Africa Economics Focus 1

AFRICA
ECONOMICS FOCUS 6
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Recent events in South Africas mining sector, while tragic, are also symptomatic of wider
economic problems that are likely to mean the country falls short of achieving its significant
growth potential over the next decade. We believe that South Africa will continue to muddle along
at growth rates of around 3%, despite having the capacity to achieve around 5% with the aid of
supply-side reforms. Accordingly, it will continue to be outperformed by other emerging markets,
particularly those in sub-Saharan Africa, but also those in Asia.
In the near-term, weakening aggregate demand due to high unemployment and a deteriorating
external environment will weigh on the outlook. We expect growth to slow from 3.1% in 2011 to
around 2% in 2012, with a modest pick-up to 2.5% in 2013.
In the medium-term, a raft of supply-side measures is needed to raise South Africas productive
capacity. In particular, steps need to be taken to increase investment levels. Whats more,
investment needs to be funded by sources other than volatile, short-term portfolio or banking inflows.
These helped to drive growth in the boom years of 2005 to 2008, but their subsequent reversal
caused South Africa to slip into recession in 2009. There are a number of options available to
policymakers in order to boost investment in a sustainable way. These include improving the
efficiency and transparency of state institutions and raising domestic savings.
Additionally, there is a need for wide-scale reform of the dysfunctional labour market, the
consequences of which have been demonstrated tragically during the ongoing labour unrest in the
mining sector. In particular, the geographic mismatch between areas of economic activity and dense
populations, skills-shortages and trade union power all require addressing.
Should at least some progress be made in these areas, then it is feasible that South Africa can lift
average growth rates to around 5% per annum. Whats more, this could be achieved without the
rise in rapid rise in commodity prices and foreign financing that drove growth from 2005 to 2008.
But we are sceptical as to whether this will happen. In particular, the ruling ANCs close ties to
COSATU, the powerful federation of labour unions, will make wide-scale reform very difficult,
especially in the context of upcoming elections in 2014. We are, however, more positive on the
prospects of the authorities raising investment levels. So, all in all, we think that South Africa will
continue to muddle along in the next decade, at a steady but hardly spectacular pace.

Shilan Shah
Tel: +44 (0)20 7808 4062

South Africa set to remain a regional underperformer
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Managing Director Roger Bootle (roger.bootle@capitaleconomics.com)
Chief Emerging Markets Economist Neil Shearing (neil.shearing@capitaleconomics.com)
Africa Economist Shilan Shah (shilan.shah@capitaleconomics.com)


Africa Economics Focus 2
Over the past 30 years, the global economy has
been reshaped by the rise of the emerging markets,
most notably China, Central and Eastern Europe,
India and Latin America. However, Sub-Saharan
African (SSA) countries have remained on the
periphery of these developments.
But, with companies increasingly looking further
afield for investment opportunities, and given
Africas abundance of resources, both natural and
human, many have suggested this will be Africas
decade. The extent to which this turns out to be
true will depend largely on the performance of
the continents economic and political
powerhouse, South Africa. In this Focus, the first in
Capital Economics Africa service, we examine the
medium-term prospects for South Africa.
Setting the scene: why focus on South Africa?
There are a number of reasons that we have
launched our Africa service with a Focus on South
Africa. Firstly, it is comfortably the largest
economy in the region, with an estimated GDP in
2011 market exchange rates of over US$400bn.
(See Chart 1.)
CHART 1: GDP (2011, US$ BN, MARKET EXCH. RATES)
0
50
100
150
200
250
300
350
400
450
0
50
100
150
200
250
300
350
400
450
S.Africa Nigeria Angola Ghana Kenya Ethiopia Cte
d'Ivoire
Source IMF
This represents around 30% of the entire SSA
economy, and 0.7% of world GDP. The economy
is roughly the same size as Argentinas or
Thailands. Secondly, population size is another
important factor. At 51m, South Africa has one of
the largest in SSA. It is also the 25
th
most populous
country in the world similar in size to Spain and
South Korea. (See Chart 2.)
CHART 2: POPULATION (2011, MILLIONS)
0
40
80
120
160
200
0
40
80
120
160
200
Brazil Nigeria Turkey S.Africa S.Korea Spain Kenya
Source IMF
Overall, this leaves South Africa with GDP per
capita of roughly US$8,000 at market exchange
rates. (See Chart 3.) Admittedly, this figure is lower
than some of the larger emerging markets, such as
Brazil and Russia. However, it far exceeds the likes
of China and India, and is comfortably ahead of
any other SSA country with a population over two
million.
CHART 3: GDP PER CAPITA (2011, US$000,
MARKET EXCH. RATES)
0
2
4
6
8
10
12
14
0
2
4
6
8
10
12
14
Russia Brazil S.Africa Colombia China Angola India
Source IMF
Furthermore, South Africa is the leading
destination for foreign direct and portfolio
investment into SSA. Financial markets are deep
and easily accessible. In terms of market
capitalisation, the Johannesburg All-Share Index is
among the 20 largest benchmark equity indices in
the world. Among major emerging economies, it is
second only to Brazils BOVESPA. (See Chart 4.)
South Africa set to remain a regional underperformer

