Competitiveness And Diversification Of South African Extractive Firms Economics Essay
Preliminary Thesis Title: An Investigation into Competitiveness and Diversification of South African Extractive Firms in Host Mineral Economies in Sub Saharan Africa
Although much of Africa remains still un-surveyed, there is no denying that the continent is well endowed with mineral resources ranging from hydrocarbons to first rankings in world reserves of platinum groups metals, bauxite, cobalt, industrial diamonds, phosphate rock, gold, and vanadium, and manganese in the world”, (Metals Economics Group 2009). Yumkella (2011) places a “conservative estimate of the current value of the mineral reserve base of Sub-Saharan Africa at US$1.2 trillion’ and highlights the importance of building sustainable development, “using the extractive industries to create competitive and diversified economic growth with positive welfare externalities” in the region.
With new number of prospects found on the African continent, such as the Ghana’s Jubilee field, coupled with the huge commodity demand from China and high world market prices for mineral commodities in the past years, (Stürmer and Buchholz, 2009); a number of resource rich countries in Sub Saharan African (SSA) are set to experience rising export revenues from the extractive sector. This upward insurgency in commodity prices has placed the extractive sector, high on the development agenda. The question that is being raised is whether this boom will result in positive economic development in SSA.
The reason for such pessimistic view follows that despite being resource rich, a number of SSA countries are still largely poverty stricken. In 1980, SSA had one out of every ten poor people. The situation worsened in 2000, with pandemic poverty with one out of every three people now considered poor (Ayivor, 2010). A decade later the future looks bleak for SSA and current projections are predicting that one out of every two poor people will live in Sub-Saharan Africa
The aim of this study is to investigate the economic contribution extractive firms, from a mature mineral economy such as South Africa (hereafter known as regional production base) and the role such regional production base’s extractive firms, play in host economies of developing mineral economies in the region. Due to the scale of its operations, duration, extraction methods, and location, the extractive industry by its nature has significant economic impact in host mineral economies, (Saffer et al 2009). The notion that regional production base could have a positive influence on regional production integration is within context of sustainable economic development; as the sustainable development models are said to support positive regional impacts of mining and the significant part of the economic benefit of mining would be retained in the region in which the rent is generated.
The reason this study focuses on the competition a regional production base’s extractive firm’s face from other international extractive firms, is because South Africa has being one of the largest investors in Africa and it has only recently been challenged by China with its particular focus on resources, (Luiz, 2010). The extractive industry is seen an opportunity for increased economic development, capable of changing trade structure to enable SSA. This would enable SSA to move out of primary commodities, away from heavy reliance in undiversified and vulnerable structure of exports that do not foster economic growth. Chinese firms with support of state or semi state owned enterprises with regards to strategy and capital resources, make a formidable competitor; however their extractive activities are showing signs of reproducing the long-standing SSA pattern, of exporting primary commodities and do not bode well for the sub continent.
Despite being resource rich and having long pursued policies aimed at reducing their dependency on the mineral sector, (Radetzki, 1977), Sub Saharan African (SSA) mineral economies have stubbornly remained primary commodity dependent. The answer being touted to deal with this economic malaise is to some like Humphrey (2002) sustainable development model, due to its emphasis on primarily regional and local regions. To the said Humphrey, the sustainability development model is more appropriate for a resource rich country as it ensures that “the regional impacts of mining and the significant part of the economic benefit of mining is retained in the region in which the rent is generated and in which the disruptive effects of mining are most acutely felt”. While to Bocoum (1999), resource based development is best achieved through “mineral processing as an industrialization strategy”, which could be beneficial to SSA economic development, provided the right policies that support the domestic market are enforced.
According to Eggert (2001), there is no universally accepted definition of mineral economies. The IMF, like Eggert (2001), uses indicators to define “resource-dependent” countries as those with at least 25% of their fiscal revenue, GDP or export earnings coming from non-renewable resources.
