Part Three of a three-part series. Read Part One and Part Two here.

Michael Power is a strategist at NinetyOne asset management.

“History does not treat kindly those societies that diagnose their structural weaknesses only after those weaknesses have become irreversible.” – William J Abernathy, Professor, Harvard Business School.

Part Three: Why the business community and government in South Africa are fluent in the language of capital but do not speak the language of manufacturing labour

There is a global debate raging on the durability of the US dollar as the world’s reserve currency and how soon dollar hegemony might be challenged by the Chinese renminbi, perhaps even in the latter’s digital form. It is not an easy debate on which one can make a definitive projection, and I will not try to do so here!

But there is one function of the US dollar about which one can still be more definitive… and it is never explicitly mentioned in the economics textbooks when they list the various functions of money: since international capital is dominated by flows to and from the United States and handled mostly by American financial companies trading in American capital and foreign exchange markets, the US dollar is unequivocally the “language” of capital.

A solid 58% of the All Country World Index for equities is represented by US stocks; 59 US companies represent 65% of the total value of the Global Top 100. Nine out of 10 of the world’s top private asset management companies are American. US investment houses dominate the league tables of the origination and trading of virtually every globally traded debt and equity product there is, and not just in the US.

Most US investors are – unsurprisingly – monolingual, speaking just US dollar. Most global non-US investors are bilingual: they speak their home country currency and US dollar. They also likely know a few “words and phrases” in other currencies. So it is in South Africa: our financial markets speak rands and dollars with a smattering of pounds and euros.

South Africa is unusually fluent in the language of capital, US dollar; indeed, our degree of capital “financialisation” is among the highest in the world. At the end of 2020, South Africa’s equity market capitalisation to GDP ratio – the so-called Buffett Indicator – stood at 359%; for the US, it was 186%; the UK, 102%; and Australia, 113%. For South Africa’s stock market players, this is ironic since the JSE’s most valuable company, Naspers, is a China play!

This bias distorts the economic debate in South Africa to a tragic degree. Why? Because the language of wages earned by semi-skilled and unskilled labour is not US dollar but Asian, with the renminbi being by far the most influential dialect.

And one can go further and argue that the dominant language of traded goods is now also renminbi: the only countries of size where the US still outsells China are Canada, Mexico and Colombia. When it comes to the base cost currency of their import mix, the rest of Latin America, Africa, Asia, Australia, New Zealand and, as of 2020, the EU and the UK now “speak” renminbi more than dollar.

By this measure, South Africa has been speaking renminbi since 2009 when China overtook Germany (after China at number two, as the US was then only number three) to become our largest trading partner. Added to this, but this time as a quasi-monopsonist consumer and not as a low wage cost product supplier, renminbi was the language of many commodities – especially the industrial variety that South Africa exports – even before 2009.

It is not just the South African business and banking community that is trapped by this bilingualism. So too is the economic cluster of government: the departments and institutions charged with executing the administration’s mandates, be they fiscal or monetary. This makes having a meaningful debate on how to fix South Africa’s chronic unemployment rate very hard if and when one side of that debate does not speak renminbi. South Africa’s economic “powers that be”, both in the public and private sectors, have very little grasp of the rapidly-rising-in-importance renminbi language.

Furthermore, whenever the policy debate moves onto the economics, for the same community because they inhabit the Western world part of the South African economy, the logic of Keynesianism and aggregate demand management overrides the conversation.

For example, more than usually, a discussion on currency valuations migrates towards purchasing power parity with how much it costs to “demand” a Big Mac often cited. (Note the 23 July 2021 Fin24 headline: “Rand should be worth R6/$, according to Big Mac index.”) In much of Asia however, where most countries still have large underutilised pools of semi-skilled and unskilled labour (often subsisting in rural areas), a more practical consideration is a form of selling power parity, an index based on how much it costs to supply an hour’s work by a skilled worker to the production process. Bangladesh today may focus on its labour costs as compared to arch-competitors Indonesia, Cambodia and Laos, but as a rule the entire region bases their intra-country wage rate comparisons against a Chinese – and so a renminbi – benchmark.

