The restructuring of South Africa's defence industry

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By Peter Batchelor and Paul dunne Centre for Conglict Resolution, University of Cape Town, South Africa and Middlesex University Business School, United Kingdom

Published in African Security Review Vol 7 No 6, 1998

South Africa’s transition to democracy and the ending of apartheid have been accompanied by a parallel process of demilitarisation, which has reversed the militarisation of South African society that occurred during the 1970s and 1980s. This process has had a number of different dimensions, including dramatic cuts in the defence budget, the ending of compulsory conscription for white males, the re-establishment of civilian control over the armed forces, and the implementation of various disarmament measures such as the termination of the country’s nuclear weapons programme.

These changes have also meant that South Africa’s domestic defence industry, which was built up in response to arms embargoes, has been forced into a process of downsizing and restructuring. This has led the industry to pursue a number of adjustment strategies, such as retrenchment of employees, increases in exports and diversification into civilian products, to minimise and survive the impact of the defence cuts.

Many of these changes have been occurring in a policy vacuum. There have been some policy initiatives that have altered the structure of the defence industrial base, such as the commercialisation of Armscor and the formation of Denel, and the introduction of more competitive procurement policies, but in general, the industry has been left to fend for itself. This makes the South African industry an interesting case study of defence industrial restructuring. It is an industry that was developed and maintained at great cost for strategic reasons during the apartheid era, but since the transition to democracy, it has lost much of its reason for existence, and has experienced unprecedented cuts in demand. At the same time, there has been little in the way of policy to encourage defence firms to convert their resources to civilian production.

There are clearly many lessons to be learned from this experience and the aim of this article is to identify these by analysing the restructuring of the defence industry that has taken place since the late 1980s.

South Africa’s defence industry was initially established with British aid, just prior to World War II. During the war it produced a substantial amount of basic weaponry for the Union Defence Force and the Allied forces, including armoured cars, bombs and ammunition. After the war, however, most of the wartime arms factories converted back to their pre-war civilian activities¹ and during the 1950s and early 1960s, South Africa relied heavily on imports of arms, mainly from Britain. In the 1960s, there was growing international opposition to apartheid and this led to South Africa’s withdrawal from the Commonwealth in 1961 and the imposition of a voluntary United Nations arms embargo in 1963. This severely limited the country’s access to international sources of arms and provided the impetus for establishing a domestic defence industry. In 1964, the Armaments Production Board was established to control the manufacture, procurement and supply of all armaments for the South African Defence Force (SADF).² This included co-ordinating arms production in the private sector, where almost 1 000 firms were involved in various aspects of arms production

In 1967 the UN Security Council passed a resolution calling on all states to stop supplying South Africa with arms. During the same year, P W Botha, the then Minister of Defence, visited armaments factories in Portugal and France as part of an in-depth investigation into various ‘models’ for domestic arms production in South Africa.³ In 1968, the Armaments Production Board was renamed the Armaments Board and made responsible for the procurement of armaments for the SADF, as well as ensuring optimal utilisation of the private sector for arms production.⁴ In the same year, the government established the Armaments Development and Production Corporation (Armscor). 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.⁵

The next major development came in 1973 with the establishment of the Defence Advisory Council (DAC) to co-ordinate the private sector’s involvement in domestic arms production.⁶ The DAC was chaired by P W Botha and included the president of the Armaments Board and representatives from many of the country’s major private sector companies. The establishment of the DAC represented the growing institutional links between the state, the military and private industry, and is often regarded as the take-off point for the country’s local military-industrial complex. These developments also took place within the context of a marked militarisation of society that occurred during the ‘Total Strategy’ era of the 1970s and 1980, when the apartheid regime mobilised vast amounts of state resources to defend white minority rule against internal and external threats.⁷ The development of a domestic defence industrial base was an important component of the government’s overall strategy.

Increasing international opposition to apartheid, and worldwide demands for a mandatory arms embargo against South Africa, prompted a major reorganisation and expansion of the defence industry during the mid 1970s. In 1976, the same year that the UN imposed a mandatory arms embargo against South Africa (Resolution 418), the Armaments Board and the Armaments Development and Production Corporation were merged to form the Armaments Corporation of South Africa (Armscor). Armscor assumed responsibility for both procurement and production of armaments for the SADF.⁸

During the 1980s, the domestic defence industry expanded considerably in response to South Africa’s increasing involvement in a number of regional conflicts (e.g. Namibia and Angola), which required a guaranteed supply of weapons of ever increasing sophistication, and to the growing militarisation of the state. New state-owned research and development (R&D) and arms production facilities were established. The private sector became increasingly involved in domestic arms production, with more than 2 000 firms involved by 1984.⁹ In addition to its investment in arms production capabilities, the government also pursued self-sufficiency in a number of related industries, such as engines, gearboxes and axles that could be used for armoured vehicles.

