Document(s) 10 of 11

How would the new South Africa balance the tasks of setting the economy on a path of economic growth, to lay the basis for prosperity and, simultaneously, redistribute income, wealth and other resources such as human capital to meet the objectives of social justice and long-term sustainability? This was the central question posed for economic policy when the democratic government was elected in 1994.

The Reconstruction and Development Programme (RDP), as indicated in the introduction to this book, addressed this conundrum by positing a virtuous circle: infrastructure development aimed largely at providing access for the poor, would also contribute to economic growth through opening up the domestic market and increasing the efficiency of the economy. In turn, this would allow further improvements in the lives of the voters. The RDP also contained an acceptance of the inevitability and necessity of globalisation, with tight macroeconomic parameters and a commitment to trade reform. Nevertheless, conservative and business circles felt that the RDP posed a danger to macroeconomic stability.

During the 1990s the state leaned towards caution. The predominant concern of the new government was to retain its sovereignty, not to risk mortgaging the country's future before the new regime was firmly in the saddle. This was particularly true once an ANC leader became Finance Minister. The ability of the country to implement the RDP was limited – the state apparatus was weak and not strengthened in the short term by intensive transformation. Both the state and the public enterprises, perhaps with the exception of Eskom, had lost their ability to scale up infrastructure investments. So while the rollout of housing and related infrastructure for the poor was fairly successful during this period, the scale of public sector investment remained relatively low.

Trevor Manuel, the Finance Minister, later described the period after he assumed office as 'a period of fiscal consolidation' (Manuel 2004). It followed a period of fiscal indiscipline in the early 1990s and only a partial correction of this in the 1994–96 period, with an average budget deficit of 4.7%, and government debt approaching 50% of GDP (gross domestic product). The emphasis in the late 1990s was on fiscal planning, increasing transparency in public finances, tax reform, reform of revenue administration capacity, and ultimately co-ordination of fiscal and monetary policy through the deployment of inflation targeting in 2001. In retrospect, it was a period of taking control of the system, before which the results of a more expansionary programme would have been unpredictable.

The government hoped that private sector investment, particularly from abroad, would make a bigger contribution in this period – this expectation of the Growth, Employment and Redistribution (GEAR) strategy was much criticised when GEAR missed its growth projections. Slow private sector investment provided ammunition for the anti-globalisation lobby and other supporters of an inward-focused development path. Private investment remained lower than hoped, even though government cutbacks were intended to make room for private investors. The currency shocks of 1996 and 1998 and the South African Reserve Bank's (SARB's) heavy-handed response increased the cost of capital and the investment hurdle rate, rather than reducing them. Added to this, the first black government in South Africa had to fight far harder for credibility for its policies than its white predecessors, even though its policies were better and its political base very firm. GEAR did not predict the Asian crisis, or the central bank's response, nor did it take into account the extra effort required of a new black government to obtain credibility in financial markets.

Though the GEAR (or 'fiscal consolidation') phase disappointed in its growth performance, it delivered macroeconomic stability. On the basis of a very low budget deficit, declining public debt, and lower costs of borrowing, the government shifted its stance in the budget year 2001/02. There were three main elements of the shift. The first was a significant tax-cut, especially for the lower middle class and the working class. The second was a commitment to speeding up public infrastructure spending, and the third was a commitment to accelerate and broaden the roll-out of social security transfers – the state pension, the newly structured disability grant, the foster-care grant, and the recently introduced child support grant. With the state as yet not strong enough to roll out investment as rapidly as desired, the tax-cut and the social grants played bigger roles in the early 2000s. From an austere outward-looking state, the South African state slipped into Keynesian mode. The Expanded Public Works Programme (EPWP) announced in 2003 was another recognisably Keynesian element.

The strengthening of redistribution through tax-cuts and the social grants were meant to complement a strategy for competitiveness and exports beyond natural resources. But the fiscal expansionary phase coincided with a period of rapid and far-reaching strengthening of the currency. This resulted partly from tight monetary policy after the 2001 shock, partly from the weakness of the US dollar, and partly from the worldwide commodity boom driven by rising Chinese imports of industrial inputs. So, while platinum, steel, iron ore, coal and aluminium producers could export in spite of the strengthening rand, the agriculture, manufacturing and services sectors faced rising rand costs without the compensation of booming international prices.

