Growth Through Inclusion

in South Africa

Ricardo Hausmann, Tim O’Brien, Andrés Fortunato, Alexia

Lochmann, Kishan Shah, Lucila Venturi, Sheyla Enciso-Valdivia,
Ekaterina Vashkinskaya, Ketan Ahuja, Bailey Klinger, Federico
Sturzenegger, and Marcelo Tokman

CID Faculty Working Paper No. 434

November 2023

© Copyright 2023 Hausmann, Ricardo; O’Brien, Tim; Fortunato, Andres;

Lochmann, Alexia; Shah, Kishan; Venturi, Lucila; Enciso-Valdivia, Sheyla;
Vashkinskaya, Ekaterina; Ahuja, Ketan; Klinger, Bailey; Sturzenegger, Federico;
Tokman, Marcelo; and the President and Fellows of Harvard College
 Growth Through Inclusion
in South Africa

A Report by The Growth Lab

at Harvard University

Ricardo Hausmann, Tim O’Brien, Andrés Fortunato, Alexia Lochmann,

Kishan Shah, Lucila Venturi, Sheyla Enciso-Valdivia (LSE), Ekaterina
Vashkinskaya (LSE), Ketan Ahuja, Bailey Klinger, Federico Sturzenegger,
and Marcelo Tokman

November 15, 2023

Acknowledgments

This report is the result of a two-year research journey in South Africa that would not have been
possible without the involvement and contributions of many individuals and organizations,
who we thank for their time, wisdom, and dedication to their missions. Our research has
benefited most from disagreement when supported by evidence, and we hope that this report
brings evidence even in cases where collaborators may disagree with conclusions.

First and foremost, we would like to express our sincere gratitude to the teams of the National
Treasury, the Presidency of South Africa, the South African Reserve Bank, the Department of
Trade, Industry and Competition, the Department of Human Settlements, the Industrial
Development Corporation, and other departments of the South African Government for their
persistent support in this project, insights, and expertise. We also thank the National Treasury’s
Data Lab team for their valuable work and assistance. We also extend our appreciation to the
various policymakers at sub-national government levels who lent their time and knowledge.
We thank the Government of the Western Cape, the City of Cape Town, the municipal
management team of the City of George, the City of Polokwane, and the Municipality of
Makhado.

We extend our great appreciation to our colleagues at the Centre for Development and
Enterprise. Their commitment and support have been indispensable to this endeavor, both in
our analytical processes as well as providing invaluable connections with South African society,
policymakers, industry, and academia. We thank Ann Bernstein and the CDE Board, Anthony
Altbeker, Stefan Schirmer, Peter Delius, William Beinart, Rehan Visser, and Sibongile Nkomana.
Furthermore, we are deeply thankful to all stakeholders who have provided rich feedback,
questions, and continued engagement on these research topics. We thank our academic
colleagues across the globe who contributed to our understanding, including Anthony Black,
Lawrence Edwards, Martin Wittenberg, Nicoli Natrass, Jeremy Seekings, Ivan Turok, Justin
Barnes, Johann Kirsten, Wandile Sihlobo, Haroon Bhorat, Edward Glaeser, Alain Bertaud,
Robert Lawrence, Celestin Monga, and all others who have contributed to this project through
their reviews and suggestions.

We further thank the many organizations who we have has the fortune to interact with and learn
from over the course of this project including the Centre for Affordable Housing Finance in
Africa, Divercity Group, Bulungula Incubator, Mdukatshani Rural Development Programme,
Vumelana Advisory Fund, Matsila Community Development Trust, Green Cape, Bushveld
Minerals and Bushveld Energy, Chem Energy SA, Anglo American Platinum, Flambard Capital,
Arcelor Mittal South Africa, HyPlat, and Sasol.

We thank members of the Growth Lab team who contributed vital research during this project
including Patricio Goldstein, Frank Muci, Nidhi Rao, Jonathan Malagón, Iván Ordoñez, and
Martin Rossi. Lastly, we thank the Association for Savings and Investment South Africa (ASISA)

2
and the Banking Association South Africa (BASA), whose generous support for this project
enabled us to spend two years conducting independent research to arrive at these findings.

About the Growth Lab

The Growth Lab is a research program at Harvard University. With its multidisciplinary team of
roughly 50 staff, fellows, and faculty led by Professor Ricardo Hausmann, the Growth Lab
pushes the frontiers of economic growth and development policy research. The Growth Lab
advances academic research on the nature of economic growth and conducts place-based
engagements that aim to understand context-specific growth processes, help address key
constraints, and identify promising growth opportunities. Through its research and teaching
activities, the Growth Lab has become a global thought leader offering breakthrough ideas,
methods, and tools that help practitioners, policymakers, and scholars understand how to
accelerate economic growth and expand opportunity across the world. Consistent with the
mission of the Harvard Kennedy School of Government, in which the program is housed, the
Growth Lab works to expand capabilities for improved economic policymaking such that more
people and societies can enjoy higher levels of wellbeing through stronger, more sustainable,
and more inclusive economic growth processes.

Growth Lab applied projects utilize a variety of tools from economics and other disciplines with
a focus on understanding place-specific growth challenges and enabling learning-by-doing to
address these challenges locally. Key frameworks developed at the Growth Lab and applied
within projects include Growth Diagnostics and Economic Complexity. Growth Diagnostics is
a methodology that identifies the most binding constraints to better growth outcomes, which
informs and allows policymakers to take highly impactful actions. Economic Complexity is a
growing field of research that leverages network science and machine learning to understand
what economic activities a given country or region could expand into next, based on what it
currently does. Growth Lab applied projects aim not only to understand constraints and
opportunities in specific places, but also to empower local stakeholders in real time and in situ
to address constraints and seize economic opportunities through training, capacity building,
and the development of practical, place-based tools. All applied Growth Lab projects aim to
generate publicly available research of relevance to the local community as well as frameworks,
tools, teaching resources and learning experiences that strengthen the HKS community.

3
Table of Contents
1 Growth Through Inclusion ...................................................................................................... 7
1.1 Executive Summary ............................................................................................................................ 7
1.2 Growth and Inclusion in Numbers ................................................................................................. 11
1.3 Prioritizing Constraints to Growth and Inclusion ......................................................................... 19
1.4 Macroeconomic Consequences .................................................................................................... 33
1.5 Summary of Recommendations .................................................................................................... 35
2 State Capacity as a Constraint to Growth ............................................................................. 39
2.1 Executive Summary ......................................................................................................................... 39
2.2 Patterns of Collapsing State Capacity ........................................................................................... 42
2.3 The Electricity Crisis and Broader Lessons ................................................................................... 47
2.4 Municipal Capacity .......................................................................................................................... 65
2.5 How to Strengthen State Capacity ................................................................................................ 76
3 Spatial Exclusion as a Constraint to Growth ......................................................................... 81
3.1 Executive Summary ......................................................................................................................... 81
3.2 Building Inclusive Cities: Bringing people to jobs ....................................................................... 86
3.3 Bridging Knowhow: Bringing jobs to people. ........................................................................... 107
4 South Africa’s Green Growth Potential ............................................................................... 126
4.1 Executive Summary ....................................................................................................................... 126
4.2 “Green Growth” in a Decarbonizing World ................................................................................ 129
4.3 Strategy 1 – Make the enablers of global decarbonization. ..................................................... 133
4.4 Strategy 2 – Make green versions of grey products. ................................................................. 146
4.5 Strategy 3 – Export green knowhow............................................................................................ 153
4.6 Summary of Green Growth in South Africa ................................................................................ 157
5 References........................................................................................................................... 161
6 Appendix............................................................................................................................. 169
6.1 List of Strategic Products within Green Supply Chains ............................................................. 169

4
Table of Figures
Figure 1.1: Real GDP Growth – South Africa vs. Peers ................................................................................. 11
Figure 1.2: Real GDP Per Capita – Observed and Forecasts ....................................................................... 12
Figure 1.3: Contribution of Expenditure Components to CAGR of Real GDP .......................................... 13
Figure 1.4: Contribution of Sectors of Activity to CAGR of Real GDP ........................................................ 14
Figure 1.5: Unemployment Rate, Total and by Population Group ............................................................. 15
Figure 1.6: Employment Rates by Municipality ............................................................................................ 16
Figure 1.7: Distribution of Employment Rates across Municipalities – Mexico (2019) & South Africa
(2011) ................................................................................................................................................................ 17
Figure 1.8: Share of Respondents Indicating Government Handling as “Very Badly” ............................. 20
Figure 1.9: Labor Market Indicators vs. Total Transport Costs by District Municipality ........................... 26
Figure 1.10: Employment Rates And Rural Population by Municipality .................................................... 28
Figure 1.11: Summary of Recommendations for Growth Through Inclusion ............................................ 36
Figure 2.1: Percentage of HHs with Access to Piped Water 2007 vs. 2016............................................... 43
Figure 2.2: South Africa’s Percentile Rank in Select Governance Indicators ............................................. 44
Figure 2.3: Share of Respondents Indicating Government Handling as “Very Badly” ............................. 45
Figure 2.4: Load-shedding in South Africa (2007 to 2022) ......................................................................... 48
Figure 2.5: Electricity Dependence of South Africa’s Exports ..................................................................... 48
Figure 2.6: Share of South African Businesses Reporting Electricity as their Biggest Obstacle (left) and
Outages vs. Cost of Outages for All Countries (right) ................................................................................. 49
Figure 2.7: Change in Household Access to Electricity between 2007 and 2016 .................................... 51
Figure 2.8: Share of HHs Who Rate Quality as Poor Across Municipalities (2016) ................................... 67
Figure 2.9: Expenditure Decentralization vs. National Income Levels ....................................................... 70
Figure 2.10: Revenue Composition by Level of Government ..................................................................... 71
Figure 2.11: Expenditure Composition by Function for Municipalities ..................................................... 71
Figure 2.12: Employment Levels in Local Municipalities ............................................................................. 72
Figure 2.13: Problem of Circular Debt and Electricity System Failure ....................................................... 76
Figure 3.1: Employment Patterns in South Africa and Mexico .................................................................... 81
Figure 3.2: Labor Market Indicators vs. Total Transport Costs by District Municipality ........................... 82
Figure 3.3: Relationship Between Density and Distance from Center for Select Cities ........................... 88
Figure 3.4: Population Density Profiles of eThekwini and Buffalo City ...................................................... 89
Figure 3.5: Ratio of Commuting Cost to Income by Mode of Transport ................................................... 90
Figure 3.6: Economic Classification of Intermediate Cities ......................................................................... 91
Figure 3.7: Population Density Profiles of George and King Sabata Dalindyebo .................................... 92
Figure 3.8: Location of Social Housing vs. Business Presence in Johannesburg Area ............................ 95
Figure 3.9: Human Settlements Budget 2022/2023 (Total: 33B Rand).................................................... 102
Figure 3.10: Binding Issues in South Africa................................................................................................. 107
Figure 3.11: Employment Rates across South African Municipalities, Urban & Rural ............................ 109
Figure 3.12: Employment Rates & Rural Population by Municipality ....................................................... 109
Figure 3.13: Share of Employment by Industry in Rural Areas.................................................................. 111
Figure 3.14: Geographic Patterns in Underreported Crop Production and Potential ........................... 112
Figure 3.15: Employment Rate (# employed/working age pop.) by Municipality .................................. 112
Figure 3.16: Employment Probability Among Individuals Who Were Unemployed and Living in Former
Homelands in 2008 ........................................................................................................................................ 114
Figure 3.17: Household Income Composition by Area, 2014 .................................................................. 114

5
Figure 3.18: Share of Municipal Revenues from Equalization Grants, 2014 ........................................... 115
Figure 3.19: Infrastructure Gaps in Road Connectivity and Piped Water Access ................................... 116
Figure 3.20: Employment Probability Based on Economic and Linguistic Diversity .............................. 118
Figure 3.21: Differing Organizational Models of Agriculture Partnerships ............................................. 120
Figure 4.1: Global Dependence of Exports on Electricity (1995-2016) ................................................... 127
Figure 4.2: Energy Consumption of Industry (toe) / GDP (2015 USD PPP) in 2018 ............................... 127
Figure 4.3: CO2 Emissions by Country (% of Total), 2015-2021 .............................................................. 130
Figure 4.4: South Africa’s Critical Mineral Resources ................................................................................ 135
Figure 4.5: Green Supply Chain Products ................................................................................................... 140
Figure 4.6: Exports of Green Supply Chain Products (2015-2020) .......................................................... 141
Figure 4.7: Green Supply Chain Products in the Product Space .............................................................. 141
Figure 4.8: Density & Presence of Green Supply Chain Products in South Africa (2020) ...................... 144
Figure 4.9: Practical Solar Potential in 2020 (PVOUT Level 1, kWh/kWp/day), ....................................... 147
Figure 4.10: Key Indicators of Green Hydrogen Potential ........................................................................ 150
Figure 4.11: Risk Factors Affecting Capital and Development Costs ...................................................... 152
Figure 4.12: Evolution of Green and Total Patents in South Africa .......................................................... 154
Figure 4.13: Comparing Green Patents in South Africa between 2001-08 and 2009-16 ...................... 155
Figure 4.14: Climate Change Patents by Assignee in South Africa .......................................................... 156

6
1 Growth Through Inclusion

1.1 Executive Summary

When South Africans threw off the structures of apartheid three decades ago, the nation
captivated the world. The early 1990s marked a victory for generations of freedom fighters,
and the future of an inclusive South Africa was set in motion. There was no telling what could
be accomplished with the full force of South Africa’s human capabilities, creativity, and
resilience in combination with its industrialized economy and established comparative
advantages in global trade. There was good reason to be hopeful as the Presidency of Nelson
Mandela ushered in an active period of reconciliation. By including all South Africans in the
functioning of society and the economy, the Rainbow Nation seemed poised to leverage its
substantial economic assets at full strength. In 1995, South Africa supported the 47th most
complex economy in the world1 — on par with China (ranked 46th) and far ahead of any other
African nation (Tunisia was next at 66th). There was good reason to believe that the economy
would grow rapidly, and opportunity would expand to many more South Africans.

But more than a generation later, jobs are scarce and South Africa’s economic potential
remains unrealized. The national economy has experienced slow, slowing, and highly
vulnerable growth. Inequality is the highest in the world, and structures of exclusion remain
embedded in South African society both within and across racial groups and geographies.
Black South Africans continue to face poverty and joblessness at very high rates, and overall
wealth, although racially more balanced, remains as concentrated in a narrow few as it was at
the end of apartheid (Chatterjee et al., 2022). Though government policies have worked to
dismantle many structures of the apartheid state and increase living standards, these efforts
have not translated into the creation of job opportunities for too many South Africans. Despite
immense effort aimed at socio-economic transformation, including policies of broad-based
black economic empowerment, inclusion has been very limited in practice.

South Africa is failing to achieve growth and inclusion. Income per capita has been falling
for over a decade. Unemployment at over 33% is the world's highest, and youth unemployment

1
See country rankings in the Growth Lab’s Atlas of Economic Complexity (https://atlas.cid.harvard.edu/rankings).
South Africa’s position has since weakened to 70th (China is now 17th and Tunisia 44th).

7
exceeds 60%. Poverty has risen to 55.5% based on the national poverty line,2 yet many more
households depend on government transfers to sustain meager livelihoods. Most cities are
failing to adequately connect people to productive opportunities and are failing to innovate,
grow, and drive inclusion. Rural areas in former homelands, where almost 30% of South
Africans live, exhibit dismally low employment rates and remain exceptionally poor. Individuals
living in these areas need to leave for an equal chance to earn a decent living. This report aims
to answer why South Africa is failing to grow and failing to move the needle on economic
inclusion three decades after the end of apartheid. The evidence points to two causes:
collapsing state capacity and the persistence of spatial exclusion.3

State capacity has collapsed across many government functions that are essential for a
functioning economy. Critical network industries, including electricity, transport infrastructure
and services, security, and water and sanitation have experienced major deteriorations over
the last 15 years. The economy has been forced to cope with increasing electricity rationing,
leading to a declaration of national disaster in February 2023 after more than 15 years of load
shedding. Rail and port capacity has declined, generating large losses in exports. The collapse
in state capacity to deliver key inputs has, in effect, squandered the country's comparative
advantage in cheap, coal-fired electricity. Urban crime is very high, and theft and sabotage
undermine the functioning of many national infrastructure systems. Communities across the
country are increasingly vulnerable to all forms of disaster — both natural and manmade — due
to weakened public services. National finances are under increasing strain as South Africa relies
on fiscal transfers to bail out state-owned enterprises (SOEs) and to redistribute national
income to households to alleviate poverty and hardship. Many municipalities now face severe
fiscal challenges which undermine already weak public service delivery. South Africa is seeing
signs of unsustainability in its repeated credit downgrades and large sovereign risk premia. All
the while, as growth slows, exclusionary forces are becoming more entrenched.

Spatial exclusion has been entrenched by well-intentioned policies in urban areas and
an absence of effective strategy to include rural former homelands. Under apartheid,
townships were intentionally separated from central business districts and economic
infrastructure, leading to fragmented and disconnected cities. Apartheid also relied on

2
Poverty figure corresponds to 2014, the latest official value.
3
Throughout the report, the terms capacity and capability are used interchangeably. They both refer to the ability
of the state or organization to effectively carry out the tasks and responsabilities assigned to them.

8
differential treatment to former homelands vis-à-vis the rest of the country, effectively
separating those areas from the industrialized economy. Despite attempts to reverse this
exclusion, policies since 1994 have unintentionally perpetuated many aspects of spatial
exclusion. We find that urban planning regulations and zoning policies prevent dense,
affordable housing in desirable locations and consequently limit both formal and informal
employment. We also find strong evidence that formal jobs are limited because long
commutes from low-density areas in and around cities make transportation costs and
reservation wages high, while low residential densities prevent the development of a thriving
informal economy. Meanwhile, rural former homelands continue to be economies separate
and distinct from the rest of the country and face extremely low rates of employment.

This report summarizes the causes of slow growth and persistent exclusion within the
South African economy. It starts by laying out the unavoidable conclusion that the economy
is not delivering the shared prosperity that South Africans desire and deserve. We then
document why growth is weakening. We diagnose a common pattern of breakdown in state
capability that has caused growth to slow (Chapter 2). Unlike a natural disaster, which is
followed by a recovery when the disaster recedes, South Africa’s collapse in state capability
will continue to erode if systemic causes are left unaddressed. But this collapse does not fully
explain South Africa’s unemployment and inequality, however, which trace to a longer-term
problem of spatial exclusion (Chapter 3). While this problem has origins in apartheid, we find
that post-apartheid policies have to a significant extent reinforced rather than counteracted
patterns and processes of spatial exclusion. These two issues — collapsing state capability and
spatial exclusion — together leave South Africa’s enormous potential in its people, land, assets,
and capabilities underutilized. Achieving a better economic future will require addressing both
constraints. Given the collapse of South Africa’s key advantage of cheap and reliable electricity,
the country must also evolve its comparative advantage in a changing global economy. Since
the 1990s, the global economy has become more integrated, and the world is now moving
increasingly rapidly toward decarbonization. South Africa may have lost its historic
comparative advantage in low-cost electricity via coal, but it has great potential to develop new
green growth drivers that will help to supply global decarbonization (Chapter 4).

Progress must come from a recognition of what is not working and corresponding actions
to address both proximate causes and deeper causes of these problems. The collapse in

9
state capacity has policy and political causes and will not be resolved without significant
change and bold leadership. The deeper causes of collapse stem in part from ideological
gridlock within government, which has prevented critical decisions to be made in time, as has
happened repeatedly in both electricity and rail. It also stems from a particular ideology that
prevents society from contributing to supply societal needs; for example, by limiting private,
provincial, and municipal power generation. It also stems from the mistaken belief that
preferential procurement rules could be imposed on complex organizations, such as the
network industries, at little cost. These rules have instead — in many cases — overburdened
critical public organizations. South Africa also has a peculiar form of fiscal decentralization that
has overburdened many municipalities that do not have the local capabilities to match the
responsibilities. Finally, South Africa has seen a rise in political patronage, which has interacted
with the other causes of state collapse. Together, these interacting causes of state collapse
have created a vicious cycle where talent becomes harder to attract and retain in government,
yet talented public servants are needed to restore and rebuild state capacity.

To reach its true economic potential, South Africa must include more of its citizens in the
growth process. The path to growth through inclusion must include the recovery of state
capacity and increasing the power of all members of society to exercise economic choice. The
country cannot prosper with over half of its working-age population not working. It cannot
afford to keep its citizens spatially disconnected. It cannot expect to grow with a collapsing
state that de facto uses its power to limit society's capacity to help accomplish essential goals
of the nation. South Africa’s economic challenges may seem overwhelming at the current
moment, but the promise of the Rainbow Nation is not out of reach. This report seeks to inform
new paths to growth that will come through more effective economic inclusion. Inclusion must
start by understanding and tackling key issues that drive exclusion. For the economy to function
and leverage all the human capabilities, productive knowledge, physical assets, and natural
endowments that South Africa has, the government needs to work. South Africa needs a more
effective form of statism that does not overburden state organizations with additional goals
that undermine their core mission. South Africa also needs to develop new and better
mechanisms for driving inclusion, empowerment, and transformation that include far more of
society. Central to this challenge is spatial inclusion, which is ultimately about giving people
the choice of where to live and what markets to access. This includes not only the labor market,

10
but also markets for ideas, innovation, entrepreneurship, capital, finance, and partnerships that
are undermined by the segregation of cities and other spaces.

1.2 Growth and Inclusion in Numbers

South Africa has a growth problem, which has intensified over the last fifteen years.
Annual GDP growth averaged 3.6% per year from 1994 through 2008, or 2.0% in per capita
terms, lower than that of upper-middle income countries and Sub-Saharan Africa on average
(Figure 1.1). At its peak in 2006-2007, South Africa grew at a slower pace of growth than most
peers and then experienced a sharper contraction in 2008-09. After the Global Financial Crisis,
South Africa’s growth remained more subdued. In fact, growth declined to an average of 0.7%
(-0.5% in per capita terms) in the five years prior to COVID-19. In 2020, South Africa’s
contraction was again sharper than others. Since 2020, income per capita has not yet
recovered to its pre-pandemic level even as South Africa has benefited from high commodity
prices of several resources. Expectations are that South Africa faces difficult years ahead.
Figure 1.2 shows the path of GDP per capita indexed to 100 in the year 2019 (before COVID-
19), according to the IMF’s projections. While Sub-Saharan Africa and emerging economies
are expected to return to growth but without a recovery to the pre-pandemic path (Panels B &
C), South African GDP is projected to continue to stagnate without returning to its pre-
pandemic level (Panel A).

FIGURE 1.1: REAL GDP GROWTH – SOUTH AFRICA VS. PEERS

12
10
8
6
4
Percent

2
0
-2
-4
-6
-8
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022

South Africa Sub-Saharan Africa Upper-middle income

Source: Own elaboration based on World Economic Outlook (April 2023) for South Africa and Sub-Saharan Africa and World
Development Indicators for Upper-Middle-Income Countries.

11
 FIGURE 1.2: REAL GDP PER CAPITA – OBSERVED AND FORECASTS
Panel A: South Africa

Panel B: Sub-Saharan Africa Panel C: Emerging Economies

Source: Own elaboration based on World Economic Outlook (April 2023 and October 2019)

The COVID-19 pandemic hit South Africa hard, which exacerbated a pre-existing
problem of declining global competitiveness across several sectors. As documented by
Hausmann et al. (2022), over the fifteen years since 2008, sustainable growth drivers
increasingly faded away, leaving an economy driven only by consumption: exports and
investment contributed virtually nothing to overall growth over 2009-19 (Figure 1.3). This
change cannot be explained by a decline in commodity prices alone because export volumes
also stagnated. As a sign of declining competitiveness in the global economy, South Africa has

12
lost global market share since 2015 across numerous manufacturing industries, including
textiles, machinery, chemicals, and electronics, as well as across agriculture and travel, and
tourism exports.4 If South Africa’s global market share had just remained constant at its 2004-
11 average, exports would have been 13.3% greater in 2019. South Africa then faced four
intensive waves of COVID-19 infection over 2020-22. The onset of COVID-19 led to a further
rapid decline in exports (by 25%) and investment (by 12%), and investment has not recovered
to pre-pandemic levels. Meanwhile, private and public consumption continued to grow but at
a slower rate than before COVID-19.

FIGURE 1.3: CONTRIBUTION OF EXPENDITURE COMPONENTS TO CAGR OF REAL GDP

Note: Due to data discrepancies, the sum of the contributions of each expenditure component for each period slightly differs
from the CAGR of the real GDP.
Source: Own elaboration based on StatsSA.

Sector performance patterns over time are reflective of key supply-side constraints. At
the sector level, the economic slowdown has been driven by declines in utilities,
manufacturing, and mining (Figure 1.4). The weakening of mining began before 2008
— despite global commodity prices remaining strong for several years after — while the fall in
utilities and manufacturing occurred over the last fifteen years. The declining growth of
manufacturing was especially noteworthy as the sector has been an important source of
government attention and middle-class jobs. Manufacturing shed jobs since 2008 at a pace
well beyond what global trends of “premature deindustrialization” can explain, as shown by
Fortunato (2022). This exceptional deindustrialization can be traced to key supply-side

4
See South Africa on the Atlas of Economic Complexity (https://atlas.cid.harvard.edu/countries/246/market-share)

13
constraints — especially the intensifying electricity crisis — and a high reliance on domestic
demand, which has declined amidst South Africa’s overall growth slowdown. With the core of
the economy not generating jobs, the few jobs that were created tended to be in security,
household services, and publicly funded community services. It is hard to imagine how this
form of job creation can generate economic dynamism to move the economy forward. Public
work programs in recent years have created some job opportunities, but these are temporary
and of much lower quality than the productive jobs that were destroyed or never created.

FIGURE 1.4: CONTRIBUTION OF SECTORS OF ACTIVITY TO CAGR OF REAL GDP

Note: Percent bold labels refer to the CAGR of the real GDP.
Source: Own elaboration based on StatsSA.

The modern South African economy is defined by exceptional levels of labor market
exclusion. South Africa’s unemployment and inequality levels are among the worst in the
world. In a labor market diagnostic, Shah (2022) puts this in perspective with the observation
that the richest decile in South Africa is about as rich as the richest decile in Greece while the
poorest decile in South Africa is as poor as the poorest decile in Cameroon. This results in a
very high poverty rate for South Africa’s level of income. But these are not new problems; they
were defining features of South Africa back in 1994, although they have worsened. On average,
unemployment has been increasing by 0.5 percentage points per year since the end of the
apartheid, reaching 33.5% in 2022 (from 20% in 1994) (Figure 1.5). Perhaps most worrisome,
youth unemployment reached more than 61.5% in 2022, according to StatsSA. Black South
Africans are not only the population group with the highest level of unemployment but the

14
difference in unemployment rates between Black and White South Africa has widened
substantially. If one looks instead at employment rates, so as not to overlook people who are
outside of the labor market because they have given up looking for work, South Africa has one
of the worst employment rates in the world (39% in 2022). The number of individuals not
engaged in education, employment, or training (known as “NEETs”) has also been on the rise.
While this is not a new or emerging problem for South Africa, low growth has worsened labor
market exclusion. But even the higher growth prior to 2008 did not fully reduce the problem.

FIGURE 1.5: UNEMPLOYMENT RATE, TOTAL AND BY POPULATION GROUP

Source: Own elaboration based on SARB and StatsSA.

Spatial divides play a crucial role in South Africa's high unemployment rate, especially
for Black South Africans. Nothing expresses more the extreme spatial imbalances in South
Africa than the difference in employment rates between the former homelands and the rest of
the country. The dismally low national rate of employment at the national level of 39% is an
average of two very different worlds. In the areas outside of non-metro former homelands (i.e.,
excluding Pretoria and Durban), where 63% of the working-age population lives, the
employment rate hovers around 46% — low but not uncommon by international standards.
Inside the non-metro former homelands, the employment rate of the working-age population
was barely 26%. In some municipalities that are within the former homeland boundaries, it is
below 10% (Figure 1.6). Within the non-metro former homelands, the problem seems to be

15
concentrated in the rural areas, which include almost 80% of the population of these areas. In
these places, the employment rate is barely 21%, while it is 42%, twice as high, in the urban
areas of the former homelands.

FIGURE 1.6: EMPLOYMENT RATES BY MUNICIPALITY

Source: Lochmann (2022)

The persistent exclusion of rural former homelands from the modern economy is one
critical type of exclusion that South Africa must reverse to achieve growth through
inclusion. The fact that the rate of employment in urban areas of former homelands is very
similar to the rates in both rural and urban areas outside the homelands indicates that there
are uniquely low job opportunities in the rural areas of the former homelands, where some
32% of South Africans live. These differences cannot be explained by the personal
characteristics of those living in the former homelands, because individuals who leave the
former homelands tend to find job success in other areas of the country at a similar rate to
anyone else (Lochmann, 2022). This implies that homelands face place-based economic
challenges that have not been overcome through various improvements to infrastructure and
social transfers in these areas. Furthermore, this means that education and skill gaps in the
former homelands, though significant, are not the binding constraint to more employment in
those areas. South Africa is extreme in both its low level of employment overall and the variance
in how low employment rates are across municipalities, as can be seen in a comparison with
Mexico, which is a country with a similar level of per capita income (Figure 1.7).

16
 FIGURE 1.7: DISTRIBUTION OF EMPLOYMENT RATES ACROSS MUNICIPALITIES –
MEXICO (2019) & SOUTH AFRICA (2011)

Source: Own elaboration based on South African National Census of 2011 and INEGI.

Space also plays a large role in explaining low employment rates in urban settings across
the country. In urban areas, workers on average face very long commute times and high
transportation costs, making them unusually far and disconnected from centers of productive
formal jobs, which tend to concentrate near central business districts. Relatedly, South Africa
has a surprisingly low rate of informal employment, especially as expressed as self-
employment or employment in microenterprises. Worldwide, these jobs tend to be spatially
more dispersed and closer to people's homes. In most middle-income countries, let alone low-
income countries, self-employment, and micro-enterprises tend to provide work and incomes
for a significant fraction of the labor force. For a country at South Africa's level of income, the
expected level of own account work, given the international experience is around 20%. But in
South Africa in 2019, before the COVID-19 recession, the rate was just 4%. According to Shah
(2022), this outcome cannot be explained by the larger presence of social grants, by stringent
labor market regulations, by low education, or by high crime. Evidence provided by Shah and
Sturzenegger (2022) suggests that South Africa's unusual urban structure with very distant and
low-density residential areas leads to very high transport costs, lowering formal employment,
but also very low foot traffic near people's homes, lowering the viability of informal work. To

17
make formal work viable, employers must compensate workers for the large direct and indirect
commute costs, making labor expensive for formal firms and less attractive for workers. In this
way, spatial exclusion can be understood as a key driver both of low formal employment and
extremely low informal employment in South Africa.

The urban structures of South Africa have origins that date back to apartheid, but these
structures have been exacerbated by housing policies and urban planning adopted since
1994. The urban areas where many South Africans live are far and disconnected from centers
of formal jobs. Although post-apartheid policy has aimed to break down spatial divides,
policies have had unintended consequences that have entrenched many of the same
outcomes. Housing policy following apartheid has centered on state-provided homes in far
away, low-density places, with an emphasis on providing publicly supplied housing through
the Reconstruction and Development Programme (RDP). City centers were kept at unusually
low densities through restrictive floor area ratios, maximum height regulations, and parking
regulations. In this context, the informal settlements that were created are telling as they are
better located and provide housing units that are smaller than the typical government-
provided RDP housing, indicating that the trade-offs implied in government policy do not
reflect the preferences of citizens.

It is unfortunately clear that South Africa’s trajectory is not one of growth or inclusion,
but rather stagnation and exclusion. South Africa’s economy is stagnating and, in fact, losing
capabilities, export diversity, and competitiveness. While the racial composition of wealth at
the top has changed, wealth concentration in South Africa has not and remains very high.
Moreover, the broader structures of the economy have not allowed for the inclusion of the
labor and talents of South Africans — black, white, and otherwise. There appear to be major
spatial impediments to labor market inclusion in cities and large spatial patterns of exclusion
in former homelands. As the performance of network industries and public capabilities have
deteriorated and growth has slowed, exclusion has only worsened. Empowerment of a few has
de facto come at the expense of the many. Since the policies that are in place today are not
accomplishing their essential goals, South Africa needs new tools and attention devoted to
more effectively achieving economic inclusion, empowerment, and transformation.

18
1.3 Prioritizing Constraints to Growth and Inclusion

Change is required to achieve South Africa’s growth and inclusion goals, but where
should change be focused? It is one thing to accept that outcomes are not in line with the
overall goals of society, but it is another thing to identify and address the constraints that are
preventing the goals from being achieved. Even in good times, governments cannot address
all constraints facing an economy all at once; but when challenges are mounting, prioritizing
binding constraints is even more important. South Africa has battled several waves of COVID-
19 infections, devastating flooding events, and episodes of violence over the last several years.
Regular and worsening rationing of electricity through load-shedding led the President to
declare a “State of Disaster”, which was later revoked, while water supply crises, port
functionality, and other severe breakdowns are also becoming disasters in their own right.
Under these conditions, it becomes natural for the government to prioritize the emergencies
it faces. However, in doing so, effective responses must also treat the deeper causes of
recurring problems, which are rarely as obvious. In some cases, response actions that treat
symptoms may worsen underlying problems.

This report provides an assessment of the causes behind South Africa’s economic
challenges and identifies a resulting set of priorities for how South Africa can achieve
growth through inclusion. Using principles of growth diagnostic research in tandem with
collaborations with numerous South African policymaking bodies, research organizations, and
private sector stakeholders, we arrive at two fundamental constraints. One of these constraints
— the destruction of capabilities to provide public goods — has been worsening over the last
fifteen years and is responsible for declining national growth. The other constraint — the
inefficient spatial structure of the economy — has been an issue for longer and helps to explain
both low dynamism over the long-term and persistent lack of inclusion even during times of
higher growth. Taken together, these two fundamental issues are at the heart of South Africa’s
economic challenge. They explain why previous research (Hausmann et al., 2022) finds that the
economic slowdown is not due to macroeconomic problems or external shocks, but rather to
persistent and worsening domestic supply-side constraints. This has meant that demand
stimulus measures via fiscal policy have proven ineffective or even counterproductive. In
addition to dissecting these constraints and offering pathways forward on each in a proximate

19
sense, we also identify several deeper issues that have undermined the state from acting on
solutions to known problems.

1.3.1 Collapsing State Capacity

The fundamental reason that growth has slowed over the last fifteen years is a collapse
of state capabilities to provide the public goods on which the economy depends. Few
things are as clear evidence of a system not working as it should as when the power goes out.
When this happens regularly and systematically, this is evidence that the electricity system has
broken down. And when similar system breakdowns happen across a variety of public goods
(Figure 1.8), this is evidence of causes that extend beyond the electricity system and a particular
SOE responsible for providing the public service — Eskom, in this case. But how do we know
when such systems are binding economic growth and inclusion? A summary of evidence is
provided here. In Chapter 2 of this report, we provide a full diagnosis of the crisis in the
electricity system to understand both electricity-specific failures and broader causes of state
collapse as well as a discussion of the problem of municipal government collapse.

FIGURE 1.8: SHARE OF RESPONDENTS INDICATING GOVERNMENT HANDLING AS “VERY BADLY”

Source: Own elaboration based on Afrobarometer Surveys.

The declaration of a state of disaster in the electricity system in early 2023 reflected
acceptance of a problem that was evident long before. Beginning in 2007, peak demand
for electricity began to outstrip supply, and Eskom started to use load-shedding to balance the
system. Since then, the electricity issue has only worsened with load-shedding intensifying and

20
electricity prices rising. Recently, the South African Reserve Bank (SARB) estimated that load-
shedding causes about a USD 50 million daily loss, on average, and without power outages
the reserve bank would have projected South Africa’s growth in 2023 to be 2.3% rather than
0.3%.5 This 2% difference is enormous and could get worse. During the winter months, load-
shedding was anticipated to reach stage 10 – meaning that upwards of 1 GW must be reduced
through rationing — in a system that only has a little over 6 GW in total capacity. But, as this
report discusses, this problem was obvious well before the rapid rise in load-shedding over
the last two years. For the situation to have gotten to this point after 17 years of load shedding
is an indication of a more severe governance failure. Countries that face similar electricity
crises, such as Colombia in 1992 and Chile in 2007 were able to turn the situation around in
less than 5 years.

