Beyond the Fiscal Cliff: Some Questions for Reflection

There are some parts of the Mbeki, et al paper with which I agree, at the broadest level. Who can disagree with the argument that care needs to be exercised by government to head off a further deterioration in state finances in a context of low growth, declining revenue and constant or rising demands on the current government expenditure side. Their assertion that the government must pursue a more “inclusive development” path is widely accepted. Their argument that there must be more emphasis on “education, health care, transport and electric power supply systems, which should support a new paradigm in South Africa, namely a reliance on knowledge and skills, rather than the mining and export of raw materials” may not be new but neither can it really be contested. Increased competition among firms and political parties is a useful reminder of things that need to happen in our economy and politics. In terms of institutional change their argument for improved state-business relations is also widely agreed upon.

Having developed the ‘spooky’ and ‘alarmist’ device of a ‘fiscal cliff’ they then place a big question mark over state spending on essential poverty alleviation measures such as social grants. They elliptically avoid the hard question implicit in their argument, ie whether government must, or should, cut down on social grants. This is simply not an option in current or near future conditions, and the game they play here is, to put it mildly, somewhat disingenuous. On the other hand, I agree on the need to keep a beady eye on the rise in the government’s wage bill, but again note that South Africa simply cannot survive or prosper without a civil service of more or less current proportions especially at lower and middle management to deliver essential services to the poor.

So while there are clearly concerns about the public sector wage bill, some context is important. The real wage growth has been at the higher levels and the problem is that, in a skill-constrained setting, public sector wages have to track private sector salaries. Mbeki, et al appear to believe that the public sector employment dynamics operates independently of the overall labour market. That’s simply not true.

The focus of analysis should be on the distribution of wage costs across the hierarchy of the civil service, and the resultant imperative to cut down on a top-heavy civil service where the largest relative share of the state wage bill is likely to reside. That includes the national cabinet, the cabinets of the nine provincial governments (whose raison d’etre for existence is questionable), the anachronism in democratic South Africa of funding burgeoning ‘royal household’ expenses and all the wasteful expenses associated with the obscene privileges enjoyed at those higher levels.

The issue of their third and new big worry, rising debt service costs, I will return to later.

Mbeki, et al make the following absolutely critical point: “The economy must be restructured to be more investment-driven rather than consumption and finance-driven” (p2). This is an essentially post-Keynesian position if, as I assume, a significant part of this investment is to be public sector investment in infrastructure, research, etc. But capital investment expenditure is more than bricks and mortar and bridges and other infrastructure. Our biggest resource is our people and the expenditure on education and health is in fact critical social investment.

If the authors believe that such investment must be privately generated they should be more explicit and then explain why they believe that this is possible in the context of South African business’s effective ‘capital strike’ and in the absence of an initial ‘crowding in’ state-led growth phase, as proposed in the MERG Report in 1993.

But beyond all this nit-picking, I would characterise the Mbeki, et al paper in the context of a neo-classical literature that since the late 1970s has been constructed to oppose an activist fiscal policy, based on the view that rising public debt is bad for growth. Fiscal discipline was the first point in John Williamson’s decalogue which lay at the heart of what became known as the Washington Consensus (see Williamson, 2000). Whether Mbeki, et al meant to follow in these muddied and now discredited footprints or not is a matter open to debate. But by not being very specific about where their ‘fiscal cliff’ scenario will inevitably take them, they leave themselves open to such negative interpretations.

Though published only in 2010, the famous Reinhart-Rogoff (RR) paper neatly encapsulates this ‘new consensus macroeconomics’. Let me set this out briefly.

A few years after the Lehman Bros crash, a hugely influential paper was published by Carmen Rienhardt and Kenneth Rogoff (2010) that purports empirically to show the negative consequences of rising public debt on growth. In this now famous and influential paper, one version of which was published in the world’s top mainstream journal the American Economic Review in 2010, Rienhardt and Rogoff argued that over the period 1946-2009 advanced economies with a public debt/GDP ratio of above 90% had an average real annual GDP growth of –0.1%. Where public debt/GDP was at lower levels, average annual growth ranged between 3-4%. Public debt levels of such a magnitude were, in other words, bad for growth. This is a key argument behind what constitutes the Treasury or orthodox view of economics and the basis of the bizarre George Osborne-inspired term “expansionary fiscal contraction”.

In a powerful rebuttal published in the post-Keynesian Cambridge Journal of Economics (2104) in which they replicated the RR analysis, Herndon, Ash and Pollin come to the conclusion that growth rates in fact averaged 2.2%, not –0.1% over the same period for the same group of countries (2014). They conclude: “we … believe that the debate generated by our critique of RR has produced some forward progress in the sphere of economic policy making. In particular, it has established that policy makers cannot defend austerity measures on the grounds that public debt levels greater than 90% of GDP will consistently produce sharp declines in economic growth” (2014).

Despite this critique, the RR paper has been and remains highly influential in the US and Europe, and sadly also in some countries in the Global South. It captured the spirit of the neo-classical position on debt that has dominated thinking on fiscal policy since the early 1980s and reset the policy agenda for a post-crisis world. Nobel Prize winning economist Paul Krugman, a fierce critic of RR, has conceded that the RR paper “may have had more immediate influence in public debate than any previous paper in the history of economics” (in Herndon, et al, 2014).

The effect of these new neo-classical interventions since the 1980s has been to severely limit, if not entirely exclude, a role for the state in macroeconomic policy. It is not my intention to fully engage the RR debate here, save to use it to show that policy-makers concerned about growth and inequality can be spooked by such paralysing analyses, leading them to hand total control of monetary policy to an independent central bank, to reject any activist role for fiscal policy, and to funnel all attention on reducing public debt to the almost total exclusion of growth-enhancing public investments. That appears to have been what has happened under the ANC in South Africa since the 1990s. It is time for some degree of pragmatic re-balancing.

