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  • What it is all about

    More often than not the economic news you read in the newspaper or hear about on the radio, needs more explanation of the Economics. Why is it that when inflation in the U.S. is high and the Fed increases its policy rate, we “must” increase the repo rate? It has to do with purchasing power parity, but that is not explained in the newspaper. I hope to take a deep dive into the economics news and, hopefully, explain it in simple terms.

  • The BIG question

    The establishment of a basic income grant in South Africa is in the news. The payment of the R350 Covid Social Relief of Distress grant was extended this year but expires at the end of the government’s financial year in March 2023. There are various proposals on how it can be transformed into a basic income grant. There are those who say that South Africa cannot afford to do it, and others who say that we can hardly afford not to do it.

    I think we agree that R350 per month per person is not a lot of money. It is not enough for someone to choose to remain unemployed to get it. Nor is it enough to greatly increase the reservation wages. In addition, research from the NIDS-CRAM project showed that the grant made a big difference in preventing people from going hungry. The idea of helping the poorest people is a good one, but “there ain’t no such thing as a free lunch” and the question is whether the public purse and the economy can bear the cost.

    Affordability is about the sustainable payment of such an allowance. In the last two years, the government has collected more taxes than it budgeted for and this windfall makes it possible to continue to pay an allowance for a year or two. What about the years after that? The conservative view is that when commodity prices cool and export earnings and tax revenues fall, there is no money in the existing fiscal framework to pay an income grant. The underlying problem is that the economy (and the tax base) is growing too slowly. The proponents of such a grant argue that the existing fiscal framework is too narrow and has no room for any new spending anyway. They say that a bold step must be taken with such a grant. Spending the grant will have a multiplier effect that will drive economic growth, promote employment creation, and increase tax revenues.

    Few of the reports on this explain the macroeconomic dynamics of such an income allowance, but a recent discussion paper published by Economic Research Southern Africa gives more insight into a model of how something like this would work.

    To explain what the impact of such a grant would be on households, businesses and the Budget, you need to have an idea of how a number of changes to the economy will play out. Suppose 33 million people each get R840 per month (this is the upper end of the food poverty line). This will cost R333 billion per year and is certainly too much for the existing fiscal framework. However, the questions are, will everyone spend the full allowance, or will part of it be saved? Will everything be spent on South African products, or will some part be spent on imported products? Such a large injection of money will increase consumers’ total spending, but will prices stay the same? Which sectors will benefit from this spending? What do the inputs of these sectors look like – are they labour or capital-intensive, what part of their inputs are imported, will production be expanded and more people employed, who then get income and spend it again?

    The money for the grant is not just going to fall out of the air and the financing of such additional spending can also have diverse impacts. If taxes are increased it will dampen other spending. Is it that simple that taxes are withdrawn on one side of the economy and then injected on the other side as a grant? If income tax is increased on high-earning individuals they will spend less, so what does their spending look like and which industries will be affected? If VAT is increased, everyone’s spending will be affected. If the grant is partially financed with government debt, what will be the impact on interest rates, and on investors who will then have to borrow at higher interest rates. What is its impact on production and employment?

    The point is that there are no thumb-suck answers to this. Good analysis requires a lot of details about how the economy works, based on historical data, summarized in a dynamic model.

    This is precisely what Hylton Hollander, Roy Havemann and Daan Steenkamp’s analysis offer. They use a dynamic stochastic general equilibrium model of the economy developed for the National Treasury to test three policy options:

    • If the R350 per month grant is made permanent.
    • If R585 per month is paid, equivalent to the food poverty line.
    • If R840 per month is paid.

    The other big variable, of course, is how many people will qualify. The financing options are combinations of increases in government debt, personal income tax, and VAT. A large-scale reprioritization of other government spending does not seem viable and was not considered an option.

    The finding is that the stimulus from the spending of the grant is offset by the higher taxes, and higher interest rates that crowd out investment, and interest payments on the government debt that crowd out other government spending. In all cases, the negative impacts are greater than the positive increase in spending. For example, paying the food poverty line of R585 per person per month to 10.5 million people would cost approximately R74 billion (all at 2020 prices). To finance this, the government debt to GDP ratio will have to increase by 8 percentage points, VAT by half a percentage point, and the effective personal income tax rate by 5.3 percentage points. Economic growth will be 1.3 per cent lower and around 200,000 job losses are expected.

