The definitive guide to market trends
INSIDE THIS ISSUE
1
9
14
SA’s most (and least) productive workforces
19
Back to basics – asset productivity and the
value-of-the-firm
Why more education won’t create more jobs
in South Africa
24
Why is capital so much more productive than
labour in South Africa?
Why South African cannot address
unemployment – An engineer’s view
28
The team
SA’s most (and least) productive workforces
Only 65 listed South African companies have labour productivity that exceeds employee costs.
The four highest-ranked of these – namely RMB Holdings, Vukile Property Fund, Investec Bank
and Assore – generate more than R100 000 of operating cash flow per worker per annum after
accounting for the contribution of capital in the production process. The lowest ranked – Wits
Gold – destroys R221 300 per worker per annum. These findings support other data which show
that labour productivity for the South African economy as a whole has fallen to a 40-year low, and
capital’s share of national income has correspondingly risen from 39,9% to 47,2% over the past
fifteen years.
Making the best use of resources
Productivity – making the best use of available resources – is a
paramount economic goal. Profitability is a separate matter: profit is
the organising principle of business affairs that leads to maximum
productivity; but it is just one of several means of achieving this goal.
Communist, socialist and mixed capitalist/socialist economies (in South
Africa lately termed the “developmental state”) have alternative methods,
along a spectrum defined by how freely corporations can pursue
profitable opportunities with varying degrees of taxation and regulation.
SA ranks #144 out of 183 countries in terms of
business bureaucracy
Since taxation and regulation set a limit on a country’s overall
productivity, they deserve further scrutiny. That august institution, the
World Bank, releases an annual “Doing Business” survey, measuring the
impact of business regulations in each of the world’s economies, and it
ranks South Africa as #35 out of 183 countries in the world, an apparent
high percentage score of 81%, just worse than Israel. The individual
sub-rankings are shown in the table. One could make the argument that
South Africa’s average ranking (#35) is misleading, since underlying
that average is a wide variety of poor rankings: trading across borders
(#144), getting electricity (#124), enforcing contracts (#81) and registering
property (#76). We would make the argument that the lowest ranking in
the list – the lowest common denominator, if you will – is a bottleneck
for all other rankings. On this basis, South Africa ranks 144# out of
183 countries, a low percentage score of 21%. Interestingly, the Doing
Business survey indicates that, in terms of total tax cost and efficiency,
South Africa’s ranking fell from 18th to 44th out of 183 economies – a
drop of 26 places – between 2011 and 2012.
1 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
South Africa: Ease of Doing Business 2012
Starting a Business
Dealing with Construction Permits
Getting Electricity
Registering Property
Getting Credit
Protecting Investors
Paying Taxes
Trading Across Borders
Enforcing Contracts
Ease of Doing Business – Overall
Source: World Bank Doing Business Survey (2012)
South Africa (ranking
out of 183 countries)
44
31
124
76
1
10
44
144
81
35
SA’s most (and least) productive workforces
SA ranks #116 out of 178 countries in terms of tax cost and efficiency
Another August institution, The Heritage Foundation, provides a list of tax revenues as a percentage of gross domestic product, which is roughly
equivalent to the share that government appropriates of all value-added in an economy. It ranks South Africa as #116 out of 178 countries, a low
percentage score of 35%, with tax revenues at 26,9% of GDP, worse than Venezuela. South Africa’s national tax rate is 32% higher than the world
median tax rate. South Africa’s national tax rate is 35% above the average tax rate for African countries, and ranks #40 out of 46 African countries, a
low percentage score of 13%. In the overall index – which includes not only tax revenue but also the rule of law, limited government, open markets and
regulatory efficiency – South Africa fell 17,8% in the past year alone.
Tax Revenues as a Percent of GDP in African Countries (2012)
Tax
revenue
% GDP
Tax
revenue
% GDP
Tax
revenue
% GDP
Rank
Eq. Guinea
1,7
1
Guinea-Bissau
Rank
11,5
16
Rank
Cameroon
18,2
31
Libya
2,7
2
Chad
4,2
3
Ethiopia
11,6
Tanzania
12,0
17
Kenya
18,4
32
18
Gambia
18,9
33
Angola
5,7
Congo, Rep.
5,9
4
Congo, D. R.
5
Liberia
13,2
19
Mauritius
19,0
34
13,2
20
Senegal
19,2
Nigeria
6,1
6
35
Mozambique
13,4
21
Djibouti
20,0
36
Sudan
6,3
Algeria
7,7
7
Rwanda
14,1
22
Malawi
20,7
37
8
Tunisia
14,9
23
Ghana
20,8
38
C. Afr. Rep.
Guinea
7,7
9
Côte d’Ivoire
15,3
24
Morocco
22,3
39
8,2
10
Mali
15,3
25
South Africa
26,9
40
Gabon
Sierra Leone
10,3
11
Benin
15,4
26
Namibia
28,8
41
10,5
12
Mauritania
15,4
27
Guyana
31,9
42
Madagascar
10,7
13
Egypt
15,8
28
Botswana
35,2
43
Niger
11,0
14
Zambia
16,1
29
Swaziland
39,8
44
Burkina Faso
11,5
15
Burundi
17,4
30
Lesotho
42,9
45
Zimbabwe
49,3
46
Country
Country
Country
Source: The Heritage Foundation (2012)
SA scores poorly on the primary measures of capitalism
Capitalism is a broad term, but it is usually taken to be consistent with light business regulations and low overall taxation. Against both these dimensions
South Africa ranks very poorly: #144 out of 183 countries in terms of business regulations, and #116 out of 178 countries in terms of taxation.
Capitalism’s (or, more likely, central banks’) propensity to produce periodic economic crises notwithstanding, the superiority of capitalism over the long
term is now well-established and widely agreed by the world’s foremost economists. The disasters connected with the alternative, socialism, can be best
illustrated by means of an anecdote.
The developmental state is not an option
In 1935, Time magazine featured a lowly Soviet coal miner, Alexey Stakanov, on its front cover. Time reported that Stakanov mined 102 tonnes of coal
in a single shift, 14 times his state-determined quota. He later beat his own record, mining 227 tonnes of coal in a shift. Stakanov became a poster boy
for the communist enterprise. Labour productivity under Soviet communism was thought to be so far superior to Western capitalism that the enterprise
might succeed and spread. Stakanov was awarded two Orders of Lenin, the Order of the Red Banner, and numerous medals. However, in 1985, the
New York Times exposed Stakanov as a fraud. The Communist Party had pre-arranged the event to boost public morale, and other miners’ tonnages
were added to Stakanov’s to inflate his production tally. Productivity under communism was a sham, leading to the deaths by famine of an estimated
15 million people.
Productivity and profitability are different
Under capitalism, corporations are the fundamental units of economic enterprise. They take risks, venture their owners’ financial capital, employ
workers, deploy capital equipment and technology, appoint managers and organise resources in such a way as to make the most productive use of
the means at their disposal. Whether they make a profit depends on many things, including the general condition of the economy (both global and
domestic), the general cost of capital (both equity and debt), levels of investment (both tangible and intangible), among others. The advantage of looking
at a corporation’s productivity is that it abstracts from these economy- and world-wide factors over which the company has no immediate control. Share
prices, in particular, are a notorious basis for evaluating managerial performance, for once market-wide influences on share prices are removed, the
overwhelming majority of managers make no independently positive returns. Naturally, profits and share prices are essential guides to firm performance
– but productivity is a better measure of managerial performance.
2 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
SA’s most (and least) productive workforces
The SA Reserve Bank’s measure
of productivity is nonsense
The South African Reserve Bank’s Measure of
“Productivity” (1967 – 2012)
160
Rand thousand
140
120
100
80
60
40
20
2011
2007
2003
1999
1995
1991
1987
1983
1979
1975
1971
1967
0
Output per worker – SA Reserve
Bank definition
Output per unit of capital –
SA Reserve Bank Definition
Source: South African Reserve Bank (2012)
Employment and Economic Activity
(1967 – 2012)
220
2 500
200
180
160
1 500
140
120
1 000
100
500
80
0
40
2011
2007
2003
1999
1995
1991
1987
1983
1979
1975
1971
60
1967
Rand thousand
2 000
Economic activity (LHS, millions)
Employment (RHS, index)
Source: South African Reserve Bank, Statistics SA (2012)
Defining operating cash flow
The definition of operating cash flows used in
this study is as follows, based on International
Financial Reporting Standards.
•Cash generated from operating customers
revenue as reported
– increase (decrease) in operating trade
receivables
– investment income (profit on asset sales,
disclosed separately in investment cash
flow)
– other income that is non-cash and/or nonsales related
•Cash paid to operating suppliers costs of
sales – stock variation = purchase of goods
+ all other expenses
– increase (decrease) in operating trade
payables
– non-cash expense items such as
depreciation, provisioning, impairments, bad
debts, etc.
– financing expenses (disclosed separately
in finance cash flow)
3 Labour Market Navigator
It is worth examining South Africa’s capital and
labour productivity as a whole, and in order
to do so, we must dismiss the conventional
measure of productivity as employed by the
South African Reserve Bank. The Reserve
Bank uses a simplistic measure – namely
output per worker – to calculate labour
productivity. As indicated in the chart, “labour
productivity” according to the Reserve Bank
has risen steadily since the 1960s, around
2% per annum. In inflation-adjusted terms,
a worker produced R64 074 worth of output
in 1967 and R143 412 in 2012 – an increase
of 127%. By contrast, “capital productivity”
according to the Reserve Bank has steadily
fallen, around -1% per annum. In inflationadjusted terms, a unit of capital produced
R7 297 worth of output in 1967 and R4 924
in 2012 – a decrease of 33%. Reserve Bank
calculations do not match reality: they do not
explain why firms continue to lay off workers
in large numbers (1,9 million since the peak in
the late 1980s); and they do not explain why
labour’s share of national income has fallen
from 60,1% in 1995 to 52,8% in 2011.
SA’s labour productivity is
declining
As the following chart shows, the South
African economy has produced more and more
output using fewer and fewer workers. Thus,
output per worker has inevitably risen – a
rise in output combined with a decline in the
workforce makes it seem as if the remaining
labour has become more productive. This, of
course, is nonsense and does not correspond
to what is meant by productivity, namely
making the greatest use of available resources.
As we show below, labour productivity properly
measured has declined steadily since the
1970s, whereas capital productivity has risen
dramatically over the same period.
Relating outputs to inputs
In order to better calculate labour and capital
productivity, we need to make use of statistical
techniques. Statistically it is possible to relate
output to various inputs. The greater the output
response of an increase in one or more of
the inputs, the more productive a firm is said
to be and the better the firm’s management
is at attaining the maximum use of available
resources. Moreover, it is statistically possible
to separate the various inputs, the most
common being capital and labour, so that we
can distinguish between the output response
of a unit of capital and the output response
of a unit of labour. A company that has high
capital and high labour output responses
is using the available resources maximally,
and such a company’s management we call
“go-getters”. A company that has low capital
and low labour output responses is using the
available resources sub-optimally, and such
a company’s management we call “slackers”.
THIRD QUARTER, 2012 (JUNE – AUGUST)
The intermediate cases (high labour/low capital
and low labour/high capital output responses)
are described below.
Several problems immediately arise:
How do we define “outputs” and “inputs”?
Inputs are fairly simple to define: for labour, we
take the number of employees; and for capital,
we take fixed assets. The only problem with
defining inputs is that many important inputs
do not have numerical counterparts. There are
good reasons to treat technology investments
separately, but they are lumped together with
fixed assets. A company’s brand and reputation
have a productive effect on output, but they are
not consistently measured between companies.
For purposes of this study, we restrict our
attention to capital and labour inputs only.
Outputs cannot simply be revenues, because
included in revenue is the sale of supplies
purchased from outside parties, among
other things. We do not want the productivity
of outside parties to be brought into the
evaluation of a specific company’s productivity,
so we exclude outside purchases, to give us
a measure of “value-added”. Cash generated
from operations is such an accounting measure
– i.e. cash generated from operations less
taxation and interest paid, investment income
received and less dividends paid gives rise
to operating cash flows. To calculate cash
generated from operations, one must calculate
cash generated from customers and cash paid
to suppliers. The difference between the two
reflects cash generated from operations
(see box).
How do we relate output to input?
Statistically we use a procedure known as
regression, which allows us to express output
as a function of various inputs and derive the
parameters that describe the relationships
between the variables. For example, if the
output/labour parameter is >0, this means
that an increase in labour input results in an
increase in output – in this case, labour is said
to be productive. If the output/labour parameter
is ≤0, this means that an increase in labour
input results in stagnant or declining output –
in this case, labour is said to be unproductive
(0) or destructive (<0). There are also special
cases: if the output/labour parameter is
>1 (≤1) then labour is said to be “superproductive”, meaning that a unit increase in
labour input results in a more-than-unitary
increase in output, something like a multiplier
or accelerator effect. The same parameter
interpretations apply to capital (see box).
SA’s most (and least) productive workforces
SA’s labour productivity at a 40-year low
Statistical note
A special statistical problem arises in the
regression, since capital and labour are
interdependent: workers use machines, and
machines require workers, to perform optimally.
It is therefore difficult to isolate the unique
productivity of labour and capital, since there
are conjoint effects between them. We can
resolve this problem in two ways: by adding
a third term to the regression, namely labour
multiplied by capital (a so-called “interaction
term”), which strips out the conjoint effects;
and by first regressing capital as a function
of labour, the residuals of which constitute a
labour-independent capital term, which is then
added to the regression instead of the original
unadjusted capital term. Both procedures yield
equivalent results.
We have used the above procedure for the South African economy as a whole, using data produced
by the South African Reserve Bank and Statistics SA. As indicated in the figure, labour productivity
has been falling over the past four decades: in the 1980s, a 1% increase in labour input resulted
in a 0,7% increase in output; whereas in the 2000s, a 1% increase in labour input resulted in a
0,1% decline in output – a decrease of 111%. This is a staggering result: in the 2000s, adding
workers to the input mix actually reduced output rather than increased it. In other words, South
African workers, on the whole, are destroying value, with the result that they are gradually being
retrenched.
SA’s capital productivity at a 40-year high
Capital productivity, by contrast, has increased steadily over the past four decades. In the 1970s, a
1% increase in capital equipment resulted in a 0,2% increase in output; whereas in the 2000s, a 1%
increase in capital equipment resulted in a 0,4% increase in output – an increase of 193%. For this
reason, capital’s (i.e. profits’) share of national income has increased from 39,9% in 1995 to 47,2%
in 2011. The South African Reserve Bank does provide capital data by sector (agriculture, mining,
manufacturing, government, etc.) and also by class of equipment (buildings, transport, machinery,
computers, etc.), so it is possible to calculate the productivity levels of sub-sets of capital, but that is
beyond the scope of this study.
Neither capital nor labour is super-productive in SA
What is alarming about South Africa’s economy-wide rates of capital and labour productivity is that
neither of them qualify for the title “super-productivity” as defined earlier. That is, a unitary increase
in neither capital nor labour produces a more-than 1% increase in output.
