Let nothing stand in the way of economic growth

The medium-term budget policy statement released last week makes for sombre reading. Its key message is that five consecutive years of subpar economic growth have left fiscal policy with no room for manoeuvre.

Spending can no longer rise faster than new tax revenue generated from future economic growth. To deliver improved public services, the government must now focus on "better use of existing resources and shifts in the composition of spending, rather than raising overall expenditure".

Large budget deficits since 2008 have increased government debt by R1-trillion. Interest payments on debt now amount to R110bn a year, or 10% of government spending. Interest payments are as large as what is spent annually on social grants. If government debt increases any further, higher interest payments will squeeze out much-needed social spending.

Debt therefore needs to stabilise as a share of gross domestic product (GDP). At the same time, the government needs to "rebuild fiscal space" — room must be recreated for it to "respond to future economic shocks" without jeopardising economic stability. For this to happen, the deficit must fall as future economic growth accelerates. Because the statement foresees only a modest improvement in growth from 2.1% this year to 3.5% in 2016, the deficit must be reduced from its present 4.2% of GDP to 3% by 2016-17.

The focus in the statement on using existing resources better and changing the composition of government spending echoes the fiscal circumstances that confronted the Reconstruction and Development Programme (RDP) in 1994. Then, the newly elected democratic government inherited high budget deficits and rapidly growing government debt.

This meant that the social goals of the RDP had to be met through reallocating existing state spending rather than new spending. To emphasise government’s straitened circumstances at that time, then president Nelson Mandela announced in October 1994 that his salary and that of his deputy presidents would be cut by 20%. Cabinet ministers, provincial premiers and top legislative officials were expected to take a 10% pay cut. MPs, he announced, would be asked to consider cutting their own pay.

The cutbacks announced in last week’s statement are mainly symbolic. Ministers, for example, will be required to travel business class when flying overseas and to live in rented apartments rather than hotels while awaiting allocation of official houses. Travel and other perks for public servants will also be curtailed.

The clear message is that the government has run out of funds to pay for increased spending. Reducing the deficit to 3% of GDP requires limiting growth in noninterest government spending in real terms to 2.1% a year for the forecast period. This is much lower than the 8% annual real increase in spending incurred over the past decade. It requires containing growth in the public sector wage bill to about 1% above inflation. So no new administrative posts will be allowed.

The statement also reflects concern that rising interest rates in the US could have serious negative consequences for our economy. Because we rely so heavily on foreign capital inflows to fund our current account deficit, higher US interest rates could mean a sharply weaker rand exchange rate, higher inflation and slower growth. It could also mean higher long-term interest rates, which will raise the costs of funding public debt.

The only way out of the fiscal bind is faster economic growth. The statement notes that "without growth we cannot generate the revenue needed to fund our social programmes, infrastructure investments, and incentives to support important industries". It reminds us that "a larger economy means higher revenue".

This emphasis on growth is significant. It is a message that appears to be directed at an audience that in recent times has seemed indifferent to the consequences of the poor performance of our economy. Such poor growth has been largely self-inflicted — it is the result of lost production from prolonged strikes, decaying infrastructure and poorly thought-out policies.

The statement reminds us that the result is not just lost jobs and wages or lower profits for business, but also reduced tax revenue. If the economy had grown at just 3.5% a year since 2008, tax revenue this year would be R70bn higher. This is half the predicted budget deficit.

There is little more that fiscal policy can do to help bring about the needed acceleration in economic growth. Higher growth is dependent upon factors outside the budget, including the creation of a better investment climate and more stable labour relations. The statement recognises this.

But its praise for the work being done by the government to restore investor confidence in the mining and motor industries rings hollow at a time when new strikes loom and South Africa has been excluded from bidding to become the assembly site for a future vehicle model.

It is time to focus urgently on growing the economy. This must be our national priority. Even the sustainability of government spending is now dependent upon this. No action from any quarter that threatens future growth should be accepted.

BY GAVIN KEETON

Keeton is with the economics department at Rhodes University.

Article Source: Business Day