A fresh look at the IMF programme


Wednesday, May 28, 2014

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AT a recent annual general meeting, one of Jamaica's private sector leaders summed up Jamaica's situation as one where "we have not managed our public finances well", and are now in the process of fiscal correction which unfortunately has had to be "driven by external forces" , meaning the IMF. He noted that the contraction of public spending affects any business in the domestic market, and that costs are going up disproportionately in line with Jamaica's continuing devaluation. The current government was trying hard, he argued, but the issue of the sustainability of the correction remained.

The opening line of the IMF statement released last week Friday by head of mission Jan Kees Martijn, echoed by Bank of Jamaica Governor Brian Wynter at his quarterly press briefing, argues: "The economic outlook is improving. Since the start of the programme in early 2013, crisis risks have receded, growth has picked up, net exports are stronger, inflation has been brought under control, and reserves have started to recover". In a key line, Martijn notes: "Reducing debt to a sustainable level is expected to take a decade of restraint and multiple years of productivity enhancing policies".

In classic Keynesian theory, such a contractionary fiscal policy decreases demand, reduces income and leads to increased unemployment. The current strategy being followed by the Government/IMF, however, is a "growth inducing fiscal reform", similar to a presentation by the same name at the Ministry of Finance and Planning more than a decade ago on April 12th, 2001. Citing international economists Giavazzi and Pagano, "The recipe for a successful stabilisation crucially depends on its effects on private demand", the presentation noted that a fiscal adjustment can cause a non -Keynesian result depending on its composition, size, state of the country and monetary policy, as these elements influence the manner in which the contraction is manifested throughout the economy because they affect expectations.

Giavazzi and Pagano compare Ireland's first failed adjustment in 1982 with its second adjustment in 1987. Ireland's first adjustment had a weak and quarrelsome coalition government, increased discretionary taxes, a disinflationary monetary policy (high interest rates), with the end result that private consumption and business investment fell dramatically. Their second adjustment, under Charles Haughey's minority government decreased government consumption and investment, had a prior sharp devaluation, with real growth resuming and the debt income ratio declining for the first time since the 1970s. Interested readers can google my paper "From Celtic Tiger to Carib Tiger — Lessons from Ireland" prepared for the PSOJ National Planning Summit in early November 2007 for further details.

The key is to generate positive wealth and income effects, restoring consumer confidence and thereby boosting growth. This is not easy. Jamaica's extremely weak economic position before the global crisis of 2008 meant that "bitter medicine" was guaranteed, whichever party was in power. The key question is how long the post-2008 "great squeeze" will continue, and the prospects for a true turnaround.

Currently, the traditional indicators of confidence: domestic interest rates (rising), the local stock market (falling) and most importantly the Jamaican dollar (also falling) are not signalling a strongly confident economy. The recent rise in the Jamaica Chamber of Commerce's Business and Consumer confidence index, whilst mildly encouraging, was from very depressed levels. A more accurate way of summing up business people's current views, in the words one informed observer, is probably "scepticism tempered by hope", meaning that when business people look at their current numbers they feel sceptical, but they have to hope for a future turnaround, or join the increasing number of Jamaican professionals seeking a new life abroad.

In reviewing what is required for a fresh look, the composition of the adjustment matters. An adjustment involving large tax increases, with expenditure cuts focusing on public investments leaving government wages, employment and transfers alone or only slightly affected, is less likely to work. So far, most of the increase in the primary surplus has been due to an increase in taxation, and the balancing item to achieve the primary surplus target when taxes unsurprisingly underperform is to cut capital expenditure. While wages have been restrained, they are now by far and away the largest item in the budget, even before one includes pension benefits. The unsurprising result is that on most measures that matter, the confidence-sensitive Jamaican economy remains highly depressed, and the last round of tax increases in the budget may have been counterproductive, in that they probably reduced confidence.

