Nine steps to exit low-growth  trap and ignite the economy

What would be the principal elements of an economic strategy that would substantially transform livelihoods and household opportunities in South Africa?

A policy framework that encourages effort from all South Africans and is open to global and domestic capital, expertise, enterprise and co-operation is more likely to succeed than a closed or conflict-based strategy. But this requires broad agreement and trust between parties who recognise their shared interest in a co-operative outcome.

A clear imperative is that the unbalanced infrastructure and market structures of apartheid should be addressed. This has several large and compelling implications. One is that far greater impetus is needed in urban development, including housing investment, more densified cities, transport integration and commercial renewal.

A second imperative is that productivity and wages should be improved, which is partly why openness and global linkages are important. A third is that job creation must be accelerated, especially for young work seekers. A fourth is that social services — schooling, healthcare, social security and welfare services — must be improved.

The context is an economy caught in a “low-growth trap” brought on by worsening commodity prices and trade conditions after the 2008 recession and a subsequent deterioration in investor confidence. Political and policy uncertainty, institutional weaknesses and unresolved regulatory conflicts have contributed to the low-growth environment.

The circumstances call for a heterodox mix of policy initiatives, to improve investment and growth and to broaden opportunities and employment. Economic activity has to be boosted without raising the public debt-to-GDP ratio beyond current projections..

Broadening credit extension

Financial deepening, the diversification of enterprise funding and real growth in private sector credit extension are enabling conditions for investment and economic growth. Public sector borrowing has grown rapidly over the past decade, but private sector investment and borrowing have been sluggish.

A more accommodating financial environment can assist in creating conditions for a more buoyant recovery. Global financial easing has kept interest rates low since the recession, but this has facilitated financial recapitalisation and disintermediation rather than easier access to trade or investment credit.

As interest rates rise over the period ahead, it is important that offsetting measures be adopted to ensure that credit conditions improve. Stronger growth in public and private sector financing cannot be expected to arise spontaneously in the presence of regulatory uncertainty or pessimism about growth prospects.

Concerted efforts are needed to construct a more favourable financial environment. A high-level accord or understanding between the finance ministry, the South African Reserve Bank and the heads of the major banks to support stronger growth in development financing and credit extension would be a useful starting point.

Although development finance institutions have a complementary role to play in this, to mitigate risk in municipal finance and the housing “gap market”, for example, the private financial sector has far greater resources and must be the main player.

A competitive exchange rate

Export-oriented manufacturing, tourism and trade in services are important growth drivers, but they cannot thrive if the exchange rate is highly volatile and overvalued. The present policy stance on the exchange rate is confused — it appears to assume that because a weak rand cannot be defended in the presence of adverse sentiment, it is also impossible to counter unwanted rand strength. It is, of course, impossible to “stabilise” the rand in real terms, but it doesn’t follow that its value should be left entirely to the vicissitudes of the market.

For a time, there was agreement between the treasury and the Reserve Bank to “lean against the wind” with foreign exchange purchases when market trends and global currency movements led to an unwarranted strengthening of the rand. This contributed to a substantial rise in official reserves until about 2010.

But there is no longer a shared understanding of the associated security holdings and sterilisation costs, and so the required forex market interventions have fallen away.

In the absence of a more active exchange rate policy, industrial development and trade rely too heavily on protectionist measures. And in the absence of better co-ordinated trade and investment policies, the current account of the balance of payments remains a drag on growth and a continuing drain on national wealth.

As with accommodative monetary and financial sector policies, a bias in favour of a weaker rand is a helpful element in creating an environment for growth, investment and job creation, but it is no silver bullet. Nonetheless, the present impasse between the treasury and the Reserve Bank on sterilising forex market interventions needs to be resolved.

Fiscal consolidation

Fiscal consolidation has three broad aspects: expenditure management and revenue strengthening, debt containment, and restructuring of state assets. Government expenditure must be kept in check while debt continues to rise as a share of GDP and the scope for raising the overall tax burden is limited.

These are not circumstances in which substantial medium-term shifts in the structure of expenditure are possible — moderation and effective spending controls are needed everywhere. But it is helpful to focus on the dominant long-term expenditure challenges that should be resolved if the fiscal space is to not remain constrained indefinitely.

