SA economy: The rand, exports and interest rates

I wanted to start my throwing around of ideas about the South African economy with a simpler story of the drivers for growth, but this week the depreciation of the exchange rate and repo rate increase by the Reserve Bank makes for the big news.

One of the stories is that the weak rand will help to boost exports. Mike Schussler ripped into this idea earlier but also talked about a lot of the other challenges facing the SA economy. Depreciation of the rand cannot be seen as a growth strategy.

To add some academic perspective I wrote a post on the School blog drawing on a paper by Lawrence Edwards and Robert Garlic. The heart of the story is the following:

At an aggregate level there is a positive association between exchange rate depreciations and export performance. Edwards and Garlic lists the results from a range of studies and show that “a one percent rand depreciation is estimated to raise long-run manufacturing exports by 0.78 to 1.38 percent”. But this aggregate relationship fails to capture changes in competitiveness at the sectoral level. Their evidence shows that primary products are less responsive to exchange rate shocks than manufactured products. Non-gold merchandise exports (including manufacturing) are less responsive to exchange rate shocks than manufacturing alone. There are also differences across manufacturing sectors: the export response in natural resource-based and machinery & metal products sectors is generally lower than in labour intensive, chemical-intensive beneficiated sectors. And what about the channels through which the exchange rate affects exports? The evidence shows that South African exporters of manufactured goods are price takers in the international market. That means that export growth is not constrained by inelastic foreign demand or an inability to price competitively in the international market. This sound like promising news the minister would like to hear, but as always there are caveats: 

• The extent of an export boom depends on the composition of exports. Historical evidence showed that manufactured exports are likely to benefit more than commodity exports, but looking at the nature of South Africa’s top-20 exports (from Edwards & Alves in SAJE, 2006) one sees that manufactured exports make up a small part of the mix.
• The length of an export boom depends on competitiveness, specifically on the cost of imported inputs and labour. The evidence shows that nominal depreciations have not sustained the profitability of exports. Domestic producer prices are very responsive to changes in the exchange rate – a 1 percent rise in import prices has raised domestic producer prices by between 0.85 and 1 percent in the long run.

Even if exporters are winners for a while, the South African consumer is a clear loser when the rand depreciates. Yesterday Neil Rankin tweeted a link to a paper that he wrote with Aron, Creamer and Muellbauer on the exchange rate pass-through to consumer prices. They found that:

overall pass-through to the almost 63 per cent of the CPI covered is about 30 per cent after two years, and higher for food.

Finally, I found this nice tweet on research about the use of interest rates to defend a currency. It is in the context of fixed exchange rates and in the South African case we are not really defending the rand, but rather the current account and fighting inflation expectations, but it still offers an interesting take-away: higher interest rates helps a bit, but only for a while.

Do High Interest Rates Defend Currencies During Speculative Attacks? @tylercowen http://t.co/tR1XudFNny http://t.co/xXuPANg2b6
— MacroDigest (@Macro_Digest) January 29, 2014

Review: The Long View

I thought that I am too slow in getting started with a post about JP Landman’s The Long View, but yesterday The Economist posted an article about South Africa (Braai, the beloved country) that has Twitter up in arms, so that makes my timing perfect.

In his new book JP Landman argues that if you look at the newspaper headlines, you are very likely to get swept up by this week’s drama (this week it is Nkandla).  Very quickly you will become very negative about the country and its future prospects. We should rather take the long view.

He asks what makes a modern successful society and evaluates the progress made since 1994 and future prospects against each of these requirements.

The first is a growing economy and he throws out some numbers: Over the last 19 years the SA economy grew by 77% in real terms, there has been social development and investment in infrastructure. The successes are ascribed to the end of sanctions, the opening up of the economy, prudent fiscal and monetary policies and increases in productivity. I would qualify this “success” and ask why did South Africa not receive much FDI, why have many sectors struggled to compete in an open economy (and are now asking for protection), how capital intensive is the growth in productivity? But the book just goes on to argue that South Africa has reached a level of economic development where democracy has a reasonable chance of surviving.

The second argument is that demography is pushing us towards modernity: population is growing slower than the economy, but it is still a young population, though not that young that it could cause instability.

