RabkinWITH THE Jamaican dollar hitting new lows, the time is right for reflection on the state of the economy. At a party last weekend I overheard two lifelong Jamaicans discussing when would be the right time to leave the country. Not yet, they agreed, but one was planning to investigate whether his Cana-dian working papers were still valid. This was the first time I had heard such a serious conversation and it was between people that had weathered the 1970s.
For any who do not yet appreciate it, the seriousness of this moment cannot be over-emphasised. It takes a thousand wrong decisions, both inside and outside Jamaica, to get to a moment such as this. It will take only two to turn it around. The Government must decide, once and for all, to relinquish its role as master strategist for the Jamaican economy. The private sector must then play its part and get back to the business of building great companies.
HOW WE GOT HERE
As a pilot once told me, it is impossible to navigate without first knowing where you are. So let me revisit just a few of the thousand things that got us to the current place. Jamaica has for a long time operated with an unusually large debt (the origins of this debt will be the subject of a future column). There are many ways to manage and extend debt, but only growing businesses with their correspondent revenue contributions to the Government can reduce debt. The bad news is that Jamaica has gone decades without real business growth. That means companies are producing less money all the time, resulting in less tax revenue for the Government. At the same time, the Government (at the urging of many, including the private sector) has been spending more and more. In order to make up the difference, the government has borrowed massive sums of money.
Just like a person, the more debt a country has, the higher is its risk of being unable to pay it back. In order to entice investors (those Jamaicans and foreigners who buy Government paper) to assume this increased risk, the Government had to offer high interest rates. In Jamaica's case, those interest rates were so high that very few companies or individual investors thought they could make more money by investing in their own products than they could by lending to the Government. So money went into bonds instead of business projects.
HOW CURRENCIES TRADE
A little over a year ago things were looking pretty good. The debt was big, but companies were starting to feel confident in the future and getting ready to start investing in new projects. This would have led to the growth that could have reduced the debt. The dollar was trading in the 40s. It is important to understand that the exchange rate is based loosely on the general market perception of how valuable goods and services are in a country relative to their value in other countries. This is similar to the way the stock market prices companies. In general, the stock price of a company reflects the market's perception of the underlying value of that company. In the case of companies, underlying value is difficult to predict, largely because it is so heavily based on what that company will do in the future. With currencies, the market also values the underlying health of the country, but this typically accounts for a much smaller portion of the way the dollar is valued. More relevant in the short run is the local interest rate (a high one makes a local dollar worth more, since you can invest it and get a good return).
Over the long run, however, it is generally believed that a currency's value will follow the value of the local price of a basket of goods and services versus that same price elsewhere. This is known as Purchasing Power Parity (PPP) and, while by no means perfect, is a much better way to compare economic performance. Based on PPP, economists expected that the Jamaican dollar would eventually come down to the high 50s.
INTEREST RATES
At that time both business and government wanted lower interest rates: businesses wanted people to start investing in them and Government wanted to stop paying so much for the money it was borrowing.
FAST SLIDE
The educated knew that the dollar would continue to fall, but nobody wanted things to happen too fast. A fast slide would result in everybody on the island having less purchasing power, ultimately making everything more expensive in Jamaican dollar terms. That's inflation and the faster it hits, the faster it can spiral out of control.
The ideal scenario was for companies to begin to invest and grow. The currency slides slowly, making people's savings worth less, but the growth in the economy offsets the decrease. Prices rise (inflation), but again more slowly than the increase in citizens' ability to pay those prices. As the economy grows, tax revenues rise, allowing the government to pay down its debts, restoring investor confidence and allowing the Central Bank to lower interest rates. Lowering interest rates encourages even more investment in and by companies, resulting in even more growth. A wonderful cycle was about to begin.
WHAT HAPPENED
Unfortunately, two sets of events occurred. First, the currency slid a bit too fast for the Central Bank's liking. Fearing the cycle might go the other way and lead to inflation, the Central Bank raised interest rates fast and high. Though quickly lowered, the damage was done. Precisely the cycle the Bank was trying to avoid was initiated. The currency started sliding more quickly, prompting the bank to keep raising interest rates. Businesses cancelled their plans to invest and prices started to rise.
Second, the country and the market lost faith in the ability of the government to provide the conditions that would enable businesses to grow. Beginning with the scandal surrounding election spending and culminating in the current budget fury, the loss of confidence has been dramatic. Investors everywhere now believe that the Jamaican economy is worth less than they did just one short year ago, because they are increasingly sceptical that companies will have an environment in which they can succeed. How much less is the economy and, thus, the dollar worth? We still don't know. More importantly, currency investors don't know and they are taking their money and running.
WHAT NEXT
What the economy and the private sector need is confidence. Confidence can only come from the belief that the government is committed to doing everything it possibly can to support the private sector, except to impede competition (source: Michael Fairbanks). The only way out of this mess is for the economy to grow quickly over a long period of time. Regular readers know that I believe in the talent and the brands that can enable growth to happen. Yet I also believe that the government has gotten in the way. By creating numerous and complicated taxes on the productive sector, growth has been limited. By creating industrial policies for the private sector instead of with the private sector, priorities have been confused. By engaging in erratic and ineffective macroeconomic and fiscal management, stability and confidence have been undermined.
The days of command and control economics are long gone. I doubt they were ever truly here. Simplify the tax code, reduce bureaucracy, and get out of the way. And when the government does what it needs to do, the businesspeople of Jamaica must get back to work. Only they can find the customers and build the companies that will produce real growth. I am certain Jamaica's business leaders will prosper; I pray they will do it in Jamaica.
David Rabkin is Project Director of the Jamaica Cluster Competitiveness Project, sponsored by the Jamaica Exporters Association. Mr. Rabkin is a Vice-President in the Boston-based advisory firm, ontheFRONTIER. He can be reached at: drabkin@onthefrontier.com
