While the influential economist Mike Schussler deserves praise for his informative infographics and graphs, I strongly disagree with his economic analysis. I am sure that Schussler is well meaning, and the following article is not an attack on him personally, but rather what I feel is a necessary and overdue response to the popular misconceptions that he promotes, and which largely go unchallenged.
In his June 2nd article in Moneyweb entitled “Inequality and poverty will not be fixed by spending” Schussler’s makes the argument that South Africa’s economic problems of inequality, poverty and unemployment are due to our state spending too much on the wages of public servants. He claims that if government does not reduce its spending on wages, and if it implements a Basic Income Grant (BIG), it will run out of money, and all our institutions will collapse, unless it raises taxes, which will reduce employment even further, and lead to capital flight. In this article I will explain why Schussler’s call to limit public sector spending on wages is counter-productive.
Schussler’s thesis is based on the popular, but mistaken assumption that government finances are limited to the amount it collects from taxation, SOE profit and bond sales. This is a false constraint. The state is monopoly issuer of Rands, and can thus spend as many Rands as it likes to into existence, and it makes sense for it to do so while there is insufficient demand, growth and employment, as long we can keep inflation low.
All national government spending is financed by SARB money creation through an overdraft facility on treasury’s exchequer account at the SARB. This spending by overdraft creates bank reserves and bank deposits (creating Rands), driving up private sector savings. Savings, when spent or invested onwards, drive up private sector production, sales, profits, incomes, employment, tax revenue and GDP growth. Sales, incomes and profit are all taxed, returning the Rands created by state spending back to the state within a few transactions, destroying those Rands previously spent by government. Until the Rands that government spends into existence are taxed back to the state (and destroyed), they just add to private sector savings.
For a more in depth explanation of how state spending (money creation) funds taxes and bond sales (money destruction) click here.
Current policy is to reduce the daily overdraft on government’s exchequer account to 0 at the end of each day by deducting Rands from government’s Tax and Loan accounts held at commercial banks (destroying bank deposits and reserves), but this does not have to be the case. The UK government’s extension on its overdraft facility on its ways and means account at the Bank of England last year is an example of what is possible, but extending the overdraft is just one way which the SARB can finance treasury. The SARB Act allows the SARB to issue loans to treasury and SOEs or the SARB can carry out QE to indirectly finance government “borrowing”. Prior to the appointment of primary dealers around the turn of this century, the SARB bought government bonds directly and sold them onwards. The SARB Act can be changed by parliament and it has been changed quite regularly.
While demand, employment and growth is too low, and inflation is cost pushed, if the SARB issues bank loans to treasury, municipalities or SOEs as the SARB Act says it can, that debt the state owes to itself (the SARB is an organ of state), can be rolled over indefinitely, at no cost. It only makes sense for government to run a surplus (tax more of the Rands that the state issues out of the private sector than it spends into it) when demand pull inflation is too high. SARB profit is paid to treasury, and the SARB creates Rands at almost 0 cost, so this arrangement costs the state nothing.
When you see it through this lens, as long as demand pulled inflation is low, there is no reason for government to limit its investment in productive employment, which increases the supply of energy, goods and services, and doing so increases the supply of Rands to the private sector, who can use those Rands to create more employment by spending or productively investing (increasing the tax base and tax payments), paying off its debt, or saving.
Schussler claims that government spending dis-incentivises productive investment by driving up taxes and interest rates. But that is only true if government chooses to remove an amount equal to its spending, from the private sector, using taxation and bond sales.
As explained above, SARB funded govt spending increases private liquid savings. Savings fund investment. A more liquid private sector, with lower debt and more flush with savings to spend or invest, is not a deterrent to investment. Quite the opposite!
If government directs its money creating spending towards paying its citizens to build infrastructure, teach, nurse, police etc, that brings down private sector costs (transportation, education, healthcare etc cost the private sector less). Lower costs and higher demand for product encourages productive investment.
Schussler bases his claims that South Africa’s public sector is bloated on our relatively high public wages to GDP ratio. What he neglects to take into account is the fact that a nation with extreme unemployment and inequality must have a higher than normal public wages to GDP ratio. This is because (a) the country is running so far below full capacity (GDP would be much higher if more people and resources were employed), and (b) a much higher percentage of our population is almost totally dependent on the state (requiring more public servants per capita).
South Africa’s public sector is not bloated. The state employs only around 3,5 public servants per 100 citizens, around half the amount of state employees per capita in the USA, even though a much larger percentage of our population depends almost entirely on the state, due to our higher unemployment, poverty and inequality.
Our problems of unemployment, inequality and poverty are not caused by the state spending too many of the Rands it creates into the private sector, but rather by the fact that the state is not spending enough employment creating Rands into the private sector and is taxing too many Rands out of the private sector. It is doing this because economists like Schussler have convinced us that government shouldn’t spend more than it earns in taxes, and when it does, that it should make up the shortfall by borrowing the Rands it issues only from private sector middlemen at inflated interest rates.
Most of our economists don’t understand that state spending creates new money and that the money that govt extracts from the private sector using taxation and bond sales is destroyed. They apparently still believe that the state spends “taxpayers money”, and therefor needs to tax before it can spend.
