Category: SA Economy

The destruction by fire of historic buildings on the campus of my alma mater, the University of Cape Town, has brought home for many the cultural and societal value that lives in so many historic buildings.

It’s not just runaway fires that destroy beautiful old buildings though. Humans willfully do so too. My wonderful wife Shirley and I frequently regret the demolition of those interesting older Cape Town inner-city buildings we fondly remember; buildings that have been replaced by non-descript office blocks. The ornate faux Granada, Alhambra, on lower Riebeeck Street that doubled as a cinema and was our largest concert venue (seating about 3,000), provides one set of memories of times past.

It was replaced by a very conventional and boring office block that now looks and will probably soon qualify for demolition or conversion into apartments. It has no redeeming architectural features and I would suggest not even decent rentals to justify its survival or maintenance.

The willing – and at the time quite uncontroversial – destruction of many an iconic Cape Town building was a reflection of a very limited cultural sensitivity. The redevelopment and widening of lower Adderley Street, a once charming, essentially narrow main shopping street for the city, to make way for a new railway terminus, was a particularly egregious example of insensitive narrow-minded urban planning.

Master plans that often go wrong are a danger to the natural evolution of the built environment, as it proved to be, for inner city Cape Town. The old Cape Town railway terminus was a Georgian masterpiece. It was demolished to make way for an expanse of uninteresting, and completely out of place, a bit of lawn, for looking at not sitting down upon.

Are preservation orders a fair process?

The cost of preserving an interesting building should be borne by the taxpayer not its owner. In other words, full market value should be offered when making a compulsory purchase of a building of historical interest, a market value that would include the value of the redevelopment opportunity. The loss of wealth that would come with freezing the development opportunity, so reducing the value of the house or commercial building, should not be imposed on the owner. Owners who will see the value of their home, perhaps representing a large part of their savings that they were depending on for retirement, decline significantly because redevelopment of the site has now become impossible.

Scarcity that comes with time and redevelopment can add value to an older structure

A particular building style that was once commonplace, for example Victorian, Georgian or Cape Dutch homes that were the fashion of their day, become less common over time with redevelopment and the introduction of newer, more favoured styles. Styles change understandably and naturally in response to newly available technologies and materials. This fading away of the past and the falling number of structures that reflect the past therefore should add to the rarity (and scarcity value) of traditional buildings and hence their resistance to redevelopment.

Scarcity and the higher rents the iconic building might attract can add to the business case for preserving at least the facades of such increasingly rare and admired buildings. The more valuable the building, the less likely it will be demolished.

I think of the attractive facades of the still many art deco apartment blocks in Vredehoek, an inner city suburb of Cape Town, that must make them more desirable to rent and therefore more valuable to their owner-occupiers (Incidentally, the particular walk-up block of flats in Vredehoek where I spent my first five years (1942- 47) is still intact).

I wonder how well these then unusual art deco blocks of flats were received in the 1930s and 1940s when they were constructed, on mostly vacant land. Perhaps they were welcomed as representing worldly progress, not resisted as a threat to established land and home owners.

The economics of redeveloping property and the case for demolition

The test of the quality of any building or architectural feature will be its ability to command interest and respect from later generations. Most new buildings are commissioned with an expected economic life of about 20 years, given current interest rates. A building would be given a much longer life to prove itself, if the interest rates and political and inflation risk premiums incorporated in high borrowing costs in SA were lower. If an investment in a new structure in SA cannot be justified with 20 years of expected rental income, enough net rental income to cover the costs of a new building, plus the costs of purchase of the land or the building to be demolished, it will not now be built. If it can last beyond 20 years, it will be evidence of the superiority of the original design that will have added value to the building.

A building might be demolished when it is worth less than the land it occupies. A building would be valued as the present value of the expected or implicit rental income it could generate when owner-occupied, and discounted by prevailing interest rates (or more generally discounted by the returns available from similarly risky investment opportunities, by so called capitilisation rates). Demolishing the building releases the land for alternative use. It makes new buildings possible, with the potential to create a greater stream of net rental income with a higher present value: a present value of net rental income value that would have to be expected by some risk-taking developer to be high enough to make a profit. In other words, a building whose subsequent market value would exceed the value of the lost income from the existing structure, after adding demolition costs and to recover the cost of the new building.

At any point in time, the vast majority of buildings do not qualify in this way for redevelopment and demolition. Hence, as can be observed, older buildings mostly remain standing for much longer than the 20 years of economic life that brought them into being. A burst of property redevelopment activity is always a good sign of economic progress under way. It informs us that the land is becoming more productive and capable of commanding higher rental incomes, or the equivalent, capable of bearing higher implicit rentals for their owner-occupiers. It is a trend that’s helpful to property owners but a threat to those hiring accommodation or intending to enter the ranks of owner-occupiers.

How to deal with the “nimby” crowd and facilitate value-adding property developments

Therefore politics, plus the expected higher costs of renting or owning, may frustrate the intending developer. The “nimby” crowd (“not in my back yard”), may not favour redevelopment because it threatens the value of their own real estate nearby. But frustrating the conversion of land from less to more productive uses, as with all such interventions that prevent value adding innovations, will mean wasted opportunity and slower economic growth.

I have long thought that the higher wealth tax receipts that come with more valuable real estate should be shared in part with the owners of property in the neighbourhood. Extra revenue generated by higher wealth taxes collected on more valuable property can be shared with the local owners as compensation for the extra noise or traffic that the redevelopments may bring. Tax revenue that could be used to improve local parks or provide better local security or better access roads, in an obviously earmarked way, would help reduce resistance to redevelopment of the back yard that then becomes more desirable. This will mean more valuable buildings and gains in wealth for the owners of surrounding property.

It is also my contention that every generation of architects and builders should have the opportunity to impress upon the world the strength and beauty of their designs. Not all changes in design will be for the worse. Many may turn out for the better – only time can tell. A city must live and evolve – it cannot be frozen in time and kept as a museum for tourists. And a lively, economically successful city that can sustain good services to its citizens, with a mixture of the new and not-so-new structures, that have been allowed to respond to essentially market forces, can surely attract visitors as well as migrants from other cities.

Property development is part of an evolutionary process that will add to the capabilities of the city to provide additional work and income earning opportunities. Developments can add to the value of real estate to be shared between its owners (paying higher wealth taxes) and the local authority, applying additional tax revenue in generally useful ways.

Property rights underpin wealth creation and are essential for attracting investment and helping communities to escape deprivation.

I once asked a meeting of law students if they knew why we have laws to protect our wealth and enforce the sanctity of contracts. They appeared to have little idea why, other than that it was morally wrong to steal, to perpetuate a fraud or not to be true to your word. Nobody had told them that protecting the rights to wealth was essential if wealth was to be created in the first instance.

