Against economic recklessness IV – Is the ground being prepared for fiscal and monetary policy adventures?
21 June 2017
Introduction
South Africa has benefited from prudent fiscal and monetary policy for much of the time since 1994. Could this be about to change?
The usually well informed Peter Bruce in a Business Day column on 8 June 2017:
There are many other ‘solutions’ being proposed, including suspending inflation targets and a huge fiscal stimulus of R 450 billion a year for three years. But where would that money come from?1
And now we have the Public Protector directing the Portfolio Committee on Justice and Correctional Services to initiate a process that will result in the amendment of Section 224 of the Constitution in pursuit of improving socioeconomic conditions of the citizens of the Republic. This direction is contained in her report on the Bankorp/ABSA matter, resolution of which does not require a constitutional change. Applications to court for a review of the report are certain to follow.
The current Section 224 can be compared with the Public Protector’s favoured formulation as follows: (Italics indicate proposed deletions, while underlining indicates proposed additions).
224 Primary object
(1) The primary object of the South African Reserve Bank is to protect the value of the currency in the interest of promote balanced and sustainable economic growth in the Republic, while ensuring that the socio-economic well-being of the citizens [is] protected.
(2) The South African Reserve Bank, in pursuit of its primary object, must perform its functions independently and without fear, favour or prejudice, but while ensuring that there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters Parliament to achieve meaningful socio-economic transformation2.
The day after the release of the Public Protector’s report on 19 June 2017, the Reserve Bank issued a press release stating that the constitutional change would have a negative impact on the independence of the Reserve Bank by stripping it of its key competence to protect the value of the currency3.
Analysis
South Africa entered a recession in the fourth quarter of 2016 and very low growth is projected for 20174, so that real per capita incomes will fall again this year. Expansionary fiscal and monetary policy are standard tools for dealing with a recession. So, what’s the problem?
It turns out that there are several problems:
1. Expansion of aggregate demand via fiscal and monetary policy is unable to make a dent on the major structural problems the economy faces. As Ricardo Hausmann, the distinguished Harvard economist and former Venezuelan finance minister, has pointed out5, South Africa has been shifting resources from the tradable sector to the non-tradable sector, and the non-tradable sector is more skill-intensive than the tradable sector. If you increase government spending to boost aggregate demand, the resulting increases in domestic spending lead to more spending on tradable imports and locally produced non-tradables. Since the highly skilled are fully employed, there is no impact on output. Encouragement of skilled immigration would help, but policy has not evolved in that direction.
2. A fiscal stimulus, as mentioned by Peter Bruce, of R450 billion a year would be astounding, especially if it were debt financed. If such a stimulus were introduced in the 2018/19 tax year, it would add 27% to public expenditure, as projected in the 2017 Budget Review, Great news for public servants and tenderpreneurs, but terrible for government debt, which would rise by over 8% of GDP in a single year. Three years of that would take the public debt/GDP ratio to well over 70%, the International Monetary Fund’s red line for emerging market economies, even assuming no calls on government guarantees of state owned enterprise debt. The stimulus would also damage the economically vulnerable, who are unable to protect themselves against higher, and probably accelerating, inflation.
3. Ought there to be a broadening of the objectives of monetary policy? The European Union makes price stability the primary goal of monetary policy, price stability being regarded as being close to, but no more than, an inflation rate of 2%. Subject to price stability, monetary policy may contribute to other goals, such as full employment and balanced economic growth.
Monetary policy goals in the United States are to foster economic conditions that achieve both stable prices and maximum sustainable employment. Like the European Union, the US regards a 2% inflation rate as representing price stability, and deviations in either direction are regarded as undesirable. On the other hand, many factors affect the structure and dynamics of the labour market, and these may change over time. Accordingly, specifying an explicit goal for employment is not regarded as appropriate. Instead, decisions are informed by a wide range of labour market indicators. At present, an unemployment rate of about 4.6% is regarded as full employment. Moreover, the term ‘sustainable’ means that the price goal and the employment goal are less divergent than they may seem. The attempt to expand employment beyond the sustainable level will increase inflation.
Also, the point about both the EU and US mandates is that the appropriateness of monetary policy can be assessed by using precisely quantified economic concepts. By contrast, the ‘socio-economic well-being of citizens’ and ‘meaningful socio-economic transformation’ are hopelessly vague. They could be invoked to justify just about anything.
4. The rationale in the Public Protector’s Bankorp/ABSA report for changing the constitution in respect of the Reserve Bank is breath-taking. The Annexure reproduces the relevant passage in the report. In so far as a coherent argument can be discerned, it implies that privately owned commercial banks should cease to exist. For how else would the Reserve Bank be able to escape its function as a lender of last resort? And if there are only state banks, might not the Reserve Bank have to act as lender of last resort to them? Or would the Reserve Bank become the single state bank? And how can it be that the benefit of protecting the currency is confined to commercial banks? Finally, there is a non sequitur between the argument advanced and the recommendation for a constitutional change.
5. Referring consultation on monetary policy to Parliament rather than to the Minister of Finance is another strand in a programme of working around Treasury. The ANC’s Economic Transformation Discussion Document prepared for its policy conference at the end of June promotes the concept of the ‘developmental state’, and proposes formalising economic co-ordination, through the Presidency and the National Planning Commission, which is housed in the Presidency. Right now, when there is very little daylight between the President and the Minister of Finance, this may not appear to matter too much, but the longer term shift in the balance between them is a matter for major concern.
From a policy perspective, things have been crazy for the last eighteen months, and they are likely to get crazier still as the year progresses. The initiatives discussed here may, in the end, amount to very little. But they are sapping confidence, dismaying ratings agencies and they will, if realized, lead to serious economic damage.
By Charles Simkins, Head of Research, HSF< 21 June 2017
Notes:
1 Peter Bruce, Put the state’s assets under the hammer, Business Day, 8 June 2017
2 Fin24, Rand tanks as Public Protector opens Pandora’s Box on currency laws, 19 June 2017
3 SA Reserve Bank, Press Release, 20 June 2017
4 Fitch currently projects a growth rate of 1% in 2017, Moody’s less than that.
5 Raising South Africa’s speed limit, Centre for Development and Enterprise Insight, December 2014
Annexure
Extracts from the Public Protector’s REPORT ON AN INVESTIGATION INTO ALLEGATIONS OF MALADMINISTRATION, CORRUPTION, MISAPPROPRIATION OF PUBLIC FUNDS AND FAILURE BY THE SOUTH AFRICAN GOVERNMENT TO IMPLEMENT THE CIEX REPORT AND TO RECOVER PUBLIC FUNDS FROM ABSA BANK
As published on the Business Day website on 20 June 2017
5.3.23 It is evident that the status of the South African Reserve Bank as the lender of last resort has commercial benefits only in respect of the financial sector market. The benefit which involves vast amounts of public money does not improve the socio-economic conditions of ordinary citizens of the Republic but of a particular financial sector.
5.2.24 Leading authors advocating and promoting the ideology of state banks and nationalization of state banks believe that the notion of the lender of last resort’s status that is inherent to central banks would cease to exist if governments take sole power in creating money through the establishment of state banks.
5.3.25 It is in this belief that once the state takes control of creating money and credit, numerous benefits aimed at alleviating economic ills of ordinary economic economically disadvantaged people may be achieved, unlike our current purely commercial transaction system which only seeks to improve a particular financial sector.
