Part Two of a three-part series. Read Part One here.

Michael Power is a strategist at NinetyOne asset management.

Part Two: South Africa’s behaviour in practice since 1994

In almost every regard, South Africa signed up to the neoliberal doctrine that prevailed in 1994, even if it was practically impossible to implement its recommendations overnight. And, for the most part, South Africa still adheres to the main disciplines required even as its intellectual companion, the Washington Consensus, is no longer “fashionable”. The recent liberalisation of the South African power supply sector, qualifying Eskom’s monopoly, is a case in point.

Yes, there has also been slippage in South Africa in recent years, especially fiscally, and this even prior to the onset of the Covid-19 pandemic. But then, there has been slippage almost everywhere recently. Indeed, with the US expected to run a 2021 double deficit of over 15% (fiscal plus current account deficits), maintaining negative real interest rates, using trade tariffs even on allies and regulating foreign direct investment for overtly political reasons, arguably the first place that the erstwhile Washington Consensus’s police might have wanted to raid was Washington DC!

South Africa’s post-1994 path to then-perceived economic orthodoxy was almost immediately confirmed by the substantial reduction in tariffs in line with the preferences of the WTO’s predecessor, the General Agreement on Tariffs and Trade, GATT. Indeed, so comprehensive was the trade liberalisation that one industrialist, Leslie Boyd, bemoaned that South Africa was “outGATTing GATT”. Early in 1995, the financial and commercial rands were unified and the arduous process of liberalising capital account flows began.

Joining the world trade system opened up the previously closed economy of South Africa to a very different regime in terms of relative prices. Many industries did not survive the more global competitive environment they suddenly found themselves operating in. In the wake of this disruption, the rand’s value broadly declined over the balance of the decade. On election day in 1994, it stood at R3.59 to the US dollar; by the end of 2000, it traded at R7.57. Notwithstanding this decline, South African annual inflation performed remarkably well – in good part due to the efforts of the South African Reserve Bank – falling from over 15% in 1991 to 5.3% in 2000.

Meanwhile, a monetary discipline that was first adopted in New Zealand in 1990 – inflation targeting – started spreading throughout the West. While independent of the commandments of the Washington Consensus, the desire that a central bank should conduct sensible monetary policies free of political pressures – for this, read ensure a real interest rate regime – was central to both. (In the wake of Covid-19, no Western central bank follows the discipline of real interest rates; indeed, many were not doing so even pre-Covid.)

Canada adopted the inflation targeting regime in 1991, the UK in 1992, Australia in 1994 and Sweden in 1995. By the end of the decade, the ECB – after 1999’s adoption of the Euro – was also de facto targeting inflation. So too was the US, though it was not until 2012, under Federal Reserve chairman Ben Bernanke, that its adherence became more explicit.

Few emerging markets were early adopters of inflation targeting. It was not until after the turbulence of the 1997-98 Asian Crisis had passed that some of the main emerging players signed the pledge: Poland, Czech and Korea in 1998; Brazil, Colombia and Mexico in 1999; Thailand and South Africa in 2000; Hungary, Indonesia and the Philippines in 2001 followed by Peru and Turkey in 2002.

So why, despite trying to play by the best practice playbook of Western macroeconomics has South Africa been so singularly unsuccessful at generating jobs since 1994 – unemployment has since doubled to over 40% – or produce the higher economic growth that would typically accompany such job creation – GDP growth has only averaged 2.3% per year from 1994 until 2021, with no two consecutive years achieving GDP growth above 5%, and with GDP per capita in 2021 still at 2006 levels?

After 1994, South Africa played macroeconomic football according to European and American rules. And we reinforced this orthodoxy by adopting inflation targeting in 2000. Since then, and to their great credit given their mandate, the South African Reserve Bank has doggedly defended its inflation targeting goal, often more successfully than some of its BRICS peers such as Brazil or Turkey. Yet there has been scant reward for such “good behaviour” in terms of job creation and economic growth. What is the problem that has led to the crisis we now face?

