Growth, Employment and Redistribution
A Macroeconomic Strategy 14 June 1996
1.1 A Long-run vision
As South Africa moves toward the next century, we seek:
A strategy for rebuilding and restructuring the economy is set out in this document, in keeping with the goals set in the Reconstruction and Development Programme. In the context of this integrated economic strategy, we can successfully confront the related challenges of meeting basic needs, developing human resources, increasing participation in the democratic institutions of civil society and implementing the RDP in all its facets.
1.2 Recent Economic Developments
Against the background of a successful democratic transition, the stagnation that characterised the 1980s has come to an end. Considerable progress has since been made in:
Notwithstanding these achievements, it has become increasingly evident that job creation, which is a primary source of income redistribution, remains inadequate. It is widely recognised that the present growth trajectory of about 3 percent per annum:
Recent exchange rate developments reinforce these conclusions. In February 1996 a depreciation, which was largely a purchasing power parity correction, occurred. However, the subsequent movements in the foreign exchange market reflected more fundamental economic uncertainties. The depreciation presents both an opportunity and a threat. An uncoordinated response, embroiled in conflict, will cause further crisis and contraction. Linked to an integrated economic strategy, on the other hand, it provides a springboard for enhanced economic activity.
1.3 Points of Departure
Sustained growth on a higher plane requires a transformation towards a competitive outward-oriented economy.
The strategy developed below attains a growth rate of 6 percent per annum and job creation of 400,000 per annum by the year 2000, concentrating capacity building on meeting the demands of international competitiveness. Several inter-related developments are called for:
The expansion envisaged in the above aggregates is substantial and entails a major transformation in the environment and behaviour of both the private and the public sectors. This must include:
Accompanying the macroeconomic strategy set out below, several appendices provide details and explanatory memoranda. Other coordinated policy programmes, such as the recently announced National Crime Prevention Strategy, complement this framework. Taken together, the Government's approach to development and growth builds a bridge between the present constrained environment and sustainable expansion within an increasingly competitive international context.
1.4 An Integrated Strategy
The core elements of the integrated strategy are:
It is Government's conviction that we have to mobilise all our energy in a new burst of economic activity. This will need to break current constraints and catapult the economy to the higher levels of growth, development and employment needed to provide a better life for all South Africans. We are confident that our social partners will join us in the combined efforts needed to achieve this goal.
2.1 Present economic trends
The trends established over the past two years suggest that the economy is on track for continued, if somewhat slower, growth in exports and investment. Policies are in place to bring the fiscal deficit down steadily and to keep inflation in check. Under these circumstances, detailed simulations, based on diverse econometric models, reach a common conclusion: growth of at best 3 percent per annum can be expected on average over the next few years. Although this represents a considerable improvement on past performance, it is not a development path which meets the goals South Africans have set for themselves.
Firstly, in the context of 3 percent growth, and without significant improvements in labour absorption coefficients, it is doubtful whether annual job creation much in excess of 100 000 would be possible over the next five years. The unemployment rate would then rise by some 5 percent to about 37 percent in 2000. This estimate takes into account about 20 000 additional jobs created per annum in response to various employment-intensive public expenditure programmes such as land reform, low-cost housing, community water and municipal infrastructure.
Secondly, the scope for increased public spending on social services would be severely limited. Medium term fiscal projections incorporating a 3 percent growth scenario, a gradual deficit reduction, the recent public sector wage settlement, and severe cuts (15 percent) in real spending in several government functions, indicate that there would be sufficient resources to increase real aggregate spending on social and community services by at most 3 percent per annum, which is barely above the population growth rate. The additional funding available would not cover 15 percent of current medium term departmental expansion plans.
Thirdly, the balance of payments remains a structural barrier to accelerated growth. The economy is dependent on imported capital and intermediate goods and, as in the past, the cyclical upswing brings a deterioration in the current account. Whereas this constraint has been eased through capital inflows since the elections in 1994, the lack of sustained long term capital inflows has made the balance of payments and the economy too reliant on short term reversible flows and consequently high interest rates.
