Why can’t Mauritius seem to Ever Grow above 3.8% anymore?
Economists are often criticized for being overly prescriptive when it comes to economic policy making. Economics is indeed more complicated than most economists think. Relationships between variables are non linear and expectations and sentiment have their own difficult to measure dynamics at play. In the case of a highly politicized Mauritian landscape, higher frequency data is also hard to come by. There is in fact a tendency in policy making circles to show great disdain for those who attempt to look at the available data to explain complex problems. This is because many economists and policy makers also often wear political hats which adds more confusion and bias to the mix. The right approach for an economist to take then is to clearly explain the logic of his arguments. The wrong identification of the problem can more often than not, lead to the wrong antidote.
The potential rate of growth of an economy is the maximum sustainable level of output than an economy can sustain given its current resources. When the realized level of growth of the economy is above capacity, the result is invariably inflation as producers of goods and services adjust prices. In this case, this is known as a positive output gap and typically the central bank responds to higher inflationary pressures by increasing interest rates while Governments can also reduce liquidity in the system by raising taxes or cutting spending. When an economy generates growth that is below potential growth, the output gap is said to be negative. In this scenario, domestic inflationary pressures are typically low, the central bank typically responds by cutting interest rates while the Government typically engages in demand side measures such as income tax cuts, negative income taxes, pension increases, minimum wage increases etc. Essentially, the idea is to stimulate demand by injecting more liquidity into the system. While this sounds simple, potential output is actually not observable and is ever changing.
Producers of goods and services can over time invest and increase or decrease production capacity. Potential output is typically estimated by using statistical techniques and by estimating a production function for the economy. A good rule of thumb to know how close an economy is to its current capacity is and by looking at whether inflationary pressures are rising or falling. When an economy has a wide and negative output gap, demand side measures as highlighted above, make some sense especially when directed to the poor and the lower middle class, because they tend to consume most of what they earn relative to the rich. This is essentially what the current Government has been doing and given the current global and local economic slowdown, further talk of pension increases and the recent interest rate cuts by the Bank of Mauritius should be viewed in this light. The challenge in Mauritius of course is that the country imports a large share of what it consumes and the rising import bill drags overall growth down thereby partly countering gains made by boosting consumption. In the chart below, I use an average of two statistical approaches known as HP and Kalman filters to estimate potential output growth over more than two decades and spanning at least 4 different political regimes after adjusting for seasonality in calculating potential growth and compare this to actual GDP growth, in order to estimate the output gap.
Admittedly, the lack of forward looking business survey data can lead to modest measurement error but the results are similar to those of the likes of the International Monetary Fund, i.e they also find that the difference between actual growth and potential growth in Mauritius very low and more worryingly, that potential growth has been slowly but surely declining during the period from close to 5% during the early 2000's to around 4% today. The reason why our ability to grow has been steadily declining is more structural or supply side driven. The decline has a lot to do with weaker growth in capital formation (productive investments made in the economy and the lack of the emergence of new sectors for quite some time), weakening labour force demographics and skills mismatches and our abysmal record when it comes to productivity growth. While all four political configurations which have governed Mauritius since the early 2000's have spoken about structural reforms, none have been able to arrest the decline in our potential growth rate so far. This is likely because structural reforms are a tough pill to swallow and only deliver results over time when politicians need results in the now. With the population greying and important structural reforms hitting the brick wall of Mauritian politics and the political system which defines it, the trend is unlikely to be reversed. Demand side measures can only take actual growth closer to potential but if the potential is declining, policy makers have and are essentially chasing a decreasing target. If the gap is low, there is also little gains which can come out of further demand side economics.
Given the fact that we import so much of what we consume, there has been no large scale response from the private sector to increase investment to augment capacity like in the United States or India in order to meet rising demand. They simply click on the import order button and a Chinese exporter benefits! The cost in terms of additional public debt on future generations has also increased with little in terms of growth pickup to show for all these demand side measures as well intentioned and pro poor as they might be. Sure, the Government has invested in the Metro Express and infrastructure but the private sector has remained timid if one includes or excludes real estate related activities. In any event such measures will take time and are unlikely to offset the large structural challenges which continue to torment the economy. In any event the economy has not seen any reversal in growing above 4% for almost a decade now. In response to rising debt levels, Government policy makers have argued that the bulk of Mauritian debt is local and still sustainable. This is partly true. The state is not like a household. Mauritius has a monopoly on the Rupee and will simply never default on Rupee debt. Inflation which is typically the bigger concern with unsustainable local currency debt has remained tepid. But if debt funded demand side policies lead to a continued rise in imports and a further deterioration in the terms of trade (financed by foreign villa sales, income from the offshore sector and tourism receipts all facing stagnation or declines) then such policies could if sustained lead to significant downside risks to the Mauritian economy and to the value of the Rupee which has continued to decline. Capital flows are invariably volatile and cyclical. And the global economy is currently slowing.
So what are some of these structural reforms and supply side measures that both the Government and the public do not like to hear much about and how do we fund it all? Any demand side measures aimed at closing the small output gap such as further sustainable pension increases should first be financed by taxation on those who are more well off. With more than 12 months of import coverage worth of international reserves, it is high time for Mauritius to seed the creation of a professionally managed and apolitical sovereign wealth fund which would aim to generate higher returns and pay dividends to the state and central bank in order to help complement tax revenues and avoid over taxation to fund demand side measures. Rather than engaging in ill-advised central bank special reserve fund transfers which are akin to printing money, the Government should issue a special perpetual bond to the central bank at a rate that is higher than the cost of conducting monetary policy but lower than market rates for long-term bonds thereby improving the balance sheet of the central bank. This will not be accounted as debt in the traditional sense although there will be a cost at the state level as Governments and central banks belong to the same country and part of the proceeds spread over five years can be used to fund massive job guaranty schemes and youth re-skilling programs. Additional funds from this special perp issuance along with continued traditional Government debt issuance can be used to seed the creation of a new venture cap, private equity, private flexible credit and start up ecosystem in Mauritius all managed within an apolitical setup to truly respond to a key challenge faced by start-ups, medium sized and large enterprises alike, the lack of adequate equity, flexible financing and mentorship. The Competition Commission must be strengthened and made to fend off oligopolistic tendencies of some private players while government contracts (and those of public companies) need to be awarded to smaller private players in a transparent and fair manner.
We must focus on providing the right kind of capital to viable firms which can scale up especially exporters. Like in all more developed emerging and developed economies, local pension funds such as the National Pension Fund too need to consider local private equity and infrastructure as an asset class. More money needs to be spent in improving the quality of local public universities and the quantum of funds to research and development must be massively increased. Mauritius must be more open to immigration and target young entrepreneurs looking to set-up shop and have a concrete strategy to grow the population over the longer-term. Last but not least, Mauritius must reform the way public companies and institutions are managed with a much greater dose of meritocracy than is currently the case. A lot of this can only happen with a reform of the current political system which holds the nation back.
Source: GDP Data from World Bank and Author Estimates.
By Sameer Sharma
from Credit Business Decisions
at New Jersey