The answer – bluntly – is that, given the make-up of our labour force, with its high percentage of unemployed semi-skilled and unskilled workers, South Africa has been playing European and American football… on an Asian “cricket pitch”. Increasingly, the rules of this version of “cricket” have been – post-1994 – determined by China. Now, as the leading edge of internationally competitive wage rates for the semi-skilled and unskilled migrates south and west from China, this form of “cricket” is also being played by Vietnam and Indonesia and, more recently, (and more fittingly given the “game”) India, Pakistan, Sri Lanka and Bangladesh… hence the title of this essay. Increasingly, success in the global economy of today involves more the “hitting of runs” than the “scoring of goals”.

With the benefit of hindsight, one can now characterise what happened to the structure of the global economy in the early 1990s. It was as if a spaceship with a billion-plus largely unemployed (or underemployed and living in rural areas) semi-skilled and unskilled labour on board crash-landed into a quasi-global economy. The economic landscape they found themselves in was dominated by Western-influenced metrics, in particular Western price and wage structures both domestically and internationally, with the latter heavily mediated via exchange rates.

The three economic atmospheres on board this Sino-Indo-Russian craft were not only “compartmentalised” from each other, they were far removed from that atmospheric pressure prevailing “outside” in the then still less-than-truly “global” economy. The “air locks” that kept these differing atmospheres separate were, in large part, capital controls reinforced by exchange rate management.

The question then arose – rather like a pilot of an aircraft deciding how quickly to equilibrate cabin air pressure with that of ground level before proceeding to land – “How quickly would China, India and Russia adjust to the new atmospheric environment?”

Russia opted to embrace the Big Bang approach, with nearly all capital controls being dispensed with, and what then happened is best illustrated by the resultant fortunes of the rouble. Trading at 27 rouble to the US dollar in July 1989, Russia’s currency depreciated to 5,921 rouble to the dollar by December 1997… before being rebased 1,000 to 1. Notwithstanding that 1997 rebasement, today’s cross-rate is 74 rouble to the dollar. Russian GDP in the 1990s, measured in US dollars, shrank 62%.

India’s approach was more considered; a function of a more gradual easing of capital controls and a tighter management of the exchange rate. The cross-rate of the rupee with the US dollar at the end of 1990 was 15 rupee. As 2000 closed, it was 42 rupee. Today it is 75. Indian GDP in the 1990s, measured in US dollars, rose 46%.

China’s approach was by far the most gradual, again not least because its capital controls were only very selectively relaxed and more for foreigners than domestic institutions and citizens; meanwhile, its exchange rate remained tightly managed by the Bank of China. The cross-rate of the renminbi with the US dollar at the end of 1990 was 5.11 renminbi. As 2000 closed, it was 8.12 renminbi. Today, in 2021, it is back down to 6.47 renminbi, meaning that over 30 years, against the US dollar, the renminbi has depreciated less than 1% per annum. Except, following Deng Xiaoping’s 1992 Southern Tour, for a sharp one-off 50% devaluation against the dollar in 1994 (to 8.78 renminbi/$, a low not recorded since), China’s currency has been “relatively stable”, at least compared with Russia and India.

Indeed, from 1994-2014, the renminbi was on a slow strengthening trend even against the dollar. Since 2008, the renminbi has fluctuated between 6.84 and 6.06: today, it trades at 6.47 to the dollar.

Note that Chinese GDP in the 1990s, measured in US dollars, rose 235%, compared to India’s 46% gain and Russia’s 62% shrinkage. Over the 1990s, Russian GDP as a percentage of US GDP fell from 8.6% to 2.5%; in 2020 it had again risen to 7%. The equivalent 1990-2000-2020 comparisons for India were 5.4% to 4.7% to 13.0% and China, 6.0% to 11.8% to 70.4%. (South Africa’s were 1.9% to 1.3% to 1.4%.)

The impact of this Chinese interpretation – built upon a supply-side consideration of the wages of semi-skilled and unskilled labour – is hard for someone schooled in Western macroeconomic thought, with its demand-side bias, to absorb. It has been especially hard for South Africa to come to terms with it.

Most observers in Western capital markets might conclude that, had China relaxed its capital controls in the early 1990s to the same degree as did Russia or even to the lesser degree that India did, the renminbi would have shadowed the rouble’s or the rupee’s performance.

