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Letter: Managing a recession
Published on February 23, 2017 Email To Friend    Print Version

Dear Sir:

In the traditional modelling of the dynamics of an economy, two state variables play important roles; the aggregate supply capacity, which is the economic capability and capacity to provide goods and services, and the gross domestic product (GDP). The supply capacity change in, say, a year is the net investment in the economy and if fully utilised increases the production of goods and services.

Hence, as an economy begins to stagnate, e.g. goes into recession, the call is usually made for new investment in the economy to produce more supply capacity, hence new goods/services and jobs etc. In fact, even in our, Trinidad and Tobago’s, current recession the government is talking about new investment in highways, construction, ports, hotels etc. The causal or control factor of economic recovery is seen as new investment and its full utilization.

However, small open plantation economies, like Trinidad and Tobago, depend on a small basket of commodity exports but also on a substantial range of imports that support the non-commodity (“onshore”) economic activity. So much so that when the foreign exchange earnings drop the economy cannot in the short to medium term produce new exports or replace a significant part of its imports by local production.

Hence a defining characteristic of such small open plantations is that they cannot exploit even existing supply capacity fully if they cannot import the products on which the major on-shore sector of the economy runs; this is the case simply because the export activity is not providing the foreign exchange required to meet the demand for imports. Hence, local investments that require associated imports and do not produce in the short to medium term exports or replacement of imports do not really grow the economy in a recession.

In fact, a new local investment that needs imports may simply exacerbate the economic situation as it tries to, for example, maintain employment. In our current recession attempting to stimulate construction of houses may indeed produce jobs but it is an activity that is high in import content. The only way such foreign exchange demands can be met is by borrowing and draw-down on reserves and foreign exchange savings (a kind of counter cyclical spending of foreign exchange income).

In the modelling of such small open plantation economies the export earnings are really an exogenous input into the system, an input over which the local economy has little control- giving us the term a boom-bust-boom economy. The long term aim of such economies is usually export diversification into globally competitive products; an aim which, for Trinidad and Tobago, seems unachievable. The immediate problem then is how do you manage or control such an economy in a recession? Still the last resort in a recession is stand-by support from the IMF.

The new economic equilibrium in a bust is achieved when the demand for imports has been reduced to match the export income. This can be achieved immediately by a drastic one time devaluation of the local currency or a more measured dose over time of a series of tax and interest rate increases, reduction in government spending and liquidity in the local market, borrowing on the foreign market, freezing of salary and wage increases. However, such an abrupt contraction of the economy in the former case, could wreak havoc on the citizenry and the more tolerable contraction, the latter, should be the aim.

Barbados has found itself in a situation where it has almost exhausted its foreign exchange reserves; it can no longer raise money via local/foreign loans and is reduced to the unthinkable – printing money. Trinidad and Tobago on the other hand has imposed minor taxation and reduced subsidies on fuel. In trying to maintain a fair amount of official reserves, now at some US$9.3 billion – 10.3 months of import cover – Trinidad and Tobago is borrowing in both local and foreign markets so as to maintain its spending, to sustain on-shore economic activity (with the inevitable positive feedback of increased foreign exchange demand) at the real cost of increasing debt (from 36.1% GDP in 2010 to 60% in 2016 while foreign debt doubled from 7.5%).

It is also preparing to approach the Andean Development Bank for more foreign debt. The foreign exchange injected into the economy over the last year is some US$6.1 billion of which US$1.807 came from the Central Bank – the total down by 19% year on year, the lowest in five years, while the GDP growth rate has declined from -0.6% in 2010 to -2.3% in 2016.

The economy is slowly contracting as is the foreign exchange being released into the market. However very little is being done to cut aggregate demand in the country, cut demand for foreign exchange: The new taxes imposed are minuscule as is the impact of the reduction in fuel subsidy, while government spending fuelled by borrowing continues unabated.

The management strategy then of the Trinidad and Tobago’s government in this recession seems obscure; albeit, there is a slower decline in the economy than could be expected supported by increasing government debt, a reduction of foreign exchange to the local market while retaining adequate reserves with no real attempt to cut aggregate demand.

The result is mixed signals to the population where, for example, with such a severe reduction in foreign exchange income some are still claiming with rancour that they cannot get US dollars at the bank!

Mary K King
St. Augustine
Reads: 2835

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