Download Three Lectures in Economics by Kenneth Creamer

Three Lectures in Economics
by Kenneth Creamer
Lecture 1:
Introduction to Economic Concepts
and Data
Lecture 2:
Economic Policy and Budgeting
Lecture 3:
Globalisation and South Africa as an
open economy
Lecture 1
Introduction to Economic Concepts
and Data
Introduction to Economic
Concepts and Data
Basic Concepts – what is economics
Measurement and economics
Key South African data
The Human Development Index and choice of
growth path
5. Revision questions
6. Historical political economy of South Africa
1.
2.
3.
4.
Topic 1. Basic Concepts:
What is Economics?
• “We don’t see dogs trading bones” – Smith
• Economics is the study of the processes of
production, exchange and regulation
fundamental to human society
• Human beings specialise => increased
productivity => increased output and =>
dependence on trade
• Interdependent human society where carmakers can buy food, school teachers can buy
cars and car maker’s children can be educated
Who is analysed in economics?
• Major role players in a ‘mixed economy’:
– Households (made up of individuals - provide labour and
consumption)
– Firms (provide organisation and know-how/ technology for
production)
– Government (various tiers offering services and enforcing
laws and regulations)
– Public enterprises (provide goods and services of strategic
importance or that would not otherwise be provided) e.g.
electricity industry, steel industry, etc.
• The factors of production are labour (households),
capital (public and private firms) and land, all of which
operate within the regulatory framework of the rule of
law (government)
What types of tools are used in
economics?
• Conceptual:
– definition of terms and ideas e.g. inflation, balance of
payments
• Historical:
– track trends and changes over time
• Empirical:
– measurement of data, reflecting on concrete experience
• Theoretical:
– developing propositions concerning the relationship
between economic variables e.g. low to moderate inflation
will stimulate economic growth
• Policy:
– actions or policies to guide economic behaviour towards
desired outcomes e.g. “intended consequences” of
expanded social assistance system is poverty alleviation,
also “unintended consequences” (UK window tax)
Defining 10 Key Concepts
1.
2.
3.
4.
5.
6.
Economic Growth
Inflation
Unemployment
Exchange Rate
Fiscal Policy
Monetary Policy
7. Balance of
Payments
8. Stock Market
9. Competitiveness
and economies of
scale
10. Industrialisation
Topic 2. Measurement is
important in economics
“What can be measured
can be changed”
Measuring pure economic data:
e.g. measure quantities e.g. level of output,
value of exports, or value of imports
Measuring levels of human development:
e.g. measures which are ‘indicators’ of
quality of human life, such as, literacy,
health measures, life expectancy, food /
calorie in take
Measuring Economic Performance
(Must be comfortable with large numbers: millions, billions
and trillions: How many people in the world, Size of South
Africa’s GDP…)
Gross Domestic Product (GDP):
Measure of the total output of goods and services produced by a
country’s economy
Gross Domestic Product per capita (GDP per capita):
Total output divided by the number of people in the economy
Example:
If in 2007 the GDP of South Africa is R1 965bn and there are
48,5 million people in South Africa then GDP per capita is equal
to: R1 965bn divided by 48,5 million = R40 515 per person per
year, or R3 376 per person per month
Two complications with using GDP
to measure economic performance
Complication 1:
The value of money changes due to
inflation (nominal vs real GDP)
Complication 2:
GDP per capita is too broad and
unspecific as a measure of human
development – it conceals as much as
it reveals, other measures are required
to track the quality of growth
Inflation and real versus nominal GDP growth
Problem
If inflation is running at 5% (i.e. in general prices rise by 5%) in a
particular year then the nominal value of GDP will rise from
R1 000bn to R1 050bn even though there has been no real
increase in output.
Solution
Nominal GDP is adjusted to take account of inflation and this
gives real GDP.
For example: If GDP is R1000bn in 2007 and is R1 100bn in
2008 then NOMINAL GDP growth is equal to 10%, but if inflation
is at 5% then REAL GDP growth is equal to NOMINAL
GROWTH MINUS INFLATION = 10% - 5% = 5%
Note
REAL GDP GROWTH is the amount by which the value of economic
output has increased as a result of actual growth i.e. after stripping
away the nominal effects of general price increases/inflation.
Real GDP Growth
Measuring human development
GDP – measures economic output / product of a country
GDP per capita – measures average output per person
Problem
GDP per capita indicates an average whereas the reality may be
that the society is divided between the few very rich and the many
very poor. For example, whereas GDP per capita in South Africa
may be about R40 000 per person in reality a few very rich people
have an income of more than R1 000 000 per year and millions of
poor people are living off less than R5 000 per year.
Solution
Economists use a wider range of measures to track human
development and assess social welfare.
Per capita income for rich and poor
Percentage of population living on less then
R3 000 a year (based on year 2000 rands)
Topic 3. Key economic indicators of
South Africa – Know your country better
•
•
•
•
•
•
•
•
Population Growth
Migration Patterns
Racial composition
Size of household
Type of household
Energy used for lighting
Energy used for cooking
Access to piped water
– Source: Stats SA’s
Community Survey 2007, in
which 274 348 dwelling units
in all provinces were visited by
field workers and completed a
detailed survey
• Gross Domestic Fixed
Investment
• Government Debt
• Exports
• Employment
• Unemployment
• Social Assistance
• Tax payers
• Life Expectancy
• HIV Prevalence
• Adult Literacy Rate
• Voter Participation
– Source: Development
Indicators, Mid-Term Review,
2006
Population Growth to 48,5-million
Migration patterns
Racial patterns
Size of households
Type of household
Energy used for lighting
Energy used for cooking
Access to piped water
Gross Domestic Fixed Investment
Government Debt
Exports
Employment
Unemployment
Social Assistance
Tax payers
Life Expectancy
HIV Prevalence
Adult Literacy Rate
Voter Participation
Topic 4 Human Development Index and
choice of growth path
Three specific measures of human development are combined
with GDP per capita to provide a composite measure of human
well-being. Components of HDI:
Life expectancy at birth (years)
Adult literacy rate (% aged 15 and above)
Level of enrolment in educational institutions (%)
GDP per capita (PPP US$)
HDI uses measures of (1) long and healthy life, (2) access to
knowledge and (3) level of income to assess human development.
Selected HDI Data (2006)
Country
Life
expecta
ncy at
birth
Adult literacy
rate
Education
enrolment
ratio
GDP per
capita
Rank
Norway
79,6
99
100
38 454
1
United
States
77,5
99
93
39 676
8
Cuba
77,6
99,8
80
5 700
50
Saudi
Arabia
72,0
79,4
59
13 825
76
South
Africa
47,0
82,4
77
11 192
121
India
63,6
61
62
3 139
126
Nigeria
43,4
67
55
1 154
159
Sierra
Leone
41,0
35,1
65
561
176
Compare SA’s HDI – 1997, 2002 & 2003
South Africa’s 1997
HDI
2002
Life expectancy
at birth
Adult literacy
rate
Educational
enrolment
GDP per capita
63,7 years
52,1 years 47,0 years
81,4%
85,3%
82,4%
81%
93%
77%
$4 291
$9 401
$11 192
HDI rank
90th
107th
121st
2007
Quality of growth
While GDP growth is a prerequisite for human
development. Studies have found that GDP growth does
not always lead to an improvement in the quality of lives of
people (and an improvement in indicators such as life
expectancy and level of education).
Certain problematic types of growth are as follows:
Jobless growth– GDP grows but the number of formal
sector jobs declines and inequality increases (current
trends in SA have tended to follow this pattern).
Ruthless growth – where growth results in increasing
polarisation between rich and poor.
Quality of growth (continued)
Voiceless growth - undemocratic forms of growth with
forced labour and/or banned trade unions
Rootless growth – growth in GDP but people’s cultural
identity is lost (developing countries experiencing forces of
cultural imperialism and not developing their own cultural
industries)
Futureless growth – where GDP growth is environmentally
unsustainable (cutting down forests without replanting, or
depleting coastal fishing stocks)
Summary
• Measurement of trends in society is important to
gauging progress in social and economic
transformation
• The economic method:
– Based on data, theories are developed and policies
implemented in order to move towards desired social
outcomes such as increased GDP growth, reduced inflation,
decreased unemployment, increased incomes for poor
households, reduced child mortality, etc
– activists to ensure that the right issues are highlighted in
economic analysis, issues of human development such as
literacy, household incomes, nutrition, employment, etc.
