White Paper on the South African Defence Related Industries

The Department of Defence (DoD) prepared a White Paper on Defence, which was approved by Parliament in May 1996 and forms the policy framework for defence. Chapter Seven of the White Paper on Defence addressed arms control and the defence related industries, and stated that government wouldprepare a White Paper on the defence industry. The DoD began such preparations within the context of the Defence Review, which built upon the policy framework of the White Paper on Defence.

On 21 August 1996 Cabinet tasked the National Conventional Arms Control Committee (NCACC) to initiate and oversee the preparation of a White Paper on the South African defence industry. On 12 November 1996 the NCACC set out ina memorandum what the broad contents of the White Paper should be. These are reflected in the chapters in this White Paper: some of the topics put forward by the NCACC have been synthesised while others have been expanded.

AIM

The primary aim of this White Paper is to review the role, nature and current status of defence industries in South Africa, to provide government’s vision for the future of the future of these industries and to prepare policy options for the governance of the industries and for those areas critical to their continued viability. The White Paper deals with the following subjects:

DEFINING THE DEFENCE INDUSTRY/ DEFENCE RELATED INDUSTRY

The term `defence industry’ is widely used internationally, sometimes interchangeably with `armaments industry’ and ‘defence suppliers’. However, the term ‘defence-related industries’ in some ways more accurately describes the focus of this White Paper, since there is a growing tendency for companies producing defence equipment to make use of civilian technologies, or to manufacture dual-use products which can be sold to both defence and non-defence markets. There is also an increasing overlap between defence and civilian production within companies, both nationally and internationally.

While there is no clearly defined ‘defence industry’ as a distinct industrial sector, it is evident that the production of armaments for use by national defence forces, and related activities, requires special control measures by governments and forms an identifiable cluster of activities which are recognisable globally and to which some specific economic and political processes apply.

For the purposes of this paper, South African defence-related industries are defined as those clusters of organisations in the public and private sector, and commercial companies and business units of such organisations, which are directly or indirectly active in the provision of goods and services to security forces which are defined as armaments. This provision can include research, design, development, production, assembly, test, evaluation, upgrading, procurement, export, import, maintenance, logistical support, human support or project management. The defence-related industries are mainly involved in the material, mechanical, electrical, electronic and chemical sectors of the manufacturing industry and produce armaments for both domestic and international clients.

Armaments are defined as any vessels, vehicles, aircraft, ammunition and weapons, as well as substances, materials, raw materials, components, equipment systems, articles, techniques or services, that are designed, modified or adapted to be utilised to equip, maintain or support security operations, or which are usedin the development, manufacture or maintenance of such armaments.

Throughout this White Paper the term ‘defence-related industries’ is used and not the term ‘defence industry’. This White Paper does not view the South African defence industrial capability as a distinct sector of the economy. It adopts the approach of addressing this capability as an integral part of the South African industrial base. The Green Paper identifies and addresses defence related capabilities and technologies within South Africa’s industrial base and seeks to apply a generic industrial strategy to these capabilities and technologies. A specific industrial strategy is adopted only for those key technologies and capabilities which are considered by government to be strategic for national defence.

GOVERNMENT’S VISION FOR DEFENCE RELATED INDUSTRIES

Government recognises that defence related industries are an integral part of South Africa's defence capability. Government also recognises the strategic and defence value of having a local defence industrial capability. However, due to budgetary constraints, and within the framework of broader national industrial strategy, government will be very selective of which technologies and capabilities are to be retained on the basis that they are strategic or that they constitute a national asset.

The South African Government, as a responsible member of the international community, perceives South African defence industrial capabilities as being singularly different from other components of the national industrial base for two reasons.

METHODOLOGY

The NCACC appointed a Steering Committee to oversee the execution and management of the research and writing process for the White Paper, with representation from:

A number of position papers and research reports were generated by experts, stakeholders and interest groups. These reports were synthesised into the White Paper, which went through several drafts, in close consultation with the steering committee and the NCACC.

CHAPTER ONE

NATIONAL POLICY FRAMEWORK

THE CONSTITUTION OF THE REPUBLIC OF SOUTH AFRICA

The Constitution envisages South Africa to be a sovereign, democratic state, founded on the following values:

The Constitution provides for the establishment of a defence force that must be structured and managed as a disciplined force and whose primary object is to defend the people and territorial integrity of South Africa, in accordance with the Constitution and international law regulating the use of force (Section 200 (1) and (2)).

The Constitution states that all persons have the right to freedom of expression, including freedom of the press, freedom to receive or impart ideas, academic freedom and freedom of scientific research (Section 16) and that fundamental human rights may only be limited to the extent that the limitation is reasonable and justifiable in an open and democratic society based on human dignity, equality and freedom (Section 36 (1) and (2)).

The Constitution requires that when organs of state contract for goods or services, they must do so in accordance with national or provincial legislation that establishes a system which is fair, equitable, transparent, competitive and cost-effective. This does not prevent the implementation of a procurement policy by organs of state providing for categories of preference in the allocation of contracts, and the protection or advancement of persons, or categories of persons, disadvantaged by unfair discrimination. National legislation must prescribe a framework within which this policy may be implemented (Section 217 (1) to (3)).

The Constitution declares four governing principles which pertain to national security (Section 198 (a) to (d)):

WHITE PAPER ON DEFENCE

The White Paper on Defence (as approved by Parliament on 14 May 1996) sees security as an all encompassing condition in which individual citizens live in freedom, peace and safety; participate fully in the process of governance; enjoy the protection of fundamental rights; have access to resources and the basic necessities of life; and inhabit an environment which is not detrimental to their health and well-being (Chapter 2: par. 2).

The national objectives of security policy therefore encompass the consolidation of democracy; the achievement of social justice, economic development and a safe environment; and a substantial reduction in the levels of crime, violence and political instability. Stability and development are regarded as inextricably linked and mutually reinforcing (Chapter 2: par. 3).

The greatest threats to the security of the South African people are socio-economic problems such as poverty and unemployment, poor education, the lack of housing and the absence of adequate social services, as well as the high level of crime and violence (Chapter: 2 par. 5).

