Guns, butter, eports and public choice

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By Cees Bruggemans, Chief Economist of FNB.

Where have the last 20 years gone? Gone in a flash or so it feels. Much has happened. Much has also not happened, some of it as a matter of choice.

We read that if South Africa had consistently invested in infrastructure at 10% of GDP between 1994 and 2009, we would have invested an additional R1.5 trill more than we actually did.

That would have been a lot more infrastructure than what we can pride ourselves on today.

Why didn’t it happen? And with what consequences?

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In the US, and long before it in the UK and other empires, the internal debate of superpowers has for very long been cast in the old trade off between “guns and butter”.

In the young Churchill’s time it was between more ‘Dreadnoughts’ and less of everything else. In today’s America, it is about raptors and rocketry as compared to medicare and social security.

Superpowers wage war, preventive and otherwise, for which purpose they need guns. Indeed, up to Napoleonic times, and in some instances even to WW1, governments in leading nations basically were mobilization engines only for war, marshalling their nation’s wealth and tax base to fund serial global engagements, mostly very expensively.

Thereafter a major change occurred and nations mostly became mobilization platforms for social redistribution.

In some instances, like the modern day US, these roles continue to exist side by side.

In the 1960s, with the Vietnam War in full cry and President Lyndon Johnson engaged in his Great Society ideals, yet nobody wanting to pay for either through higher taxes, economic overheating became a challenge, with so many consumption, investment and state spending demands being placed on finite productive resources, even in the very rich US economy.

Economists started to point out that tradeoffs were inevitable.

Just how many guns (war) and butter (social agendas) does one desire, and how is one going to pay for it? There isn’t a free lunch, only major headaches in making the tradeoff choices, none of them politically easy.

As it happened, the US throughout the 1960s wanted its cake and eat it, too, as if there were no constraints.

It choose to wage war and uplift the poor in whatever measures deemed necessary, causing so much stimulus it overreached the US economy’s productive ability.

This started to feed a groundswell of inflation and Dollar weakness greatly adding to the disturbances and global stagflation of the 1970s.

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What do tradeoff travails of a global superpower have to do with a small open trading country in Southern Africa?

Well, the same logical constraints apply to us. What are our collective wishes, and can one command the economy to deliver them, or do we end up in a swamp of unintended consequences?

It used to be, in the 1970s and 1980s, that South Africa also had a typical guns-versus-butter tradeoff constraint far worse than ever inflicted on the US at that time.

For South Africa was at war with itself, and for good measure also with global communism and its proxies (Cuba and East European weapon suppliers) and global opinion generally regarding the kind of country we had become.

This deepening existentialist conflict drained the South African state of scarce resources at a time that it wanted to accelerate the social upliftment of poor South Africans while keeping middle class South Africans relatively content (and uncomplaining).

This was a forlorn hope, given the small size of the economy and the enormity of the challenges. We all know the outcome as the old regime eventually capitulated and inclusive democracy won through.

So it isn’t as if this country hasn’t been confronted with the guns-versus-butter dilemma before.

Post-1993 we finally said goodbye to war. That made the public choice facing South Africans a lot easier. Or so it seemed at the time (and apparently long thereafter). It was only going to be butter henceforth, not so?

Perhaps that’s where many over the years made too many simple assumptions, and apparently still do.

For define ‘butter’.

Is it the undoing of the iniquities of the past? If so, how large are these, how fast do these need to be addressed and how will this be done?

And will it be done as the sole orientation of the state over many years, or do resource constraints still apply, not only financially in what the economy can generate, but also the maintenance requirements and expansion of the existing economy and state?

In other words, still more tradeoffs to take into account as we focus on the great pressing objective of the day.

So, define ‘butter’ in our modern existence.

The new political dispensation clearly aimed to change the composition of the butter allocation, away from some of the old working and middle classes and towards the poor and new working and middle classes.

Within this distributional shift, the state also aimed for massively more upliftment. More urbanization, education, health care, personal security, subsidized housing, water access, electricity access, telephone access. All, not just the privileged, were to enjoy access to such modern facilities.

