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Author: Anthea Jeffery*|

03 June 2010 14:45

Growth-focused policies: Why SA is doing so badly

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SAIRR's Anthea Jeffery examines what we are doing wrong.

Rapid economic growth is vital to increased prosperity and the consolidation of democracy. However, South Africa has again fared badly on the five factors making for growth. It has not fully exploited the global economy, while public debt is up and inflation far from tamed. It has failed to improve savings or generate enough capital investment. Further dirigiste interventions seem likely to undermine market principles, while the Government has never been committed to growth as its overarching goal. Overall, the country merits 32% for growth-focused policies in 2009/2010.

Growth in 2009/2010
The country's gross domestic product (GDP) shrank by 1.8% in 2009, while GDP per capita declined by 2.8%. This made South Africa ‘the worst performing country in Africa', according to the World Economic Outlook of the International Monetary Fund. The 2010 Budget Review projects a pedestrian growth rate of 2.3% for the current financial year.

A formula for rapid growth
In 2008 a study called The Growth Report identified five factors crucial to success in generating sustained annual GDP growth rates of 7% a year or more. South Africa's performance in 2009/2010 is assessed against these five criteria. They are exploiting the global economy, maintaining macro-economic stability, achieving high rates of saving and investment, allowing markets to allocate resources, and making growth a policy priority.

Exploiting the global economy
Rapid growth rests firstly on exploiting the global economy by exporting into global markets and attracting foreign direct investment (FDI). FDI is particularly valuable because it brings technology and skills and often generates jobs and manufactured goods for export. However, South Africa performed poorly in both these spheres. The country's exports fell by an annualised 55% in the first quarter of 2009, in the worst performance since national records began in 1960. Overall, exports declined by 21.4% in 2009 (but were up by 10.1% in February 2010 compared to the same month the previous year). SouthAfrica again fared poorly in attracting FDI for greenfields development. Though the total amount of FDI in 2009 was R48.3bn, the most significant portion of this inflow (R22.5bn) came from the purchase by Vodafone in Britain of a 15% stake in Vodacom from Telkom. The deal brought foreign currency into the country but did not establish a new enterprise. In addition, the transaction was nearly derailed at the eleventh hour at the instance of Cosatu, which was apparently averse to some R6bn in empowerment benefits from the transaction flowing to members of a rival political party, the Congress of the People (Cope). (At the time the deal was concluded, its BEE beneficiaries were leading figures in the ANC, who left the ruling party after Thabo Mbeki's ouster as national president.) Though Cosatu's attempt failed and the transaction proceeded as planned, the incident further undermined South Africa's reputation among international investors. In the latter half of 2009 there was significant portfolio investment into South Africa, amounting to some R107bn over the year. This helped finance South Africa's current account deficit, which averaged 4% of GDP in 2009. The need to keep attracting portfolio investment again helped to constrain a leftward shift in policy.

Macro-economic stability
Macro-economic stability is important because its antithesis (unsustainable public debt, high rates of inflation, and currency volatility) damages investment and limits growth. For many years South Africa did so well in managing its public debt that it eliminated the budget deficit and generated small surpluses in the 2007 and 2008 financial years. However, the global financial crisis has now reversed these gains. Said Jac Loubser, an economist, in November 2009: ‘The recession has created nothing less than a fiscal calamity, with the gains made in 15 years of financial prudence and tight management wiped out in about 12 months.'

Pravin Gordhan's 2010 Budget Review sees the budget deficit peaking at 7.3% of GDP for 2009/2010 and declining to 4.2% of GDP over the next three years. To achieve this reduction, Gordhan stressed the need for the government to confine spending to priority areas, cut corruption, and contain public sector wage increases. (Such increases took the public sector wage bill from R155bn in 2006/07 to some R259bn in 2009/10.) 

Gordhan also urged an end to wasteful spending, saying: ‘Too often, the culture in the public service and in SOEs [state-owned enterprises] is to ratchet up salaries, spend on frills, travel in luxury and spend more on marketing the agency than on fixing the service.' Moody's and Standard & Poor's (S&P), international rating agencies, were initially sceptical of the Government's capacity to trim the fiscal deficit. S&P warned in January 2010 that the country could face a debt trap within a few years. However, revenue collected in 2009/10 exceeded Gordhan's expectations, bringing the budget deficit for the year down to 6.7% of GDP, while the ratio of public debt to GDP, at around 30%, is low compared to that in many Western countries.

Inflation
Between the 1930s and the 1970s, it became apparent that artificially lowering interest rates to boost growth caused high inflation which negated earlier gains. From the 1980s, inflation targeting was thus widely used to keep inflation low and counter temptations to reduce interest rates to boost short-term growth.

Since 2002 the Reserve Bank has sought to keep inflation within a target band of between 3% and 6% a year. Its aim, as Bank Deputy Governor Xolile Guma said in May 2009, is to ‘prevent money itself from becoming a major source of economic disturbance'. By contrast, ‘with stable prices, entrepreneurs can plan and act, savers can save without fear of their savings being wiped out by inflation, and borrowers can borrow...at [predictable] interest rates'.

