Thursday, June 08, 2006

The Fallacy of the Triple External Shocks Argument

In science one tries to tell people, in such a way as to be understood by everyone, something that no one ever knew before. But in poetry, it’s the exact opposite.
Paul Dirac

Because most stars are so far away, their light has yet to reach Earth.
Edgar Allan Poe solving Olber’s Paradox in a poem

I don’t know about you but me, I have had an overdose of the so-called Triple External Shocks argument brought forward and used ad nauseam by Rama Sithanen for many months now to paint a very dark picture of our economy. The main problem with this argument is that it stands on shaky grounds at best. Let me tell you why.

1st shock: Price of sugar to fall by 5% this year and up to 36% within a few years
We knew that this was coming for a long time so that there is no element of surprise or shock here. We have been growing sugar for 300 years now and it’s been the commodity that has financed the development of other pillars of our economy – under that famous protocol – which incidentally have now dwarfed the sugar sector itself. Paradoxically, Le Grand Argentier has perhaps failed to realise that by recently announcing that the seafood hub would double in size in a few years’ time it will be yet another sector to dwarf King Sugar.
The share of sugar in the economy will inexorably keep on shrinking from its current 5%. This looks like a textbook example of the Product Life Cycle at work – you can only produce something for a given amount of time before you are outgunned by entrants with a lower cost structure than yours. Yes, the economics of the cane industry looks better than that of the sugar industry but we need to look even beyond. And this year’s price cut of 5% shouldn’t have taken so much of our Finance Minister’s saliva. The €URO has also been surging ahead this year, hasn’t it? Naturally, we should see it to it that we are treated fairly by the European Union.

2nd shock: Multi-Fibre Agreement has been dismantled (MFA)
That did not happen overnight either. We’ve known that this was going to hit us for ages. The sector has been contracting over the past few years mostly because the entrepreneurs that came to Mauritius 20 to 30 years ago because of the uncertainty of the handing over of Hong Kong to China that was to happen in 1997 and of the facilities that we offered at that time were now leaving Mauritius in droves to go set shop in China for reasons known to all.

The textile companies that have been gearing up for years in anticipation for the end of the MFA are still standing as are those that manufacture a product that is sufficiently competitive. Our textile industry has simply gone through a consolidation phase, albeit a major one. Our textile industry will probably start to grow again soon.

And the good news is that, probably for the first time too, major textile companies are openly talking of the need to move up market (from a mix of 98%/2% of low-end/value-added products to a 50%/50% mix) because we are simply not competitive in the low-end market unless of course we operate on a gigantic scale and in a vertically-integrated fashion as CMT and resort to cheap foreign labour.

By the way, it is important to note that substantial investments in the textile industry and elsewhere may have little direct effect on reducing unemployment if these additions to capital are geared towards creating low-paying jobs that will be attractive only to foreign workers that can’t find anything better at home.

3rd shock: Oil prices reach record levels
It’s true that oil prices have been increasing significantly over the past couple of years. But a correct reading of the situation should have prevented anyone from sounding overwhelmingly panicky for six months now. In fact growth forecasts for a number of economies (US, UK and the World Economy) have recently been revised upwards.

This is so because the current increase in the global price of oil is quite different from those experienced in the 1970s (1973 and 1979). Indeed, the current increase is mostly demand driven and has been more gradual. Our economy is also less exposed to oil because we have a large and growing service sector and the efficiency in its use has increased.

Besides, the percentage of the household budget spent on oil has probably fallen compared to previous episodes of rising prices just like in many countries. The impact of rising oil prices also depend on the amount of slack that we have in the economy: with 10% unemployment, I don’t think that our economy is overheating.
Interestingly enough, the increase in the price of oil will bring additional funds to the government coffers through higher VAT receipts which will help toward putting the fiscal house in order. Now, this should have Mr. Sithanen smiling.

Of course, that doesn’t mean further increases in the oil prices cannot or will not create havoc in our economy. We definitely need to have a rock-solid National Energy Policy. But it was definitely premature to cry wolf for many months already.

Economics is one term richer…
This explains why there is no doubt in the mind of an increasing number of right-thinking Mauritians, across all walks of life, that Rama Sithanen has unwittingly created his own brand of economic management which can suitably be christened Faratanomics.

This line of thinking doesn’t have any strands of single-loop learning weaved into it as no targets are set. Implementation is considered a terrible waste of time while actually wasting time is not (like attending an irrelevant presentation by LSE’s Nicholas Barr). Also, a significant premium is placed on imagining additional problems rather than solving existing ones. And it is an absolute no-no to remind the population that the national debt is increasing by several hundred millions of rupees each month or that way too many Mauritians are out of a job.

But a Titan poorer
Indeed John Kenneth Galbraith recently passed away at the age of 97 but not without leaving behind great classics such as The Affluent Society and The Great Crash and having appropriately labelled the worst beast of all: conventional wisdom.

Faratanomics in action
As an upper middle-income country with GDP per capita of about USD 4,500 you don’t need to be an economist with 25 or more years of experience to know that we obviously don’t qualify for soft loans from institutions like the World Bank (WB). Rama Sithanen begged to differ on this issue.

Indeed, he thought he would be able to get the WB to bend its rule much more than just a little so that we get these highly concessional financing that are reserved for poor countries. That probably let him to blurt out, not so secretively, to IMF’s James Bond that Mauritius was ready to go the route of “jointly-determined recommendations” with the Bretton Woods institution.[1]

He then wasted little time to put his foot in his mouth to explain to the Financial Times and therefore to the whole world (I suppose that includes the analysts at Moody’s who have recently downgraded our local currency rating) that as a good student, Mauritius was being penalised as we wouldn’t qualify for soft loans anymore.

And that particular adventure in Faratanomics came to a deafening end 5 weeks later with the WB’s Michael Klein giving a crash course in economic management to our Finance Minister and debunking another one of his fallacies at the same time: There is no such thing as one being the victim of one’s own success; if you want to play in a higher league, you’ve got to manage better; and, pal, have you ever heard of Capital Markets?[2]

Are you ready for the …World Cup?
I guess you are, but what about the Budget? I hope Mr. Sithanen is inspired by Gordon Brown’s 2005 budget speech content which lasted 45 minutes. Besides the length of the speech, it will be interesting to see how much has been saved with the MTEF framework over the past two years and how its application under the new Finance Minister is different. Don’t be surprise to see a small primary budgetary surplus and a small reduction in the debt/GDP ratio with a budgetary deficit under 4% of GDP by June 2007 when all the beans would have been counted. For anything smart and inspirational, wait for an extra 4 days when the Sele├žao plays Croatia in Berlin.

[1] It is interesting to note that the IMF has set up a star-studded panel to advise it on how to put its finances on a sounder footing.
[2] This is something that I’ve impressed upon Rama Sithanen in person some 9 months ago and persistently via my writings since then.
No. 5 June 2006
© Sanjay Jagatsingh, 2006


christina said...

That's a very good analysis of our local political rhetorics.
Faratanomics indeed!!!

Sanjay Jagatsingh said...

A good day to remember that spontaneity arrives on the fourth day as JKG turns 108.

Sanjay Jagatsingh said...

Menter, menter