Africa Economics Focus 3
CHART 4: EQUITY MARKET CAPITALISATION
(SEP. 2012, US$BN)
0
100
200
300
400
500
600
700
800
0
100
200
300
400
500
600
700
800
Brazil S. Africa Russia India Indo. Turkey Poland
Source Bloomberg
Beyond its economic importance, South Africa is a
major geopolitical player. It is Africas only
member of the G-20, making it the continents
main representative on a global level. South Africa
is also a regional leader, taking up prominent roles
in numerous organisations such as the African
Union and Southern African Customs Union.
Therefore, this Focus aims to address two key
questions. First, what is the countrys medium-term
outlook and second, what do policymakers have to
do to ensure it achieve its potential?

A look backwards
Before we can answer these questions, it is
important first to take a look backwards and assess
how the country has performed in the recent past.
For a detailed discussion of the key drivers of
South African growth, please refer to Annex 1 at
the end of this Focus.
The key point, however, is that South Africas
economic performance since the end of apartheid
in 1994 has been disappointing. This
underperformance is best illustrated by comparing
growth in GDP per capita across a range of
countries relative to their starting points in terms of
income levels. The logic here is that countries with
lower GDP per capita have the greatest scope for
catch-up growth.
Chart 5 plots average growth in GDP per capita for
a number of countries between 1991 and 2010 (on
the y-axis) against GDP per capita in 1991 (on the
x-axis). We have marked on a line of best fit,
which does suggest that poor countries tend to
grow faster than rich countries. Those economies
which lie above the line have, broadly speaking,
exceeded their potential while those below it have
disappointed. South Africa lies beneath the line.
CHART 5: GDP PER CAPITA GROWTH (1991 2010)
0
1
2
3
4
5
6
7
8
9
0
1
2
3
4
5
6
7
8
9
0 10 20 30 40 50 60 70 80 90 100
G
D
P

p
e
r

c
a
p
i
t
a

g
r
o
w
t
h

(
%

y
/
y
)
GDP per capita (1991, % of US)
South Africa
China
Poland
France

Sources A. Maddison, Capital Economics

Africa Economics Focus 4
To illustrate this further, we can look at examples
of other countries that started at the same income
level as South Africa in 1991. For instance, Poland
started at comparable level. However, per capita
growth has since risen by more than double the
rate that South Africa has sustained. On the other
side of the same coin, Frances GDP per capita
growth has matched that of South Africa since
1991. But France started from a much higher base,
and so, theoretically, South Africa would have
been expected to achieve a faster rate of growth.
What is holding South Africa back?
There are a number of economic challenges that
need tackling in order to improve the outlook. In
the near-term, global headwinds, largely
emanating from the ongoing euro-zone debt crisis,
leads us to expect moderate growth over the next
two years. We forecast growth to slow from 3.1%
in 2011 to around 2% in 2012, with a modest
pick-up to 2.5% in 2013. Looking ahead even
further, the attention of policymakers needs to turn
to remedying both supply and demand-side
constraints in order to boost growth rates.
A key supply-side issue that policymakers will
need to address is raising the level of investment to
improve South Africas economic capacity.
Worryingly, investment has been falling as a share
of GDP over the past decade, averaging less than
20%. This is too low in comparison to other
emerging markets, especially when viewed against
the emerging Asian economies, where high
investment rates are supporting rapid economic
growth. (See Chart 6.)
CHART 6: INVESTMENT (2011, % OF GDP)
0
5
10
15
20
25
30
35
40
45
50
0
5
10
15
20
25
30
35
40
45
50
China India Vietnam Mexico Turkey Nigeria Brazil S.Africa
Average = 25% of GDP
Sources IMF, Capital Economics
A lack of investment is harmful for growth and can
manifest itself in a number of ways. For South
Africa, the starkest example is in its infrastructure
problems. In particular, frequent disruptions to the
electricity supply have caused problems for the
economy since 2007. This is mainly because of a
failure on the part of the authorities to invest in
new generating capacity, and a continued
reluctance to liberalise the sector to improve
competition. (See Chart 7.)
CHART 7: ELECTRICITY PRODUCTION (%Y/Y)
2005 2007 2009 2011
-10
-8
-6
-4
-2
0
2
4
6
8
10
-10
-8
-6
-4
-2
0
2
4
6
8
10
Sources Thomson Datastream, Capital Economics
The problem is self-perpetuating. A lack of
investment hampers output in other energy-
intensive sectors such as mining, which will
dampen investor sentiment even further. According
to the World Banks 2012 Doing Business Report,
the lack of quality access to electricity is one of the
major constraints facing local and foreign
companies.
Another perennial issue is institutional weakness,
which has negatively affected both foreign and
domestic investment. In fact, the most frequently
cited investment constraint is a lack of protection
against crime. South Africa ranks 137
th
out of 142
countries in the business costs of violence and
crime sub-section in the World Economic Forums
2012 Global Competitiveness Report, making it the
lowest ranked country in SSA and the lowest
among other emerging market peers. (See Chart 8.)