The early 1980s also brought a number of problems to the defence industry. The arms embargo had forced the industry to adopt a number of uneconomical practices, such as tooling up for short production runs and stockpiling supplies of certain items which were not readily available in South Africa.¹⁰ This led to increasing production costs and, when combined with the excess capacities created by a decline in domestic demand after the initial build-up, led to drastic staff cuts at Armscor and the cancellation of a number of defence contracts with private sector firms. Some of Armscor’s production activities were rationalised and a government commission was set up in 1984 to investigate Armscor’s financial problems.¹¹

By the end of the 1980s, South Africa had a relatively sophisticated defence industry, which was able to meet most of the equipment requirements of the SADF. The local defence industry, however, did not try to reproduce R&D which had already been carried out by the major Western arms producers, but concentrated on acquiring a capacity for upgrading, modifying and modernising existing armaments and weapons systems.¹² South Africa’s ability to obtain foreign inputs (technology, personnel and components) in circumvention of the UN arms embargo was vital for its increasing self-sufficiency in arms production.¹³

The development of the defence industry during the apartheid era was shaped by a number of factors. These included:

the imposition of UN embargoes;



South Africa’s military involvement in a number of regional conflicts, which required a guaranteed source of supply of military equipment;



the ideological imperatives of the apartheid state, and the desire for self-sufficiency in strategic industries, including armaments;



government support for import-substitution-industrialisation; and



the interests of private capital, particularly the lucrative nature of domestic arms production.

These factors led to the creation of a relatively sophisticated, but resource sapping defence industrial base, which was one of the contributory factors to the economy’s poor performance during the 1970s and 1980s. To provide an understanding of just how important and expensive the defence industry was, the next section provides a detailed analysis of its economic significance during the apartheid era.

The establishment and development of a domestic defence industry in South Africa necessitated massive investment by the state, and the large-scale involvement of the private sector. Thus, by the late 1980s, the defence industry had developed into one of the most significant ‘sectors’ of the country’s industrial base, in terms of its use of resources. The use of resources to develop a military industrial base had significant opportunity costs, however, as there were alternative uses available for the expenditures, which could have been more productive. In fact, the expansion of the defence industry during the 1970s and 1980s occurred during a period when the economy, and particularly the manufacturing sector, was performing poorly, and there is evidence to suggest that it imposed a substantial ‘burden’ on the national economy and was a significant contributing factor to the country’s deteriorating economic performance.¹⁴

The defence industry did emerge as a significant creator of jobs during the 1970s and 1980s, and by 1989, over 130 000 people were employed (directly and indirectly) in domestic arms production. Total defence industry employment as a percentage of total manufacturing employment increased from less than one per cent in 1961 to over nine per cent in the late 1980s.

Given the nature of the industry, however, most of the jobs that were created, were highly capital and skill-intensive and, given the nature of the apartheid state, were largely reserved for whites. Thus, the employment benefits of domestic arms production both perpetuated the racist structure of the labour market and were inappropriate for a country with scarce capital and an abundance of unskilled labour. The defence industry also absorbed a disproportionate share of the country’s skilled labour and this is likely to have been at the expense of the civilian economy. The apartheid government sanctioned the movement of scarce skilled human resources away from more productive civilian uses, and by 1989 nearly 2 000 scientists and engineers — over ten per cent of the total number of R&D personnel in the national economy — were employed by Armscor.¹⁵

The use of scarce national resources for investment in arms production also had negative consequences for investment in the civilian sectors of the economy. Studies by Kaplinsky and Joffe et al.¹⁶ have argued that the excessive share of state investment in strategic industries (e.g. Armscor and SASOL) during the 1970s and 1980s, represented a form of ‘misinvestment’, in that large amounts of scarce resources were invested in the wrong (capital intensive) sectors and the wrong types of technology (e.g. synthetic fuels) because of strategic considerations.

The establishment of a domestic defence industry was expected to reduce the cost of arms imports, and there is a clear decline in imports as a share of procurement from 1970. However, by the end of the 1980s, it was estimated that South Africa was still spending over R2 billion (R1,4 billion in 1985 prices) on arms imports per annum (Table 1). While South Africa became less dependent upon imports of completed weapons systems after the arms embargo in 1977, it remained highly dependent upon imports of machinery, technology and components. Thus, the development of a domestic arms production capability created new forms of dependency on foreign sources of technology and machinery, and ended up absorbing increasing amounts of scarce foreign exchange resources.

