Austerity and a permanent income shock

15 July 2020

INTRODUCTION

Alberto Alesina and his co-authors[1] use a standard definition of austerity as a policy of sizeable reduction of government deficits and stabilization of government debt through spending cuts or tax increases or both. They point out that austerity may follow poor policy, notably the failure to achieve a cyclically adjusted budget balance or, less frequently, exceptionally large amounts of government spending, forced by war or disaster, or both in combination.

In the South African case, poor policy is in evidence. There has not been a primary surplus[2] since 2008, despite an upswing of 51 months in the business cycle between 2009 and 2013. The need for adjustment was already evident in the 2020 February budget, before the COVID-19 epidemic reduced expected economic growth in 2020 downwards from 0.9% in February to -7.2% in June. Real per capita GDP in 2020 is expected to be back at the 2005 level. Table 1 compares the fiscal positions in the two years:

Table 1

A PERMANENT INCOME LOSS?

GDP per capita in 2020 is expected to be 11.2% lower than it was in 2014. Most, but not all, of this drop should be regarded as a permanent setback. The rest is a temporary setback to be made up by faster than trend growth in the short term. Table 2 sets the scene for identifying the temporary component.

Table 2 – Growth projections

The Treasury does not foresee much of a short-term bounce-back in 2021 and 2022, an increase of only 1.0% in the two years taken together. The Reserve Bank May projection is more sanguine, expecting an increase of 3.8%. This puts the permanent loss component at between 7.4% and 10.2%. Both these projections will be updated by the time of the October Medium Term Budget Policy Statement. For now, we should be behaving as if we were about 8% poorer than in 2014. That is not austerity as a policy. It is decline as a fact.

A decline of this magnitude will be felt by everyone. Labour’s share in net value added in the South African economy has increased steadily since 2009, from 57.0% then to 65.1% in 2019. Over that period, real aggregate employee compensation has risen by 29%, while real aggregate net operating surplus has fallen by 9%[3]. It is difficult to see how that trend can continue. Real aggregate compensation of employees is bound to fall. Only time will tell how this fall will be apportioned between a drop in employment and a drop in average compensation per employee.

THE TRAJECTORY OF MONETARY AND FISCAL POLICY

Reserve Bank projections indicate two repo rate cuts of 25 basis points each in the third and fourth quarters of 2020[4]. This would bring the repo rate to 3.25%, marginally below the projected increase in the consumer price index of 3.4% for 2020. The CPI is projected to rise by 4.4% in both 2021 and 2022, in the middle of the target range.

Fiscal policy is more complex, and more contentious. The government has committed itself to an active fiscal policy, designed to stabilize the debt to GDP ratio at 87.4% by 2023/24[5]. As Table 3 indicates, this implies a cut in real expenditure of 8.2% in 2021/22 and a further 3.4% in 2022/23. This is to be achieved using zero-based budgeting, so that each government activity is subject to assessment of whether or not it should continue. A battle royal is under way, and we shall get the first progress report in the October Medium Term Budget Policy Statement.

Table 3 - Medium Term Expenditure Framework

CONCLUSION

Neil Coleman, in a recent Daily Maverick piece, cited:

Estimates from economists are that projected Budget cutbacks over the next couple of years will range from R 400 billion, according to business economist Nazmera Moola to as much as R 600 billion, according to Duma Gqubule.

In fact a precise figure can be projected as Table 4 shows:

R 233.5 billion represents 2.2% of GDP over the relevant period[6].

It’s tough. But it will be tougher still if there is a refusal to come to terms with our circumstances.

By Charles Simkins, Head of Research, HSF, 15 July 2020

[1] Alberto Alesina, Carlo Favero and Francesco Giavazzi,

[2] The primary balance is main budget revenue less main budget non-interest expenditure

[3] These calculations are based on data from the Reserve Bank’s online statistical data base.

[4] Reserve Bank, Statement of the Monetary Policy Committee, 21 May 2020, p 5

[5] We have seen similar promises in the past. The 2016 Budget projected debt/GDP stabilization at 46.2% in 2017/18 and the 2018 Budget at 56.2% in 2021/22

[6] Daily Maverick reports that the government may introduce a basic income grant of R 500 per month for people age 18 to 59 who are not employed and who receive no other social grant. It is estimated that this would cost R 197.8 billion per year, of which 50% to 60% could be recouped by levying extra taxes on those with jobs. The Minister of Social Development said: “Currently, the most vulnerable groups of our population are the youth between 18 and 24 and the elderly between 50 and 59. Targeting these groups first and then progressively expanding to other age groups may be warranted.” (Sandisiwe Shoba, Basic income grant on the table for South Africa’s unemployed poor, Daily Maverick, 14 July 2020) Given the country’s fiscal position, this is an astonishing proposal. It shows how incoherent government policy has become.