CTHH is a dangerous idea that borders on squandermania

Dear Editor,
The ramifications and nuances of Dr Clive Thomas’ proposed cash transfer of $5000 (all cash amounts are in US$) to all households (the CTHH) are unclear as Professor Tarron Khemraj notes in another section of the media. This essay looks at an aspect of the distribution issue, leakages via imports, inflation and the speculated boost to entrepreneurial development.
Any action, including policies, undertaken by the Government has distributional implications, which can be especially contentious in an ethnically fractured society such as Guyana. The CTHH will undoubtedly improve welfare but would leave absolute inequality among households (HH) unchanged.
Suppose the average income of the 50 per cent poorest HH (x) is $3000 and that of the richest 50 per cent HH (y) is $5000 per year. The HH inequality gap is y – x = $2000. Now assume each HH gets $5000 per year as a gift from God (whoever that person is).
The average income of these two sets of HHs rises to $8000 and $10,000, respectively. The gap is still y – x = $2000. The absolute inequality gap is unchanged and will be unchanged as long as all HHs receive a transfer of the same magnitude.
That is only the first-round effect. Spending the $5000 largesse has second-round, third-round, etc, effects. My spending on dhal and chicken becomes your income, part of which you will spend on rice and aloo.
Your expenditure becomes the income of someone else, and the process goes on for quite some time, round after round. In the end, the cumulative effect of the $5000 will be magnified, depending upon the magnitude of marginal propensities.
The marginal propensity to consume (MPC) refers to the proportion of extra income spent on consumption. For example, if $4000 of the $5000 is spent, the MPC is 4000/5000 = 0.80, but this figure is most likely to be much higher. Every time there is an injection of new demand into the circular flow, there is a multiplier effect, which magnifies the initial injection. The general formula for calculating the multiplier (k) is: k = 1/1-MPC. With an MPC = 0.8, k = 5.
A multiplier of 5 means that every $1 of new income generates $5 of extra income. Since there are 93,260 HHs in Region 4, $466 million will be injected into this region’s economy. With an MPC = 0.8, the cumulative impact, which will take several years to wear out, will be around $2.3 billion.
For Region 2 with 12,444 HHs, the final effect will be around $404 million. In contrast to the initial injection which leaves HH inequality unchanged, the multiplier effect impact is unlikely to be neutral. The final impact depends upon structural features of the regional and national economies, poverty and literacy rates, among other things.
The MPC is likely to be highest in interior regions followed by coastal regions and the economy as a whole. Over time, then, the CTHH could change consumption, income and wealth inequalities for better or worst.
The above assumes a closed economy, which is a fiction. Guyana is an extremely open economy, with import of goods and services exceeding GDP. Imports have historically exceeded exports, which is why there is a perennial current account gap. We simply consume more than we produce. Ipso facto, then, the cash transfers will lead to leakages. What fraction of the bonanza leaks out to other countries via imports? The answer is supplied by the marginal propensity to import (MPM), which is the change in imports/change in income.
Usually the change in imports is calculated in relation to disposable income (amount available for spending and saving after taxes), but the latter does not exist. I use GDP instead. Even so, it is difficult to calculate Guyana’s MPM because of the weird behaviour of total imports. On the other hand, the MPM of consumer goods was about 0.22 in 2016-17; the figure for total imports is likely to be significantly higher. This means that each dollar of extra income injected into the economy induces 22 cents on consumption good imports.
Of the total cash transfer of $1.1 billion in 2020, $220 million will leak out on additional consumption imports. Naturally, the leakage does absolutely nothing to improve the productive capacity of the economy, which includes investment in people.
When leakages are taken into consideration, the expenditure multiplier and thus the cumulative impact of the cash transfer becomes smaller. With an MPC = 0.8 and MPM of consumption goods of 0.22, k = 2.4, which means that the final effect of the CTHH in Regions 4 and 2 will be $1.1 billion and $145 million, respectively, less than half of the amount without leakage via consumption goods imports. The leakage will be different by regions, depending upon their MPMs.
One serious implication of an unconditional gift of the magnitude proposed by Thomas is this: it could negatively impact the agricultural sector and compromise food security. Even more young people will refuse to go into agriculture now that they are being showered with manna from heaven.
The oil bonanza will simply be diverted to consumption, including alcohol, cigarettes and imported luxury items, some of which are associated with poor health outcomes. With time, the cash injection will drive up the cost of health, pumped up by the incidence of rising non-communicable diseases, such as hypertension, obesity, diabetes, and cardiovascular events.
What would be the effect of the CTHH on inflation? Food prices are an important driver of inflation, according to the IMF, as are the current accommodative monetary stance and rising prices of imported commodities. The IMF predicts rising inflationary pressure, but not much work exists on inflation in Guyana; the last comprehensive study, published in 2000, was done by R Gampat.
According to him, the principal drivers of the inflationary process are expectations of inflation, excess money supply, cost of imported commodities and excess demand in that order of importance. A 10 per cent increase in these drivers will collectively push inflation up by about 20 per cent. The cash injection of $5000 per HH would boost these variables, with the exception of imported commodities, by some multiple of 10 per cent.
It is reasonable, then, to predict that the injection will drive inflation up by more than 50 per cent above its present level. This means inflation will possibly reach around 5 per cent by 2021, which is much higher than the IMF forecast of 3.5 per cent for that year. I do not think this rate of inflation will exert a strong negative impact on growth. Indeed, it will be necessary for a poor, overheated consumption-driven economy.
A recent letter in Kaieteur News argues that the cash injection will “intensify entrepreneurial development” . This argument is short-sighted for the simple reason that capital is not the most important constraint to entrepreneurial development in Guyana.
Instead, the major constraints to doing business in Guyana are red tape, corruption, poor polices, a labour force lacking in industrial discipline and the requisite skill set, erratic and unreliable supply of electricity, poor and inadequate infrastructure, lack of market (the domestic market is too small), lack of appropriate incentives, a consumption-oriented psychology and short-termism. A consumption binge rather than entrepreneurial development is likely to be the immediate outcome of the CTHH.
Unlike the Phoenix that arose from the ashes, an entrepreneur does not arise suddenly from a cash injection of $5000 per HH per year. Entrepreneurial development is a long-term process that requires vision, strategic thinking, ability to spot opportunities and capitalise on them, discipline, appropriate behavioural change, foresight and animal spirits (ability to make nimble decisions under conditions of uncertainty and ambiguity that characterise the modern economy). It also requires Government guidance and nurturing. Overall, I continue to hold that the CTHH is a dangerous idea that borders on squandermania. We seem to forget that the windfall from the short-lived sugar bonanza (1974-75) was frittered away recklessly. Those who prefer to forget the past are condemned to repeat it. Judging from the reaction to the CTHH proposition, vested interest fixes attention to academic scribblers who hear voices in the air.

Yours truly,
Ramesh Gampat