State aid must be subjected to checks and balances

Acutely mindful of the risks of the economy overly-depending on the mining sector, the previous governments raised major, modern industries around the extraction of natural resources. Most of these modern industries were championed by state-owned enterprises, who had dominated manufacturing by the end of the 1930s.

Along this developmental trajectory and owing to international isolation and economic sanctions against the apartheid regime, the design of South Africa's industrial policy was heavily focused on strategic investments to ensure self-sufficiency. It has been argued that pressure arising from the economic sanctions resulted in little State support for sustainable exports and low levels of competitiveness in many domestic industries.

Over the decades, the South African economy became very concentrated, characterised by large national champions in key industries such as fuel/petroleum, aviation, telecommunications and steel4. Industries such as textiles, pulp and paper, for example, owe their existence to support from the state-owned Industrial Development Corporation. Other state-owned firms produced fertilizer, chemicals, and arms. Modern day examples of former state-owned entities include South African Airways, Telkom, Sasol and Arcellor Mittal.

Extensive support

For years, such firms received extensive state support which took many forms such as actual legislation, exclusive licenses, sustained investments, financial aid and relationships all designed to protect these firms from competition and ensure that they do not fail. This persisted through the 20th century, and the government's role in the economy did not decline. For example, by the 1970s, the government owned or managed nearly 40% of the country's productive assets.

Ziyanda Buthelezi

The dawn of democracy in South Africa was occasioned by the liberalisation of markets (for example the telecommunications sector) and the privatisation of many of the national champions listed above. The newly elected democratic government, recognising the negative economic effects of South Africa's isolation from the world markets during the apartheid years, designed a number of investment promotion incentives whose main objective was not only to promote investment in South Africa but also bridge the gap between the upstream and downstream industries.

According to the Department of Trade and Industry, recipients of such state aid were expected to link the upstream and downstream industries. This, the competition authorities have interpreted to mean that the state aid provided was to be used to support consumers of the vital intermediate products produced by the producers which received state support.

No clear guidelines

It is interesting to note that although the competition authorities have recognised the competitive effects of state aid as far back as the famous Mittal excessive pricing case in 2007, no clear guidelines have been set to either regulate the provision of state aid, given its competition implications, and various forms of industrial development incentives still continue to form an integral part of the policy tools used by government in achieving its industrial policy objectives.

This is particularly important because recently, the competition authorities noted, in the Sasol excessive pricing case, that the historical state support received by the national champions such as Sasol continues to be relevant when assessing allegations of abuse of dominance against these firms. It is well-known that most of the firms listed above have all been found by the competition authorities as possessing statutory dominance in terms of the Competition Act in their respective markets. The competition authorities have found that these firms owe their dominant positions in no small measure to state support or ownership under the apartheid regime and beyond.

Currently, the South African industrial policy objectives, encapsulated in the Industrial Policy Action Plan, identify a number of transversal and sector-specific interventions directed at the manufacturing sector, particularly automotive products, plastics and pharmaceuticals, metals fabrications, capital and rail equipment, clothing and textiles, agro-processing, among others.

Against this background, the relevant question is what is the appropriate course of action when state support in the form of tax breaks, financial transfers, or exemptions to regulation or other forms of advantages has the potential to harm competition? This is not an easy question to answer. It is politically sensitive, it touches on the core competencies of government, namely to design economic policy which includes aid measures to support certain industries, to tax and spend the proceeds as it deems fit.

Government intervention

It is important to note that in some circumstances, government intervention in the form of aid is necessary for a well-functioning economy to offset the disadvantages occasioned by markets not performing optimally. The employment of state aid to firms in specific, designated industries is generally driven by industrial development imperatives which encompass a number of objectives including, inter alia, encouraging economic activity in a particular region, providing access to products or services that the market would not ordinarily provide or counter decline(s) in designated industries.

Yongama Njisane

While state aid can take various forms, a single common feature is that the provision of such public largesse affects competition in the relevant markets given that such aid favours or advantages certain firms over others. There is scholarly support for the view that state aid left unabated could be just as harmful to competition as traditional offences like cartel conduct or abuse of dominance.

