In 2003 the South African economy took off and the current account deficit of the balance of payments (exports minus imports of goods and services plus the difference between interest and dividends earned from offshore investments and paid out for them) increased very significantly.
From an unsatisfactory period of slow growth and a minimal current account between 1995 and 2002, after 2003 faster growth was understandably financed in greater measure with the foreign savings the economy was able to attract.
Given the low rate of domestic savings, the limits to South African growth are set in part by the willingness of foreigners to invest in local debt and business.
Without these foreign savings, the economy’s growth potential would be seriously constrained.
Foreign capital makes the difference between a rate of capital formation of an unsatisfactory 14 percent to 15 percent of gross domestic product (GDP) to a more helpful possible 20 percent rate of additional investment in plant and equipment.
Growth, or rather expected growth, attracts extra capital and the failure to grow repels capital and investment. Economic growth, supported by capital inflows, is much to be welcomed. The current account deficit indicates the supply of foreign capital, to which a highly positive connotation can be given. It also measures the demand for foreign capital by domestic economic agents – a demand that indicates vulnerability to the possibility that such requirements may not be met.
South Africa’s growth was disrupted by the global financial crisis of 2008 and the deficits fell away. However since 2011, the growth rates have been very subdued and yet the deficit has remained very large.
Economic growth rates have remained unsatisfactorily low, as has the domestic savings rate, itself in part a casualty of slower growth in incomes and higher taxes on them, while the dependence on foreign capital (represented by the current account deficit) has remained significant.
South Africa’s ability to continue to attract foreign capital is welcome. Without it, the economy could not grow even as slowly as it has done. Without it, the exchange rate would be weaker still, the outlook for inflation worse and the danger of higher interest rates greater – all of which would further diminish growth rates and the prospects for growth.
But attracting foreign capital is no free lunch for the economy. It is equivalent to having to sell the family silver to keep food on the table. The family silver sold is measured by the difference between income paid to foreigners in the form of dividends and interest, and income received from them.
The deficit on the debt and asset service account of the balance of payments has been widening as more of South African business is owned by foreigners and more debt issued to them. Income from capital invested abroad by South Africans made abroad has also increased but not nearly as rapidly as income paid out. This foreign income deficit is responsible for a large proportion of the current account deficit: about a third of it, or 2 percent of GDP this year, which is down marginally on recent years because of less profitable South African businesses paying out less in the form of dividends to offshore owners.
South African economic policy in this time of slow growth and higher inflation should be to make every effort to increase output, employment and savings.
Two obvious initiatives would make a very large difference. The urgent call is for reforms that would encourage the demand for and supply of potentially abundant less skilled labour by repealing closed shop and minimum wage laws. Imposing secret ballots on strike proposals by union leaders would surely help sustain production in the factories and mines, which has been so disrupted recently.
The other clear route to higher savings and investment output and employment is to reduce income taxes on all business in exchange for more capital invested and more jobs created. A bias towards taxes on consumption rather than income is as urgently needed as labour market reforms.
Brian Kantor is the chief economist and investment strategist at Investec.