The White Paper on Defence states that the SANDF shall be a balanced, modern, affordable and technologically advanced military force, capable of executing its tasks effectively and efficiently (Chapter 2: par. 11.7). It further states that the government will not endanger the lives of military personnel through the provision of inadequate or inferior weapons and equipment (Chapter 3: par. 43.6).

The White Paper states that the SANDF has to maintain a core defence capability because of the inherent unpredictability of the future. Such a capability cannot be created from scratch should the need suddenly arise. The maintenance and development of weapons systems is a long-term endeavour (Chapter 4: par. 6.2).

The White Paper notes that deterrence requires the existence of a defence capability which is sufficiently credible to inhibit potential aggressors. Although South Africa is not confronted by any foreseeable external military threat, this capability cannot be turned on and off like a tap. It is therefore necessary to maintain a core defence capability (Chapter 5: par. 7). A core defence capability includes a balanced and sustainable nucleus with, amongst other features, the maintenance and, where necessary, the adequate and appropriate upgrading or replacement of equipment and weaponry (Chapter 5: par. 8).

The White Paper states that the services of an efficient domestic defence industry are required to address these needs (maintenance, upgrading and, where necessary, the replacement of weapons and equipment) and enable the SANDF to meet its constitutional obligations (Chapter 8: par. 3).

The industry will permit the cost-effective purchase of certain products and systems, ensure the life-cycle maintenance and support of such systems, and perform refurbishment and upgrades of existing equipment. (Chapter 8: par. 3). The defence equipment required by the SANDF, however, cannot and should not be procured exclusively from the local industry. Many complex systems cannot be produced domestically and will have to be imported. Management expertise for the specialised procurement functions is located within the DoD (Chapter 8: par. 5).

The White Paper recognises that the government might be called upon by neighbouring countries to play a number of supportive roles. The SANDF could, for example, provide assistance as regards the maintenance and upgrading of weaponry and equipment (Chapter 4: par. 20).

The White Paper indicates that South Africa’s consideration of involvement in specific peace support operations will not be limited to the possible deployment of troops. The involvement could also take the form of providing equipment, logistical support, engineering services, communications systems and medical personnel facilities (Chapter 5: par. 25). The acquisition and maintenance of military equipment shall take account of the particular requirements of peace support operations (Chapter 5: par. 26).

The White Paper states that the approval of major weapons procurement projects is the prerogative of Parliament on an annual and long-term basis (Chapter 7: par. 5).

The White Paper requires the Defence Review to present, for the consideration of Parliament and the public, detailed and well-motivated budgetary forecasts and proposals; specific policies regarding the provisioning of logistic resources; and the identification of appropriate technology to optimise the cost-effectiveness of the core force (Chapter 7: par. 6).

It is stated that within budgetary constraints, the DoD will engage in co-operative ventures with its counterparts throughout the world in such fields as training and education, defence planning, exchange visits, combined exercises and procurement of arms and equipment (Chapter 4: par. 6.3).

The White Paper states that in circumstances of diminishing domestic defence expenditure and falling global arms sales, the industry will be encouraged to convert production capability to civilian manufacture without losing key technology capability needed for military production (Chapter 8: par 2).

The White Paper states explicitly that the defence industry must have access to international markets in order to facilitate cost-effective performance and reduce the unit costs of producing items for the SANDF (Chapter 8: par. 4). The government will support the export initiatives of the defence industry by permitting it to contract and honour obligations which have been duly approved (Chapter 8: par. 11).

Chapter 8 of the White Paper deals specifically with arms control. On 30 August 1995, Cabinet approved new interim policy on arms control. Chapter 8 of the White Paper is based largely on that policy, as contained in the Cabinet memorandum on the ‘Rationale and Proposed Principles Governing Conventional Arms Control’ (Chapter 8: par. 1).

The White Paper establishes a number of principles and guidelines governing conventional arms trade. In essence, these require that:

The principles stated in the White Paper on Defence are in alignment with the NCACC Rationale and Principles which state that the government will take the following into account when evaluating arms sales:

The White Paper on Defence established certain arms control processes and structures. Conventional armaments and related technology may not be imported, transferred through South Africa, or marketed or exported abroad without a duly approved permit. The applications shall be subject to a multi-departmental review process. The NCACC will serve as the ministerial control, policy and decision-making authority. An independent Inspectorate will be established to ensure that all levels of the process are subject to scrutiny and oversight (Chapter 8: par. 18-27).

The White Paper states that South Africa is committed to the international cause of non-proliferation of weapons of mass destruction (i.e. nuclear, biological and chemical weapons and related technology, as well as advanced missile systems and missiles as defined by the Missile Technology Control Regime) (Chapter 8: par.. 28 - 38).

THE DEFENCE REVIEW

The White Paper on Defence provided for a Defence Review, the aim of which was to elaborate on the policy framework through comprehensive long-range planning on such matters as posture, doctrine, force design, force levels, logistic support, armaments, equipment, human resources and funding. More specifically, the White Paper provided that the Review would encompass the following:

The absence of any immediate military threat to South Africa, the low probability of a significant threat within the foreseeable future, the reductions in the defence budget since 1989 and the likelihood that the budget will remain restricted for some time, have created a situation where the maintenance of extensive military capabilities is neither necessary nor affordable. The Defence Review therefore defines the minimum force level that can be maintained as a growth core, in accordance with the core force approach, without the permanent loss of capabilities.

The Defence Review deals with a number of policy matters relevant to defence related industries, such as:

WHITE PAPER ON SCIENCE AND TECHNOLOGY

The White Paper on Science and Technology deals with defence research. It notes that although South Africa’s industries allocate considerable financial resources to research and development (R&D), the balance of trade in medium and high technologies remains negative (Section 8.2.5). A notable exception is the armaments industry, which currently has a positive annual balance of trade.

The White Paper on Science and Technology states that the essence of the new strategy of the SANDF is to convert the current force into a small, but technologically more capable one. The reliance on quality intelligence will be high to allow for the timeous scaling-up of the force to meet potential threats, as will be dependence on a broad technology base (Section 8.2.5).

Insurance against threats will take the form of maintaining small, but sophisticated forces which can be mobilised quickly and which rely on technology to increase the flexibility and responsiveness of a smaller military establishment (Section 8.2.5).

