US embassy cable - 05PRETORIA2977

UNCLAS SECTION 01 OF 04 PRETORIA 002977 
 
SIPDIS 
 
DEPT PASS TO USTR, USAID 
DEPT FOR E, EB/IFD, AF/EPS, AF/S 
DEPT FOR AF/S/AMBASSADOR FRAZER 
TREASURY FOR OIA/OAN/JRALYEA, BCUSHMAN 
 
SENSITIVE 
 
E.O. 12958:  N/A 
TAGS: ECON, EAID, KMCA, EFIN, EINV, SF 
SUBJECT: SOUTH AFRICA: THE NEED AND PROSPECT FOR GROWTH 
 
REF: A) Pretoria 1998 B) Pretoria 2161 C) Pretoria 2343 
 
D) Pretoria 2621 E) Pretoria 2971  F) 04 Pretoria 171 
G) 04 Pretoria 4809 H) 04 Pretoria 5007 
 
1. (SBU) Summary: Fiscal and budgetary reforms of the 
past decade have built a firm foundation upon which the 
South African economy can build, but life for many South 
Africans has not improved much since the transition to 
majority rule in 1994.  Widespread unemployment, rapid 
urbanization, and disease make South Africa home to one 
of the most impoverished populations in the world.  The 
government knows that it cannot meet this challenge on 
the back of transfer payments alone.  Last year, the 
executive branch decided that the way to achieve higher 
growth was through fiscal expansion and investment in 
infrastructure.  It reserved a starring role for state 
owned enterprises and public-private partnerships.  The 
hitch is that implementation hinges on improving the 
capacity and effectiveness of the public sector.  The 
right kind of development assistance could help South 
Africa get the most bang for its buck, or a bigger bang 
from more bucks.  End Summary. 
 
Gauging Strengths . 
----------------------------------- 
 
2. (U) Most economists would argue that the fiscal and 
budgetary reforms of the past decade have built a firm 
foundation upon which the South African economy can 
build.  The government has reduced and then stabilized 
its fiscal balance, brought inflation under control, 
modernized its tax structure, adopted policy-consistent 
planning and budgeting systems, deepened its credit 
markets, dismantled many exchange controls, lowered 
import tariffs, reduced non-tariff barriers, and 
redirected public spending in an effort to redress the 
inequality and poverty caused by the country's racially 
skewed past.  There are clear signs that the economy is 
on the right track.  The country has experienced its 
longest period of continuous growth in its recorded 
economic history, averaging 3.0% between 1994 and 2004. 
For 2004, interest rates reached their lowest levels in 
20 years, inflation reached its lowest level since 1959, 
and the rate of GDP growth picked up to 3.7%. 
 
and Weaknesses. 
--------------- 
 
3. (U) While the ANC government can congratulate itself 
on having restructured the economy and achieved modest, 
but steady growth, life for many South Africans has not 
improved much since the transition to majority rule in 
1994.  Widespread unemployment, rapid urbanization, and 
disease make South Africa home to one of the most 
impoverished populations in the world.  Fifty-seven 
percent of the population lives below the poverty line 
[defined here as a family of four living on less than 
$215 per month].  Though 2 million net jobs have been 
created over the last decade, a rapidly growing labor 
force has resulted in the rate of unemployment almost 
doubling during this period, disproportionately affecting 
blacks and "coloureds."  About 2.8 million households, a 
quarter of the population, are still situated in 
impoverished settlements originally designed to warehouse 
a non-white population under apartheid.  A rampaging 
HIV/AIDS epidemic has reduced life expectancy to 46 years 
in 2004 - down from 63 years in 1992 and well below the 
69-year average for other lower middle-income countries. 
The precipitous decline in life expectancy has caused 
South Africa's to fall to 119 out of 177 countries in the 
2004 Human Development Index. (Ref E) 
 
4. (U) The government knows that if high unemployment 
persists, political discontent will be difficult to 
contain because unemployment is dramatically skewed along 
racial lines.  Since 1994, scores of unemployed black 
South Africans and "coloureds" have migrated to cities in 
search of work, creating huge shantytowns on the 
periphery.  Some of these shantytowns have already become 
political powderkegs for municipal governments that have 
failed to deliver on the many promises of national 
government (Ref D).  Economists and politicians 
increasingly refer to the broad measure of unemployment, 
which estimates unemployment to be 41%.  Using this broad 
measure, almost 48% of black Africans and over 30% of 
"coloureds" are unemployed -- two racial categories that 
comprise 88% of the population (Refs E, F). 
 
