Photo: Flickr, Heather Dowd.
The global recovery is in jeopardy and SA needs to buttress its fragile economy against the coming storm. Claire Bisseker expands on some of the measures government can take.
The world is experiencing a synchronised slowdown. Europe's sovereign debt crisis is intensifying. Growth in a number of major emerging market economies is slowing, and the US is rapidly approaching a fiscal cliff that could not only destroy its own recovery but drag global growth down with it.
Openly exposed to these threats, the SA economy is beginning to feel the chill. But like much of the rest of the world, it has little fiscal ammunition left to provide fresh stimulus or prop up its economy. It is also close to experiencing a crisis of confidence as consumers and business succumb to worry over the fate of Europe as well as domestic economic policy concerns.
There is no shortage of doomsayers.
Billionaire investor George Soros believes European policy makers have only a three-month window in which to correct their mistakes and reverse current trends before the crisis becomes unstoppable.
New York University economist Nouriel Roubini is as pessimistic. "Batten down the hatches," he advises, "the probability of a eurozone disaster is rising."
In revising down its global growth outlook last month, the International Monetary Fund (IMF) warned that the global recovery remained at risk and the situation in the eurozone "precarious".
It cautions that its gloomy projections - 3,9% real GDP growth for the world in 2013, 0,7% for the eurozone and 2,3% for the US - will not be met unless:
- There is sufficient policy action to allow financial conditions in the euro area periphery to ease;
- US legislators prevent a large, scheduled fiscal contraction early in the year; and
- Policy easing in emerging market economies like China gains traction.
Satisfying the last two conditions involving the US and China seems feasible but few expect a decisive resolution to the eurozone crisis any time soon. And the longer Europe is allowed to stumble on, the greater the drag on global activity will be.
Global activity in the second quarter of 2012 was deeply disappointing with the manufacturing purchasing managers' indices (PMI) of the US, Japan and China all a blink away from outright contraction.
Most major European economies are in recession, including the UK, and unemployment rates have reached new euro-era highs. Meanwhile, economists are hastening to revise down their growth forecasts for the US to around 2% this year. Materially slower growth has also been recorded in India and Brazil.
Reserve Bank governor Gill Marcus is clearly worried. In a recent speech she shared Roubini's view that Europe seemed to be heading into a "perfect storm".
The strategy adopted by European leaders of treating a solvency crisis as a mere liquidity crisis has run out of rope. For a while it allowed policy makers to use liquidity injections to buy time for longer-term solutions to be found but, says Marcus, "Unfortunately, this time has not been well used. The crisis is intensifying ... with the recession likely to worsen in the weeks ahead."
Every financial commentator has a recipe for how to fix Europe. Common to most of them is the belief that fiscal austerity should be more gradual since growth and confidence can never be revived when a policy of austerity serves to drive demand even lower.
"The consequences of Europe's rush to austerity will be long lasting and possibly severe," writes Nobel laureate and Columbia University economics professor Joseph Stiglitz for Project Syndicate (an online platform carrying commentaries by the world's leading thinkers). "Like medieval blood-letters, the country's leaders refuse to see that the medicine [austerity] does not work, and insist on more of it - until the patient finally dies."
Take Greece: the country with the biggest budget cuts has experienced the biggest falls in output and, despite the bailout, its government debt continues to rise. (The IMF has just revised its projection of Greece's debt to GDP in 2013 up, to 171% from 160%). The Greek economy is collapsing.
Cutting public spending on the back of a fragile recovery was always inviting disaster. But by 2010, it seemed many developed countries had no choice.
As a result of the global financial crisis, many countries had allowed public debt to soar as they bailed out their banks and tax revenues dried up. Once the financial markets became unwilling to lend to them at reasonable interest rates, it seemed prudent to begin cutting back.
But instead of instilling confidence in these economies, austerity has hammered their growth, further weakening their ability to reduce deficits. Confidence is in tatters.
And still the financial markets keep demanding the impossible: an immediate return to growth, a commitment to fiscal discipline, and a comprehensive resolution to the eurozone crisis.
The markets would like to see decisive steps being taken towards a fiscal union in Europe to allow debt mutualisation (many call for the issuance of some type of eurobond to pool all eurozone debt above a certain level). In addition, the markets are calling for a full banking union, including eurozone-wide deposit insurance.
But Germany's chancellor, the much maligned Angela Merkel, remains unyielding given the greater risk-sharing burden these measures would heap on her electorate. And so the risks of a disaster intensify.
"In Europe, the biggest risk is some legal, constitutional or political obstacle that makes it unfeasible for European leaders to make the next move - to keep stumbling along, because that could act as a trigger that could unleash panic on the markets," says Rand Merchant Bank (RMB) Global Markets Research head Theuns de Wet.
In the unlikely event of a quick resolution to the eurozone crisis, its growth outlook is likely to worsen. And in the absence of growth, the region's debt burden is clearly unsustainable and confidence in its most indebted, least-competitive economies will continue to crumble.