Africa Economics Focus 5
CHART 8: BUSINESS COST OF CRIME AND VIOLENCE SCORE
(2011, HIGHER SCORE = LOWER COST)
0
1
2
3
4
5
6
0
1
2
3
4
5
6
Poland China India Chile Russia Nigeria Mexico S.Africa
Source World Economic Forum
More generally, institutional corruption also acts as
a deterrent for potential investment. South Africa
ranks 64
th
out of 182 countries in Transparency
Internationals 2011 Corruption Perceptions Index.
(See Chart 9.) Admittedly, this makes it an
outperformer in comparison to other SSA
countries, coming in 7
th
place out of 48 countries
in the region. Nonetheless, this still demonstrates
that there is considerable scope for improvement.
CHART 9: CORRUPTION PERCEPTIONS SCORE
(2011, HIGHER SCORE = LOWER CORRUPTION PERCEPTIONS)
0
1
2
3
4
5
6
7
8
0
1
2
3
4
5
6
7
8
Chile Botswana Turkey S.Africa China India Nigeria
Source Transparency International
Low domestic savings are the key
While infrastructure constraints and relatively
weak institutions both help to explain South
Africas low investment level, it is also
symptomatic of a wider problem the countrys
extremely low domestic savings rate. In China,
domestic savings are equivalent to around 55% of
GDP and in India, the domestic savings rate is just
under 35% of GDP. But in South Africa, domestic
savings are equivalent to around 17% of GDP. (See
Chart 10.) As a result, the pool of funds from which
investment can be funded domestically is smaller.
CHART 10: SAVINGS & INVESTMENT (% OF GDP)
0
5
10
15
20
25
0
5
10
15
20
25
2003 2004 2005 2006 2007 2008 2009 2010 2011
Investment
Savings
Source IMF
Of course, a low savings rate does not necessarily
imply a low investment rate. South Africa, as it did
in 2005 to 2008, could borrow from abroad. But
things are not so simple. Relying on foreign capital
flows to finance investment increases an
economys external vulnerabilities, and makes it
susceptible to a sudden cut in funds in the case of
a deteriorating global environment.
Whats more, the necessary increase in the
investment rate is simply too large to be financed
through foreign capital inflows alone. South Africa
ran a current account deficit of around 3% of GDP
in 2011. But given that investment needs to rise by
around 6% of GDP to keep up with other emerging
markets, this would require running a current
account deficit of almost 10% of GDP well
above the levels normally regarded as safe by the
likes of the IMF (up to 5% of GDP). The bottom
line is, therefore, that South Africas investment
rate can only be increased in a sustainable
manner through an increase in domestic savings.
But what is to blame for the low savings rate? A
starting point here is the government budget. Since
2000, South Africa has run a public sector deficit
averaging 1.9% of GDP per annum. In net terms,
the government has been a dissaver. (See Chart
11.) A quick fix to the low savings problem would,
therefore, be to tighten fiscal policy.

