Friday, April 27, 2012

Crafting the optimal budget

As we head to the reading of the budget, I am sure that there are some serious considerations to be made by the crafters. This has been exacerbated by what has been happening globally recently, not least of which are the revised downward projection of the Jamaican economy by the IMF and the fact that Europe seems to be falling apart, with the UK and Spain going into a double dip recession, and countries like Holland and France facing some serious challenges.

In addition the last US employment numbers show that they are not yet fully recovered and China's economy has been slowing.

These considerations are things to seriously consider as we craft our already late 2012/13 budget. It is quite possible that we may not have an IMF agreement finalized by the time the budget is read. The recent attempts to raise funds from the capital markets is also indicative of the realization that the only way we are going to craft a credible budget is accept the fact that we have to increase the debt stock, as my view is (an always been) that raising taxes is only a certain way to further sink the economy.

The fact that Europe seems to be going into another round of recession should come as no surprise, and I remember in 2010 when the UK announced its fiscal austerity measures that both Ralston Hyman and I were on radio saying that it was the wrong way to go and it would only serve to contract the economy further. At the time also we said that the new taxes that were imposed on the Jamaican economy and the cut back in capital expenditure, would also contract the Jamaican economy.

Both situations are really just a classic example of pro and anti Keynesian arguments. As far as I am concerned Keynes has won again and the US, being cognizant of the argument Keynes made after the 1930s depression, was careful to stimulate the economy rather than apply harsh fiscal austerity measures. The result is that it is going to take Europe a very long time to recover from this mistake, and in the process they may have retired the Euro.

As we go into the 2012/13 budget, the lessons from Europe, the US, and our own recent experience is clear, as Timothy Geitner said, we cannot grow the economy by contracting government expenditure. This argument that the private sector will jump in and take up the slack is one of the most flawed arguments I have heard coming from persons who are supposed to know better. If we go back to Economics 101 it tells you that private firms are motivated by profit.

Where there is no aggregate demand the possibility of profits are reduced, so you will find a very cautious approach from new entrants into the market. Where there are new entrants they will mostly be from small and micro businesses, which means that the time it will take for private firms to the void (without government stimulus - or fiscal contraction) will be longer than is needed. Even in the US where new businesses have a more immediate impact they still needed the stimulus funds to get their economy growing, and even so it is just grinding along.

The argument against stimulus for Jamaica is that we are heavily indebted and we were not generating surpluses prior to the recession. That argument sounds good if one is writing a text book. But when you are talking about the livelihood of people and the worst recession in our lifetime, then text book arguments just don't cut it alone. We need to be practical. I mean if I owe money, and at the same time I am dying of hunger, do I postpone eating because in order to do so I have to borrow. Or do I borrow to satisfy my hunger, and keep from dying, and then by eating I will have the ability to consider how to deal with the debt.

The fact is that because we have impractically convinced ourselves that we could not afford new debt we ended up causing the economy to contract. And this inability to face reality has not helped us because we have ended up having to go to the capital markets anyway for new debt. So what was the purpose of the argument against expending the debt. What we have to understand is that when we contract fiscal expenditure, causing a contraction in the economy, all we end up doing is increasing the debt/GDP ratio anyway, as GDP is not growing and the debt grows by virtue of interest costs.

So as we go into the new budget, even though it is going to be very tempting to continue our old ways of taxing to close the fiscal gap, we must change the way we approach fiscal policy by focusing on expanding the economy rather than the narrow focus of just closing the fiscal gap. As an accountant I know what it must be like to be faced with a cash flow crisis and want to do everything to solve that crisis immediately. However, the approach should not be just to focus on an immediate cash solution to the detriment of the future development.

I do not expect that it will be easy for the government, assisted by the technocrats, to craft this budget, but we will need to change the way we think about the solutions and employ a more strategic long term view. Within the context of our social and economic structure we have done well to keep the ship afloat but it is time to start sailing and not just stay afloat.

In my view the solution to the fiscal crisis lies in solving the balance of payments problem as well as ensuring that capital infrastructure work continues. Luckily for us these two avenues are open to us immediately, and the ministers in charge have been speaking about the right things to be done and seem to be moving ahead with the implementation. These are the energy and transport and works ministers.

If Paulwell has his way and can implement a greater use of renewable energy at home and get competitiveness in energy distribution then we can significantly positively impact the balance of payments through lower oil imports.

If Dr Davies can get the transport system properly organized, which means less traffic congestion and a better alternative to private motor vehicles he can also positively impact the balance of payments. Additionally, if he can get the infrastructure project rolling then this will provide much needed stimulus to the economy.

So as we approach the budget reading we need to bear these things in mind to ensure our long term development.


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