Battling debt, Boosting growth

Colin Bullock, Contributor

Looking at the economy through rose-coloured lenses, we see the success of the Jamaica Debt Exchange (JDX) in easing the burden of debt servicing by stretching out maturities and lowering interest rates on a restructured domestic debt. We celebrate the securing of the 27-month standby borrowing agreement (SBA) with the International Monetary Fund (IMF), which has been catalytic in easing access to relatively low-interest funding from other multilateral financial institutions (MFIs) and grant funding from the European Union.

Continuing loans from China, including for road rehabilitation, support economic activity and help to reverse infrastructural deterioration. Following the shock of the recession, bauxite exports have resumed, an alumina plant has reopened and it is reported that there are prospects for further reopening. Remittance flows have largely recovered, and on the basis of strong promotional efforts, stopover visitor arrivals continue to increase. There is optimism about stronger signs of economic recovery in the United States. It is reported that quarterly economic growth is becoming less negative and is expected to become positive during the first half of 2011.

The Dimmer View of the Economy (Through a Lens Darkly)

As a counterpoint, several concerns are being expressed about the medium- to long-run prospects of the economy. These concerns include the following:

With a largely unchanged economic structure over 50 years, growth has averaged about one per cent per annum over 40 years. Quarterly economic growth has been negative for some 12 quarters and recovery has been slower than expected. Accordingly, there have been significant job losses and an increasing rate of unemployment. Jamaica has a highly uneven distribution of income and the incidence of poverty has increased where Jamaica already has a highly uneven distribution of income.

Unsettled public-sector wage commitments and an unresolved government-employee pension overhang add uncertainty to public-sector financial performance.

Oil and food-commodity prices have been increasing, affecting merchandise commodity import costs. Domestic energy costs are internationally uncompetitive. Jamaica is facing a bullet payment of US$400m in 2011 in the face of a threat from Standard & Poor's (S&P) to either generate faster growth or accept a downgrade of its public-debt rating.

And while the US economy shows signs of life, there are dark clouds over European economic recovery.

The Fundamental Problem - High Debt and Low Growth

The fundamental constraint to economic transformation is inherent in the coexistence of an increasing burden of public debt and anaemic economic growth. While the economy has contracted for 12 consecutive quarters, the public-debt stock increased by more than 40 per cent. The ratio of public debt to gross domestic product was expected to increase to more than 140 per cent by March 2010 before declining slowly to 115 per cent by 2014-15.

The JDX has not eliminated the public-debt problem. The IMF programme projections have debt service increasing sharply by 2012-13. The JDX eased the burden of domestic debt servicing but the recent explosion in debt has been one of external debt. This underlines the importance of the foreign-exchange constraint, because while Jamaica can print Jamaican dollars (forgive the thought), it cannot legally create foreign currency.

Negative growth over 12 quarters and slower-than-anticipated economic recovery have undermined the prospects for increased tax revenue to reduce the debt burden by cutting the fiscal deficit. The essential nature of the stabilisation programme does not naturally lend itself to a reduction of the debt burden. The IMF programme seeks to reduce the ratio of public debt to nominal GDP in an environment of lower inflation and "relative exchange-rate stability". To moderate public debt, efforts to reduce the fiscal deficit mean lower expenditure and higher taxes. These initiatives, from an aggregated point of view, may weaken growth by restricting aggregate demand. With lower inflation, the growth of nominal GDP would also be restricted. Conversely, however, use of the Budget to increase aggregate demand will mean higher fiscal deficits, more borrowing and higher debt.

These conflicts underlie the challenge from S&P for the Government to facilitate economic growth while reducing the ratio of debt to GDP. A debt-rating downgrade would mean a higher cost of access to international financial markets with associated implications for higher domestic interest rates to maintain relative exchange-rate stability.

Wake-Up Call

Jamaica, for years, has delayed taking effective action to correct its economic problems and has very often used trivial or partial responses. Jamaica has generally missed fiscal targets and, even before the international financial crisis, allowed the fiscal and debt problems to deteriorate. We have used opportunistic and 'incrementalist' taxation instead of fundamental tax reform. There were delays in recognising and responding to the impact of the international crisis. We have treated the JDX and the SBA as the 'final frontier' and did not immediately seize the opportunity it afforded for transformation.

While policy has been tardy, policy recommendations have not always recognised the complexity of the problem. Examples of oversimplification follow:

a. Devaluation will make exports competitive and improve its external accounts.

b. Lower interest rates will ensure stronger investment and economic growth.

c. Lower interest loans will resolve the debt problem.

d. Elimination of government bureaucracy will release a flood of private-sector investment.

e. Keynesian fiscal stimulus to aggregate demand (meaning more government spending, lower taxes and higher deficits) will enhance economic growth.

Elements of Things That Need To be Done Quickly

The unravelling of the interdependence between high public debt and weak growth is extremely challenging, and to give ourselves a chance, there needs to be urgent simultaneous action across a broad and variegated policy spectrum. This would include:

1. Decisions on securing lower energy costs.

2. Reversal of declining labour productivity trends.

3. Elimination of tax-incentive biases against structural diversification.

4. Stop beating the mostly dead tax horse (raising more from those who already pay) and embrace comprehensive tax reform.

5. Without increased tax revenue, there should be smaller government, prioritising security, public health, basic, technical and entrepreneurial education and MSMEs (for self-employment and economic engagement).

6. Rebalancing expenditure towards capital and prioritise on the basis of 'need to have' rather than 'nice to have'.

7. Follow simple adages of budgeting; do not overestimate revenue and underestimate expenditure, and have more meaningful contingencies.

8. Take all steps to enhance the transparency of Government, including arrears reporting, and elimination of the use of special funds for 'off-budget' expenditure.

9. Reform campaign financing to make the role of sectional interest groups more transparent.

10. The private sector needs to germinate a broader replication of its poles of success and lead the process of national productive 'self-discovery'; Government cannot do it all.

Constraints and the need for luck

Given the existing economic structure, international economic recovery is still essential to Jamaica's economic prospects. The Government needs to be strong and resolute but effectively communicative to facilitate change in the face of powerful interest groups. We need to move beyond incremental adjustments and crisis management to stop chasing, but actually overtake, the problem. Budgets need appropriate contingencies, and contingencies need good weather. Incidentally, economists love weather forecasters because of their comparable forecasting results.

Colin Bullock is a lecturer in the Department of Economics, UWI, Mona. Above was an excerpted speech delivered recently at a Rotary Club of St Andrew event. Email feedback to columns@gleanerjm.com.