Overview Driving inclusive growth in South Africa SOUTH AFRICA POLICY PACKAGE © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; internet: www.worldbank.org Some rights reserved This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and any other information shown on any map in this work do not imply, on the part of the World Bank Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. 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All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; email: pubrights@worldbank.org. Overview Driving inclusive growth in South Africa SOUTH AFRICA POLICY PACKAGE Quick wins with competitive markets and efficient institutions The new political context emerging from the May new entrants to the labor market can’t find stable 2024 elections provides a unique opportunity for and productive jobs­ leaving youth unemployment —­ South Africa. The alignment of economic and politi- above 60%. Market competition, while ensuring cal incentives, in the sense that improving the econ- greater economic inclusion and enhanced house- omy is essential for gaining political power, offers a hold welfare, is the best way to dynamize an econo- platform to launch a decisive transformation pro- my as it boosts efficiency and promotes innovation. cess, even if there is not yet an agreement on which South Africa could rebalance its economic model economic reforms to implement. Such alignment by making it easier for foreign and domestic inves- was key behind the successful economic transfor- tors and for young workers to enter markets, and The alignment mation of China in the early 1980s, Vietnam in the by reducing the protection of incumbents (including of economic late 1980s and 1990s, Poland in the 2010s, and owned enterprises). The status quo is most state-­ India in the early 2020s. Those successes were penalizing for small firms, which lack the capacity and political anchored on “a development bargain, whereby the or financial means to navigate the complex system incentives offers a platform to country’s elites shifted from protecting their own of rules and regulations, and for low-­skill workers, positions to gambling on a growth-­ based future.”1 who face a heavy income tax burden if formally This report offers pragmatic policy options, tailored employed. launch a decisive for South African policymakers who want to obtain transformation short-­term results, while creating momentum for Second, make institutions more efficient and sup- structural reforms, resume growth, and improve portive. The burden of institutions has become process ■ the overall welfare of their citizens, especially the excessive­ —­not only for businesses and citizens but most disadvantaged. also for public administration. South African policy- makers have attempted, often with good intentions, Inclusive growth through market to correct market or historical failures by interven- competition and efficient institutions ing through hard regulations, such as Black Empow- South Africa needs to transform its economy to erment policies, local content, and collective labor achieve robust and inclusive growth. How? By ad- bargaining­ —­and direct support programs to spe- dressing two major shortcomings in its economic cific groups, such as grants, tax rebates, and labor model. training). Today, these interventions have become so cumbersome that they smother the implementa- First, strengthen and broaden market competition. tion capacity of the public administration, especially Today, many of South Africa’s markets lack dyna- local officials, and open spaces for corruption. It has mism. Firm entry and exit are a third of the aver- been well documented that state capture left an en- age in a typical middle-­income country. Further, during mark on South Africa’s institutions through 1. Dercon, Stefan. Gambling on Development: Why some countries win and other lose. London: C. Hurst & Co. 1■ Despite long-recognized strengths… • Second-largest economy in Africa (after Nigeria) and Almost half of all large companies 32nd-largest in the world. in Africa are from South Africa • Large and diversified economy: mining, Rest of high-productivity agriculture, manufacturing including North Africa 11% automotive, high-productivity agro-processing, and services including a well-developed financial sector and 36 Egypt 10% 33 strong tourism potential (given natural endowments). 12 • Biggest regional transport and logistics hub: 1st in Sub-Saharan Africa and 40th (of 165 countries) in the 24 World Bank Group liner-shipping connectivity index. Rest of 15 Nigeria • Active corporate investors on foreign markets, West Africa 7% 3 East 3% representing three-quarters of 2015–19 foreign direct Africa Central 4% investment outflows from Sub-Saharan Africa. Africa • Research and Development (R&D) capacity —top three 1% universities in the continent and critical mass of highly qualified labor. • Two-thirds of the population (about 40 million people) South living in cities with potential agglomeration effects. 147 Africa 44% • Large middle-income class: around 40% of people earn between $4 and $13 a day. Source: McKinsey African Companies Database. …South Africa is on the wrong growth trajectory Real GDP per capita in 2023 Unemployment is about 30%, one Inequality is high and persistent, was less than in 2007 of the highest rates in the world as shown by the Gini coefficient Thousand rands Unemployment rate, age 15+ (percent) 85 30 80 80 South Africa, 2018 25 Namibia, 2015 60 Botswana, 2015 75 Eswatini, 2016 20 Lesotho, 2017 70 15 40 65 10 60 20 5 55 50 0 0 Ré wa a u na Le mal n so ia a o M Ni nda rit ria ig a E ria am t Li bia Bu Ken ia rk Gu ya Se na Fnea he o To es go C S gan li e ne a Iv al Be ire C in d 00 02 04 06 08 10 12 14 16 18 20 22 G gyp U Ma ts ric N ani ôt e d So nio Rw th yc as ha r d’ g n ll au ge e be o i i Bo Af 20 20 20 20 20 20 20 20 20 20 20 20 h ut So Source: World Bank. dismantling accountability mechanisms and losing private sector also benefited. MTN, a South Af- skilled personnel in key entities, weakening their rican multinational mobile telecommunications capacity to deliver public goods and services. provider, is now doing business in 22 countries Consider this: to bring phones and IT technolo- around the world. The same approach has been gies to its population, the government introduced used in aviation transport, with the emergence competition to the telecommunication market in of several regional private companies, and more the early 2000s, making South African one of the recently in power generation, where competition middle-­income countries with the highest rates has led to an unprecedented increase in renew- of digital penetration and exports. In parallel, the able energy over the past 18 months. There is no ■ 2 Driving inclusive growth in South Africa Overview What can the two drivers bring to the South Africa economy? Increase incentives to attract investments, innovate and unleash private sector potential Lower the dominance of protected incumbents that penalize customers Competitive markets Contribute to a better allocation of the country’s human, physical and financial resources Create economic and job opportunities accessible to all Improve quality of public goods and services Combat corruption, dismantle entrenched interests and build accountability Efficient institutions Streamline complex regulations that do more harm than good Create efficient coordination mechanisms within the state and between the state and other stakeholders obvious reason such an approach, when coupled (10%). So, it switched to a new economic model. In with smart regulations, cannot be applied to other less than five years, it reinvigorated its economy, sectors. doubling GDP growth to 3.1%, reducing unemploy- Now consider this: the impact of social spending ment to 6%, and cutting public debt to 40% of GDP. on poor population could be improved dramatically, How? By opening domestic markets to competition, not necessarily by spending more but by upgrading focusing the public footprint to areas where the the quality of institutions. To help young workers state is the ideal actor to provide essential goods prepare for the labor market, the government could and services, and streamlining regulations to max- coordinate the 100 active labor programs currently imize market efficiency and affordability­ exactly —­ dispersed across 20 institutions that defy coordi- the kind of turnaround that South Africans are des- nation, reduce affordability, and weaken capacity­ perately looking for.2 —­producing suboptimal results. More generally, the government could immediately erase extreme From the what to the how: four priority poverty if all the financial resources allocated to policy areas to provide a roadmap for social protection, about 4% of GDP, were equally actions distributed to the 10  million adults living on less The two drivers provide direction for South African than $2.90 a day­ —­the international threshold under policymakers­ the road they can embark on. But —­ which people are deemed extremely poor. So, the they still need a vehicle for action. For greater ef- challenge is not necessarily the lack of financial fectiveness, they should prioritize what is impactful resources­—­it is how to use them efficiently using and above all feasible. Such selectivity is well For greater the most appropriate institutional framework. aligned with international experience and further effectiveness, the Addressing the two fundamental shortcomings justified in South Africa. The state has limited finan- of limited market competition and institutional in- cial and technical capabilities to do everything at government could efficiency and ineffectiveness, could contribute to the same time. It needs to create momentum for re- prioritize what is impactful and resuming growth and making it inclusive. Beyond forms by delivering the biggest positive results pos- the successful (if limited) experiences in South Af- sible soon. And the political incentives to jumpstart rica, several East Asian countries transformed their reforms with feasible, impactful, and timely actions above all feasible ■ economies by relying more on market forces, open- are enormous. Operation Vulindlela, the delivery ing selected markets to competition, and adjusting unit created in the Presidency in 2019, produced their economic institutions. Sweden in the 1990s encouraging results in electricity and in streamlin- was exhibiting similar signs of paralysis as South Af- ing visa applications. Now, delivery units must be rica today: slow growth (around 1.6%), high public mainstreamed throughout the public administration debt (80% of GDP), and fairly high unemployment for sustainable and broad-­ based results. 2. World Bank. 2019. “The Turnaround of the Swedish Economy: Lessons from Large Business Sector Reforms.” World Bank Research Observer 34(2). August. pp. 274–308. https://doi.org/10.1093/wbro/lky007. Driving inclusive growth in South Africa Overview 3■ Four priority policy areas provide a roadmap for to markets and customers while individuals need actions: physical accessibility to jobs, which is largely deter- • Improve the efficiency of public spending and mined by infrastructure quality. The quality of pub- leverage private resources to enhance economic lic spending, including partnerships with the private growth and job creation. sector, is also important to improve service deliv- • Deliver quality, climate-­friendly, and resilient in- ery and the skills of the labor force, which are also ■ Implementing frastructure services. key determinants for productivity and job creation. reforms in each of • Promote efficiency and equitable urban devel- Cultivating such synergies through competitive opment and mobility. markets and efficient institutions has been the key the four priority • Inject dynamism in the private sector to create opening the success of fast-­ growing and inclusive policy areas jobs and productivity gains. countries. is a long-­term They were agreed on after a consultative pro- cess between the World Bank and a diverse group Jump-­starting the process with the most endeavor requiring of local and international experts (box 1). They do feasible, impactful, and timely actions sustained effort, not address all of South African economic challeng- Implementing reforms in each of the four priority es, such as water and agriculture. But without sig- term endeavor requiring sus- policy areas is a long-­ substantial nificant improvements in all four, it will be difficult tained effort, substantial financial resources, and financial resources, to achieve faster and more inclusive growth. unwavering political commitment. As demonstrat- and unwavering While these priorities are presented separate- ed by international experience and economic theo- ly, their combination will matter most for inclusive ry, South Africa will have to increase its productive political growth. Dynamic firms require good connectivity physical and human capital, which underpin strong commitment Box 1 The reform agenda proposed in this report was defined through an inclusive and participatory process • As part of the dialogue between South Africa and the World Bank, it was agreed in early 2023 that the World Bank would produce a new policy roadmap for the government through a demand-­ driven and focused process. • Three groups were constituted to support this exercise: government representatives, generally at the director-­general level, from pivotal economic departments and agencies; local experts from the private sector, civil society, and academia; and international advisers, including Nobel Laureate Michael Spence and former ministers from other middle-­ income countries (see annex 2 for details). • During the workshop organized in May 2023, these three groups advised the World Bank to develop a new narrative to revitalize the policy debate and create incentives for politicians to embark on critical reforms, while identifying concrete actions in the short term that can gener- ate momentum for reforms. In doing so, the World Bank was advised to prioritize four key areas: private sector growth; infrastructure services; urban agglomeration and mobility; and public spending. • In March 2024, in a second consultative workshop, the World Bank shared four policy notes aligned on the four above-­ recommended priorities, giving the members of the three groups the opportunity to provide feedback. This consultation was part of the World Bank’s deliberate and constant effort to improve the quality of the notes. • Some of the policy actions recommended in the notes have already been translated into re- quests from the authorities for additional technical and financial support, especially in policy areas 1 (public spending) and 2 (infrastructure services). ■ 4 Driving inclusive growth in South Africa Overview —­ Feasible, impactful, and timely (FIT) actions for each policy priority area­ see annex 1 for details Accelerate professionalization and the use of digital tools within public administration and Increase the impact incentivize sub-national governments to perform better of public spending Redirect public spending toward capital investment and job creation Secure electricity provision by connecting renewable projects to the grid and Deliver quality and climate improve revenue collection by municipalities friendly infrastructure services Open the railway network to multiple operators and strengthen the state regulatory capacities in the port and railways sectors Improve urban transport through conditional financing to the Passenger Rail Agency Enhance spatial efficiency and of South Africa and upgrading privately owned taxi buses equitable access to opportunities Enhance urban densification by facilitating development in strategic locations Increase returns in green and digital sectors with market instruments, lower barriers to entry, Inject dynamism to the and tailored labor and financial support programs private sector Unleash the potential of small and innovative firms through venture capital and mobile money inclusive growth and job creation in the longterm. And from the how to the now But such a process can be accelerated by focusing on achievable and impactful actions that can lead What can be done now to improve the impact of public to tangible results on the most pressing issues, spending? building momentum and laying the groundwork South Africa’s government has limited space to in- for broader reforms. Such a pragmatic and gradual crease spending. But it could spend better to sup- approach has been preferred in several countries port its key development objectives. Ten actions that have successfully implemented reforms. For are priorities in this area (see Policy Note 1), of South Africa’s example, in Vietnam, liberalizing foreign direct in- which three were assessed as most FIT. government vestment was first tested through experiments and The first is to improve the efficiency of public pilot projects in a few locations in the early 1990s, spending through better coordination within and could improve before being scaled up in the rest of country during between government Departments, strengthening the efficiency of public spending the 1990s and 2000s. Unlike shock therapy, this data systems so there is a better focus on outcomes approach gives time to build support for reforms and consequently, promoting better accountability in a consensual but politically contested society like for results across public institutions. This can be through better South Africa. done, for example, by gathering the management coordination within The World Bank proposes a menu of short-­ term of key investment projects in a centralized gate- actions for each of the four priorities. From the full way to realize economies of scale and accelerate and between range of possible short-­ term actions outlined in implementation through improved monitoring and government each note, a subset was selected for their techni- accountability. Several grant transfers to agencies Departments, cal feasibility, minimal political constraints, potential and municipalities can be consolidated to reduce for significant impact, and timely implementation administrative costs. In social sectors, the em- strengthening (labeled FIT actions). These options are appealing phasis could be on rationalizing labor market pro- data systems ■ to policymakers because they are fairly straight- grams, which do not have an overarching system forward to execute. They do not require significant to monitor progress or evaluate outcomes, leaving changes in the legal and institutional frameworks, significant gaps in coverage and limiting progress which are complicated and time-­ consuming in South in addressing the employment challenges facing Africa’s political economy. Further, many of them do South Africans. The education and training sectors not require additional financing, important given the in South Africa should also put more emphasis on needed fiscal consolidation over the next few years, results by re-­instituting national learning assess- but they do require political will and vision. ments in basic education and creating a system to Driving inclusive growth in South Africa Overview 5■ track employment outcomes of TVET and universi- deliver, coordinate, and regulate. This framework ty graduates. In social assistance, there are poten- was applied to the electricity and freight trans- tially large efficiency gains­ in better targeting and —­ port, partly due to close collaboration between the coverage­ —­through the establishment of a social government and the World Bank. Still, it could be registry and better interoperability of the current extended to other infrastructure sectors, such as social assistance data system, which could link cash water and waste management. grants with labor market services. For electricity, eight actions are identified to The second FIT action is for the government to achieve those goals in the short run (see Pol- expand partnership models with the private sector. icy Note 2). From this menu, two FIT actions are Such a move has already started in infrastructure screened as priorities. First, building on the recent sectors (as emphasized below) but could be broad- adoption of the amended Electricity Regulation Act ened to social sectors. The public sector alone will and the creation of the National Transmission Com- be unable to finance the fast-­ increasing needs in pany of South Africa, improved access to the grid education and health sectors, but private providers for new projects (which today is the main bottle- can also commit to high levels of accountability for neck) should be privileged, which is possible by en- improving quality and access to education services, hancing the management of the existing grid (using particularly for poor communities. The recent ex- digital tools and adjusting rules). It will also require perience of public-­ private partnerships in Western accelerating the opening of the transmission sector Cape and Gauteng could be scaled up in the imme- to private promoters, which is currently initiated by diate future. the government. Second, the billing and collection The third FIT action is to introduce several performance of municipalities­ —­critical to distribu- cross-­ cutting measures that may generate some tion and the financial viability of the sector­ —­can be efficiency gains in public spending management. improved by introducing performance-­ based trans- Among them are hiring top managers in public fers from National Treasury. The idea is to reward administration based on competencies, under the good performers, currently experimented with in auspice of the Head of Public Administration, using several initiatives from National Treasury. To make ■ Climate-­friendly digital tools to share data and streamline process these actions most effective over time, the govern- infrastructure and well as to improve monitoring and accountabil- ment will need to assess the future role of Eskom, ity, and encouraging e-­ procurement through finan- which is called to operate in a very different en- services require cial awards and penalties. A key action would be to vironment than in the past, while considering how three intertwined scale up the recent approach developed by the cen- to reorganize the distribution segment now divid- lines of action: tral government to further incentivize subnational ed between Eskom and municipalities, with well-­ governments to deliver better services by linking known challenges of coordination, governance, and opening up to the allocation of central grants to specific outcomes efficiency. competition, achieved by provinces and municipalities. Today, For transport, seven actions are proposed, in- subnational governments receive, whatever their cluding two that are identified as the most FIT. First, broadening performance, about the same resources from the the dominance of Transnet in the rail sector can be sources of central government­ —­unsustainable but also unfair reduced by separating infrastructure and opera- financing, and to good performers and ultimately to citizens. tional responsibilities. Establishing an infrastructure manager (independent of Transnet) will reduce ex- enhancing the What can be done now to deliver better quality and isting conflicts of interests and open the door to state’s capability to friendly infrastructure services? climate-­ devolving some routes to other operators. Along The delivery of quality and climate-­friendly infra- these lines, transferring operational responsibilities deliver, coordinate, structure services requires three intertwined lines on the bulk mineral routes to mining companies and regulate of action: opening them to competition to pro- could be prioritized pending the approval of clear, mote efficiency gains and innovation, broadening transparent, and equitable rules. Second, the regu- the sources of financing for investment and main- latory capability of the state could be reinforced by tenance, and enhancing the state’s capability to rapidly promulgating the Economic Regulation Bill ■ 6 Driving inclusive growth in South Africa Overview and establishing a joint regulator for the port and with the private sector, which is increasingly con- rail subsectors. Implementing these two actions is sidered for the most commercially viable routes. At backed up by the recent Cabinet adoption of the the same time, the operational efficiency of private roadmap by in December 2023, after an intensive minibus taxis could be improved by promoting dig- consultation process. These short-­ term actions ital management tools for better coordination and should be accompanied by other measures, which improved integration of this mode of transport into will take more time but remain crucial, such as the a multimodal system for the benefit of custom- imperative of bringing back Transnet’s financial ers (see Policy Note 3). The positive externalities accounts on a sustainable basis, and developing of such actions (overall benefits for society as the cleaner and more effective transport modes. Plan- gains extend to all customers) could justify a target- ners will have also to account for the changes in ed use of subsidies. While economic spatial distribution of economic activities that are Second, to make urban development more con- exclusion results expected to emerge in the future, such as the shift ducive to growth and inclusion, several actions from coal to renewable energy and the exploitation could encourage the vertical development of South from multiple of new rare-­ earth minerals. African cities by making the relative value of new factors, many studies have projects more attractive. Because the construction What can be done now to make cities engines of of new housing projects would take some years growth and economic inclusion? before becoming concrete, the government must demonstrated that Addressing economic exclusion in South African cit- act urgently. It could send strong market signals urban workers’ ies, which remains important even 30 years after to encourage densification by relaxing some zonal the end of apartheid, requires improving mobility regulations, streamlining the approval process for limited and costly and reducing distance through more efficient and strategically social projects, and improving space mobility is key equitable transport services and improving urban management with digital platforms. With these ac- in South Africa ■ development. While economic exclusion results tions, the authorities will increase the rate of return from multiple factors, many studies have demon- associated with investment projects in dense areas, strated that urban workers’ limited and costly mo- paving the way to spatial efficiency and equity in bility (accounting for about two-thirds of the labor coming years. force) is key in South Africa. On average, typical workers could spend about half of their earnings What can be done now to inject dynamism in the on transport (up to 80% for the poorest), compared private sector? with 10% in Vietnam. To foster the growth of the private sector, which Of eight action priorities to improve urban is crucial for job creation, the authorities could act transport and reduce distance within cities, two on two fronts. First, they can promote increased are assessed as the most FIT. First, starting with competition in future industries such as digital the objective of making transportation efficient and finance and green industries. The emphasis on affordable, the government could reduce the cost these sectors is well-­ founded, as they leverage for the poorest commuters by distributing free e-­ South Africa’s strengths and offer the greatest vouchers that could be used either on public trans- potential to enhance the country’s competitive- run taxi buses. port (rail and buses) and on privately-­ ness in response to shifting regional and global This could be implemented by, using phone and dig- demands. Second, the government can support ital banking, both widely used in South Africa, and the development of small and medium firms, and by redirecting some of the savings from devolving ups, which possess the greatest potential start-­ some services to the private sector. Indeed, the for innovation and employment generation. In public agency responsible for passenger transport South Africa, these firms do not emerge as fast (PRASA) could be incentivized to improve its per- as in other middle-­ income countries and their sur- formance by linking transfers from National Trea- vival rate is lower. Eight actions, of which two are sury (which account for three-­ quarters of funding) assessed FIT, are identified to achieve these two to its performance, and by developing partnerships goals (See Policy Note 4). Driving inclusive growth in South Africa Overview 7■ The first FIT action aims to develop future in- sectors. This evolution also requires addressing the dustries by reducing entry barriers for new foreign growing inefficiency in the country’s institutions, ■ To develop and domestic private investors who will bring the which has worsened over time due to the increasing industries of new technologies and train local workers. This can complexity of government interventions, significant be achieved by streamlining administrative pro- state capture, and resulting high levels of corrup- the future, the cedures and making the standard (but simplified) tion. Strengthening competition in the markets and authorities can tax regime the rule rather than the exception. The transforming institutions into enablers have already reduce entry burden of several industrial and labor policies can supported the successful transformation of some be reduced by adjusting them to the reality of the strategic sectors over the past few years, such as barriers for market­ —­for example, by generalizing the use of the telecommunications and aviation, for the benefit of new foreign Equity Equivalence Investment Programs by the customers and individuals looking for jobs. Such a Department of Trade and Industry instead of the shift should be expanded and accelerated to other and domestic hard complex conditions associated with Black Eco- sectors to adjust to today’s geopolitical, econom- private investors nomic Empowerment policies. The Special Econom- ic, and technological realities­—­both domestic and embedded in ic Zones can be reconfigured, as successfully done global­—­ shaping the world today. in Asia, to reduce the costs of doing business, while As part of this evolution, the role of the state industrial and promoting the creation of jobs through linkages remains important, but it should be refocused on labor policies with public-­ private partnerships. These measures ensuring the right conditions for rapid economic could be implemented fairly quickly since the gov- growth and strong equity. This will require the ca- ernment has already used them in some scenarios. pacity to deliver public services, including partner- The second FIT action is to relax access to fi- ships with the private sector by opening markets to nancing by start-­ ups and small firms­—­the biggest competition, and using regulations more efficiently constraint to their development, as shown in recent to align incentives, reduce costs for the private sec- surveys. While the depth of the financial market in tor, and enhance human welfare. The state will have South Africa is one of the largest among middle-­ to focus on making growth as inclusive as possible income countries, small firms generally are not con- by extending economic opportunities to all with an sidered by commercial banks, even if they are inno- effective redistribution policy, correcting potential vative. One measure could be to reduce the cost of market failures. And it will have to manage this tran- financing, which remains prohibitive for many small sition: if more competitive markets and more effi- firms, by diversifying the options. As in many other cient institutions will unambiguously improve the countries, the Central Bank could adjust regulations country’s welfare in the long-­ term, some groups to foster venture capital and e-­money and develop (such as workers in existing state-­ owned enterpris- a framework for open finance. These instruments es) may face short-­ term losses leading to resistance compete with banks, and could reduce their fees against the reform process. However, this resistance and encourage financial inclusion, as demonstrated presents a false dilemma. The government should in several countries over the past few years. The prepare state-­ owned enterprises to compete with development of small firms will need to be support- those at the forefront of global productivity and ed by other measures, such as skill development develop targeted support to affected workers and and simplified regulatory regimes to make them communities. In all, these interventions will cost more profitable. less than any attempt to resist the forces of global competition and reduce the chances of local firms What’s next? and workers as a whole reaping the benefits of such South Africa needs to reinvigorate its economic a transformation. model to get onto on a robust and inclusive growth The actions proposed here are only a beginning path and meet the expectations from its citizens. since economic development is a long-­ term enter- This does not need a revolution in its policymaking prise ultimately determined by a country’s ability but evolution to continue addressing the limit- to develop and efficiently use its productive, phys- ed competition in many of the country’s strategic ical, human, and natural capital. They are based on ■ 8 Driving inclusive growth in South Africa Overview principles of increased (but managed) competition in questions like these are simply staggering: Once and more efficient institutions. Yet, as Nobel Lau- one starts to think about them, it is hard to think reate Robert Lucas emphasized in his seminal ar- about anything else.”3 The World Bank acknowl- ticle on the Mechanics of Economic Development, edges that there may be multiple pathways to rapid achieving and sustaining inclusive growth is a com- and inclusive development in South Africa. Howev- plicated process. As he wrote, “Is there some action er, we hope this study with its in-­ depth analysis and a government of South Africa [Egypt] could take practical recommendations, will assist South Afri- that would lead the South African economy to grow can policymakers in addressing these issues and, like China [India]? If so, what, exactly? If not, what most importantly, taking action to pave the way for is it about the nature of South Africa that makes it a brighter future for all citizens. The time for action so? The consequences for human welfare involved is now – it is never too late to act decisively. 3. Lucas, R.B. 1988. “On the Mechanics of Economic Development.” Journal of Monetary Economics 22(1): 3–42. Driving inclusive growth in South Africa Overview 9■ Annex 1  FIT actions for inclusive growth in South Africa and how to implement them FIT actions How to implement them Policy area 1: Increasing the impact of public spending on inclusive growth 1. Increase the impact of public • Establishing a centralized gateway for priority capital projects above a certain threshold spending • Improve the efficiency of public spending through better coordination, a sharper focus on results, and better data systems, with special attention to intergovernmental transfers and social sectors • Consider partnerships with the private sector, not only in infrastructure sectors but in social sectors, building on successful experiences in Western Cape and Gauteng • Linking the Covid-­19 Social Relief Distress grant with active labor market programs 2. Accelerate professionalization based hiring of • Operationalize the Head of Public Administration role to strengthen the merit-­ and the use of digital tools senior managers and reduce politicization in public administration • Expand the functionality of the e-­ procurement system to bid management and compel and incentivize subnational procuring entities across levels of government to use the system and share data with the governments to perform National Treasury better • Scaling up the performance-­ based approach used for the public transport grants to other earmarked transfers from national treasury to sub-­national governments • Reducing the administrative burden associated with conditional grants to subnational governments, including through consolidation and harmonization friendly infrastructure services Policy area 2: Delivering better quality, climate-­ 3. Secure electricity provision • Ensuring the financial and operational sustainability of the National Transmission Company of by connecting renewable South Africa by adopting a new transmission tariff methodology; implementing a new wheeling projects to the grid and framework; and updating the Grid Code improve revenue collection • Scaling up private investments in transmission by adopting a regulatory framework for an by municipalities independent private transmission model • Improving electricity distribution by municipalities by streamlining the contractual approach implemented in mid-­ 2023 between the National Treasury and the municipalities; using conditional transfers to incentivize municipalities to perform better; improving local capabilities at the municipal level; and adopting standards for municipal performance 4. Open the railway network • Initiating Transnet’s unbundling by adopting the new draft Rail Bill to multiple operators and • Providing nondiscriminatory access to railway infrastructure by establishing an independent strengthen state regulatory Infrastructure Manager capacities in the port and • Developing a public-­ private framework for allowing private sector participation in railway railway sectors operations by transferring the operational responsibilities of bulk mineral rail lines to large mining companies and establishing public-­ private partnerships for running railways on feeder lines • Implementing the independent Economic Regulator section of the Transport Bill, while enhancing the technical and financial capabilities of the Regulator Policy area 3: Making cities engines of growth and economic inclusion 5. Improve urban transport based approach for allocating grants from National Treasury to PRASA • Using a result-­ through conditional financing • Distributing vouchers to poor customers, while promoting the use of digital ticketing to the Passenger Rail Agency • Building on the lessons from pilot projects in Cape Town and Gauteng to mutually corporate of South Africa (PRASA) and the minibus taxi sector upgrading privately owned taxi buses 6. Enhance urban densification • Relaxing national building and municipal zoning regulations, while amending the Spatial Planning by facilitating development in and Land Use management Act strategic locations density areas close to business • Introducing financial bonuses for social housing projects in high-­ centers • Accelerating the development and use of digital spatial planning platforms to boost information collection and sharing ■ 10 Driving inclusive growth in South Africa Overview FIT actions How to implement them Policy area 4: Injecting dynamism in the private sector 7. Increase returns in green and requisites for foreign investors by promoting the • Streamlining firms’ entry and operational pre-­ digital sectors with market use of “labor equivalent programs” sponsored by the Ministry of Trade and Industry instruments to lower barriers • Increasing liquidity in carbon credit markets to entry, and tailor labor and • Reorienting incentives and support programs away from fossil fuels and toward new green financial support programs activities 8. Unleash the potential of small growth start ups • Increasing the provision of venture capital for high-­ and innovative firms through • Authorizing nonbank institutions to issue mobile money venture capital and mobile • Developing a framework for open finance money Annex 2 – List of contributors This collection of policy notes is a collaborative effort of the World Bank produced by a core team led by Jacques Morisset (Lead Economist and Program Leader) and Javier Baez (Lead Economist). The key contributors are Smita Kuriakose, with inputs from Tania Begazo, Caroline Cerruti, Seidu Dauda Claudia Meek, Dumisani Ngwenya, Elizabeth Ninan, and Marc Schrijver for Policy Note #1. Mirlan Aldayarov and Bernard Aritua with inputs from Mariano Salto for Policy Note #2, Edward Beukes and Eric Dickson, with inputs from Bernard Aritua, Karla Carvajal Gonzalez, and Nozipho Shabalala for Policy Note #3, and Joanna Alexandra Watkins and Benedicte Baduel, with inputs from Eric Dickson, Knut Leipold, Victoria Monchuck, Dumisani Ngwenya, Elizabeth Ninan, and Paul Seaden for Policy Note #4. The Bank team benefited from strategic advice and comments from various external stakeholders, including several government agencies, coordinated by the National Treasury under the leadership of Boipuso Mopise, Deputy Director General. Several local experts provided comments and suggestions at various stages of the preparation including, among others, Tania Ajam, Haroon Bhorat, Martin Cameron, Hugh Cole, Andrew Donaldson, Mcebisi Jonas, Michael Kahn, Lolette Kritzinger-­ van Niekerk, Lullu Krugel, David Lewis, Trudi Makhaya, Renosi Mokate, Wim Naudé, Michael Sachs, and Wandile Sihlobo. Sharing its extensive knowledge and practical experience throughout the preparation of the notes, an advisory team comprised Prof. Michael Spence (Nobel Laureate), Prof. Danny Leipziger (George Washington University, former World Bank Vice-­ President), Montek Alwahulia (former Deputy Chairman of the Planning Commission of India), Dr. Mari Pangestu (former Indonesia’s Minister of Trade, and former World Bank Managing Director), and Prof. Andres Velasco (Dean of the London School of Economics, former Finance Minister of Chile). Detailed feedback, suggestions, and comments were received from three internal peer reviewers: Mona Haddad, Andrew Dabalen, and Matthew Verghis. A team at Communications Development­ led by Bruce Ross-­ —­ L arson and including Joe Caponio, Mike Crumplar, Meta de Coquereaumont, Chris Trott, and Elaine Wilson­ —­edited and laid out the report. World Bank practice managers provided invaluable support, including Karla Carvajal, Peter Ellis, Asmeen Khan, Rinku Murgai, Pierella Paci, Consolate Rusagara, and Yadviga Semikolenova. The report was prepared under the guidance of Victoria Kwakwa (World Bank Regional Vice President for Eastern and Southern Africa), Satu Kahkonen (Country Director); Marie-­ Francoise Marie-­Nelly (former Country Director), Hassan Zaman (World Bank Regional Director for Prosperity); Asad Alam (former World Bank Regional Director for Prosperity), and Marco Hernandez (Manager for Economic Policy). Driving inclusive growth in South Africa Overview 11 ■ Priority 1 Increasing the impact of public spending on inclusive growth SOUTH AFRICA POLICY PACKAGE © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; internet: www.worldbank.org Some rights reserved This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and any other information shown on any map in this work do not imply, on the part of the World Bank Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. 