    There are many possible permutations, but ultimately it is about what is important to us as a society and what we are willing to pay for it. The discussion document emphasizes that the only way to sustainably pay any grants is with faster economic growth. However, this requires far-reaching economic reforms – the reforms that so many of us write about. In short, it means that the state must get out of the way of the private sector. Throw out the collective bargaining, the BEE requirements, the local content requirements, and all the other red tape that holds back business. Deregulate markets and grow the economy.

    This piece originally appeared as an article in Afrikaans on the Maroela Media debate platform: Basiese inkomstetoelaag: edelgedagte, slegte idee.

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  • The amorphous markets and the mini-budget

    Most of us have an opinion when macroeconomic policy ideas are thrown around:

    • would it not help the economy to lower interest rates now, instead of increasing them, or
    • if we pay everyone a grant, people will spend that money again and it will contribute to economic growth and tax revenue, or
    • why don’t we lower tax rates instead and this will then lead to investment and economic growth.

    Everyone has their favorite plan for the economy. There are of course examples of how such ideas have been implemented in other places, or in the past, and have worked (or not worked). However, people don’t pay much attention to evidence. The joke goes, History is the greatest teacher, but unfortunately no one comes to class. Yet, lessons are being taught in the United Kingdom at the moment and with South Africa’s own mini-budget around the corner in October, it’s important to pay attention.

    Britain’s new Prime Minister, Lizz Truss, and Finance Minister, Kwasi Kwarteng, took one of those big policy ideas last week and built their mini-budget on it. The idea comes from Supply Side Economics and the era of Reaganomics. Their target is 2.5% economic growth over the medium term and the plan is to stimulate the economy with tax relief and deregulation. The more than ₤100 billion stimulus package consists of tax relief of ₤45 billion together with a ₤60 billion energy emergency package which should bring relief to households from the rising cost of gas. Whether it will work only time will tell, but how things play out over the long term can easily be forgotten if costs over the short term are too high.

    The markets do not like the plan. Because more debt will be issued, there will be an increase in the supply of bonds. This causes their price to fall and the interest rate on the instruments to rise. This has two consequences. On the one hand, investors who already own UK government bonds want to sell them because prices are falling, and this is pushing interest rates up even further. On the other hand, the rates on people’s home loans are linked to those interest rates.

    Maybe Truss and Kwarteng feel a bit like our then Minister of Finance, Trevor Manual, who said in 1996 “I insist on governing…. I insist on the right not to be stampeded into a panic decision by some amorphous entity… called the market” .

    However, that is exactly what happened. On Wednesday afternoon (28 Sep) it became clear that pension funds holding many government bonds were suffering huge losses and the Bank of England stepped into the market and began buying 30-year bonds to stabilize bond prices and lower interest rates. It is the same Bank of England that raised interest rates the week before to fight inflation that is now being forced to apply quantitative easing again.

    On Twitter there was talk of the possibility of a pound crisis. At least Britain does not have large foreign debt obligations in a foreign currency, so the chance of a balance sheet crisis is small. Yet, if the Bank of England says that they will do everything necessary to stabilize the bond market, investors may think that the British government is not going to repay the public debt later with tax revenues, but that they are going to print money. They also don’t have to print money like in Zimbabwe, but they can simply allow the inflationary effect of the extra spending. This will put the pound under further pressure.

    The lesson we can learn for South Africa are about how important a sustainable fiscal position is for the markets and foreign investors. We are in the process of getting the public finances on a healthier footing, reducing the budget deficit and stabilizing the level of public debt to GDP. Over the last two years, the focus has been on the spending side of the budget and the management of the state’s wage bill. However, there were also tax windfalls thanks to high commodity prices, good export earnings and solid company profits. This means that there is a little less pressure on the Minister than in 2020 and the markets like that. Credit rating agencies’ outlook for South Africa is stable. Recently, Goldman Sachs also published a very positive view on the public finances, but this is based on the Minister being able to continue to act in a fiscally conservative manner.