Topic 5. Revision Exercise – Report
on Economic State of the Provinces
• Population
– In 2007 how many people lived in the province
– Give a % breakdown by race
• Education
– In the 200/01 budget, how much was allocated to education per learner
(compared to the national average of R3 511)
– What is the trend in the province’s matric pass rate from 1994 to 2000
• Health
– What is the trend in the % of women attending antenatal clinics infected
with HIV-AIDS from 1990-99
– What were the two next most serious diseases in the province in 1998
• Housing
– How many houses were built in the province between 1994 and 2000
– To what extent was this above or below target
Group Exercise – Report on
Economic State of the Provinces (2)
• Income
– In 1999, what was the most common income category in the province
– What % of black, coloured, indian and white households live in poverty
(based on 5 person households earning less than R1500per month)
– How does the weighted average of households living in poverty compare
to the SA average of 47,4%
• Unemployment
– In 1999, what % of blacks, coloureds, indians and whites were
unemployed in the province (in terms of the expanded definition)
– How does the weighted average of unemployment in the province
compare to the SA average of 37,8%
• Public Finances
– How much revenue was available to the province in 1999/2000
– What % was from national revenue collection and what % from own
revenue (what are the sources of own revenue)
– IN 1999/2000, how much did the province spend on education, health
and welfare
Topic 6. Periodisation of South
Africa’s political economy
– Verwoerdian apartheid economy
– Reform of the late 1970’s
– Reform of the 1980’s
– Collapse of apartheid
– Post-apartheid economy
Verwoerdian apartheid 1948-1970
• Accumulation Strategy
– Import substituting industrialisation – tariff barriers, R&D,
developed Sasol, manufacturing base (Afrikaner
empowerment)
– Cheap labour policy – homeland system with influx control
and lower wage for migrants, bantu education with low skills
and low pay
• State programme
– Racial domination and ‘racially defined social welfare state’
with white access to education, UIF, housing, etc.
• Conclusion
– Apartheid functional to accumulation strategy i.e. racial
oppression served programme of industrialisation
Crisis of Verwoerdian apartheid (1970’s)
• Apartheid’s racial oppression and exploitation
became dysfunctional to accumulation:
– Manufacturing industry required a more skilled and
settled urban workforce (not only migrant labour)
(such would also provide a market for its outputs)
– Bantustans failed to be self-sustaining and could not
provide subsistence, putting upward pressure on
urban wages
– Black urban work force began to demand rights
(strikes of 1973 turning point)
– 1976 uprising against bantu education system,
(Morris notes that intensified as black urban
population was homogenised with very little
opportunity for upward mobility)
1st Phase of Reform – 1970’s
• Wiehanh Commission – black trade unions limited
trade union rights
• Riekert Commission – black local authorities to be
given greater administrative control
• Vision – boost economic accumulation by allowing a
group of black insiders to settle permanently in urban
areas (increase productivity and serve as a market),
but without any meaningful political rights
• Failed because:
– Black local authorities met resistance as own administration
required increased rentals and service charges
– Black / non-racial trade unions not co-opted, but used
limited space for political protest (Tri-cameral parliament plus
BLA’s met with launch of UDF)
2nd Phase of Reform – 1980’s
• New Urbanisation Strategy – abolished influx
controls and pass laws (end of the ‘grand apartheid’
notion of territorial segregation)
• Reflected demands of capital (business) as inflow
of labour from the bantustans and rural areas
would put down-ward pressure on wages, which
had been pushed-up due to unionisation
• Effect – begun process of de-homogenising urban
black population (e.g. township suburbs vs squatter
camps), linked to the ending of ‘petty apartheid’
such as separate amenities, immorality act
Collapse of apartheid
• Apartheid became dysfunctional to capital
accumulation
• A new economic growth path or new development
path was needed as millions of South Africans were
being structurally excluded from the economy
• Apartheid state was left debt-ridden which severely
handicapped the democratic government’s ability to
spend and increase services to all – therefore a new
macro-economic policy was needed
• A new industrial policy was needed which would
create more employment opportunities, increase skills
levels and increase the level of international
competitiveness
Contestation of Post-apartheid Economy
• National question resolved – “the land belongs to
all who live in it”
• Contestation continues over the most appropriate
post-apartheid accumulation strategy, but a new
hegemony is taking root which is subject to ongoing
contestation from the left and right:
• Characteristics of the new hegemony:
– Mixed economy with reducing role for the state and
commitment to development of the private sector
– Commitment to equal opportunity with a degree of
historical redress (distinct from equality of outcomes)
– Local industry must become internationally competitive
based on low cost inputs and higher degree of skill and
know-how
– Increasing levels of inequality and failure to include the
poor and unemployed
Post-apartheid economy (cont.)
• Contestation from the right:
– Down-sizing of the state
– Increased de-regulation
– Privatisation for ideological rather than service-oriented
reasons
– Protection of historical white privilege
• Contestation from the left:
– Strengthen the role of the state to ensure equitable
development (that all benefit rather than only a few)
– Ensure appropriate regulation e.g. the labour market, the
conduct of monopolies, etc.
– Restructure state assets e.g. telecoms, energy, transport in
such a way as to promote access and social development
– Ensure that issues such as social justice, equality and the
war on poverty dominate state policy making
RDP and GEAR
• The democratic govt’s economic policies were
contested from the left and the right
• The RDP attempted to fundamentally change the
structure of the economy with a policy of ‘growth
through redistribution’ (e.g. large scale housing
programmes and social infrastructure),
• But the fiscal position of the state and its technical
capacity may have been too limited for such a
programme
• GEAR was implemented to promote ‘redistribution
through growth’:
– limit government spending and reduce government debt
– Reduce the role of the state in favour of the capacity of the
private sector
• Key critique of GEAR is that it has failed to deliver
growth and that it has no effective plan to bring in the
historically excluded (60/40 or 80/20 solution)
Lecture 2
Economic Policy and Budgeting
Topics covered in Lecture 2
1. Macro-economic Theory
2. Economic Policy Issues
3. Budgeting issues and processes
Topic 1. Macro-Economic Theory
Y= C + I +G + X - M
C = Consumption is expenditure by households, and
business on goods and services, what is not
consumed is saved
I = Investment is private sector expenditure on capital
goods (e.g. machinery, infrastructure) and Investment
is spent out of that which is saved (through
intermediation in the financial system - banks,
pensions funds)
Macro-Economic Theory(cont.)
G = Government spending on goods, services
and infrastructure is dependent on the taxes
revenue raised plus borrowing (the deficit)
X = Income gained through exports from SA to
foreign countries
M = Income lost due to purchases by South
Africans for imported goods
X - M = Current account of balance of payments
(+ve = surplus, -ve =deficit)
Macro-Economic Theory(cont.)
• Neo-liberal assumption
Reduced government involvement in economy
(G) will lead to a stimulation of private sector
investment (I) i.e. avoid the ‘crowding-out’
problem where government and private sector
competition for savings leads to an increase in
interest rates and a decline in Investment
Note: Private sector seeks greater profits by taking on
formerly public sector activity. And govt seeks to avoid
neutralisation through debt.
Macro-Economic Theory(cont.)
•
Progressive / Keynesian assumption
Increased government involvement (G) leads
to a ‘crowding-in’ or multiplier effect by
increasing levels of consumption by
individuals (C) and levels of investment (I) due
to the fact that government invests in
infrastructure which often serves as a precondition for increased private sector
investment.
Note: Less emphasis is placed on the upward pressure on interest
rates. And government spending must be well targeted to promote
development so that increased future revenues avoid debt trap.
Macro-Economic Theory(cont.)