Percent increase in output due
to a unit percent increase in
labour input
South Africa Labour Productivity
(1970 – 2012)
0.8
0.7
True labour productivity
0.6
An alternative method of producing the same result is to take output per worker, and divide this by
the amount of fixed capital (net of depreciation) tied up in the production process. That is, we can
take gross value added for the economy, divided by the number of workers used to produce that
amount of output, and further divided by the amount of (net) capital used in the production process.
This procedure yields the series in the figure below. As indicated in the figure, labour productivity
(i.e. labour’s unique contribution to the production process) has declined steadily across multiple
time frames: by 32,5% since 1967 when official records began; and by 41,2% since the peak
reached in 1993.
0.5
0.4
0.3
0.2
0.1
0.0
-0.1
-0.2
1970s
1980s
1990s
2000s
Source: Prophet Analytics, South African Reserve Bank,
Statistics SA (2012)
Percent increase in output due
to a unit percent increase in
capital input
South Africa Capital Productivity
(1970 – 2012)
0.5
0.4
0.3
0.2
0.1
0
1970s
1990s
1980s
2000s
Source: Prophet Analytics, South African Reserve Bank,
Statistics SA (2012)
South Africa’s Labour Productivity
(1967 – 2012)
9 000
7 000
6 000
5 000
4 000
3 000
2 000
2011
2007
2003
1999
1995
1991
1987
1983
1979
1975
0
1971
1 000
1967
Rand thousand
8 000
Source: Prophet Analytics, South African Reserve Bank,
Statistics SA (2012)
4 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
SA’s most (and least) productive workforces
Reasons for SA’s poor labour and capital productivity
The Most Problematic Factors for Doing
Business in South Africa
It is not difficult to find reasons for South Africa’s lack of labour productivity. The World Economic
Forum ranks South Africa’s labour market regulations at #133 out of 139 countries, and this is
echoed in the most problematic factors for doing business in South Africa, namely ill-educated
labour (#2), restrictive labour regulations (#3), and poor work ethic (#7). South Africa’s relatively
low capital productivity, compared not to the country’s labour but to other countries, is a function
of bureaucracy (#1), corruption (#4), crime (#5), poor infrastructure (#6), and access to capital
financing (#8). South Africa’s regulatory regime is clearly highly problematic for employment and
investment, since it has dramatically reduced the returns on investment of both.
25
20
15
10
Tax rates
Government instability
Inflation
Tax regulations
Poor public health
Policy instability
Foreign currency regulations
Access to financing
Inadequate supply of infrastructure
Poor work ethic in national labor force
Corruption
Crime and theft
We can apply these techniques to differences in labour productivity between the private and
public sectors in South Africa. As indicated in the chart, private sector labour productivity is 450%
higher than public sector labour productivity. Although both series demonstrate a consistent
gradual decline over time, public sector labour productivity has declined by more (-52,2%) than
private sector labour productivity (-49,3%). Nonetheless, the important observation is that labour
productivity has been consistently declining over time.
Restrictive labor regulations
0
Inadequately educated workforce
Applying these techniques to the public sector
Inefficient government bureaucracy
5
Applying these techniques to individual JSE-listed companies
Source: World Economic Forum Global Competitiveness
Report (2011/2012)
We can apply the above principles to the evaluation of individual companies. For each company,
we take operating cash flows for the period (OPGCF) divided by the number of employees (EMPL)
and further divided by non-current assets (FASSET). The rankings for 152 JSE-listed companies
with market values above R1 billion and who consistently report employee numbers in their financial
statements are given in the table:
Labour Productivity in the Private and Public
Sectors (1980 – 2012)
400
350
300
250
200
150
100
2010
2008
2006
2002
2004
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
0
1980
50
Private sector
Public sector
Source: South African Reserve Bank, Statistics SA (2012)
5 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
SA’s most (and least) productive workforces
Ranking
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
Company name
RMB Holdings Ltd.
Vukile Property Fund Ltd.
Investec Bank Ltd.
Assore Ltd.
JSE Ltd.
PSG Group Ltd.
Capitec Bank Holdings Ltd.
African Bank Investments Ltd.
Vunani Ltd.
Wescoal Holdings Ltd.
Spur Corporation Ltd.
Merafe Resources Ltd.
Blue Label Telecoms Ltd.
Cashbuild Ltd.
Ceramic Industries Ltd.
Italtile Ltd.
Kagiso Media Ltd.
Kumba Iron Ore Ltd.
Petmin Ltd.
Adcock Ingram Holdings Ltd.
Famous Brands Ltd.
City Lodge Hotels Ltd.
Comair Ltd.
Pan African Resources PLC
Cipla Medpro South Africa Ltd.
Metrofile Holdings Ltd.
EOH Holdings Ltd.
Zurich Insurance Company South Africa Ltd.
Cadiz Holdings Ltd.
Truworths International Ltd.
Vodacom Group Ltd.
Distell Group Ltd.
Premium Properties Ltd.
Palabora Mining Company Ltd.
ADvTECH Ltd.
Phumelela Gaming and Leisure Ltd.
Raubex Group Ltd.
Coronation Fund Managers Ltd.
Mr Price Group Ltd.
Octodec Investments Ltd.
Wilson Bayly Holmes – Ovcon Ltd.
Evraz Highveld Steel and Vanadium Ltd.
Santam Ltd.
Allied Technologies Ltd.
Lewis Group Ltd.
Adcorp Holdings Ltd.
Avusa Ltd.
Kelly Group Ltd.
Sentula Mining Ltd.
Eqstra Holdings Ltd.
Iliad Africa Ltd.
Metair Investments Ltd.
Net 1 UEPS Technologies Inc.
Astrapak Ltd.
Distribution and Warehousing Network Ltd.
Clicks Group Ltd.
Caxton and CTP Publishers and Printers Ltd.
Bell Equipment Ltd.
Peregrine Holdings Ltd.
Aspen Pharmacare Holdings Ltd.
6 Labour Market Navigator
Output per worker
(Rands per annum) FY2007 – 2012
R817 050
R17 987
R625
R8 600
R774
R147
R168
R322
R690
R46
R135
R600
R172
R76
R168
R146
R95
R1 795
R139
R162
R95
R104
R103
R6
R158
R37
R33
R234
R147
R73
R1 667
R158
R222
R259
R44
R21
R99
R1 403
R42
R142
R97
R166
R380
R88
R43
R33
R40
R8
R116
R211
R17
R23
R15
R34
R20
R37
R72
R16
R123
R225
THIRD QUARTER, 2012 (JUNE – AUGUST)
Output per worker per unit of capital
(Rands per annum) FY2007 – 2012
R903 816
R325 410
R294 364
R135 638
R98 024
R68 830
R51 437
R51 337
R42 113
R38 960
R34 259
R29 826
R21 378
R18 484
R17 620
R15 224
R15 150
R15 133
R13 996
R13 550
R12 973
R11 466
R9 250
R8 989
R8 946
R8 785
R8 652
R8 499
R8 299
R7 646
R7 122
R6 525
R6 486
R6 332
R6 004
R5 883
R5 408
R5 217
R5 087
R4 957
R4 783
R4 754
R4 605
R4 341
R4 212
R3 746
R3 572
R3 350
R3 290
R3 100
R2 929
R2 922
R2 732
R2 671
R2 588
R2 541
R2 512
R2 459
R2 344
R2 294
SA’s most (and least) productive workforces
Ranking
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118
Company name
Standard Bank Group Ltd.
Invicta Holdings Ltd.
Rainbow Chicken Ltd.
AVI Ltd.
Astral Foods Ltd.
Sun International Ltd.
Basil Read Holdings Ltd.
Stefanutti Stocks Holdings Ltd.
Investec plc
Tsogo Sun Holdings Ltd.
African Oxygen Ltd.
Exxaro Resources Ltd.
Northam Platinum Ltd.
Woolworths Holdings Ltd.
Allied Electronics Corporation Ltd.
African Rainbow Minerals Ltd.
Combined Motor Holdings Ltd.
Group Five Ltd.
Compagnie Financière Richemont SA
Hudaco Industries Ltd.
MTN Group Ltd.
Hulamin Ltd.
Datatec Ltd.
Massmart Holdings Ltd.
Reunert Ltd.
Investec Ltd.
Pioneer Food Group Ltd.
Absa Group Ltd.
Super Group Ltd.
Nedbank Group Ltd.
Discovery Holdings Ltd.
AECI Ltd.
The SPAR Group Ltd.
Tiger Brands Ltd.
BHP Billiton Plc
Illovo Sugar Ltd.
Aveng Ltd.
Naspers Ltd.
Grindrod Ltd.
Sasol Ltd.
Impala Platinum Holdings Ltd.
Capital Shopping Centres Group PLC
Mondi Ltd.
Imperial Holdings Ltd.
Shoprite Holdings Ltd.
Mondi plc
Pick n Pay Stores Ltd.
Anglo American Platinum Ltd.
Telkom SA Ltd.
ArcelorMittal South Africa Ltd.
Barloworld Ltd.
Lonmin plc
British American Tobacco plc
The Foschini Group Ltd.
Liberty Holdings Ltd.
Mediclinic International Ltd.
York Timber Holdings Ltd.
Sanlam Ltd.
7 Labour Market Navigator
Output per worker
(Rands per annum) FY2007 – 2012
R246
R83
R39
R54
R37
R172
R26
R35
R9
R139
R65
R260
R98
R54
R75
R282
R6
R34
R48
R36
R1 325
R60
R6
R55
R29
R4
R42
R74
R43
R47
R84
R40
R15
R40
R371
R31
R35
R246
R35
R459
R184
R35
R18
R62
R22
R17
R14
R154
R149
R69
R37
R10
R29
R5
R415
R67
R4
R468
THIRD QUARTER, 2012 (JUNE – AUGUST)
Output per worker per unit of capital
(Rands per annum) FY2007 – 2012
R2 234
R2 177
R2 116
R2 070
R2 060
R2 034
R2 000
R1 943
R1 883
R1 874
R1 831
R1 661
R1 574
R1 534
R1 503
R1 476
R1 468
R1 434
R1 427
R1 372
R1 305
R1 252
R1 250
R1 174
R1 044
R1 005
R1 003
R943
R929
R874
R870
R818
R756
R587
R585
R543
R533
R529
R502
R463
R397
R367
R334
R329
R325
R316
R306
R289
R278
R270
R269
R265
R201
R196
R196
R193
R171
R154
SA’s most (and least) productive workforces
Ranking
119
120
121
122
123
124
125
126
127
128
129
130
131
132
133
134
135
136
137
138
139
140
141
142
143
144
145
146
147
148
149
150
151
Company name
Steinhoff International Holdings Ltd.
Mvelaphanda Group Ltd.
Nampak Ltd.
Tongaat Hulett Ltd.
Old Mutual plc
Murray & Roberts Holdings Ltd.
Anglo American plc
AFGRI Ltd.
SABMiller plc
The Bidvest Group Ltd.
DRDGOLD Ltd.
Remgro Ltd.
Pretoria Portland Cement Company Ltd.
Sappi Ltd.
Netcare Ltd.
Gold Fields Ltd.
AngloGold Ashanti Ltd.
FirstRand Ltd.
Harmony Gold Mining Company Ltd.
JD Group Ltd.
MMI Holdings Ltd.
First Uranium Corporation
Omnia Holdings Ltd.
Brimstone Investment Corporation Ltd.
Great Basin Gold Ltd.
Coal of Africa Ltd.
Blue Financial Services Ltd.
Trencor Ltd.
Lonrho Plc
Sasfin Holdings Ltd.
Brait SE
Wesizwe Platinum Ltd.
Wits Gold Resources Ltd.
8 Labour Market Navigator
Output per worker
(Rands per annum) FY2007 – 2012
R62
R6
R11
R13
R38
R7
R48
R2
R34
R16
R4
R42
R3
R9
R31
R76
R10
R206
R19
-R1
-R20
-R5
-R13
-R27
-R16
-R29
-R61
-R2 105
-R28
-R44
-R155
-R895
-R429
THIRD QUARTER, 2012 (JUNE – AUGUST)
Output per worker per unit of capital
(Rands per annum) FY2007 – 2012
R144
R142
R142
R139
R135
R126
R108
R100
R92
R90
R89
R88
R82
R65
R63
R43
R43
R28
R19
-R26
-R67
-R545
-R585
-R858
-R1 621
-R7 915
-R9 280
-R18 798
-R21 445
-R24 858
-R36 575
-R56 180
-R221 254
Back to basics – asset productivity and the value-ofthe-firm
We have not escaped the consequences of the financial collapse that started in the USA and
spread around the world. Arising from the crisis, one of the big issues of concerns is incentive
pay and the behaviours that follow from it.
Money is the most powerful lever to motivate but it’s very hard to grasp. Moreover, the higher up
you go, the more slippery it gets. The issue becomes highly emotional and political. It’s about
sharing wealth. Who do we reward with how much for what?
This article looks at business and the results of corporate chieftains being encouraged follow the
demand of the capital markets to maximise share prices. The introduction of share option
schemes as an incentive has not worked. They have fed greed and resulted in destructive
behaviour.
The article goes on to suggest that firms can start to remedy the situation through education that
breaks down the barrier of financial ignorance that exists at all levels. It gives several examples
that show how asset productivity drives the value-of-the-firm and that in the end, it is people who
make it work – not plans, budgets, and spreadsheets.
Having them understand what drives the value-of-the-firm – giving them the big picture – will
spark creativity and higher levels of productivity.
The ‘Greed is Good’ Doctrine
After the Soviet empire collapsed, capitalism became the only game in town. The ‘greed is good’ doctrine took hold and fuelled the 1980s boom, the
dotcom bubble, and then the derivative markets. They all crashed because of a fatal flaw in free-market dogma.
As the profit motive is a prime cause of human progress the argument goes, then the pursuit of greed leads to best outcomes for society. Therefore,
recruit the best talent, reward it with lavish amounts of money, and wait for excellent results to follow. That’s what some people believed anyway.
In 1990, financial economists Professors Michael Jensen and Kevin Murphy argued that CEOs were underpaid1 and rewarded like bureaucrats. They
found almost no link to performance. They asked if it is any wonder that most CEOs do not act like the entrepreneurs that companies need.
They also said that salary surveys make things worse. Firstly, they help inflate pay as everyone tries to be above average. Secondly, they encourage
systems that tie salary packages to size and growth, not performance and value. Moreover, they observed that surveys ranking the highest paid
executives stir public outrage, raise legislative eyebrows and provide good reason for increased demands in workforce wage negotiations. They
believed the basic problem was that surveys focus exclusively on what CEO pay is, not how to pay them.
This led to the widespread use of share options. By giving managers an equity stake, the aim was to get them to think and act like “owners” and to
remove the conflicts of interest that existed with shareholders. It didn’t work. Instead, it resulted in a modern version of the Shell Game.
This swindle has been carried out on streets of major towns and cities since the Middle Ages. The operator has three shells, or thimbles, and a small,
round ball often called a pea. He starts by placing it under one of the shells, and then shuffles them. He takes bets from players on where they think it is
and tells them they’ll double their money if they’re right, or lose it if wrong.
