Francois Groepe: Monetary policy and inclusive growth
Address by Mr Francois Groepe, Deputy Governor of the South African Reserve Bank, at the
3rd UBS Economics Conference, Cape Town, 12 October 2012.
* * *
Monetary policy and inclusive growth
I wish to thank UBS for inviting me to address you in my beautiful home town. The topic I
have been asked to discuss today is monetary policy and inclusive growth. This topic is
particularly relevant given South Africa's income inequality as reflected in the most recently
estimated Gini-coefficient of 0,69. The top ten per cent of the population earn approximately
58 per cent of the income and the bottom 50 per cent less than eight per cent. We
furthermore have had to contend with structural unemployment, which currently stands at
24,9 per cent.
I will now proceed with a brief overview of the concepts of inclusive growth and productive
employment before discussing the South African Reserve Bank's (the Bank) mandate, the
monetary policy framework and how the achievement of the Bank's mandate enables the
most appropriate backdrop for inclusive economic growth.
Inclusive growth
Inclusive growth refers to long-term sustained economic growth that is broad-based across
sectors and inclusive of a large part of a country's labour force, thereby reducing
unemployment significantly. Policies that encourage inclusive growth tend to emphasize
removing constraints to growth, creating opportunity, and creating a level playing field for
investment. According to the World Bank's Commission on Growth and Development, a
persistent, determined focus on inclusive long-term growth by governments is a key
ingredient of all successful growth strategies.1
Long-term sustained high growth rates are further also dependent on productivity gains.
Productivity gains lead to higher rates of growth that in turn result in rising demand for labour
as the economy expands and incomes rise in a virtuous circle.
One well-known survey, by Lopez of the empirical literature on economic growth concludes
that macroeconomic stability, low inflation rates, and appropriate education and
infrastructure-related policies have positive effects on growth and reduce inequality.
More recent research initiatives have focused increasingly on constraints to future
development and showed that a country's initial conditions have a critical impact on long-run
growth. Initial conditions include levels of income and its distribution, the extent of poverty
and many other factors including geography, governance and the set of existing
macroeconomic policies. World Bank research in 2005 highlighted the extent to which
institutional structures, policies, and resource endowments interact in unique ways to support
necessary policies such as a stable macroeconomic environment, the enforcement of
property rights, openness to trade and effective government in achieving higher growth
rates.2 The line of enquiry further suggested that local peculiarities would tend to result in
unique sets of distortions that impede growth. In South Africa this would include inadequate
infrastructure, skills shortages and inefficient administration at the local authority level. Efforts
to address the distortions and constraints could in practice result in short-term costs, in
particular if local circumstances are not well understood. If however approached judiciously,
it should yield positive results over the medium to longer term.
It was against this background that Hausmann, Rodrik and Velasco developed their
approach to identifying binding constraints to growth. Important lessons from this and other
research were that development policy is country specific rather than being one-size-fits-all
and that sometimes large positive welfare impacts could be achieved by optimally
sequencing just a few reforms to relax binding constraints. Empirical evidence also showed
that in every country structural transformation and economic diversification are required to
achieve significant income growth and poverty reduction. For countries with relatively small
domestic markets like South Africa this implies export diversification in order to access
foreign markets and achieve economies of scale.
Productive employment
Productive employment is the main instrument for achieving sustainable and inclusive
growth. Employment growth generates new jobs while productivity growth lifts the wages of
the employed and the returns to the self-employed.
The key objective with any growth strategy is to strengthen the productive resources and
capacity of individuals on the labour supply side and to open up new opportunities for
productive employment on the labour demand side.
An inclusive growth strategy should also recognize the time lag between reforms and
outcomes as in the case of investments in education and the time elapsed before improved
labour skills become available. Efforts to narrow the knowledge gap with the goal of
developing creative and competitive human resources are an important prerequisite for
higher productivity. South Africa should aim to not merely catch up in this regard. We need to
pre-empt the type of skills and knowledge that will be required over the next say two decades
and ensure that our education and training strategies are adequately aligned so as to ensure
that we have a work force with the appropriate skills. It is, therefore imperative that our
human capital development strategy is forward-looking and proactive.