If you saved and invested in a home, farm, mine or business enterprise, and somebody, stronger than you, could simply take it away, there would be no reason to save and invest in productive, long-lasting assets. Protection of wealth to encourage wealth creation is essential if any community is to become more productive and escape deprivation.

The power of a government to take what might be yours, gained fairly in exchange, is one of the obvious dangers to be averted in the public interest of increasing saving and capital expenditure. While there might be good cause for a compulsory purchase to advance a broad public interest, it should be facilitated by offering the market value of the asset as compensation. No compulsory expropriation without compensation is enshrined in our Constitution and legal practice, for good, income-enhancing reasons.

Having to offer full compensation to any owner is something of a deterrent to exercising any compulsory purchase order. The taxpayer, who also has political influence, will have to pay up for the assets. It’s an influence that is resented by those who have ambitions to change the world for what they believe will be the better and are frustrated by the lack of the means to do so. Just pay for what you wish to take, is the principle we should defend and honour.

South Africans are not just reluctant taxpayers. We are reluctant savers and maintain an unsatisfactory rate of capital accumulation. We still have to rely on foreign savings on a significant scale. We are dependent on capital that can be freely invested anywhere and is easily frightened off by threats to its being taken away by expropriation, or by changes in regulations affecting its market value.

The mere hint of expropriation of land and real estate, without compensation, makes foreign capital more expensive. Foreign investors command high expected returns to compensate for the risk of our taking it away or interfering with it. Hence our low rate of capital formation. An on-average risky JSE-listed company, to justify any addition to its plant and equipment, would have to offer a return of over 15% a year, or about at least a real 9% after expected inflation of about 6%. These are returns that few companies can confidently budget for.

Hence businesses are investing less, and saving less, by paying out more of their earnings in dividends. The ratio of JSE earnings to dividends has halved since 2010. They are retaining less because they are investing less in capex, for understandable reasons.

Figure 1: Ratio of JSE All Share Index earnings per share to dividends per share

Ratio of JSE All Share Index earnings per share to dividends per share chart
Source: Iress and Investec Wealth & Investment, 12/04/2021

It has taken Covid-19 to bring the low rate at which South Africa saves above the dismal rate at which we are currently adding to plant and equipment, adding capital at the rate only of 12% of GDP in 2020. Accordingly, we have become a net lender to the world.

Reducing the risks of investing in SA will encourage more capital expenditure and savings in the form of earnings retained by business. We could then attract the necessary foreign capital at a lower cost than we are paying now. Reducing risks means sensibly reducing the threat of taking, not adding to it.

Source: SA Reserve Bank and Investec Wealth & Investment, 12/04/2021

There is more to tax than what appears on the surface – ask National Treasury and South African homeowners.

National Treasury has had an epiphany. It has acknowledged that higher taxes can lead to slower growth and that lower taxes can lead to faster growth. Hence the decision to forgo R40bn of planned income tax increases and to propose a reduction in the corporate tax rate to 27%. All in the interests of faster growth. Hallelujah.

The Budget Review recognises that taxes have complicated feedback effects. It recognises that the burden of higher corporate taxes ends up being passed on to consumers of goods and services, in the form of higher prices and lower incomes for those who provide labour and other services to the corporation. The supply of capital to the SA enterprise and hence the supply of goods, services and the demand for labour and land, is determined by the required after-tax returns of investors. Higher taxes will reduce expected returns and so the supply of capital, goods, services and the demand for labour. The supply of capital for SA is sourced globally and the required returns are determined in the global market, as the Review recognises.

The Review could have added that personal income tax rates have supply side effects. It is the after-tax benefits provided to taxpayers by governments that establish the standard of living, which in turn determines the willingness to supply labour to an economy. The more internationally mobile the providers of labour services are, the more of a global market South African firms have to compete in for the supply of indispensable skills. Raising income tax rates at the margin drives the emigration of human capital and leads to higher prices to cover higher after-tax costs of inputs. Lower taxes could help do the opposite, that is increase supply of capital and skills. Faster growth becomes possible with a lower tax burden.

The share of income of those who will report taxable income of more than R1.5m in 2021-02 (a mere 113,192 taxpayers) are in the highest of nine tax brackets. They report 12% of all income and will pay over 26% of all personal income tax. Only when annual incomes are above R500,000 does the share of income taxes paid exceed the share of incomes earned. The numbers of high earners and taxpayers in SA have been stagnating. We need more of them to help grow the economy and provide for the relief of poverty.

It is the mix of taxes and the benefits supplied by governments that determines the standard of living and that drives the migration of labour and capital. The burden of income taxes in South Africa is highly progressive, as are the benefits of government spending. Higher income earners in South African pay much of the personal income tax and draw very little on government benefits provided.

Figure 1: Population by the nine income tax brackets (millions)

Source: Budget Review 2021-2020, Chapter 4 Table 4.5, Investec Wealth & Investment, 24/02/2021

Figure 2: Share of income and income tax paid of the nine income tax brackets (percent)

Source: Budget Review 2021-2020, Chapter 4 Table 4.5, Investec Wealth & Investment, 24/02/2021

Figure 3: Average income tax saved (rand per annum) per member of each tax bracket (total income tax saving = R51bn)

Source: Budget Review 2021-2020, Chapter 4 Table 4.5, Investec Wealth & Investment, 24/02/2021

For evidence of the relationship between taxes paid and benefits provided by government, one need only compare residential property prices in Cape Town with those in the other cities and towns. They can watch the business television channels, to be aware that magnificent homes in Johannesburg or Durban can be had for the price of a small two-bedroomed apartment in Cape Town. This is because of the more favourable mix of higher property taxes (not necessarily higher wealth tax rates) that are paid in return for comparatively good services provided by the local government.

Homeowners should be aware that higher taxes can more than pay for themselves when there is good government. And higher taxes will destroy their wealth when the service is inadequate for the taxes paid.

Higher commodity prices could bring about higher global inflation. That would not necessarily be bad news for South Africa.

There is a hint of inflation in the frigid northern air. It’s being reflected in the long-end of the bond markets, the part of the yield curve that is vulnerable to signals of high inflation and the higher interest rates and lower bond values that follow. The compensation offered for bearing the risk that inflation may surprise on the upside is reflected in the spread between nominal and inflation-linked bond yields. These spreads have been widening in the US, and in low inflation countries like Germany and Japan.

This spread for 10-year bonds in the US was as little as 0.80% at the height of the Covid-19 crisis, was 1.63% at the end of September, and at the time of writing is at 2.14%. It has averaged 1.97% since 2010. The spread has widened because investors have forced the real yield lower, to -1.03%, further than they have pushed the nominal yield higher now, to 1.15%. This is still well below the post 2010 daily average of 2.25% (see figure below).

