The economic puzzle of SA

The transformation that South Africa has undergone since its democratic transition in 1994 is nothing short of remarkable. Prior to 1994, the South African economy and polity were dominated by the white minority, and even though the apartheid regime had begun to unravel in the 1980s, the majority blacks remained deprived of basic political and economic freedoms. Given the depth of the racial and income divides that prevailed, it would not have been unreasonable to predict a cycle of redistribution and macroeconomic populism following democratisation that would wreak havoc with the economy and turn the country into a sham democracy.

Instead, the democratically elected governments led by the ANC have managed to create a stable, peaceful, and racially balanced political regime with an exemplary record of civil liberties and political freedoms.
Economic policy has been conducted in an equally exemplary manner, with South Africa turning itself into one of the emerging markets with the lowest risk spreads. While South Africa has instituted some innovative (and expensive) social transfer programmes to address long-standing disparities, it has done so in the context of cautious fiscal and monetary policies which have kept inflation and public debt at low levels. There were no nationalisations or large-scale asset redistributions. Moreover, the economy was opened to international trade and capital flows.

If the world were fair, political restraint and economic rectitude of this magnitude would have produced a booming South African economy operating at or near full employment.

Unfortunately, it has not turned out that way. In the decade since 1994, per-capita GDP grew at an average rate of 1,2% per annum—a rate that is comparable to that of sub-Saharan Africa (1,1%) and Latin America (0,8%), and considerably below that of South Asia (3,7%) and East Asia (6,2%). South Africa’s income level has yet to catch up with its peak level attained in 1980. And investment remains low at around 17% of GDP (although the bulk of the overall decline in the investment effort since the 1970s is due to the reduction in public investment).

The most worrying aspect of this disappointing economic performance is unemployment. South Africa’s unemployment rate today stands at 26% according to the narrower definition of who is unemployed, and at 40% if one includes discouraged workers. This is one of the highest rates of unemployment anywhere in the world. Furthermore, unemployment appears to have increased particularly rapidly since the democratic transition (from a “low” of 13% in 1993). (The lack of labour force surveys makes it difficult to know what the comparable unemployment rates were in the 1980s.) As would be expected, unemployment is heavily concentrated among the young, unskilled, and the black population. This poor record on employment represents not only an economic tragedy, it poses a significant threat to the stability and eventual health of the South African democracy.

The proximate cause of high unemployment is that prevailing South African wages are too high compared to real wage levels that would clear labour markets at lower levels of unemployment. Trade unions and wage bargaining play an important role in wage determination in South Africa. The trade union confederation Cosatu is a partner in the governing coalition dominated by the ANC. A cursory comparison of wages across countries would show that South African wages (in the formal sector) are quite high by the standards of countries at similar income levels. On the other hand, real wages have not risen much (if at all) since the transition to democracy, and to the extent that unions have prevailed, it seems to have been mostly to prevent the real wages of their members from falling. The evidence I will show later in the paper suggests that wage-push has not been a significant factor in determining patterns of structural change in the South African economy during the 1990s.

The deeper cause of South African unemployment lies elsewhere, and it is intimately connected to the inability of the South African [economy] to generate much growth momentum in the past decade. High unemployment and low growth are both ultimately the result of the shrinkage of the non-mineral tradable sector since the early 1990s. The weakness in particular of export-oriented manufacturing has deprived South Africa from growth opportunities that other countries have been able to avail themselves of.

The point is perhaps best made by comparing South Africa to a high-growth economy such as Malaysia, a country with which South Africa shared many common features in the 1980s. As I will show, the main difference between these two countries is that Malaysia was able to pull an increasing share of its workforce into manufacturing—the sector with the highest labour productivity in the economy—while in South Africa manufacturing lost ground to the tertiary sector.

The reason that this pattern of structural change is also a key driver of unemployment is that in South Africa non-mineral tradables (including manufacturing) are intensive in low-skilled labour compared to services. The relative shrinkage of manufacturing (along with economy-wide skill upgrading) has entailed a collapse in demand for relatively unskilled workers.

This need not have turned into a growing unemployment problem among the unskilled if one or both of two things could have happened. First, a large enough decline in real wages at the low end of the skill distribution could have compensated for the inward shift of the labour demand schedule. But this was an unrealistic option in view of social expectations and political realities created by the democratic transition. Second, the growing mass of job seekers could have been absorbed into the informal sector (where wages and work conditions are considerably more flexible). This second mechanism is how developing countries elsewhere have coped with similar labour market problems.

But while informal employment has grown rapidly in South Africa, its level remains quite low by the standards of developing countries. This is no doubt one of the legacies of the apartheid regime—which made it first illegal and then difficult for blacks to move to larger urban areas unless they already had a certified job. In the absence of sufficient real wage adjustment and informal sector growth, the decline in the demand for low-skilled workers has resulted in high unemployment.

A key implication follows from this diagnosis: expansion of non-minerals tradables—manufacturing in particular—will be good both for growth and employment. An export-oriented strategy that increases the relative profitability of producing tradables for world markets will generate economic growth by pulling labour into productive activities where their marginal product is much higher. And since tradables are relatively low-skill intensive in South Africa compared to service activities that have been the major beneficiary of recent patterns of structural change, such a strategy will entail shared growth rather than trickle-down growth. The cures for low growth and high unemployment are largely one and the same …

Why is South Africa not Malaysia?

The title of this section is not as crazy as it may sound at first. South Africa and Malaysia are both medium-sized economies with deep racial cleavages, in which an ethnic majority controls the polity but economic power lies with an ethnic minority … The economic structures of the two economies were strikingly similar [in 1988] …

But this snapshot hides important differences in the evolution of the structure of the two economies. Most importantly, Malaysia was undergoing a process of industrialisation, while South Africa had begun to de-industrialise … As of the mid-1980s, South Africa still had a larger manufacturing base: roughly 12% of its total labour force was employed in manufacturing, compared to less than 8% in Malaysia. But since then, Malaysia has industrialised by leaps and bounds, with this number reaching 16% a decade later. In South Africa, by contrast, the proportion of the workforce employed in manufacturing has come steadily down, to below 7% by 2000. What is also remarkable in Malaysia’s experience is that this pick-up in industrialisation came after a period of what looked like a continuous decline in manufacturing in the early 1980s. The latter suggests that it is possible to reverse a trend deterioration in manufacturing performance, provided the policy framework is adequate (on which more later).

The expansion of manufacturing in Malaysia has been both growth and equity promoting. It has been good for growth, because manufacturing is the sector where labour is most productive by far. Even if the productivity differences are smaller at the margin than on average, there are still large unexploited gains from moving labour into manufacturing from other activities. And it was equity promoting because much of the gains from this process of structural change accrued to the workers themselves.—Â

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