Table 1: South African arms imports, 1970 - 1989

Year	1970	1975	1980	1985	1989
Import ration*	81%	66%	48%	42%	42%
Arms imports	713	1 582	849	800	1 407
% of total imports	3,0%	5,1%	2,7%	2,8%	4,5%
% of manufactured imports	3,5%	6,8%	4,1%	4,1%	6,0%

FIgures are in Rand million in constant 1985 prices.
* Imports as a share of total procurement spending.
Sources: South African Reserve Bank, Quarterly Bulletin, various issues; Central Economic Advisory Service (1994); Armscor

In response to the problems of the industry in the early 1980s, namely rising overhead costs, excess capacities and declining domestic demand, South Africa made a major push for exports and Armscor launched a massive international marketing drive in 1982. As a result of South Africa’s willingness to supply arms to fellow ‘pariah states’ who were similarly excluded from access to the world’s major arms producers, the value of South Africa’s arms exports increased by nearly 300 per cent between 1982 and 1989 (see Table 2).

Table 2: South African arms exports, 1982 - 1989

Year	Arms exports	Arms exports/Manf exports	Arms exports/Total exports
1982	31	0,3%	0,1%
1983	34	0,3%	0,1%
1984	56	0,4%	0,2%
1985	282	2,3%	0,7%
1986	287	2,2%	0,7%
1987	347	3,1%	0,9%
1988	178	1,5%	0,5%
1989	118	0,9%	0,3%

Figures are in Rand million in constant 1985 prices.
Sources: Armscor; South African Reserve Vank, Quarterly Bulletin, various issues; Central Economic Advisory Service (1994)

Despite this increase, the contribution of arms exports to the national economy was in fact fairly insignificant, if the hidden costs of export subsidies are considered. Marketing was paid for by Armscor out of the defence budget and much of the R&D and production costs of export products were subsidised by the domestic procurement budget.¹⁷ Despite the growth in exports, South Africa’s trade balance in armaments also remained negative between 1982 and 1989. Thus, the defence sector remained a net user of foreign exchange resources throughout the 1980s.

South Africa’s external strategic environment changed dramatically after 1989. The end of the Cold War and the dissolution of the former Soviet Union, effectively put an end to superpower rivalry in Southern Africa. This contributed to the resolution of most of the region’s historical conflicts and provided opportunities for countries to reduce their levels of military spending and implement disarmament measures. It also had a positive impact on the South African state’s external threat perceptions and led to dramatic changes in foreign policy. South Africa withdrew its armed forces from Namibia and Angola in 1989 and embarked on an ambitious programme of diplomatic and economic outreach to African states.¹⁸

Simultaneously with these positive political developments, South Africa experienced its worst domestic recession since the 1930s. As a result of severe budgetary constraints and changing government spending priorities, the De Klerk government cut South Africa’s defence budget quite dramatically after 1989. The ANC-led government continued to cut the country’s defence budget, and by 1996, the defence budget had declined by more than fifty per cent. As a result, the share of defence spending in Gross Domestic Product (GDP) declined from over four per cent to less than two per cent between 1989 and 1996, while the share of defence in total government expenditure declined from thirteen per cent to less than six per cent during the same period (Table 3).

Table 3: Defence budget trends, 1989 - 1996

Year	1989	1990	1991	1992	1993	1994	1995	1996
Defence budget	11,435	1 071	8 094	7 605	6 589	7 153	6 249	5 9895
% change	5,5%	-11,9%	-19,6%	-6,0%	-13,4%	8,6%	-12,6%	-5,7%
Defence/GDP	4,1%	3,6%	3,0%	2,8%	2,4%	2,6%	2,2%	1,9%
Defence/government expenditure*	13,0%	12,4%	9,8%	8,4%	6,8%	8,1%	6,8%	5,*%

Figures are in Rand million in constant 1990 prices.
* Defence spending as a share of total government expenditure.
Source: DoD, Budget review 1998, Government Printer, Pretoria, 1998

It was not only the level of the defence budget which saw significant change, but also the structure. As Table 4 shows, the share of personnel costs and operating costs increased at the expense of procurement and R&D spending. The increasing share of personnel costs during the pre-election period was related to the SADF’s internal deployment in support of the police, particularly as a result of the increasing political violence which accompanied the final stages of the process of constitutional negotiations before the elections in April 1994.¹⁹

Table 4: Structure of Defence budget, 1989 - 1996

Year	1989	1990	1991	1992	1993	1994	1995	1996
Personnel	18,9	21,2	27,6	27,9	31,6	38,6	33,8	41,9
Operating	22,6	21,7	26,9	26,9	28,3	33,5	32,8	40,0
Procurement	58,5	57,1	45,5	45,2	40,1	27,9	33,4	18,1
TOTAL	100	100	100	100	100	100	100	100

Sources: Estimates of expenditure, State Revenue Account, DoD, Budget Review 1998, Government Printer, Pretoria, 1998

