Tuesday, September 30, 2003

Process re-engineering needed

The Finance ministry’s recent job freeze announcement is a clear indication that the government is either strapped for cash or is projecting difficulties. Either way the move is a welcome as it suggests government’s intention to meet its budget deficit target. This must not, however, be seen as the end all as it is only the beginning of the needed procedural reorganization. The government must now take this opportunity to implement the next step of process and personnel rationalization.

Process re-engineering
With that said though, the solution is not as simple as cutting jobs or remuneration as that could easily prove to be a counter productive move. Immediate cost savings cannot be interpreted as productivity or efficiency gains. For example, one could eliminate a process or person with a high value added and therefore destroy future income potential although ensuring short term cost savings. Because of this possibility the government must embark on a proper process re-engineering exercise to ensure the greatest advantages. They could in fact conclude that in order to earn the desired income they need to spend more.

It is clear that there have been initiatives to improve government’s service delivery as interactions with front line government staff are a lot more palatable. This experience is however not where it should be because of the procedures and systems that are still in place. This is the area of greatest opportunity for service improvement and reduction of waste.

Unproductive time
To illustrate this I would like to cite a recent experience I had with renewing my driver’s license. I arrived at the Constant Spring collectorate at about 10 AM and was met by a very courteous gentleman who enquired about the purpose of my visit and provided the form for me to complete. He then took the form from me, stamped and signed it and directed me to the cashier. Up to that point I felt obligated to pay for the renewal because of the refreshing service. He then directed me to the driver’s license renewal section. On arriving there, I noticed a gathering of persons who were obviously waiting to complete their renewal. The frustration was obvious on their faces and I immediately began to wonder what went wrong between the reception / cashier area and the twenty seconds it took me to get to the renewal section.

I turned in my old driver’s license along with the receipt and was told to wait for a picture to be taken. I waited for approximately 40 minutes before being called and then took the picture. I did not wait for the license as an earlier discussion revealed that it would take at least another 40 minute unproductive wait.

It occurred to me that there were some 50 persons there at the time, who were waiting for approximately 1.5 hours each, which equates to 75 hours of unproductive time. It is therefore quite possible that up to 400 hours of idle time could have been spent in that particular section on that single day. If we assume that this day was unusual and only 2/3 of that time is lost per day this still translates to 1,340 hours per week of unproductive time being wasted on the renewal of drivers’ licenses at one collectorate. If the relevant information is included for various collectorates and other sections then the number of unproductive hours lost to inefficient systems is tremendous. Is it any wonder then that the country’s productivity is so low? This means that Jamaica has to produce more per labour hour during the productive times than international competitors. The implication for businesses is that they have to pay a higher rate per output even though the rate per hour may be less than our global competitors. Simply put Jamaicans are working more for less.

Alternate process
In contrast to the present system I made some quick observations about what could be introduced to reduce this problem. I had no problem with the persons as they seemed courteous and customer driven. An improved system could easily be implemented as illustrated below, with no significant investments.

On paying the renewal fee the cashier should have taken all relevant information and a unique number be generated for that receipt. That number would be transferred electronically to the renewal section and would also act as the service number. The renewal section would have two processing sections, one for taking photographs and the other for printing and delivering the finished driver’s license, instead of the one area that does everything. They would still use the same office space but divide it into two sections. This division of labour would have been more susceptible to handling transaction volumes.

You would then hand in your receipt and wait to take the photograph. All the information would have been entered at the cashier and so would not have to be re-entered as is currently being done. When your receipt number is input then your picture would be taken and applied to the template that comes up. The fact that a re-entry would not be done would save approximately five minutes.

Instead of someone calling out your name, there would be a number service system that would be wall mounted and persons would proceed in that order as it changes. This would save another five minutes of persons leaving their desks to go and call out a person’s name. It would also improve the delivery efficiency.

On taking your picture you would then go to the next door where you would pick up your license. This would result in the greatest time savings as I observed that the same persons calling out names were the same ones taking the pictures and printing the license. The process of switching between tasks is itself time consuming as well as the fact that multi-tasking is not as efficient as a concentration on one process. If one more person was added to the process then there could be at least two persons dedicated to printing with the current three taking pictures. This would save at least 20 minutes per transaction.

Based on the preliminary observations made above savings of 30 to 40 minutes per transaction could be made by just adding a link between the systems and employing one or two more persons. On the other hand this would save the country approximately 890 hours per week or 46,454 hours per annum of unproductive time from one small section. It seems to me that any up front investment from improving this process would be worth it. Deeper analysis could improve this return on investment even further.

In concluding we need to understand that the move to save short term cash flows is just the beginning of the road and what is needed is a long hard look at the processes we are working with. The aim should always be long term rather than short term implications.

Tuesday, September 23, 2003

The Truth About the Gaming Tax

Since the introduction of the 15% winnings tax on lottery games there have been many representations re the reduction in income and the negative consequence this will have on the industry and future tax revenue inflows. Some have even said that the tax will cause current government intake to fall significantly.

Illegal Market
There is no doubt that revenue intake by the lottery companies have declined, which is estimated to approximate 40%. Anyone who understands the gaming market would have predicted this effect, as there is a significant illegal gaming market, which has no doubt become much more attractive to the player as odds increase relative to the legal game. After all the illegal operator does not pay any taxes and usually has much lower overheads. The payout can therefore be higher. Similarly the player will not have to pay any winnings tax from the illegal bounty. It is a given that the tax will contribute to the growth of the illegal gaming market. We also need to remember that the drop pan game already has an illegal structure in place that existed for decades before the legal game. It is therefore not difficult for players to move back to that structure.

Government Revenue
The government is aiming to raise an additional $1 Billion by introducing the tax, while some are saying that the government will in fact realize less because of the reduction in revenue. It has been suggested to me that the advisors do not understand the gaming market and are therefore projecting incorrectly. Is this actually so? The only way to answer this is to look at the numbers based on the current fall off in sales and the contributions made to the government coffers.

The table portrays the 2002 revenue and tax structure based on information released by the Betting Gaming & Lotteries Commission.

The table shows the payout percentages to the winner and the various government agencies. At the bottom is the weighted average payout percentages based on 2002 revenues. From this we can compute what the government intake was and what it will be with a 40% fall off in revenues.

The second table compares the taxes under the old and new systems assuming a 40% revenue decline. This illustrates that even with a 40% revenue reduction the government agencies will collect $200 Million more than in 2002. This will be significantly less than the $1 Billion projected but will still be greater than the intake before the tax. An additional 5% decline in sales would, however, result in the government raking in less than before the introduction of the tax.

The tax will also redistribute moneys from the productive private sector to the government. If for comparison purposes we assume that salaries and other direct compensation to vendors amount to 10%, then the revenue fall off will cause a steep decline in moneys available for employment, directly and to vendors. From international studies we can also assume a multiplier of three times for earnings from the industry, which means that the $1,191 Million would become $3,573 Million in earnings. After the tax we could see that reduced to $2,145.

Charities (CHASE) will also receive substantially less. This implies a need for further support of charities from government and the private sector. Routing these funds to charities via government will have administrative costs, meaning less per dollar reaching the charities. Direct payments will always be more efficient.

Impact on the Economy
The immediate negative impact includes reduced employment and business activities. Ultimately this may result in lower corporate tax collections. In this example taxes would reduce as potential earnings fall from $3.6 to $2.1 Billion.

This analysis shows that although the government will collect more direct taxes from gaming operations, the overall net tax collections may be less because of:
- Less PAYE from reduced employment;
- Less profits tax from reduced company income levels; and
- The move to illegal gaming will mean greater expenditure on enforcement.
In addition to these factors, there is also the consideration that potential investments may not be realized because of the change in the payback ratios and the uncertainty of the rules. Also, the tax could possibly cause a prolonged stagnation of the gaming market.

The question to be asked is, have we measured the opportunity cost of introducing the tax? The tax may have been a short term solution, but what is the medium to long term implication. Already the tax will not have the desired revenue effect because of the revenue fallout, and in fact will not add much more. Added to this there may be a significant indirect negative effect on other future cash flows. Have we done the right thing to introduce this tax? I guess at this point only time will tell.

Friday, September 19, 2003

Pensions and inflation

There has been much talk recently about the expected inflationary outturn for 2003. The Bank of Jamaica expects that inflation will be in the region of 13%, higher than the single digit inflation projected at the start of the year. This should be of importance to persons who will reach pensionable age within the next ten years.

High inflation environment
In a high inflationary environment pensions are always significantly affected as happened during the period of the early nineties. Inflation has caused many pensioners to be bordering if not below the poverty line. Between 1990 and 2002, the Bank of Jamaica numbers show that we have had cumulative inflation of some 294 per cent, which was reigned in only by the single digit inflation from 1997 to 2002. There are not many persons that would have seen their wages keep pace with that type of inflation and thus their pension would also suffer, as it is tied to wages. In fact, in order to beat inflation, the pension investment would have had to be returning in excess of 22 per cent compounded during that period. Not many pension funds were consistently showing that sort of return.

The pension regulations in seeking to protect the investment, does place restrictions on the type of investments that the trustees can participate in. These are usually safe investments such as government paper and certain blue chip equities, which will not give the same return as riskier investments. With that said though, this is a good thing as if there were no such restrictions there may have been serious consequences resulting from the 1990s financial crisis, as many more pension funds may have been seriously eroded.

