The circular flow model is a simplified , economic model that describes the interdependence , of an economy's participants, markets and flows in order to explain how the economy works.
A closed economy will have a simpler circular flow model than an open economy.
A country has a closed economy if there is no economic activity outside its borders, and therefore it does not import and export.
A country that has an open economy carries out trade and financial transactions with other countries, and imports and exports.
The circular flow model is represented visually by circular flow diagrams.
The circular flow diagram to the right represents an open economy.
In this diagram the dashed lines represent money flows, in the forms of payments, salaries, wages, loans and taxes. The solid lines represent reaIflows, in the forms of the factors of production and the products that are bought and sold.
PARTICIPANTS IN AN ECONOMY
Households
Households are the owners of the factors of production, and also the primary consumers
Households own the factors of production, namely land, [abour, capital and entrepreneurship. They sell these factors of production to businesses in return for remuneration (rent, wages and salaries, interest and profit). They then buy products from businesses to satisfy their needs and wants. lt is households that decide what products to buy, and when, where and how to buy them.
Businesses
Businesses (firms) are the buyers of the factors , of production, and also the primary producers.
Businesses purchase the factors of production from households in the factor market. They use (and organise)these factors of production to produce products. They then sell these products in the product market to households and the public sector for profit. lt is businesses that determine what products to sell to satisfy the households' needs and wants.
The public sector
The public sector is the part of the government that owns. produces, allocates and supplies certain goods and services to its citizens.
The public sector is both a producer and a consumer. lt receives money income from the taxes paid by households and businesses. In exchange, it buys production factors to produce merit goods, and supplies these to households and businesses. The public sector also buys some products from businesses and supplies these free of charge where they are needed.
The financial sector
The fiancial sector consist of all the financial institutions that are not directly involved in production, but act as a link between the households and the businesses (for example, banks).
In a closed economy, the financial sector is within the borders of the country and owned by the citizens of that country.
In an open economy, the financial sector could be wholly or partly located outside the borders of the country, or wholly or partly owned by citizens of another country.
The foreign sector
A country's foreign sector is made up of all the households, businesses, public sectors and financial sectors outside the country.
A country sells products to the foreign sector by exporting to other countries, and buys products from the foreign sector by importing from other countries.
Participants in a closed economy
- Households
- Businesses
- Government (Public sector)
- Financial sector
Participants in open economy
- Households
- Businesses
- Government (Public sector)
- Financial sector
- Foreign sector
MARKETS
A market is a place or situation where buyers and sellers of products meet and exchange goods, servlces and money.
There are two major markets in an economy in which this interaction takes place: the product market and the factor market.
The product market (goods market) refers to the market where businesses sell goods and services to househofds, other busInesses and public enterprises.
The factor market (resources market) is the market in which labour is hired, entrepreneurial services are , offered, capital is borrowed, and property is rented.
LEAKAGES AND INJECTIONS
Leakages
A leakage could occur in the form of savings, taxes, or payments for imports.
leakages (L) = savings (S) + taxes (T) + impoft expenditure (M)
This is also written as:
L S+T+M
lmport expenditure (M) is the total I payments made on imports. lt refers to the flow of money out of the country.
Injections
An injection (I) is money that enters the circular flow. , An injection could occur through investments, government expenditure and payments for exports.
injections (J) = investment (l) + government expenditure (G) + export income (X)
This is also written as:
J = I + G + X
Export income (X) is the total payments received in return for what has been exported. lt refers to the flow of money into the country.
Imports / import expenditure = MONEY OUT
Exports / export income = MONEY IN
The links between Leakages and Injections in the circular flow model
There are indirect links between savings and investment, between taxes and government expenditure, and between imports and exports. If more money is $ saved in banks, more money is available for banks to loan to businesses for : { investments. If income from taxes increases, the government will be more $ inclined to increase expenditure (or decrease taxes). If imports increase, $ foreigners' income will increase, and as a result they will be able to purchase $ more of the country's exports.
However, these links will not guarantee that savings equal investment, government spending equals taxes, or imports equalexports. The decisions to save and to $ invest are taken by different groups, and therefore these amounts may differ vastly. { The government may spend a different amount from the income it receives from ! taxes. lt might budget for a surplus or a deficit. Exports may be more than imports, $ or vice versa. Therefore it is possible that injections may not be equal to leakages.
When is an economy in equilibrium?
An economy is in equilibrium when:
- households spend all of the money that they earn
- businesses put all of their profits back into producing more goods and services
- production meets demand
- everyone earns enough money to purchase what they need (full employment).
In other words, equilibrium is achieved when total output = total spending.
When looking to see if an economy is in equilibrium, leakages and injections are compared:
- Where leakages are equal to injections (L = J), then the economy is considered to be in equilibrium.
- Where leakages are greater than injections, the economy is seen to be shrinking (decreasing).
- Where injections are greater than injections, the economy is seen to be growing (increasing).
The national accounts are the systems of measuring the economic activity of a country.
In South Africa, the South African Reserve Bank uses the national accounts to calculate the production and expenditure that occur in the country, so that the government can see how the country is performing economically. This allows the government to make informed economic decisions.
A national account aggregate refers to a total quantity of money or products in an economy that is related to a specific time period, whether this total is being , demanded, supplied, produced, consumed, spent or received as income.
National account conversions are changes made to national account data using established formulae to make this data appropriate for a different sort of analysis.
The table below shows what the letters in the formulae represent.
AGGREGATE EXPENDITURE
Aggregate expenditure / Aggregated spending (E) is a national account aggregate that shows the total amount spent by all the sectors of an economy in a particular time period.
aggregate expenditure = consumer spending by households + investment spending by busrnesses + government spending + spending by foreigners on SA goods - spending by South Africans on foreign goods
This is also written as: E = C + I + G + (X - M)
Aggregate expenditure is basically the same thing as national expenditure.
National expenditure is the total level of expenditure in an economy.
AGGREGATE INCOME
Aggregate income (Y) is a national account aggregate that shows the total amount earned by all the producers in an economy in a particular time period.
Aggregate income is basically the same thing as national income.
National income is the total net value of all goods and . services produced within a country over a particular period , of time, representing the sum of wages, profits, rents, , interest and pension payments to resldents of that country
When an economy is in a state of equilibrium, aggregate income (Y) equals aggregate expenditure (E). Therefore, we can replace the'E'with 'Y' in the equation for aggregate expenditure.
E = C + I + G + (X_M) and Y = C + I + G + (X - M)
national income = national expenditure
GROSS DOMESTIC PRODUCT (GDP)
The national account aggregate that is most commonly used to measure a country's level of economic activity is the gross domestic product.
The gross domestic product (GDP) is the total market value of all finished goods and services produced within the borders of a country within a given period of time (usually one year).
There are three ways that are commonly used to calculate GDP:
In the first two methods it is important to understand the concepts of factor cost, basic prices and market prices, as well as to be able to convert figures from one to the other. But before doing this, you need to be able to distinguish between two important categories of taxes and subsidies.
Taxes and Subsidies
A tax is a compulsory payment by a citizen of a country to the government.
A subsidy is a financial grant or other support from the government.
Taxes on products and other taxes on production
In the context of calculating GDP there are two relevant categories of taxes: taxes on products and other taxes on production.
Taxes on products refer to taxes levied on each item produced as is the case with VAT and import duties.
Other taxes on production refer to taxes not linked to specific goods or services, such as a tax on land or business licenses.
Subsidies on products and other subsidies on production
In the context of calculating GDP there are two relevant subsidy-categories: subsidies on products and other subsidies on production.
Subsidies on products refer to subsidies made on each item produced. They are linked to a specific product, for example, a bread subsidy.
Other subsidies on production refer to subsidies that are not linked to a product, such as an employment subsidy (learnership).
Factor cost, Basic prices and Market prices
Factor cost is the cost of the factors of production used to produce the goods and services.
Factor cost includes profit (which is the remuneration paid for the factor of entrepreneurship).
+ TAX
- SUBSIDY
Basic prices are the prices of goods and services after other taxes that are not based on each item produced have been added to factor cost, and other subsidies that are not based on each item produced have been subtracted.
Market prices are the prices of goods and services after both unit-based and non-unit-based taxes have been added to factor cost, and both unit-based and non-unit-based subsidies have been subtracted from factor cost. These are the prices that the consumers pay for goods and services.
Conversions between factor cost, basic prices and market prices
To convert factor cost to basic prices and then to market prices means to calculate the effects of the appropriate taxes and subsidies.
To convert factor cost to basic prices we do not consider taxes on products (unilbased taxes) and subsidies on products (unit-based subsidies). We only consider other taxes on production (non-unit-based taxes) and other subsidies on production (non-unit-based subsidies).
The same is true when we convert basic prices back to factor cost.
The diagram below shows when the relevant taxes and subsidies must be added and when they must be subtracted.
To convert basic prices to market prices we consider taxes on products (unit-based taxes) and subsidies on products (unit-based subsidies). The same is true when we convert market prices back to basic prices.
We do not need to include other taxes on production and other subsidies on production in either case, as these were already incorporated into the basic prices when they were converted from factor cost.
The diagram below shows when the relevant taxes and subsidies must be added and when they must be subtracted.
To convert factor cost to market prices is a two-step process.
First we go through the stage of calculating in other taxes on production and other subsidies on production, which gets us to basic prices. Then we go through the stage of taking account of taxes on products and subsidies on products.
To convert factor cost to market prices we follow a two-step process in the other direction.
The diagram below shows when the relevant taxes and subsidies must be added and when they must be subtracted.
The Production Method for calculating product gross domestic product (GDP)
The Production Method for calculating GDP is where GDP at basic prices is determined by i calculating the sum of the value added at each stage of production, and GDP at market prices is calculated by then adding taxes on products and subtracting subsidies on products.
To get an accurate final calculation, all inputs should only be calculated in once. Most goods go through a process, and it is often difficult to determine whether inputs have been counted in or not.
Intermediate inputs are those goods and services purchased and sold during the production process.
Final products are those goods and services purchased by the end consumer and not resold .
Double-counting is an error where a transaction is counted more than once.
We know double-counting has occurred when GDP at market prices ends up higher than the total value of the actual goods and services. To avoid doublecounting, the intermediate inputs should be subtracted from the final products.
To show that a figure has been calculated using the we can label it as GDP(P).
The Income Method for calculating gross domestic product (GDP)
The Income Method for calculating GDP is where GDP is determined by calculating the income earned from the factors of production withil the borders of the countrY,
To show that a figure has been calculated using the lncome Method, we can label it as GDP(l), or we can call it the gross domestic income (GDl).
The Gross Domestic Income (GDI) is the total income received by all sectors of a country's economy.
Just as the value of income should equal the value of production, the GDI should equal the GDP, particularly when the GDP is calculated using the lncome Method.
There are three steps in the method:
- calculating GDP at factor cost
- calculating GDP at basic prices
- calculating income from GDP at market prices
Calculating GDP at factor cost means adding the factors of production. This includes the amount of natural resources and capital that has been used up, the salaries and wages that have been paid to workers, and the profit made by entrepreneurs.
Remember that the factors of production are
- land (natural resources)
- labour (workers)
- capital (money, machinery and equipment)
- entrepreneurship (business owners)
GDP @ factor cost = compensation of employees + net operating surplus + consumption of fixed capital
The compensation of employees includes all gross salaries and wages.
The net operating surplus is the profit, or in other words, the total value of all goods and services produced after the costs have been subtracted. The consumption of fixed capital is the depreciation in the value of fixed assets that occurs during the production process.
Calculating GDP at basic prices
means taking GDP at factor cost and then adding other taxes on production (non-item-based taxes) and subtracting other subsidies on production (non-item-based subsidies).
GDP @ basic prices = GDP @ factor cost + other taxes on production - othersubsidles on production
Calculating income from GDP at market prices means adding taxes on products to GDP at basic prices, and subtracting subsidies on products from this figure.
income from GDP @ market prices = GDP @ basic prices + taxes on products - subsidles on products
The three steps of the lncome Method for calculaling GDP can be summarised as follows:
The Expenditure Method for calculating gross domestic product (GDP)
The Expenditure Method for calculating GDP is where GDP is determined by calculating the total expenditure on all final goods and services within the borders of the country.
Gross domestic expenditure (GDE) is the total value of spending on goods and services within a country.
To show that a figure has been calculated using the Expenditure Method, we can label it as GDP(E).
The formula for calculating aggregate expenditure that is explained on page 6 is used in the Expenditure Method. (We simply replace the 'E'for aggregate expenditure with 'GDP'for gross domestic product.)
GDP = C + t + G + (X-M)
First we calculate what C + I + G is, and this gives us our gross domestic expenditure (GDE).
GDE = C + l + G
Then we take account of X and M to qet GDP.
GDP = GDE + (X_M)
The two steps of the Expenditure Method can be summarised as follows:
CONVERTING GROSS FIGURES TO NET FIGURES
Gross figures are those that have not yet had deductyons subtracted from them.
Gross income is income before any tax has been deducted.
Net figures are those that have had something deducted from them.
Net operating income is the operating income that has already had the tax deducted.
net = gross - any deductions
CONVERTING NOMINAL GDP TO REAL GDP
Nominal GDP is GDP I expressed in terms of the prices of the relevant time period.
Real GDP is GDP where the effect of inflation on the nominal GDP has been taken into account, and the figure has , been changed by deflating the index.
Inflation is a continuous increase in the general price level of goods and services in an economy over a period of time.
The GDP deflator is a measure of inflation (or deflation) since a specific base year.
Having the real GDPs for two or more years allows us to compare the economic production that occurred in those years.
CONVERTING BETWEEN GDP AND GNP
Although the domestic production of a country and the national production of that country are related, they are not the same thing.
Domestic production refers to the production that occurs within a country.
National production refers to the production of a country's citizens.
Gross Domestic Product (GDP) indicates the production . that takes place within the borders of a country.
Gross National Product (GNP) , indicates production by the r citizens of a country locally and abroad.
When an overseas-owned product is produced in South Africa, as in the case of a Big Mac burger, it is included in GDP (as it is produced within the borders of South Africa).
When a local singer plays overseas and earns money from this performance, it is included in the GNP (as it is produced by a South African citizen abroad).
GNP @ market prices = GDP @ market prrces + primary income from the rest of the world - primary income to the rest of the world
How is expenditure related to income and production?
Households sell factors of production, and buy goods and services from businesses, while businesses buy factors of production from households, and sell them the final products.
The national expenditure is the amount of money that is spent on goods and services by the households.
The national income is the remuneration that everyone (households and businesses) receives in return for their part in the production process.
The national production is the flow of goods and services from the business sector.
SPENDING AND SAVING
We are going to discuss the concept of the multiplier. To simplify this concept, we are going to assume that we are working with a closed economy that has no public sector. This will allow us to discuss the workings of the multiplier in a clear way.
In a closed economy with no government sector:
aggregate expenditure (E) = consumer spending by households (C) + investment spending by buslnesses (/)
This can also be written as: E = C + l
In such an economy, if it is in a state of equilibrium, then aggregate expenditure (E) is equal to aggregate income (Y).
Therefore, if the economy is in a state of equilibrium:
aggregate income (Y) = consumer spending by households (C) + investment spending by busrnesses (I)
This can also be written as: Y = C + l
However, the economy could be in a state of disequilibrium - then aggregate expenditure (E) will not equal aggregate income (Y).
THE MARGINAL PROPENSITY TO CONSUME AND THE MARGINAL PROPENSITY TO SAVE
Personal income is what is paid to people as earnings or transfer payments, before tax is taken off.
Disposable income (Yd) refers to personal income after tax has been taken off.
A person can choose how to dispose of his/her disposable income. He/She will probably choose to spend some of this money, and will probably also save some of it. Each individualwill choose the ratio between spending and saving that seems the best one given his/her current circumstances.
Consumption (C) is the using of goods and services to satisfy needs and wants.
Saving refers to all the disposable income that is not spent on consumption
ln order to consume goods and services we need to spend money on getting these, or we need to have already acquired them in the past.
People's propensity to do something refers to their natural tendency to do that thing.
People's propensity to consume refers to the proportion of their disposable personal income that they spend on consumption rather than saving that money.
The proportion of their disposable income that households spend is known as the marginal propensity to consume (mpc).
This can also be written as:
If South African households save 20oh of their disposable income, this means that for every R1 of extra income households spend BOc and save 20c. ln this case, the mpc is 0,8 and the mps is 0,2.
mpc + mps=1
Whenever disposable income rises in an economy, part of this increase is spent and part of it is saved. As personal income increases, the ratio between what is spent and what is saved might also change.
Disposable national income is the total amount ' , of income (funds) available for a country to spend , once all of the debts (such as taxes, payments , owing and social benefits) have been paid
THE MULTIPLIER EFFECT
The multiplier effect is the theory that if consumer spending by households (C) and/or investment spending by businesses (l) increase, then aggregate income (Y)will increase even more than the initial increase in aggregate expenditure (E). This is because, in a circular flow model, increased expenditure has a cumulative effect.
The multiplier effect is where an increase in spending by households and/or businesses causes a disproportionate increase in aggregate income.
The multiplier is a powerful economic tool, as a small change has a proportionally larger increase.
However, the multiplier places the economy in a state of disequilibrium as aggregate expenditure (E) is then not equal to aggregate income (Y).
CALCULATING THE MULTIPLIER
The multiplier (K) is the ratio that indicates the effect of a change in income to the change in spending.
When calculating the multiplier, we only look at the amount of money put back into the economy (consumed / spent) and not the amount saved.
To calculate the multiplier, we use the mpc, because this provides us with the proportion of disposable income that households spend in the economy.
ln closed economies with a public sector, the government can choose to cause a multiplier effect to help stimulate the economy.
The reverse multiplier effect (the downward multiplier effect) , is when a small decrease in national expenditure leads to a proportionally large decrease in national income.
Governments have to be watchful and guard against a reverse multiplier effect".
Business cycles are the recurrent patterns of economic expansion and contraction in a country.
THE COMPOSITION OF A BUSINESS CYCLE
Changes in real GDP indicate changes in the level of economic activity, When these changes are plotted on a graph, the line that joins the dots will either show an increase or a decrease in the level of economic activity. These upswings and downswings form business cycles.
There are four components of a business cycle:
- the trough (the lowest point in the business cycle)
- the expansion phase (the economic upswing)
- the peak (the highest point in the business cycle)
- the contraction phase (the economic downswing)
THE FEATURES OF A BUSINESS CYCLE
The two main phases of a business cycle are both divided into two smaller phases. As indicated on the diagram, the expansion phase is divided into a recovery and a boom, and the contraction phase is divided into a recession and a depression.
Recovery
A recovery is the first part of the expansion phase of a business cycle, where the economy lifts itseIf out of a trough.
At a trough, levels of spending are low and prices are falling. Then, as prices of goods and services fall to such low levels that consumers slowly start buying again, businesses start up and expand, and employment increases. As an economy lifts out of a trough and starts to expand, it is considered to be in recovery.
Boom
A boom (prosperity phase) is the second part of the expansion phase I of a business cycle, where the economy moves towards a peak.
It is when an economy starts experiencing high levels of consumer spending. This encourages firms to employ more labour, which increases production and leads to higher income and expenditure. The growth in income, production and spending is usually quite rapid, but may be short-lived.
Aggregate demand (AD) is the total demand for all goods and selvices within the economy.
Aggregate supply (AS) is the total supply of all goods and services within the economy.
Inflation is a general rise in the prices of products.
Recession
A recession is the first part of the contraction phase of a business cycle, where the economy falls from a peak .
When an economy contracts from a peak, the first thing that happens is that consumer spending falls, particularly on luxury goods. Many businesses experience falling profits and retrench workers to save money. As unemployment starts to rise, it has an ever-worsening effect on consumption.
Depression
A depression is the second part of the contraction phase of a , business cycle, where the economy moves towards a trough
When a recession worsens, it turns into a depression, where more businesses go bankrupt and there is massive unemployment. ln this phase many people are unable to buy anything except the most basic necessities.
Deflation is a general reduction in the prices of a products.
THE EFFECTS OF BUSINESS CYCLES
Some of the most important effects of business cycles are the way that they affect levels of employment, price levels and exchange rates.
Changes in employment
During an upswing, firms will experience very high sales as consumers with high disposable incomes increase spending. Businesses that sell luxury and leisure products will benefit the most during a boom. Businesses will expand in orderto keep up with demand, and many will invest in machinery and employ more labour. Unemployment will be very low and most households will have jobs. Many people willexperience increases in income as businesses expand and promote experienced staff. Students will not struggle to find casual or temporary labour, as even small businesses such as coffee shops will experience an increase in customers.
Once a downswing occurs, firms start to experience significant decreases in sales and revenues. Banks repossess assets bought on credit. ln order to survive, businesses cut costs by making workers redundant. Businesses that sell luxury and leisure products will be particularly badly affected during a downswing.
Changes in price levels
A recovery sees consumer spending increase, and in a boom there is a large amount of consumer spending. After some time, the price of goods increases as businesses realise they can charge more in the face of the high demand and scarce supply.
The high prices will eventually lead to the central bank taking action.
A central bank is a national bank that provides financial services for the government and the commercial banks, and which issues currency and implements the government's monetary policy^
South Africa's central bank is called the South African Reserve Bank (SARB), but is also simply referred to as the 'Reserve Bank'.
The repurchase rate (repo rate) is the interest rate at which commercial ' banks can borrow rands from the South African Reserve Bank (SARB).
When the SARB raises the repo rate, it is intended to reduce consumer spending and therefore inflation. ln response to a rise in the repo rate, repayments required on credit purchases will increase. This will have a big effect on people who have taken out housing loans. Disposable income will then decrease, which will start the process of reducing the price level again as a downswing begins.
Changes in exchange rates
Exchange rates measure the value of the rand against foreign currencies. The rand tends to weaken against foreign currencies during a boom as households feel wealthy enough to splurge on imports of luxury goods. During a downswing, the rand strengthens again as South African exports increase owing to lower price levels in the country.
The effect on economically vulnerable people
While all households find they have to reduce consumer spending in a downswing, the poor are worst affected as they have few ways to reduce their already low levels of consumer spending.
ln addition, people doing tow-paying unskilled jobs are usually the first to lose their jobs when businesses scale down during a recession Therefore, downturns affect the poorest communities the most.
Different economists have suggested different explanations for why business cycles occur.
THE EXOGENOUS EXPLANATION OF BUSINESS CYCLES
Exogenous factors are factors that affect a system from outside.
Exogenous explanations of business cycles attribute the expansion and contraction of an economy to influences other than the market forces of demand and supply.
Classical economists of the nineteenth century such as Adam Smith and Jean-Baptiste Say believed that markets had a natural tendency to return to equilibrium. They believed that if the market system were left to do its work then neither a boom nor a bust would last too long or cause too much upheaval. These economists believed that external factors were the cause of prolonged economic chaos.
Examples of exogenous factors that can affect economic activity are:
- Natural disasters and dramatic changes in weather patterns
Drought or flooding can affect agriculture, causing a reduction in the food supply. Hurricanes can affect oil-drilling operations, causing a decrease in the world's oil supply. Both of these cause an increase in prices that can cause an economic downswing.
- Wars and terrorism
Wars and terrorism can disrupt international trade and transport, which can cause businesses that are dependent on these industries to go bankrupt. This can cause an economic downswing.
The people who believe in this exogenous theory of why business cycles occur have routinely been referred to as monetarists. Therefore the exogenous explanation of business cycles is also called the monetarist explanation.
Monetarists usually believe that a government should not interfere in its country's economy. ln their view, a market that is ruled by market forces will find its own stability. They regard a government as another exogenous factor that can disturb these market forces and cause a cycle of boom and bust.
THE ENDOGENOUS EXPLANATION OF BUSINESS CYCLES
Endogenous factors are, that affect a system from inside.
Endogenous explanations of business cycles attribute the expansion and contraction of an economy to elements within the market system.
Various economists have supported endogenous explanations of business cycles, such as J.C.L. de Sismondi and Karl Max in the nineteenth century, and John Maynard Keynes in the twentieth century.
The endogenous explanation of business cycles is also called the Keynesian explanation.
Examples of endogenous factors that can affect economic activity are:
- Changes in the level of consumer spending
If people's disposable income is high and consumer confidence is high, spending on products will increase, and may be fuelled by loans taken from banks. If people's disposable income and consumer confidence decrease, then spending will decrease. The changing level of consumer spending can cause an economic upswing or downswing.
- Changes in the level of investment spending If businesses are confident that the demand for their products will increase in the future, they will invest in machinery and equipment. However, if their confidence in future profits is low, they will delay these capital investments.
The changing level of investment spending can cause an economic upswing or downswing.
Economists who attribute changes in the business cycle to endogenous factors usually believe in government intervention to minimise the human suffering caused by economic downswings.
- Changes in the level of consumer spending
Decreases in the levels of economic activity have a negative effect on the people of a country. Economists who believe that governments can successfully intervene in the market system believe that it is the duty of governments to prevent or minimise downswings.
The two main ways of a government intervening in a market economy are through demand-side policies and supply-side policies.
DEMAND-SIDE POLTCIES
Demand-side policies aim to increase or decrease aggregate demand depending on the stage of the business cycle.
Demand-side policies are associated with the economist John Maynard Keynes.
The two main demand-side policies that a government can employ are monetary policy and fiscal policy.
Demand-side policies
- Monetary policy (repo rate)
- Fiscal policy (G & T)
Monetary policy
The monetary policy is the approach taken by a country's central bank , (or other monetary authority) to influence spending in an economy by influencing the interest rates and the money supply
In South Africa monetary policy is determined by the Monetary Policy Committee (MPC) of the SARB, which is led by Governor Lesetja Kganyago.
While the main aim of the MPC is to control inflation, monetary policy has the additional aims of:
- increasing economic growth
- decreasing unemployment
By increasing the repo rate the SARB can cause other banks to increase their interest rates. By decreasing the repo rate the SARB can cause other banks to decrease their interest rates.
Tne average interest rate that l commercial banks charge customers ls called the prime lending rate.
The prime lending rate will determine how much money households and businesses have to pay back to the commercial banks on the loans that they take out. When interest rates are high, fewer loans are taken out owing to the high cost of repaying them. When interest rates are low, more loans are taken out, leading to an increased money supply and increased spending, but also the possibility of inflation.
Therefore to protect against inflation (to keep prices stable) the SARB can increase the repo rate.
To increase economic growth and decrease unemployment the SARB can decrease the repo rate. This leads to a lower prime lending rate, and therefore increased consumer spending by households and increased investment spending by businesses. lt also leads to a reduced demand for rands from foreign investors seeking high interest rates. The resulting reduction in inflows of savings from foreign countries will cause the rand to weaken, which could cause exports to increase. This would then drive economic growth, which would reduce unemployment.
The aim of protecting against inflation and the aims of increasing economic growth and reducing unemployment clearly can require conflicting action on behaIf of the SARB. All of these aims are important. However, the SARB's main aim is to use the repo rate to guard against high inflation, in order to encourage aggregate demand in the economy. (Nevertheless, it will take an economic downswing and the country's unemployment levels into account when deciding on the repo rate.)
