We must be control freaks

Seeraj Mohamed

The relatively high economic growth between 2003 and 2007 is not sustainable and has been harmful for the future health of the economy.

As a member of the panel of Cosatu’s advisory economists, I found the article by Peter Draper, Tsidiso Disenyana and Andreas Freytag (“A backward leap to command economics”, September 26 to October 2) to be an example of exactly the free market dogma our country does not need.

South Africa’s recent economic growth (2003 to 2007) has been due to debt-driven consumption. There have been large movements of speculative, short-term capital inflows into South Africa. These speculative flows are associated with higher levels of debt in South Africa. The rise in debt has not led to increased productive investment but is associated with a sharp increase in household consumption. Further, there has been increased consumption of imported goods, which has led to a large increase in the trade deficit.

The trade deficit has to be paid for with foreign financial inflows. In South Africa most inflows into the economy are in the form of short-term portfolio investment flows into equities and bond markets, not foreign direct investment. One can think of these short-term, speculative investment flows into South Africa as loans. When a foreign investor buys our stocks and bonds they own a financial asset and we have a financial liability. This type of loan is potentially a very short-term loan, which is often referred to as “hot money”. One can buy a stock now and sell it for a profit a few minutes later.

I disagree with the free market perspectives advanced by Draper et al. There is a need for controls and protection. The relatively high economic growth between 2003 and 2007 is not sustainable and has been harmful for the future health of the economy. It leaves the country more indebted because we have essentially borrowed to consume. The high trade deficit makes us more vulnerable to contagion stemming from huge problems elsewhere in global financial markets.

It is obviously clear today with the global financial crisis that uncontrolled movement of capital across the globe can wreak havoc within countries. Excesses in the United States mortgage market have blown up into a financial crisis because deregulation of financial markets and global financial flows were driven by free market thinking. Further, today all states provide huge levels of support to their businesses to promote competitiveness and exports. Economies cannot industrialise without industrial policies.

Draper et al want to save South Africa’s liberalised trade and financial markets from the protectionism of Cosatu and the working masses. Unfortunately, they misunderstand the motives for Cosatu’s perspectives. For example, they argue that Cosatu is in favour of trade protection because of the high trade deficit.

Cosatu is arguing for trade protection to support a deeper, more diversified and employment creating industrial development of South Africa. Economists today understand that all countries that have industrialised and become successful exporters have done so through import substitution and infant industry protection. In short achieving openness and increased international integration is an outcome of building competitive capabilities in which trade protection is an important tool. Of course, the trade policy tools should be well monitored, consist of both carrots and big sticks and have clearly publicised lifespans.

Draper and his colleagues not only oppose capital controls, they also take an unfortunately naïve view that trade deficits should be seen as a strength not a weakness, because it shows that South Africa can attract large amounts of foreign financial flows. Somehow they believe that the ability of a country to attract short-term, speculative flows or “hot money” is a sign of strength. A number of prominent, mainstream economists, including the great proponent of free trade, Jagdish Bhagwati, support capital controls. They point out that uncontrolled “hot money” flows have the potential to be hugely damaging to a country.

South Africa has a large trade deficit financed by speculative short-term capital inflows at a time when there is a global credit crisis. Further, we have deregulated our financial markets and flows, which has integrated us into global financial markets and left us more vulnerable to contagion.

The drying up of speculative, short-term capital flows due to the crash in global credit markets could decrease the volume of capital flows to South Africa, which are required to pay for our trade deficit. We face the risk of a sudden flight of capital by these short-term speculators and a repeat of the kind of currency crisis experienced in 2001 and possibly worse.

The risk to the economy and the financial cost of dismantling capital controls and the free market policies advocated by Draper et al is huge vulnerability to the devastation of currency and financial markets. It is the state’s responsibility to keep—and, when necessary, put in place—mechanisms that can protect the economy and society against financial turmoil.

Seeraj Mohamed is director of the corporate strategy and industrial development research programme in the school of economic and business sciences at the University of the Witwatersrand, Johannesburg. This article is written in his personal capacity

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