pint(1 +t) but, also

their quantities demanded decreased from 190 units to 160 units. The net effect of the tariff

on imported motor vehicles is the loss of consumer surplus which was transferred to the

government (area KCFG) and to local vehicle producers (area ABCJ) (de Wet &

Oosthuizen,1990: 85).

14

The remaining two areas of consumer surplus, which are not transferred to anyone namely:

JCK and GFH are referred to as deadweight losses. These deadweight losses are the net cost

to society of distorting the domestic free-trade market price. They can be viewed as the

efficiency losses resulting from the higher cost of domestic production on the margin (area

JCK), plus the loss in consumer surplus along with the tariff (area GFH) on the imported

motor vehicles consumers no longer choose to purchase. As a result of the higher price of

imported motor vehicles, which resulted from the tariff, consumers will change to locally

produced motor vehicles that bring about lower marginal satisfaction per rand (du Plessis et

al.,1994: 292).

To summarise, the Phase VI local content programme has been beneficial to local vehicle

manufactures, local component manufacturers and government. But, this has been at the

expense of the local consumer who has experienced the cost of this programme. In the case

of the small vehicle incentive, which can be classified as an import subsidy, the theory on

import subsidies in section 3.1.2.2 will be used to evaluate the effects of this incentive.

The South African government made use of a small vehicle incentive to increase the

domestic production of small vehicles (as classified by the government). In this case, a set

value was not paid out to domestic producers per unit produced. Instead, the small vehicle

incentive was used as a rebatable proportion of the OEMs excise duty below the 75 percent

local content level.

In Figure 2.3, the imposition of an incentive from the government will result in the prices of

small vehicles and the relevant local components to decline to the international price (Pint)

for these goods. But, the local OEMs and local component manufacturers will still receive

the domestic price Pint(1+t). The cost of the price difference between the foreign price (Pint)

and the domestic price Pint(1+t) will be borne by the government. The small vehicle

incentive will cause the domestic supply curve to shift down vertically from S to S', until it

intersects the internal price line of Pint. This will result in the domestic quantity supplied of

these small local vehicle and associated local components increasing (Ball, 1996:92-93;

Lindert,1991:140-141).

15

Figure 2.3 -The effects of the small vehicle incentive (import subsidy) to domestic producers

(Ba11,1996:91)

The welfare effects of the small vehicle incentive are no loss of consumer surplus since

consumers are paying the international prices for the local small vehicles and applicable local

components. The government will transfer the area ABCK to the local OEMs and local

component manufacturers, of which ABCJ represents the gain in producer surplus. Area JCK

represents the deadweight efficiency loss. The taxpayer cost of the subsidy is equal to the

amount of the subsidy transfer namely area ABCK (Ba11,1996:93-94; Lindert,1991:140-141).

Lastly, the Phase VI local content programme created an anti-export bias. An anti-export bias

results when protectionist policy in the domestic industry (for example import substitution)

causes a bias against exporting that industries good. In the case of the Phase VI's local

content programme, two anti-export biases were introduced. Firstly, the domestic sales in

South Africa became more lucrative than foreign sales. Since, producers raised the prices of

motor vehicles above those that would prevail under hypothetical free-trade conditions.

Secondly, this made the OEMs who export less competitive internationally by increasing the

costs of their inputs (components), thus the cost of their production (van Zyl &

Kotze,1994:35-36).

16

The anti-export bias coefficient is used to compare the effects of a domestic policy on

incentives to export. If the domestic policy measures result in a higher effective import

protection rate relative to the effective export protection rate, the anti-bias coefficient is

greater than one. With inputs at world prices the motor vehicle and parts industry has an anti-

bias of 1,19. With inputs at domestic prices the motor vehicle and parts industry anti-bias

coefficient increase to 1,91 (van Zyl & Kotze,1994:35-36).

2.6. MOTOR INDUSTRY DEVELOPMENT PROGRAMME

In September 1995 a programme more aligned with the requirements of the General

Agreement of Tariffs and Trade (GATT) was introduced namely the Motor Industry

Development Programme (MIDP). This programme aimed to reconcile a motor industry

where the local content sector was not internationally competitive and domestic motor

vehicles were sold at a premium to world prices. Exports were at a minimum. The main aim

of the MIDP was to develop an internationally competitive industry which can supply

affordable vehicles and components to the domestic market, provide sustainable employment

and also make a greater contribution to economic growth of the country by increasing value

added and achieving an improved balance of payments (Black,1997:16).

This would imply a phased reduction in protection so as to expose the industry to greater

competition, the encouragement of higher volumes by allowing exporting firms to earn

import rebate credits and the introduction of a range of support measures and investment

incentives such as the duty free allowance (DFA) which are designed to upgrade the capacity

of the industry (Black,1997:18). Under the MIDP, various tariff provisions and rebate

facilities are used to achieve the objectives mentioned by Black (1997:18). This includes

earning import rebate credits, a DFA, a small vehicle incentive (SVI) and a reduction in the

tariff structure (Black,1997:18).

17

2.6.1. IMPORT REBATE CREDITS

Under the MIDP, any registered local Original Equipment Manufacturer (OEM), local

component manufacturer or tooling manufacturer that export their respective goods can earn

import rebate credits. The value of these import rebate credits is the difference between the

foreign currency earnings from exporting their goods and the foreign currency usage of that

particular good. The foreign currency earnings means the free carrier value [i.e. free-on-

board (FOB) and in the case of overland transport, free-on-rail (FOR), or free-on-trick

(FOT)] of the exports. This excludes freight and insurance costs in respect of the transport

and insurance of eligible exports. The foreign currency usage implies the value for customs

duty purposes of an imported good for the use in the manufacture or assembly of automotive

components, motor vehicles and automotive tooling (DTI,1995:1-3).

On a monthly basis, applications for import rebate credit certificates are lodged with the

Department of Trade and Industry (DTI) based on exports for that time period. The import

rebate credit certificate will only be issued after proof for the exports in question has been

received. These import rebate certificates may be used:

By motor vehicle manufacturers to reduce the value of imports (as defined under the

MIDP)

By other importers to claim a refund of import duties paid on imported goods, imported

by the person in whose name the certificate is used.

Thus, the exports of local motor vehicles can be used to offset the duty on imports of foreign

motor vehicles (CBUs). But, where medium and heavy commercial vehicles or automotive

components/tooling are used to offset the duty on imports of motor vehicles, the value of the

import rebate credit certificate will be reduced by 25 percent (DTI,1995:4-6).

Import rebate certificates can be transferred between participants or sold by one participant to

another, but it may not be sold, transferred or re-issued more than once (DTI,1995:6).

18

2.6.2. DUTY FREE ALLOWANCE

Local motor vehicle manufacturers are entitled to a Duty Free Allowance (DFA) of imports

(required for the manufacture of their product) to the value of 27 percent of their value of

production in a calendar year (DTI,1995:8).

2.6.3. SMALL VEHICLE INCENTIVE

The small vehicle incentive (SVI) is an incentive in addition to the DFA. The SVI is based on

motor vehicles with a sales price of less than R40 000 (0,0030 percent per RI value for each

R1 value below R40 000). The DFA is based on the "value for duty free allowance" which

can be defined as the price to major local dealers less a percentage of such price determined

by the Director General:Trade and Industry on the recommendation of the Board of Tariffs

and Trade in respect of all small motor vehicles (as defined under the MIDP) produced

during a quarter and ready for sale. In the case of new models, where prices have not yet

been determined in the market place, the Director General: Trade and Industry may

determine a price in consultation with the motor manufacturer (DTI,1995:12). TECH IKON WITWATERSRAND

LIBRARY Thus the DFA is calculated based on the sales price to major dealers for each derivative of

that particular motor vehicle model. Thus, these prices would apply irrespective of whether a

particular vehicle was sold to a major dealer or not. The DFA value can be reflected on an

import rebate credit certificate. This import rebate credit certificate is used by the

manufacturer to reduce the value of imported automotive components. Any excess DFA (in

excess of the 27 percent value of imports achieved) on such a certificate may be used by

manufacturers to reduce the value of imported motor vehicles (as defined under the MIDP).

In the latter case, the value of the import rebate credit certificate in respect of the excess

DFA, shall be reduced by 25 percent (DTI,1995:11).

19

2.6.4. MOTOR INDUSTRY TARIFF STRUCTURE

Under the MIDP, tariffs for Completely Built-up Units (CBUs) and imported components for

local vehicle manufacturers will be reduced on an annual basis as shown in Table 2.1.

Table 2.1 — Tariffs for CBUs and imported components (DTI,1995:12)

Year CBUs Imported Automotive

components

September 1995 65% 49%

January 1996 61% 46%

January 1997 57.5% 43%

January 1998 54% 40%

January 1999 50.5% 37.5%

January 2000 47% 35%

January 2001 43.5% 32.5%

January 2002 40% 30%

Table 2.1 shows how the tariffs will be reduced on imported CBUs and automotive

components from September 1995 to January 2002. The implications of this continual

reduction (phasing down) process of the tariff structure are that the local motor

manufacturers and local component manufacturers are under continual pressure to become

globally competitive. Since, the reduction of tariffs on CBUs and imported components are

allowing these foreign goods too become cheaper than local equivalents. Therefore the

imported products will compete directly with the local equivalents (DTI,1995:12).

2.7. THE EFFECTS OF THE MIDP

As mentioned previously, one of the objectives of the MIDP was for the local motor vehicle

manufacturers and component suppliers to supply affordable vehicles and components to the

domestic market. One way that local vehicle manufacturers and local component

20

manufacturers can produce cheaper cars and components is by achieving economies of scale,

so that marginal costs decline with an increase in output. To facilitate this discussion, the

analysis in section 3.3.3 on economies of scale in a duopoly framework will be used.

According to Krugman's theory (1984) as sited in du Plessis et al., a tariff is used to protect

the domestic firm from foreign firms producing the same good both for the domestic and

export markets. The imposition of a tariff will therefore cause the marginal costs for the

domestic firm to decrease. Thus, the domestic firm's sales will increase for each given level

of the foreign firm's sales in each export market. This theory of protection can be called the

tariff to promote export through economies of scale (du Plessis et al.,1994:119).

But, in the case of the MIDP, counter effects are occurring than those proposed in Krugman's

theory (1984) on economies of scale in a duopoly framework. Instead of imposing tariffs, the

MIDP is calling for a continual reduction of tariffs which is causing a decline in the

protection of local vehicle manufacturers and local component manufacturers and thus,

opening the domestic vehicle market to foreign vehicle manufacturers and foreign

component suppliers. According to Taylor (1997e:33), in 1994 when the MIDP was

introduced, local vehicle manufacturers only had to compete with two foreign vehicle

importers. But, currently that are 14 foreign vehicle importers which have 25 percent of the

domestic vehicle market. Under these conditions, it is difficult for the local vehicle

manufacturers and local component manufacturers to achieve economies of scale.

A counter argument given by the Department of Trade and Industry is that the domestic

market alone does not offer the volume necessary for cost-effective manufacturing.

Therefore, local vehicle manufacturers and local component manufacturers can achieve

economies of scale by exporting their products. But, in the case of the local vehicle

manufacturers, they are owned by Japanese or German vehicle manufacturers. Thus, local

produced vehicle exports will compete with their own holding company's exports

(Taylor,1997d: 28).

21

A second objective of the MIDP was to provide sustainable employment. But, according to

Desai (1995:2), employment in the South African vehicle and components manufacturing

sector has declined from 82,000 in 1996 to approximately 70,000 in 1997. In section 3.2.4 it

was argued that a tariff may be used to increase employment in a particular industry. This

argument follows that the tariff will cause demand to shift from the imported good to the

domestically produced good. The production of these additional domestic units will result in

more domestic workers being hired and there will thus be an increase in employment in the

domestic industry. But, again the reduction in motor vehicle and components tariffs will not

allow employment in these industries to increase (Desai, 1995:2).

The last objective of the MIDP is to improve the balance of payments. In section 3.2.6 it is

argued that a tariff can be used to improve the balance of payments since imports will be

reduced with the imposition of a tariff. Thus, the tariff could cause the balance of trade (the

value of exports minus the value of imports) to become less negative (in other words the

trade deficit is reduced) or a deficit may turn intro a surplus (the value of the exports exceeds

the value of imports). But, according to Ryan (1997:51) in 1996 exports in the motor industry

reached R4bn against R16bn for imports, under the MIDP. So the reduction of tariffs under

the MIDP will continue to increase the quantity of imports and therefore worsen the current

account of the balance of payment.

2.8. MIDP MID-TERM REVIEW

During 1998 the Department of Trade and Industry reviewed the MIDP, as a result of several

of the objectives not being met under the current MIDP. The review did not change the

MIDP in essence, but has included a few amendments, which will change the emphasis of the

programme. It allowed for the programme to be extended from the year 2002 through to

2007. The changes are discussed below.

22

2.8.1. MOTOR INDUSTRY TARIFF STRUCTURE

The tariffs for Completely Built-up Units (CBUs) and imported components for local

vehicle manufacturers will further be reduced on an annual basis as shown in Table 2.2

(DTI,2000:2-3).

Table 2.2 — Tariffs for CBUs and imported components (DTI,2000:2)

Year CBUs Imported Automotive

components

January 2000 47% 35%

January 2001 43.5% 32.5%

January 2002 40% 30%

January 2003 38% 29%

January 2004 36% 28%

January 2005 34% 27%

January 2006 32% 26%

January 2007 30% 25%

Table 2.2 shows the revised reduction of tariffs on imported CBUs and automotive

components from January 2000 to January 2007. In the initial MIDP of September 1995, it

was indicated that the lowest the tariffs would be reduced it was 40% for imported CBUs and

30% for imported automotive components. But, the Mid-term review of the MIDP has

proposed that tariffs reduce even further to 30% for imported CBUs and 25% for imported

automotive components. This will allow foreign goods too become even cheaper than local

equivalents. Therefore the imported products will compete directly with the local equivalents

(DTI,2000:2).

