Posted by: michaeldavidpower | October 3, 2010

Sunset on the Old South African economy perhaps, but when will the New Sun rise?

The South African Economy has, over much of the past decade, exhibited many outward signs of good health belying the inner deterioration of those fundamentals that must necessarily drive our longer term economic growth forward. First and foremost amongst those fundamentals has been the singular lack of success in creating new private sector jobs which are both long term in nature and structurally secure in character.

Much of the appearance of good health has been the result of cyclical much more than secular factors. Internally, a robust credit cycle supported the growth of consumer spending leading to rosy metrics such as strong retail and car sales as well as rapid house price appreciation. Indeed, fuelled by abundant credit, it was not unusual to see retail and car sales growing at rates that were over twice nominal GDP growth, clearly an unsustainable trend over time. Not surprisingly savings rates fell, debt to disposable income ratios rose, investment was diverted into consumption and, as the macro aggregator of all these factors, the current account deficit grew materially.

For those economists who might have believed in the now spectacularly disproved Cheneyism of “deficits don’t matter”, the South African economy was, and in many respects still remains, a microcosm of its UK and US counterparts. It has put the consumptive cart before the productive horse and relied on the kindness of strangers – in the form of foreign capital inflows into the bond and stock markets – to balance our national books. Extraordinarily, there was a time not so long ago when many mainstream economists believed this model to be sustainable.

No longer. Even as I write, realization is rapidly dawning on governments worldwide – but especially amongst the deficit-prone, demographically-challenged nations of the West – that this model’s shelf-life is reaching its life-cycle limits. If nothing else, the kindness of strangers is being replaced by what one European finance minister has called the cold-bloodedness of the wolf-pack.

Where South Africa has been different from the US and the UK is that, in addition to mainly consumer and not producer-led growth driving our economy forward, a bad dose of Dutch Disease has addled our residual industrial base, not merely preventing it from growing but actually compressing it. This in particular has weighed on South Africa’s capacity to generate jobs in urban areas for our rapidly-growing but still insufficiently skilled work-force.

Dutch Disease – the affliction that hits a resource-rich nation in the wake of a bonanza in natural resource prices by causing an uncompetitive appreciation in its currency – has, as it always does, manifested itself as a blessing disguising a curse. Short term, it helped create an illusion of South African prosperity; longer term, it has hollowed out South Africa’s industrial base and made material employment growth, except perhaps temporarily in non-tradable consumption-oriented areas like retail and banking, all but impossible to achieve.

As if this were not enough, Dutch Disease has even harmed sectors that are supposed to prosper in such circumstances. The overvalued Rand has hastened the decline of productivity in South Africa’s gold and diamond industries and capped growth in our platinum sector; it has also weighed on growth in our agricultural and tourism sectors.

During the period since 1994, the South African Treasury has on balance run an excellent fiscal policy, mostly cutting its expenditure suit to match its revenue cloth whilst still providing finance for many of the pent up social objectives the country so urgently needed to address. However, as the recent recession has illustrated, much of its income was ‘pumped up’ in the sense that it was derived from the credit-fuelled consumption that has characterised much of the past decade’s economic growth. With the drastic reduction of this revenue source – VAT receipts, duties on imported cars and other consumer durables – the budget’s basic underlying imbalances have been exposed. Even so, Treasury appears to be taking remedial action to address South Africa’s medium term budgetary pressures.

Besides, where Dutch Disease threatens, Government’s response must be most concentrated on the conduct of an appropriate monetary policy and not fiscal policy as the latter is not so much a cause of the malaise but usually harnessed to ameliorate its adverse consequences. When dealing with Dutch Disease, absolutely critical to the proper conduct of monetary policy is a true understanding of the effect that an overvalued currency can have on a nation’s macro competitiveness and in particular its capacity to compete in a job’s market that is increasingly determined by a global wage rate (i.e. for the sake of easy cross-country comparison, with wages priced in US Dollars and not merely in Rands).

In today’s world, to adopt a policy of benign neglect towards an appreciating currency because of an overarching commitment to a policy of inflation targeting is quite simply economically naive. Indeed as HSBC’s Chief Economist, Stephen King, notes in his latest book “Losing Control”, inflation targeting reflects a parochial focus on price stability in a world where, because of the rise of a goods-producing, resource-consuming and so for South Africa a Dutch Disease-generating Asia, consumer price inflation is no longer a proper reflection of domestic monetary conditions. King goes even further, heading one chapter “Price Stability brings Economic Instability”.

In today’s world, for a South African in search of a job, his or her wage inflation rate is our South African wage inflation rate adjusted for any movement in the Rand: a 6% local wage inflation rate accompanied by a 15% appreciation in the Rand versus the US Dollar means that the South African annual wage inflation rate (measured in US Dollars as a unit of account) would be over 20%. Even if inflation should be targeted, in today’s world one can quite legitimately argue that inflation adjusted for currency movements and not merely domestic inflation is actually the more appropriate measure to target.

Whilst addressing the overvaluation of the Rand is by no means a cure-all silver bullet for South Africa’s economic ills – and especially for our chronic unemployment rate – ignoring it, given today’s very different and very competitive global economic environment, is arguably a case of not so much benign but malign neglect.

South Africa must seriously reconsider the continued practice of macroeconomic policies made in the West and designed for the economic challenges of the West. And given that those very same macroeconomic policies have now proved themselves so spectacularly inappropriate for the West anyway, why on this earth should we continue practicing them in South Africa?

The Joint Letter from South Africa’s Manufacturers and Trade Unions is a plea for policy makers and certain private sector commentators to wake up and address the deeper realities of today’s moving-from-West-to-East global economy. If nothing else, we owe it to ourselves to have a serious debate on what set of macroeconomic policies we as South Africa need to practice. Exchange rate management is only but a part, albeit an important part, of that debate.

A brand new day, profoundly different as to where the global economic centre of gravity will be, is dawning. South Africa urgently needs to adopt a set of economic policies that matches our own very pressing needs to the coming of that new world. And in doing this, we must not hang on to the policies of yesterday, policies made in and for the world of yesterday.



  1. Hi Michael. Great stuff as always. If you get the exchange rate management and the weaker rand you are seeking, what would the associated impact on industry and employment of higher imported input costs (fuel etc.) and on the consumer of import-led inflation? Would the long-term increase in labour competitiveness be sufficient to offset these secondary effects? Would an inflationary devaluation not set off a wage-price spiral and/or social unrest as seen recently?

    • Always a risk! Which is why – in the aftermath of a devaluation – the anti-trust authorities in any country must watch out for price gouging by oligopolistic and monopolistic players, be they representing labour or capital. What is needed is a redistribution of income in favour of exporters and against importers. The losers will always complain but as the old Middle Eastern proverb reminds us “The dogs may howl, but the caravan moves on.”

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