Wal-Mart’s acquisition of Massmart: will the effects be detrimental rather than beneficial? The recently approved acquisition of a 51% stake in Massmart by Wal-Mart has brought about a lot of speculation as to whether this deal will mainly positively impact South Africa’s GDP or not. By investing in the African market, Wal-Mart will to a greater extent impact South Africa’s labour market as well as lead to the growth of the retail industry at a faster rate, thus positively impacting growth in the South African economy.
This essay will therefore show how this particular case of foreign direct investment will possibly lead to potential growth in South Africa’s GDP through examples of the AS-DS model, similar examples of such acquisitions and a demonstration of the expenditure method of GDP calculation, therefore showing the importance of such a big investment in a rapidly growing and attractive market such as South Africa.
A four billion dollar offer to buy 51% of Massmart was made by Wal-Mart, which is currently the world’s biggest retailer and this offer was recently approved by the South African government. The deal will allow 51% of Massmart, the third largest retail distributor in Africa to be owned by Wal-Mart and the general terms of the deal involved a non-binding contractual agreement between the two companies which however requires certain conditions concerning labour and bargaining to still apply.
On the surface, the deal looks extremely appealing, as it offers an investment of over four billion dollars into the economy, however it is necessary to unravel the whole issue and critically analyse the impacts of this investment on South Africa’s development and thus pose the question, will the acquisition, cause more harm than good? As according to Maylie (2011), in order for the deal to be finalised, Wal-Mart has to adhere to certain conditions which include, freezing job cuts for the next two years as well as honouring union bargaining agreements in order to secure newly created jobs.
Through such guaranteed employment creation, the South African economy will benefit immensely from reduced unemployment and this in turn will lead to an increase in income within the country. This will mean that private individuals will have more income to spend, which will lead to an increase in private consumption spending and will thus result in a relative increase in the GDP level of South Africa.
Wal-Mart pledges to create thousands of new jobs and proceeding with this deal would be the right opportunity needed to decrease South Africa’s currently increasing 25.7% unemployment rate. Through Wal-Mart’s intended plans to invest more in the building and opening of 500 to 100 new stores in the following three years and to open about 20 new Cambridge stalls per year (Watson, 2011), fixed capital formation in South Africa will greatly increase.
This increase in investment spending will add to the increase in GDP levels in the country and positively impact the growth of the South African economy. An example of a similar case whereby foreign direct investment resulted in growth of fixed capital formation would be the investment of Wal-Mart in Mexico, which has brought about an increase in fixed capital formation in respect to foreign direct investment of over 14% for the entire period 1990-2005, a ratio significantly higher than the world average (Peters, 2008:5). This therefore shows how Wal-Mart’s investment could possibly lead to a significant rise in GDP levels in the next few years.
Another likely effect of this acquisition on South African GDP is a drastic change in the general price level of goods. There is a high chance that Wal-Mart will cause a reduction in prices so much, such that it will affect the national inflation rate as it has been known to do in America (Economist, 2011). Due to Wal-Mart’s highly efficient and technologically advanced logistics in its supply-chain management, productivity is bound to increase not only in Wal-Mart stores but also in the local retail industry as other suppliers would attempt to cut down on costs in order to compete effectively on prices.
This would lead to a shift in the aggregate supply curve as productivity would have increased with no other increases in input prices. As illustrated in the diagram above, an aggregate supply shock due to increased productivity, will cause the price level to decrease i.e. a movement along the AD curve from price level P0 to P1 and real GDP to increase from Y0 to Y1, thus the shift from SRAS0 to SRAS1 is shown by the change in macroeconomic equilibrium from e0 to e1.
This means that equilibrium GDP would have increased and therefore more national output will be produced at any given price level. Wal-Mart has also made claims on its intention to invest 100 million rand in the supply-chain training of local industries in order to boost competitiveness, “the company intends to deal with South African retail suppliers in such a way that would create an incentive for Wal-Mart to work with local suppliers and help them to become efficient and sustainable” (Makholwa, 2011:33).
This in itself will be a major step towards raising South Africa’s national income level as the investment will help the domestic retailing industry to produce more efficiently. By increasing efficiency in production, local goods will be manufactured at low cost thus reducing prices of locally produced products and increasing their competitiveness on the international market. As a result, net exports will increase as well as consumption of local products within the country and thus again levels of national income will increase.