23

2.8.2. SMALL VEHICLE INCENTIVE

The value of vehicles which qualify for the additional duty free allowance and the percentage

has been adjusted as follows. This is illustrated in Table 2.3 were in January 2001, motor

manufacturers can obtain an allowance of 0,0015/R1 for a vehicle which is priced below

R44 000 (plus the increase in PPI). The allowance is further reduced to 0,0005/R1 for a

vehicle valued at 2001's price plus the increase in PPI. In January 2003 the small vehicle

allowance is no longer applicable. Thus from January 2003, it will no longer become an

"incentive" for local motor manufacturers to produce low priced small vehicles

(DTI,2000:4).

Table 2.3 — DFA allowance for small vehicles (DTI,2000:4)

Date Cut-off value of vehicle

adjustment

Additional Duty Free allowance

January 2001 R44 000 plus the increase in PPI 0,0015/R1 below cut-off value

January 2002 Value of 2001 plus increase in PPI 0,0005/R1 below cut-off value

January 2003 Withdrawn

2.8.3. ASSISTANCE FOR EXPORTERS

Under the mid-term review, the ratio of export assistance will be modified by reducing the

import rebate (credits received based on the value of the exported good) from the current 1:1

ratio of exports to duty free imports. In 2002 the ratio of exports to duty free imports is 100%

and this ratio will reduce to 70% in 2007. This will result in the credits received based on the

value of the exported good to decline and it will become a "disincentive" to import CBUs

and components. The reductions are shown in Table 2.4 (DTI,2000-6).

24

Table 2.4 — Reduction of the import rebate (DTI,2000:6)

Year Rate of complementation of exports

2002 100%

2003 94%

2004 88%

2005 82%

2006 76%

2007 70%

2.8.4. PRODUCTIVE ASSET ALLOWANCE

A Productive Asset Allowance (PAA) was implemented in July 2000 and it is in the form of

a duty credit. A duty credit certificate will be used to obtain a rebate on an imported CBU

motor vehicle's customs duty. These certificates are not tradable and they will be based on

the actual investment in productive assets with a maximum value of 20 percent of the

qualifying investment in productive assets, spread equally over five years (DTI,2000:9).

2.9. CONCLUSION

From the discussion in Chapter Two, it is evident that the challenges facing the South

African Motor Industry are difficult. In the space of six years, it has moved from a closed,

protected environment into what is rapidly becoming an open market. Only seven years ago,

the position of the industry was more secure (although by no means ideal). Both the local

content programme and massive duties on Completely Built Up (CBU) imports did little to

encourage competition and effectively gave the motor industry a free rein on pricing.

It is also clear that in all industries, including the South African Motor Industry, governments

do not adhere to free trade despite the strong case for the efficiency and welfare gains from

free trade. For many years, policymakers have been resourceful in generating different

25

devices for restricting the free trade of goods and services. At the same time, various

industries have taken advantage of the numerous instruments of trade policy to protect their

business from outside competition. Instead these various forms of protectionism have altered

trade from its pattern of competitive advantage.

In order to rectify the wrongdoings of protectionism, the General Agreement of Tariffs and

Trade (GATT) was "initiated" to breakdown the barriers of protectionism in order to achieve

free international trade. In the same way that there has been a global move (as a result of

GATT) to reducing protectionism in countries. So, the motor industry has needed to reduce

its tariff barriers in order to become globally competitive. Naturally, this process has been

quicker in the South African Motor Industry than in most developed countries. Particularly

from the discussion in 2.7, there is theoretical evidence that with the introduction of the

MIDP, both component suppliers and motor manufacturers will battle to survive and so the

MIDP will be considered a failure.

26

CHAPTER THREE

3. LITERATURE REVIEW

3.1. AN OVERVIEW OF TRADE POLICY INSTRUMENTS

3.1.1 INTRODUCTION

Governments intervene into its country's trading activities by making use of trade

instruments. Trade instruments can be classified into tariff, non-tariff barriers and export

taxes and subsidies. Tariff barriers include specific tariffs, ad valorem tariffs, import

subsidies, preferential duties, most-favoured nation treatment and offshore assembly

provisions. Whereas non-tariff barriers include import quotas, "voluntary" export restraints,

government procurement provisions, local content provisions, administrative classification

and restriction on service trade (du Plessis et al.,1994:109).

Both tariff and non-tariff barriers are used to interfere on the import side of trade, but in

certain instances export taxes and subsidies are used to interfere with the free flow of exports.

This chapter focuses on providing a description of the trade instruments which are pertinent

particularly to the South African Motor Industry. In certain instances graphical

representations will be made use of to clarify the differences between these barriers as well

as the benefits and costs associated with each (du Plessis et al.,1994:109).

3.1.2. TARIFF BARRIERS

3.1.2.1. Import Tariffs

A tariff is a tax levied on a good imported across a national border. These tariffs can take two

forms namely, an ad valorem tariff or a specific tariff. Whereas, import subsidies also exist in

certain countries (du Plessis et al.,1994:109).

27

An ad valorem tariff is expressed as a percentage of the value of the specific imported good

whereas a specific tariff is a fixed amount which is levied on the weight, quantity or volume

of an imported good. Ad valorem tariffs benefit the government during periods of inflation,

since tariff revenue automatically increases with rising prices. Specific tariffs benefit

importers since the amount they have paid remains unchanged as the physical quantities

being imported are constant. In order to combine aspects of both tariffs, use is made of

composite tariffs. Finally, an import subsidy is simply a negative import tax or tariff (du

Plessis et al.,1994:109).

(a) The effects of Tariffs

Tariffs have effects on prices, domestic supply, revenue, consumption and lastly, on the

welfare of the community. The effects of a tariff may be examined in terms of the economy

as a whole, or in terms of the market for a particular good. When the analysis of a policy

effect is confined to only one market and the subsequent secondary effects are ignored, a

partial equilibrium analysis is being conducted. If the secondary or indirect effects of the

policy are being evaluated then a general equilibrium model is used (de Wet &

Oosthuizen,1990:84).

For the purposes of this study, attention is confined to partial equilibrium analysis in a small

country - it operates as a price taker in the world market. It is assumed that the international

price of the imported good is less than the domestic equilibrium price of the import-

competing good in autarky. Furthermore, it is assumed that demand and supply relationships

of the chosen commodity are given and remain constant (Ellesworth & Leith,1984:174; de

Wet & Oosthuizen,1990:84).

On the demand side, tastes, other prices and consumers' money incomes all remain fixed. On

the supply side, technological changes, externalities and other changes in cost conditions are

ruled out (Ellesworth & Leith,1984:174; de Wet & Oosthuizen,1990:84).

28

Pint (1 +t)

Pint

Qs0 Qs 1 QD 1 QDO Quantity

Price

P1

PO

The impact of a tariff on a small economy is analysed below in Figure 3.1 in terms of the

following effects namely; price effect, domestic supply effect, revenue effect and the welfare

effect.

Figure 3.1 — The single market effect of a tariff in a small country (de Wet &

Oosthuizen,1990:85)

The price effect

In Figure 3.1, due to small country importing all that it wishes at the international price (Pint),

the domestic price (Po) is the same. If the small country imposes a tariff (t), the domestic

price of the foreign good increases by the amount of the tariff. Therefore in the case of a

specific tariff the domestic price equals Pint+tspecific and for an ad valorem tariff, the

domestic price now equals Pint (1+0 = P1. To summarise, the price effect of the ad valorem

tariff is the increase in price from Po to P1. Whereas, for the specific tariff the price increase

from to Po to Pint+t (de Wet & Oosthuizen,1990:85).

Domestic supply effects

The domestic supply effect is also referred to as the import substitution effect. According to

the import substitution effect, the increase of the price from Po to P1, as shown in Figure 3.1,

will cause the domestic quantity supplied to increase from QD1 to QDO. Subsequently, the

quantity imported will also decline from (QDO - QSO) to (QD1 - QS1) (de Wet &


29

Consumer surplus

D

Quantity

Price

P

The revenue effect

On each unit imported the government collects a duty of POP! in Figure 3.1. The revenue

effect is the sum of these duties collected over the quantity of imports QD0Qp1, which is the

rectangular area r (in other words the tariff times the quantity of imports)

(Ellesworth,1984:175).

The welfare effects

The adoption of this trade policy (in other words the implementation of an import tariff)

involves both winners and losers. The concepts of consumer surplus and producer surplus are

used to evaluate the costs and the benefits accruing to all those affected. Consumer surplus

can be defined as those consumers who pay less (the market price) than they would be

prepared to pay (as represented by the demand curve) are receiving a surplus. As market

prices rise, this consumer surplus falls; as price falls, consumer surplus increases. Consumer

surplus is illustrated in Figure 3.2 by area A above the market price but, below the demand

curve (de Wet & Oosthuizen,1990:85).

Figure 3.2 — The concept of consumer surplus (de Wet & Oosthuizen,1990:86)

A producer surplus occurs for all units of output whose marginal cost of production

(represented by the supply curve) is less than the market price received. Consequently as

price increases, producer surplus increases and as markets prices fall, producer surplus

30

decreases. Similarly in Figure 3.3, the producer surplus is the area B below the market price

but, above the supply curve (de Wet & Oosthuizen,1990:86).

Figure 3.3 — The concept of producer surplus (de Wet & Oosthuizen,1990:86)

Changes in the market price will lead to a transfer of surplus between producers and

consumers. With a price increase, producer surplus is increased and consumer surplus is

decreased and vice versa. For the purposes of this study, the changes in producer and

consumer surplus that result from a tariff-induced price change will be evaluated (de Wet &


The effects of a tariff on a market in terms of who gains and who loses will be analysed by

using Figure 3.4. The figure represents an ad valorem tariff, but the effects could also have

been explained by referring to a specific tariff. The only difference between the two tariffs is

that in the case of an ad valorem tariff, the tariff revenue will change as the value of imports

changes. For the specific tariff, the tariff revenue will change only as the physical quantity

being imported changes (du Plessis et al.,1994:292).

31

Figure 3.4 — The welfare effects of a tariff in a small country (du Plessis et al.,1994:292)

In Figure 3.4, under conditions of free trade the domestic price is R5 and the quantity

demand is 190 units. The imposition of a 20 percent ad valorem tariff will cause the domestic

price to increase from R5 to R6 and thereby increasing the producer surplus by the area

ABCJ. At the same time, the government will collect the tariff of R1 on each unit of the new

level of imports — the area KCFG represents the total receipt. The losers from this policy are

consumers. Consumers not only have to pay the higher price of R6 but, also have their

quantity-demanded decrease from 190 units to 160 units. The area ABFH represents this loss

in consumer surplus. The net effect of the tariff is therefore the loss of consumer surplus

which is transferred to the government (area KCFG) and to producers (area ABCJ) (du


3.1.2.2. Import Subsidies

As mentioned previously, an import subsidy can be defined as an indirect tariff or tax. The

intent of the import subsidy is to increase domestic production by paying the domestic

producers a subsidy per unit produced. Thereby persuading the domestic producer to supply

the same quantity at international prices as what they are willing to supply at the higher

tariff-inclusive domestic price.

32

Figure 3.5 — The single market effects of a subsidy to domestic producers (Ba11,1996:91)

In Figure 3.5, under free trade conditions, the domestic price is R6 and the quantity supplied

is 100 units. The imposition of a import subsidy of R1 for each unit produced, will cause the

domestic supply curve to shift down vertically from S to S' until it intersects the international

price line of R5. Producers will now produce 120 units in place of 100 units at the

international price of R5. The sum of the R5 international price and R1 subsidy leaves the

domestic producer in an equivalent position to the imposition of a 20 percent tariff (Ball,

1996:92-93; Lindert,1991:140-141).

The welfare effects, however, are different. Since the consumers continue to pay the

international price, there is no loss in consumer surplus in this market. The government will

transfer the area ABCK to the producers, of which ABCJ represents the gain in producer

surplus. Area JCK represents the deadweight efficiency loss. The taxpayer cost of the

subsidy is equal to the amount of the subsidy transfer namely area ABCK (Ba11,1996:93-94;

Lindert,1991: 140-141).

3.1.2.3. Preferential Duties

Preferential duties can be defined as lower preferential tariff rates which are applied to an

import according to its geographical source. An example of this is the Generalised System of

33

Preferences (GSP) where selected goods can be imported duty-free from a large number of

developing countries by a developed country (Appelyard & Field,1995:229; du Plessis et

al.,1994:346).

3.1.2.4. Most-favoured-nation treatment

The most-favoured-nation (MFN) treatment implies that trade barriers should be lowered

equally for all foreign trading countries. Thus, a concession given to any foreign country

must be given to all countries having MFN status. Therefore, the MFN treatment can be seen

as a nondiscriminatory component of tariff policy (Lindert,1991:169).

3.1.2.5. Offshore assembly provisions

An offshore assembly provision (OAP) can be defined as the tariff rate on a good that is

lower than the tariff rate listed in the tariff schedules. OAPs are used in several developed

countries, including the United States (Appelyard & Field,1995:231).

3.1.3. EXPORT TAXES AND SUBSIDIES

Governments also use export taxes and subsidies to interfere with the free flow of exports (du


3.1.3.1. Export taxes

In the case of an export tax, a tax is levied on domestically produced goods, which will be

exported abroad. This tax can be specific or ad valorem. Figure 3.6 represents the effects of a

specific export tax, but the effects could also have been explained by referring to an ad

valorem export tax. The only difference between these two types of taxes is that in the case

of the specific tax, the tax revenue will change as the psychical quantity being exported

changes. Whereas, in the case of the ad valorem tax, the tax revenue will change as the value

34

of the exports changes. The aim of these export taxes is to reduce the size of international

trade (Appelyard & Field,1995:236).

