Investigating Microeconomic Constraints Within The South African Economy
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Published: Mon, 5 Dec 2016
South Africa has been experiencing strong economic growth over the last few years. This coupled with low inflation and a decreasing budget deficit has ensured that the country has acquired a stable macroeconomic climate that has received international applause. However, microeconomic constraints can hamper even a rapidly growing economy’s ability to enhance the welfare of all its citizens and this is indeed the situation in South Africa. Additionally, evidence indicates that South Africa’s economic growth has induced a significant maldistribution of income. This paper will discuss some of the microeconomic constraints within the South African economy as well as possible policies to remedy these constraints.
The paper will be composed of four sections. The first part will be an introduction that will lay down the foundations and structure of the paper of the paper. Secondly, certain micro constraints will be discussed and presented. The third section will look at policies that have been formed to address these constraints as well possible policy options which have not been used. The final section will be the conclusion. It must be emphasised that only a few targeted micro constraints will be presented due to space constraints.
Before exploring the microeconomic constraints, a brief macroeconomic history of SA will be covered. This will put microeconomic reforms into context and show that even though SA has had impressive macroeconomic performances, getting the micro side of the economy right is just as important. While South Africa’s macroeconomic progress over the last decade has been significant and is not generally the subject of dispute, the country is still some distance from its stated objective of full economic freedom. Some of the economic highlights of SA include the country experiencing its lowest inflation in 35 years, with CPIX below the upper bound target of 6% since July 2003. Government debt as a percentage of GDP declined from 46.6% in 2000 to 35.7% in 2005. Growth has accelerated over the past year, with Gross Domestic Product at 5% for 2005. In 2005, the World Economic Forum’s Growth Competitiveness Index ranked South Africa at 42 in the 102-nation table and second in Africa. South Africa scores well, in the macro-economic environment, public institution and technology components of the Index. The Government has a neo-liberal macro-economic approach, and is seeking market-driven economic expansion and growth, facilitating market expansion, with local government having a key role to play in stimulating economic development through investment in infrastructure to crowd in private investment and boost short-term economic performance. However, by 2000, it was clear that levels of economic growth and employment were inadequate to meet the State’s policy goals. It was thought that the limits to growth persisting at the microeconomic level were preventing the country’s macroeconomic success from trickling down to all its citizens. Grinding poverty and inequality is deep-rooted, particularly in rural areas, but also in South Africa’s rapidly expanding cities, with democracy having facilitated massive urbanisation. (Dobson, 2002 and Rodrik, 2006)
In order to promote broad economic development it is increasingly being recognised that microeconomic measures at the local level are needed as well as macro-economic measures at the national level. Microeconomic constraints mean those detailed aspects to the economy and their interrelationships that make up the greater whole or the macro economy. Thus a microeconomic issue might be what specific sectors of the economy to prioritise, while a macroeconomic issue would be monetary and fiscal policy. The need for microeconomic reform is based on the view that the basics are in place in terms of macroeconomic policies but the next phase of economic reform must focus on removing those things that impede growth, namely microeconomic constraints. Compared to other middle-income economies, South Africa is highly urbanized, and while half the population is rural, agriculture accounts for less than 6 percent of GDP and 9 percent of employment. The relatively small agricultural sector, along with a stunted informal sector, imply that South Africa is missing two standard labour shock absorbers that operate in other economies during periods of adjustment. The relocation dimension of apartheid meant that millions of South Africans were deliberately located miles away from urban centres where the jobs were, fostering the emergence of complex migrant worker systems and transport patterns that remain in place today. Apartheid’s legacy is widespread inequality and poverty among the non-white population, with highly unequal socio-economic outcomes in the midst of plenty. At one extreme, is a modern, first world society that has electricity, running water and modern sanitation in almost every home; two thirds have at least a high school education, childhood mortality rates are low and poverty is minimal. At the other end, there are the impoverished where half have less than a primary school education, over a third of children suffer from chronic malnutrition, only a quarter of the households have electricity and running water, and less than a fifth have modern sanitation. (Lewis, 2001; Naidoo, 2006; Rodrik, 2006 and Dobson, 2002)
Part 2:Microeconomic Constraints