The current tax approach, in terms of sequencing and prioritisation, is unlikely to have helped the economy so far. Facing an admittedly extremely difficult fiscal situation in January 2012, one alternative strategy (if the IMF had permitted it) would have been to try to see what it would take to achieve around 10 per cent growth per annum in the tourism industry per year for the life of the IMF programme, as has been achieved by certain other Caribbean countries at different times, for example the Dominican Republic. Such a rate of growth, from about July 2012 to end 2016, would have seen an increase in tourism receipts of a little over 50 per cent, to about US$3 billion.

At the recent Bank of Jamaica press briefing, it was revealed that by virtue of a sharp fall in imports, Jamaica's current account deficit is expected to fall to about US$ 1 billion this year. In the scenario of fast tourism growth previously outlined, we would already now have a clear path to plugging the foreign exchange gap with real earnings, not borrowings, and the Jamaican dollar might already have stopped falling as local investors would have anticipated the large-scale foreign direct investment in new plant that would be required to achieve such an ambitious target, and have acted accordingly. Instead, any competitive gains from devaluation (after the associated increase in costs) have largely been swallowed up by increased taxation, with the result that tourism industry growth has been anaemic, roughly in line with the rate of economic growth of our largest source markets rather than double digit, which would require the much more difficult task of gaining share from other destinations. The same argument can be applied to the overall issue of incentives, manufacturing and exports, namely the need for flexibility rather than a straightjacket if serious new opportunities present themselves.

If the original opportunity in tourism has been missed, or at least delayed, what do we do now? To truly transform business confidence, the first step is to structure the economy to sharply reduce incentives for informality, particularly through the reduction of transactions costs, and to spread the burden of adjustment to the informal sector. Government capacity is limited, so there is a need to prioritise areas where one can achieve the greatest impact. Ground zero of such reforms are customs and the whole issue of the underperformance of property taxation (amongst the highest current leakages), which should be coupled with a reduction in property transactions costs to encourage a weak market.

While a major start was made on customs tariff rationalisation under the reforms of the incentive regime at the end of last year, much more needs to be done, even to make the last reforms crystal clear to stakeholders. The whole issue of the taxation of Caricom imports was not touched, but the need to review this is becoming critical if a logistics hub is to have meaning. The issue is that countries with large free trade zones, such as Panama, typically find it better to have relatively low tariff rates so as not to incentivise massive corruption at their ports, as Jamaica has already done so successfully with its high tariff structure. In short, we need to make a conscious choice to put in place a low tariff regime, which would incidentally allow all our citizens, particularly our poorer ones, to dramatically improve their purchasing power.

Improving property tax performance will be much more effective if the associated issues of land reform and the reform of administration of local government, particularly development approvals, are accelerated. While these issues are starting to get some attention, progress has been slow, and to change the incentive to be informal will require both carrots and sticks.

Indeed, in the same month as the recent sad passing of the "Queen of GCT", tax guru Ethlyn Norton Coke, one is still trying to work out how the new tax measure of GCT on imported services, a measure previously announced in 2009 (and withdrawn partly on her advice), will work. The critical but painful issue of not breaking the GCT chain (putting GCT on almost everything but asking for clear receipts) still remains.

Finally, fiscal space needs to be granted to allow the funding of critical interventions, even if it means recasting the current budget. As long as there is a proper medium-term cost benefit analysis, and societal consensus, through organisations such as the partnership for Jamaica, expenditure, of up to say two per cent of GDP that has the potential to pay for itself many times over the medium term, should be allowed. Appropriate areas include the revitalisation of downtown Kingston, Port Royal, and investments in crime and justice, just to name a few. These could be financed by an accelerated privatisation programme, the small relaxation of IMF austerity being that the revenues from privatisation are treated as current and not capital, and therefore part of the primary surplus. Expenditures paid for this way would not increase the debt, and as long as the investments were truly growth-enhancing, would actually improve medium-term debt sustainability, the key parameter in the IMF programme.




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