Three Lectures in Economics by Kenneth Creamer Lecture

Three Lectures in Economics by Kenneth Creamer Lecture 1: Introduction to Economic Concepts and Data Lecture 2: Economic Policy and Budgeting Lecture 3: Globalisation and South Africa as an open economy

Lecture 1 Introduction to Economic Concepts and Data

Introduction to Economic Concepts and Data 1. 2. 3. 4. Basic Concepts – what is economics Measurement and economics Key South African data The Human Development Index and choice of growth path 5. Revision questions 6. Historical political economy of South Africa

Topic 1. Basic Concepts: What is Economics? • “We don’t see dogs trading bones” – Smith • Economics is the study of the processes of production, exchange and regulation fundamental to human society • Human beings specialise => increased productivity => increased output and => dependence on trade • Interdependent human society where car-makers can buy food, school teachers can buy cars and car maker’s children can be educated

Who is analysed in economics? • Major role players in a ‘mixed economy’: – Households (made up of individuals - provide labour and consumption) – Firms (provide organisation and know-how/ technology for production) – Government (various tiers offering services and enforcing laws and regulations) – Public enterprises (provide goods and services of strategic importance or that would not otherwise be provided) e. g. electricity industry, steel industry, etc. • The factors of production are labour (households), capital (public and private firms) and land, all of which operate within the regulatory framework of the rule of law (government)

What types of tools are used in economics? • Conceptual: – definition of terms and ideas e. g. inflation, balance of payments • Historical: – track trends and changes over time • Empirical: – measurement of data, reflecting on concrete experience • Theoretical: – developing propositions concerning the relationship between economic variables e. g. low to moderate inflation will stimulate economic growth • Policy: – actions or policies to guide economic behaviour towards desired outcomes e. g. “intended consequences” of expanded social assistance system is poverty alleviation, also “unintended consequences” (UK window tax)

Defining 10 Key Concepts 1. 2. 3. 4. 5. 6. Economic Growth Inflation Unemployment Exchange Rate Fiscal Policy Monetary Policy 7. Balance of Payments 8. Stock Market 9. Competitiveness and economies of scale 10. Industrialisation

Topic 2. Measurement is important in economics “What can be measured can be changed” Measuring pure economic data: e. g. measure quantities e. g. level of output, value of exports, or value of imports Measuring levels of human development: e. g. measures which are ‘indicators’ of quality of human life, such as, literacy, health measures, life expectancy, food / calorie in take

Measuring Economic Performance (Must be comfortable with large numbers: millions, billions and trillions: How many people in the world, Size of South Africa’s GDP…) Gross Domestic Product (GDP): Measure of the total output of goods and services produced by a country’s economy Gross Domestic Product per capita (GDP per capita): Total output divided by the number of people in the economy Example: If in 2007 the GDP of South Africa is R 1 965 bn and there are 48, 5 million people in South Africa then GDP per capita is equal to: R 1 965 bn divided by 48, 5 million = R 40 515 person per year, or R 3 376 person per month

Two complications with using GDP to measure economic performance Complication 1: The value of money changes due to inflation (nominal vs real GDP) Complication 2: GDP per capita is too broad and unspecific as a measure of human development – it conceals as much as it reveals, other measures are required to track the quality of growth

Inflation and real versus nominal GDP growth Problem If inflation is running at 5% (i. e. in general prices rise by 5%) in a particular year then the nominal value of GDP will rise from R 1 000 bn to R 1 050 bn even though there has been no real increase in output. Solution Nominal GDP is adjusted to take account of inflation and this gives real GDP. For example: If GDP is R 1000 bn in 2007 and is R 1 100 bn in 2008 then NOMINAL GDP growth is equal to 10%, but if inflation is at 5% then REAL GDP growth is equal to NOMINAL GROWTH MINUS INFLATION = 10% - 5% = 5% Note REAL GDP GROWTH is the amount by which the value of economic output has increased as a result of actual growth i. e. after stripping away the nominal effects of general price increases/inflation.

Real GDP Growth

Measuring human development GDP – measures economic output / product of a country GDP per capita – measures average output person Problem GDP per capita indicates an average whereas the reality may be that the society is divided between the few very rich and the many very poor. For example, whereas GDP per capita in South Africa may be about R 40 000 person in reality a few very rich people have an income of more than R 1 000 per year and millions of poor people are living off less than R 5 000 per year. Solution Economists use a wider range of measures to track human development and assess social welfare.

Per capita income for rich and poor

Percentage of population living on less then R 3 000 a year (based on year 2000 rands)

Topic 3. Key economic indicators of South Africa – Know your country better • • Population Growth Migration Patterns Racial composition Size of household Type of household Energy used for lighting Energy used for cooking Access to piped water – Source: Stats SA’s Community Survey 2007, in which 274 348 dwelling units in all provinces were visited by field workers and completed a detailed survey • Gross Domestic Fixed Investment • Government Debt • Exports • Employment • Unemployment • Social Assistance • Tax payers • Life Expectancy • HIV Prevalence • Adult Literacy Rate • Voter Participation – Source: Development Indicators, Mid-Term Review, 2006

Population Growth to 48, 5 -million

Migration patterns

Racial patterns

Size of households

Type of household

Energy used for lighting

Energy used for cooking

Access to piped water

Gross Domestic Fixed Investment

Government Debt

Exports

Employment

Unemployment

Social Assistance

Tax payers

Life Expectancy

HIV Prevalence

Adult Literacy Rate

Voter Participation

Topic 4 Human Development Index and choice of growth path Three specific measures of human development are combined with GDP per capita to provide a composite measure of human well-being. Components of HDI: Life expectancy at birth (years) Adult literacy rate (% aged 15 and above) Level of enrolment in educational institutions (%) GDP per capita (PPP US$) HDI uses measures of (1) long and healthy life, (2) access to knowledge and (3) level of income to assess human development.

Selected HDI Data (2006) Country Life expecta ncy at birth Adult literacy rate Education enrolment ratio GDP per capita Rank Norway 79, 6 99 100 38 454 1 United States 77, 5 99 93 39 676 8 Cuba 77, 6 99, 8 80 5 700 50 Saudi Arabia 72, 0 79, 4 59 13 825 76 South Africa 47, 0 82, 4 77 11 192 121 India 63, 6 61 62 3 139 126 Nigeria 43, 4 67 55 1 154 159 Sierra Leone 41, 0 35, 1 65 561 176

Compare SA’s HDI – 1997, 2002 & 2003 South Africa’s 1997 HDI 2002 2007 Life expectancy at birth Adult literacy rate Educational enrolment GDP per capita 63, 7 years 52, 1 years 47, 0 years 81, 4% 85, 3% 82, 4% 81% 93% 77% $4 291 $9 401 $11 192 HDI rank 90 th 107 th 121 st

Quality of growth While GDP growth is a prerequisite for human development. Studies have found that GDP growth does not always lead to an improvement in the quality of lives of people (and an improvement in indicators such as life expectancy and level of education). Certain problematic types of growth are as follows: Jobless growth– GDP grows but the number of formal sector jobs declines and inequality increases (current trends in SA have tended to follow this pattern). Ruthless growth – where growth results in increasing polarisation between rich and poor.

