The Financial Crisis: Focusing on the wrong year
Published: Sunday | May 24, 2009
I have never been a student of history. I always treated it as a lower priority subject with little value to add to the present, or the future, notwithstanding the fascinating stories which some historical accounts provide for reading. How wrong!
Since I have been involved in writing my autobiography, which I have now completed, I have learned the value of history as a teacher. There is a maxim which says, learn from the past to deal with the future.
That maxim is so true today. The country is at present floundering its way through an epic recession without taking any note of the devastating events of nearly 30 years ago. At that time, at the beginning of the 1980s, what was then called the worst global recession since the Great Depression of the early 1930s was ravaging the country.
I have watched the unfolding impact on Jamaica of this world-wide catastrophe which is wiping out one-half of global assets, throwing millions of workers out of jobs, crippling powerful banks and drying up credit to a trickle. This scenario, which is the epicentre of the calamity, has not yet reached Jamaica, but there is a cloud on the horizon.
History tells us that this is precisely how the recession of the early 1980s started in Jamaica. The global devastation did not reach our shores until 1982, when the bauxite industry seriously began to crumble. I warned in three articles in my column in The Sunday Gleaner last year that the focus of the attention should prioritise the bauxite industry, because this was the barometer which would indicate the timetable and how bad the devastation could be.
As prime minister at the time, I learned this the hard way, as there was no historical precedent to guide me. The early reductions in the sale of bauxite and alumina in 1981 were considered at the outset to be a short-term episode. The expectation of a quick recovery was in keeping with the end of the recession overseas in 1982. But this was not the case in Jamaica.
By 1982, it was well recognised that this devastating global recession would create a stunning sustained decrease in bauxite production and no further increase in levy earnings to mitigate the impact. This made the challenge of recovery of the economy exceptionally difficult.
The precipitous fall in bauxite and alumina production and the export earnings of both commodities over the decade of the 1980s ravaged the Jamaican economy. Gross earnings, according to the Jamaica Bauxite Institute, were US$732.3 million in 1980, from which point the decline commenced, bottoming out at $289.6 million in 1985 and US$289 in 1986, before gradually climbing back, although at the end of the decade exports had still not returned to the 1980 value.
Twice the impact
Using the earnings of 1980 as the base year, the total loss for the decade, counting the shortfall year by year, was US$2.4 billion, or a 36 per cent loss. This was virtually twice as much as the additional cost of oil in the 1970s and, consequentially, twice the impact on the economy. Bearing in mind that the bauxite industry earned 72 per cent of the foreign exchange of Jamaica in 1980, a point was reached in 1983 during the slide, when the export earnings of the country was cut in half from US$1.3 billion to US$0.64 billion. This was an unprecedented disaster in which the loss far exceeded that of the worst natural devastation in the history of the country.
The damage was not only in the massive fallout in foreign exchange earnings. Calculating the loss in reduced bauxite levy receipts annually from the level of US$205.7 million in 1980, the total shortfall in the revenue was US$810 million, or 44 per cent of the total receipts expected. The dramatic shortfall in foreign exchange earnings and the severe fallout in revenue left exceptional gaps which had to be closed.
It is the closure of these gaps created by severe reductions in the external and domestic accounts which would have to be addressed to restore the Jamaican economy to a state of stability.
What we can learn from this is the central point that the rate of recovery in the bauxite industry is longer, because the demand depends on the recovery of the market for cars, aircraft, housing and other heavy industry users which lag behind the resurgence of general consumer goods.
Fallout and recovery
In the course of the fallout and recovery, the damage to the economy this year will be a result of the loss of export earnings of some US$850 million, which will be devastating. How great this will be over the next few years will depend on the length of time for full recovery to occur.
It is wise to consider, however, that there may not be full recovery. The plants which have been closed are owned by interests in which Rusal, the giant Russian aluminium producer, is the dominant party, and the Jamaican plants may be too small to be considered worthwhile in the resumption plans, particularly since they are inefficient. If so, the loss of foreign exchange would continue on a calamitous path beyond the recession, with severe damage to the Jamaican economy for years to come.
The damage would be a consequence of the inability of the economy to make good the shortfall of foreign exchange from new export earning sources. The existing export sector, with the exception of tourism and, to a lesser extent, remittances, has little capability for increased foreign exchange earnings, considering the condition of the major producers: the demise of the bauxite industry, the continuing decline in export agriculture and the paralysis of export manufacturing.
