Budget 2006: Meeting with Panel of Economists

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Finance Standing Committee

06 March 2006
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Meeting report

FINANCE PORTFOLIO COMMITTEE; JOINT BUDGET COMMITTEE: JOINT MEETING
7 March 2006
BUDGET 2006: MEETING WITH PANEL OF ECONOMISTS

Chairpersons
: Mr N Nene (ANC) [PC Finance]; Ms L Mabe (ANC) [Joint Budget]

Relevant documents
University of Stellenbosch briefing
Trends in poverty and inequality since the political transition by van der Berg et al (2005)
SANLAM briefing
Bureau for Economic Research briefing
National Treasury Presentation on Additional Adjustments Appropriation Bill
Additional Adjustments Appropriation Bill (2005/06 Financial Year) [B4-2006]

SUMMARY
The University of Stellenbosch presentation focused on the efficiency of social spending since 1994. Research by economists at the University of Stellenbosch had concluded that after 2000 there has been a clear decline in poverty in South Africa due to a massive increase in grant spending and better economic performance. Well targeted public spending shifts had delivered "hard" services on an unprecedented scale: 1.6 million houses, Water for 17.3 million, Sanitation for 6.7 million, 3.8 million electricity connections, 700+ clinics built. However other social outcomes such as health and education had hardly improved, due to problems of service quality and resource use. Further, although grants reduce poverty, one cannot eliminate poverty through the grant system. For that jobs were needed.

The economist from Sanlam welcomed the strengths in the economy, and highlighted some of the record highs in performance. There was however the need for a cautious approach to the country’s macro-economic and fiscal policy, and some areas for improvement were identified. It outlined the steps that could be taken to properly and effectively manage these risks to the economy. The Bureau for Economic Research briefing sketched the background to the Budget 2006 in view of recent South African economic developments and macro-economic forecasts. It also provided the macro-economic forecasts for GDP, inflation and the exchange rate over the MTEF by various bodies and outlined both general and fiscal variables for macro-economic policy aspects relating to the Budget.

During the discussion Members posed questions on the fact that well qualified educators tended to be located in the better resourced schools, government spending on social grants, the reasons for the poor performance of schools in black areas and poorer citizens' utilisation of the public health sector, government’s policy of cutting the personal tax rate, corporate tax cuts, whether government’s research and development incentive would improve the struggling manufacturing sector, and the impact of lack of skills, HIV/AIDS, the low national savings rate and the Accelerated Shared Growth Initiative on economic growth.

The Committee adopted the Additional Adjustments Appropriation Bill. This granted the he additional unforeseeable and unavoidable expenses of R2 billion to Denel for its recapitalisation and restructuring activities, and R2,7 billion to the Road Accident Fund for scheduled payments to successful claimants, and to extinguish an overdue payment to the South African Revenue Service.

MINUTES
Briefing by University of Stellenbosch

Prof Servaas van der Berg, Faculty of Economic and Management Sciences, focused on the efficiency of social spending particularly in recent years. He noted that although there had been improved economic performance and social grants had reduced poverty, too few jobs had been created. Other social outcomes such as health and education had hardly improved, due to problems of service quality and resource use. The actual targeting of social spending was analysed. He outlined government’s social spending but noted the limitations of incidence analysis as fiscal resource shifts do not necessarily reflect real resource shifts nor does it reflect service quality. There needed to be a shift in outcomes, not resources.

He illustrated the point by focusing on social delivery in school education. After evaluating the actual outcomes of school education in other African countries which were poorer than South Africa, he stated that the reason for poor performance outcomes of black matriculants in the South African school education system was not due to lack of resources, but instead the manner in which the resources were used. The cause, in the South African context, was problems with education service quality and resource use.

Discussion
The Chair thanked Prof van der Berg for the insightful presentation. He asked if the reason they had used data only up to 2003 was because updated information was unavailable.

Prof van der Berg replied that he had not yet worked on the 2004 and 2005 data sets, but assured Members that the picture did not differ much from year to year.

The Chair asked for Prof van der Berg's views on the allocation of resources in the current budget, as a response to the issues raised in his presentation.

