Terrence Farrell
Published:
Sunday, June 28, 2015
On Thursday night, in an address to the Employers’ Consultative Association awards ceremony and dinner, economist Terrence Farrell said the T&T economy has to die for it to diversify. And he suggested that the country’s resurrection could be assisted by giving up its overvalued exchange rates, dominant government, and the dependency syndrome.
In 1950, when Arthur Lewis articulated what came to be known as “industrialisation by invitation”, his world and hence his problem was a lot simpler than it is today. However, the ‘problematique’ was in some respects, similar. Then it was sugar that was in structural decline, and which decline threatened the sustainability of export earnings and hence availability of foreign exchange. Sugar employed a lot of people, so that its decline would worsen the unemployment problem.
First, Lewis had to figure out: What products could be produced in the West Indies that could be sold competitively into export markets? Competitive export pricing would have meant producing goods at a level at which economies of scale could be reaped. The specific goods that could compete would be those where the West Indian territories had some comparative advantage. Lewis saw that the comparative advantage we might have arose from our low labour costs relative to the advanced countries. He was then able to identify a number of industries in which low labour costs were important to their competitiveness.
The second problem that Lewis had to solve was: Who had knowledge of the target markets and who would organise the production process? Although Lewis was sympathetic to the democratic socialist ideology, he was clear that it would be capitalists and not governments that could address that problem. It was the private sector, albeit foreign capitalists, that should lead the charge in industrialisation and hence the diversification of Caribbean and T&T economies.
The rapid growth of the oil industry after World War II began to put T&T on a different trajectory from the rest of the West Indian islands. The oil production and refining business was capital and skill intensive and therefore not a big employer, so that it could not solve the unemployment problem. But it was a significant generator of foreign exchange earnings. However, up to the formation of OPEC and the sea change in the petroleum tax regime which OPEC instigated, tax revenues from the oil industry were not significant.
From 1973, the first oil price shock, combined with rising oil production and the discovery of gas offshore by Amoco, were ‘game changers’ for government revenues and for the role that Government perceived that it could play in economic life and diversification. It was not that Government hadn’t considered playing a more direct role in productive activities prior to 1973, but after 1973, it had the resources so to do.
Since the 1970s then, the issue of the diversification of the economy has been framed by three factors: (1) the Dutch Disease effect; (2) government’s increasing domination of economic space and the concomitant ‘crowding out’ of the private sector; and (3) the distortion of the labour market caused by the way in which government has approached the problem of employment generation.
Dutch Disease Effect
Oil exporting countries are familiar or ought to be familiar with the Dutch Disease syndrome. Economists make a distinction between tradables — goods and services that are capable of entering international trade — and non-tradables — goods and services that typically cannot be traded internationally. What is or is not tradable depends on technology, so that the category of tradables changes. A classic example is natural gas which used to be flared, but which became internationally tradable with large cryogenic tankers and long distance pipelines. Government services, housing, certain personal services are non-tradable. In our context, we can disaggregate the tradables sector into the energy industry and non-energy tradables.
Commodity booms cause significant inflows of foreign exchange. These inflows may affect the rest of the economy in ways which are inimical to its long term development. First, higher domestic incomes cause the prices of non-tradable goods to increase thus causing an appreciation of the real exchange rate. Imports are effectively cheaper, and hence there is a lower incentive to earn foreign exchange from exporting activities. Resources and investment are diverted from the tradable goods sector to non-tradables, diminishing the countries capacity to produce goods and services for export.
Secondly, wages in the tradable and non-tradables sectors are pushed up partly because of the higher domestic prices and partly because of the demonstration effect of higher wages enjoyed in the oil exporting sector. This serves to make the tradables sector less competitive in respect of exports.
While oil prices are rising, the country does not perceive any problem; but when prices collapse, the country finds itself unable to generate export earnings to compensate. As a consequence, severe adjustment may be required with some combination of significant depreciation of the currency, cuts in wages and salaries, higher interest rates and retrenchment of government spending. The economy cycles from boom to bust.
Countries that are heavily dependent on a commodity export which is subject to large cyclical swings are disincentivised to diversify export earnings during the boom period, and may not have the resources to diversify during the periods of bust.