Quality of growth (continued) Voiceless growth - undemocratic forms of growth with forced labour and/or banned trade unions Rootless growth – growth in GDP but people’s cultural identity is lost (developing countries experiencing forces of cultural imperialism and not developing their own cultural industries) Futureless growth – where GDP growth is environmentally unsustainable (cutting down forests without replanting, or depleting coastal fishing stocks)

Summary • Measurement of trends in society is important to gauging progress in social and economic transformation • The economic method: – Based on data, theories are developed and policies implemented in order to move towards desired social outcomes such as increased GDP growth, reduced inflation, decreased unemployment, increased incomes for poor households, reduced child mortality, etc – activists to ensure that the right issues are highlighted in economic analysis, issues of human development such as literacy, household incomes, nutrition, employment, etc.

Topic 5. Revision Exercise – Report on Economic State of the Provinces • Population – In 2007 how many people lived in the province – Give a % breakdown by race • Education – In the 200/01 budget, how much was allocated to education per learner (compared to the national average of R 3 511) – What is the trend in the province’s matric pass rate from 1994 to 2000 • Health – What is the trend in the % of women attending antenatal clinics infected with HIV-AIDS from 1990 -99 – What were the two next most serious diseases in the province in 1998 • Housing – How many houses were built in the province between 1994 and 2000 – To what extent was this above or below target

Group Exercise – Report on Economic State of the Provinces (2) • Income – In 1999, what was the most common income category in the province – What % of black, coloured, indian and white households live in poverty (based on 5 person households earning less than R 1500 per month) – How does the weighted average of households living in poverty compare to the SA average of 47, 4% • Unemployment – In 1999, what % of blacks, coloureds, indians and whites were unemployed in the province (in terms of the expanded definition) – How does the weighted average of unemployment in the province compare to the SA average of 37, 8% • Public Finances – How much revenue was available to the province in 1999/2000 – What % was from national revenue collection and what % from own revenue (what are the sources of own revenue) – IN 1999/2000, how much did the province spend on education, health and welfare

Topic 6. Periodisation of South Africa’s political economy – Verwoerdian apartheid economy – Reform of the late 1970’s – Reform of the 1980’s – Collapse of apartheid – Post-apartheid economy

Verwoerdian apartheid 1948 -1970 • Accumulation Strategy – Import substituting industrialisation – tariff barriers, R&D, developed Sasol, manufacturing base (Afrikaner empowerment) – Cheap labour policy – homeland system with influx control and lower wage for migrants, bantu education with low skills and low pay • State programme – Racial domination and ‘racially defined social welfare state’ with white access to education, UIF, housing, etc. • Conclusion – Apartheid functional to accumulation strategy i. e. racial oppression served programme of industrialisation

Crisis of Verwoerdian apartheid (1970’s) • Apartheid’s racial oppression and exploitation became dysfunctional to accumulation: – Manufacturing industry required a more skilled and settled urban workforce (not only migrant labour) (such would also provide a market for its outputs) – Bantustans failed to be self-sustaining and could not provide subsistence, putting upward pressure on urban wages – Black urban work force began to demand rights (strikes of 1973 turning point) – 1976 uprising against bantu education system, (Morris notes that intensified as black urban population was homogenised with very little opportunity for upward mobility)

1 st Phase of Reform – 1970’s • Wiehanh Commission – black trade unions limited trade union rights • Riekert Commission – black local authorities to be given greater administrative control • Vision – boost economic accumulation by allowing a group of black insiders to settle permanently in urban areas (increase productivity and serve as a market), but without any meaningful political rights • Failed because: – Black local authorities met resistance as own administration required increased rentals and service charges – Black / non-racial trade unions not co-opted, but used limited space for political protest (Tri-cameral parliament plus BLA’s met with launch of UDF)

2 nd Phase of Reform – 1980’s • New Urbanisation Strategy – abolished influx controls and pass laws (end of the ‘grand apartheid’ notion of territorial segregation) • Reflected demands of capital (business) as inflow of labour from the bantustans and rural areas would put down-ward pressure on wages, which had been pushed-up due to unionisation • Effect – begun process of de-homogenising urban black population (e. g. township suburbs vs squatter camps), linked to the ending of ‘petty apartheid’ such as separate amenities, immorality act

Collapse of apartheid • Apartheid became dysfunctional to capital accumulation • A new economic growth path or new development path was needed as millions of South Africans were being structurally excluded from the economy • Apartheid state was left debt-ridden which severely handicapped the democratic government’s ability to spend and increase services to all – therefore a new macro-economic policy was needed • A new industrial policy was needed which would create more employment opportunities, increase skills levels and increase the level of international competitiveness

Contestation of Post-apartheid Economy • National question resolved – “the land belongs to all who live in it” • Contestation continues over the most appropriate post-apartheid accumulation strategy, but a new hegemony is taking root which is subject to ongoing contestation from the left and right: • Characteristics of the new hegemony: – Mixed economy with reducing role for the state and commitment to development of the private sector – Commitment to equal opportunity with a degree of historical redress (distinct from equality of outcomes) – Local industry must become internationally competitive based on low cost inputs and higher degree of skill and know-how – Increasing levels of inequality and failure to include the poor and unemployed

Post-apartheid economy (cont. ) • Contestation from the right: – Down-sizing of the state – Increased de-regulation – Privatisation for ideological rather than service-oriented reasons – Protection of historical white privilege • Contestation from the left: – Strengthen the role of the state to ensure equitable development (that all benefit rather than only a few) – Ensure appropriate regulation e. g. the labour market, the conduct of monopolies, etc. – Restructure state assets e. g. telecoms, energy, transport in such a way as to promote access and social development – Ensure that issues such as social justice, equality and the war on poverty dominate state policy making

RDP and GEAR • The democratic govt’s economic policies were contested from the left and the right • The RDP attempted to fundamentally change the structure of the economy with a policy of ‘growth through redistribution’ (e. g. large scale housing programmes and social infrastructure), • But the fiscal position of the state and its technical capacity may have been too limited for such a programme • GEAR was implemented to promote ‘redistribution through growth’: – limit government spending and reduce government debt – Reduce the role of the state in favour of the capacity of the private sector • Key critique of GEAR is that it has failed to deliver growth and that it has no effective plan to bring in the historically excluded (60/40 or 80/20 solution)

Lecture 2 Economic Policy and Budgeting

Topics covered in Lecture 2 1. Macro-economic Theory 2. Economic Policy Issues 3. Budgeting issues and processes

Topic 1. Macro-Economic Theory Y= C + I +G + X - M C = Consumption is expenditure by households, and business on goods and services, what is not consumed is saved I = Investment is private sector expenditure on capital goods (e. g. machinery, infrastructure) and Investment is spent out of that which is saved (through intermediation in the financial system - banks, pensions funds)

Macro-Economic Theory(cont. ) G = Government spending on goods, services and infrastructure is dependent on the taxes revenue raised plus borrowing (the deficit) X = Income gained through exports from SA to foreign countries M = Income lost due to purchases by South Africans for imported goods X - M = Current account of balance of payments (+ve = surplus, -ve =deficit)

Macro-Economic Theory(cont. ) • Neo-liberal assumption Reduced government involvement in economy (G) will lead to a stimulation of private sector investment (I) i. e. avoid the ‘crowding-out’ problem where government and private sector competition for savings leads to an increase in interest rates and a decline in Investment Note: Private sector seeks greater profits by taking on formerly public sector activity. And govt seeks to avoid neutralisation through debt.

