Article written by Prieur du Plessis, editor of the Investment Postcards from Cape Town blog.
By Cees Bruggemans, Chief Economist of FNB.
The global arguments about what to do next are many, and find a reflection in South Africa’s own crossroads.
The rich countries continue to favour an open trading system, along market capitalist lines.
Anglo-Saxons emphasize the free market thereof, Europeans adhere to more social market ideas, while Japan has its own variant.
In contrast, China follows a mercantilist approach, organized domestically for saving and investment, with export a major growth engine (with large external surpluses taken as a long-term strategic boon rather than as the welfare loss that it is, a societal decision made by its political leadership).
The Contagion Crisis of 1998 impressed on all of Asia the need for greater financial buffers in case of global reversals. This motivated substantial savings increases and generation of export surpluses, used to beef up the foreign reserves, and invested mainly in rich country (US Treasury) securities.
Following the financial crises of 2007-2010, there is worldwide agreement about greater financial regulation.
But such micro-oversight is only one aspect of crisis prevention. The greater arguments remain macro.
In the rich Western countries there are questions about the appropriate roles of monetary and fiscal policies, also aimed at preventing financial overreach from coming into existence, pre-emption now being seen as far better than cure (it wasn’t always so in the US).
When it comes to the interplay between rich countries and the upcoming emerging universe, something else entirely comes into focus.
The main beef is between the rich Western countries and Asian mercantilists, in particular China. But it is more complex than that, as Germany is nowadays mentioned in one breath alongside China.
So the main beef is really between deficit and surplus countries, and how they are internally organized, with external consequences for trading partners.
The deficit countries are told they should save and invest more, consume less, be less reliant on monetary and fiscal stimulus (becoming more ‘prudent’), and aim to run neutral balance of payments (though possibly varying over the business cycle).
The surplus countries are told to save and invest less aggressively, consume and import more, run smaller external surpluses and accumulate foreign assets less aggressively.
As part of this changeover, deficit countries tend to suggest to surplus countries (especially China) that they should allow their currencies greater free rein to ensure ‘smooth’ adjustments of any internal and external imbalances over time.
Germany’s position is more complex at the core of the Eurozone, which overall is far more in balance with the rest of the world (but where the deficit/surplus strains are at their worst between member countries).
The rest of the emerging world and commodity producers populate a wide spectrum of policy choices, varying from modeling on mainly rich country lines (Aussie, Canada) or still having mercantilist origins of their own (Korea, Taiwan).
Many more countries today are simply democracies with capitalist market economies and open trading systems, with either a more US or European slant to their internal policies, but with many experiencing peculiar problems due to the global financial crisis and its aftermath.
Most of these emerging countries or commodity producers did not themselves experience the financial crisis, but were hurt by the global recession that occurred, with their exports falling away.
Thus many also lowered their interest rates aggressively, while their fiscal policies turned accommodative as tax revenues temporarily fell away.
For many, therefore, a return to growth was imperative in 2009-2010. And although the world economy recovered well, this was partly driven by extremely aggressive monetary and fiscal policies, especially in the US and Europe.
Interest rates at or near zero and central bank bond buying in rich countries set in motion yet another surge of global yield seeking, sending waves of capital towards higher yielding emerging countries.
Many of these were in any case inclined to generate export surpluses or found themselves beneficiaries of the ongoing global commodity price boom, partly China demand-driven and US supply-pushed (liquidity and Dollar).
The upshot was severe upwards pressure on many emerging and commodity producer currencies, to the point of overvaluation, putting downward pressure on inflation and interest rates in many of those countries and disrupting export performances.
Though this may have been exactly what Anglo-Saxon deficit countries were looking for, assisting them in their own (and the world’s) rebalancing, it was seen and experienced as destabilizing by many emerging countries.
Clearly, not everyone was prepared to give up export advantages and stimulate their domestic economies more in order to assist the larger problematic countries.
Let those bigger countries make their own INTERNAL changes rather than co-opting the entire world in their domestic effort at the cost of forcing costly adjustments on many countries (the reasoning seems to have been).
Thus these past six months there has been much talk about ‘currency wars’ as many emerging countries and commodity producers tried to prevent their currencies from appreciating too much, in some instances imposing capital controls to deflect incoming foreign capital.
In global forums such as G-20, there seems precious little agreement as to how the world should be organized, with each country mainly following its own interests, with its own policy tradition and economic structure guiding policy responses.
Thus America is seen sticking to its accommodative fiscal and monetary stances, China and Germany do not wish external targets to be imposed on them, and many emerging markets and commodity producers continue to struggle with the global pressures on them through free capital flows and open trading systems, forcing adjustments (exports, jobs) which are experienced as costly.
A large part of this debate is transitory, and limited to the aftermath of the global financial crisis.
Once the crisis-stricken countries (especially the US) have succeeded in recovering to an even keel later this decade, by closing output gaps, reducing unemployment rates and normalizing interest rates and fiscal stances, this will have its equivalent impact overseas through changing capital flows and currency adjustments.
