July 2017


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The eminent economist, Schumpeter, said that an economy develops based on creative destruction as entrepreneurs exploit market opportunities through technical innovations that simultaneously destroy old industries and approaches. This disequilibrium and change brought about by the innovative entrepreneur are the norm in a healthy economy, a sustainable economy. If, then it is concluded that our private sector, our entrepreneurs are weak in innovation or are non-innovative then it equates to saying that our economy is unhealthy, unsustainable.

The Evidence

A recent report by the IDB, “Are oil and gas smothering the private sector in T&T,” took a look at the constraints that appear to beset the development of the on-shore economy of the country. One of the first topics addressed was whether T&T suffers from Dutch Disease. The conclusion was that T&T shows the presence of this disease in an overvalued exchange rate, a falling share of the non-booming tradable sector (manufacturing and export agriculture) and increasing unemployment share of the service sector (non-tradables). The report uses the Real Effective Exchange Rate (REER) and its own adjusted measure, the AREER1, to demonstrate these effects of the disease. For this presentation it is sufficient to indicate two symptoms that indicate overvaluation of the currency; one, the association with the Purchasing Power Parity (PPP), and the inability to meet the demand for imports by the foreign exchange income earned by its exports.

Given the economy of T&T where the major earner of foreign exchange is the energy sector, during a bust it is the norm to expect that the reduced foreign exchange income would be unable to match the demand for imports as during the boom, unless some counter cyclical spending had occurred during the boom. The PPP is of less significance seeing that T&T is a small open economy that imports almost everything it requires. Hence the difference in prices will be the result of transport and distribution costs (markup). The latter could be exorbitant seeing that many people are tending to on-line shopping, given also the low productivity of the on-shore delivery process. Some economists say that the so-called overvaluation of the currency is not the core problem, but possibly an indication of this low productivity.

The problem then is not the overvaluation but what should be done about it. For example, what is the optimum value of the exchange rate that would in T&T’s case bring demand for foreign exchange into synch with the supply? Since the demand for foreign exchange can be reduced by both a devaluation and fiscal means, the optimum decision has to be what mix of these controls can bring about the demand/supply equilibrium. This suggests that there is no unique exchange rate that can fix a so-called overvalued currency since, for example, at the current exchange rate the balance may be achieved by fiscal means alone.

The IDB’s investigation of the on-shore sector turned up the following:

• The on-shore sector’ growth has declined significantly since the global financial crisis.
• Private investment points to declining labour productivity; note this impact on the REER.
• Human capital, access to finance, institutional weaknesses, infrastructure and an overvalued exchange rate are among the main factors contributing to the low levels of investment and low growth; note the impact of low investment on innovation.
• Firm characteristics are mostly unfavourable for increasing sales and total factor productivity, both of which are important if the private sector is to be the driver of diversification, sustainable growth which today depends on innovation.
• The evidence shows that most firms are either stagnant or declining. Many are old firms and family-owned or influenced.

Insufficient investment, low access to financing and human capital by local firms are synonymous with lack of innovation in the private sector, forcing the firms into decay.

The IDB report also addressed the perception of the firms themselves as to the problems of doing business on-shore in T&T. This report was augmented by the results of the 2014 Productivity, Technology and Innovation (PROTEqIN) Survey2. The latter says that the most serious obstacles as seen by the firms were an inadequately educated workforce; access to finance; crime; macroeconomic environment; customs and trade regulations; corruption; cost of finance; tax rates; electricity and telecommunication inadequacies. According to the IDB, these complaints were very similar to those elicited by the World Bank in its 2010 survey.

One may find it hard to understand why the firms find it difficult to find adequately educated people, given the current education system in T&T. Moreso, the IDB’s information shows that some 79% of the graduate workforce emigrated and are usefully employed abroad. Possibly there is a mismatch between the education system’s output (though other economies find use for them) and what the local firms require. When asked why current graduates are not trained by local firms, the reply was that this is an added cost and even so, after training they may leave the firm. Again, these are the people in these firms who would be expected to drive innovation, the source of sustainable development.

