Thursday, December 25, 2008

Confidence – key to growth

On March 30, 2007 I wrote about how important consumerism was for growth. Before and since then I have always discussed how important consumer confidence is to the development of economies, and capital markets in particular. Over the past few months we have seen where the global markets and economies have been collapsing. This also is as a result of confidence. It was being overly optimistic (confident) in the first place that led capital markets and economies to expand beyond the support of the productive bases, and it was the rapid loss of confidence that caused the faster decline in capital markets and economies globally.

Confidence and GDP
The table shows two confidence measures for the US compared to the quarterly real GDP outturn. It clearly shows that preceding the downturn in US GDP in 2009 there were significant declines occurring in confidence measures. The state street investor confidence index is a measure of confidence by looking at actual levels of risk in portfolios and the University of Michigan index measures the financial conditions and attitudes of households in the US.

This comparison is not surprising as it is confidence levels that drive spending habits and investments. Consequently if spending and investments are subdued because of a lack of confidence then naturally GDP levels will as a result decline. In order for economies to grow therefore confidence levels are important ingredients. No where is this more true than in the US where 70 percent of the economy is made up of consumer spending, and the US economy accounts for 25 percent of world consumption.

Even in an economy like Jamaica, where the state has been guiding resource allocation for many years, confidence is of utmost importance. Even more important than consumer confidence in Jamaica is investor confidence. This is because a significant part of our economy is not driven by the market but rather by paper pushing of financial institutions.

The fact is that Jamaica’s economy has been structured since the 1990s to be one based on trading of paper rather than economic activity. This is why it is so important that the management of the macro economy is far more important than the stimulus to the real economy, because we do not have much of a real economy in Jamaica. This means that even if the consumer were to spend much less this year than last year, the effect on the economy would be small compared to any fall off in trading of paper in the economy.

In any case this reveals that in both the case of the US and Jamaica confidence is key in driving the economy forward. The difference is that in the US the confidence of consumers are most important. In our case, however, the confidence of investors is most important. Understanding these differences will allow us to understand what policies are to be put in place in order to keep our economy afloat.

Regulatory need

It is this understanding of the importance of confidence in the sustainability of markets and economies that lead us to conclude that regulations and policies to drive confidence are utmost to economic development. So when people say to me that the era of the market economy is dead, this type of argument is only a representation of their limited sense of understanding what drives market economies. The need for regulation, especially as it relates to the financial sector, is not to introduce a socialist way of running economies, but to engender the necessary confidence to drive the market economy. The need for a fiscal stimulus package to drive the economy in times of recession is not to move away from the capitalist model (that has served this world so well) but to bring back the necessary confidence in order to allow the market economy to once again start growing.

The problem that we have when we start thinking about the demise of capitalism and the need to go to a more socialist type model is that we tend to over-regulate and over-control, which ultimately leads to a lack of market led growth. It is this very same situation that has led to the lackluster economic development that Jamaica has seen since the 1970s. Some persons have expressed to me recently that my view that agriculture can be the driving force behind Jamaica’s development is unfounded, as it has failed this country over the years and the way to go is high end services.

The reason why agriculture has failed is not because it does not have the potential necessary to drive Jamaica’s development. It has failed because there has been too much state intervention in the allocation of our agricultural resources and too little in terms of dealing with the very serious problem of praedial larceny. Imagine if we had policies that were geared towards (i) ensuring good roads for transporting agricultural produce, (ii) eliminating praedial larceny, and (iii) designating lands for agriculture instead of houses. This would engender the necessary confidence in investors so that they would make a business out of agriculture.

I always tell the true story of a well known Montego Bay businessman that invested 100 acres in mango production for export. As is expected in Jamaica he began having a serious problem with praedial larceny and finally caught the perpetrators on camera. Armed with the visual evidence he carried them to court and after a year the case was thrown out as the tape recording was not allowed as evidence in the courts. As you can well imagine he changed the use of the land from the planting of mangoes for export to building houses for consumption. The fact is that he no longer had the confidence that the system would protect him.

So as we move into 2009 I believe the most important policies are going to be those that are geared towards rebuilding the confidence of investors. This is especially true in a global environment that is going to pose serious economic challenges. The US is yet to face further job losses and only this week the housing numbers show that the recession is deepening in the US and the UK.

Here in Jamaica we have to ensure that our economy is still seen as a viable place to invest and this can only come about by creating an air of confidence. It is going to mean changing the way we do things and we must address as two of the most important impediments to investment, the problems of crime and bureaucracy. Even with the fiscal and economic stimulus package announced by the Prime Minister, if we are unable to deal with the problems of crime and bureaucracy then come this time next year we will be in a worse position talking about the same challenges.