South African stimulus and the risk of stagflation

The word “stimulus” has been on everyone’s lips.

Simply put, economic stimulus is an attempt by a government to kick-start growth during a recession.

There are various ways and means to do this, using monetary or fiscal policy or a combination of the two:

  • Examples of monetary policy:
    • Lowering interest rates
    • Quantitative easing (central banks buying longer-term securities in the open market – a very complex topic)
  • Examples of fiscal policy:
    • Lowering or deferring taxes
    • Increasing government spending
    • Introducing or increasing tax benefits for private sector investments in strategic sectors

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A stimulus package is typically a combination of monetary and fiscal measures introduced to get an economy out of trouble.

The usual result is a government running a larger budget deficit. This means the government is spending more than it earns in tax revenue in any given year, which in turn means it needs to borrow money to achieve this on an ongoing basis.

Over time, the debt:GDP ratio increases until the government simply cannot borrow any more, at which point spending needs to taper off. It’s exactly the same as a household with too much debt.

Rating agencies assess the government’s ability to pay the debt. A higher debt:GDP ratio means greater risk, so rating agencies downgrade the debt and it becomes more expensive to borrow. Theoretically, a point is reached where the government stops borrowing, because the cost to borrow becomes greater than the benefit of government spending (this benefit is known in Keynesian economics as the multiplier effect).

South Africa is already running a substantial deficit. Our debt:GDP ratio is high by global emerging market standards and has displayed a very worrying trend in recent years as we threw countless billions away through SOE bail-outs, wasteful spending and corruption.

Against this backdrop, we’ve now borrowed R500bn to stimulate our economy. It’s a seriously high-risk strategy. Literally, we are either going to become Zimbabwe, or we are going to become a force to be reckoned with. It’s hard to see a middle ground from here.

In theory, over time, the stimulated economy generates more tax revenue and the government can pay back the debt. Essentially, South Africa trades and grows its way out of trouble.

Importantly, this is only possible when there is private sector investment and job creation. When job creation is mainly in the public sector, as has been the case in South Africa’s “lost decade”, government is essentially an elaborate pyramid scheme, borrowing money to generate its own tax revenue.

There is also the ever-present risk of inflation. More precisely, my great fear is stagflation which is the horrendous combination of high inflation and low economic growth.

A stimulus package of this magnitude should help drive consumer spending. That will put upward pressure on inflation. Although this consumer spending also helps to drive GDP growth, it isn’t the only constituent of GDP. A decrease in exports or general government spending would put downward pressure on GDP.

In other words, it’s possible that higher consumer spending doesn’t necessarily translate into meaningful economic growth.

If there is some kind of price shock (e.g. a recovered oil price which increases fuel costs, or a sudden rise in food prices), then you can very quickly be in a situation where inflation is high but economic growth isn’t. This means the economy is shrinking in real terms every year and people are constantly getting poorer by global standards. The Rand collapses further, inflation keeps rising and…you know the rest.

South Africa is now in high-stakes gambling mode. There is simply no further room for error. Wasteful expenditure has to be completely eradicated and SOEs have to stand on their own feet. We need to do everything possible to encourage private sector investment, or we are going to end up as a failed state.

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