This is why the European Commission (EU), which is arguably one of the most authoritative jurisdictions (outside of the USA) in competition matters, has powers allowing it to assess and approve state subsidies/aid granted to companies. State aid control has become an important instrument in the EU competition framework. To illustrate how unchecked state aid could harm competition, we consider a few practical examples below:

• Unchecked state aid has the potential to be detrimental to the economy by distorting competition between rival firms. For example, if a government subsidises company A, and not its rivals, this company will be able to take a larger share of the market than it would have had in the absence of that subsidy. So company A would do quite well in that market, even if it was far less efficient than its rivals who did not receive any aid. For example, constant bailouts of the national champion could put rivals in the same market at a competitive disadvantage.
  
• Unchecked state aid could stifle innovation and risk taking which ultimately benefits consumers. If company A would have easy access to state subsidies, it would feel less need to compete on merits. It would not have a strong incentive to improve the efficiency of its operations or to invest in product or process innovation.
  
• If a company knows that it will always be able to rely on a state bail out if things go wrong, this company will be less inclined to adopt difficult measures required to become more efficient. Subsidies may also encourage the recipient to take excessive, unjustified risks in the knowledge that profits will be privatised, whilst losses would be 'socialised'. This is what is referred to as the problem of moral hazard.
  
• If unchecked state aid results in the exit or foreclosure of rivals, we can deduce consumer harm. Exclusion or rival foreclosure means less choice, product differentiation and ultimately higher prices.
  
• State aid may harm competitors even if it does not affect pricing directly. Since investments are strategic substitutes, aid that reduces the cost of capital will allow the recipient to increase investment at the cost of its rivals. It may then sell more at a higher price while the rivals sell less at a lower price.
  
• State aid could result in predatory pricing if given in large amounts. It could result in the exit or foreclosure of rivals to the detriment of consumers.
  
• Unchecked state aid could keep inefficient firms who should exit the market on account of their inefficiency on indefinite life support.

From the examples above, it is clear that unchecked state aid has the potential to distort competition in a very significant manner. This should be incentive enough for government, in consultation with the competition authorities and other stakeholders, to introduce some measures of state aid control that speak to the Competition Act. The South African Competition Act is currently only concerned with anti-competitive effects arising from coordinated conduct between firms (cartels), unilateral abusive conduct by firms and anti-competitive mergers.

Although a legislative amendment may be a step too far, it is proposed that the government, through the competition authorities, create a system that facilitates the assessment of the potential effects of state aid on competition. In this check system, all proposed state aid above a certain threshold, particularly state aid that is provided discriminatingly or on a selective basis, should be referred to the competition authorities for assessment and approval prior to implementation.

Request for information

In this regard, to ease the burden on the competition authorities, the de minimis principle would apply. Under this system, the competition authorities could be empowered to request more information from the notifying party or government department to facilitate the decision making process.

Proposed state aid that could potentially distort competition in a significant way without being justified by reasons of general economic development should be referred to an in-depth investigation. After the in-depth investigation, the competition authorities could come to three possible decisions:

• Positive decision: where the proposed state aid is approved;
  
• Conditional decision: where the proposed state aid is approved with conditions;
  
• Negative decision: where the state aid is disallowed because it distorts competition in a significant manner without any corresponding gains outweighing the harm.

As discussed above, unchecked state aid has the potential to significantly distort competition by harming rivals, to the detriment of consumers. On the other hand, state aid can also be a necessary tool to remedy a market failure. The recent global economic crisis has reaffirmed the view that markets do not always perform as they ought to, nor does free and unregulated competition always deliver the most socially desirable outcomes.

In light of this tension and to avoid undesirable market outcomes, proposed state aid above a particular threshold must be subjected to checks and balances. The manner in which such checks and balances can be designed must involve all stakeholders in the conversation, in particular the competition authorities as guardians of healthy, competitive markets.