South Africa government's support of the automotive industry: prospects of the productive asset allowance

Abstract

In 2000 the South African Government introduced an investment incentive for the automotive industry, the Productive Asset Allowance (PAA). This was intended to support the objectives of the Motor Industry Development Programme (MIDP). This paper presents an empirical assessment of the PAA's prospects for supporting the competitiveness of South Africa's automotive industry. It provides a historical overview of the MIDP and the introduction of the PAA and analyses industry performance data on investment and competitiveness from 1998 to 2004. The findings reveal that while the industry succeeded in increasing exports, the share of domestically produced vehicles in the local market decreased. Moreover, investment in R&D, as an indicator for future competitiveness, was insignificant. The offer of a generic investment incentive like the PAA seems to have a significant and positive effect on industry investment, but limited ability to support long-term industry competitiveness through R&D and innovation.

1. Introduction

After almost seven decades of protection through high tariffs and stringent local content requirements, South Africa opted for a gradual liberalisation of its automotive industry in 1995 (Barnes, 2000; Black, 2001). The Motor Industry Development Programme (MIDP) provided the framework for the liberalisation process. In lifting the protective measures, the government exposed the industry to global competitive pressures, together with international trade obligations (Bell, 1997; Barnes, 2000). The government was to review the MIDP periodically to ascertain that the industry was on the right path of graduation to international competitiveness. Based on the industry's performance in the first five years of the MIDP, the then Board of Tariff and Trade (BTT), now the International Trade Administration Commission (ITAC), recommended the introduction of an investment incentive for the industry – the Productive Asset Allowance (PAA).

Investment incentives can be broadly defined as financial or fiscal inducements provided by national or regional governments to encourage investors to establish presence, to expand existing business, or not to relocate elsewhere (UNCTAD, 2003). Two of the most common categories of investment incentives provided to investors are:

• Financial incentives, such as cash grants to an investor, and

• Fiscal incentives, such as tax holidays and tax rebates based on specified criteria.

There are other non-categorised incentives, which may take the form of subsidised infrastructures, services, market preferences or regulatory concessions.

Globally, incentives are one of the policy tools used to attract inward investment by national governments. According to the United Nations Conference on Trade and Development (UNCTAD, 2003), the number of countries granting investment incentives and the range of possible incentive measures has increased since the 1990s. Many developing countries opt to offer fiscal incentives because they cannot afford outright financial grants. For the last ten years South Africa has actively used fiscal incentives to support its automotive industry.

The PAA is such a fiscal incentive. It was introduced in 2000 to support automotive investment in state-of-the-art productive assets as a means of attaining global competitiveness. Vehicle manufacturers who wanted to benefit from the PAA had to reduce the number of models manufactured domestically. It was envisaged that such rationalisation of production would reduce average production costs and make the industry more competitive. Starting as a relatively small incentive, the PAA has attracted interest as a viable and sustainable means by which the government can support the automotive industry in the light of the potential challenges of MIDP demand-side incentives. Demand-side incentives give undue advantage to industry in the sale of its products in a particular market; as such they are considered market distorting. A government offer of import rebates based on the value of exports is an example of a demand-side incentive. There is, however, limited understanding of the PAA's potential to meet the industry's competitive objective as a stand-alone incentive or jointly with other industry support mechanisms.

The study on which this paper is based was aimed at contributing to this understanding. This first section provides a brief historical overview of the MIDP and analysis of the subsequent introduction of the PAA. Section 2 presents the MIDP, the formal policy framework guiding the South African automotive industry. Section 3 looks at the objectives, structure and operational aspects of the PAA. Section 4 analyses the type of investment that has benefited from the PAA, with the focus on performance parameters that indicate the industry's progress towards competitiveness. Section 5 presents insights from the study and Section 6 concludes.

2. The Motor Industry Development Programme (MIDP)

In 1992, the South African Government appointed the Motor Industry Task Group (MITG), a special team of industry experts, to advise it on long- and short-term strategies for the future of the automotive industry. This appointment was necessitated by the challenges of and limitations to local content requirements as a policy tool for sustaining industry growth in a liberalised trade environment. The South African Government had legislated local content requirements as an incentive for the development of the local industry. Domestic vehicle manufacturers could offset part of the excise duties, based on the level of local content used (thedti, 1994).

In 1994, the Board of Tariff and Trade was tasked to formulate a revised customs dispensation programme for light and heavy vehicles. The new dispensation had to consider the initial MITG report and provide feedback thereon. The BTT's final draft of the revised customs dispensation for the motor industry was adopted and implemented as from 1 September 1995. The revised dispensation came to be known as the Motor Industry Development Programme of South Africa. In contrast to the previous inward-looking policy stance used by the government, the MIDP focused on industry liberalisation. The programme stipulated a phased duty reduction on both vehicles and components as a means of opening up the domestic market, while allowing the industry time to adjust to competitive pressure from imports (Table 1).