Credible inflation numbers
In a recent article Raymond Forrest questioned the credibility of the published inflation statistics. There has been some doubt surrounding what is included in the basket of goods used to measure inflation and whether it has been updated to reflect the current trends. I don’t know what the truth is but if the published numbers are in fact lower than the reality then this will only serve to hurt the pensioner further.

Pensions are usually tied to wages and annual increases usually guided by the officially published inflation statistics. In addition, if we are not honest with ourselves as to what the true inflation numbers are then this will lead to a false sense of security as to the expected returns from the pension investments.

Defined contribution versus defined benefit plans
There are basically two types of pension plans, defined contribution and defined benefit.

The defined contribution plan is where the amount of the pension contribution is set as a percentage of wages. The employer usually matches the amount put in by the employee up to ten per cent of salaries. On retiring the employee will receive actuarial payments equivalent to the contributions plus the returns based on the investment gains over the period. Under this plan the pension is not guaranteed and in fact could be nil if the proper investments were not made.

The defined benefit is where the employer will guarantee a payment amount on the retirement of the employee. The risk of any deficiencies in the pension plan is borne by the employer. This exposure is one reason why some companies will not consider this plan, as in a high inflationary and unpredictable environment it is difficult to project what the company’s exposure will be. The result is that the risk of inflation is left to the employee. In some industries with a naturally high turnover rate, this exposure is reduced as the persons leaving will create a surplus in the pension plan that can be used to offset any deficiencies in the future requirements.

International Accounting Standard (IAS) 19, which deals with Employee Benefits, clearly makes this distinction and requires separate accounting treatments for both types. One of the disadvantages of IAS 19 for companies with a defined benefit plan is that it requires an actuarial valuation to be done each year for the annual report. A recent discussion I had with a representative from a pension company informed me that a $100 million pension will cost anywhere between $300,000 and $500,000 to prepare a valuation. This is an added cost to the company and for that reason he said that some companies were moving away from the defined benefit plan. On the other hand the argument can be made that this valuation is necessary to protect the members and also provide accurate financial reporting, as without this disclosure a company could go belly up without adequately protecting the employees’ pension.

A high inflation model will therefore significantly affect pensioners as it did in the 1990s and create a wider disparity between the wage earner and the person with capital. The long run effect is that the quality of life will decrease for many and there will be a greater dependence on state resources.

Even with a low inflation model, however, employees need to understand that the more popular defined contribution plan will not allow them to replace their income on retirement. Companies must shoulder the responsibility of educating their employees about other methods of savings and so remove the reliance on pension plans.

Some of the issues surrounding pensions will also be addressed in the new regulations being introduced. In the final analysis though it is up to the individual to protect his/her future income by paying close attention to their pension funds and saving in other ways during their working life.

Friday, August 29, 2003

Accounting Rules and the 1990s Financial Crisis

Subsequent to Enron, questions were raised as to the possibility of a similar occurrence in Jamaica. The failures at the time were widely attributed to the American accounting rules (GAAP) leading to much debate about their adequacy.

Proper accounting by itself would not have prevented the crisis, as inappropriate management has more to do with integrity and competence than rules. It would, however, have highlighted the problems early thereby ensuring that proactive solutions are implemented. In Jamaica, some believe that this could not have occurred because our accounting standards provided a greater measure of protection than American GAAP.

While it could be argued that our accounting rules are stronger, I am not convinced that it could not have happened here. As a matter of fact, it is my opinion that we have already seen the likes of Enron in our financial meltdown of the 1990s, especially in light of the irregular practices that existed. During this time, many financial institutions collapsed because of existing reporting methods as well as weak regulatory execution by the authorities. This in no way excuses the failure of management, but the question to be answered is why did it take so long to uncover the problems? No amount of rules will prevent failure but proper regulations will ensure that it is detected much earlier.

The Financial Gleaner of August 15, 2003, carried the first in a five-part series on the 1990s meltdown and lists in chronological order the reasons for the failure of the various financial institutions. The list included almost 20 financial institutions that were affected and included names such as National Commercial Bank, Mutual Life, Century National Bank, Life of Jamaica and Eagle Commercial Bank.

International Accounting Standards
The same article referred to the deficiency in the process of dealing with loans past due, and also significant deteriorations in the asset base of the institutions. There is no question that reporting was taking place, which no doubt came to the attention of the authorities. However, as the situation worsened the banks were still reporting profits and carrying assets at their original values, giving a false impression of what the real worth of the companies were. It is apparent that there was a loophole with our accounting standards as we were reporting on historical trends rather than providing the public with information about the future.

This led me to wonder if we would have experienced the crisis in the same proportion had we introduced International Accounting Standards ten years earlier. I focus on the extent of the crisis, as I believe that the practices contributing to it would still have resulted, as the regulatory arm seemed to have been slow in recognizing and addressing the problem.

I believe that the public might have been better warned if International Accounting Standards were being used as it is a value based accounting approach rather than the historical cost accounting that was in place at the time. This would have forced companies to reflect the true values of their assets and would show up in reducing profitability and equity base. The focus of International Accounting Standards is on Future Cash Flows and, therefore, addresses the future viability of the company in a more significant way than the Jamaican accounting standards.

IAS 36 and 39
The two standards of most relevance to this issue are IAS 36 (Impairment of Assets) and IAS 39 (Financial Instruments). These standards seek to apply fair value measurements to the assets of organizations and require that any losses or impairment of assets are written off either against the profit or directly to equity. Both standards require that if the fair value measurement of the asset is materially lower than the carrying value in the accounts then the difference should be written off against profit or equity in the year of the impairment/reduction of the asset’s value.

This application would have provided more accurate information to the investing public and the authorities and could have significantly increased the chances of curtailing a sizeable amount of the public debt that is now wreaking havoc on our economy. The amount of debt we carry today resulted primarily from the 1990s financial crisis as well as FINSAC. The effect of creating FINSAC was to transfer the losses (asset reduction) that would be recorded under fair value accounting from the balance sheets of these institutions to FINSAC and ultimately the public. If we were using International Accounting Standards then a significant amount of those losses would already have been shown on the company accounts and we would have been better prepared for the problem that ensued. This is a major reason why the projected debt problem was significantly understated.

Indications of Impairment
Both standards refer to indications that an asset has lost its value and these include the following, which were clear indicators during the 1990s:

“Significant financial difficulty of the issuer” of the instrument and “…high probability of bankruptcy or other financial reorganization…”(initial failure of some institutions should have led the others to look at the value of what they were holding);
“…default or delinquency in interest or principal payments”;
“a historical pattern of collections of accounts receivable that indicates that the entire face amount of a portfolio of accounts receivable will not be collected”; and
Significant changes in technology, market or legal environment. For example, the liberalization of the telecom industry would no doubt have led to a reduction in the estimated future cash flows of the Cable and Wireless infrastructure subsequent to other players being introduced.

These are just a few telltale signs that should have been obvious to us in the 1990s pointing to the fact that disclosed asset values would not have been realized. If these principles were applied at that time then we may have caught the problem $100 Billion before it imploded.

Lessons to be learned
What lessons can we take away from the 1990s? Certainly, the need for proper accounting rules and application are critical, as well as a strong regulatory environment, which has since been significantly improved. This means not only applying the rules but also paying some attention to the accountant. Some persons look to their accountants as they do religion. In other words, just as they find religion when their backs are against the wall, they find their accountants in similar situations.

The newly introduced accounting standards do go a far way in addressing some of the issues that resulted in our high debt costs and needs to be understood and practiced by all. Some may say that accounting matters are to be left to accountants, but accounting is merely a way of objectively measuring performance and projections. It must, therefore, be treated with the importance that it deserves.

Let us remember that it was a general weakness in our reporting and regulations that led to the extent of the debt crisis that we face today and will continue to affect our children.

Friday, August 15, 2003

Towards Greater Efficiency

I have heard on occasions persons in the private sector refer, both publicly and privately, to the inefficiency of the various government processes. The word inefficiency seems to have become somewhat of a cliché for some people and is used freely to explain every situation. A recent experience I have had with two government ministries has led me to question the source of inefficiency.

Over the past few weeks, the Managing Director of my organization and I have had reasons to interact with the Ministries of Agriculture and Finance. On one of those occasions, he intimated that the reason for the seemingly inefficient operations in Government is, in many instances, a result of the behaviour of the private sector. This led me to reflect on what we had experienced over the preceding days in dealing with these ministries, which, for the most part, was pleasant and fulfilling. In fact, our particular problem emanated from inadequacies in the communication between the private companies involved, thus, causing us to call upon the Government for a speedy resolution at short notice.

Despite this short notice, the Government personnel were able to deal with our problem expeditiously without any complaints. I found that their willingness to meet our needs was driven by their desire to satisfy the market.

I thought about Government personnel with whom I have been in contact over the past two years and the professional and courteous manner in which they have dealt with various issues. I am in no way saying that the service level is where it should be but, in my opinion, that has more to do, today with the archaic systems than the personnel. The truth is that the Government bodies have been gaining in efficiency.

