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Ramaphoria Economics:

The Likely Impact of the South African President’s Plan to Revive the South African Economy – A Focus on Economic Growth and Employment

[3 850 words, excl. references]

1. Introduction

“In the State of the Nation Address in February [2018], we announced a range of measures that we would initiate to set the country on a new path of growth, employment and

transformation.” – Hon. Cyril Ramaphosa

South Africa has for the most time since the great financial crisis of 2008 faced tough economic times characterised by low growth. It is a discomforting fact that South Africa has, unlike many other countries, not fully recovered from the aftermath of the crisis even after such a long time. The economy simultaneously faces a staggeringly high unemployment rate which currently stands at 27.6% (StatsSA, 2019) and is one of the world’s highest. Adding to the nation’s problem, the country experiences large investment and capital outflows (see Figure 4 on page 5), which are associated with and compound the above-mentioned challenges that the country faces.

It against this backdrop that the current President – Hon. Cyril Ramaphosa, who took the helm in February 2018 – proposed a plan of action that would see the country ameliorate these conditions and sit on a higher growth path. The proposed plan aspires to attract $100 Billion investment within the next 5 years, meaningfully reduce the high unemployment rate, and to effectively achieve a high and desirable economic growth rate, which is 5%, as written in the National Development Plan (NDP) (National Planning Commission, 2013).

This essay aims to assess the likely outcomes of the proposed plan on economic growth and employment in South Africa. As a precursor, we first provide stylized facts on South Africa’s economic growth, unemployment and attraction of investment to show: the economic climate in which the President proposed the plan, how dire the situation is, and hence why it urgently needs to be altered. We next unpack the proposed plan by discussing it in detail. Based on international experience, we then draw conclusions on the impacts of the proposed plan on growth and employment in South Africa.

Further, because countries have different economic and social structures and experience different degrees of depth of the problems they face, what happens in one country will not necessarily be true for another. This motivates the essay to cover empirical analysis that aids in deriving a conclusion about how the plan will likely impact on South Africa. Lastly, the essay concludes.

2. Stylized Facts on South Africa’s Economic Growth, Unemployment Rate and FDI Flows

2.1 Economic growth

As noted, South Africa’s economic growth has been sluggish and discomforting since the 2008 crisis. The country’s economic growth exhibits hysteresis effects1: it has not been able to return to its pre-

1In Physical Science, ‘hysteresis’ is the inability of an object to revert to its initial position even after the effects of an external force is removed (Ball and Mankiw, 2002). Contextually, it refers to the inability of South Africa’s growth to return to its pre-crisis levels even after the crisis.

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crisis average level which hovered around 4%2. Such low growth over years has not been a problem only for the South African economy, but also its citizens (Harmse, 2006).

Figure 1 depicts the path South Africa’s economic growth rate took from 1980 to 2018, in comparison to emerging markets, advanced economies, and world economic growth rates. Panel A depicts 1994 and shows that South Africa had a comparable growth rate. In 2018 (Panel B), however, a completely different and gloomy picture was painted. As it is seen, the country’s economic growth rate was only a fraction of advanced economies’ growth rate. Despite that this was expected since developed economies generally perform better economically, it is alarming given that the country also grew much slower than its peers, the emerging markets. Compared to 1994, the country has also significantly grown slower than world economic growth, which adds to our woes.

Figure 1: South Africa’s growth rate, 1980 to 2018

Source: International Monetary Fund (2018)

2 The average growth rate was 5% between 1994 and 2003, and 5% between 2004 and 2007 (South African Reserve Bank, 2009).

Panel A: 1994

Panel B: 2018

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Economic growth is a necessary condition for ameliorating pressing issues such as poverty and inequality. Several studies evidence this. For instance, in Ravallion (2005) and Bhorat, Van Der Westhuizen and Jacobs (2009), it is shown that economic growth is negatively associated with poverty, with estimates suggesting that a one percentage point increase in economic growth in associated with between 1.3% to 3% in poverty alleviation. Other studies that found that an increase in economic growth led to poverty alleviation include Squire (1993) and Bruno, Ravallion and Squire (1996)

Similarly, Easterly (2001), Panizza (2002), and Bahmani-Oskooee and Gelan (2007) estimated that an increase in economic growth rate moderated inequality. Thus, it is easy to see why a higher economic growth is of paramount importance to South Africa, and also why the lacklustre growth is worrying and is receiving serious attention.