Figure 3.6 — The impact of an export tax (Appelyard & Field,1995:251)

In Figure 3.6, under conditions of free trade the domestic price is Pd. An imposition of a

specific export tax, this will result in a decrease in the domestic price as producers increase

domestic sales by lowering the domestic price of a good to avoid paying tax on exports. The

domestic price (Pd) falls until it equals the international price (Pint) minus the amount of the

tax. When this occurs, producer and consumer surplus can be used as a measure to evaluate

the gains and losses (Appelyard & Field,1995:251).

As domestic price falls the quantity supplied decreases, so there is a reduction in producer

surplus equal to the area ABFG. A portion (the difference between Pd and Pint) of this loss is

transferred to domestic consumers through the lower price, producing an increase in

consumer surplus equal to area HJEG. The government will receive a tax revenue equal to

area HJEG. Finally, areas CJH and EFG reflect the deadweight efficiency losses that result

from the price distortion. These areas represent losses in producer surplus that are not

transferred to anyone in the economy (Appelyard & Field,1995:251).

35

3.1.3.2. Export subsidies

An export subsidy can be viewed as a negative export tax or a payment to the domestic firm

by the government when a unit of the good is exported. The aim of this export subsidy is to

increase the flow of trade of the country. It, however, distorts the pattern of trade and like

taxes it reduces world welfare (Appelyard & Field,1995:236; du Plessis et al.,1994:132).

Figure 3.7 — The effects of an export subsidy (Appelyard & Field,1995:252)

In Figure 3.7 illustrates the demand and supply responses to an export tax in the partial

equilibrium analysis for a small country. Before the subsidy is imposed (in other words under

conditions of free trade) the domestic price is Pint, the domestic quantity demanded is Q1 and

the domestic quantity supplied is Q2. Thus, the quantity exported is Q1Q2 (Appelyard &

Field,1995:252).

Suppose that the domestic government imposes an export subsidy. The imposition of a

subsidy raises the domestic price from Pint (without the subsidy) to Pint + sub. This increase in

price causes the domestic quantity demanded to fall from Qi to Q3 and the quantity supplied

to increase from Q2 to Q4. The quantity of exports therefore increases from QIQ2 to Q3Q4.

The export subsidy causes a fall in the domestic consumer surplus equal to the area ABCJ

36

and an increase in the domestic producer surplus to area ABFH. It is assumed that taxpayers

pay for this subsidy. The cost of the subsidy borne by the taxpayer equals the per unit amount

of the subsidy multiplied by the new quantity of exports, which is the area ECFG (Appelyard

& Field,1995:252-253).

3.1.4. NON-TARIFF BARRIERS TO FREE TRADE

Besides the use of tariffs and subsidies to distort the free-trade allocation of resources,

governments have become more proficient at using other, less visible, forms of trade barriers

(Appelyard & Field,1995:236). These are usually called non-tariff barriers to trade and they

have become more important in recent years (Lindert,1991:152). The non-tariff barriers that

will be considered include import quotas, "voluntary" export restraints, government

procurement provisions, local content provisions, administrative classification and restriction

on service trade (Appelyard & Field,1995:236; Lindert,1991:152).

3.1.4.1. Import quotas

The most prevalent non-tariff barrier is the import quota (Thompson;1993:120). An import

quota is used to limit the total quantity of imports allowed into a country each year. The

quota will therefore not only reduce the quantity imported; it also drives the domestic price

of the good above the world price. In many respects quotas have the same economic effects

as tariffs. These include effects on production, consumption, imports, the redistribution of

income and the terms of trade. This will be illustrated in Figure 3.8 (Lindert,1991:153;

Thompson,1993: 120).

In Figure 3.8, the effects of the imposition of an import quota are considered. In the figure, D

is the demand schedule for imports and S is the supply schedule under free trade. Under free

trade conditions, quantity OQI is produced and 0Q4 is consumed. Therefore, the quantity

imported is Qi Q4 at the imported price of °Pi (du Plessis et al.,1994:310).

37

Price

P2

P1

0 Q I

Q2

Q3

Q4

Quantity

Figure 3.8 — The imposition of an import quota (du Plessis et al., 1994:310)

Suppose that the government imposes an import quota limiting the amount that can be

imported to Q2Q3. Thus the new price increases with the quota to 0P2. Only at this price will

the domestic quantity demanded exceed the domestic quantity supplied by the quota. An

import quota will also cause a redistribution of income. The quota causes producers' surplus

to increase by the area A, while consumer surplus decreases by the area A+B+C+E (du


A difference between a tariff and an import quota is that no revenue accrues to the

government in the case of a quota (Appelyard & Field,1995:261). Therefore, it is unsure who

will receive the additional value of the imports Q2Q3 which is represented by the area C. In

certain cases, government officials may receive this part of the revenue through bribes, since

they are responsible for issuing the licenses for a good to be imported under a quota.

Whereas, in other instances importers could capture this portion of the revenue. This may

occur through importers obtaining licenses for larger quantities than they wish to import

themselves. The balance of their licenses are then sold off to the highest bidder. The profit,

which they will gain per unit, is the difference between the world price and the post-quota

price. Furthermore, foreign exports could also capture this part of the revenue if they have

sufficient market power to raise their export prices. In this instance the terms of trade will

turn against the importing country (du Plessis et al.,1994:310).

38

Lastly, government imposing the quota might capture the revenue represented by area C by

auctioning off the import licenses. The importers will bid against one another to obtain

import licenses and thus the collected revenue will become equal to the revenue collected

under an import tariff. In practice, the revenue resulting from a quota is often distributed

accordingly to all the methods mentioned above (du Plessis et al.,1994:310).

Thus it is uncertain who will capture the equivalent of the additional government revenue

received under a tariff. But, the sum of the areas B and E are the total deadweight losses

related to decreased domestic consumption and increased inefficient domestic production (du


3.1.4.2. "Voluntary" export restraints

The "voluntary" export restraint (VER) or "voluntary" restraint agreement (VRA) have

become alternative to the import quota. According to Greenaway (1983:225) a VER or VRA

is an agreement between importing and exporting country whereby the latter agrees

voluntarily to restrict exports to the former. If the foreign supplier does not adopt the VER

then there may be the threat of an import quota being placed on its goods.

3.1.4.3. Government procurement provisions

Government procurement provisions restrict the purchasing of foreign products by domestic

government agencies (Appelyard & Field,1995:237).

3.1.4.4. Local content provisions

According to Appelyard and Field (1995:237), the local content provisions attempt to "store"

some of the value added and some of the sales of product components for domestic suppliers.

In other words, the aim of local content requirements is to limit the practice of foreign

sourcing and in so doing encourage the development of the domestic industry. In the case of

39

the local content provisions, the winners are the producers and government whereas, the loser

in the programme is the consumer (du Plessis et al.,1994:131).

3.1.4.5. Administrative classification

Administrative and technical barriers cover various possible influences from the various

classifications that the different types of imported goods are divided into to regulations

relating to environmental control, public health and safety (Greenaway,1983:148).

3.1.4.6. Restrictions on services trade

Restrictions on service trade are less visible than other non-tariff restrictions. For example,

foreign insurance companies may be restricted to the types of policies they may sell in the

domestic country (Appelyard & Field,1995:238).

3.2. TRADITIONAL ARGUMENTS FOR PROTECTION

3.2.1. INTRODUCTION

The traditional arguments for protection have had a long history and they continue to

influence policymakers and the general public (Appelyard & Field,1995:273). The way that

the traditional arguments for protection will be discussed is by firstly presenting the

argument and then giving counter arguments to evaluate the validity of the previously

presented arguments. This will finally be followed by an analysis of whether an alternative

policy instrument might improve on achieving the objectives of the restrictive trade policy.

This will be achieved by evaluating the costs versus benefits of the alternative policy

(Appelyard & Field,1995:273).

It should be noted that the perspective from which an argument for protection is put forth is

important. Certain arguments may be directed from a national perspective implying that the

nation as a whole is thought to benefit from the protection. Whereas, other arguments may be

40

given from the perspective of an individual industry. In other words, that the alleged benefits

from protection will go to a particular industry regardless of the impact of the welfare of the

nation. The last perspective on the argument for protection will be to evaluate the welfare

effects of the world as a whole (Appelyard & Field,1995:273).

3.2.2. THE INFANT INDUSTRY ARGUMENT

The infant industry argument rests on the assumption that economies of scale exist in a

domestic individual industry or firm. The argument starts by noting that the producer would

have to start on a small and uneconomic scale. This new domestic producer would be unable

to compete effectively against the low-cost foreign supplier. Therefore, temporary protection

is required from the foreign producers to allow an individual industry or firm to realise

sufficient economies of scale. These internal economies of scale are realised as the domestic

firm now produces a large volume of output. Thus, the producer in the domestic industry will

be moving down their downward-sloping long-run average cost curves. Eventually the per

unit costs of the good will fall to such an extent that the domestic industry will become an

exporter of the foreign good. Once the domestic firm has realised sufficient economies of

scale, the protection should be removed (Hardwick et al., 1994:487).

Even though economists generally agree that this argument is theoretically valid, it does not

necessarily mean that every industry claiming to be infant should automatically be given

protection. In certain cases, it is difficult to identify industries, which will realise economies

of scale and so become low-cost producers. At the same time certain industries are

incorrectly defined as infant industries thus, the world may be burdened with permanent

protection of a high-cost industry with less efficient resource use (Hardwick et al., 1994:487).

Beyond the problem of identification, economists should question whether the tariff or

another form of protection should be used for an industry qualifying as an infant. In certain

cases, a subsidy to the domestic industry by the government would be preferred to a tariff to

accomplish internal and external economies. In other instances, economists need to ask why

the domestic industry is unable to proceed on its own and why it needs protection. An

41

entrepreneur could borrow funds from financial institutions, invest in plant extensions and so

forth, in order to achieve internal economies of scale (Hardwick et al., 1994:487).

3.2.3. THE TERMS OF TRADE ARGUMENT

The terms of trade argument for protection implies that national welfare can be improved

through a restrictive trade policy instrument. It confirms that the world welfare will decline

with a movement away from free trade because the domestic country's gains in welfare is

more than offset by the losses of welfare occurring in other countries. Thus the terms of trade

argument is a beggar-thy-neighbour policy since the domestic country will be gaining at the

expense of foreign countries. The terms of trade argument states that restrictive trade policy

can increase the ratio of P _ export/Pimport (Px/Pm) and so improve a country's welfare. Px/Pm is

defined as the commodity terms of trade where Px and Pm are indices of export and import

price respectively (du Plessis et al.,1994:336-337).

It should be noted that only a large country can employ the terms of trade argument with any

success because the tariff-imposing country must be able to influence the terms of trade and

world prices. By definition, a small country cannot influence the terms of trade. In Figure

3.9, an offer curve diagram is the best method of illustrating the terms of trade argument

(Appelyard & Field,1995:276; du Plessis et al.,1994:337).

In Figure 3.9, 0C1 represents the offer curve of the domestic country (country 1) and 0C2 is

the offer curve for the foreign country (country 2). Under conditions of free trade, the terms

of trade is TOT1. If a tariff is imposed by country 1, its offer curve shifts to 0C2, with a new

equilibrium E'. Country 1's exports are reduced from ox 1 to ox2 and its imports from Oyl to

0y2 but, its terms of trade have improved from TOT1 to TOT2. Thus, there is potential for

increased well being for country 1 because it is receiving more imports for each unit of its

exports. From a welfare point of view, country 1 will be potentially "better off' (Appelyard

& Field,1995:276).

42

Y1 0C2

Y2

0

X2

X 1

I 's imports of good Y OC' 1 2's exports of good Y

TOT2 OC I

TOT1

l's exports of good X 2's imports of good X

Figure 3.9 — A tariff to improve the terms of trade (Appelyard & Field,1995:276)

But, one fact that has not yet been taken into account in the terms of trade argument is the

effect that a decrease in the quantity of imports (as a result of the imposition of the tariff) has

on domestic welfare. So, country 1 gains from the lower world price of the imported good

but loses because of a smaller import quantity of that good. To overcome this effect, an

optimum tariff rate is used to maximise the country's welfare (Appelyard & Field,1995:277).

Ideally, the optimum tariff rate at which the positive difference between the gain from better

prices and the loss from the reduced quantity is at a maximum. Welfare will be below the

maximum, when the tariff rate is higher than this optimum rate, because the additional gain

from better terms of trade are more than offset by the additional loss from the reduced

quantity. The last element on the optimum tariff rate is that it can be defined as the point as

which country 1's offer curve intersects country 2's elastic proportion of the offer curve

(Appelyard & Field,1995:277; du Plessis,1994:117).

An important question to be asked is: How valid is the terms of trade argument? If the aim of

the tariff was to improve the domestic countries terms of trade and welfare then the

43

imposition of the tariff has achieved its goal. But, is should be remembered that the terms of

trade argument is a beggar-thy-neighbour argument since the welfare of the partner country

falls. Since the partner country has been damaged by the tariff, it may retaliate with a tariff of

its own. In comparison with the situation of free trade, both countries will now end up with

reduced welfare after the imposition of a tariff. If continual retaliation occurs, trade will

retreat dramatically in the offer curve diagram until both countries end up with terms of trade

no better than during the initial free trade period of TOT1 as shown in Figure 3.9 (Appelyard

& Field,1995 : 278-279).

3.2.4. TARIFF TO INCREASE EMPLOYMENT IN A PARTICULAR INDUSTRY

The use of tariff to increase employment in a particular industry is a microeconomic

argument. The argument for the use of a tariff to increase employment in a particular industry

follows that, the tariff will cause demand to shift from the imported good to the domestically

produced good. Since, the price of the imported good rises relative to the price of the

domestic good. This substitution in purchases will cause the domestic goods price to rise

which will in turn cause domestic producers to increase their quantity supplied. The

production of these additional units will result in more domestic workers being hired and so,

there will be an increase in the employment in the domestic industry (Appelyard &

Field,1995 : 280).

