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14 May 2008

Introduction

Madame Speaker
Honourable members
Board Members and Executives of the State Owned Enterprises
Ladies and gentlemen

It is my privilege to be able to address you for the fifth time in regard to Vote 30 - the Department of Public Enterprises (DPE). It is also my pleasure to welcome Sivuyile Ngcizela and Heibri Engel, two of the four students from the University of the Western Cape who are recipients of a scholarship from the Department. Addressing the country's skills shortage, in the current context of a growing global economy, where employees skilled in the critical areas of maths and science are in high demand, is an important initiative by government. We hope that these students, who are currently studying towards their B.Com Honours, will be an asset to our country, and will use their acquired knowledge and skills for the advancement of our economy, and the betterment of our people.

This year's Budget Vote is an appropriate point to reflect on what has been achieved, and on the challenges and opportunities that we will bequeath the next administration. It is also my intention to raise matters for consideration by the new administration in the years ahead. The task that we set the DPE and the State Owned Enterprises (SOE) reporting to it in 2004 was to restructure the SOE so as to focus on their core mandate and to strengthen their ability to deliver on that mandate.

However, as is inevitably the case when one embarks on a difficult journey, we did not envisage all of its twists and turns. We have come through four years of intense and intriguing work which I would summarise as follows:

* Without exception the Boards and Management of the SOE have dealt very well with the ever-expanding volume of work and the growing complexities that confronted them. This applies equally to the Department and to the Portfolio and Select Committees in Parliament. The progress made has been very positive.

* We have learnt hard lessons on the cost to the economy of underinvestment in infrastructure and its maintenance. We have come to better understand the very powerful developmental role that effective SOE can play and I feel confident that we have developed sound proposals on the concept of a Government Shareholder Management Model (GSMM). I believe that this model also provides important food for thought on the oversight role and capacity of Parliament in relation to the SOE.

Finally, all of the SOE reporting to DPE are at a critical stage in their development and can advance or fall back depending on what actions are taken at this juncture. The balance sheets of SOE involved in the infrastructure build programmes are stretched to the limit – all retained earnings are being ploughed back into the enterprise, which is further leveraged in an attempt to optimise its balance sheet. Failure to provide a coherent regulatory environment and adequate capital can have negative consequences both on the SOE and our economy's growth prospects. It is my view that we face a key strategic decision to support and invest in the SOE. They are a powerful engine of a developmental state, and I have no doubt that they can play a decisive role in the future growth and development of our economy.

In this address, I will focus on these lessons that we have learnt, and on the proposals we make for the future. The South African Power Project is one of such examples. I have also made available to the honourable members a financial performance review of the past five years for each of the SOE reporting to the Department.

Planning for growth

The Accelerated and Shared Growth Initiative for South Africa (AsgiSA) announced in 2004 set two important targets – a 6 percent growth rate and the sharing of that growth. What soon became evident was that neither the public nor private sector had actually planned for this higher growth rate. This became clearer as the investment plans of the SOE were developed and reviewed. The first key question we had to answer was how do we actually plan for growth? Do we take past trends and project them forward, which is the more conservative path, or do we undertake an act of will and assume that we will grow at 6 percent, and then work backwards to see what our infrastructure needs will be?

Reflecting on our experience over the last four years, the DPE would be a firm supporter and proponent of a centralised planning capacity in government (as is being considered) that is proactive and works backwards from the targeted objectives. Changes in the economy and technological advancements have created many opportunities for discontinuities in growth, so that growth is not just a standard linear relationship between past actions and the future. The risks to the economy from not being prepared for higher rates of growth are too high. If growth outstrips capacity a number of serious problems emerge and they do so rapidly:

* The first is that the growth is choked off early if bottlenecks in infrastructure occur. This leads to stop-start growth, low confidence in the prospects of growth, and a resultant underinvestment in capacity.

* Secondly, as growth rises, the pressure on infrastructure leads to rising equipment and infrastructure failure rates and exposes weaknesses in that infrastructure, further eroding confidence. This has occurred in both rail and electricity over the last few years. Our experience has shown that catching up with maintenance requirements and building new capacity places great strain on organisational capacity and skill requirements.

