Chapter 2

The Macroeconomic Environment for Labour Market Policies

 

50. The two primary objectives animating the recommendations which follow ­ the eradication of poverty and the elimination of discrimination and disadvantage ­ cannot be met through labour market policy alone. A favourable general economic environment will greatly assist the pursuit of these goals. An unfavourable economic climate may weaken, or even defeat, policies to restructure the labour market.

 

51. National economic policy must, of course, pursue other objectives as well, and trade-offs among competing objectives will be necessary. But the requirement of overcoming poverty and discrimination must occupy an important place in the shaping of general macroeconomic policies.

 

52. A successful assault on poverty, inequality and discrimination is not only a moral commitment of the South African government; it is also a prerequisite for the attainment of other economic objectives. Failure to address the legacy of apartheid, a legacy which sees millions employed at levels below their true capabilities and others not at all, will cast a long shadow of political uncertainty over South Africa's economic prospects. While growth is a crucial means of achieving successful redistribution, the Commission strongly argues that a degree of redistribution of existing income flows is consistent with the goal of more rapid growth. The claim that South Africa must preserve its extremely high degree of inequality in order to foster growth is simply false. On this the international record is clear: neither buoyant private investment nor monetary stability ­ key indicators of successful macroeconomic policies ­ will survive the social unrest and personal insecurity of a sharply divided and embattled society. Nor is a highly unequal economy consistent with strong internal markets into which the vast majority of domestically produced output must be sold.

 

53. In this chapter we consider the role of macroeconomic policies. Though beyond the strict terms of reference of the Commission, they impact greatly on the success of the labour market restructuring process, and form a vital backdrop to the recommendations made in other chapters of this Report. Here we will not make detailed recommendations but rather raise issues for consideration by the relevant policy-making bodies. Our caution in this regard is motivated in part by the observation that the macroeconomic models reviewed by the Commission and the various relevant government departments, assign very different priorities to the various economic linkages and often yielded conflicting results. Furthermore, the predictive value of empirical macro-models is significantly reduced by the fact that the data upon which they rest reflects the economic stagnation that accompanied the historically unique circumstances of the crumbling of the apartheid system. This is not to imply that macroeconomic models tell us nothing about the constraints that bind the South African economy. For instance, most models agree that South Africa experiences balance of payments constraints during growth phases, which points to the need to improve export competitiveness.

 

54. Macroeconomic policy must be consistent, co-ordinated, and oriented towards the sustainable growth of output and employment. The labour market is central to this endeavour. The Commission holds that the goal of labour market policy should be to increase both flexibility and security in the labour market, as defined in Chapter 1 of this Report and in the ILO Review. The Commission rejects any exclusive reliance on the lowering of real wages as a means of increasing employment. The burden of economic adjustment must not fall on workers alone.

A Labour-Absorbing Growth Path

 

55. While the government must play a leading role in ending poverty and discrimination, these objectives cannot be addressed solely through programmes that transfer income and other resources to South Africans historically denied opportunities. Poverty and discrimination cannot be overcome by redividing the cake alone; both objectives require an enlarged cake based on a new structure of productive opportunities in the South African economy.

 

56. This simply restates a core position held by the Commission: job creation is crucial to eliminating poverty and discrimination, but no less important is job enhancement ­ creating better jobs by recognising, developing and rewarding the skills of working people.

 

57. Expanding the employment of South Africans ­ whether in the private or the public sector of the economy ­ requires the sustained growth of output at levels considerably higher than that experienced over the past 15 years, when real gross domestic product grew at an average annual rate of just 1.3%.

 

58. Economic growth is necessary for job creation, but alone it is not sufficient. Nor is economic growth by itself adequate to overcome the historic deprivation of literally millions of South Africans. The welcome return of the South African economy to a trajectory of economic growth in recent years has generated disappointingly few jobs. The South African Reserve Bank estimates that the past two years of modest economic growth have generated a net increase of just 12 000 jobs in the formal, non-agricultural economy, both public and private. The Commission notes, however, that the employment figures used in this calculation differ by as much as 2.5 million workers from the more comprehensive October Household Survey figures, and may thus significantly understate the number of jobs created in the formal economy, to say nothing of possible increases in informal employment. The ILO Review provides a more detailed discussion of the uncertainties surrounding employment estimates. The degree of discrepancy underlines the position adopted in the ILO Review that better employment data are urgently needed to facilitate policy formulation.

 

59. South Africa cannot wait for the rising tide of economic growth to trickle down to those in poverty. Economic and labour market policies must ensure that South Africa follows a more labour-absorbing growth path which narrows the gap between the haves and the have nots. The macroeconomic co-ordinates of a labour-absorbing growth path are:

 

• Macroeconomic policies that support the steady, sustainable and co-ordinated growth of demand for, and supply of, goods and services. Demand growth without a corresponding supply response will result either in inflationary pressures or balance of payments problems or both.

