Structural Flaws In Labor Market Hold Back South Africa

| About: iShares MSCI (EZA)

South Africa has long been a country with economic potential. With abundant natural resources (such as gold, fish diamonds, and coal, etc.), the most developed infrastructure and financial markets in Sub-Saharan Africa, a relatively educated populace, and relatively stable governance, South Africa should have much stronger economic growth and a higher standard of living current levels.

What has been holding back South Africa? The main impediment to South Africa's prosperity revolves around the country's deeply divided and inefficient labor markets. Brain drain among more skilled workers and heavy union control of less skilled labor result in both shortages of skilled labor and some of the world's highest unemployment rates.

Unionized labor force and the strength of organized labor have devastated the working class of South Africa. Artificially high wages created by these unions have restricted the competitiveness of South Africa's manufacturing base. With 25% of South Africa's workers unionized, wages in South Africa are significantly higher than competing Sub-Saharan African neighbors. As a result, South Africa has miniscule levels of exports of manufactured goods.

Natural resource extraction is not immune to this problem. The labor structure of the country has affected both the agricultural and mining industries through a series of strikes that have crippled production. Not only do these strikes reduce natural resource, but they also increase local food prices due to crop harvesting concerns.

Unemployment and the social ills tied to it is a product of South Africa's labor model. Closed shop unions limit available workers to keep a floor on wage. The result is one of the world's highest unemployment rates at 26%. This number seems high, but it excludes those no longer listed in the labor force and resulting to subsistence living the underground economy for survival. It's no coincidence that South Africa also leads the world in violent crime. According to the United Nations Office on Drugs and Crime, South Africa has the highest murder rate per capita, and ranks near the top in many other crime statistics measures such as rapes, car hijackings, and race based killings.

On the high skilled end, South African labor is also experiencing problems. Educated minorities are leading the country after completing university. The emigration rate of skilled professionals is 20,000 skilled migrants per year and these people often leave to go to other English speaking countries such as the US, Australia, the UK, Canada, and Singapore. The main reasons skilled professionals are leaving South Africa is due to affirmative action policies limiting employment opportunities, and safety concerns related to the country's high rate.

The controlling party of South Africa, the African National Congress, has no intention of labor reform that will ease the strains caused by the brain drain and structural unemployment in the country as the unions who benefit from these policies are among the largest financial backers of the ANC. With ethnic demographics and the legacy of Nelson Mandela on their side, it will likely be at least a decade before a serious competing party challenges the ANC. As a result, I do not expect any positive labor reform.

These policies are clearly bearish for South Africa. The best policy to counter this is to short the South African Rand and South African stocks (NYSEARCA:EZA) in US dollar terms. The rand will continue to weaken with declines in South African exports. If strikes continue to reduce commodity exports, this will cause further weakness in the country's trade balance and therefore foreign demand for rand. South African stocks are also at risk as the structural problems in the local labor market will cause economic growth to continue to miss expectations. On top of that, South Africa's market cap to GDP of 220% is already at historically overvalued levels versus its historical average of 178%. On the commodity side, platinum prices benefit greatly from turmoil with mining strikes. Since South Africa supplies over 70% of the world's platinum, any disruption with local miners will severely constrict future supplies of platinum on the global market. As a result, I think a significant stock market correction is due there. When it comes to timing of these trades, I will keep subscribers updated with real time trade messages.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.