South Africa: From Bad to Worse

While Europe is struggling with the outcome of the European Parliamentary elections and the United States in a macroeconomic limbo after the first-quarter GDP growth shock, countries in other parts of the world face similar economic challenges. This shows that the systemic economic problems in, primarily, Europe and, secondarily, the United States are not confined to those old, mature welfare-state economies. Other countries could learn a great deal from their experiences, but we can also learn one important lesson from them, namely that the problems plaguing Europe and America are indeed systemic and not somehow unique experiences.

South Africa is a case in point: a country run by radical socialists whose policies are slowly destroying the economy. Last year I pointed to South Africa’s growing stagflation problem, which fundamentally is caused by the ANC government’s stubborn commitment to the welfare state. Since then the inflation-unemployment problem has grown worse. Premier South African publication Business Day reports:

Last week, President Jacob Zuma was inaugurated and his new cabinet announced. Their task is to implement the National Development Plan, which targets annual growth of 5.4%, and “radical socioeconomic transformation policies and programmes”. Their task is urgent. Figures this week revealed that the economy had contracted for the first time since the 2008/09 recession.

Last year I explained that the National Development Plan, with its slew of new entitlements handed out left and right,

is yet more evidence that the ANC is determined to drive South Africa into the ditch, and then have the elephant of big government stomp her to into a pile of trash. … More tax-paid educational programs that won’t lead to any new jobs, because in order to pay for them the government has to put yet more hate taxes on the “rich”. This crushes small businesses, which are almost without exception the best job creators in any economy. And since nothing is being done about the corruption in the country, except talking about it, larger corporations are unlikely to want to expand their operations in South Africa. As a result, the young who are lured into these new ANC-proposed programs – if they ever become reality – will get an education they can’t use. Their frustration with their government may be postponed, but it will be exacerbated by the years that the young feel they wasted on a useless education. … The National Development Plan shows clearly that with the ANC in power, things are only going to deteriorate. But hopefully it will also be the motivator for the political opposition to begin formulating a common-sense alternative. South Africa deserves better than socialism.

The Plan also talks at great length about promoting “ownership among historically disadvantaged groups”, in other words about keeping racism alive two decades after the death of Apartheid. Furthermore, there are large sections about reducing income differences – called “income inequalities” in the Plan – which is nothing more than the same old ideological leftovers that Europe’s welfare states have been regurgitating for the better part of a century now. Income redistribution is a safe way to discourage people from working: the free entitlement reduces efforts by those considered to be entitled by government; the taxes that pay for those entitlements discourage higher-income earners from working. In both ends the tax base shrinks and more people end up eligible for increasingly unaffordable entitlements.

In short: the National Development Plan is a recipe for a Scandinavian welfare state in South Africa. Bad, bad idea.

In fact, the idea is even worse now than it was a year ago, given South Africa’s macroeconomic ailments. The Business Day again:

When searching for explanations for the first-quarter drop in GDP of 0.6%, it is clear that local domestic factors dominate. Newspaper headlines focus on the collapse in mining output, dragged down by a platinum strike and a drop in manufacturing output amid weak demand, and rising costs. But growth in the services sector, which expanded at an annualised rate of 1.8% in the first quarter this year, is also subdued. This highlights underlying weakness in domestic demand. Consumer spending is slowing amid sluggish job creation, waning credit growth, rising inflation and low confidence levels.

That was a good summary of South Africa’s macroeconomic problems. Adding a full-fledged Scandinavian welfare state to this mix is like pouring high-octane gasoline on a fire.

I fear that the ANC is not going to listen to such warnings, but instead charge ahead with their entitlement expansion. The only way they can pull that off, even in the short term, is by printing money faster – another thoroughly bad idea in an economy with up to 40 percent unemployment.

Business Day again:

The country’s tight electricity supply will hang over growth prospects until constraints are eased. At the same time, inflationary pressure is on the rise. CPI accelerated to 6.1% in April, breaching the Reserve Bank’s inflation target 3%-6% range. Producer prices also accelerated to an annual 8.8%, which implied further upside price pressures in the months ahead. HSBC expects CPI to rise above 6.5% later this quarter, which will put more pressure on Reserve Bank governor Gill Marcus to deal with the challenges associated with this enveloping stagflationary malaise.

