Friday, February 25, 2011

2011 will be a challenging year

Last year I indicated that in 2011 we could look forward to some recovery in the global and local economy. This will be more evident in the global economy, as I believe that the Jamaican economy will still continue to struggle because of the structural issues it continues to face. It is my view also that the contractionary effect of the IMF policies will cause the recovery to be more of an uphill task than if the contraction was not as deep.

There are some positives that have happened during the recession. These include (1) Tax administration; (2) Divestment programme; (3) Attention to the Public Sector Transformation Programme; (4) Reduction in interest rates; (5) Emphasis on local agricultural production; (5) Completion of the Falmouth Pier and Montego Bay Conference Centre; and (7) Focus on reducing corruption in the police force and crime generally.

Despite these positives, however, the economy will continue to see significant challenges in 2011, in my view. Indications of this can be seen in the following areas:

o Global inflationary pressures from oil and food price increases, which I had indicated would take hold in 2011. Even before these global pressures, Jamaican businesses were already seeing inflationary pressures but could not increase prices because of falling demand;

o Interest rates globally will increase to deal with inflation and excess liquidity resulting from fiscal interventions in countries such as the US;

o The PSOJ has, through its National Security Advisory committee, pointed out that security is a major cost because of crime. They estimate that a whopping 20% of small business revenues go into security-related costs. The implication is that we may not see the upswing, in small business ventures, needed to drive job creation and growth;

o Commercial bank loans are trending down, and more importantly the loans to the productive sector, such as agriculture, have decreased;

o The majority of funds under the IMF programme have already been received. The positive side is that government has been able to successfully raise funds on the capital market, and should attempt to replace the expensive debt; and

o The trade deficit is worsening year over year.

The fact that the global recovery is slowly continuing this year represents an even greater disadvantage for Jamaica than the recessionary effect experienced last year. This may seem perplexing to some, but the reason for this is very simple. Between 2009 and 2010 when the Jamaican economy was in decline, I believe that while it proved difficult for individuals, it was good for the Jamaican economy. The reason for that is because of the way the Jamaican economy is structured. Prior to the recession, the Jamaican economy was growing, although at small rates. The contradiction, however, is that while the economy was growing, so was the debt and fiscal deficit. Simply put, what we were doing was growing by consumption, based on borrowed money. Therefore for every $1 we produced we consumed 72 cents of it, and exported 28 cents. At the same time we were importing between 70 and 80 cents to produce that $1. Mathematically, therefore, we were importing 80 cents and only exporting the equivalent of 36 cents (assuming we mark up the production by 50%).

Therefore when the economy was contracting, we were actually reducing the need for borrowed funds, and therefore cutting our suit to fit us.

Now that the global economy is recovering, we still have the same basic infrastructural problems that have been with us since the 1990s. If you factor in the negative effect of market demand, you will find that there is going to be a tug of war between fiscal and private sector demands. It will therefore be imperative for the public and private sector to find a happy medium, and this I think will be driven by government policy. There are some good initiatives undertaken (as mentioned above), but we will have to be a lot more decisive in our policies if we want to ensure that we stop the train before the track runs out.

Initiatives I support the government on - and wonder about what the IMF is thinking - are the JDIP, purchase of buses, and similar projects. If we are going to ensure that the economy does not go through any further contraction, government must take the lead in infrastructural projects that will not only provide much needed infrastructure and employment, but will also contribute to future savings in foreign exchange. The two most important sectors to focus on are agriculture and transport.

I can recall the opposition expressed when I supported the need for more money to be spent by the government on infrastructural projects. Suppose government had not continued to spend on road improvement and projects such as Falmouth Pier. Apart from the greater loss of jobs and crime we would have experienced, what sort of infrastructure would we have in this country? It is important that we not ignore our infrastructural support, or else we will be even less competitive.