This necessitates us to take a hard look at our education system, as a recent assessment of
the quality of state education amongst 142 countries, ranked South Africa at 133rd, despite
the high levels of investment in education which now stands at R207bn per annum.
Planning must therefore focus sharply on upgrading the quality and relevance of training
while enhancing the skills of the labour force. In order to upgrade human resource skills to
meet the need of an increasingly sophisticated economy, training at every level must be
strengthened to generate well-trained labour to meet industry demand both now and in the
future. An inclusive growth strategy looks for ways to raise the pace of growth by utilizing the
labour force to the fullest possible extent.
High unemployment is the result of chronic skill and geographical mismatches and of
policies, product market structure, and labour market arrangements that often protect
insiders at the expense of the unemployed. High margins in product markets and upward
wage pressure in labour markets have resulted in uncompetitive domestic costs of
production in a number of sectors. This erodes external competitiveness and as a
consequence excludes part of the population from formal economic activity. It also ends up
constraining a country's ability to diversify exports. Entry-level wages are also sometimes
above the productivity levels of less experienced workers and new entrants to the labour
market. This discourages labour demand.
Sustainable job creation that significantly reduces unemployment can be achieved with
labour and product market reforms that specifically target labour intensive production
processes. A more flexible wage setting mechanism that better aligns wages with
productivity levels at the firm level will improve the business environment and our
competitiveness and should significantly contribute towards increasing employment
opportunities.
Important factors that serve to improve individual and enterprise or micro productivity include
improved management skills, updated technology and better capital equipment. Collective
factors at the enterprise level that have a decisive influence on productivity outcomes include
the adoption of the continuous-improvement-type work ethic and overall quality
consciousness that is so prevalent in Developing Asia. In many countries, active labour
market policies also serve to raise the rate of employment creation. This includes, transport
subsidies for job seekers, on-the-job training and in some instances, temporary youth wage
subsidies.
Infrastructure as a key jobs driver
Emerging-market and developing country growth is on average higher than that of South
Africa and is indicative of country specific structural constraints. A sustained increase in the
potential output of the economy requires not only a concerted and coordinated effort from
government, but also the support and buy-in of the private sector and labour if we were to
succeed in improving the growth performance. It may even require a new social compact.
In the past, infrastructure development in particular has been held back largely due to limited
implementation capacity. This has resulted in bottlenecks in electricity generation, transport,
and port infrastructure and South Africa has therefore not benefited as much as other
resource intensive emerging market economies from large terms of trade gains in recent
years. This also discouraged investment in South Africa's natural resource industry, and has
made it difficult in some instances to maintain export volume growth. Policy certainty and
investor confidence have proven to be essential prerequisites for the capital formation
South Africa requires for substantive export led growth.
The New Growth Path sets the goal of creating 5 million new jobs by 2020 and to this end
identifies the structural problems in the economy that need to be overcome as well as the
key opportunities or job drivers in specific sectors and markets. One of the key jobs drivers is
infrastructure development which provides the basis for higher growth, inclusivity and job
creation. Government has also established the Presidential Infrastructure Coordinating
Commission (PICC) to address the challenges of delivery through coordination, integration
and accelerated implementation. A single common Infrastructure Plan will in future be
centrally driven and monitored. The objective is also to develop a twenty-year planning
framework beyond one administration to avoid the typical stop-start pattern of the past. The
PICC's mandate is to ensure systematic selection, planning and monitoring of large projects.
An infrastructure book that contains more than 645 infrastructure projects across the country
has now been compiled by the PICC. An Infrastructure Plan with identified Strategic
Integrated Projects has also been developed by the PICC and adopted by Cabinet and
although this in itself will not address all the challenges, it forms an important part of the
National Development Plan's (NDP) proposals to increase employment and growth Other
key proposals of the NDP include improving the functioning of the labour market, supporting
small business through better coordination of activities and improving the capacity of the
state to effectively implement economic policy.
Although South Africa has at times over the past 18 years, achieved significantly improved
real economic growth outcomes, built democratic institutions, transformed the public service,
extended basic services and stabilised the economy, too many people are still trapped in
poverty and too few South Africans have obtained employment over this period as growth
has not been sufficiently inclusive. The quality of education for the majority has remained
poor and government has continued to experience insufficient capacity in critical areas.