Ending load-shedding is not a sufficient policy goal. Rather, South Africa needs to rebuild
the electricity system to deliver low-cost and reliable electricity to all users. The crisis is
particularly damaging for South Africa because the country's international comparative
advantage was based on its cheap coal-fired electricity and on the energy-intensive industries
that formed around it, such as mining and mineral processing. The collapse of utilities overall
can explain around 40% of South Africa’s growth slowdown even before the recent escalation
of the crisis (Hausmann et al., 2022). With electricity now being a comparative disadvantage
and with coal being phased out in the context of the global energy transition, the country's key
industries face present and future challenges.

Outages and load-shedding have considerably increased losses for all types of firms in
South Africa but particularly for energy-intensive firms. As studied by Fortunato (2022),
while there were around 2 hours of outages per month in 2007, this increased to 20 hours in
2020, which resulted in annual losses of approximately 7% for the median formal firm. While
15% of firms reported electricity as a constraint in 2007, 55% did so in 2020 — far and away the
top-reported constraint. To overcome the loss of reliable electricity from the grid, firms
increased their use of backup generators; 60% of manufacturing firms owned or shared a
generator in 2020 (versus only 20% in 2007). In 2020, reliance on generators was in line with
far poorer countries and countries in conflict, including Yemen, Lebanon, Iraq, and the DRC.
More recently, firms have expanded off-grid renewable solutions where possible. While many

5
See Statement of the Monetary Policy Committee, January 2023.

21
African nations have struggled with electricity provision, South Africa is somewhat unique in
that it had reliable cheap electricity, which was at the core of its comparative advantage in
energy-intensive industries. The country has catastrophically lost this ability to produce and
supply electricity.

The electricity system failure helps to explain why the growth slowdown has been driven
by the collapse in manufacturing, mineral processing, and utilities that was previously
noted. Since the manufacturing sector is three times more energy-intensive than other sectors
in the economy, it is not surprising that its contribution to real GDP growth fell from 0.5
percentage points per year during 1994-2008 to zero during 2008-2018. Moreover, the
subsectors within manufacturing that are more intensive in energy (measured by the share of
electricity as intermediate input) have shown even lower growth rates during the latter period
(Fortunato, 2022). Since Eskom as a company was also devastated by increasingly weak
revenues alongside highly unproductive investment, its financial position worsened. While
manufacturing also faced other challenges, electricity is the leading cause of their negative
productivity growth and loss of competitiveness. The electricity problem looms large across all
sectors, even those that have seen recent growth, such as business process outsourcing (BPO).

Unfortunately, this pattern is also present in other network industries — including ports,
rail, water and sanitation, and digital communications. This is why the government’s current
reform effort, based on the wide-ranging Economic Reconstruction and Recovery Plan and
implemented through Operation Vulindlela, is focused on responding to challenges in each of
these systems. While electricity is the most binding constraint for the economy overall,
industries that intensively need other public inputs are also facing increasing headwinds. The
Port of Durban has experienced its own visible collapse that can be seen in the persistent
backlog of ships in the harbor, and the failings of the rail system can be seen in the bottleneck
it represents for mining output and in the complete shutdown of passenger rail lines. Water
supply is worsening due to administrative failures, and under the pressures of climate change,
many fear that water availability will be the subject of the next national disaster. Locally, Nelson
Mandela Bay has been facing a water supply crisis. While these priorities are clear, the reform
efforts of Operation Vulindlela are increasingly revealing the complexity and interrelatedness
of the breakdown in public capabilities across government.

22
As SOEs’ core competencies have deteriorated, capabilities within national and local
governments have weakened, as have their financial health. Municipalities play a
significant role in the provision of public services, often acting as intermediaries in distribution.
This is the case for the distribution of water and quite unusually in electricity. Surveys of
satisfaction with these services show a decline over time for most municipalities, and measures
of water access have worsened. Municipalities, even as intermediaries, face related financial
difficulties. The State of Local Government Finances report of 2022 found that 169
municipalities across the country were in financial distress at the end of the 2021/22 financial
year (South Africa National Treasury, 2022). As of 2022, municipalities owed water boards and
Eskom around R15 billion and R53 billion, respectively. Municipalities are unable to collect
water and electricity payments from consumers, which has substantially undermined local
government solvency, worsening underlying challenges of effective and efficient local
spending. As discussed in Chapter 2, there is a large variance in public satisfaction with local
service delivery, which traces to a fundamental pattern of shifting a high level of spending
authority and responsibility to local municipalities without the underlying capabilities to deliver
these responsibilities effectively. This is a problem sometimes referred to as “premature load
bearing,” which was brought upon by a rapid decentralization of expenditures, which precedes
the more recent crisis of financial distress of municipalities.

In electricity, the proximate cause of the crisis is poor management and under-
investment in generation, transmission, and storage capacity, but the deeper cause is a
distinct type of political gridlock. South Africa’s deficit in electricity is due to a lack of capacity
in the system. When this became apparent in 2007, South Africa committed three errors that
made today’s crisis worse. First, it bet heavily on badly designed coal power plants as the costs
of renewables were falling. Second, it delayed maintenance in its aging fleet to create more
capacity in the short run. Third, it waited too long to seriously bring in private investment.
Liberalizing the participation of society especially in generation and transmission will be the
most effective way to mobilize the necessary investments South Africa needs to get out of this
current crisis. Yet, it has taken nearly 17 years for South Africa to make serious moves in
allowing for private and municipal participation, and even now the progress of reforms is
unconscionably slow. In the meantime, South Africa bears large costs for this inaction and
gridlock. The current reform bills meant to establish an electricity market have not been

23
passed, nor do they clarify important aspects about the role of market participants and
alternatives to the current failing system of distribution by municipalities.

A current focus on emergency response and a lack of clarity in the vision for the future
shape of the electricity market prevents society from contributing more to solving the
electricity supply problem. Even if the final design of the market only takes shape over time,
economic agents need to have a much clearer idea of the direction and contours of future
policies to be able to participate today. Thus, South Africa needs to create a functioning market
for electricity with the following principles: (1) greater participation of society in generation,
transmission, distribution, and storage; (2) efficient distribution markets that are not too small
to benefit from economies of scale (as many municipalities currently are); (3) clear rules for all
market participants that eliminate conflicts of interest and prevent discriminatory treatment;
and, (4) final prices that reflect the marginal cost of production, including intra-day pricing.
Additionally, given the current state of the electricity crisis, the goal should be to procure as
much power as efficiently and cheaply as possible. This means relaxing preferential
procurement rules and focusing the power of government procurement more strategically.
Eskom has been forced to procure expensive, low-quality coal, and struggles to get good parts
and technical capacity for required maintenance. Removing such rules should be a priority not
only during the emergency response but also during the permanent functioning of the system.
The current procurement of energy through the Renewable Energy Independent Power
Producer Programme (REIPPP) should be extended to include transmission and storage
investment needs so that transmission and stability constraints do not limit the expansion of
generation.

In electricity and beyond, a collapse of public capabilities has become systematic and
requires a more systematic response. Breaking systems is usually easier than repairing them.
Repair requires a clear diagnosis of failure at a system level in both technical and wider political,
administrative, and organizational dimensions. Four primary factors contribute to state
capacity decline: political gridlock, entrenched ideology, overburdening of state organizations
with objectives beyond their core mandate, and political patronage. This reality has
empowered a minority to the detriment of the majority. Rekindling growth requires recovering
and strengthening state capacity, and we close Chapter 2 with an outline of how to do so by
reversing excessive “load bearing”, building up and protecting capacity, and leveraging rather

24
than restricting capabilities that exist in wider society. Certain capacities have been rebuilt (for
example the tax collection ability of the South African Revenue Service), showing that change
is possible.

1.3.2 Spatial Exclusion

South Africa is exceptional in its human geography, and its spatial patterns undermine
growth through inclusion. South African cities are unique in their degree of fragmentation,
with long distances between where people live and central business districts. The economics
of cities shows that the essential role of cities is as labor and product markets (Bertaud, 2018),
that is places where workers can bring their skills and abilities together, organized within
business establishments, to produce goods and services. If people cannot effectively move
from home to work and back at a reasonable cost in terms of money and time, the benefits of
agglomeration cannot be realized. This is precisely the problem facing South Africa’s cities,
and it is reflected in the very long travel times and high commute costs that South Africans face
in getting to and from work. At a certain point, paying the commute cost becomes prohibitive
for workers and businesses, especially at lower levels of skills and expected wages. Many
places in urban South Africa are beyond this threshold. South African cities are characterized
by a sprawling, low-density, and disconnected urban structure.

Spatial exclusion in cities has been entrenched through housing policies and urban
development norms followed since 1994. Though many South African cities bear the spatial
imprint of apartheid, we find that post-apartheid policies have entrenched spatial exclusion. A
national push to provide free low-density detached housing in the periphery of cities, rather
than through higher-density solutions closer to the center of cities, has made commute costs a
serious impediment to labor market participation. This problem is being repeated in fast-
growing secondary cities through norms in urban planning and policies that disincentivize
density and incentivize sprawl. Because the government housing supply excludes people from
market opportunities, informal settlements have been growing in better-connected areas.
However, they often lack the complementary public goods that make them vulnerable to
flooding, crime, and other hazards. Nevertheless, people choose to live in these vulnerable
conditions because they are closer to opportunity.

25
The direct consequence of the low proximity to labor markets is high commuting times
and transport costs, which discourage job creation. Commuting time and transport costs
are very high in South African cities. As studied by Shah (2022), while direct commuting costs
were 17% of net wage income, the total cost (including the opportunity cost of time when
commuting) averaged 57% of net wage income. These are averages across all workers and do
not even count those who cannot afford to get to work,6 and the picture looks much worse for
disadvantaged socio-economic groups as the ratio of transportation costs to wages is highly
regressive. While direct costs of transport to work represented more than 35% of labor income
for those in the lowest income quintile in 2010, they represented less than 10% for those in the
highest quintile of the income distribution. In addition, the total time of transport and the risks
of crime are much higher for the modes of transport used by low-income individuals, such as
bus, taxi, and train systems. Shah and Sturzenegger (2022) study this issue through a spatial
labor market matching model and find that this distortion can explain much of South Africa’s
labor market exclusion. Higher costs of transport are associated with a decline in wage
employment (both formal and informal) and an increase in unemployment (Figure 1.9).

FIGURE 1.9: LABOR MARKET INDICATORS VS. TOTAL TRANSPORT COSTS BY DISTRICT MUNICIPALITY

Source: Shah and Sturzenegger (2022) using 2017 National Income Dynamics Study and 2020 National Household Travel Survey.

6
Banerjee and Sequeira (2020) found, using a randomized control trial, that providing transport subsidies to young
job seekers revealed that the cost of commuting was high in relation to the actual returns from job search, leading
beneficiaries to search for opportunities closer to home.

26
Reversing this recurring problem is possible through more compact cities, which is a job
for policy. This can be achieved by removing restrictive regulations that disempower housing
choice and redirection in public housing spending to support smaller and better-located
housing options. Inertia in city design and numerous regulations on housing development
severely disincentivize organic densification and instead incentivize the development of
dislocated housing. As argued in Chapter 3 of this report, the solution must start by addressing
key constraints on housing development that come from overly restrictive building codes and
zoning regulations that prevent the development of denser housing. Taking national and local
restrictions together, these jointly restrict where you can build, how you can build, and how
dense you can build. At the same time, urban planning and infrastructure investment implicitly
incentivizes the sprawl of metro areas rather than strategically putting better-connected parts
of cities into housing production. By addressing these issues, cities can improve their economic
prospects through increasing labor market inclusion, while both cities and the national budget
can improve their fiscal positions through better allocation of public infrastructure spending.
Cities that are positioned to better absorb surplus labor, ideas, and human capacities from the
rest of the country will benefit everyone.

The spatial problem also manifests itself across regions and larger distances, especially
for residents of the rural areas of former homelands. The largest inequalities and wholesale
exclusion occur within rural areas of former homelands. While employment outcomes in South
Africa's metros and rural areas outside of former homelands are not great, what drives South
Africa’s labor market indicators to extraordinary levels is the extremely poor labor market
outcomes in rural areas of the former homelands. Since the end of apartheid, former
homelands have become more connected through infrastructure, but very long physical
distances remain. In some cases, paved roads and other basic infrastructure remain glaringly
lacking, including in large portions of the Eastern Cape Province. There has been a clear
pattern, documented by Lochmann (2022), that despite overall infrastructure improvements
and support to households, the economies of former homelands remain weaker than can be
explained by observable characteristics.7 Workers from former homelands have been

7
For more discussion see Chatterjee et al. (2022), Von Fintel (2014, 2018), David et al. (2018), Schotte et al. (2022),
Neves and Du Toit (2013, 2014), Kwenda et al. (2020), Mudiriza and Edwards (2020), Leibbrand et al. (2010), Todes
and Turok (2018), Visagie and Turok (2020), Turok (2021), Wittenberg (2003), Abel (2019), among others.

27
migrating out in search of opportunities and landing jobs on par with others, indicating that
the problem is with the places and not the people.

A place-based approach for the former homelands should make it more attractive for
businesses to move in rather than for workers to move out. Whereas internal migration is
natural and observed globally, South Africa does not reap its full possible benefits. It needs
more dynamic urban growth centers that can absorb more people and provide more jobs. At
the same time, if barriers to rural success are removed, rural areas of former homelands could
capitalize more on their latent comparative advantages. Employment patterns in rural areas
outside of former homelands are illustrative, as more rural areas outside of homelands tend to
have higher employment rates than more urban areas outside of homelands. The reverse is
true within homelands (Figure 1.10).

FIGURE 1.10: EMPLOYMENT RATES AND RURAL POPULATION BY MUNICIPALITY

Source: Own elaboration based on the South African National Census of 2011.

Exceptions to the general rule of worse economic performance in homelands are

powerful examples of what can change. There are cases of economies within former
homelands that are relatively more connected to markets and production that have managed
to capitalize on market opportunities. For example, villages around Makhado and Elim in

28
Limpopo have achieved higher employment by developing enterprises that serve demand in
the surrounding market under the umbrella of a community trust. More disconnected areas
have in some cases found ways to integrate into the modern economy through different types
of commercial partnerships, especially in agriculture (Klinger et al., 2023). What has worked in
these cases echoes organizational structures in franchising, which is a very mature business
sector and an important source of jobs in South Africa (Klinger, 2022). But these are a few
isolated cases which are exceptions to a rule of a highly dualistic agricultural sector leaving
large swaths of land idle and underutilized (Sturzenegger et al., 2023). There are also cases of
growing urban agglomerations within former homelands — for example, Mthatha in the Eastern
Cape — which are evolving quickly as they absorb internal migration and serve as hubs of retail
and other services. These cities appear to face similar problems to non-homeland cities in their
low density and sprawl but also function differently in that they are spatially less disconnected
and allow for more informal work to occur. Much of the housing expansion of these areas
occurs on communal land.

To include more residents of rural homelands in the modern economy, two responses are
needed. The first need is to better connect the most rural population centers through paved
roads and other basic infrastructure. These network expansions remain incomplete and
dramatically reduce the development pathways for large parts of the country. But lack of
physical connectivity is only one part of the problem. Even those areas that have much greater
physical connectivity often lag far behind their surrounding areas in economic activity. The
solution to this problem is an approach that we refer to as “bridging knowhow” and explain in
more detail in Chapter 3. Productive knowhow needs to be bridged between competitive
businesses and industries outside of homeland areas and communities within former
homelands, and this takes place most directly through business partnerships. South Africa has
reached a point where the benefits of such business models are proven, and several types of
entities have emerged as connectors and enablers of partnerships., namely: partnership
advisors, local NGOs, and community trusts. There are important challenges that must be
overcome when these partnerships work — including developing trust and technology transfer
— and issues of communal land and governance systems can be hurdles. However, a deeper
and more dynamic market for such partnerships is possible, which would better connect
businesses in need in need of land and labor with communities with matching comparative

29
advantages. As more areas of former homelands gain physical connectivity, these
opportunities will expand further.

1.3.3 Green Growth Potential

South Africa has lost a critical source of comparative advantage in cheap and reliable
electricity because of the collapse of state capacity. As studied by Fortunato (2022),
industries that use electricity most intensively have seen the sharpest declines in output and
employment. This has undermined South Africa’s export capacity and had an outsized impact
on the larger economy due to the very high energy intensity and electricity intensity of South
Africa’s exports overall. South Africa has effectively lost its comparative advantage in cheap
and reliable electricity. In the face of this constraint, efforts to grow through localization and
fiscal stimulus have been ineffective and may have narrowed growth opportunities further.
Localization strategies have prioritized the local market at a time when demand was not
growing and disadvantaged downstream industries in value chains, and fiscal policy has led to
rising interest rates and crowding out of capital-intensive industries. As South Africa addresses
the two binding constraints of collapsing state capacity and spatial exclusion, growth will need
to be driven by a re-emergence of comparative advantage that is consistent with changes in
the global economy. In the context of global decarbonization, this will not be possible by
simply returning to the energy mix of the past because industries and consumers are
increasingly demanding production with a lower carbon footprint.

Promisingly, South Africa has an immense opportunity to capitalize on changing global

demand due to decarbonization. It has strengths and potential for export growth and
innovation that can help to supply many of the goods, services, and innovations that the world
will need to decarbonize. Over the last decade, international agreements have tended to focus
on the demand side of decarbonization by asking countries, cities, and companies to reduce
their demand for fossil fuels and their carbon footprint more generally. At the same time, global
decarbonization creates transformative supply-side opportunities for countries to produce
goods and services that will allow the world economy to decarbonize. South Africa represents
only about 1% of global carbon dioxide emissions and a lower share of cumulative historic
emissions, so its impact on global climate change through reductions in its emissions will have
a very limited direct impact on climate change. However, South Africa has an impressive set of
assets in its resources, companies, and knowhow that could have a very substantial impact on

30
supplying the inputs to global decarbonization in the years to come. This “green growth”
opportunity could be a substantial driver of South Africa’s recovery in the future, but
opportunities will not become realities automatically. Reversing collapsing state capacity —
particularly the loss of cheap and reliable electricity — and more targeted industrial policies are
both needed to help to jumpstart new sources of growth. Green growth has such high medium-
and long-term potential in South Africa that we devote Chapter 4 to discussing this in detail.

South Africa has natural and historic advantages for three strategic pillars of green
growth. These advantages are currently undermined by collapsing state capacity, spatial
exclusion, and certain policy levers that are currently used (within industrial policy, trade policy,
and immigration policy, for example), but these conditions could be changed. The three
strategic pillars that we explore in detail are: (1) making the enablers of global decarbonization;
(2) making green versions of grey products for the global market; and (3) exporting green
knowhow. Taken together, these strategies would help to recover and expand new
comparative advantage for South Africa and, potentially, the larger region of Southern Africa.
Each requires highly targeted industrial policies.

Each of these strategies includes a range of opportunities. Under the first strategy, South
Africa could participate much more in the supply of critical minerals and provide the world with
many of the enablers of clean tech such as vanadium redox flow batteries (for grid-level
storage), platinum-metal-group-based fuel cells, and electric vehicles, among others. We
explore several relevant green supply chains in detail in this report. Under the second strategy,
South Africa could harness its ample resources of sun and wind to be a competitive location
for energy-intensive production with a low carbon footprint. These opportunities could be
spurred on initially by the development of green industrial parks, but the scale will ultimately
depend on South Africa regaining cheap and reliable electricity and sustainably reducing the
cost of capital for new projects. The third strategy of exporting green knowhow is relevant for
South Africa because the country has both excellent research and development capabilities
and existing companies — like SASOL — with unique knowhow in decarbonization-related
technologies.

Achieving South Africa’s green growth potential will require a new way of looking at the
energy transition together with targeted industrial strategies. South Africa has launched
initiatives focused on a “Just Energy Transition,” with a focus on responding to challenges of

31
regionally concentrated coal economies but which also recognizes the benefits to all of society
from new technologies that can both respond to the electricity crisis and serve as new drivers
of growth. On paper, this is consistent with the green growth opportunity, but in practice, there
is a risk that too much attention is focused on phasing out coal more quickly and too little
national policy and international support on the three strategies discussed in this report. There
may be potential to leverage more international finance and knowhow through incorporating
these strategies into the Just Energy Transition framework.

Green growth opportunities show that the South African economy does not exist in
isolation from a globalized economy, which has implications for current industrial, trade,
and immigration policies. As the growth of the South African economy has slowed, industries
that have relied on domestic demand have faced not only direct pressures on their productivity
— due to collapsing state capacity — but also faced declining demand. This has occurred in
manufacturing, construction, transportation services, and business services, among other
industries. Over the last decade, the government has relied increasingly on localization
strategies, which have focused on capturing more domestic demand by substituting imports.
In a context where the decline in domestic demand is worsened by supply constraints, this
strategy can be counterproductive. It also misses the larger opportunity of reaching global
markets that are much larger and where demand growth is much stronger than in South Africa.
As South Africa focuses inward, firms can miss out on numerous emerging opportunities to
reach global and regional demand. This is true for both existing businesses that would benefit
from government actions to expand market access and for the entry of new businesses that
could capitalize on South Africa’s comparative advantages. An inward-looking strategy in a
slowing economy is costing South Africa many jobs. As South Africa has increasingly turned to
protective measures in recent years, it may lose out on the opportunities created by the African
Continent Free Trade Area (AfCFTA), which has the potential to benefit many South African
exporters and attract new exporters.

South Africa continues to miss out on the benefits of high-skill immigration. Though
reforms to South Africa’s visa regime have been prioritized as one pillar of Operation
Vulindlela, the country remains out of step with peers who recognize the importance of high-
skill immigration as an engine of growth and transformation. Most worrisome, the country has
experienced rising numbers of skilled worker outmigration, losing more skilled workers than

32
what it receives (Halstein, 2021) and patent data shows that South Africa is seeing weakening
innovation capacity. South Africa needs access to global talent and immigration policy can be
a tool for attracting talent. The importance of high-skill immigration is not a new observation
as a straightforward policy response was already recommended by the International Advisory
Panel on ASGISA in 2008 to enable high-skill immigration (Hausmann et al., 2008, Banerjee et
al., 2008). This remains essential for South Africa to leverage its greatest strengths and expand
growth drivers, which inescapably require complementing the knowledge of South Africans
with outside expertise.

1.4 Macroeconomic Consequences

Attempts to address the effects of both the collapse of public goods and the spatial
constraints through fiscal means have weakened the macroeconomic position of the
country. Collapsing state capacity — in electricity, rail, ports, water and sanitation, security, and
local services — has caused GDP and export growth to weaken, negatively affecting tax
revenues. State capture also reportedly undermined the tax administration capacity of the
government, which has thankfully been largely recovered through improvements at the South
African Revenue Services, which have been reflected in tax revenues. With unemployment and
poverty high, there have been large pressures for social transfers and public employment. For
instance, social transfers have increased from 4.9% of GDP in 2010 to 6.0% in 2022. These
transfers were sharply increased during the COVID-19 pandemic through the Social Relief of
Distress Grant, but transfers to households were already on an upward trend prior to the
pandemic. These fiscal measures are meant to compensate people for their exclusion rather
than increase inclusion. The result of these forces was a worsening of the fiscal balance.

The poor performance of SOEs also led to large capital transfers, which had a significant
impact on national debt accumulation. Total contingent liabilities coming from guarantees
to public enterprises have increased at an annualized rate of 12.1% since 2005. More than two-
thirds of this increase comes from bailing out Eskom, followed by bailouts of other
independent power producers as well as the South African National Roads Agency Limited
(SANRAL). Contingent liabilities from Eskom grew at an annualized rate of 53.1% between
2005 and 2022, reaching 5.1% of GDP in 2022. Moreover, they imply an increase in gross

33
borrowing requirements of 3.4% of GDP between 2023 and 2025. This debt accumulation puts
increasing pressure on the budget.

These two macroeconomic responses to the growth slowdown and SOE mismanagement
worsened the fundamentals of fiscal sustainability, leading to an increase in the cost of
borrowing and a deterioration in the country’s creditworthiness. South Africa's gross debt
rose from 23.6% of GDP in 2008 to 71.1% in 2022, an increase of 47.5 percentage points in 15
years, leading to several downgrades of the credit rating to BB- in 2020, below investment
grade. In 2022, interest payments represented 4.8% of GDP and 17% of total revenues, limiting
the capacity of the government to use its revenues to address other needs. The rise in debt has
been the consequence of deficits that have been above sustainable levels. The consolidated
government overall fiscal deficit increased from 3.6% in 2011 to 9.9% in 2020, though the
government has been able to reduce the overall fiscal deficit to 4.2% of GDP in 2022 through
exercising fiscal discipline together with a recovery of revenues.

Given that the nature of the constraints facing the economy are on the supply-side, fiscal
demand stimuli have been counterproductive. In fact, fiscal multipliers have been negative
(Hausmann et al., 2022); rather than helping growth, they have been hurting it, largely by
increasing the cost of capital and crowding out investment. However, while negative, the size
of the expenditure multiplier is estimated to be small. This implies that fiscal policy cannot be
blamed for low economic growth. The central point is that expansionary fiscal policy is merely
not the right policy tool to respond to the challenges that South Africa faces today.

Looking ahead, while the primary focus of this report is not centered on macroeconomic
policies, it has become increasingly evident that the macro-fiscal situation presents a
rather challenging outlook. Despite the commendable efforts of the National Treasury, fiscal
targets have been difficult to achieve. The collapsing state not only directly impacts the
increasing debt levels but also indirectly contributes to a low tax collection due to the anemic
economic growth it ushers in. A lower-than-expected mining tax revenue — a sector dependent
on electricity, rail, and port capacity — is an example of it. Furthermore, higher-than-expected
public wages increases have constrained the reduction of government spending this year.
Finally, while SARB has succeeded in keeping inflation within its targeted band, deteriorating
public finances — in a context on increasing global uncertainty — can risk driving prices up.

34
While challenging, it is imperative for South Africa to regain investment grade. Through
the collapse of Eskom, the country has lost its comparative advantage in coal-based electricity
generation. Cheap electricity underpinned the comparative advantage in energy-intensive
industries such as mining and mineral processing. The global energy transition will require that
South Africa increasingly forgo the use of coal and expand the use of renewable energy.
Electricity is a highly capital-intensive industry as are mining, mineral processing, as well as
green versions of hydrogen, ammonia, and steel. The country's long-term comparative
advantage in these new green growth opportunities will depend on keeping the cost of capital
low. This requires a reduction of sovereign risk by returning the country to investment grade.
Given the presence of negative fiscal multipliers, fiscal consolidation can be growth-enhancing
in South Africa by crowding in investment. Hence, both the short- and long-term goals of the
country will benefit from a focus on the return to investment grade.

1.5 Summary of Recommendations

The remainder of this report discusses South Africa’s constraints in more detail and
arrives at proximate and deeper recommendations. Proximate recommendations reflect
actions that would directly impact the constraints that have led to weak growth and exclusion.
Deeper recommendations aim to address the deeper causes of these constraints and reasons
why proximate solutions have often not been implemented. Figure 1.11 provides a list
summarizing the recommendations included throughout this report.

35
 FIGURE 1.11: SUMMARY OF RECOMMENDATIONS FOR GROWTH THROUGH INCLUSION

On Strengthening State Capacity

Create a functioning market for electricity with the following principles: (1)
Greater participation of society in generation, transmission, distribution, and
storage; (2) Efficient distribution markets that are not too small to benefit
from economies of scale (as many municipalities currently are); (3) Clear
rules for all market participants that eliminate conflicts of interest and
prevent discriminatory treatment; and (4) Final prices that reflect the
marginal cost of production, including intra-day pricing.

Appoint a reform and unbundling sherpa/Czar to push implementation.

Remove all preferential procurement requirements for the REIPPP. Develop
strategic procurement programs that strengthen industries with clear
potential to eventually compete in global markets (and move toward this
On the
targeted approach instead of widespread, ineffective preferential
Electricity
procurement).
Crisis
Use REIPPP design for investments in transmission and storage. Include
transmission and storage (with geographical considerations) in the next
REIPPP procurement window.

Rent existing power plants to other operators incorporating high incentives

for efficiency.
Enable new comparative advantage in green electricity: (1) streamline
approval of renewable generation, transmission, and storage projects; (2)
promote private green industrial zones powered by renewable energy to
attract energy-intensive industries that want to decarbonize quickly; (3)
explore pumped storage hydropower with Lesotho to facilitate the
absorption of more renewable projects.
Reassign responsibility for electricity and water distribution to
geographically efficient regulated monopolies. Such companies could then
On Municipal collect other fees on behalf of municipalities via their monthly bills.
Governments Develop public “capability banks” and position national/regional entities as
service providers to municipalities for activities where local governments
cannot be expected to have local expertise nationwide.
Unburden Capacity – Expand relaxation of preferential procurement
requirements on all SOEs and other public entities.

Build Up and Protect Capacity – Gradual civil service reform to replace the
On State reliance on cadre deployment. Explore long-term system of civil service
Capacity cadres that are recruited nationally but deployed across different
Overall municipalities and levels if government.

Leverage Existing Capacity – Establish clear markets that allow for societal
capabilities to help fill supply gaps in network industries (rather than selling
assets through privatization).

36
On Spatial Inclusion

Three main areas of regulatory change:

• Relax National Building Regulations (overly restrictive materials and
accessibility restrictions).
• Relax Local Building Regulations (FAR, BCR, parking, and elevator
requirements to allow for higher density).
• Change zoning regulations to allow for greater density and mixed-
use multi-family housing.
On Urban
Planning and On urban planning and development:
Building • Incorporate underutilized urban land for housing and development.
Regulations
• Ensure that development impact fees are evenly applied in the city
core and periphery.

Process rules: Move towards regional and provincial zoning standards to

limit highly localized NIMBY vetoes to housing.

Develop and incentivize active public-private problem-solving task forces

for housing expansion.

Revise the human settlements budget to increase demand-side housing

subsidies as opposed to direct supply programs that dictate where housing
is built. Partner with the financial sector to expand mortgages/lending to
those with limited credit histories.
On Budget
Link conditional grant funding for housing and related infrastructure to
Reorientation where local building and zoning regulations meet minimum standards for
increasing density or where demand-side subsidies are mobilized.

Reorient budget towards more experimental, innovative mixed-use urban

projects, especially on well-located government-owned land.

Prioritize the revival of passenger rail, especially by devolving key

functioning routes to more capable metros.
On public
transportation
Additional pilots and scaling of efforts to formalize and expand the minibus
taxi system in a way that can support public transport systems.

Create and expand markets for business partnerships through supporting

investments in hard infrastructure (i.e., roads) and soft infrastructure and
services (information systems for matching, partnership advising).
On Bridging
Knowhow
Leverage agents to enable partnerships through matching third-party trust:
Partnership advisors, local NGOs, traditional governments (incl. trusts),
possible new roles for universities.

37
On Green Growth Potential

Targeted industrial policy for opportunities that are growing in global

demand and where South Africa can develop comparative advantage:
• Pillar 1: Make the enablers of global decarbonization – mining
strategies for critical minerals, targeted support actions for pioneers in
emerging green supply chains, and policies to transition the
automotive industry towards electric vehicles.
• Pillar 2: Make green versions of grey products for the global market –
promote privately-operated Green Industrial Parks (w/ dedicated
renewable power). Leverage SASOL's technological strengths to
develop green fuels.
• Pillar 3: Export green knowhow – Develop capabilities to export
knowledge-intensive services in engineering, procurement, and
On Green construction (EPC) of green projects, develop new mastery over green
Growth technologies (e.g., Fischer-Tropsch for green products, Vanadium
Redox Flow battery technology for grid-scale storage, membrane
technology for fuel cells and electrolyzers). Strengthen R&D support
policies for green technologies. Deepen international partnerships
and allow for easy entry of talent through more open high-skill
immigration and business travel.

Return South Africa to investment grade to lower the cost of capital of new
investments in the electricity system and other green growth opportunities
and develop a world-class electricity market to lower industry-specific risks.

Prioritize actions to reduce development costs for investment in renewable

generation, transmission, and storage infrastructure (e.g., easy permitting;
grid interconnection, government-facilitated land).

Redirect industrial policy away from import substitution for a limited and
stagnant domestic market and instead target industries that can leverage
On Trade the domestic market but that have the potential to grow by supplying the
Policy global market.

Move from laggard to leader in the African Continental Free Trade Area to
increase market access and opportunities for South African companies.

Make South Africa a competitive destination for global talent.

On Knowhow
Access
Continue to reduce administrative delays and costs of business visas.

38
2 State Capacity as a Constraint to Growth

2.1 Executive Summary

Economic growth in South Africa is constrained by the insufficient availability of critical

public goods and services essential for production. As briefly discussed in Chapter 1 of this
report, the provision of electricity, transport infrastructure (including freight rail, ports, roads,
and passenger rail), water and sanitation, and security have deteriorated substantially over the
last generation. The deterioration of utilities alone explains upwards of 40% of the country's
growth underperformance since the global financial crisis (Hausmann et al., 2022). The most
immediate of these challenges is electricity; projected load-shedding is severe and lowers
current growth forecasts by more than 2 percentage points, according to the South African
Reserve Bank. Simultaneously, freight and logistics challenges have acute impacts on export
sectors. Rail networks have shut down entirely, and port delays have become endemic. Despite
favorable external conditions, exports of minerals, metals, and agricultural products are
weakening as the cost of getting products out of the country rises. This indicates that the loss
of public goods and services has undermined South Africa’s historic areas of comparative
advantage. The electricity systems failings have undermined South Africa’s comparative
advantage in cheap and reliable electricity. Meanwhile, many population centers of South
Africa are either currently facing or vulnerable to severe water supply crises, as has most
recently been experienced in Nelson Mandela Bay Municipality. Vulnerabilities of water and
sanitation systems are growing as long-term weaknesses in maintenance and system
management meet increasing patterns of drought due to global climate change.

Many public goods and services that were previously provided effectively have
experienced substantial deterioration. South Africa's electricity system, rail infrastructure,
and ports were once exemplary on the continent. State-owned entities like Eskom and Transnet
were well-run and efficient, and ports like the Port of Durban were among the busiest globally.
However, over time, there has been a widespread collapse in state capacity, leading to system
failures and breakdowns in these industries and systems. Parastatals have experienced a major
decline in effectiveness, rendering them unable to fulfill basic mandates. At the same time,
municipalities across the country have seen public services decline and increasing levels of
financial distress. As infrastructure has deteriorated, aged, and been subjected to sabotage

39
(through both theft and more systemic influences), new investments have not been mobilized
effectively, leaving supply gaps across network systems. As the capacity to supply public goods
has broken down, so too has the ability for network industries to sustain themselves through
service fees, which has led to insolvency across the system. SOEs, including Eskom, Transnet,
and PRASA, are in dire financial situations, necessitating ongoing fiscal support and bailouts
from a fiscally constrained national government.

This chapter will argue that the collapse in state capacity within national network
industries can be traced to recurring issues of gridlock, ideology, overburdening of
public organizations, and political patronage. Gridlock within the legislative process and
leadership of government has prevented critical decisions from being made in time to address
system breakdowns. This has happened repeatedly in both electricity and rail. Ideology has
prevented the full capabilities of society from contributing to address supply needs, for
example, by limiting private, provincial, and municipal power generation or devolution of the
management of urban passenger rail to capable city governments. Things have been made
worse by a mistaken belief that preferential procurement rules could be imposed on complex
organizations, such as the network industries, at little cost. Rather, these rules have
overburdened critical public organizations by adding financial costs, reducing effectiveness,
and expanding space for patronage systems to take hold. Political patronage has been a
widespread problem, as well documented by South Africa’s Judicial Commission of Inquiry
into Allegations of State Capture, Corruption and Fraud in the Public Sector including Organs
of State, better known as the Zondo Commission. While it can be easy to place the blame of
state collapse on corruption and patronage, this would overlook the direct ways that gridlock,
ideology, and overburdening have contributed to struggling and failing public systems.
Overall, these causes have resulted in a continued loss of technical capacity and competent
management across public organizations, making capacity loss harder to overcome.

Collapsing state capacity at the local level can also be traced to issues of “premature load
bearing” alongside the breakdown of national systems. South Africa has a fiscal system that
is unusual in the degree of expenditures that take place at the local government level,
especially in contrast to its much more limited decentralization of the powers to tax and borrow.
South African municipalities were given significant local powers in the distribution of electricity,
water and sanitation management, and road development over the decade following

40
apartheid. This was done in an effort to address regional inequalities. However, many of these
responsibilities were inconsistent with local capabilities, causing service delivery to be strained.
For example, the maintenance of water systems required more experienced engineers than
many municipality governments could mobilize. Additionally, a large share of local revenues is
dependent on the collection of fees from water and electricity delivery, which has broken
down. This has led to an issue of circular debt. Municipalities have failed to collect tariffs from
households for electricity and water, resulting in their inability to pay Eskom and state-owned
water boards, further impacting infrastructure maintenance and investment.

