Background: The ‘second economy’ debate

Structural inequality and its impact on economic opportunities on the marginsPart 1Kate PhilipTrade and Industrial Policy Strategies (TIPS)Presentation to the Portfolio Committee:Rural Development and Land Affairs9/11/2011

Background: The ‘second economy’ debate • Origins of this analysis in ‘the Second Economy Strategy Project,’ an initiative of the Presidency based in TIPS. • Second Economy Strategy Framework approved by Cabinet in January 2009. • The concept of two economies resonated - and became widely used - because it seemed to explain SA’s stark disparities; • But in the process, it masked the extent to which inequality of outcomes are consequences of common sets of processes. • The ‘second economy’ is not poor and undeveloped because it is disconnected; instead, it is the terms of the connection that are the problem: • The 1913 Land Act was not about keeping the bantustans ‘separate’ or disconnected; it was about forcing black people off the land and into urban labour markets: it was about ‘linking’ them to the core economy on disadvantagous terms. (And it worked). • The issue is one of power and distribution: manifest as inequality. • Despite the concept fading from fashion, much development strategy is still implicitly based on the notion of ‘two economies.’

In SA, structural inequality has its roots in key legacies of apartheid (and pre-apartheid policies also): • The structure of the core economy: highly concentrated, increased vertical integration. • The legacy of spatial inequality: bantustans and apartheid cities: • These add huge economic costs, borne disproportionately by the poor. • The history of inequality in human development and human capital formation.

Inequality frames economic marginalisation Economic Marginalisation Deepens Poverty Social alienation Spatial Inequality Inequality of Human Development Structure the of Economy = + + • Strategies to address inequality need to frame strategies to address economic marginalisation • SA is not a poor country. Poverty is in large part an outcome of how political power was used – in quite explicit ways - to impact on distribution. • Addressing poverty includes the same challenge.

Economic Marginalisation Deepens Poverty Social alienation Spatial Human Capital Structure of Economy = + + • This presentation is focused mainly on how the structure of the economy impacts on opportunities on the margins • How spatial inequality compounds the challenges • And what that means for strategy – and rural development strategy in particular.

Starting in the core economy • The South African economy is highly centralised, capital intensive and dominated by a set of monopoly industries: with consequences for economic development strategies. • Capital intensive industries exclude SME participation and make employment creation expensive. • The focus of policy has been to try to address this within the core economy: • through the introduction of effective competition policy, • the reduction of protective tariffs where these protect vested interests; • Sector strategies to support new industries and activities • Attempts to challenge import parity pricing • and a focus on black economic empowerment to break up the tight hold on racial ownership at the centre. • But these issues matters on the margins also: • The structure of the core economy impacts on even the most survivalist subsistence activities.

Which brings us to a key policy conundrum: • Why is the informal and micro-enterprise sector in SA so small when unemployment is so high? • Why is the informal sector so dominated by retail? • Where is small-scale manufacturing? Where are services? • Why are the returns so low? • And why does money circulate so little in marginal local economies? • The answers typically focus on these issues: • Skills • Levels of entrepreneurship • Access to credit, capital • Easy of entry, regulatory barriers • These do matter. But some of the answers also lie in understanding the impacts of structural inequality on economic opportunity on the margins

Structures of production, distribution and demand • Markets in marginal areas are ‘thin’ • Poor people buy a limited basket of consumer goods. • Most of these are mass-produced in the core economy, at a scale that makes it hard to compete on price, even taking into account the cost of distance; • Legacy of sanctions and forex control? • Distribution systems are efficient enough to reach even remote areas; • Branded goods (and branded stores) provide quality assurance • Advertising impacts on aspirations Small scale producers have to compete in relation to price, quality and brand recognition. It’s very hard. It’s not always possible…..

A typical sewing co-op • There are 20 people in the project; • They aim to earn R500 a month. • This means the project must pay R10,000 a month in wages. • Let’s say wages are 25% of the cost of the dresses they make - with materials and other costs making up the rest of the costs. • This means they must sell dresses to the value of R40,000 each month – every month - to break even and pay themselves R500 each. At R100 per dress, they must sell 400 dresses a month. If the dresses cost less, they must sell more. • If the group is reduced to just five members, they must still sell 100 dresses every month to earn R500 each. If they aim to earn R1,000 each, all of these figures must double. • In most poor areas, achieving sales at this scale is hard. • And Jet and Pep Stores are just down the road….

