The Second Economic Miracle: Why did the experts spoil the show with their eerie economic forecasts?

26 août 2015

26 août 2015, 08:39

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08:39

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Par

Dr Rama Sithanen

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The Second Economic Miracle: Why did the experts spoil the show with their eerie economic forecasts?

The main projections of the Prime minister’s economic team make alert observers more than skeptical, about the whole vision, opines the author. “Fixing exceedingly elevated quantitative targets and providing a very tight timeframe for their attainment are two huge risks that should not have been taken”, he adds.

Introductory remarks

The credibility of key economic performance indicators and the best endeavours of macroeconomists to forecast the principal data within an acceptable range are vital to instill confidence and energise the nation. Given his track record, nobody doubts the sincerity of purpose of the Prime Minister in his endeavour to put the economy on a high growth trajectory. His speech on the second ‘economic miracle’ was a good one as it sets high objectives for our country in terms of GDP growth, employment, income per capita in US$ and investment.

First, he has brought back the economy from the backburner to the centre of the stage where it should lie.

Second, his personal leadership on the economic front, his dedication, commitment, his no-nonsense attitude, his appeal to the public sector to be more pro active and efficient and the private sector to be more risk-taking and entrepreneurial can make a difference to restore confidence and give reassurance to investors, operators and the nation at large.

Third, his call for hard work and discipline and the necessity to put the interests of the country first is also timely.

Fourth, his undertaking to personally follow on the facilitation and execution of major projects and to chair the public-private sector joint committee will certainly help to break some logjam and overcome bottlenecks.

Fifth, some of the measures such as those in the connectivity cluster – air access, regional airline, regional shipping line and fast digital access and affordability hold good prospects as catalyst for growth if speedily implemented.

The Prime Minister should have stopped after having focused on the vision, the blueprint and the broad strategies even if they are bound to contain an element of very high expectations. So is life, especially in politics. However it appears that his team of economic experts got him to embark on a very perilous course with a set of granular forecasts on some key economic parameters that have peppered his presentation. While we all want the economy to improve significantly, we have a responsibility and a duty to be realistic in our projections based on what has happened in the immediate past, on the difficult state of the world economy, on the various bottlenecks that must be overcome, on systemic failures, and on the political economy challenges of structural adjustments and reforms. Otherwise the quantitative objectives spelt out could quickly become empty promises that fail to pass the credibility test. Worst, it can even dampen the very trust and confidence that the Prime Minister seeks to shore up. There are two huge risks taken. The first in fixing exceedingly elevated quantitative targets and the second in providing a very tight timeframe for their attainment.

When the best becomes the enemy of the good

The main projections of his economic team are so disconnected from what is happening on the ground, both nationally and globally, and so difficult to accomplish in the absence of bold and decisive policy actions as to make many alert observers more than skeptical about the whole vision.

The devil is always in the details and in the execution. I shall deal with six headline macro economic indicators on which his economic experts have pinned significant hope to turn around the economy and deliver on the second economic miracle. They are GDP growth, employment creation, income per head in US$, investment, the quantum of FDI and the share of manufacturing to GDP.

(i) The promise of a consistent and sustained 5.5% GDP growth as from 2017

The average growth rate for the 15-year period 2001-2015 is only 4.1% while the five year mean from 2011 to 2015 is a paltry 3.5% without a single year with economic expansion at 4%. Since 2000, there has not been any period with three consecutive years of growth in excess of 5% with the exception of 2006, 2007 and 2008. The traditional sectors of textile, sugar, agriculture, construction and manufacturing are facing significant head winds while growth is being driven essentially by services and consumption. To be factually accurate, the average growth rate for the period 2006-2014 is 4.2% and not 3% as mentioned in the document. These are official figures published by both Statistics Mauritius and the Bank of Mauritius. Within a short period of 5 months, Government has already but rightly deferred the growth rate of more than 5% announced in the March 2015 budget by one year.