Macro-Economic Theory(cont. ) • Progressive / Keynesian assumption Increased government involvement (G) leads to a ‘crowding-in’ or multiplier effect by increasing levels of consumption by individuals (C) and levels of investment (I) due to the fact that government invests in infrastructure which often serves as a precondition for increased private sector investment. Note: Less emphasis is placed on the upward pressure on interest rates. And government spending must be well targeted to promote development so that increased future revenues avoid debt trap.

Macro-Economic Theory(cont. ) • Demand side factors (e. g. levels of G, C, I and X): - critical to ongoing stimulation of the economy, especially the role of G given the inherent instability and lack of co-ordination of private sector activity • Supply side factors - (e. g. reduced unemployment, increased skills levels, introduction of new technology) - improvements to the level of employment and productivity of labour and capital is crucial to long run economic growth

Topic 2. Economic Policy Issues • • Fiscal policy Monetary Policy Exchange Rate policy Industrial Policy Competition Policy Trade Policy Labour Market Policy

Fiscal Policy Expenditure = Tax revenue + Borrowing Questions: 1. How much tax should be raised and who benefits? (tax cuts benefit those with income) 2. How much should be borrowed? (lowering or increasing interest burden for future generations) 3. How can the tax structure and tax incentives be used to promote social and economic objectives? (issues such as tax holidays and the social impact of taxes like VAT) 4. How much should be spent and on what?

Does SA raise sufficient revenue? • SA raises revenue of 24, 6% of GDP, the 2003 World Development Indicators revenue to GDP ratios for the year 2000: • Czech Republic 32, 7 percent, • Denmark 36, 2 percent, • Finland 32 percent, • Germany 31, 3 percent, • Morocco 29, 6 percent, • Namibia 32, 6 percent, • New Zealand 30, 6 percent, • Poland 31, 1 percent, • Sweden 39, 4 percent, and • United Kingdom 36 percent. • Global average for low and middle income countries was revenue at 17, 1 percent of GDP in the year 2000.

Does SA borrow enough? • After years of reducing borrowing by reducing the deficit (i. e. spending minus revenue), a more expansionary policy has been adopted in this regard with the 2003 MTBPS lifting the deficit to over 3% of GDP for the first time since the GEAR framework was announced in 1996 • Question – whether such a restrictive framework was ever appropriate, given: – appeared to follow conditionality for very different circumstances of EU membership (which has now been rejected) – global average deficit to GDP ratio for low and middle income countries was 3, 3 percent of GDP in 2000

Fiscal Policy (cont. ) • Policy = fiscal restraint • Positives: – Improved ratings by credit agencies, making it cheaper for govt. to borrow – Reduction in debt and annual interest repayments • Weaknesses: – Government social programmes have been limited and capacity of state has not been developed – Investment levels have not risen sufficiently as ‘crowding-in’ rather than ‘crowding-out’ assumptions would be more appropriate to development (NOTE: ‘crowding-out’ is said to occur where government spending pushes up interest rates leading to reduced investment by the private sector

Monetary Policy • Policy = Inflation targeting • Positives: – Provides a clear purpose for monetary policy (as opposed to monetary or exchange rate targeting) • Negatives: – Setting of low inflation target results in reduced output “sacrifice ratio” mainly due to the fact that high interest rates are required to bring down inflation – IT regime likely to be disrupted by unregulated capital flows which cause exchange rate fluctuations e. g. weakening of Rand will lead to imported inflation and SARB will respond with high interest rates even if internal situation requires low interest rates, investment and employment – IT mandate of SARB not sufficiently balanced to take into account inflation as well as output and employment

Exchange Rate Policy • Policy = Free float with liberalised financial flows • Positives: – No requirement to use reserves to protect fixed value of currency – Should provide inherent flexibility to deal with foreign shocks e. g. global demand reduced then rand will weaken making exports cheaper • Negatives: – Currency volatility is disruptive to investment decisions and trade (as well as social implications e. g. food inflation due to import parity pricing) – Capital movements have potential to disrupt financial systems and overwhelm real economic factors during crises (resulting in recommendations for Tobin taxes or speed bumps, etc. )

Industrial Policy • Policy = microeconomic reform • Positives: – Focus attention on supply-side factors such as training, skills and logistics – Reduced risk of offering support to uncompetitive and unsustainable industries • Negatives: – Insufficient role for state in ‘leading the market’ and thereby aligning incentives, institutions and other policies towards strategically targeted industries – Insufficient role for the state in guiding industry onto a path of dynamic comparative advantage (as opposed to static comparative advantage – based on historical endowments and power relations)

Competition Policy • Policy = promotion of competition • Positives: – Increased legal and institutional credibility for robust competition policy that regulates corporate conduct and through merger regulation, market structure – Allows for public interest in mergers to be taken into account, including impact of merger on employment levels • Negatives: – No clear policy emerging on pricing practices and at times collusion, which allows for import parity pricing, in key markets like food, chemicals and steel – Result is to limit potential for downstream job creation that could be assisted by lowering input costs

Trade Policy • Policy = promote free trade • Positives: – Reduced protection for SA industry has assisted some in becoming globally competitive (even here ongoing support has been required e. g. automotive industry) • Negatives: – Without tariff protection certain labour intensive industries, such as textiles, have been damaged – Assumption that there would be reciprocal opening of markets (particularly in key sectors such as agriculture) have not been realised – Developed countries continue to use free trade dogma to promote their own interests through attempts to include issues of investment agreements, non-tariff barriers and intellectual property protection

Group discussion • How does economic policy effect society? • What should be the main goal of SA economic policy? • How could the capacity of the state to play a developmental role be enhanced? • How would changes in the rules of world trade impact on workers and their communities? • What role should SA play in global economic institutions?

