Macro economic commentary – August 2018

Author: Ntsekhe Moiloa

The James Bates Clark medal is an award made to the most deserving economist working in the United States, under the age of 40. It is arguably the most prestigious award after the so-called economics Nobel prize awarded by the Norwegian central bank. Shortly after Donald Trump took up the American presidency in January 2017 promising to rearrange the established global trade system, it was ironically a trade economist who went on to win the James Bates Clark medal in April. Dave Donaldson was recognised for his work on market integration and its effects on economic growth and welfare. His notable interest has been in railways, and more generally in the importance of transport infrastructure. His work on colonial-era India found that over a 60-year period, real incomes generally rose by 16 percent in districts where the railways passed over those where railroads were absent. The difference was notable. Besides lowering the effort and cost of moving goods, the railways helped communities reallocate their resources to focusing on aspects where they had comparative advantage, easily importing other resources where there was comparative disadvantage. Economists understand this dynamic intuitively, yet the notion is lost on latter day populist politicians. Donald Trump has chosen to essentially believe that the United States can supply all its own needs, slapping section 232 investigations – in terms of the Trade Expansion Act of 1962 – on a wide range of goods. British politicians appear to have also chosen to blind themselves to the risks of introducing friction to a business climate that relies deeply on multinational supply chains. In June the erstwhile British Foreign Secretary, Boris Johnson, was infamously reported to have said, “F**k business,” when asked what he thought of the worries of business leaders that the UK was heading to a so-called hard Brexit.

Mr Johnson was frequently of a different mind to his boss, the Prime Minister. In July he eventually left the Foreign Office, returning to the back benches of parliament. Towards the end of August, he already seemed to be a barely remembered figure – in Africa at least – as the Kenyan president remarked: “Last year if you recall the foreign secretary then, Boris … erm … Boris … Boris Johnson … the bicycle guy was here.” In a land where the British had been politically and administratively involved from the 1840s to independence in 1963, the Kenyan president’s words on the occasion of the visit of the British Prime Minister were interpreted in the British press as a diminution of the importance of the bilateral relationship between Kenya and the United Kingdom. Indeed, a British Prime Minister had not been to Kenya for more than 30 years. Just prior to her visit to Kenya, British Prime Minister Theresa May made an appearance in Cape Town, seemingly to the surprise of residents who are more accustomed to great traffic jams when American presidents come to town. On a very wet late August morning Mrs May kicked off her tour of select African countries in an effort to position post-Brexit Britain as a friend of the continent and a reliable trade partner. Whereas President Trump took aim at South Africa’s land reform process with threats of withdrawing trade privileges, Mrs May offered her support to the process. Cynics may suggest that Theresa May’s glad-handing is a mark of how far Great Britain has fallen towards Little England.

As the British pound dropped to one-year lows against the US dollar and the euro, we found it remarkable that in the Brexit negotiations there is endless hand-wringing about whether Brexit will be soft or hard. There is a tendency to think that Britain wields great negotiating leverage because it is the third most populous EU nation after Germany and France. Or because it is the third largest contributor to the European Union budget. Or because at 16 percent of EU GDP, the UK is the second largest economy. Or because it is the richest per capita. The UK is undoubtedly important to the EU, yet hardly indispensable.

To put it bluntly, there is almost no chance that the exit of the UK can be anything other than hard. Consider first that most countries experience their easiest and greatest value trade with their closest neighbours. For the UK that means that the best trade opportunities are with the countries of Europe, not so much with African countries that Theresa May has been touring. Yet, the government of Theresa May has declared that it cannot accept a deal with the EU that involves free movement of people. According to Article 3 in the EU’s Lisbon Treaty, the free movement of goods, money and services is inextricably bound to the free movement of people. Tying these freedoms together often makes practical sense; for example, a wind turbine will often be sold with a warranty that needs to be enforceable in a variety of locations as well as a service plan which may require mechanics to easily travel between countries, and the Single Market simplifies all of this. That wind turbine is not so much a pure good as it is a bundle of the mechanical good and its associated services. Not only is it not in the EU’s commercial interest to decouple these freedoms of movement, but the EU also cannot be seen to allow the UK to cherry-pick the parts that it likes without accepting the ones that it does not like. Theresa May’s insistence on a final deal right away does not even allow the likes of Angela Merkel to send a transitional deal home with the hopes that their successors may one day have the unenviable task of deciding whether to violate Article 3.