Some years were characterised by jobless capital intensive growth while the large
employment losses that this country suffered during the recession have still not been
recovered fully. The NDP aims to eliminate poverty and reduce inequality significantly by
2030 by growing an inclusive economy and creating 11 million jobs by 2030.
Recent developments in the labour market
Although employment levels have increased at a slower pace this year compared to 2011,
the rate of job creation has been sufficient to decrease marginally the unemployment rate in
the second quarter of 2012. Employment creation has nevertheless remained hesitant,
consistent with the moderate pace of recovery in real economic activity in South Africa and
against the backdrop of the challenging global economic developments.
The moderation in average wage settlement rates in 2011 levelled off in 2012. In the second
quarter of 2012, both the rate of increase in remuneration per worker and productivity
increased somewhat resulting in the growth in nominal unit labour cost remaining the same.
These developments mitigated inflationary pressures, but the outlook for wage growth has
become uncertain.
Recent industrial action has spilled over from mining to the manufacturing, transport and
agricultural sectors and has raised investors' concerns. Moody's Investors Service also
mentioned spreading labour turmoil as an important factor in its decision to cut South Africa's
debt rating to Baa1 from A3. Widespread labour unrest has already shut down large parts of
the mining industry and given that we are the world's top platinum producer and a major
supplier of gold, prices of precious metals have risen. The rand's exchange value has
reflected investor concerns in recent weeks, and although the negative consequences of the
unrest cannot be underestimated, I am confident the currency will return to more appropriate
levels.
The rand will remain vulnerable to any signs of intensifying labour turmoil, but government
has taken steps to address the labour unrest as a speedy resolution is crucial to restoring
broader investor confidence and medium-term growth prospects. The government has also
given the assurance that it is putting immense efforts into bringing together the employer
community, trade union movement and the government itself in order to stabilise the situation
as rapidly as possible. The longer strikes continue, the greater the implications will be for
economic growth, employment creation and fiscal outcomes in the long run.
The role of monetary policy
I have earlier made reference to the Lopez survey that concluded that macroeconomic
stability and low inflation rates inter alia have positive effects on growth and reduce
inequality. It is my contention that transparent, well-understood monetary policy is critical to
achieving stable macroeconomic outcomes. The mandate of the South African Reserve Bank
is to achieve and maintain price stability in the interest of balanced and sustainable economic
growth. The Bank also plays a central role in overseeing and maintaining financial stability.
Price stability reduces uncertainty in the economy and provides a favourable environment for
growth and cumulative employment creation over the longer term. Low inflation helps to
protect the purchasing power and living standards of all South Africans. Although low
inflation may not necessarily in itself reduce income inequality, it does ensure the protection
of income which is particularly important for poorer South Africans who generally do not have
the means to adjust their nominal incomes to take account of rapid price increases.
An inflation target range is set by government after consultation with the Bank. The
commitment is to pursue a continuous target of 3 to 6 per cent for headline CPI inflation. The
Bank conducts monetary policy within a flexible inflation-targeting framework that allows for
inflation to be temporarily outside the target range as a result of mainly supply shocks. The
Monetary Policy Committee (MPC) takes into account the appropriate medium-term time
horizon for inflation to return to within the target range, considering the lags between policy
adjustments and economic effects. This provides for interest rate smoothing over the cycle
and makes growth more sustained and consistent.
Since the implementation of inflation targeting, the instances when inflation outcomes
exceeded the target could be attributed to external shocks which exacerbated domestic
inflationary pressures. These shocks, amongst others, included depreciation of and volatility
in the exchange rate of the rand and sharp increases in international oil, commodity, and
food prices. Structural features of the South African economy such as backward looking
wage settlements, uncompetitive product markets, rapidly rising administered prices and low
productivity have also been important sources of inflationary pressures.
It is very difficult to distinguish comprehensively between the specific impact of inflation
targeting and the general impact of other concurrent economic reforms or global
developments. However, empirical evidence shows that gains in inflation performance in
inflation targeting countries were achieved with no adverse effects on output and interest
volatility. The inflation targeting framework has also served South Africa well and the most
important outcomes it has contributed towards can be summarised as follows:
•
The nominal policy interest rate has declined. This has lowered the interest rate
structure at the short end of the maturity spectrum.
