Inequality is limiting South Africa’s economic progress in more ways than we think. For most of the past 20 years, it was simply assumed that economic growth on its own would reduce inequality. This is not necessarily the case. Faster economic growth is a necessary but not sufficient condition to reduce the level of inequality. More directed action is needed to tackle inequality and these actions will boost the welfare of all its citizens.
Debate on inequality has blossomed following the success of French economist Thomas Piketty‘s new book, Capital in the 21st Century. While Piketty has picked apart how capitalism has perpetuated an unequal society, I argue that some degree of inequality is inevitable as society seeks to reward ability and effort.
But high levels of inequality, as we have in South Africa and in many other parts of the world, damages growth prospects through several channels. Education systems often reproduce inequality, hence making it more difficult to achieve high rates of social mobility. This impacts on productivity growth too. Unequal countries have higher levels of social tension.
Trust amongst social partners – an essential ingredient for development – is much harder to build. As a result, economic actors often seek quick fixes and quick returns, eschewing the long-term tasks of building sound institutions, investing in people and infrastructure and building the productive capacity of the economy. High levels of inequality also skew consumption patterns, resulting in less competitive markets, high cost structures and weak demand growth.
Returns vs redistribution
Why is it so hard to tackle inequality? While there is overwhelming evidence that steps to reduce inequality can be made without harming growth, there are still difficult trade-offs in economic and social policy.
Emerging economies such as South Africa face a dilemma of trying to attract investment while also trying to increase redistribution (which in a static sense reduces the direct returns to private investment).
In a globalised world, capital and skills are often footloose, able to move between jurisdictions seeking the highest short-term returns. There is also the issue of the “leaky bucket”. That is where tax revenue meant for the poor gets captured by corrupt, rent-seeking public servants and a small elite, undermining legitimate redistributive measures.
South Africa’s strategy to reduce poverty (an important objective in its own right) has been more successful than its efforts to reduce inequality. Its key poverty reduction strategies have focused on expanding cash transfers – now to about a third of the population. There has also been a transferral of assets (houses, water, sanitation and electricity) to the poor.
In terms of labour, there has been a broadening of collective bargaining and the institution of sectoral minimum wages, most significantly for farm and domestic workers (often the poorest paid workers). Alongside it, has been a broadening of access to basic education and health care.
These strategies have been effective in cutting the poverty rate by about half since 1994. While these measures have contributed to lowering inequality, their impact has been minimal and insufficient to counter other pressures driving inequality up.
How to reduce inequality
Notwithstanding these challenges, I can see five further steps that can be taken to reduce inequality and broaden opportunities for the poor.
First, highly unequal countries should have steeply progressive income tax systems. South Africa is an example of an unequal country that has a progressive income tax system (and a capital gains tax) that raises large amounts of revenue at relatively low cost and with relatively little tax evasion. Company taxes are already a significant share of tax revenue, though there may be scope to increase taxes from mineral rents. There is also scope to raise further the level of taxation on the richest 10%.
Second, unequal countries must spend much more on education than the norm and this spending must be pro-poor by a large margin. Investment in high-quality early childhood learning for the poor has multiple benefits, including freeing up women to enter the workforce.
For middle income countries such as South Africa, this progressivity in education spending should go all the way up to tertiary level. Society has to accept that it costs a lot to overcome the inherited legacies of apartheid education and the cycle of poverty, and hence should be prepared to spend resources to reverse this legacy.
Third, developing countries should tackle anti-competitive practices in product markets such as monopoly pricing and collusion with more vigour. This is easier said than done, but regulatory obstacles to entry drive prices up and keep profits high while depressing investment and employment.
Often, the best way of enhancing competition is to reduce tariffs and allow entry to foreign companies. Incumbents will argue this will cost jobs. In general, such opening up will lower prices for the poor and for downstream industries and reduce the economic rents that a small number of people extract from the economy. There may be a case for protecting some infant industries, but these should be sensibly evaluated and should not be the norm.
Four – the labour market. Labour market policy should first strive to achieve full employment or as close to full employment as is socially desirable. Unemployment and underemployment are major drivers of inequality. In contexts of high unemployment, even low wage employment will have positive welfare effects and reduce the level of inequality.
Well designed unemployment insurance schemes actually promote economic efficiency because they enable workers to leave work and search for more suitable employment. When countries are close to full employment, minimum wage policies have the potential to raise living standards without necessarily impacting on the level of employment. In this regard, South Africa does not yet have the right balance to maximise employment.
Finally, redress measures. Countries should have explicit, legal obligations to compel private schools, universities and even firms to set aside a proportion of places for people from historically disadvantaged backgrounds.
While race may be used as a proxy for relative deprivation (as in South Africa’s case), there are other useful measures such as parents’ income, parents’ education, geographic region and gender. Similarly, sensible land reform programmes and affirmative procurement programmes in the public sector can help broaden ownership in the economy.
Such strategies to reduce inequality will promote economic growth. Failing to tackle inequality will inevitably result in economic stagnation and social polarisation, as Piketty warns.
While governments have to be sensible about the policies they choose, the prevailing trend globally is to do too little to explicitly address inequality. Much more needs to be done to create societies in which all citizens have the opportunity to succeed. Only in this way can democracy really flourish.
Kuben Naidoo is a Deputy Governor of the Reserve Bank of South Africa. He wrote this article prior to his appointment.