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Posts Tagged ‘technology

Policy uncertainty is killing investment in what matters

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Much has already been said about South Africa’s inefficient public sector. Not only has the public sector wage bill escalated beyond the realms of the sustainable, but this has come at almost zero public sector productivity growth. In other words, we are paying more for government to do less. Add to that the poor performances of state-owned enterprises like Eskom, the SABC and most notoriously, South African Airways, and it seems that there is little more that the South African government can do to hurt the prospects for economic growth.

But there is. A new NBER working paper, published by Jose Maria Barrero, Nicholas Bloom and Ian Wright, uses new data on about 4000 US firms to investigate the sources of uncertainty in the US economy. They first distinguish between short-term and long-term uncertainty, identifying the factors that cause each type of uncertainty. They then ask how each type of uncertainty affect firms’ behaviour.

Short-term uncertainty, they find, is caused by oil price volatility. In contrast, economic variables like the oil price has less of an effect on long-term uncertainty where political risk, like policy uncertainty, has a much larger effect. The important result is that short-term and long-term uncertainty have different consequences for firm behaviour. Short-term uncertainty affects employment; long-term uncertainty affects investment in research and development.

If we assume this is true for South Africa too, how would it play out? Volatility of several macroeconomic variables, like the oil price and exchange rate, cause higher short-term uncertainty. This would likely make firms unwilling to hire new workers, or make managers unwilling to offer higher wages. These are the consequences economic commentators typically cite when referring to an unstable macroeconomic environment.

But employment and wages are not the only variables affected by uncertainty. One of the key indicators of a thriving economy is businesses’ willingness to invest in research and development. Take R&D as a percentage of GDP, shown in the Figure below. There is large variation in the share that countries spend on research and development: Israel and South Korea, for example, spend more than 4% of their GDP on R&D. South Africa spend less than 0.8%. (This figure almost reached 0.9% in the 2006-2008 period, a period not surprisingly correlated with high growth rates.)

RDspending

There is a strong positive correlation between countries that grow fast and those that invest in research and development. South Africa, unfortunately, significantly lags those countries at the technological frontier. It is important, though, to understand why this is the case. It is not only government that invests in R&D; in fact, more than half of all R&D investment in South Africa comes from the private sector.

So what will encourage businesses to invest more in R&D? Well, according to Barrero, Bloom and Wright, political risk and policy uncertainty is the biggest determinant of private sector investment in R&D. In a political environment with little policy coherence, business are unlikely to make investments where the returns can only be realized in the long-run. Even if the possible returns are substantial, a rational investment response to a murky policy environment would be to sit back and see what happens. Lower investment in R&D means falling further behind international competitors.

There are some in the South African government who realise this. Minister of Science and Technology, Naledi Pandor, has committed to doubling R&D expenditure as a percentage of GDP by 2020. This is commendable, but in the current budgetary environment, unlikely to get the support from the Minister of Finance. Other initiatives to get the private sector investing in R&D, like a refundable tax credit that will benefit small businesses, have not been implemented.

These problems are not unique to South Africa. As the authors argue: ‘Our findings are significant in the wake of recent events like Britain’s vote to leave the European Union and Donald Trump’s assumption of the US Presidency, which have generated considerable uncertainty over future economic policy around the world. As we have shown, such policy uncertainty is particularly linked with long-run uncertainty and in turn with low rates of investment and R&D that can have significant consequences for the global economic outlook in years to come.’

R&D is the bedrock of future prosperity. Political risk that leads to policy uncertainty hurts not only economic growth and employment creation, but also deters firms from investing in the one thing that can create prosperity for all. If the ruling party is serious about its slogan, it better start by enacting more coherent economic policy.

*An edited version of this first appeared in Finweek magazine of 21 September 2017.

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How our emotional intelligence makes us productive

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Emotional-Intelligence-1

Economists spend a lot of time investigating the factors that make people more productive. This is because more productive people – producing more, with less – is the reason we can today afford a much higher standard of living than our ancestors – in Africa, India or Europe – two centuries ago.

Many things improve our productivity. Technological improvements like a computer can allow us to use the power of machines to substitute manual labour. Education allow us to build faster and stronger computers. Both technology and education are key if we are to continue building and sharing a prosperous future.

