Category: SA Economy

The SA National Roads Agency (SANRAL) very clearly misjudged its pricing power when setting the original tolls for the Gauteng commuter belt. Toll road charging is as much about politics as economics, as the Agency now knows only too well.

But what are the economic principles that inform SANRAL tolls? I trawled through the SANRAL website for answers and find very little by way of guidance. How “the right price” for a new road to be built and tolled is determined appears to receive very little attention or analysis in the documentation presented to the SA public by SANRAL.

There are some clues that indicate the tolling pricing philosophy. SANRAL pays close attention to the volume of traffic on its roads. To quote its Strategy: “Traffic data forms the basis of planning in SANRAL. Because it is important for SANRAL to have accurate traffic data for the entire national road network, it is covered by strategically positioned traffic counters.” Source: SANRAL Strategic Plan

SANRAL is also naturally well aware of its credit ratings and the strength of its balance sheets. Debt management would appear to play an important role in its tolling determinations , according to its Strategy Document:

“SANRAL has historically sought to reduce its dependence on transfers from the fiscus, using the strength of its balance sheet to finance the toll road programme…….. to allow it to continue its borrowing programme efficiently to fund the toll roads. The aim is to maintain the credit ratings at sovereign equivalent levels at all times. But the recent uncertainty around the implementation of electronic tolling on the GFIP has caused nervousness among investors. The rating agency has placed SANRAL‟s ratings on review for a possible downgrade.”

Not all of the extensive road network, for which the agency is responsible, is suitable for tolling, due to the lack of sufficient traffic to cover even the costs of collecting the tolls. But the costs of maintaining and extending the road network are formidable and for meeting this responsibility, the revenue from tolls (where they do cover their costs of collection) are for SANRAL a more helpful alternative source of finance than grants from the National Treasury.

The Toll Budget proposed in 2012-13 illustrates the financial objectives for SANRAL, presuming it got its way with tolls. Income from tolls were proposed to increase from R3.69bn in 2012-13 to R6.34bn in 2014-15. Expenditure on operations was to rise much more slowly, from R2.42bn to 2.84bn over the same period. That is to say, operating profits would rise from R1.27bn in 2012-13 to R3.5bn in 2014-15.

This improvement would go some way to meeting the growing finance charges associated with a massive increase in capital expenditure on roads to be tolled, that occurred between 2008-9 and 2011-12, as well as the extra debt associated with this capital expenditure programme. Capex of R25.37bn was incurred over these years and funded largely with debt. This burst of capex on toll roads according to the Toll Budget will slow down to R2.24bn in 2012-13, R1.45bn in 2013-14 and R1.58bn in 2015-16. This mixture of rising operating profits and declining capex and debt issues would clearly improve the SANRAL balance sheet.

The strong indication is that, with these balance sheet objectives very much in mind, the guiding principle in determining the tolls charged is based largely upon what the expected, closely monitored, traffic will bear. In other words, the tolls are set to maximise revenue. The more traffic, the more essential the route to be travelled, the stronger the demand and so the higher the tolls, would seem to be the modus operandi. In other words the tolls are set independently of the costs of building and maintaining the roads, with the most popular routes producing the largest operating surpluses.

The transport engineers might call this a pure congestion charge. It is not a user charge system but a system for cross subsidising users.

It is good economics to apply user charges as an alternative to general taxation, from which the taxpayer may receive very little benefit. The Gauteng commuter, not the Cape Town commuter, should pay for Gauteng roads. Nor should the Cape Town or Gauteng motorist be expected to pay for the costs of using the little used road from Calvinia to Upington.

But then how much should the Gauteng commuter be expected to pay? Not surely as much as the Gauteng traffic could bear. Given the lack of alternative routes and transport this could be a very high price indeed – as SANRAL originally intended.

The right price for a new toll road would be a toll that could be expected to generate enough revenue and operating surplus to cover all costs of building the road, including the opportunity cost of the capital employed. It would be inflation protected. If, in applying this principle, the right price can be expected to be generated over the estimated life of the asset (say 20 years), providing revenues sufficient to cover all costs, including a (low) risk adjusted return on capital, then the road should be built. If this condition cannot be met, either the road should not be constructed at all, or some explicit subsidy from the taxpayer would have to be in the budget for the road, using the same pricing principles. This economically sensible “right price” for a new road, for which there would be good demand, as for example an improved Gauteng road network, would surely be far lower than a “what the traffic can bear” charge.

It is essentially this pricing principle that the energy regulator has used to determine the price that Eskom, with its monopoly power, is allowed to charge its customers. Nor did NERSA allow debt management considerations to influence its price determination. As with a new power station, a new road, bridge or flyover is fully justified when the price charged is sufficient to generate enough revenue to cover all costs and to provide an appropriate return on capital. And using debt to fund infrastructure also makes sense, providing the returns justify the capital expenditure. Debt management should not be allowed to influence prices.

Roads are highly productive. Building new roads or access to them can make every economic sense when the right price is charged to their users. An active road building programme for the SA economy is urgently called for, especially where demand for roads is most intense, as it is around Gauteng or Cape Town. Yet the right price to be charged to justify this programme should not be seen as a congestion charge designed to force the use of alternative transport – or as a way of cross subsidising the building of roads that cannot cover their costs.

It calls for a user charge sufficient to cover costs of building and maintaining roads, wherever possible and no more; or for an explicit subsidy that the tax payer will be called upon to supplement user charges when revenues from practically feasible user charges would fall short of the requirement to cover all costs.

These – economic return on capital – pricing principles have not guided SANRAL. That the originally intended Gauteng toll charges proved politically impossible has unfortunately made sensible toll charging of the right kind indicated less likely. It is likely to have a negative impact on productive road building in SA.

When a private company grossly mismanages a project designed to add revenues and profits or mismanages the project such that its capital costs grossly exceed budget, the management takes the blame. They may lose their jobs as well as their reputations, and the shareholders who appointed them have to bear the burden of a lower return on the extra plant and equipment created. In extreme cases the overruns and the waste of capital incurred may bring the company down, causing shareholders to lose all and debt holders to salvage what they can out of the loss making wreck.