If you don’t know the game, you’ll think several people are betting but they aren’t. They’re members of a confidence ring. Some act as lookouts for
police. Others are bouncers who intimidate unruly players. Those who pretend to play and con you into placing a bet are ‘Shills’. You’re the ‘Mark’.
They prefer to dupe one player at a time so when the operator finishes shuffling the shells, he’ll ask if you want to wager. If you do, you must put down
your cash first. Using sleight of hand to hook and reel you in, he moves the pea from one place to another without your seeing how he does it. You’ll win
only if he wants you to and he does let you pocket some money for a while. That’s when you get overconfident and greedy.
You place the big bet and then the pea appears under another shell – ‘Now you see it, now you don’t!’ However, forget about getting your money back. If
you do protest, the operator may add insult to injury. He’ll accuse you of trying to cheat him and have his bouncers sort you out.
1 CEO Incentives – It’s Not How much You Pay But How – HBR May-June 1990
9 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
Back to basics – asset productivity and the value-ofthe-firm
Today, most people think that similar con tricks
have been played on Wall Street and in other
financial centres for years. The dotcom bubble
was one of them. In this game, financiers were
the operators.
They conspired with entrepreneurs, corporate
executives, and professional firms of lawyers
and accountants to make sure they had
everything to gain, and nothing to lose. First,
there were ‘insider-trading’ bonanzas when
companies listed on stock exchanges or were
part of a merger or acquisition. Second, there
were huge bonuses and share options for
executives. Lastly, fat fees and commissions
went to the ‘professional’ advisors. Like the
pea, the profits disappeared but the cash went
into their pockets. They didn’t make money,
they took it.
Even business gurus and the financial media
fell for a fraud based on the concept of
‘intellectual capital’ and the myth of talent best
typified by McKinsey’s involvement with Enron2.
After this bubble burst, and having strongly
supported the use of share options to
get executives to act in the interest of
shareholders, Jensen revealed that they didn’t
work well after all3. In his 2001 working paper,
he said the vast increase in standard options
did little to identify management’s interests with
shareholders or society. To solve the problem,
he suggested that options should be linked to
the cost-of-capital.
Then came another version of the Shell Game.
This time it was the property derivatives scam.
Bankers created financial products based on
complex mathematical models. They mean
nothing to most people – even banking firms’
top management it seems. Some pundits
reckon they created a global casino that could
be ten times bigger than the world’s GDP.
Professor Niall Ferguson saw it in that
way. He reckoned that in 2006 the world’s
economic output was $48,6 trillion. The market
capitalisation of the world’s stock markets was
$50,6 trillion. The total value of domestic and
international bonds was $67,9 trillion. Every
month about $100 trillion changed hands on
foreign exchange and stock markets around
the world. This activity spawned ever more
financial products and firms.
The number of hedge funds grew from 610 in
1990 with $38,9 billion under management to
9 462, with $1,5 trillion under management.
By the end of 2006, the volume of derivatives
and swaps totalled $400 trillion. When it came
to profits, like the pea in the Shell game, they
weren’t there.
The cash went into bankers’ and traders’ pay
packets. In one year, twenty-five hedge fund
traders pocketed $14 billion – more than three
times the pay of eighty thousand New York
schoolteachers. Again, it was a case of taking,
not making money because most of the hedge
funds gave little or no return anyway.
By end 2008, taxpayers in the USA and UK
started bailing the bankers out. Instead of
protecting the market place, governments
seem to protect those who damage it. Then, as
the Shell Game operators do, they blame the
people they conned for being stupid.
After the market collapse, in 2011 Jensen
published another paper with Murphy4.
This time they said that almost all CEO and
executive bonus plans have serious design
flaws that dramatically limit their benefits.
They destroy value by encouraging CEOs to
manipulate the timing of earnings; to mislead
their boards about a firm’s capabilities; to take
on too much risk or too little; lastly, to ignore
the cost-of-capital.
This is not to say all business executives,
bankers and professional people are villains.
However, many seemed to fit the picture that
the socialist Fabian society had of them in
England a hundred years ago. It saw business
as a mindless game of chance any ruthless
donkey can win.
Greed for reward can destroy quality. People
aren’t stupid. They do what you pay them to
do make bad loans, take huge risks, package
and resell worthless paper, lever up balance
sheets, and pursue growth not profitability.
Greed also sparks creative, novel ways to
outsmart the rules put in place to control it.
When bonuses and promotions are on the line,
winning at all costs becomes the driving value
– not productivity and concern for customers.
People fake numbers, physical and financial
ones, and spend time and effort on ways to
rig and dominate markets. Keep feeding them
carrots and they will behave like ruthless
donkeys.
When you consider their performance, how
many of them earned the huge rewards they
received? Did they make their companies more
competitive? Did they put customers first? How
many of them generated an economic return
for shareholders – one that beats the cost of
capital?
The truth is, when you look at successful
corporations, how much of their consistent,
predictable results today are governed by
a system designed and built by previous
generations of management? As Sir Isaac
Newton said, ‘If I have seen further it is by
standing on the shoulders of giants.’
Money is the most powerful lever to motivate
but it’s the hardest one to grasp. Moreover, the
higher up you go, the more slippery it gets. The
issue becomes highly emotional and political.
It’s about sharing wealth. Who do we reward
with how much for what?
Competence and worthy results play little part
in the reckoning. Until we know what reward
systems will do, and design ones that don’t
produce destructive behaviour, the same things
will happen again. The omens aren’t good. Live
and don’t learn…that’s us!
The Problem/Opportunity
Today, capitalism is in crisis and it’s tempting
to look for a single, major cause. There isn’t
one. It’s a system that has major strengths and
weaknesses. So where do we start?
It has to be with ignorance and we can tackle
that immediately. Business is the game we play
most of our working lives and it is a mindless
game of chance for many of us because we
lack information.
Of people who lose their jobs, and even their
homes, how many know why it happened?
They think they were doing good work and
probably were. The problem is they don’t know
the rules of the game so how can they think
and act intelligently?
There is a huge opportunity to break down the
barriers of financial ignorance and to educate
people at all levels about the most important
game of all.
The Business Success
Imperative
One Big Idea that comes out of the current
problem is that the basic rules of business
haven’t changed since the days of the Pharaohs.
There is only a handful. They form part of
what is probably the only Business Success
Imperative – the time it takes from paying to
being paid. This is the Cash-to-Cash Cycle. Its
speed determines the viability of any business,
its future productivity and competitiveness.
Bruce Henderson, founder of Boston Consulting
Group and the man who turned ‘strategy’ into
a huge business for consultants and business
schools, but with questionable value for firms,
said all that counts is cash in and cash out.
‘A business is a cash-compounding machine,’
he said. You may or may not agree, but
one thing is certain. He warned that if you
keep spending more cash than you bring in
eventually you’ll be swept away.
2 The Talent Myth – Malcolm Gladwell – The New Yorker July 22, 2002
3 How Stock Options Reward Managers for Destroying Value and What To Do About It – Harvard NOM Research Paper No. 04-27, April 17, 2001
4 CEO Bonus Plans: And How To Fix Them – HBR NOM Unit Working Paper No. 12-022/ USC Marshall School of Business Working Paper No. FBE 02-11 – November 19, 2011
10 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
Back to basics – asset productivity and the value-ofthe-firm
3.Profit Margin (ROS%) – this is the Return on Sales (Operating Profit ÷
Sales X 100).
Cash ROAM and Market Value
The imperative has nothing to do with the difference between ‘intangible’
and ‘tangible’ assets. It also has nothing to do with the trendy theories
that treat people as ‘intellectual capital’ or ‘brands’ as assets.
Using recent year-end numbers to calculate ROAM and the link to value,
the first exhibit is a snapshot of 48 sectors on the Johannesburg Stock
Exchange.
As we have seen, the capital markets are not efficient for a lot of the time.
However, the fundamental driver of value is the sustainable productivity
of a firm’s asset base. This surprises most managers who believe in the
‘common sense’ of controlling costs and planning for profit growth.
There are 160 companies in the sample. The next exhibit shows how they
compare.
It asks the question, “For every Rand of Assets we manage, how many
Rands of sales are we generating?” It is the most significant competitive
measure of all. As there is a link with ROAM to market value, so is there
a link between ATO and ROAM. The higher your ATO, the higher your
ROAM is likely to be.
A trait of long-lived companies is conservative financing. Extraordinarily
successful companies do not risk their money needlessly. They
understand the meaning and value of cash in the bank. Three measures
drive the process of putting it there. They are the three most important
measures of operating management:
1.Return on Assets Managed (ROAM) – this is the total operating profit
of the business. It is driven by;
2.Asset Productivity (ATO) – the sales productivity of the asset base
(Sales Revenue ÷ Assets) multiplied by; and
Cash ROAM and Market Value
2011 – 2012
4
7
3.5
6
3
2.5
2
1.5
1
0.5
5
4
3
2
1
0
0
10
20
30
40
Mining ATO and ROAM
2011 – 2012
ROAM
Market cap/assets ratio
Market cap/assets ratio
Cash ROAM and Sector Market Value
2011 – 2012
0
Let’s drill down a bit deeper into the numbers to see what they tell us. In
the mining sector, capital intensity is high, so the ATO number will be low.
However, there is still a clear correlation with ROAM.
50
-20
0
20
40
60
80
100
The calculation for Cash ROAM is based on Cash
Operating Profit before depreciation, amortisation,
interest and tax.
There is another question to consider however. What is
the prime driver of ROAM?
The correlation with ROAM and the value-of-the-firm is
clear. As ROAM rises, so does the value of the sector.
Most managers look at the profitability of sales first.
They rarely look at Asset Turnover if at all. Yet it is the
first and most important measure in the ROAM equation.
Nampak ATO and ROAM
1994 – 2012
Retailers (Food) ATO and cash ROAM
2007 – 2011
Many CEOs and managers do not understand this.
They pursue strategies that steadily wind down the
sales productivity of their assets.
Nampak has been a classic example of that as the
next chart shows.
3
Market Cap/Assets Ratio
Cash ROAM (%)
ROAM (%)
As Asset Turnover rises, so does the probability of a
higher ROAM.
Retailers (Food) Cash ROAM and VOF
2011 – 2012
25
15
10
5
20
15
10
5
0
1
1.5
2
2.5
2
1.5
1
0.5
0
0
1
2
3
4
5
6
0
5
10
15
1994 – 2008
Pick ‘n Pay
Pick ‘n Pay
2009 – 2012
Shoprite
Shoprite
30
Source: I-Net Bridge
Source: I-Net Bridge
From 1994, Management set course in a south-westerly direction that took them to an ATO close to 1.0 and a
predictable ROAM of less than 10% in 2008.
The new management team now seems to have turned the ship back onto a northerly heading.
Of course, the exemplars of managing ATO and the cash-to-cash cycle are retailers. Let’s look at them next.
Pick ’n Pay, Shoprite and Spar have differing business designs but a higher ATO still links to a higher ROAM for all
of them.
The difference between Pick ’n Pay and the others however, is that since 2007, it has been heading southwest while the
other two held a north-easterly course.
THIRD QUARTER, 2012 (JUNE – AUGUST)
25
Spar
Spar
What effect does this have on the value-of-the-firm?
20
Cash ROAM (%)
ATO
ATO
11 Labour Market Navigator
3
Source: I-Net Bridge
30
25
20
2
ATO
Once again, there is a clear correlation. As ROAM rises,
so does the probability of a higher valuation from the
capital markets.
The Market Value is calculated by dividing Market
Capitalisation by total assets on the balance sheet.
0.5
1
Source: I-Net Bridge
Source: I-Net Bridge
0
0
Cash ROAM (%)
Cash ROAM (%)
0
100
90
80
70
60
50
40
30
20
10
0
The result is: “The first shall be last!”
In 2007, Pick ’n Pay was the leader and Shoprite in third
position. It has taken five years for them to swap places.
Pick ’n Pay’s ATO fell from 5,7 to 4,8 and its ROAM from
25,5% to 16,2%.
Is this yet another example of the cost – not value yet in
this case – of introducing a new ERP system?
Has Pick ’n Pay’s headache been caused by a whack
from SAP-wielding IT people?
Back to basics – asset productivity and the value-ofthe-firm
To return to Jensen and his view that any incentive for CEOs should
be linked to the cost-of-capital, let’s now look at three successful South
African companies that operate around the world and see why it matters.
management to beat it, this is the result over time. SABMiller is first.
Not only does management no longer report its EVA result, but unlike
most other firms it has stopped showing the level of operating assets
used to generate sales in its segmental reporting.
Last year, there was an analysis published that showed the relative
performance of an investment in a number of top companies on the JSE
over a twenty year period. Two of them were Bidvest and SABMiller.
In contrast, here is Bidvest’s performance over the same period.
Naspers is a fascinating case in that the CEO, Koos Bekker, gets no
salary. His reward is in the form of share options. Are they linked to the
cost-of-capital as Jensen suggests they should be?
R10 000 invested in the brewer would have returned around R15 000. In
contrast, the same investment in Bidvest would have yielded more than
R100 000. Having only started up in the late 1980s Bidvest grew from a
far lower base, but is that the main reason? Since 1998, its asset base
has not grown as fast as SABMiller’s. First, here is a comparison of their
relative ATO and ROAM.
If they are, then if the Naspers Board were to apply the same Cost-ofEquity as we have done so far, this is the firm’s performance for the past
ten years.
Today more than 50% of the firm’s asset base is ‘intangible’. Presumably,
the intangible US$30 billion is what management has paid for ‘brands’.
Shouldn’t shareholders expect a return on them that beats their ‘cost
of equity’?
However, over the past eight years the asset base has grown from
R3,1 billion to more than R80 billion. Inevitably, this has wound down
asset productivity. ATO has halved and that’s why Cash ROAM and the
economic value destruction curve have plunged.
Economic Profit
What does all this mean for Naspers and SABMiller?
A rough and ready approach to calculating economic profit is to take
Cash Profit after tax and deduct a cost of equity. What should that cost
be? The best companies would not be happy with less than 25%. It
means that if Graham McKay or Brian Joffe were to challenge their
And what does all this mean for management in general?
SABMiller Cash ROAM and Economic Profit
1998 – 2012 (@ 25% Cost-of-Equity)
2
20
10
5
0
0
1
2
3
-4
15
-6
10
-8
-10
5
-12
-14
4
20
-2
‘98 ‘99 ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12
0
25
8
20
6
15
4
10
2
5
0
-2
‘98 ‘99 ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11
Years
ATO
SAB Miller
Bidvest
Years
Period
Period
Cumulative
Cumulative
ROAM
ROAM
A picture like this may explain why management used
to report EVA (Economic Value Added) or economic
profit, but no longer does.
This chart shows why the sales productivity of the
asset base is the primary measure of management’s
ability.
Bidvest’s ATO went from 1.9 in 1998 to 3.3 and it is
now around 2.5.
The latest acquisition in Australia has added to the
problem. Foster’s net asset value was $400 million
but SAB paid $10 billion for the company.
Bidvest’s operating margin is less than a third of
SABMiller’s. Yet it generates a higher ROAM and an
economic profit.
SABMiller has fallen from 1.3 to 0.4 today. The reason
is that unlike Bidvest, they have always paid a big
premium for their acquisitions.
