Last year’s stimulus may have been insufficient in light of the Covid-19 pandemic. But the budget we should really be talking about will be tabled this week.

South Africa’s 1994 project sought to mobilise society on a foundation of non-racialism and unity. For the first decade of the new century, this vision was underpinned by rising real incomes for public servants, increasing public consumption and transfers to impoverished people, lower taxation, rising asset prices, falling interest rates and increasing investment.

But those days are gone.

The Congress movement is unable to lead and its once hegemonic vision is in tatters. A decade of gnawing austerity has eroded public value while failing to stabilise public debt. Any collective attempt to resolve these problems must face facts squarely and negotiate a painful social compromise.

Much ink has been spilt over the extent of the government’s “fiscal stimulus” since a special budget in July 2020 sought to respond to a world torn apart by the Covid-19 pandemic and ensuing lockdown.

The fiscal policy debate has focused on whether government spending has done enough to offset the massive contraction in economic activity and jobs, but it has failed to appreciate that the challenge we face is a real dilemma.

On the one hand, the government’s commitment to reducing its budget deficit will mean forcing down the real income of public servants, and real hardship for millions of South Africans. We need to take the problem of debt, and debt sustainability, seriously.

In global capitalism, power is rooted in hierarchical relations of money and finance. An apparently unending rise in how much of our tax revenue and national income is spent paying the interest on debt poses a central problem to the political economy of South Africa’s development.

The impasse cannot be wished away. It is not the result of errors in economic theory or constructed ideological tropes. Any solution will be difficult to design and even more difficult to carry through.

Penny-wise and pound-foolish

Debates about the role of the budget have missed the mark.

Those demanding that the government “fill” the output gap in the economy failed to grasp that the Covid-19 shock is entirely different to any normal economic cycle. The reason for the collapse of output is not insufficient demand but the closure of whole sectors of the economy: aviation, alcohol, hospitality and other services that rely on human interaction.

Even once the lockdown was eased, death and sorrow made a return to normal behaviour unlikely.

In this context, the government’s role was not to stimulate aggregate demand but to maintain incomes, ease suffering and prevent the collapse of private balance sheets. The top-up of social grants, rollout of the new Covid-19 grant and extension of Unemployment Insurance Fund (UIF) payments played a critical role in this, as did financial and monetary easing. The government was forced to suspend a huge range of activities and it made sense to reallocate spending towards these new needs.

The size of the discretionary stimulus in 2020 fell well short of the R500 billion that the government continues to claim. But it is a mistake to measure success according to whether state spending multiplied the goods and services produced in the economy, or by how far those goods and services fell short of potential economic output.

That said, more could have been done.

It was clear from the outset that financial constraints on the health response should have been regarded as a second-order problem. Government dithering on vaccine funding has epitomised the idiom penny-wise and pound-foolish. Support to sectors of the economy that were forced to close by policy choice, like taverns, could have been far more generous, and prevarication on the extension of grant top-up and UIF payments was unnecessary.

The government’s iron-clad determination to stay within expenditure limits set prior to the pandemic was a mistake. While the austere approach taken in the special adjustment budget was perhaps understandable in the wake of the financial market shock South Africa faced in April 2020, capital subsequently flowed back in and the government has faced no problem financing its deficit.

Meanwhile, elevated commodity prices have pushed tax revenue far ahead of initial expectations. The rebound in economic activity and return to pre-pandemic levels of employment happened sooner than expected. In hindsight, a much stronger easing of expenditure restraint in 2020 was warranted and possible to achieve without permanently damaging South Africa’s fiscal position.

What lies ahead?

The most important shortcoming in the debate about the 2020 stimulus has been a short-term focus on expenditure allocations that prioritised the immediate response while neglecting the dangers and choices that lie ahead. The government’s most important policy shift has been to strengthen constraints on expenditure into the future. So, the budget we should really be concerned about is not last year’s, but the one to be tabled on Wednesday 24 February.

If the government carries through on budget plans announced in October, there will be two likely consequences over the next three years.

First, fiscal policy will be at odds with the government’s core commitment to an economic recovery. The promise of economic growth will have to face off against large reductions in government consumption. By the treasury’s projections, government consumption will contract by 2.5% this year, 2.4% next year and an even larger 3.6% in 2023.

Figure 1 puts this into historical perspective. South Africa has seen real government consumption fall before. But this will be the first contraction of this size sustained over three years in the country’s modern history.

The second likely impact of the fiscal policy stance is that core elements of public provision – basic education, healthcare, social grants and the criminal justice system – will be fundamentally weakened.

Figure 2 shows how much government spending is planned to grow each year on average between 2019 and 2023 in nominal terms. Budgets for public services grow well below inflation.

