Saturday, July 31, 2010

If I had my way

LAST week I tried to convey my thoughts on the current state of the economy, and my belief that the economy has been deflated enough (whether intentionally or not) to now take the opportunity to breathe new, unpolluted air into it. I still do not believe that all the structural flaws are removed, which still act as impediments to properly aligning the economy, but the fact is that if we wait too long to restart the engine then the economic locomotive could see its engine going into a state of paralysis. Hence, what we have to do is address the remaining structural impediments while we reposition the economy for real development.

The positive structural adjustments that have taken place include (1) the successful debt restructure; (2) IMF programme; and (3) reduction of the trade deficit. It is important to note that the success of the debt restructure hinged on the IMF programme, as without the IMF funds the debt restructure would not have been sustainable for so long, as we would have long seen a return to high interest rates and even more pronounced fiscal deficits. Note I do not mention the reduced interest rates and revalued exchange rate, as these are merely outcomes of policies and by themselves should not be celebrated.

Seismic shift
The reduction of the trade deficit occurred as a result of the seismic shift in the economy that decreased aggregate demand, as the debt restructure removed discretionary capital and disposable income; and forced a change in the returns seen by companies. This is similar to what happened in the US in 2008, as any significant restructure of the financial system will always have an impact on disposable income and capital, which affect aggregate demand (for example, the unregulated financial organisations). One of the undesired consequences is the increase in unemployment, which could not be avoided as many jobs depended on the continuation of the debt bubble we found ourselves in. Therefore, a consequence of deflating that bubble meant that there were going to be some dislocation to jobs and businesses as we have seen, and this is why it was important to increase the social intervention programmes.

There is one more structural adjustment that needs to happen quickly, and is being pursued by the Government, and that is a rationalisation of the public sector and the reduction of the state's role in the economy. This by itself will cause further deflation in the economy, and so must be coupled with policies geared towards filling that gap. Some of this is happening, for example, the recent announcement of tax incentives to the tourism industry for capital refurbishment. This is the way tax policy must be used to influence development, not just as a tool to maintain the status quo of the public sector.

Another policy move, which I think will enhance the business operating environment, is the move by the tax administration to provide efficient tax payment services, including online payment and payroll tax consolidation. Kudos to the director general and her team for the direction in which they are taking tax administration. If I had my way, though, I would do away with the TCC process as is and move more towards consumption taxes, as both these structures are penalties to business efficiency and economic growth.

The recent pronouncement by the finance minister that the focus this year would be on growth needs to go further, I think. If I had my way, my focus would be on development, from which sustainable growth would come. I would continue to focus on restructuring the economic foundation and implementing facilitative policies to reduce which include bureaucracies that add to inefficiencies. One such entity that readily comes to mind is the RGD. For the life of me, I cannot understand why across administrations we have been unable to deal with the oppressive practices of this institution. We have, to some extent after all, been able to reduce violent crimes, but cannot deal with the inefficiencies at the RGD.

Positive crime- reduction effect
One other thing I have been speaking about for a while is the positive effect that crime reduction will have on the business and investment environment. This has been seen in recent weeks and the security forces must continue their efforts to attack this monster, State of Emergency or not. In fact, I wish that the politicians would retreat to some private enclave and discuss the "whodunit" of the State of Emergency saga last week, and, when they have arrived at a conclusion, present the findings to Jamaica. I, for one, am tired of the bickering about this episode and wish that both parties could just find it within themselves to have a civilised and constructive discussion on it. The public bickering is not helping our security forces.

Last year I had indicated that if I had my way I would have extended the IMF facility to allow more breathing space for the economy to adjust. While I still believe that some of that is necessary, I had indicated that belief within the context of our crime situation then, and in fact had stated that with the crime level then that the economy could not adjust fast enough to deal with the structures of the IMF programme. With the recent successes at dealing with crime, I think that the IMF programme has become more palatable but I still think that some relaxation of the straight-jacket is prudent.

I still believe, however, that our focus on fighting crime needs to be widened. Not through any military assault but through greater efforts to observe the rights of the citizen, a much more friendly and respectful approach by the police (the soldiers have received a lot of compliments), and by dealing with what I call the pillars of indiscipline -- the traffic and noise indiscipline. Crime reduction will be more permanent if these are done.

If I had my way, I would use the public sector resources to focus more on developing the local linkages in our economy. So I would place great emphasis on R&D, and put the sleeping Scientific Research Council in the spotlight, while encouraging scientific studies through scholarships and grants. For example, why shouldn't the Students' Loan Bureau be encouraged to offer scholarships and reduced interest rates to students in areas that could help build our comparative advantage?

The last thing I will mention (but by no means the end) is energy. If I had my way, I would focus much of the public sector resources on (1) eliminating the monopoly of the JPS, and (2) developing renewable energy capacity for retail and transportation consumption. Included in this would be greater investments in public transportation, even far beyond what the minister speaks about. The value-added benefit from focusing on the energy and transportation is significant, both in financial and productivity terms.

If I had my way, I would implement these and other policies to ensure that Jamaica is put on a path for economic and social development, and not restrict my focus to economic growth as we have been so consumed with in the past. Governments should never think of themselves as responsible for economic growth, because the truth is they suck at it. Governments should be the facilitators by creating the environment and push for the private sector to do what they do best.

