Budget (Micro-economic issues): hearings

Meeting report

FINANCE PORTFOLIO COMMITTEE
28 February 2001
BUDGET: MICRO-ECONOMIC PERSPECTIVE - HEARINGS

Chairperson: Ms B Hogan

Submissions handed out
Dr Iraj Abedien
Mr Stephen Gelb
BusinessMap
(see Appendix for these documents)

National Treasury representation: Mr Masemela and Mr van Rensburg from the Macroeconomic Unit in the National Treasury.

SUMMARY
Dr Iraj Abedien: Technology and market liberalisation have changed the structure of the economy. The effect of the structural change is that the demand for skilled labour is increasing while the demand for unskilled labour is decreasing. There must be training to combat this. Training must be parallel to economic growth. Economic growth without training does not solve unemployment if the skills profile of the country does not fit the jobs available.

Mr Stephen Gelb: A survey conducted recently for the Office of President indicates that the low rate of fixed investment in SA stems from low investor confidence. One interpretation of the data from the survey is that this reflects insecurity over property rights. To increase investor confidence government must increase security over property rights. Enhancing property rights security will require a credible policy framework for addressing redistribution in the economy.

BusinessMap: Concern was expressed about the increase in defence allocations over the medium term. They would like to see a greater increase in the funds going into the social welfare system. Social questions are a key issue for investors. There is concern around crime and stability in the social fabric.

MINUTES
Dr Iraj Abedien
Summary of presentation
The South African economy has undergone major transformation. The tertiary sector - mostly industry - has increased. In the post eighties and nineties the primary sector share of the economy declined. Sixty five percent of the national income now comes from the tertiary sector. If one sector in aggregate diminishes in share then this does not mean that that particular sector is insignificant or that it is falling apart. This is relative growth at play.

The skills profile of the country has also changed. The trend in all the sectors is the same: the need for skilled labour is increasing while the need for unskilled labour is decreasing. The mining sector for example is predominantly driven by technology. The type of labour force the economy needs is knowledge intensive. The knowledge-intensive, automative, less demanding of unskilled labour characteristics are irrevocable for as technology intensifies, the need for highly skilled labour increases.

Market liberalisation is second to technology in bringing about structural change. Its gains are medium-term but its losses are immediate. However the net effect is positive.

It is important to encourage SMMEs but these are not the kind of operations that will need unskilled labour. If the government is going to bank on SMMEs then they must also educate and train the workforce. There must be access to credit but this will be meaningless if the skills profile does not fit the work required.

With economic growth more jobs are created for the skilled and less jobs exist for the unskilled. The social implication of this is a skewed income distribution. There must be training for unskilled labour parallel with economic growth.

Government must promote domestic investment and not only Foreign Domestic Investment (FDI). The more local investment is marginalised, the more government adds to an environment of distrust.

Government must accelerate capital expenditure spending. Procrastination leads to a lack of credibility. They must choose priorities and then implement them effectively. An announcement must be supplemented immediately with implementation.

Government must require corporate governance ethics from financial groups active in South Africa. The current financial architecture is open to abuse. Government can safeguard its interests within the market without becoming an interventionist government. For example, rumours of the Finance Minister's resignation affected markets.

Poverty is a risk to the national democracy therefore it must be addressed. Government must decentralise the attack on poverty. Unless poverty is addressed, the medium term prospects remain uninspiring.

Discussion
A committee member asked for any specific proposals regarding skills development.

Dr Abedien replied that in the short-term government can provide subsidies in areas of nationally-recognised priority. For example, they could identify three particular skills and then set up Sector Education and Training Authorities (SETAs) for this. When government subsidises then there is more likely to be investment. Government can facilitate training but the industry must get involved. Government must not procrastinate and politic around it. If they have said that they are going to do something, then they must do it fast. In the medium term government must re-look at the education system.

Mr Feinstein (ANC) asked for a comment on curbing financial volatility. He also asked what the main impact of poverty and inequality was on the economy.

Dr Abedien replied that this related to debt. All countries have foreign debt. The challenge is to change the structure of the debt from short-term to long-term. This will make it easier to manage. There are various ways for government to do this. If for example they transformed a one year debt to a five to seven year debt then this would take the volatility out of the market. This is ''the way to go''. Poverty affects the economy by deterring investment.

Ms Mahlangu (ANC) asked how market liberation could be achieved without killing SA markets and creating more unemployment.

Dr Abedien replied that with liberalisation there were two aspects. On the one hand those who cannot compete get squeezed out. On the other hand consumers get a cheaper price. Government must not create carte blanche liberation. The liberation must be phased in. It must also be in collaboration with industry, industry by industry. Government could give a sunset clause for example, they could give businesses three years to shape up. Part of the game is that some industries must go down while others expand. However the net effect will be good.

Ms Mahlangu asked about domestic investment versus FDI (foreign direct investment). Is it true that investors always choose to go offshore? Should they have incentives to invest in South Africa?

Dr Abedien replied that all investors want incentives. This is part of human nature. It is not necessarily the solution. In some instances it plays a role, but then it is better on the tax side than on the handout side (subsidising one cent for every five cents). If no one offers incentives anymore, then it will simply end. It is because an incentive is offered that investors have a bargaining chip. Many investors simply want access to skills which is a different type of incentive. If government invests in skills development, that could end up being an incentive for investors.

