Government Expenditures to Lead Long-Run Economic Improvement

SOUTH AFRICA

Nicole Lusignan & Ben Taylor

Summary

• Background on South Africa’s Economy• Unemployment Problem• Current Account Deficit Problem• Exchange Rate Depreciation Problem• Recommendation: Expand Fiscally• Short-Run Results from Fiscal Expansion• Long-Run Results from Expansion Plan• Implications for South Africa

South Africa’s Economy

• Positives:– 4% GDP growth over last 3 years– Decreasing inflation– Increasing investment– Public debt decreased by 50% since 1999– Liberalized trade and increased consumption– Steady interest rates

South Africa’s Economy

• Negatives:– Booming current account deficit– High unemployment rates– AIDS epidemic stunting productivity– South African currency – the rand – is depreciating– Major socioeconomic disparities– Lacking in infrastructure and social services– In the 3rd (worst-off) zone of economic discomfort

Unemployment Problem• 40% of South Africans are unemployed, up 9% over

last decade• Joblessness attributed to AIDS epidemic, lack of

education, high crime rate, low productivity, and powerful labor unions

• Lack of jobs and productivity has led to a cycle of deepening unemployment due to lack of new investment

• Trend has been improving slightly very recently• South Africa is likely not at its full employment level

of output due to such high unemployment

Unemployment in South Africa (1993-2005)

0

5

10

15

20

25

30

35

40

45

1992 1994 1996 1998 2000 2002 2004 2006

YearSource: CSAE

% U

nem

pl

Broad Definition

Narrow Definition

Current Account Deficit Problem

• In 2002, there was small current account surplus• Since then, it has become negative and exploded in

magnitude, going from $0.884 billion to -$15.5 billion in 5 years

• Deficits have grown in all current account components: goods, services, transfers and income balances

• CA Deficit is now 6% of GDP and is a definite problem due to the unemployment and monetary depreciation problems

South Africa Current Account Balance in Dollars

-18,000.00

-16,000.00

-14,000.00

-12,000.00

-10,000.00

-8,000.00

-6,000.00

-4,000.00

-2,000.00

0.00

2,000.00

2000 2001 2002 2003 2004 2005 2006 2007

YearSource: Economist Intelligence Unit

CA

($)

Series1

Exchange Rate Depreciation

• South African Rand has free-floating exchange rate• Appreciated steadily from 2002-2006 after large

depreciation due to Argentina crisis• Fall dramatically in mid-2006 due to global currency

sell-off due to US monetary contraction• Has continued to depreciate and is projected to

continue depreciation through 2011• Vulnerability of rand has also increased to due free-

floating rand and continually exploding current account deficit

Exchange Rate in South Africa (2001-2011, projected)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

2000 2002 2004 2006 2008 2010 2012

YearSource: Economist Intelligence Unit

No

min

al E

xch

ang

e R

ate,

Ran

d:$

Expansionary Fiscal Policy: SR• Fiscal expansion will be long run investment in the

country’s productivity by adding infrastructure and social services

• In SR, an increase in G would theoretically increase Y and shift the DD curve outward, causing increased output and appreciation of the rand

• However, due to the huge current account deficit, it will likely counteract the fiscal expansion in the short run and actually cause the DD curve to shift backward, decreasing output and depreciating the rand further

• Investment from increase in G will still start to slowly increase productivity and joblessness and even indirectly curb the current account deficit

SR: AA-DD Model with DD pushed back due to CA deficit

Output, Y

Exc

han

ge

Rat

e, E

DD'

DD''

AA'

Expansionary Fiscal Policy: LR• Over time, the repeated increases in G will overtake the

current account deficit (that may be decreasing too)• DD curve will shift out in small increments over the long

run until full employment is reached• At this point, unemployment will be lower, the rand

appreciated, output increased and perhaps even an indirect decrease in current account deficit

• At the very least, the economy will be in far better shape, be more productive and attract more investment – and be less negatively affected by a current account deficit

Long Run Success Plan: Increase Y, Appreciate Rand and Attain Full Employment

Output, Y

Exc

hang

e R

ate,

E

AA'

DD'

DD''

DD'''

DD''''

DD'''''

DD''''''Full Employment Level of Output

In Conclusion

• While it will take a very long time for the investment now to have a serious impact, a commitment to these policies should lead to our expected results and more economic prosperity in South Africa

• Especially because in the alternative, unemployment and the exchange rate may continue to worsen South Africa and make the country at high risk for economic crisis

Government Expenditures to Lead Long-Run Economic Improvement

SOUTH AFRICA

The End