South Africa: Tough Road to Prosperity

R Stephen Brent. Foreign Affairs. Volume 75, Issue 2. March/April 1996.

Cry the Beloved Country

South Africa’s democratic election in April 1994 was widely acclaimed as a marvel of our time. A country that eight years earlier many feared was on the edge of civil war negotiated a political compromise that transferred power from the white minority to the black majority. Majority rule will be implemented in two stages; the current government of national unity, which gives all parties of significance a place, yields to unrestricted majority rule in 1999.

Since the election, the once-feared threat of right-wing violence has faded. Although extremist Eugene Terre’blanche of the Afrikaner Resistance Movement still appears on his horse from time to time, most conservative Afrikaners accept the new government, which President Nelson Mandela has made easier for them by bending over backward to respond to white concerns. And in black communities there has been little evidence of populist factions in revolt against the compromises of the new government.

Unfortunately, economic progress has not matched this rosy political picture. The economy has turned up since the election, but growth for 1995 was still only about 3.5 percent. While that pace is a marked improvement over the early 199os, when the economy contracted, it is not nearly enough to reduce staggeringly high black unemployment, estimated at 1 percent overall and higher among young people. Direct foreign investment has been slow. The new government is working hard to put its agenda for black social and economic uplift, called the Reconstruction and Development Program, in place, but the program is being criticized for slow delivery. South Africa has to break through the barriers of slow growth and high unemployment if democracy is to deliver the goods and secure long-term stability.

South Africa’s economic difficulties reflect a number of structural problems that only deep-rooted changes can correct. There is no political or economic consensus, however, on how to make those changes. Private sector growth is the only long-term solution for South Africa’s economic straits. But to generate the political capital necessary to pursue long-term growth, the government will have to combine economic liberalization with effective interventions to help the black majority.

Of Those Given Little, Much Is Asked

Despite South Africa’s reputation for a well-run economy under white rule, the policies of the National Party hampered growth severely. Apartheid brought about international isolation and economic sanctions, but the government’s economic management was also poor. For all its criticisms of the ineptitude of African states under black rule to the north, the National Party followed policies after 1948 that resembled much of the rest of Africa. It developed massive bureaucratic and parastatal structures to provide public employment for Afrikaners, many of whom were poor in 1948. It embraced strong protectionism and import substitution. It spent lavishly on public investments, especially defense and supposedly strategic industries. And it set up puppet regimes in the so-called homelands it established that had all the elements of bad governance that the National Party criticized: autocracy, patronage, corruption, and enormous budget deficits.

These policies did not have the same catastrophic effects as in other countries, partly because South Africa was trying to subsidize only 15 percent of the population and had a cushion of vast gold revenues. But the policies did limit growth. After steady gains in per capita income from 1946 to 1974, income stagnated from 1974 to 1981 and fell by 20 percent from 1981 to 1994. Today South Africa’s per capita income of $2,700 is practically what it was in the mid-1960s.

One of the main reasons for falling growth was a serious decline in savings and investment. Net domestic investment dropped to less than 5 percent of GDP in the 1990s from an average of 16 percent in the 1970s. A longer-term problem was falling productivity. Much investment occurred in the wrong places: in parastatals rather than the private sector, in mining and agriculture rather than manufacturing, and in capital investment rather than training. Competitiveness fell and protectionism prevented international competition from imposing corrections. Political unrest after 1976 and growing government deficits after 1983 further drained output. Examining South Africa’s growth record since 1970, a 1993 World Bank study concluded that “such low growth is highly unusual…. The closest parallel is with Latin American countries during their import-substitution phase, but even they performed somewhat better.”

Past policies have left a number of structural weaknesses. Rates of savings and investment are meager. Investment is capital-intensive and creates few jobs. Productivity is weak; Mexican auto workers, for example, are three times as productive as South African auto workers. Competitiveness is low South Africa ranked 42nd out of 48 in a recent report. The skill levels of the work force are low, and a large proportion of state spending is concentrated in civil service salaries. Taxes are high, but black education, health, and infrastructure are severely underdeveloped. These are serious problems, and until they are corrected they will continue to constrain growth and employment.