The list can be extended, but this is the gist of it.

What choices were made to undertake this massive ambition with what kind of consequences?

One major observation in the mid-1990s was the preponderance of infrastructure surpluses, especially in electricity and road systems.

Also in urban layouts, with a lot of open space begging for greater densification, allowing lowering of travel costs for workers relocating nearer work.

Generally, the main urban concentrations enjoyed excellent infrastructure in terms of municipal services and the like (except for the underserved townships and informal settlements on their fringes).

We can observe a number of major strategic decisions, and others perhaps less strategic but not less lethal.

Given the slow growth in the economy at the time and the huge infrastructure surpluses of various kinds it was apparently decided it wouldn’t be necessary for a while to put emphasis on their expansion, or for that matter in certain instances on their full maintenance.

The money so saved could be used better for other purposes. The great aim was more social delivery (more of everything, schools, clinics, houses, police stations, electricity, water and telephone access).

But also there were other demands, such as rapid increases in public sector wages and benefits, and the expansion of the public service.

Today it remains a question as to how much more state value added these increases in numbers and costs really generated over the years.

For these decisions were accompanied by another, namely the wholesale change in composition of the public sector workforce to eventually reflect more appropriately the larger population composition.

In many instances this was apparently done without closely considering skill or experience levels, not preventing the loss of skill through early retirement or emigration, or the expensive rehiring of many as consultants, or the loss of state efficiency in too many instances which progressively led to deterioration in service levels.

Here is a three-pronged reality: suspending expansion and full maintenance of large parts of the infrastructure stock, increasing greatly the cost of the state while apparently accepting inefficiency implications in the changes made (or rather simply denying this outcome).

A forth reality was the need to clean up the poor finances of the state, effectively bankrupted by the previous regime, meaning the budget deficit had to be reduced and the national debt stabilized and ultimately reduced as a share of national income.

This was partly achieved by greatly extending the tax base and increasing the tax burden on the economy to present day levels.

This was successful in the narrow aim of stabilizing annual finances, reducing the national debt to 22% of GDP by 2008 (and to 30% of GDP when adding back quasi-sovereign, parastatal debts/guarantees) and preventing South Africa from becoming a ward of the IMF (something that politically was to be prevented at all costs, for it might otherwise have intervened with the public choices made, denying a ‘free hand’, clearly not acceptable to the reformers).

But what was the ‘real’ outcome of all this?

The stated aim of reducing the social iniquities and past backlogs was certainly achieved in major ways. A long list of achievements over 20 years can be recorded, in school, clinics, houses, police stations built and electricity, water, telephone connectivity achieved, in addition to 15 million recipients nowadays receiving state grants or allowances.

The social achievement, in other words, hasn’t been minor. It has been massive. But relative to what, to what existed before or what could have been?

For the inefficiencies that were allowed to seep into the public sector apparatus, not only at municipal or provincial level, came at the cost of resources lost and even greater social delivery forgone.

So there could have been a lot more ‘butter’ to distribute today if the eagerness to transform the state had been more disciplined, with fewer losses of skill and experience and other types of leakages.

There could still have been the same transformation, if over a slightly longer timeframe, say 30 years rather than the achieved 17 years.

This would have been a minor inconvenience in the fullness of historic time, even if it was politically and emotionally a sensitive issue then (and not apparently acceptable at any cost).

But that leaves still other unanswered questions.

If the increase in state costs, directly through wages and benefits, and indirectly through other leakages and activities, had simply not been condoned, such money would have been available for buying more infrastructure.

Instead of feeding the country’s consumption engine (with the loss of public saving), the state could have retained greater surpluses and channeled these into infrastructure investment.

Furthermore, the single-minded dedication to do all the things enumerated above during 1994-2009 AND reducing the national debt simultaneously to 30% of GDP from nearly 60% at the time, was an opportunity loss of magnificent proportions.

Yes, we didn’t want to end up in the arms of the IMF, so we had to clean up the finances. But we did this while allowing all these inefficiencies and higher costs to intrude while starving the infrastructure.

