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Economic policy debate takes us forward only when it focuses on what is needed to grow our economy in a way which includes many more people.By Steven Friedman
There is something eerily reminiscent of very ancient religions in current mainstream South African economic discussion. It centres not on what is good for the country but on what is needed to appease an unseen force which is meant to be all powerful unless it is obeyed without question. The force in question is the dreaded ratings agencies, those all-powerful economic arbiters of good and evil with the power to decree whether economies live or die. Their instrument of punishment, of course, is junk status, whose victims are banished to the hopeless eternity of economic despair.
Our current economic debate, therefore, is less of an exchange of views than it might appear. In the mainstream, it consists purely of a discussion of what is needed to appease the-ratings-agencies- who-must-be-obeyed and of exactly how much appeasing they need. It specifically excludes what is normally understood as an economic debate, a discussion of what is needed to provide the greatest good for the greatest many whose livelihood depends on this economy. It is assumed that avoiding junk status is the only rational goal of everyone who understands basic economics.
A very large section of this debate, particularly prominent in the media and among mainstream economic commentators, takes the argument one step further. It very specifically turns the cargo cult behind this thinking (a cargo cult is a 20th century belief by inhabitants of very isolated islands that the prosperity they enjoyed in World War Two would be restored if they performed the rituals needed to get the Americans to appear out of the sky again) into a very thinly veiled attempt to turn back decades of social progress.
Their story currently centres on the events of December, in which then Finance minister Nhlanhla Nene was red. So angered were the agencies, and that other deity, the foreign investor, that they needed instantly to be appeased. A heavy price was required to win them over – the only way to appease them was to dash onto the rocks progressive income tax (by raising VAT), a national minimum wage, national health insurance, the jobs of most public servants and the pay packets of the few who were left after the carnage. Anything less and the terror of junk status was inevitable.
It does not have to be this way. A downgrade to junk would obviously be a problem for the country – but it is not the kiss of death. It would make economic recovery more difficult but would not remotely rule it out. Nor, if it came to that, is avoiding a downgrade worth abandoning the first and most important principle of economic discussion mentioned earlier – that what we ought to be discussing is what this economy needs to grow and meet the needs of South Africans. In that discussion, the country’s grading in international markets is an important factor but it is just that – a factor. Similarly, we really need to stop talking about the markets and those who invest in them as South Africans do: whether in scorn on the left or reverence on the right and in the centre, they are treated as a machine when they are, in reality, the sum total of decisions by people with lots of money who are subject to the same prejudices and loss of judgement as other people.
This article will begin by discussing the lobby which wants to sacrifice working people and the poor because it is the most common, and at the moment most influential, form of the worship of supposedly unstoppable and inhuman forces which are in reality nothing of the sort. It will then try to show why we can do better – not only by rejecting demands to make the poor pay for politicians’ mistakes but also by refusing messages which tell us that we are forced by impersonal forces to do some things rather than others even if what needs to be done fits our needs rather than their desires.
Never Waste a Good Crisis: December 9 and the Rich People’s Lobby
Probably the most extreme case of the use of a small group of people from other countries to scare South Africans into submission is the rich person’s lobby which emerged after the sacking of former Finance minister Nene.
Oddly, while this lobby championed the rich, it does not seem to have been the work of rich people. While it is customary to assume that lobbies which speak on behalf of the affluent are doing the bidding of big business, there is no evidence that this lobby emerges out of business at all – it no doubt has its supporters in business but clearly also has its opponents too. It is particularly strong among right of centre economists, commentators and, in abundance, the media (on most economic policy issues, any difference between the view of right-wing economists and that of the media is entirely coincidental). As indicated earlier, this lobby’s pitch centres around powerful and very angry foreigners who are deeply scarred by Nene’s dismissal and who must, therefore, be begged to forgive us for the President’s sin. Those who are to be sacrificed in order to appease these irate economic potentates are the poor, who usually lack the muscle to fight back. Fortunately, Finance minister Pravin Gordhan ignored them, of which more later. But the claim that we need to appease angry foreigners and that the only way we can do this is to cut government programmes which serve the poor is still very much with us and seems likely to remain so for a very long time.
If it is possible to please the agencies in a way which does not impose severe costs on the economy, this is worth doing. But, if doing so means damaging ourselves, it is surely better to endure the downgrade.
The lobby is more interesting for what it tells us about the state of the economic debate than what it says about the economy (which is nothing at all since its claims are not backed by evidence or argument beyond the tired mantra that the markets must be obeyed). It does not propose its preferred course of action because it is best for the economy but because it is imposed on it by two forces who are portrayed in an extremely misleading way – the ratings agencies and foreign investors. Both are portrayed as machine-like forces which must be obeyed if our economy is to grow. This line of thinking is very popular and looks quite neat in theory. Its only problem – besides the moral issue of blaming the weakest, rather than those who are most responsible, for problems – is that it is entirely wrong.
