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Archive for October 2012

Trends and trade-offs

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The preliminary results of the South African Census 2011 was released today by Statistics South Africa. There are few surprises: in nearly every respect, the average South African is better off today than they were ten years ago; in other words, Sir, there are more reasons to smile than cry. But, as everywhere, the average hides large disparities in incomes: the most tweeted statistic today (and certainly the most commented on popular news sites) was that the average white household earns more than six times than the average black household (R365k vs R60k) per annum. While still enormous, the good news is that the gap is closing: whites earned 8.6 times more in 2001. In fact, white South Africans’ incomes increased the slowest of all four population groups. So, while the rich grew richer, the poor grew richer faster.

Age distribution of South Africa, Census 2011

One less debated topic, but perhaps more interesting in highlighting future trends, is the demographic changes. The Census 2011 Statistical Release notes that “Contrary (to past censuses); in 2011, there was a marked decrease of males and females aged 5–9 and 10–14. Many factors could have contributed to this decrease. Further analysis is scheduled to be done to ascertain the key drivers to this occurrence.” The figure (copied from StatsSA’s Statistical Release, warts and all) shows the age pyramid for the full South African population; note the decline in the number of students in the 10-14 year-old cohort and the cohorts around it. About its causes one can only speculate: the most obvious is lower fertility rates a decade or so ago. Some corroborating evidence can be found in the Community Survey of 2007, which showed a decline in the number of children in the youngest cohorts. Alternatively, one could also argue that this “shortage” of high-schoolers represents undercounting in the Census 2011.

But what of its consequences? We’ve seen lower numbers of matriculants enrol for their final exam over the last few years, and the poor schooling system has been blamed. Perhaps this is simply a consequence of a changing demographic, unnoticed because we missed a census in 2006? Does this mean that we can budget less for future education expenditure, which is currently South Africa’s largest public expenditure item, closing schools that are underperforming and unattended? And what of the labour market? Young South Africans in their twenties are the most numerous cohort, which explains the high level of youth unemployment. But will youth unemployment be such a serious concern in a few year’s time, when fewer matriculants begin to exit the system. Is a Youth Subsidy really necessary then?

StatsSA and Treasury will certainly scrutinize these numbers to a much greater extent. A census is never perfect, and should be corroborated with other surveys and evidence. It will also be much easier to assess these economic and demographic changes once the sample data is available to researchers.

Census 2011 begins to show the progress we’ve made as a country. But, more importantly, it sheds light on the trends and trade-offs that will shape our future.

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Written by Johan Fourie

October 30, 2012 at 21:05

The lives of our grandchildren

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A provocative recent NBER Working Paper by Robert Gordon concludes that US economic growth will slow considerably over the next century to the extent that the lives of our grandchildren will not be very different from ours. The reason for this, according to Gordon, is that many of the inventions over the last 150 years have been “one-time-only inventions, which “limits the potential for a continuing stream of equally basic inventions”. Says Gordon: “Such essential improvements of human life as the conversion from rural to urban life, the speed of travel, the temperature of rooms, and the near-elimination of brute-force manual labour, have already been achieved.” While these innovations have considerably improved our productivity, he argues that more recent innovation, like Google and Twitter and the iPad, has focused less on labour-saving technology and more on “a succession of entertainment and communication devices that do the same things as we could before, but now in smaller and more convenient packages.”

Pundits have, of course, predicted the end of innovation before (and the decline of the United States). Gordon himself notes four classic examples where pessimism turned out to be unfounded, including the president of IBM in 1943 who said “I think there is a world market for maybe five computers”, or Bill Gates’s quip that “640 kilobytes ought to be enough for anyone”. But while mentioning these errors, Gordon fails to heed their lessons.

It wasn’t that these individuals were unnecessarily pessimistic about the future; they, and almost everyone else, could simply not imagine the possibilities that these new technologies would create. There is no reason to expect that we have a greater capacity today to envisage what the future might be like any better than intellectuals and business leaders of the mid-twentieth century, or even late-nineteenth century. There is also no reason to suggest that all “one-time” inventions have been discovered: a recent cover of The Economist noted the dramatic change in production and distribution that 3D printing might entail. Mobile technology may fundamentally alter our mode of exchange. Are existing roads and vehicles really the most optimal way of transport (if we include speed, safety, and cost)? And power lines to distribute electricity? There are still countless ways to make humans more productive, especially if all costs (like the impact on the environment) are priced into the market.