But, the filling up of jobs in the protected industry may be at the expense of employment in

other industries. Therefore, from a country point of view the total employment has not

increased — but, this is not the objective of the tariff. Instead, it has achieved its objective of

increasing employment in a particular industry. Economically, this argument cannot be

disputed but, when looking at the aspect of efficiency, then one can question whether a tariff

is the best method of increasing employment. From a welfare perspective, Appelyard and

Field (1995:281) have argued that a subsidy by the domestic government may be an

alternative instrument for providing jobs in the industry as it would achieve lower costs

(Appelyard &Field,1995:281).

44

3.2.5. TARIFF TO OFFSET FOREIGN DUMPING

Dumping can be defined as international price discrimination in which an exporting firms

sells at a lower price in a foreign market than it charges in other (usually its domestic)

markets (Lindert,1991:164). The argument for protection is that dumping by foreign firms

into the domestic country is in some instances unfair and constitutes a threat to domestic

producers of the low import price. Therefore, a tariff can offset the foreign firm's unjust price

advantage. In order to assess the validity of the argument for protection, economists usually

distinguish between three types of dumping (Ellesworth & Leith,1984:164-165).

Firstly with persistent dumping, the foreign country will continually sell the imported good at

the lower price in the importing country than what it would be sold for in the domestic

country. Secondly, intermittent dumping can be divided into two types: predatory dumping

and sporadic dumping. Predatory dumping occurs when the firm temporarily discriminates in

favour of some foreign buyers with the purpose of eliminating some competitors to later raise

its prices after the competition is gone. Domestic producers may then retaliate, only to have

the price reduced again to a lower level. The argument for using protection in the case of

predatory dumping is valid because of the wasteful resource movements. Due to the

fluctuating import price, factors of production move in and out of the industry and therefore

cause real costs and waste for society (Ellesworth & Leith,1984:164-165).

Sporadic dumping occurs when a foreign producer exports a temporary surplus of a good for

whatever price it will dictate. Sporadic dumping may have temporary adverse effects on

competing domestic suppliers by adding the risk of operating in the industry. An imposition

of a tariff can avoid, both the risks and the welfare losses from the possible temporary

resource movements. In the case of sporadic dumping, protection cannot be justified since it

has a short-term effect. The difficulty is determining whether persistent, predatory or

sporadic dumping is occurring. But, antidumping procedures have been set up in the General

Agreement of Tariffs and Trade to avoid the practice of dumping (du Plessis,1994:301;

Lindert,1991:164-165).

45

3.2.6. TARIFF TO IMPROVE THE BALANCE OF PAYMENTS

The argument for a tariff to improve the balance of payments claims that imports will be

reduced with the imposition of a tariff. This implies that the tariff will cause the balance of

trade to improve since, the balance of trade (the value of exports minus the value of imports)

becomes less negative (in other words the trade deficit is reduced) or a deficit turns into a

surplus (the value of exports exceeds the value of imports). The argument is made under the

assumption that exports are not affected. But, economists have reacted to this argument by

saying that it fails to recognise the political and economic repercussions of this action

(Appelyard & Field,1995:286). They have argued that the end result, when these

repercussions are taken into account, may be no improvement in the trade balance and a

reduction in the country's welfare (Appelyard & Field,1995:286).

Examples of these repercussion include:

Retaliation by trading countries.

A reduction in foreign national income and a reduced ability of foreign countries to buy

the domestic country's goods.

A reduction in exports of the domestic country if the imports which are now excluded

were inputs into the production process of the domestic country's exports.

A reduction in exports and an increase in imports of the domestic country because of a

rise in the value of the domestic currency (Appelyard & Field,1995:287-288).

Therefore, the imposition of a tariff in the domestic country is no guarantee that the balance

of trade will improve. According to Appelyard and Field (1995:287), the country would

experience less welfare loss if a policy was adopted which operates on the balance of trade in

its entirety, namely a devaluation or depreciation of the domestic currency (Appelyard &

Field 1995:287).

46

3.3. "NEW PROTECTIONIST" APPROACHES TO TRADE POLICY

INTERVENTION

3.3.1. INTRODUCTION

In recent years, various new theories have emerged on why a domestic country can probably

benefit from a tariff or other trade policy instruments. These theories are often called "new

protectionist" or "strategic trade policy" theories. The differentiating feature of these "new"

theories is that imperfect competition exists in the industries under consideration. This is a

departure from the traditional analysis where the industries were perfectly competitive in

nature (Appelyard & Field,1995:289).

The new approach claims that imperfect competition is more representative of the world

around us. Imperfect competition also introduces the concept of recognised interdependence

of the firms in any given industry. This implies that when firms are deciding their best course

of action, they take into account the reactions of other firms (Appelyard & Field,1995:289).

The "new protectionist" approaches to trade policy will be discussed by firstly looking at the

theoretical situation in which a domestic country tariff results in the transfer of some of the

profit of a foreign monopoly (the only producer of a particular good in the world) firm to the

domestic country — the strategic trade policy. Secondly, the two-firm framework (one

domestic firm and one foreign firm) will be used to evaluate how protection can generate

economies of scale and larger exports for the protected domestic firm. Lastly, the possible

beneficial impact of protection on research and development will be discussed using the two-

firm framework (Appelyard & Field,1995:289).

3.3.2. STRATEGIC TRADE POLICY

James Brander and Barbara Spencer originated the analysis of the strategic trade policy in

1991 (Appelyard & Field,1995:289). In the setting, the domestic country encounters a

foreign monopoly supplier of a good. The foreign monopoly supplier is the only foreign firm

47

Price and cost

p2

o 1

c2

c 1

MC+t = AC+t

MC = AC

0 q2

9 1

Quantity

that supplies this good in the world market and therefore there is no domestic production of

this good. In fact, the domestic country is entirely dependent on the foreign monopoly firm

for the good (Appelyard & Field,1995:289; du Plessis et al.,1994:119).

Figure 3.10 — A tariff to extract foreign monopoly profit (Appelyard & Field,1995:290)

In Figure 3.10, the domestic country's demand for the foreign monopoly firm's good is

represented by the demand curve (D). Since, the firm faces a downward sloping demand

curve, marginal revenue is less than price. For the sake of simplicity, it is assumed that

marginal cost is constant (in other words, that each additional unit of output is produced at

the same cost as the previous unit) and that there is no fixed costs and no transportation costs.

As a result of this, the marginal cost (MC) curve is horizontal and equals the average cost

(AC) curve (Appelyard & Field,1995:290; Lindert,1991:225-226).

Under conditions of free trade, the firm will set marginal revenue (MR) equal to MC in order

to maximise profits, so the quantity that will be exported to the domestic firm is Oq 1 at a

price of Op 1. The resultant profit will be the rectangle c 1p1RF. Since the producing firm is a

monopolist, there are no competitive pressures to force the price to equal MC (or AC)

(Appelyard & Field,1995:290; Lindert,1991:225-226).

48

It can now be assumed that the domestic country intends obtaining some of this foreign

monopoly profit. If a tariff is imposed, the foreign firm's marginal cost of selling to the

domestic market is MC+t, where t is the amount of tax per unit. This will cause the marginal

cost curve to shift up vertically to MC+t. This tariff implies an additional cost to the foreign

firm which is associated with supplying each additional unit of output in the domestic

market. The quantity produced for the domestic country now drops to 0q2 and the new price

charge is Op2 (Appelyard & Field,1995:290; Lindert,1991:225-226).

In order to consider the welfare change in the tariff-imposing country, the profits of the

monopoly firm are evaluated. The revised profit after the imposition of the tariff is the

rectangular area c2p2SG. The area cic2GH represents the tariff revenue and the previous

profit of the monopolist that has been transferred to the domestic country. The gain by the

domestic country must be weighed up against the loss in consumer surplus by the domestic

country consumers in the amount of trapezoid plp2SR. Since the area cic2GH is greater than

the area p 1 p2SR, the domestic country has succeeded in improving its welfare at the expense

of the foreign producer. Therefore it is evident that intervention has been desirable for the

domestic country (Appelyard & Field,1995:290-291).

Despite some economic profit being transferred to the domestic country, Appelyard and Field

(1995:291) does not conclude that the imposition of a tariff was beneficial even if the transfer

of profit outweighed the loss in consumer surplus. In fact, the protectionist action has caused

world efficiency and welfare to be reduced, since the case of the monopolist, efficiency and

welfare are enhanced if actions cause the monopolist to reduce prices and increase output.

But, the opposite has happened with the imposition of the tariff on the monopolist's good.

This results in a beggar-thy-neighbour situation where the domestic country gains can occur

while the world as a whole loses. Naturally, the impact of the foreign producer's possible

retaliation of the domestic country also needs to be considered when initiating these

protectionist policies (Appelyard & Field,1995:291).

49

3.3.3. ECONOMIES OF SCALE IN A DUOPOLY FRAMEWORK

Krugman (1984), as sited in Appelyard & Field, made a further contribution to the "new

protectionist" approaches (Appelyard & Field1995:291). Krugman's model can be defined as

protecting the domestic markets from foreign firms, helps domestic firms not only in the

protected market but in export markets as well. Thus, Krugman's model assumes that there is

a domestic firm and foreign firm in an industry — a duopoly. These two firms will compete

with each other in markets throughout the world, including in each other's markets. In this

model he makes two assumptions, the first being that marginal cost declines with an increase

in output. Secondly, each firm takes the actions of the other firm into account when making

its pricing and output decisions. So, this model recognises interdependence of the firms in an

industry (Appelyard & Field,1995:291).

In Figure 3.11 shown below, the reaction functions for the two firms are illustrated. On the

horizontal axis, Xi refers to the sales of the domestic firm in any market i. On the vertical

axis, X*I refers to the sales of the foreign firm in the same market. The reaction function for

the domestic firm is represented by H. The reasoning behind the function (H) is if the foreign

firm increases sales in the market (an increase in that X*I), then the domestic firm realises

that the price of the good will be reduced (Appelyard & Field,1995:291).

NIKON WITWATERSRAND LIBRARY

Figure 3.11 — Domestic firm and foreign firm's sales in a third-country market (Appelyard &

Field,1995:291)

50

Therefore, the profit opportunities for the domestic firm will be reduced and so the amount

sold by the domestic firm Xi will be reduced. Both the reaction functions for the domestic

firm (H) and the foreign firm (F) will be downward sloping. These reaction functions

illustrate the most profitable level of sales in market I for each firm, given the various levels

of sales for each firm. It should be noted that these functions are drawn for a given marginal

cost, which implies that each firm's total output is constant but, the sales in any given market

can vary. The equilibrium position is at point E, where each firm is selling its profit

maximising quantity, given the behaviour of the other firm (Appelyard & Field,1995:291).

In order to clarify how the point E is achieved, consider point A. If the two firms are

producing for this market at A, then the domestic market will be satisfied with its sales of

OX1 but, the foreign firm will not be satisfied with its sales OX*1. The foreign firm will

attempt to maximise its profit by cutting its production to OX*2 since the firm was "over"

producing at point A (Appelyard & Field,1995:292).

Point B is now reached with this change in sales. But, at point B the domestic firm is not

maximising profits so it will expand its production to OX2, so that it achieves point C. This

process will continue until eventually point E is reached. This movement to point E occurs

because H has a steeper slope than F. If F had a steeper slope than H, the equilibrium point

would be unstable and forces will drive the firms further away from E (if they were not at E).

Since these continual movements away from the equilibrium involve fundamental changes in

market shares, these are usually noticed in oligopoly markets. Therefore Krugman (1984)

regards Figure 3.11's slopes as more relevant than the reverse case. Thus, Figure 3.11 has

been beneficial in illustrating the sales level of each of the firms (Appelyard &

Field,1995: 292).

The next step is to examine the total output level of each of the firms in each of the markets it

operates in. It is again important to remember the assumption that marginal cost decreases as

output increases. Also, given the demand and marginal revenue curves, a shift downward or a

decrease in the marginal cost schedule leads to an increase in output (Appelyard &

Field,1995: 292).

51

Figure 3.12 — Domestic country protection and domestic firm sales through economies of

scale (Appelyard & Field,1995:292)

In Figure 3.12, the horizontal axis represents the total output of the domestic firm — this is the

sum of all the sales in all markets in which the domestic firm operates. The domestic firm's

marginal cost is represented on the vertical axis. Curve M is drawn on the assumption that an

increase in output causes marginal cost to decrease. Curve Q illustrates that a decrease in

marginal cost will cause an increase in output. The equilibrium point T, is the point at which

there is no incentive for the firm to change its output level. A similar graph (not shown)

could be drawn for the foreign firm's total output where an M* curve (equivalent to M)

intersects a Q* curve (equivalent to Q) (Appelyard & Field,1995:292-293).

Suppose, the domestic country's government imposes a tariff or an import quota on the

imports of the foreign firm. The reason for this form of protection is to guarantee some of the

domestic country market for the domestic firm. The initial impact of this protection will be

on the domestic firm's output. The Q curve will shift vertically to the right to Q', since the

domestic firm's output has increased for any given level of marginal cost. This will cause the

firm's equilibrium position to move to T', where lower marginal cost is incurred (Appelyard

& Field,1995:293).

52

Similarly, for the foreign firm (figure not shown), the Q* curve will shift to the left. Since the

foreign firm is now contravening some of the domestic country market, less output is

associated with each level of marginal cost. This would result in an increase in the marginal

cost for the foreign firm. Since the marginal cost curves have changed for each firm, there is

feedback onto the reaction functions as those functions were each drawn with a given

marginal cost (Appelyard & Field,1995:293).

