Slash red tape bonds to accelerate growth

Jonathan Katzenellenbogen identifies the requirements for accelerated economic growth in the years ahead.

Summary - South Africa desperately requires a series of fundamental microeconomic reforms to improve the supply side of the economy and lower the economy’s cost base.

The government shows every sign of being aware of the supply side problems. It says it is eager to address the cost of doing business, has looked into the labour laws and the overpricing of key inputs like steel, chemicals, and telecommunications, and is exploring ways of reducing the burden of regulation for small business. When a decision is required, however, political inertia appears.

There have been severe costs to the sluggish growth rate.

By the restricted definition of unemployment, over 25 per cent of the work force is out of work and by an expanded definition well over 40 per cent is unemployed.

Last year the country’s economy grew by 3,7 per cent and this year the treasury predicts a growth rate of 4,3 per cent. The government and the Reserve Bank frequently say the country is on a higher growth trajectory. But this trajectory, currently largely driven by consumer spending and an anticipated massive public investment drive, is unlikely to be of sufficient magnitude to make deep inroads into poverty.

The development profiles of countries that have made major inroads into poverty are characterised by two facets. The first is reduced regulation, which has generated rapid rises in productivity. The second is rapid export growth.

Measures to decrease rigidities, increase competition, reduce tariffs and lower the cost of intermediate inputs, improve access to finance and services, and decrease red tape for small business would considerably boost growth. These measures, together with an improved education system and a larger market in southern Africa, could remove what are the most binding constraints on the country’s growth rates and thereby substantially reduce poverty.

Among the greatest impediments to South Africa achieving a lower-cost economy and higher potential growth rates are the protection given to vested interests:

· The labour pricing regime benefits job-holders rather than job seekers. That results in wages that are well above levels at which a far larger number of people might be employed.

· Prices of key intermediate goods such as steel and chemicals continue to be set by import parity pricing, in which goods that are not imported are nonetheless priced at the equivalent of imported price levels, including transportation and duties.

· Telkom is able to control most access to the international backbone of the internet and price its services way above competitive levels.

· In the banking industry an oligopoly of four banks known as the “Big Four” charge among the highest fees in the world. That is good for the banks but does not help business or growth.

Moreover, excessive red tape in the way of small business acts as discouragement to new small business, despite the constant refrain from government that it wishes to encourage this sector.

According to a Small Business Project survey of 1800 companies, published last year, although the single most important factor inhibiting growth was weakness in the economy, the second most important factor was state interference and regulations. Some 30 per cent of respondents said the constraints on growth were due to the complexity of regulatory compliance; about a quarter pointed to black economic empowerment requirements, and about 17 per cent to problems experienced while interacting with the public sector.

Further issues on the microeconomic agenda include loss-making state enterprises, poorly managed government departments, and ineffective local government bodies that are responsible for service delivery. Government’s intentions to privatise state enterprises have now given way to a policy of retaining them and using these bodies as avenues for a vast public investment programme. Relying on state enterprises for growth risks political interference, however, and ultimately high investment in low-return businesses rather than in commercially viable projects.

Following an aggressive agenda of reform to get the economy’s key prices right and improving competitiveness could boost the chances of the massive investment programme generating high returns for the economy.

Since 1994 South Africa has convincingly established macroeconomic stability, but failed to achieve levels of economic growth that can even come close to the sort of levels required to reduce unemployment and diminish poverty. Macroeconomic stability with low budget deficits and low inflation is a necessary but not sufficient condition for high rates of growth.

To achieve higher rates of growth South Africa desperately requires a series of fundamental microeconomic reforms to improve the supply side of the economy and lower the economy’s cost base. It is important for the reforms to be implemented as a package. It is of little use making it easier to hire and fire while not cracking down on abuses which allow producers to extract prices way above market levels, and retaining the regulatory burdens on small business.

Soon after its election in 1994 the African National Congress (ANC) government swiftly abolished price controls in agricultural markets and then lowered trade tariffs. It also brought about a gradual easing of exchange controls, although remnants that require a vast bureaucracy remain, and it carried out a limited number of privatisations of state-owned companies. Now there are signs that the second generation of economic reforms have stalled.

A fundamental question for South African economic prospects is how quickly that could change. In late July President Thabo Mbeki announced the establishment of a high-level government panel under the chair of Deputy President Phumzile Mlambo-Ngcuka into what it takes to achieve a growth rate of over 6 per cent. It is possible that President Mbeki could use the findings of the panel, depending on what they are, to gain political space for a push toward deregulation.

However, it is far from clear that there is necessarily the political will to do so. Government increasingly speaks of a “developmental state”. Indications are that an overwhelming push for growth will come from what are almost centrally planned initiatives like massive investments by public enterprises, efforts to improve skills, and possible incentives.

Over the past few years Black Economic Empowerment has taken centre stage in policy. The state is exercising more control over certain areas of the economy in attempts to deliver to the poor and is neglecting the task of generating a competitive private sector. In an ominous sign of state interference, government has imposed retail price controls on pharmaceuticals, undermining its intention to foster growth by threatening the very livelihoods of pharmacies.