In the case of a government-owned and regulated monopoly the outcomes for the management and the company may not be so severe. Unlike the private company, the regulator may be persuaded to allow the company to charge more to maintain a regulated return on the extra capital employed. Unlike the private company facing competition and market determined prices, largely beyond its control, the public monopoly may be able to cover its cost overruns with higher prices. With little alternative, the consumer will have to pay up and hope to economise on the more expensive essential service. The consumers, not the company, then have to bear the consequences of what might well be very poor project management. And the international competitiveness of all those who use the now more expensive service suffers accordingly. Factories and mines will then become less profitable, especially in export markets, because they will not be able to pass on higher costs, so discouraging further investment in their enterprises. And households will see their real disposable incomes taxed further, discouraging consumption of other goods and services.

Making customers rather than owners carry the proverbial can for poor project management is not only unfair – it covers up for poor management so encouraging managers to become less responsible and efficient.

Price and return on capital-regulated state owned enterprises play a critical role in supplying the SA economy with essential infrastructure, such as new power stations (Medupi) and new pipelines (Transnet’s new pipeline from Durban to Gauteng). The problem is that the managers of these state owned enterprises are not making a very good fist of project management. These important projects are well behind time and well over original budget.

Fortunately for the consumers of electricity or pipelines, the regulator is adopting a more critical approach to the costs, both capital and operating, claimed by Eskom and Transnet to justify higher prices. A report (Businessday/BDlive, Razina Munshi, 2 August 2013) commented:

“The National Energy Regulator of South Africa (Nersa) is investigating the near doubling of the costs of Transnet’s new multiproduct fuel pipeline from Durban to Gauteng, in a move that could herald closer scrutiny of big cost overruns on state infrastructure projects. The outcome of the probe could also have implications for petroleum pipeline tariff hike requests in the future……. Transnet originally budgeted R12.7bn for the project, but this soon rose to R15.4bn, and it quickly became clear that even that was conservative. The final price tag of R23.4bn includes the cost of pump stations in Durban and Heidelberg, still under construction….”

Commenting on Eskom’s claim for higher prices, Business Report (12 July 2013 ) said: “The failure to push through big-enough price increases has created a 225 billion-rand cash-flow shortfall as the company struggles to meet the continent’s biggest economy’s electricity demands.”

This cash flow shortfall – the difference for Eskom revenues between a 16% per annum price increase over five years and the 8% per annum increase granted by Nersa – helps reinforce the important point. If the consumers cannot be forced to pay up for management failure, then the owners have to.

The owner of Eskom and Transnet is of course the Republic of South Africa, ie the citizens whom the government represents. To overcome the huge cost overruns they, the people, have to come up with the extra cash, that is the extra capital required to keep Eskom and Transnet going. They have to borrow the money and pay the extra interest on the additional debt, and/or impose additional taxes on themselves to cover up for poor project management. Even if some of the people believe that others, not themselves, will be stumping up it is clear that the funds so raised and the taxes paid could be put to better alternative uses, for example building homes, schools or hospitals.

It is not at all clear why the people of SA would wish to take on these risks of poor project management that they need not have to do. The assets and activities of Eskom and Transnet could be privatised, as they are in many economies, with the current plant and equipment sold off at market determined prices. The pipeline would fetch a pretty penny at current regulated prices. In this way not only would the debt levels and interest expense of the Republic be reduced significantly, the exposure of the SA citizen to huge cost overruns would be eliminated. Shareholders in privately owned utilities with highly predictable revenue streams would willingly bear those risks, especially if the regulator offers them a fair risk-adjusted return on capital. And the Republic would also collect its normal share (28%) of the profits earned by a privately owned utility and the dividends paid out.

Little sympathy should be accorded to Eskom having to raise the extra debt to cover their cost overruns. A recent positive response by a private company, Exxaro/GDF Suez Energy to a Department of Energy call for participation in electricity generation (13 June 2013);if accepted, will allow this private company to build a new coal fired power station producing a respectable 680MW of electricity, to be delivered to the grid at presumably current wholesale prices set by the regulator for Eskom – plus inflation.

This indicates that the price of electricity in SA is now more than high enough to encourage private owners to risk their capital to supply additional electricity. No doubt the company has built in high enough returns on the capital it intends to employ to make the project viable. Should it succeed SARS will be looking to its normal share of profits. And should it fail to produce a profit, or even go out of business, the shareholders will have to stand up and bear the loss. Some other group of owners would then take over the plant at what will be a distressed price and hope to manage it better.

SA citizens would surely find this a better prospect than having to bear the risks of owning assets over which they have very little control and their managers do not appear to do a very good job of managing.

By Brian Kantor

Hard Number Index updated – economy still growing but at a slower pace

We have updated our SA economic activity indicator, the Hard Number Index (HNI) for May 2013 with the release of vehicle sales and notes in circulation data. The HNI indicates that economic activity in May was still growing at an improved rate. The forward momentum however (the speed of the economy) is slowing down and is predicted to slow down further over the next 12 months. The change in the HNI may be regarded as the second derivative of the economy with the HNI or the business cycle as its rate of change – positive or sometimes negative when the economy shrinks.

The HNI and the Reserve Bank Indicator are both well above the 100 level

Our index is an equally weighted combination of new unit vehicle sales and the notes in circulation issued by the Reserve Bank – adjusted for the CPI – that we call the Real Money Base (RMB). These two hard numbers provide a very up to date view of the state of the economy, being released within a week of any month end. We show a comparison of the Coinciding Indicator of the Business Cycle as calculated by the Reserve Bank. This indicator is based upon seven or more time series mostly using sample surveys rather than hard numbers that are released with variable time lags. The latest estimate made by the Reserve Bank is only for February 2013.

