Cablegate: South Africa: Mbeki Economic Advisor Outlines The

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UNCLAS SECTION 01 OF 02 PRETORIA 004809

SIPDIS

SENSITIVE BUT UNCLASSIFIED

E.O. 12958: N/A
TAGS: ECON ETRD SF
SUBJECT: SOUTH AFRICA: MBEKI ECONOMIC ADVISOR OUTLINES THE
PATH AHEAD

1. (U) Summary. Alan Hirsch, Chief Director for Economic
Policy Coordination and Advisory Services in the South
African Presidency, met with members of the Southern African
Regional Poverty Network on October 7 to discuss South
Africa's growth path in the decade ahead. Hirsch said that
over the next five years, the Economics and Employment
Cluster in the Cabinet would continue policies that supported
macroeconomic stability, but introduce new policies to raise
the level of private investment in infrastructure to lower
the factor cost of production and improve the country's
competitiveness. Deep government intervention was required
to avoid creating a cycle of dependency on government grants
for the nation's poor. End Summary.

2. (U) Hirsch opened his presentation by recounting that in
January, after the Government published its Ten Year Review,
the Cabinet undertook extensive discussions on what was
needed to grow and develop the economy. The government had
plenty to feel good about. Under ANC leadership, South
Africa had achieved macroeconomic stability and the longest
period of growth since the 1940s (when GDP was first
recorded). South Africa also enjoyed its lowest inflation
since 1959 (as measured by CPI) and its lowest interest rates
in 23 years. Since the political transition in 1994, GDP
growth had stayed positive, averaging 2.8% per year, close to
what the major advanced countries were experiencing, but
lower than the average for all developed countries (a
statistic skewed by the inclusion of a booming China).
Hirsch noted that during this ten-year period, the government
had managed to raise social expenditures from 44.42% to
56.72% of the budget, and reduce public sector debt to below
50% of the budget. Nonetheless, the Cabinet saw that 3.4
million South African households, about 35-40% of the
population, were still living in poverty. Moreover,
unemployment had actually grown during the last ten years
from 16% to 32% due to new entrants to the labor market
(official unemployment is now 29%).

3. (SBU) Hirsch said that Cabinet discussions about what to
do about reducing high unemployment and poverty continued
after the national elections in April. The new Cabinet
wanted to know why South Africa was not growing fast enough
to improve the welfare of its poor population. According to
Hirsch, Foreign Minister Nkosazana Dlamini-Zuma demanded to
know why South Africa did not achieve 6% GDP growth by the
end of the 1990s, as envisioned under previous economic
plans. President Thabo Mbeki replied that the country could
have grown faster, but at the expense of marginalizing more
of its population. The government's strategic objective now,
as enumerated by the African National Congress' election
manifesto, was to cut poverty and unemployment in half by
2014.

4. (U) Hirsch said that the most telling weaknesses of the
government's effort from a macroeconomic perspective was its
performance on investment, job creation, and economic growth
when compared to countries at a similar level of development.
He said that private sector investment had declined from
16-17% to 12-13% of GDP over the past ten years and public
sector investment had declined from 7-8% to a low of 2% of
GDP -- although this increased to 4% of GDP in 2003. He
recollected that gross fixed capital formation was 25% of GDP
in 1980, the last time the country saw a growth rate of 6%.
Since 1992, however, gross fixed capital formation had
leveled off to 15-16% of GDP, producing an average growth of
around 3%. The question he posed was "Why did public and
private investment fall from 1994 onwards?" He attributed
this to government's preoccupation with transforming itself
from being white dominated to black dominated, with economic
restructuring, and to a lack of government confidence. He
said that the ANC government feared making too large a
commitment on the expenditure side for social services and
then not being able to pay for it. Hirsch noted the
efficiency of investment improved after 1994 (with capital
intensive oriented investment) and economic growth improved
somewhat, but it did not lead to greater employment.

