Kicking the can further down the road

Investigating a decline in infrastructure spend (part one).

February came and went with the passing of the budget by the then Finance Minister Malusi Gigaba. This would turn out to be his first and last budget. While markets reacted positively to a well-reasoned message, structural difficulties loom in the near future.

One of the biggest difficulties of any government finance department in an emerging economy is to balance an increasing burden on state resources, while maximising tax revenue in a way that presents a sustainable budget deficit into the medium term. Unfortunately, the new finance minister faces a balancing act on three fronts.

On the expenditure side, the snap announcement of free university education placed an undue burden on the fiscus (reportedly at a time when the budget was in final planning stages), while a national health insurance scheme and land expropriation without compensation remain in the pipeline. State expenditure is, therefore, likely to accelerate under current conditions.

Expenditure is typically financed in two ways – tax revenue and borrowing. Continually increasing taxes contains a different set of problems. Late last year, it was seen that the tax revenue shortfall may reach R50 billion. Raising income taxes any further will just not work. It was economist Arthur Laffer who observed a turning point, whereby any increases in taxes will bring in less revenue.

If taxes cannot be raised, then the shortfall would have to be addressed through borrowing, upon which interest is charged. Once again, the extent to which government has the ability to borrow is dependent on its perceived ability to honour interest repayments. Along with the recent spate of downgrades, the accelerating interest on our debt means that this option is perilous.

Corrective action requires government to reprioritise current spending. Usually the first victim of this is capital projects, which includes infrastructure spending.

In the latest budget, conditional infrastructure grants were reduced to the tune of R28 billion, which will probably get pushed out into later years.

Kicking the can down the road in this instance presents significant dangers. Infrastructure is subject to depreciation over time. Roads and rail networks decay and without continuing to spend on maintaining roads, the transport sector will be greatly affected, as journeys will take longer and cost more, margins will rise and inefficiencies will creep in.

With manufacturing production in South Africa concentrated in regional centres, there is a danger that transport costs in places like Coega and East London could escalate as regional road networks break down. The expansion ability of our manufacturing hubs will also be affected if the network is unable to handle greater transport traffic.