Colin Coleman: Beyond the ‘two-speed’ society

COMMENT

No society can survive with 50% unemployment, yet that is exactly what South Africa may be facing by the end of this year. Joblessness alone, exacerbated by the Covid-19 pandemic, has forced the country into a state of economic emergency. 

South Africa today is a “two-speed society” – one part modern, affluent, technologically advanced, highly skilled, mobile, and increasingly multiracial; the other jobless, marginalised, unskilled, young, mostly rural, and largely black African. 

Under the shadow of the pandemic, it is easy to forget that between the end of apartheid (1994) and 2007, South Africa made giant strides. Economic growth averaged 3.6% per year, such that GDP doubled from $140-billion to $285-billion during this period. Inflation fell to an average of 6.3%, and government debt relative to GDP dropped to an enviable 28% in 2007. Between 1994 and 2014, the government’s budget grew ninefold.

During what might be called the Mandela years, when the country adhered to the enlightened example and policies of its first post-apartheid president, South Africa introduced a highly effective and successful social grant system that now reaches 18.3-million people. But starting around 2008, this steady progress was rudely interrupted by the double whammy of the global financial crisis and the accession to power of President Jacob Zuma and his cronies. 

Zuma’s central purpose was to pursue a cynical project of state capture that hollowed out public institutions and crippled many state-owned enterprises. As a result, average annual GDP growth fell by half over the 2008-2019 period, and South Africa’s people grew poorer.

In fact, in terms of overall size, South Africa’s economy peaked in 2011, with a GDP of $410-billion. It has since shrunk by some $120-billion, returning to the same size that it was in 2007. Over those 13 years, the opportunity cost or “missing GDP” – the true costs of Zuma’s corrupt reign – amounted to a sickening R2.5-trillion ($140-billion). 

Today, overall government debt of R4-trillion represents 81.8% of GDP. Absent reform, this debt will become a runaway train, reaching 100% by 2023.

Had that R2.5-trillion of GDP not gone missing, South Africa’s debt-to-GDP ratio today would be a healthy 54%. 

Instead, the country has reached the limits of personal and household borrowing. While President Cyril Ramaphosa’s administration is unwinding Zuma’s toxic legacy of state capture, the state cannot afford above-inflation public-sector wage gains. Trend GDP growth is below population growth, and now the Covid-19 pandemic is devastating jobs and incomes.

As a result, the consolidated budget deficit is expected to reach 15.7% of GDP for the current fiscal year. The costs of public-sector wages (R640-billion), the interest on the national debt (R236-billion), and the bill for social grants (R190-billion) equals South Africa’s entire projected tax revenue this year (R1.1-trillion). With the salary and interest bills filling all of the fiscal space in the revised R1.8-trillion budget for essential government services, it is clear that both these budget lines must be thoughtfully managed down.

An economy for all South Africans

A new start with zero-based budgeting would allow policymakers to look at everything with fresh eyes. This would not be an excuse to cut budgets arbitrarily, but rather an opportunity to reallocate funding wisely to address critical national priorities.

In fact, what South Africa needs is a ten-point action plan of the kind that I outlined recently in an address at the University of Cape Town. Any such plan should aim to create a fast-growing, dynamic economy. It should offer a structure of opportunity and access that is available to everyone, particularly the historically disadvantaged – a merit-based ladder that recognises talent and hard work, regardless of race, gender, or class.

More broadly, many of us South Africans must leave our comfort zones, erase ideological boundaries, and look beyond narrow interests. That includes the business community, which needs to have an honest conversation about inclusion, executive compensation, and the threat posed by monopolistic and cartel-like behaviour. It is in everyone’s interest to expand employment, provide training and internships, support entrepreneurship, finance and mentor small businesses, and drive innovation.

In terms of concrete policies, there is clearly a need for emergency measures to address the fault lines that the pandemic is exposing and deepening. To that end, I have come to believe (though some may not yet share my view) that it is time for South Africa to introduce a fiscally neutral targeted basic income grant (BIG) to help the unemployed.

