International Growth Advisory Panel Seminar

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Finance Standing Committee

17 June 2008
Chairperson: Mr N Nene (ANC)
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Meeting Summary

The Portfolio Committee on Finance met with the International Growth Advisory Panel (IGAP) for a seminar on the findings of their research as well as to discuss the recommendations that arose from the reports generated. The National Treasury had commissioned the report in 2004 in an effort to identify the constraints to growth in South Africa. IGAP was asked to look at the internal consistency of the Accelerated Shared Growth Initiative of South Africa. The Panel presented four reports: a general overview of IGAP’s findings and recommendations, an evaluation of the unemployment and recommendations to alleviate unemployment, recommendations on tariff policies and an analysis of the impact of BEE and ways to make it more beneficial to South Africa.

The discussion session addressed all the recommendations. A Committee member pointed out that the proposed policies seemed very similar to International Monetary Fund policies on fiscal expansion. The Panel was asked where they differed from the International Monetary Fund, and what they would propose to the electorate in the upcoming election. The Committee wanted to know whether the broad or narrow definition of unemployment was used.  The Panel was asked to comment on capital deepening in manufacturing, a flexible approach to inflation targeting, an aggressively accumulating budget surplus, sustainability of recommendations and the other instruments that the central bank might use to stabilise the exchange rate. With regard to unemployment, the Committee asked if the recommendations had been put before COSATU and Nedlac. Several questions were posed in relation to growth. IGAP was asked how South Africa could achieve the rate of growth of China, given the vastly differing labour conditions in South Africa. The Panel was asked if the battle was lost on growth through redistribution. The Committee sought an assessment of agricultural opportunities and the binding constraints. The European Union’s historical advantage was pointed out in tariff policy and regional integration and the Panel was asked how South Africa could achieve the proposed growth trajectory with this implicit disadvantage. With regard to Black Economic Empowerment recommendations, the Committee asked what the risks were and how BEE constituted a tax on companies. The Panel was asked to explain its view of beneficiation as it differed from traditional comparative advantage theory. On a practical note the Committee wanted to know what government policies were proposed, how the Targeted Wage Subsidy would be implemented and how large the recommended Free Trade Areas would be.

Meeting report

International Growth Advisory Panel (IGAP) and Committee Seminar
The Portfolio Committee on Finance met with the International Growth Advisory Panel (also called the “Harvard Group”) to be briefed on the findings of their research as well as to discuss the recommendations that arose from the reports generated.

Mr Lesetja Kganyago, Director General: National Treasury, outlined the background to the report and recommendations. The National Treasury (NT) had commissioned the report in 2004 in an effort to identify the constraints to growth in South Africa. IGAP was asked to look at the internal consistency of the Accelerated Shared Growth Initiative of South Africa (ASGI-SA). The findings were underpinned by 19 widely available research papers, along with the recommendations. The NT felt that a national conversation was necessary on these matters.

The Chairperson made mention of the attendance of the other Committees in the cluster. He said that the recommendations were wide ranging and were of relevance to all present.

General Presentation on the Findings of the IGAP report
The general overview of the findings of the IGAP was presented by Professor Ricardo Hausmann, Chairperson: IGAP. The IGAP had had a very busy 2 years. He outlined the thoroughly international team on the Panel. The fundamental question put to the Panel in 2004 was what South Africa, after 10 years, had to show for the policies in place. The pre-2004 picture was summarised as showing disappointing growth. Unemployment had risen and inequality was on the rise. Since 2004, however, growth had risen, and unemployment had decreased. The widening current account deficit was a concern due to the increased consumer spending on imports and the accompanying increase in borrowing. Investment in non-tradeables had increased, but not in mining, manufacturing and agriculture. Foreign debt had accumulated along with the consumption of durables. The conclusion reached was that this growth was temporary and there was no long term growth strategy. This was to be the Panel’s basis for analysis.

A fresh look at the facts revealed that employment was remarkably low. The other countries in that group showed an average of a 50% higher employment rate. The unemployment represented South Africa’s unused productive potential. It was also problematic because there was almost full employment of highly skilled individuals and very low employment of unskilled individuals. It emerged that it was predominately blacks who were unemployed, which did not bode well for equality. From the race and age breakdowns, it became clear that any policy formulation needed to take into particular account benefits for the less educated, blacks, the young and women.

