When are macroeconomic stability and exceptionally high returns not enough for private investors?


This page in:

South Africa appears to be mired in a cycle of modest growth, high inequality and record unemployment. This, despite an exemplary record on macroeconomic management and deepening integration with the global economy. 

Inflation remains nestled within the target range of 3-6 percent and fiscal and debt management outcomes have been impressive.

Remarkably, there is broad political consensus on the issue of macroeconomic stability, recent calls for a looser stance by the labor unions notwithstanding. 

A sustained pattern of high, broad-based and inclusive growth is yet to emerge, however.  Despite a pick-up in per capita GDP growth from negative rates to an average of 1.6 percent per year during 1994-2011, per capita GDP is currently only 10 percent higher than in 1980: a period over which other developing countries have seen much more meaningful increases in their income levels.


Growth has been insufficient, and insufficiently inclusive to absorb the massive wave of new entrants into the labor market since the mid-1990s, resulting in unemployment rates persistently above 20 percent. 


Over 1980-2010, the average South African’s real income increased less than 10 percent, while the average Chinese became 13 times richer (PPP constant price GDP in US$, 1980 normalized to 100)

Source: World Development Indicators, World Bank


Among the main factors holding back a growth take-off are the country’s relatively low fixed investment rates. Currently at just under 20 percent, they are well below that of comparator countries, having dropped considerably since the last 1980s. This is explained by South Africa’s even lower national savings rates that, too, have also been on a declining trend (reasons for which may be found in the July 2011 South Africa Economic Update) as well as the tepid interest shown by foreign long-term investors. FDI as a share of GDP averaged only around 1.5 percent in the 2000s, being especially low in greenfield areas.


South Africa’s domestic fixed investment rate has slipped compared to other emerging market economies (click on the image to see it larger)


Why is the private sector hesitant to invest in South Africa’s future? Could it be that the returns on offer are not attractive enough? On the contrary, calculations of real returns to capital clearly show that South Africa is an attractive place to invest in (see the July 2011 South Africa Economic Update for details and sectoral breakdown of the returns). Real returns are high, have been sharply rising since the mid-1990s, and appear to be globally competitive. Moreover, the cost of borrowing (proxied by the real prime lending rate) has fallen sharply since the late 1990s. Clearly, something other than returns on investment is impeding private investment. 


Real rates of return to capital in South Africa have risen sharply since the early 1990s. 

Source: South African Reserve Bank data and World Bank staff calculations

An important impeding factor appears to be industrial competition, which is far weaker in South Africa than its international peers (as established by Aghion et al, 2008).


The three major (and most vocal) players in the political economy of reforms in South Africa – the government, organized labor, and existing business – appear not to be overly concerned. The status quo of industrial concentration and the associated exceptional returns works well from their point of view.


The triumvirate is locked in a continual, rambunctious public tussle over the distribution of the high rents being generated under the system. This tight-knit process does not call for entry of new businesses to normalize returns, and the noise it generates unintentionally drowns out the voices of masses that are unemployed and would like to see these exceptional returns translate into much higher investment, growth and job creation.  The result is a suboptimal equilibrium that is hard to shift but may be at the heart of unlocking the much-desired path of higher, inclusive growth in South Africa.


A suboptimal political economy equilibrium (click on it to see it larger)


Join the Conversation

Paul Jackson
March 31, 2012

Your article showed great promise with persuasive data and a good progression, and then it ended suddenly. Perhaps if you explained your final graphic in greater detail it would help? I know it's just a blog, but I would love to see you further develop your thesis.

Milan Brahmbhatt
March 29, 2012

Excellent piece. Particularly good to bring out the triumvirate of the 3 "Bigs" - Big Business, Big Labor and Big Government - and its part in locking in place the long-standing high rent/low growth equilibrium.

April 02, 2012

Very succinct and to the point.

Also very common across Africa.

What does this mean for the Bank? How can we help South Africans (and citizens of countries where this pattern persists) to break this cycle? If our interlocuters are government, then the prospects would seem limited. Clearly we need to innovate and experiment. keen to learn where we have done so and what were the results...

April 02, 2012

It's interesting to note that traditional conditions such as return on investment, interest rates, are necessary but not sufficient for sustained growth. Other factors which do not fit into that model such as big government, big unions and big business - who probably have created barriers for new entrants, are equally important. if rents under the table are high, that makes any significant shift highly improbable. This starts a discussion on good governance and the use of political economy findings. Now that we know about the rents and the big three, what can be done about it? Government is part of the big three, what would it take for it to begin to consider activities that would break the suboptimal equilibrium? Unions were once thought to represent interests of current and future employees, now that they are embroiled in the big three, who is the voice of the employees?

