Download (Nedlac) (2013) (part 1). - Lecture Notes

Macroeconomics, Fiscal Policy and
Budgeting for South Africa’s Open
Economy Developmental State
Nedlac Public Finance and Monetary Policy Chamber
17 – 18 January 2013
Presented by
Kenneth Creamer
Overview of topics
1. Understanding the historical evolution of the
macroeconomic environment
2. Causes and consequences of the Great Recession
3. South Africa as an open economy – challenges and
opportunities
4. Budgeting – overview borrowing and deficits,
5. Budgeting – expenditure
6. Budgeting – taxation
7. Budgeting – process and planning
Also a presentation by Kuben Naidoo on the National
Development Plan
Topic 1
Introduction – historical evolution of the
macroeconomic environment
• “Democratic capitalism is a political economy
ruled by two conflicting principles… of resource
allocation: one operating according to… what is
revealed as merit by a ‘free play of market
forces’, and the other based on social need or
entitlement, as certified by the collective choices
of democratic politics.”
• “one side emphasizing the entitlements of
citizenship and the other those of property and
market power”
Wolfgang Streeck, New Left Review Sept/Oct 2011
Phases of the global economy
• After WW2 (1945 to late 1960’s) democratic capitalism
was based on the following settlement of these two
conflicting principles by putting in place:
– An expanding welfare state
– The right of workers to collective bargaining
– A political guarantee of full employment
• From late 1960’s / early 1970’s growth started to falter
due to factors such as:
– (1) falling productivity, (2) an oil price shock, (3) Demand
management resulting in inflation rather than to output
and employment gains
– leading to a series of crises for democratic capitalism
– By Okun’s law if growth falls then unemployment rises
Series of crises
• The crises in the democratic capitalist system
were managed as follows as mechanisms were
sought to appease the contradictory forces of
the market and democratic politics:
• 1970’s rising inflation
• 1980’s growing public debt
• 1990’s financial deregulation
• 2000’s socialising the losses of the financial
sector and related public debt
1970’s inflation
• When growth slowed in 1970’s (due to oil price
shock and productivity slow down, etc.) policy
makers had two options:
– Use tri-partite social compacts with the aim of
achieving wage restraint and promoting growth and
development
– In most cases, tripartite structures were not strong
enough so accommodating monetary policy was
pursued as in the short-run this allowed relatively full
employment and collective bargaining to continue,
but lead to rising inflation and falling real wages (as
workers could not de facto index their wages to
inflation)
1970’s inflation
• Forms become fetters as ultimately “inflation
will produce unemployment, punishing the
very workers whose interests it may initially
have served”
• Under democratic capitalism, governments
will then come under pressure to restore
monetary discipline, and this is what
happened….
1980’s Public Debt
• Inflation was brought under control after the Volcker shock of 1979 and
in the 1980’s
• It was accompanied be determined attacks on trade unions by
governments and employers, this has been characterised as the
beginning of the neo-liberal era
• But, as inflation receded, public debt begun to increase, because:
– Taxes revenues received by govt’s fell (as growth fell) and
– expenditure by govt’s rose due to social assistance needed to compensate
the rising numbers of unemployed
– Therefore govt’ begun to borrow heavily as “Public debt turned out to be
a convenient functional equivalent of inflation, as public debt made it
possible to introduce resources into distributional conflicts”
• “as the struggle between market and social distribution moved from
the labour market to the political arena, electoral pressure replaced
trade union demands” (see falling strike activities)
• “In a democracy the demands from citizens for public services tends to
exceed the supply of resources available to government”
1980’s Public Debt
• Forms become fetters – the accumulation of
public debt cannot go on forever as it will drive
up interest rates, and limit growth, and a growing
share of public spending will have to be devoted
to debt servicing,
• Therefore a new mechanism had to be found to
manage social conflict which included “fiscal
discipline” but gave resources for growth – this is
the political economy origin of the financial
deregulation of the 1990’s
1990’s financial deregulation
• The 1990’s saw an attempt to control public debt leading to rapidly
rising inequality, as a result of weakened trade-unionism, cuts in
social spending (as Clinton heralded the end to ‘welfare as we know
it” and reduced growth due to austere fiscal policy
• Private debt replaced public debt as the financial markets were
deregulated and were expanded
• “Instead of govt borrowing money to fund equal access to decent
housing, or the formation of skills. It was now individual citizens
who, under a debt regime of extreme generosity, were allowed.. to
take out loans at their own risk to pay for their education or to
move to a less destitute urban neighbourhood.” (See Fig. showing
the rise in private debt)
• The rich benefited – as they were spared increased taxes (as
spending was contained) and they invested in financial services
bubble (See diagrams showing increasing income inequality of the
1990’s and early 2000’s)
• The poor seemed to benefit (but did not) – as access to cheap
money and sub-prime mortgages become a substitute for reduced
social protection and labour protection as the labour market
become ‘more flexible’
US income inequality
15
Income inequality increased across a
