An overview of the South African macroeconomic. environment

An overview of the South African macroeconomic environment 1 Study instruction Study Study guide: study unit 1 Study unit outcomes Once you have worked through this study unit, you should be able to give an overview of the performance of the South African economy with regards to the following macroeconomic aspects: economic growth business cycle stabilisation policy inflation unemployment balance of payments distribution of income Contents 1-1 THE DIFFERENCE BETWEEN MICROECONOMICS AND MACROECONOMICS Microeconomics deals mainly with the behaviour and decisions of individual consumers, households or families (eg groups of consumers), business enterprises (eg a vegetable farmer or electricity supplier) and other organisations (eg welfare organisations). It also studies the demand for and supply of individual goods and services and the determination of their prices. Macroeconomics deals with the economy as a whole. It involves determining and exploring the relationship between aggregate concepts (variables), such as aggregate income or production and expenditure, economic growth, inflation (changes in the aggregate price level), aggregate

unemployment, the balance of payments, exchange rates and interest rates. Instead of studying individual markets, we will be focusing on the interaction between the different macro markets, such as the market for goods and services, the financial market, the labour market and the foreign exchange market, as well as the nature of these markets, the process whereby equilibrium may be achieved and the implications of disequilibrium for these markets. We will concentrate on stabilisation policies, with the main focus on the need for and use of fiscal and monetary policies to stabilise the macro economy. While microeconomics studies the operation of the economy at the level where basic economic decisions are taken, macroeconomics concentrates on aggregate economic behaviour and the aggregate performance of the economy. 1-2 ECONOMIC GROWTH Economic growth takes place when the total production of goods and services in an economy increases. It is traditionally defined as the annual rate of increase in total production or income in the economy. This definition has to be qualified in two important respects. Firstly, production, or income, should be measured in real terms that is, the effects of inflation should be eliminated. Secondly, the figures should also be adjusted for population growth. In other words, they should be expressed in per capita terms. The growth in total production (economic growth) can be measured by calculating the percentage change in the real gross domestic product (GDP) from one year to the next. Real GDP growth rate = Gross domestic product (GDP) The GDP is the total value of all final goods and services produced within the boundaries of a country during a particular period (usually one year). GDP is an official measure of how much output was produced in a country or region during a specified time period. It is also the broadest, best-known and most frequently used measure of economic activity. GDP is a gross measurement because it includes the total amount of goods and services produced, some of which are simply replacing goods that have depreciated or worn out. GDP measures the goods and services produced inside the borders of a country by both the citizens and foreigners. This then reflects the level of economic activity that is taking place in the country. Total value is measured by expressing the value of production in terms of the prices of the various final goods and services. GDP is usually valued at market prices, but it is also possible to value it using basic prices or factor cost (or factor income). Only final goods and services are included. Final goods and services refer to those goods and services that are consumed by households and firms. Final goods are things such as television sets, clothes, chairs, bookcases, hats, and so on, while services are things such as the services provided by lawyers, doctors, teachers, plumbers, beauticians, and so forth. In the production of the final goods and services, intermediate goods are used. Intermediate goods

