Structural Adjustment: Belling the Foreign Exchange Cat(-astrophe) Part 3

Part 3: Structural Adjustment for Dummies!

Structural adjustment, simply stated, is the initiation and management of changes in the structure of an economy, that is, changes in the kinds of economic activities undertaken by a society. For example, Barbados has been heavily dependent on tourism; in previous times it was sugar. Although the country has other economic activities such as retailing and some manufacturing, the economy still depends heavily on one economic activity viz. tourism.  To bring about structural change, the country has to change its mix of economic activities.  But those changes, it is argued here, should be focused not so much on growth, but on foreign exchange management.

Foreign exchange is proposed as the strategic policy objective because of the difficulties inherent in measuring and using growth as an economic policy objective as well as our heavy dependence on it (foreign exchange) now and in the foreseeable future. Steering clear of mainstream economic jargon, I use the following illustration to explain how this might be done and the implications that arise from it.

Let us suppose, for simplicity’s sake, that we have a hypothetical economy with two economic activities only: car dealerships and the manufacture of indigenous condiments like pepper sauce etc.  Together they employ 5000 workers: two thousand in car dealerships and three thousand in condiments.

The car dealerships are heavy users of foreign exchange: both to import cars as well as car parts.  For simplicity, let us suppose that the car dealers use about 90% of the foreign exchange.  Even though it is postulated here that the condiments industry is indigenous, let us assume that it uses about 5% of foreign exchange and that the other 5% is used by private individuals, government etc.  Now let us suppose that 10% of the output of the condiments business is currently exported. However little that is, it brings in much needed foreign exchange.

Now, suppose that the government of this hypothetical Caribbean state really wanted to change the structure of the economy. Since the decision problem revolves around the criterion of foreign exchange management, the government must clearly reduce the foreign exchange being used by the car dealers and at the same time increase the foreign exchange being earned by the condiments industry.  A two-pronged approach is needed.

To implement this change, the government of our hypothetical state must first enact policies that reduce the import of vehicles; when this occurs there will be some layoffs in the car dealerships business; say 1000 were laid off.  Some of these will be genuine layoffs, that is, those needed to adjust to the reduction in car sales/imports; some may be opportunistic!   Second, government must help manage the structural adjustment process so that those one thousand workers are transitioned into the condiments industry.  To achieve this, two actions will have to be taken.

In the first place, the condiments industry will have to increase FOREIGN demand for their products.  Seeking to increase LOCAL demand or penetrate existing domestic markets is an alternative competitive marketing strategy that the condiments producers can employ. However, while that strategy may benefit some or all of the companies in the condiments industry, it does not benefit the economy as a whole as it relates to the earning of foreign exchange.  Government needs to create appropriate policies that would motivate the condiments industry to engage in foreign market development.

Next, the workers displaced from the car industry will have to be retrained for rehiring in the condiments industry to allow it to meet the increased foreign demand for its products.  (In our hypothetical economy we assume that there is some measure of social support that helps the displaced workers bridge the period of transition between the two industries – or sectors, if you like – of the economy).

Incidentally, the one thousand displaced workers could also to be retrained to engage in other economic activities that have a net foreign exchange earning impact. However, retraining aimed at getting the displaced workers into activities (such as certain types of retailing) that only consume foreign exchange may benefit the individual but, again, not the country as a whole.

As stated earlier, this analysis has been deliberately simplified; it is obvious that the real economy has many different activities and that they are often related in complicated ways. For example, I have not taken into consideration economic activities such as inward foreign investment that would serve to augment the foreign reserves. The key, however, is that in strategizing for structural change, economic activities have to be divided into those activities that use foreign exchange and those that earn foreign exchange.

I don’t know that there are any absolutely foreign-exchange-neutral activities, therefore, it may even be necessary to further subdivide economic activities on the basis of whether they earn or consume foreign exchange directly or indirectly. Irrespective of the approach taken, foreign-exchange consuming activities will have to be reduced and at the same time foreign-exchange earning activities will have to be increased. That is the basic principle that must be applied to bring about structural change in countries like Barbados.

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