How to unlock growth in JamaicaWednesday, October 22, 2014
BY KEITH COLLISTER
LAST year, in a June 2013 speech reported in the press, PSOJ President Chris Zacca noted that he had some concerns about the thinking of the multilaterals, and indeed some of our Government officials, on the subject of incentives. Zacca noted that driving the thinking of some local and international advisors is the view that incentives create a huge drain on tax revenue and that businesses benefit the most from these exceptions to the normal tax rates.
At the time, he revealed that the PSOJ had recently been given a detailed breakdown of all "tax expenditures" which measured the theoretical cost of statutory reduced rates, incentives, and discretionary waivers, for the last seven years, listed by category. Although so-called "tax expenditures" were significant, with 2011 recording $69 billion, or nearly six per cent of GDP, the PSOJ's detailed analysis for 2011 revealed a number of unobvious and interesting categories: Basic food exemptions, $8 billion; public transportation and bus incentives, $3.3 billion; charities waivers, $3.5 billion; health care supplies exemptions, $1.6 billion; residential rent GCT exemptions, $1.7 billion; and water supply GCT exemption, $1 billion.
He observed that after taking out Education, Charities, Health, Government, Petroleum, Public Transportation, Residential Rent, Water, Financial Services, etc and then further stripping out incentives for bauxite/ alumina, the PSOJ's analysis showed that general business specific tax reductions and incentives totalled a little over one per cent of GDP for 2011, split almost equally between tourism and manufacturing.
In the key line of his speech, Zacca noted: "This is a far cry from the total of six per cent of GDP. Given the contribution to the economy, employment, foreign exchange earnings, and general development that these two sectors, tourism and manufacturing, provide, that is nearly 20 per cent of our GDP, and a majority of our US dollar earnings. I am sure that most people would agree that providing incentives of around one per cent of GDP would be justified."
The wider, and related critical issue is what is the reason for Jamaica's low growth rate. Today marks the beginning of an IMF/World Bank conference, "Unlocking Growth in the Caribbean". In the 2011 World Bank country economic memorandum, entitled "Unlocking Growth", the same title as the Montego Bay conference today, Jamaica's disappointing economic performance is argued as being partly due to fiscal policies and budget management practices and policies, one of three key "binding constraints" to faster economic growth in Jamaica, the other two being crime and deficient human capital. The methodology is from Harvard's Kennedy School of Government, following the work of Ricardo Hausmann (former IDB chief economist), and Professor Dani Rodrick, with the latter gentleman acting as a reviewer of the World Bank document on Jamaica.
Quoting from the World Bank's executive summary: "Inconsistent, complex tax policy with numerous exemptions and special privileges has reduced tax revenue by an estimated 20 per cent, significantly reducing the government's spending capacity. The complex system of taxes and incentives also creates distortions for the allocation of capital and lowers investment productivity. High debt-servicing costs and a high wage bill have reduced the fiscal space available for productivity enhancing spending, including public investment that is complementary to private investment and expenditure on education and health. Underlying institutional and political economy factors are major impediments to strengthening fiscal and expenditure policy and management of public finances."
The World Bank appears to have conflated the extremely relevant macroeconomic instability and fiscal imbalance issue with the debate over the costs and benefits of incentives, on the implied basis that much of the loss of nearly 20 per cent of tax revenues, or six per cent of GDP, was the tourism sector. Hence, the focus on the removal of incentives as helping to balance the budget, and the IMF's focus on reducing "tax expenditures", or concessions, from six per cent of GDP to 2.5 per cent as a key element of the 2013 programme. However, as it happens, as Mr Zacca pointed out in his June 2013 speech, what everybody thought they knew was not the case (the tourism sector already knew this of course, from looking at their own numbers), as the benefit to the productive sector from "concessions" was a mere fraction of what had been assumed. In short, the entire initial focus of IMF policy on the "binding constraint" of incentives, and reducing tax expenditures, appears to have been based on a misconception, at least in the case of Jamaica.