The share of personnel and operating costs continued to increase after 1994 as a result of the integration process and the formation of the South African National Defence Force (SANDF) which started immediately after the elections in April 1994. The dramatic decline in the share of procurement spending to less than twenty per cent by 1996 still extremely high by international standards, reflected the cancellation and post-ponement of a number of armaments projects.²⁰

Accompanying these cuts were a number of related disarmament measures. The SADF was rationalised and restructured, with the disbanding of various units and the closure and scaling-down of bases and installations. In 1993, compulsory conscription for white males was ended. Major weapons projects were cancelled or postponed. Redundant, obsolete and surplus military equipment was sold or destroyed and the country’s nuclear weapons programme was terminated.²¹ There was also a restructuring of the public sector defence industry. As part of a policy of ‘commercialising’ public enterprises, Armscor was split into two separate organisations in April 1992. A new state-owned industrial company, Denel, was formed under the Ministry of Public Enterprises, and it inherited most of Armscor’s R&D and production facilities. Armscor remained part of the Ministry of Defence and retained responsibility for the procurement of armaments for the SADF.²²

While there is evidence that the development of the defence industry had clear economic costs, this does not mean that the severe cuts in military spending would have an immediate positive impact. Indeed, cuts of such severity in the midst of a recession exacerbate economic problems, especially if there is no attempt to replace the loss of demand in the economy. Such effects are short-term adjustment costs and are normally felt in terms of job losses and the impact on towns and regions that are dependent on defence spending. Without government action, these costs can be severe and can lead to a wastage of valuable resources.

As Table 3 shows, South Africa’s defence budget declined between 1989 and 1996 by fifty per cent in real terms, while the procurement budget declined by nearly seventy per cent. While the overall defence market declined by nearly seventy per cent between 1989 and 1996 (average of fifteen per cent per annum), the domestic market only declined by 53 per cent (average of ten per cent per annum) during the same period (see Table 5). The value and share of imports in the overall defence market have declined in line with the cuts in overall procurement spending. Surprisingly, there appears to have been little effect on imports as a result of the lifting of the UN arms embargoes in May 1994, and the share of imports in the overall market averaged just over 20 per cent between 1989 and 1996.²³

Table 5: South African defence markdet, 1989 - 1996

Year	Total market*	% change	Imports/ Total (%)	Domestic market+	% change	Domestic/ Total (%)
1989	6 236		42	3 618		58
1990	5 126	-17,8	42	2 973	-17,8	58
1991	3 931	-23,3	21	3 123	5,1	79
1992	3 242	-17,5	17	2 696	-13,7	83
1993	3 162	-2,5	17	2 625	-2,6	83
1994	2 427	-23,2	14	2 093	-20,3	86
1995	2 167	-8,4	14	1 707	-5,6	86
1996	1 984	-8,4	14	1 707	-5,6	86
1997		-14,8	23		-9,8	77

Figures are in Rand million in constant 1990 prices
* Based on total value of Armscor acquisition spending for the departments of Defence, Safety and Security (police) and Correctional Services (prisons).
+ Value of domestic acquisition spending.
Source: Armscor, Armscor annual report, various issues.

The decline in the size of the overall defence market has been reflected in the value of domestic arms production (including exports), which fell by nearly fifty per cent between 1989 and 1996 (see Table 6). This was lower than the fall in the overall market because the declines in domestic demand were offset to some extent by increases in the value of exports. The volume of domestic arms production declined by just over forty per cent during the same period. The contribution of the defence industry to the national economy has also declined since 1989, with the value of domestic arms production in total manufacturing output declining from nearly seven per cent in 1989 to around three per cent in 1996, and as a share of GDP from 1,5 per cent in 1989 to less than one per cent in 1996.

Table 6: Value of domestic arms production, 1989 - 1996

Year	1989	1990	1991	1992	1993	1994	1995	1996
Value: Arms production*	3 854	3 136	3 823	3 078	3 250	2 643	2 421	2 008
% change		-18,6	21,9	-19,5	5,6	-18,7	-8,4	-17,1
Volume: Arms production+	111,5	100	90,5	70,1	63,1	62,8	64,4	64,4
Arms production/Manufacturing output (%)	6,6	5,8	6,7	5,3	5,5	4,4	3,7	3,1
Arms production/FDP(%)	1,5	1,3	1,5	1,2	1,2	0,.9	0,8	0,6

Figures are in Rand million in 1990 prices.
* Value of domestic arms production based on value of domestic acquisition spending and earnings from arms exports.
+ Volume of domestic arms production (1990 = 100)
Sources: Armscor; South African Reserve Bank, Quarterly Bulletin, various issues.