Hence for the purpose of this study a mineral economy is defined as one which mineral export represents 25 percentage or more of total merchandise exports. Based on mineral exports as a percentage share of total merchandise exports in 1999, the said Eggert found 9 mineral economies in Sub-Saharan Africa. Eggert’s studies find support from analysis of compositions of commodities traded in SSA that finds a majority of the 54 commodity dependent developing countries are found in region, (Matringe 2006). The European Union Trade Report (2004) puts export earnings of over 20% in SSA as being in less than three soft commodities like primary agriculture commodity, non renewable mineral resources, which constitute the bulk of SSA export.
A large body of literature shows that many mineral economies in developing countries SSA included have “great difficulty in converting mineral wealth to economic development despite high investment rates”, (Bocoum 1999). Extant studies such as Sachs and Warner (1995) have demonstrated significant differences in economic growth rates between resource rich and resource poor countries, finding without exception that resource-abundant countries have stagnated in economic growth since the early 1970s and 1980s. One of the main reasons attributed to difficult in converting mineral wealth to economic development is according to Hirschman (1961), is that “the natural resource sector has no “production linkages” while manufacturing sector does.
With more new mineral prospects found in countries such as Ghana and Uganda to name but a few; Sachs and Warner’s (1995) views that “resource-poor economies often outperform resource rich economies in economic growth” implies that simply implanting capital-intensive mineral projects into immature economies, will distort some of these economies in ways which were, economically and socially damaging, (Humphreys 2002).
Mineral exporting developing countries have long pursued policies aimed at reducing their dependency on the mineral sector, without much success, perhaps as Radetzki (1977) suggests, it would be easier to base the diversification process on the mineral sector itself. The key challenge pertains to many SSA countries lacking the capacity to benefit from production linkages and their challenge is to find productive ways of tapping the large value-added which mining can deliver. To some this hurdle can be achieved by transforming mining activity into a diversified and self-supporting set of economic activities, (Humphreys 2002), such as diversification with far reaching forward integration, from mining into smelting, refining and fabricating and as well as manufacturing of metal containing finished products.
With large mining investments being normally foreign firms, Amin’s, (1974) dependency theory warns of foreign ownership of capital, determined its effect on the host mineral economy. For an economy controlled by foreign capital would not develop organically, but would rather grow in a disarticulated manner, should proper strategies to control economic direction not be implemented (Beer 1999). Mengistu and Adams (2007) find that disarticulated growth occurs because the multiplier effect from demand in one sector in country probably its comparative advantage like a natural resource would create weak demand in another, thereby leading to stagnant growth in the developing countries.
In further support of the above arguments, Yu’s theory of Advantage Integration, (Yu and Rong , 2009) states that, investments from developed economies to developing economies should integrate the quantity or cost advantage of resources in a host developing countries. Yu and Rong (2009) goes on further to state that, a passive combination in host economy has no longevity, as foreign capital and technology has been shown to flight in times of crisis and he terms this flight of “FDI Advantage Clearing-Off”.
To Yu and Rong (2009) passive combinations, are likely to results in profits from capital and technologies investments to flow to foreign firms and its owners, hence the host developing economies do not benefit from the investment and the technology brought in. Here lies the catch, although developing countries are increasingly turning to their minerals wealth as a source of growth and new economic development opportunities, driven by the prospect of higher revenues, (Humphrey 2002); they have to take into consideration that resource extractive firms’ primary motive for going abroad is to control not only the home market but the world market as well. With extractive firms having accumulated advantages that are firm specific technology, experience, financial capacity and their special access to markets, one could argue that their ventures into host economies as an opportunity to exploit these advantages, (Ozawa 1982).
