Friday, February 17, 2012

The case for fiscal stimulus

DURING the period of this recession, one of the fundamental disagreements among economic commentators is how relevant are the teachings of Maynard Keynes.

In other words, in a recessionary environment should one increase fiscal spending, in order to provide stimulus for the economy, or should one consolidate fiscal spending in order to reduce the fiscal deficit?

Those opposing fiscal stimulus, argued in countries like Jamaica, that because of the lack of resources, the only viable option was to in fact cut back on fiscal expenditure and by doing so assist in the reigning in of the ballooning fiscal deficit. This was seen by many as the only way of resolving the economic challenges faced by the country.

Some three to four years after the height of the recession, my view is that we have enough evidence to determine what has worked and what has not.

Approximately two to three years ago we saw different roads being taken by Europe and the US, on different sides of the Keynesian argument. The Eurozone went the way of fiscal austerity and the US the way of fiscal stimulus spending. The result is that the US has seen an improvement in their economic and social environment, while the Eurozone has seen a decline, including an increased threat to the Euro as a credible currency. The table shows trends in the unemployment and growth rates in the EU and the US since 2008.






Eurozone real GDP growth rate




-0.3% Q4

US real GDP growth rate




2.8% Q4

Eurozone unemployment rate





US unemployment rate





Note: The 2011 growth rate is the fourth quarter estimate

The table above clearly shows that the US has seen a faster recovery than the Eurozone, in these key measurements. This is despite the criticism Obama's administration faced about reckless fiscal spending, and the consequent increase in the fiscal debt, during the period of fiscal stimulus. Who is having the last laugh just before US elections now?

In fact, in the recent ECB February Inflation Report, Governor Mervyn King is quoted as saying "...ongoing problems in the Eurozone and fiscal consolidation at home combined to put brakes on growth". US Treasury Secretary Timothy Geithner, only a few weeks ago in a CNN interview said that it is not possible to grow by cutting expenditure in a recessionary environment.

Similarly in Jamaica we embarked, via the 2010 IMF agreement, on a policy of fiscal expenditure consolidation and new tax revenue measures in order to improve the fiscal situation. My argument at the time was that the approach was wrong and would lead to a contraction of the economy and fiscal revenues, as the fiscal side depends on the real economy and in the face of private sector spending retreat any contraction in fiscal spending would also negatively affect the economy and ultimately the fiscal accounts. The result is there for everyone to see.

How do we move forward though, as the economy is still faced with significant structural problems today and the fiscal challenges are even more chronic than in 2007, primarily because the economy is weaker and the capital markets are not as easily accessible as prior to the recession?

One reader wrote to say that my promotion of fiscal stimulus spending, and my promotion of JEEP type programmes, was tantamount to printing money to finance these programmes, which would ultimately lead to higher inflation and an unstable macroeconomic environment. If the reader had read the entire article, however, he would have seen that my argument is for value-added debt financing and not the printing of local currency, which would not be a real resolution to the problem.

One may argue that this will increase the debt to GDP ratio; however, my argument has always been that the level of the debt to GDP ratio is not as important as the trajectory of the ratio, and the use that the debt is put to. Again I refer to 1984 when the debt to GDP ratio went to 212 per cent before declining to 90 per cent in 1990.

It seems irrational to me that if one has a monthly debt payment of $100 per month and income of $50 per month (with non-discretionary expenses of $45), that you can cut expenditure enough to address the debt effectively, or before you die of starvation. While some better spending of income is needed, it should be clear that the only sustainable way to deal with the debt is to increase your income if the plan is not to default. This is what has happened in Greece, and the recent austerity measures will only make the situation there worse.

My own recommendation therefore continues to be that Jamaica has to (i) seek new debt to address value-added infrastructural projects around our areas of comparative advantage, such as tourism; and (ii) reallocation of some of the resources to focus on areas such as green energy jobs, crime reduction, law and order, and agro-processing facilities. At the same time the initiatives being implemented by Paulwell must be timely to ensure that we resolve our energy and consequently competitive challenges.

While proposing increased value-added debt, I do realise that there is a great risk if not implemented properly, but this risk increases the longer we wait to take the necessary bold decisions. The fact is that what we have been doing has not been working. Isn't it therefore time for us to realise that and take a hard look at how we make policy and fiscal decisions. Certainly new taxes and capital expenditure reduction are not optimal solutions.

One thing I can guarantee is that if we continue on the path we have always been on then we can only reap more of what we have been reaping. I can also guarantee that within the context of the current environment, the fiscal consolidation policies we have been pursuing will only lead to greater pain.