The recent exchange rate instability presents a further complication. There is a danger of a further capital outflow and a balance of payments crisis. In this scenario growth would be abruptly curtailed and structural adjustment under terms set by international agencies would be unavoidable. Leaving aside this risk, growth forecasts have already been revised downwards by most professional analysts. It is recognised that the burden of the adjustment in the short term will fall on monetary policy and that an economic contraction to reduce import demand is likely.
What options are open to government? An expansionary fiscal strategy could be considered. However, even under the most favourable circumstances, this would only give a short term boost to growth since it would reproduce the historical pattern of cyclical growth and decline. Increased growth above 3 percent would be choked off by a rising current account deficit, upward pressure on real wages and curtailment of investment plans. Higher fiscal deficits would also lead to higher inflation and higher interest rates, exacerbating the burden of interest payments on the fiscus. More importantly, in the present climate of instability a fiscal expansion would precipitate a balance of payments crisis. Without attention to more deep-rooted reforms, there is no possibility of sustainable accelerated growth.
Base Scenario Projections: 1996-2000
| Model characteristics | 1996 | 1997 | 1998 | 1999 | 2000 | Average |
| Fiscal deficit (% of GDP) (fiscal year) | 5.1 | 4.5 | 4.0 | 3.5 | 3.0 | 4.0 |
| Real government consumption (% of GDP) | 19.8 | 19.5 | 19.1 | 18.6 | 18.1 | 19.0 |
| Average tariff (% of imports) | 10.0 | 9.0 | 9.0 | 8.0 | 8.0 | 8.8 |
| Average real wage growth, private sector | 0.8 | 1.5 | 1.7 | 1.3 | 1.4 | 1.4 |
| Average real wage growth, government sector | 4.8 | 0.4 | 0.4 | 0.3 | 0.0 | 1.2 |
| Real effective exchange rate (% change) | -9.6 | 0.7 | 0.1 | 0.1 | 0.0 | -1.8 |
| Real bank rate | 7.0 | 6.0 | 5.0 | 4.5 | 3.7 | 5.2 |
| Real government investment growth | 2.6 | 2.4 | 2.2 | 2.2 | 2.4 | 2.4 |
| Real parastatal investment growth | 3.0 | 2.5 | 2.5 | 2.5 | 3.0 | 2.7 |
| Real private investment growth | 6.3 | 4.2 | 4.4 | 5.8 | 7.1 | 5.6 |
| Real non-gold export growth | 9.6 | 7.5 | 6.4 | 5.5 | 5.3 | 6.9 |
| Results | 1996 | 1997 | 1998 | 1999 | 2000 | Average |
| GDP growth | 3.3 | 2.0 | 2.5 | 2.9 | 3.3 | 2.8 |
| Inflation (CPI) | 8.4 | 10.9 | 9.6 | 9.3 | 9.1 | 9.5 |
| Employment growth (non-agricultural formal) | 0.9 | 1.0 | 0.8 | 0.9 | 1.3 | 1.0 |
| New jobs per year ('000) | 97 | 101 | 84 | 103 | 134 | 104 |
| Current account deficit (% of GDP) | 1.8 | 1.3 | 1.1 | 1.1 | 1.6 | 1.4 |
| Real export growth, manufacturing | 12.5 | 10.4 | 7.5 | 6.6 | 5.4 | 8.5 |
| Gross private savings (% of GDP) | 20.5 | 20.7 | 20.8 | 20.8 | 20.6 | 20.7 |
| Government dissavings (% of GDP) | 3.1 | 2.6 | 2.0 | 1.4 | 0.9 | 2.0 |
2.2 Elements of a Medium Term Strategy
An integrated medium term strategy is presented below which provides a broad bridge between the present constrained economic environment and an improved growth and employment performance in the period up to 2000, while strengthening the competitive capacity of the economy in the long term. The core elements of this integrated package are:
The measures outlined above are mutually supportive and constitute an integrated strategy to enhance economic growth and employment creation. It is Government's conviction that they will establish a stable and competitive environment for significantly improved export and investment growth.