In the absence of decisive policy measures to cure the weaknesses that limit our potential for growth and bold structural reforms to reverse declining trends in some key areas, there is little chance of making the leap from a growth rate of 3.5% in 2014 to a high sustained average rate of 5.5% as from 2017. It would be crucial to create the conducive climate for a more competitive, entrepreneurial, productive, innovative, technology-driven and knowledge-based economy to reach the target growth of 5.5% per year on a consistent basis. And it is vital to close the gap in infrastructure, research and development, science, technology and innovation, education and human capital, connectivity and financing. While voluntarism may help, it is above all the quality of economic policies that will make the quantitative difference. Difficult choices will have to be made between recurrent and capital spending and among competing demands for infrastructure, education, human capital financing and social expenditures in a context of rising budget deficit, spiralling public debt. To exacerbate matters, the global economy is weak, the EU growth rate is anaemic, trade preferences are being eroded while competition is fierce from low cost and labour abundant countries. The development institutions and those that have followed the trajectory of our economy since independence are forecasting a growth rate of around 3.5% for the next five years. These include the predictions of the African Development Bank and the IMF.

(ii) The promise to create 100,000 and 10,000 jobs in the private and public sectors respectively by 2019

The figures from Statistics Mauritius indicate that the change in the number of people employed over the 15-year period to 2014 is not more, on average, than 5,500 per year. Now, the objective is to raise this figure to a mean of 20,000 to 22,000 per annum, almost four times higher with- in the next five years (including 2015). When one takes into account the current level of unemployment, the number of people who join the labour force every year and the fact that there will always be some frictional unemployment of around 4% due to labour market imperfections and mismatches, the figure of 110,000 jobs by 2019 becomes surreal. Also many of these jobs would likely be taken up by foreign labour. In the Government programme of January 2015, the target was to create some 15,000 jobs annually. In August 2015, the figures have escalated to 22,000 per year.

The 70’s and the 80’s were characterised by labour-driven economic expansion while the 90’s was led, to a large extent, by physical capital growth. Going forward, the share of labour in GDP growth will decline as the population ages and we will have to rely on capital accumulation, human capital and total factor productivity and focus more on higher value-added, more innovative, knowledge and skill-intensive activities. However this is much more difficult, takes more time than is the case for labour-driven growth and requires policies and strategies that are very different from those that have underpinned our past economic success. It is crystal clear that the labour intensity of growth will diminish with technology, innovation, digitisation and better human capital. Which makes the creation of 20,000 to 22,000 jobs per annum extremely difficult, if not impossible.

(iii) The promise to deliver an income per capita of US$ 13,500 in 2018

The average growth in per capita income in US$ for the last 15 years stands at around 7% per annum. This takes into account the depreciation (or appreciation as the case may be) of the rupee to the greenback. As a matter of fact, the income per head in 2015 will be materially lower than the figure of even 2013 because of the huge depreciation of the rupee from an average of Rs 30 to almost Rs 35.50 to the US$ since the beginning of 2015. The gross national product per capita in US$ will fall from around US$ 10,000 in 2014 to about US$ 9,300 in 2015. How do we reach US$ 13,500 in 2018? We need an average increase of 13% per year for the next three years without any depreciation of the rupee. Most economists expect the rupee to surrender more value to the US$ as the US economy strengthens its pick up and interest rates start rising. I have seen econometric models with parity between the US$ and the Euro by the first quarter of 2016 and an exchange rate of Rs 40 to the two currencies. And if we do not quickly enhance efficiency and productivity, our export shall become less competitive and there will be pressure to further depreciate the rupee.