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Priority 1 Increasing the impact of public spending on inclusive growth SOUTH AFRICA POLICY PACKAGE Contents Realigning public spending to meet the country’s pressing needs and make service delivery more efficient and supportive of growth 1 Drivers of inefficient public spending 1 Three priorities for making public spending more efficient 5 Priority 1: Creating fiscal space for present and future public spending 6 Action 1: Coordinate and consolidate social programs, with a focus on results 7 Action 2: Partner with the private sector 7 Priority 2: Allocating public resources to loosen binding constraints to inclusive growth 8 Action 3: Improve public investment management 8 Action 4: Spend smarter on programs to enhance the employability of people disadvantaged in the labor market 9 Priority 3: Upgrading the public sector’s delivery capacity 10 status meritocracy Action 5: Professionalize the public sector to build a high-­ 10 Action 6: Improve monitoring mechanisms 11 Action 7: Accelerate digitalization of public services 12 Action 8: Incentivize the performance of subnational governments 13 Annex table A1 Ranking of measures through the “FIT” filter of feasibility, impact, and timing 15 Notes 17 Figures 1 The fiscal multiplier has been declining since 2010 2 2 Fiscal accounts have deteriorated since 2009 2 3 Budget allocations privilege consumption at the expense of investment compared with global standards, 2019 2 4 Public investment is below the world average and well below the level in fast-­ growing economies, 2019 3 5 Value for money in social sectors is low in relation to the rest of the world, 2020 3 6 Most governance indicators have weakened over the past two decades, 2000–2021 4 7 Subnational governments are responsible for the largest share of public spending 4 8 A guiding framework for prioritizing policies for improving the efficiency of public spending 5 iii ■ Realigning public spending to meet the country’s pressing needs and make service delivery more efficient and supportive of growth It is hard to ignore the chorus of voices in South Af- Drivers of inefficient public spending rica calling for radical reforms of the state to ensure Nearly all countries use public spending as a major better use of public resources.1 The government’s policy instrument to influence the economy and ability to deliver basic social services and infrastruc- improve living conditions. While demonstrating ture services has been eroding over the past de- country analyses show causality is difficult, cross-­ cade, while a threefold increase in the ratio of public that a 1 percent increase in public spending can lift debt to GDP has narrowed the fiscal space to fund economic growth by nearly a percentage point (the such services. How far and fast South Africa can go “fiscal multiplier”), with, however, significant varia- The government’s in redefining the role of the state to address these tions depending on initial conditions and the nature ability to deliver challenges remains unclear. As this process unfolds, of the spending increase.4 There is also a wealth of the country may want to consider reviewing similar empirical evidence that sound expenditure policy basic social and experiences in Canada,2 Europe, and Central Asia. can diminish economic and social disparities, pro- infrastructure services has been Meanwhile, policymakers cannot afford to re- mote equity, and reduce poverty while preserving main inactive.3 To guide them in making public growth objectives.5 spending a more effective policy instrument for In South Africa, public spending has not deliv- eroding, while a economic progress, this note proposes a focus on ered the desired impact on long-­ term economic threefold increase three mutually reinforcing priorities: spend more growth and poverty alleviation. Analysis by the wisely and efficiently so that the public debt trajec- Reserve Bank of South Africa found that, over the in the public debt tory does not become unsustainable; leverage pri- past decade and controlling for other variables, in- has narrowed the vate resources to increase the financing needed to creases in public expenditures have no longer been fiscal space to rebuild infrastructure and support better and more associated with growth in output.6 The fiscal multi- coordinated job-related programs to reduce unem- plier even turned negative in the late 2010s (figure fund such services ■ ployment; and improve the public sector’s service 1), and poverty (at the upper middle-­ income inter- delivery capacity by further professionalizing public national poverty line of $6.85 per person per day), administration, strengthening program monitoring at 61.6%, is well above what would be expected at and evaluation, and accelerating digitalization. South Africa’s level of development. These three priorities apply to all levels of gov- Three complementary factors help explain why ernment, not just the central government. South public expenditures have not supported economic Africa’s fiscal system devolves many important growth and poverty reduction in South Africa. spending responsibilities to subnational govern- First, the gradual narrowing of fiscal space due ments, autonomous agencies, and state-owned to high current expenditures and high and growing enterprises (SOEs). Unless their performance also debt-­ service payments means that fewer public re- improves, central government spending is unlikely sources are available for capital and social spending to become more efficient or to have a stronger im- programs that are likely to have the greatest impact pact on inclusive growth. on inclusive growth. Public debt surged from 24% 1■ Figure 1  The fiscal multiplier has been declining Figure 2  Fiscal accounts have deteriorated since since 2010 2009 Fiscal multiplier Public debt Fiscal balance (percent of GDP) (percent of GDP) 1.5 80 4 1.0 60 0 0.5 40 –4 0.0 20 –8 –0.5 0 –12 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Source: T.J. Van Resburg, S. de Jager, and K. Makrelov, 2021, “Fiscal Multipliers in South Africa after the Global Financial Source: National Treasury and World Bank. Crisis,” SARB Working Paper, South African Reserve Bank. Figure 3  Budget allocations privilege of GDP in 2008 to almost 75% at the end of 2023 consumption at the expense of investment (figure 2), increasing the risk of debt distress and compared with global standards, 2019 pushing up interest rates.7 This has further nega- Public investment (percent of GDP) tive consequences for economic growth because it can crowd out financing for the private sector.8 12 Rising public debt can also prevent demand from responding to increased public spending as con- 10 sumers increases their savings in anticipation of the future tax increases that will be needed to pay off 8 the rising public debt (the Ricardo-­ Barro effect).9 Acknowledging this risk, the government has lim- 6 ited public expenditure growth after the pandemic, especially by containing the wage bill. However, this 4 ■ Public spending has also created new challenges since contained has not been public spending could negatively affect the aggre- 2 gate demand, reducing growth, which will make in fully aligned with turn fiscal consolidation even more difficult. 0 South Africa the country’s 0 5 10 15 20 25 30 Second, public spending has not been fully aligned Government consumption (percent of GDP) needs as public with the country’s needs. Public consumption has been favored over public investment (figure 3), lead- Source: International Monetary Fund’s Investment and cap- consumption has ing to an infrastructure crisis (see policy note 2) that ital stock data set and World Bank’s World Development been favored over is strangling economic growth.10 South Africa has in- Indicators. vested 3%–5% of GDP per year less than fast-­ growing public investment countries in East Asia and six times less than China expenditures during fiscal year 2023/24,11 well below over the past two decades (figure 4). In addition, the more than 20% allocated in Malaysia, Singapore, just 11% of the budget was allocated to economic and Thailand. The misalignment of public spending ■ 2 Priority 1: Increasing the impact of public spending on inclusive growth growing economies, 2019 Figure 4  Public investment is below the world average and well below the level in fast-­ Percent of GDP Less than 2.55 2.55–3.51 3.51–4.60 4.60–6.66 More than 6.66 No data Source: International Monetary Fund’s Government Finance Statistics. with the country’s needs is also evident within sec- Figure 5  Value for money in social sectors is low The positive in relation to the rest of the world, 2020 tors, as discussed in the next section.12 impact on Third, the declining capacity of the public sector to efficiently deliver public goods and services has Human Capital Index score inclusive growth lowered the value of South Africa’s fiscal multiplier. 1.0 has been curbed by technical, Even when the government has allocated adequate resources to the right sectors, the positive impact on inclusive growth has been curbed by technical, 0.8 institutional, and institutional, and human resource deficiencies in human resource the public sector. This is illustrated by the low value for money in social sector spending, despite ample 0.6 deficiencies ■ budget allocations (figure 5). These weaknesses have resulted in the capture of public funds by the private sector and connected individuals, as em- 0.4 phasized in recent government reports.13 This de- South Africa terioration of institutions and accountability mech- anisms is reflected in the decline in South Africa’s 0.2 0 5 10 15 20 25 Worldwide Governance Indicators over the past Education and health spending (percent of GDP) two decades (figure 6).14 This decline is especially prominent in government effectiveness, quality of Source: World Bank, World Development Indicators database. regulations, and control of corruption.15 Such spending inefficiencies are found across responsible for 78% of public spending, including all levels of government, including subnational gov- the provision of most social services (provinces) and ernments and SOEs. Subnational governments are a large share of basic infrastructure (municipalities) Priority 1: Increasing the impact of public spending on inclusive growth 3■ (figure 7). As of 2021, 165 of 257 municipalities Figure 6  Most governance indicators have were classified as dysfunctional, including 30 that weakened over the past two decades, 2000–2021 were under provincial or national administrative Score ­ control.16 Similarly, the mismanagement of several SOEs responsible for infrastructure services is well 0.8 documented.17 These enterprises have failed to develop and maintain the country’s infrastructure ■ The poor have been networks, especially in energy (Eskom) and trans- 0.4 disproportionately port (Transnet and PRASA). Those failures have generated direct losses to the economy, estimated penalized by at 2%–3% of GDP growth in 2023 alone.18 They 0.0 the degradation have also resulted in successive bailouts that have in public drained public resources and cost around 6–7 per- centage points of GDP between 2009 and 2023. –0.4 infrastructure The inefficiency in South Africa’s public spending 2000 and social has disproportionately hurt the poorest segment of 2021 the population. Granted, the generous allocation of services caused –0.8 Voice Political Government Regulatory Rule of Control of public resources to social protection (around 4% of and stability/ effectiveness quality law corruption by inadequate accountability No GDP) has reduced poverty and inequality.19 But this violence maintenance positive contribution must be weighed against the regressive effects of the suboptimal use of public Source: World Bank, Worldwide Governance Indicators and investment resources. The poor have been disproportionately (https://www.worldbank.org/en/publication/worldwide​ penalized by the degradation in public infrastruc- governance-indicators/interactive-­ -­ data-access). ture and social services caused by inadequate maintenance and investment because they lack Figure 7  Subnational governments are responsible for the largest share of public spending a. Public spending is decentralized to provinces and b. Subnational governments and state enterprises are municipalities, while revenue collection is not, 2022/23 responsible for 85% of public investment, 2023/24  Percent Percent 100 50 17.3 21.3 49 0.5 82.2 40 75 27.1 36 30 50 51.6 20 25 15 10 0 0 Revenue Spending Central Subnational State-owned enterprises Central Provinces Municipalities Source: Calculated by authors using National Treasury data. ■ 4 Priority 1: Increasing the impact of public spending on inclusive growth the financial resources to switch to private services that public resources are available to meet current grid energy solutions or private schools (such as off-­ and future needs? How should public resources be and hospitals). Furthermore, the reduced impact allocated to address the country’s most important of public spending on economic growth has con- needs and yield the highest returns to growth and strained the emergence of new enterprises, espe- to poverty and inequality reduction? How can the cially micro and small firms, thus reducing demand public sector’s delivery capacity be strengthened? for unskilled and medium-­ skilled labor. A menu of eight actions is proposed to support the three priorities. Several actions build on initia- Three priorities for making public tives already launched by the government (such as spending more efficient incentives for subnational governments and SOEs South African policymakers have introduced sev- to spend better and the digitalization of public eral initiatives to improve the efficiency of public services), while others, often inspired by success- spending. Since 2019, Operation Vulindlela, a joint es in other countries, are more disruptive. All the The proposed initiative of the Presidency and the National Trea- proposed actions prioritize the short term to create actions prioritize sury modeled after service delivery units globally, momentum for further reforms. They are comple- has pushed for critical policy reforms in electrici- mented by some of the recommendations in policy the short term ty, digital communications, water, transport, and notes 2 and 4 that call for a smaller public footprint to create momentum for immigration.20 Similar institutional fixes led to the in the economy and the opening of infrastructure creation of the Presidential Climate Commission in markets to private operators while reinforcing the 2020, the Presidential Youth Employment Interven- regulatory role of the state. further reforms ■ tion in 2020, the National Energy Crisis Committee To ignite the transformation in public spending, in 2022, and the creation of the position of minister policymakers could focus initially on a subset of six of electricity in 2023, among other measures. How- reforms under the eight proposed actions. These ever, international evidence reveals that such paral- reforms are assessed as the most politically and lel units and structures often face resistance within technically feasible, impactful, and timely as they public administration, which can feel threatened by do not require large changes in the legal framework the parallel arrangements.21 (see table A1 in the annex). While the most desir- The authorities could adopt a more compre- able actions would ideally meet all three criteria, hensive approach to address the factors behind tradeoffs are likely to arise: the inefficiency of public spending. An overarching 1. Coordinating and consolidating active labor mar- analytical framework of three priorities is proposed ket programs. For example, there are more to guide interventions (figure 8). The three priori- than a hundred active labor market programs ties respond to the following three questions: How at the national level offered by some 20 gov- can the government create fiscal space to ensure ernment departments. Figure 8  A guiding framework for prioritizing policies for improving the efficiency of public spending Action 1: Coordinate and consolidate social programs, with a focus on results Priority 1: Creating fiscal space for present and future public spending Action 2: Partner with the private sector Maximize the impact Priority 2: Allocating public resources Action 3: Improve public investment management of public spending on to loosen binding constraints to inclusive growth inclusive growth Action 4: Spend smarter on programs to enhance the employability of people disadvantaged in the labor market Action 5: Professionalize public service to build a high-status meritocracy Priority 3: Upgrading the public Action 6: Improve monitoring mechanisms sector’s delivery capacity Action 7: Accelerate digitalization of public services Action 8: Incentivize the performance of subnational governments Priority 1: Increasing the impact of public spending on inclusive growth 5■ 2. Linking the Covid-19 Social Relief Distress labor unions. Hiring new staff requires the autho- grant with active labor market programs  to en­ rization of the National Treasury and the Depart- hance employability and support job creation ment of Public Service and Administration, at least and labor productivity in the longer term. for the 2024/25 financial year. To slow the rise in 3. Making the Head of Public Administration debt service costs, plans call for reducing borrow- responsible for ensuring transparent and ro- ing by controlling the fiscal deficit, seeking more bust processes for hiring and managing all top financing on concessional terms, and improving managers. debt management. These actions will take time to 4. Introducing a unified national ID standard t o have a noticeable impact because of built-in rigid- prepare for a digital ID that will improve ac- ities in many expenditures. In addition, controlling cess to social and financial services and data. the wage bill while improving public service deliv- 5. Incentivizing the uptake of the e-procurement ery necessarily involves tradeoffs. Further wage system (eTenders) for procuring entities across bill reforms are likely to erode service delivery in levels of government  by introducing financial core labor-intensive activities such as education, and nonfinancial rewards. health, and justice and security.23 Thus, wage bill 6. Scaling up the contract-based approach piloted consolidation may need to accommodate greater in the electricity sector to other sectors (water, front-line service delivery requirements and be ac- waste, education, health) and other levels of companied by recruitment reforms, which are the government t  o incentivize them to improve focus in this note. their overall financial performance. The government will have to do more to create ■ To increase fiscal The proposed actions give special attention to fiscal space as the pressures on capital spending savings in the social spending for three interconnected reasons. and social spending mount. As highlighted in poli- First, because social spending absorbs about half cy note 2, South Africa’s infrastructure needs are short-term, the of South Africa’s public budget, it will be hard to enormous, both to redress current shortcomings government can achieve large efficiency gains without improving and to adapt to climate change. Social expenditures cut or consolidate the quality of social spending. Second, budget al- are also projected to increase, especially in educa- locations to education and health are high by in- tion, where increases are needed to accommodate redundant or ternational standards yet have failed to achieve a the growing number of students and improve the nonperforming commensurate impact on human capital (see figure quality of education. For example, in basic educa- 5). Third, most of the recommendations for the so- tion, the challenge is to build some 20,000 new programs cial sectors also apply to other sectors, including classrooms and increase the teaching workforce and develop infrastructure, another major challenge (see policy by about 25,000 to prepare for the estimated ad- partnerships note 2). ditional 1.2 million learners expected to enter the school system by 2030. Without creating more fis- with the private Priority 1: Creating fiscal space for cal space, the government cannot afford to pay for sector to deliver present and future public spending these education system needs. Similar challenges Creating fiscal space is at the center of the apply to health and social protection. public services Medium-Term Fiscal framework presented by the In the short-term, the government can consid- Minister of Finance in the budget speech deliv- er two types of actions on the expenditure side to ered in February 2024. The two main levers are increase fiscal savings. First, it can cut or consoli- the wage bill, which at 12% of GDP is 5 percent- date redundant or nonperforming programs, which age points above the average in Organisation for raise administrative costs and prevent economies Economic Co-operation and Development (OECD) of scale. Second, it can develop partnerships with countries, and the expected increase in debt-ser- the private sector to deliver public services, as is vice payments.22 To rein in wage increases, the Na- already under way in some infrastructure sectors, tional Treasury has gained power and discretion to such as telecommunication and electricity, and is bargain with labor unions using the legal room cre- beginning in social sectors in some provinces, in- ated by a recent judicial decision that went against cluding in education and health. ■ 6 Priority 1: Increasing the impact of public spending on inclusive growth ■ Action 1: Coordinate and consolidate social alignments, and the role of government. For com- programs, with a focus on results mercial entities in which the state is a minority stakeholder, privatization might also offer financial Several government-supported programs in South gains, but such programs may require time to be- Africa are not well coordinated and do not track come politically acceptable. results effectively. For example, there are oppor- Partnerships with the private sector can achieve tunities to consolidate more than 100 active labor lower costs and higher quality as well if the partner- market programs offered by some 20 govern- ship contracts are well defined and private provid- ment departments at the national level, with no ers commit to high levels of accountability. Public- overarching strategy or system to monitor progress private partnership agreements could be directed to or evaluate job-related outcomes. Another example sectors that need the greatest support, in exchange is early childhood development programs, which for enhanced autonomy for the private provider and require the engagement of multiple departments with exit clauses built into the contracts in case the across tiers of government. Coordination is widely provider proves unable to meet performance tar- acknowledged to be weak, limiting effectiveness. gets. Public-private partnership are being developed There are also numerous early-grade reading pro- in several infrastructure sectors, as discussed in pol- grams that have been implemented over the last icy note 2, and could be extended to social sectors. two decades, some of which have been evaluated. There is very little private provision of education in But these interventions have not gone to scale and South Africa: in 2021, only 6% of primary school are not integrated into the routine practices of the students were enrolled in private schools, against education system. There seem to be multiple pro- 18% in Brazil and 45% in India. Partnering with the grams in some areas that are not coordinated and private sector would also be in line with the govern- that lack sufficient empirical data on outcomes to ment’s objective to expand technical and vocational support continuing them or taking them to scale. education (TVET) programs, where quality and cov- And even when data on outcomes are available, erage could be improved through workplace-based there are no well thought out and clearly articulat- and technology-based learning. ed plans for scaling up and sustaining the programs, Quick measures could include: particularly financially. • Scaling up private provision in education,  learn- ing from the experience of Western Cape and ■ Action 2: Partner with the private sector Gauteng Provinces. Western Cape Province has had success experimenting with the Collabo- As well as When properly structured, partnerships with the ration Schools model, in which a public school contributing private sector can improve the quality of service partners with an experienced nonprofit school delivery, increase access, and relieve some of the support organization that provides intensive financial fiscal pressure. As well as contributing financial support to teachers and principals through train- resources, private provid­ers resources, private providers can bring new exper- ing, additional resources, performance monitor- tise and competencies in the delivery of services. ing, and regular feedback.24 The Western Cape Several countries use alternative service delivery Education Department oversees the perfor- can offer new mechanisms to improve programs and services. mance of the nonprofit organization, holding it expertise and Prompted by concerns for the public interest, serv- accountable as part of the public school system. ice quality, client orientation, and human resource Public-private partnerships are less common in competencies, management, Canada has encouraged public sec- higher education (TVETs and universities), but lower cost, and tor managers to explore creative ways of delivering some of the best training institutions in Kazakh- higher quality in services outside of the public sector, such as public- stan, Malaysia, and Morocco are organized as private partnerships, outsourcing, and contracting public-private partnerships.25 service delivery ■ out of services. All proposals must pass a public • Expanding workplace-based learning opportuni- interest test, which covers the key dimensions of ties for unemployed youth in small and medium en- affordability, external partnerships, jurisdictional terprises. The current system of workplace-based Priority 1: Increasing the impact of public spending on inclusive growth 7■ learning has several shortcomings. Little training ■ Action 3: Improve public investment management is directed to people without work experience who are seeking such experience, and numerous The first-best solution to improve public investment bureaucratic barriers prevent smaller companies management would be to shift some resources from participating (about 80% of businesses are from current spending to capital spending, as South not participating). Initiatives such as the Youth Africa is clearly an outlier is this area (see figure 3). Employment Services turnkey model or the Cen- However, this resource shift could be difficult to ter of Specialization approach implemented in achieve in the short term. As highlighted earlier, any selected public TVET institutions demonstrate savings on recurrent spending (such as the wage the feasibility of placing unemployed youth in bill) should be used to consolidate the fiscal deficit. small and medium enterprises in South Africa. In addition, the rigidity of many recurrent spending The lessons are that learner registration proce- items, especially the wage bill, makes it difficult to dures should be simplified for small and medi- shift public funds in the short term. um enterprises and that efficient monitoring and The second-best solution is to improve the effi- funding systems are needed to enable small and ciency of capital spending. If the government can- medium enterprises to participate. not spend more, it must spend better. This could • Developing technology-based learning  to increase be achieved by reducing the fragmentation in in- relevance and cost-efficiency in post-school stitutions and processes that inhibits the coordi- education and training systems and improve ac- nation, selection, implementation, and monitoring cess for learners in remote rural areas. The use of capital projects and by streamlining processes of technology in education has barely been ex- in subnational governments, which account for plored in South Africa, particularly in TVET in- three-quarters of public investment. stitutions. Technology can enable more efficient The authorities could consider two measures in use of physical infrastructure while also provid- the short term: ing simulated practical experience. For exam- • Establishing a centralized gateway for priority cap- ple, horticulture programs at the Swiss Federal ital projects above a certain threshold (for exam- Institute for Vocational Education and Training ple, above R5 billion, or $250 million). The gov- use virtual reality glasses to enable students to ernment recognizes the institutional complexity create and implement landscape designs and to of the public investment landscape.26 In a highly simulate seasonal effects on their virtual land- decentralized and delegated environment, over ■ Dealing with the scape. Such simulation technologies can also 700 public institutions operate multiple paral- infrastructure help bridge the gap between theoretical learning lel systems for strategic projects. This system in the classroom and the skills needed in profes- comes with immense costs, generates confu- crisis requires sional settings. sion, adds complexity, and requires multiple higher capital entities to administer. To create a more stream- Priority 2: Allocating public resources and maintenance lined and transparent framework for identifying to loosen binding constraints to and prioritizing strategic infrastructure projects, spending, inclusive growth South Africa could follow the direction taken while reducing Two of the major challenges facing South Afri- by countries like the Republic of Korea, New ca—inadequate infrastructure and high unemploy- Zealand, and the United Kingdom, which have unemployment ment—require the more efficient allocation of pub- established a central project information man- requires allocating lic resources. Dealing with the infrastructure crisis agement (PIM) unit with oversight of strategic resources requires higher capital and maintenance spending. public sector projects.27 Bringing together a few Reducing unemployment requires allocating re- existing units/entities will encourage a stronger to programs sources to programs that improve the employability portfolio approach to PIM, particularly for large, that improve of workers in South Africa. The authorities can con- strategic infrastructure projects, and help cre- sider the following two actions to better align public ate a center of excellence by gathering exper- employability spending with these two challenges. tise under one roof. Projects above a threshold ■ 8 Priority 1: Increasing the impact of public spending on inclusive growth would undergo a rigorous gateway review (such past 10 years. The employability of the labor force, as the one announced in the Medium-Term in particular, remains extremely low. Budget Policy Statement), with support from Part of the inefficiency of social and labor mar- Part of the one institution or through a reconfiguration of ket programs stems from their fragmentation, rais- inefficiency existing units. A crucial remaining question for ing the stakes for consolidation, as recommended the authorities is how to embed this centralized above. Building on the vast literature on this topic, associated with gateway mechanism in the high-level decision- including some by the South African government, social and labor market programs making process. Countries have adopted differ- the following three additional actions can be con- ent solutions. sidered to enhance the impact of these programs • Reducing the administrative burden associated with on the employability of workers, especially youth: stems from their conditional grants to subnational governments. As • Linking the Covid-19 Social Relief Distress grant to fragmentation, of 2023, provinces and municipalities had to deal active labor market programs. Under the Covid- with more than 42 different grants (24 for the 19 Social Relief Distress grant, South Africa raising the stakes provinces and 18 for the municipalities). Many provides unconditional income support (R350 for consolidation ■ grants have overlapping purposes, and some are per person) to about 8 million adults who can for relatively small amounts (12 grants provided work. Introduced in 2020 to mitigate the impact less than $25 million a year to all subnational gov- of the Covid-19 pandemic, the grant was ex- ernments). Reporting requirements generally dif- tended to 2025. As many other middle-income fer across programs as well, adding to the admin- countries have done, South Africa could tie part istrative burden. Having a large number of grants of the grant to the participation of beneficiaries increases transaction costs; limits the absorptive in job-counseling services. Panama gradual- capacity of local governments, especially in small ly scaled down its Covid-19 response program and poor areas; increases the potential for misuse; by increasing job-search requirements for ap- and slows execution. To ease the administrative plicants. In Denmark and Finland, employment burden on subnational governments, the central services and social assistance are often located authorities can reduce the number of grants (for at the same job centers and are coordinated to example, the provinces received six grants for the support clients who need both income and em- education sector alone) and harmonize reporting ployment assistance. South Africa could reform requirements. Grants can also include conditions the Employment Services system by providing that reinforce planned PIM reforms (for example, counseling services to job-seekers and by link- through mandatory gateway reviews supported ing the databases of the Department of Social by centralized institutional arrangements). Development and the Employment Services system. ■ Action 4: Spend smarter on programs to enhance • Using wrap-around approaches to improve the the employability of people disadvantaged in the labor effectiveness of active labor market programs. market South Africa’s active labor market programs could follow the direction of programs in sev- South Africa is among the highest spending coun- eral middle- and high-income countries. For tries on social protection and active labor market example, Bosnia and Herzegovina and the Unit- programs. The country spends around 4% of GDP ed Kingdom provide integrated wrap-around on noncontributory social assistance alone, com- services to work-seekers and vulnerable house- pared with a world average of about 1.5%. This holds that face multiple barriers to employment, level of spending has been part of the social con­ after an initial comprehensive assessment of tract between the state and its citizens since the their needs. South Africa has experimented with end of Apartheid and is justified by the high levels this approach in the Basic Package of Support of entrenched poverty, inequality, and unemploy- pilot program for vulnerable youth, which is ment.28 While there have been some successes, complemented by ongoing rigorous evaluation. most outcomes have been disappointing over the Another comprehensive approach, though on Priority 1: Increasing the impact of public spending on inclusive growth 9■ a small scale, is the Jovenes model applied in implement given the multiplicity of views (and vest- several Latin American countries, which com- ed interests) in South Africa. bines technical and workplace behavior training However, there are several opportunities to accel- (three months), apprenticeships (three months), erate the state capacity-­ building agenda. Proposed life coaching (six months), career guidance, below are four actions that can produce short-­ term transport vouchers (and childcare stipends for results while laying the foundation for more compre- women), and job placement through publicly fi- hensive future reform. To produce tangible results, nanced