The subsequent sections of this chapter delve into the decline in state capacity, its
causes, and its consequences for South Africa. First, we describe the overall collapse in state
capacity across various service systems and levels of government, which has slowed South
Africa's growth and undermined inclusion. The following section examines the electricity
sector crisis, which has had the most widespread impact on growth. We unpack the technical
challenges of the system and critically assess the reform pathway to rebuild a reliable and low-
cost electricity system. We further identify the deeper underlying causes of failed policies and
strategies, namely gridlock, ideology, overburdening of public entities, and patronage, which
affect public goods provision far beyond electricity. We then explore the challenge of
premature load bearing through rapid decentralization that has contributed to state capacity
collapse at the municipal level. This problem is essential for understanding issues of circular
debt and reimagining the role that municipalities and provinces can play in rebuilding public
capabilities. This is especially important for spatial inclusion across the country.

Addressing the collapse of state capacity requires more than just identifying technical
fixes and long-term reforms — it requires grappling with the deeper policy and political
drivers that have caused public goods to deteriorate with little implementation of known
solutions. While many of the technical fixes and long-term reforms are well-known and even
outlined in proposed legislation, the political process for implementation has often been
incompatible with necessary actions. Take, for example, the electricity system. South Africa's
electricity system lacks sufficient generation, transmission, and storage capacity, while its
existing coal-fired plants are aging and increasingly unreliable. South Africa urgently needs
substantial investment in renewable generation, grid infrastructure, and storage. This must
come from sources beyond Eskom, with increased participation from private firms with the

41
knowhow and balance sheets to execute investment. To facilitate such participation, the
government must establish a well-functioning market with transparent rules and non-
discriminatory treatment of participants. These principles have been long-known and
documented in government white papers. Yet, these actions have not been taken for many
years and legislation has not been passed at the time of writing, leading to perpetual crisis
management. Current emergency actions will likewise remain insufficient in the absence of
long-term market clarity and non-discriminatory treatment. But with such steps, new sources of
generation, transmission capacity, and innovations in grid storage would enable both the
emergency response to the crisis and power a sustained economic recovery.

This chapter closes with a strategic direction for strengthening state capacity. We can
view actions to strengthen state capacity as covering several dimensions. This includes actions
to unburden capacity by further relaxing preferential procurement rules to allow public entities
to deliver on their core functions more effectively. Unburdening municipal governments must
include reducing problematic responsibilities where local capacities are poorly suited to
deliver in most municipalities, particularly in electricity and water distribution. The government
must seek to build up and protect capacity through civil service reform to replace the reliance
on cadre deployment over time. In the process of building capacity, this could include more
centralization of challenging government capabilities alongside “capability banks” or other
public tools that position national and regional entities as providers of technical services to
municipalities for project planning and execution. Importantly, South Africa has much to gain
by leveraging existing capacity by establishing markets with long-term clarity that can crowd in
new capacity and strategic procurement of services by SOEs. This is likely to be a faster and
more effective way to recover capacity in key public goods than through privatizing state
assets.

2.2 Patterns of Collapsing State Capacity

Over the last 15 years, South Africa has seen a broad-based collapse across critical public
goods and services. There has been a deterioration in the provision of electricity, freight rail,
ports, roads, water, and passenger rail. Figure 2.1 shows a particularly glaring example of
collapse. Whereas piped water access is expected to grow over time in any developing
economy not facing conflict or widespread natural disasters, South Africa has seen a

42
widespread decline in access. At the time of writing, the provision of services across many areas
appears to be getting worse despite clear government efforts, as prioritized Operation
Vulindlela from the wide-ranging Economic Reconstruction and Recovery Plan that followed
COVID-19. In the first half of 2023, total load-shedding in South Africa was more than the
entirety of 2022, which had previously been the worst year of load-shedding on record
(Business Tech, 2023). Freight rail volumes are 30% lower than their peak in 2015, and since
2014, the percentage of freight transported by rail has declined from 30% to 20% of total
payload (News24, 2021). This has meant that more freight has needed to travel by road, which
has put additional pressure on the road system. The ports of Durban and Cape Town, South
Africa’s two largest ports, which saw port throughput in South Africa decline prior to COVID-
19, now have some of the lowest performance scores of all ports in the world (World Bank,
2023). Similarly, passenger rail has seen a steep decline in ridership and an increase in delays.

FIGURE 2.1: PERCENTAGE OF HHS WITH ACCESS TO PIPED WATER 2007 VS. 2016

Source: Own elaboration based on South Africa Community Surveys.

The simultaneous collapse of these public services is indicative of a general collapse in

state capacity. One system showing a decline in service delivery might suggest a specific
problem in that sector, but the deterioration in public service provision across many areas

43
associated with SOEs and municipal governments suggests deeper causes at play. This is also
reflected in a general decline in South Africa’s position in the Worldwide Governance
Indicators compiled by the World Bank (Figure 2.2). South Africa’s global ranking in
government effectiveness and control of corruption declined steadily in the late 1990s and the
first decade of the 2000s. This decline clearly preceded the Zuma administration of 2009-18
and widely reported issues of state capture that occurred during that period.

FIGURE 2.2: SOUTH AFRICA’S PERCENTILE RANK IN SELECT GOVERNANCE INDICATORS

85

80

75

70

65

60

55

50
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Government Effectiveness Regulatory Quality Control of Corruption

Source: Own elaboration based on World Governance Indicators, World Bank.

Public perception surveys indicate a sharp decline in service provision. The

Afrobarometer survey, which has been repeated in two-to-three-year waves since 2000,
reflects a continuous decline in public perceptions of many services (Figure 2.3). This includes
a large increase in the share of respondents who selected “very badly” in response to questions
on government performance in providing reliable electricity (from 23% in 2008 to 44% in
2021), providing water and sanitation services (from 22% in 2008 to 41% in 2021), and
maintaining roads and bridges (from 20% in 2008 to 48% in 2021). This is likewise true for
fighting corruption and a wide range of economic performance questions, from “managing
the economy” to “improving the living standards of the poor” to “creating jobs” and “narrowing
income gaps.” Since surveys in 2021 capture the impacts of COVID-19, Afrobarometer surveys
across countries tend to show poorer performance across all these areas. However, South

44
Africa shows a distinct collapse of performance across many public services after 2015 that is
well above and beyond the norm across African countries.

FIGURE 2.3: SHARE OF RESPONDENTS INDICATING GOVERNMENT HANDLING AS “VERY BADLY”

Source: Own elaboration based on Afrobarometer Surveys.

The collapse in state capacity has been a major drag on overall economic performance.
In early 2023, the SARB estimated that load-shedding is costing the South African economy
nearly USD 51 million a day and has reduced its forecast for growth by two percentage points
due to the intensity of power cuts. Some estimates suggest that the impact of the logistics
challenges might have lowered growth by a similar amount or more (The Economist, 2023).
Hausmann et al. (2022) find that South Africa’s slow growth since the Global Financial Crisis is
not explained by external factors affecting terms of trade or macroeconomic stresses but rather
by a decline in total factor productivity (TFP) resulting from a supply shock in South Africa’s
network industries. If left unaddressed, these breakdowns will continue to constrain economic
growth. Even during favorable external conditions, such as the commodity boom in 2021,
South Africa's ability to benefit has been hampered by these supply-side bottlenecks.
Consequently, demand-side policies, such as monetary and fiscal measures, are ineffective in
reviving growth because they would only exacerbate supply constraints.

The primary channel through which the collapse of state capability has undermined
growth is through the deterioration of core functions of SOEs. Many public services in
decline center on SOEs, including Eskom for electricity, Transnet for logistics, PRASA for

45
passenger rail, SANRAL for roads, and water boards in the case of water — that have seen a
decline in operational efficiency and a loss of technical capacity and talent. While underlying
issues of SOE mismanagement, financial distress, and outright corruption are all intertwined
and difficult to unpack, the resulting low productivity and underinvestment in infrastructure
maintenance and expansion are clear to see. This has resulted in declining public services in
terms of measurable performance and public perceptions. Yet, the lack of adequate
investment does not mean that SOE spending has been low. The sector received bailouts and
recapitalizations totaling USD 14 billion or 6 percentage points of GDP in the 2009-2020
period, and in addition, borrowed USD 35 billion (8% of GDP) (Hausmann et al., 2022; Research
and Markets, 2021). In 2023, the South African government took on an additional USD 14
billion of Eskom’s total USD, while SANRAL and Transnet have received additional support
through the last medium-term budget. These bailouts have weakened the government’s ability
to put its debt on a sustainable path.8

With these larger patterns in mind, the next section unpacks the electricity crisis and
Eskom's role in revealing larger patterns of state failure. The case reveals that necessary
investments in generation, transmission, and storage were delayed, and then hampered by
fundamental disagreements within government leadership as to the vision for the sector,
especially regarding allowing the private sector a role in electricity generation. As the system
weakened, decisions were taken with increasingly short-sighted timeframes and expectations.
As a consequence, facilities were not taken offline for regular maintenance in order to
temporality limit load-shedding. But this made the problem progressively worse through
declining plant availability factors, as power plants experienced persistent breakdowns that
forced them to be taken offline. Large investments in new generation had serious design flaws,
experienced extreme cost overruns, and faced delays, intensifying the generation shortfall and
Eskom’s massive financial burden (Hosken, 2019). In this context, Eskom was not allowed to
leverage private generation due to highly restrictive limits on private electricity generation,
which limited investment in supply. This has left the system more reliant on Eskom, a company
with deteriorating capabilities, a weak balance sheet, and an inability to repair and expand the
system. Similar patterns underlie the decline of logistics networks. Transnet is no longer able
to maintain its rail network, including by protecting it from sabotage and cable theft, while it

8
Based on authors’ Debt Sustainability Analysis.

46
also does not have the rail stock to run trains. Ports have seen deteriorating productivity and a
backlog of maintenance and investments needed to be able to process the volumes they used
to process. Similarly, passenger rail has been left to deteriorate as PRASA has also faced
deteriorating productivity and underinvestment while wages and other expenditures
increased rapidly (Stent, 2022).

2.3 The Electricity Crisis and Broader Lessons

2.3.1 Current State of the Electricity Crisis

South Africa is facing an enormous crisis in electricity provision. In the early part of 2023,
the Government of South Africa declared a National State of Disaster due to the ongoing
electricity crisis. At the time, South Africa was facing load-shedding (i.e., rolling blackouts) with
some areas losing power for nearly 10 hours (stage 6 load-shedding). This year has seen an
acceleration in the long-term dynamic of the rationing of electricity that started in 2007 (Figure
2.4) (Pierce and Le Roux, 2022). This state of national disaster, as an official measure, was later
revoked due to legal issues, but the problems in South Africa’s electricity system remain as dire
now at the time of writing as they were in the earlier part of the year. Load-shedding for the
first three months of 2023 alone was greater than the total amount of load-shedding for the
years 2018-2021 combined, and South Africa saw daily power cuts without a break for more
than three months (Daily Investor, 2023b).

South Africa’s traditional sources of comparative advantage in mining, metals, and

capital-intensive manufacturing developed in a context of low-cost and reliable
electricity. South Africa has historically had access to cheap coal and historically, it took
advantage of this resource not just by exporting its coal, but also creating an electricity system
that could translate that cheap coal into cheap electricity. This allowed South Africa to develop
a comparative advantage in energy-intensive export sectors like mining, metals, and
manufacturing sectors like automobiles. Figure 2.5 shows how dependent South Africa’s
exports are on electricity relative to the export baskets of other countries. The boxes represent
the middle 50% of countries for each year in the electricity intensity of their exports. From this
figure, we can see that South Africa has historically had an export basket that was highly
intensive in electricity as an input — always among countries in the top 25% of electricity
intensity of exports. But the electricity crisis both in terms of prices and reliability has destroyed

47
the foundations of South Africa’s historical comparative advantage. Additionally, all countries
with high electricity intensity are facing a global change in demand, which we can begin to see
in the final years of this figure and will be discussed at length in Chapter 4 of this report.

FIGURE 2.4: LOAD-SHEDDING IN SOUTH AFRICA (2007 TO 2022)

Source: Pierce & Le Roux, CSIR (2022).

FIGURE 2.5: ELECTRICITY DEPENDENCE OF SOUTH AFRICA’S EXPORTS

Note: Red dots highlight South Africa.

Source: Own elaboration based on UNCTAD, US BEA Input-Output Tables, Atlas of Economic Complexity.

48
South Africa’s collapse in electricity provision has been the most immediate binding
constraint on South Africa’s growth. In fact, the electricity crisis showed clear signals of being
the binding constraint on economic growth well before the rapid acceleration of load-
shedding and declaration of the state of disaster – revoked soon after – in 2023. The relatively
high price of electricity price and extreme unreliability have created a large strain on firms
across sectors and especially in manufacturing (Fortunato, 2022). Electricity tariffs in South
Africa have skyrocketed since 2007, rising by a factor of roughly 6.5 from 2007 to 2022 as
general inflation has only raised prices by a factor of just 1.3 (Moolman, 2022). This was in part
a consequence of tariffs not being cost reflective prior 2007. Yet, this large increase has not
cleared the market, necessitating that the government ration electricity demand through load-
shedding. Electricity has become the number one obstacle for all firms of all types in South
Africa as businesses have faced a large increase in outages and the cost of outages, putting
South Africa out of line with international norms (Figure 2.6). As further analyzed by Fortunato
(2022), there has been a proportional increase in generator and off-grid renewable energy use
as businesses strive to bypass the challenges in the electricity sector. The same report finds
that it is precisely the industries that are most intensive in electricity use that have seen the
largest shocks to their growth.

FIGURE 2.6: SHARE OF SOUTH AFRICAN BUSINESSES REPORTING ELECTRICITY AS THEIR BIGGEST
OBSTACLE (LEFT) AND OUTAGES VS. COST OF OUTAGES FOR ALL COUNTRIES (RIGHT)

All 15
55
Manufacturing 19
62
Services 4
52
Exporters 17
58
Non-Exporters 15
55
Large (100+) 15
67
Medium (20-99) 11
62
Small (5-19) 18
48
0 20 40 60 80

2007 2020

Source: Fortunato (2022) using World Bank Enterprise Surveys.

49
South Africa currently finds itself in a permanent “emergency mode” due to unreliability
and constant breakdowns of its existing plants and an absence of spare generation
capacity. Emergency maintenance lowers capacity, requiring load-shedding to make sure
there is not a system-wide blackout. Other emergency responses include using very expensive
diesel generation and further delaying planned maintenance or decommissioning, which
increases the likelihood of more breakdowns in the future. As the supply shortfall intensifies,
additional emergency supply measures are considered, including procuring energy imports
through “powerships”. There are limits to how far “emergency mode” can go to solve the
problem, and the escalation of load-shedding in 2023 is one indication that such limits have
already been reached. Recently — in 2020/21 — the crisis finally convinced the government to
allow for greater private sector participation in generation. This is an important step for moving
past emergency mode, but it does not bring new generation online immediately and comes
with power purchase agreements at elevated costs to compensate private generators for the
risks of investing in a sector without clear rules and with a weak counterparty. The government
has also removed a requirement for independent power producers of embedded generation
to have a license and has eliminated the caps on capacity that previously existed. REIPPP has
also been re-opened for new bids. This program has seen some success in attracting
investment interest, but projects have faced difficulties in moving forward. In the last round,
only around 1,000 MW out of a call for 5,600 MW could be allocated because of insufficient
grid capacity (Daily Investor, 2023a).

Eskom now faces a situation where it cannot avoid persistent load-shedding as low
electricity availability factors (EAFs), unplanned maintenance and breakdowns, theft,
non-payment, and shaky financials persist alongside transmission and storage
challenges for bringing new generation online. Eskom’s overall EAF in 2022 was only 59%
compared to a target of 65%, and this EAF has worsened each year since 2017 (when it stood
at 78%). Just in the last 6 months, Eskom has had major issues with nine of its powerplants
which has left nearly 4,700MW offline (five stages of load-shedding) for extended periods of
time (Daily Investor, 2023c). So long as these problems continue, Eskom will be unable to use
its current fleet to service South Africa’s electricity needs.

50
2.3.2 Causes of the Electricity Crisis

There is broad consensus that the proximate cause of this dynamic is an electricity system
that lacks the generation, transmission, and storage capacity to meet energy demand. In
1998, the Department of Minerals and Energy commissioned a white paper on the power
sector in South Africa. This paper warned that though Eskom was operating with excess
capacity throughout the 1990s, this excess capacity would soon run out by 2007 if there were
no additional investments in generation (Department of Minerals and Energy, 1998). In
addition, the government embarked on a successful plan to electrify all households by the year
2012, especially in previously underserved areas (Figure 2.7) (Bekker et al., 2008). Despite this
plan to increase demand further, no new investments in generation were carried out, and as
predicted, the reserve margin did indeed run out by 2007, causing the first load-shedding to
occur.

FIGURE 2.7: CHANGE IN HOUSEHOLD ACCESS TO ELECTRICITY BETWEEN 2007 AND 2016
HHs that accessed electricity for cooking (%) HHs that accessed electricity for lighting (%)

Notes: Metros (type A) and local municipalities (types B1-B4 which reflect different levels of socioeconomic development). HHs
stands for households.
Source: Own elaboration based on Community Surveys.

Once it was clear that demand would outstrip supply in 2007, South Africa made three
strategic errors on the way forward. The first error was doubling down both on coal and
on Eskom to increase generation capacity. At the time the plants were announced, coal was
still the cheaper source of additional capacity, but costs for solar and wind were declining. By
the time the Medupi units came partially online in 2015, the cost advantage of coal was no
longer clear, and by now it has now disappeared. Regardless of cost competitiveness

51
questions, bad technology and design choices, and well-documented issues of corruption
meant that the Medupi and Kusile plants were delayed and faced large cost overruns. The two
are still not fully operational. Today’s alternative generation choices look very different, but
South Africa continues to wait for the two plants to come fully online. While rapid reductions in
the cost of solar, wind, and other technologies were not predicted in 2007, the choice to go
with very few and very large new plants and exclusively through Eskom can be viewed as an
error, even without the benefit of hindsight. This was compounded by the next two issues.

Second, while South Africa waited for new capacity to come on through these two new
power plants, Eskom increased the energy utilization factor (EUF) of existing plants. This
decision implied operating the plants close to their limits (Oberholzer et al., 2022). This reliance
also meant delaying or skipping planned maintenance to increase plant availability in order to
avoid even worse load-shedding. This might have made sense if the additional new capacity
from the Medupi and Kusile plants were to come online without delays, but this was not the
case. Instead, delaying maintenance and overrunning the plants created systemic problems by
2011/2012. As the System Status and Outlook notes, it was around this time that the EAF of
Eskom’s plants started to fall behind peers, with the identified reason being that maintenance
and breakdowns became unavoidable for such an old fleet that had been worked so much
beyond capacity. These problems may have been reduced if more forceful demand
management policies rather than rationing had been adopted at the time, e.g., by allowing
electricity tariffs to reflect actual scarcity, especially for industrial consumers.

Third, South Africa stalled and then actively prevented participation of the private sector
in generation and transmission. There were multiple attempts at allowing more participation
of the private sector — including proposals to privatize some generation through the
introduction of feed-in tariffs in 2009, and renewable energy bids in 2011 — but these attempts
were stalled and aborted at the time in favor of the strategy focused on the construction of two
large coal-fired power plants. Had South Africa allowed more private sector participation, the
electricity crisis might have been resolved long ago. The case of Chile is informative of what an
alternative path might have looked like in South Africa (see Box 2.1). Chile faced its own
electricity crisis in 2007, around the same time South Africa began to first experience load-
shedding. However, through a combination of quick action on long-term reforms together with
effective short-term emergency management, Chile allowed the system to adjust quickly

52
through strong private sector investment in generation, transmission, and distribution. The
result was that Chile was able to avoid load-shedding and resolve its electricity issue in less
than 5 years.

Box 2.1: Managing an Energy Crisis and Making Long-Term Reforms: The Case of Chile

Chile was a pioneer in the liberalization of its electricity sector in the early 80s. Thus, by the 2000s,
it had competitive market for electricity generation. In this market, power companies and large
customers could freely negotiate bilateral supply contracts and there was an exchange market
for generators to trade their instant energy imbalances. In 1995, Chile signed the Gas Integration
Protocol with Argentina. As a result, the private sector built seven pipelines uniting both
countries, while electricity generators and gas distribution companies negotiated long-term
contracts with Argentinian natural gas producers. As additional power plants were built and
connected to the grid, the share of gas in the generation mix grew continuously through 2004,
when they reached 36% of electricity generation (see Figure below).

Unfortunately, due to domestic economic difficulties and dubious policy choices, Argentina froze
natural gas prices, leading to a precipitous decline in gas production. In this context, Argentina
defaulted on their long-term gas contracts with Chilean generators. At the same time, Chile faced
additional negative shocks to its electricity supply, including a historic dry season that reduced
hydropower generation capacity and earthquake in the north of the country that took several
plants offline for a period.

To address the collapse in the supply of Argentinian natural gas, which affected 36% of electricity
generation, the government plan involved a combination of medium term measures to
encourage private investments in regasification plants to allow the importation of liquified natural
gas (LNG), and in alternative energies, while adopting a short term plan to let prices reflect the
actual scarcity, which encouraged plants to shift back to liquid fuels and coal, while high prices
encouraged industrial consumers to curtail their demand. The system adjusted without the need
for load-shedding. An initial move to oil to fill the gap was quickly reversed once LNG arrived.
Later, the private sector moved quickly to solar and wind. In sum, the emergency response used
prices to encourage short-term demand shifts and long-term supply response, while the market
institutions were strengthened to allow new energy sources to compete on equal footing with
each other. The system adjusted without load shedding and without blackouts.
In short, South Africa and Chile faced similar deficits in generation capacity at the same time, but
Chile was able to resolve these challenges permanently in less than 5 years while avoiding
blackouts, South Africa has faced severe loadshedding and continues to see the crisis worsen
after more than 15 years.

53
 Box 2.1: Managing an Energy Crisis and Making Long-Term Reforms: The Case of Chile
(cont.)

There are a few lessons for South Africa. First, the participation of the private sector was crucial to
flexibly respond to the crisis. Second, using prices rather than rationing during the emergency
phase encourages a faster private sector response both on the demand and the supply side.
Third, structural reforms that allow the market to function more effectively can accelerate the
supply response and lower the long-term costs of the system. Finally, the emergency itself can
create a consensus for substantial reforms that can overcome the narrow interests that
oppose change.
Chile’s Electricity Generation by Source, 1996-2022

Source: CNE.

South Africa’s errors in planning and system operations were exacerbated by corruption,
a loss of talent at Eskom, declining productivity in coal mining, cost overruns, and
municipal non-payment. All these gutted the capability of Eskom. The company lost critical
talent and technical expertise in the lead-up to and during the crisis (News24Wire, 2022). It did
not help that the crisis coincided with the height of a period of state capture, where Eskom was
hard hit by corrupt contracts and mismanagement. Among the most prominent examples of
such were the contracts for building Medupi and Kusile, which not only were delayed in their
construction but had excessive cost overruns and design flaws. These two projects alone
generated USD 20 billion in overruns and delays by 2019 (Smit, 2022). At the same time,

54
despite large increases in electricity tariffs, revenues did not fully cover the ballooning costs of
Eskom, widening its losses.

The deeper causes of the crisis can be traced to political gridlock, ideological choices,
overburdening through preferential procurement rules, and political patronage. Political
gridlock has prevented prompt action, even in the context of a catastrophic situation with large
social and political costs. Ideology justified excluding other parts of society from contributing
to a solution, at immense cost to the economy and society. Additionally, the use of
procurement power of SOEs for additional goals beyond the delivery of cheap and reliable
electricity has raised costs and undermined productive capacity. For example, Eskom has been
affected by preferential procurement requirements that have required it to source expensive
and often low-quality coal from mines far away from where its plants are located. Deriving from
a constitutional mandate, preferential procurement as structured by the Preferential
Procurement Framework of 2000 has led to numerous inefficiencies (National Treasury, 2015).
In fact, the impact of these policies became so problematic that the government eventually
had to roll them back as it became clear that procurement of critical equipment for
maintenance of infrastructure would not be possible under these stricter guidelines
(Boonzaaier, 2022). At the same time, Eskom has been one of the government entities most
affected by cadre deployment and then state capture. It is a long-standing policy of the ANC
to place party members in influential roles across government and crucially parastatals.
Academic research on the subject suggests that this policy laid the groundwork for state
capture (Swanepoel, 2021). In addition, the Zondo Commission’s findings said that the ANC’s
cadre deployment process can be abused to facilitate corruption and possibly state capture.
In fact, they found substantial evidence as indicative that multiple appointments were made to
key positions in order to facilitate state capture (Judicial Commission of Inquiry into State
Capture, 2022).

2.3.3 Addressing the Electricity Crisis

A long-term solution to the electricity crisis must accomplish a broader set of goals; a
narrow goal of ending load-shedding is not enough. A great deal of media and political
attention has been focused on load-shedding and it harms the economy. There is no doubt
that the extent of load-shedding is causing massive harm to the economy. But Growth Lab
research shows that electricity was a constraint for the South African economy even prior to the

55
current situation of extreme load-shedding. Even as prices of electricity rose with less load-
shedding (or firms had to rely on expensive generators and diesel), there were many negative
impacts since South Africa’s traditional source of comparative advantage was its reliance on
cheap electricity. Ending load-shedding would be major a relief to South African society, but
ending load-shedding is not enough for South Africa to overcome the constraint on electricity.

A larger set of goals must be achieved for South Africa to regain a comparative
advantage in energy-intensive production and exports to the global economy. An
overemphasis on the narrow goal of eliminating load-shedding is risky because the current
emergency approaches to end load-shedding are expensive, both to users of electricity and
to the South African government, and unsustainable. The South African government has
needed to backstop the entire system through its financial support of Eskom and
municipalities. This is not sustainable in the long run. There will ultimately be tradeoffs between
price and access. While South Africa has made great strides in electricity access, according to
World Development Indicators, some 10% of the population still lacks any access, and many
places do not have full access still. Finally, South Africa must develop an electricity system that
not only delivers reliable and cheap electricity today but also that is positioned to give South
Africa a comparative advantage in the future. For this reason, rebuilding the system cannot be
isolated from the realities of global green transition (see Box 2.2 and Chapter 4). Taken
together, we can understand the goal of addressing the electricity crisis not just as one goal of
ending load-shedding but rather as a set of goals listed below:

1. Load-shedding ends (i.e., the market fully clears).

2. Tariffs to consumers are low and fair.

3. Every part of the system is fiscally/financially sustainable.

4. Access to electricity is expanded to all sections of society.

5. Renewable energy strategy is incorporated to position South Africa for the future.

It is important to evaluate both the current approach and alternatives on their ability to
accomplish all these objectives over the long run. It is possible to make progress on one
goal but in a way that undermines one or more other goals. For example, in theory, South
Africa could end load-shedding and make the entire system financially sustainable by allowing

56
prices to rise enough to clear the market. This would reduce demand on the system so that
load-shedding ends and would allow Eskom to recoup costs, but at such high prices
businesses and economic activity would need to be severely curtailed and it would be the poor
that would especially lose access. Similarly, the current approach may end or reduce load-
shedding through emergency measures and private generation through IPPs while increasing
some renewables on the system. But such a system would not lead to lower prices, a more
efficient grid, or financial sustainability for all actors. At the end of the day, either energy
consumers or the government will be liable for the costs of expensive diesel, “powership”
contracts, and sovereign guarantees to REIPPP participants.

At the same time truly solving the electricity crisis requires addressing both the more
proximate causes of system failure and the deeper causes of dysfunction. The proximate
solutions that address all goals hinge on creating long-term clarity of market fundamentals to
crowd in broader participation and investment in generation as well as transmission and
storage. Private investment comes with knowhow, efficiencies, and balance sheets that Eskom
lacks, but the state must set clear and reliable rules of the game to benefit from private
capabilities. This will require creating a functioning market based on a set of broad principles,
which we list below. At the time of writing, Eskom is expanding its purchase of power from
private generators, but Eskom and South African society overall must pay a premium to these
generators to compensate them for the risk of selling to a failing system with unclear rules. In
addition to generation, transmission and energy storage infrastructure have become especially
important given the rise of cost-competitive renewable generation sources. Storage is essential
because wind and solar are not dispatchable: they only generate power when the wind blows
and the sun shines. Storage allows the system to use them on demand. The transmission
buildout is needed because wind and solar resources are concentrated in parts of the country
that are not currently connected to the grid. But history shows that addressing these proximate
causes will not be possible without also tackling deeper issues that have caused the crisis to
begin with and that have hampered effective solutions for over 15 years. Thus, actions today
must confront the challenge of a government with divided interests and ideologically-driven
policies that have proven counterproductive, and with an endemic use of SOEs for political
patronage.

57
To establish an electricity market that will power South Africa in the long term while also
allowing for a stronger emergency response, clear rules must be based on four
principles. First, the market must enable much greater participation of society not only in
generation, but also in transmission, storage, and distribution. Second, it must allow for
efficient distribution markets that are not too small to benefit from economies of scale. Third,
there must be clear rules for all market participants that eliminate conflicts of interest, especially
for the system operator, and prevent discriminatory treatment of market participants. Fourth,
final prices must reflect the marginal cost of production, which must include dynamic intra-day
pricing. Taken together, if a system achieves these principles, it will be positioned to provide
reliable electricity across the country at low costs and with the ability to adjust over time,
including in the context of the global energy transition.

Box 2.2: Electricity in a Decarbonizing World

South Africa faces its electricity crisis in a context where the world economy is beginning to
decarbonize. Thanks to technological advancements, renewable energy costs have fallen
substantially and continue to do so, and this has made it possible for developed countries to
demand faster decarbonization globally. This creates pressure for developing countries to
decarbonize faster, even in cases where countries have significant supply gaps.

This complicates the task of solving the electricity crisis in South Africa but also creates
opportunities. South Africa needs coal generation as part of its electricity system to overcome
the crisis, but the role of coal will undoubtedly change in the future. South Africa has significant
renewable potential in wind and solar, as well as opportunities for battery and pumped hydro
storage. South Africa needs to leverage all capabilities. This underscores the importance of a
competitive, functioning market, where market players can freely trade with one another and
make investments with no discrimination.

Renewable sources of solar and wind are intermittent and fluctuate based on weather and time
of day. As a result, a system based on renewables will need large investments in battery and
other storage as well as transmission to make energy dispatchable. South Africa’s solar is
concentrated in the Northern Cape where needed grid infrastructure is lacking, and wind
potential is high offshore. A system based on renewables will require massive investments in not
just generation but also transmission and storage.
South Africa’s path forward may be better enabled by international support via the Just Energy
Transition (JET) framework. Rather than a focus on accelerating the removal of coal and other
fossil fuel generation, international support could more forcefully help to finance and build the
transmission and storage infrastructure in South Africa. This would better respond to the crisis
and enable a fuller transition to a decarbonized system over time.

58
A new Electricity Regulation Amendment Bill, drafted and approved by the Cabinet in
March 2023 and recently tabled in Parliament, attempts to address the proximate causes
of the electricity crisis, but there remain unresolved issues that continue to undermine
market clarity. The bill aims to unbundle Eskom into separate generation, transmission, and
distribution entities, which would then allow for fluid trading of electricity with private sector
participation. The unbundling of Eskom has begun, and a new entity TSO (Transmission System
Operator) has been established. Generation licenses have already been made less onerous to
acquire through deregulation, and the new bill attempts to create a market for private
generation to be sold to the TSO as well as private buyers through PPAs and through a trading
platform. The unbundling of Eskom into separate entities is crucial for creating a level playing
field for all players, especially in generation and distribution where they are envisioned to play
a much stronger role. The National Energy Regulator of South Africa (NERSA) will have an
expanded role in determining pricing, investments in the grid, and regulating this market.
However, several areas lack clarity, adversely impacting long-term decisions of potential
entrants into all areas of the electricity business, including transmission and storage.

• First, the bill does not clarify key dimensions of the future marketplace. For example,
it has not decided whether South Africa would have a centrally mandated pool, like is the
case in Chile, where all private players are required to operate within a common framework
of rules, or if the market will be voluntary like the one in some states in the United States. It
leaves potential lack of clarity and consistency in the roles of NERSA and TSO, as these
entities currently have many functions which are handled by separate entities in other
countries. Since electricity investments are capital intensive, with costs being sunk upfront
and justified based on expectations of positive cash flows over a long period, this creates
the need for clarity now about the rules of the game in the relatively distant future. If current
reforms are not clear enough about that future, this creates risks that will be reflected in the
cost of capital and the price of electricity today.

• Second, regardless of the market structure, there remains high potential for
government to change the rules of the game in ways that harm private actors.
Governments have incentives to promise high profits to get the investment going but once
in place, they will have incentives to renege on those promises to de facto lower the cost of
electricity to voters (e.g., either with artificially lower tariffs or by not collecting payment).

59
 One way in which this risk shows up is as counterparty risk for generation investments that
sell to Eskom. This risk increases the cost of capital and makes electricity more expensive.
These risks can be reduced if generators are free to sell their output in the free market and
the rules of the market are well understood. Uncertainty about the future will mean lower
investment and higher electricity costs today. That is why it is important to solve these issues
now, rather than to leave questions unanswered until the emergency has been resolved.

• Third, the bill may not adequately address what role municipalities can and should
play in the system going forward. Currently, municipalities are distributors for a
significant part of the electricity market, but they have been plagued by non-payment and
poor service. When municipalities have attempted to secure their own electricity through
PPAs, these decisions have been effectively overridden by load-shedding. With the
expected growth of private investment, contractual relationships between such companies,
municipalities, and Eskom will need to work within a clear and predictable system.
Otherwise, the result will again be underinvestment by the private sector and higher prices
to compensate for risk.

• There is no reason for transmission and storage to be excluded from private

investment. Transmission lines can be contracted out to the private sector in exchange
for service fees that the TSO would have to collect from market participants to compensate
investors. This is technically trivial. More complex is the issue of storage in a world of
renewable energy. Storage can make renewable energy dispatchable, but this requires a
significant difference in price between mid-day, when the sun shines, and peak demand,
to justify the investment. Moreover, it is not clear what technologies will dominate the
storage market going forward. Some competing technologies are grid-scale batteries (of
various types), pump storage in hydro dams, molten salts, and green hydrogen, inter alia.
The pricing system needs to be flexible enough to allow investors to explore different
storage needs: from minute to minute, from day to night, from windy days to calm days,
and from summer to winter. Moreover, storage can save on transmission lines: while
traditionally these lines are designed for peak power, they remain underutilized most of the
day. It is more efficient to transmit during the day and store the energy for peak time. This
increases the capacity of the existing transmission system.

60
Market-related issues with the new bill aside, there may not be a clear enough
commitment to the process of reform and to the unbundling of Eskom to overcome
prevailing issues of gridlock, ideology, overburdening, and political patronage. The lack
of reforms to date, as well as the slow pace with which the crisis has been addressed, reflect
that there is no clear consensus within the government on the direction of reform. Ideological
differences and constituencies result in a problem where the President’s own cabinet is not
necessarily aligned on the direction of reform. In recent public statements, Cabinet members
have stated that the unbundling of Eskom is not necessarily a major priority of the government
(Tandwa, 2023). This dampens private willingness to invest in the sector, lengthening the crisis.
To crowd in generation and grid capacity, the government needs to credibly signal that the
priority of this crisis supersedes business-as-usual politics.

There are several ways that government can signal credible commitment and enable
proximate solutions to the crisis to take hold. A first meaningful step would be a clear
change in the public orientation of the Presidency to prioritize reforms that would establish the
long-term market. This could include making the passage of the Electricity Regulation
Amendment Act its essential priority — ideally while also addressing the issues discussed above
within the bill. Another meaningful action would be implementing proposals advocated by
experts, such as appointing an Eskom “Unbundling Czar” (Eberhard, 2023). Importantly, it is
not effective to continue to place additional restrictions on private sector participation during
an emergency. There have already been steps to remove red tape for new renewable energy
projects, and the executive has moved with various waivers to expedite the regulatory process
(The Presidency Republic of South Africa, 2023). But this focus could be stronger. The
suggested Omnibus Bill to amend various regulations and laws seems to have stalled. The local
content requirements for solar modules have reportedly been lowered from 100% to 30% this
year. But in such a crisis, the rationale for even keeping them at any such level is unclear. Local
content and black economic empowerment-related requirements for procurement and private
energy projects raise costs at a time when every effort to get projects operating is necessary.
These steps would not replace the need for emergency management but would help indicate
to market participants that now marks the end of 15 years of treating the crisis through only
emergency measures.