But it is not only technology and education that improve our living standards. There are formal and informal institutions – things like the criminal-justice system, property right regimes and the political system – that create the incentives for us to invest in technology and education. And there are the even less tangible things, like the way we make decisions (often referred to as ‘culture’), or our personalities. Economists are only now beginning to explore the roots of these ‘soft’ determinants.

Psychologists have known for long that our personality affect the way we make decisions. One example: Whether we apply for that senior position may depend on whether we exhibit the leadership qualities that is required to lead a large team. But what determines whether we have those leadership abilities? Is it nature or nurture?

One option is to look at siblings. If genetic traits (nature) were the only source of leadership qualities, then almost all the variation we find in society would be between families. In other words, there should be little variation between brothers, for example, as they have a lot of genetic overlap.

This is not the case, however, at least according to a recent NBER Working Paper written by three economists, Sandra Black, Björn Öckert and Erik Gröngqvist. Almost a third of total variation in personality traits, they note, are within the family. So, if it is not only nature that determine much of your personality, where do these within-family differences come from?

One possibility, they argue, is birth-order. Using a very rich Swedish dataset, the authors find that first-born children are ‘advantaged’ when measured on their ‘emotional stability, persistence, social outgoingness, willingness to assume responsibility and ability to take initiative’. Note: these are non-cognitive abilities, i.e. there is little difference in terms of a first-born and a third-born’s innate ability to do math, for example. It is on the softer abilities, instead, that first-borns clearly outperform their lower-ranked siblings: third-born children, for example, have non-cognitive abilities that are 0.2 standard deviations below first-born children.

These non-cognitive abilities matter. Controlling for many things, they show that first-born children are almost 30% more likely to be Top Managers compared to third-borns. This is because managerial positions, they argue, tend to require all Big Five domains of personality: openness to experience, conscientiousness, extraversion, agreeableness, and emotional stability.

But why does birth-order matter? The authors argue for largely three possible reasons. First, biology. Successive children may have less of the stereotypical male behavioural traits due to the mother’s immunization to the H-Y antigen. But this seems unlikely to explain most of the variation, as the authors also find that birth order patterns vary depending on the sex composition of the older children: third-born sons perform worse on non-cognitive tests when their older siblings are male compared to when they are female.

This suggests that it has something to do with how parents allocate their time and resources, especially in the early years. ‘First-born children have the full attention of parents, but as families grow the family environment is diluted and parental resources become scarcer’, the authors argue. Parents may also have incentives for more strict parenting practices towards the first born to ensure a reputation for “toughness” necessary to induce effort among later born children.

Thirdly, children may also act strategically in competing for parental resources. Siblings compete for possession of property and access to the mother. Older siblings, research shows, tend to take a more dominant role in conflict and have more elaborate conflict strategies. To minimise conflict, parents tend to invest more in the dominant, older sibling.

Using a novel approach, the authors can identify which of these effects is largest. They find that biological factors only explain a small part, and may actually benefit later-born children. It is however in the behaviour of parents that there are distinct differences between first- and later-born children: they find that later-born children spend substantially less time on homework and more time watching TV. Parents are also less likely to discuss school work with later-born children, suggesting that it is the parents that lower their investment which explains the large gap in non-cognitive skills.

What the authors do not do is to link their results with the general improvement in living standards over the last two centuries. We are becoming ‘better angels of our nature’ because we grow up in smaller families with more parental attention and resources, improving our non-cognitive abilities.

It is not only the vast improvement in technology and education that has made us more productive, but also because we have become more conscientious, agreeable, responsible and willing to take the initiative. We are rich, in part, because we are more emotionally intelligent.

*An edited version of this first appeared in Finweek magazine of 1 June 2017.

Written by Johan Fourie

June 23, 2017 at 07:49

The future is an unknown unknown

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Humans know how to adapt. We have populated the planet not because we found an agreeable environment everywhere, but because we were able to adapt to the diverse and often hostile environments we moved into. And so it is today. To survive and thrive, we need to adapt to the global forces of our times, from climate change to automation.