The White Paper on Science and Technology (Section 8.2.5) notes that the maintenance of a strong technology base is a prerequisite of the new SANDF strategy and must serve a number of purposes, namely:

The White Paper on Science and Technology states that the future of the South African defence industry cannot be seen as distinct from that of its civilian manufacturing counterpart and that dual concepts should be understood and applied. The view that defence technology should be phased out in favour of civilian technology, or converted into it, is not tenable. Instead, the defence industry must make special efforts to leverage spin-offs in the civilian sector and to develop relationships with civilian institutions in the National Science Initiative (NSI) to promote spin-on’s (Section 8.2.5).

The White Paper on Science and Technology states that the Department of Defence, Department of Arts, Culture, Science & Technology and the Department of Trade and Industry should co-operate closely to develop a strategy for optimal promotion of the local defence industry (Section 8.2.5).

The Defence Research and Development Board budget should be displayed in the government science, education and technology (SET) budget, as well as in the Department of Defence budget. This would give government and the public the opportunity to evaluate the entire SET spend in an non-fragmented way (Section 8.2.5).

FOREIGN POLICY ON ARMS TRANSFERS

South Africa's destiny is inextricably linked to that of the region and the continent (Foreign Policy Framework for Southern Africa: Section 1.2). To achieve lasting peace and security, South Africa will actively promote its foreign policy principles. South Africa will, within the Southern African region, promote respect for human rights and democracy. South Africa will be guided by the principles of justice and international law (Foreign Policy Framework for Southern Africa: Section 1.2.2).

The Department of Foreign Affairs aims to develop regional policy through negotiations and mutual co-ordination. (Foreign Policy Framework for Southern Africa: Section 2.1.1).

Government will support the export initiatives of defence related industries by permitting them to contract and honour obligations which have been duly approved in terms of the national arms control system. Government shall however reserve the right to prohibit or withdraw such support should it be in conflict with or irreconcilable with international or national interest at any given time (NCACC Rationale and Principles).

SOUTH AFRICAN MACRO-ECONOMIC AND INDUSTRIAL POLICY

The Department of Trade and Industry is responsible for the general well-being of South Africa’s industrial base, its general trade and contribution to economic growth, and establishing and promoting trade relations within the international community.

From an economic point of view, the government is committed to the basic principles of fiscal and monetary discipline. Furthermore, there has been a fundamental shift in trade and industry policy from an inward orientated, import substitution approach to an outward orientated approach focusing on the achievement of international competitiveness. Government announced, in support of these basic principles, a framework for sustainable growth and development with an outward orientation - the Growth, Employment and Redistribution strategy (GEAR).

GEAR

Central to the GEAR strategy is the enhancement of non-gold exports, increased private sector investments (with a primary focus on increasing labour opportunities), development of infrastructure and improved service delivery. Key ingredients which impact specifically on defence related industries include, amongst others:

GEAR intends to lead off with the sale of non-strategic assets and the development of public-private partnerships in transport and communications. Strategic equity partnership arrangements, rather than full-scale privatisation, is envisaged for large public corporations.

The GEAR programme includes the restructuring of state assets which could include the reorganisation of assets into new companies, privatisation, strategic equity partnerships, and a suitable range of related actions.

Industrial policy in South Africa is undergoing an historic change in direction. Previously, the key concern was self-sufficiency, largely for political and strategic reasons. In this context industrial policy was largely focused on demand-side incentives (e.g. tariffs, subsidies, quotas), through which firms were encouraged to produce for a highly protected domestic market.

Today the major focus of industrial policy is towards providing long-term improvements in employment and wealth creation in South Africa, through the creation of a sustainable, internationally competitive manufacturing base. In order to achieve this, industrial policy has shifted from demand-side incentives towards supply-side measures, which are designed to lower unit costs, and encourage firms to invest in products and processes that are internationally competitive.

This supply-side approach is intended to revitalise South African industry and to expedite the country's evolutionary progress up the so-called value chain towards competitiveness in more skills-intensive and technology-intensive products.

Historically, defence related industries, because of their strategic importance in the context of United Nations arms embargoes against South Africa, benefited from a high degree of direct and indirect support from government. The support that these industries received from government was determined by strategic not economic considerations.

As a result of its previous privileged access to state resources, defence related industries developed into some of the most significant parts of South Africa's industrial base. Thy also became some of the country's leading producers and exporters of high value-added and technology-intensive products. Government no longer regards defence related industries as being unique, although they will be treated differently to other industries in some respects for the following reasons:

Defence related industries are an integral part of South Africa’s industrial base. National industrial policy is therefore applicable in its entirety to these industries, except in those key strategic areas where national defence priorities indicate a deviation from such policy. These exceptions are limited solely to those strategic technologies and capabilities which are crucial to the national defence interest.

National industrial policy is aimed at the promotion of industrial expansion, employment creation, exports, small business development and black empowerment and contains a number of policy directions impacting on defence related industries.

The Department of Trade and Industry (DTI) is responsible for formulating and implementing national industrial policy in South Africa. However, none of its policy initiatives are specifically directed toward defence related industries. Small, medium and micro enterprises (SMMEs) engaged in defence production, particularly those that are owned or managed by individuals from previously disadvantaged communities, should benefit significantly from many of these industrial policy initiatives.

Supply-Side Support Measures. The supply-side support measure (SSM) agenda has several elements, which contain a range of strategies and programmes. A key area of the SSM is technology promotion or innovation support.

Investment Support. Investment support is designed as an incentive fore relatively labour-intensive manufacturing industries, to support industrial growth in regions of existing or potential high agglomeration economies and to support new investments in SMME's. As described below, this support takes a number of forms.

As already noted in this paper, the White Paper on Science and Technology touches on several aspects relevant to defence related industries. It indicates that the balance of trade in medium and high technologies remains negative, with the exception of the armaments industry, which highlights the importance of defence related industries in maintaining the overall technology base. It confirms the importance of a strong local technology base as an essential component of the core force concept and lists several capabilities required to support the SANDF strategy.

National Industrial Participation Programme. The mission of the programme is to leverage economic benefits and support development of South African industry by effectively utilising government procurement.

