South Africa’s economic strategy should concentrate on stimulating the domestic market rather than on foreign direct investment
Xolela Mangcu South Africa’s macro-economic growth, employment and redistribution (Gear) strategy is underpinned by a three-part syllogism. It proceeds as follows: the government should implement a set of structural-adjustment policies (low budget deficits, privatisation of state assets, relaxation of labour laws, competitive exchange rates, low inflation, and so on); this will attract foreign investment; and this, in turn, will lead to higher economic growth rates and employment levels.
The policy question that should be asked is whether the relationship among these variables is as automatic as it has been made out to be. To be more precise, do the structural adjustments listed earlier really produce the desired results of increased foreign direct investment, and does foreign direct investment really yield economic growth and job creation? And if they don’t, why does South Africa persist with these policies?
Any investigation of the gap between intent and implementation in economic policy must necessarily address the theoretical assumptions underlying those policies; it may well be that implementation is hampered by flaws in the intellectual foundations, assumptions and hypotheses on which economic policy is built. The government has been fairly successful in getting prices right. According to American economist Stephen Gelb, changes in prices (interest, inflation, exchange and wage rates) ”can be implemented through fairly straightforward administrative processes by those with authority over government finances”. And, true enough, interest rates have come down from 25,5% during the Asian crisis to current levels of 14,5%; the inflation rate has declined from 9% in 1994 to 3,37% in 2000 and is now targeted at between 3% and 6%; and the budget deficit has been reduced from 5,5% of gross domestic product in 1994 to 2,3% of gross domestic product in 1999. However, while the government’s self- inflicted structural-adjustment programmes have been relatively successful, the record in respect of the second part of the syllogism, that is attracting foreign direct investment, has been less encouraging. There were net outflows of foreign direct investment between 1994 and 1996. Foreign direct investment reached a peak of near R6,8-billion in 1997 before declining to R1,6-billion in 1999. Even the temporary rise in foreign direct investment in 1997 had more to do with the privatisation of Telkom than with any expansion of productive capacity. This has led to the Minister of Finance, Trevor Manuel, complaining that even when South Africa has done all it could to put its financial house in order, investments have still not been forthcoming. The relationship between structural adjustment policies and expected outcomes becomes even more elusive in respect of the third part of the syllogism, where none of the policy intentions of increased growth and employment has borne fruit. Growth projections have been revised down from 6% in the Gear document to about 3% in Manuel’s most recent budget speech. The job situation is even more disastrous; the economy has shed about one-million jobs since 1990, and about 500 000 since 1994. Why does South Africa persist with these policies if they are not yielding the desired outcomes?
There are at least two reasons for this: one economic and the other political. >From an economic perspective, the government seems to have misread the causality between foreign investments and domestic growth. Contrary to current economic orthodoxy in this country, international evidence shows that it is domestic growth that spurs foreign direct investment, and not the other way round. Multinationals are attracted to already growing and profitable economies. Moreover, the impact of trade and foreign direct investment on growth and employment is usually very weak. In his book Pop internationalism, influential American economist Paul Krugman demonstrates that most economic activity takes place within countries, not between them. For instance, in the United States only one- eighth of output is traded, while two-thirds of added value consists of non-tradeable goods and services. What about the much-vaunted role of exports in stimulating growth and employment? Those companies that are productive in the domestic market tend to self-select and enter the more lucrative export markets (hence the correlation between high domestic growth rates and exports). This again reverses the causality – that is, instead of assuming that export industries spur growth, the evidence is that domestic growth spurs exports. Most of the discussion of exports in South Africa proceeds as if exports are an end in themselves. The argument goes something like this: if you get the exchange rate right, your exports will enable you to pay for your imports, which will in turn lead to lower prices and lower levels of inflation. But this is the wrong way of looking at why exports are important, and can have the unintended effect of destroying instead of creating jobs.
Exports are nothing but the means to buy inputs for growing domestic production. The idea behind trade promotion should not be to replace existing industries by importing finished consumer goods, but to use exports to expand domestic investment and employment. In this perspective, exports become part of a strategy for spurring domestic growth. >From a policy perspective this means that the focus should be on labour-intensive foreign direct investment. However, as University of Cape Town economist Nicoli Nattrass points out, South African exports are becoming relatively less labour intensive and more skills intensive, despite Gear projections of increasing labour intensity. This has to do with sectoral shifts from food and textile production towards the more capital intensive chemical, iron and steel industries. Even more worrying is the fact that the decline in labour intensivity in exports has been accompanied by the increased imports of labour intensive products such as clothing, footwear and cars. The implications are that the job losses in exports are not compensated for, but actually worsened, by the import of finished consumer products. Export-led strategies should be pursued on the back of domestic productivity and job- creation strategies. This minimises the chances that special interests will usurp the policy process simply on the basis that they are in the export business, irrespective of their domestic productivity, comparative advantage or contribution to employment. Why would a government pursue intellectually flawed policies? The explanation lies in that venerable variable in policy: politics. The government’s economic strategy is backed by the most powerful financial institutions and personalities in the world: the World Bank, the International Monetary Fund and Wall Street.
>From the outset, its formulation was insulated from outside pressure groups that might have sought more attention to social spending. And for these reasons, Gear is unlikely to be amended unless this is necessitated by social unrest.
While it is important to get prices right, foreign investors are often driven by a whole host of considerations including social stability, market size and returns on private investment.
But even with these factors in place, negative investor perceptions of political risk have a far greater effect on foreign investors than structural-adjustment programmes.
Thus the important thing is to first grow the domestic economy and ensure returns to investors within a stable, democratic, peaceful political culture. In this respect, economics is as much about getting the policies right as getting the politics right. Dr Xolela Mangcu is a policy analyst for the Centre for Policy Studies. This is an edited version of an article that appeared in Synopsis