Fiscal consolidation's unintended consequences

Not all weight loss is good. In other words, if you lose weight by cutting into muscle, then it can actually have a negative effect on your health. Nutritionists will therefore tell you that it is very important to eat properly and avoid a “no food” diet, because lack of food will affect your energy level and ultimately your health.
This is certainly no different in relation to business, or even at a country level. The fact is that if your strategy is focused on simply reducing expenditure, then you will ultimately find that you have no capacity to expand or compete effectively. As a result you will begin to chart your own demise, irrespective of how great your intentions are. In other words, the most rewarding way to survive is to grow, not to stay the same or to shrink.

In an article I wrote on Friday February 2, 2007 (in the Jamaica Observer) titled 'The problem of capacity', I pointed out: “This lack of a proper plan to national development causes us to focus short-term on things like balancing the budget, while what we sacrifice in order to do that is the capital expenditure and investment required to develop that infrastructural support needed for economic growth.”

So in effect, what we have been doing as a country, since the 2007/08 recession, is “reducing muscle” and ignoring the consequences.

This approach, in my view, has led to the infrastructural challenges that are causing the traffic congestion we see today (costing us around $200 billion annually in lost productive hours), and more recently, the flooding that we saw in Montego Bay, as well as the crime problems that plague us daily.

I say this because our primary economic management tool since 2007 has been centred on reducing expenditure. And I remember around that time, a few of us were constantly warning that fiscal consolidation alone is not a long-term strategy, as the only way to achieve sustainable development is to start growing by at least three per cent per annum for a few years.

PATTING OURSELVES ON THE BACK

But instead, we kept patting ourselves on the back because of the results of the fiscal consolidation.

Today, however, we have discovered that reducing expenditure is easy (all you have to do is owe people or not execute), but growth is much harder and requires different strategies and skill sets.

In the same way that the government moved away from borrowing as much as they used to, many financial institutions and individuals learned that different skills are required to earn profits than those needed to rely on high interest rates. But whereas the financial institutions adapted, fiscal policies never changed to meet that reality.

So where have we ended up? Today we have very poor infrastructure, which creates significant opportunity losses, and we have inefficient use of capital, which continues to limit growth in the economy.

We have failed to invest in the equipment needed by the police force. We have not dealt with the serious problem of informal settlements, with the result that criminal activity is perpetually on the rise, costing the country some four to six per cent of GDP, or more than $80 billion annually.

We have failed to address the regulatory environment that restricts the efficient use of capital (such as the Minimum Capital Test, Reserve Ratios or what pension funds can invest in), costing the country tens of billions of dollars in capital investment and economic growth, the result being lower growth and a lower per capita income for the labour force, both pre- and post-retirement.

We have failed to address the procurement rules for government, again costing the country tens of billions in economic activity and lost productivity (taking over 10 years to look at the procurement rules/amendments).

We have failed to predict traffic needs in the face of the growing population and increasing economic activity. We have not invested wisely in our road networks or a proper public transportation system, resulting in traffic congestion, which has cost around $200 billion annually in productivity losses. We have also failed to invest in technology to monitor our road networks, resulting in increased man-hours for the police force, instead of using technology, resulting in higher costs on the fiscal accounts.

We have also failed to invest in upgrading our justice system, resulting in lost productivity and increased criminal activity.

THREE PER CENT

Oh, yes, we have been very successful at meeting our fiscal consolidation targets, and we all agree that that was necessary because of the dilemma we found ourselves in when the recession started. But because of our failure to think beyond the exigencies of the fiscal challenge at the time, we have found ourselves celebrating one per cent growth, when what we need is three per cent, and we see the results in the form of traffic congestion, crime, and flooding.

The transition to growth is necessary, but it continues to elude us. Some of us now realise that achieving high levels of sustainable growth is a difficult task that requires different strategies. It requires a different skill set, which must either be developed in the people responsible, or be brought in with new people.

Either way, it requires a mindset change, and an understanding that the policies we continue to follow in many respects cannot give us the growth we need. For example, in the US, when they want growth they reduce taxes at all levels. In our case we reduce at one level and increase even more at another, without understanding that the effect is a net take from the economy.

Until we start to appreciate this distinction, then the type of sustainable growth levels we need will continue to elude us.