Figure 3.13 — Domestic country protection and domestic firm sales through economies of

scale (Appelyard & Field,1995:294)

In Figure 3.13, H shifts to the right to H' due to the decrease in marginal cost for the

domestic firm. This has caused the domestic firm's sales to increase for each given level of

the foreign firm's sales in each export market. Similarly, F will shift down vertically to F'

(not shown) as a result of the increase in marginal cost for the foreign firm and the firm will

sell a smaller amount of the good for each given level of domestic firm's sales. Therefore, the

new equilibrium in this duopoly situation is E' which implies that the domestic firm has

gained sales in all markets at the expense of the foreign firm (Appelyard & Field,1995:294).

Thus, this theory of protection can be called the tariff to promote export through economies

of scale. Since, these new sales in all the I markets are exports from the domestic country.

Krugman (1984) not only used his economies of scale approach as a recommendation for

protection, but it was also used as an explanation for phenomena such as understanding how

53

Japan became a leading exporter of several products despite its domestic producers having

initially been protected (for example automobiles). Under these circumstances, it makes

sense. But, invariably with any protection policy, the foreign firm will retaliate with a tariff

of their own (Appelyard & Field,1995:294).

3.3.4. EXTERNALATIES — RESEARCH AND DEVELOPMENT AND SALES OF

THE DOMESTIC FIRM

Krugman (1984) also developed the externality approach to protection. It is similar to the

economies of scale approach but considers the tariff to promote exports through research and

development. It again assumes a duopoloy market structure consisting of a domestic firm and

foreign firm and these firms are competing in many markets. The marginal costs for each

firm are assumed to be constant in regard to output (therefore the marginal cost curves are

horizontal). But, for any given level of output, marginal costs will be dependent on

investment in research and development (R&D). The relationship between R&D expenditure

and marginal cost is negative. Therefore, the greater the amount spent on R&D, the greater

the reduction in the marginal cost. A positive relationship, however, exists between R&D

expenditure and the level of output. Larger outputs will generate greater profits which can be

used to finance additional R&D. This is based on the assumption that firms do not borrow

from the capital markets to finance their R&D. The key relationship in this R&D model is

illustrated in Figure 3.14 (Appelyard & Field,1995:294; Ellesworth & Leith,1991:124).

In Figure 3.14, the vertical axis shows the amount spent by the domestic firm on R&D.

While, the domestic firm's output is measured on the horizontal axis as the sum of all the

firm's sales in all the markets (i). The upward sloping M line shows that as output increases,

the amount spent on R&D increases due to larger profits. The upward sloping Q line

indicates the positive relationship between output and R&D. This line thus reflects that as

R&D spending increases, the firm's marginal cost falls and greater output is produced.

Therefore, the equilibrium point between R&D spending and output is the point T.

Corresponding to this graph would be a similar graph for the foreign firm (not shown), with

54

M* line drawn against a Q* line with an equilibrium point T* (which is equivalent to point T

on Figure 3.14) (Appelyard & Field,1995:294-295).

Figure 3.14 — Domestic country protection and domestic R&D spending and output

(Appelyard & Field,1995:295)

The outcome of protection in this model resembles the outcome in the economies of scale

model. Suppose that the domestic country's government imposes a tariff to secure some of

the domestic market's sales for the domestic firm. The imposition of this tariff, will cause the

line Q to shift to the right to Q'. This shift implies that a greater amount of output is now

associated to each amount of R&D spent. But, the new equilibrium position T' produces a

larger amount of R&D spending, which will bring lower marginal costs so that the firm is

able to take sales away from the foreign firm is all markets. The gain in sales at the expense

of the foreign firm is confirmed if it is considered that the opposite process takes place for

the foreign firm. For the foreign firm, output has decreased with each associated level of

R&D. The decline in R&D spending for the foreign firm will cause a rise in marginal costs.

This will in turn lead to a decrease in sales in each of the markets served by the duopoly

(Appelyard & Field,1995:295).

55

Again, when assessing this argument, the possibility of retaliation against the R&D

orientated industry needs to be considered. Also, the argument assumes that the firm's

primary determinant of sales is R&D. But, other factors such as patent protection may be

more important than sales. Furthermore, R&D may be aimed at new product development

rather than towards cost reduction of producing existing goods. But, the basic point

concerning import protection of economies of scale and research and development is that it

can potentially generate exports, whether the mechanism operates by way of economies of

scale, generation of R&D spending or other possible routes (Appelyard & Field,1995:295-

296).

3.4. CONCLUSION

Section 3.1 entailed a discussion of the various trade policy instruments used to alter the free

pattern of trade. Special attention was given to tariff barriers, non-tariff barriers and export

taxes and subsidies.

Section 3.2 then follows with an examination of the traditional arguments for protection. The

various arguments discussed gave several reasons for tariffs namely:

To improve the welfare of the world (the infant industry argument);

To improve national welfare of an individual industry (the terms of trade argument);

To improve the welfare of an individual industry (the tariff to increase employment in a

particular industry).

In addition to these arguments, attention was given to the possibility of using welfare

benefiting alternatives such as subsidies rather than beggar-thy-neighbour policies.

Furthermore, the difficulties in applying the policies in practice were also considered.

Lastly in Section 3.3 the new theories regarding the possible benefits of protection were

focused on. This section stressed that protection can bring about potential gains such as a

transfer of foreign monopoly profit and the realisation of economies of scale that will lead to

greater exports. An increase in research and development spending, with subsequently

enhanced exports, can also be achieved through domestic market protection. However,

56

protection based on these arguments do not necessarily guarantee an improvement in

domestic welfare, since among other things, foreign retaliation is ignored. Also, the

originators of the theories are not necessarily recommending protection, but are attempting to

show the possible implications of departing from the perfect competition assumption of

traditional trade theory.

57

CHAPTER FOUR

4. RESEARCH METHODOLOGY

4.1. INTRODUCTION

According to Saunders et al., (2000:2) people undertake research in order to find things out

in a systematic way, thereby increasing their knowledge.

Three methods of research designs were used namely: exploratory research, explanatory

research and survey. Each of these methods will be discussed in detail.

4.2. EXPLORATORY RESEARCH

In Chapter Two and Three, exploratory research was conducted in the form of a literature

review. The literature review consisted of collecting secondary data through undertaking

searches in textbooks, publications and journals. The economic theories of protectionism

dated backed to approximately 1961 but, it is still viewed as relevant today. The secondary

data collected on the Motor Industry Development Programme (MIDP) relates to its

inception in 1995 and its subsequent review in 2000. The incorporation of this information in

the research was intended to covey recent thinking of protectionism in the South African

Motor Industry.

4.3. EXPLANATORY STUDY

In Chapter Two and Three, an explanatory study is used to establish whether there is a casual

relationship between the benefits/effects of the MIDP and the outcomes of the protectionist

tools.

58

4.4. SURVEY

A cross sectional survey was used as a research method to support and evaluate the

exploratory and explanatory research conducted in Chapter Two and Three. The survey

comprised of a self-administered questionnaire (see Appendix I) sent to a sample of Financial

Directors/managers from the component industry in South Africa. The questionnaire was

faxed or mailed electronically to the respondents.

The questionnaire was designed to canvas the opinions and views of the selected respondents

regarding the effects that the MIDP has had on the component suppliers. Thus, the questions

posed in the questionnaires covered a broad range of issues that would affect the component

supplier since the introduction of the MIDP. The questionnaire was also utilised to evaluate

whether the proposed benefits of the MIDP were realised, for example: increased

employment, increase exports and so forth. The issues were then grouped under main

headings of general, international competitiveness, employment, economic growth, balance

of payments, effects of MIDP, recommendations and the future of the MIDP. Table 4.1

indicates the group categories and the corresponding question numbers.

Table 4.1 — Questionnaire grouping and the corresponding question numbers

Group Question numbers

General 1, 2, 9, 10

International competitiveness 3, 4, 5, 6, 7, 8

Employment 11

Economic growth 12,13, 14, 15, 16, 17, 18, 19, 20, 21

Balance of payments 22

Effects of MIDP 23, 24

Recommendations 25

Future of MIDP 26

59

Once the questionnaire had been formulated it was distributed to colleagues, superiors,

friends and family for proofing and criticism. The comments received from these individuals

were then incorporated, where applicable, into the questionnaire.

Different scale techniques were utilised in the questionnaire. The total number of questions

set were twenty-six and a total of eighteen questions made use of nominal scales to obtain

basic information. According to Saunders et al., (2000:328) nominal data is impossible to

measure the category numerically or rank it. Of these eighteen questions, five questions

required the respondents to answer yes or no. The balance of the questions, namely eight,

were open-ended questions. Therefore, all twenty-six questions resulted in categorical data

since the data collected couldn't be measured numerically but, could be classified into

categories according to the pre-defined characteristics required.

4.4.1. SAMPLE SELECTION

The selection of the sample is important for the accuracy of the survey and the process of

selecting the sample was undertaken through utilising a probability cluster sampling method.

Cluster sampling requires that the population be divided into discrete groups prior to

sampling. These groups are called clusters (Wegner,1999:56).

The population consisted of 193 National Association of Automotive component and Allied

Manufacturers (NAACAM) members. On an annual basis, NAACAM publishes a directory

which contains: a list of all their members, contact details and a classification of the markets

which the members service. The classifications/clusters are detailed in Table 4.2 below:

60

Table 4.2 — Classification of NAACAM members (NAACAM,2001:5)

A Manufacturers and suppliers of OE components to vehicle assembly plants

only

B Manufacturers and suppliers of OE as well as P&A (Part and Accessory)

and aftermarket/replacement components

C Manufacturers and suppliers of components to the distributive sector

D Manufacturers of allied products supplied to vehicle assembly plants and

other sectors of industry e.g. paint, glass, abrasives, fasteners etc

E Suppliers of products/service to the motor industry

Since the questions in the questionnaire related to the component supplier's supply to the

three markets namely: original equipment, replacement/P&A and export, it was appropriate

that the criteria for the sample would be suppliers which were classified as "B" suppliers by

NAACAM . The number of "B" classified suppliers were seventy-nine. The names of the

Financial Directors or Managers were determined telephonically, seventy-nine questionnaires

were faxed or where applicable, electronically mailed to these people.

A response rate of 20% was anticipated which implied receiving sixteen responses from the

seventy-nine questionnaires sent. The actual response rate achieved was 51%, which implied

that forty out of seventy-nine component suppliers responded. This represents a good return.

4.4.2. DATA ANALYSIS

The primary data obtained was input into a computer spreadsheet programme to allow for

quantitative analysis and comparisons between the different questionnaire returns. Where

relevant, this data was represented as a figure and/or tabled for presentation, analysis and

interpretation between the response from the Financial Directors/Managers of the component

suppliers. The information returned from question 23, 24, 25, 26 were coded by assigning

numbers to the answers such that the responses could be grouped into a more narrow range of

61

classes for analysis. These verbatim responses to these four questions are detailed in Chapter

5 and also Appendix I.

A data matrix was set up in Excel for the quantitative analysis of the data returned by the way

of the questionnaires. Component suppliers were assigned a unique number according to

their company's alphabetical listing. As questionnaires were completed and returned, the

responses were captured alongside the applicable question number and unique respondent

number. This was done to set zero default and so take cognisance of non-responses to

specific questions.

Table 4.3 provides an indication of the analysis performed on the responses obtained from

the returned questionnaires.

Table 4.3 — Quantitative analysis performed per question

Analysis performed Questions

The number of responses

The % of responses per category

The total population % response for each question

1, 2

15,

26

3,

16,

4, 5,

17,

6,

18,

7, 8,

19,

9,

20,

10,

21,

11,

22,

12,

23,

13,

24,

14,

25,

62

CHAPTER FIVE

5. DATA ANALYSIS AND INTERPRETATION

5.1. INTRODUCTION

The data obtained from the questionnaires was collected and collated. The questionnaires

were sent to seventy-nine selected component suppliers in South Africa to evaluate the

effects that the MIDP has had on them and whether the M1DP' s objectives are being realised.

Forty component suppliers responded, which implies a response rate of 51%.

The summary responses and analysis of the responses, as outlined in Chapter Four are

presented in this chapter along with illustrative figures, where appropriate. The responses to

the open ended questions were analysed after having been grouped and coded for analysis

and to present summarised answers.

5.2. RESPONSES TO THE QUESTIONAIRE

The responses to the questionnaire are dealt with on a per question basis and the necessary

cross-references made where appropriate. The responses have been taken from a sample of

seventy-nine Financial Directors/Managers are as follows:

Question 1

Type of product manufactured?

Each respondent from the respective sample of companies indicated that they produced a

unique product in South Africa. Therefore, none of the respondents were in competition with

one another locally. Instead, their competitors consisted of overseas suppliers.

63

40%

35%

30%

25%

20%

15%

10%

Question 2

Which Motor Manufacturers do you service?

BMW Daimler Delta Ford Nissan Toyota Volkswagen

The responses were as follows:

30% (12) of respondents supplied to all 7 OEMs; 10% (4) supplied to 6 OEMs; 12.5% (5)

supplied to 5 OEMs; 20% (8) supplied to 4 OEMs; 5% (2) supplied to 3 OEMs; 15% (6)

supplied to 2 OEMs and lastly, 7.5% (3) supplied to 1 OEM. This is illustrated in Figure 5.1

below.

Figure 5.1 — Percentage of supply to OEMs

The mean or average number of OEMs supplied to by the sample component suppliers is 6.

The mode is the most frequently occurring value in the dataset. In this instance, the mode is

7. The median is the value of a random variable, which divides an ordered dataset into two

equal parts. Thus, the median is 4. This implies that 70% of the component suppliers are

servicing 6 out of the 7 OEMs and only 30% of component suppliers are supplying to all 7

OEMs (Wegner,1999:54 — 61).

64

80%

70%

60%

50%

40%

30%

20%

10%

0%

More interesting than the number of OEMs that a component supplier is supplying to, is the

percentage per OEM that the component supplier is servicing. This is illustrated in Figure

5.2.