This should not distract to the importance foreign direct investment into a region though, as studies such as Blomström (1986) finds that sectors with a higher degree of foreign ownership exhibit faster productivity growth. Yu and Rong advocates developing countries to actively promote the accumulation of advantages by getting “ownership”, as a means of ensuring that they consistently accumulate their own capital, technology and management know-how advantages through utilizing external advantages. The Advantage Integration framework was developed by Yu to measure China’s miracle economic growth in East Asia Yu and Rong (2009), and is relevant to this study due to Japan’s contribution as a production base to Taiwan, South Korea, Singapore, Hong Kong and the investments they in turn made into China’s economic development.
Metwally (1993) has shown correlation in export led growth models in East Asian countries (South Korea, Singapore, Hong Kong and Taiwan), between regional integration, exports and economic performance. According to Young (1995) who investigated the case of East Asia from the 1960s to early 1990s, found that the spectacular economic growth in Hong Kong, Singapore, South Korea and Taiwan originated in large part from the “reallocation of ‘production process’ from the low productivity agricultural sector to the high productivity industrial sector”, with Japan acting as catalyst for the region.
This occurred as a result of natural process, through the search for competitive edge by firms. In this instance the term ‘production process’ consists of production of various intermediate goods (parts and components), final assembly and has also been referred to as “production integration”, (Hamaguchi 2008). Meaning the production process is physically divided into different units that are united through systematic logistic arrangement also otherwise known as fragmentation in the literature of the international trade.
A structural analysis of production process in intra-regional trade in East Asia showed that East Asian countries have a high share of intermediate trade. Further analysis to determine regional trade in East Asia by class of product, namely finished, intermediate or raw material to determine which class was driving the expansion of intra-regional trade, showed that the proportion of intra-regional trade accounted for by intermediate goods increased rapidly, rising from 42% in 1980 to 60% in 2005, Ayivor (2010). This confirmed that intermediate goods were driving intra-regional trade and the root of economic development in East Asia, was its ability to reallocate its production factors within its region, hence spreading its comparative advantage.
It has been argued that in East Asia regional production integration has been successfully used as the Factory Asia model is not designed as discussed above, but rather developed organically through the natural process of individual firm’s seeking higher productivity using regional production integration. Hence large firm activity was the catalyst for regional integration in East Asia, as they sought to appropriate location, to achieve higher productivity. On could further argue that multinational firms are the decisive contributory actors in the process. Multinational extractive firm activity is evidenced in SSA as well. In 2006, Saffer et al (2009) found that the top ten out of the 230 mining companies’ active in Sub-Saharan Africa controlled 35 percent of global mining and of these South African global mining giants include Anglo American, BHP Billiton, De Beers, (Luiz 2010), to mention but a few.
Unlike East Asia, SSA mineral economies have show that “countries abundant in labor and capital tended to export manufactures, and countries abundant in natural resources tended to export raw materials”, Davis (2009). However the fact remains that East Asia’s regional production integration has been crucial to economic development as it promotes intra industry, trade specialization and results in intra trade in among developing countries, between them and developed countries, Bhagwati and Srinivasan (1983) and Krueger (1990).
This view is supported by North, (1955) statements that successful regions exploit their natural resource distributions and comparative advantages to produce goods with a lower opportunity cost to developed countries experience economic growth, be it abundant labor or natural resources. On premise Bhagwati and Srinivasan with contradictory opinion to Filatotchev and Morrissay (2001) findings of serious implications for trade of exports on marginalized economies, that if products from developing countries continue to be contract suppliers of commodities, they remain marginalized from the global economy as is the case with SSA.
In the past decade the Sub Saharan Africa region has acquired new trade partners mostly emerging economies. Wang and Bio-Tchané, (2008) have placed China as now “Africa’s third largest trading partner after the United States and the European Union”. According to Wang and Bio-Tchané export from Africa to China grew by 40% from 2001 to 2006. Xioa (2010) says in less than a decade, China and Africa’s trade has increased from $8 billion to $86 billion in 2008, averaging an annual growth rate of 35 percent, and said to be higher than China’s overall trade growth rate of 17 percent.
