There is little choice but to constrain government spending. I’m not sure that this reality has dawned on government outside of National Treasury. There are only two choices: cut back spending or induce a financial crisis. There is no option in which spending can somehow increase without putting the solvency of the state at risk. 

I say this so boldly because it needs to be said. There are dangerous narratives being pushed, the idea that spending should remain high because somehow it will deliver both more social spending and growth. It will not, and every day when talking to business people I can understand why.

A state tipping into insolvency is a disaster. From Argentina and Greece to Zimbabwe, it inevitably involves massive disruption to public services, the retrenchment of much of the public sector workforce, and the collapse in value of government debt. That triggers a crisis in the private sector which is the biggest lender to government.

Investors are always forward looking. Theywant to understand the returns they will earn and the risks to those returns.State collapse is a serious risk. And the less stable the government’s financesare, the more investors have to price for the risk that the government coulddefault. This affects the whole economy because state collapse inevitablytriggers a major recession. So, the riskier government’s finances look, theless the private sector will invest. That means economic growth falls.

The contrary narrative is that state spending drives economic activity and supports growth. Well, if that were true,the past several years of massive government deficits would have spurred much economic growth. Instead, we have had 10 years of declining GDP per capita. The problem has never been a lack of state spending, it has been the structure of the economy, failing public enterprises, and crime and corruption. State spending that is financed out of debt also hits the economy in another way: it sucks money out of the private sector. If government is leaning on the financial system to buy its bonds, that financial system is then not lending to companies and people to spend and invest.

Improved social security would be a good thing but it cannot be done at the cost of a financial crisis, which would instantly remove the social safety net even as it is. Increases in social spending have been done successfully in the past like in the mid-2000s when government finances were strong, and spending could be increased dramatically without risking the financial health of the state. Growth creates the opportunity for social spending, not the other way around.

When Covid hit we immediately knew there were serious risks to government finances. We lost our investment grade credit rating at the start of the crisis. Public finances were already precarious given the ruining of the state-owned enterprises during the state capture years. However, we were to receive an unexpected reprieve in the form of booming commodity prices during the crisis. Despite the sharp downturn in economic activity during the lockdowns, government coffers were filled by a taxon the production and sale of platinum and many other exports. That windfall seems to have led to complacency, but it is now fully behind us. Commodity prices have slumped, and miners are retrenching workers because they cannot get their output to the ports given the failing logistics system.

We will see in next month’s medium-term budget policy statement just how dire the situation has become. We already know that government revenue has been falling short of targets because economic growth has been worse than forecast. Already government is having to borrow more than it had expected. As I wrote last week, given the national election next year, the pressures are obvious for increased spending on both welfare and the government payroll. 

Business is clear that the line must beheld. A vicious cycle will ensue if government finances are not kept well under control which ultimately leads to low growth and financial collapse. Finance minister Enoch Godongwana has said that government does not intend to cut spending on infrastructure and social services, but that some infrastructures pending will be paused in the short term. Of course, infrastructure spending is vital to growth, but protecting government finances is even more vital.National Treasury has been right to hold the line and business confidence is better for it.

The conversation needs to move off government finances and on to how we grow the economy. We need to fix the logistics crisis that is directly constraining businesses from exporting and generating the revenue they could be paying to government. We need to accelerate reform of the electricity sector. We need to consolidate reform of the criminal justice system and get on top of organised crime that is consuming both public and private sector resources. We need to get the skilled visas system working; we need to finalise digital migration to allow an expansion of data access; we need to fix the education system; we need to improve our international relations; we need to get off the FATF greylist; we need industrial policy that supports the development of a competitive,export-oriented economy. Growth is the one enduring and feasible way to solve government’s financial position and enable social spending.

 

Issued by BLSA