Jamaica: Debt, Economic Performance and Labour Productivity
September 27, 2006 8:40 |by Michale Sheckleford
The Jamaican economy suffers from serious debt, high inflation and uneven growth rates. Current economic policies, such as exchange rate devaluation and debt-servicing, only exacerbate Jamaica's economic downslide. To resolve this crisis, the government must implement measures aimed at sustainable growth, such as improving the quality of education and facilitating credit access for small borrowers. Ultimately, Jamaica may be forced to walk the Argentine road of debt renunciation in order to keep from going under, argues Michale Sheckleford
Jamaica Faces a Sombre Future
The Jamaican economy has suffered numerous challenges and setbacks in the increasingly competitive global environment. Ultimately, if Jamaica cannot solve its problems by conventional means, it may be persuaded to take the Argentine road of debt renunciation.
Since the 1960s, when the country enjoyed growth rates ranging from 2 percent to 8 percent per annum, the island has been unable to sustain high growth rates over an extended period of time. Jamaica continues to be vulnerable to falling prices and worldwide economic shocks, which have contributed to the pronounced fluctuating nature of its economy. The primary economic problems currently facing the Caribbean nation include high internal debt, a large trade deficit, swollen interest and inflation rates, chronically elevated unemployment levels, as well as low worker productivity, all of which fuel political unrest and escalating gang violence.
Traditionally, the Jamaican populace has blamed its political elites for the country's poor economic performance. However, the position of the economy is attributable to more than just poor policy implementation on the part of national leaders. External factors also play a large role in its present parlous position. The oil crises of 1973-1974 and again in 1978-1979 significantly damaged the heavily petroleum-dependent state. During the 1970s and 1980s, both the Manley and Seaga administrations, in an attempt to revamp the economy and with the aid of international financial institutions, embarked on a programme of macroeconomic and structural reform, which focused on liberalizing the economy.
Since the 1980s, the government has undertaken the responsibility of limiting the state's role in the economy, promoting the development of export driven production, reducing the fiscal and current account deficit, as well as eliminating poverty and inequality. Thus far, these objectives mostly have been met with limited success. The debt situation is alarming and continues to hamper economic growth by drawing heavily upon resources that could be put to more productive uses. The debt overhang also limits the extension of credit to the weaker margins of the private sector, particularly towards medium and small borrowers. In order to improve the economic situation, policies aimed at sustainable growth, such as a greater investment in education, have to be implemented to increase human capital and the labour force's productivity.
The Economic Situation in Brief
Currently, the Jamaican economy is service-oriented and accounts for 60 percent of the island's GDP (US $12.17 billion for fiscal year 2005). The primary sources of foreign exchange include remittances, tourism and bauxite mining. The worldwide economic recession in the wake of the September 11 terrorist attacks had adverse economic implications for Jamaica. Even though the economy recovered partially between 2003 and 2004, the country still faces a number of long-term problems. The current debt-to-GDP ratio is 135 percent, pointing to a serious budget deficit which only expanded in the wake of Hurricane Ivan because of the expenditures necessary to repair the damage incurred by the natural disaster.
During the 1990s, there was a reduction in the inflation rate, which had been in the double digits for much of the 1970s and 1980s. The benefit of controlling inflation, coupled with an increase in remittances from overseas, brought much of the population above the poverty line, which had declined from a peak of 44.6% in 1991 to 16.7 % in 2001. The control of inflation, however, was achieved by increasing net foreign currency reserves, which was partly financed by borrowing. This eventually sank the country even deeper into debt. In the long run, this borrowing led to more debt financing as more money was allocated towards the payment of loans. This capital could have been far better applied to other sectors of the economy, generating much needed revenue and therefore improving socio-economic conditions and reducing the alarming incidence of crime. Unfortunately, the inflation rate, which was in single digits since 1997, once again entered double figures in 2003. While the inflation rate is still in double figures as of 2005 (12.9 percent), it has been exhibiting a declining trend from a high of 14.1 percent in fiscal year 2003.
The Debt Crisis
The crisis currently affecting the Jamaican economy with respect to high debts, interest rates and burgeoning trade deficits, is grounded in the severe economic setbacks of the 1990s. This decade was characterized by negative or otherwise abysmal economic growth and high levels of unemployment. After realizing economic growth rates of 5.5 percent in 1990, the next highest growth rate for the Jamaican economy was only 2 percent in 1993. Furthermore, Jamaica experienced negative growth rates in GDP during the 1996-1999 period, when unemployment rates averaged over 18 percent. The Jamaican government absorbed debts amounting to 44 percent of GDP in the wake of the financial sector crisis of 1995-96, one of the most crushing economic catastrophes in the world in terms of its effects on GDP. This crash was due to the poor regulation and management of the Jamaican financial sector. Since the crisis, monitoring and regulation has substantially improved. It was this financial crash that primarily contributed to the island's currently high debt-to-GDP ratio. Most of this debt is held by local creditors (90 percent), with the financial sector preferring to extend credit to the government rather than to the private sector.