So a microeconomic reform strategy affects how to approach the inner workings or the details of an economy. Carter (2006) states microeconomic reforms as “policies that create a more inclusive economy, one in which time and markets work in an arena for the betterment of all citizensâ€¦the inclusive economy requires a minimum asset base all citizens and access of low wealth people to markets from which they are traditionally excluded, especially the market for credit and insurance” (Carter, 2006. PG 6). Naidoo (2006) lists several microeconomic constraints or blockages within the South African economy. These are: the functioning of the skills system including workplace skills iniatives, spatial development patterns introduced by apartheid, poor passenger and freight transport systems, poorly regulated monopoly markets, labour market constraints high poverty, inequities in the tax system, low productivity in high tariff industries, low levels of efficiency in public run enterprises and high levels of crime. It is evident that poverty and inequality is the root cause of many of the microeconomic constraints within the S.A. economy. So for this paper, the primary microeconomic constraint examined will be poverty and inequality. The other constraints examined will be Aids, the labour market, skills constraints, infrastructure access, crime and land distribution. The basic outline of the constraints is shown in the figure below, whereby poverty is shown as the primary constraint. (Naidoo, 2006; Carter 2006 and Meth, 2007)
Figure 1: Microeconomic Constraints
Poverty and Inequality
Ray (1998) states that there are two reasons to be interested in inequality and poverty. Firstly, there is the ethical and social harmony reason whereby it is not ethically correct for some people to have very limited access to assets and income. The second reason is that of a functional nature whereby inequality and poverty can actually affect national output. High inequality creates a political demand for redistribution that can only be met by higher taxes on the wealthy. This creates a disincentive to accumulate wealth. Additionally, Ray states that there is a substantial negative relationship between inequality and growth. Poverty and high inequality restricts access of the poor to vital markets such as credit markets since the poor traditionally lack collateral in the form of assets or income. The neo-liberal argument states that inequality provides incentives for effort and risk-taking, thereby raising efficiency. Also, redistribution of income or assets has a distortionary effect on the economy. The counterargument is that this productive incentive effect applies only at slight levels of inequality such as those in Scandinavia and not at levels of a South African nature. Also, higher income inequality within a country can cause higher poverty, slower economic growth, higher unemployment and higher crime which themselves create distortions within an economy. Meth (2007) suggests some reasons why high inequality translates into greater political and social stability in South Africa. They are: the inequality divide has increased and grants are considered highly imperfect substitute for jobs, thereby increasing antipathy. Also, poverty perceptions are based on relative well being rather than absolute, so that poor individuals feel worse off in relation to the middle class. According to Meth (2007) and Lewis (2002), overall the literature favours a reduction of poverty and high inequality. (Lewis, 2002; Ray, 1998 and Meth, 2007)
The most significant factor distinguishing South Africa from other African countries is its particular experience of colonialism and apartheid. The most direct aspect of this pressure was the dispossession of land by whites, through which African farmers were forced either to retreat to other areas, or to become sharecroppers or farm labourers. According to Bhorat (2004) income poverty has increased in the country over the last few years. Bhorat shows, using to two separate datasets, that the headcount index has increased nationally from 32 to 34 per cent between 1995 and 2000 or from 26 to 28 per cent between 1996 and 2001, based on a $2 a day poverty line. On a poverty line of $2 a day, the mean poor household earned 11 per cent below this line in 1995 and by 2000 this had increased to 13 per cent. Between 1995 and 2000, absolute and relative poverty levels amongst African-headed households increased. Income inequality has also increased with the Gini coefficient rising from 0.565 to 0.577 between 1995 and 2000, while on a 1996 and 2001 comparison the Gini rose from 0.68 to 0.73. Whichever Gini measure is taken, SA is ranked as one of the most unequal countries in the world. The Gini coefficient has risen consistently across all race groups. The 1996-2001 Census data analysis suggests that both absolute and relative poverty levels increased for African, Coloured and Asian households for that period. The figure below shows SA falling GDP per capita for the period 1980-2000. The falling GDP per capita viewed in conjunction with an increasing Gini coefficient and headcount index, shows that SA is experiencing increasing poverty and inequality. (Aliber, 2003; Meth, 2007 and Bhorat, 2004)
Figure 2: Diagram showing South Africa’s GDP per Capita
Source: Dobson, 2002
Unemployment, Education and Skills Constraints
According to Aliber (2003), the lack of access to employment is arguably the single greatest cause of poverty. Impediments to cost competitiveness exist in the labour market as a result of a mismatch of labour demand and supply, the low levels of education and skills of the workforce, and the need for ongoing review of labour market regulation. This section will focus on the labour market specifically, but also on education and the skills constraint, since the poor generally lack the income to afford adequate education thereby limiting their skills.