2.3 Accelerated Growth
The recent depreciation of the rand represents one element in the improved competitiveness which the economy must achieve for higher growth to be sustained. Although higher import prices will impact negatively on importing firms in the short term, the advantages of a lower rand for producers of traded goods for both export and domestic markets represent a crucial window of opportunity over the next few years. It is Government's intention to utilise this opportunity to the fullest. This requires several further adjustments to avoid erosion of the improved trading outlook by macroeconomic imbalances.
In brief, government consumption expenditure should be cut back, private and public sector wage increases kept in check, tariff reform accelerated to compensate for the depreciation and domestic savings performance improved. These measures will counteract the inflationary impact of the exchange rate adjustment, permit fiscal deficit targets to be reached, establish a climate for continued investor confidence and facilitate the financing of both private sector investment and accelerated development expenditure.
Drawing on several models of the South African economy, the effects of an integrated economic reform strategy on growth and employment prospects have been tested. Results, bearing in mind the inevitable uncertainties of economic projections, are as follows.
The package will establish a stable platform for a powerful expansionary thrust, with non-gold export growth rising to 10 percent per annum over the period. Against the background of this expansion and supported by the proposed investment incentives, as well as the integrity of the package as a whole, private sector investment can be expected to continue its strong upward momentum, averaging some 12 percent growth between 1995 and 2000. Accelerating public sector investment growth, driven by public corporations and local authorities, programmed to reach growth rates of up to 10 percent per annum by 1998, will complement the demand stimulus of stronger non-gold exports and private investment performance. In the aggregate, these developments are expected to provide sufficient impetus for GDP growth to climb to the targeted 6 percent by the year 2000.
The danger of an increase in the rate of inflation, reinforced by a wage-price spiral, is a constant threat to the expansion anticipated by the strategy. To contain inflationary pressures requires concerted implementation of complementary stabilisation measures: accelerated tariff liberalisation, sharper deficit reduction, tight monetary policy, and above all, productivity linked wage increases. Taken together, these measures would hold the inflation rate below the 10 percent barrier throughout the period, and preserve the competitive advantage of the depreciation.
As a result of the reduction in government consumption expenditure relative to GDP, and the reversal of government dissaving, gross domestic saving is expected to rise from 18 percent to 22 percent of GDP. This represents an important basis for the sustainability of the long-run growth path. Gross domestic investment is expected to increase from 20 percent to nearly 26 percent of GDP in the year 2000. This requires capital inflows equivalent to almost 4 percent of GDP. The integrity of this growth strategy is therefore dependent on maintaining a favourable investment climate, in order to attract foreign investment.
Employment projections are sensitive to assumptions regarding real wage growth, easier access to formal job opportunities and accelerated programmes of small business and small farmer support. A favourable employment response to accelerating growth, reinforced by effective public sector programmes, would see job creation rise to 400,000 per annum by the year 2000. The unemployment rate would then begin to show a visible decline.
There are, in sum, several inter-related aspects of the growth strategy. Given the recent depreciation of the exchange rate, which provides a competitive advantage to exporters, the expected economic expansion will be strengthened if the real value of the currency remains at a stable level. Inflation will not erode competitiveness for the following reasons:
In addition to maintaining financial stability, job creation is enhanced:
Responsible monetary policies anchor the competitiveness and stability of the economy in regard to both the domestic value of the rand and its foreign purchasing power and encourage domestic saving and investment. Finally, the fiscal containment in the package reduces the burden placed on monetary policy.
The policy package is also consistent with long-run sustainable growth on a higher plane:
While recognising that policy-making must remain sensitive to changing circumstances, there is an urgent need to establish firm foundations for this approach to growth and employment creation in the South African economy. The Government's proposals for such a framework are set out in more detail below.