Which, again, I warned about more than a year ago.

There are other knock-on effects of this weak growth. For one thing, it is likely to undermine tax revenues, while the stoppages in the platinum sector will suppress exports. The country’s twin deficits — the fiscal deficit and current account deficit — are likely to deteriorate in this environment, and the near-term outlook could be clouded by more poor data, whether from mining and manufacturing production, retail sales, international trade, or GDP growth in the second quarter.

How is the ANC government going to fund its deficit? With stagflation de facto already in place it is unlikely that foreign investors will have the confidence needed to invest in South African Treasury bonds. This effectively forces government to ask the Reserve Bank to print money to fund the deficit.

This does not necessarily mean accelerating inflation over night. But with zero growth and inflation already in place, it could have that effect sooner than in other economies (such as the euro zone where they are currently trying to fend off deflation).

That said, there are some mitigating circumstances. For example, some of the depressing growth numbers in the South African economy are due to single-sector events. Explains Mail & Guardian business reporter Thalia Holmes:

South Africa’s gross domestic product (GDP) has shrunk for the first time since the 2009 recession, decreasing by 0.6% in the first quarter of the year, and causing analysts to scale back their predictions of upcoming interest rate hikes. The nominal GDP at market price during the first quarter of 2014 decreased by R2-billion from the last quarter to R874-billion. This marked a sharp change in direction from last quarter’s GDP growth of 3.8%. South Africa’s fall in productivity was largely due to a huge loss of output in the mining and quarrying industry, which decreased by almost 25%. “Economic activity in the mining and quarrying industry reflected negative growth of 24.7%, due to lower production in the mining of gold, the mining of other metal ores [including platinum] and ‘other’ mining and quarrying [including diamonds],” said the report from Statistics South Africa (Stats SA).

Nevertheless, an economy has the structure it has. If it depends heavily on one industry, such as mining, then all its residents, businesses and households alike, as well as government will have to pay the price for that dependency. If anything, this is a wake-up call to the ANC government to get serious about promoting private-sector growth on a broad scale, to pursue industrial diversification through deregulations, tax cuts and ironclad protection of property rights.

Unfortunately, I don’t see this happening so long as their focus is on the National Development Plan.

And just to make matters a bit worse, Thalia Holmes continues:

However, Nedbank observed in an emailed note that “the economy’s fragility was on display in most other sectors too. Manufacturing output dropped sharply.” Output in the sector declined by 4.4% from last quarter. Investec group economist Annabel Bishop attributed the slowdown to “work stoppages caused by strike action and electricity constraints”. Nedbank added that “the pace of activity in most of the services industries also slowed to the low single digits. The only rays of light came from construction and agriculture, where output rose by annual rates of 4.9% and 2.5% respectively over the quarter.” At the same time, the South African Reserve Bank has released a report indicating that the country’s Leading Business Cycle Indicator has continued to decline. The leading indicator, which predicts trends in the economy, was down by -2.36% in March from the same time last year, following a similar -2.7% decline in February.

As the Business Day story pointed out, consumer spending plays a big role in this. The combination of high unemployment and high inflation is venomous to consumer spending. Add to this that many analysts in South Africa seem to expect the Reserve Bank to raise interest rates soon, and the outlook for the country’s economy is even more pessimistic. Higher interest rates discourage consumer-directed installment credit, which will hold back consumers on both the housing market and the market for cars and similar big-ticket durables. This spills over into small businesses, which are often run on basically the same terms as  family finances.

South Africa’s problems are structural. The country has earned a reputation for being unreliable, and the reputation has reached such momentum that Japanese car manufacturer Nissan recently decided to choose Nigeria instead of South Africa for its African production expansion.

When you lose out to Nigeria, you know you are in trouble…

I wish I could express great hopes for South Africa, but so long as the ANC keeps pursuing their welfare-state dream and keep trying to push it onto an already struggling private sector, things can only go downhill.

If, on the other hand, the ANC abandoned its socialist delusions and actually started governing for the future, South Africa would have enormous potential.