Rather than boldly opting for attacking SA firms which abuse their pricing power and deregulation the government seems to view public investment and accompanying special measures as more important to ensure growth than eliminating regulation. But the evidence strongly suggests that rapid growth alone would generate the desired benefits.

“Policymakers who seek to accelerate growth in the incomes of poor people, and thus reduce overall poverty, would be well advised to implement policies that enable their countries to achieve a higher rate of overall growth,” says a recent World Bank study on pro-poor growth in the 1990s. It says, “The pace of overall economic growth is the main factor that determines how quickly poverty declines.”

South Africa’s growth rates have remained slightly above three per cent for the past decade, well below the at least six per cent that is widely thought to be necessary to make progress to absorb new labour entrants. There have been severe costs to the sluggish growth rate.

By the restricted definition of unemployment, over 25 per cent of the work force is out of work and by an expanded definition well over 40 per cent is unemployed.

According to the 2005 Development Report produced by the United Nations Development Programme, the Development Bank and the Human Sciences Research Council, “generally speaking, the statistics show that both poverty and inequality have increased since 1993”.

The International Monetary Fund (IMF) has said that without structural reforms, the economy will be constrained to a four per cent growth rate. But the fund’s Deputy Managing Director Anne Krueger has said that if there are structural reforms, particularly of the labour market and a further liberalisation of the country’s tariff structure, South Africa could achieve a growth rate of six per cent.

The development profiles of countries that have made major inroads into poverty are characterised by two facets, rather than by high rates of public investment alone. The first is that they have been able to grow fast because of reduced regulation, which has generated rapid rises in productivity. The second is that they have benefited from rapid export growth.

China and India, the present world icons of economic performance, were given their initial spurts of growth by deregulation. In China it was achieved in two spurts: the first, which extended the scope of private enterprise, began in 1978; the second which included state agrarian reform and further measures facilitating township and village enterprises, began in 1984. India only achieved its spectacular performance with the end of what is known as the “License Raj” in the early 1990s. Indian economists often say that India was colonised by its own bureaucrats after independence from the British Raj.

South Africa does not need to make such large leaps as India and China in deregulation, but measures to decrease rigidities, increase competition, reduce tariffs and lower the cost of intermediate inputs, improve access to finance and services, and decrease red tape for small business would considerably boost growth. These measures, together with an improved education system and a larger market in southern Africa, could remove what are the most binding constraints on the country’s growth grates and thereby substantially reduce poverty.

Among the greatest impediments to South Africa achieving a lower-cost economy and higher potential growth rates are four sets of protection given to vested interests.

The labour pricing regime benefits job-holders rather than job seekers. That results in wages that are well above levels at which a far larger number of people might be employed.

Prices of key intermediate goods such as steel and chemicals continue to be set by a practice known as import parity pricing. Although these goods are not imported they are priced at the equivalent of imported price levels, including transportation and duties. This forestalls the development of potential downstream export-oriented and labour-intensive industries.

Telkom is a landline monopoly, but it also controls the bulk of access to overseas telecommunications. It is therefore able to control most access to the international backbone of the internet and price its services way above competitive levels.

In the banking industry an oligopoly of four banks known as the “Big Four” (First National, Absa, soon to be reinforced by the British bank, Barclays, Standard and Nedbank) dominate. They charge among the highest fees in the world, which makes this the most profitable banking industry in any market of significance. That is good for the banks but does not help business or growth.

Excessive red tape in the way of small business acts as discouragement to new small business, despite the constant refrain from government that it wishes to encourage this sector.

What characterises the pricing of labour, key industrial inputs, and banking services is the ability of vested interests to impose prices that are way above competitive levels. Because of its role in supporting the liberation struggle, labour was rewarded with legislation that protected those workers from easy firing and empowered them to negotiate almost completely inclusive industry-wide agreements.

Heated debate surrounds the impact of this legislation, particularly on the point of whether it is the labour laws or lack of skills that are the cause of high unemployment. That South Africa’s economy is characterised by increasing investment in capital intensity in the face of a labour surplus is indubitable, however.

After the rejection in July of labour reform by the ANC’s key policy making body between conferences, the National General Council, the future of labour law reform could be in doubt. The ANC discussion document on economic growth and labour reform has nevertheless placed the issue on the political agenda. It essentially proposes a practical compromise on the matter by suggesting “a number of small adjustments” that could produce substantial returns for job creation. Among the proposed options are for younger people and the tourism, textile and clothing, household and childcare, and agricultural sectors to be exempted from minimum wage and collective bargaining arrangements, thereby making it easier to fire poor performers. Such a compromise if it can be achieved, would give the growth of labour intensive industries a far better chance.

On its own, changes in the labour laws could disappoint hopes of faster economic growth. But if combined with measures that would reduce the lack of competition in South Africa’s key intermediate input producers, greater positive results might be achieved.