Mr Andrew (DP) commented that there is often a focus on FDI because the perception is that if one attracts FDI then there will be an attractive environment and the domestic investment will follow. He referred to Mr Abedien's comment that faster growth led to inequality in the short-term and pointed out that the growth would however give government the capacity to train. Mr Andrew asked Dr Abedien (one of the co-ordinators of GEAR) why the growth target was not achieved. Was there any prospect of South Africa achieving a six percent growth rate?

Dr Abedien replied that export and skill augmentation were the key drivers of GEAR. The three successive global shocks (South East Asia, Russia, and Brazil) was a key problem for export. Also the labour absorption which was expected did not happen and the proceeds of privatisation took much longer to come in than expected.
Growth and boosting is less of a government challenge and more of a business challenge. For example, a practising dentist creates approximately eight semi-skilled jobs. Thus if a few dentists leave the country then many jobs are lost. Micro institutional issues are very important.

Mr Andrew referred to the suggestion of a code of ethics for institutions - in light of the fact that rumours affect markets. He asked how one would distinguish between an unjustified rumour and an analytical judgement.

Dr Abedien replied that this would go a long way to putting institutions under check as they will think twice before spreading rumours. If they are bound to a transparent declaration of good ethics, then rumours are limited but analytical judgement is not eliminated.

Professor Turok (ANC) commented that with liberalisation, it is important to avoid shocks. He pointed out that there are some industries which are labour intensive and not all SMMEs require skilled labour. For example some are simply involved in bead-making. He asked if it was not good for government to encourage this and in this way discourage the dependency approach.

Dr Abedien replied that it is correct to minimise shocks with liberalisation. Labour intensivity can be promoted as much as one liked but the fact remains that in the mainstream economy, technology will dominate. For example Mercedes Benz will never go labour intensive. Government must create an environment for SMMEs to flourish. Microbusiness, small operators, and medium business (such as dentists, technicians, and manufacturers) should not be lumped together. They all require different kinds of support.

Dr Rabie (NNP) noted that there are fewer farms now than in the past. In light of this he asked if it was a viable option to develop rural areas into a commercial, small farming sector or if they should rather concentrate on industry.

Dr Abedien replied that agricultural development is an option. There is fantastic potential on tap. The communal control of land has been under-utilised. The government must find ways of dealing with this. Farms have become fewer but their productivity is greater because of technology. The relative share decline does not mean that the activity is insignificant. Agriculture is a critical part of the economy and South Africa cannot do without it.

Mr Stephen Gelb
Summary of presentation
A survey was conducted which indicates that the low rate of fixed investment in SA stems from low investor confidence. One interpretation of the data from the survey is that this reflects insecurity over property rights.

Property rights relates to the ownership of assets as well as adequate control over future returns generated by the assets. The insecurity over property rights emanates from the polarisation and inequality in society. Polarisation is reflected in the highly unequal distribution of wealth and incomes in South Africa. This polarisation creates this insecurity and an assessment of heightened risk that there will be a major shift in the economic policy regime. Firms in such societies feel uncertain about their claims on future returns from operations, therefore choose not to invest in fixed capital. The issue is not the firms attitude per se to government but rather the but their concern that government will respond positively to popular demands for redistribution.

To increase investor confidence, government must increase security over property rights. Enhancing property rights security will require a credible policy framework for addressing redistribution in the economy. By actively addressing the demand for more equal distribution in society investors will have more certainty about claims on their future incomes.

A credible framework would include social consensus including the support of businesses. Also, the principles underlying distribution must not be based on current income but rather on income-earning assets. A credible framework would also have to maintain macroeconomic stability.

Discussion
A committee member commented that there is a government perception that capital expenditure is needed to absorb unskilled labour.

Mr Gelb replied that capital expenditure was lower in the nineties than previously. The reversal of this in the 2001/2002 Budget is welcomed. However low levels of capacity in the government sector is a problem. It is important to improve the productivity of spending. From a macroeconomic point of view it is inappropriate to simply increase spending. Society needs to address inequality and poverty. Government must focus on a better distribution of assets rather than a better distribution of current income. People need assets which will entitle them to a claim on future growth in the economy. There is scope for spending more while also trying to improve performance.

Mr Feinstein referred to the survey and asked precisely which methodology was used in the survey and what questions were asked - to lead the presenter to the conclusion that there was insecurity over property rights.

Mr Gelb replied that the survey asked to what extent various issues (such as tax policy, infrastructure, crime, and government economic policy) posed obstacles to investment decisions. The question of interpretation is open to debate but Mr Gelb pointed out that personally he felt that it reflects insecurity over property rights.

Mr Masemela commented that the statements on insecurity over property rights was an oversimplification of the investor confidence problem. Redistribution raises the question of trust. To embark on redistribution will not be successful because it will affect confidence negatively. Thus Mr Gelb has oversimplified the confidence issue.

Mr Gelb said that he is not suggesting that the government simply take existing capital assets and give it to the others in society. However equality and distribution must be at the centre of economic policy. Distribution must be wider and more equal than currently the case. Social consensus (including the consent of business) will be required to give effect to this policy.