The tradeeable sector had been shedding the most jobs. There were absolute losses in manufacturing, mining and agriculture. These industries were less intensive in highly skilled individuals and employed mostly unskilled workers. As a result they would be the most beneficial to the economy. The Group reached the conclusion that South Africa had a skills mismatch. This mismatch was exacerbated by the type of growth in South Africa. It was effectively weighted against the unskilled and impacted on international competitiveness.

The implication of these findings was that traditional Keynes-ian policies would not work. The long term exports performance was dismal. South Africa showed performance comparable to its 1960s levels. This was a very unusual situation as most developing countries had done better. The lack of dynamism from the export sector was seriously retarding growth. The rapid decline in mining had the dual impact of more people being unemployed and a depleted resource endowment. This was not compensated for by manufacturing and agriculture.

The implication for the Panel was a need to identify the binding constraints. The heart of the matter was that South Africa needed growth in the tradeables sector. Exporting for jobs was the key. With its export dynamism,  South Africa could not achieve the ASGI-SA targets. Export jobs were harder to create and South Africa needed to compete with other countries. Such jobs were also needed to make the other jobs possible, and increasing export jobs would create a demand for other jobs.  The reverse was not true. Therefore, export jobs were the binding constraint. Good jobs (of any kind) were the key to shared growth. The binding constraint could be explained by the fact that it had been relatively unprofitable to invest in tradeables. Shared growth had also not been the only goal of government. An additional goal had been empowerment. With this in mind, there were trade-offs to be made. Virtuous circles could be found where these goals could be complementary. Integration was beneficial in attracting talent to the economy.

The Panel’s core suggestion was that South Africa should “increase the speed limit and drive the speed limit”. Prof Hausmann outlined the Panel’s proposals to relax the skills constraints. He also discussed the recommendations on the interplay between monetary policy and fiscal policy. He said a more competitive exchange rate would require higher domestic savings. The key to responding to external shocks and changes was a more stable exchange rate. The fiscal policy had to be set with a structural balance in mind to protect the stability of the Rand. This could be seen from the case of a comparable economy, Chile. The upshot was that monetary policy needed to pay more attention to the exchange rate.

Discussion
Prof B Turok (ANC) commented that the presentation was controversial and complex in places. He referred specifically to the idea that fiscal policy should be tighter and said that this was contrary to expansion. He made the observation that the recommendations were very similar to International Monetary Fund (IMF) policies. He said that it was precisely these types of policies that had created the current imbalance in the economy.

Prof Hausmann agreed that the goals were the same as the IMF. He said that fiscal policy had to be viewed in the context of the whole economy. He noted the rising current account deficit, which clearly pointed to consumption exceeding production, leading to excess demand. This demand was composed of spending focused on the output of skilled workers and this was the essential problem of the skills mismatch. Fiscal policy must be conscious of this. The competitiveness of unskilled workers should be as high as possible, and therefore expansion was necessary. In this scenario a tighter fiscal deficit was in line with growth, especially with the need to increase investment to aid electricity provision and transportation expansion.

Prof Turok referred to the general position that having a surplus in a developing country was nonsensical. South Africa needed to a more clear direction to pull the poor out of poverty. Export-led growth had not worked because the policies were inappropriate for a poor country. He asked what IGAP would propose to the electorate in next year's election, and whether IGAP could distinguish between their macroeconomic stance and that of the IMF.

Prof Hausmann responded that it was true that in this case the Panel was in agreement with the IMF, but the IMF was generally right in some cases and wrong in most. The Panel disagreed with IMF policies with regularity, but had come to this conclusion on the fiscal deficit, for different reasons.

Ms A Dreyer (DA) asked if the narrow or broad definition of employment was used. She said she got the impression that the narrow definition was used, as the broad one would have yielded a much bleaker picture.

Prof Hausmann replied that IGAP had used the narrow definition but added that the picture was equally bleak either way.

Mr K Moloto (ANC) asked what the Panel thought of South Africa's policy of capital deepening with regard to manufacturing. He asked about the proposed flexible approach to inflation targeting and the implication that the SA Reserve Bank (SARB) must intervene in the foreign exchange market. He took this to mean the SARB must trade in foreign currency. Assuming the SARB had a level in mind, he queried whether this would not be too costly to the economy.

