Economic Sense, a lucid analysis

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Eric Ng’s recently published “Economic Sense” was officially launched on the 12th of April. On that occasion, Sushil Khushiram, independent consultant and former minister of Economic Development, made a review of its content. He will be sharing with readers a last part tomorrow.

Economic Sense, a lucid analysis (Part I)

SMEs

The first section deals with real economy issues and Eric Ng takes on the populist beliefs that often lead to misguided macroeconomic policies. He starts by questioning the effectiveness of state support for SMEs, calling it “state sponsored entrepreneurship”. Promoting SMEs is often held as a panacea for greater employment and growth. But, like economic democratization, SMEs can turn into a mere slogan. 

SMEs have not really been successful over time, despite decades of support by the DBM, which became saddled with sizeable non-performing loans (NPLs). We have not drawn our lessons from the past failures of two cooperative banks, MCCB 1 and 2, and from the defunct Post Office Savings Bank and First City Bank.

As Eric Ng states, “Entrepreneurship is not a question of finance, but of opportunities”. I would add that a genuine SME strategy must put more emphasis on productivity, and on export orientation, so as to create productive employment and raise the country’s long run growth potential. Concessional lending to SMEs is not necessarily a sound approach.

Trade deficit

Eric Ng then denounces the alarmist concerns raised by “modern day mercantilists” about the size of the external trade deficit. Domestic manufacturers want to shift consumption from imports to local products by imposing import duties and tariffs, while exporters view the large trade deficit as evidence of an uncompetitive exchange rate, and press for a depreciation of the rupee.

An external current account deficit cannot however be taken in isolation. It is the converse of a capital account surplus, which basically reflects low domestic savings and therefore a reliance on foreign capital. A lower current account deficit will inevitably be associated with reduced foreign capital flows to finance investment spending and growth. We cannot have our cake and eat it too.

An effective response to an unsustainable current account deficit is to boost the domestic savings rate, both by enhancing private savings and reducing the government deficit. Low real interest rates do not encourage savings. 

Real estate investments

The concentration of our investments in real estate activities is a contentious topic. Eric Ng takes a dim view of malinvestments in the real estate sector that have led to an oversupply of residential and commercial space, while property prices remain beyond the purchasing power of most Mauritians. Banks are faced with a significant amount of non-performing commercial property loans. This “diversion of scarce resources from productive projects to unproductive ones” has been abetted by cheap and loose money. Eric recommends that the housing and property markets be allowed to adjust, and not propped up by a low interest rate policy.

It should be pointed out that opening real estate to foreign investments for creating economic value has never been disputed, including for hotel and tourism-related accommodation, educational institutions and campuses, healthcare facilities, global business and other financial activities.

However, the strategy on real estate development should be better tailored to attract foreign investments in productive activities, along with expatriate talent and expertise, in targeted sectors. Policies should incentivize investments that expand the industrial base, and help producers tap into foreign markets and access new skills and technologies.

Inequality and Taxation Eric Ng downplays the issue of growing economic inequality, arguing that “income inequality is an essential feature of the process of wealth creation”. He takes comfort in the decline in absolute poverty to 6,9% of the population in 2012, while noting that relative poverty and inequality as measured by the Gini index have both risen between 2007 and 2012. 

He does not believe that progressive taxation and other redistributive policies are appropriate for tackling inequality, and instead favours the provision of targeted income support to the most needy. However, his stand on the irrelevance of tax policy for addressing inequality must be regarded with some skepticism.

Even Singapore, which has a low but progressive tax system, is raising its top marginal tax rate, and the tax rate for the top 5% bracket, to fund a sharp rise in healthcare spending, and provide extra support to retirees and low earning workers. The expensive cost of living, rising housing prices, and concerns about worsening inequality are driving these tax changes.

Eric Ng makes an impassioned plea for flat taxation, probably in response to the frequent criticism that its introduction has contributed to widen inequality in Mauritius. Eric claims that because a flat tax is a proportional tax, it is therefore also just. This concept of just taxation is highly controversial.

His contention that a low, certain, and convenient tax regime is conducive to eco- nomic growth is more reasonable. And he does not rule out an increase in tax rates, or a higher top marginal rate, to finance greater capital spending and to stimulate growth.

The relationship between inequality and growth is a complex one. What matters more is the inequality that arises from rent seeking, when wealth buys control of Government and influences policies for narrow and selfish gain. This is the view of Angus Deaton, the 2015 Nobel laureate in economics, expressed in a Financial Times interview last December

 

Economic Sense, a lucid analysis (Part II)

Public Governance 

Turning to the second section on political choice, or the vagaries of public governance, Eric Ng again lambasts populist axioms, and the nefarious influence of politics on public governance.

He lists the numerous examples of dilapidation of taxpayers money on public interest projects, such as the infamous Heritage City Project, and the dismantling of the BAI Group. Taxpayers will bear the burden of substantial liabilities potentially arising from the adjudication of several compensation claims on Government.

