Ian Boyne, Contributor
THIS YEAR'S Budget debate was really between Opposition Leader Edward Seaga and Finance Minister Omar Davies, two of the sharpest minds in Jamaican politics.
Challenging the Finance Minister on a fundamental issue of economic strategy, that of the exchange rate, Mr. Seaga proposed at the least a fixed exchange rate or the adoption of a currency board arrangement as a centrepiece of economic policy. Mr. Seaga drew on a number of academic sources to bolster his arguments, substantially raising the calibre of budget presentations. These are the kind of challenges that Dr. Omar Davies, an academic at heart, relishes. On Wednesday, he successfully met the Seaga challenge, though his work could have been more rigorous in terms of scholarly documentation.
However, his rebuttal was lucid, his logic compelling and his critique at times biting. Seizing upon the Opposition Leader's statement of the "magically motivating dynamic force which a fixed exchange rate holds for the market," the Finance Minister said Mr. Seaga's "dramatic language" would seem to move the matter "into the realm of magic rather than where it should remain rooted in hard analysis."
Taking a swipe at the Opposition Leader's theme, "Finding a fresh wind", Dr. Davies said this pursuit in certain instances led the Opposition Leader into 'flights of fantasy'. In his budget presentation, Seaga committed the unpardonable sin by suggesting that Omar Davies needed a refresher course and "that I needed to take a break from politics to review recent developments in the area" of exchange rate policy. The intellectually vain Finance Minister (who has ample justification for that vanity) would never let that aside pass. He later took Mr. Seaga to task for allegedly using outdated research material and for closing off his research in 2000 the year before the Argentinean Crisis (Argentina had a currency board arrangement, which Mr. Seaga favours).
"In this era of he Internet, it is impossible to believe that the Leader of the Opposition did not and does not have access to the data for the period subsequent." I myself pointed out last week that the March 2004 issue of the IMF's quarterly magazine Finance and Development has two insightful articles on the fixed exchange rate system versus the floating exchange rate and that neither favours Mr. Seaga's proposal. One examines evidence from as many as 150 countries and the other looks at exchange rate policy over the last 100 years: both raise serious problems over the fixed exchange rate regime.
THE ARGENTINIAN CRISIS
Argentina is the embarrassment of the Steve Hankes of the world who espouse the currency board model. The point is not that it was the currency board mechanism that triggered the Argentinean crisis; the point is that the inflexibility and non-discretionary nature of the currency board system prevented Argentina from effectively addressing the root causes of its implosion. The main sources of Argentina's problems were high public sector indebtedness, a low exports-to-GDP ratio and a highly skewed export sector plus heavy reliance on foreign-currency denominated borrowing and high dollarisation.
Many economists believe that if Argentina had a floating exchange rate it would be able to use currency depreciation to strengthen its export sector, just as other countries facing similar challenges did. Argentina's currency board shackled the country and removed the manoeuvrability that is critical for the state. In the mid-1970s Spain was faced with serious economic challenges. In 1977 the country devalued the peso by 20 per cent and between then and 1985 boosted exports significantly, thus averting a major crisis. In Chile, between 1973 and 1992, the ratio of exports to GDP rose by an astounding 30 percentage points, accompanied by considerable product diversification. This performance was facilitated by a 50 per cent real depreciation of the currency between 1980 and 1991.
Similarly. in New Zealand whose economy is similar to Argentina's, being natural-resource-intensive the currency depreciated by 15 per cent between 1995 and 2001. The export sector grew by seven percentage points. Argentina's currency board hobbled economic policy and the people paid heavily for this straitjacket.
Turkey is another example of a country that was helped out of its economic crisis by a flexible exchange rate system rather than the sterility of a fixed exchange rate system or a currency board.The 1970s was a period of severe crisis for Turkey.
But over the period 1981-1991 the real exchange rate depreciated by approximately 20 per cent and this boosted exports significantly. The export-to-GDP ratio moved from five to 17 per cent by 1989, while the share of manufactured exports in total exports rose from 36 per cent to a whopping 78 per cent.
A major paper issued by the International Monetary Fund (IMF) last year October, Lessons from the Crisis in Argentina, says: "Argentina's failure to substantially raise its export share during the 1990s may be associated with the currency board to the extent that it constrained downward adjustments in the real exchange rate."
