Trends in Global Economy

Just would like to share my thoughts on some of these issues that I have been reading about more frequently in the past few weeks in economic papers, business magazines and mainstream media. As SA is quite an open economy, global trends affects us as well.

• Inflation - the entry of China, India and the rest of South East Asia as a production hub has kept labour costs down and suppressed inflation throughout the world for about a decade. However, this situation is starting to change, but few people know what this would mean in the short, medium and long term. E.g. what the implications will be for monetary policy if we come to realise, with the advantage of hindsight, that the low inflation of the past decade had more to do with the global trading system and less to do with inflation targeting and interest rates?
  
• Financial risks - the rapid rise of hedgefunds is making some people nervous, especially the central bankers. The ability of these funds to shift/spread risk around the world and into various other financial instruments has certainly been useful and probably resulted in fairly low interest rates in many countries, but there are some persons who are afraid that some of the risks are accumulating somewhere in the system and they are not able to identify where and what precautionary measures to take. (think "Matrix" or "I, Robot" where the error/residual accumulates over time and has to correct sometime in the future, or lead to catastrophic consequences)
  
• Inequality is rising - IMO it is mainly between capital and labour in the US and the developed world, but more between skilled and un-/semi-skiled labour in the developing world, though skilled labour is closely correlated with the owners of capital in the developing world
• Global infrastructure constraints - not enough capital has been invested in infrastructure over the past 2 decades to meet the rising demand. There are numerous reasons for this, including privatisation and subsequent lowering of investment horizons, poor policies in many countries, poor modeling, higher than expected growth in demand, changing consumer demand, paying shareholders rather than investing, global concentration of investment in China over the past decade and neglecting it in many other parts of the world, etc. The sudden rush for infrastructure investments has also fueled the global shortage of skilled labour
  
• Global skills shortage - The global economy needs more and more highly skilled labour, and the global economy is not able to supply enough skilled labour at the right locations at the right time. The changes necessary to allow skilled labour to move freely throughout the world is slowly being enacted to balance it with other requirements, but not fast enough for the likes of many businesses. Remaining constraints include attitude / cultural changes (willing to live in another country / community) and the acceptance of foreigners in a local community (xenophobia), immigration laws (the developed world is most advanced in thinking about this, but even there this is changing very slowly).
  
• Global power crises - oil production is peaking, meaning we will have to shift to other sources of power to meet the ever growing demand, which has been more expensive to generate/capture than simply pumping oil out of the earth - nuclear, coal, ethanol, bio-fuels, solar, wind, etc
• Climate change is having a more marked effect on human activity and leads to more volatile natural environment, and also ncreasing risks in the economic system. Are we still underestimating the potential impact our activities have on mother Earth due to our short sighted nature and need for "instant" satisfaction, or will we be able to develop a good enough insurance mechanism to protect us from this growing risk, e.g. is carbon credits really good enough??
  

The details may proof me wrong, or my explanations above may be quite poor / flawed, but this is my opinion - and striclty speaking, opinion is never wrong :)

Soweto Monorail

The new monorail project between Soweto and Johannesburg is an innovative way of solving one of the biggest problems in Gauteng and a big constraint for faster economic growth in future. Most of the mainstream media has complained of the traffic problems in northern Johannesburg and between Pretoria and Johannesburg, but very few have highlighted the serious problems in the southern part of Johannesburg. The following excerpt from the M&G Online describes the project:

A R12-billion monorail will be built between Johannesburg and Soweto in the next two years … no one from Soweto should have to wait more than 15 minutes for transport … Work on the 44,7km monorail and its 39 stations will start in September. The monorail is intended to complement and not compete against existing forms of transport … The problem in South Africa when it comes to public transport is ... people queue for three to four hours [for transport]. … "We want to move people ... efficiently; ... safely; ... in an affordable way." It is hoped the monorail will move 1,5-million passengers a day between Soweto and Johannesburg, to ease congestion on the roads.

The monorail service will consist of 4,5m-high, rubber-wheeled, carbon-fibre carriages, 10m long and 3m wide -- able to carry 107 passengers each. These will run on concrete beams atop 6m-tall pillars situated mainly on the centre medians between road carriageways, and will dock at aerial stations accessed via escalators. The hybrid variety used in South Africa will run on a combination of electricity and solar-powered batteries.

