Friday, June 27, 2008

Taming the inflation monster

Inflation is probably the greatest threat facing the consumer daily. This is because the global impact of food and energy will continue to have a devastating effect on the incomes of Jamaicans. Those at the lower income levels will feel it even more, and our policies over the years have created many such persons.

It is because economies move in cycles (good times followed by bad) that I have for years lamented the fact that as a country we have failed to take advantage of the record growth levels the world has seen in recent years. When times are good it is essential that we put aside resources to help us through the bad times. So when the world was growing at rates of six per cent to eight per cent as a country we failed to take advantage of it. In fact, we seemed to have been satisfied with growth rates of two per cent, as whenever we made that mark it would appear we were in a celebratory mode. This is even as neighbouring countries were growing at rates between 8 per cent and 10 per cent per annum.

Adapting to inflation
So here we are today, like everyone else negatively affected by global inflation. Every country in the world today is trying to cope with escalating energy and food prices, of which the greater threat to the world is food inflation. The truth is that food inflation will continue for longer than high oil prices, as while we can curb energy consumption it is very difficult to do so with food. So the main failing that we have as a country is not really that we cannot satisfactorily control the global impact but that (1) we have failed to take advantage of the high growth rates; and (2) the lack of infrastructural investment over the years means that our capacity to deal with the global impact is just not there.

In other countries, such as the United States (US), while they are faced with high energy prices they are able to curb consumption by increasing their use of the mass transit system. In the US since last year they have increased the use of mass transit by over five per cent. So they are able to reduce energy consumption by not only fewer people driving but obviously it means less traffic, and also the consumers are able to reallocate the funds saved on energy consumption from transportation to food. In Jamaica's case, however, because of the lack of any proper mass transit infrastructure (road, rail, and water) the Jamaican consumer is not able to move to mass transit, and therefore continues to face high energy and food costs without being able to reallocate expenditures.

So while countries with choices can minimise the impact of inflation, countries like Jamaica get the full brunt of it. This is primarily because of our failing over the years to invest in the capital and social infrastructure of the country, even while we have racked up debt of J$1 trillion. The debt has not gone into development but rather consumption.

So while on the one hand we have a very significant debt level, there is nothing to show for it because the significant part of our debt has gone into consumption. And this is why places like the IMF, and local commentators like myself, have been saying for years that the continued expenditure on places such as Air Jamaica, Sugar Company, and JUTC without any strategic benefit was giving away our nest egg. In addition to these expenditures we have seen the money that has been wasted on scandals such as the Intec fund, Sandals Whitehouse, NSWMA, Operation Pride, and others.

We could do well today with the billions of dollars wasted on these for social programmes support, as the US is doing with the rebate cheques they have sent out. Instead, during the good times our approach has been to waste our resources, and "suck salt through a wooden spoon" when times are bad. This is not a new phenomenon for us, as after the boom of the 1960s we again wasted our resources by our policies in the 1970s, when we had an accumulated negative growth of close to 20 per cent.

What is the solution?
But how do we now address this? What we have to do is first understand what is causing the problem. The inflation problem is caused primarily by the global impact of rising oil and food prices. Even local food is affected because of our dependence on imported fertilizer, and exacerbated by the low agricultural productivity, which results from small farm plots, inadequate irrigation, and the lack of technology. What we also have to realise is that inflation in Jamaica is mainly caused by food, which accounts for approximately 41 per cent of total inflation. Energy consumption makes up less than 10 per cent. It would seem logical then that any attack on inflation must first be directed at food and energy, as these account for almost 50 per cent of inflation.

In addition, because our import dependence is so high, it means that inflation not only causes increased price pressures directly but it also causes a greater demand for foreign exchange, which places pressure on the exchange and inflation rates. So we must develop strategies that have the effect of (1) minimising our need for foreign exchange; and (2) increasing our agricultural productivity. Some of these solutions will take some time but others can have an immediate impact.

The low-hanging fruit, for example, is in the area of energy consumption. One such solution is in place already and this is the $500,000 loan offered by the NHT (10 years) for solar energy equipment. The NHT of course needs to ensure that anyone who accesses this loan is tax-compliant. But a typical three-bedroom home may cost about J$300,000 to J$400,000 to place the lights, television, computer, and other small appliances on. This could run these for the entire night and could reduce your energy bill by at least half. So if your light bill is $10,000 per month, the payback period on the investment is 6 to 8 years, and the life on solar equipment is approximately 40 years. This is a conservative example, as the bill and percentage saved is usually higher.

In addition, the introduction of fiscal policies to curb consumption could have an immediate payback. For example, charging private cars to access areas such as New Kingston during work hours, and having significant parking charges in these areas will encourage people to move to mass transit. At the same time though an immediate investment in buses to accommodate park-and-ride services will make our public transportation system more palatable. In the UK and US one pays to go into London and Manhattan during work hours. In the UK there is a charge for vehicles such as SUVs that drive into certain designated zones. The effect on the retail consumption of electricity and transportation could see reduction in the energy bill of between US$700,000 and US$1 Billion, if properly implemented.

The longer-term strategy being adopted by Chris Tufton should have a beneficial effect on food inflation. What we must do is not only start to grow more of what we consume, but we must also (1) develop local organic fertiliser on a mass scale; (2) grow staple crops, such as rice, cassava, yams etc on a large scale and not the small farming plots we do now; (3) put money in fixing the long- neglected arterial roads for greater access to farming lands; (4) use technology, such as is done in Israel, to ensure the greatest yield possible, standardise our agricultural products, and ensure year-round production of certain items. If we approach this properly we can have enough for export also but certainly will be able to replace the imports in the hotel sector.

Just as Jamaica lacked the capacity to grow at rates in excess of three per cent in good times, we also do not have the capacity to adapt to changing economic circumstances because of the lack of proper infrastructural investment, and wastage of our resources. There are some short-term fiscal policies that can address inflation concerns, but the timing and proper implementation is critical.

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.