T Manuel: Economic Policy and South Africa's Growth Strategy

19 March 2007

Introduction

Good evening ladies and gentlemen. Thank you for inviting me to address you
today to discuss 'new growth paths' in South Africa. Allow me to begin by
making two points about 'new growth paths.' The first is simply that our new
paths have to be organic shoots growing out of our past. We can never fully
escape the myriad of economic events, decisions and systems that inform our
history; they in many cases determine the structure of the economy that we have
addressed over the past 12 years and with which we grapple today.

My second point is that we must use ideas generated here and abroad to
develop new paths that reach organically from our past into a future that is
determined and shaped by our new democracy. So while the new must come from the
old, the direction they take into our common future can and must be consciously
influenced by us. I would like to speak with you tonight about some of those
paths, where they are going and what I hope they mean for our future.

South Africa's growth path will be the manifestation of a series of
underlying dynamics, including a more productive and lower cost set of network
inputs to final production, a sustained and rapidly growing array of exports
from a more diversified and competitive manufacturing and services industries
and a more proactive, efficient and capable state. Greater levels of
employment, both in the short and long term, of a productive workforce needs to
be a further critical support to our growth strategy.

Over the medium and long-term, key public infrastructure investments and the
renewal of telecommunication and transport networks and energy production
systems will raise investment growth rates, pulling in higher levels of private
sector and foreign direct investment and raising productivity. More rapid
economic growth facilitates rising saving and investment as the cost of capital
falls. And more rapid growth helps to incentivise firms to finance the skills
acquisition and development that is central to sustained increases in labour
productivity, rising real wages and declining poverty.

Macroeconomic stabilisation and the roots of growth

Over the past century, the South African economy has been perhaps the
epitome of a mineral-rich economy, exporting its commodities � gold, platinum,
diamonds, and coal to the rest of the world. Agriculture, a variety of
manufacturing industries, services, an expansive wholesale and retail
distribution networks, and other facets of a more full economic life developed
around that basic exporting system.

Apartheid, of course, set strict and ultimately politically untenable limits
to the ambit of formal and/or modern economic life. A growing population was
excluded from economic life in any meaningful sense and this was the genesis of
many of our skills constraints and labour market problems of today. These, in
turn, represent some of the largest obstacles to a more rapidly growing economy
today.

The limits imposed by apartheid on the accessibility of people to economic
activity also resulted in a severely handicapped public sector, incapable of
addressing the needs of the majority of South Africans, imbued with a staid
bureaucratic culture and outlook and reliant on outdated tools for implementing
public policy. The regulatory and legal structures and industries that give
effect to much of our corpus of law were similarly debilitated and simply not
ready for the era of democracy and freedom to live an economic life.

By the early 1990s, the attempts of successive apartheid era governments to
grow the economy in the face of rising political discontent, an inflexible
economy and regulatory system and the handicaps of minimal foreign trade and
capital, had resulted in an inflationary spiral and falling investment. The key
reforms of the first few years of the new government included a series of micro
and macro adjustments. The articulation of the Reconstruction and Development
Programme (RDP) helped to set a guide for the compositional shifts in
government expenditure that continue through to today to align spending to
South Africa's poor majority, even though the spending targets of the RDP were
set aside in the initial years. In order to resolve our fiscal and monetary
problems of those years, that was the right decision. Along the way,
Government's goals and means of achieving them have been sharpened.

From 1996 to 2000, fiscal policy contributed to economic growth by lowering
the financial cost of the budget deficit. This is sometimes referred to as a
"growth-oriented fiscal contraction," and it seems to me this is an appropriate
term. By reducing the level and cost of our public debt, we increased the
amount we had available to spend on social policies and permanently lowered the
future cost of debt. Since 1998/99, debt service costs as a percentage of Gross
Domestic Product (GDP) declined from 5,6 percent to 3,2 percent in 2006/07, and
are expected to decline further to 2,5 percent in 2009. This represents a
cumulative saving of about R33 billion which has been available for more
productive expenditure.

