Policy uncertainty is killing investment in what matters

Johan Fourie is associate professor in economics at Stellenbosch University.
Johan Fourie is associate professor in economics at Stellenbosch University.

Much has already been said about South Africa’s inefficient public sector. 

Not only has the public sector wage bill ballooned beyond the realms of the sustainable, but this has come at almost zero public sector productivity growth.

In other words, we are paying more for government to do less.

Add to that the poor performances of state-owned enterprises like Eskom, the SABC and most notoriously, South African Airways, and it seems that there is little more that the South African government can do to hurt the prospects for economic growth.

But there is. A new NBER working paper, published by Jose Maria Barrero, Nicholas Bloom and Ian Wright, uses new data on about 4 000 US firms to investigate the sources of uncertainty in the US economy. 

They first distinguish between short-term and long-term uncertainty, identifying the factors that cause each type of uncertainty. 

They then ask how each type of uncertainty affects firms’ behaviour.

Short-term uncertainty, they find, is caused by oil price volatility. In contrast, economic variables like the oil price have less of an effect on long-term uncertainty where political risk, like policy uncertainty, has a much larger effect. 

The important finding is that short-term and long-term uncertainty have different consequences for company behaviour. 

Short-term uncertainty affects employment; long-term uncertainty affects investment in research and development (R&D).

If we assume this is true for SA too, how would it play out? Volatility of several macroeconomic variables, like the oil price and exchange rate, causes higher short-term uncertainty. 

This would likely make firms unwilling to hire new workers, or make managers unwilling to offer higher wages. These are the consequences economic commentators typically cite when referring to an unstable macroeconomic environment.

But employment and wages are not the only variables affected by uncertainty. One of the key indicators of a thriving economy is businesses’ willingness to invest in R&D. 

Take R&D as a percentage of GDP, shown in the graph. There is large variation in the share that countries spend on R&D: Israel and South Korea, for example, spend more than 4% of their GDP on R&D. 

SA spends less than 0.8%. (This figure almost reached 0.9% from 2006 to 2008, a period that, not surprisingly, correlated with high growth rates.) 

There is a strong positive correlation between countries that grow fast and those that invest in R&D. SA, unfortunately, significantly lags behind those countries on the technology front. 

It is important, though, to understand why this is the case. It is not only government that invests in R&D; in fact, more than half of all R&D investment in SA comes from the private sector.

So what will encourage businesses to invest more in R&D? Well, according to Barrero, Bloom and Wright, political risk and policy uncertainty are the biggest determinant of private sector investment in R&D. 

In a political environment with little policy coherence, businesses are unlikely to make investments where the returns can only be realised in the long run. 

Even if the possible returns are substantial, a rational investment response to a murky policy environment would be to sit back and see what happens. 

Lower investment in R&D means falling further behind international competitors.

There are some in the South African government who realise this. Minister of science and technology Naledi Pandor has committed to doubling R&D expenditure as a percentage of GDP by 2020. 

This is commendable but in the current budgetary environment unlikely to get the support from the minister of finance. 

Other initiatives to get the private sector investing in R&D, like a refundable tax credit that will benefit small businesses, have not been implemented.

These problems are not unique to SA. As the authors argue: “Our findings are significant in the wake of recent events like Britain’s vote to leave the European Union and Donald Trump’s assumption of the US Presidency, which have generated considerable uncertainty over future economic policy around the world. 

As we have shown, such policy uncertainty is particularly linked with long-run uncertainty and in turn with low rates of investment and R&D that can have significant consequences for the global economic outlook in years to come.”

R&D is the bedrock of future prosperity. Political risk that leads to policy uncertainty hurts not only economic growth and employment creation, but also deters firms from investing in the one thing that can create prosperity for all.

If the ruling party is serious about its slogan, it better start by enacting a more coherent economic policy. 

Johan Fourie is associate professor in economics at Stellenbosch University.

This article originally appeared in the 21 September edition of finweekBuy and download the magazine here.

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