South Africa: A Miracle, But It Has to Do Better

South Africa has confounded the doomsayers of 1994 – both those who predicted that the black majority’s accession to power would lead to economic and institutional decay in very short order, and those who feared that the charisma and caution of the new leaders would not go far enough to meet the expectations or simply contain the frustrations of the people. They (we) were wrong.

Those leaders have managed to find just the right mixture: a lot of financial orthodoxy (with the reorganisation of public finances starting precisely in 1995), the required amount of transfers of economic power (to make a start on creating a black middle-class), and a fairly generous sprinkling of transfers to the most disadvantaged. And it has all held together for the past 15 years in a genuinely democratic environment. This success story, which allows South Africa to project itself as the driving force of the continent, will not be called into question by the new governing team, despite the higher profile of the African National Congress’ (ANC) left wing.

Unfortunately, all that is still not enough to ensure takeoff for the South African economy. Growth is below the threshold needed to absorb unemployment, which stood at 24.3% in December 2009, and initiate the genuine integration of South African society. South Africa’s economy is still a juxtaposition of “First World” (the financial sector, mining, and a few service activities) and very uncompetitive activities, i.e., agriculture and most of its manufacturing industry. This is the fault of natural conditions (in the case of agriculture) and geographic location (it is a long way from the world’s biggest markets, at least, until its neighbours’ economies take off). But it is also a leftover from the past, with highly unequal income distribution, an entire generation deprived of access to schooling, and a lack of infrastructure (as evidenced by 2008’s electricity cuts). In economic terms, these handicaps have translated into growing imbalances in the balance of payments (exacerbated by an over-valued rand as a result of capital inflows), and the public finances (raising doubts about the viability of the policy of social transfers). The quality of the country’s macroeconomic management means it can approach the years ahead without any major worries, but there are fears that the inevitable adjustments are may not be achieved from the bottom-up in the medium term, leading to an increase in social tensions.

Chart 1: GDP Growth
constant 2005 prices
Chart 2: Activity Indicators y/y growth, %  


1. Business Climate: Emerging from Recession

After contracting for three consecutive quarters, South Africa’s GDP grew by 0.2% then 0.8%(q-o-q) in the third and fourth quarters of 2009 respectively. Year-on-year, GDP is still down, but this modest recovery has limited the drop in GDP to 1.8% over 2009 as a whole. However, this is the first recession since the ANC came to power in 1994.

Recovery was confirmed in the first quarter of 2010: industrial production was up once more, at 3.1%(y-o-y) in February, and even car sales, which had been falling since early 2007, rebounded strongly, gaining 16.5% (y-o-y).

Activity was sustained by a counter-cyclical economic policy. The Central Bank has cut its key rate by 550 basis points since November 2008, and the government has left public spending unchanged despite the sharp contraction in tax receipts, which are forecast to be around 11% lower than the amount budgeted in February for fiscal year 2009/10 (April to March). The budget deficit will therefore be far higher than expected, at 7.5% of GDP, with, for the first time since 1993, the emergence of a primary deficit (4.9% of GDP). This is a significant change, as the public finance situation had been steadily improving since the ANC came to power in 1994.

Chart 3: Prices and Interest Rates %

Chart 4: Public Finance Balances % of GDP  

The mid-term budget outlook was presented in late October 2009 by the Ministry of Finance in a “Medium-Term Budget Policy Statement” (MTBPS). Although this was generally considered realistic by observers, the fact remains that it is worrying. If we add to the budget deficit1 the needs of the non-financial public sector, (Eskom and Transnet in particular), the additional funding requirement for the public sector relative to the figures in the 2009/10 budget comes out at SAR 331 billion, or nearly 14% of GDP for the current year. Inevitably, South Africa’s public debt, which had been falling since 1995 and has reached 23.8% of GDP, looks set to rise very rapidly, and will no doubt exceed 40% in 2012.

2. Imbalances Still Under Control, But Gaining Ground

There are concerns that the deterioration in South Africa’s public finances is structural. The improvement between 1995 and 2007 was, of course, down both to orthodox management and improved tax collection, but also to a favourable environment, as the price of gold and, more importantly, of platinum, has surged since 2001. This relative comfort made it possible to pursue a relatively well-targeted and managed policy of social transfers2, which have guaranteed a certain social harmony. Financing these will become more difficult in a less upbeat climate, however.