Integrated Scenario Projections: 1996-2000
| Model characteristics | 1996 | 1997 | 1998 | 1999 | 2000 | Average |
| Fiscal deficit (% of GDP) (fiscal year) | 5,1 | 4.0 | 3.5 | 3.0 | 3.0 | 3.7 |
| Real government consumption (% of GDP) | 19.9 | 19.5 | 19.0 | 18.5 | 18.1 | 19.0 |
| Average tariff (% of imports) | 10.0 | 8.0 | 7.0 | 7.0 | 6.0 | 7.6 |
| Average real wage growth, private sector | -0.5 | 1.0 | 1.0 | 1.0 | 1.0 | 0.8 |
| Average real wage growth, government sector | 4.4 | 0.7 | 0.4 | 0.8 | 0.4 | 1.3 |
| Real effective exchange rate (% change) | -8.5 | -0.3 | 0.0 | 0.0 | 0.0 | -1.8 |
| Real bank rate | 7.0 | 5.0 | 4.0 | 3.0 | 3.0 | 4.4 |
| Real government investment growth | 3.4 | 2.7 | 5.4 | 7.5 | 16.7 | 7.1 |
| Real parastatal investment growth | 3.0 | 5.0 | 10.0 | 10.0 | 10.0 | 7.6 |
| Real private sector investment growth | 9.3 | 9.1 | 9.3 | 13.9 | 17.0 | 11.7 |
| Real non-gold export growth | 9.1 | 8.0 | 7.0 | 7.8 | 10.2 | 8.4 |
| Additional foreign direct investment (US$ m) | 155 | 365 | 504 | 716 | 804 | 509 |
| Results | 1996 | 1997 | 1998 | 1999 | 2000 | Average |
| GDP growth | 3.5 | 2.9 | 3.8 | 4.9 | 6.1 | 4.2 |
| Inflation (CPI) | 8.0 | 9.7 | 8.1 | 7.7 | 7.6 | 8.2 |
| Employment growth (non-agricultural formal) | 1.3 | 3.0 | 2.7 | 3.5 | 4.3 | 2.9 |
| New jobs per year ('000) | 126 | 252 | 246 | 320 | 409 | 270 |
| Current account deficit (% of GDP) | 2.2 | 2.0 | 2.2 | 2.5 | 3.1 | 2.4 |
| Real export growth, manufacturing | 10.3 | 12.2 | 8.3 | 10.5 | 12.8 | 10.8 |
| Gross private savings (% of GDP) | 20.5 | 21.0 | 21.2 | 21.5 | 21.9 | 21.2 |
| Government dissavings (% of GDP) | 3.1 | 2.3 | 1.7 | 0.7 | 0.6 | 1.9 |
3.1 Recent fiscal trends
In response to the unsustainable fiscal situation that had developed by 1992/93, when the overall deficit reached 7.9 percent of GDP, fiscal policy has been informed by the following goals:
Although government dissaving has not yet been eliminated, progress has been made in this respect. The cash-flow adjusted exchequer deficit was reduced to an estimated 5.4 percent in 1995/96. Consolidated general government tax revenue has increased from 25.6 percent to 26.8 percent of GDP between 1992/93 and 1994/95, but still somewhat below the 1989/90 level of 27.1 percent. At the same time, significant shifts in the allocation of expenditure have been effected in accordance with reconstruction and development priorities.
3.2 A tighter fiscal stance
To increase domestic savings and benefit from the expansionary impact of the stronger investment and export performance which is envisaged in this strategy, a tighter fiscal policy is necessary. In this way, inflationary pressures will be kept in check and domestic resources will be released for financing capital formation. A lowering of the fiscal deficit target from 4.5 percent of GDP to 4.0 percent in the 1997/98 fiscal year is therefore proposed. Two further reductions of 0.5 percent of GDP in each of the subsequent years would bring the deficit to a satisfactory long term target of 3.0 percent of GDP in fiscal 1999/00. This, together with the envisaged strengthening of government investment spending, would eliminate government dissaving, currently at 2.5 percent of GDP.