Challenges to be addressed include:

• Road Accident Fund claims, which, despite the substantial increase in the Road Accident Fund levy, continue to accrue an annual deficit of some R30‑billion;

• Government personnel expenditure, including the size and structure of the public service;

• Strengthening of infrastructure investment within an affordable and sustainable fiscal envelope that switches expenditure from remuneration, goods and services to infrastructure; and

• Rationalising overlapping and fragmented government departments.

South Africa’s revenue base has been strengthened considerably since the 1990s, mainly with better tax administration and the broadening of the tax base. There will be further opportunities for revenue enhancement ahead, although increases in the tax burden should be balanced against the need to encourage investment and retain wealth and capital domiciled in the country.

User charges and fees are an important supplement to tax revenue — and assist in managing the consumption of scarce resources.

Appropriate pricing of water services is important for cost recovery purposes and to ensure that access to water is fair and sustainable.

Carbon pricing and environmental charges are likely to play an increasing role. But the main revenue policy issues will continue to be the progressiveness of personal income tax and its allowances, the structure of company tax, and maintaining a broad value-added and indirect tax base.

Against the backdrop of the modernisation of tax administration, consideration now should be given to improving the horizontal fairness of income tax, for example by phasing in allowances for dependants that are revenue-neutral.

South Africa’s fiscal consolidation path is aimed at stabilising the debt-to-GDP ratio at about 50%. Overall public sector debt is considerably higher, and is rising mainly because of Eskom’s borrowing requirement for its build programme. Eskom and Transnet are at some risk of future financial difficulties associated with rising debt, particularly if economic growth remains sluggish.

Shift the economic landscape

Cities are the engine rooms of modernisation and technology change. They are the co-ordinating hubs of trade, markets and enterprise development. Apartheid was in part about retarding and distorting the patterns of urban development, and so urban investment, consolidation and neighbourhood improvements are especially important for transformation and inclusive growth.

Improved city planning, accelerated investment in water and electricity networks and transport systems, enhanced education and training institutions, and better co-ordination between civic and business leaders are key aspects of the urban development challenge.

The principal cities are well placed to step up investment and infrastructure maintenance, because they are not overly indebted. However, in some cases financial and revenue management weaknesses need to be addressed.

Cities need to be able to invest for the long term and improve their maintenance of infrastructure without creating a greater burden on the national fiscus. This means municipal revenue sources need to be strengthened and private investment must be mobilised more effectively.

Investment in housing

Alongside economic and community investment in cities, a substantial increase in housing investment is needed. There is an ongoing role for government-sponsored housing schemes and upgrading of informal settlements, but greater emphasis must be given to private investment in housing stock as part of urban densification initiatives and to contribute to affordable, improved residential neighbourhoods.

Investment in housing not only meets the growing need for shelter and living space, but also generates employment and business opportunities with a comparatively low leakage of spending on imports. Over time, it will yield secondary benefits in improved education and health outcomes and informal and small-scale enterprise opportunities.

House ownership is the largest and most enduring vehicle for the accumulation of family wealth.

A new initiative is needed in which the government partners with the banking sector in expanding investment in new and improved housing stock, supported with a limited fiscal subsidy or guarantee plan and aligned with municipal densification and transport integration plans.

Modernise network industries

Power, transport, water and communications are network industries in which public regulation and licensing are necessary, but there are many possible blends of public and private ownership of infrastructure and services. South Africa has historically relied on state-owned, integrated utilities to maintain these infrastructure networks and secure the supply of network services.

But this approach leaves little scope for diversification and modernisation associated with technology change, and relies heavily on public debt raised against the assurance of a regulated price together with limits on market competition.

The impasse between Eskom and the energy department on independent power producers (IPPs) has damaging consequences for South Africa’s reputation in the investment and infrastructure markets. There might well be a need for a new approach to agreeing on the future project pipeline ahead of the IPP procurement process, but the current set of projects needs to be signed off to restore investor confidence.

Continued rounds of IPP investments, in renewable energy and the envisaged coal and gas projects, are not just about meeting medium-term power requirements at agreed prices. They are also about creating a market in which power can be contracted at competitive prices beyond the initial term of the IPP projects.

One possible route would be for Eskom to retain its system operations, purchasing and transmission responsibilities and selling or partially disposing of its generating plants.

In this way network control and co-ordination remain in public hands, where they belong as a “natural monopoly”, but operating plants migrate into a competitive environment in which the advantages of private ownership and management can be mobilised.