Figure 5.2 — Percentage of supply to each OEM

Figure 5.2 illustrates what percentage the component supplier supplies to each OEM. The

highest percentage (75%) of supply by a component supplier is to Ford and Nissan and only

45% are supplied by component suppliers to BMW. Thus, 55% of BMW's supply is made of

overseas supply whereas only 25% of Ford and Nissan's supply is supported by imported

supply. The factors, which will influence an OEM when sourcing the supply is, price,

quality, ability to adhere to OE specification and supply performance. It could therefore be

assumed that BMW has more stringent requirements for supply than the other OEMs.

Question 3

Do you export your product?

Yes

No


65

75% of the respondents do export and therefore the balance, namely 25% don't export. Of

the 25% which didn't export, they do export indirectly through the OEM who inturn export

the component supplier's product as part of the fully assembled motor vehicle.

Question 4

If the answer to Question 3 is yes, which countries do you export to?

USA

UK

Australia

EU

Other Africa

If other, please specify


Of the 75% component suppliers which export, the percentage that export to a specific

country are detailed below in Table 5.1 in descending order.

Table 5.1 — Percentage of exports per country by component suppliers

Country No. of component suppliers supplying

exporting to that country

% of components supplier

exporting

UK 23 76.7%

EU 23 76.7%

USA 14 46.7%

Africa 12 40%

Australia 12 40%

Japan 4 13.3%

Asia 2 6.7%

Middle East 2 6.7%

South America 2 6.7%

Israel 1 3.3%

New Zealand 1 3.3%

66

Question 5

In which year did your company start exporting?


54% starting exporting prior to the introduction of the MIDP i.e. 1994 and 46% began

exporting after the introduction of the MIDP. It therefore, appears that other forces other than

the MIDP has encouraged component suppliers to export.

Question 6

State the percentage of your exports which are generated by yourself or by the OEM

Yourself

OEM

The responses to Question 6 are illustrated in Figure 5.3 below.

Figure 5.3 — Percentage of exports generated by component suppliers' vs that generated by

OEMs

Figure 5.3 indicates that most of the exports are generated by the component supplier's

themselves (43.3%) rather than making use of the OEMs assistance. But, in a few instances,

67

component suppliers do make use of the OEMs assistance. It applies particular to catalytic

converters, leather and alloy wheels.

Question 7

Do you have a parent company?

Yes No


25% of the respondents do not have parent companies which implies that 75% do have parent

companies.

Question 8

If answer to question 7 is yes, are your exports generated by your parent company?

Yes No


Of the 75% component supplier which do have parent companies, only 23.3% of the exports

are generated by the parent company. The balance of the component suppliers (76.7%)

generates their own exports.

Question 9

Have you utilised any government incentives?

Yes No

The responses were as follows:.

68

17.5% of the respondents indicated that they did not make use of government incentives

which implies that the majority, namely 82.5%, do make use of government incentives.

Question 10

If your answer to Question 9 is yes, please specify which incentives have been utilised.


The majority of the respondents (84.4%) made use of the MIDP. The other less utilised

government incentives were: General Export Incentive scheme (GEIS) (9.4%), Marketing

Development assistance (9.4%), Small and Medium Enterprise Development programme

(SMEDP) (6.3%), Section 37 tax holidays (6.3%), Productive Asset allowance (3.1%), Iscor

Steel export rebate scheme (3.1%), low interest rate loans from the Industrial Development

Corporation (3.1%) and the A&B incentive (3.1%).

Therefore, from Question 6, 8 and 10, it can be seen that component suppliers rarely make

use of other sources to generate their exports (namely OEMs or parent companies) instead,

they ensure that they pursue exports with the assistance rather of certain government

incentives.

Question 11

Have the number of employees employed by your company increased, decreased or remained

the same from 1994 until today? (Please mark the applicable box with X)

Increased

Decreased

Same

If there has been an increase or decrease in the number of employees, what has been the

reason for this?

69

The results are as follows:

40% percentage of respondents indicated that the number of employees employed increased

from 1994 until today. 45% of the respondents stated that the number of employees

employed had declined since 1994 and 15% of respondents had no change in their

employment figures since 1994. This is illustrated in Figure 5.4 below.

Figure 5.4 — Change in employees employed since 1994

A summary of the reasons for the increase in employment since 1994 are listed below:

Local/domestic growth through the OEM export contracts

Capacity expansion

Increase in product range

Increased market share

The main reasons given for the decline in employees employed since 1994 were as follows:

The reduction of customer demand due to international competition

Increased use of automation

Productivity and technology improvements

Rationalisation

Restructuring to become more efficient and competitive

Streamlining the process

Declining local volumes

70

70%

60%

50%

40%

30%

20%

10%

0%

Outsourcing

Question 12

If applicable, have the number of units sold to the OEM's increased, decreased or remained

the same since 1994?

Increased

Decreased

Same

If there has been an increase or decrease in the number of units sold to OEM's, what has

been the reason for this?


62% of respondents indicated that the number of units sold to OEMs had increased since

1994. 28% respondents stated that their sales to OEMs had declined since 1994 and 10% of

respondents indicated that the number of units sold to OEMs had remained the same. This is

illustrated in Figure 5.5 below.

Figure 5.5 — Change in number of units sold to OEMs since 1994

The reasons given by the respondents for the increase in sales to OEMs are as follows:

Decline in local competition

Local demand (car sales) has increased due to lower interest rates

71

Weakening rand has allowed for OEM Export contracts

Increase in new products

Increased local market share since reduced overseas competitors

Increase in units built

Increase in amount of plastic per units

Aggressive marketing campaign, whilst improving quality, service and value for money

A summary of the reasons for the decline in the units sold to OEMs are as follows:

Decline in OEM's manufacturing engines in South Africa

Smaller offtake from OEMs

Increase competition due to international competitors selling at lower prices

, Imports are replacing local product

Globalisation — more business is being supplied by the German OEMs


Less locally built vehicles, thus greater import of vehicles

Decline in local market requirements

Question 13

If applicable, have the number of units exported increased, decreased or remained the same

since 1994?

Increased

Decreased

Same

If there has been an increase or decrease in the number of units exported, what has been the

reason for this?

The results were as follows:

88% of the respondents indicated that the number of units exported had increased since 1994.

6% of the respondents stated that their units exported had declined since 1994 and the same

72

percentage (6%) noted that their units exported had remained the same. This is illustrated in

Figure 5.6.

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

6% 6%

Figure 5.6 - Change in number of units exported since 1994

The reasons given for the increase in the number of units exported are as follows:

Right hand drives is a niche in world production terms which means that South Africa

has the capacity and labour to service this market

Increase in leather covers due to the MIDP

Increase in market share

Focus on exports as main growth area

Increase use of marketing campaign


More accessibility to USA and European markets

Increasing volumes in Australia

Export driven OEM programmes

Increase demand for products

Promotions

Two main reasons were given for the decline in the units sold in the Export market. These

are:

International competitors sell at lower prices

73

• Export restrictions due to license agreements

Question 14

If applicable, have the number of units sold in the local replacement market increased,

decreased or remained the same since 1994?

Increased

Decreased

Same

If there has been an increase or decrease in the number of units sold in the local replacement

market, what has been the reason for this?


36% of the respondents had an increase in the number of units sold to the local replacement

market since 1994. Whereas, 28% of the respondents stated that their sales to the local

replacement market had declined from 1994 until today. The balance of the respondents

(36%), indicated that their units sold to the local replacement market had remained the same

since 1994. From these results, it appears that there has not been dramatic change in the sales

patterns since 1994 in the local replacement market. This can be seen in Figure 5.7.

50%

45%

40%

35%

30% 25%

20%

15%

10%

5%

0%

Figure 5.7 — Change in the units sold to the local replacement market since 1994

74

The reasons given for the increase in the units sold in the local replacement market are as

follows:

Increase and growth in market and market share

Competitor closed their factory

Increase in crime which requires further replacement of stolen or broken components


Larger vehicle park which is aging

The explanation given by the respondents for the decline in the units sold to the local

replacement market are as follows:

More imported cars, therefore reduced demand for replacement parts

Discontinuation of certain models of cars

Local demand has declined

Question 15

In 1994, which was the most profitable market for your company?

OE Export Replacement

The responses are as follows:

In 1994, 54% of the respondents stated that OE was the most profitable market for their

company. 32% of the respondents indicated that the Replacement market was the most

profitable for them. Whereas, 14% of the respondents noted that the Export market was the

most profitable market in 1994.

Question 16

In 2000, which was the most profitable market for your company?


75

In 2000, the number of respondents that indicated that OE was the most profitable market

dropped from 54% (in 1994) to 38%. 27% of respondents indicated that the Replacement

market was the most profitable market in 2000 (in 1994 it was 32%). The percentage of

respondents that indicated that Export was the most profitable market increased from 14% in

1994 to 35% in 2000. The change in profitability from 1994 to 2000 in the various markets is

shown in Figure 5.8.

Figure 5.8 — Change in profitability of markets from 1994 to 2000

Question 17

If there was a change between the answer in Question 15 and that in Question 16, what has

been the reason for this?

The main reasons for the changes in the profitability from OE to Export or Replacement

market since 1994 are as follows:

Growth in exports but, no growth in replacement market and OE

OEM's only grant 2-3% price increases, therefore there is no margin. Whereas, exchange

rate devaluations are favourable for exports.

Exported products achieve higher volumes and higher benefits, especially through the

MIDP

76

30% 28%

13% 12°/0_

-0(7c7- OW 2%._

Pi 1r .

iv+ 0% 0%

0 0 0 0 0 C‘ 43 co A 0 0 c1/0 b0 <00co ACY

40%

35%

30%

25%

20%

15%

10% 5%

Question 18

What percentage of your factory capacity is your company utilising?

The responses were sorted into categories and are illustrated in Figure 5.9 below.

Figure 5.9 — Utilisation of company's capacity

From Figure 5.9, the highest category of capacity utilisation was those companies that only

use 60-69% of their capacity. This accounts for 30% of all company's capacity utilisation.

28% of companies utilise between 90-100% of their capacity. In descending order, 22% of

companies use 80-89% of the capacity and 13% of companies utilise 70-79% of their

production capacity. Only 5% of companies use 50-59% of their capacity and the balance of

companies (2%) utilise 40-49% of their capacity. There are no companies that use less than

40% of their production capacity.

Question 19

If your answer is not 100% to Question 18, what is the reason for not using the full capacity?

The reason given for not utilisation 100% of the production capacity are detailed below:

• Bottlenecks allow some areas to be less than 100%

77

International market share is not strong enough to bring the volume to South Africa

New projects are not yet in full production

No third shift — it is difficult to find management for the 3 rd shift

Models are running out but, not being replaced

Insufficient orders

Fluctuations in supply and demand

Low market growth

No demand due to imports and declining demand from OEMs

Less OE engines manufactured in South Africa

New company which is fighting to obtain orders against local and global competition

Provision for new business


Technology changes in export market

Local market needs keep changing as OEMs change the specifications

Question 20

Have you made any capital investments in your manufacturing facility since 1994?

Yes

No

The results were as follows:

98% of all respondents had made capital investments since 1994 and only 2 % had not made

any capital investments in their manufacturing facilities. This indirectly implies that the

component suppliers have invested in the future of their business and are therefore optimistic

about the future of the motor industry.

Question 21

If the answer to Question 20 is yes, what is the reason for this investment?

78

25% 23%

10% 10% 10% gyo

5% 5% ___ ___

5%

rp ,b(3 1,b <e§b c,C) , '‘C # & .■C5 er iz: DO cr er cy er :• •• 9, ,b tx 4) 0 AQ' 0 0

30%

25%

20%

15%

10%

5%

0%

The following reasons were given for the capital investment in their manufacturing facilities:

Replacement in old equipment

Upgrade in technology to maintain quality and adhere to specifications

Expansion of facilities

Increase capacity as a result of the growth

Rationalise manufacturing process

New factories

Capture new market share

Introduction of new products and model changes

Question 22

What percentage of your product contains imported materials/components?

The responses were sorted into categories and are illustrated in Figure 5.10 below.

Figure 5.10 — Percentage of product which contains imported materials/components

From Figure 5.10, 67% of all component supplied contain between 0% to 39% imported

material/components. Thus the balance of payments should be favourable with exports from

components suppliers exceeding the imports from component suppliers.

79

Question 23

Describe the positive aspects that the MIDP has contributed to your company?

As summary of the responses given on the positive aspects that the MIDP has contributed,

are listed below:

Additional sales to OEM's, who in turn export

Helped to fund the logistics leg of the export thus making our product globally

competitive

Opened up export opportunities (through export credits) thereby increaTsEicrifigNviKooluNmv es

rt Increased ability to export competitively and profitably

Improved cashflow position of OE

Improved profitability of company VVATERSRAND LIBRARY

Able to quote lower competitive prices on export products

Less model variants

Forced technology upgrades

It has forced the industry to become more competitive both locally and internationally

It has forced companies to concentrate on their core business

It has forced smaller companies to go out of business and reduce local competition

It has resulted in foreign investment

MIDP compensates for offering lower prices to importers

Allowed for price competitiveness

MIDP Mid term review will help in future as OEM's are forced to look at the local

manufacture of a volume model

Through the MIDP incentive the negative impact of low volume production as well as

physical remoteness to major markets is decreased

Increased product range

Increased employment of both skilled and unskilled staff

Improved utilisation of idle machinery

Increase demand for locally supplied raw materials

80

Enabled the achievement of economies of scale since there are more volumes of the same

product

Provided more certainty to the planning period that the MIDP affords

Given opportunity to become world class

In summary, there were numerous positive aspects given by the respondents but, the most

comment aspect mentioned by more than half of the respondents was that the MIDP allowed

them to be competitive internationally which assisted them with supplying into the export

market. This allowed the component suppliers to produce higher volumes and improve the

profitability of the business. Other common responses given were that the MIDP allowed for

an increase in their economies of scale and their employment. Despite all the positive aspects

mentioned on the MIDP by the respondents, 13% of respondents felt that there were no

positive aspects of the MIDP to mention.

