The deteriorating investment climate in South Africa

In 1994 South Africa, led by its iconic first democratic president Nelson Mandela, was the darling of the world. Investors flocked to the newly free country.

It is now 23 years later. And it is not looking good. Data from the South African Reserve Bank shows that foreign direct investment to South Africa reached a record level of ZAR 80.1 billion in 2013, declined somewhat to ZAR 62.6 billion in 2014, and then plummeted to ZAR 22.6 billion in 2015. After a brief and slight recovery by 38 percent in 2016, prospects for 2017 are bleak.

Transparency International’s 2013 global Corruption Perception Index shows that South Africa has dropped 34 places since 2001, with half the decline of 17 places occurring since 2009. South Africa is currently ranked at number 72 out of 175 countries and heading downwards.

Conventional wisdom has it that the South African government has been “captured” by a family of extremely wealthy Indian businessmen, the Guptas, who have been accused of controlling even the appointment of cabinet ministers.

In March 2017, President Zuma dismissed Finance Minister Pravin Gordhan, generally regarded as a prudent and thrifty finance minister, and replaced him with a Zuma (or Gupta) loyalist. This caused panic in the markets. Rating agencies Fitch and Standard and Poor downgraded South Africa’s sovereign credit rating to junk status.

In the latest quarter, the economy posted a negative growth rate, effectively constituting a recession.

How has it come to this?

The meltdown has been years in the making

For instance, compare South Africa’s performance since 1994, when all was meant to change for the better, with a selection of average peers selected purely on the basis of per capita GDP (Costa Rica, Algeria, Serbia, Macedonia, Columbia, Mongolia, Tunisia, Ecuador, Dominican Republic, China, Jordan, Peru, Sri Lanka and Albania): Per capita growth in this peer group is more than three times that of South Africa, and average unemployment less than half. And these are a random selection, not top-performers.

There are a number of individual items in the World Economic Forum’s Global Competitiveness Report 20162017 where South Africa’s ranking is worse than 130 out of 138 countries rated. These include:

  • Business costs of crime and violence: 133
  • Quality of education system: 134
  • Quality of math and science education: 138
  • Cooperation in labour-employer relations: 138
  • Hiring and firing practices: 135
  • Flexibility of wage determination: 135

South Africa’s investment climate is becoming progressively less investor-friendly. The following figures from the Fraser Institute’s Economic Freedom of the World Index, that measures economic freedom by country, show the movement of the measurement of South Africa’s economic freedom since 1970. (See chart right)

In the years leading up to 1995, the economic system was not free. The high-water mark of freedom was in 2000, when South Africa scored 7.09 (compared to countries like Singapore, Hong Kong and New Zealand at just below 9 out of 10). But since 2000, South Africa’s rating has gradually declined from 7.09 to where it stands today, at 6.64.

Clearly and significantly South Africa is moving in the wrong direction. Its economic freedom ranking in the world (out of 159 countries today) declined from 42 in 2000, to 71 in 2005, to 87 in 2010, to 93 in 2013, to where it is now, in 105th place.

My view is that South Africa’s particularly poor economic showing is due to the fact that, instead of building a free economy since 1994, it has nurtured a culture of rent-seeking – that is, set up structures enabling citizens to get benefits from the system without giving commensurate production in return. That has unfortunately had a devastating effect on the investment climate by undermining productivity of the workforce.

Nothing illustrates this as graphically as the phenomenon of welfare payments. By law, the South African government has since the advent of democracy in 1994 progressively paid increasing amounts by way of social welfare grants to the unemployed.

In its May 2016 report “South Africa: A new growth strategy”, the South African Institute of Race Relations (SAIRR), a think-tank, tellingly observed: “… the number of people on social grants now exceeds the number of people in employment. In 2001, before the major roll out of child support grants occurred, there were 312 employed people for every 100 on social grants. Now there are only 86 people with jobs for every 100 people on social grants.”

In a 2014 opinion piece, Johann Redelinghuys, a partner at international leadership consulting firm Heidrick & Struggles, pointed out that: “By 2012, according to Frans Cronje of the Institute of Race Relations – quoting from his publication ‘Our next ten years’ – a number of black households were saying that welfare is almost as important as employment. This would suggest that we may be approaching the point seen in some socialist economies where the comforts of welfare payments may make it less attractive to go out and find a job.”

An obvious litmus test for the investment climate of a country is its level of entrepreneurial activity. SA fails this test hands-down. A comparison of the percentages of the population intending to start a business in South Africa with the other African countries cited in the Global Entrepreneurship Monitor 2016/17 Global Report (GEM Report), shows that 49.5 percent of the population in those countries intend starting a business. In South Africa the figure is 10.1 percent.

