Johannes Fedderke recently released a new paper exploring the unusual economic structure of South Africa. For a small middle income developing country, South Africa is somewhat unusual with many features that more closely reflect high income countries such as the UK, than other middle income countries such as China, Brazil or Argenitina. Specifically,
a) the service sector accounts for around 60% of our GDP (Gross Domestic Product) whilst in other emerging market economies it only accounts for 50% of GDP (on average).
b) the industrial sector has been in long run decline now only accounting for approximately 30% of our GDP from a high of 45% in the 1980’s.
Fedderke hopes to explain this economic structure and discover whether or not it has meant that the SA economy is efficient, inefficient, or if the structure has no real bearing on economic efficiency.
He begins by indentifying the economic theories which may account for the rise in the significance of the service sector. These theories fall into two main categories:
1) Supply – It is assumed that there is some “sector-biased technological change”. The economy is made up of three different sectors: primary (agriculture, forestry and mining), secondary (manufacturing, industrial activity) and tertiary (services) and the TFP growth rates in each of these sectors are different. This means that workers may move from one sector to the next as jobs are created and lost. He predicts that results will depend on the price elasticity of the goods/services produced in each sector.
> If the price elasticity is high (people quickly change the amount of a good/service which they buy as its price changes) then he predicts that employment will move to the sectors which have a high TFP growth rate. A high TFP growth rate is associated with lower prices, so, if the price of goods in this sector falls and people respond by buying more of their goods/services, then they can afford to employ more workers.
> If price elasticity is low (people don’t really change how much of a good/service they buy as its price changes) then he predicts that employment will move to sectors with a low TFP growth rate. A low TFP growth rate means prices won’t be falling but rather increasing relative to other sectors which have a high TFP growth rate. But, since people are not buying less goods or services from this sector (even though their relative price is higher), then this sector can afford to employ more workers.
2) Demand – It is assumed that households (that is you and me) have a hierarchy of preferences. We prefer some things more than others. We first need essential goods (food) then we begin to think about products (computers) and finally to luxury items (massage). Thus any changes in the sectoral composition of GDP are due to differences in income elasticities of demand (when your income increases, how much of the good/product do you then buy?).
> If income elasticity of demand for the goods of a sector is high, then output from that sector should naturally grow as income in the country rises.
> If income elasticity of demand for the goods of a sector is low, then output will fall as income in the country rises.
In his analysis, Fedderke finds that the different sectors in the SA economy report big differences in TFP growth rates. He also finds that price elasticity of demand is low across the economy and that different sectors also have different elasticities of demand! The sectors can then be further subdivided into four different types:
Type 1: (Manufacturing and Construction – Secondary Sectors) Due to low price markups these are characterised by a high TFP growth rate. They also have a low income elasticity of demand. The prediction would be that these sectors should therefore experience labour shedding and moderate output growth (due to the low elasticity of demand). His results serve to confirm this prediction.
Type 2: (Agriculture, Forestry and Fishing, Mining and Quarrying – Primary Sectors) Due to high price markups, these sectors have a low TFP growth rate. They also have a low income elasticity of demand. The prediction would be that these sectors should therefore have an increase in labour but a low growth of output. His results do not confirm this prediction since there was very little increase in employment in this sector.
Type 3: (Electricity, Gas and Water, Wholesale and retail trade, Catering and accomodation, Transport, storage and communication – Tertiary Sectors) Due to low price markups, these sectors should have a high TFP growth rate. They also tend to have a high elasticity of demand. The prediction would thus be for labour shedding and strong output growth. Fedderke’s results confirm this prediction.
Type 4: (Finance, insurance, business and real estate services – Tertiary Sectors) High price markups in this sector should lead to low TFP growth, but these sectors have a high elasticity of demand. This predicts that there should be an increase in job opportunities and high output growth. Fedderke’s results confirm this prediction.
Thus, the economic structure of South Africa is the “outcome of the complex interplay between supply-side, demand-side, labour market and output market forces”. As a result of differences in price markups, income elasticities of demand for the different goods and services on offer and an overall low price elasticity, the unusual structure of South Africa’s economy is an efficient response to all the different forces which have a bearing on national production and consumption.