    The challenge is precisely that “extra” money. The Minister can no longer just say, NO, there is no money, and everyone else has lots of ideas about how to spend it. The biggest of these is the R350 Covid allowance and the idea of turning it into a more permanent basic income allowance. The other major issues are around things like Eskom’s debt, bailouts for other state-owned enterprises, money for infrastructure maintenance, the dire financial position of most municipalities and so on.

    Nor does being fiscally conservative mean that all these demands should be ignored. Relieving Eskom’s debt burden is the key to more sustainable electricity supply and ultimately economic growth. A decision with resources behind it cannot be postponed any longer. But Britain’s experience shows that big ideas and stimulus packages do not stand up to market discipline. We have to hope for a very boring mini-budget.

    This piece originally appeared as an article in Afrikaans on the Maroela Media debate platform: Leer asseblief lesse uit Britse mini-begroting.

    Since writing the piece Mamokete Lijane had a great BusinessDay article on the dangers of policy adventurism.

    And the PM has reversed course on some of the tax cuts and it has supported markets and emerging market currencies.

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  • How do we think about the big policy trade-offs?

    Among the few things, South Africans agree on are the economic challenges facing our country: a low economic growth rate, high unemployment rate, poverty and inequality. There is even reasonable consensus about the causes of these problems. For example, South Africa has a small, open economy that is far from world markets, the economy is built on mineral wealth, but has already deindustrialized, and the consequences of Apartheid are still with us. Citizens and policymakers agree that sweeping reform is needed, and this is where we get stuck.

    The reform plans that are proposed usually lie on a spectrum from market-oriented liberalization to a developmental state. Over the last 28 years, there have been many official plans, strategies and initiatives, from the RDP, GEAR, and AsgiSA, the NGP, and NDP, to the so-called Treasury document (still under Minister Mboweni), and the ERRP. Currently, the government’s plans to grow the economy and create jobs are about infrastructure investment in railways and ports, electricity generation, regulatory reform, support for small businesses, localisation, labour-intensive growth in agriculture and services -sectors, and regional integration. It lies somewhere in the middle of the ideological spectrum where the market and the state have a role to play. In the last year or so it sounds like the role of market forces has prevailed. The question then becomes, why do we struggle so much with the implementation?

    The easy answer is to say it is because of the factions within the government, different departments pulling in different directions, or simply ineffectiveness and incompetence. This is certainly part of the story, but I think there is a more fundamental challenge to get the buy-in of the state, labour, business and community, and to make the sacrifices necessary to make the plans work. One reason for this is that grand macroeconomic strategies are never very clear about their assumptions. The other is that they are also not clear about the trade-offs.

    Thinking about the assumptions of macroeconomic plans need not get technical. What will be the private sector’s response to investment in network industries? Are they going to jump in right away, or wait and see? How will the markets react if part of Eskom’s debt is taken over by the government (the taxpayer)? Will a basic income grant only help to alleviate poverty, or also cause people to expect even higher wages to work? Most strategies do not try to answer such difficult questions. At this point, the strategy becomes less of a plan and more of a big social experiment.

    Economists think about the consequences of the decisions we make (or don’t make) as opportunity costs. The opportunity cost of the option you choose is the value of the option you do not choose. If more money is spent on grants, the opportunity cost is the infrastructure maintenance you didn’t do. If you deregulate the retail fuel industry the opportunity cost is the industry’s consolidation and job losses. Usually, little is said about the opportunity costs of different options.

    An exception is a recent OECD report which made a number of recommendations on policy reform in South Africa. The recommendations include better management of public enterprises, more effective government investment, and increasing productivity through improved infrastructure and training. They also propose privatisation, and the reduction of the state’s wage bill, and the reform of the collective bargaining system. These are suggestions that most of us would nod in agreement at, but then they explain what it will cost. To pay for all this they propose that the base of corporate and personal income tax should be broadened. To increase the effective rate of tax paid they suggest that allowable deductions should be reduced. They also suggest that the VAT rate can be increased by 2 percentage points from 15 to 17 per cent.