2.2 Unemployment

Correlated with and partly caused by the slow growth in South Africa is its high unemployment rate which is one of the highest (27.6%) in the world (see figure 2 below).

Figure 2: South Africa’s unemployment rate in comparison to other countries

Source: OECD (2018)

A bundle of factors are drivers of this high unemployment rate. One of these is the quality of education and a skills mismatch between workers and employers. Particularly, there is cry by education specialists and employers that the quality of education in South Africa is low, as Matriculants are required to obtain mediocre marks to enter university3 and South Africa ranks bottom and second last in mathematics and science4. Furthermore, the education sector has failed to

3 In 2015, only 15% of the cohort of students who enrolled in primary school made it into tertiary education after 12 years, and more than 25% of those enrolled dropped out in their first year of university (Mlachila and Moeletsi, 2019). 4 In a group of Grade 4 learners from 49 countries, Grade 5 learners from South Africa ranked second from the bottom in Trends in Mathematics and Science Study (TIMSS) test scores (Mlachila and Moeletsi, 2019). Moreover, in a group of 39 science and mathematics Grade 8 learners from different countries, South Africa’s Grade 9 learners rank second and bottom and second last, according to TIMSS test scores (Mlachila and Moeletsi, 2019).

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sufficiently produce Science, Technology, Engineering and Mathematics (STEM) graduates that the labour market requires. This shows that there is a mismatch between what South Africa’s education sector yields and what employers demand, which has translated into high unemployment.

It is worth noting that a bulk of South Africa’s unemployed form part of the youth. Hence, South Africa’s youth unemployment is startlingly high (52.4%) and is also one of the highest in the world. Figure 3 below shows this.

Figure 3: South Africa’s youth unemployment in comparison to other countries

Source: OECD (2018)

Overall unemployment and youth unemployment at these levels are unsustainable and breed poverty and inequality. Again, this has been supported by empirical evidence; Tregenna and Tsela (2008) estimated that expanding employment in South Africa would reduce inequality, which means that the high unemployment rate in South Africa aggravates inequality. Mafiri (2002) pens that large-scale unemployment in South Africa is also responsible for its prevalent poverty.

Other causes of high unemployment rate in South Africa include increases in the labour force (Hodge, 2002), slow economic growth and demand for labour in relation to rising supply of labour (Kingdom and Night, 2007), and higher labour market participation of African woman (Casale, 2004) who were unskilled (Banerjee et al., 2008) and who were previously excluded from the labour market, inter alia.

2.3 Foreign Direct Investments (FDI)5

The dawn of democracy in South Africa saw the country enjoy many economic benefits, among which was a steep increase in FDI into the country. At the back of this, the country was ranked among countries that had high attraction of FDI. The change of presidency in 2009 completely changed the picture, with the prevalence of corruption and frequent episodes of political turmoil intensifying, to

5 FDI is an investment in a country such that the investor owns a stake in a project or business in that country. It is usually in a form of starting a business in another country. FDI is different from portfolio investment, wherein an investor only acquires equity in a foreign business.

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date. The result of this was a steep decline in net FDI6 and, accordingly, South Africa was the third country in the world in terms of a high net outflow of FDI in 2017 (United Nations Conference on Trade and Development, UNCTD, 2017). Figure 4 below shows this.

Figure 4: South Africa’s net FDI as a percentage of GDP, in comparison to other countries

Source: UNCTAD (2017)

This reveals that investors are wary of and are withdrawing from investing in South Africa. Together with Angola and Togo, South Africa is the only African country on the list. Interestingly, this means that South Africa has more outflow of investors than countries that are much more mired in stagnation, such as Zimbabwe. Indeed, the only logical reason for this to happen is very low investor confidence, which has been true for South Africa, with business confidence trending downwards over the last ten years (See figure 5 in the appendix).

FDI plays a vital role in an economy through investment in fixed capital and growing of businesses, both of which contribute to economic growth. Through expanding economic activity, FDI is partly responsible for job creation (Masipa, 2018). In summary, South Africa needs to attract FDI and record a positive net FDI, which will assist in nursing its stubbornly low growth and in bettering its poverty and inequality landscapes.

3. In Full: The President’s Plan to Revive the South African Economy

3.1 The Stimulus package

6 Net FDI is the difference between what foreign investors invest in a country and what the country invests in other countries. A negative net FDI thus shows that investors – local and international – are losing interesting and have low confidence in a country.