* Lastly, since the lead time for infrastructure construction is lengthy, the stop-start effects over a number of years cannot be corrected quickly. 'Growth years' are wasted and this is a serious setback for development in an economy like South Africa. It leads to growing infrastructure backlogs, a loss of opportunities to create employment and reduce poverty, and inevitably socioeconomic tension. We must plan to prevent this in the future.

The importance of effective SOE is that they can drive the investment required to promote growth. The tendency in the private sector is to respond to growth rather than to lead it. However, for the SOE to carry out this function they need to be financially strong and work within a carefully defined regulatory environment. What is essential in the latter is that an appropriate growth-orientated economic model must underpin the specific rules that the regulators must implement.

The importance of detailed and co-ordinated planning for growth is not only evident in infrastructure. The same logic applies in the areas of advanced, technologically-driven manufacturing. Over the last four years strategic decisions have been taken for South Africa to enter these advanced manufacturing areas. For the DPE this is specifically in Denel, the Pebble Bed Modular Reactor (PBMR), the wider nuclear industry, in the form of Eskom's Pressurised Water Reactor Programme, and in new carbon emission reduction technologies. Our experience is showing that detailed and long range plans have to be made that incorporate the energies of both the public and private sector if success is to be attained. Piecemeal and episodic attempts do not provide the critical mass of science, technology, investment and skill to compete with other economies that are co-ordinating their effort.

In short, an effective developmental state has to have a long-range planning capacity that is cogent, coherent and capable of dealing with complexity and detail over many years. In the implementation of these plans, strong, effective SOE, working in partnership with the private sector, play the decisive role.

SOE as agents of development

The work done begins to expose the full potential of the SOE as agents of economic development – indeed as being in the vanguard of a developmental state. Economic development is the active creation of processes and programmes that bring into being new economic activities that did not exist in the economy before – new capacities, products, technologies and infrastructure. Such new capacities would not arise from the ordinary workings of national and global markets, and require specific interventions by the State. We are learning that effective SOE are a potentially powerful agent for such state intervention. This potential resides in their operation as modern enterprises. By this we mean that their decision-making processes, financial, accounting and managerial systems are well understood by the global market place. They operate within the market disciplines of capital and product markets and they compete with global counterparts (this also applies to the infrastructure SOE).

However, they differ from privately owned enterprises in that their shareholder is the State and the State has, or should have, long-term developmental objectives rather than short-term market driven objectives. A sophisticated balance has to be struck between ensuring that the strategic intent of the State is met whilst ensuring that the enterprise can sustain itself in a commercial environment. Achieving this balance for the SOE will endow them with three critical advantages as effective forms of State intervention:

* They have the ability to raise capital and financing on the capital markets utilising a far greater range of instruments than that available to the national fiscus. This allows the State to focus its revenue on public expenditures that cannot easily be addressed through market related economic activity. The fiscus may still be expected to support struggling SOE or to fund new growth, but as a standard, these entities trade off their balance sheets.

* They have the ability to partner with global companies that can provide additional capital and rapid access to new strategic technologies, business processes and markets. Such access allows development to proceed at a far quicker pace and in a wider scope than that which can be achieved in national isolation (the same can be said for partnership with the domestic private sector). In carrying out these activities they become the most effective form of technology transfer from more advanced economies, and they form a very powerful platform for driving technology penetration and generation in the South African economy.

* There are a variety of established enterprise management practices that have been developed to rapidly align incentives and accountability within the organisation so as to operate sustainably within the disciplines imposed by a market environment. This enables the efficient mobilisation and co-ordination of resources within the enterprise in ways that would be extremely difficult to achieve within the context of the public service. The State is able to use the modern enterprise - one of the most powerful institutions driving the global economy – to carry out strategic developmental objectives.

However, to take advantage of these properties of a modern enterprise, a sophisticated system of governance has to be developed, and it is necessary to introduce the required dynamism and flexibility to manoeuvre within the market.