 

• Stable relationships among the social partners that will help ensure a trajectory of prices, productivity, salaries, wages and taxes sufficient to maintain adequate levels of private investment. The determinants of stability and investment are explored in more detail below. Chapter 10 explores the crucial role that a national Accord for Employment and Growth can play in contributing to a co-ordinated package of labour market and macroeconomic policies.

 

• Exchange rate policies which do not prejudice domestic producers ­ both exporters and those producing in competition with importers ­ and which will avoid both the employment dampening effects of an overvalued rand and the inflationary effects of excessively rapid depreciation. The Commission does not take a position on the complex technical and political question as to whether the exchange rate is currently under- or over-valued. We are cognisant of the rand's recent significant depreciation against the other major currencies, and of the fact that this depreciation would likely be accelerated were the Reserve Bank to lower the interest rate. The Commission also notes that the removal of exchange controls could have a dramatic effect on the value of the rand, and hence argues that policy in this area must be carefully sequenced with other policy reforms.

 

• Policies aimed at increasing access by labour-intensive businesses to credit markets and reversing the historical legacy of favouring highly capital-intensive investments. These are explored in Chapter 3.

 

• Public sector employment programmes to produce needed infrastructure in the areas of housing and rural public works; these are discussed in Chapter 7.

 

• Public investment to enhance the infrastructure of the growth process in fields such as human resource development, transportation and communication.

 

60. The Commission thus rejects the view that policies impacting on interest rates, the budgetary deficit, the exchange rate, and the rate of inflation should be formulated without regard to their impact on employment creation. The general view held by the Commission is that macroeconomic policy must be designed with both its short-run and long-run effects on the level of employment in mind. However, in like measure, we reject a narrow conception of labour market policies: their effect on macroeconomic outcomes such as economic growth, inflation, investment and global competitiveness must be fully taken into account.

 

61. The primary means by which labour market policies influence macroeconomic outcomes is through the wage-determination process. When nominal wages increase more rapidly than labour productivity, the result may be a more rapid rate of inflation. While this linkage is well documented, it is important to note that inflation (rising product prices) is neither synonymous with nor caused solely by rising wage levels. In particular, the degree of competition in product markets is a key factor in determining whether firms are able to pass wage increases along to consumers in the form of higher prices.

 

62. The possible negative consequences of higher rates of inflation are several. Firstly, higher rates of inflation may undermine investor confidence and thus reduce the growth rate of the capital stock. Secondly, higher rates of inflation reduce the living standards of the most vulnerable members of society whose incomes are typically not indexed to inflation. Third, higher rates of inflation may cause an appreciation of the real effective exchange rate, reflecting higher unit labour costs, a reduction in international competitiveness, and hence decreased profitability and employment in export-oriented sectors. Otherwise stated, rapidly rising wages may prevent nominal exchange rate depreciation from translating into real depreciation.

 

63. According to the South African Reserve Bank, real unit labour costs in the non-agricultural economy reached a peak in 1992, and have since fallen by about 5.5%. The Commission holds that further reductions in unit labour costs are desirable, but observes that unit labour costs are determined by a host of factors in addition to the blue-collar wage bill, including the level of productivity, managerial efficiency, and the cost of white collar salaries and wages. The recent depreciation of the rand has lowered South Africa's unit labour costs relative to those of its major trading partners. Furthermore, the impact on average unit labour costs of depressing unskilled wages in some sectors is relatively small in comparison to the effects of changes in the other determinants of unit cost. All of these factors must be addressed as part of a coherent strategy to improve competitiveness and productivity.

 

64. The Commission recommends in Chapter 10 that a national Accord for Employment and Growth be negotiated to help reduce the risk of "wage-push" inflation. While acknowledging that the precise dynamics of inflation are poorly understood, the Commission notes that recent low levels of inflation are an encouraging development and may provide policy makers with some room for manoeuvre on this front. However, the Commission acknowledges that this room for manoeuvre is limited by the rand's recent depreciation, which, by one estimate, may be expected to add two percentage points to the rate of inflation of consumer prices in the coming year.

 

65. What is required is a co-ordination of labour market policies, macroeconomic policies, and industrial, particularly trade-related, policies. The major actors must recognise trade-offs where they exist, and select policies in all areas in light of the full range of the objectives of the government.

 

66. One conspicuous example of the negative employment consequences of the failure to co-ordinate policy reforms is the recent experience with tariff reductions that were not offset by reductions in the value of the rand. The result of reduced tariff protection without an offsetting reduction in the value of the rand has been dramatic employment loss and increased imports in certain labour-intensive sectors. While the rand's significant depreciation in the first few months of this year has eased the pressure of competition from imports somewhat, the Commission holds that the need to co-ordinate exchange rate and tariff policies is a strong argument for the importance of a comprehensive national Accord around these and other macro-variables, as detailed in Chapter 10.