Monetary policy is a reasonably direct way of intervening in the economy, because the SARB can alter the repo rate on a monthly basis.
The inflation rate is the rate at which the general level of prices for goods and services is rising.
A higher repo rate and the resulting higher interest rates:
- decrease the inflation rate
- decrease consumer spending by households
- decrease investment spending by businesses
- increase unemployment
- strengthen the rand and therefore decrease exports.
A lower repo rate and the resulting lower interest rates:
- increase the inflation rate
- increase consumer spending by households
- increase investment spending by businesses
- decrease unemployment
- weaken the rand and therefore increase exports
Monetary policy also includes:
Fiscal policy
The fiscal policy is the approach that the government takes to , taxation and ggvefnment spending in order to regulate the economy.
When the government uses the national budget to influence economic activity, then this is referred to as fiscal policy. ln South Africa the National Treasury is in charge of fiscal policy, led by Minister of Finance Pravin Gordhan.
Fiscal policy has three main aims
: .- increasing economic growth
- decreasing unemployment
- protecting against an increase in inflation
To increase economic growth, fiscal policy can be used t:
- lower taxes
This encourages consumer spending by households and investment spending by businesses. These are important components of GDP. As they rise, so does nationaloutput. .
- increase government expenditure
Public-works programmes, infrastructure development, and spending on health and education create jobs. This will increase consumer spending and the output of businesses.
To decrease unemployment, fiscal policy can be used to:
- lower taxes
This encourages consumer spending by households and investment spending by businesses, which increases businesses' profits, encourages more investment spending by businesses, and fuels job creation.
- Increase government expenditure
Public-works programmes, infrastructure development, and spending on health and education create jobs. This will increase consumer spending and the profits of businesses, and lead to further job creation.
To decrease inflation, fiscal policy can be used to:
- raise taxes
Higher taxes will decrease investment spending by businesses, as there will be less likelihood of making a profit. Higher taxes will also mean that consumers will have less disposable income, so will lead to a decrease in consumer spending. This slows down the rate of money moving around the circular flow and leads to a slowdown in buying and selling. Products then become cheaper as firms experience a drop in sales
- decrease government expenditure
Lower government spending will result in a decrease in jobs, and, as households'disposable income falls, so consumer spending will decrease.
When fiscal policy is used to control inflation it has lagged effects. ln addition, the measures used will decrease economic growth and increase unemployment. Fiscal policy is therefore a secondary tool for dealing with inflation - certainly in the short term. It is not as direct as monetary policy as it is only determined once a year. However, if the medium- to long-term outlook is bleak in terms of high inflation, then fiscal measures can be put into place to assist monetary policy in this regard.
An expansionary fiscal policy is where the government decreases taxes and increases spending
The lower taxes and higher government expenditure are used to stimulate economic growth and decrease unemployment.
A contractionary (restrictive) fiscal policy is where the government decreases , spending and increases taxation.
Because a contractionary fiscal policy decreases households'consumer spending and businesses' investment spending, it decreases inflation.
A contractionary fiscal policy will ultimately result in tax revenue exceeding government expenditure. This will allow a government to pay back its debts.
SUPPLY-SIDE POLICIES
Supply-side policies aim to improve an economy's r ability to produce products/
By increasing business efficiency and competitiveness, an economy is able to increase output and to lower prices. This results in growth that is sustainable in the long run, and does not just focus on short-term gains from higher demand.
The two main kinds of the supply-side policy that a government can use are those strategies that try to improve the productivity of factors and those strategies that try to improve the performance of businesses.
Supply-side policies
- Strategies to improve factors' productivity (better workers)
- Strategies to improve businesses' performance (better businesses)
Improvement in the efficiency of inputs
Increased efficiency of inputs moves the supply curve to the right (.'. increase in supply). This can be done using two approaches, i.e. productivity of factors and performance of businesses.
Strategies to improve productivity of factors
These include:
- better education and training of workers and entrepreneurs
- increased mobility of work
- performance-related pay and local rates for workers in the public sector
- reductions to the powers of trade unions
Strategies to improve performance of businesses
These include:
- helping new businesses get started
- helping businesses implement new technology
- helping businesses reach new markets
- privatising government industries (state-owned enterprises)
The problem with supply-side policies is that they can be expensive and take a long time to take effect. They can also cause a widening of the gap between rich and poor, and are often resisted by trade unions or foreign businesses that benefit from protected foreign product markets.
Households and businesses experience changing fortunes at different stages of the business cycle.
The new economic paradigm refers to the modern trend for governments to use supply-side policies alongside demand-side policies to smooth business cycles to reduce the suffering associated with severe recessions and depressions.
Embedded in the new economic paradigm is the realisation that demand-side policies are not sufficient to prevent a boom-and-bust cycle. While the demand side of the economy is easier to manage, by themselves demand-side measures result in a lack of stability. Monetary policy and fiscal policy tend to fuel brooms, which then need to be reigned in again once the economy overheats.
Supply-side policies aim to enhance the productive capacity and efficiency of the economy going forward. This ensures that supply is better able to meet a higher demand without accompanying higher prices as supply runs out.
Counter-cyclical policies are approaches that cool down the economy when it is in an upswing and stimulate it when it is in a downswing.
The new economic paradigm aims to combine demand-side and supply-side measures as part of counter-cyclical policies, so that the economy can experience slower but more sustained growth, with less chance of harmful downswings. Steady economic growth is considered better than very fast growth that spikes, because quick highs are very often followed by deep troughs.
The new economic paradigm does not aim to eliminate fluctuations in economic activity altogether.
A government that is employing the new economic paradigm will use an expansionary policy to stimulate economic activity during recessions and depressions.
Such a policy could include:
- decreasing the repo rate (a demand-side measure, part of monetary policy)
- increasing government expenditure (a demand-side measure, part of fiscal policy)
- increasing education subsidies (a supply-side measure, focusing on the improvement and productivity of e.g. the factor of production, labour)
- increasing the help given to businesses entering foreign markets (a supply-side measure, focusing on businesses' performance)
Such a government will use a contractionary policy to calm economic activity during a boom and, if necessary, to get itseIf out of debt at the same time. S uch a policy could include:
- increasing the repo rate (a demand-side measure, part of monetary policy)
- decreasing government expenditure (a demand-side measure, part of fiscal policy)
Date refers to facts and statistics that gathered for analysis.
An economic indicator is a statistic used to measure some aspect of the economy.
A forecast is calculated prediction about the future.
Forecasting is the process of basing future predictions on past occurrences.
In Economics, we use data and economic indicators to assist in forecasting. Together with numerical tools, such as moving averages and extrapolation, these can be used to make reasonably accurate forecasts.
ECONOMIC INDIGATORS USED IN FORECASTING
A wide range of economic indicators are available to economists to enable them to form judgements about how things will change.
All indicators can be classified into three main groups, namely:
- leading,
- coincident and
- lagging economic indicators
Leading economic indicators
A leading economic indicator is a measurable factor that changesiust ,. before a change in economic activity or a change in an e-c3nomic trend. ,
Leading economic indicators warn of conditions to come. They peak before the actual peak in economic activity, and reach a trough before an actual trough in economic activity.
Examples of leading economic indicators are:
- the space used by job advertisements
- the number of building plans approved
- the average weekly wage paid in the manufacturing sector
Coincident economic indicators
A coincident economic indicator is a measurable factor that changes af a similar time as a change in economic activity or a change in an economic trend.
Coincident economic indicators occur at the same time as the prevailing economic conditions. They show where the economy is currently situated.
Examples of coincident economic indicators are:
- real GDP
- the personal income levels of households
- the value of retail sales
Lagging economic indicators
A Lagging economic indicator is a measurable factor that changes after a change in economic activity or a change in an economic trend.
Lagging economic indicators confirm the existence of a trend, and shed light on what has already happened in the economy.
Examples of lagging economic indicators are:
- unemployment rates
- real investment in machinery and equipment
- the average prime interest charged by banks
THE LENGTH AND AMPLITUDE OF BUSINESS CYCLES
The length of a business cycle is the amount of time taken to move from a peak to a peak.
A cycle has gone its full course once it has experienced the key features of recession, depression, recovery and boom.
Not all of a country's business cycles are of the same length, but often they are of similar lengths. So knowing the length of a country's past business cycles helps economists make forecasts about future business cycles.
The amplitude of a business cycle is the difference between the value of total output at a peak and the value of total output at the trough that preceded it.
The amplitude gives a sense of the size of the change in economic activity that has occurred.
MOVING AVERAGES
A time series is a sequence of data measured at regular points in time.
Moving averages are averages calculated along a time series, so that a smoother graph can be drawn based on these averages than on the original data
A graph drawn based on moving averages makes it possible to see the big picture over a particular time period, because the viewer is not distracted by small variations in data.
EXTRAPOLATION
Extrapolation is when we estimate unknown data based on a pattern of known data.
We do not have data about the future. However by taking data about the past and extending its pattern onwards, we can anticipate future events.
TRENDS
A trend is the general direction that an economy is moving in, despite the fluctuations of a business cycle.
The trend line for GDP shows how GDP changes over time.
The trend allows an economist to focus on the overall picture of an economy rather than individual peaks and troughs.
Types of business cycles, and their lengths
Apart from these real business cycles, a number of economists have proposed that there are discernable patterns of higher and lower spending in particular contexts, which are considered other types of business cycles that could exist:
- Joseph Kitchin proposed that there are short fluctuations over three to five years where businesses increase and then decrease the amount of finished stock in their inventories, based on the demand that they can discern. These are called Kitchin cycles.
- Clement Juglar proposed that there are fluctuations over seven to eleven years where businesses increase and then decrease their investments in fixed capital (land, buildings, machinery, equipment and vehicles). These are called Juglar cycles.
- Simon Kuznets proposed that there are medium-range economic waves of 15 to 20 years where the construction industry increases and decreases its activity. These are called Kuznets cycles.
- Nikolai Kondratiev proposed that there are long-range economic waves of 40 to 60 years where structural changes, such as increases in technology, or exogenous shocks, such as war, affect growth trends. These are called Kondratiev cycles.
The validity and usefulness of these theories are still under debate.
The public sector is the part of the government that owns, produces, allocates and supplies certain goods and services to its citizens.
The government is therefore almost the same thing as the public sector, because most of what the government does is provide public goods and services, law and order, and safety from external threats, and regulate the economy so that it functions in a fair way.
THE COMPOSITION OF THE PUBLIC SECTOR
ln South Africa the general government consists of three levels:
- the national government
- provincial governments
- local (municipal) governments
Together with parastatals, such as Eskom, they comprise the public sector.
The National government
The national (central) government makes laws, interprets laws and runs the country.
The legislative branch of national government makes the laws of the country.
The executive branch of national government determines the national policy relating to the provision of public services, in line with the country's laws.
The judicial branch of national government interprets the laws of the country, arbitrating disputes and passing sentences.
Provincial governments
The provincial governments form the second layer of government, and they administer the provincial departments.
ln South Africa each of the nine provinces has its own provincial government, led by that province's premier. The provincial government manages provincial issues such as healthcare, education and the provision of housing. The provincial government can also make laws about some issues in the province
The provincial governments allocate money to local governments to ensure that their policies are carried out.
Local governments
The local governments (municipal governments) form the third layer of government, and they administer the metropolitan and district municipalities.
Metropolitan municipalities are those that , cover urban areas (cities or parts of cities).
District municipalities are those : that cover rural areas (not cities).
The various municipalities provide the essential public services, such as the provision of water and electricity, and the removal of refuse. Municipalities also beautify the suburbs under their control by sweeping streets, cuttlng grass and planting trees.
Parastatals
The word 'state' can refer to a country or the government that runs a country.
Parastatals are parts of the public sector that are run like businesses and provide goods and services to households.
Parastatals are also called 'publicly owned corporations', 'public corporations', 'state-owned enterprises' and'state-owned companies' (SOCs).
Parastatals operate in a similar way to privately owned businesses. They also aim to make a profit and follow sound business practices, such as keeping costs low. However, they are heavily subsidised by the government to help people to be able to afford the goods and services they provide. The idea is that the goods and services that are provided by parastatals willtherefore cost less than they would if provision were left to normal businesses.
Examples of parastatals are:
- Eskom (Eskom Holdings SOC Limited)
- Telkom (Telkom SA SOC Limited)
- Transnet (Transnet SOC Ltd)
- SAA (South African Airways SOC Limited)
THE NECESSITY OF THE PUBLIC SECTOR
Human rights are the basic rights that we accept all people have. Human rights include the right to life, the right to a fair trial, freedom of speech and freedom of movement.
The Universal Declaration of Human Rights is a l document created by the United Nations (UN) in 1948 to recognise people's human rights, and to influence states to recognise and protect these rights.
Social rights are the rights that people have to participate fully in society. Social rights include the right to educatfon and to have a famIfV,
Economic rights are the rights that people have to provide for themselves. Economic rights include the right to own property and the rlOht to start a business.
In addition, states may recognise citizens' social and economic rights.
These social and economic rights are dealt with partly in the Universal Declaration of Human Rights, and also in the UN's lnternational Covenant on Economic, Social and Cultural Rights.
The International Covenant of Economic, Social and Gultural Rights of 1966 is a treaty where states agreed to work towards granting these rights to their citizens
The Convention on the Rights of the Child is a United Nations i treaty from 1989 that sets out l the rights of people under the . age of eighteen.
If a state accepts these three documents, then it has the responsibility to protect many rights. This needs to occur through the public sector. A state cannot leave the fuIfillment of these rights to market forces.
Market forces do not always result in all households receiving a fair allocation of goods and services, or in businesses always producing enough of certain goods and services.
The public sector:
- regulates the socio-economic environment
- stabilises the economic environment
- provides some goods and services
- re-distributes money through taxes and weIfare payments
The regulatory role of the public sector
The public sector regulates the social environment and the economic environment, and controls externalities.
Regulating the social environment
The government maintains the legal framework of the country. lt provides a police service to uphold the laws of parliament. Through a system of courts, it ensures that the legal system runs its course in line with the democratic values of the constitution. Therefore businesses are able to operate in an environment where their business interests are protected. This stable environment also protects the property rights of households and businesses, which encourages investment spending by businesses as well as foreign investment.
Regulating the economic environment
The government promotes competition, and laws prevent brusinesses from gaining monopoly power. The government raises taxes to prevent overspending, and reduces taxes when the economy is slowing down.
Controlling externalities
Externalities are the side-effects of activities that affect people who were not involved in these activities.
Negative externalities are the side effects of production and consumption activities that have a bad effect on people who were not involved in these activities.
positive externalities are the side effects of production and consumption activities that have have a good effect on people who were not involved in these activities.
The stabilising role of the public sector
The government uses monetary and fiscal policy in its attempt to achieve stability in the economy and in society.
The South African government uses monetary policy to keep inflation low and sustainable, as this reduces boom-and-bust cycles. lts target range for inflation is 3 - 6%. To help achieve this, the SARB raises the repo rate when required.
The South African government uses fiscal policy to help it towards its target of an economic growth rate of 5% per year. This is the level of groMh needed in order to give the marginalised sections of the population greater access to the economy, thus decreasing unemployment and increasing the stability of South African society. The National Development Plan of 2012 aims to create 1 1 000 000 newjobs by 2030.
The providing role of the public sector
One of the most important functions of the public sector is the provision of important goods and services that the private sector does not provide. Public goods can be divided into 3 groups:
Merit goods Merit goods are provided for society by the public sector because the government thinks it is beneficial for society to have them, not because of people's demand for them.
Clean water and education are examples of merit goods.
Community goods Public goods are beneficial products provided by the government to all citizens, even if they do not pay for them, and which can be consumed by many people without causing a decrease in quality or quantity.
Lighthouses and national defence are examples of public goods
Collective goods Collective goods include parks and beaches, where fees, charges or tolls can be levied to exclude free-riders.
The redistribution role of the public sector
The United Nations"Universal Declaration of Human Rights'states that a person's society should help that person to get food and shelter, and to access health services and development opportunities, with extra help given to the most vulnerable people.
This security that a society should offer its people is termed social security.
If a government believes in the concept of social security, this will lead to it providing social weIfare.
Social weIfare (weIfare) is government support that aims to improve the standard of living of all citizens up to a certain minimum level.
In South Africa social weIfare is the responsibility of the Department of Social Development.
A weIfare grant is where the government subsidises people who are in soclal distress through transfer payments. ',
For every one person paying tax in South Africa, four people are dependent on weIfare grants. The state allocates about 20% of its total budget towards the following types of weIfare grants:
- unemployment benefit
- child-weIfare grant
- disability grant
- old-age pension
- war-veteran's grant r housing subsidy
By taxing high-income earners and business profits, the government is able to spend money on social weIfare. A large portion of taxes is used for poverty alleviation and for providing services to those who cannot afford to pay for them.
There are a number of problems that the public sector faces when it is providing goods and services, namely:
- how to determine people's needs and decide on priorities
- how to price its products
- how to ensure efficient service delivery and accountability
- how to balance contrasting economic priorities
The above often leads to a discussion of whether to privatise key national industries or not.
DETERMINING PEOPLE'S NEEDS AND DECIDING ON PRIORITIES
A private company decides what to produce and how much to produce based on market research. The demand for goods and services is the key driver of output in free markets. However, the state has to provide for a wide range of socio-economic needs, many of which are unknown or difficult to quantify. Rural areas may be in need of electricity or clean water, but unless their elected representative brings this to the attention of local or provincial government, these needs may take a back seat to other needs. ln addition, the government has difficulty in prioritising which provinces deserve attention, and then which areas or population groups within those provinces need the most urgent attention.
PRICING PRODUCTS
The public sector does not want to exclude people from consuming their share of the goods and services it provides. However, by charging something for these goods and services, even by charging a price that is below the cost of producing them, the public sector will be able to increase what it is able to provide. Therefore the public sector must decide whether to:
- provide a good or service free of charge
- require a reduced fee for this good or service, which the public sector must then also partly subsidise, or
- charge users a fee based on the cost of producing the good or service.
ENSURING EFFICIENT SERVICE DELIVERY AND ACCOUNTABILITY
The public sector may be led by officials with good intentions, but it must be accountable for how well these intentions have been translated into real goods and services for the people who need them.
Service delivery is the implementation of public services so that goods and services reach the people I that they are intended for at the appropriate time.
Poor planning and logistical problems can result in poor service delivery. For service delivery to be efficient the public sector needs to use its limited resources effectively. The public sector often uses practices from the private sector to help achieve this (for example, the processes of planning, leading, organising and controlling).
While the departments and managers of a business are accountable to the owners of that business, the public sector is theoretically accountable to the people of the country. However, it is more difficult for these people to hold public sector officials accountable for mismanagement of public resources. This is because information on the mismanagement is not always available, and the officials who are in charge of holding other officials to account on behaIf of the people may not choose to do so, or may let corrupt officials off so lightly that the punishment will not act as a deterrent in the future.
BALANCING CONTRASTING ECONOMIC PRIORITIES
The public sector has limited resources. For example, if more money is spent on education, this means that less money is available to be spent on healthcare.
When preparing the national budget, the government has to choose how much it will spend on each of its responsibilities in the year ahead.
Economic objectives can also be in conflict with each other. For example, a high unemployment rate may require increased government spending on public works, but this might be in conflict with an aim of reducing inflation. The government therefore has to balance its different objectives when deciding how much to spend on what aspect of the economy.
NATIONALISATION AND PRIVATISATION
A very topical debate in South Africa is the one of whether to nationalise or privatise industries.
Nationalisation is a socialist policy of state ownership of natural resources and industries that are important for strategic and employment reasons.
Nationalisation is costly to implement as the government needs to invest heavily in nationalised industries using tax-payers' money. Because they are not run with a profit motive, many of these industries tend to be inefficient and run at a loss. However, they do provide employment and prevent capital flight. The redistribution effects are significant.
Privatisation is the process of transferring ownership of something from the public sector to the private sector.
Privatisation can lead to greater efficiency, competition, more choice and a higher standard of living. Private businesses pay tax if they make a profit, so privatisation can lead to an increase in tax revenue. However, private businesses may not always act in the best interests of society because they are primarily profit-driven.
OBJECTIVES OF THE PUBLIC SECTOR
ln a mixed economy, the government is ultimately responsible for the overall performance of the national economy. Although private businesses and individuals will act in their own interests, namely to make a profit, it is the role of the government to ensure that the economy performs well in all areas. To do this the government sets certain macro-economic objectives.
South Africa's macro-economic objectives relate to:
- economic growth
- fullemployment
- price stability
- exchange-rate stability
The macro-economic objective of economic growth
Economic growth is probably the most important macro-economic objective as it is the force that drives all of the other objectives.
Economic growth is measured as percentage change in real GDP Year-on-year calculations are made to determine the progress of the economy.
The macro-economic obiective of full employment
In an ideal world, all of the factors of production would be fully employed. lt is particularly important that labour is employed, because unemployment leads to poverty, hunger and other social problems such as crime.
To prevent the negative impacts of unemployment on a country, the unemployment figure should be kept as low as possible. However, this is difficult if government is unable to meet its first objective of economic growth.
Economic growth and increased employment opportunities are very closely linked. Measures to increase economic growth will create an environment where job opportunities abound and prosperity increases.
The macro-economic objective of price stability
Stable prices are an important objective. Necessary goods and services should be affordable to all economic participants.
Price stability leads to economic stability, makes planning easier, and ensures r, that people do not have their spending power, living standards and savings eroded by inflation.
In addition, inflation reduces business and consumer confidence, and can also harm international perceptions of the country, and thus affect its economic prospects.
Therefore a government must decide what is the acceptable range for the country's inflation rate to fluctuate within, and use monetary policy to keep the inflation rate within this target range.
The macro-economic objective of exchange-rate stability
These days all countries engage in international trade. Countries earn large amounts of foreign currency by exporting goods. lmports, however, result in leakages of income from the national economy. lt is therefore important to keep an accurate record of the flows of money that occur in international transactions.
The balance of payments (BOP) is a statement that records the economic transactions between a country's residents and foreign countries over a particular period of time.
Inflation that is caused by an increase in the price of imports is called imported inflation.
THE NATIONAL BUDGET
Government revenue is the total money received by the government through taxation and other sources.
Government expenditure (government spending) is the total value of all spending by government on goods and services.
The national budget is the government's plan for government revenue and government expenditure for the coming fiscal year.
The difference between government revenue and : government expenditure over one fiscal year is called the budget deficit (if expenditure is greater than revenue) or the budget surplus (if revenue is greater than expenditure).
If the income obtained from taxes falls short of the revenue needed, the remaining necessary expenditure is financed through borrowing.
One way that a government borrows money is by selling government bonds.
A government bond is a document that acknowledges a government debt in exchange for a loan, where the government promises to pay back the loaned amount plus a certain amount of interest to the holder of the bond at a specific date.
For the fiscal year beginning in April 2013 the South African government set a budget of R'l 100 billion for government expenditure. This was to be funded from the total revenue collections of R985,7 billion and borrowings of R163,7 billion.
Millions, billions and trillions
- 1 million rand = 1 000 000 rand
- 1 billion rand = 1 000 000 000 rand
- 1 trillion rand = 1 000 000 000 000 rand
A country's national debt is the money that a country owes, ' either on government bonds that it has sold, or on loans that it has received from the World Bank or financial institutions.
Sources of government revenue
Government revenue comes from:
- taxation (taxes)
- the way in which state assets are used to earn an income
Taxation
In South Africa the bulk of government revenue comes from taxes
The taxes that the national government receives can be classified in terms of two main categories:
- direct taxes
- indirect taxes
A direct tax is a tax imposed on the income or wealth of a person or business.
Examples of a direct tax are the personal income taxes such as:
- Pay-As-You-Earn (PAYE)
- Standard lncome Tax on Employees (SITE)
Capital gains tax (CGT) is a direct tax levied on the sale of assets.
An indirect tax is a tax that is charged , when money is spent on products.
Examples of indirect taxes are:
- Value Added Tax (VAT), which is levied on almost all expenditure
- customs duties, which are levied on imported goods
- the fuel levy, which forms about 30% of the price charged for petrol and diesel at the pump
- excise duties, which are inland taxes on specific products
Revenue from state assets
The state also owns assets, which it uses to generate revenue by leasing them, renting them out, or selling them to private institutions.
Among these state assets are the eight state-owned companies (SOCs) that are accountable to the Department of Public Enterprises:
- Eskom, which generates about 95% of the electricity used in South Africa, and distributes this to agricultural, mining, industrial, commercial and residential customers
- Alexkor, which is a diamond mining company in the Alexander Bay area of the Northern Cape
- Denel, which manufactures defence equipment and vehicles, and is a supplier to the South African National Defence Force (SANDF)
- Broadband lnfraco, which is a telecommunications company that tries to increase the long-distance network infrastructure
- Safcol, which is a forestry company committed to sustainable economic development
- Transnet, which manages and oversees the running of ports and pipelines
- South African Airways (SAA), which is South Africa's national airline offering domestic, regional and international flights
- South African Express Airways, which is an airline offering domestic and regional flights
Categories of government expenditure
The South African Constitution requires that every year a Division of Revenue Act is used to divide up the government revenue between the national government, the provincial governments and the local governments. The various departments of the national government usually get about 5070 of the money, about 42% gets divided up between the provinces, and about B% gets divided up among local governments. This is because the functions for which the national and provincial governments are responsible are more expensive than those for which the local governments are responsible.
The medium-term expenditure framework (MTEF) is an expenditure plan that takes account ofthe next three years, notjust the year ahead.
An MTEF is prepared every year for the three years ahead. The Minister of Finance must refer to the most recent MTEF when preparing the annual national budget.
When drawing up the national budget, the Minister of Finance must allocate the money in the most equitable way. The national budget must take account of which provinces are most in need of development, and which spheres within each province require attention (such as education and healthcare). All allocations must be in the overall national interest.
In the national budget of 2O13,the South African government's planned expenditure for the year was more than R1 100 billion.
The pie chart below shows the amount of money allocated to each of the government's functions. This gives a clearer picture of the government's priorities than knowing how much was allocated to the national government, the provincial governments and the local governments.
Government spending (G) makes up about 30% of all GDP in South Africa. It is an important driver of growth and job creation.
Changes in government spending since 1994
After 1994 the spending priorities of the South African government changed. The focus on social weIfare and economic upliftment increased, and so did the expenditure on these functions. This required that less was spent on other functions.
THE PROVINGIAL BUDGETS
Each province has its own budget. The amount that is given to each province is based on the equitable share formula. This takes account of factors such as the number of each province's poor people, the number of people without access to medical aid, and the size of its school-age population.
Provinces can also raise their own revenue through various fees.
Provinces must spend their revenue on education, health services, police services and justice, among other things.
THE LOCAL BUDGETS
Local (municipal) governments receive equitable share grants and conditional grants. Local governments can also raise their own revenue through various fees. Local governments must spend their revenue on basic services and infrastructure, among other things. Together with their community, each local government has to create an lntegrated Development Plan for the municipality's long-term development.
The fiscal policy is the approach taken to taxation and government spending in order to regulate the economy.