The Chairperson noted that the presenter and Dr Abedien were both saying that poverty must be addressed in order for the country to move forward economically. The effect of poverty manifests in all forms including affecting investor confidence in the economy. The issue which Mr Masemela raised was one of semantics. The term ''redistribution" had a negative connotation to it. Perhaps a different term should be used. Perhaps they should rather say ''a sustained attack on poverty''. She asked Mr Gelb if he agreed.

Mr Gelb agreed with this to some extent but said that it was not just poverty alleviation. Government must go beyond this and focus on not only on current income but on income earning assets.

The Chairperson said that perhaps the term they were looking for was ''economic empowerment''.

Mr Gelb replied that this would be acceptable. The point was that government must think harder about the relationship between equality and economic growth. If they improve equality then they will also improve growth performance.

Professor Turok asked for Mr Gelb's assessment of government's capacity to do the things that he was advocating.

Mr Gelb replied that capacity is a major problem in government. He admitted that he honestly did not know. An essential aspect is the question of leadership, leadership of not only government but also business.

Mr Andrew commented that poverty and inequality was addressed by the speaker as though it was necessarily the same thing. Sometimes it is possible to address the one without the other. This is especially so in the case of delivery. For example, preferential procurement policies assist previously disadvantaged businesses to obtain contracts.

Mr Gelb replied that broadly speaking he agreed. In trying to reduce inequality, there should be a shift from trying to increase current income (such as the preferential procurement programme) to a focus on the redistribution of assets which will contribute to future growth.

Mr Andrew said that he agreed with the Chairperson naming the concept ''empowerment'' and perhaps also ''opportunity''.

BusinessMap
Summary of presentation
Ms Karen Heese and Ms Jenny Cargill raised the following issues:
- Their concern for the fact that the defence allocations rise over the medium term. They would like to see a greater increase in social welfare funding. Social questions are a key issue for investors. Investors are dismissive about SADC's buying size because they say that there is no buying power. There is concern around crime and stability in the social fabric. This is an investment concern raised by international investors.
- They would like to have greater engagement around the budget. Hearings should precede the drafting of the budget.
- Pension grants did not rise above inflation.
- The Child Care Grant has barely risen above inflation.
- They would like to see a real increase in the Health Budget.
- Increased spending on the criminal justice system is critical.
- The quality of spending is very important.
- The Financial Fiscal Commission should be more involved. Presently they seem to be a bit marginalised
- A problem that arises with having big discretionary funds is that government officials within departments then lobby for the discretionary funds. Instead of putting money into big discretionary funds the money would be better used to boost pension funds (social security grants).
- Businesses criticise that the general business environment continues to need support. The Department of Trade and Industry's efforts have sometimes been disappointing.

Discussion
Dr Rabie asked for examples regarding the comment that businesses feel that DTI's efforts have been disappointing.

Ms Heese replied that the DTI package of available support measures is generally not known. There is a lack of communication. It is difficult to tap into the system to get speedy processes. Ms Cargill added that there was a problem with access to information.

Mr Andrew referred to the comment that there should be greater participation by the public and Parliament in the budget process. He said that the intent of the hearings held now is to serve as a critique for the following year's budget. He asked what other processes they were suggesting for Parliament to be included in the budget process. He added that he felt that the current process was substantial.

Ms Cargill replied that perhaps the FFC should be more involved. The level of technical submissions could move to the end of the year prior to the budget being tabled. There could be an extension of the processes that already exist.

Ms Mahlangu (ANC) asked why Businessmap correlated the spending on defence with spending on health. The spending on defence only increased because of the arms deal.

Ms Cargill replied that investors are concerned about the impact of HIV/AIDS. Investors worry about what the country's priorities are. Overspending on defence often occurs in more unstable countries.

Mr Masemela (Macroeconomic Department: Treasury) asked Businessmap how one should make use of the information from the survey on investors.

The panel replied that the issues emerging from the survey were dialogue and trust. More meaningful dialogue between government and business is wanted. There is NEDLAC already but for some reason not all the benefits are achieved from that. On the trust issue, there is still some distrust between business and government. Who speaks on behalf of business? Is it still white South Africans? Open dialogue will be a movement in the right direction.

Mr Masemela said that many of the questions raised have clear answers. If these issues are a worry to businesses then there is a communication problem.

Mr Lekgoro (ANC) asked them to expand on their objection to discretionary funds.

Ms Cargill replied that they have no objection per se. It is important to have this for things such as flood relief for example. The problem they have is with the size of some of them, for example, the Poverty Alleviation Grant. This is something each Government Department must tackle. There should rather be poverty alleviation through better pensions. The focus should be on better core services. Discretionary funds should only be used to fine tune. More can be done to alleviate poverty this way than by devoting government resources to new programmes.

In conclusion the Chairperson said that it was a pleasant change to focus on micro issues. The meeting was adjourned.

Appendix 1
Dr Abedien: Submission

SA Economic Structure
SA Economy has undergone major transformation.

