Let’s listen to heterodox economists for a change

In the fourth part of this month’s New Frame, New Economy forum, Seeraj Mohamed provides an alternative to Michael Sachs’ analysis of the trajectory of our economic policy.

Too many people in South Africa in leadership positions or with the ears of those in power reject views held by those they disagree with by accusing them of not recognising reality or of being ideological.

In his article, Michael Sachs takes an early shot at heterodox economists who have been arguing for an approach to fiscal policy they believe could drastically reduce suffering while supporting job creation, investment and growth in South Africa.

Sachs suggests that some people are missing the point because they are preoccupied with “ideological tropes”. There is a “real dilemma” underlying the government’s fiscal problem, he says. The nature of this dilemma, according to Sachs, is that the government is committed to implementing continued fiscal consolidation that will “mean real hardship for millions” while, at the same time, there is a need to take the problem of debt and debt sustainability seriously.

Sachs criticises heterodox economists by arguing that adopting a new theory of the economy will not change this basic dilemma. But he fails to realise that his own views are also obviously ideological – one cannot help but perceive reality through ideological filters that can become blinkers when one doesn’t recognise one’s views as shaped by ideology.

The new macroeconomics orthodoxy

Many mainstream or orthodox macroeconomists have realised that much of their theory, models and policy prescriptions over the past two decades were incorrect. They have struggled against these blinkers and have begun to develop a new mainstream macroeconomic consensus. This new policy approach has been particularly evident in developed countries, but also in many developing countries. The experimentation with these new policies took off in response to the global financial crisis of 2007, intensified to spur on recoveries during the abysmal post-crisis period and have been, and continue to be, hugely escalated to address the impact of the Covid-19 pandemic and its socioeconomic consequences.

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Sachs does not acknowledge these almost revolutionary changes in the application of macroeconomic policies. He also does not refer to the impact of those large changes in macroeconomic policy choices, particularly the unprecedented use of quantitative easing and large fiscal stimuli on mainstream macroeconomic perspectives and theories.

The central argument that Sachs makes is that interest charges on the South African government’s debt are bound to grow in the future. The instability and unsustainability of government debt because of this inevitable growth in debt-service costs, he suggests, are the central political economy problem of South Africa’s development. The reason for this difficult situation is that the South African government, for various reasons, cannot increase debt or erode the value of outstanding debt because that would amount to going up against “the structural power in global capitalism, [which] is rooted in hierarchical relations of money and finance”.

Unfortunately, Sachs does not expand on his understanding of the nature of this structural power and its hierarchical relations. Instead, he presents them as forces of nature. The weakness with his formulation is that there is little examination of the complex and dynamic relations present in the current turbulent and evolving global financial architecture.

An examination of the debates and policy choices made across the globe regarding the use of capital controls since the Asian financial crisis and the Great Recession provides one with tons of ammunition against the idea that the structural power relations and hierarchical relations of money and finance in global capitalism are immutable.

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Instead, these structural power relations are navigable and can be challenged. Several developing countries have done so quite successfully. They have chosen not to wear the ideological blinkers constraining key figures in the South African government, particularly the National Treasury.

A similar argument can be made about changes to thinking about stimulatory fiscal policy, the need for more integrated fiscal and monetary policy thinking, the independence of central banks and the financing of government debt by central banks.

There is a huge opportunity for South African macroeconomic policymakers with the political will to implement expansionary and redistributive policies to navigate this changing mainstream macroeconomic terrain and to find creative economic solutions. I fear that much of this new reality among the global status quo is missing from Sachs’ discussion, and South African policymakers do not seem to have the political will to find the necessary solutions.

Fiscal expansion can increase sustainability

Much of Sachs’ analysis rests on his prognosis that “the public sector’s financial solvency will continue to erode” and that “the real danger is not the government’s solvency … but the risk of a liquidity crisis in which debts can no longer be rolled over.” 

“It is then,” he writes, “that the International Monetary Fund [IMF] or exceptional measures come into play.” In South Africa, however, the problem is not the IMF but inside the government. Our really scary scenario started with a self-imposed structural adjustment programme that is now almost 25 years old. We are still suffering through it.

