SA’S ECONOMIC VALUE TRAP
The fiscal consolidation SA has embarked on so far may have been illusionary and doing more of the same could be self-defeating
Economists like to recount this old joke: While on a foreign trip a government official of country A visits the glamorous apartment of his friend B, a bureaucrat in a poor country. A admires the fine residence but wants to know how his friend can possibly afford it on his salary. Taking his friend to the window, B replies: “Do you see that highway running through town? 10%.”
Subsequently B visits the even poorer country of his friend C, who owns an even more luxurious apartment. When B asks how this is possible, C takes his friend to the window and says: “See that highway running out into the jungle?” After straining his eyes for a minute, B replies that there is none. “Exactly,” says C with a wink, “100%.”
Prof Lant Pritchett of Harvard’s Kennedy School of Government, a former World Bank economist, tells this joke in his seminal paper, “The Tyranny of Concepts”.
He uses it to explain the notion that the cost of public capital investment is not necessarily the same as the value of that investment, even though when it comes to compiling national public accounts, the distinction is not usually made.
This doesn’t matter when a government is responsible for only a small fraction of national investment and is reasonably effective, as in the US, he explains. But when the government is a major investor and is ineffective (as in SA), the gap between the amount of capital invested and what scholars call the “cumulative, depreciated investment effort” (Cudie) may be enormous.
Take the real-life example of two steel mills built by two parastatals in two very different countries.
The Pohang Iron & Steel Company mill in South Korea is a model of efficiency and a serious competitor in world steel markets. The Ajaokuta Steel mill in Nigeria, which cost upward of Us$4bn to build, has never been finished to its planned capacity, much less produced to that capacity, according to Pritchett.
After the end of Nigeria’s military government in 1998, reports emerged that $2bn had been siphoned from the project by various government officials.
Pritchett’s point is that while a public steel mill may absorb billions as a capital investment, if it cannot produce steel it has zero value (or Cudie).
SA’S public sector infrastructure expenditure has climbed from around R50bn/year in 1998/1999 (which was 6% of GDP then) to R250bn/year in 2015/2016 (still 6% of GDP). Over this entire period it has averaged 6% of GDP, having peaked at just over 8% of GDP in 2010.
Relative to GDP, the fixed capital stock of SA’S state-owned enterprises (SOES) — essentially their physical assets, like machinery — increased from 30% of GDP in 2007 to 48% of GDP in 2016.
On paper this is an impressive achievement. However, given the extent of corruption at SOES, their declining operational efficiency, mounting debt and dismal return on equity, the actual value of this investment (the Cudie) has arguably been considerably less than the official capital cost.
Hence Pritchett’s call on scholars to
“end this tyrannical reign of conceptual confusion: let’s call capital, capital and let’s call Cudie, Cudie”.
The distinction between the two concepts helps to explain how a government’s net asset value (NAV) can decline even as it spends more on capital investment, as SA has been doing.
SA does not have an official public sector balance sheet, mainly because of the difficulty in estimating the provincial asset base, but the Reserve Bank aims to publish one by the end of 2018. This will provide a clear sense of how the NAV of the public sector has changed over time.