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Lower interest rates will not lead to growth
ID: INTERACTIVE DIALOGUE
DAVID MULLINGS
Sunday, September 26, 2010
LOWER interest rates in Jamaica will have little positive benefit on the growth rate of the country unless low productivity is addressed.
This statement is based on historical data and reports from the World Bank, Inter-American Development Bank (IDB) and the International Monetary Fund (IMF). It is ironic that the largest reported growth in GDP in the last 10 years was 2003 when BOJ rates jumped from 14.41 per cent in the previous year to 18.78 per cent. Yes, the year in which interest rates went up, 2003, GDP was higher than the years with lower interest rates.
Conventional wisdom says that lower interest rates will lead to increased borrowing, more investment in private business, more start-ups and more jobs. It also says that lower rates on government bonds should mean that banks would shift towards consumer loans and increase lending. All of this leads to more tax revenue for the Government, which means in theory that borrowing can be reduced.
This is also part of the reason so many people are calling on banks to reduce the interest rates on their loans. The thinking is that lowering the interest rate spreads is good for national development. Some people also repeat calls for "more foreign direct investment (FDI)" in the country because of this conventional wisdom.
In short, increased investment and lending leads to increased GDP.
One example of conventional wisdom working is in Brazil where banks have shifted away from government bonds due to the lower rates being paid and increased lending for 17 consecutive months up to July of this year. (One should also note that 10-year Brazilian government notes were yielding around 11.33 per cent in August 2010 while the banks were lending at an average of 35.4 per cent and yet Brazil was still growing.)
Unfortunately, conventional wisdom has never applied to Jamaica and is the exact reason that the World Bank country study in 2004, titled The Road to Sustained Growth in Jamaica, said that "Jamaica's measured GDP growth was low in the 1990s while, paradoxically, measured investment was high".
The IDB refers to the "paradox of high investment and low growth of this economy" in reference to Jamaica in the March 2010 Productive Development Policies in Jamaica.
The IMF country report on Jamaica from March 2006 provides the clearest rebuttal of this conventional wisdom: "Jamaica has experienced persistent low growth despite high rates of investment. Real GDP grew, on average, by 1.6 per cent from 1980 to 2004, while investment rose from 15 per cent of GDP to 33 per cent over the same period."
Investment doubled and Jamaica still experienced low growth.
Record FDI was attracted under the last PNP administration but it did little to boost official growth rates. It will be no different under the current JLP administration if the real issues are not tackled.
If banks lowered their interest rates to three per cent above inflation and increased lending, there would be little positive impact on Jamaica's growth. Why can Brazilian banks lend at 35 per cent, three times their Government's 10-year bond rates, and yet Brazil still grows, but Jamaican banks lending at a lower spread does not result in growth?
What is the cause of the "paradox"?
The World Bank, IMF and IDB all provide similar answers:
IMF: The study finds that Jamaica's 'high-investment low-growth' experience appears, to some degree, to be due to measurement problems. Specifically, official growth rates may be underestimated because the informal economy, which has increased rapidly in size, is not being picked up in the statistics.
World Bank: A number of factors suggest that Jamaica's GDP growth is underestimated, which would reduce the apparent paradox of high investment (and increasing foreign direct investment) despite low measured GDP growth. It would also reduce the paradox of low growth and rapid poverty reduction.
This makes sense when it is reported that during the 1990s under the PNP, the number of Jamaicans reported as living below the poverty level was cut in half and yet the country experienced no real growth.
How can a country so dramatically reduce poverty yet not have any growth to report? It cannot.
The IDB paper provides the most satisfactory answer: "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, old schemes seem politically difficult to dismantle."
Jamaicans should not be surprised that politics plays a role in our under-performance as a nation. There are powerful vested interests in our country that have benefited from the current status quo, and some politicians do not want to make the changes that are required.
Brazil is able to have high interest rates and high spreads yet experience real growth because productivity is far higher than Jamaica. Crime is one of the biggest causes of this low productivity and helps to explain why a fellow Caribbean country like Barbados was able to see productivity increase more than five times that of Jamaica from 1960 to 1990.
Debt reduction plays a role in improving growth prospects, but reducing the debt without addressing productivity is akin to trying to clap with one hand. Our politicians must tackle the productivity problem in order to improve the business climate. Crime increases costs and drives away productive Jamaicans. Red tape increases the cost of doing business and our archaic tax structure reduces our competitiveness.
Nothing happens overnight, but one cannot run around calling for lower interest rates when the environment does not exist for low rates to lead to increased growth.
The proper environment must exist for increased lending and investment to have any real positive effect on the GDP of Jamaica, otherwise the "paradox" will simply continue.
Low interest rates would be good, but the reality is that they are not required for real growth. It is time that our politicians focus more on implementing the policies that address issues affecting productivity and competitiveness.
