Friday, May 9, 2008

Recommendations for economic growth in South Africa

These are snippets of conclusion of an international panel on growth for South Africa written by Ricardo Hausmann, its Chairman. These are just growth diagnostic snippet from the summary paper. There is a long list of recommendation- a good set of recommendations, in fact. More here.

...the growth acceleration observed since 2004 does not appear to be externally sustainable. Eventually, domestic demand will have to grow more slowly than GDP in order to reestablish external balance, but as demand slows down, it will bring down the growth in the non-tradable sector: (construction, finance, retail and other services). To maintain overall growth and employment, the country will need to rapidly increase its exports.

This is a major challenge, as South Africa’s exports have exhibited remarkably little dynamism over the long run. In the 44 years between 1960 and 2004, the real value of exports grew by only 34 percent (about 0.7 percent per year). By contrast, export growth was 169 percent in Argentina, 238 percent in Australia, 1887 percent in Botswana, 385 percent in Brazil, 387 percent in Canada, 390 percent in Chile, 730 percent in Israel, 1192 percent in Italy, 4392 percent in Malaysia, 1277 percent in Mexico and 120 percent in New Zealand, to name a few relevant comparators.

The recent growth spurt has also highlighted the importance of infrastructure bottlenecks. Over the long period of slow growth since 1980, the country has invested little in its transportation and energy infrastructure and this translates into congestion and brown-outs as the increased demand pushes against a limited supply. This corroborates the importance of the investment program identified in ASGI-SA. But since investment is particularly import-intensive, this will further increase the pressures on the external accounts.

Summing up, the current rate of growth of the economy is above what is sustainable given the current pattern of growth and the structure of the economy and, still, it remains below the desired target of 6 percent announced by ASGI-SA for the start of the next decade. To achieve the growth target of 6 percent, additional efforts will have to be made to relax the binding constraints that keep the speed limit of the economy below what ASGI-SA would like to achieve. Identifying those binding constraints and relaxing them through policy interventions in a way that achieves a better participation of the population in the fruits of growth is the key to achieve the goals of ASGI-SA.

In contrast with other high growth countries, the decline in primary sector jobs was not compensated with increased employment in manufacturing, which also declined since 1982. During the decade between 1994 and 2004, manufacturing jobs fell by 11.7 percent or 165,448 jobs and by 21.0 percent or 332,441 jobs since its 1982 peak.

Hence, a strategy for externally sustainable and shared growth involves the creation of jobs in the tradable sector, which in an open economy translates into export for jobs. Such a pattern of growth is needed in order to create the external resources required to sustain growth. It is also needed to create the kinds of jobs that use the human resources that the society has at its disposal.

It is clear from business surveys and from the general national debate that skills are in short supply and a strategy to relax this constraint is necessary. However, we argue that the skills constraint is aggravated by the pattern of growth that South Africa is experiencing, and in fact is in large part its result. The growth strategy of ASGI-SA has to be based on the people that South Africa has, not on the people that it wished it had. A strategy based on the relative expansion of the tradable sector represents a better match with the currently under-utilized human resources of the economy.

The fact that investment and growth in the tradable sector have lagged is indicative of problems with the level and stability of the real exchange rate.

Now, the real exchange rate is an endogenous variable. Its level and volatility are not set by government but are the outcome of the whole macroeconomic balance. Therefore, it is this balance that must be the focus of policy. The greater the level of domestic demand, the stronger the real exchange rate. The more volatile the level of domestic demand, the more volatile the real exchange rate. We will therefore propose that the government maintain the main features of its macroeconomic strategy in terms of fiscal prudence and inflation targeting, but that it introduce some changes. First, fiscal policy should be set with an aim of increasing savings so as to make a significant contribution to funding the ASGI-SA public investment objectives. Second, the target fiscal policy should not be the actual deficit but the structural deficit, i.e. a concept of deficit that takes into account the expected levels of the terms of trade and the cyclical conditions of the country. This will introduce more stability to the level of government spending. Finally, the South African Reserve Bank (SARB) should maintain its flexible inflation targeting regime but should be more responsive to deviations of the real exchange rate. It can do so through a greater use of intervention in the currency market when it deems it necessary to prevent excessive appreciation, and by signaling its concern about the level of the exchange rate to markets when appropriate. The SARB should communicate its new emphasis to the public.

In addition, the effective relative price faced by a particular tradable activity will depend on trade policy. The existence of tariff protection in intermediate goods acts as a tax on those industries that use these goods as inputs. Work by Edwards and Lawrence for this project suggest that this effect is important and that a strategy based on the relative expansion of the tradable sector would benefit from a reduction in the tariff on inputs. We will therefore suggest changes to the tariff regime and to the regional integration strategy followed by South Africa.

In addition, many markets in South Africa suffer from limited competition. High margins and restricted entry are in theory and obstacle to growth. Work by Aghion, Braun and Federkke for this project have shown that on average margins in South Africa are 50 percent higher than in other countries and that this is strongly related to poor growth. Hence, there is evidence that lack of competition is a problem, limiting investment in activities that present large barriers of entry or that use inputs from activities with strong pricing power.

we propose a wage subsidy allowance for all 18-year olds that they can use throughout their life to facilitate the school to work transition and to assure that the educational skills of the new cohorts do not deteriorate through a long period of unemployment. We will propose that during the probation period in which the allowance is used, employers be free to dismiss workers without any justification. This will encourage more experimentation and a more efficient matching of workers to jobs.

We shall propose a strategy to accelerate structural transformation by encouraging search and by addressing coordination problems in the supply of specific public goods. In addition, we will propose a strategy to improve the performance of key government agencies that affect competitiveness.