Sandeep Mahajan
April 05, 2012

Paul, thanks for your comment and interest in the topic. S Africa's political economy is highly complex and insufficiently understood. The diagram in the blog is an observation of the insider-outsider phenomenon that appears to be at the heart of the issue. Big business, government and organized labor are locked in a perpetual struggle over who gets a bigger share of the extra normal profits that get generated because of lack of competition. The outcome is shaped by a number of conditioning variables such as labor laws, competition and tax policies and the strong sense of fairness and equity that motivates much of the rhetoric. How these conditioning variables interact to yield the outcomes (division of rents) is not clear at this stage. What is clear, however is that the process, noisy and often acrimonious as it is, operates within a tightly sealed political box which shuts out outsiders such as new businesses and the unemployed and marginalized who lack political voice but are contained through an extensive system of social grants.

manoel bittencourt
April 10, 2012

Thanks for this piece, I would have some comments though:
1. you write "deepening economic integration ...", I think it is worth mentioning that SA is still a rather closed (society) and economy. Perhaps the initial conditions matter here.
2. you write "broad-based and inclusive growth is yet to emerge ..." How can this happen with "if on average growth has been 1.6 percent per year..." ? If there is no growth, how can that be inclusive?
3. you write "new entrants into the labour market since the mid-1990s..." If unemployment now is high because of these new entrants, where were these people before? Employed? Unemployed?
4. you write "factors holding back a growth take-off are the country's relatively low fixed investment..." This statement preceds Solow, is Harrod-Domar back? We know that technology, and not investment, is behind sustained economic growth (and all that technology captures and requires).
5. you write "FDI as a share of GDP averaged only around 1.5 percent..." What happened to the "deepening economic integration" you mentioned before?
6. I certainly agree with the claim about "lack of competition", however this is not the only problem in SA.
7. In addition, macroeconomic stability (and Stanley Fischer and William Easterly told us back in the 1990s) is a pre-condition for prosperity, but not sufficient.
8. I found the piece interesting, but it needs more economics so that we can start making sense of this society.
I hope it helps,

Maikel Lieuw-Kie-Song
April 11, 2012

Thanks for a nice piece that was recommended to me. Most of what is said makes sense to me having lived and worked in various sectors in South Africa for ten years. And having moved to Brazil four years ago, has given me much room for reflection and comparison on some of these issues. (And your photo the bicycle repair shop hit a nerve as one thing I tried was to set up a network/ franchise of bicycle shops in townships and rural areas in SA).

With regard to the difficulties of fostering competition and the weak informal sector- my sense is that the effects of the way the economy is structured spatially are still not fully understood- but I suspect they are far greater than we realize. And I am referring to both apartheid township/ banstustan separation from economic centers, as well as the settlement patterns within townships and bantustans. This settlement pattern, consisting of huge areas of single story detached housing structures kind of resembles the "suburbs"- and replicates many of the disadvantages associated with suburbs: relatively large distances, low catchment for businesses and public transport, car dependency, poor public spaces and costly services. I think it is a terrible settlement pattern for fostering small businesses (and a drive through a suburb in the US tend to confirm this view?)

So if want to set up a business in a rural or township area you not only have to find a way to make it work in a "suburban area", but you are also far removed from the things a business needs: markets, suppliers, credit, security, innovation and others who are running successful businesses you can learn from etc. For me this is one of the big differences I see with Brazil where the small business sector appears to be doing much better. Of course anybody who has seen some of the favelas in Brazil knows that some of these spatial dimensions also exist here- but at least the favelas are high density and the separation from economic centers are no where as severe and entrenched as they are in SA.

I guess my point is that that much more research work needs to be done on the effects of the spatial structure of South Africa and what the options for "spatial restructuring" of South Africa would look like (And government should stop building "RDP" housing using this costly suburban settlement pattern!)

