October 10, 1996 DRAFT
II. Constraints in the External Sector
III. Constraints That Affect the Competitiveness of Guyana's Exports
IV. Constraints Which Inhibit Capital Formation
V. Constraints That Affect the Efficiency of the Economy
VI. Constraints Which Weaken the Functioning of Government
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The principal constraints to Guyana's development at the most general level are described in Chapter 4, and constraints that come into play at the sectoral level are reviewed in the corresponding Chapters of Volumes III through V of the Strategy. The topic of this Chapter is constraints that hinder the functioning of the economy at the macro level. They include constraints occurring in the external sector, those in the policy realm that affect the competitiveness of the economy, those that inhibit capital formation, and those which limit the Government's ability to carry out its proper role in the economy.
These classes of constraints arise out of a mixture of: a) policies in other countries plus trends in the international economy; the b) historical context of Guyana's economy and its past policies; and c) aspects of the current policy framework that have not yet received sufficient attention. Some external constraints, of necessity, have to be accepted as givens, but all the others fall under the purview of policy. They can be addressed and at least ameliorated by the macroeconomic reforms indicated in Chapters 11 through 15, in conjunction with the sectoral reforms posited in the other sections of the Strategy. It must be borne in mind constantly that the different facets of macroeconomic policy are intimately interrelated, and that solutions in one area cannot be designed without full consideration of the implications in other domains.
Before passing on to a review of the macroeconomic constraints that still are a matter of concern in policy formulation, it is appropriate to observe that for the past several years policy makers have been constrained by an overriding national obligation: the need to reduce inflation rates to acceptable ranges. In this regard and others, Guyana's record of macroeconomic management has been successful. Inflation has been reduced, fiscal deficits have been contained to levels that could be financed internally and externally without difficulty, the banking system has been strengthened, and a comfortable level of foreign exchange reserves has been secured. Nevertheless, this constraint on fiscal and monetary behaviour has produced some undesirable side-effects, such as extensive operations on the bond market to sterilise liquidity, with the result of higher Government indebtedness and less availability of financing for private investments and relatively high real interest rates. Fortunately, the economy shows signs of emerging successfully from this stabilisation phase and in the future policies can give greater emphasis to promoting sustainable economic growth.
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A high level of external indebtedness continues to impede Guyana's economic recovery. The two rounds of debt relief achieved in this decade, through applications of the Naples terms to selected categories of bilateral indebtedness, supplemented by some efforts of multilateral agencies to restructure the terms of their credits, have been most helpful in reducing the outstanding obligations. However, in practice their main effect has been to bring scheduled debt payments into line with the Government's capacity to service them. As pointed out in Chapter 16, those payments still stand at a very high 34 percent of Government revenues, a circumstance that severely squeezes the funding for vital infrastructure, social services, and salaries in the public sector. Guyana will continue to bring this issue to the attention of external donors, but also it should be recognised that continuing growth of the economy will contribute to diminishing the proportionate burden of the debt.
In recent years, Guyana's net inflows of concessional foreign assistance have been generally negative. In the external financial environment, other developing countries compete for the limited amount of concessional external assistance, which in the broadest sense includes debt relief. One criterion for allocating external assistance is past economic performance and management. But because the major donor countries are taking steps to reduce their own budget deficits and reform social programs, the outlook for increased bilateral external flows is uncertain at best. Any acceleration in the flow of external assistance beyond current levels is likely to be gradual and will be based on Guyana's ability to demonstrate continued and measurable progress in making the key structural reforms in the economy that are set out in this Strategy. Therefore, in order to release the external financial constraint, the essential issue is how Guyana can speed its move along the path of adjustment and optimise the impact of its own limited resources. Improved performance at home will lead to greater cooperation from abroad. This is not only true of official development assistance, but also of private capital flows which, for developing countries as a whole, now are of much greater magnitude than official credits.
Another potentially serious constraint in the external sector is posed by the uncertain prospects for continuation of the preferential access enjoyed by sugar and rice to markets in OECD countries. The renewal of the Lomé IV Convention is now in serious doubt, in part because of the policy stances taken by the newest members of the European Union and in part because of the general fiscal situation of the EU. Failure to renew would eliminate the preferential prices received by our rice exporters, most of whom are currently unable to compete at the world market price.
