Worrying+facts+underlie+economic+patina+of+health,+B+Day

Business Day, Johannesburg, 21 April 2006
=Worrying facts underlie economy’s patina of health=


 * Neva Makgetla**

THE South African economy is looking more and more like that of so many of our compatriots: living beyond their means on the basis of high debt and low savings.

Household metaphors for national economies are always dubious. Still, this one seems apt, as extraordinary levels of foreign capital flow into the country without much increase in local investment, but a boom for rich consumers.

It is time that government, which has tried hard to contain excessive consumer borrowing, did something similar for the nation.

Capital flows into SA have grown extraordinarily rapidly over the past three years. Total foreign investment multiplied 10 times between 2002 and 2005, reaching R130bn last year, the largest yet recorded. Net financial inflows in 2005 totalled almost 5% of gross domestic product (GDP), in contrast with an average of 1% over the previous 10 years.

The biggest single investment was the Absa sale. Most of the rest was equity holdings in mining and finance.

But the capital inflows have not sparked an equivalent upswing in domestic investment. Rather, they fuel the soaring rand and balance of trade deficit, while the main productive sectors, employment and wages stagnate.

Last year, gross fixed capital formation — that is, total investment in SA — came to just under 17% of GDP, about 0,5% over the 2004 rate. Capital inflows climbed R50bn a year in 2004 and 2005. Investment, which ultimately drives economic growth, rose half as much, and public investments accounted for a third of the increase. Capital formation remains far below the 20% of GDP generally considered necessary for sustained economic expansion.

It should not come as a surprise that short-run foreign capital does not contribute to actual investment. After all, it underpins the overvaluation of the rand, which hobbles manufacturing exports and mining revenues.

Instead of stimulating investment, capital inflows have paid for a massive trade deficit. In 2005, the deficit reached 4% of the GDP, compared with an average of 0,5% in the first 10 years from 2004. Between 2000 and 2005, the volume of imports rose 44%, while export volume increased just 12%.

The resulting malaise in manufacturing threatens SA’s industrial capacity, as well as employment and investment. While financial and business services, construction and retail have benefited, mining, manufacturing and agriculture have faced mixed fortunes.

In 2002 to 2005, manufacturing grew about half the rate of the economy as a whole. In contrast, financial and business services expanded twice as fast as the GDP, and absorbed two-fifths of the growth in investment.

In these circumstances, economic growth remains exclusive and unstable. Certainly there are some broader benefits, in the form of job creation and higher government spending. But job creation remains too low to reduce unemployment substantially, and most of the jobs created are in retail, construction and lower-level services — typically poorly paid and insecure.

Still more worrying, if the capital flows reverse, these jobs are likely to be shed rapidly, while government finances face a renewed crisis.

As long as unemployment remains high, the main benefits from the current structure of growth will go to the already prosperous. The share of remuneration in the national income has continued to decline, and inequalities in income and wealth remain among the worst in the world.

Meanwhile, even the recent modest growth spurt could easily be reversed by a hiccup in world capital markets. Economic crises in middle-income countries as a result of sudden capital flight have become a feature of the global economy in recent years. A slowdown in commodity markets could leave SA bereft of both export revenues and short-term foreign investments, forcing painful adjustments. In the short run, government should consider two strategies to reduce the risks.

First, it should urgently introduce deterrents to short-run capital inflows. This type of measure, known as “speed bumps”, could for instance require that foreign investors place a share of their capital in long-term holdings, or impose a tax on short-term transactions.

Second, government should avoid concessions in trade negotiations that would further undermine manufacturing. With an overvalued rand, producers already face a harsh economic climate. Cutting tariffs will likely only undermine industrial capacity even further.


 * Makgetla is a Congress of South African Trade Unions economist.


 * From: http://www.businessday.co.za/articles/opinion.aspx?ID=BD4A188747**

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