As the chart shows, our HNI has identified rather accurately recent turning points in the Reserve Bank indicator. The Reserve Bank recently rebased this indicator to December 2010 and we have done the same. Numbers above 100 in these diffusion indexes indicate that the economy is growing and numbers below that the economy is shrinking. Both the HNI and the Coinciding Business Cycle Indicator are recording numbers well above the 100 of December 2010, implying still strong growth momentum. Our indicator predicts that this forward speed has slowed and will slow further in the months to come.

Vehicle Sales remain a strong feature of the economy – real money base growth slowing

The most encouraging feature of the SA economy is the strength of new vehicles sold domestically. Export volumes have also gathered momentum, accounting for about half of domestic sales volumes. While the growth in unit vehicle sales has slowed down it has remained close to an 8% annual rate and is predicted, via a time series forecast, to maintain this rate. The supply of central bank cash, adjusted for higher consumer prices, peaked recently at about an 8% real rate and is currently growing at about a 4% rate – held back by more inflation and a slowdown in the growth in cash held by the public and banks. It is forecast to slow further.

Money supply (M3) and Bank Credit Growth have picked up

The bank credit and broader measures of the money supply have been updated to April 2013. As we show, the growth in M3 and in credit supplied to the private sector has gathered momentum despite consistent weakness in demands for mortgage finance. Bank credit could not be regarded as a drag on growth.

The drag on the economy is coming from the rand

The drag on growth in domestic spending is now coming from offshore. The limits to this growth are set by the willingness of foreign suppliers of capital in one form or another to fund our spending. This willingness is revealed in the foreign exchange value of the rand. This has deteriorated significantly in recent months, putting upward pressure on the prices consumers and firms have to pay for their goods and services, especially those with high import content. These higher prices might also be accompanied by higher interest rates.

Our view is that, given the weaker predicted state of the economy, the Reserve Bank will wisely resist increasing short term interest rates. Relief for the economy will however not come from lower interest rates. The source of recovery will have to come from increased exports, especially of metals and minerals. The rand is weaker because it is expected that the mining sector, which accounts for 60% of exports, will be further disrupted by strike action. Were the mines able to operate at a better than expected rate, the rand would benefit and the chances of lower interest rates, well justified by slower growth in domestic demand, would greatly improve.

A crisis of poor returns on capital invested and declining employment opportunities

SA mining is in crisis. And the travails of SA mining, more particularly those of gold and platinum mining are having a very negative impact on GDP and expected GDP growth and on the value of the rand. To survive as viable businesses able to cover their costs of capital the mines have to plan for lower costs of operations and that means to plan for lower levels of production and employment, that is plan the closing rather than the opening of mining shafts. Investors in the industry and in the South African economy are not at all sanguine about the prospects for the industry and this lack of confidence is well reflected in the market value of the mining companies and in the exchange value of the ZAR.

The market fears further disruption of mining output by uncooperative trade unions. Union leaders do not appear to share the same sense as have shareholders and potential investors have of an industry in crisis. The Unions are expected to further resist retrenchment of their members and to continue to demand what shareholders and also the government regard as hopelessly unrealistic demands for improved employment benefits.

The future of deep level mining in South Africa may well lie in much higher levels of automation. This is a course of action not suited to an economy with so many unemployed or employed on far inferior terms outside the mining sector.

The mining sector contributes much to exports and to the outlook for the rand and interest rates

Lower levels of mining production, particularly if they are the result of strike action, threaten the trade account of the balance of payments and justify a weaker rand. The weaker rand then implies more inflation that makes it harder for the Reserve Bank to offer relief to the economy in the form of lower interest rates, relief, absent a widening trade deficit, that would make every economic sense.

Growth in Domestic Expenditure (GDE) has held up significantly better than growth in domestic output (GDP) meaning stronger growth in imports than in exports. The failures of the mining sector to produce more and to take advantage of what has been until recently, highly favourable price trends ( as we will show below) are a large part of the explanation of current rand weakness and slow economic growth generally.

The share market doesn’t expect growth in output or even growth in earnings and dividends from the mining houses and their subsidiaries. It is rather demanding that the mining houses pay much closer attention to cost control and operational excellence. These low market expectations should act as a warning to managers, workers and the government responsible for mining policy. The lower profits and reduced growth expected is not in synch with demands for higher wages, electricity prices and government interference with mining rights and the taxation of mining profits.  The potential upside for shareholders is that if these low expectations can be countered by sober management and better relations with labour and government then these mining companies stand a stronger chance of recovering their status with investors. Merely sustaining the output of gold, platinum even at lower planned levels, would be surprisingly good news and likely to be well received in the share and currency markets.

How dependent then is the SA economy on the mining sector? It all depends on how the share is measured

The SA economy remains highly dependent on the export of minerals and metals. Directly exported minerals and metals account for as much as 60% of all export revenue. Hence the sensitivity of the foreign exchange value of the rand to mineral and metal prices and their production.

Mining’s share of the Gross Value Added (GVA) by all sectors of the SA economy in 2012 was no more than 5.5% when measured in constant 2005 prices. When both mining output and GVA, including mining output, is measured in current prices, mining’s share rises to 9.3% of GVA. As we show below, when measured in constant 2005 prices, the contribution of mining to GVA and GDP has been steadily declining over many years from a large 23% share in 1960 to the current less than 6% share , regardless of the direction of global metal and mineral prices and so mining revenues.

As we also show that when the share of mining is measured in current money of the day prices the share of mining in the economy takes on a very different complexion. The share of mining in the SA economy, so measured as a ratio in current money of the day prices, was less than 12% in 1960, compared to over 23% in constant price terms that year. In 1970 the share of mining in GVA was 8.8% if measured in current prices, or a much higher share, 20% of the economy,  if measured in constant 2005 prices. Thereafter the mining share measured in current prices rises significantly rises in response to the very significant increases in the gold price in the seventies. When the gold price peaked in 1980 the share of mining in GVA in current price terms was as much as 21%- but then only about 12% if recorded in constant 2005 prices. Thereafter, as the gold price fell away and the prices of mining output were subject to a long period of deflation and a further decline in the output of gold, the share of mining in current price terms fell further to a much less important 7% by the year 2000. Thereafter when measured in current prices Mining gained a marginally larger share of the economy to the 9% share measured in 2012. The increased output of and higher prices coal and iron ore were significant contributors to thei increase in economy share. The share of mining in the economy in constant price terms by strong contrast declines continuously after 1960 and appears completely unaffected by relative prices or industry trends as we show below.

