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From chimera to prospect: South African sources of and constraints on long-term growth, 1970-2000

Policy Paper 01

The paper takes stock of South Africa’s past growth experience during the period 1970-2000. It discuses major factors of growth, including physical and human capital, and institutions, and draws conclusions about the constraints to long-run growth in the future. We highlight three main conclusions on physical capital and uncertainty, market distortions (especially in labor markets), and human capital accumulation.

First, empirically, one of the main reasons for South Africa’s structurally declining growth rate is its declining investment rate in fixed capital. Investment in South Africa, as elsewhere, responds positively to the rate of return on capital and negatively to the real user cost of capital, thereby providing policy makers with some immediate policy levers. But a key determinant of investment appears to be uncertainty, especially uncertainty that arises from institutional constraints on economic performance. For example, uncertainty in South Africa proves to be crucial not only for investment in physical capital stock, but also for capital flows required in meeting the shortfall of private sector savings relative to private sector investment. Uncertainty affects investment both directly and indirectly, by lowering the effectiveness of the policy levers that the rate of return on capital and the user cost of capital provide.
Second, despite considerable liberalization since 1994, there remain significant market distortions in the South African economy in capital, labor, and output markets, including external trade. Much remains to be done to improve microeconomic policies and the efficiency of resource allocation. A continued, high level of market concentration and related market power in output markets, as well as incomplete trade liberalization remains a concern in an increasingly globalized and competitive world. But perhaps the most enduring concern remains the now well-documented distortions in the labor markets. These distortions pose real constraints to long term, labor-absorbing, equitable growth. To alleviate these constraints and engender more robust and widely shared growth, concerted microeconomic reforms are needed.

Third, the impact of human capital on growth reflects the twin combination of a declining contribution of human capital accumulation to growth and a declining quality of education. While much has been accomplished to widen and equalize access to education across racial groups, quality of education has suffered. Even the best parts of the schooling and university systems do not seem to produce the sort of educational output required for long term economic growth in sufficient quantity — yet they do so at a relatively high cost.

The main policy implications are threefold: (1) South Afica needs to further reduce remaining uncertainty and engender credible, overall policy environment and favorable climate for private sector investment and growth; (2) further microeconomic and regulatory reforms are needed to reduce market concentration and remaining distortions, especially in labor markets and international trade; and (3) while continued emphasis on broad-based education is very much needed to help eliminate the past inequities, strong reforms to monitor and improve the quality of education must also be put in place.

Policy Paper 01
1 January 2006
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