This reality has been obscured by the euphoria that followed the 1994 elections and by upturns in the economy based on increased private investment, especially in manufacturing, and an inflow of foreign capital. After 12 years of economic decline, these gains have been greeted with understandable enthusiasm, but they must be put in perspective. Current annual growth of 3.5 percent is not enough to begin to reduce black unemployment; World Bank economists estimate growth of 4.25 percent is required. Most foreign investment has been portfolio rather than direct investment, and total private investment is still low in absolute terms. Most of the beneficiaries of higher growth have been white South Africans and the small black middle class. The person in the street has seen little change.

To make real progress in raising black living standards, South Africa needs higher growth, at least five to six percent a year, and it must be more employment-intensive. To achieve this the new government will have to address South Africa’s structural weaknesses and expand foreign investment and trade. In this effort it faces a series of dilemmas. It knows it must attract domestic and foreign investment, but business confidence is hard to earn. It knows it must liberalize trade, but lowering barriers risks severe dislocations since South Africa’s many uncompetitive industries will suffer. It wants to spend more on black social needs, but taxes and government spending are already high. It wants to create jobs for black South Africans, but it cannot hire more civil servants or force the private sector to make labor-intensive investments.

A Window for Progress

Growth Is inevitably a long-term process for which a government has to create the right conditions. The government’s ability to create those conditions will depend on the patience of black South Africans. The conventional wisdom is that after years of deprivation under apartheid the black majority will put enormous pressure on the new government to produce rapid gains in jobs, housing, and education, which could push the government toward a counterproductive populism. Some evidence supports this view in a common anecdote a man is waiting for the government to “give me my house.” But there are also reasons to question predictions of overwhelming black expectations. Intensive studies of black opinion since the election show a surprising patience and realism. Most people seem to understand that change cannot come overnight. In addition, the closest historical parallel-the political transition in Zimbabwe in 198o-does not support the overwhelming expectations view. When majority rule came to Zimbabwe, the new government did not face overwhelming demands for economic payoffs. Most people felt that the political goal of majority rule had been achieved, and they recognized that economic progress would take time.

Black expectations may not overwhelm the South African government in the near term as long as the disadvantaged see some tangible changes occurring and have a realistic hope for a better life for their children, which opinion polls indicate is particularly important. The risk is greater in the medium to long term, particularly if progress in expanding black employment and participation in the private sector is disappointing. Fourteen years after its change, Zimbabwe is seeing a black backlash against white domination of the economy, fueled by economic stagnation, lack of jobs, and lack of black ownership. This backlash has occurred even though the Zimbabwean government succeeded in raising social welfare, particularly in education, and increasing black employment in the public sector. Zimbabwe’s experience shows the limits of statism as a method to uplift a disadvantaged majority.

In South Africa the government has a medium-term window of time to show tangible gains for the disadvantaged. This progress cannot consist only, or even primarily, of benefits provided by the state. Rather, it must be based on economic growth and private sector development. The feat in South Africa will be finding ways to advance the majority population durably through economic growth, private sector jobs, and black ownership-what Zimbabwe failed to accomplish. The challenge for the government is to keep the focus on long-term growth but provide enough benefits to the majority population along the way that political consensus can be maintained and moral commitments protected.

Neither Tiger nor Tortoise

In its first year in office the new government focused on implementing its Reconstruction and Development Program rather than economic overhaul. Last July President Mandela announced a new emphasis on economic growth to be managed by a council that includes key politicians-Deputy President Thabo Mbeki, Deputy President F. W. de Klerk, and Minister of Home Affairs Mangosuthu Buthelezi-as well as leading economic ministers. Commentators cited the Asian tigers as models of the kind of rapid growth with social equity for which South Africa should strive.