Source: Bloomberg and Investec Wealth & Investment, 11 February 2021

Investors are paying up to insure themselves against higher inflation by buying inflation linkers and forcing real yields ever more negative. Clearly, the nominal yields continue to be repressed by Fed Bond buying (currently at a $120 billion monthly rate). One might think it’s easier to fight the Fed with inflation linkers, than via higher long bond yields, to which the currently low mortgage rates and a buoyant housing market are linked.

The Fed is insistent that it is not even thinking yet of tapering its bond purchases. The Treasury, now led by Janet Yellen, previously in charge of the Fed, insists that a new stimulus package of US$1.9 trillion is still needed for a US recovery.

Metal and commodity prices, grains and oil are all rising sharply off depressed levels. Industrial metals are 45% up on the lows of last year, while a broader commodity price index that includes oil is up 51% off its lows of 2020.

Source: Bloomberg and Investec Wealth & Investment, 11 February 2021

These higher input prices will not automatically lead to higher prices at the factory gate or at the supermarket. Manufacturers and retailers might prefer to pass on higher input costs. But they know better than to ignore the state of demand for their goods and services. They can only charge what their markets will bear, which will depend on demand that in turn will reflect policy settings.

Higher inflation rates cannot be sustained without consistent support from the demand side of the economy. Yet supply side-driven price shocks that depress spending on other goods and services can become inflationary, if accommodated by consistently easier monetary and fiscal policy. In the 1970s, it was not the oil price shocks that were inflationary. They were a severe tax on consumers and producers in the oil importing economies, which in turn depressed demand for all other goods and services. It was the easy monetary policy designed to counter these depressing effects that led to continuous increases in most prices. That was until Fed chief Paul Volker decided otherwise and was able to shut down demand with high interest rates and a contraction in money supply growth that reversed the inflation trends for some 40 years.

The financial markets will be alert to the prospects that demand for goods and services will prove excessive and inflationary in the years to come – and that they may not be dialed back quickly enough to hold back inflation.

There is consolation for South Africa should global inflation accelerate. It will be accompanied by higher metal prices and perhaps bring a stronger rand to dampen our own inflation. It may also help reduce the large South Africa risk premium that so weakens the incentive to undertake capital expenditure as well as the value of South African business. Our inflation-linked 10-year bonds now yield a real 4.13%, a near record 5.15 percentage points more than US inflation linkers of the same duration. Any reduction in South African risk would thus be welcome.

Source: Bloomberg and Investec Wealth & Investment, 11 February 2021

January 27, 2021

There is some very good news to cheer South Africans up. They are a lot wealthier than they were when the lockdowns were announced in March. And wealthier than they were on January 1^st 2020. If their wealth has been diversified through the JSE, the average shareholder will be 70% better off than they were in March. And 13% up on their portfolios of the 1^st January 2020. The All Bond Index has returned 31% since March and 9% since January 2020. Those with shares off-shore would also have done well, but not as well. They would be up 59% if they held an MSCI EM benchmark tracker or 46% if they had tracked the S&P 500 March. That foreign holiday plan sadly disrupted in March would now be about 16% cheaper in USD. Since the ZAR/USD bottom of April the mighty ZAR has also done a lot better than the average EM currency.

To what should South African wealth owners attribute their much improved financial condition? The usual global suspects can be interrogated. A weaker dollar in a more risk on environment and so buoyant EM stock markets, to which the JSE is umbilically attached, is a large part of the explanation. A rising S&P 500 is a tide that lifts all boats, though some higher than others, as we have seen of the JSE and the ZAR.

But there are more than global risk-on forces at work. SA specific risks, as measured in global bond markets, have declined, notably so since October. They have also have declined relatively, by more than the risks attached to Brazil, Mexico and Russia bonds of the same duration. In April, at the height of market turbulence, the yield on RSA USD denominated 5y bonds had risen to over 7% p.a. And the risk spread, the extra yield over US Treasuries, was about 6.5% p.a. These bonds now offer 3.1% p.a. and an extra 2.7% p.a. over US T Bonds, less than half their levels in March 2020 with much of the improvement also registered after October. Insuring RSA Yankee bonds against default now costs but 1.1% p.a. more than it would cost to insure the average of Brazilian, Mexican and Russian debt. This extra insurance premium to cover SA default SA was 1.5% in October.

The reasons for lower SA risks are not at all as obvious as the benefits. By reducing risk and helping to add to the wealth of South Africans they encourage more spending needed to encourage output and employment. Lower risks moreover reduce the returns required of business adding to their capital stock in SA, so much more of which is needed to permanently raise output employment and incomes. And tax revenues rise with income.

Such improved prospects will be completely reversed by an additional wealth tax. It will not be expected to be a once off event. It will mean more SA risk and demand higher returns on the cash firms invest, meaning still less capex. It will reduce the value of SA companies so that they can meet such higher required risk adjusted returns for investors and immediately reduce the rewards for saving and the value of pensions. It will encourage the export of the savings of tax paying wealth owners and the emigration of skilled taxpayers. Tighter controls on capital flows would inevitably have to follow that would undermine the depth of our capital markets. Have those who advise wealth tax increases estimated how much collateral damage will be done to tax revenues over the longer run?

The sensible way to fund an unavoidable increase in government spending is to call further on the R160b of Treasury cash held at the Reserve Bank. And to raise a temporary overdraft from the Reserve Bank to supplement this cash balance, should this become at all necessary.  Adding more money to the wealth portfolios of South Africans, including to their deposits at the banks, created this way, would further stimulate spending, income growth and tax revenues. It would be growth enhancing and therefore risk reducing.

The failure to secure a large supply of vaccines to help South Africa to reach herd immunity quickly, reveals a vacuity in thinking about the cost to the economy.

The fiasco over the supply of vaccines reveals fully the vacuity of South Africa’s approach to Covid-19. The deposit of R283m to secure a supply of vaccines was not budgeted for because we didn’t have the money for it – even though money for much else was found in the adjusted Budget.

In this context, I observe that the Treasury deposits at the Reserve Bank amounted to R160bn in October, boosted by loans from the IMF and other agencies with anti-pandemic action front of their minds. Has anyone in the Treasury or government attempted to calculate how much additional income will be lost for want of the vaccine – and how much tax revenue the Treasury will not be able to collect?

It will be many times more than the R20bn to be spent on the vaccine. Bear in mind too, that R7bn of this is to be funded by members of medical schemes, which in effect makes it a tax increase or expropriation by any other name, unhelpful given the state of the economy.

Yet a supply of additional money could have been made available by the Reserve Bank, in the same way that money is being created on a large scale by central banks all over the world to fund the extra spending that the lockdowns have made imperative. And the Bank could still do so, to help the Treasury fund the vaccine and the money cost of rolling it out. The idea of raising taxes to fund the extra spending when the economy is under such pressure makes little sense. A higher tax rate or taxing specific incomes will slow the economy even further and might lead to lower tax revenues of all kinds.