are purchased to be used as inputs in producing other goods before they are sold to end users. Intermediate goods, such as the crude oil used to manufacture petrol, or flour for baking bread, are excluded to avoid double counting. GDP measures the production of new goods and services (also called current production) during a specified period and is an annual flow because it measures the value of goods and services produced over a year. A GDP of R60 billion implies that the South African economy produced R60 billion worth of final goods and services during a specific year. Nominal GDP versus real GDP Nominal GDP or GDP at current prices is the sum of the quantities of final goods and services produced, multiplied by their current price. An increase in nominal GDP might increase over time as a result of an increase in the quantity of goods and services produced an increase in the prices of goods and services produced Real GDP or GDP at constant prices is a measure of GDP in which the quantities produced are valued at the prices in a base year instead of at current prices. Real GDP therefore measures the actual physical volume of production. A base year is used to overcome the problem of price changes by expressing the prices of goods and services in terms of prices in a particular year. TABLE 1.1 GDP at current and constant prices 1990 2009 R millions Year Current prices Constant prices (2005) 1990 289 816 1 086 901 1991 331 980 1 075 833 1992 372 225 1 052 843 1993 426 133 1 065 830 1994 482 120 1 100 300 1995 548 100 1 134 582 1996 617 954 1 183 445 1997 685 730 1 214 768 1998 742 424 1 221 053 1999 813 683 1 249 847 2000 922 148 1 301 773 2001 1 020 007 1 337 382 2002 1 171 086 1 386 435 2003 1 272 537 1 427 322 2004 1 415 273 1 492 330 2005 1 571 082 1 571 082 2006 1 767 422 1 659 121 2007 2 016 166 1 751 499 2008 2 274 139 1 814 134 2009 2 395 969 1 783 617 The table gives both the evolution of nominal GDP (current prices) and real GDP (constant prices) for South Africa from 1990. The base year in the table is 2005. In other words, the GDP for each year is expressed in terms of 2005 prices. Since the base year is 2005, nominal GDP for 2005 is equal to real GDP for 2005. This shows that real GDP for 2009 was 1.6 times higher than real GDP for 1990, while nominal GDP indicates that it was 8.3 times higher.

Source: South African Reserve Bank, Quarterly Bulletin Time Series Real per capita GDP Positive economic growth actually occurs only when total real production or income grows at a faster rate than the population. If population growth rate exceeds the economic growth rate, a decline in real GDP per capita occurs. Real GDP per capita is widely used as a measure of the economic welfare or wellbeing of residents of a country. If real GDP per capita rises, it is assumed that people are better off. There are, however, a number of problems with using real GDP per capita as a measure of economic welfare. Apart from the measurement problems associated with GDP, there is also a problem with the composition of output and the distribution of income. If a factor such as an increase in defence expenditure was responsible for the increase in GDP, it does not necessarily follow that there was a concomitant increase in economic welfare. An unequal distribution of income implies that the benefits of an increase in GDP flow largely to a relatively small group of people and do not "trickle down" to the poor. Economic growth in South Africa According to the data in the following table, the economic growth performance of the South African economy has, on average, deteriorated significantly since the 1960s. For example, the rate of growth in real GDP declined from an annual average of 5.5% during the 1960s to 1.4% during the 1990s and increased to 3.6% during the 2000s. This had an important impact on the living standards of the average South African as will be explained in the section below. TABLE 1.2 Real economic growth in South Africa (Five-year average growth rate in real GDP) 1960-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94 1995-99 2000-04 2005-09 5.66 5.32 4.38 2.12 2.98 1.5 0.2 2.58 3.62 3.68 Source: South African Reserve Bank, Quarterly Bulletin, various issues If we take a closer look at the growth performance after 1990, the following picture emerges: TABLE 1.3 Real economic growth in South Africa Annual percentage change in Year Real GDP Real GDP per capita 1990-0.3-2.4 1991-1.0-3.1 1992-2.1-4.2 1993 1.2-0.9 1994 3.2 1.1 1995 3.1 1.0 1996 4.3 2.1 1997 2.6 0.5 1998 0.5-1.6 1999 2.4-0.2 During the first three years of the 1990s, South Africa experienced negative economic growth rates. A negative economic growth rate means that the real value or volume of production in that particular year was lower than in the previous year. Looking at the growth rate since 1994, the downward trend after the 1960s appeared to turn around. The period after 1994 was characterised by two important developments that had a particular influence on the South African economy: the political democratisation of South Africa and economic globalisation. Economic globalisation refers to the integration of the