What is unique about this project is that it is privately funded, compared to the Gautrain that is using public / government funds. Congratualations to the Gauteng Economic Development Agency (GEDA) who has identified the need, found a possible solution and worked hard behind the scenes to source a willing private investor for such a big project. Indeed, GEDA is one of the main driving forces behind the recent spate of investments in Soweto, Newtown, the Innovation Hub and other places.

What would be interesting to watch is the reaction from the taxi associations and operators. Despite what public officials are saying, it will compete directly with these taxi operators that provide the service between Joburg and Soweto. Ideally one should get the taxi operators to complement the service and one way is to ensure they also benefit from the project. Here is my suggestion to the investors:

Get the taxi associations and operators in as your BEE partners in the operations. Negotiate / decide on what % of shares should be allocated to the BEE partners (say initially 40% with the option to purchase more shares at a later stage). Only registered taxi operators should be invited to bid for the shares. Various financial tools could be used to achieve this. The taxi operators will have representatives on the board to ensure their participation in operations are guaranteed. It is also in their interest to ensure that the monorail is profitable and will be more likely to align their own operations to that of the monorail. In addition, they also offer a unique insight into the everyday commuter between Joburg and Soweto - which should benefit the project. It is also more broad-based BEE than other BEE deals that involve the usual BEE candidates. This will not negatively affect the project, as most existing taxi operators are entrepreneurs who understand the dynamics and pressure of business. The taxi operators' knowledge of and networking with existing black enterprises will also assist the project in identifying potential sources of supply.

I hope this project is a massive success to spur more private capital going into the grey area between private and public goods, as well as taking initiative to address some of the identified constraints to further economic growth and not always waiting for government to take the initiative. Another example would be private schools that is based on volume of scholars rather than high cost per pupil.

Danger of Over Investing

Over the last year or two I feared for an oversupply of infrastructure capacity in China as a result of their construction boom, resulting in a significant drop in construction growth in China. This would potentially lead to a slowdown in demand for construction inputs such as steel and cement, possibly triggering a drop in demand for other resources and manufacturing inputs, thereby affecting the growth in the world economy, including the SA economy. However, many other economists more knowledgeable on China did not share my views. Nonetheless, the oversupply of capacity was recently confirmed when a friend, after visiting China, commented that a high number of buildings stand empty after construction in many of the big cities. But he allayed my fears somewhat by further commenting that many of these buildings are simply torn down a year or three after construction to make way for new buildings. The net effect is thus the build up of extra capacity in China is lower than it could have been. This general picture of wasteful expenditure was confirmed when reading an environmental article on overall efficiency in China, “Each unit of GDP (in China) takes seven times more resources to produce than in Japan, nearly six times more than in the United States and nearly three times more than in India” (Mail & Guardian, 26 February 2007). But what would really happen if China were to double their efficiency in using their resources? And what lessons should South Africa learn from this?

South Africa currently faces significant capacity constraints due to the faster than expected economic growth over the last three years, in particular on our infrastructure. The fast growing economy is placing enormous pressure on our existing, ageing infrastructure. There is thus a rush to develop the necessary infrastructure to meet the demand generated by the economy, replace ageing infrastructure and meet the necessary requirements for hosting the 2010 Soccer World Cup. The private sector is also contributing through private construction developments taking place across the country, significant investments in expansions by many firms to increase output capacity, and many more. This is one of the main reasons why SA was able to achieve a 5% growth rate in 2006. The impact of this injection of expanded capacity through infrastructure investments in the SA economy will be felt in the next few years as it will allow the economy to grow even faster, or at least continue to grow at its current pace.

However, it is important to caution the public that there is the danger of creating too much infrastructure capacity in this current rush/frenzy to develop infrastructure. If an oversupply of infrastructure capacity were to occur, there could be a significant slow down in economic growth as “supply will have to wait for demand to catch up”. This is a key reason for many of the boom and bust cycles of the past in the world, including the current house market slow down in the US. There is also the danger of developing the wrong type of infrastructure to stimulate further economic growth at that particular point in time. This could result in many “white elephant” infrastructure projects dotting the landscape, or that the infrastructure remains un- or underused for a number of years, as was the case with the many mothballed power stations in South Africa. A potential knock-on effect could be a loss of confidence in the economy’s growth prospects, leading to a further slowdown in economic growth.

