Friday, March 01, 2013

Devaluation not good for Jamaica

Over recent weeks there have been utterances from several quarters - including economists, analysts, and technocrats – about the benefits of devaluation for the country.

The argument being made, is based on the theory that if we were to devalue the J$ in relation to the US$ then our exports would get relatively cheaper and this would lead to a greater demand for Jamaican exports. This is a strategy that countries like the US, Europe, and China are well aware of, and it seems as if there is a constant currency value war between these countries. The US for example is constantly complaining that China’s currency is undervalued, which leads to China’s goods being cheaper than the US gods, resulting in the massive trade deficit the US has with China.

If this argument holds true then the position being put forward by those in favour of the Jamaican dollar being devalued, and as some put in finding its true value, should be correct then.

The question is, if this argument is true then why has the J$ moved from a position in the 70s where it was stronger than the US$, to where it is today (approaching 100) and it seems as if our economy is getting worse, and more importantly our trade deficit is expanding. Shouldn’t the massive devaluations we have seen (over average $2.50 per year since the 70s) result in an improved trade deficit.

This is where those who propose devaluation fall short in their argument, as the assumptions they make is incomplete.

The fact is that devaluation can only help a country’s currency IF and only IF the country’s currency being devalued has the productive capacity to replace the imports. So in Jamaica’s case where 45% of our imports are oil (35%) and food (10%), the question to be asked is do we have the productive capacity to replace the imports. So as expensive as oil gets can we substitute it with locally produced energy sources? Or can we replace our food imports with locally produced foods?

The answer to these questions is no. So therefore irrespective of how much the dollar is devalued, we will still need to import oil and food, because we have not put the energy policy in place to grow for example renewable energy generation to replace foreign oil. And in the case of food, praedial larceny, lack of proper roads, and using farm lands for construction inhibits local food production.

The other argument for imports that we can substitute with local production, is that 70% of our export content is from imported raw materials, as labour costs (unlike China) are a very small percentage of inputs. So it follows that as the dollar devalues the cost of exports increase also because more money has to be found for the imported content.

Therefore, my conclusion, as was the same for Seaga and Davies, is that the only thing devaluation does is cause inflation and erodes spending power. The only way to solve the problem is to fix the structural issues of crime, energy, and bureaucracy.

68 comments:

Anonymous said...

Mr. Chung, I would also argue that the devaluation argument contains a logical fallacy:

Just because someone's goods are cheaper does NOT mean that consumers are more likely to buy it. The consumers have to want it first. And consumer wants are dictated by price and quality. People will pay a lot of money for German vehicles because they want the vehicles and are assured of a high quality product. But offer someone the choice between a cheap 1980s Toyota and an even cheaper 1980s Lada and many persons are more likely to buy the Toyota because the quality is perceived to be better. And Jamaica definitely has a problem in this regard because some (note I said some, not all) of our industries are antiquated and inefficient and thereby produce goods of lower quality than our international competitors. (a good example is the local printing industry which had the JMA as an advocate in recent times even though a JMA representative admitted (on television no less) that locally made books are more expensive but of lower quality than books produced elsewhere such as in the USA, Trinidad and China).

The arguments put forward by "devaluationists" is in essence related to Say's Law for the macroeconomy (as outlined by Wilberne Persaud in his article entitled "Devaluation Solution Persists Despite Contrary Evidence" for the Financial Gleaner on March 1, 2013). It essentially rests on the supply-side economics idea that "supply creates its own demand". But this is a dangerous argument on which to rest the fate of the spending power of thousands of people.

For the devaluation argument to work people must want to buy the goods available from a country simply because the goods already exist. And they must be more willing to buy them (and willing to buy more of them) as a result of the devaluation. But if they don't wish to buy the goods or prefer to choose better quality but more expensive goods or competing goods of similar quality but lower (sustainable) prices from countries which can actually benefit from devaluation then the entire argument for devaluation of the Jamaican dollar falls down.

I can't imagine that it helps any little bit that some (if not most) of Jamaica's exports are priced in US dollars (as any sensible exporter is going to prefer to price their goods in US dollars). So unless the US dollar price of the exports drop in line with the devaluation (for example, good A used to cost J$90 and was priced as US$1 when the exchange rate was 90:1 but now still costs J$90 but is priced as US$0.93 when the rate is 97:1) then the only benefit from devaluation would be that exporters see their earnings go up without having to raise their prices to clients. And exporters would be disinclined from dropping the price quoted in US dollars because the increased profit they get from the devaluation would be useful to offset the inflation and erosion of spending power caused by the inflation.

Anonymous said...

Continuing,

It would be nice if the BOJ and GOJ could take the opportunity afford by the current trend to fix the dollar when it reaches a rate of 100:1 and then either keep that rate, or revalue the currency to a rate of 2:1 (so J$50 old dollars would be equal to J$1 of the revalued currency (with a new currency code to replace the old JMD code, perhaps JMR with the R being used for "revalued"). Money could then be saved by declaring all old coins to be of the same value in the revalued currency and then just reissue some new $50 and $100 bills maybe with Sam Sharpe and Nanny on them to ensure all the national heroes are on the money). Perhaps it might even be possible to institute something similar to the 1948 currency reform in Germany where the old currency (the Reichsmark and Rentenmark) were exchanged for the new currency (the Deutsche Mark) at a rate of DM 1 = RM 1 for the essential currency such as wages, payment of rents etc., and DM 1 = RM 10 for the remainder in private non-bank credit balances, with half frozen (large amounts though were exchanged for RM 10 to 65 Pfennig) and where each person received a per capita allowance of DM 60 in two parts, the first being DM 40 (on the day of the currency reform, Sunday June 20, 1948) and the second DM 20 (one month later).

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