The government intends to erode much of this value by forcing down the real incomes of nurses, doctors, police officers, magistrates, court officials, prison warders and teachers, along with auxiliary and support workers in these sectors – public servants who account for 70% of the government wage bill.

But it is highly unlikely that this can be achieved without a reduction in the number of personnel, particularly in basic education, the criminal justice system and the defence force. Considering that the population they serve is increasing, the real value of these services will decline. Budgets for essential goods and services, like textbooks, petrol, medicines or maintenance, will also come under increasing pressure in the battle to rein in consumption spending.

So, the government is attempting to move in opposite directions at the same time. Fiscal policy would impose a large shock to aggregate demand and erode the value of core public services, but the government is promising a strong and inclusive economic recovery while holding out the prospect of continuing expansion of social provision.

Forcing down health consumption expenditure, for example, is inconsistent with the implementation of a national health insurance. Transforming institutions in the public health sector is no mean feat at the best of times, but will be near impossible if the state is trying to force down the real income of nurses, porters and laundry workers. More generally, a large and sustained reduction in government consumption contradicts the rollout of free tertiary education, increasing the quality of education or more effectively fighting crime and corruption.

The contradiction is most stark – bordering on doublethink – in claims that the government is about to fund a “presidential employment stimulus”.

There are two important aspects of South Africa’s debt position that distinguish it from the rest of the world. The first is that the country faces high interest rates on government debt that are far above the rate of economic growth. The new fiscal consensus, which has counselled greater acceptance of public debt in the Global North, assumes that growth rates exceed interest rates. In South Africa, as Figure 3 shows, this is far from the truth. The 10-year bond yield – a benchmark interest rate on government debt – has been rising for years, while economic growth has fallen into the mire.

The second is that the debt level is not stable. There is no particular threshold of the debt-to-GDP ratio that should concern us, but if debt is rising without limit, it is unsustainable. And so, where other countries have accepted a once-off increase in their level of debt to fund their pandemic response, South Africa faces a continuous escalation of debt without credible prospects for stabilisation.

As a consequence of this unsustainable fiscal position, the public sector’s financial solvency will continue to erode. Most would agree that, in a time of crisis, the government should be prepared to risk its financial net worth if this contributes to economic recovery. But using the public-sector balance sheet as a bridge across troubled water makes little sense if the opposite shore is so far away that its very existence is in doubt.

It might be said that the real danger is not the government’s solvency (which in any case is difficult to define), but the risk of a liquidity crisis in which debts can no longer be rolled over. It is then that the International Monetary Fund or exceptional measures come into play.

There are several reasons why – even if South Africa does not resolve its underlying fiscal and economic maladies – a sudden crisis of debt distress may not occur over the medium term. For one, global investment is exuberant and, in a world with zero interest rates, the return on a South African bond is high. Second, the Reserve Bank has agreed to stand by the bond market as a buyer of last resort, something it has the credibility and the balance sheet to do. Finally, the broader South African sovereign balance sheet is strong. The state could resort to drawing down financial assets – the Government Employees Pension Fund, for instance – long before it is forced into defaulting on its debt.

So, global conditions remain supportive, local institutions are resilient and domestic markets can absorb the turbulence. Given these factors, should we even be worried about sovereign debt? The answer is yes. Even without a liquidity crisis, the slow grind of sovereign bankruptcy will exert forces over time that will be difficult for South Africa to contain.

The real measure of debt is not how much we owe but the burden of our interest payments. It will soon amount to 25% of revenue and will continue increasing. The government must either continue to force down its public consumption – with the aforementioned implications – raise taxes each year to finance the rent on debt or renege on obligations.

There are many ways a state can try to renege on its debt obligations.

Not only is the government the biggest issuer of debt in the economy but it also has regulatory authority over debt contracts. Macro financial policy can be brought to bear to erode the value of outstanding debt and influence the interest the government pays on it. Historically, this has involved depreciation of the currency and inflation, capital taxation, capital controls and various forms of state direction of private finance.

In effect, the country would be trying to force its interest rate down to its woefully low rate of economic growth. In this case, the ability and willingness of the treasury to honour its obligations will be questioned, the balance sheet of the South African Reserve Bank will be placed in doubt, eroding its credibility and authority, and questions will be raised about the capacity of the state to underpin private financial institutions.

There are circumstances in which a combination of increasing the money supply and reducing taxes can kick-start a new cycle of growth.

The fundamental issue is the response of private fixed investment. Capital formation is the engine of economic growth and if macro policy easing leads to an upsurge of investment, both private and public, concerns about the consequences are less salient.