Industrial policy interventions with unintended consequences

Scrap generators are effectively subsidising their customers.

One of the sectors in the South African economy where the unintended consequences of government intervention is best demonstrated is the scrap metal industry, XA Global Trade Advisors’ second and final report on the scrap metal industry notes.

Government is offering a wide range of incentives to boost local demand for scrap metal by suppressing the price in an environment where supply is shrinking. The lack of supply is due to the distress of the main suppliers.

ADVERTISEMENT CONTINUE READING BELOW Read: Serious accusation about government intervention in scrap metal market Scrapmania fined for illegal scrap metal exports

The report points out that “state-owned enterprises are in trouble, manufacturing is a disaster, construction companies are failing, mining is in decline and households are buying less, which means fewer washing machines and stoves are being scrapped”.

The main incentives driving demand are the Price Preference System (PPS), export duties on scrap metal, and preferential finance from the Industrial Development Corporation (IDC).

Price controls

“In a normal market, when demand increases, but supply remains static, prices rise. The price controls around scrap mute that important signal and so the market is not responding and increasing supply,” the report notes.

Scrap suppliers in effect subsidise the consumers of their products (mainly the mini-mills).

“We transfer around R8.5 billion a year in value from the scrap generators, mostly going through recyclers and ending up with the mini-mills. That is a fairly meaty transfer of value by way of the price preference system,” says Donald MacKay, CEO of XA Global Trade Advisors.

The PPS (effectively a discount of between 10% and 30%) was supposed to be replaced by the export duty (ranging between 10% and 20%) but has been extended for a few more years.

Export duties remove around R460 million per year from the economy.

Another driver is “friendly” financing (or policy-driven lending, as MacKay describes it) from the IDC to increase demand. While ArcelorMittal SA (Amsa) has a market cap of around R1.5 billion, the state-owned IDC has a R14 billion exposure in the market.

“There is something wrong in that space,” says MacKay.

The report notes that R3 billion (3.2%) of the IDC’s total book is currently in business rescue, but of that, R2 billion (66%) are scrap consumers (like the mini-mills).

Cheap local steel

The argument by the mini-mills is that it is better for South African consumers to buy cheap local steel rather than cheap imported steel. “And for just a moment, that almost sounded logical.”

The people who never complain about subsidies are the people receiving them. The pain is always felt by the competitor to the subsidised product, in this case, Amsa, the XA Global report adds.

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“When China (or anyone else) subsidises their steel sector local producers have access to the World Trade Organisation’s countervailing remedy, designed to allow the importing country to impose duties large enough to offset the effect of the subsidies, but this remedy is not available against subsidised competition in the domestic market.”

So how is Amsa supposed to compete against a “China on its doorstep”, asks MacKay.

Shifting the risks and costs

In 2021 more interventions were introduced. Scrap metal sellers have to transport the scrap to the buyer at no cost to the buyer. According to XA Global, transport companies are reluctant to allow scrap metal dealers to use their trucks as it damages their vehicles.

A typical load of scrap will weigh between 27 and 34 tons and will cost around R1 000 per ton to transport from Cape Town to Johannesburg and around R500 per ton from Bloemfontein or Durban.

Transnet used to sell its scrap on auction but must now sell directly to consumers – dramatically reducing its potential market and dropping the value of what it can recover.

“Yet another entity that is capital-hungry at the moment but is subsidising a sector that is unable to wash its own face,” says MacKay.

Solutions?

The report highlights three solutions offered by Dani Rodrik, member of the presidential economic advisory council, that will make industrial policy succeed:

1. Incentives should be provided only to “new” activities where “new” refers to both products that are new to the local economy and to new technologies for producing an existing product.
2. There should be clear benchmarks for success and failure. In the absence of a clear idea of what constitutes success and observable criteria for monitoring it, failures can get entrenched.
3. There must be a built-in sunset clause. This will prevent resources being tied up in activities that are not paying off.

MacKay says there seems to be a willingness from leaders in the government of national unity to be more open to discussions on the unintended and damaging consequences of policy interventions on the economy.

Read: Decision on scrap metal trade restrictions taken in ‘bad faith’ [Jul 2021] South Africa proposes 6-month ban on scrap metal export to fight theft, vandalism [Aug 2022] SA approves measures to restrict trade in scrap metal [Nov 2022] SA extends ban on scrap metal exports by six months to curb theft [Jun 2023]

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