Moreover, there is little prospect of more inflation to come. Should inflation emerge at some point, a reversion to normal funding arrangements would be called for. The danger then is that central banks like our Reserve Bank might not act soon enough and inflation picks up. But it is a danger that pales into insignificance when compared with the present danger posed by the pandemic.

Governments around the world know enough economics to know that spending more to help employ workers (and machines) who would otherwise be idle was a costless exercise – costless in the true opportunity cost sense. But South Africa seemingly cannot bring itself to think through the problem this way. The upshot is that South Africa lacks the essential self-confidence to do what would be right now.

The monetary and financial market statistics tell us how unready the economy is to sustain any recovery of output and employment. The supply of extra Reserve Bank money in the form of notes and deposits by banks with the Reserve Bank, what is described as the money base or M0, rose by 8% in 2020. There was a flurry of extra such money in March and July 2020, since reversed. In the US, the money base is up by 43% (See figure 1).

Figure 1: Annual growth in central bank money, SA and US

Source: SA Reserve Bank, Federal Reserve Bank of St. Louis and Investec Wealth & Investment

The SA banking system is hunkering down, not gearing up. Bank deposits have been growing at about an 8% rate, while lending to the private sector is up a mere 3%. The banks are building balance sheet strength, raising deposits and are cautious about lending more. They are relying less on repurchase agreements made with the Reserve Bank and other lenders, reserving more against potential bad debts while not paying dividends and hence adding to their reserves of equity capital. All of these act to depress growth.

Figure 2: SA bank deposits and lending (R million)

Source: SA Reserve Bank and Investec Wealth & Investment

Figure 3: SA banks – adding to equity capital

Source: SA Reserve Bank and Investec Wealth & Investment

The financial metrics continue to paint a grim picture of the prospects for the SA economy. Long-term interest rates remain above 9%, even as inflation is expected to average 5% over the next 10 years. This makes capital expensive for potential investors who are therefore less likely to add to their plant and equipment. The difference between borrowing long and short remains wide, implying sharp increases in short-term interest rates to come and expensive funding for the government (that is taxpayers) at the long end. The risk of South Africa defaulting on its US dollar debt demands that we pay an extra 2.3% more a year than the US government for dollars over five years.

Figure 4: Key financial metrics in 2020-21

Source: Bloomberg and Invested Wealth & Investment

Poorly judged parsimony and monetary conservatism have brought SA great harm in the fight against Covid-19. They have made the prospects for a recovery in GDP and government revenue appear bleak. It is not too late to change course. We should be funding the extra unavoidable spending on the vaccine and its roll out by drawing on the cash reserves of the government or by raising an overdraft form the Reserve Bank.

There is one constant that applies pre- during and post-Covid. Market driven economies adapt continuously to the changing tastes of consumers and the opportunities technology provides to supply them more profitably. Best practice
evolves so that firms can attract their essential business partners, their workers, supervisors, and capital providers on market driven terms.

Businesses and their supply chains including their supplies of labour and skills have sometimes to respond to circumstances that are beyond their control and they could not have anticipated. As with the Covid lockdowns. They
were an extreme form of government interference in the roles economic agents may ordinarily choose to play. With outcomes that few would describe as predictable or fair.

This forced households and businesses to adjust rapidly to dramatically changed circumstances to minimize losses as best they could. The Covid economy offered grave dangers and some opportunity. It accidentally produced a few big
winners and many more losers for whom income or debt relief from their governments, who caused them so much damage, seems only fair. Businesses as usual will be doing all they can, to accurately anticipate our preferences and
actions as consumers, as suppliers of labour and skills, and as providers of capital.

The Covid economy has proved that if your job is to deliver a service and the only machine you need with which to combine your labour and intelligence, is a computer, you can work anywhere, including home. And connectivity to other
computers is bound to improve and become less expensive. Wider choices have therefore presented themselves to both sides of the employment nexus.

Trade-offs of income for other benefits including the quality of the working environment have always to be made. Who indeed pays for the Google campus and how valuable are its benefits? Ask Google. The requirements and solutions for
business success will differ from firm to firm. Yet first mover advances in the right new direction are very valuable. It takes time for the competition to latch on, catch up and compete away the temporarily high returns to owners and the
superior benefits they may provide to attract “best of breed”.

In the post-Covid economy how much of our incomes will be earned from our homes? And how much will we play in or outside, in restaurants, resorts and cruise-liners. (Merely mentioning them makes me salivate in anticipation of happier
times) Will our output, be higher or lower working from home, or higher in face-to-face collaboration with colleagues and fellow workers at a more or less distant work-place? The owner of a business, to survive, is compelled to measure
what employees deliver, wherever they may deliver it or wish to deliver.

Potential and actual employees will also be estimating the extra benefits and extra space costs working from home. Benefits that include more time for leisure or to bring up their children? Clearly very little is produced commuting to
work. Potential income and leisure are sacrificed in the time commuting, or higher actual or owner equivalent and market rentals are incurred reducing the time and costs of getting to the office, factory or warehouse. The savings in
time and money and office or house rentals are open to trade-offs, experimentation and ultimate resolution. The providers of transport, cars, busses, trains above and below ground, aircraft and highways, not to mention office
buildings, will be predicting and observing the outcomes.

Workers would have to accept less pay to work at home should they prove less productive there and prefer to do so. They can expect to earn more if the opposite proves true. Or will employers have to offer them more to get them to

come to the office, to bear the extra costs of commuting? Should they be expected to be more productive and creative in F2F collaboration. Which may well be a lot more fun and even worth sacrificing some income and leisure and time at
home for. We will find out what mix of income and salary and working conditions work best and for whom. There will be no cookie cutter solutions. We should be confident that the process can best be left to work out in the usual, successful,
evolutionary way.

Doing what is right for the depressed economy while hoping to regain a reputation for fiscal responsibility over the long run is no simple task. The adjustments made to the Budget last Wednesday (28^th October) were made in these highly adverse circumstances. Tax revenues have collapsed along with incomes and output inevitably increasing the borrowing requirements of government- indeed more than doubling them as a per cent of GDP. The sacrifice of incomes in the lockdown however calls urgently for more government spending not less and lower, not higher tax rates.

Economic theory tells us that spending more on resources that will otherwise remain idle makes good sense.  Extra income or benefits in kind provided by governments for households and firms brings more spending in its wake and results in more output, incomes and employment. The normal trade-off of schools for hospitals or cleaner air for more expensive electricity or spending less today to spend more tomorrow, does not apply when an economy operates well below potential and can be expected to continue to do so. More can be spent now so that more will be produced. The extra spending has no economic cost. It is the proverbial free lunch now being consumed generously, sensibly and widely across the globe in response to lockdowns.