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The proposed stimulus package has four broad parts: (i) implementation of growth-enhancing reforms; (ii) reprioritization of government expenditure to support job creation (iii) the establishment of an Infrastructure Fund, and (iv) addressing pressing issues in health and education.

3.1.1 Growth-enhancing reforms

The President indicated that these reforms centered around key industries that are drivers of growth and creators of employment in South Africa. It also considers stabilizing the fiscus.

Mining sector

That said, the mining sector was a target. The sector is important in terms of its tax contributions. It is therefore an important industry for the country, but has been disappointingly ailing, with its contribution to economic growth declining over years and the sector shedding jobs7. To stimulate the sector, the President noted that, together with the finalization of the mining charter, the Mineral and Petroleum Resources and Amendment Development bill was withdrawn.

Agriculture

As a sector that employs many unskilled people who make up a chunk of the labour market in South Africa, the agricultural sector was also the target. In this regard, the President pledged to resolve the controversial land reform and land expropriation without compensation. Resolving these controversial issues would restore confidence and certainty in the sector, which would boost employment. The Ministry of Finance will also fund the farming of export-oriented crops that are intensely labour-intensive, which is expected to boost employment. Lastly, the government will finalise the process of signing of 30 years leases, which will provide liquidity for farmers and agricultural development.

Tourism

The sector contributes 9.5% to total employment and 2.9% to growth in South Africa (Stats SA, 2019). Due to VISA regulations, the sector has been recording numbers that reflected a slow influx of tourist into the country, which threatens the sector and employment. Accordingly, the President announced that VISA regulations are being amended to boost tourism.

Manufacturing sector

The sector is also responsible for employing many unskilled South Africans. Unfortunately, it has not escaped the shedding of jobs: the sector lost 85 000 jobs between mid-2010 and mid-2018 (Presidential Job Summit, 2018), which extended South Africa’s doldrums.

To revive the sector, the President highlighted that there would be a localization program which will promote local procurement of products such as textiles, furniture and water meters.

3.1.2 Reprioritisation of Government Expenditure

This entailed spending on activities that had marked, positive impact on economic growth, domestic demand and employment. Specifically, emphasis was on townships and rural economies, women and youth8. The President further highlighted that the country needed to wisely manage its finances as there was limited fiscal space to increase expenditure or borrow. However, the upwardly revised budget deficit (from 4.2% to 4.5%) and expenditure ceiling that was increased by R16 Billion (National Treasury, 2019) are potentially a threat to expenditure reprioritization.

3.1.3 Infrastructure Fund

7 The sector has shed 20% (80 000) jobs since 2012. 8 A township and rural entrepreneurship fund to provide funds for new businesses or supporting start-ups is being stablished.

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Realizing the importance of quality infrastructure to economic growth, attraction of investment, and therefore employment, the President set to establish a fund that would be designated to fundamentally transforming the government’s approach to rolling-out, building and implementation of infrastructure projects. The fund would also reduce the current, visible fragmentation of infrastructural spending and ensure more effective and efficient utilizations of resources. More than R400 Billion will be spent on the fund over the medium term.

To ensure that the funds are used appropriately, on time and on budget, an Infrastructure Execution Team is being established by the Presidency. The team will comprise of individuals with extensive project management and engineering expertise.

3.1.4 Addressing pressing issues in education and health care

To address shortages in hospitals, funds will be immediately directed to hospital infrastructure such as beds and linens. The Minister of Health will immediately fill 2 200 medical posts (including nurses and interns), to address personnel shortages.

Funds will be directed to the education sector, so that the dire situation of sanitation in public schools will be sorted. This will be initiated by completing 1 100 sanitation projects in the 2018/2019 financial year.

3.2 Job summit

The summit is expected to create 275 000 jobs per year (Presidential Jobs Summit, 2018). To achieve this target, the country’s social partners – business people, labour unions, government and community constituents – signed an agreement which proposed many solutions to the country’s unemployment conundrum (Presidential Jobs Summit, 2018). These solutions were the output of months of engaging between social partners and the National Economic Development and Labour Council (Nedlac) on how to create and retain jobs (Presidential Jobs Summit, 2018). These solutions included a ‘rapid-response’ teams of experts that will assist businesses before they retrench; the revival of the training layoff scheme; the promotion of local exports and providing of finances for business at a greater scale (Presidential Jobs Summit, 2018).