In essence, we need to balance the supply of extra capacity in the economy through infrastructure development with the growth of demand in the economy (both local demand and international demand for our products and services), as well as our ability to address other capacity constraints such as the skills shortage, general health of the population, technical innovation (research and development), including improving the efficiency of existing infrastructure assets, to name but a few. Up to now, the government has been lauded for their management of the economy since 1994, i.e. returning the economy to good health after the absolute mess given to them by the previous government and managing the economy’s inclusion into the global economy through the turbulences of the late 1990s and early 2000s. However, it is important that this apparently healthy animal that is the South African economy don’t suddenly start to run away from us. We don’t have the resources and possibly not the political authority, like China, to spend precious resources on wasteful infrastructure projects. It is thus important that we continue to carefully monitor the potential of the economy and what the economy is actually producing (i.e. the output gap), as well as to timeously address other capacity constraints that may hinder the future growth of the South African economy.

Electricity Supply Problems in SA

There is an interesting assessment of the root causes of the electricity supply crisis in SA by Anton Eberhard published in the Business Day that supports my view that it boils down to bad planning on the part of the State:

The root causes of these failures are sometimes misunderstood. Many have argued that electricity consumption and demand growth have been higher than expected because of higher economic growth rates. Let’s look at the facts.

Annual peak demand has grown on average by just more than 3,6% a year since 2000. Current peak electricity demand is actually lower than that predicted in Eskom’s Integrated Strategic Electricity Plans, which were prepared in 2001, 2003 and 2005.

Furthermore, as far back as 1998, the Energy Policy White Paper warned of supply shortages in about 2007. The claim that electricity demand has grown faster than predicted is not supported by the data.

So what are the ultimate causes of recent supply failures? There are at least four main causes. First, policy uncertainty between 1998 and 2004 inhibited and slowed investment. During this time, consideration was given to breaking up Eskom and introducing competition and private investment. In 2001, Eskom was prohibited by government from building new generation capacity. Investment planning and decision-making fell 18 months behind schedule. Some consequences of the delays are that the commissioning of base-load generating plant (in the form of return-to-service coal stations that were previously mothballed) and new peaking plant (open-cycle gas-fired turbines) has been too late. In addition, policy uncertainty delayed the re-establishment of dedicated project teams and departments in Eskom to manage the new capacity expansion programmes.

Second, poor co-ordination has caused further setbacks. The lack of co-ordination and integration of the different electricity planning, investment decision-making, approval and procurement processes between Eskom, the National Energy Regulator of SA (Nersa), the minerals and energy department and the public enterprises department has created dangerous risks in terms of contradictory and badly timed decisions being made, and procurement processes that might lead to costly and late investments. An example is the delay in finalising the minerals and energy department bids for private, independent power plants. Emerging risks are also evident in the licensing delays by Nersa and the legal requirement for ministerial approval for any deviation from the official Nersa plan, which is already out of date.

Third, while there has been a great deal of planning, some of the earlier planning assumptions were wrong. The estimates for existing generation plant availability were too optimistic. It was assumed that municipalities would be able to contribute more generation capacity than is currently available. The assumed cost of unserved energy was unrealistically low. And planning was constrained by applying too low a reserve margin (10% compared with a more acceptable 15%). Together these faulty assumptions have resulted in planned capacity additions that are 18 months to two years too late.

Fourth, inadequate maintenance or negligence may have played a hand. An investigation by Nersa concluded that, in the case of the Western Cape outages, there was negligence on the part of responsible Eskom personnel, maintenance procedures and remedial actions were inadequate, and protection systems had been operated incorrectly.

These root causes help explain how we have arrived at where we are today.

He goes on in making suggestions to increase supply security and the reserve margin, primarily by increasing base load capacity. However, in the short term a more effective strategy will be to improve the efficient use of electricity in SA. This is particularly the cae in this era of climate change, where it becomes critical that we become more efficient in the use of out existing electricity resources.

Improving and properly maintaining the distribution network will certainly reduce the wastage of electricity on the network. A critical part he neglects to mention is to improve the efficiency of electricity usage in homes and factories. Yes, it will reduce demand for electricity by existing users, but the slack will most certainly be taken up by the growth in demand from new users and expanding businesses.

Some indicated that improving efficiency in electricty usage is not really in Eskom's best interest, as their business is basically to sell as much electricity as possible. IMO, in order to change this, more efficient electricity usage must be one of the key performance indicators of Eskom. Futher, Eskom is a SOE, and ideally their KPI should be aligned to national government targets, i.e. reducing greenhouse gas emissions by increasing efficiency in electricity usage and more environment friendly generating capacity; increasing the electricity supply reserve margin to acceptable levels to avoid future supply crises but growing electricity supply so that it dont constrain future economic growth; spread generating capacity geographically to reduce security risks while maintaining economic efficiencies; etc.