A bad example
Spending our public and private savings on consumption is shortsighted
This is a free post from Our Long Walk, my blog about South Africa’s economic past, present, and future. If you enjoy it and want to support more of my writing, please consider a paid subscription to the twice-weekly posts, which include my columns, guest essays, interviews, and summaries of the latest relevant research.
My podcast talk with Tobi Lawson is now available on his Substack channel. Listen to it here:
When Minister of Finance Enoch Godongwana announced in his February Budget Speech the drawdown of R150 billion from South Africa’s Gold and Foreign Exchange Contingency Reserve (GFECRA) account over the next three years, many commentators noted the obvious: that spending your savings on consumption is a bad idea. Although the Minister noted that the money will help keep borrowing and debt service costs low, it also allowed him to keep several spending programmes on the books. One is the COVID-19 Social Relief of Distress Grant (SRD Grant) until March 2025. The other is the additional R105.5 billion allocated to provinces over the next three years to cover the cost of implementing the 2023 public-service wage agreement. Paying such grants and salaries means that the R150 billion drawdown is eaten up by consumption expenses, resulting in a higher budget deficit and R15.7 billion more in debt service costs, not less. The debt-to-GDP ratio will be higher than predicted in last year’s budget speech.
This is no way to spend your savings. As any financial advisor knows, spending on consumption is different from spending on investment. Investments are expected to generate future returns, increasing wealth over time. In contrast, consumption spending typically offers no financial return and will only reduce the resources available for future investment. Had the Minister invested in new infrastructure - efficient ports, electricity transmission, fixing water pipes - the story would have been different.
But South Africans should be careful to point fingers at National Treasury for making such ill-advised decisions. Read the budget carefully, and you’ll find the Minister mention the two-pot retirement system, due to kick off on 1 September, that will allow retirement fund members to make partial withdrawals from their retirement funds before retirement. Under this reform, future contributions to retirement funds are divided, with one-third allocated to an accessible pot for pre-retirement withdrawals under certain conditions, and the remaining two-thirds dedicated to a retirement pot that cannot be accessed until retirement.
On the surface, this may appear to be another ill-informed policy decision: Many South Africans will want to ‘cash in’ their retirement savings, often spending it on consumables rather than investments like tertiary education. But the truth is that the current system, which forces households to keep all their savings until retirement, is worse.
South African households save very little for retirement, averaging just above 2% of GDP per annum, with a significant portion not preserving their savings upon changing jobs. This behaviour leads to inadequate replacement values at retirement - the percentage of a person's pre-retirement income that is replaced by retirement income - with the average replacement ratio standing at an insufficiently low 30%.
And then came Covid. The pandemic and lockdowns highlighted the vulnerability of many households, with many facing financial distress without adequate short-to-medium-term savings to fall back on. This forced many to quit their jobs to access their retirement savings. Thus, the true alternative to the two-pot system is not a scenario where individuals conserve all their savings until retirement, but rather one in which they deplete their savings entirely during a crisis. By allowing limited pre-retirement withdrawals while introducing a preservation requirement to improve retirement outcomes, the new system aims to strike a balance between ensuring the long-term growth of savings for retirement income and providing the necessary flexibility for individuals to manage financial challenges before retirement.
Come the first of September, thousands of South Africans are likely to dip into their retirement funds. Do we have a sense of how much this will be? Treasury budgets R5 billion in additional revenue for the 2024/2025 budget year, calculated at 18%, so a ballpark figure could be around R30 billion. (This will be a once-off windfall, as the reform allows members to withdraw up to R30,000 of their savings initially.) My suspicion is that this is a conservative estimate.
And what will South Africans spend it on? That is more difficult to say, but a new working paper about the effects of an Australian experiment during Covid-19 paints a grim picture. The Australian government permitted individuals to withdraw up to A$20,000 from their retirement savings accounts, which are typically inaccessible until retirement. This policy aimed to provide immediate financial relief during the pandemic, with one in six working-age individuals withdrawing a total of A$38 billion, representing 2% of the GDP. The four economists ask how individuals spent these early withdrawals and the implications for economic policy and personal financial behaviour.
They find a high marginal propensity to spend (MPS) from these withdrawals, with at least 43-48% of the funds being spent rapidly, mostly within four weeks of withdrawal. Remarkably, gambling emerged as the largest category of expenditure, surpassing even credit card repayments. The researchers then show that low rates of savings and high levels of gambling before the withdrawal were strong predictors of both the decision to withdraw and subsequent spending patterns.
The Australian results have dismal implications for South Africans: Given our low savings rates and the growth of sports gambling, the two best predictors of withdrawal and spending in the Australian study, it is likely that much of the retirement drawdowns come 1 September will be largely funnelled into fleeting pleasures.
This calls for concerted action from our government, employers, and, in particular, retirement funds, to guide their members away from the pitfalls of early withdrawals. Regrettably, the example set by our Minister of Finance in his Budget Speech hardly points us in the right direction.
If you want to know more about the two-tier retirement system, read this FAQ factsheet. For a much more thorough discussion, read this. An edited version of this article was published on News24. Support more such writing by signing up for a paid subscription. The image was created with Midjourney v6.