3.3 FDI Attraction (Investment drive)

The plan herein is to achieve a target of $100 Billion investment into the country within the next 5 years. To make this possible, the President appointed a team of business, economic and finance experts that will be responsible for scouring the globe to achieve this target. The economic team includes the former Minister of Finance, Mr. Trevor Manuel. In a quest to attract many investors into the country, the team will envoy to Europe, Asia and across Africa. The success of this would significantly boost investment and employment in the country, thus relieving it of the economic and fiscal issues it faces.

4. Learning from international experience9

China

9 Space permitting (also see Korea and Thailand), and because these countries have in a short period of time grown in a manner that is uncharacteristic, in this section we only consider China, Japan and Vietnam.

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Notwithstanding the differences between the economies of South Africa and China, South Africa’s current economic setting shares some similarities with economic setting China had in 1979 (Algu, 2014). Prior to 1979, China experienced high unemployment and stagnant growth (Morrison, 2014). In 1979, China implemented several economic reforms that saw the economy rank second in the world after 30 years (Morrison, 2014). One of these reforms was to open-up the Chinese economy, which saw a high inflow of FDI into the country. Accordingly, since the 1990s, China has been amongst the countries with largest attraction/inflow of FDI (Lo, 2004). This, together with rapid expansion of international trade, strengthened the country’s integration into the world economy (Lemoine, 2000) and rapidly increased economic growth and employment.

China’s experience also teaches the importance of export-creation and reviving the manufacturing sector – which are emphasized in the South African President’s plan – to foster growth with rising employment. In late 1970s, China began investing in promoting exports in its manufacturing sector (Morrison, 2014). This led to a rapid rise in productivity and to the success of the manufacturing sector (Morrison, 2014), which in turn boosted employment in the sector and the economy in general. From China’s experience, we thus expect the President’s plan to boost employment, economic growth and alleviate socioeconomic issues such as poverty and inequality.

Japan

Similar to China, Japan amazingly grew from being a small economy to one of the world’s powerhouses, in less than 30 years. After world war II, the Japanese economy grew at a high rate, so much so that countries such as the U.S. felt threatened by Japanese firms (Bebenroth, 2015). This was triggered the abolition of heavy restrictions on inward FDI by foreign firms dealing with Japan that Japanese authorities had set (Bebenroth, 2015). However, these restrictions were seemingly still felt by foreign investors, with foreign investors citing that it was still, although to a lesser extent, a challenge to invest in Japan.

In response to this and in a bid to boost new investment into the country, Japan further removed its restrictions on inward FDI (Bebenroth, 2015). As a result, by mid-1990s Japan had transformed from being a small economy to a ‘mid’ economy in Asia (Wolff, 2000) and to one of leading economies today. This highlights the important role FDI plays on countries and that the President’s plan could potentially play in South Africa.

Vietnam

Just 30 years ago, Vietnam was one of the poorest countries in the world (Vanham, 2018). In mid-1980s, Vietnam’s GDP per capita was stuck between $200 and $300 (Venham, 2018), which reflected how poor the country was. Today, the country is one of the “stars” of emerging markets (Vanham, 2018), with its economic growth rate of between 6% - 7% surpassing the U.S.’s and rivaling China’s. How did this happen? According to Eckardt et al. (2018), this economic miracle is due to mainly three factors, one of which was opening its borders to foreign investors. This was made through its First Law on Foreign Direct Investment, which enabled foreign firms to enter and invest in Vietnam (Eckardt et al., 2018).

Since then, the law has been revised many times to make it more pro-investor while mitigating administrative bureaucracy and better facilitating foreign investors (Baker McKenzie, 2016). This saw the country first enjoy the economic benefits (such as a prospering and thriving economy) that it enjoys to date. The country also spent significantly more on its human capital and physical infrastructure (Vanham, 2018). The country’s manufacturing sector – which is the backbone of the country’s economic success – is largely driven by FDI, which forms about 90% of the manufacturing sector’s exports (Eckardt et al., 2018).

Key takeaway from the international arena

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These countries grew by attracting more FDI, spending more on and reviving their manufacturing sectors, and spending on infrastructure and human capital (education). These are at the heart of the President’s proposed plan. Therefore, drawing on international experience, the President’s plan will likely boost employment and economic growth, which is expected to remedy challenges such as poverty and inequality in the country.

