Prospects for SA’s economic growth in 2018 and beyond
Cyril Ramaphosa’s policies, introduced in the run-up to the ANC election at the end of 2017, targeted 3% growth in gross domestic product (GDP) by as soon as the end of 2018, with the suggestion that successful policy implementation could see annual economic growth surpass 5% by 2023.
The key issue at play is how realistic those targets are, which requires an understanding of the structural factors impacting South Africa’s growth.
There are essentially two very powerful models that we can use to understand economic growth, namely the Solow Growth Model, which is driven by human capital, and the Classical Growth Model, which is driven by physical capital.
The Solow Growth Model shows that a country’s structural growth rate results from combining population growth with changes in productivity and labour force participation. If there is a rise in all three, it means that a country has a growing workforce population, that more people are being absorbed into the economy and that the labour force is becoming more productive year on year.
If we look at South Africa’s numbers in the past ten years, there has been annual population growth of around 1.5%, average growth in productivity of 1.0% per year and decreases in the labour force participation rate of around 0.5% per year. Putting these three elements together sums to a structural growth rate of 2% per year, which corresponds almost exactly with the average rate of economic growth of 1.8% per year recorded over the last decade. For Ramaphosa’s target of 5% to be achieved something needs to change.
The Classical Growth Model identifies gross domestic fixed investment (GDFI) as the central pillar that explains a country’s structural growth rate.
In India, this investment rate is around 35% of GDP, which translates into economic growth of roughly 6% per year. This relationship holds across countries and across time, which gives us a useful gauge for assessing South Africa’s growth structure and also understanding what is needed to achieve the growth target of 5% per year.
Unfortunately, South Africa’s investment rate over the past ten years has been a modest 16% of GDP or less than half of India’s. It is no coincidence that this depressed investment rate has corresponded with sluggish economic growth of just under 2% per year.
From these two models, it is evident that If South Africa is to achieve 3% growth by the end of 2018, we would need to see improvements in labour force participation and improvements in productivity growth. Even a reversal in the labour force participation rate from falling by 0.5% per annum to rising by 0.5% per year would be enough to lift the economy into 3% growth territory. Alternatively, if we saw an improvement in productivity growth from 1% per year to 2% per year, this would be sufficient to achieve and sustain 3% growth.
These numbers are not outrageous but changes may prove difficult to achieve, meaning that we also need to see support from improvements in investment rates from 16% of GDP to roughly 22% to build the investment base alongside the work force.
Such an improvement in the investment rate is well within the realm of possibility to the extent that I would venture that just a reasonable recovery in investor sentiment under Ramaphosa and even modest improvements in foreign direct investment could be enough to add the extra 6% to our rate of investment.
All together then, with improvements in our labour force conditions and investment conditions, we could easily see growth of 3% in the economy by the end of this year. However, one more ingredient will be needed for South Africa to achieve 5% growth by 2023, and that is a connection to ‘our neighbourhood’.
Sub-Saharan Africa is one of the fastest growing regions in the world and South Africa remains of the most competitive economies within the region, which makes the country a viable competitor in the regional economy and opens up enormous opportunity for regional trade and investment.
Connecting to the neighbourhood and taking advantage of the excellent economic prospects right on our doorstep could easily add 2% to our annual growth rate, so while 5% growth sounds almost miraculous, it is, in fact, reasonably achievable.