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The incentives for entrepreneurs

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Vast volumes have been written on the importance of entrepreneurship in building prosperity. Entrepreneurs innovate, identify new markets, implement new systems and process, connect labour, capital and technology in novel ways; in short, entrepreneurs make stuff more efficient than before. But measuring the contribution of ‘entrepreneursip’ to growth has been difficult, given the unquantifiable nature of entrepreneurial traits: motivation, creativity, risk-taking, to name a few. In a recent working paper, Sascha Becker and Hans Hvide claim to have found an answer to the question: Do Entrepreneurs Matter? They consider Norwegian companies between 1997 and 2008 and identify 500 firms where the founding entrepreneur died. This exogenous shock they show had strong negative consequences for these firms, regardless of firm size, age and location. Interestingly, more qualified entrepreneurs had a larger negative impact. (Read the review here.) Entrepreneurship clearly matters.

The more important (policy) question, though, is how to cultivate entrepreneurship. How important is formal education in creating entrepreneurs? (What type of education?) Does access to finance play a role? Rules and regulations? Inequality?

Koos Bekker at the World Economic Forum

Koos Bekker at the World Economic Forum

William Baumol, in his famous 1990 paper, suggests an alternative framework for thinking about entrepreneurship. Instead of (attempting to) cultivate entrepreneurship, he assumes a given stock of entrepreneurs in all societies. (Just as one would assume that there is a given stock of land-handed people in all countries, instead of trying to ‘cultivate’ left-handed individuals.) The important question, Baumol suggests, is how to change the incentives for entrepreneurs so that they participate in what he calls “productive” activities. Here is his central hypothesis: “the exercise of entrepreneurship can sometimes be unproductive or even destructive, and whether it takes one of these directions or one that is more benign depends heavily on the structure of payoffs in the economy – the rules of the game.”

Baumol use historical examples to show how the incentives for entrepreneurs – in essence, the risk-taking individuals in society – determined whether they were involved in productive or unproductive activities. Where warfare was the most likely activity to yield wealth, ‘entrepreneurship’ was rewarded through war spoils, with destructive consequences for the economy. In other societies, incentives were directed to rent-seeking, i.e. spending resources on obtaining a larger share of existing wealth, instead of growing the wealth, also known as redistribution. The most successful entrepreneurs, in this context, were those that could extract as much wealth from the state.

These ideas are particularly relevant for South Africa. The rules of the game changed dramatically for white South Africans during the late 1980s and early 1990s. Gone were the days where the state could be relied on for support, where rent seeking could be a profitable exercise. Instead, as I’ve written before, it was Afrikaner entrepreneurs that came to the fore after 1994 – Jannie Mouton, Michiel le Roux, Christo Wiese, Koos Bekker. Much of this success has been built on export markets: between 1998 and 2013, Naspers shares increased by more than 1900%, largely due to investments in China, Russia and Brazil. The Financial Times recently dubbed Bekker the “exemplar of the post-apartheid Afrikaner”.

But how has the post-1994 “rules of the game” changed incentives for black South Africans? Have Black Economic Empowerment facilitated productive or unproductive activities by black entrepreneurs? Where are the highest financial rewards for black South African entrepreneurs: to sell to a market, or to sell to government? In the former, competition is rife and global; in the latter, competition is protected because only BEE-rated businesses compete. It seems the incentives are heavily biased in favour of (unproductive) government contracts.

Here is the key question for policy-makers: What can we do to modify and improve the rules of the game (the reward structure of the economy) so that entrepreneurs – black and white – change the type of activities they engage in (from unproductive to productive)? Allocating more entrepreneurial resources towards more productive activities is the key to building a prosperous future.

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Written by Johan Fourie

March 28, 2013 at 07:13

Lessons from apartheid

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Discussing the legacies of apartheid: Andile Khumalo, Lumkile Mondi, Johan Fourie and Bheki Mngomezulu (moderator)

Discussing the legacies of apartheid: Andile Khumalo, Lumkile Mondi, Johan Fourie and Bheki Mngomezulu (moderator) Photo: Reinhardt Germishuijs

On Friday, I joined Andile Khumalo and Lumkile Mondi as panellist during the ERSA workshop on the Economics of Apartheid (held from 20-22 March in the Slave Lodge Hall in Cape Town). Our topic: Solutions to the legacies of apartheid. Each panellist had 10 minutes to state his case. Here is my introduction:

It is impossible to think about a set of policies that will, within a short space of time, eradicate the apartheid legacies of poverty, unemployment and inequality. I say this because history provides an excellent guide: the poor white problem, already fervently discussed in policy circles during the 1910s (as Lindie discussed this morning), only really ‘disappeared’ from policy discussions during the 1960s (even though, as Edward John Bottomley shows, it still persists). Even though the poor white problem was about a third as severe as black poverty today, it required 40 years of 5% annual economic growth for it to be ‘eradicated’. Perhaps a more contemporaneous example is more appropriate: Hans Rosling tweeted earlier this week that Africa will need 5% annual growth for the next 50 years to reach the same living standards that Europeans currently have.

