Growth Through Inclusion in South Africa with Ricardo Hausmann

DISCLAIMER: This webinar transcript was loosely edited and there may be inaccuracies.

Moderator: Welcome to the Growth Lab podcast.

The Growth Lab at Harvard Kennedy School is a research program that pushes the frontiers of economic growth and development policy research by collaborating with policymakers to design actions and sharing insights through teaching tools and publications.

Today's episode is part of our South Africa Growth Through Inclusion series which takes a deeper dive into our two-year research engagement in South Africa.

If you'd like to learn more about this work or download the full report, visit our website at growthlab.hks.harvard.edu.

Andres Fortunato: In 1994 South Africa ended apartheid and created a democracy. At the time, the country supported the 47th most complex economy in the world. Far ahead of any other African nation. There were good reasons to believe that the economy would grow rapidly and opportunities would expand to South Africans previously excluded by apartheid. Fast forward to 2023 and South Africa has become less complex when compared to the rest of the world. Jobs are scarce, economic growth is low and highly vulnerable and inequality is the highest globally. Though government policies have dismantled many apartheid institutions, these efforts have not created an inclusive economy for the majority.

In 2021 the Growth Lab at Harvard University started a two year research project in South Africa in collaboration with the National Treasury of South Africa and the Center for Development and Enterprise. This project was focused on understanding the root causes of the country's economic hurdles and potential pathways towards inclusive growth. My name is Andres Fortunato and I am a research fellow here at the Growth Lab. I was part of the South Africa project and today I have the pleasure of interviewing my boss Ricardo Hausmann, the founder and Director of Harvard's Growth Lab and the Rafik Hadidi, professor of Practice in international political Economy at Harvard Kennedy School. This is the first episode of a podcast series about South Africa. And in this episode, we will summarize the key takeaways of our research project.

Ricardo, I wanted to start by asking you about your decades long experience in South Africa. Your first project there was in 2004, right? So what were the main economic problems back then?

Ricardo Hausmann: So back in 2004, I was asked to chair an international advisory panel because the government had adopted something that they call the accelerated and shared growth initiative of South Africa that were the acronyms, and they asked us to give them a broad view as as to, you know, what were the issues and, and what they should be focusing on. And I put together a really remarkable group.

We had Dani Rodrik, we had Philip Aguon, Abhijit Banerjee. We had Robert Lawrence, we had Matt Andrews. We have areally interesting group of scholars, Jim Robinson. And we, we looked across the board, obviously, they had very, very high unemployment and we asked ourselves to avoid the unemployment problems.

Where were they coming from? But in general, that, that was a very hopeful period. commodity prices were high, the economy was, was improving in its performance. Unemployment was very high, but coming down. And so it, it looked like, you know, things were going in the right direction and the question is how could they go even in a better direction? And, and we had a, a bunch of ideas that we shared at the time. I remember our final report I presented to Parliament in 2008 in a big act in parliament. It was, it was a super fun experience.

Andres: You started the second Growth Lab project in 2021. What had changed then?

Ricardo: With respect to the first project, that's a very interesting question because the atmosphere could not have been more different. Actually the macroeconomic paper that we wrote in the first period together with Federico Sarne, who was at the time, a faculty at the, at the Kennedy School and then became the Governor of the Central Bank of Argentina. The macro paper was called macroeconomic Challenges after a decade of success. And in the second involvement, they asked us to write an update on that report. And so we thought, OK, so let's do, let's revisit those issues. But we couldn't use the term macroeconomic challenges after a decade of success because that the previous decade was no success. So, it was really trying to explain why macro performance had been so lousy, why had growth decelerated so much? Why had income per capita been falling? Why unemployment had risen even, you know, significantly more. And so that, that already tells us, you know, that the issues have changed, the hopefulness had gone. And the economy was performing very poorly.

Andres: And in this updated paper, in the second project, what were the main takeaways? And what were your answers to those questions of life?