However, Cosatu and the SACP oppose inflation targeting and want lower interest rates to boost growth and jobs. Their objections grew from 2006, when soaring international oil and food prices pushed inflation out of the target band and the reserve bank raised the repo rate by five percentage points even though the cause of inflation had little to do with domestic demand. Cosatu blames the interest rate hikes, implemented from 2006 to 2008, for triggering South Africa's first recession in 17 years. In December 2008, with the global economic crisis deepening, the reserve bank began lowering the repo rate again, reducing it by five percentage points by August 2009. Thereafter, the Bank held the repo rate steady at 7% for a number of months, saying inflation still exceeded the target range and might rise further. In response, Cosatu urged the removal of the ‘arrogant' Tito Mboweni as the bank's governor, demanded that the repo rate be cut to 3%, and staged demonstrations outside the bank to buttress this demand.

In November Mboweni was replaced by Gill Marcus. Meantime, Cosatu and the SACP stepped up further demands for the ANC to honour the pledges it had made (at Polokwane and elsewhere) to change the Bank's mandate to target jobs as well as inflation. In January 2010, when Marcus left interest rates unchanged, calls for the nationalisation of the Bank soon followed.

Gwede Mantashe, ANC secretary general and SACP chairman, hinted that the Bank might be nationalised in keeping with the aims of the Freedom Charter. Cosatu and the Young Communist League welcomed the idea, saying it would help reorient monetary policy and limit the malign influence of ‘anonymous private shareholders'. However, as Business Day noted, it was merely a quirk of history that South Africa's central bank still had private shareholders.

These shareholders had no impact on interest rate decisions, for inflation policy was devised by the Treasury and implemented with the support of the Government as a whole. The ANC downplayed reports that it wanted to nationalise the bank, saying the ‘status quo remained'. ANC spokesman Jackson Mthembu said Mantashe had merely ‘flagged' the issue. However, yet another call for nationalisation on top of many others caused further uncertainty.

In his 2010 Budget Review, Gordhan stuck both to inflation targeting and the established target band. He said the State had no plans to change the Bank's mandate to include growth or employment goals because such considerations were already included within it. (According to the Constitution, the bank's role is to ‘protect the value of the currency in the interests of balanced and sustainable economic growth'.)

However, Gordhan was quickly forced on to the defensive by an angry union response. One trade union leader berated him for ‘talking Left while walking Right', while Cosatu general secretary Zwelinzima Vavi threatened a general strike in October 2010. Gordhan backed down, saying he had already written to Marcus outlining a ‘new' and ‘expanded' mandate for the bank. In terms of this, ‘growth and employment needs' would have to be taken into account, along with various other factors. Business Day said that the bank now faced a difficult task in deciding which factor merited the most weight. A key benefit of its narrower focus - the anchoring of inflation expectations- might thus be lost. In March 2010 Marcus went against the expectations of most economists by lowering the repo rate by 50 basis points. Inflation, at 5.1%, was then back within the target band but Eskom had been granted major price hikes, oil prices were rising, and the risk of higher inflation was real. Though the Press generally ignored this, it seemed likely that Marcus had yielded to pressure from the Left.

Currency volatility
In 2009 the rand was again highly volatile. In October 2008, under the impact of the global financial crisis, the currency fell overnight from R9.40 to R11.85 to the US dollar. But in 2009, as portfolio investment picked up, the rand rose 26% against the US dollar, firming to a best level of R7.20 in October 2009. At the time of writing, it stood at R7.54 to the dollar. Cosatu demanded that South Africa follow China's example by pegging the rand's value at an artificially low rate to make the country's manufactured exports more globally competitive. But the director general of the National Treasury, Lesetja Kganyago, countered: ‘In policy making, you must accept there are things you do not control. The exchange rate is one, unless you have deep pockets. When the currency weakens and you want to intervene to protect it, you need huge reserves. And if the currency is getting too strong and you want to intervene, you are going to have to buy [foreign currencies]. Where do you get the resources to do that?' In his budget speech in February 2010, Gordhan resisted populist pressures to fix the rand against any of the major currencies. Instead, the reserve bank would seek to counter currency volatility by building up foreign reserves, making verbal interventions, and reducing exchange controls. Wrote Quentin Wray in Business Report: ‘This will disappoint those trying to buy artificial competitiveness through the exchange rate rather than through productivity gains.'

Savings and investment
High rates of saving and investment are needed to expand the economic base and provide essential infrastructure. However, South Africa's record in savings has been poor while public fixed investment has failed to meet the scale of need. Since 1994 the ratio of savings to the disposable income of households has never risen above 2%, remaining far below the 14% peak attained in 1962. Since 2006 the ratio has been in negative territory. It hovered around -0.8% from 2006 to 2008, but improved somewhat to 0.4% in 2009.