The point is: we have to be patient. But this is not to say that we cannot do anything.

The first priority is that we have to know, to interrogate, have far we have come and how much has changed. Collecting long-run wage series by race and occupation, as Martine called for on Wednesday, is important if we are to understand the divergence of interracial inequality (how unequal were white and black wages at the start of the 20th century?), its persistence, and its convergence (since the 1970s). But we also need within-group wage series: as has been suggested at this workshop, there is no such thing as an homogeneous experience for black South Africans during apartheid. The inequality of black incomes during the twentieth century is still badly understood. Such within- and between-group disaggregated wage data can then begin to inform our models of economic development.

A second priority, and one that has been highlighted throughout the workshop, is to separate the racial prejudices and ideologies of apartheid from evaluating its economic policies, programmes and institutions, many of which still persist today. As Nicoli mentioned, it is perhaps only now, nearly 20 years after apartheid, that we can begin to acknowledge that not all apartheid policies were detrimental to development. Lumkile and Ganief mentioned that the IDC was an important pillar of industrial development from the 1940s and continues that role today. Servaas mentioned yesterday that social transfer policies were already highly redistributive by 1994. While the motives may not have been benign, the outcomes were. Studying the apartheid period is therefore not only important for the way we understand and interpret our shared history, but it suggests that we can learn from its successes and mistakes.

Thirdly, then, this workshop (and earlier research) has begun to investigate these lessons, but much more needs to be done. Here I offer some suggestions.

  • There is little doubt that the success of Afrikaner society to “pull themselves up by their bootstraps” can be attributed to the dramatic improvement in white education. Spending on white education already began after unification, but spending was only part of the story: Jan Smuts emphasised the improvement in teacher quality. Yesterday, Servaas mentioned the poor quality of South Africa’s teachers, specifically in math and science. Are there lessons to be learned from the large, state-sponsored roll-out of teacher education during the early twentieth century for today?
  • In addition to the higher quality teacher, and something that has been given very little attention, is the important role of civil society in improving the white education system. Women’s leagues (notably the ACVV) and the Dutch Reformed Church, for example, not only provided facilities for rural schools, but also funded and managed school hostels and feeding programmes for poor rural kids. This was indeed a policy of ‘no child left behind’. It’s great to see Oprah and Patrice Motsepe investing in education, but can we draw on lessons from private spending in the twentieth century to improve education outcomes today?
  • On Thursday, Dieter showed the massive spatial inequalities that persist, that the highest unemployment levels remain in the former homelands (even though the boundaries and barriers to migration have been removed). During the general discussion, culture was mentioned as a possible explanation; that people ‘have an affinity to the land’ or ‘treasure their roots’. Ironically, these same arguments were made by the first Carnegie commission into white poverty in 1932. Afrikaners were seen to value the land and therefore would not move to cities, remaining isolated and impoverished. But within a generation, better education and better job prospects meant that most Afrikaners were living in urban areas. Are cultural explanations for poverty really helpful?
  • Edward argued that apartheid’s industrial decentralisation policies were ineffective in bringing manufacturing industries to the borders of the homelands, mostly because the focus was on outcomes other than financial viability. Will policy-makers’ current attempts to establish special economic zones, for upliftment and development purposes, learn from these apartheid spatial policy errors?
  • Danelle discussed the complexities within the white labour movement of the 1970s. Is the same not happening within COSATU at the moment?
  • Laurence collected data on agricultural inputs and outputs during the apartheid period, which allow economists to calculate whether the introduction of new technologies – like tractors or harvesters – were labour complementing technologies or labour-substituting technologies. (Tractors may have been labour-complementing while harvesters labour-substituting, but this is still just an hypothesis.) Such lessons may have important implications for the current episode of labour unrest and mechanisation on farms.
  • There are certainly other lessons not discussed at this workshop: for example, what is the role of entrepreneurship and how is it cultivated? It is certainly not incidental that Anton Rupert rose to prominence during the 1940s and 1950s. What is the role of financing for entrepreneurial ventures? What support did Volkskas (literally, the people’s bank) play in connecting Afrikaner savings and investment? Where are the black savings institutions? What role did science and technology play during apartheid? Where are the black Hendrik van der Bijl’s, who founded Eskom, Iscor, the IDC and many more. What was the role of trade and regional integration during apartheid? South Africa is part of the oldest customs union in the world – SACU – which was founded in 1910. Why is this institution in decline? How is our integration into the rest of Africa so slow?