Prof van der Berg responded that the international debate centred on whether the resources should be distributed on educators or on learning material, such as textbooks. He shared the view of those who believed that the funds would be better spent on learning material, because it empowered educators as well as children in poorly functioning schools.

Mr K Moloto (ANC) noted that the presentation failed to mention user fees, and he asked Prof van der Berg to indicate the extent to which they prevent the poor from accessing services.

Prof van der Berg replied that user fees could to some extent be a restriction, but the statement must be contextualised. In most schools these fees amounted to less than R100 a year, yet the real cost of education was not these user fees but rather uniforms and books. There was also the Child Support Grant (CSG) which amounted to about R2 000 per year, which was used to pay those fees. He stated that user fees were thus not the real restriction on underprivileged children in the poorer schools, but it could very well be a restriction on underprivileged learners who move on to better resourced schools that have higher school fees.

Mr Moloto sought clarity on the statement made in the presentation that, when comparing South Africa relative to other African countries, Prof van der Berg concluded that the well qualified and well paid educators tended to be located in the better resourced provinces.

Prof van der Berg replied that his studies indicated that South African educators were better qualified than educators in most other African countries. Those educators commanded more pay because the country had more fiscal resources. Generally speaking, South African learners were not as poor as those countries but, despite that, they were performing significantly worse than learners in those countries. This was especially true of South African matriculants.

Dr S Van Dyk (DA) noted the professor's comment that government should look into the long-term efficacy of social grants because, as his studies indicated, they were not a long term solution to eradicating poverty. He asked when that stage would be reached.

Prof van der Berg responded that the social grant had probably gone as far as it could go, in terms of the structure and threshold. He predicted an increase in grant spending over the next few years, due to the fact that people who had applied in the past were only now becoming eligible and receiving their payments. Whether government decided to rethink the purpose and long-term efficiency of social grants over the next ten years, was another issue.

Mr B Mnguni (ANC) noted the professor's comment that the provision of jobs did not immediately reduce the dependency ratio for state assistance. He sought clarity on the time lag involved in the professor’s studies.

Prof van der Berg replied that it would depend on the number of jobs created. A survey conducted in 2005 indicated that approximately 600 000 jobs were created each year, and if those figures were maintained then government would soon "eat into the unemployed" and begin to empower its citizens. The primary factor was thus not the number of jobs created per se, but rather the consistent growth of economy which was necessary to create those jobs.

Mr Mnguni sought clarity on the reasons for the under-performance of black schools because, over the past ten years, significant resources had been shifted to them to improve capacity. He asked if the professor was of the view that it was the quality of the teaching in those schools that was the problem and, if so, what did he propose be done to address the matter.

Prof van der Berg responded that it was difficult to improve the quality of teaching once educators were already operating in schools. It was a problem that required large numbers of properly trained educators. The current complement of active educators was diminishing due to factors such as HIV/AIDS and educators leaving the profession. This left large-scale gaps that needed to be filled. The quality of teaching in South Africa remained a problem.

He continued that there were three primary reasons why schools under-performed. The first was a lack of good management, which ensured discipline amongst both educators and learners. He found that this was most lacking. The second issue was the lack of proper incentives for educators. It was however very difficult to use a positive incentive system for the teaching profession because one could not properly assess which educators were good and which were not performing to standard. He believed in the use of incentives, but acknowledged that there would be times when the stick would have to be used if the carrot did not work. One of the major factors here was that the Apartheid regime had stripped the education inspectorate of all its legitimacy.

The third reason was lack of accountability, which meant that there was an urgent need for more information on what exactly was happening and being done in the South African schools system. At the moment there was only adequate information at the matric level, but there was no information on the rest of the grades. Prof van der Berg believed that government should be systematically testing whether South African learners were in fact learning enough, as was currently being done by the Western Cape Education Department. A study found that, on average, more than half of all South African Grade 6 learners were more than 3.5 years behind in terms of their comprehension of mathematics. This did not necessarily mean that they needed to repeat a year. However it did highlight the urgent need to gather sufficient information on the earlier grades so that government could react to the problems earlier.