Challenges and opportunities

As I indicated in my summary of the lessons learnt, all the SOE reporting to the DPE are at a critical point in their development. This may seem odd in the light of the fact that some of them, such as Transnet and Eskom, are now mature enterprises. The critical nature of the current position is, however, not years of existence, but current circumstance. South Africa's economy has to accelerate and share its growth if we are to establish a society with both political and economic freedom. This growth depends on us developing new capacities, technologies, products and infrastructure. This imperative occurs in the dynamic conditions of globalisation, where many economies are striving to achieve the same developmental objectives – China, India, Brazil and Russia are all massive and world changing economies.

Let me illustrate the issues at hand by looking at the current challenges we face with the supply of electricity. At the rate at which our economy is growing, we have to double our generating capacity over the next twenty years. However, as we do this we have to take into account the need to reduce our carbon emissions, which means that we have to diversify our primary energy sources away from coal. This imposes immense challenges in terms of the scale of the build and the need to introduce new technologies. In addition, we are not the only economy that is massively investing in its energy sector.

How should we respond to this challenge? Do we buy the equipment off the international shelves or do we attempt to industrialise and produce a significant portion of the equipment within the South African economy? Being merely a buyer has serious drawbacks - not only would we remain a price taker, but we become subject to the risk of the long supply queues, keeping us very vulnerable to international supply and economic conditions, and possibly lead to delays in our build programme, and certainly increase its cost. Furthermore, this will massively increase our import bill and worsen the balance of payments and exchange rate challenges we already face. If we want to use this opportunity to industrialise then it is crucial that we move now. We have to provide a clear plan and a predictable environment if we are to induce the global original equipment manufacturers (OEM) to locate production in South Africa, and thereby develop our national capacities.

We have to be prepared to co-invest and to develop a range of second, third and fourth-tier suppliers. The private sector and market forces alone will not be capable of such a long range strategic response. Yet it would be equally unwise to expect that Eskom should provide such a leadership role as this would stretch its resources and place its core tasks at risk. We need therefore, to consider new SOE and new partnerships with the private sector – both national and global, in order to leverage on the SOE build programme and its associated procurement.

Our challenge is to truly become a developmental state and find ways to seize the opportunities offered in all our key sectors, and not only the example of electricity that has been given. If we rely on the private sector and market forces alone, we will not develop or transform this economy. If we keep the SOE locked into rigid structures and do not adequately capitalise them, we will also lose these opportunities.

The conclusion that the DPE has come to over the last four years is that we need four important and related institutional changes to be made if the SOE are to fulfil their potential as agents of a developmental state. These are:

* an improved and harmonised system of governance of the SOE that balances strategic intent and commercial sustainability, whilst retaining the financial disciplines of the Public Finance Management Act (PFMA)

* the ability for the SOE to respond to dynamic change and to act as agents of development by allowing for an efficient mechanism to establish and restructure the SOE, whilst retaining the focus and discipline of the state's strategic intent

* an effective mechanism for the capitalisation of the SOE, whilst retaining the overall fiscal discipline and stability of the public sector, and

* a clearer definition and institutionalisation of parliamentary oversight, whilst retaining the logic of the shareholder relationship between the executive and the SOE.

All these institutional changes are possible and the proposals that the DPE is making can realise them. In what follows we briefly outline the essential architecture of these proposals.

The Government Shareholder Management Model (GSMM)

We are proposing the development of a new form of institutional governance within the South African State which we define as a Government Shareholder Management Model (GSMM). This builds on existing practices but accommodates the imperatives of modern enterprises. Enterprise ownership allows government to leverage well established and globally accepted institutional mechanisms to raise capital, develop productive capabilities, manufacture products and deliver services in the achievement of strategic national objectives. However, these advantages of an enterprise depend on the government conducting itself within the modern framework of a shareholder as it is understood in the market. What many states are now evolving towards is a model of the State as shareholder that combines the benefits of the resources and dynamism of markets with the long-term and public nature of the state's strategic ownership.