The outlook for the balance of payments is another cause for concern. Until 2006 the balance of payments deficit, although already growing, was more or less financed by capital inflows, and especially by portfolio investment. But the deficit has continued to widen, rising to 7.1% of GDP in 2008. In 2009, the slowdown in domestic demand brought the deficit back down to 4.0% of GDP, and to just 2.8% of GDP in the first quarter of 2010. But it is highly unlikely that we will see a return to alternating surpluses and modest deficits as was the rule until 2003. External deficits should persist, at a relatively high level (4-5% of GDP). The reason for this is well-known: growth that is too exclusively sustained by household consumption (the personal savings ratio is very weak, at just 2% of GDP), an insufficient investment rate, and the mediocre competitiveness of the South African economy3.

Table 1: South Africa: Historic Data and Estimates

Above and beyond this, these weaknesses point not only to a very unequal distribution of incomes and a very high unemployment rate, which are forcing many households to spend all their income, but also to the after-effects of apartheid which closed access to education to an entire generation, which is now fairly unemployable. The problem is that absorbing hangovers from the past (and unemployment) call for far higher growth than that which South Africa is currently able to achieve, even at the price of excessive external imbalances.

Chart 5: Public Debt
% of GDP
Chart 6: Current Account Deficit Financed
by Foreign Investors

In view of this, the rand will remain vulnerable, as it is highly sensitive to portfolio investment flows, and hence to the mood swings of a jittery market. The sudden depreciation of SAR in late 2008, which was more marked than in most of the emerging currencies, highlights the risk: the openness of the capital account and the size of the local financial market (which is high relative to the size of the economy) make South Africa one of the prime candidates for market arbitrage moves, in the event of an increase in aversion to emerging market risk, or, more simply still, of interest rate increases in the developed countries.

3. Lacklustre Growth Outlook

The Economist Intelligence Unit is forecasting average annual growth of 3% between now and 2020. This seems a reasonable forecast, although it is disappointingly low for a country at this stage in its development.

One of the main difficulties facing South Africa is that it has one of the world’s most strikingly two-speed economies. Alongside a modern sector, comprising the financial sector, mining, several processing industries, tourism and part of the agricultural sector, the major part of the population survives in a relatively unproductive pre-industrial economy comprising traditional farming and the urban informal sector.

The outlook for growth in South Africa’s “first economy” is patchy. The outlook for the healthy financial sector is good in a country where the penetration rate of banking services is still relatively low. There is considerable potential for tourism, and the sector could generate a huge number of jobs, but its development suffers from the distances separating it from developed markets and the public order situation. The mining sector will continue to be one of the country’s biggest currency earners, but the outlook for volume growth is very modest. It has even shed many jobs in recent years. Agriculture will remain a niche activity (fruit, wine, etc.), notably restricted by the availability of water resources.

Chart 7: Exchange Rate vs US$ and
Real Effective Exchange Rate
Chart 8: Per Capita GDP at
Purchasing Power Parity

Manufacturing has proved more resilient than expected due to the dismantling of tariff protection after the end of the apartheid era: some sectors, such as textiles, have declined, but others, such as the automotive sector, have managed to become exporters. But a range of factors including the emergence of new competitors in Asia and Brazil, along with the low productivity of local labour as a result of poor training levels, the modest size of the domestic market (with a “middle class” of no more than 15 million, at most), the distance separating the country from solvent foreign markets, and the persistent over-valuation of the rand, are compromising the growth prospects of South African industry as a whole. It is difficult to imagine that the sector will drive growth in the years ahead.

The “second economy”, for its part, will continue to play an essentially passive role, creating or destroying a few hundred thousand more or less “formal” jobs at the whim of fluctuations in the modern sector.

Chart 9: Human Development Index

From Apartheid to Democracy

4. Difficult Social Context But Low Political Risk

Since the change of regime in 1994, average annual growth of the South African economy has been 3.3%: an honourable performance, with population growth of 1.4% per year over the same period, and only 1.0% today4. In 2005, 2006 and 2007, economic growth actually topped 5% a year. Over the long-term (1995-2010), South Africa’s performance has thus been comparable to that of the big Latin American economies. But its performance is nevertheless significantly poorer that of the Asian countries or Turkey. The latter was on a par with South Africa in terms of per capita GDP in the early 1990s, but is today well ahead.