For those like the Big Mac Index’s author, The Economist magazine, who do not readily speak the language of renminbi, who live in a US-dominated world of capital and who are schooled in the Keynesian macroeconomic tradition of aggregate demand management, they find it inordinately difficult to see the other side of this argument. But that side is there. And every day, as the economic forces of the Asia-centric vortex grow stronger, this side of the argument grows stronger. And it is this other, Asian side of the argument that matters most for South Africa’s economic future.

Supply-side management, a practice loosely implemented by China’s public and private sectors even before the early 1990s, initially involved corralling their workforce onto one of the lower rungs (for which read more globally competitive in terms of wages) of a variety of value-added supply chains for specific products that then went on to be sold globally: the all-important keystone industry was textiles, but it also included shoes, toys and plastic goods. 

To the average Westerner schooled in Keynesian demand management thinking, this approach simply “did not compute”. (For economists reading this, see my endnote to Part 3 below, on how Keynes, in the early 1930s, brushed aside objections that might have torpedoed his demand-oriented thesis, objections built upon the supply curve.)

Exceptionally, there has been and remains one group of Westerners who have learned to speak and depend upon the language of renminbi for their fortunes: those Western multinationals whose supply chains are rooted in China, based upon the China Wage and who, by capturing the profit margin between that China Wage and the end selling price obtainable from consumers in the West (the “China Price”), have done extraordinarily well financially as a result. Exhibit A is for Apple, the world’s most valuable company.

Such countries as Vietnam, Indonesia, India, Pakistan, Sri Lanka and Bangladesh – who have semi-skilled and unskilled workforces, often in their rural areas, who are now climbing onto the lower rungs of those value-added product ladders as their wage structures are lower than China’s in these sectors – understand to a high degree of fluency the language of this conversation. Increasingly, so too do three countries in Africa – Kenya, Rwanda and Ethiopia – though they are far from being fluent in these Asian languages.

So in the conversation about what to do about South Africa’s chronic unemployment problem – again, far worse than was experienced in the West during the Great Depression, with our unemployment over 40% and youth unemployment over 70% – one cannot reasonably have that conversation in the language of capital, US dollar. Rather, it must be conducted in the languages of our unemployed labour: above all, Chinese renminbi but increasingly Vietnamese dong, Indonesian rupiah, Indian rupee, Pakistani rupee, Sri Lankan rupee or – as I suggest in the title of this essay – Bangladeshi taka. How long will it be before this conversation will have further evolved and we in South Africa will need to learn to speak a few phrases in Ethiopian birr, Rwandan franc and Kenyan shilling?

The external valuation of the South African currency has gone from fluency in one foreign currency language to another before. After the South African pound became the rand in 1961 at a cross-rate of R2 to the pound sterling, it took but a decade for the rand’s value to migrate firmly into the orbit of the language of US dollar, a journey that the pound sterling definitively took following the 1967 Sterling Crisis. The rand’s shift was cemented in 1971 when President Richard Nixon ended convertibility of the US dollar into gold and, soon thereafter, unleashed the era of floating exchange rates. The yellow metal was then almost 40% of South Africa’s exports and the US dollar was gold’s reference currency.

The rand has thus already changed its reference currency within the West once. Is it time to do so again, but this time from West to East, from a “reoccidentation” to a “reorientation”? One South African broker began their weekly foreign exchange report on 16 March 2021 with the observation: “ZAR Insight – Weak economic data out of China dents risk appetite at start of new week…” suggesting that deep down, and so likely beneath the surface for many, that reorientation has already begun.

Endnote to Part Three: How Keynes dismissed the supply curve – that which might turn out to be the Achilles’ heel of what is the essence of Keynesianism: aggregate demand management

To summarise: Unlike in the West, where aggregate demand management (ADM) is a synonym for macroeconomics, China appears to place far more emphasis on aggregate supply management (ASM) and on a global, not merely a national, scale as is typically done with ADM. This ASM approach does not compute in the Western economics lexicon.

Piero Sraffa, Keynes’s close friend and the economist Keynes rescued from Mussolini’s Fascist Italy in 1927 by bringing him to Cambridge having arranged a lectureship for him, may have turned out, at least with hindsight, to have been Keynes’ most challenging critic.

Sraffa warned JMK that the Achilles heel of his then-coalescing thesis might be related to the supply curve, having previously noted that in “the tranquil view which the modern theory of value presents us, there is one dark spot which disturbs the harmony of the whole”: the supply curve.  