Even if management disagrees with a shareholder
expectation of a 25% Return on Equity, the curve will
still be in steep decline.
Until the firm beat an ATO of 2.0 it made an economic
loss. However, it’s more than an arithmetic calculation.
It’s about how you design and run the business.
They are very different businesses but always judge
the trend, not numbers in isolation. Since 1998, SAB’s
ATO has headed south-west while Bidvest took the
opposite course.
Naspers Cash ROAM and Economic Profit
2003 – 2012 (@ 25% Cost-of-Equity)
25
5
20
0
15
-5
-10
10
-15
-20
-25
‘03
‘04
‘05
‘06
‘07
‘08
‘09
‘10
‘11
‘12
ROAM (%)
Economic Profit R billion
10
Despite a falling ROAM and economic loss, expectations from the capital markets are high.
The market capitalisation of the company at year-end was double the size of the asset base and more than four
times sales revenue.
5
These expectations, as for SABMiller, are probably bolstered by a high ROS%.
0
Naspers generates a cash operating margin of more than 20% and has done so for years.
Years
Period
Cumulative
ROAM
12 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
0
ROAM (%)
15
10
25
0
ROAM (%)
Economic profit US$ billion
25
Bidvest Cash ROAM and Economic Profit
1998 – 2012 (@ 25% Cost-of-Equity)
Economic profit US$ billion
SAB Miller and Bidvest ATO and ROAM
(1998 – 2012)
ROAM (%)
It’s a matter of time. Unless they turn the value destruction curve around,
there will be a revaluation sometime in the future. It’s inevitable.
Back to basics – asset productivity and the value-ofthe-firm
Education
For most employees, the shares
they own are just a perk. At best,
they may know the share price
but they have no idea how
valuable equity is or how they
can grow it. They don’t know
that every Rand they can ‘make’
or ‘save’ can become around
R10 or more when it becomes
‘retained profit’ and part of
shareholders’ equity. It means
there’s a huge opportunity to
harness their brains. All they
need is knowledge of simple
arithmetic to understand the
basics of finance and that’s
ROAM – especially Cash ROAM.
Remove ignorance if you want
people to work effectively
together – especially financial
ignorance.
13 Labour Market Navigator
People make ROAM work – not spreadsheets,
plans and budgets. One issue the financial
crisis forces us to face is the existence of a
huge productivity barrier – financial ignorance.
Despite it, many companies today use a costly
incentive tool that either stimulates the wrong
behaviour, or achieves nothing at all. It is the
employee share scheme. To investors and
long-term savers, they are a waste of money.
Yet today, most employees in listed companies
are now shareholders.
To find out how high the barrier is – and how
big the opportunity – do this test. Ask people
from boardroom to the workplace these four
questions:
1. ‘What is the value of the assets we managed
last year?’
2. ‘What sales did we generate from them?’
3. ‘What operating profit did we make?’
4. ‘Who pays your salary?’
Less than 5% will have the answers to the first
three and many of those who don’t know will be
at senior level – maybe even in the boardroom.
As to the last one, most people won’t say “Our
customers” or understand that the only profit
lies with a satisfied customer. There are only
costs inside the firm.
The answers to the first three questions
enable you to measure the asset productivity
of the business – ROAM – Return on Assets
Managed. As all the charts have shown, this
measure drives the share price and value of
listed firms. The key productivity measure
within the ROAM model is ATO. Do people
know how they influence it?
THIRD QUARTER, 2012 (JUNE – AUGUST)
For most employees, the shares they own are
just a perk. At best, they may know the share
price but they have no idea how valuable equity
is or how they can grow it. They don’t know
that every Rand they can ‘make’ or ‘save’ can
become around R10 or more when it becomes
‘retained profit’ and part of shareholders’ equity.
It means there’s a huge opportunity to harness
their brains. All they need is knowledge of
simple arithmetic to understand the basics
of finance and that’s ROAM – especially
Cash ROAM. Remove ignorance if you want
people to work effectively together – especially
financial ignorance.
Very few companies educate their people
this way. How many of them explain how
one person’s actions affect others? Do they
know what cash effect their actions have on
the company? Do they understand how their
company’s products and services create value
for customers?
In other words, give them the Big Picture.
Dump the ‘employee’ way of thinking. You want
an educated, flexible, alert company filled with
people who think like ‘owners’. It’s tough to
do. Most people find work incredibly boring. To
them a job is just a job. They become zombies
– the walking dead!
So, create the conditions that change the way
people think. Teach everyone the numbers that
an owner and traditional bank managers used
to worry about. That way they’ll see how every
cent can make a difference in creating value.
Why is capital so much more productive than labour
in South Africa?
The SA Economy since 1995: Capital Excellence yet Indifferent Output Growth and Declining
Employment
Explaining the exceptional returns provided by JSE companies in the new South Africa and
addressing why SA business has become more capital and less labour intensive.
JSE listed companies have an impressive
record of generating wealth for their
shareholders. We show how they have done
so through their excellent management of
the capital they have invested. We show also
that such impressive performance has been
associated with tepid growth in Real Value
Added by the SA economy and declines in
formal employment1.
Cumulative returns USD 100 invested on
1 January 2003
500
400
300
200
100
50
0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
New York S&P 500
MSCI EM Benchmark
JSE USD
Source: I-net Bridge and Investec Wealth and Investment
Commodity Prices (The Commodity Research
Bureau CRB Index) and the Gold Price per
ounce US Dollars
2 000
1 600
1 200
CRB index
450
800
400
350
Gold price
500
400
300
0
250
200
150
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
All commodity price index (USD)
Commodity research Bureau CRB
Gold price USD per ounce
Source: I-net Bridge and Investec Wealth and Investment
JSE real earnings since 1970
500
400
300
200
100
50
0
1970
1975
1980
1985
1990
1995
2000
2005
2010
JSE real earnings smoothed
JSE real resource earnings smoothed
JSE real findi earnings smoothed
Source: I-net Bridge and Investec Wealth and Investment
How well run are companies listed on the JSE
and do they create shareholder value? Have
they been able to improve their economic
performance over the past 18 years since SA
became a democracy and SA businesses could
freely trade with the world and engage helpfully
with global financial markets and also list their
shares on the major stock exchanges? How
do their returns on capital invested compare
to those of companies in other countries? Can
shareholders in JSE listed companies hope to
benefit from more favourable recognition by
global and local investors of the inherent quality
of their holdings? How does uncertainty about
government economic policies influence risk
appetite and market valuations of companies?
We answer these questions below.
Reviewing the recent history
of the JSE. Measuring the
outstanding returns provided
by the JSE for shareholders
especially since 2003.
Shareholders in JSE listed companies have
enjoyed outstanding returns over the past ten
years. The JSE All Share Index has kept up
with the average Emerging Equity Market2
average and outperformed the S&P 500 by
a very large margin as we show below. A
hundred dollars invested on the JSE in January
2003 would now have compounded to USD371
by the end of May 2012 including dividends
reinvested in the market. The same USD100
invested in the S&P 500 would have grown
to USD176, less than half the gains in USD
realised over the same period by the JSE.
It is the economic performance of a company
that will determine its value to shareholders.
We will focus on the returns realised by JSE
listed companies on the capital they have
invested on their shareholders behalf. An
examination of the history of JSE reported
earnings over the longer run, from 1970 to the
present, provides a very interesting perspective
for this analysis. In the figure below we show
inflation adjusted real JSE All Share earnings
per share since 1970. These earnings per
JSE average real earnings per share declined
in real terms between 1980 and 2003. Index
earnings per share did not recover their
1980 levels until approximately 2004 – 05.
Earnings per index share were boosted in the
mid seventies and early eighties by dramatic
increases in the price of gold that began the
decade at $35 per ounce and averaged $600
in 1980 and 1981. Then SA mines produced
600 metric tons of gold compared to the less
than 200 tons they produce today. JSE listed
companies, particularly resource companies,
were hard hit by the deflation of underlying
metal and mineral prices that occurred through
the mid eighties and nineties as we show in the
figure below. This deflationary backdrop made
it very difficult for JSE listed mining companies
to deliver growth in real earnings or provide
good returns on capital invested.
Financial and Industrial Index earnings
per share did not suffer as badly from the
commodity price deflation of the nineties, but
they also only recovered from their depressed
levels of the nineties in the past decade. It
is surely encouraging for investors in JSE
listed companies that real earnings reported
today now exceeded their previous pre global
recession peak levels. FINDI real earnings,
while having recovered from the recession of
2008 – 09 are still below their previous peak
real levels.
The benefits of political change
for economic freedom and
efficiency in SA
A further factor that made it difficult for SA
companies to deliver earnings and returns on
capital were the economic sanctions imposed
on SA business undertaking global operations
and realising potential economies of scale and
specialisation only possible with a footprint well
beyond the South African economy. Successful
SA companies with restricted opportunities to
expand their core business activities tended to
invest excess cash in acquisitions of unrelated
businesses. Their shareholders encouraged
them to do so. They were subject to very strict
controls on their offshore portfolio investments
and had few alternatives to invest in shares
other than those listed on the JSE.
1JSE listed companies operate globally as well as in SA. Our discussion of returns on capital apply to all the operations of these
listed companies not only to those that would be represented in South African national Income Statistics to which we refer when
we discuss Value Added and Employment statistics.
2 Represented by the Morgan Stanley (MSCI) EM benchmark
14 Labour Market Navigator
share are also broken down into earnings per
index share reported by Resource Companies
and earnings per share for the Financial and
Industrial Index. The JSE by market value has
been about equally divided between resource
and other counters.
THIRD QUARTER, 2012 (JUNE – AUGUST)
Why is capital so much more productive than labour
in South Africa?
South Africa industrial/service firms
-3sd
-2sd
-1sd
avg
+1sd
+2sd
0.45
0.40
Density
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
-25 -20 -15 -10 -5
0
5
10 15 20 25 30
35 40
Source: Credit Suisse HOLT
The global average CFROI is 6%
which also equates to the
long-term real cost of capital.
Firms who generate a CFROI of
6% are generally value neutral.
The average CFROI for South
African companies is an attractive
9.2% with a median of 8,2%. Note
the long-tail and skew towards
value creating returns.
Historically, 63% of CFROI values
for JSE listed companies were
above the global average of 6%,
which is an impressive result.
30% of CFROI results were above
12%, which generally gets
rewarded with an enterprise value
to book multiple of 2. Relative to
the rest of the world, listed South
African companies are generating
impressive economic returns on
capital!
15 Labour Market Navigator
This opportunity set for SA companies and their
shareholders changed comprehensively with
SA democracy in 1994. SA entrepreneurs and
managers were no longer treated as pariahs
by potential partners or investors outside South
Africa and were much more free to expand
their businesses offshore. SA wealth owners
and their agents, the pension and retirement
funds, were also allowed increasing freedom
to invest directly offshore. The opportunity to
add value for shareholders improved for SA
business with much improved economic and
political freedom. The discipline imposed by
more open capital markets was also tightened
given the much wider opportunities their
shareholders gained to invest outside South
Africa. We are able to demonstrate that South
African companies generally have registered
much improved and impressive returns on the
capital they have invested.
The opportunity cost of funding the projects
undertaken by a company is its real cost
of capital. It is the real return required by
investors in the company given the many
other alternative uses of their savings open to
them. This required return reflects the market’s
appetite for risk and the company’s mixture of
debt and equity funding. When the internal rate
of return generated by the company exceeds
this required market determined rate of return
appropriately risk adjusted, the company will
be adding economic value by getting more
out of the resources it employs than they cost.
The market place is very likely to reward such
achievements by attaching a higher value to
the company to the great advantage of its
shareholders.
An Economic Return on Capital
Based Analysis of the JSE
To answer whether South African companies
are value creators, we generated a distribution
curve with historical CFROI values dating
back to 1982 for publicly listed, non-financial
companies. Note that this is a real return – fully
adjusted for inflation. The sample includes
industrial, service and resource companies. It
excludes the financials sector.
If a company can generate a return on capital
that beats the opportunity cost of the capital
it employs, it will create shareholder value.
The market will in time award the successful
company a value that exceeds the value
of the cash invested in the company by its
management over time. This would clearly be
value adding for its shareholders. The strategic
imperative for such a firm should be to maintain
its profitability and grow. If a company is unable
to invest its shareholders capital at least as well
as the shareholders could do for themselves
by holding shares in other similar companies,
it will be destroying shareholder value and
should minimise reinvestment. A company that
meets its cost of capital is value neutral, and
its management team should focus on the hard
and exacting chore of improving operating
returns instead of growing its asset base.
In general, firms that create shareholder value
trade at market values in excess of their book
values; firms that destroy shareholder value
trade below their book values; and firms that
meet their cost of capital trade at their book
values. The books of a company will record
all the cash invested in the company by its
management over time.
The aim of a sound return on capital measure
should be to minimise accounting distortions
and estimate the underlying economic return
on a company’s investments. To measure the
economic performance of a company and
to calculate its (internal) return on capital,
we employ CFROI®, which is a real,
inflation-adjusted cash flow return on
operating assets. Because the measure is real,
it is comparable across time and over borders.
In other words, a South African company can
be compared to itself in different inflationary
environments, and to companies in countries
with lower inflation. This makes CFROI a
very powerful benchmarking and economic
return measure.
THIRD QUARTER, 2012 (JUNE – AUGUST)
Measuring the return on capital
realised on the JSE
Distribution curve of the
historical CFROI values for
South African companies
The global average CFROI is 6% which also
equates to the long-term real cost of capital.
Firms who generate a CFROI of 6% are
generally value neutral. The average CFROI
for South African companies is an attractive
9.2% with a median of 8.2%. Note the longtail and skew towards value creating returns.
Historically, 63% of CFROI values for JSE listed
companies were above the global average
of 6%, which is an impressive result. 30% of
CFROI results were above 12%, which generally
gets rewarded with an enterprise value to book
multiple of 2. Relative to the rest of the world,
listed South African companies are generating
impressive economic returns on capital!
How returns on JSE listed
capital have evolved
What about the evolution of those economic
returns? In the next chart, the median CFROI
is plotted from 1982. To eliminate outliers,
i.e., companies with exceptionally high or low
returns on capital, we show the trends for
companies within a band around the median
return, excluding the top and bottom 20%
of performers. Bands for the 20th and 80th
percentiles give an indication of how the range
of returns on capital has developed over time.
We show that the economic return on capital
has improved spectacularly over time, with
today’s median firm reporting a very healthy
CFROI of 10%. Until 1994, the average South
African company was sporting a CFROI at or
below the global average of 6%.
Why is capital so much more productive than labour
in South Africa?
Since 1994, the CFROI has sloped upwards and remained well above 6%. The new South Africa
has been a value-creating South Africa! Note that at the peak of the commodity super cycle in 2007
– 2008, the median CFROI was a stunning 13%. The top and bottom quintiles have also sloped
upwards, indicating greater value creation for the best firms and less value destruction for the worst
firms. Presently, 20% of South African firms are generating economic returns on capital above 15%.
20% of today’s companies are generating a value destroying CFROI of 4% or less.