Mr I Davidson (DA) referred to the presentation slide dealing with utilisation of public and private health facilities per wealth quintile. It appeared that those in the poorer quintiles were not happy with the public health sector, yet they were unable to afford the private health services. If that was the case, it seemed that they were then not accessing any health services at all. He asked the professor to indicate why they had a negative perception of the public health system.

Secondly, the same could be said of the schooling system. If there had been a redistribution of resources to underprivileged schools, why was there a persistent lack of quality in schools in the previous black areas despite that extra allocation of resources

Prof van der Berg replied that it was an international norm that poorer citizens used health services far less than more wealthy citizens did. Secondly, many of the poorer citizens preferred self-treatment or natural healers. The fact of the matter was that most poorer citizens avoided State health services. Studies indicated that people generally had a negative image of the quality of care given by the public health system. They were made to endure long queues and unsatisfactory treatment. Government should test those perceptions because it was so difficult to measure the outcomes of the public health system. It was however possible to measure people’s perception of that system and whether it was meeting their requirements.

Ms J Fubbs (ANC) referred to the slide entitled "Matriculants by performance, 2003" and asked when precisely the drop out rate began to occur.

Prof van der Berg responded that the drop out rate seemed to indicate that virtually every learner up to the age of 16 was still in school. The problem however was that many learners dropped out before that age, and they could thus be a grade or two behind at age 16. There were also region-specific patterns and trends that played a role. In the Western Cape, for example, learners in the coloured communities tended to drop out at a younger age, as opposed to black learners. This was because they may have links to the labour market at that age, which enticed them to leave the schooling system and enter the labour market at an early age to get a head start.

Ms Fubbs expressed concern at the low quality of the matric pass rate of black learners. She asked whether it meant that the quality of education in South Africa was poor from Grade 1 or did the quality deterioration began in high school.

Prof van der Berg replied that his study had focused on the matric pass rate alone. The current problems with the poor matric pass rate of black learners went back to earlier grades, and those root causes had not changed since the transition in 1994. There was currently no evidence that suggested that the South African school system as a whole was improving. This was a serious cause for concern because the effect of poor education lasted for many generations.

Mr Y Bamjee (ANC) stated that the presentation was interesting, but contained a number of limitations. It should have included data up to 2006.

Prof van der Berg responded that that would not have changed the overall picture.

Mr Bhamjee stated that the fact that English was by and large the language of instruction in South African schools meant that most black learners struggled to understand the concepts in subjects such as mathematics. This could very well contribute to their low pass rate in that subject.

Secondly, he reminded Prof van der Berg that South Africa's democracy was only 11 years old, and it was thus not entirely fair to compare it to other countries that have been functioning as a democracy for many decades.

Prof van der Berg agreed that the language barrier was an issue, but stated that it was an issue in all countries on the African continent. In fact it could be argued that South African learners were exposed to English much more than learners in, for example, Tanzania. There was a language factor, but even that did not explain the large disparity between the results of black South African learners and other racial groups.

Mr T Vezi (IFP) offered an alternative view for black South Africans not being interested in taking advantage of the free services offered by the public health system. He argued that it was due to the pride of black South Africans, especially Africans, which precluded them from accepting hand-outs. He emphasised that this view was based on his own observations.

Prof van der Berg replied that even that said something about the faith held in public health service, which a serious issue. He reiterated his earlier point that there was an urgent need for user surveys on the performance of both the public and private health sectors.

Mr Vezi referred to the statement made in the presentation that not much housing was being developed in the poorer rural areas. The reason was that there were no informal settlements in rural areas, as they all resided in the urban areas because people left the rural areas for the greener pastures in the urban areas, only for that dream to remain unrealised. It was probably for that reason that government focused its housing funding on urban areas.

Prof van der Berg responded that even so, the funding was targeted at the poor and underprivileged.

Mr Vezi stated that he knew of schools that were 100% white and now had 100% blacks learners, and the white learners all moved to private schools and so did the highly qualified educators. He asked how that phenomenon could be remedied.

Prof van der Berg replied that it was clear that race continued to play a role in the South African context. It was also an international phenomenon that more qualified educators tended to avoid the poorer schools, where it was more difficult to teach. This was a problem that government would have in many schools, especially those in the rural areas.

