BILLIONAIRE entrepreneur Mark Shuttleworth has struck the Reserve Bank a heavy blow — in the region of R350m. Most significantly and laudably, he is to put his R250m refund, plus interest, into a fund to help South Africans pursue their constitutional rights. In this way, he may well help to protect property against seizure by the government without proper compensation. Whether exchange control itself would survive a Constitutional Court action remains as moot as ever.

Shuttleworth’s appeal succeeded on the basis that the 10% levy collected by the Reserve Bank did not pass the constitutional test of "a money bill — as defined by sections 75 and 77 of the constitution" and not because the court decided that exchange control was either illegal or unhelpful.

His argument that the purpose of exchange control is to benefit SA’s banks provides a very narrow and inadequate case against exchange control. It is true that exchange control is administered diligently by SA’s banks and could not work without them. However, it is not at all so obvious that the banks (that is, their shareholders) in practice charge more than it costs them to provide the service demanded of them by the law. The considerable cost in management time and computer systems devoted to the task is mostly bundled into the fees all the customers of the banks are charged.

While trading in foreign exchange may be a profit centre for SA’s banks, managing exchange control is something the banks would surely happily give up if they were allowed to do so. It should be noted that exchange control and controls against money laundering (a cost borne by the fees charged to bank clients) are inevitably combined.

More convincingly, Shuttleworth’s team said: "The case has a strong personal element for him, because it is exchange controls that make it impossible for him to pursue the work he is most interested in from within SA and that forced him to emigrate years ago."

Shuttleworth himself said: "I pursue this case in the hope that the next generation of South Africans who want to build small but global operations will be able to do so without leaving the country. In our modern, connected world, and our modern connected country, that is the right outcome for all South Africans."

The intended purpose of exchange control is to restrict the flow of South African wealth abroad so that it increases the availability of capital to local borrowers, thus reducing the cost of capital in SA to the intended advantage of SA’s borrowers or raisers of equity capital. Lower returns to wealth or savings will, however, be to the disadvantage of lenders or suppliers of equity capital (mostly supplied by pension and retirement funds) that are therefore denied the opportunity to seek or realise the highest expected risk-adjusted returns.

These apparent benefits (in the form of lower interest rates) are most obvious when exchange control, especially when first imposed, appears to protect the exchange rate against devaluation. Indeed, SA’s exchange control imposed in the early 1960s was seen as an alternative to a threatened devaluation, which would have brought more inflation and higher interest rates. Higher interest rates may also be used as a defence against devaluation.

The complete abolition of exchange control could be expected to add further to these benefits for savers. Surely serving the interests of savers is an important practical consideration for a society in which individuals do not in general provide adequately for their old age and are very likely to become a burden on hard-pressed taxpayers.

The practical question is whether exchange control actually reduces the costs of funding over the longer term. Answering this question with confidence becomes difficult when the evidence is complicated by flexible exchange rates and differences in rates of inflation across countries that make it difficult to measure and compare real interest rates — with or without exchange control.

There can be little doubt that imposing exchange control on foreign residents in SA, or even any threat of such, would greatly discourage foreign investors. It would add to their risks of doing business in SA, for which they would demand higher returns as compensation. SA cannot fund even the modest share of gross capital formation in gross domestic product (GDP) — about 19% — from domestic savings that run at about 14% of GDP. Thus, SA is highly dependent on inflows of foreign capital to sustain even lacklustre growth. Any exchange control imposed on foreign investors would very clearly mean more expensive capital for SA’s business and the government. It might frighten such capital away almost completely.

The present inflows of foreign capital mostly take the form of foreign purchases of South African government bonds and of purchases of shares in JSE-listed companies. These are sold by South African fund managers who manage the great bulk of SA’s wealth via contributions to pension and retirement plans. For almost every foreign buyer of a share in a JSE-listed company there is a local seller. These local sellers are doing so to buy foreign assets that help diversify the risks and to improve the risk-adjusted returns on the portfolios they manage. These exchanges of local for foreign shares and bonds have been made possible by the partial relief of exchange control and can be expected to enhance the risk-adjusted returns provided for South African savers and their retirement planning.

The complete abolition of exchange control could be expected to add further to these benefits for savers. Surely serving the interests of savers is an important practical consideration for a society in which individuals do not in general provide adequately for their old age and are very likely to become a burden on hard-pressed taxpayers.

However, would such greater freedom actually add to the costs of capital for SA’s capital raisers and borrowers? The abandonment of exchange control would not only lead to a lower cost of banking in SA and ease the costs of running a global business from SA, as Shuttleworth has suggested, it may well lead to a reduction in the risk premium demanded on any investment in SA. If so, it would reduce the cost of capital.

The freer a capital market, the more liquid and less volatile it becomes and the more capital it would tend to attract. A free capital market, unencumbered by exchange control and its expensive administration, would also discourage the so-called transfer pricing that the tax authorities in SA are much agitated about. These actions are designed to reduce taxes but also serve as exchange control avoidance. The more severe the exchange control, the greater the exchange control evasion and the corruption associated with it.

SA has ample experience of the unintended influence of exchange control, as well as the wealth-creating opportunities it can provide to lawless types gaming the system. As we also know only too well, exchange control encourages the export of dividend or allowance-receiving children sent abroad. It also encourages the emigration of skilled high-income and high-tax paying individuals, who would be frustrated by their inability to diversify their wealth from the risks associated with working and living in SA.

The absence of exchange control would mean an increased supply of professional and other skills — and so, less expensive skills. It might also increase flows of funds to SA-based wealth managers able to invest abroad.

Exchange control is an affront to economic freedom. It has unintended consequences that are impossible to measure with any accuracy. The intended consequence of a lower cost of capital may well prove to be illusory. Reforming exchange control in SA has been a step in the right direction. Wisdom would lead us to fully abolish it.

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