20yrs of progress & underperformance?

Last Sunday was Freedom Day in South Africa – the 20th anniversary of the first democratic election under universal suffrage after the end of apartheid. It provides another opportunity to consider where South Africa has come from, and more importantly where it is going.

The progress over the last 20 years is clear to see and well documented elsewhere as follows:

In this file photo, President Jacob Zuma speaks to a crowd in Nelspruit. Picture Marco Longari. Credit: AFP

- The building of a stable, non-racial, constitutional democratic republic with one of the most progressive constitutions and bill of rights. Liberty.

- The rejection of the more extreme forms of ideology, such as racialism and nationalism or true socialism/Marxism.

- The creation of a growing black middle class in this period.

- Bringing most South Africans out of poverty through grants, house building and economic freedom. Improved health care and life expectancy. A widespread increase in access to utilities and education.

- Sound macroeconomic policy with borders opened to investment.

- A vibrant civil society and strong institutions.

The ANC can take significant credit for these advances, though just as it overplays its claim to be the liberator of South Africa from apartheid, we should also consider that others have been involved – whether it be civil society itself, other parties, businesses or independent institutions and NGOs.

From an external perspective, South Africa’s first 20 years in its current form have involved some of the following rollercoaster of concerns, some exaggerated, some not:

- The opening up of the market and exuberance of post-1994 South Africa led to a flood of capital inflows. The ANC came to power with the Reconstruction and Development Programme (RDP), which was viewed as dismissing the more radical possibilities of economic policy. Much of the government of national unity of that period was focused on the state and its institutions at the national and local level.

- Foreign direct investment (FDI) and portfolio flows, which had basically been zero in the later years of apartheid under international sanctions, had picked up with portfolio flows moving into positive territory in a meaningful way from 1991, as the process of transformation really started to get under way and Nelson Mandela undertook peace talks more formally, together with the repeal of major apartheid laws. Net FDI, meanwhile, was slower to respond as there were initial capital outflows, with the removal of some apartheid restrictions, the slow lifting of exchange controls allowing South Africans to invest more offshore and dividend extraction by foreign companies.

Indeed, it was not until 2000 that consistent positive net FDI inflows were recorded. Between 1994 and 1999, net FDI outflows averaged R1.5 billion per year.

- The rand crisis of 2000/02 rocked confidence, but inflation targeting, the new economic plan GEAR and the arrival of president Thabo Mbeki from the conservative centre-left of the party soon established a degree of confidence. However, there were substantial portfolio outflows in those three years of some R85.7bn.

- Through the period, however, growth was generally only around 3.75 percent with a mini-cycle through the Asia crisis in 1998/99.

- Empowerment first arrived in 2003, though in a much narrower sense than now (black economic empowerment or BEE arrived in 2007). This led to a questioning and scepticism by some foreign investors on the point of transferring ownership to rich, politically-connected individuals and some soothing had to be done by the government.

- An outcry by foreign investors in 2003/04 at the lack of action by the government on tackling Aids and Mbeki’s denial on the subject, combined with local pressure, to start a change in policy. However, it was not until Mbeki was recalled and Motlanthe became president in 2007 that real relief was offered.

- Growth bounced higher through 2004 and 2007 on a credit-fuelled boom that saw growth averaging around 5 percent over the period, though we believe long-run potential was still only around 3.75 percent in that period. During the period there were net portfolio inflows of some R273.3bn. However, net FDI flows were only R19bn. Through the period conservative fiscal policy and declining debt led to ratings upgrades, and investor attention instead shifted to current account and reserve level vulnerability concerns.

- With the global crisis of 2008, there were significant net portfolio outflows of R134.9bn in that year, but FDI inflows continued and were strong thanks to a small number of large details. In subsequent years, foreigner inflows continued steadily in net FDI, averaging some R30.3bn per year, but with significant volatility and not breaching the 2007 peak, while portfolio flows only averaged around R43.5bn a year. During this period, twin deficit concerns surfaced and the potential growth rate was very low.