Briefing by Sanlam
Mr Jac Laubscher, Group Economist, noted the remarkable growth rate which would grow to marginally over 5% by the end of the year. Real share prices were at record level, house prices in nominal and real terms were the highest they have ever been, CPI inflation was currently at its lowest since 1970 and the long term bond yield was at its lowest since 1979. There were record inflows into the economy unlike anything experienced before, South Africa was enjoying its smallest budget deficit since 1981 and its international credit-rating had just been upgraded.

A cautious approach to the country’s macro-economic and fiscal policy was however necessary, as stated by the Deputy President and the Minister of Finance. The reasons included the following:
- the economy had the largest deficit on its current account since 1983;
- the manufacturing sector was struggling;
- household consumption alone could not be relied on to drive growth;
- the household savings rate was at its lowest since 1952 and household debt was at its highest level ever;
- the national savings rate was at its lowest since 1949.

There was thus a need to look at the risk of economy and so that it could be managed carefully, and he outlined the steps that could be taken to properly and effectively manage that risk. This would essentially result in change in the fiscal stance.

The Chair thanked Mr Laubscher for the thought-provoking presentation. It was agreed that the Bureau for Economic Research present immediately followed by questions on both presentations.

Briefing by Bureau for Economic Research
Prof Smit, BER Director, outlined the economic background to the Budget 2006 in view of recent South African economic developments and macro-economic forecasts. These included the fact that the business confidence index was at a 24 year high, consumer confidence was at an historic high, inflation was currently at the middle of the targeted range and Gross Domestic Product (GDP) growth since 1994 has been at its longest upswing in recent history and no downswing was expected. He provided the macro-economic forecasts for GDP, inflation and the exchange rate over the Medium Term Expenditure Framework (MTEF) by various bodies. He also outlined both general and fiscal variables for macro-economic policy aspects relating to the Budget.

Discussion
Mr Mnguni asked whether government’s tax relief policy of cutting the personal tax rate was the correct choice.

Prof Smit replied that 57% of the Budget was allocated to social spending, which would increase by 11,5% per year for the next five years. He was of the view that personal tax cuts were essential. Broadly speaking the South African personal tax structure needed substantial restructuring, which was what had been happening over last five years. He had no doubt that tax cuts were required, rather than increasing social spending.

Mr Mnguni stated that tax cuts have been introduced consistently over the past few years and service delivery had not improved, yet the BER was now calling for a cut in corporate tax as well. He asked whether that tax cut would assist domestic companies that sought to invest offshore. Secondly, he sought clarity on the impact of the level of savings on macro-economic stability.

Prof Smit responded that that referred to unbalanced growth which had resulted in the balance of payments moving to a R65 billion deficit, which was a natural result of a stronger moving currency.

Mr S Dithebe (ANC) referred to the government incentives aimed at boosting expenditure on research and development, and its link with improving the performance of the manufacturing sector. Given that incentive, he asked how long it would take for that incentive to have a direct impact on the manufacturing sector.

Mr Laubscher replied that innovation played an important role and research and development was a manifestation of innovation. For that reason government’s incentives were welcomed. He was unfortunately not sure how long it would take. Tax incentives would help, but innovation could not always be encouraged via incentives. It would be better to create a better culture of entrepreneurship for all sectors.

Mr Dithebe noted that the Budget Review indicated that VAT was not paid on municipal property rates, which amounted to a benefit of R1 million to municipalities. He asked whether that meant that it was the residents themselves who did not pay VAT.

Mr Laubscher responded that that question would best be answered by the accountants.

Mr Vezi stated that much criticism had been levelled against National Treasury for failing to do enough to reduce corporate tax. Its defence was that the international ‘investors’ had confessed to using South Africa as springboard to invest in other African countries, the result being that the funds were merely in transit in South Africa and were not meant for investment in South Africa itself. He sought comments on this.