The defence cuts and disarmament measures have also had a dramatic impact on the size and structure of the domestic defence industry. Many defence firms went out of business or exited the defence market, and the industry as a whole has undergone a process of downsizing and restructuring.²⁴ As Table 7 shows, total employment in the defence industry declined by over 55 000 between 1989 and 1996, including over 10 000 in the public sector defence industry. Employment fell more quickly in the defence sector during the recession than in the overall economy as reflected by the decline in its share of manufacturing and total employment.

Table 7: Defence industry employment, 1989, 1996

Year	1989	1990	1991	1992	1993	1994	1995	1996
Armscor/Denel	26 348	23 630	21 387	16 580	14 914	14 847	15 209	15 218
Total defence industry	131 750	118 750	10 6935	82 900	74 570	74 235	76 045	76 090
Defence industry/manufacturing employment (%)	8,6	7,7	7,2	5,8	5,3	5,3	5,4	5,3
Arms industry/total employment (%)	2,3	2,1	1,9	1,5	1,4	1,4	1,4	1,3

Sources: Armscor; South African Reserve Bank,Quarterly Bulletin, various issues.

Skilled workers in occupation categories, such as engineers and scientists, bore the brunt of the retrenchments in the defence industry and there is evidence to suggest that many of these retrenched defence workers have found it difficult to find work in the civilian sectors of the economy.²⁵ There was no attempt by government to use the savings in the defence budget to create employment for these skilled workers in the civil sector. Instead, the impact of the recession was exacerbated.

Defence R&D spending from the national defence budget declined by nearly seventy per cent between 1989 and 1996 (an average of nearly fourteen per cent per annum), while the share of R&D spending within the defence budget declined from nearly nine to five per cent (Table 8). The share of defence R&D in total R&D spending also declined quite dramatically from nearly fifty per cent to less than twenty per cent in 1993 and, while more recent figures are not available, it is likely that it has declined even further in the last few years.

Table 8: Defence R&D expenditure, 1989 - 1996

Year	Defence R&D	% change	% of Defence budget	Total SA R&D spending	Defence/Total (%)
1989	985		8,6	2 043	48,2
1990	793	-19,5	7,9
1991	580	26,9	7,2	2 455	23,6
1992	467	-19,5	6,1
1993	342	-26,8	5,2	1 831	18,7
1994	342	0	4,8
1995	342	0	5,5
1996	329	-3,8	5,5
Average '89 - '96	523	-13,8	6,4

Soutces: Armscor; Estimates of expenditure; SA science and technology indicators, Foundation for Research Development, various years.

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. Between 1992 and 1995, Denel’s R&D funding from external sources (e.g. the defence budget) declined by 25 per cent in real terms. During the same period, the company’s funding of defence R&D from internal sources increased by fifteen per cent in real terms.

In the face of declining demand for their products, there are a number of ways companies can respond in an attempt to survive. They can take an offensive adjustment strategy, whereby the firm tries to maintain or increase its defence business. The most common offensive strategies have included increasing arms exports, mergers and acquisitions, and joint ventures with local and/or foreign defence firms. Alternatively, they can take a defensive strategy, whereby the firm attempts to reduce its dependency on its defence business. This normally involves some form of conversion and/or diversification. Conversion is a general term for the reorientation of production from military to civil. The common usage of the term concerns plant or establishment-based conversion, which involves the alternative (civilian) use of a specific defence plant’s existing skills, equipment and technology to produce civilian products — i.e. the classic ‘swords into ploughshares’.

Given the differences that have emerged between defence and civil production methods, plant conversion is no longer seen as a feasible policy.²⁶ Instead, the focus is now on company conversion, which may involve the transfer of resources and the reorientation of productive capacities from military use to civil purposes. It may also involve the conversion of all or certain company facilities to civilian production, the development of new or alternative civilian products using existing defence resources (spin-off/dual use), the scaling down of various plants and facilities, and the opening up of new facilities.²⁷

Similarly, diversification within a company is a means of reducing its dependence on military business by moving into, or broadening its civil production. This can be achieved by investing in new capital or acquiring new civil companies. In addition to outright purchase, mergers, joint ventures and co-production agreements with civilian companies are possible. Diversification may be a permanent alternative to defence business, or just a (temporary) complement to defence business during periods of limited or declining demand for armaments. Of course, firms may also diversify into the production of other weapons systems.

Conversion can also be seen in a wider policy context. The government creates the military industrial base and is its main customer, as a monopsonist, so it can also force or assist firms to convert. It can simply cut military expenditure and take a ‘hands off’ approach, but it can also have some form of proactive policy, using the savings from defence expenditure to aid the adjustment to civil production. This can be done by creating new demands and/or some form of industrial and regional planning.²⁸ In South Africa, the government has taken a ‘hands off’ approach to conversion, apart from the creation of Denel in 1992. The result has been a variety of responses by individual companies, which are discussed below.