We therefore need to ask ourselves what we must do to change course and ensure that we meet the 2030 vision of the place of choice to live, work, and raise families.

Friday, February 03, 2012

Jamaica's options diminishing

THIS is one time when I hate to say "I told you so" as it is in relation to Jamaica's economy. This is because it always seems as if the appropriate prediction to make is that implemented policies will not work and will cause our economic situation to worsen. I can, however, share this feeling of despair with Anne Shirley, Al Edwards, and Ralston Hyman, and therefore say "We told you so", as most other regular financial commentators do not need to share this feeling of guilt.

The recent fiscal and trade numbers point to what we have been saying since 2009, that the taxes imposed and the IMF programme would have had a contractionary effect. Added to this the fact that the IMF agreement was in limbo for over a year and this created industrial instability caused by the decision to reverse public sector wage contracts.

So here we are two years later with tax revenues running $14.5 billion behind target, for the first nine months of 2011/12, which I expect to worsen as we head into the final quarter. In addition, the balance of payments (BOP) for the first eight months of the 2011 calendar year showed a worsening current account deficit over the prior year comparative period of US$647.6 million, or over 150 per cent.

This suggests, in the strongest possible way, that we have not addressed the structural challenges facing the economy. But is this any surprise when the same IMF programme projected that oil imports would move from 14 to 14.5 per cent of GDP over the projected period?

What is more frightening about the fiscal numbers (as shown in the table) are the following:

- When compared to prior year, June, November, and December 2011, all showed reduction in tax revenues;

- For the nine months tax revenues were just up 5.1 per cent, when inflation was approximately 7 per cent, signifying a real reduction in tax revenues;

- In the current fiscal year, tax revenues fell short of budget by $13.3 billion more than the shortfall in the prior year; and

- The last three months of the fiscal year are always the most difficult for meeting tax revenue targets.

Against this background the minister and his team must craft a fiscal budget for 2012/13. This seems like a very difficult task within the context of our political, social, and economic environment. I have always maintained over the years that there are always options that can take us out of this mess, and I can think of a few. If these will be considered is dependent on our political and social environment. Will we take the road less travelled in Jamaica to economic development? I hope so, but history is not on the side of that being done.

What is clear is that because of the fiscal decisions taken since the recession hit us, we find ourselves here today. So all those who thought that Maynard Keynes was just something out of a Mother Goose fairy tale, it is instrumental to note that even Europe is now accepting that they need some stimulus to help create growth, as the fiscal austerity they embarked on two years ago has not worked. On the other hand, the US went the way of Keynes, and provided stimulus to the economy, resulting in growth, even though fragile. The US dollar has once again regained some credibility.

It is evident that our options are diminishing fast, as our failure to take the bold decisions have had persons comparing us with the demise of Greece and other parts of Europe. Instead we should have been compared with the US today, if only we had not discarded the teachings of Keynes.

So it is clear that programmes like the JEEP and Jamaica Employ are going to be critical to move the economy forward. I can think of a few ways that these can get off the ground while having the advantage of improving our BOP and using the least amount of resources. I trust that the cabinet retreat will emerge with a solid programme that will provide the much-needed stimulus.

It is going to be difficult, though, because of limited resources available. I have long said that Jamaica has a bigger accounting than economic problem. But being an accountant, maybe my views are prejudiced.

Apart from the stimulus option, the only other solution to the fiscal problem is to go for more value-added debt through the IMF programme. Going to the market is going to drive up interest rates, so it should not be seen as a solution. And also, cutting expenditure and/or raising taxes are only going to cause a further contraction in the economy.

It is important to reach an agreement with the IMF as soon as possible, as each passing day can only bring uncertainty. It was important for the minister on assuming office to have met with the IMF, and made the announcement of the status as he did. It is important now to finalise the discussions and keep the markets informed about what is happening.

It is also prudent to understand that of the three much-talked- about reforms being pushed (tax, pension, and public sector), only one can practically happen before the next IMF agreement, and that is tax. In the present form, however, the green paper will only serve to continue the tradition of the fiscal priority negatively affecting the economy.

Pension, I have always maintained, is an embedded compensation and therefore requires much consultation in addition to reforming the structure, as all the money has previously been lost in the consolidated fund. Public sector reform was approached in the wrong way and was therefore doomed to long deliberations.

With all that said, what is obvious is that our options are very limited, and it is going to take the best of the minister, his team, and the Government to steer the Jamaican ship through the troubled waters ahead.