First, the agencies, whose mediocrity is forgotten amidst a religious awe which places them at the centre of the exercise of wisdom and power. On the wisdom front, their ratings are assumed to be the result of an entirely rational process in which highly skilled analysts interpret top quality data using criteria known openly to all. On power, the agencies are assumed, through their ratings, to be able to shape the economic future of nations, large and small. This reverential awe is usually bestowed only on those agencies based in the US or Europe, not those which originate from Japan and Korea. This is no surprise because the ratings of those agencies which are held in awe are the product of a highly subjective process in which the most important voices are not those of logic or evidence, but that of local business people, in particular bank economists. The idea that the agencies are academic institutions, filled with geeks who are simply interested in where the evidence takes them, is a quaint fiction. They are businesses and their decisions tend to reflect that reality far more than evidence or logic.
Since 2008, the agencies have become far more negative about those they rate; this does not re ect worsening economic conditions – it means that they have become more negative than they used to be given the same set of figures. This has nothing to do with changes in actuarial science and everything to do with the fact that they made over-optimistic calls about major companies (such as Lehman Brothers), have been threatened with legal action in the US because their incompetence allegedly cost investors lots of money, and are therefore frantically covering their backs in the hope of preventing a repetition.
Having spoken to the American and European agencies for several years,I became increasingly convinced that they were not very interested in evidence and argument. Coincidence presented me with a chance to test how interested they were. During one of their visits, I offered them research findings which contradicted a statement they had made. I offered to send them the findings and they agreed. It then occurred to me that simply handing over the research might turn out to be futile since I would have no way to check whether they bothered to consult it. So I decided to wait to see whether they asked for it – as the Asian agencies had done in previous exchanges. They did not – they showed no interest in the research at all. I then decided that I would not see them again since there is little value talking to people who have no interest in listening. This reached the ears of the media and I landed up on business television, debating the head of one of the agencies based here. The presenter asked me at one point what the agency could do to convince me that they were serious. I said the research was still available and the agency head was welcome to get it from me – I never heard from him.
If the initial incident could have simply been a case of busy people forgetting, the failure of a senior of cial to show willingness to consult evidence to which they did not have access in any other way, and which challenged their claims, surely shows bias. There is also hard evidence that the agencies take their lead from local business opinion – one local business person boasted in a private discussion that they had persuaded the agencies to downgrade this country in the hope of changing policy. So the local business people who warn repeatedly of what we have to do to please the agencies are really telling us what is needed to do to please them. The ratings agency attitudes of which they warn are actually their own attitudes – which they could, of course, change if they wanted.
The Power of Exaggeration
But, whatever you think of the agencies’ ethics or competence, don’t they exercise great power? Yes and no. It is true that the agencies wield entirely unjustified power not because their arguments convince anyone but because many companies’ systems are programmed in such a way that they automatically sell bonds or shares if a country or company is downgraded to non-investment level or ‘junk’ status. So it is preferable not to be downgraded: it does become more difficult to borrow money at interest rates which are affordable and it does commonly prompt capital out flows – money which leaves the country. The question, however, is whether meeting that fate is so damaging that just about any sacrifice is worth it to avoid being downgraded to ‘junk’. The emphatic answer is no. Most mainstream discussions about ‘junk’ status imply that it is a fate used for states with non-functioning economies. Even if it is conceded that some ‘junk’ countries have workable economies when they acquire this status, it is assumed that they don’t have them for very long after the downgrade – those who endure this fate, it is claimed, are usually forced to beg for IMF hand-outs and to hand over the management of the economy to the Fund’s bureaucrats.
In fact, the list of economies which have experienced ‘junk’ status at one time or another includes Turkey, Brazil, South Korea and India. While some are currently in difficulty, others such as India are turning in growth rates of more than 7%.
In fact, the list of economies which have experienced ‘junk’ status at one time or another includes Turkey, Brazil, South Korea and India. While some are currently in difficulty, others such as India are turning in growth rates of more than 7%. Certainly, none of them would be considered economic basket cases. So a downgrade makes a country’s economic life more difficult – it does not end it. It is also worth mentioning that one frequently heard argument – that doing what the agencies are presumed to want is vital if we are not to lose our sovereignty to the IMF – is a little odd because it argues, in effect, that we should give up our sovereignty to ratings agencies to avoid giving it up to the IMF. Finally, and most importantly, people who know the financial markets will tell you that the capital out flows which are predicted to ow from a downgrade here have already happened as a reaction to December 9. So a significant part of what we are supposed to be preventing has already happened – and we are still here, even if our economy is in a poor state.
