The focus of fiscal policy in South Africa on the long run interests of the economy by living within your means has been admirable. It means building balance sheet strength in the good times when revenue growth is strong rather than indulging in a spending fever. So that when the economy slows down, more debt can be raised to finance government spending to avoid a self destructive resort to higher tax rates. Higher tax rates in a recession can easily lead to less rather than more tax revenue and slow down the economy and revenue growth further.
On reading the Medium Term Budget Policy Statement (MTBPS) one was gratified that the Treasury and its Minister understood these facts of economic life very well. No resort to higher taxes was to be made while government spending was to be sustained. And then the Minister of Finance in comment later last week, in all innocence presumably (hopefully) pronounced on the necessity to raise taxes should the economy not grow as expected.
This is very worrying. The most urgent task facing those responsible for managing the economy is to do all they can to get the economy moving again. This means all the encouragement they can offer households and firms to spend more now. It should mean lower rather than higher tax rates. For example temporarily accelerated investment allowances would help private sector capital formation, which has stalled so badly, as would every effort made to accelerate the award of tenders for the infrastructure programme about which the construction industry is so concerned.
Monetary policy also needs to try a lot harder than it has to get money and credit supply growing again. Lower interest rates might not help much on their own any more, but if accompanied by the quantitative easing practiced everywhere else to pump extra cash into the economy, it would do no harm and might do some good.
Yet despite the recession and the deflation of prices at the factory and farm gates one still hears whispers out of official circles of the danger of self fulfilling inflationary expectations. The theory that inflation can be self perpetuating irrespective of the state of demand in the economy is wanting in ordinary circumstances – it is simply damagingly nonsensical at times like this.
The biggest danger to the recovery of the economy would be the much higher charges Eskom would like to impose on the economy, charges that would allow Eskom to avoid to a significant degree drawing on the government balance sheet to finance its essential capital expenditure. Incidentally this capex is particularly welcome at this stage of the business cycle.
Such price increases well above the cost of supplying additional electricity (costs understood to include an appropriate return on capital to be invested) should be resisted by raising more government debt. That is to say, it should be financed with more Eskom debt, assisted by a further government guarantee, should the considerable guarantees provided for Eskom debt to date be insufficient to the purpose of avoiding excessive price increases.
Increased charges (i.e. taxes) for electricity would continue to add to measured inflation as they have done to date. They will also, as they have done to date, tax away spending on almost everything else. Could the SA authorities, despite the state of the economy, not only raise taxes in the form of excessive charges for electricity but in addition also raise interest rates because of the impact higher electricity prices will have on inflation, and maybe therefore on inflation expected? Such responses are not apparently impossible to contemplate and so represent a most dangerous threat to the long term health of the economy.
The long term health of the economy and the willingness to invest in its long term potential will depend on the confidence investors and households will have in the ability of the authorities to manage the business cycle in a sensible way. They would spend and invest more now knowing that the path back to sustainable growth has been clearly marked out. Some of the signals received from the Treasury and the Reserve Bank about how to make the transition from the short to the long run do not always inspire confidence.
The global recession has led the monetary and fiscal authorities to usefully recall the advice Milton Friedman offered on how to deal with a banking crisis by the central bank acting as the lender of last resort (in his Monetary History of the US published in the late 1960s) and the instruction John Maynard Keynes provided on how to deal with depression with vigorous government spending (in his highly influential General Theory of Employment Interest and Money, published in 1936). Keynes was cynical about the human condition but it might be well for our authorities to be reminded in current circumstances of his celebrated remark that “in the long run we are all dead”.