There is no doubt that the business processes in Jamaica require far too much interaction with Government bodies which, in many instances, have arduous rules to follow, but beneath all of that is a reason for the procedures. Much of the seemingly difficult rules put in place by the Government have resulted from the private sector’s own actions. In many cases, we try too much to “beat the system”, and many times boast about the successes in doing so.

Many will, no doubt, have heard references to persons who will try to “beat the gate”, even though the function being attended is free. This type of behaviour is not restricted only to the man on the street, as many businessmen will try to buy favours, even when it costs more, in the long run, to beat the system than to do the right thing first time around. They are always trying to get ahead by bending the rules in their favour but, if someone else tries to do the same thing, they themselves will publicly call for that person’s head. This is not the only source of inefficiencies in the systems, resulting from the “red tapes” put in place by Government, but also our lack of international competitiveness, as we do not seem to have what it takes to compete fairly.

My own experience with Government has also made me aware that the reason Government bodies put legislation and rules in place is to ensure that the private entities (companies and individuals) do not take unfair advantage of a situation. The problem with our society is that the “beat the system” mentality seems to be so (pervasive?) that it has become a way of life for many. To counter this type of behaviour, therefore, the Government, in many instances, has had to put procedures and rules in place to prevent the abuse of the system by some to the disadvantage of others. This has resulted in having processes, which are both time-consuming and inefficient. Hence, the build up of a slow-moving and unfriendly investment environment, which hinders serious investors.

Our private sector has called, time and time again, for protectionist policies and has only taken advantage of those policies without adding any real value to the economy, thus, questioning our inability to survive globally, when this protection is lifted. This is, however, not the case in all situations, as some industries do need protection but, in some cases, the intention is not about national development but rather self-interest. This type of behaviour develops from the individual level where, for example, we will go into a bank and head to the front of the line and ask our friend for a favour, or we speak highly against indiscipline but refuse to pay our monthly housing maintenance fees or rent.

One of the problems that have contributed to the proliferation of this type of behaviour is our outdated laws, which are unfriendly towards investment capital and, ultimately, development. Over the years, Governments have placed band-aid solutions on this by offering incentives to certain investments, but this will not work, if we are serious about development, as we need to apply fundamental changes to our underlying structures, if we are to effectively deal with the problems.

We have seen the benefits that can accrue to us from a competitive and well-regulated market from the examples of the telecommunications and media industries. The introduction of multiple players has resulted in increased economic activity and greater benefits for all. This would not have been possible, however, without the efforts of the Broadcasting and the Fair Trading Commissions to ensure that there is a level playing field for all players. These are the models that we need to emulate in the development of other sectors.

The Government must continue to lead the change process, as they have been doing, as the private sector may not be capable of doing this effectively, due to self-interest. The Government has begun the process of change and this is evident by the type of persons they employ and the increasingly efficient ways in which issues are addressed. There is still a need for improvement in many areas but, over the past few years, the wheels have been turning in the right direction.
The private sector needs to be cognisant of the role they must play in the country’s development and, in this process, towards greater efficiency.

Friday, August 01, 2003

Problems with inner cities

Recently during a workday, I was driving along Spanish Town Road, from Three Miles to Downtown. As I was traveling, I noticed several empty buildings that once boasted some of Jamaica’s most successful/productive entertainment centres and businesses. In addition to the wasted real estate, I noticed many young men and women loitering on street corners, evidently searching for something to occupy their time. A conversation I had with one person revealed that most, if not all, would love to have the opportunity of employment.

It suddenly hit me that this is one of the reasons for our current economic condition. The real problem of the inner city emanates from the extensive idle resources they contain. These resources are potential business establishments and productive labour that are going to waste. What’s more, the situation worsens with each passing day. How can any nation or company survive in a competitive environment, if it does not fully utilise all of its available assets? Yet, we have been trying to compete with other countries that fully utilise their productive resources.

The problems facing us as a nation are primarily:

1. Idle real estate that lies in many inner city areas because of crime, as well as neglect by the relevant authorities over the decades. These properties, potentially, are thriving businesses that could be employing thousands of persons; and
2. Increasing idleness of our human resources, particularly, in the inner city.

Both these factors are wasted resources, which, as long as they are idle place a greater requirement on the productive sector, as the wants and needs to be satisfied remain relatively inelastic.

In my opinion, the productive employment of these resources is certainly one way of more evenly distributing the tax burden. For example, take two companies with assets valued at $100. If company A invests the whole $100 at 20% per annum it will earn $20 over a year. If company B invests only $70 and leaves $30 unused, it will have to realise a return of approximately 28.5% to earn that $20. Similarly, in our situation, we are competing against countries using a higher percentage of their productive base, both in terms of real assets and labour. In order for us to compete effectively, we, therefore, must realise a higher rate of return on our assets.

A review of statistics on the population and the economy reveals some interesting points. Our total population has increased while our labour force in absolute numbers and as a percent of total population has decreased, moving from 44.52% in 1997 to 42.86% in 2002.

The implication of this is that we have less persons working to support an increasing population. Over this same period, there has been an increase in the average US$ weekly earnings from US$145.50 to US$173.08 - a 19% increase. Similarly, the total earnings over the total population has increased from US$64.78 to US$74.18, a 14.5% increase, over the same period. The implication is that the work force was, on average, earning more in real terms in 2002 than in 1997. Other implications include a growing young population, increased dependence on the breadwinner and, more importantly, a greater concentration of wealth in the hands of the working class. Whatever the fundamentals are, it translates to a decrease in the productive population.

I deliberately neglected to imply an increase in productivity, as while earnings per capita has been increasing, there has been a decrease in real GDP growth. How is this possible since greater earnings should imply more productivity? I would propose that the increased earnings have more to do with increased debt levels rather than productivity. Over the same period of declining GDP, we have seen significant increases in the debt, moving from J$196 Billion in 1997 to J$497 Billion in 2002.

The implication is that increased earnings are stimulated through the injection of borrowed money. It is only recently that we have seen any growth in GDP and, even so, it has been marginal and equivalent to earlier declines. This means that debt is being used to create earnings without any productive assets to support it. Thus, the debt is being channeled significantly towards consumption, rather than capital investments. On the other hand, it could be argued that the debt was necessary to spurn consumption and positively affect growth, which will inevitably feed on itself.

This situation again follows the argument above regarding the underutilisation of property and human resources. Here, we are again underutilising financial assets. In all areas, we seem not to be using our resources in the most productive manner. This problem may be as prevalent in the private as in the public sector and it may do well to do some research in this regard. The Government seems to have recognised this, and is attempting to address it through its public sector modernisation programme, but is already at a disadvantage as decades of cultural and infrastructural acceptance of waste is difficult to overcome.

Apart from the non-use of assets, we also have been placing emphasis on industries that have long become unproductive and uncompetitive, thereby not using our assets in the most effective and productive way.

Whatever the approach, we must put to productive use the many idle and unproductive resources existing in the inner city. This necessitates a shift in the social and economic paradigm of the country. If we are not able to fully leverage our assets and make them productive, then we are already at a disadvantage in a global environment.
It is within this context that the work of the Kingston Restoration Company is critical to the future of our country and the Government and private sector must be applauded for the effort being placed on this venture. The Government has also shown its intention to focus on the renewal of the inner cities, which can only be beneficial for the country and should be supported by all. If we can address this, focus effectively, then many of our economic and social problems will be resolved.

Friday, July 25, 2003

The Necessity for Established Rules

I have often thought of the potential Jamaica has for meaningful development. This idea has consistently been echoed by various commentaries. Ever since my awareness of current affairs, I have always heard references to Jamaica’s potential for tourism, agricultural crops, reggae music, etc. This has led me to think about why we have not been able to realize this “much talked about” potential and why we always seem to be on the brink of a breakthrough but never attaining it. There is no denying that Jamaica is truly blessed with natural resources and a resilient people and could easily be first class in areas of natural competitive advantage.

In my experience, the development of a country can be easily related to that of a company. Why do some companies succeed to become large national or multinationals and yet there are others that are not able to expand beyond medium to large size? The development of a company to national or multinational status depends primarily on two things:

1) People and
2) Established rules and procedures.

Multinationals usually have strict policies and procedures that must be adhered to and rewards are usually based on set performance criteria and not left to the subjectivity of any one person. Companies that always seem to be on the brink of national growth but never attaining it, usually have a dominant personality who seeks to direct everything and stifles the initiative of others. This dominant personality is usually instrumental in the start and initial development of the company but restricts the company from growing further because no action can be taken without his/her input.

Similarly with a country, established laws and rules are needed to allow the players to exercise their initiative in their own areas. Importantly, however, the rules must be stable. In other words, the players must be able to make long-term projections without fear of any changes to the rules of the game while they are playing. The consequences of actions also need to be predetermined so that the potential outcomes are evident. In addition, rules must be relevant to the objectives that one is trying to achieve.

It seems to me that this is one of the primary problems we face as a country. This problem did not begin with this Government but has always been in existence. In fact, in my opinion, the present Government has made a far greater effort to update the antiquated colonial laws than any other but still faces an uphill task because of the long period of inaction in this area. In short, the problem that we have suffered from is that our antiquated laws have no relation to the objectives that we are trying to achieve as a country.
Many of our laws still refer to the discretion of ‘the Minister’ and so the development of industries usually relies on the mood or will of an individual. Many years ago, this was acceptable but today this reliance on an individual leads to a bottleneck for progress.