Africa Economics Focus 6
CHART 11: BUDGET BALANCE (FISCAL YEARS, % OF GDP)
00/01 02/03 04/05 06/07 08/09 10/11
-7
-6
-5
-4
-3
-2
-1
0
1
2
-7
-6
-5
-4
-3
-2
-1
0
1
2
Average
Surplus
Deficit
Sources Thomson Datastream, Capital Economics
Indeed, the Finance Ministry has committed to
doing this, as it aims to cut the deficit to around
3% of GDP by 2015.
However, this could create problems in itself.
Fiscal tightening has the effect of reducing
aggregate demand at a time where growth is
expected to remain slow. And of course, aggregate
demand needs to be supported to ensure that any
increase to supply via higher investment levels is
not futile in terms of its effect on growth.
But we think that some of the decline in aggregate
demand can be counteracted by simultaneously
loosening monetary policy. Indeed, the South
Africa Reserve Bank cut its benchmark repo rate by
50bps to the historically low level of 5.00% in July
2012. Looking ahead, with core inflation pressures
likely to remain subdued, we expect interest rates
to be cut by another 100bps (to a new record low
of 4.00%) over the next 18 months.
Private sector savings must rise
But while there is scope for South Africas
government to save more, this alone cannot
explain why the overall level of domestic savings is
much lower than in some parts of Asia. In India,
for example, the general government budget deficit
has averaged just over 7% of GDP over the past
five years far higher than in South Africa. Yet
domestic savings are much higher in India.
Clearly, other private sector-related factors are at
work. One of these is the pensions system. The
problems that South Africa suffers are quite
different from those of other major emerging
markets such as Turkey or Brazil. In these
countries, state pensions are very generous, which
discourages private savings from a younger age.
But in South Africas case, the major failure is in
the governments regulation of the private
pensions system. In particular, there is currently a
dearth of competition, with private pensions only
being provided by a small number of companies.
This means that the costs to consumers of entering
a private pension scheme are often prohibitively
high. The good news for South Africa is that, in
theory at least, making the necessary reforms to the
pensions system will not create the same level of
political opposition as is likely to be the case in
Turkey or Brazil.
Finally, despite having one of the most
sophisticated financial systems in the emerging
world, there appears to be a lack of access to
financial services among small businesses and low-
income groups. According to a World Bank study,
only around 15% of the low-income group
participate in the financial system. Most rely on
informal, community-based schemes, known as
stokvels to fill this void. But these lack adequate
regulation, and are vulnerable to fraud. The net
result is that there is often simply no outlet for
people to save.
In Table 1, we highlight some of the major policies
and measures to look out for in the coming years,
which can help determine how well policymakers
are faring in their efforts to raise investment levels.
The list is not exhaustive, but should be a useful
guide as to whether progress is being made.
On balance, we believe that the authorities will
make at some least progress in raising investment
levels. There is wide acceptance of a dire need to
raise domestic savings levels. We think that at least
some improvement to the pensions system and
access to financial services will be made in the
coming years. Furthermore, the government
appears committed to intermittently raising energy
tariff prices through to 2014, despite the rises
proving to be politically unpopular in 2011. This
should ultimately plug a funding gap and pave the
way for future investment.

Africa Economics Focus 7
But, on a less positive note, investor sentiment is
likely to wane in light of a number of recent
events, particularly in relation to the mining
sector. The first is the ruling African National
Congress (ANC) partys most recent five-yearly
policy conference, held in June 2012. Admittedly,
during the conference, President Zuma ruled out
nationalisation of the mining sector. But the
nationalisation debate has been replaced by talk of
greater state involvement through higher taxes. We
think that if all of the measures discussed were to
be implemented, it would make the mining tax
regime one of the least competitive in SSA.
The second is the high levels of labour unrest
throughout the mining sector. This has hit the
headlines in recent weeks following the tragic
deaths of 34 miners at the Marikana platinum mine
in August 2012. But in reality, unrest has been
growing for the best part of two years. Given the
complex relationship between labour unions, state
security and the government in South Africa
(which is explored in the next section), there
appears to be no quick-fix solution to the unrest.
As a result, further outbreaks of violence cannot be
ruled out. This is likely to add to investor wariness
over the next few years.
TABLE 1: RAISING INVESTMENT LEVELS
Problem What to look for

Beneficial outcome
likely?
Infrastructure deficit





Energy tariff rises (2012 to 2014)
Tariff rises could quicken inflation in the short-term, but could also help to plug
Eskoms funding gap in the medium-term. Tariff hikes can be regarded as a positive
signal for potential investors, as it suggests that the government is willing to
implement politically unpopular measures in order to reduce the energy deficit.

Yes




Institutional weakness
















Protection of State Information Bill (2013)
The much maligned bill is up for discussion in the National Council of Provinces in
2013, having been passed by the national assembly in November 2011. It has been
condemned by numerous democracy advocacy groups for repressing the freedom
of the local press, as its ambiguous wording means it can be manipulated to block
reporting on public sector corruption. Should the bill be formalised into law, as we
believe it will be, it will further dampen investor sentiment towards the country.

Expansion of Violence Prevention Through Upgrade (VPUU) Scheme (2013
2014)
An expansion of the scheme can be regarded as positive news by investors, given
the impact it has had in dramatically reducing crime in the Cape Town township of
Khayetlisha. However this is not to say that its success will immediately be
replicated elsewhere. If a rolling out of VPUU does occur, it will be in FY2013/14
at the earliest.