• Demand side factors (e.g. levels of G, C, I and
X):
- critical to ongoing stimulation of the
economy, especially the role of G given the
inherent instability and lack of co-ordination of
private sector activity
• Supply side factors - (e.g. reduced
unemployment, increased skills levels,
introduction of new technology)
- improvements to the level of employment
and productivity of labour and capital is
crucial to long run economic growth
Topic 2. Economic Policy Issues
•
•
•
•
•
•
•
Fiscal policy
Monetary Policy
Exchange Rate policy
Industrial Policy
Competition Policy
Trade Policy
Labour Market Policy
Fiscal Policy
Expenditure = Tax revenue + Borrowing
Questions:
1. How much tax should be raised and who
benefits? (tax cuts benefit those with income)
2. How much should be borrowed? (lowering or
increasing interest burden for future
generations)
3. How can the tax structure and tax incentives
be used to promote social and economic
objectives? (issues such as tax holidays and
the social impact of taxes like VAT)
4. How much should be spent and on what?
Fig.2 Govt Spending (as a % of GDP)
34.0%
% of GDP
32.0%
30.0%
Govt Spending (as a
% of GDP)
28.0%
26.0%
24.0%
22.0%
1995
1997 1999 2001 2003
Years
2005
% of GDP
Fig.1 Revenue raised as a % of GDP
26.5%
26.0%
25.5%
25.0%
24.5%
24.0%
23.5%
23.0%
22.5%
22.0%
Revenue raised as a
% of GDP
1995 1997 1999 2001 2003 2005
Years
Does SA raise sufficient revenue?
• SA raises revenue of 24,6% of GDP, the 2003 World
Development Indicators revenue to GDP ratios for the
year 2000:
• Czech Republic 32,7 percent,
• Denmark 36,2 percent,
• Finland 32 percent,
• Germany 31,3 percent,
• Morocco 29,6 percent,
• Namibia 32,6 percent,
• New Zealand 30,6 percent,
• Poland 31,1 percent,
• Sweden 39,4 percent, and
• United Kingdom 36 percent.
• Global average for low and middle income countries was
revenue at 17,1 percent of GDP in the year 2000.
Does SA borrow enough?
• After years of reducing borrowing by reducing
the deficit (i.e. spending minus revenue), a more
expansionary policy has been adopted in this
regard with the 2003 MTBPS lifting the deficit to
over 3% of GDP for the first time since the
GEAR framework was announced in 1996
• Question – whether such a restrictive framework
was ever appropriate, given:
– appeared to follow conditionality for very different
circumstances of EU membership (which has now
been rejected)
– global average deficit to GDP ratio for low and middle
income countries was 3,3 percent of GDP in 2000
Fiscal Policy (cont.)
• Policy = fiscal restraint
• Positives:
– Improved ratings by credit agencies, making it
cheaper for govt. to borrow
– Reduction in debt and annual interest repayments
• Weaknesses:
– Government social programmes have been limited
and capacity of state has not been developed
– Investment levels have not risen sufficiently as
‘crowding-in’ rather than ‘crowding-out’ assumptions
would be more appropriate to development
(NOTE: ‘crowding-out’ is said to occur where
government spending pushes up interest rates
leading to reduced investment by the private sector
Monetary Policy
• Policy = Inflation targeting
• Positives:
– Provides a clear purpose for monetary policy (as
opposed to monetary or exchange rate targeting)
• Negatives:
– Setting of low inflation target results in reduced output
“sacrifice ratio” mainly due to the fact that high interest
rates are required to bring down inflation
– IT regime likely to be disrupted by unregulated capital
flows which cause exchange rate fluctuations e.g.
weakening of Rand will lead to imported inflation and
SARB will respond with high interest rates even if internal
situation requires low interest rates, investment and
employment
– IT mandate of SARB not sufficiently balanced to take into
account inflation as well as output and employment
Exchange Rate Policy
• Policy = Free float with liberalised financial flows
• Positives:
– No requirement to use reserves to protect fixed value
of currency
– Should provide inherent flexibility to deal with foreign
shocks e.g. global demand reduced then rand will
weaken making exports cheaper
• Negatives:
– Currency volatility is disruptive to investment
decisions and trade (as well as social implications
e.g. food inflation due to import parity pricing)
– Capital movements have potential to disrupt financial
systems and overwhelm real economic factors during
crises (resulting in recommendations for Tobin taxes
or speed bumps, etc.)
Industrial Policy
• Policy = microeconomic reform
• Positives:
– Focus attention on supply-side factors such as
training, skills and logistics
– Reduced risk of offering support to uncompetitive and
unsustainable industries
• Negatives:
– Insufficient role for state in ‘leading the market’ and
thereby aligning incentives, institutions and other
policies towards strategically targeted industries
– Insufficient role for the state in guiding industry onto a
path of dynamic comparative advantage (as opposed
to static comparative advantage – based on historical
endowments and power relations)
Competition Policy
• Policy = promotion of competition
• Positives:
– Increased legal and institutional credibility for robust
competition policy that regulates corporate conduct
and through merger regulation, market structure
– Allows for public interest in mergers to be taken into
account, including impact of merger on employment
levels
• Negatives:
– No clear policy emerging on pricing practices and at
times collusion, which allows for import parity pricing,
in key markets like food, chemicals and steel
– Result is to limit potential for downstream job creation
that could be assisted by lowering input costs
Trade Policy
• Policy = promote free trade
• Positives:
– Reduced protection for SA industry has assisted
some in becoming globally competitive (even here
ongoing support has been required e.g. automotive
industry)
• Negatives:
– Without tariff protection certain labour intensive
industries, such as textiles, have been damaged
– Assumption that there would be reciprocal opening of
markets (particularly in key sectors such as
agriculture) have not been realised
– Developed countries continue to use free trade
dogma to promote their own interests through
attempts to include issues of investment agreements,
non-tariff barriers and intellectual property protection
Group discussion
• How does economic policy effect society?
• What should be the main goal of SA economic
policy?
• How could the capacity of the state to play a
developmental role be enhanced?
• How would changes in the rules of world trade
impact on workers and their communities?
• What role should SA play in global economic
institutions?
Topic 3 Budget Issues and Processes
•
•
•
•
•
•
•
Basic data and trends in SA govt finances
Arguments regarding deficit and tax policy
Expenditure issues
Case study: Education spending
Tax issues
Local govt
Budget process
Key fiscal trends
(% of GDP)
General govt. tax revenue
Government consumption
expenditure
Individual services
Collective services
Gross fixed capital formation
General government
Public entities
General government saving
Interest on public debt
Gross national savings
Public sector borrowing requirement
1996
1997
1998
1999
2000
24,7
19,4
24,9
19,8
26,0
20,0
26,7
19,4
26,1
18,4
8,7
10,8
9,3
10,5
9,4
10,6
8,8
10,5
8,5
9,9
2,4
1,9
-4,9
6,3
15,8
5,9
2,4
2,0
-4,7
6,1
14,5
5,1
2,4
3,0
-3,5
6,3
14,3
4,2
2,2
2,5
-2,6
6,2
14,6
2,5
2,2
2,0
-1,8
5,9
15,2
1,4
Projected fiscal developments
Nominal GDP
Real GDP Growth
GDP inflator
Tax/GDP ratio
Deficit
Expenditure/GDP
Debt service costs/GDP
Non-interest spending/GDP
Main budget borrowing requirement
(R million)
Foreign
Domestic short term
Domestic long term
2001/02
982,600
2002/03
1,068,600
2003/04
1,155,400
23,8%
2,5%
26,3%
4,9%
21,3%
7 451
23,7%
2,3%
25,9%
4,6%
21,4%
19 472
23,6%
2,1%
25,8%
4,4%
21,3%
19 402
11 305
3 500
-7 354
12 305
4 000
3 167
10 882
4 500
4 020
Government debt declining
Effects of tight fiscal policy
• Inflation has been declining steadily since 1996
• Real interest rates are lower
• Policy certainty and credibility has been established (crucial for any new
govt.)