A critical look at the balance of payments tells us about the challenges that lie ahead. A cursory look seems to indicate that things are going well, as we see the current account deficit improving by US$137.7M for the January to September period in 2010. The areas of improvement were (i) Services - US$56.2 million; (ii) Income - US$93.7 million; and (iii) Current Transfers - US$82.5 million. This overall performance is good, as any line we get the money from to turn around our fortunes is good. We have to be careful about how we develop these areas, however, so that we do not revert to the structural challenges coming out of the 1990s, as this will lead to a need for high interest rates in order to have macroeconomic stability.

The challenges from the BOP can be seen in:

(1) Declining trade deficit. Specifically we see a reduction in exports and an increase in imports;

(2) Services, although improved, show one of the reasons as a decline in expenditure of Jamaicans travelling abroad. This is good as it means lower consumption of overseas items but not because of increased expenditure locally, which means that it is a weakness of consumer demand;

(3) Income has improved because of reductions in official interest payments and reduction in profits remittances. The former is what we want to achieve, and is a move in the right direction, but the latter means there is less incentive for foreign investments; and

(4) Current transfers, which have come primarily from remittances, and an indication that the country is heading back to reliance on non-productive income.

The BOP and economic stagnation tells me that the market is trying to make the necessary adjustment to become more efficient. This is the way markets work. We continue to be dogged, however by societal, political, and bureaucratic challenges that inhibit this necessary market adjustment. If these challenges are not addressed effectively, then we will find ourselves with the same structural problems we have had since the 1990s.

Overall this means that although we see the global recovery, because of Jamaica's inherent structural problems we will continue to face challenges in 2011. Hopefully some of the policies being pursued by the government will bear fruit and alleviate some of these challenges.

Friday, February 18, 2011

A SWOT analysis of Jamaica's economy Part 3

OVER the past two articles I tried to develop a simplistic SWOT analysis and demonstrate the method that should be used to target the development objective of the country in the most efficient manner. There is no one solution that is right and the others wrong, but there is always going to be one that is the most efficient use of resources and greatest value-added return, which is what this analysis is trying to do.

Coming out of the last article, I identified three possible areas that would provide maximum return, in relation to the resources that need to be invested. The three specific areas I identified were (1) dealing with indiscipline to create order and fairness in the society; (2) breaking up the JPS monopoly hold on the energy distribution lines and creating an efficient transportation system; and (3) reforming the tax system (already we have seen where just improving tax administration has resulted in significant compliance improvement. Can you imagine if this was coupled with real productivity-oriented tax reform?).

This week I want to take a simplistic look at the possible effect of focusing on these three areas by imputing financial numbers from the initiatives, and hence completing another step in looking at the SWOT approach.

GDP Effect ($M)
Yr 1 Yr 2 Yr 3 Yr 4 Total
Productivity plus from improved justice   34,048   34,048   34,048   34,048   136,190
Import substitution / agro-processing     7,695   15,390   23,085   26,933     73,103
Energy savings - retail   25,650   12,825     7,695     7,695     53,865
Energy savings - transport  
Tax reform effect   16,314   16,314   16,314   16,314     65,256
  83,707   78,577   81,142   84,989   328,414
US$ equivalent        979        919        949        994       3,841
BOP Effect ($M)
Yr 1 Yr 2 Yr 3 Yr 4 Total
Productivity plus from improved justice  
Import substitution / agro-processing     7,695   15,390   23,085   26,933     73,103
Energy savings - retail   25,650   25,650   25,650   25,650   102,600
Energy savings - transport   25,650   25,650   25,650   25,650   102,600
Tax reform effect  
  58,995   66,690   74,385   78,233   278,303
US$ equivalent        690        780        870        915       3,255

The table (Figure 1) shows imputed values from the initiatives outlined. It shows a total four-year positive effect of J$328.4 billion on GDP and J$278.3 billion (US$3.2 billion) on the Balance of Payments (BOP). The actual outcome could be more or less, so what I am trying to do here is show an approach to selecting the best value-added initiatives and how to do an analysis on the financial projection. It is important to focus on the effect on GDP and BOP, as these should be the real objective of economic policy.