Table 1: MIDP phase-down of customs import duty for vehicles and vehicle components for light vehicle, medium and heavy vehicle categories

Effective date	Light vehicle segment		Medium and heavy vehicle segment
	Vehicles (%)	Components (%)	Vehicles (%)	Components (%) – Engines
1 January 1995	65.0	49.0	40.0	50.0
1 January 1996	61.0	46.0	37.5	45.0
1 January 1997	57.5	43.0	35.0	40.0
1 January 1998	54.0	40.0	30.0	35.0
1 January 1999	50.5	37.5	25.0	30.0
1 January 2000	47.0	35.0	20.0	25.0
1 January 2001	43.5	32.5	–	–
1 January 2002	40.0	30.0	–	–
Source: thedti, 1995.

To further support the competitive objective and participation in global business, the MIDP detailed that:

• A 35 per cent duty-free allowance on imported industry inputs becomes effective.

• Local content requirements cease forthwith.

• International trade duty rebates be introduced. Firms in the industry could earn the rebates based on their export volumes and foreign exchange earned.

• A small vehicle incentive in the form of an additional duty-free allowance be granted to OEMs (Original Equipment Manufacturers) in respect of motor vehicles below a net ex-factory selling price of R40 000. The incentive was to be phased out over a period of three years. (thedti, 1994)

These recommendations constituted the first MIDP. The overarching objective of the programme for light vehicles was to improve industry competitiveness to such an extent that it would survive in the long term under less protection. For the heavy vehicles category, the programme aimed to reduce the costs of such vehicles, with a commensurate reduction in the cost of inputs used to manufacture heavy vehicles (thedti, 1995). The programme had to be reviewed periodically, to minimise deviations from the intended objectives. Although there have been changes in the levels of duties payable, the calculation of rebates and the introduction of new incentives, industry competitiveness remains the main focus of the programme.

3. The Productive Asset Allowance (PAA)

The PAA is an import rebate earned by manufacturers of specified light motor vehicles who are registered with the South African Department of Trade and Industry (thedti) under the MIDP. Investment in productive assets by component manufacturers may qualify for the incentive as long as the components to be produced are supplied to a PAA-qualified vehicle manufacturer for fitment into PAA-based vehicle. The main motivation for the PAA's rationalisation requirement was to encourage manufacturers of specified light motor vehicles to reduce the proliferation of light motor vehicle models produced by importing low volume niche products rather than attempting to produce these models domestically. Rationalisation would also support the localisation of original equipment components for fitment to these rationalised models and for export (thedti, 2005). It was envisaged that, in the process, volumes per local platform would increase, average production costs would decrease and, consequently, local industry competitiveness would be promoted.

The incentive is calculated on the value of investment in productive assets. Vehicle manufacturers in the Southern African Customs Union (SACU) receive 20 per cent of the value of their investment. The benefit is spread over a period of five years at 4 per cent per annum. For component manufacturers investing in the SACU region, the instrument provides for an effective 16 per cent of the value of capitalised productive investment via a client vehicle manufacturer. If a vehicle manufacturer were to invest R100 million in qualifying productive assets, for example, he would qualify for R20 million worth of Import Rebate Certificates (IRCCs). He would receive R4 million in import rebates per year for five years. If a component manufacturer were to undertake the same value of investment, the investment would still qualify for R20 million worth of IRCCs, but receivable via a consenting vehicle manufacturer. The vehicle manufacturer is obliged, according to the PAA statute, to pass on to the investing component manufacturer 80 per cent of the value of the IRCCs. Effectively, the component manufacturer would receive rebates worth R16 million spread over a five-year period. The PAA is non-tradable between vehicle manufacturers and may be used only by approved motor vehicle manufacturers to import specified light motor vehicles.

3.1 Criteria for approving projects for the PAA

Apart from investing in productive assets that may take the form of land and buildings, plant, machinery and tooling, or capitalised R&D, applicants have to show how the investment would support MIDP objectives. Applications are holistically assessed based on the following:

• Substantial increase in production levels for existing vehicle manufacturers. For new manufacturers, production levels of at least 20 000 units per platform have to be reached within two years of the commencement of production.

• Support for local manufacturing through sourcing of components from domestic manufacturers.

• Contribution towards reduction in net foreign exchange use in the industry.