In order to achieve the new fiscal targets in the 1997/98 budget, the Minister of Finance has initiated a thorough audit of government expenditure, including RDP allocations, to identify those areas in which budgetary cuts can be made without detracting from the priorities and commitments of the Government.
3.3 Public service restructuring
The process of administrative restructuring of the public service provided for in the Constitution gathered pace in 1995. With the first phase of the process involving the integration of the public service at national and provincial levels nearing completion, attention is shifting to the longer-term issue of creating a more cost-effective service.
A major step was taken in early 1996 with the devolution to line departments of all career related personnel functions. The restructured Public Service Commission will retain a research and monitoring role, while the Department of Public Service and Administration will be responsible for broad human resource policy, conditions of service and labour relations.
Careful management of the overall government wage bill is central to the fiscal strategy. In implementing the three-year public service salary adjustment and right-sizing programme, affordability considerations, maintenance of public services and macroeconomic consistency are paramount. Agreement has been reached on the principles of broad-banding and occupational classification.
In order to effect a right-sizing of certain parts of the public service, a voluntary severance package has been introduced. This will be implemented with considerable circumspection in order to limit both the resulting loss of skilled personnel and associated costs to the fiscus.
Successful implementation of the agreement would lead to a real increase in the government wage bill of approximately 2 percent per annum over the next five years. This, together with strict containment of spending on other goods and services and current transfers, implies a roughly constant level of real recurrent government expenditure and a reduction of 3 percentage points in this aggregate relative to GDP by the year 2000. This would allow an increase in discretionary RDP-related spending on projects of a capital nature of about 8 percent per year, compared with little more than 2 percent per year in real terms in the absence of accelerated growth. This represents substantial room for manoeuvre in the developmental dimensions of the budget.
3.4 Budgetary reform
The budget is the primary vehicle through which access to social services is assured. Nearly half of all government spending is devoted to education, health, welfare, housing and related services. Strengthening of the redistributive thrust of these expenditures remains a fundamental objective of economic policy. Reprioritisation within the health and education budgets, a municipal infrastructure programme, restructuring of the welfare system, land reform and a review of training and small business support policies are amongst the initiatives which aim to address the claims of the poor to a fair package of basic needs. These adjustments are being accompanied by the elimination or scaling down of activities which cannot be provided to all or which could be undertaken effectively by the private sector.
Government recognises the importance of a longer-term fiscal planning framework alongside the annual budgetary process. A multi-year fiscal model has recently been developed which will be updated annually to provide greater clarity regarding public expenditure trends and priorities. It is envisaged that a draft medium-term expenditure model will be available to assist in the preparation of the next budget.
Several budgetary reforms are presently under consideration, including the earlier presentation of budgets to Parliament, the possibility of a switch to an accrual accounting system, a revised basis for reporting assets and liabilities, a restructuring of the accountability of the various departments and a transformation of the structure of inter-governmental financial relations.
3.5 Revenue issues
International experience confirms that it is on the expenditure side that the fiscus is most effectively able to contribute to redistribution. It is nonetheless important that the incidence of taxation should remain progressive, while at the same time impacting across a broad base so as to avoid excessive rates. Several further steps in the overhaul of the tax structure including the rewriting of the Income Tax Act will be undertaken. A new dispensation for the taxation of retirement funds, higher rates of excise on tobacco products and improved tax collection will lead to increased revenue on the current income base. This will be partially offset by adjustments to the personal income tax structure with a view to correcting for fiscal drag and reducing the distorting impact of excessive rates of tax.
