Opinion Piece

A strong government is essential for a well-functioning economy

One of the fastest growing commercial banks in South Africa, Capitec, has a wonderful tag line, which I like, that says ‘simplicity is the ultimate sophistication’.

Often simple solutions can prove the most portent to the most intractable problems. Last week, I concluded my writing, ‘Solution to South Africa’s ‘Growth Question’ hiding in plain sight’, urging the government to go back to the basics and recognise its centrality in the economy. This week, I expose the significance of a strong government to a well-functioning economy.

Any economy, at its basic level, is measured by the gross domestic product (GDP) whose basic equation is given as follows:

GDP = C + I + G + NX

Where C = Consumption, I = Investment, G = Government Spending and NX= Net Exports

Consumption is a function of vibrancy of economic activities in the I and G. Nothing better explain the significance of consumption, households’ consumption in this case, in the economy than the number of malls, which number some 1 817. Top ten malls have a total gross leasable area (GLA) of a million square meters.

On the other side is labour that drive feet into the malls. Unfortunately, labour has been on a losing streak, with labour share of the GDP having declined from 50% a decade ago to 45%. Weakened state of labour unions, households’ debts and family responsibilities in the sea of unemployment constrained labour’s bargaining powers with negative impacts on C. Spending is the lifeblood of capitalism, without which businesses have no customers and ultimately no reason for existence.

Turning to investment (I), total investment can be disaggregated into public investment and private investment. Public investment as percentage of total investment is averaging 18% while private investment is averaging 70% with a peak of 76% in 2022. The difference is accounted for by public corporations.

Any further elevation of private investments together with privatization will take private investment edging closer to or above 80%. Even if this is achieved, there is no guarantee that enough jobs will be created to mop up the employed. This is because conventional technology menu is overly represented by labour displacing automation technologies. Investments may materialise but with enough jobs failing to materialise.

Government, as a not-for-profit entity, has a leeway to choose labour intensive technologies when effecting public investments. Such a freedom is absent in the globally competitive private sector.

Besides, private sector is already too big, accounting for 91% of the economy. Anything higher would lead to what Daren Acemoglu and James Robinso called ‘Absent or Paper Leviathan’ (basically absent government) in their book, ‘The Narrow Corridor’.  The proof that is in the pudding of an Absent or Paper Leviathan is poor delivery of public goods and services, including peace and security and ultimately a failed state.

Turning to G, the government wants to elevate the role of the private sector even higher, and President Ramaphosa is leading the charge, through initiatives such as South Africa Investment Conferences and others. Recently, the Ministry of Finance has floated the idea of launching a credit guarantee scheme to unlock private sector investment on infrastructure. Through this scheme, the government wants to create and add to existing stock of contingent liabilities, currently amounting to R1 trillion, when deficit spending on infrastructure can add to the country’s asset base without the corresponding liabilities.

The scheme is probably premised on the ‘crowding out’ thesis that says that government borrowing deplete savings for the private sector, constraining the latter’s ability to invest cheaply in the economy. The thesis works like this:

deficit requires borrowing, borrowing deplete the supply of savings available to the private sector for productive investment, reduced supply of savings lead to higher interest rates, which then discourages private investment, ultimately leading to slow growth of the economy.

With the credit guarantee scheme, the thinking must be that fiscal deficit will not have to increase as infrastructure investment is outsourced to the private sector. This will free the government to continue with austerity, albeit at added cost of contingent liabilities. With credit enhancement provided by the credit guarantee scheme, private sector will access savings for infrastructure investment with no competition from the government at low interest rates. In truth, however, crowding-out thesis does not hold for a currency issuing country like South Africa wherein fiscal deficit does not imply borrowing other than that fiscal spending has been more that tax receipts. For households, businesses and countries that are currency users, deficit do mean borrowing.

The government’s contribution to the GDP is measured by fiscal spending. However, this cannot be at gross level but at a net level, net of taxes. On this basis, fiscal surplus represents a government that is not adding new fiscal spending into an economy as taxes would be more than fiscal spending. Fiscal deficit, on the other hand, represents net new additional fiscal spending and does not mean borrowing as it does with households, corporations or currency users. With the South African government, fiscal deficit just mean fiscal spending (already undertaken) was more than tax receipts in any given year and nothing else. This is true of all currency issuers with monetary sovereignty and not true for those without monetary sovereignty.

Let us take a detour and look at the role of taxes, by way of an example, in a currency issuing country like South Africa. A good example is to look at the designs of garden planter pots. All good planter pots are designed with holes underneath to drain excess irrigation water. Without drainage holes, irrigation water accumulates, leading to an overflow of water and ultimately suffocation of a potted plant due to lack of oxygen. Irrigation water in this case represents freshly injected money onto the economy through fiscal spending. Taxes performs similar function as the aforesaid drainage holes, to drain excess liquidity out of circulation, lest the economy overheats, engendering inflation, something Milton Freidman called “the most destructive disease known to modern societies”.

As can be seen from figure 1 below, fiscal deficit acts as a source of surpluses/savings for the non-government sector (private sector and households) (see figure 1). As Stephanie Kelton put it in her bestselling book, ‘The Deficit Myth, “government’s red ink is our black ink”, with ‘our’ referring to the non-government sector. In other words, fiscal deficit adds to our financial savings and wealth. True to form, the two years associated with COVID19 witnessed an increase in the combined savings of private sector and households on the back of the widening government deficit to countercyclically response to the crisis. Isn’t it amazing that it is during 2020 and 2021 that households recorded surpluses/savings?

With the government back to its default mode of austerity, households’ savings have been depleted. So, what would anchor the C and keep feet in the malls?

Source: South African Reserve Bank, September 2024

Lastly, net trade (NX) is a function of how well labour is paid relative to the value of goods they helped produced. As pointed out earlier, labour share of the GDP has been declining during the last decade and it is no surprise that the country has been recording trade surplus after another. In essence, trade surplus points to a weak domestic demand and the opposite is true of trade deficit.

In conclusion, the size of the government, at 9%, is already too small relative to that of the private sector and cannot become any smaller without risking plunging the country into a failed state. As stated above, conventional technology menu is overly represented by labour displacing automation technologies such as robots and AI. This means even if there is an increase in private investment, including foreign direct investment, there is no guarantee that enough jobs will be created.

Households swung from savings position to deficit and that will affect consumption spending. The government, as a not-for-profit entity, should focus on economic outcomes, not budgetary outcomes. Fiscal deficit should exist, but the trick is to prevent it from getting too big or too small. As Stephanie Kelton put it “the right size of deficit is one that provides just enough support to keep the economy humming along without risk of igniting inflation. Well-designed fiscal policies, including those that increase fiscal deficit, can catalyse private investment, sparking a virtuous cycle that leads to the crowding-in of private investment, rather than crowding it out”.

Disclaimer: The views expressed in this article is solely that of Independent Agricultural Economist, Robert Matsila, and does not necessarily reflect the views of Mzansi Agriculture Talk, his employers, or other associated parties.

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