What about agriculture? • There are local markets for fresh produce: although markets are thin and returns are low here too. • But the history of land dispossession, land degradation, coupled with rising returns to migrancy resulted in major de-agrarianisation of SA’s rural/former bantustan areas: • Less than 50% of rural households engage in agriculture • OF THESE: • Only 1.1% do so as their main source of income • Only 2.8% do so even as an extra source of income. • Only 6.2% do so as their main source of food. • 87% of households are dependent on store-bought maize all year round. (LFS Survey 2004 in Aliber) • SA’s rural areas became labour-sending areas for mines and industry. But now that there are fewer jobs in these sectors: there is no easy return to the land: nor is there easy access into agricultural markets.

Deagrarianisation: often economically rational • While land productivity in ex-bantustans declined, the returns from migrancy were increasing: until decline in jobs. • Availability of cheap agro-processed products raises the relative risks of own crop production: • Weather and water • Goats, unfenced livestock • Theft • Availability of cheap agro-processed products- and fresh produce - limits scope for market entry and disincentivises production of surpluses. • Where poverty is high, agriculture involves a trade-off between eating today and (maybe) eating in 2-3 months time. • Unequal institutional development between commercial areas and ex-Bantustan areas raises costs and risks.

Access to agricultural markets: this space is taken • The traditional approach to rural development and improving farm incomes in poor countries is to assist farmers to go up the value chain by supporting forms of agro-processing. • This assumes the production of surpluses: not the case in SA…. • But in addition: in SA, a highly-centralised, vertically-integrated agro-processing sector already exists in relation to every key staple you care to name… • Maize meal (Iwisa, Ace, White Star), bread (Albany, SASKO, Blue Ribbon), sugar (Illovo, Tongaat-Hulett), milk and dairy products (Clover), Dairy Belle), sunflower oil (Nola, Epic), flour (SASKO, Premier Milling), tea (Joko, Glen, Five Roses), coffee (Ricoffy, Frisco), peanut butter (Yum-Yum, Black Cat),margarine (Flora, Rama), beer (SAB), fruit juices (Ceres, Liquifruit, Oros), canned goods (Koo, Gold Crest, All Gold), rice (Tastic), Simba Chips and Coca Cola.

‘Core-periphery’ debates • Many LED strategies focus on ‘local production for local consumption’: because of its obvious advantages: • New entrepreneurs understand their own local markets best: they know what people want • The logic of these strategies actually follows the old ‘core-periphery’ debates: • There’s an ‘import substitution’ logic to setting up local maize mills, local peanut butter co-ops, etc • These strategies may work in developing countries where no such sectors exist in the national economy, and where the rural economy can supply growing (unmet) urban demand for fresh and processed foods. • But in SA • (a) the urban areas are already perfectly well supplied from within the established agricultural and agro-processing sectors and • (b) so (often) are marginalised rural areas! • In addition: the policy options associated with these approaches aren’t available - there are no tariffs to protect ‘infant industries’ in SA’s marginal areas, no anti-dumping clauses: our ‘core and periphery’ exist within one economy…… …..we don’t have two economies….

In response to the challenges: A shift in SME strategies to ‘external’ markets: Many enterprise development strategies are trying to overcome the limits for small-scale manufacturing and agro-processing by targeting ‘external’ markets – and participating in wider value chains: • A focus on niche/artisan products targeting higher value but relatively low-volume external markets: • Designer craft, goats milk cheese, rooibos tea, mushrooms, essential oils, etc • Strategies to enter high-volume low value commodity markets: • Timber, sugar, sunflower oil, beans, maize. • Strategies to sell to the retail giants.

Accessing wider markets brings new challenges and is also hard: • Entry into ‘external’ markets means an end to informality: • As soon as a transaction is no longer face to face - and entails transacting across ‘distance’ - it requires an enforceable contract to mitigate the risks of exchange: for both parties (origins of contract law). • invoices, delivery notes, receipts, bank accounts, an address a cell phone number • Without these – formal business can’t ‘recognise’ the transaction: because neither auditors nor SARS will do so. • In the informal sector, what you see is what you get: participation in wider value chains requires greater quality assurance, quality consistency, compliance with complex standards; • The value-proposition is often unfamiliar. • Increasingly, buyers in value chains require delivery against a set of specifications and standards; certification.