Recognising the importance of effective tax administration, the new SA Revenue Service has embarked on the upgrading of its revenue and customs and excise offices, including personnel training and modernisation of information systems. This will, in due course, contribute to improved collections and greater fairness of the tax system.
The improvement in economic growth, together with improved tax administration, should lead to a strong increase in tax revenue relative to GDP. This will create considerable scope to effect further reductions in the rates of personal and corporate taxation, while maintaining a ratio of tax to GDP of about 25 percent.
In addition, the Department of Finance is reviewing the existing arrangements for the financing of government debt and the management of outstanding debt. The outcome of this process will be the establishment of a fully-fledged Debt Management Office leading to savings on the interest bill in the medium-term. A first step has been taken in this regard with the review of cash management within the public sector.
4.1 Monetary policy and inflation
The main objective of monetary policy will continue to be the maintenance of financial stability and the reduction of the inflation rate. Positive real interest rates are a minimum condition for overall financial stability. Low inflation is an important requirement for higher economic growth, the creation of employment opportunities and a more equitable distribution of income.
Inflation reduction has been facilitated by other developments. Trade liberalisation has contributed significantly to the containment of domestic prices, while more moderate wage-setting and improved industrial relations have also played a role in holding cost increases in check.
Monetary policy will also aim to maintain real interest rates at positive levels to encourage savings and investment. However current levels of interest rates are bound to have negative effects on economic growth. High interest rates hamper the development of the small business sector which is dependent on bank credit and put home ownership out of reach of more people. It is not possible, however, for the Reserve Bank alone to lower interest rates if conditions are not appropriate. Lowering the Bank rate could lead to higher credit demand, higher inflation, and as inflationary expectations take hold, higher long term interest rates. In addition, such a policy would lead to declining capital inflows, capital flight and higher imports, which all add up to a balance of payments crisis.
What is required are the conditions for lower (but positive) real interest rates. The strategy outlined in this document aims to bring about these conditions. These include sustained lower rates of inflation; a reduction in government dissaving which will reduce pressures on the capital markets; and the attraction of long term capital inflows, particularly direct investment flows, which will make the capital account less dependent on short term capital inflows which are attracted by high real interest rates; the commitment to a stable real exchange rate and higher growth will also reduce the risk premium facing foreign capital inflows and this would then allow for lower real interest rates.
By combating domestic inflation the monetary authorities will also contribute to stabilising the external value of the rand. Over the long run, low domestic inflation is a prerequisite for greater stability in the real effective exchange rate.
4.2 Exchange rate policy
Since mid-February the foreign exchange market has been subjected to intense speculative pressure, causing a substantial real depreciation of the rand. This development to some extent reflects that the rand had become somewhat overvalued in response to a temporary capital surge, but was also the result of increased concerns regarding policy trends and economic prospects. The movements of the exchange rate signal some uncertainty in financial markets and call for careful policy responses.
In order to maintain the current competitive advantage created by the depreciation of the rand in the first four months of 1996, the objective is to keep the real effective exchange rate of the rand at a competitive level. Although short-term fluctuations may at times be unavoidable, monetary and other policy measures will be geared towards the attainment of long-term real effective exchange rate stability. This will provide the stable environment needed for a concerted expansion of export industries.
Although the exchange rate is primarily market determined, its value at any moment cannot be considered a true reflection of the underlying value of the rand while exchange controls exist. The Government has stated repeatedly that it is committed to phasing out controls in a prudent manner. In line with this commitment, the financial rand was abolished in 1995.
In view of the many inherent disadvantages of exchange control, such as the distortion of the price mechanism, the problems encountered in the application of monetary policy, the detrimental effects on inward foreign investment and the large administrative costs, all remaining exchange controls will be dismantled as soon as circumstances are favourable. The gradual approach to the abolition of exchange control is designed to allow the economy to adjust more smoothly to the removal of controls that have been in place for a considerable period.
The current round of exchange control liberalisation is designed as a balanced package which will enhance economic activity. The new measures include the following:
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