Introduction

The Minister of Finance, the Honourable Nhlanhla Nene, delivered his Medium Term Budget Policy Statement (MTBPS) on Wednesday, 21 October 2015. In the foreword of the full version of the MTBPS the minister makes the following observation,

 ‘Sluggish growth and volatility look set to remain features of the world economy for some time to come. This has led to downward revisions of economic growth forecasts, particularly for developing countries, with knock-on effects on tax revenue projections. In South Africa’s case, these difficulties are compounded by structural factors: electricity constraints, weak business confidence and low household demand have limited growth. Government has moved to adapt to this turbulent environment. We have begun making structural reforms to boost growth. We have adopted a package of fiscal policy measures to maintain the health of the public finances. And we have protected spending on the social and economic programmes that help transform South African society.’

 First, I am unconvinced by the need to adapt as opposed to seeking creative solutions where nothing is off the table. Second, the theoretical soundness of this approach is dubious. Most economists (seemingly with the exception of those at the treasury) now accept that the stabilising potential of activist discretionary fiscal policy is, at best, limited. Furthermore, as I will show below, there has been a marked change of focus away from fiscal policy towards monetary policy as the main tool of stabilisation policy. The empirical evidence also indicates that in the short to medium term monetary policy has real effects.

Monetary Policy

Minister Nene devotes passing remarks in various places to monetary policy, and yet this is the most potent policy instrument available to the government and the South African Reserve Bank (SARB) to influence the growth rate and reduce unemployment. The apparent failure to realise that it is the contractionary policies of the SARB and the Treasury, and not ‘electricity supply shortages [which] pose the largest domestic risk to growth,’ is puzzling as there’s ample theoretical and empirical evidence to suggest this. It is also unhelpful to talk about a ‘low-growth world’ as if this is a given, especially when there are countries that are growing at rates higher than the world average. Why should our growth aspirations be so low?

Typically, the objectives of macroeconomic policy are the attainment of full employment (or the reduction of unemployment levels), within an environment of low inflation, high and sustained economic growth, and a ‘healthy’ balance of payments. The emphasis on one or the other objective is a choice that is informed by a number of factors. Some of these may be informed by ideology, others may be the result of pressures external to the economy (especially for a relatively small, open economy like South Africa which is dependent on external financial flows and trade).

All things being equal, some of these objectives (at least in the short to medium term) may be mutually exclusive. For instance, a low inflation (not factoring in inflationary expectations), high interest rate environment may negatively impact economic growth and employment levels. The opposite may also hold true. As economics is about choice, policy makers have to choose not based on ideology but based on the objective conditions they are confronted with and the outcomes they (or the citizens) desire.

There’s general consensus (and empirical evidence clearly upholds this) about the inverse relationship between the level of the interest rate and the rate of economic growth and the level of employment. Put simply, high interest rates lead to lower levels of economic growth and therefore lower levels of employment (or higher unemployment). High interest rates may attract speculative international financial flows, but these are generally fleeting and mostly do not lead to productive investments.

All things being equal, the current inflation target (range), with the resultant relatively high interest environment, is incompatible with the stated growth and employment objectives. In other words, the current monetary policy stance of the SARB harms the country’s growth prospects and is not supportive of the government’s stated growth and employment objectives. This is not an ideological or contraire view. It is a view formed on the basis of the objective conditions and international empirical evidence.

The minister and the SARB should dispassionately and non-ideologically take stock of the situation and accept, as evidence seems to suggest, that they will not attain their growth and employment targets with the current policy incompatibility. Since the mandate of the SARB comes from government, more specifically the minister for Finance, it is inconsistent to persist with an inflation target range that clearly is at odds with the growth target and the creation of employment. What compounds the situation is the observed unstated goal of the SARB to target the median of the range. What is the point of the 6% upper limit if the SARB conducts policy in such a way that the rate of inflation is generally restricted from testing this upper limit?

Although the minister observes that, ‘persistently high unemployment remains one of South Africa’s most pressing challenges,’ (I would argue this is an understatement, it is the most pressing challenge as most other economic, social and political challenges flow from it) he offers nothing radical or creative to deal with this. The reduction of unemployment, and not a low rate of inflation, should be the key objective of macroeconomic policy in the short to medium term. This would have a positive impact on the budget deficit through reduced social spending while revenue collections increase. This would allow the government space to increase spending on growth enhancing items like education, even as the number of those who cannot afford fees reduces (or they require a lower ‘subsidy’). In other words, creating a ‘virtuous circle.’

Clearly this macroeconomic policy has to be complemented by strategies implemented by government and the private sector to ensure that growth is in sectors with the greatest employment creation potential. In other words, avoid the curse of jobless growth.

It is interesting to note in passing that the (cost of living components of) wages demanded by unions, particularly public sector unions, clearly indicate that their inflationary expectations are high. This is puzzling as the SARB has maintained consistently low and relatively stable rates for a long time.