Lending to private institutions has been considered "risky business" since the banking crisis, when non-performing private-sector loans led many financial institutions to declare bankruptcy. Also, the interest rates on government loans are higher than that of private loans, making government borrowing more attractive. Therefore, this limits the accessibility of capital to the private sector, particularly for borrowers who lack significant collateral (which is security for loans, such as land). With regards to government loans, domestic interest repayments are four times greater than foreign interest repayments. This played no small part in causing domestic debt to amount to approximately 37 percent of expenditures and 54 percent of tax revenues, in part because of the high as well as fluctuating interest rates on government treasury bills (monetary instruments used by the government to borrow money from the public). External debt now amounts to 60 percent of Jamaica's GDP, and is governed by the floating exchange rate. Clearly, the current debt situation is very bleak. Economic growth has been stifled by crowding out private loans as a result of heavy debt-servicing obligations.
The government's policy of maintaining an unfavourable exchange rate is a double-edged sword. Along with reducing tariffs and eliminating duties on raw materials and other imports necessary for production, exchange rate depreciation continues to be one of the primary tools employed by the government to improve Jamaica's competitiveness in the world market. It has been argued that a weakening currency improves trade deficits because one's exports become cheaper relative to other goods on the market and therefore improves the competitiveness of one's products in the global trading arena. Conversely, a declining exchange rate increases the cost of imported goods within one's country. However, while such economic reasoning might be sound on the surface, other factors have to be taken into account. Jamaica is heavily dependent on imported raw materials, particularly oil, which is necessary for electricity generation, transportation and production. This is especially true in the bauxite sector, a heavily energy-intensive industry.
Since Jamaica is not an oil producer, this essential resource has to be imported. Moreover, the cost of oil is denominated in U.S. dollars, which has been appreciating steadily in value against the Jamaican dollar, therefore making this resource increasingly expensive on the domestic market. Currently, the exchange rate is roughly US $1.00: J$ 65.00, which not only increases the price of oil and its dependent processes, but also inflates the cost of production overall, making the final price of goods and services uncompetitive. This is one of the contributing factors to the escalating inflation rate. The free-floating exchange rate is also highly volatile, subject to sharp declines, therefore dampening investor confidence and stifling economic growth. In this light, the declining exchange rate seems to hamper rather than improve Jamaica's economic competitiveness.
Another very serious trade off in devaluing the Jamaican currency is that, since the majority of debt is in American dollars, it is determined by the exchange rate. Thus, as the exchange rate continues to decline, the level of debt continues to escalate as a percentage of GDP, as increasing amounts of money have to be allocated towards debt-servicing. In the end, the debt overhang and interest payments will continue to increase, taxing the economy by using funds that could be put to more productive use.
A Better Approach
There may be more practical ways to improve Jamaica's competitiveness in the global market. More could be done to boost labour force productivity. Education increases the human capital of any given society, leading to greater worker productivity and therefore economic advancement. Furthermore, the incidence of the young engaging in risky behaviour, including violence, is much lower for both sexes who possess a solid educational background. This is particularly important for Jamaica, which needs to increase labour productivity and reduce its crime rate. The high crime rate profoundly hurts economic development because it burdens the business environment with additional security costs. It also creates an environment of instability, producing reluctance on the part of both local businessmen and foreigners to invest in the island's economy.
Improving the educational system, however, will prove to be an expensive venture. One way to raise the amount of funding allocated for education is to use savings created by reducing the roster of the government bureaucracy and its functions, in particular the ever-increasing public sector wage bill. Currently, the salaries of public sector employees account for about one-third of government spending. The cost savings to be realized by controlling salary increases can instead be invested in improving the quality of the educational framework. At the same time, the purpose of a society is that it is there to serve the needs of its people, which means that social justice measures need to be advanced, not retarded.
Jamaica's large informal sector should also be taxed in order to improve the educational system, but one should not ignore the limited funds at play here. The informal sector in this instance refers to street pedlars, known in common parlance as "higglers," along with other petty traders who currently do not pay taxes in order to operate their businesses. Taxation in the form of licenses and permits could be employed to achieve this objective. In addition, in order to retain the country's trained professionals, more needs to be done to stem the "brain drain" afflicting the island. This can be achieved by producing incentives to entice young, trained professionals to remain on the island, through expanding industry, increasing investment and most importantly, by addressing the crime situation, which drives many to emigrate.
It is imperative that the debt overhang be eliminated and that policies are geared towards boosting the human capital of the country in order to improve Jamaica's economic competitiveness. The current debt crisis is limiting potential private sector loans, particularly amongst small and medium borrowers who find it virtually impossible to secure credit. In turn, this makes it difficult for individuals to invest within the economy, again stymieing economic growth. Credit bureaus should be established to access credit reports in order to distinguish between those who will repay their loans from those who will not. This would encourage domestic investment in the Jamaican economy, be an essential source of additional tax revenue, as well as a credible means for employment. Also, the mechanisms for tax collection need to become more efficient to address the pressing problem of the country's debt, and at the same time, provide the necessary funding to improve the educational system. Already, the current tax rates are high and burdensome. Therefore, raising taxes would only incite serious political and social unrest. Improvements in labour productivity would also enhance economic growth and international competitiveness, despite Jamaica's comparatively high cost of labour in the region. Thus, it is imperative for the government to reduce the country's debt burden and invest in education so as to increase Jamaica's human capital. This would be perhaps the most obvious way to facilitate the island's emergence from the chronic problem of poor and uneven economic growth.
Michale Sheckleford is a Jamaican national and a Research Associate of the Washington-based Council on hemispheric Affairs.