The IMF paper issued by the Policy Development and Review Department says, "The currency board turned from being a source of policy credibility to a handicap to adjustment the currency board may have suppressed a more rapid expansion of exports after trade was liberalised and did constrain monetary policy when the economy slid into recession."
The Finance Minister was, therefore, absolutely correct in saying: "The fact is that a fixed rate, backed by legislation, locked Argentina into certain structural deficiencies that could not be adjusted in the face of the fixed exchange rate."Dr. Davies rightly concludes that, "The Argentine example demonstrates the potential negative consequences if the central bank is unable to respond to difficulties within the domestic financial sector."
I reject the proposal for an independent central bank because that removes the discretionary powers of the state to act in the interest of the country, particularly the poor and vulnerable.
SOUND MACROECONOMIC POLICY
If human discretion has been abused, as it has been in Jamaica under PNP and JLP Governments, the answer is to correct that, not to eliminate human discretion. In an IMF working paper looking at the Barbadian experience with the fixed exchange rate published in August last year and titled 'Economic Resilience with an Exchange Rate Peg: The Barbados Experience, 1985-2000', four economists make the point that "small open economies face a dilemma with respect to exchange rate strategy: although an exchange rate pegged to a stable, low-inflation currency may be desirable in order to contain inflation, exchange rate pegs are susceptible to speculative attack."
But, interestingly, the authors point out that "the design of institutions for policy making is often seen as key to the resolution of this dilemma." That's human discretionary power.The countries that have low inflation, low interest rates and growth have achieved those macroeconomic targets because of sound macroeconomic policies overall, not simply because of the exchange rate system. Exchange rate policy can be crucial for economies undergoing high inflation, high interest and anaemic growth but the exchange rate is not a chimera. It is not something magical or fictional. The Jamaican example that Dr. Davies drew on demonstrated that.
Every business person and anyone with the slightest information on Jamaica's economic history over the last few decades knows of the fictional $5.50 to US$1 exchange rate and the times when the Bank of Jamaica itself had agents buying black marked US dollars. The exchange rate was a joke and nobody took the published rate seriously. The exchange rate has to reflect what is really taking place in the economy, particularly the productive sector. Otherwise, you are talking about 'voodoo economics'. We have been the route of a fixed exchange rate before and it was a disaster.
Now that interest rates have been tumbling, inflation is trending down, the fiscal targets are being met, there is an abundance of net international reserves, projected investments are high, the stock market is booming and we are having the highest level of domestic private sector confidence in the Jamaican economy in decades, we have no need for a fixed exchange rate and even less need of the currency board.
There must be some significance to the fact that an article in the March 2004 Finance and Development magazine points out that while more than 50 per cent of countries today still have either a fixed exchange rate or currency board, the figure has dropped from 80 per cent in 1990 before many of the financial sector crises.
SMALL BUSINESS DEVELOPMENT
Clearly, a number of countries are not as conclusive as Mr. Seaga that a pegged exchange rate is inevitably associated with low inflation, low interest rate and growth. Where the Government remains vulnerable to Opposition critique is on its strategy for small business development and the nurturing of entrepreneurship.
Of course, the Government can point to many small business projects that it bankrolls and the work of excellent agencies like the Jamaica Business Development Centre. But it is doing nowhere enough and does not have the kind of bold, innovative and daring schemes and projects to really move entrepreneurship in this country. It will not be enough to rely on the big projects the Government is now bragging about.As another excellent IMF Working Paper by Philippe Beaugrand (And Schumpeter said, 'This is how Thou Shalt Grow': The Further Quest for Economic Growth in Poor Countries), "The question remains how governments in poor countries can unleash entrepreneurial spirits and thus promote economic development. As a rule, poor countries are more likely to develop through the promotion of homegrown entrepreneurs. Development from the ground up is more prone to generate virtuous circles of growth and raise national income, since FDI implies large income transfers to the rest of the world." And that's the IMF speaking.
The $1 billion scheme announced by Scotiabank will not address the needs and cover innovatively and imaginatively the people we need to pull into the net of economic activity. They will be frustrated by the usual set of off-putting collateral requirements and burdensome preconditions that they can't meet. Jamaica needs real development banking, venture capital, not the inundation of risk-averse banks that we have. This budget debate still leaves that big question unanswered of how we can strengthen broad-based entrepreneurship and destroy the bottlenecks to production.
Ian Boyne is a veteran journalist. You can send your comments to ianboyne1@yahoo.com.