- Through the past 20 years there have been worries about political transition and ANC elective conferences – particularly Jacob Zuma’s election in 2007 to be president of the ANC, as well as Zimbabwe blow-up theorists, though the prevalence of that view probably peaked just before the 2009 election and has receded to be more like a tail risk.

- Labour issues have ebbed and flowed for investors, but were only the focus in the latter years of Mbeki, and particularly in the last three years as their frequency and spread has increased. Equally, utility security was unfortunately largely ignored by investors until the loadshedding incident of 2008 and since has been a frequent topic of discussion.

Differently, infrastructure complaints by FDI investors have been present, though we think the government has only really undertaken an aggressive programme of investment since 2008.

- While the nationalisation debate was sealed off by Nelson Mandela before 1994 with a rejection of parts of the much more left-wing Freedom Charter, the debate surged back from the end of 2012, pushed by the ANC Youth League and others to the concern of investors, though the senior leadership of the ANC always made it clear that such a policy would never happen.

- Throughout the last 20 years, the rand has remained one of the most volatile currencies globally.

This potted history is given to get a perspective of how, despite strong improvements in the country, investment has, in an era of globalisation in goods and financial markets, not been “charitable” to South Africa.

But we also look at net FDI in the figures above to show that, while foreigners have been investing in South Africa throughout this period, outflows by locals have offset this and not only increased current account vulnerability, but withdrawn capital from the local economy.

We have an issue with that, not because capital outflows are intrinsically or morally wrong, but because it is indicative of the assessment of local capital holders through the period of South Africa’s prospects versus the rest of the world – and more recently particularly the rest of Africa – and it is not being offset by additional inflows. This is where the “underperformance” theme starts to develop – the fact that with other policy choices the economy could have grown faster and more importantly created more jobs and so lower inequality.

Broadly, we believe that the government got policy right in terms of state intervention in welfare (the grant system and extension of utility provision) and macroeconomic policy especially, but microeconomic policy has led to the underperformance of development beyond the basics during the past 20 years. This is evident in the developments in the labour market since 2008 – the external shock was exacerbated through domestic policy choices and the foundations in place, and was ultimately a failure of micro- rather than macroeconomic policy. Put bluntly, while the lives of the average South African are undoubtedly much better liberated after 20 years of democracy, we believe it could have been better still with alternative policy choices.

In our obituary to Nelson Mandela (“Giant footsteps, long shadow”), we started to address some of these issues about how the ANC’s direction was influencing the government and the country, but this broader look at three presidents allows us a more complete perspective on why this underperformance has occurred.

Policy through this chart has been dictated by the ANC and also its multi-faceted components. In particular, there is what we term the “conservative centre-left”, which is where the likes of Pravin Gordhan, Trevor Manuel and Gill Marcus are within the party.

There is also significant overlap in policy between the DA and ANC in this area. Then there is the left, which ranges from mild socialism to full-blown communism of a Marxist variety. But the key is the tenderpreneurs and BEE crowd that rely on the ANC as gatekeeper and rent extraction. Cadre deployees, that is ANC supporters and backers placed in state posts, also fall within this section.

We have notionally marked where each president has been in terms of political leanings in the ANC, but more importantly there have been subtle, but not major, moves. The more dramatic shift has been the increase in the involvement of the “non-ideological” (in economic terms) tenderpreneurs successively under each president.

We express things slightly differently in Figure 3 to see how there have been three different “economy” choices since 1994. The key is the involvement and close alliance with labour and Cosatu, as well as the decision early in the ANC’s formation of a programme for government around 1991/92, that it would need to transfer wealth to a new black elite as part of a new compromise to maintain the broad corporate interests of ‘white’ capital under apartheid. This was BEE in its various forms, but also overtime with the ‘sins of incumbency’ as it is euphemistically called – came rent extraction and tenderpreneurship.

Each of these economies looks quite different, though arguably a clean and beneficial balance between labour and investor interests could have been found. However, a free market, transparent, clean and competitive economy is very different from a BEE-style economy that encourages state intervention and control.