Gordon’s contention that many technologies developed in the early twentieth century (the automobile and flight, for example) reached their peak in mid-century is questionable. Gordon uses the example of aircraft: “air travel by 1970 had been completely converted to jets with no further increase in speed”. Speed is, of course, not the only criterion that should be used to judge efficiency: planes are much safer today than in the 1960s and 1970s and, most importantly, also cheaper, more frequently used by the median citizen. Moreover, these days we also have Skype for that meeting with someone on the other side of the world, lowering transaction costs dramatically. A more personal example may be more apt: even though a modern dentist looks very much like his 1960s counterpart, the diversity of dental services offered is much greater today (and the experience is much more pleasant).

Gordon also only focuses on the United States. Surprisingly, globalisation is perceived to be negative for US growth, causing greater inequality. But globalisation also broadens the scope for adopting ideas and innovations discovered elsewhere, today much faster than in the past. Apple has created excellent products, but is also in competition with Samsung, a South Korean conglomerate. Samsung may have used ideas from Apple, but would Apple have built a mini if it wasn’t for Samsung’s Note? In telecommunications and computer services where network economies are increasingly important, global competition may be the only antidote to local monopolies. Moreover, the vast majority of the world can still benefit from the twentieth century discoveries. Such productivity increases elsewhere will create larger markets for US producers, driving further innovation (and more “homesourcing”).

But Gordon also neglects the two most important reasons to be optimistic about the future. While noting the six “headwinds” of an ageing population, a lower level of education, greater inequality, outsourcing, climate change and household and government debt, the innovations of the last two decades (notably in information and telecommunications technology) have caused what Daron Acemoglu calls a “rights revolution”: in ‘The World Our Grandchildren Will Inherit’, he argues that greater political freedom is the ultimate cause of long-run increases in living standards, and the expansion of political rights will make the world a better place for our grandchildren. Perhaps its not only political freedom though. Perhaps its social freedom. A more integrated world, results in a more peaceful and – most importantly – cooperative world. A world of greater trust. And, as Stan du Plessis argues in this TEDx Stellenbosch video, human prosperity is founded on our ability to cooperate.

There is no reason to suspect that we will cooperate less in future. As social media and telecommunications expand, humanity will continue to move closer together, even though there will always be resistance to change. Ideas will spread faster across a greater number of people than in the past. The reward for innovation is greater, the pool of beneficiaries larger.

For Gordon, the heyday of productivity growth was the period 1928 to 1950, but not everyone at the time thought that it was. Here’s John Maynard Keynes in 1930 on Economic Possibilities for our Grandchildren: “We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the nineteenth century is over; that the rapid improvement in the standard of life is now going to slow down – at any rate in Great Britain, that a decline in prosperity is more likely than an improvement in the decade which lies ahead of us.” He continues: “I believe that this is a wildly mistaken interpretation of what is happening to us. We are suffering, not from the rheumatics of old age, but from the growing-pains of over-rapid changes, from the painfulness of readjustment between one economic period and another. The increase in technical efficiency has been taking place faster than we can deal with the problem of labour absorption, the improvement in the standard of life has been a little too quick.”

Gordon makes the same mistake as Keynes’s contemporaries. As Stan says in his TEDx talk, once you’ve swallowed the blue pill of economic progress, there is no way of going back.  Our only constant is change, and it will also be true for our grandchildren.

Written by Johan Fourie

October 26, 2012 at 14:56

Smile, the beloved country

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South Africa is the feature of this week’s edition of The Economist. The magazine paints a pessimistic picture of South Africa’s future, summarised by the cover caption of “South Africa’s sad decline”. Its lead article makes two points: that the country’s bad economic performance is mostly but not entirely the result of the African National Congress, the party that has ruled South Africa since its first democratic elections in 1994; and that the only way to solve the current crisis is to make political competition a reality. This is not wrong, but it is quite weak and simplistic, especially coming from The Economist (as Ferial Haffajee, editor of South Africa’s City Press, agrees). South Africa’s future depends on much more than simply political competition, and its recent past is also more complex than the linear decline The Economist insinuates.

Thabo Mbeki’s reign was not all bad. Between 1999 and 2008 (his two terms), the South African economy grew at an average of 4.2% per annum. According to most development economists and across several poverty indicators, the high growth caused South African poverty to decline significantly in this period: the World Bank estimates that this was from a poverty headcount ratio of 38% in 2000 to 23% in 2006, although this may be too optimistic. See Yu (2010) for a more detailed analysis. We tend to forget that many of the problems we encountered over the last five years – electricity cuts, infrastructure failures, yes, even service delivery backlogs in cities – are partly the results of faster than expected economic growth.