Alongside the set of fiscal and macroeconomic adjustments made in the early
years, the opening up of trade policy played a critical role in providing
impetus to investment and growth in productivity. The series of liberalisations
of the exchange control environment, beginning with the elimination of the
financial rand, have contributed to a robust two-way flow of capital into and
out of the economy, demonstrated that South Africa was prepared for longer-term
direct investment and strengthened the flow of knowledge of all sorts into the
economy.

A central factor in the strengthening performance of the economy has also
been the structural decline in inflation since 1994 and the stabilisation of
interest rates. Trade policy and fiscal policy were important underlying
contributors to lower inflation over the years. Monetary policy and its conduct
was also critical, although as the economy became more exposed to international
financial volatility the need to put in place a more appropriate monetary
framework also grew.

The inflation targeting framework developed between the National Treasury
and the Reserve Bank in 1999 and announced in 2000, provided a more transparent
policy with a clearer ordering of policy priorities and greater degrees of
freedom to achieve them. A key element of the shift was that the exchange rate
would be allowed to float to adjust to external economic shocks and in doing so
to create more stability for domestic interest rates and economic growth.

The economy today and fiscal policy

We live in an economy today that has undergone profound transformation. In
real terms, the economy is about 40 percent larger than it was in 1993. Growth
averaged on annual basis 5 percent during the past three years (2004-2006), up
from 3 percent in the preceding decade (1994-2003) and a mere 1 percent in the
decade 1984-93. The economy is expected to grow by 5,4 percent by 2009 and
average 5,1 percent in the next three years (2007-2009). Shortly after the
publication of the 2007 budget, the latest release from Statistics South Africa
reported real GDP growth of 5 percent in calendar year 2006. The final quarter
of 2006 was also the 33rd consecutive quarter of growth, the longest economic
expansion since 1945.

The present economic expansion has its roots in both responsible
macroeconomic and fiscal policies and favourable global conditions. Strong
employment growth, rising real wages (underpinned by substantial increases in
labour productivity) coupled with substantial tax relief and significant
increases in social grants in recent years have further increased disposable
household income and hence household consumption. Our investment performance
has been especially robust. Real gross fixed capital formation grew by an
annual average of 9,4 per cent between 2003 and 2005, rising to about 12
percent in 2006. Private investment (over 12% in 2006) has been responding to
strong domestic demand, reflecting the positive outlook for economic growth and
high business confidence.
Construction is currently the strongest-growing sector at an annual average
rate of 12,1 percent over the past three years (2004-2006), compared to only
2,8 percent in the preceding decade (1994-2003). The global economy has
remained supportive of our growth performance, in response to exceptional
growth in China and India, healthy growth in G7 countries and high commodity
prices. The commodity price rally has entered its sixth year. Between 1999 and
the end of 2006, the gold price rose 121 percent, the oil price rose 144
percent, and the prices of both platinum and coal rose by more than 150 per
cent. These price increases have helped to boost the value of South Africa's
exports in recent years.

But a greater expansion in the volume and value of exports and
export-related employment is needed to lift and sustain the economy's growth
rate beyond 6 percent a year. I will return to this point later. Our current
account deficit has risen to levels close to 6 percent of GDP last year and we
expect the deficit to continue running at between five and six percent over the
medium term. This is a sign of robust economic growth and other economies are
similarly taking advantage of strong exchange rates to increase imported
capital goods for domestic investment and capacity expansion.

The 2006 and 2007 budgets which transitioned from targeting 3% deficits to
1% to a balanced position were predicated on our understanding of current
macroeconomic dynamics and the need to be mindful of the global economy. So,
while some observers have argued that our revenue overruns and low budget
deficits have created much leeway for government to accelerate spending and
slash taxes, we have tended to take a more prudent approach. The fiscal stance
reflects the importance of raising government saving as our economy grows
rapidly.

