South Africa’s eroding growth potential

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By Cees Bruggemans, Chief Economist of FNB.

For the past ninety years for which modern data sets are available, South Africa’s GDP has grown by an average of 3.5% annually through many business cycle ups and downs.

Some decades faster, some decades slower, over- and undershooting this average, but always reverting back to this mean.

It can be taken as a rough estimate of the pace at which South Africa has invested capital, absorbed labour, achieved some productivity gains in its mature industrial and post-industrial phases of development.

For instance, over the past forty years, earmarked by exceptional growth spurts but also long dormancy, the formally employed labour force doubled, suggested an average annually increase of 1.8%.

If we take it from business cycle peak to business cycle peak, it averages out at roughly 2% annually on average.

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Post-1994, the country’s political transformation injected much greater freedom into the economy, making for a changed allocation of scarce resources, potentially enhancing efficiency and therefore output ratios (growth achieved for given inputs).

Also in this period, there was a greater opening up to the outside world, similarly suggesting efficiency gains.

Both stimuli could have been expected to increase the country’s growth potential.

From 2005 onward, the low investment-to-GDP ratio of previous decades started to be undone, as especially more public sector investment lifted the ratio-to-GDP from 15% towards 20%-25% territory, also assisted by the cresting of a remarkable private sector expansion boom.

This was yet more reason to suspect that the country’s growth potential had been lifted.

Yet of all this there is as yet no true evidence in the data, especially when taking note of saving and foreign trade behaviour.

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Of course, the post-1994 decades also saw a massive ejection of scarce labour skills, locally into early retirement, abroad through emigration, and not necessarily always more efficiently redeployed locally.

The local redeployment was often motivated on political rather than economic grounds. Available cadres became newly employed, but not always with established skill sets in mind, in many instances on political rather than economic grounds.

This may have improved the political and social welfare of the country, certainly in parts, but not necessarily its growth potential, not even in the short-term.

Still, some of these costs may have been of a transitory nature, and therefore lessening over time.

Certainly, for some while the country’s growth potential post-1994 didn’t seem to fall. But it didn’t materially expand either over repeated business cycles, at least not noticeably. Whatever was being gained in some places was being countered by losses in others.

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Recent years saw a massive growth boom (2004-2007) and a major cyclical dip/recession (2008-2009).

Looking through these cyclical phenomena through 2010-2015, one had still reason to assume of having a mostly unchanged growth potential of the order of 3.5% (the long-term mature average) or even somewhat better (given the lifted investment-to-GDP ratio promising faster resource absorption and output growth in future).

Or had we? Was there a chimera at work?

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The essence of a modern economy’s expansion is the pace of investment (capacity creation), the rate of labour absorption, and any multifactor productivity gain.

Such a modern economy works on certain principles, searching for resources, and combining these into output, in the most efficient manner offered by a market pricing mechanism and a set of government-managed rules ensuring arms-length transparency and therefore best use.

One encounters these modern mindsets daily in most parts of the economy. Sometimes private enterprise tends to circumvent these rules, as more frequently happened in early stages of development when rule mechanisms weren’t yet as well developed, but in mature phases of development going outside the rules becomes less of a feature, and a lesser drag on development.

However, in recent years other aspects have come more noticeably into focus, regarding the entire economy, and the public sector in particular.

The one aspect is the basis on which some labour is deployed. The ruling political party likes to describe this as cadre deployment or redeployment, and it does not necessarily have an economic basis.

One finds for instance consulting engineers mentioning that the public sector has apparently reduced its technically-trained cadre from 5500 to 1500 these past two decades, in an economy that has grown a third bigger.

The implied inefficiencies one can observe especially in public infrastructure efforts, partly hobbling overall fixed investment performance.

It is a feature that specifically does not add to growth potential. Meritocracy would. Anything else has the potential to erode growth potential, especially if becoming pervasive rather than remaining relatively limited in scope and therefore absorbable.

Such inefficient resource allocation marks especially command economies. This was clearly displayed by the old Soviet Union and Eastern Europe, and can today still be observed in North Korea and Cuba.

The other aspect concerns rulemaking.

A modern market economy is a finely tuned mechanism, in which resources are offered and demanded, with information fulfilling a crucial allocation role, and the rules of the game important in ensuring certainty and encouraging efficiency and the willingness to incur risk, as opposed to creating uncertainty, adding to risk and undermining the willingness to take risk.

When rulemaking starts to descend into organized chaos, whether as simple as the rules governing traffic, or mining rights, or property rights, or government appointments, or the functionality of municipalities, provinces or state departments, or the labour market, with good exceptions highlighting the bad ones, there tends to be a loss of system efficiency.

Economic agents tend to partially get around such inefficiencies by undertaking the necessary actions themselves, whether acquiring personal safety, education, health care, water access, solar power, job access or anything else that needs to be acquired (such as needed infrastructure to get exports to harbour or supplement the national electricity grid), while often also still carrying the increased burden of any increased inefficiencies levied by the larger system.

Such burdens constitute a form of redistribution. But where they undermine efficiency and risk taking, they erode the growth potential.

An interesting question facing South Africa is how far such erosion has progressed, whether it is stabilizing, or whether it is accelerating, with what kind of impact on the economy’s ability to grow (its potential).

If the rulemaking becomes sufficiently discretionary and arbitrary, not with economic efficiency in mind, but with greater goals in mind only known to the rule-makers, one has to allow that the institutional fabric is changing, but possibly not for the better and that the growth potential may well start to deviate from the longer term norm.

And this despite more democracy, greater freedoms and higher investment/GDP ratios.

There’s much talk about wanting a HIGHER growth potential for the country, indeed doubling it towards 7%. Perhaps first things first, preventing erosion of this country’s long-established, if limited, growth potential.

Apparently, that might be quite an achievement, given current trends towards losing growth potential.

Source: Cees Bruggemans, FNB, February 14, 2011.

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