• From 2001 budget real spending could increase
• Debt service costs reduced
• Room to increase infrastructure spending
• Focus shifts to quality of spending
• Negative – macro-economic stabilisation was achieved at the expense
of addressing the ‘social deficit’ – access to housing, basic services,
quality education, etc. remains limited for the vast majority
Note on pro’s and cons of
foreign borrowing
• Limited foreign borrowing shows confidence
of country
• Brings forex into country, same effect as FDI
– Boosts reserves, stabilises currency
– Allows forward book to be run down
– Relieves pressure on domestic capital markets
– Contributes to lower interest rates
• In the absence of FDI, is a sensible thing to
do
Risks of foreign borrowing
• Risks
– If currency depreciates, interest payments may
increase rapidly
– Interest payments constitute capital outflow
– Large amounts of foreign borrowing strengthens
the currency
• This could harm exports
• Cause Balance of Payment imbalance
Post-Gear what should be
the policy emphasis?
• Govt used Gear to but back spending to
avoid a debt trap, now that this has been
achieved what should be the emphasis of
government policy:
– Cut taxes
– Cut the deficit
– Increase infrastructure spending
– Increase welfare spending
(1) Reducing the tax/GDP ratio
– Considering that few people in formal tax net, tax rates are
too high, Middle income people pay very large proportion
in taxes
– Tax system places too high a cost on production, lower
taxes would boost the economy as this would:
• Lower production costs
• Increase domestic demand
• Boost private savings
• Increase economic growth
• Tax/GDP ratio would naturally rise as economy grows faster,
employment increases
(2) Lower fiscal deficit – continue
to restrict spending
– Deficit of 2% still higher than competitor countries
– Structural weakness of low savings rate still not
fixed - hence real interest rates still high
– Government capacity to spend at present is weak
– A lower deficit of about 1% to 1,5% would
• Contribute to lower risk rating, lower interest rates
• Cushion against a serious recession
• Provide more room to respond to challenges in future
years
• Lower debt service costs - releasing more money for
social spending
(3) Increase spending
(infrastructure)
• More capital spending
– Deficit financed capital spending doesn’t
contribute to lower national savings
– Lean years forced reduction in capital,
maintenance
– Higher capital spending will crowd in private
sector investment
– Social infrastructure is great for equity
– Economic infrastructure lowers costs of
business
(3) Increase spending (welfare)
• Higher welfare spending
– Poverty is actually an obstacle to economic
growth
• Poor nutrition reduces learning outcomes,
increases health costs
– Transport, municipal costs high, resulting in
under-utlisation of infrastructure
– More cash welfare payments would allow
utility markets to work better, attracting
investment
– Govt. capacity to spend on capital is weak
Budgeting: Process
• What is contained in govt’s budget?
– Expenditure decisions
• How much to spend on what items?
– Revenue decisions
• Who to tax and how much?
– Overall macro-economic decisions
• How much debt should the state get into in order to
stimulate the economy
The steps in the budget process?
• Setting policy priorities
– Cabinet sets political priorities for the budget process e.g. from recent years
infrastructural spending, welfare spending or spending on HIV-AIDS
• Fiscal framework is established
– Set revenue target and deficit target (Gear set these at 25% of GDP and 3%
of GDP respectively) to establish the ‘resource envelope’
• Division of revenue
– Vertical : national ! provincial ! Local
– Horizontal : - various departments
• Bidding process
– Govt department approach Medium Term Expenditure Committee and bids
for resource allocations – the value of requests is significantly larger than the
amount available, also an incremental process not a zero-based one
• Cabinet and Cabinet Committee scrutnises the proposed
allocations and approves
• Budget documentation is approved and presented on Budget Day
[ Process runs from June to February, P 143, Naidoo]
Weakness with budgetary process
• The setting of sending, tax and macro-economic policies
is top-down with minimal parliamentary oversight or public
participation
• Currently, Parliamentarians are only in a position to
accept or reject the budget as presented on Budget Day,
no amendment of the budget as presented is possible
• This is despite the constitutional provision that requires
legislation to empower parliament to amend the budget
and other ‘money bills’
• Why? There is concern that after the lengthy process of
drawing up the budget in the executive that Parliament
would delay the budget or propose changes that are
difficult to implement
• Answer? It is important that Parliament should have a real
say in shaping the decisions which effect all South
African’s and the capacity of parliament should be
strengthened to do this in an effective manner, also of civil
society through parliament and Nedlac, etc.
Budget: Spending
• In the budget, government spending is
classified in two ways:
– Functional classification: by government
department e.g. education, health, defence, etc.
– Economic classification: by type of spending e.g.
• Current spending – salaries, subsidies, welfare
transfers
• Capital spending – infrastructure, roads maintenance,
buildings, etc
Projected expenditure in 2003/04 (by function)
Rbn
Protection Defence & intelligence (R19,6bn), police
R52bn
services
(R20,1bn), prisons (R7,6bn), justice (R4,8bn)
Social
services
Education (R66,4bn), health (R33,6bn),
welfare (R36bn), housing (6,8bn)
% of
total
16,8%
R144,2bn 46,5%
Economic water, fuel and energy, agriculture, forests
services
and fishing, mining manufacturing and
construction, transport and communication
R25,6bn
8,3%
General
services
R28,8bn
9,3%
R51,0bn
16,4%
Reserve
R8,8bn
2,6%
Total
R310,3bn 100%
Interest
[down from 4,9% of GDP in 2001 to 4,4% of
GDP in 2003]
Projected expenditure in 2003/04
(by economic type)
Rbn
Current
Personnel (R109,3bn),
R275bn
spending other goods and services
(R40,4bn), interest (R51bn)
Capital
[Note a trend increase in
R26,5bn
spending capital spending from 7,1%
of total in 2001 to 8,5%]
Reserve
R8,8bn
Total
spending
% of
total
88,6%
8,5%
2,6%
R310,3bn 100%
Expenditure Policy tradeoffs
• Should we spend more on personnel?
– Government has serious capacity problems
– In some areas, we need to hire more people, in
others we may need better pay
• Should we spend more on infrastructure?
– Capital spending provides highest economic
returns, but capacity constraints limit progress
– Social infrastructure is good for equity
– Economic infrastructure lowers production
costs, crowds in private investment
Policy tradeoffs
• Should we spend more on welfare transfers?
– Social security well targeted towards poor
– Alleviates worst effects of poverty
– Better nutrition may lower costs in health,
education
– Do we increase child support grant in value or do
we give more people the grant?
– How do we create jobs, avoid a dependency
culture?
Policy tradeoffs
• Within social services
– Do we spend more on health and education?
– Do we expand social safety security net?
– How do we tackle HIV/Aids?
• Access and equity were priorities for past
five years
– How do we begin to improve quality in these services?
• Do we allow higher local and provincial
taxation and borrowing, now that national
government has stabilised public finances?
