Is the Jamaican economy going the way of the PIGS?
NO, it is not the pigs you are thinking about. We are talking about Portugal, Ireland, Greece and Spain. These countries on the periphery of Europe are suffering from the noxious mix of yawning budget deficits and unsustainable debt/GDP ratios. Except for Ireland, these countries only emerged from under the spell of authoritarian regime in the 1970s.
The level of debt severely affects these countries ability to respond to financial crisis. Jamaica has the fourth highest per capita debt burden in the world, after Japan, Zimbabwe and Lebanon. However, one must realise that Japan relies on external financing for only six per cent of its debt. Moreover, countries which experience public debt over 90 per cent of GDP usually lose at least one per cent in economic growth. Everyone should be envious of the Scandinavian countries Norway, Sweden, Demark and Finland.
Over 40 per cent of the global GDP resides in countries with budget deficit north of 10 per cent. With Portugal at 9.4 per cent, Ireland 14.3 per cent, Greece 13.6 per cent and Spain at 11.2 per cent, at 8.7 per cent Jamaica’s budget deficit may not seem very high, but the concern is how it is being financed. On a cash basis these deficits are much higher. You cannot borrow perpetually to finance this deficit. Jamaica should not also fall into the trap of borrowing to support exchange rather than reducing the deficit. Jamaica is now suffering from the ingenious fiscal and monetary policies of the previous government. With the high interest rate choking off GDP growth. The delta between nominal GDP growth and interest on the debt is extremely wide. This gap can be meaningfully reduced if the economy starts growing at its potential.
Greece seems to be in the worse condition. The $146 billion bailout is much needed to avoid default. It comes with austere conditions. Remember it was Greece, the Phoenicians and the Etruscans who fought for the supremacy of the Mediterranean. Its problem has contributed substantially towards the decline of the euro in the foreign exchange market with the highest yield on any sovereign two year bond at 13.5 per cent, higher than Venezuela at 11 per cent and Argentina at 8.8 per cent, where 30 per cent of VAT is not collected. In 2009 only six Greeks reported income of over one million euro and eighty five declared income over half million euro. Income tax as a per cent of GDP is only five per cent, way below the European average of eight per cent. The manufacturing sector is in a free fall. Its competitiveness has declined 30 per cent over the last decade.
Spain with the fourth largest economy in the Eurozone now suffers from a 20 per cent unemployment rate, doubling since 2007. Making it extremely difficult to cut its 11.2 per cent deficit, its 54 per cent debt/GDP is manageable. But the economy was over reliant on the construction and real estate industry. These two industries have come crashing down and is unlikely to return to its vaulted state anytime soon. It will be a while before any other sector of the economy take up the slack. Above all, the availability of easy credit further contributed to this contraction of the economy. We must remember that as recently as 2007 Spain ran a budget surplus.
The Portugal economy is very uncompetitive and GDP growth has been abysmal. The economy has been stagnant. It has expanded less than one per cent annual for over ten years. Even though its external debt is 76.8 per cent when one take into account both the private and public debt it ballooned to 236 per cent. Making it the highest in Europe, much higher than Italy at 205 per cent and Greece at 195 per cent. Portugal is then being forced to finance its deficit with foreign capital.
Ireland with the highest deficit at 14.3 per cent, has been most aggressive in addressing its economic crisis. Cutting spending by 20 per cent. The Irish GDP declined 7.5 per cent in 2009. But the drastic steps taken by the Irish government has put it on the path of sustained GDP growth. The Irish has shown us that it is a lot better to swallow bitter medicine swiftly.
Because of these conditions the PIGS have seen their cost of funding increase dramatically when compare to Germany.
Here is the illustration;
Most if not all the conditions above apply to Jamaica. The Jamaican economy needs an amalgam of spending cuts and tax increases to put its back on a growth trajectory. There is no logical reason why the economy cannot sustain a five per cent annual GDP growth. There is a massive revenue leakage which needs to be plugged immediately. This is the ideal time for government to implement a rational tax increase to enhance its revenue. Not too sure what the Minister of Finance is looking at for him to declare that there will be no tax increase. Whether he is using differentiated physics or common sense, it comes to the same conclusion tax as a percentage of GDP is way too low. For those who think that increased taxation will adversely affect the economy just take a look at Norway, Sweden, Denmark and Finland where tax is north of 40 per cent. Look at their envious budget surplus/deficit and debt/GDP. With falling nominal interest rate and rising GDP growth Jamaica can seriously put a dent in its budget deficit. What this needs is some thinking dexterity to stimulate the economy. Given the forecast below, Jamaica has a long way to go.
From the The Economist:
The people who make money in Jamaica do not pay their fair share of taxes. It is the employees without many options who bear the blunt of the taxes. There has to be some equity in this equation. Jamaica needs to more aggressively address tax evasion. Tax as a per cent of GDP should be targeted in the 35 per cent to 40 per cent range. Adopt the Scandinavian tax model.
Jamaica’s saving rate is far too low. Net national savings after adjusting properly for capital consumption is negative. Jamaica should target a savings rate of at least 10 per cent of GDP. It is just not generating enough internal cash flow. Take a look at Chile which suffered recently from a devastating earthquake. Because of it high savings rate it did not have to rely on external financing for its recovery.
The delta between interest rate and GDP growth is definitely too wide. High interest rates cause the debt ratio to explode. It seems as if most of the growth in the economy over the last 15 years was the result of credit expansion. Moreover, deficit spending has significantly outpaced GDP growth.
Jamaica needs to become an export driven economy.
Productivity and competitiveness must expand
Low competitiveness mixed with large current account deficits is a recipe for disaster. Also, the Government must reduce the number of expense items in the budget. The debt has metastasised and now need a cogent and painful approach.
GDP growth is the center of gravity around which economy firmament orbits. It is the basic tenet of any government to make its country competitive and prosperous.
The efficacy of this prescript is to put Jamaica in its rightful place as a competitive economy. We can follow the Irish model of taking our bitter medicine swiftly and lay the framework for sustained growth or the Japan model of tinkering at the edge and end up with stagnant GDP and the festering of
the problems.
The Greeks may have the Oracle of Delphi to call on but Jamaica needs gumption.
Del Warmington is a Managing Partner at Delwar Capital Management LLC. You can email him at dlwarm2001@yahoo.com