Understanding trends in value chains • Lead firms demanding higher volumes • Trend to commission own products rather than resell the products of others • Concentration at the centre cascades through the value chain: fewer ‘purchase points’ = fewer entry points • Certification used to reduce the governance costs of quality assurance = high compliance requirements • Profits gravitating to logistics, branding, marketing and design and away from production. • A hostile environment for small producers (S.Lowitt TIPS 210)

So: opportunities in wider markets come with increased challenges • Access into external markets can create massive increases in volume requirements – as well as capital requirements and risk • This involves a step-change in what is required…. • With much higher barriers to entry…. • Marula: needed 4,000 women in 42 villages to reach Ceres’ volume requirements for Marula Mania; • Il Corte Inglese (a Spanish department store) ordered 17,000 beaded bracelets in a single order to ‘Gone Rural’: it took 200 beaders to produce; entrepreneur had to mortgage his house to buy the beads….. • Umgeni beans: sought 8,000 tons of beans from small farmers: could secure only 17.3 tons.

Entry into wider value chains and markets need intermediary forms of organisation and co-ordination. • Rather than ‘cutting out the middle man’: a need to transform this function: a key interface between enterprise on the margins and access to markets. • For small-holders, forms of co-ordination are required to enable: • the volumes required for participation in value chains; • The economies of scale required for affordable input supplies • The economies of scale required for infrastructure such as storage facilities. • In many parts of the world, this is the form of co-op that works best • A voluntary association of small-holder farmers…. • In SA, the emphasis is often on collective production co-ops in order to create jobs: and less on this form of ‘user co-op’. Yet the latter is required for sustainable self-employment for small-holders/small producers.

Evidence from urban areas Different opportunities – but similar problems Jobs created in SME’s Finscope Survey Gauteng 2006 BSM: A set of indicators of business sophistication BSM1: most marginal BSM 7: most ‘sophisticated’: formal SME’s SME’s with up to 200 employees included in survey. Evidence of the ‘step-change’ in capacities - but also returns - between informal, micro enterprise - and enterprise involved in B2B transactions and value chains.

Average SME turnover per annum…. Scope for intermediation? Perhaps… With a 20% profit margin / ‘take-home’ rate: Average earnings in BSM 6 of just over R1,100/month: But significant increases in returns for BSM7.

No necessary ladder upwards… BSM 1-5 are predominantly in retail: and for retail, there’s no ladder to climb up: if anything, ‘big retail’ is coming down the ladder

Key shift in BSM 7: B2B transactions In BSM7: participation in value chains. The argument: participation in B2B transactions creates a different level of opportunity; this is what drives formalisation – not the other way around. Strategy therefore needs to be informed by the nature of market insertion.

So, a tension in SMME strategy… 1. There are no particular benefits to formalization for informal traders/service providers involved in direct sales to consumers; • Limited social impacts of informality either: • This segment does not employ people at any scale: self-exploitation is the problem; • They are below the tax threshold. • They are barely affected by regulation • At most, there may be consumer protection/public health issues in some sectors. BUT 2. Limited scope for growth withoutformalisation for sme’s trying to break into wider markets, value chains. • No escape from meeting basic standards, business practices, compliance: regulation not even the main issue. • If you can’t fill out a UIF form, unlikely to survive other compliance requirements. • Ability to comply unlocks opportunity: • mitigates risks of exchange; • a necessary condition for B2B transactions: • It’s where the growth potential is.

It is not that there are no opportunities;But understanding what they are (and aren’t) should drive strategy • There are structural limits on ‘local production for local consumption’: the classic LED model; • There are some opportunities for services (eg the taxi industry), but constraints on small scale manufacturing also constrains business services in marginal areas, leading to a bias to personal services. • The simplest entry point into markets involves moving cheap branded goods from the core to the margins, which is why retail dominates the informal sector. • But the returns are marginal. • This means there is no easy entry into markets from below; • Little scope for the poor to ‘self-employ’ their way out of poverty. • The opportunities that do exist require access into higher value, higher volume external markets. • This requires a ‘step-change’ in levels of formality, capital, and compliance; for small and marginal producers, access requires strategies of co-ordination and intermediation.