Mr Laubscher replied that, as mentioned in his presentation, he believed there was a need for a better informed debate on the status and feasibility of corporate tax in South Africa. Both National Treasury and the business sector was guilty of being much too simplistic on this matter. He doubted whether lower corporate tax rates would encourage investors to invest offshore, because the international principle was that a lower tax environment was regarded as attractive for both domestic and foreign direct investment. He agreed that there were many companies that used South Africa as a springboard, but even so they would still have to set up operations in South Africa and the economy would benefit from that capital flow. He reiterated that a proper debate on corporate tax cuts was needed.

Dr Van Dyk noted that Mr Laubscher’s presentation did not refer to the impact of the undisciplined actions of labour unions on the market, as possible risk factors.

Mr Laubscher responded that his presentation dealt with the Budget and for that reason he had not referred to labour policy because he did not believe that the budget could do much about labour policy. His presentation focused on international risks, because he believed those were the greatest risks to the economy. Land reform needed to be removed from the agenda, and government did have the resources to deal with it once and for all.

He called on government to move as quickly as possible to scrap all currency controls. His reason was that the volatility in the Rand was to be found in the fact that government had relaxed exchange controls on foreigners and residents in an uneven manner. As a direct result trading in the Rand largely moved offshore and was now managed by foreigners. Local institutions, companies and individuals must become more active in managing our currency. This could be achieved by relaxing the current impositions on southern African countries.

Ms Fubbs stated that the skills risk was an important issue, and sought clarity on the impact of skills constraint on both economic growth and asset-based growth.

Mr Laubscher replied that the second last slide contains the challenges identified by Minister Manual himself because government acknowledged that, along with infrastructure backlogs, skills shortages were generally regarded as the biggest constraint on economic growth. The skills required, especially in the education system, was not really a matter of money, because there was not much more funding that government needed to provide. The real problem was the performance of the education system itself, as argued by Prof van der Berg.

Secondly, he stated that there was a phenomenon referred to by the South African Reserve Bank as "asset backed lending", which entailed extending loans to individuals to buy assets such as a house. He believed that much of the "asset backed lending" ended up merely in consumption, rather than people buying physical assets. It was true that most South Africans in the past could not accumulate assets, and the big challenge facing government at the moment was not to allow people to take on more debt. Instead their existing assets must be freed up to allow them to access the equity they have on existing assets, such as their homes. This was a challenge for the financial sector.

Mr Bhamjee asked Prof Smit to elaborate on the impact of HIV/AIDS on the economy.

Prof Smit responded that studies have shown that by 2020 the population will be 15% less than if it were not affected by HIV/AIDS. In turn the labour force would be 18% lower than it would have been without HIV/AIDS, that growth would be affected by approximately 0.5% per year and that inflation would be 1% higher. Employment would have been about 0.33% lower growth than it would have been without HIV/AIDS, but of course there would be substantially fewer people that needed jobs. These were clear indications that there was a good economic case to be made for government to roll-out a large-scale ARV programme.

Mr Bhamjee asked whether there was such a thing as a "patriotic bourgeois class" and, if it existed, how effective it would be as a check on capital flight.

Mr Laubscher replied that it was ironic that South Africa wanted its own business sector to be patriotic and invest locally, yet it also wanted the foreign business sectors to behave unpatriotically and invest in South Africa. The fact of the matter was that, at the moment, South Africa was receiving more foreign investment than investments it was making offshore. If all countries were to adopt a patriotic approach, South Africa would actually lose out. He cautioned against viewing businesses who invest offshore as being simply unpatriotic, as they would only invest offshore if it was worth their while. There were in fact quite a few examples of South African companies that acquired foreign companies and invested offshore, but ended up burning their fingers. He stated that South Africa must instead make it as attractive as possible for all businesses to invest in South Africa, whether domestic or foreign.

Mr Gabela stated that there was general agreement that government had a consistent expansionary budgetary policy. Over the past five years the national savings rate has declined, but there was also growth in the economy in the region of 2%. He asked why it would then be overoptimistic to target a 6% growth rate, because it appeared to him that economic growth and the national savings rate were mutually exclusive.