It is for this very reason that multinationals and first world countries have established rules that apply to everyone. It would be impossible for their own control and survival to rely on anything less. This is a consequence of development, that is, less reliance on individuals and more on systems and controls, which is the only way to monitor and reward progress.

Jamaica suffers immensely from this problem. On the one hand, we desire economic growth and ever so often it seems as if we are about to but we are restricted because we do not allow private sector initiative to flourish. Too often, the rules change at the drop of a hat. There is no certainty about what will happen after its occurrence and so we plan for the short-term aware of the fact that we could be playing by different rules later. The consequence is that many companies experience a difficulty in making long-term plans and commitments.

No one will invest seriously in Jamaica unless they are assured of stability. For that reason we will attract persons seeking to make quick profits in the services or trade industries or seeking to make a quick return from our relatively high interest rates but no serious investments in capital goods.

The present regime has sought to provide some form of stability in the market and has been fairly successful in doing so in the areas of inflation and exchange rates. The Government must be applauded, as these are very important to corporate planning. The problem, however, has been that this has been achieved at the expense of maintaining relatively higher interest rates than our international competitors.

The effect of the high interest rate policy is two-fold:

1. High interest rates prevent entrants with little or no capital, which either comes from equity or debt, as they will not be able to afford debt financing. The result is a restriction of the entrepreneurial initiative; and
2. High interest rates encourage low risk interest bearing deposits, thus discouraging productive investment.

These two factors have combined to cause the erosion of our productive sector and made us primarily a service and trade-oriented economy. These factors have been compounded by the uncertainty of the legislative and social environment, resulting in uncertainty in the economic environment. This is the primary reason for the continued decline in investments in capital goods by private entrepreneurs.

Businesses already have to grapple with the uncertainty of markets and consumers and so will shy away from countries with high political and economic risk. The political and economic risk can only be minimized by assuring investors of the relevance and stability of the rules by which they will be governed. In today’s global environment, we cannot afford the luxury of this type of uncertainty. We must conform to global practices and ensure that we develop and maintain a business environment that will provide the type of long-term stability that investors require.

Friday, July 04, 2003

Defining Third World

Interacting with government agencies is one of the most frustrating activities one can face. Every time I face this ordeal it reminds me immediately of our third world status. The definition of third world in my mind does not have to do with the type of industries we have but the way we execute our socialization and business processes. We can be financially successful in any activity we choose but this depends significantly on the method of execution.

I had a recent experience with the tax office, which demonstrated only too clearly this concept. I went to replace a motor vehicle title that had been lost. The process started with a trip to the Half Way Tree police station to make a report. This was a rather pleasant experience. I was directed to the office responsible for this. On entering I was asked immediately by a lady what the problem was, who expeditiously dealt with my report. A few weeks after I made a trip to the tax office to complete the transaction and was told that the other person named on the title had to be there in person to sign the application. This of course meant waiting a few more weeks as it was difficult for the both of us to find the time. When this was finally possible, it was discovered that the person’s name had to be changed on the motor vehicle registration as the tax office had mistakenly left off the hyphenated extension to the person’s name. I was then sent to another desk to correct the error. On completion I was directed to another point to get a substitute document. On arriving there I was told that I had to pay a fee to correct a mistake made by the tax office. I protested on a point of principle as the documents were correctly presented to them and it was therefore their error, only to be told that the error was made by the Cross Roads office, which was separate from Constant Spring and if I didn’t want to pay I had to go back to Cross Roads. For your information, these are branches of the same agency.

After protest I eventually got the replacement done without being charged. I then had to go back to the original desk to have the documents stamped in order to pay the replacement fee at the cashier. When I got back to the cashier I was told that I needed to be in possession of the insurance certificate for the car, which did not exist because the insurance had been up on the car for a while. A supervisor came to my rescue and allowed the transaction to go through after much explanation. The end result of all of this is that a transaction that should have taken 15 minutes ended up lasting for one hour during which time I went though various emotional stages.

This experience prompted me to think that this is the reason why we are a third world country. The difference between a first and third world country has everything to do with the ease of carrying out transactions and daily living. How can we as a nation be serious about development when so much time is wasted with experiences such as these? At the same time I was there I heard a man cursing that he was just trying to pay some money to close down a business, as he was frustrated with the process, and even the act of paying much needed revenue to the government was difficult.

It is this bureaucracy that it helping to stifle our development. The problem I find is not necessarily with the people who carry out the daily functions at the government agencies. There has evidently been a wide scale introduction of people trained in customer service in the various government agencies. The problem is that these very same persons are restricted in what they can do by the rules and processes that act as a noose around their necks. They obviously do try to assist and the frustration is also evident on their faces. Very soon these people will fall into the mode of inefficiency and we will have to start all over again.

Customer service does not change because new computers and policy manuals are introduced. The most important part of any system or technological improvement depends on people. If we set up a system where the natural talent and discretion of employees are restricted by the rules then the system will be as inefficient as before the change. The problem in many instances is because the same administrators that existed before the changes are the same ones retained, with the same mind set in many cases. System improvement emanates primarily from a change in the way of thinking and skills. Our present government bureaucracy is based on the principle of “guilty until proven innocent”.

The same is true for the private sector. There are many companies that do not understand what service is. When you call them you get this new and improved telephone answering system that provides a grand tour of the office extensions and after you have wasted 15 minutes trying to get someone you are then placed on hold for another 5 minutes. At the end of it you feel as if you have just been afforded a privilege to spend your money.

This is the main distinction between today’s large organization and tomorrow’s international corporation, and is at the heart of our inability to compete internationally. The cumulative effect of the bureaucracy of government agencies and the internal inefficiencies of companies result in very high cost structures.

How then do companies such as Grace Kennedy and Jamaica Producers Group compete so effectively on an international scale? Only recently these companies were facing challenging times and have made remarkable recoveries. I also remember that it was on the basis of human capital that IBM saved itself from extinction. I know because I was working at IBM at the time of the reorganization.

The difference with these companies is that they hire and reward good human resources. This is the same model that can be found in the Fortune 500 companies around the globe. In today’s world it is the quality of the human resources that is going to give any company a competitive edge. If you can think of one good employee within your own company, think how difficult it is to replace that person and what it would be like if you could not rely on that person. The cost of sub-standard human resources is much higher than properly rewarding good people. Most persons will realize this only after the person has left the company.

The next time you think about why Jamaica is a third world country, it is because of the long approval process to start business, the dependence on personalities to complete transactions, the corruption that exists, the lack of service within private companies, the need to be aggressive on the roads, the frustration to pay taxes and the preference of a friend over expertise for a job. In short it is the lack of productive human capital and the resistances to properly reward excellence and build our organizations on human resource talent that make us third world.

Sunday, June 15, 2003

Economic Impact of Gambling

The debate on gambling in Jamaica is one that will not go away, as gambling is inter-woven into our economy. Many are still not aware of the current and potential benefits of gambling. I, for one, was not aware of this until my involvement in the industry between 1998 and 2002, when I served on the Betting, Gaming and Lotteries Commission (BGLC).

Many argue that gambling is immoral and that it increases crime. While I agree that gambling does have some negative impact, I do not believe that the activity of gambling itself creates crime. Crime is driven by deviant behaviour, referred to repeatedly by the Prime Minister as ones “values and attitudes”. Furthermore, if we examine the impact of gambling in Jamaica and cite examples from other countries, we would see that gambling creates much greater benefits than disadvantages. In fact, the National Gambling Impact Study Commission (NGISC) report shows that in the United States alchohol and drug dependence and abuse are significantly higher than pathological gambling. The findings are that over a lifetime the percentage of the adult population susceptible to alcohol abuse was 23.5% , as against 11.9% for drug abuse and 5.4% for problem gambling.

In 2002, estimated earning from legal gambling in Jamaica was $17 Billion, of which lotteries accounted for $12.4 Billion and horse racing $4.6 Billion. In 2001, the figure was $9.4 Billion. The increase resulted primarily from the games introduced by Supreme Ventures Limited (SVL).

There is the view that Jamaicans are spending a significantly greater amount of their incomes on gambling to their detriment. This is not necessarily so as increased earnings from gambling result from what is known as the churn. In other words, SVL games are played twice per day, six days a week. This means that someone who bets $100 on Monday and wins in the morning will bet the winnings in the afternoon and so on for the week. With the lottery played twice per week that $100 would be bet on Wednesday and any winnings could only be bet on Saturday when it might have been spent otherwise. This is similar to the economist’s explanation of the multiplier effect of money.

The increased earnings create a positive economic impact as it results in increased contributions to taxes, good causes (charities) and increases in direct and indirect employment levels. GDP currently approximates $370 Billion, which means that earnings of the gambling industry approach 5% of GDP. This is not an insignificant contribution and shows that many depend on the industry for their livelihood. A recent BGLC release estimates that over 20,000 jobs are directly or indirectly generated by the gambling industry. Add to this the multiplier effect, and we could be approximating at least 60,000 persons.

