Financing for development

Claude Clarke, Contributor

Few would disagree that the economic collapse which led to the devastation called FINSAC and its even more destructive successor, the cynically misnamed Jamaica Redevelop-ment Foundation, was the result of Government's high-interest rate policy of the 1990s.

That fateful policy was created by the Government as it scrambled to halt the slide of the Jamaican dollar, which was put under pressure by its failure to keep domestic inflation under control. Inflation had skyrocketed 315 per cent between 1991 and 1994. The hopelessly deformed economic structure that emerged bore two distinctly contrasting features: a puffed-up financial sector, and a shrivelled productive sector. To paraphrase the Reverend Ronald Thwaites, this was the most massive transfer of wealth from the productive to the unproductive in history. The economy was left chronically dysfunctional.

Had our economic stewards been guided by honest analysis, they would have realised that the financial sector's rapid expansion was the result of Government's interest-rate policy sucking capital from the productive sector, undermining its wealth-creating capacity and its ability to grow the economy. But it was only when what should have been obvious could no longer be misconstrued - that there was little real value to support the massive profits that were being recorded by the financial institutions and the high interest returns they were paying their depositors - that the Government responded. When it did, its response was purely reflexive and ultimately destructive rather than constructive. It focused on the symptoms of the financial sector's pain and not the underlying economic malady: the gutting of the country's productive capacity.

No proper diagnosis

What is clear is that the Government's actions did not have the benefit of a proper diagnosis. If it had, it would have recognised the incongruity of the financial sector's almost 80 per cent expansion in just four years, and the productive sector's decline. And it would have realised that a rebalancing of the financial and productive sectors was a necessary prerequisite for equilibrium and growth to be restored to the economy.

In 1987, when economic growth was at its post-1960s zenith, at over six per cent, the financial sector was only seven per cent of GDP. However, in 1995, when the economy was in contraction, the sector was almost 15 per cent, more than doubling its share of GDP.

One might, therefore, have been forgiven for believing that although it was chaotic and ugly, the financial sector shake-up, which led to a 25 per cent contraction in its size between 1995 and 1998, was intended to rebalance the economy. However, no sooner had the sector approached a size more proportionate with the economy, than its expansion resumed, this time with fewer players - bigger, richer, and far more easily cartelised than ever before. Now their profits were no longer a mirage but real, substantially financed by the massive debt incurred by Government to rescue them in the early 1990s.

But the Government, having bailed out the financial sector, left in place the policies that had created the economic crisis to begin with - policies that moved Jamaican capital from productive use into highly profitable but relatively unproductive activity in the financial sector. It is, therefore, not surprising that by 2009, the financial sector grew by a further 45 per cent while the productive side of the economy, including tourism, stagnated.

Growth by a domestically focused financial sector cannot be sustained in the midst of declining production, and only presages future economic collapse. The Inter-national Monetary Fund pro-gramme notwithstanding, the recovery of the economy will not be possible without the resump-tion of growth in the productive sector. This will only begin when the bleeding of the sector's capital is reversed and strategies for capital to be attracted to it are implemented.

The present administration, having promised a change of economic course while campaigning for office and after three years in office, has failed to put forward a coherent plan to correct this dangerous misalignment of our economy and point us towards development. No less alarming is the fact that the plans of the Opposition for a return to office do not include a repudiation of its policies, which created the worst economic crisis in our history, as architects of those policies continue to play a prominent role in preparing plans for our economic future.

Development demands diversified and competitive financial services, services that provide easy and competitive links to the full range of capital available from domestic and foreign sources. But Jamaica has evolved a financial sector that is mainly focused on mobilising funds to finance the Government and to satisfy consumption demands. The narrow breadth of its offerings belies the significant share of our GDP that it commands.

A financial sector which claims such a large portion of an economy would be expected to offer the full range of services required for production and growth. However, this is not the case in Jamaica, and the few services that are available are much too expensive for the local businesses that use them to be internationally competitive.

Critical changes

It is clear that for Jamaica to develop, there will have to be critical changes in the structure and operation of our financial sector. These changes must begin at the central bank, whose focus must be redirected towards keeping our currency competitive and strong, while making the cost of capital within the economy internationally competitive. The entire world is doing this to maintain the health of their respective economies. We can do no less.

Superprofits made by financial institutions in a contracting economy are unsustainable and self-destructive. And the extent to which this continues is the degree to which Jamaica's productive sector will be deprived of the affordable capital it needs to succeed. Our major commercial banks, for example, have been earning in the order of 25 per cent on equity in our declining economy and in the midst of the world's worst economic crisis in over 75 years, while in the United States, return on equity for commercial banks averaged no more than 15 per cent during the boom years of the 1990s, and plunged to less than one per cent during the crisis.

This problem cannot be solved unless the Jamaican Government takes itself out of the local debt market so that our domestic capital will be forced to find alternative investments in the private side of the economy. Our capital is under-utilised in the unproductive hands of government, and the Government must, therefore, move speedily to seek its loan financing from external sources, particularly from low-cost bilateral and multilateral institutions. Finance Minister Audley Shaw, to his credit, has begun to do this, as exemplified by last week's US$200-million loan secured from the Inter-American Development Bank at just over one per cent.

If the hundreds of billions of dollars of Jamaican capital now in the hands of Government are released and become available for use in the private domestic economy, the opportunity for the creation of the varied forms of financing, which a truly productive and dynamic economy needs, will emerge. And it is within Government's power to use fiscal and regulatory tools to lead the financial sector to create this varied financial architecture.

The highly successful Junior Stock Exchange is an outstanding example of how government policy can positively influence the finance landscape. Its policies could be equally effective in developing private-equity funding, investment banking, develop-ment banking, and a corporate bond market, based on Jamaican capital but plugged into the abundance of inter-national capital.

At present, both the Government and Opposition seem to be lost in a fairyland belief that little pockets of special subsidised financing, doled out to selected interest groups and sectors, can achieve economic development.

While these special arrangements can have some palliative benefit, today's competitive world demands a complex of institutional arrangements, which will give all businesses within the economy access to the full range of financing options at internationally competitive prices.

With a more diversified and engaged private financial sector, special government financing institutions will be able to concentrate on the services for which government is needed. These services would include micro-business financing and similar socially beneficial services, export financing oriented towards overseas marketing and distribution, a development bank engaged in direct lending to promising start-ups, expanding productive businesses, and an investment bank linked to Jamaica Trade and Invest/JAMPRO to provide that agency with the leverage and clout it needs to bring capital to its investment-promotion initiatives.

Finance is as vital to the health of our economy as blood is to our bodies. However, that blood and all its elements must be in balance with our body for proper health and development to be assured. Government must apply policies that will achieve that balance in our economy. We must hope that both the governing Jamaica Labour Party and the opposition People's National Party are now formulating policies that can bring this balance into effect, and that we will be having an intelligent public debate about them before long.

Claude Clarke is a former trade minister and manufacturer. Feedback may be sent to columns@gleanerjm.com