range of countries - not just the US
16
A longer view of inequality
17
1990’s financial deregulation
• Forms become fetters – as the financial
system was not well regulated it became a
dangerous bubble that burst with devastating
consequences
• This was exacerbated by the very low interest
rate policies by the US Fed after 2001, know as
the Greenspan put – where the Fed would cut
interest rates to provide stimulus to the
financial sector
2000’s – Socialising the losses of the
financial sector
• In response to the collapse of the financial system
in 2008 (to be discussed in greater detail in the
next session):
– govt’s bailed out the financial sector, essentially
socialising the bad loans that had been made by the
financial sector which was deemed “too big to fail”
– Introduced fiscal stimulus to try and boost economic
growth
– To save democratic capitalism “political power was
deployed to make future resources available for
securing present social peace” and financial stability
2000’s – Socialising the losses of the
financial sector
• Forms become fetters – the increased budget deficits and
increased public debt needed to save the financial system has
been met by calls for fiscal austerity (e.g. for Greece and
Spain ad Ireland)
• But in the current period there is a contestation between
those who wish to prioritise growth (e.g. in the US) and those
who wish to prioritise austerity and primary budget balance
(such as in the EU) so as to avoid further indebtedness
• See Krugman’s aricle on Japan praising the new Japanese
govt’s fiscal and monetary expansion programme despite the
country’s large national debt (i.e. Krugman is in the camp that
promotes growth over austerity as a strategy to get out of the
recession)
• But as The Economist article on Japan warns this will only
work of returns on this investment in infrastructure in Japan
are higher than the cost of borrowing
What are the likely effects of the
recent crisis?
• Streeck argues that Economically the average citizen will be negatively
effected and will experience:
–
–
–
–
Reduced Public pension benefits
Cuts in public entitlements
Reduced pubic services, and
Higher taxation
• Politically,
– “the capacity of nation states to mediate between the rights of citizens and
the requirements of capital accumulation has been severely affected”
– “No govt today can govern without paying close attention to international
constraints and obligations”
– “Politics still contains and distorts markets, but… at a level far remote from the
daily experience and organisational capacities of normal people”
– Previously, in the 1970’s, contestation took place in national labour markets,
with social compact potential, in the 1980’s it was possible for national
contestation in the politics of public spending, in the 2000’s the international
and complex nature of the crisis has made contestation by ordinary people
very difficult – dominated by general apathy, but punctuated by protest
What are the Parallels for SA?
• 1960’s strong economic growth and investment (Harold Wolpe and
the article by Stephen Gelb characterising apartheid as functional to
capitalist development during this period)
• 1970’s labour unrest, slowing growth rates (Wolpe and the article
by Stephen Gelb characterising apartheid as becoming
dysfunctional to capitalist development during this period)
• 1980’s dead-end for apartheid (Gelb’s “Crisis of the South African
economy”)
• 1990’s transition becoming a democratic capitalist society or
perhaps a developmental state (i.e. a state that is able to use its
key instruments to engage the global and local economic system in
such a way as to create inclusive social and economic structures and
thereby eradicate the legacy of unfair exclusionary structures)
• 2000’s – SA’s financial system did not experience a melt-down even
though the economy as a whole was heavily effected by the global
recession that followed
What are the Parallels for SA?
• 2010’s – SA is experiencing:
– heavy contestation in the politics of public spending i.e. service
delivery contestation, tax and user-pays contestation
– Some contestation around whether we should view inflation as a
threat to investment of long-run growth, or an acceptable
consequence of demand management and fiscal expansion
– Our primary terrain of contestation remains national / domestic,
rather than international like other countries such as Greece,
– South Africa’s sovereign control over economic policy has not been
compromised as severely as many other countries – this strengthens
the potential for a social pact for growth and development
– This being said we do not have compete policy independence - SA is
an open economy so our macroeconomic policy choices must
necessarily be mindful of issues of international trade and capital
flows, having become particularly dependent on such flows and
vulnerable to the adjustment costs that would be associated with a
reversal of such flows
Questions
1. Is it correct to characterise the economy on the
basis of conflicting class interests or should
focus rather be on the common national
interest?
2. To what extent is SA free to set its own
economic policies? Do global forces assist or
limit the SA economy?
3. SA avoided the excesses of the sub-prime crisis –
how should we view the extension of credit and
household debt? Is it a positive growth in access
to financial services? Or a negative potentially
destabilising force?
Topic 2: Crisis and Recession
1.
2.
3.
4.
Introduction
Crisis in US
Crisis in Europe
Economic policy lessons for South
Africa
1.Introduction
• What is an economic crisis?
– It is a period of economic stress and failure in which
confidence evaporates, growth rates fall, investment
declines, government’s get into debt, banks fail and
unemployment rises?