For sugar, it seems likely that the special arrangements (protocols) will continue, but the price received by exporting countries under those arrangements depends on the price set in Europe's Common Agricultural Policy (CAP). European Governments are increasingly concerned about ways to reduce the fiscal cost of the CAP, and that issue will become much sharper as the date of accession of Eastern European countries comes closer. Given the role of agriculture in economies like Poland, if they were to join the EU under the present provision of the CAP, the fiscal cost to all members would be well above a level which could be supported. Hence the most likely prospect for sugar is a reduction in the CAP support price, and hence a reduction in the real price Guyana receives in European markets, a trend which in fact has been underway for some time now. Therefore, a rationalisation of our sugar industry appears to be an indispensable measure, especially in view of the fact that three of the estates lose money even under the present prices of the European quota.
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There can be no doubt that several of Guyana's principal exports are lacking in competitiveness on non-preferential world markets. Summary results of an exhaustive recent study of that issue are presented in Table 10-1. (That study is reviewed more fully in Chapter 12.) In the case of agricultural exports, while impetus has been provided by improvements in drainage and irrigation, the introduction of improved rice varieties and better sugar estate management, there is no doubt that the combination of the policy reforms of the structural adjustment programme and Guyana's access to preferential markets has fueled the growth of recent years. However, owing to the international factors mentioned above, the situation of competitiveness will worsen for rice and sugar unless large increases in the productivity of land and labour used in those crops can be achieved in the next few years. Yet the level of export competitiveness is crucial to maintaining our economy's external balance and sustained growth, so these concerns have national as well as sectoral implications.
Domestic Resource Costs and International Prices for Selected Commodities
(US$ per metric ton)
Commodities World Price European Union Domestic Cost
Rice 320 425 366
Sugar 284 617 410
Pineapples 465 --- 487 Bauxite 133 --- 181
Source: A. Angel, Analysis of the Effects on Guyana's Export Sector of Changes in International Markets, 1996.
Although the expected trends in world market prices in coming years may constitute a major constraint to our ability to continue exporting in the necessary volumes, domestic policies have a great deal to do with the competitiveness of our exports. First of all, any level of import tariffs, no matter how small, weakens the international competitiveness of exporting sectors, because it raises the costs of production. In this regard, the progress of recent years in reducing average tariff level represents a positive trend. Nevertheless, customs levies still exist and the fact that they affect adversely the exporting sectors to a degree should be recognised.
Secondly, exports are made more costly than necessary by the inadequate state of transport infrastructure, including harbours and airfields, and by the currently restrictive policies for commercial aviation. However, these constraints are not macroeconomic in nature and are discussed in Chapter 38 and elsewhere in this Strategy. In the present context, it suffices to note that their solution needs to be accorded the highest national priority.
Thirdly, the difficulties that domestic firms experience in obtaining credit and (sometimes) foreign exchange places them at a disadvantage with respect to their competitors in other countries and points up the need for continuing improvements in the domestic banking system. The very high levels of excess liquidity that the banking system has accumulated (Chapters 14, 15) in the face of urgent needs for working capital on the part of businesses is a clear symptom that the system of financial intermediation still is deficient in some important respects. The recent commencement of a downward trend in real interest rates is a welcome sign but does not fully address the concern. Automatic approval of dollar loans, measures that oblige domestic banks to open up interbank trading in foreign exchange, and other steps to deal with these concerns are described in Chapter 14.
Fourthly, and perhaps most importantly, the appreciation of the real exchange rate experienced since 1992 puts Guyana's exporters at a signal disadvantage in world markets. As discussed in Chapter 12, the success of the East Asian "Tigers" and other rapidly growing economies has been based fundamentally on policies that have not allowed their exchange rates to become overvalued. It is only after two or three decades of extremely rapid export growth, and after per capita incomes in those countries have increased several-fold, that the balance of payments enabled the exchange rate to appreciate slightly without causing significant damage to the economy. Exchange rate policies are a somewhat arcane subject, and sometimes what is convenient in the short run (apparent stability of the exchange rate in spite of domestic inflation) is not convenient in the medium and longer run (because it creates marked disincentives to production and therefore to the creation of employment).