Ricardo: So when we try to answer the question of why was the economy performing so poorly? I mean, the standard answers that people suggested were, you know, first of all kind of bad luck, you know, commodity prices fell, you know, international financial markets behave more indifferently, et cetera. So, external causes and what we found is that the external causes explain a very, a relatively small fraction of the worsening performance, and you know, South Africa underperformed vis a vis other countries that also suffered the same kinds of shocks. So we thought that yes, you know, sometimes you have the wind in your back, sometimes you have the wind up front. But, but how much does the wind affect you,, might say more about you? And, and so we thought that no, that the causes were fundamentally internal. So we started asking ourselves, well, was there macro mismanagement? Were they just not a adopting the right macro policies? And so we did a deep dive into the macro policies that they had adopted both on the fiscal and on the monetary side. And we found that they were not the culprits and they were, if anything, the victims that a fiscal policy had been hurt by the decelerating growth, And that that, that has eaten, had eaten into, into tax revenues that a growth had been below expectations. So the government also made mistakes because the economy surprised always on the downside. But that you know, people are blaming fiscal policy for being too austere, but that was not the problem because if anything, the, the debt to GDP ratio went from the thirties percent of GDP range to the 70% of GDP range. And and it had not stimulated growth.

We did some fiscal multiplier calculations to show that actually, the multipliers of fiscal policy, that is the impact of fiscal policy on growth instead of being positive was actually negative that the impact of fiscal policy on worsening credit conditions, declining credit ratings, widening country risk had raised the cost of capital to the whole economy and that had had more negative effects than any stimulus demand stimulus on, on the positive side. But more importantly, we realized that something else that the government was underperform in some areas, for example, electricity and that lower electricity had explained about half of the deceleration of growth. And it had also explained in part the the worsening of the fiscal accounts because there had been several bailouts of the electricity company. And there has been more bailout since since we wrote that that paper. So we called it a macroeconomic challenges after the decade of microeconomic turbulence because it was all these micro things that had really damaged the economy.

Andres: Now, we just published yesterday, the final report of the South Africa project we started in 2021. What do you think expands that initial paper? What new answers do we find? What new questions do we find? And what are the root causes in the in South Africa's economic underperformance that we describe in that final report?

Ricardo: Well, the report says, look, there are here two kinds of issues. One kind of issue is what explains the deterioration vis a vis a 15 years ago. And the other one tries to explain, you know, what are the structural constraints that you know, before in the happy days and now in the Saturdays in both periods, South Africa was under. So to explain the deceleration, we say that the culprit is what we call collapsing state capacity that you have an economy, a fairly sophisticated economy. It depended on having a competent state able to provide the electricity that it had committed to provide.

The rail transport that is important for a mining company, a mining country like South Africa, the passenger rail that was important to bring workers to to their places of work ports that was important to bring stuff out and, and, and, and bring stuff in telecoms security, municipal governments, water, they were all deteriorating at an astonishing rate. And so we documented that this was really hurting the economy. Broadly. The electricity issue was particularly important because all of South Africa's comparative advantage was built on the availability of cheap reliable coal fired electricity and the electricity company was in a tailspin.

It was they started rationing electricity something that in South Africa they call load shedding, but it's like planned blackouts and they went from something like two hours a day in 2007 to something like 20 hours a day in, in this, in some, in some periods this last year. So for an economy whose comparative advantage had been based on, on electricity, suddenly having electricity no longer be either cheap or reliable meant a huge shock to, to to the economy. And in a paper that you wrote, you show that manufacturing employment had underperformed particularly dramatically even considering the fact that manufacturing employment has declined worldwide as a share of total employment. But South Africa's decline of manufacturing employment is orders of magnitude bigger than, than expected. And and that also, even though the whole policy of the government was very much industrial policy focus, they wanted to push manufacturing and so on. But the policy had not delivered on those, on those aspirations. And your paper kind of shows that it is electricity because the industries that were more dependent on electricity performed worse. And that's kind of like a telltale evidence that electricity played a big role in there. So, but you know, we could say the same thing about all these other areas of government malfunction. So we have to ask ourselves the question, how come a government that knows how to deliver cheap electricity, that knows how to deliver more water in more places suddenly loses that capacity. How, how could state capacity be declining? I mean, there's no war is is. So what is the process? And, and we thought that some attempts to use the state to do more right at the time when the state's capability was diminishing. So you have in some sense, this excessive load bearing, where you put more responsibility on the, on the state when the state is losing capability.

So it kind of like implodes and the more responsibility that was put on the state is that the state was told you not only have to deliver all these things that you promise to deliver, but you have now to deliver them in a way that transforms society that gives more opportunities to of affirmative action they would call in the US. And, and these affirmative action policies translated especially in preferential procurement, I think got out of control. There are different ways of preferential procurement in South Africa. And some of them have to do with the rules procurement rules that were imposed in different legal instruments and so on. So I I'm not going to go into the details, but essentially you, you were told the government, OK. Now you, I want you to prove more to do more, but I'm gonna tie your hands in terms of who you can, can buy stuff from. I'm gonna tie a bit of your hands on who you can hire and, and that combination ended up being much, much more costly than people expected it to be.