    It’s human to want the improvements or benefits without the costs, but that’s not how life or policy reform works. We cannot spend more without raising taxes. We cannot become more productive without it affecting wages. But it is a difficult trade-off to get everyone to agree on and the result is that most of our good plans remain just documents that get a new acronym in a few years and then promise growth and job creation all over again.

    This piece originally appeared as an article in Afrikaans on the Maroela Media debate platform: Die geleentheidskostes van beleidshervorming.

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  • How to know what’s going on in the economy

    Students have been asking me, How do I keep up with what’s happening in the economic news?

    There is an app for that. My work screen looks like this at the moment:

    • For the news:
      • I am subscribed to Netwerk24 as well as the BusinesLive platform, which gives you Business Day (BusinessLive Premium is R120 a month, think about it).
      • Moneyweb is excellent for news, views, podcasts and some basic markets data and most of it is free.
      • BizNews is Alec Hogg with longer opinion pieces, a daily breakfast briefing, and a Youtube channel.
    • For up-to-date news and opinion, don’t underestimate #EconTwitter. South African economists and journalists that you can follow include:
      • Hugo Pienaar (@hugopien), Isaah Mhlanga (@IsaahMhlanga), Mamokete Lijane (@mamokete30), Clair Bisseker (@ClaireBisseker), Thabi Leoka (@thabileoka), Gina Schoeman (@ginaschoeman), Daan Steenkamp (@daan_steenkamp), Christie Viljoen (@CVeconomist), Francois Stofberg (@FrancoisStof), Piet Viljoen (@pietviljoen), Wandile Sihlobo (@WandileSihlobo), Theo Vorster (@sakegesprek), Kevin Lings (@lingskevin), Alec Hogg (@alechogg), Adrian Saville (@AdrianSaville), Bruce Whitfield (@brucebusiness), Chris Hart (@chrishartZA). It is not everyone, but should get you started.
    • I use Google’s app to listen to podcasts, but any podcast app will work. I like:
      • The Indicator from Planet Money.
      • NPR Planet Money.
      • The Economist’s The Week Ahead.
      • For SA content, there is Peter Bruce’s Podcasts from the Edge and the Big Daddy Liberty Show that are interesting.
      • There are a lot of personal finance and investing podcasts out there if you are interested.

    The EcoDoc app is a dictionary of economics terms in all 11 South African languages!

    For an excellent summary of the week’s economic news, I recommend subscribing to the Bureau of Economic Research’s BER Weekly newsletter. You can get it free in your mailbox every Monday morning. They also have many other excellent resources like their consumer and business confidence surveys. For some of those you need a subscription though.

    Of course, you can also catch my daily podcast: Die Ekonomie Minuut / The Economics Minute. Search for it in whatever podcast App you are using and subscribe, or catch it on Anchor, or Spotify. And it has a blog page.

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  • Figuring out how the economy is doing

    When you ask, how is the economy doing, you hope that it is growing and making everyone a little bit better off. You are interested in GDP and economic growth and the forces that influence it. At the moment, only the first quarter’s GDP figure is known and then the economy grew by 1.9%. The second quarter’s figure will only be announced on 6 September. Other indicators of what has happened in the meantime can be divided between the supply side and demand side.

    The supply side is about the use of capital, labour, natural resources and entrepreneurship in the production process and one does not expect this to change much in just a few months. However, April’s floods in KwaZulu-Natal and June’s load shedding were supply-side shocks that would dampen production. The use of the production factors is also not something that is easily measured, with the exception of employment which is measured quarterly. It grew slightly in the first quarter. At least there are also monthly measurements of production in the manufacturing and mining sectors. We know that industrial and mining production has been in decline for four months running. Statistics South Africa also has other benchmarks that give you an idea of what is happening on the production side. For example, the amount of electricity generated (4% lower in June), the transport of freight (9% higher in May), and capacity utilization by large enterprises (it stood at 77.2% in May).