Prof Hausmann responded that the member was correct on the point of capital deepening. The problem was that it increased the productivity of those already employed and caused shrinkages in the labour market. He said the only way to deal with this would be to have a competitive sector with expansions in total output, promoting larger growth. He used the oil rig repair project at Cape Town Harbour as an example. He said this was the kind of industry that would be beneficial and create thousands of jobs for unskilled workers. Biomass was another avenue for growth in agriculture. The focus here should be on capital deepening to create the right kind of jobs.

On flexible inflation targeting, Prof Hausmann reported that the Panel proposed that SARB should not constantly intervene in the foreign exchange market, but rather that it should have an arsenal of instruments at its disposal. These could include inflation targeting, changing debt composition and capital controls. The central bank should communicate its views to the market with the idea to inform and guide the market to respond favourably. He said it was difficult to stop the currency from weakening. Preventing appreciation of the currency was a far easier task. South Africa was still seen as risky due to Rand volatility. This attacked the engine of job creation. The Panel did not want inflation targeting to be abandoned. The credibility of the SARB had increased as result of this and they were managing a complex situation well. The appropriate fiscal policy should communicate a stable exchange rate and a monetary policy to ensure that.

Mr S Marais (DA) said that the budget surplus was accumulated aggressively and asked for the Panel’s comments on this. He remarked that at the recent conference of the World Bank, South Africa was regarded as the most expensive on labour costs, and he asked for comments.

Prof Hausmann considered the scenario where the fiscal surplus was spent. This would cause government spending to increase, which would lead to increased consumer spending, causing inflation to rise. There would thus be higher interest rates and a current account deficit, hence a stronger Rand. In the opposite scenario, where the economy slowed, the rationale had been that income would be lower and tax revenue would decrease, necessitating decreased government spending, and causing a decrease in consumer spending. He would suggest that government not increase spending in boom times to deliver a more stable rate evolution. From this point of view a fiscal surplus could be beneficial.

Mr S Dithebe (ANC) referred to the recommendations on job creation, specifically the probation period and the suggestion of dismissal at will. He said that the Congress of South African Trade Unions (COSATU) had indicated that it was vehemently opposed to this. He asked if the proposals had been put before COSATU or New Economic Development and Labour Council (Nedlac).

Prof Hausmann replied that there was a very high rate of unemployment among school leavers. He said that it was fundamental to accelerate that transition. The perception was that the risk attached to a school leaver was high. The recommendations were designed to cover all South Africans 18 years or older through a universal approach. The IGAP proposed a ten week trial period for inexperienced hires. IGAP had presented their findings to Nedlac on the previous day. The Panel was of the opinion that this was reasonable. COSATU was an important player and must be on board.

Mr N Singh (IFP) referred to the comparison with China and asked if the comparison was really valid and covered the same bases. He pointed to China’s poor labour conditions and asked how South Africa could be expected to accelerate growth in the same way when labour conditions were so different.

Prof Hausmann responded that South Africa did not have to compete on the same basis as China. China could be a very good customer and South Africa could have a very robust export arrangement with China. There were many things South Africa could do to improve competitiveness. The unemployed in South Africa had more education than the average Chinese employed worker. South Africa must deploy its capabilities better.

Mr M Johnson (ANC) referred to the findings on empowerment and shared growth. He asked if the battle was lost on growth through redistribution, as it seemed so from the report. He also wanted to know if the Black Economic Empowerment (BEE) report was meant to pre-empt that discussion. He disagreed with the view that it benefitted only the few. He asked for clarity on the comment that BEE was a risk to business. He also asked the Panel to elaborate on the other instruments the central bank could use.

Prof Hausmann responded that the equity component could be very unequally satisfied and could lead very easily to widespread inequality. It was desirable to have as many people at the bottom to have income too. He asked the members to consider the impact on firms not yet in existence.

He added that the SARB shared this problem with other central banks worldwide. Other central banks reacted to changes in the exchange rate, inflation and aggregate output. The SARB did not respond at all to the additional factors. The Panel was proposing that the SARB be more like other central banks. Other possible instruments were reserve purchases or sales, capital controls on inflows to restrict “hot money”, restricting domestic spending by adjusting the banks’ reserve requirement and changing the reserve currency composition. He mentioned some of the tactics used abroad such as “constructive ambiguity”. This was the art of releasing information into the public domain in order to stabilise speculation and push the market in the right direction. This was often achieved through “cheap talk”.