Much more important, however, than debating the actual amount of tax paid, or even the flawed concept of using tax expenditures as a key fiscal target to determine policy (and most surprisingly a metric of the IMF programme), is the apparent lack of understanding of what is truly behind Jamaica's growth problem. Much faster economic growth is the one sure way to get Jamaica out of its current debt trap, with the debt overhang most certainly being a key "binding constraint".
A key reason for the World Bank promoting incentives as a "binding constraint" was their seeming acceptance of a local argument from the early 2000s (which to many local observers seemed merely an official excuse for the low-growth following the financial crisis) that there was a high-investment/low growth puzzle in Jamaica. In their study, the World Bank had noted that Jamaica's fixed asset investment supposedly averaged 25 per cent between 1960 and 2008, and even higher in the last two decades, not far off some Asian economies, and therefore Jamaica's low growth was surprising. This number was also surprising for many businessmen, who couldn't see what this investment was going into. This exact question was addressed by Professor Donald Harris in Chapter 7 of the PIOJ's 2012 publication, written in 2011, "A Growth Inducement Strategy for Jamaica in the Short and Medium term". In a chapter entitled "Resolving the Supposed 'Puzzle' of Low Growth Rate and High Investment Rate in the Jamaican Economy", Harris identifies the key problem as a matter of "supply-side constraints arising from deficiencies and distortions in the existing structure of economic incentives (risks, rewards, costs, externalities) that drive entrepreneurial decision making." Just one of many potential examples of what he calls the "economic waste of capital" is the construction sector : excessive constructions costs "cost overruns due to poor quality of construction work, costs of profiting security on site, kickbacks of various sorts from contractors to offsite agents, excessive post-construction costs of repair and maintenance due to abnormal "wear and tear" (due to neglect or actual use) and cost of security "protection" for the current operation. There are many other examples of these supply side issues, such as Jamaica's inability for decades to fill its sugar and banana quota when it had them, and countless stories of foreign importers calling Jamaica "the land of samples". In short, Jamaica had major competitiveness issues that, acting together, stymied private sector development.
Interestingly, a group of brilliant Caribbean Harvard Kennedy School students, led by the subsequent former head of the PSOJ economic policy committee Nick Scott, under the same Professor Hausmann, in a March 2006 Economic Growth Assessment of Jamaica, identified only two binding constraints, namely macroeconomic instability and imbalance, and lack of industrial self-discovery. Their conclusion was that Jamaica's debt trap meant that tough macro policies are necessary, but "not sufficient for growth", which needed to be complemented by "a pro-active firm-centric, export-orientated policy aimed at developing new sectors." Taxation, although an issue, was viewed by them, in my view, correctly, as part of a larger "macro instability tax" that hindered the private appropriation of returns.
This 2006 analysis, emphasising industrial self-discovery, was totally in line with the much more detailed analysis of a decade earlier in the 1997 book Jamaica's Export Economy : Towards a Strategy of Export - Led Growth by the same Professor Donald Harris. His analysis is actually the key to "unlocking growth in Jamaica", as a review of his book reveals that we have the same exact problems nearly two decades later except that they are possibly worse. When this is combined with his update paper "Jamaica's Debt-Propelled Economy : A Failed Economic Strategy and its Aftermath" , originally prepared for the Jamaica Chamber of Commerce's National Economic Forum in October 2009, it clearly shows the reason for Jamaica's poor performance. In short, the National Industrial Policy of 1996, a strategy of export-led growth, was never implemented. Harris notes instead that "what we see here is an extraordinary and phenomenal transformation in the structure of the Jamaican economy. At the outset, in 1992-1993, manufacturing is more than 1.7 times the size of finance and insurance. By 2007, the situation is completely reversed : finance and insurance becomes 1.4 times manufacture". He adds, "A similar process of relative decline occurs in agriculture".
Harris proves a not-unfamiliar narrative that high interest rates drove real exchange rate appreciation, making Jamaica uncompetitive and destroying any chance of export growth. Despite supposedly over-generous incentives, tourism's share of GDP actually declines for much of the period, with a slight uptick in the second half of the 2000's due to the Spanish investment, overall ending at roughly similar levels over the decades.
