Lesetja Kganyago: Inflation, but no jobs or growth - policy responses to
South Africa's economic challenges
Address by Mr Lesetja Kganyago, Governor of the South African Reserve Bank, at the
Labour Law Conference, Johannesburg, 24 August 2016.
* * *
Good morning, ladies and gentlemen
Thank you for inviting me here today to address this forum.
South Africa is suffering from a combination of stagnant economic growth and rising inflation.
The economy contracted in the first quarter of the year, and although the second quarter
looks considerably better, we expect no growth in 2016 overall - which compares
unfavourably to the 1,3 per cent achieved in 2015 or the 3 per cent average since 1994.
Furthermore, for the first time since the global financial crisis, we expect to lose jobs this
year, on a net basis. Yet even as economic growth and job creation stall, prices - fuelled by
food price and currency shocks - as well as wages and salaries continue to increase above
the targeted inflation rate.1 This keeps headline inflation higher than economic conditions
warrant. Underlying this inflation outcome is a set of markets, rules and systems that
generate strong price, wage and salary pressures and play a large role in generating this
combination of high inflation, high unemployment, and low growth.
Today, I will discuss policy options for addressing this problem, including the contribution
from monetary policy.
One of the things we need is for price and wage demands to abide by the inflation target, so
that we achieve a lower inflation rate more consistently. Attaining these outcomes will require
change, including institutional reforms. And reforms will create space for monetary policy. We
would prefer not to tighten policy during a slowdown, but as long as our economy is geared
to produce weak growth and high inflation, we have to do just that. Higher inflation begets
higher interest rates. Lower inflation, alternatively, enhances the competitiveness of the
economy and reduces interest rates, supporting investment, job creation, and poverty
reduction.
South Africa as a labour market outlier
South Africa's unemployment rates, narrowly defined, have exceeded 20 per cent since the
early 1990s. From a comparative perspective, sustained unemployment rates at these levels
are very rare. At the moment, according to data published by the International Monetary
Fund (IMF), they are shared by just four other countries. Two of these are Greece and Spain,
which have suffered intense and prolonged economic crises.2 But both expect to see
unemployment decline in the next few years. In fact, Spanish data in May showed
unemployment falling to just under 20 per cent for the first time since the global financial
crisis. In South Africa, no such improvement is being forecast. In fact, the IMF numbers show
our unemployment deteriorating, from about 25 per cent now to around 27 per cent in three
years' time.
It is quite extraordinary for unemployment to remain so high throughout an economic cycle.
Compare South Africa with Brazil, a country similar in many ways. When Brazil's economy
boomed, unemployment fell to below 5 per cent. Since then, Brazil has fallen into a deep
recession, with growth close to minus 4 per cent in each of the past two years, the worst
performance in a century, including the Great Depression.
Unemployment has more than doubled; it is now over 10 per cent. This is a terrible economic
experience. But if we could get unemployment in South Africa to 10 per cent, that would be
viewed as a tremendous success. There isn't much to envy about Brazil's economy these
days, but I would happily take their unemployment rates.
Many observers look at South Africa's levels of joblessness and reflexively describe them as
unsustainable. But they have persisted for around two decades, so it is a bold prediction to
say that they cannot continue. A better interpretation is that we have very unusual, even
unnatural, labour market dynamics. This implies that we have vast scope for improvement.
Almost every other country has a larger share of its people in work - and most have a larger
share participating in the workforce.
The National Development Plan sets unemployment goals of 14 per cent by 2020 and 6 per
cent by 2030. For labour force participation rates, the plan envisions 60 per cent by 2020 and
65 per cent by 2030, up from the estimated 56 per cent today.3 We don't have to achieve a
world-beating performance to arrive at these sorts of numbers. Mexico has a 65 per cent
labour force participation rate right now. Brazil is at 70 per cent. Meanwhile, world average
unemployment rates are at about 5,5 per cent currently, and a little lower in emerging
markets.4 In other words, the goals of the National Development Plan are perfectly sensible.
