Rand weakness is not a ‘quick fix’

The weak rand is a key focus again, but despite some claims of economic benefits, its ability to boost domestic economic growth meaningfully seems questionable at best. It is well known that South Africa has high unemployment and poverty rates, and is one of the most unequal countries.

This raises the potential for social unrest and instability, and it is therefore unsurprising that virtually no day passes without a continuation of the debate regarding what to do economic policy-wise in order to eliminate these problems one day.

Sadly, some of the participants in the economic debate appear to believe that there exist “quick fixes” to the economy.

Two potential “quick fixes” stand out. The first one is to lower interest rates, stimulate borrowing growth by households and corporates, and in so doing boost economic growth and job creation… until the economy becomes over-indebted, at least.

The second “quick fix” is a weaker rand. Focus on the rand has increased again, due to the recent bout of apparently negative sentiment-driven rand weakness, and with it the debate regarding its potential economic “benefits”.

A weak rand will supposedly make exports more “competitive”, boost the volume of exports as a result, and thereby support stronger economic growth and job creation. So it’s all really easy, some would have us believe. However, there’s an old saying that goes: “If something looks too good to be true, it probably is.”

Indeed, it is conceivable that in an ideal world a weaker rand could, all other things remaining equal, lead to higher domestic production for two reasons. First, exports in foreign currency terms would become cheaper and may be able to better compete with foreign produced competitor goods. Second, industries producing for local markets but competing against foreign imports, may see their position improve because in rand terms the imports would become more expensive for local buyers. But in South Africa, a real world country, the situation is not that simple.

When the rand weakens, exporters’ cost structures often rise quickly because some of their inputs into production are imported or their input prices’ are linked to global prices. So, the potentially positive affect of rand weakness is watered down.

However, the main flaw in the weak rand argument is that it appears based on a lack of consideration of the individuals who run companies and supply the labour, which is surprising given that economics is a social science.

A weakening in the rand is in theory an increased barrier to foreign competition. And the general human experience is that the more you protect people or industries against competition the less efficient they become. Many state-legislated and other monopolies provide strong evidence of this, as have past experiments with high import tariffs. This human tendency suggests, therefore, that the potential positive affect of a weaker rand would further be watered down by a deterioration in efficiencies or “competitiveness”.

And then we come to the household sector. Rand weakening in a country dependent on imports, and with many globally influenced consumer items’ prices, exerts upward pressure on consumer price inflation, petrol and food to name but two, and this in turn exerts upward pressure on wage demands in a highly unionised economy; not to mention the indirect impact in terms of potentially higher interest rates, as a result of higher imported inflation, aimed at curbing inflation expectations in an inflation targeting economy.

And so the cost structures through much of the economy tend to steadily rise, limiting any potential positive affect on production emanating from rand weakness. The result is that one doesn’t see strong evidence of major benefits in the economic data, emanating from sometimes lengthy historic periods of rand weakness.

But it goes even further. Longer term currency weakness can support a skills drain, and I would go further to contend that the overall impact of a weak rand might even be negative. This is admittedly tough to quantify, as are the potentially positive affects.

Household sector: thoughts on the ‘uncompetitive’ rand

The weak rand debate is back, and the arguments in favour of a weak currency still seem to largely ignore the realities of human behaviour.

But have you ever wondered why London – one of the great services-driven city economies with a questionable lifestyle which is not known for great weather – has for many years attracted excellent skills from countries across the globe, including outdoor sun-loving South African, Australian and New Zealand folk, and many other nationalities?

Nurses, teachers, and a whole host of other highly skilled and much needed labour have flocked in that direction over the years. Some visit only temporarily with the view to earning “hard currency” before returning to their own countries, while some stay on permanently.

The highest profile skills drain from South Africa, as well as from New Zealand and Australia (I add those countries just before some cite crime as the only reason), has perhaps been seen in professional rugby, an industry in which we, along with New Zealand, have long since been proud of our “competitive advantage”.

A good number of key players have trickled off to the UK and France, in search of little apparent benefit other than larger pay cheques. Some clubs, seemingly smaller than large local southern hemisphere brands, are able to compete salary-wise, and I would contend that it is in a large part due to the usually strong currencies of those regions when measured against the rand on a purchasing power parity basis.

As a result, the day may come where South Africa and New Zealand provincial competitions are no longer the strongest in the world. Now professional rugby is a very small sector of our economy, despite being a very high profile one. However, if the gradual weakening of our (and certain other countries’) skills base is happening in the small industry of professional sport, then this partly “hard currency-driven” skills drain is probably happening in other more crucial sectors such as health care and education, where many of the skilled professionals could perhaps, with all due respect, be classified as “lower paid professionals”.

While it is also often about a search for a better working environment (and yes, crime and concerns over South Africa’s long-term future do also play a key role), for many of these much-needed professionals, the lure of that strong UK pound and other stronger currencies over the past few decades must have been very strong.

Yes skills are also effectively an export when they leave, and the possibility exists that, as in the case of goods exports, a weak currency can boost skills exports too. Is this the way to improve a country’s competitiveness? I doubt it.

So, be it London City’s services economy, European club rugby or football or other industries, many can buy their way to global competitiveness, helped in part by strong currencies. This is in part because their strong currencies make global skills affordable, and skills are a cornerstone of modern economies/industries, especially services-dominated ones like South Africa.

This clashes with the seemingly over-simplistic economic theory highlighted above, regarding how a weak currency can boost one’s economy. A key error lies in weak rand protagonists’ narrow definition of exports as “goods” that are shipped out on cargo ships. When one broadens the definition of “exports” to include skilled labour, a different picture my well emerge.

It is a picture that shows the skilled labour component of South Africa’s “exports” doing well over the years, sadly, with young skilled people, I would contend, chasing the lure of the mighty pound and other “hard” currencies (albeit with a temporary dip during the recent global turmoil). Call it a “brain drain” or “skills exports”, the gradual decimation of a country’s skills base makes it less competitive. I believe that a weak currency supports this far less desirable form of “export” (although it is by far not the only supporting factor).

Strong currency economies, besides being exposed to higher levels of global competition which will improve efficiencies, should be more easily able to “import” the required skills to improve their competitiveness and performance over the long term.

Finally, it is important for the weak rand supporters to realise that many of South Africa’s households seem to see the weak rand in a negative light, rightly or wrongly. Not only is the recent rand weakness perhaps reflective of poor sentiment toward the country, but it can also drive a deterioration in sentiment. Given that it is the household sector’s skills that drive the economy, this can hardly be positive.

Therefore, besides the impracticalities of successfully implementing any “weak currency strategy”, the potential benefits of a weak and “un-competitive” currency seem dubious at best, when one broadens the definition of “exports”, and considers what crucial production factors may leave one’s shores as a result.

The level of a currency has potential implications not only for sectors strongly commodity export-driven, but also for key services sectors such as health care and education, for banking and property, just as it has for professional sport. And unfortunately, the implications of a “weak” currency don’t appear nearly as positive as some would believe.

In short, there’s no easy road to higher long-term economic growth. It’s about measures designed to increase labour productivity, increase savings to fund higher fixed investment, improve service delivery and make the country more competitive.

Human nature suggests that long-term economic improvements can’t be achieved by weakening a currency (nor through cutting interest rates for that matter) and in so doing making the country less competitive due to greater effective protection of inefficiency, along with potentially promoting a greater skills drain.

John Loos is a household and consumer sector strategist.