With the decline in domestic demand for armaments, South Africa’s defence and defence-related companies have had to reconsider their corporate strategies, resulting in large changes to the structure of the industry. Denel and the major private sector defence contractors, such as Reunert, Grintek and Altech, have all attempted to vertically integrate, by outsourcing far less of their defence business than in the past. This has reduced the demand for the output of hundreds of smaller defence firms, particularly those which act as suppliers and sub-contractors for the larger firms. Many small and medium-sized private defence firms have merged with, or have been acquired by larger defence firms in the last few years, while others have exited the market. This has meant that the domestic defence market (excluding imports) has become increasingly concentrated, and by 1996 Denel and the three largest private sector defence firms accounted for over ninety per cent of total domestic acquisition spending (see Table 9).

Table 9: Stucture of South African defence market in percentages, 1992 - 1996

Year	1992	1993	1994	1995	1996	Average '92 - '96
Imports	17	17	14	17	14	16
Denel	43	34	38	42	44	40
Private sector	40	49	48	42	42	44
Total	100	100	100	100	100	100

Sources: Armscor, Armscor annual report, various issues; Denel, Denel annual report, various issues

As a result of these developments, the structure of the domestic defence market has changed quite considerably since the late 1980s. Denel has continued to dominate the domestic market, averaging 48 per cent of market share in the period 1992-1996, while the private sector’s share has averaged 52 per cent during the same period. Denel’s current share of the domestic market is significantly lower than in the 1980s, when the former Armscor subsidiary companies (now part of Denel) accounted for nearly seventy per cent of the domestic market.²⁹

Denel also continues to dominate most of the seven major sectors of the domestic defence market, particularly aerospace, ammunition (small, medium and large calibre), weapons systems (including infantry weapons, cannons, artillery systems and missiles) and military vehicles, and many sub-sectors, such as information technology and testing. The other major sectors of the domestic defence market, namely electronics, maritime and support equipment, remain dominated by the three largest private sector defence firms, namely Reunert, Altech and Grintek. These three companies accounted for over eighty per cent of the private sector’s share of the domestic defence market in 1996.

One of the most significant responses to the declining domestic defence market has been the significant increase in South Africa’s arms exports. Almost all defence firms, without exception, have pursued export markets quite aggressively since 1989, and particularly since the lifting of the UN arms embargoes in May 1994. Armscor’s international marketing efforts, the presence of South African defence firms at international defence exhibitions, together with the support of the ANC-led government, have contributed to the increasing value of the country’s arms exports shown in Table 10.

Table 10: South African arms exports, 1990 - 1996

Year	1990	1991	1992	1993	1994	1995	1996
Arms exports	163	758	438	739	641	721	345
% change		365,2	-42,3	68,8	-13,3	12,5	-52,1
Arms exports/manufactures exports (%)	0,7	3,0	1,9	3,2	2,5	2,2	n/a
Arms exports/Total exports (%)	0,2	1,1	0,7	1,1	0,9	1,0	n/a

Sources: Armscor; South African Reserve Bank, Quarterly Bulletin, various issues

The value of South Africa’s total arms exports are dominated by Denel who accounted for nearly eighty per cent of the total in 1996 and has averaged nearly eighty per cent per annum since 1992. As a result of the success of its export sales, Denel has also benefited significantly from the General Export Incentive Scheme (GEIS), which was introduced in 1990 to promote manufactured exports and which provides subsidies of up to 19,5 per cent of the value of each export contract. Since 1992, Denel has been one of the largest recipients of GEIS payments and, in 1992, was the second largest recipient of GEIS payments after Iscor.³⁰

In addition to finding new export markets, most defence firms have also actively pursued international joint ventures with foreign defence firms, to strengthen their chances of bidding for, and winning new defence contracts in South Africa and in foreign markets. According to the South African Defence Industry Association (SADIA), there were more than ninety joint ventures between South African and foreign defence firms by early 1996. Most of these are with European defence firms, and are concentrated in a number of key niche markets (e.g. armoured vehicles, remotely-piloted vehicles, demining technology) in which South Africa has a ‘proven’ international competitive advantage. The value of these international joint ventures, both in monetary terms and in terms of the technology transfers involved, is difficult to quantify, and will only become apparent if and when a local defence firm and its joint venture partner win a domestic or foreign contract.

Denel has actively pursued strategies of diversification and conversion since its inception in April 1992. These strategies have included joint ventures, acquisitions and/or mergers with civilian firms, the purchase of existing non-military product lines or licensing agreements, and the development of civilian products using existing defence technology and production facilities (i.e. spin-off).³¹ These diversification strategies have been accompanied by significant investments in R&D and new product development, as well as a major marketing strategy to identify new (local and foreign) civilian markets. Only one of Denel’s divisions has pursued an explicit strategy of conversion. Houwteq, which was formerly involved in military satellites, converted all its facilities to civilian purposes in 1992, and became involved in the development and marketing of low-earth orbit (LEO) satellites. However, the initiative was not commercially viable and was terminated in October 1994.

