Coffee table economics with Anchor

Anchor’s coffee table economics note by Casey Delport will be distributed intermittently and is a collection of Casey’s opinions on key economic factors and events shaping markets globally and in South Africa (SA). It is essentially Casey’s thoughts and perspectives on the multiple dynamics at play in the global and local economy.

 

Executive summary

In this week’s edition, we highlight the following:

  • China: An economic powerhouse that is more than manufacturing and exports. By the end of 2022, China’s exports (of an estimated US$3.6trn p.a.) were bigger than the entire economies of countries like the UK, India, and France. China has become the world’s factory, with a robust manufacturing sector producing a wide range of goods. However, it is important to remember that China is also regarded as an economic powerhouse for reasons other than the country’s impressive level of exports of manufactured goods.
  • Raising the roof: What is all this fuss around the US debt ceiling? The furore around the US debt ceiling is beginning to heat up, with Treasury Secretary Janet Yellen reiterating at the beginning of the week that the US likely would not be able to pay all its bills beginning next Thursday (1 June) if Congress does not raise the debt ceiling from its current US$31.4trn level by then. However, despite the uncertainty and political noise, history points to the various sides in the US always managing to (eventually) come to an agreement – albeit a bit close to the wire.
  • Unemployment is a constant battle against the tides: South African workers struggle to stay afloat in a sea of joblessness. The fact that South Africa (SA) faces a significant unemployment problem, unfortunately, is old news. However, according to the latest Quarterly Labour Force Survey (QLFS) data, the domestic unemployment rate continues to rise despite a slight increase in employed persons.
  • The cost of Lady R – the African Growth and Opportunity Act (AGOA) trade agreement? They say to be careful of the company you keep – this could not be truer for SA. Our seemingly cosy relationship with Russia (as brought to the fore by the docking of the Lady R [a sanctioned Russian ship] debacle and alleged sale of arms to Russia) may just cost us our privileged access to the US market under AGOA.

 

China: An economic powerhouse that is more than manufacturing and exports

China’s historic economic strength is an impressive testament to its remarkable journey from an agrarian society to becoming one of the world’s leading economic powerhouses. The nation’s economic transformation began in the late-1970s with Deng Xiaoping’s policy reforms, which embraced elements of market-oriented principles and opened China’s doors to foreign investment and trade. Over the past four decades, China’s rapid industrial transformation made it the manufacturing powerhouse of the world, and exports rapidly ballooned. If we consider more recent trends, in 2001, when China joined the World Trade Organization (WTO), the value of its merchandise exports stood at US$266bnn. Over the next seven years, the country’s exports grew uninterrupted until the 2008 global financial crisis (GFC) caused a sharp decline in international trade.

This cycle would repeat with consecutive growth until 2015 (another global trade slowdown), followed by slower growth until 2020 (and the onset of the global COVID-19 pandemic). Since then, merchandise exports have skyrocketed by 30% in 2021, and by the end of 2022, China’s exports alone (an estimated US$3.6trn p.a.) are bigger than the entire economies of the UK, India, and France. As a result, China has become the world’s factory, with a robust manufacturing sector producing a wide range of goods. Moreover, the country offers low labour costs, a vast workforce, and efficient production capabilities, making it an attractive destination for multinational companies to set up manufacturing operations.

However, it is important to remember that China is also regarded as an economic powerhouse for reasons other than the country’s impressive level of exports of manufactured goods. It has transformed from a largely agrarian society into the world’s second-largest economy through its economic reforms and ‘opening-up policies’. As a result, its average annual GDP growth rate has consistently exceeded most other major economies. China has complemented this growth by making substantial investments in infrastructure development. The construction of high-speed rail networks, modern airports, ports, and highways has improved connectivity within the country and facilitated the efficient movement of goods and people. These infrastructure investments have contributed to economic growth, enhanced productivity, and attracted foreign direct investment (FDI). In addition, China has employed strategic industrial policies to foster key industries and sectors.

