The University of the West Indies, Mona

The Great Growth Debate in Perspective
“One ‘chiney’ can do ten s’mady wuk” (Frequently quoted on “Perkins Online”)

The Protagonists and Antagonists

A common critical comment on the recently concluded budget debate is its limited focus on economic growth. The main budget presentation spoke to the importance of macroeconomic stabilization in creating an environment for investment and growth. The Prime Minister’s presentation was a detailed elaboration of this theme. Immediately following the main presentations, concerns were expressed regarding the absence of perspectives on sectoral and structural initiatives including the facilitation of medium and small enterprises. There was sympathy for the Government’s perspective that Jamaica is heavily constrained by its public indebtedness and the international economic crisis and had to resolve its fiscal and debt problems as a context for growth. This writer has commented that while stabilization policy is necessary, it will not by itself guarantee economic growth.
More starkly opposed to the stabilization perspective is an ongoing “fiscal stimulus” theme; growth is the only way out of debt and fiscal stimulus is necessary for growth. IMF type stabilization programmes are criticized for being “pro-cyclical” (i.e. restricting government expenditure and increasing taxes when the economy is already in recession).  It is suggested that Jamaica should run higher fiscal deficits to increase aggregate demand to stimulate increased output and employment. Support for this is drawn from Lord Keynes, who recommended the use of increased Government spending to pull developed market economies out of the Great Depression of the 1930s. There is also reference to the current role of “fiscal stimulus” in counteracting   economic contraction in developed market and other economies.
Looking more at “the supply side” a former Minister of Industry, himself a “Captain of Industry”, has raised the importance of enhancing the competitiveness of Jamaican production. He related this to exchange rate policy relative to inflation and the overarching and overwhelming constraint of crime. He referred to “the failure of the Government to organise the economy in a manner that provides opportunity and reward for enterprise, thrift and honest work…”
The Importance of Growth
Everybody agrees that growth and preferably strong growth is essential. The following table gives the now familiar approximations of per capita output in Jamaica, Barbados and Singapore in 1970 and 2005:
         
 

The weakness of Jamaica’s economic and social indicators in the new millennium is directly related to its anemic economic growth in the last quarter of the twentieth century. Jamaica has to generate much stronger growth for realization of Vision 2030 (Jamaica: the “place of choice” to live and work).
Over the next five years, capacity to service debt will be crucially dependent on stronger growth to generate revenue and eliminate fiscal deficits. The problem is how to get from debt and stagnation to economic growth.

Simplifying Theoretical Perspectives on Economic Growth

Long run growth of output per head (GDP per capita referred to above) is dependent on the product of how much is produced by each worker (average labour productivity) and the fraction of the population in the labour force (the labour force participation rate):
Output/Population = (Output/Labour Force) x (Labour Force/Population)
As students stay in school longer and as retired persons live longer, the labour force participation rate may decline over time. Growth is therefore likely to be more dependent on output per member of the labour force (average labour productivity). Average labour productivity is dependent on the quantity and quality of enterprise, capital and technology, as well as the education, training and health facilities available to workers, industrial relations and attitudes to work. This identifies growth as a longer term process and locates the importance of efficiency in aggregate supply.
More formal theories of long run economic growth have focused on the roles of the national saving rate to finance investment, population growth to make more workers available and technological progress to make production more efficient.
Simplified Keynesian analysis focuses on the short run impact of aggregate demand. As Government spends more and reduces tax revenue, aggregate demand increases eliciting increased output (a multiple of the increase in Government spending) and employment. Keynesian analysis then extends itself incorporate the money market. Increasing fiscal deficits and aggregate demand will increase government borrowing to finance the deficit and increase the need to hold money to undertake transactions. Unless the central bank accommodates this by “printing money” interest rates will increase. This leads to a reduction in private sector investment (referred to as “crowding out the private sector”).
The analysis so far assumes that output (aggregate supply) is freely responsive to aggregate demand without any impact on the rate of inflation.  It is more likely that an increase in output is likely to be at higher prices; an increase in the rate of inflation. Unless accommodated by increased money supply, inflation will diminish private consumption and investment, offsetting the impact of the “fiscal stimulus”. Inflation also increases the need to hold money for transactions pushing up interest rates and reducing private sector investment. In the extreme case, the increase in inflation and interest rates will cause a reduction in consumption and investment that is equal to the initial increase in the “fiscal stimulus” so that there is an increase in the rate of inflation without an increase in output.
The simplified Keynesian case is also presented for a mostly “closed economy” i.e. one which spends almost entirely on domestically produced goods and where most production is to supply the local market. In highly open economies, most expenditure leaks into imports and most production is for export. A “fiscal stimulus” therefore does not expand the domestic economy.
Economic growth in highly open economies is therefore highly dependent on external demand and competitiveness. The movement in the nominal exchange rate compared to inflation relative to trading partner inflation is important but yet not fundamental. What is fundamental is the real productivity (output per worker) of the economy as dependent on enterprise, capital stock, education and other factors listed above. In a productively uncompetitive economy, inflation is a symptom of deficient real productivity and exchange rate policy becomes an ineffective fig leaf to cover the nakedness of this deficiency.

Policy Considerations for Jamaica

The Government is correct that the fiscal and debt problem has to be resolved to guarantee sustained quickening of economic growth. It is the delay in recognition of this reality that led to the current dire economic circumstances. Jamaica has suffered from the schizophrenia of trying to correct a fiscal problem while embarking on grand projects which become memorials to fiscal folly (an “edifice complex”).
Without stronger economic growth (especially relative to the medium term projections) however, Jamaica may not be able to manage its increased mountain of debt. As we stabilize, policy also has to focus on how recovery from stagnation to growth may be accelerated.
Jamaica does not have the fiscal and structural characteristics to allow it to afford or maximize benefits from “fiscal stimulus”. Unless “stimulus” is financed by grants (money we don’t have to pay back) the result will be either increased debt, or higher inflation and nominal interest rates from “printing money”. Given he extreme openness of the economy, any “stimulus” is likely to increase the demand for imports, deplete official foreign exchange reserves, and generate exchange rate depreciation and inflation.
In engineering competitiveness, careful attention has to be paid to inflation. Policy has to be vigilant relative to the meeting of fiscal targets and to moderation of the price shocks that flow from taxation. This vigilance is essential because in the context of the extreme openness of the economy, movements in the exchange rate generate increased inflation and so cannot correct for other inflationary impulses.
The engineering of competitiveness has to go beyond exchange rate and anti-inflationary policy. There are also microeconomic supply-side issues at the level of the productive unit. These relate to enterprise, investment, technological enhancement, skill training, attitudes and industrial relations. For countries without their own energy resources, other efficiencies have to be evolved in compensation.
The debt exchange is expected to facilitate lower lending rates to generate private sector investment to move the economy forward. Government needs to follow through to see that the sacrifice of its creditors is not in vain. Government must have a perspective on what sectors have the best prospects and how it may facilitate the recovery or growth of these sectors. If medium and small enterprises or agro-processing, sports or entertainment have strong prospects, what is being done to facilitate their buoyancy and incorporation in the formal economy?
Jamaica always picked winners which were very often dependent on external demand (sugar, bananas, bauxite/alumina, tourism and garment exports). Do we have the capacity, within our fiscal constraints, to manage public and private expenditure to facilitate supply-side recovery and diversification? Or do we simply wait for the global recovery and hope for the best?

Colin F,
Bullock

Department
of Economics, UWIMONA

May 6, 2010