Earlier this year The Economist published an article arguing that governments worldwide are living in a fiscal fantasyland. Leaving this fantasyland will be difficult, and many will be reluctant to abandon the illusion. However, governments must find a way out before disaster strikes.
SA is stuck in its own version, which took many years to conjure up. Since 2008 government debt as a percentage of GDP has tripled, increasing from 24% to about 72%. More worrisome than the level of debt is that debt servicing costs have increased exponentially and are putting the country’s fiscal sustainability at risk.
A key point in the 2008 Budget Review was that “Debt-service costs continue to decline as a result of prudent fiscal management”. Since then, debt servicing costs have become the fastest-growing expenditure item in the national budget.
In 2008, for every rand in revenue collected by government about 8.2c went towards servicing debt. By the beginning of this year the figure had increased to 19.4c in the rand. Moreover, the main budget earlier this year estimated that debt servicing costs would amount to R340bn in the current financial year. To put this into perspective, it is roughly five times more than government spending on primary and secondary education in Gauteng.
However, the environment has deteriorated significantly since the budget speech in February and debt has become even more expensive. Yields on government bonds have increased substantially, and SA’s yield curve has become even steeper. Inevitably, a larger proportion of revenue will have to be allocated towards servicing debt. That crowds out expenditure on critical service delivery areas.
There are many elements at the heart of our fiscal fantasyland architecture. One of the most prominent elements must be the inability to distinguish between productive and unproductive expenditure, with the latter often being the victor. For example, we have been financing the perpetual bailout cycle for dysfunctional state-owned enterprises by directly or indirectly reducing spending in areas such as health and education at the provincial level.
This inability to distinguish often creates perverse incentives, where bad performance gets rewarded and good performance is penalised. Although the National Treasury’s push to reduce expenditure is undoubtedly in the correct general direction to exit fiscal fantasyland, there are already signs of perverse incentives.
For example, a blanket freeze on hiring personnel might seem rational. However, not distinguishing between departments and provinces creates perverse incentives. Trolling through provincial government budget documentation one finds that some provinces are managed prudently, while others are not.
For instance, the Western Cape’s “compensation of employees” budget amounts to about 51% of total expenditure. Other provinces spend far larger proportions on compensation of employees, such as Mpumalanga at 63% or Limpopo at 65%. A one-size-fits-all policy option is not the correct approach because it disproportionately penalises good past performance, which reduces the credibility of the road map out of fiscal fantasyland.
There are those who believe we should venture deeper into fiscal fantasyland rather than exiting it. This would involve increasing expenditure, accelerating debt accumulation and ignoring the reality of debt servicing costs. This view is motivated by the notion that increased public spending will ignite economic growth.
Although the need for economic growth is undisputed, increased public expenditure and the acceleration of debt accumulation is unlikely to trigger significant growth in the current SA context. In fact, research conducted by the Reserve Bank in 2020 suggests that SA’s fiscal multiplier is extremely low and could possibly be negative.
Furthermore, the research indicated that government debt accumulation is likely to have weakened economic growth over the past decade. As such, narrowing the budget deficit and stabilising government debt along with structural reforms are more likely to support economic growth.
The general direction to exit fiscal fantasyland is clear. However, the detailed map is not, and pursuing a process that inadvertently creates and deepens perverse incentives will get us stuck there.
• Botha, an independent analyst focused on public finance and fiscal policy who is currently reading for a master’s degree at the London School of Economics & Political Science, was a strategic analyst in the Western Cape department of finance & economic opportunities.
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