PROPOSED NATIONAL PROCUREMENT POLICY

In April 1997 the Ministry of Finance and the Ministry of Public Works issued a Green Paper on Public Sector Procurement Reform in South Africa. It seeks to enable small, medium and micro enterprises (SMME’s) easier access to the public sector tendering system. Government recognises the important role of SMME’s in the macro-economic development of the country. In the past, the tendering system favoured larger and more established businesses, and the Green Paper seeks to level the playing field.

The Green Paper proposes that the current state and provincial tender boards are abolished and that these are replaced with Procurement Centres at departmental and provincial level. It is envisaged that these are overseen at national level by a Procurement Compliance Office. In effect each Director General will be empowered to conduct all departmental procurement.

Government is the largest single purchaser of goods and services in the country, and as such government procurement must support South Africa’s overall macro-economic objectives.

The Green Paper has a number of socio-economic objectives which have significant implications for defence related industries and the manner in which the DoD conducts its procurements. The objectives include:

When this document is adopted, the Secretary for Defence, as Head of Department in the DoD, will be empowered to conduct all DoD acquisition and procurement.

OTHER POLICIES

The following legal and policy frameworks are also relevant to the defence industry and have been taken into consideration in this White Paper:

CHAPTER TWO

OVERVIEW OF DEFENCE RELATED INDUSTRIES

HISTORY

The origins of the domestic defence related industries can be traced back to the 19th century, but it was only during the Second World War that substantial quantities of armaments were manufactured locally (5 770 armoured cars, 600 guns and 30 000 military vehicles) to support the Allied war effort. Local development of armaments was also undertaken: notable achievements were the MK1 armoured car and the JB1 radar. After the war most of the wartime factories converted to their pre-war civilian activities although a very modest defence industrial base was retained.

In the early 1960's the government decided to expand the defence related industries in the face of increasing international isolation as a result of apartheid and growing resistance domestically and in the region. At that stage armaments production was largely in the hands of private industry. The first step was the establishment in 1964 of a statutory body, the Armaments Production Board, that was responsible for both acquisition for the SADF and the establishment and management of public sector defence related industries. The Board was also tasked with the co-ordination of arms production in the private sector, and by the mid-1960's nearly 1000 private sector firms were involved in various aspects of domestic arms production.

In 1968 the Armaments Production Board was renamed the Armaments Board and tasked with the acquisition of armaments for the South African Defence Force, as well as ensuring the optimal utilisation of the private sector. In the same year the government established the Armaments Development and Production Corporation of South Africa (Armscor) (Act 57 of 1968), with the mandate to foster and develop South Africa’s domestic defence industry and to supervise the manufacture of armaments. During the next few years Armscor took over various private sector companies, such as Atlas Aircraft Corporation, and established a number of new production and research and development facilities.

Domestic production was also encouraged through the government’s support to strategic industries and its import-substitution drive. An important development during this period was the establishment of quality standards appropriate for the manufacture of military equipment. This had a profound effect on the lifting of quality standards in the manufacturing sector of the economy. Applied research and development capabilities were also greatly enhanced, especially through the National Institute for Defence Research of the Council for Scientific and Industrial Research (CSIR).

Increasing international opposition to apartheid, and world-wide demands for a mandatory arms embargo against South Africa prompted the government to embark on a major reorganisation and expansion of the domestic defence related industries during the mid-1970's. The rationale behind the establishment of Armscor was based primarily on the then government’s strategic concerns in the context of the United Nations’ arms embargo. The motivation for the establishment of Armscor was fundamentally strategic in nature, due primarily to the strategic concerns of the government of the day.

In 1976 the Armaments Board and Armscor were merged to form the Armaments Corporation of South Africa (Armscor), which assumed responsibility for the procurement and production of armaments for the SANDF.

The imposition of the United Nations' mandatory arms embargo against South Africa in November 1977 led to the establishment of new defence production facilities by Armscor in a drive for self-sufficiency in armaments. Armscor also became the state organisation used to break or circumvent imposed sanctions. The policy was to utilise the private sector industry wherever possible. Capabilities that already existed in the private sector, e.g. in the vehicle and electronics industries, were not duplicated. Armscor was primarily responsible for weapons systems development and integration, whereas the private sector supplied materials, components, subsystems and in many cases complete products. The major portion of South Africa’s defence related industries thus remained in the private sector.

The Armaments Development and Productions Act defined the mandate, roles and functions of Armscor. Armscor had three main tasks, namely manufacture of armaments, acquisition of armaments and arms control. A number of secondary functions existed. These included testing and evaluation, defence research and development, industrial development and the marketing and the sale of SADF excess stock.

Armscor played an important role in the overall co-ordination of the industry and was given the de facto mandate for developing policy for the industry. The Armscor Board acted as the state tender board for the acquisition of capital equipment in terms of the SADF’s Special Defence Account, as well as for the SA Police and other government departments such as the Prisons Services.

The establishment of product development capabilities was a major milestone during this period. An example of this was the establishment of Kentron in 1978, placing the missile development industry on a firm footing. This elevated the status of the manufacturing sector of the economy to that of a designing industry. The concentration on development of the defence sector, however, inevitably entailed opportunity costs for other sectors of the economy and on a macro-level the economy was probably adversely affected.

Armscor and the private sector defence related industries expanded rapidly during the 1980's as a result of South Africa’s military involvement in a number of regional conflicts (e.g. Angola). Completely new sectors of the defence related industries were established, and the capabilities of the general industrial base were vastly improved through substantial investment. During this period, about half of the rapidly increasing defence budget was allocated for the procurement of armaments.

As a result of massive state investment Armscor developed into one of the largest industrial groups in South Africa and by 1981 had assets of R2000 million, a yearly turnover of R1500 million and more than 25 000 employees. Armscor was also contracting more than 900 companies in the private sector, which employed about 120 000 people. System development capabilities were established: Armscor set up operational research and systems engineering facilities such as Milistan, Gennan and Armatron and the concept of system suppliers was introduced in the defence industrial base.

Due to the arms embargo, Armscor was obliged to adopt a number of uneconomic practices (stockpiling supplies of certain items and investment in R&D for commercially unviable production facilities). It also carried out covert and illegal activities (such as establishing front companies) to circumvent the embargo. The then government authorised chemical, biological and nuclear weapons programmes - the latter was carried out under the auspices of Armscor and resulted in the assembly of at least six nuclear devices. Most of these activities were carried out in secrecy, protected by legislation such as the Armaments Development and Production Act no 57 of 1968 (as amended). The Atomic Energy Corporation supplier the material for this endeavour.