What is structural transformation?
· It is a complex multidimensional issue
· Its key indicators are:
- Sectoral changes
- Skills profile at a given time
- Production technology in use. Defined by:
Capital / Labour ratio
Real gross value added per employee

Tracking structural change from 1950s to 1990s:
Increasing share of the tertiary sector
Note: Rising tertiary share does not mean that other sectors are not important
Examples of changing skills profile:
Manufacturing, engineering and related services:
Highly skilled: 1970 - 4,8; 1997/8 - 12,6
Skilled: 1970 - 25,6; 1997/8 - 27,4
Unskilled: 1970 - 69,7; 1997/8 - 60,0

Health & Welfare:
Highly skilled: 1970 - 15,5; 1997/8 - 28,6
Skilled: 1970 - 74,7; 1997/8 - 68,7
Unskilled: 1970 - 9,8; 1997/8 - 2,8

Mining - a dramatic rise

Agriculture
Consolidation in farms:
1985: 55 000, 1996: 45 000
Outsourcing of capital intensive operations

- General trend is towards increasing automation or technology intensity
- Business process re-engineering is also at play

Drivers of change:
(a) The impact of TECHNOLOGY
- it affects all sectors and industries
- it disproportionately affects unskilled labour
- it increases demand for skilled labour

Why Technology Pervades?
- Competition requires it
- Spurs innovation and creates consumer demand
- it tends to self-perpetuate

(b) Market Liberalisation
- Made possible by new political dispensation
- it is a double-edged sword
- its gains are medium-term but its losses are immediate
- its nett effect is clearly positive
- market liberalisation is second to technology in bringing about structural change

Challenges and Opportunities
(a) Public Policy
- Creating jobs for unskilled people has become harder
- Training and education are required
- Need to encourage and facilitate creation of SMMEs (the question of skills!)
- Question of labour legislation
- Need better services data for policy formulation
- Social implications for government (eg skewed income distribution)

(b) for BUSINESS
- a greater need for collaborative relations with organised labour to produce win-win solutions
- Company structures and culture need to be geared toward encouraging innovation
- Service delivery standards need rapid improvement

(c) for LABOUR
- job preservation versus job creation
the replacement of life-long jobs with life-long training

Policy implications: Boosting sustainable growth:
· Need for a 'trust building campaign' across society
· Promote domestic investment not FDI only
· Accelerate CAPEX spending via credible spending programmes/ projects
· Increase efficiency in general, but also as prerequisite for lower 'quasi taxes'
· Reduce Financial Volatility
· Consolidate macro-financial framework by closing down 'Forward Book of SARB'
· Require appropriate and transparent 'corporate governance ethics' from financial groups active in SA, esp. acting as SA Govt agents in public sector tenders.
· Supplement SETA levies with appropriate & sectorally differentiated subsidies
· De-bureaucratize immigration policy particularly with regard to skilled individuals; eg: introduce rules and remove discretion.
· Set up high level, sector-specific task teams to introduce effective training action plans for each sector
· Re-configure the management framework of all public education institutions
· Co-ordinate policy for 'perception management'
· Introduce a 10-year plan of action involving govt, business, labour, and the various organs of civil society
· Decentralize attack on poverty, using all the national social capabilities
· Using IGFR, engage local governments in a nation-wide programme of public works' programmes to alleviate poverty
· Report on PFMA implementation progress, particularly with respect to delivery of services at all three spheres of government

Concluding Remarks
· Managing the national and global perception of SA is vital
· High level of trust and collaboration are lacking; globalization demands it!
· Economic fundamentals are right, but economic leadership is inadequate
· Unless poverty is addressed, the medium prospects remain uninspiring.

Appendix 2:
Constraints on investment in South Africa

STEPHEN GELB: DEVELOPMENT BANK OF SOUTHERN AFRICA

FEBRUARY 28 2001

This focus of this presentation is the impact of the Budget on investor confidence in South Africa. If the Budget is to be evaluated according to its own objective of moving the focus of economic policy from consolidation to growth, from macroeconomic stabilisation to microeconomic reform, then a key issue is its likely impact on confidence and hence on private investor performance. Since the South African economy has been characterised by low levels of fixed investment for a long period of time, it is essential for improved growth performance that investment levels and rates pick up, together with an improvement in capital productivity (or output per unit of capital) which has basically stagnated for two decades.

The basis of this presentation is a study recently completed for the Office of the President, addressing the low rate of fixed investment in South Africa. This study concludes that low investor confidence in South Africa is linked to firms' insecurity over 'property rights', which is in turn tied to the high degree of polarisation and inequality in the society. Polarisation produces property rights insecurity because it raises firms' assessment of the risk that there will be a major shift in the economic policy regime, so as to produce a different distributional outcome. Firms in polarised societies therefore feel uncertain about the size of their claims on the future returns from their operations, and thus choose not to invest in fixed capital, but instead to hold assets in which the returns are more certain or their investments more 'reversible'.

The basis for the Investment Study was a National Enterprise Survey, in which over 1400 firms (with more than 5 employees) in thirteen sub-sectors within manufacturing and services were surveyed between November 1999 and February 2000. The timing of the survey is important: it was carried out before the recent business community concerns and tensions with government over policy towards stability in the Southern African region and towards HIV/AIDS. It can also be noted that the period November 1999 to February 2000 was a period of historically high levels of business confidence, as measured by both the BER and the SACOB business confidence indices: the BER index was at its highest level since early 1996 (before the Rand crisis), while according to SACOB, confidence was at a peak in the period of democratic government. At the time that firms were asked to complete the survey, interest rates had been on a downward trend for about 12 months, and the economy was just emerging from the downturn which had started in late 1996.

