Containing inflation is not just about interest rates. It is time we looked at the cost of doing business in South Africa.
Globally the world has moved into a higher inflation environment and South Africa is no exception. However, interest rates can contain inflation only to a certain degree and, like chemotherapy, it has the potential to destroy what is good in an economy while trying to cure the illness.
This week’s release of our latest GDP figures suggests the medicine might have been administered a bit too strongly. GDP grew by only 2,1% in the first quarter this year, down from 5,3% last year. It is the lowest growth rate experienced since 2001 and was below expectations.
The trick to being a good Reserve Bank governor, like a good doctor, is to know when to stop the chemo before the patient dies.
In a recent interview with the Mail & Guardian, an economist at the Department of Economic Development in Dubai said that inflation is a consequence of economic growth. One cannot expect to contain inflation when an economy is growing rapidly. It is a trade-off and one has to find the right balance.
Dubai is currently experiencing an inflation rate of 9,5% but economic growth is at 17%. It is a price Dubai is willing to pay. South Africa, however, is experiencing lower growth rates, and inflation, like cancer, is an incredibly destructive force and cannot be left to grow unchecked. But rather than increasing interest rates indefinitely, government needs to reduce the cost of producing goods and services by increasing competition in the country.
Stanlib economist Kevin Lings points out that although inflation has increased in the United States, to around the 4% level, it is nothing like the numbers in the 1970s, when the US saw inflation averaging more than 7% and hitting 10%. Current US inflation is well below our inflation rate of about 10%.
Lings says the intense competitiveness of the US has contained inflation. He argues that South Africa needs to deregulate the economy by reducing the cost of doing business and improving productivity. This requires a review of an inflexible labour market, high compliance requirements and over-regulation.
The reason South Africa saw a structural change in its inflation rate in the early part of this decade was because both globally and at home deregulation was taking place. Globalisation became the buzz word, with many markets opening to trade. At the same time China liberalised its economy and its productivity was boosted. South Africa opened up its trade barriers and started to deregulate parts of the economy.
However, capacity constraints have begun to show and China’s labour force is no longer as cheap as it was five years ago — the country is now outsourcing to Vietnam and Cambodia. Protectionism has crept back into the global arena — and with it inflation.
Rather than continuing to free up the economy and make business easier, South Africa started to increase regulation. In 2005 Strategic Business Partnerships (SBP), an independent private sector development and research company, calculated that the cost of regulation was R79-billion a year, or 6,5% of GDP.
The report highlighted the fact that the cost of regulation is borne by individuals and small businesses as they have little pricing power. “In fact, poorer consumers tend to bear a heavier burden than those who are better off — when producers and retailers increase their prices to compensate for the regulatory costs they have incurred, all consumers are affected,” the report says.
The cost of goods could effectively be reduced by 6,5% if we had no regulation. Although an extreme example, it highlights the effect regulation has on price. One has only to consider the Financial Intelligence Centre Act (Fica), for example, to see how regulation affects costs. The Act cost the banks about R750-million to implement and has an ongoing effect which the banks incorporate into “the cost of doing business”.
This cost is picked up by consumers. Apart from a direct effect on consumers, every cent a small business spends on tax and labour consultants, UIF payments and compensation funds increases the price of doing business and makes it prohibitive to start a new business, reducing competition.
Last year South Africa fell dramatically in the world competitiveness report from 38th position to 50th out of 55 countries — the biggest fall experienced by any country that year. Yet competitiveness is the key to reducing prices. Rigid labour laws was an area in which South Africa scored particularly badly.
Globally, one of the main reasons for the decline in inflation since the 1970s has been an increase in productivity. Labour and assets have been used more efficiently. The Far Eastern countries — for example China, Hong Kong, Malaysia, South Korea and Vietnam — all have a minimum leave policy of 10 days compared with South Africa’s 21 days.
The week of April 27, in which there were only two working days, increased the salary costs of businesses that stayed open by 13% because of overtime pay — this before calculating the loss of income to those businesses that remained closed. The higher salary costs either get priced into the cost of the goods and services or negatively affect smaller companies which cannot easily transfer the cost burden to consumers.
In an attempt to control price rises in certain sectors, the government has indicated that price setting might be a consideration to keep costs under control. However, Lings says the government has to think twice before using price-fixing to contain prices. If, for example, the government regulates private hospitals and decides to allow only a 10% price increase each year, that becomes the target increase for hospitals. If a hospital is able to increase efficiencies and would normally have increased prices by 8%, they would now increase prices by 10% because they know their competitors will too — they will not price themselves out the market.
Price setting reduces competition, which is created when companies try to compete on price. If you know what your competitor will charge and that consumers have no choice, why bother to compete at all?
If government is to get serious about bringing inflation back into the target range on a sustainable basis, it can’t leave the job entirely to the Reserve Bank governor whose only mechanism is interest rates against a global rise in resource prices and food.
Removing the inefficiencies in our economy would produce a far more sustainable environment for lower inflation — without the negative impact of slowing down growth. It would in fact become a panacea for higher growth.
CPIX up 10,4%
The increase in South Africa’s consumer price index excluding mortgage rate changes (CPIX) for metro and other areas, which is used by the South African Reserve Bank (SARB) for its inflation target, was up 10,4% year-on-year in April from 10,1% in March, Statistics South Africa said last Wednesday.
CPIX was up 1,6% month-on-month after it had increased 1,6% in March. This was the 13th month running that CPIX had been above the 6% upper target limit.
Headline consumer prices — the 12-month rate of change in the consumer price index (CPI) for metropolitan areas — was up 11,1% year-on-year in April from a 10,6% increase in March. — I-Net Bridge