Brian Kantor
24 June 2008
opinion
Johannesburg — FAILURE to adequately increase the output of skilled school-leavers is SA's most serious long-term economic problem. But in the medium term, that dubious honour must now go to the problems posed for economic and employment growth by price and wage inflation and the policy responses to them.
South African inflation rates began rising about two years ago, driven by weakness in the rand following a disinflationary period of currency strength going back to mid-2002. More recently, inflation has been driven ever higher by further rand weakness linked to a lack of confidence in emerging-market assets, and sharply rising world prices of energy and food over which we have no control.
Unfortunately, the Reserve Bank's policy response to inflation driven from offshore -- that of repeatedly increasing interest rates -- has added to the harm caused by higher prices themselves. The higher prices have forced consumers to adjust their living standards. Higher interest rates, now about 70% above where they were in June 2006 when their rise began, have added to consumers' difficulties without offering lower inflation or reducing inflationary expectations.
It hopefully has become clear to the Bank that it cannot avoid higher inflation caused by supply-side shocks unless interest rates are pushed high enough, and domestic spending forced to slow down far enough, to cause local suppliers to meaningfully cut offer prices. They will do this only if they are faced with substantial excess production capacity, which would imply higher rates of unemployment than those with which we already battle. The accompanying loss of income and output is ghastly to contemplate and surely enough to cause the Bank to desist with its policy of pushing interest rates higher regardless of the reasons for higher prices. Responsible authorities must worry about growth as well as price stability.
The Bank is not the only branch of government failing to respond constructively to the inflation crisis. A country importing higher inflation through imports, as SA is now, should not continue to directly add premiums to import prices through tariffs and other trade barriers. Yet, as the Bank overreacts to inflation, the trade and industry department under-reacts: we see no sign of a concerted effort to unwind the burdens of import restrictions on domestic consumers. Many products entering SA for sale to consumers, and as intermediate production goods, face imposed augmentations of prices in the form of import tariffs. Industrial policy further adds to the burden. For example, the department's support for the motor vehicle industry boosts the average price of cars on the domestic market by about 10%.
Particularly illustrative in this respect are quotas on selected Chinese clothing and textile products, introduced at the end of 2006 to try to protect SA's clothing and textile manufacturing industry from competition. The industry's unions sought such protection because high costs relative to other producers, and a strong rand during the period 2002- 06, had rendered their products uncompetitive against Asian substitutes, especially on export markets.
SA's own consumers benefited greatly from this. During 2004- 06, the influence of imported clothing and textiles reduced domestic prices of these products by an average of 12%. Because clothing expenses account for 2%-4% of total annual consumer purchases by value in SA, this contributed significantly to the general fall in inflation during those years. During that same period, prices of other finished industrial goods, including motor vehicles, declined by only 3% on average.
For several years low-priced Chinese imports have dominated the lower value-added segment of the market. This meant that poorer South Africans, those most directly affected by inflation, enjoyed the largest proportionate counter-inflationary gains. This was good for the poor directly and good for the South African economy, particularly in the form of additional jobs created in the clothing market at retail and wholesale levels. Importers of Chinese products thus achieved an important part of what the Bank is now attempting in combating inflation.
The quotas against selected Chinese import lines reversed these gains. Faced with quotas, importers tend to shift out of the lower-value-added side of the market. Their niche there is then filled by two sources: domestic firms that were less competitive and become able to stay in business by charging higher prices and, alternatively, previously less price-competitive foreign suppliers not subject to quotas.
The inflationary effect of the quotas has been less severe than economists initially feared it would be. This is because all but about 23% of restricted Chinese imports have been replaced by products sourced from other Asian countries such as India, Indonesia and Vietnam. This was during a period in which Chinese wages, and hence costs and prices, were increasing. Thus to some extent the quotas sped up the creation of new supply channels that would have been discovered by the market anyway. In this respect, we were lucky: action by retailers partly cancelled out the consequences of destructive action by the government. But the point remains that just at the time when inflation raised serious threats to our economic wellbeing, the department adopted a policy that could only make it worse.
The quotas are due to expire at the end of the year, and should be allowed to pass away unlamented. Amazingly, department spokespeople have lately suggested that they are thinking of extending them. While Reserve Bank Governor Tito Mboweni chokes the economy with interest rate hikes in a well-intentioned but misguided effort to hold back inflationary pressures in the particular interest of poor South Africans, another branch of government may be considering action that would continue to put pressure on those same consumers through its effect on another unavoidably large share of their consumption basket -- clothing. It is distressing enough that we have two poorly chosen policies. It is particularly galling when we find bad policies at cross-purposes with one another and compounding one another's destructive effects.
Kantor is an investment strategist at Investec Securities.
Be the first to Write a Comment!
Copyright © 2008 Business Day. All rights reserved. Distributed by AllAfrica Global Media (allAfrica.com). To contact the copyright holder directly for corrections — or for permission to republish or make other authorized use of this material, click here.
AllAfrica aggregates and indexes content from over 125 African news organizations, plus more than 200 other sources, who are responsible for their own reporting and views. Articles and commentaries that identify allAfrica.com as the publisher are produced or commissioned by AllAfrica.