We learned from the Minister that the SA economy is not expected to recover to 2019 levels until 2024-25. A much slower process of recovery than is expected elsewhere, for want presumably of enough stimulus, and a reason for spending more now. It will nevertheless take strict control over government spending, especially on the employment benefits provided for its own employees to regain a much better fiscal balance over time. And limiting such highly attractive employment benefits has to start now, as the Minister emphasized . Stabilizing the debt to GDP ratio to limit spending on interest should take a good deal longer. The very limited reactions in the Bond and currency markets to the revised Budget indicate that the jury is still very much out. Unproven is the interim judgment.

While the Treasury is constrained by want of reputation, the Reserve Bank is not so.  It could be helping to hold down the costs of funding long dated government debt. And lending more freely to the banks so that they could fund much more, lower cost short term debt issued by the government. It should lower interest rates further and encourage the banks to lend more freely and make use of the loan guarantee scheme. Which is much the largest part of the Treasury’s stimulus package, regrettably still largely unused. Creating money as the cheapest form of funding government debt is as right now for SA as it is everywhere else. And the Reserve Bank has the anti-inflation credentials to be expected to reverse its monetary course when the time and the recovery calls for it.

Last Wednesday, a vital opportunity to enhance SA’s growth prospects and hence its ability to raise revenue and greatly relieve its Budget constraints was revealed outside Parliament. In the confirmation of a major energy resource in South African waters. Total and partners have speculated heavily on and in South Africa and have triumphed. Good for them and for all of us. The Intergrated Resource Plan (IRP 2019) sees very little scope for natural gas in SA as part of the energy mix. The plan predictably will have to be rewritten. And much better replaced by not another plan but a process well known to balance supply and demand. That is a market led process. One that would leave Total to develop its discovery as it sees best unencumbered by unhelpful regulation or crony capitalism or retrospective expropriation. The potentially favourable consequences of the right approach are hard to overestimate.

The construction of pipelines and urban gas grids and an infrastructure led growth beckon.  Municipalities seeking electricity are likely partners as is Eskom. The people of SA will benefit from additional royalties, income and VAT and taxable income earning opportunities of all kinds. And from cheaper energy. The financial and structural constraints on our economy can be relieved. More immediately can be expected to be relieved with the right business friendly approach.  Our fiscal and investment reputation depends upon it.

An economic recovery programme for South Africa demands the kind of business and political leadership that now appears to be lacking.

These are truly unprecedented economic times. Never before have large sectors of our own and most other economies been told to stop working. Large numbers of potential participants in the economy are being forced to stay at home. The impact on the supply of goods and services, the demand for them and the incomes normally earned producing and distributing them, has been devastating. Perhaps up to 20% of potential output, or GDP in a normal year, will have been sacrificed globally to the cause. We will know how much has been sacrificed only when we look back and are able to do the calculations.

In South Africa’s case this one fifth of GDP would amount to about R1 trillion of income permanently lost. These are extraordinary declines in output and income. Ordinary recessions, when GDP declines by 2% or 3% in a quarter or a year, are much less severe than this.

Compensation however can be paid to the households and business owners who, through no fault of their own, have lost income and wealth. It is being provided on different scales of generosity across the globe. The richer countries are noticeably more generous than their poorer cousins. South Africa, alas, is among the more parsimonious, at least to date in practice.

There is however no way to recover what has been lost in production. All that can be hoped for is a speedy recovery of the economy when businesses and their employees are allowed to get back to normal. But getting back to producing as much as before the lockdowns means not only more output and jobs becoming available. Any recovery in output will have to be accompanied by more demand for the goods and services that the surviving business enterprises can supply. Without additional spending during the recovery process, there will not be additional supplies of goods, services, jobs and incomes.

Providing unemployment benefits and other benefits paid in cash to the victims of the lockdowns will help to stimulate spending. In the US, every household received a cheque in the post of over $1000 and temporary unemployment benefits of $600 per week were more than many would have earned. The average US household will come out of the crisis with more cash than they had before. And more may be on the way. Spending the cash will help the pace of recovery.

The US and many other countries will be doing what it takes to get back to normal. They will also be learning along the way just how much spending by governments it will take before they can take their feet off the accelerators. They are not being constrained by the monetary cost of such spending programmes. The cheapest way for a government to fund spending is by printing money and redeeming the money issued with more money.

The central banks of developed economies are supplying large extra amounts of cash to their economies in a process of money creation also known as quantitative easing or bond purchasing programmes. The supply of central bank cash in the largest economies has grown 30% this year. Central banks have been buying financial securities, mostly issued by their governments in exchange for their cash that is so willingly accepted in exchange. By so doing, they have helped force down the interest rates their governments pay lenders to very low levels – sometimes even below zero for all government debt, short and long dated. This is an outcome that has made issuing government debt even for 10 years or more even cheaper than issuing money.

These governments have also arranged on an even larger scale (relative to GDP) loan guarantee schemes for their banks to encourage bank lending that will enable businesses that have bled cash during the lockdowns to recapitalise, on favourable terms. Central banks, secured by funds committed by their governments, are covering up to 95% of any losses the banks might suffer if the loans are not repaid. The take-up of such loans by businesses in the US has been very brisk.

South Africa, as mentioned, has not adopted any do-what-it-takes approach to our crisis of perhaps larger relative dimensions. I have argued that we should practise the same logic as the developed economies and rely in the same way on our central bank to create money to hold down the interest cost of funding higher government spending and the accompanying debt. This would be a similarly temporary exercise in economic relief – one well-explained and understood as such – for only as long as it takes.

South Africa has moreover introduced a potentially significant loan guarantee scheme for our banks, with a potential value of up to R200bn. Sadly, little use of the credit lines has so far been made: only R14bn appears as taken up. Every effort should be made to encourage businesses to demand more credit and for the banks to lend more, since they are exposed potentially to only 6% of the loans they make. Working capital, which is necessary to restart SA businesses, is therefore available. The confidence to re-tool seems to be lacking, as is the determination of the banks to find customers willing to invest in the future, from which they will benefit permanently, should they succeed.

The recovery programme demands a business and political leadership that now appears to be lacking. Leadership should want large and small businesses to believe in their prospects after the lockdown and to act accordingly. Economic recovery – getting back to normal as quickly as possible – demands no less.

https://www.youtube.com/watch?v=TNxqk1XX2GI&feature=youtu.be

Post the lock downs the patterns of household spending are widely expected to change permanently. How it will change is of overwhelming importance to almost all business that supply households or are once or twice or three times removed from making sales directly to households. The demand to fly to some holiday destination not only affects hotels, B&B’s, restaurants, airports, travel agents, airlines and car rental companies taxi companies and all they employ or contract with – it will have the most profound implications for Boeing and Airbus and all their component suppliers.

Household spending accounts for 60% of all spending in SA and 70% in the US and other developed economies. Absent the control and command of governments (very active in the lockdowns) the decisions of households to spend or save or borrow to spend always moves the economy in the one direction or another. The market-place, post-covid19, will make the same call on its suppliers to adapt profitably to changing tastes. And to innovate successfully. That is to lead household spending to their own portals, real or virtual, depending on what will work best and be rewarded accordingly.

