Economy: A nation in denial

South Africa dreams of being a winning nation even as it wallows in mediocrity. Claire Bisseker confronts the lies SA tells itself about the economy.

SA’s recovery is becoming more and more fragile. A toxic mix of rising domestic inflation and slower global growth is suppressing the outlook for the economy. Growth is now expected to slow to about 2,8% this year - too little to dent high unemployment.

But while much of SA’s current slowdown is the result of contagion from the persistent crisis in Europe, SA has long been plagued by deep-seated structural inefficiencies that are thwarting its growth ambitions: the rate of saving and investment is too low; productivity growth is too slow; and what growth there is, is not labour-intensive enough.

These are the main levers that government needs to adjust in trying to put SA on the high road to faster, more inclusive growth. But as much as South Africans think they understand what is needed to super-charge the growth rate, economic debates are often riddled with misconceptions about the economy.

The FM canvassed the opinions of several leading economists in response to a series of common myths about the SA economy. Government, as it unveils the 2012 national budget, would do well to heed the uncomfortable truths unearthed.

The message is that SA has drifted off course but lacks the political will to make the really hard choices that could turn it into a winning nation.

To make matters worse, the outlook for the economy is subdued and any fiscal space the authorities had to boost growth has been used up responding to the global financial crisis. In this low-growth environment, unemployment and poverty will remain insurmountable.

It’s time the nation stopped kidding itself.

MYTH 1: With the right economic policies, SA can eradicate unemployment

SA is stuck with a high unemployment rate - maybe even as high as 20% - because unemployment in SA has become structurally entrenched after decades of below-par education for the majority of the population.

Even with the economy growing at 5,2% on average for four years (2004- 2007), unemployment failed to dip below 22%. This is because a large proportion of SA’s working-age population is unemployable given the modern, capital- and skills-intensive nature of SA’s growth path: they have the wrong skills, inadequate qualifications, weak basic schooling, cannot afford tertiary study or live far from work opportunities.

“SA’s unemployment issue is increasingly a case of a failed education and human resource development policy, and it bears almost no relation to the country’s economic policies,” says Pan-African Capital Holdings chief economist Iraj Abedian. “Until adequate political will is generated to eliminate or substantially remove the lethal cocktail of poor management of the education system, under skilled teachers and declining standards of maths and science, our new graduates will continue to swell the ranks of the unemployed - with or without economic growth.”

However, in a normal economy (where employment is not so strictly regulated) the labour market would clear by producing low-wage, low-skilled jobs for anyone prepared to work in them, argues Nedbank chief economist Dennis Dykes. “After a while, skills acquisition would take place and workers would progress to semi skilled jobs at better wages and then later still to skilled jobs at good wages.

“The problem is that policy and practice [government’s goal is the provision of decent work, not just any work] is stopping the creation of such jobs on the basis of them being unacceptably low-earning. Unfortunately, millions are being condemned to no wage at all.”

The closure last year by the National Clothing Bargaining Council of clothing manufacturing firms in the poorest parts of the country because these firms were not paying the minimum wage is a case in point.

UCT economics professor David Kaplan points out that more than half the job losses in industry have been in labour-intensive areas such as textiles, clothing and footwear. “The key is that we cannot compete at the lower, less skilled end at current wage rates and with current labour market practices,” he says.

In being unable to stare down Cosatu on labour-market issues, government is effectively trying to leapfrog the country collectively to middle-income status.

Its approach is to use industrial support and incentives to shift the nature of SA’s current commodity-heavy growth path to a new one in which dynamic, new manufacturing and services industries play a lead role in generating decent jobs and growth.

Investing in industrial development may be essential to create an attractive platform for new industrial activities, but doing so by pushing a variety of capital incentives is problematic given that the cost of capital is not the problem.

“Government wants higher growth and more labour-demanding growth but is not prepared to reform the labour market,” says Kaplan.