To decrease unit costs for its local customers and to utilise excess capacity, Armscor entered the export market in 1982. Since the early 1980's the value of defence exports has increased substantially, and defence related industries are now some of the largest exporters of manufactured goods in the country. The relative success of South Africa’s arms export drive resulted in United Nations Security Council Resolution 558 of 1984 requesting all nations to refrain from purchasing armaments produced in South Africa.

By the late 1980's defence production had become one of the most significant activities in the country’s industrial base, both in terms of employment and contribution to the national economy. Defence related industries employed over 130 000 people directly and indirectly, which accounted for 9% of manufacturing employment. More than 3000 firms and business units (10% of all manufacturing establishments) in the public and private sector were involved in various aspects of defence production as contractors, sub-contractors and suppliers.

Defence production had also reached a relatively high degree of self-sufficiency by the end of the 1980's and most of the equipment requirements of the South African Defence Force (SADF) were met domestically. However, because of the country’s limited research and development resources, and the UN arms embargo, the local defence related industries did not try to reproduce or emulate the R&D which had already been carried out by the major Western arms producers. Instead the industries concentrated on acquiring a capacity for upgrading, modifying and modernising existing armaments and weapons systems.

By 1989 Armscor was ranked as one of the largest industrial companies in South Africa. It was ranked 30th in the country in terms of total assets (R2,5 billion) and fifth in the public sector after Eskom, Transnet, the Post Office and the Land Bank. It had a turnover of R3 200 million in 1989/90 and was ranked 15th in the country in terms of total employment with more than 30 000 employees.

The dramatic expansion of defence related industries, particularly during the late 1970's and throughout the 1980's, was informed by strategic as opposed to economic considerations, and occurred during a period when the economy was performing poorly. Thus, the development of the domestic industries imposed a substantial burden on the national economy and was a significant contributing factor to the country’s deteriorating economic performance in the 1970's and 1980's.

While defence related industries emerged as significant providers of jobs and skills during the 1970's and 1980's, most of these jobs were highly capital and skill intensive and thus inappropriate given South Africa’s factor endowments. These industries captured a disproportionate amount of the country’s scarce labour resources (10% of total scientists and engineers in the country in late 1980's), imposing costs on the more productive sectors of the economy and lowering the aggregate productivity of human capital.

The high levels of state investment in defence related industries during the 1970's and 1980's (including R&D spending) also crowded out both public and private sector investment in the more productive sectors of the civilian economy, and thereby contributed to the declining productivity and output performance of the manufacturing sector.

DEFENCE CUTS AND DOWNSIZING OF THE DEFENCE RELATED INDUSTRIES

Changes in the Strategic Environment

South Africa’s external strategic environment changed dramatically after 1989. The end of East-West contestation was accompanied by a reduction in ideological tensions within and amongst African countries, by significant moves towards political pluralism in Southern Africa and by the end of apartheid in South Africa. These developments contributed to the resolution of most of the region’s historical conflicts and, especially after South Africa had set itself on the road to democracy, provided opportunities for countries in the region to reduce their levels of military spending and implement disarmament measures, including the demobilisation of former combatants.

These interlinked processes of democratisation and disarmament, which occurred in many countries in the region, had a positive impact on the South African state’s threat perceptions, and this lead to dramatic changes in the country’s defence and foreign policies and a rapid decline in the defence budget.

Between 1989/90 and 1997/98 the defence budget declined by over 50% in real terms, while the acquisition budget (the Special Defence Account) declined by over 80% in real terms during the same period. In 1997/98 acquisition spending accounted for 20% of the defence budget, down from nearly 60% in 1989/90.

The dramatic cuts in defence spending have had a major impact on domestic defence related industries, which have been forced to downsize and restructure as a result of the cancellation or postponement of defence contracts, resulting in the retrenchment of large numbers of workers since the late 1980's.

During 1990 and 1991 Armscor made representations to Government to commercialise some of its industrial facilities. It was felt at the time that most of Armscor’s industrial facilities could be utilised for commercial purposes, while still being available as manufacturing resources capable of supplying the country’s defence needs.

On 1 April 1992 Armscor was divided into two separate organisations. A new state-owned industrial company called Denel Pty (Ltd) was established under the Companies Act as a commercial enterprise reporting to the Minister of Public Enterprises. Armscor was thus involved in the production of armaments up until 1992, when its manufacturing capability was transferred in Denel.

Armscor however remained responsible for acquisition management, defence industrial development policy and arms control. Armscor contracted Denel in the same way as it contracted private sector companies. Armscor carried out no manufacturing activities, but remained responsible for acquisition for the South African National Defence Force (SANDF) and, to a lesser extent, for the South African Police Service (SAPS) and South African Correctional Services.

In 1995, as a result of the Cameron Commission reports, and especially the recommendations from the Modise Commission (resulting in a Cabinet Memorandum on 30 August 1995), the roles and functions of Armscor with respect to the import and export of conventional arms were transferred to the National Conventional Arms Control Committee (NCACC).

Two of the three primary roles of Armscor have been transferred (production to Denel in 1992 and arms control to the NCACC in 1995) thus focussing Armscor on acquisition management and the management of certain strategic capabilities on behalf of the DoD through its subsidiary companies.

During 1996, Armscor, with the cooperation of the DoD, conducted an investigation into the roles and functions of Armscor. This investigation made proposals with regard to the management and execution of the DoD's acquisition function. The roles, functions, structure, division of responsibilities, organisational positioning and interface between the SANDF, Defence Secretariat, Armscor and the defence industry were addressed. This was published as the MODAC 1- 4 reports, which were approved by the Minister of Defence.

The Current Role of Armscor

The South African Defence Review, approved by Parliament in April 1998, addressed the role and function of Armscor in Chapter Nine (Force Structure) and in Chapter Thirteen (Acquisition Management Process). The Defence Review envisages an integrated Department of Defence Headquarters which includes the Defence Secretary, C SANDF and the Chiefs of the Corporate Divisions. Armscor resides outside of this integrated headquarters, though the Chairperson of Armscor reports to the Minister of Defence in the same manner as the Defence Secretary and the C SANDF do.