The Study confirms that firms' investment rates (investment as a share of their fixed assets) are extremely low, as reflected in the aggregate data published by the SA Reserve Bank. Investment activity in recent years has been motivated primarily by firms' search for efficiency and productivity increases, rather than firms' entry into new markets, responses to growth of overall demand, or responses to labour issues. Firms' investment decisions - both the rate of investment and their reasons for investing - are significantly influenced by both size (number of employees) and the industrial sector. In some sectors, notably clothing and furniture, exporters have higher investment rates than non-exporters. Market size and demand are significant investment determinants in the services sectors and in the machinery industries. Skill shortages are identified as a major problem for investment and ongoing operations by many firms, but firm expenditure rates on employee training are disturbingly low. Both race of the owner/manager and the firm's age are significant factors in determining access to finance.

A key question in the survey asked firms to consider seventeen different possible constraints to investment. The degree to which each of the seventeen issues had discouraged capital spending over the previous 2 years was rated on a scale running from "insurmountable" to "no impact". The major obstacles to investment identified in the responses included interest rates, 'crime and social issues', 'labour regulations' and, especially for small firms, 'uncertainty over government economic policy'. Firms were asked in additional detail about the impact of these particular issues on their day-to-day operations as distinct from their investment decisions. Although the most important constraints on investment were also seen as having a negative impact on operations, there was a noticeable difference between the strength of the respective impacts: while these issues posed relatively severe barriers to further investment and expansion, the costs they imposed on ongoing operations were perceived as fairly moderate.

This disjuncture suggested that over and above the direct effects of the cost of capital (via interest rates), profitability (via labour costs) and market demand on the investment decision, uncertainty and lack of investor confidence were probably more important elements. Starting with Keynes, economists have emphasised confidence and uncertainty as critical to investment decisions. Keynes argued that investor confidence, which he called 'animal spirits', is for the most part based on a convention (or assumption) that present circumstances will continue pretty much unchanged into the future, unless people have specific reasons to expect a change. One important element underpinning this convention projecting the present and the future is the stability of the broad institutional framework, of which central features are property rights, the rule of law, and the predictability of policy and administration, to which I will return below.

Keynes' insight has recently been developed through application of the theory of options to capital expenditure decisions. The conclusion is that it pays the firm to wait for new or additional information to emerge about the expected returns to the investment, because it can thereby avoid the costs of 'bad news' affecting its realised returns. Thus, waiting has a value: if the firm makes the investment immediately, it kills the option of waiting and forgoes that value. Because downside risk is minimised, even a low probability of loss due to future 'bad news' results in a significant 'value of waiting', which must be added to the required return from a project derived from standard measures of NPV or IRR. In other words, many projects which might yield adequate returns based on the latter criteria, are ruled out once the value of waiting is taken into account. Furthermore, a small increase in the probability of future 'bad news', or a small shift in expectations towards 'worse' news, will disproportionately raise the 'value of waiting', and therefore lead to the postponement of additional capital spending projects. These arguments help to explain why investment rates are lower than might be expected, given levels of the cost of capital and of profitability, and why they often do not respond quickly or strongly to improvements in these levels.

Naturally, the probability of 'bad news', and how bad the news will be, are both subjective assessments, so that the 'option value' of waiting depends on firms' own risk assessments. Such subjective assessments might be labelled 'perceptions' or 'feelings', and seen as distinct from another set of issues and criteria labelled 'reality', as some commentators have done. But the approach just outlined suggests that it is futile to make such a distinction and then try to shift the focus from perception to reality - if waiting to invest is an option, then its value, and hence the overall investment decision, must depend on a considerable dollop of subjectivity.

The disjuncture in the survey results between the impact of various constraints on day-to-day operations and on investment decisions suggests that Keynes' convention linking the present and the future is not operating effectively in South Africa at present. Rather, firms feel there is a high probability of 'bad news' in relation to the issues mentioned above, such as interest rates, crime and social issues, the labour regime or policy uncertainty. It is not the current levels of these factors but the expectation of their deterioration that is holding back investment. Firms choose not to invest in fixed assets, from which it is difficult to 'exit', but instead hold assets about whose return they are more certain, or assets in which their investment is more easily 'reversible'. It is noteworthy that despite the historically high levels of the published confidence indices at the time of the Survey, it still reveals that investor confidence is a major barrier to investment. This also helps us to understand investment performance during 2000. Even though the private investment level (in real Rands) in the third quarter of 2000 was 5.9% higher than its average level for 1999 (reflecting the improvement in confidence at the end of 1999), the private investment rate - the share of GDP, or proportion of total output in the economy, devoted to investment - only rose fractionally to 11.7%, compared with 11.6% for 1999. This rate remains far too low to push the economy's overall growth rate above its apparent ceiling of 3%, and a substantial and sustained increase in the investment rate seems unlikely unless it is linked with a fundamental shift in confidence.

To investigate in more depth the issue of confidence - why firms expect 'bad news', additional statistical analysis was carried out on the firms' responses to the question regarding constraints on investment, to try to reduce the large number of constraints (seventeen) to a smaller group, reflecting firms' attitudes to different dimensions of their environment. This analysis strongly suggested that a range of political and social issues - including labour regulation, crime, taxation, and uncertainty over economic policy - should be combined into a single 'factor'. Other factors were also identified, one grouping issues in the macroeconomic environment, including interest rates, exchange rates and the level of aggregate demand, and another combining issues arising from financial and product markets, such as market competition or lack of access to finance. These factors (or groups of investment obstacles) were independent of each other, in other words, could be clearly distinguished from each other in terms of their negative impact on investment decisions.

