National income accounts: Demand side reality check

There is even less comfort than before from the demand side of the SA economy – calling urgently for an economic reality check

 

The national income accounts for Q2 2014 now include the aggregate expenditure estimates and these make for very uncomfortable reading. These estimates of expenditure make it clear that SA has a serious demand side as well as a supply side problem.

 

The Reserve Bank confirmed that growth in spending by households, firms and the government is slowing down and may shrink further in the quarters to come.  Estimates of expenditure for Q2 2014 reveal that final demands for goods and services, adjusted for higher prices, slowed to a 1.3% annual rate in Q2 2014, down from a still weak 2.9% rate in 2013. Spending by households slowed to a paltry 1.5% rate. Growth in spending on plant and equipment also slowed down, to a half a percent crawl as private businesses reduced rather than extended productive capacity. Private formal businesses not only reduced their capital stock, they also employed fewer workers in Q2 2014.

The only growth in spending and employment came from the government sector. While government spending is helpful on the face of things in sustaining aggregate demand, it should be appreciated that such spending is almost all funded by the hard pressed taxpayer out of their disposable incomes and therefore acts as a further constraint on private spending. All central government spending, excluding interest payments and on budget, was 8.8% up in Q2 (interest expenses were only 3.8% higher) while taxes on income profits and capital gains were 9.2% higher in Q2 and VAT collected from domestic consumers was 12% higher and 1.6% above budget. Total central government revenue came in 7.3% higher and below budget, mostly because revenue from imports declined.

Aggregate demand is not growing at anything like the rate that could justify additional fixed capital expenditure by the private sector or a larger formal workforce. Decisions by firms to invest in people or capacity are derived from the state of demand for their goods and services, which are predominantly exercised by households rather than government agencies. The SA economy currently has a short term lack of demand problem that has to be resolved if the economy is to pick up momentum. The danger is that demands will remain subdued for an extended period of time, prolonging the failure of the economy to fulfil even its modest, economic policy-constrained supply side, potential of, at best, 4% GDP growth.

Where will the spark that lights up the SA economy come from? Just as the damage has come from higher prices and interest rates, relief can only come from a reversal of these price trends. The light at the end of what appears to be a long dark tunnel would have to be a stronger rand or a stable exchange rate that brings down inflation and interest rates. Furthermore, it would be helpful if the government, local governments and Eskom did not look to higher prices for electricity and other services as their preferred funding mechanism, given the state of demand. Raising what are in practice expenditure tax rates (in the form of higher charges for electricity and other utilities , including road use taxes, to fund government spending is a particularly bad idea right now. It would make much more sense to fund capital expenditure undertaken by government agencies (including Eskom) with as much debt as possible, so spreading the interest rate burden on to future generations who will benefit from the additional infrastructure. It would make even better sense to sell off some of the government owned infrastructure to private operators who would manage the assets better and help to reduce Budget deficits and the incentive to raise tax rates.

The only wiggle room for the Treasury would be the proceeds from privatisation. The aging, poorly managed Eskom plant should be a prime candidate for sale. The alternative is for the government to borrow more to meet Eskom’s cash shortfall of up to R200bn or to allow still higher electricity prices that slow household spending and undermine the competitiveness of manufacturers and mines. More government borrowing and / or slower growth would be reason to downgrade RSA debt, thus perhaps raising government borrowing costs and adding to the fiscal deficit and the case for raising tax rates. Only a serious privatisation programme can reverse the rot of slower growth, leading to lower tax revenues, higher tax rates and less growth.

The state of the economy in Q2 would surely have justified much lower borrowing costs. The ability of households to spend is being pressurised by higher prices linked to a weaker rand and to rising administered prices. These trends are being accompanied by the weaker labour market, making it difficult for even those who retain their jobs in the private sector to achieve the inflation adjustments to nominal salaries and wages.

How likely then is a stronger or stable rand? How likely is it that the government will worry less about its balance sheet and much more about the immediate state of the economy? The latest news about the state of the SA balance of payments has not been helpful to this end. The deficit on the trade account of the balance of payments deficit widened. This was the result largely of increased imports of fuel oil needed to run the gas turbines that expensively help Eskom keep the lights on. Lower prices for commodity exports combined with strike disrupted mining and manufacturing production were another reason for a weak foreign trade balance.

The large current account deficit was largely funded by inflows of foreign capital in Q2 without pressure on the rand. Foreign capital therefore continued to be made available despite the slow growth and the want of real capital expenditure.