It was as if the path had shifted from export competitiveness to inward industrialisation, except for the fact that the rand became so strong that domestic producers could not take full advantage of the consumption boom and were forced to compete with imports, especially in consumer durables such as Korean refrigerators and European cars. So it happened that South Africa experienced its first-ever boom based on a broad-based expansion of domestic consumption, alongside a reasonably healthy minerals and metals export sector.

One of the most striking and novel features of the boom of the mid-2000s was the role played by the emerging black middle strata. From white-collar workers through to professionals and managers of the very highest economic stratum, the progress of black people in the economy was one of the key drivers of domestic demand and growth. A merchant bank put it this way in a report for investors: 'On both an 18-month and five-year view, we expect the emerging black market to continue to support volume growth across the South African economy' (Moola and Moloto 2004: 3).

This broad-based rise in consumption is being driven by a significant shift in the position of the black middle strata. The Bureau for Market Research reported:

In 2001 4.1 million out of 11.2 million households in South Africa lived on an income of R9 600 and less per year. This decreased to 3.6 million households in 2004, even after taking the negative effects of price increases on spending power into account. On the other hand, households receiving a real income of R153 601 and more per annum rose from 721 000 in 1998 to more than 1.2 million in 2004 (Bureau for Market Research 2005).

Trends for groups between R9 600 and R153 601 are similarly positive, indicating significant real improvements in all these levels between 1998 and 2004. At the lowest level, the expansion of the social grants has impacted on the poor, reducing levels of extreme poverty and significantly strengthening their purchasing power. The percentage of poor households as defined in the terms used by the Bureau for Market Research shrunk from 40.3% of households to 29.8% between 1998 and 2004. At the opposite end of the scale, of South Africa's 23 000 multimillionaires, 11 000 are white and 12 000 are 'black' (including Africans, coloureds and Indians) (Sake Rapport 30 January 2005).

In short, the impact of employment equity and economic empowerment pressures have been to create a new dynamic within the economy of a very broad set of households that is able to accumulate private real assets for the first time in history. Combined with the impact of the social grants and the tax-cuts of 2001, the expansion and strengthening of the broad black middle strata has added a significant new element to the growth story in South Africa. Perhaps this is best captured in the fact that a very large proportion of the foreign inflows into the Johannesburg Stock Exchange in 2003, 2004 and 2005 were directed at domestic market-oriented stocks, especially in financial and service sectors, rather than the traditional natural resource counters.

So there would seem to be a virtuous circle between redistribution and growth, perhaps even more than ANC leaders expected in the early 1990s. But exciting as this outcome is, serious challenges remain. Indeed, some are serious enough to pose significant threats to the future of the South African economy. Several of these were dealt with in the previous chapter: the challenge of raising investment levels; the challenge of improving human resource development standards and throughput; and the challenge of integrating the second economy into the modern industrial economy. Beyond these challenges, recent peculiarities in South Africa's economic performance remind us that macroeconomic policy remains less than optimal – perhaps the key challenge is in the co-ordination of fiscal and monetary policy.

In a recent and as yet unpublished Investment Climate Survey by the World Bank and the South African government, firms were asked what the main obstacles to growth were. While the shortage of skills, the threat of crime and labour regulations were prominent answers amongst manufacturers, one of the highest responses pointed to 'macroeconomic instability'. With steady low inflation rates and relatively low interest rates, the only logical conclusion is that these manufacturing firms were challenged by the volatile and unpredictable currency. A currency that veers regularly by 20% or more, most recently strengthening by 50% against the dollar over three years, makes effective integration into the world economy extremely difficult. This recent 'positive' currency shock was the fourth currency shock in the 10 years since 1994, following negative currency shocks of more than 20% in 1996, 1998 and 2001. Observation has suggested for several years, and the World Bank survey now confirms, that the volatility of the currency is the single greatest obstacle to higher rates of investment by the private sector.

In one sense this is a positive development – other obstacles to investment symptomatic of serious malfunctioning of the state, such as crime or health-related concerns, have now subsided, and more purely economic policy matters have come to the fore. This indicates that the new democratic state has convinced investors that it is effectively addressing public service management issues, even if challenges remain. But the volatility of the currency remains a frustrating obstacle to a really significant increase in the rate of growth.

