Growth and development: path dependence Notes on South Africa’s Response to the Great Recession

1. Growth and development: path dependenceNotes on South Africa’s Response to the Great Recession Andrew Donaldson National Treasury August 2009

2. As global economy slows, so too does South Africa… World GDP growth and SA growth Global slowdown dampens export demand from US, Europe and Japan Emerging markets affected by lower commodity prices, reduced export demand, risk aversion. Source: IMF WEO Apr 2009, including forecast for South Africa.

3. South Africa’s fiscal outlook • Economic growth in retreat • SA savings rate too low to sustain rapid growth • Redistribution through fiscus needs to be complemented by improved household saving and investment • Global economic context is highly uncertain, outlook for growth will depend on effective international coordination • South Africa’s macroeconomic framework aims to cushion the adjustment and sustain growth and development • Strong fiscal position: shift from surplus to deficit • Inflation set to fall, target remains in place • Phased approach to exchange control liberalisation • Sound banking and financial sector regulation • Financial support for capital spending programmes of major infrastructure utilities • 2009 Budget framework emphasises continuing spending on infrastructure, public services and programmes aimed at cushioning the poor against slower growth

4. Budget balances – 2000/01-2011/12

5. Key spending trends

6. Growth in gross fixed capital formation

7. Infrastructure finance – ten-year outlook • Infrastructure investment requirements continue over medium to long term • Pace of growth will be more moderate • Eskom capital programme will need public and private sector co-financing • Role of development finance institutions under review • Municipal water supply and treatment plants • Mix of project management & financing needs • Transport investment tied to urbanisation and industrial development • Likely to dominate post-2010 city planning • Communications liberalisation under way • Education, health and social infrastructure • Public-private partnership opportunities • No more sports stadiums…

8. 275 250 Construction 225 200 175 Finance Index (2001=100) 150 Trade 125 Manufacturing 100 75 Mining 50 2001 2002 2003 2004 2005 2006 2007 2008 2009 Creating jobs – sectoral trends… 2 million jobs created since 2001… many at risk, especially in non-traded goods sectors. Need to create an additional 2 million jobs… How to create conditions for private sector to make more jobs? How can public sector contribute cost-effectively? Formal sector employment by industry

9. South Africa’s response to global crisis • Good luck doesn’t last forever: • Industrial and trade competitiveness has to be fostered • Broadening of income support and social security underpins more broad-based development • Good time to strengthen regional economic linkages • Re-assertion of the role of development finance institutions • Sectoral and industrial policy: targeted industry support measures • Re-shaping of the balance between public and private services: education, health, enterprise development… • Inclusive development: opportunities for strengthening social security and labour market institutions • Acceleration of EPWP job creation; short-term training lay-offs

10. Fiscal policy choices critical to growth and macroeconomic sustainability • Higher deficit over the long-term = more borrowing = less future economic growth (as debt repaid) • Spending must have larger economic impact as costs rise. • Borrowing to pay wages, interest on debt is unsustainable as growth forecast deteriorates. Public spending choices… 1. Size of deficit 2. Type of spending Spending on consumption: Growth ▲ in ST but not LT (and lower) = inflation & LT rates higher = real appreciation (less comp) = employment ▲ in domestic sectors • Spending on investment: • Higher growth ▲ in ST & LT • = higher future tax revenue • = inflation & LT interest rates lower • = real depreciation (more competitive) = employment ▲ in exporting industries

11. Counter-cyclical fiscal stimulus supports economy through growth-enhancing spending decisions • Borrowing of the public sector expands rapidly • Strong growth in expenditure, including capital • Capital expenditure (6.6 per cent average real growth over MTEF) continues to grow faster than current expenditure (3.7 per cent average real growth over MTEF). Adjusts to deterioration in economy Fiscus recovers with economy Calibrated for supportive economic environment

12. Adjustments to economic outlook: distributional considerations Redistribution Pooling of funds Saving Out-of-pocket Government UIF benefits Curtailment of tax and spending Drawdown on savings consumption Income pc (logscale) Risks mitigation: pooling & saving Contingent Risks Income (before tax) Lifetime vulnerability Pooling of funds Income (after redistribution) Households

13. Institutional perspectives: governance counts • Does anybody teach Comparative Economic Systems any more? • More complex institutional arrangements: • Regulation of markets • Competition within the public sector • Public-private partnerships • Public economics beyond the sovereign state • Governance failure: a problem the modern corporation shares with rent-seeking states • Solutions to principal-agent problems • Incentives and the profit motive • Information failures, audit and disclosure requirements • Corporate governance and accountability • So what has gone wrong? • Macroeconomic boom-bust • Market regulation failure • Governance on holiday • Macro-structural imbalances • Different adjustment paths in different countries • Surplus vs deficit economies • Aged vs young populations • Deindustrialising vs emerging economies • Implications for South Africa?

14. Path dependence • Future course of the economy and public finances depends on the institutional legacy • Depth of SA’s financial markets has a long history • Transport, housing and the apartheid city • Labour market policy and SA’s political transition • Social security, income security & the evolution of contractual savings • Path dependence can extend beyond discontinuities: monetary & fiscal restraint after hyper-inflation • ‘Bounded rationality’ of applied public finance • ‘Limits of organisation’: understanding the ‘second best’ • ‘Learning by doing’ – the epidemiology of institutional change • Economics of system shocks: crisis as a reconstruction opportunity

15. Government’s Medium Term Strategic Framework • Ten strategic priorities • Growth, decent work, sustainable livelihoods • Investment in infrastructure • Rural development, land reform, food security • Skills, schooling and further education • Improving the health profile of all South Africans • Fighting crime and corruption • African advancement and international cooperation • Sustainable resource management and use • Building a developmental state – improvement of public services, strengthening democratic institutions

16. Policy choices that need to be supported by underlying evidence… • Short-term fiscal interventions to support economic activity while avoiding an unsustainable rise in public debt… • Monetary and fiscal policy credibility, capital market deepening, credit extension in support of growth & development… • Public infrastructure investment priorities, regulatory and tariff policies… • Effective and well-targeted government spending… • Long-term planning and alignment of budgetary and development framework • Trade and industrial policy: competitiveness, productivity, technology, support for R&D investment… • Human capital development, effective skills development… • Health financing and systems