David Mullings is on Twitter at twitter.com/davidmullings and Facebook at facebook.com/InteractiveDialogue
http://www.jamaicaobserver.com/colum...growth_7991294
ID: INTERACTIVE DIALOGUE
DAVID MULLINGS
Sunday, September 26, 2010
LOWER interest rates in Jamaica will have little positive benefit on the growth rate of the country unless low productivity is addressed.
This statement is based on historical data and reports from the World Bank, Inter-American Development Bank (IDB) and the International Monetary Fund (IMF). It is ironic that the largest reported growth in GDP in the last 10 years was 2003 when BOJ rates jumped from 14.41 per cent in the previous year to 18.78 per cent. Yes, the year in which interest rates went up, 2003, GDP was higher than the years with lower interest rates.
Conventional wisdom says that lower interest rates will lead to increased borrowing, more investment in private business, more start-ups and more jobs. It also says that lower rates on government bonds should mean that banks would shift towards consumer loans and increase lending. All of this leads to more tax revenue for the Government, which means in theory that borrowing can be reduced.
This is also part of the reason so many people are calling on banks to reduce the interest rates on their loans. The thinking is that lowering the interest rate spreads is good for national development. Some people also repeat calls for "more foreign direct investment (FDI)" in the country because of this conventional wisdom.
In short, increased investment and lending leads to increased GDP.
One example of conventional wisdom working is in Brazil where banks have shifted away from government bonds due to the lower rates being paid and increased lending for 17 consecutive months up to July of this year. (One should also note that 10-year Brazilian government notes were yielding around 11.33 per cent in August 2010 while the banks were lending at an average of 35.4 per cent and yet Brazil was still growing.)
Unfortunately, conventional wisdom has never applied to Jamaica and is the exact reason that the World Bank country study in 2004, titled The Road to Sustained Growth in Jamaica, said that "Jamaica's measured GDP growth was low in the 1990s while, paradoxically, measured investment was high".
The IDB refers to the "paradox of high investment and low growth of this economy" in reference to Jamaica in the March 2010 Productive Development Policies in Jamaica.
The IMF country report on Jamaica from March 2006 provides the clearest rebuttal of this conventional wisdom: "Jamaica has experienced persistent low growth despite high rates of investment. Real GDP grew, on average, by 1.6 per cent from 1980 to 2004, while investment rose from 15 per cent of GDP to 33 per cent over the same period."
Investment doubled and Jamaica still experienced low growth.
Record FDI was attracted under the last PNP administration but it did little to boost official growth rates. It will be no different under the current JLP administration if the real issues are not tackled.
If banks lowered their interest rates to three per cent above inflation and increased lending, there would be little positive impact on Jamaica's growth. Why can Brazilian banks lend at 35 per cent, three times their Government's 10-year bond rates, and yet Brazil still grows, but Jamaican banks lending at a lower spread does not result in growth?
What is the cause of the "paradox"?
The World Bank, IMF and IDB all provide similar answers:
IMF: The study finds that Jamaica's 'high-investment low-growth' experience appears, to some degree, to be due to measurement problems. Specifically, official growth rates may be underestimated because the informal economy, which has increased rapidly in size, is not being picked up in the statistics.
World Bank: A number of factors suggest that Jamaica's GDP growth is underestimated, which would reduce the apparent paradox of high investment (and increasing foreign direct investment) despite low measured GDP growth. It would also reduce the paradox of low growth and rapid poverty reduction.
This makes sense when it is reported that during the 1990s under the PNP, the number of Jamaicans reported as living below the poverty level was cut in half and yet the country experienced no real growth.
How can a country so dramatically reduce poverty yet not have any growth to report? It cannot.
The IDB paper provides the most satisfactory answer: "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, old schemes seem politically difficult to dismantle."
Jamaicans should not be surprised that politics plays a role in our under-performance as a nation. There are powerful vested interests in our country that have benefited from the current status quo, and some politicians do not want to make the changes that are required.
Brazil is able to have high interest rates and high spreads yet experience real growth because productivity is far higher than Jamaica. Crime is one of the biggest causes of this low productivity and helps to explain why a fellow Caribbean country like Barbados was able to see productivity increase more than five times that of Jamaica from 1960 to 1990.
Debt reduction plays a role in improving growth prospects, but reducing the debt without addressing productivity is akin to trying to clap with one hand. Our politicians must tackle the productivity problem in order to improve the business climate. Crime increases costs and drives away productive Jamaicans. Red tape increases the cost of doing business and our archaic tax structure reduces our competitiveness.
Nothing happens overnight, but one cannot run around calling for lower interest rates when the environment does not exist for low rates to lead to increased growth.
The proper environment must exist for increased lending and investment to have any real positive effect on the GDP of Jamaica, otherwise the "paradox" will simply continue.
Low interest rates would be good, but the reality is that they are not required for real growth. It is time that our politicians focus more on implementing the policies that address issues affecting productivity and competitiveness.
David Mullings is on Twitter at twitter.com/davidmullings and Facebook at facebook.com/InteractiveDialogue
http://www.jamaicaobserver.com/colum...growth_7991294
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