It turns out that the whole focus on reducing or eliminating incentives is probably misguided, at least as a solution to Jamaica's growth problem, as Jamaica's key problem, other than the debt, is actually a lack of "industrial self discovery", as the Caribbean Harvard school group said. Another way of saying this even more simply is that Jamaica has completely failed to create any new export industries since the 1980's, and really since the 1950's, as we are still relying on a now marginal bauxite industry and tourism. The only major new industry of the 1980's, the 807 textile industry, has completely disappeared almost as though it never existed. Even the business process industry which emerged in late-1980s (Jamaica was actually early in world terms) but its growth was stymied, and only now, decades later, is it starting to develop some critical mass, although its foreign exchange earnings are still only a tenth the size of tourism.
Speaking of tourism, in 2009 the industry, against all expectations at the time, recorded positive growth amongst the highest of its Caribbean peers, most of whom had negative to very negative growth, as would be expected during the collapse of US consumer demand experienced during the global financial crisis. This superior performance was not an accident, as it reflected not only an aggressive marketing campaign, but most importantly a temporary but extremely well-timed cut in the then half-rate of GCT of 8.5 per cent by a further half to 4.25 per cent, as well as the impact of the previous year's devaluation, the combination allowing Jamaica to price very aggressively and gain share in a declining market. However, since then, Jamaica's tourism performance has been roughly in line with the anaemic growth performance of the US economy (the GCT rate cut was not only reversed but the rate was increased to 10 per cent), with the positive (but temporary) impact of devaluation on its competitiveness over the last two years being completely offset by an increased tax burden. Added to this, the sector now appears to face the very "macro instability tax" hindering the private appropriation of returns mentioned by the Harvard group, in that it is apparently being forced to give up incentives that they had been legally granted.
A recent study by Oxford Economics revealed that despite being one of the World Bank's supposed "enclave" sectors, tourism actually has amongst the highest economic multipliers of any industry in Jamaica, including being slightly higher than manufacturing. Moreover, the study reveals, as also shown by Harris, that non-tradables have actually increased their share of the economy, through pricing power and not volume, with the reverse being true of tourism. Critically, and as a possible explanation, both tradable sectors, tourism and manufacturing, have suffered from the near quadrupling of electricity prices in US currency over the past decade.
Neither sector would have been able to pass on this increase, competing against global competitors who pay one quarter to one half the rate, making it one of the key reasons for severe margin pressure in both industries. In fact, this margin pressure has recently led to the complete exit of the local company responsible for starting all inclusive tourism in Jamaica, for years the other major local player in the industry. In addition, despite roughly two thirds of our tourists being American, the only major US hotel group to invest in Jamaica in decades, the Ritz-Carlton, has also recently exited Jamaica. This suggests the issue of competitiveness is not unique to the inherently high cost "everything included, all you can eat" model of all inclusive tourism but that the same issue is faced by European plan hotels.
In conclusion, what all of this means is that, in understanding Jamaica's poor performance, in at least one area, the World Bank and other multilaterals were looking in the wrong place, incentives, when the real issue was one of competitiveness. As some of their own studies have noted, including the World Bank's 2003 report (which incidentally does emphasise the issue of the debt overhang and lost competitiveness during the 1990s), a more competitive economy means that investors will require less in the way of incentives. This is simple common sense. If investors are beating down your door to invest in your country because it is so internationally competitive, then you may not need to give any incentives. However, if you are like most small countries, including even some of the most successful such as Singapore (incidentally a masterful user of incentives over time), and have to try harder to attract global investment when competing against destinations with huge internal markets such as China, then the ability to use incentives for "industrial self discovery" is a critical part of the developmental toolkit of any sovereign nation.
Now you can read the Jamaica Observer ePaper anytime, anywhere. The Jamaica Observer ePaper is available to you at home or at work, and is the same edition as the printed copy available at https://bit.ly/epaper-login