South Africa: Five reasons why it’s the worst of the Brics – for now

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South Africa has, on the face of it, huge strengths: commodities, rule of law, strong institutions and consumption prospects, a social contract – aided by decent incomes per capita – and a sophisticated financial system, among other factors. But it’s failing in five key areas.

South Africa is squandering its substantial natural and human capital, and being left behind by fellow Brics economies on many of the most important underpinnings of economic health.

Indeed, South Africa could be toppled from its position as Africa’s largest economy as soon as 2015 by Nigeria, which is growing almost three times as fast. It’s already lost its status as the continent’s most competitive economy to Mauritius, the only African market in the World Economic Forum’s (WEF) 2013-14 Global Competitiveness Report’s top 50.

As South Africa stumbles, many of its competitors are improving their economic landscapes. South Africa used to be ranked at 35 in the world, way ahead of China, but now the positions are reversed with China climbing into the top 30.

It’s not that Brazil and Botswana or Russia and Rwanda are model economies, far from it, but that South Africa is failing to fulfil its potential in some key productivity-impacting areas, including its macroeconomic environment, labour market and education.

In addition to the negative impact its toxic labour relations is having on the real economy, the country remains more exposed than most to capital flows because of a large current-account deficit that depends on foreign portfolio investment to be funded, and falling commodity prices.

What’s changing is that the risks to the economy of failure to deliver tangible socio-economic gains and make the country a better place to do business, by reining in its militant trade unions, are causing foreign investors to lose faith.

This is evidenced by recent resumption of the sell-off in the rand, a slowing of inflows and the shelving of expansion plans by large multinationals such as BMW.

Here are the top five reasons why South Africa is set to underperform its rival Brics economies:

1. The unions: South Africa has long suffered from toxic labour relations, but waves of violent strikes in the past year, some deadly, have scarred the country. The strikes, mainly affecting the mining and auto sectors, hit exports, widening the trade and current-account deficits.

More importantly, the unrest also made investors nervous and damaged the country’s image as an investment destination, in particular its ability to attract all-important FDI. The level of pay bargaining and job protection that unions have won for workers is partly responsible for the sky-high unemployment rate because it makes firms reluctant to hire.

“South Africa’s biggest constraint is the labour market because it’s where a lot of the country’s problems start,” says Capital Economics’ Africa economist Shilan Shah.

“If you’ve got 25% unemployment and a highly unionized labour force causing continued interruptions to output by striking for higher wages, once companies have to cave in this puts limits on profits, which in turn leads to higher prices, structurally higher levels of inflation and lower rates of productivity.

“It’s a very difficult environment for firms to operate in but labour-market reform and reducing the power of the trade unions is not something that can be tackled overnight because this is all steeped in South Africa’s legacy of apartheid and the trade unions historically representing black interests.

“It’s very difficult to see that happening from within the ANC itself.”

2. Growth: South Africa has been underperforming other Brics economies, growing at around 2% to 3% since the financial crisis compared with 4% to 5% for its rivals. The IMF forecast growth to slow to 2% this year on record-high unemployment dragging on consumption and lack of progress in attracting foreign investment.

The central bank has warned growth of 5% is required to have any meaningful impact on the jobless rate, which tops 30% adding in those who’ve given up looking for work. Youth unemployment is more than 50%. The central bank is constrained on using monetary policy to boost growth by high inflation that is running close to 6% and under pressure from the weaker rand and above-inflation wage settlements.

“We’ve lowered our forecast for GDP growth on declining investor confidence as a result of the strikes and consumption, which remains under pressure from high unemployment,” says Matthew Wooderson, economist at Oxford Economics. “There’s also stubbornly high inflation, which as a whole is hampering domestic demand, which traditionally been quite a strong driver of growth.

“Our view is generally turning pessimistic compared to even a month ago. Some of the noises coming out of the country, such as cancelling bilateral trade agreements, are not going to do any favours for changing that view any time soon.”

He adds: “We do see growth rising above 3% in 2015 and beyond, but this is quite dependent on whether the government’s actually able to implement any kind of meaningful reforms.”

Based on its past track-record, that remains in doubt.

3. Twin deficits: Current- and budget-account deficits running at 6.5% and 4.1% of GDP respectively amid anaemic growth helped propel South Africa to the bottom of last month’s Economist survey of investors on the most vulnerable emerging markets.

Finance minister Pravin Gordhan’s effort to trim the fiscal deficit is facing headwinds from weak growth and pressure on government spending ahead of elections next year. The current-account deficit is putting pressure on the currency because South Africa is dependent on receiving capital flows from international investors to finance such a wide deficit.

“In this position, South Africa will be quite dependent on investor sentiment and financial markets in general, so that should put some increased volatility into the rand,” says Wooderson.

Business confidence in South Africa fell close to an all-time low in October and international investor jitters are coming through in the weakening rand.

“The rand’s fall will support exports and curb import growth, but the pace of adjustment will be slow and the current-account deficit will stay substantial for some years, exposing the rand to further bouts of downward pressure,” adds Wooderson.

4. Education: South Africa came third from last in WEF’s education rankings – only Yemen and Libya doing worse. With many school-leavers lacking basic literacy and numeracy skills, the government has pledged to improve the poor quality of education, which is blamed for high unemployment, particularly among the young.

However, government figures show it’s also failing on access to education, with one-third of the country’s 10.4 million young people aged 15 to 24 not in education, employment or training.

Capital Economics’ Shah says: “There’s a very big skills deficit in South Africa and the problem that this creates is that it’s difficult for workers to then go and find jobs in what you’d call more productive areas of the economy, such as financial services, or to a lesser extent, manufacturing.

“When the quality of education is that low, it’s difficult to generate productivity growth, and with the finance ministry aiming to tighten fiscal policy in the next few years that will constrain spending on education as it is, again this is going to be another problem that holds back growth.”

5. Governance: While South Africa is world leading when it comes to

developing, managing and regulating its financial sector, and corporate governance, the government is falling down on its responsibilities in almost every other sphere, from public services and administration to health, and poverty to joblessness.

It’s not as simple as a lack of money – the government budget has quadrupled to R1.1 trillion ($108 billion) since 2001 sending the fiscal deficit spiralling – but how it’s being spent.

Life expectancy is among the world’s worst, as is the cost to business of tuberculosis/HIV, and crime and violence. Corruption is a growing problem, with South Africa now in the company of the world’s most shady states for favouritism in decisions of government departments (although transparency of government policymaking remains relatively strong).

Trust in politicians is also on the decline, with ANC officials accused of siding with big business in exchange for directorships. Crime remains a substantial problem, with communities believing violence is the only effective route to air grievances.

The big hope lies with the government’s ambitious National Development Plan, which aims to promote greater competitiveness and better public services while encouraging business investment and growth, but the unions – the ANC’s key political ally – are vehemently opposed.