Through initiatives like “Made in China 2025,” the country aims to upgrade its industries, promote innovation, and become a global leader in high-tech sectors such as artificial intelligence (AI), robotics, and renewable energy. The government provides support in terms of funding, infrastructure, and regulatory frameworks to boost these industries. Chinese tech giants like Alibaba, Tencent, and Huawei have emerged as global leaders in their respective fields, driving innovation and contributing to China’s economic strength. China boasts a massive domestic market with a population of over 1.4bn people. Rising incomes, urbanisation, and an expanding middle class have led to increased consumer spending, driving domestic demand for goods and services. This large and growing market offers tremendous opportunities for businesses, both domestic and international, to thrive. As such, China has actively pursued global trade and investment partnerships. It has been a major player in international trade, engaging in bilateral and multilateral trade agreements. Initiatives such as the Belt and Road Initiative (BRI) have expanded China’s economic influence globally by promoting infrastructure development and trade connectivity with partner countries. Lastly, China’s emphasis on education and human capital development has contributed to its economic success. The country has invested in its education system, producing a large pool of skilled labour and fostering technological innovation. China has a strong STEM (science, technology, engineering, and mathematics) education focus, ensuring a competitive workforce in emerging industries.

 

The bottom line

It is important to note that China’s economic rise also faces challenges such as income inequality, environmental concerns, and debt sustainability. Nonetheless, much like the broader global economy, the Chinese economy is starting to re-adjust. For one, the country is beginning to rebalance exports from its manufacturing-heavy mix to a more even allocation of manufacturing and services. Second, the economy’s overall reliance on exports has decreased significantly from its highs in the mid-2000s, with an aim to increase domestic consumption and have a more self-sufficient economy overall. However, that is not to say that Chinese dominance on the world export stage is expected to waver anytime soon. With far-reaching economic policies like the One Belt, One Road initiative and the RCEP trade agreement between 15 countries in Asia and Oceania, there are plenty of future growth avenues for Chinese exports. Moreover, given the country’s unprecedented internal demographic shift in the coming decades (amongst other notable headwinds), China’s robust export sector will, in turn, be key to continued economic growth for the country as a whole.

 

Raising the roof: What is all this fuss around the US debt ceiling?

It is understandable if you have not been following negotiations around the US debt ceiling. It does not exactly strike one as the most interesting of investment-related topics, after all. However, the furore around the debt ceiling is beginning to heat up, with Treasury Secretary Janet Yellen reiterating at the beginning of the week that the US likely would not be able to pay all its bills beginning next Thursday (1 June) if Congress does not raise the debt ceiling from its current US$31.4trn level by then.

To understand exactly why this is important (if it is not apparent already), it is helpful to start by asking the most obvious question – what is the US debt ceiling? Well, it is essentially the limit on the total amount of outstanding securities that the US government is legally allowed to have issued to finance its budget deficits and thus meet its obligations, such as interest on the existing national debt, social security payments, tax refunds and other payments. Congress first created it in 1917 in response to the massive expenditure outflows associated with World War I to increase flexibility whilst ensuring fiscal responsibility. Since then, the limit has been raised over 100 times, with the cap currently set at US$31.4trn.

As such, the fuss around the US debt ceiling typically arises when the government approaches or reaches the limit. If the debt ceiling is not raised or suspended, the Treasury will no longer be able to borrow money to pay for expenses that exceed its revenue. This could lead to a situation where the government cannot fulfill its financial obligations, such as paying its bills, Social Security benefits, military salaries, and other government services. When the debt ceiling is reached, Treasury must resort to extraordinary measures to continue funding the government’s operations.

These extraordinary measures are simply fiscal accounting tools utilised to meet obligations, such as suspending investments in savings plans for federal employees. The idea is that once the cap is lifted or suspended, the Treasury will backfill the missing payments. However, the issue is that these measures can only provide a limited amount of time before the Treasury exhausts all available options. Hence why, according to Yellen, this said X date could be as soon as 1 June, depending on net budgetary flows. A simple and logical question for many of us surrounding this thorny issue would likely be, “Why can’t US lawmakers reach an agreement to raise the ceiling once again?”