The third requirement for a modern, successful economy is employment. The book first unpacks some numbers, showing that South Africa has not experienced jobless growth as some have argued. We have had low rates of economic growth and low rates of job creation – this has a lot to do with the capital intensity of growth. Then there are three sets of constraints to faster job creation and the NDP are said to address them: NDP for faster growth, NDP for improved transport and dense cities to bring people and jobs together, NDP for better health and education! Here JP draws on Prof Frederick Fourie’s Three Discourses article and it is worth it to have a good look at the original work or at least the econ3x3 post – his is a much more nuanced story. The book goes on to argue that there are no quick fixes and we should systematically chip away at the obstacles. The structural measures include better education (also FET), expanded measures to link work seekers with jobs, improved public transport etc. The so-called elastoplast measures include the expanded public works programme and the jobs fund.

I feel that “taking the long view” and doing some hand waving about education, transport or public works may understate the depth of the challenges facing South Africa. Prof Servaas van der Berg and the RESEP group’s work on education paints a more somber picture.

The other requirements for a modern successful society include open societies, creative individuals, learning and social capital. With these you are either an optimist, pointing at the Constitution, the success of the World Cup and talking about leadership. Or you are a pessimist listing fraud and corruption, talking about extractive institutions. The Long View strikes a positive note, but with few examples and no evidence.

In the final sections JP presents a balance sheet of forces pushing growth up and down. The down-side forces are the familiar challenges of political uncertainty, strikes, social unrest, poverty, inequality, crime, weak public sector institutions, low productivity. The up-side forces that are listed include planned infrastructure investment, rising employment, property rights and a sound legal system, the ability to adopt new technologies, increasing relations with the BRIC countries and integration into sub-Saharan Africa. It is argued that we can muddle through with growth of 3%, that “even low growth weaves its magic”. The long view is that our bigger ambitions lie in the NDP. The stepping stones to this are massive infrastructure development, the Industrial Policy Action Plan and “various proposals under the NDP”, including promoting exports, support for SMEs and a more responsive labour market. Moving beyond economics, the arguments are that government and the private sector need to trust one another, that we need an ambition to perform and that leadership is critical.

Overall I think that there is a lot that recommends the book, but we probably don't need another one like it. Amongst policymakers and pundits there is agreement on the challenges and the possible solutions, also about the fact that it will take time. I wonder about the political sustainability of a middle-income, low-growth trap. Will we muddle through, or just muddle? Are there examples of countries that have muddled through? What did they do, how did they do it? Why will the NDP be different from all the previous plans? Are there examples of an NDP making all the difference? How exactly will the social capital-trust-leadership thing work? Who are those future leaders? How can we make institutions and growth inclusive?

Some macro thoughts and Zumanomics Revisited

Last Friday saw the official launch of Prof Raymond Parsons' new book Zumanomics Revisited. I was involved in the first drafts of a number of sections and really enjoyed it. Writing blogs is good practise for working on more accessible, popular writing about the SA economy.

This past week a few posts that fit right into the story, caught my eye. The first was a Project Syndicate post that describes the current bumpy ride for emerging markets, South Africa included.

some countries are at risk, especially those with large current-account deficits, large foreign capital inflows relative to the size of their financial markets, and low foreign-exchange reserves. Among the most vulnerable are Turkey, South Africa, Brazil, India, and Indonesia – a group that Morgan Stanley researchers have dubbed the “Fragile Five.” 

Bradford DeLong comments that in the wake of tapering in the U.S., emerging market central banks have three options:

• Raise interest rates to maintain the differential and their currencies, but at the cost of production and employment.
• Maintain interest rates and let the exchange rate deteriorate, hopefully boosting exports, production and employment.
• Split the difference.

The third option is the difficult one if expectations of future nominal currency values against the dollar are not well anchored. Letting the rupee or the rand drop now may not restore confidence if investors then expect a domestic exchange-rate inflationary spiral. In South Africa such a fear may be well founded considering current wage claims and strike action. At Alec Hogg's BizNews, Gideon du Plessis had an excellent post on the highway or dirt road options for South Africa's labour story.

Which brings us back to Zumanomics Revisited. When examining the deficits facing the SA economy, Prof Parsons' political economics background is a big advantage. He makes some key points about the trust deficit between business and labour and government. Trust is exactly what is needed for the highway scenario and the bumpy ride ahead in international financial markets.