By world standards, they are normal, or even a little worse than normal. But if we're going to
get there, we're going to need to create 11 million new jobs given the population growth.
At the moment, however, we are going in the wrong direction. Both the Quarterly
Employment Statistics and the Quarterly Labour Force Survey have recently shown declines
in the number of people working - the first negative numbers since the global financial crisis.
Our forecasts suggest that this trend will continue, as the public sector achieves financial
sustainability and the private sector only slowly recovers from the current lows.
The private sector remains the major employer in this economy, providing around
threequarters of all jobs. And while we have seen higher employment in service sectors such as
finance and trade, catering, and accommodation since the crisis, private-sector job growth
stalled a few years ago. The mining sector is grappling with lower commodity prices and a
difficult investment environment; it now employs about 80 000 fewer people than it did at its
peak in mid-2012. The manufacturing sector continues to shed workers, persisting on a
multi-decade trend. We need to get private-sector employment going again.
The public sector employs far fewer people than the private sector does, but it has been the
prime source of new jobs in the post-crisis period. Since 2009, public-sector employment has
grown by about 300 000 people. The share of the budget spent on compensation has also
risen markedly; South Africa's government wage bill is now one of the highest among
emerging markets - not so much because the state employs an unusual number of people,
but because it pays them comparatively well.5 Our national finances can no longer bear this
sort of wage growth and government has had to implement a personnel freeze, removing
one source of job growth in recent years.
The overall result is a bleak outlook for labour markets. The question is what to do about it.
The inclusive reform agenda
The answer is fundamentally about growing again, reforming product markets, and making
labour markets more inclusive. We've built an economy that produces much more inflation
than growth and spits out unemployment as a by-product. As long as we can use commodity
prices or debt to grow - the path taken between 2004 and 2014 - we look like we're making
progress. The economy expands (albeit modestly) and jobs are sustained, but real income
per capita doesn't move much.6 When the debt burdens get too heavy and commodity prices
fall, however, inflation stays sticky while growth falls below the population growth rate,
entrenching inequality and worsening poverty. At its core, the formal sector of the economy
protects itself from the growth slowdown by raising prices, aggravating the downturn, and
imposing the cost on those losing their jobs and those without the market power to set prices
and wages.
There is an alternative path, in which strong investment and increasing labour force
absorption allow the economy to expand without accelerating inflation.7 That's where we
need to go. There are a series of product and labour market reforms that can help us get
there.
Start with product markets, which offer us our most attractive reform opportunities. OECD8
studies of product market regulation show that South Africa has unusually high barriers to
entry for new businesses.9 Targeting and reducing these barriers would encourage new
business creation and investment, and would raise productivity. In particular, lowering the
costs in network industries - such as telecommunications, energy, and transport - would
benefit many other parts of the economy. The cost of utilities feeds into the underlying cost
structure of the economy; it makes South African goods expensive for the export market and
raises that cost of living for the average South African. Research suggests that we could
raise our potential growth rate by 1,5 percentage points by reducing the markups in product
markets to world benchmarks - which would roughly double the economy's current "speed
limit".10
Of course, structural reforms of this type are difficult. Their benefits, in the form of stronger
growth and more employment, tend to be widely distributed across the population. The
diffusion of benefits is important in the policy debate, because the costs, by contrast,
generally appear quickly and affect a smaller number of people. For example, bringing down
International Monetary Fund, 2016 Article IV consultation: South Africa, pp. 18-20, July 2016
(https://www.imf.org/external/pubs/ft/scr/2016/cr16217.pdf).
6
From 1991 to 2000, the gross domestic product (GDP) per capita contracted slightly by, on average, -0,2 per
cent per year. From 2001 to 2010, it grew by 2,2 per cent per year (on average). From 2011 to 2015, GDP
growth per capita slowed to 0,5 per cent on average; the numbers for 2014 and 2015 are -0,04 per cent and
-0,48 per cent respectively.