As per the norm in the US, the debate around the debt ceiling often involves political disagreements and negotiations between different branches of government, primarily the executive branch (the president) and the legislative branch (Congress). Parties may use the debt ceiling as a bargaining chip to push for policy changes or to express their concerns about government spending and fiscal responsibility. As such, current negotiations appear to be at a bit of a stalemate – with neither the Republicans nor the Democrats seeming willing to compromise (unsurprisingly). The Democrats are campaigning for a clean debt ceiling increase, separate from any other bills, in contrast to the Republicans who are demanding that it be paired with substantial spending cuts and reversals to crucial elements of the White House agenda. There is somewhat of a historical precedent of such a situation where negotiations take place up to the deadline, driving substantial market volatility. The debt ceiling crisis of 2011 is one prime example, where a resolution was agreed only two days before the X-date.

 

The bottom line

Despite the uncertainty and political noise, history points to the various sides in the US always managing to come to an agreement, albeit as in 2011, a bit close to the wire. Across the market, investors are pricing in that the bickering politicians will probably work out a solution before the deadline, with Democrats perhaps agreeing to modest spending cuts. As a result, the implied probability of a default in the credit default swaps market was 3.6% on 19 May, compared to a peak of 6.9% during the debt ceiling standoff in 2011. However, until that point of agreement (or proverbial ceiling) is reached, expect the political sparks to continue to fly.

 

Unemployment is a constant battle against the tides: South African workers struggle to stay afloat in a sea of joblessness

The fact that SA faces a significant unemployment problem (which continues to pose challenges for our economic and social development) is, unfortunately, old news. The unemployment rate has remained stubbornly high for many years, with a complex range of factors contributing to the issue – a churning sea of complexities, if you will. A combination of structural deficiencies, such as a lack of skills, limited access to quality education and training, and inadequate job creation, has resulted in a large portion of the population being unable to find gainful employment. Indeed, the latest QLFS data indicate that employed persons increased by 258,000 to 16.2mn in 1Q23 vs 4Q22. Nevertheless, despite the slight increase in employed persons, the official unemployment rate has risen to 32.9% in 1Q23 from 32.7% in 4Q22. This results from an increased number of persons returning to the labour force (i.e., a decrease in discouraged workers). Whilst this within itself is not necessarily bad, it does add to the lunar pull of the already high tides in the SA job market.

The unemployment rate, according to the expanded definition (which includes those discouraged from seeking work and is thus more reflective of the actual number of unemployed persons in SA), now sits at 42.4% – concerningly high. This points to longer-term, structural issues within the local economy as it is difficult to reincorporate and entice discouraged work seekers back into the labour force. Of further concern is the long-term unemployment rate (i.e., those unemployed for a year or longer), which has steadily increased over the past decade – from 65.5% in 1Q13 to 77.2% in 1Q23. Moreover, our unemployment problem remains particularly acute among the youth, where high levels of unemployment hinder their prospects and exacerbate social inequalities. As such, the youth unemployment rate has risen again and is now at 62.1%.

It has long been understood that SA largely suffers from a structural unemployment problem, which is typically more complex than other types of unemployment. Whereas cyclical unemployment is related to fluctuations in an economy’s business cycle, structural unemployment tends to be confined to particular industries, sectors or categories of workers. Structural unemployment essentially refers to a type of unemployment that occurs due to fundamental shifts in an economy’s structure, leading to a mismatch between the skills and qualifications of workers and the available job opportunities. Of the many drivers of structural unemployment in SA, we particularly struggle with skills mismatch, where the skills possessed by the workforce do not align with the requirements of available job opportunities. This is often attributed to deficiencies in the SA education system, which is failing to equip individuals with the necessary skills for a modern job market.

 

The bottom line

Regardless of the exact details in the data, typically, in the domestic economy, material job creation has only occurred when GDP growth approaches 3% p.a. Currently, businesses remain under significant pressure from the ongoing effects of loadshedding, which is also weighing on jobs and the unemployment data. Thus, the economy is simply not growing at an adequate rate to sustainably boost long-term domestic employment prospects. At the end of the day, SA’s unemployment problem is a complex and multifaceted issue that requires sustained and coordinated efforts from all sectors of society to create inclusive and sustainable employment opportunities for all South Africans. Aside from direct employment (or rather, a lack thereof), rising debt service costs and high food inflation will be the primary factors weighing on workers this year. South African workers are no longer simply treading water- they are struggling to stay afloat.

