NEWS & ANALYSIS

The economy: Adapt or die (III) – The long term

Charles Simkins proposes initiatives for the longer term

The economy: Adapt or die (III) – The long term

11 July 2019

INTRODUCTION

 The distinction between the medium and long term is fluid. Some of the initiatives proposed for the medium term will spill over in to the long term, and preliminary work on long term measures can be started in the medium term. The latter is true for the four initiatives proposed here.

1. Maximize the contribution of the mining sector to the economy. Development of the South African economy started with mining, considerable deposits remain for potential exploitation, and promising parts of the country have yet to be prospected adequately. Moreover, mechanized mining has the potential to extend mine life, by allowing greater access to deposits and reducing the cutoff grade (the grade below which it is not feasible to mine deposits).

 The extent of mining activity depends heavily on the regulation and taxation of mines. While the final version of the current Mining Charter rectified some of the most egregious aspects of the first draft, it is far from grappling with all the issues surrounding the state off take from the mining industry. In particular, the approach to mining taxation should be considered in the light of optimal contract theory, the parties to the contract being the state and mining companies. The state’s objective is, or should be, the maximization of the net present value of social benefits from mining while the objective of mining companies is to maximize the private return of capital invested. For mining contracts to exist, the conditions for both parties to participate must be satisfied. At present, there is simply too little consideration by the state of what is needed to obtain the participation of mining companies over the long term.

 The irrelevance of sunk costs to current decisions - whether or not to continue operating - means that the state can tax existing mines to the point where short-run operating costs are just covered by revenue. But taxes at those levels will choke off new mining investment, since prospective investors will not invest without seeing a return on their capital spending. The net present value of social benefits provides the criterion for trading off between the present and future, once a social discount rate has been established1. There is no evidence that the criterion is being applied in the Mining Charter or in any other determination of state off take.

It will be easier to obtain mining investor participation if the taxation regime is stable. Instability raises risks and, in so doing, required target rates of return, reducing new investment. Moreover, the commodity price cycle make returns variable so that the state off take should come from the bottom line rather than the top. It is no accident that industry concerns about the first draft of the current mining charter were precisely about these points: shifting goal posts and a proposal (deleted in the final version) about a tax on revenue. And finally, given that there is an optimum level of off take, loading more imposts on the industry through the charter should be matched by lower levels of royalties and/or corporate taxation. Quite apart from negotiations around any future version of the mining charter, consideration needs to be given about the basis for future expansion of the mining industry. Outcomes will depend, in part, on how bold the industry is prepared to be.

 2. Reform the public service. The functions of the public service are to administer the state in accordance with law and to serve as a repository of expertise. A patrimonial public service cannot underpin economic growth: it fails to recruit the best available human capital, it undermines institutional integrity, and it invites corruption. “If you want to see his monument”, runs the tribute in St Paul’s Cathedral in London to its architect, “look around you”. Here and now, the devastating consequences of patrimonialism are likewise visible.

Three reforms are needed. First, recruitment into entry level administrative positions should be determined by performance in a competitive examination. Secondly, the instability at the top of the public service needs to be tackled, particularly the propensity of new ministers to squeeze out existing directors-general in order to install pliant new ones. Thirdly, the capacity of the public service to resist criminal conspiracies must be strengthened. There have been reigns of terror in parts of the public service to coerce officials into actions which they know to be illegal. Without these reforms, the building of a capable state is simply impossible.

3. Redesign information systems to collect more information about employment and income outside the five large metros and start a debate about how to improve both. The approach of government so far has been to require municipalities to produce integrated development programmes. Municipalities are expected to consider available information, to consider what can be done with own revenues, the equitable share of national income allocated to municipalities and earmarked grants, to relate to regional nodes and corridors, and to consult widely when compiling plans. But the planning loop is not closed. There is no standardized data base from which the (inevitably variable) quality of plans can be assessed. Nor is there a basis for assessing progress against goals.

 In fact, we know next to nothing about the extent to which economic progress, or regress, is being made in individual municipalities year by year. The Quarterly Labour Force Survey (QLFS) and the General Household Survey (GHS) samples are too small to yield reliable quarterly and annual estimates of employment and incomes at the municipal level, and the much larger Community Survey of 2016 collected no information on these variables, though it did collect data on service delivery. Our collective ignorance is dangerous.

However, it is possible to estimate information on the components of household income, and the percentages of households producing food and receiving remittances by province and geographical type, from the 2017 third quarter QLFS and the 2017 GHS. A table setting out the estimates is attached as an Appendix. It indicates that 93% of household incomes in metros come from earnings, compared with 88% on farms, 84% in non-metro urban areas and 62% in traditional areas. Four per cent of households in metros produce food for their own consumption, compared with 9% in non-metro urban areas, 23% on farms and 47% in traditional areas.

4. Establish lightly regulated export processing zones at points along the east coast, from Richards Bay to Port Elizabeth. China’s rapid economic growth and rising wage levels, and its turn towards raising domestic consumption has created opportunities for new countries to enter light manufacturing for export. Asian countries, such as Vietnam and Cambodia have taken advantage of these opportunities and there is no reason why we should not join them. It would create low wage employment, but given the low employment rate along much of the east coast, an adequate supply of labour could be expected. Production exclusively for export would not undercut production for the domestic market. The Centre for Development and Enterprise has produced a detailed proposal for an export processing zone for the Nelson Mandela Bay metro2. It should be piloted and, if successful, replicated. Every 100 000 jobs created at the national minimumwage would add 7% to household incomes in KwaZulu-Natal traditional areas or 10% in Eastern Cape traditional areas. The addition to earnings would be 12% in KwaZulu-Natal and 20% in the Eastern Cape. The EPZs would be the new border industries, looking outwards rather than inwards.