This indirectly helps to moderate the current account deficit and keep the
economy competitive overall. It also ensures that when commodity prices start
to fall and the value of our exports weakens, we have the fiscal space
available to offset a softer economy with fiscal spending. The fiscal position
also helps to lower interest costs and maintain the investment spending by the
private sector and public corporations that is so critical to the long-term
strengthening of our potential and realised economic growth rates. Improvements
in the fiscal position over the years have been self-reinforcing, as stronger
growth rates from lower costs of capital in turn push up corporate earnings and
government revenue.

Real growth in non-interest government expenditure averaged 9,2 percent over
the past three years. Government will reinforce the fiscal contribution to
economic expansion and more balanced growth as real average growth in
non-interest expenditure of 7,7 percent a year is projected over the next three
years and growth in capital expenditure increases relative to current
expenditure.

Future directions in economic policy and growth

Our efforts to stabilise the macroeconomic environment created a durable
platform for the microeconomic reforms also required to further lift South
Africa's economic growth rates. A central theme of the growth story is the
reinvestment in our network industries to raise their productivity and lower
their costs as inputs to final production. Key public infrastructure
investments and the renewal of telecommunication and transport networks and
energy production systems will raise investment growth rates, pulling in higher
levels of private sector and foreign direct investment and raising
productivity.
Another theme of the growth story is to foster rapid growth in a wide range of
exports from a more diversified and competitive manufacturing and services
industries.

These economic aims need to be achieved by a more proactive, efficient and
capable state that co-operates with the private sector to raise production and
investment. A critical input to the growth story must also be much higher
levels of employment and a skilled and productive workforce. More rapid
economic growth and the need to break through the constraints of capacity will
incentivise greater corporate interest in skills development, easing the
financing of that process and leading in the longer run to rising labour
productivity, real wages and household living standards. The feedback of that
link through to further human capital development is fundamental to our
long-run economic future.

As our economic expansion picks up pace, rising income of firms, households
and government helps to lower the cost of capital by increasing saving and
investment. South Africa's future growth path is being determined by the series
of choices made about the allocation of government spending to create and
improve the human and physical capital of the country. It is also being shaped
by the ways in which the state regulates and sets the pattern of incentives
facing the private sector to invest, produce, employ and take risks. Both
domestic and international policies matter greatly here, including for instance
the regulatory structure of the telecommunications sector and its impact on
pricing, or the extent to which trade and industrial policy induces firms to
sustainably invest and export.

The improved policy frameworks and greater spending on health, education and
other social services, alongside the ongoing renewal of economic infrastructure
and step up in financing for research and development and higher education,
will strengthen economic growth by lowering supply prices and supporting
innovation across the economy. Government has placed a special emphasis on
improving the regulation of network industries, such as telecommunications and
transport, in order to make them efficient providers of key economic services.
The development of human capital is a central responsibility of the public
sector and a key ingredient to South Africa's current and future
prosperity.

South Africa spends about 5,6 percent of its GDP on education overall,
considerably higher than in most other middle income economies. Trying to
alleviate skills shortages in education and other parts of the social sector
has been an important area of focus that is further supported in the 2007
Budget by an allocation of R700 million for the Department of Education to
implement a bursary scheme for prospective educators.

Longer-term research and development, knowledge creation and innovation will
play an increasingly important role in growth. Considerably stepped up funding
for higher education in the last two budgets has been achieved. The 2007 Budget
allocates an additional R1,2 billion for an integrated approach to human
resource development, knowledge generation, investment in infrastructure and
improvements to the strategic management of the public science and technology
system. More broadly, government continues to emphasise the importance of
skills acquisition and development of the labour force to lower the supply cost
of workers, improve productivity and increase employment prospects.

Over the medium-term, key public infrastructure investments and policy
reforms will raise investment growth rates, pulling in higher levels of private
sector and foreign direct investment and raising productivity. The efficiency
of the state at national, provincial and local levels plays an important role
in strengthening those outcomes.