At the heart of a progressive fiscal policy should be a commitment to drive public capital investment to promote growth and increase employment, while not losing sight of the dangers of profligacy. In order to assist in this regard serious attention needs to be given to the separation of the budget into two accounts: one current and one capital budget. The current government budget to be used for countercyclical purposes is to be balanced annually; the capital budget deficit would be limited to no more than an average of 3pc of GDP over say a 5-year cycle.

Contrary to some perceptions, this imperative to control the current budget deficit is very much in line with post-Keynesian ideas as well as that of inequality researchers such as Thomas Piketty (2012) and Steve Pressman (2015). The separation would allow for greater transparency in the budget process, with the overall objective of ensuring control over profligate consumption expenditure, especially in the higher levels of the government’s wage bill, while allowing for growth-enhancing capital expenditure in areas such as infrastructure, and non-wage expenditure on education and health among others to grow even at the short-term risk of running deficits.

Having separate capital and current budgets is not new to South Africa. In 1937 the government “onder die invloed van Keynesianisme” (translated as ‘under the influence of Keynesianism’ (Gildenhuys 1989:641) established a Revenue Account separate from a Loan Account. Current expenditure was financed from the Revenue Account and capital expenditures from the Loan Account. These accounts were only re-integrated from 1967 on the recommendations of the Franzsen Commission (Browne, 1973:2/22) and in the wake of the dismantling of Keynesian thinking.

Once a separate capital account is set up, consideration must be given to the establishment of a representative National Investment Board to make decisions on allocation of funds for all capital expenditures in line with social and economic needs and across sectors, regions and other dimensions. Both Keynes in 1928 and Beveridge in 1942 proposed such a capital allocation institution located within the state. But I would not go as far as Beveridge who proposed that even private entrepreneurs “must win approval of the National Investment Board” before undertaking investments (Wasson, 1960:218).

Mbeki, et al do us a service by developing a neat technical device of the ‘fiscal barometer’ to remind us of the dangers of profligate state consumption spending. But by (implicitly) targeting cuts in areas such as social grants and state provision of essential free services to the poor they are being neither realistic (given South African economic and social conditions) nor progressive and forward looking in their theoretical thinking and policy advice. In fact, while it may not have been their intention, they push us back to a world view that has not worked anywhere in the interests of the poor and the working class, but one that has served only the interests of rentiers and their ilk.

The real problem with the budget is that we’re operating under very low levels of economic growth. If growth picks up, revenue immediately picks up and we’re out of the woods. So the focus of policy attention must be on growth (and employment) and not on the budget deficit (or inflation). And the role of the state in boosting growth and employment is essential under conditions such as those prevailing in South Africa today.

In the end Mbeki, et al offer little or nothing apart from the following vague and somewhat trite conclusion:

 

. . . the fiscal cliff barometer nevertheless shows that the cliff remains a clear and present danger. This leaves no room for complacency in government’s fiscal policy approach, particularly in respect of social assistance payments, civil service remuneration and debt-service costs.

 

South Africa can only overcome this malaise by embracing a new fourth political regime to restore a faster economic growth trajectory. In the period running up to successes being reaped from this new regime, the country should avoid a fiscal cliff (p9).

 

How is this ‘embrace’ of a fourth political regime to happen? What are the main policy drivers of the faster economic growth they (rightly) want restored? How precisely is the fiscal cliff to be avoided, by cutting which budget line items? And who is going to convey the message to the recipients? What will be the political costs to the ruling party of a cut in social grants (even in the state bureaucracy)? These are the hard questions that an analysis like that attempted by Mbeki, et al must address if they are going to avoid being labeled both alarmist and ultra-conservative.

By Prof. Vishnu Padayachee

This article originally appeared in New Agenda Issue 70. For access to this edition please subscribe here.

 

NOTES

 

Thanks to my colleague, Imraan Valodia, for comments on an earlier version of this paper.

 

REFERENCES

 

Browne, G. W. G. 1973. “Fiscal Policy in South Africa,” in Lombard J. A. (ed.) Economic Policy in South Africa: Selected Essays. Landsdowne: Haum. 2nd edition.

Gildenhuys, J. S. H. 1989. Owerheidsfinansies. Pretoria: Van Schaik.

Herndon, T, Ash, M. & Pollin, R. 2014. “Does high public debt consistently stifle economic growth? A critique of Reinhart and Rogoff.” Cambridge Journal of Economics. Vol 38, No 2.

MERG (Macroeconomic Research Group). 1993. Making Democracy Work, a framework for macroeconomic policy in South Africa. Belville: CDS Publications.

Mitchell, W. & Fazi, T. 2017. Reclaiming the State, a progressive vision of sovereignty for a post-neo-liberal world. London: Pluto Press.

Piketty, T. 2012. Capital in the 21st Century. Cambridge, Mass: Belnap.

Pressman, S. 2015. Understanding Piketty’s Capital in the Twenty-First Century. Routledge, VitalBook file.

Reinhart, C. & Rogoff. K. S. 2010. “Growth in a time of debt.” American Economic Review. Vol 100, No 2.

Wasson, G. 1960. “Beveridge’s ‘Full Employment in a free society’.” in The Critics of Keynesian Economics. (ed.) Hazlitt. H. Princeton, NJ: van Nostrand Company.

Williamson, J. 2000. “What Should the World Bank Think about the Washington Consensus? The World Bank Research Observer, Volume 15, Issue 2.

 

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