Government’s financial cistern is dry

Please allow me to add my two cents worth to the debate on the state of Government’s finances and suggestions of how to resolve this mess. For the past 25 years my job has been to analyse companies’ financial statements, make investment decisions based on this analysis, and recommend (or in rare cases force) senior management and directors of public companies to take action to address problems.

In the long-run, both private sector companies and governments are bound by the same fiscal discipline. -Neither Government nor the private sector can spend more than it earns indefinitely, nor continue to increase debt indefinitely as a proportion of revenue. Companies that do so eventually go bankrupt,- and governments that do so eventually find their credit risk so high that they become subject to disciplines imposed by the International Monetary Fund and currency devaluation usually follows.-They then spend so much in interest and debt service that little is left to provide services.

Most of the recent discussion has focused on

(1) Raising revenue,

(2) Suspending pension contributions and

(3) Blaming the UK for being so hypocritical in obstructing CI Government from taking on more debt.

  1. Raising revenue

The chart below illustrates that from 1998-2004 government revenue as a percentage of Gross Domestic Product remained remarkably stable at about 20 per cent of GDP. Post-Ivan, it climbed to around 24 per cent of GDP. Even if revenue fell slightly to $487 million- in the fiscal year ended June 2009 (the most recent estimate I have seen), then it will still amply exceed 20 per cent of GDP. Government needs more stable and predictable revenue sources. – The estimated decline in Government revenue in the fiscal year just ended was only a few percent and represents the first decline since at least 1992, which is as far back as ESO statistics go. -Revenue therefore is not the problem. Everyone knows that the introduction of any new tax is the thin edge of a wedge.

(2) Suspending pension contributions

The pension plan for those employed pre-2000 is a defined benefit plan, with generous benefits, which is (and always has been) underfunded. -A defined contribution plan is in place for civil servants employed from 2000. If the government takes a pension holiday, the liability for the DB plan continues to accrue unless benefits at retirement are reduced. Taking a pension holiday will not help the situation. Such action will only defer the pain to future generations.

  1. Blaming the UK

As old Caymanian sea captains and shipbuilders knew, ‘cut your sail according to your cloth.’ We knew our debt parameters years ago and should have remained within these limits – blaming the UK serves no purpose.

A look at the Government’s expenditure over the past 10 years is illuminating.

The Government cannot abandon its capital projects mid-stream without losing huge value and incurring penalties. Going forward, savings can possibly be made. The lesson to be learned is that we can not engage in huge multiple capital projects at the same time.

Recurrent expenditure has been insidiously creeping up from about 17 per cent of GDP to over 22 per cent of GDP during the past 10 years. A breakdown of current government expenditure highlights a few salient points:

  • Subsidies nearly quintupled from $21.5 million in 2001 to $105.5 million in 2008.
  • Personnel costs increased by 50 percent in three years from $182.6 million in 2005 to $245.2 million in 2008.
  • Page 53 of the ESO 2008 Annual Economic Report states that personnel costs expanded to $245.2 million [$64,500 per employee], higher by 14.9 per cent compared to a year ago, despite a 1.1 per cent reduction in the number of personnel in the civil service to 3,801 in 2008.

A better way forward

Well-run private sector companies become more efficient and stronger in recessions and gain a competitive advantage. Let us not follow the rest of the world and end up with a more bloated government sector to supposedly bail out the private sector in this downturn. The Wall Street Journal recently published an interesting article and accompanying chart, which showed that countries like China with lower government expenditure as a percentage of GDP fared far much better during this recession than countries such as the US and UK which have much higher government expenditure as a percentage of GDP.

Increasing revenue is not the answer. To protect our Cayman Islands, the Government must control expenditure and borrowing restrictions must remain in place. Now is the time for Government to educate the electorate of the fact that a cistern can supply no more water then the quantity of water that flows into it. Now the financial cistern is dry. A comprehensive plan for cutting Government expenses must be implemented. This will require tough decisions, but in the long run, this will be in the best interests of Caymanians and we will all be better for it.

Desmond Kinch