Caymanas Track itself is a small town with bustling daily activities leading up to the race day anticlimax. There are 67 Off Track betting stations and 560 betting shops owned by the 15 bookmakers. In gaming there are two large companies, SVL and Jamaica Lottery Company (JLC), providing employment for hundreds of persons either directly or indirectly through their 1,300 sales outlets and administrative offices. The industry has the unique privilege of employing labour island-wide. Additionally, there are many service and product providers doing business with the industry. An economic impact gambling study undertaken in South Africa shows the GDP multiplier effect at 3 times, that is, every $100 generated by the sector produces another $200 through indirect and induced effects. The employment multiplier was found to be 3.15. Jamaica has no official numbers on this but I have no doubt that it could be similar.

In addition to the employment benefits, there is the tax and good cause contributions. Good cause contributions include education, health and sports development. In the area of sports development, one of the most significant contributions has been made to the Sports Development Foundation and ultimately the Reggae Boyz campaign to France 98. Many curse gambling but enjoy and boast about the benefits. In fact, the lottery games contribute approximately 7% to good causes, which in 2002 amounted to some $870 Million. Additionally, between lotteries and racing an average of 7 – 8% was contributed to government taxes, resulting in $1.2 to $1.4 Billion in direct tax contributions. In addition to all of this, these companies pay statutory contributions and profits tax.

A recent Sunday Observer (June 8, 2003) article revealed that in first quarter of 2003 Government earned $18.75 Million in gaming machines fees, and estimated that if all machines were brought into the net, earnings would be $150 Million annually.

There have been many references to the extent of illegal gambling in Jamaica, which seems to persist without any control or revenue benefit and carries with it uncontrolled levels of problem gambling. It is my opinion that proper regulation will not only serve the interests of Government but that it will also improve the lot of illegal operators as they will have the ability to properly market and expand their operations.

Two recent international racing events gave us an insight into the contribution we could expect from a well developed and regulated industry. The first is the recent Belmont Stakes in New York, where a horse called Funny Cide was making its bid to be the first horse in 22 years to win the Triple Crown. Funny Cide did not win, but this single race attracted some 125,000 spectators at the track alone. It was also televised and bet on internationally. At the same time, the English derby attracted some 20 Million Pounds in bets on the race alone. Seven percent of this (representing contribution to Government taxes) would be 1.4 Million pounds (J$134.4 Million). This could significantly benefit the health and education sector as well as the sports industry.

We must get serious about developing a well regulated and first class gambling industry in order to realize the full potential. Internationally, gambling is no longer seen as a scourge on society and is today an integral part of the entertainment industry. In particular, casino gambling is an important part of tourism worldwide. The official statistics shows that our tourism arrivals have increased over the years but per capita tourist spending reduces each year. In the Bahamas, on the other hand, the number has been increasing. The Bahamas, despite having a well developed casino market, has a much lower reported crime rate. Casinos can potentially increase foreign exchange by increasing the take from tourism.

In true Jamaican style, we never take on any one industry and become the world leaders. We created reggae music but have allowed other countries to exploit it financially, to a great degree of success. Similarly, why are we not the regional, if not world, leaders in tourism with our indigenous culture, natural beauty and people resources ? We must realize that our competitive advantage is mainly in the entertainment and tourism industry of which the gambling industry is a critical part of that. An expanded and well regulated gambling industry can only serve to increase economic activity and benefit Jamaica as a whole.

Sunday, June 08, 2003

Jamaica’s Debt Dilemma

The main crisis facing Jamaica today is the stranglehold of the public debt. The debt ballooned from $45.8 Billion in 1991 to its present level of over $601 Billion at March 31, 2003 and now approximates 140% of GDP at current prices. At this date, the external debt was $235 Billion and the internal debt was $366 Billion or 39.1% and 60.9% respectively. The massive debt stock has been the primary cause of our economic woes, resulting in a reduced standard of living and Jamaica’s increased global uncompetitiveness. The 2003/04 budget projects that debt servicing will be $169.5 Billion or 64.8% of expenditure, up from $152 Billion and 63.6% in 2002/03. The trend has been for debt servicing to devour a greater share of the budget with each new fiscal year. It is evident that if this continues there will be a consistent reduction in the money available for government spending, which will have devastating consequences for the country.

The 2003/04 budget expects to amortize $90 Billion and add $116 Billion in debt. In 2002/03 new debt of $122 Billion was added and a similar $90 Billion amortized. This is definitely not the desired direction as this alone will add another $26 Billion in debt this year. Another consideration is the US$ denominated debt, which totaled US$5.4 Billion on March 31, 2003 when an exchange rate of 56.24 was used. Today the exchange rate is 60, adding another $20 Billion in debt. The debt increase from these two factors alone will be some $46 Billion in this fiscal year.

Assuming stability in all other factors and dead on estimates, we will achieve a debt stock of $647 Billion by March 31, 2004, or a 7.65% growth rate. The outturn will most likely be an additional $11 Billion in debt servicing in 2004 (if amortized over 10 years) before any other adjustments to expenditures. In short we must of necessity achieve growth in order to satisfy our expenditure needs next year or face massive cutbacks as it is not possible to excavate anymore tax revenues from the existing GDP levels. Growth can only come from private sector investments and an improvement of the trade deficit. Growth will of course depend on the comparative trade off between productive risky investments versus the paper non-productive paper investments we have become so well acquainted with. Productive investments will only be realized if interest rates are low enough to encourage risk at the expense of safe investments.

Of the total internal debt $189 Billion is at variable interest rates. The implication is that the recent increase in interest rates has also increased debt servicing requirements and we may well exceed the 64.8% of budget allocated for this purpose. For every 1% increase in interest rates an additional $1.89 Billion per annum is needed for debt servicing and every $1 deterioration in the exchange rate adds $5.4 Billion in debt. This means that a 35 cents movement in the exchange rate equates to a 1% movement in interest rate on the internal debt, based on our present debt structure. The government therefore finds itself delicately juggling between exchange and interest rate movements to minimize the effect.

This is the dilemma of our debt crisis. The choices we face are:
1. Do we reduce interest rates (and at what pace) causing greater devaluation, inflationary pressures and significant increases in the debt, or
2. Do we maintain a high interest rate policy to stabilize our exchange rate and further erode our productive base?

The debt maturity profile (Table 2) shows that within the next 1 – 5 years we will be faced with significant amortizations, requiring high levels of revenue. It is important to note that the majority of the US$ debt amortization will not take place until 10 years time. This means a high risk exposure to movements in the exchange rate for the next 10 years. The debt’s voracious appetite for cash over the next 5 years necessitates consistent and increased future cash inflows. This can only come from new investments, again requiring lower interest rates. It is evident that some amount of debt restructuring must be done.

The powers that be need to undertake detailed projections and properly examine the financial and social consequences. Nothing short of this type of analysis will suffice. The fact is that if we do not immediately address this problem we will face dire consequences. Our focus must be on our long term economic sustainability. Any chosen highway will carry some amount of hardship. There is no painless option and we must consider what is less painful in the long run, that is the lesser of the evils. Leadership must have the courage to look beyond the next one to five years. This is going to require serious long term planning and a factual realization of what must be done.

It is not as important where we are today as the direction we are moving in. The government needs to undertake a detailed long term financial plan for the next five to ten years and provide the details to the country in order to restore much needed confidence. The plan needs to:
1. Be credible and bought into by all. The government must include all sectors to be a part of the review process;
2. Include a plan to retire more debt each year than is added. If we continue adding greater amounts of debt than is amortized then we will be in a continuously worsening situation. Our debt will no doubt grow over the next year but we must have a plan to reverse this trend in the following years; and
3. Include the retiring of US$ debt at a faster pace to neutralize the effect of exchange rate movements when interest rates fall. In other words a restructuring of our total debt stock.

We have to accept the fact that growth can only be accompanied by productive investments, which need lower interest rates as an impetus. It will always be a more feasible option to go for lower interest rates while making a conscious effort to reduce our foreign currency exposure through overseas debt reduction and import substitution.

A country cannot close down as companies can and will always survive no matter the extent of the suffering. Many have always commented on the potential that we have as a country to move forward and I too believe so. It is time to turn that potential into reality through the involvement of state, private sector and the public at large in the pursuit of a unified objective, as we are all in this thing together.

Friday, May 16, 2003

Assessing the Causes of Recent Devaluations

The recent slide in the exchange rate is certainly cause for concern. In Jamaica, rapid devaluation of the currency is inevitably followed by periods of high inflation and significant decline in our standard of living, mainly because of our high levels of importation. It is even more worrying as the usually effective high interest rates do not seem to be having the desired impact. This necessitates that we find an alternate solution to the problem.

We may also conclude that too great an emphasis was placed on exchange rates and inflation, as these are merely symptoms of the underlying problems. The Government has used high interest rates successfully in the past to arrest the exchange rate and inflation by restricting the supply of the J$. Traditionally, we have seen an approximate 10 per cent per annum devaluation. What then has caused the recent freefall in the exchange rate?

Between January 1 and May 9, 2003 there has been an 18.74% devaluation of the J$ against the US$, moving from an exchange rate of 52.98 to 60.73. Over the same 2002 period the devaluation was 1.29%, moving from an exchange rate of 47.55 to 48.08. The 2002 trend was consistent with that of the late 1990’s to 2001. In fact, Table 1 shows that over the same period there was an accumulated shortfall between purchases and sales of US$51.15 Million and US$97.51 Million in 2003 and 2002 respectively. The numbers show that there has been an increased supply of US$ and a greater satisfaction of demand in 2003 over 2002.