The Defence Review states that there will be a state corporation as an Acquisition Agency of the DoD, this being consistent with the MODAC 1 - 4 Reports. Armscor, as the designated acquisition agency of the DoD, is today responsible for professional program management and the drafting of tender documentation for the contracting of industry on behalf of the DoD during the execution of armament acquisition programmes. It ensures that the technical, financial and legal integrity in contract management are in accordance with DoD requirements. The DoD and Armscor also jointly oversee industrial development of the industry, in order to support DoD acquisition programmes and the retention of strategic defence technologies and capabilities.

Once projects have been approved by the Armaments Acquisition Council (AAC), Armscor places contracts on industry for project execution. All such contracts are authorised by formal Contracts Authorisation Committees with respect to legal, financial and technical integrity, as well as the integrity of the contractor selection process. The composition of these Authorisation Committees reflect appropriate representation of all relevant stakeholders.

Organised Defence Industry is timeously involved in the acquisition process in order to ensure local defence industry participation and industrial cost-effective solutions for the DoD’s requirements. All technical review teams include, where appropriate, members from Armscor, the Defence Secretariat, and the SANDF.

The Armscor Board serves as a decision making board for tender adjudication (Special Defence Account) and ensures that all contractual obligations of project management are in accordance with national procurement legislation and are in the national interest.

The DoD Transformation Project may make further recommendations to the Minister of Defence to adjust or change the present acquisition approval process as indicated in the MODAC studies. On acceptance by Parliament of the proposals of the Green Paper on Public Procurement, and the final re-engineering of the DoD acquisition function, the Armaments Development and Production Act must be reviewed to reflect the new functions and authority of the Armscor Board and the roles, powers and responsibilities of the DoD’s acquisition Agency.

The transformation of Armscor must be driven by two government imperatives, namely the attainment of efficiency and economy in acquisition management and the fostering of civil control and accountability.

DEFENCE RELATED INDUSTRIES TODAY

Characteristics

Defence related industries comprise various organisations, companies and business units such as:

The firms and companies involved in defence work vary in size considerably. Most have sales of less than R100 million per year, and at least a third have sales of less than R10 million per year. Hardly any of these companies carry out defence work exclusively and for most of them it is a relatively small part of their business.

Table 2.1 Performance of the Four Largest Defence Manufacturers [1996/7]

	REUNERT	ALTECH	GRINTEK	DENEL
Turnover	Rm 4742	Rm 1593	Rm 2044	Rm 3013
*Defence as % of turnover*	18%	10%	11%	69%

Note
Figures: Rand million in constant 1990 prices. (Figures in italics are in %.)

Cross-contracting and sub-contracting are important features of defence related industries. Although only the larger companies can usually act as main contractors, much of the work is contracted out, to the point where the value added by the main contractor may be a minor fraction of the total value of the project. Much of the value therefore trickles down to smaller companies, including many commercial suppliers which are not considered armaments producers.

Government is the sole domestic client for defence business, and most of its contracts are placed by Armscor. Over 90 per cent of these contracts are accounted for by companies that are members of the South African Aerospace, Maritime and Defence Industries Association (AMD).

Armscor currently has contracts with approximately 700 local firms and companies, which act as contractors, sub-contractors and suppliers of armaments and non-defence goods and services.

Over 80 % of defence work takes place in Gauteng Province, mostly in the Johannesburg/Pretoria area. Other areas of concentration include Durban/Pinetown and Cape Town and vicinity.

SOUTH AFRICAN DEFENCE MARKET

The domestic defence related industries have undergone a dramatic process of downsizing and restructuring since the late 1980's. The industry has become increasingly concentrated, as many small and medium-sized companies have gone out of business, exited the defence market, merged with, or been acquired by larger private sector companies.

The size of the overall defence market, as measured by total Armscor acquisition spending, declined by nearly 70 % in real terms between 1989/90 and 1996/97 with an average decline of 15% per annum. The decline in the size of the market has been reflected in massive reductions in the value and volume of domestic arms production.

Imports are not a large portion of defence industrial inputs, representing about 14% of total purchases in 1996/97 (R483m). This is primarily due to the past requirement for maximum self-sufficiency, and the fact that Armscor imports directly when necessary. The value and share of imports has declined in line with the cuts in acquisition spending. The share of imports averaged 20 % between 1989 and 1996.

The domestic defence market, as measured by domestic acquisition spending, declined by over 50% between 1989/90 and 1996/97, with an average decline of 10% per annum. This decline is directly attributable to the defence budget cuts of over 50 % during this period. Purchases by Armscor from the local defence related industries peaked at R3,6 billion in 1989/90 (1990 Rands), declining to R1,7 billion in 1996/97.

State-owned Denel and three large private sector industrial groups - Altech, Reunert and Grintek, currently dominate the domestic defence market. These 4 companies account for over 90% of domestic acquisition spending.

Denel is the largest defence-related company in South Africa, both in terms of the value of its defence sales, and its dependence on defence sales. Its sales account for nearly half the domestic market. The three major private sector defence-related groups, Reunert, Altech and Grintek, account for the other 40 %. The remaining 10 % is accounted for by hundreds of small and medium firms.

Accurate statistics on the size of defence related industries are difficult to arrive at, as it is often impossible to separate civilian and defence work. According to a survey of AMD member companies carried out in 1996 total South African defence sales (including exports) amounted to R 4 083 million.

Table 2.2: South African Defence Market, 1989/90-1996/97

YEAR	TOTAL MARKET*	*% CHANGE*	IMPORTS/ TOTAL (%)	DOMESTIC MARKET +	*% CHANGE*	DOMESTIC/ TOTAL (%)
1989/90	6236		42	3618		58
1990/91	5126	-17.8	42	2973	-17.8	58
1991/92	3931	-23.3	21	3123	5.1	79
1992/93	3242	-17.5	17	2696	-13.7	83
1993/94	3162	-2.5	17	2625	-2.6	83
1994/95	2427	-23.2	14	2093	-20.3	86
1995/96	2167	-10.7	17	1808	-13.6	83
1996/97	1984	-8.4	14	1707	-5.6	86
AVERAGE 1989 - 1996		-14.8	23		-9.8	77

Notes
Figures: Rand million in constant 1990 prices. (Figures in italics are in %.)
Source: Armscor; Armscor Annual Report (various years)
* Based on total value of Armscor Acquisition Spending for Departments of Defence, Safety and Security (Police) and Correctional Services (Prisons).
+ Value of Domestic Acquisition Spending

The contribution of defence related industries to the national economy has also declined since the late 1980's. The value of domestic arms production in total manufacturing output has declined from nearly 7% in 1989 to around 3% in 1996, and as a share of gross domestic product (GDP) from 1.5% in 1989 to less than 1% in 1996.