• Even though the crisis of 2008 – called the Great
Recession - was rooted in the developed world
there is much we can learn about how economies
work by analysing the crisis – we can draw
lessons applicable to our own experience
• Also the ongoing global economic crisis has direct
implications for the South African economy and it
is important to try and understand how the crisis
impact on our economy
2. US Crisis – regulatory failure
• A major regulatory change lies at the heart of the current US
financial crisis
• In 1999 the Glass-Steagall Act of 1933 was repealed (New Deal
programme after banking crises of the Great Depression late
1920’s early 1930’s)(See Eichengreen article in which he says
Obama’s Dodd-Frank Act is not as strong as the Glass-Steagall
Act)
• As Streeck outlined, the 1990’s and 2000’s was the period of
financial deregulation allowing for the explosion of private
debt
• The Glass-Steagall Act had provided for a strict separation of
investment banking and commercial banking
• Under the Glass-Steagall Act depositors money could not be
used by commercial banks to invest in high risk securities (this
would have been the preserve of investment bank who were
taking risk-taking investors money and chasing high return)
US Crisis – regulatory failure
• In a sense it the repeal of the Glass-Steagall Act took away an
important regulatory pillar of the process of financial
intermediation which matched that risk-averse depositors
(with govt-backed deposit insurance) with low risk (lower
return) types of investment and disallowed depositors funds
to be used in the high risk-high reward “casino” of Wall Street
• What is financial intermediation?
• banks take depositors money and then lend it to investors (i.e.
savings are transformed into investments and the banks make
a profit as they pay depositors a lower interest rate than the
return they make an the investments that they fund i.e.
borrowers pay a higher interest rate than depositors receive)
US Sub-prime crisis
• In 1999 the year before the repeal of the Glass-Steagall
Act sub-prime loans were around 5% of all mortgage
lending, in 2008 sub-prime loans were around 30% of
all mortgage lending
• In effect: Low risk savings were being invested in high
risk assets
• In chasing high returns the less regulated banks started
using depositors money to chase the high returns
associated with lending people money to buy houses
that they probably would not be able to afford
• Sub-prime loan is a housing loan to a person who is
due to their poor financial position is going to pay a
higher interest rate for the house that they purchase –
often with “teaser rates” or with “repayment holiday”
clauses
The securitisation of sub-prime loans
• Sub-prime loans were securitised i.e. financial companies take 10
000 bonds and rolled them up into a product called “Property Bond
Product A”
• A bank no longer regulated under Glass-Steagall takes depositors
money and buys this product “Property Bond Product A” as it offers
good returns i.e. the bond repayments of 10 000 families each
month as well as the underlying value of the property (which was
assumed always to be rising)
• Furthermore, the rating agencies (S&P, Moodey’s, Fitch, etc) have
rated products such as “Property Bond Product A” as a completely
safe and secure investment i.e. AAA rated based on the assumption
that while one or 10 families may defaults on a bond it is not
possible for 10 000 families to default and on the assumption that
property prices will always rise
• Financial companies such as insurance company AIG sold credit
default swaps (CSS) which essentially allowed those who wished to
bet against the sub-prime loans, billions of $ of insurance if the subprim market failed
• All in the name of “financial innovation”
Then the wheels feel off….
• Families began defaulting on sub-prime bonds and the
property bubble burst – property prices began to fall
• AAA-rated products like “Property Bond Product A”
which had been worth hundreds of millions of dollars
one day (and had been bought with depositors money
were worth almost nothing as the products become
illiquid and cannot be sold “toxic”)
• The US government had to bail out banks that had lost
depositors money (or more banks would close like
Lehman Brothers)
• The US government had to bail out the insurance
companies (like AIG) that had miscalculated risk and
had to pay out billions of $ on credit default swaps
(CDS)
Recession stalks the US
• Dangers in US - Unemployment is high, confidence is
low and government debt is high
• There is a danger that the US government does not
have the instruments to turn the economy around as
both fiscal and monetary instruments are appearing
impotent
– Fiscal policy – govt is heavily indebted and is running a
large budget deficit with no political consensus on whether
to raise taxes or cut spending (fiscal cliff)
– Monetary policy – interest rates are very low and cannot
go much lower, resulting in the risk of deflation deflation 0
bound) therefore the Fed is using non-interest rate
instruments such as Quantitative Easing (QE) i.e. huge
increases in the money supply to try and inject some
inflation and liquidity into the system
Dangers of Deflation
• There is the danger of a deflation trap e.g. where nominal interest
rates are zero and there is deflation then the real interest rate is
