Inequality and poverty will not be fix by spending more but only by growing more

Did you know that the countries with the highest inequality in the world have a lot of seemingly unrelated economic indicators in common that do not always come front of mind when many commentators talk about inequality?

In short many of the poorest, low growth, high unemployment, unequal and high tax countries are in Southern Africa. I believe the economic outcomes and indicators are related. For example, high unemployment means higher inequality as many do not have an income.

High tax burdens result in firms investing elsewhere resulting in even few jobs as population grows and therefore more unemployment.

High tax revenues often go to small part of the population being paid well – the civil service.

These economic indicators are not something mainstream commentators and leaders talk about either because they have not seen the penny drop or they are unaware. Worse I see very few in Academia making the connection either.

South Africa has kicked the spending and deficit can far down the road - the road has come to an end so we can no longer just spend more in the hope it will get better.

The Covid 19 crisis has now brought that end closer. The world became more unequal during the crisis and nothing makes me think that will not be the case in emerging markets too.

Indicators that add to inequality and poverty for emerging markets

Firstly, all the countries with high inequality have in common is a very high unemployment rate. All five Southern African Customs Union (SACU) countries are among the ten highest unemployment countries in the world and in the top 12 most unequal societies too.

Brazil is also in both categories and there is clear evidence of this across the world in terms that high unemployment is a very good indicator for high inequality. For example, Colombia, Malawi and Rwanda have double-digit unemployment rates like most of the other high inequality countries.

Simply put too few people working means fewer people with an income. That increases poverty and also means far fewer people with any form of income which then translates into inequality.

In effect I think high poverty rates add more to inequality than simply having a few high-income earners. High income cannot be singled out as the cause particularly for the employer and self-employed could mean that they are made to feel that the poverty and inequality is their fault. They are however the main source of the destruction of poverty if they are not just rent-seekers but industrial and effective employers who see opportunity in providing products and service in their host county or around the world.

Selected World Inequality rankings

Source: Economist 
Source: Economost pocket World Figures 2020 edition. Countries selected on Tax and employee compensation data availability.

High tax burdens reduce private fixed investment

High tax-to-GDP ratios is another factor that many may not see as a inequality indicator but it is clear that many emerging markets who have high tax burdens also have high inequality. Again, all five SACU countries are in the top 30 highest taxed countries in the world.

High tax burdens in SACU and the Southern African Development Community (SADC) are well known and often over my professional life I have been ask what happens to all the tax revenue. Does more than a third go to salaries? Often it is well over 50% and in some cases, it is more than 90% such as in Zimbabwe for most of the decade to 2018.

Tax burden: Taxes collected as percentage of GDP for emerging markets 2017.

10 of the highest taxed emerging markets are also in the highest 15 unequal countries in the world. One could think that a very progressive income tax that countries such as SA and Namibia have would result in lower inequality, but this does not appear to be the case.

Taxes do not decrease inequality - they actually increase it in these emerging markets! Tax data and indicators along with Gini coefficients show this year in and out.

The reason becomes quite clear when one looks at the share that government wages take out of the economy.

High Government wages do not lead to more growth or better services

Add a high government wage bill as percentage of GDP, along with the high tax burden and one finds the third inequality indicator is that emerging countries with higher total government wage bill as a % of GDP have a good correlation with inequality.

Namibia and SA lead the world in the burden of government wages. Brazil, Eswatini and Botswana are in the top government compensation countries too. The highest developed market Sweden has a lower wage bill than the average for the Southern African Customs Union countries.

Companies need a level of returns that reward the risk and pay more than the cost of capital. High tax burdens reduce the returns and often reduce the market size too. This leads to less new infrastructure and new employment opportunities that come with direct investment.

Also, when high-government-wage-bill countries spend, much of the new spending ends up in the hands of the few working in government and not in the hands of the common man or in extra medicine or grants. It goes straight to the pocket of an elite – often a new elite fewer in number, but very well paid.