The Need for Growth 
------------------- 
5. (U) The government faces formidable medium and long- 
term challenges to reduce unemployment, alleviate 
poverty, and eliminate the racial divisions that plague 
South African society.  In 2004, policy makers concluded 
that that, while much had been accomplished to provide 
housing, electricity, water, and other services to the 
poor, the government could not overcome poverty through 
transfer payments alone.  The government now spends 4.5% 
of GDP on child support, disability, and foster care 
grants - constituting one of the largest non-contributory 
income redistribution programs in the world.  Further 
increases in transfer payments risk creating dependencies 
on government and attitudes of entitlement among the 
general population that will ultimately buckle the 
country's relatively small, modern economy.  To eliminate 
extreme poverty and open employment paths to the modern 
economy, policy makers concluded that higher growth was 
needed, of a kind that generated employment opportunities 
for the poor and unskilled.  Without faster economic 
growth, the country had little chance of alleviating 
poverty and virtually no chance of reaching the 
government's goal of halving unemployment by 2014. 
 
6. (U) In his paper entitled, "The State Must Review 
Priorities and Step Up Performance" published in mid 
2004, President Mbeki's Chief Economic Advisor Alan 
Hirsch argued that the major reason for South Africa's 
relatively modest growth compared to other emerging 
economies was South Africa's low level of fixed 
investment, which had fallen from 28% of GDP in the early 
1980s to only 17% of GDP in early 2005.  Hirsch noted 
that, over the last decade, the government and state- 
owned enterprises, such as Eskom (the electric utility) 
and Transnet (port, rail, and air transportation 
services), had actually consumed more capital than they 
had contributed.  The result was the gradual 
deterioration of the nation's infrastructure, greater 
inefficiency embedded in the economy and, in some cases, 
a loss of international competitiveness for South African 
businesses.  Hirsch argued that South Africa needed to 
raise the level of fixed investment to 20-25% of GDP 
(similar to South Korea and Australia) to drive the kind 
of growth the country needed to successfully reduce 
unemployment and alleviate poverty.  As it stood, public 
sector fixed investment had declined from a peak of about 
16% of GDP in the late 1970s to 4% in early 2004.  While 
domestic private sector investment was holding its own -- 
even growing at a healthy rate -- it would not be 
sufficient to spawn rapid growth in the near term without 
increases in foreign direct and/or public sector 
investment. (Ref G) 
 
If You Build It, They Will Come 
------------------------------- 
 
7. (U) Hirsch observed that, with the exception of mining 
and manufacturing, South Africa had not been able to 
attract the level of foreign direct investment (FDI) as 
had its peer countries.  In 2003, South Africa attracted 
just $820 million in FDI, much less than Poland and 
Chile, which attracted over $4 billion and $3 billion, 
respectively.  Often cited reasons have been the high 
degree of concentration of ownership in some sectors in 
South Africa, labor market rigidities, affirmative action 
policies, a volatile exchange rate, a high crime rate, 
relatively high interest rates, the low rate of domestic 
growth, social inequality and the perceived will and 
capacity of government to deal its many problems.  While 
policy makers, including Hirsch, recognized that 
"microeconomic reforms" would be needed to address some 
of these issues, they generally concluded that foreign 
investors would come to South Africa once domestic growth 
picked up. 
 
The Plan for Growth 
------------------- 
 
8. (U) Given this analysis, policy makers concluded that 
the government should pursue a policy of fiscal expansion 
to promote faster economic growth through greater public 
sector investment.  The ensuing plan was clearly 
articulated by Manuel in his Medium Term Budget Policy 
Statement in October 2004.  Manuel declared that the 
government's goal was to increase the rate of fixed 
investment from 16% of GDP to 25% by 2014 in an effort to 
produce a 6% rate of growth.  Most of the increase in 
fixed investment would come from state-owned enterprises 
and public-private partnerships.  State-owned enterprise 
investment would expand by at least 20% over the next 
five years.  General government would expand fixed 
investment by about 7% a year over the next three years. 
An "Expanded Public Works Program" would create one 
million temporary jobs in a range of sectors over the 
next five years.  Public sector borrowing would increase 
from under 1% of GDP in 2002 to 4.6% in 2007; interest on 
public debt would ultimately stabilize at around 4.5% of 
GDP. (Ref H) 
 
9. (U) Manuel reserved a starring role for Eskom and 
Transnet, state owned enterprises that the government 
would spare from privatization for the time being.  Eskom 
would spend up to $16 billion on new power plants and the 
expansion of its transmission network.  Transnet would 
spend up to $7 billion in port projects and almost $1 
billion on the refurbishment of 24,000 freight rail 
wagons.  These investments would create jobs, stimulate 
economic growth, and raise the competitiveness of export 
related industries. (Ref B) 
 
10. (U) Manuel also reserved a starring role for 
national, provincial, and municipal government to entice 
the private sector to invest alongside government through 
an extensive program of public-private partnerships. 
Guidelines were issued and a unit created in Treasury to 
govern the process.  Treasury projected an increase in 
capital spending associated with public-private 
partnerships, from about $300 million in 2003 to about 
$800 million in 2007. (Ref A) 
 