The public sector's roles of providing public and merit goods and services, and redistributing wealth through weIfare grants, are two of the ways in which government spending occurs. However, the public sector's roles of regulating and stabilising the economy are the focus of fiscal policy.
Fiscal policy has five major purposes:
- increasing economic growth
- decreasing unemployment
- protecting against an increase in inflation
- creating income equality
- creating exchange-rate stability
Fiscal policy is used to achieve these aims by affecting demand and supply in the economy.
The way it does this is through:
- the level of government expenditure (G) injected into the economy, and how this is distributed
- the level of taxes (T) that it causes to leak from the economy, and how these taxes are raised
EXPANSIONARY FISCAL POLICIES
An expansionary fiscal policy entails lowering taxes and increasing government expenditure so as to inject money into the circular flow
By lowering taxes and/or increasing government spending the government encourages economic growth and helps to decrease unemployment.
Lower taxes encourage both investment by businesses and spending by consumers. This encourages increased output and job creation, and so lowers the level of unemployment.
Higher government spending in the form of public works, infrastructure development, healthcare and education also creates jobs for the unemployed, and consequently increases consumer spending.
CONTRACTIONARY FISCAL POLICIES
A contractionary fiscal policy entails raising taxes and decreasing government expenditure so as to withdraw money from the circular flow.
By raising taxes and/or decreasing government spending the government helps to keep inflation under control.
Higher taxes will reduce business incentives to invest. Consumers will have less disposable income after tax rises, leading to less consumer spending. Goods and services will become cheaper as firms experience a drop in sales.
Lower government spending will result in fewer jobs. As disposable income falls, so spending on goods and services will slow down.
TAXATION SYSTEM
Regressive taxation systems are those that require people who earn less to pay more in taxes.
Proportional taxation systems are those that require each , person to pav the same proportion of their income in taxes. to pay the same proportion of their income in taxes. person to pay the Same proportton ol thelr lncome in taxes.
Progressive taxation systems are those that require people who earn more to pay more in taxes.
Progressive taxation systems
Progressive taxation systems protect low-income earners from being overwhelmed by the burden of tax, while requiring high-income earners to make a significant contribution to national revenue.
In such a system, people are classified according to how much they earn. They are then taxed on their incomes using a system of tax brackets.
People who earn very little will not fall into any tax bracket.
People who earn a low amount will fall into the lowest tax bracket and have to pay the tax rate for that bracket on their whole income.
People who earn a moderate amount will be taxed according to two tax brackets. Their income up to a certain point will be taxed according to the rate set for the first tax bracket, and what they earn beyond that point will be taxed more heavily according to the rate set for the next tax bracket.
People who earn even more will have different portions of their income taxed according to three or more tax brackets.
Each bracket has a minimum level of income and, except for the top-most bracket, a maximum level of income.
According to this system, the people who fall into the higher tax brackets will ultimately have to pay a bigger proportion of their income to the government as tax.
The tax rate charged on a particular tax bracket is , called the marginal tax rate for that tax bracket.
THE DANGER OF HIGH PERSONAL TAX RATES
The average tax rate must not be so high so as to create a disincentive for taxpayers to pay tax. High average tax rates encourage tax avoidance and even tax evasion. These result in lower tax revenues.
Tax evasion means dodging tax in illegal ways, such as misrepresenting taxable income r in order to pay a reduced amount of tax.
Tax avoidance means finding , legal ways to pay less tax through an underslanding of the tax laws.
Some countries charge a'supertax'on particularly high-income earners. One danger of this approach is that it might cause these people to relocate to a different country to avoid the high taxes. This would mean that the country that was trying to get more tax from these high-income earners would ultimately get less tax from them.
A person's average tax rate can also affect that person's choice about how hard to work. If the rate of personal income tax becomes very high and people feel they are not earning much more for the extra hours they are working, they may decide they will get more utility from their time if they spend it on leisure activities.
THE LAFFER CURVE
The Laffer curve is a visual representation of the idea that no government revenue will be earned if the tax rate is 0% or 100%, and that somewhere between these points is an optimal point where the tax rate will result in the maximum government revenue possible.
A Laffer curve shows the relationship between tax rates and government revenue. The curve shows that at a zero tax rate the government would earn no tax revenue. lt also shows that, as the curve moves away from a zero tax rate, tax revenue increases, until a certain point where people prefer not to work or not to work as hard (no overtime), thus reducing tax revenue. The Laffer curve suggests that this could reach the extreme where the tax rate is 100% and nobody wants to work as they would have to hand over all their money to the state. If this occurred, tax revenue would be zero as nobody would earn an income.
The Laffer curve illustrates the idea that an optimal rate of tax is one where tax revenue is maximised. Charging a lower rate of tax than the optimal rate results in revenue being foregone, whereas charging a higher rate than the optimal rate will also result in a decrease in tax revenue (for example, through tax evasion).
THE EFFECTS OF FISCAL POLICY
Fiscal policy affects:
- consumption (high taxes decrease consumption spending and low taxes increase consumption spending; progressive taxes usually also increase consumption spending)
- the price level (a contractionary fiscal policy will reduce consumption and therefore decrease the pressure on supply, thus stabilising prices)
- income distribution (progressive taxes lead to income redistribution In favour of the poor, while regressive taxes lead to income redistribution in favour of the rich)
- incentives to work and take entrepreneurial risks (high direct taxes reduce the incentive to work harder and take entrepreneurial risks because they reduce the potential wages, salaries, overtime pay and profit that would be earned, while low direct taxes have the opposite effect).
In addition to the above, best practice regarding fiscal policy also affects the amount of discretion that the minister of finance has when deciding on the national budget. For example, the best practice rule that 'borrowing should only be used to fund capital spending' will limit what the country borrows.
While the public sector involves itseIf in the economy to prevent market failure, it is not always successful. The public sector can sometimes fail to regulate and stabilise the economy, provide the goods and services it set out to provide, or redistribute money effectively to help the poor.
Public sector failure occurs when government intervention in an economy to prevent market failure results in a more inefficient allocation of resources than would have occurred without that government intervention.
REASONS FOR PUBLIG SEGTOR FAILURE
Public sector failure can occur because of various reasons, including:
- poor management
- lack of accountability
- excessive regulation
- lack of information vote-seeking behaviour
- lobbying
- corruption
Poor management
If the people who are employed to manage the state's resources do not do this well, then resources will be wasted. A lack of experience or skills can lead to state resources being badly managed.
In addition, if the salaries paid in the private sector are much higher than the salaries paid in the public sector, this can pull competent people away from the public sector.
A lack of accountability
Government departments do not always hold their employees accountable to high standards in the way that often occurs in the private sector. This can lead to a lack of focus on key objectives and a lack of service delivery. A lack of accountability can also lead to poor management of resources.
In addition, because politicians are not directly answerable to the people who elected them, they can make decisions that are often not examined by the public.
Excessive regulation
The many rules and regulations (red tape) that govern state departments can lead to poor service and a failure to meet government targets. While it is important to have rules in order to uphold standards, there should not be so many that they stop service delivery.
A lack of information
While government departments might be trying to serve the public, they will struggle to do this if they don't have the appropriate information. Research is sometimes done to determine specific needs. Nevertheless, sometimes an attempt to deliver a service is not well matched to the needs of the target communities.
In addition, in attempting to provide free or subsidised goods or services, the government cannot fully predict how this will affect the demand for the same or similar services produced by businesses in the private sector.
For example, by subsidising a national carrier such as SAA, the government riiaintains the reputation of our flag carrier overseas. However, this may come at the expense of competition. Profits that could have been earned by private competitors are eroded by the government support for an otherwise ailing airline.
Vote-seeking behaviour
Politicians might make promises while they are canvassing for votes before an election. If they are elected they are likely to feel that they need to fuIfil these promises so that people will vote for them again, even if it becomes clear that fuIfilling these promises is not the best use of the government's funds.
Lobbying
Lobbying (rent-seeking) is a process where people or businesses send out a representative to influence high-level decision-makers (such as the government or a regulatory body) on certain aspects that affect them.
Economic rent' is a term used to refer to the income earned that is more than the minimum required to keep a factor of production employed.
By lobbying, people or businesses aim to increase the economic rent that they can earn.
For example, trade unions can lobby on behaIf of their members, and the South African Chamber of Business (SACOB) can lobby on behaIf of businesses in South Africa.
Lobbying can affect the decisions that government makes. lt can cause the government to make decisions that are not in the best interest of the public at large.
Corruption
Corruption refers to dishonest action taken by people in positions of responsibility.
Corruption often occurs because an official is being bribed or is engaged in fraud.
An official is being bribed if he/she is being given money or gifts to act in a particular way.
Fraud is when people deceive other people in order to make or save money.
Nepotism is when a powerful person gives a job or business contract to a relative or friend, rather than finding the most suitable person for the job.
EFFECTS OF PUBLIC SECTOR FAILURES
When the public sector fails to achieve an efficient allocation of resources this can result in:
- a lack of economic stability
- a lack of social upliftment
- a lack of social stability
- a lack of foreign investment
- a lack of economic growth
SUGGESTIONS ON HOW SOUTH AFRICA GAN AVOID PUBLIC SECTOR FAILURE
The South African government can make an effort to avoid public sector failure by:
- Improving the quality of management skills in the public sector
- reducing corruption, including nepotism when hiring public sector employees
- checking the CVs of job applicants
- reducing bureaucracy by investing in modern systems, such as lT systems
- increasing accountability
THE MAIN REASONS FOR INTERNATIONAL TRADE
Globalisation is the process of increased international co-operation and communication operation and communication which has led to increases in trade and international business transactions.
International trade allows countries to develop new markets for their goods and services, and so increase their wealth.
International trade also allows countries to import goods and services that they do not produce themselves, or which they can cannot produce as cheaply as other countries.
The reasons for internationaltrade are divided into demand-related and supplyrelated reasons.
Demand-related reasons
Demand-related reasons include:
- households' tastes and preferences for a variety of different goods and services, not all of which can be produced by their domestic economy
- households' increasing income levels, which drive the demand for goods and services
- households'increasing wealth, which increases demand
- an increase in the size of countries' populations which increases demand
- differences in consumption patterns
- migrants' demands for goods and services from their country of origin
- businesses'demands for capital goods to be used in the production process, to fuIfil households' demands for particular products
Supply-related reasons
Supply-related reasons include:
- the uneven distribution of natural resources and climate, which allows the primary sectors of some countries to produce goods through agriculture, forestry, fishing and/or mineral extraction while other countries cannot
- the uneven distribution of expertise and labour, which allows some countries to specialise in the production of certain goods and services
- the uneven distribution of capital and technology, which allows some countries to succeed in industries that require large amounts of capital investment and/or technology.
ABSOLUTE AND COMPARATIVE ADVANTAGES IN INTERNATIONAL TRADE
For example, the USA has an absolute advantage at producing wheat. Countries with an absolute advantage at producing something will clearly benefit from international trade, because their efficiency will allow their products to have low prices, which will mean that buyers from around the world will choose to buy from them.
However, even countries that do not have an absolute advantage in any product could still benefit from international trade, because the countries with an absolute advantage in producing a particular product are likely to specialise in that product, leaving other gaps in the market.
A country specialises when it focuses on the production of a limited range of products in order to become more efficient at producing these.
THE EFFECTS OF INTERNATIONAL TRADE ON COUNTRIES AND THEIR INDUSTRIES
International trade stimulates economic growth and can raise people's standard of living. However, domestic industries can be very differently affected. Those with an absolute or comparative advantage will succeed in global markets. But those that are notably inefficient compared to the same industries in other countries are Iikely to collapse.
International trade results in countries specialising in what they are good at. The larger markets lead to mass production and increased efficiency. lnternational trade also leads to globalisation, which is the process of increasing international co-operation and communication. However, it also creates an interdependence between countries, which makes them vulnerable to economic shocks that occur outside their borders.
The 'balance of payments (BOP)' refers to the set of accounts that record the flows of currency that have occurred between a country and the rest of the world during one year (or other specified period of time), representing the difference between the total currency inflows and the total currency outflows.
Every international transaction is recorded in the BOP in one or other specific account. These transactions include income from exports, payments for imports, inward and outward investments, and the buying and selling of assets (such as gold and fixed property) on international markets.
By recording these flows, a government can keep accurate records of inflows (injections) and outflows (leakages).
The South African Reserve Bank (SARB) produces South Africa's balance of payments.
There are four BOP accounts that show the flows for different kinds of transactions:
- the current account
- the capital transfer account
In addition, there are sections for:
- unrecorded transactions
- changes in liabilities relating to reserves
- special drawing right allocations
- the financial account
- the official reserves account
THE CURRENT ACCOUNT
The current account records flows of money into and out of the country that relate to goods and services, or are primary income or current transfers, and that have occurred during one year (or other specified period of time).
The current account has four conceptual categories:
- the trade balance
- net services receipts
- net primary income
- net current transfers
The trade balance
The trade balance or balance of trade (BOT) is the figure that , represents the difference between the total income received for exported : goods (merchandise) and the total payments made on imported goods , (merchandise) during one year (or other specified period of time).
There are three items on the current account that must be used to calculate the trade balance:
- merchandise exports
- merthandise imports
- net gold exports
The trade balance includes net gold exports, but these are shown as a standalone item so trends can be identified.
trade balance = merchandise exports + net gold exports - merchandise imports
When a country exports more goods than it imports, it will have a positive trade balance. When a country imports more goods than it exports, it will have a negative trade balance.
The trade balance has a big impact on the current account, because, of all the flows reflected on the current account, the trade in goods has the most value.
Net service receipts
We call the monies earned from exporting services 'service receipts'.
net seruice receipts = service receipts - payments for services
An example of a service transaction that would result in a service receipt is tourism into South Africa.
We call the monies paid for importing services 'payments for services'.
An example of a service transaction that would result in a payment for a service is the payment for the transport of goods that are being imported.
The net service receipts is the figure that represents the difference between the income received for exported services and the payments made on imported services during one year (or other specified period of time).
Net primary income
Primary income is income earned from three primary factors of production: labour, capital and e,n!ryOreneurship.
The net primary income is the figure that represents the difference between the income earned by South African factors of production in the rest of the world, and the income earned by foreign factors of production in South Africa, during one year (or other specified period of time).
We call the monies earned by South Africans living abroad 'income receipts'.
Income receipts could be compensation for employees based abroad or investment income earned by South African residents abroad (such as interest, dividends or profit). This income is only recorded as an inflow when it is transferred to a bank account inside the country (a bank account held with a domestic bank).
We call the monies earned by foreigners living in South Africa 'income payments'.
Income payments reflect the compensation and investment income earned by foreigners living in South Africa. This money is invariably re-routed back to the country where the person resides permanently.
net primary income = income receipts - income payments
Net current transfers
In the context of Economics, a transfer is a one-way flow of money for which no money, good or service is received in exchange.
A current transfer is a transfer payment from one country to another for a purpose other than investment, and is not intended to facilitate any kind of economic transaction.
When a current transfer is made, the money comes out of the current income of the party making the payment, and it goes into the current income of the recipient, where it is normally used for consumption expenditure. Nothing is received in exchange for the current transfer.
Current receipts are current transfers that are made from parties outside of the country to parties inside the country.
Current payments are current transfers that are made from parties inside the country to parties outside the country.
The net current transfers is the figure that represents the difference : between the current receipts and the current payments that have occurred during one year (or other specified period of time).
Examples of flows that would be reflected in net current transfers are gifts of money, donations, taxes, tax refunds, and pensions paid to a person residing in a different country to where the pension fund is based.
net current transfers = current receipts - current payments
South Africa's current account in recent years
The extract below compares the current account of South Africa from 2005 fll 2012
THE FINANCIAL ACCOUNT
The financial account records all the currency flows into , and out of the country that are investments and which have occuled during one year (or other specified period of time).
It shows the net change in asset ownership for the country.
An asset is something of value that is owned by a person or business.
A liability is a financial obligation , that a person or business will have to pay in the future
When foreign people and businesses invest in South Africa, money flows into the country. However, although this will generate future income, the initial investment amount will need to be repaid at some stage. Therefore foreign investment inflows are recorded as liabilities on the financial account.
When South African people and businesses invest in other countries, money flows out of the country. However, it is recorded as South Africa acquiring an asset because the buildings, machinery or whole businesses acquired overseas will generate an income for these South African investors.
Capital refers to the money and equipment that is used in production.
Because investment takes many forms, the financial account has three sub-sections:
- direct investment
- portfolio investment
- other investment
net direct investment + net portfolio investment + net other investment = balance on financial account
Direct investment
In the context of international trade, direct investment or foreign direct investment (FDl) refers to people or businesses acquiring an influential interest in a business in another country (either through buying shares or being involved in a merger or take-over), or to a company opening a branch or building a factory abroad.
In direct investment the purpose of the investor is to gain control of the business or to get a meaningful say in the management of the business, in addition to getting a part of the potential profits of the business.
Direct investment can occur when foreign parties invest in South African businesses, or when South African people or businesses invest in foreign businesses.
When a foreign business invests in a South African business, this results in money flowing into the country. Such an inward direct investment is recorded as a liability because it will need to be repaid.
When a South African person or business invests in a business in a foreign country, this results in money flowing out of the country. Such an outward direct investment is recorded as an asset because the entity acquired overseas will generate an income for these South African investors.
net direct investment = direct investment liabilities - direct investment assets
Poftfolio investment
Portfolio investment is where the investor is only interested in, the financial returns to be gained from investing in shares or bonds, and not in influencing the management of a business. '
Portfolio investment is a more long-distance and indirect approach to investment.
When foreign people or businesses buy shares on the Johannesburg Stock Exchange (JSE) or South African government bonds, this results in money flowing into the country. However, the money will have to be repaid at some stage. Therefore, foreign purchases of shares and bonds are recorded as liabilities. When South African people or businesses buy shares in companies that are listed on foreign stock exchanges or buy foreign government bonds, this results in money flowing out of the country. However, because South Africans are obtaining ownership of foreign shares or bonds, these purchases are recorded as assets.
net portfolio investment = portfolio investment liabilities - portfolio investment assets
Other investment
A residual category is one that cannot be formally represented within a given classification system. lt acts as a category to contain those items that , do not fall into the other categories, and yet must be included in the system.
The category of 'other investment' is a residual category that covers all internalional investment not included under direct investment or portfolio investment.
Trade credit is where one business supplies goods or services to another business and agrees to wait a certain period of time before these need to be paid for.
net other investment = other investment liabilities - other investment assets
THE CAPITAL TRANSFER ACCOUNT
The capital transfer account records capital transfers made by people who are moving from one country to another, transfers of fixed assets or funds from the sale or purchase of these, and debt forgiveness, which have been made or granted during one year (or other specified period of time).
Mostly, the capital transfer account records the net sale of assets relating to migration. People who plan on emigrating first need to sell their house, furniture and other movable and immovable property. The proceeds from such sales are outflows, and so are reflected as negative figures on the capital transfer account of the country of the person emigrating. Money that comes into a country with an immigrant is an inflow, and so is reflected as a positive figure on the capital transfer account.
THE OFFICTAL RESERVES ACCOUNT
A central bank's gold reserves are the gold that it holds on behaIf of the state.
A currency is money issued by a government for use within an economy.
Most countries have their own currencies. For example, South Africa has the rand (R), the United States of America has the US dollar ($), tne United Kingdom has the British pound (f), and Japan has the Japanese yen (Y). However, the euro (€) is a currency used by many of the countries in Europe. In South Africa the SARB is the custodian of all foreign currency. This means that it stores foreign currency and dispenses it to commercial banks when there is a demand for it.
Foreign currency that is used for settling international transactions is also referred to as foreign exhchange (forex).
A central bank's foreign exchange (forex) reserves are the amount of foreign currencies that it holds on behaIf of the state.
The International Monetary Fund (IMF) is an institution established to facilitate international trade.
Specialdrawing rights (SDRs) are a claim to credit from the IMF.
The SARB's official reserves are the amounts of foreign currencies, gold reserves, SDRs and government bonds (from other countries) that it holds.
The official reserves account is a record of changes in the SARB's reserve position ove-r one year (or other specified period of time).
As deficits occur on the current, financial and capital transfer accounts, foreign exchange and gold reserves are sold to pay for these, and outflows occur from the official reserves account.
Alternatively, if there are surpluses on the current, financial and capital transfer accounts, this will increase inflows into the official reserves account.
The official reserves account is affected in the same positive or negative direction as the total of the other three main BOP accounts. If they come to a negative figure, the 'change in net gold and other foreign reserves owing to balance of payments transactions'will be the same size, and will also have a minus sign in front of it. If the total of the other three main accounts comes to a positive figure, the 'change in net gold and other foreign reserves owing to balance of payments transactions' will be the same size, and will also have a plus sign in front of it.
The changes in net gold and foreign reserves are the changes in the value of the gold and foreign exchange reserves that are made in response to a surplus or deficit in the sum of the current, financial and capital transfer accounts.
DEFICITS AND SURPLUSES ON THE MAIN BOP ACCOUNTS
A BOP deficit is when an account's total debit entries (the total currency outflows) are greater than the total credit entries (the total currency inflows).
A BOP surplus is when an account's total credit entries (the total currency inflows) are greater than the total debit entries (the total currency outflows).
Understanding what a deficit or surplus on each of the main balance of payments accounts indicates
The information in the current account can be used to judge how stable an economy is. lnternational investors will look at this data to see whether more is being imported than exported.
Countries that have a large current account deficit for a long time are importing more than they are exporting, so this could be seen as a sign that the country is lacking in productive potential or a sign of high inflation. However, a current account deficit could also be seen as a sign that a developing nation is investing in future production potential by importing machinery, expanding its infrastructure and upgrading its stock of capital.
Countries that have a large current account surplus for a long time are exporting more than they are importing. This is a sign of productivity. However, it could also be a sign that the country is concentrating on meeting foreign demand rather than domestic demand, which could lead to lower living standards inside the country. lt could also be a sign of inflationtargeting measures that are reducing domestic demand. Both of these could ultimately lead to social and political unrest within the country.
The information in the financial account can be used to judge whether investors perceive a country to be worth investing in. If investors are decreasing their investment in a country it will have a deficit on its financial account, and if investors are increasing their investment in a country it will have a surplus on its financial account.
The information in the capital transfer account can be used to judge whether people are viewing a country as a desirable place to live, work and officially reside for tax purposes. lt shows the effect of immigrants and emigrants moving their assets into and out of the country.
The information in the official reserves account shows the net effect of all the transactions that have occurred on the other accounts of the BOP. The position of the official reserves account will also indicate if the state is likely to have to borrow money in the future.
Correcting balance of payments deficits
Deficits on the BOP result in a weaker currency. As long as this is not too destabilising, it can be seen as positive as it promotes the competitiveness of the country's exports.
The main disequilibria that a government might want to correct are:
- a deficit on the current account
- a deficit on the financial account
Correcting a deficit on the current account
A deficit on the current account arises when imports exceed exports, which weakens the value of the domestic currency in a free floating exchange rate system or a managed floating exchange rate system. To correct this, the central bank can raise the repo rate to increase interest rates in the country and so decrease domestic demand. Higher interest rates will also encourage temporary savings (hot money) to flow into the economy. However, the higher interest rates will reduce economic growth, and the strengthening of the domestic currency will negatively affect exporters. But the government can also promote exports to help reduce the current account deficit, and to minimise the impact of higher interest rates on exporters and the economic growth that they generate. lmport substitution focuses on domestic consumption of local products and reduces expenditure on imports. If the rand weakens, imports will also automatically decrease.
When there is a deficit on the current account the government can also try to dealwith this by encouraging a surplus on the financial account.Correcting a deficit on the financial account
A deficit on the financial account arises when there is reduced net inward investment.
To deal with this the government can sell To deal with this the government can sell government bonds in order to access loans and cause currency inflows from international investors. However, the high interest rates that will make government bonds attractive to international investors will also reduce domestic demand.
It is also difficult to attract investment if there is economic instability, labour unrest, government inefficiency and structural economic issues in a country. Therefore a country may have to attend to such issues before it can attract significant foreign investment. The government can also dealwith a deficit on the financial account by encouraging a surplus on the current account.
The foreign exchange market is an international, decentralised market for trading currencies.
It is not based in any one place. lt is a global computerised network, and it forms the largest financial market in the world. It has been estimated that $4,5 trillion are traded each day on the foreign exchange market.
The main participants in this market are central banks and large commercial banks, but other parties such as investment banks, brokers and investors also trade foreign currencies.
THE ESTABLISHMENT OF FOREIGN EXCHANGE RATES
The exchange rates for a currency are the prices of the currency in terms of other currencies
THE DEMAND FOR AND SUPPLY OF FOREIGN EXCHANGE
The demand for foreign exchange is determined by domestic parties who want foreign currency, and how many rands they are prepared to offer in exchange for foreign currencies.
The supply of foreign exchange is determined by foreign parties who wanl rands, and how much foreign currency they are prepared to offer in exchange for rands.
South African importers have to pay for imports using foreign currency, such as US dollars. This causes an increase in the demand for foreign currency. As the demand for a foreign currency rises, the price of this foreign currency increases.
Foreign importers buying exports from South Africa need to buy rands in order to pay for whatever they are importing from South Africa. This leads to a supply of foreign currency, such as US dollars, and an increase in the price of the rand.
The same concept applies to all inflows and outflows of currency relating to other BOP transactions.
Domestic firms investing overseas need to buy foreign exchange with rands in order to build a factory on foreign soil or to buy shares on foreign stock markets. lnward investment, whether it goes directly into South African businesses or onto the JSE, needs to buy rands with foreign exchange.
Primary income earned in rands by foreign workers in South Africa needs to be exchanged for foreign currency when this income is transferred back to the person's country of permanent residence.
South African residents who are working abroad and earning foreign currency need to buy rands when they bring this wealth back into South Africa
FACTORS THAT AFFECT THE EXGHANCE RATE
The exchange rate of the domestic currency is affected by the net inflow of capital.
This is influenced by
- the domestic inflation rate (which affects imports and exports)
- the domestic business cycles (which affects interest rates, consumption, savings, and imports and exports)
- foreign business cycles (which affects imports, exports and foreign investment)
- investor confidence in the longterm structural stability of the domestic economy
EXCHANGE RATE SYSTEMS
Exchange rate systems are the ways that countries choose to manage their currencies in relation to the foreign exchange market.
Some countries allow the price of their currency to be set by market forces, while others do not, and some try to negotiate a middle path.
There are three types of exchange rate systems
:- systems with free floating exchange rates
- systems with managed floating exchange rates
- systems with fixed exchange rates
Free floating exchange rate systems
A free floating exchange rate exists when a central bank allows the currency of a country to fluctuate in value according to the demand for and supply of this currency.
South Africa operates a free floating exchange rate system. As such, the rand is at the mercy of free markets.
As the demand for the rand increases, the rand will strengthen. As the demand for foreign currency increases, the rand will weaken.
As the supply of rands increases, the rand will weaken. As the supply of rands decreases, the rand will strengthen
Managed floatng exchange rate systems
A managed floating exchange rate (controlled floating exchange rate) exits when the central bank allows the value of the country's currency to float between an upper and lower limit.
