Monday, November 5, 2012

A severe budget blemish.

How unholy alliances and cosy relationships destroy Gordhan’s noblest intentions.

A severe budget blemish.

How unholy alliances and cosy relationships destroy Gordhan’s noblest intentions.

Size does not matter. Behaviour does. In a different context that statement would no doubt trigger some sniggers and a long standing adolescent debate about whether bigger is better.

But in the context of government, traditional free market wisdom has it that the opposite is true – that the smaller the government, the better it is for economic growth, prosperity and national competitiveness. It’s a criterion championed with some fanaticism, as I discovered in responses to a recent article on the encroachment of government in national economies worldwide.

This may explain Finance Minister Pravin Gordhan’s pride, as reflected in the “mini-budget”, about his ability to keep (as a percentage of GDP) government revenue and expenditure to below 30% respectively, the budget deficit at below 5% and overall public debt at below 40%. The proportions are better than for most of the developed countries (see graph in this article) and better than Brazil and Russia in the BRICS group.

The budget reflects government’s claim on resources. Not all of it. You still have to add other activities such as state owned enterprises. A claim on resources is only one part of government involvement – the other probably as, if not more important, is its regulation of economic activity through laws. Here we rank rather poorly according to the Legatum prosperity index and there’s been much criticism of what is arguably highly restrictive regulation in the South African economy.

To understand the debate at all, we have to go back to the basics of wealth creation itself. Tangible wealth is created in legitimate transaction which insists on freedom of choice, free moving prices, maximum suppliers and optimum consumer awareness. This creates a state of perfect markets, which in turn perfectly reflect all our imperfections. All of these conditions can only come together fully in a utopian state – a state that has to be driven by sound human values and not by competition alone and certainly not by short term raw material self-interest.

Rarely can government itself meet these conditions. Its job therefore, is mainly to enable the creation of wealth by others and ensuring through laws that the above conditions are nurtured. Its secondary role is to reduce social tensions, severe inequalities and imbalances through what Gordhan calls a “social wage” by redistributing wealth in such a way that it does not discourage wealth creation itself.

clip_image002The graphic illustrates how fully dependent government’s financing is on wealth creating cells such as companies. There are some others, such as user-pays services, and customs and excise duties which fall under spending taxes such as VAT and rates at local level. But companies, broadly defined to include professionals and the self-employed, are the primary wealth creating cells and in turn provide the bulk of government income. Loans cannot, or should not be viewed as income. Indeed, ultimately they become a cost burden.

In support of my opening statement that size of government as measured by the budget, does not seem to matter, we need only examine state expenditures in some relatively good performing economies such as Norway, Denmark, the Netherlands and Germany which are all between 40% and 50% -- well above South Africa’s less than 30% and still poorly performing economy.

The answer can be found in many other features of the South African economy, including restrictive laws. This is well beyond the scope of this article and is also a much covered subject in most of the media including Moneyweb over a number of years.

But focusing purely on the budget, and leaving out for this article, the all-important question of whether government is spending money on the right things, such as ostentatious presidential homes and arguably an excessively burdensome social wage, one of the most critical questions the Finance Minister has to contend with is the behaviour of those charged with spending state funds.

Corruption, maladministration and inefficiencies are a severe blight on state financing. Yes, it has received much attention before and is a favourite topic for investigative journalists. But we are understating its severely debilitating role. It goes far beyond the staggering estimated loss of R385bn at every level of government since 1994. It also goes far beyond neutering all laudable intentions in the budget, the severe tarnishing of its credibility and the escalating costs of policing these. The worst is the spread and on-going cultivation of corrupt behaviour which robs all of us of a fair deal not only with government but in all social and economic relationships.

This must be strangled at birth, and not only when the perpetrators are caught in the act which happens too seldom. Here government alone cannot be blamed. We forget too easily that corrupt relationships involve two parties – one invariably in the private sector. My questioning the immediate self-interest driver in business has often solicited the accusation of being naïve. But it’s the same kind of naiveté that exposes the king with no clothes, the elephant in the room and underpinned a question that brought down the mighty Enron.

And with this naiveté I question the easy acceptance of appointments to company and corporate boards based not only on B.E.E. considerations but on who they know rather than what they know. It only comes to our attention when it reaches outrageous levels such as those exposed by Barry Sergeant recently, but there’s a germ of corruption in many of our economic activities, from the lunch invitation to massive donations to political parties. It is very easy to defend these activities and relationships when one accepts the premise that the sole purpose of business is to maximise returns for its owners.

It becomes much more difficult to defend if the question is whether it is in the interest of the customer; more difficult still if it is in the interest of enhancing competition. And it becomes virtually impossible to defend in the interest of the broad public.

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