Those with the freedom and ability to adapt to these global forces will benefit most. Take automation. Artificial intelligence and robotics now allow most tasks that manual labourers perform to be done without human intervention. One of the most exciting technologies revealed at the end of 2016, from my perspective at least, is an automated washing and ironing machine. Dirty clothes go in on one side and the fully-ironed clothes, folded by tiny robotic hands inside the machine, come out on the other side. Finally those dreary Sunday afternoon ironing exercises will be a thing of the past! Collectively this technology will save millions of productive human hours, particularly for women who in almost every society are still responsible for most home labour.

And yet, this wonderful new technology won’t be welcomed by everyone. South Africans employ more than 1 million domestic workers (or more than 8% of the work force), most of whom are women from poor households. If the cost of this new machine falls considerably in the next decade (and minimum wages continue to rise), we might soon see a significant decline in demand for ironing services. Because poor South Africans do not have the freedom to adapt to these new technologies, unemployment and inequality will likely increase.

There are many other examples. Tesla and other car companies are working on self-driving cars (no need for taxi drivers) and, which is likely to have an even bigger effect, self-driving buses. Truck driving is America’s sixth most common occupation. Or consider McDonald’s most recent innovation: self-ordering counters. No need to employ more expensive and unreliable staff. How long until everything in a McDonald’s restaurant is automated, from food preparation to servicing and cleaning? Amazon has recently revealed its plan to open 2000 automated grocery stores across the US. And then there are the many disruptive digital technologies, which The Economist editor Ryan Avent writes about in his latest book The Wealth of Humans.

The political consequences of these supersonic changes are unknown. As Avent notes, we are the first generation to live through an industrial revolution. There is little in history that tells us how society will react to such rapid changes. He predicts social unrest, unless government or civil society can reform social welfare programs on a massive scale. We have already seen this in South Africa and elsewhere: the democratic process, for many, is too slow and cumbersome. Service delivery protests, the #MustFall-movement and the global shift towards a more nativist conservatism suggest that the voices of those at the bottom of the income distribution will be heard outside the ballot box.

More creative solutions to support those left behind by the benefits of technological innovation and globalisation must be found. One idea is to institute a basic income grant that would give every person in South Africa a monthly stipend. This is no novel idea – Thomas Paine proposed a similar idea in 1797 – but economists are increasingly willing to put the idea in practice: Utrecht, a beautiful Dutch city south of Amsterdam, will next year give several hundred of its inhabitants an annual monthly stipend of 960 euro.

The concern is that people opt out of productive labour if they receive money for free. The consensus, though, is that this is unlikely: the aspirational drive of humans to move up the income ladder will push them to work hard regardless. What a basic income grant does is to make sure the ladder is solidly grounded.

But even a basic income grant won’t do enough. The rapid change will bring about psychological and sociological consequences that are hard to predict. Which social policies to implement, from early-childhood development to adult retraining programmes, in order to combat the technological disruption will be important research questions in the next few years. Creative use of technology, ironically, might be one solution.

Donald Rumsfeld famously quipped that there are known knows (the things we know we know), unknown knows (the things we know we don’t know), and unknown unknowns (the things we don’t know we don’t know). The future used to be mostly unknown knows. With some degree of likelihood, we could analyse the past and make conjectures, following somewhat linear trends, about what the future might hold. Change was incremental; we had time to adapt.

The period of rapid change we have seen since the dawn of the Internet is only likely to accelerate. As a species, we have never been required to adapt this fast, and not everyone in society will have the freedom and ability to do so. This will lead to social conflict. To minimise the consequences of this social conflict, the greatest challenge of the next decade is to enable as many as possible to adapt to the inevitable unknown unknowns of our rapidly-changing world.

*An edited version of this first appeared in Finweek magazine of 29 December.

**As this is my first post of the year, I would like to wish all readers a productive and memorable 2017. Let’s hope this will be a good one.

Written by Johan Fourie

January 5, 2017 at 07:09

How Uber makes the world a better place

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uber-logo

The first thing students are taught in any introductory microeconomics course is that the price of something, let’s say chauffeur services, and the quantity of it that consumers want is depicted by a negative-sloping demand curve. The difference between what consumers are willing to pay for a chauffeur ride (the demand curve) and what the chauffeur asks (the market price), is what is known as the consumer surplus. The bigger the consumer surplus, the better for society.

But even though the idea of consumer surplus is used in many applications, measuring it has always been problematic. That is because, in the real world, demand and supply move together, and it is therefore difficult to establish the exact shape of a demand curve.