The overall ratio of gross domestic savings to GDP peaked at 34% in 1980 while the trend since then has been downhill almost all the way. In 2008 the ratio was 14.9%, while in 2009 it was only a little better at 15.3%. As regards investment, in 1994 real gross fixed capital formation as a proportion of GDP stood at 15.2%, far off the Government's goal of 25%. However, the ratio rose to 22.5% in 2008 and remained much the same (at 22.4%) in 2009 notwithstanding the recession. The ANC often complains of an ‘investment strike' by business. In fact, the private sector has contributed some 70% of overall fixed investment since 1994. In addition, private fixed investment has virtually tripled over the past 15 years. The Government has long been promising to implement a major infrastructure expansion programme. The 2009/2010 budget brought anticipated expenditure on this to R787bn over three years, while the State said many of its projects were well under way. It nevertheless remains difficult, as Nedbank reports, to ‘match the R787bn to specific projects'. The Government's own fixed expenditure has remained sluggish, but public enterprises such as Eskom and Transnet have been spending rapidly, mostly on new power plants and improvements to ports and rail. The 2010 Budget Review increased the amount allocated to fixed public investment to R846bn over three years. The bulk of this spending (some R700bn) is expected to come from parastatals.

Market allocation
The private sector is robust and there remains considerable scope for the market allocation of resources. However, state monopolies inherited from the apartheid era continue in key sectors, while market allocation has been reduced since 1994 by anumber of dirigiste interventions intrinsic to the national democratic revolution (NDR) to which the ANC recommitted itself at Polokwane.

The ANC's allies in Cosatu and the SACP see the NDR as leading to a socialist (and ultimately communist) future. The ANC itself has publicly denied any commitment to socialism. However, it sees the global economic crisis of 2008/09 as proof of the failure of market forces and of the need for much greater state control. In May 2009 Trevor Manuel, minister in the Presidency, said: ‘The financial crisis has given regulators the fuel with which to exert more pressure on the corporate world. The period of deregulation has come to an end.' But he also urged a degree of caution, saying: ‘We should be careful not to shift to the other extreme, where we tie companies up in so much regulation that they barely function.' In its anniversary statement in January 2010 the ANC said the global financial crisis presented an opportunity to think differently about economic policy and the failures of ‘an unfettered free market system'. It was ‘determined to use this space strategically' to address structural flaws in South Africa's economy. ‘Fundamental to the transformation of the economy is the need to eradicate apartheid production relations and bring about a more equitable ownership and distribution of wealth and income,' it said. Since 2002 the ANC has been calling for a strong ‘developmental state' to give direction to the economy.

What it means by this has never been fully explained. According to Manuel: ‘A developmental state is one that is determined to influence the direction and pace of economic development by directly intervening in the development process, rather than relying on the uncoordinated influence of market forces to allocate resources.' However, Cosatu and the SACP see a key function of the developmental state as being to ‘roll back the capitalist market and construct elements of socialism', as Cosatu said at its annual congress in September 2009. Since Jacob Zuma became president, no major policy changes have been made. However, calls for the nationalisation of the mines have frequently been made by Julius Malema, president of the ANC Youth League, who could (as The Citizen commented) be ‘flying a kite to test the wind' for others. Ironically, despite its long commitment to nationalisation, the SACP has criticised Malema for seeking state control of the mines. At the same time, the ANC remains under constant pressure to allow its socialist allies to set the pace and direction of the NDR. In addition, Rob Davies of the SACP and Ebrahim Patel, with his strong ties to Cosatu, are busy adopting industrial and other interventionist policies which could do further damage.

Growth the priority
Attaining a high rate of growth requires a committed, credible, and capable government, which consciously chooses growth as its priority, takes steps to improve the business environment, and ensures that its interventions work to support the market economy rather than undermine it. South Africa has fared badly here. Zuma's Cabinet is large, unwieldy, and divided, the economics cluster, in particular, having been splintered into so many pieces as to make coherent policy unlikely. By May 2010, the key question - whether Gordhan or Patel was to decide macroeconomic policy - had not yet been resolved.

The South African Chamber of Commerce and Industry has warned that business is alarmed over continuing uncertainty. This is partly why South Africa has yet to share in the vigorous economic recovery anticipated in other emerging economies ‘Opaque and incoherent policy signals undermine local business confidence, investor confidence, and the pace of economic recovery,' the chamber said. As the NDR shows, the ANC's emphasis remains on redistribution rather than growth. The Government has also failed to improve the business environment. Skills and productivity remain weak, regulation looks likely to be ratcheted up, and the infrastructure programme is not delivering on the scale required. In addition, despite the ANC's strong disclaimers, repeated calls from various figures in the ANC alliance for nationalisation have raised doubts about respect for property rights.

South Africa's score
In 2009 the Fraser Institute (Canada) and the Heritage Foundation (US) gave South Africa 64% for economic freedom, a key requirement for rapid growth. Measuring South Africa's performance against the five criteria for growth reveals further weaknesses. The country's earlier macro-economic gains are under pressure, while policy malaise and socialist rhetoric are undermining the business climate and the prospects for more rapid growth. Overall, the country merits a score of 32% for growth focused policies in 2009/2010, down from its 35% score for the first 15 years of ANC rule

*This article first appeared in the SAIRR's Fast Facts May 2010 issue

Topics: economic growth, GDP, global economy, south africa, inflation, currency volatility, market allocation, savings, investments



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