Archive for October 2015
A few months ago, I had one of the most gratifying experiences of my academic career, as a member of an appointment committee at Stellenbosch University. We had two candidates for a tenure-track position in economic history within the Department of Economics. Both were Masters students within our department, but the quality of the interviews would have suggested otherwise: the candidates were clearly passionate, eloquent and thoughtful in their answers. I remember thinking afterwards of the story of Paul Samuelson’s dissertation defense at Harvard, when one member of the committee, the great Joseph Schumpeter turned to another member, Nobel Laureate Wassily Leontief, and asked, ‘Well, Wassily, do you think we have passed?’. And it’s true: the questions both candidates asked of us were often more grueling than what we asked them.
The point is, if we had the resources, there was no reason not to appoint both. In fact, that was the recommendation of several members of the appointment committee.
But we couldn’t. Because of something called the Budget Constraint.
This week, on campuses across South Africa, students will continue their protest against higher tuition fees. Classes at Wits University were called off for several days last week as students demanded that a fee increase of 10.5% for next year be rescinded. Similar protests are happening as I write his at UCT and Rhodes and Stellenbosch in the face of similar increases.
In some of the comments I’ve read, the increases are seen as a sinister way to exclude poor students, almost all black, from South Africa’s elite universities. (This is happening at other universities too: Fort Hare has proposed an increase in registration fees of 42% and an increase in tuition fees of 15%. As I write here, there are other serious issues at Fort Hare too.) But this sinister explanation is simply not true: universities are desperate to attract the best talent and ensure their success. What students often don’t know is that a university forgoes its government subsidy when a student fails, which covers about two-thirds of the total cost. Failure is expensive, both for the student and the university.
But it is also true that a 10.5% hike is close to double inflation. And attending university is already incredibly expensive. By my estimates, at least 95% of South Africans cannot afford to spend R100 000 a year to send their kids to varsity (which would include tuition fees, accommodation, textbooks, and spending money). To give some context, only 4% of South African households earn R500 000 per year or more. Most students need a loan, as I did and almost all of my friends. But we were the lucky ones. Many students’ parents simply don’t have the collateral to get loans. Some parents saved throughout their adult lives, forgoing many things to give their kids the opportunity of a better life. Here’s a story of one of our students:
My dad always reminiscences on the poverty of the 70s in KZN, when my grandfather couldn’t get a job in Johannesburg. My grandfather would sell one of his cows, so that all the children would at least have a pencil to write with and a book to write in. This meant that there was never any money left over for shoes. Dad always talks about the frost bites in winter and how he couldn’t feel his toes on his way to school. But, all he knew was that he had to get to school .
From those harsh experiences, my parents have instilled in us a deep sense of love, respect and appreciation for education. At some point my sister and I were both at Wits and UCT respectively and my parents definitely felt the financial burden to get us through school. It wasn’t easy, but all they knew was that they had to get us through varsity. We thank God that they could. I know that a 10.5% increase in fees would have compromised their ability to get us through school. Some of my friends were not so fortunate. I’ve seen many friends and colleagues being financially excluded in the middle of their degrees.
The #witsfeesmustfall campaign is legitimate. For some a degree is just a paper, yet for another that degree is a ticket out of poverty.
So how should universities balance fee increases with the need to grow their talent pools, specifically of black staff? There are only three other alternatives: 1) cut budget items elsewhere, 2) raise income from third party sources, or 3) greater transfers from national government.
The first is dangerous. The first item on any budget – for a university, but also for a country or a household – that is usually slashed in the face of pressure is new infrastructure and maintenance of existing infrastructure. Consider this: when your monthly salary suddenly falls, what will you cut first? Probably the new tires for your car. You can always do that next year, right? Governments do the same: we can always build that power plant next year, or skip the maintenance on those roads for when we have a bigger budget. Many campuses across South Africa already struggle with dilapidated facilities. Infrastructure construction has not kept pace with student enrollment, meaning that students often have to sit on the floor in lectures. The point is: there is very little scope in university budgets for further fiscal restraint.