No







Too early to say
Low Domestic Savings
















Pensions Reform (ongoing)
The government has acknowledged the need to raise domestic savings and is
aiming to reform the pension system to achieve this. Measures that have been
discussed include a compulsory preservation scheme, which would effectively
prevent workers from withdrawing retirement savings until they actually retire.
However, this may not be politically viable, as a similar proposal in the 1980s led
to mass protests. A more feasible measure is the removal of restrictions on where
pension funds can invest, in order to make the industry more competitive. The
government is also aiming to implement regulation which would make the costs to
consumers more transparent.

Improving access to financial services (ongoing)
There are signs that policymakers are making strides in this area. Efforts to formalise
stokvels have had fairly positive results the countrys four largest banks all have
savings products designed to cater for the community-based schemes. Further
formalisation of the practice and the opening of more bank branches outside of the
major cities will improve access to financial services among low-income groups.
Too early to say










Yes

Source Capital Economics

Africa Economics Focus 8
Labour market reform remains critical
The second part of the challenge for policymakers
is to reduce unemployment. This will involve
implementing wide-scale reform to the countrys
dysfunctional labour market. The starting point for
any analysis of South Africas labour market
problems is the non-accelerating inflation rate of
unemployment (NAIRU), which, as the name
suggests, is the unemployment rate at which
inflation remains stable.
Estimating a countrys NAIRU is extremely difficult
and it is not an exact science. But on balance, we
think that South Africas NAIRU is between 20-
25%. This is extremely high, particularly in
comparison to other emerging market economies
at a similar stage of development, such as Mexico
and Turkey (See Chart 12.)
CHART 12: UNEMPLOYMENT RATE (%)
0
5
10
15
20
25
30
35
0
5
10
15
20
25
30
35
1990 1994 1998 2002 2006 2010
S.Africa
Turkey
Mexico
Source Thomson Datastream
The challenge is, therefore, to lower the NAIRU in
order to increase South Africas supply capacity.
But why is unemployment so high in the first
place? Much of the problem is a throwback to the
apartheid era. There are logistical constraints, as
areas of booming economic activity tend not to be
in the same vicinity as areas of high population
density. Furthermore, the skills deficit, particularly
among the local black population, desperately
requires addressing.
Another issue is that labour relations in South
Africa are far more heavily skewed in favour of
unions than in other emerging market economies.
The reason for this is that labour relations are
determined by the historical ties between the ANC
and the Congress of South African Trade Unions
(COSATU), the powerful labour federation. The
ANC draws much of its electoral base from
COSATUs two-million strong members. Protracted
wage disputes and work stoppages organised by
COSATU over the past several years give a stark
demonstration of the bodys political clout. This
has taken a heavy economic toll, particularly in the
manufacturing and mining sectors.
In the mining sector, some critics argue that
COSATUs process of collective bargaining has put
greater emphasis on wage growth for white-collar
workers in the sector than it has done in ensuring
adequate health and safety standards and
remuneration for blue-collar employees. Labour
costs have therefore comfortably outstripped
productivity gains over the past few years,
weighing on the sectors profitability. This is turn
has led to marked decline in mining-sector
employment. In fact, this was a major factor in the
Marikana tragedy, as violence initially flared up
between affiliates of COSATU and a rival union,
which had been set up by disillusioned former
members.
The process of higher wage bargaining over higher
employment is also evident in the manufacturing
sector, where wages have increased by two-thirds
more than productivity since 2000. (See Chart 13.)
CHART 13: MANUFACTURING REAL WAGES & PRODUCTIVITY
(2000 = 100)
50
100
150
200
250
300
50
100
150
200
250
300
2000 2003 2006 2009 2012
Manufacturing Wages
Manufacturing Productivity
Source Thomson Datastream, Capital Economics
The ANC is well aware of the unemployment
problem. In November 2010 it launched the New
Growth Path, a large initiative aimed at creating
five million new jobs and reducing headline

Africa Economics Focus 9
unemployment by 10%-pts by 2020. However, the
crucial point is that any fundamental reforms to the
labour market will likely come as a result of
change in the dynamic of the relationship between
the ANC and COSATU. Table 2 highlights some of
the key policy measures needed to reform labour
markets. As with Table 1, the list is by no means
exhaustive. But it can help to give an indication of
how much progress is being made in this area.
On balance, we are sceptical about the likelihood
of any large-scale labour market reform being
implemented over the next few years. In fact, very
little progress will be made until 2014 at the
earliest. This is when presidential and
parliamentary elections are due to be held, so it is
highly unlikely that the ANC will risk displeasing a
key part of its electoral base.
Beyond 2014, we still doubt that there will be a
fundamental shift in dynamics. Given the ANCs
stranglehold over politics, and the removal of
populist youth leader Julius Malema from the
party, it seems likely that incumbent President
Jacob Zuma will stay win the 2014 elections.
Zuma has particularly strong ideological ties to
COSATU, stemming from both playing prominent
roles in the anti-apartheid movement. Furthermore,
COSATUs public support for Zuma was a key
reason for his victory at the ANCs previous
leadership election, at Polokwane in 2007. We
therefore doubt that he will take the necessary
steps to break the break away from the federation.
TABLE 2: LABOUR MARKET REFORM
Problem What to look for