Restructuring, Downsizing and Diversification

Companies involved in defence production have survived during this period of defence cuts by increasing defence and other exports, and by diversifying into civilian production.

Denel and the three large private sector defence-related groups have significantly reduced their dependence on defence sales since the late 1980's. Denel’s share of defence sales in turnover was 64% in 1996/97, down from nearly 80% at the time of its formation in 1992.

In a recent AMD survey, defence work accounted for less than 20 per cent of turnover in three-quarters of the companies involved in such work.

Sales of civilian manufactured products by AMD members, as a result of diversification, more than doubled over the period 1992 to 1996: in these companies defence sales accounted for 76% of total sales in 1992 but only 54% in 1996.

Defence Exports and the International Market

The value of defence exports has increased quite substantially as a result of the decline in domestic demand for armaments, and the lifting of the UN arms embargoes against South Africa. The value of exports (in 1990 prices) increased from R163 million in 1990 to R721 million in 1995 before declining to R345 million in 1996.

By 1995, nearly 29% of the defence output of AMD member companies was exported, although a third of these companies were not exporting at all and most companies were exporting less than a quarter of their output.

Table 2.3 Export Permit Values: Comparative Figures, 1995-97.

	1995		1996		1997
AREA	Rm	% of Total	Rm	% of Total	Rm	% of Total
Africa	70.96	8	175.20	31	106.42	8
Europe (Inc. CIS & Israel)	43.67	5	107.90	19	253.23	18
Far East	91.65	11	103.40	18	809.44	58
Middle East	477.28	57	82.00	15	73.85	5
Americas	160.20	19	90.60	16	143.37	10
TOTAL	Rm 843.76	*100*	Rm 559.00	*100*	Rm 1 386.31	*100*

Note
Figures: Rand million in current prices. (Figures in italics are in %)
Source: Directorate Conventional Arms Control, Department of Defence

Despite the increases in defence exports between 1990 and 1995, South Africa is a very minor player in the international armaments market. Its contribution to the world trade in conventional arms is less than half of one per cent, and appears to be declining even further. An analysis of the value of defence exports (as measured by the value of export permits) since 1995, is given in table 2.3.

Government actively supports the export of South African defence products and state resources are used to maintain the country’s defence export infrastructure. A portion of Armscor’s operating subsidy from the defence budget is used to maintain overseas offices, to provide international marketing support, and to assist the participation of South African firms at international defence exhibitions. Ministers also use their overseas visits to promote South African defence products.

The South African defence related industries has followed the global trend towards multi-national defence industrial co-operation. International joint ventures and strategic alliances have been established with defence-related companies in 20 different countries. The UK tops the list, followed by France, and there are a significant number of joint ventures with companies in the USA, Germany and Malaysia.

The Department of Defence and Defence Related Industries

Despite the growing emphasis on the export market, the DoD remains the largest, and in many cases the only, client for defence products and services. In 1996/97 the DoD purchased nearly R3 billion in products and services domestically, which accounted for over 85% of its total acquisition spending. Most of the products purchased are developed to the specific requirements of the SANDF, which funds roughly half the R&D carried out by the defence related industry and therefore owns much of the immaterial property rights. Following a global trend, the SANDF also contracts out a large portion of its logistic and operational support. Defence related industries thus become indispensable to the SANDF’s logistic and operational capability, both during times of peace and war.

The DoD believes that domestic defence related industries may help to maintain independence from possible foreign coercion in times of tension. In certain strategic areas, such as electronic warfare and secure communications, and when equipment needs to be developed specifically for local conditions, systems and services are not available on the international market. Preference is therefore given to the procurement of defence products and services from local suppliers, providing such procurement represents good value for money.

A key concept in the acquisition of armaments is derived from systems theory, which defines a hierarchy of systems and subsystems as shown in the following table. Acquisition takes place at all the levels of the hierarchy and each level supplies to the next higher level. The DoD is primarily responsible for system acquisition at levels 8, 7 and 6; Armscor is responsible for acquisition of level 5 systems, while the suppliers in industry are the acquiring parties at the lower levels.

Table 2.4 Systems Hierarchy as used in the DoD and SANDF.

System designation	Level	Configuration Example
		SA Army	SA Air Force	SA Navy
Operational force	8	National Defence Force	National Defence Force	National Defence Force
Combat grouping	7	Joint Combat Force	Joint Combat Force	Joint Combat Force
User system	6	Operationaly ready regiments, battalions etc with main equipment, facilities, personnel and own logistic support systems	Aircraft, facilities, personnel and support systems of SA Air Force squadron	Naval vessels, facilities, personnel and support systems of Naval Fleet and bases
Product system	5	Tanks, infantry fighting vehicles, artillery guns, AA guns, simulators and own logistic support equipment	Aircraft, weapons, flight simulator and logistic support equipment	Ships, submarines, weapon systems, simulators and logistic support equipment
Product	4	Tanks, infantry fighting vehicles, artillery guns, AA guns etc	Aircraft	Ships and submarines and platforms
Product subsystem	3	Platforms, engines, radars and radios	Engine, airframe and avionics	Hulls, main propulsion systems, combat suite and sub systems
Component	2	Instruments, transmitters and recievers	Instruments, turbine blades, undercarriage	Instruments, propellors and sonar transducers, PC boards
Characteristic/ materials/process	1	Castings, aluminum, titanium, carbon fibre	Castings, aluminum, titanium, carbon fibre	Castings, aluminum, titanum, carbon fibre

Core Competencies

The major competency of Denel and the three major private sector defence related groups is overall system or sub-system design, development, integration and testing. Most of the actual manufacture and assembly is sub-contracted out to more specialised industries which are part of the country’s general industrial base. Many of the systems (such as attack helicopters or main battle tanks) are very complex systems, requiring complex project management and competent design, development, production and upgrade capabilities.