“Government is not prepared to confront the nature of the employment problem and the constraints that are holding back employment-demanding growth."

With more imagination on the part of business and more flexibility on the part of the unions and government, Dykes believes the unemployment rate could halve in government’s timeframe (by 2020) even with relatively low growth.

MYTH 2: Halving unemployment would halve poverty, solving most of SA’s problems

According to the Human Sciences Research Council (HSRC), even if unemployment were solved, most people would be working in low- and semi skilled service jobs that are inherently uncertain and relatively low paid.

It will remain essential, therefore, to reduce the cost of living and improve the quality of public services, especially of education and health care. It also means that social grants will continue to claim a large share of the budget indefinitely. “Widespread poverty and structural unemployment are not, and nowhere have they been, self-correcting,” says Abedian. “They require effective public-sector operations. Together, poverty and unemployment will continue to pose a political economic risk and a fiscal risk, to SA.”

MYTH 3: The private sector, not government, should be creating all the jobs

Though the private sector is and should remain the main source of job creation, the backlog of unemployment and the numbers of new entrants into the labour market each year are simply too large for a private sector the size of SA’s to absorb.

“No matter how successful employment policy is, it is quite certain that severe unemployment and under employment will persist,” says HSRC executive director Miriam Altman. “The problem has simply become too big for market-based solutions to solve within the next 10- 20 years.”

This means there will always be an essential role for public employment schemes and other special interventions in SA - but they come at a cost. For instance, to make it cheaper for firms to hire young, inexperienced workers, government will introduce a youth wage subsidy in April this year. In announcing the subsidy last year, treasury conceded that, “given the uncertainty about the potential of school-leavers, employers consider entry-level wages to be too high relative to the risk of hiring these inexperienced workers”.

Treasury estimates that 178000 net new jobs will be created at a cost per job of R28000. The whole scheme will cost R5bn over three years.

MYTH 4: SA is plagued by jobless growth

Over the past decade, there has been a strong correlation between economic growth and job creation in SA. Though the unemployment rate remains unacceptably high, it has in fact fallen dramatically - from 30% in 2003 to 23,9% now.

The SA economy created 340000 jobs last year, according to Stats SA’s Quarterly Labour Force Survey, but shed about 1m jobs during the global economic crisis. These employment losses have still not been recovered and future employment prospects remain uncertain because of the dismal economic outlook. For government to meet its goal of halving unemployment by 2020, SA must create 500000 new jobs each year on average.

This means the economy must grow faster and that requires the existence of profitable opportunities that encourage the expansion of businesses, especially smaller and medium-sized businesses, argues Altman. “In SA, there are too many barriers slowing this down, from business registration, issues around the supply of energy, market concentration, planning frameworks, the delivery of critical infrastructure and the quality of public transport, among other things.”

MYTH 5: If interest rates were a bit lower, firms would invest more and the economy would grow much faster

Neither domestic nor foreign firms are investing to the extent that they should be but this is not because the cost of capital is too high or returns on investment too low.

On the contrary, a recent World Bank study found that the real returns from investment in SA have risen sharply since the early 1990s, and averaged close to 22% from 2005-2008, the same as for China.

In the construction, and retail and wholesale trade sectors, returns over the past decade have been extraordinarily high - 85% and almost 60% respectively. In finance, real returns rose from an average 8% in the 1990s to almost 20% in the 2000s, and in manufacturing, from 17% to 25%.

“Such high returns are especially striking given SA’s modest GDP growth,” states the report. “They have also risen comfortably in excess of the borrowing cost, measured by the prime rate, which has declined sharply since the late 1990s.”

So why, despite high and rising real returns, has private investment not responded with more vigour? The World Bank believes worsening risk perceptions and structural barriers are the real impediment. All the economists canvassed concur.

Four key issues stand out: high industrial concentration; significant skills gaps; contentious labour relations and work stoppages; and SA’s low savings rate.

