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ENDING SOUTH AFRICA'S FOREVER RECESSION

03/01/2020

South Africa today is in a forever recession, at a time when the economy should be expanding at rates exceeding, or at least in line with, those experienced by other emerging countries around the globe.

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Since 2011, recession has been the norm, with only three short spikes of non-recession.* Seldom has a seemingly well-functioning country under-performed for so long. I ask myself what’s next, especially since the trend is negative.

This dismal picture is driven by an under-performing education system, a swollen public sector, and a lack of strategic flexibility within South Africa’s private sector. Addressing these issues will lead to stronger economic growth, increasing wealth equality, and a more stable social and political environment for South Africa.

These goals cannot all be reached in the short-term, and require both the private and public sectors to contribute to them if they are to be achieved at all. However, countries that turn around their performance pull surprisingly few policy levers, so the task at hand is manageable.

If the goals are reached, they will be to the benefit of all South Africans, and in the meantime the journey towards them will change a pessimistic national outlook and reignite the hope of a brighter South African future.

EDUCATION

The first issue facing South African growth is the education system, which is deeply flawed and unable to deliver the quality of graduates that is required to build a multi-faceted economy. South Africa ranked 75th out of 76 countries in the 2015 OECD education league tables. Adult literacy is the lowest among peer countries.

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In addition to failing to deliver a literate workforce, the South African education system perpetuates a system of racial inequality, with black students ten times less likely than white students to do well enough to study a subject like engineering.

While there has been a modest improvement in the standard and equality of the education system since the end of apartheid, these statistics illustrate the challenges that remain.

Economies are largely driven by the intellectual capital of their work forces, and this is increasingly true in a world that is becoming more automated and specialized. If South Africa cannot improve its education system, it will struggle to drive and maintain long-term growth.

Changes to the education system will require time. The major roadblocks standing in the way of these changes are the poor quality of teaching in South African schools, racial disparities in school quality lingering from apartheid, and an inefficient government that lacks resolution, accountability, and integrity.

A way to get going quickly is to embrace school choice, allowing students to choose between public schools and government-funded private schools. This was introduced in Sweden many years ago and could serve as a study chamber for South African educators.

PUBLIC SECTOR

The second issue, a bloated government, impacts all sectors and is endemic to developing nations. It is an affliction that is often the result of a government that tries to reduce unemployment and improve public opinion by hiring large numbers of people. When this happens, leadership stagnates, bureaucracy increases, and skills cannot be brought to bear where they are most needed.

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Bureaucracy is stifling and above that in peer countries. And in fact, reaching their level is not good enough. South Africa should have the ambition to be a prosperous country. This requires behaving like one ahead of full prosperity.

Look at China. The country is systematic in all respects. It aims, with certain success, to be as good at government as affluent countries. South Africa should do the same. Set a goal, perhaps to be like Germany, and build towards that goal.

Rejuvenation starts at the top by paring down the cabinet to a core group of qualified people who have been selected for their skills and leadership abilities, and who are able to drive changes where they are required.

Today the cabinet has 28 members (down from 35). One of Parkinson’s laws states that decision bodies optimally should have 3-20 members. The United States has 15. South Africa should aim for 18.

Unfortunately for South Africa, employment in the public sector has grown rapidly over the years. The government is now the nation’s largest employer and the sector has become a parking lot for creating employment.

While this is an understandable reaction in a country with high unemployment, much of this government work is simply aimed at creating short-term and oftentimes unnecessary jobs rather than creating long-term value, either for the economy or for the individual.

The best way to shift this talent pool into more productive endeavors is to allow the private sector to grow.

This means that South Africa must reduce the bureaucratic impediments to doing business. It is too difficult to set up new businesses, hire employees (especially internationally), and grow once a business is established.

This stifles entrepreneurship and innovation, makes South Africa a less attractive target for international investment, and limits the private sector’s ability to grow. Simplifying the complex process of operating a business in South Africa is a necessary step to enabling the private sector to expand as it needs to.

With the electricity crisis, quickly allow private actors to generate energy for industrial buyers (also allow own power generation within companies). And maybe full competition between power generators should be allowed. Be more careful with the power distribution market though. Liberalizing markets without competition will only lead to higher prices.

PRIVATE SECTOR

The third issue facing South Africa lies within the private sector itself, which has not adapted to the market as it has changed. These changes have presented new opportunities with consumers under pressure, high internal migration, and a weak rand, but the private sector is not capitalizing on them.