In the process we did a lot more during 1994-2009 than we perhaps bargained for. We fundamentally undercut our growth capacity which could have provided some of the means (the higher income and tax revenue) to pay for a lot of the extra resources needed to put it all in place (and then some).

If, instead of waiting for 14 years (!), the decision had been made in the mid-1990s to start up with the infrastructure investments nearer 10% of GDP, we would have set in motion electricity maintenance and expansion that would not have cut us short, as it did, from 2008, thereafter limiting us to a 3%-3.5% growth expansion for the next decade (and possibly longer).

It would not have allowed the national rail network to have atrophied the way it did. Instead, more efficiency would have been introduced, making it unnecessary to expand so much commercial road transport, in the process overexploiting our limited and under-maintained national road network and introducing yet more costs/inefficiency.

Most important, we could have outachieved Aussie in terms of new export rail-links, harbours and import pipelines.

The outcome of THAT would have meant being able to ship double the tonnage of coal and triple the tonnage of iron ore we actually do today, to hungry global markets paying top Dollar, in addition to other export opportunities so far forgone (chrome ore, manganese, but also maize).

Pipedreams? The evidence of recent years suggest differently.

But if we had made such choices, could it have prevented the healthy consolidation of our national finances?

Probably not. Instead of ending up with national debt (sovereign and quasi-sovereign) of 30% of GDP in 2007, we would have ended up with 45% of GDP (of which half government and half quasi-sovereign guarantees).

The global crisis of 2008-2009 would have pushed this to 65% of GDP by 2013, instead of the 60% it will in any case now be.

Instead of belatedly since 2008 starting to substantially increase government guarantees to state enterprises (quasi-sovereigns), taking it from 7% of GDP in 2007 to nearer 20% by 2013, we should have done it much sooner and have had the benefit of continuous expansion and maintenance of infrastructure geared for maximum growth and exploitation of global export opportunities these past 12 years.

This in addition to the extra domestic value-added such infrastructure additions would have made possible in the economy via more consumption and private investment.

If we had kept public sector infrastructure investment nearer 10% of GDP since 1994, how could we have financed the R1.5 trill that would then have been needed?

Possibly a quarter could have been financed by not boosting the consumptive cost of the state so much (wages, benefits and numbers remaining contained) WITHOUT a loss of public sector value-added. The social delivery of this period could still have been achieved.

Likewise, another quarter could have been financed by not accepting the rise in inefficiency brought by the demise of skill and experience and “other” types of inefficiency we have become used to on an unprecedented scale.

At least a quarter could have been financed by the early rather than the late granting of quasi-sovereign guarantees/borrowing by the state.

And a quarter could have been generated from the higher export and GDP growth generally the country could have achieved if these things had been undertaken.

And if each of these sources could have generated yet more free cash flow than here stated, the additional infrastructure investment opportunity since 1994 might have been nearer R2 trill, with the country’s formal employed labour pool by now some one-third larger (three million) and its seven million unemployed, underemployed and discouraged smaller by half (for there would also have been more informal job opportunities).

This would also have assisted in achieving a lower incidence of crime, another major inefficiency draining away societal resources and undermining national morale.

It may have created a stronger financial base from which to attempt the future national health scheme. And fewer social grants recipients might have resulted, further reducing the drain on state resources, freeing these resources for more constructive social delivery (such as better education and more housing).

Guns, butter, exports and social gains.

Opportunities foregone, often through deliberate decisions, undoubtedly made for very good reasons, but giving us major unintended consequences 20 years later.

One other consequence is that in addition to our existing tax burden and state inefficiencies we find ourselves increasingly being invited today to fund needed future infrastructure, belatedly and over and above our other burdens, through tolls and other additional imposts.

This, too, while the successful debottlenecking of the economy, more fully exploiting global and local opportunities and defusing domestic social and political strains, is delayed by yet another decade, if not longer.

These are major tradeoffs.

Source: Cees Bruggemans, FNB, June 12, 2011.

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