positive,
– r = i – π (real interest rate) and i ≥ 0
– If i = 0 then r = – π
– If π < 0 (deflation) then minimum real rate is positive and r rises as
prices fall further (further deflation)
• Demand channel: If there is continued weak demand and deflation
is fueled further this will lead to a rise in the real interest rate (the
wrong impulse as it results in further suppression of demand)
• Financial channel: Deflation means that bond payments go up in
real terms (as in nominal terms they are fixed but price and wages
are falling) e.g. if you are paying a bond of R5 000 a month but
prices and wages are falling this is equivalent to a rise in the interest
rate
• Consumption channel: Deflation slows consumptions as delayed
consumption will be rewarded with lower prices
3.European Crisis
• At the root of the European crisis was a also a bursting
of the property bubble and related collapse of the
financial system, but the most visible sign of the
problem was rising govt debt:
– Ireland bailed out its banks and the budget deficit rose
from 3% of GDP to around 30% of GDP
– Spain and Greece, etc tax revenues collapsed as a result of
the crisis
• Unlike the US who could use monetary and fiscal policy
measures, European countries had:
– no fiscal space (as there bond rates started to rise)
– No monetary instrument (as policy was controlled by the
ECB)
– No nominal exchange rate instrument (as they shared a
common currency the Euro)
Shrinking Fiscal Space
• Expenditure = Tax revenue + Borrowings
• Borrowing = Expenditure – Tax Revenue
• In order to borrow govt’s sell bonds e.g. govt sells a
bond for Euro 1 bn
• “follow the money” – this means govt is given Euro 1
bn and makes a commitment to pay this bond back
with interest
• NB – the amount of interest you must pay depends on
how risky you are perceived to be by lenders (what is
important here is often subjective and based on herd
mentality – behavioural vs rational economics)
European bond market
• Greece and Spain, etc. began to be perceived as more
risky so there cost of borrowing began to rise
• Language of the bond market – “the yield spreads are
rising” i.e. the amount of interest that they will have to
pay on the Euro 1 bn that Greece is borrowing will be
much more than the interest rate that Germany has to
pay (as Germany is perceived to be less risky)
• The result for Greece is that its fiscal position appears
to be shifting from precarious to unsustainable i.e.
there is a risk that it will not be able to re-pay its debt
and this results in a vicious circle where the risk of
default pushes up interest rates and makes it even
harder for Greece to pay its debts
The Market for Greek Debt
• If supply rises of something then prices come down (Greeks need to
borrow)
• If demand falls for something then prices come down (perceptions of
Greek risk rising)
• As Greek position worsens they may wish to sell a bond for Euro 1bn
• Originally they could have sold this bond (a commitment to repay Euro
1bn in 10 years) for Euro 950 million [case 1]
• During the crisis as Supply is up and Demand is down they may only be
able to sell the bond for Euro 700 million) [case 2]
• As bond prices fall, bond interest rates rise
• The bond yield, interest rate or cost of borrowing is calculated as follows:
– Case 1 (1 + Interest Rate)10 = 1000/950
=> Interest Rate = (1000/950)1/10 – 1 = 0.51% per year
– Case 2 (1 + Interest Rate)10 = 1000/700
=> Interest Rate = (1000/700)1/10 – 1 = 3.63% per year
• So the bonds spread between Case 1 and Case 2 is 3.12% or 312 basis
points
• The Greek cost of borrowing has risen – what are the implications?
Budget or fiscal implications
• Rising interest rates ‘crowd-out’ other spending
• As interest rates rises a higher and higher portion of tax revenues
have to paid in interest payments
• Year 1
• Tax (950) + Borrowing (50) = Spending (1000) (comprising salaries
and consumption 750 + investment 240 + interest repayments 10)
• Year 2 (after interest rates borrowing costs rise)
• Tax (950) + Borrowing (50) = Spending (1000) (comprising salaries
and consumption 750 + investment 210 + interest repayments 40)
• Notes:
– In year 2 interest payments have risen sharply “crowding-out”
investments (as salaries and consumption are typically more difficult
to reduce)
– To reduce debt a country would have to run a primary budget surplus
(i.e. revenue > non-interest expenditure) e.g. in year 2non-interest
spending would have to be cut to about 940 (from 960) in order to use
some revenue to pay the debt service costs, rather than borrowing
money to pay these costs
Loss of monetary and exchange rate
instruments
• European countries could get out of debt by cutting
interest rates or devaluing the currency – but this
cannot be done in Euro area as ECB controls interest
rate and there is a single currency
• Real exchange rate is given by RE = P*e/P, can’t
influence P* (foreign inflation) or the nominal
exchange rate (e)(the Euro) therefore the must try to
reduce P (domestic prices) to devalue the real
exchange rate to increase “competitiveness”
• But this is politically very difficult e.g. general calls for
wage moderation and reducing public servants salaries
would be resisted in the context of rising VAT rates and
measures to increase tax compliance
Housing Bubble
• Moving from high inflation to low inflation e.g.
