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Presentation of Draft Report Balance of Payments Dynamics, Institutions and Economic Performance in South Africa Workshop organised by SAIIA/TIPS/FES August 13, 2008 Pretoria Andreas Freytag FSU Jena and ECIPE, Brussels.
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Presentation of Draft Report Balance of Payments Dynamics, Institutions and Economic Performance in South Africa Workshop organised by SAIIA/TIPS/FES August 13, 2008 Pretoria Andreas Freytag FSU Jena and ECIPE, Brussels
Balance of Payments Dynamics, Institutions and Economic Performance in South Africa Outline of the Presentation 1. Introduction 2. Balance of payment in South Africa: an overview 3. Theoretical background 4. The evidence 5. Policy conclusions: preliminary lessons for South Africa
1. Introduction • The Economist: The global current account deficit ( 132 bn US-$) demands for urgent responses: an appropriate means may be a trade barrier against Mars! • In the last decade, current account imbalances increased all over the globe, both in absolute terms and in relation to GDP. • South Africa has experienced an increasing current account deficit since 2003. • Many observers see huge current account imbalances as a threat for global stability. • From a theoretical perspective, imbalances in the balance of payments indicate that an intertemporal trade has taken place. Consumption today is exchanged against consumption tomorrow.
Whether this trade is welfare enhancing, is depending on how capital imports are used (sustainability?) • in other words: is a bop-imbalance automatically a disequilibrium? • What factors does the current account depend on? • We attempt to combine the dominant macroeconomic analysis with institutional economics to sort out how to judge the South African current account development.
2. Balance of payments in South Africa: an overview Figure 1 shows the current account in South Africa, figure 2 gives an overview about global imbalances, Table 1 displays the current economic situation in South Africa. Figure 1: South African Current Account 1953 to 2007 Source: IMF
Figure 2: Global imbalances in 2007: current account in bn US-$ SA: -17 China: 363 Developing countries 630.9 USA: -736.8 Sub-Saharan Africa: 1.6 EU: -202.8 Oil exporters 423.5 Capital Emerging Europe: -121.5 Japan 212.8 Source: IMF, World Economic Outlook April 2008.
Since 2002, South Africa has been rapidly growing. Employment has also been increased, inflation has been moderate (until late 2007), fiscal policy prudent. The current account deficit of roughly 6 per cent of GDP in 2006 is obviously caused by private savings-investment gap (IMF 2007). Table 1: Main economic South African indicators 2003 - 2007 2003 2004 2005 2006 20074 Real GDP1 3.1 4.8 5.1 5.0 4.8 CPI 5.8 1.4 3.4 4,7 7.1 Unemployment 28.0 26.2 26.7 25.5 24.2 (20) National government budget² -2.0 -1.7 -0.6 0.4 0.7 National government debt² 35.4 35.1 33.9 31.4 30 Current account -1.1 -3.2 -4.0 -6.5 -6.5 Gross reserves³ 1.6 2.6 2.9 3.3 3.5 1: annual growth rate; ²: in per cent of GDP; ³: in months of next year’s imports; 4: partlyprojections. Sources: IMF (2007, International Annex, p.10), SA Reserve Bank, Stats SA
Following the IMF (2007, Box 2, p. 10 and p.6, see below), the current account deficit is driven by an increase in private investment and a decrease in private savings. X-M = S-I Figure 3: Investment, Savings, Current Account • Is this development worrying, as some observer claim? • “sudden stop” argument 1) How to define reversals? 2) What drives reversals? 3) What are the effects? (Smit 2007 on the macro perspective) Source: IMF (2007, p. 5)
3. Theoretical Background To explain and judge developments in the balance of payments (BoP), many approaches are available. Identity: Exports minus imports equals savings minus investments! Thus, it is impossible to analyse the current account and/or trade balance without looking at the capital account. The most serious and widely accepted view is the intertemporal approach to the balance of payments (e.g. Böhm-Bawerk 1914; Obstfeld and Rogoff 1994; Dluhosch, Freytag and Krüger 1996; Corden 2007). According to this approach, the balance of payments is the result of disaggregated, i.e. individual decisions about consumption, sales, savings and investments, i.e. intertemporal trade.