The other input which would restrict growth and innovation in firms is financing. The IDB report quotes the ROSE-C3 review which demonstrated that compared with the rest of small economies of the world, the ratio of domestic credit to GDP is lower than the benchmark for this group of countries. Access to finance is a constraint for most firms. This applies to firms operating in the retail/distribution sector and small startups that are budding innovators. There is little credit, no venture capital or major grant funding, though ExportTT is attempting to help small firms with small grants.

In small, open economies, economic survival depends intimately on the ability to export and today being competitive is a function of the innovation of the firm. In the economy of T&T, outside of the energy sector, not many firms are exporters. The IDB report suggests that large, young and foreign-owned firms in the manufacturing sector are more likely to be exporters. But only a small share of on-shore T&T firms, 14%, reported that a percentage of their sales come from direct exports.

R&D expenditure in T&T is low. T&T spends some 0.04% of its GDP on R&D, the major source of innovation, while the average for ROSE-C countries is 1.2%. Firms claim that they spend some 0.95% of sales on R&D, innovation. But this is focused on non-technological innovation (organizational and marketing). Though public sector support is provided to exporters the evidence suggests that most firms do not benefit and have a great difficulty in achieving export promotion targets. Further innovation expenditure is low and this weighs negatively on the firm’s productivity and export performance.

An Analysis

The foregoing suggests that the economy is defined by a set of variables that say how the economy is behaving, a set of inputs or controls on the economy which drives the state variables, economic behaviour, depending on the dynamics or model of the economy, the outputs of the economy which are functions of the state variables and finally, on disturbances or exogenous inputs, over which the local economy has no control.

The IDB report discusses qualitatively the impact of some of the characteristics of the on-shore model of the economy, of some inputs on economic behaviour, the state variables. The performance of the off-shore, the foreign exchange earned, is seen as an exogenous input which has a direct impact of the Dutch Disease.

An ECLAC system analysis attempts to quantitatively define such an economic system by mathematically relating the system dynamics to the state variables, the inputs, and hence the impact on the economic outputs. The coefficients of the equations can be estimated by regression analysis of the recorded past performance of the economy in question. This approach was used by St Cyr et al to develop such a quantitative model for the T&T economy. Some of the state variables used in the analysis included; GDP, aggregate supply capacity, public sector debt, foreign debt, money supply, national reserves. The inputs included private and public investments, foreign exchange income, private sector bank credit, current savings and internal Central Bank credit. The system disturbances included price of export commodities and natural resource production.

It was intended to use this model to force the economy to a certain state, to behave a certain way, even drive innovation, by choosing the inputs in specified ways. The problem with this is twofold. First any meaningful results would have to be for a very short term since the model cannot account for any changes in its dynamics; e.g. Schumpeter-like changes and the current dynamics of the model represent all that has already been discussed, e.g. lack of a qualified workforce and financing, no R&D, the preponderance of non-tradable firms as opposed to those that export and the incorrect assumption that any set of state variables is reachable using the defined inputs.

Hence this regression model tells us nothing about how we change the on-shore economic system to respond to say, a drastic change in our natural resources or moreso the identifiable changes or unpredictable ones in the global economy.

The Reconstruction

The evidence and the analysis showed that the current economic model, its dynamics, is/are not adaptive: little R&D, a lack of higher risk finance are both indicators of this. It is of interest to investigate what could have caused such an economy to develop and how indeed can we craft a model that can adapt to the fundamental changes in the local and global environments?

