South Africa’s government finances are facing a severe squeeze and will continue to do so as long as we have a miserable economic growth rate and high spending demands.
This afternoon the Finance Minister, Enoch Godongwana, will deliver a Budget Speech which is an annual attempt at a balancing act between responsible fiscal policy and acceding to the wishes of the ANC for more spending. Deep spending cuts are difficult, as about two-thirds of spending is uncontrollable, and raising income tax would only yield marginal amounts of revenue and would inflict economic damage.
Without politically difficult reforms, we will continue to be stuck in our low-growth trap and remain at risk of a public sector borrowing crisis.
Low growth means a low tax take and higher borrowing and debt service. Last year our growth, according to a number of estimates, was less than 1 percent, implying no growth in our per capita income. A slight rise in growth to 1.5 percent is expected by the International Monetary Fund (IMF) this year, but there is nothing on the horizon that will come close to shooting the lights out for our economy. Much of the improvement this year is due to the end of load shedding and the expected improvement in our freight system – ports and railways, as well as an improved international environment.
Higher debt burden
Low growth means a higher debt burden. Treasury’s projected debt to GDP ratio made in October last year was 75.5 percent for this year. That is well above the emerging market 2023 average of 57 percent. But most emerging markets are growing a lot faster than we are and can therefore carry this sort of debt with greater ease.
Uncontrollable spending, which is either legally mandatory or cannot be cut without severe consequences, makes up about two-thirds of state spending. After capital investment, debt service will be the fastest-growing category of spending, at nearly seven percent a year over the next three years, as laid out in the Medium-term Budget Policy Statement released in October last year. Debt service is projected to take up about 17 percent of spending over the next three years; education, 20 percent, grants, nearly 16 percent, and health, slightly more than 11 percent.
There is upward pressure on all these categories. If low growth and high spending persist, we are likely to need to borrow increasing amounts, which can only be done at higher interest rates. Grants cannot be cut and will grow with population growth and as more people live longer. As has been demonstrated with the Social Relief of Distress grant, brought in as a temporary measure to alleviate hardship during the Covid epidemic, grants are politically impossible to cut.
Despite the need to finance uncontrollable spending, our tax base is extraordinarily narrow. About 20 percent of individuals contribute 75 percent of personal income tax, which makes up about 35 percent of tax revenue. And that helps pay 40 percent of individuals who rely on social grants. Nearly 32 percent of the workforce are unemployed and unlikely to ever be taxpayers.
If there is one possible solution to our poor fiscal state, it is faster growth. But ANC rule has pretty much made faster growth impossible.
After 1994
For more than ten years after 1994, SA experienced reasonably strong growth. With President Jacob Zuma coming to power and the ensuing State Capture, and the Global Financial Crisis, we never fully recovered our growth rate. Our annual average growth rate between 1994 and 2007 was 3.6 percent, and between 2008 and 2023 only averaged 1.1 percent, very slightly above our population growth rate of 0.9 percent a year.
Behind this growth collapse has been a sharp fall in growth in Total Factor Productivity, the combination that contributions of capital and labour make to growth. This is the magic potion of growth as it reflects how good management is at making good decisions about allocating labour and capital, and then how well it runs things.
Growth can rise with increasing contributions from either capital and labour, but Total Factor Productivity reflects how adeptly investments were made and managed, and their longer-term contribution to growth. Between the two periods 1994 to 2007 and 2008 to 2023, this type of productivity declined by nearly two percentage points, according to the IMF in its report on SA released last week.
Behind this was low private investment and a rising share of that by the public sector. According to the Fund, the causes of low private investment in SA are, “bureaucracy, corruption, red tape, and political instability.”
“Despite being substantial, public investment has been inefficient, primarily directed towards underperforming large State-Owned Enterprises (SOEs),” says the IMF in its latest report on SA. Public enterprises remain a disaster area, but the government remains committed to using them as vehicles for investment and growth.
Major investment
The government now plans major investments in infrastructure, with a more than ten percent annual rise in such spending over the next three years. State investment under the ANC has resulted in a gross misallocation of resources.
The IMF says there are other factors, such as high market concentration in manufacturing and banking which inhibits smaller firms that create new jobs. And there are also factors such as “high labour costs, skills mismatches, and regulated hiring and firing practices that have also contributed to high unemployment and low productivity growth,” says the IMF.
Black economic empowerment is also a continuing drag. Many companies simply won’t invest here because of empowerment ownership requirements, but the government just does not seem to care. Empowerment carries a heavy price for growth both in the extra cost it incurs on investors and on the prices the public sector is permitted to pay for empowerment procurement.
Another factor behind the downward pressure on growth is the disastrous state of municipalities that have long been run by the ANC.
Grand economic reform
If our growth rate is even to slightly improve, grand economic reform is a necessary, but not a sufficient condition. That would involve privatisations, easing up on labour restrictions, scrapping red tape, and doing a lot else that any ANC-government – never mind an ANC- controlled Government of National Unity (GNU) – would find impossible.
Operation Vulindlela, the ANC’s reform programme, is really about trying to deal with the symptoms of an essentially rotten system rather than addressing the underlying issues.
One great disappointment in the GNU is that the ANC is able to dominate, although it only has 40 percent of the vote. Under a deal, the DA says it has agreed with the ANC that the full National Health Insurance project will not be implemented, and private medical aids will continue. It also has, for the moment, ministers in key departments that can thwart Expropriation Without Compensation and the Basic Education Laws Amendment Act. But the DA cannot push for full-blown grand reform.
That is why, despite slightly higher growth, our economy and public finances remain vulnerable to crisis.
The views of the writer are not necessarily the views of the Daily Friend or the IRR.
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