The share of Mining in Gross Value Added using constant 2005 prices or current prices

Source; SA Reserve Bank Data Bank, Investec Wealth and Investment.

Real prices matter a great deal to producers

A key to the role of any sector of the economy, with an improving or deteriorating share of the economy, is surely relative price trends. When a sector enjoys what may be called pricing power, that is to say the sector can price increases ahead of the average rate of inflation , then one would expect improved profit margins to follow and extra output to be encouraged. In the figure below we show how the SA Mining Sector Price Index, that is the mining sector deflator, has compared over the years with all prices, including the prices of metals and minerals, as reflected by the Gross Value Added Deflator.

As may be seen between 1960 and 1970 Mining Sector selling prices lagged well behind the selling prices of all SA production or value Added.   In the seventies, helped especially by a rising gold price, prices realised by the SA mines, rose significantly faster than prices in general. A long period of metal and mineral price deflation then followed until approximately 1999 when commodity prices picked up strongly in absolute and relative terms. These favourable trends or terms of mining trade were then disrupted by the Global Financial Crisis of 2008-09

The Mining Sector Deflator compared to the Gross value Added Deflator (2005=100) Logarithmic Scale

Source; SA Reserve Bank Data Bank, Investec Wealth and Investment.

 If we divide the Mining Sector deflator by the GVA deflator we get the relative price of mining output. For producers in any sector the higher the relative price the better and the more encouragement offered to increase otput.[1] In the figure below we compare these relative prices with the share of Mining in GVA, measured in current prices. As may be seen the share of mining grows and declines very consistently with improvements in or a deterioration of the relative prices of mining output. Such responses make every economic sense. That the share of mining, when measured in constant price terms, declines consistently and independently of these relative prices makes very little intuitive sense. Relative prices appear to make no positive impact on the mining sector at all when the mining share is measured in constant prices. The share of mining in the economy, when measured in constant prices, simply declines continuously as may be seen.

The reason for this highly counterintuitive result is simply in the arithmetic of National Income Accounting conventions. If sector prices – for example mining sector prices – rise faster than prices in general then the share of that sector in the economy, when measured in constant prices, automatically declines and vice versa when sector prices rise more slowly than prices in general the share of that sector will rise automatically. [i]

The presumption of such a result is that it is the supply side of the economy, rather than demand forces that drive relative prices and so relative shares in national income methods of calculation. That is it is an increase in supply that results in a lower relative price and so a larger share of the economy. Rather, that as in the case of mining output, where prices are set globally and the mines are price takers, to presume that it is an increase in global demand that leads to higher prices and in turn to more profitable production and so increases in output and in the share of the economy realized by a sector.

Applying the standard convention to the share of Mining and also Exports in SA subject to similar price trends becomes seriously misleading. Measuring sectoral shares using current prices makes much more economic sense.

It should be noticed in the figure below that SA miners benefitted from an extraordinary increases in the prices for their output compared to prices in general in the seventies and after 2000. Relative prices have moved further to the advantage of the mining sector over the past twelve years as may also be seen. That Mining’s share of the economy did not rise anything like as significantly in the past decade and more reflects the wasted opportunity to benefit from the commodity super cycle. The mining boom in terms of volume of output produced regrettably largely passed South African production by. The costs of mining gold and platinum rise as rapidly as did prices. Uncertainties about government policies towards mining and the failure to invest in additional transport infrastructure to export more coal and iron ore also contributed significantly to the modest supply side responses to much more favourable relative price trends.

Mining share of GVA and Relative Mining Prices

Source; SA Reserve Bank Data Bank, Investec Wealth and Investment.

Another very good reason to question the use of constant prices to calculate sectoral shares of the economy  is that these shares can change meaningfully with changes in the base year used to measure constant prices. Using exactly the same price series, the same deflators, measured in constant 2005 prices or constant 2000 or constant 1970 prices can make a large difference to the share of a sector measured in constant prices as we show below. Using a deflator with 1970 prices =100 for both Mining and GVA, to one using much lower 2000 prices or 2005 prices as the base equal to 100 shifts the share of mining in constant prices in 2012 from 2.4% using 1970 prices to 4.8% using 2000 prices to 5.5% using 2005 prices. [ii]

Share of Mining In the SA economy using different base years

Source; SA Reserve Bank Data Bank, Investec Wealth and Investment.

 

That changing the base year can have such a meaningful effect on the sector share makes the use of constant prices as the basis for calculating the share of different sectors in the economy highly unsatisfactory. While the trends in the sector share, measured in constant prices using different base years, remains exactly the same the numerical values can turn out to be very different. Every change in the base year results in once and all constant shift in the trend giving a different impression of the importance of the sector to the economy. This is why in our judgment the most consistent measure of mining’s contribution is the ratio of mining output to Gross Value Added ( GVA)when both mining output and that of all sectors including mining GVA, is measured in money of the day prices. By this calculation the share of mining in the SA economy peaked in 1980 at over 20% and currently contributes about 9% of all value added as we show above.

The contribution of manufacturing to the SA economy is exaggerated using constant price calculations

 

The same approach to measuring the share of Manufacturing in  SA production can  be taken. In the figure below we show Manufacturing’s share in GVA as well as the relative price of manufacturing Output. As may be seen the share of Manufacturing measured in current prices was approximately 24% in the eighties. It has since declined markedly to a 12.4% share in 2012. This declining share has been accompanied consistently by an almost continuous decline in relative prices. This downward price pressure has clearly accelerated in recent years. Manufacturing in SA has become increasingly exposed to competition, especially from abroad. Consumers and retailers and their employees have benefited from the competition.

