So South Africa’s “Big Issue” has very much to do with economic growth, or lack thereof

Posted On Monday, 14 December 2015 13:39 Published by
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Economically, we are likely in the early stages of what I call the “stagnation” or “correction” phase of the economic super-cycle, “early” meaning perhaps 4-8 years in (depending on whether you ignore the short growth up-tick around 2010/11 and start the clock in 2008, or otherwise start counting from 2012), and the length of such super-cycle stagnation phases can conceivably roll on for far longer than that.

John_LoosFNB

The super-cycle stagnation phase may have a good number of years to run, and it has its roots long before last week, perhaps a few decades ago. 

Over the past week, surprise changes in Ministers of Finance have been the Big News.

The news of the 1st change last week created a noticeable rise in “panic” amongst corporates and investors, and was reflected in market movements. But this news, to me, was arguably not the big economic news of the week. Rather, another slew of dismal economic data releases, which went by relatively overshadowed, was It.

The data continued to show that the new Finance Minister would face an increasingly challenging environment, because South Africa’s “Big Issue” still looms larger than life.  An “economic slide” has been occurring for some years, and negative economic news has become so frequent that little should surprise us.

Annual economic growth is into its 4th year of broad slowdown (well, it appears that 2015 will be slower than 2014), and 2016 looks set to be worse, with recession risk high.  The OECD Leading Indicator for South Africa picked up further downward speed to -1% year-on-year decline in October. It has been in year-on-year decline almost continuously for 2 years, and the latest rate of decline is the biggest one since August 2009.

How is this possible, you may ask? After all, less than a decade ago we had an economic boom, and even around 2010/11 we were achieving respectable economic growth albeit for a very brief period. Yes, this is true, but purely because of extremely low bases created back in the 1980s and 1990s, which gave us some important macroeconomic levers to pull.

And these “levers” could only be pulled once or twice, and then they were done. 2 key structural characteristics that constrain our long term growth rate, and had their origins many years ago, are an inflexible labour market, which is well documented, and a highly unequal skills distribution, originating in policies decades, and even centuries, ago.

An unequal skills distribution means that many are ill-equipped to participate in a modern economy, even should they wish to, and this translates into a highly unequal income distribution. There is very little one can do about this other than to drastically improve the education and skills levels.

Redistribution of income from the skilled to the unskilled currently takes place on a large scale, but the tax base is too small and government finances far too fragile to sustain a largescale welfare state. But this didn’t matter quite as much two decades ago, at which stage we had some important economic “levers” to pull. The first big one was to, virtually with the stroke of a pen, end economic boycotts and sanctions in the early-1990s. It obviously wasn’t nearly that easy.

A political settlement had to be achieved first, and that was extremely tough, but once we were there, there was little standing in the way of uplifting the economic isolation measures. And so, from a very low base in the early-1990s, it was relatively easy for South Africa’s economic performance to improve significantly, purely by normalizing trade and business relations with the rest of the world, and through improved investor confidence in the country which was boosted by the political settlement.  Those were exciting days.

The rigid labour market was there, and frequently mentioned, but things were still improving due to other factors, so it wasn’t quite that important yet. The highly unequal skills distribution was also still there too. But we had just pulled the 1st important economic lever, so things were “on the up”. By the late-1990s, we still had extremely high interest rates, and as a result of this high cost of credit we had a relatively low level of household indebtedness. All the while, consumer price inflation had been slowing since the mid-1980s’ double digits rates. Interest rates hadn’t come down, though, because 1990s monetary policy was more focused on using interest rates to try and protect the value of the Rand.

But in the late-1990s, it was announced that we would be moving away from “Rand Targeting” and towards an official CPI inflation target of 3-6%. As inflation was not far from that range, having Prime rates as high as 25.5% for a short time in 1998 was no longer necessary, and we had what I term a “once-off downward structural adjustment” in interest rates to far lower levels by early last decade. This move unleashed arguably the largest residential property and consumer spending boom on record, helping to take economic growth up another notch. Households were capable of growing their credit driven spending 

strongly for a while, because their indebtedness was still relatively low. This helped real economic growth up to levels above 5% for a few years prior to 2008. So interest rates were the 2nd big lever to be pulled. But ultimately, by 2007/8 the Household Sector had adjusted its Debt-to-Disposable Income Ratio higher, to become highly indebted, and could no longer respond aggressively to low interest rates or interest rate cutting thereafter.

This was proven when, after the country had been hit by an Oil and Global Food Price inflation shock, along with a Global recession, starting late in 2008 the SARB moved once more to be more supportive of economic growth by taking Prime Rate down into single-digits for the 1st time since the 1970s. Desperate times call for desperate measures, and our economy also received indirect support on an almost unprecedented scale from massive monetary and fiscal stimulus across much of the world. The response was muted, curbed by high levels of household debt.

The consumer didn’t go into orbit this time. The interest rate lever would no longer be very effective. In the mean time, the labour market remained rigid, and the skills distribution remained highly unequal. But there was one last lever left to pull in order to “keep the party going”. During the strengthening phase of the economic super-cycle through the 2nd half of the 1990s and 2000s up until 2008, National Treasury had been able to use the resultant strong tax revenue growth to narrow the Government’s fiscal deficit and lower its Debt-to-GDP Ratio dramatically.

From the early-1990s it could also cut back sharply on the Defence Budget, and so grow key areas of social expenditure quite significantly without compromising the macro fiscal situation. And so, from 2008/9 onward, with the interest rate lever no longer as effective a stimulus as it was a number of years earlier, government could assist with a fiscal stimulus, widening its deficit and lifting its Debtto-GDP ratio steadily until the present day, in order to give a very significant additional boost to economic growth.

Extremely accommodative monetary and fiscal policy was a policy response in many other countries too, and up went the entire planet’s Debt-to-GDP ratio to even higher levels that what they were in the 2008 Global Crisis. And so, the 3rd, and possibly final major macroeconomic lever, to pull, that being the Fiscal Lever, has now been pulled.

This, along with highly accommodative monetary policy, has kept Domestic Expenditure well above the country’s National Income for some years, in an attempt to keep us spending our way to economic glory. Of course, though, if you live beyond your means as a country, you need foreign capital to fund the income shortfall.

But the foreign capital has long since begun to become increasingly concerned as to the sustainability of all of this. This concern has been heightened by the fall of global commodity prices since 2011, and its effect on our exports and GDP growth. And so, the Rand has been sliding since around 2011, and economic growth has been sliding from around 2012.  

If we don’t pro-actively lift interest rates get SA living back within its means, and arrest the steady rise in Government Debt-to-GDP, the capital flows are likely to become even more scarce and a lot more costly to obtain. And still, the labour market remains inflexible, and a highly unequal skills distribution remains intact.

The  result is still-high levels of income inequality, despite some years of raising effective tax rates and a huge and probably unsustainable welfare support system. But now, as the still-intact skills/income inequality fuels rising social tensions, these “major structural impediments to economic growth have become a huge problem.  

Why only now? Because now, we have gone about as far as we can with spending our way to “economic success”. Further economic growth from here onward, if it is going to happen, is about being competitive globally, and that requires a far better skilled and “equipped” labour force, with strong incentives to be increasingly effective and productive. Because now, there are no easy macro-economic levers left to pull.  

Last modified on Tuesday, 15 December 2015 08:23

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