With respect to productivity improvement from improved justice and discipline, this assumes an improvement of one productive hour per week per person in the labour force multiplied by the average labour output dollar amount. The assumption is that if we were to improve justice and order in the society then we could see people being at work longer and producing more productively as a result of (1) persons not spending time focusing on issues of justice; (2) fewer resources being spent in the courts dealing with justice and indiscipline problems; (3) greater availability to the human and real estate resources in the inner-city communities; (4) less traffic congestion and more productive time as a result of improved road conditions; and (5) productivity increase from lower crime levels, including extortion and praedial larceny. What is obvious is that the initiative of creating a more ordered society and improved justice will always have the largest positive impact on GDP because it creates greater efficiencies in the market economy.

Another initiative mentioned in the table is the focus on food import substitution from increased agricultural productivity and agro-processing. The table assumes that food import substitution is done to 10 per cent in year one, 20 per cent in year 2, 30 per cent in year three, and 35 per cent in year four. This initiative will have a positive effect on both GDP and the BOP to the same extent, and is assumed to have a positive four-year effect of J$73.1 billion.

The energy initiative that focuses on retail consumption (through renewables) and transportation (through an efficient public transport system) is assumed to have the effect of reducing the energy consumption of these two sectors by 50%. This is not hard to believe given the significant positives that can flow from these initiatives, and is assumed to have a positive impact on GDP and BOP of J$53.9 billion and J$205.2 billion respectively. The effect on GDP comes from the creation of energy jobs. The attractiveness aspect of it is that they are short-term initiatives, yet they have the largest positive impact on the BOP.

The final initiative of productivity-oriented tax reform, I assume will cause a positive GDP impact of 5% of tax revenues budgeted for the current year. This I think is very conservative, but you know us accountants. Never count our chickens even after they hatch, as they could still die. In addition to the good work being done by the Tax Administration to reduce bureaucracy, we should be looking at tax reform aimed at improving productivity and keeping monies longer in the economy to have a greater multiplier effect. These include moving more towards indirect from direct taxation. This will allow for greater spending and hence a higher multiplier effect. Incentives also need to be geared more towards production and productivity in foreign exchange-earning industries.

This is by no means an exhaustive list of value-added initiatives and requires much deeper and dedicated analysis, especially to arrive at the financial possibilities. What I have tried to do over these three articles, however, is show one method for arriving at the greatest value-added initiative given the limited resources we have.

The debate will no doubt continue, but what is obvious is that we need to define our SWOT and systematically choose the best initiatives based on return on investment and difficulty to achieve.

Friday, February 04, 2011

A SWOT analysis of Jamaica's economy Part 2

THE article last week generated quite a bit of interest from persons in and outside of Jamaica, with many wanting a deeper breakdown of the SWOT analysis. While I am not able to provide a complete analysis because of space constraints, although needed, it was always my intention to go into more specifics.

A SWOT analysis is nothing more than a snapshot that tells at a point in time what the various areas of the analysis are. This would be the same approach one takes to a business plan, and is a very logical and objective way of properly assessing the current situation of a company or country. My own view is that fixing the economy and society is not a difficult task. What we have always lacked is the will to place the interest of the country above that of the party. I will try to outline below some of the initiatives that can have the greatest positive impact on the country's development.

In looking at what was produced by the SWOT analysis, what you want to do is strengthen (or maintain) the strengths, fix the weaknesses, develop the opportunities, and minimise (or eliminate) the threats. If you can successfully do this, within the context of your agreed objectives, then it will lead to greater development.

But you will never have enough resources to do all the things that need to be done. So a government, for example, has a limited amount of funds available to it but has a multitude of challenges to address and calls for help to answer. How do you then decide which one to address, and when? The when is important because timing is of course critical. The way to do this is to determine what the most efficient use of your resources are.

