DARYL SWANEPOEL: Is Treasury on the right track with fiscal consolidation over expansionary stimulus?
The chosen approach is not economically and politically attainable in a low-growth, high interest-rate, higher-inflation environment
The economy is in a precarious position that threatens its ability to provide the necessary growth required to fund the country’s economic and social needs. This in turn is crucial to provide social justice, stability and cohesion.
The Treasury’s chosen fiscal course is one of fiscal consolidation, aimed at reducing what it has identified as a debt burden that is too high for the state coffers to finance. And of course there is truth in this. But with fiscal consolidation comes a cutting of public services and reduced infrastructure development. And if there is minimal infrastructure development the economy will not expand.
The mining industry has a market for and is capable of producing at least 20% more ore than what it is now exporting. But it cannot get it onto the ships due to the collapsing rail networks and inadequate port facilities. In similar vein, the agricultural sector could export about 7.5% more produce, but insufficient cold storage facilities at the ports negate this opportunity. Economic infrastructure refurbishment and expansion is necessary to grow the export market, associated jobs and improve the country's balance of payments. Not to mention the concomitant increase in tax revenue.
Therefore, the question needs to be asked: is fiscal consolidation the right path for the current economic environment? The answer: yes and no. In reaching this conclusion the two approaches to debt should be weighed up.
Austerity is a form of voluntary deflation in which the economy adjusts through the reduction of wages, prices and public spending to restore competitiveness, which is (supposedly) best achieved by cutting the state’s budget, debt and deficits. Its adherents believe it will inspire business confidence, since government will either be crowding out the market for investment by amassing available capital through the issuance of debt, or adding to the nation’s already considerable debt burden, which they regard as too large and unsustainable in the long term.
Other economists suggest evidence and results from the 1939 Great Depression and 2008 global financial crisis demonstrate that fiscal stimulus is the most effective way to cut deficits, resist recession and combine deficit reduction with rapid growth. In addressing the economic woes of 1939 then US president Franklin D Roosevelt said, “as desirable as a balanced budget might be, the needs of recovery come first”. Similarly, from the mid-1940s to the mid-1960s the public debt to GDP ratio was considerably larger in Britain than it has been at any time since the 2008 financial crisis, with high growth rates. Britain was also establishing its welfare state at the time, developing a foothold for the welfare state in Europe, and then globally. Its debt to GDP ratio in 1948 was more than 200%, more than double what it has been over the last two decades.
The prevailing narrative is that at 70.1% SA’s debt to GDP ratio is too high. But by international standards it is not particularly onerous. The other plus in the case of SA is that most of our debt is rand-denominated, which shields government from some volatility in debt costs due to fluctuations in the exchange rate. The world average is 97%; advanced economies 120%, emerging markets 66%, upper income higher than 66%, Asia 73% and Latin America 72%. But the interest rate on our debt is high, at 8%-9%.
By comparison, developing countries’ average debt cost on external borrowing is three times higher than that of developed countries. In the low interest environment of the past decade, developed countries borrowed at an interest cost of an average 1%. The interest differentiation thus does confine the extent to which SA can extend its public debt, but there is scope.
The appropriate policy mixes, contextual to SA’s situation, should be implemented so that its economic turnaround can occur in the short term and be sustainable. We believe there should be less severe budget cuts as part of a more gradual, realistic, less procyclical framework and more long-term orientated fiscal recalibration than the current Treasury one, which is too ambitious in its outlook. Given the current dismal global economic scenario (likely to continue into the medium term), fiscal consolidation is not economically and politically attainable in a low-growth, high interest-rate, higher-inflation environment.
A more realistic fiscal approach should result in a more gradual rise in the primary surplus in the years ahead, rather than a short, sharp shock approach that risks dumping the economy into a recession with all its negative attributes.
Fiscal consolidation has costs attached to it, such as a reduction in government personnel, less funding for public services and infrastructure maintenance and development. A recent Financial Times editorial captured the sentiment by suggesting that “Rigidly sticking to fiscal orthodoxies in a crisis is not always wise, as much as it needs to be balanced with boldness”. So, on the no side of the answer, it is argued that fiscal consolidation will stifle longer-term economic growth.
However, the expanded fiscal space generated by less severe budget cuts must be spent on economic infrastructure development and job-enhancing projects and programmes, and not on consumption. It would not be wise to crowd out spending on infrastructure that is needed to underpin the productive sectors of the economy. Economic infrastructure development will undoubtedly lead to higher economic growth and a bigger market, with an accompanying increase in tax revenues and more social and political stability; a win-win situation.
Whereas the Treasury envisages public debt peaking at about 89% in 2025/26, by being slightly more flexible and allowing for an incremental rise it will free up considerable fiscal space to fund economic infrastructure development. This is also motivated by the critique of a group of economists from Amherst-Massachusetts, who disproved of the Carmen Reinhart and Kenneth Rogoff paper “Growth in Time of Debt”, which was seized upon by many finance ministers in the developed world to justify spending cuts and sharply lower government debt. They established that “policymakers cannot defend austerity measures on the grounds that public debt levels greater than 90% of GDP will consistently produce sharp declines in economic growth”.
On the yes side of the answer: wasteful expenditure and unnecessary perks should be ruthlessly erased from budgets, and state-owned enterprises should be radically restructured and better governed, underpinned by the necessary structural reforms of the economy. There are enough areas to cut in government spending with the amount of waste and inefficiencies that are now prevalent.
There is good and bad debt. Bad debt is consumption debt, which does not spur economic expansion to the same extent as investment debt (good debt). We believe the twin reforms of austerity related to consumption spending and debt expansion to accelerate economic infrastructure development will enable growth and future tax revenue enlargement that is capable of servicing the newly acquired debt and future public spending expansion.
• Swanepoel is CEO of the Inclusive Society Institute. This article draws from the institute’s soon-to-be-published occasional paper “Contractionary Fiscal Consolidation vs Expansionary Fiscal Stimulus in the Context of the SA Budget”.
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