Manufacturing Sector; Share of Output and Relative Prices

Source;  SA Reserve Bank Data Bank, Investec Wealth and Investment.

Conclusion

Economic statistics should accurately reflect economic realities and hopefully lead to appropriate economic policy and policy changes. Measuring sector shares in SA in constant price terms as is the National Income Accounting Convention is very misleading about the role of mining in South Africa and therefore also about the role of other sectors, including Manufacturing as we have argued. A irony is that if shares in the economy were measured in current rather than constant price terms this past quarter the disappointing and currency moving Q1 GDP numbers would have looked rather different. Manufacturing, with a lower share of the economy when measured in current prices, 12.3% share in current prices in 2012 compared to 17.2% in constant prices, with a close to 8% decline in output on a seasonally adjusted and annualized basis, would have been less of a drag on economic growth. And mining output that increased in Q1 given a larger share of GVA (5.6% in constant prices, 9.3% in current prices) would have added more to the growth rate.

 

A lead article in BD by Alexander Parker, (Friday 5 April) was introduced with the headline State-Aided car exports ‘almost 40% of trade gap’.

The article quoted Roger Pitot of the National Association of Automotive Components and Allied Manufacturers, that the motor industry’s trade deficit was R49bn “or more than 40% of the national trade deficit … by far the highest we’ve ever had”. Presumably this trade deficit is the difference between the imports of motor vehicles (fully built) and also of components of motor vehicles (to be assembled in SA) and the exports of motor vehicles and components from SA.

Fair enough – but then the article goes on to quote Gavin Maile from KPMG “… local production of vehicles for export also contributed to the trade deficit …” an observation given prominence in the headline.

(This last statement is a non sequitur. Any exports of motor vehicles from SA would reduce the trade deficit provided, which seems reasonable enough to assume, that the prices received for the the exported vehicles covered at least some of the labour, transport and rental cost etc incurred in SA assembling and/or shipping out the vehicles. This would be true even if all the components of the vehicles exported were imported. Indeed, if the fully built up vehicles were shipped to SA and then re-shipped to neighbouring countries, outside the customs union, provided there were extra rands to be earned in these operations, the SA trade deficit would decline.) Imports might go up in rand terms importing the vehicles and or their components, but if some of the imports were then re-exported exports measured in rands would go up by more than the rand cost of the imported vehicles or the components previously imported.

But these logical quibbles aside, the more important point is that there is no logical reason to expect or plan for a balance of imports and and exports in any one sector of the economy as perhaps the component producers are suggesting and would prefer. There will always be sectors of the economy that profitably export far more than they import: for example mining or farming and other sectors, such as the motor industry where the opposite applies.

We and the firms we own and work for strive to profitably produce a surplus of the services or goods that we specialise in to supply the world of consumers and users, both domestic and foreign. We then turn these sales into money for salaries and wages and rents and taxes and profits for owners who then exchange this income for all the other goods and services that are cheaper to buy in than produce ourselves. As Adam Smith explained many years ago, division of labour and the productivity gained through specilaisation is limited by the extent of the market. These benefits of trade are widened by opportunities to sell to and buy from foreign firms and households.

An economy protected against foreign competition will not only import less but also export less because it denies itself the advantages of specialisation in goods and services in which it has comparative advantages (in both the domestic and foreign markets). The notion that trading partners will willingly buy from SA firms without an equal opportunity for their firms to also sell to SA customers is clearly false. Trade is a two-way street where the traffic is best kept flowing freely in both directions.

It is possibly a moot point whether SA would have much of a domestic motor assembly, let alone a domestic motor manufacturing industry, were it not for a long history of protection offered to the domestic manufacturer and component producer. The effective protection against imports may have declined to a degree – hence the greater volume of imported vehicles. The one great advantage of the current system of incentivising exports by giving license to import, is an SA market with a great variety of vehicles (though how well prices paid on the local showroom floors compare with prices abroad is a subject of much debate).

This variety of new vehicles on offer in the domestic market – from luxury to utility – not only encourages demand for vehicles but also employment in the distribution and maintenance of these vehicles. One wonders how the numbers employed in distributing and servicing the vehicle stock compare with those employed in manufacturing vehicles and components. Less variety on offer would mean reduced demand for new vehicles and a smaller slower growing vehicle park to service and trade.

But aside from employment gains made in distributing and servicing an enhanced vehicle park, there is another very valuable benefit from having a great variety of new motor vehicles for customers to choose from. The quality of motoring experiences for many highly paid and highly skilled participants in our economy – the indispensable rain makers so to speak – ranks for them (in lifestyle) not far behind, in importance and relevance, to the quality of their homes, children’s education and medical services. Force them all to drive the equivalent of the East German Trabant or a limited selection of cars that might be produced cheaply in relatively large numbers in SA, would mean a less attractive life style for them and so effectively a still higher tax rate imposed on their incomes.

With all taxes or exactions on their standard of living, these key personnel with artificially diminished choices in vehicles or in any other goods and services they wished to spend their own incomes on, would have to be compensated with higher pre- tax incomes to help keep them in SA. Being able to exercise consumer sovereignty not only makes you free: it also makes your economy more competitive in the market for skills and so in all markets for goods and services that domestic suppliers enter.

Freedom to enjoy the full variety of goods and services on offer in the global village, especially educational, medical and motoring services (at competitive prices that only openness to imports can bring), helps hold down the cost of attracting essential skills without which no industry or economy can hope to be competitive. Adopting free trade helps supply a better quality of life, including importantly a better quality of motoring. This is sensible economic policy that pays off for all sectors of the economy, especially for those that have a comparative advantage in exporting their surplus production. Protecting the market against imported goods or services inevitably will bring lower levels of exports and a lower standard of living for all- rich and poor.