Unless trade is forced or restricted, the balance of payments is based on optimal plans (which may turn out to be suboptimal in the future). Instead of being a disequilibrium, current account imbalances can be interpreted as sustainable equilibria (Dooley, Garber and Folkerts-Landau 2007). Thus, it seems inappropriate to talk of improvement or worsening with respect to the trade balance. The exchange rate is an adjustment parameter to bring about the transfer from the capital account to the current account. However: In politics, an alternative thinking, labelled the competitiveness approach, is fashionable. The exchange rate is a policy instrument to redirect trade flows Marshall Lerner condition.
What drives (individual) decisionmaking with respect to savings and investment? • ability to save (not really given for many in South Africa) Drivers of savings: age structure, income, educational level, institutions, inflation • MEC • MEC is driven by institutions, that is rules, habits, morale etc which are investment friendly; • besides, infrastructure, education and demographics matter; • natural resources may encourage fdi • fiscal and monetary stability are encouraging private investment. • A national current account imbalance (deficit or surplus) tells us to what extent a country is successfully competing on the world’s savings, I.e. mobile capital. • Special role for fdi (vs. portfolio investment)
Theoretically, a current account deficit makes perfectly sense, if the accumulated debt is used for investment purposes rather than consumption (Germany in the early 1990s, US in 2005ff?) Sustainability has also a micro dimension! To aggregate it is sensible to look at the state of development of countries. The theory of the debt cycle shows how an “ideal development” of the bop looks like (Figure 3). Countries undergo this cycle in analogy to firms. To finance investments, debt is accumulated, accompanied by a trade deficit (I). The investments pay off, debt is reduced by a trade surplus (II). Later in the process, net wealth is accumulated, earning capital yields (III). Finally, a mature creditor country runs a trade deficit and a capital yields surplus (IV).
Figure 3: The Debt Cycle Young debtor country Mature debtor country Young creditor country Mature creditor country II III IV I Net foreign wealth Balance of capital yields Time Trade balance
The role of the exchange rate Adjustment parameter? Real exchange rate defined as follows ereal = PT/PN South Africa: Capital inflows⇧ PT constant, PN ⇧, real exchange rate ⇩ X ⇩ , M ⇧ current account deficit. Once the supply side has adjusted so that the appreciation is no longer needed to allow the current account deficit, the currency may well depreciate again overshooting! Policy variable? The latest depreciation did not reduce the current account deficit!
4. The evidence • What are the main drivers of the current account deficit? Does South Africa match this ideal pattern? How sustainable is the development? • Macroeconomic conditions • Exchange rate development • Structural change • Structure of imports and capital inflows • Debt cycle • Institutions • South African policy framework (Asgisa, NIPF) • Relevant: OECD report on microeconomic shortcomings and planned remedies! • The Harvard group has also discussed economic policy issues comprehensively.
Macroeconomic conditions Figure 4: Inflation in South Africa The macroeconomic development since the late 1990s is generally seen positive, latest increase in inflation makes a bit more sceptical. Remark: World wide savings up from 20.5 per cent of GDP in 2002 to 23.7 per cent in 2007; savings glut (Bernanke 2005). Source: SA Reserve Bank
Exchange rate development Figure 5: Exchange rate development Source: SA Reserve Bank
The role of the exchange rate Adjustment parameter! Real exchange rate: ereal = PT/PN ⇩ How have relative prices developed? Between 2000 and June 2007: dPT = 40 per cent (Stats SA P0141, CPI) dPN = 50per cent Caveat: 1) it depends on whether petrol is a tradable or not 2) CPI may be biased by distortions 3) it is generally difficult to distinguish between tradables and non- tradables Therefore, it makes sense to look at structural change.