Government has concentrated in recent years on improving the capacity of
government at all levels to develop, plan and finance, and roll out
infrastructure spending. The partnership called the infrastructure delivery
improvement programme (IDIP) was established to address under spending of
provincial capital infrastructure budgets and target poor planning, lack of
delivery, management systems and the general lack of skills. IDIP initially
focused on the education sector and will be expanded to provincial health,
public works and transport departments.

The Siyenza Manje programme will use R600 million from the Development Bank
of Southern Africa (DBSA) and R741,2 million allocated from government to
develop skills in engineering, planning and financial management within
municipalities. The new neighbourhood development partnership grant fund
provides financial assistance to municipalities for partnership-based community
and commercial infrastructure in townships and informal settlements. These
sorts of creative policy initiatives will help to improve the use of public
resources in the development of public space and public infrastructure at the
level of single communities as well as larger municipal and provincial
projects.

The scale of government's public infrastructure spending is also an
important aspect of the growth story. Because in addition to the many small and
local projects being funded, there are also a set of quite large projects that
will incentivise even greater investment spending by the private sector.
Government plans to boost investment in infrastructure by R416 billion over the
medium term, as projected in the latest budget. This infrastructure programme
is a fundamental part of the modernising impetus and will contribute to a
steady increase in the gross fixed capital formation ratio.

The infrastructure programme include investment in electricity generation
and electrification, roads, commuter rail, housing, bulk infrastructure,
research and development, water and sanitation, hospitals and clinics, as well
as stadium upgrading and construction and improving public transport networks
in preparation for the 2010 FIFA World Cup. The 2010 World Cup stadiums, for
instance, will need extensive redevelopment of urban areas around the stadiums
and new transport hubs to service them. The ripple effects of further
investments by private sector agents will be felt throughout the relevant
municipalities and their communities.

The same is true for the development of the Gautrain in Gauteng and the King
Shaka airport outside of Durban. Another area of extensive investment is the
redevelopment and renewal of sectors covered by our public corporations. In the
next ten years or so, roughly speaking, South Africa will in effect recreate
its rail and road transport network, develop a new telecommunications backbone
and link to the rest of the world and build a new energy production and
distribution system. These developments will drive down the cost of providing
the relevant inputs, increase productivity of users of those inputs, and
directly strengthen South Africa's potential rate of economic growth.

Investment by our public corporations, like our major government
infrastructure projects, draws in private sector investment and innovation and
will strengthen overall investment in the economy. The strong private and
public investment rates of recent years have begun to reflect those
public-private interactions.
Cement, steel, electricity and fuel producers, in particular, are currently
operating at or near full capacity. Significant capacity expansion is expected
over the next three years in response to rapidly growing demand. Economic
growth over the medium and long-term will also increasingly reflect a better
export performance on the back of more competitive manufacturing and services
industries, a point made in the past year by government's international panel
of economists and specialists.

South Africa initiated an ambitious set of tariff and trade policy reforms
in the mid-1990s, including substantial multilateral liberalisation through the
World Trade Organisation (WTO) which moved tariff levels towards the
international norm. The number of tariff lines has almost halved from
1990-2004, and about 80 percent of all tariffs is now duty-free. Other trade
policy reforms included the elimination of quotas and most import surcharges;
the replacement of most tariffs with ad valorem duties; and new agreements with
the European Union and Southern African Development Community.

At the same time, however, South Africa's export performance has been
erratic over the past 10 to 15 years. Total merchandise exports have fallen
from 0,7 to 0,5 percent as a share of global exports between 1994 and 2004.
Although total export volume growth increased to an annual average of 3,9
percent between 1990 and 2005 from only 1,2 percent growth in the preceding two
decades, this growth was much lower than the average annual growth in world
trade of about 6 percent.