To close the US$850 million gap with little new alternative export prospects and the equally limited capabilities of the existing export sector, the recourse will have to be a combination of judiciously drawing down on the Net International Reserve, which now stands at US$1.6 billion, or coming to an agreement with the IMF to provide some or all of the foreign exchange to fill the gap. Both of these courses could have daunting results.
Drawing down on the Net International Reserves could create some panic with the usual consequence of a flight of capital and depreciation of the exchange rate, both of which could be more damaging than the problem itself to be overcome.
To reduce this presentation to its essential points, the gap to be closed on the domestic (fiscal) budget would be about $23 billion, or US$250 million, after all other adjustments are made. This amount can be provided by the IMF, if there is an agreement. But, while this would close the gap in 2009-10, what would happen thereafter? The IMF would not be involved on a continuous basis to close a continuing shortfall in future years.
The corresponding foreign exchange gap in the external budget will be about US$850 million in 2009-10. While this could be closed by the IMF or drawdown on the Net International Reserves, what would happen thereafter? The IMF would not be involved on a continuous basis to close the continuing shortfall in future years.
This is the real problem of the Jamaican economy, not the temporary recessionary gaps and the method of closure, but the holes in both budgets for which no drastic solutions have yet been found. Yet, drastic solutions are needed now to deal with the financial problems which have persisted for some 20 years and show no sign of relief. If they are not tackled now, the future will still be much the same as the past: little or no growth, high inflation, high interest rates and high unemployment. The economic crisis provides a perfect rationale to take the drastic steps now.
In the 1980s, my government had only one choice it could make to close the fiscal gap, since the size of the national debt was not a solution. The size of the public sector staffing had to be reduced. Painful as it was, there was no choice. It was done. The fiscal budget was, thereafter, in surplus instead of deficit, until 1995.
To deal with the shortfall in the external budget, we launched a new export subsector in apparel manufacturing to earn more foreign exchange. It became one of the leading foreign exchange earners within a few years. This did not satisfy the IMF. Further devaluations were required. I refused, and after a stand-off of many months the fund agreed to a pegged exchange rate of J$5:50 to US$1, which continued to 1989. It was in this period that the Jamaican economy recovered and returned to solid growth.
In the current circumstances, government appears to be going the route of an agreement with the IMF to cap the national debt at the same level as the GDP. This would restrict budgetary expenditure, which is the same as reducing expenditure. I have not seen the figures yet as to how effective this would be in terms of whether the reduction in debt would release sufficient revenue to enable expansion of capital investment in the budget on a meaningful basis, unlike the past many years.
This constraint on capital expenditure has been one of the main reasons for lack of economic growth. If this is a viable route, the longer-term fiscal problem could be solved. If not, the only alternative for longer-term benefit would be the reduction of staff. The IMF, however, is essential in the immediate future to first stabilise the economy and make it ready for the longer-term solutions.
The external budget offers more difficult options. Increasing export performance from the existing base revolves, first, around further growth in tourism to whatever extent there is additional development possibilities. Second, given the situation with bauxite, and the lame-duck status of manufacturing, the only meaningful underutilised area for development is agriculture. I have spoken and written on the potential of agriculture a dozen times or more in recent years. When I think of the potential, my head spins in exhilaration. Others I speak to experience headaches. However, it must be recognised that without a resumption of bauxite production, agriculture is the only remaining resource base for economic take-off.
For the ultimate recovery of the economy, the IMF will have to be made to understand that devaluation of the Jamaican dollar is not an option. All the gains would be wiped out by depreciation of the exchange rate.
But it is also true that without any IMF pressure, domestic economic stress can also depreciate the exchange rate and increase interest rates. These are areas of the economy yet to be confronted by government. They hold the key to an open door of economic success or confinement to a deep hole with a short ladder to which the economy has been consigned for many, many years.
It is not the recession that should be feared. What should be foremost in our minds is that when it recedes we would have by then structured long-term solutions for it to remove the seemingly interminable pitfalls of suffering years.
Edward Seaga is a former prime minister. He is now the Pro-Chancellor of UTech and a Distinguished Fellow at the UWI. Email: email@example.com or firstname.lastname@example.org.