- Beyond Covid-19, most economists agree that the best way to reduce South Africa’s debt burden is to grow the economy.
- The belief that we can spend our way out of low growth is misguided.
- Structural reforms are essential.
South Africa’s supplementary budget puts forward a path to restore the sustainability of the fiscus, without compromising on important social programmes. The belief that we can spend our way out of low growth is misguided.
In considering our economic future beyond Covid-19, most economists agree that the best way to reduce South Africa’s debt burden is to grow the economy. Higher, more inclusive growth, will be accompanied by higher investment and job growth that will place the South African economy on a sustainable path. It allows us to reduce debt-service costs as a proportion of our spending, direct resources towards economic activities that can support long-run growth and empower the state to take care of the most vulnerable in our society.
At this point, however, a disagreement emerges. Some economists believe that the responsible way to stabilise debt is to increase government spending to boost economic growth. A few of them further believe that a focus on structural reforms is unproductive. Others disagree, and point out that high levels of debt constrain the impact of additional spending on growth. Proponents of the latter also believe that changing the underlying structure of the economy is the best way to enable sustainable and inclusive growth in the long run.
Let me take some time to explain what informs this view.
Between 2009 and 2019, government expenditure increased from 27.8% to 32.2% of GDP. At the same time, economic growth was persistently lower than expected. Estimates of our long-term potential growth have fallen from close to 4% in the late 2000s to around 1% in 2019.
There are two possible explanations for this outcome. First, there are structural constraints, such as the lack of affordable and reliable electricity, that depresses economic growth.
Second, unsustainable government spending, funded by tax increases and greater debt issuance, has led to higher debt, which has constrained public and private investment and thus growth. The recent supplementary budget allows for a substantial short-term increase in debt and spending, which we believe is a prudent way of balancing the needs of the present crisis with inescapable long-run fiscal sustainability concerns.
South Africa faces a number of structural constraints to growth that were identified in the National Development Plan. In response, detailed structural reforms were articulated in government’s document entitled Economic Transformation, Inclusive Growth, and Competitiveness: Towards an Economic Strategy for South Africa. These reforms are structural in the sense that they do not respond to cyclical changes in economic activity (like a downturn in global demand) or sudden demand or supply shocks (such as the Covid-19 pandemic).
Instead these structural reforms are meant to strengthen a country’s resilience to cyclical changes by addressing the underlying structural elements that contribute to low growth. The release of telecommunications spectrum is an example of a structural reform that can enhance the ability of businesses to deploy new technologies, lower the cost of data for households and act as a mechanism to allow new participants to enter the industry.
Since 2017, despite strong spending growth, investment has collapsed, dragging down economic growth. Investment growth has been negative in 12 of the last 17 quarters. There was a 20.5% decline in investment in the first quarter of 2020, before the onset of Covid-19.
One explanation for the recession and low levels of investment that preceded Covid-19, which is consistent with a careful review of the economics literature, is that South Africa’s fiscal multipliers are in fact quite small.
A fiscal multiplier measures the impact of fiscal policy decisions, that is government’s spending and tax decisions, on output (or private spending and investment). This empirical finding is unsurprising because the international literature shows that multipliers in emerging markets are smaller than in advanced economies and can be negative, particularly in the longer term and when public debt is high.
High-debt countries have lower multipliers, because fiscal consolidation is likely to have positive credibility and confidence impacts on private demand and the interest rate risk premium. Studies that find higher fiscal multipliers do so because they tend to ignore debt dynamics. As we demonstrate in a paper on fiscal multipliers published through our research partnership, Southern Africa – Towards Inclusive Economic Development (SA-TIED), in countries with high debt such as ours, unsustainable spending increases can actually have a contractionary impact on growth because higher debt service costs crowd out important economic and social expenditure.
In other words, recent spending growth has raised aggregate economic risks, and, with it, the costs of borrowing in the economy as a whole. South Africa’s risk premium – the additional return that investors demand to compensate for higher risk – increased from 3.2% at the end of 2019 to 5.3% by 30 June 2020.
A higher risk premium means that South Africa has to pay more to borrow money because our lenders are concerned that we cannot repay our debt. This is dangerous for us because we rely on others to fund the structural gap between our revenue and expenditure that has persisted since 2009.
Higher borrowing costs lower investment as businesses expect tax increases in the future and constrains the ability of state-owned companies and the government to invest in public infrastructure. This results in slower economic growth and less employment.
The belief that we can spend our way out of low growth is inconsistent with the best available empirical evidence and ignores South Africa’s recent poor performance in using government spending as a tool to unlock much-needed economic growth. Gambling with our future on risky economic strategies that have failed elsewhere is something we are not prepared to do.
Tito Mboweni is South Africa's Minister of Finance.