Time series of South African CFROI –
medians and bands about the median
20
18
16
14
12
10
8
6
4
2
0
The returns required by the share market of JSE listed companies –
measuring their real cost of capital
1982
1987
1992
1997
2002
2007
2012
80th percentile
Median
20th percentile
Source: Credit Suisse HOLT
Investors expect higher returns when taking on more risk, so it seems logical to assume that South
African investors demand better economic returns on the cash they invest. What is the cost of
capital for South African companies and how does it compare to the economic return on capital
generated by South African firms?
The market-implied real cost of capital for various countries is measured on a weekly basis by
Credit Suisse HOLT. That is the calculation of the required rate of return or discount rate implicit in
the observed relationship between economic performance as measured by HOLT and the market
value of a company. Excessive multiples (market/book value) and market values imply that risk
appetite is high and the expected cost of capital (the discount rate) is undemanding. The risk
premium is low. When multiples are low and market prices depressed, risk appetite is low and
the expected cost of capital high. That is the market is attaching a high discount rate to expected
performance when it values the company. Results of this exercise for the USA and South Africa are
shown in the next plot.
Real cost of capital for South Africa and the USA
The average real cost of capital as demanded by the market and implied by market prices and cash
returns (the implicit real discount rate applied in the share market when it values companies) for the
US since 1950 is 6% but since 1991 it declined to about 5%. Note how low it dropped during the
Dotcom bubble and how it remained at a risk denying rate of 4% for much of the Noughties. As a
rule of thumb, a discount rate below 5% indicates euphoric risk appetite, and a discount rate above
7% indicates a high degree of investor pessimism and bearishness3.
10
9
8
7
6
5
4
3
2
1
0
Since 1991 the median real cost of capital, the required market returns of investors in JSE listed
companies has been 6,1%, which is 110 basis points above the US over this period but still well
below the CFROI reported by the majority of South African companies, who are indeed creating
value for shareholders. In 20% of the time since 1991, the real cost of capital has been above a risk
averse 7% in South Africa and reached 9,4% after Lehman Brothers went bankrupt!
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Discount rate (%)
Global standard firm discount rates:
South Africa and USA
South Africa
USA
Source: Credit Suisse HOLT
Capital and Labour in South Africa. Returns on capital are necessary
but not sufficient to the purpose of faster economic growth
These excellent and improved returns on capital have unfortunately been realised with significant
declines in the numbers of workers employed. While the return on capital has improved the
production process in South Africa has become more capital and less labour intensive. In the
figures below we show some very unpleasant truths of SA economic life by demonstrating the
relationship between real value added and the numbers employed by non-financial SA corporations.
As may be seen the numbers employed per unit of output by SA business has declined dramatically
over the years with the secular decline only partly restrained by the cyclical upswing between 2003
and 2008.
The SA Economy: Real Value Added and
Employment 1995=100
170
160
150
140
130
120
110
100
90
80
1996
1998
2000
2002
2004
2006
2008
2010
Employment
Real gross value added
Source: SA Reserve Bank and Investec Wealth and
Investment
3Holland, David and Bryant Matthews. “Market-implied Returns: Past and Present.” Credit Suisse Global Investment Returns
Yearbook 2011; February 2011, Credit Suisse Research Institute, pp 25-29.
16 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
Why is capital so much more productive than labour
in South Africa?
The share in value added captured by
employees has trended lower over the period
(see below). What has changed significantly
is the fewer numbers employed per unit of
output. In other words fewer workers have
been employed by formal business and
government organisations and corporations
to produce significantly larger output of goods
and services at significantly improved levels of
remuneration per worker employed.
Total Real employee compensation and
employment 1995=100
200
180
160
140
120
100
80
1996
1998
2000
2002
2004
2006
2008
2010
Real compensation (compensation/cpi)
Employment
Source: SA Reserve Bank and Investec Wealth and Investment
Growth in real value added and employment
6
5
4
3
2
1
0
-1
-2
-3
-4
Returns on capital have
improved significantly –
economic growth remains
unsatisfactorily slow
1996
1998
2000
2002
2004
2006
2008
2010
Growth in real value added
Growth in employment
Source: SA Reserve Bank and Investec Wealth and Investment
Share of Labour in Gross Value Added. (LHS)
Gross compensation of employees and
Gross Operating Surplus of non-Financial
Corporations (R million)
Share of labour in value added
600
400
56
200
54
0
52
50
48
1996
1998
2000
2002
2004
2006
2008
Operating surplus and gross remuneration (R’000)
800
46
Real compensation per employee between
1995 and 2011 increased at an average
annual rate of 4,23% while real value added
has grown by 3,27% p.a. over the same
period. The relationship between growth
in output and growth in real compensation
does not accord with economic theory very
obviously. For example as we show below
during the recession of 2008 – 09 when output
growth turned negative real compensation
per employee rose strongly and employment
fell Those employees who have kept or
gained jobs have clearly made significant
real gains over the period. The average real
compensation of those employed doubled over
the period 1995 – 2011 as we also show.
2010
Share of labour in value added by
non-financial corporations
While output has grown over the years the
pace of growth itself has remained subdued.
Non-financial corporations have grown their
value added at an average rate of only
3,64% p.a. over the period 1995 – 2011.
For a developing economy this represents
unsatisfactorily pedestrian growth. We have
shown that the returns on capital realised
by JSE listed companies have improved
consistently over the years and that they
compare very favourably on this measure with
their global peers. Despite these very good
returns on capital invested and appreciation by
shareholders, it may be fairly concluded that
SA business has remained somewhat reluctant
to increase output and to invest in additional
fixed capital accordingly. They have also been
very reluctant to provide additional jobs.
We have shown that the cost of this capital,
in the form of the returns required by global
investors has not declined over recent
time. Thus while capital has become more
productive it has not become less costly for
firms to employ in ways that might have driven
the substitution of capital for labour to the
large degree measured. Perhaps the freer
availability of capital (from internal sources that
is additional cash retained, given improved
returns on capital) may have played some part
Non-financial corporations operating surplus
Non-financial corporations remuneration
Source: SA Reserve Bank and Investec Wealth and Investment
17 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
in encouraging more capital intensity. As might
easier access to the transfer of best practice
technology from sources much more keen to
do business in South Africa have encouraged
a higher degree of capital intensity. Such best
practice is likely to have evolved in economies
where labour is more expensive.
The availability of relatively lower cost SA
labour, as indicated by very high levels of
unemployment and underemployment, might
have worked to counter such forces. That
it has not done so and the extreme degree
to which capital has been substituted for
labour by highly profitable, successful and
expanding SA business must surely have
its explanation in government policies that
discourage employment and labour intensive
entrepreneurship. It seems impossible to come
to anything but this obvious conclusion from
the facts of the labour market.
These policies have been imposed on
business in the interest of the Trade Unions
who represent workers in employment. Their
numbers may have declined in all but the public
sector but their real levels of compensation
or cost to employers and so the basis upon
which Unions can levy and collect dues from
members (mostly in shops closed to non-union
members or where all employees are obliged
to pay union dues) have increased consistently
in ways that are to some degree independent
of the business cycle itself as we have shown.
The conclusion one comes to is that labour
in SA has become uncompetitive in an
increasingly global economy to which SA
business has become exposed. Hence the
reluctance of SA business to employ more
labour. Business, as judged by improving
returns on capital, has become if anything
more, not less globally competitive over the
years. They have become more competitive in
the market for global capital.
Business would surely have been able to have
become more competitive and grown faster
and invested more with more encouraging
incentives to employ labour. One senses that
formal business in SA has learned to cope
very comfortably with a more closely regulated
labour market, and consequently higher paid
labour. That is with a labour market that is
well designed to protect established workers
rather than to encourage young workers to
enter formal employment. SA business has
been able to deliver competitive rates of
return on capital invested by employing fewer
better paid workers, more carefully selected
workers, assisted by improved equipment and
improved resource management. The social
and political case for changes in policies to
encourage entrepreneurs to compete with
Why is capital so much more productive than labour
in South Africa?
Growth in real compensation per formal sector
employee and growth in total real value added
8
6
4
2
0
-2
-4
1996
1998
2000
2002
2004
2006
2008
2010
Growth in real compensation per worker
Growth in real value added
Source: SA Reserve Bank and Investec Wealth and Investment
established business by adopting more
employment intensive methods of production
is an overwhelmingly strong one given the
availability of young potential workers who
struggle to gain entry level jobs.
It takes infusions of capital, labour and
technology to raise GDP over time. SA
business is proving itself capable of realising
returns on capital sufficient to attract extra
capital from global markets. Adapting proven
technologies is another growth stimulant
now easily available to SA business. The
potential for SA business to transfer abundant
labour from low productivity employment or
unemployment would add greatly to the growth
potential of SA business and the SA economy.
But this requires changes in policies for the
labour market over which business appears to
have little influence.
The role of government in
reducing the real cost of capital
South African companies should
continue to focus on generating
world beating returns on capital
while government focuses on
minimising the risk premium
between South Africa and
investor friendly environments
such as the US. And in particular
to remove artificial constraints on
employment growth in SA that is
such an urgent requirement of
economic policy. This positive
feedback loop between
government and business is
We have shown that listed South African
firms create value and sport impressive
economic returns on capital. Returns have
been improving. Over the long run, stock
market valuations depend on the economic
returns generated in the form of return on cash
invested, on the sustainability and improvement
of such returns, on reinvestment, and on the
risk-adjusted returns required by investors that
we have also described as the market-implied
cost of capital. While companies do all they can
to generate shareholder value, government
should do all it can to ensure a favourable
environment for business activity in SA to
reduce as far as possible the uncertainty and
risk premium demanded by investors.
The right business friendly policies that
are expected to be maintained with a high
degree of certainty is highly value adding for
shareholders and very good for the economy.
essential to reinvestment, growth,
job creation, skills development
and the generation of tax
revenue, which would help all of
society prosper.
18 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
It reduces required returns and increases
market values and by so doing encourages
firms to grow faster and invest more in
machinery and the people they employ.
The wrong policies, especially those about
which there is considerable uncertainty, is
shareholder value destructive and undermines
economic development.
Investors don’t like uncertainty and prefer
transparency in government and corporate
policy. If global risk appetite is diminished,
then shareholders in all countries will suffer.
But those with the least uncertainty when it
comes to corporate governance, government
policy, inflation, and tax policy will be perceived
as safe and suffer less. There are immense
benefits to aligning policy with uncertainty
reduction. A lower real cost of capital will
increase market values, and make marginal
investments more attractive. This fuels growth
and reinvestment, which create more jobs and
tax revenue. A 1% drop in the cost of capital
translates into a 20% increase in equity values!
The re-rating of South African risk from 2001
until the peak of the super cycle in 2007 is
impressive as evidenced by the drop in the
cost of capital relative to the US. Improving
CFROI coupled with decreasing cost of capital
leads to remarkable multiple expansion.
South African companies should continue to
focus on generating world beating returns on
capital while government focuses on minimising
the risk premium between South Africa and
investor friendly environments such as the US.
And in particular to remove artificial constraints
on employment growth in SA that is such an
urgent requirement of economic policy. This
positive feedback loop between government
and business is essential to reinvestment,
growth, job creation, skills development and the
generation of tax revenue, which would help all
of society prosper.
Why more education won’t create more jobs in
South Africa
We hear daily that education is the solution to South Africa’s unemployment problem. This gets
the direction of causality wrong. More education does not create jobs. Higher levels of economic
growth and more jobs change the returns to education, thus increasing education levels. However,
the level of cognitive skills, such as reading and mathematics, developed in school are one
aspect of education which has been shown to be important for future economic growth. The
South African education system is extremely bad at training learners in these skills. In the 1990s
the Brazilian educational system was as dysfunctional as the South African system currently is.
Since then a series of reforms has dramatically improved education quality and the level of
cognitive skills among Brazilian pupils. What lessons can we draw for South Africa from the
Brazilian experience, and how would we go about implementing these?
Introduction
This article considers the role of
education in the labour market,
the link between education and
economic growth and the
characteristics of a successful
education system. It examines
the experiences of Brazil, a
country whose education system
shared a number of similar
characteristics to South Africa’s,
but which has successfully
reformed its education system to
improve both quality and equity
and draws some lessons for
South Africa.
Education is supposedly at the heart of the
South African unemployment problem. Almost
every discussion on creating jobs argues for
increasing access to education, producing
better educated individuals or making
education more relevant. Yet South Africa
already spends a relatively large proportion
of GDP on education (over 5% of GDP) and
increasing rates of school enrolment and
matric pass rates have not led to higher levels
of economic growth. More education of the
current type will not create any more jobs.
What type of education will?
The impact of education on jobs and economic
growth depends crucially on the role that
education plays in the labour market. Education
can provide useful skills but also acts as a
signalling mechanism for characteristics, such
as motivation, which are difficult for employers
to easily ascertain. In an environment where
the number of job applicants exceeds the
number of available positions, such as for
low-skilled work in South Africa, educational
qualifications act as sorting mechanisms.
Without the creation of more jobs, there is
merely qualification inflation where the level
of education required to be considered for the
same job increases as more and more people
gain qualifications.
This article considers the role of education in
the labour market, the link between education
and economic growth and the characteristics
of a successful education system. It examines
the experiences of Brazil, a country whose
education system shared a number of similar
characteristics to South Africa’s, but which has
successfully reformed its education system
to improve both quality and equity and draws
some lessons for South Africa.
The role of education in the
labour market
There are two dominant views of the role that
education plays in the labour market. The first
is that it imparts skills or some sort of human
capital. At lower levels of education this is
obvious – people learn to read, write and do
their sums. At higher levels of education people
can also obtain skills through education – think
19 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
about doctors, engineers and accountants.
However, it is not at all obvious that in all cases
what people learn in school is relevant for the
work they undertake. If this is the case, why
do people engage in education beyond a basic
level? It is because of the second role which
education plays in the labour market – that of
a signal of some characteristic or ability which
is either inherent in an individual, and can be
signalled to others by engaging in education,
or which is built up through education but is not
related to what is taught.
Even at moderate levels of education
qualifications can act as a signal of inherent
characteristics or developed traits that have
nothing to do with the quality or type of
education. Perseverance is one characteristic
which higher levels of education may signal.
Achieving a qualification like matric requires at
least 12 years of school attendance on a daily
basis during term time. At times, requirements
at school may seem pointless or mundane. To
continue to attend school, particularly in difficult
circumstances, requires a certain type of
person. One of the characteristics of this type
of person is perseverance. A school leaving
certificate signals that a person has this, and
other related qualities which are required for
finish school.
Employers often value these, generally
unobservable, characteristics more than
they value what is taught at school. A stark
illustration of this is the large increase in
probability of being employed for those with
matric, compared to those with only grade 11.
The difference in learning or skills between an
individual who just failed the matric exams and
one that just passed is small, yet the person
who passed faces a much better chance in the
labour market.
Educational qualifications also serve as a
sorting mechanism when firms are hiring.
Interviewing large numbers of people for jobs,
particularly if these jobs are low-skilled where
good matches are not required, is expensive.