Raising third-stream incomes is a better alternative. But this type of income is often a consequence rather than a cause of excellence. Only the top universities will be able to attract third-stream incomes, either from donors or in collaboration with the private sector. Donor money is also incredibly contingent: donors want to add their names to new buildings, or see their donations spent on sport teams, or pay for bursaries. Few want to donate money to pay salaries. Third-stream incomes through collaborations with the private sector can provide additional capacity in some industries – like engineering – but even here the effect on the total budget is limited.
The only alternative is to increase government funding, which in South Africa lags behind what other countries spend on tertiary education. Here is Belinda Bozzoli earlier this year in the Financial Mail:
The fundamental problem is that the anchor of it all, the government subsidy, is low in absolute terms, by world standards. SA university funding languishes at levels below those of dozens of emerging economies. At a mere 0,6% of GDP it is dwarfed by the levels in Saudi Arabia (2,3%), Russia (1,8%), Argentina (1,4%) and India (1,3%). Furthermore, SA’s expenditure on higher education is a mere 12% of expenditure on education as a whole, whereas for the rest of Africa it is 20%, for OECD countries it is a massive 23,4%, and for the rest of the world it is 19,8%.
To make it worse, the core subsidy for universities has consistently fallen in real terms in relation to student numbers, which have, in turn, risen dramatically. This has skewed the entire model. The fall began under apartheid, when many free-thinking universities were regarded with suspicion, and continued apace under the ANC, which continues to choose to place nearly all of its education funding into schools.
Given the difficult environment Minister Nhlanhla Nene will face this week in his Medium Term Budget Policy Statement, with growth slowing, tax income falling, and few prospects of a reversal, a sudden increase in higher education funding is unlikely.
So what to do? As Dan de Kadt, a PhD student in Political Science at MIT remarked on Facebook this week, universities face a new impossible trinity: appoint more black scholars, reduce student fees, or cut costs through outsourcing and maintenance on facilities. An impossible trinity means that you can only have two of the three: so, which two will it be? That is why university management is such a difficult task: there has been protests on campuses against all three issues this year, and I’ve seen a poster on Twitter this morning demanding all three. This is like asking for healthy food, a lot of food and cheap food, all at the same time. It is an impossible trinity. You can always only have two of the three. (I know which two I chose as a student.)
The Budget Constraint is a reality that we cannot wish away. We can label it elitist, racist, capitalist, colonialist, and neoliberal, but it won’t disappear, not for a university, not for a country (as Minister Nene will try and convince parliament this week) and also not at the household level. The Budget Constraint is the reason poor families struggle to afford sending their kids to university. We have to find solutions within the Budget Constraint.
So what is the solution? I don’t think we can afford to relax spending on maintenance while running university facilities into the ground. (If we do, we also lose the ability to collect third-stream incomes, which further exacerbate the problems.) There is a trade-off between hiring more black academics (i.e. transforming faster) and lowering student fees. My preference is for the first, because I think we can think more creatively about the second.
I would argue for better targeted support for poorer students, instead of a blanket reduction in student fees. Here is my colleague, Eldridge Moses, on the topic:
Would bursaries and other forms of economic alleviation instruments not be more targeted interventions than the blunt instrument of blanket fee reductions or freezes? I would strongly suggest more progressive thinking on inequality reduction. A blanket freeze on fees benefits the rich way more than it does the poor due to access issues.
Eldridge is correct. Reducing student fees will benefit the wealthy more than poorer students because tertiary education is more accessible to the rich. So I would take a different approach and increase student fees by 25%. Yes, you read that right: 25%! Then I would use the additional 15% income from these fee increases to provide bursaries for students that come from poor backgrounds. A multi-tier or sliding scale system – where, for example, those with parents earning above R500 000 per annum pay R150 000, and those earning less than R50 000 pay R15 000 – is a far more equitable option than scrapping fee increases for all. And there will be additional funds to appoint black staff.
The sad reality is that the pressure to have a blanket fee reduction for all students will not only benefit wealthy students more than poor students, but it will inhibit universities’ ability to appoint excellent, young black scholars. In the job interview I took part in a few months ago, both candidates were female, black South Africans. Due to the Budget Constraint, however, we could appoint only one. The other candidate, equally brilliant, had a grandfather who struggled to get a job in Johannesburg and therefore had to sell his most prized possession to give his children, and grandchildren, the education they deserve.
