Clyde Seepersad

Southern Africa Environment Project

October 1998.

PREAMBLE

This paper uses the social cost-benefit approach to compare two proposed projects in the Eastern Cape Province of South Africa. The first of these is to build a deep water harbour and IDZ on the outskirts of Port Elizabeth. This project is sanctioned by the Government, which is keen to promote economic development in a historically disadvantaged area. However, there have been many concerns raised about whether this is the right direction for development policy in this particular area. As a result, some economists have proposed an alternative project which is instead based on promoting agriculture and tourism in the province. This paper explores the decision of the South African government to support the IDZ/harbour rather than the agri-tourism model and compares this with the outcome which would have prevailed if the decision criteria had been different.

Unemployment and poverty are particularly high in the Eastern Cape and this paper argues that government policy should be primarily geared towards alleviating these phenomena. Considerations such as maximising GDP growth and foreign exchange earning remain important but must be subject to an over-riding concern for the most disadvantaged members of society, especially when mutually exclusive alternatives are being evaluated. In light of this, the proposed projects are subjected to a Social Cost-Benefit Analysis (SCBA) in order to determine their impact on the different socio-economic groups in addition to their overall impact on the Eastern Cape. Although both projects will have an impact throughout the country, this paper considers only the effects within the Eastern Cape, partially because of the difficulty in estimating the appropriate parameters but also because our priority of poverty reduction requires that alternatives be evaluated on the basis of their actual effect ‘on the ground’ rather than at the more abstract national level.

The Eastern Cape Province has been identified by the Government as one of the provinces most in need of socio-economic development. According to the Ministry of Welfare (1998), the Eastern Cape has the highest number of households living in poverty, with 72% of households being classified as poor. In addition, only 19% of the population of workforce age in the poorest regions have regular work. The Government’s 1997 White Paper on Social Welfare further states that:

For over a decade, unemployment in the Eastern Cape has been on the rise. This was exacerbated by the pull out of Ford and General Motors in 1986 (in response to the trade sanctions against the apartheid regime), since the motor companies had previously employed a large number of people. The Central Statistical Services (1998) show that unemployment in the province was 48.5% in October 1996, which represents a total of 742,427 unemployed persons. This position is exacerbated by the fact that, 42.3% of the Eastern Cape population have not completed primary school and a further 41.7% have not completed secondary school. The evidence is that the majority of the unemployed fall into one of these two categories. The 1994 October Household Survey (CSS 1994) found that of the then total of 799,335 unemployed persons, 735,481 (92%) were not trained or skilled for specific work and 789,743 (98.8%) had no post-school qualification. Since 1994, it is likely that the situation has deteriorated even further. The wide ranging changes required in the education system in order to address the root of this problem are, however, beyond the scope of this paper. What we can say is that, the unemployment situation can only be solved in the short to medium term by creating a large number of unskilled jobs.

During the latter half of 1996, there was a proposal by two companies, Gencor and Kynoch, to establish an industrial complex in South Africa. Several sites were evaluated and the one at Coega was chosen. In response to this opportunity, the government declared the formation of the Coega IDZ. Gencor would build and operate a zinc smelter and Kynoch would put up a phosphoric acid plant whose feedstock would be the sulphuric acid by-product of the zinc smelter. An integral aspect of the proposal is that deep-water harbour facilities will have to be available within close range of the proposed facility.

There is an existing harbour at PE but this would have required extensive modification in order to support the increased traffic and there is already some concern that the port, which is located right next to the Central Business District, is an eyesore which impacts negatively on the tourism potential of PE. As a result, it was decided that a new port should be built next to the IDZ, on the mouth of the Coega river. The construction of a new deep water harbour has therefore became an integral part of the IDZ concept.

One of the most attractive aspects of this project from the government’s point of view is the level of employment which will be created during the construction of the port and the factories. Pakes (1997), in the preliminary economic assessment of the project, estimated that employment generated within the Eastern Cape during construction would peak at 16,000 of which roughly 8,600 were direct jobs. The remaining jobs would be created indirectly because of the need for support services to the main contractors. Indirect jobs would also comprise the majority of the employment created by the operation of the various facilities since direct employment is only expected to reach 1,100. It should be noted, however, that the majority of the jobs during the construction phase will only exist for the first three years of the project and that the figures given are peak levels which endure for even shorter periods. The actual job creation potential of the IDZ is therefore much lower than it initially appears.