More recently, legal (and illegal) immigration has continued to soar. If the country was really falling apart, why would thousands of (economic) migrants be tempted to our shores, and those that left earlier, to return? (Yes, push factors play a role, notably the bad economic conditions of Zimbabwe, DRC and Somalia, and the global economic crisis, but if, as The Economist would have it, other African countries are on the up while South Africa is going down, why don’t migrants stream to these countries? The answer: South Africa is still a land of opportunity.) Our financial system remains one of the best in the world. (Yes, that’s right folks: according to the World Economic Forum’s Competitiveness Survey, South Africa ranked third on overall financial market development, first in the regulation of securities exchanges and first in the strength of auditing and reporting standards.) We receive close to 10 million tourists annually who appear to enjoy the rural and urban wonders of South Africa, and these numbers continue to grow. Our companies are investing in African markets like never before, in manufacturing, retail, telecommunications, banking and agriculture. We are at the forefront of mobile technology and payments which could revolutionise trade and exchange. We have earned the right to host the Square Kilometre Array which will look further back into the past than ever before, and we continue to make new palaeontological finds that helps to unravel the history of mankind.

This is not to deny the many challenges we face. The prolonged mining strikes have dented investors and the public’s confidence, cost mining companies millions of earnings, and the South African government billions in unearned taxes (a back-of-the-envelope calculation suggests that lost tax revenue from these strikes equals the annual amount spent on bursaries for South African students). The Nkandla mess, where R247 million of taxpayers money will be spent to built a private residence for president Zuma in rural Kwazulu-Natal, reflects the general attitude towards corruption and cronyism in government. (Let’s be optimistic: as in the tradition of European monarchs who used to spend gazillions on summer palaces, perhaps in a century’s time, Nkandla will be as synonymous with South Africa as Balmoral Castle is with Scotland, drawing millions of visitors to the countryside.) HIV/Aids has dwindled in media attention, but it’s still very much real in the lives of millions of South Africans. The quality of education is bad. Crime is violent and personal security poor. Inequality persists.

But South Africa is not dead-and-buried. It’s not a failed state, or a banana republic. We are not hopeless. On the contrary,  after 18 years of democracy, reality has finally sunk in. We’ve realised we are not a miracle, even though the political transition was unique: we are “sad” only because the lofty (and perhaps unrealistic?) ideals we envisioned in 1994 did not materialise.

Perhaps, looking towards the next 18 years, reality is a better point of departure. And it suggests that there are still many reasons to smile.

Written by Johan Fourie

October 20, 2012 at 09:44

War and peace

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(c) Johan Fourie

Many observers found the Nobel Committee’s decision last week to award the European Union the 2012 Nobel Peace Prize surprising. Several European countries are in the midst of a deep recession, and as a quote from this New York Times article suggests, many in southern Europe see the austerity measures imposed by the leaders of Northern European countries, notably Germany, as “economic war”.

Regardless of the current financial frailties, though, the Committee is correct in pointing out that the existence of the European Union has coincided with peace in Europe. The European Coal and Steel Community, founded in 1951 between France, Germany, Italy, Belgium, Luxembourg and the Netherlands, aimed to integrate the major economies of western Europe to such an extent that warfare would simply be too costly for all parties concerned. (Incidentally, it is this integration that also make recessions like the current one more pervasive.) And it certainly has realised its mission: Europe has enjoyed peace for 67 years (except for civil wars in the Balkans) and it is, at least for my generation, impossible to imagine war between major European nations today.

But two issues should be raised: Firstly, it is not clear whether the European Union has caused peace. To attribute peace in Europe to the work of the European Union implies a causal link. With the Marshall Plan contributing to rapid post-War growth (and growth elsewhere in the world providing lucrative export markets), was Europe not anyway on the road to such prosperity that warfare would be too costly? Perhaps deeper integration (i.e. European Union) and a peaceful region is both simply a consequence of greater levels of prosperity. (Of course, greater prosperity is also the result of integration and a peaceful region – bi-directional causality.)

The Nobel Committee warns that “there is a real danger that Europe will start disintegrating. Therefore, we should focus again on the fundamental aims of the organization”. But it is no coincidence that Europe is suffering from its worst recession since the 1930s, the period preceding World War II. Prosperity → integration → peace. Perhaps the Nobel Committee should have awarded the Peace Prize to twentieth-century European entrepreneurs, rather than the European Union.

