US embassy cable - 04PRETORIA4809

UNCLAS SECTION 01 OF 02 PRETORIA 004809 
 
SIPDIS 
 
SENSITIVE BUT UNCLASSIFIED 
 
E.O. 12958: N/A 
TAGS: ECON, ETRD, SF 
SUBJECT: SOUTH AFRICA: MBEKI ECONOMIC ADVISOR OUTLINES THE 
PATH AHEAD 
 
 
1. (U) Summary. Alan Hirsch, Chief Director for Economic 
Policy Coordination and Advisory Services in the South 
African Presidency, met with members of the Southern African 
Regional Poverty Network on October 7 to discuss South 
Africa's growth path in the decade ahead.  Hirsch said that 
over the next five years, the Economics and Employment 
Cluster in the Cabinet would continue policies that supported 
macroeconomic stability, but introduce new policies to raise 
the level of private investment in infrastructure to lower 
the factor cost of production and improve the country's 
competitiveness.  Deep government intervention was required 
to avoid creating a cycle of dependency on government grants 
for the nation's poor.  End Summary. 
 
2. (U) Hirsch opened his presentation by recounting that in 
January, after the Government published its Ten Year Review, 
the Cabinet undertook extensive discussions on what was 
needed to grow and develop the economy.  The government had 
plenty to feel good about.  Under ANC leadership, South 
Africa had achieved macroeconomic stability and the longest 
period of growth since the 1940s (when GDP was first 
recorded).  South Africa also enjoyed its lowest inflation 
since 1959 (as measured by CPI) and its lowest interest rates 
in 23 years.  Since the political transition in 1994, GDP 
growth had stayed positive, averaging 2.8% per year, close to 
what the major advanced countries were experiencing, but 
lower than the average for all developed countries (a 
statistic skewed by the inclusion of a booming China). 
Hirsch noted that during this ten-year period, the government 
had managed to raise social expenditures from 44.42% to 
56.72% of the budget, and reduce public sector debt to below 
50% of the budget.  Nonetheless, the Cabinet saw that 3.4 
million South African households, about 35-40% of the 
population, were still living in poverty.  Moreover, 
unemployment had actually grown during the last ten years 
from 16% to 32% due to new entrants to the labor market 
(official unemployment is now 29%). 
 
3. (SBU) Hirsch said that Cabinet discussions about what to 
do about reducing high unemployment and poverty continued 
after the national elections in April.  The new Cabinet 
wanted to know why South Africa was not growing fast enough 
to improve the welfare of its poor population.  According to 
Hirsch, Foreign Minister Nkosazana Dlamini-Zuma demanded to 
know why South Africa did not achieve 6% GDP growth by the 
end of the 1990s, as envisioned under previous economic 
plans.  President Thabo Mbeki replied that the country could 
have grown faster, but at the expense of marginalizing more 
of its population.  The government's strategic objective now, 
as enumerated by the African National Congress' election 
manifesto, was to cut poverty and unemployment in half by 
2014. 
 
4. (U) Hirsch said that the most telling weaknesses of the 
government's effort from a macroeconomic perspective was its 
performance on investment, job creation, and economic growth 
when compared to countries at a similar level of development. 
 He said that private sector investment had declined from 
16-17% to 12-13% of GDP over the past ten years and public 
sector investment had declined from 7-8% to a low of 2% of 
GDP -- although this increased to 4% of GDP in 2003.  He 
recollected that gross fixed capital formation was 25% of GDP 
in 1980, the last time the country saw a growth rate of 6%. 
Since 1992, however, gross fixed capital formation had 
leveled off to 15-16% of GDP, producing an average growth of 
around 3%.  The question he posed was "Why did public and 
private investment fall from 1994 onwards?"  He attributed 
this to government's preoccupation with transforming itself 
from being white dominated to black dominated, with economic 
restructuring, and to a lack of government confidence.  He 
said that the ANC government feared making too large a 
commitment on the expenditure side for social services and 
then not being able to pay for it.  Hirsch noted the 
efficiency of investment improved after 1994 (with capital 
intensive oriented investment) and economic growth improved 
somewhat, but it did not lead to greater employment. 
 