Eric Ng’s prescription is to strengthen constitutional checks on the discretionary powers of public officials, notably by giving elected representatives the legal powers to control bureaucrats. We agree that public officials should be held accountable for bad decisions, but all too often these are taken at the behest of ministers.

Special Parliamentary Committees, such as a more empowered Public Accounts Committee, which can summon public officials to explain their decisions, could indeed provide a better oversight of public decision making. While Mauritius is deemed to have a legal separation of powers, the legislative has traditionally been accommodating to the executive. A more powerful and assertive legislative arm might well enhance democracy in Mauritius.

Eric Ng takes a critical look at the Metro Express project, which he reckons is driven by political rather than economic considerations. He acknowledges the potential benefits, but is concerned by the lack of a detailed evaluation, and the fiscal impact of this mega investment.

Eric Ng wants to do away with all the nonsense associated with the widespread resistance to privatization, which feeds on fears of unemployment and erosion of the welfare state. Our public utilities are mostly mismanaged and represent a burden on the economy. They are loss making, encourage waste, promote pork barrel and white elephant spending, are over staffed and offer poor customer service. It is a harsh but valid indictment.

If well managed by private operators, these public utilities could even generate surpluses to strengthen tax revenues and consolidate the welfare state. I hasten to add that even if state agencies can prove to be performing, as in Singapore, Mauritius is abysmally short of the requisite high standards of governance.

Eric Ng considers that the Boards of state owned enterprises do not function independently and even become dysfunctional as a result of heavy political interference. The separation of powers between a Chief Executive and a Chairman is ineffective in improving governance, and he therefore prefers the choice of an executive Chairman as a single centre of authority.

Eric Ng makes an objective evaluation of the comparative performance of two central bank governors, in both style and substance, and offers some prescriptions for shoring up the institutional independence and effectiveness of the central bank.

Interest rate policy

The third section, entitled sound money, pertains to the role of monetary, interest rate and exchange rate policies. In my view, this section constitutes a real tour de force, reflecting the author’s deep-seated and long-held conviction that the pursuit of loose monetary policies, lower interest rates and of a weaker rupee do not make economic sense.

He faults the BOM for its lack of independence in furthering loose monetary conditions, by creating too much money, and lowering interest rates. In a situation of excess bank liquidity, the effectiveness of the Key Repo Rate (KRR) as a policy signal is undermined. The central bank has failed to mop up all this surplus liquidity through reverse repo operations,and to restore proper conditions for the conduct of monetary policy.

The twin objectives of monetary policy are to ensure price stability and balanced growth. Eric reminds us that inflation is a monetary phenomenon. Although the CPI increase is currently subdued, what matters most for monetary policy is expected not current inflation, as well as money expanding faster than nominal GDP.

He believes it is a myth that loose monetary policies can grow an economy. Despite several cuts in the KRR, investment has been declining in real terms over several years. Less productive investments, notably in the construction and real estate sectors, have been encouraged by rapid credit expansion, running in double digits between 2005 and 2012. Likewise, NPLs at banks have risen significantly.

The exchange rate

While the official reason for lowering interest rates is to stimulate investment and overall growth, Eric holds that a stronger motive is to shore up the export sector by artificially depreciating the rupee to improve external competitiveness. To him, this is tantamount to currency manipulation, and he adds that “The belief that currency manipulation can spur export driven economic growth is a much devalued idea”.

The rupee will tend to depreciate whenever the BOM purchases foreign currencies in exchange for rupees, when it eases the money supply, or when it cuts interest rates. The BOM has been very active on all three fronts in 2016, especially to counter a strengthening rupee against the pound sterling, post Brexit. The Mauritius exchange rate index showed a depreciation of around 9% in 2015, and appreciated only marginally in 2016.

Eric Ng has consistently opposed what he calls “an insidious policy of devaluation pursued over many decades”, laying down, with compelling arguments, the case against a weaker rupee in view of poor price responsiveness of global demand for our goods, and especially our services.

He has been a rather lonely figure in endorsing the previous BOM policy of a stable rupee, and in standing up to the relentless campaign waged by both business and Government for rupee depreciation. The IMF, too, held that the rupee was only moderately overvalued, and emphasized instead the need for productivity-enhancing structural reforms to boost the economy.

We are all conscious of the urgency of fundamental reforms required to address economic rigidities, raise productivity, especially in the public sector, encourage savings, and enlarge the country’s production base, notably by expanding into foreign markets and accessing new technologies. In the longer run, this is where the real source of competitive advantage lies, not in rupee depreciation.

The general consensus is that exchange rate policy has a role to play in the short term in response to large and unexpected external shocks. But, it must be acknowledged that the BOM’s previous stable rupee policy has, over the years, induced the export sectors, notably tourism, to make the necessary cost structuring and productivity Improvements.

 

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