The outcome of Denel’s diversification efforts since 1992, is reflected in the trends in the company’s turnover and profitability and in the changing composition of the company’s business. Denel’s turnover declined in real terms between 1992 and 1996, largely as a result of the dramatic declines in the value of domestic defence business. In addition, the composition of Denel’s business changed quite dramatically, with domestic defence business declining from 63 per cent in 1992 to fifty per cent in 1996. The company’s poor level of profitability over the period was related to the commercially unviable nature of many of the company’s assets and facilities which it inherited from Armscor.

Table 11: Denel composition of turnover, 1992 - 1996

Year	1992	1993	1994	1995	1996	Average '92 - '96
Turnover	3 839	3 507	3 376	3 507	3 013
% change		-9	-4	-4	-14	06
Domestic defence (%)	63	53	48	45	50	52
Defence exports (%)	16	20	23	24	14	19
Domestic commercial (%)	20	24	25	25	30	25
Commercial exports (%)	1	2	4	5	7	4
Total defence/turnover (%)	79	73	71	69	64	71

Figures are in Rand million in constant 1996 prices.
Source: Denel, Denel annual report, various issues.

The declining contribution of domestic defence business was offset to some extent by increases in exports (mainly arms exports) and civilian sales. The increasing value and share of the latter are directly related to the company’s diversification efforts in some of the groups, such as Denel Informatics.

Most private sector defence firms have pursued diversification strategies since the late 1980s in order to minimise the impact of the defence cuts. Some firms (e.g. Grinaker Avitronics) have been relatively successful in developing civilian products (e.g. microwave products, voice technology products) from their existing military technologies. However, most small and medium-sized firms have found it more difficult to develop spin-offs because of the resources needed to fund R&D to develop new civilian products. Most of the large defence firms (e.g. Reunert) have been successful in acquiring civilian firms, or civilian product lines through licensing agreements with civilian firms. Conversion has not been popular among private sector firms, as it is perceived as expensive and difficult.

Table 12: Private sector defence industry diversification efforts, 1992 - 1996

Year	1992	1993	1994	1995	1996	Average '92 - '96
1. Reunert
Turnover	3103	2905	3933	4889	4915
% change		-6	35	24	1	13
Total defence sales	854	744	764	859	981
% change		-13	3	12	14	4
% of turnover	28	26	19	18	20	22
2. Grintek
Turnover	1683	1687	1887	2106	2230
% change		0,3	12	12	6	7
Total defence sales	293	256	236	231	235
% change		-12	-8	-2	2	-5
% of turnover	17	15	13	11	11	13
3. Altech
Turnover	1213	1147	1206	1379	1592
% change		-5	5	14	15	7
Total defence sales	218	218	188	148	156	150
% change		-14	-21	5	-4	-8
% of turnover	18	16	12	11	9	13

Figures are in Rand million in constant 1996 prices.
Sources: Company annual reports, various issues.

The results of these private sector diversification efforts have been mixed. According to information supplied by the SADIA, the private sector defence industry as a whole witnessed real declines in the value of its total sales between 1992 and 1996, largely as a result of the cuts in defence spending. However, the share of civilian sales (both domestic and exports) in total sales increased quite substantially from around twenty per cent in 1992 to nearly fifty per cent in 1996.³²

The diversification experiences of the three largest private sector defence firms also provide some indication of general trends in the private sector. All three companies witnessed significant declines in the share of total defence sales in turnover between 1992 and 1996. The value of Grintek’s defence sales declined by twenty per cent, while Altech’s declined by over thirty per cent during the same period. Both experienced positive average real increases in turnover between 1992 and 1996, despite negative average real declines in defence sales. Thus, their growth in non-defence sales, as a result of diversification efforts, exceeded the growth in defence sales. In contrast, Reunert’s defence sales increased by fifteen per cent during the same period, reflecting the company’s relative success in the defence market. However, its growth in non-defence production was also relatively high over the period and higher than defence, suggesting some successful diversification efforts.

Overall, the private sector’s diversification efforts have not been particularly successful, given the presence of a number of barriers to exit from the defence market. These barriers have included:

The defence firms which were most successful in their diversification efforts tended to be small or medium-sized firms with a moderate dependency on defence sales. Large defence firms, such as Reunert, were relatively successful in their diversification efforts, because they were financially strong enough to be able to use their resources to develop new civilian products and markets. Small and medium-sized defence firms, which did not have the resources to invest in new civilian products and markets, found it extremely difficult and costly to diversify, and many of these firms went bankrupt or exited the defence market completely.