All of this suggests that, if it is possible to please the agencies in a way which does not impose severe costs on the economy, this is worth doing. But, if doing so means damaging ourselves, it is surely better to endure the downgrade. It also means that, whatever the agencies do, our prospects of resuming growth depend on relations between government and local business, not in finding the (non- existent) magic formula for appeasing the agencies. And, since much of what the mainstream commentators fear has already happened, the really important impact of a downgrade to ‘junk’ may be political, not economic. If this country is a guide, the real function of ratings agencies is not to pass credible judgments but to play into domestic politics. Until now, they have been used to force the government to make changes which many in positions of authority would prefer not to make – it has been an important lever nudging policy and practice in particular directions. But what if the country is downgraded to junk (which seems likely)?
The lever will then, of course, have been stripped of its power – a downgrade may then be used to achieve precisely the opposite purpose to that for which it has been used up to now. It could be argued then that, seeing that we have already been downgraded to ‘junk’, we have no reason to pay any more attention to what the agencies and their allies think. More dangerously for the country, it could be used to discredit Gordhan and the Treasury – it will be said that they failed to prevent a downgrade and should therefore be replaced by someone more competent, such as a politically connected back bencher. The irony of using ratings to impose policy approaches is that the threat of a downgrade works. But actually downgrading to junk could deprive the downgrade of its power – and might actually achieve precisely the opposite of the stated intention by freeing those who want to endanger the economy from the constraints imposed by the rating. There is only one way to make this very unlikely – to persuade the key interests in the economy that life does not end with a downgrade and that the same considerations which prompted an alliance in the cities to demand a credible nance minister would apply if the economy is downgraded to ‘junk’.
An equally misleading aspect of this argument is the message it sends on foreign investors. Again, the impression is created here that we are dealing with an entirely machine-like force which we have no power to influence. In reality, foreign investors are even more likely to be influenced by local business people than the ratings agencies. This flows from a common sense reality. If foreigners are considering a significant investment, the people they are most likely to consult are local business people – so again, since it seems reasonable to assume that foreign investors will be heavily influenced by what their local peers say, again what is passed off as foreign opinion is really local sentiment. Much of what we read about investment is also based on a fallacy – that investors invest when countries tick a check list of economic correctness and political pliability. In reality, investors base their decisions on the only issue which matters to
them – will they make money? This depends not on meeting check lists but on whether the economy is doing well enough to generate yields on investment – and that depends on whether local investment has been stimulating growth. Here and everywhere, the key to growth is local investors – foreigners come in if the economy is already growing, they do not make it grow in the first place.
In both cases, then, what is presented as a discussion about what foreigners think is really about what locals in business think. Many lessons ow from this but the one most relevant in this discussion is that economic policy debate takes us forward only when it focuses on what is needed to grow our economy in a way which includes many more people. Central to this is a discussion between South African economic interests, what they want and what they are willing to compromise to get it. What the ratings agencies or the ‘foreign investor’ think is far less important than what the country needs, whatever the people from elsewhere do.
More dangerously for the country, it could be used to discredit Gordhan and the Treasury – it will be said that they failed to prevent a downgrade and should therefore be replaced by someone more competent, such as a politically connected back bencher.
The 2016 Budget: A way forward?
It is surely not reading too much into this year’s budget to argue that it adopted, broadly, the approach recommended here.
Gordhan and his team were clearly under pressure to use the budget to sacrifice the poor on the altar of politicians’ mistakes. They decided not to listen and so the budget avoids the dramatic pro-market measures which the economic correctness lobby demanded. On the other hand, Treasury did take seriously the views of business, with whom it had been talking in the period just before the budget in an attempt to restore confidence. And so the budget proposed not an assault on any one interest group but a partnership approach in which the major economic actors worked together, motivated by a common interest in growth. While labour is not currently in a t state to participate effectively, the door has been left open for it to do this as and when it feels ready.
This clearly is an approach which gives priority to the country’s need for growth over the next few decades over the demand for a quick x which would have won glowing media approval, excited those who adore the agencies, and created so much conflict and so many barriers to opening the economy to the talents and energies of many who have been excluded thus far that it would, in not too long a time, have wiped out all the pluses and would have created a set of new minuses far more than a downgrade.
Whether the approach will work is an important discussion but one which is too complicated to be squeezed into an analysis of broader issues. At this point, the crucial issue to remember, which the budget’s framers seem to have understood, is that the verdicts of the ratings agencies are only one of a range of factors which need to be considered when government and private interests discuss how to boost growth in a way which includes many more people than are now part of the economic mainstream. What government, business and labour have been doing needs to change and so there are good reasons for reform, whatever the agencies say. But all the major interests will move us forward only if they devote far more time to what they need to do to relate more effectively to each other than on how to appease those supposedly all- powerful ratings businesses from across the water.
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