The official unemployment rate in South Africa is 26.7% for 2005 or 41.1% when going by the broad definition of unemployment. Both of these are very high by any standard of comparison. For example, in 1994, unemployment was substantially lower than it is today at 15.6%. By the end of the decade, unemployment had jumped to 30 percent before declining slightly. The figure below shows SA escalating unemployment rate for the period 1995-2005. This compares unfavourably with other developing countries such as Brazil (10%), Ethiopia (23%), Botswana (19%), Venezuela (15%), Mexico (5%) and Mauritius (9%). Among the reasons for the high unemployment are a decrease in formal sector employment, privatisation of state owned assets and insufficient skills of labour. The skills discrepancy will be explained below. (Banjeree et al, 2006 and Rodrik, 2006)
Figure 3: Diagram showing the unemployment rate in South Africa
Source: Banjeree et al, 2006
A major challenge facing the government’s ability to reduce poverty is the high rate of unemployment and the decline in formal sector employment, which is one of the main reasons households remain in poverty since their members repeatedly fail to gain employment over sustained periods. Even in commercial agriculture, which has traditionally been a labour-intensive sector, unskilled workers are gradually being replaced by machinery, contributing to higher rural unemployment. Decades of apartheid policies that restricted education and training to whites only, has led to enormous under-investment in the skills of the black majority, who have been denied the opportunity to invest in human capital. The effects of historically low investments in African education still impact post-Apartheid employment outcomes. In a 1999 World Bank survey, 80 percent of firms in SA reported experiencing extreme to moderate difficulty in finding people with managerial and professional skills. Around 70 percent of firms reported extreme to moderate difficulty in finding people with service and craft skills. Conversely, 95 percent of firms indicated there was no particular difficulty in finding unskilled workers. The diagram below illustrates the unemployment levels within South Africa, based on labours skill category. As is evident, job creation over the past three decades in the unskilled and semi-skilled labor category has been low. The figure illustrates that for all classes of labor, unemployment rates were quite low in the early 1970s. However, since 1976, unemployment rates for unskilled and semi-skilled labor have increased. In 1995, the unemployment rate for unskilled and semi- skilled labour surpassed 50 percent, and has since continued to climb even further. In contrast, the unemployment rate for highly skilled workers has been negligible throughout the period, while the rate for skilled labour began to climb more recently and has also reached a fairly significant level. Total employment of unskilled and semi-skilled labourers in 1999 was 8 percent lower than the level in 1970. Formal sector employment of unskilled and semiskilled labourers in 1999 was only three million compared with four million employed in 1970. Between 1981 and 1999, the level of formal sector employment declined in every year but three, losing a total of 1.3 million jobs in the space of less than two decades. (Aliber, 2003; Lewis, 2002; Dobson, 2002; and Bhorat, 2004)
Figure 4: Unemployment in South Africa based on Skill Levels
Source: Lewis, 2002
But what of the schoolings system ability to educate people so that their skill levels can improve? Investment in human capital formation can play a major role in boosting economic development that benefits the poor. Lucas (1988) constructs a theoretical model of long run growth where the primary driver is the accumulation of human capital. The average level of human capital is raised to a power value and is then entered into the aggregate production function. Lucas estimated the exponent value using USA data, and derives an exponent value of 0.417 for the elasticity of U.S. output with respect to the external effects of human capital on production. This exponent implies that an additional year of average education increases USA total factor productivity by 3.2%. Also, Giovanni and Ciccone (2000) find that a one-year increase in average schooling raises average labour productivity by 8% to 11 %. Both these studies illustrate that there are definite positive returns to additional education for an economy. Why isn’t SA then educating its citizens more intensely? The reason is that socio-economic status is the major determinant of school performance in South Africa and poverty and inequality are preventing SA’s skill base from expanding. Firstly, approximately 80 per cent of South African schools are said to be dysfunctional. These dysfunctional schools are often the only source of education for the poor. Secondly, the majority of good schools in SA are expensive and a lack of income prevents parents from sending their children to these schools. Tertiary education is also expensive and a lack of income is a barrier to many parents and children. Poor people