Dominant Government
Initially government came to the view that the foreign multinationals were the problem. With petrodollars in hand, the government set about acquiring Shell, Tate and Lyle, and Texaco. It pushed the banking and insurance multinationals to localise their businesses. The “commanding heights” of the economy had to be under local control, which increasingly meant government control. The portfolio of state enterprises and state-sponsored organisations began to grow — Unit Trust Corporation, Reinsurance Company, Home Mortgage Bank were added to BWIA and TRINTOC.
Today, state-owned enterprises and statutory bodies dominate key sectors of the economy and some are larger than the largest private sector conglomerates: in energy, NGC, Tringen, Petrotrin and a stake in Atlantic LNG; Caribbean Airlines in air transport; First Citizens in banking; HDC in housing construction; UDECOTT; TSTT in telecommunications. Of course the utilities (water, electricity) are mainly state-owned, with couple of private companies involved in power generation.
Today, General Government absorbs 35 per cent of GDP, but more significant, it accounts for about two-thirds of the Non-Energy GDP. Transfers and Subsidies by Central Government average about 25 per cent of non-oil GDP. That is how dominant Government is in T&T.
The rationale for state ownership of commercial enterprises has shifted and evolved over time. The reasons for retaining state ownership now have a political dimension which makes rational economic decision-making in respect of these businesses much more difficult.
But the increasing dominance of government in commercial and industrial activities was accompanied by an increasing scepticism, even cynicism about the capabilities of the local private sector. While foreign businessmen, especially those in the energy sector where state capability was considerably lower, could be respected and their contribution valued, as government expanded, the local business community came to be less respected.
Within government circles, local businessmen were regarded as risk averse, tax evaders, quick to export capital (during the period of exchange control) and exploitative of their workers. By the 1990s, they could be labelled a “parasitic oligarchy”. Today within government, the local private sector is, I think, perceived more as a “pressure group” though of waning influence, and not as a real partner in the development of the country. To be sure, the perception of the local business community has overtones of the ethnic tensions and competition within Trinidad society. The dominant local private sector personalities in the period up to the 1970s were French Creoles. They gave ground to Syrian-Lebanese from the 1980s and in recent times, Indo-Trinidadian businessmen have come to the fore.
What is perhaps more important is that the local business community came to acquiesce in its relegation to the role of junior partner in the development of the country and the government’s dominant role as ‘prime mover’. Certain observations sustain that conclusion:
• The leading businessmen have become less vocal and less visible in public and have ceded public advocacy to hired CEOs
• The representation of the local private sector has become more fragmented (TTCSI, TT Chamber, Energy Chamber, British Chamber, Tunapuna, Chaguanas and Tobago Chambers, TTMA, and the ECA—it should be noted that Jamaica and Barbados have one over-arching body, the PSOJ and the BPSA, representing the private sector nationally.)
• There is no tripartite consultation mechanism;
• The profile of Senate appointments reflecting business interests has become lower;
• The local private sector (except for the Energy Chamber) has little capacity for research into and development of policy positions beyond canvassing the opinions of its members
There are exceptions of course. Lawrence Duprey’s CL Financial forayed out of insurance into the energy sector at a time (1990s) when the Government had no resources to invest. Use of insurance money, rapid, uncontrolled expansion and poor governance led to the collapse of Duprey’s emerging empire.
At the end of the import substitution era, only the Food and Beverage industry has emerged as foreign exchange earners and overseas investors — Arthur Lok Jack’s Associated Brands, the Bermudez group, and Aleem Mohammed’s SM Jaleel. In banking and insurance, Republic Bank, First Citizens, and the Guardian Group ventured into the Caribbean and further afield through acquisitions. Some of these ventures failed, but all these financial institutions have strong presence in markets outside of T&T, and Republic Bank has recently entered Africa via Ghana.
It is also important to note that this country also has a group of professionals — petroleum engineers and other energy professionals, construction industry workers, management consultants, and lawyers — as well as entertainers and creative industry professionals, who work across the Caribbean region and some even further afield. I will return to the significance of this later on.