Specifically, the World Bank finds that industrial competition is much weaker in SA than in its international peers. This points to entry barriers that discourage new investment despite high returns.

It also argues that the SA skills shortage is an important deterrent for firms wishing to expand. “The problem starts with basic education, where access has improved but quality has not,” says the report. “With intakes largely ill-equipped with cognitive skills, the problem only gets compounded at the higher and technical education levels.”

On labour relations, the World Bank concludes that protracted wage disputes and work stoppages are an implicit tax on investment. In addition, wage levels relative to worker productivity are significantly higher than among SA’s peers. This also discourages new investment.

Other key constraints identified by SA firms in the World Bank’s 2010 Investment Climate Assessment, as well as in the latest Global Competitiveness Report, include: crime and violence, access to reliable electricity, corruption, access to finance by small and medium enterprises, and anticompetitive practices. Policy uncertainty, and the problems associated with a volatile and overvalued exchange rate, are also frequently cited.

“SA’s problem is not that the cost of capital is too high but that the cost of running a business is too high,” echoes Reserve Bank governor Gill Marcus. She has, for instance, questioned the need for Eskom to be awarded any further significant above-inflation increases, noting that “the determination of administered prices should not act as an inhibitor to growth and investment”.

MYTH 6: SA’s public finances are in much better shape than most other major economies, so government still has plenty of resources available to stimulate the economy and address poverty

Though SA’s gross debt and budget deficit to GDP ratios may be much better than key developed economies (where they are dreadful), SA has experienced a sharper deterioration in its fiscal position since 2008 than its developing country peers.

The global financial crisis is used as a convenient excuse to explain expenditure overruns of 22% each year on average over the most recent three fiscal years. But it masks the fact that SA has been spending on the wrong things. Government has allowed wage increases and entitlement spending to cannibalise more than 50% of the budget, crowding out productive economic investment.

“SA’s headline fiscal ratios appear healthy but this masks SA’s unfunded critical economic infrastructure deficit and appalling micro fiscal management practices,” says Abedian. “These two factors make the SA fiscal framework as unsustainable as that of the EU member countries, albeit for completely different reasons.”

In other words, SA has managed to keep its public debt down by not funding Eskom and not maintaining crucial public infrastructure like roads, water and sewerage works. This fact, together with the inefficiency of public expenditure and systematic abuse of public funds, makes a mockery of SA’s so-called sound macro fiscal configuration.

Take local government: municipalities will need to spend an estimated R300bn over the next nine years to respond to local growth and the rehabilitation of existing infrastructure, but it is unlikely they will be able to spend more than 70% of their capital budgets, judging from past experience.

“Municipalities are under spending massively on capital and the constraint to growth and employment creation is becoming critical,” says BNP Paribas Cadiz Securities economist Kim Silberman.

Between 2008/2009 and 2010/2011, municipalities used only R45bn on capital expenditure instead of a budgeted R66bn, a 32% shortfall.

Over the same period, operating expenditure has been 23% or R27bn over budget, largely due to unbudgeted spending on personnel and amortisation and depreciation.

For years municipalities have been using unspent capital allocations and grant funding to cover bloated operating costs, specifically rising wages, though national treasury has finally put a stop to this practice.

The upshot of these trends, as well as deficit spending to counter the 2008 global financial crisis, is that government debt has climbed back to levels last seen in 1999/2000.

When SA’s direct debt and guarantees for state-owned companies’ obligations are included, government debt approaches 50% of GDP - a ratio that is not considered sustainable according to international benchmarks.

State debt costs are now the fastest-growing item of state expenditure at 14%/year and SA is borrowing to pay this interest bill. National treasury is determined to turn this situation around within the next three years but, in a context of weak economic growth, it will have to engineer a sharp slowdown in government spending growth to do so.

There will be little room for new growth-supportive spending. And if the wage bill continues to balloon, infrastructure spending could be curbed. This would undermine SA’s longer-term growth prospects.

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