generally struggle to access credit markets because they lack collateral and are also deemed to be lacking in incentives to repay a loan. Credit is sometimes a necessity for situations when a person does not have enough personal capital. Educational is an example where credit might be required. Higher education is relatively expensive but this education allows an individual to become more productive thereby increasing their income. However, if one does not have the initial cost outlay of the education option, then credit must be sought. The lack of credit for further studies limits the poor from acquiring vital skills in the labour market and therefore limits their earning potential. As Ray (1998) says, inequalities in education feed into the cycle and reinforce initial differences in inequality. The skills constraint within the economy is shown below for the year 2000. Again, highly skilled labour has zero unemployment whereas unskilled has a 50% unemployment rate and informal labour has a 41% unemployment rate. (Meth, 2007, Lewis; 2002; Moretti, 2002 and Lucas, 1988)
In terms of labour market flexibility, South African business leaders cite labour regulations and union as activities discouraging employment creation. The World Economic Forum’s Global Competitiveness Report ranks South Africa at the bottom of its fifty-nine nation comparison on whether labour regulations on wages, hours or dismissals favour flexibility. Relative to the rankings of business counterparts in other economies, South Africa came in dead last on most matters concerning flexibility, labour relations and the work ethic of the labour force. Thus, labour legislation may be hindering growth in domestic investment and hence employment creation. Rodrik (2006) says the large level of unemployment experienced by SA could have been avoided if the many unskilled job seekers could be absorbed into the informal sector, but SA’s informal sector is small by developing country standards. Informal sector employment remains a fraction of what it is elsewhere in Africa, Latin America, and Asia. The reasons for the small scale of the informal employment sector range from apartheid’s restrictive laws to high levels of crime, which acts as a tax on small-scale enterprises, to social grants. Below, is a diagram illustrating the size of SA’s informal employment sector relative to other countries. As is evident, SA has a very small informal employment sector relative to Asia, Latin America and the rest of Africa. (Rodrik, 2006 and Lewis, 2002)
Figure 6: Informal Sector Employment rate
Source: Rodrik, 2006
South Africa’s crime problem is typical of those experienced by countries undergoing transitions. According to Cassim (2006), crime is an overwhelming problem within SA and its negative effects on growth should not be underestimated. South Africa’s incidence of both violent and non-violent criminal activity remains one of the highest in the world. United Nation statistics show the murder rate in SA to be 60 per 100 000 of the population. Australia and Peru in comparison have a murder rate of 4 and 10 per 100 000 respectively. In a firm Survey undertaken by the World Bank in 1999 in South Africa, crime and theft were rated by 94 percent of firm CEOs as the single biggest obstacle to firm growth within the country. Additionally, 83 percent of firms reported they had suffered from some type of crime during 1998, with many listing more than one incident. 61 percent of firms reported that employees had been victims of crime while travelling to or from work. 60 percent of firms reported that they had increased spending on crime prevention between 1997 and 1998; spending on security averaged 1.6 percent of revenues. There was a positive but low correlation between annual crime prevention expenditure and sales per employee and investment in 1998 and employee expansion during 1997-98 was negatively correlated with crime prevention spending. Apart from the uncertainty generated by these high levels of crime, thereby impeding long-run growth, it is also clear that it significantly increases the operating costs of firms. In addition, it is a key contributor to skilled labour emigration. (Lewis, 2002; Bhorat and Kanbur, 2005)
Micro evidence suggests that high levels of income inequality are a significant and positive determinant of the incidence of burglary and vehicle theft as well as violent crime. The link to higher crime is said to come from the inability of unskilled men in high inequality societies to play traditional male economic and social roles, which includes the role of providing an income. Ultimately, there exists a vicious cycle, which links income inequality to crime that, in turn, induces high levels of investment uncertainty. This acts as possibly one of the key constraints to long-run economic growth in South Africa. Crime, with its massive social and private costs, has a larger impact on the poor than the well off, since the poor cannot afford additional security services and devices. As such, a redistribution of resources towards the combating of crime could benefit the poor disproportionately. Lack of upward mobility in the