Reprioritisation – guiding
expenditure
• Reprioritisation from apartheid expenditure
patterns to more equitable service delivery
– From defence to social expenditure (criticism continues
in this area)
– From racially-skewed social services to equitable social
services (challenge is ongoing)
– From current expenditure to capital expenditure as
social infrasturucture is key driver of equitable social
development (must continue to prioritise the
development of human capacity in public service even
though personnel is current expenditure e.g. clinics
need skilled doctors and nurses)
Social issues and govt
expenditure
• Pattern of pro-poor expenditure should prevail
• Gains should not be eroded
– e.g. suggestion that nominal value of the SOAP be
maintained which would have seen a decline in real
terms
• The ‘take-up rate’ of social services must be
taken into account
– e.g. where people have the right to access certain
services such as welfare grants, but the state’s
administrative capacity means only a small % of
those with the right are in a position to exercise it
Pro-poor spending
• The redistributive effect of govt. spending must be
monitored to ensure pro-poor spending
• Key question: how much of government spending
on a particular service gets to poor households
– Strong redistributors – Social assistance such as State
Old Aged Pensions (SOAP), child maintenance, also
housing (Diagram: indicates that 80% of the welfare
grants get to the poorest 60% of households)
– Weak redistributors – spending on education and health
(an FFC study in 1998 found that only 40% of the
country’s schooling budget goes to the poorest 53% of the
population and that 23,4% of these resources benefit the
richest 12,5% of households)
– Non-redistributor – spending on tertiary education benefits
better-off households more than it benefits the poorest
Equity in spending
Cum. % of spending/pre-transfer
income
100%
80%
Pre-transfer income
School education
60%
Tertiary education
Health
Social assistance
40%
Housing
Line of equality
20%
0%
0%
20%
40%
60%
80%
Cumulative % of population
100%
Case study: Education
Historical spending trends
• In 1996/97, education spending went up 22,1% in
real terms
– Mainly personnel driven
– But also large RDP fund capital projects
• Between 1997/98 and 2000/01, spending has
declined by 2,5% a year in real terms
• W Cape, E Cape and KZN saw largest real cuts
• Personnel spending declined by 1,6% a year
• Non-personnel fell by 7,8% a year
• Education fell as share of provincial budgets
Historical spending trends
• During this period of consolidation
– Teacher rationalisation and redeployment
– Improved financial management
– SA Schools Act gives greater powers to parents
• Effect is a much more stable education system in
most provinces
• Budgets are sustainable, cost drivers under
control
• More balance budgets
2000/01
• 2000/01 budget signaled a turnaround
• Education budgets grew by 1,4% in real terms
• Faster growth in KZN, E Cape and N Prov
• Personnel grew by 0,9%, mainly due to once-off
payments
• Non-personnel grew by 5,6% in real terms
• Rationalisation and redeployment process near
completion in most provinces
Medium term projections
• From 2000/01 to 2003/04
– Education spending to grow by 1,5%
– Spending grows strongly in KZN, E Cape, Free
State and Gauteng
– North West and N Cape still see slight real declines
– Capital spending set to grow by 53% a year
– Other non-personnel by 9% a year in real terms
Per learner comparisons
• Provincial average of R3 658 per learner
• N Cape (R4 801), Gauteng (R4 396) and W Cape
(R4 392) amongst highest
• KZN (R3 067), E Cape (3 4 36) and N Prov
(R3453) amongst lowest
• Disparities mainly due to enrolment rates, cost of
teachers and relative priorities
• Most provinces doing well in terms of 85:15 split in
budget
• Poorer provinces still have work to do in this regard
School enrolment
• School enrolment increased from late
1980’s, accelerated from 1994 to 1997
• Enrolment has begun to decline, mainly for
demographic reasons
• Learners number peaked at 12,3 million in
1997, will fall to 10 million in 10 years time
Access to education achieved, how we’re
doing on equity and quality?
Enrolment, pupils and classrooms
School enrolment1
Thousands
Pupil:teacher ratio
Learner:classroom
1996
2000
1996
2000
1996
2000
2 325
2 106
36.3
31.5
55
43
780
743
30.1
31.9
38
33
Gauteng
1 569
1 554
29.2
30.9
34
32
KwaZulu-Natal
2 772
2 669
37.1
35.7
45
40
Mpumalanga
931
894
36.0
34.8
45
48
Northern Cape
204
201
30.2
30.6
32
27
1 823
1 845
33.9
33.5
50
40
North West
946
909
30.2
30.3
40
34
Western Cape
963
916
32.9
30.7
33
31
12 314
11 836
33.7
32.7
43
38
Eastern Cape
Free State
Northern Province
Total
1. Includes both public and independent schools
Teachers and classrooms
• Pupil teacher ratio declined in all provinces
from 33,7 to 32,7
– Eastern Cape 36 to 31
• However, classroom pupil ratio still higher,
due to excess teachers in some provinces
• Northern province has 20% more teachers
than classrooms
• Hence, pupil teacher ratio looks good, but
classes still overcrowded
Overcrowding
Percentage
1996
2000
Eastern Cape
65
52
Free State
25
16
Gauteng
24
26
KwaZulu-Natal
61
48
Mpumalanga
49
56
Northern Cape
16
10
Northern Province
66
50
North West
42
28
Western Cape
16
17
Total
49
41
Source: 1996 and 2000 Schools Register of Needs
Physical infrastructure
• In 1996
– 59% without telephones
– 55% without sanitation
– 40% with no running water
– 60% without electricity
• In 2000
– 34% without phones
– 17% without sanitation
– 34% without running water
– 47% without electricity
• About 25 102 classrooms built since 1996
Maintenance
• In 2000, 15% of all toilets did not work due
to lack of routine maintenance
• School condition categorised as:
– Excellent or good dropped from 11 000 to 5 000
– Schools needing repairs went up from 10 500 to
12 100
– School classified as weak went up from 3000 to
7000
• In 2000, only 1% of all schools under
renovation, this should be closer to 3%
Spending on fixed assets
• Dropped from R1,4 billion in 1996/97 to
R432 million in 1998/99
• Maintenance spending dropped from R232
million to R104 million
• Total spending on fixed assets dropped from
4.5% of budget to 1,6%
– Largest drop in E Cape, from 4,6% to 0,25%
and KZN from 6,8% to 1%
– Gauteng had smallest decline from 3% to 2,8%
Computers, crime etc.
• No. of schools with computers went from
2 241 (8,3%) with 34 483 computers to 6
581 (24%) with 59 333
• In Gauteng, only 16% have no computers
at all
• E Cape, 84% with no computers
• 24 540 burglaries in 2000, loss of R155
million
• 5000 assault cases, 1860 serious crimes
Matric results
Percentage
1997
1998
1999
2000
Eastern Cape
46.2
45.1
40.2
49.8
Free State
42.5
43.4
42.1
52.7
Gauteng
51.7
55.6
57.0
67.5
KwaZulu-Natal
53.7
50.3
50.7
57.2
Mpumalanga
46.0
52.7
48.3
53.2
Northern Cape
63.8
65.4
64.3
71.2
Northern Province
31.9
35.2
37.5
51.4
North West
50.0
54.6
52.1
58.3
Western Cape
76.2
79.0
78.8
80.6
Total
47.4
49.3
48.9
57.9
Matric results
• Impressive increase in pass rates in 2000
• However, 14% drop in candidates writing
– N Prov 35% drop
• No. who wrote maths declined from
50105 in 1999 to 38520 in 2000
• No. passing maths dropped from 27 187
to 24 877
• Same story with science
• Low female take-up of maths and science
Budget: taxation
• Types of tax –
– Direct taxes are levied against a particular
person (natural or jurisitic based on their level
of income, gain or profit, etc)
– Indirect taxes are levied against specific
occurences, events or transactions, etc.
Classification of taxes (cont.)
Direct taxes
Income tax
Indirect taxes
Property tax Commodotiy
taxes
Personal
Death duty Value added tax
income tax
(VAT)
Corporations tax Donations
Customs duty
tax
Capital gains
Property
Import tariffs
tax
rates /
Wealth tax *
Assessment of direct taxes
• Merits
– Certainty: tax payer know ho mush to pay and state can
estimate its revenue
– Equity: direct taxes can be designed to fall more heavily
on the rich based on the principle of the ability to pay
– Elasticity: govt’s revenue increases with increase in tax
rate or increase in incomes of the people (fiscal drag)
• Demerits
– Inconvenience: taxpayers must submit declaration of
income
– Evasion (illegal) prone: as taxpayer can falsify his or her
records
– Can create disincentive to work or save (e.g. if rate is too
high on interest from savings)
Assessment of indirect taxes
• Merits:
– Convenience: indirect taxes are usually paid in small amounts rather
than as large lump-sum, is collected by manufacturers and importers
and is included in the price of purchase
– Evasion is difficult
– Coverage is wide
– Can be used to promote social welfare e.g. increased ‘sin tax’ on
alcohol / cigarettes
– Can target luxury goods with higher rates
• Demerits:
– Regressive: indirect taxes usually fall more heavily on the poor than
on the rich
– Discourage saving: as price of essential commodities increases
(unless zero-rated)
– Uncertainty: authorities cannot accurately predict the total revenue
form indirect taxes as demand for different goods is influenced by
many factors
Social impact of taxation
• Progressive rate of tax
– The rate of taxation increases with an increase in the tax
base
– e.g. the rate of personal income tax in South Africa
increases from around 30% for middle income earners to
42% for the highest earners
• Regressive rate of tax
– A regressive tax places the same obligation on rich and
poor alike e.g. VAT rate, poll-tax
– Key point: A regressive tax takes a declining proportion of
income as income rises
– e.g. a poor household may pay 14% of it income to VAT
(as it spends all of its income on VAT-able commodities)
while a rich household will only pay say 7% of its income
to VAT as not all of its income goes to VAT-able
commodities, but also to savings, etc.