•
The real policy interest rate has declined and has become less volatile. This has
reduced the inflation risk premium embedded in interest rates as inflation
expectations became better anchored.
•
Nominal bond yields have declined. This has lowered the cost of borrowing of
government and the cost of funding of the private sector to the benefit of real
economic activity.
•
Growth in real gross domestic product and real gross fixed capital formation has
increased and become less volatile. This has encouraged employment creation,
particularly in the pre-crisis years.
The extent of the gains derived in part from inflation targeting largely depends on the Bank's
ability to anchor inflation expectations within the inflation target range. Anchored inflation
expectations reduce the effect of external shocks and require less policy intervention.
The inflation targeting framework has been important in providing greater resilience to the
large shocks coming from the global external environment. As the nominal exchange rate of
the rand is determined by supply and demand conditions, exchange rate flexibility serves as
an important transmission mechanism and shock absorber of external shocks. This approach
allows output growth and interest rates to be less volatile and delivers the best outcomes in
terms of price stability and lower exchange rate volatility subject to the risk of over- or
undervaluation in response to external shocks.
Inflation targeting has also been successfully practiced in a growing number of countries over
the past 20 years, and many more countries are moving toward this framework. Empirical
evidence on the performance of inflation targeting is supportive of the effectiveness of the
framework in delivering low inflation. The monetary policy framework has allowed the Bank to
provide stimulus when required while keeping inflation expectations well anchored. Since its
introduction in 2000, inflation targeting in South Africa has been applied as a flexible
framework that has been resilient to changing circumstances, including the recent global
financial crisis. The inflation targeting framework has thus far enabled the Bank and most of
the other inflation targeting countries to steer clear of unconventional measures in achieving
their key monetary policy objective. The Bank's inflation forecast shows inflation remaining
within the inflation target range over the forecast horizon to 2014.
Conclusion
Although there is a short-run trade-off between economic activity and monetary policy, it is
generally accepted that low and stable inflation produces an environment in which overall
economic performance and inclusive growth can flourish. The Bank's flexible approach to
inflation targeting, I believe positions South Africa to best deal with external shocks and
minimise their disruptive impact on the domestic economy. Growth, employment and income
levels have been more stable and consistent since 2000 and the introduction of the current
inflation targeting framework.
Achieving greater economic inclusion is a critical need for the country. Monetary policy
should be complemented by growth-oriented and job-creating fiscal, industrial and labour
policies. Emerging market and developing economies are now more resilient than in previous
decades but structural issues still need to be addressed. Weaknesses in any subsector or in
regulation or corporate governance will limit monetary policy efficacy and lead to weak
growth, which in turn is a drag on fiscal consolidation. Policies in general must therefore
emphasise the resolution of underlying structural problems within the economy, and
monetary policy must be as supportive as possible, with due regard to ensuring price
stability. Although monetary policy can therefore contribute to inclusive and sustainable
growth (and you will probably agree that the SARB has indeed adopted policies that are
supportive in this regard), one needs to recognise the limitations of monetary policy and
hence acknowledge that other policymakers and stakeholders also have an important and
significant role to play in achieving both inclusive and sustainable growth over the longer
term.
Thank you.
References:
Aron J. and Muellbuaer, J., "Transparency, credibility and predictability of monetary policy
under inflation targeting in South Africa", Department of Economic, Oxford and Nuffield
College, Oxford, 31 March 2007.
Ianchovichina, E and Lundstrom, S. What is Inclusive Growth?, Policy Research Working
Paper No. 4851, The World Bank. 2009
Hausmann, R., Rodrik D., and A. Velasco. Growth Diagnostics. Mimeo, Harvard Kennedy
School. Cambridge. 2005.
Lopez, H. "Pro-Poor Growth: A Review of What We Know (and of What We Don't)" Mimeo.
World Bank. 2004
The Infrastructure Plan, Presidential Infrastructure Coordinating Commission (PICC), April,
2012.