To what extent could this volatility be countered? What are the options for a relatively small open economy? South Africa does not have huge scope to adjust its relationship to international markets, but there are some significant instruments, and they are not trivial. The central bank can build its reserves, which remain low by international standards; exchange controls could be further loosened; the interest rate remains a valid instrument to address over- or under-valuation of the currency; and what the SARB Governor calls 'open mouth operations' or talking the currency up or down could be an effective instrument.

What is absolutely necessary, though, is effective co-ordination of fiscal and monetary policy. For example, if the currency is seen to be over-valued because South Africa's real interest rate is considerably higher than in most significant economies, the SARB can reduce interest rates to reduce the interest rate differential. The risk is that this move might overheat the domestic economy, which could lead to a rise in inflation, putting the SARB's mandate of inflation targeting at risk. However, if fiscal policy worked in consonance with this monetary policy move, and was able to moderate domestic demand, the risk to the inflation target would be reduced, which would allow an appropriate monetary policy stance. Inflation targeting is the central tool used to co-ordinate fiscal and monetary policy, but without deepening that co-ordination, inflation targeting becomes too blunt an instrument, with potentially serious unintended consequences.

There is scope for further co-ordination of fiscal and monetary policy. If this were achieved, the potential for growth would be considerably greater. The economy would not veer as giddily between export competitiveness and domestic demand as drivers of alternate periods of growth when the rand is weak and strong respectively, and would move towards greater balance and stability. It might hit the 'sweet spot' that some investment analysts have recently written about, when South Africa can take advantage of both its strongly booming domestic demand and its export opportunities for commodities and manufactures and services.

How the key questions have shifted in the 11 years since the first democratic elections is a sign of South Africa's progress. In 1994 the question was: how can we combine growth and redistribution so that the economy prospers and poverty and inequality are significantly reduced? Today, in 2005, I think it is fair to say that we know the answers to this question. The challenge of redistributing assets remains great, but the success in redistributing income is gathering pace. The performance of the economy has been strong, with post-1998 being the longest continuous period of growth in South Africa's recorded national accounts history, also achieving a 46-year low in inflation and a 24-year low in interest rates. The question today is: how do we take the economy to a higher growth plane so that we can effectively sustain our programme of redistribution and the integration or elimination of the second economy? Many analysts inside and outside of government do not think it is too hard to answer the new question, as we discussed in the previous chapter.

Perhaps a fictitious analogy would help to explain where we seem to be. Eleven years ago, a young and enthusiastic team took over the management of a rally car. The car, though well built, was battered and old, and had failed to obtain a podium finish for decades. Of late, it had failed to complete most races. Often it ran short of fuel because of shortages of funds. Because the races never stop in this rally series, the new team was forced to learn to drive the vehicle and to begin to modify it simultaneously. First it cut back on costs, and then it began to invest in skills and equipment. After six or seven years, the vehicle was running reliably, finishing races and performing well on some courses. The rally team was sustainable, if not thriving. Further modifications over the next few years clearly improved the performance of the vehicle, but this was not enough to take it to the podium. Though teamwork was improving, it wasn't good enough. What is lacking is a higher level of co-ordination between the designers, the mechanics, the driver and the navigators, not to mention the financiers. Once this is overcome, success will be around the corner.

Current projections for the South African economy generally indicate growth in the vicinity of 4% for the next three to four years.1 This suggests that South Africa has stepped up a level from average growth of around 2.9% in the first 10 years, to an average rate of growth around 1% higher. Government and businesses in South Africa have learned to manipulate the levers of growth, and redistributive policies are reinforcing the positive growth trajectory. Where the ceiling is no one really knows – the rate of investment is constrained by capital flows, the rate of savings and the availability of skills. It looks increasingly feasible that South Africa can attain growth in the vicinity of 5–6% consistently. South Africa last saw growth at those levels in the 1960s and 1970s but then the economy was built on an undemocratic society with deep inequalities of wealth and income, which both politically and economically limited the growth rate in the long term. This time the growth surge is built on and fed by a democratic state striving to reduce poverty and inequality.

Note

1 Several of the locally based bank research units in organisations such as Standard Bank, Deutsche Bank and others have made similar projections for the next three to four years as of early 2005.

Document(s) 10 of 11