Keith Collister, Gleaner Writer
DAVIES
A NEW study by the Inter-American Development Bank (IDB) suggests that the powerful impetus towards informality, such as over-weening bureaucracy and the seeming high costs and low returns from operating in the formal sector may be one of the causes of Jamaica's continued anaemic economic growth despite the country's heavy inflows of foreign direct investment (FDI), which have averaged six per cent of GDP over the past four fiscal years.
Other consequences of our poor incentive framework mentioned in the study include investment of time and energy in tax avoidance, investment in sectors with low social rates of return, and investment in capital intensive production techniques all contributing to a low growth rate of the formal sector economy.
Jamaica has struggled for well over a decade to push its growth rate beyond two per cent per annum, despite relatively high investment. Jamaica's gross capital formation (one measure of investment) between 1990 and 2003 ranged from a low of 23.8 per cent (1991) to 31.8 per cent (2002), or an average of 28.4 per cent. According to the IDB, investment rates in this range, near 30 per cent of GDP, used to be associated with growth rates of 7-10 per cent per annum in East Asia, although these days, and particularly in other regions such as Eastern Europe, the growth effects are less.
JAMAICAN CONUNDRUM
Dora Currea, the IDB's division chief of the Caribbean, attempted to provide answers to this puzzling Jamaican conundrum in her presentation at the Private Sector Organisation of Jamaica (PSOJ) annual economic seminar on Tuesday, using as her point of departure a report titled: "Jamaica - A Private Sector Assessment" prepared by Paul and Sarah Holden of the Washington based Enterprise Research Institute.
Ms. Currea argued in her presentation that Jamaica's rate of 'fixed capital formation' in the high twenties, similar to its level of gross capital formation, should be associated with a growth rate of six-seven per cent of GDP. In the view of the IDB, even investment rates in the low twenties, as seen in Jamaica in the early 1990s, should be associated with growth rates of four-six per cent of GDP.
Ms. Currea's point "why not more bang for the buck" had also been made by Minister of Finance Omar Davies in his opening speech at the conference. He asked "Why was it that with unprecedented levels of FDI, was growth so low?" a point that he admitted had also been made by Opposition leader Bruce Golding in his budget debate speech in Parliament.
THE IMPORTANCE OF INCENTIVES
In attempting an explanation, Currea started with a quote from American economist Steven Levitt's best-seller "Freakonomics: A Rogue Economist Explores the Hidden Side of Everything,": "Incentives are paramount. If you understand someone's incentives, you can do a pretty good job of predicting their behaviour." In her presentation, Currea argued that the IDB think problems with incentives can explain some of the growth paradox in Jamaica.
The informal sector is large, representing 40 per cent of GDP according to a 2004 IDB study. There appear to be powerful incentives for informality, as the costs of formality appear high, whilst the benefits are low. According to the study, "The main reasons to become formal [for smaller businesses] are to give businesses access to finance to fund growth and access to the legal system to enforce contracts. Neither finance, nor the legal system are in practice accessible to smaller businesses in Jamaica. Incentives for informality are therefore powerful and the size of the informal sector is unlikely to decline significantly if the situation does not change".
The study suggests the private sector needs appropriate macro incentives, fewer distortions, a financial market that funds entrepreneurs, secure property rights, less regulation, a modernised legal environment and adequate infrastructure.
MACROECONOMIC CONTEXT
According to the study, "The public sector commands the equivalent of nearly 39 per cent of GDP, one of the highest among developing countries of its size and income level. By comparison, when the industrial countries had a per capita GDP similar to Jamaica's their levels of tax and spending were the equivalent of 12-13 per cent of GDP"
In her presentation, Ms Currea defined a "supportive macroeconomic environment as including a stable real exchange rate and interest rate that is "sustainable" over time. This should also be non - distortionary in that the achievement of the first two shouldn't damage the incentive framework.
Currea cited a need for a more simple, neutral tax and incentive structure, reducing the spread between the private and social rate of return. In her view, for example, it made no sense to lower relatively the cost of capital in a country with a labour surplus like Jamaica.
According to the study, financial markets do not fund investment and entrepreneurship in Jamaica, whilst the high public sector debt adds a significant risk premium to interest rates. Amongst other problems, Ms. Currea argued the collateral framework makes lending costly and time consuming.
According to the study, land titling and registration is complicated and costly, whilst land transactions costs are very high, with the result that much of the countries land lies under-utilised and untapped. The current legal system imposes substantial transactions costs making it relatively inaccessible to small businesses.
Asked by the audience to prioritise the proposed reforms in order of importance, the IDB team put tax reform first on the agenda, followed by the reform of factor markets (land and finance), reducing regulation and modernising the legal system, and only lastly ensuring the provision of infrastructure. In Ms. Currea's view, business climate reform was in its infancy in Jamaica, and would require strong public - private dialogue and consensus building in the face of political difficulties or vested interests.