While, Gencor/Kynoch were to be the anchor tenants at the IDZ, the hope is that this will lead to the establishment of a cluster of industries on the site. If construction of new facilities continues as new tenants come on-site, the relatively high level of direct employment would continue. In addition, an expanded number of tenants on the IDZ would facilitate the creation of many more indirect jobs in the service provision sector. As at the end of August 1998, however, no new tenants had made a commitment to the IDZ. In fact, Kynoch withdrew entirely during early 1998, thereby reducing the expected employment at the site. It should also be noted that all the studies done to date have included the impact of a proposed cement plant. Pakes (1997) states that the cement company has indicated that construction of the new plant would go ahead regardless of whether the IDZ gets off the ground. The inclusion of this plant in the calculations of the impact of the IDZ cannot therefore be justified in the context of this paper. While the inclusion of the cement plant is consistent with an appraisal of the IDZ from the developers point of view, the government (whose perspective this paper attempts to replicate) would ignore it in assessing the options, since the plant would be built under either scenario.

Another aspect of the project is that the construction of the Coega port will allow many of the unattractive ‘back of port’ facilities at the current port to be relocated there. The facilities referred to include stockpiles of certain materials as well as several large holding tanks. The relocation will have the added advantage of freeing up an area of waterfront for tourism oriented development. A hotel/casino is proposed for the area that will be created as a result.

The Coega project will require the Government to commit 1.5 billion Rand towards construction of the port and IDZ infrastructure. Since tenants would receive a package of fiscal incentives including tax holidays and customs exemptions government receipts from taxation will be relatively low and only start occurring several years after the start of the project.

There are two current operations which would have to be closed if the IDZ plan goes ahead. The first of these is a salt works located on the Coega river estuary and which has 136 employees, most of whom are relatively unskilled. The second is an abalone (perlemoen) farm which could not continue in operation once the pristine waters of Algoa bay are affected by polluted run off from the IDZ and higher silt levels as a result of increased shipping. It seems likely that both these facilities could be successfully relocated to sites within the Eastern Cape. The cost of relocation is treated as a cost of the IDZ option.

In response to the perceived inadequacy of the Coega project to address the needs of the unemployed masses, an alternative project has been outlined. The starting point for the analysis is a paper by Hosking (1997) which outlines the developments that would form part of the project and quantifies their effects.

The Coega river basin and a site on the banks of the nearby Swartkops river called the Logan Braes (which has been specially set aside for black farmers), have the potential to be prime agricultural sites. The Eastern Cape already has a very successful citrus industry which could be easily extended into these two areas. The only constraint is the reliable availabilty of water. The study done on the bulk water requirements of the completed IDZ and port estimates that the capital cost of the infrastructure required to service the estate with up to 98 Ml/day would be 366 million Rand (Silva McGillivray 1997). The agri-tourism option argues that the government could spend some money on the water infrastructure but direct the water towards establishing agricultural projects in the Lower Coega and Logan Braes river basins.

Hosking estimates that the agricultural option provides 188 direct jobs for each million litres of water compared to just 56 direct jobs for the Coega project. The annual income of the Coega project per million litres is 4.4 million Rand while the corresponding figure for agriculture is 20.4 million Rand. This paper uses the Hosking scenario which is based on 49.5 Ml/day of water being available. This would allow 600 hectares at Lower Coega and 2,500 hectares at Logan Braes to be brought into citrus production. The approximate cost, based on the Silva McGillivray report, would be 115.42 million Rand (Appendix 1)

There has also been a proposal by a consortium of business parties called Umtha Welanga to build a 700 million Rand recreation complex on an area of land which overlaps the IDZ/harbour site. The project would include a hotel, casino, water park and a golf course. The fully operational complex would provide direct employment for over 2,400 persons. The establishment of a successful complex could stimulate the development of similar projects in the surrounding area.

Since there are a fixed number of casino licences available within the Eastern Cape, it is likely that an alternative project will be realised if Umtha Welanga fails to go ahead. However, this paper treats the waterfront casino proposed under the Coega option as being the relevant alternative. The figures for both projects are therefore included in the relevant project analysis (with the waterfront project estimated to be half the size of Umtha Welanga).

In general terms, government is concerned with raising the standard of living in a country. In recent times, inter-generational concerns have also been highlighted, resulting in an increased focus on sustainable development. The World Commission on Environment and Development (WCED 1987) put this concept onto the front burner and defined sustainable development as that (sic) which provides for the needs of the current generation without compromising the ability of future generations to meet their own needs. The WCED also noted that poverty in developing countries contributes to unsustainable development practices and that economic growth which reduces poverty must be part of the solution. In this respect, the WCED broadened the sustainable development debate to include both intra-generational and inter-generational concerns.

