Wednesday, November 07, 2007

Importance of fiscal discipline

The World Bank and IMF projected that global growth reached a peak in 2006, and from hereon we will start to see lower growth levels. It is still expected that China, India, and Russia will lead the way, having grown 11%, 9%, and 8% respectively in 2006, which accounted for half the world’s growth. Global growth is also burdened by the sub-prime situation in the US, which has already seen write offs around US$30 Billion, and expected to be between US$60 Billion and US$250 Billion. The wide range in the estimated write offs is evidence of the continuing uncertainty, which does more harm than the actual losses itself.

There is no doubt that that global events will affect countries such as Jamaica, as we are seeing with the liquidity crunch and rising oil prices. How much it affects us though will depend on how we approach the management of our internal affairs. Over the past few years the global economy has seen high growth levels, and because of the management of our own affairs we did not manage to benefit from that growth. Similarly, while the global market is going through a challenge, it is still expected that countries will still see strong growth.

Hedging our risks
What is important is that we recognize the risks to our economy and seek to hedge against any issues that may surface. Jamaica in particular has quite a large exposure to the global situation because we are seen as closely aligned to the US dollar. This of course is because we have 25% of our exports going to North America, 75% of tourists coming from there, and 75% of our external debt is in US dollars. Naturally therefore Jamaica’s main exposure is to the US dollar rather than the Euro and Canadian dollar. In addition, we see where our oil bill is approaching 50% of our total import bill, and oil prices are expected to rise further, at least in the short term.

The confluence of these factors, if left unchecked, has the effect of creating inflationary pressures, among other tings, in Jamaica. And of course given the already low income levels of Jamaicans this will create a further social burden. It is therefore very important that there is a careful examination of what our greatest exposure is and how it will filter into the Jamaican economy, with a view to hedging against these risks.

My own view is that the main problem Jamaica has comes down to the fiscal accounts and the debt. There is no doubt that since the early 1990s we have seen a significant deterioration of both. The problem Jamaica has had over this time is not mainly an economic one but rather an accounting problem. That is we have continually spent more than we earn and therefore have to borrow to support our over expenditure, and no amount of juggling will help if we do not get to the point where we are living within our means.

For the 45 years since independence we have only managed to see a fiscal surplus for approximately 6 of those years. Because of this we have managed to grow our debt from $34 Billion (1990) to close to $1 Trillion today. Over the same period debt/GDP has moved from 90% to the current level of 130%. The only other country with a higher debt/GDP ratio is war-torn Liberia. This trend is unsustainable and certainly the commitment by the JLP to cap the debt/GDP ratio is obviously a welcome sign in a country where unbridled fiscal irresponsibility prevailed.

Forecasting essential
For years various analysts have been saying that the importance of balancing the fiscal accounts cannot be emphasized enough. Well with the expected slow down in the global economy, and galloping oil prices, once again we will be reacting to a problem rather than forecasting and putting measures in place to address it before it happens. It is always more difficult to react rather than be proactive. In many ways we were still managing the economy as if in the protectionist era of the 1970s and 1980s. Even though we opened up the economy in the 1990s, which in itself was good, we still had a mindset of protectionism and continued to manage our affairs in that way. Hence, while we removed the tariff protection for local companies, we instead subsidized them by providing high interest rates on paper, which many of them invested in rather than face the realities of competition.

In order for us to turn around this economy, especially in light of global challenges, we are going to have to focus on managing down the risks we face. At the heart of it though is the need to move towards a balanced fiscal budget, and then move from there to creating a surplus. This of course means that we have to scrutinize each dollar we spend to ensure that there is a positive return (opportunity benefit).

In many respects we have fallen down on this, as we have not come to grasp with the concept of opportunity cost. We still manage our affairs like old time book keepers, who only focus on the absolute dollar. Such a person faced with a decision to spend $10 or $50 will always spend the $10 because it is less. Never mind the fact that if the $50 is spent you could see a return of additional $50, while the $10 spend may only create $5 in benefit. So this is the way we analyze contracts, and structure our operations. So why should I hire someone and pay them $100 when I can get someone else for $50. Never mind that the $100 person brings more value than the $50 person.

So as we move forward we need a paradigm shift away from the old book keeper mentality. We must start to focus on “value creation” and not just actual expenditure. We need to look at areas where our expenditure will achieve the greatest return after analyzing where our greatest risks are. We then need to identify what the benefits are. For example, if we were to spend the necessary monies to ensure a reliable and efficient public transportation system, then we could save on transportation consumption (30% of total bill). After 45 years of independence it is time that we start thinking outside of the box as what we have been doing for the last 45 years has not worked.


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