Based on the international poverty benchmark of $2 per day (which is around R1 080 per month), a BIG for the country’s 10.8-million unemployed people aged 18-59 would cost around R140-billion per year before inflation. Alternatively, one could take that pool and pay all 32-million adults R365 per month, or all 23.4-million labour-force participants R500 per month. Experts should be appointed to weigh the administrative simplicity, cost, speed, and effectiveness of these options in terms of helping those most in need. To make the BIG programme fiscally neutral would require large but eminently achievable tax reforms, as outlined in the table below.

In any case, a BIG programme should be viewed as an investment, not as an expenditure. It may even be South Africa’s best option for providing short-term economic stimulus during the Covid-19 crisis. The recipients are likely to spend the grant money on food, clothing, and other essential household goods, yielding immediate benefits across the economy, not to mention boosting value-added tax payments and corporate taxes.

Mopping up the old economy

The fact that a R140-billion grant programme can be financed in a fiscally neutral way exposes the false dichotomy at the heart of South Africa’s national discourse about fiscal constraints and national needs. When the trade-offs are carefully considered, it turns out that national priorities can still be addressed within the current financial limits.

Tax reform should be accompanied by a renewed focus on tax compliance, with all South Africans being encouraged to support the South African Revenue Service (Sars) and enforcement agencies in clamping down on the country’s pervasive illegal and unrecorded economy. Sars is reportedly working with the Davis Tax Committee (a body established by the finance minister in 2013 to align the tax system with today’s globalised economy) to combat tax evasion and avoidance. The authorities are targeting R100-billion or more of non-compliant funding streams, from the abuse of transfer pricing and profit shifting to VAT fraud and other schemes. These ongoing efforts deserve the public’s full support.

Equally important is the need to root out corruption and related abuses within the state machinery. According to the auditor general’s reporting, wasteful, irregular and unauthorised expenditures at all levels of government totaled some R94.6-billion in the 2018-2019 fiscal year. Those responsible must not be let off scot-free. Either the culprits should be punished, or the departments should lose funds in proportion to the reported abuses.

Owing to the pandemic, there is also an urgent need to protect households and preserve the productive capacity of businesses. These twin priorities should guide the emergency fiscal response and any adjustments to the president’s announced R500-billion pandemic response package. Needless to say, the proposed BIG programme would help households significantly.

To rescue pandemic-hit but otherwise viable businesses, policymakers should think more ambitiously about a yet-to-be-allocated R100-billion loan-guarantee scheme. Not unlike the US Troubled Asset Relief Program following the 2008 financial crisis, these funds could be structured as equity, hybrid-equity investments, or even interest-free or subsidised loans in qualified businesses.

An economic growth plan

Beyond addressing the immediate economic emergency, South Africa also needs to put itself back on the path to sustained growth, driven by the private sector. As the industry group Business For South Africa points out, business in South Africa accounts for 83% of GDP, 55% of taxes, 79% of jobs, and 69% of investment. But for business to play its proper role as the engine of growth, the government must remove existing obstacles to investment, particularly the lack of private-sector confidence and weak state institutions. The goal should not be a “big” or “small” state, but one that works.

In my ten-point plan, I focus on several growth opportunities. First, policymakers need to boost confidence among small, medium, and micro enterprises (SMMEs). Commitments to buy, build, and employ locally must feature prominently. The state should also commit to supporting black entrepreneurs; providing essential business infrastructure, technology, and subsidised or free internet; and paying SMMEs on time. In return, SMMEs must pay their fair share of taxes and contract with the state in a fair and transparent manner at all times.

Second, South Africa needs to start pursuing more public infrastructure projects and private-public partnerships (PPPs), in addition to facilitating private-sector investments in cargo rail, ports, airports, roads, water, pipelines, renewable energy, aviation, and telecommunications (including issuing spectrum). For PPPs, we will know there has been progress when we see the government issuing requests for proposals.

Third, South Africa should be investing in “e-government” technology. This is the wave of the future. And given South Africa’s administrative failures – not to mention the prohibitive cost and low returns of raising public-sector wages – e-government is a practical way to modernise public services. The goal should be to invest in a digital platform that is available to all citizens on their mobile devices.

Within a decade, visas, taxes, passports, birth and death certification, immigration documents, traffic fines, education, health, police, municipal billing, social-grant administration, banking, insurance, asset management, and other activities could all be officially recorded and published online (privacy permitting). Likewise, South Africa needs to catch up with advances in biometric technologies. Such investments made today will save billions of rands later, freeing up funds for police stations, hospitals, and schools, and making the economy more attractive to foreign investors.

