Economics: We can’t win for losing

Crafting and executing policy responses during deepening recessionary conditions is a very challenging task, partially because the goal post (ie the extent of the recession) is uncertain during such a volatile period.

But if we add to that challenge the absence of monetary policy tools, a cultural shift towards protectionism, and a recent rise in anti development sentiments, the Cayman Islands seems to have worked itself perfectly into a “lose/lose” corner. 

Most governments operate on the principle, or more accurately the aspiration, of a balanced budget and in the case of the Cayman Islands this is required as a matter of law. The instinctive reaction is therefore to respond to an economic recession by either raising taxes/revenues or cutting expenditure, or a combination of both. 

Unfortunately, introducing these policies is never as simple as it may seem. The Cayman Islands government will find now and for the foreseeable future, that virtually all of its expenditure reduction and revenue generating policies will receive criticism.

This will occur because conventional wisdom among economists and the wider public in general suggests that both the raising of taxes and significant cuts to government expenditure are bad for the economy during a recession.

In addition, the unemployed and particularly small businesses will have little patience for taking on any additional burden (be it increased taxes or a reduction in consumers as a result of government expenditure cuts) as part of the recovery strategy. 

In the public debate on the government’s fiscal challenges and the discussions contained within the Miller Commission report, the idea of cutting public sector expenditure is a prominent recommendation. 

And just about everyone agrees that the public sector must restructure itself with urgency so that its expenditures are reduced in order to have a sustainable operating position on an ongoing basis. This can be achieved through privatisation and restructuring. However, this can only be executed as a medium term strategy as time is required to assess the potential areas and secure the necessary partnerships with the private sector.  

However, in the short term, the government cannot immediately make ‘significant’ cuts to either public services or staff in an attempt to help balance the budget. The government is effectively the largest business in the country and by a very wide margin given the size of the Cayman Islands.

Therefore, when the government cuts expenditure there is an immediate and noticeable reduction of spending throughout the economy. When government cuts the number of staff, and on the assumption that government will make the staffing cuts on an objective basis, this will lead to an increase in the number of unemployed Caymanians.

Neither of these scenarios will help the economic recovery process.  

Increasing taxes is something that the government has done to some degree, but this presents an equally challenging situation as this leads to increased cost of doing business and cost of living for those who are already negatively impacted by the recession. So while this helps to address the immediate fiscal issue of balancing the budget it also ends up in the basket of issues in the no win corner. 

On the one hand, the private sector has responded to the crisis by at least making the necessary cuts, which is what should be expected to ensure commercial viability. But it is an oversimplification to argue that the government, which is held politically accountable for both the implications of private sector activity and public sector responses, should do the same on a wide spread basis.  

The developed economies’ way of dealing with this dilemma was the launching of so styled “stimulus packages’ financed largely by borrowing; an option which is unavailable to the Cayman Islands due to the nature of its monetary system, laws and restrictions placed by the Foreign and Commonwealth Office.

In addition we should bear in mind that even in cases where governments have made large expenditure cuts; many of these governments have welfare and unemployment safety nets in place to assist the unemployed, which does not exist in the Cayman Islands. 

So where can we go from here on the issue of cuts and taxes? When you consider the above within the context that the Cayman Islands is already a relatively expensive place to do business (and to live), its lack of reserves, its limited ability to borrow to finance the shortfall or provide a stimulus to the economy, it becomes clear that devising so called harmless fiscal policy is virtually impossible in the Cayman Islands during the current economic recession.  

There is only one practical solution to all this and that is to find ways to grow the economy so that both unemployment and government revenues can be increased organically. But that takes an approach to inward investment that the country does not seem culturally or politically ready to embrace. This may be the only way out of the “lose/lose” corner, and time is ticking. 

GOAP-open

The Government building where many civil servants work.

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