«Productive Development Policies in Jamaica Mónica Panadeiros Warren Benfield Inter-American Development Bank Department of Research and Chief ...»
IDB WORKING PAPER SERIES # IDB-WP-128
Policies in Jamaica
Inter-American Development Bank
Department of Research and Chief Economist
Productive Development Policies
Mónica Panadeiros *
*Foundation for Latin American Economic Research
** Sir Arthur Lewis Institute of Social and Economic Studies,
The University of the West Indies
Inter-American Development Bank
Cataloging-in-Publication data provided by the Inter-American Development Bank Felipe Herrera Library Panadeiros, Mónica.
Productive development policies in Jamaica / Mónica Panadeiros, Warren Benfield.
p. cm. (IDB working paper series ; 128) Includes bibliographical references.
1. Economic development—Government policy—Jamaica. 2. Jamaica—Economic policy. 3. Industrial policy—Jamaica. I. Benfield, Warren. II. Inter-American Development Bank. Research Dept. III. Title. IV.
HD436.P36 2009 © Inter-American Development Bank, 2010 www.iadb.org Documents published in the IDB working paper series are of the highest academic and editorial quality. All have been peer reviewed by recognized experts in their field and professionally edited. The views and opinions presented in this working paper are entirely those of the author(s), and do not necessarily reflect those of the Inter-American Development Bank, its Board of Executive Directors or the countries they represent.
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1 Jamaica seems to be a puzzling case for economic growth: despite the structural reforms implemented in the last three decades and adequate investment levels, real GDP per capita is roughly the same as in 1970. The disappointing performance of this economy suggests that productive development policies (PDPs), including first-generation reforms, have not been enough to create a better environment for productivity growth. This paper examines the PDPs in Jamaica and concludes that behind the paradox of high investment and low growth of this economy are the “public debt trap” and a highly distortive tax incentive structure to attract foreign direct investment (FDI) and promote exports. Although industrial policy is moving towards a more modern conceptual design, the old schemes seem politically difficult to dismantle.
JEL classification: L52, O25, O54.
Keywords: Productivity, Industrial policy, Foreign direct Investment, Jamaica The authors wish to thank Dacia Leslie for her insights and contributions to this paper.
1. Introduction Even when the economic strategy adopted in the 1990s called for dismantling the productive development policies (PDPs) that had been set in the past, most countries in Latin America and the Caribbean went on applying some of them. These policies responded to a diversity of prevailing foundations for government interventions and/or were a consequence of the significant influence of pressure groups. Many Latin American economies already carry out various forms of industrial policy, but in most cases it is likely that such scattered PDPs cannot be justified on a solid basis according to modern economic principles (Rodríguez-Clare, 2004).
These principles take into account not only the failures which these policies intend to address and the extent to which they “hit the target,” but also the institutional features concerning the design and implementation process.
A major obstacle to undertaking any critical assessment of PDPs in the region, especially from an analytical point of view, is limited information on the scale of interventions. This study, part of an extensive research project involving several country studies, intends to fill this gap by analyzing the industrial policy of Jamaica.
Jamaica seems to be a puzzling case for economic growth; despite the macroeconomic and structural reforms implemented in the last three decades and investment at levels sufficient to permit an average annual growth rate of 4 to 6 percent, the current GDP per capita at constant prices is roughly the same as it was in 1970. The disappointing performance of this economy suggests that current PDPs, including first-generation reforms, have not been sufficient to create a better environment for productivity growth. The analysis of existing PDPs may help answer the question of why social returns to investment are so low.
This study is organized as follows: Section 2 presents a discussion of the long-term performance of the Jamaican economy, its strengths and weaknesses, the main characteristics of the private sector and the way in which different actors have historically interacted within it and with the government. Section 3 examines the general landscape of PDPs currently applied in Jamaica, highlighting how different sectors or activities are affected, and the kinds of failures they are intended to address. The analysis then focuses on a selected group of five illustrative PDPs (Section 4). Taking into account the relevant literature, the study seeks to conduct a critical review, assessing the theoretical justification for the implementation of each of these policies, the technical design features of the PDP (such as instrument chosen, incentives and penalties, and accountability), and the institutional arrangements involved in the design, implementation, evaluation, and eventual deepening or disrupting of the policy according to results. Section 5 contains concluding remarks and proposes some guidelines that should be considered for the redirection of the country’s PDPs, particularly those that seem to be important determinants of Jamaica’s economic performance.
2. Economic Growth in Jamaica
2.1 Growth-Investment Paradox Historically, the Jamaican economy has been based on agriculture and dependent on a few staple export crops, primarily sugar and bananas. New economic development began with bauxite mining (after 1952) and the tourism boom in the 1950s and 1960s. However, the brisk economic growth of those years was followed by modest performance. Since 1991, annual real GDP growth has averaged 1 percent, only a few sectors—tourism, telecommunications, and bauxite— have been dynamic, and the unemployment rate remained over 10 percent. Presently, Jamaica, with a GDP per capita of nearly US$3,700, is the second largest economy in the Caribbean community (CARICOM) and is classified as a lower middle-income developing country.
Since 1980, the government has been engaged in a program of macroeconomic and structural reform, which advanced significantly during the 1990s. This included removal of price controls, trade liberalization, tax reform, privatization of several government-owned entities, and a restructuring of the financial system. Relatively successful in reducing inflation although incomplete as the state still plays a large role in the economy, these market-oriented reforms have failed to deliver sound policy outcomes. In this sense, Jamaica seems to be a puzzling case for economic growth. 2 The causes are complex, but a key factor has been the heavy burden imposed by a long history of high public debt, which ballooned to nearly 150 percent of GDP after the banking crisis in the mid-1990s, reversing the declining path observed in the first part of that decade. The public debt currently stands at 128 percent of GDP, with service payments amounting to 16 percent of GDP.