In Guyana's case there are complicating factors. The aforementioned high ratio of debt servicing means that devaluations would put increasing pressure on a fiscal budget that already is in straitened circumstances. Also, the "windfall" gains provided by the access to preferential markets for sugar and rice have provided inflows of foreign exchange in amounts sufficient to sustain the exchange rate at its present level. Chapter 12 discusses ways to manage such factors in ways that permit the emergence of a more competitive exchange rate, including more complete liberalisation of the exchange market. For present purposes, it is important to note that this issue represents a very important constraint on the future evolution of the export sector, and it will become more critical after the year 2000, if real sugar and rice prices for Guyanese exporters decline as expected. Above all, it needs to be borne in mind that our national economic performance will rise or fall with the success of our exports.
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Except for education and training to improve the quality of the labour force, capital formation is the most basic factor in the process of economic development. Therefore it is incumbent on economic policy to avoid approaches that discourage capital formation, whether intentionally or not.
This is an area in which a very substantial advance has been made in recent years, with the moves toward decontrolling and opening the economy and clarifying many basic policies. Nevertheless, there remains a distance to be traveled so it is well to remind ourselves of what the still-existing constraints are in this area. Perhaps the most fundamental constraint is one that is not so easy to quantify but which is pervasive: a sense of confidence on the part of the business community that Government policies are consistent, clear and headed in a productive direction. It is hoped that the development and issuance of this comprehensive Strategy document will, of itself, lay to rest many of those kinds of concerns that persist. Nevertheless, we must recognise that decisive implementation of the key policy measures in the Strategy will be of the utmost importance in engendering such confidence. Without confidence, levels of investment, and therefore production and employment creation, are reduced. Without confidence, capital flight occurs so that the wealth of the country is undermined and eventually, as we have found, skilled human beings take flight also.
Above all, a clear investment code that provides comparable treatment to investors in all sectors should be issued as soon as possible, and the approval process for investments can be further simplified and made transparent. Of equal priority is reduction of the range of variation of the consumption taxes and customs duties, so that differing products and sectors are treated more equitably (Chapter 13). A number of other measures are quite important in this respect, including removing the Government from the field of timber marketing (Chapter 30), making agricultural land leases tradeable and removing regulations that restrict land rents (Chapter 29), and accelerated privatisation of State-owned enterprises (Chapter 36). The latter measure also would open the door to the participation of strategic investors in the recapitalisation of major industries, something that could not be expected from the Government in its present fiscal and foreseeable circumstances.
A reduction in the rate of issuance of Government bonds, as recommended in Chapter 12, would favour private investment as it would lower the "crowding-out" effect in financial markets that such bonds tend to have.
Thus the constraint to greater levels of capital formation can be seen to have the following dimensions: a) the psychological one of confidence, b) a financial one related to the effectiveness of domestic financial intermediaries, c) a fiscal one related to Government behaviour in the financial marketplace, d) a regulatory one in respect of investment and tax codes and investment approval processes, and e) an institutional dimension in terms of land tenure and ownership of productive assets. All these aspects of this constraint are susceptible to improvement through sound policy decisions and policy implementation.
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Countries that are most successful in promoting economic growth are those which establish uniform rules of the game so that industries and sectors with great potential have a fair opportunity to establish themselves and expand, and so that they are not discouraged by economic preferences granted to less efficient firms and sectors. Chile has been an outstanding example of setting a level playing field and allowing winners to emerge on the basis of their own inherent potentials. Those winners have proven to be powerful engines of employment creation and growth.
Although East Asian economic history is sometimes misread, it too provides largely the same lesson. In the 1960s and 1970s, for the most part South Korean policy did not try to select the winners in advance, but rather it offered ex post rewards, in the form of economic incentives, to those firms which proved most successful in exporting. Furthermore, continuance of the rewards from year to year was conditioned on the firm's continuing to excel, reaching ever-greater heights in export performance, and not just resting at the plateau previously achieved. An exception to this approach was found in the Pohang Integrated Iron and Steel Complex, which was built at Presidential initiative and confounded predictions that it would not become viable. The greatest failure of Korean economic policy in the past thirty years was, in the 1980s, an attempt to guide the private sector into heavy chemical industries, through a variety of incentive mechanisms. It failed utterly and had to be retracted.
Similarly, although Japan had some early successes in promoting heavy industrialisation, Japanese policy makers in recent years have admitted the failure of their attempts to decide ex ante the best structure of industrial output. The Japanese economy would have performed better without such interventions, at least in the latter stages of Japan's industrial policy. In Latin America, attempts to guide industrialisation have been uniformly disappointing.
