Targeting state pension funds rather than state assets would be a more efficient way of addressing the Budget deficit, writes Ravi Naidoo
The direction of macro-economics policy reflects the political agenda being pursued by the government. So the government’s belated unveiling of its macro- economic plan is indeed a defining moment. However, judging by the cheers and “hallellujahs” of business, it seems safe to assume that the government’s plan has strayed too far across the fence.
But the government is under immense pressure. Foreign capital (and undiluted domestic power blocs) are putting pressure on it to follow conservative macro-economic policies as a precondition for new investment. The failure of current conservative macro-economic policies means less economic growth in 1996/97 — and less government revenue and a higher interest bill — squeezing the fiscus.
Furthermore, the failure of delivery policies seems to have frustrated the government into at least offering reasons for the failure. “Slow” consultative processes are a suitable target, even if the government is the one late with a plan.
The macro-economic plan is based on the assumption that a market-driven, state-assisted growth strategy is suitable for South Africa. The counter-argument for a stronger government role through expansionary policies is summarily dismissed in one paragraph stating the deficit must be reduced.
However, while the overall stategy is likely to be revisited through negotiation of some form, there are two points worth exploring here.
How serious is the debt “problem”?
The government debt, most of it interest-bearing, stands at R287-billion, 55% of gross domestic product (GDP). The interest payments on this debt are essentially the cause of the budget deficit (government expenditure exceeding revenue). This deficit is now 5% of GDP.
First, and mostly because of sanctions, government’s debt is not high by international standards. The Organisation for Economic Co-operation and Development (OECD) average debt-to-GDP ratio is 72%, for example. However, real interest rates in South Africa are 15% (against 4% in the OECD), making debt expensive.
Second, deficits are neither inherently good nor bad. The difference is the ability to direct the expenditure to ensure higher future returns so that you can repay the debt. Directing expenditure means putting it mostly into capital goods and not consumption. At the moment, government capital expenditure is low — about 8% of the budget, and much of that in “fixing thatched roofs”. Therefore the government probably does need to redirect its spending before it can increase the deficit.
Third, if a quick deficit increase can be dangerous, a deficit reduction could be worse. Deficits, calculated as a percentage of GDP, tend to be counter-cyclical. They increase when the economy slows down but decrease when it grows. Therefore, the best way to reduce the deficit may be to increase GDP. Accordingly, in an economy with excess capacity (manufacturing capacity utilisation is around 80%) such as South Africa, the fiscally prudent policy is to target the growth rate, not the deficit itself.
This policy is suggested in the International Labour Organisation report on South Africa. Also Malaysia (a “tiger”) disregarded International Monetary Fund advice and ran a deficit of over 20% — with good results.
Predictably, the business community claims that privatisation proceeds can be used to pay off debt. However, privatisation of even most state assets will not dent the national debt, nor the R30-billion annual interest payment. In fact, assets of most of the largest parastatals (including Transnet and Eskom), once you have subtracted their debts, are not much more than one year’s interest payments. Moreover, most of the larger parastatals are showing positive net incomes. In sum, privatising to cut the debt is a poor idea.
A better example of unnecessary debt is the government employees pension fund — and its mythical “fully-fundedness”. Research has shown that changes to the way the massive R120-billion government pension arrangement is funded can make a big difference both to government debt and the deficit.
In short, there are two ways to fund public servant pensions — and the government is using the wrong one. Fully-funded (pre-funded) systems are usually used by private firms, where a separate fund full of assets guarantees workers’ pensions even if the firm is liquidated. Governments, which theoretically cannot be liquidated, usually have pay-as-you-go systems (where pensions are paid out of general revenue). While most countries use a pay-as-you-go system to pay their public servants, South Africa uses an expensive fully-funded plan.
Apart from being out of step internationally, the South African government has been filling its `fully-funded’ system with R70-billion of interest- bearing government stocks (basically government promises to pay) — making up a large part of the national debt and deficit. Importantly, the difference for the government between promising to pay pensions out of its annual budget (pay-as-you- go) or a fund full of promises to pay (the `fully- funded system) is huge — amounting to an extra R14-billion every year.
That is what the government paid last year as interest (R8-billion) on unnecesssary bonds in its pension fund and its normal contributions as employer (R6-billion). Most of this R14-billion (roughly the value of Telkom) is what the government could put aside each year for infrastructural spending if it just changes its funding arrangement.
Moreover, it makes no difference to future taxpayers whether an obligation to pay pensions is thrust on them through redeemable government bonds in a trust fund — or an unfunded contractual promise.
To confirm this fact, the Smith Committee, appointed by the Minister of Finance to examine pension provision, concluded that “South Africa’s budget deficit before borrowing would have been much smaller had our civil service pension funds been managed on a pay-as-you-go basis — as the majority of our overseas counterparts seem to do.”
As the table shows, changing to a pay-as-you-go system will halve the deficit — even without resorting to desperate measures such as privatisation or social spending cuts.
However, standing in the way of a pay-as-you-go systems are conservative public servant unions, which are reluctant to give up their influence over the present indebted fund. As for their members, a separate fund (even an indebted one) is psychologically more comforting than being paid out of an African National Congress budget. No doubt, these are difficult issues for the government.
But the government is likely to find changing the pension fund much easier, and more justifiable, than privatisation or cutbacks in social spending. Moreover, in the former option, the government is likely to have the support of progressive public servant unions. And even a small fraction of the billions in annual pension savings could be translated into better pay and conditions, winning the support of most concerned public servants.
In sum, amid all the noise about cutting the deficit, it seems to have been overlooked that privatising and cutting social spending are not the only options. Using the pension fund as an example, there are clearly some ways to accommodate an increased role for the government even within a tight fiscal framework. “Flexibility” needs to be extended to fiscal policy.
Ravi Naidoo is head of the National Labour and Economic Development Institute (Naledi)