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With the economy entering a new growth cycle from October 2009, how much of an expansion can we expect this decade in terms of amplitude and durability?
What will boost growth, restrain it and ultimately cut it short? And how will this play by sector/industry?
Our population growth has dwindled to less than 0.5% annually, though African migration remains potentially a source for tapping major labour reservoirs.
The likely expansion of the economy’s output, however, will be more determined by the increase in the formally employable labour force, the pace of fixed investment and productivity gains. That’s an output view.
Equally important will be the income and spending drivers, business risk-taking and government locomotive roles in making things happen (or not happen ………).
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These past 90 years, the South African economy has averaged 3.5% growth annually. Will this also be the norm for the 2010s, and if so, will we just meet it, underperform or outperform it?
In order to underperform the long-term growth norm for a full decade, our headwinds must be particularly bad.
Tail risks (high-risk low-probability events) that could jointly or severally cause such underperformance include:
- another overseas crisis causing global recession and falloff in our exports. Chances this decade: ?
- major drought (or several years of drought) severely hurting agricultural and associate output. Chances this decade: not minor (after two decades of rain)
- major epidemic (flu?): Chances ?
- political strains causing loss of confidence and consequent falloff in investment: Chances ?
- policy stances turning out to be costly mistakes. Chances: not minor (with our history?)
A naturally pessimistic frame of mind can find many reasons as to why our brief and fragile revival so far could be cruelly cut short, and yielding underperformance in the 0%-1% GDP growth range (our lot in the 1980s for mainly political reasons and the bad policy choices made as a consequence).
I fully acknowledge such potential, but term it tail risk as I don’t feel confident that the likelihood thereof is high. Yet we have experienced all such things at some point or another in the past 100 years, sometimes severely, and there exist excellent reasons to fear future repeats. So go cautiously.
Even so, the underlying growth reality appears more stable and promising (though not all will see it this way, nor should we be blind to global cyclical conditions capable of cutting short our expansions, just as much as that they can prolong them).
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Overperformance requires an absence of constraints and an exuberance overcoming many internal shortcomings.
We have shown before that we are capable of such exuberance and growth outperformance, especially late in long cyclical expansions, such as in the 1960s (growth outperforming at over 5% annually, if for less than five years) and again for four years (2004-2007) during the past decade.
But these spurts of outperformance have been few and far between, once every generation at most, hinting at exceptionally lucky convergence of favourable conditions? This has never really happened for a full decade during our post-industrial maturity.
For that kind of outperformance you need to go back to our modern industrial take-off in the closing decades of the 19th century (1870-1900), during our gold mining rushes and the start of our major urbanization and industralisation drives, for which GDP estimates don’t exist (but going by folklore these were WILD times).
So without trying too hard, for the immediate future one falls back on the long-term growth average of 3.5% this past century, which has been our average for a reason.
Our path dependence (resource economy, migrant society, turgid politics) created an institutional fabric which may be more resilient than the daily news flow may suggest, but which also has its shortcomings. That fabric has its own rules and its own performance yardsticks.
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There are three very good reasons why we may have another decade-long expansion, potentially getting us to 2020 in one piece. A lot of luck (timing, position) is involved in having shaped present conditions at this juncture (so don’t blame any hard work by anyone just as yet).
Firstly, there is Asiatic catch-up growth, with Latino, Aussie and other commodity producers in tow. Three-quarters of the world’s 7bn population is poor, impatient and willing to exert itself using rules proven elsewhere.
This is firing 10% growth in countries like China and shortly India (potentially for decades) and keeps the emerging half of world GDP growing at over 6%, as its middle classes, cities and industrial capacities are forcefully expanded from very humble beginnings.
In the process, much demand for our exports is created and export prices are kept high, for decades (not just this coming one).
Secondly, the rich half of the world has incurred bad financial crises only very recently, and is still struggling with their protracted aftermath.
US labour market conditions show massive deviations from potential which may take the entire decade normalizing.
Europe is also going through public and private debt adjustments that may take a decade to be completed.
Japan continues to struggle with deflation already active for two decades and giving little sign of abating.
These respective struggles are important for us, as for the duration there is much anxiety and policy support (feeding precious metal prices and boosting our export prices as much as the Asian growth story does).
But these struggles also create oversupply (US labour), maintains minimal global inflation, keeps interest rates low for years while inviting additional policy stimulus (fiscal and QE), between them causing global capital flows to seek higher returns elsewhere.
Such incoming capital dissolves our balance of payments constraint (except in short episodes of extreme risk aversion), keeps our currency strong and overvalued, suppresses inflation, boosts asset markets and skews growth towards domestic sources (also because we now have low interest rates).
And if these two decade-long global drivers aren’t enough, our own domestic configuration (with much current resource slack) can also sustain ‘moderate’ (average) growth for many years (potentially even a decade counting from 2010) without creating major bottlenecks (though watch out for balance of payment deficits, electricity and professional skill shortages).
Our fixed investment ratio relative to GDP has been lifted above 20% of GDP and can probably be maintained, if healthy support can be sustained from the public sector.
The labour force is so constituted that out of a 50 million population and 22 million labour force about 9 million formally employed workers are responsible for generating 90% of GDP.
The recent recession and ongoing annual crop of new labour cohorts has created a pool of over one million matriculants and graduates available for work.