61
In the short to medium-term, action must focus on two things: (1) relieving the most
pressing constraints on additional private generation, and (2) removing any obstacles
that make such generation more expensive or difficult. An outright ban on private
generation had been the obvious constraint in the past. But with this relaxed, the last bid
window showed that the most immediate constraint for greater private renewable generation
is not the willingness of generation companies to participate (at a cost that justifies risk), but
rather transmission and storage since awarded bids cannot secure grid access. Thus,
transmission investment is complementary to additional generation. A redesign of the bid
window process should take geography and capacity of the grid as well as project proposals
on transmission and storage into greater account when awarding bids. In addition, the system
must quickly move to allow for contracting out extra transmission and storage on a competitive
basis. For this to happen, it may be required to move further on the unbundling of at least the
transmission entity of Eskom. Since transmission is pressing in the short run to allow
generation, this unbundling process should be prioritized above other unbundling decisions
and processes of the future that may be more contentious.

The continued struggle to improve the EAF of existing plants suggests new avenues for
their operation, such as rental contracts with incentives for efficiency, may be needed.
Improvements in the operation of existing plants remain essential for the system to provide
reliable baseload power and will remain the engine of the electricity system for years to come.
South Africa simply cannot build a reliable and cheap electricity system on renewable energy
sources alone with existing technologies. Rather, dispatchable renewable sources and
conventional baseload power are complements in the system. This makes it problematic that
performance continues to decline despite a range of emergency measures. One option that
has not been utilized yet is to rent existing power plants to private operators. This would not
need to be done across all plants. Doing this in select cases may improve the performance of
select plants and would also increase competition across plants. If renting proves effective in
initial cases, it could be used for more plants. Rental contracts would require careful design
and should incorporate high incentives for efficiency, but these would have to achieve a
balance that does not make the contracts so risky that private operators are unwilling to enter.

South Africa has high potential to activate more renewable generation at lower costs. As
will be discussed in more detail in Chapter 4, South Africa has significant natural advantages

62
for solar and wind generation. Along with the market development actions discussed above,
there are a few policy improvements that could go a long way to directly enabling this
potential. First, there is space to streamline approvals of renewable generation and storage
projects to reduce unnecessary transaction costs and delays across the board. Second, South
Africa is strategically positioned to promote private green industrial zones powered by
renewable energy. Such zones would have multiple benefits. They would make for attractive
places for energy-intensive industries whose customers demand a lower carbon footprint to
locate. They would also encourage the rapid entry of renewable generation at low cost
because of the dedicated demand they would provide. Since renewable generation would
need to be developed in excess capacity to account for variability, these zones could become
net exporters of electricity to the grid and accelerate the increase in overall electricity supply.
Third, South Africa may have a unique opportunity to leverage the hydropower capability of
the Lesotho highlands as a source of pumped storage. This would be a complement to the rest
of the system. Pumped storage hydropower operates like a battery by allowing for variable
renewable power to pump water into reservoirs when there is excess generation, which is then
dispatched to generate hydropower when needed.

2.3.4 Broader Lessons for Addressing Declining State Capability

There are several commonalities and lessons from the case of electricity with other SOEs
that have seen a collapse in capacity. In many instances, the proximate causes of collapsing
services are an undersupply of public goods and services that could have been provided by
more open access to state-owned infrastructure. Numerous SOEs face issues of poor
management, patronage networks, and inefficient procurement. Together these issues lead to
financial problems that constrain investment and proper maintenance of infrastructure. This
situation causes service levels to decline. In the cases of electricity, freight rail, ports, roads,
and passenger rail, the emerging solution requires crowding in other actors in society with the
balance sheets and capabilities to help fill supply gaps. As discussed in South Africa, this is not
a matter of privatizing SOEs but rather of mobilizing other actors and granting them access to
the relevant market.

Thus, there are technical reforms that South Africa will need to undertake to allow for
greater participation and investment from the rest of society in many network industries.
Just as electricity requires a functioning market for the expansion of generation, transmission,

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and storage, addressing the freight rail crisis requires the ability of the private sector to invest
in rail stock and play a stronger role in security, maintenance, and operations. Similarly, for
ports, investment will likely need to come from more private participation in the aspects of port
services that are causing backlogs. In passenger rail, there is a need to implement a stated
policy to devolve functions to capable municipalities. But like in electricity, many of these
solutions are, in fact, known or already written in pending legislation. The challenge tends to
be in a lack of consensus across different political actors to confront the narrow interests that
keep critical network industries in crisis.

The deeper causes of collapsing state capacity in electricity and beyond center on
gridlock, ideology, overburdening, and political patronage. Ideological differences on the
role of the state and suspicion towards alternative growth models have impeded progress and
created political gridlock on necessary actions. Despite the limited financial and managerial
capabilities of Eskom, South Africa was egregiously slow in allowing private firms, metro
governments, and households to invest in much-needed energy generation, transmission, and
storage. The government's historic reluctance to devolve the management of the urban
passenger rail system to capable and willing metros, despite PRASA's failures, is another
example. Meanwhile, preferential procurement rules have created a burden on tendering that
has de facto increased costs, limited options, and ultimately reduced service quality. Finally,
political patronage rather than effectiveness is often an explicit goal of appointments to SOEs.
Specifically, the policy of cadre deployment within SOEs is a longstanding practice to place
party members in influential roles. There are clear interactions between these deep issues of
gridlock, ideology, overburdening, and patronage. For example, the preferential procurement
system has exacerbated patronage opportunities, and this patronage is reflected in contract
opacity and failed investments.

Ultimately, politics needs to be the solution to gridlock, ideology, overburdening, and

political patronage. In a democratic system, citizens are empowered to change the system
when it becomes ineffective. Power is contestable and political patronage is constrained by
the need to attend to the needs of an electoral majority. This often is enough to constrain abuse
and prompt action. It has not been so in South Africa yet, maybe because of the political
dominance of the ANC. But as this dominance wanes, prioritizing state capacity and
overcoming narrow interests becomes essential for political survival. Moreover, as the public's

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priorities shift towards a greater emphasis on government effectiveness, many political players
will have strong electoral incentives to offer a platform that overcomes the interacting causes
of gridlock, ideology, overburdening, and political patronage.

There is no path to growth and inclusion in South Africa without rebuilding and
expanding the capacity of the state. Up to this point, this chapter has focused on network
industries and the respective national SOEs. However, state capacity has also been unraveling
at the local level, which has resulted in a pattern of extreme financial distress affecting
hundreds of municipalities. Local governments collectively owed nearly USD 5 billion at the
end of 2022, of which USD 3 billion was owed to Eskom alone. Clearly, the financial distress of
municipalities is linked to the electricity crisis, but patterns of municipal service delivery
suggest additional challenges beyond fiscal management. We next discuss the deeper
challenges of municipal service delivery in the next subsection, including critical failures in
fiscal decentralization and how weakening municipal balance sheets linked to national systems
have further undermined local public capabilities. This raises important questions about the
role that local public capabilities can play in including more South Africans in the productive
economy — a topic that will continue in the following chapter. This chapter then closes with
recommendations for restoring and strengthening state capacity.

2.4 Municipal Capacity

2.4.1 Symptoms of the Crisis of Municipalities

There is a widespread view that South Africa’s municipal governments are in crisis. The
most recent Consolidated General Report on Local Government Audit Outcomes (MFMA
2021-22) of the Auditor General of South Africa states that only 38 of 257 municipalities
received clean audits reflecting “sound financial and performance management disciplines”
and that they “perform their functions in accordance with applicable legislation.” The report
finds that the financial health of municipalities has been deteriorating in recent years. The
MFMA 2021-22 report finds 70 municipalities in a “concerning financial position,” with at least
three such municipalities from each province and many of these municipalities showing
financial distress year after year. But the underlying causes of financial distress are more
widespread. The Auditor General’s report discusses systemic issues in revenue collection,
where municipalities do not collect what they are owed, including significant losses in water

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and electricity distribution. The MFMA 2021-22 report estimates that municipalities in total will
only recover 34% of revenues they should collect according to their rates and taxes. While
failures in revenue collection are likely the most immediate cause of financial distress, the
report also notes widespread problems in spending related to poor payment practices, unfair
or uncompetitive procurement practices, under-delivery of services procured, and outright
fraud.

While the financial distress of many municipalities is important, ultimately, the problem
is poor service delivery. The performance shortfall is most evident in water delivery (Figure
2.1), a highly decentralized service in South Africa, as discussed below. Observers regularly
point to shortages in water engineers and skilled professionals across municipalities, and this
problem has been persistent for a long time.9 In water systems and beyond, the Auditor-
General’s report documents patterns and examples of inadequate planning, services that are
not delivered, and reporting systems that reflect an inability to monitor the delivery of core
services. In the building of infrastructure, projects are plagued by endemic delays, cost
overruns, and — arguably most problematic — poor build quality. Moreover, there are glaring
deficiencies in resources spent on infrastructure maintenance. The 2021-22 report finds that
39% of all municipalities spend 1% or less of the value of their infrastructure on repair and
maintenance, well below acceptable norms.

There is widespread variation in local service delivery and financial performance. Though
the issues underlying the municipal capability crisis are systemic, some municipalities do
manage to deliver core functions and remain fiscally sound. While very few municipalities have
expanded reliable water access, some have sustained high levels of access. For example,
eThekwini Municipality maintained a level of piped water access close to 90% over the period
when many municipalities saw declining access. This reflects a sufficient level of state capacity
to deliver the service. The MFMA 2021-22 Auditor General’s report notes that eThekwini and
Cape Town are the only two metros that mobilized higher levels of spending on maintenance
of infrastructure assets overall, at 8-9% of the value of the infrastructure. Figure 2.8 shows a
high variance in public service delivery across municipalities in many areas based on the share
of households that report each service quality as “poor”. The largest differences occurred in

9
See, for example, “Navigating the water crisis: where do we need the skills?” reported by Stats SA in based on
2014 data (https://www.statssa.gov.za/?p=5787).

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water, with very high variance in sanitation, healthcare services, policing, and refuse removal.
Lower variances occur in electricity and education, which are services that have somewhat
higher national uniformity.

This variation in local performance suggests that at least some drivers of the collapse of
state capability have locally determined causes and are not due to the collapse of
national systems alone. We argue that these patterns reflect a clear problem of “premature
load bearing” of municipal governments — that is, putting too much responsibility on local
governments when they do not have sufficient capacity to deliver, to begin with. In this sense,
the decentralization process that transferred spending responsibilities to new municipal
governments led to many of them failing to deliver on core mandates immediately after they
were devolved those responsibilities. However, the more capable municipalities could cope
with the assigned responsibilities, succeeding while the median municipality failed.

FIGURE 2.8: SHARE OF HHS WHO RATE QUALITY AS POOR ACROSS MUNICIPALITIES (2016)

Source: Own elaboration based on the 2016 Community Survey and StatsSA.

2.4.2 Failed Decentralization Due to Premature Load Bearing

During the late 1990s, South Africa significantly changed the responsibilities of local
governance by enacting the Municipal Systems Act and the Municipal Structures Act,
effectively creating new local governments. The new system was motivated by the

67
necessity to rectify the historical imbalances in spatial economic development. The White
Paper on Local Government (DPLG, 1998) assigned local governments a key role in economic
development, with the primary goal of municipalities being to work with their constituencies in
finding “sustainable ways to meet their social, economic, and material needs and improve the
quality of their lives” (DPLG, 1998). This resulted in “developmental local governments” that
would embrace multiple functions and responsibilities (Palmer et al., 2017). Through
substantial decentralization, especially in spending responsibilities, local governments
assumed critical roles in areas that determine the economic and spatial development of places.

The design of a post-apartheid local government system resulted in the creation of

numerous district and local municipalities, which had to be built from the ground up.
Primary responsibilities of district municipalities included: the design of Integrated
Development Plans (IDPs), which serve as a foundation for a region's spatial development
through infrastructure design, service coverage reach, and land use planning; support
functions to local municipalities for service delivery and capacity building; and disaster
management. Meanwhile, local municipalities were given responsibilities for a wide range of
functions. This included primary responsibilities in public service delivery, including water and
sanitation, electricity distribution, waste management, and road construction and
maintenance. Local municipalities took on roles in management of municipal finance, including
selected areas of revenue collection, budgeting, financial management, and procurement.
They also were given powers in land use management and urban planning, including zoning
regulations and the issuance of building permits. Finally, local municipalities also were made
responsible for the enforcement of regulations and implementation of key processes such as
local elections.

The new system led to very high decentralization of public spending by international
standards. South Africa’s subnational governments execute over half of the general
government spending, which is very high for a middle-income country and more in line with
much wealthier countries like Canada, Switzerland, and the United States (Figure 2.9, Panel A).
South Africa is also exceptional in how high expenditure decentralization is in comparison to
revenue decentralization (Figure 2.9, Panel B). It is normal for spending to be more
decentralized than revenues, but the difference is especially large for South Africa, which
necessitates large transfers from the central government. This is reflected in Figure 2.10.

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Whereas provinces are overwhelmingly funded through transfers from the national
government, municipalities receive over half their revenues, on average, from the collection of
fees and other non-tax revenues. A large portion of these fees are from electricity and water
tariffs, which are collected locally. However, these fees do not become sources of discretionary
local spending. The municipalities must pay the providers of electricity (Eskom) and water
(usually water boards). Municipalities often charge an extra fee, which is meant for local use,
but this system at present is not delivering reliable local revenues as there are widespread
challenges in bill collection and resulting municipal debts.

The abrupt transition to this peculiar decentralization system layered on too many
responsibilities too soon for many municipal governments. The “too much, too soon”
phenomenon has been called “premature load bearing” (Andrews et al., 2017). This is an apt
description of what happened in South Africa: by giving newly created local governments the
same or similar responsibilities that metros had, responsibilities overwhelmed capacity. These
responsibilities were designed to address the fundamental problem of spatial inequality.
However, the reform had the opposite effect due to the absence of the necessary
organizational capabilities and specialized staff to execute these responsibilities across more
than 200 local governments. Increasingly, the collapse in network industries at the national
level has interacted with the challenge of local government capacity as lower revenue
collection from electricity and water bills — including evasion of bill payment — undermined
substantial revenue sources for municipalities. Figure 2.11 summarizes the composition of
expenditures, on average, for the three distinct categories of municipalities in South Africa:
metros (of which there are 8), district municipalities (of which there are 44), and local
municipalities (of which there are 205). Having assumed responsibility for the distribution of
electricity and water, metros and local municipalities became heavily reliant on residents’ water
and electricity bills as sources of revenue to pay for operational spending and investment.

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 FIGURE 2.9: EXPENDITURE DECENTRALIZATION VS. NATIONAL INCOME LEVELS

Panel A

Panel B

Notes: Data for 2017. SNGs = Subnational Governments, including provincial and local municipalities. GG = General Government,
including SNGs and central government.
Source: Own elaboration based on IMF Fiscal Decentralization Database 2020.

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 FIGURE 2.10: REVENUE COMPOSITION BY LEVEL OF GOVERNMENT

Notes: Data for 2019. Grants comprise current and capital transfers from foreign governments, international organizations, and
other general government units. Other non-tax revenues include sales of goods and services (user charges), fines, penalties, and
forfeits, and property income (interest and dividends).
Source: Own elaboration based on SARB.

FIGURE 2.11: EXPENDITURE COMPOSITION BY FUNCTION FOR MUNICIPALITIES

Notes: Data for 2019. Grants comprise current and capital transfers from foreign governments, international organizations, and
other general government units. Other non-tax revenues include sales of goods and services (user charges), fines, penalties,
forfeits, and property income (interest and dividends).
Source: Own elaboration based on SARB.

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Although the metros already had capable governments at the time of decentralization,
many secondary cities, small towns, and rural areas had yet to develop local state
capacity. Figure 2.12 shows employment in local authorities per 1,000 people in 2001, soon
after the creation of local governments. The size of the government gives a blunt indication of
the heterogeneity in the starting points of the different types of places. Metros and secondary
cities already had between 8 and 4 local government employees per 1,000 people, while many
rural areas had less than 4 local government employees. Approximately 35% of local
municipalities had less than one employee per 1,000 people. Several areas of the Northern
Cape had yet to establish local authorities, which may partially explain why the Northern Cape
has a very high prevalence of local municipalities in financial distress today. In many cases, the
first term of office of the newly created municipalities was almost entirely dedicated to
understanding and setting up the complex institutional mechanisms that were recently put in
place (Pieterse and van Donk, 2008).

FIGURE 2.12: EMPLOYMENT LEVELS IN LOCAL MUNICIPALITIES

Source: Own elaboration based on the South African Census of 2001 and StatsSA.

As one tool for overcoming the challenge of local state capability, municipalities often
outsource roles to private providers. An example of this is the distribution of electricity.
Although the municipalities are Eskom’s largest customers and are mandated to distribute
electricity in their jurisdictions, most of them outsource the operations and management to the

72
private sector. According to data from Stats SA, this tendency fluctuates from a minimum of
almost half of the municipalities in the Western Cape to a maximum of 80% in the Eastern Cape.

2.4.3 Preferential Procurement Policy

In addition to challenges in delivering core functions due to premature load bearing,

municipalities have also been subject to additional demands through procurement
policy. Preferential procurement in South Africa traces to a constitutional requirement and is
structured according to the Preferential Procurement Policy Framework Act (PPPFA) of 2000.
The purpose of resulting preferential procurement rules is to enable socio-economic
transformation by giving preference to previously disadvantaged groups, SMMEs, and local
production. This was a response to the pre-1994 public tendering system, which favored large
and predominantly White companies such that “it was almost impossible for newly established
businesses to enter the public tendering system” (SALGA, 2020; Ministry of Finance and
Ministry of Public Works, 1997). However, many critical issues were documented with PPPFA
in a Public Sector Supply Chain Management Review by the National Treasury in 2015, which
outlined paths forward based on system and process improvements to address severe
fragmentation of rules. Yet, those proposed changes were not enacted to replace the existing
framework, neither at the time of the study or when later introduced through a new Public
Procurement Bill. This remains a bill rather than a law at the time of writing.

Compliance with preferential procurement requirements has led to increased

administrative costs for both the public sector and contractors. Implementation of the
PPPFA has been problematic for public supply chain management (National Treasury, 2015).
This has been particularly concerning for impact on the value for money in infrastructure
development carried out by local governments. For the public sector, added costs can involve
more extensive tendering processes, evaluation criteria, and compliance monitoring, all of
which require time, resources, and expertise, which are scarce for local governments. Perhaps
more importantly, a more limited pool of contractors can drive up prices for goods and services
— particularly in smaller local markets. On the suppliers’ side, compliance with PPPFA adds a
layer of complexity to the process of applying for contracts with the public sector, which adds
barriers to entry. The increase in costs can also be due to the lack of specific technical skills that
are not available within local or designated providers, which in turn need to hire other

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subcontractors or consultants at an additional cost. This affects the quality of the pool of
bidders and impacts project timelines, quality, and overall value for money.

Scattered evidence indicates that the cost of PPPFA compliance is notably high both in
direct costs and in more systemic effects. Migro (2011) documents procurement costs in
different government departments of the North West Province in 2006-2007. He shows that
the premium paid for PPPFA compliance in this period was 27% in the transport department,
28% in agriculture, 9% in education, 28% in public works, and 62% in sports, arts & culture
(Migro, 2011). In this case, not only was the cost of compliance very high on average (31%), but
the very high variation in the premium paid across departments suggests large differences in
the resulting market power of qualifying contractors in different municipalities and different
activities. In 2020, the South African Local Government Association (SALGA) identified a series
of challenges for public procurement in a study conducted after 24 years of enacting the first
procurement regulations. They collected information from officers directly involved in supply
chain management and procurement compliance in local governments. The research
highlighted widespread issues: high prevalence of fronting (i.e., misrepresentation by
companies to qualify); compliance challenges for smaller businesses; lack of understanding of
rules and laws; supply chain delays; inadequate screening; limited rotation of companies;
escalating corruption and weak oversight; limited transparency; political pressure on supply
chain management officials; and a rise of “tenderpreneurs”.

The PPPFA essentially functions as a direct tax on tenders, while also undermining the
effectiveness of local procurement. When PPPFA raises costs for contractors, these
additional expenses are passed on to the local population, including by crowding out other
potential uses of public spending. But widespread qualitative observations and formal reports
(e.g., the MFMA 2021-2022 Auditor General’s report) point to an arguably worse problem than
higher prices, which is a substantial loss of quality and even outright failures to deliver what is
procured. This is highly problematic in infrastructure procurement. For example, when shoddy
construction causes a bridge to fail, communities pay the consequence.

A key question is whether the benefits of PPPFA are worth the costs. Importantly, given
decades of experience, this is not a theoretical question but rather a practical one that can be
answered based on quantitative evidence. According to the 2020 study on public procurement
by the SALGA, the PPPFA did not foster a more competitive environment for government

74
procurement as intended. Instead, it has made securing public contracts more challenging for
new businesses. In 2023, the IMF published an issue paper on the topic and noted that
improved procurement practices as proposed by the Treasury’s review could amount to up to
“20 percent of the cost of goods and services procured (3 percent of GDP or 12.7 billion US
dollars)”. By distorting the market for inputs, the system has increased costs, worsened the
effectiveness of public spending, and expanded space for systems of patronage. Furthermore,
the rise of 'tenderpreneurs' and fronting practices suggests that the most successful bidders
are not necessarily the most productive suppliers nor the intended beneficiaries of the policy.
There is strong evidence that the costs of the system are high, and the benefits are not just low,
but negative.

2.4.4 Municipal Finances and the Spiral of Circular Debt

Although service delivery failures at the local level are driven by premature load bearing,
exacerbated by preferential procurement rules, financial problems interact to create
vicious cycles. While the Municipal Structures Act, followed by the PPPFA, are almost 25 years
old, service delivery has been deteriorating at an accelerated pace over the last decade. This
is due to additional dynamics associated with poor finance, which causes growing financial
distress and a pattern of circular debt. Understanding this cycle of debt is essential to
developing an effective plan of action to strengthen state capacity at the national and local
levels, while also addressing the compounding debts in the system.

The electricity crisis has created a chain of debts across government. Municipalities
purchase electricity in bulk at wholesale prices from Eskom and then sell it to the end user with
a markup which ranges, according to NERSA, between 20-150%. This already highlights the
inefficiency of many distribution systems. Even in normal times, many municipalities have
severe deficiencies in bill collection, due to gaps in metering, billing systems, and staffing. But
the electricity crisis has put additional strains on the system as load-shedding means reduced
sales as well as increased consumer dissatisfaction and lowered willingness to pay.10 While
collections have been strained, Eskom’s wholesale prices are increasing as the SOE tries to

10
Further, consumers are actively working to circumvent high tariffs and outages: wealthier residential and
commercial consumers are moving to generating their own energy through viable off-grid technologies. Yet, these
consumers still rely on the grid at times and for transmission.

75
recover its own financial standing. In practice, municipalities are not being paid by households
and businesses, who are in arrears to local municipalities, and municipalities are not paying
Eskom. This chain of debt further undermines Eskom's finances and increases the need for
national bailouts to unburden Eskom’s balance sheet. In the process, municipal capabilities are
further weakened. Figure 2.13 shows this problem as well as how fiscal support from the
Treasury is used as a response to financial distress across the system.

FIGURE 2.13: PROBLEM OF CIRCULAR DEBT AND ELECTRICITY SYSTEM FAILURE

Source: Authors’ elaboration.

2.5 How to Strengthen State Capacity

If South Africa is to return to growth, it must arrest the collapse of state capacity and start
a process of rebuilding capacity. The economy cannot grow and include more people
without a capable state and the provision of essential public goods. Strengthening state
capacity comes from a conscious and consistent effort to address both the proximate and
deeper causes of failures in SOEs, network industries, and national government institutions as
well as through response actions to address longer-term problems of premature load bearing
of local governments. Recovering municipal capacity will require a rethink of decentralization
and procurement. Instead of helping to address spatial inequalities, the current system has
exacerbated them. Given the problem of circular debt, large fiscal resources are already being
devoted to addressing the solvency crisis, but these resources can be better targeted and
better supported through strategies that treat causes rather than symptoms of state collapse.

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Strengthening state capacity will be a challenge but the upside is that recovering core functions
in the most binding areas — especially reliable electricity in the current moment — will have
immediate positive impacts on growth.

Rebuilding state capacity is a big task, but informed by the findings of this chapter, the
path to strengthening state capacity can be achieved through actions along three
dimensions. First, it is essential to unburden capacity by relaxing secondary and tertiary goals
that are layered onto the functioning of public entities, at both the national and local levels.
Addressing the imbalance of responsibilities and capabilities on most local governments
(premature load bearing) in distribution markets is also critical for developing functional
electricity markets and a more sustainable fiscal system. Second, South Africa must build up
and protect capacity. It is not sufficient to only unburden government entities; the process of
building and protecting public capabilities. Civil service reforms from other countries show that
it is possible to gradually transition from systems of cadre deployment to merit-based
employment and building of a civil service system that attracts and retains talent increasingly
over time. This is essential for ensuring that the collapse of state capabilities does not re-
emerge. At the same time, South Africa can re-organize public service delivery in areas where
capabilities are spread too thin by centralizing units and deploying them to municipalities in
the form of a “capability bank”. Third, South Africa can much better leverage existing capacity
by involving the capabilities of society in the response to struggling systems, especially across
network industries.

Unburdening Capacity

The state faces major burdens in preferential procurement rules that undermine core
functionality in the pursuit of black economic empowerment and localization aims. These
overly broad systems should be revisited as there are more effective ways to include previously
disadvantaged groups in all parts of the economy and to promote local production, including
SMMEs. The evidence suggests that preferential procurement — through its costs on state
performance — may be doing much more harm than good for the intended beneficiaries.
Instead, procurement should be strategically used to support early-stage industries with
potential to compete in international markets (see Chapter 4 for examples). In the context of
collapsing state capacity, any secondary and tertiary goals should be set aside urgently to
unburden public entities to serve their core functions. Thus, we recommend continuing to

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expand the relaxation of preferential procurement requirements on all SOE procurement,
including and especially within the procurement of electricity system investment in generation,
transmission, storage, and distribution. This is a necessary condition for South Africa to better
achieve its ultimate goals of empowerment and inclusion, though more direct and effective
measures will be needed (see Chapter 2 for findings on spatial exclusion).

Given the fundamental challenges of premature load bearing, South Africa’s current and
peculiar type of decentralization will need to change. There needs to be a move to a system
that allows for variance in municipal-level expenditure responsibilities based on their
underlying capabilities. For municipalities that currently deliver public services effectively,
especially metros, and which have maintained fiscal solvency, no change may be needed, but
for most municipalities, there needs to be a change in decentralization to centralize the roles
that have put municipalities under strain. The clearest areas for change are the municipal
government’s current roles in managing the distribution of electricity and water. Electricity
distribution is an area that has become such a strain on local governments that it has impacted
their abilities to serve other functions. At the same time, addressing the failing national
electricity system through an electricity market will be aided by distribution markets that are
larger than the typical municipality to achieve better economies of scale. Municipalities often
already outsource as much of their electricity functions as they can and, distribution companies
internationally often have significantly better capabilities for bill collection and technology
adoption.

This change can come with benefits to municipalities and must occur within a process to
address the financial crisis of local governments. Municipalities may be unwilling to release
any responsibilities to higher levels of government voluntarily, but changes must be initiated
within the unfortunate context of municipality financial distress. If municipalities cannot show a
viable path to service delivery and fiscal stability with current capabilities, national policy can
enforce a change. This change can also be accompanied by benefits to municipal
governments. Change in this system would affect municipality revenues but would also impact
their expenditures, with the net impact likely varying greatly across municipalities. Many of the
most financially distressed communities may benefit. This re-organization could be
accompanied by new tools for municipalities to finance their operations, while also being
careful not to burden municipalities with taxing responsibilities prematurely. Currently,

78
property taxes play a relatively small role in municipal finances, and this may be an area to scale
up through voluntary application since these play a much stronger role in other countries.

Building Up and Protecting Capacity

Building up and protecting capacity entails moving away from cadre deployment and
replacing this with a different organizing principal. An example would be broader civil
service reform that changes the appointment of civil servants especially for more technical
positions into a more merit-based system rather than one that is overly influenced by politics.
Such changes do not happen overnight; they can and should instead be built and expanded
gradually. Eventually achieving a system of merit-based appointments for operational and
higher-level bureaucratic roles is an important milestone for a country's development. Take the
example of the United States which transitioned from a "spoils system" of the federal
bureaucracy to an initial merit-based system for just 10% of the federal workforce after the
passage of the 1883 Pendleton Act. Today, merit-based appointments and exams are the norm
in U.S. federal employment.11

While civil service reform should start at the national level, the principal can be expanded
to enable more capable decentralization over time. Given South Africa’s challenges of
spatial exclusion and its history of premature load bearing across municipalities, systems of
civil service rotation across the country should be explored. By recruiting talent nationally and
deploying individuals in multi-year appointments across geographies, South Africa may be
able to better bridge gaps in capabilities across municipal governments over time. For
example, the experience of India in developing a prestigious civil service system — e.g., its
Central and State Engineering Service — is illustrative of what such a system can look like, even
in a country with very high ethnic diversity and significant development challenges. Simply
hiring locally can reinforce capability gaps between wealthier municipalities and historically
disadvantaged communities. This approach helps to break this cycle. This approach could be
a longer-term strategy whereas “capability banks” can be utilized much more quickly.

Some capabilities could be more effective if centralized to meet local needs through new
administrative structures. In the relationship between the municipal, provincial, and national
governments, it can be useful to trial a model where local governments can “contract” or

11
See https://www.archives.gov/milestone-documents/pendleton-act.

79
“procure” services from higher levels of government when needed. Rather than maintaining a
local staff with all the relevant expertise for water system planning or major road development
contracting or a range of other functions that are technically complicated and require
specialized skills, municipal governments could simply hire support from dedicated teams that
are based in the province or national level. Such a model can more efficiently use scarce human
capabilities. Such a system could create strong incentives for effectiveness, especially if
multiple teams within the government system compete for service contracts with local
governments. This concept can be thought of as a “capability bank” that municipal
governments can draw upon, especially for planning and project execution roles. Under this
structure, historically disadvantaged places could be given advantaged access to the capability
bank through fiscal mechanisms and national outreach to local governments based on needs.

Leveraging Existing Capacity

At the heart of a strategy of growth through inclusion is a recognition that South African
society has far more capabilities than are currently leveraged. This is true when it comes
to network industries as private companies have shown the willingness and ability to provide
needed investment and service delivery roles. By including more of these capabilities in the
response to the collapse of state capability, the economy will in turn be able to include more
individuals, regions, ideas, and assets in the South African economy of the future. Leveraging
this capacity is not, generally speaking, a matter of privatizing state companies and assets,
which is time-consuming and fraught with risks to manage. Much can be leveraged through
opening access to existing infrastructure through more open markets. This approach was
discussed at length in the case of the electricity crisis earlier in this chapter, but the
opportunities are also clear in other areas where state capability has weakened and supply
gaps have deepened — including roads, ports, passenger and freight rail, water, sanitation, and
likely more. To leverage the capacity of South African society in this way, the government must
overcome gridlock, ideology, and patronage that has delayed and prevented the
establishment of relevant markets in the past. Overcoming the politics as usual to leverage
capacity is the single most important step that government can take to reverse South Africa’s
economic struggles and jumpstart growth. It would mark the beginning of the end of a period
of emergency management by enabling long-term solutions.

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3 Spatial Exclusion as a Constraint to Growth

3.1 Executive Summary

South Africa is exceptional in its spatial patterns of economic inclusion. As discussed in

Chapter 1 of this report, South Africa faces some of the world’s highest rates of inequality and
unemployment, which vary greatly across geographic space. Municipalities are highly unequal
in their employment rates. For example, Witzenberg in the Western Cape had an employment
rate of 60 percent in 2011, comparable to an advanced economy, whereas Msinga in KwaZulu-
Natal had employment rates as low as 9 percent. Figure 3.1, Panel A shows that low
employment rates largely overlap with the former homelands. Despite three decades of
explicit efforts to reverse this spatial exclusion, post-apartheid policies have done little to
address spatial inequality of job opportunities.12 Whereas regional divides are not uncommon
along the path of economic development (World Bank, 2008), the extent to which South Africa
is unequal in space is unique. When compared to Mexico, a country with a similar level of GDP
per capita, we observe that South Africa’s employment rates vary enormously (Figure 3.1, Panel
B). Furthermore, the highest employment municipalities in South Africa tend to have lower
employment rates than the lowest employment municipalities in Mexico.

FIGURE 3.1: EMPLOYMENT PATTERNS IN SOUTH AFRICA AND MEXICO

Panel A: Employment Rates across Panel B: Distribution of Employment Rates across
Municipalities in South Africa, 2011 Municipalities in Mexico and South Africa, 2011

Source: Own elaboration based on the South African National Census, 2011 and Instituto Nacional de Estadística y Geografía.

12
See, among others, Lochmann (2022), World Bank (2008) and Chatterjee et al. (2022).

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South Africa’s unique labor market structure can be explained in large part by issues of
transportation costs. When we further compare Mexico with South Africa, both countries look
relatively similar in their formal employment rates, but there are huge differences in their
informal employment rates and consequently in their rates of unemployment (Shah, 2022).
Therefore, a key puzzle of South Africa is why people end up unemployed in South Africa rather
than in informal employment as they do in other developing countries. Shah (2022) and Shah
and Sturzenegger (2022) explore a large variety of barriers to both formal employment and
informal employment and find that high transport costs (direct costs and time costs) create a
wedge in the South African labor market that reduces employment. This is an especially salient
feature for major and secondary cities. Cities are, at their essence, labor markets, but high
transport costs undermine efficient cities. Figure 3.2 shows that places with higher total
transport costs (including the opportunity cost of time spent in transit) tend to have lower-wage
employment and higher rates of inactivity. Own-account employment increases only very
slightly with transport costs in comparison.

FIGURE 3.2: LABOR MARKET INDICATORS VS. TOTAL TRANSPORT COSTS BY DISTRICT MUNICIPALITY

Source: Shah and Sturzenegger (2022) using the 2017 National Income Dynamics Study and 2020 National Household Travel
Survey.

We find that South Africa’s high unemployment rates and low informality rates are a
direct consequence of its exceptional spatial structure. Transport costs are highly
regressive and such high costs for lower-income level individuals can effectively wipe away any

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take-home pay. For the lowest quintile of incomes, we find that direct transport costs amount
to more than a third of wage income for workers on average. The result is even more striking
when for total transport costs, which amount to over 80% of income for the lowest income
workers and more than 50% of income for all but the highest quintile of incomes. Under these
exceptionally high costs of getting to work, the logical decision of workers is therefore to
remain out of the workforce. Access to a car makes transport costs a much lesser constraint for
higher-income households, but roughly two-thirds of households do not have a car (Stats SA),
let alone a reliable car. Meanwhile, the extreme population dispersion across South African
urban centers makes it expensive to implement most types of public transport in cities, since
public transport systems (like Bus Rapid Transit systems) are designed to connect higher-
density areas. It also undermines the effectiveness of bicycles and motorcycles as a means of
getting to work. As a consequence, city labor markets are made inefficient by spatially
excluding workers from opportunities. This creates significant costs for businesses, which must
pay higher wages to attract workers than they would in denser labor markets to compensate
for the cost of transport.

Housing in desirable locations is prohibitively expensive while most affordable housing

is in the periphery. This chapter explores what drives this extreme spatial organization of
urban areas. The root of the problem is with the housing policy and housing markets, which
have an overwhelming impact on defining where housing is built and how dense housing can
be built. Although South Africa’s exclusionary urban structures have a history dating back to
apartheid and before, post-apartheid housing policies explain the continuation of spatial
exclusion of cities today, including the continuation of spatial exclusion in growing secondary
cities. Reasons beyond apartheid itself must explain the fact that South Africa continues to see
low housing density in emerging cities both outside of and within former homeland areas. Post-
apartheid housing policies have aimed to deliver free or highly subsidized housing combined
with tight regulations that prohibit diverse and dense housing. This has naturally pushed
housing to the periphery of cities, leading to long travel distances and high total costs of
transportation. Many individuals respond to the lack of job opportunities reachable from where
they live by choosing to live in informal settlements closer to the city, even though the size of
these houses is much smaller, and housing is generally of much lower quality.

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Low-density housing settlements also lower the profitability and therefore the scale of
potential informal activities. South Africa’s very high unemployment is in part a consequence
of its very low informality. We find that the spatial structures of cities also go a long way to
explain South Africa’s unusually low level of informal work — even after accounting for
mismeasurement and surveying challenges. The reason for this is that whereas many informal
business activities in other countries are centered around the home, low-density and
disconnected housing limits the foot traffic around people’s homes. This limits the market size
for home-based businesses in many areas of the country. In the areas where densities are high,
such as in denser townships of Alexandra (in the Johannesburg metro area) or Dunoon (in the
Cape Town metro area), an informal sector is much more present. Moreover, when housing is
located very far from the city center, where foot traffic is higher, this disincentivizes individuals
from commuting to denser areas of the city for informal work. This pattern is common in South
African cities but may be less pronounced in cities within former homelands (e.g., Mthatha)
where housing is sprawling but where distances between population centers are not as far as
in established metro areas (e.g., Johannesburg).