Question 24

Describe the negative aspects that the MIDP has contributed to your company?

58% of the total number of respondents that they have not experienced any negative aspects

that the MIDP has contributed to their company. 42% of the component suppliers do have

negative experiences of the MIDP and there are listed below:

Business becomes reliant on incentives and therefore not always focusing on purpose of

MIDP.

Efficiencies not realised in quickest possible period

Extra cost of administration with no incremental income

Too much red tape. The rules are complicated and not easily understood by overseas

Possible liability to OEM's if DA190's are not correct

Big change "overnight"

Lots of investment required

3 years of extremely low profitability

81

It has resulted in more imported vehicles

Various license agreements resulted in lower OE volumes

Loss of some OE business as OEM's import more components for new models

MIDP is more favourable to OEM's than component suppliers

It has allowed local component suppliers to become inefficient

MIDP is only claimable via OEMs

Run lengths have increased not still not the same as overseas equivalents

Exportation of catalytic converters, alloy wheels and leather seats means reduced

potential for local industry

High percentage of vehicles are cheap entry levels vehicles with very little accessory

potential

Reduced margins as required to match landed cost prices of imported equivalents

OEM sourcing routes target catalytic converters and leather seats as a source of MCC' s

to offset CKD imports

The affects of local inflation are largely ignored by the OEMs and are expected to be

absorbed

The two most common negative aspect of the MIDP was, the cumbersome administration

required and secondly, OEMs expecting local suppliers to match the landed cost of imported

goods. This caused component suppliers to make no or very little margin.

Question 25

In your opinion, what recommendations would you make to the DTI in terms of the current

MIDP?

40% of respondents that they have no recommendations to make to the DTI and they would

suggest making no changes with the current MIDP. But, the balance of the respondents

(60%) did make numerous recommendations in terms of the current MIDP. These are

detailed below:

Component manufacturers are able to benefit directly from OEM exports

82

MIDP should be a mechanism for component manufacturers to develop themselves.

Under current circumstances, certain OEMs wish to grab MIDP for merely having a

parent company overseas. The MIDP needs to go to the intended recipient not to a top up

duty account

Monitoring of improvement in productivity. This would entail an annual review of results

of company to determine reliance

Needs to remain in place for a longer period so that certainty for future investment can be

given

Change the barriers to entry. Encourage foreign capital investment which will result in

more work and competition.

Encourage joint ventures, alliances and partnerships between component suppliers and

OEMs

Restrict import duties on raw material and capital equipment

Need to start considering rules for 2008 since OEMs are already planning their model

replacements for 2007/8

Even through current administration is onerous, if its was made any simpler, opportunity

for "manipulation" would arise

Component suppliers must do strategic pricing with OEMs

Need to keep MIDP in place to assist the industry and in the interim, need to work at

becoming more internationally competitive and grow exports

Not all the MIDP benefits are passed on the component supplier and this needs to be re-

evaluated

Retain the MIDP for longer time periods and reduce tariffs slower in years to come

Continue with incentives in one form or another but, increase incentives for capital

investment and training of staff

Ensure proper central procedures are put into place and enforce this to avoid exploitation

and unfair advantage with respect to obtaining business or to be able to compete on a

level with competitors

More transparency between OEMs and component supplier regarding the use of credits

83

Enforce more correspondence/communication with companies e.g. seminars, meetings

and so forth. These should provide companies with updated and more accurate

information

The reduction in platforms has not been significant so component manufacturers still

have negative economies of scale

Recommend further incentives for rationalisation of models produced in South Africa

Reduce export-import complementation for leather seats, catalytic converters and alloy

wheels since it is taking up too much of the available forex pool and is reducing the

emphasis on exporting other components

A minimum local content needs to be established in the long term as local OEMs cannot

continue to import components and expect to export right hand vehicles economically

Needs clearer and wider publicity

The most common concern for the component suppliers is what will happen to the MIDP

after 2007. Their suggestion is that it should continue as per the current MIDP.

Question 26

In your opinion, how do you foresee the future of the component industry under the current

MIDP?

A summary of the various responses on the future of the component industry under the

current MIDP are detailed below:

Component suppliers who export directly will benefit, whereas component suppliers

unable to export directly will stagnate

It is going to become much tougher to compete globally with the MIDP reduction. We

are already seeing OEMs shying away from Export projects because the MIDP retention

is not in line with their requirements. Unfortunately, we are being forced to work through

the local OEMs for orders.

Majority of companies will not survive in the foreseeable future without MIDP incentive

More OEM's moving towards higher volume, export based strategy with fewer variants

84

Greater integration between local OEM's and their international parent companies

Increased use of automation

Very favourable

A new system needs to be devised to incentivise the local component industry

There will be fewer bigger players

Each year the items are shrinking due to fraud and if this continues, there wont be a

future

More difficult to export, it will only be competitive when the rand devalues

South Africa must comply with GATT rules which makes it very difficult

Will become internationally more competitive through additional throughput for direct

exports as well as increased indirect exports via OEMs

Problem could arise if materials cannot be sourced locally

We do not have sufficiently skilled and business orientated labour to be competitive with

global markets at this stage and this will probably not change in the next 5 to 6 years

Will have to look for overseas partners, as duties cannot maintain local suppliers to be

price competitive

The reductions in incentive rate will be a real test for component suppliers if the drop in

revenue is not substituted by economies of scale and other benefits until 2007

Uncertainty adds to what happens after 2007 will also hinder new and replacement

investment

The industry though will be more impacted by other macro-economic factors such as

political decision-making, privatisation, monetary policies, crime and so forth. Rather

than the economic fundamentals of the MIDP

The industry will become more marginalised due to the lack of export credits gained

Majority of new technology capital investment will be difficult to justify due to the

rand/exchange rate considerations and payback time frame

OEMs will continue to use South Africa as an assembly source whilst it remains

profitable and labour force instable

Small and medium component supplier will either close or be bought over by overseas

partners/competitors or rely on supplying the world aftermarket.

85

• Will be under extreme pressure due to: price pressures — world pricing, globalisation and

imports

In summary, 25% of the respondents viewed the future of the MIDP has favourable whereas,

13% indicated that the future years will be difficult for component suppliers. At the same

time, 13% stated that without the MIDP, the industry would not survive and 15% of

respondents felt that without MIDP there would be no exports and without exports, there

would be not survival.

5.3. GENERAL CONCLUSIONS

Certain general conclusions can be made from the responses to the questions. These

conclusions are presented in this section under the grouped headings described and listed in

Table 4.1.

5.3.1. GENERAL QUESTIONS

As mentioned previously, from Question 1 it can be concluded that the members of

NAACAM each supply a unique product to the motor manufacturer and therefore, there is no

local competition between component suppliers. Instead, their competition will be from

overseas suppliers.

From Question 2, it is interesting to notice that all component suppliers do not supply to all

the OEMs. Only 30% of component suppliers supply to all seven OEMs and a cumulative

percentage of 52.5% supply to five of the seven OEMs. The OEMs, which receive the

highest percentage of supply from a component supplier, is Ford and Nissan, with BMW

receiving the least supply from the local component suppliers. This indicates that the

component suppliers have not made themselves solely reliant on the OEMs for the business

and some OEMs have also not relied entirely on local component supplier for supply.

86

In Question 9, it was established that the majority of component suppliers, namely 82.5%,

make use of government incentives. In Question 10, the most commonly used incentives

were detailed. The most commonly used incentive was the MIDP. The other less commonly

used incentives include: General Export Incentive Scheme (GEIS), Marketing Development

Assistance, Small and Medium Enterprise Development Programme (SMEDP), Section 37

Tax holidays, Productive Asset allowance, Iscor Steel Export rebate scheme, low interest

rates from the Industrial Development Corporation and the A& B incentive. Question 9 and

10 suggests that the MIDP is well received by component suppliers due to this high level of

utilisation.

5.3.2. INTERNATIONAL COMPETITIVENESS

In order to understand the component supplier's international competitiveness, the following

was established namely: do they export and if so were to; in what year did they start

exporting and how were exports generated — via yourself, parent company or OEM. This

discussion will be conducted in conjunction with the theory of economies of scale (see

section 3.3.3).

From Question 3, it is noted that three quarters of component supplier's export and the

balance of the suppliers that do not export, export indirectly through the relevant OEM,

which exports their product. From the component suppliers that do export, 54% started

exporting before the introduction of the MIDP. Thus, other factors besides the MIDP have

encouraged component suppliers to diversify into the export market.

The most dominated regions to which the component suppliers are exporting to are UK, EU,

USA and Africa. Other regions being exported to include: Australia, Japan, Asia, Middle

East, South America, Israel and New Zealand.

Regarding how the exports are generated, the component suppliers themselves generate most

of the exports rather than making use of the OEM's assistance. But, in a few instances such

as catalytic converters, leather and alloy wheels, these component suppliers have made use of

87

the OEM's assistance. In the case were the component supplier generates its exports, a small

percentage (23%) of these exports are generated by the parent company.

In summary, it can be assumed that the majority of component supplier has become more

internationally competitive since they have been able to supply to the export market and this

has been achieved solely by the component suppliers with some assistance from the MIDP.

One of the methods that component suppliers can become internationally competitive is

through achieving Krugman's (1984) model on economies of scale (see section 3.3.3) which

is defined as protecting the domestic markets from foreign firms, helps domestic firms not

only in the protected market but in export markets as well. But, Krugman's model assumes

that the domestic country's government imposes a tariff or an import quota on the imports of

the foreign firm. The reason for this form of protection is to guarantee some of the domestic

country market for the domestic firm. The initial impact of this protection will be a decrease

in the marginal cost of the domestic firm which will cause the firm's sales to increase for

each given level of the foreign firm's sales in each export market. Since the foreign firm is

now contravening some of the domestic country market, less output is associated with each

level of marginal cost. This would result in an increase in the marginal cost for the foreign

firm (Appelyard & Field,1995:291).

But, the tariffs are reducing for CBUs and imported components as shown in Table 2.1 and

Table 2.2. under the current MIDP. Therefore, Krugman's (1984) model of using

protectionism to achieve economies of scale does not hold any weight for the MIDP. Instead,

the component suppliers are making use of other methods (excluding protectionism) in order

to achieve economies of scale and therefore become international competitive in the export

market.

5.3.3. EMPLOYMENT

According to Appelyard and Field (1995:280) a tariff can be used to increase employment in

a particular industry (see section 3.2.4). The argument for the use of a tariff to increase

employment in a particular industry follows that, the tariff will cause demand to shift from

88

the imported good to the domestically produced good. Since, the price of the imported good

rises relative to the price of the domestic good. This substitution in purchases will cause the

domestic goods price to rise which will in turn cause domestic producers to increase their

quantity supplied. The production of these additional units will result in more domestic

workers being hired and so, there will be an increase in the employment in the domestic

industry. Simplistically, it should therefore be assumed that is tariffs decline then

employment will also decline (Appelyard & Field,1995:280).

As indicated in Question 11, the majority of component suppliers (45%) had a decline in the

number of employees employed since 1994. Whereas, 40% of component suppliers had an

increase in the number of employees employed and the balance of component supplier's

(15%) employment numbers remained the same since 1994.

As mentioned in Section 2.6, one of the main aims of the MIDP was to provide sustainable

employment. At face value, it appears that the MIDP has not succeeded in one of its

objectives since the majority of component suppliers have decreased the number of

employees employed since 1994. This also appears to agree with Appelyard and Field's

(1995:280) model of the relationship between a tariff and employment (see section 3.2.4).

But, from the reasons given by the respondents for the decline, it is evident that the main

reason for the reduction was rather the effects of globalisation and the need for component

suppliers to become competitive with the external environment. Only in one instance was it

mentioned that the declining local volumes were the cause of the reduction of employees.

But, in this case, the component supplier does not supply a competitive product and is

therefore not always used by the OEM's as a supplier.

5.3.4. ECONOMIC GROWTH

In order to establish the economic growth of the component suppliers, four main issues will

be evaluated namely: the change in units sold to the three markets since 1994 and its

respective profitability. Thirdly, whether component suppliers are utilising their production

89


0

10% 6%

-- ---- 36% ____ 28%

-- — -- — — -- — - -- --

-- — 28% --

— -- — 88%

---

62% ____

-- 36% —

100%

90%

80%

70%

60% -

50%

40%

30%

20% -

10% -

0%

Sarre

Decreased

o Increased

capacity and lastly, whether component suppliers have made any capital investments since

1994.

The movement in units sold to OE, export and the local replacement market from 1994 is

illustrated in Figure 5.11 below.

Figure 5.11 — Change in units sold to OE, export and local replacement market since 1994

The largest change in the units sold since 1994 occurred in the export market. This agrees

with the responses to Question 3, were 75% of component suppliers export their product. The

second largest increase in units sold since 1994 was to the OEMs. This increase was due to

the export contracts, which were awarded to BMW, Daimler and Volkswagen. The units sold

in the local replacement market have remained quite stagnant since 1994.

In terms of the profitability of the various markets, in 1994 OE was the most profitable

market followed by the local replacement, then the export market. Currently, the OE market

is still the most profitable (but the level of profitability has declined since 1994). But, the

export market has increased it profitability since 1994 and is now the second most profitable

market with the local replacement market being the least profitable. This is illustrated in

Figure 5.8.

90

According to Section 3.1.2.1 a tariff will cause the price of the product to increase in the

domestic market and domestic supply will increase. Thus, if the tariff is reduced, as indicated

by the MIDP (see Table 2.1 and 2.2), then the inverse should occur. In other words, domestic

prices of the product will reduce and domestic supply of the product will decline. The above

discussion on the units sold since 1994 in the respective markets, indicates that Section

3.1.2.1 model has not occurred and instead, with the introduction of the MIDP the units

produced by component suppliers have continued to increase and prices and profitability

have not reduced.