Distortion of
employment creation
As I indicated earlier, the growth of the energy sector solved the foreign exchange earning problem, but did not and does not solve the employment problem. The Dutch Disease syndrome explains why a set of labour-intensive industries did not develop which could absorb the unemployed without having to earn foreign exchange. Wage rates were too high, and more important, real wages (wage rates adjusted for labour productivity) were even higher. Secondly, Government chose to create jobs itself directly within the central government, statutory bodies and state enterprises and indirectly through the Transfers budget in URP and CEPEP programmes. Government is the largest employer of labour.
Workers are represented by strong trade unions, and daily-paid or contract employment has evolved into lifetime employment in low productivity work. There has also been expansion of Subsidies—gasoline and diesel, travel to Tobago, and hidden subsidies for housing accommodation.
Understanding the current problematique
The impetus for diversification remains valid today as it was in the 1950s when Arthur Lewis addressed the problem. This is because foreign exchange earnings and hence government revenues from the energy sector are subject to cyclical downturns, some of which can be sharp. Arguably, we could save during the upswings and maintain consumption during downturns by drawing down the savings.
However, there are three considerations to bear in mind:
• First, oil and gas are wasting assets and significant investment is required to just maintain production.
• Second, during upturns, consumption and hence foreign exchange demand ratchets up to a higher level, and we are already a society that is consumption and not savings oriented.
• Third, at some point, the oil and gas will run out.
This does not mean that every last recoverable barrel of oil or cubic foot of gas will have been extracted. It means that it becomes no longer economically attractive with current technology for companies to produce that marginal barrel or scf of gas. When that happens, the economy must have alternative engines already running. Establishing and sustaining those alternative economic engines takes time.
The alternative engines must be in tradable goods and services because we need to earn foreign exchange and that requires that we address global markets. By global markets, I mean any market of any size outside the home market, where hard currency can be earned. Some economists argue that the industries producing the tradable goods and services must exhibit increasing returns to scale. I think where increasing returns are possible, the opportunities should of course, be grasped. But I think that niche markets can be effectively and profitably exploited where firms are nimble enough to shift from niche to niche. I also think that external economies are as important as scale economies, if not more so.
Diversify into what?
I am not an advocate of industrial policy, that is, where the government picks industries that it believes will be successful. I am doubtful about industrial policy because I am doubtful that government officials have the capacity and knowledge, superior to the market, to determine what businesses and industries should be pursued. Governments, in my view, should provide extensive and efficient infrastructure, and efficient public services, and leave much else to the private sector. There are exceptions of course, but these should be genuine exceptions based on strict criteria and the criteria reviewed for relevance over time.
There are things that economists do know or should know in respect of a country like T&T in the current global environment. First, large scale commodity manufacturing cannot compete. China is currently too dominant. So much so that even wholesale and retail distribution is threatened now that the Internet, global brands, global logistics and the use of credit cards gives the middle class person access to the best stores and products, manufactured in China, delivered to your door, at prices which the local retailer cannot match. As I said earlier, niche manufactures can compete on the basis of unique raw materials or unique designs where intellectual property can be effectively protected.
Niche manufacturers have to be prepared to constantly innovate and leave the niches when the scale players appear. On these arguments, government policy would not support commodity manufacturing, but would support niche manufacturing for export.
Because exploration and development costs in T&T offshore fields will be higher, our traditional comparative advantage based on low energy costs, as fuel or as feedstock, will no longer be significant. But what about industries downstream of ammonia, urea methanol, what has been termed ‘diversification within the energy sector’? These industries include acetic acid, melamine, and plastics from propylene and ethylene. These in turn can generate a host of consumer products. These are not new ideas. Indeed when the potential of natural gas became clear in the mid-1970s, the Ken Julien-led team had identified these types of industries as possibilities provided that natural gas supplies were sufficiently great.
The development of these types of industry will depend on our finding significant reserves offshore in deepwater or importing gas from Venezuela, bringing those reserves onshore, and attracting foreign manufacturers to set up operations here.
Services, I think, are our best bet. Our citizens have to be employed in decent jobs which pay good salaries. Neither niche manufacturing nor an integrated chemicals sector will absorb sufficient of our under-employed workers. Here is where we depart from Arthur Lewis who focused on manufacturing. Tradable services are varied, with different sources of competitiveness.
There are three (3) sources of competitiveness that I can identify: location and history; competencies and knowledge; and in the regional context, access to capital.