The socio-political factor was by far the dominant dimension in constituting investment confidence. In the analysis of the survey data, property rights concerns, expressed as the socio-political dimension of confidence, turned out to have a statistically significant influence on firms' investment rates, a result which held across the sector and size class of the firm and across race of firm ownership/management. This finding should be interpreted in light of the strong levels of business confidence indices at the time of the survey (as discussed above).

Recognising that statistical data are open to alternative interpretation, my own view is that this socio-political factor reflects firms' 'insecurity over property rights'. Property rights are often taken to mean the ownership rights of individuals and firms over their assets or over their labour, with fragile or insecure property rights reflecting perceived or actual threats of loss of ownership of assets via expropriation. But a more general interpretation of property rights, more appropriate to South African circumstances, is that it involves not just ownership of assets, but adequate control over returns to assets, in other words, claims on the future distribution of income generated by assets. On this basis, property rights are inadequately protected if contract enforcement is weak (for example, in several east European states), but also if there is a possibility of economic policy shifts which would result in far-reaching changes in the income distribution regime. Secure property rights have historically been one of the keys to economic growth, since it stands to reason that entrepreneurs do not have an incentive to invest or innovate if they are uncertain about their claims on future returns from the operation of the assets they have purchased and installed.

What underlies firms' insecurity over property rights? I would argue that this insecurity goes beyond simply being a reaction to statements by the President or other government officials, since the period during which firms were surveyed was marked by an absence of explicit tensions over social and political issues which developed between business and government later in 2000. Rather, firms do not feel they have sufficient control over the distribution of the returns to their operations as a result of the economic polarisation in the society - this latter feature is the fundamental source of property rights insecurity. Polarisation is reflected in the highly unequal distribution of wealth and incomes in South Africa, which hardly needs elaboration here. The Gini coefficient, for which South Africa has amongst the world's highest is a good proxy for economic polarisation in a society. This increases the risk of firm losses through private criminal acts against the firm assets, owners or employees.

More fundamentally, polarisation increases the (perceived) risks of far-reaching shifts in economic policy - to the tax or input regulation regimes, for example - which could significantly reduce firms' claims on returns to their operations. The issue is not firms' attitudes per se to government, but their concern that government will be overwhelmed by (or choose to respond positively to) 'popular' demands for redistribution. Occasional statements by senior government or governing party officials provide credence to the fear of major policy reversal, which in turn underpins the volatility of the investor community's 'mood'.

Polarisation means that improved distribution is a political imperative for government, at least in the medium to long term. This makes it more difficult for government to commit credibly to an economic policy framework which does not ensure redistribution, or in other words, firms are less likely to believe that 'the rules of the game' are settled for the long-term if these rules do not credibly address inequality and polarisation in the society. These insecurities have been strongly reinforced by the heated and long-running debate over economic policy, particularly over GEAR, within the governing party and its allies. This debate was fuelled by government adopting a stance before its announcement that the policy was 'non-negotiable', and then refusing to reconsider this position, notwithstanding the strong evidence that broadening support amongst domestic constituencies for macroeconomic policy would yield substantial net benefits, in terms of the policy's credibility.

It is important to underline that the relationship between insecure property rights and low investor confidence is neither surprising nor unique to South Africa. These two features, and their relationship, are commonly found in societies which are highly distributionally polarised. The World Bank recently analysed the relation between polarisation and growth across a large sample of more than 60 countries. They concluded that "insecure property and contractual rights can affect growth directly, by influencing the choice of production process and the efficiency with which production is carried out, [and] by reducing incentives to invest." (Knack & Keefer, 2000, emphasis added) If societies have also experienced recent democratic transitions, as South Africa has, demands for greater equality have been able to obtain political expression, thereby raising the probability of a major policy reversal. Such a reversal is likely to be perceived by firms as raising their risks, and the response in turn will likely be lowered investment rates.

In other words, South African firms' reluctance to invest is less an expression of a lack of 'patriotism' or of racism (white-owned firms reacting negatively to a predominantly black government), as some commentators have suggested, than it is a rational response (from the perspective of risk-averse firms) to the fundamentally transformed balance of power in the politics of the 'new South Africa'.

What must be done to improve investment performance? The standard policy measures to raise investment rates involve either trying to raise aggregate or sectoral demand through macroeconomic policy or directed government spending programmes or trying to enhance firm profitability through tax policy and subsidies. The Office of the President Investment Study suggests that such interventions will make a significant difference to investment rates, only if the underlying confidence issues are addressed also. What is needed is to increase security over property rights by mitigating firms' risks, firstly that government policy and regulatory regimes might shift substantially in the future, and secondly that firm property and employees face threats from crime and illegal activity.

The Survey data can not offer clear guidance on how to achieve this reduction in risk, of course. But if it is correct to argue that economic polarisation is the underlying cause of property rights insecurity, then it follows that enhancing property rights security will require a credible policy framework for addressing redistribution in the economy. By actively addressing the latent and actual demand for more equal distribution in the society, investors will have less need for anxiety about this demand spilling over into far-reaching policy shifts and more certainty about claims on their future incomes.