Secondly, and much more contentiously, while we know economic integration boosts prosperity, to what extend is political integration good for growth? Here’s Douglas North (2005: 42-43):

Conformity can be costly in a world of uncertainty. In the long run it produces stagnation and decay as humans confront ever new challenges in a non-ergodic world that requires innovative institutional creation because no one can know the right path to survival. Therefore, institutional diversity that allows for a range of choices is a superior survival trait, as Hayek reminded us. Religious diversity such as Luther and Calvin produced has long been celebrated as providing just such a stimulus, as Weber famously argued. But a more fundamental source of creativity has been the evolution of institutional diversity in general, of which Protestantism was one illustration and symptomatic of the overall diversity in thinking associated with the Renaissance. Political fragmentation in western Europe played just such a role in creating diverse and competing institutional settings for diverse beliefs and hence economic institutions which were critical in the relative rise of Europe as well as critical to the growth of impersonal exchange which underlies modern economic growth.

China, the most prosperous world region of the Middle Ages, was politically unified and as a result had no competition between polities that would create diverse institutions. Political fragmentation in Europe did exactly that, and those institutions that resulted in prosperity were those that was adopted by the countries left behind. And as David Landes notes, “that is the way of achievement, correction, improvement, and success”.

Peace in Europe (and everywhere else) is built on prosperity and, more fundamentally, on the institutions that incentivise entrepreneurship and trade (of which regional integration is one of many pro-growth institutions). But peace should not equate conformity. Political fragmentation which results in institutional diversity – allowing countries to experiment with different policy options in a fast-changing world – is perhaps key to Europe’s long-run survival.

Written by Johan Fourie

October 15, 2012 at 08:26

Restaurantonomics

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(c) Johan Fourie

The recently released Eat Out Restaurant Award nominees show how Stellenbosch has become the gastronomy capital of South Africa: 7 of the 19 South African nominees for the title of top South African restaurant are based in or just outside Stellenbosch. A further 3 are located in Franschhoek, or on the road between Stellenbosch and Franschhoek (a town about 30 kilometres from Stellenbosch). A further 6 are based in Cape Town, which means that of the top 19 restaurants in South Africa, 16 are based in a radius of about 60km in the Western Cape, and only 2 are based in Gauteng. (The final nominee is located in the Kwazulu-Natal midlands.)

How would an economist explain this? It’s clear that it’s not only demand driving this: Gauteng, the wealthiest province of South Africa, has only 2 nominees (one in Johannesburg, one in Pretoria and zero in Sandton). Tastes may play a role – Capetonians may prefer more exquisite dishes while patrons in Gauteng prefer something else – but I think it would take a brave man to argue (and prove) this. In fact, I don’t think it has anything to do with local demand, except that there must be a minimum level of ability-to-pay, which both exist in the Cape and Gauteng. Tourism is perhaps a better explanation: Cape Town is South Africa’s favourite tourist destination and the surrounding Winelands is in the top 5 most popular South African destinations. But why so many in Stellenbosch, and why doesn’t Soweto, or the Garden Route, or the Kruger Park, also top ten destinations, have any nominees?

It is supply, rather than demand, that is key: the Cape performs better because it is better at supplying the inputs that is required to produce a quality restaurant establishment. As I am no food connoisseur and should tread carefully in discussing food inputs, but perhaps the Western Cape may have a climate conducive to producing the vegetables and other greeneries that are required for exquisite dishes (although, you’ll find the best meat in Gauteng, where there’s a much larger market). But Cape restaurants are close to the (very fertile) Atlantic Ocean, which provides ready access to a large source of fish and shellfish. And they often have a great setting: 6 of the 7 Stellenbosch restaurants are located on wine estates (although, scrolling through the criteria for selection for the Eat Out Awards, it doesn’t seem as though setting counts for anything.) They also have direct links with Europe and elsewhere – I’ve heard a rumour that a certain Cape Town restaurant imports fresh bread from France – but so does Johannesburg, of course.

My suspicion is that they have two things which Gauteng don’t. Chefs and competition. The Cape hosts a number of internationally accredited hotel and culinary schools that produce talented young recruits for the restaurant industry. These young chefs know that if they want to be successful, the Cape is the place to be: it’s here that they’ll have access to the best tutors, and the most up-to-date fashions, styles and trends. It’s here where a new idea or concept or taste will be noticed faster by the rest of the gastronomy community (such as food blogs). Firms (restaurants) benefit because they have a wider pool of possible recruits. Labour (chefs) benefit because the pool of possible job opportunities is larger, and the opportunities to do something new and exciting and brilliant greater.

