South Africa’s Sources of Growth (or Decline)

I have an assignment about South Africa coming up for my class Growth and Development Economics. The goal is to analyse South Africa’s growth and development performance in the past decade  and to assess the role of institutional development in the country’s growth process.

South Africa was officially invited to join the BRICS (Brazil, Russia, India, China) in 2010. This term used to group together the fastest-growing emerging economies. However, Brazil and Russia have been hit by recessions lately, China’s economy is slowing down, and India is struggling to pass important economic reforms (Foroohar, 2015). South Africa is no exception and faces a range of challenges: Skills shortages, high unemployment, inflation and inadequate infrastructure (mainly constrained electricity supply) have dampened the country’s prospects. Also issues such as high income inequality and political stability play a key role (EIU, 2015).

Before actually starting my essay and as a nice exercise for today, I decided to produce an overview on South Africa’s economic performance from 1960 to 2011. I deploy the Penn World Tables 8.1 – in particular, the Growth Accounting Data for South Africa – for the analysis. The standard production function used in the Penn Dataset is:

Y = A f (K, L) = A Kα (E hc)1−α

where HC stands for human capital (education) and E represents the number of workers in the economy (Inklaar and Timmer, 2013). By definition GDP increases if there is an increase in capital, increase in labour or increase in human capital. As these factors alone would be inadequate to explain sustained long-run economic growth (see basic and augmented Solow growth model), it is assumed to be Total Factor Productivity (A) which allows economies to grow in the long run. This production function can then be rearranged to the growth accounting equation which I’ll use to assess South Africa’s performance shortly. I don’t want to go too much into detail here but the growth accounting framework merely states that output growth per worker can be decomposed into growth in physical capital per worker, human capital and growth in total factor productivity (measured as residual because it is not observed).

South Africa Sources of Growth

The diagram above includes the three key elements of the sources of growth in addition to real GDP per worker* which is measured at constant national prices and stated in 2005 US$. Firstly, there is total factor productivity at constant national prices and indexed at 2005=1. The second element on the vertical primary axis is the Human Capital per person which is based on years of schooling (Barro/Lee, 2012) and returns to education (Psacharopoulos, 1994). On the secondary vertical axis we have capital stock per worker**. I chose per worker figures for convenience. Also, when using real GDP and capital stock without accounting for changes in the labour force, I end up with the somewhat misleading diagram below:

South Africa Sources of Growth 1.png

So, what can be inferred from the first diagram? Total factor productivity has actually declined on average since the 1970s. What is more, it relatively closely matches changes in GDP over time. This supports the assumption that TFP is a major determinant of long-run economic growth. From 1984 the capital stock per worker starts to plunge dramatically until the end of 2002. Since then it has increased again rapidly. One potential explanation are the government’s white elephant projects. These are uneconomic large-scale infrastructure projects with the goal to stimulate FDI and generate returns exceeding the initial investment (Saul and Bond, 2014). However, due to corruption and mismanagement, these projects may have only increased total physical capital per worker while failing to spur the economy. Lastly, South Africa experienced large improvements in human capital per person from the beginning of 1986 to 1995. After a subsequent drop it reached its 1995-level of human capital per person in 2007 again. It seems that there was a re-orientation from investment in physical capital to investment in human capital in the 1980s to 1990s. Overall, the diagram clearly shows that the impressive growth in physical and human capital per person failed to result in similar growth rates in output per person. It may well be that low factor productivity dampens the transmission mechanism between investment in physical and human capital and the South African economy’s output. In short, South Africa will likely need to re-orientate towards enhancing its productivity rather than accumulating more and more capital stock per worker which does not seem to add much value.

Thanks for reading my post today!

Jasse


*Real GDP at constant 2005 national prices (in mil. 2005US$)/Number of persons engaged (in millions)

**Capital stock at constant 2005 national prices (in mil. 2005US$)/Number of persons engaged (in millions)

EIU (2015). Country Report South Africa September 2015. London: The Economist Intelligence Unit N.A., Incorporated.

Feenstra, Robert C., Inklaar, R., and Timmer,M.P.  (2015). The Next Generation of the Penn World Table, forthcoming American Economic Review, available for download at http://www.ggdc.net/pwt

Foroohar, R. (2015). Why the Mighty BRIC Nations Have Finally Broken. [online] Available at: http://time.com/4106094/goldman-sachs-brics/

Inklaar, R. and Timmer, M.P. (2013). Capital, labor and TFP in PWT8.0. Groningen: Groningen Growth and Development Centre, University of Groningen July 2013.

Saul, J. S., and Bond, P. (2014). South Africa, the present as history: from Mrs Ples to Mandela & Marikana. Woodbridge, Suffolk, James Currey.

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