A bias towards employment

Industrial and urban development policies under apartheid were designed to constrain employment growth and retard opportunities for black economic participation, outside of Bantustan areas and decentralised enterprise zones. The law and governance arrangements have changed, but the structure and dynamics of economic growth have not yet reversed these distortions.

Deliberate policy measures and interventions are needed to push the economic growth bias towards employment and inclusiveness.

Tourism and related services have continued to grow despite difficult market conditions. More accommodating visa and border control arrangements would be helpful.

Special economic or export-oriented industrial zones need to be given greater impetus, and associated institutional and regulatory barriers must be addressed.

Some subsectors of manufacturing have considerable employment potential, such as food processing, clothing and textiles, and furniture manufacturing. Industry partnerships as part of the Industrial Policy Action Plan need to be supported and implemented aggressively. Bargaining council agreements need to recognise the need to accommodate and support small and low-productivity enterprises.

There is further growth potential in the extended public works programme (EPWP), particularly in cities, larger municipalities, schools and health facilities. Support for work seekers in bridging the gap between school or college and the work environment is central to improving young people’s prospects.

Well-managed implementation of labour market reforms and support for low-productivity activities are central to a successful transition to more inclusive growth.

Implement the minimum wage

The government has indicated an intention to introduce a national minimum wage that has considerable potential to protect vulnerable workers, but could also lead to higher unemployment and reinforce a “dual” labour market in which informal, noncompliant enterprises become more common.

The minimum wage should be accompanied by suitable complementary measures to strengthen social protection and assist low-productivity enterprises.

It has been recommended that the EPWP and similar programmes, such as the Community Work Programme, should be exempt from the minimum wage. This is morally cynical and institutionally impractical. If there is a socially agreed-on minimum wage, then the government must lead by example.

It is mistakenly thought that the minimum wage would be “unaffordable” for EPWP projects — in fact, current levels of EPWP participation are still well below what they should be, and the costs of phasing in compliance with a R20 an hour minimum wage by 2019 are modest. This would send a clear message of the government’s intent to respect the new standard.

The minimum wage task report recommends temporary relief for workers in agriculture and domestic service, for an adjustment period of two to three years. A better approach, aligned with the country’s structural employment challenges, would be to extend the employment incentive to all low-wage employees, subject to compliance with minimum wage and social security participation.

The circumstances of young, entry-level employees, whether in training or internship positions or in part-time or relief employment, need to be distinguished from the employment status of older workers in more stable jobs.

South Africa has an especially severe youth unemployment problem, and it is neither practical nor affordable to extend labour standards or social security requirements fully to young work seekers. The present employment incentive operating through the tax system is not enough.

The commitment of business leaders to the “million jobs” initiative needs to be given recognition and impetus, including appropriate regulatory relief to align the costs, benefits and incentives associated with youth employment.

Social security and health

Proposals for comprehensive social security and health insurance were set out in the Taylor committee report nearly 15 years ago. The policy frameworks are still far from adequate as practical implementation plans and credible financing strategies.

In the absence of progress in social insurance and integrated health coverage, the gap between publicly funded services and private pensions and health insurance widens.

But the underlying policy issues and social security design considerations are complex and politically contested. The relevant government departments and social security funds and entities do not collaborate effectively. There is little engagement with private sector and civil society stakeholders.

There are several pressing needs and opportunities for reform targeted at the most vulnerable. Key social security proposals include a basic income transfer for long-term unemployed work seekers, and a standard retirement pension and basic death and disability cover implemented using the Unemployment Insurance Fund administrative platform.

What’s to be done?

Achieving social consensus on an economic strategy and its implementation will be enormously difficult. There is insufficient trust and engagement among stakeholders, and views are highly polarised.

Yet there is considerable common ground in our substantive imperatives: we need accelerated growth and investment; housing and urban development are unarguable priorities; employment and rising wages have to be achieved; and social services must be improved.

It is easy to state the obvious: political leadership and a clear national vision and plan are needed.

But it is also important to emphasise the role of diverse forums of engagement — between municipal officials and local business and civic leaders, between business organisations and financial institutions, between organised labour and investors, between social service departments and public benefit organisations.

These sites of struggle have the potential to become engines of inclusive growth.

Andrew Donaldson is former head of the Government Technical
Advisory Centre. This is an edited version of a paper published in GTAC WhatsUp at www.gtac.gov.za

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