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Economic Challenges Facing South Africa

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1992
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The need for policies that foster redistribution with growth to address the problems of the country’s poorest

Following the remarkable changes in South Africa’s political climate since the February 1990 release from prison of Nelson Mandela, there has been a growing public debate over the future political and economic structure of the country. The dismantling of the apartheid system and negotiations between the ruling white minority and representatives of the majority black population have focused attention on the enormous economic imbalances between the races and underscored the need to address the problem of poverty and maldistribution of income. For while South Africa’s overall per capita income is estimated at around $2,300, making it a middle-income country, a large proportion of its nonwhite population—who represent some four fifths of South Africa’s 35 million population—has an average per capita income that is about one quarter that amount. This much lower standard of living for nonwhites is also reflected in their lower life expectancy, higher infant mortality, and lower literacy rates.

This article is based on Economic Policies for a New South Africa, edited by Desmond Lachman and Kenneth Bercuson, IMF Occasional Paper Number 91, available from IMF Publications Services, $15.

The amelioration of poverty in the years ahead, therefore, will need to be high on the political and economic agenda of the new South Africa. However, the extent of poverty in the country is severe. This suggests that redistribution policies alone will not be sufficient to conquer it. Rather, South Africa needs to move to a path of redistribution with growth sufficient to generate the resources necessary to satisfy the longer-term needs of the least privileged sectors of society. This article, which draws on a recently issued IMF staff study (see box), analyzes the difficult choices with which any future Government in South Africa will be confronted as it attempts to improve income distribution while promoting economic growth.

Poverty in South Africa

South Africa’s per capita income is skewed along racial lines and also along the urban-rural divide, with most of the poor living in the countryside, often in the “homelands” reserved for the native black population. There is a sharp contrast in social indicators, with the extreme poverty of the latter group (see Table 1) typical of most Third World countries, clashing against the First World living standards enjoyed overwhelmingly by the white minority. This is also reflected in the more standard measures of income distribution, such as the Gini coefficient. These latter measures indicate, for example, a Gini coefficient for South Africa of the order of 0.55, suggesting an income distribution that is among the most imbalanced on record.

Table 1Selected social indicators in South Africa in the 1980s
WhiteColoredAsianBlack
Life expectancy

at birth

(In years)
69.558.665.558.5
Rates of adult

literacy

(In percent)
99.384.592.467.0
Infant mortality

(Deaths per 1.000 live

births)
13.257.517.457.4
Sources: Official Yearbook of the Republic of South Africa; and Department of National Health and Population.
Sources: Official Yearbook of the Republic of South Africa; and Department of National Health and Population.

In the 1970s, the black population made some progress in catching up with the living standards of the white population by moving to the economically active sectors and regions of the economy. In many respects, this was the result of the vigorous growth of the South African economy and its concomitant labor shortages, which enabled blacks not only to increase their employment but also to unionize and thereby to achieve real wage increases. At the same time, as various discriminatory labor practices toward the end of the 1970s were eased—such as the phasing out of the reservation of skilled jobs for whites and the elimination of influx control (that regulated entry of blacks into “white areas”)—the “wedge” or difference between white and black wages for jobs requiring similar skills was reduced. Thus, whereas whites were paid almost double the wages that blacks would receive for the same job in the mid-1970s, the differential has now declined to around 15 percent.

The 1980s saw a decline in the rate of South Africa’s economic growth brought about by a worsening in the investment climate, as a result of heightened political uncertainty and the imposition of international financial sanctions against South Africa. This particularly curbed black employment and wage growth and slowed the earlier trend toward income equalization. A fundamental feature of the economic downturn was a decline in the ratio of investment to GDP by around 5 percentage points in the mid-1980s, when South Africa was shut out from foreign capital markets and moved from being a net importer of foreign capital to being a net repayer of foreign capital. GDP growth slowed to about 1.5 percent a year in the 1980s, well short of the 2.5 percent a year growth in the population. This slower growth raised the proportion of the economically active population that was without employment opportunities in the formal sector of the economy, from 25 percent in the mid-1970s to about 42 percent by the end of the 1980s.