More "green" tourism research

If you are interested in Economics and Tourism, the International Association of Tourism Economics conference is the place to be. This year the meeting is in Ljubjana, Slovenia and you can have a look at the conference programme here.

I have a paper there with Melville Saayman on the cyclists participating in the Argus cycle tour, their views on the green initiatives at the race and their willingness to pay to mitigate their carbon footprint. Check it out.

A round-up of posts

Dear readers who stumble across this blog, apologies that April has flown by and I have hardly made any posts. But here is a quick round-up of posts that I made on the School blog:

• South Africa's economic growth prospects (things are not looking good).
• Different perspectives on the challenges we face (real and significant progress has been made since 1994).
• The delivery deficit at local level (there is one).

I am also still playing around with podcasts and have this one on the BRICS summit (in Afrikaans):

Opinion posts about the year ahead

This time of year there are many posts out there with views on the shape of the economy, what to expect in 2013, trends for 2013, ect. They are all fine, but I have been getting worked up about how they are often set against the background of the challenges that the SA economy faces: a low economic growth rate, high unemployment rate, poverty and inequality. But then the discussion that follows is mostly about short-term concerns over interest rates and exchange rates that can play only a small role in addressing those challenges.

So I wrote a whole post about it on the School's blog: The SA economy in 2013.

And by the way, if you are interested in the things that need to get done for the long-term, have a look at Johan Fourie's post: Five wishes for the new year. It's good stuff.

More on the beloved country

Yesterday I weighed in on The Economist's "Cry, the Beloved country" article on the School blog: What if leadership matters?  The point that I try to make is that that there are many different ways of reading “the evidence”. There are indicators of progress and signs of decline. The challenge is to look for clues to the long-run path of growth and development. These clues, I argue, lie in the way that we try to implement our plans, i.e. market-lead vs developmental state. I favour the pragmatic market-lead mixed-economy approach and the post goes on to explain that it requires a working relationship between government, business, labour and civil society. This, in turn, requires some leadership. Not the speechifying, big-man type of leadership. Rather, the inclusive type that can outline a vision, build trust and get disparate groups to work together. 

If we can find evidence of this, South Africa will be fine and The Economist would be wrong. At the moment though, it seems that our political institutions are extractive and the economic institutions look set to remain so as well.

Since writing the post I have stumbled across a few interesting links:

• Marginal Revolution University's latest lecture is on the importance of trust for economic growth.
• National Planning Minister Manual said on Friday: The ANC’s policy-making process under which branches are called upon to make decisions on the nitty-gritty of complex issues "doesn’t work" and is damaging both the party and the country.

Another example was discussions on nationalisation. At the ANC’s policy conference in June, delegates queued up to voice their support for nationalisation, not wanting to be seen to speak out against the idea. "That is policy-making by vuvuzela," Mr Manuel said.
"Sloganeering around policy" was not in the interests of either the living standards of working people or industry, which would see underinvestment or excessive profit-taking by owners if they feared that nationalisation was a real possibility.

Too true. Another example to the above is President's Zuma's new 5-step land reform plan. Analysts are calling for more detail, but they forget that he is not really speaking to the farming community - the proposals are bait for those that will end up supporting him in Mangaung. What really happens with land reform we'll only learn later. Inclusive, or extractive?

The IPAP-2 and the North West Province

Last week's World Economic History Congress once more left me convinced that I should stick to the things that I love and know a bit about: what happens where and the stories of sub-national growth and development. Earlier this year I wrote about:

• The spatial distribution of manufacturing,
• Industrial policy on my mind,
• IDZs, SEZs and the place of industrial policy, and
• recently I recapped the whole story on the School's blog.

Today I want to take the next step and write about the IPAP-2 and its possible place in the North West province.

Government’s broad approach to industrialisation is set out in the National industrial Policy Framework. The implementation of policy is set out in the Industrial Policy Action Plan (IPAP). IPAP-2 is an action plan designed to help build South Africa’s industrial base in critical sectors of production and value-added manufacturing, which are largely labour-intensive industries. IPAP-2 is therefore designed to address the decline in industrial and manufacturing capacity and contribute to the reduction of chronic unemployment.