• Support for consumer benefits. One way of supporting consumers is by making available quality vehicles at affordable prices.

• Contribution towards employment and technology enhancement.

Adjudication on the qualification of an asset under the PAA is based on whether an asset is seen as productive, new and related to an approved project. The value of the productive asset is based on the capitalised value in the balance sheet. Rented and leased land and buildings may be capitalised according to generally accepted accounting practice. Where the actual asset value of the total project exceeds or is projected to exceed the approved amount, the applicant would be required to make a supplementary application to the Department of Trade and Industry.

The PAA is mutually exclusive with any other investment incentive provided in the SACU region. Manufacturers from the region obtaining investment incentives from their respective governments are be excluded from the PAA for the investment in question. Investors may opt for alternative incentives whenever they perceive that the alternative incentive offers superior benefits to the PAA.

3.2 PAA applications and claiming process

To access the benefits of the PAA, qualifying vehicle and component manufacturers have to submit an application to the International Trade Administration Commission. Applications have to reach ITAC six months prior to commencement of production. In addition to a formal application, applicants have to submit a five-year business plan outlining company details, investment schedule, employment, production, marketing and supplier development plans. Financial information showing projections for a period of five years from the commencement of the project must also be provided. ITAC evaluates projects on whether the planned investment contributes towards the realisation of MIDP objectives. Project approval is adjudicated in a holistic manner; an application can only be turned down based on inadequately projected performance.

As the project is implemented, information submitted at the application stage forms the basis for future decisions when issuing certificates for subsequent years.

Claims for the PAA can only be submitted after the approval of the project. This approval ensures that rebates will be received on qualifying investments undertaken and within the maximum capitalisation value allowed for the project. Assets in a claim for a particular year of capitalisation have to be audited. The claim must be accompanied by an external auditor's unqualified report. A claim should contain sufficient information on invested assets and project performance, presented in a way that allows for technical assessment by a qualified engineer. ITAC appoints engineers to inspect investment sites and ascertain that the claimed investment has taken place and thus qualifies for the PAA. Based on the information provided in the claim, an external auditor's unqualified statement and an engineer's report, a decision is made on whether to issue certificates.

For each year of capitalisation a separate claim has to be submitted. Claimants have to provide updated information on their business plan, company ownership, most recent financial statements and a tax clearance certificate before each subsequent year's 4 per cent certificate is issued. The issuing of subsequent annual certificates could be terminated if there are significant performance deviations from information submitted in the business plan at the application stage. Claimants are required to motivate performance deviations of more than 10 per cent.

4. Investment Under The PAA

The PAA was introduced in 2000 but investment as far back as 1996 was eligible for the incentive. A wide range of investments, including advanced production equipment and world-standard water-based paint plants, have benefited from the PAA. By 2004, the incentive had attracted 31 applications for investment amounting to R10.5 billion (thedti, 2004).

The nature of investment undertaken has a bearing on the process towards achieving competitiveness by an industry. According to Waddock & Graves (1994), R&D investment as opposed to capital investment is associated with improved industry competitiveness. Investment in plant, machinery and tooling is important for realising firms’ short- to medium-term profitability, but in the long run it is the R&D investment and the subsequent potential to innovate that is likely to determine industry competitiveness (Lee, 2000: 493; Koschatzky et al., 2001: 312; Taymaz & Ozcelik, 2004: 410; Fan, 2006: 367). R&D investment intensity can also indicate firms’ willingness to commit themselves to new products and improved processes within a particular location (Waddock & Graves, 1994: 4). By deciding to undertake R&D and innovative activities, enterprises signal the importance they attach to a location in terms of future competitive strategy.

Investment in R&D is one of the main determinants of innovative capacity. For a domestic automotive industry to continue supplying automotive products competitively, it has to keep pace with the ever-improving technological specifications of global automotive vehicle manufacturers. Innovation is a critical element in achieving production processes and resultant products that meet global standards (Koschatzky et al., 2001: 312). To offer an industry investment incentives and an increase in investment does not guarantee support of the industry's competitiveness objective. The offer of non-targeted investment incentives can even potentially lead to enterprises switching to less costly technological investment that yields quicker returns on investment in the short run at the cost of long-term competitiveness (Zhu et al., 2006: 51). The nature of investment that has taken place under the PAA dispensation can, therefore, provide insights into the extent to which the PAA is helping to realise the competitiveness objective of the South African automotive industry.

For the period 1998 to 2004, investment in plant, machinery and tooling constituted more than 80 per cent of the vehicle manufacturers’ total annual investment. Investment in support infrastructure that included R&D was less than 10 per cent of total expenditure (Table 2). Land and buildings accounted for the rest of the investment. Moreover, the bulk of the investment categorised as investment support infrastructure was related to technical fees paid to foreign experts who provided specialised services at the launch of new models in the country.

