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Jamaica: Navigating through a Troubled Decade

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1989
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The Government, the Fund, and the World Bank coordinate efforts to help bring the economy back onto a path of sustainable growth

It has become increasingly apparent during the 1980s, that for many developing countries, economic stabilization and structural transformation must take place over an extended period of time. In part, this is due to the deep-seated structural rigidities that pervade many economies. But it also takes time for the various economic agents to be convinced that the economic policy changes are not just transitory. This medium-term focus for comprehensive economic reform means that new demands are being placed on all the parties involved—the governments, as well as the World Bank and the Fund. Policy reforms have to be properly sequenced, and adjustment strategies must be sufficiently flexible to respond to changes in the external environment.

Jamaica’s experience over the past nine years illustrates the challenges that a nation faces as it attempts to move along the path of sustained adjustment, supported by Bank and Fund programs (see Table 1). The road has not always been a smooth one—largely due to a prolonged deterioration in the terms of trade—but throughout this period, a variety of lessons were learned by all participants that helped improve policy implementation of both short-term adjustment measures and supply-oriented structural reforms. The much improved economic performance since 1986, and the speed with which the economy recovered from the effects of Hurricane Gilbert, which struck the island in September 1988, suggest that progress has been made toward laying a foundation for Jamaica’s future growth (see Table 2). Continued improvement, however, hinges on perseverance with the adjustment effort, particularly in public finances and trade reform.

The drift into trouble

The 1960s and early 1970s were relatively prosperous periods for Jamaica, with strong growth in real output, led by the main export industries, mining and tourism, and newly established import substitution industries. From 1965–70, real GDP growth exceeded 5 percent per year, on average, supported by domestic financial stability and direct foreign investment—the latter covering in large part the prevailing external current account deficits. For much of the 1970s, however, the overall economic performance deteriorated dramatically, as real GDP fell by an overall 21 percent from 1974 to 1980. To some extent, this reflected adverse international developments, notably, oil price increases and a decline in tourism; but it also reflected the failure to adjust economic policies to external shocks.

The Government that was elected in 1972 wanted to give Jamaica a new post-war economic vision, directed at reducing the economy’s traditional dependence on foreign investment, redistributing income, boosting real wages, and providing employment through an expanded role of the public sector. But over time, this policy led to excessive consumption and inhibited growth in the export sectors. Adequate and timely exchange rate adjustments were not made, and the overall fiscal deficit was permitted to rise to unprecedented levels. Domestic credit to the public sector, in turn, jumped fivefold, with the bulk of the increased spending going to noninvestment activities. In the context of sharply rising domestic prices and negative real interest rates, domestic savings fell and the structure of incentives became increasingly biased toward the production of nontradable goods and services. Higher emigration, particularly of skilled and professional workers, and a massive outflow of capital further aggravated the situation.

Attempts were certainly made by the Government to adjust and correct the country’s changing economic fortunes (see “Conditionality and the use of Fund resources,” by G. Russell Kincaid, Finance & Development, June 1981). However, the measures adopted, while helping in the short term, did not bring about the needed realignment of the economy. Facing a worsening economic performance, the Government increased taxes (raising income taxation to prohibitive levels and burdening the bauxite sector with a production levy); imposed an array of direct controls on imports, prices, and wages; and resorted to stepped-up external borrowing, as well as a depletion of external reserves. But by 1980, the sizable deficits in both the domestic and external accounts had become unsustainable, and it was clear that, given the severity of the financial imbalances and structural distortions, a sustained adjustment effort was the only answer if the basis for satisfactory growth and long-term viability of the balance of payments was to be restored.

The adjustment strategy

In late 1980, the newly elected Government sought to reverse the economic decline by gearing policies to the revitalization of the private sector. At the core of its recovery program was an improvement of the economy- wide incentive system, with a view to diversifying the economic structure while creating adequate scope for private sector activity through a reduction in financial imbalances. The size of the public sector needed to be reduced, financial resources needed to be allocated more efficiently, and savings performance needed to be strengthened. To this end, the Government entered into a series of financial arrangements with the Fund, and three structural adjustment and two sector adjustment operations with the Bank.

Initially, the Government opted for a gradualist strategy, putting in place private sector stimulus through liberalization while seeking to strengthen the public finances. But the pace of recovery was slow, and Jamaica’s adjustment effort was complicated by a collapse of the bauxite/alumina sector. In late 1985, the Government took the rather unusual step of publicly asking the Bank, the Fund, and the US Agency for International Development to evaluate the appropriateness of its adjustment policies. The tripartite review found that structural reform had to be broadened and intensified, while the pace of financial adjustment had to be stepped up. The Government subscribed to the broad thrust of the analysis, although it questioned the timing and pace of reform recommendations. Accordingly, during 1986, the Government, in close collaboration with the Fund and the Bank, prepared a comprehensive reform package for the trade, finance, and public enterprise sectors, defined a policy mix to accelerate financial adjustment, and identified steps to address weaknesses in financial management that had surfaced in the early 1980s. On the basis of this reform agenda, in early 1987, the Government entered into a 15-month stand-by arrangement with the Fund and two sector adjustment loans with the Bank.

