ERSA’s Fiscal Futures webinar series (V)

27 October 2020

In this brief we cover the discussion around the policy reforms which South Africa needs to make. Brief one introduced you to the theme, the participants and then the first two topics; first Treasury and the South African Reserve Bank’s Response to COVID, and second the fiscal deficit and fiscal sustainability. The second brief covered the fiscal deficit and fiscal sustainability, brief two the discussion around debt, including a presentation made by Treasury, brief three discussed economic growth and brief four the credibility of South Africa’s financial institutions and complacency risk.

INTRODUCTION

There was a consensus in the seminars that a number of policy reforms need to be implemented. Countries globally now have budget deficits not seen in decades and we are at a policy response cross-road of how to respond to the crisis, as well as South Africa’s economic growth challenges in general. However, the seminar participants were still divided into those in favour of fiscal and monetary easing, and those for fiscal consolidation and against monetary easing. We will begin the brief with the points made by the former camp and end with general points made about South Africa’s economic policies and their reform.

THOSE IN FAVOUR OF FISCAL AND MONETARY EASING

In 2018 government over estimated inflation by 2% and its budget was allocated using this figure, which resulted in a type of inflation shock. Therefore, fiscal consolidation will drive us deeper into trouble.

What we have now is a policy coordination problem and, with the required confidence, coordination can be achieved largely through the private sector balance sheet, thereby avoiding self defeating fiscal consolidation.

South Africa has two paths available to it. The first involves fiscal consolidation but the social and investment damage will be extreme. The second is mild expansion in 3-5 years leading to transformative growth, which can increase debt but will rescue the economy. Currently we are in-between the two, which will not it cut enough to see the benefits of consolidation nor will it stimulate high enough demand. Pursuant to this, the economic effects of bi-polar austerity and stimulus strategies are catastrophic.

THOSE IN FAVOUR OF FISCAL CONSOLIDATION AND AGAINST MONETARY EASING

With regards to the call to expand the monetary base:

Arguments for it focus on the need to support government and demand as if it was an imperative necessary for development and successful in advanced economies.

We still have positive interest rates compared to other countries that have done this with rates which are essentially zero.

We still rely on foreign investment and quantitative easing (QE) will erode our financial credibility, deterring foreign investment.

It does not address the fundamental problem of high government debt and the cost of interest attached to it.

The demand problem it seeks to address does not exist independently of the supply side issues.

Are we saying the economy should grow to fit the size of the budget, rather than the budget being tailored to fit the economy?

We need to start from where we are, not where we wish to be. Currently South Africa’s government is expensive and ineffective.

With the inflow of funds from QE elsewhere in the world over the years since the global financial crisis, South Africa has not use the funds in a way that have given the commensurate return. So if we go into expansive monetary policy we want to know that reforms are in place and the money is put to proper use.

Fiscal austerity does pay off when you address the deep structural problems and Belgium is a case in point. QE, on the other hand, is a monetary back-stop meant for ironing out bad equilibrium in markets, but it must not be abused and if government solvency/risk of default is an issue stay out of it.

A big shock locally has been the response to the global financial crisis and how South Africa has been dealing with it since, with an increasing government wage bill and crowding out investment. In addition, the state owned enterprise (SOE) accommodation and increased government expenditures are locked in.

A large chunk of South Africa’s spending is good with regards to inequality alleviation, but SOEs are placing pressures on the budget with large scope for improvement there.

Treasury’s budgets have failed and we need a way to shift from consumption to investment spending. Government should rather be committing to significant consumption expenditure restraint and introduce a well planned investment programme, aimed mostly at urban infrastructure.

Problem programmes must be cut while holding onto those that promote economic inclusivity, which is a political problem because those extracting rents have much louder voices than those who require service delivery. South Africa’s issues have likely been state capture, the protection of incumbents and a lack of state capacity.

GENERAL POINTS ABOUT GOVERNMENT POLICY AND REFORM

Reform of the supply side of the economy is required. While the demand side of at least non-emerging market economies is mostly taken care of due to pent up demand, supply issues will take time. A good analogy or even example for this would be changing flight attendants to nurses.

