Facing the challenge to adjust, the question is to what extent South African markets, specifically labour and
investment markets, are flexible enough to enhance its global competitiveness, without having to revert to
inward domestic protectionism. In investigating the level of flexibility in this regard, we need to determine
the adjustment potential or capacity of the South African economy. However, modelling potential output
and/or capacity is problematic.
Building on previous research, this paper’s estimation of potential output for South Africa is based on a
structural production function relationship with the maximum level of output consistent with stable
inflation, supported by a full-scale macro-econometric model which is primarily supply-side driven, with
capacity utilisation (or the output gap) as one of the key drivers of economic activity. The extent to which
capacity is utilised in the economy is determined (defined) by the actual output (gross domestic product)
relative to the potential of the economy to generate gross domestic product.
Following this approach, South Africa’s potential employment needs to be determined. Does the entire
labour force of working age have the potential and necessary skills to fill the available vacancies in the job
market? On the contrary, our belief is that there exist certain constraints/rigidities in the labour market,
which reduce the ranks of the potentially employable. In order to capture this effect, we assume that some
“equilibrium or natural rate of unemployment” exists. Therefore, we presuppose a NAWRU − a natural
rate of unemployment consistent with stable wage inflation.
Ideally speaking, the NAWRU of an economy should be stable and not trending. However, the estimate
we obtain for the NAWRU of the South African economy is increasing at a steady rate, suggesting severe
structural problems in the economy, in particular, the labour market. Using this calculated NAWRU, we
obtain estimates for potential output based on the structural production function approach. Our results
indicate that the capacity of the South African economy is lower than conventionally expected. This
reveals the essence of the impediments on the South African economy, primarily due to the sizeable
constraint posed by rising labour market disequilibrium.