Joan Robinson – Keynes’ closest intellectual collaborator – felt Sraffa might have been onto something, though the Italian had not followed his hunch to its “aggregate” conclusion. As Robinson wrote to Keynes:

“I think that, like the rest of us, you have had your faith in supply curves shaken by Piero. But what he attacks are just the one-by-one supply curves that he regards as legitimate. His objections do not apply to the supply curve of output (as a whole) – but heaven help us when he starts thinking out objections that do apply to it!”

Keynes dismissed these concerns, noting:

“We leave saving to the private investor… We leave the responsibility for setting production in motion to the businessman… [T]hese arrangements, being in accord with human nature, have great advantages.”

So what happens when not the private investor but the public sector helps set “production in motion”, as does the Ministry of Industry and Information Technology in China, and as did – more than coincidentally – the Ministry of International Trade and Industry in Japan, the Ministry of Trade, Energy and Industry in Korea and the Industrial Technology Research Institute in Taiwan before it? Indeed, aspects of all the latter four approaches can be traced back to Konrad Adenauer’s “Rhine capitalism” or “coordinated market economy” as was implemented in post-WW2 West Germany.

Maybe, in a world where the Western economies are pumped up by debt-financed Keynesian demand, East Asia has found, in managing the “supply curve of output (as a whole)” or its macroeconomic derivative, aggregate supply management, those objections that do apply to aggregate demand management.

Part Four: Questions arising from the above diagnosis of what ails South Africa’s economy

As noted at the outset, the object of the exercise sought by this four-part essay (in three parts) is to get those in South Africa – both in the private and public sectors – to think deeply about what ails our country. And, having done that, to move on to the more important matter of WHAT TO DO ABOUT IT.

The final part of this essay will do this by asking a series of questions. Those who have read the earlier parts of this essay will likely see which answers broadly arise. The debate would then move on to deciding the various different ways in which South Africa as a nation could move towards implementing those answers.

With the overwhelming objective of narrowing the gap between the semi-skilled and unskilled wages of South Africa with South Asia:

• Should South Africa prioritise targeting the external price of money via the exchange rate over targeting the internal price of money via the interest rate?
• Should South Africa aim to run, in a more normal non-Covid impacted environment, a current account surplus and so become a net saver as a nation? If so, how would those current account surplus savings be managed? Should they be added to foreign exchange reserves? Or disbursed to pay down foreign debt? Or used to establish a sovereign wealth fund?
• Should, in order to make South African semi-skilled and unskilled wages more globally competitive, capital controls be further relaxed on savings in South Africa that might rather want to invest abroad? The likely result of more capital flowing abroad would be a more competitive rand exchange rate;
• The advent of bouts of the commodity bonanza-driven Dutch Disease on a commodity export-oriented country like South Africa – because the most immediate consequence nearly always leads to a less competitive currency and so less competitive wages – complicates the pursuit of a manufactures-for-export strategy. Malaysia and more recently Indonesia have grappled with this predicament. How should South Africa seek to inoculate itself against future infection from bouts of the Dutch Disease in the wake of a commodity bonanza?
• Other than ensuring a currency level that would make South African semi-skilled and unskilled wages more competitive globally, what other policies might help close the all-in production cost gap with, in particular, South Asia?
• For instance, in addition to those more competitive wages in a global context, might the establishment of “no taxes of any variety” export processing zones assist in improving South Africa’s competitiveness in the export manufacturing trade? China did this with its multifaceted special economic zones in the 1980s and 1990s, though the first mover in this regard was Shannon, Ireland, in 1959;
• Might South Africa also pursue – as Uruguay has done via Montevideo’s Zonamerica – the establishment of “export services zones”? Unlike goods-oriented EPZs, such zones need not be set up near sea ports;
• In supporting this process, what other constructive roles can government play? As noted above, improving education, infrastructure and security are taken as givens. Are there yet other areas where government can and must play a constructive role?
• How else might South Africa ease the process of attracting foreign capital to be directed at the creation of jobs in the manufacturing export and service export trades? Such easing must ultimately be reflected in lowering the costs – of all varieties and not just wages – and so increasing the competitiveness of a South African-based venture.

Let the debate – the deep down debate – begin. Before it is too late. DM