South Africa’s high level of poverty and unemployment (24%) has saddled the government with the challenge of integrating this segment of society into the economy.

The South African government last month revealed an ambitious borrowing plan designed to pull the economy out of recession and meet electoral commitment on job creation and welfare.

Finance minister Pravin Gordhan told parliament that government planned to raise $84bn in debt over the next four years. Government debt is expected to increase from 23% of GDP this year to 41% of GDP by March, 2013 while interest payments will nearly double to R100bn.

He said he expected the public sector borrowing requirement, which includes funding requirements for municipalities and state enterprises, to rise to 11.8 per cent of gross domestic product in the current fiscal year that ends in March.

Much of the planned spending on roads, railways, power stations, housing and water is geared to improving the country’s preparedness to host next year’s football World Cup.

What does this planned fiscal expansion mean for South Africa?

Increased government borrowing puts pressure on credit which drives up interest rates. This will depress investment and hurt economic growth in the medium run. Resources are scarce and have alternative uses, government using up credit means that less credit is available for private sector use. South Africa’s stock exchange and economy will not grow as expected this year and next because of an increase in borrowing by the government.

If South Africa has a floating exchange rate,  government borrowing will trigger capital inflow due to higher interest rates.  This will cause the Rand to appreciate and hurt exports. This could further devastate export-oriented sectors (mining) of the economy, increase unemployment and dampen government efforts to increase growth in the short run.

A big reason for high unemployment rates in South Africa is her trade unions. By demanding wages that are not set by the markets they increase productions costs and drive manufacturers to inefficiency. This has the effect of further driving up unemployment rates by eventual relocation and or demise of these industries. Workers who have jobs earn wages that are higher, but effectively lock out potential job seekers because the company is unable to expand and hire more workers as a result of depressed profits due to higher production costs.

Although the Minister Gordhan clearly indicated that waste and an unnecessary increase in state bureaucracy will be curbed, his statement represents a stark contradiction. First, fiscal expansion typically comes with more government bureaus since government is stimulating growth and monies need to be channeled.  Second, building houses for everyone and brand new infrastructure where economic growth does not drive it could be problematic for South Africa. If people cannot pay for those homes or the infrastructure is eventually not utilized or underutilized it will reduce economic growth in the long run due to resource misallocation.

A massive fiscal expansion might send the wrong signal to investors. It makes government look bloated, inefficient and potentially corrupt even when the last case is not obvious. Investors prefer a lean and mean government model. This has kept the South African economy from slowing down for over ten years despite high poverty and unemployment rates.

What is good about this plan?

Despite the risks (not unique to South Africa) associated with this policy it is good for the economy. Channeling resources towards projects that will improve human development (health, universities and research etc.) and in a manner that compliments the private sector, (a skilled and healthy labor force is attractive to investors for instance) could help the economy. 

In closing, South Africa’s unemployment rate is unacceptably high for a middle income country. It means that human resources are underutilized and the economy is performing sub optimally.  New jobs created by this plan will reduce the problem of idle human resources, poverty and crime whilst boosting growth in the process. Countries with developed human capital, lower poverty and unemployment rates are more attractive to investors than those without.  Integrating poorer segments of society into the economy is crucial to any nations’ growth and development.

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