World Bank South Africa Economic Update

World Bank South Africa Economic Update: Strengthening Economy Shifts Focus to Faster, More Inclusive, Growth.

In a new report, World Bank experts project that South Africa’s economy will grow to 3.5 percent in 2011 allowing the country to focus on long-term challenges including boosting employment.

Executive summary.

The firming of the economic recovery is putting the policy spotlight back on the longer term challenge of faster, more inclusive GDP growth. Modest investment rates despite attractive returns and low savings rates despite favorable demographics are important impediments. A virtuous cycle of faster capital accumulation, job creation (especially for the youth), and technological advancement needs to be stimulated. There are no quick fixes that can produce the desired stimulus. The quest for inclusive growth calls for a different, bolder approach. Integration of the advanced and less-developed economies and more effective integration with the global economy, using Factory Southern Africa as a platform, hold considerable potential.

Broad-based economic recovery in South Africa

South Africa’s medium-term growth prospects point to a strengthening recovery. GDP growth is projected to be 3.5 percent in 2011, 4.1 percent in 2012 and 4.4 percent in 2013. The long-term potential growth rate under the current policy environment is estimated at 3.5 percent.

The ongoing global recovery should continue to support exports, but strengthening domestic demand will increase imports and moderate net contribution of trade to growth. Consumer spending is expected to remain strong, and gross fixed capital formation is forecast to grow after declining for two consecutive years. As businesses demand more labor, employment should rise and further strengthen consumer spending. Strong government spending, as part of the countercyclical fiscal policy, will boost growth in 2011 and 2012, but is likely to wane thereafter.

In light of South Africa’s low national savings, the reemergence of high current account deficits, financed mostly through volatile portfolio flows, will reemerge as the biggest cause for macroeconomic concern over the medium term.

With considerable strengthening of the economic recovery and GDP projected to reach its potential by 2014, the focus shifts back to the longer term challenge of raising GDP growth to 6–7 percent—and making it much more inclusive to tackle the extremely high unemployment.

Faster inclusive growth: Focus on savings and investment

Confronted with widespread and persistent exclusion and unemployment, policy makers in South Africa have rightly set their eyes on a trajectory of faster, more inclusive GDP growth. This will require lifting the current low rates of investment and savings, more intensive use of labor, and heavy doses of productivity enhancements.

A suboptimal equilibrium of low rates of savings and investment—low employment intensity of production—slow productivity growth has emerged in South Africa (see figure), undermining the quest for inclusive growth. A stimulus to any one of the three elements can generate a virtuous cycle of faster capital accumulation–job creation–technological advancement.

Employment-intensive growth would enhance productivity by skilling and tooling the unemployed labor force. Tackling youth unemployment would benefit from the favorable demographics and raise savings. Productivity enhancements, in turn, will raise GDP growth and attract private investment, while lessening the burden on investment and saving to support higher growth. Just as higher savings rates will need to underpin higher growth over the long run, higher incomes, especially among the lower end of the income spectrum, will raise the level of savings.

What explains the low investment rates?

The low private investment rates could mean one of two things: either the real returns to capital are low, or private investors are not responding to changes in real returns because of risk perceptions or structural barriers to investment. Our research shows that returns are high across most major sectors and have been increasing since the mid- 1990s: South Africa ought to be an attractive place for investment. This suggests that the real problem might be insufficient savings, rising risk perceptions or deeper structural impediments.

Four issues stand out in this regard:

• Industrial competition is much weaker in South Africa than its international peers. This points to entry barriers that discourage new investment despite high returns.
• Skills development remains an important deterrent for firms, new and old, looking to expand their business. The problem starts with basic education, where access has improved, but quality has not. Test scores show South Africa faring miserably relative to global comparators. With intakes largely ill-equipped with cognitive skills, the problem only gets compounded at the higher and technical education levels.
• Labor relations are much more contentious in South Africa than other emerging market economies. This is an implicit tax on investment, partly explaining why global investors, armed with options, have eschewed long-horizon opportunities in South Africa. In addition, wage levels relative to worker productivity are significantly higher than among South Africa’s peers, also discouraging new investment.
• Savings rates are low, as discussed below.

What explains the low savings rates?

South Africa’s savings rates have been significantly below the potential suggested by its economic and structural characteristics. Our analysis suggests that visible improvements in the national savings rate will depend most of all on:

• Resolving the high youth unemployment. The young-age population ratio in South Africa fell from 58 percent in 1996 to 47 percent in 2009. This demographic group is still under 30 years of age and, according to employment statistics, facing acute unemployment. Resolving the unemployment problem for this group holds tremendous potential for increasing the savings rate.
• Ensuring a productivity-led spurt in GDP growth. Substantial increases in economic growth are typically accompanied by increased savings, as consumption patterns tend to change more slowly, in line with the habit formation hypothesis. The increase in savings, in turn, lays the foundation for sustained high growth over the long run.
• Fiscal consolidation as envisaged by National Treasury should have a desirable effect on national savings. Global experience shows that permanent increases in public savings tend to increase national savings. Furthermore, reductions in recurrent public spending tend to be more effective than increases in tax collection.

The way forward

How to jumpstart the virtuous cycle of faster capital accumulation, job creation, and technological advancement? No quick fixes or small perturbations will produce dramatic results. The quest for inclusive growth will require, above all, a significantly different mindset. Two major pushes, both in the spirit of creative and bold thinking, seem to hold the most potential— one requiring a more intensive inward look, and the other an outward look.

More effective internal integration

A big push is needed to better integrate the advanced economy and the less-developed economy, marked by the spatially separated townships and informal settlements where the bulk of the unemployed live. Faster growth will have to come from the less-developed economy, which has the potential to take off in the same way that other successful emerging market economies have. Ways will have to be found to exploit the “arbitrage” between the two economies to ensure that capital flows into, not out of, the less-developed economy, and that labor is more mobile toward the advanced economy while entrepreneurs have greater access to its markets. Integrating the two economies will require a big push on public transport infrastructure while implementing programs to enhance financial inclusion and improving the cognitive and technical skills of youth.

Smarter regional integration

More effective integration with the global economy is needed based on South Africa’s latent comparative advantages, particularly its two surplus endowments in natural resources and unemployed labor. South Africa should be an attractive destination for long-term global investment but it is not. A clear, consistent, and predictable strategy for attracting foreign direct investment will be important in this regard. Factory Southern Africa can underpin South Africa’s competitiveness in global markets, based on nimble “win-win” regional production supply chains.

Download more information on the South Africa Economic Update