SA's choice: Crisis or reform?

Jonathan Katzenellenbogen writes on the implications of the recent World Bank report

A deep sense of foreboding is gripping prominent South African commentators and many in business.  

Last week Hermann Giliomee, writing on PoliticsWeb pointed to the failure to deal with the country's deepening economic problems due to policy indecision, lack of inclusion, and a runaway state. Later in the week commentator Max du Preez writing in Moneyweb said SA was facing a "perfect storm" and  "Tunisia Day" could occur a lot sooner than in 2020.

That is the year in which Moeletsi Mbeki, who coined the term "Tunisia Day", said more to make a point than predict, that a mass uprising against the ANC would occur. In his February 2011 article in Business Day, Mbeki wrote that in 2020, China expects its minerals intensive industrialisation to end and hence its imports from South Africa would collapse. This in turn would bring about a fall in SA's tax revenue and cuts in social grants, which would light the fire of an uprising.

Things might not be so drastic yet, but a World Bank report warned last week that government no longer has the cash to expand the grant system. The warning is also that government no longer has room to use grants to cover up for poor economic policies that are struggling to create growth and jobs on a sufficiently large scale to sustain welfare payments.

The report was couched in more diplomatic terms and bore a headline acknowledging that ANC policies have lifted 3.6 million South Africans out of dire poverty. But now the "fiscal space for more redistribution is limited due to the high fiscal deficit and debt."

According to the Bank report "South Africa Update: Fiscal Policy and Redistribution in an Unequal Society", transfers have caused the poverty rate to fall from 46.2 percent to 39 percent. A recipient in the poorest 10 percent of the population with an annual income of R200 could benefit from as much as a tenfold increase in income from cash transfers.

Grants reduce SA's income Gini coefficient, a measure of inequality with 0 representing equality of all and 1 showing one person as the only earner, by almost a quarter. Before tax and social spending the Gini Coefficient is 0.771 and after it is reduced to 0.596. This reduction in inequality through tax and spending is larger than in any other country. 

The sheer number of those dependent on grant cash transfers mean that grants are politically unassailable even if a government is ultimately forced into making severe cuts in its spending. Even if cuts are forced by, say an IMF programme, grants and certain services might well be protected by Section 27 of the Constitution which guarantee the right to healthcare, sufficient food and water, and social security. That is not to say that inflation could not erode their real value.

About 30 percent of the population receives grants. The number receiving social grants in SA has nearly doubled over the past decade from almost 8 million in 2003/04 to 15.8 million in 2013/14. According to the Bank's report this doubling in spending on grants was mostly due to raising the age limit of the child support grant, from 7 to 18 years of age. A drop in the age at which the poor the old age grant can be received, from 65 to 60, also forced up spending.

South Africa's system of grants, free basic services and healthcare and education for the poor make the country a unique welfare state for a developing country.

SA is doing more by way of tax and government spending to lower poverty and inequality than any other developing country. The 3.3 percent of GDP spent on all direct cash grants in 2010/11 - the most recent year in which comparative data was available, is more than twice the median spending on this sort of transfer across developing countries.

In 2010/11 government spending was 32.2 percent of GDP of which 17.6 percent of GDP was spent on social services. Grants in the form of cash transfers make up 3.8 percent of GDP.  Other free services of electricity, water, and sanitation for the poor cost about 0.5 percent of GDP. In kind transfers like education spending amounting to 7.0 percent of GDP and healthcare 4.1 percent, and that on housing 1.5 percent. They are well targeted but healthcare and education care are not efficiently delivered, says the Bank.

"If South Africa is to make further reductions in poverty and equality it will be important to have more inclusive job intensive growth," says Catrona Purfield, the World Bank's Lead Economist on SA and a co-author of the report.

The South African economy simply cannot support continued expansion of grants and free services. Real GDP growth declined from a post crisis peak of 3.6 percent in 2011 to just 1.9 percent in 2013 and to 1.3 percent year on year in the first half of this year.

The Bank says the slowdown since 2011 is mostly due to own goals. Prolonged strikes by platinum miners, then metal workers, the electricity shortage, transport problems and the skills shortage.

With the slowing economy has come pressure on tax revenue. "Fiscal space has declined, and the slowdown in growth has placed public finances under pressure. The gross stock of public debt stood at 45.9 percent of GDP at end-2013/14 up almost 10 percentage points since 2010/11. Revenue collections are expected to fall short of the budget target," the report says. The Medium Term Budget Policy expects a sizeable deficit of 4.1 percent of GDP this fiscal year, 2014/15, which it hopes to reduce to 2.5 percent over the following two years.

One of the reasons given by Moody's for cutting the country's credit rating is that, "recurring fiscal deficits combined with weak growth will lead to a continued rise in gross debt to nearly 50 percent by 2017/18, according to official forecasts." The fast rise in debt has made interest payments the fast growing budget item.

In its Medium-Term Budget Policy Statement last month the government said the main risks to the outlook are economic performance, the public sector wage bill and the balance sheets of state owned enterprises. Fast public sector jobs growth has driven up the civil head count and government will ultimately have to face down public sector unions to curb wages.

Another reason for the Moody's downgrade was that "structural weaknesses are meant to be addressed in the National Development Plan, but will likely hold back growth for a number of years."

Moody's also does not see much to drive growth in the economy. It expects energy availability "to remain challenging until at least mid-2017" when new generation capacity will come on stream. As SA exports are highly energy intensive, shortfalls in energy will mean the current account deficit will remain at relatively wide levels of around 5.5 percent of GDP for several more years. Moody's is also concerned about the poor state of industrial relations and the absence of labour market and education reforms that could improve growth prospects

The World Bank often plays an astute political game in pushing a reform agenda. It leaves room for interpretation as part of a process of trying to get locals to discuss and to buy into the need to confront economic problems.

Inequality is an issue high on the international agenda and SA remains a grossly unequal society. Thomas Picketty in his book "Capitial in the Twenty-First Century" published earlier this year has thrust the issue to fore. This report is the World Bank's take on the subject in the SA setting.

The World Bank's message to government and the Economic Freedom Fighters is in short "get real" as the money is running out. The message might also be aimed at the local proponents of the SA version of the "developmental state" in and outside of government.

The message clearly aimed at government is that you simply cannot afford to do more with state spending, other than to drastically improve the quality of health delivery and education.

And there might well be an addendum to this message - don't try and expand government expenditure to further bolster electoral support  - we have seen this sort of thing many times before all over the world and it has inevitably led to ruin.

Looming crises often force reform. Might this one bring about reform, or will the core ANC constituencies behind the ANC - state employees and the unions see to it that reforms does not happen. 

With the sort of fiscal pressures the government is now under, the environment is now open to key policy changes or a prolonged crisis.

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