That reduces the money for government investment in economic infrastructure. With high tax rates it also means that the private sector is less likely to make up the economic infrastructure shortfall, unless it is well compensated. Thus, things like toll and private hospital fees are relatively expensive resulting in the poor using these services lee.

10 of the highest 12 emerging market wages bill countries for which we have recent data are also in the top 20 most unequal societies in the world. Of the rest that we have data on are also inside the more unequal half of countries.

This, combined with the high tax burden, means that most of the tax money goes to consumption expenditure, and a small group of citizens getting a large slice of the cake. Again, all SACU countries are in the top 10 and are joined by Brazil while Zambia and Mozambique are inside the top 20.

In fact, for emerging countries high government wage burdens are a very good indicator of inequality.  More often than not civil servants who get the large chunk of GDP are in the top 10% of 5% or earners in those countries.

For example, analysing tax data in South Africa shows that between 37% and 42% of the top 10% of earners are in the broader public service. (This would include University, agency and all level of government). So 20% of the formal workforce makes up double that number in the top 10% earners.

Add the employees of some bigger SOEs and South Africa have even more government-related employees in the top 10% of earners. Also, with the formal sector employees only representing less than 30% of all adults, it is clear that this alone also breed inequality.

Furthermore, it also means governments do not have much left to pay for medicine, books or roads.

Graph: Government wage bill as % of GDP for 2016 or later

Note: All for central government plus local and other tiers of government apart from Angola, Malawi, Namibia, Nigeria, and Mozambique are central government only while India is local and Central excludes state government, Zambia and Angola exclude local. Honduras seems to be missing local government data.

The other indicator that deserves more investigating here is that government with high civil service bills as a share of GDP probably spend less on infrastructure. The citizens therefore get very little efficiency back in the form of roads, rail, dams, schools etc. In SACU many roads are tolled and even border crossings are being tolled. Many schools are overflowing, as not enough schools are built and administrative posts are created while teachers and health positions are often just not filled.

Part 2 Government's role in inequality and poverty
Government makes debt to pay for the cost of running an extended state

Fourthly, government debt burdens and government interest payments relative to the size of the economy are also good indicators of stress in an economy. The burden of government interest payments as a % of GDP in SA is the 4^th highest of major emerging markets while the government deficit is also one of the highest. Brazil also has a high government deficit as do so many SADC countries.

Government debt is not an obvious indicator of inequality but more of leg iron for potential growth to close the poverty gaps, and the ability of infrastructure to lift growth. If there is little growth, there will be no improvement in poverty and unemployment levels.

Many of the countries with very high inequality have high government-to-debt-to-GDP levels, with the very clear exception of Botswana. Interestingly the reverse also seems generally true in that lower debt to GDP countries have less inequality as in the case of Eastern Europe, Turkey and Thailand. India and in a sense Argentina, are exceptions in the major emerging markets.

Note all for general government except Angola, Namibia, Zambia Mozambique, Rwanda, Eswatini, Lesotho, Botswana, Honduras and Malawi which are central government only.

The problem is that some governments and many academics seem to believe that spending more will solve problems of inequality and poverty. This is pertinently untrue for emerging markets at least, and most economies. Even reserve currencies will implode at some stage with the debt burdens being imposed.

High government debt often lowers country ratings, as well as increasing interest rates. This means these emerging markets do not just sit with high tax burdens and high deficits, but also higher cost of capital.

Cost of capital is a factor in investment decisions particularly when fixed investment has a long time frame - which is the case in many projects. Not just capital-intensive ones but also those that employ a lot of labour - such as new construction, as the owner of a new building has to borrow money and therefore pay interest on the completed project.

Debt is not just a risk factor and a government spending item, it is a cost driver in investment decisions for emerging markets who have high debt levels. Low growth rates and high debt payments are a bigger danger to poorer countries than to richer ones.

