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Fiscal conservatism and economic wildfires

13th November 2009

By: Seeraj Mohamed


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Many economic commentators and journalists are raising concerns about South Africa’s growing budget deficit.

They say that a large Budget deficit threatens the future health and performance of the South African economy. One interesting warning is that increasing the size of the deficit allows the current government to be careless in its spending by passing on debt to future generations.


These views are worth discussing further because they seem to convince many people that government should be curbing expenditure during these turbulent economic times.

Unfortunately, many senior government economic policymakers do not seem immune to these populist appeals to fiscal conservatism. At a time when it is crystal clear that government has had a hugely inadequate response to the global financial and economic crisis, it is tremendously dangerous to fall into the ideological trap of populist fiscal conservatism. When there is a wildfire threatening to destroy a forest, you do not skimp on firefighting expenditure because you will increase government’s Budget deficit. You risk losing the entire forest and being left with a wasteland.
The million jobs lost during the first three-quarters of this year were lost because the wildfire was allowed to spread. These job losses were partly the result of hand wringing over short-term increases of government’s Budget deficit while the manufacturing sector collapsed.


The ‘overconfidence’ in government’s estimates of the impact of the crisis on South Africa recently referred to by Minister in the Presidency responsible for the National Planning Commission and former Minister of Finance Trevor Manuel is another cause of the huge job losses. Standing around watching relatively uncontrolled short-term capital flows to South Africa and currency market speculation drive the rand to close to R7 to the dollar is also to blame.
The National Credit Act was introduced because government recognised the problems associated with the behaviour of banks. Unfortunately, government did not see the other huge problems in the economy. Government failed to recognise that credit misallocation was not a problem of increased mortgage, vehicle finance and credit card credit extension to households only – it failed to notice that there were huge problems in investment patterns in the economy.

Credit extension to the private sector increased by about 22% from 2000 to 2008 but private business investment increased by only 5% during that period. Lots of that credit extension did go towards increasing household indebtedness through debt-driven consumption. It drove the bubble in real estate prices. More importantly, the increased credit extension to the private sector drove a bubble in South Africa’s financial-asset markets.
The banks, households and even corporate business enterprise took credit they received from financial institutions and used that money to buy financial assets. The reason why we are losing thousands of jobs today is that South African businesses have not maintained their buildings and machinery and equipment used in their productive activities.

In fact, corporate businesses have been using much more of their credit for net purchases of financial assets than for net fixed investment. Levels of depreciation in the South African economy have increased while fixed investment in most manufacturing sectors has declined. There has been a divergence of capital away from productive investment towards increased speculation in financial markets.
It is not surprising that we have huge job losses. An overconfident government failed to recognise the huge negative impact of its macroeconomic policies and financial liberalisation on the economy. It allowed increased credit extension to be wasted on debt-driven consumption and financial speculation.

Government did not do enough to stem a crisis because it was concerned about a short-term increase in government’s Budget deficit.


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