The devaluation dilemma

Claude Clarke GUEST COLUMNIST

The 2014-15 Budget Debate has raised a number of issues of grave importance to Jamaica's economic future. Most important, in my view, is the issue of exchange-rate policy, on which Finance Minister Peter Phillips has appropriately called for an honest debate. In accepting the challenge, Opposition Spokesman on Finance Audley Shaw advanced the view that the present devaluations should end, the exchange rate fixed, and after an unspecified period, a managed float introduced.

The debate may be largely academic for Dr Phillips, though, as his Government is already committed by the IMF agreement to its present programme of gradual devaluation and cannot be seen to doubt its own policies.

Devaluation as a means to achieve economic competitiveness is not an unworkable strategy, nor is it new. But the manner in which it is now being implemented defies elementary logic as it negates the possibility of realising its intended purpose.

If achieving economic competitiveness is the purpose, the crawling nature of the present devaluation programme has not had, and is unlikely to ever have, that effect. So far, it has neither increased the competitiveness of Jamaican production nor decreased the attractiveness of imports. After a 25% devaluation, stretched torturously over two years, 2013 saw Jamaica's trade deficit rise to a record level of almost three times the value of our exports.

COMPLEMENTARY POLICiES

It isn't that devaluation as a strategy to gain competitiveness is without merit. But it cannot work by itself. To work, it must be supported by complementary policies which ensure that a cheaper currency leads to lower domestic costs; and that these lower costs can be maintained. It is also essential that the means exist or can be developed to capitalise on the competitive gains of the devaluation.

More and more observers seem to be accepting my long-held view that the Jamaican dollar has been chronically overvalued for many years and has been a major cause of the country's stubborn economic stagnation. The Government and the IMF are clearly of the same view and have now decided to do something about it. But the approach they are taking suggests that they are uncertain of the extent of the overvaluation and the level of adjustment needed to achieve competitive equilibrium.

SERIOUS ANALYSIS ABSENT

Last year, at the beginning of its present agreement with the Government, the Fund pronounced vaguely that the Jamaican dollar was overvalued by between 8% and 22%. This imprecision suggests an absence of really serious analysis; and perhaps explains why one year into the programme and an 11% devaluation, there is no evidence that Jamaica's competitiveness has improved.

What is clear is that even if our currency had miraculously become competitive, the mechanisms to maintain that competitiveness are not in place. Locally generated inflation, as opposed to imported inflation, is still running ahead of the rate of the dollar's depreciation and will continue to undermine economic competitiveness.

Policies necessary to restrain the rise in domestic costs have not been implemented. And so, as fast as the Jamaican dollar falls, local costs rise even faster. As the opposition finance spokesman aptly described it, the operation of this policy is like 'a dog chasing its tail'.

This is not to say that devaluation cannot be used to improve competitiveness. It was effectively employed in the 1980s and helped lay the foundation for the economic recovery experienced in the second half of that decade. In just over one year, the Jamaican dollar was devalued from 1.78:1 to 5.50:1, creating a significant gain in competitiveness. The Jamaican dollar was then effectively pegged at 5.50:1 for five years (the problems of the auction system notwithstanding), during which the economy grew by an average of more than 5% per annum and our trade deficit moved from 100% of the value of our exports to be just two-thirds in 1990. The lesson learned here is that devaluation, if it is to be used, must be sufficient and swift.

POLICY REGIME

Even so, the devaluation strategy of the 1980s didn't work by itself. It was supported by a policy regime including an incomes policy that held inflation in check and made it possible for the cheaper currency to translate into lower domestic costs, more competitive exports and increased local demand for domestic production to replace imports.

This time around, such a cost-constraining economic policy framework does not exist. Instead, the Government has allowed the currency to depreciate, ostensibly by market forces, as if expecting magic to do the rest. The pace of depreciation has been slow enough to allow domestic price increases to overtake it, making any potential competitive gains redundant before they can be realised.

This is perhaps what prompted Mr Shaw to propose that the exchange rate be fixed. But fixing an uncompetitive exchange rate will merely entrench the economy's uncompetitiveness and deepen our chronic economic crisis.

The question is not whether we should have a fixed or floating exchange rate. The real question is whether there are policies to maintain competitiveness once it is achieved. And because competitiveness cannot be achieved without reducing domestic costs, devaluation is a legitimate strategy to achieve it.

INTERNAL DEVALUATION

On the other hand, when a country opts for a fixed exchange rate in the face of an uncompetitive currency, it is left with only 'internal' devaluation as an instrument to achieve currency competitiveness. However, internal devaluation is seen by economists like Nobel Prize winner Joseph Stieglitz as a failed strategy. It largely targets people cost and is believed to be overly harsh on incomes and employment levels.

The profound economic crisis into which Greece fell is substantially the result of the fact that, locked in the fixed exchange-rate conditions created by the euro, there were no other options available to improve its competitiveness than draconian internal devaluation measures that sent unemployment soaring to 27% and youth joblessness to more than 58%.

In recommending a fixed exchange rate, therefore, Mr Shaw should say what strategies he would employ to restore Jamaica's competitiveness. Is he prepared to embrace the harsh actions of internal devaluation with its negative social consequences?

Greece is beginning to show signs of improvement and its export price competitiveness is slowly improving. But the painful journey it had to take because it didn't have the power to manage its currency should warn us that if the competitiveness of Jamaica's currency is not properly handled, the scuppered bank withdrawal tax that angered everyone could prove to be no more than the tip of a gigantic iceberg of social and economic pain to come.

The question our leaders must address is whether they are prepared to leave the country trapped in its pattern of pointless devaluations, delivering pain without competitive gain. And if they aren't, will they be bold enough to devalue sufficiently and swiftly and combine the devaluation with effective cost-containing policies that will make the benefits stick. In this way, we may make our path to economic competitiveness smoother and more rewarding than that travelled by Greece. This is what worked for us in the late 1980s.

Maybe we could learn from our history for a change.

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