Forces of spatial exclusion extend far beyond cities in South Africa. South Africa faces a
particular pattern of low rural opportunity concentrated across former homeland areas.
South Africa’s rural areas are not universally poor by any stretch of the imagination. Many rural
areas of the country support employment rates at or above that found in cities. But there are
highly notable geographic exceptions to this pattern. Employment rates in rural areas of former
homelands, on average, are roughly half of what they are in all other parts of the country,
including in urban areas of former homelands. This is not explained by any observable features
of the populations who live there (Lochmann, 2022), and low wage levels are not well explained
based on income levels of surrounding areas as they are for the rest of the country (Mudiriza
and Lawrence, 2021). Since individuals who leave former homelands fare equally well in the
labor market as anyone else (Lochmann, 2022), this reflects a place-based problem affecting
these areas where roughly 30% of the population continues to live.

This section explores why South Africa faces such striking patterns of spatial exclusion,
both across the country and within cities, and identifies solutions. We find distinct drivers
of these two types of exclusion. Within cities, housing, zoning, and urban development policies
are at the root of spatial exclusion and cause a repeated pattern of low-density housing being

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built in disconnected areas rather than high-density housing in the core of cities. Therefore, we
recommend changes in housing market policies — especially zoning and regulations — and in
the structure of budgetary spending on city infrastructure — especially through budget
mechanisms on human settlements. Ultimately, South Africa could reverse the pattern of spatial
exclusion of cities and enable organic growth of higher-density cities by relaxing restrictions
on denser housing, channeling more fiscal resources toward demand-side housing
instruments that enable households to choose where to live and ensuring that infrastructure
spending does not de facto incentivize the building out of cities at the expense of building up.
This shift would be strengthened by a coordinated national policy shift, but there are also
substantial opportunities for local governments to lead and jumpstart changes in their urban
structure through strategic uses of urban land.

Extreme spatial exclusion of rural former homelands comes less from active policies
(unlike urban spatial exclusion) and more from a lack of physical connectivity and
connections in knowhow. We find that although many infrastructure gaps have narrowed
between homeland areas and the rest of the country, there remain critical shortfalls in basic
connecting infrastructure, especially paved roads. This is the binding constraint for some of
South Africa’s most rural and disconnected communities. The underlying causes of these gaps
were discussed in the previous chapter, along with recommendations for strengthening state
capacity in relevant ways. However, we also find that connecting via physical infrastructure is
not enough to fully close the gap in employment outcomes between homeland areas and non-
homeland areas. Once connected physically, economies of rural former homelands do not
automatically connect to surrounding productive ecosystems and discover new comparative
advantages, even if these are established in very nearby communities.

We find that one approach that has been successful and which can be built upon is
partnerships between established commercial entities and communities within the rural
former homelands. We find that there are examples of success in agriculture through diverse
organizational structures and broad similarities to South Africa’s successful franchising sector
(Klinger, 2022; Klinger et al., 2023). Success cases are limited, however, and face large
challenges in building trust, overcoming information asymmetries, achieving technology
transfer, and managing risk — especially climate risk. At the same time, limited success shows
that committed and well-structured partnerships can work to bridge knowhow, even in

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situations of communal land ownership and traditional governance. For more of these
partnerships to take place, there needs to be a thicker market for businesses and communities
to find one another and a scale-up of tools for structuring partnerships based on success cases
— like what exists in the franchising sector. We find that South Africa has several “agents of
change” that currently support the matching and building of such partnerships, including
partnership advisors and local NGOs. We also find that, in the best cases, communities
themselves can seek out such opportunities through their local trusts or enterprises. There
should be an important role for the government to play in supplying public resources and
initiatives that help to create a larger market for such partnerships, including through
leveraging the public university network.

This chapter argues that addressing the collapse of state capacity discussed in the
previous chapter is only one necessary step toward growth through inclusion. For a
recovery of growth to be enhanced by the inclusion of more people, actions to reverse historic
drivers of exclusion must also take place. The path to spatial inclusion in South Africa must
include housing policy change and urban planning and spending changes that would “bring
people to jobs”. This would increase the ability of cities, including secondary cities, to absorb
more job seekers and, to some extent, lower the pressure on rural unemployment. Meanwhile,
there is also a need for a focus on connecting infrastructure and bridging knowhow to “bring
jobs to people” in the country’s most struggling areas. The next section discusses the challenge
of inclusive cities, and the following section discusses the challenge of bridging knowhow.

3.2 Building Inclusive Cities: Bringing people to jobs

The core function of a city is that of a market — a market for products, labor, ideas,
innovation entrepreneurship, partnerships, and more. Cities are places where people
choose to live to be near other people. Urban economics focuses on the role of “agglomeration
economies”, where firms, people, and economic activities cluster together in a particular
geographical area. Through agglomeration, cities can support highly diversified, productive,
and high-income economies as businesses have access to a large pool of differentiated
workers, access to suppliers, and access to markets. But to achieve agglomeration economies,
cities must be physically connected through transportation infrastructure that allows people to
interact, especially for workers to get to work. Efficient cities tend to have high density in the

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city core or multiple city cores, with high land prices, and lower density with lower land prices
as one moves outward from the city core (Bertaud, 2018). This is the natural outcome of
businesses and firms bidding up land prices for the greatest connectivity, which then supports
the construction of dense build-up and housing in small units. As cities expand outward,
individuals and businesses trade-off space for connectivity. For cities to continue to benefit
from agglomeration as they grow outward, urban infrastructure must allow people to travel
efficiently across the city.

South Africa’s largest metros diverge from spatial patterns of efficient cities. As shown in
Figure 3.3, Johannesburg and Cape Town are distinctively different from most global cities in
the distribution of their population across space. Each city lacks a traditional city core and
declining population density as one moves away from that core. This pattern has been
attributed to apartheid planning. However, this explanation must be critically assessed by
looking at more recent indications of urban density and spatial patterns of emerging cities that
have not been as subject to apartheid-era planning. More recent data tends to show a recurring
pattern for South African metro areas. Figure 3.4 shows the relationship between population
density and distance from the city center for eThekwini and Buffalo City — in both 1-dimensional
and 2-dimensional space. These two urban areas reflect a common pattern across South
African cities, which tend to lack a dense urban core and instead have largely disconnected
and dispersed populations. Later in this chapter, we will explore additional examples.

South African cities are growing horizontally, but people continue to be attracted to
more connected areas. In growing cities, market pressure for housing densification is
expressed either vertically (by building up) or horizontally (by building out). If densification is
expressed vertically, we would observe a decreasing built-up density gradient with increasing
distance from the central business district (CBD) in the graphs above. Expressing densification
vertically means enabling developers to build higher-rise mixed-use buildings. Meanwhile,
expressing it horizontally, as we tend to see in South Africa, implies urban sprawl. However,
this does not mean that people choose to live far from the city center by choice. Instead, South
African cities have significant infill squatting and growing informal areas as people choose to
live in more connected areas. Furthermore, if given the choice, many South Africans express
to prefer better location and shared amenities over single-family homes, and rental over
ownership. Backyarding is a signal that many people who are given single-family homes on

87
little land plots will informally build up the area, which implies that they prefer additional
income over space. Other strong signals come from Maboneng, Johannesburg. Jewel City is
an affordable housing complex that provides ample shared amenities and proximity to
economic opportunity. The success of the housing complex, which provides affordable rental
units for over 1,000 units and is currently over-subscribed, further showcases that, if given the
choice, many South Africans would choose location and shared amenities over single-family
homes in the disconnected periphery.

FIGURE 3.3: RELATIONSHIP BETWEEN DENSITY AND DISTANCE FROM CENTER FOR SELECT CITIES

Source: Bertaud and Malpezzi, 2003.

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 FIGURE 3.4: POPULATION DENSITY PROFILES OF ETHEKWINI AND BUFFALO CITY

Note: Blue colored part in the map is the central business district (CBD).
Source: Own elaboration based on South African National Census 2011.

As a result of their spatial structure, South African cities suffer from problematically long
commute times. An efficient city is good at locating people and jobs close to each other. One
“golden rule” is that efficient cities keep maximum commuting times under one hour (each
way), regardless of the mode of transport (Bertaud, 2018). In South Africa, we see that
commuting is very expensive and it takes a long time. Taking national averages, the total cost
of commuting (including time cost) is close to 80% of net income for those who commute by
bus, train, and even employer-provided transportation (Figure 3.5). This cost is primarily driven
by the cost of the time spent commuting (based on hourly wages). In other words, workers
spend a very large portion of their workday commuting.

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 FIGURE 3.5: RATIO OF COMMUTING COST TO INCOME BY MODE OF TRANSPORT

Source: Shah and Sturzenegger, 2022.

These costs tend to be regressive in a variety of ways. As reflected in Figure 3.5, the cost
as a share of income is relatively lower for those with access to a car, but access to a car remains
out of reach for most South African at their income levels. Given the large distances in South
African cities, network coverage of buses and trains is impossible without very large public
subsidies, which South African municipalities cannot afford. This urban structure makes
minibuses or taxis the cheapest and most efficient mode of transport. When other forms of
public transportation have been built, such as Gautrain in Johannesburg or MyCiTi in Cape
Town, ridership is very low, and access is limited to higher-income commuters rather than
addressing the very large transport needs of the population. The differences are striking in
comparison to other global cities. For example, Cape Town’s BRT system runs a similar length
to that of Bogotá, but Cape Town has only about one rider for every 50 in Bogotá (see Box 3.1).

Patterns of spatial exclusion repeat themselves in growing cities. During apartheid, spatial
policies generated sprawling and disconnected cities, excluded certain population groups,
and prevented cities from densifying naturally through price mechanisms and the build-up of
city centers. However, three decades after apartheid, we continue to see these problems
repeat themselves in growing secondary cities. Secondary cities are important destinations for
internal migrants and drivers of inclusive growth. According to a report from the South African
Cities Network (SACN), secondary cities contribute approximately 15% of the national GDP.
These cities tend to have a more diverse economic base than rural areas. Between 2008 and

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2018, secondary cities in South Africa contributed to around 23% of national employment
growth (South African Cities Network, 2021a). These cities have different growth drivers (Figure
3.6), but they share one thing in common. They tend to recreate patterns of spatial exclusion.

Box 3.1: BRT in Bogotá vs. Cape Town

Bogotá's BRT system, known as TransMilenio, began operations in 2000 and has grown to become
one of the largest and most extensive BRT systems in the world. As of 2021, it had over 12 lines
covering approximately 114 km of dedicated busways. Cape Town's BRT system, known as MyCiTi,
started operations in 2010. As of 2021, it consisted of 42 stations along eight main routes, covering
about 80 km of dedicated busways. In 2021, TransMilenio’s ridership was around 2.4 million
passengers per day, whereas MyCiTi had a daily ridership of around 50,000. MyCiTi is a bit smaller
than TransMilenio but has only one-fiftieth of the ridership.

Bogotá is a dense city with a large population, which makes it ideal for a high-capacity mass transit
system like the BRT. The demand for public transportation is high, and the BRT system offers an
affordable and relatively fast solution for many commuters. Cape Town has a more sprawling urban
layout, with lower population density and a more extensive car-centric transportation infrastructure.
This makes it more challenging to create a successful BRT system, as the demand for public
transportation is not as high and the existing infrastructure favors private car use.

Sources: www.transmilenio.gov.co; www.myciti.org.za

FIGURE 3.6: ECONOMIC CLASSIFICATION OF INTERMEDIATE CITIES

Source: South African Cities Network (2021b.)

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Recurring spatial exclusion can be seen in very different cities. Figure 3.7 shows the
population density of two growing secondary cities, George and King Sabata Dalindyebo
(which contains the city of Mthatha), and Box 3.2 profiles each of these cases. George lacks a
dense city center but is more compact than larger cities discussed earlier, with an estimated
population of around 160,000. However, as it grows, it appears to be recreating disconnected
spaces at a larger scale despite a desire to grow more inclusively. Mthatha has become a
sprawling population center with a rapidly growing periphery where housing is being built on
communal lands surrounding the formal boundary of the city. There appear to be common
drivers that result in spatial exclusion in very different circumstances across South Africa.

FIGURE 3.7: POPULATION DENSITY PROFILES OF GEORGE AND KING SABATA DALINDYEBO

Note: Blue colored part in the map is the central business district (CBD).
Source: Own elaboration based on the South African National Census 2011.

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Box 3.2: Deeper dive into two secondary cities: George and Mthatha

George: A growing but disconnected city with advantages in tourism and agriculture
George is known for its tourism, agriculture, and forestry industries. It is the sixth oldest town in South
Africa. Located on the popular Garden Route, George attracts many domestic and international
tourists each year. Agricultural output is concentrated in dairy, fruits, and vegetables. Population
inflows provide increased growth in these tradable sectors, but also jobs in non-tradable services.
Informal activity is encouraged and supported, with stands in strategically important areas, as well as
the development of smaller business centers in -denser areas like Thembalethu, a township in the
model of larger cities. George has experienced significant growth in population, which accelerated
during and after the pandemic. According to interviews and city strategies, absorbing people in an
inclusive way is high up on the agenda of the policymakers. Yet, George still faces non-inclusive
outcomes. Although Thembalethu is only 5km away from the CBD (close by South African standards),
it is still difficult for residents to commute to work outside of the township. They need to cross a major
highway with one bridge that is highly congested during peak hours. The commute is, hence, either
a long walk, or a very slow drive. George has recently introduced GoGeorge, a bus transport system
that has yet to be extended to Thembalethu. Densifying the CBD with focus on affordable and mixed-
use housing is high on the priority list of the policymakers, yet progress is proving difficult. Zoning
restrictions, historic (no longer active) parking regulations, red tape, and building costs make those
kinds of developments unprofitable.
Mthatha: A growing and sprawling but more connected city in a former homeland
Mthatha was the capital of Transkei. As South Africa transitioned to a democratic system, this led to
a re-orientation of the city. Like many other cities in South Africa, Mthatha has experienced significant
urbanization over the past thirty years. The surrounding rural population continues to migrate to the
city in search of better economic opportunities, education, and services. This has led to a rapid
increase in the city's population, putting pressure on its infrastructure, housing, and services. The
economy of Mthatha has shifted from being predominantly government-driven to a more diverse mix
of sectors, and Mthatha plays a notable role as a services hub for the surrounding area. Mthatha has
an active informal economy, especially in the city core, in contrast to many other cities in South Africa.
Nonetheless, even Mthatha faces spatial sprawl – not from apartheid planning, but from a
combination of a low-density city core and the pull from the periphery where communal land is cheap
home building is easy. Unlike more disconnected cities, Mthatha a relatively constant density with
distance. This time lapse shows new developments in Mthatha in terms of where new settlements are
arising in the time span 2016–2023: https://www.planet.com/stories/mthatha-and-surrounding-
hU48KHf4g

We see that these three requirements of efficient, inclusive cities are missing across
South Africa: people and economic opportunities are disconnected, formal housing is
exclusive, and mobility is expensive. Post-apartheid policies are not reversing these
outcomes. In fact, we find that they are exacerbating them. In the next section, we describe
how post-apartheid housing policy is at the center of these recurring outcomes. A push to
provide high-quality housing for all South Africans through public supply led to housing on the

93
periphery of cities, where land prices are lower, which has worsened spatial exclusion.
Affordable housing is rare in city cores, which leaves people with the choice to live in the
periphery or informal settlements. Commutes are expensive, especially on the lower end of
the income distribution, disincentivizing formal and informal work, and creating poverty traps.
Public transport options are costly and inefficient due to lacking density.

3.2.1 Housing Policies at the Heart of Exclusive Cities

Due to South Africa’s RDP-style housing programs, housing is disproportionately built in

economically disconnected areas. South Africa’s Constitution states that “everyone has the
right to have access to adequate housing”. Although South Africa still suffers from a shortfall of
adequate housing, this has been the motivating goal of housing policy. In the immediate post-
apartheid period, housing policy was highly supply-driven: RDP and, later, Breaking New
Ground (BNG) housing programs built single-family unit homes on a massive scale. This
provided many poor households with a relatively high-quality home. However, by taking away
the agency of people to choose where they want to live, these programs exaggerated spatial
exclusion in cities, locating RDP and BNG housing in areas where land is cheap. This resulted
in the pattern seen in Figure 3.8, where housing for the poor (blue dots) was systematically
located away from concentrations of businesses and economic activity (color scale).

This orientation of housing policy has had long-lasting consequences and created
substantial inertia. Although the focus of housing policy – at least on paper — has partially
shifted from supply-side policies towards demand-side approaches over the past decades
(under programs like the Finance Linked Individual Subsidy Programme (FLISP) that provide
individuals money to choose their own housing), these programs remain very small within the
budget structure of the Department of Human Settlements. In practice, the approach has had
immense staying power as well as implications for local infrastructure spending and the
functioning of private housing markets. Because of the need for infrastructure buildout to
connect low-cost land, a large share of Department of Human Settlements grants to
municipalities are earmarked for arterial infrastructure. Given the large presence of RDP-
influenced home building, similar construction is provided by the private market due to
established supply chains and business models of housing developers. Moreover, free or
highly subsidized housing has become an expectation of many South Africans, even if
beneficiaries are often dissatisfied with housing quality and location.

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 FIGURE 3.8: LOCATION OF SOCIAL HOUSING VS. BUSINESS PRESENCE IN JOHANNESBURG AREA

Note: Blue dots on the map indicate social housing complexes as of 2018.
Source: Own elaboration based on economic data from Nell, A. Visagie, J. Spatial Tax Panel 2013-2018, Version 1. National
Treasury - Cities Support Programme and Human Sciences Research Council, 2021 and Housing data from Scheba et al (2021).

Small-scale demand-side instruments have faced numerous problems. The uptake of FLISP
has been very low (at less than 16,000 households and half the target for 2012 to 2020), and
there are widespread explanations for the low uptake (Department of Human Settlements,
2021; Hoek-Smit and Cirolia, 2019).13 These point to the following causes, among others: the
type of subsidy that is granted, which is on the down payment rather than a subsidy on
mortgage interest rates; the rigidity of the financial system, which is inaccessible to many
people; the titling backlog, which constrains people in the access of financial resources; and
low marketing and limited public knowledge. However, a simpler but important explanation is
that the program is very small in comparison to other uses of the Human Settlements budget.
A scale-up of the transition from supply-side policies, which dictate where housing is built, what
kind of housing, and how dense, to demand-side instruments that allow demand to dictate
each of these dimensions would be a step in the right direction. At the same time, it is important
to explore why denser housing is not already built on a larger scale on the private market.

13
See also several studies by the Center for Affordable Housing Finance (CAHF) - https://housingfinanceafrica.org/

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Significant supply-side restrictions affect housing construction today and would not be
resolved by a larger shift to demand-side subsidies. National and local zoning and building
regulations make it expensive, and in parts illegal, for developers to build high-rise buildings
at affordable rates in desirable locations. The regulatory framework disincentivizes building up
in the core and implicitly subsidizes building out in the disconnected periphery. For a demand-
side subsidy to have its desired effects, supply must be responsive in desirable locations. This
requires making it more attractive for developers to build in the city core (Hoek-Smit and
Cirolia, 2019). Regulations make it practically impossible — and illegal — for developers to build
housing supply that would reflect a better spatial equilibrium in cities. Below are some of the
most binding regulations and distortions to inclusive housing developments in desirable
locations, which are necessary to revisit. The optimal level of building regulations is not zero,
but these areas are noteworthy because they do not appear to be necessary public safeguards,
yet they have large unintended consequences.

• National Building Regulations: The National Building Regulations and Building

Standards Act 103 of 1977, last amended in 2008,14 provides a framework for the
establishment of uniform building standards and regulations across the country. The act
covers a range of aspects of building construction and management: building standards,
building regulations, building plans, and approvals and penalties. Some specific
regulations stand out as rather unique in South Africa when compared to other countries
in their restrictiveness, for example, single-point access staircase regulations, as well as
building material requirements. The use of traditional materials like wood and glass is more
restricted in South Africa, as is the construction of prefabricated homes — a form of
construction that has advanced significantly globally. Such restrictions not only increase the
building cost significantly but make it more difficult to build units of different sizes and
diversity — leading to more expensive and less versatile housing units that cannot
accommodate different price ranges. We, therefore, recommend relaxing overly restrictive
materials and accessibility regulations at the national level.

14
Besides SANS 10400-XA: Energy Usage in Buildings, which has been amended in 2020.

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 • Local Building Regulations: An increasing body of research has studied the role of
restrictive land use policies on increasing racial segregation and income segregation.15
Restrictive floor area ratios (FAR) and building coverage ratios (BCR) are two measures.
With limited space for development, land values in areas with low FARs and BCRs tend to
be higher, which can make it difficult for developers to build affordable housing and for
people to afford housing in those areas. Certain types of developments, like higher-rise,
mixed-use buildings with a variety of different apartment sizes become infeasible with low
FARs and BCRs. These measures in South Africa differ across cities and zones but tend to
be low. In several municipalities’ housing codes, FARs of 1, oftentimes in combination with
low BCRs, appear to be constraining in zones that could lend themselves to densification.
As an indication of how binding FARs can be, Paris doubled its number of housing units
built per annum from 40,000 to 80,000 between 2009 and 2019, partly explained by a
national law that eliminated floor-area-limits in local plans (Denoon-Stevens and Nel, 2020).
Finally, parking minimum regulations which have been eliminated in many places, can also
significantly increase building costs and skew the type of buildings that can be viably built.
The same is true for elevator requirements and other local regulations. We recommend
that municipal governments relax FAR, BCR, parking and elevator requirements, and other
restrictive local building regulations to allow for higher density.

• Zoning Regulations: Extensive empirical research has demonstrated a strong connection

between exclusionary zoning and increased housing costs, diminished housing
construction, and reduced overall welfare.16 Zoning restrictions inflate building costs, limit
housing variety, and discourage diverse, affordable housing. Single-family home zoning
especially limits the development of apartments, multi-family, or mixed-use homes, thus
artificially reducing housing supply and increasing prices. Furthermore, these regulations
frequently result in housing types being concentrated in specific areas, which can
contribute to economic segregation and reinforce existing inequalities in the housing
market. Like South Africa, the United States is often noted for its extensive single-family
zoning. In the U.S., this type of zoning was historically used to segregate neighborhoods
by class and race, and it continues to shape American cities today. However, in recent years,

15
See, among others, Rothwell, and Massey (2009); Sahn (2021); Trounstine (2020); Lens and Monkkonen (2016);
and Rothwell and Massey (2010).
16
See, among others, Glaeser and Gyourko (2018); Glaeser et al. (2005), and Hsieh and Moretti (2019).

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 there has been a growing push in some U.S. cities to reform single-family zoning to allow
for more diverse types of housing and promote greater affordability and inclusivity. In
Europe, on the contrary, single-family homes are common in suburban and rural areas, but
multi-family buildings predominate in urban centers. We recommend a local shift to less
single-family zoning, prioritizing mix use in city cores.

Based on international experience, a few additional policy dimensions could be

important in enabling more inclusive housing. First, denser and more inclusive housing is
often blocked at the project level by narrow non-in-my-backyard (NIMBY) interests at the
expense of wider benefits to society. Countries that have struggled with this have discovered
some solutions. Second, it is important to leverage development charges or impact fees
equally across space so as not to de facto incentivize building on the city periphery. Third, since
housing development is a dynamic challenge, policy changes should not be limited to one-off
regulatory changes. Rather, the government can utilize active problem-solving approaches in
coordination with the private sector to understand emerging challenges and partner to find
solutions. Each of these policy dimensions is discussed below.

• Addressing NIMBYism proactively: In the United States and other countries (like France
and New Zealand – see Box 3.3), land use and housing policy control is increasingly being
moved to higher administrative levels, for example, the state rather than cities and towns.17
When decision-making power is shifted from local municipalities to higher levels of
government, very narrow local opposition to development can have less direct influence.
Higher-level authorities can reflect the needs of broader society. For instance, if a state
mandates that all towns must allow multi-family housing in residential areas, local
opposition can do little to prevent it. Additionally, systems that pre-approve projects based
on a pre-determined spatial development plan and simple criteria can also limit
opportunities for NIMBYism. Under such arrangements, community approval is front-
loaded in the form of strategic plans and neighbors must pre-approve projects that are in
the common good even if they happen to develop in their backyard.

• Ensure impact fees are equally applied: Impact fees, also known as development
charges, are fees charged by local governments on new developments to help pay for the

17
See Denoon-Stevens and Nel (2020) for the case of Paris.

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 costs of providing services and infrastructure to support growth. Development charges are
typically charged on new residential, commercial, or industrial developments and are
calculated based on the type, size, and location of the development. The fees are intended
to facilitate necessary improvements in water and sewer systems, roads and transportation
infrastructure, parks and community facilities, and other municipal services that are needed
to accommodate the growth of the community. The purpose of development charges is to
ensure that the costs of new development are borne by the developers and new property
owners, rather than being passed on to existing taxpayers. By doing so, development
charges help to ensure that growth and development are sustainable. It is important to
ensure that municipalities do not waive or reimburse development charges on peripheral
development in ways that undermine the natural functioning of housing markets and
inadvertently incentivize building out rather than filling in and building up.

• Establish continuous public-private problem-solving: Public-private problem-solving

task forces can be effective ways to continuously address constraints in particular sectors
or around specific constraints. By regularly meeting and incrementally addressing issues,
such task forces can develop trust, reveal information, and develop innovative solutions.
Such task forces could be nationally focused but may be more effective at the city level to
uncover and address city-specific constraints. Understanding the key constraints of the
relevant stakeholders in the housing market, notably, developers, helps shift the focus from
a system that operates entirely on fiscal incentives towards addressing the real costs and
hurdles that undermine diverse and spatially inclusive housing construction. Such initiatives
are effectively free to the public sector and can lead to a much more effective use of
resources.

Taken together, a relaxation of supply-side restrictions and an increase in demand-side

instruments would have a profound impact on housing development and spatial
inclusion in South African cities. Shifts in the spatial structure of cities would occur gradually,
but this is the path to fundamentally changing the exclusive spatial structure of cities. Inclusive
cities would be stronger economically and eventually reduce demand for informal settlements.
In the shorter term, this shift would enable growth in housing construction, creating jobs and
demand in the supply chain of housing construction materials. Growth in the private housing
market would also allow municipalities opportunities to grow their tax base through property

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tax revenues and opportunities to put underutilized land to use for urban development goals.
In either the long- or shorter-term the shift would be expected to have a positive impact on
crime by increasing inclusion and job opportunities. Other countries have taken similar
measures at a large scale, for example, New Zealand in addressing restrictive supply-side
regulations and Colombia in leveraging demand-side instruments (see Box 3.3).

Box 3.3: New Zealand and Colombia Approaches: Liberalize Supply and Support Demand

New Zealand: Relaxing Supply Side Restrictions

New Zealand has experienced a significant rise in housing costs over the past decade, with the
median house price increasing by around 130% between 2011 and 2021. This increase in
housing costs is partly due to an undersupply of housing. In response, the New Zealand
government has introduced several housing reforms aimed at increasing housing supply and
affordability. One of these reforms is the Medium Density Residential Standard, which requires
the most populous cities in the country to allow medium-density housing on all existing
residential parcels of land. This reform is a reversal of previous land use policies, which
encouraged low-density housing in residential areas. The zoning reform is expected to stimulate
housing construction through redevelopment, with the Auckland Unitary Plan providing a
blueprint for the policy's success. The Auckland Unitary Plan, introduced in 2016, led to a
construction boom in the city, with a significant increase in new housing units permitted and a
shift towards attached multifamily housing.

Another policy introduced by the New Zealand government is the National Policy Statement on
Urban Development, which requires large cities to zone for residential structures of up to six
stories within walking distance of rapid transit stations. This policy aims to promote more
compact cities and lower energy consumption through shorter commutes and increased use of
public transit. These reforms have increased housing construction in New Zealand, but it remains
to be seen whether they will significantly improve housing affordability.

Colombia: Demand-Side Policy Focus

In 2021, the UN named Colombia a standout in social and affordable housing. Several Latin
American nations have subsequently taken cues from Colombia's "Mi Casa Ya" program in
developing their own housing strategies. Colombia's housing policy is multifaceted and has
seen some notable progress, such as a 17% annual increase in the housing sector's GDP, a 40%
increase in sector employment in four years, and a 70% growth in the mortgage portfolio over
three years. It also improved social housing quality, decreased urban segregation by moving
less affluent people closer to city centers, and ensured that most subsidies reach the poor.

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 Box 3.3: New Zealand’s and Colombia’s Approaches: Liberalize Supply and Support
Demand (cont.)

Colombia’s approach to housing policy is based on three pillars:

1. The flagship of the housing policy is “Mi Casa Ya”, the demand-driven program. The demand-
side subsidy is provided to the poor by default. Each mortgage is supported by a Guarantee
Fund. Down payment is provided by the government and poor people are intended to pay
less for the mortgage than they previously paid for the rent. Meanwhile, supply-driven
programs remain in place but are mainly associated to reallocations, risk management,
catastrophes, or victims of violence.

2. Each subsidy for a new house has been accompanied by four subsidies for house and
neighborhood improvement. Responding to the qualitative deficit has been prioritized. This
has included legalization of informal neighborhoods and providing public goods including
schools, libraries, police stations and hospitals, and improving dwellings.

3. A new housing law and many regulatory innovations facilitated by sub-national governments.
The central government financed studies for the expansion plans of some municipalities,
included instruments to effectively capture the value of the land in time (Tax Incremental
Financing) and manage to simplify the process to provide construction licenses.

Source: Greenaway-McGrevy (2022) for New Zealand’s case and Jonathan Malagón, former
Ministry of Housing of Colombia for Colombia’s case.

3.2.2 Better Utilizing the Human Settlements Budget

To capitalize on the relaxation of supply-side restrictions, we recommend a substantial

shift in the Human Settlements budget to demand-side instruments. Human Settlements
spending is a concurrent function between the national and provincial departments. The
largest share of the budget occurs through block grants to provinces and metros, largely for
subsidized housing and settlement upgrades. Close to two-thirds of this spending (more than
ZAR 20 billion in 2022/23) flows through two grant programs — the Human Settlements
Development Grant (HSDG) and Urban Settlements Development Grant (USDG) — and another
8.8B Rand flow through the Informal Settlements Grants (Figure 3.9). The HSDG is
administered by provinces to finance housing-related infrastructure in local municipalities,
whereas the USDG is administered by the metros. The end uses of these two grants are not
fully transparent (especially, USDG), with spending choices made at these local levels of

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government. Historically, these programs have de facto favored housing construction on the
periphery of cities, serviced sites, and public infrastructure investment that implicitly subsidize
urban sprawl. The National Department of Human Settlements directly controls budget
spending on less than 10% of the budget, through the remaining programs including SHRA
grants, FLISP, and Admin and other (a total of only ZAR 3 billion out of ZAR 33 billion).

FIGURE 3.9: HUMAN SETTLEMENTS BUDGET 2022/2023 (TOTAL: 33B RAND)

35

30

Admin + Other
25
FLISP
Rand Billion

20 SHRA Grants

Informal Settlements Grants

15

Urban Settlements Dev. Grant

10
Human Settlements Dev. Grant

Source: Own elaboration based on 2022 Estimates of National Expenditure, National Treasury.

We recommend three steps for restructuring the Human Settlements budget:

1. Shift of the budget towards demand-side subsidies spending.

2. Review and restructure the USDG grant with the possibility to transform it from a
“schedule 4” to a “schedule 5” grant.

3. Provide mechanisms to tie USDG and HSDG spending to where demand-side subsidies
follow peoples’ housing choices, instead of de facto promoting supply-driven sprawl.

First, we recommend a shift in this spending toward demand-side subsidies. The main
advantage of demand-side subsidies is that they provide greater consumer choice at the
lowest cost to the government. However, they perform best in markets where they can trigger
a supply response. If supply is tight, demand-side subsidies can exacerbate affordability
problems for non-subsidized low-income households as rents or prices increase. This is why,

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South Africa needs to unlock the housing supply constraints as a pre-condition for demand-
side subsidies to unlock the affordable housing market.

The design of demand-side instruments is not a trivial matter. A combination of rental

subsidies, up-front subsidies/down payment support for home buyers, and subsidized
mortgage payments can benefit different population groups more flexibly than one type of
subsidy. The instruments should enable a large segment of society to access housing options
that meet their needs, but at the same time, the instruments must not create fiscal guarantees
that undermine fiscal policy goals. Some considerations of different demand-side supports are
discussed below.

• Up-front Subsidy / Down Payment Support: Subsidies applied on the down payment are
the current mechanism used within FLISP. Other options of up-front subsidies could apply
to closing costs or the mortgage insurance premium. These tools are useful for many
households who lack significant savings, and the fiscal implications are straightforward
because payments are one-time. Yet, this form of subsidy is not effective in targeting
households in the lowest income tiers and can exclude low-income households with low
credit scores. This is a challenge in South Africa since many households do not have a
savings history or a prior property title deed as collateral.

• Subsidized Mortgage Payment / Interest Payment: These subsidies lower the monthly
cost of housing payments. These subsidies are more useful for households who can cover
larger down payments (through savings or Stokvels in the case of South Africa), but who
struggle to afford mortgage payments over time. This pool of beneficiaries may be narrow,
so these could be combined with down payment support. If not designed and managed
carefully, these subsidies can create fiscal risks as they are recurring payments. If subsidies
are fixed in value, this planning is straightforward, but if these payments are variable, fiscal
management can become a challenge.

• Rental Subsidies: Rental subsidies target renters rather than home buyers and
homeowners. In the case of Colombia, these rental subsidies allowed individuals without
credit history to build a credit history that then allowed them easier access to mortgage
markets. The development of the rental sector comes with real advantages to the economy.
It enhances labor mobility and is an option for households who don’t have the means to

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 buy a home or wish not to, including young adults and new migrants. A thriving rental
sector further provides a choice for asset investment and a source of complementary
income. Demand for rentals in the affordable segment is clearly present, as shown by the
rapid increase in “backyard” rentals, as well as by the high demand for rental units in the
city core. Rental subsidies are typically paid out continuously and do not directly impact
home ownership and home construction.

Regardless of the combination of demand-side subsidies, certain administrative

improvements will be needed in South Africa. Hoek-Smit and Cirolia (2019) raise several
administrative issues. These include a need to better delineate responsibilities between
provincial governments, the entity with the budget, and the National Housing Finance
Corporation (NHFC), which is the national overseer. Municipalities need to play a larger role in
disseminating information about housing programs and managing these programs.
Municipalities often serve as the initial contact for residents seeking housing, manage waiting
lists, gain insight into local housing markets for both new and existing homes, and develop
relationships with the key participants in the real estate market. Municipalities also maintain
connections with local employers and other groups that can contribute to the successful
operation of demand-side subsidy programs.

Second, we recommend reviewing and restructuring the USDG grant. USDG grant is
currently a “schedule 4b” grant, which implies allocations to metros to supplement the funding
of programs or functions funded from metro budgets. This limits the margin of action of the
Department of Human Settlements, which has no impact on how and if the budget is spent.
According to the Department of Human Settlements (2015), large chunks of the budget are
not spent on housing-related programs and infrastructure, and allocated money is often not
allocated until a rush ad the end of the calendar year. The HSDG, meanwhile, is a schedule 5
grant, entailing specific purpose allocations. Aligning HSDG and USDG by restructuring USDG
to schedule 5 would help to provide greater oversight of how the budget is spent and allow
for more direction to projects that enable more compact urban housing. Another possibility is
to transfer the infrastructure parts of USDG to the Department of Cooperative Governance and
Traditional Affairs CoGTA (and align it with MIG grants to local municipalities) while structuring
the remaining budget tied to housing infrastructure via schedule 5 grants.

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Finally, it is possible and desirable to link demand-side spending instruments with the
relaxation of supply-side restrictions discussed previously. This can involve tying a certain
amount of grant funding to municipalities that have implemented a set of reforms. For
example, supplemental grant funding could be available for local governments that have
relaxed counterproductive zoning and regulatory barriers to density. Or, alternatively, grant
funding for urban infrastructure could be tied to the actual mobilization of demand-side
subsidies, such that the communities that are seeing more uptake automatically gain additional
resources for infrastructure upgrades to support more housing. In addition to the human
settlements budget, transport budgets could, in principle, also be used to incentivize local
regulatory change. For example, new public transport projects could be nationally funded
conditionally on a municipality densifying its housing (through relaxation of overly restrictive
building regulations and actively working to reform zoning regulations). Developing an easy-
to-implement set of local regulatory and zoning reforms could be a task for the Department of
Human Settlements together with the City Support Programme of the National Treasure and
the larger research community.

