Friday, April 27, 2007

Globalization and devaluation

Over the past few weeks, two significant events have happened in the global market. The first is that the US dollar has weakened considerably against major currencies, reaching record lows against the Sterling and Euro, and secondly the Dow Jones Industrial Index (DJIA) passed 13,000 for the first time. The US economy has also been steadily weakening as a result of the housing problems.

The record level of the DJIA is supported by strong earnings growth of listed US companies despite a weakening US economy. As expected under economic theory the devaluation of the US dollar has led to greater earnings for US companies, as US produced goods have got relatively cheaper, and Europeans have been buying goods in the US. What this means is that US companies sell more goods, as a result of the devaluation, thereby increasing revenues and earnings. Costs would not have been impacted at the same pace as revenue increases.

Jamaica’s uniqueness
In Jamaica, however, we have found that devaluations have not been supported by greater export earnings. In fact the data between 2002 and 2006 shown in the graph, illustrates that export has not grown at the same rate as devaluations. The data shows that even when we have had significant devaluations this is not necessarily followed by strong export growth. Similarly, 2006 showed a strong growth in exports but the rate of devaluation was relatively low.

The question then is why countries such as the US show a close link between devaluations and exports. Additionally, why does the US show strong earnings report when the US economy is showing signs of slow down? In contrast, when the Jamaican economy shows signs of weakness it affects corporate profits. In Jamaica we have seen in 2006 that export of goods have grown 27.2% (US$453M) but the trade deficit widened by 14.1% (US$816.6M) as a result of imports growing at a faster absolute pace than exports, 19.2% (US$816.6M). This trend is a continuation of 2005, where imports grew by US$699.5M while exports grew at US$62.7M, resulting in the trade deficit widening by US$636.8M.

This was not the case in 2004, when imports and exports grew at the same absolute amount thus leaving the trade deficit unchanged. It is relevant to note though that between 2001 and 2006 the trade deficit has continually worsened, moving from US$1,618.2M to US$2,944.9M (82% decline) over the period. This in my opinion is the real number to focus on, when we are discussing growth, and not just the growth in the GDP number. This is the real reason for the massive increase in our debt even though we are celebrating growth. In other words, the economy grew by 2.8% in 2006 but at the same time we saw devaluation of just under 5% and the trade deficit worsened by US$363.6M. The question then is (1) how can this occur when we have recorded the highest growth rate in over a decade; and (2) what has caused this disparity between growth and a worsening trade deficit. After all one would expect that if one’s income grows then you should be able to have greater savings not find yourself in deeper debt.

High import content
The answer to this question is the reason why (1) US companies show greater earnings when there is devaluation and the US economy is weakening; (2) why we do not benefit from devaluation; and (3) our debt level is climbing despite growth. The problem is that our economy and major companies are not geared towards export, but rather relies heavily on the internal market. In addition, much of our goods and services produced are composed of a high import content, so that the more we produce the more we import. So even though the percentage increase in exports is higher than that of imports, imports outweigh exports by such a high amount that even a smaller percentage increase is much greater than the absolute increase in exports.

Additionally, what this points to is the fact that our economic growth is not being facilitated primarily by domestic input but by imports. Thus when the Jamaican economy is vibrant, and real growth experienced, based on the present arrangements of our production input factors, the growth we experience actually causes us more pain in the long run. For this reason when we grow we actually have increases in debt, as in order to grow we need to borrow more money to facilitate the widening trade deficit. This is the situation we face that can only be changed with proper strategic planning to ensure that we not only grow but replace foreign inputs with local ones.

In the US we find that companies are doing better as a result of the strong growth experienced globally. US companies are net exporters, that is local inputs are greater than any foreign inputs. So while they grow because of increased net earnings we grow in Jamaica as a result of increased borrowing to finance foreign inputs. Therefore, if we were to re-organize our production inputs we would find that we can positively affect our devaluation issues as well as the debt problem in the long term.

In order to do this we must look at the trade numbers and identify areas where we are deficient and develop strategic policies to address them. When one looks at the trade data, it shows that the greatest opportunities lie in the areas of food, mineral fuels, chemicals, manufactured goods, and machinery & transport equipment, which shows exports being less than imports by US$380M, US$1,491M, US$606M, US$682M, and US$1,108M respectively. Further analysis of course needs to be done in these areas to determine what value added the imports bring to the country but these areas should be the catalysts for developing a national policy for growth. This should be with a view to ensuring that growth is not merely accrue from borrowing money to encourage greater expenditure but real growth of Jamaican inputs. The area of fuels stands out, and shows the importance of developing a sound energy policy and transportation system that reduces the amount of fuel consumption. If we can achieve this then we can also address the problem of unemployment and real per capita income growth.

The data therefore shows that even though we had growth of 2.8%, the benefits of this growth is going to be short lived unless we can go further to develop our local inputs for inclusion in the growth of the economy, replacing imported inputs. This is no different from living a lifestyle of luxury off borrowed funds. In the short run growth in personal assets are possible from debt, but over the long term the debt has to be repaid.


Anonymous said...

It is very interesting Mr. Chung, how well you have delineated the problems faced by our beloved country, and the possible solutions thereto.

It leaves me asking many questions, among which I ask, 'cui bono?' (who benefits?) For if you know the problems and the possible solutions: what is preventing our 'esteemed' leaders from knowing the same.

You want to know what I believe, They just don't give a damn!

bill said...

Unfortunately there are a couple of 500 pound gorillas in the barroom which have to be dealt with before any rational approach to the trade deficit can be implemented.

First is the annual oil import bill which I calculate at around $1.9 billion USD or $130 Billion JA. PetroCaribe does nothing to help this, only defers some of the cost to outyears in the form of more debt. IMHO the only long term solution for this is the implementation of a nuclear power generation program with a corresponding aluminum production capability (viable with lower cost nuclear power) since solar, wind, biomass, and hydro are not going to have much impact.

The other big problem is the massive debt. If I read the budget figures for 2007/2008 correctly, it appears that the only way JA is able to allocate money to capital expenditures in the amount of approximately $39 Billion JA is to borrow that same amount on top of the $100 Billion already being borrowed to make up the budget shortfall.

Talk about a vicious circle!!!

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