Private Firms: Engines of Economic Growth

Published on 18th January 2010

South Africa is fast approaching a watershed moment as Finance Minister Pravin Gordhan prepares for his inaugural budget policy statement next month. In his October medium-term budget policy statement (MTBPS) Mr Gordhan forecast a consolidated budget deficit of R184bn (or 7.6 per cent of GDP). He said that in 2008 government expenditure rose from R715bn to an estimated R841bn in 2009, some 35 per cent of GDP. Despite the expected R34bn decline in revenue, government expenditure of R127bn (a 17.8 per cent increase from 2008) was budgeted.

The overall public sector borrowing requirement for the 2009/10 fiscal period is estimated to amount to R285bn, which equates to 11.8 per cent of GDP. By comparison last year the public sector borrowing requirement was just R89bn. On these projections government debt will increase from 23 per cent of GDP in March last year to 41 per cent by March 2013. Interest on state debt will increase from R54bn to just under R100bn in 2013. Mr Gordhan stated that the SA government will raise some R640bn in borrowings over four years. Not surprisingly the level of debt will increase and the costs of servicing these debts will rise concomitantly. Mr Gordhan said that, “Higher borrowing is the right thing to do, in these times.”

But is it really? The simple reason government spending fails to end recessions is because every rand the government "injects" into the economy must first be taxed or borrowed out of the economy. No new income and therefore no new demand for goods and services is created. Money is merely redistributed from the productive sectors of the economy to the non-productive sectors. Government cannot create new purchasing power out of thin air. It is not government but private firms that generate wealth and are the engines of economic growth. The mistaken view that fiscal stimulus is good persists because we can actually see the people put to work with government funds. What we cannot see are the jobs that would have been created elsewhere in the economy with that same money had it not been taxed or borrowed by government.

Considering SA’s high rate of poverty and unemployment, some may well ask, “How will the government support the 13-million odd individuals currently benefiting from the fruits of others’ labours?” The best way to improve conditions for the poor is not by taxing those who are producing wealth and simply redistributing the proceeds, but by allowing people to work and by pursuing policies that promote economic growth. As the late Dr Adrian Rogers said, “You cannot multiply wealth by dividing it”. In SA, when we combine all taxes, many people are paying upwards of 40 per cent. This means that for the first five months of the year, effectively they are working to support somebody else.  Only after May do they begin earning an income to support themselves.

High marginal tax rates reduce the incentives for entrepreneurs to risk their capital or sacrifice their time and energy to earn higher incomes. High marginal tax rates also interfere with the ability of individuals to pursue their goals because they result in less disposable incomes. Less disposable income means less saving; less saving means less capital formation; less capital formation means lower labour productivity, and lower labour productivity means lower real wages.

In this economic climate, government, like business, should focus on its core activities. Part of government’s core functions is to ensure that there is sufficient policing, the courts are impartial and efficient, and the rule of law is respected and enforced. The security of property rights is essential for economic growth. If individuals know that their land and possessions are protected, they have an economic incentive to go out and earn a living.

High crime rates increase the cost of doing business significantly because firms are forced to spend resources to protect their employees and their assets. This kind of ‘investment’ is virtually a deadweight loss to society. It is money that could be invested in more fruitful ways to increase the productivity of business and the country. Crime also degrades the quality of life for everyone. It frightens away skilled immigrants and forces some workers to leave their jobs, their homes and their country to settle elsewhere where it is safer. By adversely affecting peoples’ movements, crime discourages the accumulation of human capital and thereby diminishes the country’s available pool of knowledge.

Government protection is therefore essential for individuals and for the creation of an enabling environment where businesses, both large and small, can operate. Redistributing existing wealth by taxing productive individuals and companies reduces any incentive to produce goods and services, and retards growth. Next month’s budget speech will reveal whether government chooses to view redistribution or economic growth as its main priority. History has demonstrated that it is economic growth that is the key to reducing poverty and not the redistribution of wealth.

By Jasson Urbach,  an economist with the Free Market Foundation.

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