The GSMM seeks to integrate the principles and imperatives of commercial sustainability with strategic public intent. The three key principles of governance that impact on commercial sustainability are viability, predictability and transparency:

* Viability: Is the enterprise operating efficiently in a commercially viable manner? This involves an assessment of whether the scope and scale of the market will adequately compensate the enterprise for its investment in fixed and working capital, and whether incentives and sanctions are in place to ensure that the enterprise is operating at adequate levels of efficiency to earn these returns.

* Predictability: Are the governance systems designed in a manner that protects the commercial viability of the enterprise? This involves assessing whether there is, within the enterprise, a consistent process of effectively screening out non-commercially viable activities and practices, except when the organisation will be adequately subsidised for undertaking these activities. This requires clarity on the decision-making process, as well as the structure and apportionment of powers within the governance of the enterprise.

* Transparency: Does the enterprise provide accurate and reliable information on its performance – both its financial and operational health - in a manner that can be easily evaluated by the market? This requires internationally accepted financial, accounting and managerial practices.

The real innovation in contemporary SOE is the sophisticated introduction of public purpose and strategic state intent into the operation of an enterprise. Injecting these non-market and public objectives into the private sector capitalist market system is the underlying economic concept of a Government Shareholder Management Model. There is a delicate balance in that if the strategic purpose subverts commercial viability the enterprise will collapse, but if commercial considerations override the strategic purpose, government objectives will be compromised.

The GSSM proposes legislative and institutional changes in the following key areas:

* the institutionalisation of the practice of providing a precise definition of the State's strategic intent through a transparent mandate to SOE so as to promote accountability and improve the State's ability to optimise the value of its shareholding in strategic SOE

*the introduction of robust mechanisms to ensure accountability for operational performance in both the SOE and the state body responsible for shareholder oversight or management (the Executive Authority)

* the establishment of comprehensive policies to codify and harmonise shareholder practices across government so as to promote consistency in the corporate governance of SOE.

The GSMM integrates the process of enterprise oversight with its strategic intent in a manner that supports the principles of viability, predictability and transparency, thus ensuring enterprise commercial sustainability to the greatest extent possible. In addition, the GSMM establishes safeguards to ensure that when conflicts arise, they are resolved in a manner that protects the integrity of the organisation and its strategic intent. Furthermore, the GSMM creates mechanisms to ensure Board and Management accountability for enterprise performance in relation to the SOE strategic purpose, whilst at the same time holding the executive authority accountable to that same strategic intent.

Restructuring the Portfolio of SOE

The mechanisms for establishing new SOE are currently imprecisely defined and not uniform across government. The decision making process as to how public entities should be classified in terms of the PFMA is also unclear and the role of the National Treasury overrides Cabinet and other shareholder Departments. The process needs to be reformed. At present it is very hard to carry out corporate restructuring or form new SOE, and this rigidity militates against a dynamic response by SOE to changing conditions. The GSMM addresses this situation and following reforms in the Public Service Act, provides for a more flexible but disciplined approach to this matter.

The DPE is making an additional proposal that it, or a like-mandated department, should be charged with the management of a strategic 'Developmental Portfolio' of SOE. The current portfolio of SOE reporting to DPE offers this opportunity. Essentially this 'Developmental Portfolio' approach is built around the strategic management of the operation of the SOE in five areas of activity. The first is the strategic network infrastructure investment needs of the country (i.e. energy system, freight transport logistics and broadband infrastructure). The second is in the area of advanced manufacturing related to defence, aerospace and the supply chain requirement (capital goods and other input suppliers) of the network infrastructure. The third is from the portfolio of possible strategic research and development initiatives emerging from the SOE themselves. The fourth is from the portfolio of large national science projects from South Africa's research institutes. In this case, the objective is to develop to scale those innovations from South African research institutions which have global application and have potential to develop new industries or deepen existing areas. Finally, over time, it is expected that investments in other African economies will be included, especially in activities related to the network infrastructure system.

These five areas provide a framework for considering investments and partnerships with the private sector – both multinational and domestic. The investment activities within the 'Development Portfolio' are focussed around core areas of competence and located within a framework that strives for global competitiveness. The paper on the South African Power Project illustrates how this wide range of developmental activities can be co-ordinated.