    Then there are the measures of how businesses themselves are doing, such as the Bureau of Economic Research’s purchasing managers’ index and business confidence index which have been falling for the last few months. Though, SACCI’s business confidence was up in July. Statistics South Africa also provides information on liquidations and insolvencies and these increased in June. Wholesale trade sales were high in May than in April, but lower than in May last year.

    To summarize: the economy has grown more slowly in the second quarter, and many analysts predict that it has shrunk, but there are also forecasts of growth around 2% for the year as a whole. One must therefore also take the demand side into account.

    The demand-side drivers of growth are the components of aggregate spending – in other words, consumption spending, investment, government spending and net exports.

    There are a number of indicators that are clues to how consumers are doing. Statistics South Africa publishes retail sales figures and they grew by just 0.1% year-on-year in May. Also, BankservAfrica’s Economic Transactions Index was lower in June. One can also think in terms of households’ ability to spend and it is about disposable income and use of credit. BankservAfrica’s Take-home Pay Index has been declining over the past year. The Reserve Bank measures private credit extension, and it has grown slowly over the past year, even with rising interest rates. TransUnion data shows that distressed borrowing is increasing, but the fintech group Altron has a household financial resilience index and it indicated in the first quarter that households’ ability to take on and repay debt remained stable in the first half of the year. However, the Bureau of Economic Research’s consumer confidence index has declined recently. On the other hand, malls seem to be resilient and there is a housing boom.

    Measures of investment spending are not frequently available, but there are reports such as Nedbank’s Capital Expenditure Project Listing report which showed last week that fixed investment could rise by 3.5% this year. Analysts do not pay much attention to government spending from quarter to quarter. The net effect is that it stimulates aggregate demand because the spending is more than what is withdrawn from the economy through taxes. The last measure is net exports. We know that an important part of the last year’s growth was driven by exports and specifically by high commodity prices. It has levelled off in the last few months, but is still positive for growth.

    To summarize: consumers have been hit hard by the higher inflation rate and interest rates of the second quarter, but from the aggregate demand side, there is some spending that supports growth.

    But these are all short-term factors. For long-term growth, we need those structural reforms that everyone likes to talk about.

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  • The arguments in favour of a repo rate increase

    The Reserve Bank’s Monetary Policy Committee is meeting from today to Thursday afternoon when they will announce their repo rate decision. The consumer price inflation rate for June will be announced tomorrow and is expected to be in excess of 7%, well above the 3-6% target band. The repo rate is sure to go up and there is some debate about how much, or how little.

    The arguments in favour of a small increase (or no increase) are that it will constrain consumers and businesses, and dampen investment and economic growth without making any difference to the causes of the inflation, namely high international prices of oil and food commodities.

    The arguments in favour of stronger medicine were made by RMB economist Ettienne le Roux in the Financial Mail this week. He points to the fact that core inflation has been rising and this year’s wage settlements may exceed the inflation target band while there is limited scope for productivity improvements.

    He also makes two more technical points that are interesting. The first is that GDP has recovered to pre-pandemic levels. This means that even the low rate of economic growth that economists are expecting this year (around 2%), can put pressure on prices. Economists talk about the output gap – the difference between potential and actual production. When the economy grows close to its potential growth rate, scarce inputs become more expensive.

    The team at Codera analytics recently shared their modelling of the output gap and conclude:

     the output gap may be shifting into positive territory. This suggests excess capacity built up during the COVID-19 pandemic has reduced and inflationary pressures are beginning to build. 

    Codera Analytics

    Ettienne’s second point is that there is still monetary stimulus with the negative real repo rate. This means that the banks borrow money from the Reserve bank and repay it later with money that has less buying power. Though the repo rate has been increased a number of times, credit is still cheap in real terms and can fuel those inflationary pressures. Again, a Codera graph shows this clearly.

    Ettienne concludes:

    The Bank is therefore right to be hiking. It is also right to signal that further increases are in store to convert what is still a negative real policy interest rate into a more appropriate positive one. A necessary strategy also, given that major global central banks are aggressively removing monetary policy stimulus.

    Ettienne le Roux

    We could well see a 75 basis points hike on Thursday.

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