At this stage, the retrenching began to pay off, and the Government, at last in a position to take a longer-term view, prepared a medium-term macroeconomic policy frame work. The report, which was presented to donor governments in December 1987, was intended to guide economic policy, stabilize expectations, and provide a basis for donor support. The framework extrapolated the prevailing strategy, anchoring it on a further reduction of financial imbalances, a strengthening of the economic infrastructure, a greater investment in human capital, an improvement in social services, and a safety net for the poorer segments of society.

Table 1.Chronology of IMF arrangements with Jamaica during the 1980s
Date approvedAmount

(In millions)
April 13, 1981Extended Fund facility (3 years)SDR 477.7
April 13, 1981Compensatory financing facilitySDR 37.0
August 25, 1982Compensatory financing facilitySDR 19.4
June 22, 1984Stand-by (1 year)SDR 64.0
June 26, 1984Compensatory financing facilitySDR 72.6
July 17, 1985Stand-by (21 months)SDR 115.0
March 2, 1987Stand-by (15 months)SDR 85.0
March 2, 1987Compensatory financing facilitySDR 40.5
September 18, 1988Stand-by (20 months)SDR 82.0
Chronology of World Bank adjustment operations
in Jamaica during the 1980s
July 3, 1982Structural adjustment loan I$76.2
June 14, 1983Structural adjustment loan II$60.2
November 20, 1984Structural adjustment loan III$55.0
June 17, 1987Trade and finance sector adjustment loan$40.0
June 17, 1987Public enterprise sector adjustment loan$20.0
Table 2Selected macroeconomic indicators
197819801982198419861987Prel.

1988
(Percentage annual change)
Real GDP (market prices)0.5–5.71.2–0.91.95.22.5
Consumer prices (average)35.028.26.527.814.86.78.2
Broad money18.318.023.317.028.016.037.7
(Percent of GDP)
External current account balance–3.3–6.3–12.1–13.1–5.1–3.8–0.6
External debt outstanding55.870.081.8135.8150.2138.0122.9
Overall public sector deficit1–13.7–17.8–15.7–15.1–5.6–5.4–13.3
Gross domestic investment15.015.720.923.018.522.624.0
Memorandum items
Real exchange rate (1980 = 100)96.0100.0110.572.968.566.768.2
Terms of trade (1982 = 100)114.8103.8100.090.484.491.195.2
Tourism visitors (stopover,
thousands)381.8395.3467.8603.4663.6738.8648.9
Bauxite (thousand tons)11,77612,0538,3788,9376,9537,7027,300
Debt service/Exports214.719.332.831.547.849.446.7
Sources: Statistical Institute of Jamaica; Bank of Jamaica; and staff estimates by the World Bank and the Fund.

Fiscal year basis (April/March).

After rescheduling, in percent of export of goods and nonfactor services.

Sources: Statistical Institute of Jamaica; Bank of Jamaica; and staff estimates by the World Bank and the Fund.

Fiscal year basis (April/March).

After rescheduling, in percent of export of goods and nonfactor services.

The policy mix

Throughout the 1980s, an extensive policy dialogue between the Government and the staffs of the Bank and the Fund took place, helping to shape a common view of the objectives and strategies of adjustment. The Fund gave priority to the design of financial policies, while the Bank focused on reforming the trade, financial, and public sector structures. The Fund-supported programs concentrated on a strengthening of Jamaica’s external position through improvements in financial policies. They called for a market- determined flexible exchange rate system, liberalization of the trade and payments system, gradual elimination of price controls, and in later years, guidelines on incomes policy. Furthermore, to contain aggregate demand, the overall public sector deficit was to be substantially reduced and monetary policy tightened.

External reform. Initially, the Government was reluctant to allow for an adjustment in the exchange rate, but by late 1982 a depreciation of the currency became unavoidable as Jamaica had increasing difficulties in obtaining external financing for its widening external current account deficit. Accordingly, in January 1983, the existing parallel exchange market was legalized and moved to the commercial banks, resulting in an immediate devaluation of 55 percent of the Jamaican dollar to J$2.76 per US$1.00. The two-tier exchange rate system (comprising a fixed and a flexible rate) was replaced in November 1983 by a unified rate determined at twice- weekly foreign exchange auctions operated by the central bank.