3.2.3 Other Urban Policy Priorities for Inclusion

Local governments can further enable inclusion by incorporating underutilized urban

land for development purposes. Publicly owned land, particularly in key urban centers or
near transport nodes, has a high potential for developing inclusive housing. As the government
already owns this land, the cost of acquiring land (which can be a substantial part of total
development costs) is eliminated. This significantly reduces the overall cost of developing
affordable housing units, making it more financially feasible for the government or private
developers to build such housing. An example of this is the Air Force Base Ysterplaat in Cape
Town, which is a large and strategically located area that no longer serves its original public
purpose. This creates an enormous opportunity to change the urban fabric. Innovative housing
development in the area can also serve as a model for other areas and the process can also
deliver significant revenues to the city to be reinvested.

Given the spatial sprawl of South African cities, which undermines cost-effective public
transport options, there is likely scope for improvements through the existing minibus
system and reviving once-functioning passenger rail systems. Large-scale public transport
solutions that assume a certain urban density will become efficient in a new spatial equilibrium,

105
but more immediate improvements in the quality and efficiency of urban transport may come
through collaborative solutions with the minibus network. The Department of Public Works and
Infrastructure Africa has detailed a wide-ranging strategy to reform and restructure the nation's
public transport system in its National Infrastructure Plan 2050. The department plans to create
a more integrated transport system by 2050, focusing on new technologies such as electric
vehicles and green hydrogen. Major goals include linking transport and housing policies,
transforming and formalizing the minibus taxi industry, encouraging private-sector
involvement, accelerating dedicated road space for public transport, reviving rail networks,
ensuring daily frequency of bus or minibus taxi services in rural areas, and promoting green
hydrogen and other alternative energy sources. Among these priorities, actions to formalize
the minibus taxi industry and reviving existing passenger rail lines especially through
devolvement to metros are likely to have the highest potential for short-term improvements in
transport times and connectivity of cities.

Many work opportunities could be enabled by bringing down barriers to informality in

cities. Hostility against informal work poses significant barriers to informal activity. Across cities
in South Africa, there are still restrictions on informal activities such as street vending, even
within township areas. These regulations include zoning limitations and strict enforcement of
space usage. For instance, restrictive zoning in busy city areas, close to or intersecting with
townships, reserves them exclusively for residential purposes, preventing microenterprises
from operating in potentially more successful locations (Shah, 2022). In the context of the South
African labor market where formal jobs are limited, this has a direct result in increasing
unemployment. After the problem of spatial exclusion in urban structures, direct restrictions
on informal work are likely the second biggest cause of low employment in South African cities.
Ongoing research is exploring priority policy responses to address this problem in ways that
would be complementary to the actions discussed in this report.

Finally, it is important that urbanization, which allows for economic agglomeration in

cities, be treated as a national priority. Overall, we find that the binding issues to spatial
inclusion in South Africa’s urban labor market differ from what is commonly assumed in many
ways. Figure 3.10 summarizes some common beliefs and compares these with findings from
this research.

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 FIGURE 3.10: BINDING ISSUES IN SOUTH AFRICA
Common Understanding Issue Based on This Research

Source: Authors’ elaboration.

3.3 Bridging Knowhow: Bringing jobs to people.

Inclusive cities alone would not address South Africa’s most extreme form of spatial
exclusion — that of the rural former homelands. Inclusive cities would be able to absorb
more people into their labor markets. All things equal, this would be expected to reduce
unemployment in rural areas by some degree. However, the presence of more jobs in urban

107
areas would do little to nothing to improve employment outcomes among those who remain
in rural former homelands. There is already a strong pull for individuals from struggling areas
to migrate, at least temporarily, to cities and other places where work can be found, including
seasonal jobs in agriculture and work in mining. This results in flows of remittances back to
homeland areas. However, Lochmann (2022) and others find that these remittances do not
alter the productive opportunities of the areas that workers left. Rather, money tends to be
invested in rural houses and used to increase living standards. As cities hopefully absorb more
people in the future and offer more permanent employment opportunities and housing
options, pressure on rural areas will decrease, which could free up more areas of land
productive uses. This makes it more important to strengthen place-based pathways to growth
that would provide more residents of rural former homelands the opportunity to stay and
participate in productive work.

Employment patterns underscore that it is possible to generate economic opportunity in

rural South Africa. South Africa’s rural areas offer a dual picture of employment outcomes
(Figure 3.11). Among municipalities that are classified as “rural,” there is a dramatic divergence
of employment rates — calculated here as the share of the active labor force that is employed
(i.e., 1 minus the unemployment rate). One group of rural municipalities achieves employment
rates that tend to exceed most urban areas. While employment rates in this group are still low
by international standards (note that the group centers on an unemployment rate of close to
15%), employment is several times higher than the other group of rural municipalities, which
tend to have employment rates that tend to be lower than most urban areas. Figure 3.12 shows
this same duality but with more information. In this case, the colors represent municipalities
that are within the borders of former homeland areas and those that are not. The horizontal
axis is the same as the previous figure, but the vertical axis captures the share of the population
in the municipality that is classified as rural, as opposed to the municipality overall. This shows
that nearly all the rural municipalities in the lower employment group are within former
homelands and almost all the rural municipalities that have higher employment are not within
the former homelands.

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 FIGURE 3.11: EMPLOYMENT RATES ACROSS SOUTH AFRICAN MUNICIPALITIES, URBAN & RURAL

Source: Own elaboration based on the South African National Census of 2011.

FIGURE 3.12: EMPLOYMENT RATES & RURAL POPULATION BY MUNICIPALITY

Source: Own elaboration based on the South African National Census of 2011.

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South Africa’s rural employment challenge is distinctly faced by former homeland areas,
which have effectively been left excluded from the modern economy. This glaring divide
between economic outcomes in former homelands and the world outside is well known and
has been studied Lochmann, 2022; Mudiriza & Edwards, 2021), but the particular divide
between rural former homelands and rural areas beyond is especially important. There are
growing divides globally between urban agglomerations and rural areas, but this type of rural-
urban divide does not explain South Africa’s particular problem. The employment rate in rural
former homelands is, on average, half of the employment rate of rural areas outside. South
Africa faces a rural-rural divide, where the rural areas that are excluded from job opportunities
share a common history as former homelands that were set apart from the functioning of the
rest of the South African economy for many decades prior to the end of apartheid. However,
this does not explain why three decades after the end of apartheid this large difference
continues to persist. A relevant policy framing is asking what it would take communities in the
top-left of Figure 3.12 to move to employment levels more like communities on the right side
of the graph.

There are clear differences between the two extremes of rural employment, which begin
to explain the mechanisms behind exclusion. First, there is a clear pattern in Figure 3.12 that
the excluded areas tend to be significantly more rural (i.e., a higher share of the population in
the municipality that is rural) than rural, non-homeland areas with the highest employment
rates in the country. The rural areas of former homelands can be understood to be more
remote and less likely to have population agglomerations within rural municipalities.
Interestingly, this does not mean that the rural former homelands are more concentrated in
agriculture than rural areas elsewhere in South Africa. Figure 3.13 shows the share of
employment based on South Africa’s latest population census. In rural areas outside of the
former homelands, upwards of 1 in 5 jobs is in agriculture, forestry, and fishing, roughly double
that of rural areas within former homeland areas. Rural areas outside homelands are also
slightly more concentrated in both manufacturing and financial intermediation but these
differences may be statistical noise. Rural former homelands, meanwhile, have a higher
concentration of jobs in community, social, and personal services (1 in 4 jobs), as well as in
mining, though this is a smaller source of jobs (1 in 20 jobs), and a slightly higher concentration
of jobs in construction, which may again be statistical noise. Rural areas do not look different

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in other large sectors of employment including wholesale and retail trade and household-
based work.

FIGURE 3.13: SHARE OF EMPLOYMENT BY INDUSTRY IN RURAL AREAS

30
Rural areas inside former homelands
Rural areas outside former homelands
25

20

15
%

10

0
Agriculture, Mining and Manufacturing Electricity, gas Construction Wholesale and Transport, Financial Community, Private
hunting, quarrying and water retail trade storage and intermediation, social and households
forestry and fish supply communication insurance, re personal
services

Source: Own calculation based on the South African National Census of 2011.

The difference in agriculture does not come from differences in the natural endowment
of land for crop production. Given the stark differences in agriculture employment and even
starker differences in commercial agriculture output, Klinger et al. (2023) use satellite imagery
together with estimates of potential yields by the Food and Agriculture Organization (FAO) of
the United Nations to better understand the potential for crop production across the country.
They confirm a well-known issue that actual crop production is underestimated by South
Africa’s Census of Commercial Agriculture, which captures only commercial agriculture (Figure
3.14, Left Panel). But they also find that some areas — particularly across former homeland areas
in the Eastern Cape and KwaZulu-Natal, as well as Free State Province — have crop production
potential well above their best estimates of current production (Figure 3.14, Right Panel).
Explaining this pattern, therefore, can help to explain why employment opportunities are low
for some areas within the former homelands, but not others.

Yet, the employment gap in former homelands cannot be explained by gaps in

agriculture alone. Figure 3.15 maps the overall employment rate (i.e., the number of
individuals employed over the working age population) by municipality. The problem is more

111
widely faced than gaps in agricultural production and employment can explain. Approximately
30% of South Africa’s population — upwards of 20 million people — live in rural former
homelands. Thus, it is essential to better understand the drivers of this type of spatial exclusion
and what policymakers can do to better include people and latent capabilities of these places
in the productive economy.

FIGURE 3.14: GEOGRAPHIC PATTERNS IN UNDERREPORTED CROP PRODUCTION AND POTENTIAL

Note: Former homeland areas are outlined in black.

Source: Sturzenegger et al. (2023).

FIGURE 3.15: EMPLOYMENT RATE (# EMPLOYED/WORKING AGE POP.) BY MUNICIPALITY

Note: Former homeland areas are outlined in blue.

Source: Own elaboration based on the South African National Census of 2011.

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3.3.1 Understanding the Drivers of Exclusion

The exclusion of former homelands has obvious roots in apartheid and before, but
history cannot explain the post-apartheid failure to include these places. A long legacy of
spatial exclusion, from the early colonizers through the institutionalization of spatial exclusion
in the form of the Bantuastans (“homelands”), has distorted the spatial equilibrium of South
Africa. The total effect was to keep these areas separated from the emerging modern economy
of South Africa for decades18. This history is foundational, but the current degree of exclusion
is surprising three decades after the end of apartheid. Moreover, there are no indications that
opportunity gaps are on pace to close within the foreseeable future. There is no reason why
South Africa cannot overcome its past, yet it is clear that the current approach is not working
to include these historically excluded places.

The problem is much more driven by the productivity and opportunity of places than by
the characteristics of people. Lochmann (2022) investigates what drives the differences in
employment outcomes and finds that various policies that have worked on the individual level
— for example, improvements in education and health — have not counteracted what is a place-
based problem. One strong indication of this is captured by Figure 3.16, which shows what
happens if you take an unemployed individual from within the former homelands and move
them to another place in the country. The employment probability of those that move
immediately doubles and grows over time to reach an employment probability three times
higher than those who remain. The fact that these individuals were unemployed at the start of
the period accounts for some of the “selection effect” of those who choose to leave former
homeland areas in search of work. Not shown here but important for reference is that the
overall employment probability of working-age people in areas outside the former homelands
is only 30-35% over this period (Lochmann, 2022). In other words, individuals from former
homelands who leave for opportunity tend to have more success than the rest of the
population.

Equalization grants and other monetary transfers have been unable to include rural
former homeland areas and overcome the place-based challenge. The former homeland
areas are today characterized by small local economies that are largely consumption-based

18
See, among others, Butler et al. (1977), Christopher (1994), and Beinart (2001).

113
and lacking business investment and production. And yet, these places are not lacking in terms
of several important production factors: there is underutilized arable land, unused labor force,
and there are significant monetary inflows to these areas in the form of government grants and
transfers as well as in the form of remittances from internal migrants who leave these areas to
work in more productive places in the country (in agriculture, mining, and urban labor markets).
Figure 3.17 captures how grants and remittances make up a large share of household income,
while Figure 3.18 shows the share of municipality revenues that come from equalization grants.

FIGURE 3.16: EMPLOYMENT PROBABILITY AMONG INDIVIDUALS WHO WERE UNEMPLOYED AND
LIVING IN FORMER HOMELANDS IN 2008

Source: Lochmann (2022) using the National Income Dynamics Study (NIDS) panel.

FIGURE 3.17: HOUSEHOLD INCOME COMPOSITION BY AREA, 2014

Grants
Tribal areas (former homelands) Salaries/wages/commission

Remittances

Income from a business

Other / unspecified
Other areas
No income

Pensions

0% 20% 40% 60% 80% 100%

Source: Lochmann (2022) using the General Household Survey, 2014.

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 FIGURE 3.18: SHARE OF MUNICIPAL REVENUES FROM EQUALIZATION GRANTS, 2014

Note: Former homeland areas are outlined in blue.

Source: Lochmann (2022) using the South African National Census, 2011.

Physical Connectivity

One critical input that remains missing is connecting infrastructure — many rural former
homelands remain surprisingly disconnected from markets and surrounding economies.
Over the last few decades, access to many types of infrastructure and services has increased
for former homeland areas. According to General Household Surveys, electricity access
increased from 60% to nearly 100% in former homeland areas over the years 2002 to 2014,
though some of the most rural areas of the country are continuing to be connected to the
electricity grid. As of 2014, there was almost no gap in electricity or cell phone access within
and outside former homelands, and access to nearby health facilities and secondary schools
and above had likewise expanded, though smaller gaps with the rest of the country remained.
However, former homelands remained much more disconnected than the rest of the country
in road connectivity as well as access to piped water. Road connectivity is especially important
for connectivity to markets, inputs, and the mobility of people. Figure 3.19 shows how stark the
gap in the national road remained for former homeland areas in 2016. Large gaps in the
network exist across several areas, despite these regions supporting larger populations than
large parts of the country with better road connectivity.

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 FIGURE 3.19: INFRASTRUCTURE GAPS IN ROAD CONNECTIVITY AND PIPED WATER ACCESS

Source: International Steering Committee for Global Mapping and own elaboration based on South African National Census, 2011.

This lack of connectivity reduces the comparative advantages of rural former homelands.
Anyone who has traveled for multiple hours on unpaved roads, especially after heavy rain,
knows how this impacts a place’s competitiveness. The absence of paved roads not only adds
hours to travel times to get inputs in and products out but also dramatically increases damage
to sensitive products and the potential for disruptions in supply chains. In the context of South
Africa’s competitive commercial agriculture, the disadvantage of road connectivity has large
implications. For regions with underexploited crop potential, for example in the Eastern Cape
(Figure 3.14), any potential to produce high-value fruits and vegetables that match the demand
for quality of domestic supermarkets and international markets is constrained. Time, damage,
and uncertainty all act as a form of tax on potential production. Outside of agriculture, these
costs also help to explain the lower prevalence of manufacturing in rural former homelands
versus other rural areas of South Africa. As captured by Figure 3.19, infrastructure shortfalls
appear most prevalent in the former Transkei region of the Eastern Cape, parts of the former
Bophuthatswana region of the North West Province, and regions of KwaZulu-Natal. The
infrastructure gaps for these areas are compounded by their large size and disconnected
geography. Although road connectivity is poor within former homeland areas within Limpopo,
these areas are less disconnected from surrounding areas with denser infrastructure networks
and are located on high-traffic international corridors.

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The underlying reasons for these infrastructure shortfalls and the resulting lack of
connectivity to the rest of the South African economy were discussed in the previous
chapter. Premature load bearing within the country’s decentralization framework together
with collapsing state capacity can help to explain why these types of infrastructure shortfalls
persist. In the case of former homelands and the presence of communal land ownership and
traditional governance, there is an additional layer of challenge in land use and permitting.
This adds some complexity to the situation, but it is municipality governments that have had
authority and responsibility for local roads and water planning. As discussed in Chapter 2,
preferential procurement frameworks can create intensive challenges in areas such as the rural
former homelands because a limited pool of building contractors leads to poor quality
construction and state resources channeled to “tenderpreneurs” at the expense of effective
infrastructure development.

Knowhow Connectivity

Beyond physical infrastructure connectivity, bridging knowhow between rural former

homelands and the rest of the South African economy is critical. Even for areas of rural
former homelands that are relatively more connected, employment rates remain extremely
low. This indicates that physical connection is not enough; what is missing from the system is
the knowhow to employ factors of production in the rural former homelands. Knowhow – or
tacit knowledge — reflects the aspect of technology use that cannot be transferred simply
access to the tools themselves (i.e., machines or software) or the written knowledge of how to
use them (i.e., owner’s manuals). Putting technology to use requires expertise that is gained
through experience. This is true for any technology, and it is also true for the production of
goods and services. Competitive production of goods and services requires not only the use
of a range of technologies but also knowledge of markets, suppliers, and a large range of built-
up expertise. Given the sophistication of the South African economy — including its commercial
agriculture sector — it makes sense that knowhow would be the limiting factor that prevents
former homeland areas from integrating with the rest of the economy even after infrastructure
connectivity improves. Physical connectivity makes bridging knowhow easier, but this process
is not automatic.

When areas of former homelands do gain the ability to participate in the same industries
as surrounding areas, they begin to catch up, and this seems to require the mixing of

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companies and people. A strong indication of this reality comes again from Lochmann (2022),
which shows that when municipalities converge in either their economic complexity, which is a
measure of economic diversity based on their industry composition, or in linguistic diversity,
employment outcomes tend to converge with the rest of the country (Figure 3.20). Thus, in
addition to improving physical connectivity of rural former homelands, strategies that actively
work to bridge productive knowhow between places are essential. We find that the most direct
mechanism of knowhow transfer — investment by companies outside of rural former
homelands in expansions within former homelands — is limited. Direct investment is rife with
risks and uncertainties, including due to systems of communal land ownership. However, we
do find that there are other mechanisms for bridging knowhow that are occurring at a limited
scale and in limited cases. These operate through business partnerships between competitive
companies outside former homelands and firms, entrepreneurs, and communities within the
rural former homelands. Klinger et al. (2023) explore how partnerships have emerged in select
cases in the space of commercial agriculture in South Africa using a range of organizational
designs and how these overcome prevailing constraints. We also find signals that these models
could scale significantly and pave a path to fully overcoming constraints to direct business
investment with time.

FIGURE 3.20: EMPLOYMENT PROBABILITY BASED ON ECONOMIC AND LINGUISTIC DIVERSITY

Source: Lochmann (2022) using the National Income Dynamics Study (NIDS) panel.

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3.3.2 Partnerships as an Opportunity for Bridging Knowhow

Partnership models have emerged to overcome the challenges of investing in the

context of communal land. Communal land in South Africa is typically governed by traditional
authorities. This does not mean that there is not a land market, but it does mean that land
markets operate differently and are disconnected from national systems, including the legal
system and the financial system. Properties have locally provided “permission to occupy” (PTO)
rights but do not have legally binding land titles and are thus not recognized by the formal
banking system. This can be problematic for local startups that may struggle to access capital,
which is an important problem, but it is not necessarily a constraint when local entities partner
with outside commercial entities. In the long-term, increasing land titling and more effective
interaction between communal land governance and national systems should be a strategic
priority, but in the shorter-term partnerships have shown an ability to bridge knowhow despite
this constraint. Such partnerships could even pave the way for innovations that bridge formal
and traditional systems.

Partnerships between commercial agriculture companies and communities in rural

former homelands provide examples of what is possible and reveal constraints that must
be overcome for models to scale and duplicate. Klinger et al. (2023) explore three distinct
cases of organizational models where commercial agriculture businesses (Wiphold, Amadlelo,
and Zamkulele) have partnered with communities to the sustained benefit of both parties. The
commercial entities expand their operations by utilizing the land and latent comparative
advantages of the communities, while the community members benefit through income
streams, jobs, and the learning-by-doing that occurs as knowhow is transferred. However,
these partnerships face numerous challenges, many of which they are still actively working to
overcome. Each of these three partnerships has developed iteratively as both parties
contributed to developing organizational structures and tools that met their context. This
resulted in different approaches to property frameworks, governance structures, risk-sharing
approaches, and a range of other dimensions summarized in Figure 3.21. These partnerships
are nascent and scattered, but they could become a larger tool for bridging knowhow across
space, both within the agriculture sector and in other areas. Scaling successes, however,
requires wrestling with the constraints faced by these and other initial examples.

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 FIGURE 3.21: DIFFERING ORGANIZATIONAL MODELS OF AGRICULTURE PARTNERSHIPS

Source: Klinger et al. (2023).

Klinger et al. (2023) identify four key challenges faced by these partnerships. First,
building trust is critical yet difficult. Second, there are massive information asymmetries that
companies and communities face in finding one another and establishing organizational
structures that work. Third, technology transfer is difficult. Fourth, partnerships must manage
many risks, and climate risk is a particular challenge for agriculture partnerships. The ways in
which the partnerships are tackling these challenges provide important lessons.

• Mechanisms to build trust at scale: Trust building at scale is pivotal in the execution of
such large-scale initiatives. In the beginning, there is natural mistrust, and it tends to take
a lot of time and money to build trust naturally. Trust emerges from familiarity and
repeated interactions, and can be facilitated by mutually trusted third parties, so
mechanisms to build trust at scale focus on reliable intermediaries sharing past
experiences (both successes and failures). This could take the form of universities and
NGOs studying partnership experiences and sharing them with communities and
corporates in conferences and publications, or by the public sector sponsoring study
tours for both community leaders and potential corporate partners. Generating trust
takes much more than an attractive sales pitch, but rather a credible track record.

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• Creating a market between communities and farms: The concept of creating a market
for partnerships between communities and commercial agriculture provides a promising
avenue for bridging knowhow at a greater scale, as today these partnerships are few and
far between. The marketplace is an important part of what allows the franchising sector
to work, as companies and franchisees can find one another and follow an established
roadmap for operations. In a marketplace for partnerships, communities with idle or
underutilized land would be presented with a variety of proposals and potential partners,
such that they can match their community’s goals and constraints with the right partner.
Likewise, corporate agriculture seeking to partner with communities would have
mechanisms to express this interest to a wide set of potential partners and connect with
those that are most interested in their proposition. Both sides of the market would have
access to information on the track record of the other party. Without such a market,
matching between communities and commercial agriculture is very time-consuming and
will fail to reach a relevant scale.

• Transferring technology to smaller farms: Transferring technology to smaller farms is

an essential part of establishing competitive operations, but it is infamously difficult.
Government-led extension has limited scope and impact in helping farmers to compete
in a highly competitive landscape. Public extension is likely better suited to improving the
productivity and resilience of the smallest farmers and in a narrow range of products. The
corporate sector, on the other hand, can enable technology transfer in a broad range of
areas through the operations of joint companies. In the partnerships studied, this
technology transfer is an integral part of the partnership, as the closer partnership ties
allow more focus on transfer than is possible in traditional out-grower models. There is a
degree of trial and error in technology transfer in these partnerships, which requires that
companies take a long view of the partnership as an investment, which will take years to
generate returns.

• Reducing the risk through parametric climate insurance: Partnerships are full of risks.
As Figure 3.21 shows, the cases studied have developed approaches not only to share
risks between communities and outside companies but also to share and manage risks
between communities. In agriculture, climate risk is a growing problem. Each of the
partnerships studied is facing climate risk but without an adequate response. On this

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 challenge, there is a tool that has been developed and utilized in other countries in
parametric climate insurance. This type of insurance uses predefined weather events to
trigger payouts, rather than assessing actual damage. This has benefits for hard-to-reach
insurance markets. Given South Africa’s highly developed financial sector, this is a tool
that could be applied in South Africa.

There are pathways for these types of partnerships to expand in scale by leveraging
agents of change. Following the study of these agriculture partnerships, the Growth Lab
conducted an exploration to see if similar partnerships could be found in other sectors and
what local conditions could explain where partnerships are found. Despite their limited scale
and impact today, the partnership approach could significantly impact the economic trajectory
of rural former homeland areas where they operate and pave the way for more complete
integration into the national economy. Key to the expansion is leveraging “agents of change”
— organizations that have already emerged to spur partnerships or that could be leveraged to
do so in the future. Several types of agents of change are discussed below.

• Traditional Authorities and Local Governments: Both formal and traditional local
authorities can play crucial roles in spearheading these changes. By leveraging their
influence, resources, and relationships, these authorities can serve as agents of change
within their communities, catalyzing efforts toward economic development. Enabling
productive access to land and promoting infrastructure development are both essential
elements in this approach. Access to land allows for a variety of productive activities, while
infrastructure is crucial for supporting these activities and ensuring their sustainability.
Traditional governments tend to have more authority over land whereas local
governments (municipalities) tend to have control over infrastructure. Traditional
governments can be the most effective agents of change when local leadership and
governance are aligned toward the goal. An example of a community that develops
partnerships is the community of Matsila in Makhado Municipality in Limpopo. Through
its Matsila Community Development Trust, the community owns enterprises in
agriculture, meat processing, tourism, and energy generation, among others. In the
formation of these enterprises, the community partners with outside entities, including
commercial agriculture entities located nearby to utilize their supply chain infrastructure
and gain expertise. The Trust has proven able to drive change and seek out partners that

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 are consistent with its vision and business opportunities that it identifies. As it has gained
experience, it is considering new ventures ranging from banking to supermarkets.

• Facilitators: Given the challenges in communities and companies in finding one another,
developing organizational models that work in their context, and building trust,
facilitating entities have emerged as important agents of change. Such entities can help
with matching, share models and lessons across partnerships, and can serve a role in trust
building if they are viewed as trusted and impartial third parties. Two distinct types of
facilitators are worth noting based on current practice in South Africa. The first type of
facilitator serves the role of partnership advisor. By working across geographies on many
partnerships, such entities develop expertise and a proven track record. An example is
the Vumelana Advisory Fund,19 which is a non-profit organization that assists communities
in the structuring of commercial partnerships between investors and local community
groups. Vumelana reports have concluded 23 projects in 18 communities. Many of these
projects are in high-value agriculture products, but partnerships also include tourism
enterprises, other natural resources, and local energy generation. Another type of
facilitation occurs through locally based NGOs. These entities are not positioned to serve
the same matching and knowledge-sharing roles as partnership advisors, but they can be
powerful in establishing trust and helping partnerships solve problems in the places
where they are located. One example of this is the Bulungula Incubator, a non-profit
located in a remote area of the Eastern Cape. Enabling partnerships is not the central
focus of the Bulungula Incubator, but the non-profit itself runs a lodge and has been
approached to serve as a trusted third-party intermediary in opportunities ranging from
lemongrass production to exploring renewable energy generation opportunities given
the wind resources of the area. However, aside from building trust, such entities are not
able to provide the full range of support as facilitators that partnership advisors are.

• Universities: Universities, especially public universities in former homeland areas, are

well positioned to play a larger role in supporting partnerships. As centers of knowledge
and research with access to resources and deep local connections, existing programs
and new university-based initiatives could play a similar role to partnership advisors.
Additionally, universities can leverage their physical space and networks to help create

19
See https://www.vumelana.org.za/

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 markets for partnerships. Universities commonly play such a role in supporting
entrepreneurship, business incubation, and industry-related research. South African
universities could also play a pivotal role in jumpstarting partnerships and serving as a
public source of knowledge about what works. Moreover, an impartial analysis of
corporate and community track records would go a long way to building trust between
the two. Finally, universities could play important roles in enabling technology transfer.

• National and Provincial Governments: Higher levels of government can facilitate these
partnerships, and possibly play a more active role in creating or partnering with already
existing agencies and facilitators. Governments could develop their own partnership
advisory services, building on the innovations of the non-profit entities that have
emerged. They could also serve the goal indirectly by providing resources to the agents
of change listed above. Government resources may be especially useful in helping to
establish markets for partnerships, through such approaches as national exchanges and
conferences, study tours, and online resources to help communities and companies find
one another.

Efforts to expand partnerships would be complementary to improvements in connecting

infrastructure. When communities are better connected to surrounding economies and
productive ecosystems, their potential opportunities can increase exponentially. In the
example of the Matsila Community Development Trust provided above, foundational
businesses in fruit and vegetable production and high-end tourism would not be viable in
communities much more disconnected from surrounding economies and transportation
corridors. By contrast, the community of Bulungula, where the Bulungula Incubator operates
has ventured into lemongrass production, a product that can more easily withstand long travel
distances without refrigeration and benefits from backpacker tourism as opposed to high-
value tourism. But increasing physical connectivity merely increases the opportunity set for
partnerships. Most reasonably well-connected former homeland areas have not capitalized on
partnerships and continue to have very limited economic opportunities. Thus, there is
considerable potential to scale the success of partnerships with very little need for national
budgetary resources.

Connecting infrastructure requires not only strengthening state capacity but also
sufficient fiscal resources and focus on connecting rural former homelands. Chapter 2

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summarizes the path to strengthening state capacity as needing to leverage, unburden, re-
centralize and distribute, and protect capacity. In terms of road connectivity, unburdening
procurement is especially important as the focus should be on building quality roads with
efficient use of fiscal resources. Within a process of re-centralizing responsibilities, where more
of the buildout and maintenance of roads may be moved to SANRAL (reflected in South Africa’s
National Infrastructure Plan 2050), deficiencies in paved road connectivity of rural homelands
could be prioritized in how resources are allocated. This would provide a chance for South
Africa to reverse a pattern of worsening road quality under the current institutional
arrangement that currently depends on national, provincial, and municipal road authorities. By
centralizing responsibilities such that technically capable teams can be structured and then
allocating spending on high-need areas, South Africa has the potential to better connect and
include rural former homelands.

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4 South Africa’s Green Growth Potential

4.1 Executive Summary

The South African economy is hampered by supply-side constraints that limit its
economic growth. Chapter 2 of this report showed how a collapse in state capacity to supply
and maintain key infrastructure and services have slowed growth. Chapter 3 discussed longer-
term causes of spatial exclusion and how these have limited South Africa’s growth potential by
preventing individual capabilities from interacting. These two issues constrain the ability of the
South African economy to create and maintain jobs. At the time of writing, the ongoing
electricity crisis hinders business productivity, while freight and port operations disruptions
limit the productivity of mining and other regional value chains. Problems in network industries
also obstruct businesses' capabilities to fulfill demand due to widespread delays stemming
from port conditions, electricity shortages, and freight disruptions. Addressing these supply-
side constraints is crucial to enhancing the competitiveness of the economy.

The electricity crisis is especially critical because South Africa had previously developed
a comparative advantage in electricity- and electricity-intensive industries. Figure 4.1
shows the electricity intensity of South Africa’s exports in comparison to other nations.20 South
Africa’s electricity intensity of exports has remained consistently high - at around the 90th
percentile - relative to the rest of the world from 1995 to 2016. Figure 4.2 shows that the energy
consumption by the country's industrial sector (manufacturing, construction, and mining) as a
share of GDP is also high compared to the rest of the world. Both South Africa’s exports and its
domestically oriented industrial sector are highly intensive in electricity and energy use. In
other words, South Africa has developed a comparative advantage in industries that demand
high levels of energy and electricity. The most prominent example of this can be seen within
the mining sector and its downstream activities (products that use mined resources as inputs)
and upstream activities (mining services, mining machinery, etc.). However, this also applies to
the manufacturing sector more broadly, where the metal and chemical industries consume
significantly more electricity per unit of value than mining (Fortunato, 2022). South Africa has

20
The coefficients were calculated using the same model Rajan and Zingales (1998) used to analyze financial
dependence’s role on economic growth.

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also developed multiple downstream industries with solid linkages with energy- and mineral-
intensive activities, like fabricated metals, structural metals, and alloys.

FIGURE 4.1: GLOBAL DEPENDENCE OF EXPORTS ON ELECTRICITY (1995-2016)

South Africa

Sources: Own elaboration based on International Trade Data from Atlas of Economic Complexity and US BEA Input-Output
Tables.

FIGURE 4.2: ENERGY CONSUMPTION OF INDUSTRY (TOE) / GDP (2015 USD PPP) IN 2018

0.09
0.08
0.07
0.06
0.05
0.04
ZAF
0.03
0.02
0.01
0
Source: Own elaboration based on International Energy Authority (IEA) World Energy Indicators.

South Africa developed this comparative advantage many decades ago thanks to the
availability of cheap energy from coal. Since the 1920s, Eskom has been using abundant
deposits of cheap coal. By 1930, Eskom's electricity was one of the cheapest in the world
(Eberhard, 2007). Until around 2007, Eskom was able to supply the economy fully with cheap
electricity. By that time, energy-intensive customers in the mining, metals, and manufacturing
industries represented a large fraction of the electricity demand. Eskom’s sales to direct large-
scale customers represented 60% of total sales (Eberhard, 2007). Historically, this ability to

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provide ample amounts of cheap energy was predicated on the country's capacity to exploit
coal. As a result, South Africa has consistently been one of the ten countries that consume the
most coal per capita in the world (BP, 2021).

Modern South Africa has lost the ability to transform coal into cheap energy, and coal is
not as competitive as an energy source as it used to be. Several factors have changed. First,
Eskom lost its capacity to produce energy cheaply. Between 2007 and 2022, electricity prices
increased by a factor of 6.5 while the overall price index increased by only a factor of 1.3 (based
on data from Eskom and StatsSA), meaning that the real price of energy (i.e., the price after
controlling for inflation) increased by more than 200%. This implies a major deterioration in the
country’s comparative advantage in electricity-intensive production. Part of the initial increase
in tariffs was the result of a recognition that tariffs were set below long-run marginal costs and
implied not just a comparative advantage but a distortive subsidy. However, the problem is not
only with price. At the same time, load-shedding means that actual tariffs do not fully measure
the loss of competitiveness of the industry: unreliable supply has become a major source of
disadvantage. Moreover, coal has become relatively less competitive as a cheap fuel source
for electricity generation, given changes in energy-producing technologies. For example, the
relative price of solar and wind energy has declined exponentially over the past decade,
eroding the competitive advantage of coal in electricity generation. According to IRENA (2022)
estimates, newly installed solar-powered energy plants in 2021 had lower costs than the
cheapest coal-fired option in the G20. This implies that relative to the rest of the world and
other energy sources, even if Eskom's problems are overcome, South Africa's comparative
advantage in coal-fired energy will not be as important as it used to be.

For these reasons, it is vital for South Africa to focus on creating new sources of
comparative advantage by leveraging the global changes that the energy transition is
creating. As is well known, global emissions of Greenhouse Gases (GHGs), particularly carbon
dioxide, are causing climate change. Reductions in GHG emissions will require an energy
transition that can only work at a global scale. This represents a fundamental change to the
structure of the global economy and the determinants of comparative advantage. Beyond
electricity generation, economic shifts are beginning to take shape across transportation,
industrial and agricultural sectors, which also produce GHG emissions. While the transition
represents a challenge for the countries and industries that rely heavily on fossil fuel energy

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today or export fossil fuels, it will create ample economic opportunities. This chapter will
characterize what these changes might entail and explore ways to exploit them to create new
sources of comparative advantage and growth in South Africa.

4.2 “Green Growth” in a Decarbonizing World

Though not yet at the pace needed to meet international climate change goals, the world
is making substantial strides toward decarbonization. Regardless of whether the Net Zero
Emissions (NZE) goals are met sooner or later, there is no doubt that global demand for clean
energy and technology will continue to increase. The International Energy Agency (IEA)
estimates that to achieve the NZE goals by 2050, solar-powered energy generation needs to
grow at an average annual rate of 25% in 2022-2030 (IEA, 2022b). This rate is not impossible,
considering that solar PV manufacturing increased at a compound annual growth rate of 25%
between 2015 and 2021 and by 35% in 2022 (IEA, 2023b). In addition, electric vehicle (EV)
sales have been exploding since 2022. The EV share of the overall car market went from 4% in
2020 to 14% in 2022, and it is expected to reach 18% in 2023, according to IEA’s projections
(IEA, 2023a). Battery manufacturing capacity increased by 85% in 2021-2022 (IEA, 2023b). In
short, the attempt by many countries to decarbonize their economies is leading to very rapid
growth in certain enablers of that decarbonization. These enablers have emerged - after years
of research and development - as economically viable technologies. Averting increasingly
disastrous global impacts of climate change will require innovation and scaling of technologies
that reduce GHG emissions across the economy through a process that is sometimes referred
to as “deep decarbonization”.