On top of all this lies the ever-present worry that Greece could stage a disorderly exit from the eurozone, causing the entire edifice to break apart and likely tip the globe into another recession.
With the world's major economies slowing and the ill wind blowing from Europe, the SA economy is also beginning to lose momentum.
Manufacturing output and exports have wilted in tandem with the worsening external environment. Of particular concern is the collapse in SA's manufacturing PMI to 48,2 in June on top of weak mining sector data.
At the same time consumer and business confidence has nosedived, because of worry over Europe as well as in response to domestic political developments.
According to the FNB/Bureau of Economic Research index, consumer confidence plummeted in the second quarter to -3, a level last seen at the onset of the global financial crisis.
"This time around, a confluence of adverse economic and political developments has been gradually weighing down SA's economic prospects and it appears as though consumers have now also capitulated," says First National Bank chief economist Cees Bruggemans.
This suggests that household consumption expenditure growth - the mainstay of SA's economic growth over the past two years - will be much slower during 2012. Investment is unlikely to pick up the slack while businesses face such uncertainty. Though this may not yet represent an acute crisis of confidence, the odds are tilting against SA achieving the consensus expectation of 2,8% real GDP growth this year.
Last month, finance minister Pravin Gordhan told Reuters that current indications are that growth is likely to be below even treasury's estimate of 2,7%.
Many economists are revising down their SA forecasts and warning of subdued growth and limited job creation throughout this year and next.
Assuming the world avoids a calamity, this is the best SA can look forward to. But if the world does experience a major event, SA's growth will be hammered with firm closures and job losses recurring in a potential replay of 2009.
So what should SA be doing to prepare for the worst?
The most important thing is for SA to maintain macroeconomic stability. Unfortunately, the amount of fiscal space SA has is limited. The global financial crisis caused a dramatic swing in the budget balance from a 1% surplus in 2007/2008 to a shocking deficit of 7,3% of GDP by 2009/2010. Three years later, SA still faces a deficit of 4,6%, a level not widely regarded as prudent.
The best course for SA is to stick to its fiscal consolidation plan while following through with treasury's avowal to shift government spending away from consumption (wages) to productive investment (infrastructure).
SA has more room to move on the monetary policy side and it was no surprise to the FM when the Reserve Bank grabbed this space last month, announcing a 50 basis point (bp) cut in the repo rate, given that the Bank has been consistently more bearish than the consensus on the global economy.
The Bank had room to move as renewed domestic and global economic weakness allowed it to revise down both its growth and inflation outlook. (It now expects 2012 GDP growth to be 2,7%, not 2,9% and for inflation to keep declining to a new low of 4,9% in the second quarter of 2013.)
The rate cut was a "proactive" attempt to minimise the negative spill-over effects on SA from global developments, said governor Marcus. The monetary policy committee expects these effects to intensify and be further reinforced by SA's "fragile" private-sector investment and consumption trends. As such, it sees the risks to its new 2,7% growth forecast as being on the downside.
Whether the Bank cuts again in September and November (economists feel there is room for 100bp-150bp cuts altogether) depends largely on whether the global economy deteriorates further.
The main channel through which SA stands to be affected is through trade, since Europe accounts for just under 30% of SA's manufactured exports. Fortunately, an increasing share of SA exports is going to Asia and Africa. As such, SA should be doing everything possible to expand its trade links with these and other fast-growing regions.
Another major channel of contagion is likely to be from the impact of falling commodity prices on SA's terms of trade. If there is a major event in Europe, further sustained declines in commodity prices are possible.
Positive terms of trade are crucial for delivering income growth to SA households and corporates, which in turn lifts consumption and investment and generates economic growth. When commodity export prices fall, it doesn't just undermine the already weak mining sector, the rand weakens, income growth and investment decline, and SA tends to experience much weaker growth overall.
"Because SA lacks the fiscal and monetary policy room to respond to another crisis, we would be locked into an environment of low growth with a falling investment ratio against a backdrop of likely declines in commodity prices," warns Sanlam Investment Management economist Arthur Kamp.
One thing that is perfectly clear is that SA cannot afford a recurrence of the 1m job losses that occurred in the wake of the global financial crisis. Vastly more jobs were lost than was warranted by the contraction in SA's GDP, with by far the majority of those affected being young, unskilled people.
Job cuts occurred but the main reason for the fall in employment was a sharp slowdown in job creation. Gross job creation nearly halved in the 12 months to February 2010 as firms cut back on hiring.
By the fourth quarter of 2011, employment levels were back up to 13,5m, roughly the same level they were at the end of 2007, before the downturn. In other words, the global financial crisis set SA employment creation back four years.
But even as unemployment was rising, public-sector wage growth exploded. Government employee compensation increased by 36,2% (or R23,5m) between 2008 and 2010.
Though this additional spending power supported consumption growth during that period, it should be viewed in the context of SA's high unemployment rate. SA needs to create about 500000 net new jobs annually to achieve its employment targets. But instead of maximising the creation of new jobs, government chose to pay existing workers more.