Beginning in 1981, the Government also gradually liberalized the rigid comprehensive import licensing system, which was backed by some 364 specific quantitative restrictions. The resulting initial widening of the external current account deficit was envisaged to be accommodated by higher official foreign borrowing. By April 1985, the bulk of these restrictions were removed and licensing was abolished for virtually all imports (excepting a number of basic food items, vehicles, and goods restricted for health and security reasons). And in April 1987, the Government embarked upon a comprehensive tariff reform program designed to achieve, over a four- or five-year period, a simple system composed of three to four rates.

Fiscal reforms. The reduction of the overall public sector deficit, including that of public enterprises, was a crucial element of the adjustment program. In 1983, the Government began work on a comprehensive tax reform program, following increases in a number of taxes and efforts to improve tax administration. The ensuing reforms in 1986 and 1987—covering personal income, property, and corporate taxation—relieved the poor of any income tax burden, improved incentives through lowering the former high marginal tax rates, broadened the tax base, and simplified tax administration. The Government has recently developed a value- added tax system that will amalgamate the large array of indirect taxes.

On the expenditure side, improvements in controlling both the size and structure of government outlays were critical for containing aggregate demand and enhancing the public sector’s efficiency. There was substantial labor retrenchment in 1984/85 and 1985/86, and general subsidies were phased out and where necessary replaced with targeted subsidies—exceptions were made for certain basic food items whose subsidies were reintroduced in 1986 to cushion the effect of the sharp depreciation of the Jamaican dollar. Furthermore, the public sector investment program was strengthened, and the financial management system of the central Government reformed. Considerable attention has been directed to the public enterprise sector, which suffered from poor management practices and an inadequate price structure. To remedy this, in 1983/84 and 1984/85, a number of pricing measures were introduced and, based on a series of management audits of enterprises, management and productivity measures were implemented. Under a subsequent reform program, the Government targeted a further reduction of the sector and its deficit via divestment of assets, improvements in financial performance, and elimination of intergovernmental arrears.

Jamaica: Restructuring of Exports

Changing composition of exports of merchandise and nonfactor services

Source: Bank of Jamaica.

Monetary reform. Throughout most of the 1970s and early 1980s, monetary policy in Jamaica had been subordinated to the financing of large and persistent public sector deficits. Monetary management, effected mostly through direct controls, distorted credit allocation and the interest rate structure in favor of the public sector. Controls took the form of changes in cash reserve and liquid asset requirements, overall and selective credit ceilings, and a minimum interest rate for savings deposits. Following a review in late 1985, the Government revised the banking legislation, strengthening the central bank’s financial policy mandate and supervisory functions. Subsequently, monetary management relied more on market-oriented instruments, in particular open market operations with the central bank’s own certificates of deposit.

Sectoral reforms. From the outset, the Government attached particular importance to reducing the distortions and constraints created by controls and regulations. The scope of price controls was substantially reduced, with direct controls remaining for a number of basic food items, agricultural inputs, and medicines. Furthermore, the Government placed a variety of agricultural marketing organizations in private hands, eliminated price controls on agricultural products, and created a number of specialized lending institutions. It also undertook extensive rehabilitation of the transport, power, and water sectors.

Economic results

The reforms clearly were ambitious, and the results, at least in the first half of the decade, disappointing. From 1981 to 1985, overall economic activity stagnated, with real GDP at the end of 1985 only 1 percent higher than at the end of 1980. The recovery program was hampered by an unforeseen decline in bauxite/alumina exports, due mostly to changing world market conditions. When the initial adjustment program was formulated in 1981/82, Jamaica’s exports of bauxite/alumina had stood at about 12 million tons, with gross export earnings of about US$670 million. But by 1985, it was evident that the fall in volume and earnings, to about 6 million tons and US$280 million, respectively, and the concurrent drop in revenue from the bauxite levy from 6 percent of GDP to 2 percent was not a temporary phenomenon.

This contraction inhibited the achievement of the planned improvements in the external accounts and public finances, with the latter also suffering from weakness in expenditure control. Thus, the overall public sector deficit remained above 13 percent of GDP throughout the first five years of the adjustment program, inflationary pressures built up, and foreign debt accumulated rapidly. Even so, there were still some positive signs, as in a less regulated environment, agriculture, manufacturing, and tourism all displayed growth during 1981–85. Tourism receipts grew by 80 percent, and nontraditional exports, by 40 percent.

In many respects, 1985 proved to be the watershed for Jamaica. Thereafter, structural and financial adjustment accelerated and the economy responded to earlier reforms and favorable external developments. As the bauxite/alumina market recovered, oil prices and international interest rates declined, tourism revived, economic growth resumed, and substantial progress was made toward reducing financial imbalances. In the subsequent years, Jamaica enjoyed significant economic growth and the lowest rate of unemployment in over a decade. All sectors of the economy expanded, with particularly strong growth in tourism, nontraditional export manufacture, and recovery in the bauxite/alumina sector (see chart).