I say: Let’s get a better fee system, and appoint his granddaughter.
Imagine you’re a young entrepreneur and have built up a profitable IT business. You can expand either by going at it alone, or partnering with a more established, perhaps international firm. Which should you choose?
Sign up with the multinational.
That’s the advice of a new NBER Working Paper ‘Does Foreign Entry Spur Innovation?’ by three US trade economists, Yuriy Gorodnichenko, Jan Svejnar and Katherine Terrell. They find, using a large firm-level dataset of eighteen countries, that foreign direct investment (FDI) have a significantly positive impact on product and technology innovation of domestic firms in emerging markets. In other words, those domestic firms that receive FDI become more innovative over time than other domestic firms.
This isn’t surprising. Trade economists have long argued that increased trade and investment boosts domestic firms’ productivity. Foreign firms tend to bring new innovative ideas, technology and management practices that replace potentially inefficient practices of domestic firms. When SA opened up to the world after the isolation of the apartheid years, the argument goes, local firms’ productivity increased significantly because they suddenly had to compete against more competitive producers.
This was difficult to prove empirically: industry-wide statistics are often too vague to give reliable evidence that FDI has a positive impact, and some firms may close due to tougher competition. But this study uses firm-level data, measuring the size of spillover effects from the international partner to the domestic firm, and documents the impact on innovation instead of noisy productivity estimates.
The authors found that the benefits of FDI don’t accrue to other firms in the industry, but is localised to the domestic firms immediately connected to the foreign firms. They conclude: Simply being in an industry populated by foreign firms generally has a weak, if any, effect on innovation. In fact, if our entrepreneur doesn’t get a foreign partner but his competitors do, he may find himself out of business.
This study is important for policy makers too. Firstly, encouraging FDI is critical to growing an economy. Public (and political) sentiment is often against foreign competition; consider the long (and expensive) deliberations preceding the Walmart-Massmart merger. Let me be unequivocal about this: this study shows that foreign competition drives innovation in domestic firms, making them more competitive and longer-lasting. We need more, not less, of it.
The authors also found, in short, that FDI from rich countries is better. Again, this makes intuitive sense. Firms in the rich world already operate at the technological frontier. Now, for the first time, it has found empirical support. One wonders about SA’s attempts to cosy up to our BRICS partners instead of encouraging investment from our traditional (and still largest) trade partners. If we believe the results of this study FDI from China is less beneficial for SA than from the US or Germany.
Another, perhaps more controversial, finding: because the benefits of FDI only accrue to firms within the supply chain of the acquired domestic firm, it might mean that policies which require foreign firms to have significant local content (for example, a rule which states 20% of a firms’ inputs must be locally made) may be justified. Minister Rob Davies will be happy to hear this.
But he’ll first need to get foreign firms excited about SA. In late July, he introduced the Promotion and Protection of Investment Bill in parliament as an attempt to do just that. The bill aims to protect and promote investment, but, sadly, falls short. As Webber Wentzel’s Peter Leon argues, it contains few of the protections one would typically find in a bilateral investment treaty. ‘Fair and equitable’ treatment for investors, such as market value compensation in the event of expropriation, are missing.
The rapid growth of emerging markets over the last two decades seems to be tapering off. SA cannot rely on foreign firms entering the country seeking investment opportunities as had happened during the good times. We have to up our game and become more attractive. That means improving all sorts of things, like skills and infrastructure, but the low-hanging fruit of investment bills and secure property rights should be top priority.
*This column first appeared in the 1 October edition of Finweek.
After missing his flight and his much-anticipated Cape Town lecture, Thomas Piketty, the French economist who published the widely-acclaimed and best-selling Capital in the Twenty-First Century last year, arrived in South Africa to deliver a lecture at Wits University yesterday. And he did not disappoint, calling for higher minimum wages, land redistribution and, echoing his call in Capital, a wealth tax. But his most stinging critique he reserved, it seems, for economists: “No such science as economics”, one conference attendee tweeted Piketty, “everyone can have an opinion. Applause from room full of social scientists & historians”.