There is continued foreign appetite for SA equities and bonds, at a competitive price or yield. But such sales of securities by local owners or issuers (mostly the government) made to fund the current account deficit are no free lunch. They result in a usually growing flow of interest and dividend payments abroad. The weak state of the economy helped reduce the growth in dividend payments to increasingly important foreign shareholders in SA companies. But we would have been in a much stronger position to attract essential foreign capital on favourable terms had more profitable SA companies been able to pay out more by way of dividends.

Faster growth and the capital gains and stronger dividend flows that follow it, would surely attract foreign capital. Stronger growth could then be accompanied by a rand made stronger by capital inflows – that is faster growth with less inflation is surely the right goal for monetary policy to pursue. Imposing higher interest rates that inhibit growth that in turn drive the rand weaker and discourage the flows of foreign capital is the wrong approach. It would be helpful were the Reserve Bank to appreciate that the lack of SA savings is not a constraint on growth unless it leads to a weaker rand and more inflation – as it appears to have done recently.

The economy needs a dose of lower interest rates to stimulate household spending and the capital expenditure and foreign capital inflows that would follow. Only privatisation can avoid a round of government induced austerity – in the form of higher tax rates and slower growth in government spending. Correcting the supply side of the economy needs mostly a reform of labour regulations. Essentially it requires an economic reality check that the Reserve Bank and the Government generally need to undertake urgently. The economy and all who depend on it deserve no less.

4 thoughts on “National income accounts: Demand side reality check”

  1. Professor Kantor.

    You have made the topic of the Demand side problem( with regard to the National income accounts), so easy to understand, as I never really understood what, the National accounts deficits and surplus, and the GDP effects are to me as an individual.

    The “Where will the spark that lights up the SA economy come from? Just as the damage has come from higher prices and interest rates, relief can only come from a reversal of these price trends.” point:
    • Won’t in reversing the “higher prices and interest rates” will have the effect of the demand pull inflation as the rate of borrowing by consumers will lead to increased demand for producer goods and ultimately the trend moving the circle?

    With the point “Raising what are in practice expenditure tax rates (in the form of higher charges for electricity and other utilities , including road use taxes, to fund government spending is a particularly bad idea right now.” I can understand that:
    • As rising the prices for those necessity goods will prevent private spending by households thus not even changing the demand side problem of the economy, worsening the aggregate demand by individuals.

    The selling of government infrastructure would help reduce the budget deficit, agreed, but it wouldn’t it also depend on the type of infrastructure that would be made for sale? as other forms of infrastructure being privatized would require households tightening their pockets even further? As the one population would be able to acquire them(or rather afford) than the other portion of the population.

    With the weakening of the Rand hopefully the above raised suggestions are not the only solutions that the government can use to alter the problem of demand in the economy by households.

    Thank you for making the topic easy to understand.
    Kind regards.

    1. Professor Kantor

      It was a privilege to come across your blog because it really made me as a, economics student, to see how easy the National accounts deficits and surplus, and the GDP effects are.

      Mr/ms 14244994 has made perfect point on your blog that really stood out to me especially the part where she/he comments on “Where will the spark that lights up the SA economy come from? Just as the damage has come from higher prices and interest rates, relief can only come from a reversal of these price trends.”
      I do agree that it might move in a trend cycle as the demand-pull will have a positive effect on the economy.

      Thank you for enlightening me with the blog and I hope 14244994 will agree on my understanding of the demand-pull effect in the economy.

      Kind regards.
      14060494

  2. I could agree with comment made by 14244994 as the economy is moving into a bad state,any help with reducing the current account deficit would be a great impact on on GDP. The selling of government infrastructure could be helpful in generating revenue for the state but again it could be a negative effect on the public as most of the citizens will not be able to afford the use of the infrastructure after it has been privatized( as the fight of the privatization of mines continues it shows no light at the end of the tunnel.
    The revenue from the taxes charged should be used accurately (and with knowledge that it is not enough to run the country’s economy) other incomes are there at the country’s disposal.

    I hope that brings input in the matter.
    kind regards

  3. I agree with the comments made by 14064384 in the sense that government should not look at tax revenues as the primary way of receiving income,it should rather focus on strengthening the labour market and try to stabilize the economy’s aggregate demand.Consumer expenditure is very important and plays a very major role in determining the level of our GDP and with rising inflation and interest rates coupled with the weaker form of the Rand makes it hugely difficult for consumers to spend their last rand on the goods and services.Increases in prices of goods and services shifts the aggregate demand curve to the left which thus lowers down the level of aggregate output because largely of the fact that consumers do not spent and they would rather save than to spend their last rand.

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