Brian Kantor

New unit vehicle sales fell off the torrid pace set in January 2013. On a seasonally adjusted basis, unit sales fell back from the 57 834 units sold in January to 52 760 units sold in February. We had suggested that January sales may have been boosted by pre-emptive buying in response to rand weakness.

As we show in the chart below, unit sales (seasonally adjusted and smoothed) remain on an upward tack. If current trends are maintained, the distributors of new cars in SA could be looking to monthly sales (seasonally adjusted) of 59 000 units by this time next year. This would take the industry almost back to the record levels of sales achieved in 2006. It is instructive to notice how little growth in vehicle sales volumes occurred between 1990 and 2002, but also how sales took off in the boom years (2003- 2007) before the recession knocked them back again. That sales are again approaching boom time volumes should be regarded as very good news about the resilience of the SA consumer.

While sales in the local market are satisfactory, even as their growth may have slowed, the motor manufacturers and component suppliers will be well pleased with fast growing export volumes. New vehicle exports numbered 27 011 units, or 5 057 more units than exported a year ago, a gain of 22.4%. It will be appreciated that vehicle exports are now running at a fraction more than 50% of domestic sales. This boost to exports will be particularly appreciated by the authorities and the currency traders worried about the slow pace of exports and the large trade deficit recorded in January 2013. Clearly vehicle sales have been encouraged by low interest rates and available bank credit. The low interest rates and banks eager to lend are very likely to continue to add impetus to the vehicle market. The weaker rand however, will make it harder for the dealers to compete on the price front – not only with other dealers but with all other goods and services that compete for a share of the household budget. Brian Kantor

Money supply and credit numbers for January 2013 show that while the supply of money (broadly defined as M3) continues to increase, the pace of growth remains subdued at about the 6.5% to 7 % year on year rate. The asset side of the bank’s balance sheet, represented by credit granted to the private sector, has been growing at a slightly faster rate, closer to a 9%.

There would however appear little evidence of any pickup in growth in bank lending or in the broadly defined money supply. Mortgage lending, which is usually a large component of credit supplied by the banks, about 50% of all bank credit provided to the private sector, continues to grow very slowly. Clearly house price gains and thus growth in mortgage lending are increasing very slowly, with the rate of growth slowing down.

These money supply and credit trends, as well as the very subdued trend in house prices, make the case for lower interest rates. Until such time as these trends move strongly in a higher direction, short term interest rates in SA will remain on hold – though given these money and credit trends the economy could well have done with lower interest rates. Brian Kantor

The National Energy Regulator (Nersa) turned down the heat for the energy user, allowing Eskom to levy 8% annual increases for its electricity over the next five years, half the increases Eskom had applied for.

The most obvious beneficiaries are the large energy intensive users, the beneficiators of raw materials, who account of about 44% of the load. They contribute heavily to SA exports and they need all the help they can get with the trade balance under pressure form much stronger growth in imports than exports. Their viability would have been seriously compromised had Eskom had its way.

Property owners and their tenants, directly or indirectly paying more for electricity, will also be relieved, as will lighter industry and the ordinary household (though for them the electricity supplier is not Eskom but their local friendly municipalities).

When Eskom supplied artificially cheap electricity until recently – its charges have tripled over the past five years from about 20c per Kwh to the current 61c – the municipalities did not hesitate to use the monopoly power thay had to charge local users a whole lot more.

A new funding mechanism, the equitable share formula, introduced in the 2013 Budget, will give municipalities a grant of R275 for every household with income of less than R2 300 per month – this is estimated to mean more than 59% of all households in SA. This source of funding will hopefully take the pressure off the electricity tariffs that have been used as a very convenient tax. Using the broader tax base rather than electricity tariffs to help the poor is the right approach and should help encourage industrial and commercial users in the cities that generate jobs and incomes.

Nersa thinks the right price for Eskom’s electricity is the price that would give the utility a 3% real return on the capital it employs. This, as we have discovered, is very much in line with the global average. Listed utilities world wide seem to survive and even thrive with real returns on their large capital investments with returns on all capital employed of about 3-4%. They presumably also do a reasonable job of containing their costs than Eskom.

We have pointed out before that the less Eskom charges, the more debt it or the SA State will have to issue to fund its heavy and essential expansion programme, absent a willingness to sell off some of its generating capacity to private owners.

It would be a very good idea to have other managers running power stations so that useful comparative benchmarks on operational costs could be established for Eskom. Such partial privatisation might be judged essential should extra debt have to be issued.

In Eskom’s case for 16% annual increases it had estimated that some R350bn of debt would have to be issued by 2018. We have calculated that this debt would rise to over R500bn if price increases were confined to 8% and similar operational and capital costs were incurred. Nersa is of the view that these costs, as estimated by Eskom, should be better controlled. If Eskom achieves these cost controls, it would improve cash flow and reduce the volume of debt finance.

The SA Budget and borrowing plans have factored in about R330bn of Eskom debt. This will have to be revised higher. And with the extra government borrowing requirement now running at about R100bn a year, this additional debt of about R30bn a year for five years, will not be welcome to the Treasury or the bond market.

Listed electricity utilities are in practice the least risky activity of all – they realise the lowest betas on the US stock exchanges. They therefore can and should finance what are low risk operations with high ratios of debt (around 55% of assets on average). Furthermore a real return of 3% a year, if achieved, would allow Eskom to fund with debt and meet its interest and capital repayment obligations. After all, funding essential infrastructure with debt that supports economic growth, is very different to funding consumption spending by government (as the rating agencies should appreciate).

There is however an obvious alternative for government having to raise debt or taxes to fund infrastructure. This would be to sell off some of the valuable assets it owns. Privatisation may become a less dirty word when the after-Nersa realities are understood. The price to be realised by auctioning off an established power station on Eskom’s balance sheet (hopefully to be listed on the JSE) will be greatly enhanced by regulatory certainty. With its sensible target for electricity generators of a 3% real return, Nersa may well have provided this. Brian Kantor

We look at the regional and other factors at play in the failure of to employ more people and draw some conclusions about what can be done about it.