In light of the current situation in the Eastern Cape, the primary objective must be economic growth which is targeted at the reduction of unemployment and poverty. While the overall growth of the South African economy is an important part of the Government’s strategy, it is the engine behind the growth which must be considered. With 72% of households living in poverty and nearly 50% of the population unemployed, the Eastern Cape cannot afford to pursue a strategy which results in ‘jobless growth’.

The cost-benefit approach has been the traditional way of conducting project evaluation . The method seeks to identify the incremental costs and benefits which occur over time as the result of a project and uses some form of discounting to consolidate these into a measure of whether or not the project will create value. Initially, the costs and benefits which were utilised were those which had a direct financial impact on the evaluating body. However, this resulted in substantial externalities being ignored, leading to a situation where projects were being approved even though they destroyed value when looked at from the perspective of society as a whole. The externalities involved include direct costs/benefits to other parties (such as extra medical or reduced transport costs) as well as indirect effects such as the loss of welfare from having to live next to an industrial site or the negative impact on the quality of the environment. In response to these concerns, the cost-benefit approach has been widened to enable decision makers to consider the full range of impacts of a proposed project. The major items which can now be included in an analysis are environmental impacts of a project on aspects such air and water pollution and threats to the existence of wildlife. Concern for the physical environment is an integral part of the sustainable development concept.

Even with these refinements, there was a further concern about the overall impact of a project on different socio-economic groups. The difficulty with the traditional cost-benefit measure is that it treats all income effects equally, regardless of which socio-economic group it accrues to. While this may be justified in terms of Pareto efficiency, government should have a clear preference for extra income to the poor rather than to the wealthy. According to Angelsen (1994), a SCBA refers to ‘the method developed around 1970, in which each cost and benefit component of a project is weighted with distributional weights’ which are negatively correlated with the income of the affected group. This aspect recognises that the costs and benefits of a project will not be evenly spread between the different socio-economic groups and gives a higher weighting to those items which affect the poor.

There are four main steps in conducting an SCBA instead of a ‘traditional’ cost-benefit. These are:

1. Identifying all the relevant costs and benefits

2. Quantifying these costs and benefits

3. Developing a weighting system to recognise the impact on different groups

4. Arriving at an appropriate discount rate

The last two of these present particular problems. Firstly, given the lack of available data on economic parameters which would normally be used in coming up with a weighting system, this paper uses a simpler, but intuitively attractive approach. Income groups are split into ‘poor’, ‘average’ and ‘rich’. The weighting given to each group is the inverse of its income as compared to the ‘average’. Thus, if the poor received only a quarter of the average income, the weighting of income/costs to the poor would be four times as much as for the average. In this paper, the poor are defined as earning less than 30,000 Rand per annum and the rich as earning more than 70,000 Rand per annum. In the circumstances, the following income figures (based on figures given in the KPMG Cost benefit analysis) were used:

Secondly, the discount rate has been set at the level used by the Coega project’s consultants. Since the basis of the paper is to uncover the commercial reality of the alternative projects, the rate used by commercial consultants would seem to be the valid one. This also ensures that the results are free from the suspicion of bias that might arise if a different figure were utilised. The discount rate used is 8%.

The following table summarises the costs and benefits of the Coega project as it relates to the three income groups (details at Appendix 2):

The figures for the agri-tourism option are:

These results demonstrate quite clearly the danger of relying on traditional cost benefit analysis when making policy decisions about alternative projects. The agri-tourism option generates a net benefit of R4.62 Billion, once we take the weightings of income to different groups into account. This is substantially larger than the R3.71 Billion that is generated by the Coega project.

When the impact of the alternatives on the poorest members of society is taken into account, the difference is staggering. Agri-tourism would generate R913 Million in benefits to the poorest members of society (those earning less than R30,000 p.a.) while Coega can only muster R245 Million. In other words, the agri-tourism option would leave the poor people of the Eastern Cape four times better off than the currently preferred Coega option!

The employment results (detailed in Tables 2 and 3, Appendix II) are just as dramatic. Total employment under the agri-tourism option peaks at just over 5,500 persons and is maintained consistently after 2004. In contrast, Coega employment peaks in the first year at 12,376 but this lasts for just one year and falls rapidly until reaching its long term value of just 1,200 in 2006. The employment impact of the agri-tourism option is nearly five times that of Coega. What is even more remarkable is that these figures do not include any multiplier effects for agri-tourism while the corresponding figures for Coega have been scaled up by 60%. Even under this extremely conservative scenario, it is quite clear that Coega is the inferior project from the point of view of society as a whole (instead of just the developers).