There is every reason for governments and their central banks to ameliorate the economic damage of their own making and offer compensation for the loss of incomes from work- including for the owners of businesses. Governments have every reason to encourage the demand for all goods and services when they allow firms after the lockdown to do what comes so naturally to them. That is to freely compete for custom and for the resources, labour and capital and premises to help them do so. There is no more reason for governments to get involved trying to pick post-covid business winners or losers than they would have at any other time.

And to leave future taxpayers with as little a burden of interest to pay on the additional government debt that is being incurred. Printing money rather than issuing expensive debt (when debt is as expensive as it is for the SA taxpayer) makes very good sense. The inflation in SA that might ordinarily come with money creation is a long way away- that is until supply and demand, both so damaged by the crisis, can recover to something like their potential.

They say no crisis should be wasted. The crisis does provide an opportunity to stimulate what would be the most helpful source of growth for SA. That is export and import replacement led growth. The much weaker rand has made SA potentially much more competitive than it was only a few months ago. Adjusted for differences between SA and USA consumer price inflation the rand at USD/ZAR 17.50 is now about 50% undervalued Vs the dollar and about 18% more competitive with the US exporter or importer than it was at year end. A purchasing power equivalent dollar would now cost no more than R8.70 (See figure 1 below)

Fig.1; The USD/ZAR exchange rate and its Purchasing Power Equivalent[1] to May 27^th 2020.

Source; Bloomberg, Investec Wealth and Investment

There is a strong case for retaining this competitive advantage. It is very easy to inhibit exchange rate strength should it materialize. The Reserve Bank can buy dollars with the rands it has an unlimited supply of. The Swiss National Bank does this all the time to hold back the Swiss franc. Furthermore buying dollars with rands would add to the supply of rands – it would be another form of money creation. And very helpful when every extra rand may encourage more spending and lending – so urgently needed for the recovery.  Preventing exchange rate weakness should never be attempted.

In figure 2 below we chart the relationship between the purchasing power value of the rand and its market value. This relationship represents the real exchange value of the rand with lower values indicating real rand weakness, or equivalently greater competitiveness for SA producers, and vice versa. We compare the real rand dollar exchange rate using the Consumer Price Indexes for SA and the US and the real rand exchange rate as calculated by the Reserve Bank. This real exchange rate is adjusted for the prices of manufactured goods of our 20 largest trading partners (weighted by their importance in our trade) using the prices of manufactured goods as the basis of comparison. This ratio has not been updated since year end. Given the stronger dollar the depreciation of the real rand so calculated is generally less severe than the real dollar exchange rate. The nominal trade weighted rand has declined by 20% since year end and so the real rand is likely to have declined by a similar degree this year.

Fig2. The real rand Vs the US dollar and SA’s trading partners. (2010=100)

Source; Bloomberg, SA Reserve Bank and Investec Wealth and Investment

The value of the real rand is totally dominated by changes in the market value of the rand that fluctuates so widely and unpredictably. We compare quarterly movements in the market trade weighted value of the rand and its inflation adjusted value. As may be seen it is very much a case of the market exchange rate leading and the direction of inflation following. Rather than inflation leading to compensating changes in the market value of the rand. The so called pass- through impact of a weaker or stronger rand on prices in SA depends also on the direction of import prices in USD.

Especially important for the price level in SA is the dollar piece of oil that makes up a large percentage of SA imports- up to 40% at times. With oil prices as low as they are now the pass-through effect on SA prices and inflation is likely to be very subdued. Exporters from SA especially of metals and minerals that still make up a large percentage of SA exports are largely price takers established in US dollars. The weaker rand translates automatically into higher rand prices and vice versa. How much the weaker rand drives up the costs of our exporters and those suppliers who compete with imports depends very much on the direction of SA inflation. This is likely to remain subdued for now given the general weakness of demand for goods, services and labour.

It is not only the level of the real rand that matters for the real economy. Movements in the market value of the rand and hence its real value of great importance for operating profit margins are also of great relevance. The USD/ZAR and the Euro/Rand exchange rate has been almost twice as variable on average as the USD/Euro exchange rate. This year is no exception. We show below how the volatility of these exchange rates on a daily basis this year.

Managing this volatility of the rand exchange rate is a burden carried by SA exporters and importers and those who compete with exports and imports.. It adds to their costs of hedging exchange rate risk and the pure uninsurable uncertainty about the actual direction of the rand demands a discouragingly higher expected return on their investments.

Fig.3 Quarterly per centage movements in the Nominal and Real Trade weighted rand – lower numbers indicate rand weakness.

Source; Bloomberg, SA Reserve Bank and Investec Wealth and Investment

Fig.4; Volatility of the USD/ZAR, the USD/ZAR and the Euro/USD Daily Data 2020 to May 25th[2]

Source; Bloomberg and Investec Wealth and Investment

There should be two objectives for exchange rate policy during and after the crisis. Firstly, should the opportunity present itself, to inhibit rand strength to encourage domestic production and consumption. Especially since inflation will be looking after itself well enough and interest rates do not need a stronger rand to decline further. The very weak domestic economy is reason alone for still lower interest rates.  Secondly, and a much more difficult longer-term exercise, would be to seek ways to inhibit exchange rate volatility that is such a burden on foreign trade.

[1] The PPP rand is calculated as USD/ZAR in December 2010 (USD/ZAR=6.31) multiplied by SA CPI/US CPI) 2010=100

[2] Volatility is calculated as the 30 day moving average of the Standard Deviation of daily percentage movements in the exchange rate

Interview with Brian Kantor on CliffCentral.com, discussing the impact of the Covid-19 lockdown: http://cliffcentral.com/gcs/gareths-guests/professor-brian-kantor/

An extraordinary week has passed. When the government ordered and prepared for a shut-down of much (how much??) economic activity to deal with the health crisis. All, including the participants in capital markets, have tried to come to terms with the evolving realities at home and abroad. And it was a week when the SA Reserve Bank moved from conventional to unconventional monetary policy.

The Bank at its monetary policy proceedings on the 17^th March reported in an explicitly conventional way. It cut its key repo rate by an unusually large 100bp- on an improved inflation outlook. By the 25^th March it was practicing Quantitative Easing (QE) buying RSA bonds in the market to reduce “…excessive volatility in the prices of government bonds…”  and freely  providing loans to the banks of up to 12 months.