I may be accused of advocating populist policies, but my answer to that (as I will show in the next section) would be, ‘I am in good company.’

International Experience: the US, UK, EU, Japan and China

Central banks ordinarily conduct monetary policy by buying and selling short-term debt securities to target short-term nominal interest rates. These purchases and sales of assets change both short-term interest rates and the monetary base (the quantity of currency and bank reserves in the economy.) This conventional monetary policy can potentially stimulate the economy through two types of channels: asset price channels (including interest rates) and credit channels.

However, when interest rates are at zero increasing the monetary base is not, by itself, considered an effective stimulus. This is what the central banks of the United States, the United Kingdom, the European Union and Japan were faced with when they lowered their rates to zero to alleviate financial distress and stimulate their economies.

Faced with this scenario, the Fed, the Bank of England (BOE), the European Central Bank (ECB) and the Bank of Japan (BOJ) turned to unconventional policies that often dramatically increase their monetary bases. Some of these unconventional policies involve direct lending to specific distressed short-term credit markets, whereas others involve purchasing long-term assets that are intended to reduce real, long-term interest rates.

The Fed, BOE and ECB have steered their respective economies through these difficult times and further showed that their decision-making is empirically based. For example, in recent times whenever there has been an expectation that the Fed will raise interest rates, it has not done so because the employment numbers have indicated to them that the US economy is still fragile.

The People’s Bank of China (PBOC) has shown similar responsiveness to shocks to the Chinese economy, for instance when there was a stock market collapse and the slowing down of the economy.

The purpose of this section has been to show that other central banks have been prepared to lower interest rates to zero and then to further implement unconventional policies in order to stimulate economic growth. (Employment growth acts as an excellent proxy for this as it is among the first indicators of improving business confidence.) This happened in an environment of scepticism about the potential effectiveness of these policies, but they stayed the course and the evidence suggests they were correct. Interestingly, with the exception of the PBOC, these are central banks in ‘right wing’ economies, while the SARB and Treasury in a ‘left wing’ environment are steadfastly implementing policies that are anti-growth and anti-employment.

 Foreign Direct Investment

Equally important in a globalized economy is the attraction of FDI. This is important for all economies, even the big ones like China or the US, but it is critical for smaller economies like South Africa. The policy environment, therefore, has to be supportive for the attraction and retention of FDI.

Policies that should encourage FDI and other external flows seem to be inadequate or contradictory (for instance the visa debacle). The other apparent shortcoming relates to the nimbleness of decision-making and implementation, even when due recognition has been made of policy shortcomings.

Further, policies that militate against the attraction of FDI and other external flows should surely be abandoned.

Budget allocations

There appears to be too much emphasis on social spending like housing and grants. While these are indeed necessary and commendable, they however do not contribute to long-term economic growth. Funding allocations should instead be shifted towards growth supporting activities like education and crime fighting. An educated workforce improves business confidence and encourages investment by business and attracts FDI. Equally, with education and better earnings people can potentially provide housing for themselves, leaving the state to provide only for the truly indigent. A lowering of the crime rate will also have similar growth benefits, while also directly impacting the quality of life of citizens.

Recapitalising Eskom using proceeds from the sale of Vodacom shares was a smart decision. This should be followed by a commitment to exit all private and state-owned enterprises (SOE’s) that have no direct or indirect developmental role. While it makes sense for the government to own SOE’s like Eskom, the SABC, NECSA, etc. and provide budgetary allocations when necessary (although clearly these SOE’s also need to be better managed) there is no need to continue holding shares in Telkom in an environment where citizens mostly utilise communication tools being provided by privately owned enterprises. In other words, the initial justification of the developmental role of Telkom has been largely eroded. The funds from a sale of Telkom shares could fund a number of positive initiatives, for instance tertiary education and/or reducing the budget deficit. Equally, there is no clear developmental justification for holding onto a 100% stake at SAA and making budgetary allocations to it and/or providing guarantees on its behalf.

 Public sector salary and wage increases

The minister makes the following statement, ‘the 2015 budget assumed that the public-sector wage agreement would not depart significantly from inflation. The final settlement increases the salary and benefits of public servants by 10.1 per cent in the current year, followed by improvements that will be at least two percentage points higher than consumer inflation in the next two years…. The shortfall in compensation budgets has significant consequences for the public finances, absorbing resources that had been set aside for other priorities.’ This statement is, at best very curious, and at worst shocking.

First, is the minister telling the nation that the then-acting minister of Public Service and Administration, the Honourable Nathi Mthethwa, acted negligently in agreeing to an increase that had not been budgeted for? Second, where was Cabinet in all this; indeed, where was minister Nene? Third, is minister Nene suggesting he was bullied by his colleague or the Cabinet into signing off on an increase that was not only unjustifiably two times the rate of inflation in this current year and above inflation for the next two periods, but was also clearly unaffordable? Fourth, perhaps the alternative narrative is that it was poor budgeting on the part of Treasury, engaging in wishful thinking.