5. (U) Hirsch believed that the major constraints on
investment during the last ten years included the country's
relatively high cost of capital, exchange rate volatility,
uncontrolled inflation, a low government investment rate, and
the country's relatively low growth rate. By 2004, most of
these constraints were no longer important, yet investment as
a percentage of GDP continued to be low. Hirsch believed
that this phenomenon had to do with misperceptions about
South Africa. These included that South Africa faced
instability due to income equality among its people and the
lack of social cohesion. Another misperception was
uncertainty about the government's will and capacity to
resolve social problems. Hirsch said that many in business
held negative viewpoints about crime, active labor unions,
and "whites under siege" in South Africa. The government's
apparent protection of Zimbabwe did not help this. Finally,
Hirsch thought that some investors had a "gut feel" or "sixth
sense" that South Africa was destined to fail. This, he
thought, revolved around a lack of trust between the business
and ruling classes arising from a cultural gulf between the
political and economic elite. For this reason, it was
important to establish an organization like the National
Economic Development and Labor Council (NEDLAC) and
Presidential working groups with industry to be established.

6. (U) Hirsch said that the government's main focus now was
to increase the rate of investment. The goal was to reach
gross capital formation of over 25% of GDP by 2015. To do
this, the government would increase public sector investment
to R267 billion over the Medium Term Economic Framework and
reinforce its efforts to win over both foreign and domestic
investors. He said that monetary stability and successful
inflation targeting had led to lower interest rates, and that
would help. What remained was to arrive at a competitive and
stable foreign exchange rate, which he viewed as currently
"mispriced."

7. (U) At the microeconomic level, the government would
target priority growth and labor absorbing sectors, such as
agriculture, tourism, crafts, telecommunications,
mining/metals, clothing/textiles, chemicals, biotech,
automobile manufacturing, transportation, as well as
services. To support growth in these sectors, government
would improve infrastructure in transportation, energy,
water, and telecommunications. In this respect, Hirsch
admitted that there had been a change of philosophy around
state owned enterprises; they would now be employed to lead
investment. A concern was that the delivery of many
infrastructure-related services were managed by local
municipalities, where there was a lack of capacity and
something had to be done. Hirsch said that the government
would continue undertake what he termed "crosscutting
interventions" to promote black economic empowerment, reduce
income inequality, and counter investor pessimism.

8. (U) Hirsch went on to discuss South Africa's "second
economy," the one that "is peripheral of the cities and
towns, and in deep rural areas." He said that one-third of
South African households essentially lived outside the
system. Poverty and exclusion were leading to rapidly
growing demands for public services and transfer payments.
If things did not change, social transfers would grow to the
point where the government could no longer afford them, and
the result could lead to social conflict. Resolving such
problems required deep government intervention.

9. (U) Hirsch said that social investment had grown to about
10% of GDP over the past ten years. At the same time, social
transfers went from 1.5% to 4% of GDP. Among the major
movers in this category were child support grants and
disability payments. Government had to do something to break
the growing demand and dependency on social grants.
Government had to eliminate extreme poverty and at the same
time ensure easy mobility to the country's first economy.

10. (U) The government's second economy strategy included
creating temporary work opportunities combined with skills
and infrastructure development. The government would also
focus on home and child services, healthcare and health
education, intense skills development, adult basic education
and training, and increasing access to capital for small
businesspersons. To be successful, he thought that there
would have to be more of a two-way flow of information
between government and people in the communities affected.

11. (SBU) Comment: Hirsch's overview was heartening in the
sense that he grounded the government's economic program in
realism. The insight that he provided into government
thinking revealed a Cabinet that was growing impatient with
high unemployment, low growth, and the government's failure
to merge the country's first and second economies. The
Cabinet does not believe that the private sector acting alone
can deliver what it needs. Privatization will stay on the
back burner while the government employs its parastatals to
manage and invest in large-scale infrastructure programs
designed to foster targeted investment, growth, and
employment. Some may question this tack, given that the
country's parastatals have consumed more fixed capital than
they have created over the past ten years, and are
increasingly criticized for ineptitude. Interestingly,
Hirsch made no mention of trade policy in his presentation.
FRAZER

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