This paper develops a theoretical macro-economic model that links social infrastructure investment, taxation, and wages to income determination and job creation. The framework incorporates productivity effects, a fiscal budget constraint, and the public good nature of social infrastructure investment and wages, identifying a multiple equilibrium problem with the possibility of a low social infrastructure investment trap. Three major results follow from the analysis.
First, fiscal austerity (characterised by reduced social infrastructure investment, lower taxes, and a low fiscal deficit) may reduce long run national income and economic capacity if the economy is in a low social infrastructure investment trap. The conventional trade-off between equity and growth disappears, and increases in social infrastructure investment and a relaxed budget constraint may improve both national income and distribution.
Second, wages play an important role in characterising the low social infrastructure investment trap and providing the government with policy alternatives. A low wage trap reinforces the scarce social infrastructure investment equilibrium. In an economy with massive unemployment, wages can provide important externalities, particularly through remittances and social inclusion effects. Firms may have insufficient incentives to raise wages to the socially optimal level, and this reluctance is reinforced by low levels of labour productivity associated with the scarcity of social capital.
Third, the low social infrastructure investment trap is reinforced by technology characterised by rapidly diminishing returns to labour. The more inelastic is the substitutability of labour for capital, the more likely will labour productivity enhancements lead to job destruction rather than job creation. South Africa's unemployment problem exhibits many of the characteristics associated with the low social infrastructure investment trap. Policies that may address this problem include increased taxes and borrowing to finance expanded social infrastructure investment, higher wages for the working poor, and restructuring industrial policy towards more labour-intensive production. Labour-intensive production need not entail low wage activities-industrial policy that raises labour productivity while increasing the elasticity of substitution between capital and labour can increase labour intensity while improving wages. Appropriate social infrastructure investment strategies can support this industrial policy.