The economy: Adapt or die (III) – The long term

11 July 2019

INTRODUCTION

 The distinction between the medium and long term is fluid. Some of the initiatives proposed for the medium term will spill over in to the long term, and preliminary work on long term measures can be started in the medium term. The latter is true for the four initiatives proposed here.

1. Maximize the contribution of the mining sector to the economy. Development of the South African economy started with mining, considerable deposits remain for potential exploitation, and promising parts of the country have yet to be prospected adequately. Moreover, mechanized mining has the potential to extend mine life, by allowing greater access to deposits and reducing the cutoff grade (the grade below which it is not feasible to mine deposits).

 The extent of mining activity depends heavily on the regulation and taxation of mines. While the final version of the current Mining Charter rectified some of the most egregious aspects of the first draft, it is far from grappling with all the issues surrounding the state off take from the mining industry. In particular, the approach to mining taxation should be considered in the light of optimal contract theory, the parties to the contract being the state and mining companies. The state’s objective is, or should be, the maximization of the net present value of social benefits from mining while the objective of mining companies is to maximize the private return of capital invested. For mining contracts to exist, the conditions for both parties to participate must be satisfied. At present, there is simply too little consideration by the state of what is needed to obtain the participation of mining companies over the long term.

 The irrelevance of sunk costs to current decisions - whether or not to continue operating - means that the state can tax existing mines to the point where short-run operating costs are just covered by revenue. But taxes at those levels will choke off new mining investment, since prospective investors will not invest without seeing a return on their capital spending. The net present value of social benefits provides the criterion for trading off between the present and future, once a social discount rate has been established1. There is no evidence that the criterion is being applied in the Mining Charter or in any other determination of state off take.

It will be easier to obtain mining investor participation if the taxation regime is stable. Instability raises risks and, in so doing, required target rates of return, reducing new investment. Moreover, the commodity price cycle make returns variable so that the state off take should come from the bottom line rather than the top. It is no accident that industry concerns about the first draft of the current mining charter were precisely about these points: shifting goal posts and a proposal (deleted in the final version) about a tax on revenue. And finally, given that there is an optimum level of off take, loading more imposts on the industry through the charter should be matched by lower levels of royalties and/or corporate taxation. Quite apart from negotiations around any future version of the mining charter, consideration needs to be given about the basis for future expansion of the mining industry. Outcomes will depend, in part, on how bold the industry is prepared to be.

 2. Reform the public service. The functions of the public service are to administer the state in accordance with law and to serve as a repository of expertise. A patrimonial public service cannot underpin economic growth: it fails to recruit the best available human capital, it undermines institutional integrity, and it invites corruption. “If you want to see his monument”, runs the tribute in St Paul’s Cathedral in London to its architect, “look around you”. Here and now, the devastating consequences of patrimonialism are likewise visible.

Three reforms are needed. First, recruitment into entry level administrative positions should be determined by performance in a competitive examination. Secondly, the instability at the top of the public service needs to be tackled, particularly the propensity of new ministers to squeeze out existing directors-general in order to install pliant new ones. Thirdly, the capacity of the public service to resist criminal conspiracies must be strengthened. There have been reigns of terror in parts of the public service to coerce officials into actions which they know to be illegal. Without these reforms, the building of a capable state is simply impossible.

3. Redesign information systems to collect more information about employment and income outside the five large metros and start a debate about how to improve both. The approach of government so far has been to require municipalities to produce integrated development programmes. Municipalities are expected to consider available information, to consider what can be done with own revenues, the equitable share of national income allocated to municipalities and earmarked grants, to relate to regional nodes and corridors, and to consult widely when compiling plans. But the planning loop is not closed. There is no standardized data base from which the (inevitably variable) quality of plans can be assessed. Nor is there a basis for assessing progress against goals.

 In fact, we know next to nothing about the extent to which economic progress, or regress, is being made in individual municipalities year by year. The Quarterly Labour Force Survey (QLFS) and the General Household Survey (GHS) samples are too small to yield reliable quarterly and annual estimates of employment and incomes at the municipal level, and the much larger Community Survey of 2016 collected no information on these variables, though it did collect data on service delivery. Our collective ignorance is dangerous.

However, it is possible to estimate information on the components of household income, and the percentages of households producing food and receiving remittances by province and geographical type, from the 2017 third quarter QLFS and the 2017 GHS. A table setting out the estimates is attached as an Appendix. It indicates that 93% of household incomes in metros come from earnings, compared with 88% on farms, 84% in non-metro urban areas and 62% in traditional areas. Four per cent of households in metros produce food for their own consumption, compared with 9% in non-metro urban areas, 23% on farms and 47% in traditional areas.

4. Establish lightly regulated export processing zones at points along the east coast, from Richards Bay to Port Elizabeth. China’s rapid economic growth and rising wage levels, and its turn towards raising domestic consumption has created opportunities for new countries to enter light manufacturing for export. Asian countries, such as Vietnam and Cambodia have taken advantage of these opportunities and there is no reason why we should not join them. It would create low wage employment, but given the low employment rate along much of the east coast, an adequate supply of labour could be expected. Production exclusively for export would not undercut production for the domestic market. The Centre for Development and Enterprise has produced a detailed proposal for an export processing zone for the Nelson Mandela Bay metro2. It should be piloted and, if successful, replicated. Every 100 000 jobs created at the national minimumwage would add 7% to household incomes in KwaZulu-Natal traditional areas or 10% in Eastern Cape traditional areas. The addition to earnings would be 12% in KwaZulu-Natal and 20% in the Eastern Cape. The EPZs would be the new border industries, looking outwards rather than inwards.

CONCLUSION

Two points by way of conclusion:

1. The focus on the particular projects and initiatives in this brief series should not detract from a reorientation towards growth in the whole of government. Rigorous cost-benefit analysis of all public investment, for instance, would be a growth-promoting practice, independently of particular growth promoting strategies.

2. The enemy of a pro-growth orientation is ‘radical economic transformation’, fronting for large scale theft, institutional destruction and impoverishment. The battle is on, and victory for the growth party is not assured. Should the growth party fail, South Africa will be on the road to ruin. The opportunities for growth are there, but mindsets need to be changed for the opportunities to become visible. Adapt, or die.

By Charles Simkins, Head of Research, HSF, 11 July 2019