Table 2: Investment expenditure, domestic market and export share of vehicle manufacturers 1998–2004

Year	Investment (Rm)^1	Investment in support infrastructure (incl. R&D) as % of total OEM investment	Investment in plant, machinery and tooling as % of total OEM investment
1995	847	9.2	86.6
1996	1171	11.1	85
1997	1265	8.8	81
1998	1342	10.4	85.2
1999	1511	7.6	87
2000	1562	9	83.9
2001	2078	11.8	86.6
2002	2726	9.6	84.8
2003	2325	8.3	85.5
2004	3577	10.1	86.9
Source: thedti, 2004; NAAMSA, 2001–06.

Since the inception of the PAA, investment in the industry has accelerated. Between 2000 and 2004 total investment increased more than twofold. However, corresponding investment in R&D activities has been minimal. Most importantly, there seems to be no evidence that the incentive is supporting industry innovation. The low level of R&D in the automotive industry seems to be in line with the findings of the South African Innovation Survey of 2001 (Oerlemans et al., 2003) which showed that 51 per cent of firms in the country were not engaged in R&D in terms of persons working internally on R&D activities (Table 3). On average, firms in South Africa allocated less than 2 per cent of their annual turnover to R&D innovation activities (Oerlemans et al., 2003). The percentage of gross domestic expenditure on R&D has remained below 1 per cent of the country's gross domestic product, lower than most developed countries (DST, 2005).

Table 3: R&D intensity classes 2000

R&D intensity∗	Percentage of firms	Cumulative percentage
0%	51.2	51.2
0.01 to 1.50%	14.9	66.1
1.50 to 3.00%	16.9	83
3.00 to 4.50%	8.9	91.9
4.50 to 6.00%	1.4	93.3
6.00% or more	6.7	100
∗R&D intensity refers to the percentage of workers in the total workforce of an organisation performing R&D activities.
Source: Oerlemans et al., 2003.

Considering the type of investments that have benefited from the incentive thus far, as well as the national effort towards R&D, the potential of the PAA to support the industry's progress towards sustainable global competitiveness appears to be weak.

In terms of actual industry competitiveness, industry performance indicators show mixed results. According to the European Competitiveness Report (EC, 2004), competitiveness can be defined as the ability of an industry to defend and/or gain market share in open markets relying on the price and/or the quality of its goods. Common indicators for assessing industry competitiveness include the growth rate or increase in domestic market share of locally produced vehicles and export growth rates (Narayanan, 1998: 219). The weak support of the competitiveness process by the PAA is compounded by the seemingly diminished industry competitiveness.

The domestic market share of locally produced vehicles decreased from 93.2 per cent in 1995 to 71.6 per cent in 2004 (Table 4). According to Auto Insight (2006: 21), the sale of locally produced vehicles increased by only 19.6 per cent, while the sale of imported cars increased by 155 per cent from 2004 to 2005. On the other hand, the industry realised reasonably high growth rates in vehicle exports between 1997 and 2001 (Table 4), indicating that more automotive products from South Africa were being put on the global market. In the context of the automotive industry in South Africa, however, export growth rates can be a weak proxy for international competitiveness. The offer of export-based import rebate credit certificates, as an incentive under the MIDP, cushions domestic vehicle manufacturers from competitive pressure. Although the increase in exports is a desirable effect of the MIDP, one has to take into account the government support received for exports before one can make a statement about industry competitiveness based on an increase in exports.

Table 4: Domestic market share of locally produced vehicles and vehicle export growth rate of the South African automotive industry

Year	Domestic market share of locally produced vehicles (%)	Vehicle export – Annual growth rate
1995	93.2	–
1996	88.7	− 26.7
1997	85.6	69.4
1998	81.1	32.3
1999	81.5	130.6
2000	81.3	13.9
2001	77.9	59.2
2002	75.8	15.7
2003	77	1.1
2004	71.6	− 12.8
Source: Calculations based on NAAMSA, 2001–06.

It should, however, be noted that the PAA has played a role in supporting the industry rationalisation process. To the extent that rationalising production can contribute to industry competitiveness by reducing the average costs, the PAA may have indirectly supported industry competitiveness. Applicants for the incentive have to present a business plan in which they state their planned rationalisation process. The issuing of subsequent certificates depends on performance deviating minimally from or showing an improvement on the initial projection. Effectively, the PAA provided a mechanism through which the government could observe some details associated with the performance of vehicle and component manufacturers towards achieving MIDP objectives. Since the inception of the PAA, the number of model platforms for qualifying vehicle manufacturers has decreased from 31 platforms with an average annual volume of 9500 units per platform in 1996 to 18 platforms with an average annual volume of 24 500 units per platform in 2004. Nevertheless, despite the increase in domestic vehicle production, the market penetration of imported vehicles leads one to question the extent to which realisation of higher production volumes through the rationalisation process can translate into industry competitiveness.