The industries in which we can compete on location and history are tourism and the natural environment — specifically our unique plant and animal life. Because our history has been so traumatic, there is a tendency to be amnesiac, as Derek Walcott termed it. It lives only in forts and derelict sugar mills. But confronting the trauma is one way of overcoming it, and we can then discover that our history has been really interesting and can be interesting to foreigners. The Brechin Castle sugar museum is an example in that regard. Our plant and animal life also support Tourism, but importantly, should also support an indigenous pharmaceutical industry. The medicinal and therapeutic properties of a host of local herbs and oils such as coconut oil and aloe are yet to be properly explored and commercialised.
Secondly, we can compete on competencies and knowledge. I have in mind here industries such as energy services in which we have considerable experience and which is already being exported to markets around the world. And there are possibilities to be explored in legal, accounting and other professional services. Many professionals are already involved in selling their skills overseas. Some work mainly in the Caribbean, there are others who ply their trades much further afield.
Finally we can compete on capital in that given our relative amount of capital in Trinidad and Tobago we should be investing in opportunities in other regional territories under the Caricom umbrella including agriculture in Guyana, Suriname and Haiti, minerals in Guyana and Haiti, and tourism in Cuba.
Firms Compete
Michael Porter reminds us that it is firms that compete, not nations. So, unless the firms in question are government-owned, the question that arises then is: what can be done about our moribund and risk averse private sector? It seems to me that we have a local private sector parts of which have become bound up in partisan politics because their fortunes turn on which party is in power. When their chosen party is in power, the contracts and legal briefs flow and business booms. When their party is out of power, business shrinks. The fear of victimization is pervasive. Closeness and access to those in the corridors of power also ensures that high status, so important to our elite, is conferred and recognized. It means invitations to the cocktails parties, the Diplomatic Centre, honorary doctorates and national awards, and lots of pictures in the newspapers.
As I see it, the private sector has to undergo an epiphany, a realisation that government dominance is not conducive to diversification and long-run development and that it has to:
(1) step up in shaping and influencing government policy, and
(2) re-engineer its own businesses to address global marketplace.
There are some specific matters that it can address. First, the fragmentation of the business community has to be reversed, and perhaps an umbrella body similar to what Jamaica and Barbados have would be the way to go.
Second, the private sector needs to insist on a tripartite mechanism that moves government away from its belief that it alone determines and shapes policy to a situation in which on critical areas of economic policy, not just industrial relations, government, business and labour act like social partners to discuss and shape policy in the national interest.
Third, there needs to be meaningful partnerships developed between the private sector businesses, the universities, and the sources of innovation which are not necessarily within the mainstream private sector.
Today’s businessmen and women, many of whom are themselves university trained, need to develop greater respect for and interaction with intellectual work, including scientific and technological work at the universities. I have in mind here working with entrepreneurs in the creative industries – film, fashion and design – as well as exploiting and finding new uses for our local herbs, fruits and medicinal plants, and exploring opportunities in alternative energy.
The local private sector has to begin to escape the mindset of more shopping malls and more foreign franchises for food and entertainment, all of which are consumers of foreign exchange.
So What Can Government Do?
For the private sector to flourish, the government itself must experience its own epiphany and come to understand that its current role and posture in the economy is dysfunctional, promotes dependency, and inhibits diversification. The local economy is no longer where it was in the 1960s and 1970s. The global economy is in a different place from the 1960s and 1970s. So the posture and policies appropriate to that era are simply no longer appropriate to our 21st century world order.
So what then becomes the role of Government? Government remains critical to successful diversification, the development of the alternative engines outside of the traditional energy sector. There are three roles that it can play to support the initiatives and investment of the private sector in non-energy tradables for export.
First, Government can assist in leveraging our ‘brands’. Our internationally recognized and accomplished athletes, sportsmen and women, our musicians and entertainers can be considered ‘brands’ which can be leveraged to promote particular products and services using traditional as well as social media. Trinidad Carnival is itself a brand, as are for example our regional Nobel Laureates. St Lucia has done well to leverage its two Nobel Laureates, Derek Walcott and W. Arthur Lewis.