Table 2 shows the downward trend of interest rates over the years. Up to the late 2002 all were hopeful that interest rates would have continued the downward trend and drive much needed investments. It was not until immediately prior to the 2003 budget that interest rates were substantially increased. This increase in rates would have typically caused some amount of stability in the exchange rate.

What then could have caused the current devaluations in the J$? The trade numbers (Table 3) show that the deficit has consistently worsened and in particular there has been an increasing decline in exports recently. At the same time imports have been increasing year over year since 2000. Despite this, the Government has maintained a relatively stable exchange rate. Despite exports falling we have managed to increase US$ supply through remittances from nationals overseas, an increasing informal economy, and the conversion of US$ to J$ to take advantage of the relatively higher interest rates, especially with the fall in interest rates in the United States.

The continued erosion of the trade deficit would have ultimately led to devaluations in the value of the J$ but does not explain the sharp depreciation. This suggests that there is a more fundamental problem that has been causing the sharp devaluation in the dollar since the start of 2003. The following factors have supported the decline:

1. Consistent high interest rates have created a significantly larger supply of Jamaican dollars in the market with no corresponding increases in goods or services. The result being more money chasing less goods and services, ultimately leading to inflationary pressures;
2. Investors have shifted from real investments to investments in paper to benefit from higher risk free returns, thereby restricting re-investment in productive ventures; and
3. The increasing importation of raw materials and declining exports is symptomatic of the higher import inputs in our products and services which have led to less value added in exports.

Despite these underlying problems, they should not be sufficient drivers of the current rapid devaluations. There are some who believe that our dollar is overvalued and this recent spate of devaluations is a process of “catch up”. While there may be some overvaluation of the dollar, the high interest rates should be enough to prevent swift devaluations, as we have not had any fundamental shift in the measures.

It is my opinion that the primary cause will not be found in the historical numbers but rather in the rational expectations of the economic players. The problem we have is one of confidence. Business persons are rational economic thinkers and act based on future expectations. The announcement by the Minister of Finance prior to the budget that the fiscal target would not be achieved, and the higher than expected debt, was the first blow to confidence. Subsequent to that nothing has been done to show that steps are being taken to fuel the growth of business. It is, therefore, clear that the first step for policy makers is to re-gain investor confidence by demonstrating a credible development path. If the future prospects are not promising then we will continue to have an exchange rate problem. Until we solve the confidence problem then we will continue to face behavioural challenges from the players.

Traders have argued with me that there is a shortage, but I would like to propose that this is not so. The significant sector demanding the US$ are dealers, who are demanding it to cover short positions. This is happening not because there is any real need for the US$ but rather because there is a lack of confidence in holding J$ positions. The apparent shortage arises because everyone wants the US$ at the same time and cannot get it at the desired rates.

Investors do not act on the basis of today but rather on future projections. As the Prime Minister has said, what we need is an understanding between all players in the economy so that we can move forward together. This means that there must be trust and support for each party to that “contract”. This cannot come from written understandings but must be played out in the consistent actions of each stakeholder. The market system will eventually determine the behaviour of individuals. We need to remember that economics is a social science that relies on the rational expectations and behaviour of people.

What is important is not where we are today but the direction in which we are moving, which has to be consistent progress. The Minister of Finance has the ability to gain the trust of the business community as he has done in the past. He must once again get us back on that path of economic growth and stability.

Friday, May 09, 2003

Alternatives to Government’s 4% Cess

The introduction of a 4% cess on imports by Government is currently the most disturbing issue to business leaders. This is understandable as it will have a devastating effect on businesses (even those that are exempted) and the economy as a whole. While Agricultural and some manufacturing entities will not be required to pay the cess directly, they utilize the services of companies that will bear the burden of the cess. If these companies are operating on small margins or are unprofitable they will have no option but to pass on this cost to their clients/customers.

In a previous article in this publication, I highlighted the negative implications of the cess on companies’ profitability. I further propose that we will also see negative effects of the cess on the economy such as:
· Reduced company profitability and ultimately lower tax revenues to government. This is be compounded by the fact that the additional 2 – 3% cost of capital may prove too much for some businesses to remain operational.
· Reduced investments as overseas and local investors will have to face an added cost which will no doubt make Jamaica less attractive in comparison to its competitors in other regions;
· Increased unemployment resulting from business closures or cost cutting measures. This too will ultimately lead to lower tax revenues and increased expenditure on social support programmes due to increased unemployment;
· Increased international trading uncompetitiveness; and
· Increased costs to sectors such as tourism, as hotels will no doubt have to increase rates to compensate for the added costs generated by the imposition of the cess.

While many agree on the negative impact of the cess, there is no doubt that the government needs additional revenue to service our ever-increasing national debt. The Minister of Finance has said this in no uncertain manner and it is a fact that we cannot ignore. It is obvious that the cess has been introduced as a measure to provide a credible source of revenue for our creditors and to save us from the consequences of not being able to service the debt. I also agree that there is not much to be salvaged on the expenditure side of the budget, as debt accounts for 64.45%. There has to be a credible revenue source, as the fact is that if revenue is not forthcoming this year then there may not be a next year to speak of.

If we agree that additional revenue is necessary and savings from the estimates of expenditure will not be substantial, then is there an alternative to the cess? Not only do I think that there is a more credible alternative to the cess, but I also believe that failure to find an alternative will have serious consequences. We all agree that the only way to solve our problem is through production. The cess will have the opposite effect on production, and create its own future revenue problems, and so we need to find another solution to this tax measure.

What is needed is an alternative to achieve the same revenue objectives and will not be as counter-productive as the cess. A credible alternative revenue source was proposed by Mrs. Ethlyn Norton-Coke at a recently held ICAJ public forum. Mrs. Coke posited “Abolishing personal income tax (with a ceiling on the income exempt…) and increasing GCT to 25%...which is more equitable…as all persons would be brought into the tax net.” GCT is not only a difficult tax to avoid but is also more efficient than income tax. It is difficult, for example, for the informal economy to avoid GCT and easier for the authorities to collect this tax. In addition, the tax dollar collected from GCT costs less than that collected for personal and company income tax. The authorities expend less effort to prove a GCT liability, as it is a simpler tax to monitor and compute. The added implication is that expenditure in tax collection could be reduced.

The additional GCT that could be collected from this effort can be easily computed from the tax breakdown (2002/3) provided by the Budget Memorandum. PAYE accounted for 22% and GCT 26% of tax collections, or $22.6 and $26.78 Billion respectively. This means that if we were to increase GCT to 25% then this would mean adding some $17.85 Billion to GCT, which is close to the amount from PAYE. This would be without the broadening the GCT net.

If PAYE were removed then this would also have the effect of reducing companies’ administrative cost and also removing the cost of companies’ contribution. This would ultimately result in greater profit margins / consumption and thus higher taxes, so that although the direct impact is less than the 22%, there is an indirect revenue flow that could make up for the shortfall. I am also proposing a reduction of the PAYE rate to 5%, which would mean income of $4.52 Billion, an amount greater than the $3.4 Billion to be collected from the cess. There should also be a commitment to totally remove PAYE, which would again spurn greater consumption and increased GCT. Within the year we would cover our revenue position and within 2 – 3 years increase it while increasing consumption.

The question may be asked, what will happen to the persons employed by income tax that will no longer be needed. There is no doubt that some would be absorbed by GCT but many could be employed in the private sector, as companies would not have the added cost of PAYE administration and contributions. Companies would employ persons to increase their productivity, which they are currently restricted from doing because of the high cost of labour. Increased revenue to companies and individuals would no doubt encourage consumption that would fuel more investments and ultimately higher tax revenues, in the short to medium term, as is being done through tax cuts in the United States.

This alternative would have the following advantages over the cess:
1. It is a credible revenue source and in the long term is more sustainable than the cess;
2. It is a tax on consumption and not production and while consumption may contract locally it leaves the producer with the option of international markets at a more competitive price;
3. It will not inhibit new investments compared to the effects of the cess;
4. The cost structure for sectors such as tourism will not be adversely affected and
5. Employment may be increased as companies would be able to afford much needed labour.

In all of this we need to remember that we should not tax production as the effect of this is ultimately disastrous.

A Note on the Debt
In 2002/3 we paid out $152 Billion in debt payments, of which $90 Billion represented principal amortization. We added $122 Billion to the debt stock. In 2003/4 we estimate that we will pay out $169.5 Billion, of which $90 Billion will be principal amortization. We estimate that we will add $116 Billion to the debt. The trend is that we are adding more debt than we are eliminating. In 1990/1 the total debt stood at $45.8 Billion. Today it is $601.2 Billion. What will be the debt position in 2004/5? Will we need additional revenues to address this? This further supports the point that we need to produce our way out of our debt problem and so short term solutions such as the cess will not help. We, therefore, need long term planning and measures to stimulate profitable growth or else 2003/4 will be nothing compared to 2004/5.

Friday, April 25, 2003

Impact of the 2003/2004 Budget on Companies’ Profitability

Now that the new tax package has been announced, it is time for companies to examine its impact on their operations. The question is, “What are the additional costs of operations and how attractive are the investment options?” The measures that will affect most companies are:
· 4% cess on imports;
· 20% GCT on telephone charges;
· Assets tax increase and
· Removal of tax credit on bonus shares

Cess and Telephone Tax
The Minister of Finance in his presentation stated that, “From the perspective of the importer who systematically files returns, this cess would have minimal impact, only so far as it affects his cash flow.” What companies will need to examine are the various effects that this will have on their operations, as the cost of money differs between companies. Whatever the extent of the impact, it is certain to be negative.