Prof John Foster of Queen’s University, Australia, took a more general look at economic systems and saw them as complex adaptive systems. It is complex in that they are not monolithic, but collections of many, many semi-autonomous systems that interact with each other without some overall control. For example each and every one of us is part of an economic system, all with a certain independence of economic choice and activity, but still interacting with each other’s economic sub systems. They are adaptive in that they can change their behaviour in response to changes – slow or discontinuous – in the economic environment in which they operate. However, the fundamental point that Prof Foster makes is that this ability to adapt, to respond to change, can atrophy, be destroyed, given the history of the economy of the players.

In other words, if the history of the dynamics of the economic system has not required the system to change for a long time, then the ability to adapt to change in this economic environment can be impaired. The model of our present on-shore system, its dynamics, reflect the complete history of the island in that certain commodities are produced for the export market and the foreign exchange income is used to import virtually everything that is needed to survive. Many authors have discussed this model, the plantation economy, so much so that this is the economy that has produced the societies of the Caribbean islands. What this model says is that the on-shore economy does not need and has never needed technological innovation to globally compete since it is merely in general about import-markup-sell locally. Even the IDB report shows that existing firms are stagnant or declining and the evidence points to declining labour productivity. Further, the report says, that though we need to look to the private sector to become globally competitive in exports, the existing companies will be unable to match up to the task, to adapt to the changing local and global market circumstances.

The commodity sector has changed over the years from agriculture to oil and now to natural gas. Another change is that the commodity sector initially needed the lion’s share of the available labour, today it only employs some 4% of the workforce. One result of this is the need to provide on-shore jobs with the demand for enhanced social services – make-work provided by government resources.

The incapacity in our economic environment, and one that has been expected for years, is the inability of the energy sector to provide in the long term the foreign exchange to satisfy the demands of the on-shore. In the past the boom-bust nature of the global market for commodities shaped the economic on-shore activities, since the few busts were followed by a boom, which seems to be expected again. However, the depletion of the natural resources and the long-term outlook for low petroleum prices suggest that the off-shore will be increasingly unable to deliver the required foreign exchange. The fundamental failure of the current on-shore economy is that it has traditionally little use for innovation and hence the need to produce globally competitive exports.

T&T’s economic system has to have this dual adaptive ability – distributed and quickly responsive through semi-independent agents, and the ability to plan centrally and develop strategy. Hence the players either learn to adapt – create adaptive systems – in the sure circumstance of depleting energy resources and the uncertainty of the global economy, or fail.

In today’s world where knowledge and R&D are vehicles for doing new things, the establishment of centres of excellence can help the adaptation process via the creation of innovative commercial enterprises and spillovers, all the while creating the knowledge and skills to respond quickly to an opportunity. In this stage of economic unpredictability all we can and need to do is develop the observational ability to notice change very quickly and respond. We need many ways to respond instead of deciding a priori on what is optimum.

Hence the country’s innovation system has to possess semi-autonomous redundant systems, various centres of excellence and a cadre of researchers that can respond to these signals, so developing a store of knowledge and techniques for use and re-use. This adaptive system has to establish interconnections and channels of communication (marketing/market development) such that multi-faceted challenges can be addressed using an integrally connected agent network. The major lesson here is that it is useless spending time to develop predictive models and optimising routines in an unpredictable world, in an unpredictable global market. But the bigger challenge ahead is how to prepare and respond effectively via creating an abundance of flexibility and skills that can be combined to meet the challenges ahead – centres of excellence provide the training environment – the Innovation Diamond4.

Though we are familiar with the Triple Helix of Eztkowitz model of the triad of government, academia and the private sector which can create an adaptive and innovative economy, one of the partners of the T&T’s triad, the current private sector has all but disqualified itself, possibly because of its history. Other countries have found themselves in this position and in particular the Chilean Government opted to teach its private sector how to adapt as it built its world class salmon farms. Hence the task facing T&T is: should the current private sector be taught as Chile did, or rebuild the private sector especially since financing for the adaptation will be at a premium?

St. Clair King is an engineer, and Mary King, an economist. This is an abridged version of what was presented by Professor St. Clair King at the Innovation Conference at the Teaching and Learning Complex.