I can understand the frustration with economists. They write in a language few other social scientists understand. They tend to support a system of wealth creation that is not very hipster. And Piketty is right: For a while in the previous century economists may have believed that economics is a science on par with physics, and that the economy can be manipulated much like a giant computer. But for the most part, economists have now realised (and incorporated into our models) the knowledge that people are not always rational agents, and that they make decisions within social settings where context and institutions matter as much as incentives. Witness the rise of behavioural economics and the renaissance of economic history.
Yet bashing economics is a favourite past-time of social scientists in South Africa. At the recent South Africa Historical Society conference in Stellenbosch, a historian and one of the organisers of yesterday’s Piketty event suggested to a room full of his colleagues and students that instead of studying economics, historians should just read more. I agree that we all should read more, but why deride economics in the process?
It is difficult to not attribute such ridicule from social scientists and historians to a fear of numbers. Because what economists – and certainly most South African economists – do, is measure. We measure the increase in prices in order to determine the most appropriate level for the interest rate. We measure the quality of schools to ascertain why kids drop out too early, or why many of our high-school graduates struggle to find jobs. We measure the international trade of goods and services to understand competitiveness and adjust tariffs. And yes, we measure income levels to say something about inequality and its historical evolution. Still, there is much we don’t yet measure, which is why we need more (historical) statistics, not less, much like Piketty called for yesterday: “We need data to have a better conversation about inequality in South Africa.”
More data allow us to test our hypotheses about how the world works. Because we believe, much like other (social) scientists do, that theories help us to explain and understand the world better than simply ‘having an opinion’. Astrologers have an opinion. Homeopaths have an opinion. But I don’t rely on them to tell me why I am ill. Social scientists (yes, all of them, even historians) construct theories about how the world works, and then use evidence (quantitative or qualitative) to test the relevance of these theories.
Which is why I find it surprising that very few of the commentators at yesterday’s Piketty lecture actually engaged with Piketty’s theory at all. I assume everyone actually read the book – or at least the first chapter that summarises the thesis quite nicely. But did any take the trouble to read at least some of the critiques? This paper is a good start, written by an economist and political scientist. It actually uses South Africa as a case study (in comparison to Sweden) to show why Piketty’s measurement of inequality misrepresents what actually happened in both countries during the twentieth century. Or there is this (rather long) response from Deirdre McCloskey, certainly no proponent of the mathematical direction economics took in the 80s but also not averse to fighting with numbers.
And why did no one – not even Piketty himself – make an effort to gather historical data on wealth inequality in South Africa? With little effort and using Reserve Bank data, a PhD student at Stellenbosch could calculate wealth and income rates for South Africa going back to 1975. Instead of finding the same U-shaped rebound in private accumulated wealth as Piketty did for rich countries, she found that in South Africa the wealth-to-income ratio has been relatively low and stable at about 250% for the past 40 years.
This is important not only because it shows that social context and institutions matter, but because it could have very real policy implications. The Davis Tax Committee’s recent recommendation on estate duties is partly motivated by extensive references to Piketty’s book. Acccording to the Financial Mail, the committee suggests that the rules should change so that tax revenue from estate duties increases by about 10 times. Here’s Stan du Plessis, dean of Economic and Management Sciences at Stellenbosch and PhD supervisor of the student, on the topic: “The Davis Tax Committee and everyone else in SA assumed that since inequality is so high in SA, what Piketty was saying must also hold true for SA. It does not.” That is what economists do.
Land expropriation is another policy of choice to reduce inequality. Piketty argues that because land redistribution have reduced inequality in Brazil, for example, it should work in South Africa too. Not quite: I don’t know much about farming, but I do know that most land in South Africa is not as fertile as in tropical Brazil. Here a farmer needs a lot of capital equipment to be productive, which in turn requires large scale farming to be profitable. It also requires management and technical expertise. Those things, in contrast to land, are difficult to expropriate and transfer. Why not, instead, give poor, black South Africans a choice: I am quite confident that not all would prefer to become farmers. Offer them shares (at massively discounted rates, perhaps subsidised with the income from the wealth tax) in companies listed on the Johannesburg Stock Exchange. To begin with, the SA government owns shares in several listed companies too: if these are transferred to poor South Africans, they have liquid capital which they can – if they so choose – either sell and buy land or hold on to earn dividends. This is what BEE is all about, and in the few cases where it was implemented correctly, like in Naspers selling discounted shares to black South Africans, it has created immense wealth. Giving someone land without the necessary scale, capital and skills to work it (especially someone living in a city, like most South Africans now do), dooms them to a live of subsistence farming.
