Recalibrating the Economy

Given Jordan has a well-educated labor force, why is its GDP so low, why does it struggle to add economic value, and why does it have a chronic trade deficit?

By Laith al Qassem

Typically, the higher the level of economic sophistication a country has, the greater the level of integration there is among its firms and the greater the level of added value that is generated by its economy. Jordan’s low export numbers and chronic trade deficit validate the Jordan Strategy Forum’s findings that the Kingdom’s economic sophistication is generally low.

Presumably, if education levels are directly proportional to economic efficiency, our industries should be well managed and our GDP and ability to add value should be higher. They are not. So what’s going on?

Economic output is proportional to the general efficiency of domestic businesses and the sophistication and integration of the economy. The greater the sophistication the more competitive an economic sector is likely to be and the greater the probability of export success and increased economic output. In addition to sector sophistication, a competitive business environment is a prerequisite for a competitive economy. A competitive business environment is transparent and predictable, which enables business owners and managers to plan and expand their businesses. Predictability also is a result of a stable regulatory and legislative environment as well as agreed upon interpretations of the law and corresponding regulations.

Today, Jordan has undergone numerous changes in the tax and investment laws. Many changes are still being evaluated for consideration and presentation to parliament. Competing objectives are creating indecisiveness as the government vacillates between attempting to reduce its deficit and at the same time attracting both foreign and domestic investment. Additionally, the Social Security Corporation, whose investments are also a victim of an unstable regulatory and poor business environment, have been increasing social security contributions by employees and employers to cover a likely future shortfall.

Gross domestic product is a measure of a country’s economy. GDP represents the total value of everything produced (products and services) by all the people and companies within a country. GDP figures include the economic output of foreign citizens and foreign-owned companies in a specific country. If these people and companies reside within a country’s border, the government counts their production as GDP. Furthermore, national prosperity is often measured by GDP per capita. Prosperity reflects a country’s ability to sustainably produce and compete economically, or it reflects the individual country’s endowment of natural resources.

GDP can be measured using:  GDP = MV = PQ

  1. Where M is the money supply in the economy
  2. Where V is the velocity of money circulation within the economy
  3. Where P is the nominal price level within the economy and
  4. Where Q is the quantity of output

Therefore, the velocity of money through an economy (V) is equal to GDP (PQ)/Money Supply.

Thus V =   PQ 

M

Since prices are generally determined in the international market by the lowest cost producer, or by companies which can extract additional margins for brand, quality, design, etc., and since money supply (M) is generally static for short periods of time (with the exception of the USA’s recent quantitative easing), then the velocity of money is directly related to economic output (Q).

The frequent regulatory changes in Jordan have led to increasing the diversion of private economic effort from the formal sector to the informal sector. This has been done as Jordanians seeking out to scratch out a living are seeking a path of greater clarity and predictability and least bureaucratic resistance. As such, the velocity of money V through Jordan’s economy can be considered the sum of two unique components (Vformal and Vinformal).

Thus, Vtotal = Vinformal + Vformal

Vformal is the velocity of money in the formal economy. This is the part of the economy which operates according to the complex and often opaque series of laws and regulations. An increase in complexity and opacity reduces the velocity of money throughout the economy as businesses who wish to remain legal and above board take on increasingly more expensive and time consuming bureaucratic measures to remain in compliance with the myriad of ever changing laws and regulations. Thus velocity is decreasing in the formal economy.

Vinformal is the velocity of money in the informal economy. This part of the economy seeks out efficiencies by bypassing heavy, complex and opaque regulations and legislation. Many companies are laying off employees only to rehire them as part timers or consultants. Many independent business people are operating at the edge of legality to be able to provide for their families and avoid the difficulty and randomness of doing business in a legal manner.

Managing a country’s economy well is extremely difficult. Healthy and sustainable economic growth depends on balancing a variety of characteristics related to doing business. These characteristics include speed of doing business, transparency and clarity of doing business, innovation within businesses and government and control. Control is related to fairly regulating how business is conducted such that all economic players play on a level playing field. The characteristics of doing business are often referred to as the business environment.

Jordanian GDP can be improved and improved relatively quickly. There are two challenges the country and the government face:

The first challenge is that the size of government is too large. Any suggested reforms are likely to lead to an increased deficit. This currently is a non-starter because our deficit is currently hovering around 95 percent of GDP. The government can only seriously take on reform when it has reduced the size of government employment that currently represents approximately 52 percent of the work force and more than 85 percent of the government’s current expenditures.  This can be done over time, possibly over five to 10 years. When the budget deficit is substantially reduced, the government can develop and commit to long-term sustainable reforms.

The second challenge is that Jordan needs to rationalize its laws and re-engineer its processes with the objective of creating long-term economic growth and employment. Currently, Jordan has numerous free trade agreements, which it is unable to effectively exploit due to low existing added value and low industry sophistication. Jordan needs export-led growth but cannot achieve it with the low level of industrial sophistication that it currently has.

A stable legislative and tax regime, which does not seek to only extract funds from the private sector but rather to develop and grow the national economy and create sustainable prosperity for the citizens of Jordan, is essential to creating the long-term investment needed to build sectors, improve economic integration and sophistication. Jordan should consider the creative use of investment tax credits to direct investment to establish or expand firms, which increase economic sophistication. If this is done, the competitiveness of the Jordanian economy will increase.

With increased integration and sophistication, Vformal will increase, fewer companies and individuals will seek to work in the informal economy, and economic output (Q) and GDP will increase.

Laith al Qassem is the CEO of Arabian Business Consultants for Development