The Minister is correct in saying that the measures will affect cash flow. The effect on cash flow and, ultimately, operations could be devastating. The table below shows a typical company, with revenue of $100 per month, a cost of sale of 50% and other costs of 40%. It further assumes that this company invests approximately $200 every quarter in capital goods, imports 80% of cost of sales and has telephone expenses of 2%. The imposition of the 4% cess and additional 5% GCT on telephone charges will reduce this company’s net cash flow position by more than half.

This may be seen as a timing difference as the tax can be recouped in the tax returns at the end of the year and the GCT is reclaimable the following month, but the implications are much greater. Effectively, the company’s cost of capital has increased and a comparison must be made against other investment options. If the company is unable to claim the tax until the following year (for whatever reason) then the additional cost of capital will be approximately 5%. The recent press conference by the Minister suggests that companies will be able to claim this against quarterly filings, which is good, but what of the companies who are carrying forward a tax loss. They will be left with the additional cost of capital and ironically they are the ones who will need the cash flow most.

In our present environment, it would be better to take the additional cash and invest it in bank deposits making 30% before tax. In a rational economic environment, the company would reduce (or eliminate) the quarterly investments in capital goods and place that additional cash in relatively risk-free cash deposits, based on current rates. The implication for the economy is that we may have reducing long-term investments, as companies may only keep cash for working capital purposes. Furthermore, when it comes to retooling, the rational investment decision may be not to reinvest.

The new tax measures, therefore, is not simply a matter of cash flow but becomes a matter of capital and investment decision. What has effectively happened is that the Government will receive a loan to be financed by the private sector, which will be paid back at the time of the tax returns being filed. If we follow the 70:30 ratios, this means that the government will have to raise funds to replace the 70% of tax collections at the time of the returns being made.
The argument put forward by the Minister is that “…of the real economy only 70 per cent of activities are included in the tax net. All are agreed that we must seek to bring this additional 30 per cent into the tax net.” No one will disagree with the intention, but the method seems to create more problems than it will solve. Why stifle the 70% to get at the 30%? What may happen is that the 30% will be brought in at a cost greater than the additional collections, as many companies will not be able to afford an additional 5% on their cost of capital and there will be reduced capital investments.

In addition, new entrants to the market may be even further restricted. It might have been a better solution to increase General Consumption Tax (GCT) and eliminate income tax, as we would achieve the purpose of capturing more of the informal economy and equating the tax burden for the existing taxpayers, as was suggested at the ICAJ forum on April 9th.

These measures are also going to increase the tax burden on the current PAYE taxpayers. Companies may have to increase prices to deal with the increased cost of capital and increased GCT, which will negatively impact consumers. We will, therefore, see a direct impact on inflation from the tax measures announced. The combined factors of reduced investment and increased inflation may in turn have the undesired effect of reducing consumption and economic activity, thereby reducing future tax collections.
It is evident from the reaction of private sector leaders that the confidence needed to drive the economy forward is being eroded. What has been presented are stop-gap measures that cannot be maintained, if we want long-term solutions to the economy. It is similar to a company seeking short-term working capital funding, until revenue inflows become stronger.

The only problem is that we have a “Bridge Financing Budget” without the prospect of the increased revenue flows being outlined. In addition to the above consequences, the following will also have to be considered:

· How are companies that are already making losses or who have tax losses carrying forward, to be compensated? Will this cess increase the tax loss or is a cheque to be reimbursed to companies on a timely basis? It is necessary that this be clarified so that companies can make projections to determine what their options are
· The administration of this cess will no doubt cause the income tax to become an even more inefficient tax. What is the return on the tax dollar from implementing such measures? Will the cost of administering the tax be more or less than the additional revenue collected? What of the increased operational cost to companies of administering this tax?

Tax Credit on Bonus Shares
The removal of the tax credit on bonus shares may also have the effect of reducing investment in capital. Companies may now find it more prudent, in light of lower returns, to pay out profits by way of dividends instead of reinvesting in capital through bonus issues. What this means is that the company who wants to expand may be faced with more expensive funding.

There is no doubt that the new tax measures will have a negative impact on the cash flow, and effectively a company’s cost of capital. This may mean reduced capital investments and profitability. In the long run, this will result in lower economic activity and tax revenues. Companies will have to go back to the drawing board and take another look at their investment options, as the option of business activity is now even less attractive compared to holding cash deposits.

Thursday, April 17, 2003

The Economy’s Performance: An Accountant’s Perspective

Jamaica’s economic performance has been the most hotly debated topic over the past few years. Measurement of economic performance is similar to the way we approach analyzing our own company’s prospects, as many indicators can be compared to the ones utilized by businesses.

Economic Indicators Equivalent Company Indicators
Balance of Payments (BOP) & Trade Financial Statements
Money Cash Flow
GDP and Income Sales
CPI Cost Structure
Labour Human Resources
Debt Ratio Debt/Equity

It is necessary to find objective measurements to arrive at consensus re the underlying problems, which is the first step to finding solutions. Over the years there have been too many emotive analyses of our economic situation and what needs to be done.

I will attempt to do an analysis from an accountant’s perspective. I am not able to reason based on the complicated models our economic commentators use frequently, as the only higher economics learning I have had is from my sixth form teacher, Mark Figueroa (UWI) and Richard G. Lipsey.

The web sites of the PIOJ (www.pioj.gov.jm) and STATIN (www.statinja.com) carries statistics of various aspects of the economy (1997 – 2001), which can be used to examine historical trends and give an indication of where we are heading.

Trade and Revenue
A look at our Trade account shows that between 1997 and 2001 total imports increased by 7.6%, of which consumer goods increased 10.5%, raw materials increased 15.1% and capital imports declined 14.2%. On the other side traditional exports declined 5.1% and non-traditional exports declined 26.3%. The fiscal side shows total revenues increasing by 13.6% (recurrent by 5.9%) and total expenditure increases of 11.2% (recurrent up 21.6%, capital down 3.6% and debt servicing up 76.6%). During this same period increases occurred in the CPI by 38.7%, current prices GDP by 39.1% (constant prices by 1.6%) and GNP by 32.4%.

The above statistics reveal that production and growth increases are fueled by debt. It is also worrying that the increase in GDP, caused by increasing production, does not have at least a corresponding increase in recurrent revenues. One implication of this is that although earnings are higher, there may be no corresponding increases in recurrent revenues as companies are much less profitable. This results in lower tax collections. Additionally, higher revenues are being driven by inflation and not increased productivity or consumption. The country is experiencing what companies saw in the mid 1990s, that is the cost of debt exceeds returns. The declining capital imports imply that retooling is not taking place thus making us even more uncompetitive. The increased raw material import suggests an increasing make up of imported raw materials in production. It would be very interesting to see what portion of exports comes from local value added.

Money Supply and Inflation
The money supply indicators shows increases (1997 – 2001) in M1 by 58.4% (1999 -39.5%) and M2 by 52.7% (1999 – 20.4%). There is, however, no higher productivity to back these increases. In fact money supply increase has surpassed inflation. A look at the numbers reveals that this may have been one of the fundamental drivers of inflation as is shown in the following table.

The table shows that money supply increase always exceeds the inflation rate, with the exception of 2000, when this was preceded in 1999 by significant increases in money supply. Additionally, the 11.48% increase in the exchange rate in 2000 was preceded by the 39.5% and 20.4% increases in M1 and M2 in 1999 and coincided with a sizeable increase in the NIR. What’s more, money supply has increased by rates way in excess of real GDP growth. The implication is that we have created money, with no productive backing, and in fact the exchange rate and inflation changes are caused primarily by increases in money supply. This increase in money supply has been affected by the high interest rates that we have entertained, which in itself creates money, without any corresponding increases in goods and services. The question then is, is inflation and exchange rate movements not caused primarily by money supply increases and not inflation caused by exchange rate movements?

As a country we have had a preoccupation with inflation, coming out of the regime in the 80’s and early 90’s. Inflation is not necessarily an indication that the economy is deteriorating, but may also indicate that the economy is growing rapidly. What we need to determine is the type of inflation we are having. If inflation is caused by productive earnings increases outpacing the availability of goods then it may mean that we are having significant growth, which needs to be controlled. On the other hand, we have inflation caused by increased money chasing lower output. In fact, we could even have deflation caused by reducing income levels (productivity), which would be a bad thing. What is of great importance is stability, wherever that level resides.

Labour and Population
Over the same period, constant prices per capita income has been stable. This means that there has been no real increase in income levels earned by people, and in fact is somewhat consistent with our relative stability in GDP. The education statistics show that between 1997 and 2001, enrolment in primary institutions increased 9% and secondary institutions increased 4%. Over the same period, enrolment in tertiary ones increased 195%. This means that fewer people are able to access secondary education, even though more persons leaving secondary levels are entering tertiary education. This is supported by the increase in training output at the technical and managerial level and decreases in the skilled and semi-skilled categories. This will negatively affected labour productivity, as secondary education is crucial to productivity of our labour force. It is important to factor these numbers into any industrial plan we develop.

