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South Africa’s medium-term budget should provide an indication of how public finances will be managed over the next three years, but over the past decade it has largely served to illustrate the persistent gap between aspiration and reality. In part, this is due to limited economic growth and repeated shortages in tax revenues.
The COVID-19 pandemic has led to a rapid deterioration in the situation, as reflected in the debt-to-GDP ratio: a monetary measure of broader national hopes that have been dashed over the same period. The cumulative result is that, unless economic growth undergoes a miraculous recovery, the country will have to implement large spending cuts or revenue increases to keep debt in check. Critics argue that this will further damage growth, while proponents argue that the alternative – risking a possible debt default – is worse.
The Treasury proposes spending cuts of 300 billion rupees over the next few years, mainly to the amount earmarked for salaries, and a relatively minor increase in taxes of 25 billion rupees over the same period by measures that have not yet been specified. It is also pushing a series of so-called “structural reforms” to boost growth.
But the spending cuts require a political solution that failed to materialize under President Cyril Ramaphosa, despite hopes that it could facilitate a social pact. And structural reforms are not convincing and poorly justified.
From fiscal consolidation to austerity
After the immediate impact of the global financial crisis between 2007 and 2009, the Treasury allowed spending to continue to grow in the face of lower economic growth and lower-than-expected revenue collection. As a result, the debt has increased both in absolute terms and in relation to the size of the country’s economy.
Subsequently, it sought to implement a “fiscal consolidation” policy to stabilize debt levels while avoiding spending cuts. Some have wanted to call this “austerity,” in a way that recalls the kind of policies implemented in Greece after it defaulted on debt repayment and came under the control of the International Monetary Fund and the European Central Bank.
But this is obviously misleading. At best, some of the decisions implemented were a form of what might be called “stealth austerity”. This led to the maintenance of spending limits in the face of the increase in the salaries of public employees and the growth of the population. This meant that the number of civil servants relative to the population was small in sectors such as health and education. While promises have been made to protect posts that were crucial to service delivery, little evidence has been provided to prove this actually happened.
The situation is now more serious. Over the years the government’s debt stabilization targets have increased from 40% of GDP to 50%, hence a short-term concession in the 2017 mid-term budget that debt would exceed 60% of GDP and halt its rise it may not be possible for the foreseeable future. From the 2018 budget onwards, the Treasury has returned to narrative: the 2018 budget promised debt stabilization at 56% by 2022, the 2019 budget promised 60% by 2023. Then the 2020 budget again admitted defeat, stating that “the debt should not stabilize in the medium term”.
After the impact of COVID-19 on the global economy and the rigid government blockade on the local economy, the special adjustment budget presented in July outlined two scenarios: one in which drastic measures were taken to stabilize the debt to 87% of GDP by 2023 and the other where it would rise to 106% by that year and will continue to grow. That budget claimed to aim to hit the lower target within three years, but the medium-term budget has already given up on both dimensions. It now aims for 95.3% by 2025.
While excuses and justifications can be given, the simple result is that South Africa’s public finances are worrying and its objectives increasingly unreliable.
Although some economists try to estimate what the maximum and sustainable debt-to-GDP ratio is for a country, there is no magic number. For most countries, without correspondingly higher economic growth, the higher the ratio, the greater the likelihood of defaulting their debt. South Africa’s proportion is already the highest in the post-apartheid era and is growing rapidly with reduced economic growth.
Public spending, economy and wages
The first key area of debate is whether austerity measures are the best way to stabilize public finances.
Critics of the current plan argue that cutting government spending will reduce economic growth and revenue collection, making the situation worse, not improving. There is evidence of this kind of vicious circle from other countries such as Greece, the UK and various countries in Africa and Latin America during the 1980s and 1990s.
But proponents argue that government spending has done little to stimulate growth after the financial crisis, while rising debt service costs will still reduce spending in other areas and the negative consequences of a default on debt repayments are too much. serious to risk. Here too, there are many examples, such as Argentina, of the harmful consequences of not holding back public finances first.
A problem that plagues both groups is that neither group has compelling ideas for improving economic growth. This, however, is a bigger problem for those who argue that growth is an alternative to reducing spending.
The second area is, if spending cuts are the chosen path, how should they happen. The Treasury’s plan is to target public service wage spending for most cuts, which means cutting jobs or reducing salaries. But fiscal consolidation has already led to a decline in jobs with little indication that this has been done in a way that prioritizes service provision.
The Treasury is now proposing to reduce wages. At first glance this seems sensible, given the country’s extremely high unemployment rate and the shortage of civil servants in critical areas. But the fundamental question is the structure of the public service.
Five years ago I suggested to two senior Treasury officials that a win-win situation would be to cut jobs from inflated management structures, reduce manager-level salaries, and reallocate those funds to create paid “front-line” jobs but of value as social workers. This could reduce wage costs, increase employment and improve service delivery. There was little interest at the time.
Five years later and now the Treasury is starting to talk about doing just that. He suggested that managers’ salaries could be cut. And one of the few newly funded initiatives is allocating R7 billion of teaching assistants. There are good educational arguments for such assistants, but in some countries they have been used to weaken the educational workforce and weaken trade unions. So in both respects the devil will be in the details.
In principle, a plan based on a political agreement with public sector unions remains in Ramaphosa’s negotiating power. Considerable cuts in the salaries of those at the top of the public sector, broadly defined, will be crucial to obtaining union consensus. Likewise, the government should consider higher taxes for the wealthy, for other high-income workers, and for profitable businesses.
In practice, the lack of progress over the past two years does not bode well. The country cannot afford another failure to implement a credible plan, nor the damage of the mass action of the unions.
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