To date the discussion has focussed on whether after a drop in foreign exchange earnings it is more efficient and effective to stabilise a small open economy via a devaluation or, instead, fiscal means whereby aggregate demand can be reduced in an attempt to again achieve trade balance.
The view is emerging that such a devaluation, say in the case of Barbados (or even T&T), could have also solved the problem of the fall in foreign exchange earnings by initiating more and new exports and replacing imports by local goods and services.
The general economic literature refers to the Marshall-Lerner conditions which underpin this recovery engendered by a devaluation. The argument goes thus: The goods and services of interest are those exported and imported whose prices are influenced by the world market–in our case our oil and gas as exports and machines, electronics, clothes, drugs, you name it we import it.
With a devaluation the cost of these goods/services in the domestic currency will rise, which could divert purchases locally to equivalent non-tradables (import substitution) so reducing the demand for imports.
Further, the increased cost of exports (measured in the local currency) could reduce the local demand for these goods
(assuming they are also used locally), so releasing more production for export.
The increased profitability of the export sector, arising from the fact that export earnings, measured in the local currency, have risen in comparison with the local costs to produce, could stimulate new production of exports and import-competing goods. These circumstances will draw more resources into these industries encouraging economic growth.
In summary, the above argument is: the small open economy would have the capacity to replace some of its imports by local production, and higher export prices would encourage increased production of exports, of import-competing goods and even new exports. This argument holds whether the country devalued because of an external economic shock or not.
Let us see how this argument applies to the T&T's economy. First oil/gas and derivatives provide some 85-90 per cent of the foreign exchange earned. Negative external shocks usually refer to drops in the prices for the energy sector products. Hence it is impossible to increase the production of these products simply because the TT$ was devalued, particularly since the production of gas/oil has been on the decrease. Further, given the structural constraints on the local economy it is impossible for the on-shore private sector to either engage in import substitution (we tried it once and failed) or to produce new globally competitive exports.
I have been writing for decades about the need to do the latter, to diversify, and as usual, with a collapse in the energy sector capacity to earn foreign exchange, there is the general outcry for diversification.
The structural deficiency in the economy is simply that the energy sector earns the foreign exchange and the on-shore sector, virtually risk free, engages in the lucrative business of importing, markup and sell what the population needs to live in its present lifestyle. This history has created economic rigidity, a private sector and a financial sector that are risk averse, and with the past experience that a boom follows the bust, the business strategy is simply to await the return of the good times.
But simply having the investment and the desire to export is insufficient. To be successful any on-shore exports have to be globally competitive and today such competitiveness depends on being innovative–business and technological innovation.
The literature and successes of other countries tell us, in keeping with the economic architecture defined by the Triple Helix, we have to build a national innovation system–a triad of government, universities/research institutions and a new and risk taking private sector.
This process can begin to deliver the results (barring a few low hanging fruits), new globally competitive exports, in eight to ten years–the time frame within which we can hope to expand our exports. Devaluation does not contribute to this process.
Some refer to the growth in T&T's economy in the early 90s and relate it to the devaluation of the TT$ in the period. This growth, however, depended on the new exporting capacity of LNG which was unrelated to the devalued TT$.* Jamaica has devalued its dollar from J$0.9 to the US$ in 1977 to the staggering J$121 to the US$ today with no impact on its ability to export, so much so that it is still under the IMF.
What is even more sinister about the structural constraints on this economy, of having to import substantially most of what we require to live, is that the development of the economy depends on the positive difference between what we earn in foreign exchange and what we spend on imports–the resources required to fund the creation of the new and innovative export sector. Some see this as the job for foreign direct investment–but that discussion is for another day.
Devaluation may help in the short term to stabilise the economy after an external shock but it comes with price inflation, which then drives local demands for wage and salary increases and in our economy it does not address the problem of export growth.
Mary K King,
St Augustine
* Editor's note: The exporting of LNG began in 1999