5. Empirical analysis

This section seeks to analyse the relationship between FDI (net inflow as a % of GDP), unemployment and economic growth in South Africa. We chose these three variables since they are at the center of the President’s plan and thus simultaneously impact on each other. For instance, if the plan succeeds and the desired FDI is achieved, economic growth is likely to edge up, with a moderating unemployment. A low unemployment rate and higher economic growth rate, in turn, will likely induce more FDI inflow, as they would be signaling a stable macroeconomy. Thus, there are feedback effects present. To take this into consideration, we employ the Vector Autoregressive (VAR) model, with the representation due to Russell (2015):

Where X and Y are vectors of (endogenous) dependent and independent variables, respectively.

The sample period ran from 1991Q1 to 2017Q4 with data interpolated to increase the sample size and hence accuracy. The beginning of the sample (i.e. 1991) was guided by the availability of South Africa’s unemployment data. All data were sourced from the World Bank’s Open Data repository. Tracking Masipa (2018), we included total government expenditure (as a % of GDP), trade (ratio of imports plus exports to GDP) and real effective exchange rate as other variables in the model. Variables were differenced once to satisfy stationarity requirement of VAR.

The following impulse responses were obtained from our estimation:

From the graphs above, a 1 standard deviation increase in FDI between quarter 1 and 2.5 has no impact on growth. After 2.5, FDI increases with reducing economic growth, indefinitely. With unemployment, FDI increase has no impact from quarter 1 to quarter 4.5, after which unemployment increases. These results suggest that FDI into South Africa reduce economic growth and hike unemployment rate. However, a caution is in line: the above IRFs should be interpreted in inverse (opposite) to what they depict. We used net FDI inflow as a proxy for FDI. Net FDI has been negative for most of the time in South Africa and hence also in our sample, which, as discussed, signals that more investors have been flowing out of the country.

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More investors flowing out implies lesser number of businesses and jobs and lower economic growth in the country. Thus, a decrease in net FDI inflow (i.e. more negative net inflow) results in a decrease in economic growth and an increase in the unemployment rate. Hence, to the extent that the above IRFs suggest that more investors flowing out of the country reduces economic growth and hike the unemployment rate, the above IRFs also imply that FDI has a positive impact on economic growth and unemployment rate in South Africa. From this we infer that the President’s plan will likely induce a higher economic growth rate and lower unemployment rate.

6. Conclusion

While the essay concludes that the plan will have a positive impact on growth and employment, we caution that the impact will be minimal. This is because the plan largely focuses on deteriorating growth, employment and FDI inflows, because of structural problems faced by the country. In essence, the plan looks at treating symptoms rather than causes of economic stagnation and low FDI inflows.

These structural problems include low skills stemming from low tertiary enrolment and poor basic education, corruption, political and economic uncertainty (land reform and spectrum allocation, for example), declining competitiveness (SA is slipping because of factors such as deteriorating infrastructure), poor governance of SOE’s (most notably ESKOM) and rising government debts (arising mostly from bailouts to failing SOEs).

Unless the government treats these fundamentals, any plan it carves will, if any, have minimal positive economic impacts. We thus caution that the plan should be implemented in line with policies suggested at tackling these fundamentals. For instance, the country is in need of stabilizing finances of SOEs, lest the fiscus is pressured and economic growth stifled

7. Appendix

Figure 5: Investor’s Confidence in South Africa

Source: Trading Economics (2019)

8. References

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Baker McKenzie, 2016. Baker McKenzie. [Online] Available at: hhttps://www.bakermckenzie.com/en/insight/?keyword=japan&articletypes=9cbfe518-3bc0-4632-ae13-6ac9cee8eb31&skip=18&reload=false&scroll=2860 [Accessed May 2019].

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Banerjee, A., Galiani, S. F., Levinsohn, J. A., McLaren, Z., & Woolard, I., 2008. Why has unemployment risen in the new South Africa. Economics of Transition, 16(4), 715-740. Bebenroth, R., 2015. International Business Mergers and Acquisitions in Japan. Tokyo: Springer Japan.

Bhorat, H., Van der Westhuizen, C. & Jacobs, T., 2009. Income and non-income inequality in post-apartheid South Africa: What are the drivers and possible policy interventions?

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Mafiri, M.I., 2002. Socio-Economic Impact of Unemployment. Pretoria: Van Schaik Publisher Masipa, T.S., 2018. The relationship between foreign direct investment and economic growth in South Africa: Vector error correction analysis. Acta Commercii,i 18(1), 1-8 Mlachila, M. & Moeletsi, T., 2019. Struggling to Make the Grade: A Review of the Causes and Consequences of the Weak Outcomes of South Africa’s Education System, IMF.

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