Such a 'Developmental Portfolio' approach is possible and the building blocks are already in place. What is necessary is to bring about the institutional reforms that allow it to take place in a reasonable period of time. It is essential that we are alert to the fact that developments in other economies will soon foreclose many of the opportunities identified.

The capitalisation of State Owned Enterprises

If we accept the arguments outlined thus far that a reformed governance model for the SOE and a disciplined flexibility to restructure and form SOE will allow them to play a decisive role in a Developmental State, then we have to address how the State capitalises them.

The economics of public finance is the collection of revenue through taxation and borrowing by the State in order to carry out public purpose activities. In the post-Keynes era, such large revenues are also used for macroeconomic management purposes. Public purpose activities will require both current and capital expenditures. However, the management of capital and current expenditures is significantly different. Capital expenditure requires forward projection over the long term and also requires systems to ensure maintenance expenditure. Current expenditure is essentially about controls and disciplines over expenditure and cash management.

The very successful fiscal, budgetary and macroeconomic reforms since 1994 have focused in the main on fiscal discipline and macroeconomic management. The reasons for this and its validity are well known. However, there is a growing recognition that our systems of capital and maintenance budgeting have not been as well developed. In regard to the capitalisation of SOE, there are additional complexities. Capital expenditure on state budgets is in the main related to the level of services to the economy and citizens that the state aspires to provide.
Once this is determined, the required level of capital expenditure can be determined and the associated maintenance programme developed. The systems of planning and control are longer term and the expenditure patterns different to that of current expenditure.

As we have argued in this address the investment decisions of the SOE described are such that they lead the market and economic growth, and are designed to have a structural impact on the economy. Accordingly, State decisions to capitalise these SOE are more complex and strategic than regular capital expenditure. Specific budget mechanisms have to be developed for such decisions. In looking at international experience, other states are coming to similar conclusions, and the DPE has made proposals to deal with this in the GSMM.

Safcol and Alexkor

The finalisation of the land claim in the Richtersveld was a very important achievement, which is in large measure due to the courage and vision of the leaders of that community. This presents a very important opportunity to initiate a sustainable development process in the Richtersveld and the larger Namaqualand. The implementation of this agreement is no easy matter and I am very pleased with the initial progress being made. However, there is much still to be done in order to ensure that the mining rights are handed over to the community.

What is interesting about this experience is the prospect of an SOE acting as an agent for development within a regional economy. The partnership that we may be able to build between Alexkor and communities in the Northern Cape points to developmental possibilities that we should not lightly dismiss. In the case of South African Forestry Company (Ltd) (SAFCOL), the disposal of Komatiland Forests (KLF) is going to take longer than we thought due to the complexity of the land claims in the area. In the light of this we may well want to think of other strategic approaches and see if there is anything that we have learnt in the Richtersveld that could be applied in the case of SAFCOL.

The importance of unions

In 2004, I stressed the commitment of government to a strong trade union movement. I believe that this is even more important now as the opportunities and challenges of the investment programme unfold. It is my view that SOE should indeed be the leaders in labour market reform. Our objectives should be job security, excellent employment conditions, continuous training, high levels of skill and productivity and an ability to adjust to changing economic conditions without the burden of that adjustment unfairly falling onto workers.

We have recently started some initial exploratory discussions in this direction but in truth we have not made any progress. The relationship has continued to be dominated by the restructuring era where the prime concern of the unions was, correctly, to ensure the fair treatment and protection of their members. However, I am convinced that a new era is possible and that if taken advantage of, will massively enhance the developmental role of the SOE.

The SOE are gearing up their training capacity to play a key role in the future provision of skills in South Africa. However, we should take this opportunity to ensure that wider labour market improvements are made. A response to globalisation that is based on competition of low cost labour is not sustainable. However, traditional labour market structures were not developed in the fast changing environment that most economies are now faced with. We have to develop new structures that can combine equity, benefit, skill and flexibility. This is a critical challenge that has to be addressed by democracies.