7
This is discussed, for instance, by Ruchir Sharma in The rise and fall of nations: forces of change in the
postcrisis world, published by W.W. Norton & Company, New York, in 2016. See especially chapter 7.
8
Organisation for Economic Co-operation and Development.
9
This is available from the Organisation for Economic Co-operation and Development, Indicators of product
market regulation (http://www.oecd.org/eco/growth/indicatorsofproductmarketregulationhomepage.htm).
10
See David Faulkner, Chris Loewald and Konstantin Makrelov, 'Achieving higher growth and employment:
policy options for South Africa', Working Paper 13/03, July 2013 (http://www.resbank.co.za/Lists/
News%20and%20Publications/Attachments/5806/WP1303.pdf).
the price of a product like electricity is good for all the millions of users of electricity but
painful for the producer, the latter having to become more efficient. For this reason, reform
opponents usually mobilise more effectively than the prospective beneficiaries.
Nonetheless, there are extra, easy benefits that make reform yet more attractive right now.
South Africa has acquired a reputation for devising sound development strategies and then
failing to implement them. Following through on reform could reframe the whole South
African narrative and boost business confidence. Global conditions would also help. Interest
rates are now exceptionally low internationally, and investors are desperately searching for
yield. That's an opportunity; a lot of money would move this way if we became a better
growth and investment story.
Then there are reforms which affect the labour market directly. South Africa, arguably, has a
three-tier labour market. One is mostly informal and pays low wages. The second is
formalised and pays intermediate-range salaries, typically negotiated on an industry-wide
basis. The third tier pays the highest salaries and features mostly highly skilled employees.
Each of these poses different challenges.
On average, participants in the third market earn the highest salaries and benefit from skills
shortages in South Africa. These shortages mean that employer competition for workers is
quite intense, and unemployment in this category is therefore relatively low. But this doesn't
mean that the labour market for the highly skilled is a healthy one. The elevated wages in
this market feed our high levels of inequality and contribute to inflation. Furthermore, skills
shortages are a problem for economic growth and employment creation. Workers of different
skill levels are complementary "goods"; with more engineers you can employ more
construction workers to build more bridges. What this segment of the labour market needs, in
the longer run, is more and better education to open the highly skilled job market to more
South Africans and better match what students study with the skills required by the private
sector. We could also temporarily welcome more skilled immigrants to increase competition
and help firms find the people they need to grow while we invest in growing our domestic
knowledge base. The possibility of pro-growth, pro-equality reform in this area should make it
a policy priority.
South Africa's other two labour markets don't absorb nearly enough people, which leaves
many South Africans unemployed or out of the labour force entirely. As the National
Development Plan recognises, this problem has a lot to do with spatial legacies and access
to information about work. As a result, the plan pays special attention to the distances
between people and jobs. It also points out that if we are going to create 11 million new jobs
by 2030, many of them cannot be highly paid. This ties in with the product market reform
agenda: if the wages in new jobs can't be that high, we need to achieve downward pressure
on prices so that the possible wages command decent buying power. It also speaks to the
links between wages and employment. As Bheki Ntshalintshali of COSATU11 recently
reminded us, there is the real risk of excessive wage demands producing higher
unemployment.12
We know that the agricultural sector shed hundreds of thousands of workers after the
imposition of a minimum wage at an excessive level.13 We know that this economy lost a
disproportionate number of jobs during the global financial crisis relative to the decline in
economic output, in large part because of high wages and rigidities during periods of normal
business operations.14 Based on historical trends, we forecast persistent wage growth
despite rising unemployment and minimal growth. If we try to play a game in which fewer and
fewer people get higher and higher wages while more and more people wind up
unemployed, we can only lose. We have to get more people into work.