It should be acknowledged that the low rate of attracting R&D activities in South Africa could be attributed, in part, to the strategic tendency of parent vehicle manufacturing companies to centralise such activities at their headquarters. To change the status quo, South Africa may have to encourage and incentivise technological alliances between local firms and international research entities that already have closer working relationships with the global vehicle manufacturers. This could open up opportunities for some of the R&D activities to be outsourced to the country.

5. The PAA as an Industry Competitive Incentive

The PAA does not operate in isolation from other MIDP incentives and the general automotive policy framework in South Africa. The theoretical underpinnings of the MIDP are complex and the dynamic relationship between various incentives and industry performance indicators is unclear. It is quite difficult to identify the cause and effect of the various industry variables of the MIDP policy framework (Flatters, 2002; Barnes & Black, 2003; Bell & Madula, 2003), and the PAA adds to this complexity. To make an unqualified statement about the effectiveness of the incentive requires for a start untangling the complexity of all the factors at play in the industry. This process could benefit from the introduction of a systems approach to the model behind the MIDP and the use of system dynamics modelling techniques to simulate industry outcomes under various government support scenarios. A systems approach takes cognisance of complexity emanating from the interconnectedness of actions and outcomes, while system dynamics modelling provides the means for making sense of such complex situations.

The immediate industry variable that the PAA has an impact on is the level of industry investment, yet the offer of investment incentives alone is not a significant determinant in the local investment decision in the automotive industry (Rhys, 2000). The reasonable investment by global OEMs in the South African automotive industry, despite comparatively low levels of investment incentives, attests to the fact that some other fundamentals necessary for attracting investment could be in place. Again, the increase in investment does not guarantee industry competitiveness.

Most importantly, the South African automotive manufacturing industry cannot be viewed in isolation from global automotive dynamics. With the automotive industry so highly integrated globally, national sovereignty is almost inapplicable. One can no longer talk of a South African automotive industry but rather of the automotive industry in South Africa (Rhys, 2000: 1). The structure and trends in the global automotive industry reveal that continued participation in and benefit from the global value chain will depend on the extent to which entities at each level of the industry hierarchy enhance their productive capabilities to meet increasing demands placed on them by the market dynamics. Local vehicle manufacturers will operate according to strategies set by their parent companies in the developed world. Component manufacturers will carry the biggest share of investment activities. In South Africa most industry investment is made by vehicle manufacturers. This may have to change if the industry is to align itself to global trends. In the future, strategic access to vital core competencies will play a major role in the survival of global automotive business, as will building lasting relationships with the right partners. The overall success of the PAA depends in part on how it will fit in with and affect global automotive dynamics at play in the domestic industry.

6. Conclusion

Sustainable industry competitiveness is achieved by advanced technology, and developing such technology is costly in terms of time and financial resources (Zhu et al., 2006: 66). The offer of an investment incentive may not be influential enough to motivate a profit-oriented industry to invest in R&D and innovation activities. This seems to be the case with the PAA for the South African automotive industry. The industry has increased its investment in production equipment and tools just to produce vehicles and components to meet the international standards, but with no visible effort to improve the status quo. The offer of a generic investment incentive like the PAA seems to have a significant and positive effect on industry investment, but has revealed a limited ability to support the process of long-term industry competitiveness through R&D and innovation activities.

The success of the PAA in supporting the competitiveness objective of the South African automotive industry will ultimately depend on the extent to which the incentive will help integrate the local industry into the global value chain. Trends in the global automotive business reveal that the acquisition of technological capabilities to meet ‘new’ supply requirements and market requirements will be a decisive factor in this regard.

Additional information

Notes on contributors

Jasper L Steyn∗

∗ ∗Respectively, PhD candidate, Institute for Technological Innovation, University of Pretoria; Professor, Institute for Technological Innovation, University of Pretoria; and Professor, Faculty of Engineering, Built Environment & Information Technology, University of Pretoria.

Notes

^∗Respectively, PhD candidate, Institute for Technological Innovation, University of Pretoria; Professor, Institute for Technological Innovation, University of Pretoria; and Professor, Faculty of Engineering, Built Environment & Information Technology, University of Pretoria.