So, why does Sachs say that South Africa’s solvency will be eroded over time? His argument draws on the idea that if the interest rates charged on government debt exceed the growth rate of the gross domestic product (GDP), the size of the debt-to-GDP ratio and the ratio of debt-service costs to GDP will continue to increase over time unless the government reduces expenditure and lowers these ratios.

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In his view, South African government debt and debt-service costs will continue to increase every year because the annual growth rate is very low and is expected to continue to remain low, and the interest rates the government pays on its bonds is expected to stay high. He says the consequence will be that eventually the government will be unable to service its debt.

His view draws on a rule of thumb deemed to represent the relationships between interest rates and growth. But the way we think about the relationship between these variables is affected by how they are situated in macroeconomic equations and models. Sachs’ prognosis is constrained by the very real possibility of fiscal policy to stimulate recovery and growth in South Africa, which will likely improve debt sustainability while increasing investment, jobs and growth.

One does not have to resort to leftist ideology or invoke heterodox macroeconomic thinking to point out where Sachs is incorrect. The mainstream macroeconomists who have been shaping the new mainstream macroeconomics consensus will suffice.

There is now sufficient empirical evidence to suggest that fiscal expansion can improve fiscal sustainability. Proponents of this new macroeconomic consensus on fiscal policy would disagree with Sachs’ argument that if interest rates are higher than growth then debt will inevitably become larger and larger. Even where interest rates are higher than growth rates, they argue, countries with a lot of debt can, and should, stimulate their economy to promote economic growth, while being careful that those actions do not increase interest rates on government borrowing.

If South Africa can boost growth while not causing interest rates to increase, or increase too much, then the debt-to-GDP levels will decline, and debt will be viewed as more sustainable. My view is that the government should pursue a macroeconomic policy where monetary policy accommodates fiscal stimulus. The government has several effective levers to manage interest rates and even lower them.

The National Treasury already went some way in this direction when it reduced the risk of the government’s debt profile before the pandemic by increasing the overall maturity profile of government debt. During 2020, it increased shorter-term debt because its borrowing costs were significantly lower than that of debt with maturities of 10 years or more. But, much more can be done.

There is an alternative

Sachs correctly says that South Africa’s sovereign balance sheet is strong, and adds, “The state could resort to drawing down financial assets – the Government Employees Pension Fund [GEPF], for instance – long before it is forced into defaulting on its debt.”

But why wait to leverage the strength of this strong balance sheet only when faced with a default? Even before the pandemic, some South African economists had repeatedly urged the government to use the funds of the GEPF to increase expenditure to relieve the suffering of impoverished households and to boost economic performance. The use of the GEPF is a twofer: it would lower the interest rate and very likely boost GDP and so increase debt sustainability.

A big contribution to reducing debt and raising growth must be played by the South African Reserve Bank. The bank’s approach to monetary policy and the cost of debt should be guided – and some would say dominated – by the government’s attempts to stimulate growth through fiscal policy. The Reserve Bank could also ease the debt situation and government’s borrowing costs by directly lending to the government at zero or very low interest rates. This quantitative easing would be another twofer: it could radically increase debt sustainability and support recovery and growth.

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Sachs says that sovereign insolvency could raise questions about the solvency of the Reserve Bank and erode its credibility and authority. The opposite is true: a more supportive role by the bank could bolster the credibility of the government and the bank itself through supporting growth and increasing the sustainability of government debt.

Sachs suggests that South Africa has little fiscal space and no fiscal policy options. Unfortunately, this view that “there is no alternative” seems to be shared by the National Treasury and economic leadership in the government. The only option, according to Sachs, is “social solidarity and real compromise on wages and rents” without actually explaining what he means and how much should be compromised by whom.

I agree that we need social solidarity, but not that we do not have fiscal policy options. Heterodox economists have much more to offer with regard to improving economic conditions in South Africa. The rejection of their views hurts all of South Africa and the prospects for recovery and a better future.

Public finance specialist Zukiswa Kota discusses how fiscal policies can help fulfil human rights obligations:

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