To tackle this problem, one of the things we should do is reconsider the institutions we use to
negotiate wage pricing. There is an important argument in academic literature, specifically by
Lars Calmfors and John Driffill, connecting unemployment to the kinds of collective
bargaining rules used in a country.15 The basic idea is that a country can achieve better
employment outcomes when collective bargaining is done either at a low level, such as one
union per firm or plant, or at a very high level, such as the whole economy. The worst
outcome is to be in the middle, between the two options. This is because company or
plantspecific unions have a special interest in the health of the firm that employs their members
and will not want agreements that make the firm unsustainable. By contrast, very large
unions have the power to shape macroeconomic outcomes. They will therefore avoid making
deals which will push up inflation, drive up interest rates, reduce investment and growth, and
ultimately destroy jobs.
By contrast, medium-sized institutions, such as those that cover industries, are big enough to
inflict costs on the economy but not big enough to experience those costs themselves - the
costs are pushed onto others. In these systems, it is easy to reach a deal that keeps out new
and smaller firms, so you get a lower level of employment at higher wages and a smaller
number of businesses with larger profits. This is a reasonable description of South Africa's
collective bargaining arrangements. We should not be surprised that this is contributing to
bad employment outcomes, an effect probably only partially mitigated by exemptions.16
Indeed, there are reliable estimates suggesting that these arrangements reduce employment
in affected industries by 8-13 per cent, in large part because they hurt small, labour-intensive
firms.17 South Africa has surprisingly few of these firms, relative to its peers. This helps
explain our unusually high levels of unemployment.
The reform conversation and the problem of good faith
Ladies and gentlemen, labour market discussions in South Africa are difficult. In particular,
they are difficult because they are convened against a backdrop of historical oppression and
deep race and class divides.
As in some other countries with large economic and social problems, the discussion quickly
moves beyond economics. It stops being about appropriate trade-offs and the sorts of
experiments which might get us to a better place. Rather, it becomes a discussion about fear
of the future and about a shortage of trust; the exchange stops too soon and often at the
point where insults fly. If the conversation ends there, nothing gets solved. We are, together,
responsible for the choices we make now - and we have the power to make better choices.
The people who have the most to gain from reform are the people locked out of the
economy. They don't have much power. Government therefore has a special duty to
prioritise their interests. For many South Africans in jobs, the struggle is to hold on to
employment and keep wages growing enough to support large numbers of dependents. We
need to turn this around, increasing employment and lowering dependency ratios. The best
way to raise household incomes is to increase employment. A growing economy and rising
productivity will push up real incomes for workers; this need not be done at the expense of
jobs. For this reason, there will be long-run benefits for both the unemployed and the workers
in the reform agenda.
By contrast, opening up product markets will deprive some people of lucrative,
overprotected niches in the economy. That's a good thing. Capitalists often preach the benefits of
free markets; we think they should try some competition themselves. We can also see that
the labour market reforms needed to temper bad economic outcomes should go hand in
hand with other reforms to boost economic growth. By achieving both sets of reforms, we will
create permanent gains from greater inclusion and higher productivity - gains sufficient to
offset any temporary economic sacrifices imposed on our economy's "insiders".
In addition to managing labour laws, government also has a role to play in managing labour
market dynamics. Firstly, by writing the rules and regulations which ensure that product
markets remain competitive. Secondly, by providing basic services that are accessible and
lower the cost of living. Planning for affordable housing that is closer to centres of
employment and the provision of adequate public transport systems would be examples of
these. One of the things that have become clear from the experience in the mining sector is
that we do not have adequate rental housing stock for entry-level workers. Thirdly,
government will support long-term labour market productivity by providing quality education
and health care. Finally, government can ensure that policy conversations balance the
interests of "insiders" and "outsiders".
The role of monetary policy
I'd like to end on the subject of the contribution from monetary policy.
The South African Reserve Bank has been tasked with maintaining inflation within the target
range of 3-6 per cent, to be implemented flexibly. Being flexible means that inflation may,
from time to time, find itself temporarily outside the target range. There are several reasons
for this. Sometimes, there are inflation surprises and it is impossible to change policy in time
to have any impact. Sometimes, it would be costly to return inflation to target very rapidly, so
we may prefer to disinflate more gradually. And sometimes, we choose to look through
departures from the target range because they are expected to be temporary.
