Finance ministries are responsible for the custody and management of public money. The annual budget statement ierefore both a communication device and a key tool in fiscal and economic policy management. The public and business need to understand the budget’s objectives and the economic model on which it is based. In T&T, the budget has additional significance as the basic economic data is often either unavailable or the data is out of date. In advanced economies, the model’s assumptions are published for public scrutiny and independent assessment. Unfortunately, in T&T, those with a professional interest are often reduced to the status of “uninformed commentators.”
It is important to understand T&T’s economic model to ensure that suitable policies are adopted, leading to sustainable outcomes. The temptation to use construction projects or similar “game changers” is ever-present, as they have an immediate short-term impact on employment and economic activity but ignore long-term sustainability. Such projects, whilst they may alleviate an existing need (office space, housing), may cause additional recurrent expenditure without addressing revenue generation.
Professor Dudley Seers, writing in the Social and Economic Studies (Vol 13, No 2 June 1964), outlined a model based on Venezuela’s experience which he called “The Mechanism of an Open Petroleum Economy”. Whilst T&T is now a gas economy, the model is relevant to our circumstances. The current economic decline has been caused by low energy commodity prices, reinforcing the idea that the country is over-reliant on the energy sector.
In September 2018, two Central Bank researchers (Stefan Edwards and Timothy Woolford) examined this theme in a working paper entitled “The Economic Impact of Energy Price Shocks on a Small Open Petroleum Economy.” The researchers developed a statistical model based on autoregression techniques, using an energy price index derived from the WTI oil price and Henry Hub natural gas price to measure its impact on the rest of the macroeconomy.
The analysis concluded that the T&T economy benefitted from high energy prices, but the benefits disappeared when energy prices were constrained. Fiscal, financial and real sector conditions all deteriorated if energy prices did not exceed one standard deviation of its 12-period moving average. Given low energy price conditions, “governments of small, open, petroleum price-taking economies will likely try to immediately stimulate economic activity through fiscal and monetary policy.” The writers noted that “…this approach can often be costly, resulting in accumulated rapid, long term deterioration in fiscal conditions and depletion of official reserves through defending a currency peg.”
Unfortunately, this is the strategy government has followed. This strategy is not sustainable.
The reality is that the annual budget has been in persistent primary deficit and the economy has declined for five years. The cycle is unbroken and the available options are decreasing. Taxation is based on the national income.
When national income declines, taxation automatically declines. The Finance Minister’s alternatives are to dip into the Heritage and Stabilisation Fund (HSF), sell assets, cut expenditure, or increase taxes. Perhaps a combination of all. The country understands and accepts, that COVID-19 has created conditions which require the maximum withdrawal permissible from the HSF.
The revenue alternatives are raising Vat from 12.5% to 15% and/or unifying the income tax rate at 30%. Cutting expenditure will be a tough proposition.
Since all income is ultimately generated by the private sector and foreign reserves are under pressure, measures geared toward increasing exports or displacing imports are required. There will be the temptation to use infrastructure projects to jumpstart the economy. This is not always useful.
There are four criteria by which any incentive or project announced should be evaluated. First, is the measure viable? The project/incentive must have a strong economic rationale and lead to tangible long benefits and build a competitive advantage. Projects must be selected on reliable data and robust financial models.
Second, the measure should be effective. Ease of doing business initiatives for example should demonstrate that the removal of bottlenecks should lead to improved labour and industrial productivity.
Third, they should promote and improve efficiency. A key issue which bedevils all projects is the slow pace of governmental approvals. Indeed, even government projects are often “completed” without the necessary permissions. In large energy-type projects, obtaining all the necessary approvals can take years, not months. Finally, any measure proposed should have network or spinoff effects. It should have collateral benefits.
The climate for increasing foreign direct investment inflows is not propitious. Therefore, government must look beyond its criticism of the private sector and enroll it as a business partner.