The Rule of 72 can help make sense of South Africa's economy

In any economy, the challenge is to balance what is created for those who consume it and at what cost.

Those tasked with managing South Africa's economy need to manage the conditions that regulate economic activity. There are four basic scenarios.

  • Growth - More people, extracting resources, manufacturing products or supplying services to people with the ability to pay a fair price
  • Stagnation - little change in production or consumption
  • Decline - too few people to consume the products
  • Inflation - too few products to meet the demand

What makes this so complex is that usually, all the scenarios are playing out in various sectors of the economy and so focussing on just one does not give the full picture.

The Rule of 72

There is a simple mathematical equation that illustrates the time it takes for something to double or half in value. When used with indicators for inflation or the country's growth rate you can get a better sense of the impact those indicators will have on the economy and so, you.

It is calculated by dividing the rate by 72 to get an approximation of how many years it will take for the outcome to double or half.

If you invest money and are offered a return of 7% on the investment then 72/7 is a little over 10 years which means your initial investment would double every ten years.

If you use the inflation rate, which is about 5%, then the money you have today will be worth half what it does now in 72/5 or 14,5 years.

There are calculators to give you a more accurate answer.

Growth

Under the correct conditions, the economy will reflect a positive growth rate which means there is more production and consumption. Using that rate and the Rule of 72 and you can calculate how long it will take for the economy to double. That is important because a growing economy needs more people to both to consume the output but also to create it.

In this way, there is a correlation between the growth rate, the inflation rate, the population growth rate and the unemployment rate.

To achieve growth the population needs to grow at the rate than the economy does to ensure there are people to work. In South Africa, the unemployment rate suggests there are more people than the economy can employ to create products and services. It is more accurate to say that there are too many people who lack the skills needed for the jobs that do exist.

For the economy to grow, we need to get more people working.

Employing people relates to the education they receive and the work opportunity that exists where they live. In South Africa, there has been a challenge to improving the quality of education and that work opportunities are greatest in urban areas.

At the moment South Africa's growth rate is about 1% which means it would take 72 years for the economy to double.

At the same time, you can look at South Africa's population growth rate which is also about 1% which means the population should double in about 72 years.

Keeping the population and economic growth rates close makes sense, but for South Africa, the issue is the very high unemployment rate which will not only prevent growth but is likely to result in a decline to the economy.

Inflation

Inflation occurs when the price of a product increases. It could be that supply falls, making the item scarce, or that the currency used to purchase it decreases or that people become more wealthy and are willing to spend more on the product.

In Zimbabwe, inflation became a major issue as access to products fell and the value of the currency declined. An inflation indicator of 5% suggests what you can buy with one rand will halve in 14,5 years or that prices will double in 14,5 years. If salaries don't increase at the same rate, there are major issues for maintaining the economy.

Venezuela is expected to reach an inflation rate of 1 million percent this year. It means the value of the money you hold will half every 37 minutes! Thankfully inflation rates like that are very rare.

How to use it

The South African Government is charged with allocating a budget to help create an economic environment to absorb the new workers coming into the economy, provide for the infrastructure to allow business and residents to be economically active and to be kept safe while doing so.

Using the indicators for growth, inflation, and population and applying the Rule of 72 to determine the time frames for things to double or half, you can assess if the plans by the government, or any company for that matter, are practical or sustainable.

If the government says it wants 3% growth but does not explain how it will manage or reduce inflation or unemployment then there is little chance of success.

Often governments will look to invite investment, but investors will apply a more sophisticated Rule of 72 to determine if the conditions in a country are likely to generate a greater return that it would generate elsewhere. If the investment was not made for an economic return then residents should question why the investment was made.

If you are planning on investing your money, consider the rate of return you will get on the investment and deduct it from the effect of inflation. If an investment return is about the same as inflation, you are effectively not getting a return.

In the same way, when you are promised returns significantly above inflation you can assume that you are not being told about all the risk or you may be investing in an unsustainable pyramid scheme.

Hopefully, the indicators that are so often quoted (growth, inflation) when combined with the simple mathematical formula to determine their impact will help you engage in stories about the economy and challenge those that make promises they can't keep.


This article first appeared on 702 : The Rule of 72 can help make sense of South Africa's economy


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