Sources of Revenue in South
Africa (*trend of underestimation)
2001/02 (Rbn)
2002/03 (Rbn)
Taxes on income and
profits
131 682
143 641
Taxes on payroll and
workforce
2 800
3 000
Taxes on property
4 709
5 127
Domestic taxes on
goods and services
VAT
86 705
92 673
Taxes on international
transactions
9 427
10 792
Stamp duties
1 585
1 726
Total
236 808
256 959
Budget: local government
•
Sources of local govt. finance (rounded-off)
–
65%: Fees from payment for services e.g. water and
electricity, etc
–
20%: Rates – tax on property
–
5%: RSC levies
–
10%: Inter-governmental transfers (equitable share pluscapital
grants channeled through the Consolidated Municipal
Infrastructure Programme)
Controversies:
Challenge that share from inter-governmental transfers is
inadequate to fund the necessary developmental programmes
of local govt (about 3% of national tax revenue) – leading to
problem of ‘unfunded mandates’
2) Results in persistent inequality amongst local govts e.g. urban
vs rural as rural structures have limited own revenue potential
Analysis of local govt revenues
• User charges for services such as water, electricity and refuse
removal
– Cost recovery is important to the sustainability of the service,
councils require accurate reliable billing systems
– A minimum amount of water, electricityetc. must be made
available to sustain life
• Property taxes (rates): property owners pay on the basis of their
revenues (potentially significantly progressive tax)
– Ensuring correct valuation of properties (certain areas not revalued for many years)
– Require entrenched system of regular aluation
– Bring untaxed areas into the tax net
• Regional Service Council levies: tax on companies’ payrolls
– Regarded as disincentive to employment, but continues as a
source of revenue
• Inter-govt transfers i.e. transfers from national revenue fund
to local govt. decided in the national budget process (with
active input from Salga and the local authorities)
– Campaign for increased resource allocation for local govt.
– Concern from Treasury that such transfers will be used to fund the
operating expenses of ineffective local govt bureaucracies that will fail
to target the poor and provide services
• Borrowing by local Government
– Potential exists for local govt to engage in borrowing e.g. through the
issueing of local govt. bonds, but first track record of good financial
management should be established
– Central govt concerned of inheriting any bad debts
• Concessional finance
– Make use of public sector financing bodies such as the DBSA to fund
local govt. infrastructural projects on a concessional basis (i.e. on
more favourable terms than bank loans)
– Also develop technical skills and know-how in such bodies, regarded
as a ‘knowledge bank’
Principles of local govt. finance
•
•
•
•
•
•
Revenue adequacy and certainty
Sustainability
Effective and Efficient Resource Use
Accountability and transparency
Equity and redistribution
Investment and development
Integrated Development Planning (IDP)
• IDP’s enable communities to align their financial and institutional
resources with agreed plans and policy objectives
• IDP planning process:
– Prepare a workplan
– Outline vision / statement of intent
– Development framework: Outline what services are to be
delivered e.g. refuse removal, water, electricity,
– Development strategies: how is this delivery to take place
– Operational planning: implementation
– Monitoring, evaluation review (e.g. look at impact on HDI in the
local govt’s area)
Note: to succeed requires community involvement at all stages
of the process
Review glossary
Lecture 3
Globalisation and South Africa as an
open economy
Topics covered in lecture 3
1. Theoretically – what are the pro’s and con’s
of international trade
2. How open is the South African economy –
understanding the Balance of Payments
3. The dynamics and effects of exchange rate
fluctuations
4. Group Exercise
5. Historical evolution of global financial system
6. Policy issues on a domestic and global level
Topic 1
International Trade –
Pro’s and Con’s
Theory of international trade
• Advocates of free trade – “trade is an engine of
development”
– Theory of Comparative advantage – countries who
can produce goods must efficiently should specialise
in production of such goods for export and will then
use revenues to purchase imports that cannot be
produced efficiently (dynamic not a static notion)
– Economies of scale – larger production runs allow
cheaper production cost per unit, therefore trade
creates efficiencies as production is for export and is
not just confined to domestic market
– Mutually beneficial gains from trade for all countries
Theory of international trade (cont.)
• Trade pessimists – “free trade will not promote
development and may even serve to entrench
inequalities”
– It has been argued that there is an “absorption problem”
i.e. if all developing countries attempt to develop
through promoting exports there would not be sufficient
demand to absorb these exports (‘fallacy of
composition’)
– Problem of market access – advanced countries protect
‘grand-father’ industries (e.g. US steel) and subsidies
local suppliers (e.g. European food security)
– Free trade disallows LDC’s from promoting there own
industries (e.g. through import substitution strategies),
lack of access to new technology, etc.
• Need a balanced view on international
trade:
– Positives:
can serve to promote development through
increased efficiency, increased access to
technology and access to larger markets
– Negative’s:
trade focus should not substitute for national
development strategies, and should not
undermine policy needed to promote dynamic
comparative advantage (promoting new
industries) i.e. state can lead the market
towards winning industries
Topic 2
How open is the South African
economy?
How open is the South African economy?
• There are two key economic flows which
measure the extent of “openness” of an
economy (or the degree to which the
economy is integrated into the global
economy)
• Firstly, the flow of imports and exports
(trade in goods and services) referred to as
the Current Account of the Balance of
Payments
– SA in 1994 imports and exports = 41% of GDP
– SA in 2000 imports and exports = 49,5% of
GDP
Openness of the SA economy
• Secondly, the flow of financial resources (people’s
savings seeking good returns) referred to as the
Financial Account of the Balance of Payments
– Financial accounts (previously known as capital
account) are relatively more volatile as certain financial
flows or ‘hot money’ flows (such as portfolio
investment) move rapidly than trade in lumpy goods
and services
• Note: Portfolio investment is usually short-run investment in
financial assets e.g. shares / equities and bonds
• Foreign Direct Investment (FDI) is long-run investment in real
assets e.g. land, plant and machinery
Balance of Payments
• BoP – summarises a country’s foreign
economic transactions
– Current Account
• If imports > exports => deficit on current account
• If exports (+ve) > imports (-ve) => surplus on
current account
– Financial Account
• If financial inflows (+ve) > outflows (-ve) => surplus
on financial account
• If outflows (-ve) > inflows (+ve) => deficit on
financial account
BoP (Reserves as balancing entry)
• If there is a net surplus in both the current
account and financial account, then there will be
a increase in the country’s holding of FOREIGN
EXCHANGE RESERVES
• If a deficit on the current account is not off-set by
financial inflows (i.e. a surplus on the financial
account, there will be a decrease in the country’s
holding of FOREIGN EXCHANGE RESERVES
• Example: United States is a ‘net borrower’ as it
sustains its persistent current account deficit
with large capital inflows as investors ‘fly to
quality’
BoP (Reserves Cont.)
• Foreign exchange reserves are the amount of
foreign currency which Central Banks (Reserve
Banks) hold on behalf of the country
• SA holds reserves in US Dollars, Japanese Yen,
British Pounds, Euros and gold
• Measure of whether enough Foreign Exchange
Reserves are held = how many weeks worth of
imports could your reserves pay for
• Example: SA had enough reserves to pay for
only 7 weeks of imports in 1996, in 2002
reserves were sufficient to purchase 20 weeks
worth of imports
• Minimum recommended amount of Reserves =
value of 12 weeks of imports
Topic 3
The dynamics and effects of
exchange rate fluctuations
Current Account
Capital Account
Years
2000
1994
1988
1982
1976
1970
1964
1958
Reserves
1952
120000
100000
80000
60000
40000
20000
0
-20000
-40000
-60000
1946
Rands millions
Balance of Payments 1946 - 2004
The dynamics and effects of
exchange rate fluctuations
• International trade and investment takes place in
a world with various currencies
• Example:
– SA resident buys a German car in Rands, but
German car manufacturer will expect to be paid in
Deutsch Marks
=> Rands will be used to buy Deutsch Marks
=> There is a Supply of Rands and a Demand for
Deutsch Marks
If there is an increase in the Supply of Rands and an
increase in the Demand for Deutsch Marks – the price
of Rands will decrease and the price of Deutsch
Marks will increase
Exchange rate dynamics
• The Rand weakens if we have to use more
Rands to buy a single unit of a foreign
currency
e.g. the Rand weakens from R8 to the US$ to
R9 per US$
• The Rand strengthens if we can use less
Rands to buy a single unit of a foreign
currency
e.g. the Rand strengthens from R8 to the US$
to R7 per US$
Exchange rate dynamics
• Question:
What causes the Rand to either strengthen or
weaken?