The IPAP-2 sets out to contribute to rural development, advanced technological capabilities, downstream minerals beneficiation, promotion of energy efficient goods and services, strengthened linkages between tourism and cultural industries, interaction between sector strategies and the creation of sustainable jobs. To make these contributions, each of the above can be related to key sectors on which the IPAP-2 will focus. These can be clustered into three groups.

The policies outlined above clearly have to be formulated at the national level (competition, regulation, trade policy), but have particular sub-national impacts. The implications for economies at provincial and local level are closely linked to the location of the sectors identified in IPAP-2. The firms that produce the goods and services are located in specific provinces, cities and towns and while the pursuit of the different IPAP-2 polices may be driven by national government, it has implications for provincial authorities.

To link the IPAP-2 to the North West province one first needs to consider the nature of the provincial economy. First, the North West province is a relatively small player in the national economy. In terms of population the province ranks seventh out of nine provinces with approximately 7.1 per cent of the population. The population density is low at 32 people per square kilometre. The province’s Human Development Index score of 0.51 is slightly below the national average of 0.56. In terms of contribution to the national economy, the North West Province does well. The Gross Value Added per capita is approximately R46 684. It is below the national average of R49 344 in 2010, but the province ranks fourth out of the nine provinces.

The second point to consider is the unique make-up of the provincial economy that has particular implications for the interpretation of the IPAP-2. The following figure shows the primary, secondary and tertiary sectors’ contribution to gross value added in 2010.

In the North West province the primary sector plays a larger role than in any of the other provinces. Along with the Northern Cape and Limpopo provinces the secondary sector (manufacturing) makes up a small part of GVA (8.2%). The tertiary sector contributes half of the provincial GVA. When the provinces’ share of national total GVA is examined in the following figure, it is clear that the North West makes the biggest contribution to primary sector GVA. Following the Northern Cape it makes a very small contribution to secondary sector GVA. Even though the tertiary sector accounts for half of the provincial GVA, the tertiary sector in the North West contributes only 5 per cent of the national gross value added.

A detailed breakdown of GVA and employment in the North West province confirms the large contribution of the primary sector, specifically the mining sector to GVA and employment. The sectors that are grouped together as the tertiary sector, from retail to transport and communication, finance and real estate, education and health etc., make up 49 per cent of value added and almost 45 per cent of employment.

The implication for the interpretation of the IPAP-2 for the Province is that the manufacturing focus of the IPAP-2 has only a limited footprint in the province. Since the manufacturing sector is small, the gains from industrial policy are likely to be limited. For the province the challenge will be to identify linkages between the primary and secondary sector and to consider the product space and scope for down-stream beneficiation, linked to national and international opportunities for such products.

The table below shows that matching of the sectors for which data are available at provincial level and the IPAP-2 clusters of sectors. It is not possible to clearly match the IPAP-2’s green and energy saving industries, automotive components and vehicles, bio-fuels and business process servicing to the available industrial classification of sectors from the Regional Economic Explorer database. The whole of cluster 3; nuclear, advanced materials and aerospace can also not be matched at provincial level. For the other IPAP-2 sectors there are close-enough proxies in the REX database. Cultural industries and tourism is matched with hotels and restaurants, which is not a close match, but also not too unreasonable to work with.

Taken all together the match between the IPAP-2’s focus sectors and the current state of production in the North West province is limited. Cluster 1 industries represent 2.6 per cent of value added and Cluster 2 industries make up 3 per cent of value added.

It is possible to have a closer look at the component sectors of clusters 1 and 2 in terms of their contribution to the provincial economy in 2010 and growth in GVA, employment and gross operating surplus over the period 1996 to 2009.

The table confirms the fact that the sectors in the IPAP-2 clusters make small contributions to the economy of the North West province in terms of value added, employment and gross operating surplus. The cultural industries and tourism seem to be slightly more labour intensive. The table below shows the growth rates over the period 1996 to 2009.

Thus, my point is that there is only a limited match possible between the IPAP-2 and the small manufacturing sector of the North West province. National and provincial politicians have to be careful when pursuing industrial policy. Targeted support of industries, or special economic zones may fail simply because there is no viable cluster to support.  So-called localisation (import substitution by any other name) is also likely to fail without the elements that make up a successful agglomeration: a pooled labour market, specialised suppliers of intermediate inputs, knowledge spillovers, and infrastructure. In the North West province policies focus should be on the factors that drive long-term competitiveness - lots of scope for research and blog posts!