Manufactured goods (such as automobiles and some iron and steel products) and mined commodities (such as coal, platinum and gold) form the backbone of South Africa's economy. These industries employ a high number of workers and constitute the bulk of South Africa's exports, and consequently they can significantly affect the value of the South African rand. Any degradation in the health of these sectors indirectly affects other economic sectors. For example, coal, one of South Africa's largest exports, is used to generate roughly 70 percent of the country's primary energy and roughly 90 percent of its electricity.
High Production Costs
On Aug. 13, labor negotiations broke down between unions and the Chamber of Mines, which represents the major coal mining companies. Now the negotiations are being mediated, and the unions can legally strike if an agreement is not reached. The major points of contention involve wage increases and housing allowances. While the unions' demands and companies' offers vary, ultimately the companies will capitulate to the unions, resulting in higher production costs.
Higher production costs, in turn, affect the rest of the South African economy. They have hit Eskom, the national electric utility, particularly hard. For the fiscal year ending March 31, Eskom's primary energy costs rose by about 36 percent, with coal responsible for more than half of that increase. This follows increases in previous years.
Moreover, Eskom's production cannot meet demand, forcing the utility to invest in two new 4,800-megawatt thermal power plants, both of which will be among the world's largest coal power plants. One plant, the Medupi Power Station, was expected to be online already, but construction strikes and other problems have made the project much more expensive — from 50 billion rand (roughly $4.9 billion) to about 150 billion rand — and have delayed its operations.
Notably, after apartheid and the transition to democracy, the ruling African National Congress needed to subsidize industry, mining and the delivery of electricity to the black population, its critical support base. This delayed market forces from acting swiftly on energy prices until now.
All these factors have contributed to Eskom's need to transfer energy costs onto consumers, and it has raised the price of electricity accordingly. It has raised prices by about 15 percent per year since 2008, and it tried to raise them even more in 2013. However, the National Energy Regulator of South Africa forced it to agree to an increase of only 8 percent.
In any case, Eskom estimates that it needs to double electricity prices by 2018. Electricity prices in South Africa already are roughly the same price as those in France and the United States, and higher than those in Canada and Sweden. Electricity prices are expected to surpass those of the United States in 2014, and Eskom is already planning to attempt to increase electricity prices 16 percent for the next few years. High electricity costs have squeezed the industrial and construction sectors, effectively eliminating any benefits the country enjoys from cheap labor costs. This is one reason that South Africa probably will not benefit from the manufacturing leaving China.
This directly affects South Africa's automobile sector, which is energy intensive and accounts for 6 percent of the country's gross domestic product. High electricity costs prevent it from raising wages for its employees, who currently are demanding 20 percent wage increases (though they would probably settle for 10 percent). The same dynamics are playing out in other mining sectors, including platinum, which is very expensive to refine.
Forced Intervention?
This cycle — whereby companies constantly raise wages as energy prices soar — is problematic for the South African economy. Already it has affected some specific mining sectors, such as platinum, where several mining companies are downsizing their South African operations due to higher domestics costs and a tough global commodity market. Various government officials have proposed ideas to resolve the problem, including nationalizing certain sectors, increasing regulation and control on labor negotiations, and declaring coal a strategic asset.
However, imposing measures that disrupt the annual wage increases could work against the African National Congress. The party was first elected in 1994 to succeed the apartheid government, and its constituents are mostly black South Africans, many of whom work in the sectors most prone to strikes. While the African National Congress' authority has not been threatened yet, it will not condone a course of action that would expose it to criticism from a rival party.
But demands from laborers will not be tolerated if they threaten South Africa's economic health. The African National Congress will have to tread lightly as it intervenes, making sure it does not lose support for acting against the interests of its constituents or for not being able to control the economy.
The African National Congress will conclude that the mining community can bear these additional costs; coal companies' profit margins will likely validate this belief. The party will also calculate that it will still receive foreign investment in its mining sector, which may be able to absorb the increases in cost. Mining companies will argue about profit margins and corporate shareholder concerns, but the government and its constituents will cite investment activity as a basis for extracting a few more concessions from the companies. However, if labor and energy costs continue to increase by 10-15 percent annually, Pretoria may well be forced to intervene on behalf of the economy.
For the mining sector, problems may be compounded by slowdowns in China and other major economies, which in turn translates to lower commodity prices. Going forward, mining companies will be stuck with increased pressure from Pretoria and workers on one side and with sluggish commodity prices and revenue on the other.