Topic 3 Budget Issues and Processes • • Basic data and trends in SA govt finances Arguments regarding deficit and tax policy Expenditure issues Case study: Education spending Tax issues Local govt Budget process

Key fiscal trends

Projected fiscal developments

Government debt declining

Effects of tight fiscal policy • Inflation has been declining steadily since 1996 • Real interest rates are lower • Policy certainty and credibility has been established (crucial for any new govt. ) • From 2001 budget real spending could increase • Debt service costs reduced • Room to increase infrastructure spending • Focus shifts to quality of spending • Negative – macro-economic stabilisation was achieved at the expense of addressing the ‘social deficit’ – access to housing, basic services, quality education, etc. remains limited for the vast majority

Note on pro’s and cons of foreign borrowing • Limited foreign borrowing shows confidence of country • Brings forex into country, same effect as FDI – Boosts reserves, stabilises currency – Allows forward book to be run down – Relieves pressure on domestic capital markets – Contributes to lower interest rates • In the absence of FDI, is a sensible thing to do

Risks of foreign borrowing • Risks – If currency depreciates, interest payments may increase rapidly – Interest payments constitute capital outflow – Large amounts of foreign borrowing strengthens the currency • This could harm exports • Cause Balance of Payment imbalance

Post-Gear what should be the policy emphasis? • Govt used Gear to but back spending to avoid a debt trap, now that this has been achieved what should be the emphasis of government policy: – Cut taxes – Cut the deficit – Increase infrastructure spending – Increase welfare spending

(1) Reducing the tax/GDP ratio – Considering that few people in formal tax net, tax rates are too high, Middle income people pay very large proportion in taxes – Tax system places too high a cost on production, lower taxes would boost the economy as this would: • Lower production costs • Increase domestic demand • Boost private savings • Increase economic growth • Tax/GDP ratio would naturally rise as economy grows faster, employment increases

(2) Lower fiscal deficit – continue to restrict spending – Deficit of 2% still higher than competitor countries – Structural weakness of low savings rate still not fixed - hence real interest rates still high – Government capacity to spend at present is weak – A lower deficit of about 1% to 1, 5% would • Contribute to lower risk rating, lower interest rates • Cushion against a serious recession • Provide more room to respond to challenges in future years • Lower debt service costs - releasing more money for social spending

(3) Increase spending (infrastructure) • More capital spending – Deficit financed capital spending doesn’t contribute to lower national savings – Lean years forced reduction in capital, maintenance – Higher capital spending will crowd in private sector investment – Social infrastructure is great for equity – Economic infrastructure lowers costs of business

(3) Increase spending (welfare) • Higher welfare spending – Poverty is actually an obstacle to economic growth • Poor nutrition reduces learning outcomes, increases health costs – Transport, municipal costs high, resulting in under-utlisation of infrastructure – More cash welfare payments would allow utility markets to work better, attracting investment – Govt. capacity to spend on capital is weak

Budgeting: Process • What is contained in govt’s budget? – Expenditure decisions • How much to spend on what items? – Revenue decisions • Who to tax and how much? – Overall macro-economic decisions • How much debt should the state get into in order to stimulate the economy

The steps in the budget process? • Setting policy priorities – Cabinet sets political priorities for the budget process e. g. from recent years infrastructural spending, welfare spending or spending on HIV-AIDS • Fiscal framework is established – Set revenue target and deficit target (Gear set these at 25% of GDP and 3% of GDP respectively) to establish the ‘resource envelope’ • Division of revenue – Vertical : national ! provincial ! Local – Horizontal : - various departments • Bidding process – Govt department approach Medium Term Expenditure Committee and bids for resource allocations – the value of requests is significantly larger than the amount available, also an incremental process not a zero-based one • Cabinet and Cabinet Committee scrutnises the proposed allocations and approves • Budget documentation is approved and presented on Budget Day [ Process runs from June to February, P 143, Naidoo]

Weakness with budgetary process • The setting of sending, tax and macro-economic policies is top-down with minimal parliamentary oversight or public participation • Currently, Parliamentarians are only in a position to accept or reject the budget as presented on Budget Day, no amendment of the budget as presented is possible • This is despite the constitutional provision that requires legislation to empower parliament to amend the budget and other ‘money bills’ • Why? There is concern that after the lengthy process of drawing up the budget in the executive that Parliament would delay the budget or propose changes that are difficult to implement • Answer? It is important that Parliament should have a real say in shaping the decisions which effect all South African’s and the capacity of parliament should be strengthened to do this in an effective manner, also of civil society through parliament and Nedlac, etc.

Budget: Spending • In the budget, government spending is classified in two ways: – Functional classification: by government department e. g. education, health, defence, etc. – Economic classification: by type of spending e. g. • Current spending – salaries, subsidies, welfare transfers • Capital spending – infrastructure, roads maintenance, buildings, etc

Projected expenditure in 2003/04 (by function) Rbn Protection Defence & intelligence (R 19, 6 bn), police R 52 bn services (R 20, 1 bn), prisons (R 7, 6 bn), justice (R 4, 8 bn) Social services Education (R 66, 4 bn), health (R 33, 6 bn), welfare (R 36 bn), housing (6, 8 bn) % of total 16, 8% R 144, 2 bn 46, 5% Economic water, fuel and energy, agriculture, forests services and fishing, mining manufacturing and construction, transport and communication R 25, 6 bn 8, 3% General services R 28, 8 bn 9, 3% R 51, 0 bn 16, 4% Reserve R 8, 8 bn 2, 6% Total R 310, 3 bn 100% Interest [down from 4, 9% of GDP in 2001 to 4, 4% of GDP in 2003]

Projected expenditure in 2003/04 (by economic type) Rbn % of total Current Personnel (R 109, 3 bn), R 275 bn spending other goods and services (R 40, 4 bn), interest (R 51 bn) 88, 6% Capital [Note a trend increase in R 26, 5 bn spending capital spending from 7, 1% of total in 2001 to 8, 5%] Reserve R 8, 8 bn 8, 5% Total spending 2, 6% R 310, 3 bn 100%

Expenditure Policy tradeoffs • Should we spend more on personnel? – Government has serious capacity problems – In some areas, we need to hire more people, in others we may need better pay • Should we spend more on infrastructure? – Capital spending provides highest economic returns, but capacity constraints limit progress – Social infrastructure is good for equity – Economic infrastructure lowers production costs, crowds in private investment

Policy tradeoffs • Should we spend more on welfare transfers? – Social security well targeted towards poor – Alleviates worst effects of poverty – Better nutrition may lower costs in health, education – Do we increase child support grant in value or do we give more people the grant? – How do we create jobs, avoid a dependency culture?

Policy tradeoffs • Within social services – Do we spend more on health and education? – Do we expand social safety security net? – How do we tackle HIV/Aids? • Access and equity were priorities for past five years – How do we begin to improve quality in these services? • Do we allow higher local and provincial taxation and borrowing, now that national government has stabilised public finances?