What makes competition from a production base such as China which currently seems stiff and currently insurmountable, is that its Chinese state- or semi-state-owned firms, that are said to be highly active in the resource rich SSA economies, with their access to very low-cost capital operating finance which is specifically highly concentrated in resource rich countries (Xioa 2010). The scholar goes on to submit that, Africa’s raw mineral export, which are inclusive of petroleum and ores and metals, to China have arisen from only 42 percent of its total export and a decade and a half later accounted for 87 percent total exports. Xiao has found a trend of increased export raw mineral from Africa to China is similar to its world exports, which are proportion increase from 56 percent in early 1990s to 67 percent in late 2000s, (Xioa 2010).
With the composition of raw mineral exports traded between SSA and China being the same as SSA’s other trading partners; one could conclude that the current demand for commodities from emerging economies will reproduce the long-standing SSA pattern of exporting primary commodities (Sindzingre, 2008). This pattern of not only exporting primary commodities but also raw minerals speaks to the very structure of the natural resources industries, which have traditionally been concentrated with a handful of oligopolistic firms controlling the vertical integrated production (Ozawa 1982). The general effect of vertical integration within the foreign company is to make mineral resource an internally rather than an internationally traded commodity. Hence they then become subject utilization needs of the international company, as an economic unit rather than to the needs of national economic unit, (Girvan 1967). Girvan goes on to say that this leads to the level and rate of growth of each country’s raw material production as we see in SSA, being determined by:
The particular foreign companies which mine in the host economy;
The share of international markets controlled by these foreign companies;
The share of raw material requirements drawn from the foreign company’s source in that particular host economy.
Significance of the Research
The study will investigate a research problem that will generate results and elucidate this debate, but also add to the existing scholarship on, competitiveness and diversification of regional production base’s extractive firms within mineral economies in Sub Sahara Africa in the context of sustainable development. This researcher has not been able to locate any research study that has considered the economic contribution of regional production base and as opposed to international foreign mining companies whose ownership of and accessibility to facilities that fall outside SSA. This is important to regional production, as ownership that falls outside SSA results in, location decisions which minimize the area’s share in value added and input demand generated (Girvan 1967).
In view of the above literature review, firstly it would appear the problems of mineral dependence in SSA mineral economies are related to how the mining sector and how it is not linked with domestic economic activities in host economies, (Eggert, 2001). Eggert suggests that in such a scenario it would be appropriate to examine the size of the regional production base’s extractive sector relative to the overall economy of the host mineral economy and determine whether at all there is any value added in mineral production as a percentage share of gross domestic product is occurring, speaking to diversification. Still using Eggert’s assumption, with regards to problems of mineral dependence in SSA that originates in international trade and its effects on a national economy, and it would be appropriate to investigate mineral exports relative to total exports (e.g., mineral exports as a percentage share of total merchandise exports in a country.
. On the premise from a theoretical perspective this studies is looking at the extractive industry from regional production integration point of view and also considers the competiveness of extractive firms in the host mineral economies.
Export Based Theory
The European Commission’s Directorate-General Regional Policy report, states that a region’s economic performance and development has been said to depend on the size and success of its export-orientated industries, where a region’s comparative growth depends simply on the growth of its economic base. Therefore export base theory is very relevant to an analysis of extractive industry, primarily because export based theory was formulated to explain the growth of diversified prosperous regional economies based upon the export of primary products rather than upon industrialization (Harris, et al 1998). The theory conceives the economy as comprising two complementary sectors: the ‘basic’ sector is export-oriented and attracts ‘new’ revenue into a region or country, whereas the ‘service’ sector re-circulates such expenditure through the domestic economy
Export-based theory is a regional extension of the basic Keynesian income model and emerged from international trade theory, where the use of economic base models were sought to explain a region's growth through the examination of its inflows and outflows (North, 1955) as cited by Auty (2006). The export-base model is widely used in regional economic analysis and is a widely accepted economic model utilized by economic development practitioners and regional economic policy analysts for regional growth, (Kimbugwe, et al 2010).