• Answer:
A complex interaction of supply and demand forces.
• How does this work:
If the Demand for Rands increases relative to Supply
(i.e. the Supply of Foreign exchange increases) then
the Rand will strengthen
If the Demand for US$ strengthens (i.e. the Supply of
Rands increases relative to Demand) then the Rand
will weaken
Exchange rate dynamics
• What are the key drivers of the Demand for
Rands (Supply of foreign exchange) leading to
STRENGTHENING of the Rand:
– Exports of goods from SA bought by foreigners.
Positively dependent on South Africa’s
competitiveness, on access to developed markets, on
the state of the world economy / trading partners.
– Financial account inflows where foreigners invest
their savings in SA either in FDI (real assets) or in
portfolio investments (financial assets).
Positively dependent on sentiment about South
Africa’s short, medium and long terms economic
prospects. Negatively effected by lack of confidence
– where perception is as powerful as reality.
– Tight Monetary Policy – high interest rates (attracting
financial inflows), low inflation rate
Exchange rate dynamics
• What are the key drivers of the Supply of Rands
(Demand for foreign exchange) leading to
WEAKENING of the Rand:
– Imports of goods from overseas. SA dependent on
machinery and technology imports. As SA economy
grows there is an increase in imports of such goods.
– Financial account outflows where South Africans invest
their savings overseas due to diversification and
negative sentiment. Exchange controls limit the extent
to which such outflows can occur – so called ‘blocked
rands’.
– Loose monetary policy – low interest rates (less
attractive to financial inflows, unless stimulatory of
growth) and high inflation
Effects of Exchange Rate
Fluctuations
• In general, volatility (meaning both rapid and
significant strengthening or weakening of the
currency) –
– leads to uncertainty amongst potential investors and
people setting prices in the economy, resulting in slower
decision making and placing limitations on growth, with
negative impact of employment and growth output
– currency becomes target of speculative activity, as
‘reversion to mean’ theory creates speculative
opportunities
– preferable to have gradual adjustments in currency value
in order to foster a greater degree of certainty, but
attempts to protect or fix value of the currency are limited
by amount of foreign currency reserves and limited
forward borrowing
Effects of Exchange Rate
Fluctuations
• Theoretical effects of strong currency:
– Weakens export performance (as cost of
exports to foreigners is relatively high
– Local manufacturers face external competition
and usually lobby for protection
– Induces capital flight as devaluation is
anticipated
– Efforts to defend currency (e.g. through high
interest rates) can led to recession
Effects of Exchange Rate
Fluctuations
• Theoretical effects of weak currency –
– Improves export performance (as exports become
cheaper to foreigners)
– Local manufacturers enjoy a degree of protection as
cost of imported goods rises
– Effect on capital movements is uncertain and
depends on expectations of future currency
movements
– If less emphasis on protecting currency, then
monetary policy will focus on containing inflation and
is less likely to result in tight/high interest rate policies
inducing recession
Effects of Exchange Rate
Fluctuations (in practice)
Empirical studies show that real economy
factors do not move as rapidly as prices
movements i.e. price movements are
continuous, whereas real economy decisions
are discontinuous :
For example: Let us ask:
In reality, how do exports and imports respond
to a currency devaluation?
Effects of Exchange Rate
Fluctuations (in practice)
• Because real economy decisions take longer it
takes 2-3 years (empirical studies have shown)
for a currency devaluation to result in a situation
where the value of exports increases and the
value of imports declines (volume effect
dominates price effect)
• For the first 6 months after a devaluation (price
effect dominates volume effect) the deficit on the
balance of payments is likely to increase as
importers are paying more for imports (and there
are no domestic substitutes) and exports have
not increased (as external markets have not
been found) – the J-curve
Effects of Exchange Rate
Fluctuations (in practice)
• Two aggravating factors:
• If volatility disturbs these factors (if the currency
strengthens after an initial devaluation) then
decision makers will not be able to sustain gains
in export markets
• Also, if due to structural factors, the devaluing
economy is not in a position to access export
markets and/or is not able to generate import
substituting technologies then the a devaluation
may experience a ‘prolonged trough’ of current
account deficit intensification
Effect of Foreign Shocks
• Negative foreign shock
Such as oil price increase, recession in trading partners,
negative sentiment, limitations market access
E.g.1. effect of increase in oil prices will be increased
inflation as SA is dependent on imported oil, put
downward pressure on value of the Rand as our
imports will be more costly increasing out demand for
foreign currency
E.g.2. recession in US/EU trading partner or limitation of
access to these markets will lead to increased exports
from SA will have a positive effect on jobs and growth,
will lead to increase in demand for Rands and
therefore upward pressure on Rand currency value
Effect of Foreign Shocks
• Positive foreign shocks
Such as a gold or platinum price increase, or a free
trade agreement increasing market access to
developed markets
E.g.1 Increased gold/platinum price will lead to
increased investment and employment in the mining
sector, and increased demand for Rands and will tend
to strengthen the currency
E.g.2. Increased market access could result in
increased exports, leading to an increased demand
for Rands and will tend to strengthen the currency
(remembering that reciprocal agreements or
asymmetrical reciprocity as with the EU FTA will
dampen these effects due to increased demand for
Euros and European goods)
Topic 4
Group Exercise
Group Exercise on International
Economics
Format
• Television panel discussion on the following topics, with
Interviewer asking questions of representatives of each
of the constituencies present, including:
• Government
• Labour
• Industry
• Unemployed
• Reserve Bank
• Foreign investor
• Each group to consist of seven (7) members i.e. one
interviewer and six panelists.
Group exercise (cont.)
Topics
(1) The strengthening Rand – good or bad for South Africa?
• Ask each constituency:
• (1) what they believe to be causing the strengthening of the Rand,
and
• (2) how they think the strengthened currency will impact on the South
African economy as a whole, including inflation, the quantity of
imports and exports, economic growth and job creation?
(2) The weakening Rand – good or bad for South Africa?
• Ask each constituency:
• (1) what they believe to be causing the weakening of the Rand, and
• (2) how they think the weakened currency will impact on the South
African economy as a whole, including inflation, the quantity of
imports and exports, economic growth and job creation?
(3) War in the Persian Gulf has seen the oil price rise to over $36
per barrel – what does this mean for South Africa?
• Ask each constituency:
– how the increase in the oil price will effect their particular interest
– how the increase in the oil price will effect the South African economy as
a whole, including inflation, the value of the rand and economic growth
Group exercise (cont.)
(4) Global uncertainty has led to a sharp increase in the gold price
to over $400 per ounce – what does this mean for South Africa?
• Ask each constituency:
– how the increase in the gold price will effect their particular interests
– how the increase in the gold price will effect the South African economy as a whole,
including the value of exports, the value of the rand and economic growth
(5) As a result of the development round of WTO talks, the European
Union has announced that it will be opening up its market for
agricultural goods – what benefit will this have for South Africa?
• Ask each constituency:
– how the increase in agricultural market access will effect their particular interests
– how the increase in agricultural market access will effect the South African economy
as a whole, including the quantity of exports, the value of the rand and economic
growth
(6) The United States has announced that it will be closing its
market to South African steel exports in order to protect
American jobs – what effect will this have on the South African
economy?
