Unpacking the potential impact of the Covid-19 pandemic on the South African economy and the housing sector

CAHF has undertaken research into housing construction and housing rental value chains in South Africa and other African countries.[1]   The estimated economic value chain for residential construction in South Africa calculated a direct impact output multiplier of 3.22 in 2017. This showed that housing construction has the potential to provide a significant stimulus to not just to the construction sector – but to numerous “upstream” supplier sectors (especially manufacturing sub-sectors) as well.  Further analysis revealed the specific impact of government’s subsidised housing programme, and that different housing subsidy programmes have different direct impact output multipliers.  Specifically, we can see that the highest direct impact output multiplier found among South Africa’s national housing subsidy programmes is with informal settlement upgrading.  This blog sets out an approach to considering the impact of the Covid-19 pandemic on the South Africa economy, and asserts the importance of housing construction in developing a response.

1. Context

The global economy is far more integrated today than it was decades ago.  Whereas in the early 1960s less than 5 percent of all the goods and services produced in the world moved across an international border, today it is closer to a third.  The world is also more interconnected by people movement (532 million international tourist arrivals through airports in 1995 up to 1.44 billion in 2018), digital communications, and international capital flows.

While this greater global integration has generally been good for economic growth and development, it increases the risks of contagion effects arising from both biological sources (such as the Covid-19 pandemic) and economic sources (such as the 2008 Global Economic Crisis).  These effects now move through the world with much greater speed and have significantly greater negative impacts than they would have had in the 1960s, 1970s and 1980s when levels of integration were much lower.  By way of example, although South Africa had a sound, well-regulated financial system, with almost no direct exposure to toxic sub-prime mortgages, its economy was still negatively impacted by the Global Economic Crisis of 2008 – due largely to the negative wealth effects of falling asset prices, and to a sharp decline in export earnings.  The net result was that the South African economy experienced its deepest, and most prolonged recession since the 1930s.   Similarly, although it was thousands of kilometres from the West African Ebola epidemic between 2014 to 2016, and recorded no cases, South Africa experienced a drop in the number of international tourists.

2. How the Covid-19 Pandemic is impacting the South African economy

It is important to recognise that the South African economy’s performance has been less-than-pedestrian for a number of years.  Since 2014, the country has consistently achieved economic growth rates that were lower than the rate of population growth, with the result that average real per capita incomes declined.  Between 2014 and 2019, real per capita GDP (a proxy for average real incomes before taxes and transfers) fell by 3 percent.  However, rapid higher-than-inflation increases in electricity, water and other administered prices, together with effective increases in taxes have resulted in a significantly more pronounced decline in real per capita discretionary incomes.   Over the same period, tax collections fell short of targets and government debt levels rose sharply, prompting all of the major ratings agencies to downgrade South Africa’s sovereign debt.  On 27 March of this year, Moody’s joined S&P and Fitch in rating the country’s long-term debt as sub-investment grade.  This means that future attempts by the government to borrow will be more constrained and more expensive, and that fiscal options have become even more limited.  South Africa is having to confront the Covid-19 Pandemic in an already-compromised state.

In its early stages, the Covid-19 epidemic resulted in a supply-side shock because it disrupted highly integrated global supply chains.  The shut-down of factories in China resulted in a lower demand for South African exports of minerals and other inputs into Chinese production chains, while also reducing the supply of Chinese inputs into South African production chains.  These impacts have increased in scale and severity as other countries have shut-down parts of their economies – so South Africa is now not just exporting less to China, but to most other countries too.  There has also been a decline in most commodity prices.  South Africa’s lock-down also impacted domestic supply chains, so in the space of a few months, almost every sector of the economy has been negatively affected.

As these negative supply-side impacts persist, they increasingly give rise to lost incomes (wages, interest, rent and profits) that then result in rapid declines in demand.  The direct income losses due to the shut-down are exacerbated by negative wealth effects arising from the dramatic fall in asset prices – which were also negatively impacted by the Moody’s downgrade.  Between 16 February and 19 March of this year, more than R2.3 trillion was wiped off the market capitalisation of the Johannesburg Securities Exchange.  While the equity markets have recovered some of these losses since then, most investors (both direct and those invested indirectly through retirement funds and other savings schemes) are, and feel, poorer.  Their economic behaviour in coming months and years will tend to reflect this.

