PUBLIC AFFAIRS - Recovery needs stable, competitive dollar

Claude Clarke, Guest Columnist

Andrew Holness, locked in a battle to retain the leadership of his party, has sought to shore up his image in financial matters and perhaps pander to public sentiment by demanding that the devaluation of the dollar be halted.

He has cited as his reason the fact that "the continued uncertainty is doing little to restore business and consumer confidence", "making the business environment generally unstable". In that he is right. But he could not be more wrong if he believes the Government can arbitrarily stop the dollar's slide without again plunging the country into the deep economic decline that resulted from similar efforts to hold back devaluation in the 1990s, 2000s, and again in 2010.

Jamaicans are justified in their disappointment with the management of our currency since it was liberalised at the beginning of the 1990s. Since 1989, the Jamaican dollar has suffered a precipitous decline. Even Argentina's 80 per cent devaluation, following its devastating economic collapse at the end of the 1990s, and subsequent debt default, pales in comparison.

However, while Argentina's devaluation helped to convert its US$500-billion trade deficit in 1998 to a surplus of more than US$12 billion today, Jamaica's experience has defied the logic that a devalued currency results in increased exports and reduced imports. The Jamaican dollar has been devalued by 95 per cent since 1988, and since then our trade deficit has multiplied eightfold.

Strategic direction absent

This paradox of Jamaica's depreciating currency resulting in ever worsening trade performance is explained by the absence of strategic direction in the management of our currency. Devaluation has been reflexive and reluctant; occurring only when forced by persistently surging demand for foreign exchange, caused by the widening gap between rising domestic incomes and the stagnant real value of the country's productive output. This demand has been so great that it could not be satisfied, even when more than US$2 billion of unearned remittances, or almost 15 per cent of GDP, are added.

Spontaneous currency depreciations resulting from the interplay of demand and supply cannot be simply accepted as the inevitable result of market forces. In a small, weak economy such as ours, they do foster uncertainty and weaken business and consumer confidence, as Mr Holness said. Used as an exchange-rate policy for a weak, underperforming economy, it is little better than playing Russian roulette with only one empty chamber. Yet, Jamaica has been subjected to this for almost a quarter of a century, during which our currency has shrunk and our economy has floundered.

On the other hand, a strategic devaluation, properly executed, has demonstrated the real potential for bringing economic gain. Trinidad's strategic devaluations which began at the end of the 1980s sharply reduced the value of its currency by almost 60 per cent. But it brought enormous gain. In the 15 years after the process was completed, Trinidad's economy grew by 150 per cent.

On the other side of the globe, Malaysia's experience was just as positive. Having been severely hurt by the East Asian financial crisis in 1998, its programme of devaluations led to an average growth of 6.5 per cent during the 14 subsequent years. China's undervaluation of its currency to promote the competitiveness of its exports and domestic sales is now legendary and has elevated it to the status of banker to the United States, holding US$1.3 trillion of US treasuries, largely purchased with its enormous trade surpluses.

The fact that, in Jamaica, devaluation has produced poor results is not an indication of its ineffectiveness as a tool of economic management. Rather, its harmful outcomes have been the result of the unstructured and disorganised manner of its execution.

For any devaluation to succeed, it has to be strategic and combined with supporting policies, which hold inflation at levels that will not undermine the currency's competitive value. It must be applied in the shortest possible time and to the full extent necessary to price domestic economic inputs at levels that are competitive with our trading partners. It must then be supported by measures that prevent the unwarranted rise of incomes and cost of domestic services. In this way, the nominal exchange rate and the real exchange rate can be aligned and maintained.

Unnecessary attention has been given to the type of exchange-rate system that would be best for Jamaica's economic health. A convincing case can be made for all three systems that have been advocated: the pegged (fixed) rate, the free-floating rate, and the managed floating rate. All three have been employed in the Americas with mixed results.

Jamaica has attempted all three. Here, the floating regimes have brought nothing but instability, economic decline and pain. The only time that there was anything remotely resembling economic stability and sustained growth in the last 40 years was during the last five years of the 1980s when, after a steep devaluation that established a degree of competitiveness, there was an attempt to fix the exchange rate at J$5.50 to the US dollar.

Improving our productivity and competitiveness

However, this should not be seen as evidence of the superiority of a fixed-rate regime. Rather, it is evidence that the strategies that were used to ensure the viability of the exchange rate made stability and growth possible. These strategies were (1) containing the growth of incomes and (2) contracting the cost of our most overpriced domestic service: the Government. Both factors helped improve our productivity and competitiveness by reducing inflation and domestic input costs. We should learn from this experience.

There are similar lessons to be learned from Barbados, which has a fixed rate, and Trinidad, which has a managed float, if we wish to understand what is really required to make the Jamaican economy viable and productive. Questions of the relative effectiveness of a fixed or floating exchange rate become far less relevant if inflation-containing strategies are used to secure the currency's competitiveness.

Importance of a competitive currency

The importance of having a stable and competitive currency is further underscored by the fact that an unstable currency will never be seen as a secure store of wealth. Domestic capital will consequently seek the safety of more stable currencies, leading to flight away from the local currency and an increase in the pressure to weaken it. Further, without the confidence of a stable exchange rate, investment decisions will tend to be driven by short-term goals. The long-term outlook required for investments in production will be subordinated to the short-term activities of trading and other domestic services.

However, the stability and competitiveness of a currency cannot be assured if government does not exercise vigilance over unproductive foreign exchange inflows from remittances, illegal activities like money laundering, and other types of 'hot' money.

Way back in 1993, Chile's finance minister explained to some members of a visiting Jamaican government team, of which I was a part, that left to market forces alone, the excessive flow of foreign currency into the Chilean economy would have undermined the competitiveness of the Chilean peso, and that the government had to use special measures to ensure that the competitiveness and viability of the Chilean economy was not harmed.

Twenty years later, Jamaica has not learned this lesson and seems not to recognise the critical importance of currency competitiveness to a viable economy. This despite the fact that Government holds the two most important tools of currency management firmly in its hands: first, ensuring there is no disjuncture between the price and the real value of our currency, and second, controlling domestic inflation by containing the growth of incomes and holding down the cost of domestic services.

Our current economic and social ills can be traced to this failure of government to discharge its core responsibility of establishing and maintaining a viable economy. Instead, while the economy's viability wanes, the government prioritises the servicing of debt without offering policies capable of expanding the base of production to improve the country's ability to service its debt.

Former Prime Minister Bruce Golding has used the safety of his political retirement to join me and other commentators in advocating pro-production policies while pursuing its debt reduction strategies - action which his administration failed to take when it had the opportunity to do so.

Finance Minister Peter Phillips' declaration in Parliament last week that the objective of the new Omnibus Incentive Regime is to "establish a platform for growth and incentivise production" is also very encouraging. It suggests that the Government, too, has woken up to the reality that the effort to increase production cannot await the reduction of our debt. If we wait, we will have neither a viable economy nor the economic means to reduce our debt.

The minister also needs to recognise that while investment incentives are important, nothing can substitute for the economic stimulating benefit of a stable and competitive currency. Without this, the hope for a viable and growing economy that can be relied on to provide economic opportunity for our people will continue to recede.

The consequences of an economy incapable of providing opportunity for its people in an already lawless society with a growing army of inadequately educated young people, cultured more towards destruction than construction, are too terrible to contemplate.

Claude Clarke is a businessman and former minister of industry. Email feedback to columns@gleanerjm.com.