Spain made the same mistake. Its 11,3% cumulative loss in employment between 2008 and 2011 was accompanied by a cumulative increase of 11,2% in nominal wages. Spain's unemployment rate, already the highest in the euro area, reached a record high of 24,4% in the first quarter of 2012. SA's was 25,2%.
According to a European Commission staff working document, Spain's rigid system of wage bargaining and generalised use of ex-post wage indexation to inflation are partly to blame.
But unlike in SA, which has commenced the most significant tightening of labour regulations since 1995, both Spain and Italy are trying to make their labour markets more flexible so that next time a crisis hits, wages will give way, not jobs.
Spain has introduced reforms to make collective bargaining more flexible; reduce the costs of and simplify dismissal procedures; and make it easier for firms to opt out of sectoral agreements (giving individual companies greater flexibility in setting their own working hours, tasks and wages). Italy has taken similar steps.
Furthermore, the common practice of indexing wage increases to inflation in Spain has been put on hold until 2014 under a recent social partners' agreement.
Adcorp labour economist Loane Sharp argues that SA should also relax some aspects of its labour regulations, notably the two provisions that most strongly affect business productivity and its willingness to create jobs: the difficulty in firing nonperforming workers, and the extension of collective bargaining agreements to nonparties.
In addition, Italy and Spain have confronted youth unemployment, providing financial incentives to encourage firms to hire young people while also reforming their vocational training and apprenticeship systems.
In SA, the proposal of a youth wage subsidy, first raised by government in 2010 and backed by a budgeted R5bn, has yet to be implemented because of opposition from Cosatu. Government looks set to replace it with a watered-down version in which unions and bargaining councils may block its implementation in specific industries.
What is evident in Italy and Spain is a sense of urgency and the willingness of social partners to come to the party. Both these conditions remain absent in SA.
"In SA, the public debate has reverted to ideological stances that will not help us move forward," says the Human Sciences Research Council's Miriam Altman.
"It is critical that business, labour and government come together in a way that resolves the key issues facing the country - not necessarily in a national accord, but perhaps in smaller, sector-based agreements," she says.
Marcus made a similar appeal last month when she urged SA to focus on the key components of successful countries which have invariably developed a common alignment of interests between government, business, trade unions and society.
"In today's unprecedented global fragility, this is not a nice-to-have, but a way in which we can protect our gains and build our future," she said at the gala dinner of the National Union of Metalworkers' national conference. (Numsa is pressing for nationalisation as a solution to SA's economic problems.)
In the absence of broad labour-market reform, government's response to the job losses caused by the global financial crisis was to tinker at the edges, announcing among other things a R2,4bn training lay-off scheme and a R9bn jobs fund.
But by late last year, government had spent only 5% of the R2,4bn set aside for the training lay-off scheme and trained only 20000 workers. The scheme had design flaws, its administration was too slow and its conditions too burdensome, according to a source close to the economic development department that devised it.
For instance, the scheme initially required that firms demonstrate distress as a result of the global crisis before accessing support, but this was hard to prove immediately. Though the rules were subsequently changed, this took some time to happen.
"Government seems to think it's doing business a favour with support measures instead of realising how key business is to growth," says Industrial Development Corp chief economist Lumkile Mondi. "SA lacks policy stability, clarity and continuity. The bigger issue is that it requires a much stronger partnership between business and government. Without that trust, we'll see public support schemes not being accessed."
In the absence of fiscal room to provide any new economic stimulus, it is important that government not pull back on its ambitious R844bn infrastructure spending plans, even if it means a slight worsening of the budget deficit.
Ensuring competitive infrastructure in areas such as energy, water, transport and telecommunications is critical and, if implemented as planned, will make a significant impact on jobs, economic efficiency and SA's growth potential.
So far the public sector has had no difficulty raising funds to finance this programme. But if the global downturn intensifies, there would be a spike in risk aversion and capital flight from emerging markets. SA would be unlikely to obtain all the offshore funding for infrastructure that it needs.
"The room for mistakes has just disappeared," says RMB's De Wet. "It is easy to afford mistakes when money is for free. If a crisis hits, money will not flow from offshore anymore."
Granted, a lot of the bigger capital projects have been pre-funded. But SA's domestic savings rate is very low. If it doesn't attract the required foreign capital inflows, domestic investment will be forced to decline.
This means that government will have to exhibit far greater efficiency in how it delivers infrastructure.
"It appears that at least some of [the] infrastructure provision may be over-specified, some of it may not be absolutely necessary, and the technology choice and pricing are not [always] competitively determined. This must be resolved if we are truly going to get costs down," says Altman.
The need for greater cost containment applies across the public sector. There is much SA can do to squeeze efficiencies out of government so SA's pace of development can accelerate, without hiking spending or devising grand schemes.
Most European countries have been forced by the debt crisis to undertake structural reforms to make their economies more competitive. This typically includes modernising ineffective public bureaucracies, reducing barriers to doing business, and enforcing competition.
SA knows what it needs to do to raise its productivity growth and efficiency but, like Europe, SA could be forced to experience much more pain before it does the right thing.