Sandeep Mahajan
April 11, 2012

Manoel, thanks for your questions/comments. Here are my responses in the order of your 8 questions/comments. Hopefully, these will lessen the confusion:
(1) A good measure of global integration, perhaps above all, is alignment of domestic prices (of factors and goods) with global prices. With the elimination of apartheid sanctions, removal of a plethora of trade taxes and capital controls and a move from a dual exchange rate system to a flexible one, I think the evidence of "deepened global integration" seems pretty strong for South Africa. Moreover, trade/GDP (an outcome of integration) increased from 40% in 1994 to over 70% in 2008. So, yes, very much a reflection of the initial conditions, and still an unfinished agenda, I agree, although I would not categorize it as a closed economy.
(2) Yes, low growth is the main challenge before we think about making it inclusive. That's precisely the point para 4 makes.
(3) There are comparability issues with labor data over time, but it seems that female participation has increased significantly since the apartheid days. This would suggest a shift from "not economically active" category to "unemployed".
(4) In fact, growth driven by factor accumulation during transition or "catch-up" phase is fully consistent with the Solow growth model. It's only in steady state that it gets more tricky. Moreover, the transition phase can be fairly long, which is why investment/GDP is one of only two variables (trade openness being the other) that Levine and Renelt(1992) find positively and robustly correlated with long-run growth. Since growth is volatile and investment is not, it is true that year-on-year changes in growth are driven by changes in TFP growth. TFP growth is also important to generate returns on capital so as to boost investment. And that brings us back to S Africa's challenge -- that private investment response to returns on capital has been weak for the reasons (rooted in the political economy) argued in the article.
(5) Please see response to (1). FDI is low not because of lack of integration but likely because of risk perceptions felt by long term investors. There are a whole lot of other measures of integration which have been on the up.
(6) Agreed, which is why the blog post doesn't say that competition is the only problem.
(7) Bruno and Easterly (1995), Fischer (1993) etc don't include returns to capital in their analyses. If these are high, in addition to macro-stability (or low macroeconomic uncertainty), and private investment is not respondive, it adds another layer to their hypothesis.
(8) Hopefully, these responses injected more economics into the arguments.

April 08, 2012

Thanks Sandeep for trying to explain this issue which has dogged South Africa. Whilst I wouldn't necessarily agree with everything you have said, it is the first time that I have read an article which does not parrot many of the myths that are currently peddled in the South African and international media and blazes its own trial of analysis. Have you considered whether some of the growth is in the informal sector? This is very large in South Africa and is obviously not as accurately tracked as the formal sector. Could this possibly explain why the growth is so anaemic whilst in countries like Malaysia much of the growth is by large multinationals and so is easier to track / report?

Sandeep Mahajan
April 10, 2012

Ian - glad that you found the blog post useful, and appreciate your reference to the informal sector, which I agree can be an important source of growth and dynamism. However, even that doesn't seem to be happening on a large enough scale in South Africa -- whether you look at the national statistics or draw on anecdotal evidence. There is a flurry of informal activity here and there, but nowhere at the scale seen in other emerging markets. That is not surprising, however, given how throttling the urban by-laws are toward such activity, enforced with vigor rarely seen elsewhere in the developing world. Moreover, the townships, where a large proportion of the unemployed reside, remain geographically cut-off from urban centers and carry surprisingly little economic activity within. Your point, however, is very valid. This, and not the first-world South Africa, is where the growth potential lies. The Bank is starting new analytical work to understand the economics of South African townships, which should shed some light on the issue. Watch this space for more on that soon.

Manoel Bittencourt
April 11, 2012

Thanks for your reply Sandeep,
1. exactly, the initial condition matters in this case, SA has come a long way, however it is still a relatively closed society, not only in terms of goods, but also in terms of ideas (the debates we watch on TV illustrate the role of ideas).
2. the discussion of inclusive growth is only meaningful if something else is (are) happening at the same time, which in this case is education (supply and demand for human capital).
3. this is more about semantics, the truth is that the economy cannot absorb more domestic cleaners and gardeners, we all know that growth is an avalanche of things happening, and one of those things is increased demand and supply of human capital, which is not moving fast enough in SA at the moment.
4. investment matters, the USSR had a lot of it and it collapsed, technology is the main driver, and it requires human capital (the human capital story again).
5. That we don´t know, FDI is low perhaps because it is difficult to get into SA (role and quality of bureacracy perhaps), or perhaps FDI needs human capital in place, or perhaps the country is not open enough, or perhaps of lack of competition (which leads to your political economy story), or perhaps because there is no economic activity after 6pm, or perhaps because there is no reliable public transport, or perhaps all those things are interconnected, who knows?.
6. I am sure we are all talking about the same things, and I am sure we know how an economy which grows fast behaves (or how come the miracle of 1978 in China, 1991 in India and 1995 in Brazil happened), and SA does not behave as such.

April 11, 2012

Thanks for this piece. It is both interesting and correct in its analysis.

The problem is that it doesn’t deal with how to unlock product markets. How do we encourage greater competition in product markets? This is not simple or straight-forward. In many areas where there are high profits and high concentration, there are no explicit policy barriers to entry for newcomers. We have pretty good competition law and pretty credible anti-trust authorities, but this is only a small part of the problem. Why has tariff liberalisation not resulted in more competition? Does our distance from global markets impose an inbuilt rent that is hard to break?

What exactly should we do to promote competition? I am sure that a different answer is required in each sector, steel is different from banking, which is difference from producing bread.

What are we missing as policy makers in finding solutions to this problem of concentrated product markets?