nongovernmental organization–private these actions need to be implemented at all three sector partnerships.29 levels of government (central, provincial, and local), • Developing microentrepreneurship programs, w  hich as well as in autonomous agencies and SOEs. are largely absent in South Africa. Operating suc- cessfully in more than 80 low- and middle-income ■ Action 5: Professionalize the public sector to build countries, these programs complement govern- status meritocracy a high-­ ment social assistance schemes with job-relat- ed supports, helping beneficiaries use their re- Building a professional, high-­ status bureaucracy sources for productive endeavors and become is a critical step for a country that aspires to high-­ self-sufficient. Colombia’s Jefes y Jefas de Hogar income status. In response to the disturbing evi- and Kenya’s Hustler Fund are directed to adults dence presented in reports of the Department of ■ Measures to and youths in poor households, providing them Public Service and Administration and the Judicial accelerate with a bundle of services (training and coach- Commission of Inquiry into Allegations of State ing, savings schemes, business preparation, Capture, Corruption, and Fraud in the Public Sector state capacity investment grants, and so on) over a discrete (the Zondo Commission), the government adopted building need to period (18–24 months) to start or expand viable the Framework Towards the Professionalization of be implemented microenterprises. Impact evaluations indicate the Public Sector in 2022.30 Recent efforts have fo- that these programs have sustainable impacts cused on legislative reforms to harmonize standards at all three levels on employment and earning outcomes, especial- of employment across levels of government, delin- of government, ly for youth and women. eation of the political/administrative interface, and extension of the Public Service Commission’s over- as well as in Priority 3: Upgrading the public sector’s sight to provincial and municipal governments.31 autonomous delivery capacity While recognizing that building a new profes- agencies and State capacity has severely deteriorated in South sional bureaucracy will take time, the authorities Africa. The causes for this deterioration are diverse, can consider several measures to accelerate this state enterprises ranging from the declining technical capacity of process: staff in several strategic departments, subnational • Making the Head of Public Administration respon- governments, and SOEs to the deliberate misuse sible for ensuring transparent and robust processes of public resources through misguided human re- for hiring and managing all top managers, w  hich sources policies and corruption. Corruption has could reduce political interference in hiring and had a corrosive effect on South Africa’s public in- management practices for senior public servants. stitutions, in particular on accountability institu- This role for the Head of Public Administration tions and the management and oversight of SOEs, would draw a new line of administrative and as documented by the Commission of Inquiry into operational accountability between senior pub- State Capture. On the 2023 Corruption Percep- lic servants (director generals) and the Head of tions Index, South Africa dropped below the global Public Administration, who would play a key role average, scoring 41 out of 100 (where 0 is highly in appointment processes and discipline manage- corrupt and 100 is very clean), reflective of per- ment for director generals, replacing the current ceived stagnation in the fight against corruption. practice of presidential ministerial approvals. Addressing these challenges requires a comprehen- • Expanding the role of the Public Service Com- sive agenda, but that will take time to develop and mission, an independent body established by the ■ 10 Priority 1: Increasing the impact of public spending on inclusive growth Constitution, in reviewing key public sector ap- are directed to institutions based on the number of pointments across all three levels of government students enrolled, which reinforces the country’s and SOEs. As a starting point, independent tech- commitment to accessibility but is a poor predictor nical experts can integrate the multiple selection of institutional performance. The development of in- panels for senior appointments, including heads novative interventions has been discouraged by the of departments, municipal managers, and SOE absence of clear, measurable, and shared definitions board members. Many OECD countries have of targets and of the rigorous monitoring and evalu- centralized recruitment for senior civil servants. ation systems needed to convince policymakers to For example, in Australia, a Public Service Com- continue and scale up innovative programs.32 missioner is a full participant in the Senior Exec- The projected fiscal consolidation process esca- Ongoing budget utive Service recruitment process, and experts lates the urgency of improving monitoring mecha- cuts, stagnating from the Australian Public Service professions nisms in education and training systems. Ongoing are systematically included in recruiting panels. budget cuts, combined with stagnating graduation graduation • Enhance anti-corruption efforts and public integ- rates and rising national demand for highly educat- rates, and rising national demand rity management by reducing fragmentation and ed workers, make it increasingly important to en- gaps in the financial disclosure framework across sure the efficient use of limited public resources for institutions and levels of government. This includes education. for educated removing gaps in the coverage of high-risk offi- The following three measures are aimed at im- workers make cials, extending the disclosure form to address proving the monitoring of education and training unjustified wealth, strengthening enforcement programs, but the principles of just-­ in-time report- it increasingly and sanctions mechanisms, and establishing the ing, agility, and ex post corrections are relevant to important to foundations for automated verification process- other sectors as well: ensure the es and public access to disclosures. A thorough • Instituting regular national learning assessments review of the decentralized institutional frame- and functional school-­ based assessments in basic efficient use of work for disclosure, verification, and sanctioning education. South Africa’s annual national assess- limited public is also needed to introduce a uniform, central- ment of grades 3, 6, and 9 was discontinued in ized approach to electronic disclosure that ad- 2015. Western Cape Province is currently the resources for dresses gaps in oversight and inconsistency in only province that still conducts annual assess- education ■ the application of regulations and the issuing of ments. Reinvigorating annual learning assess- sanctions. ments is vital for tracking systemwide learning performance. Improving learning through time- ■ Action 6: Improve monitoring mechanisms ly interventions and effective planning requires accurate and timely data on learning outcomes Experience demonstrates that appropriate mon- not only at the end of each grade but as learn- itoring mechanisms significantly improve public ers progress through a grade.33 Thus, national sector performance. To be efficient, monitoring learning assessments need to be complemented mechanisms must be agile and transparent, results by a system for continuously assessing student must be shared publicly, and measures must be in- learning and recommending remedial actions to cluded that reinforce good outcomes and penalize ensure that all students are on track. The School bad ones. Monitoring mechanisms in South Africa’s Based Assessment, which is currently used only public administration need critical improvements. as a tool for promoting students from one grade Consistent with this note’s focus on the social sec- to the next, could be transformed to serve this tors, the education system can illustrate the urgency continuous assessment role. of implementing good monitoring mechanisms. The • Moving toward performance-­ based funding and absence of a regular national assessment of stu- instituting tracer surveys for higher education. As dent performance has impeded the optimal use of budgets for higher education shrink, govern- resources for students and teachers who need fur- ments in several countries are using performance-­ ther support. At the higher education level, finances based funding to align their objectives with Priority 1: Increasing the impact of public spending on inclusive growth 11 ■ those of higher education institutions and to Although the South African government has ensure that limited public funds are used more begun its digital transformation, digitalization is productively. Higher education institutions must not progressing as quickly as in the most advanced ensure that students complete their training countries. South Africa was ranked well behind and graduate with the skills to be successful in global leaders (Estonia, Finland, and Korea) and re- a dynamic economy. Having performance-­ based gional leaders (Rwanda) on both the World Bank’s funding systems in place is particularly impor- GovTech Maturity Index and the UN’s Online Serv- tant as more private providers enter the educa- ice Index in 2022.35 Its slow digitalization is further tion and training market. Most European coun- evidenced by the limited number of online services: tries and states in the United States have used only 120 public services are available online today performance-­ based funding for higher educa- against a target of 255. Although the e-­ government tion for decades. South Africa could learn from service portal (www.eservices.gov.za) is visited by them. At a minimum, South Africa could institute 300,000 users monthly­ —­a reasonable number­ —­ ■ The slow tracer surveys in all universities and TVETs to satisfaction is low. implementation of track student completion and employment out- The slow implementation of the digital agenda comes. Digital systems should be leveraged for reflects budgetary challenges as well as technical the digital agenda this purpose. and governance problems. The budget allocation reflects budgetary • Focusing on programs that demonstrate results to information and communication technologies challenges as and can be scaled up. South Africa has tried a shrank 5% in real terms between 2016/17 and range of interventions to improve public sector 2020/21, with a lower share directed to developing well as technical delivery capacity. Still lacking is the collaborative and digitizing government services and functions and governance leadership needed to identify the priority prob- for the public.36 Public digital services are frequent- lems to be addressed and glean the lessons from ly disrupted by technical problems, including elec- problems domestic programs and those in other countries. tricity blackouts, and by the inadequate technical There have been numerous exercises to doc- knowledge and skills of civil servants. The State ument the plethora of interventions in active Information Technology Agency, the key agen- labor market programs, early childhood devel- cy responsible for digitalization of the public sec- opment, parenting programs, and early grade tor, is beleaguered by governance and operational reading programs. The next step is to appoint a challenges.37 team of leaders to assess the evidence on which Accelerating the use of digital solutions in four programs show the greatest promise and map areas could increase transparency, speed transac- out ways to integrate the most robust interven- tions, and improve intergovernmental coordination. tions into the day-­to-day functioning of related These solutions would build on several pilot pro- programs. jects in South Africa and successful experiences in other countries: ■ Action 7: Accelerate digitalization of public services • Developing real-­ time dashboards to track major infrastructure projects across levels of govern- Governments across the world are using new digital ment. A real-­time snapshot of how investments technologies to improve public services. The digita- in water, transport, energy, and telecommunica- lization of decision processes reduces transaction tions are performing would be a big step toward costs for public administration and for individuals improved decisionmaking and collaboration and businesses. Shared digital platforms create inside and outside of government. Experience economies of scale and improve policy decisions with South Africa’s major infrastructure invest- using just-­in-time and collaborative data. Digital ments for the World Cup and New Zealand’s solutions have also reduced human interference in Infrastructure Commission shows that simple, processes, narrowing opportunities for corruption straightforward reporting to decisionmakers and improving accountability through more trans- can reduce obstacles. Relevant information parent reporting mechanisms.34 could also be disclosed to the public in an easily ■ 12 Priority 1: Increasing the impact of public spending on inclusive growth accessible format to increase transparency and ■ Action 8: Incentivize the performance of accountability to taxpayers on how their money subnational governments is being spent. • Introducing a unified national ID standard to pre- South Africa’s quasi-­ federal fiscal system devolves pare for the introduction of a digital ID for access- key infrastructure and social spending responsibil- ing social and financial services. The draft Nation- ities to subnational governments, in line with the al Identification and Registration Bill of 2022 subsidiarity principle of public finance.38 However, aims to introduce a unified national ID standard limited technical capacity, especially in poor and iso- that will contribute to the development of a dig- lated provinces and municipalities, and rising gover- ital ID for use in areas such as healthcare, social nance challenges have led to the deterioration of protection, and financial services. Public consul- local services. Many subnational governments suf- tations on the draft bill were held in early 2023, fer from the politicization of cadre deployment, the and the bill is awaiting submission to Parliament. incursion of vested interests into decisionmaking, • Incentivizing the uptake of the e-­procurement sys- and the poor organization of delivery processes tem (eTenders) for procuring entities across levels across departments.39 The lack of transparent, just-­ of government. An e-­ procurement system to in-time, independent monitoring systems has also track supply chain management/procurement reduced the accountability of local managers and stages that meets interoperability and data shar- policymakers, as highlighted earlier. ing standards is critical to improving the trans- Along with limited technical capacity and weak parency and efficiency of public spending across governance, subnational governments have few levels of government. All tender opportunities incentives to improve performance due to the un- and contract awards should be published on balanced fiscal decentralization of responsibilities the eTenders system. Bangladesh and Rwanda between expenditures and revenues. Subnational used incentives to roll out their e-­ procurement governments are responsible for almost 80% of na- systems fairly quickly. Incentives included team tional public expenditures, but they collect less than bonuses for meeting e-­ procurement targets, the 20% of national public revenue. Provinces and most provision of new information technology equip- municipalities are highly dependent on transfers of ment to units, and awards for top achievers. about $30  billion a year from the central govern- • Introducing digital tools and shared data platforms ment to finance their activities.40 This dependence in strategic sectors, including machine learning reduces the accountability of local governments and artificial intelligence. For example, the de- and relaxes fiscal discipline as their expenses are ployment of a fully interoperable national health financed by national rather than local taxpayers. Introducing a information system that provide access to digi- The International Monetary Fund estimates that performance- tized health records for all patients and connects this expenditure–­ revenue imbalance increases the healthcare providers and patients could dramati- fiscal deficit by 1 or 2 percentage points of GDP.41 based element cally improve the quality of services. Similarly, an Balancing the spending and revenue responsi- to subnational transfers will open logistics platform with standardized data bilities of local governments could improve their formats available to shippers and transporters accountability and fiscal performance. South Africa would be a critical tool for reducing information could follow the model of several countries with de- strengthen asymmetry in logistics and sharing just-­ in-time centralized fiscal systems that have achieved such performance data on road and port conditions and waiting balance, including Canada, Iceland, Sweden, and lines, as China and India have done, for example. Switzerland. But this will take time because political incentives for As the logistics platform evolves, it could pro- consensus is required to amend the constitution. local authorities vide electronic solutions for paying multiple fees A more immediate solution is to introduce a in the short term and custom duties and for submitting requested performance-­ based element to subnational trans- regulatory documents through a unified portal fers. Subnational authorities have few incentives and pave the way rather than separately through different agen- to perform better since they will receive transfers for future reforms ■ cies and local governments. from the National Treasure even if they perform Priority 1: Increasing the impact of public spending on inclusive growth 13 ■ poorly. The central government has implemented • Scaling up the performance-­ based approach used several initiatives to remedy this situation, such as for public transport grants to other earmarked those used in other middle-­ income countries, in- transfers (20% of total transfers), which are di- cluding Brazil. rected mainly to infrastructure services. Public The government could scale up these recent transport grants are determined partly on the initiatives and complement them with additional basis of measurable outcomes.42 The authorities performance-­ based measures. These measures expect to extend this approach to the water and will not immediately turn around the poor service energy sectors and to funds for building resil- delivery performance of subnational governments, ient infrastructure. The challenge is to define which will require deeper reforms at the local level measurable outcomes and to ensure that local and in the design of fiscal decentralization. Howev- governments have the technical capacity to im- er, they will strengthen performance incentives for plement the targeted programs. Technical assis- the local authorities in the short term and pave the tance might be required to support implementa- way for future reforms. tion, including the use of management contracts • Adding a performance-­ based element to the eq- where appropriate.43 uitable formula for nonearmarked transfers (80% • Scaling up the contract-­ based approach piloted in  hich is currently based solely of total transfers), w the electricity sector to other sectors and levels of ■ One lesson on the needs and capacity of each subnational government t  o incentivize them to improve their after a year of government. Making this adjustment is relatively overall financial performance. In May 2023, the easy technically but harder politically because National Treasury offered to clear municipalities’ implementation underperforming local governments are like- arrears with public electricity supplier Eskom of the contract- ly to oppose it, and an efficient and transpar- conditional on meeting a set of performance based approach to ent monitoring and evaluation mechanism will indicators. By early 2024, more than 70 mu- be needed as well. Some countries have been nicipalities had accepted this contract, totaling incentivize financial able to add a performance element to transfers R56.7 billion or 96.9% of total municipal debt. To performance by applying them to the incremental increas- further incentivize participating municipalities, es in transfers rather than to their total value the 2024 budget introduced a new conditional is the need to (reducing losses for underperformers) and by grant of R2  billion to fund the rollout of smart include conditions focusing on simple outcome measures. To illus- prepaid meters over the next three years to im- related only to the trate, imagine that the value of unconditional prove municipal electricity tariff collection. One transfers to a subnational government increas- lesson after a year of implementation is the need most important es from R585 billion in 2023/24 to R600 billion to include conditions related only to the most objectives in 2024/2025. Applying a performance-­ based important objectives because of the limited ca- measure to the incremental increase only would pacity of municipal authorities and to tailor them because of the mean that R15 billion would be allocated based to the structural constraints in the sector. This limited capacity on performance. The central government could contract-­ based approach could be applied to of municipal further incentivize subnational governments by other sectors and extended to provinces, which offering technical assistance to help them im- are also cash constrained and in arrears with in- authorities prove their performance. frastructure service providers. ■ 14 Priority 1: Increasing the impact of public spending on inclusive growth Annex table A1  Ranking of measures through the “FIT” filter of feasibility, impact, and timing Feasible Impactful Timely Total Priority 1: Creating fiscal space for present and future public spending Action 1: Consolidate and coordinate 1. Cutting 60–80 small social programs 2 2 2 6 social programs (National Treasury proposal), merging some departments, and closing some units 2. Consolidating and coordinating active 3 3 2 8 labor market programs and early childhood education programs Action 2: Partner with the private 3. Scaling up private provision in education 3 2 1 6 sector 4. Expanding workplace-­based learning 2 2 2 6 opportunities for unemployed youth in small and medium enterprises 5. Developing technology-­ based learning to 2 2 2 6 efficiency in increase relevance and cost-­ post-­school education and training systems and improving access for learners in remote rural areas Priority 2: Allocating public resources to loosen binding constraints to inclusive growth Action 3: Improve public investment 6. Establishing a centralized gateway for priority 3 2 2 7 management capital projects above a certain threshold 7. Reducing the administrative burden 2 2 2 6 associated with conditional grants to subnational governments Action 4: Spend smarter on programs 8. Linking the Covid-­19 Social Relief Distress 3 3 2 8 to enhance the employability of grant with active labor market programs people who are disadvantaged in the 9. Using wrap-­around approaches to improve 2 2 3 7 labor market the effectiveness of active labor market programs 10. Developing microentrepreneur programs 2 2 3 7 Priority 3: Upgrading public sector delivery capacity Action 5: Professionalize public 11. Making the Head of Public Administration 3 2 3 8 service to build a high-­ status responsible for ensuring transparent and meritocracy robust processes for hiring and managing all top managers 12. Expanding the role of the Public Service 3 2 2 7 Commission in reviewing key public sector appointments across all three levels of government and state enterprises. 13. Enhancing the financial disclosure framework 3 2 2 7 by removing gaps in the coverage of high- risk officials, extending the disclosure form to address unjustified wealth, strengthening sanction mechanisms, and establishing the foundations for automated verification processes and public access to disclosures. Priority 1: Increasing the impact of public spending on inclusive growth 15 ■ Feasible Impactful Timely Total Action 6: Improve monitoring 14. Instituting regular national learning 2 2 2 6 mechanisms assessments and functional school-­ based assessments in basic education 15. Moving toward performance-­ based funding 2 2 3 7 and instituting tracer surveys for higher education 16. Focusing on programs that demonstrate 2 2 1 5 results and can be scaled up Action 7: Accelerate digitalization of 17. Developing real-­time dashboards to track 2 2 2 6 public services major infrastructure projects across levels of government 18. Introducing a unified national ID standard to 2 3 3 8 prepare for the introduction of a digital ID for accessing social and financial service procurement 19. Incentivizing the uptake of the e-­ 2 3 3 8 system for procuring entities across levels of government 20. Introducing digital tools and shared data 2 2 2 6 platforms in strategic sectors, including machine learning and artificial intelligence Action 8: Incentive the performance 21. Adding a performance-­ based element to the 1 3 1 5 of subnational governments equitable formula for nonearmarked transfers 22. Scaling up the performance-­ based approach 2 3 2 7 used for public transport grants to other earmarked transfers 23. Scaling up the contract-­ based approach 3 2 3 8 piloted in the electricity sector to other sectors and levels of government Source: Authors. Note: The scores range from 1 to 3, with 1 being the lowest. The actions with the highest score are highlighted in yellow. ■ 16 Priority 1: Increasing the impact of public spending on inclusive growth Notes 1 Key policy priorities for the Medium-Term Budget challenging given the gradual loss of appetite from Policy Statement, presentation by the National Trea- nonresidents for public debt. While nonresidents sury to Cabinet, September 2023. held about 40% of public debt in 2019, this propor- 2 For the Canadian experience, see J. Bourgon, 2009, tion declined to 25% in 2023. “Program Review: The Government of Canada’s Ex- 9. The Ricardo-Barro effect, also known as Ricardian perience Eliminating the Deficit, 1994–99: A Cana- equivalence, is an economic theory that suggests dian Case Study,” Institute for Government. that when a government tries to stimulate an econo- 3 This note focuses on spending-side reforms, while financed government spend- my by increasing debt-­ acknowledging that broader challenges are not ing, demand remains unchanged because the public covered. Fiscal policy also includes debt and reve- increases their saving to pay for expected future tax nue policy and management, but the government increases that will be needed to pay off the debt. has faced fewer challenges in these areas than in 10. Throughout this note, “public investment” refers to spending. consolidated government spending on gross fixed 4. See International Monetary Fund, 2015, “Policy capital formation. This distortion would be even Paper on Fiscal Policy and Long-Term Growth,” bigger if the expenses financed through municipal- June; and N. Batini, L. Eyraud, L. Forni, and A. ities’ own resources were included. In 2023, capital Weber, 2014, “Fiscal Multipliers: Size, Determinants, spending represented only 12% of the consolidated and Use in Macroeconomic Projections,” Technical municipal budget, or around 0.4% of GDP. Notes and Manuals, Fiscal Affairs Department, In- 11. The International Monetary Fund’s Government Fi- ternational Monetary Fund, September. nance Statistics classification defines economic ex- 5. In Spain, for instance, the net effects of govern- penditures as general economic, commercial, and ment taxation and public spending reduced the labor affairs; agriculture, forestry; fishing and hunting; Gini coefficient (a standard measure of inequality) fuel and energy; mining, manufacturing, and construc- significantly, from 0.45 to 0.25. G. Gomez Bengoe- tion; transport; communication; other industries, R&D chea, 2020, “The Welfare State in Spain: An Impact related to economic affairs; economic affairs. Assessment,” Commitment to Equity (CEQ) Working 12. B. Moreno-Dodson,2008, “Assessing the Impact of Paper Series 95, Tulane University, Department of Public Spending on Growth: An Empirical Analysis Economics. for Seven Fast Growing Countries,” World Bank Pol- 6. T.J. Van Resburg, S. de Jager, and K. Makrelov, 2021, icy Research Working Paper No. 4663, July. “Fiscal Multipliers in South Africa after the Global 13. See , for example, https://www.statecapture.org.za/. Financial Crisis, SARB Working Paper, South African 14. World Bank, Worldwide Governance Indicators, Reserve Bank, WP/21/07. /world​ https://www.worldbank.org/en/publication​ 7. A detailed Debt Sustainability Analysis can be found -governance-indicators/interactive-data​ wide​ -access. in World Bank, Sustainable and low-carbon energy 15. This decline is corroborated by the Berggruen Gov- transition development policy loan, 2023. ernance Index, which dropped 14 points over the 8. While this effect has not yet materialized in South same period. Africa due to the depth of the domestic financial 16. National Treasury, 2022, “State of Local Govern- sector, private sector financing can become more ment Finances and Financial Management,” June. 17 ■ 17. The total cumulative amount of money spent on state- partnerships in the province, including models like owned enterprise recapitalizations and bailouts from the charter schools in the United States or the acad- 2000/01 to 2019/20 is R187.4 billion or about $10 bil- emies in the United Kingdom. lion. https://www.treasury.gov.za/publications/other​ 25 H.A. Patrinos, F. Barrera-Osorio, and J. Guáqueta, /minansw/2020/PQ%201426%20-%20Schreiber​ 2009, “The role and Impact of Public-Private Part- %20-%20NW1797E.pdf.. nerships in Education” (English), World Bank Group, 18. World Bank, 2023, “South Africa’s Economic Up- https://documents1.worldbank.org/curated/en​ date,” December. /453461468314086643/pdf/479490PUB0Role101 19. Oosthuizen, Morné, 2021, “South Africa: Social As- OFFICIAL0USE0ONLY1.pdf. sistance Programs and Systems Review” (English), 26 Stats SA, Capital Expenditure by the Public Sector, World Bank Group, http://documents.worldbank​ 2022, p. 9101. .org/curated/en/238611633430611402/South​ 27 See New Zealand’s Infrastructure Commission, Ko- -Africa-Social-Assistance-Programs-and-Systems​ rea’s Public and Private Infrastructure Investment -Review; World Bank, 2014 “South Africa Economic Management Center, and the United Kingdom’s In- Update. Fiscal Policy and Redistribution in an Un- frastructure and Projects Authority. equal Society.” 28 Nearly a quarter (23%) of South Africans rely on so- 20 See quarterly report for advancements of these re- cial grants as their main income source, and social forms. https://www.stateofthenation.gov.za/assets​ grants make up, on average, 54% of household in- /downloads/Operation_Vulindlela_Progress_Report​ comes (World Bank calculations using the General _Q4_2023.pdf. Household Survey, 2022). 21 For a short review of delivery units in Africa, see 29 O. Attanasio, A. Guarín, C. Medina, and C. Meghir, ht tps://blogs.worldbank.org /governance/four​ 2017, “Vocational Training for Disadvantaged Youth -ways-delivery-units-africa-can-drive-change-and​ in Colombia: A Long-Term Follow-Up,” American -improve-public-sector-performance. See also, for Economic Journal: Applied Economics 9(2): 131–43. the experience in Malaysia, D. Iyer, 2011,“Tying Per- 30. Some 21% of the public sector’s 9,500 senior manag- formance Management to Service Delivery: Public ers at national and provincial levels did not meet the Sector Reform in Malaysia, 2009–2011, Innovations minimum competency requirements for the positions for Successful Societies,” Princeton University. they occupied in 2022 (National Development Plan 22 Since the Covid-19 pandemic, the government has and State Capacity Conference, Nov. 7, 2022, Uni- tried to limit increases in wages and other com- versity of KwaZulu Natal, available at https://www​ pensations (resulting in a decrease of its share in .youtube.com/watch?v=zIKwH_ZNxuE&t=14228s.) A noninterest expenditure to 37% of GDP over the study by the Public Service Commission also revealed last three years), but designing a comprehensive that 57% of public servants indicated the use of un- wage bill reform that has buy-in from all the stake- ethical practices in recruitment and selection, espe- holders and is consistent with objectives and priori- cially for senior and middle management appointments ties for public services delivery will take time. (Public Service Commission, 2022, “Ethics in Recruit- 23 M. Sachs, A. Ewinyu, and O. Shedi, 2022, “Public ment and Selection Processes in the Public Service”). Services, Government Employment and the Bud- 31. These encompass the Public Service Amendment get,” SCIS Working Paper 9, Public Economy Project, Bill, the Public Administration Management Amend- Southern Centre for Inequality Studies, University ment Bill, and Public Service Commission Bill. of the Witwatersrand, October. 32. South Africa has been a pioneer in testing different 24 There was recently some resistance to this public- interventions to support improvements in education private partnership model by teachers unions and and training service delivery. However, many of these civil society organizations, who claimed that it is interventions have been short lived and not taken to inconsistent with the Constitution and the 1996 scale because of limited funding and the absence of Schools Act. This claim was dismissed by the West- systematic monitoring and evaluation systems. Ex- ern Cape High Court in July 2023, paving the way amples include several early grade reading interven- for the expansion of various models of public-private tions introduced in the early 2000s, early childhood ■ 18 Priority 1: Increasing the impact of public spending on inclusive growth development and parenting programs implemented Effectiveness of a Centralised ICT Procurement Sys- by numerous nongovernmental organizations across tem,” Government Technical Advisory Center. the country, and several government active labor 37. Address by Mlindi Mashologu, Director-General, market programs. Some interventions benefited from Department of Communications and Digital Tech- strong monitoring and evaluations systems. South nologies Deputy, at the Digital Government Work- Africa, for example, has been a pioneer in effective, shop, September 2023. https://www.gov.za/news/ contextually relevant structured reading programs speeches/communications-and-digital-technolo - that have been rigorously and independently evaluat- gies-digital-government-workshop-06-sep-2023. ed to determine whether they have an impact on ear- 38. These include 8 metropolitan municipalities, 228 ly-grade reading outcomes. These interventions re- local municipalities, and 44 district municipalities. main an exception and have been financed mainly by 39. See, for example, National Treasury, 2024, Reform- nongovernmental parties, explaining why they have ing Metro: Trading Servicers and the Role of Incen- not gone to scale and are not integrated into routine tives, March. practice by the Department of Basic Education. 