Reprioritisation – guiding expenditure • Reprioritisation from apartheid expenditure patterns to more equitable service delivery – From defence to social expenditure (criticism continues in this area) – From racially-skewed social services to equitable social services (challenge is ongoing) – From current expenditure to capital expenditure as social infrasturucture is key driver of equitable social development (must continue to prioritise the development of human capacity in public service even though personnel is current expenditure e. g. clinics need skilled doctors and nurses)

Social issues and govt expenditure • Pattern of pro-poor expenditure should prevail • Gains should not be eroded – e. g. suggestion that nominal value of the SOAP be maintained which would have seen a decline in real terms • The ‘take-up rate’ of social services must be taken into account – e. g. where people have the right to access certain services such as welfare grants, but the state’s administrative capacity means only a small % of those with the right are in a position to exercise it

Pro-poor spending • The redistributive effect of govt. spending must be monitored to ensure pro-poor spending • Key question: how much of government spending on a particular service gets to poor households – Strong redistributors – Social assistance such as State Old Aged Pensions (SOAP), child maintenance, also housing (Diagram: indicates that 80% of the welfare grants get to the poorest 60% of households) – Weak redistributors – spending on education and health (an FFC study in 1998 found that only 40% of the country’s schooling budget goes to the poorest 53% of the population and that 23, 4% of these resources benefit the richest 12, 5% of households) – Non-redistributor – spending on tertiary education benefits better-off households more than it benefits the poorest

Equity in spending

Case study: Education Historical spending trends • In 1996/97, education spending went up 22, 1% in real terms – Mainly personnel driven – But also large RDP fund capital projects • Between 1997/98 and 2000/01, spending has declined by 2, 5% a year in real terms • W Cape, E Cape and KZN saw largest real cuts • Personnel spending declined by 1, 6% a year • Non-personnel fell by 7, 8% a year • Education fell as share of provincial budgets

Historical spending trends • During this period of consolidation – Teacher rationalisation and redeployment – Improved financial management – SA Schools Act gives greater powers to parents • Effect is a much more stable education system in most provinces • Budgets are sustainable, cost drivers under control • More balance budgets

2000/01 • 2000/01 budget signaled a turnaround • Education budgets grew by 1, 4% in real terms • Faster growth in KZN, E Cape and N Prov • Personnel grew by 0, 9%, mainly due to once-off payments • Non-personnel grew by 5, 6% in real terms • Rationalisation and redeployment process near completion in most provinces

Medium term projections • From 2000/01 to 2003/04 – Education spending to grow by 1, 5% – Spending grows strongly in KZN, E Cape, Free State and Gauteng – North West and N Cape still see slight real declines – Capital spending set to grow by 53% a year – Other non-personnel by 9% a year in real terms

Per learner comparisons • Provincial average of R 3 658 per learner • N Cape (R 4 801), Gauteng (R 4 396) and W Cape (R 4 392) amongst highest • KZN (R 3 067), E Cape (3 4 36) and N Prov (R 3453) amongst lowest • Disparities mainly due to enrolment rates, cost of teachers and relative priorities • Most provinces doing well in terms of 85: 15 split in budget • Poorer provinces still have work to do in this regard

School enrolment • School enrolment increased from late 1980’s, accelerated from 1994 to 1997 • Enrolment has begun to decline, mainly for demographic reasons • Learners number peaked at 12, 3 million in 1997, will fall to 10 million in 10 years time Access to education achieved, how we’re doing on equity and quality?

Enrolment, pupils and classrooms

Teachers and classrooms • Pupil teacher ratio declined in all provinces from 33, 7 to 32, 7 – Eastern Cape 36 to 31 • However, classroom pupil ratio still higher, due to excess teachers in some provinces • Northern province has 20% more teachers than classrooms • Hence, pupil teacher ratio looks good, but classes still overcrowded

Overcrowding

Physical infrastructure • In 1996 – 59% without telephones – 55% without sanitation – 40% with no running water – 60% without electricity • In 2000 – 34% without phones – 17% without sanitation – 34% without running water – 47% without electricity • About 25 102 classrooms built since 1996

Maintenance • In 2000, 15% of all toilets did not work due to lack of routine maintenance • School condition categorised as: – Excellent or good dropped from 11 000 to 5 000 – Schools needing repairs went up from 10 500 to 12 100 – School classified as weak went up from 3000 to 7000 • In 2000, only 1% of all schools under renovation, this should be closer to 3%

Spending on fixed assets • Dropped from R 1, 4 billion in 1996/97 to R 432 million in 1998/99 • Maintenance spending dropped from R 232 million to R 104 million • Total spending on fixed assets dropped from 4. 5% of budget to 1, 6% – Largest drop in E Cape, from 4, 6% to 0, 25% and KZN from 6, 8% to 1% – Gauteng had smallest decline from 3% to 2, 8%

Computers, crime etc. • No. of schools with computers went from 2 241 (8, 3%) with 34 483 computers to 6 581 (24%) with 59 333 • In Gauteng, only 16% have no computers at all • E Cape, 84% with no computers • 24 540 burglaries in 2000, loss of R 155 million • 5000 assault cases, 1860 serious crimes

Matric results

Matric results • Impressive increase in pass rates in 2000 • However, 14% drop in candidates writing – N Prov 35% drop • No. who wrote maths declined from 50105 in 1999 to 38520 in 2000 • No. passing maths dropped from 27 187 to 24 877 • Same story with science • Low female take-up of maths and science

Budget: taxation • Types of tax – – Direct taxes are levied against a particular person (natural or jurisitic based on their level of income, gain or profit, etc) – Indirect taxes are levied against specific occurences, events or transactions, etc.

Classification of taxes (cont. ) Direct taxes Income tax Indirect taxes Property tax Commodotiy taxes Personal income Death duty Value added tax (VAT) Corporations tax Donations Customs duty tax Capital gains tax Property Import tariffs rates / Wealth tax *

Assessment of direct taxes • Merits – Certainty: tax payer know ho mush to pay and state can estimate its revenue – Equity: direct taxes can be designed to fall more heavily on the rich based on the principle of the ability to pay – Elasticity: govt’s revenue increases with increase in tax rate or increase in incomes of the people (fiscal drag) • Demerits – Inconvenience: taxpayers must submit declaration of income – Evasion (illegal) prone: as taxpayer can falsify his or her records – Can create disincentive to work or save (e. g. if rate is too high on interest from savings)

Assessment of indirect taxes • Merits: – Convenience: indirect taxes are usually paid in small amounts rather than as large lump-sum, is collected by manufacturers and importers and is included in the price of purchase – Evasion is difficult – Coverage is wide – Can be used to promote social welfare e. g. increased ‘sin tax’ on alcohol / cigarettes – Can target luxury goods with higher rates • Demerits: – Regressive: indirect taxes usually fall more heavily on the poor than on the rich – Discourage saving: as price of essential commodities increases (unless zero-rated) – Uncertainty: authorities cannot accurately predict the total revenue form indirect taxes as demand for different goods is influenced by many factors

Social impact of taxation • Progressive rate of tax – The rate of taxation increases with an increase in the tax base – e. g. the rate of personal income tax in South Africa increases from around 30% for middle income earners to 42% for the highest earners • Regressive rate of tax – A regressive tax places the same obligation on rich and poor alike e. g. VAT rate, poll-tax – Key point: A regressive tax takes a declining proportion of income as income rises – e. g. a poor household may pay 14% of it income to VAT (as it spends all of its income on VAT-able commodities) while a rich household will only pay say 7% of its income to VAT as not all of its income goes to VAT-able commodities, but also to savings, etc.