South Africa’s welfare-state mentality of dependency and entitlement undoubtedly has a role to play in this unimpressive outcome. There are about 17 million welfare recipients in South Africa – about 30 per cent of the population. We are talking here of a massive injection of cash for no productive work in return. South Africa spends $396.27 per capita per year on welfare. Burkina Faso spends $20.35 per person per year and Uganda, recently named the most entrepreneurial country in the world, a puny $11.10. These figures are typical in Africa, and so low that clearly there is strong motivation to work or start a business in those countries.

The inference is irresistible that the helping hand of government has helped douse the entrepreneurial fire in South Africa. That hampers wealth creation and dampens consumer demand, which is damaging to investment prospects.

According to the South African national budget for 2017/18, welfare comprises about 11.5 per cent and free government housing 12.5 per cent of total expenses. Public-service salaries and remuneration amount to 35 per cent of the budget. Between 2000 and 2012, a quiet, insidious revolution took place in South Africa, in that unproductive government employment rose by approximately 46 per cent, while private-sector employment barely increased. The ratio of private to government workers declined from 5.5:1 to 3.9:1 over this period. While private-sector employment stagnated, government employment increased by 850,000 jobs.

All these unproductive, rent-seeking expenses have helped push South Africa’s government spending to about 32 percent of GDP. It should be about 20 percent in order to compete with its most successful peers in GDP per capita terms – such as China, Peru and Sri Lanka – whose average per capita income growth is more than seven times that of South Africa, and unemployment more than five times lower. Labour law must be added to this mix.

Compulsory cost increases due to minimum wages, strikes and union negotiations depress the ability of the economy to absorb labour. This means that employment growth does no longer keeps pace with whatever economic growth may occur. After the Labour Relations Act of 1956 became applicable to black workers in 1979, private, non-agricultural employment started declining relative to growth of GDP. In other words, private-sector labour-absorption capacity suffered a near-fatal blow from which South Africa has never recovered.

Under the labor law, employment, once obtained, is not easily lost on account of low productivity. There are difficult procedures for employers to follow in order to dismiss employees for poor performance. In addition, strike law encourages work stoppages in order to get pay increases, which are typically not accompanied by higher productivity.

As elsewhere the world, trade union density retards employment growth. In the graph below, the block to the left of the vertical axis expresses union density, defined as a percentage of the economically active population. The right-hand side of the vertical axis shows the formal employment growth or decline. It is uncanny how the two curves run in parallel.

In 2011, Adcorp (a labor brokerage) reported that since the introduction of the new Labour Relations Act in 1996, after-inflation wages had increased by 28.8 per cent, nearly triple the increase in the preceding 25 years. Per unit of productivity, real wages increased in that period at an average annual rate of 7.6 per cent, or 200 per cent in total. Due to the wage-push effect of labour laws, workers have been compensated way above the level of their productivity – a textbook case of rent-seeking. Constraints on job creation does nothing to encourage investors looking for flourishing consumer markets.

A further form of rent-seeking is affirmative action legislation in the form of so-called black economic empowerment (BEE) and employment equity. The former in effect requires businesses to have prescribed ratios of black shareholders and suppliers, the latter certain prescribed ratios of black employees in all levels of management. In a survey of European Union businesses in 2014, 90.2 per cent of respondents identified BEE (including employment equity) as a barrier to investment in South Africa, second only to the volatility of the rand, in particular the legal obligation of ‘employing and retaining “black” employees with required skill levels’ (89.9 per cent).

South Africa’s education system is one of the poorest in the world. In the World Economic Forum’s Global Competitiveness Report 2016-2017 the quality of South Africa’s education system was rated 2.3 out of a possible 5, and ranked 134 out of 138. In terms of maths and science education, it came in last, at 138. In a league table compiled by the OECD, South Africa’s education system was recently rated 75th out of 76 countries assessed.

The main reason is that the government has sought to impose a one-size-fits-all government-run centralized education system on one of the most diverse societies in the world. Coupled with this is the South African Democratic Teachers’ Union, the ANC-aligned teachers’ union, that has in some cases taken over the management of schools, and has successfully resisted the evaluation, promotion and remuneration of teachers on the basis of merit. So education itself has become a massive rent-seeking scheme. Resultant skills shortages are a direct impediment in the way of future investments.

The golden thread that runs through all these structures ostensibly put in place to redress the disadvantages of apartheid, is that they enable people to get something for nothing.

Together they are, sadly, assured to destroy productivity, and with that much hope for future investment growth. The bitter irony is the counter-productivity of these structures, as they harm the very victims of apartheid that they ostensibly aim to help, ultimately by driving away domestic and foreign investment. Nothing short of a change of government and structural reform of seismic proportions will fix that.