High debt requires increased tax collection 3 in order to obtain a considerable primary surplus (currently around 9 percent of GDP). 4 It also creates the need for external borrowing, making the economy vulnerable to fluctuations in the international bond market. Additionally, because much of the government’s financial needs may have been provided by the domestic financial system, 5 this also may have helped to keep interest rates relatively high, making access to finance for the private sector limited and expensive.
High public debt seems to have a more adverse impact on productivity than on investment. In fact, investment rates are high, averaging over 25 percent of GDP in the last 15 years as Jamaica has been relatively successful in attracting foreign direct investment (FDI) in tourism and bauxite. These sectors are largely shielded from country-specific risks through tax incentives, but they have limited backward linkages. Therefore, the “debt overhang” appears not The Heritage Foundation publishes an Index of Economic Freedom, and its most recent version indicates that the Jamaican economy is the world’s 45th freest. Its overall score is higher than the regional average, ranking 10th out of 29 countries in the Americas. Nonetheless, it has a lower degree of freedom compared with other Caribbean countries, namely, Trinidad and Tobago and Barbados. Jamaica scores very well in investment freedom and business freedom but is weak in government size and corruption (Heritage Foundation, 2008).
At present, tax revenues are about 25 percent of GDP.
A primary surplus of 10 percent of GDP will be required to stabilize the public debt ratio. See, for example, Artana and Navajas (2004).
Jamaica has maintained macroeconomic stability for an extended period despite its persistently high public debt levels. An important factor in this regard has been the country’s ability to rely on local financial markets (approximately 50 percent of public debt is domestic).
to have so much reduced investment, the way that debt usually affects growth, but rather skewed it towards safer but lower-return activities and industries.
Furthermore, high debt service, which represented about a third of expenditures in the first half of the 1990s and grew to more than 40 percent in recent years, limits the government’s ability to channel funds into social and physical infrastructure. Given the complementarities between public and private investment, countries with very low public investment, such as Jamaica, appear to grow more slowly, even if private investment remains high. There is some evidence that high debt is behind the poor performance as well as the paradox of high investment and low growth of the Jamaican economy (IMF, 2008).
Source: World Development Indicators.
Another possible reason usually advanced for the coexistence of a relatively high investment-to-GDP ratio and low economic growth is the increasing significance of the informal sector in the Jamaican economy. In 1991, the informal economy represented 12.9 percent of GDP, rising to 40 percent in 2000 and, according to the IMF (2008), currently greater than 40 percent. The increase in informality means that both GDP and investment may have been underestimated, but as these activities are usually labor-intensive, the underestimation of GDP is probably even greater. 6 According to the IMF country report, the average GDP growth underestimation between 1991 and 2000 may be as high as 3 percent, or 2.7 percent higher than official estimates. Besides informality, computation of the national Informal activities are very often of low value added, have limited potential for productivity growth, low capacity for physical and human capital accumulation, and limited access to international markets. However, in Jamaica, this characterization may not be very accurate, as the informal sector is very complex. It includes the illegal trade in ganja (marijuana) and other drugs, as well as music and entertainment, which has been one of the most creative and dynamic sectors of the economy that employs domestic capital.
Another explanation for the investment/growth paradox may be that capital created in the early 1990s was used to strengthen public safety. Crime increased sharply in the period, reaching one of the highest rates of intentional homicide in the world (44 per 100,000 inhabitants). This evolution reflects severe social problems resulting from high unemployment, organized crime associated with the drug trade, and urban slums. A 2004 World Bank study estimates expenditures on security at around 4.4 percent of GDP, with an astonishing 1.3 percent of GDP expended on private security. 7 High investment can also reflect an inefficient substitution of capital for labor due to rising and high real wages pushed by powerful trade unions, labor rigidities, and a flawed tax system that favors capital expenditures, even less productive ones.
Finally, Jamaica is highly vulnerable to natural disasters (hurricanes and floods), which can cause macroeconomic volatility, important losses, and constraints on growth.
The trend of high investment and low growth implies a decline in productivity of 0.5 percent per year from 1960 to 2000, compared to a 0.9 percent increase in the world average (Downes, 2004).
2.2 Private Sector Environment Jamaica is a relatively open economy, underpinned by four pillars: tourism, alumina, remittances, and the informal sector. Within a narrow export base, tourism has been the main source of foreign exchange earnings since the 1990s: it generates 37 percent of exports, and employs 20 percent of the labor force both directly and indirectly. Exports of goods are about 18 percent of GDP, and about half of them are bauxite and alumina. 8 Remittances grew tenfold account is difficult because services, which are hard to measure, account for more than 70 percent of GDP, and income from relevant activities such as tourism can be recorded abroad.
According to the Heritage Foundation (2008), the police force is understaffed.
Virtually all exports of alumina go to a plant located in the United States.
since the early 1990s, to a level equivalent to 18 percent of GDP, 9 causing the economy to be heavily dependent on these inflows.
As previously mentioned, the informal sector is estimated to represent more than 40 percent of GDP. Additionally, formal firms undertake informal activity by performing a proportion of their work outside their normal accounting systems in order to reduce their tax burden (Holden and Holden, 2005).