Friday, July 02, 2010

Jamaica's productivity misallocation



ABOUT a week ago I was asked to do a presentation on the Jamaican economy, and in my research looked at the problem of productivity and its impact. Even more important was the misallocation of our resources even as we strive to improve productivity and our economic fortunes.

The table shows that while we grapple with the problem of productivity, the challenge is even more far-reaching than we think. The implication from the numbers is that Jamaica's productivity problem does not only arise from input costs and the efficiency of workers but rather speaks directly to a problem of market allocation of resources.


Compensation challenge
The source of the measurements shown is the Jamaica Productivity Centre's recent publication of a study for the period 1973 to 2007.

It shows that there is a serious disconnect between percentage changes in output per worker versus unit labour cost. This is illustrated at the total and sector levels as follows:

* Total Economy --measurement shows that even though the output per worker has declined by an annual average of 1.3 per cent, at the same time the unit labour cost (compensation) has increased by an average of 0.4 per cent per annum.

* Sector level -- both the goods and services sectors show declines of 1.7 per cent and 0.5 per cent respectively; however, per unit labour cost did not reflect this decline in productivity, as wages fell by only 0.6 per cent in the goods-producing sector and rose by 1.2 per cent in the services sector. This is even more pronounced when you consider that over the years we have increased the services sector from less than 50 per cent of the total economy to over 70 per cent. So over the years we have been rewarding declining productivity.

* Industry level -- a look at the specific industries also reveals that in agriculture, mining, and transport, storage and communications we have seen average productivity increases while at the same time seeing declines in unit labour cost per worker. The converse is true for construction and the financing and business services sectors. In the much-touted manufacturing sector, while there has been a decline in productivity, unit labour cost has remained flat.

What these numbers show us is that a primary problem of productivity is that we have been allocating resources very inefficiently, and implies that one of the reasons why we may not have seen more capital being allocated to various industries is that the market is broken. In other words, markets will usually allocate resources where it is most efficient to do so but clearly, something has been wrong with the allocation of resources in Jamaica, as we seem to have been rewarding markets that are inefficient while penalising markets that increase in productivity. This, of course, leads to a distorted return on capital and this uncertainty results in capital staying out of any long-term investment in the market.

Decreased competitiveness
The result of all of this, of course, is that productivity declines and with increases in compensation relative to output, inflation results. GDP output also becomes less competitive in relation to the rest of the world and so exports suffer in favour of the more competitive imports. This in turn results in the devaluation of the Jamaican dollar and inflation ravages bring compensation back in line with market conditions and we end up in a vicious circle with inflation, or increased debt, and high interest rates.

The fundamental cause of all of this is, of course, the political system, which results in inefficient allocation of resources. The problem is that our market is not allowed to work correctly because policies have always encouraged behaviour aimed at encouraging political results instead of economic results. So when, over the years, politicians sit in Parliament and make policy decisions it is done primarily because of political reasons and not to cause the market to improve. As an example, duty waivers and incentives may be given to those with close political connections or to repay a debt for campaign contributions.

These policy actions have the consequence of rewarding persons/companies that are not the most efficient and also industries in which Jamaica might not have a natural comparative advantage. Economic theory teaches us that if a country wants to maximise its global competitiveness then it must focus on where it has

its comparative advantage. However, interruptions in the smooth workings of markets by the state cause market determination to be distorted, and this eventually was what led to the collapse of socialist states such as the Soviet Union and Eastern European countries, and the move by China towards a market economy.

An inescapable fact is that the market will always have its pound of flesh and, just as the false creation of wealth in the United States (US) led to the recent financial crisis, so too the distortion of market activity through politically motivated policies has caused Jamaica's economic and social decline. At least in the US whenever there is a problem in the economy the markets are allowed to self-correct, with a minimal amount of government assistance to allow for a smoother correction. In Jamaica's case, however, there has never truly been a period where the market has been allowed to work effectively and so the problem has accumulated.

It has always been my view that if we are to truly fix Jamaica's economic challenges then government intervention must be kept to the minimum, always ensuring that public policy does not determine private sector resource allocation, as was done with interest rates in the 1990s. And this use of interest rates to distort market allocation was not unique to Jamaica as this was a primary cause of the global financial crisis.

Until then we will always remain less competitive than we can be as a country even though we have the potential to be very successful.

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