The international framework that has taken hold through landmark accords such as the
Paris Agreement of 2015 is focused on achieving global decarbonization by having each
country focus on targets for their own decarbonization. Countries identify and announce
their "nationally determined contributions" and international systems attempt to monitor
progress toward achieving them. To reach international goals, these commitments must
become increasingly ambitious over time. Countries are asked what they can do to reduce
their own emissions. Yet, CO2 emissions are concentrated in a handful of countries (Figure 4.3).
China (30%), the United States (15%), India (7%), and Russia (5%) represented 57% of global
emissions in 2015-2021. South Africa represented only 1.3% of emissions during the same

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period. Therefore, drastically reducing South Africa's emissions will have very minor effects on
global emissions and climate change.

FIGURE 4.3: CO2 EMISSIONS BY COUNTRY (% OF TOTAL), 2015-2021

Source: Global Carbon Atlas, 2023.

However, there is much more that South Africa can do to contribute to global
decarbonization under a different “green growth” paradigm. If one thinks beyond the
narrow and constraining notion of “what can you do to reduce your emissions” and instead ask
“what can you do to help the world reduce its emissions,” South Africa has much more to
contribute to the global effort. As the world strives to meet the Paris Agreement goals, demand
for a wide set of products will have to increase very significantly. South Africa could become a
major exporter of these products. In other words, beyond decarbonizing itself, the country can
strive to become a major supplier of the means of global decarbonization. These products
have the potential to propel the country by leveraging rapidly growing global markets. The
world is going to need a large increase in the products and services that will enable (or supply)
decarbonization. This makes the global fight against climate change perhaps the most exciting
driver of innovation and growth potential in this generation.

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The path toward global decarbonization is full of uncertainties, but there are some clear
directions of change based on fundamental economic realities and emerging shifts. First,
the world will need to electrify anything that can be electrified. Good examples are electric
vehicles for transportation and electric arc furnaces for producing and recycling steel and
making alloys. Second, electricity must be made in green ways, leveraging solar, wind,
hydropower, and nuclear technologies. Variable sources of energy will require balancing the
electric grid with storage, using either grid-scale batteries or pump storage. Transmission lines
will have to connect new sources of energy to the grid. All of this will require metals made by
refining minerals that must be dug out of the ground. There is no way to decarbonize the planet
without a mining boom. Third, manufacturing processes that emit CO2 for chemical reasons
will have to be abandoned in favor of alternative processes. For example, the reduction (i.e.,
de-oxidation) of minerals to make metals currently use coal and natural gas as reducing agents
and emit CO2 in the process. Technologies using hydrogen as the reducing agent or
electrolysis will compete to make green steel and other alloys. Fourth, things that cannot be
electrified, such as ships and airplanes, will need green ways of making fuels. Finally, the world
is going to need ways to capture carbon. These changes require a major transformation to the
global economy and a shift in the underlying determinants of comparative advantage.

We propose a framework to formulate strategies and policies that can explore and
exploit these emerging opportunities. We classify the opportunities into three main buckets
that are of the highest relevance to South Africa:21

1) Make the enablers of global decarbonization,

2) Make green versions of grey products for the global market,

3) Export green knowhow.

Strategy 1: Make the enablers of global decarbonization. To decarbonize, the world will
need a vast set of goods that will enable low or zero-carbon electricity systems. This will include
equipment for electricity production (e.g., solar panels, wind turbines), transmission (e.g.,
cables, converters, capacitors), and storage (e.g., batteries, pump storage) of clean energy.

21
One additional strategy would be to monetize carbon sinks and carbon storage. Stakeholders are already working
on identifying the feasibility of carbon capture and underground storage (CCUS) in South Africa. The national
government, in collaboration with partner institutions, has already started a Pilot CO2 Storage Project (PCSP) in a
preliminary analysis phase focusing on the onshore Zululand and Algoa Basins (Surridge et al., 2021).

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Electric vehicles (EVs), fuel cells, and other products and technologies are emerging that allow
for transportation and other human necessities to be done without the use of fossil fuels. Other
types of machinery, for example, electrolyzers as a key technology for green hydrogen
production, are poised for rapid growth. These goods are also heavy users of metals and rare
earth minerals. Strategy 1 involves a move to participate in the emerging supply chains that
enable the rest of the world to decarbonize.

Strategy 2: Make green versions of grey products for the global market. Oil and coal are
highly energy dense. This makes them cheap to transport. Consequently, the local availability
of energy has not constrained the location of production over the last several decades. For
example, energy-poor countries such as Japan, Korea, and Germany have been able to
specialize in energy-intensive products such as steel. Since the cost to transport energy has
been low, they just import energy. Green energy, by contrast, is much harder to transport. Solar
PV became the cheapest source of electricity in 2020, providing a levelized cost of electricity
of less than 34 dollars by barrel of oil equivalent (BOE) (IEA, 2020). Still, in 2019, storing that
energy in the form of green hydrogen increased the cost to over USD 476 per BOE on average
(BloombergNEF, 2020). When converting the green hydrogen to green ammonia for more
accessible transport, the costs increased to over USD 884 per BOE (Ibidem). Additionally, the
transport of green hydrogen requires significantly higher degrees of infrastructure. Hydrogen
would need 3-4 times more storage infrastructure to replace natural gas in today's global
economy. This is anticipated to come at an expense of USD 637 billion by 2050 if it were to
ensure a comparable degree of energy security (Ibidem). This implies that there will be a great
incentive to use energy close to where it can be produced efficiently. One implication is that
global decarbonization can be achieved more easily if energy-intensive activities such as steel,
aluminum, and ammonia production or data storage move to places that, because of their
endowments, can produce green energy cheaply. Strategy 2 is based on developing a local
capacity to produce cheap green energy to attract energy-intensive industries that must
relocate to reduce their carbon footprint.

Strategy 3: Export green knowhow. Much of the knowledge needed to decarbonize will not
be embodied in tools — such as solar panels or electrolyzers — or in easily replicable protocols
or other codified knowledge that can be easily moved between places. Knowledge will
intensively require the deployment of human capabilities in the form of services. For example,

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projects require engineering, procurement, and construction (EPC), often bundled with
finance. Complex manufacturing requires knowledge that may be licensed, such as the
Fischer-Tropsch process that SASOL has mastered. These knowledge-intensive services will be
in high demand in a decarbonizing world. The strategy aims to maximize the export of such
activities to grow by supplying the knowledge needs of a decarbonizing world.

South Africa’s green growth strategy should seize these opportunities to capitalize on
the changes brought about by global decarbonization. In the rest of this chapter, we
analyze a series of topics that are strategic for South Africa under each of the above
approaches. This is not a comprehensive list of issues and opportunities but instead a list of
opportunities that should be evaluated in the context of a national green growth strategy.

4.3 Strategy 1 – Make the enablers of global decarbonization.

South Africa is well-positioned to supply the world with critical minerals needed for the
energy transition and to enter strategic segments of clean energy value chains. Mineral
opportunities include those related to platinum group metals, chromium, vanadium, and
others. Opportunities of interest in supply chains for energy technologies include the
production of membranes, catalysts, and assembly of fuel cells and electrolyzers within the
hydrogen supply chain; research, demonstration, and production of flow batteries based on
vanadium and other chemistries; the electric vehicle supply chain; and the wind energy supply
chain. Policies to promote entry into each of these supply chains must be industry-specific, and
depend highly on industry characteristics, South Africa’s context, and the component parts of
supply chains that South Africa seeks to occupy. The following subsections expand on these
opportunities.

4.3.1 Critical Minerals

The world needs a mining boom to develop clean energy systems. Clean energy
technologies are significantly more mineral-intensive than technologies based on fossil fuels.
For example, an electric vehicle currently requires six times more minerals than an internal
combustion engine (ICE) vehicle, and a wind farm requires nine times more minerals than a
coal-fired power plant (IEA, 2021b). These technologies are driving huge increases in demand
for specific minerals. For example, according to IEA projections (IEA, 2021b), the demand for

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rare earth minerals could increase three to seven times between 2021 and 2040. The demand
for lithium, cobalt, and copper is currently high and projected to increase even further in the
upcoming decades.

South Africa is a leading producer of critical minerals. Figure 4.4 lists minerals that have
been classified as critical for the green energy transition and reports the share of South Africa
in their current global production. South Africa is, by a substantial margin, the world's largest
producer of platinum and platinum-group metals (PGMs). These are essential to produce and
use hydrogen because they are essential for the membranes that go into electrolyzers and fuel
cells. South Africa is also a major producer of chromium. This mineral is used as a catalyst in
these membranes, goes into lithium-ion batteries, in high-performance solar panels, and in
making stainless steel alloys used in solar, hydro, and geothermal plants. According to IEA, the
demand for chromium will double by 2040, in a scenario that only includes currently
announced nationally determined contributions (NDAs). It would quadruple in a scenario
consistent with achieving net zero by 2050 (IEA, 2021b).

This bodes well for the demand for South Africa's mining products, but these
opportunities are constrained by collapsing state capacity. As discussed in previous
chapters, the mining industry has been hampered by the electricity crisis, problems in rail and
port services, policy uncertainty, and cumbersome licensing and regulations specific to the
mining sector. For example, platinum production hit record under-production due to power
outages in 2023 (Dempsey, 2023). Since the electricity crisis started to intensify in recent years,
exports of platinum have decreased significantly. Even before load-shedding started in 2007,
regulations prevented the country from expanding its market share during the commodity
super-cycle that started in 2004. If the country is to maximize the benefits of the coming global
boom in mineral demand, it will need to address these issues.

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 FIGURE 4.4: SOUTH AFRICA’S CRITICAL MINERAL RESOURCES

South Africa’s
Mineral Global Market How many countries have the resource?
Share (2021)

Chromium 43.5% Seven countries produce Chromium.

14 countries produce Fluorspar. Most Fluorspar

Fluorspar 5%
mining is in China.

Manganese 38% 17 countries produce Manganese.

Palladium 40% Six countries produce Palladium.

Platinum 73% Six countries produce Platinum.

Tellurium < 1% Eight countries produce Tellurium.

Six countries produce Vanadium. Most Vanadium

Vanadium 8%
comes from China.

Zirconium <1% Eight countries produce Zirconium.

Source: Own elaboration based on U.S Geological Survey.

To take full advantage of the global mining boom, South Africa must improve its policy
framework specific to the expansion of critical minerals exploration, production,
processing, and innovation. South Africa has the knowhow needed to claim a place in these
markets, but it will need to address the state failures that have limited its potential to date.
Projects to supply critical minerals often require significant time to develop. IEA (2022c)
estimates that the major mines that began operations from 2010 to 2019 took, on average,
over 16 years to progress from the discovery to the initial production stage. However, the exact
time frame is context-specific: it can differ based not only on the physical characteristics of the
project (e.g., the mineral concentration, location, and type of mine) but also on licensing
bottlenecks, regulatory burdens, availability of infrastructure services, and policy uncertainty.
Countries like Australia, China, and the United States are pursuing aggressive policies. South
Africa would need to change its current practices to seize the opportunity.

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4.3.2 Green Supply Chains

Beyond mining, South Africa has the potential to participate in multiple value chains that
use minerals. Mineral processing is highly concentrated in China, which holds around 35% of
nickel refining, 50-70% of cobalt, and 90% of rare earth elements (IEA, 2021b). This shows that
the local availability of the mineral is not enough to translate into a comparative advantage of
downstream products in South Africa. Previous research (Hausmann et al., 2008) has shown
that countries that are rich in mineral resources do not necessarily acquire a comparative
advantage in downstream industries. Conversely, the industries with high potential in each
country are not necessarily those that are downstream from their own raw materials. After all,
most products do not rely on a single raw material, meaning that the others will have to be
imported anyway. If transportation costs are low enough, places can become globally
competitive in industries for which they do not have any relevant raw materials locally available.
China is a good example of this. In cases where transport costs are more significant, places
with locally available raw materials do have an advantage. Currently, geopolitical forces are
creating opportunities for countries like South Africa in mineral processing. Excessive
dependence on China is seen as a strategic risk both in the US and Europe, who want to
diversify their suppliers to "de-risk rather than decouple" from China, as Janet Yellen, the US
Treasury Secretary, has argued. South Africa could exploit this moment of opportunity to attract
investment in mineral processing, but to do so, it would need to credibly address its electricity,
rail, and port issues, among others.

South Africa may also be able to innovate much more around the development of clean
technologies. The world is focused on improving technologies that can balance the supply
and demand of electricity in grids that rely on variable sources of energy like sun and wind.
Two technologies — grid-scale batteries and pumped storage hydropower — are increasingly
used to balance electricity supply and demand. Between 2020 and 2021, the world increased
by 100% its installed capacity in grid-scale battery storage, and according to IEA’s Net Zero
Scenario, it is expected to expand 44-fold by 2030 (IEA, 2022a). South Africa has companies
like Bushveld Energy working on making vanadium redox flow batteries (VRFB) cost
competitive. It could be strategic for South Africa that this technology succeeds in carving a
role for vanadium in this market since South Africa has ample sources of vanadium and a
potential first-mover advantage in developing storage technology. To do so, it would need to

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invest in R&D and get on a more rapid learning curve. This can be enabled by developing a
strategic partnership between Eskom and Bushveld Energy to buy and test VRFB batteries. The
process could also be accelerated by acquiring foreign firms that have key capabilities in this
area. This is a somewhat unique opportunity for South Africa given its natural endowment. At
the same time, South Africa may have potential to incorporate more pumped storage
hydropower in its electricity system, but it does not have the same noteworthy advantages for
innovation and positive economic spillovers through research and development as with grid-
scale battery storage.

An area of opportunity for South Africa is to innovate around flow batteries for grid-scale
storage of electricity. Flow batteries are considered important for the energy transition but
are yet to be employed at scale in energy systems (IEA 2023c). The most mature flow battery
chemistry is the Vanadium Redox Flow Battery (VRFB), though many groups are trying to
innovate in flow battery chemistries to overcome cost and technological constraints in VRFBs.
South Africa is a leading supplier of Vanadium, has companies attempting to commercialize
VRFBs (such as Bushveld Energy), and could marshal expertise to innovate around flow battery
chemistries. Complexity analysis suggests that flow batteries are a high-potential opportunity
in South Africa (below). As an emerging technology, supporting flow batteries involves applied
research, piloting, and demonstration projects, attracting frontier knowhow from abroad, and
making limited investments to develop knowledge and test assumptions around whether
commercialization benchmarks are realistic and achievable (such as those related to learning
curves and potential cost reductions for VRFBs). To manage risk across different technologies,
South Africa should endeavor to explore multiple battery chemistries, before doubling down
on vanadium-based chemistries around which it has expertise.

If the hydrogen economy takes off globally, South Africa has the potential to participate
in several ways. Despite a rapid uptick in national strategies for hydrogen production, there
remain critical questions about the potential size and reach of the hydrogen economy given its
high current costs and challenges in transporting hydrogen. However, if these challenges are
overcome and hydrogen becomes a critical fuel vector globally, South Africa is well positioned
to play several roles in the supply chain. First, the hydrogen economy will need an ample
supply of electrolyzers to convert electricity into hydrogen and fuel cells to convert the energy
back into electricity. One of the technologies used in both processes is proton exchange

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membranes or PEMs. One of the dominant technologies today uses platinum as a catalyst in
fuel cell membranes and iridium and ruthenium — two platinum group metals or PGMs — for
the PEMs used by electrolyzers. Hydrogen South Africa (HySA) has been investing in these
technologies since its founding in 2008 and has established a fully owned subsidiary, Hyplat,
to commercialize catalysts for fuel cell PEMs. South Africa could also have strategic advantages
in other parts of the upstream supply chain as well as the downstream use of hydrogen in
production processes — especially in coordination with the wider region — which is an
opportunity discussed under the strategy of utilizing energy resources to “make green versions
of grey products,” which is discussed in the next subsection.

Fuel cell manufacturing represents an interesting potential entry point for South Africa
into the hydrogen value chain. South Africa hosts a nascent ecosystem around fuel cell use
and manufacturing, comprising homegrown component makers such as Hyplat, international
manufacturers such as Chem SA, and pioneers in frontier applications of fuel cells such as
Anglo American (which is developing a fuel cell mining truck). As a technology that is entering
commercial deployment at scale (IEA 2023c), policy to support this industry may involve
identifying niches in which South Africa is well-positioned, supporting the scaling of supply
chains and demand within these niches, and attracting foreign direct investment.

There is in fact a wide range of industries with the potential to take advantage of the
global energy transition. Clearly, a decarbonizing world will need massive amounts of more
mature products like solar panels, electric vehicles, lithium-ion batteries, transmission lines, as
well as emerging products, like electrolyzers and grid-scale batteries. Many more products will
likely emerge in the years to come. Each of these products are at the end of long value chains
that open many opportunities for participation. We use the product space methodology
(Hausmann et al., 2014), and add to it a database of industries and products from relevant
supply chain reports using natural language processing techniques.22 Products comprising this
database are not exclusively utilized in green supply chains, which means that they can also
cater to other markets. Figure 4.5 below shows each of the identified supply chains along with
a high-level disaggregation of stages for some of them. It also shows the total number of
internationally traded products involved in each of them, along with the share of those

22
Most supply chain reports are from the Department of Energy of the United States (DoE); also utilized IEA reports
on critical minerals and green hydrogen; excluded primary cells and primary batteries (HS code 8506), and
semiconductor devices (HS code 8541), which are challenging to manufacture.

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products present in South Africa with a revealed comparative advantage (RCA>=1). The fact
that South Africa produces 50% of the products that are involved in the storage and injection
stage of carbon capture does not imply that those products are being utilized for that specific
industry within the country. Rather, it indicates that South Africa possesses the capability to
diversify into that industry, considering its competitive edge in exporting half of these
products. The construction of this database can help identify what are South Africa’s areas of
opportunity when it comes to green growth drivers.

In the landscape of products involved in green supply chains, multiple opportunities can
help drive diversification moving forward. As we can see in Figure 4.6, South Africa’s green
exports are concentrated in platinum, although this mineral holds a relatively small share of
green exports globally. Electronics, machinery products, chemicals, and metals are prominent
in global green supply chains, and South Africa has clear capabilities in each of those sectors
as shown by its current exports. The rapidly growing demand for many of these products
presents a window of opportunity for South Africa to tap into the global just energy transition
by developing industries for which the country has productive capabilities. Some of the inputs
are utilized in highly concentrated stages of the supply chains, but others are part of stages
that are more ubiquitous. For example, some of the products on this list are required for
producing semiconductors or solar PVs, so entering their markets might be more challenging
because of their concentration levels. In turn, other products that are in the metals, electronics,
or machinery sections are used for the distribution, transportation, and operation of green
supply chains. For example, developing electric grids requires multiple types of electric
devices and metal goods, and green hydrogen distribution requires different measuring and
regulating apparatuses.

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 FIGURE 4.5: GREEN SUPPLY CHAIN PRODUCTS

Products that Products that

Number of
are present in are competitive
Green Supply Chain Stage Products
South Africa in South Africa
(4 digits)
(% of total) (% of total)

Carbon Capture Capture 22 73% 36%

Carbon Capture Drying and liquefaction 8 75% 25%
Carbon Capture Storage and injection 2 100% 50%
Carbon Capture Transportation 3 100% 0%
Electric Grids Production 37 68% 22%
Flow batteries Production 13 92% 15%
Green Hydrogen Distribution 22 82% 14%
Green Hydrogen Production 67 90% 24%
Green Hydrogen Transportation 13 85% 15%
Green Hydrogen Utilization 6 83% 33%
Hydropower Production 10 80% 0%
Lead-Acid Batteries Production 9 89% 56%
Lithium-Ion Batteries Production 15 73% 27%
Nuclear Production 45 82% 20%
PGM Catalysts Production 21 90% 48%
Rare Earth Magnets Production 19 74% 21%
Semiconductors Assembly, Testing, Packaging 3 67% 0%
Semiconductors Fabrication 8 50% 25%
Semiconductors Utilization 1 0% 0%
Solar PV Production 28 75% 14%
Wind Production 25 84% 12%

Source: Own elaboration based on multiple DoE and IEA reports.

Many products are involved in global green supply chains In which South Africa can
become competitive. These represent strong pathways to growth in a decarbonizing world.
Figure 4.7 shows the Product Space (Hausmann et al., 2014), which provides a comprehensive
perspective on how approximately 1,200 internationally traded products are related in terms
of the similarity in the capabilities required in their production. The links between the products
are based on a measure of how likely they are to be exported by the same country (proximity)
or, in other words, their co-location probability. The proximity of products reflects the overlap
in the productive capabilities that are required to be competitive in them. The products
highlighted in Figure 4.5 are those that belong to green supply chains. Outside of minerals
and primary commodities, these tend to be located at the center of the Product Space,
indicating that they share capabilities with many products. As a result, they represent powerful

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pathways to also develop wider productive capabilities that can strengthen South Africa’s
comparative advantages in exports over time.

FIGURE 4.6: EXPORTS OF GREEN SUPPLY CHAIN PRODUCTS (2015-2020)

South Africa World

Source: Own elaboration based on international trade data from Atlas of Economic Complexity and Growth Lab internal dataset
constructed using DoE and IEA green supply chain reports.

FIGURE 4.7: GREEN SUPPLY CHAIN PRODUCTS IN THE PRODUCT SPACE

Sources: Own elaboration based on international trade data from Atlas of Economic Complexity and Growth Lab internal dataset
constructed using DoE and IEA green supply chain reports.

South Africa has a presence in or is close to having a comparative advantage in several

products in green supply chains. It is possible to measure whether a country has a

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comparative advantage in an internationally traded product by utilizing the Balassa index to
express its revealed comparative advantage (RCA) in trade. The RCA is measured as the share
of that product’s exports within a country’s total exports over the share of that product’s exports
in global trade. In that sense, it measures whether a country exports more (RCA > 1) or less
(RCA < 1) than its “fair share” of that product. South Africa has RCA over 1 in many green supply
chain products within the metals sector (e.g., aluminum plates), electronics (e.g., electrical
insulators), or chemicals (e.g., lead oxides). However, the country is also close to having a
comparative advantage in several other products like primary cells, special-purpose motor
vehicles, pumps, and surveying instruments. South Africa’s position in the Product Space shows
that the country has productive capabilities similar to those required by products in green
supply chains. These products are therefore compelling areas to focus attention on because
South African firms (or foreign companies looking for investment locations) will be more likely
to develop global competitiveness in these products.

The appendix provides a detailed list of South Africa’s opportunities for participating in
green supply chains. The theory of economic complexity provides tools for evaluating these
opportunities based on several factors: a product’s complexity (i.e., the span of capabilities the
product requires); its density (i.e., how close it is in terms of capabilities to products that South
Africa already exports competitively) and its complexity outlook gain (i.e., how developing the
capabilities to excel in that product would improve the opportunities for further diversification).
Using these three variables, we can construct a composite score that indicates how feasible
and strategic a product is for South Africa. Furthermore, we can weigh each of these three
variables differently depending on whether we want to put more focus on products that are
more feasible because they rely more heavily on existing capabilities (i.e., more weight on
density) or that open up more opportunities for further growth (i.e., more weight on strategic
outlook gain). The appendix shows a list of five products per green supply chain that rank high
in terms of their opportunity score on the “extensive margin” — that is, products that South
Africa does not already export with relative comparative advantage. The table contains two
different measures of opportunity scores: one that prioritizes the feasibility of a product and
another one that prioritizes the attractiveness of a product in terms of its complexity and
outlook gain.23 It also reveals five products within each supply chain that South Africa can

23
The first way of constructing the opportunity score belongs to a strategy of parsimonious industrial policy, and
the second one to a strategy that prioritizes strategic bets. In the first case, the score is constructed by assigning a

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leverage in the intensive margin, that is, with an RCA greater than 1. These represent the top
five products ranked by their PCI.

The industries involved in green supply chains that have high potential in South Africa
are primarily in metals, chemicals, machinery, and electronics. Out of the 66 identified
products on the extensive margin, 30% are chemicals, another 24% are machines, 22% are
metals, and 15% are electronics. Meanwhile, 50% of the products in green supply chains that
are already exported by South Africa (i.e., the “intensive margin”) are chemicals. This is a strong
indicator of South Africa’s potential to repurpose its chemical industries to make the enablers
of global decarbonization. South Africa’s chemical industries are diversified in terms of
products but not in terms of their markets. Over 80% of its chemical exports are destined for
the rest of the African continent (and 90% in 2020). South Africa could leverage global
decarbonization to increase chemical exports to the rest of Africa and diversify its markets to
the rest of the world, where they are in increasing demand. The country also has a comparative
advantage in several products within the machinery, electronics, and metals sections, but
exports have been steeply declining since 2008 for reasons discussed earlier in this report.

This analysis reveals varying potential in the different green supply chains. Figure 4.8
shows the competitiveness of South Africa in the RCA vs. the average density of products
grouped by green supply chain in South Africa. On the horizontal axis is the average RCA in
South Africa for products in the indicated green supply chain (in logs), and the bubble size
shows how many products within each supply chain are present in South Africa as a percentage
of the total number of possible products. The vertical axis is a measure of how feasible it is to
develop products that are not currently present in South Africa based on Product Space
density. These measures can help understand the potential of each supply chain in South
Africa. For example, the lead-acid batteries supply chain shows growth potential in South Africa
since the average density of its products is the highest. The average RCA is also high, and over
50% of the products are already competitively made in South Africa. Nevertheless, South
African exports of lead-acid batteries as a final product are a small fraction of global exports.
Their RCA in 2020 was below 0.3. The figure also shows high density in the supply chain of flow
batteries. Meanwhile, green hydrogen and PGM catalysts supply chains both show high RCA

weight of 60% to density, 20% to PCI, and 20% to COG. In the second case, the score is calculated by giving a weight
of 50% to density, 20% to PCI, 30% to COG, and filtering out the PCI that is lower than the mean PCI for South Africa.

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on average, but low density, meaning that South Africa is already competitive in producing
part of the value chain, but other parts of the value chain are far from South Africa’s current
productive capabilities. These are long jumps or strategic bets for South Africa because they
would involve developing many capabilities that are relatively new to the country.

FIGURE 4.8: DENSITY & PRESENCE OF GREEN SUPPLY CHAIN PRODUCTS IN SOUTH AFRICA (2020)

Source: Own elaboration based on international trade data from Atlas of Economic Complexity and Growth Lab internal dataset
constructed using DoE and IEA green supply chain reports

The world is moving quickly towards BEVs, with important consequences for South
Africa’s automotive industry. Sales of BEVs grew by a factor of 10 between 2016 and 2021
based on Statista and grew by 35% in 2022, moving from 9% to 14% of total sales. This is the
consequence not only of policy stimuli but also of technological improvements and cost
reductions alongside increasing consumer demand. Capital markets assume that the tangible
and intangible assets that companies own to produce ICE vehicles are not going to be worth
much. For example, the current combined market value of Toyota, Mercedes, BMW, Ford,
Nissan, and Isuzu (6 OEMs present in South Africa) at USD 501 billion,24 well below that of Tesla

24
Toyota at USD 255 billion, Mercedes USD 87 billion, BMW USD 70 billion, Ford USD 60 billion, Nissan USD 17
billion, Isuzu USD 12billion, as of July 2023.

144
(USD 882 billion) alone, even though these companies produced 30 times more cars than
Tesla. Consequently, most major car companies are now playing catch-up. They will have to
confront new Chinese entrants such as BYD that produce more BEVs than all the OEMs present
in South Africa combined. Given this horizon, it is unlikely that OEMs will be planning to expand
capacity and even R&D efforts for ICE vehicles and will concentrate their efforts on the move
to EVs. Some may shrink as new entrants such as Tesla and BYD expand their presence, as
markets currently expect.

This is problematic for South Africa because the automotive industry represents almost
a fifth of manufacturing activity, with over 100,000 jobs and 10% of the export of goods
in 2019. Since plants take years to plan and build and are expected to be in operation for at
least a decade, it is unlikely that the OEMs present in South Africa and their suppliers will be
willing to consider either major investments or greater localization in their current product
lines, which are focused on ICE vehicles. The exception that proves the rule is BMW, a company
that announced a new investment in South Africa to produce plug-in hybrids (Reuters, 2023),
a transition product that currently sells half as many vehicles as BEVs and is expected to be just
1/3 of BEVs by 2028 based on Statista. Moreover, over 60% of South Africa's automotive
exports go to high-income countries in Europe, North America, and Japan that are not
expected to be buying ICE vehicles by 2035. These markets are likely to move massively
towards battery-electric vehicles by that year. Therefore, South Africa faces the choice of seeing
its automotive industry shrink significantly or move aggressively towards BEVs through either
substantial change in product lines by existing OEMs in the country or the entry of new
companies with BEV production.

South Africa's move from ICE vehicles to BEVs is made more difficult because of the
electricity crisis. Given the shortage of generation capacity, it makes sense that the authorities
have not prioritized the move to BEVs in the domestic market through investment in charging
infrastructure and other subsidies at the scale of many other countries. Moreover, charging
BEVs with electricity made from coal has scant environmental benefits. However, car
manufacturing facilities are long-term investments that take time to materialize. By that time,
hopefully, the electricity crisis will be over, and the country will be living through a boom in
electricity investments. South Africa would benefit from developing an integrated power and
transportation strategy to rebuild the country's comparative advantage. The strategy should

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leverage the capabilities that the country already has in the value chains that supply ICE cars
but will have to be enhanced with capabilities in the production of batteries, IT systems, and
other components that play a bigger role in BEVs than in ICE vehicles. It will be important to
design a strategy to develop the domestic market by making sure that the country is covered
with charging stations as quickly as possible, in a manner consistent with the recovery of the
electrical grid. In this respect, off-grid charging stations may be an important contributor. It will
be important to explore the possibility of attracting upcoming Chinese players such as BYD in
cars and CATL in batteries. Having a large local or regional market is always important to
convince OEMs to move their plants and value chains to the country.

Fuel cell electric vehicles (FCEVs) might constitute a potentially large market in the long
term, but a few relevant applications might take off earlier. While BEVs appear to be the
dominant emerging technology today, some countries, and U.S. states (e.g., California) are
betting on FCEVs for a longer time horizon. The absence of an ample hydrogen distribution
system limits adoption, but two features of FCEVs make them attractive for some uses. First,
FCEVs, just like BEVs, do not emit noxious gases. Second, FCEVs can be refilled more quickly
and made more powerful than BEVs. This is particularly useful for mining equipment, since they
need to be very powerful, must be refueled quickly, and not emit gases that might endanger
workers in underground mines. Also, pressures to decarbonize minerals and metals may force
the adoption of equipment that runs on clean energy. South Africa already has a presence in
this industry with companies such as Bell. Becoming a leader in the development of FCEV
technology as applied to mining equipment might be an interesting niche.

4.4 Strategy 2 – Make green versions of grey products.

As noted earlier, green energy is much more expensive to transport than fossil energy.
Therefore, to be competitive, energy-intensive industries that want to decarbonize will need to
relocate near cheap sources of green energy. They will also need to be substantially
redesigned, justifying new greenfield investments. For example, green steel will either be
made with electric-arc furnaces and hydrogen or with electrolysis of iron ore. These processes
are sufficiently different from traditional production such that they cannot easily be done as
brownfield investments justifying their development in new locations. Regions that develop
competitive green sources of energy will be able to participate in this investment trend. The

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industries that are likely to relocate include inter alia chemicals, steel, aluminum, and mineral
processing. South Africa has a long history and relevant accumulated capabilities and
knowhow in many of these industries.

South Africa has remarkable potential for renewable energy production, which should
be an advantage for this second strategy. Figure 4.9 shows the fifteen countries with the
highest maximum yields of photovoltaic power, excluding land with identifiable obstacles to
utility-scale PV plants. In addition to having high maximum solar yields (comparable to
Namibia, Saudi Arabia, or Egypt), South Africa also has high median yields, higher than China,
Nepal, or Argentina. South Africa also has enough wind power potential to complement its PV
energy. All of which makes it an attractive location for the development of renewable energy
projects. The pace at which these picked up after the government allowed the licensing for it
in 2022 indicates that the market is aware of this potential.

FIGURE 4.9: PRACTICAL SOLAR POTENTIAL IN 2020 (PVOUT LEVEL 1, KWH/KWP/DAY),

LONG-TERM

Chile, up to parallel 45°S

Argentina, up to parallel 45°S
Bolivia
Peru
Arab Republic of Egypt
China
Namibia
Jordan
Republic of Yemen
Nepal
South Africa
Oman
Saudi Arabia

0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00

Maximum Median
Source: Own elaboration based on Global Solar Atlas, World Bank, ESMAP and SOLARGIS.

However, in addition to its electricity system failure, South Africa's current energy mix is
highly carbon intensive. With over 90% of its generation capacity based on coal, South Africa
has one of the most carbon-intensive energy systems in the world. It will take decades for the

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country to transition towards cleaner energy. In the meantime, electricity from the South
African grid will be carbon-intensive on average such that industries that rely on the grid are
bound to have a high carbon footprint, negating the incentives to relocate to the country.
Moreover, dirty energy will be a competitive disadvantage for existing energy-intensive
exporting industries in reaching markets.

One way to deal with this disadvantage and leverage the country's renewable energy
resources is to develop green industrial parks, where dedicated renewable power is
supplied to businesses located in the parks. However, it may not be acceptable to global
consumers and regulators to simply reallocate green energy sources to some export-oriented
industries and increase the share of grey energy in the rest of the economy. Given this risk,
green industrial parks must meet specific criteria. First, their establishment must be based on
new sources of clean energy, not merely repurposing existing capacity. Second, to prevent
non-emission-reducing reallocations, South Africa must still abide by its previously announced
nationally determined contributions, or even increase its level of ambition. Third, for the sake
of efficiency and stability, it would be important to connect the new green zones to national
electricity grids, but this should be conditional on the zones becoming significant net exporters
of clean energy to the grid rather than net importers from the grid.

Establishing green industrial parks and their clean-energy resources would not
necessarily require government funding. Such real estate and energy investments should
be profitable and thus privately financed. Nevertheless, this does not mean that governments
should play no role in their establishment. On the contrary, to become competitive, these
zones must also strive to compete on the availability of other production inputs, such as human
resources, local supply chains, research and development capabilities, logistics, and more.
Government can accelerate the process by introducing effective green-energy regulations,
facilitating right-of-way provisions for transmission lines, adjusting zoning regulations, building
arterial infrastructure, and investing in urban development and human resources. Other
countries have already started this process. Indonesia, for example, has an aggressive strategy
toward attracting green industries to utilize its renewable energy resources. The Kalimantan
Industrial Park Indonesia (KIPI) project aims to attract EV battery manufacturing to utilize its
hydropower plants as energy sources (Hafisa, 2023).

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The case of the green steel industry stands out as a promising area for South Africa. Devlin
et al. (2023) have found that locations with renewable energy resources and iron ore mining
will likely be cost-competitive for developing green hydrogen-based steelmaking. Within the
group of regions identified in that paper, South Africa stands out as one of the places where
the cost of producing green-hydrogen-based steel is potentially the lowest. In addition, South
Africa has a long tradition of steelmaking which means that it has relevant capabilities and
knowhow compared with other locations that also have abundant renewable energy resources.
Competitive local provision of green hydrogen would also attract other industries. Some
industrial processes require very high temperatures that cannot be achieved by using
electricity. These so-called hard-to-abate industries require a green fuel that can play a heating
role and green hydrogen is likely to be the fuel of choice. According to IEA (2022d), in the Net
Zero Emissions by 2050 Scenario, approximately 65% of the primary steel production in the
G7 nations is expected to be achieved through the hydrogen (H2) DRI-EAF method. In theory,
it is also a potential solution to decarbonize long-distance heavy transport as it might be more
cost-competitive than electric transportation, given the limitations of battery storage systems.
In addition, as with green steel, hydrogen can play the role of a reducing agent. So, green
industrial parks may choose to offer green hydrogen as an additional valuable input.

The country has clear potential to develop green hydrogen in a competitive way. Figure
4.10 presents four indicators that show South Africa’s potential for green hydrogen production
vis-à-vis the rest of Southern Africa. The developers of the indicators calculated the amount of
hydrogen that can be produced in each geographical region in theory and considered
available resources and conditions. The first two maps (A and B) show that South Africa and,
especially, the Northern Cape, has the highest green hydrogen production potential in the
region, both per unit of area and in absolute terms. This results in a relatively low cost of
hydrogen production (map C), which is partly due to the low cost of electricity from PV (map
D). The country shows even more potential for developing green hydrogen production when
adding South Africa’s existing infrastructure and its productive capabilities in the metals and
chemicals sectors to the mix. According to IEA’s hydrogen projects database, there are five
projects currently being evaluated for feasibility, located in Bogoebaai NC (Sasol), Nelson
Mandela Bay EC (Hive Energy), Sasoulburg FS (Sasol), Secunda MP (Sasol), and Siyathemba
NC (Prieska). The private sector, including influential agents of change like Sasol, is aware of
South Africa's potential for green hydrogen development. Nevertheless, to actualize this

149
potential, the country needs to build a comparative advantage in electricity, although this time
not through coal but by harnessing renewable sources of energy.