That was, until Uber. A team of economists (including Steven Levitt of Freakonomics fame) recently published an NBER Working Paper that uses almost 50 million UberX ‘consumer sessions’ to identify a demand curve for taxi services, and then calculate the consumer surplus that these services generate. A ‘consumer session’ is basically when someone logs onto the UberX app and requests the price for a proposed trip. The consumer either accepts the price and wait for an Uber driver to pick them up, or they don’t, and find alternative transport.

What makes Uber unique is that its prices vary according to demand (for its services) and supply (the availability of drivers). This unfortunately also means that it is not possible to simply calculate a demand curve when the price increases by 10%, because the increase might be the result not of greater demand by consumers for Uber trips, but of lower supply (having fewer drivers on the route). The research team use a clever trick to get around this. Say the algorithm predicts that the price must increase by 1.249. This is then rounded down to 1.2 for the consumer. Other times the algorithm suggests the price must increase by 1.251, but the app then rounds this up to 1.3. It is this discrete difference when the price is essentially the same which the authors exploit using regression discontinuity analysis.

uber_advertIf this sounds very geeky, the results are worth the wait. First, the authors find that demand is quite inelastic (around 0.5). This means that if prices increase by 10%, demand will only fall by 5%. Second, they compute the dollar value of consumer surplus in Chicago, Los Angeles, New York and San Francisco to be roughly $2.8 billion annually. This is more than six times Uber’s revenue in those cities. Put another way, for each $1 spent on an UberX ride at the lowest price, the authors estimate that the consumer ‘receives’ $1.57 in extra surplus. In short, Uber generates massive benefits for society-at-large.

Why does Uber generate so much consumer surplus compared to normal taxi operators? Another NBER Working Paper, written by Judd Cramer and Alan Krueger, suggests that it is because of the higher capacity utilisation rate of Uber drivers: “UberX drivers spend a significantly higher fraction of their time, and drive a substantially higher share of miles, with a passenger in their car than do taxi drivers.” There are four reasons for this. First, Uber’s better matching technology (an app that anyone can download on their phones). Second, the larger scale of Uber’s usage in comparison to taxi companies. Third, highly inefficient taxi regulations which limit the number of routes or time periods taxi drivers can operate. Fourth, Uber’s flexible labour supply model and pricing model which match supply with demand.

South African regulators have had varied responses to Uber’s entrance in the local market. There has been opposition from the taxi industry, sometimes violent. Proponents of Uber, on the other hand, often highlight the entrepreneurial and job-creating opportunities the service creates.

What this research shows, though, is that Uber’s main benefit is the massive surplus it generates for consumers. According to the Levitt research team, one day’s worth of consumer surplus in the four US cities they analyse is worth about $18 million. “If Uber were to unexpectedly disappear for a day, that is how much consumers would lose in surplus.”

Aside from this consumer surplus, Uber services create many positive externalities, from lower congestion and pollution levels to semi-skilled employment to, perhaps more tenuously, greater social interaction and cohesion – I’ve had some fascinating conversations with Uber drivers, and know of one driver that was offered a scholarship by a client. But, most importantly, when regulators and policy-makers debate the pros and cons of Uber and other such services that will almost certainly appear in the next few years, it is worth remembering one of the basic principles of introductory economics: the immense benefits society derives from the additional consumer surplus.

*An edited version of this first appeared in Finweek magazine of 20 October.

Written by Johan Fourie

November 23, 2016 at 08:56

How technology will shape Africa’s future

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Renewables

Much has been said about the economic future of sub-Saharan Africa. One camp is largely optimistic, claiming that the relatively high economic growth rates of the last decade (even during and after a global financial crisis) is evidence of ‘Africa rising’, a continent slowly emerging from three decades of slumber. Another camp is less optimistic, claiming that this growth was limited to natural resource industries benefiting from rapid Chinese growth. (To put Chinese growth in perspective: even though China grew at ‘only’ 6.9% in 2015, it added $714 billion to its GDP. In contrast, South Africa’s GDP in 2014 was $350 billion. In other words, China added more than two South Africas to the global economy in 2015 alone.)