society may be linked to the prevalence of crime and people who perceive their poverty as permanent may be driven by hostile impulses rather than legal pursuit of their interests. Sensitivity to inequality, especially by those at the bottom, leads to higher risk tactics, such as crime, when the expected payoffs from low-risk tactics are poor. Hence, the lack of upward mobility in a society, combined with poverty leads to a breakdown of standards and values. Violent crimes are more likely to happen in areas with high expenditure inequality but are not consistently correlated with mean expenditure levels, indicating that inequality is more of a factor in crime than poverty. Some economic and sociological theories of crime suggest that there may be a positive relationship between poverty and crime levels. Most of the correlation between overall inequality and violent crimes in South Africa is attributable to inequality within racial groups, although between-group inequality also has a significant but very small correlation with crime. The empirical results indicate that inequality is highly correlated with both burglary and vehicle theft. Property crime is strongly correlated with mean expenditure in the area. The link between poverty, inequality and crime highlights the need for policymakers to focus on the distribution of income when devising strategies for economic growth, as the welfare benefits from growth may be associated with decreased safety if such growth is accompanied by increased inequality. The debate in South Africa has, however, taken a very unfortunate turn, at least in part because the most vocal critics of government’s attempts to deal with crime is perceived to be those with the highest incomes. According to Cassim (2006), if the debate could somehow be shifted to focus on the poor, it would probably be the single most significant pro-poor investment that could be made. (Wade, 2004; Lewis, 2002; Bhorat and Kanbur, 2005; Meth, 2007 and World Bank, 2006)
South Africa’s HIV/AIDS infection rate is one of the highest in the world and the prevalence amongst adult’s aged 15-49 was 21.5 per cent in 2003. When compared with a global average of 1.1 per cent and a mean of 7.5 per cent for Sub- Saharan Africa, it becomes apparent how serious the situation is in SA. South Africa now stands at the brink of a full-blown AIDS crisis and since the onset of the AIDS epidemic, more than 500,000 South Africans have died of AIDS related causes. By 2015, this number is projected to be more than 10 million deaths. By 2008, overall life expectancy in South Africa is forecast to fall from its pre Aids level of 65 years to only 40 years. In addition, the pandemic has disproportionately struck young, economically active adults as well as those categorised as unskilled and poor. The consequences of the pandemic will be intense for millions of families, and it will place extraordinary pressure on institutions that confront its direct effects, such as the health care system for the care of those living with AIDS and social services systems for the care of dependents of AIDS victims, such as orphanages and places of safety. At the end of 1999 there were 371,000 living AIDS orphans in South Africa, climbing to 920,000 in 2005 and an estimated two million in 2010. It is possible to live a healthy and long life even if one has AIDS, provided that you can access the right medication. The medication, however, is not cheap, and the very poor can scarce avoid it. Those hardest hit by the epidemic will be the people who cannot afford the necessary medication. (Cassim, 2006; Aliber, 2003 and Bhorat and Kanbur, 2005)
Figure 7: Effect of Aids on GDP in South Africa
Source: Lewis, 2002
AIDS impacts on the long-run growth of an economy through various channels. These include dwindling productivity amongst the infected, increased pressure on health and other social services as the pandemic matures, reduced investment expenditure and savings in households treating infected individuals. In a study carried out in Lewis (2002), over a 10-year horizon, per capita GDP is likely to be on average 8 per cent lower. Estimates of the impact on long-run growth indicate that the pandemic may result in a 0.5 to 1 per cent reduction in real GDP per annum. Population growth will slow from 2.3 percent annually early in the 1990s to zero by 2010, and labour force growth will slow as well. The diagram above illustrates the effects of AIDS on GDP using a model developed by Lewis (2001). From, the diagram it can be seen that the changes induced throughout the economy will extend far beyond the direct loss of productive workers: recent estimates point to overall GDP declines of 19 percent by the end of the decade or 8 percent in per capita terms. Of this decline, only one-eighth is directly attributable to slower labour force growth; the rest reflects the possible impact on productivity, private consumption, and government expenditure and financing patterns. (Lewis, 2002; Bhorat and Kanbur, 2005; Meth, 2007)