countries like Greece, Italy and Spain - money illusion
in buying houses
• Housing bubble occurs as property prices are perceived
to be lower (due to lower nominal payments, but over
time the real payments are higher due to lower
inflation) (see next slide)
• As a result there is an investment boom in housing
stock and then when it is revealed that people cannot
afford housing then housing price fall and housing
developments are left unfinished
• This puts further pressure on economy and banks as
defaults rise
12000
1200
10000
1000
8000
800
6000
600
4000
400
2000
200
0
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
Money illusion – moving from high to low inflation
High Inflation Case: Initial bond payment is Euro 10000 but with inflation at 25% p.a. the
real bond payments rapidly decrease over 20 years
Low Inflation Case: Initial bond payment is Euro 1000 but with inflation at 5% p.a. the
real bond payments are comparatively higher over the 20 year life of the bond
Due to misperception that the low inflation case is cheaper (Euro 1000) than the high
inflation case (Euro 10 000) a housing bubble develops
Current debate in policy about the role of monetary policy or macro prudential policy in
avoiding the development of asset bubbles e.g. push up taxes / transfer duties on
houses when you move from high inflation to low inflation (e.g. Singapore)
Likely results of European Crisis
• Euro introduced to avoid currency volatility and currency
speculators
• Now imbalances have been revealed with no ready
instruments to address the imbalances
• Ultimately, it is unclear which of the following scenarios will
play out:
– Euro will collapse (countries will leave) or
– Countries will lose fiscal policy independence as well (e.g.
budgets will have to be passed by pan-European govt in Brussels
with the aim of preventing too much borrowing or allowing
unsustainable spending)
– Austerity will lead to a return to competitiveness and stable
govt finances
– Growth will return to the world economy and assist in lifting
Europe
4.Economic policy lessons for SA
• From the US crisis – keep appropriate regulation of the
financial sector
– In SA we have had exchange controls on SA citizens and
companies and prudential regulations on the banks (versus
ideological position of maximum freedom minimum
regulation a la Greenspan)
– There are moves to strengthen banking regulation and
increase liquidity requirements (but SA banks are arguing
that the requirements of Basle 3 are problematic)
• From EU crisis – avoid getting into fiscal distress
– In SA we have avoided debt trap (see diagram that we are
relatively strong in this regard)
– Recently increased budget deficits have meant that govt
debt has been on the rise (mostly Rand denominated)
Gross government debt as a % of GDP
17.1
China
25.4
Indonesia
Turkey
39.4
SA
39.6
2007
2011
63.9
Spain
65.7
Brazil
80.1
Germany
83.0
UK
Euro area
87.3
France
87.6
90.6
Portugal
99.5
US
102.9
Advanced
114.1
Ireland
120.3
Italy
152.3
Greece
229.1
Japan
0
20
40
60
80
100
120
140
160
180
200
220
240
260
Gross government debt: % of gdp
Questions
• Why to you think the US failed to properly
regulate its financial sector?
• What are the best options for European
countries to resolve their economic crisis?
• Does SA regulate its financial sector correctly
or could its excesses destabilise the economy?
Topic 3:
South Africa as an open economy
1. Data on the open economy
2. Theoretical summary on the role of the state
and on the open economy
3. Strategic perspective on the open economy
1.Data
• South Africa is a relatively open economy as compared to
other countries
• While SA has its own internal economic dynamics (due to
consumption, investment, government taxation and
spending) South Africa experiences positive growth and
negative shocks linked to developments in the rest of the
world
• The recent Great Recession (2008-2009) had roots in the
developed world, but transmitted globally, including to
South Africa
• In the past 10 years Africa is a region experiencing relatively
high economic growth (second only to Asia), but there are
concerns about the quality of Africa’s growth as it is not
based on industrial development i.e. there is mining,
agriculture and tourism, but not enough secondary industry
to support these sectors
DEGREE OF OPENNESS
(imports + exports as % of GDP)
120
100
80
South Africa
Brazil
60
Russia
India
China
40
20
0
World
DEGREE OF OPENNESS
• South Africa has been a relatively open economy
over the past 50 years, sanctions against
apartheid decreased that openness in the 1980’s
and 1990’s, but our openness has increased since
democracy in 1994
• India, China and Russia have rapidly opened up to
international trade in the past 20 years
• Brazil is noticeably less open than the rest of the
BRICS (but it is likely to become more open in the
year’s ahead)
GREAT RECESSION (2008-2009) AND BEYOND
(GDP growth rate (%))
14
12
10
8
6
4
2
0
-2
-4
-6
World
Developed
Asia
SubSaharaAfrica
GREAT RECESSION (2008-2009) AND BEYOND
• The world economy operates as a relatively integrated
system – when the developed world entered the 2008-2009
recession due to a financial crisis all regions of the world
were effected
• In the next five years, it is projected that Asian growth will
be around 7-8%, Africa around 6% and the developed world
around 2%.
• There is no certainty on this and there are risks (e.g. Euro
Area implosion, China’s growth, US fiscal cliff), but if these
projections are correct then in the next few years we can
expect that international growth will contribute positively
to South Africa’s growth and development.
SA AND WORLD GROWTH
(GDP Growth rate (%))
8
6
4
World
2
SubSaharaAfrica
South Africa
0
-2
-4
SA AND WORLD GROWTH
• South Africa’s growth since 1994 has suffered from 2 significant
negative international shocks
– 1998’s Asian crisis
– 2008-2009’s Great Recession
• South Africa experienced high growth (up to 5%) in the period 2003
to 2008 this was closely linked to high global growth (and a boom in
commodity prices)
• Not all negative shocks are due to external factors. For example,
South Africa in the late apartheid period had much lower growth
rates than the rest of the world)
• Internal events like the recent strike wave in mining and other
sectors also have the potential to result in negative growth shocks –
resulting in falling investment, loss of confidence and lower growth
rates.