Recommendations of the International Growth Advisory Panel:
Two Policies to Alleviate Unemployment in South Africa
Professor James Levinsohn, Economics Department, University of Michigan, and member of IGAP, briefed the Portfolio Committee on the recommendations of the IGAP for the alleviation of unemployment in South Africa. The broader definition of unemployment was used for this analysis. He discussed the breakdown of the unemployment rates by gender and age groups. The key messages that had emerged from the data were that unemployment rates were high and had risen over time. Unemployment was a problem for those with matric or less, and was especially a problem for the young. The difficulty seemed to lie in getting into the formal workforce and it was this aspect that most needed to be addressed. People who managed to achieve this tended to stay employed, though they may change jobs occasionally.  The costs of unemployment included the loss of economic output. People who were not currently employed were not gaining experience and skills for future productivity. Unemployment also carried the cost of social ills, as unemployment was often a gateway to crime, disengagement with the political process and lack of investment in self.

The first proposal was a Targeted Wage Subsidy (TWS) to facilitate the school-to-work transition. The targeted population was to be school leavers. The subsidy would be accompanied by a very short probationary period during which dismissal would be “at will”. After this period the usual regulations applied. A TWS was defined as the opposite of a wage tax. It would decrease the cost of labour, encourage employment in the formal sector, decrease revenue for the National Treasury and discourage investment in labour-saving capital. Something was preventing school leavers from getting that first job. He outlined the economic argument for the TWS. The market imperfections mentioned were a nationwide problem and there was an argument for the TWS across all sectors of the economy. The caveats included possible abuse of the probationary period, stigma to the targeted population, inducing students to leave school, possible increases in inflation and fraud. The TWS would take the form of a debit card and everyone would get a card when he or she turned 18. The implementation issues covered the eligibility, the amount of the subsidy (R 5 000 per month), expiration, the probationary period (10 weeks) and the total cost (around R 3.75 billion per year at a 75% take-up rate). Experimentation and evaluation were a good idea as these numbers were only provisional.

The second proposal regarded the argument for immigration reform. The premise here was that South Africa had a shortage of skilled workers. South Africa was likely to be able to attract the best talent from the Southern African Development Community (SADC) region and other African countries. This should be seen as a “brain gain” and it should be remembered that skilled and less skilled workers were complementary as they posed an opportunity for skills transfer. The implementation issues were the definition of acceptable educational qualifications and the use of permanent and temporary workers.  Implementation should be done with care and accreditation would be key.

Related policy responses could be revisions of Black Economic Empowerment (BEE), industrial policy, the education system and the Public Works Programme.

The conclusion reached was that these policies would alleviate unemployment. A TWS was both more ambitious and more effective than current approaches. It must be borne in mind that there were costs to these policies but there was a greater cost in doing nothing.

Southern African Customs Union (SACU) Tariff Policies: Where should they go from here?
Prof Robert Lawrence, Albert L Williams professor of international trade and investment at Harvard University, and member of IGAP, gave the Portfolio Committee background on the Most Favoured Nation (MFN) tariff structure in place in South Africa. MFN tariffs had hardly changed since 2000 and challenges remained. He summarised the paper. The first conclusion reached was the proven randomness of rates. It was unexplainable and there were usually only historical reasons behind the tariffs. This was not an appropriate structure for the trade framework. It was still very restrictive on final goods and inputs, and he noted the tariffs on textile inputs and final product as examples. The Panel would like to see a simplified structure to enhance the export capabilities.

The second conclusion was that the tariff structure was in
efficient and costly to consumers in preserving employment. Jobs were protected in textiles, footwear and motor vehicles, but jobs were lost in primary sectors, services and export sectors. The costs fell disproportionately on the poor, relative to income. The whole system was regressive in nature.

The third conclusion referred to the reason for the costs, being infant industry protection. The current structure could no longer be justified on these grounds. An alternative structure was proposed, with exceptions used only as a safeguard action, a drastically simplified structure and a targeted liberalisation of tariffs on inputs and outputs. The key ideas were that si
mplification would reduce the burden of administering tariffs, provide a transparent signal for resource allocation and was less open to corruption and industry lobbying. Lower input tariffs promoted exports by reducing export taxes, but increased effective protection on remaining sectors. This provided scope to benefit consumers by reducing output tariffs without severely dislocating production in sensitive sectors. There would be clear priority sectors to improve industrial policy. There was currently no clear-cut rule that applied to the majority.