CONCLUSION

Two points by way of conclusion:

1. The focus on the particular projects and initiatives in this brief series should not detract from a reorientation towards growth in the whole of government. Rigorous cost-benefit analysis of all public investment, for instance, would be a growth-promoting practice, independently of particular growth promoting strategies.

2. The enemy of a pro-growth orientation is ‘radical economic transformation’, fronting for large scale theft, institutional destruction and impoverishment. The battle is on, and victory for the growth party is not assured. Should the growth party fail, South Africa will be on the road to ruin. The opportunities for growth are there, but mindsets need to be changed for the opportunities to become visible. Adapt, or die.

By Charles Simkins, Head of Research, HSF, 11 July 2019

1 The real social discount rate is the determined by a judgement about the difference between having a rand now and having the same real value in a year’s time.

2 Centre for Development and Enterprise, An EPZ for the Nelson Mandela Bay metro, The Growth Agenda, April 2016

Table 1 - Summary statistics by province and geographical type outside the five large metros, 2017

 

Province

Type

Earnings

Private pensions

Remit- tances

Social grants

Household income

Earnings /income

Per cent of households

Population

Income per capita

 

R million

per cent

Agri cultural produc tion

Receiv ing remit tances

 

Rand p.a.

 

Western Cape

Urban

63 085

7 210

1 129

5 167

76 591

82

2

8

2 021 021

37 897

 

Traditional

 

 

 

 

 

 

 

 

 

 

 

Farms

8 856

57

117

721

9 751

91

6

5

314 863

30 970

Eastern Cape

Urban

78 139

4 551

2 658

8 445

93 793

83

9

18

1 274 650

73 584

 

Traditional

18 638

1 199

2 950

14 084

36 871

51

56

30

3 167 558

11 640

 

Farms

3 832

0

4

264

4 100

93

23

2

40 273

 

Northern Cape

Urban

24 026

1 023

875

3 211

29 135

82

7

14

895 991

32 517

 

Traditional

4 403

66

254

1 011

5 734

77

15

23

252 080

22 747

 

Farms

1 964

0

51

141

2 156

91

24

6

65 928

32 708

Free State

Urban

62 824

4 094

2 801

6 645

76 364

82

13

18

1 676 439

45 551

 

Traditional

2 099

14

219

974

3 306

63

49

22

248 502

13 305

 

Farms

3 651

16

4

357

4 028

91

21

1

141 961

28 372

KwaZulu-Natal

Urban

76 374

4 408

1 265

4 525

86 572

88

8

12

2 172 296

39 853

 

Traditional

30 200

548

4 194

15 410

50 352

60

45

33

4 370 004

11 522

 

Farms

10 467

63

551

2 568

13 649

77

32

18

776 049

17 587

North West

Urban

65 245

2 673

1 772

4 335

74 025

88

4

16

1 860 569

39 786

 

Traditional

27 238

736

1 663

6 296

35 933

76

13

24

1 832 509

19 609

 

Farms

4 073

47

26

265

4 411

92

14

8

163 091

27 044

Gauteng

Urban

60 613

2 914

1 870

3 148

68 545

88

4

16

1 757 418

39 003

 

Traditional

 

 

 

 

 

 

 

 

 

 

 

Farms

2 483

0

69

141

2 693

92

4

10

106 806

25 215

Mpumalanga

Urban

84 785

1 947

1 878

3 198

91 808

92

8

16

1 722 892

53 287

 

Traditional

28 432

677

2 383

7 234

38 726

73

41

23

2 451 493

15 797

 

Farms

12 349

272

226

547

13 394

92

24

11

269 688

49 664

Limpopo

Urban

43 840

817

1 183

1 981

47 821

92

13

11

1 161 830

41 160

 

Traditional

40 513

919

4 988

15 361

61 781

66

53

29

4 496 049

13 741

 

Farms

4 487

0

8

93

4 588

98

13

2

120 654

38 029

 

All

Urban

464 457

29 637

15 431

40 655

550 180

84

9

15

17 103 942

32 167

 

Traditional

134 874

4 159

16 651

60 370

216 054

62

47

26

16 984 673

12 721

 

Farms

47 584

455

1 056

5 097

54 192

88

23

9

2 088 499

25 948

Total

 

646 915

34 251

33 138

106 122

820 426

79

26

19

36 177 114

22 678

 

Metro

 

Cape Town

 

250 507

8 146

3 823

7 748

270 224

93

3

7

4 174 510

64 732

Ethekwini

 

125 750

3 496

3 462

8 645

141 353

89

2

10

3 756 197

37 632

Ekurhuleni

 

177 626

3 424

2 531

5 647

189 228

94

7

11

3 576 816

52 904

Johannesburg

 

295 561

4 541

4 903

9 316

314 321

94

3

12

5 396 564

58 245

Tshwane

 

246 514

5 130

2 061

5 098

258 803

95

5

9

3 440 748

75 217

Total

 

1 095 958

24 737

16 780

36 454

1 173 929

93

4

10

20 344 835

57 702