The real problem with the exchange rate


Friday, August 17, 2018

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Every time there is a sharp decline of the exchange rate, it becomes a major topic of discussion, and rightly so. The fact is that the exchange rate is very important to the consumer, as it does have an impact on prices.

If the J$ depreciates against the US$, then because most of our imports come out of the US, it inevitably affects the average man's purchasing power as his earnings are denominated in J$.

This is because most of the things that we consume are either directly imported from the US or have an import content that ultimately affects the costs and prices of the finished product/services.

Even when it is a service that is provided, the cost of providing that service is affected by rising oil prices (electricity bill and travel cost), stationery imports, furniture imports, etc. Even when you are taking a vacation in Jamaica, and you book a hotel, the price is quoted in US$, which is understandable.

One can argue that the exchange rate does not impact, in any significant way, the basket of goods that affects inflation, as much of the basket consists of locally produced foods and other things that are not directly impacted by the exchange rate. This is true, but the argument assumes that as people improve their standards of living they will want to continue consuming only what is in that basket of goods.

The fact is that if we think that people in improving their lives want to consume things that improve their standards of living like televisions and other appliances, brand-name clothing, imported foods, etc, then we also have to assume that their cost of living will be affected by the exchange rate.

So, it is therefore inconsistent to talk about improved standards of living and a lower exchange rate, as when the economy improves (as we have been seeing), unemployment falls, and average wage levels increase, then naturally people will demand more luxury goods, which we do not produce.

Also, as oil prices increase, we are fully aware that we will always be vulnerable. And oil prices are today over US$70 per barrel, coming from under US$50 per barrel just a year ago.

Oil imports account for over one-third of our total imports, and hence foreign exchange use, so when oil prices go up, we have a higher demand for US$, and when it goes down the balance of payments (BOP) benefits. It is the reduction in oil prices that resulted in our good fortune at the start of implementing the current IMF agreement, and benefited the economy.

But the truth is that during that time, when we had the benefit of oil prices, we had not really done much to change the structure of our economy. So when oil prices started to trend back up we began to once again see pressure on our BOP.

Instead of addressing this issue – we continue to have conversations around monetary policy, as a way to address the sliding dollar. So we talk about the auction system, BOJ selling US$ into the market, interest rates etc – but this does not address productivity which is the fundamental issue that causes a weak economy, and ultimately a weaker J$. This is maybe because we don't truly understand productivity, or want to do the things that will cause higher productivity.

The logic is that higher productivity results in more competitive products/services (whether from reduced comparative prices or greater value added), which will increase our exports relative to imports – or increase local consumption of locally made products.

If approached properly, it also means that labour will become more productive, and result in higher earnings in real terms. This will mean not only more employment, but also more high value employment, and an increased cost of living. This will play out in the exchange rate and result in a relatively stronger J$.

What has been happening, though, is that we have always sought to control the exchange rate through monetary, rather than fiscal policy, and hence we have not really addressed the issue of productivity, and more specifically labour productivity.

Instead, what we have done is sought to improve living standards by income distribution, for example, through tax policy, but this at best has a short-term impact and causes greater future hardship on the very people we are trying to help in the first place, as markets and money will always adjust to the more productive factors.

This constant focus on monetary solutions, rather than taking the decisions to address the underlying problem, is what causes our currency not to achieve a much stronger position. The problem also is that we believe that a stronger currency will make our incomes improve, when what we really need to do is address the productivity issues that cause a stronger currency and thus have real sustainable standard of living improvement.

So what are the things that will cause a stronger currency, and result in a sustained improvement in living standards?

The first thing we need to do is recognise where our currency exposures lie, and if you look at the BOP, the matter of oil is a standout.

So, I would think that the first thing to do is to reduce the level of dependency on oil imports. To do so, we should determine what we use oil for. And as far as I recall, we use 30 per cent for transport, 30 per cent for retail consumption and 30 per cent for manufacturing. This is where I have always been saying that a well-run and properly funded public transport system would save us billions of dollars. In addition, the move to LNG and renewables (as much as is feasible) would also reduce our dependency.

The second thing for us to understand is the role that discipline (on the roads and in the

workplace) plays in improving productivity, and reducing chaos.

This includes protection of the environment, driving on the roads, and labour productivity. I have discussed all of these before, but just want to say on this that the need to reform the labour laws, which was supposed to have been implemented over a year ago based on the IMF agreement, is critical.

What is more is that we don't understand that the longer we take to address this not only makes workplace productivity suffer, but also puts the people in the labour force at a significant disadvantage.

Instead, we have chosen to delay this and by so doing delay the productivity of labour and hence the earnings are kept at a minimum – which will result in a serious earnings challenge for the labour force when they retire.

The last thing I want to mention is the legislative hindrance to productive capital.

Our legislation, in many respects, restricts capital from working, which causes underperforming capital productivity, resulting in lower returns and less earnings for workers and economic expenditure. The result is while we restrict local capital we encourage foreign capital, which eventually becomes an outflow.

These are some of the reasons productivity is low, and if productivity is lower than our trading partners, then competitiveness is reduced, which in turn causes our exports not to be able to cover our imports – hence a weaker currency.

This for me is the reason behind a weaker currency. Any reliance on purely monetary policy fixes, while desirable in the short term, is not sustainable.

Dennis Chung is the author of Charting Jamaica's Economic and Social Development AND Achieving Life's Equilibrium . His blog is . E-mail:

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