The relatively small size of South Africa’s economy only allows for a few profitable players in industries that are characterised by large economies of scale but are unable to export the bulk of their output such as steel, chemicals, and paper.

As there are few sellers in these industries, an oligopoly, as distinct from a monopoly, exists. While no one firm has control over price, in an oligopoly the main firms can strongly influence, if not completely control, the price through co-operation and collusion.

This is what allows steel, aluminium, and chemical producers, and also plate glass manufacturers, to use import parity pricing, thus pricing domestically produced commodities at the same price as the equivalent of imports landed in South Africa.

By some estimates the price of goods subject to import parity pricing is in the region of 30 to 50 per cent higher than it would be if transport and customs duties were excluded. The department of trade and industry is bringing pressure on some of South Africa’s largest companies with regard to import parity pricing, but evidence suggests these industries are not about to abandon this abuse.

The effect of this practice on growth is to raise the price of key intermediate goods in the economy and, in many cases, eliminate the comparative advantage for downstream industries that could allow South Africa to export value-added products on a larger scale.

A forthcoming department of trade and industry study on the issue could generate pressure for partial price cuts by some companies and a greater number of special deals for large buyers. Tariff reductions on imports would go some way to raising competition.

South Africa faces similar price abuse in telecommunications, which also has adverse consequences for growth and job creation. For all intents and purposes, Telkom is a monopoly in that it controls price, albeit subject to a weak regulatory regime. “The pricing evidence clearly suggests that Telkom’s pricing structure is excessive, and that some sort of intervention in the market may therefore be appropriate,” a recent South African Foundation report on telecommunications prices states. The study adds: “… because telecommunications are an input into virtually all productive activities, if telecoms prices are higher than their competitive level, they act as a drag on industry and a drag on economic growth.”

Despite high levels of competition among South African internet service providers, the foundation’s report says monthly fees for internet service are the highest on a purchasing power parity basis. One reason for this is that the internet service providers have to buy access from Telkom, which according to the report affects the pricing structure on both normal and broadband services.

The high costs of Telkom’s services have an impact on a range of businesses, but most seriously on call centres, financial institutions, and internet-based businesses. Even with legalisation of the use of Voice over Internet Protocol, call centres still have to face high international bandwidth prices in South Africa. In short, Telkom’s pricing is thwarting large-scale job creation in the call centre business. This is an issue that the government’s deregulation plans for the industry fail to address, according to the report.

Government speaks at length about the digital divide, the division between those who have access to digital services and those who do not. Addressing the issue of Telkom’s monopoly would be a definitive step in bridging the divide.

The labour laws, the price fixing by oligopolists, and Telkom’s deadening grip have to adversely affect the prospects of small business. These business must also face an excessive regulatory burden.

According to a Small Business Project survey of 1800 companies, published last year, the second most important factor that these businesses believe inhibit their growth is state interference and regulations. The single most important factor inhibiting growth for most respondents was weakness in the economy. Some 30 per cent of respondents said the constraints on growth were due to the complexity of regulatory compliance; about a quarter pointed to black economic empowerment requirements, and about 17 per cent to problems experienced while interacting with the public sector.

Black economic empowerment has vast consequences for the economy, but no large-scale study has been done assessing its impact on economic growth. The economic benefits of the acquisition of greater skills and the growth of a consuming middle class are all clear. While empowerment is an attempt to move away from the racially-biased ownership structure of the past, and is a means of building social stability, there are economic costs.

So far, black economic empowerment deals have had more to do with the distribution of assets than value creation. The positive impact on growth of the programme is probably rising as deals become broader based. But the uncertainties created by government’s targets for black ownership and signs of changing goal posts has created increased uncertainty for domestic as well as foreign investors about the consistency of economic policy.

The ANC discussion paper on economic policy includes a large section on the role of initiatives such as the Marshall Plan in the reconstruction of post-war Europe, the influence of aid on East Asian growth, and the European Union’ structural funds. It concludes that “development (cannot) be left to the market alone”.

There are signs that government is now intent on embarking on using public enterprises as instruments in such a role. The state-owned electricity generation utility, Eskom, and Transnet, the state owned mega-transport holding company, will be responsible for the bulk of the investment programme. There is a definite need for expanded electricity generation capacity and improved road, rail, and port facilities. Relying on state enterprises for growth risks political interference, however, and ultimately high investment in low-return businesses rather than in commercially viable projects.

Bibliography

South Africa Foundation. Telecommunications prices in South Africa, An international peer group comparison, April 2005.
Small Business Project, Counting the Cost of Red Tape for business in South Africa, Main Report, June 2005
Department of Public Enterprises, Republic of South Africa, An Analysis of the Financial Performance of State Owned Enterprises, 15 April, 2005.
African National Congress National General Council, Discussion Documents, Document on Development and Underdevelopment. 2005.
United Nations Development Programme, Development Bank of Southern Africa, Human Sciences Research Council, 2005 Development Report. Overcoming Underdevelopment in South Africa’s Second Economy.