The question facing South Africa now is: How to revitalize the economy, while reducing the gross inequalities of income and economic opportunity that currently exist within its economy? The answer to this question would appear to lie in the crafting of sound economic policies and reorienting of budgetary priorities. How well this is accomplished and how soon will determine the success of not only the current government but also any future government emerging out of the political dialogue that is now underway.

Medium-term growth scenario

The trade-off between redistribution and growth confronting policymakers in South Africa can best be brought out by an illustrative medium-term scenario of the sort presented in Table 2. The model used to generate this scenario is based on two key elements: (1) a simple production function relationship between inputs (e.g., capital and labor) and the output of the economy, and (2) a savings-investment accounting framework that focuses on the mobilization of resources by different sectors of the economy necessary to finance any level of capital accumulation.

Table 2South Africa: medium-term scenario for 1991—2000(In percent, unless otherwise indicated)
Average

1981–90
1990Scenario

average

1991–2000
Real GDP growth1.4–0.93.5
Employment growth0.7–0.43.0
Nonwhite underemployment rate141.741.736.6
Real wage growth1.41.90.7
Investment share of GDP23.019.324.8
External current account as percentage of GDP0.42.2–1.7
Private savings as percentage of GDP223.620.921.5
Government savings as percentage of GDP–0.20.61.6
Government revenue as percentage of GDP25.528.529.6
Government expenditure as percentage of GDP28.129.730.3
General government balance as percentage of GDP–2.7–1.2–0.7
Current government expenditure per capita, 1990
Rand12,3722,3722,568
Source: Staff estimates.

Estimated value at end of period.

Includes the savings of public corporations and public business enterprises.

Source: Staff estimates.

Estimated value at end of period.

Includes the savings of public corporations and public business enterprises.

It is assumed in this model that as South Africa regains fuller access to both international financial markets and to improved international technology, multifactor productivity would rebound to a rate of increase of around 0.5 percent a year after having declined at a similar rate over the past decade. Moreover, it is assumed that as international financial sanctions are removed, South Africa, rather than repaying capital at the current rate of 2-3 percent of GDP, would experience an external capital inflow of around 1.75 percent of GDP a year over the rest of the 1990s, which would be somewhat below that experienced prior to South Africa’s having been shut out from the international capital market. In view of the likely overall ex ante shortage of global savings and the demands on these savings from Eastern Europe and the Middle East, however, South Africa would need to create an attractive investment climate to win its share of foreign savings through the pursuit of sound domestic macroeconomic policies (particularly the control of inflation and the opening up of the economy to trade and investment).

Irrespective of future population growth, South Africa’s labor force is set to grow at an annual rate of around 2.5 percent over the next decade. Economic policy, therefore, would need to aim for economic growth of at least 3.5 percent a year if overall living standards are to be improved and if black underemployment is to be reduced from its present high level. The analysis suggests that such a rate of economic growth could only be sustained through a marked improvement in investment performance. Specifically, the ratio of investment to GDP would need to rise steadily from its present level of 19 percent to around 27 percent by the end of the decade.

A significant portion of the required increase in investment could be financed from capital inflows from abroad provided sound domestic policies were followed. However, the increased access to external savings would need to be supported by a continued effort to maintain domestic savings. Even if the private sector savings ratio were to rise moderately to 21.5 percent, the public sector would still need to produce savings of roughly 1.5 percent of GDP a year, a considerable improvement over South Africa’s performance over the 1980s.

The need to maintain public savings at this relatively high level has clear implications for public spending policy. As discussed more fully below, in view of the limited scope for raising the overall tax burden beyond its present level, public spending of a nonproductive nature over the medium term would need to be constrained. This means that efforts to ameliorate poverty and create better economic opportunities for the hitherto underprivileged black population would need to rest mainly on a redirection of budget priorities. With GDP growing at a faster rate than the population, the maintenance of a constant ratio of public spending to GDP would nonetheless mean a marked increase in government spending per person over time.