Both camps, of course, have elements of the truth. Many African countries, some of them very poor, have seen high economic growth rates over the past few years, growth that was and remain essential in lifting many thousands of people out of poverty. But it is also true that much of this growth has been limited to resource sectors that do not have the same spill-overs into other parts of the economy that manufacturing, for example, has. This raises doubts about its sustainability.

In April, the United Nations Economic Commission for Africa published a new report that clearly sides with the more cautious view. African countries are stuck in low-productivity, primary sector exports; the fall in the price of commodities, like oil in the past 18 months, has swelled budget deficits in places like Sudan, Nigeria and Angola. It is likely to have political consequences too.

To combat such vulnerability, the authors advocate ‘smart’ industrial policies to ‘upgrade’ the commodity sectors and promote the ‘development of higher-productivity sectors, especially manufacturing but also some high-end services’. They acknowledge that there are two trends working against such industrial policy action. First, a shrinkage of the ‘policy space’ due to the establishment of the WTO and the proliferation of bilateral and regional trade agreements. Simply put, countries have less scope for raising tariffs or other creative industrial measures than before. Second, the strengthening of global value chains makes ‘nationalistic’ industrial policy less effective. But this does not deter them: ‘There are still many industrial policy measures that can be used. Moreover, if anything, these changes have made it even more necessary for developing country industrial policy-makers to be ‘smart’ about devising development strategy and designing industrial policy measures.’

So what are these so-called ‘smart’ industrial policies? Unfortunately, after spending 156 pages explaining the need for ‘smart’ policies, the authors give us only one page of very vague principles: policy-makers ‘need to identify the ‘right’ policies’; policy-makers ‘need to induce foreign firms to create linkages with the domestic economy’; and policy-makers ‘should pay attention to the possibility of upgrading not just through the development of capabilities to physically produce goods but also through the development of producer services, such as design, marketing, and branding’. So much for practical guidelines!

The authors have missed a golden opportunity to actually think more creatively about Africa’s economic future. Technology is changing Africa’s comparative advantage. Global manufacturing will become increasingly capital intensive as robotics and technologies like 3D-printing (not mentioned once in the report) advance. What we consider low-skilled labour-intensive manufacturing (shoe-making, for example) may, overnight, become high-skilled, capital-intensive (once shoes can be printed), with production switching from countries like Vietnam and Bangladesh back to the developed world. Cheap labour will become less of an advantage as robotics becomes more affordable.

An additional factor that makes manufacturing in Africa so expensive is trade costs. We have few large cities on the coasts with easily accessible port facilities. How can landlocked Zambia compete with similar-sized Cambodia? Zambia has a railroad that goes through two other countries before it reaches the eastern coast of Africa; Cambodia’s capital has a river port that can receive 8000-ton ships. And statistics confirm this: the World Bank calculates that the cost to import a 20-foot container to Cambodia is $930. It is $7060 in Zambia. It is difficult to see how any ‘smart’ industrial policy can mitigate these massive cost differences.

Does this mean Africa is doomed to remain a primary good exporter? Not necessarily. Mobile technology is revolutionising the way Africans do business. It is a technology that negates Africa’s rugged terrain, leapfrogging the need for expensive fixed-line infrastructure. If it can receive the necessary investment, broadband and wireless technologies will do the same. This will allow Africans to provide services to a world that would have been impossible to reach only a decade earlier.

Can services alone propel Africa into the industrialised world? Apart from a few small economies – Singapore and Luxembourg – there is little past evidence that it can. A pessimist may thus proclaim little hope for the continent; an optimist may instead remember that technological innovation has a way to revolutionise existing industries. It is already happening: consider the much higher returns of Ugandan farmers after mobile technology allowed them access to real-time market prices for their goods. Or how Airbnb has empowered middle-income South Africans with a spare room to benefit from the country’s thriving tourism industry. Or how renewable technologies – also completely neglected in the UN report – will affect African countries’ power generation and distribution capabilities, supplanting the need for coal and other minerals.

What is clear is that the image of factories with thousands of low-skilled labourers working 8 to 5 jobs belongs to a previous century. To imagine that industrial policy can somehow transplant that image to Africa in the twenty-first century is fictional. The smartest industrial policy we can hope for is instead a belief that Africans have the agency to shape their own destiny, as long as they have access to the hard (fast and affordable internet and reliable electricity) and soft (IT colleges and programming degrees) infrastructure that will allow them to benefit from the technologies of the future.

