No politician has yet been able to identify the 'magic bullet'

Published in the Jamaica Gleaner: Friday | August 17, 2007

When governments boost spending they essentially have three options to raise the necessary cash. They can raise it through taxes; borrow it; or print it.

Printing money doesn't necessarily mean that governments are printing bank notes through the nigh as Zimbabwe's recent efforts show, they can. More likely, the government will simply credit the bank accounts of its suppliers, leaving the beneficiaries to spend essentially Monopoly money.

Borrowing is more straightforward. In return for an agreed rate of interest, governments can borrow from private lenders, be they banks, individuals or foreigners. Taxes are equally straightforward. Govern-ments have the power to increase the share of the economic pie which they appropriate for their expenses.

Each option, however, has its cost. Printing money causes an increase in the money supply. Individuals have more in their accounts and so more to spend. Since money supply has risen faster than the supply of goods and services, buyers begin bidding up prices.

Inflation - a persistent rise in the general level of prices related to an increase in the volume of money and the currency to losing value-results. This is what happened in the 1970s, when the Jamaican government's deficits were 'monetised', resulting in a sharply increased inflation rate. When inflation rises, people try to spend money before it loses value.

Poor suffers most

While the economy will often accelerate quickly at first, low savings diminishes investment and slows output down the road, thereby worsening the imbalance between money supply and economic output. Moreover, because poor people have fewer assets to shield them against economic vagaries, they tend to suffer the most from inflation. Indeed, the sharp drop in Jamaica's poverty rate in the 1990s, despite a moribund economy, has largely been credited to the country's falling rate of inflation.

Up to 1995, deficits were mostly financed by printing money. Since then, deficits have been financed by borrowing. As a result, inflation has come down.

Nevertheless, borrowing is not free. Just like buying on credit, borrowing can lead to buyer's remorse. The government regrets the borrowing. Programmes offered today can, when the cost has to be paid by the next generation, later diminish the legitimacy of government.

For instance, the Jamaican government was once very generous in its spending - but today, citizens too young to remember the days of free education and other such initiatives wonder why they should pay taxes at all to pay off a debt from which they never even benefited.

Beyond the political and moral issue, though, lies the logic of the market. When a government borrows money, it competes with private borrowers - businesses, homeowners, students going to university, and other economic agents - for a finite pool of savings. When demand for savings rises faster than their supply, interest rates rise as well. Investment then becomes an expensive proposition as any student with a loan to repay will tell you.

Tax the other option

That leaves taxes as another option. Increasing taxes need not cause inflation or rising interest rates - but it can slow economic activity since people have less to both spend and save. Less spending means less economic activity, and hence economic growth. Less savings in turn means less investment, again restraining growth. We have to be careful here though, because increasing taxes can just as equally stimulate economic growth if re-allocated in the right areas. In any event high taxes, though inimical to growth, tends to be less damaging to long-term growth prospects than inflation and debt.

As Margaret Thatcher once famously put it, there is no such thing as a free lunch. Every choice will involve a trade-off. One way politicians love to get around this is to say that they will generate the growth needed to pay off the added revenue because their spending programmes will boost economic activity. This is the JLP's plan.

As Audley Shaw said in his debate with Dr. Omar Davies, a JLP government would pay its expenses by putting people to work. While the logic seems sound, the actual track record of things working out this way shows how difficult it can be. Tax cuts do not necessarily precede growth and do more harm than good. A famous instance of this occurred in the U.S. when President Ronald Reagan said tax cuts would actually raise revenues by boosting growth; in fact, the opposite happened and debt ballooned.

Also as our analysis yesterday revealed, the challenges of creating large-scale job growth in Jamaica in the short-term future are huge, and it costs well beyond what either party has budgeted.

More forthright

This does not in and of itself necessitate a commitment to a balanced budget or minimalist government. However, it does require that politicians be more forthright with the citizenry than many are being at the moment. Countless politicians around the world have promisedthey could find the magic bullet that would solve their country's woes painlessly, but none has yet succeeded in producing one.

Bruce Golding was asked during the political debates how he plans to finance his proposals; he announced that increased growth is that main magic bullet. Indeed, creating a robust investment environment appears to be the main means of budget financing for the JLP. Despite these claims, the reader is yet to understand where these investments will emerge and in what magnitudes. On account of tax reforms and other economic policies and programmes, the JLP has so far failed to announce investment policies which can be matched by its investment or even borrowing arrangements.

On the contrary, while the JLP has kept silent about the monetary value of most of its promises, the PNP has made some effort to provide information on both incomes and projected expenditures in its manifesto. Again, as expected, attracting investments is a crucia for financing the 'new' policies and programmes of the PNP's administration.

Notwithstanding the provision of financial details or lack thereof, looking at Jamaica, even if we take the most optimistic estimates both parties give for the investment they can attract, the amount of private investment they say they can lure into the economy still falls well short of what CaPRI's model has estimated would be required to create a full-employment economy (the sort of economy that would generate the revenues to pay for all the pledges the parties are making). To recap from Wednesday's article, CaPRI estimates that $1 trillion of investment is needed to mop up unemployment. In order to get the jobs created, which will be for the skilled and highly skilled, the government will need to spend $1 billion on re-training.

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