Even without consciously trying to select winners, economic policy often provides a decidedly uneven playing field, conferring considerable advantages to some firms, sectors, or subsectors, to the detriment of the prospects of the others. The pervasive irony is that it is precisely the least efficient firms that often gain the greatest preferences, because their inability to compete forces them to turn to the tactic of asking for favours through the regulatory channel. To respond to such pleas seems a justifiable course of action, because of the fears that shrinking businesses will put people out of work. This is a paradox, for the end result of granting various forms of economic protection to such firms is to eventually concentrate the labour force in industries which have weak growth prospects, and therefore in which the workers have little chance of enhancing their earnings.
This lesson may seem obvious, but the trap is often fallen into. It appears when, for example, tax rates and customs duties are markedly uneven across firms and industries, so that effective protection rates different significantly. It occurs when some categories of production have preferred access to loans from State-owned banks, or differential access to plots of State-owned land for factory sites. It occurs when rates for infrastructure services vary across firms, and in many other ways. Without putting too fine a point on the issue, it is essential to make economic policy as uniform as possible in these respects, in order to ensure that labour, land and capital are continuously allocated to the productive activities which have the strongest economic prospects. Over a period of time as short as a few years, the results can be dramatic in terms of overall economic growth rates, to the benefit of workers, farmers and their families as well as entrepreneurs.
Guyana has progressed well in this area, mainly through a compression of the range of customs duties, but there yet remains room for further achievements, especially in the realms of taxation and customs duties.
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In a number of chapters this Strategy affirms the primacy of the Government in guiding and overseeing the development process, through its many policies and programmes. Government is the repository of trust of the citizenry in the realm of collective decisions, and correspondingly Government has an obligation to return the trust to the populace in the form of wise decisions and a policy framework which decentralises responsibility to the greatest extent possible. The less obtrusive, "enabling" role for Government is usually the more effective one, especially if it is accompanied by great clarity and simplicity of the policy and regulatory framework and an ability to register effects where they are most needed, viz., in providing infrastructure and mounting targeted programmes in benefit of the more disadvantaged groups in the population. Among other things, playing its role well requires a capacity that is sometimes overlooked: a strength in documentation and analysis. Government must be continually monitoring developments in all areas of the economy, extrapolating trends, and devising new, preferably indirect, approaches to problems as they arise. Fulfilling such a role does not require a large labour force in the public sector, but it does require a highly skilled one.
A major constraint to Government's playing its role effectively in this regard is the fact that its staff in general does not have the requisite levels of skills, as has been amply recognised by many commentators. This constraint in turn is related to the very low levels of remuneration that characterise public service, as well as to many factors related to staff recruitment, deployment, training and management (Chapter 13).
The remuneration constraint leads directly to another one: the fact that the Government's revenue base is still unduly narrow. Too many individuals and firms escape the taxman's net altogether, and consequently those who are in it tend to pay more than they ought to over the longer run. This is another area in which considerable advances have been made recently, but it is essential to push ahead further. In recognition of the key nature of this constraint, Chapter 13 and some of the sectoral chapters make well-founded recommendations for widening the tax base and reaping additional Government revenues through other channels as well.
Profound reforms in Public Service and budgeting procedures (Chapter 13) also are vital to bringing about a more effective performance on the part of Government. These measures, in addition to those related to revenue collection, could lead to vastly strengthened Government. In contrast, retention of the ownership of means of production weakens Government and saps its credibility, for it puts Government into areas where it does not have the institutional modalities required for effective performance. It also obviates opportunities for the private sector to utilise those same assets with more beneficial results in terms of creating employment and generating foreign exchange and income, including revenues for the Government. In this respect it can be seen that the fundamental conception of the role of Government can be a major constraint on the performance of the economy. A role that concentrates on guidance through policies offers the best chance of improving the economy's growth prospects.
Finally, it bears repeating that the high level of indebtedness that the Government has been saddled with has severely limited its scope for action and has aggravated the other problems mentioned above. The solution undoubtedly consists of a combination of three approaches: continued lobbying in international fora for additional debt relief, in light of the exceptional debt burden of Guyana; encouragement of debt swaps and promulgation of other debt-reduction policies as discussed in Chapter 14; and achieving a diminution of the relative magnitude of the problem through rapid economic growth, without incurring in a proportionate new increase in indebtedness.