Commentary on the Medium Term Budget Policy Speech

On Tuesday, Minister of Finance, Pravin Gordhan, completed his inaugural medium term budget policy speech (MTBPS) when every South African citizen, as well as foreign investors, would have avidly tuned in to gauge the direction of economic policy in SA.

The MTBPS has come at a time when SA is facing its toughest economic climate in at least 17 years. On the one hand. Mr Gordhan is under pressure to substantially increase government spending on infrastructure and social grants, and, on the other, to adopt prudent macroeconomic fiscal policy.

Mr Gordhan indicated five strategic priorities for the medium term: 1. Creating jobs; 2. Enhancing education and skills development; 3. Improving health services; 4. [Supporting] rural development and agriculture; and 5. Intensifying the fight against crime and corruption. In order to accomplish these goals he said that government expenditure will rise from R715 billion in 2008 to an estimated R841 billion in 2009, or some 35 per cent of gross domestic product. Despite the expected R34 billion decline in revenue, increased government expenditure of R127 billion (representing a 17.8% increase from 2008) has been budgeted. The reduced revenue is primarily as a result of decreased income tax, VAT and customs receipts. The net result is a widening borrowing requirement: the consolidated budget deficit will amount to R184 billion in 2009/10, or 7.6 per cent of GDP.

The overall public sector borrowing requirement this fiscal year will amount to R285 billion which equates to 11.8 per cent of GDP. By comparison last year the public sector borrowing requirement was just R89 billion. On these projections government debt will increase from 23 per cent of GDP in March this year to 41 per cent by March 2013. Interest on state debt will increase from R54 billion last year to just under R100 billion in 2012/13.

Mr Gordhan stated that the SA government will raise some R640 billion in borrowings over four years, in order to sustain investment in the five strategic priority areas. Not surprisingly the level of debt will increase and the costs of servicing these debts will rise concomitantly. Mr Gordhan said that, “Higher borrowing is the right thing to do, in these times. But we will also support our spending on priorities by vigorously conducting a campaign to reduce waste.”

The above immediately reminds one of the comment by American President Herbert Hoover, “Blessed are the young, for they shall inherit the national debt”.

Borrowing creates no new income, and therefore no new demand. By borrowing money, the government merely redistributes it from one group of people to another. Government cannot create new purchasing power out of thin air. What makes the mistaken view of fiscal stimulus persist, is that it is easy to see the people put to work with government funds and the infrastructure spending that the government has committed itself to. What we do not see are the jobs and the investment that would have occurred elsewhere in the economy with that same money had it not been spent by government.

Mr Gordhan curiously quoted the recent report by the Commission on Growth and Development chaired by Professor Michael Spence in which it offered the following five summary points of the strategies followed by 13 countries that had succeeded in expanding national output and incomes by over 7 per cent a year for at least 25 years:

1. They fully exploited the world economy… “They imported what the rest of the world knew, and exported what it wanted”;
2. They maintained macroeconomic stability, by focusing on keeping inflation low and budget deficits moderate;
3. They mustered high rates of saving and investment to finance economic growth;
4. They let markets allocate resources, including in economic downturns, and provided appropriate training and skills development to enable people to move from declining to rising sectors; and
5. They had committed, credible, and capable governments that held public agencies accountable and sought to achieve long-term targets that were publicly articulated.

On point number one. In order to “fully exploit the world economy” the SA government would have to do away with the perverse barriers to trade it has erected such as quotas on imports and tariffs that protect inefficient local manufacturers. To promote SA exports the government would have to make the environment in which exporters operate more conducive to doing business by reducing the taxes it imposes and reducing the cost of doing business.

Mr Gordhan seems to have overlooked the latter half of point number 2 “keeping … budget deficits moderate”. A budget deficit of 7.6 per cent of GDP cannot by any criterion be considered moderate. He correctly points out the importance of keeping inflation low. Under inflationary conditions, it becomes impossible to plan or to make any rational economic decisions as people become more concerned with anticipating inflation than with seeking out profitable new production opportunities. Inflation also has negative implications for trade because it adversely affects the competitiveness of export- and import-competing industries. The negative consequences for exporting industries can be compensated by a depreciation of the currency but this is just a temporary remedy that raises the cost of imports and increases their prices. Inflation imposes higher taxes on taxpayers when their real incomes might be static or declining. It benefits borrowers at the expense of creditors and savers because it erodes the real value of money. Given that government is generally the biggest borrower and taxes escalate when real incomes have not increased, inflation invariably redistributes wealth from the private sector and individual taxpayers to government. A stable money supply is therefore imperative. Under inflationary conditions individuals spend almost all of their income on consumption and taxes and virtually no money is saved. This leads to point 3.

The importance of savings is critical. Savings lead to investment, which finances the purchase of machinery and equipment as well as research and development. These types of investments make workers more productive and result in higher wages. In the absence of savings, individuals become worse off and their quality of life declines.

In point number 4, the Commission indicated that the successful economies allowed the markets to allocate resources, but this seems to go against what the Treasury is proposing. As noted previously, borrowing money simply redirects money from one group of people to another. It is a strategy that assumes government is more efficient at providing goods and services. For free movement of labour between sectors to occur, there have to be fewer barriers to movement. Numerous studies have demonstrated the inflexibility of the SA labour market. Will government be brave enough to tackle this thorny issue?

Point number 5 suggests that successful countries had “committed, credible and capable governments that held public agencies accountable and sought to achieve long-term targets that were publicly articulated”. Mr Gordhan certainly expressed that the government would be clamping down on wasteful expenditure when he stated, “We cannot spend money on wasteful extravagances and golf-days, we cannot tolerate unnecessary bureaucratic structures, and we must achieve greater value for money in contracting for goods and services”. If government succeeds in eliminating waste, fraud, corruption and incompetence it will do the country’s citizens a great service.

Mr Gordhan, though, must be congratulated for easing exchange controls. This is a move to be welcomed by all. Companies can now invest R500 million offshore (up from R50 million) without prior approval from the Reserve Bank. This not only makes it easier for companies and individuals to invest offshore but will also attract foreign investment because foreign companies and individuals can now extract their money more easily. This sends the message that SA is open for business.

Author: Jasson Urbach is an economist with the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation.

FMF Feature Article / 27 October 2009

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