(iv) The promise to generate investment of Rs 185 b

from the private sector and Rs 75 b from the public sector To rekindle growth and generate gainful employment, we must raise the share of both investment and savings to GDP. Investment as a share of GDP has dropped over the years from a high of 30% of GDP to its lowest level since two decades at 19% today while the savings ratio has plummeted from a high of 25% of GDP to 12% now. More worrying, the share of private investment continues to go south and is falling both as share of GDP and gross investment. It has nose-dived from 20% in 2007 of GDP to below 15% today. Public, corporate and household debts are very high and severely constrain the capacity of the country to invest in major public and private sector projects. The investment rates and the savings ratio in Mauritius are much lower than during the high growth phases of the Asian Tigers (Singapore, Hong Kong, Taiwan and South Korea). Economists agree that there cannot be a sustained yearly growth rate of 5% without an investment ratio to GDP that is higher than 25% while savings must go up significantly to ensure resource mobilisation. One is struck by the fact that 90% of the private sector investment of Rs 185 b emanates from real estate development with the smart cities taking the lion’s share at 65%. It is plain that the development of the smart cities would take a very long time (in some cases up to 50 years) while their initial impact would not be felt before at least five years. An amount of Rs 75 b is earmarked over a five year period for public sector investment in major infrastructure, representing a yearly average of Rs 15b. It is more than is usually spent by the public sector taking into account budgetary constraints, implementation capability, the usual delays in project execution and now the crowding out of capital spending by recurrent expenditure. The capacity of government is also limited by the size of the budget deficit and the high level of public sector debt. Also business confidence remains very muted.

v) The promise to attract Rs 140 b of FDI over the five year period to 2019

Excluding global businesses, the average annual inflow of FDI over the 10-year period to 2014 is around Rs 11 b. This includes many exceptional items like the conversion of Barclays from a branch to a wholly owned subsidiary bank. A fifteen-year average would be significantly lower as there was no substantial FDI prior to 2005 except for the Mauritius Telecom transaction with France Telecom in 2000. Against a background where there will be a flight of capital from emerging markets to developed economies in the wake of monetary tightening in

the USA, the economic experts of the Prime Minister are forecasting a yearly inflow of Rs 28 b for the next five years. We should discount 2015 as this figure will not be attained which implies that the average for the next four years would have to be higher than Rs 28 b.

(vi) The promise to raise the share of manufacturing from 18% to 25% of GDP in 3 years

Services account for around 75% of our GDP as the growth in the tertiary sector has been much higher than those in manufacturing and agriculture. Over a period of 25 years to 2015, the share of manufacturing to GDP has dropped from 25% to lower than 17% while the contribution of export oriented enterprises has fallen during the same time frame from 12% to 6% of GDP. The document itself mentions that most of the growth would come from the services sector (financial services, tourism/cruises, ICT/BPO, real estate, wholesale and retail trade, etc). It is expected that the share of services will continue to grow as we graduate to higher level of income. It took almost 25 years to see manufacturing shrink from 25% of GDP to lower than 17% in 2015. Now the experts tell us that it will require only three years to go back to a share of 25% of GDP.

Breaking the logjam and overcoming impediments To become a high income country is tougher than it looks in theory. On paper, one needs only 15 years with an average annual growth rate of 5% to reach the high-income level from an upper-middle income level. This is indeed not a long period. The East Asian tigers have done the leap in fewer years. Singapore took 10 years to graduate from an upper middle income country to high income status while Japan made the move in 9 years. Hong Kong, South Korea and Taipeh accomplished the transition in 7 years. Israel and Spain did it in 17 years while Greece waited for 28 years before entering the elite group of high income. The median number of years to reach high income level from an upper middle income status is 13. Mauritius attained upper middle income rank in 1992, almost 23 years back. Depending on the rate of annual economic growth going forward and the depreciation of the rupee to the US$, it could take another 8 to 15 years to reach high income status, implying a stay of between 31 to 38 years in the upper middle income range. Many countries that reached middle-income status as early as the 1960s and 1970s have failed to transition to high income status since then. For instance South Africa, Brazil and Malaysia have been stuck in the middle for quite a while.

>Biopark, in Phoenix. It is important to create a conducive climate for a more technology-driven and knowledge-based economy.