Any company in our economic position would not have favourable prospects. Serious analysis and planning would be imperative to address the underlying problems. Businesses, faced with inflationary pressures, have had to increase prices so as not to be overwhelmed by an increasing cost structure. This has resulted in more expensive produce, without any value-added increase.

The reality is that even if we are to experience real growth in all sectors over the next five years, we may find ourselves in the position we were five years ago. This while our international competitors have been experiencing real growth. Before we can solve the problems we first have to agree what they are. I am not sure what the best solutions to our economic problems are, as I am not a trained economist, but from a layman’s perspective I know that we cannot continue to spend more than we earn. Maybe we need to ask the real economists to stand up and not be detracted by the village economists. For too long we have treated symptoms and ignored the illness. Our first priority then remains the need to admit the problems before we can agree on a strategy to address them.

Friday, March 21, 2003

Incentives and Labour Productivity

A previous article by Mr. Geoffrey Messado examined the need for a revision of our current incentives in order to make a more direct positive impact on labour productivity. Mr. Messado illustrated that Jamaica’s productivity increases were way behind that of similar developing countries over the period examined. The following table summarizes the productivity illustration:

Labour Productivity Increase (1960 – 1990)
Singapore - 386.6%
Barbados - 118.9%
Jamaica - 18.8%

It is therefore no wonder why we remain in an uncompetitive position in the global market, resulting in our continuing economic woes. Our labour productivity is so far behind that it seems highly improbable that we will earn our way out of our economic difficulties by utilizing our labour resources.

Over the years we have had numerous incentives, which are aimed at encouraging investments and exports. The question asked by Mr. Messado, which we need to answer is has these incentives worked and if not why not. The website of the Planning Institute of Jamaica (www.pioj.gov.jm) shows the following statistics between 1997 and 2001:

Unit 1997 1998 1999 2000 2001
Average weekly earnings of all employees (1990 J$) J$ 177.2 881.9 869.1 277.7 n/a
Exports as % GDP (current) % 21.4 19.5 18.4 18.5 17.0
Imports as % GDP (current) % 49.4 46.9 44.4 46.0 41.0
Income per capita (constant) J$000 7.5 7.4 7.3 7.4 n/a

These statistics show us a picture of our labour productivity and highlights that our current incentive schemes are not bearing the fruit we expected.

The JAMPRO website (www.investjamaica.com) categorizes incentives under the following industries:

General manufacturing
The Information and Communication Technology sector

I will look at these incentives and offer some analysis on their relevance to our competitiveness. This is based on the information taken from the JAMPRO website, which I thought was most appropriate to use as this is the country’s investment promotion arm.

General Manufacturing / Textiles
The site states that the manufacturing sector employs about 90,000 persons or 9.4% of the employed labour force. The sector earned in excess of US$2 Billion in exports in the years 1993 – 1997 (the web site refers to these years as the last 5 years, which means that this site has not been updated since 1998 and this is Jamaica’s Promotion Agency), where textiles and apparel is the major revenue item. Export growth has slackened since 1996 due to trade liberalization and price stabilization. It further states that since 1993 more than US$3 Billion in consumer goods have been imported.

This shows that the sector is not competitive as trade liberalization has had an impact on the performance of this sector. What has happened is that we are producing for export markets based on special contracts etc. but not on a competitive basis and at the same time we are importing more than we export.

The incentives listed under this sector are:
1. Export Industry Encouragement Act – “To qualify under this act the manufacturer must be an exporter of manufactured products.” It further states that the business must be designed to export to earn hard currencies “therefore, the CARICOM market is not usually the focus of the exporter”.
2. Jamaica Export Free Zone Act – to qualify a manufacturer must ensure that all transactions are conducted in US currency in addition to the fact that they are located within the free zone area. Some firms outside of the free zone may qualify. To get free zone status a company must (i) be registered under the Companies Act; (ii) export at least 85% of its production, and (iii) receive an approval from the BOJ.
3. Accelerated Depreciation / Special Capital Allowance – “upon qualification, a certified business is granted a special allowance of capital expenditure for 50% of the full cost of any new machinery in the year of purchase, and a further 50% in the 2nd year.”
4. Bauxite and Alumina Industries Encouragement Act – businesses engaged in “the mining of bauxite or production of Alumina in Jamaica automatically qualify for import duty concessions on capital goods, lubricating oils, grease and other chemicals.”
5. Petroleum Refinery Encouragement Act – relates to registered oil refineries where they can import articles for construction and refinery operations duty free. They are also exempt from paying income tax or tax on dividends (this was repealed on public companies which indicates when this site was last updated) for a period of up to 7 years after which he has 6 years to carry forward net losses incurred during the period.

“Investor’s who invest in Jamaica’s agricultural and agribusiness sector can benefit from the following incentives and support services:
· Approved farmer status, which guarantees income tax and import duty concessions for up to 10 years for exporters;
· Income tax relief for a specified period of time…..
· Import Duty concessions on the importation of pick-ups and trucks used exclusively for agricultural purposes.”

This sector can also benefit from the pre-clearance facility.

Motion Picture Industry Encouragement Act – recognized film producer can benefit from income tax relief for a period not exceeding 9 years after the first release of a film. Can also benefit from an investment allowance of 70 per cent of total expenditure on production facilities for carry forward. May also be exempted from payment of certain import duties.

Information technology and Communication
1. Export Free Zone Act – allows “tax exemptions. Duty free import, repatriation of earnings, and minimized customs procedures for companies” operating in designated Free Zones.
2. Export Industry Encouragement Act – “provides duty free importation of raw materials and capital goods, and a tax holiday on profits for 10 years.”
3. Moratorium on Duties – “allows investors without free zone status to pay their import duties over an average two year period.”
4. Telecommunications – “companies in the IT sector can with Single Entity Free Zone status can apply for licences to provide their own telecommunications.”
5. Training – companies can benefit from training grants.
6. Accelerated Depreciation / Special Capital Allowances

1. The Hotel Incentives Act – 10 – 15 years income tax and duty relief is available to new and existing hotels under this act.
2. The Resort Cottages Incentives Act – under this act up to 7 years relief from income tax and import duty can be obtained by resort cottages.

If these incentives offer such an attraction to investors such as training assistance, income tax, duty relief and accelerated depreciation, why then has there not been a flood of investments coming to Jamaica? Why is our trade deficit growing and we are becoming increasingly more uncompetitive?

1. A look at the incentives above reveals that there are some inherent problems with them. Mr. Messado stated that there needs to be a clear set of guidelines existing to create an objective measurement for qualification. Bureaucracy and subjective measures must be removed in order to allow businesses to have a realistic expectation of qualification.
2. JAMPRO may also do a great job of communicating these incentives overseas but how much is known about these incentives locally?
3. The incentives frequently refer to export earnings as a means of qualifying, while at the same time that we focus on export earnings imports are rising at a faster rate. What is the sense of increasing export earnings if all we are doing is sending our current production of goods and services overseas and consuming more imports locally? Mr. Messado pointed out that the best period for labour productivity was between 1954 and 1969 when the emphasis was on import substitution. It is obvious that the current incentives are only addressing a part of the equation as shown by the amount of imported produce at more competitive prices than our local produce. The JAMPRO web site states that “the CARICOM market is not usually the focus of this exporter”. This is said even though Trinidadian products can be found in great quantities within the region. I would never have thought that US$ earnings from CARICOM is of any less significance than those earned in the US. We can also be more competitive in these markets because of the CARICOM agreements.
4. It seems also that Jamaica needs to provide many incentives because our present business environment is not friendly to the investor. Having to provide so many tax breaks and grants is saying to the investor that we are in a hostile business environment and therefore we need to provide incentives for you to invest. This suggests that our business environment is not suitable for competitive business practices globally. What then of those businesses that do not qualify for any incentives?
5. The granting of incentives in specific industries almost gives the government a hand in determining which sectors do well and which do not. Government has to get out of the business of industry building through incentives on a sustained basis. The private sector should pick winners not the government. If the business environment and opportunities are right then investments will happen. One reason that the incentives nay not be working is because enterprises with the best returns are outside of the industries qualifying for incentives. These incentives have been around for a while and the environment has been constantly changing.
6. The incentives do not encourage productivity but rather deals with general objectives such as total exports. Additionally, it does not even measure a quantum of exports but rather a relationship to local production. Although a company exports it may be lose money, but as long as the investment has already been made then it will continue to operate while covering its variable costs. Incentives may even make the business profitable in the short to medium term but at the point of retooling the numbers may not add up. Therefore the present incentives may not encourage sustained investments.

Government needs to re-examine the current incentives and determine what objectives they are trying to achieve. Once identified (should be sustained long term growth) then they need to identify incentives and shape them around those objectives. This means that incentives need to be constantly under the microscope to meet any changing objectives. The fact is that the current incentives are not geared towards addressing productivity. Labour in Jamaica is extremely unproductive. Apart from being unproductive the cost of that labour is too high, that is terms of the value it provides. The ten percent in taxes that employers have to pay to employ labour is prohibitive as is the cost of replacing labour with more productive methods (i.e. redundancy payments). Additionally, the low skill and education level of labour in Jamaica can only attract industries where labour is compensated at minimum levels.