Looking to the high-growth countries of Asia shows a healthy self confidence and hope for the future. If it signifies a political commitment to growth and employment creation as the main vehicles for social mobility, it increases the chances the latter will eventually be achieved. To aspire to East Asian levels of performance, however, is to reveal how far South Africa has to go. The country is starting from a base that is inconsistent with elements of Asian success. According to the World Bank, the most important factors in the growth rates of the Asian success stories have been high levels of investment in physical capital and education, especially private investment and primary and secondary education. Investment accounted for two-thirds of the growth in these countries overall, 87 percent in Malaysia. South Africa is at the other end of the spectrum. Its savings rate is less than 18 percent of GDP, compared to East Asia’s 35 percent. As noted earlier, its net domestic investment is less than 5 percent of GnP, and mass education is one of its weakest points. Several other elements are missing. East Asia has single-mindedly focused on exports, especially manufacturing exports, based initially on low-cost labor and later on skilled labor. But South Africa’s exports are mainly commodities. Many of its companies are geared to import substitution, and its manufacturing productivity is below international norms. It is not a low-wage producer, it has a skilled labor shortage, and its advanced sectors are heavily unionized. Industrial and agricultural development have been strongly linked to employment creation in East Asia, but not in South Africa. Strong internal competition among firms and good technocratic capacity in government have been lacking in South Africa, and macroeconomic stability may be hard to maintain.

Like South Africa, Malaysia in the early 1970s was divided between an ethnic economic elite-the Chinese-and a disadvantaged majority population, the Bumiputra. Malaysia used the power of government to help the Bumiputra through public employment, expansion of parastatals, and government-funded education. However, the greatest gains for its disadvantaged population came through sustained growth fueled by the traditional Asian strengths of macroeconomic discipline, high savings, strong exports, and low-cost labor, as well as the entrepreneurial skills of many members of its Chinese population. In reaction to global economic problems in the 198os, Malaysia liberalized its economic policies and undertook some privatization, which has led to growth of 8 percent a year or higher. Many Bumiputra are now moving out of government and into the private sector.

Malaysia shows that an unequal society can lift up a disadvantaged population and reduce poverty in a generation if it can combine effective government programs with high growth. South Africa will probably promote social uplift by similar means. The question is whether it will be as successful, or even close to as successful, in achieving sustained growth.

This is not to say that South Africa should not aspire to East Asian success in the long run. But given the very different starting points, East Asia is not likely to be a helpful guide for near-term reform. For that purpose, Latin America may be better because it faced many of the obstacles South Africa must overcome, including low savings, inward orientation, low productivity, large public and parastatal sectors, high unemployment, and high inequaltity. Latin America tried to reverse chronic stagnation and inflation by orthodox stabilization and liberalization: government cutbacks and deregulation, privatization, and trade liberalization. Chile pioneered radical liberalization starting in the mid-1970s after Salvador Allende’s rule, with impressive results in growth, trade, and living standards. Mexico, Argentina, Peru, and other Latin countries began liberalizing reforms in the early 1990s with more mixed results. Many were rewarded with substantial increases in foreign investment, but these were reversed after the collapse of the Mexican peso in 1994. Even before the peso fell, growth averaged only 3.1 percent in Latin America as a whole. Export expansion was mainly within the region. The underlying weaknesses of low savings, poor international competitiveness, high inequality, and ineffectual public institutions changed little. In post-mortems on the Latin crisis in the July/August 1995 issue of Foreign Affairs, Paul Krugman and Moises Naim noted the failure of liberalization to address these structural problems and argued that it had been unrealistic from the beginning to expect liberalization alone to produce rapid growth and development.

Foreign models of development have a double-edged implication for South Africa. On the one hand they suggest that South Africa has to liberalize if it is to have a chance of attracting foreign capital and increasing productivity, growth, and trade. South Africa’s competitors in Eastern Europe, Southeast Asia, and Latin America are already well along this path. On the other hand, foreign models also imply that liberalization is not likely to bring quick gains; Latin experience suggests that liberalization often worsens poverty in the short run. The only way around this conundrum is to make industry and agriculture more employment-intensive in the near term, along Asian lines.

This situation is at odds with the political and moral pressures on the government to deliver tangible benefits. Apartheid discredited capitalism for black South Africans by identifying it with white dominance. In such circumstances it is not politically realistic to expect the new government to focus exclusively on growth and private sector development. The government will also have to take direct action to improve black welfare through social programs, affirmative action, and changes in the economy to increase black employment and ownership. The government must pursue these efforts with enough vigor and competence to show the majority its commitment to black uplift, even if their needs cannot be satisfied in the near term.

