Economics Unit: Developing a new Economic Growth Strategy for Jersey.

STATES OF JERSEY

ECONOMICS UNIT: DEVELOPING A NEW ECONOMIC GROWTH STRATEGY FOR JERSEY

Presented to the States on 20th September 2011 by the Minister for Economic Development

STATES GREFFE

2011   Price code: F  R.115

Economics Unit

Developing a new Economic Growth Strategy for Jersey

June 2011

CONTENTS

EXECUTIVE SUMMARY 3

1. INTRODUCTION 23

1. WHAT IS ECONOMIC GROWTH AND WHY DO WE NEED IT? 25
2. WHAT DRIVES ECONOMIC GROWTH? 26
3. THE JERSEY ECONOMY 27
4. RECENT ECONOMIC GROWTH PERFORMANCE AND MEASURES OF SUCCESS 28
5. EXISTING STRATEGIES AND COMMITMENTS 30
6. CAN MORE BE EXTRACTED FROM ECONOMIC GROWTH? 33
7. JUSTIFYING GOVERNMENT INTERVENTION 37
8. THE KEY DRIVERS OF ECONOMIC GROWTH 41

2. ENTERPRISE, INNOVATION AND BUSINESS DEVELOPMENT 46
3. SKILLS AND THE LABOUR MARKET 58
4. COMPETITION AND CONSUMER POLICY 70
5. INVESTMENT AND PHYSICAL INFRASTRUCTURE 94
6. CROSS-CUTTING POLICY AREAS: PLANNING & RUDL 97

1. PLANNING 97
2. REGULATION OF UNDERTAKINGS AND DEVELOPMENT LAW (RUDL) 100

7. DEMAND: MACROECONOMIC STABILITY AND COMPETITIVENESS 103

1. COMPETITIVENESS 103
2. MACROECONOMIC STABILITY 105

8. STRUCTURAL CHANGE AND DIVERSIFICATION 109

1. STRUCTURAL CHANGE 109
2. DIVERSIFICATION 109
   1. WHAT IS MEANT BY DIVERSIFICATION? 109
   2. IS DIVERSIFICATION DESIRABLE? 110
   3. COSTS OF DIVERSIFICATION 111
   4. BENEFITS OF DIVERSIFICATION 112
   5. EVEN IF DIVERSIFICATION IS DESIRABLE, IS IT ACHIEVABLE? 117
   6. EXAMPLES OF DIVERSIFICATION 119
3. CONCLUSIONS AND IMPLICATIONS FOR POLICY 123

Developing a new Economic Growth Strategy for Jersey

Executive Summary

Introduction

Why have a growth strategy?

• Economic growth is about increasing the value of the goods and services that are provided locally for both the domestic and international market. It is not, as is often perceived, a goal in its own right, but instead a means to an end. The end is a higher standard of living for local residents through higher income, greater job opportunities, lower tax rates and better public services.
• Growth  can,  and  should,  be  consistent  with  well-being,  environmental sustainability  and  social  cohesion.  Inequality,  discontent  and  negative environmental effects are not the consequences of growth per se, but the consequences  of  inappropriately  managed  growth.  Government  can  and should use its capacity to intervene to ensure that growth is achieved in a sustainable and fair manner.
• The Council of Ministers has agreed a strategy to deal with the effects that the global recession has had on the Jersey economy. This consists of three key elements, one of which is maximising economic growth (the others are reducing and improving the focus of expenditure; and raising extra revenue from  taxes  and  charges).  Financial  forecasts  conducted  after  the  global financial crisis suggested that the States faced a structural deficit in the public finances  in the  near  term. In  addition,  there  are  a  variety  of  spending pressures and challenges that could add to the problem in the medium to long-term, such as an ageing population.
• These fiscal pressures have been highlighted on several occasions by the Fiscal Policy Panel, which has urged the States to put in place a medium- term strategy to manage these pressures.
• Although the States has in place many policies which as the legacy of the previous Economic Growth Plan address many of the issues relevant for economic growth, there is no explicit economic growth strategy in place. It is therefore important to provide clarity for Islanders and their businesses in terms of what the framework will be for supporting growth in the Island going

forward, setting out where the States can expect to make a difference and where it cannot.