Structural change We compare the sectoral development of value added and exports/imports for the periods 1994-2002 and 2002-2007. How did the value added of the sectors (Stats SA, P0441, 2000 prices) change (increase in per cent)? 1994-2002 2002-2007 Agriculture 7 -3 Mining -4 7 Tradables 29 21 Non-tradables (excl. government) 38 37 How did the export value (SARB, current prices) change (increase in per cent)? X: 1994-2002 2002-2007 M: 1994-2002 2002-2007 Merchandise 314 83 262 104 Net gold 83 -9 - - - - Services 206 83 333 123
Import structure It is further necessary to analyse the structure of imports. If imports consist mainly of consumption goods, the degree of sustainability would be low. If, however, imports mainly consist of capital and intermediate products, one could expect a boost in productivity. The distinction is difficult. Table 2: Import structure Source: WTO, own calculations
Structure of capital imports Also, the structure of capital imports as well as assets and liabilities is of interest. Driver: portfolio investment, implications? Recently (Q4/07 and Q01/08) , investment has been reduced and deposits have been increased. “wait and see”-strategy? Figure 6: Net capital inflows Source: SA Reserve Bank
Debt cycle? To what extent are capital controls for South African contributing to the deficit? Role of transfers (SACU, guest workers?) Figure 7: A start of a debt cycle? Source: SA Reserve Bank, own calculations
Institutional aspects Governance indicators show that there was no significant change after 2002. Table 3: Governance indicators since 1990 1990 1995 2000 2002 2003 2005 2007 HDI (0-1) 0.735 0.742 0.696 0.658 0.674 TI CPI (0-10) 4.8 4.5 5.1 FH PR (1-7) 5 1 1 1 FH CL (1-7) 4 2 2 2 Fraser (1-10) 5.3 6.3 6.8 6.8 These institutions change only very slowly, but structural breaks possible. In addition: public spending on health and education is rather low.
Current economic policy problems, responses and their potential impact on the current account • The Harvard group as well as the recent OECD (2008) report on microeconomic shortcomings and planned remedies shows the current problems of the South African economy: • governance problems (at least when looked at it from outside), • high unemployment coupled with poor outcome of education policy, • brain drain, • HIV/AIDS (high economic cost) • monopoly structures in network industries (bottlenecks), • low productivity growth, • weak public administration.
South African has introduced four policy frameworks since 1994 (RDP, GEAR, AsgiSA, NIPF). • Whereas GEAR was successful with respect to macroeconomic stability, all other programs so far did not deliver. • Neither AsgiSA nor NIPF is likely to tackle the economic problems adequately. Rather they contribute to new problems: • distortions, • incentives, • rent-seeking (relatively high number of interest groups) in combination with corruption, • knowledge problem (v. Hayek).
In addition: do the problems as well as inappropriate responses have any effect on the future development of the current account? Example: If South Africa allows competition in telecommunication, one can expect a surge in fdi in this industry. This contributes further to the current account deficit (in line with the theory of the debt cycle), improving the price competitiveness of many industries. But if South Africa increases subsidies to domestic producers while at the same time restricting trade further, the reversal is more likely, if S-I is changing due to the policy. If it does not change, then distortions reduce gross flows without changing the balances.
5. Policy conclusions: preliminary lessons for South Africa • 1) The capital inflows of the past are obviously less related to institutional change than to macroeconomic improvements and increased saving in the world. • 2) Sustainability is not only dependent on macroeconomic factors, but also driven by • private behaviour, • regulations (market entry, labour market), • subsidies, • economic activities of the government, • trade distortions, • public investment (education, health, infrastructure).
3) It is, however, difficult to identify thresholds (e.g. investment structure, import structure, institutions, net wealth position to GDP) to judge the sustainability. 4) Nevertheless: South Africa needs more capital to modernise the economy and increase the potential productivity. This implies to import net capital and use is for investment. 5) In particular, bottlenecks such as telecommunication, transportation and energy are to be widened. 6) In the longer run, savings have to increase: Education ⇧ Employment ⇧ GDP ⇧ Savings ⇧. 7) It is too early to state whether or not South Africa is at the beginning of a beneficial debt cycle. Signs are encouraging.
To summarise, today the threat to sustainability (or the danger of a reversal) may be bigger on the microeconomic front than from the macroeconomic side. Therefore, the South African government should seriously rethinking any interventionist strategies and consider some of the recommendations made by the Harvard group and even more so the options shown by the OECD. More attention should also be paid to crime and corruption (rule of law).