It’s these same reason that industries agglomerate in certain areas. Demand is important, yes, but demand simply means cheap access to international markets (tourism in the case of Cape restaurants, or fast, reliable and affordable port services in the case of manufacturing). The Cape gastronomy industry is a good example of how, with little government involvement, the market creates agglomeration economies that lowers the costs for each individual firm. More importantly, no policy-maker or consultant would have spotted this trend a decade ago. My own (bad) advice would have been to focus on the fashionable districts of Sandton, where local demand is largest.

All that that shows is that our “predictive ability” about future trends is extraordinarily bad. Any policy-maker with a taste for involvement in the market economy (read: “industrialisation” or “beneficiation”) should carefully heed the lessons of the South African gastronomy industry.

PS: This post is now also available on Finweek.com.

Written by Johan Fourie

October 7, 2012 at 09:29

De(con)structing mining

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Job creation or job destruction? Wages will rise, but jobs will fall. Photo by Taurai Maduna/Eyewitness News.

What South Africans should realise is that the mining industry will contribute little to economic growth of the future. Yesterday, The Economist wrote about the bleak future for South Africa’s mining industry. My first reaction: why is that such a bad thing?

Let’s use a production possibilities frontier to map all the possible production options for an economy (let’s say, in this economy, mining and manufacturing are the only two products being produced). If we’d like to produce more mining products – if we already use all our productive resources efficiently – we’d have to give up something else, in this case, manufactured products. In other words, the more mining we produce, the less of everything else. This is known as opportunity costs. You may argue that the South African economy is not producing at efficient levels: just consider the massive unemployment (which I’ve written about before), estimated to be between 20-40%. With all these unemployed workers, we could produce more mining without having to incur the opportunity cost of reducing producing elsewhere.

But there are two problems with this: those 20% (let’s be optimistic) workers that are unemployed, are probably unemployable. They are not located close to cities (or mines) where jobs are more easily available. (Because of South Africa’s warped spatial segregation during Apartheid, even if these workers live in cities, it is still expensive to get to work.) They are not well educated or trained (rock-drill operators isn’t anyone’s forte; if it was, the Lonmin workers won’t be able to earn R 11,200 per month which place them in the top 20% of South African wage earners). It’s also not only about labour. Deep-level mining is extremely capital intensive, and it’s becoming more so. Except if all this capital is obtained from external sources (which will also come at the cost of other sectors: foreign investors will demand Rands, appreciating the exchange rate, making our exporters in other sectors less competitive), it has to come from domestic savings, savings that could have been invested elsewhere in the economy.

A second counter-argument might be that the mining sector produces a lot of stuff that other sectors use. This is only partially true. Firstly, the prices of the raw commodities are often set internationally, and because we are a minor producer of several mineral types, our production really doesn’t affect the international price. This simply means that you can get coal from a South African producer or from somewhere else for pretty much the same price, so what is the benefit of producing it locally? In platinum, though, where we supply nearly 80% of the market, our production certainly will affect the price of platinum. But I’m not sure we add much value here: our largest exported product in 2011 was ‘platinum, unwrought or in semi-manufactured forms’, of which we exported more than $10 billion. Some of our production is used in making catalytic converters, for example, of which we exported $61 million, mostly to Japan and Germany. But, this is a tiny industry; compare that to the more than $467 million of grapes (also a raw commodity) exported 2011.

Mining is becoming more capital-intensive. It is not the way to address South Africa’s unemployment crisis; the mining industry, to remain competitive, will lay off workers – as it should. (Incidentally, this is also why those workers that remain will be able to earn higher salaries – as capital replaces labour, those workers that remain become more productive. And why CEO salaries will increase even more.)

What will happen to those laid-off workers? In a market where wages are free to move (not South Africa), those workers that are retrenched by the mining companies will lower the wage rate in other industries, making these industries more competitive, and shifting South Africa’s comparative advantage. (If wages cannot move, the unemployment rate will.) This is already happening: today, mining only composes 5.7% of South Africa’s GDP, about four times smaller than financial and business services. South Africa’s twentieth century economic success may have been built by cheap labour on the mines, but if we are to make a success of the twenty-first century, mining won’t have a starring role. The sooner we realise this, the better.

I’m not saying that the mining industry will completely self-destruct. It won’t, as long as there are lucrative opportunities to extract valuable minerals at relatively low costs (and, if you’d like to be cynical, profiteering politicians). But the South African mining industry is not the economic power that it once was. It’s malaise is simply part of the process of creative destruction that all economies – if they want to grow – have to endure. Of course, not everyone shares this enthusiasm for relative decline, not least the people working in those industries, but we should remind ourselves that “destruction” is as necessary as “creative” for an economy to move forward.

Written by Johan Fourie

October 1, 2012 at 13:20