Companies need a mechanism to reduce
the pool of potential candidates. Excluding
candidates without qualifications like matric
is a quick way to do this and a further reason
why the probability of employment is higher for
those with matric.
Why more education won’t create more jobs in
South Africa
30 000
130
25 000
110
20 000
90
15 000
70
10 000
50
5 000
30
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
0
Secondary school enrollment
Real per capital GDP
Figure 1. Levels of real per capita GDP and
gross secondary school enrolment
Korea: GDP
South Africa: GDP
Mauritius: Education
Mauritius: GDP
Korea: Education
South Africa: Education
Source: Penn World Tables, World Bank’s World Development
Indicators
Notes: Per capita GDP is calculated at purchasing power parity prices;
secondary school enrolment may be above 100% if more students are
enrolled in secondary school than in the eligible age group mostly due to
grade repetition or late starting of school.
Real per capita GDP
Figure 2. Real per capita GDP and secondary
school enrolment, 1990 – 2009 (5 year intervals)
15 000
14 000
13 000
12 000
11 000
10 000
9 000
8 000
7 000
6 000
5 000
4 000
3 000
2 000
1 000
0
20
30
40
50
60
70
80
90
100 110 120
Secondary school enrollment
Brazil
China
India
Russia
South Africa
Source: Penn World Tables, World Bank’s World Development
Indicators
Notes: Per capita GDP is calculated at purchasing power parity prices;
secondary school enrolment may be above 100% if more students are
enrolled in secondary school than in the eligible age group mostly due to
grade repetition or late starting of school.
Figure 3. Relative performance of BRICS’
learners in standardised tests
700
600
500
400
300
200
100
0
South
Africa
Brazil
China –
Hong
Kong
China –
Shanghai
India –
Tamil
Nadu
India –
Russia
Himachai
Pradeesh
TIMMS 2003 – Maths
TIMMS 2003 – Science
PISA 2003 – Maths
PISA 2003 – Science
PISA 2009 – Maths
PISA 2009 – Science
Notes: TIMMS tested grade 8 learners; PISA tested 15 year olds. South
Africa did not participate in the PISA evaluations.
20 Labour Market Navigator
School enrolment in South
Africa and other comparator
countries
The proportion of children enrolled in school
is often used as a measure of the success of
an education system and for future economic
growth. However, high levels of school
enrolment do not lead to higher rates of
economic growth. Countries like South Korea
and Mauritius which have grown at high rates
over sustained periods of time did not increase
school enrolment prior to these growth periods.
Rather, increases in education were the result
of better economic performance. South Africa’s
experience further demonstrates that higher
enrolment rates do not cause growth – over the
past 25 years secondary school enrolment has
increased dramatically but GDP levels have
only increased sluggishly. The causality from
economic growth to education suggests that
for South Africa to improve education levels
it needs to focus on higher economic growth
levels first.
The performance of other BRICS countries
further show that school enrolment rises during
periods of rapid growth. Over the past twenty
years, secondary school enrolment rates in
China and India have increased substantially –
more than doubling for China and increasing by
60% for India – as GDP levels have increased
substantially. In Russia, enrolment rates were
already high but have remained stagnant.
Brazil has increased school enrolment rapidly
in the past ten years. This is partly a result of
school reforms and conditional cash transfers
to parents who keep children in school, but it
is also an outcome of the changes in returns
to education associated with higher economic
growth increased opportunities in the economy.
These figures show that school enrolment is
a bad measure of the quality of the education
and is not a predictor of future economic
performance. So what skills imparted by
education matter for growth and jobs?
What skills actually matter for
economic growth and jobs?
A large body of international evidence
(summarised in Hanushek & Woessmann,
2007) indicates that it is the cognitive skills
which children learn in the education system
which matter for economic growth. These
practical skills include reading, mathematics
and science. International comparisons show
that there is a wide variety of competence
both between and within countries. A number
of surveys administer tests of these cognitive
skills which are comparable across countries
and time. These include: Trends in International
Mathematics and Science Study (TIMSS) run
by the National Centre for Education Statistics
in the United States; the OECD’s Programme
for International Student Assessment
(PISA); and the Southern and Eastern Africa
Consortium for Monitoring Educational Quality
(SACMEQ) which is a collaboration between
the Departments of Education in 15 countries.
THIRD QUARTER, 2012 (JUNE – AUGUST)
South Africa’s dismal level of these basic
cognitive skills is clear from these tests. In
2003, grade 8 pupil from South Africa ranked
last among the 51 countries that participated
in the TIMMS assessment. Countries like
Ghana, Botswana, the Philippines and Chile
all scored higher on average. Although South
Africa did not participate in later rounds of
these comparisons, relative levels of other
countries which did suggest that South Africa
has by far the lowest levels of cognitive skills
of all the BRICS. South Africa also lags behind
a number of countries in the region. In the
SACMEQ evaluations in 2007 which compared
performances in Southern and Eastern African
countries, South Africa ranked eighth in maths
and tenth in reading, behind countries like
Kenya, Swaziland, and Botswana.
A striking characteristic of the South African
results is that the spread of performance
is large. This indicates the dramatic quality
differentials which exist in South African
education. Although students in the top quarter
of South African schools do perform better on
average than students in the top schools in
other countries in the region, this difference in
not dramatic. Average results from the richest
25% of learners still rank South Africa fifth in
the region in maths and fourth in reading – as a
comparison Kenya ranks second in maths and
fifth in reading. For the bottom 25% the results
are abysmal – South Africa ranks twelfth in
maths and fourteenth in reading. South African
schools thus do very little to improve cognitive
skills and levels of these are largely the result
of the socio-economic status of the learner.
Education in South Africa is not a mechanism
for social mobility but rather reinforces
inequality. Furthermore, given the causal link
between cognitive skills and economic growth,
future growth rates in South Africa are likely
to be constrained by these low levels of
cognitive skills.
What skills actually matter for
employers?
The ability to read, write and do simple
mathematics are important basic skills but
not the only characteristics which employers
look for when hiring. These characteristics
differ across the type of job. When considering
applicants for skilled positions, companies look
for things like previous work experience and
relevant qualifications. Important characteristics
for unskilled applicants are education signals
like matric, signals of ability like previous work
experience but also personal characteristics
like loyalty and trustworthiness and proficiency
in English. These personal characteristics
are the dominant factor which firms consider
when actually hiring a person and are relatively
more important for unskilled applicants. Thus
improving education for people who are likely
to be employed in low-skilled jobs is unlikely
to create new jobs. Rather, an increase in the
matric pass rate merely increases the pool
of applicants which companies have to sort
through. This makes the hiring process more
expense and will lead to firms using other
Why more education won’t create more jobs in
South Africa
Table 1: Important characteristics of unskilled
and skilled applicants
Unskilled
Skilled
applicants applicants
University degree
–
9,87
Technikon degree
–
6,58
0,60
7,89
23,35
7,24
Diploma
Matric
Schooling with less than
matric
7,19
–
Ability to do the job
6,59
3,95
Ability to write and read
6,59
4,61
Drivers licence
1,80
1,32
Previous work experience
14,97
20,39
English language
proficiency
10,78
3,95
–
0,66
Afrikaans language
proficiency
Appearance and manners
2,99
0,66
11,38
5,26
–
19,08
13,77
8,55
Loyalty and trustworthiness
Relevant qualification
Other (please specify):
Note: Figures are in percent. Other includes job specific
characteristics (physical strength, good with children) and
whether the applicant “fits into” the company culture.
Source: Own survey
Table 2: Characteristic of final applicant that
led to his/her appointment
Unskilled skilled
Ability to do the job
15,00
English language proficiency
10,00
–
7,50
16,00
Experience
Personal characteristics
(Confidence, honesty,enthusiam,
good attitude)
References
40,00
16,00
28,00
2,50
8,00
Willingness and ability to learn
10,00
12,00
Other
15,00
20,00
Notes: Figures are in percent. Other includes various reasons
such as the ability of candidate to fit into company, desperate
need to fill position, the candidate was the only applicant, etc.
Source: Own survey
signals of education, such as diplomas, as
ways to eliminate applicants. Rather, applicants
need productive skills, like the ability to
communicate effectively and soft skills like the
ability to work in teams.
Successful education reform –
Lessons from Brazil
In the 1990s the education system of Brazil
had many features recognisable in the South
African education system of today: high
rates of grade repetition; large proportions of
students who were functionally illiterate; high
numbers of school drop-outs; and poor quality
teachers. According to Simon Schwartzman,
an expert on the Brazilian education system,
students quit school not because they were
lured by job prospects but rather because
the quality of teaching was so poor and the
curriculum irrelevant. Parents generally had
low levels of education and so although they
demanded access to schools for their children
they were unable to judge education quality.
Since the 1990s Brazil has introduced a
number of reforms to the education system
which have resulted in increases in cognitive
scores and education quality. What lessons for
education reform can South Africa draw from
the Brazilian experience?1
Brazilian education reform began in the
1990s when funding changed from a
population-density formula which favoured
large cities to a more equitable distribution,
teacher salaries were increased and a cash
transfer system (Bolsa Escola) which paid
parents if their children stayed in school and
had medical checkups was introduced. An
important reform during this period made
educational assessment and evaluation
independent. Assessments in grades 4, 8
and 11 were made universal for grades 4
and 8 and existing coverage extended for
grade 11. These standardised tests meant
that performance could be compared across
schools, municipalities and states and over
time. These results were made public and in
some states such as São Paulo schools and
teachers received training on how to analyse
the data at the classroom level and introduce
strategies to improve teaching and learning.
Results in grade 4 and 8 were then used to
create an index for each school and school
level targets established. These targets and
results are publically published at the school,
municipality and state level so that parents,
communities and politicians are aware of these
ratings and poor performing schools can be
easily identifiable and helped.
President Fernando Henrique Cardoso, whose
government introduced many of these reforms,
cleverly used the dismal results of Brazilian
students in international benchmark tests to
mobilise support for reform. This is in sharp
contrast to South Africa which withdrew from
these standardised tests. The federal nature of
the Brazilian state also helped reform. States
could engage in innovative approaches, some
of which have lead to improvements in quality.
These included appointment of assistant
principals to support teachers on teaching
approaches; rewarding schools which improved
their performance with more autonomy; and
targeted assistance for the worst performing
schools.
There are a number of key lessons for South
Africa from the Brazilian experience. The
first is that improving education outcomes
requires political commitment and support from
the broader public. Entrenched interests in
Brazil, such as teacher unions, are politically
powerful and opposed many of the reforms. To
overcome this opposition required commitment
to reform at different levels of government
and support and pressure from the public who
demanded improvements in the quality of
education. To achieve reform many politicians
appealed directly to the public highlighting the
poor state of Brazilian education and the lack
of opportunity which was a result of this.
Second, the federal system allowed each state
to adapt reforms to their own circumstances.
States could learn from the experiences
of others and adopt approaches which
had worked in other parts of the country.
Furthermore, political battles were fought at the
state level rather than the country level which
made change easier.
Third, standardised testing by an independent
authority provided information on how each
school, state and municipality was doing
compared to others but also to itself over
time. This information was used to create
benchmarks and targets at the individual school
level and incentives were tied to these targets.
This information was publically available so that
parents, communities and politicians knew how
their schools were performing.
Fourth, teacher salaries were improved and
teaching was promoted as a legitimate career
path. Training programmes improved the
quality of existing teachers and a number of
reforms focused on teaching pedagogy.
Fifth, programmes at the national level provide
incentives for children to attend and staying in
school through cash transfers. However, these
programmes do not incentivise hard work or
school achievement. A number of states have
started to provide these types of incentives now.
1A recent OECD (2011) report contains a number of case studies of countries which have reformed their education systems. This
discussion is drawn from this report.
21 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
Why more education won’t create more jobs in
South Africa
Conclusion
In South Africa it is often
argued that education will
create jobs. This argument gets
the direction of causality wrong.
Education is an outcome, and at
least at early stages of
sustained growth, a result of
rather than a cause of growth.
Countries like South Korea and
Mauritius, which have had
sustained high levels of
economic growth, started off
with low education levels which
only increased with economic
growth. This growth changed
the returns to education,
encouraging more people to
invest in education, and
provided higher levels of
government revenue, which
allowed the government to
invest further in education.
In South Africa it is often argued that education
will create jobs. This argument gets the
direction of causality wrong. Education is
an outcome, and at least at early stages of
sustained growth, a result of rather than a
cause of growth. Countries like South Korea
and Mauritius, which have had sustained high
levels of economic growth, started off with low
education levels which only increased with
economic growth. This growth changed the
returns to education, encouraging more people
to invest in education, and provided higher
levels of government revenue, which allowed
the government to invest further in education.
Without the widespread creation of jobs,
education acts as a sorting mechanism
to allocate rather than create jobs. This is
particularly the case for low skilled jobs where
companies are reluctant to spend large
amounts of money on finding exactly the
right match. A school leaving certificate is a
mechanism to shrink a large pool of applicants.
Participants in the labour market know this. The
stampede at the University of Johannesburg
earlier this year shows that young people
are desperate for any type of qualification
which would improve their chances in the
labour market. The large relative jump in
the probability of getting a job with a matric
certificate is further evidence of this signalling
mechanism. The signalling and sorting role
of education favours the relatively better off,
who can afford to have their children complete
school, further entrenching inequality. It is
also a wasteful use of resources which can be
more efficiently used by individuals and the
government in other areas.
The South African education system is
particularly bad at teaching the types of
skills which are valued by employer and the
cognitive skills which matter for economic
growth. It does not emphasise important skills
like communications, team work and life skills.
Although learners now take ‘life orientation’
as a subject at school, the material covered is
often not relevant and the both teachers and
learners do not take the subject seriously.
A wide body of international evidence indicates
that cognitive skills in mathematics, science
and reading are closely related to economic
growth. South African learners perform
particularly badly on international measures of
these cognitive schools, lagging behind other
countries in the region such as Botswana,
Swaziland and Kenya. Even better off South
African learners perform relatively badly. The
failure of the education system to act as a
mechanism for social mobility is reinforced
by the wide variation in the levels of cognitive
skills between learners of different socioeconomic groups.
International evidence also shows that to
encourage economic growth educational
22 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
systems do not have to choose between
building basic cognitive skills and high quality
education which culminates in a university
degree. Rather combined strategies which are
successful in teaching cognitive skills but which
also allow a minority of learners to progress to
university work well. Particularly in developing
countries where the number of graduates is
small, returns to investing in higher education
can be large.
The successful Brazilian experience shows
that reform requires difficult political decisions
and taking on entrenched interest groups, like
teachers’ unions. In the Brazilian case, this
was done by going directly to parents with the
results from international comparisons which
showed Brazil’s dismal performance, and
through a federal system which encouraged
reform at the state level. The reforms in Brazil
also accord with international evidence on how
successful education systems are organised
(Hanushek & Woessmann, 2007). Successful
education systems provide a set of incentives
to produce high-quality and suitable education,
through rewards and penalties. Autonomy,
accountability and community involvement in
schools are all characteristics associated with
better school outcomes, particularly if found
together. In successful systems, external
exams, set by an independent body, provide
clear indications of student performance and
a framework for accountability. A key reform
in the Brazilian process was to create school
specific targets and then to put in place
mechanisms to help schools achieve these.