The second thing is that, you know why the ANC is a single party has been empowered. It's really many constituencies that have very different views and, and there has been gridlock among, among the the members of the coalition. So a lot of the of, of the problems are, you know, the situation is deteriorating but you cannot agree on a solution. So a case in point is a case of electricity, it was obvious that the electricity sector was malfunctioning w worse and worse. But, but they could not agree on a course of action because some were more status, other were more market oriented and they could not agree and they didn't need to agree because they didn't fear necessarily that they were going to lose an election because there's nothing that disciplines more a political party than the perception that their hold of power is at stake. And that was never sort of like a dominant fear. So it allowed for this difficulty making decisions to, to, to, to endure and to, there was a lot of procrastination because there was not enough political discipline on the process. A third one is ideology. There is a dominant ideology that, that wants to see the state perform certain functions. And when they mean the state perform certain functions, they also mean using the coercive power of a state to prevent others to perform that function. So, well, you might say you know, yeah, electricity has to be produced by the state. But, and you say, well, can you let me produce some electricity? So, no, no, you can't or so it took, you know, years and years of of load shedding of these these blackouts for them to authorize the private sector to build some generation capacity. And you know, the same problem occurs in rail and in a bunch of other areas. So ideology, I think is at stake and finally, there's just corruption and capture and so on that, they call it state capture in South Africa that also played a role and in some sense, it was partly enabled by the fact that these preferential procurement rules gave preference to to some kinds of entrepreneurs. They call them interestingly in South Africa tenderpreneurs which are people who, who are specialized in tendering for state procurement only to, to then sell you know, subcontract or, or try to keep as much money and maybe default on, on those on, on those contracts. So it also corrupted the whole, the whole structure. So our perception was that the dynamics of the deterioration had to do with the deteriorating state capacity. And at the core of the deteriorating state capacity is these four interacting dynamics that I've just mentioned.

Andres: I also wanted to cover the second big topic that we address in the report, which is spatial inclusion. Could you describe and explain what do we mean by special inclusion? And why is it a problem in South Africa?

Ricardo: Well, a lot of people had looked into South Africa's labor market and, you know, labor economists are always going to mention things like minimum wage legislation or unions or skills, etcetera. But, and, and we acknowledge all of all of those discussions of South Africa, but we noticed that space played a really, really interesting role that we did not expect it to play. And since we have done a lot of work on Mexico, we had data on Mexico. it occurred to us that, you know, it was cheap for us to compare how South Africa looks with what, how Mexico looks. And in South Africa, in Mexico, in some sense, you can imagine it, it could be a country that's somewhat similar to South Africa in the sense that it's a multi ethnic place where there are some communities that speak different languages. You know, South Africa has 11 official languages. I think Mexico has like 100 and 60 different indigenous languages. So there are some municipalities that are indigenous and, and where people speak Spanish as a second language. And, and there are some municipalities that are, are more more you know, Spanish speaking and there's large differences in income between different, these different municipalities. But what there is is differences in employment rate by LA South African standards, employment rates are incredibly homogeneous in Mexico and incredibly high in South Africa. They are much, much smaller on average and they are much, much more unequal.

So for example, in the rural regions of what they call now, former homelands, it used to be called Bantustans. These areas where Apartheid had tried to concentrate the African population or the black population in those areas in those rural areas, employment rates are ridiculously low are, you know, they're, they're in the low 20% rate of the working age population which is about half or less than half of, of the, the national average. So, and in other parts, they look like Mexico. So really, it spans on enormous inequality. And then we try to ask ourselves how come and we found two kinds of spatial issues. One kind of spatial issue is happening inside cities where the logic of apartheid was to put a black people very far away from the central business district where the white people live. So, so they put people very far apart and very far apart in very low density communities in the last 30 years since the end of apartheid housing policies. Have kept a little bit the flavor of the previous policies. They think of themselves as being very generous in giving people significantly large plots of land in, in houses that are fairly decent in terms of size and, and infrastructure, but in godforsaken places and that means that commute distances are very large. But in addition, since these places are super low density where these houses are built, then there is no dense communication between areas. And consequently urban transport solution like metros or bus, bus, rapid transit are not the solution for most people. They, they use these mini buses called taxis. And that makes transport relatively expensive. And in addition, the low densities of these residential areas makes it hard for people to dedicate themselves to the informal economy.