The role of Parliament

The proposals being made by the DPE in regard to the GSMM will, if adopted, require innovations in our institutional structure. The GSMM defines a specific relationship between government as shareholder, the Board and Management of the enterprise. As already stated, this relationship is one that is well understood by global markets but does allow for the state to achieve strategic objectives through its ownership of the enterprise. The SOE are in the public sector and it is therefore imperative that Parliament has oversight powers. However, if these are not precisely defined then that very oversight could erode the shareholder relationship. The same applies to any imprecision in the relationship of shareholder Minister to the SOE.

We have to begin a more careful discussion on the precise role of Parliament in the oversight of the SOE. There are a number of factors that have to be taken into account:

* The first are practical issues of capacity and resources. The SOE operate within a complex commercial environment and management of these SOE is a specialist function. If the Parliamentary Committees are to carry out any form of oversight then they must have access to specialist capacity and will have to develop an analytical business skills-base within their ranks as well. Our MPs will not have to be experts in their own right, as not all non-executive directors are experts, but they will have to be experienced and knowledgeable in a number of fields. It is manifestly evident that the current resource base is inadequate – the Autumn School has proved to be a good initiative but it is only a beginning.

* Secondly, the SOE operate in a commercial environment where they have to contract with other parties on a commercial basis. Accordingly, information is sensitive and the means of its disclosure have to be well understood and on the same basis with other enterprises in the private sector. In addition there are SOE such as Denel and PBMR whose strategic activities are related to national security. It is necessary to find a relationship between the Executive and Parliament where such sensitivity is protected. Possibly the mechanisms used for intelligence oversight could be considered.

* The third issue is to define who is accountable: Are the management and boards of the SOE directly accountable to Parliament? Such a situation would be very problematic and few managers and skilled professionals would be prepared to accept such a widely defined line of reportage. The proposals made in the GSMM are designed to provide the basis for a clear line of reportage and accountability. An important innovation achieved through the statement of strategic intent is that the Executive Authority can also be held to account. This provides the basis for a relationship of accountability to Parliament. The Executive and Department are accountable to Parliament for the implementation of the strategic intent. Interaction with the SOE is for the purpose of understanding and information, and not to exercise authority over them.

If we can evolve to such a system of accountability we will add another critical dimension to institutional reform in our new democracy, allowing Parliament to effectively oversee and guide very complex and sophisticated economic operations.

Conclusion

For the SOE this is a time of challenge and opportunity. For Parliament it is a time to reflect and decide on the lessons learnt and to make farsighted decisions. It is a critical time and the thrust of this address is that careful consideration needs to be given to the role of the SOE. Parliament should reflect on its own role in this context where we are required to meet the pressing economic challenges and commercial pressures of the present conjuncture.

The last four years have been an intense time but rich in experience and innovative thinking. I must express the most sincere of thanks to the Boards and management of the SOE who, through their work and participation in the various forums established in the DPE, have allowed all of us to learn.

My respect and admiration for the Director-General and her team in DPE has grown with every hour of hard work and professional thought they have given in the most challenging of circumstances. They convince me that we have no shortage of exuberant talent in the public service if we marshal our resources well. The DPE team's commitment towards excellence and professionalism extends beyond the office environment. Our soccer team are the proud winners of the SuperSport Corporate Soccer League (Pretoria Region) – a title we hope to hold onto for the foreseeable future.

Finally on behalf of the DPE, I we wish to express our thanks to Fatima Chohan and the members of the Portfolio Committee. I can say without hesitation that you have been an inspiration to us as your knowledge, interest and commitment has driven us harder to ensure we meet your expectations. It has been a thoroughly invigorating experience. The loss of Ncumisa Kondlo was made all the sadder because of her constant unfailing support and the energy she added to our work. She is sorely missed.

I would like to pay special tribute to the President and Deputy President. We have had to deal with many crises and make some very difficult decisions. We would not have been able to do this without their counsel and support. I am confident that they provided this since they too are acutely conscious of how important the SOE are to the South African economy.

I end with an appeal to this august house that it consider the opportunities ahead and take the brave decisions needed to realise those opportunities and stave off the challenges.

I thank you and commend our budget for your support.

Issued by: Department of Public Enterprises
14 May 2008