An international study was carried out in 2004 and was commonly known as the The Copenhagen Consensus. This was a panel, consisting of nine of the world’s leading economists that sought to provide clarity and solutions on critical issues facing the world today. The panel examined 10 challenges facing the global economy. The challenges examined included AIDS, sanitation, trade policy, malnutrition and agriculture amongst others. Each challenge was discussed at length with its principal author and with other specialists who had been commissioned to write critical appraisals, and then the experts met in private sessions. The panel then ranked the proposals, in descending order of desirability. The prevention of HIV/AIDS was shown to have the greatest return on investment when compared to all the other policies and had a benefit to cost ratio of 40:1. This represents an extremely good investment for any economy and shows that the prevention of AIDS will have massive net returns for an economy. (www.copenhagenconsensus.com, 2007)
SA is seriously behind other middle-income countries in terms of its citizen’s access to infrastructure. Only 50 people per 100 000 have access to computers. This compares negatively when compared with Australia, which has 400 computers per 1000 people. When one considers how essential computers and computer literacy is in modern day economy, it becomes evident that that this is a serious constraint. The diagram below shows SA’s telephones per 1000 people in comparison to other countries. SA has 120 phone mainlines per 1000 people. Australia, Korea and Malaysia have 520, 430 and 200 telephone mainlines per 1000 people respectively. Additionally South Africa has one of the highest call rate costs in the world. Again, telephones are an essential form of communication and having such a low penetration and high call charges are a definite constraint. For both of these forms of infrastructure, it is the poor who have limited access. (Dobson, 2002)
Figure 8: Telephones per 1000 People in South Africa
Source: Dobson, 2002
South Africa’s energy costs are among the lowest in the world and this is of definite benefit to the poor. Additionally, a certain amount of free electricity is provided per a household. However, many of the poor do not have access to electricity. For the year ending in March 2006, ESKOM electrified 135,868 additional homes, surpassing its 85000 target and has now electrified 3 346 425 homes since the inception of the electrification programme in 1994. This equates to over 70% of households in South Africa that now have electricity. Unfortunately, supplying rural areas with electricity remains a challenge and this is where the majority of the remaining 30% of households are. To solve the problem, non-grid technologies are being introduced in areas where the cost of grid electrification is too high. Government plans to implement 300 000 non-grid connections over the next five to eight years. Other forms infrastructure constraints are housing and transport. For example, the housing programme has provided shelter for upward of 5 million people who were previously homeless. Since 1994 Government has spent R35 billion on the housing programme, which has enabled the construction of 1,877958 houses. However, it still has an estimated 2.4 million backlog. The provision of free basic water is also a priority. At present, 35 million South Africans of the population are receiving this necessity. Hence, the share of households with access to piped water has increased from 80 to 85 per cent between 1996 and 2001. The lack of affordable and efficient public transport, especially in rural areas, is cited as a major constraint to development at both the local and national level. (Eskom, 2006; Bhorat and Kanbur, 2005 and Meth, 2007)
The arrangement of land ownership and use in South Africa provides clear evidence of the extreme distortions caused by the legacy of apartheid policies. While many other countries are characterized by unequal distribution of agricultural land, the historic path followed in South Africa’s rural areas virtually eliminated the small farming sector, establishing in its place a dualistic structure of highly mechanised white large farms and overcrowded black homelands and dormitory towns. The result of these policies are: many rural people are essentially landless; many rural people who do have access to land have very little land or very poor land and many rural households having access to land derive little economic benefit from it. Lack of financing, training, and market access are among the problems faced by rural smallholders. The discriminatory policies date back to the Native Lands Act of 1912, which effectively prohibited blacks from owning, renting, or sharecropping on lands outside the designated reserves, which represented only around 8 percent of South Africa’s land area. Subsequent efforts relocated most blacks that had legitimate farming operations into the homelands, where tenure restrictions, high population density, and lack of capital and market access made commercial agriculture virtually impossible. The average land held by blacks per person was 1.3 hectares compared to 1,570 hectares by whites.
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