The Bank is therefore creating money of its own volition. Cash reserves, that is deposits of the private banks with the Reserve Bank, are created automatically when the Reserve Bank buys government bonds and shorter-term from the banks or its customers. These deposits serve as money – and are created without any cost to the issuer- the central bank- acting as the agent of the government. These additional cash reserves support the balance sheets of the banks. And could lead to extra lending by them, as is the intention

Had the Reserve Bank not acted as it did, the bond market would surely have remained volatile. But more importantly it might not have been able to absorb a deluge of bonds and bills that the government would be issuing to fund its emergency spending. Including coping with a draw-down of R30b of bonds sold by the Unemployment Insurance Fund to generate cash for the government to spend on income relief.

The yield on the 10 year RSA was about 9% p.a. in early March. By March 24^th it was over 12% p.a. and declined marginally in response to the Reserve Bank intervention. The derating of SA credit by Moody’s on the Friday evening, after the market had closed, seemed inevitable in the circumstances. On the Monday morning the yields on long dated RSA bonds jumped higher on the opening of the market and then receded and ended as they were at the close on Friday (see figures below)

RSA Five and Ten-Year Bond Yields Daily Data 2020 to March 27th

Source; Bloomberg and Investec Wealth and Investment

RSA 10 year Bond yield 26 -30 March Intra day movements

Central banks all over the world are also doing money creation – in very great quantities. Doing so as a predictable response to their own lock downs and collapse of economic activity and its threats to financial stability. But in the developed world they deal for bonds and other securities at much lower interest rates. Though no doubt the scale of their bond and other asset buying programmes (QE) is part of the explanation for very low yields – both short and long. Yet despite money creation on a vast scale more inflation is not expected in the developed world.

Not so in SA as we have indicated and in many other emerging markets. Issuing longer dated government bonds in their own currencies is a very expensive exercise. And has become more expensive post Corona.

Lenders to emerging market governments, in their own currencies, demand compensation for high rates of inflation expected, and receive compensation for the inflation risks There is always the chance that the purchasing power of interest income contracted for, and the real value of the debt when repaid, will be eroded by inflation of the local currency.

The danger is that fiscally strained governments will, sometime in the future, yield to the temptation to inflate their way out of the constraints imposed by bond investors.  By turning to their central banks, to fund their spending to a lesser or greater degree, rather than to an ever more demanding bond market.  Issuing money (creating deposits) at the central bank to finance spending carries no interest cost. It can be highly inflationary depending on how much money is created and how quickly the banks use the extra cash to extend loans to their customers.

The growing risk that SA would get itself into a debt trap and create money to get out of it has been the major force driving long-term RSA yields on RSA debt higher in recent years. Higher both absolutely and relative to interest rates in the developed world. Bond yields have risen for fear that SA would create money for the government to spend in response to ever growing budget deficits and borrowing requirements and a fast-growing interest bill. As the SA government has now done with the co-operation of the Reserve Bank- though in truly exceptional circumstances and justifiably so.

Avoiding the debt trap, controlling budget deficits and convincing investors and credit rating agencies that the country can fund its spending over the long term without resort to money creation, is the task of fiscal policy. For SA to regain a reputation for fiscal conservatism and an investment grade credit rating is now more unlikely than it was when a promising realistic Budget was presented in February.

The Reserve Bank may hope to control domestic spending and so inflation through its interest rate settings.  It does not however control inflation expected and so the interest rates established in the bond market. The more inflation expected the higher will be interest rates. Expected inflation over the long run is dependent in part on the expected fiscal trends and the likelihood of a resort to money creation. And these fiscal trends, thanks to Corona virus, have deteriorated as they have almost everywhere else.

How therefore should the government and the Reserve Bank react to current conditions in the bond market? Long term yields are unlikely to recede significantly; and the yield curve is likely to get steeper should the Reserve Bank reduce its repo rate further – as it is likely to do.

The government should therefore fund as much as it can at the cheapest, very short end of the capital market. To issue more short dated Treasury Bills to fund current spending and to replace long dated Bonds as they mature with shorter term obligations.  It will save much interest this way. The actions of the Reserve Bank by adding liquidity (cash) to the money market through QE will have made it much easier to borrow short from the banks and others.

And when the economic crisis is behind us it will remain essential to strictly control government spending to regain access to the long end of the bond market on more favourable terms.  Only the consistent practice of fiscal discipline will deserve and receive lower longer-term borrowing costs.

The 2020 Budget tax and expenditure proposals are steps in the right direction for the SA economy. Holding the line on real government spending and avoiding a growth defeating increase in tax rates, is part of the right mix of policies.

The SA economy is hostage to fortune as well as to its economic policy proposals. Market reaction to the Corona virus overtook the Budget proposals that were initially well received in the market place.  RSA 10 year bond yields were 8.76% p.a the day before the Budget on the 26^th February and 60bp lower immediately on the Budget news. They were up to 9.1% on the 2^nd March. They then declined to 8.76% on March 4^th after the Fed in a Corona pre-empt, cut its benchmark rate by 50bp and US 10y Treasury Bond yields went below 1%

RSA bonds are not a safe-haven asset for investors inside and outside the country as are US Treasuries and the dollar itself.  Yet were SA to be convincingly judged to be avoiding the debt trap and its money creation and inflationary dangers, taxpayers will gradually be rewarded with lower interest rates and interest expenses on their RSA debts. Global events that are now adversely affecting all EM borrowers and their currencies notwithstanding

The continued failures of the SA economy are elaborated upon in full grim even pious detail in the Budget Review.  Some Treasury mea-culpa would however be entirely appropriate for what has gone so badly wrong on the Treasury watch. Most egregious was the failure to recognize and contain operating costs at Eskom. And earlier to have permitted the explosion of public sector employment benefits in the boom years after 2005. We could have done with a Sovereign Wealth Fund then, reinforced by successful BEE partnerships with it.

The Budget Review contains a broad reform agenda. Including most helpfully bringing the employment benefits of government employees back in line with  “ .. the rest of the economy….” and promises legislation to “…eliminate excessive salaries and bonuses being awarded to executives and managers…” in the public sector that are indefensible. Eliminating the state’s “… complex and often ineffective procurement system. ….” is a reform long overdue.  And the intended reform of the exchange control system to best OECD practice is especially welcome for the wealth friendly signals it emits. Undertaking the “…urgent regulatory reforms of the Ports …”  would be a good step. But not only corporatizing the ports and cutting them loose from Transnet but allowing  them to compete with each other for custom would be much better for the economy.

Staying well out, as intended, of the “….exports of intellectual property..” will greatly encourage the creation of IP. To  “ Reduce the corporate tax rate”  in line with the competition and eliminating many of the complex tax allowances is essential. It is these complications that are responsible for “…South Africa’s tax incentive system…”  that “…favours incumbents and those able to afford specialist tax advice…”

Eliminating the extraordinarily large R600b liability for Third Party accidents of the Road Accident Fund (RAF) as was alluded to in the Budget Speech, would improve the State balance sheet. R2 per liter paid at the pump for the RAF could then be saved by households and businesses. Private insurance companies are more than capable of offering compulsory third-party cover at competitively determined rates. And capable of effectively contesting damage claims in court.