Local defence related industries have developed a strong set of core competencies in the following three main areas, although there is also significant competence in vehicle systems, simulators, unmanned aircraft and logistics:

In part as a result of the arms embargo which made major equipment purchases almost impossible, South African defence related industries are today world leaders in the field of upgrading outdated systems, in many cases resulting in significant exports. It is possible to keep systems in service much longer than their normal life expectancy, through effective maintenance programmes and life extension developments. This enables large reductions in cost to be attained.

Research and Development and Technology

Expenditure on defence research and development (R&D) has declined by more than 70 % in real terms since the beginning of this decade. In 1996/97 R329m was spent on R&D from the defence budget, down from nearly R1 billion in 1989/90 (in constant 1990 prices). Defence R&D spending currently accounts for 5% of the total defence budget, down from nearly 9% in the late 1980's. In the context of these budgetary constraints, local defence firms have been forced to fund an increasing amount of defence R&D from their own sources.

While the cuts in defence R&D spending since the late 1980's have not been accompanied by significant increases in total R&D spending in the South African economy, there has been an improvement in South Africa’s innovative activity (as measured by patenting activity) during the same period. This suggests that the crowding out of civilian innovative activity, which may have occurred during the 1980's when defence R&D was at very high levels, may be being reversed.

The National Research and Technology Audit, covering 1996/97, aimed to provide information to be used as the basis for policies directed at increasing the effectiveness of technological innovation as a contributor to productivity, economic growth, environmental sustainability and international competitiveness. Defence related industries were included in this audit.

The survey results indicated a high level of awareness of technologies within the defence related industries, with an emphasis on product technologies. In these industries, 94% of R&D investment was directed towards products (as opposed to processes, support or information), which was higher than in any of the other parts of the manufacturing sector. Only 11% of technology was outsourced, of which 7% was sourced abroad, a very low proportion compared to other parts of the manufacturing sector.

Respondents in defence related industries indicated that 18% of turnover was invested in R&D, considerably higher than any other sector. This was directly a result of research contracts placed by the SANDF, the funding for which came largely from the defence budget. All this money was spent locally, indicating little international co-operation in R&D.

Table 2.5: Defence R&D Expenditure, 1989/90-96/97

YEAR	DEFENCE R&D	% CHANGE	% OF DEFENCE BUDGET	TOTAL SA R&D SPENDING	DEFENCE/ TOTAL (%)
1989/90	985		8.6	2043	48.2
1990/91	793	-19.5	7.9
1991/92	580	-26.9	7.2	2455	23.6
1992/93	467	-19.5	6.1
1993/94	342	-26.8	5.2	1831	18.7
1994/95	342	0	4.8
1995/96	342	0	5.5
1996/97	329	-3.8	5.5
AVERAGE 1989 - 1990		-13.8	6.4

Notes
Figures: Rand million in 1990 prices. (Figures in italics are in %.)
Source: Armscor; Estimates of Expenditure; SA Science and Technology Indicators (Foundation for Research Development, various years).

It is difficult to accurately estimate the number of jobs linked to the defence industrial activity. However, it is estimated that direct and indirect employment currently amounts to approximately 76 000 people, down from a peak of over 130 000 in the late 1980's. Direct employment amounts to 26 000 including 15 000 in the public sector defence related industries. The dramatic cuts in defence spending have led to a large migration of skills and capacity from manufacturing industry in general and the defence related industries specifically.

The largest defence employer in the country is Denel with over 14 000 employees, while a significant number of small companies employ fewer than 20 people. Three-quarters of defence related industries comprise small, medium and micro enterprises (SMMEs).

More than half of all employees in defence related industries are engineers, scientists, technicians or artisans and the industries are currently staffed at most levels by white, largely male personnel. The lack of gender and ethnic diversity is particularly marked in the middle to senior management levels, as well as in all the technical fields.

VIABILITY OF DEFENCE RELATED INDUSTRIES

The cuts in the defence budget have had a dramatic impact on the profitability of defence related industries. Many firms have gone bankrupt, exited the defence market or been taken over or acquired by other firms. These developments, and the prospect of further cuts in defence spending, have raised concerns about the continued economic viability of defence related industries.

In order to illustrate the declining profitability of defence related industries the financial performance of Denel and two of the large private sector defence related groups (Reunert, Altech) is presented in the following paragraphs.

Since 1992 Denel’s financial performance (in terms of profitability and asset management) and productivity has not been particularly impressive. The poor performance of the company, particularly since 1995/96, has been a result of the severity of the cuts in defence spending, and the failure of a number of large potential export orders, which did not materialise for various reasons.

Turnover has declined in real terms by an average of 1.6% per annum since 1992, while operating profit has declined by an average of 13% per annum during the same period. The company made a net loss (for the first time since its existence) of R72 million in operating profit during 1996/97 and the company’s operating margin (operating profit/turnover) declined from a high of 8.1% in 1995/96 to –2.4% in 1996/97. The company’s net profit declined by nearly 78% in real terms from R442 million in 1995/96 to R95 million in 1996/97 (in constant 1996 prices). The company’s return on assets (net profit/turnover) declined from a high of 6% in 1995/96 to 1.7% in 1996/97.

The dividend that Denel pays to the state, its sole shareholder, has also declined by over 80% from R100 million in 1995/96 to R20 million in 1996/97 (in constant 1996 prices). Denel’s total employment has declined by an average of 2% per annum since its establishment in 1992, and total employment in 1996/97 was 14 200, down from 15 500 in 1992/93.

In terms of productivity, the company’s capital productivity, or capital output ratio (total assets/value added) declined by an average of nearly 6% per annum and showed no real improvement between 1992/93 and 1996/97. The company’s labour productivity or output-labour ratio (value added/employment) declined by an average of 6% per annum between 1992/93 and 1996/97, despite slight increases in 1993/94 and 1994/95. The capital intensity of the company, as measured by the capital labour ratio (total assets/employment) declined quite significantly after 1992 as a result of significant retrenchments and a revaluation of Denel’s assets in 1994/95 as a result of the termination of the space programme at Houwteq.