With regards to South Africa’s growth path that has become unbalanced and strongest in low productivity sectors,[1] policies targeting the supply side of the economy and international competitiveness are likely to be more effective in raising employment and growth than policies targeting returns to labour. Wage growth alone will be insufficient to address unemployment.

What is needed is a platform of economic reforms aimed at reducing the cost of living, doing business and finding work. Namely electricity sector reform, the regulation of network industries and addressing the drivers behind administered price growth.[2]

Structural reform is not a good description to use because it generates a reaction. Better would be to ask, are there policies which can produce growth and inclusion at the same time?

We must look at fiscal policy with regards to the supply side for economic inclusion and income equality, which is also needed for political stability. For inclusive growth, obvious policies are improved education and network infrastructure such as telecoms.

The qualities of fiscal policy are important and we need to target new sectors, infrastructure gaps and labour policies which increase the labour participation rate. The tax system too needs to be favourable to growth. Capacity of the public sector is important for growth and private sector investment too. How do we get the private sector involved? Inclusivity; we are keeping labour and investment out with regulations that are very limiting. The labour market is unskilled and policy must gear towards absorbing low skills at market prices.

Argentina in 1990s had similar problems to what we have with Eskom now. It then unbundled the electricity sector, as we planned to do here, and though heavily regulated it was also privatised. The result was that the state did not have to spend anymore on this, electricity prices dropped 40% and within three month there were no more blackouts.

In order to improve things in the short-term we need to anchor medium-term expectations. To do this South Africa could address the following:

Increase internet penetration, which is extremely low by any standard.

Electricity capacity has been poor for 12 years and there is excess demand, so why no boom in investment as a typical response?

Policies which help the network industries are good for growth, inclusion and fiscal solvency.

Improved public sector wage structure and levels.

In the medium to long-term, the impact of the President’s structural investment projects have been gazetted, so the red tape has been removed and we are seeing the real beginnings of cooperation between the government and private sector. It is still long to go with these large projects but we need an enabling environment for smaller projects, and a more decentralised approach for local businesses and municipalities.

Policy uncertainty has been a problem since the 2000s and needs to be addressed in order to attract investors. All countries which have had large growth thanks to foreign capital have had governments that developed a clear strategy from the top, thereby creating consensus.

To improve growth we need to look at sectors that could be new sources of growth, instead of a holistic approach in the labour markets and others. Our production markets are too rigid and need more flexibility, especially in ease of market entry as we are currently trying to protect the incumbents. The political-economy is at the heart of preventing the implementation of well discussed economic strategies. Political structures currently protect insiders and are not something that can foster a changing economy; our economy has not changed in the last couple of decades.

There is possibly not enough measuring and publication of government’s service delivery outcomes, and we could create competition between provincial and local governments by making performance outcomes more public.

Putting Eskom aside, the other largest constraint is skills which are a long-term dynamic for long-term growth and the clearest solution is education. Implementation here has failed but the resources are there; a larger portion of our resources are spent here versus a lot of other countries, but the outcomes are lower due to teachers unions within the local power structures protecting inefficiency.

With regards to prescribed assets as a possible policy choice to direct funding towards government backed projects and investments, South Africa’s financial assets are fully invested and it is hard to make the case that shifting resources from the private sector to the public will generate improved economic returns.

CONCLUSION

None of this is new. Treasury has been advocating much of the above for over ten years now. South Africa’s problem has been the inability for government to address issues and its capacity to implement policies. What is new is the unprecedented economic deterioration, the financing constraint of debt and the emergence of fiscal stress.

By Charles Collocott, Researcher, HSF, 27 October 2020

[1] As sectors with faster total factor productivity[1] growth produce more real (inflation adjusted) output over time, their relative prices fall and the price changes trigger increases in consumption demand that less than offset the price fall. As a result, sectoral shares in nominal (including inflation) output decline. Over time, this generates a structural shift of the labour factor input for growth to low productivity sectors -

[2] Administered prices are those determined or influenced by the government or a government agency, without any reference to market forces.