Unemployment as well as incomes varies significantly by Province.

According to the 2011 Census a mere 39% of the adult population of SA is employed. The rate of absorption into the labour market varies from 70% for the white group to about 33% for households headed by black Africans (see below)

Source: Census 2011

When those registered as unemployed by the census are added to those employed, the participation of the adult population in the labour market can be established. The average rate of participation of adults in the labour market is of the order of 55% of the adult population force, using the stricter definition of unemployed.

*Note The provincial order in the above two figures corresponds with the order used in the QLFS, and is therefore different from the geocode which is used in other publications.
Source: Census 2011

*Note The provincial order in the above two figures corresponds with the order used in the QLFS, and is therefore different from the geocode which is used in other publications.
Source: Census 2011

The census indicates not only significant income differences across the provinces, but also highly significant differences in the unemployment rate across the different provinces, as is shown above. The poorer the province, the higher the unemployment rate of that province and the lower the rate of participation of its adult population in the labour market. The unemployment rate ranges from about 20% in the Western Cape to nearly double 40% in Limpopo.

The participation rate in the labour force ranges from nearly 70% in Gauteng to barely 40% in the Eastern Cape. The divide between the provinces appears very much as an urban rural divide. It is the highly urbanised provinces, Gauteng and Western Cape, which deliver higher incomes and much faster growth in employment.

Population and employment has grown fastest in Gauteng and the Western Cape

The unemployment rate is lowest in the provinces to which people have migrated in significant numbers over the past 10 years: Gauteng, with net migration of over 1m people, and the Western Cape, which has absorbed over 300 000 extra people since the last census in 2001. The population of Gauteng, 12.27m in 2011, making it by far the most populous province, grew by 30% over the 10 years – twice the national average and that of the Western Cape (28%).

Clearly employment growth in the two fast growing provinces (given little change in the unemployment or labour force participation rates in Gauteng and Western Cape since 2001) has also been well above average too. The implications of these demographic and economic trends would seem to be obvious. If a greater number of South Africans are to be employed they are most likely to be employed in fast growing Gauteng and Western Cape. Or in other words, the rate of migration to Gauteng and Western Cape will have to accelerate further if the unemployment problem in SA is to be addressed in a meaningful way.

What it means to be employed, unemployed or not working and therefore not part of the labour force

According to the census, of the SA working age population (16-65) of 33.2m, only 13.18m were employed – a “labour force absorption rate” of a mere 39.7%. The census counted 5.594m workers as unemployed, leading to an unemployment rate of 29.8%. The SA labour force is the sum of the employed (13.18) plus the unemployed (5.6m) or a labour force of 18.7m potential workers. The numbers of adults defined as “not economically active” by the census numbered 14.5m. Thus, the labour force participation rate in SA was but 55.6% of the adult population of 33.2m in 2011.

The Quarterly Labour Force Survey (QLFS) conducted regularly by Stats SA counted fewer officially unemployed in 2011, some 4.24m unemployed and so an unemployment rate of 23.9% – presumably because those conducting the QLFS applied a stricter interpretation of actively seeking work. 

Those officially unemployed according to the Census would have responded affirmatively to the question in the census questionnaire (P25) “…that they had looked for any kind of job or tried to start a business in the four weeks before October 10th 2011”.

In other words you are only regarded as unemployed if you have recently actively sought work. You may not be working for a variety of reasons, including studying or having retired early or a full time home maker, or more simply because you prefer not to work. If you are neither working nor seeking employment you are understandably not counted as part of the labour force. By neither working nor seeking work your actions can have no influence on the numbers employed or employment benefits (wages and salaries) offered and accepted –hence you are not participating in the labour market.

The census asked a number of further questions as to why people were not seeking work. Among the possibilities considered  included “no jobs available in area” , “ Lack of money to pay for transport to look for work” and“No transport available”. The census also asked a supplementary question “If a suitable job was available would you take up the job within 7 days”?  A job to be regarded as suitable must include a sense of attractive enough pay as well as within easy reach of the household. Thus it is surely unlikely that any potential worker not working or seeking work would respond anything but positively to such a hypothetical, probably highly unrealistic, offer of a suitable job at an attractive wage nearby. If an attractive employment opportunity were on offer many of the currently not working in rural SA would happily take it up. But the prospect of finding such work in the rural areas is very poor. Answering yes to such a purely hypothetical question would therefore not make you a member of the labour force in the sense considered earlier, in the sense of your actions or intentions having any influence on the supply of demand for labour or rates of remuneration.

Including those who would work, if only an attractive enough opportunity were offered them, greatly increases the numbers of the unemployed. It would include as unemployed all those whose experiences seeking work and not finding it would have discouraged them from seeking work and so led them to withdraw from the labour force and to stop looking for work that is practically not available.  However should these discouraged workers be included in the ranks of the unemployed, a higher expanded unemployment rate would follow. Perhaps the census unwittingly included many more discouraged workers as unemployed compared to the QLFS.

Why those not working – especially in rural SA – should be regarded as not working and therefore as not part of the labour force or unemployed

For many potential workers, particularly in the rural areas of SA, the knowledge that there is no realistic chance of a job in the area does not make them unemployed and therefore they are not part of the labour force.

Workers in rural areas might be willing (even if reluctantly) to accept employment at lower wages if given the opportunity to do so within easy reach. The clothing workers in Newcastle, KwaZulu-Natal, provide such  a case study. The reasons why there are in fact so very few jobs offered in the rural area may have a great deal to do with the regulation of wage rates (minimum wages and nationwide wage agreements for example).

These regulations discourage potential employers, using labour intensive methods, from offering employment at lower wages that workers outside the major urban areas might well be willing to accept, as an alternative to not working. It is perhaps only lower wages that can make rurally based enterprises competitive with those employers operating in the urban areas. In the major centres, well established firms are able to provide better employment benefits, because of all the other advantages an urban area offers to business, for example, being close to customers or transport nodes and having easy access to essential services and skills. These advantages are not typically available in more remote regions and the opportunity to pay lower wages may be the only reason for operating in a more rural location.