The major step toward a less protective trade regime had large immediate and
longer-term benefits. Greater competition via higher levels of import
penetration has spurred domestic investment, productivity and higher value
added in a range of industries. Partly as a result, export orientation has also
increased strongly. Despite the improvement in manufacturing and services
exports, trade policy should be set to enable a sustained improvement and
expansion in South Africa's export performance.

In particular, the work of the international panel indicates that exports,
particularly of manufactured goods, are still constrained by high prices for
intermediate inputs and capital goods. The competitiveness of our exports will
be improved in the long term through continued reforms to the regulatory
structure of our economy and key policies like trade, improvements to
infrastructure and networks and sustained investment and productivity
growth.

These sorts of policy reforms are important to influencing private sector
behaviour towards greater investment, innovation and employment. And in
particular, towards promoting the sustained increases in labour productivity
that are needed to allow consistently rising real wages, household incomes and
living standards. Productivity growth is affected by the regulatory framework,
the use and management of inputs to production processes, incentives to
innovation, new technologies, skills levels and the competitive dynamics of
particular markets, including barriers to entry. Over the longer term, a well
conceived and implemented industrial policy will stimulate stronger growth and
job creation through encouraging businesses to use more labour, inducing
continuous growth in productivity and ensuring that new ideas translate into
new opportunities. Industrial policy interventions should provide additional
support for new activities and remove regulatory or infrastructure-related
obstacles to existing activities.

It should also target productivity-enhancing activities instead of
individual firms or sectors and maximise public accountability and
transparency, which will help to ensure positive net economic benefits and
provide clear mechanisms for discontinuing programmes that do not work.
Industrial policy will be most effective if it is being complemented by a broad
range of other policies, including tax and fiscal policy, regulation and
price-setting for network industries, competition and trade policy. Government
is working on filling in the details of a more proactive approach to industrial
policy this year.

Concluding comments

I have presented to you this evening with some of the features of our
structural economic legacies. The macroeconomic and microeconomic responses to
that legacy have been profound. We have created a more open and accessible
economy at the same time as we have modernised our regulatory structures. In
our common future lies an economy in which key reforms of the past 12 years
reach their fruition and the key reforms of the present and future find
traction and deliver a competitive, modern, diversified economy. A number of
the current and future reforms have already taken shape. We know that in our
future lies a more comprehensive social security system that provides
appropriate levels of income at retirement and short-term adjustment assistance
to the economically vulnerable.

This complements our approach to skills development, which emphasises the
need to take advantage of economic opportunity and to broaden access to the
economy.
We also know that our industries and our exports must be competitive and far
more diversified. A range of policies, many of which are already underway such
as infrastructure development and modernisation of our network industries, have
benefited from a more precise articulation of reform and outcomes and will help
to increase the potential growth rate of the economy.

The redevelopment of the energy, transport, road, and telecommunications
systems will do the same and also help to boost our investment rates closer to
the 25 percent needed for a sustained economic growth rate considerably higher
than at present. Trade and industrial policy are also important to our
long-term growth prospects, because they help to build a confident, competitive
set of industries that can compete on the world stage.

Getting the microeconomics of these policies right is fundamental to much
more rapid growth in industrial investment and the resolution of a significant
part of our employment problem. Our growth story has to include labour force
participation rates much higher than at present, with steady growth in jobs to
enable our youth to look forward to an 'economic life' and with wage rates that
reflect a modern and productive economy. A greater proportion of investment
spending in the economy and stronger labour force participation will directly
help to raise the current economic growth rate in coming years.

Allow me to conclude by noting that our growth story depends on the
pragmatic and necessary marriage of a development-oriented and active use of
state resources in the service of a long-term public good aligned to the
enthusiasm, creativity and investment of our private sector. It is this
public-private co-operation that we see reflected in our approach to policy
design and reform, that lies behind our current robust economic growth and
which will support and sustain our growth story in coming years.

Thank you.

Issued by: National Treasury
19 March 2007