The approach here uses work by Adam Pzreworski, who considered the transition from capitalism to socialism in the 1980s[1] and from socialism to capitalism in the 1990s[2] . It will work for any radical change in an economic system. The argument proceeds in several stages.
1. Radical change in an economic system necessarily causes a temporary fall in aggregate consumption which can last several, or many, years [3]. Such change is socially costly and politically risky. It is likely to hurt large social groups, evoking significant opposition from important political forces. In the process, democracy may be undermined or reforms abandoned, or both.
Figure 1 presents the situation graphically, based on the optimistic assumption that the new system will support growth. If not, the lower level of consumption (point B in Figure 1) will continue or decline further.
Figure 1 – Consumption during a transition
In South Africa, we are already in a valley, with real per capita income currently below the 2014 level, and a recovery to the 2014 level is not expected until after 2022[4] . The existing situation is stressing the social fabric, and a radical transition will make things much worse.
2. Transitional costs may include inflation, high interest rates, increased unemployment, capitaldestruction, adverse distributive consequences, budget deficits and balance of payments crises.
The precise mix depends on circumstances. Populist policies, for instance, usually lead to inflation, fiscal deterioration and balance of trade difficulties, especially if the central bank is rendered unable to implement appropriate monetary policy. Under these circumstances, consumption may actually rise for a short period, only to crash harder as economic conditions become unsustainable.
Mexico made a different type of mistake by pegging its currency to the dollar, while failing to reduce inflation to the United States level. By 1994, the Mexican peso was overvalued to the point where housewives crossed the border to shop in Texas. The balance of payments could not be sustained, and the Mexican government found itself issuing shorter and shorter term bonds at ever increasing interest rates. At the end of 1994, the Mexican government defaulted and real GDP per capita dropped by more than 7% in 1995, while inflation rose from 7% to 35%. It took the entire United States currency stabilization fund to deal with the situation. Leaps in inflation always produce adverse distributional consequences: the most economically marginal are the least able to protect themselves against it.
Capital destruction has been most apparent in the countries comprising the former Soviet Union and communist Eastern Europe. The collapse of communism meant that the economies now had to cope with world prices and a very large number of enterprises could not survive the change. Thousands and thousands of ruined factories blight the landscape. But capital destruction can occur in subtler ways. As output declines, expectations become more pessimistic and share prices decline, destroying financial capital in the process. Investment in new projects ends and existing projects may shut down in part as a whole.
Usually matters are brought to head by a balance of payments crisis, which occurs when a nation is unable to pay for essential imports or service its debt repayments. In a floating exchange rate world, this is accompanied by a rapid depreciation of the currency. Foreign investors become concerned about the level of debt their inbound capital is generating, and pull out their funds[5] . The can raise interest rates, but such a move further depresses the economy. This is the point at which help from the International Monetary Fund is sought and it comes with structural adjustment conditions. Of course, a country can decline IMF assistance, but this will result in a further downward spiral.
In the first ten or fifteen years after 1994, the government was anxious to avoid any situation where IMF help would be needed, as it inevitably means loss of policy control. It was this anxiety which prompted GEAR in 1996, and a reduction in public debt as a proportion of gross domestic product up to 2007. This caution seems to have evaporated in recent years, with general government gross debt has risen from 27% in 2008 to 50% in 2016. The most recent IMF country debt assessment for South Africa in 2016 found that, on base line assumptions, our debt position was sustainable, but that risks were rising. They have just risen again.
What would radical economic transformation look like in South Africa, and how would it move us down the curve shown in Figure 1? Two components can be identified. The first is loss of macroeconomic balance, occasioned by weak leadership at the Treasury. Given very low economic growth, spending ministries are champing at the bit for a while, and some departments and state owned enterprises are forcing transfers to themselves. In addition, weaknesses at the South African Revenue Service are becoming apparent, and the risk of signoff on economically damaging projects is rising. The result must be loose fiscal policy and an increase in the rate at which government debt rises. The Reserve Bank can offset the effects to a degree, but there are limits on the extent to which interest rates can rise, even assuming continuing Reserve Bank independence, which is far from assured. This is the trajectory of macroeconomic populism.
