Is SA headed for a “double dip” recession?

According to Statistics South Africa, our economy grew at a rate of 3.2 per cent in the second quarter of 2010. After the sharp fall in the second half of 2008, there was a modest recovery in the second half of 2009 and a promise of growth when the rate of 4.6 per cent was measured in the first quarter of 2010. These latest results have caused many South Africans to quiver in their boots.

As evidenced by analysts polled by Bloomberg, these figures have come somewhat as a shock as they had believed our economy would grow by 3.8 percent in the second quarter of this year. Analysts polled by Reuters, believed GDP would grow by 3.6 per cent. With unemployment at over 25 per cent, many fear that SA is headed for a so-called double dip recession. There have been calls on government to do something. Monetary authorities should relax interest rates and/or increase fiscal stimulus. I agree that government should do something, but it involves neither monetary nor fiscal stimulus. Business cycles are often of uneven length, depth, and severity. Economic recoveries do not always proceed smoothly and it usually takes a while before the economy reaches and then surpasses previous levels of growth.

South Africa’s Monetary Policy Committee (MPC) meets this week to discuss interest rate policy. With the MPC now explicitly considering growth and employment and with inflation easing to 3.7 per cent in July – its lowest level since July 2006 – there is renewed hope there will be a cut this week. But, will easing monetary policy necessarily boost economic growth? At best, it is simply a lever that can be tweaked to influence growth. It is not, as some have come to imagine, a magical wand that can be waved and, hey presto, bring on the good times.

Around the world, central banks have been cutting interest rates in the hopes of spurring growth. Consider some of the prevailing repo interest rates from major economies around the globe: Canada 0.75%; United Kingdom 0.5%; Japan 0.1%; United States 0.25%; Switzerland 0.25%; New Zealand 2.75% and Australia 4.5%. The latest available growth rates in these economies are: Canada 0.1% (May 2010); United Kingdom 1.1% (2Q2010); Japan 0.1% (2Q2010); United States 2.4% (2Q2010); Switzerland 0.4% (1Q2010); New Zealand 0.6% (1Q2010) and Australia 0.5% (1Q2010).

In the case of the United States, the Federal Reserve has a dual mandate to consider both inflation and unemployment, but during times of difficulty, it has tended to default to employment, ignoring the fact that inflation is an obstacle to growth. Interest rates can serve only as an accelerator or brake – they are not the engine of growth and should be determined by the market. You only have to look at the low interest rates in the countries above and their growth rates to see that you can cut interest rates as much as you like, but it is the underlying fundamentals that really matter.

The problem with cutting interest rates too far is that the capital allocation in the economy is skewed when capital is allocated to marginal activities. For example, if interest rates are zero, you will not want to hold cash balances because you will not be earning a return. So you will look for alternative places to invest. In low interest rate environments, these alternatives might be very marginal activities, which normally would not attract your investment. As soon as interest rates increase, marginal investments are exposed.

Increased government spending does not spur growth. Government cannot create new purchasing power out of thin air. Every rand it "injects" into the economy must first be taxed or borrowed out of the economy. It creates no new income and therefore no new demand for goods and services. It merely redistributes money from the productive sectors of the economy to the non-productive sectors. It is private firms that generate wealth and are the engines of economic growth. The mistaken view that fiscal stimulus is good persists because you can see the people put to work with government funds. What you cannot see are the jobs that would have been created elsewhere in the economy with that same money had it not been taxed or borrowed by government.

The best way to improve conditions for the poor is not by simply taxing those who are producing wealth and redistributing the proceeds, but by pursuing policies that promote economic growth. Allow private firms that increase and sustain economic growth to multiply and grow, and allow all people the freedom to work wherever they can find employment.

Government should focus on its core activities, which involves the creation of an enabling environment for businesses to operate. According to the World Bank, in SA, it takes twenty-two days on average to start a business, compared to the OECD average of thirteen days. Moreover, SA, on the ability of businesses to hire workers receives a poor rating of 56 out of 100, where the higher values represent more rigid regulations. The average in the OECD countries is a rating of 26.5. Redistributing existing wealth by excessively taxing productive individuals and companies reduces any incentive to produce goods and services, and retards the economic growth of the country as a whole.

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/ 07 September 2010