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The good, the bad and the ugly options

The next political generation faces three kinds of options, namely good, bad and ugly ones.

Strengthening the economy's supply side, enhancing its growth potential beyond 5% (good options).

Loading demand in the hope of getting even faster output growth, but instead reaping growing structural distortions (bad options).

This could include higher budget deficits and national debt, bigger current account deficits, higher inflation and greater income disparities as the poor will be inflation's greater victims.

Distorting the incentive structure, always with good intentions in mind (ugly options).

This could include higher import restrictions, more subsidies, more labour restrictions, higher taxes for higher incomes, fewer burdens for the poor (free education, more social welfare, cheaper housing, free infrastructure services), and such burdens becoming costlier for the paying middle class.

Ugly options try to do good where needs are highest, imposing greater 'solidarity' on the middle class.

The problems would be three-fold. Anything for free would boost its demand. Anything facing higher burdens will have its incentive to incur effort undermined.

The incentive to save will become weaker, a fatal choice in a country whose national savings effort is already far too weak relative to its fixed investment needs (the gap probably opening up beyond 10% of GDP, which is what the current account deficit would be).

That would incur its own disruptive logic from the outside, greatly complicating things internally.

The bad option is to try and have more cake and eating too, even if it may be popular to do so.

In an economy pumping on all pistons, which is what we do when growing at 4.5%-5.5%, to simply load demand would reap debilitating distortions rather than more output.

More government spending on social delivery and tax cuts for the poor (funded through more borrowing by running a budget deficit) would no doubt be popular, and would favour the targeted households.

And by abandoning inflation targeting, directing monetary policy to be more accommodating to growth, this would practically lead to lower real interest rates, boosting credit usage.

Increased spending would aim to grow demand faster, thereby creating more output opportunities ('grow output faster'), thus creating more work opportunities, reducing unemployment faster.

The only problem here is that the economy's supply side is not automatically capable of producing faster when one loads demand yet more.

Only when there are unutilized resources can this work, until the resource slack is taken up and the supply side finds itself constrained by its traditional constraints from expanding faster.

Yet the cry will be that with so much unemployment (at least 35%) it is nonsense to talk of resource constraints, that there is plenty scope to load demand creating its own supply.

If most unemployed labour is currently unemployable in the post-industrial economy we have already become, let's change that paradigm!

If for instance we were to lower the exchange rate until our industry can even compete with China, our businesses could shift to simple labour-intensive industrial activities, absorbing in a matter of years much of our reservoir of unemployed labour.

But what would inflation do? What would real incomes of existing workers do? With inflation higher, existing skilled workers would demand more to compensate for the higher inflation.

If one were to deny them, favouring the currently unemployed, what would happen? Unionised workers would strike, paralyzing society, politically an unappealing prospect. And skilled workers would emigrate, starving the country of yet more of its scarce skills.

This would be the way back to the Stone Age beginnings of our industralisation, undoing progress to date.

The alternative is much harder. It focuses on the supply side of the economy. Improving the quality of education and thereby the abilities of 18-year olds annually joining the labour force and providing training opportunities to currently unemployed.

Increasing the supply of infrastructure (electricity, ports, roads, municipal infrastructure, telecommunications). Reducing the regulatory jungle, facilitating rather than obstructing market pricing and decision-making.

By ensuring adequate demand growth, the economy's improving supply side would be able to grow output faster. It would need more workers to do so, increasing the pace of employment creation and unemployment reduction.

With the nation's national income growing faster, living standards would improve faster, but also government revenue, allowing it to undertake more redistribution towards the poor without undermining the general incentive structure and work effort.

Doing more of the same we have been doing (improving the supply side) should be the first priority of the next political generation. The rest of their ambitions would follow.

Trying to do it any other way in our democratic social market economy would primarily harvest regression and distortions.            

Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on www.fnb.co.za/economics