Sources of Revenue in South Africa (*trend of underestimation) 2001/02 (Rbn) 2002/03 (Rbn) Taxes on income and profits 131 682 143 641 Taxes on payroll and workforce 2 800 3 000 Taxes on property 4 709 5 127 Domestic taxes on goods and services VAT 86 705 92 673 Taxes on international 9 427 transactions 10 792 Stamp duties 1 585 1 726 Total 236 808 256 959

Budget: local government • Sources of local govt. finance (rounded-off) – 65%: Fees from payment for services e. g. water and electricity, etc – 20%: Rates – tax on property – 5%: RSC levies – 10%: Inter-governmental transfers (equitable share pluscapital grants channeled through the Consolidated Municipal Infrastructure Programme) Controversies: Challenge that share from inter-governmental transfers is inadequate to fund the necessary developmental programmes of local govt (about 3% of national tax revenue) – leading to problem of ‘unfunded mandates’ 2) Results in persistent inequality amongst local govts e. g. urban vs rural as rural structures have limited own revenue potential

Analysis of local govt revenues • User charges for services such as water, electricity and refuse removal – Cost recovery is important to the sustainability of the service, councils require accurate reliable billing systems – A minimum amount of water, electricityetc. must be made available to sustain life • Property taxes (rates): property owners pay on the basis of their revenues (potentially significantly progressive tax) – Ensuring correct valuation of properties (certain areas not revalued for many years) – Require entrenched system of regular aluation – Bring untaxed areas into the tax net • Regional Service Council levies: tax on companies’ payrolls – Regarded as disincentive to employment, but continues as a source of revenue

• Inter-govt transfers i. e. transfers from national revenue fund to local govt. decided in the national budget process (with active input from Salga and the local authorities) – Campaign for increased resource allocation for local govt. – Concern from Treasury that such transfers will be used to fund the operating expenses of ineffective local govt bureaucracies that will fail to target the poor and provide services • Borrowing by local Government – Potential exists for local govt to engage in borrowing e. g. through the issueing of local govt. bonds, but first track record of good financial management should be established – Central govt concerned of inheriting any bad debts • Concessional finance – Make use of public sector financing bodies such as the DBSA to fund local govt. infrastructural projects on a concessional basis (i. e. on more favourable terms than bank loans) – Also develop technical skills and know-how in such bodies, regarded as a ‘knowledge bank’

Principles of local govt. finance • • • Revenue adequacy and certainty Sustainability Effective and Efficient Resource Use Accountability and transparency Equity and redistribution Investment and development

Integrated Development Planning (IDP) • IDP’s enable communities to align their financial and institutional resources with agreed plans and policy objectives • IDP planning process: – Prepare a workplan – Outline vision / statement of intent – Development framework: Outline what services are to be delivered e. g. refuse removal, water, electricity, – Development strategies: how is this delivery to take place – Operational planning: implementation – Monitoring, evaluation review (e. g. look at impact on HDI in the local govt’s area) Note: to succeed requires community involvement at all stages of the process Review glossary

Lecture 3 Globalisation and South Africa as an open economy

Topics covered in lecture 3 1. Theoretically – what are the pro’s and con’s of international trade 2. How open is the South African economy – understanding the Balance of Payments 3. The dynamics and effects of exchange rate fluctuations 4. Group Exercise 5. Historical evolution of global financial system 6. Policy issues on a domestic and global level

Topic 1 International Trade – Pro’s and Con’s

Theory of international trade • Advocates of free trade – “trade is an engine of development” – Theory of Comparative advantage – countries who can produce goods must efficiently should specialise in production of such goods for export and will then use revenues to purchase imports that cannot be produced efficiently (dynamic not a static notion) – Economies of scale – larger production runs allow cheaper production cost per unit, therefore trade creates efficiencies as production is for export and is not just confined to domestic market – Mutually beneficial gains from trade for all countries

Theory of international trade (cont. ) • Trade pessimists – “free trade will not promote development and may even serve to entrench inequalities” – It has been argued that there is an “absorption problem” i. e. if all developing countries attempt to develop through promoting exports there would not be sufficient demand to absorb these exports (‘fallacy of composition’) – Problem of market access – advanced countries protect ‘grand-father’ industries (e. g. US steel) and subsidies local suppliers (e. g. European food security) – Free trade disallows LDC’s from promoting there own industries (e. g. through import substitution strategies), lack of access to new technology, etc.

• Need a balanced view on international trade: – Positives: can serve to promote development through increased efficiency, increased access to technology and access to larger markets – Negative’s: trade focus should not substitute for national development strategies, and should not undermine policy needed to promote dynamic comparative advantage (promoting new industries) i. e. state can lead the market towards winning industries

Topic 2 How open is the South African economy?

How open is the South African economy? • There are two key economic flows which measure the extent of “openness” of an economy (or the degree to which the economy is integrated into the global economy) • Firstly, the flow of imports and exports (trade in goods and services) referred to as the Current Account of the Balance of Payments – SA in 1994 imports and exports = 41% of GDP – SA in 2000 imports and exports = 49, 5% of GDP

Openness of the SA economy • Secondly, the flow of financial resources (people’s savings seeking good returns) referred to as the Financial Account of the Balance of Payments – Financial accounts (previously known as capital account) are relatively more volatile as certain financial flows or ‘hot money’ flows (such as portfolio investment) move rapidly than trade in lumpy goods and services • Note: Portfolio investment is usually short-run investment in financial assets e. g. shares / equities and bonds • Foreign Direct Investment (FDI) is long-run investment in real assets e. g. land, plant and machinery

Balance of Payments • Bo. P – summarises a country’s foreign economic transactions – Current Account • If imports > exports => deficit on current account • If exports (+ve) > imports (-ve) => surplus on current account – Financial Account • If financial inflows (+ve) > outflows (-ve) => surplus on financial account • If outflows (-ve) > inflows (+ve) => deficit on financial account

Bo. P (Reserves as balancing entry) • If there is a net surplus in both the current account and financial account, then there will be a increase in the country’s holding of FOREIGN EXCHANGE RESERVES • If a deficit on the current account is not off-set by financial inflows (i. e. a surplus on the financial account, there will be a decrease in the country’s holding of FOREIGN EXCHANGE RESERVES • Example: United States is a ‘net borrower’ as it sustains its persistent current account deficit with large capital inflows as investors ‘fly to quality’

Bo. P (Reserves Cont. ) • Foreign exchange reserves are the amount of foreign currency which Central Banks (Reserve Banks) hold on behalf of the country • SA holds reserves in US Dollars, Japanese Yen, British Pounds, Euros and gold • Measure of whether enough Foreign Exchange Reserves are held = how many weeks worth of imports could your reserves pay for • Example: SA had enough reserves to pay for only 7 weeks of imports in 1996, in 2002 reserves were sufficient to purchase 20 weeks worth of imports • Minimum recommended amount of Reserves = value of 12 weeks of imports