40. An exception is the eight large metropolitan mu- 33. One of the key factors helping Poland reform its ed- nicipalities that collect about two-thirds of their ucation system and move from below OECD-aver- revenues. age learning outcomes to one of the top-performing 41. L. Eyraud and L. Lusinyan, “2011, Decentralizing countries in Europe was using reliable learning-level Spending More Than Revenue: Does It Hurt Fiscal data to target reforms to the poorest performers. Performance?” IMF Working Paper, Fiscal Affairs 34. Of course, the introduction of new digital tools has Department, September. also created new challenges linked not only to tech- 42. World Bank, 2022, “Performance-Based Fiscal nical and financial capacity to implement them but Transfers for Urban Local Governments: Results also to data protection and security. and Lessons from Two Decades of World Bank 35. https://www.worldbank.org/en/data/interactive​ Financing.” /2022/10/21/govtech-maturity-index-gtmi-data​ 43. See National Treasury , 2021, “Concept Note: The -dashboard. Importance of Management Contracts as an Inter- 36. D. Makoni and M. Mpofu, 2022, “ICT Expenditure vention to Improve the Management of Water Serv- Review with a Focus on SITA Services: Assessing the ices in South Africa,” February. Priority 1: Increasing the impact of public spending on inclusive growth 19 ■ Priority 2 Delivering quality and climate-friendly infrastructure SOUTH AFRICA POLICY PACKAGE © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; internet: www.worldbank.org Some rights reserved This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Priority 2 Delivering quality and climate-friendly infrastructure SOUTH AFRICA POLICY PACKAGE Contents Leveraging the private sector while building state delivery and regulatory capabilities 1 Electricity 2 Freight transport and logistics 2 The insupportable cost of the degradation of infrastructure networks 2 The causes underlying the infrastructure crisis 3 Three priorities for addressing the infrastructure crisis 4 Case 1: Accelerating reforms in the electricity sector 5 Priority 1: Encouraging innovative and efficient delivery mechanisms by opening markets 6 Action 1: Ensure the financial and operational sustainability of the National Transmission Company of South Africa 6 Action 2: Continue to encourage private investment in renewable energy projects to increase generation and reduce demand 7 Action 3: Establish a competitive wholesale electricity market 7 Priority 2: Broadening financing options to scale up investment 8 Action 4: Scale up private investments in transmission 8 sharing instruments Action 5: Diversify sources of financing with new risk-­ 8 Priority 3: Upgrading state capability to deliver, coordinate, and regulate 8 Action 6: Strengthen the capacity of the electricity market regulator 8 Action 7: Enhance Eskom’s governance, accountability, and investment management 9 Action 8: Boost competition in generation by horizontally unbundling Eskom’s generation assets 9 Action 9: Improve electricity distribution by municipalities and Eskom 10 Case 2: Igniting reforms in the freight transport and logistics sector 11 Priority 1: Encouraging innovative and efficient delivery mechanisms by opening markets 12 Action 1: Finalize the classification of railway lines to assess the potential for future ownership 12 Action 2: Initiate Transnet’s unbundling 13 Action 3: Provide nondiscriminatory access to railway infrastructure 13 Priority 2: Broadening financing options to scale up investment 13 Action 4: Improve Transnet liquidity and financial sustainability 13 private framework for allowing private sector participation in railway operations Action 5: Develop a public-­ 14 Priority 3: Upgrading state capability to deliver, coordinate, and regulate 14 Action 6: Implement the independent Transport Economic Regulator section of the Transport Bill 14 Notes 19 Figures 1 Declining public capital stock since 2000 2 i■ 2 Systematically low public investment relative to East Asia over the past two decades 3 3 An overarching framework for efficient delivery of quality, equitable, and climate-friendly infrastructure services 4 4 A menu of proposed actions to make the electricity market more efficient, climate-­ friendly, and equitable 7 5 A menu of proposed actions to make the transport and logistics sector more efficient, climate‑friendly, and equitable 12 6 The railways network by route classification 12 A1 Proposed split of infrastructure network and rail/port operations under the Cabinet’s December 2023 Roadmap for the freight and logistics sector 18 Tables A1 Ranking of measures through the “FIT” filter of feasibility, impact, and timing 16 ■ ii Priority 2: Delivering quality and climate-friendly infrastructure Leveraging the private sector while building state delivery and regulatory capabilities Infrastructure networks are crucial for economic been announced in Transnet in the freight trans- development, anchoring growth, and ensuring de- port sector. A strong signal has been sent that the cent living conditions. For each 1 percent increase country is moving away from the public-­ centered in infrastructure spending, a country’s output is ex- infrastructure delivery model that had prevailed pected to rise 1–2 percentage points, while poverty for decades. The shift is motivated primarily by the is substantially reduced.1 This connection, support- failure of the current model but also in part by the ed by both economic theory and empirical evidence, successes of the new strategy in the country’s tele- explains why countries give so much attention to communication and aviation sectors and the les- the coverage and quality of their infrastructure sons from international experience. services and why infrastructure is often among the This note proposes a comprehensive framework main priorities of development strategies. to support government efforts to provide quality For many years, South Africa was a top infra- and climate-­ friendly infrastructure. The framework structure performer. It provided reliable electrici- is built on three mutually reinforcing priorities: en- ty and improved water sources to almost 90% of hancing the adoption of new technologies, business its population, and residents and businesses could models, and efficiencies by opening markets; scal- count on a transport network with a road density ing up investments in infrastructure by diversifying higher than that of the United States and world-­ financing sources and leveraging additional private standard ports and airports. Fast forward to the financing; and upgrading state capacity to coor- present, and the situation has deteriorated dramat- dinate, regulate, and deliver (when needed) infra- ically. Electricity availability is sporadic, with out- structure services. This note applies the framework ages averaging 8–10 hours a day in 2023, at a cost to the electricity and the freight and logistics sec- of about 2% in GDP growth. Major bottlenecks in tors, but it could be extended to other infrastruc- railways and ports reduced the country’s export ture sectors (such as water and waste management) capacity by about 20% (equivalent to 5% of GDP). in a next step. Poor logistics cost the mineral sector an estimat- Implementing infrastructure reforms is a long-­ ed $275 million annually. And disruptions in water term endeavor requiring sustained effort and com- provision have become so frequent in many urban mitment to achieve comprehensive and systemic areas, including the Johannesburg-­ Pretoria area, changes. In the interim, focusing on key short-­ term that customers face days and even weeks without actions can build momentum and address some of water. the most pressing challenges, providing immediate The infrastructure crisis has provoked social and relief and laying the groundwork for broader re- political tensions, pushing South African policy- forms. To guide policymakers, a menu of actions makers to act. The electricity generation market and reforms is proposed, of which seven (three in has gradually been opened to private investors. The the electricity sector and four in the freight trans- unbundling of state-­ owned enterprises (SOEs) has port and logistics sector) are assessed here as the begun with Eskom in the electricity sector and has most technically and politically feasible, impactful, 1■ and timely over the next few months (see table A1 Figure 1  Declining public capital stock since 2000 in the annex): Constant 2011 US dollars (thousands) Electricity 1,000 1. Ensure the financial and operational sustain­ a­ bility of the National Transmission Company of Malaysia South Africa b  y adopting a new tariff meth- 750 odology, a comprehensive wheeling pricing framework,2 and a revised grid code to en- sure nondiscriminatory open access to the 500 transmission grid. South Africa 2. Scale up private investment in electricity trans­ mission projects  by setting clear and predict- 250 South Africa, able rules for independent investors and adjusted offering blended finance and risk-­ sharing instruments. 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2017 3. Improve electricity distribution b y scaling up performance-­ enhancing transfers from the Source: Authors using International Monetary Fund data. National Treasury to municipalities. https://www.imf.org/external/np/fad/publicinvestment/pdf​ /csupdate_aug19.pdf. Freight transport and logistics Note: The public stock, in constant 2011 US dollars, is adjust- 1. Initiate Transnet’s unbundling  by enacting the ed by assuming a 10% depreciation rate of the existing capital new draft Rail Bill that opens the sector to and a diversion of 10% of annual gross investment from its third-­party operators. intended allocation. 2. Provide nondiscriminatory access to railway in­ frastructure by establishing an Infrastructure Estimating the economic losses associated Manager for railways that is independent of with degradation of the public capital stock is not Transnet operations. straightforward as the impacts on businesses and 3. Develop a public-­private framework for allowing people take multiple forms and are not necessarily private sector participation in railway opera­ linear.3 However, extrapolating from the results of tions  on bulk mining corridors and feeder lines. recent cross-­country studies suggests that South 4. Implement the Economic Regulator section of Africa has lost an annual average of 2–3 percentage the Transport Bill  to strengthen regulation points of GDP growth over the past decade.4 of ports, trucking, railways, and intermodal Further insights can be obtained by examin- transport. ing the electricity, water, and transport sectors in greater detail. For electricity, the economic losses The insupportable cost of the have increased along with load-­ shedding, reaching degradation of infrastructure networks 2–3  percentage points of GDP in 2023 accord- The degradation of infrastructure services reflects ing to the Reserve Bank of South Africa and the years of neglect and underperforming policies. World Bank.5 The main adverse effects occur on Since the late 2010s, the value of the public capital the supply side, with higher production costs and stock­—­a proxy for infrastructure­—­has declined an temporary declines in output and working hours.6 estimated 20%, an unprecedented drop for a coun- These costs are greater for electricity-­ intensive try that has not been exposed to armed conflict sectors such as mining, manufacturing, and tele- or significant climate shocks (figure 1). South Afri- communications and for small and informal firms ca and Malaysia reported approximately the same that cannot afford to invest in off-­ grid solutions, stock of public capital in 2000, but South Africa’s is such as diesel generators and solar panels. Mis- three times lower today than Malaysia’s. management of Eskom, the SOE operating in this ■ 2 Priority 2: Delivering quality and climate-friendly infrastructure sector, has cost taxpayers about $15–$20  billion The causes underlying the infrastructure in the form of cash injections from the National crisis Treasury since 2009. Responding to the infrastructure crisis requires The economic cost of water shortages is im- identifying the root causes. Public investment aver- mense, since water is a vital factor of production aged just 2.9% of GDP in South Africa over 2000– in key sectors of the economy ranging from ag- 2017, which is 5–6 percentage points lower than in riculture to manufacturing and health. Recent successful East Asian economies and about 6 times droughts in the Western Cape and the Eastern lower than in China (figure 2). This chronic under- Cape provinces are estimated to have cost about investment reflects a set of underlying factors that 3.4% of provincial GDP and 0.3% of nation- need to be better understood to avoid repeating al GDP.7 As several officials have warned, these the same mistakes. Three primary root causes are costs could rise quickly as a water crisis is looming common across sectors: in the Johannesburg-­ Pretoria area due to invest- • Limited competition. Infrastructure sectors are ment delays (as in the case of the pipeline with dominated by SOEs with monopolistic power, Lesotho), damaged infrastructure, and excessive such as Eskom in electricity and Transnet in consumption. transport. Although this state delivery model Freight and logistic sector failures are estimat- worked well until the early 2000s, when they ed to have cost the South African economy about were used as a challenging mechanism of tar- $30 billion in 2023. Trade losses have affected ex- geted state interventions such as rapid elec- porting industries (such as mining), the government trification, the isolation from competition al- (through declining revenues), and customers (who lowed the SOEs to evolve dysfunctional and experience higher prices and long delays in receiv- ing products).8 Some customers switched to other Figure 2  Systematically low public investment modes of transport, such as trucking instead of rail, relative to East Asia over the past two decades or diverted their shipments to ports in other coun- Public investment, 2000–17 (percent of GDP) tries, such as Maputo and Beira in Mozambique. Road freight now handles nearly 90% of all freight 20 volumes, with severe negative effects, including 18.2 deteriorating road safety, rapidly worsening con- gestion in key urban areas, fast-­ rising road main- 15 tenance and upgrade costs on major arteries, and mounting carbon emissions. The crisis is regional as well as national, as South Africa’s freight networks 10 9.7 are used by neighboring countries. The infrastructure crisis has also dispropor- 6.4 tionately penalized the poorest segment of the 5 5.8 5.8 5.3 population and exacerbated inequalities, work- 3.2 2.9 2.6 ing through both consumption and income chan- nels. On the consumption side, poor customers 0 a ia m nd a ea ia a es are more exposed as they generally live in areas in di ric s es na in r la ay Ch In Ko Af n pp ai et al do Th Vi h of ili M where electricity and water shortages are more ut In Ph p. So Re pronounced, and they have fewer financial re- sources for accessing alternative, often more ex- Source: Authors using International Monetary Fund data. pensive infrastructure solutions. On the income https://www.imf.org/external/np/fad/publicinvestment/pdf​ side, businesses respond to the negative impacts /csupdate_aug19.pdf. by cutting jobs or working hours, especially in low-­ Note: The public stock is adjusted by assuming a 10% depre- skill occupations, resulting in lower incomes for ciation rate of the existing capital and a diversion of 10% of many poor people. annual gross investment from its intended allocation. Priority 2: Delivering quality and climate-friendly infrastructure 3■ noncommercially oriented services and ignore have been exacerbated by rising corruption (or technological and financial innovations, resulting state capture) and coordination failures with- in a deterioration of services to the detriment of in and across government levels and agencies. customers. Fragmentation of the institutional framework • Incomplete financing options. The public sector has diluted responsibilities and accountability. In has been the main (sometimes exclusive) source the electricity sector, it has become difficult to of infrastructure financing, through end-­ user distinguish the roles and responsibilities of the charges and transfers from the central gov- Department of Mineral Resources and Energy, ernment. Both mechanisms have deteriorated the Department of Public Enterprises, the Na- over time, as many end-­ users are not paying for tional Treasury, Eskom, and the municipalities. services, and the central government’s budget In the transport sector, in the absence of policy has not prioritized infrastructure in the context direction from the Department of Transport and of budget constraints. Contrary to the practice the Department of Public Enterprises, Transnet in many other countries, the private sector has has assumed the de facto roles of infrastruc- contributed only marginally to financing in the ture owner, manager, operator, regulator, and electricity, water, and transport sectors. policymaker, with devastating effects on the • Weak management by the state. Shortcomings costs and efficiency of logistics services.9 include poor design and implementation of in- The impacts of these three factors on the de- vestment projects; declining technical capabili- clining performance of South Africa’s infrastructure ties in policy setting, regulation, oversight, and sectors have increased. They have prevented the implementation; the exodus of highly skilled tal- sectors from adjusting to changes in the external ent; and lack of transparency. These challenges environment­ —­such as the increasing pace of inno- vation and the growing impact of climate change­ Figure 3  An overarching framework for efficient delivery of quality, —­that are reshaping the provision of infrastructure equitable, and climate-friendly infrastructure services services worldwide. The low-­ carbon transition is reorienting investments from high- to low-­ emission sources in the energy and transport sectors as in- dustries and consumers are compelled to become cleaner. Extreme climate events are revealing the Priority 1 Priority 2 vulnerability of infrastructure assets. South Af- Encouraging Broadening rica has declared a national state of emergency innovative and financing efficient delivery for drought three times in the last four years, and mechanisms options to Durban was devastated by major floods in 2020 by opening scale up investment and 2022.10 The list of disasters is long and will grow markets Objective longer since climate risks are projected to worsen. Deliver quality, equitable, and Three priorities for addressing the climate-friendly infrastructure infrastructure crisis To guide government efforts to address the infra- structure crisis and deal with the three underlying causes, this note proposes an overarching frame- work with three priorities (figure 3): Priority 3 1. Encourage more innovative and efficient deliv­ Upgrading state ery mechanisms by opening infrastructure sec­ capability to tors to greater competition. Competition will deliver, coordinate, incentivize incumbent operators to deliver and regulate better and cheaper products while allowing new firms to bring in updated technologies ■ 4 Priority 2: Delivering quality and climate-friendly infrastructure and competencies. Since many of these tech- poorest customers in remote areas. Further, nologies are developed elsewhere, barriers environmental considerations could require to entry against foreign direct investment government policy and regulatory interven- should be relaxed, while synergies are cul- tions, which will necessitate strengthening tivated with local industries and the labor institutional and legal frameworks, especially market. More innovative and efficient deliv- to address coordination failures, weak tech- ery mechanisms will be beneficial to domes- nical capabilities at national and local levels, tic customers, who will get better and more and deficiencies in public investment man- affordable infrastructure services, creating agement and procurement, including in SOEs. additional benefits for the economy. Pursuing these three priorities should improve 2. Broaden the sources of financing to scale up the quality and availability of infrastructure services investment t  o meet the substantial needs and bring substantial benefits to businesses and in infrastructure sectors, which could total households. However, some groups (such as some $100 billion over the next decade. With pub- fractions of SOE workers) may lose out because of lic borrowing and SOEs’ financial distress these reforms and might therefore resist change. both already high, the state cannot cover all But this is a false dilemma. Greater domestic com- these costs alone. Complementary options petition will yield positive results and welfare gains could include raising the tariffs for infrastruc- for most of the population. Meanwhile, short-­ term ture services and leveraging private financ- costs can be managed by preparing SOEs to com- ing sources. Considering the current level of pete with businesses at the forefront of global pro- tariffs and the low level of affordability for ductivity and by providing targeted support to af- most consumers, raising tariffs risks having fected workers and communities. only a marginal effect. The only realistic op- While each of these three priorities is important tion in South Africa, with its deep domestic individually, they make the greatest contribution to financial sector (large reserves accumulated the delivery of quality and climate-­ friendly infra- by pension funds and the robust appetite of structure services when approached together. For international institutional investors, including example, opening markets will require risk-­ sharing some development partners), is to attract and financing mechanisms to attract private operators leverage private sector financing. In the short and effective regulations to protect customers. term, the state will also need to address leg- In the following sections, the proposed guiding acy debt associated with state capture, theft, framework is applied to the electricity and trans- and vandalism, as well as unfunded social port sectors, with the objective of identifying a set mandates. of concrete actions. It can also be applied to other 3. Upgrade the state’s capability to coordinate, infrastructure sectors as well. regulate, and (when unavoidable) deliver infra­ structure services. Opening the infrastructure Case 1: Accelerating reforms in the sector to new (private) operators without electricity sector first establishing rules, regulations, and incen- Since the peak of the electricity crisis in 2023, tives could end up replacing dominant SOEs several reforms have been implemented along the with private operators with excessive market lines of the three priorities in the proposed frame- power that allows them to maximize profits work. A landmark reform is the Electricity Regula- at the expense of customers. Legal and insti- tion Amendment Act, which President Ramaphosa tutional frameworks must first be established signed into law in August 2024 and is expected to that would account for the targeted market be promulgated soon. Since the further opening of structure. In addition, the state may need to the power generation market and the removal in continue to deliver infrastructure services in 202of the threshold requirements for licensing of areas where attracting private sector opera- renewable energy projects that sell electricity di- tors might not be feasible, for example, for the rectly to private consumers (embedded generation), Priority 2: Delivering quality and climate-friendly infrastructure 5■ the number of registered private sector projects in (through Eskom) in generation. This could be renewable energy has increased fivefold (priority 1). achieved by consolidating several partial strategies The conditional debt relief provided to Eskom by and updating the 1998 White paper (the govern- the National Treasury and the development of pilot ment’s last comprehensive strategy statement).11 public-­ private partnership projects in transmission Doing this can help electricity market players (in- have expanded financing options (priority  2). And cluding Eskom) adjust during the transition. To better performance has been incentivized with- good effect, the government shared its vision for in Eskom though the conditions in the debt relief the telecommunication sector in the early 2000s package and in municipalities through the condi- and for the aviation sector in the 2010s.12 Agreeing tional write-­ offs of their arrears with Eskom (priority on a vision for the electricity section is likely to be 3). In total, more than 6 gigawatts (GW) of renew- slower and more contentious, however. able electricity generation by independent power Meanwhile, the government cannot afford stasis. producers has already been connected to the grid, This note proposes a menu of nine actions under with an additional 5 GW currently in execution. The the three pillars/priorities to guide the government private sector–led distributed energy capacity (pri- in accelerating reform in the short term (figure 4). marily rooftop solar) increased from about 2 GW in Three of the nine actions have been assessed as the 2023 to close to 5.7 GW in 2024, and another 7 GW most technically and politically feasible, impactful, is expected by 2030. Thanks to these efforts, which and timely as they do not require substantive were supported by a development policy loan, there changes to the legal framework. Ideally, the actions has been a continuing supply of electricity (with no would meet all three criteria, but trade-­offs are like- load shedding) since March 2024. ly to be necessary (see table A1 in the annex). These and other measures must now be consoli- dated to create an efficient and equitable electricity Priority 1: Encouraging innovative and efficient sector. Building on the results from power genera- delivery mechanisms by opening markets tion reforms, the government should shift its focus Opening the electricity market to new operators toward reducing the sector’s main bottlenecks and and breaking Eskom’s monopoly have already begun financial sustainability risks, namely transmission as private investors have entered the electricity and the distribution grid. For example, although the generation market. This has been most prominent number of renewable energy projects grew substan- in the renewable energy segment, which is espe- tially in late 2024, their scope is constrained by lim- cially conducive to the development of small, agile ited access to the grid and serious gaps in transmis- projects. The entry of more efficient firms increases sion infrastructure. The initial steps in unbundling contestability, incentivizing Eskom to improve its Eskom and amending the Electricity Regulation Act operations to protect its customer base. This line of must be accompanied by new regulations and price reforms could be accelerated by making it even eas- mechanisms to implement the law. The investments ier for new investors to enter the generation market needed in transmission infrastructure (up to $15 bil- and by also opening the sector to new investors in lion over the next five years) cannot be funded by electricity transmission. the state alone, given its tight budget constraints, while the domestic financial market’s interest is ■ Action 1: Ensure the financial and operational dulled by the risk associated with these projects. sustainability of the National Transmission Company Improvements in distribution by Eskom and munic- of South Africa ipalities, which share responsibility for distribution, are required to enable end-­ users to benefit from the Unbundling Eskom vertically into separate gener- reforms in electricity generation and transmission. ation, transmission, and distribution functions is To provide a sense of direction to the reforms, a key step in opening the electricity market. Fully the authorities ought to share their vision of how operationalizing the National Transmission Com- they want the electricity market to look in 5–10 pany of South Africa (NTCSA) is the most urgent years, including specifying the role of the state priority for achieving that goal. This will require ■ 6 Priority 2: Delivering quality and climate-friendly infrastructure friendly, and equitable Figure 4  A menu of proposed actions to make the electricity market more efficient, climate-­ Action 1: Ensure the financial and operational sustainability of the National Transmission Company of South Africa Priority 1: Encouraging innovative and efficient Action 2: Continue to encourage private investment in renewable energy projects delivery mechanisms by opening markets to increase generation and reduce demand Action 3: Establish a competitive wholesale electricity market Action 4: Scale up private investments in transmission Priority 2: Broadening financing options to scale up investment Action 5: Diversify sources of financing with new risk-sharing instruments Action 6: Strengthen the capacity of the electricity market regulator Priority 3: Upgrading state capability Action 7: Enhance Eskom’s governance, accountability, and investment management to deliver, coordinate, and regulate Action 8: Boost competition in electricity generation by horizontally unbundling Eskom’s generation assets Action 9: Improve electricity distribution by municipalities and Eskom ensuring NTCSA’s operational decision-­ making in- can encourage the development of renewable energy dependence from Eskom. The rules of the game projects to rapidly scale up generation capacity by: required for NTCSA’s financial sustainability should • Scaling up Eskom’s land leasing program for in­ be established upfront by the National Energy Reg- vestors, as the land is generally located close to ulator of South Africa (NERSA), including: transmission lines. • Adopting a new transmission tariff methodology, • Facilitating connection to the grid by redirecting  applicable to the NTCSA independently of Eskom, potential investors to areas with excess trans- to eliminate cross-­subsidization of tariff charges mission capacity (such as, Mpumalanga), improv- with generation or distribution activities.13 ing grid management by introducing digital plat- • Implementing a new wheeling-­ pricing framework forms to manage data and coordinate the flow of  that defines grid connection charges for the di- power across the national grid,14 and adopting a rect network connection capital requirements, new Grid Code (see action 1). network development charges to cover the net- Concurrently, investments in off-­ grid solutions work capacity required for wheeling, and use by businesses and households to reduce demand of grid charges to cover network operating and can be promoted by: maintenance costs. • Scaling up the subsidized credit scheme ( the • Updating the Grid Code, b  ased on the draft “bounce-­ back” scheme) for the purchase/lease Transmission Enabling Roadmap, to better define of solar equipment by small businesses and poor provisions required for integrating renewable households, which has had early positive results. energy projects into the grid­ —­from both public • Allowing residential investors to feed surplus and private sources. The new Code should allow power back to the grid b  y establishing time-­ of- some flexibility in redundancy levels to promote use criteria. Such an approach, authorized in a more economical use of the grid. pilot project in Cape Town, could be scaled up to other municipalities. ■ Action 2: Continue to encourage private investment in renewable energy projects to increase generation ■ Action 3: Establish a competitive wholesale and reduce demand electricity market Beyond digitalizing the Energy One-­ Stop Shop that The government has outlined its intention to allow was established as a single point of entry for all ener- consumers to choose their electricity supplier. The gy project applications in July 2023, the government transition to a competitive power market will be Priority 2: Delivering quality and climate-friendly infrastructure 7■ achieved through a stepwise approach that could in Nigeria and other countries, has the poten- start by: tial to optimize the use of public finance and • Establishing a multimarket trading platform, along concessional official finance by leveraging ad- with the necessary policies, rules, and regulations. ditional private capital from private financial • Adopting the Market Code for NTCSA,  which will markets. To mobilize private capital in support require establishing a Market Code Advisory of sustainable infrastructure development, the Committee and Market Surveillance Panel, with blended finance and risk-­ sharing platform could members appointed by NERSA. deploy a range of financial products, including equity, subordinated and mezzanine debt, and Priority 2: Broadening financing options to scale first losses and credit guarantees. up investment To compensate for years of underinvestment and Priority 3: Upgrading state capability to deliver, neglected maintenance and to finance the shift from coordinate, and regulate coal to renewables will cost around $47.2 billion over Although the government has not yet shared a uni- 2023–2027 and up to $250  billion by 2035.15 Be- term vision for the electricity sector, it is fied, long-­ cause of fiscal constraints at all levels of government clear that the state will continue to have two im- and financial disarray in Eskom, the state can no lon- portant roles in the sector. First, it will adopt and ger serve as the sole source of funding for the sector. coordinate policies and regulate the sector. Second, The private sector can be expected to step up, given it will complement the private sector by continuing the depth of the financial sector, and end-­ users should to deliver some services, especially in transmission be required to pay for their electricity consumption as and distribution, to ensure affordable electricity for specified by law (discussed later in action 9). all. To effectively fill these roles, the government needs to upgrade its capabilities. ■ Action 4: Scale up private investments in transmission ■ Action 6: Strengthen the capacity of the electricity To finance the additional 14,200 kilometers of market regulator high-voltage lines and 170 transformers re- extra-­ quired to enable the projected increase in new re- The opening of the electricity sector to private op- newable energy–based power generation capacity erators has heightened the importance of the reg- by 2032, the government will need to attract the ulator, NERSA. As the sector continues to evolve, support of the private sector by: NERSA’s role in market regulation, technical over- • Adopting a regulatory framework for an indepen­ sight, and tariff setting will become even more crit- dent private transmission model  following the ical. Once the Electricity Regulation Act Amend- model adopted in Kenya, which includes a long-­ ment is passed, NERSA will be responsible for term contract between a private transmission developing and implementing regulations that align company and the power company for investing with the evolving market structure of the energy in transmission lines.16 This approach is being sector and that promote transparency, competition, tested in two pilot projects, but there is an ur- and efficiency. gent need to adjust the legal framework to pro- The following steps can be taken to enhance vide greater predictability to private investors. NERSA’s capabilities: • Expanding technical and financial resources. The ■ Action 5: Diversify sources of financing with new government will need to allocate additional re- risk-­sharing instruments sources to NERSA so that it has the technical expertise and financial support needed to carry To catalyze more private financing for the energy out its expanded mandate effectively. This in- transition, the government could consider: cludes investing in modern regulatory tools, sharing plat­ • Creating a blended finance and risk-­ data analytic capabilities, and infrastructure. form. This method, which has been successful The UK Office of Gas and Electricity Markets ■ 8 Priority 2: Delivering quality and climate-friendly infrastructure has successfully implemented data-­ driven reg- mitigating the impact of load shedding in the short ulatory practices to improve market efficiency term. Eskom has also transitioned to a new senior and transparency. leadership that has committed to redoubling efforts • Providing comprehensive training and capacity to improve governance and financial and operation- building. NERSA needs training programs and al sustainability. capacity-­ building initiatives to equip staff with Short-­ term priorities for Eskom could focus on the skills to handle the complexities of market the following measures: regulation, technical oversight, and tariff setting. • Designing clear and transparent reporting and Sharing best practices from successful regula- monitoring mechanisms t  o strengthen account- tory bodies worldwide will be essential. The US ability and responsibilities across Eskom Group. Federal Energy Regulatory Commission offers This approach will also contribute to an envi- extensive training programs and workshops to ronment that is less susceptible to corruption, continually enhance the skills of its regulatory which is essential for long-­term success. staff. • Improving investment management, including • Establishing a performance benchmarking system. public procurement, to accelerate the construction NERSA needs a permanent performance bench- of new transmission lines. Over the past three marking system that enables it to monitor and years, Eskom has built an average of 125 kilome- enforce good behavior within the sector, espe- ters of new lines a year, whereas the objective cially for the distribution sector. This will help is to construct about 1,400 kilometers of new maintain accountability and ensure that all mar- lines a year until 2031. ket players adhere to high standards of gover- • Implementing key performance indicators in proj­ nance and operational efficiency. Spain’s Nation- ect design, procurement, and completion a  nd al Commission on Markets and Competition has sharing this information regularly with the public implemented a robust benchmarking system to in a readily accessible format. Such a permanent monitor and evaluate the performance of elec- performance benchmarking system for Eskom tricity distribution companies. would enable NERSA to monitor and enforce good behavior. This system would provide for ■ Action 7: Enhance Eskom’s governance, ongoing oversight and accountability, ensuring accountability, and investment management that Eskom adheres to high standards of gover- nance and operational efficiency. Even as the electricity market gradually opens to other operators, Eskom is expected to remain a ■ Action 8: Boost competition in generation by major player, especially in transmission and distribu- horizontally unbundling Eskom’s generation assets tion. To operate efficiently, Eskom must improve its balance sheet, which has severely deteriorated in A critical step in reforming South Africa’s energy recent years because of high operational expenses, sector is the horizontal unbundling of Eskom’s gen- excessive debt service payments, and below-­ cost eration assets by separating Eskom’s generation tariffs. Despite operational profits, net losses were operations into multiple, independently operated as large as R25 billion ($1.67 billion) in fiscal 2021 entities that compete with each other within a reg- and R12.3 billion ($821 million) in fiscal 2022, with ulated wholesale electricity market. Unbundling is total debt of R396 billion ($27.3 billion) at the end essential to reduce Eskom’s market power monop- of March 2022, which is about 8.6 percent of GDP. oly, enhance competition, and enable more efficient Meaningful efforts are under way to improve delivery of electricity by leveraging private sector Eskom’s efficiency, especially the conditional debt participation. relief plan that the National Treasury approved in Horizontal unbundling has proven effective in 2023 and Eskom’s updated Corporate Plan, which other countries, where it has driven operational includes internal measures to reduce unplanned efficiency, improved service reliability, and reduced outages through improved maintenance­ —­a key to costs by introducing competitive pressures. In the Priority 2: Delivering quality and climate-friendly infrastructure 9■ current structure, Eskom’s dominance in generation initial step could be for the authorities to conduct creates excessive market power that deters private an inventory of electricity distribution services investment and stifles innovation. A horizontally and create a dashboard to compare efficiency and unbundled generation sector would allow inde- service quality across distributors. Nigeria’s Power pendent generators, including private renewable Sector Recovery Program17 and Ghana’s Energy energy developers, to compete on a level playing Sector Recovery Program18 are examples of such field. To ensure transparency and equity in this government-­ initiated programs and could inspire environment, the government must implement ro- South African policymakers.19 In the short term, bust wholesale electricity market regulations that low-­ hanging fruit can be harvested by improving govern bidding processes, pricing mechanisms, municipalities’ performance in collecting revenue and grid access. These regulations would prevent from their customers.20 Higher revenue collection market abuse, safeguard affordability for consum- will allow municipalities to pay Eskom for its bulk-­ ers, and promote investments in clean energy. By supplied electricity, contributing to Eskom’s finan- shifting the capital and operational responsibility cial sustainability, and to finance maintenance and of generation to multiple entities, some of which investments in their own distribution networks. could be privately owned or public-­ private part- Municipalities’ performance could be further im- nerships, horizontal unbundling would also reduce proved by leveraging the transfers from the Na- the financial risks borne by the state. The following tional Treasury that account for the bulk of their step could advance the unbundling of electricity financing. The combination of the following mea- generation: sures could be considered: • Developing and implementing a detailed roadmap • Unbundling NEDCSA and defining distribution for splitting Eskom’s generation assets into multi­ roles. The government should prioritize splitting ple, independently managed entities, with clear the National Electricity Distribution Company timelines and legal frameworks. This unbundling of South Africa (NEDCSA) off from Eskom and will need to be aligned with a transparent and establishing it as a separate entity with clear well-­regulated wholesale electricity market, in- governance and operational independence. In cluding potential market trading, commercial, parallel, there is the need for a comprehensive and subsidy mechanisms to support Eskom’s leg- strategy to define and differentiate the roles and acy coal generation assets until their retirement, responsibilities of Eskom’s distribution company such as through contracts-­ for-difference. and of municipalities, ensuring clarity in their mandates. This strategy should explore whether ■ Action 9: Improve electricity distribution by a transition to regional distribution companies is municipalities and Eskom necessary to enhance efficiency and equity in service delivery. Once the strategy and the as- The electricity distribution subsector faces sever- sociated Roadmap are completed, reforms could al challenges and will require restructuring in the begin incrementally, guided by benchmarks and next few years. The restructuring is likely to be pro- performance metrics