Capital formation urgently required to sustain GDP growth

Cynics that had predicted negative GDP growth for 2022 will have to wait at least another 12 months to see whether their pessimism may eventually be proven correct.

Although last year’s real economic growth rate of 2% is nothing to get excited about, it signals a full recovery from the debilitating effects of the Covid pandemic, which led to a structural constraint on economic growth that lasted for two years.

The positive year-on-year growth rate (in real terms) was achieved in the face of arduous challenges, including the following:

• Lingering supply-side constraints resulting from the Covid pandemic, especially due to China’s zero-Covid policy, which was only abandoned earlier this year

• A spike in domestic and global inflation, caused, inter alia, by higher energy prices and an unheard of increase in global freight shipping costs. On some routes, this increase amounted to more than 700%.

• Hawkish monetary policy since the end of 2021 which, in South Africa’s case, led to an increase in the cost of credit (and capital) of 54%

• Semi-permanent electricity rationing of up to 8 hours in a 26-hour cycle, which has inflicted huge additional costs to businesses and households in terms of solar power installations, generators and fuel

• Decaying logistics infrastructure, especially the railways and many provincial and municipal roads (except for the Western Cape)

Against this background, the positive real economic growth rate for 2022 is nothing short of a miracle. Unless government starts getting its act together with restoring the quality of the country’s infrastructure, however, last year’s GDP growth rate will be a nigh impossible act to follow.

Closer scrutiny of the latest GDP data, released by Statistics SA on 7 March, reveals one of the root causes for the sluggish economic performance over the past seven years, namely the consistent decline in the ratio of fixed capital formation to GDP, especially the share of government and public corporations.

Since 2008, the global average ratio of fixed capital formation to GDP has increased by from 24% to 26% of GDP. South Africa has followed the opposite trend, with this ratio declining from almost 20% to merely 14.4% of GDP.

In 2015, private business enterprises were responsible for 63.2% of all the country’s fixed capital formation (essentially new factories, equipment, vehicles and other productive facilities). Last year, this has increased to 72.4%, with the public sector’s share (essentially infrastructure) as a ratio of GDP declining to a meagre 4%.

This means that all the intermediate inputs into productive economic activity and all final products had to utilise the same roads, railways and harbours that have existed more or less since the transition to democracy in 1994, but they have not been maintained. This unfortunate scenario is a recipe for economic lethargy, hence the paltry average annual GDP growth rate of only 1.2% since 2010 – not remotely sufficient to create jobs for a rapidly expanding population.

Unless government implements fairly drastic measures to restore the functionality of several key state-owned enterprises and many municipalities, especially with regard to the maintenance and upgrading of infrastructure, GDP growth will remain muted. The answer to this challenge is simple: privatisation on an unprecedented scale.