Topic 3 The dynamics and effects of exchange rate fluctuations

The dynamics and effects of exchange rate fluctuations • International trade and investment takes place in a world with various currencies • Example: – SA resident buys a German car in Rands, but German car manufacturer will expect to be paid in Deutsch Marks => Rands will be used to buy Deutsch Marks => There is a Supply of Rands and a Demand for Deutsch Marks If there is an increase in the Supply of Rands and an increase in the Demand for Deutsch Marks – the price of Rands will decrease and the price of Deutsch Marks will increase

Exchange rate dynamics • The Rand weakens if we have to use more Rands to buy a single unit of a foreign currency e. g. the Rand weakens from R 8 to the US$ to R 9 per US$ • The Rand strengthens if we can use less Rands to buy a single unit of a foreign currency e. g. the Rand strengthens from R 8 to the US$ to R 7 per US$

Exchange rate dynamics • Question: What causes the Rand to either strengthen or weaken? • Answer: A complex interaction of supply and demand forces. • How does this work: If the Demand for Rands increases relative to Supply (i. e. the Supply of Foreign exchange increases) then the Rand will strengthen If the Demand for US$ strengthens (i. e. the Supply of Rands increases relative to Demand) then the Rand will weaken

Exchange rate dynamics • What are the key drivers of the Demand for Rands (Supply of foreign exchange) leading to STRENGTHENING of the Rand: – Exports of goods from SA bought by foreigners. Positively dependent on South Africa’s competitiveness, on access to developed markets, on the state of the world economy / trading partners. – Financial account inflows where foreigners invest their savings in SA either in FDI (real assets) or in portfolio investments (financial assets). Positively dependent on sentiment about South Africa’s short, medium and long terms economic prospects. Negatively effected by lack of confidence – where perception is as powerful as reality. – Tight Monetary Policy – high interest rates (attracting financial inflows), low inflation rate

Exchange rate dynamics • What are the key drivers of the Supply of Rands (Demand foreign exchange) leading to WEAKENING of the Rand: – Imports of goods from overseas. SA dependent on machinery and technology imports. As SA economy grows there is an increase in imports of such goods. – Financial account outflows where South Africans invest their savings overseas due to diversification and negative sentiment. Exchange controls limit the extent to which such outflows can occur – so called ‘blocked rands’. – Loose monetary policy – low interest rates (less attractive to financial inflows, unless stimulatory of growth) and high inflation

Effects of Exchange Rate Fluctuations • In general, volatility (meaning both rapid and significant strengthening or weakening of the currency) – – leads to uncertainty amongst potential investors and people setting prices in the economy, resulting in slower decision making and placing limitations on growth, with negative impact of employment and growth output – currency becomes target of speculative activity, as ‘reversion to mean’ theory creates speculative opportunities – preferable to have gradual adjustments in currency value in order to foster a greater degree of certainty, but attempts to protect or fix value of the currency are limited by amount of foreign currency reserves and limited forward borrowing

Effects of Exchange Rate Fluctuations • Theoretical effects of strong currency: – Weakens export performance (as cost of exports to foreigners is relatively high – Local manufacturers face external competition and usually lobby for protection – Induces capital flight as devaluation is anticipated – Efforts to defend currency (e. g. through high interest rates) can led to recession

Effects of Exchange Rate Fluctuations • Theoretical effects of weak currency – – Improves export performance (as exports become cheaper to foreigners) – Local manufacturers enjoy a degree of protection as cost of imported goods rises – Effect on capital movements is uncertain and depends on expectations of future currency movements – If less emphasis on protecting currency, then monetary policy will focus on containing inflation and is less likely to result in tight/high interest rate policies inducing recession

Effects of Exchange Rate Fluctuations (in practice) Empirical studies show that real economy factors do not move as rapidly as prices movements i. e. price movements are continuous, whereas real economy decisions are discontinuous : For example: Let us ask: In reality, how do exports and imports respond to a currency devaluation?

Effects of Exchange Rate Fluctuations (in practice) • Because real economy decisions take longer it takes 2 -3 years (empirical studies have shown) for a currency devaluation to result in a situation where the value of exports increases and the value of imports declines (volume effect dominates price effect) • For the first 6 months after a devaluation (price effect dominates volume effect) the deficit on the balance of payments is likely to increase as importers are paying more for imports (and there are no domestic substitutes) and exports have not increased (as external markets have not been found) – the J-curve

Effects of Exchange Rate Fluctuations (in practice) • Two aggravating factors: • If volatility disturbs these factors (if the currency strengthens after an initial devaluation) then decision makers will not be able to sustain gains in export markets • Also, if due to structural factors, the devaluing economy is not in a position to access export markets and/or is not able to generate import substituting technologies then the a devaluation may experience a ‘prolonged trough’ of current account deficit intensification

Effect of Foreign Shocks • Negative foreign shock Such as oil price increase, recession in trading partners, negative sentiment, limitations market access E. g. 1. effect of increase in oil prices will be increased inflation as SA is dependent on imported oil, put downward pressure on value of the Rand as our imports will be more costly increasing out demand foreign currency E. g. 2. recession in US/EU trading partner or limitation of access to these markets will lead to increased exports from SA will have a positive effect on jobs and growth, will lead to increase in demand for Rands and therefore upward pressure on Rand currency value

Effect of Foreign Shocks • Positive foreign shocks Such as a gold or platinum price increase, or a free trade agreement increasing market access to developed markets E. g. 1 Increased gold/platinum price will lead to increased investment and employment in the mining sector, and increased demand for Rands and will tend to strengthen the currency E. g. 2. Increased market access could result in increased exports, leading to an increased demand for Rands and will tend to strengthen the currency (remembering that reciprocal agreements or asymmetrical reciprocity as with the EU FTA will dampen these effects due to increased demand for Euros and European goods)

Topic 4 Group Exercise

Group Exercise on International Economics Format • Television panel discussion on the following topics, with Interviewer asking questions of representatives of each of the constituencies present, including: • Government • Labour • Industry • Unemployed • Reserve Bank • Foreign investor • Each group to consist of seven (7) members i. e. one interviewer and six panelists.

Group exercise (cont. ) Topics (1) The strengthening Rand – good or bad for South Africa? • Ask each constituency: • (1) what they believe to be causing the strengthening of the Rand, and • (2) how they think the strengthened currency will impact on the South African economy as a whole, including inflation, the quantity of imports and exports, economic growth and job creation? (2) The weakening Rand – good or bad for South Africa? • Ask each constituency: • (1) what they believe to be causing the weakening of the Rand, and • (2) how they think the weakened currency will impact on the South African economy as a whole, including inflation, the quantity of imports and exports, economic growth and job creation? (3) War in the Persian Gulf has seen the oil price rise to over $36 per barrel – what does this mean for South Africa? • Ask each constituency: – how the increase in the oil price will effect their particular interest – how the increase in the oil price will effect the South African economy as a whole, including inflation, the value of the rand economic growth