FIGURE 4.10: KEY INDICATORS OF GREEN HYDROGEN POTENTIAL

Source: SADC H2 Atlas, Institute of Energy and Climate Research - Techno-Economic Systems Analysis (IEK-3), Forschungszentrum
Jülich, https://africa.h2atlas.de/sadc

For South Africa to develop cheap renewable electricity it must achieve a low cost of
capital. The sun shines for free and the wind blows for free. The bulk of the costs are associated
with the cost of installing the capacity and the cost of financing that capacity. Therefore, having
access to capital at a low cost is one of the main determinants of competitiveness in green
energy. Renewable energy projects require a combination of debt and equity, with equity
demanding higher returns than debt. The riskier the country, and the industry, the higher the
cost of both debt and equity and the larger the share of equity in the financing mix, causing
the weighted average cost of capital (WACC) to go up more than proportionally. Countries

150
with good natural renewable resources could squander them because of high financing costs.
In the case of South Africa, the weakening of the fiscal solvency indicators and repeated credit
downgrades have caused an increase in the yields that the government needs to pay to attract
capital. Beyond this so-called sovereign risk, other sources of risk are specific to energy
projects. The Cost of Capital Observatory of IEA describes the factors that can influence these
variables (Figure 4.11). Off-taker risk is serious because of Eskom’s weak performance and
balance sheet, requiring repeated recapitalizations. That is why the government has been
guaranteeing payments to generation projects, but this comes at a fiscal cost. In addition,
several other factors are problematic in South Africa, including land, permitting, regulatory,
and political risks. If these are not addressed, they can radically diminish the feasibility of South
Africa’s green growth prospects.

Hydropower and pumped storage could accelerate the energy transition in South Africa.
It is hard to incorporate sun and wind into an electric grid because these sources of energy are
not dispatchable (i.e., they cannot be adjusted up or down at will). To absorb more sun and
wind generation, the system needs more sources of dispatchable energy. The dominant
technology today is natural-gas or diesel turbines, which depend on fossil fuels. The green
alternatives include grid-scale batteries as well as hydro and pump storage. South Africa could
explore expanding both hydropower and pumped storage by exploring the
complementarities with Lesotho. Currently, Gauteng buys water from the Lesotho Highlands
Water Project. The project and resource have been historically conceived of as a source of
water rather than as a source of energy. When the last deal was negotiated in 1985, South
Africa did not perceive a need to import electricity, given its ample coal-fired generation.
Today, things are radically different. Not only is there a shortage of electricity generation in
South Africa, but Lesotho could provide two important elements that are extremely valuable
to South Africa. First, hydropower is dispatchable and hence can be used to balance the grid
so that it may absorb a larger supply of sun and wind generation. Secondly, the waterworks
can be used as storage, pumping water up the mountain in periods of excess sun and wind
generation and using the water at peak times. The potential of the Lesotho Highland Water
Project should be evaluated in the context of a strategy to green South Africa's electricity
supply. South Africa will be able to absorb more solar and wind generation in the presence of
more electricity generation and storage capacity in Lesotho.

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 FIGURE 4.11: RISK FACTORS AFFECTING CAPITAL AND DEVELOPMENT COSTS

Risk name Description of risk

Changes in expected revenues/return as a result of political or social
Political
instability
Regulatory Fear of changes in law/regulation
Unclear laws/regulations
Risk of public debt becoming unsustainable and the government not
Sovereign
being able to pay its debt obligations in time and form
Currency Risk of changes in foreign exchange rates
Inability – or complicated processes – to convert local currency to hard
Transfer
currency, or to repatriate hard currency
Off-taker Delays in the payment of power purchased by off-taker(s)
Delays in the signing of PPAs; higher-than-expected project costs relative
Bankability of PPA
to a fixed-price contract
Land Low availability of land
High land cost
Long lead times
Complications arising from overlapping planning permits, fragmented
ownership, or unregistered land
Transmission
Insufficient exchange of electricity and system services across states, which
network and
can hamper balancing
evacuation
Risks around the infrastructure available to evacuate power (e.g., uncertain
availability of local grid connections)
Permitting Long lead times
Volume Curtailment of power
Low electricity demand
Meteorological variations
Technology Underperformance of technology
Little experience with the technology being used in the country
Faulty operation and maintenance, etc.

Source: Cost of Capital Observatory, IEA.

South Africa could become a major producer of green hydrocarbons, including

sustainable aviation fuels (SAF). One of South Africa's unique technological capabilities is
the mastery of the Fischer-Tropsch process by Sasol. Initially developed to make liquid
hydrocarbons out of coal, the process can be adjusted by changing the feedstock to make low-
carbon fuels. Sasol is currently developing a plant capable of using green hydrogen and the
CO2 captured from other industrial processes — such as the Arcelor-Mittal's South African steel
plant — to make hydrocarbons. Burning such hydrocarbons emits CO2, but those molecules
had already been emitted by a previous industrial process. According to European Union rules,
fuels made from captured CO2 will be considered green until 2040 in the hope that other

152
cleaner technologies will have been developed by then. Air travel is one of the hardest to abate
industries, making SAF a promising market for the coming decades. South Africa has several
unique advantages to becoming a major supplier: unique expertise in the Fischer-Tropsch
process; good natural endowment of sun and wind to produce green hydrogen; and industrial
sources of captured CO2. Mastering the technology will require further research and
development to control the kind of hydrocarbons that the process creates, by tweaking the
catalysts that are used. By 2040, captured CO2 will need to be substituted by biomass, direct
air capture (DAC), or other more sustainable sources of carbon.

4.5 Strategy 3 – Export green knowhow.

South Africa has a long history of innovation in technologies that are relevant to the
energy transition, but the country appears to be losing innovation capacity. Figure 4.12,
Panel A shows the number of patents25 in green technologies and processes that were issued
to South African assignees in 1994-2016,26 as documented by the European Patents Office
(EPO) in the Worldwide Patent Statistical Database (PATSTAT). The surge in the registration of
patents until 2002 indicates that South Africa had the capability to create green technologies27.
However, after that, the number of green patents stopped growing at a time when they
ballooned in the rest of the world. As a consequence, measures of relative innovative capacity
show a significant decline. This decline is true whether one looks at the number of total patents
issued to South African assignees as a share of the U.S. (Panel B), upper-middle income
countries (Panel C), or Sub-Saharan African countries (Panel D).

25
Patents counts normally just sum the total number of patents awarded in all patent offices. These include patents
that have been registered in more than one location, leading to double- or multiple-counting. In these numbers, we
use so-called patent families that correct for this issue.
26
As classified by the United States Trademark Office (USTO) under Y02 to Y02W.
27
According to IRENA, many of the green patents that were registered in South Africa during the period until 2011
are within a diverse group that IRENA calls “enabling technologies” (38% in 2011): smart grids, energy efficiency,
CCUS, fuel cells, electromobility-related technologies, and others. A number of patents were also filed for solar
energy (33% in 2011). Source: IRENA’s patents evolution data in https://www.irena.org/Data/View-data-by-
topic/Innovation-and-Technology/Patents-Evolution

153
 FIGURE 4.12: EVOLUTION OF GREEN AND TOTAL PATENTS IN SOUTH AFRICA

Note: Panel A shows patent families of “climate change technologies as classified by USTO under Y02 to Y0W.
Source: Own elaboration based on PATSTAT and World Bank Data.

South Africa must achieve a higher pace of innovation to keep up with the development
of green knowhow worldwide. Figure 4.10 shows a comparison between the assignees that
filed patents in 2001-2008 and those that did so in 2009-2016 in South Africa. These numbers
are broad estimations given the data’s limitations when it comes to identifying assignees.28
Several patterns stand out when comparing the two periods. The number of green patent
families decreased overall, even as many new assignees registered patents in the latter period.
Few individuals filed patents during both periods. Rather, most of those who filed patents in
the earlier period did not do so in the later period and most of the assignees in the later period
were new. Taken together, these patterns show a clear shift in green patents in recent years.

28
Many of them change their name in time or fil patents under different names. The registry of patents might have
duplicated names or firm ids.

154
Thus, as South Africa’s general environment for patenting has weakened a few areas of
strength appear to be emerging.

FIGURE 4.13: COMPARING GREEN PATENTS IN SOUTH AFRICA BETWEEN 2001-08 AND 2009-16

Assignees that filed patents in both periods

Assignees that did not file any patent in 2009-2016

New assignees in 2009-2016

Change in patent families registration (2001-2008

to 2009-2016)

-50 0 50 100 150 200

Source: PATSTAT.

South Africa may be able to better leverage these emerging sources of innovation. The
case of Hydrox Holdings LTD29 is illustrative since the company was granted a special
distinction in the 2022 Monaco Prize for Innovation in Renewable Hydrogen30 for their
innovations in the development of a membrane-less electrolysis system. Another illustrative
case is Solar MD31 (Parker, 2021; Kuhudhai, 2023). The company assembles batteries with
components imported from CATL and sells them in South Africa and across Southern Africa.
They developed a 14.3 kWh pack that filled a gap in a market where customers facing load-
shedding needed more storage capacity than the one provided by the batteries directly
imported from China. The company has also created its own battery and energy management
system. Because of the electricity crisis, the company faces such high demand that, as of March
2023, it had a three-month backlog for delivering orders (Kuhudzai, 2023). Finally, they are
exporting decarbonization knowhow since the company expanded its operations to Bulgaria
in 2023 (Todorovic, 2023). The development of businesses like this one can help South Africa

29
See: https://hydroxholdings.co.za/home/
30
See: https://monacoh2.org/prize-2022/
31
See: https://www.solarmd.com/

155
spur its green growth process. The energy storage solutions are especially strategic for the
country, given their upstream and downstream linkages with the metals sector.

Overall, Sasol stands out as a key source of knowhow in South Africa. Increasingly, South
African research universities may play a greater role. As noted previously, Sasol's mastery
of the Fischer-Tropsch process is one source of intellectual property that may be adapted for
future green growth uses. By measure of patents, Sasol is also the most innovative company in
South Africa, with 14% of patents filed in 2001-2008 and 12% in the following period (Figure
4.14). Sasol already exports this knowhow as it is now utilizing a flexible approach that
combines licensing of its technology, entering partnerships, advisory agreements, and other
forms of collaboration. Producing at home and exporting knowhow are not substitutes but
complements. It is because the company produces at home that it can master, test, improve,
and develop the technology so that it becomes a more effective and credible exporter of
knowhow. Figure 4.14 also highlights that some of the shift in patenting that has occurred over
the last two decades has come through an increasing role of several South African universities.
This is a promising development to build upon through partnerships that combine university
resources and capabilities with the production and market knowledge of private companies.

FIGURE 4.14: CLIMATE CHANGE PATENTS BY ASSIGNEE IN SOUTH AFRICA

Assignee 2001-2008 2009-2016
Sasol 50 47
PEBBLE BED 35 4
BHP BILLITON 25 2
Anglo American 12 2
ESKOM 10 2
University of Cape Town 9 11
North West University 7 12
MINTEK 6 6
University of Witwatersrand, Johannesburg 6 11
Azoteq PTY 5 3
University of Stellenbosch 0 44
The South African Nuclear Energy Corp LTD 0 5
University of Pretoria 0 5
CSIR 0 4
HYDROX Holdings LTD 0 4

Source: Own elaboration based on PATSTAT.

156
South Africa can further capitalize on its productive capabilities to expand its
engineering, procurement, and construction (EPC) exports. In addition to Solar MD, other
companies have the potential to expand exports of green services and energy systems
solutions. PVinsight,32 for example, is a company in Port Elizabeth developed by researchers
from Nelson Mandela University that offers consulting and testing services for solar projects.
Companies like PVinsight can take advantage of the fact that EPC services are and will continue
to be an essential element in the deployment of renewable energy worldwide and on the
African continent.

4.6 Summary of Green Growth in South Africa

While the previous chapters discussed two fundamental constraints to growth in South
Africa, this chapter explored growth opportunities moving forward in the context of
global decarbonization. These noteworthy green growth opportunities show that the South
African economy could have a promising future, but the nature of these opportunities also
highlights the ongoing damage from collapsing state capacity. Many of the opportunities
explored here are disincentivized by the failing electricity system, collapsing state capacity in
other critical public goods, and high cost of capital. Addressing these problems will be central
to achieving the promising green growth future that is possible for South Africa. Given that
these opportunities depend on reaching the global market, policies focused on boosting
demand through fiscal means or localization policies can be of limited benefit. In fact, given
the country's precarious creditworthiness, a demand-side focus would run the risk of raising
interest rates and the cost of capital of green investment. South Africa’s growth potential
moving forward comes from the supply side of green growth — that is, capitalizing on its
potential to help the world decarbonize through producing many goods, services, and
knowledge that global decarbonization will require.

Fully addressing the electricity system failure and rebuilding state capacity are urgent
challenges that not only undermine green growth today but in the future. The
opportunities of decarbonization favor first movers. This historical opportunity will relocate
industries to places that can provide cheap green energy. However, once industries start to
cluster in new places, late entrants will have a harder time gaining a foothold in maturing

32
See: https://www.pvinsight.co.za/page/about

157
industries. China was able to become a world leader in manufacturing solar systems, electric
vehicles, and batteries because they started long before the cost of electricity from PV became
lower than the cost of coal-fired electricity. Meanwhile, South Africa doubled down on and then
lost its comparative advantage in cheap electricity via coal. A wide range of countries are
pursuing aggressive strategies to develop first-mover advantages. The Inflation Reduction Act
(IRA) case in the U.S. is noteworthy, though a similar approach that is heavy on state subsidies
would be infeasible and likely counterproductive in the South African context. Many other
countries (e.g., Australia, Chile, Indonesia, and Namibia) are also gaining strength on the road
toward green growth by focusing on their existing and potential comparative advantages.
South Africa needs a strategy that matches its strengths and its limitations.

South Africa needs an active strategy for pursuing green growth opportunities that
would allow the country to build new comparative advantages. Based on the
opportunities previously identified, this strategy should be based on three pillars: (1) making
the enablers of global decarbonization; (2) making green versions of grey products for the
global market; and (3) exporting green knowhow. In addition to solving cross-cutting
economic issues, this strategy requires industry-specific policies that target each of the areas
of opportunity that have potential in South Africa. Rather than relying on government
procurement and localization, which have become South Africa’s main approaches to industrial
policy as the economy has stagnated, the strategies explored here would be far more targeted
and focused on capturing expanding demand in the global market in areas where South Africa
has clear possibilities to grow. This has obvious advantages versus reliance on government’s
highly strained fiscal resources and the weakening domestic market.

Within Strategy 1 (making the enablers of global decarbonization), two main areas of
opportunity are taking advantage of the mining boom and promoting the development
of industries that are both likely to see rapid global demand growth and are consistent
with South Africa’s knowledge base. In addition to addressing collapsing state capacity,
which constrains many of these opportunities, South Africa also needs targeted approaches.
South Africa needs tailor-made mining and industrial policies. In the first case, a focus on
exploration, production, and innovation is required to ensure that the country maximizes the
benefits of mineral resource extraction. A revision of the mining policy framework is crucial for
South Africa to take advantage of the critical minerals boom. In the case of other green supply

158
chains, the government must be an enabler rather than a central planner. Some emerging
opportunities might need supply-side measures to enhance competitiveness via a more
efficient provision of public inputs; others might need targeted demand-side policies to ensure
they are price-competitive during their early stages. Pursuing one-size-fits-all solutions without
considering the industries’ specificity would be less effective than defining industry-specific
policies. Generally, companies that are first movers in emerging supply chains need easy
access to imports and markets. This makes local content requirements (LCRs) a risky policy tool
in many cases. However, LCRs may be powerful instruments in select cases and there is also a
role for government procurement to be used to spur innovation within South African
companies. The analysis included in this chapter merely provides a starting point for
understanding emerging opportunities, and this information could be leveraged within
emerging strategies and “masterplans” in development in South Africa today.

For Strategy 2 (making green versions of grey products), the electricity crisis is by far the
most fundamental constraint. South Africa needs a boom in renewables to make green
versions of grey products, and a boom in renewable generation also requires a rapid
expansion of transmission in storage. South Africa has advantageous natural conditions for
renewable energy generation but major disadvantages in electricity market design and the
cost of capital for project development. Therefore, South African policymakers should focus
on establishing a long-term market for electricity and lowering capital costs by reducing
sovereign risk. Reducing development costs chiefly depends on state capacity. These
improvements will take time, but South Africa also has high potential to kickstart this strategy
through the development of green industrial parks. These parks could crowd in both
dedicated generation and storage, which could be exported to the grid, and electricity-
intensive manufacturing for exports. Green industrial parks should not be a public investment
but rather a private sector opportunity that is enabled by government policy, including
expedited permitting, and supporting infrastructure. The operators of parks would be capable
and highly motivated to find tenants and create the environment that they need to succeed.
These tenants may include such industries as mineral processing, green steel, ammonia-based
fertilizers, as well as highly electricity-intensive services like data centers.

Strategy 3 (exporting green knowhow) presents South Africa with the opportunity to
employ its top-tier technological resources to address global and regional challenges.

159
South Africa has several examples of companies that have developed solutions that are much
needed in a decarbonizing world. Sasol’s capacity to utilize the Fischer–Tropsch is rare in
developing countries, making it a strategic player in exporting that technology to other parts
of the world. At the same time, South Africa has seen noteworthy success in private innovators
in the green economy and has advantages in the research capacity of its university system.
Building on these advantages requires bringing capabilities of the private sector and academia
together and mixing South African talent with global talent. For this strategy, the issues
discussed in Chapter 3 on spatial exclusion are of particular importance. Additionally, South
Africa’s highly restrictive policies on high-skill immigration and inefficiencies in business travel
are very problematic. For businesses that cannot bring the complementary human resources
that they need into South Africa, the natural response is to move their businesses out of South
Africa. Finally, South Africa should be well-positioned to expand its position in engineering,
procurement, and construction globally, but especially across Africa. However, this industry
requires the flexible movement of people, which is limited by South Africa’s immigration
policies. Ultimately, excelling in the green knowhow space will depend on South Africa
becoming a place where talent from across the country and from around the rest of the world
can more easily come together. South African metros have the building blocks to be such hubs,
but their full potential is constrained by policy.

160
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 6 Appendix

6.1 List of Strategic Products within Green Supply Chains

Parsimonious industrial policy

HS Code HS Code (2 Opportunity

HS Name Section PCI Green Topic
(4 digit) digit) Score
Organic
2910 Epoxides Chemicals 1.05 1.62 Carbon Capture
chemicals
Appliances for
Industrial
8481 thermostatically Machinery 1.04 1.51 Carbon Capture
Machinery
controlled valves
Pumps,
Industrial
8414 compressors, fans, Machinery 0.95 1.14 Carbon Capture
Machinery
etc.
Equipment for
Industrial
8419 temperature Machinery 0.93 1.09 Carbon Capture
Machinery
change of materials
Other base
8104 Magnesium Metals 0.80 0.81 Carbon Capture
metals
Flat-rolled products
7225 of other alloy steel, Iron and steel Metals 1.03 1.50 Electric Grids
width > 600 mm
Electrical
Semiconductor
8541 machinery and Electronics 0.95 1.44 Electric Grids
devices
equipment
Insulating fittings Electrical
8547 for electrical machinery and Electronics 0.91 1.02 Electric Grids
machines equipment
Electrical
Electrical insulators
8546 machinery and Electronics 0.89 0.98 Electric Grids
of any material
equipment
Electrical
Electrical
8532 machinery and Electronics 0.88 1.06 Electric Grids
capacitors
equipment
Industrial
8413 Pumps for liquids Machinery 1.00 1.39 Flow batteries
Machinery
Equipment for
Industrial
8419 temperature Machinery 0.93 1.09 Flow batteries
Machinery
change of materials
Electrical
Primary cells and
8506 machinery and Electronics 0.89 1.09 Flow batteries
primary batteries
equipment
Articles of stone or Articles of stone,
6815 of other mineral plaster, cement, Stone 0.85 0.88 Flow batteries
substances etc.
Glass and
7019 Glass fibers Stone 0.69 0.40 Flow batteries
glassware

169
 Instruments for Apparatuses
Green
9027 physical or (optical, Machinery 1.11 1.80
Hydrogen
chemical analysis medical, etc.)
Screws and similar
Articles of iron Green
7318 articles of iron or Metals 1.09 1.60
or steel Hydrogen
steel
Ion-exchangers Green
3914 Plastics Chemicals 1.09 1.69
based on polymers Hydrogen
Appliances for
Industrial Green
8481 thermostatically Machinery 1.04 1.51
Machinery Hydrogen
controlled valves
Apparatuses
Measuring Green
9031 (optical, Machinery 1.02 1.41
instruments Hydrogen
medical, etc.)
Appliances for
Industrial
8481 thermostatically Machinery 1.04 1.51 Hydropower
Machinery
controlled valves
Ball or roller Industrial
8482 Machinery 0.98 1.21 Hydropower
bearings Machinery
Machines used in Industrial
8454 Machinery 0.89 0.96 Hydropower
metallurgy Machinery
Electrical
Electric motors and
8501 machinery and Electronics 0.81 0.74 Hydropower
generators
equipment
Other articles of Articles of iron
7326 Metals 0.81 0.75 Hydropower
iron or steel or steel
Electrical
Primary cells and Lead -Acid
8506 machinery and Electronics 0.89 1.09
primary batteries Batteries
equipment
Lead -Acid
7804 Lead foil <2mm Lead Metals 0.59 0.04
Batteries
- Lead -Acid
3915 Plastic waste Plastics Chemicals 0.33
0.84 Batteries
Lead refined - Lead -Acid
7801 Lead Metals 0.13
unwrought 1.53 Batteries
Miscellaneous
Chemical elements Lithium-Ion
3818 chemical Chemicals 1.10 1.96
for electronics Batteries
products
Silicones in primary Lithium-Ion
3910 Plastics Chemicals 1.05 1.57
forms Batteries
Electrical
Semiconductor Lithium-Ion
8541 machinery and Electronics 0.95 1.44
devices Batteries
equipment
Electrical
Lithium-Ion
8507 Batteries machinery and Electronics 0.90 1.10
Batteries
equipment
Electrical
Primary cells and Lithium-Ion
8506 machinery and Electronics 0.89 1.09
primary batteries Batteries
equipment

170
 Appliances for
Industrial
8481 thermostatically Machinery 1.04 1.51 Nuclear
Machinery
controlled valves
Industrial
8413 Pumps for liquids Machinery 1.00 1.39 Nuclear
Machinery
Industrial
8406 Steam turbines Machinery 0.97 1.16 Nuclear
Machinery
Compression-
ignition internal Industrial
8408 Machinery 0.97 1.23 Nuclear
combustion piston Machinery
engines
Nickel bars, wire
7505 Nickel Metals 0.97 1.29 Nuclear
etc.
Electrical machines Electrical
Platinum Group
8543 with individual machinery and Electronics 0.95 1.34
Metal Catalysts
functions n.e.c. equipment
Impregnated,
Textile articles for coated or Platinum Group
5911 Textiles 0.90 1.04
technical use laminated textile Metal Catalysts
fabrics
Electrical
Primary cells and Platinum Group
8506 machinery and Electronics 0.89 1.09
primary batteries Metal Catalysts
equipment
Saturated acyclic
Organic Platinum Group
2915 monocarboxylic Chemicals 0.75 0.73
chemicals Metal Catalysts
acids
Other base Platinum Group
8108 Titanium Metals 0.72 0.51
metals Metal Catalysts
Pumps, Rare Earth
Industrial
8414 compressors, fans, Machinery 0.95 1.14 Permanent
Machinery
etc. Magnets
Electrical Rare Earth
8505 Electromagnets machinery and Electronics 0.93 1.17 Permanent
equipment Magnets
Rare Earth
Industrial
8417 Industrial furnaces Machinery 0.90 1.05 Permanent
Machinery
Magnets
Electrical Rare Earth
Electronic
8542 machinery and Electronics 0.90 1.14 Permanent
integrated circuits
equipment Magnets
Rare Earth
Industrial
8471 Computers Machinery 0.83 1.03 Permanent
Machinery
Magnets
Miscellaneous
Chemical elements
3818 chemical Chemicals 1.10 1.96 Semiconductors
for electronics
products
Apparatuses
Measuring
9031 (optical, Machinery 1.02 1.41 Semiconductors
instruments
medical, etc.)

171
 Electrical
Semiconductor
8541 machinery and Electronics 0.95 1.44 Semiconductors
devices
equipment
Electrical
Electronic
8542 machinery and Electronics 0.90 1.14 Semiconductors
integrated circuits
equipment
Halogenated
Organic
2903 derivatives of Chemicals 0.85 0.94 Semiconductors
chemicals
hydrocarbons
Miscellaneous
Chemical elements
3818 chemical Chemicals 1.10 1.96 Solar PV
for electronics
products
Halides of Inorganic
2812 Chemicals 1.01 1.73 Solar PV
nonmetals chemicals
Industrial
8483 Transmission shafts Machinery 1.00 1.27 Solar PV
Machinery
Instruments for Apparatuses
9030 measuring (optical, Machinery 0.97 1.27 Solar PV
electricity medical, etc.)
Electrical
Semiconductor
8541 machinery and Electronics 0.95 1.44 Solar PV
devices
equipment
Flat-rolled products
7226 of other alloy steel, Iron and steel Metals 1.04 1.56 Wind
width < 600 mm
Flat-rolled products
7225 of other alloy steel, Iron and steel Metals 1.03 1.50 Wind
width > 600 mm
Industrial
8483 Transmission shafts Machinery 1.00 1.27 Wind
Machinery
Pumps,
Industrial
8414 compressors, fans, Machinery 0.95 1.14 Wind
Machinery
etc.
Electrical
Electronic
8542 machinery and Electronics 0.90 1.14 Wind
integrated circuits
equipment

Strategic bets

HS Code HS Code Opportunity

HS Name Section PCI Green Topic
(4 digit) (2 digit) Score
Appliances for
Industrial
8481 thermostatically Machinery 1.03 1.51 Carbon Capture
Machinery
controlled valves
Organic
2910 Epoxides Chemicals 1.02 1.62 Carbon Capture
chemicals
Pumps,
Industrial
8414 compressors, fans, Machinery 0.92 1.14 Carbon Capture
Machinery
etc.

172
 Equipment for
Industrial
8419 temperature Machinery 0.91 1.09 Carbon Capture
Machinery
change of materials
Other base
8104 Magnesium Metals 0.74 0.81 Carbon Capture
metals
Flat-rolled products
7225 of other alloy steel, Iron and steel Metals 1.02 1.50 Electric Grids
width > 600 mm
Insulating fittings Electrical
8547 for electrical machinery and Electronics 0.89 1.02 Electric Grids
machines equipment
Electrical
Semiconductor
8541 machinery and Electronics 0.88 1.44 Electric Grids
devices
equipment
Electrical
Electrical insulators
8546 machinery and Electronics 0.86 0.98 Electric Grids
of any material
equipment
Electrical
Electrical
8532 machinery and Electronics 0.82 1.06 Electric Grids
capacitors
equipment
Industrial
8413 Pumps for liquids Machinery 0.98 1.39 Flow batteries
Machinery
Equipment for
Industrial
8419 temperature Machinery 0.91 1.09 Flow batteries
Machinery
change of materials
Electrical
Primary cells and
8506 machinery and Electronics 0.84 1.09 Flow batteries
primary batteries
equipment
Articles of stone or Articles of stone,
6815 of other mineral plaster, cement, Stone 0.81 0.88 Flow batteries
substances etc.
Glass and
7019 Glass fibers Stone 0.63 0.40 Flow batteries
glassware
Instruments for Apparatuses
Green
9027 physical or (optical, Machinery 1.10 1.80
Hydrogen
chemical analysis medical, etc.)
Screws and similar
Articles of iron Green
7318 articles of iron or Metals 1.09 1.60
or steel Hydrogen
steel
Ion-exchangers Green
3914 Plastics Chemicals 1.07 1.69
based on polymers Hydrogen
Appliances for
Industrial Green
8481 thermostatically Machinery 1.03 1.51
Machinery Hydrogen
controlled valves
Apparatuses
Measuring Green
9031 (optical, Machinery 1.01 1.41
instruments Hydrogen
medical, etc.)
Appliances for
Industrial
8481 thermostatically Machinery 1.03 1.51 Hydropower
Machinery
controlled valves

173
 Ball or roller Industrial
8482 Machinery 0.96 1.21 Hydropower
bearings Machinery
Machines used in Industrial
8454 Machinery 0.85 0.96 Hydropower
metallurgy Machinery
Other articles of Articles of iron
7326 Metals 0.77 0.75 Hydropower
iron or steel or steel
Electrical
Electric motors and
8501 machinery and Electronics 0.76 0.74 Hydropower
generators
equipment
Electrical
Primary cells and Lead -Acid
8506 machinery and Electronics 0.84 1.09
primary batteries Batteries
equipment
Lead -Acid
7804 Lead foil <2mm Lead Metals 0.52 0.04
Batteries
- Lead -Acid
3915 Plastic waste Plastics Chemicals 0.23
0.84 Batteries
Lead refined - Lead -Acid
7801 Lead Metals 0.01
unwrought 1.53 Batteries
Miscellaneous
Chemical elements Lithium-Ion
3818 chemical Chemicals 1.07 1.96
for electronics Batteries
products
Silicones in primary Lithium-Ion
3910 Plastics Chemicals 1.03 1.57
forms Batteries
Electrical
Semiconductor Lithium-Ion
8541 machinery and Electronics 0.88 1.44
devices Batteries
equipment
Electrical
Lithium-Ion
8507 Batteries machinery and Electronics 0.85 1.10
Batteries
equipment
Electrical
Primary cells and Lithium-Ion
8506 machinery and Electronics 0.84 1.09
primary batteries Batteries
equipment
Appliances for
Industrial
8481 thermostatically Machinery 1.03 1.51 Nuclear
Machinery
controlled valves
Industrial
8413 Pumps for liquids Machinery 0.98 1.39 Nuclear
Machinery
Industrial
8406 Steam turbines Machinery 0.96 1.16 Nuclear
Machinery
Compression-
ignition internal Industrial
8408 Machinery 0.95 1.23 Nuclear
combustion piston Machinery
engines
Nickel bars, wire
7505 Nickel Metals 0.94 1.29 Nuclear
etc.
Electrical machines Electrical
Platinum Group
8543 with individual machinery and Electronics 0.90 1.34
Metal Catalysts
functions n.e.c. equipment
Textile articles for Impregnated, Platinum Group
5911 Textiles 0.87 1.04
technical use coated or Metal Catalysts

174
 laminated textile
fabrics
Electrical
Primary cells and Platinum Group
8506 machinery and Electronics 0.84 1.09
primary batteries Metal Catalysts
equipment
Saturated acyclic
Organic Platinum Group
2915 monocarboxylic Chemicals 0.68 0.73
chemicals Metal Catalysts
acids
Other base Platinum Group
8108 Titanium Metals 0.66 0.51
metals Metal Catalysts
Pumps, Rare Earth
Industrial
8414 compressors, fans, Machinery 0.92 1.14 Permanent
Machinery
etc. Magnets
Electrical Rare Earth
8505 Electromagnets machinery and Electronics 0.88 1.17 Permanent
equipment Magnets
Rare Earth
Industrial
8417 Industrial furnaces Machinery 0.87 1.05 Permanent
Machinery
Magnets
Electrical Rare Earth
Electronic
8542 machinery and Electronics 0.84 1.14 Permanent
integrated circuits
equipment Magnets
Electrical Rare Earth
Electric motors and
8501 machinery and Electronics 0.76 0.74 Permanent
generators
equipment Magnets
Miscellaneous
Chemical elements
3818 chemical Chemicals 1.07 1.96 Semiconductors
for electronics
products
Apparatuses
Measuring
9031 (optical, Machinery 1.01 1.41 Semiconductors
instruments
medical, etc.)
Electrical
Semiconductor
8541 machinery and Electronics 0.88 1.44 Semiconductors
devices
equipment
Electrical
Electronic
8542 machinery and Electronics 0.84 1.14 Semiconductors
integrated circuits
equipment
Halogenated
Organic
2903 derivatives of Chemicals 0.80 0.94 Semiconductors
chemicals
hydrocarbons
Miscellaneous
Chemical elements
3818 chemical Chemicals 1.07 1.96 Solar PV
for electronics
products
Industrial
8483 Transmission shafts Machinery 0.99 1.27 Solar PV
Machinery
Halides of Inorganic
2812 Chemicals 0.96 1.73 Solar PV
nonmetals chemicals

175
 Instruments for Apparatuses
9030 measuring (optical, Machinery 0.93 1.27 Solar PV
electricity medical, etc.)
Electrical
Semiconductor
8541 machinery and Electronics 0.88 1.44 Solar PV
devices
equipment
Flat-rolled products
7226 of other alloy steel, Iron and steel Metals 1.02 1.56 Wind
width < 600 mm
Flat-rolled products
7225 of other alloy steel, Iron and steel Metals 1.02 1.50 Wind
width > 600 mm
Industrial
8483 Transmission shafts Machinery 0.99 1.27 Wind
Machinery
Pumps,
Industrial
8414 compressors, fans, Machinery 0.92 1.14 Wind
Machinery
etc.
Electrical
Electronic
8542 machinery and Electronics 0.84 1.14 Wind
integrated circuits
equipment

Intensive margin

HS Code HS Code Opportunity

HS Name Section PCI Green Topic
(4 digit) (2 digit) Score
Industrial
8421 Centrifuges Machinery NA 0.94 Carbon Capture
Machinery
Acyclic Organic
2901 Chemicals NA 0.44 Carbon Capture
hydrocarbons chemicals
Other base
8112 Other metals Metals NA 0.27 Carbon Capture
metals
Salts of oxometallic Inorganic
2841 Chemicals NA 0.24 Carbon Capture
acids chemicals
Aluminum plates >
7606 Aluminum Metals NA 0.43 Electric Grids
0.2 mm
Tanks etc. > 300 Articles of iron
7309 Metals NA 0.29 Electric Grids
liters, iron or steel or steel
Other base
8112 Other metals Metals NA 0.27 Electric Grids
metals
Hydrides, nitrides,
Inorganic Green
2850 azides, silicides and Chemicals NA 1.67
chemicals Hydrogen
borides
Ketones and Organic Green
2914 Chemicals NA 1.17
quinones chemicals Hydrogen
Precious metals Green
7110 Platinum Stone NA 1.15
and stones Hydrogen
Miscellaneous
Catalytic Green
3815 chemical Chemicals NA 1.00
preparations Hydrogen
products

176
 Industrial Green
8421 Centrifuges Machinery NA 0.94
Machinery Hydrogen
Inorganic Lead -Acid
2824 Lead oxides Chemicals NA 0.45
chemicals Batteries
Polymers of Lead -Acid
3902 Plastics Chemicals NA 0.29
propylene Batteries
Miscellaneous
Lithium-Ion
3801 Artificial graphite chemical Chemicals NA 0.58
Batteries
products
Flat-rolled products
7219 of stainless steel of Iron and steel Metals NA 0.99 Nuclear
a width > 600 mm
Industrial
8421 Centrifuges Machinery NA 0.94 Nuclear
Machinery
Other base
8101 Tungsten (wolfram) Metals NA 0.83 Nuclear
metals
Miscellaneous
3801 Artificial graphite chemical Chemicals NA 0.58 Nuclear
products
Structures and their
Articles of iron
7308 parts, of iron or Metals NA 0.37 Nuclear
or steel
steel
Precious metals Platinum Group
7110 Platinum Stone NA 1.15
and stones Metal Catalysts
Miscellaneous
Catalytic Platinum Group
3815 chemical Chemicals NA 1.00
preparations Metal Catalysts
products
Industrial Platinum Group
8421 Centrifuges Machinery NA 0.94
Machinery Metal Catalysts
Inorganic Platinum Group
2808 Sulfonitric acids Chemicals NA 0.29
chemicals Metal Catalysts
Other articles of Precious metals Platinum Group
7115 Stone NA 0.09
precious metals and stones Metal Catalysts
Other base
8112 Other metals Metals NA 0.27 Semiconductors
metals
Structures and their
Articles of iron
7308 parts, of iron or Metals NA 0.37 Solar PV
or steel
steel
Precious metals
7110 Platinum Stone NA 1.15 Wind
and stones
Structures and their
Articles of iron
7308 parts, of iron or Metals NA 0.37 Wind
or steel
steel

177