As an example, if you have $1,000 and can either pay off debt that costs 20 per cent per annum, or put away the money at 10 per cent per annum, then it seems more prudent to pay off the debt, and save 10 per cent of $1,000. On the other hand, you may be running a business and therefore may need cash resources of $200 to ensure that the business will not be threatened. You may therefore choose to pay off $800 in debt and maintain $200 in debt and $200 in cash. The direct cost of that decision is $200 times 10 per cent but there may be an opportunity benefit, as if you were cashless the cost to the business might have been much more.

Similarly, as a country we should do the things that add the greatest value in the shortest possible time. That is if a decision adds value of $1,000 in five years, it may not be as valuable as one that adds $300 in one year. This is the sort of analysis that needs to take place if we are to maximise our resources.

What then are some of the major initiatives that I think will add the greatest benefit to Jamaica? If our objective is economic and social development, and in particular, the best improvement in per capita income and social interaction, then we must focus on those things that cause these to happen. This for me means improving the quality and standard of living. The way to improve the quality and standard of living is to ensure (i) a basic respect for the human rights of every Jamaican citizen; (ii) universal access to a minimum standard of education and health care; (iii) increased opportunity for greater income levels; (iv) structure and discipline in the society, so that everyone can enjoy quiet and civility when interacting with others, for example when driving; and (v) a prosperous private sector, which in turn can create jobs. I do not, and never will, believe in the government trying to pick winners or providing massive amount of welfare for communities. This merely discourages an efficient market, undermines productivity, and in the end causes corruption and disorder in society. Another spin-off, which we know all too well, is that this results in significant debt.

Therefore we need to focus on the things that will increase private sector productivity and competitiveness; and also improve the quality of life of people. The latter is necessary, as even if you are wealthy and live in a society with high levels of indiscipline, your quality of life is still substandard.

So for me therefore, it is a no-brainer. I want to improve my strengths but realise that that does not necessarily mean focusing on the strengths. If I were to focus on the weaknesses then that would serve the purpose of removing the weaknesses and improving the strengths. So the first order of business for me would be to deal with the culture of indiscipline. In doing this I would strengthen tourism, improve productivity and production, and improve tax compliance. The other positive of focusing on this is that it does not require any resources really, what it needs is greater accountability. So if the police and public sector were held more accountable, then they would implement the regulations already on the books. So just imagine the police did the simple job of strictly enforcing discipline on the road and the Noise Abatement Act. Just imagine if the KSAC enforced the zoning laws. Just imagine, if instead of a bureaucratic public transformation process we put accountable people in charge of public bodies, and schools, and give them the authority and held them accountable when they failed to meet agreed objectives. These things don't take any additional resources but have far-reaching effects in strengthening the quality of life, improving productivity, and reducing crime.

Secondly, I would break up the JPS monopoly and encourage persons to invest in renewable energy and put a few billion dollars into the JUTC to create an efficient and secure public transportation system. These two initiatives could result in approximately US$600 million per year in import savings, and eliminate the trade deficit in four years.

My third focus would be to reform the tax system to encourage private sector development, and export in particular, rather than the narrow focus on the fiscal that we have practiced for decades. This would include moving away from direct towards indirect taxation, and removing the incentives from industries to rewarding foreign currency earnings. The government has recognised the need for reform, and the $6-billion investment is welcome. What we must ensure is that the reform is not just about collecting more for government but more importantly will focus on tax reform to encourage private sector development and exports.

If these three areas are focused on then it will take care of most of the items identified on the SWOT. So, contrary to the content of some of the responses I received, it does not matter if the list of weaknesses is longer than the strengths, as the value added from focusing on just a few of the weaknesses will significantly reduce the list of weaknesses and threats.

The result of focusing on these three areas will definitely mean development, and real growth for Jamaica. So I don’t consider it difficult, but it must be a deliberate strategy with specific and measurable objectives. The real solution would be to introduce the separation of powers, but that may be a lot more difficult to achieve in the current environment.

Much more analysis is needed on this, but again space does not permit.