Businesses must capture these new markets; pricing for consumers with less disposable income, offering differentiated services to the growing urban middle-class, and expanding into other African markets, which offer a significant opportunity.

With the South African economy in recession, consumers are struggling to maintain their standard of living at a time when they have less disposable income to maintain it with. By adjusting pricing, pack configurations, and discounts, companies can capitalize on these opportunities, but many South African businesses have been slow to do so.

Meanwhile, the rest of sub-Saharan Africa is expected to grow rapidly both in GDP and in population terms. With around one billion people, surely South African companies should invest there.

Yet few South African executives know much about the region. I say this based on numerous discussions with executives. Yes, there are leading edge companies, but many play meaningfully only in neighboring small countries, or not at all.

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A complaint is that Africa is difficult and uncertain. Of course it is. All new opportunities are. If they were not, someone would have captured the opportunity a long time ago. Risk appetite has to increase, as does off-the-beaten-path travel in the region.

Like many emerging countries, South Africa is seeing a massive migration of people away from rural areas and into cities, especially among the young, working age population. This kind of demographic movement offers opportunities that range from housing and transportation to consumer goods and healthcare.

Much of the growth is centered in the outskirts of major cities, where housing is more affordable but infrastructure has not yet been developed to cater for this many people. This offers an opportunity that must be seized if South Africa is to match the growth of its emerging peers.

South Africa needs to grow its middle class as quickly and sustainably as it can, as a young, urban middle-class typically consumes and produces more than any other group. Presently, the urban middle-class in South Africa expands at 1% a year. In Viet Nam, for comparison, the rate is 12%.

Instead of attempting to divert valuable and scarce resources away from cities into rural areas, South Africa needs to focus on catering to the growth of the urban middle-class population.

Away from urban areas the emphasis needs to be placed on boosting agricultural productivity, but rural communities must be expected to decline due to increased migration as South Africa develops.

No prosperous country has a large share of its population working in agriculture, and neither will South Africa. Make migration an opportunity, not a flight. Have people enjoy the wonders of bright lights, big cities.**

Although commodity prices are cyclical, and prices will inevitably increase, it is unlikely that commodity earnings will ever again reach the levels of the mid-1900’s, and South Africa should focus on developing its services sector instead of trying to rebuild its agricultural or manufacturing industries.

The services sector should focus not just domestically or on the wealthy, developed markets of the EU and North America, but also on the rest of Africa. This market offers a significant opportunity, is under-serviced, and South Africa is uniquely positioned to access it.

The African middle-class is similar in size to that found in the United States, and twice that found in other emerging countries like Brazil and Indonesia. It is an opportunity that is largely under-exploited because of the low average incomes throughout the region, but wealthy individuals in Africa cluster together in the cities, simplifying access and increasing profitability.

There is a pervading sense of pessimism in the South African market, with businesses unclear on where the opportunities lie, unwilling to invest in new ideas, and unsure of how to move forwards. They see the weak domestic market as a curse, stunting their growth and removing opportunities, rather than as a driving force for change and evolution.

Businesses that are able to adapt and address the market as it is, rather than as it was, will grow and outpace their current competitors. All changes create opportunity, and South African businesses must adopt a more positive outlook and seek out these opportunities to return the economy to growth.

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South Africa has much in its favor. Its geographic positioning at the doorstep to sub-Saharan Africa, structural strengths, and international reputation mean that it can reassert its status as a leading emerging economy.

There is no reason that it cannot match the growth of countries like Poland, Colombia, and Thailand, and should be targeting GDP growth of 3% per year by 2023. Tackling problems systematically and aligning public and private growth efforts will drive the country towards this goal.

The keys will be improving education, reducing the size of the public sector, and increasing private sector flexibility to seize growth within the rapidly changing African landscape.

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* Economic performance = output (GDP) / input (working-age population). A society can choose to have those people in jobs, at school, at home, unemployed, in the military, and other uses. The mix is up citizens, companies and government, but those are the input resources available.

** Read “The Economic Lives of the Poor” by Banerjee and Duflo, 2/3 of last year’s Nobel Prize in Economics winners, to learn that city migration is both economically and emotionally satisfying to most people.

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An earlier, less developed, version of this article was published in Business Times in 2017.