This shows that not only the supply side is affected by this deal, there is however several impacts of the acquisition on the demand side as well. “Any rise in autonomous desired private consumption, investment, government consumption or net export spending that is associated with each level of GDP shifts the AD curve to the right” (Lipsey, 2007:408), this therefore means that the increase in investment through fixed capital formation and increases in net exports due to increased efficiency and lower prices in the local industry, will result in shocks in the aggregate demand curve.
As illustrated in the diagram below, an increase in both investment and net exports will shift the aggregate expenditure curve from A1 to A2 causing an increase in GDP level from Y0 to Y1.
This in turn will lead to a rightward and upward shift in the aggregate demand curve from AD0 to AD1, causing an increase in real GDP and a relative rise in price level from P0 to P1 thus shifting from macroeconomic equilibrium point e0 to e1. This shift in aggregate demand will thus cause an upward movement along the aggregate supply curve meaning that retail suppliers will supply more at the given increased price level due to the higher level of demand.
Having looked at how foreign direct investment might positively impact South Africa’s GDP, there is however the possibility that not all the effects of this deal will turn out to be of benefit to the country. Due to Wal-Mart’s refusal of a procurement agreement, the bulk of the goods they will sell may have to be imported from cheaper foreign suppliers rather than purchasing locally produced South African products. This will flood the market with cheaper imported goods, causing a decrease in net exports as people will consume more of the imported goods instead of locally produced products.
Instead of increasing the growth of the economy, these imports will end up causing a decline in national income levels thus proving the acquisition to be detrimental to GDP growth. Wal-Mart is well known for its low cost management through the use of technologically advanced logistics and has in the past, proved to be extremely competitive among other retail outlets. This has in some cases caused other smaller retail businesses to close down as they were not able to compete with the low prices offered by Wal-Mart. Wal-Mart has made clear its intention to expand and open more outlets once they have established the deal and this may result in Wal-Mart stores dominating the retail industry in South Africa.
The local retail industry therefore faces the possibility of a massive reduction in the number of smaller retail outlets as they may find it increasingly difficult to compete against Wal-Mart’s destroyer pricing strategy. This will result in a reduction in employment as people previously employed in the local retail industry will be made redundant when these businesses close down, and thus reduce disposable incomes, leading to a decrease in consumption and GDP levels. Wal-Mart has the ability to rapidly expand through the advantage of economies of scale that it possesses and it is therefore likely to quickly dominate the retail industry in South Africa once it has started operations.
However, dominance by a single large retailer may result in limited choice of products and detrimental effects on prices, quality and service (Makholwa, 2011:33) which in turn will result in unsatisfied consumers thus reducing consumption. Be that as it may, despite the fact that there may be possible negative effects on GDP brought about by this deal, the evidence still overwhelmingly points towards the fact that the acquisition of Massmart by Wal-Mart will to a greater extent lead to the economic growth of South Africa as well as positively impact its GDP level. In conclusion, this therefore provides enough incentive for the full approval of the acquisition without however neglecting to carefully monitor Wal-Mart’s activities within the country.
List of References: Maylie, D. 2011. Wal-Mart, Massmart Deal Gets Nod in South Africa. (Online). Available: http://online.wsj.com/article/SB300014240527023036574045 76357132239525222.html [2011, June 01].
Makholwa, A. 2011. Trouble in store. (Online). Available: http://web.ebscohost.com/ehost/detail?sid=4400036b-ca22-47f5-8e6f-c709efd0e02e%40sessionmgr14&vid=1&hid=19&bdata=JnNpdGU9ZWhvc3QtbGl2ZQ%3d%3d#db=buh&AN=60818467 [2011, April 14].
Watson, L. 2011. Wal-Mart to focus on SA culture. (Online). Available: http://www.fin24.com/Companies/Retail/Walmart-to-focus-on-SA-culture-20110604 [2011, June 05].
Peters, D. E. 2008. The Impact of Foreign Direct Investment in Mexico. (Online). Available: http://ase.tufts.edu/gdae/Pubs/rp/DP11Dussel%20PetersApr08.pdf [2008, April]. Lipsey, R. G. & Chrystal, K. A. 2007. Economics. Oxford: Oxford University press Inc. Economist, 2011. The beast in the bush. The Economist. 398(8721): 72-74.