Perhaps. But this is to miss the point entirely. And this gets to the nub of the issue. The following insight has given me the greatest “a-ha” moment I have had in trying to understand what has happened in the global economy since South Africa achieved majority rule in 1994: What China has been progressively doing since 1994 is more equilibrating the rest of the world’s atmospheric pressure to its own, rather than vice versa.

This China has done through exploiting the one “category-killing” supply-side advantage it has had in abundance: its vast pool of surplus semi-skilled and unskilled labour (now shrinking fast). And compared to similar labour in the “outside world”, given its extremely competitive wage levels, that pool was made available to global supply chains rooted in China.

In the 1990s, the phrase most often used in the US about China’s effect on the world was to note the strikingly low “China Price” of goods. This is a typically demand-side interpretation. The Chinese way of looking at this phenomenon would have been more supply-side in its perspective: they would have seen it as their competitive “China Wage” that was the foundation of the resultant low (to Westerners) “China Price”.

(The fallout for Western economies of these low Chinese wages and resultant Chinese prices – which will not be discussed in detail here – has been massive; it is still only partially understood and so being appreciated. But for a single snapshot image that goes a long way to capturing that fallout, readers would do well to acquaint themselves with the Elephant Curve, academically called the Lakner-Milanovic graph. It clearly illustrates that China, aside from being the price-maker in the determination of semi-skilled and unskilled wages, has also been the wage increase “capper” for more skilled production workers in the global wage hierarchy, especially in the West. Another aspect of this curve is that it clearly shows China has been equilibrating the rest of the world’s atmospheric pressure to its own, more than vice versa.)

The impact of this Chinese interpretation – built upon a supply-side consideration of the wages of semi-skilled and unskilled labour – is hard for someone schooled in Western macroeconomic thought, with its demand-side bias, to absorb. It has been especially hard for South Africa to come to terms with it.

To correct an observation made above, there was of course a fourth economy on board that spaceship that crash-landed into the global economy of the early 1990s: South Africa. (And to be even more accurate, countries of the former Soviet bloc were also on board.) Prior to 1994, apartheid – which not just literally but metaphorically meant “the state of being apart” – pursued separate economic development not just between races within South Africa but also, as a result of international boycotts and through the pursuit of national self-sufficiency, a high degree of separate economic development by South Africa from the other states of the world.

What made South Africa so different from China, Russia and India in 1994 was that it was (and to a large degree, still is) sharply divided between what are two very distinct economies: a developed quasi-“Western”, consumer-oriented economy (naturally, one that thinks in Keynesian terms) and an underdeveloped emerging market with a supply side full of unemployed semi-skilled and unskilled labour. The lattice of relative prices – and most importantly wages – surrounding each of these two economies was and remains very different.

Yet, since early 1995, both structures have been forced to live within the confines of a single rand exchange rate. That rate has suited and by and large still suits the more developed component of the South African economy. But for the emerging component of the South African economy, it has constituted a straitjacket that has all but prevented its members from getting internationally competitive jobs, as the wages they would seek would be above – way above – the like-for-like, job-for-wage metric prevailing particularly in its Asian competitors. 

Hence South Africa’s present crisis: an unemployed pool of labour almost twice the size in percentage terms of that experienced by the Anglo-Saxon economies of the West during the Great Depression.

To reinforce this point: for South Africa’s emerging population component, especially when it comes to comparing the prevailing rand wage for semi-skilled and unskilled labour to that which has been benchmarked by China but (now that a growing part of China’s workforce is skilled) which is now migrating to the lower-wage-than-China Vietnam, Indonesia, India, Pakistan, Sri Lanka and Bangladesh, the prevailing rand exchange rate simply does not work for the unemployed of the South African economy.

Indeed, it leaves South Africa’s semi-skilled and unskilled labour force largely aloof and unemployed and, for reasons dictated by a company’s cost-to-revenue ratio, unemployable in the context of a global workforce. Again, that is why I have entitled this essay “Why the Bangladeshi taka is now the South African rand’s most important cross-rate”.

So what then is the gap between Bangladeshi and South African wages? The minimum wage for a textile worker in Dhaka is taka 8,000 – or R1,400 a month. This covers 4.4 million workers in 4,620 factories and does not include overtime. South Africa’s minimum wage – based on an eight-hour day, 22 days a month – is R3,520. It is a wide disconnect, and unsustainable as the production world of low- to mid-value manufactures becomes ever more Asia-centric. South Africa is often advertised as a “cheap Europe” production base: in reality, it is an “expensive Asia”.