South Africa has thrown off the shackles of apartheid and is slowly charting a course for a future in which all her citizens will be free from enforced poverty and deprivation. An important step along the way must be the provision of opportunities for socio-economic advancement to the black majority which has been denied these for so long. The creation of such opportunities requires progressive government policy in the areas of education, health and housing, many of which the current regime has already put in place. Nevertheless, no plan of action can be complete without taking into account the strategies needed to address the critical problems of poverty and unemployment.

It is not enough for the government to pursue strategies which raise GDP and bring in more foreign exchange. Unemployment and poverty are the joint enemies of social upliftment and must be at the forefront of any effort to create the ‘new’ South Africa. It is precisely because it ignores the employment and net income effects on different socio-economic groups that this paper has argued against the traditional cost-benefit analysis, of the kind carried out in evaluating the Coega proposal. What is needed is a tool, such as SCBA, which explicitly puts these concerns at the heart of the decision process.

The above analysis shows quite clearly that the preferred project should be the agri-tourism option. Even with the extremely conservative assessment, which treated the multiplier effect of the agri-tourism option as being zero, the employment generated is almost five times that of the Coega alternative. When we look at the total value (i.e. weighted NPV) of the alternatives, the agri-tourism option generates R4.6 Billion, compared to R3.7 Billion for Coega, i.e. it would represent a 25% improvement. More starkly, the positive impact on the poorest section of the community is almost four times as much as for the Coega project.

By ignoring the social distribution of the project, the current decision making framework is sacrificing the massively increased benefits to the poor for the very small absolute increase in the income generated by the Coega option. This is precisely the type of decision which South Africa can ill afford if it is to deliver to its citizens the promise of a better tomorrow.

This paper has looked at the Coega project from a perspective of giving priority to addressing unemployment and poverty. It finds that the project appears attractive from the investors point of view. However, the government would be failing to discharge its responsibility if it relied solely on the traditional cost-benefit framework to come to a decision when faced with the choice between Coega and the agri-tourism option. The wider point is that a method such as SCBA can, and should, play a major part in the project appraisal process of the Government, not only of South Africa, but of any country concerned to give a fair deal to its most disadvantaged citizens.

References:

Angelsen A., Fjeldstad O. and Sumaila U.R., 1994. Project Appraisal and sustainability in Less Developed Countries, Christian Michelsen Institute, Development and Human Rights Studies, Report 1994: 1

Angelsen A. and Sumaila U. R., 1995. Hard Methods for Soft Policies; Environmental and Social Cost-Benefit Analysis, Christian Michelsen Institute, Development Studies and Human Rights, Working Paper 1995: 1

Central Statistical Services (CSS), 1994. October Household Survey 1994: Eastern Cape.

CSS, 1998. 1996 census results at http://www.css.gov.za/censuspr/Population.htm.

Erasmus J., 1996. Eastern Cape: A human development profile. Development Bank of South Africa, Centre for Policy and Information. Development Paper 108.

Hosking, S., Exploring the economics of an alternative to the Coega IDZ and harbour project. Unpublished paper based on an Environmental Education Task Group Seminar at the University of Port Elizabeth on July 31, 1997.

Ministry of Welfare and Population Development, 1998. White Paper on population policy for South Africa. Pp 16-18.

Pakes T. and Nel H., 1997. Coega Industrial Development Zone and port - preliminary economic assessment. Specialist Report for Coega SEA. Department of Economics, University of Port Elizabeth. Report Ref: CEE

Silva McGillivray Incorporated, May 1997. Bulk Water Supply Infrastructure Requirements. Private report commissioned by the Coega IDZ Initiative. Report Reference: CTW 1041/2.

World Commission on Environment and Development (WECD). 1987. Our common future, Oxford: OUP

List of Abbreviations

IDZ Industrial Development Zone

PE Port Elizabeth

SEA Strategic Environmental Assessment

EIA Environmental Impact Assessment

PEA Preliminary Economic Assessment

tpa Tonnes per annum

SCBA Social Cost-Benefit Analysis

CBA Cost-Benefit Analysis

DBSA Development Bank of South Africa

SDI Spatial Development Initiative

NPV Net Present Value

Appendix I - Cost of water supply to Lower Coega and Logan Braes.

These figures are based on the costs estimated using section 5 of the Silva McGillivray report and could provide up to 100Ml/day:

APPENDIX II - CALCULATIONS OF PRESENT VALUES

Table 1 - Present value of wages under agri-tourism model.

The assumptions are that :

1. 80% of wages go to unskilled (poor) labour with the balance to ‘average’ labour. Rich workers get all their remuneration from profits.

2. 40% of permanent income goes towards wages

3. Growth path for employment is as shown on Table 2

Table 2 - Underlying figures for income and employment under agri-tourism model

Table 3 - Employment generated by Coega