Thursday, June 12, 2008

Breaking the vicious cycle

At the end of the last fiscal year, we officially got to the $1 Trillion national debt mark. This is something that was well within out reach from early last year, and with the off the book debts we had well surpassed long ago.

Now that we have achieved the $1 Trillion figure though what does that mean to us. As many people would be aware, I am not one who is concerned just about the level of debt. Whether it is $1 Trillion, $200 million, or $200 Trillion is not important all by itself. One could say that the debt/GDP ratio is an important mark, and it is from a comparative view, but again is not in itself the sole indicator of whether or not things are getting better or worse.

The debt/GDP ratio is a good trend indicator of whether as a country we are doing better or worse, but still has its weaknesses. In our case the debt/GDP ratio started to decline around 1996/97 with the financial crisis of the 1990s and the introduction of FINSAC. From that point on the situation got progressively worse until around 2006/07 when we started to see the gap begin to narrow but not by much. With the debt figure getting to over $1 trillion at the end of 2007/08 the debt/GDP ratio still went down from 132% at the end of 2006/07 to 126%, as a result of a greater rate of GDP growth relative to the debt level.

Pyramid economy
This, however, is not the full story as the growth in GDP includes inflationary growth, which we know last year was relatively higher but also because the GDP component is also very important. In the last quarter, January to March 2008, GDP growth was 0.2%, which is one of the worst numbers we have seen in a while. My own view is that the global impact has had a lot to do with this, but even more importantly the constant decline in productivity over the years is beginning to catch up with us.

Since 1962 Jamaica has recorded growth of approximately 97%, of which some 69% occurred between 1962 and 1971. So over 35 years we have seen accumulated growth of around 28%, and this is at the heart of our problems. For the last 35 years we have had an average annual growth rate of approximately 0.8%. We did see some reversal of this worrying trend in the 1980s, when between 1982 and 1991 the accumulated growth was approximately 15%, but since then growth has averaged just about 1%. This is while other countries were growing consistently at rates over 5%, so obviously Jamaica is going to become relatively poorer.

The significant reversal in our fortunes started, as I indicated, around the mid 1990s when the financial crisis occurred and money stopped moving into productive ventures and went into chasing paper, producing no productive assets. So the economy was operating like one big pyramid scheme where high returns were being promised on paper without the productivity to back it. The only way to keep the paper chasing going was obviously to borrow money to pay those that invested in our high yielding paper. This as far as I am concerned is similar to a pyramid scheme where new monies have to be taken in all the time to pay out those who are already holding paper instruments, which is a promise to pay.

Over the past few years though we have seen some growth in the economy, and also have boasted about the amount of foreign direct investment that has come into the economy. We have also seen record inflows in terms of remittances and each year we have broken the mark of the number of tourists that arrive on our shore. Based on these and other numbers we have been propagating that poverty is down, the economy is growing, and Jamaicans are better off. We have even gone as far to say that Jamaicans are better off because they have more cell phones, more cars, and yes “man have more gal”.

Changing productive and consumption relationships
But even while “man have more gal”, cell phones, and cars we still see where Jamaica’s debt has been climbing, inflation is going up, and the economy seems to be stagnating as growth rates of 3% and above seem like a fairy tale. And the truth is that unless we break the vicious pyramid like cycle, where we continue to borrow money to pay those who were in before, we will always face the same challenges. The only way to break free of that cycle is to fundamentally change our consumption and productive relationships.

Even though we are seeing growth, and some erosion of the debt/GDP ratio, this reliance on this indicator is also misleading. My own view is that the only way for us to really address the problem of the debt/GDP, and how much of each dollar we pay out in debt, is not to focus primarily on the debt but rather to focus on the denominator, GDP. And it is not just a matter of growth in GDP that is important but what sectors have grown. In the 1960s, when we saw significant growth rates, this came primarily from manufacturing and at that time the Jamaican dollar was valued more than the US dollar. At that time we also took advantage of the areas we had an economic comparative advantage in also.

Since the 1990s the growth that we have had is primarily in the services (financial, real estate, distributive trade) and construction. The real sectors such as mining & quarrying, tourism, and agriculture have not performed as well. So our growth in recent years is sort of like a two edged sword. While on the one hand it makes our numbers looks good, these are in sectors where we do not have a natural comparative advantage and where a significant part of the inputs are imported. So while our growth numbers look good the balance of payments suffer, and we end up spending more than we earn. This in itself leads to greater demand for foreign currency and the only way to keep the exchange rate stable and keep inflation low is to borrow money. It is because of this cycle why we are being affected so significantly by the global crisis. The fact is that as credit tightens globally interest rates on debt is going to be negatively affected and as prices globally go up we are going to import inflation. This is the corner we have painted ourselves into with the economic policies we have pursued.

The only way for us to break out of this is to fundamentally change our approach to economic growth. The focus for growth must be in the areas of agriculture, and not just the growth of primary products but also agro-processing where we retain greater value in the economy, and also in tourism and mining. These are the areas where we have a comparative advantage and economics 101 teaches that in the areas where there is a comparative advantage there is also the potential to retain greater value.

The other area that we can have a significant impact is to change our consumption patterns in energy. The energy bill at current oil price levels will move by over US$1 billion. My own view is that an investment of some J$5 billion in this area could see us saving up to US$1 billion (J$71 billion). This seems like good value for money.

The point though is that since the 1990s Jamaica has been caught in a vicious cycle of debt chasing debt (borrowing more to pay older debt), resulting in a pyramid type economic effect. Unless we fundamentally change our production and consumption arrangements then we will forever be like the stupid dog that continuously chases its own tail.

1 comment:

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