The Triangle of Economic Activity, Inequality and Green Transition in South Africa

South Africa is one of the most unequal countries in the world, with clear race and gender factors seeming to play a major and increasing role in soaring wealth inequality and income inequality. Upon a closer look at inequality, there is a strong relationship between the size distribution of households and sectoral inequality. The link between the productive structure of the economy and domestic as well as international policies shapes the dynamics of growth and inequality. This, in turn, determines how resilient or vulnerable the economy is in case of an extreme event, such as the COVID-19 pandemic or climate-related disasters.

A new working paper by Özlem Ömer and Jeronim Capaldo builds upon an existing demand-driven growth and climate model. The model is modified to include the size distribution of two different households – the bottom 90 percent of the households versus the top 10 percent of the households – with different consumption behaviors. In this version of the model, the authors trace external debt and emissions under different scenarios in more detail. The modifications allow for the study of the dynamics of economic activity, fiscal and monetary policies and debt, as well as their relationships with income and emission inequality patterns, under different climate pathways and with different policy options for South Africa.

Key findings:

• The bottom 90 percent of households will be most impacted by the crises and policies triggered by climate change, requiring macrostructural policies to be studied in detail to avoid distortions in green policies that may worsen existing inequalities.
• Achieving higher economic activity to support green structural transformation in a more equitable and sustainable way will necessitate proper coordination between the public and private sectors as well as support from regional and international institutions, including multilateral development banks, the International Monetary Fund, the World Bank and beyond.
• For the necessary green structural change, economic activity must be supported by sustainable productivity increases, spurring job creation via increased actual (and potential) output in the economy.
• Productivity enhancing structural change must be combined with progressive redistribution policies, especially since climate change related downturns will impact sectors which employ the most vulnerable part of the population more severely.
• Employment must be more inclusive, meaning that unskilled workers, mostly Black Africans, at the bottom 60 percent of households should be given more opportunities. 
• Gender responsive planning, budgeting and policy must be at the center of distributional policies. Women’s participation in the green transformation can be supported by sector specific public and private training programs.
• Government grants, transfers and unemployment protection programs and progressive taxation tools must be utilized to redistribute income more equally. These programs must be strengthened and made universal.
• Policymakers face a trade-off between inequality and long-term debt. On the one hand, stricter fiscal and monetary policies produce lower external debt at the expense of low economic growth and higher income inequality, which endanger the green structural transformation in the long run. On the other hand, expansionary mitigation and adaptation policies, which are supported by progressive taxation and income policies generate more plausible results that are key to greener, sustainable and more equitable economic growth.

In all, a combination of public spending on mitigation and adaptation, combined with progressive redistribution, a stable and competitive real exchange rate and a relatively low real interest rate can be instrumental in restructuring the economy and improving its prospects for greener development. Through this combination of policies, income inequality can be tamed and unemployment reduced while fiscal space is expanded, supporting long-term debt sustainability, simultaneously.