I guess if I have to find a way to summarise all of this, I will refer to something I know much more about: sport. A UCT geographer once told me the Parable of the World Cup, and I’d like to repeat it here. He asked me, just before the 2010 FIFA World Cup, what the best way is for a country to win the World Cup: is it to appoint an expensive Brazilian coach? Or is it to give every kid in South Africa a soccer ball to play with. I think apartheid is the story of how white, but specifically Afrikaner kids, were all given soccer balls. Playing fields were built and good coaches at the junior levels were appointed. Forty years later, whites in South Africa ‘won’ the proverbial World Cup, reaching levels of income as high as any country of the world. Of course, the story is not that simple: apartheid meant that sometimes the balls and fields of black kids were taken to the benefit of the white kids. Or they were simply excluded from team selection.

But the question today is this: how do we ensure that all South African kids get a soccer ball? Only then can we dream of an equal-opportunity and prosperous future.

Written by Johan Fourie

March 23, 2013 at 12:07

Why apartheid ended

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There is no consensus about the reasons for the demise of South Africa’s political system of apartheid. Was it the domestic unrest and political awakening of black South Africans that forced the White government to turn to the negotiating table or face civil war? Was it the magmanimous leadership of FW de Klerk or the reconciliatory courage of Nelson Mandela that allowed a peaceful transition? Or was it economics: changing internal and external resource allocations that by the end of the 1980s made apartheid non-viable even for the whites which were the supposed beneficiaries?

This is a question raised in Hlumelo Biko’s new book, The Great African Society. Biko argues that “global discomfort with the apartheid government’s modus operandi ultimately contributed significantly to the undoing of the apartheid regime” (p. 4), assigning an important role for the international community – and sanctions – in raising the costs of apartheid and increasing the likelihood of capitulation. But Biko’s view is challenged by an earlier literature. Already in 1997, Anton Lowenburg, Professor of Economics at California State University, published a paper in Contemporary Economic Policy which argued that “the direction of causality between sanctions and economic damage might have been quite the reverse of that normally supposed”. He provides evidence which shows that sanctions followed internal events, such as the 1973 strikes and Soweto riot, rather than causing those events. He argues that instead of forcing the government to the negotiating table, sanctions may have resulted in a conservative backlash from white South Africans, contributing to the continuation of the regime. Think of the impact of sanctions on Robert Mugabe’s Zimbabwe, for example, or North Korea.

Apartheid

A different economic explanation is found in Martine Mariotti’s recent paper on “Labour markets during apartheid in South Africa“, published in the Economic History Review. Mariotti argues that white skills improved significantly during apartheid (due to the emphasis on education), reducing the number of semi-skilled white workers and increasing the number of skilled white workers. Apartheid also coincided with a large increase in the manufacturing and services sectors, where skilled and semi-skilled labour was required. Thus, instead of white labourers competing with black labourers (as was the case during the early part of the twentieth century and the reason for the imposition of the colour bar), white labour and black labour was now complementary. White skilled labourers and the white owners of capital needed to fill semi-skilled positions with black workers, which is why the apartheid government in 1979 followed the recommendations of the Wiehahn Commission to abolish all forms of statutory job reservation. Apartheid, of course, would still continue for another 15 years, which suggests that economic forces don’t immediately trump racial ideology. But the shifts in the labour market, changing the economic incentives for white labourers, put the apartheid policies on an inevitable road to failure.

There were likely other economic causes as well: the high costs of industrial decentralisation, the use of import-substitution policies during apartheid that left huge current account deficits, industrial policy that attempted to pre-empt the impact of sanctions (like building SASOL), and the high security and military costs. The extent to which these policies mattered is still open for debate.

Understanding the reasons for apartheid’s failure is today, 19 years after its end, still important. Says Biko (p. 4): “To date the focus has been on a diagnosis of the racial symptoms of apartheid, resulting in a weak prescription of a Truth and Reconciliation Commission with a narrow mandate focused on racist-motivated crimes against humanity, and prescribing a cocktail of Black Economic Empowerment and affirmative procurement (policies) as a remedy for South Africa’s economic ills. If the desired outcome behind BEE as a policy was broad-based economic empowerment of previously disadvantaged South Africans, then so far it has failed”. If we are to address the legacies of apartheid that still persist – and Biko makes a number of radical suggestions, which is a discussion for another day – it is essential to gain consensus on the economic causes for the fall of the apartheid regime.

*From 20-22 March, Economic Research Southern Africa will host a workshop on the Economics of Apartheid in Cape Town. Several South African economic historians, including Martine Mariotti (mentioned above), will present papers. Send me a mail for more information.