Piketty’s other proposal of a higher minimum wage also fails to acknowledge the excellent work of South African economists over the last few years. Yes, a higher minimum wage in the United States might not increase unemployment (because it is off a low base and much lower than the median income level), but to recommend such a policy in a country with an unemployment rate above 30% is not only irresponsible but disastrous. New research by labour economists in my Department at Stellenbosch shows a stark rise in unemployment, 4.8% in the Western Cape of mostly temporary workers, following the increase in the Western Cape minimum wage on farms two years ago.
Because data allow us to test and improve our models, certain theories become generally accepted. One of them is the likely impact of a wealth tax. I am not necessarily against a limited wealth tax (for political economy reasons), but what Piketty and his commentators failed to do was spell out the likely effects of such a tax. So let me attempt to do so. A wealth tax favours the young and punishes the old. Young people, like me, have many debts. If the wealth tax is instituted on net wealth (which I think is what Piketty argues for), then it will have a limited impact on me but will tax my parents heavily, who have paid their debts during their lifetime. So here are my options: either I live frugally now, saving carefully and repaying my debts, only to be taxed by government when I’ve done so, or I stop saving and buy a fancy new car, because that’s better than giving it to government. Rather than growing my savings, I would instead find ways to consume all my earnings. (This is why Bill Gates suggests a progressive consumption tax instead. Piketty warns that consumption is difficult to measure, which is true. But it actually encourages saving, investment and accumulation, something a wealth tax does not do.)
Except, of course, one type of investment which cannot be (directly) taxed: education. So expect to see parents, because they cannot leave their children a large physical inheritance, spend even more on educating them. Surprisingly, this will likely increase inequality in South Africa even further. As economists know very well and as Kuben Naidoo, Deputy Governor of the South African Reserve Bank, so eloquently put it yesterday, “the major increase in inequality in South Africa is as a result of rising skills and not wealth accumulation”. Even if all the gains from the wealth tax is spent by government on education (unlikely to be the case), we will continue to have a schooling system that is horribly unfair. A lot of tax money so far has failed to fix the problem; South African economists that have measured these things clearly show that more school resources (like higher teacher salaries or buying more books) help little to improve education outcomes. Why is that likely to change if we add even more money to the mix?
Wealth taxes are most likely to reduce investment and social mobility, exactly the opposite of what is necessary to fix South Africa’s economy. Yes, we may get the richest billionaires to cough up some more of their wealth to government. But will it really matter to the kid from Soweto or Soshanguve whether Nicky Oppenheimer or Johann Rupert or Patrice Motsepe has R8 billion or R4 billion in wealth? Not a lot.
What will matter to that kid is whether he will get a fair chance in life. That is unlikely to happen if we don’t fix our education system first and make it easier for people to do business and create jobs. A wealth tax that discourages investment and raises the cost of education is not going to help, and might even have a perverse impact.
I agree that we need to address South Africa’s massive inequality. To correct this wrong is the reason many economists choose to study economics in the first place. And I also understand Piketty’s appeal: he proposes three policies that are relatively easy to implement and requires little more than political will. But, unfortunately, these policies are disconnected from the real world, the world which South African economists study. In a best case scenario these policies will reduce inequality marginally in the short run; a worst case scenario is that they inhibit investment and put further limits on social mobility by raising the returns to quality education.
I realise that I cannot convince everyone about the need to study economics. As an economic historian I’ve had my own gripes with the mathematisation of the discipline. But to ignore the theories of human behaviour that economists construct, theories that have been empirically shown to be worth keeping, is wrong. Opinions without facts are not worth listening to, as Hans Rosling perfectly explained. Let’s encourage our students to engage with Piketty’s theories, test them against the evidence, and keep them and use them if they apply to South Africa. Or improve them if they don’t.