As long as the value of the currency does not go outside of these limits, the central bank will not act. However, if the value of the currency appears in danger of crossing the upper or lower limit the central bank will intervene.
For example, if South Africa set an upper limit and a lower limit on the value of the rand in terms of the US dollar, it could choose to set the upper limit at R9 to the US dollar, and the lower limit at R11 to the US dollar. (The cheaper the price of one US dollar in rand terms, the higher the value of the rand.) This would create a range (a band) within which the value of the rand would be allowed to fluctuate (float) against the US dollar.
The diagram below shows how the price of one US dollar changes in rand terms as the demand for and supply of US dollars changes, and how SARS can influence the price of one US dollar in rand terms.
Fixed exchange rate systems
A fixed exchange rate (pegged exchange rate) exists where the value of a currency is set in terms of something else, such as the currency of another country or the price of gold.
In a fixed exchange rate system, the central bank does not allow the currency to simply increase or decrease in value. The value of the currency is pegged at a certain level and it is not allowed to float at all.
For large economies, this system is usually only applied during periods of economic crisis, such as in a period of hyperinflation, where the value of the currency has to be protected and maintained at all costs.
However, many small economies use such a system and set the value of their currency in terms of another currency. For example, the Namibian dollar is pegged to the South African rand (1 Namibian dollar = 1 rand), and the Barbados dollar is pegged to the US dollar (2 Barbados dollars = 1 US dollar). This simplifies foreign trade for the small economy.
If necessary, a country that has pegged its exchange rate can revaluate or devaluate its currency.
To revaluate the pegged exchange rate of a currency means to set it at a new and higher level.
To devaluate the pegged exchange rate of a currency means to set it at a new and lower level.
Foreign exchange controls
Foreign exchange controls are limits that a country can set on the amount of domestic currency that a resident can exchange for foreign currencies.
Countries that are experiencing, for example, extreme political upheaval or civil war, will find that their residents will start demanding more foreign exchange as they emigrate or try to move their assets out of the unstable country. ,o$.;\. ln this kind of situation, countries might institute foreign exchange controls in an attempt to stop their currencies from weakening and/or their foreign exchange reserves being used up
TERMS OF TRADE
The terms of trade (TOT) are expressed as a percentage that gives the value of a country's exports relative to the value of its imports.
The TOT indicate how much money the country is earning through its exports versus the money it spends on imports.
FREE TRADE AND PROTEGTIONISM
Free trade is a policy where goods, services, labour, entrepreneurship and capital can move freely between countries without government intervention through tariffs, quotas, subsidies and so on.
Protectionism is a trade policy that tries to keep the domestic economy safe by restricting the import of goods and services.
The BRICS countries are:
- Brazil,
- Russia,
- lndia,
- China and
- South Africa
Export promotion is an outward-looking government strategy to encourage economic growth, where domestic producers are helped to make products for foreign markets.
The policy of export promotion means that the government provides various incentives for businesses to increase output for export.
REASONS FOR / BENEFITS FROM / ADVANTAGES OF EXPORT PROMOTION
Export promotion is beneficial to a country for a number of reasons:
- It brings in foreign exchange.
- It leads to job creation.
- It encourages industrial development.
- It allows businesses to benefit from economies of scale.
- It decreases inflation.
Bringing in foreign exchange
Exports create inflows of foreign exchange. This improves the country's trade balance and strengthens the domestic currency. lt also increases national income.
If there are enough inflows of foreign exchange, this will allow the residents of a country to import products without being affected by a weakening currency. The luxury consumer goods that they import will increase their Iiving standards.
Leading to job creation
When businesses start up or expand in order to produce for foreign markets this increases their demand for labour, which decreases unemployment and increases economic growth.
Encouraging industrial development
The government helps businesses in the secondary sector develop. This means that the country does not just export raw materials but also exports finished goods, which increases national income. This also increases the productive capacity of the country and stimulates economic growth.
Allowing businesses to benefit from economies of scale
Economies of scale refer to the reductions in the unit costs of items when these items are produced in large quantities.
Foreign markets are much bigger than domestic markets. When selling to foreign markets, local producers can produce larger quantities of products. By doing so, they can benefit from economies of scale and engage in bulk buying, mass production and division of labour.
This enables these businesses to optimise their utilisation of resources and become more competitive in the global marketplace.
Decreasing inflation
As domestic businesses become more efficient, prices decrease, or do not increase at such a fast rate. This means that domestic consumers can buy a larger amount of goods and services to satisfy their needs and wants.
TYPES OF EXPORT PROMOTION
South Africa's Department of Trade and lndustry (dti) is the state department that manages the counlry's commercial and industrial policies.
The dti is the primary trade promotion organisation in South Africa, and the key driver of export promotion. lt uses both financial and other incentives to help achieve its aims.
Financial incentives
Export subsidies are the financial incentives that ' the government gives businesses to help them produce products for export more cheaply.
South African export subsidies include:
- cash grants
- tax exemptions and rebates to provide relief
- refunds on import tariffs related to export activities
Cash grants are amounts of money that are given to reduce the costs of production.
Tax exemptions are allowances granted to taxpayers who would have had to pay a particular tax but instead are allowed to not pay it, or to pay a reduced amount.
Tax rebates are payments that are made back to taxpayers because SARS has decided that too much tax has been paid.
Industrial development zones (IDZs) are enclosed areas positioned next to harbours or airports where production for export is encouraged through incentives.
Other incentives
The other incentives that are given for export promotion are:- government surety for businesses' loans to ensure they get credit, and at a reasonable rate of interest
- Low-cost storage facilities in industrial development zones
- Low-cost freight services from industrial development zones
- opportunities to participate in international trade exhibitions
- opportunities to be represented by trade envoys travelling overseas to set up trade agreements
- the dti's advice for exporters regard ing product specifications, marketing and distribution
- partial compensation by Export Marketing and Investment Assistance for costs incurred in developing export markets for South African products
Export Marketing and lnvestment Assistance (EMIA) is a scheme that provides assistance to South African exporters. The scheme aims to develop export markets for South African products, and to attract new foreign direct investment into the country.
DISADVANTAGES OF EXPORT PROMOTION
Despite many benefits, export promotion does have its problems:
- lncentives can lead to distorted prices, making goods appear cheaper than their real cost of production.
- Artificially low domestic prices can discourage foreign producers from exporting their produce to a country, which can deprive local consumers of a wider variety of goods.
- Foreign countries may react to domestic subsidies that impact negatively on their ability to export to South Africa by imposing tariffs and quotas on South African exports.
Import substitution is an Inward-looking strategy that restricts imports in order to allow domestic businesses the opportunity to supply similar goods.
REASONS FOR / BENEFITS FROM / ADVANTAGES OF IMPORT SUBSTITUTION
Import substitution is beneficial to a country for a number of reasons:
- lt strengthens the domestic currency.
- lt leads to job creation.
- lt increases a country's productive capacity.
- lt promotes diversification.
- lt increases a country's seIf-sufficiency.
Strengthening the domestic currency
Import restrictions are normally set up because there is an unfavourable trade balance that is weakening the currency. As the country then reduces the size of its imports, the trade balance will reflect fewer outflows. This will reduce the deficit on the current account and strengthen the currency.
Leading to job creation
Import restrictions allow new domestic businesses to start up and existing ones to expand. Both of these lead to a higher demand for labour, thus creating jobs. This will reduce unemployment and stimulate economic growth.
Increasing a country's productive capacity
New and expanding domestic businesses will increase the country's man ufacturin g capacity.
Promoting diversification
Domestic businesses will produce a wide range of goods that previously were imported. This can ultimately lead to lower prices and increased choice for consumers.
Promoting seIf-sufficiency
Reducing a country's reliance on imports is a good way to promote seIf-sufficiency.
TYPES OF IMPORT SUBSTITUTION
The South African Revenue Service (SARS) monitors, controls and imports through its Customs and Excise office. lt does this through:
- tariffs
- non-tariff measures
Tariffs
Tariffs, which are also called customs duties or , excise taxes, are taxes on imports.
A port of entry is a place where people and goods may lawfully enter a country. lt can be a border post, an international airport or a harbour that has a customs office.
Before goods are allowed to move through a South African port of entry the exporting firm must pay the correct tariff to SARS.
Tariffs increase the cost of importing goods, making them less desirable on local markets. Tariffs also contribute about 9'/o of government revenue.
Non-tariff measures
Non-tariff measures are any import restrictions that do not use tariffs.
Non-ariff measures include:
- quotas
Quotas are limits on the quantity of goods that may be imported. Customs and , , excise officials monitor how much of a good is coming into the country, and stop imports of that type of good if the amounts exceed the quota. Quotas reduce the amount of imported goods competing with locally produced goods
The price of imported goods also increases when there are quotas, because the demand for them is greater than the supply.
- Locally produced goods are not always of a high enough quality or low priced enough to make import substitution worthwhile.
- Emerging economies cannot afford to reduce imports of machinery and equipment that are needed for production.
- A strengthening currency can cause exports to become more expensive in foreign markets.
- Foreign countries may react to South African tariffs and quotas with tariffs and quotas on South African exports.
- Uncompetitive domestic industries might not increase their efficiency while they are protected from serious foreign competition by tariffs and quotas.
bureaucratic processes
Lots of administrative paperwork and time delays before clearance certificates are granted slow the movement of imports into a country.
exchange rate policy
The SARB can allow the currency to weaken to discourage imports. As imports start to cost more, the number imported may decrease.
bans
A country may ban products from entering the country if they are considered to be harmful to society.
boycotts
A country may boycott imports from other countries if it considers their governments to be immoral
PROBLEMS WITH IMPORT SUBSTITUTION
Despite possible benefits, import substitution must be carefully considered before being applied. This is because:
Protectionism is a trade policy that tries to keep the domestic economy safe by restricting the import of goods and services.
A developed country has a high level of industrialisation good infrastructure, a high standard of living, and a high GDP in relation to the size of its population.
Many developed countries used protectionist policies when they were industrialising, but are now against protectionism as they try to sell their low-priced products on foreign markets.
Many developing countries are cautious about stopping protectionist policies although developed countries are calling for them to do so. They are unconvinced that allowing unrestricted imports of low-priced merchandise is the best way to develop their own industries.
Merchandise consists of goods and marketable raw materials, and can include commodities and differentiated products.
ARGUMENTS FOR PROTECTIONISM
There are a number of reasons supplied to support protectionism:
- It protects infant industries and encourages industrial development.
- It protects strategic industries. It protects jobs and wage levels.
- It protects against price manipulation by powerful multinational businesses.
- It protects the value of the currency.
Protecting infant industries and encouraging industrial development
An infant industry is a new domestic industry with great promise that , cannot compete with established foreign competitors when it starts out.
New businesses have very high costs and low revenue. Protectionism helps such businesses in infant industries by giving them the time they need to establish themselves before they have to compete with foreign businesses. ln this way it encourages industrial development.
Protection for infant industries is seen as temporary, something that will fall away once the businesses have become competitive.
Protecting strategic industries
Goods and services that are essential for the long-term sustainability of a nation's economy need to be protected. lt is important for a country to control key industries such as agriculture, energy and mining, so that it is not dependent on other countries for food, electricity and minerals.
Protecting jobs and wage levels
Foreign competition may force businesses to reduce wages or salaries, or to retrench staff, in order to remain competitive. But in countries where there are high levels of poverty and unemployment, it is important to protect jobs. Also, in countries with great income inequality, reducing the wages of industrial and agricultural workers will worsen this divide and the social tensions that come with it.
Protecting against price manipulation by powerful multinational businesses
Multinational businesses operate in more than one country, and can become so large as to become worldwide monopolies.
Powerful multinational businesses can sometimes manipulate markets through their pricing strategies. One of the ways that they do this is through dumping.
Dumping is when products are sold in a foreign market at a price that is lower than the price charged on the domestic market.
In such a foreign market, the sudden arrival of cutprice goods will affect competing businesses in a negative way, and could cause weaker businesses to close down. Therefore dumping is a predatory move that foreign businesses make when they want to take control of a foreign market in the long term.
Through protectionism a country can ensure that its industries are not affected by dumping and other forms of price manipulation.
Protecting the value of the currency
If imports increase at a faster rate than exports, this results in a current account deficit and a weaker currency. Protectionism helps to prevent this, because it controls the rate at which imports increase. lt also reduces fluctuations in the exchange rate.
ARGUMENTS AGAINST PROTECTIONISM
Protectionism has lost support in the last twenty years because it does not take account of broader economic objectives and the benefits of global integration. There are a number of arguments against protectionism:
- lt increases foreign barriers to export.
- lt allows for inefficiency.
- It decreases consumer choice.
- It leads to a lower average standard of living as there is lower variety and choice.
- lt leads to higher prices as domestic goods may be more expensive.
Increasing foreign barriers to exports
A loss of revenue by foreign industries affected by tariffs, quotas and subsidies can lead to these foreign industries pressurising their own governments to retaliate. This retaliation will take the form of similar tariffs, quotas and/or subsidies being instituted by foreign countries.
Allowing for inefficiency
Domestic businesses that are protected from foreign competition sometimes lack the incentive to become more efficient. As long as they receive protection, they are not driven to find new, creative and cheaper methods of production. ln addition, under protectionist policies, a country's production is not based on its areas of comparative advantage, leading to an inefficient allocation of resources.
Leading to higher prices
Under protectionism, imported goods cost more because of tariffs and quotas, and inefficient domestic businesses have to selltheir products at higher prices to make a profit. This means that domestic consumers have to pay more for products.
Decreasing consumer choice
Quotas reduce consumer choice directly, and tariffs reduce them indirectly as consumers become unable to afford imported goods.
Leading to a Lower standard of living
Consumers who have less choice about what to buy and can afford fewer products will experience a lower standard of living.
Free trade is a policy where goods services labour entrepreneurship and capital can move freely between countries without government intervention through tariffs, quotas, subsidies and so on.
ARGUMENTS FOR FREE TRADE
There are a number of reasons that support a country's choice to engage in free trade:
- Specialisation
- Choices / lncreased weIfare
- lmproved international relations
- Economy of scale
- lnnovations / Best practice
Specialisation
When a country's businesses can export to other countries, it allows businesses to specialise, and to produce new products that previously would not have been financially viable because the markets were too small. lt also means that businesses have to be efficient to remain competitive.
Economy of scale
Exports also create a larger market and means that they can take advantage of economies of scale.
Choices / lncreased weIfare
Lower prices and more consumer choices lead to a higher standard of living. People also like to be able to choose where they will live and work, and this freedom improves their quality of life.
Innovations / Best practice
As businesses become more efficient and competitive, prices decrease. Consumers benefit from the greater variety of products on offer when there are no barriers to imports. They also benefit from all the new products on offer.
Improved international relations
If a country imposes tariffs and quotas on imports, and provides subsidies for exports, this willaffect businesses in foreign countries. Foreign countries are likely to retaliate by bringing in their own tariffs, quotas and subsidies. However, both countries could agree to remove all barriers to trade, allowing each to export as much as it chooses to the other country. The free trade that would follow would be a result of their co-operation, and would probably lead to further co-operation.
ARGUMENTS AGAINST FREE TRADE
There are a number of reasons given against free trade:
- It fails to protect infant industries.
- It fails to protect strategic industries.
- It fails to protect jobs and wage levels.
- It fails to protect against price manipulation by powerful multinational businesses.
- It fails to protect the value of the currency.
Failing to protect infant industries
In the face of cheap imports, infant industries do not have the time to develop into businesses that can compete with established foreign firms. ln addition, they can be negatively affected by the strict health standards that developed countries place on their imports.
Failing to protect strategic industries
A country that allows itseIf to become dependent on imports for critical products, such as food, can be very badly affected if a gloobal crisis causes a shortage of these products. Therefore, if free trade causes the decline of strategic industries, this will leave a country in a vulnerable position.
Failing to protect jobs and wage levels
If imported goods are cheaper than domestic goods of the same type and quality, domestic businesses will have to reduce their expenses in order to survive. One way that domestic businesses can cut their costs is by reducing the wages and salaries that they pay their employees. Another way is to replace some workers with machinery that will, over the long run, lead to less money being spent on production.
Failing to protect against price manipulation by powerful multinational businesses
If multinational businesses try to dump goods to disrupt domestic industries, the country will not be able to combat this dumping through quotas and tariffs.
Failing to protect the value of the currency
Consumers importing luxury goods, or emigrants leaving a country with their assets, could cause a deficit on the current account, and thus cause a country's currency to weaken. This could be damaging to a country that needs to import machinery to increase its productive potential.
Countries usually choose a position somewhere between the policy of free trade and the policy of protectionism. The position that a country chooses will depend on its stage of development and its macro-economic objectives.
Any position will come with trade-offs. Solving one economic problem could very well create another.
South African policies regarding free trade and protectionism are designed to embrace free markets and encourage inward investment and other inflows of foreign currency, while at the same time paying attention to the need to create domestic jobs in very competitive sectors such as the textile industry.
Once a government has decided what mix of free trade and protectionism best suits its economy, it needs to find countries that have a similar position. This will ensure that the trading partners that are chosen will be willing to trade under the conditions set.
ECONOMIC INTEGRATION
Trade protocols are agreements that set the rules of trade between the countries that sign these agreements with each other, and which can also affect the rules of trade between these countries and other countries.
There are four main types of trade protocol, each of which results in the member countries achieving a particular kind of economic integration. These four states of economic integration are:
- the free trade area
- the customs union
- the common market
- the economic union
FREE TRADE AREAS
A free trade area (FTA) is created when some countries agree that they will trade goods and services among themselves without using tariffs or quotas. ,
However, protectionism can still be used against non-member countries, and each member of the free trade area Gan make its own rules about how it deals with non-member countries.
One example of a free trade area is the South African Development Community (SADC). At present, it has 14 member states: Angola, Botswana, the Democratic Republic of the Congo, Lesotho, Malawi, Mauritius, Mozambique, Namibia, the Seychelles, South Africa, Swaziland, Tanzania, Zambia and Zimbabwe.
Another example of a free trade area is the European Free Trade Association (EFTA), which is made up of four European countries that are not part of the European Union: lceland, Norway, Switzerland and Liechtenstein.
CUSTOMS UNIONS
A customs union is a free trade area where the member countries agree to adopt the same level of tariffs and quotas against non-member countries.
No country may reduce or increase these without being in contravention of the customs union agreement.
An example of a customs union is the South African Customs Union (SACU), which is made up of South Africa, Botswana, Lesotho, Namibia and Swaziland.
COMMON MARKETS
A common market is a customs union where the member countries'ff HIrti,"-tJ::iffi"gi::"f capitarand
People may live wherever they want in a common market.
An example of a common market is the one that exists in South America, called Mercado Com[n del Sur (Mercosur), which is Spanish for'Southern Common Market'. lt consists of Brazil, Argentina, Paraguay, Uruguay and Venezuela.
ECONOMIC UNIONS
An economic union is a common market where member countries attempt to co-ordinate their fiscal and monetary policies with the aim of establishing a central bank and adopting a common curren-cJ:
An example of an economic union is the European Union (EU). lt consists of 28 countries: Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, lreland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the United Kingdom.
GLOBALISATION AND TRADE LIBERALISATION
Globalisation is the process of increased international co-operation and communication that has led to increases in trade and international business transactions.
Trade liberalisation refers to the removal or reduction of , restrictions on the free exchange of goods between nations. '
In 1947 the United Nations Conference on Trade and Employment led to the GeneralAgreement on Tariffs and Trade.
The World Trade Organisation (WTO) tries to reduce trade barriers and facilitate trade agreements between countries of the world.
The WTO has led to increased trade liberalisation, with all the benefits that this brings. Since 1947 the world has become a far richer place, and increases in trade are partly responsible for this. The WTO has also accelerated the growth of globalisation.
South Africa is an active member of the WTO, and this brings with it many advantages and opportunities. Because of its involvement with the WTO, South Africa has reduced its tariffs on imports.
South Africa has also entered into preferentialtrade agreements with many countries around the world:
- In 1910 South Africa became a member of SACU.
- In 1994 South Africa became a member of SADC.
- In 2008 SACU (which includes South Africa) formed a trade agreement with EFTA.
- In 2009 SACU (which includes South Africa) signed a trade agreement with Mercosur.
- In 2010 South Africa became a member of the BRICS trading bloc (Brazil, Russia, lndia, China and South Africa).
In addition to this, since 2000 South Africa has benefited from the USA's 78 African Growth and Opportunity Act.
The African Growth and Opportunity Act (AGOA) is an American law that allows countries from Sub-Saharan Africa to export certain products to the USA without trade barriers if these countries fuIfil certain economic and labour-rights requirements"
South Africa has also benefited from being a member of the Organisation of African Unity (OAU) between 1994 and 2002, and this organisation's successor: the African Union (AU).
The African Union (AU) is an organisation of 54 African countries that , encoulages economic development and political stability in Africa.
Established in 2001, the African Union is working towards greater economic integration between its members, and economic alignment along the lines of the European Union. One of the ultimate aims is monetary union. Current measures include greater trade co-operation.
The term 'market structure' refers to the characteristics of a market that affect the behaviour and performance of businesses in that market.
There are five main characteristics that will determine the market structure:
- the number of businesses
- ease of entry into and exit from the market
- influence over price
- availability of information
- the nature of the product
Homogenous products do not really differ from one business to the next, and customers in such a market consider one business's products to be as good as another's.
Heterogenous products differ from one business to the next, and customers do not consider them to be interchangeable.
The answers to the questions above will determine whether a market is a perfect market or an imperfect market.
Perfect competition is when there are so many businesses and customers for a homogenous product that no particular business or customer can set the price of that product, but must instead accept the price set by the market.
A perfect market is a market in which perfect competition exists.
While few markets are actually perfect markets, some are almost perfect markets. For example, a country's market for freshly squeezed orange juice is an almost perfect market. This is because there are many businesses that offer this homogenous product and they cannot set the price. lt is easy to enter or leave this market, and businesses and customers can easily find the information that they need to make decisions.
A business operating in a perfect market is said to be operating under a state of perfect competition, or can just be called a perfectly competitive business.
A perfect market has the following characteristics:
- There are thousands of businesses offering a large quantity of the products, so customers can choose who to buy from, and there are no shortages.
- There are no barriers to entry that stop new businesses entering the market, and there is freedom of exit from the market, because sunk costs are low.
- No business or customer can control the price or significantly influence it. Prices of products are low because they are set by the forces of demand and supply, and businesses do not collude (work together) to raise the prices.
- All the customers and businesses have perfect information (complete knowledge) about the product, its market price, and the existence of alternatives.
- The products being sold are homogenous.
Perfect markets contain thousands of businesses and customers, most of whom are unknown to each oth6r. Contact is generally made in a localised area only, meaning that businesses and customers that are located close to each other will do business together. There is no need for buyers in one part of the market to make contact with sellers in another. However the opportunity to do this exists, which ensures that the market remains perfectly competitive.
In a perfect market each business is a price taker. which means it has to sell its products at the market price.
The main reason for this is that each business has an unbelievably small share of the total market. A business can't really charge a higher price than the market price as no-one will pay this price.
On the other hand, it can't be forced to charge a lower price than the market price, as the buyers can't set the price either.
Therefore in a perfect market each individual business will charge the market price no matter how many products it produces.
The term 'industry' refers to all the businesses producing a particular kind of product in a market.
In a perfect market, an industry consists of thousands of businesses. Therefore the price of a particular product is not determined by individual businesses but by the forces of demand and supply.
If all of the businesses were able to co-operate with each other, prices could be set at a high level that would benefit all of them. However, in a perfect market this does not happen because of the huge number of businesses involved. Each business is a small part of the industry and must therefore accept the price that is charged for products in this industry.
As can be seen in the diagram, the market price is determined by the supply and demand of all the businesses and customers in the market.
COST CURVES
Economies of scale occur when additional production decreases the average cost of producing a product. Up to a certain point of production, , increased production will be advantages to your business.
Diseconomies of scale occur when additional production , increases the average cost of producing a product
Distribution costs are an example of costs that can lead to diseconomies of scale, if a market is spread out and there is a high cost of reaching far-off customers.
The marginal cost (MC) is the increase in total cost that results from the production of one additional unit.
marginal cost = change in total cost+ change in output quantity
DETERMINING THE BREAK-EVEN POINT FOR A BUSINESS IN A PERFECT MARKET
The break-even point (BEP) is where a business is making neither a profit nor a loss.
DETERMINING THE PROFIT MAXIMISING OUTPUT LEVEL FOR A BUSINESS IN A PERFEGT MARKET
The level of output is an important production decision. While the total revenue earned by the business increases with each additional unit produced, so does the business's total costs.
At any point where total revenue is greater than total cost, the business will make a profit. However, as a profit maximiser, the business will want to make the maximum prof
The profit-maximising output level (PMOL) is the quantity produced at which the business makes the most profit.
THE EFFECT OF THE INDUSTRY'S OUTPUT CHANGING IN A PERFECT MARKET
Because an industry is the sum total of all its individual businesses, the industry's output is the sum total of the output of all the individual businesses.
Entry into and exit from perfect markets are very easy, and when businesses make these decisions they affect the supply curve, as shown below.
In Economics, normal profit is the amount of money that an entrepreneur needs to earn so that he/she continues to run a business rather than turning to the best foregone opportun ity
In Economics, supernormal profit (economic profit) is the amount of money that an entrepreneur makes beyond the normal profit he/she has earned.
When total revenue'equals total cost, the business is making a normal profit. When total revenue is greater than total cost, the business is making a supernormal profit.
If total cost equals total revenue, then average cost equals average revenue. Therefore, when average cost equals average revenue, we know the business is making a normal profit.
THE PROFITS POSSTBLE FOR A BUSINESS IN A PERFECT MARKET
Different profits are possible for a business in a perfect market dependlng on whether we are considering the short run or the long run.
In Economics, the short run is the period of time when at least one factor of production is fixed.
In the short run, it is possible for a business in a perfect market to make a loss, a normal profit, or a supernormal profit (economic profit).
However, in the long run a business that is making a loss will be able to close down, and a business making a supernormal profit will find that other businesses enter the market, which will erode its ability to continue making a supernormal profit. Therefore, in the long run businesses in a perfect market only make a normal profit.
An economic loss is made when total cost (economic cost) is greater than total revenue, which is also when average cost is greater than average revenue.
economic loss = total revenue - total cost
In a perfect market, businesses do not make an economic loss in the long run, because they close down instead. However, in the short run, businesses can make an economic loss.
REASONS WHY BUSINESSES MAKE A LOSS
There are a number of reasons why a business might make an economic loss:
- When a business opens, it will be faced with the high costs associated with starting a business and very low revenue.
- A business can experience a loss of market share, leading to a reduction in total revenue (and average revenue).
- A business can experience an increase in total cost (and average cost).
FINDING THE SHUTDOWN POINT FOR A BUSINESS IN A PERFECT MARKET
Fixed costs are those costs that exist no matter how many units of a product are produced.
Variable costs (VC) are those costs that change depending on how many products are produced.
In a perfect market, a business's total cost encompasses fixed costs, variable costs and normal profit. ln the short run the business cannot stop paying the fixed costs even if it is making an economic loss. However, it can stop paying the variable costs.