What features of a redistribution framework would make it credible? The first and most important is, as already implied, that it reflects a social consensus and has wide and explicit support across the society, including, but obviously not restricted to, support from business. The debate over distribution needs to be shifted from fundamental paradigmatic differences to focus instead upon differences about scope, speed and scale.

Secondly, and consequent upon the need for a broad-based consensus, a credible framework would require shifting the principles underlying redistribution away from their present focus on a zero-sum, 'winner takes all' game over current income levels, towards a positive-sum game leading to a more equitable distribution of wealth, or income-earning assets. The concern to raise current incomes provides incentives for groups to try to increase their shares of income at the expense of other groups, and to try to build political support for a bigger share of transfers out of current income. By shifting the focus to assets - such as skills and 'human capital' (the most essential), housing, land and infrastructure - groups would by contrast face incentives to contribute to overall growth so as to acquire rising income streams into the future. Such a shift to a growth, rather than current income, perspective would be a clear signal to firms that their own claim on the future returns on their assets was not threatened.

Thirdly, and again consequent upon the previous point, a credible framework would have to produce some degree of success relatively quickly. This will require more far-reaching measures to achieve equity in asset distribution than have been considered during the past 7 years. An example of this would be the immediate transfer to long-term occupants of all government-owned housing stock older than some threshold. As important, it will require rapid improvements in policy implementation ('service delivery') in areas such as education, health, housing and household infrastructure, all of which are essential to enhancing human capital. The link between improvements in service delivery to low income and poor citizens and improvements in fixed investor confidence is clearly essential to the positive-sum dimension of the approach. If this link can be brought more explicitly into the policy debate, it is potentially important in building broad consensus.

Fourthly, a credible framework would have to maintain macroeconomic stability. Particularly in an internationally open economy, premature or overly rapid relaxation of fiscal or monetary policy can lead to a macroeconomic shock which would greatly slow down efforts to improve distributional equity. At the same time, too contractionary a stance will also hold back greater equity. It is also worth underlining that the impact of macroeconomic shocks is greatly mitigated in situations where distributional conflict is well-managed, so that a credible and effective framework for addressing distribution would produce additional benefits at the macroeconomic level, over and above the intended impact on fixed investment.

Appendix 3:
Business Map
Submission to Parliament's Finance Portfolio Committee on the 2001/2002 Budget

Introduction
Chairpersons, honourable members of the Portfolio Committee, we are grateful to have been invited to present a submission on this year's Budget. We view the Budget as a remarkably important public document - it effectively steers the economy towards a set of goals, and as the Minister of Finance indicated in his Budget speech last week, it determines the fruits of liberation that we, and future generations, might enjoy.

In this submission, we wish to both commend the progress made by the National Treasury in its great strides to develop the budgetary process, and to make suggestions around key areas where we feel, from our discussions with investors and other stakeholders, further progress is needed.

These areas relate to:
· Further deepening of democratic involvement in the budget process,
· Greater focus on furthering social development, and
· Improving the general business environment.

A good foundation
It is undisputed that great accomplishments have been made under South Africa's new government in stabilising our macroeconomic position. We have noted, from speaking to investors, the great confidence that exists in our macro-economic policy. We achieved a rating of over 70% in this area in our latest Country Risk Rating, when we quizzed investors on their views of key variables that they consider in reviewing a country's suitability for investment. This year's budget will almost certainly further encourage two other key areas that we interrogate - privatisation (as an indicator of both opportunities and commitment to opening up the economy), and infrastructure.

Furthermore, specific indicators that investors consider in their estimation of our economy that have been strengthened by the latest budget include:
· Growth prospects - now comparable to those of developed economies at 3%,
· The deficit to GDP ratio, where dividends from fiscal discipline are obvious at a projected 2.4% for this fiscal year,
· Reduced debt services costs to 5.1% for 2001/02, declining even further over the medium term,
· Contained inflation rates, with CPIX measuring 7.7% last year, and
· Boosted revenue from the restructuring of state assets providing a much-needed boost to perceptions surrounding government's commitment to this area.

The process of the Budget itself has made great strides too. In particular:
· Greater transparency and predictability has been afforded by medium term budgeting and the release of the Medium Term Budget Policy Statement prior to the Budget, and
· The measurable outputs included in the Estimates of National Expenditure Survey, allow for greater accountability of government organs in meeting their delivery targets - a critical innovation to ensure that budgetary allocations are translated into meaningful spending.

Further procedural improvements
Despite this considerable progress, transformation is necessarily a long and complex process and it is important that the Budget takes further steps to improve its meaningfulness for all South Africans. We wish to submit that the process requires greater levels of parliamentary participation before its finalisation.

We suggest the following:
· That hearings such as these precede the Budget so that major objections or suggestions can be conveyed and debated,
· That parliament calls for greater assistance and advice from the Financial and Fiscal Commission (FFC) - a body dedicated to serve parliamentarians in negotiating complex policy surrounding budgets and other financial issues.

Were such a process deepened - and we recognise that it would need to be tempered by deadlines and not be overly swayed by interest groups - we feel that allocations would better reflect the needs of South Africans. As an example, we feel that the size of the arms procurement deal may have been smaller.