If the budget deficit were to increase as a result of increased public spending that was not of a productive nature, it would reduce the resources available for social development and thus slow down economic growth. An increase in government current spending equal to 1 percentage point of GDP, without an offsetting increase in savings in the private sector, would produce a corresponding decline in overall investment of 1 percentage point of GDP. The consequently lower rate of capital accumulation would in turn mean that both output and employment growth would be reduced by 0.3 percentage points per year. As a result, less progress would be made in reducing black underemployment (see charts). The higher ratio of public spending to GDP would, over time, translate to a level of public expenditure only somewhat higher than in the case where the ratio of public spending to GDP was lower, since the economy would now be smaller in size.

South Africa: medium-term scenario

(In percent)

Source: South African Reserve Bank, Quarterly Bulletin.

Budgetary policy options

To foster economic growth, budgetary policy in the new South Africa will need to maintain an adequate level of public saving. In other words, increases in overall public spending will need to be matched by corresponding increases in government revenues. In framing revenue policy, however, the government will have to consider carefully the so-called disincentive effects (whereby an increase in taxes may push people to work less or to reduce their saving, thereby producing less revenue for the government), as well as the need to create a favorable domestic environment for foreign investment.

At approximately 24 percent of GDP, South Africa’s overall tax burden appears to be above the average for countries at a similar stage of development. Indeed, if one were to confine one’s attention to the narrow stratum of society that currently pays the overwhelming proportion of taxes, one would draw the conclusion that the South African tax burden is already more at the level of the industrial countries. This is also apparent from the current high marginal income tax rates of 42 percent at the top end of the scale, as well as from a corporate tax rate of 48 percent. Accordingly, the effort to raise tax revenues would need to focus less on raising tax rates than on reducing tax exemptions and allowances, broadening the tax base, and changing the mix between direct and indirect taxes.

The scope for redirecting public spending to alleviate social backlogs appears to be relatively large in South Africa, since the country already spends a sizable proportion of its GDP on the social sectors. Overall, social spending in South Africa is about 14 percent of GDP, close to the average for countries at its stage of development. Moreover, public spending on education and health, at 6 percent of GDP and 3.5 percent of GDP respectively, is comparable to that in the more industrialized countries.

Yet, the relatively high level of overall social spending in South Africa is accompanied by a very wide disparity between the different race groups, despite the fact that such spending on whites declined significantly in the 1980s. Thus, while per capita education spending on a white child currently is around R 4,100, that on a black child barely averages R 900. Similar differences, some less marked than others, characterize official spending on health, social security, and housing.

Considerations of equity would suggest that budgetary policy should aim as a minimum to equalize public social expenditures per capita between the different racial groups. However, raising such expenditures to the present levels for the white population would clearly be beyond the capability of the budget. Thus, for example, to equalize education spending at the present per capita white level would require expenditure of over 15 percent of GDP on education alone. From an economic point of view, this is clearly not a feasible proposition, irrespective of what the public’s aspirations might be.

By contrast, equalizing social spending at the current average per capita level would provide substantial social benefits to the least privileged sectors of the country without compromising the government’s budget or long-term social and economic development. Again, taking educational spending as an example, equalizing this spending at the current average of R 1,400 per child would produce a 50 percent increase for the black community. Similar improvements could be made for the black community by equalizing other categories of social spending at their average levels. The political difficulties of effecting such an equalization process are, of course, not to be minimized, since it would involve reductions of between 40 and 70 percent in the current level of public sector per capita social spending on the other racial groups, particularly the whites.

Challenges for policymakers

The basic goal of social upliftment in the new South Africa will pose fundamental challenges to budgetary policymakers. In this respect, difficult choices will need to be made between more social spending now and better prospects for economic growth and for future social spending. In light of the broad-based nature of poverty and the very high levels of unemployment and underemployment from which the new South Africa will be starting, and given the prospective rapid rate of growth in the labor force, it is important that policies that promote long-term sustainable economic growth are emphasized over those that aim for shorter term but transient results.

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