SA GDP AND INVESTMENT GROWTH
(growth rate (%))
15
10
5
GDP Growth
Investment
0
-5
-10
SA GDP AND INVESTMENT GROWTH
• South African investment (private sector, SOE’s,
government and foreign investment) is linked to growth
• Strong investment growth took place from 1994 to 1996
(RDP period) and from 2003 to 2008 (Asgisa period)
(period’s of growth in the world economy)
• Investment has fallen sharply during periods of
international crisis
• This illustrates the need for counter-cyclical fiscal and
monetary policy to try and stimulate growth and
investment during down-turns
• As we can see from the next slide: the public sector and
SOE’s are leading the growth in investment a la some form
of state capitalism (unlike the GEAR period in which private
sector investment was meant to take the lead, but did not).
Investment growth over past 5 years
has been driven by the Public Sector
SA EXPORT AND IMPORT GROWTH
(growth rate (%))
20
15
10
5
Exports
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
-5
-10
-15
-20
Imports
SA EXPORT AND IMPORT GROWTH
• Import growth is linked closely with economic growth
in SA
• Export growth is linked closely with economic growth
in the the rest of the world (trading partners)
• In the longer-run, these dynamics can be structurally
altered by:
– trade policies that create access for our exports to new
markets (linked to our trade and industrial policy), but this
will usually require a reciprocal opening of our markets to
certain imports)
– Local content, import substitution policies aimed at
promoting our own industry e.g. local content
requirements around our electricity or rail infrastructure
expansions
6
SA EMPLOYMENT (% CHANGE)
4
2
"Public sector"
0
"Private sector"
1990199119921993199419951996199719981999200020012002200320042005200620072008200920102011
Total employment
-2
-4
-6
Note: 13.5 million employed and 4.2 million unemployed (23.9%), with a labour
force of 17.7 million (QLFS Q42011). 13.2 million employed and 5.6 million
unemployed (29.8%), with a labour force of 18.8 million (Census 2011)
TOTAL EMPLOYMENT (000’s)
14200
14000
13800
13600
13400
13200
13000
12800
12600
12400
EMPLOYMENT TRENDS BY AGE GROUP
SA EMPLOYMENT
• The South African economy creates employment
during periods of economic growth e.g. 2003 to
2008
• Jobs are lost during periods of low growth
(usually linked to international crises such as the
Great Recession)
• Public sector employment seems to be relatively,
but not completely, de-linked from developments
in the international economy
• The employment of young people has declined
more sharply than of older people in the
Recession period.
SA CURRENT ACCOUNT FINANCIAL
ACCOUNT AND RESERVES (R millions)
200000
150000
100000
50000
Current Account
0
Reserves
2003
-50000
-100000
-150000
-200000
2004
2005
2006
2007
2008
2009
2010
2011
Financial Account
SA CURRENT ACCOUNT FINANCIAL
ACCOUNT AND RESERVES
• South Africa imports more than it exports (leading to a
current account deficit)
• More foreign savings (foreign capital) flows into South
Africa than flows out of South Africa (leading to a financial
account surplus)
• Inflow of foreign savings is useful as it tends to finance
investment (e.g. higher shares prices and lower interest
rates), but it poses some dangers if it funds a consumption
bubble and it is reversible as it is sentiment driven
• South Africa is tending to grow it holdings of foreign
reserves as a matter of policy –
– at times to slow upward/strengthening pressure on the rand
and
– to hold reserves representing a higher number of weeks of
imports
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
REAL EXCHANGE RATE (2000=100)
155
145
135
125
115
Rand Exchange Rate
105
95
85
75
REAL EXCHANGE RATE
• The real exchange rate has been volatile preand post the 1994 democratic period
• The Rand weakened sharply form 1996 to
2002
• The Rand strengthened during the growth
period form 2003 to 2006
• And then weakened during the Great
Recession period, strengthened and then
weakened again….
2. Theory
Some key questions that require answering are:
– Does our macroeconomic policy framework fully
support the vision of a developmental state aimed at
transforming our society from apartheid economic
relations?
– What are the opportunities and constraints due to our
economic interaction with the rest of the world?
– How should we configure our interaction with the rest
of the world to our maximum advantage?