 

The cost of Lady R- the AGOA trade agreement?

They say to be careful of the company you keep – this could not be more true for SA. Our seemingly cosy relationship with Russia (as brought to the fore by the Lady R debacle and the alleged sale of arms to Russia) may just cost us our privileged access to the US market under AGOA. AGOA is a trade agreement between the US and eligible sub-Saharan African countries, including SA. It was enacted by the US Congress in 2000 and provided preferential access to the US market for a wide range of products from participating African nations. As such, AGOA offers several benefits to SA:

  1. Duty-free access to the US market: AGOA provides duty-free and quota-free access to the US market for thousands of products, including textiles, agricultural goods, and manufactured goods. This preferential access allows South African businesses to export their products to the US without high tariffs, making their goods more competitive in the US market.
  2. Promotes economic growth and diversification: AGOA encourages economic growth and diversification in SA by providing opportunities to expand export industries beyond traditional commodities. By diversifying their exports, South African businesses can reduce dependence on a single market or product, increasing economic resilience and stability.
  3. FDI attraction: AGOA’s preferential trade benefits, coupled with a stable investment climate, can help attract FDI to SA. Increased FDI can spur economic development, create job opportunities, and contribute to technology transfer and capacity building.
  4. Enhances competitiveness and capacity building: AGOA promotes trade capacity building and technical assistance programmes to help African countries meet the agreement’s requirements. These programmes support local businesses in improving their product quality, meeting international standards, and enhancing their competitiveness in global markets.
  5. Facilitates regional integration: AGOA encourages regional integration and cooperation among African countries. SA can leverage this agreement to strengthen trade ties with other African nations, promote intra-African trade, and foster economic integration within the African continent.

Given the above-listed benefits, it is obvious that losing the trade agreement would be fairly detrimental to the SA economy. In 2022, SA exported about R275bn in goods to the US, of which c. 21.6% or R59.59bn entered the US under AGOA. Around half were in motor vehicles –high-end Mercedes-Benzes and BMWs – and c. R8bn was in agricultural products, much of it citrus and wine. Jewelry was another major export. By contrast, SA consistently runs a large trade deficit with China, our largest single trading partner. Last year, that deficit was c. R177.89bn, up from over R94bn in 2021. This is largely because we mainly sell raw materials to China and, in turn, mostly import manufactured goods. The relatively high component of manufactured, value-added goods in the basket of SA exports to the US (and to the European Union [EU], incidentally) also means that trade with those countries is creating more jobs and helping to boost industrialisation in SA.

 

The bottom line

AGOA expires in 2025, at which point the US Congress will have to either renew or terminate the programme. As things stand, it seems likely to be renewed. But it is not so clear that SA’s participation will also be renewed. Currently, countries can be removed from the trade agreement for two primary reasons:

  1. Human rights abuses, including waging war, for supporting terrorism or for raising unacceptable barriers to US trade.
  2. Or acting contrary to the US national security or foreign policy interests.

The latter could cause SA to be removed from AGOA, as many US legislators regard SA’s warm ties with Russia (including its alleged sale of weapons to Moscow) as undermining US national security interests. Furthermore, SA’s participation has been in doubt for some time, given that we are Sub-Saharan Africa’s most industrialised economy, and AGOA is intended to uplift poorer countries.

Moreover, depending on how the current spat with the US over Russia is ultimately resolved, SA could theoretically even be removed before the 2025 overall AGOA expiry date through an “out-of-cycle review” – in much the same way that SA was provisionally suspended from some AGOA benefits in 2015 after slapping extra import duties on US meat. So, at this point, investors should be pricing in the strong possibility that we may soon have to wave goodbye to AGOA. Indeed, be careful of the company you keep.

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