Beneficial outcome
likely?
Regional Mismatch







E-tolling and improvements to transport links (2012 - 2014)
From a logistical perspective the government is aiming to solve the geographic
mismatch problem by improving transport links between townships and major
cities. However, the programmes are being funded by tolls that are being charged
on existing highways, which may dissuade travel and actually increase the
mismatch in the interim. The long-term success therefore depends on the scale of
improvements and the total incurred via the e-tolling.

Too early to say







Skills deficit
















Schooling 2025 (2013 to 2025)
Schooling 2025 is a long-term strategy set out by the ANC during the conference in
June 2012. The strategy includes, among numerous other things, a wider scope of
free education, universal access to computers for everyone above grade 3, and
better provision and distribution of textbooks via a liberalised publishing sector.
Theoretically, the measures will help to reduce the skill deficit, but with the finance
ministry committed to fiscal tightening, considerable changes to revenue collection
are required in order to fund the programme.


Teacher incentives and accountability (ongoing)
One way of reducing the skills deficit among the black population would be to
increase the incentives and accountability of teachers with regard to secondary
school test scores, which are among the lowest in the world. But progress in this
area has been disappointingly slow. Pay incentives appear unfeasible at the
moment due to the finance ministrys move towards fiscal tightening.

Too early to say









No






Trade union power









ANC national conference (December 2012)
President Zuma is clear favourite to win the party leadership elections, which
would pave the way for him to run for another term of presidency in 2014. Other
ministerial posts are also being contested. Should these be won by COSATU
supporters, the ANC-COSATU alliance is likely to remain firmly intact.

Amendment of Labour Relations Bill (early 2013)
The bills, which include a ban on broking and laws to regulate contract work, have
the backing of COSATU. If passed, as we expect to be the case, they would add
further rigidity to the labour market, and exacerbate unemployment concerns.
No





No




Source Capital Economics

Africa Economics Focus 10
The growth outlook
Bringing all of this together, we can map out a
trajectory for South African growth. (See Table 3
and Chart 14.) There are three scenarios that
emerge. The first is a no change scenario, whereby
labour market rigidities and low investment
constrain growth capacity to around 3%. The
second, optimistic scenario is where
considerable progress is made in both these areas.
In this scenario, if investment levels rise by 5-6%
of GDP, and the unemployment rate is steadily
reduced by 10%-pts over the next decade, annual
real GDP growth could reach about 5%.
TABLE 3: POTENTIAL GDP GROWTH (% Y/Y, NEXT 10 YRS)
No
Change
Scenario
Optimistic
Scenario
Core
Scenario
Real GDP Growth (y/y) 3.0% 5.0% 3.5%
Of which contributions by:
Labour 0.5% 2.0% 1.0%
Capital accumulation 1.0% 1.0% 1.0%
Total Factor Productivity 1.5% 2.0% 1.5%
Source Capital Economics

CHART 14: REAL GDP FORECAST (2004 = 100)
80
100
120
140
160
180
200
80
100
120
140
160
180
200
2004 2008 2012 2016 2020
Optimistic scenario
Core scenario
No change scenario
Source Capital Economics
But we are sceptical as to whether such wide-
ranging reforms needed to achieve this can be fully
implemented in the coming years.
This leads to the third, core scenario, where the
labour market remains extremely rigid due to the
ANCs reliance on COSATU support, but small
improvements are made in raising investment
levels. In this scenario, growth is likely to average
around 3.5% per year.
This represents an average annual increase of 2%
in GDP per capita terms. This rate of growth is
likely to outperform most developed markets. But,
in the context of South Africas current level of
income per capita, it will remain disappointing.
Summary
To sum up then, a combination of domestic
structural problems and a weakening external
environment leads us to expect South African
growth to slow from 3.1% in 2011 to just over 2%
in 2012, with a modest pick-up to 2.5% in 2013.
Looking further ahead, there is much for the
government to get its teeth into to improve the
growth outlook. Considerable levels of supply-side
reforms are needed to raise capacity, with
particular focus on raising investment level.
Additionally, wide-scale labour market reform is
required.
Should at least some progress be made in these
areas, then it is feasible that South Africa could
boost average growth rates to 5% per annum
experienced in 2005 to 2008. This could occur
without a heavy reliance on commodity price rises
and foreign financing.
However, given the ANCs close ties to labour
unions, we are sceptical that wide-scale reforms
will be implemented. A more likely scenario is that
some, slow structural progress will be made in the
coming years. If this is the case, South Africas
economy will muddle along at rates of around 3%
per annum. This is by no means disastrous. But
equally, it suggests that South Africa will continue
on the same unspectacular growth path that is has
done since 1994. Most likely, it will continue to be
outperformed by other emerging economies,
particularly the rest of sub-Saharan Africa and Asia.






