By Steven Horwitz ~ For The Nassau Institute:
In his column of March 18, Dr. John Rodgers offers a four point plan for helping the Bahamas emerge from the current recession. His plan is a mix of a few good ideas, some not so good ideas, and an overarching but misguided faith in the ability of government to guide the process of recovery and growth.
In particular, Rodgers refers at the start to "the failure of the free market system" as a cause of the current recession. Nothing could be further from the truth, as several of his own arguments illustrate later in his article.
In fact, the path toward economic recovery involves releasing the forces of free market capitalism from the government shackles that have prevented the Bahamas from having the sustained economic growth that Rodgers hopes to achieve. Below, I offer some criticisms of his plan as well as some alternatives that Bahamians might consider as they debate these important issues.
The most important and correct point that Rodgers raises is proposing an end to the exchange controls on the Bahamian economy.
As he notes, the Bahamas is one of the few places in the world that still has such controls and they have a dramatic negative effect on trade, especially internationally.
Exchange controls do indeed increase the cost of raising funds from outside the country, forcing entrepreneurs to pay more, and have to look hard to find, local sources of funding. The Bahamian economy also sits atop a very small base of US dollars that will continue to make more drastic controls necessary if the government cannot reduce its debt and the central bank cannot get better control of the internal money supply.
There is no doubt that ending exchange controls would make for some short run economic pain as devaluation would surely accompany it, but like the addict who must go through withdrawal before returning to true health, that pain would be worth it.
Dollarising the Bahamian economy would be a substantial improvement over the status quo, but over the long run, finding market-driven alternatives to the central bank would be even better at capping government debt and maintaining an appropriate money supply.
Rodgers rightly recommends more competition in the retail banking sector. The Banks and Trust Companies Regulation Act of 2000 places a variety of barriers to entry in the way of new banks opening up, especially ones with foreign ownership or desiring to have foreign subsidiaries.
Allowing offshore banks to compete in the retail market would be a good first step, but true competition also requires that government policies that restrict entrepreneurship, or make it unnecessarily expensive, must be eliminated. Doing so will cultivate a truly competitive and consumer-friendly banking sector.
Introducing antitrust laws, as Rodgers suggests, will not do much when the source of the "oligopoly" in the banking system is government policy. Such laws are more likely to be abused by existing banks who will complain about the competitive tactics used by new entrants. Antitrust laws tend to be just another way for private firms to use government policy to harm their competitors and make consumers worse off in the process. Competition requires only freedom under the law, not antitrust enforcement.
Rodgers' tax plan is the most problematic part of his proposals. He is correct in arguing that moving from import duties to a sales tax would reduce what economists call the "deadweight loss" of taxation. A sales tax would likely cheapen goods in comparison to import duties.
However, if the long run goal is to balance the government's budget, expenditure cuts are indeed needed. Lowering the costs of goods and services by ending import duties would reduce the prices of things government spends on, reducing its total expenditures, but to believe these will stick requires the naïve view that politicians would not quickly find ways to spend on new programs the money thereby saved.
What is needed is fewer programs, not just cheaper goods. The total size of government, regardless of its debt, is the problem to be solved.
Cuts in expenditures should be combined with reductions in the overall size of the revenues that government takes from the economy. Rodgers proposes a "revenue neutral" switch to a sales tax. Even though such a switch might generate those revenues by expanding the economy, even more growth can be obtained by reducing the total tax take of the government, which would free up resources for private entrepreneurs to use to meet consumer demands.
Rodgers' claim that $500 million in savings that would come from a better tax policy encouraging more business in the Bahamas is also misguided. He refers to the "velocity of money" to argue that each dollar will "circulate four or five times" before it becomes an expenditure on imports. This reasoning is fallacious along several lines.
Aside from the fact that what he is talking about here is not "the velocity of money" (that refers to a different concept), this argument, like others in his piece, ignores the benefits of international trade. Notice that the assumption is that it is "bad" when Bahamians spend on imported goods as that causes money to "leak out" of the Bahamian economy. Rodgers makes this argument earlier as well when he bemoans the "unfortunate" fact that the Bahamas is a net importer.
Funds spent on imports need not "disappear" from the Bahamian economy. Ending import duties would make imports cheaper, enabling residents to have money left over to spend on products made locally and other imports. And where importing goods is cheaper than making them domestically, consumers benefit as well.
If consumers were able to freely convert to and from US dollars without exchange controls, the funds spent on imports would flow back to the Bahamas as investments in Bahamian assets. Just as the US current account trade deficit implies that the dollars spent come back to it when foreigners use them to buy US assets, so would Bahamians benefit from duty-free imports combined with the elimination of exchange controls. It would lead to a flow of capital resources into the country, which would help make up for the low domestic savings rate noted by Rodgers.
Small countries like the Bahamas can ill-afford to isolate themselves from the world economy. The notably freer trade caused by ending import duties and exchange controls would make goods cheaper for its citizens and more easily enable non-citizens to invest back in the Bahamas by buying stocks, bonds, buildings, and other assets. The Bahamian dollars spent on imports have to come back as investment in Bahamian capital.
Rather than demonstrating the failures of free markets, the recent problems in the Bahamian economy, a number of which Rodgers correctly notes, are in fact created by restrictions on those very market freedoms. The path forward for the Bahamas is to reduce the cost of goods and services by opening up international trade and freeing the entrepreneurial spirit of its people by lowering taxes and reducing regulations, particularly on the very uncompetitive banking sector.
This would free up the flow of capital to fund new business and reduce the costs of borrowing to the thousands of small entrepreneurs who are the lifeblood of economic growth. Rodgers' plan does not go nearly far enough in these directions.
Steven Horwitz
Charles A. Dana Professor of Economics
Hepburn Hall
St. Lawrence University
Canton, NY 13617
April 09, 2010
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