A Critique of the 2017 #MTBPS

Introduction

The Minister of Finance, the Honourable Malusi Gigaba, delivered his Medium-Term Budget Policy Statement (MTBPS) on Wednesday, 25 October 2017. This document seeks to provide a broad analysis of the MTBPS as presented and to highlight some shortcomings and areas that require urgent attention if the current low growth trajectory is to be addressed.

In particular, I intend to focus on the following issues:

·      Monetary policy

·      Benefits of a Government Digital Strategy

·      Budgetary Allocations

Monetary Policy

Minister Gigaba, like previous minister of Finance, devotes passing remarks in various places to monetary policy, and yet this is the most potent policy instrument available to the government and the South African Reserve Bank (SARB) to influence the growth rate and reduce unemployment. The apparent failure to realise that it is the contractionary policies of the SARB that are negatively impacting growth and employment is puzzling as there’s ample theoretical and empirical evidence to suggest this. In several places, the minister remarks and observes, without any irony, that the world economy is growing. In particular, South Africa’s major trading partners are experiencing higher economic growth. This, as I will show below, is happening precisely because they harnessed the power of their monetary policies to make it happen.

Typically, the objectives of macroeconomic policy are the attainment of full employment (or the reduction of unemployment levels), within an environment of low inflation, high and sustained economic growth, and a ‘healthy’ balance of payments. The emphasis on one or the other objective is a choice that is informed by a number of factors. Some of these may be informed by ideology, others may be the result of pressures external to the economy (especially for a relatively small, open economy like South Africa which is dependent on external financial flows and trade).

All things being equal, some of these objectives (at least in the short to medium term) may be mutually exclusive. For instance, a low inflation (not factoring in inflationary expectations), high interest rate environment may negatively impact economic growth and employment levels. The opposite may also hold true. As economics is about choice, policy makers make choices that ultimately harm or benefit their economies and citizens.

There’s general consensus (and empirical evidence clearly upholds this) about the inverse relationship between the level of interest rates and the rate of economic growth and the level of employment. Put simply, high interest rates lead to lower levels of economic growth and therefore lower levels of employment (or higher unemployment). High interest rates may attract speculative international financial flows, but these are generally fleeting and mostly do not lead to productive investments. On the other hand, they negatively impact demand and domestic investment expenditure.

All things being equal, the current inflation target (range), with the resultant relatively high interest environment, is incompatible with the stated growth and employment objectives. In other words, the current monetary policy stance of the SARB harms the country’s growth prospects and is not supportive of the government’s stated growth and employment objectives.

The minister and the SARB should dispassionately and non-ideologically take stock of the situation and accept, as evidence seems to suggest, that they will not attain their growth and employment targets with the current policy incompatibility. Since the mandate of the SARB comes from government, more specifically the minister of Finance, it is inconsistent to persist with an inflation target range that clearly is at odds with the growth target and the creation of employment. What compounds the situation is the observed, unstated goal of the SARB to target the median of the range. What is the point of the 6% upper limit if the SARB conducts policy in such a way that the rate of inflation is generally restricted from testing this upper limit?

Although the minister observes that high unemployment remains one of South Africa’s most pressing challenges, he offers nothing radical or creative to deal with this. The reduction of unemployment, and not a low rate of inflation, should be the key objective of macroeconomic policy in the short to medium term. This would have a positive impact on the budget deficit through reduced social spending while revenue collections increase. This would allow the government space to increase spending on growth enhancing items like education, even as the number of those who cannot afford fees reduces (or they require a lower ‘subsidy’). In other words, creating a ‘virtuous circle.’

Clearly, this monetary policy would have to be complemented by strategies implemented by government and the private sector to ensure that growth is in sectors with the greatest employment creation potential. In other words, avoid the curse of jobless growth.

It is interesting to note that the wage increases typically demanded by unions, particularly public-sector unions, clearly indicate that their inflationary expectations are consistently higher than CPI. This is puzzling as the SARB has maintained consistently low and relatively stable rates for a long time. This, in fact, seems to reflect the strong power that unions have in South Africa. This may reflect general historical union development, but it may also be due to the existence of an alliance between unions and the governing party.

Aggressive Monetary Policy – the US, UK, EU, Japan and China

Central banks ordinarily conduct monetary policy by buying and selling short-term debt securities to target short-term nominal interest rates. These purchases and sales of assets change both short-term interest rates and the monetary base (the quantity of currency and bank reserves in the economy.) This conventional monetary policy can potentially stimulate the economy through two types of channels: asset price channels (including interest rates) and credit channels.

However, when interest rates are at zero increasing the monetary base is not, by itself, considered an effective stimulus. This is what the central banks of the United States, the United Kingdom, the European Union and Japan were faced with when they lowered their rates to zero to alleviate financial distress and stimulate their economies.

Faced with this scenario, the Fed, the Bank of England (BOE), the European Central Bank (ECB) and the Bank of Japan (BOJ) turned to unconventional policies that often dramatically increase their monetary bases. Some of these unconventional policies involve direct lending to specific distressed short-term credit markets, whereas others involve purchasing long-term assets that are intended to reduce real, long-term interest rates.