The realistic alternative for many potential workers now not working in the rural areas is to seek work in the cities where opportunities to seek and find work are a realisitic alternative. When typically younger workers migrate to the urban areas to seek work they qualify as part of the potential labour force – and hopefully they will be only temporarily unemployed. Their decisions to migrate to the cities will have an impact on the labour market in the urban areas.

It is not accidental that labour force participation rates in SA (those in work and looking for work) as a percentage of the adult population peak at between 70% and 80% for the cohorts between the ages of 25 and 45. (see below)

Source: Census 2011

But potential workers, by electing not to migrate to the cities of opportunity for whatever reasons, are unlikely to ever be able to find work in the rural areas in significant numbers. But it makes little economic sense to describe such non-workers as unemployed. They are however part of a potential labour force that, with very different economic policies, might become a much more productive part of the labour force.

Regional policies to encourage employment and participation in the labour force

Such policies might usefully include better, well targeted Budget support for those urban regions of the country that have proved able to create additional employment. The right policies might include better funded housing, schools, vocational training and hospitals and the transport systems that could make these regions still more attractive to potential migrants and potential employers.

Poverty relief in the form of cash grants provided on a means tested basis to support children, the aged or the disabled can and has had the unintended consequence of discouraging entry into the labour market, especially from the rural areas of SA. As economists put it, such support for poor families raises the reservation wage of labour: it raises the wage that makes it worthwhile to accept or even seek work. Such work, at wages attractively higher than the reservation wage, may simply not be available in significant volumes outside of the urban areas.

It should be understood that for the unskilled the only work available might be physically onerous work at relatively low wages. But the incentive to work or seek work does depend on the improvements in the household’s standard of living that may be realised by some family members accepting work (or by not seeking or accepting work by subsisting on the welfare system) or the family relying on some mixture of work and welfare.

The fact that the participation and employment rates in the labour force are so much higher for the average white than the average black SA resident has everything to do with these economic incentives. The white South Africans participate much more fully in the labour force because they can earn much more on average than they could expect from welfare.

Conclusion: the path to faster growth in the labour force

The best form of poverty relief in the long run is the creation of employment opportunities and of the skills that qualify workers for higher earnings. The best prospects for employment and income growth in SA are in those regions that have performed so much better in attracting and employing labour. Improving the economic performance of the provinces with competitive advantages should be a clear objective of economic policy. In this way the successful regions can better facilitate the creation of higher incomes and employment over time. Allowing for more flexibility in wage determinations across a diverse geography should be another.

The first indicators of economic activity in November 2012 are now to hand, in the form of new vehicle sales and the value of Reserve Bank notes in circulation. Unit vehicle sales in November were marginally down on October sales, when adjusted for seasonal influences. Unit sales, seasonally adjusted, appear to have stabilised over the past three months at about the 53 000 per month rate, equivalent to about 645 000 units sold annually. When monthly sales are annualised, smoothed and extrapolated, unit sales appear to be still on an upward path and are heading for 695 000 units in 2013 compared to sales of about 645 000 in 2012.

This, if achieved, would represent growth of about 7.5%, and would take domestic unit vehicle sales close to their record levels of 2006. This would be regarded as highly satisfactory in circumstances of generally subdued spending growth. What with built up exports picking up strongly, to over 28 000 units in November (well up on the pace achieved earlier in the year), the sector involved in manufacturing, assembling and distributing new vehicles is a source of growth for the economy. Lower interest rates have probably helped and will continue to do so.

The supply of notes issued and demanded in November 2012 – a very good indicator of household spending intentions in the crucial month of December – continued to grow very strongly. As we show below, growth in the note issue, on a three months seasonally adjusted basis, has maintained the strong recovery that began in the second quarter of 2012. On a smoothed basis, annual growth in the note issue is running at about 13% p.a, indicating continuing strength in household spending.

We combine the note issue with unit vehicle sales to form our very up to date Hard Number Index (HNI) of the state of the SA economy. Our HNI for November indicates that the SA economy continues to move ahead at a more or less constant speed. Numbers above 100 indicate growth while the second derivative of this measure of the business cycle – the rate of change of the HNI – indicates that the pace of growth is slowing down but only very gradually (see below).

This up to date news about the state of the SA economy in November 2012 should be regarded as encouraging. The strong demand for cash at November month end indicates that the tills will be ringing loudly this December, given that spending in December at retail level is 36% above average spending month. The demand for new vehicles suggests that households and firms have not given up their taste for big ticket items. Rumours of the death of the SA consumer may well be exaggerated. Brian Kantor

The news from the credit and money supply fronts is not very encouraging. Money and credit supplies need encouragement from lower interest rates, not discouragement from ill timed regulatory intervention

Broadly defined money supply (M3), as well as bank credit extended to the private sector declined marginally in October 2012 on a seasonally adjusted basis. Annual growth in these aggregates, when smoothed, also declined marginally. The broadly defined money supply, mostly made up of deposits with the banks, is now growing at an underlying rate of about 6.6% p.a. while underlying growth in credit extended to the private sector is about 8.2% p.a. Mortgage lending by the banks is growing at an even slower rate of about 2% p.a.

It should be appreciated that these are very modest growth rates, especially given inflation of the order of 6% p.a. With the economy operating well below its potential, it needs all the help it can get from domestic spending and the support money supply and credit growth give to domestic spending. With export prices and especially export volumes under severe pressure, household spending has been supporting economic growth and so the employment and incomes of employees. This helps them maintain their credit.

At this especially vulnerable stage for the SA economy, attempts to reform the credit system in SA are especially likely to lead to less credit being offered, less spending and still slower growth in incomes. Any additional restraints on the willingness to supply credit or to secure credit are precisely the wrong recipe. They are likely to lead to more, not less, distress in credit markets as the economy slows down. Brian Kantor