Half of the component suppliers are utilising 80% to 100% of their capacity and no supplier

is using less than 40% of their production capacity. This implies that the component suppliers

have the potential to grow since they are not constrained by production capacity.

Lastly, 98% of component supplier have made capital investments since 1994. This indicates

that component suppliers are optimistic regarding the future of the motor industry and their

future potential.

5.3.5. BALANCE OF PAYMENTS

In Section 3.2.6. it is argued by Appelyard and Field (1995:286) that a tariff will improve the

balance of payments since imports will be reduced with the imposition of a tariff. Again, it

therefore can be assumed that if the tariff is reduced then imports will increase and the

balance of payments will be disadvantaged. From these assumption, it should be expected

that the balance of payments will be negative under the current MIDP due to the reduction in

the tariffs on CBUs and imported components (Appelyard & Field,1995:286).

As indicated in Question 22, the majority of component suppliers' products (67%) contain

between 0% to 39% of imported material/components. But, since there is such a large

percentage of component suppliers exporting profitably, it can be assumed that the value of

the exports exceed the value of the imports. Therefore, the balance of payments for the motor

91

industry should be positive and again Appelyard & Field's model (1995:286) is not valid

since an industry improve the balance of payments without making use of a tariff.

5.3.6. EFFECTS OF THE MIDP

The component suppliers have given numerous positive and negative aspects to the effect

that the MIDP has had on them. There are detailed in their responses to Question 23 and 24

respectively. In summary, the positive effects that the MIDP had on the component suppliers

was that it allowed them to become internationally competitive and therefore gave them the

opportunity to supply to the export market. This in turn increased their volumes produced

and the profitability of their business. This increase in volumes supplied created economies

of scale and employment.

The negative effects of the MIDP were that OEM insisted that component supplier match the

landed cost of imported product, which caused the local suppliers to make no or very little

margin. A further negative aspect of the MIDP was that it required cumbersome

administration.

5.3.7. RECOMMENDATIONS

A detailed outline was given by the responses to Question 25 and the recommendations will

be discussed in more detail in Chapter 6.

5.3.8. FUTURE OF THE MIDP

Most of the component suppliers view the future of the MIDP as positive but a minority felt

that the future years would be difficult for component suppliers. It was also indicated that

without the MIDP the industry would not survive. The reason being that without the MIDP

there would be no exports and without exports, there would be no survival by component

suppliers.

92

CHAPTER SIX

6. CONCLUSION AND RECOMMENDATIONS

6.1. CONCLUSION

There is no denying that moving from a highly protected industry to a less protected industry

will place numerous pressures on that industry. When an industry is highly protected, there is

no need for firms in that industry to produce efficiently since they are protected from outside

competition. This was the case in the component industry, when prior to 1995, component

suppliers would produce product at any cost since they would get the price they wanted with

the required profit. In additional suppliers could, in certain instances, negotiate specifications

with the OEMs, which adhered to their production capabilities and therefore did not put

additional cost pressures on them. OEMs also dominated the local car market since they

produced 95% of the vehicles on the road. The balance of cars, consisted of low volume,

premium priced imported vehicles.

Thus, component suppliers were very profitable since they supplied all the components to all

the OEMs at a healthy profit and were protected by government via the local content

programmes. These component suppliers also dominated the local replacement market and

therefore also supplied to this market at a profit since there was very little overseas

competition.

But, with South Africa signing the General Agreement on Tariffs and Trade (GATT), all

industries were required to adhere to the requirements of GATT thus, reducing the level of

protectionism to a minimum. Thus, attempting to practice some degree of free trade between

countries. These requirements of GATT brought upon the introduction of the Motor Industry

Development Programme (MIDP), which in essence brought the tariff levels down by

approximately 60% in eight years. This was a short time span for an industry to change when

it has been protected for thirty-five years.

93

As a result of the reduction of tariff, due to the introduction of the MIDP, more imported

vehicles and components have entered into the country. Currently, 30% of cars in South

Africa are imported. This overseas competition has placed major pressure on the OEMs to be

able to produce a competitively priced vehicle, which has all the same features as those in

imported vehicles. Thus, when OEMs source component supplies, they are looking for

superior specifications at affordable prices. In most cases, this is obtainable from overseas

component suppliers since they produce large volumes of highly specified products to all

overseas OEMs. Therefore, local component suppliers will attempt to match the overseas

suppliers' price and make minimal or no margins. In addition, local component suppliers will

produce reduced quantities of OE products since OEMs only supply 70% of the vehicles in

South Africa. Component suppliers were also required to make large capital investments in

new technology or upgrades in order to achieve the specifications required by the OEMs

(which had been dictated by their parent companies).

Based on the situation described above, it indicated that both local motor manufacturers and

component suppliers would be placed into difficult time unless they changed to overcome the

situation. Unfortunately, a few small component suppliers could not weather the storm. Both

motor manufacturers and component suppliers realised that they could not survive by only

supplying to the local market, instead they needed to diversify into the export markets using

incentives from the MIDP. Three OEMs have been awarded export contracts to produce right

hand drive vehicles to the European market. This increase in the OEMs production will have

a knock on effect for the local component suppliers since it will increase their OE production,

which should assist in achieving economies of scale and cost reduction. Component supplier

who were awarded the OEM export contract and those who weren't also started exporting.

Thus the process, as detailed above, was the objective of the MIDP. This required that both

local motor manufacturers and component suppliers would start exporting which would then

bring on the other following benefits: the industry becoming internationally competitive;

increased volumes and economies of scale which will result in costs declining and

employment increasing and lastly, improvement in the balance of payments. The process

94

may seem very simplistic and easy but it has been an uphill struggle for both component

suppliers and motor manufacturers. It has been hard to be exposed to globalisation without

having the "armour" to attack against these forces.

In many ways, the motor industry can be compared to an infant that is protected and nurtured

by its parents. But, as a result of an agreement signed by the government (i.e. GATT) the

infant is now removed from its parents and is expected to become an adult in eight years and

defend for itself. As much as this is explained as a traumatic process, if no pressure was

placed on the motor industry to "grow up", it would have continued in its "comfort zone" and

relied on the government to keep external competition out. Therefore, despite the initial

difficulties experience by both the local motor manufacturers and component suppliers, the

MIDP has been a step in the right direction for the motor industry. This sentiment is also

shared by the component suppliers as was indicated in their responses in the questionnaire.

Lastly if economic theory was used as per the discussion in Chapter 3 and Section 2.7 as a

prediction for the outcome of the MIDP, then it would have been predetermined that it would

not succeed. But, instead the responses from the questionnaires and the discussion in Section

5.3 indicate that the predictions of economic theory have not occurred. Instead, the counter

has occurred in the component industry.

6.2. RECOMMENDATIONS

The majority of component suppliers (60%) made numerous recommendations regarding the

current MIDP. These recommendations are detailed below:

A system needs to be put in place whereby component suppliers are able to benefit

directly from the OEM export contracts. In addition, not all MIDP benefits are passed on

to the component supplier and this needs to be re-evaluated.

Under certain circumstances, certain OEMs take MIDP for merely having an overseas

parent company. Therefore, the MIDP needs to go to the intended recipient rather than

act as a top up duty account.

95

MIDP should be a mechanism for component suppliers to develop themselves. In order

to achieve this, an annual review of the company results needs to be introduced to

determine reliance on the MIDP and to monitor productivity improvements.

The barriers to entry need to be changed so as to encourage foreign capital investment,

which will result in more work and competition.

The DTI needs to encourage joint ventures, alliances and partnerships between the

component suppliers and the OEMs. This will include component suppliers undertaking

strategic pricing with the OEMs and transparency between OEM and component

suppliers regarding the use of credits.

MIDP needs to restrict import duties on raw materials and capital equipment.

The export-import complementation for leather seats, catalytic converters and alloy

wheels needs to be reduced since it is taking up too much of the available forex pool an is

reducing the emphasis on exporting other components.

Even through current administration is onerous, if it was made any simpler, opportunity

for manipulation would arise.

Ensure proper central procedures are put into place and enforce this to avoid exploitation

and unfair advantage with respect to obtaining business or to be able to compete on a

level playing field with competitors.

Enforce more correspondence and communication with companies in the form of

seminars, meeting and so forth. These will provide companies with updated and more

accurate information.

Further incentives for rationalisation of models produced in South Africa required since,

without this component suppliers will continue with negative economies of scale.

A minimum local content needs to be established in the long term, as local OEMs cannot

continue to import components and expect to export right hand vehicles economically.

The MIDP needs to remain in place for a longer period so that certainty for future

investments can be given and industry can work at becoming more internationally

competitive and exports can continue to grow.

Continue with incentives in one form or another but, increase the incentives for capital

investment and staff training.

96

• Lastly, the DTI needs to start considering rules for 2008 since OEMs are already

planning their model replacements for 2007/8.

In conclusion, initially the effects of the MIDP on the component suppliers were negative

since their healthy margins from the OEMs were reduced and volumes declined due to the

increased overseas competition. But, now component suppliers are viewing the MIDP as

positive since they have become internationally competitive with higher volumes and

margins. Thus, without the MIDP there would be no export and without exports, they would

not have survived.

97

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102

APPENDIX I

QUESTIONNAIRE ON EFFECTS OF MIDP ON COMPONENT INDUSTRY

Please complete the questions detailed below

1 TYPE OF PRODUCT MANUFACTURED:

2 WHICH MOTOR MANUFACTURERS DO YOU SERVICE? (Please mark the applicable box(es) with an X)

Ford

Nissan

Toyota

Volkswagen BMW

Daimler

Delta

3 DO YOU EXPORT YOUR PRODUCT? Yes

No

4 IF THE ANSWER TO QUESTION 3 IS YES, WHICH COUNTRIES DO YOU EXPORT TO?

Africa USA UK Australia EU Other

If other, please specify

5 IN WHICH YEAR DID YOUR COMPANY START EXPORTING?

6 STATE THE PERCENTAGE OF YOUR EXPORTS WHICH ARE GENERATED BY YOURSELF OR BY THE OEM YOURSELF OEM

7 DO YOU HAVE A PARENT COMPANY? Yes

No

8 IF ANSWER TO QUESTION 7 IS YES, ARE YOUR EXPORTS GENERATED BY YOUR PARENT COMPANY?

Yes

No

9 HAVE YOU UTILISED ANY GOVERNMENT INCENTIVES? Yes

No

1

APPENDIX I

10 IF ANSWER TO QUESTION 9 IS YES, PLEASE SPECIFY WHICH INCENTIVES HAVE BEEN UTILISED

11 HAS THE NO. OF EMPLOYEES EMPLOYED BY YOURSELF INCREASED, DECREASED OR REMAINED THE SAME FROM 1994 UNTIL TODAY? (Please mark the applicable box with X)

INCREASED

DECREASED

SAME

If there has been an increase or decrease in the number of employees, what has been the reason for this?

12 IF APPLICABLE, HAVE THE NUMBER OF UNITS SOLD TO OEM'S INCREASED, DECREASED OR REMAINED THE SAME SINCE 1994?

INCREASED

DECREASED

SAME

If there has been an increase or decrease in number of units sold to OEM's, what has been the reason for this?

13 IF APPLICABLE, HAVE THE NUMBER OF UNITS EXPORTED INCREASED, DECREASED OR REMAINED THE SAME SINCE 1994?

INCREASED

DECREASED

SAME

If there has been an increase or decrease in number of units Exported, what has been the reason for this?

9

APPENDIX I

14 IF APPLICABLE, HAVE THE NUMBER OF UNITS SOLD IN THE LOCAL REPLACEMENT MARKET INCREASED, DECREASED OR REMAINED THE SAME SINCE 1994?

INCREASED

DECREASED

SAME

If there has been an increase or decrease in number of units sold in the Local Replacement market, what has been the reason for this?

15 IN 1994, WHICH WAS THE MOST PROFITABLE MARKET FOR YOUR COMPANY? OE Export Replacement

16 IN 2000, WHICH WAS THE MOST PROFITABLE MARKET FOR YOUR COMPANY? OE Export Replacement

17 IF THERE WAS A CHANGE BETWEEN THE ANSWER IN QUESTION 15 AND THAT IN QUESTION 16, WHAT HAS BEEN THE REASON FOR THIS?

18 WHAT PERCENTAGE OF YOUR FACTORY CAPACITY IS YOUR COMPANY UTILISING?

19 IF YOUR ANSWER IS NOT 100% TO QUESTION 18, WHAT IS THE REASON FOR NOT USING THE FULL CAPACITY?

20 HAVE YOU MADE ANY CAPITAL INVESTMENTS IN YOUR MANUFACTURING FACILITY SINCE 1994?

Yes No

3

APPENDIX I

21 IF THE ANSWER TO QUESTION 20 IS YES, WHAT IS THE REASON FOR THIS INVESTMENT?

22 WHAT PERCENTAGE OF YOUR PRODUCT CONTAINS IMPORTED MATERIALS/ COMPONENTS?

23 DESCRIBE THE POSITIVE ASPECTS THAT THE MIDP HAS CONTRIBUTED TO YOUR COMPANY?

24 DESCRIBE THE NEGATIVE ASPECTS THAT THE MIDP HAS CONTRIBUTED TO YOUR COMPANY?

25 IN YOUR OPINION, WHAT RECOMMENDATIONS WOULD YOU MAKE TO THE DTI IN TERMS OF THE CURRENT MIDP?

4

APPENDIX I

26 IN YOUR OPINION, HOW DO YOU FORESEE THE FUTURE OF THE COMPONENT INDUSTRY UNDER THE CURRENT MIDP?

5

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