The Fed, BOE and ECB have steered their respective economies through these difficult times and further showed that their decision-making is empirically based. For example, in recent times whenever there has been an expectation that the Fed will raise interest rates, it has not done so because the employment numbers have indicated to them that the US economy is still fragile.

The People’s Bank of China (PBOC) has shown similar responsiveness to shocks to the Chinese economy, for instance when there was a stock market collapse and the slowing down of the economy.

The purpose of this section has been to show that other central banks have been prepared to lower interest rates to zero and then to further implement unconventional policies in order to stimulate economic growth. (Employment growth acts as an excellent proxy for this as it is among the first indicators of improving business confidence.) This happened in an environment of scepticism about the potential effectiveness of these policies, but they stayed the course and the evidence suggests they were correct. Interestingly, with the exception of the PBOC, these are central banks in ‘right wing’ economies, while the SARB and Treasury in a ‘left wing’ environment are steadfastly implementing policies that are anti-growth and anti-employment.

Benefits of a Government Digital Strategy

Want to reduce corruption, reduce the cost of doing business and serving citizens? Studies show that digitization is one of the biggest drivers of a nation’s economic success. Digitization reduces the costs of doing business for both the state and private economic actors, in turn benefiting the economy as a whole. Digitisation also markedly reduces the incidence of corruption and increases access for citizens to services at reduced cost.

For example, digitizing procurement increases competition, reduces costs, reduces arbitrary decision-making, reduces human interaction in the submission and evaluation of tenders, thereby eliminating or reducing opportunities for corrupt or collusive behaviour. Downloadable tender documents and digital submission also benefit the environment in many ways: it reduces the need for printing and for driving to collect and submit documents, etc.

In another example, a pilot study in the US involved the use of Artificial Intelligence/algorithms to allocate bail for various categories of offences. This showed a marked reduction in the prison population of awaiting trial prisoners. This clearly has budgetary and justice benefits.

With no bias in decision-making, algorithms can take over a lot of decision-making, especially those decisions dependent on quantitative data. For instance, decisions about the repo rate by the SARB can be made by algorithms without any political or other bias, purely on the numbers. Incorporating machine learning means computers can also make increasingly better decisions even where qualitative data are necessary for decision-making.

The use of digital technology in education and health care are well documented. All that is required is a clear strategy and improved implementation efforts. Building computer labs in township and rural schools, and then leaving these to be completely vandalised or at the mercy of corrupt teachers is pointless and a waste of public and donor funds. We have also seen the impact of digital technology on access to financial services for unbanked or underbanked people.

At the other end of the scale, access to government services may be greatly improved through improved ICT infrastructure across the country, including poor areas and rural areas. This should be complemented by a continued reduction in data charges.

Investment in digital services can prove comparatively inexpensive because once the systems are in place, the marginal cost of adding users are close to zero. For example, when you have a computer in each village (a “digital centre”) with the birth certificate program installed, extra birth certificates cost almost zero. And adding more apps to the computer, allowing for help with other government services (like agricultural extension services) adds little cost too.

Budgetary allocations

Budgetary allocations towards social grants and housing are indeed necessary and commendable; they, however, do not contribute to long-term economic growth. Funding allocations should instead be focused on growth supporting activities like education and crime fighting. An educated workforce improves business confidence and encourages investment by business and attracts FDI. Equally, with education and better earnings people can potentially provide housing for themselves, leaving the state to provide only for the truly indigent. A lowering of the crime rate will also have similar growth benefits, while also directly impacting the quality of life of citizens.

Disposing of government’s stake in companies like Telkom is good, but using these proceeds to recapitalise SAA is a complete waste. There is no clear developmental justification for holding onto a 100% stake at SAA and making budgetary allocations to it and/or providing guarantees on its behalf. The minister’s subsequent public justification in an interview, namely that this is to preserve jobs, is at best, ‘throwing good money after bad’. And, at worst, it appears to be very unscientific. Where is the research that informed this view?

‘Radical economic transformation’ should include radically reviewing the government’s ownership of SOE’s, especially those that have no clear developmental role, and yet keep enjoying bailouts or guarantees out of public funds.

Increasing spending on defence is also the wrong option. South Africa is at peace with the world and will continue to be for the foreseeable future. Why, therefore, should defence spending increase, especially to finance expensive and fancy equipment like the Gripen fighter jets? To fight against Swaziland or Malawi? Our porous borders, evidenced by the millions of undocumented immigrants, also belie the justification of border control. Maritime patrols to protect our fisheries and a level of peace-keeping on the continent are seemingly the only justified defence expenditure. On the other hand, drastically increasing expenditure on the police would yield significant benefits and would in the end pay for itself through increased FDI, tourism and other virtuous benefits as mentioned above.

Public sector salary and wage increases

The minister expresses a concern about the possibility of public service wage negotiations concluding on an increase that is higher than CPI. This is, at best very curious, and at worst shocking. It is in fact not the first time that a minister of finance has raised such concerns, but clearly seemed impotent to do anything about it. It clearly reflects what I raised above, the power of unions to extract increases from the government which have no basis in economic reality.