• It is not necessary to set a target for economic growth, as there are reasons to believe that GVA growth alone may not be a good measure of success. Also the aim is not growth per se, but that of the type and nature that is complementary to wider economic and social objectives. Setting a target can therefore distract from the real objectives.
• Neither is there a need to set a time limit for a growth strategy, as the over- arching  principles  and  strategy  should  remain  relevant  indefinitely and  a successful  strategy  must  be  ongoing  and  self-reinforcing.  However, the policies and programmes that are implemented to achieve economic growth need to be continuously reviewed and evaluated against their objectives, and where relevant, revised or stopped.
• Instead, the strategy should set out the over-arching principles and create a framework under which the policies for the new Economic Growth Strategy can be developed (see Figure 0.1 below). It is envisaged that a series of supporting strategies that  cover issues  such  as  enterprise  and  skills  will follow. These will build on the principles set out here, and will set out more specific and detailed policies that will deliver sustainable economic growth. The  new  Economic  Growth  Strategy  should  also  form  the  basis  of  the economic aspects of the 2012 Strategic Plan.

Figure 0.1 Economic Growth Strategy and policy development

• The key policy themes covered by the strategy should be:

• The main drivers of productivity:

• Enterprise, Innovation and Business Development,
• Skills and the Labour Market,
• Competition and Consumer Policy, and
• Investment and Physical Infrastructure.

• Important cross-cutting policy areas (Planning and RUDL)
• Demand: Macroeconomic stability and competitiveness, and
• Structural Change and Diversification.

• Policy development in each of these key areas should be done in a consistent and robust manner. Figure 1.11 (page 38) sets out the policy cycle that requires:

• Development of clear rationale and objectives
• Continued appraisal of policy alternatives
• Monitoring of the impact during and after implementation
• Evaluation against objectives
• Discontinuation of policies that turn out to be ineffective.

These policy themes that should be covered by the new strategy are covered in more detail below.

Enterprise, Innovation and Business Development

Innovation is the implementation of a new or significantly improved product (a good or service), or process, a new marketing method, or a new organisational method in business practices, work-place organisation or external relations.1 Enterprise is the process of capturing the outputs from the innovative process, developing them and taking them to market.

The combination of innovation and enterprise is a powerful one, and one that creates new economic value in two main ways. First, it can be a driver of technological

1 OECD and Eurostat (2005) Oslo Manual: Guidelines for Collecting and Interpreting Innovation Data

progress and raise productivity directly. Second, it raises the level of competition and in doing so creates the incentive for innovation, efficiency and productivity across all firms.2

Significant progress has been made in the past few years in the areas of enterprise, innovation and business development in Jersey. Since 2007 Jersey Enterprise has provided support to hundreds of businesses through initiatives such as the small business  support  service  and  financial  support  through  the  Small Firms  Loan Guarantee Scheme and grants for exports and innovation. However, it is important to take stock of what has been achieved, learn lessons from past experience, and set out  a  strategy for  the future.  The  new  strategy  should  therefore  include a new Enterprise and Business Development Strategy to set out policies consistent with a number of over-arching principles, which in turn are based on evidence about what works. In particular:

• Government will not be able to determine which individual businesses will succeed and those that will fail. Instead the primary focus will be to create an environment conducive to enterprise and innovation of all shapes and sizes, achieved  through  a focus  on  addressing  market failures, and  particularly barriers  to  entry,  growth and  contraction.  This  may  be  supplemented  by targeted,  conditional  support  to  emerging  industries  where  it  can  be demonstrated that there is a convincing case of their value to the Island and that there is a role for government in assisting their establishment.
• Business development, enterprise and innovation are as much about survival and growth as start-ups and new ventures. The latter should receive special attention only where specific market failures can be identified.
• The  failure'  of  some  businesses  and  activities  is  acceptable,  and  even inevitable. The important thing is to ensure that support to businesses and activities that are not viable or successful, and which do not meet other objectives (for example social and environmental aims), is withdrawn at the right  time and  in  the  most  appropriate  manner.  Equally,  there  is  little consensus about best practice' in the area of enterprise and innovation, therefore policies should be continually evaluated and adapted to ensure they are as effective as possible.

2 For a summary, see Nyström (2009) Economic growth and the quantity and quality of entrepreneurship

Innovation  and  enterprise  policy  has  taken  significant  steps  forward  since  the previous Economic Growth Plan in 2005. However, it is time to take stock and make any necessary adjustments to enterprise and innovation policies. To take forward these  issues,  a  new  Enterprise  and  Business  Development  Strategy  should  be developed based on an evaluation of activities in each of the following six key areas:

Support for new and emerging activities

Generic policies towards enterprise, combined with similar policies for competition and macroeconomic policy, should all serve to support the development of new and emerging activities that have the potential to provide high economic value – in the form of more job opportunities, better paid jobs and higher tax revenue for the same level of taxation – to the Island. Inward investment will also have a role to play here; by marketing the benefits that Jersey has to offer to prospective businesses and investors, Jersey will be able to attract them to the Island, and in turn generate job opportunities for local people and potentially diversify the economy.