Many say people in Mexico would, would live in the would not go to work very far away, stay around their home and do activities in their home and sell to their neighbors. But since these places are relatively dense, you have many neighbors and there's a lot of foot traffic, there's a, a local market. We find that in, in places where these dismally low employment rates, people live too far from each other to have any local market. And so there's no informal employment. So it's very hard to get to formal jobs and it's very unproductive to, to work from home and sell to your neighbors because of the low densities. And those two things explain in our mind why the why cities are so inefficient as places where workers find jobs and firms find workers.

So that was one dimension, that was an urban dimension, but it also had a rural dimension. And we found that in these former homelands, you know, road densities were dramatically lower than elsewhere 30 years after apartheid, in part, because these municipalities that are responsible for responsible for these local roads also have, are very weak and they were given extra powers in the year 2000. But but they were not given, they were not set for success and they have been also imploring their role in in serious financial trouble with very, very poor provision of services. And and so, these places are quite disconnected and they're disconnected physically but they also disconnected economically. So, those disconnections, I think make South Africa,  so unequal.

Andres: Lastly, I also wanted to ask you, how can South Africa recover a path of sustainable economic growth? And what are the key areas of opportunity for the country to achieve that?

Ricardo: I think you know, we need ideas for, for the recovery of state capacity. We have some ideas on what to do with space. We think that in space there's a win, win possibility. because we think densification is, is a way to go to have more compact cities that, where people will be able to live closer to where the jobs are. We think that we can get there by empowering people with the right to live closer to their work that goes to, you know, policies that restrict or affect land use. So you know, urban density is regulated to be very minimal. And if you regulate urban density, the poor cannot outcompete the rich for, for land because one way in which the poor cannot compete, the rich is if they build higher. So, you know, they amortize the cost of the land by building more floors on that land. And that allows them to have maybe smaller apartments, better located apartments closer to jobs. And actually, that's what, what South Africans do when they are allowed to vote with their money or with their feet. But the, but the regulation is pushing in the opposite direction. It's encouraging urban sprawl very far away places. That means commute, times are very long, commute costs are very high, both direct costs and indirect costs. And and it makes it makes for a very inefficient labor market.

So, so we think that with a new urban strategy, there will have to be a lot of new construction and that new construction is going to generate jobs in the short run, but it's going to generate more, more efficient and inclusive cities in the medium to long run. So that's one idea there. But we also looked into something we call green growth and green growth is not just about you know, focusing on what can you do to lower your emissions. It's really about thinking of the world and the emissions problem of the world and producing things that will lower global emissions. So a world that wants to decarbonize, it's a world that's going to need a lot of stuff. So we try to map out what is the stuff that the world is going to need. And from those things that the world is going to need, which ones are closest to South Africa's capabilities. And that's one thing that we try to pan out. And we found very interesting growth ideas in the space of, you know, producing things that will allow the rest of the world to decarbonize, you know, there is critical minerals in, in South Africa. They have mastered some, some of these critical minerals are critical for, for the membranes and the catalyst that go into fuel cells that go into electrolyzes that go into batteries. They have they are exploring new technologies of this thing that they call redox flow batteries that are good for grid scale storage of electricity. They're exploring these ideas using vanadium. They happen to have vanadium, they're a vanadium producer. And that's one kind of of green growth opportunities.

A second kind of green growth opportunities is based on the idea that we think that in a, in a decarbonizing world, energy, green energy is going to be very hard to move. So there are going to be very strong market incentives to use the energy where it's being produced. And and I if you happen to have a lot of sun and a lot of wind as South Africa happens to have, then you could potentially produce very competitive electricity. And that we want that to use that to attract investments away from places that are currently producing a lot of energy intensive things. But importing gray energy like Japan, Korea, Germany and so on those industries, if they are going to decarbonize, they will have to relocate to a green sources of cheap competitive sources of green energy. And I think that's a, a growth opportunity theme for South Africa. So we end up in a pretty positive note in the sense that we think the last decade, it hasn't been a good one but the next decade, we could turn the situation around. So I think it's an optimistic an optimistic message for the country. All right.

Andres: Thank you, Ricardo.

Ricardo: Thank you for the opportunity.