The shutdown point is the level of output where a business can only just cover its variable costs but not its fixed costs, and where, by stopping production (perhaps temporarily), the business can minimise its losses.
A business's average variable cost (AVC) is its variable costs divided by the units of output produced.
average variable cost = variable costs + quantity produced
At the shutdown point the average revenue is only enough to cover the average variable cost, so there is little reason for the business to continue producing. Where output is below the shutdown point, it definitely does not make sense for the business to continue producing.
However, where output is above the shutdown point, it does make sense for the business to continue producing. lt may not make even a normal profit this way, but it can still cover all its variable costs and some of its fixed costs, which it is bound to pay anyway in the short term.
Another way of identifying the shutdown point is finding where the marginal cost curve crosses the average variable cost curve.
THE SUPPLY CURVE FOR A MARKET A BUSINESS IN A PERFECT MARKET
The supply of a product is the amount of that product that a business is willing and able to produce at a given price.
The supply curve for a business is derived by plotting the output that a business is willing to produce at each price.
BENEFITS
Competition has the following benefits:
- an efficient economy
- lower prices
- increased output
- a wider range of products
- higher quality products
Because of these benefits, a state should encourage and protect competition" As part of this, it should ensure free entry into and exit from markets, because this will help to keep individual businesses and groups of businesses from dominating industries.
LEGISLATION TO PROTECT COMPETITION
The Competition Act (No. 89 of 1998) promotes and maintains competition in South Africa.
It has six objectives:
1 to help the economy develop, adapt and become more efficient
2 to promote a greater spread of ownership
3 to promote employment and socio-economic weIfare
4 to provide consumers with competitive prices and product choices
5 to ensure that small and medium-sized enterprises can participate in the economy
6 to expand opportunities for South African businesses in a global economy
The Competition Act regulates:
- restrictive trade practices
- mergers and acquisitions
Regulating restrictive trade practices
Dominant businesses are those who have a market share of 35o/o or more, and those with market power.
Restrictive trade practices are anti-competitive practices used by dominant businesses.
The Competition Act has rules against restrictive trade practices in order to protect competition. lt protects against both restrictive horizontal practices and restrictive vertical practices.
Restrictive horizontal practices (collusion) occur where businesses in the same industry come to an agreement so that they are not pressured to be so competitive and can increase their profits.
For example, managers of two competing businesses might agree about how it would be easier for both businesses if they together decided on the price at which a particular kind of product would be sold.
Price-fixing is collusion among businesses in the same industry to set prices above the market price
Collusion improves the position of businesses at the expense of consumers.
Vertical restrictive practices occur when two or more businesses at different points in a supply chain reach agreements that are anti-competitive
For example, manufacturers of a certain product could require all shops who want to stock it to agree to sell it above a particular price. This would result in higher profits for both the retailers and the manufacturer.
Minimum resale price maintenance is where a manufacturer of a product gets all the distributors of this product to agree to sell the product above a particular minimum price.
Regulating mergers and acquisitions
A merger occurs when two companies become one company.
An acquisition occurs when one company completely takes over the ownership of another company.
When companies grow and increase their market share this can threaten the competitiveness of an industry. Therefore the state might not allow mergers and acquisitions to occur in order to discourage dominant businesses from forming.
BODIES TO PROTECT COMPETITION IN SOUTH AFRIGA
The Competition Act created three bodies for protecting competition in the South African economy:
- the Competition Commission
- the Competition Tribunal
- the Competition Appeal Court
The Competition Commission is the investigation and enforcement agency. Uncompetitive behaviour can be referred to the commission by the general public. lt has the power to impose fines and reject merger applications.
The Competition Tribunal judges cases, very much like a court.
The Competition Appeal Court considers appeals against decisions of the Competition Tribunal.
The Competition Act also made it compulsory for businesses to notify the Competition Commission and/or the Competition Tribunal about proposed mergers and acquisitions that will involve large amounts of money.
Two types of efficiency
Technical efficiency occurs when a business or economy produces the maximum quantity of outputs from the minimum quantity of inputs. Allocative efficiency occurs when there is an optimal distribution of goods and services.
While an economy may be technically efficient, this does not mean it will be I allocatively efficient and take into account consumers' preferences.
An imperfect market is a market in wnich perfect competition does not exist
Imperfect competition exists when one or more of the following five criteria for a perfect market is missing:
- homogenous products being sold
- a huge number of businesses supplying the products
- no barriers to enter and exit the market
- no business or customer able to control the price
- all businesses and customers having perfect information
A business operating in an imperfect market is sometimes called an Imperfect competitor
In the real world all markets are imperfect to some extent. The idea of a perfect market is a concept to which real-world markets are compared.
There are three main kinds of imperfect markets:
- a monopoly (where only one business is supplying a particular product)
- an oligopoly (where only a few businesses are supplying significant amounts of a particular product)
- monopolistic competition (where many businesses supply the product, but they try to differentiate the product they are selling)
The Law of demand states that, all other factors being equal, as the r Orice of a product increases, demand for the product will decrease.
When a business in a perfect market increases the price of a product, consumers do not buy it because they go and buy the same kind of product elsewhere instead.
When a business in an imperfect market increases the price of a product, fewer consumers buy it, but some still do.
A price setter (price maker) is a business that has the , power to influence or control the price of its products because these products do not have perfect substilutes,
REVENUE CURVES OF BUSINESSES OPERATING IN AN IMPEREECT MARKET
The total revenue curve of a business operating in an imperfect market
total revenue = price of product x quantity of products sold
The shape of a total revenue curve for a business operating in an imperfect market shows that initially as the price increases, so does the total revenue, but that after a certain point the price becomes so high that total revenue decreases as well. This is because as the price rises, demand decreases.
The average revenue curve of a business operating in an imperfect market
average revenue = total revenue + quantity of product sold
For price setters as well as price takers, the average revenue per unit equals the price of a unit.
Therefore, in imperfect markets, just as in perfect markets, a business's average revenue curve is the same as its demand curve.
This means that the shape of an average revenue curve for a business in an imperfect market slants down to the right (is negatively sloped), just like the demand curve for a business in an imperfect market.
The marginal revenue curve of a business operating in an imperfect market
marginal revenue = change in total revenue + change in output quantity
While for a price taker marginal revenue equals price, for a price setter marginal revenue is less than price. This is because a business in an imperfect market is facing a negatively sloped demand curve and the price must be lowered to sell an extra unit.
Therefore the shape of a marginal revenue curve of a business operating in an imperfect market slants down to the right (is negatively sloped), and it lies beneath the average revenue curye.
For a business in an imperfect market, as the price decreases the marginal revenue received by the business also decreases, and it can even become a negative figure. For example, in the table and the graph below, you can see that when output changes from 6 units to 7 units, then the price has to drop to R40 for all of these to be sold. This means that total revenue (P x Q) drops from R300 to R280, so at an output of 7 units marginal revenue is -20.
COST CURVES OF BUSINESSES OPERATING IN AN IMPERFECT MARKET
Cost curves are based on cost schedules, such as the one shown below.
The total cost, average cost and marginal cost curves of a business operating in an imperfect market are similar to those of a business operating in a perfect market.
FINDING THE PROFIT MAXIMISING OUTPUT LEVEL FOR A BUSINESS IN AN IMPERFEGT MARKET
As for a business in a perfect market, a business in an imperfect market (for example, a monopoly) will maximise its profit if it produces at the point where marginal cost equals marginal revenue.
In the diagram below, marginal cost equals marginal revenue at Qe. At this point the business is not able to make any more profit per unit by producing more units, so this is the profit-maximising output level.
However, a business will not always make a supernormal profit by producing at the profit-maximising output level. lt can also make a normal profit, which is what occurs if average revenue equals average cost, and the business produces at the profit-maximising output point.
The business represented in the diagram above could lose its supernormal profit if either the average revenue curve shifts to the left (for example, because it loses customers through poor service) or if the average cost curve rises (for example, because of higher labour costs).
A monopoly (monopolist) is a business that is the only supplier of a particular product.
CHARACTERISTICS OF MONOPOLIES
A monopoly has the following characteristics:
- It offers a unique product. (There are no substitutes that a buyer can buy instead.)
- It is the only business in the market. (This gives it complete market power.)
- There are high barriers to entry, and often also high sunk costs. (This makes it difficult, and risky, for new businesses to enter the market and try and compete with an established monopoly that is already benefiting from economies of scale. These barriers to entry allow the monopoly to make a supernormal profit in the long run as well as the short run.)
- It is a price setter. (But the price set will still need to take account of the quantity demanded by the market at that price.)
- It does not supply information about its industry to potential competitors or to customers, so they have imperfect information about the market. (This allows the monopoly to manipulate the market.)
MONOPOLY OUTPUT IN THE SHORT RUN AND THE LONG RUN
A monopoly will try to maximise its profit by producing at the profit-maximising output level, which is where marginal cost equals marginal revenue.
In the short run a monopoly can make a supernormal profit, a normal profit or a loss (if costs are too high or demand is too low).
In the long run a monopoly can make a supernormal profit or a normal profit. It cannot make a loss in the long run as making a loss in the long run is unsustainable, and the business will have to close if it is in this situation.
A monopoly is likely to make a supernormal profit, or at least a normal profit.
TYPES OF MONOPOLIES
Monopolies can be divided into the following types:
- a natural monopoly
- a state-owned monopoly
- a local monopoly
- an artificial monopoly
A natural monopoly
A natural monopoly is a business with high fixed costs that operates in a market that is not large enough for a competitor to enter.
Natural monopolies exist in industries where high fixed costs need to be spread out through economies of scale. The industry as a whole does not earn enough revenue for competition to be sustainable, because many smaller businesses will not be able to benefit from economies of scale in the way that one large business can.
In the twentieth century, telephone companies were often natural monopolies because of the cost of creating the network of telephone lines, among other things. For example, AT&T was a telephone monopoly in the USA that employed a million people.
State-owned monopolies
A state often establishes these monopolies in an attempt to provide an affordable public service for its people.
A state-owned monopoty is one that is part of the pubtic sector.
In industries where there will be a natural monopoly, a state will often create a stateowned monopoly rather than leave the industry to be controlled by a private business.
For example, in 1991 South Africa set up Telkom SA as a state-owned company and monopoly to controlthe telecommunications industry.
A local monopoly
A natural monopoly or state-owned monopoly often encompasses a whole industry in a country. Monopolies can also exist on a smaller scale.
A local monopoly exists in a particular area where it is not worthwhile for a competitor to set up, or for some reason a competitor cannot set up.
For example, a payphone business in a rural area can be a monopoly if there are no other payphones around. This business can simply be one person who owns a cell phone and who charges other people for using it. ln such a context this one-person business will effectively be a monopoly that can set prices.
An artificial monopoly
An artificial monopoly is one that comes about through uncompetitive practices, such as buying out all the competition, or illegal practices, such as intimidation.
For example, in the nineteenth century Standard Oil, an oil production and oiltransportation company, was a monopoly in the USA that bought out its competitors and engaged in illegal practices.
Comparison between a monopoly and a perfect competitor
The following graph shows the differences between a monopoly and a perfect competitor.
An oligopoly exists when there are only a few businesses with significant market share that sell products that consumers can substitutes for each other.
An oligopoly has the following characteristics:
- The market largely consists of a small number of large businesses. (Each business has a lot of market power and can charge high prices.)
- The businesses engage in non-price competition. (lnstead they compete using advertising, product differentiation and loyalty schemes, etc.)
- There are often high set-up costs that are a barrier to entry for new businesses, and advertising costs create barriers to entry and exit. (lt is difficult for new businesses to compete without advertising to a similar degree, yet the amount spent on advertising is a sunk cost.)
- Businesses try to stay informed of what their competitors are doing. (They have to adjust their strategies in response to what their competitors do.)
- The businesses' products can be homogenous or differentiated. (ln a pure oligopoly the products are homogenous, and in a differentiated oligopoly the products are heterogeneous but are close substitutes.)
The Kinked Demand curve theory
The Kinked Demand curve theory states that prices are stable in situations where there are oligopolies, because if a business raises the price above a certain point, it loses significant market share, and if it lowers the price below this point, it causes a price war between itseIf and its competitors, to the disadvantage of all of them.
TYPES OF NON-PRICE COMPETITION
Instead of competing by lowering their prices, businesses in an oligopoly compete with each other in different ways.
The types of non-price competition they use include:
- attempts at product differentiation
- advertising
- loyalty schemes
Attempts at product differentiation
The businesses try to create variations to make homogenous products seem like heterogeneous products.
For example, an Apple lphone and a Galaxy Samsung smartphone could be seen as homogenous products, but some consumers will not see them as interchangeable.
Advertising
The businesses use advertising to try to make consumers perceive their products as different from, and better than, competing products. Advertising can help to establish brand loyalty.
Brand loyalty occurs when consumers become committed to one brand and continue to buy that brand even if the prices of the products increase.
Loyalty schemes
Businesses encourage consumers to sign up for loyalty cards so that they are more likely to shop at their stores.
For example, both Woolworths and Pick n Pay have loyalty card schemes.
COLLUSION
Competition between businesses erodes their profits.
Collusion or restrictive horizontal practices occur where businesses in the same industry come to an agreement so that they are not pressured to be so competitive and can increase their profits.
Collusion can occur in two ways, i.e. cartels and price leadership.
Cartels are when collusion between oligopolies occur explicitly and , in a formal manner. A cartel is an association of producers who club together to restrict output and raise their prices.
Explicit collusion is illegal, yet is often practised by businesses in oligopolies. Deciding to fix prices at a high level, and carving up and sharing out markets, are both examples of collusive behaviour that could result in large fines from the Competition Commission.
Price leadership: Since cartels are actually 'illegal' and often fail, oligopolies decide to do it tacitly, instead of explicitly.
A price leader is an industry's dominant business whose pricing decisions have a big influence on its competitors.
When there is a pattern of a price leader raising its price, and its competitors then also raise their prices, this can be seen a type of tacit collusion. Tacit collusion is not illegal.
Monopolistic competition exists where many producers , sell products that are differentiated from each other.
Businesses operating under monopolistic competition have the following characteristics:
- The products are heterogeneous (differentiated).
- There are many businesses selling similar products in the market, and many buyers.
- There are few barriers to entry and exit.
- The businesses are price setters.
- Information is imperfect and asymmetrical. The buyers have less information than the businesses selling the products.
PROFIT
Under monopolistic competition, a business has some market power and is a price setter rather than a price taker. However, it does not have the same market power, or the same ability to set prices as a monopoly or a powerful business in an oligopoly. This is because the demand for its products is more elastic.
In the short run a business under monopolistic competition can make a supernormal profit, a normal profit or a loss.
In the long run a business under monopolistic competition will make only a normal profit. Owing to low barriers to entry, new businesses will enter the market if a business is making a supernormal profit, eroding this until the business makes only a normal profit. A business that makes a loss in the short run will close down in the long run.
Resources are any items of value, including natural resources and final goods and services.
When resources are efficiently allocated in a society:
- people receive the goods and services they need
- there are no shortages or surpluses
- there is no wastage in the production process
- prices are fair
While many governments would like to leave it to the free market to achieve such an efficient allocation of resources, the interaction of market forces does not always ensure that the correct quantity of goods and services are produced to meet demand, and that they are offered at a fair price.
Market failure occurs when the market system is unable to achieve an efficient allocation of scarce resources, and is therefore not able to achieve the best available outcome (for example, in providing goods and services efficiently).
When market failure occurs there is a misallocation of resources. This is when:
- some people do not receive the goods and services they need
- there are shortages or surpluses
- there is wastage in the production process
- prices are not fair
When markets fail some people benefit but other people suffer.
Market failure is caused by:
- externalities
- missing markets
- imperfect competition
- lack of information
- immobility of factors of production
- unequal distribution of wealth and income
EXTERNALITIES
Externalities are the side effects of production and consumption activities that have an impact on people who were not involved in these activities.
When externalities are not taken account of (internalised) during pricing, this can result in the overprovision of products with negative externalities and the underprovision of products with positive externalities.
The over-provision of products with negative externalities
Negative externalities are the side effects of production and consumption activities that have a bad effect on people who were not involved in these activities (for example, air pollution from businesses manufacturing products or from consumers smoking cigarettes)"
The under-provision of products with positive externalities
Positive externalities are the side effects of production and consumption activities that have a good effect on people who were not involved in these activities (for example, the consumption of education does not only benefit the person consuming the service but can lead to general social upliftment, reduced crime and increased tax revenue).
When individuals consume goods and services, they only consider the private benefit to themselves of doing so. However, the benefit to society may be a lot higher than the private benefit if the good has positive externalities.
Market failure occurs when the free market does not produce adequate levels of products that have positive externalities.
Representation of the potential weIfare loss and potential weIfare gain related to externalities
WeIfare loss is the economic weIfare that is lost when too much I or too little of a good or resource is produced or consumed.
WeIfare gain is the economic weIfare that is gained when a good or resource is produced or consumed in increasing or decreasing quantities.
MISSING MARKETS
A missing market is a situation where I there is demand for a product but no supply,
A missing market normally arises in relation to public goods rather than private goods.
Public goods (also called community or collective goods) are not privately owned and can be consumed by many people without causing a decrease in quality (for example, lighthouses and traffic lights).
Businesses do not normally supply such goods because it is difficult to charge for them. This is partly because people automatically benefit from them if they are provided. Because people can effectively catch a'free ride'they are therefore unlikely to pay for the use of these goods. This is referred to as the 'free-rider problem', and it leads to missing markets, and therefore market failure.
IMPERFECT COMPETITION
Most markets are not perfectly competitive. There are often some barriers to entry or exit so that new businesses do not enter a market even when supernormal profits are being made on the sale of a particular good or service. The resulting lack of competition prevents the price of the product from falling. The output level is then also not high enough to ensure that the whole market is satisfied.
LACK OF INFORMATION
A business that produces a particular product will know more about that product than other businesses considering entering the same market, and will probably do what it can to discourage entrepreneurs from starting new businesses that would compete with it.
A business may also know more about the value of labour in its particular industry than the workers who are selling this labour. This could affect the price paid for labour.
A business will also know more about a product than consumers. lt might try to sell it to people who do not need it, or at a higher price than what could be charged.
IMMOBILITY OF THE FACTORS OF PRODUCTION
A business might find that the factors of production that it needs are not available in its area. Land is by its nature not mobile. Labour and entrepreneurship are not always situated where they are needed, and people might not want to relocate in search of better economic opportunities because of the impact this has on their personal lives. Capital may not always be moved easily, as there may be transport problems with machinery, and money (one of the easiest things to move) can be restricted by exchange controls.
UNEQUAL DISTRIBUTION OF WEALTH AND INCOME
Some people are born into wealthy families, and their family money helps them to make more money. Their good education and the time that they can spend learning a high-income profession also help them to become successful. People born into poorer families do not have these advantages, and often have a poorer education and have to enter the workforce without the opportunity to gain a tertiary qualification that could lead to a high salary. Their low incomes mean that they have little ability to accumulate wealth. This creates a cycle of poverty. ln such instances the market has failed to provide an adequate level of educational services to all the people who want them.
When markets fail this results in:
- inefficiency
- externalities
- government intervention
INEFFICIENCY
Imperfect competition allows existing businesses to be inefficient, as they are not threatened by the entry of competitors into the market. This results in high prices and a lack of new jobs.
Productive inefficiency occurs when a business or economy does not produce products at the lowest possible cost.
Allocative inefficiency occurs when products are not produced in the right proportions to reflect consu mers' preferences.
EXTERNALITIES
It is always better to have more positive externalities than negative externalities in a situation (see pages 111 - 112). Therefore positive externalities should be encouraged and negative externalities should be discouraged (see page 1 16). Negative externalities exist unchecked because market forces do not take account of them. This reduces the weIfare of society.
Positive externalities do not exist in sufficient quantities because market forces do not take account of them. This reduces the weIfare of society.
GOVERNMENT INTERVENTION
When is there a need for government intervention?
Because it is a matter of opinion what the most efficient allocation of resources is, it is a matter of opinion whether market failure has occurred. However, when society at large thinks that market failure has occurred, then the government of a democratic state has a responsibility to try to correct this market failure. lt can do this through both direct and indirect controls.
A direct control is one that is imposed on the production, pricing or distribution of specific products,
An indirect control is one that is imposed on the economy as a whole, such as a fiscal policy.
The government can intervene by:
- promoting competition
- making sure more information is provided
- reducing inequalities of wealth and income
- helping factors of production become more mobile
- encouraging positive externalities and discouraging negative externalities
- setting maximum prices, minimum prices and minimum wages
Promoting competition
Laws can be used to try and make a country's markets come as close to perfect markets as is possible. For example, South Africa's Competition Act promotes competition in South Africa. ln addition, state support can be given. For example, the dti offers loans to entrepreneurs who want to set up businesses, which helps them to compete with established businesses.
Providing information
The government can pass laws that specify what information a business must provide on the packaging of its products.
Reducing inequalities of wealth and income
Taxes on wealth and income allow the government to redistribute wealth in favour of poorer people. ln particular, it can spend more on education and supporting new businesses, so that people can improve their lives and overcome poverty.
Laws can also be used'to reduce the effects of inequality. For example, affirmative-action laws help previously disadvantaged groups of people become part of the formal sector.
Helping factors of production become more mobile
By improving the infrastructure of a country, a government can help labour, entrepreneurship and capital become mobile
Encouraging positive externalities and discouraging negative externalities
Laws can be used to encourage the production and consumption of products with positive externalities, and to discourage the production and consumption of products with negative externalities. For example, laws can be passed where all people have to go to school until a particular age, and where people are not allowed to make or take drugs.
At an international level, conventions can be created to reduce negative externalities that affect all countries.
Fiscal policy is an important part of encouraging positive externalities and discouraging negative externalities, because it encompasses government spending and taxation.
The price mechanism is the way in which prices affect the demand for and supply of goods and services.
Using government spending to correct market failure
When market failure occurs the government can try to correct the situation by becoming involved in production. The government can spend money on providing free or low-cost products that have positive externalities.
Merit goods are provided for society by the government because the government thinks it is beneficial for society to have them, not because of people's demand for them (for example, educatlon and national defence).
Subsidising means giving a government grant or other government support.
Government spending is also a way of boosting employment.
The state sometimes promotes the consumption of merit g oods through public-awareness campaigns, such as the campaign for HIV testing.
The diagrams below illustrate the effect of government intervention to encourage the increased consumption of products with positive externalities.
In both diagrams the market has failed when the business produces at Qe and Pe, At this output level and price, the market is not considering the full social benefit. Yet the government can intervene to see that positive externalities are internalised.
In both cases illustrated above, the subsidy results in more of a product with positive externalities being produced.
Using taxes to correct market failure
The government can also raise taxes (or take out loans) to allow for increased expenditure. State weIfare projects aim to redistribute wealth from the rich to the poor. Progressive taxation ensures that those on low incomes pay little or no tax, while high income earners pay progressively more.
Demerit goods and services are those that are bad for the people who consume them and/or have negative externalities, and governments therefore , often discourage the production and consumOtyon of them
An excise duty is an inland tax (not a border tax/customs duty) on a specific product.
A sin tax is an excise duty that the government imposes to discourage the consumption of demerit goods
Sin taxes can be used to discourage the production and consumption of demerit goods and services (products that have negative externalities), while also generating tax revenue for the state.
The diagram shows how a sin tax increases the cost of production and therefore the price of a product, and in this way reduces the quantity produced.
Setting maximum prices, minimum prices and minimum wages
Minimum wages
The labour market is the market where workers sell their labour to employers and the price of people's labour is determined. The labour market is a sub-section of the factor market
In a free-market situation there is no guarantee that all people will earn in the labour market what the government considers a fair income. Therefore some governments, including the South African government, decide to set minimum wages to ensure that people earn a fair income for the work they have done.
A wage is a rate paid for a particular job done by a worker, and can be paid per hour, per week or per product completed.
A minimum wage is a minimum rate paid for a particular job done by a worker, and can be paid per hour, per week or per product completed
Examples of minimum wages set by the government are minimum wages for domestic workers and minimum wages for farm workers.
The purpose of intervening in the labour market in this way is to protect the vulnerable (the poor and uneducated workers). However, when a minimum wage is set this can disadvantage people who are unemployed and willing to work for less than the minimum wage. However, according to the South African Constitution these individuals still have the right to earn an income.
Resources are scarce, therefore we must consider the costs and benefits of a project before allocating resources to that project.
Cost-benefit analysis (CBA) is a process of comparing the social costs and social benefits of a project.
Cost-benefit analysis allows planners to work out if going ahead with a proposed project is a good decision. lt can be used in the public or private sector to evaluate large-scale investment projects.
Cost-benefit analysis requires that the private costs and private benefits of a project are calculated, and thatthe external costs and external benefits are calculated. This also requires that all externalities are identified and then calculated. Only in this way can the social costs and social benefits be summaris
If the social cost of a project is greater than the social benefit it will bring, then the project should not go ahead.
When considering a project, planners must also consider the opportunity cost (the next best alternative foregone) of choosing to go ahead with that project.
Cost-benefit analysis also allows planners to compare two proposed projects to work out which one is the better option. lt is an essential tool in making objective decisions.
THE PROGESS OF COST_BENEFIT ANALYSIS
There are four steps involved in performing a cost-benefit analysis of a project:
- Step 1: Calculating the social costs
- Step 2: Calculating the social benefits
- Step 3: Comparing the social costs and social benefits
- Step 4: Deciding whether the project should proceed
Step 1: Calculating the social costs
Firstly, the private cost must be calculated using market prices.
Secondly, the external cost needs to be identified and estimated. lt needs to be quantified in terms of money.
A shadow price is the best estimate of a price for something that is not part of a normal market.
Then the private cost and the external cost are added together to work out the social cost of a project.
The present value of a future amount of money is one where the effects of time (such as inflation and interest) have been taken into account and the value has been reduced (discounted) accordingly, if necessary.
Step 2: Calculating the social benefits
Firstly, the private benefit must be calculated.
Secondly, the external benefit needs to be identified and estimated. lt needs to be quantified in terms of money.
Then the private benefit and the external benefit are added together to work out the social benefit of a project.
Step 3: Comparing the social costs and social benefits
The social cost and the social benefit are compared using the coslbenefit ratio (CBR).
Step 4: Deciding whether the proiect should proceed
The CBR is used to make the final decision as to whether the project should proceed:
- If the cost-benefit ratio is greater than 1 (CBR > 1), the project can proceed.
- If the cost-benefit ratio equals 1 (CBR = 1), it will not be worthwhile proceeding with the project.
- If the cost-benefit ratio is less than 1 (CBR < '1), the project will detract from the economic well-being of society, and should be abandoned.
If a project is to go ahead, the social cost should never exceed the social benefit.
However, just because a project has a cost-benefit ratio that is greater than '1, does not mean it is the best use of scarce resources.
If a project is being compared with one or more other projects to determine which is the best use of the available resources, then the coslbenefit ratios of each project need to be compared. The project with the highest cost-benefit ratio will be the one that will be chosen.
