24
Thu, May

Should a government build factories in a place like Ghana?

At Large
Typography
  • Smaller Small Medium Big Bigger
  • Default Helvetica Segoe Georgia Times
No way can a government that fails to create an environment for flourishing private enterprise do better in the same environment running businesses that the private sector is failing at. But if the private sector is flourishing in a sector then what is the point of government intervention there? Why not just take 25% of what they make as taxes plus the payroll taxes as well?
Share/Save/Bookmark

Should the government build factories? Or invest in business ventures In Ghana?

It is one of the abiding mysteries of the contemporary society that government ownership and management of business ventures are seen as ideological, whilst support for the conduct is seen as “pragmatism”.The truth though is that the pragmatic position would be to oppose direct government investment in business ventures, at least in Ghana, on grounds of common sense.

 

Why? Simple: common sense.

Why would a government be investing in a company? Not for revenue? What should the revenue be spent on? Not public/social welfare?

With that in mind, consider what such an investment would really mean.

The Ghanaian government suffers a perpetual budget deficit, so every investment would mean borrowing to invest.

Due to the genius of our ways, our government borrows at nearly 20% at the medium-term international cedi rate or 9% at the international dollar rate. It borrows at roughly 15% at the short-term, domestic, cedi rate, but that is irrelevant for this analysis since no serious business investment can be short-term.

So assuming government goes and borrow at 20% in order to establish a business, say in agro-processing.

Since the government is borrowing at 20% to invest, we have to assume that its required return on capital is at least 30%.

Assuming the government wants to set up a chocolate factory in Sefwi to take advantage of the cocoa industry there.

The intended end products are cocoa butter and dark cocoa powder/refined cake.

From detailed schematics I have seen in the context of a private project, $7.5 million is required for a plant that can process 2 tons per hour. Just the plant for now. Let’s say Government wants to make a serious dent in our raw cocoa exports so they peg the production at 80,000 tons per annum, which is about 10% of the average annual yield over the analysis horizon.

The minimum investment required for such a plant would be $160 million (including start-up working capital and auxiliaries).

For perspective, note that the most consistent production plant we have had in the contract is the CPC plant (various others have collapsed or are on the verge of collapse). It is a 65,000-ton capacity plant, which now needs urgent capitalisation to the tune of $300 million. It is swimming in debt and currently reliant on political life-support, being a relatively successful state-owned enterprise.

Let’s say that capacity utilisation is a remarkably successful 75%.

The final conversion ratios for cocoa butter and powder are quite similar, at around 70%. So let’s adjust our capacity numbers for finished products to say 26,000 tons of cocoa powder and 30,000 tons of cocoa butter.

Let’s use $7000 as the projected mean price for high-grade cocoa butter, based on our historical analysis and a price of roughly $2500 for powder.

Let us also assume an average price over the period under the analysis of $2500 for Ghana grade I cocoa beans (note that if Government decides to subsidise the light crop beans as it has sometimes done in the past, this will still involve spending Government funds).

This is all very rosy analysis, but let’s keep it that way for simplicity sake.

Gross margin per ton of cocoa products manufactured will thus be $3500 or 58%.

However, adjusting for conversion factors we get this interesting result:

$200 million goes into purchasing cocoa. When the cocoa is ground, converted to butter and powder/cake, and sold, the proceeds amount to less $280 million. A 28% gross margin.

Labour costs haven’t been accounted for. Electricity, no. Water, no. Maintenance, no. Depreciation, no. Overheads, no. Supplies, no.

Is it any surprise then that well-funded cocoa processing companies run by seasoned management executives cannot afford to pay Cocobod (the national cocoa agency) for the cocoa they buy? Or that many have shut down? A story similar across our industrial landscape?

Let’s say, the Government of Ghana has miraculous powers.

Let’s say, all other costs of the factory are squeezed into 60 million dollars per year. So a neat profit of $20 million can be realised from pure operations (i.e. ignoring financial effects).

How long will it take the Government of Ghana to pay off the $160 million loan?

Eight years, right? If nothing out of the ordinary happens. Of course, as the factory ages, costs will escalate due to higher maintenance and replacement costs etc. (as the finance folks like to say, risk is a function of time) but let’s keep things simple, shall we?

But actually, it is not 8 years. That’s too optimistic. There is something crazy called “compound interest”. Let’s ask Excel to help us.

Actually, if year 8 was to be chosen as the break-even year, the amount owed would have ballooned to $520 million thereabouts, assuming no money was borrowed to run the factory in the intervening period.

No matter how you looked at the picture, it isn’t pretty. We haven’t even touched the IRR and NPV calculations using the 30% weighted average cost of capital. But even without any detailed analysis, I am sure that you can see cumulative losses in the region of at least $400 million in the first decade of the operation of this factory.

Now here is the question, if the point was social or public welfare, why not simply invest the $160 million directly in health, education, and the like today and reap the results earlier?

I can hear two objections: a) you chose cocoa processing deliberately to present an impossible prospect; b) you are only accounting for economic costs and results, what about the benefits of employment?

Sadly, none of these protests make any sense.

Whatever the venture you choose, if it is manufacturing, the payback period in Ghana would not be less than 8 years. In so far as government’s cost of capital is so ridiculous, forget it. It will produce only losses. But do we want the government to get into trading and services? In industries requiring low capitalisation and quick payback period? I don’t hear a ‘yes’.

What does this mean?

No way can a government that fails to create an environment for flourishing private enterprise do better in the same environment running businesses that the private sector is failing at. But if the private sector is flourishing in a sector then what is the point of government intervention there? Why not just take 25% of what they make as taxes plus the payroll taxes as well?

Secondly, the employment that shall be generated is a function of the profitability of that enterprise. If the government is paying too much for labour, then the losses will compound.

At any rate, if these labourers are citizens of Ghana then their employment shall be at the expense of other Ghanaians denied the social investments that could have been made with the $160 million and saddled, on top of the neglect, with the $400 million dollars debt burden. The 500 or so workers of one factory will be living large on the misery of 500,000 Ghanaians. In fact, as we saw with Ghana Airways, that usually is the case: only the Government hirelings benefit.

Now, tell me: who is being pragmatic and who is being ideological: the constructive sceptics who advise against direct government investment into business ventures or the ideologues who have never developed any model or simulation to back their views but hold on to them like articles of faith?

 

Source: brightsimons.com

 

BLOG COMMENTS POWERED BY DISQUS
Sign up via our free email subscription service to receive notifications when new information is available.