The real problem is not spending, but to fix inefficiencies and crime

South Africa and Southern Africa generally have failed to fix government efficiencies or badly run state-owned enterprises (SOE's), government functions such as public transport. Instead, corruption has engulfed every facet of life in government and the destruction simply continues.

It is downhill from here as the kitty has now run dry. With deficits of over 14% this year and nearly 10% in 2022 , it is silly to think the South African government's debt will remain below the level of the country's GDP.

Of this year non-interest expenditure, 52% is financed by debt - that is not even close to sustainable. Over 40% is normally a clear sign of a debt or hyperinflation crisis.

With an extreme tax burden that is crushing growth potential, while spending is mostly on consumption by government, and our presidency that relies on a dominate trade union federation and "favours" from SOEs and government tenders, it seems unlikely that the country will be able to run a sustainable spending and tax regime.

The hard-left trade union-inspired government spending and taxation will not be going away easily.

But as debt levels rise to closer to 100% of GDP the room to do things will be crushed. Government will not be able to tax more in a very weak economy without fully destroying the already cracked golden egg.

So far SA has brought time to avoid this but with ever more voices crying for higher wages in the SOEs and public sector this will be closely watched. It is also a major financial market predictor now I believe. Investors and traders have woken up to the fact that public wages are just too high in SA and in other SADC countries. (Recently an analyst pointed out the mess in Mozambique, saying they pay for an army but got long distance runners instead).

In short, it's over if we do not make massive reforms

If we do not, I can tell you that universities will close, PRASA and the Gautrain will no longer be around, social grants will become worthless, and hospitals will be empty places that employ doctors who can prescribe but not provide medicine.

Inequality and poverty will rise even more. Unemployment will rush higher too. Interestingly, all 9 of the highest unequal countries in the world - with unemployment data - have unemployment rates higher than 13% generally while the top 7 are about 20% and above unemployment rates.  

So, if government spends more it will at a stage have to tax more, and that will chase away even more potential employers or future employers which increases unemployment and creates even more pressure for government to employ more civil servants and raise taxes yet again while cutting purchases of books, medicine as well as  infrastructure spending.

This is a bad cycle and the shouting for a Universal Basic Income grant will threaten the current employed with even more taxes, and the richer folk with wealth taxes. High company tax burdens - along with red tape - will prohibit more firms from starting, and thus more potential employers. Unemployment and poverty will increase.

We are getting closer to this awful scenario, where the country will take crushing measures like changing pension regulations, begging at the IMF, or hitting the rich with ever higher taxes chasing even more job creators away.

And it's not just South Africa but much of our region of the world. Look at the government spending excluding social security – and Lesotho and Namibia are in the top 12 in the world and top 3 in emerging markets. These 3 are followed by Brazil Botswana and Eswatini all in the highest 10 unequal countries in the world. Again, government spending on mostly consumption aids, rather than fights, poverty at least in emerging markets.

I am not a pessimist by any means, but South Africans honestly need to pray that the finance minister can keep spending locked down, or the country will only have more problems. We just consume too much (never mind the corruption). We buy things for now and do not do nearly enough about investing into the future.

Yet the penny has not dropped for those that earn a cheque from the government – also academics - will need to understand these facts quickly or they will find themselves unemployed too, as a government that needs so much money will end up closing universities and departments too. Many a union thinks just another 20% increase will lessen inequality and unemployment because people will spend more but often that is spent on cell phones, imported clothes, cars and champaign which means the money flows out of the country. The four imported Cs.

If SA just spends and spends then our children will leave and rather work elsewhere. They do not deserve the burden they will carry, for enriching the few at the expense of the many. Already we are seeing ever more young people with education leave our shores; SA has produced more dollar billionaires outside SA than inside the country - a situation that I think is unique in the world.

While I do not have comparative figures for countries highly taxed emerging markets cannot afford to lose billionaire and talent to when debt burdens and poverty are high.

This arrticle was first published on Moneyweb on 2 June 2021.