Challenges 
---------- 
 
11. (U) A successful public sector-led growth strategy 
will hinge on the ability of government and state owned 
enterprise to implement it.  President Mbeki has readily 
conceded that the "Achilles heel" of his effort to 
transform South Africa is the shortage of skilled persons 
to carry out needed reforms and implement government 
programs.  In June, Minister of Provincial and Local 
Government Sydney Mufamadi admitted to Parliament that 
136 of 284 municipalities were "under performing." 
[Note: The exact definition of "under-performing has not 
been made public, but is likely to include the inability 
to deliver basic services, shrink the housing backlog, 
disburse funds, and file reports to provincial and 
national government in accordance with the Municipal 
Financial Management Act. End Note.]  State owned 
enterprises have had their own management difficulties, 
making Minister of Public Enterprises Alec Erwin's 
central mission to ensure that these enterprises are 
strong enough to accomplish government's objectives (Refs 
B and D). 
 
12. (U) Recently, rigid labor policies have become a 
public policy concern.  Companies seem to avoid hiring 
because of the costs and legal obligations that it 
imposes.  As a result, the most successful firms in South 
Africa continue to be those that are capital intensive, 
such as metals processing, chemicals, and pulp and paper. 
Labor-intensive industries such as clothing and textiles, 
footwear, food processing, wood and wood products are for 
the most part weak competitors against cheap imports.  A 
debate has been initiated on how to make it easier to 
hire unskilled workers.  There is concern that government 
training programs are not effective in meeting the demand 
for skilled labor. 
 
13. (U) In June 2005, the ANC released a controversial 
document, penned by Deputy Minister of Finance Jabu 
Moleketi, entitled "Development and Underdevelopment - 
Learning from Experience to Overcome the Two Economy 
Divide" that suggested a more flexible labor regime. 
Proposals included waiving minimum wage and other 
collective bargaining arrangements for younger workers, 
establishing a separate regime for certain sectors such 
as tourism, textiles and clothing, agriculture, small and 
medium enterprises, as well as household and child care, 
and establishing a separate regime for industrial 
development zones.  The document evoked considerable 
criticism from the union and communist wings of the ANC 
at its National General Council Meeting in July 2005. 
The political jury is still out. (Ref C) 
 
14. (U) On July 24 2005, after a three-day cabinet 
retreat, President Mbeki publicly embraced the 6% growth 
target and announced the formation of a high-level 
economic task force headed by Deputy President Phumzile 
Mlambo-Ngcuka to find ways to achieve it.  Task force 
members include Finance Minister Trevor Manuel, Trade and 
Industry Minister Mandisi Mpalhwa, and the premiers from 
Guateng and Eastern Cape Provinces.  They are charged 
with proposing ways to speed up growth and job creation 
in time for the Medium Term Expenditure Framework due in 
Parliament in October. 
 
Comment: The Prospect for Growth 
--------------------------------- 
 
15. (SBU) A growth rate of 3.7% created a net 168,000 
jobs for the economy in 2004, but economists agree that 
job growth will have to be considerably higher to make a 
real dent in unemployment.  Most economists agree that an 
average annual growth rate in the neighborhood of 6% or 
more would be needed to reduce unemployment and poverty 
in half by 2014.  Hirsch and other policy makers assume 
that a 25% fixed investment to GDP ratio would be 
required to achieve 6% growth, but do not see it 
happening until 2014.  The Department of Treasury expects 
growth to be 4.3% in 2005 and to average 4.2% per year 
over the next three years. 
 
16. (SBU) While the level of fixed investment needed to 
stimulate higher growth and significantly reduce 
unemployment can be debated, the shear volume of public 
sector investment that the government is prepared to push 
onto the economy is bound to stimulate growth above the 
country's ten year average of 3.0%, reduce unemployment 
levels, and hopefully the number of people living in 
poverty.  The real question is "How much bang for the 
buck will the government get?" 
 
17. (SBU) Prospects for short-term success would improve 
if municipalities were better able to manage their public- 
private partnerships, if state owned enterprises were 
better managed, and if there were better skills 
development programs for the unemployed.  Prospects for 
long-term success and the trajectory for growth would 
improve if the government could afford more fixed 
investment in the early years.  This leads us to conclude 
that foreign development assistance that added to the 
size of the stimulus in the early years, or to the 
ability of government to manage the stimulus, would go a 
long way in helping South Africa achieve higher, 
sustainable growth, reduce unemployment, and alleviate 
poverty sooner rather than later.  Given that South 
Africa is perhaps the only real engine of growth for sub- 
Saharan Africa, we would like to see that happen sooner.