Friday, July 26, 2013

Why private sector led growth is central to development

LAST week I wrote about what the pillars of growth are. Today I want to answer a question, often asked in a roundabout way, by persons who say that the private sector has not done what is necessary to grow the economy, so why should they be accommodated with a more business-friendly environment. This is a question asked often by persons who I don't think truly understand how markets work.

It is very important to understand, as I have often said, that sustainable growth cannot, and will not, happen without private sector prosperity. This concept is sometimes elusive in the Jamaican society, where it is often felt that the "big" man just wants to exploit the "small" man and so must be doing something unethical or illegal to make his money.

There were similar sentiments against the banks in the US, after the 2008 financial crisis, but this emotion soon gave way to the practical knowledge that the poor cannot improve their lot without the growth of the "greedy" private sector. The problem we have is that this feeling is not only restricted to the so-called small man but is oftentimes perpetuated by some politicians and intellectuals in their quest to explain why market economies are bad, and instead proffer state intervention and more brimstone and fire on the rich through taxation.

Ironically, these same persons who find it convenient to put down the "capitalists" are usually very persistent in seeking charitable contributions from them, or support in some other financial matter. In fact, much of the charitable spending that happens in the society is not from government, but rather from private companies and individuals.

But why do I say that private sector-led growth is critical to sustainable economic growth?

We can answer this question by first understanding what drives economic growth. Economic growth is measured by the growth in the Gross Domestic Product (GDP), which is simply the increase in real productive value from period to period, that is adjusted for inflation. GDP growth involves private sector production and spending, as well as government spending. So one may say that government spending is a part of GDP, and therefore, why is the private sector necessary? And it is for this reason that government can play a role in stimulating economic growth, such as during a recession, as they also contribute to GDP.

The problem is that government spending is not sustainable with a stagnant, or struggling private sector. And this has been the experience in Jamaica, and we have seen a similar example in the US model coming out of the recession, as opposed to the European approach, which did not emphasise market growth. The reason why government spending is not sustainable without private sector growth is that government spending depends significantly on private sector income, through taxes. So the income taxes, customs duties, corporate tax, and consumption tax depends on activity in the private sector. Therefore, if the private sector is stagnant, or declining, then it is logical that there can be no increase in government spending.

Thus, in the final analysis, GDP growth at every level depends on private sector activity. Therefore, the logical conclusion is that if we want to see robust growth in the economy, then we need to have robust private sector growth.

It would seem logical, then, that fiscal and monetary policy should have as its primary goal, the facilitation of growth in the private sector. Put another way, which Obama and Bernanke understands very well: the role of government policy must not only be full employment, but also high- value employment through constant innovation. On the contrary in Europe, and particularly Greece, the focus of policy was not on private sector facilitation but rather, fiscal consolidation. The result of both scenarios is there for all to see.

This is important for us to understand, not just in Jamaica, but also the Caribbean. This is because the Caribbean has a tendency towards a government dependency syndrome. Add to that the culture of a lack of embracing of private sector success, and you have a compounded negative effect.

The market economy may not be a perfect system, but the truth is that it's the best. If we want to improve the quality of life for everyone, including the most vulnerable in society, then it is essential that private sector growth be robust.

So as we continue the implementation of the IMF agreement and structural policies, we need to continue to bear in mind that at the heart of it must be the facilitation of a business environment that encourages private and corporate prosperity. So, as an example, the concepts companies of lower tax rates for PAYE and companies, lower energy rates, more efficient government bureaucracy, and improved law, order, and justice system are all critical to supporting that private sector growth.

Our focus of policy must be on encouraging investment and spending through competitive return on investments or feeling secure about one's future. Our focus must be on businesses and individuals feeling safe, and respected by the justice system. It is this focus that will make Jamaica experience robust growth and become the place to live, work, and raise families.