Prof Lawrence clarified that this was not free trade versus protectionism. The panel was recommending neither.
The South African government needed to behave strategically. South Africa’s current focus was on the regional trade arrangements of SACU and SADC. The revenue sharing formula of SACU was counter productive on customs and needed to be fixed. A specific development fund needed to be set up and SADC would have to be re-oriented. South Africa seemed too enchanted with the European Union (EU)model. However, this current arrangement created many problems in the form of overlapping commitments. In response to this, the Panel rather advocated the use of Free Trade Areas (FTAs).

Is BEE a South African Growth Catalyst?
Mr Matthew Andrews, Assistant Professor of public policy at Harvard's Kennedy School of Governance, and member of IGAP, presented the Panel’s findings and recommendations on Broad Based Black Economic Empowerment (BBBEE, referred to for ease of clarity simply as BEE). BEE called for a change in the way economic players interacted and it changed the relational fabric of society. Two key questions emerged. The first was when change would catalyse growth. It became clear that horizontal structures were preferred to vertical ones. South Africa’s structures were historically limited, with a small concentration of resources and ownership. It was noteworthy that not many boards of BEE companies included economists, as was the case in these professional networks. Chartered accountants were preferred for this purpose, placing a higher premium on this qualification.

This structure created many outsiders in the first and second economy. It limited new opportunities for firms as well as stifling new ideas. There were constraints on competition and creativity and many outsiders existed,  especially at the bottom.

Opening the relational structures of the South Africa’s industry could catalyse growth. BEE could be a vehicle for this. Macroculture was the key as it informed on relational structures. The current conditions created a natural ceiling and limited entry of people who could think in new ways, exacerbating the skills constraint. With preferential procurement even “new suppliers” generally were old suppliers that looked different.

The bottom line was that BEE was causing change but there were costs associated. New firms could not comply with BEE, and they were precisely the firms that were so necessary for growth. The situation had tremendous potential. The main problem was that there was a great focus on insiders, to the greater exclusion of the outsiders.

The core idea was that South Africa needed a strategy with better balance, focus and implementation. There should be additional elements of employment creation added to the scorecard. Companies should also be given greater choice in how to earn those points. There was a recommendation that new firms should be excluded. BEE, in its current form, facilitated “box ticking” whereas there should ideally be clarity on evaluation and also monitoring of the timeframes set for the meeting of objectives.

General Presentation on the Findings of the IGAP report: Continued
Prof Hausmann continued the overview of the Panel’s findings. He examined South Africa’s industrial policy, with a focus on beneficiation. There were obstacles to structural transformation. There has been a move toward production of nearby inputs but the real question was how to produce new outputs. The market side of this problem dealt with itself through the free trade mechanisms of demand and supply. This automatic system would provide what was needed (Adam Smith’s “invisible hand”). Government inputs, however, needed to be provided and in this way government could become an obstacle, if it was non-responsive in providing inputs to new activities. Government did not know what was missing. Industrial policy was geared at finding out what was missing and developing a strategy to provide it.

He discussed the four principles for public/private co-operation. This should be premised on letting society self-organise. This would create an open architecture where government responsibilities had to be delivered on time and more efficiently than at present. The focus should be on whatever increased productivity. Government should also have a willingness to co-finance private sector projects. This was not meant to be a social programme for the rich. It must have value for everyone, be transparent and justified for the public good.

Some policy initiatives were recommended. Dialogue must take place at similar levels and government must be more embedded in society. This was sorely missing in South Africa. He said development finance bodies such as the Industrial Development Corporation (IDC), were well positioned to achieve this but needed to be better organised, resourced and controlled. They needed to become Google-like search engines for innovations in industry. To do this they must be empowered and evaluated. The Coega project was an example of a persistent search for opportunities. This was very different from central planning. Things were happening accidentally and should be strategic.