A debt for equity swap with Eskom debt holders is essential to the purpose of making it financially viable- otherwise a further R112b will  be coming its way, on top of the R62b provided to date. And with no guarantees that operating results will improve.

Debt swaps on agreed terms that introduced influential private shareholders to help govern the company will make Eskom economically viable. It would reward its managers conditional on improvements in return on capital. And pay them well enough – which is the usual private sector method for adding economic value.

Wallowing in despair at the highly unsatisfactory economic condition of SA is not helpful. Past failures can be seen as providing much scope for improvement. Hopefully the Budget proposals can provide an upside surprise for the SA economy.

The RSA is currently offering its bond holders a real 3.8% a year for 10 year money. It is the lowest risk investment that can be made in rands over the next 10 years. One made without the risk of inflation reducing the purchasing power of your interest income and without risk of default. If you wished to invest in a US Treasury inflation protected security (a ten year TIPS) you would have to (pay) Uncle Sam 13.3 cents per $100 invested for the opportunity.

Thus investors willing to accept RSA risk are currently being compensated with an extra 4% real rand income each year for the next ten years. This real risk spread was a mere 2.3 % p.a. a year ago. Other possible measures of RSA risk are as unflattering. The RSA borrowing dollars for five years has to pay an extra 2.2% p.a more than the US Treasury for five year money making RSA debt already well into junk status where it has languished for some time not withstanding its fragile investment grade status with Moody’s. Our rating compared to other EM borrowers has deteriorated and the ZAR is expected to weaken at a faster rate (See figures below)

The real risk spread for SA assets

Source; Bloomberg and Investec Wealth and Investment

Measures of SA risk

Source; Bloomberg and Investec Wealth and Investment

It all makes for very expensive national debt that taxpayers have to fund and higher costs of capital for SA business. These higher real rates also raise the returns that SA businesses have to hurdle to justify capital expenditure. Ever fewer such opportunities are seen to be on offer. And so the best many SA economy facing businesses can now do for their share owners is to opt out of the race in ways that are not good for growth. That is to use the cash they generate to buy back shares or pay dividends rather than attempt to grow their businesses.

The cause of this deteriorating credit rating and the higher discount rates applied to SA earnings is obvious enough. The RSA appears increasingly unlikely to manage its public finances with any degree of competence. The 2020-21 Budget has to cover an extra R50b to hold the fiscal line drawn as recently as last October. It is the result of less revenue than expected as growth has slowed and rapidly growing government expenditure on failed state-owned enterprises. A growing interest rate bill on ever more government debt is a further growing strain on the Budget .

There are however alternatives to raising taxes or borrowing more. That is to raid the SA pension and retirement funds. That is to compel them to hold more RSA debt of one kind or another on less favourable terms than have currently to be provided. Such forms of EWC have one major advantage for the politicians imposing them. Their full consequences will not become obvious for many years. That is in the form of lower than otherwise returns for pension funds and depleted pension payments. Including the bill ultimately to be presented to taxpayers for underfunded defined benefits owed to public sector employees- and largely incalculable today.

Swapping most of the debts and interest payments of SOE’s for equity without guaranteed returns has however one major potential upside. It could mean the effective transfer of ownership and rights of ownership from government to the private sector. This would bring greater efficiency and the avoidance of further losses for SA taxpayers and consumers of essential services.  Such a step would bring down real interest rates and encourage private sector investment.

It would moreover indicate something much more fundamental to investors in SA. That is when accompanied by credible controls on the size of the government payroll it would clearly signal something all important for investors. And that is the primary purpose of the SA government is not to provide a growing flow of real benefits for those employed by government. This is the essential question that the Budget, we must just hope, will answer in the affirmative.

The achievements of a few highly successful economies are highly admirable and conspicuous. Consistent growth in incomes and output over many decades has eliminated poverty. The growth has been accompanied by growing tax revenues that are easily collected, without much disturbing the engines of growth. And are then redistributed in cash and kind to provide a high measure of security for all its citizens against the accidents to which individuals and their families are always vulnerable.  Growth provides the means to fight crime, protect borders, provide roads, sewers and vaccinations, of equal value to all.  The caveat is that this historically unprecedented abundance is not better appreciated and more popular than it appears to be. Continued success can never be taken for granted.

Open access to the markets for all goods and services and for the resources, labour capital and natural resources with which to compete for custom, is a critical ingredient for success. Innovation threatens established interests and must be well recognised as a force for better. Rights that protect wealth and persons against fraudulent or violent assault and rule by predictable laws and transparent regulations are essential for success.

Competent and responsive government agencies are essential to the economic purpose. And a society, critical of government action, aware and unafraid of what a powerful government might arbitrarily do to them, makes for good government.

Harvard economists Acemoglu and Robison (A&R) have followed their influential “Why Nations Fail” with “The Narrow Corridor” [1]It explains in fascinating detail why it has been so difficult for nations to do what it so obviously takes to enter and stay in the narrow corridor that leads to economic success.

They explain the advantages of the “Shackled Leviathan” when the potential abuse of state power is effectively constrained by an empowered and critical civil society. A state very unlike the “Despotic Leviathan” that maintains essential order but does so at huge disadvantage for a cowered and vulnerable people. China, old and new, is cited as one such example. Another alternative may well be the “Paper Leviathan” an expensive and incompetent government, but only in name not in action. South America provides more than a few hapless cases of governments that serve only the people on their payrolls.

In all the many cases of national failure there is an elite who have a powerful interest in the stagnant status quo – and who resist the obvious reforms that would stimulate and sustain faster growth. Zimbabwe comes to obvious mind.

A&R also examine the potentially suffocating role of the “Cage of Norms” – well entrenched customs- that stultify access to markets and inhibit competitive forces. The caste system in India is still such an inhibitor of economic progress. Traditional land rights are a serious obstruction to producing more in SA.

South Africa, (A&R) argue, entered the narrow corridor that leads to success with the help of Nelson Mandela. They regard BEE as very helpful to economic success because it broadened the political interest in established enterprises and business practice enough to help protect them and the economy against destructive expropriation. That cutting a new elite into business success was necessary for stability and growth.

One wonders how A&R might now react to the revelations about state capture and corruption? And to the failures of the SA state to deliver satisfactory outcomes for the resources made available to it.

This raises an essential question. Will the highly transformed SA elite act in the general interest and encourage the invigorating forces of meritocratic competition for resources and customers? Or will they act to protect their gains and privileges against them?

The new elite should be aware that a failing economy will not be politically acceptable and any elite dependent on it will be highly vulnerable. They should be encouraged by our open and critical society to take the steps to get SA back into the narrow corridor that leads to economic success

[1] Daron Acemoglu and James A. Robinson, THE NARROW CORRIDOR, States, Societies and the Fate of Liberty, Penguin-Viking, 2019.