What lessons can South Africa learn from the
Brazilian experience and what steps should it
take to improve the education system?
The first reform would be to allow greater
autonomy for Umalusi, the current body
responsible for certification and to reduce
the political pressure placed on the body
to increase matric pass rates. Devaluation
of the standard of the school leaving exam
does little to help identify inherent problems
in the education system. Politicians need to
view standardised exams as a diagnostic tool
which can be used to improve the system
rather than merely a metric by which they
are judged. International standardised tests,
the standard of which cannot be influenced,
provide a benchmark to measure education
improvements. South Africa should participate
in these assessments wherever possible.
The second reform would be to introduce a set
of common exams set by an external body, or a
number of bodies, at the end of primary school
(grade seven) and also in an earlier grade (for
example grade four). These would test core
cognitive skills – mathematics, science and
reading – and provide a benchmark of primary
school performance which could be compared
across schools and over time. It is essential
that these are set by an external body with no
incentive to lower the level over time. These
results would be released at a school level and
Why more education won’t create more jobs in
South Africa
References
CDE. (2010). Hidden Assets:
South Africa’s low-fee private
schools. Centre for the Study of
Development and Enterprise.
Hanushek, E. A., & Woessmann,
L. (2007). The Role of Education
Quality in Economic Growth.
World Bank Policy Research
Working Paper 4122 .
OECD. (2011). Lessons from
PISA for the United States,
Strong Performers and
Successful Reformers in
Education. OECD Publishing.
used to construct school level targets. Schools
achieving these targets would receive greater
autonomy; those not would receive specific
assistance.
In parallel to this, provinces would be allowed
more room to innovate in education. This
would allow for provinces to create systems
to deal with province-specific issues. It would
also allow for provinces to follow different
approaches and copy successful innovations
from others.
At the high school level, flexibility and
product differentiation should be encouraged.
Independent school leaving exams should be
written at two levels – grade ten and grade
twelve. These exams should be standardised
and set by independent institutions but
individual schools could choose the set of
exams they wrote. This would allow for schools
to choose exam sets with different focuses,
from vocational to academic. It would also
allow schools to respond to market needs.
Choice and competition can be encouraged
by transferable subsidies based on learner
achievement. These subsidies could be
varying amounts, and lengths, depending
on achievement in the grade seven exams.
High achievers might receive larger amounts
that were available for five years and would
cover attendance at more expensive, and
more academically orientated, schools. Those
with lower results would only be subsidised
until grade ten. In addition to subsidies tied
to learners, schools should receive subsidies
based on their performance and for meeting
their specific targets.
This structure would create a broad pool of
people with basic cognitive skills, measured
at the end of grade seven. From this pool
those with the potential to become ‘rocket
scientists’ could be easily identified. These
students would go on to university education
after the standardised exams in grade twelve.
An education system like this would allow for
differentiation and responsiveness to labour
market requirements.
These reforms seem ambitious but there are
a number of exiting characteristics of the
education system which could be leveraged
to achieve them. The first is that a notionally
independent body for setting school leaving
exams exists already – Umalusi. It just needs
de facto independence and political support for
this independence. The second is the existing
provincial system on which Brazil-style reforms
could be built.
Thirdly, parents are beginning to realise that
the government education system is failing
their children and many are transferring
their children to private schools. A recent
report by the Centre for Development and
Enterprise (CDE, 2010), which focuses on
low-fee private schools, estimates that the
number of private schools is much higher
than the 4,3% estimated by the Department
of Education. In addition to this, enrolment
in these types of private schools has grown
23 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
exponentially in recent years. Parents are
prepared to pay relatively large amounts
for private schooling – the schools in CDE’s
sample charge on average over R100 per
month, and competition in this sector means
that these schools are responsive to the needs
of parents and learners. In the CDE sample,
teacher absenteeism was low, schools focused
on the essentials of teaching and students
did no worse than students in public schools.
Education reform could tap into this parental
dissatisfaction. It could also build on these
emerging private schools which are clearly
filling a need.
Improving educational outcomes, particularly
cognitive skills, is an important policy goal.
It will require bold political action. However,
educational reform is easiest in a fast growing
economy and by itself will not cause economic
growth. More education will not create more
jobs but more growth and jobs will increase
education levels and quality. A policy focus on
education is not enough – South Africa need
much higher levels of economic growth and
more jobs.
Why South African cannot address unemployment
– An engineer’s view
In order to create a practical solution to a problem, it must be clearly identified and understood.
The problem we face in South Africa is that about 80% of young adults will never find a job. Why
is this? South Africa has good managers, abundant raw materials and plentiful labour to transform
itself into a leading economy and create the jobs and wealth the majority of our people need.
In the early 1960s Ford and GM
had no difficulty in transforming
South Africa’s automobile
industry into the second-largest
industry through the local
content programmes instituted
by the government. This
transformation made Port
Elizabeth the fastest-growing
region in southern Africa, where
it was cheaper to plan, design,
develop and manufacture a car
or truck than in Germany, the
United Kingdom or the United
States. Port Elizabeth was the
city through which
manufacturing and modern
business management entered
South Africa, and this flood of
industrial knowledge after World
War II placed the city about
30 years ahead of South Africa’s
economic hub, Johannesburg.
So what is the reason behind this human
tragedy and how do we remedy this? I try to
answer this question by providing personal
snap-shots of my industrial experience as a
mechanical engineer from the early 1960s to
the present. The tale speaks for itself.
In the 1960s, South Africa had the skills to
transfer from a mining into a manufacturingled economy. But why should we have
considered this change? Mining, forestry,
farming, fishing and manufacturing are the
principal providers of sustainable industries
and jobs world-wide. Of these farming can
create more labour intensive jobs than any
other industry, whereas manufacturing can
create more wealth. China demonstrated this
by focusing 38% of its labour into farming and
28% into manufacturing. It therefore stands to
reason that in order to address joblessness,
farming and manufacturing should drive South
Africa’s economy. Instead, South Africa ignores
the potential of manufacturing and farming
development and concentrates on mining
and infrastructure. This is partly done in the
belief that comparatively, we have a shortage
of skills next to the Chinese and that we also
lack their competitiveness. Simplistically, this
is the fundamental reason why unemployment
accelerated after 1994 and today the majority
of South Africa’s youth will never find a job in
their lifetime.
For those who do not understand why we
should be focusing on manufacturing and
farming to create jobs, these are the facts.
Providing infrastructure only creates jobs for a
relatively short period of time. Mining creates
wealth only once due to the evolution of the
universe; once the seam has been mined,
production stops. Forestry creates wealth every
twenty to thirty years, the time it takes to grow
a tree. Fishing, like farming, produces wealth
a few times a year and is limited to coastal
regions. Through science and technology,
farming can become virtually a countrywide
industry. But since Henry Ford, manufacturing
has demonstrated that it can create wealth
many thousands of times during the course of
one day, virtually anywhere there are people.
Manufacturing is by far the most efficient
wealth creator known and in its simplest
form is man’s oldest industry. Tool-making or
“manufacturing” stone tools enabled humans
to hunt and procure the energy-rich meat they
needed to progress and this industry predates
the development of agriculture and fishing by
nearly 2.5 million years. Manufacturing, in the
sense of tool-making, is the most natural of all
human industries, for which most humans have
a natural aptitude.
24 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
In the early 2000s, President Mbeki’s economic
advisor, Prof Wiseman Nkuhlu, asked me if
black people were “suited” to manufacturing. I
related the following to him. In the 1960s Ford
and General Motors (GM) controlled more than
60 % of the automobile industry in South Africa.
During the Rivonia trial they were hit by severe
work stoppages and the then-government
asked them to stay open at all costs. To do so,
Ford sent buses into New Brighton Township
and hired black women off the streets. In 1964
black women generally had no industrial skills.
Many could not read and were prohibited by
law from working in factories. In spite of their
severe limitations, using graphically illustrated
manufacturing process sheets, these women
were each trained to perform a specific task
on the assembly line. Just a few days into
a particularly severe work stoppage, the
line restarted and, by placing close to 2,000
illiterate low-skilled women next to men on
the assembly line, two things happened:
productivity increased and quality improved.
In the early 1960s Ford and GM had no
difficulty in transforming South Africa’s
automobile industry into the secondlargest industry through the local content
programmes instituted by the government.
This transformation made Port Elizabeth the
fastest-growing region in southern Africa,
where it was cheaper to plan, design, develop
and manufacture a car or truck than in
Germany, the United Kingdom or the United
States. Port Elizabeth was the city through
which manufacturing and modern business
management entered South Africa, and this
flood of industrial knowledge after World War II
placed the city about 30 years ahead of South
Africa’s economic hub, Johannesburg.
In the case of Ford, their management
systems were based on the original “Wiz
Kids” who, after World War II, transformed
Ford world-wide, bringing statistical rigour into
management systems. The Wiz Kids came
from the United States Air Force statistical
command, and they offered their management
techniques developed during World War II to
Henry Ford II, who hired them. They made a
huge impact in the 1950s and 1960s and one
of the Wiz Kids became President Kennedy’s
Secretary of Defence and then went on to
head the World Bank. The rest took their
knowledge and experience back to Ivy League
universities. This legacy led to the creation of
an industrial management dynasty that has
influenced almost every American corporation,
every automobile manufacturer world-wide
and every MBA student ever since. The
management transformation at Detroit filtered
into Port Elizabeth in the early 1950s and
Why South African cannot address unemployment
– An engineer’s view
only became part of South African business
understanding in the 1980s.
Car manufacturers worldwide adopted and
adapted the Wiz Kids’ management systems.
Toyota’s Taiichi Ono probably used Ford’s
giant River Rouge’s capacity to turn pig-iron
into car parts within 48 hours, as an example
to take the next step and develop “just-intime” manufacturing. In South Africa in the
1960s, when viewing the gap between how
Port Elizabeth car and tyre manufacturers
ran businesses and how businesses were
run locally, was like stepping back in time.
Even though Port Elizabeth was transforming
into a city of international manufacturing
standing, it was also clear that South Africa
did not have the calibre of business leadership
that could bring the country into the modern
manufacturing world.
In 1968 Ford decided to develop a light pick-up
locally. This was the Ford Cortina bakkie which
later became the Ford One-Ton bakkie. I was
understudy engineer to the vehicle engineer
Ford sent from Britain to initiate planning,
design and development. An executive
engineer, Ray Pitman, was also sent from Ford
USA to oversee project development. He was
part of a team at the University of Michigan
who worked on establishing the crushing
strength of human skulls in the early 1950s in
order to improve vehicle crash worthiness. In
July 1968 he gave a lecture at the University of
Port Elizabeth to the Eastern Province Society
of Engineers. The subject matter was dropping
severed human heads down a lift shaft in a
controlled manner to determine the impact
strength of a skull bone. Although all this was
very interesting the really earth shattering
remark was made at Q&A time
Effectively the manufacturing infrastructure
Ford and GM developed gave South Africa
the means to transform into a manufacturingled economy and create the jobs and wealth
this country needs for its entire population.
Unfortunately it did not have the local business
leadership that could capitalise on this
development. Argument was that apartheid
prohibited this type of development. This
was not true and anyone observing industrial
development in the late 1960s could easily
see that the corpse was driving the hearse
and the first nails were been driven into the
coffin of apartheid. The rapid expansion of the
automobile industry resulted in a demand for
factory workers that white workers could not
meet. Government was already turning a blind
eye to using black factory workers contrary to
job reservation laws.
The 1970s saw Port Elizabeth factories expand
into the car export market and by then the city
was awash with world-class tool designers
and manufacturers. By the 1980s the city’s
assembly plants were twenty years older than
those assembly plants that started in the late
1960s and were no longer competitive.
I left Ford and moved to Johannesburg in 1970.
Some years before, I told the Neave assembly
plant manager, Neville Cohen, that if I identified
a product that could be used to create labour
intensive factories in squatter camps I would
contact him. This was an extremely difficult
problem as the product had to provide the
volume and capacity to make manufacturing
viable. It had stumped Cohen and others at
Ford and GM. Cohen had been the one who
hired the transport to bus black women to the
Ford factory during the labour crisis.
Pitman said that in the 1950s, because of
severe problems with labour unions, Ford
and GM asked their engineering team to
help reduce car factories’ reliance on labour.
Engineering responded by saying that by
2050 all Ford and GM factories would be free
of labour. It is now likely that this will occur
around 2030. Some car plants already switch
off the lights in sections of their factories since
robots do not require lights to operate. One
must remember that in 1968 the calculator was
not around, let alone the personal computer.
Pitman’s statement made an enormous impact
on me. The next day I asked him whether, if
robots could replace workers on assembly
lines, this meant that ultimately they could also
replace office workers, business administrators
and senior management. He replied, “Yes –
but don’t tell the bosses, else they’ll fire us.”
In 1984 I contacted Cohen, then the
manufacturing director at Ford, and told him
that I had identified a product that had the
capacity in terms of volume and necessity
that could start manufacturing, not only in Port
Elizabeth’s squatter camps, but in squatter
camps countrywide. I said that we could
teach people in informal settlements how to
manufacture their own houses, classrooms
and all the components to manufacture these
products. Furthermore I suggested that we
could run the house production lines using the
same industrial process management systems
that Ford uses to run their productions lines.
He agreed and asked me to fax some sketches
of my house production ideas down to him. He
phoned back later to ask me to fly down to Port
Elizabeth to discuss the plan with him and the
managing directors of General Motors, Bob
White, and Goodyear, Wally Life.
Every day we now use robots that have
eliminated possibly millions of clerical jobs.
They are called automated teller machines
(ATMs). In the next twenty years computers
will most likely have the capacity to challenge
the decision making ability of accountants,
attorneys and other professionals. By
then business leaders will not be able to
make the decisions that maintain business
competitiveness.
They all agreed my plan could work and,
in terms of the Sullivan Code, the three
companies pledged to fund development,
make the factory work in one community, then
market the idea to get support for developing
squatter camp factories country wide. The use
of housing and classroom manufacture when
replicated offered South Africa the potential
to develop skilled manufacturing labour in
squatter camps. These skills coupled with
25 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
product engineering capabilities. Many Port
Elizabeth tool-makers and skilled workers
at the car factories were laid off due to
automation, and they provided the technical
and business means to transform South Africa
into a manufacturing-led economy form the
bottom up, unlike the much later “trickle-down”
attempt of the Growth, Employment and
Redistribution Programme (GEAR).
We immediately came across a problem.
Various sectors of business claimed that black
people would only accept brick-built homes.
In 1984 the Urban Foundation asked directors
from Ford to provide a report on housing
problems facing the black community. One
of the important findings was that squatter
camps should be incorporated into the overall
housing policy of South Africa since they were
not transient, as everyone believed, but were
permanent.
Subsequently the government acted upon this
recommendation and included squatter camps
into South Africa’s housing strategies. Bricks
are not suitable products for manufacturing. In
this environment of understanding the black
housing market Cohen asked me to examine
the claim that brick houses were the only
homes acceptable to black people.