Second, Government can assist by leveraging our Caribbean diaspora and ancestral connections in Africa, India, and China. Government can facilitate connecting the diaspora to the national economy by providing special facilities and incentives for home ownership by West Indians abroad, connecting diaspora skills with the local creative industries, universities and business parks, and promoting diasporic tourism.
Third, Government can assist by leveraging our regional relationships with under-exploited markets such as Haiti, Cuba, Guyana, and Suriname. The opportunities presented by these four regional markets are huge. But opening these markets require diplomatic support and special arrangements including perhaps government to government projects using local professionals and contractors.
The Diversification Agenda: What Needs To Be Done
First, we need to understand the problem. Unfortunately many of the people who talk about diversification do not grasp the underlying economics –the Dutch Disease syndrome coupled with dependency-promoting policies which block diversification. To illustrate we have the Central Bank publishing as indicators of ‘diversification’ the share of non-petroleum GDP in total GDP. You know now of course that that measure makes little sense. We need to be able to identify non-energy tradables. Counting home goods and services such as Government, housing and personal services is simply not correct.
econdly, where some person do understand the economics, they do not fully appreciate the socio-political factors which inhibit diversification. Hence the comment by Ewart Williams and Richard Young in their recent excellent Sunday Guardian article on tourism as to why over the years nothing has happened! Citing a number of initiatives to promote tourism, they noted: “Most of these have been proposed at one time or another before, but have not been implemented…”
Once we understand the problem and its dimensions, prescribing what is to be done is easy enough. The first task is to correct and subsequently avoid Dutch Disease. This means changing the explicit and implicit structure of incentives in the economy so as to promote the non-energy tradables sector.
Four sets of policies need to be configured correctly: exchange rate policy, monetary policy, fiscal policy and incomes policy.
The nominal exchange rate must be set and managed at a level that avoids appreciation of the real effective exchange rate. Determining the rate appropriate for tradable services is however a more complex challenge than doing so for manufactured exports where labour costs are decisive.
Monetary policy must restrain domestic prices as should fiscal policy, and fiscal policy has the additional responsibility of managing the transfers and subsidies budget so that dependency is not fostered and there is meaningful incentive to improve worker productivity. Similarly, incomes policy needs to avoid wage inflation. Government should also promote policies that encourage higher productivity and service excellence.
Government must begin to change its indifferent or antagonistic view of the local private sector. Our politicians have come to believe that government initiatives must be the drivers of economic activity and the private sector is marginalized. As in many other areas of national life, ethnic competition is operative even here. ‘Business’ is categorized, though of course not officially, as ‘French Creole’ or ‘Syrian’ or ‘Indian’. (With the demise of Clico and CL Financial there are no black-owned businesses of any significance.) Our politicians fail to see the limitations of state-owned enterprises and that ultimately expansive government encourages the scope for corruption and distorts the incentives needed to develop non-energy tradables.
Government therefore needs to refocus and reduce the size and scope of government activity. Sensible investments in infrastructure are always warranted. But much more investment now needs to be made in Process and People, and I do not mean the facile strategy of increasing the throughput of tertiary level graduates, but instituting systems and processes that work to produce consistent good outcomes in education, health care and the delivery of social services.
We need to secure increased savings out of energy-sector rents, partly to promote inter-generational equity and partly to temper the high levels of consumption which promote Dutch Disease. And Government needs to use its diplomatic and other ties to open doors for Caribbean and T&T businesses. Our international relations, including our relations with Caricom, have declined steadily since this country and the region played significant roles in the Law of the Sea, the ending of apartheid in South Africa, and stood in regional solidarity with Cuba.
Knowing what to do is the easy part; the hard part is to take the medicine. The theme chosen for this address was ‘Diversify or Die’. Some of you may know that in certain theological perspectives, the individual has to ‘die’ in order to have life, meaning that you have to give up those human pleasures which may separate us from the Divine. This country has to ‘die’ in order to diversify. It has to give up overvalued exchange rates, dominant government, and the dependency syndrome which is supported by rents from the energy sector. We have to have a ‘Ramadan’ experience, a ‘Lenten’ experience if we are to emerge with an economy which will be prosperous, productive and strong when the oil and gas fails. If we fail to do that, we or our grandchildren will experience penury and economic death.
Business Guardian