Friday, July 19, 2013

Identifying Jamaica's growth pillars

MY last article looked at how we can increase competitiveness in the tourism industry, which is critical for Jamaica because tourism is our highest foreign exchange earner, and the area in which we have always had the greatest comparative advantage. The same challenges that affect tourism can be seen right across the social and economic landscape, and are the main inhibitors of growth.

The IMF agreement has been heralded as one of the last chances we have of saving ourselves from economic disaster, and whether so or not, it certainly is a significant effort to bring fundamental changes to the economy. In itself the implementation of the agreement is going to be disruptive to the economy and society, as we know it, simply because there is so much fundamentally wrong with our economic and social arrangements. Any change we try to make for the better will of necessity be disruptive.

What we must ensure is that

(1) the disruption is carried out with consultation. So that even if some persons do not agree with some things, they will at least understand. Failure to do so could end up with an outcome that nobody wants to own or participate in.

(2) the disruption must not be too radical, or else we could replace inefficient earnings with nothing in its place. This includes ensuring that when certain adjustments are done, that prior to those being done, something new, and more efficient, is put in place to substitute.

(3) the outcome must be measured, and be one that will bring greater benefit. One challenge we have had as a country is that there have been too many disruptions implemented without the desired outcome, for many reasons, but nonetheless ending up not adding any value.

One thing that we must figure out is: What are the pillars of growth? It is important for us to understand this, as failure to do so will only cause the economic plight of the country to deepen.

The first thing we must realise is that sustainable growth can only come from the private sector. While Government can stimulate economic growth, it cannot be sustained. If we do not understand this, and act in a manner that encourages private sector growth, then we will not achieve sustainable economic growth.

Secondly, it is impossible to maintain low debt/GDP, low interest rates, stable exchange rates, and a current account deficit. In the short run, we may be able to use monetary and fiscal policy to achieve all these at once, but this is not sustainable. What it does is lead to black markets, as we saw with the exchange rate in the 80s and 90s. Irrespective of what type of political system and ideology is in place, markets will react, either through the formal or informal system, which is one reason why Jamaica has such a large informal sector.

Finally, the business environment must be one that encourages businesses, and individuals, to prosper. One of the reasons that the US economy has done so well, and is easy to rebound from economic crises, is precisely because people and businesses have the opportunity to flourish to their potential within the formal environment. If this environment is not present then (1) an informal economy, and society, will develop and (2) capital and human resources will not fully participate in the economy, and may even go to another economy, through migration and business relocation.

It is very important for us to understand these underlying pillars of growth as we move forward under this IMF agreement. In the past I have found that there has been too much preoccupation with focusing on the fiscal solutions, not understanding that everything that happens on the fiscal side depends directly on what happens in the market economy. Because, if the market economy does not grow, then fiscal revenues and the balance of payments will suffer. And if fiscal revenues suffer, then the debt/GDP and foreign exchange rate will suffer. What this will do is create a vicious circle that puts the economy into a downward vortex.

In an attempt to salvage the fiscal downturn, what will happen is that Government will administer more taxes, or more debt, which will again lead to a further downturn.

The only way to break this cycle is to create an environment in which businesses will flourish, and this may also mean providing incentives for foreign exchange earners, in particular. This in turn will increase GDP, and improve the balance of payments, leading to greater earnings for businesses, which will then increase employment, causing greater spending, greater profits, and greater fiscal revenues. This is the only sustainable model. Anything outside of this will be temporary, and will only mean that macroeconomic stability will only be temporary, and can only be artificially held.

The IMF agreement and economic programme does include initiatives that can create this winning equation. These include comprehensive tax reform, insolvency legislation, financial sector legislation, labour market and public sector reform, and financial support for businesses. And these are very good initiatives, but we must be careful to ensure that the initiatives are implemented with reference to what I described above as the pillars of growth.

Therefore, as we move forward in the IMF programme, it is very important for us to understand that the main risk lies in not building on these growth pillars, as failure to do so will certainly result in short-term gain and long-term failure.

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