Thus ‘normality’ in many respects should be regained globally after the emergency is finally over.
What probably will not change (much), going by present noises, is the inclination of successful countries like Germany and China of sticking to proven economic formulas, and still generating relatively large external surpluses and accumulating large foreign asset holdings (whose nature in coming years could change considerably, given the experiences of recent years).
In that particular way, the global arguments will likely remain major, as global deficit/surplus imbalances will remain a reality, with implications for capital flows, asset markets and presumably policy in many countries (Greenspan’s ‘conundrum’ of 2005 when the US Fed discovered that US long-term bond yields were no longer responding in quite the usual way to its policy moves).
Thus global strains and stresses may change, but they will hardly go away as long as people globally divert so much in their economic approaches.
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South Africa also finds itself at yet another important crossroads as it recasts its policy framework.
South Africa progressed these past 150 years from an underdeveloped agricultural country into a fast growing commodity exporter and used this as a platform to industrialise through import substitution.
Its political choices imposed severe internal economic rigidities throughout this period of modern development, ultimately also imposing external exchange controls.
When change came 20 years ago, it was marked by increased freedom of exchange domestically and externally, with reform aimed at freeing the flow of labour, capital and trade while reintroducing strict macro discipline, thereby reducing inflation and national indebtedness.
The country was remarkably successful in this, with the employed labour force changing its composition, inflation and interest rates falling to thirty year lows, the national debt-to-GDP ratio more than halving, with fiscal support fundamentally rotating in support of the poorer majority of society.
Not than any of this represented completeness, but a long road was already traveled in these twenty years.
What wasn’t ultimately achieved was a noticeable increase in growth potential, a much more rapid increase in national income, and a more thorough reduction in inequality of opportunity (education, work, income, wealth) than had existed before despite the middle class expanding and greatly changing in composition.
Change was achieved through redistribution efforts, but unemployment remained strikingly large, poverty serious and the political clamour for more change insistent.
Throughout these twenty turbulent years, there was never much unity as to which policy mixtures were the better ones to apply to South African challenges.
There remained many who preferred alternative approaches. With change in leadership came the opportunity to also change policy emphasis. This is ongoing and brings a different set of challenges to the fore.
The main issues concern macro discipline and market processes as opposed to greater policy intervention.
The demand is for greater fiscal pro-activity, a more accommodative monetary policy (rejection of inflation targeting), a weaker currency and more trade protection.
This suggests a greater role for the state in the economy and less reliance on markets, also as regards the external world.
All of this has been tried elsewhere in the world at various stages in various countries, including South Africa itself.
Though some of these policy stances have been successful in some countries, these were ultimately undertaken in supportive institutional frameworks.
China was successful, though it has been reducing state intervention in the economy while labour unions don’t exist and consumers are not socially protected and thereby incentivised to save maximally, for instance.
The South African policy stance has so far not abruptly changed from what has prevailed since 1990.
The government continues to adhere to macro policy discipline, with the SARB following a flexible inflation targeting policy. Fiscal policy was judiciously used to counter the deflationary shock following the global recession of 2008/2009, since then steadily normalizing.
Though the country has been gradually rebuilding its foreign reserves these past 15 years, the hands-off policy regarding the currency has changed of late as more aggressive foreign reserve intervention was undertaken from January after exchange control relaxations had been announced in December.
Thus South Africa has been acting like so many other emerging countries in trying to limit overvaluation of its currency in the face of exceptional overseas policy conditions.
More fundamental (so far) is its domestic micro policy repositioning.
The country continues to restructure its social welfare distribution. State education is increasingly for free, a new national health insurance scheme is being proposed and there are now over 15 million recipients of social allowances. In addition, employment creation enjoys much political attention.
Industrial policy favours the continuation of major public infrastructure expansion/replacement and greater selective subsidy support for promising industries, thus hoping to increase the country’s growth potential.
Especially infrastructure-related import substitution of capital goods production is coming back into focus, after being largely abandoned 25 years ago as the last large infrastructure effort at the time wound down completely.
There are also demands to make the labour market less free and more open to greater unionization, with such legislation proposed but as yet not enacted.
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Given all this movement, the question is whether South Africa is lessening its macro disciplines and market openness and is starting to rely to a greater degree on state intervention to achieve growth and redistribution objectives?
It is as yet not obvious that the macro policy stance is shifting fundamentally.
In a micro sense there will be more change, some of it a throwback to the distant past (import substitution, economic subsidies, labour market) and others new (state mining company).
But so far it isn’t yet clear how far these interventions will go or how quickly they will progress, including the new national health insurance where affordability may remain a consideration.
The South African policy mix is changing, in response to old ideological preferences and a new sense of political urgency as the country’s democracy keeps steadily evolving expressing an ever greater insistence on change.
On this latter score we are no different from just about every other part of the world.
Source: Cees Bruggemans, FNB, February 22, 2011.
South African crossroads was first posted on February 23, 2011 at 5:50 am.
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