Back to business

It is now time to clean up Eskom’s balance sheet once and for all. Eskom remains South Africa’s biggest systemic risk, accounting for 77% of the state’s contingent liabilities. The government’s guarantees on R300-billion out of Eskom’s total debt of R480-billion represent around 15 times the company’s earnings before interest, taxes, depreciation and amortisation (ebitda).

Rather than sinking R245-billion into a hole, the government should resolve Eskom’s capital structure by moving all the guaranteed debt onto its own balance sheet, on negotiated and enhanced terms with bondholders. Given the spread between borrowing costs for the government and Eskom borrowing costs, this would save the equivalent of R3.5-billion per year.

Moreover, this move would be credit-neutral for the sovereign, because the rating agencies have already included the contingent liabilities in their sovereign-debt models. As such, there would be around R154-billion of debt left – or around five times ebitda – which is still at the high end relative to international norms. Ideally, one would persuade debt holders such as the Public Investment Corporation to swap R60-billion of debt for equity, leaving Eskom with around R90-billion. That would give it a capital structure with which it can stand on its own, allowing an attractive refinancing for the remaining debt stock.

As a quid pro quo, the government could simultaneously negotiate lower-cost coal supply contracts and wage restraint with Eskom workers, to put the utility’s cost structure on a sounder footing. These changes would free the company to concentrate on its core function of providing low-cost, secure, reliable energy.

Finally, the government should review and evaluate the current policy mix of industrial incentives. In the next decade, South Africa will need to create five million jobs, twice the rate of the last decade, to bring formal unemployment to below 20%. Other countries’ experiences with special economic zones (SEZ) show that, if well-resourced and properly targeted, SEZs can signal to private investors that the country is open for business. In the most successful cases, SEZ islands of competitiveness have expanded to include the entire country.

As countries increasingly seek to diversify sources of supply – including away from China – South Africa should be reviewing its own past attempts with SEZs, such as the Coega industrial development zone near Port Elizabeth. By exploring and targeting sectors with high potential (manufacturing, agriculture, natural gas, services), South Africa could create its own Silicon Valley, complete with technology data centres and a growing population of tech entrepreneurs. Similarly, South Africa needs to be looking for ways to make the African Continental Free Trade Area work, so that it can capitalise on an export market of 1.2-billion Africans.

A policy package for boosting competitiveness need not centre on labour concessions. It also could include government subsidies, worker training, tax incentives and infrastructure provisions such as subsidised rent on property, ports, roads and rail. 

The net overall cost of manufacturing and exporting needs to be attractive for any SEZ tenants. Finding the first large anchor tenants and then signing up 1 000 additional tenants over the course of the next two decades are the key milestones to success. Following international precedents, Ramaphosa should guide this policy from a unit within his own office to ensure the right outcomes.

Towards a new society

Finally, South Africa needs to confront the structural apartheid that still exists in urban planning patterns. The human, social, and economic costs of segregated and remote townships and informal settlements are unacceptable and unaffordable. Releasing land for integrated urban settlements is probably the largest untapped economic and infrastructure opportunity of our time. By creating non-segregated, denser cities offering proximity to work opportunities, South Africa could utterly transform its social landscape for the better.

Such changes call for a massive government-led effort to bring together urban planning experts, construction companies, civil-society groups, and other stakeholders. Only then can South Africa bridge its divides and provide hope to those who are destitute, starving and jobless.

This ten-point plan represents a comprehensive proposal to turn the tide toward economic inclusion and dynamism. 

Expanding the economy by 2.5% per year in the short term, and by 5% in the medium and longer term, should be the country’s paramount goal – one that would enable a doubling of the rate of job creation to bring formal unemployment below 20% by 2030. Only such a dramatic turnaround can assure South Africa’s survival as a democracy and beacon of progress for the continent.  — © Project Syndicate

Colin Coleman, a senior fellow and lecturer at Yale University’s Jackson Institute for Global Affairs, was CEO of sub-Saharan Africa at Goldman Sachs. This is an edited version of an article from Project Syndicate