Africa Economics Focus 11
Annex 1: Post-apartheid economic performance
South Africas economic performance since the
end of apartheid can be split into three distinct
periods; 1994 to 2004, 2005 to 2008, and 2009 to
2011. In this annex we study each of these periods
in turn.
1994 2004: steady but unspectacular
Trade and financial sanctions and protracted
political deadlock helped turn the years 1984
1993 into poorest decade of growth performance
since the Second World War. In this context, then,
average annual growth of 3% during the first ten
years after the end of apartheid in 1994 can be
considered a relative disappointment. This
becomes even more apparent when compared to
the per capita growth rates seen elsewhere in the
emerging world.
During this decade, the mining sector witnessed
diverse performance. A number of sub-sectors such
as platinum group metals posted solid
performances. But the gradual decline in gold
production was a major drag on growth, as
profitability fell due the maturity of mines and
more costly health and safety regulations. (See
Chart 15.)
CHART 15: GDP BY INDUSTRY (%-PT CONTRIBUTION)
1994 1996 1998 2000 2002 2004 2006 2008 2010
-3
-2
-1
0
1
2
3
4
5
6
7
-3
-2
-1
0
1
2
3
4
5
6
7
Manufacturing Mining Services
Sources Thomson Datastream, Capital Economics
Instead, the major driver of growth was the
services sector, as the supply of increasingly
sophisticated financial services was finally able to
keep pace with demand, as South Africa reaped
the benefits of being re-integrated into the global
financial system.

2005 2008: a turnaround in performance
In marked contrast, between 2005 and 2008
average annual growth rose to 5%. Some
commentators have attributed this to the boom in
global commodity prices during these years.
Indeed, it is true that South Africa is a net exporter
of commodities. Furthermore, all three of South
Africas major commodities - platinum, gold and
iron ore - witnessed rapid price rises during this
period. (See Table 4.)
TABLE 4: COMMODITY PRICES (YEARLY AVERAGE)
2005 2006 2007 2008
Gold (US$/oz) 449.0 614.1 705.3 874.3
Platinum
(US$/oz)
901.5 1151.1 1320.7 1615.4
Iron Ore
(US$/mt)
28.8 34.3 37.6 63.2
Source Bloomberg
However, a frequently misunderstood point is that
a change in commodity prices a rise in commodity
prices is a price effect rather than a real effect.
Therefore, it has no direct impact on real GDP
whatsoever.
Of course, that is not to say that South Africa hasnt
benefitted from higher commodity prices. After all,
it earned more from exports in these years than
had previously been the case. In economic jargon,
its terms of trade improved.
Between 2005 and 2008, export revenues from the
three largest commodity groups increased by a
cumulative US$50bn. Of this, we have calculated
that US$17bn can be attributed to price increases.
The implication of this extra income is that South
Africa was able to spend more.
However, we must also account for the fact that
South Africa is a net oil importer. From 2005 to
2008, oil prices also rose dramatically. Repeating
our calculations, we estimate that South Africa
imported a cumulative US$9bn worth of oil due to
price rises. On balance then, we estimate that, as
a result of the 2005 to 2008 commodities boom,
South African net income increased by a
cumulative US$8bn.