*An edited version of this first appeared in Finweek magazine of 2 June.

Our watershed… opportunity

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SlingShot: Could this device make water infrastructure redundant?

SlingShot: Could this device make water infrastructure redundant?

South Africans are gearing up for a tough summer. While loadshedding (the frequent power shortages that plagued the country since 2008) has eased, a new issue came to the fore this week: watershedding. In areas of Germiston and the East Rand, water shortages have been reported and watershedding between 10am and 3pm is on the cards. While the heatwave and drought across the country are the immediate cause of the shortages, there are far deeper structural problems that is likely to make watershedding a common feature of daily life in South Africa in the near future.

This should not come as a surprise. There has been several warnings in the media about the likelihood of watershedding over the past few years, well before the heatwave and drought made the situation acute. On 25 June, Niki Moore wrote the following in the Daily Maverick:

The reason for any potential water shedding is almost a mirror image of why we have load-shedding. Since 1994, millions of people have been added to the water grid with very little thought being given to increasing the capacity of water storage or water intake plants. Combined with mismanagement of water, non-payment for water, huge water wastage through lack of maintenance and neglect, and poor governance through corruption, we are facing a high noon of water shortages that might start affecting us in as soon as a few months.

Well, that was pretty accurate. But watershedding – a shortage of water – is only one concern. The more serious one is the pollution of existing drinking water, which is likely to have serious health consequences. Here is Anthony Turton on the water crisis:

The possibility of major public health crises in the short to medium term is growing and can no longer be discounted. We could soon see a major bloom of toxic cyanobacteria, especially in the light of the increased water temperatures likely to result from the El Nino Southern Oscillation now evident in southern Africa. The growing risk to both companies and individuals needs to be anticipated and understood, so that remedial action can be taken as quickly and effectively as possible.

The reason this is unlikely to happen, he argues, is political:

All available data suggests there is little in South Africa’s water sector to be optimistic about. The level of politicisation has become so high that decision-making is no longer rooted in hydrological realities. Ideology is regarded as paramount, while reality counts only as a secondary factor. The ideological filters in place make it very difficult to carry out any serious technical assessment of water quality or management. In addition, no serious attempt is currently in place to embark on evidence-based policy reforms.

Perhaps the greatest failure of the new order since 1994 has been deteriorating water quality. This has been caused primarily by massive failures in the management of municipal wastewater treatment plants, which have made the State the biggest polluter of water in the country. This looming disaster could have been avoided by more rational and less ideologically-driven policy choices. We need to challenge this approach if we are to re-invigorate our democracy and extricate ourselves from the horns of the dilemma arising from the politicisation of water in a highly water-constrained national economy.

So what can be done about this? The easy but unsatisfactory answer is that local government elections are next year, and South Africans should use this opportunity to demand change. But much of the problem is more systemic and pervasive than local governments can solve on their own; as Turton argues, the “first essential requirement is a new and technically robust national strategic plan for managing, conserving, and augmenting the country’s limited water supplies”. National elections, though, are only in 2018, and it is difficult to envisage dramatic change.

Instead, South Africans will have to find solutions to the water crisis outside the remit of government. This is difficult with a water utility, which is the epitome of a natural monopoly and the reason the state is almost always involved. But just as the case with loadshedding, technology may provide a solution.

Last night, I watched a 2014 documentary about the SlingShot, a device developed by the creator of the Segway, Dean Kamen, to purify water. Much like Elon Musk has created the PowerWall to allow households access to electricity at all times, the SlingShot is a device which would allow anyone able to convert contaminated and filthy water (or even seawater) into drinkable water. The device has been tested in Ghana, South Africa and in several Latin American countries. It has the support of Bill Clinton and the CEO of Coca-Cola.

I’m a technoptimist. I don’t know whether this particular technology will be successful, but as Estian Calitz and I argued in this 2009 paper, technology will allow public goods to be increasingly viewed as private goods, or natural monopolies to be made into competitive industries. Cell phones are a good example, breaking down the need to have large, fixed-line networks that doesn’t make sense to build more than once: i.e. the natural monopoly of Telkom. Elon Musk’s PowerWall, coupled with renewable energy generation, will break the natural monopoly of Eskom. Perhaps Kamen’s SlingShot (or a similar device) will do the same for water.