2000 4.2 2.1 2001 2.7 0.8 2002 3.7 1.9 2003 2.9 1.3 2004 4.6 3.1 2005 5.3 3.9 2006 5.6 4.2 2007 5.6 4.3 2008 3.6 2.4 2009-1.7-2.7 Source: South African Reserve Bank, Quarterly Bulletin Time Series South African economy into the international economy. There are three ways in which the dismal performance of the South African economy after the early 1980s can be explained. One explanation is that the decline was largely inevitable because the South African economy was in the downward phase of the so-called long wave in economic activity. Another view is that the downward trend was a symptom of growing social and political conflict in South Africa, which resulted in stagnating private fixed investment, high inflation and balance of payments problems. A third view ascribes problems to the use of inappropriate economic policies during the period. Given a population growth rate of 2.5% per annum in South Africa, a real economic growth rate of more than 2.5% was needed for the real GDP per capita to increase. According to the above table, South Africa has experienced an increase in real GDP since 1993. In spite of the fact that real GDP has increased, this increase has not always been sufficient to bring about an increase in the real GDP per capita. During 1993, 1998 and 1999 and 2009, a decline in real GDP per capita was experienced. This was an indication that the economic growth experienced during those years was not enough to increase the per capita GDP. The cause of the 2009 decline was the impact of the international financial crises that led to what is now known as the Great Recession. The extent of the impact on the South African economy can be seen from the following quarterly data: TABLE 1.4 Real economic growth in South Africa (Quarterly data) 2008/03 2008/04 2009/01 2009/02 2009/03 2009/04 2010/01 2010/02 2010/03 2010/04 1.13 0.76-6.45 2.14 1.69 2.30-4.24 3.50 1.28 3.37 Source: South African Reserve Bank, Quarterly Bulletin Time Series Do activity 1.1 in the workbook.

1.3 The SOUTH AFRICAN BUSINESS CYCLE A business cycle refers to the expansion (ups) and contraction (downs) of economic activity in a country. An increase in economic activity is followed by a decrease in economic activity, which is followed again by an increase in economic activity. From the data on past business cycles in South Africa, we see that there are no simple patterns. Some are long and some are short, others are mild and others again are severe. 100 90 80 70 60 50 40 30 20 10 0 44 8 17 7 36 20 24 40 44 19 15 21 35 51 42 33 99 The longest business cycle in South Africa, if measured from trough to trough, started in March 1986, reached a peak in February 1989, and ended in a trough in May 1993 a total period of 86 months. The shortest contraction phase lasted seven months, starting in June 1967 and ending in December 1967, while the longest contraction phase lasted 51 months, starting in March 1989 and ending in May 1993. The shortest expansion phase lasted 15 months, starting in April 1983 and ending in June 1984, while the longest expansion phase lasted for 99 months, starting in September 1999 and ending in November 2007. The end of the expansion phase was caused by the international financial crises that originated in the USA. In the rest of the module we will be using models to look at the causes of these fluctuations and how fiscal and monetary policies can be used to smooth the cycle. Do activity

Do activity 1.2 in the workbook.

1-4 STABILISATION POLICY In this module, our main concern is how fiscal and monetary policy can be used to stabilise the economy as opposed to analysing the determinants of economic growth. The following two policies play a major role here: Fiscal policy Fiscal policy is the government's policy in respect of the nature, level and composition of government spending, taxation and borrowing, aimed at pursuing particular economic goals. The main instrument of fiscal policy is the budget, while the main policy variables are government spending and taxation. In South Africa, the budget is presented to Parliament annually by the Minister of Finance, usually in February. A distinction can be made between an expansionary and contractionary fiscal policy. An expansionary fiscal policy entails an increase in the demand for goods in the economy by increasing government spending and/or decreasing taxes. A result of such a policy is that the budget deficit increases. A contractionary fiscal policy entails a decrease in the demand for goods in the economy by decreasing government spending and/or increasing taxes. A result of such a policy is that the budget deficit decreases. At the macroeconomic level, fiscal policy is one of the main elements of demand management or stabilisation policy. In the models you will be studying in this module fiscal policy has a vital impact on the equilibrium level of output and income. Monetary policy This involves all deliberate actions by the monetary authorities to influence the monetary aggregates, the availability of credit, interest rates and exchange rates, with a view to affecting monetary demand, output, income, prices and the balance of payments. A distinction can be made between an expansionary and contractionary monetary policy. An expansionary monetary policy entails an increase in the money supply to bring about a decrease in the interest rate in order to increase the demand for goods in the economy. A contractionary monetary policy entails a decrease in the money supply to bring about an increase in the interest rate in order to decrease the demand for goods in the economy. It is mainly the impact of the interest rate on the equilibrium level of output and income that we will study in this module. Do activity 1.3 in the workbook. 1-5 INFLATION Inflation is defined as a continuous and considerable rise in prices in general. Note that this is a neutral definition of inflation as opposed to a causal definition of inflation, since it does not tell us what the causes of inflation are.