Figure 1 illustrates the direct, indirect and induced impacts of a sales order received by a business in a particular sector, and explains why almost all sectors of the South African economy will be affected by the Covid-19 Pandemic.  Starting at the bottom right of the illustration, production and incomes are sustained by a continuous stream of sales orders.  If the sales of a particular business or sector are disrupted, this impacts sales (and incomes) not just in that business or sector, but in all the businesses and sectors that are direct or indirect suppliers of intermediate inputs to it, and in all the other sectors that sell products to households whose incomes are derived from these activities.  The longer the disruption persists, the more pronounced the negative direct, indirect and induced impacts will be.

Figure 1. Direct, indirect and induced impacts in a typical value chain

While there are a few product categories – such as personal protection equipment (PPE), sanitisers and digital communications – where suppliers have experienced an increase in sales orders, and some where the impact is likely to be more benign, most sectors, businesses and households of the South African economy are being negatively affected by Covid-19 and the measures taken to limit its spread.  Figure 2 illustrates that the sectors least affected are likely to be those providing basic needs for survival, such as food and non-alcoholic beverages.  These impacts are also determined by the scope of the “lock-down” regulations.

Figure 2. Expected impact of the Covid-19 Pandemic on different sectors of South Africa’s economy in 2020

The sector that will experience the most negative impact will almost certainly be tourism[2] – given that the movement of people, both domestically and internationally has been severely limited.  At an international level, these limitations are likely to largely remain in place until an effective vaccine has been developed and a widespread global vaccination programme implemented.  Failing this, quarantine requirements will probably make most international travel impractical. Domestic tourism will also be negatively impacted by constrained household incomes in the post lock-down period – even if some of the limitations on movement are lifted.

Other sectors that will be severely negatively impacted include trade, catering and accommodation; finance and insurance; the manufacture of durable household goods, especially motor vehicles; and construction.  Table 1 details the contribution of each sector to South Africa’s economy in 2019, as well as the anticipated impact of the Covid-19 pandemic on it.

Table 1. Expected impact of the Covid-19 Pandemic on different sectors of South Africa’s economy in 2020

The performance of the construction sector was already constrained, with growth having dropped from an average of 8.8 percent a year between 2000 and 2010, to only 0.5 percent a year between 2010 and the end of 2019.  Between the last quarter of 2016 and the end of 2019, the real value added by construction decreased by an average of 2.6 percent a year.  Figure 3 indicates the contributors to this decrease.

Figure 3. Contribution to the reduction in real spending on construction products between 2014 and 2019

As shown in Figure 3, over the past five years (end 2014 to end 2019), real expenditure on construction products decreased by R28 billion in constant 2010 price terms.  The decrease in spending on residential buildings contributed R6 billion (22 percent) of this decline, with drops of R15.3 billion (55 percent) in spending on non-residential buildings, and R6.7 billion (24 percent) in construction works accounting for the balance.

In the absence of effective interventions, the Covid-19 Pandemic is likely to accelerate these declines.  Firstly, the contraction of the economy will reduce the demand for commercial and industrial space – which was already experiencing rising vacancies in many parts of the country.  Secondly, decreased household incomes will – in the absence of appropriate subsidies, or other assistance – serve to further limit housing affordability.  These impacts could be deepened by a general loss of consumer confidence.  Thirdly, fiscal constraints and the re-prioritisation of government expenditure in order to deal with the most immediate impacts of the Covid-19 Pandemic could result in reduced public funding for infrastructure.

3. The potential of housing construction to aid the post-Covid-19 recovery

Under these circumstances an argument can be made for government to use its limited resources in ways that yield the greatest “bang for buck”, so as to aid a post-pandemic economic recovery.   The impact of government spending will be greatest in relation to those activities that give rise to the largest multiplier effects.  Direct output or GDP multipliers are calculated by using the ratio of the first-round intermediate inputs (adjusted to eliminate import leakages) to the gross value added associated with a particular economic activity or sector.  According to Statistics South Africa’s Supply and Use Tables for 2017, construction had a direct impact output multiplier of 3.21 – higher than all other major sectors with the exception of manufacturing (3.85).  This implies that for every rand of value generated in the construction sector itself, R2.21 had to be spent on inputs from other sectors.  While these figures do not take account of import leakages, these are almost certainly higher in manufacturing than in construction.