to ensure alignment with longed because of the number of players and the broader sectoral goals. rigidities in the legal and institutional frameworks. • Streamlining the contractual approach imple­ The distribution market is divided between Eskom mented in mid-­ 2023 between the National Trea­ and municipalities, with municipalities responsible sury and the municipalities that have accumulat­ for about 60% of electricity distribution. ed arrears with Eskom ( about US$3  billion as of As part of the unbundling of Eskom, the govern- the end of 2023). As part of this contract, the ment intends to reorganize the National Electricity National Treasury will clear the arrears of mu- Distribution Company of South Africa (NEDCSA). nicipalities that can demonstrate progress on However, some of the prerequisites are not yet a series of indicators. This initiative has been in place. For example, the government’s vision for accepted by about 60 municipalities, but the Eskom’s role in distribution remains unclear. An results have been mixed after the first year of ■ 10 Priority 2: Delivering quality and climate-friendly infrastructure implementation,21 largely because the conditions In December 2023, the Cabinet adopted a new imposed on municipalities are too numerous and Roadmap for transforming freight transport and too complex for their current capabilities. The logistics that offers a shared vision for the sector. National Treasury should streamline these con- Produced through an intensive consultation process ditions by rewarding municipalities that improve across government departments, labor unions, and their revenue collection and that pay Eskom fully other sector stakeholders, the Roadmap seeks to and on time.22 address the underlying causes of the crisis and ad- • Using conditional transfers from the National vocates for radical change in market structure. The Treasury to incentivize municipalities to perform authorities propose to reduce Transnet’s monopo- better. The rationale for such transfers, ex- listic powers by opening the market to new players. plained in policy note 4, is especially relevant for This could generate efficiency gains and fill part of the electricity sector. The central government the financing gap while strengthening state regula- budget for fiscal 2024/2025 includes grants for tory capabilities, which is especially important in an municipalities that install prepaid meters and open and competitive market.26 The ultimate objec- that use the revenues collected appropriately. tive of the Roadmap is to improve freight services Such transfers could be scaled up and linked to for customers, generating an increase in traffic and other performance indicators. in economic benefits for the country. • Improving local capabilities at the municipal level, Opening the market to competition will require  including the adoption of turnaround strategies the vertical and horizontal unbundling of railway by city councils that ring-­ fence the distribution and port infrastructure services under Transnet. of electricity revenues. For ports, the Roadmap aims to separate opera- • Adopting standards for municipal performance, tions and regulation. For rail, it proposes a verti-  which NERSA will apply, for renewing licenses cal separation between infrastructure services and and for approving new tariffs for electricity dis- network operations (see figure A1 in the annex). tribution services. This separation will enable increased private sec- tor participation in running trains and providing lo- Case 2: Igniting reforms in the freight gistics services, while the public sector will remain transport and logistics sector responsible for infrastructure through a dedicated Years of poor performance in the freight transport manager that will provide fair and nondiscriminato- and logistics sector culminated in crisis in 2023, ry infrastructure access to all operators. when the country lost about 20% of its export ca- The Roadmap provides a shared vision for the pacity as the railway network failed and port con- freight transport and logistics sector, but full im- gestion worsened. The South African rail system plementation is a long-­ term goal. Completing the performs far below international benchmarks. Ex- needed institutional and legal reforms and shifting cept for iron ore, the system moves too little traffic, the mindset of the main players will take time, and too slowly, and with low productivity. The container reforms could face resistance from groups that may terminal at the Port of Durban was ranked 365th lose out in the transition to a new market structure. out of 370 ports worldwide in 2022, and the ter- While the overall benefits to the country are clear, minal at the Port of Ngqura was ranked 361st.23 the restructuring of Transnet needs to be managed Underlying the deterioration in performance are carefully to prepare workers for the new market contradictory commercial, political, and social structure. mandates for the public sector logistics company Within the overarching framework of the three Transnet that are not supported by a clear and sus- priorities shown in figure 3, this note proposes a tainable financing strategy,24 as well as underinvest- menu of six actions to begin implementation of ment in the rail network and ports, ex- acerbated by the Roadmap (figure 5). The emphasis is on short-­ governance failures. This has created a vicious cycle term interventions to ease constraints and rapidly as lack of investment reduces efficiency, which in increase freight volumes, creating momentum for turn reduces revenue and investment.25 further reform. Four of the six actions have been Priority 2: Delivering quality and climate-friendly infrastructure 11 ■ Figure 5  A menu of proposed actions to make the transport and logistics sector more efficient, climate‑friendly, and equitable Action 1: Finalize the classification of railway lines to assess the potential for future ownership Priority 1: Encouraging innovative and efficient delivery mechanisms by opening markets Action 2: Initiate Transnet’s unbundling Action 3: Provide nondiscriminatory access to railway infrastructure Priority 2: Broadening financing Action 4: Improve Transnet liquidity and financial sustainability options to scale up investment Action 5: Develop a public-private framework for allowing private sector participation in railway operations Priority 3: Upgrading state capability Action 6: Implement the independent Transport Economic Regulator section of the Transport Bill to deliver, coordinate, and regulate assessed as the most technically and politically delivery mechanism. The task is to assess the high-­ feasible, impactful, and timely. Ideally, the actions traffic lines that are commercially viable and those would meet all three criteria, but trade-­offs are like- that would require subsidies to provincial govern- ly to be necessary (see table A1 in the annex). ments to serve local social priorities. The rail lines These short-­ term actions provide a useful and identified as commercially viable are candidates for pragmatic starting point. They will need to be private sector participation. This task requires: complemented by additional measures, including • Identifying which railway lines could be effectively reforms and investments in ports, to enhance the operated by entities other than Transnet b y differ- vertical efficiency (from firms to ports) and horizon- entiating four types of routes: bulk mineral cor- tal efficiency (across locations) of the entire trans- ridors, core railway network, feeder rail system, port system. and short lines (figure 6). For bulk mineral corri- dors, the transfer of operational responsibilities Priority 1: Encouraging innovative and efficient from Transnet to mining companies is proposed. delivery mechanisms by opening markets The core railway network would continue to The priority is to introduce contestability to the be managed by the proposed Infrastructure market by opening the sector to multiple operators. To move quickly in that direction, the authorities Figure 6  The railways network by route must identify which railway lines could be effec- classification tively operated by entities other than Transnet, adjust the legal framework accordingly, and avoid conflicts of interest between operations and infra- structure management. ■ Action 1: Finalize the classification of railway lines to assess the potential for future ownership Transnet inherited a network of railroads that is complex, extended, and multifunctional. Some lines, deemed to be commercially viable, were ded- icated to specific mining and industrial customers. Others were built with equity in mind, to unlock the economic potential of lagging areas. Like rail Bulk mineral corridors Feeder rail system reforms in North America and Europe, South Afri- Core rail network Short lines ca’s Roadmap proposes switching from a single op- erator to multiple operators within a disaggregated Source: Freight Logistics Roadmap, 2023. ■ 12 Priority 2: Delivering quality and climate-friendly infrastructure Manager, with fair access to all operators. For all commercial arrangements between the Infra- the feeder lines that serve specific customers, structure Manager and the rest of Transnet are such as automotive and dry bulk customers, conducted on an arms-­ related length or market-­ private partnerships are proposed. Man- public-­ basis, and establishing an independent board of agement of short lines could be determined by mainly nonexecutive directors. provincial or municipal governments. Priority 2: Broadening financing options to scale ■ Action 2: Initiate Transnet’s unbundling up investment Modernizing the freight transport network will South Africa needs to adjust its legal framework to cost hundreds of billions of dollars over the next transition from a public sector–led to an open deliv- decade. The state cannot shoulder this financial ery model in freight transport. Toward that end, the burden alone, given the constrained central gov- government could focus on the following measure: ernment budget and Transnet’s limited borrowing • Adopting the new draft Rail Bill that provides capacity. Longer-­term measures to consider include the legal basis for unbundling Transnet. The bill development of risk-­ sharing financial instruments is expected to be ready for public comment in to attract domestic and international financial in- December 2024 and presented to Parliament stitutions. In the meantime the government could by February 2025. Accelerating its enactment act on two short-­ term measures, one related to im- would send a strong signal to market players and proving Transnet’s financial position and one that make policy reversal more difficult. leverages private financing in line with the strategy of opening management of several railway lines to ■ Action 3: Provide nondiscriminatory access to the private sector. railway infrastructure ■ Action 4: Improve Transnet liquidity and financial Clarifying Transnet’s institutional roles and man- sustainability dates is urgent. The priority is distinguishing be- tween the functions of infrastructure provision, Strengthening Transnet’s financial position is im- which is the role of the public sector, and rail oper- portant for the sector’s performance. In fiscal ations, which should accommodate multiple actors 2023/2024, the company was unable to settle its access basis. This can be achieved in the on a fair-­ debt maturities of approximately R14 billion, forcing short-­term by: it to refinance with costly short-­ term borrowing. To • Establishing an Infrastructure Manager, who will avoid a possible default, Transnet received an ad- be responsible for the maintenance, renewal, and ditional government guarantee of R47  billion as a development of the infrastructure network. The financial rescue package in 2024. position requires organizational independence Several steps are needed to get Transnet back from Transnet operations (within a framework of onto a sustainable financial path, in close coordina- regulatory supervision) over decisions about ca- tion with the National Treasury: pacity; access to the rail network and train path • Classifying the debt stock by risk profile and iden­ allocation, including identifying and assessing tifying the debt accumulated because of state the availability and allocation of individual train capture or the diversion of resources. This effort routes; and infrastructure charges, including set- is in the initial stages of designing a strategy to ting and collecting access charges. Several sup- restructure short-­ term and high-­interest debt port measures are needed for the Infrastructure and exploring ways of attracting long-­ term insti- Manager to be effective: developing a code of tutional investors based on stable demand from conduct for the Infrastructure Manager’s staff Transnet customers. that clearly separates the responsibilities of the • Identifying a list of disposed noncore assets along Infrastructure Manager and Transnet, imple- with milestones and timelines of disposal. Noncore menting a transfer pricing regime to ensure that assets include fixed assets, such as land in prime Priority 2: Delivering quality and climate-friendly infrastructure 13 ■ locations, and movable assets that are not nec- core network but that are critical for complex essary to operating efficient logistics services. intermodal operations. As part of the conditions for bailout, the Na- tional Treasury has required Transnet to submit Priority 3: Upgrading state capability to deliver, by August 31, 2025, a list of disposed noncore coordinate, and regulate assets, along with milestones and timelines. Dis- In the Roadmap vision, even with the transfers of posing of noncore assets could ease short-­ term some lines to private operators, the state contin- cashflow problems but will not solve Transnet’s ues to play a key role in the freight transport and underlying financial problems. logistics sector. Transnet is expected to continue to manage many railway lines, while the Department ■ Action 5: Develop a public-­private framework of Transport will remain responsible for designing for allowing private sector participation in railway strategies and plans. To be effective, the manage- operations ment of both Transnet and the Department of Transport needs to be upgraded, including through Classifying railway lines (action 1) is an unproduc- the introduction of strong key performance indica- tive exercise if it does not translate quickly into tors and incentives. The government’s regulatory the transfers of some lines to third-­ party opera- capabilities also need to be strengthened in antici- tors. To promote the participation of the private pation of an open and competitive market. sector in the short term, two opportunities can be considered: ■ Action 6: Implement the independent Transport • Transferring the operational responsibilities of bulk Economic Regulator section of the Transport Bill mineral rail lines to large mining companies. These lines serve few customers and run freight trains The President has approved the Transport Bill, only from mines to ports. As Transnet’s main which will consolidate current regulatory agencies source of cashflow, revenue from these lines has in the transport and logistics sector (such as the cross-­ subsidized the other, non-­ cash-generating Ports Regulator, rail regulator, trucking regulator, rail lines. In keeping with the Roadmap, a trans- and intermodal regulator) into the position of in- action advisory service should be commissioned dependent Transport Economic Regulator (TER). to develop a mechanism that allows large mining Such approval is pivotal as it instills confidence customers to join in addressing the investment that the sector is based on fair, transparent, and backlog and restoring reliable services, with nondiscriminatory access for all parties. Among Transnet having a minority shareholding. The other roles, TER will regulate the pricing of access transaction needs to be structured on commer- to the network, which is critical to meaningful ver- cial terms that give the private sector confidence tical separation. The dominant operator and its that long-­ term contracts will be honored. external competitors need to face the same pric- • Establishing public-­ private partnerships for run­ ing schedule for access to infrastructure, which ning railways on feeder lines that serve clusters should be cost based and reflect a fair allocation of of diverse industries  whose products can be overhead costs. containerized or palletized. For example, BMW, The following steps are necessary to build TER’s Ford, and Toyota, with assembly facilities in the capabilities: Gauteng region, depend on a cheap, reliable, • Enhancing technical and financial resources. Ad- and functioning railway system to bring in inputs equate resources need to be allocated to TER and move finished products to ports. With net- to ensure that the regulator has the technical work rationalization, a public-­ private partnership expertise and financial support needed to carry strategy could help maintain the central contain- out its expanded mandate effectively. er corridor and associated port operations, as • Providing comprehensive training and capac­ well as the feeder lines that are not part of the ity building  to equip TER staff with the skills ■ 14 Priority 2: Delivering quality and climate-friendly infrastructure required to handle the complexities of market system will help maintain accountability and regulation, technical oversight, and tariff set- ensure that all market players adhere to high ting. Drawing on best practices from success- standards of governance and operational effi- ful regulatory bodies worldwide will be essen- ciency. Spain’s National Commission on Markets tial, including through exchange programs and and Competition has implemented this type of internships. robust bench- marking system to monitor and • Establishing a performance benchmarking sys­ evaluate the performance of electricity distribu- tem  to monitor and enforce good behavior. This tion companies. Priority 2: Delivering quality and climate-friendly infrastructure 15 ■ Annex table A1  Ranking of measures through the “FIT” filter of feasibility, impact, and timing Feasible Impactful Timely Total Accelerating reforms in the electricity sector Priority 1: Encouraging innovative and efficient delivery mechanisms by opening markets Action 1: Ensure the financial and 1. Adopting a new transmission tariff 3 3 3 9 operational sustainability of the methodology National Transmission Company of 2. Implementing a new wheeling framework South Africa 3. Updating the Grid Code Action 2: Continue to encourage 4. Scaling up Eskom’s land leasing program for 3 2 3 8 private investment in renewable investors energy projects 5. Facilitating connection to the grid 6. Scaling up the subsidized credit scheme 7. Allowing residential investors to feed surplus power back to the grid Action 3: Establish a competitive 8. Establishing a multimarket trading platform 3 3 2 8 wholesale electricity market 9. Adopting the Market Code for NTCSA Priority 2: Broadening financing options to scale up investment Action 4: Scale up private investments 10. Adopting a regulatory framework for an 3 3 3 9 in transmission independent private transmission model Action 5: Diversify sources of 11. Creating a blended finance and risk-sharing 2 2 2 6 financing with new risk-sharing platform instruments Priority 3: Upgrading state capability to deliver, coordinate, and regulate Action 6: Strengthen the capacity of 12. Expanding technical and financial resources 2 3 2 7 the electricity market regulator 13. Providing comprehensive training and capacity building 14. Establishing a performance benchmarking system Action 7: Enhance Eskom’s 15. Designing clear and transparent reporting and 2 3 2 7 governance, accountability, and monitoring mechanisms investment management 16. Improving investment management, including public procurement to accelerate the construction of new transmission lines 17. Implementing key performance indicators in project design, procurement, and finalization Action 8: Boost competition in 18. Developing and implementing a detailed generation by horizontally unbundling roadmap for splitting Eskom’s generation Eskom’s generation assets assets into multiple, independently managed entities, with clear timelines and legal frameworks Action 9: Improve electricity 19. Streamlining the contractual approach 3 3 2 8 distribution by municipalities implemented in mid-­ 2023 between the and Eskom National Treasury and the municipalities that have accumulated arrears with Eskom 20. Using conditional transfers by the National Treasury to incentivize municipalities to perform better 21. Improving local capabilities at the municipal level 22. Adopting standards for municipal performance ■ 16 Priority 2: Delivering quality and climate-friendly infrastructure Feasible Impactful Timely Total Igniting reforms in the freight transport and logistics sector Priority 1: Encouraging innovative and efficient delivery mechanisms by opening markets Action 1: Finalize the classification 23. Identifying which railway lines could be 2 2 3 7 of railway lines to assess future effectively operated by entities other than ownership Transnet Action 2: Initiate Transnet’s 24. 18. Adopting the new draft Rail Bill 3 3 2 8 unbundling Action 3: Provide nondiscriminatory 25. Establishing an Infrastructure Manager and 3 3 3 9 access to railway infrastructure issuing operating licenses to private train operators Priority 2: Broadening financing options to scale up investment Action 4: Improve Transnet liquidity 26. Classifying the existing debt stock by risk 2 2 2 6 and financial sustainability profile 27. Identifying a list of disposed noncore assets along with milestones and timelines of disposal 28. Completing the process for identifying critical investments for ports equipment and operational efficiency constraints and developing key performance indicators for ports Action 5: Develop a public-­private 29. Transferring the operational responsibilities 3 2 3 8 framework for allowing private sector of bulk mineral rail lines to large mining participation in railway operations companies 30. Establishing public-private partnerships for running railways on feeder lines Priority 3: Upgrading state capability to deliver, coordinate, and regulate Action 6: Implement the independent 31. Setting up a fully functional Independent 3 3 3 9 Economic Regulator section of the economic regulator in line with the bill Transport Bill 32. Completing the merger and integration of port regulator and interim rail regulator 33. Establishing a performance benchmarking system Source: Authors. Note: The scores range from 1 to 3, with 1 being the lowest. The actions with the highest score are highlighted in yellow. Priority 2: Delivering quality and climate-friendly infrastructure 17 ■ Annex figure A1  Proposed split of infrastructure network and rail/port operations under the Cabinet’s December 2023 Roadmap for the freight and logistics sector Reform policy and regulation: Rail freight Horizontal separation between locomotives and wagon fleets Vertical separation between infrastructure services and network operations Horizontal separation between terminals and operating slots Horizontal separation Freight operators between low- and high-density lines Moving freight and providing logistics services through system Infrastructure operations manager • Train operating company Creating capacity and maintaining • Logistics provider the infrastructure Infrastructure owner • Infrastructure The landlord Manager • Rail owner (infraBel, Network Rail, BNSF, NS) Source: Freight Logistics Roadmap, 2023. ■ 18 Priority 2: Delivering quality and climate-friendly infrastructure Notes 1. C. Calderón and L. Servén, 2014, “Infrastructure, March 2024, which in the absence of a strong regu- Growth, and Inequality: An Overview,” World Bank lator could not be contested. Policy Research Working Paper. 7034. https://ssrn​ 9. The impact of the weak management of the sector .com/abstract=2497234. These authors also pro- is also evident in the network statement and pro- vide a summary of the literature. posed tariffs of March 2024, which, in the absence 2. Wheeling pricing refers to charging for electricity of a strong regulator, could not be contested. transmission from one system to another. 10. The Day Zero drought cost the Western Cape over 3. The impact of declining infrastructure services can R5 billion and put under strain the water and sanita- take different forms depending on the type of serv- tion framework as the local authorities had to ration ice (for example, water is different from electricity or water services while having to invest in desalination, transport); the intensity of the failure (2 or 8 hours underground extraction from aquifers, and water of disruption do not have the same impact); the loca- reclamation/reuse. tion of the activity (urban or rural area); the sector of 11. Department of Minerals and Energy, 1998, activity (production processes differ in use of ener- “White Paper on the Energy Policy of the Repub- gy and water); and the income level of the customers .gov​ lic of South Africa,” December, https://www​ (not everyone is equally vulnerable). .za/sites/default/files/gcis_document/201409​ 4. C. Calderón and L. Servén, 2014, “Infrastructure, /whitepaperenergypolicy19980.pdf. Growth, and Inequality: An Overview,” World Bank 12. “White Paper on Telecommunications Policy.” Gov- Policy Research Working Paper. 7034. https://ssrn​ ernment Gazette 370 (March 1996) and “White .com/abstract=2497234. Paper on National Civil Aviation Policy” 2017. 5. South African Reserve Bank, June 2023, Occasional 13. As defined in the National Energy Regulator of South Bulletin of Economic Notes. OBEN/23/01. Africa’s consultation paper “Electricity Price Determi- 6. C. Calderón and L. Servén, 2014, “Infrastructure, nation Methodology (EPDM) Rules” issued in August Growth, and Inequality: An Overview,” World Bank 2023. https://businesstech.co.za/news/wp-content​ Policy Research Working Paper. 7034. https://ssrn​ /2023/08/Nersa-consultation-paper.pdf. /uploads​ .com/abstract=2497234. 14. The National Treasury, Department of Mineral Re- 7. For further details, see World Bank, 2022, South Africa: sources and Energy, and Independent Power Pro- .world​ Climate and Development Report. https://www​ ducers Office could consider the use of regional /south​ bank.org/en/news/infographic/2022/11/01​ incentives to realize the public good externalities -country-climate-and-development​ -Africa​ -report. associated with these projects for these provinces 8. J.H. Havenga, Z.P. Simpson, H. Neethling, A. De (supply increase, job creation, and other social tran- Bod, and S. Swarts, 2023, “The Macrologistics Ef- sition considerations). Such regional incentives could fect of a State-Owned Enterprise, Transnet, on the include reduced or preferential tariffs for infrastruc- South African Economy,” Journal of Transport and ture and access to land, blended concessional fi- Supply Chain Management, 17(0), a952. https://doi​ nancing, or even tax and tariff incentives. .org/10.4102/jtscm.v17i0.952. The impact of the 15. “Making Capital Work: Unlocking US$8.5 Billion for weak management of the sector is also evident in South Africa’s Just Energy Transition,” 2022, Presi- the network statement and proposed tariffs of dential Climate Transition Report (2022–2050). 19 ■ 16. A private transmission company has long-term con- 24. Commonly, when a subnational government is ex- tracts with Kenya Power to earn wheeling revenue pected to deliver on development objectives that are from electricity transmitted through its power lines. not commercially viable, adequate funding is provid- This company is investing $298  million in two pri- ed through subsidies. For example, in India an explicit vately owned power transmission lines—a first in subsidy that is calculated every year to allow Indian —­ Africa­ covering 237 kilometers. Railways to provide freight and passenger services to 17. https://www.psrp.org.ng/. low-economic-density areas, with the understand- 18. ht t p://energ ycom.gov.gh/public-notices/112​ ing that the subsidy allows mobilization of labor and -energy-sector-recovery-programme-esrp. makes it cheaper for firms to locate to these areas, a -­ 19. For example, in the municipality of Maluti-­ thereby creating jobs. In the case of Transnet, this Phofung, billing comes to only half the cost of bulk explicit subsidy arrangement is missing. purchases from Eskom. 25. Key aspects of the governance failures at Transnet 20. https://powermin.gov.in/en/content/overview-5. are detailed in the Judicial Commission of Inquiry 21. According to the National Treasury, as of March into State Capture Report, Part V, Volumes 1 and 2 31, 2024, none of the participating municipalities (https://www.justice.gov.za/commissions/STCC​ complied with all conditions, while only 26 reported .htm). A particular problem has been the electrified moderate compliance and 36 poor compliances. locomotive fleet procured from the China Railway 22. One challenge is that the Electricity Regulation Act Rolling Stock Corporation. Because of disputes over of 2006 prohibits restricting Eskom electricity sup- the procurement process, many of the locomotives plies to nonperforming municipalities. stand idle or have not even been delivered. 23. World Bank, 2022, World Bank Container Port Index. 26. Such change is not completely new for the trans- /en https://documents1.worldbank.org/curated​ port sector. Partnerships with the private sector /099051723134019182/pdf/P1758330d05f3607​ have been developed such as the Gautrain regional f09690076fedcf4e71a.pdf. rail service, bus rapid transit operations, private air- ports, and the Richards Bay Coal Terminal. ■ 20 Priority 2: Delivering quality and climate-friendly infrastructure Priority 3 Making cities engines of growth and economic inclusion SOUTH AFRICA POLICY PACKAGE © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; internet: www.worldbank.org Some rights reserved This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Priority 3 Making cities engines of growth and economic inclusion SOUTH AFRICA POLICY PACKAGE Contents Connecting markets and people with effective transportation and more compact cities 1 Urbanization has not been a driver of inclusive growth 2 Three priorities for addressing the urban mobility challenge 2 Priority 1: Enhancing the performance of passenger railways 6 Action 1: Incentivize PRASA to perform better 6 Action 2: Leverage information technologies to increase management efficiency 6 Action 3: Consider alternative models for passenger rail investment and operations 7 Priority 2: Improving the efficiency and affordability of minibus taxis and integrating them into the urban transit system 7 Action 4: Reduce the cost of transportation for poor customers 8 Action 5: Foster the integration of minibus taxis into the public transit system 8 Action 6: Incentivize individual minibus taxi operators to cooperate and organize themselves 8 Priority 3: Redirecting urban planning policies and regulations toward higher densification 9 Action 7: Adjust zoning and land use regulations to encourage land and building development closer to business areas 10 Action 8: Adjust pricing mechanisms to encourage land development in strategic areas 10 Action 9: Facilitate access to finance for projects in strategic areas 11 Action 10: Use digital tools to improve urban planning and coordination 12 Notes 16 Boxes 1 Virtual connectivity 5 2 private partnerships in urban transit systems Lessons from international experience with public-­ 7 3 Opportunity zones in the United States 11 4 How smart cities around the world have used spatial planning platforms 13 Figures 1 High transportation costs penalize low‑income workers in South Africa 3 2 Commuters have moved away from the public transit system toward privately run buses and taxis over the past decade, 2013–2020 4 3 Spatial exclusion in Pretoria, 2023 4 4 A guiding framework for prioritizing policies to leverage cities for stronger and more equitable growth 5 Table A1 Ranking of measures through the “FIT” filter of feasibility, impact, and timing 14 iii ■ Connecting markets and people with effective transportation and more compact cities South Africa is a mostly urban country, with about Reforming urban transport and development two-­ thirds of the population and three-­ quarters of is a long-­ term endeavor requiring sustained ef- economic activities concentrated in urban areas. Yet, fort, financial resources, and political commitment. urban mobility is difficult for people without a car Transforming South African cities into modern and (80% of the population) or who live in remote and livable hubs for their inhabitants, businesses, and poor neighborhoods.1 It can take a poor worker 2–3 workers will take time. In the interim, focusing on hours and cost half their daily earnings on average key short-­ term actions that address the most press- It can take a to reach their workplace­ —­four times higher than in ing issues can provide immediate relief and lay the poor worker many East Asian cities and one of the most expen- foundation for broader reforms. To guide policy- sive commutes in the world. These costs interfere makers, this note proposes a menu of 10 actions 2–3 hours and with the efficient functioning of product and input and 24 short-term recommendations. Five of these cost half their daily earnings markets and result in substantial losses in output and recommendations have been assessed as the most employment. The poor are disproportionally harmed; technically and politically feasible, impactful, and for example, employment is 86% lower in poor neigh- timely (see table A1 in the annex). While the most on average to borhoods of Johannesburg than in affluent ones.2 desirable actions would ideally meet all three crite- commute to Limited urban mobility is largely a legacy of the ria, tradeoffs are likely to arise: Apartheid era, but it has not been addressed con- 1. Using a results-­ based approach for allocat- their workplace ■ vincingly over the past three decades. Investments ing grants f  rom the National Treasury to the in urban transport networks have been insufficient state-­ owned Passenger Rail Agency of South to achieve spatial efficiency and equity. Another Africa (PRASA) to incentivize better invest- obstacle is the horizontal spread of South African ment and maintenance performance. cities. Decades of urban development have favored 2. Distributing vouchers to poor customers t o urban sprawl into the suburbs, where land is cheap- reduce their transportation costs, while ex- er. As a result, the average population density of tending the use of e-­ payment and e-­ ticketing. major cities like Johannesburg is two to three times 3. Relaxing National Building Regulations and lower than in comparable cities in Latin America municipal zoning regulations and amending and East Asia. the Spatial Planning and Land Use Manage- Improving urban mobility in South Africa requires ment Act  to encourage land development in addressing two intertwined challenges.3 First, urban dense areas, with special attention to nation- centers in South Africa, like all modern cities, must al building regulations and municipal zoning offer efficient and affordable mass public transit regulations. systems (railways, bus rapid transit) integrated with 4. Introducing financial bonuses for social housing more agile transport modes on feeder roads, such as projects in high-­ density areas close to business buses and minibus taxis (MBTs). Second, cities need centers. to become more compact, with shorter distances 5. Accelerating the development and use of digital between businesses, workers, and consumers. spa­tial planning platforms t o collect and share 1■ in-time and integrated information to man- just-­ While substandard and expensive urban mobility age urban  development projects, including in affects all households, the poor are penalized most partnership with the private sector. heavily. Due to tighter budget constraints, the cost of urban transport, including commuting time (opportu- Urbanization has not been a driver of nity cost), takes as much as 80% of the earnings of inclusive growth the poorest segment of the population. This burden “Urban immobility” has weakened the ability of ur- helps explain why almost two of three working-­ age banization to drive inclusive growth in South Africa. South Africans are unemployed or not actively seek- Worldwide, the concentration of economic activities ing employment, with poor people again dispropor- and people in cities has generated agglomeration ef- tionately affected. For every 10% increase in trans- fects that promote economies of scale and synergies portation costs, the urban wage employment rate within and across markets, contributing to economic falls an estimated 2%.9 By contrast, transportation development. Both economic theory and empirical costs in Vietnam are estimated at only 10% of net evidence reveal a positive relationship between well-­ wages because of shorter distances and more effi- planned and managed densification and econom- cient modes of transport, including motorcycles. In ic development.4 South Africa has been an outlier. other words, of the same gross salary, the average In fact, during the past decade, output per capita South African worker retains less than half of the contracted more rapidly in urban provinces than in earnings that a Vietnamese worker retains (figure 1).10 rural ones.5 Living conditions have deteriorated for many urban households because of the declining Three priorities for addressing the urban availability of basic infrastructure services (electric- mobility challenge ity and water, higher pollution) and rising insecurity.6 To address the challenge of urban immobility, South Nonetheless, people in rural areas and poor neigh- Africa developed a two-­ pillar strategy as early as ■ Together with borhoods have continued to migrate to cities, drawn the mid-­ 1990s. South Africa adopted an urban mass urban sprawl, by expectations of higher wages and a better life.7 transit strategy based on international best practic- Together with urban sprawl, limited mobility is es. It also focused attention on urban development, limited mobility one of the most important factors explaining the low spending billions of dollars on housing develop- is one of the returns to urbanization in South Africa. When mar- ments in poor communities. Despite some success- most important kets are hard to access, transaction costs are high for es, especially in the first decade after the end of firms and people, who will move and trade less. High the Apartheid, implementation of these policies has factors explaining mobility costs also reduce opportunities for sharing been uneven, as reflected in disappointing results. the low returns technologies and skills, which are essential for gen- The urban transport strategy was clearly artic- erating economies of scale and productivity gains ulated in the 1996 White Paper on National Trans- to urbanization across all sectors of the economy. Similarly, lengthy port Policy. Implementation of the policy included in South Africa and expensive commutes weaken economic incen- the 2007 development of integrated rapid public tives to acquire human capital and look for work. On transit networks, including bus rapid transport.11 average, daily commutes are about 107 minutes for The objective has been clear, with a dual emphasis train travelers, 84 minutes for bus travelers, and 63 on modernizing commuter rail services and devel- minutes for taxi travelers.8 The high time and money oping MBTs to make transports affordable for all.12 costs of transport negatively affect labor productiv- However, after almost 20 years of implementation, ity: in the most urbanized province (Gauteng), real the urban transit system remains undeveloped and gross valued added per worker in industry, a rough costly, having contributed little to reducing spatial approximation of labor productivity, fell 5% between inequalities in South African cities. 