Written by Johan Fourie

March 15, 2013 at 17:43

Nashuanomics

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FlyingcarMy favourite programme on South African TV in the 1990s was Beyond 2000, a programme which showcased technologies that would (apparently) revolutionise living in the future. For a teenager, this was the stuff of dreams. The futuristic end to the opening (watch it here) showed cities with flying cars and infinitely high skyscrapers. How many of these ideas materialised? As Peter Thiel, founder of eBay, famously quipped about the technological inventions since the year 2000: ‘We wanted flying cars, instead we got 140 characters’.

There is little doubt that technological improvements causes higher productivity (making more stuff with fewer inputs) which in turn underpins economic growth. Economists like to think about two types of productivity: labour productivity is about making workers more productive through adding physical or human capital, usually measured as the amount of goods and services produced with one hour of labour. Total factor productivity, or TFP, is the increase in productivity that are not accounted for by increases in labour or capital, i.e. technological improvements. Another way to think of it is what I’ve called Nashuanomics: saving you time, saving you money. Any technological innovation that does these two things, improves productivity, increases growth, causing greater prosperity.

Economists measure the improvements in technology through TFP. One would expect that periods of rapid technological progress, like during the Industrial Revolution or the discovery of electricity, would cause large increases in TFP growth. But this is the conundrum: As Paul David has argued in several papers, there is not necessarily a clear link between new inventions of what he calls ‘general purpose technologies’ and our measures of total factor productivity. This is for the obvious reason that it takes time for new technologies to permeate society. Electricity, for example, took more than two decades before only half of all US factories had access to it. David finds similar results for the dynamo. While computers (and the internet) spread rapidly to households across the developed world, it had delayed effects on standard measures of total factor productivity. Which gave rise to Robert Solow’s quip: “We see computers everywhere but in the productivity statistics”.

Others counter by saying that we measure TFP inaccurately, that we cannot account for improvements in quality or utility. So a more intuitive question, perhaps, is to ask how the technologies of the last decade has allowed us to save time and money? The largest technological breakthroughs of the last decade that have affected our lives are arguably smart phones and tablets, and social media. Smart phones now offer access to email everywhere and a level of communication and interaction that was not possible before. Not only have access spread, costs have come down too. But how large have these gains been? Facebook and Twitter boosts networking and communication. But by how much? There are certainly large savings that accrue from using a typewriter to using Microsoft Word, but are we saving anything by shifting from Word 2007 to Word 2010 to Word 2013? And Angry Birds? A 2011 study reported that the world plays 5 million hours of Angry Birds per day.

Perhaps the software advancements over the last few years allow us to be more productive, but that that productivity allow for more leisure. As a student in my class recently remarked: Economists can now run regressions much faster than we could in the 1990s, but that just gives us more time to play around on Facebook. Is this evidence of a backward bending labour supply curve?

Of course, if we really want to see the new technologies in the productivity statistics, these technologies must infiltrate most of society. There are not many economists that run regressions in South Africa, which means that the savings from developments in Stata will be limited to a lucky(?) few. Technological improvements in mobile technology, instead, may have a far more dramatic impact. There are now 6 mobile phones for every 5 people in South Africa, which means that everyone has access to this time and cost-saving technology. (Even though mobiles reduce the costs of communication, I suspect the poor spend a larger part of their budget on phones than in the past, substituting lower utility leisure. This is just a conjecture though.) How can the poorest of the poor save time and money? Women in rural areas spend several hours a day collecting water. A simple technology – a tap – may save countless hours of labour. (Here one must tread carefully: women also use these hours away from the home to interact socially with other women. A tap in the home may save hours of hard work, but also isolate women and reduce their power within the household.) By asking the simple question – ‘What goods and services could we provide that will save the most time and money? – Nashuanomics is a great shorthand for government officials to think about the public provision of infrastructure.

And, finally, there is the constant fear that we’ve reached the end of new technologies. I’ve written about this before. As long as Nashuanomics exists though – as long as there are still savings in time and money possible – we haven’t seen the end of technological improvements. Predicting these new technologies is probably a futile exercise. One possibility is that they will be in those areas where the largest savings in time and money is possible. According to Andrew Kerr of UCT, a black commuter in South Africa spends on average 96 minutes of his day commuting. White South Africans spend 60 minutes. (This compares to 37 minutes in the EU and 49 in Europe). A better designed transport network or new technologies (trains or self-drive cars, which allows one to work will driving) would result in massive productivity (and utility, because who likes sitting in traffic?) gains in South Africa.

Flying cars are probably unrealistic. But spreading existing technologies to a greater proportion of the South African population could make a telling contribution to higher productivity, incomes, and quality of life.

Written by Johan Fourie

March 8, 2013 at 10:31