The Growth Illusion: How Government Spending Fails to Transform South Africa’s Economy

South Africa's fiscal policy continues to reveal a structural paradox that is increasingly relevant for emerging economies: government spending remains an effective short-term stabilisation tool, yet it struggles to generate sustained long-term growth. A comprehensive new study by Luyanda Majenge and Simiso Msomi examines whether government spending can sustainably drive economic growth in South Africa or whether its effects are only temporary. Based on more than four decades of data (1980–2024), the research published in the Journal of Risk and Financial Management applies advanced nonlinear econometric models to unpack how fiscal policy interacts with growth under changing economic conditions.

The analysis found that government spending does stimulate economic activity, but only in the short run. Once the immediate effects fade, there is no evidence that public expenditure permanently raises South Africa's growth trajectory. The study finds no long-run equilibrium relationship between government spending and GDP, meaning fiscal expansions do not translate into sustained economic transformation.

While Keynesian theory argues that government spending can stabilize economies during downturns, the research confirms that this stabilisation is temporary. Once fiscal support is withdrawn, growth tends to revert to its underlying structural path, shaped by productivity constraints, labour market inefficiencies, and institutional weaknesses.l.

Debt, Governance and the Hidden Drag on Fiscal Effectiveness

The study highlights three structural forces that shape how effectively fiscal policy operates: debt, corruption, and institutional capacity.

1. Public debt emerges as a consistent drag on economic performance. Higher debt levels are associated with weaker short-term growth outcomes, largely due to investor uncertainty and reduced private investment. In essence, borrowing to finance spending can dilute the very growth effects that fiscal expansion seeks to achieve.
2. Corruption plays a critical role in weakening fiscal transmission. The research finds that governance failures reduce the effectiveness of government spending, particularly during periods of high expenditure. In environments where institutional integrity is weak, a portion of public resources is effectively lost to inefficiencies and misallocation, reducing the growth impact of fiscal policy.
3. Government revenue tends to support growth more effectively than debt-financed spending. This suggests that fiscally sustainable expansions, those backed by strong revenue systems, are more likely to produce stable economic outcomes.

These findings collectively point to a deeper structural constraint: fiscal policy does not operate in isolation. Its effectiveness is shaped by the quality of institutions, the sustainability of public finances, and the efficiency of resource allocation systems.

A Smooth Cycle, Not a Sharp Switch: How Fiscal Effects Actually Work

The study finds that fiscal effects in South Africa do not shift abruptly between "high-impact" and "low-impact" regimes. Instead, they evolve gradually.

Using nonlinear models such as Smooth Transition Autoregressive (STAR) frameworks and threshold Granger causality tests, the study finds that fiscal multipliers adjust smoothly across economic conditions. While government spending does influence growth in both low- and high-spending environments, there is no statistically strong evidence of a sharp threshold where fiscal effects suddenly change. This challenges the common assumption that fiscal policy operates in clearly separated regimes, such as recession versus expansion. Instead, South Africa's fiscal-growth relationship appears to move along a continuum.

Local projection results further reinforce this interpretation. Government spending shocks generate relatively weak and short-lived effects on output, often fading quickly over time. In some cases, confidence intervals suggest high uncertainty around the magnitude of these effects, indicating that fiscal stimulus does not consistently deliver strong or predictable output gains.

Additionally, government debt consistently shows negative effects on growth, reinforcing the idea that fiscal space matters. Even when spending increases stimulate demand, the broader macroeconomic environment, particularly debt levels, determines how durable those gains will be.

Policy Reality Check: What This Means for South Africa and Beyond

The study's findings carry significant implications for fiscal policy design in South Africa and other emerging economies facing similar structural constraints.

• Fiscal policy should be viewed primarily as a short-term stabilisation tool, not a long-term growth strategy. While government spending can support demand during downturns, it does not appear capable of permanently lifting economic growth without complementary reforms.
• The results highlight the importance of fiscal discipline and debt management. Rising debt weakens the effectiveness of fiscal interventions and introduces risks that can offset short-term stimulus benefits. For policymakers, this means that the composition and financing of spending matter as much as its scale.
• Institutional quality emerges as a central determinant of fiscal success. Weak governance reduces the efficiency of public spending, while stronger institutions could significantly improve outcomes. This places anti-corruption reforms and public sector efficiency at the centre of any credible growth strategy.
• Targeted and efficient spending may be more effective than large-scale stimulus packages. Investments in infrastructure, education, and health are more likely to generate productive long-term benefits than broad-based consumption spending increases.

Many developing economies are increasing public debt to support growth and recovery efforts, but this study reinforces a cautionary message: without structural transformation, fiscal expansion alone cannot deliver sustained development.

In a development context where fiscal policy is often seen as a primary tool for growth acceleration, the findings serve as an important reality check. They suggest that the real constraints on South Africa's growth are not just cyclical, but structural, rooted in debt burdens, governance challenges, and weak transmission mechanisms.