2011 and 2019. The negative effects of urban immo- • In passenger rail, despite large capital allocations bility on productivity are exacerbated by the diver- for network renewal, service quality deteriorat- sion of financial resources away from investments in ed rapidly after 2013, reflecting underinvest- education or other productivity-­ enhancing endeav- ment in maintenance and delays in upgrading of ors and toward transportation expenses. networks and rolling stock. ■ 2 Priority 3: Making cities engines of growth and economic inclusion Figure 1  High transportation costs penalize low‑income workers in South Africa For the same gross salary, a low-income worker in South Africa will take home less than half as much money as will a Vietnamese worker. Transport costs: Transport costs: Works in $508 a month $96 a month Lives in Sandton Tây H`ô, (51% of net wage) (10% of net wage) Hanoi 39 km 7 km Works in Lives in the French Soweto quarter Gross salary $1,000 a month In pocket In pocket Personal income tax: $384 $862 Personal income tax: a month a month $108 a month $42 a month Tax allowance: $400 Tax allowance: $475 Tax rate: 18% Tax rate: 5% up to $215, thereafter 10% Dumisani Danh 25 years old 23 years old Source: Morisset 2023. • Subsidized commuter bus services have not kept inefficient as a mass commuter service, more ex- As formal public up with urban growth, partly because of the de- pensive, dangerous, and poorly organized. transit systems cline in operational grants from the central gov- The failure of mass public transit and the emer- ernment. Meanwhile, the provinces, with limited gence of privately run MBTs have dramatically altered stag­nated, own-­ revenue sources and largely dependent on ridership patterns over the last decade (figure 2). As privately owned, independently the national government for funding, have not of 2020, publicly supported transportation in the been able to noticeably increase funding for form of rail and commuter buses combined made these services. The uncertain legal framework up less than 7% of the transportation mode share, operated, has also discouraged long-­ term investments. while privately owned and operated transportation, and weakly Interim contracts for operators are still in place in the form of MBTs and private cars, made up 72%. and are being renewed annually, despite court The remaining share (21%) of people walked, often regulated rulings requiring their termination. because they could not afford or did not have access minibus • As formal (subsidized) public transit systems to other public or private options. One consequence taxis greatly stagnated or broke down, MBTs­ privately —­ of this change in the pattern of transport is that the owned, independently operated, and weakly government spends about R16 billion ($840 million) expanded their regulated­—greatly expanded their market share. annually to subsidize mass public transit (railways market share ■ However, they are an imperfect substitute for and buses) for only 7% of ridership today. This un- formal public transit systems because they are derscores the large regressivity of the current state not integrated into public transit systems and are of public transit in South Africa. Priority 3: Making cities engines of growth and economic inclusion 3■ Figure 2  Commuters have moved away from the Figure 3  Spatial exclusion in Pretoria, 2023 public transit system toward privately run buses and taxis over the past decade, 2013–2020 Percentage change 20 13 6 0 –4 –20 –24 –40 ■ Business center –60 ■ Poor residential area ■ Rich residential area –78 –80 Source: Beukes, E., 2023, Transit in South Africa, World Bank. Train Bus Taxi Car Walking Source: South Africa statistical office. connectivity and utility of rail service by extending its reach and spreading the benefits of its subsidies On the urban planning front, the government more broadly. As for urban development, the gov- has focused on building affordable housing in dis- ernment, recognizing past failures, has set devel- advantaged communities, greatly improving access oping more compact cities, better integrated into to housing and basic public services among dis- economic areas, as a priority. Improved land use advantaged groups. However, less attention has planning and densification policies are also criti- ■ Residential gone to improving urban mobility and densification cal for preventing urban development in disaster-­ areas where in economically dynamic areas. Travel distances prone areas and for providing additional protection from most poor communities to business centers to vulnerable groups exposed to climate risks. Com- most low-­income and jobs remain long. Residential areas where most plementary to these two strategies are recent ef- households live low-­ income households live are generally poor- forts to expand virtual connectivity (box 1). are generally ly covered by public transit. Consider the case of Transforming South African urban hubs into robust Pretoria. The poorest residential areas are far from engines of growth demands substantial investments. poorly covered the business center and job opportunities, while af- Large investments are needed in transportation in- by public transit fluent residential areas are much closer (figure 3).13 frastructure and buildings to reduce the distance be- Recent analysis using tax data reveals that employ- tween home and work and between businesses. The ment in the most asset-­ deprived neighborhoods is, required level of financing will be difficult not only on average, 79% lower in Johannesburg than in the for the central government to meet but also for even wealthiest areas and 44% lower in Cape Town.14 more fiscally constrained provincial and municipal Aware of the continuing urbanization challeng- governments. In addition, decision and approval pro- es, the government is taking new actions. For pub- cesses are long and complex, delaying impacts. lic transit, the foundations are in place. Strategies To initiate the shift toward denser and more ac- have focused on the right objectives by prioritiz- cessible cities, this note outlines three key priorities ing a multimodal approach to reverse the historical aimed at achieving better and more equitable mobility trend of underinvestment and poor maintenance and greater economic and population density (figure of public transit system and address the limitations 4). In the short term, to create momentum for reform, of the privately run MBTs. The aim is to integrate the authorities could focus on policies and regula- MBTs into the urban transit system to increase the tions to incentivize a shift toward greater innovation ■ 4 Priority 3: Making cities engines of growth and economic inclusion Box 1  Virtual connectivity Virtual connectivity can help reduce distances between economic agents. Rather than traveling from one location to another to complete a transaction, it is now possible to do so by clicking on a smartphone or computer. Also, virtual connectivity can reduce the need for transportation for some types of workers, especially those with skilled and semi-­ skilled jobs in some service sectors. The digital revolution is under way in South Africa, but its progress has been uneven. South Africa was ranked 58th of 63 countries on the 2021/22 IMD digital competitiveness index, be- hind most upper middle-­ income countries. This low ranking captures the fact that 36 percent of South Africans were still unconnected to the Internet in 2021/22, and those who were connected do not have the kind of high-­ speed connections needed to access cloud software or streaming services. Connection costs are high as well, with data approximately 20 times more expensive than the cheapest data costs globally. An additional challenge to digital connectivity is users’ lack of information technology knowledge, including businesses. Weak and limited data skills impede the development of information highways (data capture, analysis, and processing at large scale). Additionally, although digital tools have enabled South Africans to communicate and conduct financial transactions virtually, virtual and physical connectivity are not always perfect substitutes. For example, a product can be ordered online but will still need to be shipped to its destination at a reasonable cost and in a timely manner. Figure 4  A guiding framework for prioritizing policies to leverage cities for stronger and more equitable growth Action 1: Incentivize PRASA to perform better Priority 1: Enhancing the Action 2: Leverage information technologies to increase performance of passenger railways management efficiency Action 3: Consider alternative models for passenger rail investment and operations Achieving better and more equitable mobility Action 4: Reduce the cost of transportation for poor customers More compact, Priority 2: Improving the efficiency and accessible, and affordability of minibus taxis and integrating Action 5: Foster the integration of minibus taxis productive cities them into the urban transit system into the public transit system Fostering greater Action 6: Incentivize individual minibus taxi economic and operators to cooperate and organize population density Action 7: Adjust zoning and land use regulations to encourage land and building development closer to business areas Action 8: Adjust pricing mechanisms to encourage Priority 3: Redirecting urban planning land development in strategic areas policies and regulations toward higher densification Action 9: Facilitate access to finance for projects in strategic areas Action 10: Use digital tools to improve urban planning and coordination and improved delivery mechanisms. These measures which will require public-­ private partnerships as can be implemented without delay as they require the government does not have the resources to more political will and vision than time and money. do it alone. It is also critical to introduce more The three mutually reinforcing priority areas are: contestability and performance-­ based incen- • Enhancing the performance of passenger railways. tives to a sector dominated by the public agency Investments are needed to upgrade the system, PRASA. This can be done by opening the sector Priority 3: Making cities engines of growth and economic inclusion 5■ to new operators that can bring new technolo- relief offered to Eskom in 2023 (see policy note 2 gies, competencies, efficiency gains, and finan- for details). The Treasury could also consider open- cial capital. ing these funds up to competition by offering them • Improving the efficiency and affordability of MBTs to other stakeholders as well (municipalities, private and integrating them into the urban transit system sector, taxis/buses), as discussed below.  by encouraging cooperation across operators (including with new digital technologies) and ■ Action 2: Leverage information technologies to coordination with the public transit system to increase management efficiency create economies of scale and synergies for the benefit of customers. As technology has advanced, so has innovation • Redirecting urban planning policies and regula- in urban transit systems. New digital instruments tions toward higher densification b  y providing and information-­ sharing mechanisms can improve better value for money for developers, while the management of both supply and demand by enhancing coordination between central, pro- enabling the collection and analysis of just-­ in-time vincial, and municipal authorities. data. South Africa, like many other countries, has started this digital transition, which could be accel- Priority area 1: Enhancing the erated through a few measures, including: performance of passenger railways • Using digital dashboards to improve municipal Since the peak of the urban transit crisis in 2021, the management of urban transit systems. Running government has taken important steps to rehabilitate an efficient urban transit system requires access and expand passenger rail services and accelerate to up-­ to-date information that can be analyzed the development of bus rapid transit. PRASA’s new in real time. The development of the internet corporate plan (2023–2026) allocates approximately of things and the internet of everything means R120 billion ($6 billion) in capital spending over the that transit data can be fed into other networks next three years, and its implementation has already for more effective and efficient management of led to the reopening of several stations and routes. municipal transit services. Colombo, Sri Lanka, Concurrently, the government has turned its atten- and Can Tho, Vietnam, have implemented such tion to governance reforms within PRASA, such as initiatives. bringing independent and private members onto the • Introducing digital ticketing for customers without ■ The most direct Board to strengthen its technical capacity and ac- digital bank accounts. While passengers can al- way to incentivize celerating the adoption of new technologies. These ready use digital banking to pay for their tickets, measures are a good beginning, but more is needed. many poor customers do not have access to a PRASA is to Three actions are proposed to improve sector digital bank account or are discouraged from apply a results-­ performance in the short term. using it by high fees. In line with the proposal based approach in policy note 4 to authorize nonbanking insti- ■ Action 1: Incentivize PRASA to perform better tutions to issue e-­ money, the authorities could in allocating implement a system of e-­ payment, as several transfers; the The most direct way to incentivize PRASA is to apply African countries have done, Côte d’Ivoire and based approach in allocating transfers. Cen- a results-­ Tanzania among them. In addition to reducing Treasury could tral government transfers account for almost 90% of transaction costs for customers, an e-­ ticketing also consider PRASA’s budget, at close to R20 billion a year. That system could enable the government to target opening these gives the government (especially the National Trea- vouchers to poor customers, which would re- sury) considerable leverage over PRASA. These trans- duce the high cost of transportation for them. funds up to fers, which are currently based mainly on PRASA’s • Tightening security and reducing thefts of rail in- competition capacity and needs, could also take its performance frastructure through real-­time monitoring of crime into account. Such a results-­based approach would areas. The government could scale up the pilot be similar to the incentive scheme the government project in Cape Town that uses closed-­ circuit tele- used in the energy sector, under the conditional debt vision cameras to relay data to security providers ■ 6 Priority 3: Making cities engines of growth and economic inclusion and the police in real time for immediate action. of infrastructure and maintenance on par with the With added data analytics and artificial intelli- best in the world. The model highlights the benefits gence capabilities, the security system could re- of having a capable, competent, independent con- veal other information relating to possible crimes cession manager paired with experienced conces- or incidents. sionaires and operators through a well-­ structured A public-­private contract. partnership ■ Action 3: Consider alternative models for passenger Another delivery model to consider is public rail investment and operations partnerships with the private sector, especially for passenger on urban corridors with commercial prospects. A rail could ease government While government strategies call for opening the public-­private partnership for passenger rail could passenger railway sector to operators other than ease government budget constraints while offering PRASA, no actions have been taken in that direc- opportunities to acquire new technologies and ca- budget tion.15 Inaction reflects mainly political economy pabilities. Such partnerships, which can take differ- constraints concerns, but also an inadequate legal framework. sharing ent forms, require clear and transparent risk-­ Legal reforms are necessary to empower munici- mechanisms (box 2). One challenge is managing and while offering palities to choose the solution best suited to their coordinating the responsibilities of the central, pro- opportunities jurisdiction and to develop an integrated transport vincial, and municipal authorities and PRASA. to acquire new plan that creates an interconnected transit system that includes MBTs. Currently, the licensing process Priority area 2: Improving the efficiency technologies is under ­PRASA’s control. and affordability of minibus taxis and and capabilities ■ Meanwhile, the subnational authorities could integrating them into the urban transit find inspiration for opening railways to private op- system erators in the Gautrain Rapid Rail Service model ad- Privately run MBT services have become by far the opted in Gauteng Province in 2006, which includes most used means of urban mass transit in South Af- an independent concession manager and experi- rica. Private MBT services have expanded as a mar- enced operators. The Gautrain Management Agen- ket response to the government’s failure over many cy was established to manage and oversee conces- years to maintain and expand the public transit sys- sion agreements for the province and coordinate tem. By conservative estimates, the MBT industry and exchange information with institutions, au- has grown to 200,000–250,000 vehicles, with an- thorities, and professional bodies on rail matters in nual income of approximately R50 billion. However, South Africa. These concessions have been provid- private MBT services have also suffered from sev- ing a consistently high quality of service for nearly quality eral shortcomings that have resulted in low-­ 15 years, with operating performance and quality and costly services. Passengers complain about the private partnerships in urban transit Box 2  Lessons from international experience with public-­ systems Increasingly, governments are entering into partnerships with the private sector for urban transit projects. While most experience with such public-­ private partnerships has been in high-­ income countries (Australia, United Kingdom, United States), some middle-­ income countries (Brazil, Ma- laysia) have adopted such partnerships in recent years. The main lessons of experience are the following: • Design long-­term contract because gains take time to accrue. • Set up clear and transparent risk-­sharing mechanisms and responsibilities, especially for maintenance. • Agree up front on payment mechanisms, including procedures for tariff adjustments. • Provide technical assistance and training for local staff. • Integrate projects for infrastructure, stations, parking, and adjacent infrastructure. Priority 3: Making cities engines of growth and economic inclusion 7■ high cost, the lack of integration with other pas- Several steps can be taken to integrate urban senger transportation modes, and insecurity (poor transit modes: maintenance of vehicles, accidents, robberies). Ad- • Establishing a dialogue between the government dressing the challenges requires a multidimensional and the MBT industry to identify the reforms and approach implemented through a close partnership supports needed to expedite industry develop- between the private and public sectors, as in the ment and consolidation. Since the National Taxi following three proposed actions. Task Team reports of 1996, both industry and government have signaled their intentions to ■ Action 4: Reduce the cost of transportation for poor pursue this agenda, but intentions have not been customers followed up by actions.16 • Supporting municipalities with initiatives and Subsidizing MBT trips for the poorest segment of technical support to better integrate MBTs into the population through vouchers is a step that can public transit networks. Municipalities are already be taken immediately. A traveler using MBTs spends pursuing measures to integrate MBTs into their an average of R960 a month, well above the average planning for rapid transit. cost of buses (R745) and trains (R581). The subsidy • Streamlining, updating, modernizing, and strength- would enable low-­ income workers to retain more ening regulatory structures to improve performance of their earnings. The government could distrib- and responsiveness to a restructured MBT sector. ute vouchers to the poorest households through The current structure of provincial regulatory en- a mobile application or an electronic card, using tities interfacing with municipal planning author- the same distribution system as for other income ities on licensing and management, coupled with grants. The subsidy should be given to customers outdated regulations and under-­ resourcing, has rather than operators to avoid capture of the ben- led to severe licensing backlogs. This undermines efit. The subsidy could be financed by reallocating the objectives of regulation and enforcement. In funds from consolidating or cutting other programs addition, the regulatory system is not fully pre- ■ Residents of (see policy note 1 for details). pared for MBT consolidation and will need some South Africa’s adjustments to support this transition. ■ Action 5: Foster the integration of minibus taxis largest cities into the public transit system ■ Action 6: Incentivize individual minibus taxi face long and operators to cooperate and organize themselves expensive Residents of South Africa’s largest cities face long and expensive commutes in part because of the The lack of an organizing structure in the MBT in- commutes in part poor integration of different modes of transport. dustry creates perverse incentives, with individual because of the As a result, passengers often have to pay multiple drivers/operators competing recklessly with one times to move from one place to another, increas- another to maximize profits. With earnings based poor integration ing congestion and travel times. To deal with the on the number of passengers served, competition of different modes problems created by inadequate regulation and leg- among drivers for passengers, especially during of transport islation, the MBT companies have organized them- peak periods, leads to speeding and other forms of selves into route-­ based associations affiliated with reckless driving. It also results in long working hours national representative bodies such as the South for drivers. The combination of reckless driving and African National Taxi Council and the National Taxi fatigue leads to high accident rates. Alliance. While these structures impose some order, Shifting to a more collaborative approach could they have also led to uneven spatial coverage and benefit drivers and customers. Greater cooperation limited integration between MBTs and other transit and consolidation would bring scale, organizational modes. Integration­ —­of payment systems, routing, capacity, and resources that would enable drivers to scheduling, service quality standards, and planning maintain their vehicle or invest in newer ones. The high and investment­ —­is challenging without some con- cost and difficult access to financing and insurance are solidation in the industry. binding constraints on the sector’s development.17 ■ 8 Priority 3: Making cities engines of growth and economic inclusion To accelerate cooperation, consolidation, and integrate excluded areas. At least three factors ex- corporatization of the MBT industry, the authorities plain urban planning’s lack of progress in reducing can build on the lessons from local cost-­ effective major spatial inefficiencies and inequalities: models, including pilot projects in Cape Town and • Overly restrictive land and zoning regulations. Gauteng Province.18 The program of Cape Town’s While considerable progress has been made in en- Transport Operating Company envisages devel- abling higher density formal development in urban oping a joint plan for the MBT industry and pub- areas, municipal zoning schemes and the National lic transit. The Gauteng Provincial Government’s Building Regulations do not make sufficient pro- Smart Mobility initiative plans to merge MBT serv- vision for less formal development. Not enough ices with conventional public transit offerings by in- is being done to rezone, acquire, or release land cluding MBTs in bus service contracting processes for new affordable development close to urban and allocating a portion of subsidized contracts to centers. As a result, the urban poor often opt to MBTs. The Gautrain Management Agency already live in dangerous, informal settlements closer to has agreements in place with Gauteng taxi associa- economic opportunities rather than in formal de- tions to provide contracted feeder services to their velopments far from the center. Amending the Gautrain stations. Moreover, several bus rapid tran- Spatial Planning and Land Use Management Act sit companies, formed mainly by MBT stakeholders, and increasing the flexibility of municipal zoning have been operating for nearly a decade. and land use management schemes are critical to Government intervention, including technical enabling safe, less formal development. and financial support to MBT owners, is crucial for • Few incentives for investors to develop projects creating a more efficient MBT market. The indus- in strategic locations or underserved areas. Post-­ Government try lacks the ability to transition to a more efficient Apartheid housing policies have inadvertently intervention market on its own. That requires new operating supported the development of residential areas models, technologies, and financing plans, along far from economic centers, often because land is crucial for with legal and change management support. More and construction costs are cheaper. One of the creating a more efficient minibus critically, the transition requires access to afford- most visible failures is the dearth of housing de- able capital for fleet and support facilities. Mobiliz- velopments around transit stations, reflecting a ing private capital for these transitions is very chal- lack of coordinated planning and development taxi market, lenging without state support. Incentives similar to between government departments and agencies as the industry those in the bounce-­ back credit schemes offered responsible for land use and transport. Addition- to businesses purchasing solar equipment could be ally, land speculation and gentrification around cannot do so considered for operators that agree to consolidate prime urban transit hubs have driven up prop- on its own ■ and work in partnership with the government.19 erty prices in these strategic locations, making The government can support private operators them unaffordable for lower-­ income residents in organizing themselves by helping them develop and small businesses. These residential patterns the tools needed for better coordination. Improved exacerbate social and economic inequality and data collection on the MBT system’s operation limit the potential economic benefits of mixed-­ using just-­ in-time digital platforms could facilitate use station hubs. the assessment of performance metrics and pas- • Missing or incomplete information and data chal- senger preferences, which in turn can enable the lenges. The lack of necessary data contributes more timely and efficient allocation of vehicles. to poor management by urban planners, coordi- nation failures across agencies, and inadequate Priority area 3: Redirecting urban investment decisions. planning policies and regulations toward Addressing these three challenges requires sub- higher densification stantial investments in buildings and infrastructure. Urban development initiatives have not significantly However, in the short term, policymakers could im- reduced the spatial divide in South Africa, which is plement four key actions to enable increased urban a major constraint to creating market linkages that density and connectivity. Priority 3: Making cities engines of growth and economic inclusion 9■ ■ Action 7: Adjust zoning and land use regulations to management, clean water, and sanitation, develop- encourage land and building development closer to ers are able to significantly reduce project timelines, business areas resulting in cost savings and increased efficiency in ■ Building codes the construction processes. should enable Strategically amending municipal zoning codes to re- In the short term, the authorities could consider duce costs, along with tightening enforcement, can the following measures: development in go a long way in incentivizing affordable, centrally • Relaxing the National Building Regulations  to central areas, while located housing. Green or brownfield development allow cheaper, alternative building materials and the construction in central, well-­located nodes is often expensive reduce accessibility restrictions. because of higher land costs relative to the periph- • Relaxing municipal zoning regulations t  o allow for of foundational ery. Building codes should be reformed to enable higher densities by increasing floor area ratios, infrastructure development in central areas. Reducing parking re- building coverage ratios, and height restrictions; quirements for properties adjacent to public transit by allowing greater density and mixed-­ use mul- to create future corridors, for example, can reduce building costs. tifamily housing; and by reducing parking and capacity can Another important challenge is weak code enforce- elevator requirements. incentivize ment. Corruption in the construction industry is es- • Amending the Spatial Planning and Land Use Man­ timated to cost the state about R10 billion a year. age­ment Act to enable safe, less formal development. development Proactive land acquisition strategies are easing • Developing form-­ based guidelines that comple- near employment constraints to land ownership, which have long hin- ment conventional zoning for development with- dered urban development and inclusive growth in in strategic transport corridors,  including street opportunities many cities. Land acquisition strategies, such as those fronts, building typologies, ground floor activi- being implemented under Johannesburg’s Corridors ties, public spaces, and private-­ public boundaries. of Freedom and Inner-­ City Rejuvenation Programs, are demonstrating effectiveness. The approach ■ Action 8: Adjust pricing mechanisms to encourage starts with identifying and acquiring strategically lo- land development in strategic areas cated land parcels using municipal funds to purchase plots in the open market. Subsequently, the authority Land prices are high in business areas, mainly be- allocates capital funds to develop the infrastructure cause of limited supply. Another factor is land spec- necessary to support future developments in these ulation based on anticipated future price increases. targeted areas. Through a formal request for propos- Local governments can navigate this obstacle by al process, the local authority then seeks private sec- auctioning public land or directly releasing land for tor partners for long-­term lease agreements, typically specific projects, such as the Johannesburg Inner-­ spanning 50 years, that lay out specific development City Rejuvenation Program. Since 2017, this initia- guidelines and social objectives. This approach has tive has released city-­owned properties to the pri- yielded positive results in increasing high-­ density vate sector for redevelopment through long-­ term developments and inclusive housing opportunities leases with strict development conditions. Devel- in the identified corridors. By taking the initiative on opment projects now include mixed-­ use affordable land acquisition, Johannesburg is tackling land own- housing, student accommodations, and affordable ership issues while promoting sustainable urban de- space for small and medium enterprises. The initial velopment and socioeconomic growth. group of developments generated about 10,000 Similarly, constructing foundational infrastruc- jobs within the city and built approximately 6,500 ture to create future capacity plays a crucial role housing units rented at more affordable rates. in incentivizing development closer to employment In addition, public land allocation, local munici- opportunities. This strategic approach by local au- palities can reduce the price of land in dense areas thorities creates a valuable incentive for develop- in other ways: ers to establish projects close to job hubs. When • Introducing financial bonuses for social housing local authorities offer ready-­ to-use infrastructure density areas close to business projects in high-­ capacity, such as electricity, roads, stormwater centers. One option is conditional grants for ■ 10 Priority 3: Making cities engines of growth and economic inclusion housing and related infrastructure that include ■ Action 9: Facilitate access to finance for projects in a location criterion. strategic areas • Implementing mechanism to capture land values,  sponsored by municipalities, to fund infrastructure Another constraint to land development in stra- improvements and public amenities around stra- tegic areas is the cost of financing for developers. tegic locations, including around transit stations. The following options could be considered by the • Strengthening regulatory mechanisms, such as authorities: taxes, to discourage private land from laying idle, private • Developing financial incentives for public-­ vacant, or underutilized and to consolidate frag- partnerships to create affordable housing and mented ownership of land around strategic loca- commercial spaces c  lose to vibrant mixed-­use tions  (e.g., transit stations). As it stands, the tariff transit station hubs. Another rates imposed under municipal rate policies on • Collaborating with the financial sector to expand constraint various categories of land use, including vacant mortgages/lending to projects close to business- land, are uniform regardless of the land’s strate- es and transit centers, i ncluding through the to land gic importance. Local authorities could explore bounce-­ back credit schemes advocated in prior- development in strategic areas the use of a grading system within the vacant ity note 4. land use category, which could ensure that prop- • Encouraging investments from private and insti- erties are fairly assessed and taxed in accordance tutional funds. Several labor and trade unions is the cost of with their strategic value within a neighborhood. in South Africa have substantial resources that financing for developers ■ Box 3  Opportunity zones in the United States Opportunity zones (OZs) were designed in the United States with a simple premise: the tax code should encourage private investment in communities that are struggling to attract capital, cre- ate jobs, and lift residents out of poverty. OZs were first proposed in the bipartisan Investing in Opportunity Act, introduced in Congress in 2016. OZs provide federal incentives for certain types of long-­ term, productive investments in low-­income urban and rural communities nationwide. • OZs are low-­ income census tracts nominated by state governors and certified by the U.S. De- partment of the Treasury on which investors can make qualifying investments in new projects and enterprises in exchange for certain federal capital gains tax reductions. There are more than 8,700 OZs in the country, including in every state and territory. At the time of designa- tion, 97.4% of the OZ communities qualified for OZ status under the Treasury Department’s “low-­ income community” standard, and 2.6% qualified under the law’s provision allowing tracts adjacent to a low-­ income community to receive designation under certain circumstances. Fully 71% of OZ communities met Treasury’s “severely distressed” definition. • All eligible investments must be made through a Qualified Opportunity Fund (QOF) to be eligi- ble for the tax incentive. A QOF is any private investment vehicle organized as a corporation or partnership for the purpose of investing in OZs. QOFs must register with the Internal Revenue Service and invest at least 90% of their capital in qualifying investments within OZ communities. • OZs offer investors three incentives for cashing out of these investments and putting their cap- ital gains to work supporting the economic development of low-­ income communities. • The taxes due on any capital gains placed into a QOF may be deferred until December 31, 2026. • Investors who keep their money in a QOF for five years receive a 10% step-­ up in basis on that original investment and an additional 5% after seven years. • Investors who hold their investments in OZs for at least 10 years face no capital gains taxes on the investments when they sell them. Priority 3: Making cities engines of growth and economic inclusion 11 ■ could be used for local economic development. to develop effective strategies for sustainable and For example, the United States created opportu- equitable land management. nity zones in poor urban communities to attract The authorities could consider the following op- capital, create jobs, and lift residents out of pov- tions for improving data collection and sharing and erty (box 3). the use of digital tools: • Accelerating the development and use of digital ■ As cities expand ■ Action 10: Use digital tools to improve urban spatial planning platforms to boost information planning and coordination and evolve, collection and sharing. Building on the successes of several modern cities around the world, the planners must The rapid growth and changing dynamics of urban authorities could use spatial planning platforms continually update areas make it challenging for urban planners to keep to lay the foundation for smarter urban planning and reconcile pace with the evolving data landscape. As cities ex- and management (box 4). pand and evolve, planners must continually update • Ensuring the efficient collection and sharing of data their data sets to and reconcile their data sets to accurately reflect needed to inform decisionmaking in numerous appli- accurately reflect the current state of land use and development. cations,  including urban planning, disaster risk man- Failure to do so can result in outdated and inaccu- agement, public financial management, transport, the current state rate information, leading to poor land management and citizen and business services. Spatial planning of land use and decisions. platforms also reduce fragmentation and informa- development Additionally, the fragmentation of data collec- tion asymmetries, which can improve institutional tion across different government agencies and coordination and implementation efficiency. private organizations makes it difficult to obtain a • Supporting local governments in developing inte- comprehensive view of a city’s land and resources. grated urban land use, housing, and transportation This lack of cohesive data can lead to inefficiencies plans that identify high-­ priority infrastructure in- and oversights in land management. Inaccurate or vestments i n electricity distribution, public tran- incomplete data can also exacerbate issues such as sit, road network expansion, and water supply urban sprawl, inefficient land use, and environmen- and sanitation. Clear capital investment plans tal degradation. Without a clear understanding of can then form the basis for a