Pivoting the budget even further around citizens' needs
Although tremendous progress has been made in shifting budgetary spending to the needs of the majority of South Africa's citizens, we feel that this value is not fully entrenched in the details of the budget, and this is why we urge greater democratic participation.

In particular we are concerned, as are other stakeholders, that spending on defence has too high an opportunity cost for human development. We note with concern that allocations for defence rise over the medium term, from R13.8bn last year to R15.8bn this year, and R16.8bn in 2002/2003 - an escalation that might have been mitigated had the hedging procedures of the now R43.7bn procurement deal been more closely scrutinised. As COSATU noted, it is a worrying signal that defence spending is growing at a faster rate than the overall budget (by 14%, or 8% in real terms against 2.4%).

We note, however, with enthusiasm:
· Tax relief afforded to lower and middle income earners,
· Zero rating of paraffin,
· Increased education and criminal justice spending by R10bn and R4bn, respectively,
· The introduction of key performance indicators to encourage a focus on the quality and not just quantity of budget spending, and
· Consideration of the incidence of budgetary spending.

We recognise that these and other innovations and improvements have occurred despite the onerous fiscal constraints placed on policy makers, but feel that they still need to go further. We have two particular areas of suggestion, namely that:
· Greater injections are seen in our social welfare system, especially in light of the burden that fiscal discipline and economic restructuring has placed on South Africans, and
· Discrete funds become a secondary consideration for government departments in addressing key social areas such as HIV/Aids and poverty alleviation.

The focus of social spending needs to shift to the core of departmental budgets - we do not view discretionary funds, such as the poverty alleviation fund, as sufficient, or even desirable. From what we have observed, they have a tendency to distract administrators' attention by lobbying for funding for discrete projects, when core activities have not yet been mastered, and consultants' fees can dilute the benefits of their delivery. Furthermore, these funds are often under-spent or not fully utilised, defeating their intended ends. We would like to see, for instance, evidence of a positive impact of the Umsobomvu fund, intended to impact on unemployment with its almost R1bn's worth of capital

We suggest that the thrust of every policy targeting, or at least, considering, poverty and unemployment - key obstacles to South Africa's growth and development. We do not feel, for instance, that the R410m of the R1.5bn poverty relief grant to deliver improved water and sanitation is the correct intervention. What is needed over the long term is the Department of Water Affairs and Forestry, along with local government's focus on addressing basic water and sanitation needs across the country, and as a matter of urgency in areas afflicted with cholera - with funding reflecting this priority (according to the Budget Review, capital grants to local government for infrastructure programmes grow by only 6.6% over the medium term expenditure period). We fear that a discrete fund sends the wrong message to players in this area - that a tremendous challenge is being dealt with by what should essentially be a pilot project.

We are therefore distressed to see a reduction, or only small increases, in key forms of social assistance, namely:
· Pension funds's R30 increase to R570 (at par with inflation),
· The child support grant's R10 addition to R110 (slightly over inflation),
· Housing allocations marginal rise from R3.7bn this year to R3.9bn and R4bn over the next two (national department allocations),
· Health's decline in real terms from R6.6bn this year to R6.7bn next year (national department allocations), despite the greater incidence of HIV/Aids, and
· A drop of 5% in land reform allocations, with a 28% cut for restitutions.

Supporting investors
We are heartened by increased expenditure on economic services and infrastructure developments. Along with skills development, these are key areas of concern for investors seeking a competitive advantage in the location of their enterprises. This generally facilitating environment is critical to create the jobs needed to ensure that freedom does in deed bear sweet fruits.

However, the criticism we hear from business is that the general business environment continues to need support, such as a further cut in the corporate tax rate, and that discrete interventions such as the R3bn allocated for industrial projects should only be implemented once the overall restructuring of government is accomplished and core services, such as the processing of work permits, are streamlined.

Without details, we cannot judge whether the R3bn incentives for industrial projects are worth their opportunity costs (for as the Minister noted, the process of budgeting requires a fine balancing act between key priorities). Experience in other developing countries has demonstrated the importance of assisting certain sectors, but in this regard the thrust towards improved infrastructure and skills development should play a crucial role. We are concerned that the track record in administering discrete fiscal interventions, like tax holidays, has demonstrated that the capacity is not yet in place to attempt to determine the best channel for investment, or even to expend full allocations.

We also wish to raise two points of particular concern for those finalising the incentive package:
· We would discourage allowing those enterprises participating in industrial off-set programmes, who are already benefiting from the arms procurement deal, to gain a second set of incentives from this package, and
· We would like to see "industrial" apply to typically non-industrial, but important strategic and employment generating sectors such as services as IT.

Furthermore, we are concerned that incentives do not encourage the establishment of unsustainable ventures. Wage incentives need to be particularly careful in this regard, after bitter experience under apartheid's decentralisation programme, they can create no more than a window for opportunists to take advantage of an incentive only while it is in place, retrenching workers when it is dropped. We have also heard the question why the skills training levy is not lowered for labour creating or small enterprises instead of a wage incentive, to promote the same critical end of job creation.

Conclusion
We submit therefore that this very sound budget and its recent predecessors have made tremendous progress, but that further advances are required. We wish to caution the National Treasury to consider the impact of discrete incentives on both national departments in delivery social services and on economic players making investment decisions, especially when we are still undergoing the fragile process of institutional transformation. And we encourage systems that would allow other stakeholders to engage in debates such as these.