Increase in quantity and quality of investment will spur on dynamism
Pull out all the stops to attract more productive private sector input and funding, especially from abroad
The release of SA’s appalling first-quarter GDP growth data was a shock. The 2.2% GDP contraction requires us to urgently take stock of the strategic priorities of our government — it must put in place and implement the correct policies needed to drive economic growth.
In SA building economic dynamism is urgently needed. If nothing else, the economy has to generate more jobs for the vast numbers of the unemployed and underemployed, especially among the youth. Over the longer term it is equally necessary to raise productivity and increase the country’s global competitiveness. And the key to building economic dynamism at this juncture in SA lies in investment and the intellectual property that comes with it.
The President has appointed four capable individuals to spearhead this crucial task, namely Mcebisi Jonas, Phumzile Langeni, Trevor Manuel and Jacko Maree.
But structural reform carried out by a functional and agile state is required before their efforts will have measurable impact.
Fundamentally, investment is the prime mover of economic growth. An increase in investment translates immediately into higher GDP growth. And if investment-induced economic activity also turns out to be labour intensive, the effect on employment creation could be significant. Should investment be made in the right areas where it can generate sustainably high returns, longerterm gains in productivity would follow as well. The result is economic dynamism.
SA’s investment level is simply too low for what the country needs. Between 2010 and 2017 the average annual investment as a percentage of GDP was 19.9%. This was the second lowest among the Brics group of leading developing countries (SA is marginally higher than Brazil’s 19.5%) and lags significantly behind China’s 46.3% and India’s 34.6%, and is lower than Russia’s 23.1%. The experience of the successful economic takeoff in East Asia suggests that investment needs to rise to at least 30% of GDP — preferably higher — over a sustained period of two decades or more to really move the needle in economic growth and decent social development.
More investment is needed so that workers can be equipped with better tools, machinery and infrastructure, thereby raising their productivity. The demand for more and better tools, machinery and infrastructure in turn increases the need for more workers. This then leads to an increase in capital stock per capita.
High-income developed countries typically have high capital stock per capita, which also explains their workers’ high productivity.
For example, the capital stock per capita in the US and Germany was estimated to be $68,700 and $68,100, respectively, in 2015, compared with India’s mere $6,100. For SA it was about $11,000 in 2015, which is lower than all other Brics countries (using IMF and UN data). With a fastgrowing population, SA has to dramatically increase its capital stock to have a rising capital stock per capita. This means much higher investment will be needed.
Increasing the quantity of capital is only one side of the coin, however. The quality of capital has to improve as well. This is captured by the socalled incremental capital output ratio (Icor), which estimates how much investment is needed to raise GDP growth by 1%. The higher the Icor, therefore, the less productive the capital. Over the 2010 to 2017 period SA’s Icor was estimated at 10, which means that it takes an increase of investment equivalent to 10% of GDP to raise SA’s GDP growth by 1%. This compares very poorly with China’s 5.8 and India’s 4.8. SA has the second-highest Icor among Brics countries. Only Brazil’s Icor, estimated at 14.3, is higher than that of SA. Should SA be able to bring its Icor down to the levels of China and India, its capital can become twice as productive.
The fundamental task of building economic dynamism in SA therefore requires a simultaneous increase in both the quantity and quality of investment.
In this context, what should President Cyril Ramaphosa’s strategic priorities be?
We would suggest that in formulating public policies to encourage higher investment, the priorities are: give preference to private sector investment over public sector investment, and in so doing focus on attracting foreign direct investment (FDI), and achieving a better mix in investment in terms of the different sectors in the economy as well as its geographic distribution.
We believe unabashedly that, as a rule of thumb, private sector investment is qualitatively superior to public sector investment. In a market economy, private sector investment typically faces competitive pressure that is not always present in public sector investment. Thus private sector investment has to be sufficiently productive to survive. The bottom line is that with any given amount of investment, the higher the proportion coming from the private sector the more productive it is likely to be.
In this connection, FDI is particularly impactful because it usually comes with a lot of inbound transfer of know-how and skills. As demonstrated powerfully by the experience of East Asia, global companies are instrumental in introducing stateof-the-art technical and management techniques and in upgrading the skills of the local workers they employ in countries in which they invest. This is true whether it is with respect to capitaland knowledge-intensive sectors such as banking and finance, biotechnology, electronics and aerospace (as in Singapore and Malaysia) or labour-intensive industries like light manufacturing, construction and transport (as in Thailand, Indonesia and, most spectacularly, China).
Unfortunately, SA has not been exactly successful in attracting FDI. According to World Bank data, in the period from 2005 to 2016 it amounted to just 7.4% of total investment. As mentioned earlier, the average annual investment in SA in recent years is estimated at 19.9% of GDP: at 7.4% of total investment, average annual FDI therefore comes to a minuscule 1.5% of GDP. Attracting more FDI must be a top strategic priority for Ramaphosa.
In spite of persistent volatility and elevated levels of uncertainty in the global economy, we believe conditions continue to be favourable for attracting FDI to SA. Global FDI flows did contract between 2016 and 2017, but this was concentrated in the developed countries, where it dropped from $1.2-trillion in 2016 to $0.72-trillion in 2017. For developing countries, FDI flow was basically unchanged at $0.63-trillion in 2016 and $0.62trillion in 2017 (UN Conference on Trade and Development data). Clearly, global companies are still very interested in seeking opportunities in developing countries. SA must pull out all the stops to position itself as a preferred FDI destination. With any given amount of FDI inflow the more it is directed to low-income regions of the country with high concentration of the unemployed, the better. The pattern of FDI inflow in SA appears to be the opposite of what should happen. Close to half of FDI has flowed to financial services, real estate developments and other business services that are highly concentrated in urban areas. FDI has in effect gone into expanding business operations to serve the urban middle class, which constitutes a minority of households in South African society. However, an increase in FDI in infrastructure across the whole country, including more efficient and affordable transport, would do wonders in creating jobs and raising productivity economy-wide.
To the extent that investment flow, FDI or otherwise, can be channelled to target business start-ups and small entrepreneurs, the impact on building economic dynamism would be even more pronounced. For example, it is estimated that 21% of private equity investment in China has gone to start-ups and early stage business development, whereas in Japan the estimate is just 4%. Instead, some 82% of private equity investment in Japan is in buying out established and profitable businesses. No surprise that the Chinese economy is far more dynamic than the Japanese economy however it is measured.
We believe these are the strategic priorities Ramaphosa should focus on in building economic dynamism in SA. The stakes cannot be higher or the need more urgent. The time to act is now.
GLOBAL COMPANIES ARE STILL INTERESTED IN OPPORTUNITIES IN DEVELOPING COUNTRIES. SA MUST POSITION ITSELF AS A PREFERRED FDI DESTINATION