Can the New Growth Plan create growth and employment?

The official endorsement of the New Growth Plan (NGP) by the ANC was announced by President Jacob Zuma on 8 January. Instrumental in devising the plan through his position on the ministerial advisory panel was the eminent Nobel Prize winning economist, Joseph Stiglitz.

Prof. Stiglitz has indicated that he is in favour of the NGP (of course), but his recent comments on certain issues should cause us some concern. Prof. Stiglitz says there are two policies that can make a big difference in terms of promoting growth and employment in SA.

His first suggestion is “an appropriate exchange rate [because]… high exchange rates make it difficult for countries to export or to compete with cheap imports”. How can anyone, or any government official obtain sufficient information to determine what an ‘appropriate exchange rate’ should be? By deliberately lowering the value of the rand, SA will be subsidising our foreign trading partners’ consumers and increasing the costs of local companies that rely on imports as inputs in the manufacturing process.

Cheap imports allow people to get more ‘bang for their buck’. They then have money left over to save and invest in productive areas of society. Investment makes it possible for levels of productivity to be driven higher, which in turn allows real wages to increase and the prices of our commodities to decrease and become more attractive to foreigners. In simple terms, if we artificially undervalue our currency, we effectively subsidise foreign consumers’ purchases of our goods and penalise ordinary South Africans by making them pay higher prices for foreign produced goods. Interfering with the exchange rate also creates a negative perception of the economy and implies that the government is willing to pander to vested interests at the expense of ordinary South Africans.

Prof Stiglitz’s second suggested policy intervention is to lower interest rates. “High interest rates,” he says, “can stifle growth in two ways: making credit more expensive, and thus stifling investment; and increasing the exchange rate”. But, can monetary policy that deliberately aims to reduce interest rates necessarily boost economic growth? Will it not merely create imbalances that will harm the economy?

Around the world, central banks have been cutting interest rates in the hopes of spurring growth, with little success. Capital allocation has been skewed because capital obtained cheaply is being allocated to marginal activities. With interest rates not being allowed to be determined by supply and demand for credit, people are desperately looking for places to invest where there is some return. In many cases, these opportunities are found in marginal activities that normally would not attract investment. As soon as interest rates increase, for example, as they will do in due course in the US when the Federal Reserve is compelled to stop printing money, marginal investments will be exposed, the value of investments will drop and investors will lose, as American home buyers discovered when the residential property boom turned into a bust.

As far as inflation is concerned, Prof Stiglitz admits that “Monetary authorities can't, of course, ignore inflation”, but then states “A single-minded focus on inflation, without sensitivity to the source of inflation, will produce neither growth nor stability”. But the sole source of inflation (general price increases) is the printing of excessive quantities of money for which governments and their central banks are entirely responsible. Inflation undermines growth and creates instability. In essence, inflation is the result of weakening the internal purchasing power of a currency, which inevitably leads to the weakening of its external purchasing power. Under inflationary conditions it is impossible to plan or make any rational economic decisions as people are more concerned with anticipating inflation as opposed to seeking out profitable new production opportunities. When inflation forces prices to increase rapidly, people spend more of their income on consumption and virtually no money is saved.

Inflation has negative implications for trade because it adversely affects the competitiveness of export industries and import-competing industries. The negative consequences for industries can be partially offset by a depreciation of the currency through the manipulation of the exchange rate but this is just a temporary remedy that raises the cost of imports and increases the price of imported goods for the man in the street. Inflation benefits borrowers at the expense of creditors because it erodes the real value of money. Given that government is generally the biggest borrower, inflation therefore invariably redistributes wealth from the private sector to government. Money with a relatively stable purchasing power is imperative for the proper functioning of an economy. Deliberately weakening the internal and external purchasing power of a currency to foster exports is an extremely costly way to benefit exporters and comes at the expense of the population at large.

In truth, there is nothing new about the New Growth Path. Many countries have attempted to increase the role of the state in their economies but history demonstrates that the state simply cannot gather and compute enough information to understand the intricacies of the market. In fact, what the evidence does reveal is that economies that are freer and have less government involvement grow faster and are economically more prosperous. In economically freer countries, where people are responsible for their own lives, there are lower levels of poverty and unemployment, higher levels of income per capita and longer life expectancies. The SA government needs to adopt policies that foster economic growth. It needs to get out of the way so that South Africans are left free to choose for themselves how to conduct their lives and run their businesses.

Author: Jasson Urbach is an economist with the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author's and are not necessarily shared by the members of the Foundation.

FMF Feature Article / 15 February 2011