South Africans have many reasons to be pessimistic about the future. But, as David Landes writes in the Wealth and Poverty of Nations, it pays to be optimistic.

In this world, the optimists have it, not because they are always right, but because they are positive. Even when they are wrong they are positive, and that is the way of achievement, correction, improvement, and success. Educated, eyes-open optimism pays; pessimism can only offer the empty consolation of being right.

Maybe the watershed moment for South Africa is when we realise that the promise of a better life for all lies not in the next elections, but instead in embracing new technologies.

Written by Johan Fourie

November 12, 2015 at 09:44

Our entrepreneurs (and policy makers) need to learn from abroad

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Imagine you’re a young entrepreneur and have built up a profitable IT business. You can expand either by going at it alone, or partnering with a more established, perhaps international firm. Which should you choose?

Sign up with the multinational.

That’s the advice of a new NBER Working Paper ‘Does Foreign Entry Spur Innovation?’ by three US trade economists, Yuriy Gorodnichenko, Jan Svejnar and Katherine Terrell. They find, using a large firm-level dataset of eighteen countries, that foreign direct investment (FDI) have a significantly positive impact on product and technology innovation of domestic firms in emerging markets. In other words, those domestic firms that receive FDI become more innovative over time than other domestic firms.

This isn’t surprising. Trade economists have long argued that increased trade and investment boosts domestic firms’ productivity. Foreign firms tend to bring new innovative ideas, technology and management practices that replace potentially inefficient practices of domestic firms. When SA opened up to the world after the isolation of the apartheid years, the argument goes, local firms’ productivity increased significantly because they suddenly had to compete against more competitive producers.

This was difficult to prove empirically: industry-wide statistics are often too vague to give reliable evidence that FDI has a positive impact, and some firms may close due to tougher competition. But this study uses firm-level data, measuring the size of spillover effects from the international partner to the domestic firm, and documents the impact on innovation instead of noisy productivity estimates.

The authors found that the benefits of FDI don’t accrue to other firms in the industry, but is localised to the domestic firms immediately connected to the foreign firms. They conclude: Simply being in an industry populated by foreign firms generally has a weak, if any, effect on innovation. In fact, if our entrepreneur doesn’t get a foreign partner but his competitors do, he may find himself out of business.

This study is important for policy makers too. Firstly, encouraging FDI is critical to growing an economy. Public (and political) sentiment is often against foreign competition; consider the long (and expensive) deliberations preceding the Walmart-Massmart merger. Let me be unequivocal about this: this study shows that foreign competition drives innovation in domestic firms, making them more competitive and longer-lasting. We need more, not less, of it.

The authors also found, in short, that FDI from rich countries is better. Again, this makes intuitive sense. Firms in the rich world already operate at the technological frontier. Now, for the first time, it has found empirical support. One wonders about SA’s attempts to cosy up to our BRICS partners instead of encouraging investment from our traditional (and still largest) trade partners. If we believe the results of this study FDI from China is less beneficial for SA than from the US or Germany.

Another, perhaps more controversial, finding: because the benefits of FDI only accrue to firms within the supply chain of the acquired domestic firm, it might mean that policies which require foreign firms to have significant local content (for example, a rule which states 20% of a firms’ inputs must be locally made) may be justified. Minister Rob Davies will be happy to hear this.

Global supply chains: the poorest countries are also those with the weakest links to the global network. Source.

But he’ll first need to get foreign firms excited about SA. In late July, he introduced the Promotion and Protection of Investment Bill in parliament as an attempt to do just that. The bill aims to protect and promote investment, but, sadly, falls short. As Webber Wentzel’s Peter Leon argues, it contains few of the protections one would typically find in a bilateral investment treaty. ‘Fair and equitable’ treatment for investors, such as market value compensation in the event of expropriation, are missing.

The rapid growth of emerging markets over the last two decades seems to be tapering off. SA cannot rely on foreign firms entering the country seeking investment opportunities as had happened during the good times. We have to up our game and become more attractive. That means improving all sorts of things, like skills and infrastructure, but the low-hanging fruit of investment bills and secure property rights should be top priority.

*This column first appeared in the 1 October edition of Finweek.

Written by Johan Fourie

October 13, 2015 at 03:36