The Centre for Affordable Housing Finance in Africa (CAHF) has undertaken research into housing construction and housing rental value chains in South Africa and other African countries.   The estimated economic value chain for residential construction in South Africa in 2017 is drawn from one of these studies and is shown in Figure 4.[3]  Based on its high direct impact multiplier of 3.22, housing construction has the potential to provide a significant stimulus to not just to the construction sector – but to numerous “upstream” supplier sectors (especially manufacturing sub-sectors) as well.  Figure 4 also indicates the estimated share of each component of the value chain contributed by subsidised housing.  In 2017 subsidised housing comprised about half of South Africa’s R85 billion housing construction economy and directly accounted for approximately 0.4 percent of South Africa’s GDP.

Figure 4. The total housing construction value chain showing the portion contributed by subsidised housing

Source: Gardner, D., Pienaar, J., and Lockwood, K. (2019). “Analysing the Economic Impact of South Africa’s Subsidy Housing Instruments: Cost Benchmarking and Impact on the Economy”. Centre for Affordable Housing Finance in Africa (CAHF).

However, as Figure 5 indicates, different subsidised housing products generate relatively larger, or smaller, multiplier effects.  As a result, the mix of subsidised products funded by government will affect the overall impact of the subsidy programme on the housing sector specifically and on the economy in general. For reference, Table 1 below includes a description of each of these subsidised housing programmes.

The Upgrading Informal Settlement Programme (UISP) has the highest direct impact output multiplier (3.48) of all the government subsidised housing programmes, including the Breaking New Ground (BNG) free-standing housing product (2.46). Notably, the programmes which support incremental building in the context of informal settlements have the highest direct impact output multipliers, suggesting that increased expenditure or prioritisation of these programmes in the housing budget would have positive effects on the economy.

Figure 5. Direct impact output multiplier of various government subsidised housing programmes

Source: CAHF, 2019.

Of course, the different subsidy instruments involve different levels of expenditure per house type by the state: the absolute value of the subsidy in relation to the total cost of each housing type also needs to be taken into account.  These are shown in Table 1 and Figure 6 below.

Table 1. Unit cost and unit subsidy amounts of various government subsidised housing products

Source: CAHF, 2019.

Figure 6: The unit cost of different subsidised housing products, showing the subsidy portion

Source: CAHF, 2019.

As illustrated, and especially in the context of a Covid-19 related response to the myriad of housing needs as they are expressed in South Africa, the case for in-situ upgrading via incremental building through programmes such as UISP, PHP and site and service, is supported by this economic analysis.  These programmes all show high direct impact multipliers – the highest of the government housing programmes assessed.  In the context of increasing fiscal constraints, the likely reduction in budgets for housing – both nationally and provincially, and the need for actions which support South Africa’s economic recovery, it makes sense to prioritise spending on these incremental programmes which will address the needs of informal settlements at the same time that they serve to stimulate the economy.

Of course, other factors also need to be taken into account in relation to the mix and scale of subsidised housing products provided by government – it is not just about budget alone.  And, different housing outputs depend on different capacities and factors at the local level – for example, the availability of land, municipal management capacity, and incremental building support systems.  However, from the perspective of using the housing subsidy programme to boost the post Covid-19 Pandemic economic recovery, it would make sense to favour those housing types that are associated with the biggest direct impact output multipliers.  These happen to also be products where the subsidy value per unit is comparatively low, and that support incremental building in informal settlements.

[1] See CAHF’s Housing in the Economy Project: https://housingfinanceafrica.org/projects/housing-and-the-economy/

[2] Tourism is not technically a sector in terms of the Standard Industrial Classification (SIC) as it cuts across a number of other SIC sectors (accommodation, catering, transport, retail, community and personal services).  Its contribution to the economy has been estimated for 2019 using an approach developed by Statistics South Africa.

[3] Gardner, D., Pienaar, J., and Lockwood, K. (2019). “Analysing the Economic Impact of South Africa’s Subsidy Housing Instruments: Cost Benchmarking and Impact on the Economy”. Centre for Affordable Housing Finance in Africa (CAHF). https://housingfinanceafrica.org/documents/analysing-the-economic-impact-of-south-africas-subsidy-housing-instruments-cost-benchmarking-and-impact-on-the-economy/

See also: Gardner, D., Pienaar, J., and Lockwood, K. (2019). “Estimated Contribution of Housing Construction and Residential Rental Activities to the South African Economy in 2017.” Centre for Affordable Housing Finance in Africa (CAHF). https://housingfinanceafrica.org/documents/estimated-contribution-of-housing-construction-and-residential-rental-activities-to-the-south-african-economy-in-2017/