If I had my way, I would reduce government and the public sector to the role of spectator in the game of economic development, always cheering along their team while staying away from participating in the play. If only I had my way.

Friday, July 23, 2010

Is the economy improving?

Over the past few weeks there has been much debate about whether the macro-economic measurements are any indication of improvements taking place in the economy, and by extension whether we are witnessing the start of an economic turnaround. Those who support this idea point to (i) a revaluing Jamaican dollar; (ii) lower inflation numbers; (iii) improvements in agriculture; (iv) significant improvements in the trade deficit; (v) declining interest rates; (vi) increased confidence numbers; and (vii) reduced crime levels.

On the other hand those who oppose the idea of improvements in the economy point mainly to (i) increased unemployment; (ii) negative effects of revaluation on exports; (iii) stagnant and declining income levels; (iv) increased business difficulties; and (v) reducing exports and future effect of oil price increases on imports.

Both arguments have validity
The question that must rest on the minds of non-technical Jamaicans is, who is right? Is the economy in fact improving, or is it that the declining economy is causing the macro-economic measurements to portray improvements in the economy?

The answer is that both arguments have validity, as one could successfully argue either position, especially if you are preaching to an audience sympathetic to your own leanings. What is needed, though, is an objective analysis of the economy to determine what the true position is. I will attempt to provide a synopsis as I see it, but the truth is that much more space than this column would be needed to go into the detailed analysis required.

In making any assessment, one should always start with the objective. For example, if one is assessing the economy in relation to the motor car versus thew agricultural industry then you would need to state different objectives. This is because both industries can oppose each other in terms of what is good for each. Agriculture earns foreign exchange while motor cars require it, and so within the context of our current economic circumstances the interest of one is opposed to the other. In different economic circumstances they could be aligned. But any proper analysis needs to be done in relation to present circumstances.

In the case of the Jamaican economy the objective must be to see the improvement in the standard of living of all Jamaicans and the general improvement in the economy. The way to measure that is at a macro level looking at overall GDP growth, but to also drill down to look at income levels, job creation, and which sectors are improving. The reason for this is that the country can achieve growth while the economic foundation is getting worse. For example, in the fourteen years to 2007 although Jamaica saw growth in every year, deeper analysis showed that in all fourteen years the non-exporting sectors grew while in only three of those years the export sectors grew (Chung, 2009). So while the overall economy was growing, this was being done by the growth in debt rather than production. In other words we were growing based on other people's money.

So the economic challenges we are seeing over the past two years are due in part to the global recession, but more importantly because of our economic management for decades before that.

Recent data from STATIN shows that Jamaica's imports have been growing at an increasing rate versus exports since the 1980s. Surprisingly, the numbers reveal that in the 1970s, exports increased by 136 per cent while imports increased by 97 per cent. On the other hand, the period of the 1970s was the worst growth period on record. The years after that did see some growth, but imports surpassed exports at an ever increasing rate up to 2009. The direct correlation with the increase in debt leads to the conclusion that we were improving our lifestyle based on borrowing.

1970s similarity
The problem we faced in the 1970s, however ,is similar to the challenge we face today, in that we are experiencing GDP decline but at the same time we are seeing improvements in the trade deficit. One difference between the 1970s and today is that we have recently been seeing a revaluation in the Jamaican dollar, but this can be explained in four ways (i) a reduction in demand for US dollars, as a result of declining economic activity and financial transactions; (ii) a liberal foreign exchange system today that reacts more to demand and supply than before; (iii) a shorter assessment period, so that sustainability has to be questioned; and (iv) the inflow of loans from the IMF and multilaterals. The truth, though, is that the improvement in the exchange rate today is not due to productivity improvements but rather a decline in economic activity, as supported by the productivity data. This is not a good thing, as it means that income levels will eventually fall on this premise.

The same argument holds true for lower inflation numbers and to some extent interest rates. The main argument for reduced interest rates is of course the game-changing JDX programme, as this alone caused a steep fall-off in the average rates of interest rates offered by the government, which was the main competitor to private loans. The appetite of government for debt did not change, and what happened was that with the inflow of external loans, the demand for local debt and higher interest rate pressures decreased. The lower economic activity assisted by ensuring that demand for US dollars decreased.

What one realises from all of this, however, is that the improvements in the economic numbers are not as a result of improved productivity or exports, but are caused by other factors that give a sense of well-being. It is for this reason that the confidence indices have therefore increased. Because as the numbers show, even though consumers are more confident they also have low expectations for any job prospects or increased spending. The confidence increase is therefore more psychological than based on any real improvement. In fact confidence numbers were at their highest in Q3 2007, just before the recessionary decline.

With all this said, though, this adjustment in the economy is necessary if we are to see the much needed revaluation, as the economy was similar to an addict. Only in this case the drug was debt and declining productivity. In order for the rehabiliatation to occur it was therefore necessary to deflate the economy and create a new foundation that can lead to sustainable development.

It is my belief that the current state of the economy provides a good platform for creating a sustainable development path. This, however, will require carefully crafted policies geared towards development rather than short-term consumption.

So in my own view, while there are positive macro indicators, these are not because of real development but as a result of the necessary economic contraction. I don't know of anyone who paints a car without first removing the old coat.

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.