• Ask each constituency:
– how the closure of the US steel market will effect their particular interests
– how the closure of the US steel market will effect the South African economy as a
whole, including the quantity of exports, the value of the rand and economic growth
Topic 5
Historical evolution of Global
Financial System
Historical Developments in the
Global Economy
(1)The functioning and demise of
the Bretton-Woods system of
fixed exchange rates
(2)The East Asian crisis
(3)Looking-back at the apartheid era
balance of payments constraint in
the SA economy
Major trends
The past decades have seen major
changes to the international monetary
system, particularly:
– shift from fixed to floating exchange rates
regimes (study: collapse of the fixed
exchange rate system in the 1970’s)
– significant increase in private lending and
capital flows (study: destabilising effect of
capital flows in the East Asian crisis of late
1990’s)
(1) Bretton-Woods system
• Gold standard - where all currencies were
exchangeable for a fixed amount of gold had been
blamed for deflation (Great Depression) (where high r
was used to attract investment and maintain
reserves)
• Post WW2 imperatives addressed by B-W:
– maintain currency stability to promote international
trade and avoid destabilising speculation
– allow for adjustments in currency where ‘fundamental
disequilibira’ occur e.g. persistent BoP deficits, so as to
avoid pursuit of disinflationary policy (increase in r) or
barriers to trade (high tariffs on imports)
(1) Bretton-Woods system (cont.)
• Operation of B-W ‘fixed but adjustable’ system:
– exchange rates fixed (oz of gold = $35, all
others to the $ and allowed to fluctuate by
1%)
– exchange rate adjusted if ‘fundamental
disequil.’ but not by more than 10% and only
with IMF permission
– IMF also provided conditionality-based ‘credit
facilities’ to countries with BOP problems (to
avoid deflation and barriers to trade)
• Collapse of B-W fixed/adjustable
system:
– $ became overvalued and US experienced
unsustainable BOP deficit, speculators moved out
of the $ knowing it would have to be devalued
(and other currencies strengthened)
– US $ liabilities > gold holdings (and CB’s agreed
not to sell ‘official gold’ for higher price on private
market)
– therefore, US unilaterally announced $ no longer
convertible to gold, imposed 10% tariff on imports
and called on other countries to revalue currencies
(to improve US competitiveness, BOP)(1971)
– From collapse of B-W, a system of floating
exchange rates evolved
• Explanations of the collapse (cont.)
– lack of adjustment mechanism: US could not
devalue $ against gold because (1) confidence in
entire system would be undermined, (2) US
competitiveness (BoP problem) would not be
improved as other currencies fixed to the $ (3) US
did not wish to increase r and risk recession, and
(4) other countries did not wish to show weakness
(devalue) or lose export advantage (apprec.)
• Post B-W (currency turmoil in the
1990’s):
– “technology, innovation, free capital mobility and
investor’s desire for international diversification…
increase vastly the potential for shifting large
amounts of financial capital around the world and
across currencies at great speed …(leading at
times) to foreign exchange market crisis” (BIS, 1994,
after speculative attacks on pound and other EU currencies)
– in post B-W “non-system” there are a wide range
of exchange rate regimes from free-floating to
pegged arrangements: problem of destabilising
volatility and crisis from time to time, as result
various proposals for reform of global financial
architecture
Post B-W reform proposals
Proposed reform measure
Williamson' Set exchange rates for
s target zone sustainable BoP and allow for
Critique
No agreement on
methodology to
periodic adjustment, fluctuate establish ‘sustainable
in soft 10% bands to avoid 'one exchange rate’
way bet'.
Will not rule out
major exchange rate
swings.
McKinnon's Allow for changes in level of
Currency switching
global
national money supply as
in portfolios is not as
monetary
investors adjust mix of
prevalent as
target
currencies in their portfolio.
switching between
Non-sterilized interventions
domestic and foreign
would assist appropriate
bonds. Sterlized
adjustments to money supply interventions would
and lessen volatility.
assist in stabilising
money supply.
(1) Post B-W reform proposals
Proposed reform
Tobin Tax Exchange rate volatility is
Critique
- Certain s-r capital
caused by destabilising short movements are desirable
run capital flows responding and assist in stabilising
to (small) movements in
currencies through
domestic interest rates.
increasing liquidity,
Therefore, a small tax on all
breadth and depth of
foreign exchange transactions markets.
would reduce the incentive for - Tax would be
speculators to frequently
circumvented through
move capital in response to
development of new
small changes, without
instruments.
greatly interfering with long - Would national policy
term flows.
autonomy (such as
reduction in r) be wisely
used without discipline
of exchange rate
movements
2) East Asian crisis
• Nature of the crisis:
– banking and currency crisis
– not a crisis of macro-economic
mismanagement (typical of private to public
Latin American debt crisis of the 1980’s), but
based on private to private capital flows with
failure of proper public regulation and industry
self-regulation
2) East Asian crisis (cont.)
• Causes of the crisis:
– surge in capital flows and integration of global
markets outpaced building of domestic institutions in
East Asia to properly supervise and regulate the flows
– banking system borrowed in $, engaged in poor
quality lending in local currency, based on cronyism
and doubtful collateral, and failed to take into account
currency risk (i.e. how to repay borrowing in event of
significant currency depreciation e.g. collapsing of
bhat/$ peg)
2) East Asian crisis (cont.)
• Strategies to prevent crisis (World Bank, 1988) incl:
– financial sector supervisory capacity should precede
liberalisation
– emphasise best practice in corporate governance,
accounting standards, etc
– transparent bank ownership to avoid ‘connected
lending’
– should consider depositor insurance schemes to limit
negative externalities
– should consider - lender of last resort (IMF credit line),
especially important in avoiding panic and contagion
effect, but may result in moral hazard i.e. promote
excessive risk taking by private corporations who no
that the cost of their failure will be ‘socialised’
(3) SA’s apartheid era BoP constraint
• SA’s position in the ‘international division of
labour’ - exporter of raw materials, importer of
manufactured goods & equipment
• BoP constraint: imports (and GDFI due to
machinery requirement, fig. 5) are pro-cyclical
i.e. growth results in inc. in M putting pressure
on the current account of the BoP, therefore:
growth is limited by BoP constraint, unless (1)
foreign borrowing or K inflows (which extend
period over which BoP deficit to be repaid, after
B-W), or (2) sustained increase (& changed
composition) of X
SA’s apartheid era BoP constraint
• Responses to current a/c shock (e.g. gold price down)
– deflationary policy (reduce consumption and inv e.g.
through increase in r), or
– depreciation (reduce M if they are price elastic),
– increase barriers to imports (tariffs and NTB’s)
• Responses to capital account shock (e.g. political
crisis)
– deflationary policies leading to reduction in
investment, increase in saving (through rise in r)
– depreciation to limit outflow of capital, but can be
counterproductive if debt is $ based
SA’s apartheid era BoP constraint
• Differential impact of exchange rate depreciation
(flexible exchange rate system) in SA in 1980’s
– benefits mining sector, esp. if commodity prices are
falling
– harms manufacturing sector - due to increase cost of
inputs, but outputs are more competitive, also volatility
disrupts rels. with export markets
– real exchange rate depreciation means cost of imports
increasing more than wages (inflation) indicating a
decline in real wages
– debt servicing effect - increased rand value of $ based
debt
Topic 6
Policy Issues
5. Policy issues on a domestic
and global level
• Trade in goods and services
– International level:
• Free trade and Fair trade
• Race to the bottom vs labour rights and environmental standards
• Access to protected markets for LDC’s especially in agri goods and
steel (multilateralism and regional ‘butterfly strategy’)
• Issue of developed world subsidisation of industries and agriculture
– Domestically:
• retain domestic capability to conduct industrial policy, ‘active tariff
policy’ and promotion of national bourgeoisie through preferential
incentives (vs Multilateral Agreement on Investment)
5) Policy issues (cont.)
• International Financial Flows:
– International level:
• Create incentives for long run FDI and
disincentives for destabilising ‘hot money’ flows
e.g. Chilean time-requirement (financial flow must
remain for at least one year)
• Tobin tax on foreign exchange transactions
– Domestic reforms:
• Prudential financial regulation