Wilberne Persaud, Financial Gleaner Columnist
Devaluation as cure for Jamaica's balance of payments and resultant growth woes is wholly contraindicated by economic vital signs and structure of production.
Yet, like Say's Law for the macroeconomy, it may take a century or more for this 'cure' to be finally and permanently discredited and abandoned, by which time it might, paradoxically, have become an indicated cure for such a condition.
French businessman and economic thinker Jean Baptiste Say is recognised for the law bearing his name in classical economics which states that "supply creates its own demand".
Actually, the phrase occurs first in the writing of James Mill, father of better-known economist/philosopher John Stuart Mill.
Regardless, Say's Law claimed that in a capitalist free enterprise economy, involuntary unemployment could not exist. Why? Because to create a product (supply), an amount of value equal to the market price of that product would have been expended in its production.
Those who supplied the raw material and labour would therefore possess the means with which that product could be purchased. The final good, after all, was what people wanted.
So the law lived happily for more than a century in classical economics until the Great Depression, at which time the sight of thousands of unemployed men in soup lines collided with shuttered factories lying idle as capitalists gave up hope that there would be sufficient money-backed demand to buy the products their factories could churn out.
Keynes developed his 'General Theory' identifying the basis of involuntary employment while advocating the benefits of pump priming - or stimulus as it is called today - government expenditure to take up the slack as private investors lose confidence.
Say's Law was 'finally and permanently discredited and abandoned'. But we humans are remarkable. A new variation or mutation of this idea did develop - supply-side economics and tax cut inspired job creation.
So much for analogy and digression. Let's rewind to early Jamaica/IMF encounters.
These usually ended, after months of private closed-door negotiations amid acrimonious public politico-economic policy squabbles, with a completely predictable formula. This formula later, in 1990, became known as the Washington consensus - reflecting triumph of the Reagan-Thatcher privatisation liberalisation crusade.
Inevitably, the inked deal would require privatisation, liberalisation of trade regimes, deregulation and, of course, devaluation of the currency.
Jamaica hopped this bumpy unrewarding ride from 1977, and today there are some who continue to advocate it as a true solution to the problem of over consumption of luxury goods, unsustainable energy imports and an underperforming export sector.
The prescription is based on the idea that at a lower price, people purchase more of a commodity, and vice versa for a higher price.
So, why has Jamaica, after so many devaluations and managed flexibility in the exchange rate, not beat the problem and prospered?
First, let's look at the theory. There is something economists refer to as PPP - purchasing power parity.
PPP basically says exchange rates should equalise the price of a basket of goods in any two countries freely engaged in trading activities, over the long run.
Indeed The Economist produces a metric they call the Big Mac Index. The magazine describes as "a light-hearted guide to how far currencies are from fair value". The Economist basket of goods "contains just a single representative purchase, but one that is available in 120 countries: a Big Mac hamburger. The implied PPP, our hamburger standard, is the exchange rate that makes the dollar price of a burger the same in each country."
A brilliant idea you think. And you're so correct because it allows one to spot the fallacy in the devaluation argument pretty quickly. I am going to save time - composing without Internet access - and quote a clip from an old 2007 magazine in my archives: the actual values are, therefore, not current.
Of the 120 countries it tracks, we find that "most currencies are trading a long way from that yardstick [PPP equality]. China's currency is the cheapest. A Big Mac in China costs 11 yuan, equivalent to just US$1.45 at today's exchange rate, which means China's currency is undervalued by 58 per cent. But before China's critics start warming up for a fight, they should bear in mind that PPP points to where currencies ught to go in the long run.
"The price of a burger depends heavily on local inputs such as rent and wages, which are not easily arbitraged across borders and tend to be lower in poorer countries. For this reason, PPP is a better guide to currency misalignments between countries at a similar stage of development."
That last point is the most important. An 'optimum exchange rate' for Jamaica must not be confused with the PPP value generated by comparing the baskets of goods.
Following Bill Clinton, one should say 'it's arithmetic', not an economic policy metric supporting devaluation.
The narrow range of output available from Jamaica's production structure does not include a wide base of high-demand exportable products facing big increases as devaluation cuts prices to foreigners.
Devaluation policy relies on PPP and depends on what economists call teh 'elasticities approach' to the balance of payments.
The elastic mataphor is invoked to compare responses. A small drop in price calls forth a greater expansion in demand for the product. In other words, demand stretches. But to meet it, supply must also stretch.
Euro devaluation immediately results in increased tourist expenditures from US citizens in Paris. Jamaican devaluation does not immediately convert to increased tourist expenditures locally. Indeed, its impact may well be the opposite.
So tell me, will devaluation stretch our sugar production, bauxite production, exports of Pickapeppa? I don't know, do you?
Will devaluation reduce demand for luxury SUVs? Never seemed s to do in the past. There was indeed a tme, as duties provided the fix, when our Government seemed addicted to car imports.
Jamaica's extreme inequality of income distribution means that regardless of the currency's value, luxury imports shall continue apace. Devaluation is a blunt axe likely to damage the entire tree trunk, whereas limb surgery - invasive, let it be known - is indicated.
Wilberne Persaud, an economist, currently works on technology change and capital solutions for Caribbean SMEs. Email email@example.com.