coherent financing the current state of urban land, planners struggle strategy based on potential revenues. ■ 12 Priority 3: Making cities engines of growth and economic inclusion Box 4  How smart cities around the world have used spatial planning platforms Improved urban planning. In Dhaka, Bangladesh, the World Bank supported the development of GeoDASH, a public geospatial data sharing, management, and visualization platform that promotes interagency coordination of urban planning and disaster risk management by facilitating the sharing of data, resources, and infrastructure between agencies. The platform has been used to assess the current conditions of schools­ their infrastructure, water and sanitation facilities, access to roads, —­ and disaster resilience. Geospatial layers have also been used to generate cyclone risk maps to guide investment plans for cyclone shelters in urban and rural areas, as well as a coastal embank- ment improvement project focused on arresting erosion of vulnerable coastal polders. The World Bank is also supporting the development of a spatial planning platform in Can Tho, Vietnam, that will integrate spatial and nonspatial data on a publicly accessible web portal, allowing governments, businesses, and citizens to access geospatial information for urban planning, business services, mass transit and traffic management, disaster risk management, and other applications. Improved infrastructure asset management. Yunnan Province in China wanted to expand its highway network to boost economic development, but it lacked asset management systems and integrated databases so that it could monitor road conditions and natural disasters and optimize road main- tenance strategies. An integrated management information system was established with support from the World Bank to collect data on vehicular traffic and the performance of large infrastructure projects. The data were used in decisionmaking and performance evaluation of highway assets. Increased resilience to climate change. In Sri Lanka, the World Bank helped develop RiskInfo, a pub- lic web-­ based disaster risk information platform for collecting, storing, processing, sharing, and analyzing geospatial data, including high-­ quality aerial imagery, risk exposure data, historical flood maps, and land-­ use maps. The platform is used to develop local multi-­ hazard risk maps that enhance understanding of disaster exposure, support disaster planning and preparedness and emergency response operations, and guide prioritization of resources for recovery and financial assistance. Timely and reliable data that allow for near real-­time disaster monitoring have enabled more effec- tive institutional coordination in Sri Lanka, especially during emergency responses. Priority 3: Making cities engines of growth and economic inclusion 13 ■ Annex table A1  Ranking of measures through the “FIT” filter of feasibility, impact, and timing Feasible Impactful Timely Total Priority 1: Enhancing the performance of passenger railways Action 1: Incentivize PRASA to based approach for allocating 1. Using a results-­ 3 3 2 8 perform better grants Action 2: Leverage information 2. Using digital dashboards to improve municipal 3 2 3 8 technologies to increase management management of urban transit systems efficiency 3. Introducing digital ticketing for customers 3 2 3 8 without digital bank accounts 4. Tightening security and reducing thefts of rail 1 3 2 6 time monitoring of infrastructure through real-­ crime areas Action 3: Consider alternative models 5. Opening the passenger railway sector to 1 3 2 6 for passenger rail investment and private operators operations 6. Seeking partnerships with the private sector, 1 3 2 6 especially on urban corridors with commercial prospects Priority 2: Improving the efficiency and affordability of minibus taxis and integrating them into the urban transit system Action 4: Reduce the cost of 7. Distributing vouchers to poor customers 3 3 3 9 transportation for poor customers Action 5: Foster the integration of 8. Establishing a dialogue between the 2 2 2 6 minibus taxis into the public transit government and the minibus taxi industry to system identify the reforms and supports needed to expedite industry development and consolidation 9. Supporting municipalities with initiatives and 2 3 1 6 technical support to better integrate minibus taxis into public transit networks 10. Streamlining, updating, modernizing, and 2 2 2 6 strengthening regulatory structures to improve performance and responsiveness to a restructured minibus taxi sector Action 6: Incentivize individual 11. Building on the lessons from pilot projects 2 3 2 7 minibus taxi operators to cooperate in Cape Town and Gauteng Province to and organize themselves accelerate cooperation, consolidation, and corporatization of the minibus taxi sector 12. Providing technical and financial support to 2 2 2 6 minibus taxi owners to create a more efficient market 13. Supporting private operators in organizing 3 2 2 7 themselves by helping them develop the data and digital tools needed for better coordination ■ 14 Priority 3: Making cities engines of growth and economic inclusion Feasible Impactful Timely Total Priority 3: Redirecting urban planning policies and regulations toward higher densification Action 7: Adjust zoning and land 14. Relaxing National Building Regulations 3 3 2 8 use regulations to encourage land and municipal zoning regulations and and building development closer to amending the Spatial Planning and Land Use business areas Management Act 15. Developing form-­based guidelines for 2 2 2 6 development in strategic transport corridors Action 8: Adjust pricing mechanisms 16. Introducing financial bonuses for social 3 3 2 8 to encourage land development in density areas close to housing projects in high-­ strategic areas business centers 17. Implementing mechanisms to capture land 2 2 2 6 values 18. Strengthening regulatory mechanisms to 2 3 1 6 discourage private land from laying idle and to consolidate fragmented land around strategic locations Action 9: Facilitate access to finance 19. Developing financial incentives for public-­ 2 3 2 7 for projects in strategic areas private partnerships to create affordable housing and commercial spaces close to transit hubs 20. Collaborating with the financial sector to 3 2 1 6 expand mortgages/lending to projects close to business and transit centers 21. Encouraging investments from private and 2 3 1 6 institutional funds Action 10: Use digital tools to improve 22. Accelerating the development and use of 3 2 3 8 urban planning and coordination digital spatial planning platforms to boost information collection and sharing 23. Ensuring the efficient collection and sharing 2 2 2 6 of data needed to inform decisionmaking in numerous applications 24. Supporting local governments in developing 2 3 3 8 integrated land use, housing, and priority transportation plans that identify high-­ infrastructure investments Source: Authors. Note: The scores range from 1 to 3, with 1 being the lowest. The actions with the highest score are highlighted in yellow. Priority 3: Making cities engines of growth and economic inclusion 15 ■ Notes 1. Car ownership is 90% for White households but just which was followed by the integrated rapid public 20% for black households (South Africa Statistics transit network program that was launched in 12 Office). urban centers. 2. J. Baez and V. Kshirsagar, 2024, “Spatial Impedi- 12. Implementation was supported with substantial ments to Economic Inclusion: An Analysis of South funding through a dedicated capital grants to par- Africa’s Local Labor Markets.” World Bank, unpub- ticipating cities for integrated rapid public transit lished manuscript. networks (more than $4 billion has been allocated 3. Virtual connectivity, which is becoming increas- to date) along with capital funding to PRASA for its ingly important for urban mobility, is not covered modernization program (targeting rolling stock, sta- in this note (see box 1 later in the text for some tion renewal, and signaling system upgrades). explanations). 13. Another reason that businesses have not been at- 4. There is a large literature on this topic, including tracted to poor areas is the low purchasing power of World Bank, 2009, World Development Report 2009: residents, explaining why the density of formal jobs Reshaping Economic Geography; V. Henderson, 2003, is three times lower in poor than in affluent urban “The Urbanization Process and Economic Growth: areas and why spatial exclusion is still prevalent in The So-What Question,” Journal of Urban Economics; all big cities. World Bank, 2014, “The Economics of M. Greenstone, R. Hornbeck, and E. Moretti, 2010, South African Townships.” “Identifying Agglomeration Spillovers: Evidence 14. J. Baez and V. Kshirsagar, 2024, “Spatial Impedi- from Winners and Losers of Large Plant Openings,” ments to Economic Inclusion: An Analysis of South Journal of Political Economy 118 (3), 536–598. Africa’s Local Labor Markets.” World Bank, unpub- 5. This is partly explained by faster population growth in lished manuscript. the main urban settlements, which continue to attract 15. This principle is in line with the 1996 white paper on the local migrants from the poorest, more rural provinces. National Transport Policy and National Land Trans- 6. The latest household survey available is for 2014. port Act (https://www.gov.za/documents/white​ 7. For example, Johannesburg’s population expanded -papers/national-transport-policy-white-paper-20​ more rapidly than the national average, reinforcing -aug-1996) and the 2009 National Land Transport the decline in income per capita in this city. Act (updated in 2021). The rationale was twofold: 8. https://www.statssa.gov.za/publications/P0320​ bringing the decision process closer to customers /P03202020.pdf. (the well-known subsidiary principle in public fi- 9. M. Shah and F. Sturzenegger, 2022, “Search, Trans- nance) and addressing some of the coordination fail- port Costs, and Labor Markets in South Africa.” CID ures between central and local authorities. Research Fellow and Graduate Student Working 16. https://documents1.worldbank.org/curated/en​ Paper Series 2022.142, Harvard University, Cam- /594051468781195258/pdf/multi0page.pdf. bridge, MA, October. 17. The World Bank, 2023, “Transforming Transit in 10. J. Morisset, 2023, To reduce South Africa’s unemploy- South Africa: Formalizing Minibus Taxi Services in ment, make work more attractive, Brookings. South Africa,” December draft. / 11. https://www.gov.za/documents/white-papers​ 18. This is one of the lessons of the pilot project sup- national-transpor t-policy-white-paper-20 -aug​ ported by the World Bank and the Development -1996. See also, for example, the 2007 Public Trans- Bank of Southern Africa in Gauteng Province. port Strategy and Action Plan (DoT 2007) (PTSAP), 19. See policy note 2 for more details on this scheme. ■ 16 Priority 3: Making cities engines of growth and economic inclusion Priority 4 Injecting dynamism into the private sector SOUTH AFRICA POLICY PACKAGE © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; internet: www.worldbank.org Some rights reserved This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Priority 4 Injecting dynamism into the private sector SOUTH AFRICA POLICY PACKAGE Contents Determine what is stifling private sector growth and unleash its potential 1 South Africa’s story of low productivity and the imposing presence of the state 1 South Africa’s productivity losses are costly 2 Low competition, low productivity 3 Excessive government intervention reinforces private sector inertia 4 growth firms, with a focus on two priority areas Unleashing the potential of high-­ 6 Priority area 1: Fostering competitiveness in industries of the future 8 Action 1: Upgrade the competition framework 8 Action 2: Facilitate foreign direct investment 8 Action 3: Harness the growth of digital finance 10 Action 4: Build a platform for developing a green economy using catalytic market instruments 10 Priority area 2: Upgrading the capabilities of high-­ growth small and medium enterprises 11 Action 5: Facilitate access to finance for small and medium enterprises 12 Action 6: Upgrade workers’ and managers’ skills 13 income earners Action 7: Incentivize labor search and mobility for low-­ 13 Notes 16 Box 1 South Africa’s strong potential in the battery market 12 Figures 1 South Africa is on the wrong side of productivity growth, 2011–2022 2 2 The gap in labor productivity between South Africa and the world is widening in all sectors, 2001–2017 2 3 Drastic declines in labor productivity in South Africa relative to peers 3 4 South Africa has lost its development edge compared with Malaysia, 1990–2019 3 5 Entry and exit of firms, 2021 3 6 Foreign direct investment lags that in peer economies, 2011–19 4 7 The top-­10 constraints reported by South African and Sub-­ Saharan African firms, 2020 5 8 A majority of South African state enterprises operate in competitive sectors of the domestic economy, and they operate across an unusually wide range of sectors 6 9 A guiding framework for prioritizing policies to enhance the development of high-­ growth firms 7 Tables 1 Large firm dominance in South Africa compared with peers and the European Union, 2019 4 A1 Ranking of measures through the “FIT” filter of feasibility, impact, and timing 15 iii ■ Determine what is stifling private sector growth and unleash its potential Private sector growth is the key to rapid and inclu- green industries, where the country already pos- sive economic development. When firms expand, sesses strategic assets and has the potential to they invest in capital and technology, hiring more generate numerous direct and indirect employment people and fostering virtuous circles between prod- opportunities, and supporting the emergence of uct and input markets, crucial for inclusive growth. dynamic and high-growth small and medium start- This model has not yielded the desired outcomes in ups. In each of these areas, emphasis should go first South Africa for many years, however. On average, to short-­ term actions that create momentum for firms have lost about 8%–10% of their productivity longer term reforms. To guide policymakers, this since 2011, meaning that they are becoming less ef- note presents a menu of seven actions under two ficient at using resources. These productivity loss- key priority areas, along with suggested reforms. Swiftly changing es, unprecedented globally over such an extended Swiftly changing global dynamics make it even global dynamics period, undermine competitiveness and inhibit the more imperative that South Africa act rapidly to fa- ability of the country’s initiatives to alleviate some cilitate private sector dynamism.1 The rapid emer- make it of the highest unemployment, poverty, and in- gence of megatrends, including fast-­ moving tech- imperative that South Africa equality rates globally. nological advances, presents both opportunities for To end this stagnation, policymakers need to innovation and growth and challenges such as digi- confront the stultifying presence of the state, tal exclusion and job displacement. Climate change act rapidly which has increasingly curbed the growth potential compounds the challenges, manifesting particularly to facilitate of the private sector. Complicated and restrictive as extreme weather events and shifts in agricultur- regulations, along with direct market interventions al patterns within the country. Additionally, geo- private sector such as those of state-­ owned enterprises (SOEs) political shifts and the emergence of new regional dynamism ■ with quasi-­ monopolistic control, have created mar- trade agreements, notably the African Continental ket distortions. Creative destruction, the natural Free Trade Area, are altering trade, investment, and process of new firms entering the market and mori- geopolitical alliances. Successfully navigating these bund ones exiting, which is vital for a vibrant private global megatrends to increase the country’s resil- sector, has been largely absent. This stagnation has ience and enable sustainable development necessi- stifled innovation and diverted human and financial tates strategies that capitalize on opportunities and resources from future technologies and industries, address challenges. A robust and thriving private disadvantaging both workers and customers. sector is critical to this effort. Decisive reforms are essential to foster dyna- mism in the private sector. The government needs South Africa’s story of low productivity to focus on establishing an enabling environment and the imposing presence of the state that supports firms with the greatest growth po- Productivity improvements are the foundation tential. Attention needs to focus on two connect- for the dynamic firm behavior that is so crucial ed areas: promoting competition and foreign direct for economic growth and job creation. As Nobel investment (FDI), particularly in digital finance and Laureate Paul Krugman argued, “productivity isn’t 1■ everything, but in the long run it’s almost every- over that period been the same as India’s, its GDP thing.” Productivity rises when firms boost their would have grown by 6.6% a year. firm productivity gains internal capabilities (within-­ South Africa’s declining productivity has affect- through innovation or adoption of new technolo- ed the entire economy but has been especially evi- gies or better management techniques) or when re- dent in labor. The gap in labor productivity between sources move from low- to high-­ productivity firms South Africa and the global average has widened (between-­ firm productivity gains) as less efficient in all sectors, with the biggest declines in agricul- firms exit the market and new, more efficient firms ture and manufacturing (figure 2). World Bank enter it. Each of these components has a positive enterprise surveys find even wider gaps between impact on aggregate productivity growth and eco- South Africa and other emerging market economies nomic transformation. (figure 3).2 While there have been “niches of excel- lence” in South Africa, such as in communication, ■ Understanding South Africa’s productivity losses are costly they are rare. South Africa’s Understanding South Africa’s productivity chal- South Africa’s productivity declined 0.8% a year lenge is crucial because of the direct effects on eco- productivity over the past decade, explaining to a large extent nomic growth and inclusion and the indirect effects challenge is the limited expansion of the economy. Contrast this on the accumulation of physical and human capital crucial because weak performance with the rapid annual productivi- and the country’s competitiveness in internation- ty growth in successful economies like India (+2.7%), al markets. Empirical evidence shows that low-­ of the effects on Vietnam (+1.2%), China (+1.1%), and Malaysia (+0.5%) productivity firms struggle to invest adequately economic growth (figure 1). Had South Africa’s productivity remained in physical and human capital and to develop new the same as it was in 2011 instead of declining, its technologies, and those investment deficits exacer- and inclusion, GDP would have expanded by 3.9% a year between bate their productivity woes.3 This vicious circle ex- accumulation 2011 and 2022. And had its productivity growth plains why South Africa’s employment, exports, and of physical and Figure 1  South Africa is on the wrong side of Figure 2  The gap in labor productivity between human capital, and productivity growth, 2011–2022 South Africa and the world is widening in all competitiveness Growth decomposition (percent) sectors, 2001–2017 in international 12 Labor productivity gap (Index: 2001 = 1) markets Real GDP 3 9 Agriculture 6 2 Manufacturing 3 Tradable services 1 Nontradable services 0 –3 South Malaysia Türkiye Vietnam China India Africa 0 2001 2010 2017 Capital stock Labor Total factor productivity Source: Authors using data from World Development Indica- Source: Authors using data from World Development Indica- tors database. tors database. Note: Solow growth decomposition. ■ 2 Priority 4: Injecting dynamism into the private sector Figure 3  Drastic declines in labor productivity in Figure 4  South Africa has lost its development South Africa relative to peers edge compared with Malaysia, 1990–2019 Real annual labour productivity growth (percent) Multiplier 5 8 South Africa 7.3 Malaysia 2.3 2.2 0 –0.8 6 5.9 –4.3 –4.9 –5 4 3.9 –10 2 2.3 2.3 –15 –16.9 1.4 –20 0 India Indonesia Malaysia South Türkiye Vietnam Value of Value of Employment Africa capital stock exports (millions) .enterprise​ Source: World Bank Enterprise Surveys (https://www​ Source: IMF and World Bank databases. surveys.org/). South Africa’s Figure 5  Entry and exit of firms, 2021 Note: The enterprise survey was conducted in different years productivity in different countries. It was conducted in India in 2022, Indonesia in 2023, Malaysia in 2019, South Africa in 2020, Percent of adult population decline is, to a Türkiye in 2019, and Vietnam in 2023. 15 Net entry large extent, 13.9 Destruction rate caused by physical capital (as measured by the value of capital the lack of stock) expanded much slower than Malaysia’s, for 10 9.8 competition in example, between 1990 and 2019 (figure 4).4 most economic Low competition, low productivity 6.5 sectors, 5 which allows South Africa’s productivity decline is, to a large ex- tent, caused by the lack of competition in most eco- incumbents nomic sectors, which allows incumbents to remain 1.3 2.1 2.0 to remain unchallenged, sapping their drive to innovate. Lack unchallenged ■ 0 South Global Upper middle of competition weakens the creative destruction Africa income process, whereby obsolete firms are replaced by innovate ones, and results in the lack of dynamism Source: Global Entrepreneurship Monitor. that has characterized the private sector in South Africa for years: • Large firms have changed little over time. Of the • Small and medium enterprises (SMEs) have 10 largest companies (by capitalization) in South grown more slowly in South Africa than in other Africa, 8 were also among the top 10 in 2000. middle-­ income countries. The net rate of new Most of these firms are in traditional sectors like firm entry is notably sluggish, at approximately finance and mining, with two exceptions in the 60 percent of that in countries at similar income communication sector. levels (figure 5). Priority 4: Injecting dynamism into the private sector 3■ Figure 6  Foreign direct investment lags that in So, the dominance of large incumbent firms has peer economies, 2011–19 been only weakly challenged. Large incumbents continue to hold disproportionately high shares of Net inflow (percent of GDP) revenue and employment in South Africa compared 5 with other middle-­ income countries and counter- 4.8 4.6 parts in the European Union (table 1). The domi- 4 nance of large incumbent firms makes it difficult for new firms to enter the market and allows incum- bents to benefit from high markups. In concentrat- 3.3 3 ed markets, where firm entry and exit are limited, markups exceed global standards.5 Markups by 2 2.2 publicly listed firms increased 25% in South Africa from 2000 to 2016, more than four times the aver- 1.6 age global increase (6%).6 1 1.1 Market concentration has substantial costs for the economy, and these have risen over time.7 0 When market power is concentrated in a few domi- South Türkiye China Malaysia Vietnam Brazil Africa nant firms, markets are unlikely to innovate and find solutions that will allow them to remain competitive Source: Authors using World Bank data. https://data.world​ over time. The International Monetary Fund esti- bank.org. mates that South Africa could boost GDP per capita growth by 1 percentage point in the short term and ■ Firms in South • The private sector’s lack of dynamism makes it up to 2.5 percentage points in the long-­term by im- Africa face harder to attract high-­ value FDI. While South proving contestability in key markets. 8 Africa is host to several multinationals, they tend elevated entry to be heavily concentrated in natural resources Excessive government intervention reinforces private and operational sectors. The country’s attractiveness to FDI lags sector inertia costs economies like Türkiye, China, Malaysia, Viet- nam, and Brazil (figure 6). Numerous studies have concluded that firms in South Africa face elevated entry and operational costs (figure 7).9 Some costs, such as those associ- Table 1  Large firm dominance in South Africa ated with crime, corruption, and access to electric- compared with peers and the European Union, ity, were as high as or higher than the average for 2019 Sub-­ Saharan Africa in 2020, and some have likely Share of Share of risen since then due to breakdowns in infrastructure labor force national GDP services, especially electricity, transport, and water. Country or group (%) (%) Other costs are related to factors within firms, such South Africa 74 61 as limited skills, poor internal organization, and out- Middle-­income dated technology and equipment. And still others countries 35 54 are related to serious failures by key stakeholders, European Union 32 43 such as the government, banks, and skill developers. Government failure is evident in the top constraint Source: McKinsey, 2020, ”How South African SMEs can sur- reported by firms, which is the poor quality of elec- vive and thrive post COVID-19,” https://www.mckinsey.com/ tricity services (the sector is dominated by the pub- featured-insights/middle-east-and-africa/how-south-african​ lic utility Eskom; see policy note 2) and other public -smes-can-survive-and-thrive-post-covid-19. goods such as transport, water, safety, and justice. Note: Large firms are defined as firms with a turnover of more Excessive and poorly designed public interven- than $22 million a year. tions have stifled private sector dynamism. The ■ 4 Priority 4: Injecting dynamism into the private sector 10 constraints reported by South African and Sub-­ Figure 7  The top-­ Saharan African firms, 2020 Percent of firms 60 50 South Africa, 2020 40 30 20 Sub-Saharan Africa 10 0 Electricity Access to Political Corruption Crime, theft, Courts Practices of Labor Access Tax finance instability and disorder the informal regulations to land rates sector Source: World Bank Enterprise Survey 2020. South African government has employed various and agriculture (figure 8).13 Several SOEs have industrial and labor policies to tackle historical ex- been found to have breached competition laws clusion, but in the process has created market dis- in trying to consolidate their market power.14 tortions and raised entry costs. Two undesirable Further, due to weak sectoral regulations and outcomes have been market dominance by SOEs corporate governance, many SOEs deliver poor and poorly designed regulations that suppress firm quality services, while facing huge financial and growth and competition:10 technical challenges. In addition to the electricity • Dominance of SOEs in several strategic sectors sector, such deterioration is evident in the water that deliver basic goods and services. During and transport sectors (see policy notes 2 and 3). Apartheid, large SOEs or “national champions” These inefficiencies in network industries create Productivity were established to provide subsidized resourc- substantial costs for businesses, lowering their needs to grow es for industrial production, leading to concen- productivity and depressing domestic demand.15 trated ownership and anticompetitive practices. • Well-­intended but poorly designed regulations 1%–2% a year International trade restrictions further strength- to correct market failures. South Africa’s SMEs to move South Africa toward ened incumbents’ market power. Building on the spend an average of 202 working days (3.7% of initial success of this model (for example, the the total workforce for the average SME) and public electricity utility Eskom was considered $39,000 (R532,801) annually on administrative high-­income a global leader in the early 2000s), 22 primary tasks.16 Additionally, labor regulations to protect country status SOEs and 82 subsidiaries are now operating in workers disproportionately burden small firms around 180 business segments along 47 supply by impeding their ability to hire and thus exac- and significantly chains.11 The World Bank’s Global Businesses of erbate unemployment, especially among youth. reduce poverty the State database records at least 725 active Furthermore, industrial and affirmative action by 2050 ■ businesses linked to the government through di- policies like the Broad-Based Black Economic Em- rect and indirect full, partial, and minority owner- powerment Act (B-­ BBEE), which are intended to ship.12 Shielded by protective policies, they wield extend shareholding to historically marginalized quasi-­ monopolistic power in network industries groups, have not been evaluated for effective- (energy and transport) and dominate in commer- ness and forgone public revenue, while creating cial activities such as manufacturing, finance, additional market distortions.17 Finally, there are Priority 4: Injecting dynamism into the private sector 5■ Figure 8  A majority of South African state enterprises operate in competitive sectors of the domestic economy, and they operate across an unusually wide range of sectors Nearly all state enterprises operate in competitive or The broad sectoral reach of South African state enterprises contestable economic segments  Percent 100 Finance Manufacturing Professional services Wholesale and retail trade 75 Digital Real estate Transport and storage Other services 50 Agriculture Construction Mining and quarrying Energy 25 Water and waste management Hospitality Unknown 0 0 25 50 75 100 125 150 South India Russia Vietnam Kenya Nigeria Brazil Africa Number of businesses of the state Competitive Contestable Traditional state-owned enterprises Natural monopoly Unknown All businesses of the state Source: World Bank Global Businesses of the State database 2019. severe regulatory limitations to competition in by liberalizing markets to increase contestability key sectors of South Africa’s economy: the level and competition, which are the main forces propel- ■ High-­growth of restrictiveness is close to three times high- ling a creative and dynamic economy. Other coun- firms are powerful er than that in the top-­ performing countries.18 tries have derived substantial gains from following these practices , not only creating a dynamic pri- drivers of job Unleashing the potential of high-­growth vate sector, but also reducing pressure on the pub- creation and firms, with a focus on two priority areas lic budget, creating new jobs, and producing more, output growth For the private sector to drive growth and em- better quality, and less expensive products. ployment in South Africa, productivity will need to Sustained productivity growth does not nec- by transferring rise 1%–2% a year. This is the rate of productivity essarily stem from improvements across all busi- knowledge, growth required to move South Africa toward high-­ nesses simultane­ ously but is typically driven by income country status and significantly reduce pov- advances in a small set of high-­ growth firms.20 A creating networks, erty by 2050, according to the long-­ term growth recent World Bank study found that high-­ growth and fostering model developed by the World Bank.19 While fast-­ firms are powerful drivers of job creation and out- competition growing economies in Asia have attained this rate put growth.21 While making up 20% or less of firms of productivity growth (see figure 1), it would rep- in manufacturing and services, high-­ growth firms resent a substantial turnaround for South Africa. generate as much as 80% of all new sales and job To achieve this goal, South African policymakers opportunities in these sectors. Apart from their piv- could apply two key lessons from successful econ- otal contribution to job creation and output growth, omies. First, focus on creating a conducive environ- high-­growth firms also produce positive spillovers ment that fosters the development of high-growth to the economy by transferring knowledge, creat- firms and industries that could in turn provide wide ing networks, and fostering competition, leading to economic benefits. Second, minimize interventions price reductions. ■ 6 Priority 4: Injecting dynamism into the private sector Most high-­ growth firms in rapidly growing econ- benefited from global forces and the technolog- omies emerge from two transformational process- ical revolution, but the results would likely not es. First, many high-­ tech startups experience rapid have been as impressive had the authorities not A strategy to and sustained growth due to qualities intrinsic to fostered greater contestability. This lesson could support the the firm. Examples include Flipkart in India, Airbnb be replicated in other sectors, such as digital fi- in the United States, and Bolt in Estonia. The pol- nance and green industries. creation and icy objective is to provide such firms with access • Upgrading the capabilities of high-­ growth SMEs. A scaling up of high-­growth to financial and technical resources that allow them combination of steps to facilitate firm entry and to realize their potential. Second, some high-­ growth expansion can unleash their potential. The emer- firms emerge in strategic sectors in which the coun- gence of a vibrant SME startup and expansion firms in South try possesses or is cultivating a strong comparative ecosystem will not only generate productivity Africa could advantage. Examples include apparel and electron- gains but also gradually erode the dominance of ics in Vietnam, green industry in China, and call incumbent firms, increasing competition, creat- focus on center services in the Philippines. ing jobs, boosting innovation, and further ele- upgrading SME Targeting high-­ growth firms­ —­ by aiming to boost vating productivity over time. capabilities policy selectivity and efficiency­—­ has become increas- These two priorities could be supported by a set ingly appealing to policymakers in both high-­ income of seven actions and 18 proposed reforms. These and fostering and developing countries. However, for venture capi- actions and proposed reforms were selected for competitiveness talists as well as policymakers, it is more an art than a technical and political feasibility, ability to make a science to identify businesses with high ­ potential and difference (impact), and the feasibility of their im- in industries implement measures to expedite their growth. plementation in the short term. While the most de- of the future ■ Drawing from these lessons, this note advocates sirable actions would ideally meet all three criteria, a targeted strategy to support the creation and tradeoffs are likely to arise (see table A1 in the annex). scaling up of high-­ growth firms in South Africa by Of the 18 reforms, 5 have been assessed as the focusing on two priority areas: most technically and politically feasible, impactful, • Fostering competitiveness in industries of the and timely: future. Firms operating in these sectors need 1. Strengthening oversight of SOEs and liberaliz- to adapt to shifts in technology and consumer ing the markets in which they operate  to im- demand. Recent successes in the telecommu- prove their performance and make room for nication and aviation sectors demonstrate that private sector investments. South Africa can increase contestability by re- 2. Streamlining firm entry and operational prereq- ducing barriers to entry and aligning incentives uisites for foreign investors related to the 2013 to market needs. Today, after liberalization mea- B-­BBEE Act b  y making systematic use of Eq- sures in the early 2000s, the telecommunica- uity Equivalence Investment Programs when tion sector in South Africa is one of the most investors commit to train Black workers and advanced in the region, connecting more than develop supply chains with local businesses. 203  million people in 22 countries across Afri- 3. Authorizing nonbank institutions to issue mo- ca and the Middle East. The sector undoubtedly bile money  to reduce transaction costs and growth firms Figure 9  A guiding framework for prioritizing policies to enhance the development of high-­ Action 1: Upgrade the competition framework Priority 1: Fostering competitiveness Action 2: Facilitate foreign direct investment in industries of the future Action 3: Harness the growth of digital finance Enhancing performance of high-growth firms Action 4: Foster green industries Action 5: Facilitate access to finance for small and medium enterprises Priority 2: Upgrading the capabilities of high-growth small and medium firms Action 6: Upgrade workers’ and managers’ skills Action 7: Incentivize labor search and mobility for low-income earners Priority 4: Injecting dynamism into the private sector 7■ improve the financial inclusion of small and ■ Action 1: Upgrade the competition framework informal businesses. 