• Two important theoretical frameworks can be
used in answering these questions:
– The theory on the role of the state
– The theory of international macroeconomics
Developmental State
• Mixed Economy – state and market
strengths are utilised
• Industrial policy – state guides the
development and transformation of
industrial structure
• Investment promoted by SOE’s and
incentives for private sector
• Fiscal policy used to stabilise
economy in the short-run and to
promote investment in the long-run
• State changes the structure of the
economy to be more inclusive e.g.
education, health and housing
• Aim at labour fairness and wage
policies
Neo-liberal State
• Market-led economy – state assumed
to be inefficient
• Industrial policy not needed – as
market will reveal sectors for
profitable investment
• SOE’s privatised and state’s role is to
create enabling environment
• Fiscal policy should avoid debt and is
not used in counter-cyclical stabilising
manner
• State does not seek to change the
structure of the economy, marketlogic is extended to public services
• Deregulate labour market and reduce
labour protections
Developmental state vs neo-liberal state
• Political economy analysis that the contestation
of class forces will determine whether South
Africa’s racialised democratic capitalist sate will
be predominantly developmental or neo-liberal
• This raises the question as to whether:
– (1) class forces in South Africa are capable of uniting
around a social compact where the surplus is used to
fund programmes of development that change the
structure of opportunity in society
– (2) class forces are such that the surplus is not
effectively mobilised and redistributed by the state
and market forces and trickle-down policies are
allowed to predominate
International macroeconomic theory
• International economic theory poses what is
called the “open economy trilemma” to
explain policy options and limitations
• This theory states that due to limitations only
two of three beneficial policies can be
maintained simultaneously:
– Open capital market
– Fixed exchange rate
– Monetary policy independence
Fixed Exchange
Rate
China
Monetary
Independence
Hong
Kong
South
Africa
Free Movement of
Capital
The tri-lemma in South Africa
• In South Africa, as we have chosen to have free capital flows and
independent monetary policy then the theory tells us that we cannot fix our
exchange rate.
• If we try to fix our exchange rate and then the exchange rate comes under
pressure then we will have to increase our interest rate (give up monetary
policy independence) or limit capital outflows (with dire consequences for
future inflows). (Only 2 out of 3 possible)
• During the 1998 Asian crisis Chris Stals’s SARB tried a version of this where,
in an attempt to strengthen the Rand, they raised interest rates to over 20%
and intervened in the capital market (borrowing USD30-billion to buy Rands
and strengthen it). (See my article in the reading pack)
• Stals could not beat the tri-lemma so after this, under Mboweni, SA made it
clear that it would let the rand float freely in future, and monetary policy
would be set based on domestic inflation conditions and would not be used
to try to fix the exchange rate. Resulting in a period of relatively low interest
rates in South Africa (see next diagram).
Interest rates
The tri-lemma in Hong Kong
• Hong Kong – has chosen a fixed exchange rate
and free movement of capital, therefore its
interest rate is determined by factors outside of
their economy (no independent monetary policy)
• If Hong Kong tries to increase interest rates (due
to low US-linked interest rates promoting a
property bubble) then capital will flow into the
economy (and capital will have to be blocked) or
the exchange rate will strengthen (and will not
longer be fixed)
• (Only 2 out of 3 possible)
The tri-lemma in China
• China – has chosen a fixed exchange rate and
independent monetary policy, therefore it cannot allow
free movement of capital
• If China tries to allow free movement of capital (as it
may want to in order to extend the power of its
financial system) then capital might flow into the
economy and the exchange rate would strengthen
(and will no longer be fixed) or if it wishes to keep a
fixed exchange rate it might need to lower its interest
rate to avoid a currency appreciation (and thus lose its
ability to have an independent monetary policy)
• (Only 2 out of 3 possible)
3. Strategic perspective: How best to interact
with the global economy to create jobs
• Strategic question – how can SA take advantage of the trade and
capital linkages with the global economy?
• Interaction with the international economy gives us positives:
– Markets to sell goods (growth and expansion)
– Access to savings (capital)
– Access to technology
– Access to skills and labour
• And Negatives
– Exposure to shocks
– Exposure to unfair trade
• What is needed is a long-run strategic perspective which we
should expect may suffer short-run reversals as a result of
negative shocks, but which will seek to maximise the positives
and minimise the negatives of our interaction with the global
economy.
Strategic perspective (trade)
• Trade linkages –
– increased exports can assist in expanding access to larger
African and global markets and create space to develop
domestic industry and employment
– Technology transfer can be used to seed the development
of domestic industry and stimulate jobs e.g. through local
content requirements around our infrastructure expansion
– Aggressive positioning is required to make most beneficial
use of trade and to engage assertively in trade conflicts
e.g. British attempt to steal our wine bottling industry
– Geo-political alliances such as those offered through BRICS
and the AU provide an important foundation for this
strategic approach
Strategic perspective (capital)
• Capital linkages –
– The inflow of foreign capital can assist in lowering interest rates
and lowering the cost of investment which will stimulate growth
and investment
– But, short-run capital flows can misalign the currency are
sentiment driven, and can be highly volatile and disruptive
– Should we attempt to mitigate this:
• Through active foreign exchange market intervention using SA’s
holdings of foreign reserves and even build a greater reserve pool
including the reserve of the BRICs countries, or
• by implementing controls over capital flows – there has been some
success in this regard e.g. in Brazil, but the introduction of controls
might trigger the very thing that we are trying to avoid (i.e. volatility
and adjustment costs),
– or should we ‘ride the tiger’ of international capital flows
knowing that they are volatile and sentiment-driven, but that
the benefits (access to capital and lower interest rates) are
greater than the costs (of greater volatility)?