Central to the conceptualizing and measuring the impact of economic projects in a region is a tool of export based theory known as ‘linkages analysis’, which is one of three principal tools. The other two, are identified as the economic multiplier and cost-benefit analysis Auty (2006). It has been well noted that linkage analysis provides more flexible and comprehensive approach, as it captures the dynamics of the economic impacts, by providing an explanation for the evolution of the regional economy, (Auty 2006). Bocoum (2000) citing Hirschman (1977) submits that the mechanism of the “export base model can be described in terms of four principal sets of linkages or socio-economic stimuli”, which are:
Backward linkage (the establishment of firms to provide inputs to the export commodity);
Forward linkage (the establishment of firms to process the commodity prior to its export);
Fiscal linkage (the spending of government taxes levied on the commodity);
Final demand linkage (the activities set up in response to the local spending of wages and profits by labour and the owners of capital).
Yu and Rong (2009) submit that, economic development of many countries cannot be attributed solely to a country’s own resource endowment alone. The scholars are of the opinion that high quality and high speed development can be achieved by efficiently linking of integrating advantages from all over the world to the host economy. Therefore the role of a mature mineral economy within a region cannot be understated, as it can constitutes, linkage effect of “integrating advantages”. Meaning the regional base provides or creates certain kinds of “developmental factors”, or economic factors which are good for realizing high level development strategies in host mineral economy of a developing country (Yu and Rong (2009). The linkage effect of integrating advantages can be defined as ability to linking the potential ability of the developing economy to more advantageous advanced economy, that in enables the developing countries to trigger further production integration (Yu and Rong, 2009).
The Witwatersrand region in South Africa is an example of mature mineral economy that has reached the final stage. By final mature stage the mineral economy’s mining sector, “has acted as the catalyst for the emergence of diversified economic region”, (Auty 2006) where mineral export is no longer dominant. South Africa as a mature developing mineral economy with sufficiently diversified into additional commodity exports, services and/or manufacturing” in SSA, (Auty 2006), has a lot to offer other mineral economies in the region.
With regards to how diversified within the extractive sector of a host mineral economy forward and backward linkages will be important to investigate. Particularly forward linkage as it will help determine any truth in Girvan’s (1967) statement that mineral resources produced in host economies by foreign company are not available for processing to host economies companies, but to processing companies in foreign companies’ economies and hence only corporate integration occurs in SSA. Crucial to this, is whether the production process of the mineral resource of the region break into segments and whether these are only related through the structure of the company.
The five-stage sequences to diversification (Watkins 1963), cited by Bocoum (1999) should help measure these integrating factors. This study assumes that the first stage, where a foreign extractive firm identifies minerals within a host mineral economy with potential comparative advantage and begins to export it, has been already achieved. It is the second to the third stage under investigation and only these stages are listed here as follows:
The second stage sees mineral production expand resulting in investment remaining mostly within the mineral export. This yields both internal economies of scale and external economies by improving infrastructure (such as roads, electricity supply) that lower average production costs and further boost the mineral’s competitiveness, (backward linkage) in the extractive industry.
Third stage productive linkages, more investment in the host mineral economy to undertake processing prior to export, such as refinery, smelter or fabricating plant, (forward linkage).
This study is concerned with whether South Africa which has economically diversified through its mineral resources can provide the same impetus to the SSA region’s economic development. To Martin (undated) reporting in the EU Cohesion Policy report, a nation or region may be composed of “highly competitive firms in the microeconomic sense but if these firms are engaged in activities that create low value-added per worker, and this does not make the economy competitive in the macro-economic sense”. On the premise contribution to the region by extractive firms should have an impact by lowering average production costs and further boost the host mineral economies’ competitiveness.