There was a problem with the co –ordination in the inter-Ministry market. The solution was to empower departments to interact and trade resources and information, in order to assist new business initiatives. Beneficiation was not the right way to think about transformation. The traditional thinking of transforming a raw material to a processed raw material needed an adjustment. Instead of concentrating on resources, the focus should be on how to develop capabilities. He used a stylised example of how Finland progressed from mainly exporting wood to having one of the biggest cellphone companies worldwide, Nokia. He highlighted the need to think laterally about beneficiation, certainly more broadly than the definition suggested.

Discussion
Ms N Mokoto (ANC) expressed her gratitude for the enlightened work. She asked what the sustainability of the growth strategies was. She said that South Africa had a market economy and asked about the success of other mixed economies, and for an assessment of the performance of the agricultural sector, specifically pertaining to the binding constraints. Finally, she asked what was being put forward regarding the integrated sustainable development strategy.

Prof Hausmann replied that there were plenty of opportunities for additional agricultural expansion in South Africa. The prevailing idea was that water and arable land constraints were limiting, but the Panel had found that the available resources could be made more productive. They had good research that found that an improvement in logistics could generate a lot of productivity in that sector. South Africa could learn from models in Chile, Argentina and Peru, where the sector was growing due to technological innovations and the creation of new opportunities.

Mr B Mnguni (ANC) commented on the macroeconomic outlook of the SARB. He asked if it was the view of the Panel that the central bank should look at factors such as growth and the exchange rate.

Prof Hausmann said that there were other central bank models to be considered. For example the USA Federal Reserve had a dual mandate of controlling inflation as well as promoting economic growth. The question was to decide what the right combination for SARB would be. The SARB had a proven sensitivity to stabilising the level of output of the economy. IGAP would like policy to evolve in that direction. IGAP was not in a position to say if that should be done through legislation, but this was generally a very hot global issue.

Mr Mnguni asked about the statement that BEE represented a tax on companies. He quoted the fact that BEE companies registered higher profits in general.

Mr Andrews responded that endogenality was the major problem. One should be careful of the link between BEE and increased profits. When the data was controlled, the picture that emerged was that BEE was very exclusive. The recommendations were for new firms needing space to change; and these would be existing firms  who had trouble getting into the door with BEE. For them it constituted a significant tax. The focus was on creating social space for firms that had no physical space.

Mr Mnguni noted that the Panel’s view of beneficiation was in direct opposition to the traditional trade theory of comparative advantage. He asked for comments on this observation.

Prof Hausmann responded that the trick would be to effect change on the goods in which South Africa already had a comparative advantage – seeing beneficiation more as an evolution. South Africa was much more developed than most countries and needed to think of other outlets. It needed to look laterally at raw materials and concentrating on a capabilities expansion.

Mr S Dithebe (ANC) referred to recommendations on trade tariffs. He said that the agricultural policy of European Union was a major subsidy programme. They had first advantage. He asked how it was possible for South Africa to continue its long term growth trajectory against the historic advantage of the EU.

Prof Lawrence replied that Mr Dithebe was right about the EU. He said that this was not a policy to emulate. The European system was very inefficient. The issue was not the length of time the policy was in place, rather it was how good and rational was that policy. There had been no impetus for change in South Africa. Wanting to develop an accompanying industrial policy was not an excuse. All tariffs should be benchmarked against a simple rule that would apply to the majority of tariffs.

A member of the Cluster said that she viewed the recommendations on the state and self organisation as the most important aspect of the report and added that the government must be more rational in future. She asked which of the recommendations the IGAP would choose as their most important one.

Prof Hausmann responded that there was currently an adversarial relationship between departments and business. There should be a national goal of achieving a new comparative advantage. Industries and export jobs should be a priority. A plan to call to task Ministers who did not do their jobs would also be important. Other positive outcomes would emerge from this.

Dr D George (DA) pointed out the disparities, migration and shocks the South African economy faced, and stated that government spending needed to be ongoing and targeted. He asked how the Targeted Wage Subsidy recommendations could be implemented and how large the proposed FTA would be.

Prof Lawrence responded that customs unions were tricky and FTAs were more simple, as they could be extended to all willing parties, thereby expanding in an area of co-operation, as countries were ready to form the link. Changing the tariffs would be easy. Co-ordination with the rest of Africa would be the real work. There was no limit to the extent of the FTA as long as such expansion was meaningful.

The meeting was adjourned.

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