ECONOMIC GROWTH
An economy's productive capacity is the maximum output that is possible with its current resources.
Economic growth is the increase in the productive capacity of an economy over a period of time.
A government's micro-economic policy is aimed at specific sectors and is involved with specific ways in which businesses and consumers interact, : all in order to bring about economic goals such as promoting economic growth through productivity and investment in the economy.
MEASURING AND COMPARING COUNTRIES' ECONOMIC GROWTH
The gross domestic product (GDP) is the total market value of all finished goods and services produced within the borders of a country within a given period of time.
The term 'per capita' means'per person' (literally, in Latin, 'per head').
A country's GDP per capita refers to that country's output divided by its population.
A country's economic growth can be measured by the increase in that country's real GDP per capita.
For example, in 2012 the change in South Africa's real GDP per capita from the previous year was 1,3%.
To compare the annual economic growth of countries of different sizes, we should compare their increases in real GDP per capita.
For example, in 2012, Niger had an increase of 6,7% in real GDP per capita, which is much greater than South Africa's increase of 1,3%, and Norway had an increase of 1,7%, which was slightly better than South Africa's. However, in the same year Belgium had a 0% increase in real GDP per capita, which shows that it did not experience economic growth at all that year, and South Sudan had a decrease of -49,8% in its real GDP per capita, which shows extreme negative eco n o m ic g rowth. (http ://data.worldban k.org. Retrieved 1 5 January 201 4.)
International benchmarking is the process of comparing how a country is performing on a specific aspect by using a specific indicator, and by comparing this to how other countries are performing regarding the same aspect, expressed using the same indicator.
Economic development is the improvement of the standard of living of a country's citizens.
Economic development includes:
- ensuring that the basic needs of all of a country's citizens are met
- increasing people's socio-economic circumstances through education, healthcare and environmental sustainability
- increasing people's freedom of choice by providing them with a variety of opportunities
- promoting the self-esteem and seltrespect of citizens
A government's macro-economic policy deals with the economy as a whole and co-ordinates tools such as monetary and fiscal policy to raise the standard of tiving in a sustainable way.
MEASURING AND COMPARING COUNTRIES' ECONOMIC DEVELOPMENT
The gross national income (GNI) is the sum of country's GDP and is net income received from outside the country.
A country's GNI per capita refers to the gross national income of a country's citizens divided by the number of citizens.
A country's economic development can be measured by the increase in that country's real GNI per capita.
An increase in the real GNI per capita could be expressed in terms of the US dollar, or as a percentage. For example, according to a World Bank report published in 2012, South Africa's real GNI per capita was US$ 10 330 in 2010 and US$l0 790 in 2011, while its percent increase in real GNI per capita during the same period was 4,26%. )(http:i/tradingeconomics.com. Retrieved 25 January 201 4.)
Economic development and human development are very closely linked concepts, therefore a country's HDI (which is discussed below) is considered another way of measuring economic development.
Human development is the improvement of the opportunities facing a country's people so that they can lead long full educated and healthy , lives, accessing resources and participating in their communities.
MEASURING AND COMPARING COUNTRIES' HUMAN DEVELOPMENT
Countries' human development is measured and summed up by the United Nations' Human Development lndex.
The Human Development lndex (HDI) is a composite statistic of income, education and life expectancy of all people in a country and it serves as an indicator of social and economic development.
Countries can be compared in terms of,their HDls in order to compare their human development. HDls are expressed as values between 0 and 1. A score of 0 would be the lowest possible HDl, and a score of 1 would be the highest possible HDl. ln reality scores fall between these two points.
For example, in 2013 Niger had the lowest HDI: 0,304, while Norway had the highest HDI: 0,955. South Africa had an HDI of 0,629, and is seen to have a medium level of human development. (Source: http://en.wikipedia.org. Retrieved 1 5 January 2014)
The South African government has implemented a number of macro-economic policies and micro-economic policies to stimulate groMh and development in the country.
The Reconstruction and Development Programme (RDP) was a socio-economic policy framework designed to reduce poverty and increase social services.
The RDP (1994 - 1996)was designed to:
- provide housing, water, electricity and primary healthcare to the
- implement a public-works programme
- implement land reform
The Growth, Employment and Redistribution (GEAR) programme was designed to continue with the service delivery to the poor that the RDP had started, while also growing and stabilising the economy.
GEAR (1996 - 2001) was designed to:
- continue with service delivery to the poor, and to increase spending on this
- improve the infrastructure to improve service delivery
- create economic growth through encouraging trade and foreign direct investment, and developing workers' skills
- stabilise inflation through monetary policy
- reduce the national budget deficit through a more effective fiscal policy
The Accelerated and Shared Growth Initiative for South Africa (AsgiSA) is a combined public and private sector initiative designed to overcome constlaints to economic grow_th through a variety of prolects
AsgiSA (2006 - >)was designed to:
- overcome constraints to economic growth ( through improvements in infrastructure, production capacity, skills development, and access to the first economy)
- improve economic development
- halve unemployment by 2014
The Joint initiative on Priority Skills Acquisition (Jipsa), launched in 2006, is the part of AsgiSA that deals with improving people's skills to help unemployed people meet the country's skills shortage.
The New Growth Path (NGP) is designed to reduce unemployment, and make the South African economy more equitable.
Launched in 2010, the NGP aims to:
- reduce unemployment by creating 5 million jobs by 2020
- increase economic growth by between 6% and 7% a year to achieve this job-creation target
- istribute the benefits of econornic growth more fairly
The National Development Plan (NDP) is a I longterm socio-economic plan designed to improve services and the standard of living , through capacity-building and inclusivity.
Launched in 2012, the NDP is a long-term holistic plan that aims to:
- create 11 million jobs by 2030
- eliminate poverty
- improve infrastructure
- improve healthcare
- improve integration reduce corruption
- improve education
- improve safety
- improve equality reduce pollution
As well as these five main policies many others have been implemented.
The Black Economic Empowerment (BEE) Act of 2003 and its revised version, the Broad-Based Black Economic Empowerment (BBBEE) Act, were designed to improve the distribution of wealth in South Africa by requiring businesses to have a greater proportion of black owners, managers and skilled workers.
The Expanded Public Works Programme (EPWP) was launched in 2004 with the purpose of creating employmenf opportunities for the poor and vulnerable.
The Industrial Policy Action Plan (IPAP) aims to strengthen the Department of Trade and lndustry (dti), industrial development, enterprise development, investment, export promotion and incentive support. IPAP is updated every three years, and the current version is called IPAP 2013 I 2014
In addition, various Department of Trade and Industry (dti) programmes offer (or have offered) financial and other kinds of support to small, medium and micro enterprises (SMMEs). Examples are:
- the Black Business Supplier Development Programme (BBSDP)
- the Co-operative lncentive Scheme (ClS)
- the lncubation Support Programme (lSP)
- Small and Medium Enterprise Development Programme (SMEDP)
There are two main approaches to increasing economic growth:
- the demand-side approach
- the supply-side approach
South Africa uses a combination of demand-side and supply-side policies to stimulate economic growth and development, which is viewed as the most effective approach.
THE DEMAND-SIDE APPROACH
The demand-side approach to increasing economic growth uses monetary and fiscal policies to increase the aggregate (total) demand for goods and services.
The total demand for goods and services in a country is determined by:
- the level of consumption spending by households (C)
- investment spending by businesses (l)
- government spending (G)
- exports minus imports (X - M)
These four contributors to aggregate demand are called demand factors.
total demand = consumer spending by households + investment spending by businesses + government spending + spending by foreigners on SA goods - spending by South Africans on foreign goods
This is also written as:
AD = C + l + G + (X - M)
The following diagram highlights how it is possible to stimulate economic groMh by stimulating aggregate demand.
A government can stimulate aggregate demand by:
- increasing the consumption spending of households (for example, by lowering the repo rate)
- increasing government spending (for example, by spending more on public works programmes)
- increasing investment spending by businesses ,' (tor. example, by granting tax allowances to businesses who are constructing new buildings)
- increasing the value of exports (for example, by implementing an export promotion strategy)
- decreasing the value of imports (for example, by implementing an import substitution strategy)
Export promotion is an outward-looking government strategy to encourage economic growth, where domestic prodi-rcers are helfed lo make products foi foreign market.
Import substitution is an inward-lookingg strategy that restricts imports in order to allow domestic businesses the opportunity to supply similar goods.
HOW SOUTH AFRICA IMPLEMENTS A DEMAND-SIDE APPROACH
South Africa uses the demand-side approach in its monetary policy and its fiscal policy.
The monetary policy is the approach taken by a country's central bank (or other monetary authority) to influence spending in an economy by influencing the interest rates and money supply.
South Africa's central bank is called the South African Reserve Bank (SARB), but is also simply referred to as the'Reserve Bank'.
The SARB's monetary policy implements a demand-side approach through:
- controlling the repo rate - to affect the interest rates that commercial banks can offer
- engaging in open market transactions - to affect the amount of credit that commercial banks can offer by influencing their liquidity
- moral suasion - to persuade commercial banks to take account of the economic conditions of the time
- setting the cash reserve requirement - to affect the amount of credit that commercial banks can offer by influencing the ratio of what they may loan out to what they must keep in reserve
However, the SARB's primary goal is to protect the value of the rand by guarding against high inflation. This restricts to what extent it can use monetary policy to stimulate aggregate demand, because it may not do so if the result will be inflation outside of its target range.
The fiscal policy is the approach that the government takes to taxation and government spending in order to regulate the economy.
South Africa's national budget is the main vehicle of fiscal policy, as it dictates where taxes will come from and how the government will spend its money. Under the Minister of Finance, Pravin Gordhan, the National Treasury decides on the national budget.
The South African government's fiscal policy implements a demand-side approach through:
- progressive personal income tax
- wealth tax
- welfare payments
- social services
- subsidies for poor people to buy their first home
- land restitution and redistribution
- other redistribution
Through policies that redistribute resources from the rich to the poor the government can increase the demand of the poor people for goods and services, at the cost of the rich being able to save less (which would have been a leakage from the economy anyway). ln this way South Africa uses its fiscal policy to stimulate economic growth, and consequently employment.
THE SUPPLY-SIDE APPROAGH
The supply-side approach to increasing economic growth aims to do this by improving the economy's ability to supply goods and services.
A country's productive capacity is determined by the quantity and quality of the country's factors of production.
The factors of production are:
- natural resources (land)
- human resources (labour)
- capital
- entrepreneurship
By improving the quality of the supply factors, and by allocating them efficiently, a country can increase its aggregate supply and create growth and development.
Natural resources
Natural resources (often simply called 'land') are things that occur naturally and can be used in economic activities, such as soil, water and sunshine.
South Africa's supply of natural resources is fixed. They are of a limited range and a set quality.
The quality and quantity of these natural resources have a direct impact on the country's level of production, and therefore its level of output.
They are very important for the economic growth of a country, and must therefore be protected and used in a sustainable way.
Human resources
Human resources (often simply called 'labour') refer to the strength and skills of a country's labour force (economically active population).
The quality of a country's human resources can be improved by:
- nutrition
- healthcare
- a clean, safe and positive environment
- education and training
- inclusive opportunities for professional growth
The quantity of a country's human resources can be improved by increasing the birth rate and the life expectancy of the population, and the quantity needed in a particular area can be increased by providing affordable housing and transport.
Capital
A country's capital consists of money and capital goods.
Capital goods are physical assets such as buildings, machinery and 'equipment that a busfness or organisation uses to produce goods or services.
The quality of capital goods can be improved by technological development and ' innovation. ln order for the country to increase its productivity, the country requires a greater quantity and better quality of capital goods.
However, to get more and better capital goods, businesses need access to finance. The quantity of money available for investment is an important factor in economic growth.
When the stock of capital is increasing in keeping with the increase in the labour force, we call this capital widening.
Capital deepening leads to greater productivity.
Entrepreneurship
Entrepreneurship is the process of starting a business by using natural resources (land), human resources (labour) and capital in an attempt to make a profit.
Entrepreneurs recognise a gap in the market and use this opportunity to start a business. They take the risk of investing their own or borrowed money into this new venture.
Entrepreneurs are seen as the driving force behind the country's economy, and the following diagram illustrates the importance of entrepreneurs.
Entrepreneurs play an important role in the economic growth of a country.
HOW SOUTH AFRICA IMPLEMENTS A SUPPLY-SIDE APPROACH
South Africa uses the supply-side approach by:
- making markets efficient and effective (by protecting competition, promoting SMMEs, integrating black people into the mainstream economy, and privatising parts of the public sector)
- encouraging businesses to become efficient (by offering advice and support, and improving education and training)
- reducing the cost of doing business (by keeping taxes in check, reducing rules, providing infrastructure and encouraging investment).
To evaluate whether South Africa's approaches to stimulating economic growth and development have been successful, economists need to measure the results and analyse this information in order to make judgments.
EVALUATING THE SUGGESS OF SOUTH AFRIGA'S MOST IMPORTANT EGONOMIG POLICIES
The RDP (1994-1996) was successful in that its labourintensive public-works programmes helped to reduce poverty by providing employment, and at the same time provided houses, water, electricity and primary healthcare for the poof. Lahd reform was also implemented. However, there were logistical problems and, two years after being introduced, the RDP was replaced by the GEAR programme.
GEAR (1996 - 2001) was successful in controlling inflation and in reducing the national budget deficit. However, South Africa was not successful at gaining foreign direct investment and it did not achieve its growth targets.
AsgiSA (2006 - >) has resulted in improved infrastructure and some increases in productive capacity, and there has also been some success in making a bridge from the second economy to the first economy. Therefore it did overcome some constraints to growth. However, unemployment has only slightly decreased, and the target of halving unemployment by 2014 was not achieved.
Other economic policies are hard to evaluate, either because they have not been running for very long, or because information tracking the success of their interventions is not available. However, we can use South Africa's economic indicators to evaluate their combined impact on the country's growth and development.
EVALUATING SOUTH AFRICA'S ECONOMIC GROWTH USING ITS ECONOMIC INDICATORS
To analyse South Africa's economic growth we can look at the size of its annual increase in GDP, which is shown in the table below, and compare this to the government's target of an economic groMh rate of 5%.
The table shows that in 2005, 2006 and 2007 South Africa achieved growth greater than 5%, but that after that the groMh rate dropped and the target growth rate of 5% was not achieved.
ANALYSING SOUTH AFRICA'S EGONOMIC DEVELOPMENT USING ITS EGONOMIC INDICATORS
To analyse South Africa's economic development we can look at the annual figures for its GNI per capita. We can also look whether its HDI has increased, decreased or stayed the same - and compare this to similar economies in the developing world.
The following table shows that South Africa's GNI per capita has been steadily increasing, so we can say that economic development is occurring steadily.
There is a tendency for developed countries to be located in the north of our world, and for developing countries to be located in the south. So economists use the term the North/South divide to show this division between the rich (and more politically stable) countries of the North, and the poorer (and less politically stable) countries of the South.
Countries in the North include:
- the United States
- Canada
- the countries of Europe
- lsrael
- Japan
Countries in the South include:
- the countries of Africa
- the countries of Central America
- the countries of South America
- many countries in Asia
There is disagreement over exactly which countries should be included in the North, and which in the South. ln the 1980s the Chancellor of West Germany, Willy Brandt, drew a line between the countries he considered developed and those he considered developing. Despite being physically located in the north, Mongolia and China were included by Brandt as part of the South. Similarly, although Australia and New Zealand were physically located in the south, Brandt included them as part of the North.
The following table highlights the main differences between the North and the South.
The countries in the North and the countries in the South have very different standards of living (per capita income, life expectancy and education).
Therefore a country's HDI is a good indicator of whether that country should be categorised as belonging to the North or the South.
INDUSTRIAL DEVELOPMENT POLICIES
The term 'industry' can refer to either economic activity in general that is concerned with processing and manufacturing, or to particular branches of economic activity, such as the clothing and textiles industry or the tourism industry.
Industrial development is the planning and building of new industries, and the expansion of existing industries.
Industrial development strategies are processes and guidelines for improving the efficiency and competitiveness of the industrial secto
lndustrial development policies are laws or rules aimed at encouraging investment, improvement and expansion of particular industries.
International best practice shows that industrial development policies are most successful when they:
- promote investment in infrastructure, physical capitaland human resources
- embrace international trade
- support technology
- create macro-economic stability (so that businesses can plan ahead)
- follow free-market principles
- protect against anti-competitive behaviour
- are implemented by a credible government which has little corruption
SOUTH AFRICA'S ENDEAVOURS AT INDUSTRIAL DEVELOPMENT
Past industrial development approaches in South Africa
Before 1994 South Africa set up a number of parastatals / state-owned enterprises to support industrialisation. However, while some areas experienced significant development, others did not. The state's policies of import-substitution, and the sanctions in response to its discriminatory political policies, meant that it was not successful at finding markets for many of its exports.
From 1994 onwards the new democratic government had a different relationship with countries around the world. lt shifted the industrial development policies to make South African industries more export-oriented through lndustrial development zones (lDZs), and used Spatial development initiatives (SDls) to cause investment in under-developed regions. Support was also given to South African businesses that now faced increased competition from global imports.
Current industrial development approaches in South Africa
South Africa is trying to develop its industrial base more quickly, because the secondary sector:
- creates more jobs than the primary sector, and these jobs are also of a more skilled and higher-paying nature
- increases consumer choice and the standard of Iiving
- contributes to higher export revenue, and so leads to injections of foreign currency into the country
- diversifies the economy, making it more resilient to change
The National Research and Development Strategy (NRDS) was released in 2002 to enhance innovation, provide human resources and transformation in science and technology, and create an effective science and technology system.
The NRDS was the basis for lhe National System of Innovation (NSl) and influenced the establishment of the Department of Science and Technology (DST).
The Integrated Manufacturing Strategy (IMS) was released in 2002 to co-ordinate government actions to increase the competitiveness of South African businesses.
For example, the IMS supported businesses' use of information and computer technology (lCT).
The Industrial Development Corporation (IDC) is part of the Department of Economic Development, and provides finance to industrial development projects as well as researching and leading new industries.
The IDC helped the dtiformulate the National lndustrial Policy Framework in the light of international best practice.
The National lndustrial Policy Framework (NIPF) was launched in 2007 to give direction to South Africa's industrial policy, and to make it clear what the government's goals for industry were.
These goals were:
- to intensify South Africa's industrialisation process and move towards a knowledge economy
- to help the economy move away from a reliance on traditional commodities, and diversify
- to increase value-added activities before exporting products
- to specifically encourage the kind of industrialisation that creates jobs
- to integrate historically disadvantaged communities and marginalised regions into this industrialisation process
- to contribute to industrial development on the African continent with a view to increasing economic integration
The NIPF was designed in accordance with the government's goal of job creation, and with an acceptance that public sector spending alone could not solve the country's unemployment problem. Like GEAR, it was based on the idea that increasing national output and productive efficiency is very important in job creation.
The NIPF targets specific sectors of the economy that have considerable potential for increased output and job creation:
- agriculture (including food production)
- tourism
- information and computer technology (ICT)
- cultural industries
- export sectors (including automobiles, chemicals, minerals and metals)
The NIPF also relies on the existence of cross-cutting services.
Cross-cutting services are vital inputs that ensure the proper functioning of the entire industrial sector, such as ' transport, telecommunications, energy and financial services.
The provision of cross-cutting services is often state-funded. The state advertises the need for such services in the Government Gazetfe, and requires businesses to tender for state contracts (such as road-building contracts).
To tender for a contract means to make a formal offer to do the task for a particular price.
State contracts provide lucrative business opportunities for small, medium and large businesses. The awarding of tenders is regulated by financial oversight committees, and is part of the public procurement process.
Progress towards the NIPF goals has been implemented through the lndustrial Policy Action Plans (lPAPs), which have attempted to:
- reduce industrial decline
- increase internationally competitive manufacturing
The first action plan, IPAP 1, was introduced in 2007 , and, among other things, this focused on:
- developing the automobile (motor vehicle) industry
- supporting the clothing and textiles industry
- supporting the business process services industry
This action plan was revised in 2012 as IPAP 2, and, among other things, this focused on:
- developing the mineral beneficiation industry
- developing the agro-processing industry
- helping regulators reduce anti-competitive behaviour
Regional development is the promotion of economic development in areas where poverty, unemployment and income inequality are high, in order to uplift these areas.
As econornic development occurs in a particular region, the benefits are fed back into the community, so that economic development continues to occur.
International best practice shows that regional development policies are most successful when:
- public-private partnerships are formed (local and national governments must use public funds to help private businesses to be able to function, for example, by creating infrastructure)
- a free-market approach is followed (government intervention in the businesses themselves is discouraged so that competition and innovation can ensure efficiency)
- a sustainable / long-term approach is followed (rather than aiming at short-term profit and job creation)
- there is good governance (state management of projects is free of corruption and financial oversight is practised)
- there is investment in social capital (communities benefit from the investment directly and indirectly, and there is less transfer of profits away from these communities)
- there is provisioning of resources (the state provides necessary infrastructure, and public and private partnerships ensure labour is mobilised effectively)
When regional development is successful it leads to the introduction of new skills and technology, which in turn leads to:
- increased inward investments
- networking and shared innovations
- a sustainable business culture
SOUTH AFRICA'S ENDEAVOURS AT R.EGIONAL DEVELOPMENT
South Africa's shift from centralisation to decentralisation
The Apartheid government centralised industrial development in certain areas. Its policies led to many businesses beinE attracted to these industrial 'hotspots'. Many regions of South Africa are now economically prosperous because of the industrial businesses that they contain. For example, Gauteng benefits from the gold-mining industry, Cape Town and Durban have many manurfacturing businesses, and Port Elizabeth benefits from the automobile industry. However, these areas were developed at the expense of other regions, which now offer few economic opportunities to the people that live there.
The present government is trying to decentralise the economy by encouraging economic growth and employment beyond the traditional centres. To do this it is focusing on regional development. lt is trying to create a stable economic environment in regions where poverty, unemployment and income irregularity are high, in order to encourage investment in these areas.
As part of its Spatial Development Programme, the government is encouraging businesses to set up in particular under-developed areas with high untapped growth potential, and it has other regional development programmes that support regions that are not part of this focus.
The Spatial Development Programme
Under the Spatial Development Programme, the Department of Trade and lndustry (dti) and the Department of Transport (DOT) are encouraging both industrial development and regional development through the establishment of:
- industrial development zones (lDZs)
- special economic zones (SEZs)
- spatial development initiatives (SDls)
In addition the dti is encouraging industrial development in generalthrough:
- incentives
Industrial development zones
In 2001 South Africa launched its programme of industrial development zones.
An industrial development zone (IDZ) is an enclosed area positioned next to a harbour or airport where production for export is encouraged through incentives.
IDZs are purpose-built sites that offer:
- good basic infrastructure
- easy access to a port and / or airport
- duty-free imports of raw materials and other inputs
They are part of an export-promotion policy to make South African exports internationally competitive.
Examples of IDZs are:
- Coega IDZ in Port Elizabeth
- East London IDZ (EL IDZ)
- Richards Bay IDZ (RB IDZ)
- OR Tambo lnternationalAirport lDZin Gauteng (ORTIA IDZ)
Special economic zones
In November 2011, the government passed the Special Economic Zones Bill to provide for new areas for development.
A special economic zone (SEZ) is an area set aside for specifically targeted economic activities, which is then supported by the public sector through specialarrangementg-.
SEZs have a wider industrial development objective than lDZs and can be located in any area.
IDZs are really just a sub-category of SEZs, and will now fall under the SEZ programme.
Spatial development initiatives (SDIs)
Economic corridors are geographical regions connecting important iconomic points.
Spatial development initiatives (SDIs) are corridors of land containlng areas of untapped economic potential that lie between areas of higher economic activity, and which the government has targeted for regional development.
Examples of SDls completely inside South Africa are:
- the West Coast SDI (from Atlantis to Saldanha Bay)
- the Fish River SDI (from Port Elizabeth to East London)
SDIs also cross over national borders, as in the case of:
- the Gariep SDI (from Alexander Bay to Upington), which crosses into Namibia
- the Maputo Development Corridor SDI (from Johannesburg to Maputo), which crosses into Mozambique
It can be difficult to evaluate the impact of South Africa's industrial development policies because there is often a lack of data regarding the various sectors of the economy. lt is also difficult to separate the impact of the dti's strategies from the impact made by other influences.
However, we can look at the annual value of South Africa's exports, which has a relationship to industrial development.
The graph below shows that exports tripled between 2OO4 and 2013, which is a good reflection of the country's industrial policies because it shows that production capacity has increased beyond the domestic market.
Success factors include:
- increased investment in technological infrastructure (for example, broadband)
- the upgrading of major transport links (for example, the new King Shaka lnternationalAirport outside Durban, the Richards Bay Harbour, and the MyCiti bus services in Cape Town)
- selected lDZs and SDls (for example, Development Corridor SDI)
External limitations include:
- the international economic downturn
- preferential trade agreements
- high oil prices
Internal limitations include:
- a lack of skilled labour
- corruption and tender fraud
- a lack of local demand
- high petrol prices
We can also say that South Africa's industrial development policies are in line with many aspects of international best practice as they have:
-
. promoted investment in infrastructure, physicalcapital and human resources (for example, the Business Process Outsourcing and Off-shoring incentive programme has created at least 6 000 new jobs and attracted R303 million in direct investment, and the Critical lnfrastructure Programme supports projects designed to improve critical infrastructure in South Africa)
. embraced international trade (for example, through the development of IDZs, and through the lPAPs, which have attempted to increase internationally competitive manufacturing )
. supported technology (for example, the National Research and Development Strategy and the Support Programme for lndustrial lnnovation support the development of new technological products and processes)
In addition, the clear industrial policies, together with the SARB's inflationtargeting, have helped to contribute to macro-economic stability.
While temporary subsidies are often offered as incentives, South Africa remains committed to following free-market principles over the long term.
The Competition Act of 1998 protects against anti-competitive behaviour, and the Department of Public Services and Administration co-ordinates government initiatives against corruption.
SUCCESSFUL REGIONAL DEVELOPMENT INITIATIVES
South Africa's approach of taking work to the workers through regional development is in line with international best practice. However, some of its regional development initiatives have been more successful than others:
- The four IDZs have had mixed success but have created 48 000 jobs since inception. ln particular, the Coega IDZ in the Eastern Cape has benefited from long-term planning, and is on track to attract R50 billion worth of cumulative investment by 2014.
- Two SDIs have been very successful - the Maputo Development SDI and the West Coast SDl. The Maputo corridor in particular has seen $5 billion invested, and led to the birth of the new N4 highway.
- The infrastructure plan was only launched in 2012 so it cannot really be evaluated yet.
Incentives
The dti has provided many financial incentives to businesses to promote industrial development, such as those explained below.
The Black Business Supplier Development Programme (BBSDP) offers grants to small black-owned businesses and provides grants of up , to R1 million, including RB00 000 fortools, machinery and equipment.
The Small Enterprise Development Agency offers the SEDA Technology Programme (STP), which makes technological support available to small enterprises.