Policy options within this strategic
perspective
Option 1
Option 2
• Floating exchange
rate
• Free capital flows
• Independent
monetary policy
• Weakened / pegged
exchange rate
• Free capital flows OR
• Independent
monetary policy
Pros and Cons of Option 1
• Pros:
– Gives SA access to foreign savings, for as long as there are net inflows
this will finance investment, growth and jobs beyond our own savings
base, keep downward pressure on interest rates
• Cons:
– The exchange rate is volatile, periods of exchange rate strength driven
by capital inflows lead to falling exports and rising imports (limiting
growth and job creation)
– Capital flows are sentiment driven and highly reversible
– Capital inflows can be used to finance consumption and imports
rather than infrastructure investment, industry and employment
creation
– Capital flows are often short-term in nature and can lead to bubbles
and to financialisation of the economy rather than real economic
activity
Pros and Cons of Option 2
• Pros
– A weakened Rand will make our exports more
competitive, stimulating investment and jobs
• Cons
– we would have to then give up monetary policy
independence (like Hong Kong our interest rates would
follow those of the country to which we pegged our
currency)
– or we would have to give up on free capital flows likely
resulting in high interest rates and increasing cost of
capital/investment (with significant domestic adjustment
costs if currency inflows dried-up)
– Exchange rate weakening is likely to only provide a
temporary boost as the real exchange rate RE = P*e/P and
if the nominal exchange rate e rises (depreciates) then
domestic prices (P) will rise wiping out the deprecation of
RE
Weighing-up the options
• On the balance of evidence, it would appear that Option 1 is preferable
as it provides access to foreign financial flows that are essential to the
growth and infrastructure investment phase that we are undertaking,
but this brings with it the risks associated with exchange rate volatility
and with volatile capital flows.
• To choose Option 2 and to attempt to fix the exchange rate at more
competitive levels will mean that we must begin to regulate capital
flows at this stage or to give up our monetary policy autonomy and
there is a real probability that the boost will only be temporary
• This could serve to introduce new kinds of shocks and volatility to the
economy, and would certainly include serious adjustment costs. It
would be particularly problematic to adopt any policy that might cause
a sharp drop in investment flows during the current period of
infrastructure expansion, as this would serve to retard and push up the
costs of such investments.
• Perhaps, within the ambit of Option 1 we could explore what has been
termed by IMF researchers a “Two target two instrument policy”
Two target two instrument policy
• A possible strategic approach which is alive to the
underlying fundamental forces explained by the
tri-lemma theory has been suggested by some
staff at the IMF (IMF discussion note SDN/12/01)
1. Use the interest rate instrument to maintain low
inflation (primary target)
2. Use sterilised foreign exchange market
interventions (instrument) to ameliorate volatile
currency movements (secondary target)
How would it work if the rand
strengthens?
• If the Rand appreciates (strengthens)
• Intervene in the foreign exchange market by buying
FOREIGN RESERVES (SELLING RANDS) => weakening
the Rand
• But the money supply will grow, unleashing inflation =>
the to achieve the INFLATION TARGET the intervention
must be sterilised by selling bonds (and there is a cost
in servicing these bonds)
• The limitation is that if inflation persists (and it is the
primary target) then interest rates will have to rise
which may cause the rand to appreciate/strengthen
again
How would it work if the rand
weakens?
• If the Rand depreciates (weakens)
• Intervene in the foreign exchange market by
selling FOREIGN RESERVES (BUYING RANDS) =>
strengthening the Rand
• But the money supply will fall, inflation will fall =>
under INFLATION TARGETING then interest rates
may fall and this may further weaken the rand
• The limitation is that you can only use this
strategy while you are holding sufficient foreign
exchange reserves (and you risk running down
the reserves at times of currency weakness)
Resourcing the Developmental state
• In order to change lives the structure of opportunity SA
must change to provide inter alia for:
– More equitable, quality education
– A National Health Insurance system
– Active Industrial policy to create employment
– Effective trade policy
– Land reform and rural development
– Expanded infrastructure
– Expanded Public Works Programmes
• The state needs the resources to fund such
transformative interventions.
Resourcing the Developmental state
• Our macroeconomic policies must be
designed to ensure that sufficient resources
are made available for such development
– These resources come from internal sources –
taxation, borrowing
– And from external sources – trade and investment
flows
• Therefore, polices to promote economic
growth and promote trade and investment
are in the interests of our developmental
objectives
Questions
1. Do you think that the net effect of SA’s economic
relations with the rest of the world are
beneficial?
2. Could SA resource its development as a closed
economy?
3. Could we protect SA better from negative
foreign economic shocks?
4. Is there a possibility that SA can build a
developmental state? Would it need to be based
on the co-operation of govt, business, labour
and the communities or not?