We must educate these economists so that they stop placing false constraints on public spending, and so the state can stop taxing us too much and for the wrong reasons. Governments don’t spend taxes. Taxes are essential and useful, but only to remove money from the private sector in order to control inflation and inequality, to strengthen the Rand, and to discourage unwanted behaviour. For more on optimising tax policy click here.
We can lower taxes and increase public spending as long as demand, employment and growth is too low and inflation is mild and not driven by local demand pull. Currently prices in SA are being driven higher mostly by international demand, supply constraints and administered prices. Higher taxes and interest rates just add to these cost push factors, and reduce already insufficient demand even further. Public spending financed by low interest loans from the SARB, instead of by taxes and bond sales at higher interest, increase demand, employment & growth without adding to cost push. Lower production costs and higher demand incentivise productive investment.
High interest payments by the state and SOEs, are currently major drivers of high taxes and increasing SOE tariffs. Interest, tax and SOE tariffs (such as Eskom electricity tariffs) add to private sector costs. The SARB, as monopoly issuer of the Rand at near 0 cost to itself, has full control over the interest rate that both the private sector and the public sector pay on Rands.
As the SARB cannot issue forex, the only interest rate that the state pays that the SARB does not have control over is the rate it pays to attract forex to make up for any balance of payments shortfall (the difference in South African forex earnings from exporting goods, services and investment and forex spending on importing goods, services and investment). But the balance of payments shortfall does not equal the government budget deficit.
For example, in the year 2020-21, South Africa’s government budget deficit amounted to R552 billion, while in the same year, there was no balance of payments shortfall. South Africa achieved a current account surplus of R108 billion in 2020 which means that SA was a net lender to the rest of the world. It makes absolutely no sense for government to have financed the R552 billion budget deficit of 2020-21 at the higher rate needed to attract forex, when the SARB could have loaned the Rands needed to fund treasury’s budget deficit at the repo rate. To protect SARB’s policy rate, any excess bank reserves (created from the resultant government spending) could be sterilised by issuing SARB debentures or govt bonds to the South African private sector at slightly higher than repo.
When Schussler points to high capital costs as a reason for government not to deficit spend more Rands into our private sector, he is perpetuating the fallacy that the market decides the interest rates (bond yields) that our state pays to private sector middlemen for the Rands that the state issues. That is incorrect. The SARB (the organ of state that is monopoly issuer of Rands) decides the rate which the state and commercial banks pay to borrow Rands.
The market only appears to decide the interest rate government and SOEs pay on Rand denominated public debt, because our policy choice is for SARB not to issue loans to treasury directly, or to buy government bonds on the market (QE). This policy choice means that government increases inequality by transferring hundreds of billions of Rands per year in unnecessarily high interest payments to bond holders, who are already net savers, while extracting that amount from tax payers (a large portion of whom are poor and in debt). MMT pioneer Warren Mosler calls interest payments “basic income grants to people who already have money”, and he has a point.
South Africa has a large amount of corporate savings and pension funds that are either tied up in non-productive financial investments, or invested overseas. South Africans have more invested overseas than foreign investors have invested in South Africa. The problem is that we are not investing that money in growing our productive, forex earning, job creating sectors… our real economy. High interest rates incentivise non-productive financial investment while they drive up the costs incurred by our productive sectors (cost of capital, taxes and SOE tariffs etc), while driving down demand for our products and services, which dis-incentivises productive investment.
Since 1994 our non-productive financial sector, who benefit from higher interest rates, has grown to become the largest sector in our economy, even larger than our state, yet we don’t hear calls from Schussler to reduce the size of a “bloated financial sector”, or reduce the incomes of those in our financial sector which are far, far higher than public servant salaries at the executive level, and a major driver of inequality. For a break down of jaw-dropping South African financial sector executive remuneration click here.
The gap in public sector incomes is lower than that of the private sector, so it follows that increased public sector employment reduces inequality. There is no reason to offset employment creating public spending with employment destroying taxation while demand pulled inflation is too low.
Schussler says in his article that we should reduce public spending on wages and grants because public servants and grant beneficiaries might spend a portion of their income on imports, meaning an outflow of money from South Africa. But that is true of all earners in South Africa, including the bondholders to whom the state transfers 100s of billions per year, and financial sector employees earning 100s of millions per year. The richer we are, the more share of our income we can spend on imports and outward investment, but that doesn’t mean that we should reduce employment and incomes as Schussler suggests.
The best way to reduce imports and offshore investment by South Africans is for the state to invest more of the Rands that it creates in increasing local production of energy, goods and services (through direct employment, and through subsidies, low interest loans and transfers to the local productive sector), and by increasing productivity (investing in education, infrastructure etc). It also makes sense to put in place tax policies and capital controls to incentivise local private sector productive investment and spending on local products and services, and dis-incentivise spending on imports, outward investment and non-productive financial investment.
Schussler makes a valid point that we should reduce public sector inefficiency, wasteful-expenditure and corruption.
Most wasteful expenditure is happening through unnecessary government outsourcing to private companies, something that government will have to do more of if it employs less people directly as Schussler is advocating for. Instead of employing workers directly, and paying them a decent salary, outsourcing allows government officials to direct hundreds of billions in public money towards connected, rent seeking private company shareholders, executives, “consultants” and themselves (bribes / kickbacks), while those companies pay their workers peanuts. How this will reduce inequality is anyones guess.
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