The Skills Support Programme (SSP) makes , a cash g3nt available for skills development
The Critical Infrastructure Programme (ClP) offers a grant of between 10o/o and 30% of the qualifying development costs of projects designed to improve critical infrastructure facilities in South Africa.
The Automotive Production and Development Plan (APDP) offers production incentives and custom-free import credits to automobile manufacturers in an attempt to boost local production to 1,2 million units a year by 2020.
The Foreign lnvestment Grant (FlG) is designed to encourage foreign manufacturing businesses to relocate to South Africa by covering the costs of settlng up a manufacturing facility.
The Strategic lnvestment Program (SlP) offers tax deductions to manufacturing projects where large investments are made that create employment.
The Business Process Outsourcing and Off-shoring (BPO&O) incentive programme is designed to create jobs in the business process servlces (BPS) industry
The Clothing and Textile Competitiveness Improvement Programme (CTCIP) aims to build capacity among clothing manufactulels and other areas of the clothing and textile indus
The Support Programme for Industrial Innovation (SPII) ' gives financial support for the development of new technological products and processes.
Other regional development initiatives
The Spatial Development Plan is complemented by the lnfrastructure Plan, which responds to the needs of communities rather than focusing on their groMh potential.
The Infrastructure Plan finds out which regions have the least developed infrastructure and ensures that infrastructure is delivered to these regions.
The Infrastructure Plan is implemented through Strategic lntegrated Projects (SlPs). For example:
- SIP 1 aims to support mining in Limpopo through improved infrastructure.
- SIP 4 aims to support mining, agriculture and tourism in the North West Province through improved infrastructure.
- SIP 10 aims to provide access to electricity for all.
- SIP 15 aims to provide broadband internet access for all.
Economic performance refers to how successful a society is at producing, consuming and distributing goods and services.
ECONOMIC INDICATORS
Economic indicators are statistics that give information about macro-economic variables, and which arJ used as tools to give information about how well an economy is performing
Economic indicators allow an economy's present performance to be compared to its past performance, and for it to be compared to the performance of other economies.
It can also be compared specifically with the average of other economies that fall into the same income category (low income, lower middle income, upper middle income or high income).
Economic indicators can be divided into various categories:
- inflation rate
- foreign tra
- employ
- productivity
- interest rates
- money supply
Production indicators :
Production indicators such as GDP and GDP per capita show how much is being produced, and can be used to measure economic growth.
Income indicators:
Income indicators such as GNI and GNI per capita show how much income is being earned, and can be used to measure economic development.
Inflation rate
Inflation is a continuous increase in the general price level of a variety , if goods and services in nq economy over a period of time.
Inflation indicators show by how much the purchasing power of money is decreasing in the face of inflation.
Inflation indicators include:
- the PPI
- the CPI
The inflation rate shows the average rate of change of the general price level during one year.
A price index is an average price calculated for a particular category of products in a given region during a particular period of time.
The producer price index (PPl) measures the average change in prices of domestically , produced goods when they leave the factory, while also taking into account the prices of imported goods, and measures this for a particular country over a particular period of time.
The consumer price index (CPl) , measures the change in the price level , of a representative selection of consumer goods and services bought , by households in a particular country , over a particular period of tlme
Foreign trade
Foreign trade is the exchange of goods, services and capital across international borders.
After the end of Apartheid the sanctions and boycotts that other countries used to help end Apartheid were lifted, and foreign trade therefore increased.
South Africa is:
- the second largest exporter of gold in the world
- the third largest coal exporter in the world
- a net exporter of farming products
South African imports include:
- machinery
- transportation equipment
- chemicals and petroleum
Foreign-trade indicators show how healthy a country's export sector is.
Examples of foreign{rade indicators are:
- the terms of trade
- the exchange rate
The terms of trade (TOT) are expressed as a percentage that gives the value of a country's exports relative to the value of its imports.
The trade balance or balance of trade (BOT) is the figure that represents the difference between the total income received for exported goods (merchandise) and the total payments made on imported goods (merchandise) during one year (or other specified period of time).
If a country's terms of trade come to less than 100%, this means there is more money being spent on imports than there is coming into the country through the payments received for exports. lf a country's terms of trade come to more than 1OO%, this means there is more money coming into the country through the payments for exports than there is being spent on imports. Therefore it is a good sign if a country's terms of trade are above 1O0Yo.
lf a country's terms of trade increase, this is to that country's advantage. lf a country's terms of trade decrease, this is to the disadvantage of that country.
South Africa has a floating exchange rate, and the value of the rand against other currencies is constantly changing.
As the exchange rate changes, the prices of imports and exports are influenced. The exchange rate shows how much it will cost to import foreign products, and how much local products will cost foreign buyers.
The table below gives the rand-US dollar exchange rate on two particular days within a five-month period.
A weak rand helps exporters become competitive on international markets unless they need to import machinery or raw materials needed for production, because these will cost a lot more when the rand is weak. As South Africa is a developing country it does need to import machinery in order to grow its secondary sector. lf the rand becomes too weak it becomes difficult to do this, so a rand that is too weak is not a good sign.
Employment
The economically active population (EAP) (which is also referred to as the workforce or labour force) is the group of people between the ages of 15 and 65 years who are willing and able to work.
The EAP includes:
- employees in the formal and informal sectors of the economy
- self-employed people
- unemployed people
Employment indicators show what proportion of the EAP is employed.
Employment indicators include:
- the employment rate
- the unemployment rate
The employment rate is the number of employed people expressed as a percentage of the EAP
The employment rate is used to highlight:
- employment trends in different sectors of the economy
- any structural changes in the economy
Employment rates are calculated as the ratio of the employed to the working age population (EAP).
The unemployment rate is the percentage of the EAP that is unemployed at any given date
unemployment rate = unemaloved members of the EA/ EAP x 100/1
It can be based on a narrow or a broad definition of unemployment.
The general definition of unemployment is that it is the situation of those people who are willing and able to work, but who don't have a job.
The narrow definition of unemployment is that it is the situation of those people within the EAP who don't have a job but have been actively looking for work in the past four weeks and are available to begin work in a week.
The broad definition of unemployment is that it is the situation of those people within the EAP who don't have a job. even if they have given up looking for one.
The Department of Labour uses the narrow definition of unemployment, but Statistics South Africa provides unemployment figures according to both the narrow and the broad definitions of unemployment. There can be a big difference in the unemployment figure depending on which definition is used.
Productivity
Productivity refers to how much is produced (output) in relation to the factors of production that are used (input).
Productivity indicators show how efficient production is.
Productivity indicators include:
- labour productivity
- remuneration per worker
Labour productivity refers to how much is produced r in relation to the labour that is used.
labour productivity = real GDP / number of workers employed
Remuneration per worker refers to how , much a worker is paid for his/her work.
The average remuneration per worker (the wage level or salary level) is the average that is paid for labour in a particular industry or in a country's economy.
The average remuneration per worker and the labour productivity level impact on the prices of goods and services. lf the real wage and salary levels increase more than the level of labour productivity, the prices of goods and services will rise, causing inflation.
Interest rates
The monetary policy is the approach taken by a country's central bank (or other monetary authority) to influence spending in an , economy by influencing the interest rates and the money supply
The monetary conditions of an economy refer to the result that the monetary policy has had on the economy.
Therefore, monetary-condition indicators show how easy or difficult it is to borrow money.
Monetary-condition indicators include:
- the repo rate
- the M3 money supply
The interest rate is the rate at which interest must be paid by borrowers for the use of money that they borrow from a lender.
The repo rate (repurchase rate) is the interest rate at which commercial banks can borrow rands from the South African Reserve Bank (SARB).
The average interest rate that commercial banks charge customers is called the prime lending rate.
The SARB primarily uses the repo rate to influence interest rates, and therefore spending in the South African economy, and in this way attempts to keep the inflation rate between 3% and 6%.
If the repo rate, the prime lending rate and other interest rates are high, then monetary conditions are tight, which could lead to a downswing in the economy and decreased inflation. If they are low, monetary conditions are easy, which could lead to an upswing in the economy and increased inflation. Therefore the repo rate, the prime lending rate and other interest rates indicate what is likely to happen in terms of economic activity (production and spending) in a country. (This affects economic growth, business cycles and inflation.)
Money supply
A countny's money supply (M3 money supply) consists of its stock of currency and the deposits that its dornestic private sector have with its financial institutions.
The money supply can be dlvided into three categories that exist one inside another:
- M1 which consists of: notes; coins; and demand deposits that the clomestic Private sector has with banks.
- M2 which consists of: notes; coins; and demand, short-terrn and medium-term deposits that the domestic private sector has with banks.
- M3 whlch consists of: notes; coins; and demand, short-term, medium-term and long-term deposits that the domestic private sector has with banks.
An increase in the money supply will lead to an increase in the demand for goods and services, which will then lead to an increase in the general prices of goods and services - which we call inflation. An increase in the supply of money indicates that there will probably be an upswing in the economy, and a decrease in the money supply indicates that there will probably be a downswing in the economy.
SOCIAL INDICATORS
Social indicators
are statistics that measure one or more ,aspects of a society, and which can be used as tools to give information about the well-being of the people in that society.
Some of the social indicators available fall into the following categories:
- demographics
- nutrition
- health
- education
- services
- housing and urbanisation
Demographics
Demographics (demographic indicators) are the statistics regarding a population's characteristics.
For example, if the appropriate demographic data has been collected, statistics can be given regarding the size of a country's population and the average life span,of people living in that country.
The government of South Africa uses these statistics for policy development and the implementation of social programmes.
Demographic indicators include:
-
population growth
life expectancy
The population of a region or a country is the nurnber of people living there.
Population growth indicates the rate at which a country's poputation is growing.
Life expectancy expresses the average number of years that new-born babies are likely to live for under the existing conditions in a region or country.
Nutrition
A country's levels of nutrition and health are a direct indication of the quality of life of that country's population, as well as affecting the quality of the labour force.
Nutrition is the process of a person's body , OettinS tfe food necessary for health and growth,
Nutrition indicators include:
- malnutrition
- obesity
Malnutrition occurs when a person does not get enough food, or the food is lacking in important nutrients or even 1f a person consumes too much food.
However, when most people use the term'malnutrition'they are referring to under-nutrition or protein-energy malnutrition (PEM).
To measure PEM, a person's body weight is compared to an ideal for a person of that age, sex and/or height. However, physical signs also need to be taken into account as people of normal weight, or people who are overweight, can still be suffering from deficiencies in particular nutrients.
Obesity is when a person puts on so much fat that this could have a negative effect on that person's health and it leads to a decreased life expectancy.
Health
Health is the state of complete well-being, where a person functions optimally and is free from illness or injury.
Health indicators include:
- infant mortality
- under-five mortality
- spending on health
- access to clean water
- access to sanitation
Infant mortality refers to the death of babies before the age of one year.
Infant mortality is often connected to a low birth weight, which can be caused by a pregnant mother's malnutrition, stress, or by her smoking, alcohol or drug abuse. The infant mortality rate is normally given as the number of deaths per 1 000 live births.
Under-five mortality (children mortality) refers to the death of babies or children before the age of five years.
Under-five mortality is often connected to malnutrition, diarrhoea, measles, malaria and respiratory infections.
The under-five mortality rate is normally given as the number of deaths per 1 000 live births.
Health expenditure is the amount that the state and the private sector spend on health.
Access to clean water means that people have safe drinking water coming out of taps in their houses or yards, or have access to a communal source of safe drinking water.
Access to sanitation means that people have access to toilets, pit latrines or similar improved sanitation facilities that keep r €XC[erTrent away from other humans, animals and insects.
Education
Education is one of the key instruments for reducing poverty and inequality in a country. lt has a direct influence on the quality of a country's labour force. This influences the level of income, and, in the long run, the standard of living. A better-educated population contributes to higher levels of productivity and improved competitiveness, and increases the wealth of a country.
Education indicators include:
- the percentage of public expenditure on education
- the secondary enrolment percentage
The percentage of public sector expenditure on education is the percentage of the national budget that the government spends on schools, education administration and related areas.
The secondary enrolment percentage is the total number of people enrolled in secondary education, regardless of age, expressed as a percentage of the population of official secondary education age.
Services
Particular services are necessary for a country's people to achieve a certain standard of living in a country.
These services include:
- access to electricity (delivered by the public sector)
- access to refuse removal (delivered by the public sector)
- access to clean water (which is discussed on page 156 as a health indicator)
- access to sanitation (which is discussed on page 156 as a health indicator)
Access to electricity is measured as the percentage of the population whose homes are connected to the main electricity supply.
Housing and urbanisation
Housing refers to houses, apartments . and other shelters in which people live.
Housing is at the forefront of the national agenda for delivery, and the government of South Africa is taking overall responsibility for providing houses to all citizens. The government's goal is to create sustainable housing developments in all areas whereby people own their own properties. The National Housing Subsidy Programme aims to stimulate both rural and urban development.
Housing indicators include:
- the number of houses completed
- the percentage of households that live in a formal dwelling
Urbanisation refers to the increase in people living in cities or towns instead of in the countryside.
Urbanisation happens because of:
- the migration of peopte from ruralto urban areas
- the natural growth of the urban population
- the founding of new towns
As people move from rural to urban areas (generally to find work) the government has to plan for the changing population levels in different areas.
Urbanisation indicators include:
- the rate of urbanisation
- the percentage of the population living in urban areas
Globalisation has allowed knowledge to be collected from all over the world.
Economic and social performance indicators allow us to compare countries' economic and social development against that of other countries.
International benchmarking is the process of examining how a country is performing in a specific aspect by using a specific indicator, and by comparing this to how other countries are performing regarding ' the same aspect, expressed using the same indicator.
The World Bank is an international financial institution that provides loans to developing countries for investments in infrastructure and other , development programmes that will l reduce poverty.
The World Bank also provides free information on how countries are performing based on particular economic and social indicators. (See: http://data.worldbank.org. ) South Africa is classified as an upper middle income country.
We can use such indicators to compare South Africa to any country that is measured using the same indicators, and to international averages. However, when evaluating South Africa's development performance it is more fair and useful to compare it to developing countries facing similar challenges.
For example, we can compare South Africa to:
- other countries in the same part of the world
- other countries who are part of BRICS
- other countries with a similar GNI per capita
- low income countries
- lower middle income countries
- upper middle income countries
- high income countries
The World Bank divides countries into four categories based on their GNI per capita income. [t uses the following categories: .
When the Wortd Bank gives an economic or social indicator for a country, it often also provides the average for that indicator for all the countries that fall into the same income category. This allows us to compare a country's performance regarding a particular aspect with the average of the other countries in the same category.
For example, the World Bank reports that in 2011 life expectancy was 55,3 years in South Africa, and that in the same year in other upper middle income countries it was 74 years.
Economic and social indicators are tools that allow a country to identify what it is doing well, and where it needs to focus more attention. By looking at these indicators in the context of international benchmarks a country can develop an even better sense of its performance in particular areas, and can identify countries that it can learn from.
USING EGONOMIC AND SOGIAL INDICATORS IN APPLICATIONS FOR FINANCIAL AID
The International Monetary Fund (lMF) is an international organisation that encourages international trade, global monetary co-operation, and sustainable economic growth, and also tries to reduce poverty.
The United Nations (UN) is an international organisation of member states that tries to maintain peace, protect human rights, encourage social and economic development, and provide aid when there are disasters.
To get financial aid and support from international organisations, countries must compile their economic and social indicators according to these international standards. South Africa's annual budget review is compiled in terms of the GFS specifications, and the SARB compiles the data for its Quarferly Bulletin in terms of SNA specifications. By co-operating with the systems set up by these powerful international organisations South Africa becomes eligible to apply for financial aid from them, as well as from the World Bank.
Investment banks can also use these economic and social indicators when they forecast what returns they could earn if they invested their capital in a particular country.
Inflation is a continuous increase in the general price level of a variety of goods and services in an economy over a period of time.
This definition has two important elements:
- Firstly, the price increases must be ongoing, and not a once-off increase.
- Secondly, the price increases must be across all goods and services, and must not be limited to individual products.
CHARACTERISTICS OF INFLATION
There are two important characteristics of inflation:
- Firstly, it reflects a reduction in the buying power of a country's money.
- Secondly, it creates its own momentum in what is referred to as a wage-price spiral. (lncreased wages lead to price rises because products become more expensive to produce when wages go up. These price rises then lead to workers demanding increased wages because workers need to earn more to meet their cost of living. And so it goes on ...)
The inflation rate shows the average rate of change of the general price.level during one year (or other specified period of time).
The consumer price index (CPl) measures the change in the price level of a representative selection of consumer goods and services bought by households in a pa(icular country or region over a particular period of time.
When the CPI is calculated, each category of expenditure makes up a fraction of the total amount. Those categories on which the average consumer spends a lot of money (such as housing) contribute to a larger fraction of the CPl. Those categories on which the average consumer spends less money (such as clothing) contribute to a smaller fraction of the CPL By weighting the various goods and services in this way the CPI is made to represent how the average person's spending is distributed over the various categories, When the costs of a category increase, the effect on the CPI will be in proportion to how big a part of the CPI that category is.
The inflation rate is calculated based on the CPl, and the inflation rate is therefore often called the'CPl inflation rate'.
The economists who calculate the CPI choose one year as the base year, and the CPI in this year is set as 100. lf the total price of the CPI's representative selection of consumer products rises in the years that follow, then the CPI number will rise accordingly.
We can calculate the inflation rate using the following equation:
CPI inftation rate = CPIyear 2-CPIyear 1 / CPIyear 1 x 100
If you are not given the CPI for two consecutive years but are instead given the CPI for a particular month, and the CPI for the same month in the previous year, the above equation can be adapted as follows in order to calculate the inflation rate
CPI inflation rate = CPI for month in Year 2 - CPI for month in Year 1 / CPI for month in Year 1 x 100
An alternative equation for calculating the inflation rate is:
CPI inflation rate = CPI for a particular month in a particular year / CPI for the same month in the next year x 100
As well as the consumer price index, the producer price index is a way that inflation is measured.
The producer price index (PPI) measures the average change in prices of domestically produced goods when they leave the factory, while also taking into account the prices of imported goods, and it measures this for a particular country over a particular period of time.
Inflation rates can provide useful comparisons. The comparisons are used in the following ways:
- The SARB's Monetary Policy Committee (MPC) compares month-on-month inflation rates to make decisions regarding the repo rate.
- The SARB compares year-on-year inflation rates to see the inflationary trend in the country, and then uses this information to make policy decisions on how to control inflation.
- Global investors compare countries' inflation rates when deciding which countries to invest in. lnvestors are attracted to countries that have stable inflation,
Developed nations tend to have lower inflation. Although consumption and credit is high, the production capacity in the UK, USA and Europe is high enough to keep prices under control. Emerging markets such as South Africa, Argentina, Brazil and lndia have higher rates of inflation. This is because consumption is high and growth is coming off a lower base, so production capacity struggles to keep up.
A number of terms exist to describe particular kinds of inflation.
Sometimes the terms used to describe types of inflation are connected to the causes of the inflation, as in the case of demand-pull inflation and cost-push inflation. These are the most important type of inflation to understand.
DEMAND-PULL INFLATION
Aggregate demand (AD) is the total demand for all goods and services within the economy. (lt refers to what ' all the consumers are willing and able to buy over a given period of time.)
Aggregate supply (AS) is the total supply of all goods and services within the economy. (lt refers to what all the producers are willing and able to offer over a given period of time.)
Demand-pull inflation
You know that:
E = C + l + G + (X - M)
This shows that the aggregate expenditure occurring in an economy comes from:
- consumer spending by households
- investment spending by businesses
- government spending
- spending by foreigners on South African goods
- spending by South Africans on foreign goods
When these variables cause an increase in aggregate expenditure that is not met by an increase in production, prices rise, and demand-pull inflation occurs
Therefore demand-pull inflation can be caused by:
- increase in household consumption
- decline in saving
- tax reduction
- access to credit
- investors expenditure
- government expenditu re
- export services
The monetarists' explanation of inflation
Monetarists are economists who believe that an economy's inflation rate and economic performance can be controlled through the money supply.
Milton Friedman, the most famous monetarist, argued that inflation was caused solely by an increase in the money supply. Friedman maintained that the money supply was exogenously influenced by the monetary authorities (the central bank). According to him, the real rate of growth was not influenced by changes in the quantity of money, but rather solely by changes in real factors such as labour and land.
The speed with which the money moves around the economy (velocity) is also a determining factor in monetarist inflationary theory. With this in mind, the monetarists explained that the growth in money supply, together with the velocity of money, determined price levels - and did this independently of output.
For example, if real growth in output was 5% and the money supply grew by 20%, then inflation would be calculated as follows: 20% - 5% = 15%
The graph below illustrates demand-pull inflation. lt shows how increases in aggregate demand affect the general price level: as the aggregate demand curve shifts to the right the price level goes up. This graph also shows how increases in aggregate demand affect real GDP (total output.
COST-PUSH INFLATION
Cost-push inflation occurs when the , prices of goods and services rise because , the prlces of productlon factols increase,
When cost-push inflation occurs prices rise and output decreases.
Cost-push inflation can be caused by:
- an increase in wages and salaries (often brought about through the power of trade unions)
- an increase in the cost of key inputs
- an increase in the price of foreign exchange (which can push up the cost of imported inputs and capital goods)
- an increase in businesses' profit margins (what the entrepreneur wants to earn)
- a reduction in labour productivity
- natural disasters (which cause scarcity of essential items and inputs)
Inflation decreases the value of money and leads to higher interest rates.
DEBTORS AND CREDITORS
A debtor is someone who owes money to a creditor.
If a debtor borrows money when it is worth a lot, and pays it back when it is worth less, together with interest that does not cover the rate of inflation, then that debtor will have benefited from the high rate of inflation.
A creditor is a person or organisation that lends money for a period, after which it must be paid back.
If inflation erodes the value of the currency more than expected, a creditor (such as a bank) will lose out financially. Unless the interest charged is enough to cover the cost of inflation, it will receive less money in real terms at the end of the loan period than it initially lent out.
WAGE AND SALARY EARNERS
As prices rise, wage and salary earners are able to buy less with their income (unless their incomes rise to keep up with inflation). Low-income households are affected the most by inflation, because they spend a larger percentage of their income on necessities. As the prices of these necessities rise, low-income households may struggle to buy everything they need.
INVESTORS AND SAVERS
Inflation deters investors. High interest rates make it expensive for foreign investors to invest, and the building of factories and installation of machinery require loans from domestic banks. For this low interest rates are required. Local investors who are looking to produce goods for export will also be wary of investing in the face of high inflation, as it will make the price of goods uncompetitive in comparison to countries with low inflation.
Inflation erodes the value of savings, and is therefore to the disadvantage of savers. ln particular, inflation makes pensioners, who are on fixed incomes, very vulnerable to rising prices. This is because a pensioner's annual income does not adjust in the same way as the income of a salaried earner.
TAX PAYERS
Inflation leads to increases in salaries and wages, which increases tax revenue. However, as the poor struggle with the higher cost of living, the state will be required to increase welfare payments, which makes it possible that taxes will be increased in the future. This would affect tax-payers negatively.
INDUSTRIAL PEACE
As people see the inflation rate rising, they want to be paid more. Trade unions will put increasing pressure on employers to raise wages and salaries in line with or above inflation. lf these demands are not met, this will lead to unrest among the workers.
BUSINESSES
As production costs rise, businesses have to raise their prices, have their profit margins eroded, or find new ways of competing so that they do not lose market share. lnflation makes it particularly difficult to compete in foreign markets.
THE CURRENT ACCOUNT OF THE BALANCE OF PAYMENTS
High inflation leads to the prices of domestic goods being high compared to those of other countries that are not experiencing high inflation. This makes domestic goods uncompetitive on foreign markets, which results in decreased exports. lmports will also seem relatively cheaper to local residents, so imports will increase. The combined effect of decreased exports and increased imports will lead to a current account deficit.
THE GOVERNMENT
As a buyer of goods and services, the state also experiences a loss of buying power when inflation occurs. As welfare claims increase in the face of rising prices, the state will increase spending on welfare grants. However, if wages, salaries and business profits rise, then the state will also benefit from increased taxes.
The government is also responsible for targeting inflation in order to keep it under control.
An inflation-targeting policy is put in place by a central bank that is committed to making the country's inflation rate stay within a particular range.
High inflation tends to dampen people's expectations of the future. lt can have a contractionary effect on spending as people anticipate tough times ahead and spend less and save more, but it can also create expectations of higher wages.
Low inflation results in low salary increases. lt also restricts the degree to which businesses can increase prices, and thus affects overall profits.
If deflation occurs, this means the prices of goods are falling. This makes it difficult for businesses to survive.
The late 1980s were a politically turbulent time in South Africa. The rand fell, and the price of imports rose. Government spending was also exceedingly high. This fuelled inflation.
The inflation rate then fell in the 1990s as South Africa became a democracy. The SARB's Monetary Policy Committee (MPC) set an inflation target of 3% - 6%, which has largely been achieved.
But the SARB has to be very watchful because a number of factors are contributing to inflation :
- the demands of trade unions contribute to demand-pull inflation
- South Africans' high propensity to consume contributes to demand-pull inflation
- oil prices contribute to cost-push inflation
- the weak exchange rate contributes to both demand-pull inflation (because of the high prices of imported finished goods) and cost-push inflation (because of the high prices of imported inputs and capital goods).
The inflation rate in South Africa between 1985 and 2013
As South Africa is a developing country, it is natural that it will experience higher levels of inflation than developed countries as consumer spending and investment spending rise. ln addition, most economists do not see mild inflation as a bad thing.
However, if South Africa has a high inflation rate it makes it harder for South African businesses to compete on global markets, as their products will increase in price more quickly than those of their foreign competitors.
Demand-pull inflation can also be reduced by fiscal policy that reduces the money supply. To achieve this the National Treasury can:
- increase taxes
- decrease government expend iture
MEASURES TO COMBAT COST-PUSH INFLATION
Cost-push inflation can be reduced by the government using the following:
- increasing productivity (through skills development and the support of technological developments)
- protecting competition (through the Competition Commission)
The state can also reduce energy prices through long-term planning, and limit wage increases through guidelines or compulsory policies.
Because high prices and decreased national output are combined in situations of cost-push inflation, it is difficult to combat cost-push inflation using monetary measures. The SARB's main tool for controlling inflation is the repo rate, but in cases of cost-push inflation, raising the repo rate is likely to cause an even greater decrease in national output, which would be very undesirable as it would increase unemployment and poverty.
Therefore a combination of demand-side and supply-side policies is needed to ensure low inflation and stable growth (increased output.
TYPES OF TOURISM
Tourism is the practice of people visiting places outslde their usual environment for less than a year.
The tourism industry encompasses a wide range of goods and services, and so includes a wide range of businesses (such as travel agencies, airlines, restaurants and hotels.
Tourists can be divided into three categories:
- tourists travelling for leisure and recreation
- tourists travelling for business
- tourists travelling for other purposes (such as study and medical treatment)
For a person to be categorised as a tourist, helshe needs to stay overnight at the destination for at least one night, but not more than a year.
If the person stays for only a day he/she is called a same-day visitor.