The most commonly used indicator of changes in the general price level (inflation) is the consumer price index (CPI). This reflects the cost of a representative basket of consumer goods and services. The CPI is calculated by comparing the index of a particular month with the index of the corresponding month in the previous year, and then expressing it as a percentage. The following table summarises the inflation history of South Africa after 1960: TABLE 1.5 Increase in CPI in South Africa (Five-year average) 1960-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94 1995-99 2000-04 2005-09 1.6 3.2 7.5 11.8 13.5 15.7 12.5 7.3 5.5 6.8 Source: Statistics South Africa TABLE 1.6 Inflation in South Africa, 1990 2010 Year Annual percentage increase in CPI 1990 14.4 1991 15.3 1992 13.7 1993 9.8 1994 9.2 1995 8.6 1996 7.3 1997 8.6 1998 6.8 1999 5.1 2000 5.4 2001 5.8 2002 9.1 2003 5.8 2004 1.4 2005 3.4 2006 4.6 2007 7.2 2008 11.5 2009 7.1 2010 4.3 Source: Statistics South Africa Between 1973 and 1992, South Africa experienced an inflation rate in excess of 10%. In 1993, an inflation rate below 10% was recorded for the first time and from then on the trend was downward until the end of the decade. In 2002, inflation increased sharply in the wake of a depreciation of the rand against the major international currencies. In 2008, it again rose sharply, and then decreased again. In study units 8 and 9, we will take a closer look at the impact of the demand for goods as well as the supply of goods on the price level. Do activity 1.4 in the workbook.

1-6 UNEMPLOYMENT An unemployed person is someone who is willing and able to work but who does not have a job. But this is where the simplicity ends and, for the purpose of measurement, different definitions are used. The strict definition of unemployment used by Statistics South Africa is as follows: Unemployed persons are those persons who, being 15 years and older, are not in paid employment or self-employment were available for paid employment or self-employment during the seven days preceding the interview and took specific steps during the four weeks preceding the interview to find employment or self-employment. The expanded definition of unemployment omits the requirement that a person actively seeks employment. The argument is that many people are discouraged from actively seeking work owing to the small probability of finding a job. In South Africa, the unemployment rate is calculated by Statistics South Africa, which conducts a survey on a representative sample of the South African population on an annual basis (or more frequently). The unemployment rate is the number of unemployed people as a percentage of the economically active population. The number of unemployed people will differ, depending on whether the strict or the expanded definition of unemployment is used. The table below indicates the unemployment rate as well as the percentage change in the unemployment rate, according to this strict definition, in South Africa since 1994. Year Unemployment rate % TABLE 1.7 Unemployment rates in South Africa: 1994 2010 % Change 1994 22.9 3.3 1995 16.7-27.0 1996 19.3 15.6 1997 21.0 8.4 1998 25.2 20.3 1999 23.3-7.4