A notable achievement was the improvement in net savings performance, stemming largely from the 40 percent real devaluation that occurred in 1984–85, and the increase in real interest rates, which fostered the return of private capital held abroad. Further support came from the improvement in public finances: the overall fiscal deficit declined after 1985/86 to about 5.5 percent of GDP, due to the revenue impact of tax reforms and economic recovery, current expenditure reduction, as well as improved public enterprise operations. As a result, good progress was made in restoring the viability of the country’s external accounts. The current account deficit narrowed from 15 percent of GDP in 1985 to 5.1 percent in 1986, and 3.8 percent in 1987, while the burden of external debt was gradually reduced.

The effects of Hurricane Gilbert in the fall of 1988, therefore, interrupted Jamaica’s progress in its economic adjustment. But the Fund and Bank responded speedily to the crisis by providing additional emergency financing (along with other international donors) and helping the Government adapt the ongoing economic program. This enabled Jamaica to quickly craft a rehabilitation program, restoring much of the damaged economic infrastructure. The previous Government returned to office in February 1989, and shortly thereafter, reconfirmed its commitment to the medium-term adjustment strategy and announced policies to regain the adjustment path.

Lessons learned

The Jamaican adjustment experience has provided Bank and Fund staff with valuable insights into the formulation of stabilization and structural adjustment programs, highlighting the need for close collaboration. As the various programs progressed, the scope and range of coordination between the two institutions evolved and intensified, resulting in, for example, the two 1987 Bank sector adjustment loans, which were both dependent on, and supportive of, policies incorporated in the accompanying Fund stand-by arrangement. The Fund arrangement sought to safeguard competitiveness, thus facilitating the reforms in the trade and tariff regime; similarly, the reduction in the fiscal deficit made reforms in the financial sector easier to achieve. The two adjustment loans also contributed to the achievement of the targets of the program with the Fund. An important part of the projected fiscal improvement in 1987/88 came from larger savings of the public enterprises and divestment, as envisaged under the Public Enterprise sector adjustment loan.

Ultimately, however, the crucial interdependence of the Bank’s and Fund’s adjustment operations came from their collective impact on the restoration of growth. Without export growth, prospects for success in any of the programs would have been dampened. Jamaica is highly import dependent, and thus the achievement of viability in the balance of payments is determined to a large extent by the ability of the economy to generate new exports and control the fiscal deficit. The aggregate set of policies—both macroeconomic and sectoral—were designed to provide room for private sector activity and expand nontraditional exports, with growth thus contributing to the achievement of long-term viability.

Another important lesson was that structural realignment will not prove effective until significant macroeconomic adjustment and stabilization measures have been undertaken. It is crucial to come to grips with fiscal imbalances as soon as possible in an adjustment program and to ensure from the outset that exchange rates are at appropriate levels. The weaknesses in fiscal management—notably delays in revenue measures and shortcomings in expenditure control—in the early stages of Jamaica’s adjustment experience, increased the public sector’s need for resources, thus pre-empting private sector access to the domestic credit that was required to adjust to the. changing incentive structure.

Moreover, reforming the incentive system proved to be an inherently lengthy process. Exhaustive time-consuming studies often had to be conducted before decisions could be taken, let alone implemented; in the case of the system of protection and fiscal incentives, changes in the incentive structure had to take place progressively so as to allow for the redeployment of assets engaged in activities previously encouraged. In addition, the implementation of new incentives was slowed by the delayed macroeconomic adjustment. The tariff system had to be consistent with the macroeconomic policies adopted and therefore could not be fully liberalized until the economy was stabilized.

Still another lesson learned, one that might seem intuitively obvious, was that international lending agencies must have a thorough knowledge of individual country dynamics that encompasses institutional structures, as well as the cultural and political milieu. A clear perception of the rigidities in the various sectors of the economy is essential for realistic assessments of the degree of responsiveness to changing incentives. There are lags in the effects of changes in relative prices that inevitably differ from country to country, a factor that was sometimes underestimated in the early stages of Jamaica’s adjustment experience.

Finally, fiscal austerity measures need to be accompanied by a careful restructuring of expenditure to help avoid cuts in areas that affect the economy’s potential for growth, minimize social disruptions, and soften the impact of adjustment on the neediest groups of society.

But even if all of these elements are on track, Jamaica’s experiences—first with bauxite, and then with Hurricane Gilbert—vividly illustrate the need to be prepared for unexpected setbacks caused by external shocks. Such shocks inevitably require a redesigning of the reform agenda and flexibility in the pace of reform, thus calling for flexibility in the conditionality attached to Fund and Bank lending.

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