Mandela’s Caution

Faced with demanding economic and social problems, the new government has avoided populist temptations and worked to encourage private investment. It has not, like Zimbabwe, massively expanded the civil service to provide jobs for supporters or boosted social spending to unsustainable levels. In fact, its first post-apartheid budget deficit was smaller than the last of the preceding National Party government, although still large at 5.8 percent of GP. The government is also trying to move South Africa into the global economy encouraging foreign investment, abolishing the dual exchange rate, and liberalizing trade to meet the requirements of the World Trade Organization.

These policies are not what many predicted based on the daunting legacies of apartheid and the African National Congress’ (ANC) traditional belief in African socialism. Under the pressures of governance, the new leadership has emphasized ideological moderation, the limits of state intervention, and the need to rely on the private sector and foreign investment as the main engines of growth. This thinking is internally led. The new government is determined to steer its own ship in economic affairs, avoiding the dependence on the International Monetary Fund and the World Bank that it sees in the rest of Africa. It wants trade and investment, not long-term aid.

The government’s approach to black uplift in the Reconstruction and Development Program has also been moderate. It stresses redirection of government programs rather than new spending. A special fund set up to help redirect spending was given $700 million in its first year out of a total GDP of some $115 billion. In spite of enormous social needs, government expenditures on black education, health, and other areas have been increased at a deliberate pace. Hampered by government bureaucracies that have little experience with grassroots development and by ineffective administrations in the old homelands, the government has tried to monitor the quality of its programs. It has also encouraged community involvement in development activities despite the time it takes.

The general picture is one of a new government trying to do the right things. Some of the credit goes to President Mandela, a hero who has set a tone with his leadership that permeates the government. But the new policies are not a one-man show and are led by a collection of influential ministers and senior officials who agree on basic principles. Many of these people came from the trade unions, the South African Communist Party, and other militant backgrounds, which gives the new policies a degree of credibility with important constituencies.

Nevertheless, in the economic sphere, the new government has been more successful at avoiding mistakes than at charting a new path. Government recognition of the perils of deficit spending and inflation has laid a foundation for future growth, but the government has not yet put forward a program for increasing investment, improving productivity, and expanding exports and jobs.

A Mixed Path

As argued earlier, South Africa has no choice but to pursue liberalization. This means holding down government spending, reducing its massive bureaucratic structures, and beginning to dismantle extensive trade protections. However, liberalization will do little to help the black majority in the short term and should be supplemented by other measures to help the disadvantaged. First best economic prescriptions must be tempered by political constraints. Holding down government spending is desirable but conflicts with political imperatives to expand social services for black communities, upgrade township infrastructure, raise the pay of police, nurses, and teachers, and fund programs such as land reform. Spending cannot be contained by cutting services to whites precipitately because that would encourage white flight and endanger social cohesion. The only answer is to find new ways to finance government spending.

One possible solution is privatization. South Africa’s publicly owned and parastatal assets are substantial, by one estimate accounting for 52 percent of the country’s capital stock. While economists are wary of using privatization to solve fiscal problems, in South Africa it would make sense to use the proceeds of sales of state assets to fund one-time social investments during this critical period. Moreover, there are strong efficiency arguments for privatization. While recent commercialization efforts have brought some improvements in parastatal efficiency, on the whole the sector remains a bastion of Afrikaner employment, a fiscal drag, and a damper on productivity and competitiveness. Privatization can raise productivity through sales to local and foreign investors who will bring capital, new technology, and better management. A focus on areas where productivity gains can enhance long-term growth and use of the proceeds to boost development should be the core of a privatization strategy. In other areas, privatization can expand black ownership of capital through voucher schemes or other methods of distributing ownership shares to the population. Unfortunately, the labor unions, which fear job losses and have recently threatened strikes, have hamstrung all privatization options. In this field the government cannot afford to bow to an interest group, even one that played an important role in an anti-apartheid struggle. The interests of the unions are at odds with the national interest, and a hard choice has to be made.