But there are limits to how flexible we can be. We acknowledge that inflation has been rising
recently in response to supply shocks. South Africa has been suffering from a severe
drought, which has so far pushed food prices 11 per cent higher than they were in the middle
of last year. We are also seeing the effects of sustained currency depreciation, with the rand
losing about half its value against the US dollar over the period May 2013 to July 2016.
Our forecasts, and our experience, suggest that shocks of this scale pass through into prices
and wages more generally and over time, accelerating both inflation and unemployment. This
would have been an unacceptable outcome. Accordingly, we have been raising interest rates
in a gradual way, taking the repo rate from 5,0 per cent in January 2014 to 7,0 per cent in
March this year. By defending the target range, even in difficult conditions, we have helped to
control the expectations of future inflation. Together with some currency strength, and the
prospect of softening food prices, we expect underlying inflation to remain reasonably well
contained. And yet, with inflation hovering at around 6,5 per cent, the real interest rate level
of about 0,5 per cent remains exceptionally supportive of economic activity.
We are sometimes asked how we could have raised interest rates when the economy was
slowing, but when inflation is sticky and even rising despite slowing growth, more and more
monetary accommodation has adverse longer-run consequences. If above-target inflation
becomes the "new normal", longer-term interest rates will quickly rise in response. Lenders
expect to be compensated for inflation and inflation risk. In turn, the share of current income
that we need to spend on servicing debt increases, draining resources from other priorities,
like investment.
So it is clear that we need to focus on doing things that reduce the general level of lending
rates instead of permanently raising them. As I have discussed today, the markets for goods
and services in South Africa are commonly dominated by a few big firms. And labour markets
are uncompetitive because of skills shortages, restricted entry, and extended industry or
sectoral determinations. The result is that prices and wages are only flexible in an upward
direction, and are otherwise rigid.
This rigidity problem constrains our efforts to improve outcomes and permanently lower
interest rates. Our inflation outcomes appear to have settled at around the top of the target
range, close to 6 per cent. This implies that nominal market interest rates will never fall much
below 9 per cent. This cannot be an acceptable end point of macroeconomic policy, but it
also cannot be changed easily with shifts in the monetary policy stance. If we want lower
interest rates and we want them without going through a recession, then we have to lower
inflation outcomes arising from administered price processes and, above all else, the way in
which prices and wages are determined in our collective bargaining system. Simply reducing
the inflationary impulse from price and wage setting, to something around the middle of the
inflation target range, would help to create jobs economy-wide and ease constraints on
policy.
Conclusion
In conclusion, I have spoken today about some key challenges facing the South African
economy. The solution probably isn't going to emerge from rising commodity prices or a big
rebound in world growth which helps exports. It also cannot come from yet more fiscal or
monetary stimulus. Macroeconomic policy is already doing what it can, but the constraints
are tightening; we are running out of room to borrow and we have too much inflation to lower
interest rates.
This leaves us with the option of reforms. South African product markets are ripe for change;
opening up network industries would in particular have widespread growth benefits. Labour
markets for skilled people could be made more competitive, helping growth and reducing
inequality at the same time. Our wage bargaining institutions could be more supportive of
better economic outcomes. Less nominal wage pressure on prices would help us to lower
inflation and the overall level of interest rates. Our institutions could also be less hostile to
small firms, the kinds of companies which create lots of jobs - and which are also scarcer
here than they are in other countries. Getting more people into jobs would lower dependency
ratios, reducing the urgency of high real wages which themselves price many people out of
work entirely.
Finally, we need to think about the kind of conversation we are having. The reform
discussion can be difficult, partly because of vested interests and partly because of a
shortage of trust between parties. Given our difficult situation, we need to find ways of talking
to each other that ultimately solve problems instead of merely emphasising our differences.
We are all partners in this country and its future. We have a shared responsibility to make
that future better.
Thank you.