Brexiteers have often mentioned the Commonwealth as a potential pool of trade partners. However, the UK itself makes up about a third of the Commonwealth economy. India, Canada, Australia and South Africa are the next largest and are so geographically distant that it is hard to imagine why they would prefer to import British-made cars rather than sourcing them from nearer locations. Especially not when the UK would pay third-country rates to transport goods through key trade routes like the Suez Canal as well as dodge Somali pirates and perhaps also pirates in the Straits of Malacca. Quite apart from all of that, the UK is precluded from setting out to talk to potential trade partners for as long as it remains a member of the EU.

Thus, it was the case that Theresa May’s visit hardly featured in the local news beyond the day or two that she was in South Africa. It simply seemed as if South Africa had bigger fish to fry. The South African public broadcaster reported President Cyril Ramaphosa remarking, “I don’t know what Donald Trump has to do with South African land because he has never been here and he must keep his America; we will keep our South Africa”. Beyond these slightly outward looking matters, the country was more involved in dual instances of navel-gazing: the South African inquiry into State Capture got underway in earnest during August, while the commission of inquiry into the South African Revenue Service was also underway.

While the internal operations of the tax service were being scrutinised, the National Treasury released its July figures for national revenue, borrowing, and expenditure. While the deficit for July was worse than the same time a year ago, the cumulative year-to-date deficit is less by ZAR 5.2 billion than at the same point in 2017. If the cumulative trend holds, it would suggest an early recovery of tax collections. Indeed, year-to-date revenues are ZAR 373.5 billion compared to ZAR 334.6 billion a year prior. Although ZAR 497.1 billion in expenditures is higher than the ZAR 463.4 billion a year ago, the growth nevertheless appears to be well-contained, raising hopes that the fiscal deficit for the full year will narrow. With an election due within the next year, investors will need to keep a close eye on spending before confirming that government under the leadership of Ramaphosa is behaving more responsibly. The investing public should also examine the patterns in tax collection. We note, for example, that collections were improved on the back of less money being paid out in VAT refunds. For companies, tougher scrutiny of VAT refunds can extend cashflow stress and so it is worth watching. Meanwhile personal and income tax receipts are running behind budget, which usually points to an overestimate in the economic growth assumed at the time that the main budget was set.

Worries about economic growth could also be evinced from the July goods trade figures released at the end of August. The consensus view was that the trade balance would be in surplus to the tune of ZAR 5.2 billion, but instead came in at a deficit of ZAR 4.7 billion. A good deal of the slippage came from mineral imports, specifically oil. With the rand weakening from below ZAR 14 to the US dollar to nearly ZAR 15 to the US dollar as a result of Turkish and Argentinian contagion, there is concern that third quarter growth will be negatively impacted.

For South Africa the sharp weakness in the local currency is an additional planning challenge at a time when the calendar 2018 GDP estimates for the country are steadily decreasing; from 2.0 percent in May, to 1.6 percent in June, to 1.5 percent in July, and 1.4 percent in August.

Discussions with the managements of businesses in a variety of sectors invariably end with the same refrain: “It’s tough out there. It’s really, really tough out there.” The Markit Whole Economy Survey diffusion index for South Africa weakened from 50.9 to 49.3 between June and July, down from as high as 57.5 in November 2017. Consumer demand is struggling to rebound and unemployment remains stubbornly high. A country like South Africa desperately needs to be exporting strongly at this time, but with poor and worsening productivity, this will remain difficult.

On the contrary, we observe a curious situation where a nation like South Africa has a stated policy of expanding trade and investment opportunities, yet appears caught up in domestic intrigues. The same is true of the United Kingdom and even of the United States. Dave Donaldson’s paper this year, “Railroads of the Raj: Estimating the Impact of Transportation Infrastructure” reminds us that there is more opportunity for each of these countries in looking up and actively courting trade.