In addition, there may be some cases where generic support is not sufficient, and there is a justification for dedicated support to be provided to a particular sector with promising  characteristics.  In  essence the  proposed  approach  involves  targeted assistance to address barriers to the growth of sectors with the potential to be high- value and low footprint. Such support should be accompanied by strong conditionality (for example, automatic sunset clauses), and guided by a close and productive dialogue with industry.

The advantage of such an approach is that it will be supportive of new activities that could serve to diversify the economy, while at the same time ensuring that such diversification is consistent with economic growth and the continued prosperity of the Island.

Support for incumbent sectors

Although slightly different in nature, ongoing support for incumbent sectors should be appraised  using  a  similar  framework  to  that  proposed  for  new  and  emerging activities. That is, support should be targeted at those areas where support can be justified by market failure, where it is likely to support innovation and enterprise and where high-value can be demonstrated.

The Rural Economy Strategy provides an example of this; in particular, the Rural Initiative Scheme is designed so that support goes to support approved business plans which demonstrate that new and existing businesses will:

• Develop new higher value markets and services
• Add value and reduce costs
• Improve productivity
• Enhance employment and improve skills
• Not displace existing Jersey businesses
• Not have an adverse impact on the environment

Ideally  however,  there  may  be  advantages  in  moving  towards  a  more  general approach, and trying to incorporate existing sector approaches into generic support policies.

Business support

Existing  business  support  policies  should  be  evaluated  to  ensure  that  they  are meeting their objectives in an effective and targeted manner. This should include:

• A  review  of  the  issues  concerning  access  to  finance,  including  loans, subsidies, grants and other forms of finance, with particular emphasis on identifying market failures;
• A review of the existing market development and export support such as the Export Development Initiative (JEDI). For example a review might explore the current barriers to exporting and the merits of using loans, export credits or guarantees either in addition to, or instead of, the current grant system;
• An assessment of the balance of current policies between those aimed at supporting growing businesses or start-ups, and determine whether there is scope or value in shifting this balance more towards facilitating growth in organisations of all sizes and away from encouraging start-ups per se; and,
• An evaluation of the business support services currently provided (including Jersey Enterprise) to determine whether they can be made more effective, in terms of focus, content or delivery.

Encouraging enterprise skills and culture

Encouraging enterprise skills and culture is an important role, so the development of enterprise skills should be covered by the new skills strategy, while fostering an enterprise culture should be covered by both a new skills strategy and the new Enterprise and Business Development Strategy.

Marketing and promotion

The two largest areas of focus for marketing and promotion are tourism and finance, with inward investment also receiving a small amount of resources for this purpose. Inward investment is likely to continue to play a significant role in the success of the Jersey economy. This should be based on a standard proposition to all potential businesses  and  investors  (tailored  to  the  requirements  of  individual  sectors), although it may be supplemented in some cases with considered sector specific support for emerging industries where it is deemed appropriate under the framework set out in Section 8 of this report on Structural Change and Diversification.

Tourism-related marketing and promotion activities in this area will be examined to inform  a  new  Tourism  Strategy,  however  there  may  be  scope  to  do  more.  In particular, there may be value in evaluating the effectiveness of other marketing and promotion activities, as well as looking at how such activities are managed and delivered, and whether there is scope for a more coordinated approach in certain areas.

Regulatory framework

There should be a commitment in the new Enterprise and Business Development Strategy to undertake a review of local regulatory requirements and their impact on current  and  future  business  operating  in  Jersey,  with  the  aim  of  reducing  any undesirable or unintended barriers to enterprise and competition. Of particular focus should be  whether there  is  scope  to  improve the  way  in  which  regulations are administered: for example, through streamlining the process of submitting information to regulators and government departments.

Skills and the Labour Market

Substantial progress has been achieved since the previous Economic Growth Plan. Jersey's  Skills  Board  and  Skills  Executive  were  established  by  the  Council  of Ministers in 2008. The Skills Executive comprises the Ministers for Education, Sport and Culture, Economic Development and Social Security and their respective Chief Officers.  The  Skills  Board,  which  advises  the  Executive,  and  drives  forward  its policies and strategies is employer led'. Collectively they are referred to as Skills Jersey', and they cover 3 main areas of responsibility:

• Capturing employer and learner demand for skill development;

• Developing an all age Careers Information, Advice and Guidance Service; and
• Managing resources for the provision of vocational education and training opportunities.