As a BEE economy cannot move too far from an investor-friendly one (as banks, partners and other sources of capital are needed), there cannot be a “blow up” scenario in South Africa, but there is underperformance in our view. Hence there are faults in a microeconomic policy, even though an investor-friendly macro policy has to be put in place to maintain this balance.

However, such clashes over different economic visions explain the many economic plans over the past 20 years and the contradictions in policy that have become deeper over time without resolution – as evident in the most recent slew of legislative changes.

The fact the ANC has a wide variety of people in different camps in government and across the state from each faction means that performance is also very uneven. This is why we reject notions of a “failed state”, and why such achievements over the past 20 years that we outlined at the start were possible. The ANC has achieved much in order to maintain the balance in Figures 2 and 3, but underperformance has come from the choices required to maintain this stability of factions.

It means that there can be a failing department like Home Affairs that with a change of minister can be turned around, while health care at the central government level makes solid advances under the last two ministers there, yet at the same time there is failure at the provincial level in similar departments. Equally, centres of excellence such as SARS and the National Treasury can be built up even though waste is occurring elsewhere – seen most obviously in Nkandla but more widely through provincial tendering.

In the ANC, it also explains how, on the one hand, there is cadre deployment and tenderpreneurship, but on the other an ANC that carefully analyses corruption in its electoral list systems; an ANC that wants to improve the efficiency of the state yet benefits from its inefficiencies; strong constitutional institutions and a rule of law yet both are seemingly constantly under threat.

Policy-wise the balance means that the ever expected significant shifts to the left have never really occurred, or if occurring in some specific areas, have been balanced in some areas by shifts in the opposite direction in other policy areas. This innate balance is clear in government, but also in the ANC’s policy and elective conferences, and has allowed the orthodoxy on macroeconomic policy to become entrenched and largely undebated and uncontested in recent times.

This is ultimately the fascinating thing to us about South Africa, and it has been sustained by an incumbent party that has not been challenged electorally and has been able to close ranks around itself, for instance, through closing off debate in Parliament.

But here too is the challenge for the next parliamentary period. We expect a real rival for the ANC to be produced from the breakdown of Cosatu and a National Union of Metalworkers of SA-backed workers party that will solidify the 2019 election in terms of economic class rather than race.

The left-wing “bubble” of the ANC in Figure 2 will fragment as a result, and the choice will come then for a more evenly balanced ANC (between tenderpreneur class and conservative centre-left, not natural bed fellows for many in the ANC), to either shift right in a quest to win support and travel a more liberal policy route to gain jobs, or shift left to electorally contest directly such a new workers party.

After 20 years of democracy and a steady evolution of policy and positioning of ANC’s focus – it will be this choice, a brand new choice unlike those of the last 20 years, that will be the bite point, the point of bifurcation of South Africa, and how it will be able to perform in the next 20 years.

At this stage, it is unclear which way the ANC will jump, though we would dismiss those that believe it is “obvious” the ANC will move left and given the make-up of the remaining part of the party, together with an evolving tenderpreneur class that wants to secure its gains, the likelihood the ANC tacks right is moderately high.

The concern, however, is that until that point South Africa’s microeconomic policy contradictions will get deeper still. As such, immediately after the election this week we will watch closely for personnel deployments and how the latest slew of legislative changes in recent months are actually implemented.

Looking back the government has achieved much since 1994, but we recognise alternative choices (in a less state intervening and free market model of micro policy) could have led to better outcomes for labour and capital, as well as development as a whole.

Foreign investors have done very well out of this period – a range of significant foreign direct investors in the local economy, particularly in manufacturing, have learnt how to handle the ins and outs of the country’s development in those 20 years. Portfolio investors have also performed adequately, with high real yields maintained through much of the period.

In the debate surrounding South Africa’s problems over the past 20 years most jobs and investments have been created by the private sector (with the help of foreign investment) and the same will be needed for the next 20 years.

Peter Attard Montalto is an executive director and emerging markets economist at the Japanese investment bank Nomura.