National Planning Commission

Chris Loewald
April 11, 2012

This is a really good piece. The question to take forward is how to refocus the public discourse on future returns to investment (new areas of econ activity by more firms/people) and future returns to using other technologies (Manoel's point) rather than on current returns. I would have thought that the combination of weak labour absorption and the non-renewable nature of current rents (plus the rising cost of exploiting those rents) would have encouraged that refocusing. But the short-run economics of the rents appears to outweigh the short-run political costs, while the long-run economic and political gains (evident for instance in the comparative work of the Growth Commission) are heavily discounted.

Manoel Bittencourt
April 12, 2012

I think this issue of the township being far from everything is important, but there is a twist. In Rio the favelas are not that far from where the economic activity takes place, but in other Brazilian cities they are. The difference is that in Brazil the poor is mobile, people move around to go to work, to go to football, to concerts, to parks, etc; they are always on the move. And this happens because there is transport; trains, trams, buses and even a version of the mini taxis (called lotacao in some cities). Sao Paulo is a gigantic city and the poor live far away, but they move, and more importantly, one or two generations later, they actually move from the favela, which implies change and growth. I agree about stop providing RDP houses in those areas of SA, but that is going to be hard to sell, so we need to start thinking about doable things.
I hope it helps,

Alan Hirsch
April 12, 2012

Firstly, a couple of methodological issues. The choice of data points overstates the problem. 1980 is not a good base year for any series on South Africa, with the highest real gold price in history. Also, per capita income declined quite dramatically in the last decade of apartheid (ending 1993), and per capita income has grown considerably more quickly since 2000 than in the previous three decades.

Nevertheless, the basic thesis is correct--investment rates are relatively low, and amongst the major factors are the oligopolistic market structures which encourage rent-seeking and the low level of public investment (prior to the late noughties). The spatial disadvantages that Maikel points out are amongst several factors that reduce national and local competitiveness.

The low rate of FDI results from a condition peculiar to South Africa--it is the reverse image of the high margins of oligopolistic companies which have no difficulty in attracting foreign investment through the stock-exchange. The capitalisation JSE is much larger in proportion to GDP than any other emerging market. (See the recent BRICS Report which shows that in 2010 SA's listed firms were worth 278% of GDP compared with 93% in India as the next highest.) Domestic oligoplies attracting cheap foreign indirect investment are the other side of the coin of low FDI.

There is no single policy answer to the problem, and the answers are widely known in SA--ASGISA, the "Harvard report"the New Growth Path and the National Planning Commission's outputs have enough obvious common correct points. What concerns me particularly right now is the low level of innovation in SA, the absence of sufficient emerging innovative companies, and the lack of concern about this in SA.

Manoel Bittencourt
April 12, 2012

A market-based economy is based on changes, also at the top. I always give to my students at Pretoria the example of Pan Am, TWA and IBM in the US, and how small companies like MicroSoft, Google and now Facebook have grown over time. There is change there. Of course, GM was supposed to have gone down too, but thanks to their incredible powers of persuasion (Sandeep's political economy), they convinced the American tax payer to bail them out and now we even have a new expression in Economics which is "too big to fail". The GM case is an example of bad economics.
In SA, and please correct me if I am wrong, we don't see that amount of change happening, my guess is that the four big banks have been there since "forever", no change. And I would extend my guesswork to say that the same is true in other sectors.
Every little helps, we know that people who have access to credit can invest in productive activities (perhaps a small corner shop, or a brand new BMW plant). The question is how to "incentivise" our big four banks to lend money to potential small entrepeneurs? Or how to provide a different sort of incentives to our banks so that they start providing student credit?

Manoel Bittencourt
April 12, 2012

the lack of innovation you mention is really crucial, since innovation is key, but remember that for innovation to take place we need human capital in place (and then also bear in mind that supply and demand for hk should be moving more or less together), plus other things that SA actually has (the Harvard group gave SA full marks in almost everything apart from the state of the labour market), and it seems that we are going full circle, macroeconomic stability is necessary but not sufficient.

July 09, 2012

In my view what we are seeing is the culmination of years of bad education, coupled with a quick fix policy of Black Economic Empowerment (“BEE”) that has only worsened the situation. While after independence, the focus should have been two-fold (i.e. on ownership distribution AND increased economic activity), it has only focused on BEE. The problem with BEE is that it does not create wealth, rather, it transfers wealth. And in the process it distorts the perception of reality in a way that may take a generation to fix:

1. The very few that have benefited from BEE are wealthy and presumably believe that their actions, manner and ways contribute towards the productivity of South Africa – they also receive considerable attention in the media and can be assumed to be “modern” role models in South Africa; and

2. Those that have not benefited from BEE are poor, and instead of looking for ways out of poverty via hard work/innovation and the commercialisation of their activities, focus too much on the lottery of BEE. This is only compounded by the worsening education system.