At the same time, contention against ‘white monopoly capital’ implies an assault on property rights, which can be expected to become increasingly disorderly as the economy moves down the curve. This will affect domestic and international confidence alike, choking off investment, making the capital account of the balance of payments more precarious and resulting in the destruction of financial and physical capital and rising unemployment [6].
3. Radical economic changes unleashes new political dynamics between government and people which can have several and often destructive outcomes.
One issue is the speed of the transition: a radical approach might entail a deeper drop in consumption and a more rapid recovery (‘shock treatment’) while a more gradual approach would entail a smaller drop but recovery over a longer period. Voters may prefer a radical approach if they are confident about the longer term future making up for shorter term deterioration. Less confident voters are more likely to prefer the gradual strategy and voters with no confidence will choose the status quo. Governments, on the other hand, would like to see the economy moving upwards by the next election, giving them an incentive to adopt a radical strategy.
Political conflict will in any event emerge as social costs are experienced and a radical strategy will intensify opposition. This may force vacillation: the radical strategy may have to be modified under pressure, or even abandoned. Should this happen, public confidence may turn to scepticism. Under these circumstances, governments face a choice between co-operation with a broad set of social partners, or destroying them. The latter strategy undermines democracy. A second form of vacillation may then occur: first an attempt by the government to ram through a programme, followed by reversion to ‘bargaining’ in order to orchestrate support for policies already chosen, increasing distrust in the process. In this way, radical transformation may destabilize democracy.
4. How deep can the valley of transition be and how long can it last?
Figure 2 graphs GDP per capita in constant purchasing power parity dollars for Zimbabwe, based on an index of 100 in 1990.[7]
Freedom House rates Zimbabwe at 5 on its political rights scale and 5 on its civil liberties scale (1 is best and 7 is worst) in 2017. It is at the bottom of the “partly free” range.
So the valley of transition can be very deep (the projected 2022 level is 40% below the 2000 level) and very long (more than twenty years without an upturn if the sharp drop between 2008 and 2010 in response to the global financial crisis is not taken into account). The country also has poor political rights and civil liberties indicators, as the theory suggests.
Conclusion
So the question must be asked: can the government impose a valley of transition on an economy in which average living standards have been dropping without undermining our democracy? The prospects do not look good. Public confidence in ‘radical economic transformation’ is not promoted when there is such weak definition of its elements, and when there is widespread suspicion that it is a cover for further elite enrichment. The level of conflict within the tripartite alliance and the division among the trade unions are indicators of a concentration of power and the construction of faits accomplis within which everyone is expected to work.
Does the argument in this brief and the preceding one rule out progress within a democratic framework? By no means, and the final brief in this series will explain why not.
Charles Simkins
Head of Research
charles@hsf.org.za
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[1] Adam Przeworski, Capitalism and social democracy, Cambridge University Press, 1984
[2] Adam Przeworski, Democracy and the market: political and economic reforms in Eastern Europe and Latin America, Cambridge University Press, 1991
[3] As an illustration, Argentina’s real per capita GDP in 1980 was not reached again until 1997, Brazil’s until 1987 and Mexico’s 1981 level until 1999. Venezuela, under Chavez and now Maduro, is in free fall. Its projected real GDP per capita in 2022 is 39% below the 1992 level. The inflation rate in 2016 was 255% and is projected to increase much further. The unemployment rate tripled between 2015 and 2016.
[4] International Monetary Fund, World Economic Outlook Data Base, April 2017
[5] Capital controls might be imposed, but invariably they are least effective when they are most needed.
[6] In the fourth quarter of 2016, there were 5.8 million unemployed people and a further 2.3 million discouraged workers.
[7] The information is based on estimates and projections in the IMF World Economic Outlook data base, April 2017