 

67. Whether economic growth is jobless or employment creating, and whether it deepens existing economic divisions or attenuates them, depends in important part on the institutions and policies governing the growth process. The Commission has identified two pillars of a growth strategy capable of generating secure employment on a scale adequate to South Africa's needs: investment and economic stability (the latter an outgrowth of the institutional framework) and the quality of information flowing through those institutions.

Investment for Jobs and Growth

 

68. Investment in the South African economy stagnated in the decade prior to the formation of the Government of National Unity. In 1983 gross domestic fixed investment was 26.8% of GDP, while in 1993 this figure stood at 15.5%.

 

69. Despite the more favourable investment record achieved in 1995, when gross domestic fixed investment rose by 10.5%, the promotion of investment and the installation of new plants and equipment remains a central challenge.

 

70. As important as the total amount of investment is the form which it takes. New equipment may destroy jobs or it may create them; massive investment in sectors or projects employing few will do little to address the jobs problem, at least not in the short or medium term. Thus the scale of investment, its distribution among sectors of the economy, and the actual technologies chosen by investors all have an impact on the rate of job generation. The sectoral composition of investment and technology choice is dealt with in Chapter 3 of this Report. Here we are concerned with the overall determinants of investment.

 

71. Much is confidently asserted about the best way to foster a strong investment climate. However, the subject remains controversial. Common sense suggests that investment will take place when:

 

• There is a demonstrated need for new productive capacity. The level of demand for goods and services must be sufficiently great to be pressing on existing capacity.

 

• Investors are satisfied with the basic "rules of the game" governing business and are confident that these rules will endure for the duration of their investment.

 

• The after-tax returns on investment are sufficiently high both to motivate expansion of capacity and to provide (some of the) funds for future investment.

 

• The cost of borrowing funds for the purpose of productive investment (and the returns to using these funds for speculative, financial or other non-productive purposes) is sufficiently low to render productive investment profitable relative to other options. The Commission notes with concern that the Reserve Bank's inflation-fighting policies have resulted in one of the highest real interest rates in the world. This has unquestionably inhibited the rate of domestic investment, particularly by small enterprises. Likewise, consumers' ability to borrow for the purpose of purchasing housing is impaired by high real interest rates, with negative implications for the labour-intensive housing construction industry.

 

• There exists the prospect for stable and productive relations between labour and management over the long term.

 

72. There is overwhelming evidence ­ for South Africa and internationally ­ of the importance of growth in demand as a determinant of private investment. For example, the demand-side determinants of investment were emphasised in a recent analysis by the Reserve Bank which attributed the healthy growth in investment in consumer goods and durables in part to growth in demand from consumers, bolstered by increases in the real remuneration of employees. But we should caution that demand growth by itself is not sufficient. The other supports for investment must also be in place. Expenditure-generating policies which have little other economic rationale will not support high levels of investment except in the very short run.

 

73. None of the above-mentioned determinants of investment requires the complete elimination of inflation. Instead, national policies should address each of these preconditions through co-ordinated fiscal, monetary, industrial and labour market policies. The Commission holds that such co-ordination will be best achieved by a process of national, tripartite negotiations around wages, prices and investment, as outlined in Chapter 10. In the absence of such an Accord, concern with inflation leads to a reliance on the relatively blunt instruments of fiscal and monetary tightening, both of which have negative effects on the level of employment in the short run.

 

74. The Commission heard conflicting arguments over the relation between interest rates and the public debt. Reduced interest rates might lower the government's cost of deficit finance, freeing up funds for more productive purposes. However, others argue that lower short-term interest rates will generate inflationary expectations that will raise the cost of long-term public finance.

 

75. It is also clear that an excessively rapid reduction of public investment can reduce the growth rate of the capital stock, both directly though its effects on the public capital stock and indirectly insofar as public and private investment are complementary. Recent evidence of this complementarity, or "crowding in", may be found in an analysis by the Reserve Bank that lists progress in rural electrification as one of the sources of increased consumer demand for durable electrical appliances, which has in turn spurred investment in that sector. These effects certainly mitigate, and may even overpower, the investment-dampening effect of higher interest rates caused by public borrowing.

