Companies using incorrect economic variable to plan investment
SOUTH AFRICA HAS ENJOYED almost 90 months of uninterrupted economic growth, by far the longest upward trend in the business cycle the country has ever enjoyed.
However, the good times haven’t come without their challenges. The fact remains that the economy’s productive capacity hasn’t kept pace with the demand-led growth trajectory, resulting in widespread infrastructure bottlenecks.
That’s evident from SA’s current rate of capacity utilisation – 86,6% – recorded in fourth quarter 2006. It’s also the clearest signal that companies haven’t planned their investment strategies adequately enough to meet the rising levels of demand in the economy.
You need only to consider the fact that SA is running short of everything from electricity and cement to the carbon dioxide needed to carbonate fizzy drinks to see the point.
Though the standard explanation for that dilemma is that SA companies underestimated the upswing in GDP growth, Stanlib chief economist Kevin Lings says companies haven’t been focusing on the correct economic variable to plan their expansion strategies. “Many firms use models based on GDP growth to make their investment decisions, but that may not be the best variable.”
Instead, Lings says firms should be looking at gross domestic expenditure (GDE), which he believes is a better proxy for the true levels of economic activity in an economy.
To explain the difference between the two variables, Lings uses the analogy of an isolated coastal city. “If that city were very busy exporting a certain commodity overseas, its GDP growth rate could be flying while the malls, roads and offices stood empty, meaning its domestic expenditure levels would be very low.”
Expressed as a formula, GDE simply amounts to GDP less exports plus imports (GDP - Exports + Imports = GDE).
The reason exports are excluded is because expenditure on exported products occurs outside of SA’s economy. By contrast, imports are included in the calculation because expenditure on imported goods typically occurs domestically, even though money is initially leaked out of the economy to pay for imported goods.
That money leakage is precisely why imports aren’t included in GDP calculations, as the goods aren’t manufactured in SA.
What’s more, if domes- tic expenditure (GDE) is greater than domestic production (GDP) it follows that the country is importing more than it’s exporting. That’s precisely the situation that SA finds itself in. SA’s current GDP growth rate of 5% is decidedly smaller than its GDE growth rate of 8,7% – the recorded average for the past four quarters.
Lings says the fact that GDE exceeds GDP by such a healthy margin implies that domestic economic activity levels can’t be adequately gauged by looking at GDP alone.
That’s why Lings says you have to focus on domestic expenditure when planning capacity expansion, as the burdens placed on infrastructure typically come from expenditure levels and not necessarily the growth in income levels, as implied by GDP.
“The levels of activity one witnesses on a daily basis in the form of demand for housing, transport and electricity aren’t conscious of the leakage of money from an economy that occurs due to imports,” Lings says.
“Just because you’re filling your home with imported goods doesn’t mean that levels of domestic economic activity are constrained.
“You still need trucks fuel, roads and electricity to facilitate the sale of those goods.”
Not preoccupied with GDP. Kevin Lings