The relationship between poor municipal governance, low economic activity and administered prices is presenting acute inflationary shocks to municipalities around the country in a trend that needs to be studied at a higher level.
This is according to a paper by Economic Research Southern Africa (Ersa), which found that governance quality appears to moderate the relationship between audit outcomes, regional differences in inflation levels and persistence, as well as economic activity, particularly in administered prices.
With local government elections approaching later this year, the management of municipalities is facing increased scrutiny, not just on the side of governance and corruption but also on the role that local government administration plays in the rising cost of living for households and businesses.
The paper’s co-author, David Fadiran, said lower-activity municipalities tend to have thinner markets due to fewer firms and outlets, weaker retail competition and slower price adjustment, so when a price shock hits, it dissipates more slowly and inflation becomes more persistent.
“Infrastructure and market-integration constraints can amplify local supply bottlenecks, while spillovers from nearby regions can worsen pressures spatially. Essentially, markets in poorer municipalities are less self-correcting,” he said.
The study used CPI data from 27 local municipalities between 2008 and 2023 to understand inflation persistence in different regions of the country, using autoregressive specifications and audit outcomes from the auditor-general.
“The results indicate substantial regional differences in both inflation levels and persistence. Regions with lower economic activity tend to experience higher inflation persistence, which may mean harsher conditions for already poorer regions,” Fadiran said.
He said administered prices are set and implemented via municipal administrative processes such as tariff setting, billing and enforcement.
Regions with lower economic activity tend to experience higher inflation persistence, which may mean harsher conditions for already poorer regions.
— David Fadiran, Ersa paper’s co-author
“Where governance capacity is weaker, administered-price inflation can embed inefficiencies in cost recovery, procurement and the management of technical or non-technical losses, which can translate into higher and more persistent administered-price inflation.”
Municipalities operating on the “wrong side of the curve” charge residents more than actual service costs while simultaneously losing capital through poor financial management, Fadiran said.
“The paper finds governance quality [municipal audit outcomes] effects on persistence are substantially stronger in the administered-price basket than the market basket, particularly in fixed-effects specifications — meaning governance is most consequential precisely where municipalities have direct pricing power.”
He said the paper’s position on how these dynamics play into headline inflation was cautionary rather than prescriptive, as the central implication is that a single headline print obscures substantial regional variation, so a monetary policy calibrated to national inflation may be simultaneously too tight for some municipalities and too loose for others.
“The paper argues that some component of regional persistence is rooted in municipal administrative processes that monetary policy simply cannot reach — suggesting the Reserve Bank should treat regional heterogeneity as an informational input into its strategy, and that structural complements [such as] governance reform [and] improved tariff administration are needed alongside conventional monetary tools.”
Similarly, municipalities, in setting tariffs, should be cognisant and perhaps also consult with the Reserve Bank in doing so, given this new understanding of the persistent nature of inflation in certain regions, he said.
The study says governance quality moderates this relationship, particularly in administered prices, while its effect is weaker in market-determined prices. Different inflation rates across regions may reflect local economic activity, the policies in place, market structures and supply-side shocks.
‘Notable disparities’
“These differences motivate the analysis of heterogeneous policy transmission. In South Africa, for example, the overall inflation rate varied from 7.2% in 2009 to 3.2% in 2020. Yet, over the same period, there are notable disparities between provinces, including municipalities,” Fadiran said.
“Take Limpopo province, for example, where the inflation rate reached a maximum value of 7.9% in 2016, compared to North West province, which saw the lowest rate value of just 0.6% in 2020. Municipal-level heterogeneity is also pronounced.”
The study says this may reflect differences in municipal governance and highlights the importance of understanding regional heterogeneity, as broad monetary policies aimed at managing the national average inflation rate may not transmit uniformly across regions.
“Governance inefficiency is often visible when municipalities set fee prices too high. If a local government increases fee prices beyond a certain point to cover administrative waste, it can lead to a shrinking tax base as residents and businesses flee,” Fadiran said.
“Municipalities can be deemed inefficient if they operate on the ‘wrong’ side of the curve by increasing the price of living in the city while decreasing total revenue due to capital flight. Governance structures also shape price dynamics in the broader market.”
The report says effective local governance fosters an environment where businesses can operate efficiently, facilitating quicker adjustments to supply and demand shocks that influence prices.
“As a result, the persistence of inflation may vary significantly between these two categories of goods, with governance quality playing a crucial role in determining the extent to which inflationary pressures are sustained over time.”
The report says municipal-determined prices exhibit higher persistence, suggesting that price changes in this category are stickier and that, once adjusted, these prices do not revert quickly.
“This aligns with expectations, as administered prices tend to follow regulatory cycles and may incorporate cost-based pricing structures that limit short-term flexibility. Market-determined prices, by contrast, exhibit lower persistence, consistent with the idea that competitive pressures drive more frequent price adjustments, allowing prices to revert more rapidly.”
It’s simply wastage and mismanagement of those municipalities … Weak management of those municipalities, which inevitably means high salaries to employees and tender fraud, leads to weaker economic growth.
— Dawie Roodt, Efficient Group economist
Upon the release of the consumer price index print for March, Stats SA head of price statistics, Patrick Kelly, said prices increased, on average, by 0.6% in March compared with February, and 6 of the 13 categories in the CPI basket recorded higher annual rates, including restaurants, accommodation, education, transport, housing, and utilities.
Fadiran said that in transport, the annual rate increased from -2.1% in February to -1.6% in March, as transport goods and services in general were 1.6% cheaper in March compared to March last year, mainly due to fuel prices declining by 8.7% over the 12 months and a marginal increase of 0.4% in vehicle prices.
Briefing parliament this week, minister of mineral & petroleum resources Gwede Mantashe said the government should consider intervention into the array of inflationary pressures that have added to the cost of living for households.
“If the price of water is increasing, it is not a function of the price of petrol that is increasing [the price of] water,” he said. “It is a different process, which means administered prices can be regulated and ameliorate the impact of the dip. All I’m trying to say to you is that we should use the poor to cushion the middle class.”
Efficient Group economist Dawie Roodt said the administrative pricing seen in low-growth economies is linked to weak management, poor leadership, corruption, and incompetence at the local government level.
“It’s simply wastage and mismanagement of those municipalities … Weak management of those municipalities, which inevitably means high salaries to employees and tender fraud, leads to weaker economic growth,” Roodt said.
He said it would be interesting to compare local inflation with that of headline national inflation, as this would be an indication of good management at the local government level and its role in localised inflation trends.
“It would be very nice if we could provide these inflation rates of the various local authorities and make it more publicly known so that it will be an instrument in the hands of the public to put pressure on the local political management to do a better job.
“The Reserve Bank, of course, is more concerned about overall inflation, because macroeconomic policy has to do with macro inflation or overall headline inflation and core inflation, not with the local areas specifically.”
Business Times approached the Reserve Bank for comment on the paper and the local government’s administrative-pricing role in inflation, but the Bank referred the publication’s questions to the authors of the paper.
Business Times
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