Not all the wage difference between South Asia and South Africa would need to be closed by a more competitive exchange rate to make South Africa a more viable production-for-manufactures base.

But those who question the role a currency’s valuation can play in promoting economic growth forget that a competitive currency has lain at the heart of every main post-WW2 industrial miracle. This advantage was absolutely central to Germany’s “Wirtschaftswunder” (economic miracle) and Japan’s “Jukagaku Kogyoka” (ditto).

Capitalising upon the fixed exchange rate discipline of the 1944 Bretton Woods Agreement, the two defeated Axis powers were allowed to fix their currencies at rates that were soon revealed to be very competitive and to grow even more competitive with the passage of time. From 1949 to 1969, the Deutsche Mark was tightly managed on either side of DM4 to the US dollar; from 1949 to 1971, the yen was fixed at ¥360 to the dollar. The 1971 Smithsonian Agreement brought the beginning of the end to the fixed exchange rate era of Bretton Woods for the Group of Ten – which by then included a revived Japan as the world’s second-largest economy and a revived Germany as the third – extraordinary achievements for the two Axis powers defeated only a quarter of a century earlier – by introducing flexibility into currency cross-rates. The degree to which the Deutsche Mark and the yen had been competitive was soon revealed. By 1980, the DM had appreciated to 1.82 and the yen to 227, both to the US dollar.

This “you-need-to-have-a-competitive-currency” precedent was then emulated across Asia. In particular, heavily managed exchange rates (for which read “suppressed” by their central banks) underpinned the economic rise of the Four Asian Tigers: Hong Kong, South Korea, Singapore and Taiwan. The 50% devaluation of the renminbi in 1994 from 5.8 to 8.7 to the dollar helped supercharge China’s economic performance beyond that date.

Vietnam has more recently followed a similar practice: the dong has risen only some 10% against the dollar in the past decade, even as Vietnam’s GDP has risen 100%, three times faster than the US’s GDP.

Unquestionably there are mechanisms other than a more competitive currency available to help narrow that wage gap surplus that South Africa exhibits over its emerging Asia competitors. Lesotho uses its membership of AGOA (the US’s African Growth and Opportunity Act: this is an option not open to South Africa where apparel manufactures are concerned) to help make itself more competitive: its textile sector now accounts for 92% of Lesotho’s manufacturing jobs, 43% of its exports and 20% of its GDP.  

Even though Lesotho is in the Rand Monetary Area, wages in its textile sector are between 1,900 to 2,100 maluti/rands per month, much more in line with Bangladesh’s R1,400 equivalent. (Across the consumer basket, Lesotho has only a marginally lower cost of living than South Africa, as many items are imported from South Africa.) AGOA – which allows quota and tariff-free entry to the United States for textiles manufactured in select African countries – helps close nearly all of Lesotho’s R1,900 to R1,400 wage differential with Bangladesh.

For South Africa, there is no argument that there is much else beyond having a competitive currency that we can do to improve our national competitiveness. However, in the final analysis, even these improvements need to be aggregated and reflected in the rands and cents wage of a like-for-like job and the price of the product produced (most likely for export) as a result of that job.

Perhaps the most important factor a South African government can address in the comparative wage-for-job space is education; with time, a worker’s educational qualifications will reflect the degree of complexity and so value-add that a worker can undertake in the execution of their job. Beyond this, the government can play a vital role in improving the enabling environment so as to allow manufacturing businesses to flourish. This includes the provision of appropriate infrastructure (critically including a reliable supply of water and electricity) and ensuring a secure operating environment for both enterprise and worker.

Finally, and this is something that must emerge from inside us all: we need to exhibit – as Siya Kolisi’s Springboks have shown to be very possible – a national desire to compete and win.

But as part of this overall “competitiveness package” that would make South Africa financially viable as a production base for manufactured exports, it is clear that a more competitive currency would have to do much of the heavy lifting.

Why has most of South Africa’s business community, and in particular those members of that community who work (as I do) in finance, been unable to grasp this gaping disconnect? DM