If the person stays for longer than a year he/she is a resident.
WAYS TO MEASURE TOURISM
Foreign tourists are people who visit another country (ralhel than just stopping over on their way somewhere else).
It is easy to measure the number of foreign tourists because they need to pass through a border post.
Domestic tourists are tourists who are visiting another place r in their own country that is a significant distance from their normal ptace of residence (at least 160km away).
REASONS FOR THE GROWTH OF TOURISM
International tourism has grown because of the following reasons:
- the development of jet aircrafts
- the establishment of low-cost airlines
- the development of package holidays
- increased efficiency from new technology for making bookings
- the more efficient process of getting foreign exchange
Domestic tourism has grown because of:
- the increase in leisure time
- the increase in consumers'disposable income
- the increase in car ownership
- improved accommodation facilities
- the increased marketing of tourism products
THE EFFECTS OF TOURISM
Tourism has both positive and negative effects on a country.
THE EFFECTS OF TOURISM ON A COUNTRY'S GDP
Tourism increases a country's GDP through both its direct and indirect contributions. The direct contributions are made by:
- tourists when they spend money on goods and services
The indirect contributions are made by:
- businesses in the tourist industry, when they pay for intermediate inputs and invest in facilities
- the employees in the tourist industry, when they spend their disposable income
- the government, when it spends money on infrastructure to facilitate tourism
THE EFFECTS OF TOURISM ON EMPLOYMENT
Tourism increases employment. Because the tourism industry is generally labour-intensive its growth can have a substantial effect on the employment rate of a country.
THE EFFECTS OF TOURISM ON POVERTY
Tourism reduces poverty by increasing income and reducing unemployment.
Tourism is also one of the industries that benefits rural people, because many tourist attractions are in the countryside. By starting up tourist businesses in rural areas, or by getting jobs in these businesses, rural people can avoid having to look for work in urban areas.
However, tourism can cause inflation, which could make goods and services less affordable to locals.
It can also cause an increase in the prices of specific goods and services, or put a price on what had been free before, For example, areas that were once free to walk in, and rivers and bays that were once free to swim in, could now become part of national parks that charge an entrance fee.
THE EXTERNALITIES OF THE TOURISM SECTOR
Externalities are the side effects of production and consumption activities that have an impact on people who not were involved in these activities.
Tourism can have positive externalities and negative externalities.
Positive externalities are the side effects of production and consumption activities that have a good effect on people who , were not involved in these activities,
An example of a positive externality of domestic tourism is the improved road system in rural areas popular with tourists. Thls benefits everyone who uses the roads, not just the tourists and the tourist industry.
An example of a positive externality of foreign tourism is the inflow of foreign exchange. The improvement in the country's BOP benefits everyone in the country.
Negative externalities are the side effects of production and consumption activities that have a bad effect on people who were not involved in these activities.
An example of a negative externality of domestic tourism is the air pollution caused by car exhausts. This decreases the air quality for everyone in the area, and contributes to global warming.
An example of a negative externality of foreign tourism is the inflation caused by foreigners spending money. This increases prices for everyone in the country.
THE EFFECTS OF TOURISM ON THE ENVIRONMENT
Tourism can have both a positive and a negative impact on the environment.
Its direct impact is generally negative, as the passage of people and cars through the naturalworld cause the partial destruction of that world. ln particular, the air pollution caused by jet aircraft is a significant contributor to global warming.
Tourism's indirect impact can, however, be positive. The financial benefits of tourism encourage the government to see the environment as a resource that requires conservation. This leads to laws being made to protect it, and the establishment of national parks.
The revenue from tourism can be used to maintain fragile areas and develop them in ways that will minimise the impact of visitors. For example, boardwalks above wetlands and dune habitats allow many tourists to pass through these areas with little damage being done.
THE EFFECTS OF TOURISM ON INVESTMENT
Tourism leads to increased demand, which makes businesses more willing to invest in capital goods and labour.
The potential benefits of tourism also encourage government expenditure on infrastructure, as this is seen as investment that will bring returns.
Sometimes the private sector is brought on board to help create this infrastructure.
A public private partnership (PPP) is where a venture is funded and I operated by government together with one or more business.
THE BENEFITS OF TOURISM
Tourism is one of the biggest income-producing industries in South Africa, and it brings benefits to households, businesses and the state - and is particularly useful in the area of infrastructure development.
Tourism benefits households by:
- creating job opportunities
- encouraging rural development
- encouraging skills development
- leading to new infrastructure
Tourism benefits businesses by:
- providing opportunities for entrepreneurs to start business ventures
- allowing existing businesses to improve the quality and variety of their products
- facilitating increased sales, because of the increase in demand
- allowing perfect competitors to increase their profits
- allowing natural monopolies, such as the Table Mountain Aerial Cableway, to achieve abnormal profits
Tourism benefits the state by:
- bringing in foreign exchange
- bringing in extra tax revenue (including tax revenue from businesses earning abnormal profits)
- stimulating the economy
- reducing unemployment in a way that requires comparatively little government expenditure
- stimulating infrastructure developement
SOUTH AFRICA'S TOURISM PROFILE
In 2011,760/o of South Africa's tourists were domestic tourists, and 24o/o were foreign tourists.
AIM WITH VISITS
In 2012 a total of 9 1BB 368 foreign tourists came to South Africa.
Of these foreign tourists, most came from other African countries and Europe. While those coming from other African countries form the biggest group of foreign tourists, those coming from Europe spend the most money overall.
The main aim of their visits are summarised in the following pie diagram.
LOCAL DESTINATIONS
The Western Cape continues to be the top tourist destination regarding leisure and attractions in South Africa. Gauteng is seen as the economic heart of Southern Africa, and is a favoured destination for business and shopping.
The following graph indicates which of South Africa's provinces receive the most tourists.
SOUTH AFRICA'S DOMESTIC TOURISTS
In 2011 a total of 26,4 million trips were taken by domestic tourists in South Africa.
The National Department of Tourism aims to grow domestic trips to 54 million by 2020 and ensure that domestic tourism makes up 60% of tourism's Overall GDP contribution, according to the National Tourism Sector Strategy.
Visiting friends and relatives is the main reason for domestic tourists undertaking a trip in South Africa, and the second reason that most domestic tourists travel is for holidays and leisure.
SOUTH AFRIGA'S INDIGENOUS KNOWLEDGE
UNESCO World Heritage Sites are places listed by the United Natrons i Educational, Scientific and Cultural : Organisation (UNESCO) as having special cultural or physical significance.
People who have lived in an environment for generations have an understanding about how to survive and thrive in that , environment that is referred to as indigenous knowledge
An indigenous knowledge system (IKS) is a set of cultural information and traditionaf skills that has developed around a specific community.
The South African government has created policies to protect, develop and promote indigenous knowledge systems in areas such as:
- building and construction
- medicine and wellness
- arts and crafts
- food and drink
This attracts tourists as well as protecting the traditions of local people. Many tourists want to understand the traditional cultures of the country they are visiting, and exposure to indigenous knowledge systems helps them achieve this. By protecting and celebrating South Africa's indigenous knowledge systems, the government helps South Africa to be seen as a unique destination.
Attractions that incorporate indigenous knowledge systems include:
- World Heritage Sites, such as Robben lsland, the Fossil Hominid Sites of South Africa, iSimangaliso Wetland Park and Mapungubwe Cultural Landscape
- Arts festivals, such as the National Arts Festival in Grahamstown
- Cultural villages like the Basotho Cultural Village in QwaQwa
- Cultural tours, such as those of Soweto
Cultural tours that are built around indigenous knowledge can be developed inexpensively and bring great benefits to poor communities.
Tourism is seen as a source of economic growth for developing countries.
Tourism policies are largely created and implemented by the Department of Tourism.
The Department of Tourism aims to grow and develop tourism in South Africa by increasing information, innovation, collaboration and capacity.
The Department of Tourism is headed by Minister of Tourism, Derek Hanekom. lt led the creation of the National Tourism Sector Strategy and the Tourism Bill.
The National Tourism Sector Strategy (NTSS) aims to speed up the growth of the tourism sector in a responsible way between 2010 and 2020"
The objectives of the NTSS include the following:
- to grow the tourism sector's absolute contribution to the economy
- to provide excellent people development and decent work within the tourism sector
- to deliver a world-class visitor experience
The Tourism Bill of 2012 aims to create an enabling environment for . the development of tourism that will benefit all South Africans, and to , create enforceable rules that will lead to susfainable tourism.
As with other industries, incentives have also been established to encourage the growth of the tourism industry.
The Tourism Support Programme (TSP) is a cash grant that aims to support the development of tourism enterprises that will stimulate job creatfon and increase the geographfc spread of tourism investment.
Suggestions about how to grow and develop tourism in South Africa are often made. Some of the key suggestions are:
- market South Africa effectively as a tourist destination
- improve the infrastructure
- improve education and training
- improve environmental management
- improve safety and medical support
MARKETING SOUTH AFRICA EFFEGTIVELY AS A TOURIST DESTINATION
South African Tourism (SAT) is a state-ownecl enterprise that markets South Africa as a tourist destination to both domestic and international tourists.
SAT aims to:
- increase the number of tourists coming to South Africa, and how long they stay and how much they spend
- improve the geographic distribution of where these tourists go
- increase the number of tourists coming during the industry's off-peak season
- help disadvantaged South Africans benefit from the sector
SAT has offices in Australia, China, France, Germany, lndia, ltaly, Japan, the Netherlands, the United Kingdom, the United States and Nigefia. The Nigerian office was opened in the city of Lagos in 2014" and it illustrates the increased focus on marketing South Africa as a tour\st destination to other African countries.
Applying the 4 Ps of marketing to South African tourism
In marketing there are four important aspects, called the 4 Ps. When applied to tourism these can be explained as follows:
product: Products should be designed with the consumers in mind. Recreational tourism should meet people's desire to see new places and experience new cultures. Therefore the products should incorporate physical elements with a great experlence.
price: Prices need to be perceived as good value for money, and must be set with an awareness of what consumers can afford.
promotion: Advertising and tourism fairs such as lndaba are promotion activities.
place: In tourism, the product cannot be moved to the consumer, so the consumer must be transported to the product in an efficient and pleasurable way.
IMPROVING THE INFRASTRUCTURE
Good infrastructure, such as tarred roads, allows tourism to grow.
South Africa is continuously maintaining and upgrading all infrastructure, and also facilitates the funding of major tourism infrastructure.
IMPROVING EDUCATION AND TRAINING
When people have the appropriate skills the tourism industry can grow. The right skills also help the industry to be internationally competitive.
Therefore the Department of Tourism must work closely with the Department of Education and private institutions to provide effective education and training, and must ensure that this is available to all previously disadvantaged people.
The Department of Education offers Tourism as a matric subject.
The youth are also encouraged to become exposed to the industry through holiday jobs, and the industry is encouraged to offer such jobs.
IMPROVING ENVIRONMENTAL MANAGEMENT
The government has to set guidelines for environmental management so that tourism does not threaten South Africa's natural resources. lt therefore makes Iaws to protect the environment and implements these.
There are also incentives for businesses that are environmentally friendly.
IMPROVING SAFETY AND MEDIVAL SUPPORT
The government must implement strategies to reduce crime. It must also make sure that medical services are easily accessible in case of an accident.
The twentieth century saw a sustained increase in the world's population, and in people's wealth and average standard of living.
This has led to a situation where more people are putting increasing pressure on the world's limited resources. An increase in wealth is accompanied by an increase in the demand for products. This leads to an increase in businesses' demand for raw materials, and to increased industrial output. This results in increased pollution, deforestation, erosion and climate change.
POLLUTION
Pollution : refers to the contamination of soil, water or the , atmosphere by the discharge of harmful subslances
There are four main types of pollution:
- air pollution
- water pollution
- land pollution
- sound pollution
All of these forms of pollution impose external costs on society and are therefore examples of negative externalities.
Pollution can occur for many reasons, but the links with economic growth and development are very obvious. As output and consumption increase, so the following problems are exacerbated:
- Toxic chemicals and gases are released into the atmosphere or into rivers, streams and other natural environments.
- The demand for oil rises, sometimes resulting in oil spills from oil tankers which have catastrophic effects on marine life and coastal areas.
- More waste needs to be disposed of, and much of this material is not recycled and ends up in landfill sites. These sites displace fauna and flora, lead to the development of methane gas build-up, and possibly pollute groundwater.
- Increased air travel for business and leisure purposes leads to higher carbon dioxide (CO2) emissions, noise pollution on busy flight paths, and the expansion of airport hubs and runway developments that encroach on green belt land.
EROSION
Erosion is the process that occurs when wind and water move earth from one location to another.
Some erosion occurs naturally. However, human behaviour can also cause erosion. Expanding housing developments, expanding farming developments, mining activities and mining exploration, as well as extreme sports, can all cause erosion.
DEFORESTATION
Deforestation is the removal of trees so that the land that they were on can be used in a different way.
Population growth has led to people living in previously uninhabited areas, and to the increased conversion of forests into farmland. Between 6 and 7 million hectares of forests are lost each year as land is cleared for housing developments and farming.
CLIMATE CHANCE
Climate change is a long-term change in weather patterns.
Human activities are a significant cause of recent climate change. ln particular, gas emissions are affecting the Earth's atmosphere in such a way that more heat is being allowed into the atmosphere and being stored there. So far this has caused a slight rise in the surface temperature of the Earth about 0,80) between 1910 and 2010 lRmerica's Ctimate Choices, 2011).
Global warming is a clear and continuous increase in the Earth's average temperature.
CONSERVATION
Conservation is an approach that tries to maintain the natural world by limiting the amount of raw materials and energy sources that are removed from it.
Humans are becoming aware that they need to manage the Earth's resources in a sustainable way.
Oil reserves are expected to run out within 47 years if consumed at the same rate as today. However, the rate at which oil is used up can be decreased by using alternative energy sources, such as wind or solar energy, to meet some of mankind's total energy needs.
Changing consumption patterns can also place less pressure on resources. For example, humans can use public transport instead of driving.
PRESERVATION
Preservation is an approach that attempts to keep certain parts of the natural world untainted by humans.
Environmental sustainability refers to the potential to continue functioning in the same way regarding one's environment over the long term.
There is an increased awareness of the need to safeguard the environment so that production activities and the use of resources are possible for future generations.
MARKET RELATED POLIGIES IN RESPECT OF THE ENVIRONMENT
The private cost is the internal cost incurred by the business or consumer.
The external cost is the cost of any negative externalities.
The social cost includes both the private cost and the external cost connected to a product.
By itself, the market does not require businesses to pay for the external costs of production. Therefore in a completely free market businesses do not have to pay the full social cost of production.
The private benefit of consumption is the benefit to the consumer.
The external benefit is the value of any positive externalities.
The social benefit includes both the private benefit r and the external benefit connected to a product.
Consumers only consider the private benefit of a product, not the external benefit. Therefore in a completely free market the total social benefit is not internalised.
Consequently, in terms of environmental sustainability the market fails because it delivers too many negative externalities (pollution, deforestation, erosion, climate change) and not enough positive externalities (clean air and water, forests, sufficient topsoil, consistent weather patterns). ln such cases the market as a mechanism has failed.
The diagram below shows how the market can fail by ignoring negative externalities, such as pollution.
GOVERNMENT INTERVENTIONS
When the market fails to ensure environmental sustainability, then there is a need for government control and intervention.
The government can:
- create laws to control emissions
- charge for waste emitted into the environment
- issue marketable permits
- extend property rights
- levy environmental taxes
- pay environmental subsidies
- encourage businesses to enter into voluntary agreements
- educate people about environmental sustainability
LAWS TO CONTROL EMISSTONS
The command and control (CAC) approach sets legal limits on emissions and prosecutes businesses and individuals when these are not adhered to.
Laws and regulations can be set to limit the quantity of waste emitted into the environment.
In addition quality standards and social impact standards can be set for particular areas, and the local government must try to see that these are met.
Among others, the following laws have been passed in South Africa since democracy:
- the Environmental Laws Rationalisation Act, No. 43 of 1997
- the Mineral and Petroleum Resources Development Act, No. 28 of 2002
- the National Environmental Management: Air Quality Management Act, No. 39 of 2004
- the NationalVeld and Forest Fire Act, No. 101 of 1998
- the NationalWater Act, No. 36 of 1998
These laws create a framework within which businesses and individuals need to behave. Failure to do so can result in fines and/or jail terms.
Charges for emitting waste products into the environment
The government can charge households and businesses for the waste products that they need to get rid of. They can be charged for sanitation services, rubbish removal and the gases emitted by vehicles and industrial processes.
Marketable emission permits
In order to meet the goals of the Kyoto Protocol, governments have brought in a permit system to control the amount of a pollutant that a business may emiy. Permits are issued that give businesses the right to give off a specific volume of a specific pollutant. Businesses that reduce their emissions can sell their permits to businesses that still have high emissions. ln this way businesses that reduce their emissions can profit by the reductions that they have made.
Emissions trading refers to the trade that occurs in these emissions permits.
Property rights
Individuals are more likely to act efficiently and responsibly in managing their own resources.
For example, a home owner will not dig up his entire garden in the hope of finding a precious stone. However, mining companies might do so on public land if they are not expected to pay for the external costs of their mining (for example, the scarring of the landscape).
If a natural resource is not owned by an individual, it is unlikely to be looked after. However, if ownership is granted, then the owner can take action against people who damage that resource.
For example, water companies rely on dams, rivers and streams to provide fresh water to customers, which they then charge these customers for. lf rivers are polluted by private individuals, the water companies can be granted the right by law to sue these individuals for the cost of cleaning up the water sources.
Extending property rights is therefore an attempt to internalise negative externalities by allowing the owner to hold people accountable for any damage to that resource.
Environmental taxes
Paying for environmental subsidies
When a business is producing in an environmentally friendly way, it may be encouraged to produce more by being subsidised. A subsidy is the opposite of a tax in that it reduces the production costs and increases the number of units produced.
These subsidies will encourage other businesses in the industry to recycle material, dispose of waste legally, and invest in more efficient production methods.
Voluntary agreements
If the government convinces businesses to enter into agreements where they set their own emissions targets in an environmentally responsible way, this can result in these businesses choosing to go along with the government's environmental agenda.
Education
If people are educated regarding environmental sustainability they are likely to live and work in a way that upholds environmental principles.
For example, more people are choosing to recycle glass and other waste products.
INTERNATIONAL MEASURES
Government intervention will only achieve meaningful results if a broad-based and global approach is adopted.
The issues of concern are
:- sustaining biodiversity
- chemical waste
- hazardous waste
- climate change policy
- loss in indigenous knowledge
Sustaining biodiversity
Biodiversity is the variety of organlsms on Earth.
Largely because of the impact of humans, the extinction of species is increasing and biodiversity is decreasing. This means a natural asset is decreasing in a way that cannot be reversed.
It also means that the resources that scientists can draw on when making medicines and modifying plants are growing smaller.
International laws for the protection of biodiversity generally aim to protect threatened species and conserve ecosystems where threatened species exist:
- The 1992 Convention on Biological Diversity aims to prevent the unsustainable exploitation of species, among other things.
Chemical waste
Chemicrl waste the unwanted by-product that is produced when harmful chemicals are used in production.
When released into the environment, chemical waste can cause death, disability and infertility in humans, animals or plants.
International laws regarding chemical waste ban or reduce the use of certain chemicals:
Hazardous waste
Hazardous waste is waste that poses a significant threat to people or the environment because it is toxic, flammable, corrosive and/or reactive.
Hazardous waste should not be disposed of like ordinary waste, but can be stabilised, solidified and sealed in landfill sites or incinerated.
International laws regarding hazardous waste regulate how it can be disposed of, and in what circumstances it can be exported and imported between countries:
Climate-change policy
The present occurrence of global warming is a consequence of humans' gas , emissions, in particular the emission of chlorofluorocarbons, carbon dioxide , and methane.
Chlorofluorocarbons (CFCs) are chemical compounds made up of carbon, chlorine and fluorine.
CFCs have been produced for use in refrigeration system, aerosols and solvents. They damage the ozone layer so that more heat reaches the earch and sea through the atmosphere.
The ozone layer is the part of the Earth's atmosphere that absorbs most of the Sun's radition.
Carbon dioxide (CO2) is a chemical compound made up of carbon and oxygen.
Carbon dioxide occurs naturally in the atmosphere because humans and animals give it off when they breathe. But it is also given off by cars, planes, power plants and other things that use fossil fuels, and is therefore increasing in the atmosphere.
Trees and plants absorb carbon dioxide, but as deforestation is occurring, the trees and plant can absorb less and less of the carbon dioxide in the atmosphere.
Methane (CH4) is a chemical compound made up of carbon and hydrogen.
Cattle, sheep and goats emit methane because of how their digestive system works. As more of these livestock are farmed, more methane is emitted into the atmosphere
Carbon dioxide and methane are called greenhouse gases because they trap heat in the atmosphere.
Emissions of carbon dioxide and methane are together referred to as carbon emissions.
International laws regarding climate change concentrate on reducing emissions:
- The 198Q Vienna Gonvention for the Protection of the Ozone Layer is a treaty provides a framework for international efforts to protect the ozone layer.
- The 1987 Montreal Protocol on Substances that Deplete the Ozone Layer is an international treaty designed to stop the production of CFCs.
Loss in indigenous knowledge
People who have lived in an environment for generations have an understanding about how to survive and thrive in that environment that is referred to as indigenous knowledge.
When indigenous knowledge is applied in an environment to make a living, this is often done in a way that is environmentally sustainable.
When more modern, international methods are applied they can be more effective in the short term, yet may not be sustainable in the long term.
Managing the resources in an environment should therefore be done with an awareness of both indigenous knowledge and modern methods in an effort to achieve environmental sustainability.
LOCAL MEASURES
In 2009 South Africa received $500 million for its Clean Technology Fund lnvestment Plan (CTFIP), helping it to generate renewable energy and improve energy efficiency. The CTFIP is developing solar thermal power and wind power for public use.
South Africa is also providing rebates on solar water geysers that are installed in South African homes so that less energy is required from the national grid.
In response to UN initiatives, South Africa's Department of Environmental Affairs convened a Green Economy Strategy Summit in 2010 to explore moves towards a green economy. lt encouraged investments in both the public and private sectors so that they could be reconfigured in a green way.
South Africa is looking at new ways to generate clean energy and so reduce its dependency on coal. lt is implementing mitigation actions that aim to reduce emissions by 42% by 2025 relative to its current trend. However, this will need finance and technological support from the UN and developed countries.
South Africa's Long Term Mitigation Scenarios (LTMS) focus on accelerated energy efficiency across all sectors, support low-carbon technology research and development, and encourage behavioural change. Regulations are also being put in place to see that this new green vision is enforced.
A summit is a conference where heads of state meet to discuss specific issues.
There have been many international meetings and summits to decide on how to move forward on the issue of the environment.
An agreement is a negotiated arrangement between two or more parties, and is usually legally binding.
International co-operation is behind all the major international agreements that have been concluded since the 1970s.
A treaty or convention is a written agreement between countries.
A protocol is the first copy of a treaty or convention, or an addition to or an amendment of one.
THE UNITED NATIONS CONFERENCE ON ENVIRONMENT AND DEVELOPMENT / RIO DE JANEIRO SUMMIT
The United Nations Conference on Environment and Development (UNCED) was held in 1992 in Rio de Janeiro, Brazil. lt is often called the Rio de Ja.neiro Summit or Earth Summit 1992.
At this conference the United Nations Framework on Climate Change was negotiated and made available for signing.
This outlined the importance of global co-operation in fighting the increasing environmental deterioration.
In addition, the summit led to the adoption of two key documents:
- The Rio Declaration on Environment and Development balances people's right to economic development with their responsibilities to protect the environment. lt aims for greater inter-governmental co-operation to improve human-centred sustainable development.
- Agenda 21 deals with socio-economic issues as well as conservation. It aims to reduce poverty and improve human living conditions.
THE WORLD SUMMIT ON SUSTAINABLE DEVELOPMENT (WSSD) / JOHANNESBURG SUMMTT
The World Summit on Sustainable Development (WSSD) was held in Johannesburg, South Africa in 2002.|t is often also called the Johannesburg Summit.
This summit re-focused on sustainable development. lt agreed that globalisation was leading to increasing inequality and the carbon footprint of developed nations was the issue to be tackled. lt also undertook to create a platform whereby wealthy nations would assist developing nations to overcome HIV/AIDS and provide improved access to clean water and sanitation.
The summit led to the Johannesburg Declaration on Sustainable Development where parties agreed to focus on socio-economic conditions worldwide that pose severe threats to sustainable development. A broad plan was adopted to set targets on issues such as infant mortality and access to clean water.
THE UNITED NATIONS GONFERENGE ON SUSTAINABLE DEVELOPMENT (UNGSD) / RtO +2O SUMMTT
The United Nations Conference on Sustainable Development (UNCSD) was held in Rio de Janeiro, Brazil in 2012.lt is often called Rio +20 Summit because it was held 20 years after the United Nations Conference on Environment and Development, which had also been held in Rio de Janeiro.
This conference resulted in a non-binding document: The Future We Want. This document attempts to shape a sustainable future that lifts people out of poverty, advances social justice and protects the environment.
THE MILLENNIUM SUMMIT
In 2000 world leaders met at the Millennium Summit in New York in the United States of America to discuss the role of the United Nations.
They also ratified:
The United Nations Millennium Declaration with its eight Millennium Development Goals (MOD):
- 1. Eradicate extreme poverty and hunger.
- 2. Achieve universal primary education.
- 3. Promote gender equality and empower women.
- 4. Reduce child mortality.
- 5. lmprove maternal health.
- 6. Combat HIV/Aids, malaria and other diseases.
- 7. Ensure environmental sustainability.
- 8. Develop a global partnership for development.
THE UNITED NATIONS CLIMATE CHANGE CONFERENGE / THE 17TH CONFERENCE OF THE PARTIES
In 2011 the 17th Conference of the Parties (COP17) was held in Durban, South Africa. lt was also called the United Nations Climate Change Conference.
The aim of this conference was to find ways to reduce global temperature increases to below 2% between 2011 and 2100. However, the creation of a new treaty was deferred until 2015.
Nevertheless this conference saw the launch of :
The Green Climate Fund. This fund (which had been conceived of at COP16 in Cancun, Mexico in 2010) aims to raise $100 billion each year to help developing nations create environmental strategies.
ANNUAL CONFERENCES OF THE PARTIES
Since 1995, the Parties that have signed the UNFCCC have met every year at the Conferences of the Parties (COP). At these conferences the parties assess how much progress has been made in dealing with climate change.
In 1995 the Parties met in Berlin, Germany at the 1st Conference of the Parties (COP1) to outline specific targets on emissions.
In 1997 they met in Kyoto, Japan to establish emission-reduction targets for developed countries. The amendment to the UNFCCC made at the 3rd Conference of the Parties (COP3) in Kyoto was called the Kyoto Protocol.
The Kyoto Protocol addressed emission reductions, and it was ground-breaking because it insisted on a firm and non-voluntary commitment from signatories to reduce emissions by 5% per year.