In addition, we deliver annually nearly 400 000 new graduates and matriculants, of which at most 100 000 are needed to replace retirees. Thus quite a pool of new labour exists this decade to support a modest GDP growth rate, in addition to which there is still the contribution from less skilled labour more informally deployed or in time also absorbable by the formal sector as presently constituted.
As to WHY the economy then grows relatively modestly in the presence of 20% capital formation and such copious labour supply, there are many factors holding us back.
One factor is the rule-makers, their presence and actions potentially creating many diverse obstacles to less inhibited risk-taking, labour absorption, income growth, spending and output expansion.
Other growth constraining factors are more sector-specific, such as electricity availability, the more constrained credit culture, and the overvalued Rand.
Ours is a noisy society. That can be fruitful, but our modern mature make-up doesn’t support 10% growth. It is a 3%-4% engine, at best (and it has bad hair days, too ……).
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Despite these three long-term drivers potentially sustaining modest growth for a decade, are there features other than excessive tail risks that can cut us short?
Yes, the obvious one also in play five years ago is inflation, specifically commodity driven, originating in the global growth drive overwhelming global supply abilities (and triggering nationalistic constraints).
We see this mainly in oil and food. As and when these commodity prices become too lively, our inflation rate tends to rise, triggering second-round effects in a growing economy. Countering such tendencies, we find SARB raising interest rates, potentially sufficiently so to snuff out the upswing.
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Thus the main outlook is for a decade-long 3%-4% growth expansion, initially slow but eventually stronger, with growing risk of getting caught and brought low by new commodity price surges and SARB interest rate increases, with in the background massive tail risk potential ignored at one’s peril.
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The make-up of our cyclical upswings, especially after a recession shock, tends to be consumption-led, with fixed investment only gradually coming back on stream as resource utilization, business confidence and balance sheets improve.
Thus the experience of the past 18 months is nothing new, and can be projected further out into the decade.
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The lead sector is household consumption durables, especially where pent-up demand has been created due to long delays in replacement cycles.
The car industry is well into recovery, with a 25% gain in 2010. Its gains will become less massive in the 10%-15% range through 2012 as the replacement cycle keeps normalising. By mid-decade, this industry should be expanding in line with urban and formal employment gains in the 2%-5% range.
Household appliances, furniture and communication equipment also incurred delayed replacement and their pent-up demand should similarly allow 5%-10% growth rates through mid-decade, and half that thereafter.
Household consumption semi-durables (clothing, footwear) have benefited from low import prices, income growth and redistribution via social allowances, also benefiting from lifestyle emphasis. Growth of 5%-10%.
Non-durable goods (food, drink, everyday necessities) benefit from income growth, and especially base-spreading effects through employment gains and more people receiving social grants. Real household income gains of 3%-4% should ensure similar growth in this sector.
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In contrast, fixed investment shows a much more complex expansion story.
During the 2009 recession, private fixed investment fell off by 15% peak-to-trough, with machinery and equipment falling off by a third, stabilizing at these levels in 2010. Though 2011 will probably still be slow, resource improvement thereafter should see a gradual revival in these spending categories, cycle-bound, in 5%-10% territory post-2012.
Private residential building activity has gone through a slump, but has probably bottomed at low levels.
Its recovery should have been fast, going by previous upswings, given the interest rate declines (prime dropping by 6.5% from 15.5% to 9%) during 2009-2010.
Yet this time could be different, with the overseas housing crises, the National Credit Act and the high household indebtedness making access to credit more selective, maintaining for longer an oversupply of living space and limiting house price gains, favouring renting over buying, possibly for some years through mid-decade.
Residential building activity may therefore face a long recovery cycle, if at much slower growth gains than in previous cyclical upswings. Real growth of 2%-3% from later this year looks feasible.
Non-residential building activity traditionally lags residential activity, may only bottom out next year, but should be back in modest recovery mode after 2012.
Public infrastructure investment has seen a major build-up in base load activity during 2004-2008, as there was bunching of electricity, railway, roads, airports and sport stadia mega-projects.
Some of these activities have come to an end, but the infrastructure needs in other areas (electricity, roads, water, municipal) remains massive.
Contract flow, however, has slowed and appears to be a function of state capacity. Activity may eventually stabilize and start growing again, hopefully from 2012 if the state could find a new urgency to get contract awards flowing faster again.
For now it seems unlikely that the cracking pace of pre-World Cup days will be achieved any time soon, even if infrastructure maintenance, replacement and expansion needs are gigantic, and engineering contractors never give up hope of this ship turning eventually.
Export volumes continue to expand only very slowly, with cars a leading growth sector. Mining should be a star performer and has come back from recession lows, but is yet to show signs of matching the rapid expansions observable elsewhere in the world. Legal issues keep dogging the industry, with infrastructure capacity (especially electricity, rail transport, harbours) also a drawback, keeping new investment relatively subdued.
Retail, manufacturing, transport and communication look set for 4%-6% growth rates this year and next.
Government will likely remain an important absorber of labour, supporting household income flows.
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In sum, the outlook henceforth is for steady, if modest, output gains in most domestic sectors.
The main weaknesses initially can be observed in the building and construction sectors (relative to potential) with mining also struggling to make most of the global opportunities on offer.
Spending-wise, it is fixed investment and net exports where the growth shoe pinches most, probably still for some years, holding back the overall economic performance to modest growth.
Cees Bruggemans
Chief Economist FNB
Cees@fnb.co.za
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