South Africa nonetheless probably needs a lot more, or at least a “different” kind of growth to absorb the social problems accumulated during the apartheid era and to deal with the new problems that have arisen since 1994. The best indicator of the sheer scale of the challenge is no doubt the United Nations Development Programme’s “Human Development Index” (HDI). This has regressed slightly in South Africa since the 1990s, whereas it has improved almost everywhere else: the country has thus largely been overtaken by Brazil, Turkey and Thailand, and has just been overtaken also by Botswana. Extrapolating current trends, it will also fall behind India within a dozen years.

In calculating the HDI, two factors are especially penalizing for South Africa. On the one hand is a very unequal income distribution (Gini coefficient of 57.8, higher than almost all the countries in Latin America). This is largely the outcome of apartheid, but it has only been marginally corrected by the “black empowerment” policy of the past 15 years, which has undoubtedly created an embryonic black bourgeoisie but has done nothing to improve the prospects for the major part of the black population living in rural areas, who are unemployed or working in the informal sector. But the greatest impact is that of the very poor health indicators in South Africa. Life expectancy there is only 51.5 years, compared with 71 in Morocco and Cape Verde, and the probability of dying before the age of 40 for the 2005-2010 cohort is 36% compared with 6.5% in Morocco and Cape Verde. This, of course, is a consequence of the Aids epidemic, the scale of which is the responsibility of post-apartheid governments, which were in denial for many years. Education indicators are better, but these only show the literacy rate and school registration, and say little about the population’s general level of training, which is far lower than that of its competitors in the emerging world.

Chart 10: Governance Indicators
Rating scale from -2.5 to +2.5
Chart 11: The National Assembly
After the April 2009 Election

at 24.3%. Between 2004 and 2008, with an average annual growth rate of 5.0%, South Africa managed to create 1.1 million jobs, taking the unemployment rate to 21.9% at end-2008. But 870,000 jobs were destroyed in 2009. The situation is in reality much worse than that reflected in the unemployment rate: only 54.8% of the working-age population are deemed to be “economically active” (ie, employed or seeking employment). In rural areas, for example, a considerable proportion of the population is quite simply isolated from the labour market, living on public or private transfers. In all, only 41.5% of the working-age population is effectively in work.

In most countries, the combination of social problems on this scale (unemployment, massive inequality – especially as these are strongly correlated with race – plus the relative deterioration in social indicators) would normally result in a sharp rise in political risk. But this is not the case in South Africa, for a variety of reasons. The most obvious is that the majority of South Africans remember what apartheid was like, with its injustice and day-to-day humiliations. The situation of the vast majority of the population is thus far better than it was 15 years ago, despite the disappointments. A second reason is “negative”: things are even worse in almost all the neighbouring countries. The Zimbabwean experience is a foil, and the inflow of immigrants (not only in southern Africa but also to the Congo and even West Africa) continually demonstrates that the local situation is better than elsewhere.

Last, the ANC is for black South Africans a sort of “independence party” and as such enjoys lasting legitimacy (perhaps not eternal, but certainly not under threat at present). Its management is not bad, either: despite a number of scandals (often, but not always, prosecuted by a largely independent judiciary), governance indicators are better than in most comparable emerging countries. The last general election in April 2009 led to an ANC landslide: the Democratic Alliance (DA) is still a party of Whites and Coloureds with a majority only in Cape Province, while the COPE breakaway ANC faction did not make any major breakthrough among the black population.


1 Expected to move back towards balance, but a primary deficit seems likely to persist until 2012/13 inclusive.
2 Via a range of channels: transfers in the strictest sense, but also hiring, employment housing construction, etc.
3 Between 1990 and 2000, South Africa’s market share in world trade fell from 0.7% to 0.5%, and has stagnated at this level since then, despite a 23% improvement in the terms of trade.
4 Probably more, in reality, because the inflow of illegal immigrants is only partially factored in.