Percentage 2000 25.6 9.7 2001 29.4 14.8 2002 30.4 3.5 2003 28.0-8.1 2004 26.2-6.3 2005 26.7 2.0 2006 25.5-4.4 2007 22.7-11.2 2008 21.9-3.7 2009 24.3 11.2 2010 24.8 2.1 Unemployment rates for South Africa 40.0 30.0 20.0 10.0 0.0 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: Statistics South Africa, Household survey, various issues. These figures can be regarded as minimum figures for unemployment in South Africa. Statistics South Africa also provides a figure for discouraged workers. These are people who do not qualify according to the strict definition because they are not actively seeking work. Adding this figure to the number of strictly unemployed will increase the unemployment rate. Another problem with the estimation of unemployment in South Africa is the issue of unemployment in the informal sector. If the informal sector is to be regarded as a last resort for those who are unable to find jobs in the formal sector, the labour absorption capacity of the formal sector can be used to gauge the extent of unemployment in South Africa. The following table shows changes in employment in the non-agricultural sectors of the South African economy: TABLE 1.8 Employment in the non-agricultural sectors in South Africa, 1995 2009 Year Number % change 1995 5 269 118 1.4 1996 5 235 979 1.4 1997 5 146 030-0.1 1998 4 966 132-2.2 1999 4 866 714-0.9 2000 4 734 158-1.5 2001 4 658 411-0.8 2002 5 576 838 0.6 2003 6 395 847-1.6 2004 6 660 960 2.1 2005 7 110 705 1.1 2006 7 910 778 2.9 2007 8 322 650 2.7 2008 8 469 409 1.8 2009 8 218 498-3.0 Source: South African Reserve Bank, Quarterly Bulletin Time Series In spite of the economic growth rates that were recorded, these did not always translate into significant employment opportunities in the formal sector hence the occurrence of so-called jobless growth. The decline in the labour absorption capacity of the formal sector clearly indicates a growing unemployment problem given that it is currently estimated that in South Africa, between 400 000 and 500 000 new people enter the labour market every year. Unemployment is a major economic issue that needs to be addressed in South Africa.

The unemployment rate is not only high in South Africa, but also differs in terms of race, gender, age and educational qualifications. A young black female who failed to complete her secondary schooling has the highest probability of being unemployed. Unemployment has a negative impact not only on the individual and his or her family, but also on society. High unemployment is associated with crime and social unrest and presents a loss of output. We are all worse off because of unemployment. The causes of unemployment are varied, and at any given time, it may be caused by more than one factor. It might, for instance, be the result of the contraction phase of the business cycle as well as structural changes in the economy. Because the causes of unemployment are varied and complex, there is not only one solution to the problem. To deal with unemployment, one needs to simultaneously address low economic growth, the cost of labour, labour market flexibility and the promotion of labour-intensive strategies. In this module we deal with unemployment caused by an insufficient demand for goods and services (study units 2 to 7) and unemployment relating to the structure of the labour and product markets (study units 8 and 9). When working through the module keep in mind that there is a close relationship between output and unemployment. An increase in output implies an increase in employment and a decrease in unemployment. Do activity 1.5 in the workbook. 1-7 BALANCE OF PAYMENTS The balance of payments is a systematic statistical record of all economic transactions between residents in the reporting country (eg South Africa) and the rest of the world during a particular period (a quarter or year). The South African balance of payments summarises the transactions between South African households, firms and government and foreign households, firms and government. The balance of payments consists of four basic accounts: the current account the capital transfer account the financial account unrecorded transactions The balancing item in the balance of payments (in principle) is the change in the country's gold and other foreign reserves. The two major accounts are the current and financial account. The current account records a country s involvement in international trade (exports and imports), while the financial account