Implications for strategy • At an overall level, strategies need focus on addressing structural inequality; • Yes, the New Growth Path starts to do so…. • Strategies also need to focus on the scope for change within the current market structure: • What instruments are available to tackle concentration – and to change the distribution of power and profits in value chains? • What role for new forms of intermediation, that bridge the gap between small producers and wider markets? • What role for forms of co-ordination that consolidate volumes and create economies of scale? • But structural change will take time (and other change processes will still exclude the poor). • So, complementary strategies are needed to enable economic participation even where markets don’t……

Part 2: Enabling economic participation when markets don’t

Structural inequality and the unemployment crisis…. • Structural inequality places constraints on the scope for ‘employment ‘from below’ in South Africa • In a country with chronic structural unemployment – the unemployed have (almost) no social protection. • Social grants cover those who society does not expect to be economically active – children, old people, those with disabilities. • Why then are we surprised that they don’t become economically active? • Only 3% of the unemployed are covered by benefits at any one time (Klasen and Woolard) • Young men particularly vulnerable/disempowered. • Constraints on market access coupled with the lack of social protection leaves the unemployed in SA unusually dependent on goodwill transfers from remittances or social grants intended for other purposes. • Workers and the poor provide this ‘private’ safety net: raising wage pressures at the low end and pushing poor households deeper into poverty: with further disequalising effects.

A grant would help: but it’s about more than the money • In a context in which more than half of the unemployed under 35 have NEVER worked: • Those who lose their jobs lose the skills of ‘work’ and become unemployable • Those who have never worked never learn these skills… • Those who have never worked are least likely to succeed in self-employment • For many people, the link between work and remuneration is simply missing: ‘work’ is just not where ‘income’ comes from… • Being economically productive is part of transition to adulthood • Long-term structural dependence has influenced peoples sense of economic ‘agency’ - their scope to change their material conditions through their own actions. • The crisis is about the meaning of work in society… • And about the erosion of ‘work’ skills on a systemic scale

The Community Work Programme – innovation in public employment • The CWP was initiated and piloted as part of the Second Economy Strategy Project in TIPS, with strategic oversight from Presidency and DSD, to complement existing forms of public employment in EPWP. • The CWP was designed as a response to the above issues, as well as to the Review of EPWP Phase 1: • Too many people exiting back into poverty: because of the structural nature of unemployment in SA. • CWP: designed as an ‘employment safety net’ until other solutions kick in. • CWP provides ‘regular and predictable part-time work’ in marginal areas, where jobs are unlikely to come any time soon: • two days of work per week (or 8 days a month in remote areas). • Access to a minimum level of regular work has a range of impacts: • creates structure and inclusion • An earnings floor impacts on nutrition, education • Does not displace existing livelihood activities- and is likely to enable them.

CWP: creating new forms of partnership in development • CWP is a government programme, but it is implemented by non-profit agencies • Building the capacity of civil society in marginal areas • In CWP, the ‘work’ is decided through participatory local processes. • As a result, it is multi-sectoral. • The typical menu includes community care (elderly, sick, orphans), food security, education support, youth recreation, community safety, environmental rehabilitation.

CWP: current status • Since April 2010, the Community Work Programme has been run as a programme in the Department of Co-operative Governance. • Strategic oversight from a Steering Committee: includes Presidency, DSD, NT, DPW, EDD, DRDLR. • By March 2011, a participation rate of 89,000: rapid growth for a new programme. • Its target is to have a presence in every municipality by 2013/14. • At the July Cabinet lekgotla, a new target to scale CWP up to 1 million participants per annum by 2013/14: a further boost to existing public employment targets in EPWP.

In conclusion:CWP as part of Rural Development • The implementation model – building new forms of partnership between government, civil society and communities • Participatory processes: unlocking the ‘agency’ of participants and of communities: as roleplayers in their own development. • Incomes help to ‘thicken’ local markets, strengthen local multipliers • CWP a platform for a ‘big push’ on food security: renewing the culture of food production at local level. • The assets and services created provide a social and economic return on investment: an investment in people as well as in productivity at the local level. Building a developmental society Enabled by a developmental state.

Background: The ‘second economy’ debate