In keeping with Porter (1998) definition of ‘cluster of economic activity’ as a geographical area or spatial economic unit in which a particular resource is present, the extractive industry in Sub Saharan Africa was chosen due to the significant concentration of economic activities focused in the mining sector in the region. Being a broad concept, cluster enables competitiveness to be situated at the core of regional analysis; specifically the meso- cluster level of analysis, enables study emphasis on inter- and intra-sectoral linkages of a extractive industry within the mineral economy, (Economic Commission for Africa, 2004).
So as per the above mentioned Economic Commission for Africa report, an extractive firm evaluation and analysis is chosen as it is suited to review the strategic competitive advantages of the extractive industries in the region. This meso cluster evaluation will then determine what the economic contribution the foreign firms, producers, customers and competitors, who are in geographical proximity or linked by complementary expertise, bring to SSA in terms of efficiency and increased specialization.
Both a hybrid of qualitative and quantitative approach will be used in this research as the research objectives inherent to this study, necessitates a flexible and comprehensive approach. Anticipating that some mineral economies might lack of data, this study will rely on both survey data and international-trade data. A semi-structured interview survey process consisting of written questionnaires will be used. Where possible, follow up interviews will be undertaken to significantly test firms’ intentions and what is happening on the ground.
The survey will be conducted on firms selected from listed members of Chamber of Mines of South Africa (COMSA) and also firms listed mining associations of the host mineral economies. The data will be collected through 2012 and obtained for the period 2000 and 2009. To expand the dataset sufficiently to enable a robust statistical analysis, anticipating possible limited survey response, supplementary and consistent data will be sourced from other publications such as of the Johannesburg Stock Exchange and other sources.
This study will compare the export performance of a sample of foreign extractive firms from South Africa and China in SSA mineral economies in 2000 and 2009, using descriptive statistical techniques. The study will also examine the expansions and or future plans of expansion with regards to production processing in mineral exports by the said firms exports and their contribution to the changing comparative advantage of SSA extractive sectors, through change in trade structural changes.
An ex post approach that uses historical international trade data will be used to conduct trade flows analysis, through the assessment of trade patterns and/or trade performance. Trade performance analysis would allow export trade performance to be measured through an analysis of growth and pattern in the direction of trade, composition of trade and export concentration and principal products by the extractive firms. The competitiveness assessment would not only look at competitiveness but also at specialization and complementarity of the export trade in the region. This would be achieved by analyzing international competitiveness of exports, determining the export specialization and trade complementarity and intensity in the region.
The data source and data type this study intends to gather and expound upon is data on SSA mineral economies and worldwide exports by industry extracts from the data portal World Integrated Trade Solution (WITS). WITS are maintained by The World Bank in close collaboration with the United Nations Conference on Trade and Development (UNCTAD). The ultimate source of the exports data is Commodity Trade (COMTRADE).
Research Questions and Objectives
The objective of this study is to determine how competitive and diversified South African extractive firms are compared to Chinese extractive firms are in mineral economies of SSA. The sub objectives of this study to be determined include:
The percentage share of mineral exports accrued to South African and to Chinese mining firms in the mineral economy.
The product type of mineral exports South African and to Chinese mining firms in the mineral economy.
The percentage of minerals exports accruing to South Africa and China to total exports of the mineral economy.
In order to achieve objectives of this study the following questions will have to be answered:
In which Sub Saharan African mineral economies are both South African extractive firms Chinese extractive firms found?
What is the share of international markets controlled by these foreign firms?
What is the share of raw material requirements drawn from the foreign company’s source in that particular host mineral economy?
Are the mineral resources produced in host economies by foreign company available for processing to host economies companies, or are they for processing companies in foreign companies’ economies?
Is production process of the mineral resource by foreign extractive firms broken into segments and whether these are only related through the structure of the company?
Are any of the extractive firms mining activity that undertakes processing prior to export?
What is the overall impact of the production base on regional production integration in the extractive industry?
Can the advantage integration of regional production base to host mineral economies increase SSA’s lead to competitiveness and increase regional production integration that can lead to successful economic development trajectory?
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