Africa Economics Focus 12
Who benefits?
The boost to welfare from higher commodity prices
has spread into the wider economy through three
channels. Firstly, the income of mining companies
will have increased, meaning that wages paid to
workers and dividends paid to shareholders have
risen. Secondly, extra income will have passed into
the wider economy by being spent on other orders,
such as construction or machinery to more general
service providers. Thirdly, the government has
benefitted, as it imposes a 28% mining tax rate.
Given that the government mostly spends
revenues, we can assume that this has translated
into higher demand. However, we must also
account for the fact that mining firms are likely to
repatriate a large share of their profits, and also at
least some of the boost in demand would seep into
imports. In fact, South Africa has a marginal
propensity to import of about 30%. Taking these
various factors into account, we calculate that,
between 2005 and 2008, the commodities boom
added roughly US$4bn to domestic demand.
Boost to domestic demand
The impact of this boost to demand on the real
economy is dependent on South Africas supply
constraints. If the economy was operating at full
capacity, firms would be unable to increase
production to response to extra demand. Instead,
increased demand would simply be inflationary.
But if there was spare capacity, then the boost to
demand could elicit an increase in domestic
production and thus increase real GDP.
Measuring the extent of spare capacity is difficult,
but on balance it does seem as though the post-
apartheid decade of tepid growth, relatively low
inflation and rising unemployment left a significant
amount of spare capacity in the economy. As a
result, there is no reason to believe that capacity
constraints would have prevented output from
increasing as a result of increased demand.
Using the GDP deflator, we have calculated that
the real value of the increase in domestic demand
between 2005 and 2008 is around US$3bn. At the
same time, real GDP increased by a cumulative
US$22bn. This implies that just under one-seventh
of real GDP growth from 2005-2008 can be
attributed to the impact of higher commodity
prices.
In other words, had commodity prices remained
stable between 2005 and 2008, South African real
GDP growth would have averaged something like
4.2%, instead of the 5% it actually managed.
This is a substantial contribution, but it is by no
means overwhelming. Clearly, other factors were
at work. After all, growth of 4.2% would still have
been higher than 3%. A look at contributions to
GDP growth by expenditure during this period
reveals that investment played a considerably more
prominent role than had previously been the case.
Between 1994 and 2004, investment made an
average annual contribution of under 1%-pt. But
from 2005 to 2008, it accounted for over 2%-pts
per annum. (See Chart 16.)
CHART 16: REAL GDP & INVESTMENT
1997 1999 2001 2003 2005 2007
-1
0
1
2
3
4
5
6
-1
0
1
2
3
4
5
6
Real GDP (% y/y)
Investment (% -pt contribution)
Sources Thomson Datastream, Capital Economics
Alongside this, the current account deficit widened
markedly. After years of remaining roughly in
balance, the deficit ballooned to 7% of GDP by
2008. This suggests that much of the increased
investment activity during the boom years was
being funded from overseas. A look at the
breakdown of South Africas capital and financial
accounts shows how the current account deficit
was being financed. (See Chart 17.) In line with the
broader appetite for riskier emerging market assets
during this period, much of the financing came
from foreign portfolio investors piling into South
African bonds and equities.

Africa Economics Focus 13
CHART 17: NET CAPITAL INFLOWS (ZAR BN, 12M SUM)
2004 2005 2006 2007 2008
-60
-40
-20
0
20
40
60
80
-60
-40
-20
0
20
40
60
80
Portfolio
Other
FDI
Sources Thomson Datastream, Capital Economics
Additionally, there was a clear uptick in other
investment. This is especially true from 2006
onwards, with a notable surge occurring from mid-
2007. Included in the other investment
category is banking flows, the counterpart to
which is the amount of external debt held by the
banking sector. (See Chart 18.)
CHART 18: SHORT-TERM EXTERNAL DEBT (US$BN)
0
5
10
15
20
25
30
0
5
10
15
20
25
30
2003 2004 2005 2006 2007 2008
Other institutions
Banking sector
Sources IMF, Capital Economics
There is ample evidence here that the sector took
on increased levels of short-term debt from
overseas, rising from around US$7bn in 2004 to
almost US$20bn by 2008. In other words, banks
were borrowing from abroad to finance loans for
local investment and consumption.
Clearly, the composition of external financing was
heavily skewed towards short-term inflows. These
tend to be volatile in nature, and can easily dry up
or reverse direction in the case of a deteriorating
external environment. In the case of a protracted
global downturn, this left the South African
economy highly vulnerable to going from boom to
bust.
2009 2011: small recession, sluggish recovery
Therefore, it comes as no surprise that South Africa
slipped into recession in 2008-09, as commodity
prices crashed and capital inflows reversed.
However, although the economy contracted by
1.8% in 2009, South Africas recession was not as
severe as a number of other commodity producing
emerging economies. For example, neighbouring
Botswana, the worlds largest diamond exporter,
suffered a recession of nearly 5% of GDP. Further
afield, the oil-rich Russian economy contracted by
almost 8%.
Perhaps more worrying is the fact that, in
comparison to some of its emerging market peers,
South Africas recovery since 2009 has been
lethargic. (See Chart 19.) Admittedly, the headline
growth numbers arent a huge cause for concern.
GDP expanded by 2.9% in 2010 and 3.1% in
2011. But, the crucial point is that this recovery
has been uneven, with an over-reliance on
household consumption. Indeed, investment and
export levels are yet to reach their pre-crisis peaks.
CHART 19: GDP (SEASONALLY ADJUSTED, Q1 2008 = 100)
90
95
100
105
110
115
90
95
100
105
110
115
2008 2009 2010 2011
Poland
Brazil
South Africa
Sources Thomson Datastream, Capital Economics
Overall then, it is fair to conclude that,
notwithstanding the commodities and foreign
investment driven boom of 2005 to 2008, since
1994 South African growth has been
disappointing.