4. Increasing liquidity in carbon credit markets  to Promoting competition and creating a level playing incentivize the shift to green sectors. field for firms will entail comprehensive reforms to 5. Increasing the provision of venture capital for prevent market dominance by a few firms, including high growth startups  to improve their access SOEs. Sustained efforts will be required to bring to external financing. about significant change. In the meantime, immedi- ate attention could be given to: Priority area 1: Fostering competitiveness • Enhancing the competition policy framework. Elim- in industries of the future inating regulations that restrict competition is an While promoting market openness is a fundamental important first step, as Australia, Chile, Colombia, principle underlying the recommendations in this and other countries have done to great effect. note, implementing it universally may prove chal- Systematic assessments of current regulations lenging, for two main reasons. First, strategic sec- and incentives are needed to evaluate their de- ■ South Africa’s tors, particularly infrastructure, may require direct sign appropriateness and impacts, including direct financial market state intervention due to their inherent public goods and indirect effects on markets, and to identify nature. Second, introducing measures to promote gaps requiring attention. Enforcement could be is the most competition and contestability could face opposi- strengthened by incorporating the perspectives of developed on tion from incumbent firms and interest groups that the Competition Commission of South Africa into the continent, could lose privileges during the transition. sectoral reforms aimed at promoting competition These challenges suggest the need to achieve and mitigating the risks of abuse of dominance. but small firms short-­term results and demonstrate successes. • Strengthening oversight of SOEs, and liberaliz- face the same Prioritizing knowledge industries has been a suc- ing the markets in which they operate  in order cessful strategy in several fast-­ growing economies, to attract private investments. In the short to challenges in such as Chile, Korea, and Malaysia, with productiv- medium terms, this will require systematizing getting access to ity increasing twice as fast in these industries as in information on the real economic footprint of financial products others and contributing substantially to job creation the state, including the government’s indirect in both developed and developing countries over and minority shareholdings. In the medium term, as they do in the past decade.22 the government could clearly delineate the dif- other countries South African policymakers could focus on two ferent economic rationales for state ownership future-­directed knowledge- and technology-­ intensive in commercial and noncommercial sectors, thus sectors: digital finance and the green econ­ omy­—­ separating their mandate. This would introduce activities that are just emerging in the country. This checks and balances for SOE expansion and approach would align with South Africa’s emerging state ownership of businesses, while identify- strengths in these two sectors, where investor in- ing less distortive mechanisms to achieve policy terest is already evident, including that of foreign objectives. Additionally, oversight mechanisms investors. Prioritizing digital finance and the green should be restructured to strengthen the gov- economy would require developing the skill and ernance frameworks and practices of SOEs by technology capabilities needed to meet current incorporating good governance principles into and future demand from local and international SOE management to enhance their perfor- consumers, driven by technological advances and mance. Systematically evaluating SOEs’ attain- climate considerations. ment of public policy goals is also essential, as is Four policy actions are proposed to maximize identifying the risks SOEs pose. the competitiveness of strategic, forward-­ looking sectors. Two are cross-­ sectoral and aim to improve ■ Action 2: Facilitate foreign direct investment the competition framework and ease the barriers to entry for FDI, and two are specific to digital finance FDI has been crucial to the success of East Asian econ- and the green economy. omies, allowing them to catch up with more advanced ■ 8 Priority 4: Injecting dynamism into the private sector economies, which own most of the new technologies. commit to train Black workers and develop sup- This channel has become even more important as the ply chains with local businesses. The B-­ BBEE pace of innovation has accelerated. Attracting foreign requires companies to meet specific thresholds investors is an explicit element of South Africa’s de- of Black ownership and management control velopment strategy, supported by significant reduc- to participate in government tenders and con- tions in entry barriers23 and by top officials promoting tracts. While the B-­ BBEE is well intentioned, South Africa at international trade events. managing required scorecards places a heavy Despite these efforts, South Africa has fallen burden on public administration and foreign short of its goal of attracting more and higher qual- companies. The government has taken actions ity FDI (see figure 6). One factor behind this un- to reduce this burden by adopting the Equity derwhelming performance has been the confusing Equivalence Investment Program, which has signals sent by the authorities to investors. On the been applied to IT companies (Microsoft and one hand, the authorities have lowered barriers and Amazon Web Services) and banks (J.P. Morgan) offered cash grants, tax allowances, concessional since 2021. This revised approach replaces B-­ funding, and preferential infrastructure access BBEE requirements with local worker training through a complex targeting system to attract FDI.24 and supply chain development with local com- On the other hand, various industrial policies (such panies. The government’s next step could be to as the B-­ BBEE, local content requirements, and extend these programs more broadly by clearly public procurement), though not explicitly targeting outlining eligibility criteria for investors interest- foreign companies, have significantly increased the ed in participating. cost of doing business in South Africa. These poli- • Exempting investment projects in strategic sectors cies often discourage foreign firms, which typically in export processing zones from national regula- operate on a global scale and can easily opt for lo- tions. In China and Vietnam, where national laws cations with fewer economic obstacles. and regulations impose substantial burdens on A better approach for South Africa is to stream- enterprises, as in South Africa, governments es- line entry and operational requirements for foreign tablished “geographic islands” where exporters investors. Both economic theory and real-­ world evi- dealing with foreign competition can apply ex- dence show that clear and stable regulations do more traterritorial laws and regulations. For instance, Promoting to attract FDI than complex benefit arrangements. labor laws in these geographic islands offer market Malaysia and Mauritius, two of the most successful greater flexibility in hiring and firing workers countries in attracting FDI, began to show results than do national laws and regulations, which is openness as they lowered standard tax rates while eliminating balanced by higher salaries or additional benefits may prove challenging—so most of their incentives during the past 10 years. in areas such as housing, schooling, and training. This policy change enabled them to lower both in- • Accelerating the issuance of work permits for vestment costs for foreign firms and the associated qualified workers. Foreign investors often en- there is a need monitoring expenses for public administrators. counter barriers in the form of complex work to achieve The first-­best option would be to replace most permit requirements to bringing in expatriate incentives with a more investor-­ friendly common staff with specialized skills. Simplifying the work short‑term regime that is easy to navigate for investors, as Ma- permit process for skilled professionals through results and laysia and Mauritius have done. However, given the streamlined visa procedures, as in Malaysia and demonstrate complex social and political context in South Afri- the United States, could go far in attracting and ca, the government could consider the simpler and retaining high-­ value investments and facilitating successes ■ more practical approach of focusing on the most knowledge transfers to South Africa. Expediting binding constraints: the proposal to streamline business visa proce- • Streamlining firm entry and operational prerequi- dures would be instrumental in achieving this BBEE for foreign inves- sites related to the 2013 B-­ goal. For example, professionals who earn above tors  by making systematic use of Equity Equiv- a certain high salary (say, R40,000 a month) and alence Investment Programs when investors have a contract with a recognized tax-­ paying Priority 4: Injecting dynamism into the private sector 9■ firm in good standing could be granted a limited-­ financial services. The South African author- time visa (say, three years), subject only to the ities, led by SARB and the National Treasury, usual health and criminal background checks. are amending the National Payments Act to allow nonbanks to access the payments systems ■ Action 3: Harness the growth of digital finance and participate in the Payments Association of South Africa. This move aims to enhance com- South Africa’s financial sector is by far the most de- petition in the banking sector, reduce costs for veloped on the continent, but costs are high, mak- customers, and promote financial inclusion. In- ing access to financial services difficult for smaller tegrated universal QR codes and interoperabili- firms and poor households. The transition to digital ty between payment providers, as in the Quick ■ Foreign direct banking and the emergence of financial technolo- Response services in Ghana and Nigeria, will be investment has gies (fintech) offer an opportunity to lower access crucial for enabling this transition. barriers through a diverse range of new products • Developing a framework for open finance. Many been crucial to the and services, including online banking, mobile pay- countries have implemented a framework for success of East ments, peer-­ to-peer lending, digital wallets, and open finance, a multilateral and open data-­ Asian economies; financial management tools. Fintech is intensifying sharing regime that enables all parties that meet competition for banks, which are under pressure to defined requirements to exchange data, includ- attracting foreign upgrade their services. ing customer data. The policy motivations for investors is an To leverage the development of digital finance, open finance include increasing competition in South Africa could adopt a series of simple-­ to- concentrated financial markets by allowing new explicit element implement measures in the short-­ term, as Kenya, Ni- entrants to engage with consumers and their fi- of South Africa’s geria, and several other countries in Africa have done: nancial data more easily, simplifying the know-­ development • Adjusting South African Reserve Bank (SARB) your-customer process, encouraging product regulations to ease administrative process for the innovation through better consumer data and strategy entry of fintech providers. Key hurdles include enabling payment initiation, and deepening fi- unclear application of regulations and lengthy nancial access and inclusion for consumers. Less licensing processes for new fintechs. While reg- than two years after its launch, Brazil’s open ulations are vital for quality assurance and con- finance system reported serving more than sumer protection, a balance is needed that also 27 million customers with 41 million accounts as seeks to minimize entry barriers. For instance, of September 2023. the SARB can improve and streamline the cur- rent sandbox process,25 expanding its scope ■ Action 4: Build a platform for developing a green in the medium term and establishing a fintech economy using catalytic market instruments roadmap for post-­ sandbox engagement. The framework developed in the European Union South Africa should move gradually but decisively can serve as reference. from a strategy based on its historical advantage in • Authorizing nonbank institutions to issue mobile coal to leveraging its assets in the green economy. money. While mobile money was introduced in Not only does the country have abundant natural South Africa as early as 2010, nonbank insti- green energy resources, such as sunlight, wind, vast tutions, such as mobile network operators and land areas, and valuable minerals like platinum and fintechs, have not been authorized by the mon- chromium, but it also boasts one of the most robust etary authorities to issue e-­money or access the mining and industrial bases. These resources can be national clearinghouse and settlements system. used to produce products like batteries and elec- This precautionary measure may be excessive tric vehicles, which will be in high demand in global now that e-­money has proved to be a secure and markets in coming decades.26 The government has innovative payment solution in many countries. recognized this opportunity, understanding that the E-­money has evolved to support electronic pay- transition to a green economy can provide a new ments and serve as a platform for distributing impetus for the country’s development and address ■ 10 Priority 4: Injecting dynamism into the private sector the urgent need for more jobs.27 The transforma- prioritize offsets that generate sustainable devel- tion to a low-­ carbon economy could generate up to opment co-­ benefits and employment opportu- half a million jobs by 2050.28 nities within South Africa, while simultaneously The transition to a green economy is a shared ob- increasing the number of credits available on the jective of most countries, and South Africa needs to market and fostering cost-­ effective mitigation of act swiftly to leverage its advantages and establish greenhouse gas emissions. itself as a regional leader.29 While large investments • Reorienting incentives and support programs from in physical and human capital will be necessary to fossil fuels toward new green activities. Under its manage this transition efficiently, the process can G20 commitments, the South African govern- be fast-­ tracked by introducing a series of market in- ment attests that it does not provide fossil fuel struments that will incentivize both the government subsidies that encourage wasteful consump- and the private sector to move in this direction:30 tion. In practice, however, Sasol, which sup- • Accelerating implementation of the carbon tax. plies roughly 30% of the country’s fuel and is The government is following a phased approach the largest contributor to the country’s carbon South Africa’s to implementing a carbon tax. Introduced in emissions, benefits from preferential arrange- financial sector 2019, the carbon tax combines a low tax rate ments, such as the fuel pricing mechanism and and numerous exemptions until 2026 to allow a recent carbon tax exemption. These prefer- is by far the firms to adjust to the new conditions. Howev- ential benefits are costly for taxpayers and slow most developed on the er, the carbon price remains effectively zero for the transition to a low-­ carbon economy. Addi- exempted activities, at $8.20 per ton of carbon tionally, support to the coal industry, including dioxide in 2023 and increasing to about $16 by debt relief packages provided to Eskom by the continent, but 2026. This rate is too low to induce significant National Treasury over the past decade, incurs costs are high, behavioral change, given that the estimated substantial costs to the state. damage from climate change resulting from a ton While such interventions may be partially making access of carbon dioxide emissions is $35. justified for energy security reasons, the gov- to financial The recommendation is to streamline the list ernment can gradually shift its support toward services difficult of exempted activities and accelerate the carbon green activities, for example, by financing a tax rate increase. Another reason to expedite the temporary value-added tax exemption and sub- for smaller carbon tax is that, when entering industrial coun- sidizing credit lines on the purchase of renew- firms and poor try markets, South African exports will increas- able energy equipment by small businesses and ingly face a carbon tax on carbon-­ intensive prod- households (see policy note 2). These resources households ■ ucts, like the EU’s Carbon Border Adjustment could also be used to finance the exploration Mechanism. From a fiscal perspective, it would of new mineral deposits and the development be more advantageous to collect this tax domes- of green industrial parks. Encouraging devel- tically rather than paying foreign governments. opment of the battery industry in South Africa If the concern is to maintain firms’ competitive- could also yield substantial benefits, considering ness during the transition, the government could the country’s potential to be a major player in consider reducing other taxes, such as those on this industry (box 1). labor, to stimulate job creation by easing labor costs and incentivizing firms to increase energy Priority area 2: Upgrading the efficiency and invest in cleaner energy sources. growth small and capabilities of high-­ • Increasing liquidity in carbon credit markets. Car- medium enterprises bon credit markets have already been quite suc- In recent years, the government has started to em- cessful in South Africa, but the markets have es- phasize promoting agile and innovative small firms.31 sentially been dominated by one company (Sasol). The Department of Small Business Development is Developing domestic standards for local service deploying a one-­ stop shop to streamline business providers to issue and validate carbon credits registration and has proposed a series of support could broaden the market. Such standards could programs to facilitate access to cheaper credit and Priority 4: Injecting dynamism into the private sector 11 ■ to upgrade skills.32 Yet, a 2020 McKinsey survey re- Box 1  South Africa’s strong potential in the battery market veals that only 36% of small firm owners acknowl- South Africa has the opportunity to play a significant role in the global edged receiving any kind of government support, battery value chain, which is likely to grow by more than 3,000 gigawatt either because of lack of awareness or because of hours (GWh) by 2030. The country’s domestic battery storage market is procedures that are perceived to be complex and expected to reach 10 GWh by 2030, driven primarily by the electric vehi- uncertain.33 Closing the information gap and stream- cle sector. Integrating renewable energy sources into the grid, particularly lining procedures could help, but more actions are solar photovoltaic and wind, necessitates adequate storage solutions, such as battery energy storage systems, to balance the grid. South Africa has al- needed. SMEs face deep structural constraints that ready released grid-­ scale energy storage tenders in response to this need. require fundamental changes, including removing The projected expansion could potentially create 25,000–55,000 direct obstacles in addition to simplifying processes. and indirect jobs, depending on various factors. A menu of three actions is proposed to acceler- South Africa is well-­endowed with many of the minerals needed to pro- ate the development of SMEs. These actions aim to duce lithium-­ stage activities in this ion batteries. It has benefited from early-­ facilitate their access to finance, to upgrade their value chain as well as from a diversified automotive industry that is strongly earning workers to join skills, and to incentivize low-­ dependent on exports and will need to transition to the manufacturing the labor force or become entrepreneurs. of electric vehicles. Battery pack assembling and battery energy storage system integration opportunities also exist. Battery cell manufacturing at the estimated needed market scale is feasible. More challenging for South ■ Action 5: Facilitate access to finance for small and Africa is producing cathode active–material, lithium salts, and separators. medium enterprises Achieving the required manufacturing scale (15–20 GWh equivalent) and overcoming technological barriers require working at a larger scale than the South Africa’s financial market is the most devel- domestic market. Additionally, local companies would require technological oped on the continent, but small firms face the same support from entities with a substantial market presence. challenges in getting access to financial products as The government plays a crucial role in directing industrial policy toward they do in other countries. The World Bank esti- developing the local battery value chain, prioritizing the production of minerals, battery materials, and energy storage systems for stationary and mates that only one in three SMEs in South Africa, industrial use. Despite the region’s abundant stores of battery minerals, including just 15% of startups, benefit from external mineral beneficiation has declined in South Africa. To help South Africa financing, which is similar to the regional average but enter the global battery value chain, the government could: lower than in Ghana and Kenya.34 This is dispropor- • Explore policies and incentives for the beneficiation of battery minerals. tionately low given the size of the domestic credit • Foster regional collaboration through bilateral trade talks with neigh- market (equivalent to 120% of GDP) and the avail- boring countries Democratic Republic of Congo, Mozambique, Tanza- ability of more than $600 billion in private wealth, nia, and Zimbabwe. • Establish a research program on energy storage systems, with a focus including funds accumulated by pension funds, and on engineering, manufacturing technologies, and systems integration. reflects both supply and demand weaknesses. • Establish a competitive battery testing and certification facility. Nonetheless, several short-­ term improvements • Facilitate the establishment of a training program for the battery indus- are feasible: try by the Energy and Water Sector Education Training Authority in • Increasing the provision of venture capital for collaboration with universities and the battery industry. growth startups. Encouraging the develop- high-­ • Improve access to finance, possibly with subsidized credit through ment of venture capital can reduce the financing public-­private sharing instruments. challenges faced by SMEs. Scaling up private– • Consider tax incentives for investments in this sector, such as acceler- ated depreciation of credits. public initiatives such as the South Africa SA • Introduce regulations to encourage the use of electric vehicles, which SME Fund has considerable potential. Estab- will increase domestic demand for batteries. lished as a collaboration between government • Streamline and accelerate the application process for projects. and business, this initiative has raised funds from Some of these actions will incur fiscal costs. To make them budget the Public Investment Corporation and some neutral, the authorities will have to reallocate some existing energy subsi- ­ 50 publicly listed firms, channeling more than dies to the battery industry. based capital to $65 million (R3.61 million) in risk-­ Source: World Bank, 2023, Battery Storage Market and Value Chain Assessment in South small and innovative firms in less than two years. ­ —Synthesis Report (English). Washington, DC: World Bank. http://documents.world​ Africa­ sharing model, in which government This risk-­ bank​ /curated​ .org​ /en/099155502102332395/P17268201ebc89050b1960f40c83775 23a. assumes the first loss, could be extended to ■ 12 Priority 4: Injecting dynamism into the private sector domestic institutional investors (such as pension particularly affect disadvantaged groups. To ad- funds, which own assets equivalent to 100% of dress this, the authorities could consider: GDP). In several Organization for Economic Co-­ • Scaling up workplace-­ based learning programs in operation and Development (OECD) countries, SMEs. These programs are currently highly con- such funds are authorized, under strict regu- centrated in large firms. This measure is further lations and supervision, to invest in small busi- detailed in policy note 1. nesses and funds. They contribute to two-­ thirds • Improving training in digital skills, which are crit- of venture capital funds in the United States and ical for most SMEs. Digital technologies present one-­ fifth in Europe. an opportunity for SMEs in South Africa to ex- • Reviewing and redesigning public credit support pand their reach and lower the cost of increas- programs, phasing out direct lending, upscaling par- ing their efficiency. Around half of South Africa’s tial credit guarantees, and introducing monitoring SMEs have embraced digital technologies, but and evaluation frameworks. South Africa has more adoption rates are behind those of countries than 50 government credit programs, including including Brazil, Malaysia, and Türkiye, where direct lending, guarantees, and wholesale lending, adoption rates reach 70%. Data from the De- totaling 0.36% of GDP, or 2.8% of SME credit in partment of Higher Education and Training and 2020. Despite initiatives like Khula Credit Guar- LinkedIn show that 10 of the top 11 in-­ demand antee (KCG), underutilization persists due to eli- skills are in the information and communication gibility and risk criteria barriers. KCG guaranteed technology sector, with many job vacancies. R248 million in loans to 87 SMEs in 2020, a mere The government could partner with private 0.005% of GDP, compared with 0.03% of GDP information technology (IT) companies, follow- South Africa in Mexico and 4% in Korea. The impact of these ing the Philippine model, to foster early acquisi- should move programs remains uncertain, however, because tion of IT skills and improve tertiary IT education. data on nonperforming loans and robust impact This approach created more than 1.5 million IT/ gradually but studies are lacking. Improved coordination and business process outsourcing jobs in the Philip- decisively from a strategy consolidation, along with fintech integration, are pines, including through innovative local start- vital for enhancing SME credit delivery. ups. South Africa could also emulate Malaysia’s • Reforming policies and regulations to upgrade the national commercialization platform, PlaTCOM based on its credit information environment and the secured Ventures, which supports students and young historical transaction framework. Steps to strengthen the entrepreneurs in transforming ideas into digital credit information environment include mandat- products and services. advantage ing reporting of commercial credit information in coal to ■ Action 7: Incentivize labor search and mobility for by SMEs and commercial credit institutions to leveraging its credit bureaus, enhancing use of alternative data low-­income earners for assessing credit risk, and establishing a legal assets in the framework for a central credit registry. Other Increasing returns for low-­ income earners would green economy ■ steps include establishing a movable asset reg- boost employment and small enterprise creation. istry, which could reduce collateral requirement Low labor demand, high income taxes, and steep barriers and enable lenders to claim assets in transportation costs discourage workers from en- case of default, in alignment with the Depart- tering the labor market or starting businesses. ment of Small Business Development’s strategic A worker in South Africa typically receives only plan.35 Countries including Ghana, Nigeria, and half the income of a worker in Vietnam with the Zambia have adopted a movable asset registry. same base earnings (see policy note 3).36 Reduc- ing these costs would enhance firms’ ability to hire ■ Action 6: Upgrade workers’ and managers’ skills workers and incentivize individuals to establish their own businesses, particularly as many low-­ The skills deficit in South Africa is exacerbat- income workers enter the labor market through ed by deficiencies in the education system that employment. self-­ Priority 4: Injecting dynamism into the private sector 13 ■ The government can act quickly to reduce costs • Reducing the entry tax rate of the personal in- to low-­income workers and make employment a come tax from 18% to, say, 5%, or increasing the more attractive option: threshold for paying the personal income tax, an • Lowering transportation costs for low-­ income work- approach used in many East Asian economies. ers to improve job search. Transportation costs The benefit is clear for low-­ income workers absorb on average 80% of the earnings of low-­ (who will take home more money), and the costs income workers. Several solutions are discussed in to the government will be low, as South Africa’s policy note 3, including subsidizing trips in minibus top income decile contributes almost 80% of taxis, which are by far the most frequently used personal income tax revenue. mode of transportation by low-­ income workers. ■ 14 Priority 4: Injecting dynamism into the private sector Annex table A1  Ranking of measures through the “FIT” filter of feasibility, impact, and timing Feasibility Impact Timing Total growth small and medium enterprises Priority area 1: Upgrading the capabilities of high-­ Action 1: Facilitate access 1. Increasing the provision of venture capital for 3 3 2 8 to finance for small and ups high growth start-­ medium enterprises 2. Reviewing and redesigning public credit 2 2 1 5 support programs, phasing out direct lending and introducing monitoring and evaluation frameworks 3. Reforming policies and regulations to upgrade 3 2 1 6 the credit information environment and the secured transaction framework Action 2: Upgrade workers’ 4. based learning programs Scaling up workplace-­ 2 2 2 6 and managers’ skills in small and medium enterprises 5. Improving training in digital skills, which are 2 2 1 5 critical for most small and medium enterprises Action 3: Incentivize labor 6. Reducing the entry tax rate of the personal 2 2 1 5 search and mobility for income tax income earners low-­ 7. Lowering transportation costs for low-­ income 1 3 2 6 workers and job searchers Priority area 2: Fostering competitiveness in industries of the future Action 4: Upgrade the 1. Enhancing the competition policy framework 1 2 2 5 competition framework 2. Strengthening oversight of state enterprises 2 3 2 7 and liberalizing the markets in which they operate Action 5: Facilitate foreign 3. Streamlining firm entry and operational 1 3 3 7 direct investment prerequisites for foreign investors related to the 2013 Broad-­ Based Black Economic Empowerment Act 4. Exempting investment projects in strategic 1 2 1 4 sectors in export processing zones from national regulations 5. Accelerating the issuance of work permits for 1 2 1 4 qualified workers Action 6: Harness the 6. Adjusting South African Reserve Bank 2 3 1 6 growth of digital finance regulations to ease administrative processes for entry of fintech providers 7. Authorizing nonbank institutions to issue 3 3 3 9 mobile money 8. Developing a framework for open finance 2 2 1 5 Action 7: Build a platform 9. Accelerating implementation of the carbon tax 1 2 1 4 for developing a green 10. Increasing liquidity in carbon credit markets 3 2 2 7 economy using catalytic 11. Reorienting incentives and support programs 1 3 1 5 market instruments away from fossil fuels and toward new green activities Source: Authors. Note: The scores range from 1 to 3, with 1 being the lowest. The actions with the highest score are highlighted in yellow. Priority 4: Injecting dynamism into the private sector 15 ■ Notes 1. N. Stern and M. Romani, 2023, “The Global Growth 8. International Monetary Fund, 2020. IMF Working Story of 21st Century, Driven by Investment and Paper “African Department Market Power, Growth, Innovation in Green Technologies and Artificial In- ence,” and Inclusion: The South African Experi­ telligence,” Grantham Research Institute on Climate https://www.imf.org/-/media/Files/Publications​ Change and the Environment, January. /WP/2020/English /wpiea2020206-print-pdf.ashx. 2. These surveys were conducted in different years: 9. For a summary, see, World Bank, 2018, “An Incom- 2022 in India, 2023 in Indonesia, 2019 in Malaysia, plete Transition,” Systematic Country Diagnostic; 2020 in South Africa, 2019 in Türkiye, and 2023 in and World Bank, 2022, “Diagnosing South Africa’s Vietnam. For India and Indonesia, the surveys were High Unemployment and Low Informality.” conducted during or right after the Covid-19 pan- 10. International Monetary Fund, 2020. IMF Working demic, which could explain the declines. Paper “African Department Market Power, Growth, 3. For example, McKinsey (2020) estimates that a pro- ence,” and Inclusion: The South African Experi­ ductive firm in South Africa is 2.6 time more likely https://www.imf.org/-/media/Files/Publications​ to invest in research and capital accumulation than /WP/2020/English /wpiea2020206-print-pdf.ashx. an unproductive one. “How South African SMEs can 11. Considering direct and indirect shareholdings of the survive and thrive post COVID-19,” https://www​ state above 10 percent, the business of the state ex- .mckinsey.com/featured-insights/middle-east-and​ tends to 80 percent of the sectors (NACE-4 digit) -africa/how-south-african-smes-can-survive-and​ of the South African economy. World Bank, 2023, -thrive-post-covid-19. “The Business of the State” (Overview). https://​ 4. Contrary to common perception, productivity openknowledge.worldbank.org /handle/10986​ growth and employment growth are not mutually /4034303. exclusive goals. Recent empirical research shows 12. Data are from the World Bank Global Businesses that businesses with rising productivity contribute of the State (BOS) database, which tracks business significantly to investments in capital and technol- entities with a government stake of at least 10%, ogy and, critically, exhibit the highest increases in whether directly or indirectly owned by the nation- employment. R. Hornbeck and E. Moretti, 2019, al or subnational government. However, there was “Who Benefits from Productivity Growth? Direct special treatment for the subsidiaries of two SOEs in and Indirect Effects of Local TFP Growth on Wages, South Africa, the Public Investment Corporation and Rents, and Inequality,” NBER, Working Paper 24661, the Industrial Development Corporation. These two January, http://www.nber.org/papers/w24661. SOEs had large portfolios of subsidiaries with own- 5. See, for example, J. Fedderke et al., 2018, “Markups ership stakes of less than 50%. To help deal with all and Concentration in South African Manufactur- these subsidiaries in the data gathering stage, only ing Sectors: An Analysis with Administrative Data,” subsidiaries in which the two SOEs had ownership South African Journal of Economics, vol. 86 (January). stakes of at least 50% were included in the BOS 6. International Monetary Fund, 2020, IMF Working base for South Africa. data­ Paper “African Department Market Power, Growth, 13. IMF 2020. and Inclusion: The South African Experience,” 14. Of 21 abuses of dominance referred to the Compe- https://www.imf.org/-/media/Files/Publications​ tition Tribunal between 1999 and 2016, 13 involved /WP/2020/English/wpiea2020206-print-pdf.ashx. former or current SOEs. D. Healey, 2018, “Compe- 7. See P. Aghion and P. Howitt, 1998, “A Schumpete- tition Law and State-Owned Enterprises: Enforce- rian Perspective on Growth and Competition,” in F. ment,” OECD Global Forum on Competition, DAF/ Coricelli, M.D. Matteo, and F. Hahn, eds, New The- COMP/GF. ories in Growth and Development, London: Palgrave 15. SOEs receive direct and indirect budgetary support, m illan, https://doi.org/10.1007/978-1-349- Mac­ which entails a fiscal drain and risks. Direct budget- - 0_2. 26270​ ary support via bailouts to SOEs over the past five ■ 16 Priority 4: Injecting dynamism into the private sector years have averaged around R46 billion a year, and 24. https://www.thedtic.gov.za/wp-content/uploads​ dividend payments have been nearly zero. When /the-dti-incentive-schemes-guide-2021.pdf. Most of viewed from the perspective of opportunity costs, the incentives proposed by South Africa are based such budgetary support to SOEs is very costly. For on a complex set of criteria, including location, size of example, the bailouts are equivalent to 18% of the the enterprise, sector, and the size and race of the in- annual health budget and could have funded basic vestor. To illustrate, to qualify for a cost-sharing grant education for more than 2 million students. in agribusiness, projects have to have a minimum in- .small​ 16. For more information, see https://www​ business​ vestment of R1 million; have a B-BBEE level of 1–4; /2019/12/ILO​ institute.co.za/wp-content/uploads​ demonstrate that at least 50% of raw materials will be -Cost-of-Red-Tape.pdf. sourced from South African suppliers, 30% of which 17. C. Loewald and M. Stern M. (eds), 2023, Unlock- must be Black South African suppliers; can commence ing Growth Prospects in Post-pandemic South Africa, the project or activities applied for within 90 calendar South African Reserve Bank. https://www.resbank​ days after the application has been approved; and .co.za/content/dam/sarb/what-we-do/research​ must create additional jobs and pay at least the mini- /UNLOCKING%20GROWTH%20PROSPECTS%20 mum wage. The benefits also depend on the type of FINAL%20050423.pdf. investment (building, equipment, vehicles). See http://​ 18. According to the 2018 Product Market Regulation www.investsa.gov.za/wp-content/uploads/2021​ (PMR) indicators of the OECD calculated for more /03/PRINT-Incentives_compressed.pdf and https:// than 50 countries, South Africa’s regulatory frame- /wp-content/uploads/the-dti​ www.thedtic.gov.za​ works are more limiting to competition in key product -guide-2021.pdf. -incentive-schemes​ markets than those of most countries covered by the 25. In a regulatory sandbox, a financial sector regulator PMR data, including every OECD country and even allows small-scale testing of innovations by private peer countries such as Russia and Vietnam (https://​ firms in a controlled environment under the regula- data-explorer.oecd.org/vis?tenant=archive&df[ds]=​ tor’s supervision. DisseminateArchiveDMZ&df[id]=DF_PMR2018&df​ 26. Platinum and platinum-group metals are essential [ag]=OECD&dq=.&lom=LASTNPERIODS&lo=5&to[​ for hydrogen production, while chromium is used as TIME_PERIOD]=false). a catalyst in lithium-ion battery production. 19. h t t p s : // w w w . w o r l d b a n k . o r g /e n / r e s e a r c h​ sa.gov.za​ 27. See, for example, http://www.invest​ /wp- /brief/the-long-term-growth-model-fundamentals​ -Investment​ content/uploads/2023/05/South-Africa​ -extensions-and-applications. -Conference-2023_Case-Booklet_on. 20. They are often referred to as stars, superstars, ga- 28. World Bank, 2022, Country Climate and Development zelles, or unicorns. bank.org​ Report for South Africa, https://www.world​ 21. See A. Grover Goswami, D. Medvedev, and E. Olaf- /en/news/infographic/2022/11/01/south-africa​ sen, 2019, High-Growth Firms: Facts, Fiction, and Pol- -country-climate-and-development-report. icy Options for Emerging Economies, World Bank. 29. The cost of not transitioning to a green economy 22. International Monetary Fund, 2015, “The Level of can be large, as South Africa’s highly carbon-inten- Productivity in Traded and Non-Traded Sectors sive exports will be increasingly penalized by the for a Large Panel of Countries,” https://www.imf​ restrictions imposed by importing countries, such .org/en/Publications/WP/Issues/2016/12/31/The​ as the Carbon Border Adjustment Mechanism and -Level-of-Productivity-in-Traded-and-Non-Traded​ the Deforestation Act recently implemented by the -Sectors-for-a-Large-Panel-of-Countries-42750 . European Union. 23. South Africa (with a score of 0.034 on the OECD FDI 30. In other words, the objective is to incentivize new Regulatory Restrictiveness index) scores below the projects in the green economy by increasing their global average (0.10), placing it as one of the most expected rate of return by changing the relative competitive performers. (World Bank, 2024, “SADC prices between high- and low-carbon energy sourc- Investment Climate Scorecard”). See, for example, es rather than subsidizing particular projects. “Investing in South Africa,” https://www.thedtic.gov​ 31. For clarity, a SME is defined as a “separate and dis- .pdf. .za/wp-content/uploads/Investor-Roadmap-2020​ tinct business entity, together with its branches or Priority 4: Injecting dynamism into the private sector 17 ■ subsidiaries, if any, including cooperative enterpris- 34. Data from the South African Reserve Bank indicate es, managed by one owner, or more predominantly that the collective credit exposure of SMEs to banks carried on in any sector or subsector.” Specifically, in 2020 was R631 billion, constituting just 25% of the focus is on businesses with a turnover of less business loans facilitated by the banking sector. than R500  million ($22  million) per year and so in- Government programs provide R18 billion, which cludes a relatively wide range of businesses from amounts to 0.36 percent of GDP or 2.8 percent of very small (self or household entrepreneurs) to me- the total credit exposure to SMEs. dium size with several employees. 35. Department of Small Business Development, 2023, 32. http://www.dsbd.gov.za/programmes. “SMME and Cooperative Funding Policy 2023.” 33. For more details, see McKinsey, 2021, “How South 36. See J. Morisset, 2023, “To reduce South Afri- African SMEs can survive and thrive post COVID- ca’s unemployment, make work more attractive,” 19,” https://www.mckinsey.com/featured-insights​ Brookings. https://www.brookings.edu/articles/to- /middle-east-and-africa/how-south-african-smes​ - south-africas-unemployment-make-work- reduce​ -can-survive-and-thrive-post-covid-19. -attractive/. more​ ■ 18 Priority 4: Injecting dynamism into the private sector