This paper examines the response of South African manufacturing production to changes in prices and exchange rates. A restricted profit function is used to model the behaviour of the manufacturing sector, as well as a number of manufacturing sub-sectors, and of the agricultural and coal mining sectors. Labour and intermediate imports are treated as variable inputs into the productions process. Capital is treated as a fixed input. Outputs of the production process are goods for the domestic market and exports. Using estimates derived from the restricted profit function, both price and exchange rate elasticities are calculated.
There are a number of key findings:
- For the manufacturing sector as a whole, prices do determine output supply and input demand. This is the case for most manufacturing sub-sectors and agricultural production.
- Manufacturing export supply is very inelastic with respect to export prices, as well as domestic prices and import prices and wages. This means that price changes have a very small impact on the amount of exports supplied.
- Changes in the price of intermediate imports or the price of domestic goods have a larger impact on the quantity of exports supplied than do changes in the price of exports.
- Like export supply, domestic output supply is also very inelastic.
- In most sectors exports and domestic output are compliments. This suggests that an increase in domestic price increases export supply and vice versa.
- Both domestic supply and exports respond negatively to an exchange rate devaluation. We suggest that this is the result of the increase in the price of intermediate imports caused by a devaluation. The magnitude of this reaction has decreased since 1994.
- A 25% devaluation in the nominal effective exchange rate of the Rand (a devaluation similar to that experienced at the end of 2001) causes a 2 percent decrease in total manufactured exports and a 5 percent contraction in domestic supply. However, a number of sectors benefit from this depreciation. The electrical, radio and TV and transport sectors expand exports by between 4 and 5 percent in response to this devaluation. Domestic supply falls in all these sectors.
The results of our estimations suggest three areas particularly relevant for policies designed to increase export supply and labour demand (and consequently decrease unemployment):
- Firstly, domestic prices (the price the producer receives in the domestic market) are one of the most important determinants of both export supply and labour demand. Policies which increase these prices will boost exports and the demand for labour. Policies which aim to increase firm efficiency, stimulate domestic demand, or decrease taxes should do this.
- Secondly, the price of intermediate imports has the largest effect on the quantity of exports produced. A decrease in this price through a reduction in tariffs would increase the quantity of exports and domestic goods produced. It would also increase labour demand.