Relationship between fiscal deficits and unemployment in South Africa

Abstract

Orientation: Heterodox economic scholarship has challenged the neoclassical doctrine that fiscal deficit increases unemployment in the long-term.

Research purpose: This article examined the relationship between fiscal deficits and unemployment.

Motivation for the study: The renewed debate about the role of fiscal consolidation in controlling unemployment in South Africa motivated the study. Neoclassicists in South Africa maintain that fiscal consolidation is the solution to unemployment, while heterodox thinkers argue for active fiscal policy.

Research approach/design and method: The study utilised the Toda-Yamamoto Granger non-causality test and the Autoregressive Distributed Lag Modelling framework to test the relationship between unemployment and fiscal deficit. The quarterly data for the period 1994–2019 were obtained from the South African Reserve Bank.

Main findings: This study found that fiscal deficits reduce unemployment in the short- run but increase it in the long run, thus confirming the neoclassical claim.

This study found no statistical evidence for the heterodox view that fiscal deficits reduce interest rates and the neoclassical crowding-out hypothesis. Rather, the interest-neutrality of fiscal deficits was found. The adoption of a fiscal belief system that builds on the expansionary fiscal contraction hypothesis has been associated with high unemployment.

Practical/managerial implications: Fiscal authorities have to use fiscal deficits creatively in managing unemployment to create a balanced economy. The fiscal balance, up to a threshold, between 0.8% (surplus) and 1.9% (deficit) of gross domestic product (GDP) in the short term and between 1.7% (deficit) and 1.9% (deficit) in the long term reduces unemployment as per the estimates of the study.

Contribution/value-add: The finding that fiscal deficits increase unemployment does not justify a weak fiscal policy stance. The finding that fiscal deficits reduce unemployment up to a point before they begin to increase it in the long-term complements existing literature, which shows that South Africa’s government expenditure to GDP ratio has exceeded its optimal level.