There is nothing inevitable about a low growth rate and a middle income trap. It is an obstacle to be overcome. Equally, however, it is highly possible not to have a high growth rate. It all depends on the quality of economic policies and the speed and efficiency with which we implement them. The document is very long on expectations but extremely short on the reforms and adjustments necessary to accomplish them. We need pro-active policies to augment the investment and savings ratio, to diversify our markets and the basket of exportable goods and services, to raise the share of trade in goods and services to GDP, to significantly enhance FDI and to sharpen competitiveness through productivity and efficiency increases. Indeed we require robust policies to lift the growth capacity and the output potential of the country. It is clear that in the absence of structural adjustments and economic reforms in many key sectors such as education, training, human capital, labour force participation, infrastructure, technology acquisition, innovation, regulatory framework, institutions, factor markets amongst others, we run the risk of not meeting the objectives of high investment, high growth and high employment.

The document speaks of inclusive growth but is silent on the policies to achieve it. While GDP growth and employment are necessary to fight poverty and raise living standards, they are not sufficient to ensure inclusion, shared prosperity and sustainability. It means that two other sets of reforms are absolutely essential to eradicate absolute poverty, to reduce inequality, to broaden the circle of opportunities for micro, small and medium enterprises and to protect the environment. It is an empirical fact that the globalisation, ‘financialisation’, externalisation and digitisation of the economy benefit some categories more than others, much to the disfavour of the poor and the middle income groups. We need bold reforms that will ensure that the benefits of the welfare system accrue more to the most deserving of our compatriots so as to lift them out of their precarious predicament and remedy this ‘distributional market failure’. Otherwise both relative poverty and inequality will rise. South Africa and Brazil are mired in yawning inequality and high poverty rates. Currently, the benefits of our welfare system go disproportionately to the non-poor. In addition, access to, quality and relevance of education and training, investment in infrastructure that support the poor more and availability and access to financial resources for the vulnerable groups also have an impact on poverty alleviation, inequality reduction and economic democratisation.

Concluding Notes

Fate is indeed not predetermined. As well stated by the Prime Minister, we have our destiny in our own hands. Mauritius should and can avoid a prolonged period of sustained slowdown and stag-nation by embracing the right policies and adopting structural reforms. This will allow us to reignite the engines of high growth and if complemented with the right social and environmental policies, it will also ensure inclusion with lower absolute poverty, a reduction in inequality, shared prosperity, and sustainable development.

To succeed we must avoid three lethal mistakes:

First, we should stop looking in the rear mirror and believing that the strategy that underpinned our successful transition from low income to upper middle income rank will take us to the next level of development. If anything, it will certainly fail us and may even lead to a regression. Conditions have changed dramatically both internationally and domestically. The global, institutional, and structural environments have evolved and past strategies are no longer effective.

Second we should be careful about exiting too early from sectors that could help us make the transition to higher growth. For instance we simply cannot exit the incentives-driven global businesses too early. Substance and incentives can go hand in hand like in Singapore. The country needs time to make the transition. I sincerely hope that the Prime Minister will be able to salvage some of the benefits of the double taxation avoidance treaty with India in his discussion with Prime Minister Modi.

Third, we cannot afford to have an economic strategy where there is a blatant lack of coordination, coherence and cohesion. We need direction and strong anchors to guide us through these challenging times. One can only hope that the various committees set up by the PM will bring a unity of purpose in the design, conduct and execution of economic and social policies.

>The median number of years to reach high income level from an upper middle income status is 13.

We are at a critical juncture in the economic history of our country. Most of us have a very good idea of what would not work. What is more challenging is to have a thorough knowledge and understanding of what will deliver on the second economic miracle. The quality of economic and social policies will be primordial. Evidence-based policies and experience from countries that have made it can show us the way even if our history, context and circumstances must be factored in the equation.

The strategy must be country specific. Of course structural adjustments and economic reforms can be very complex. In addition we must make sure that policies are implemented in a timely and effective manner. Undoubtedly we need a tinge of a dream but we should not grossly overstate the figures as they will not pass the test of political credibility and economic introspection. We should be ambitious but within bounds. If one is over zealous and tries to make something better than one is capable of, we may end up ruining it. In such cases, the best becomes the enemy of the good.