Civil servants wages eat into ability to build crucial capacity

By Time of article published Jan 25, 2011

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The unavoidable reality in South Africa is that there are fewer than 6 million individuals available to pay 95 percent of income tax. Add to this the fact that more than 90 percent of company tax revenue comes from only 2 000 companies and the small size of the taxpayer base becomes apparent.

This tiny taxpayer base supports not only social welfare payments (to 14 million recipients, which will rise to 18 million by 2013), but also the rocketing increase in civil servants’ pay (both due to ever greater numbers of civil servants and their well-above-inflation pay increases).

Tax revenues are also needed to fund infrastructure investment and cover the costs of service delivery, along with the contingency reserve.

Indeed, the finance minister has said that the 2010 civil servants wage increase will add R6.2 billion to the budget, reducing funds available for infrastructure and other spending priorities.

It is therefore worrying that data from the Reserve Bank show that investment in infrastructure stagnated last year, after contracting sharply in 2009. And this weakness in capital spending is broad based across parastatals, government departments and the private sector.

In contrast, public sector remuneration has seen rapid growth, rising by 29.4 percent year on year in 2009/10, due both to substantially higher salaries and the employment of additional civil servants.

Much will depend on the trend in capital expenditure to achieve and maintain economic growth of 7 percent to 8 percent and cut unemployment to 15 percent, making inroads into providing jobs for South Africa’s 24 million low-income earners.

There is a very close correlation between growth (and hence the potential to create employment) and a country’s total fixed capital stock (or productive capacity). Fixed capital stock is the actual physical capacity available for repeated use in the production of goods and services and includes power stations, railways, roads, ports, water supply and machinery.

Between 1946 and 1977 growth in fixed capital stock averaged 6 percent a year, with the result that gross domestic product (GDP) growth averaged 5 percent – available figures show employment levels rose at least 4 percent a year. This is in stark contrast to the period 1978 to 2003, when productive capacity expanded by less than 2 percent a year – GDP growth slipped to 2 percent a year and employment growth to 1 percent a year, the latter then contracting in the last 10 years of the period. This demonstrates how close the relationship between growth and capital investment is – growth and employment tend to rise or ease as fixed capital stock does.

Diverting tax revenue to increase civil servant pay comes at the cost of both investment in infrastructure and a rate of employment significant enough to push the unemployment rate down to 15 percent.

South Africa is failing to generate sustainable growth (of the 6 to 7 percent plus required to meaningfully reduce unemployment) because the government is confusing the need to provide vital infrastructure and economic services with an opportunity to create employment.

Indeed government finances will be at risk of becoming unsustainable if the trend of ballooning civil service numbers and pay persists without a concomitant rise in service delivery.

This year’s public sector strike and high wage settlement (8.6 percent) are in no doubt partly related to the significantly higher cost of living South Africans now face due to steep increases in electricity and water tariffs, rising rates and taxes for home owners and high debt burdens.

The vast majority of those who took part in the civil service strike are middle-income earners, with their remuneration falling between R50 000 and R300 000 a year. Indeed, the Bureau of Market Research estimates that there are 6.7 million middle-income earners in total, although close to half earn below R120 000 and contribute less than 5 percent of income tax.

In South Africa it is middle-income earners who go on strike for higher real wages, while the country’s 24 million low-income earners (less than R50 000 a year) lose out on employment prospects as the real incomes of the middle class increase.

The finance minister has specifically said that because wage settlements came out 2 percentage points higher than budgeted this would significantly restrain the government’s ability to create more jobs.

In addition, private sector wage settlements tend to be influenced by those in the public sector and this year’s high wage settlements are likely to have discouraged firms to rehire.

With close to four times as many low-income earners compared with those in the middle class (potentially another 9 million can be added to the low-income category as this is the number of children qualifying for child support grants), it is crucial for South Africa’s future stability that more low-income earners get drawn into a level of employment that provides a living wage. This would come at the expense of the ongoing enrichment of the middle class, but it is more important that rapid inroads are made into the low living standard of the bulk of the population.

The majority of indebted households fall into the middle-income category. Indeed, close to half of credit active South Africans are impaired (three or more payments in arrears or have a judgment, administration order or adverse listing).

There is no doubt that the high cost of living, including funding the expansion in infrastructure, is eating into household budgets, driving the demand for high wage settlements.

While rand strength has overshadowed the impact of the sharp rise in administered prices on the consumer price index, those who are impaired have limited opportunity to take advantage of most of the lower costs that rand strength brings, apart from food and transport costs.

In addition the National Credit Act prevents highly indebted individuals from taking on more debt without a significant increase in income.

However, the key issue with high real wage settlements for civil servants is that future government spending on infrastructure will be proportionately lower.

Higher government borrowing will be needed to pay substantially higher civil servant remuneration than was budgeted for and interest costs on government debt will rise, exacerbating the situation and the burden on the taxpayer.

Simply put, there will be less money to spend on building power stations, roads, hospitals, schools, water purification plants, sewerage systems and houses because a greater proportion of government revenue is being paid to civil servants.

This has the potential to become a vicious circle as electricity and water tariffs continue their steep ascent and the cost of living escalates (impending toll fees to pay for road infrastructure will add to the financial burden of most households, as will higher taxes to fund the National Health Insurance, and even a potential 1 percent SABC tax) perpetuating pressure for higher wages through debilitating strikes.

Consumers are deleveraging but unemployment is still rising, indeed significant levels of employment creation are not expected before 2012, the year taxes are likely to rise.

What is also worrying is that an additional 7 500 individuals are applying for debt review each month, and only 39 percent of credit active consumers are up to date with their debt repayments.

At some stage the rand will weaken, especially when interest rates in advanced economies rise significantly and the resultant higher inflation and interest rates will see over-indebted households debt servicing costs rise, with likely resultant significant pressure for wage increases.

Annabel Bishop is an economist at Investec Group Economics.

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