In order to understand this, an idea that white
people still mention today, I asked the question:
As there are no manufactured houses in South
Africa that most people are aware of, how do
black people know what a manufactured house
is in order to make a comparison? Immediately
I asked this question I realised that there was
something wrong with the story. Black people
living in rural areas in 1984 generally lived in
wattle and daub homes and on migrating to
cities due to poor economic circumstances
they usually live in corrugated iron shacks.
In sharp contrast they saw white folk living in
sturdy brick built houses. So if you asked a
black person which house he would prefer to
live in, he would naturally aspire to the brick
built house, the best option within his frame of
reference.
Therefore the question asked was selfconfirming. The more I researched this
problem, the more I realised that the brick
house claim was propaganda created by local
business leadership’s vested interest in brick
construction and it products. The origin went
back to around 1910, when prefabricated
homes were common along the coast and on
the Reef especially for mine houses.
I re-phrased the question and asked black
people I interviewed in Soweto-on-Sea,
Ibhayi, Port Elizabeth, which was then still a
squatter camp: Do you prefer to live in a brick
built house or a manufactured house that
looked just like a brick home but was superior
in quality and strength and cost about half
that of a brick equivalent? Virtually everyone
canvassed chose the house they could afford
most, a manufactured home.
By 1986 I had proved the concept and gained
the support of trade unions, the United
Why South African cannot address unemployment
– An engineer’s view
Life, managing director of
Goodyear, confirmed in January
1987 that we had the means to
address South Africa’s housing
problem by saying:
“I am happy to inform you that
following your December 2, 1986
presentation to the Goodyear
Executive Committee, and my
follow-up visit to the prototype
house, we are willing to support
this project with a donation.
“What impressed us most is that
a lot of thought had gone into
materials and construction
methods to provide a reasonably
priced yet durable dwelling,
which is available at the
affordable level of a substantial
number of people who require
just that.
“Once the project is functioning
well in Port Elizabeth, we will
encourage moving into the
Kwonobuhle (Uitenhage) market
(where the Goodyear factory is
situated).”
Democratic Front (UDF), Ford, GM and
Goodyear and the Bishop of Joh
annesburg, Desmond Tutu. I taught
young black men and women without any
prior industrial skills to produce simple
manufacturing tooling and then use the tooling
to manufacture a house. Life, managing
director of Goodyear, confirmed in January
1987 that we had the means to address South
Africa’s housing problem by saying:
“I am happy to inform you that following
your December 2, 1986 presentation to the
Goodyear Executive Committee, and my
follow-up visit to the prototype house, we are
willing to support this project with a donation.
“What impressed us most is that a lot
of thought had gone into materials and
construction methods to provide a reasonably
priced yet durable dwelling, which is available
at the affordable level of a substantial number
of people who require just that.
“Once the project is functioning well in Port
Elizabeth, we will encourage moving into the
Kwonobuhle (Uitenhage) market (where the
Goodyear factory is situated).”
GM responded similarly and the managing
director, Bob White, told me he was prepared
to give us a cheque for the first house that
came off the assembly line and truck it to his
river site at Bushmans.
Three directors from Ford stayed with the
project up until 2000 trying to encourage
government and business leadership to
use this project and grow manufacturing
countrywide from the bottom up. This
relationship stopped when Cohen died and one
of the other directors became ill. We all failed
miserably.
When the three manufacturers decided to
leave South Africa the project stopped. Support
from the unions also vanished and Bishop
Tutu’s warnings came true. When I met him at
St Albans in 1985 to ask him what he thought
about industrialising informal settlements
through community- and worker-owned
factories, he supported the idea and wished
me success. He did, however, warn me that
this project would have many enemies in “black
power” politics. This proved to be true.
When leaving, General Motors asked
Anglo American Corporation to take over
the project. Even though Anglo American’s
senior architect, Tony Young, supported using
the plan to transform hostel communities
into family communities, we were told in no
uncertain terms that the mines would not
support this industrial plan. Ford directors tried
to get the banks to find funds, to no avail. I
tried to get the UDF, whose members at the
three manufacturers supported the plan in
terms of the Sullivan Code, but without the
manufacturers I could not get a debate going.
26 Labour Market Navigator
the Housing Act 107 of 1997 and also most
of the Department of Housing’s legislation up
until 2008. Thatcher arranged a telephonic
conversation between the late Joe Slovo and
me. I made it clear that if government did
not use the delivery of Reconstruction and
Development Programme (RDP) housing to
create industries and jobs in the communities,
all RDP housing would achieve would be a
vast expenditure and acceleration of poverty.
He agreed and stated that the prime objective
of RDP housing was to use it to economically
empower communities so that they were no
longer a financial burden on the state. I replied
that if this was the government’s intention then
it must realise that the construction industry
cannot be used to create sustainable industries
and if government was serious about job
creation coupled to housing delivery, then it
has to go the manufacturing route.
He said that he did not understand this and I
replied that, if the construction industry was
capable of creating economically sustainable
industries, then the modern world would be
construction- rather than manufacturing-driven.
He got the picture and suggested I write to the
Director-General in the Department of Housing
to explain. My letter was ignored. Thatcher
suggested I approach the RDP office in the
Presidency. An official in Jay Naidoo’s office
told me that, as an engineer, I was an elitist
with no further part to play in the development
of South Africa. Winnie Graham at The Star
tried to get an explanation from Naidoo.
In the meantime I was approached by Peter
Kingma from Siemens Medical Engineering
who had learned something of my endeavours.
He told me that without a project such as
mine providing industry and management
infrastructure into low skilled communities,
South Africa could not benefit from cheap
medical diagnosis provided by the use of
telemedicine. At once I realised that what
cybernetics could do for medicine, was
possible in manufacturing, farming and other
industries.
During my visit to Soweto-on-Sea in the
1980s I had observed the poor attempts by
the squatter residents at farming vegetables.
I remarked to Cohen that I was positive I
could use manufacturing methods to create a
system whereby the farmers could farm more
effectively and profitably. He agreed. I also
realised, through telemedicine, South Africa
had the technical means to maintain factories
and farms developed in poor communities
while the workers became skilled in their
respective tasks in the business. This could
prevent businesses collapsing in informal
settlements and rural communities anywhere in
southern Africa.
The project crashed and I went insolvent.
Factory and farming businesses could easily
be replicated throughout southern Africa, but
we could get nowhere without government and
business buy-in.
1994 came and I was fortunate enough to
meet Richard Thatcher, the attorney who
drafted the Housing White Paper of 1994 and
I was advised to contact Jack Bloom of the
Democratic Alliance in February 1995. After
meeting, Bloom wrote to Gauteng Premier
THIRD QUARTER, 2012 (JUNE – AUGUST)
Why South African cannot address unemployment
– An engineer’s view
It is essential for political
stability to transform South
Africa into a manufacturing-led
economy. Without this industrial
approach and the power of
manufacturing’s economic
engine, it is easy to understand
why 80% of the present
generation cannot find jobs.
Tokyo Sexwale and suggested that his staff
evaluate the project. Three of the Premier’s
advisors indicated that the project was viable
and should be adopted, but that government
policy prohibited provinces from funding
development. I had a phone call from the
Premier’s assistant asking me to advise
the Premier as government policy did not
allow such a development. I suggested that
the Premier should give the problem to the
Department of Trade and Industry (the dti).
On 7 July 1995 I received a letter confirming
that the Premier had done just that. I again got
no response from the dti. I made a nuisance
of myself and eventually Minister Trevor
Manuel’s office informed that the project had
been placed before a director in the dti. I was
introduced to another dti official, and a number
of meetings were held in his office comprising
the Council for Scientific and Industrial
Research (CSIR), the Minister of Housing’s
technical advisor. The meetings broke down
because Housing and the CSIR did not want
manufactured housing. A scientist from the
CSIR’s rural development programme called
them “irresponsible” for failing to support
the initiative. The Foundation for Research
Development (now the National Science
Foundation) supported the plan, and they
funded a report on how to industrialise squatter
communities.
The Chairman of Iscor offered to place the plan
on the agenda for debate, as did the Chairman
of the Urban Foundation. We were denied this
opportunity and later a dti official confirmed that
business leaders had stated that the plan did
not conform to good corporate governance. If
that was the case, the 70 million cars annually
delivered are contrary to good corporate
governance.
By 1998 it was clear that that government and
business leaders could not see, or did not want
to see, jobs develop through manufacturing
and farming in informal sentiments and rural
communities.
Over a period of 10 years, a positive change in
attitude towards the project emerged. In 2010,
with support from the European Union, Minister
Pandor and Director General Phil Mjwara at the
Department of Science & Technology provided
a R2 million grant to re-create the 1985 proofof-concept (POC). The POC conclusively
demonstrated how ordinary people could be
trained to manufacture a house and many
other products to quality specifications.
Over R150 billion has been spent on RDP
housing using technology that cannot develop
economically sustainable communities and
jobs. The many young people from informal
settlements who visited the factory where the
27 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
POC was developed, were angry to see what
their communities had been deprived of.
Also in 2010, a transformation occurred
at the dti, under a different attitude with
Dr Rob Davies as minister. There was a sense
of urgency and responsibility that up until
then I had not experienced. All these years
later, the farming management proposal was
unanimously accepted as a viable technology.
Together with the dti, Gauteng Economic
Development Agency, the African Housewives’
League and agricultural businesses, we are
now in the initial planning stage of developing
a plan to create factories for houses and
classrooms and shade net farms close to
around nine informal settlements. The plan is
to bring those communities into industry and
farming all at once. Once this project is up and
running, it will be possible to replicate these
“industrial hubs” countrywide.
There are 2,700 informal and rural settlements
countrywide. The replicating plan would
initially deliver about 100 co-operatively owned
industrial hubs where workers from nearby
communities are drawn. These hubs will
produce all the components for manufacturing
houses and classrooms, including products
such as school desks, black boards, house
furniture, plumbing, roof goods, window and
door frames, gas hobs and geysers to name
a few items. These products will then be
transported to about 500 small assembly plants
close to informal settlements where they need
RDP houses and classrooms. Assembled
houses and classrooms will then be delivered
by truck to site and erected in a few hours
ready for occupation.
Within five years, the hubs and assembly
plants will initially provide informal settlements
and rural communities with close to half
a million jobs and the capacity to develop
farming and manufacturing industries close to
people’s homes. This capacity on the industrial
side would deliver about 350,000 SABSapproved houses, 50,000 classrooms with
their components and vegetables countrywide.
Then, through the product engineering skills
tried and tested so long ago to develop the
local component manufacturing industries,
these industrial hubs could be expanded
through a new manufacturing business model
that defines a better relationship between
machines and humans.
It is essential for political stability to transform
South Africa into a manufacturing-led economy.
Without this industrial approach and the power
of manufacturing’s economic engine, it is
easy to understand why 80% of the present
generation cannot find jobs.
The team
Loane Sharp
Director: Economic Analysis, Prophet
Loane Sharp is a labour economist at Prophet Analytics, South Africa’s leading labour
analytics company. Loane is an international award-winning researcher who has published
widely in books and academic and business journals. His research interests include
employment, employment policy and workforce optimisation. He is an expert in the fields
of atypical employment and labour productivity. Prior to Prophet, Loane was an investment
strategist at Investec, South Africa’s leading investment bank, where he was one of the
country’s highest-rated analysts. Loane has an MCom from the University of Cape Town
specialising in economics and statistics. He has received scholarships from, among others,
the National Research Foundation, and he has been awarded prizes by, among others, the
Natale Labia Society. In competition with companies such as Sony, IBM and Vodafone, his
work recently won two coveted European awards. He is a director of Productivity SA.
Peter Aling
Director: Quantitative Analysis, Prophet
Peter Aling is a quantitative analyst at Prophet Analytics, South Africa’s leading labour
analytics company. Peter joined Prophet after completing his MCom in Economics, Finance
and Statistics at the University of Cape Town and is currently pioneering alternative
workforce management approaches using self-designed software-based algorithms in the
area of human capital optimisation. Known as “distribution-based management”, Peter
has successfully worked with a number of JSE-listed companies over the past three years
achieving cost savings of over R15 million for clients. Among his personal achievements,
Peter is an avid and accomplished tennis player, oarsman, golfer and squash player, having
represented his university at provincial level.
Ted Black
Management guru
Ted Black has held senior positions in organisation development, general management and
been a director of companies. Today, he acts as mentor and coach to executives. Using the
ROAM model (Return-on-Assets Managed) to pinpoint opportunity, he helps them design
high-precision, results-driven projects. These turn strategy into action. In turn, the process
grows managers and their teams fast and measurably – the prime goal.
He has published three books. One of them, “Who Moved My Share Price?” was coauthored with Professor Andy Andrews. It was a successful and controversial story about
the issue of ethical management, asset productivity and shareholder value.
He also speaks at conferences and business schools, writes regularly for Business Day,
and is an affiliate of Robert H. Schaffer and Associates (www.rhsa.com).
28 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
The team
David Holland
Corporate Performance Guru, Senior Advisor Credit Suisse
David Holland is an independent consultant and senior advisor to Credit Suisse. He was
previously a Managing Director at Credit Suisse based in London, and in charge of HOLT
Valuation and Analytics, the research and development arm of Credit Suisse HOLT. He
regularly meets with global fund managers to discuss market expectations at the macro
level, and to advise on quantitative stock selection strategies. David joined CSFB in May
2002 from Fractal Value Advisors, a corporate strategy and finance advisory business he
owned in South Africa. Fractal advised on the use of the HOLT CFROI framework at South
Africa’s leading corporations and asset management firms. David has written a book on
company analysis and valuation titled “Beyond Earnings: A User’s Guide to Excess Return
Models and the HOLT CFROI Framework” and has presented at universities and investor
conferences. David holds degrees in Chemical Engineering from the University of Illinois
(BS) and Stanford University (MS). He earned his MBA at the University of Cape Town.
Prof Brian Kantor
Economics Guru, Professor Emeritus University of Cape Town,
Chief Economist Investec Wealth and Investment
Brian Kantor is South Africa’s foremost financial economist. His most influential work,
published in the acclaimed Journal of Economic Literature, was “Rational Expectations and
Economic Thought”, which changed the way economists understood the effects and, more
importantly, the limits of economic policy, which applies to this day. He has consulted widely
to international organisations including Anglo American, BMW, the United States Federal
Reserve, Ogilvy and Mather, Salomon Smith Barney, Sun International, Volkswagen, and
countless others. His proudest achievement was as long-serving founding chairman of
Cape Town’s historic Victoria & Alfred Waterfront. He is well remembered by thousands
of economics and business school students at the University of Cape Town, many of
whom have made major contributions to the economy in South Africa and globally. He
was a member of the Competition Board. He worked with Nobel Prize winner Prof Milton
Friedman at the Fraser Institute in Vancouver, pioneering the theory and measurement
of economic freedom around the world, which is still the gold standard for evaluating
economic policy to this day. He has written many academic and business articles and
books, including “South African Economic Issues” and “Understanding Capitalism”. He is a
longstanding critic of South African monetary policy.
29 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)
DISCLAIMER
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Midnight Star
30 Labour Market Navigator
THIRD QUARTER, 2012 (JUNE – AUGUST)