records the country s involvement in international capital flows. If there is a surplus on the current account, this indicates that the value of the country s exports exceeded the value of its imports during the period under review. If there is a deficit, then imports were greater than exports. A surplus on the financial account indicates that more funds flowed into than out of the country during the period concerned and a net inflow of foreign capital occurred. A deficit on the financial account indicates that the outflow of capital exceeded the inflow of capital and a net outflow of capital occurred. The balancing item in the balance of payments (in principle) is the change in the country's gold and other foreign reserves. The sum of the current account balance, the capital transfer account, the financial account balance and the unrecorded transactions are therefore reflected in the change in foreign reserves. Balance of payments stability exists when there is some balance between exports and imports. Balance of payments stability is one of the macroeconomic objectives. In technical terms, this means that the balance of payments and exchange rates should be fairly stable. The main elements of South Africa s annual balance of payments between 1990 and 2009 are summarised in the following table: TABLE 1.9 South Africa s balance of payments: 1990 2009 (R million) Year Current account balance Financial account balance Change in net reserves 1990 3 997 2 708-871 1991 3 910 1 222-3 127 1992 5 599-183 -2 285 1993 9 076-4 536-5 500 1994 56 1 792 3 544 1995-9 045 8 613 20 862 1996-7 114-7 101 10 547 1997-10 231 9 733 25 955 1998-13 100-6 928 14 749 1999-4 156 11 816 19 379 2000-1 192 5 366 1 909 2001 2 869-12 237-23 247 2002 9 680 16 080 12 435 2003-12 599-4 858-14 503 2004-42 948 37 528 44 139 2005-54 495 34 263 76 259 2006-93 799 29 792 106 759 2007-140 551 47 816 153 513 2008-161 874 26 066 96 139 2009-97 062 17 037 113 219 Note: The sum of the current account balance and the financial account balance does not add up to the change in net reserves. The difference is the result of unrecorded transactions. Source: South African Reserve Bank, Quarterly Bulletin Time Series

The first column shows the balance on the current account, that is, the difference between exports and imports. The second column shows the balance on the financial account, that is, net inflow (denoted by a plus) or net outflow (denoted by a minus) of capital. The third column shows the change in the country s net gold and other foreign reserves after unrecorded transactions have been taken into account. This reflects the overall balance of payments position. The balance of payments is explained in more detail in study unit 5. In study units 5 to 7 we will develop an economic model to analyse the impact of the demand for goods on the level of output and income in an open economy. Do activity 1.6 in the workbook. 1-8 DISTRIBUTION OF INCOME The following is an extract from Economics for South African students (4th edition) by Philip Mohr, Louis Fourie and associates. South Africa has a highly skewed distribution of personal or household income. Income distributions are difficult to measure and are therefore not estimated regularly. Moreover, the estimates are subject to a significant margin of error. In some countries, the distribution of income among individuals or households has never been estimated, while in other countries such estimates are made only infrequently. Nevertheless, it is widely accepted that South Africa has one of the most unequal distributions of personal income in the world. In South Africa, the Gini coefficient has been estimated to be as high as 0.68. This is one of the highest Gini coefficients ever estimated in the world. Estimates for the industrial countries tend to average between about 0.30 and 0.45, and for developing countries, the estimates generally vary between about 0.40 and 0.60. Clearly, South Africa's figure is extremely high. Gini coefficients for selected countries are included in table 1.10. TABLE 1.10 Gini coefficients for various countries Country Year Estimated Gini coefficient Japan 1993 0.25 United Kingdom 1999 0.36 United States 2000 0.41 Korea 1998 0.32 Malaysia 1997 0.49 Thailand 2002 0.42 Argentina 2003 0.53 Brazil 2003 0.58 Chile 2000 0.57 Kenya 1997 0.43 Zambia 2002 0.42 South Africa's personal income distribution has traditionally followed racial lines, with whites earning the most, followed by Asians, coloureds and blacks. In recent years, however, the gaps between the different races have tended to become smaller. At the same time, the distribution in the black group has become much more unequal. This can be ascribed to increasing unemployment, the relatively fast rate of increase in the wages of blacks employed in the formal sector of the economy and increased poverty in the rural areas as a result of the impact of severe droughts, floods and other natural disasters. Gini coefficients for the different population groups in 2000 were estimated at 0.57 (blacks), 0.51

Zimbabwe 1995 0.50 South Africa 1993/94 0.58 Source: World Bank, World Development Report (2006) Do activity 1.7 in the workbook. (coloureds), 0.51 (Asians) and 0.45 (whites).