Clearly, there have been major changes in the South African defence industry, with defence companies having a variety of responses to the cuts in military procurement expenditure. The restructuring and commercialisation of South Africa’s public sector defence industry since April 1992, has had a dramatic effect on the private sector defence industry. The changes in Armscor’s procurement policies, which have entailed more competitive procurement, acquisition from abroad, and the formation of Denel as a contractor and competitor, have fundamentally altered the ‘cosy’ relationship that was evident between the public sector defence industry and the private sector from the early 1960s. The outcomes of these adjustment strategies have included:

a changed local defence market in terms of size and structure;

the increasing concentration and monopolisation of the domestic defence market;

a dramatic increase in defence export sales;

the increasing internationalisation of the domestic defence industry through international joint ventures;

a significant increase in diversification and conversion initiatives; and

a continued restructuring of the public sector defence industry.³³

Analysing the experience of the South African military industrial base over the period of intense cuts in defence spending provides a valuable and instructive case study. It lends support to the argument that, if a policy of conversion is to achieve a ‘peace dividend’, it will need to comprise some form of interventionist policy.

In South Africa, the lack of government policy with respect to defence industry conversion has left the onus on individual firms. This has led to offensive corporate responses whereby defence firms attempted to capture as much of the remaining domestic arms market as possible; and to defensive responses whereby firms attempted to find alternatives to the defence market. The offensive activities of both public sector and private sector defence contractors have led to increased concentration in the market. In addition to the reduced orders, vertical integration by the main defence contractors has reduced the value of work which they outsource to subcontractors and suppliers. Firms have been taken over, merged or have simply left the market. There has been an increase in the number of international joint ventures, to help the exploitation of domestic and international markets, but it is not yet clear how successful this strategy will prove. The only area in which the government has provided some support is for arms exports through Armscor’s marketing efforts, and the GEIS. However, GEIS was phased out at the end of 1997.

With regard to defensive strategies, diversification efforts varied, including mergers and acquisitions of civilian firms, acquisitions of civilian products, and the development of new civilian products based on existing defence technologies. This has led to higher levels of civilian sales among defence firms, but has been of limited success. The absence of any government support for the conversion of the country’s defence resources (labour, capital and technology) has left firms to their own devices. This has meant that, in many cases, they have attempted to produce civilian prototypes of existing defence products without any real knowledge or understanding of how commercial markets work. The limited number of successful conversion efforts in South Africa’s defence industry are not unique. International evidence suggests that, without government support and the political will to support conversion, only those companies with relative strengths in dual-use technology markets, or those companies at the lower levels of the product hierarchy, will find conversion relatively easy.³⁴

This has resulted in a marked decline in the defence industry, which exacerbated the general economic recession that occurred in the early 1990s. It has also meant that defence firms have continued to pursue strategies aimed at increasing their share of both local and foreign defence markets and that a real opportunity to reduce the power of the apartheid ‘military industrial complex’ and to improve economic performance has been lost.

There will be further cuts in defence spending and the overcapacities in the international defence market make the potential for expansion of trade rather limited. This means that there is still a need for a conversion policy and, given the failure of a purely market-driven conversion policy, it is evident that the government will need to become proactive. Top-down approaches, adopted in government orchestrated conversion strategies, have not been particularly successful in Eastern Europe and the former Soviet Union. An alternative approach to defence industrial restructuring therefore needs to be identified for South Africa. A national conversion strategy which is concerned with demilitarising the economy and restructuring the country’s industrial and technological priorities, rather than with the microlevel, technical aspects of conversion, seems to be the most appropriate.³⁵ As part of such a conversion strategy, the government should provide a conducive macro-economic environment, which encourages the conversion of resources from military to civilian purposes. This could be achieved through mechanisms and incentives, such as tax breaks, subsidies to spin-off companies, retraining programmes for defence workers, and economic regeneration programmes for towns or regions affected by the recent defence cuts. In addition, the government in conjunction with industry, labour, local and regional authorities and other interested parties, should formulate a national defence conversion strategy. This conversion strategy should be integrated with existing defence, industrial and science and technology policies. It should aim to redirect the country’s industrial, technological and scientific resources and capabilities towards meeting the country’s pressing socio-economic needs

The government’s support for a strategy of conversion for the domestic defence industrial base is extremely significant for two compelling reasons. Firstly, conversion is an important strategy for demilitarising those components of the South African industrial base that were part of the apartheid military-industrial complex and which have ‘survived’ into the post-apartheid era. Secondly, it is also the most appropriate mechanism for developing and regenerating the county’s industrial base and for eradicating the destructive legacy of militarism, which is still so pervasive in South and Southern Africa.³⁶