Trade liberalization also requires balance. Reducing protections over the long term is imperative, but quick liberalization is not. Rapid liberalization in a protected and uncompetitive economy like South Africa’s would result in severe dislocations. It would be better to lead with focused changes that can bring some export payoffs, such as export processing zones and duty rebates to insulate exporters from the costs of protectionism, while phasing in broader liberalization.

Liberalization should be accompanied by special intitiatives to boost growth and employment. Private sector job creation has to be a priority. This means not only new investment, but more labor-intensive investment. The capital intensity of South Africa’s industrial and agricultural sectors is not going to change quickly, but strong incentives have to be put in place to direct new investment to job creation. Current government subsidies to capital-intensive mineral industries should be redirected to small business development, which will create jobs. Labor market reform is also needed. South Africa has one of the most centralized labor negotiation systems and widest disparities between union and non-union wages in the developing world. These characteristics hurt international competitiveness, formal sector employment, and small business development. The power of the unions, which represent only 17 percent of the economically active population, has to be reduced for the sake of expanding employment. Finally, a key to long-term employment creation is better education, especially primary and secondary education. Deliberate undereducation of the black population was one of the most economically irrational aspects of apartheid. While all social needs appear pressing in the Reconstruction and Development Program, basic education has the most direct link to future growth and employment and should be favored in allocating scarce government resources.

There are no quick routes to higher growth, as Latin American development demonstrates. However, one step is increasing savings and investment. In the early 198os Chile privatized its social security system, shifting from a government-funded pay-as-you-go system to a scheme of mandatory contributions to private pension funds, which invested in Chile’s capital markets. This plan removed the cost of social security from the budget and dramatically boosted private savings and investment. Acording to Chile’s ambassador to South Africa, “Chile’s economic success is linked to its high savings rate, which is in turn largely attributable to the pension scheme.” If South Africa were to follow a similar course, it might increase savings and investment significantly, with major benefits for growth.

Of Those Given Much, Much Is Asked

Developing and building political support for an economic reform program will not be easy. South African politics are not conducive to radical reform. The country is not emerging from the sort of economic catastrophe often required to produce political commitment to deep reform, and the recent economic upturn has made structural changes seem less urgent. Moreover, South Africa lacks interest groups or parties that combine a strong interest in economic reform with political clout. The ANC has political power, but its incentives for economic reform are mixed. Its first goal is to empower and uplift those hurt by apartheid-a distributional goal that fits poorly with economic liberalization, which in the short run benefits the better educated, the better trained, and the better off. Other interests and parties have not been effective advocates of reform. The business community has offered few ideas of its own and has resisted many changes proposed by the government, notably policies to increase competition. Labor unions have defined their interests narrowly. Many other political parties have been content to stand on the sidelines and call for free market changes without acknowledging that most of their proposals would entrench white privilege. No major party has come forward with a broad platform for combining black uplift with private sector led growth.

In one version of South Africa’s future, the most important actors remain locked in narrow conceptions of individual self interest, and the country as a whole is consigned to slow growth. This outcome will create pressure for government redistribution and endanger racial cohesion over the long term. But in another version, those actors participate in a positive-sum game, agreeing to take exceptional steps or make exceptional sacrifices for the broader good in return for similar concessions from others. Only the route of mutual sacrifice will lead to higher growth and lasting social betterment.

The determining factor will be leadership, which cannot come entirely from the government. The ANC-led government has a major role to play, but it is unrealistic to expect the ANC to lead a liberalization thrust by itself. The business community, the unions, and other political parties will have to cooperate. Those who hold the best economic cards-the business community and the white population in general-must be willing to make contributions proportional to their economic strength. The historical National Party goal of Afrikaner uplift has been achieved. The business community and whites in general prospered under National Party policies, even as those policies sapped growth and structurally weakened the economy. These groups must now take special responsibility. As the proverb says, “Of those to whom much has been given, much will be asked.” For reform to work, not just economically but also politically, this will be necessary.

If South Africa were a “normal” country, one could not expect this kind of joint leadership to be forthcoming. Indeed, the odds would have to be placed against the South African economy breaking through to six percent growth. But South Africa is not a normal country. It has emerged from a history of tragedy to become a model of compromise and creative leadership for the world. Those qualities give special hope that the new challenges of growth and development will be met.