Group exercise (cont. ) (4) Global uncertainty has led to a sharp increase in the gold price to over $400 per ounce – what does this mean for South Africa? • Ask each constituency: – how the increase in the gold price will effect their particular interests – how the increase in the gold price will effect the South African economy as a whole, including the value of exports, the value of the rand economic growth (5) As a result of the development round of WTO talks, the European Union has announced that it will be opening up its market for agricultural goods – what benefit will this have for South Africa? • Ask each constituency: – how the increase in agricultural market access will effect their particular interests – how the increase in agricultural market access will effect the South African economy as a whole, including the quantity of exports, the value of the rand economic growth (6) The United States has announced that it will be closing its market to South African steel exports in order to protect American jobs – what effect will this have on the South African economy? • Ask each constituency: – how the closure of the US steel market will effect their particular interests – how the closure of the US steel market will effect the South African economy as a whole, including the quantity of exports, the value of the rand economic growth

Topic 5 Historical evolution of Global Financial System

Historical Developments in the Global Economy (1) The functioning and demise of the Bretton-Woods system of fixed exchange rates (2) The East Asian crisis (3) Looking-back at the apartheid era balance of payments constraint in the SA economy

Major trends The past decades have seen major changes to the international monetary system, particularly: – shift from fixed to floating exchange rates regimes (study: collapse of the fixed exchange rate system in the 1970’s) – significant increase in private lending and capital flows (study: destabilising effect of capital flows in the East Asian crisis of late 1990’s)

(1) Bretton-Woods system • Gold standard - where all currencies were exchangeable for a fixed amount of gold had been blamed for deflation (Great Depression) (where high r was used to attract investment and maintain reserves) • Post WW 2 imperatives addressed by B-W: – maintain currency stability to promote international trade and avoid destabilising speculation – allow for adjustments in currency where ‘fundamental disequilibira’ occur e. g. persistent Bo. P deficits, so as to avoid pursuit of disinflationary policy (increase in r) or barriers to trade (high tariffs on imports)

(1) Bretton-Woods system (cont. ) • Operation of B-W ‘fixed but adjustable’ system: – exchange rates fixed (oz of gold = $35, all others to the $ and allowed to fluctuate by 1%) – exchange rate adjusted if ‘fundamental disequil. ’ but not by more than 10% and only with IMF permission – IMF also provided conditionality-based ‘credit facilities’ to countries with BOP problems (to avoid deflation and barriers to trade)

• Collapse of B-W fixed/adjustable system: – $ became overvalued and US experienced unsustainable BOP deficit, speculators moved out of the $ knowing it would have to be devalued (and other currencies strengthened) – US $ liabilities > gold holdings (and CB’s agreed not to sell ‘official gold’ for higher price on private market) – therefore, US unilaterally announced $ no longer convertible to gold, imposed 10% tariff on imports and called on other countries to revalue currencies (to improve US competitiveness, BOP)(1971) – From collapse of B-W, a system of floating exchange rates evolved

• Explanations of the collapse (cont. ) – lack of adjustment mechanism: US could not devalue $ against gold because (1) confidence in entire system would be undermined, (2) US competitiveness (Bo. P problem) would not be improved as other currencies fixed to the $ (3) US did not wish to increase r and risk recession, and (4) other countries did not wish to show weakness (devalue) or lose export advantage (apprec. )

• Post B-W (currency turmoil in the 1990’s): – “technology, innovation, free capital mobility and investor’s desire for international diversification… increase vastly the potential for shifting large amounts of financial capital around the world and across currencies at great speed …(leading at times) to foreign exchange market crisis” (BIS, 1994, after speculative attacks on pound and other EU currencies) – in post B-W “non-system” there a wide range of exchange rate regimes from free-floating to pegged arrangements: problem of destabilising volatility and crisis from time to time, as result various proposals for reform of global financial architecture

Post B-W reform proposals

(1) Post B-W reform proposals

2) East Asian crisis • Nature of the crisis: – banking and currency crisis – not a crisis of macro-economic mismanagement (typical of private to public Latin American debt crisis of the 1980’s), but based on private to private capital flows with failure of proper public regulation and industry self-regulation

2) East Asian crisis (cont. ) • Causes of the crisis: – surge in capital flows and integration of global markets outpaced building of domestic institutions in East Asia to properly supervise and regulate the flows – banking system borrowed in $, engaged in poor quality lending in local currency, based on cronyism and doubtful collateral, and failed to take into account currency risk (i. e. how to repay borrowing in event of significant currency depreciation e. g. collapsing of bhat/$ peg)

2) East Asian crisis (cont. ) • Strategies to prevent crisis (World Bank, 1988) incl: – financial sector supervisory capacity should precede liberalisation – emphasise best practice in corporate governance, accounting standards, etc – transparent bank ownership to avoid ‘connected lending’ – should consider depositor insurance schemes to limit negative externalities – should consider - lender of last resort (IMF credit line), especially important in avoiding panic and contagion effect, but may result in moral hazard i. e. promote excessive risk taking by private corporations who no that the cost of their failure will be ‘socialised’

(3) SA’s apartheid era Bo. P constraint • SA’s position in the ‘international division of labour’ - exporter of raw materials, importer of manufactured goods & equipment • Bo. P constraint: imports (and GDFI due to machinery requirement, fig. 5) are pro-cyclical i. e. growth results in inc. in M putting pressure on the current account of the Bo. P, therefore: growth is limited by Bo. P constraint, unless (1) foreign borrowing or K inflows (which extend period over which Bo. P deficit to be repaid, after B -W), or (2) sustained increase (& changed composition) of X

SA’s apartheid era Bo. P constraint • Responses to current a/c shock (e. g. gold price down) – deflationary policy (reduce consumption and inv e. g. through increase in r), or – depreciation (reduce M if they are price elastic), – increase barriers to imports (tariffs and NTB’s) • Responses to capital account shock (e. g. political crisis) – deflationary policies leading to reduction in investment, increase in saving (through rise in r) – depreciation to limit outflow of capital, but can be counterproductive if debt is $ based

SA’s apartheid era Bo. P constraint • Differential impact of exchange rate depreciation (flexible exchange rate system) in SA in 1980’s – benefits mining sector, esp. if commodity prices are falling – harms manufacturing sector - due to increase cost of inputs, but outputs are more competitive, also volatility disrupts rels. with export markets – real exchange rate depreciation means cost of imports increasing more than wages (inflation) indicating a decline in real wages – debt servicing effect - increased rand value of $ based debt

Topic 6 Policy Issues

5. Policy issues on a domestic and global level • Trade in goods and services – International level: • Free trade and Fair trade • Race to the bottom vs labour rights and environmental standards • Access to protected markets for LDC’s especially in agri goods and steel (multilateralism and regional ‘butterfly strategy’) • Issue of developed world subsidisation of industries and agriculture – Domestically: • retain domestic capability to conduct industrial policy, ‘active tariff policy’ and promotion of national bourgeoisie through preferential incentives (vs Multilateral Agreement on Investment)

5) Policy issues (cont. ) • International Financial Flows: – International level: • Create incentives for long run FDI and disincentives for destabilising ‘hot money’ flows e. g. Chilean time-requirement (financial flow must remain for at least one year) • Tobin tax on foreign exchange transactions – Domestic reforms: • Prudential financial regulation