 

76. These caveats notwithstanding, we do caution against a profligate approach to public expenditure. We acknowledge that, at 5.5% of GDP, the fiscal deficit for the 1995/96 financial year is high and if, in the event of an economic downturn, it mushrooms, it could rapidly prove to be unsustainable. This would then involve extremely harsh cuts and, all else aside, this would severely dampen investment. On the other hand, the unique requirements of the current historic transition to a democratic government and the urgency, both economic and political, of delivering on the promises of the RDP, provide a compelling case for the value of public borrowing in the short term. The current issue is then less one of arguing against fiscal restraint, than about arguing for greater efficiency in delivery of public goods, although we acknowledge that efforts to improve the performance of the public sector may involve costly initial outlays. For example, "rightsizing" the public sector requires more than a simple arithmetic reduction in the number of public sector employees or the size of the public sector wage bill. It also requires restructuring public sector employment and public sector wages. Hence, the leap in the public sector wage bill allowed for in the recent budget, a leap occasioned by the need to restructure public sector employment and wages, could be consistent with the longer-term objective of containing public sector expenditure, even though, in the short term it results in an increase in this expenditure. The Commission welcomes the government's expression of concern with the issue, as manifested by the appointment of the Presidential Review Commission on the Public Service.

 

77. Our argument also supports the re-prioritisation of public expenditures. In the next chapter we suggest a focus on publicly funded programmes that most successfully target the poor. We also welcome the commitment of the government to public investment in productive infrastructure as well as the commitment to recoup these investments through user charges. A favourable investment climate requires adequate levels of public expenditure to maintain and enhance South Africa's transportation and communication infrastructure and to break the education and skills bottlenecks which retard growth.

The Requisites of Economic Stability

 

78. An institutional and policy-setting environment capable of stimulating investment and a labour-demanding growth path must go considerably beyond matters of interest rates and fiscal deficits. What is needed is that all economic players ­ large and small, public and private ­ have a reasonable expectation that they will benefit from the economic contribution that they make and correspondingly that they will incur the costs that their decisions entail. A currency whose real value is predictable is a part of this institutional framework, but alone it is hardly sufficient. For economic stability much more is required, including:

 

• The policy commitments of the government must be credible; they must not be subject to unanticipated changes or reversal which may drastically change the calculus of profit and loss or the simple requirement of making ends meet.

 

• Labour relations between employees and employers will never be entirely free of conflict, but they should be predictable, and agreements secured should not later be undone. In this regard, the Commission welcomes the strengthened dispute resolution mechanisms contained in the LRA and, in particular, the establishment of a publicly funded, independent dispute settling institution. The Commission holds that such mechanisms both reduce the frequency of industrial conflict and lower the costs of conflict when it does occur by providing for its more rapid resolution.

 

79. These are the requisites for the economic stability which South Africa now needs in order to foster investment and economic growth. As the experience of many Latin American economies demonstrates, none of these is likely to be achieved in a deeply divided society, one marked by enduring discrimination and mass unemployment. It is equally clear that these conditions cannot be met by a rigid, blunt commitment to downsizing government: much of what is required, whether it be security services, growing aggregate demand, or stable labour relations, cannot be supplied only by private individuals pursuing private interests.

 

80. Indeed, comparisons among nations indicate that the factors which foster high levels of both domestic and international investment, especially direct investment, have surprisingly little to do with the size of the public sector, tax concessions, the trade balance, or the rate of inflation. Rather it is the absence of high levels of social polarisation, extreme inequality, and the social tensions occasioned by these, and the presence of adequate human resources and growing aggregate demand which appear to drive the investment process. International investment is now flocking to China, a country which meets very few of the orthodox criteria for a favourable investment climate. One of the widely accepted lessons to be gleaned from the rapid economic ascendancy of many East Asian economies is the value of institutional arrangements that ensure that the benefits of growth are widely shared.

 

81. The Commission believes that broadening the concept of economic stability to include these foundations of successful economic growth and employment generation would provide a framework in which macroeconomic and labour market policies could be co-ordinated in the pursuit of common objectives.

 

82. Fiscal and monetary policy must respond to a diverse set of objectives reflecting not only a larger public interest but also the needs of those groups closely affected by its impacts. Monetary stability and the interests of the financial community are prominent among these concerns. But it is an outdated ­ and, often, self-serving ­ fiction to think that monetary and fiscal policy and labour market policy play themselves out in separate arenas, with little impact of one upon the other. For this reason, the Commission urges that job generation and the interests of the employed and the unemployed be given an adequate hearing in the formulation of macroeconomic policy.

 

83. As stressed from the outset of this chapter, the Commission does not wish to make detailed recommendations around macroeconomic policy. Instead we have attempted to present a balanced view of the relation between the labour market and the macro economy, and of the constraints that each imposes upon the other. We hold that labour market policy reforms must work in conjunction with employment-stimulating macro policies, with neither being relied upon as the sole solution to the present employment crisis. We note that increased investment is required for employment creation, and that the stability of economic, industrial, and political relations is a crucial precondition for investment. We further argue that both stability and the degree of co-ordination of policies can be increased by means of a nationally negotiated Accord around wages, prices, investment and other macro-economic variables, as described in Chapter 10.