5. (U) Hirsch believed that the major constraints on 
investment during the last ten years included the country's 
relatively high cost of capital, exchange rate volatility, 
uncontrolled inflation, a low government investment rate, and 
the country's relatively low growth rate.  By 2004, most of 
these constraints were no longer important, yet investment as 
a percentage of GDP continued to be low.  Hirsch believed 
that this phenomenon had to do with misperceptions about 
South Africa.  These included that South Africa faced 
instability due to income equality among its people and the 
lack of social cohesion.  Another misperception was 
uncertainty about the government's will and capacity to 
resolve social problems.  Hirsch said that many in business 
held negative viewpoints about crime, active labor unions, 
and "whites under siege" in South Africa.  The government's 
apparent protection of Zimbabwe did not help this.  Finally, 
Hirsch thought that some investors had a "gut feel" or "sixth 
sense" that South Africa was destined to fail.  This, he 
thought, revolved around a lack of trust between the business 
and ruling classes arising from a cultural gulf between the 
political and economic elite.  For this reason, it was 
important to establish an organization like the National 
Economic Development and Labor Council (NEDLAC) and 
Presidential working groups with industry to be established. 
 
6. (U) Hirsch said that the government's main focus now was 
to increase the rate of investment.  The goal was to reach 
gross capital formation of over 25% of GDP by 2015.  To do 
this, the government would increase public sector investment 
to R267 billion over the Medium Term Economic Framework and 
reinforce its efforts to win over both foreign and domestic 
investors.  He said that monetary stability and successful 
inflation targeting had led to lower interest rates, and that 
would help.  What remained was to arrive at a competitive and 
stable foreign exchange rate, which he viewed as currently 
"mispriced." 
 
7. (U) At the microeconomic level, the government would 
target priority growth and labor absorbing sectors, such as 
agriculture, tourism, crafts, telecommunications, 
mining/metals, clothing/textiles, chemicals, biotech, 
automobile manufacturing, transportation, as well as 
services.  To support growth in these sectors, government 
would improve infrastructure in transportation, energy, 
water, and telecommunications.  In this respect, Hirsch 
admitted that there had been a change of philosophy around 
state owned enterprises; they would now be employed to lead 
investment.  A concern was that the delivery of many 
infrastructure-related services were managed by local 
municipalities, where there was a lack of capacity and 
something had to be done.  Hirsch said that the government 
would continue undertake what he termed "crosscutting 
interventions" to promote black economic empowerment, reduce 
income inequality, and counter investor pessimism. 
 
8. (U) Hirsch went on to discuss South Africa's "second 
economy," the one that "is peripheral of the cities and 
towns, and in deep rural areas."  He said that one-third of 
South African households essentially lived outside the 
system.  Poverty and exclusion were leading to rapidly 
growing demands for public services and transfer payments. 
If things did not change, social transfers would grow to the 
point where the government could no longer afford them, and 
the result could lead to social conflict.  Resolving such 
problems required deep government intervention. 
 
9. (U) Hirsch said that social investment had grown to about 
10% of GDP over the past ten years.  At the same time, social 
transfers went from 1.5% to 4% of GDP.  Among the major 
movers in this category were child support grants and 
disability payments.  Government had to do something to break 
the growing demand and dependency on social grants. 
Government had to eliminate extreme poverty and at the same 
time ensure easy mobility to the country's first economy. 
 
10. (U) The government's second economy strategy included 
creating temporary work opportunities combined with skills 
and infrastructure development.  The government would also 
focus on home and child services, healthcare and health 
education, intense skills development, adult basic education 
and training, and increasing access to capital for small 
businesspersons.  To be successful, he thought that there 
would have to be more of a two-way flow of information 
between government and people in the communities affected. 
 
11. (SBU) Comment: Hirsch's overview was heartening in the 
sense that he grounded the government's economic program in 
realism.  The insight that he provided into government 
thinking revealed a Cabinet that was growing impatient with 
high unemployment, low growth, and the government's failure 
to merge the country's first and second economies.  The 
Cabinet does not believe that the private sector acting alone 
can deliver what it needs.  Privatization will stay on the 
back burner while the government employs its parastatals to 
manage and invest in large-scale infrastructure programs 
designed to foster targeted investment, growth, and 
employment.  Some may question this tack, given that the 
country's parastatals have consumed more fixed capital than 
they have created over the past ten years, and are 
increasingly criticized for ineptitude.  Interestingly, 
Hirsch made no mention of trade policy in his presentation. 
FRAZER