Prof Smit responded that there must be savings in order to finance an investment, and a high investment rate was needed in order to maintain a high growth rate over a long period. South Africa’s investment rate was currently 17% and the savings rate was 13%, and the 4% difference came from foreign capital. Thus as long as South Africa had foreign capital, it would be able to make up the gap. If however that gap increased, it would place serious pressure on government to secure foreign capital. He believed that if the economy grew at a rapid pace, the growth rate would improve and savings would improve as part of that as well. Consequently, reliance on foreign investment would then decrease.

Mr Gabela asked one of the presenters to explain why tariffs were not considered.

Prof Smit replied that South Africa had tried over the last fifteen years to conform with international standards on use of tariffs. It was thus dependent on international factors, and thus left very little scope for government to use it as a policy instrument.

Ms Mokoto noted the statement in the BER presentation that South Africa’s economic growth was unbalanced and biased in favour of commodities and capital inflows. She asked whether Prof Smit was of the view that the priorities set by the Accelerated Shared Growth Initiative of South Africa (ASGISA) would overcome that imbalance, and for how long it would be sustainable.

Prof Smit responded that he meant that much of the growth was on the demand side. The problem was this it was not supported by production, which caused an increase in imports. It was for that reason that the balance of payments became problematic.

He stated that, following the input by the Harvard University academics, ASGISA now focused government’s actions on removing constraints instead, which supported a more balanced growth going forward. ASGISA now followed a much more solid approach than it did at the outset.

Mr Bici sought an indication of the equity South Africans derived from economic growth and job creation. Secondly, he asked the presenters to indicate whether there was anything government should be doing to improve economic growth.

Prof Smit replied that the answer was very simple: more jobs were needed. Jobs were by far the best way to eradicate poverty and ensure growth in a country like South Africa..

Mr Laubscher agreed that jobs were needed, but it was true that the majority of jobs in the economy would be skilled jobs. Therefore people outside the job market must improve their skills and thus the improvement of the education system was vital.

Ms Mabe thanked the presenters for their input.

Additional Adjustment Appropriation Bill: briefing and adoption
Mr Neil Cole, Chief Director: National Budgets, stated that he would summarise the presentation, in the interests of time. He outlined the components to the adjustments budget, which contained the unforeseeable allocations that needed to be made to the National Department of Transport and the Department of Public Enterprises.

An amount of R2 billion would have to be transferred to the Department of Public Enterprises, which they would in turn hand over to Denel. The funds would be used to cover two activities undertaken by Denel, its recapitalisation and restructuring.. Without the rescue package, Denel would have had to be wound down, and that entire exercise would have cost the government R10 billion. It was thus considered financially prudent to allocate the unforeseen R2 billion.

The second allocation was the amount of R2,7 to the National Department of Transport, which it would then hand over to the Road Accident Fund (RAF). Due to the amendments effected to the RAF Act and the problems with its management structure, as well as the high number of road accidents, it required an additional unforeseen amount of R2,7 billion. The allocation would allow the RAF to discharge its scheduled payments to successful claimants, and to extinguish an overdue payment to the South African Revenue Service.

He concluded by assuring Members that both amounts qualified as unforeseeable and unavoidable in view of National Treasury. The result was that government’s projected deficit would now increase to 1,5%.

Discussion
Mr Nene and Mr Bhamjee sought clarity on the actual calculations involved in arriving at the total adjustment figure of a R1 billion increase, if R2 billion was being allocated to Denel and R2,7 billion to the RAF.

Mr Cole explained that the figures were explained on the slide entitled "Revised National Budget 2005/6". It reflected the savings made by government on the state debt cost, the national skills fund and other standard appropriations. If one set that total amount off against the R4,7 billion to be allocated to Denel and the RAF, then the net increase in total expenditure would be R1 billion.

Mr Bhamjee was still not on board and requested further clarity.

Mr Cole explained that the total adjusted appropriation for the 2005 budget was R417 billion but, because of increased expenditure and contingencies, if one nets it out it amounted to only R1 billion. It thus resulted in an increase from R417 billion to R418 billion.

Additional Adjustments Appropriation Bill: adoption
Mr Nene read the Committee Report on the Bill, to which members agreed. He noted that the Committee had adopted the Bill.

The meeting was adjourned.

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