In the short time since it was created Skills Jersey has already added significantly to the knowledge base about local skills, and the 2011 Business Plan contains a comprehensive set of objectives and key performance indicators relating to the development of skills at all levels.

The Jersey Early Years and Childcare Partnership (EYCP) has been established and 20 hours a week (term-time) free States-funded nursery education is available for children in the year before they are due to start primary school at a nursery provider which is committed to the work of the EYCP. This includes primary schools, day nurseries and pre-schools.

Other developments since the previous Economic Growth Plan include a significant increase in the offering by private sector education provides for further education and professional development. These organisations cater for the continuing professional development needs of employees in the financial sector and other businesses, and complement the suite of courses on offer at Highlands College well.

Skills Jersey requires three government departments (Education Sport and Culture, Social Security and Economic Development) to work together at both officer and Ministerial level. As is the case with the other elements aspects of economic growth, it would make sense to review and assess whether the current structure is the most effective and efficient way of meeting the Island's skills objectives. A review is already underway and any recommendations that could improve collaboration and delivery should be implemented.

There may be potential to strengthen the approach to skills and the labour market in a number of areas. Governance and incentives could be strengthened, for example, by making more use of cross-department budgets and objectives to align the incentives of different departments (Education, Social Security, Economic Development and Treasury). Further there should be a shift in emphasis with regards to labour market policy towards permanent active labour market policies for the young and hard-to-reach' groups.

Skills  are  an  important  driver of  productivity  improvements  and  there  are  clear circumstances under which market failure exists and government intervention can be justified. However, it will be important to determine where these circumstances exist in Jersey and critically what the most effective government interventions might be.

Skills framework

If the review of the structure and operation of Skills Jersey recommends ways that it can be improved to enhance delivery of the Island's skills objectives, they should be acted on quickly to enhance this aspect of the new Economic Growth Strategy.

A new Skills Strategy for Jersey

Much progress has been made in Jersey in addressing skills issues not least with the establishment of Skills Jersey and the research that it has undertaken. However, there is still a clear need to establish a holistic Skills Strategy for the Island that covers all the key issues including:

• Evaluating  existing  skills-related  policies,  identifying  gaps  and weaknesses  and  drawing  on  any  lessons  learned  from  local  and international experience.
• Raising  the  skills  levels  across  the  population  including  reducing  the proportion of the population with no formal qualifications.
• Identifying and addressing skills gaps within the existing workforce and providing a vehicle to identify current and new opportunities.
• An assessment of recent developments in early years care and education against the objectives and identification of strengths, weaknesses and opportunities for improvement of the existing approach.
• Continued development of a strategy to address literacy and numeracy skills across the population.
• A detailed response to the issues raised in the Green Paper on Primary, Secondary and Tertiary Education.
• Continued  development  and  improvement  in  the  vocational  education offer in Jersey
• An expanded strategy for dealing with youth unemployment and drawing on the success of the New Deal for Young people in the UK to build on the strengths of Advance to Work.

• Assess the strengths and weaknesses of management skills in the Island and identify any issues that merit government policy.
• Identify whether more could be done to stimulate employers to network and collaborate with each other and government in skills development and investment.

The development of this strategy should be led by Skills Jersey seeking advice from the States Economics Unit where appropriate.

Employee involvement and commitment

Effective  polices  to  improve  employee  involvement  and  commitment  can  bring benefits for employees and employers and there can be a number of barriers to their development. Further work should explore whether these barriers exist in Jersey and whether greater application of policies could bring benefits. For example, Jersey Enterprise should consider whether it might be of benefit to run a series of Master Classes on improving the skills and knowledge of employers on how to maximise the potential of their employees.

Support for Jobseekers

It will be important to act on the recommendations of the ongoing review of income support to ensure that policies towards the unemployed and those on low incomes minimise disincentives to work and are conducive to economic growth.

This should include an examination of the current strategy for dealing with youth unemployment, drawing on the success of the New Deal for Young people in the UK where necessary. This will include examining whether more information is needed on those young people not in employment, education or training (NEETs) in Jersey.

Further  Active  Labour  Market  Policies  for  job  seekers  of  all ages  should  be considered  in  the  context  of  the  Jersey  labour  market  and  pursued  where appropriate.

Minimum wage

During 2011, the Employment Forum will review the trainee rate and the associated code  of  practice  with  a  view to  making  further  recommendations  to  the  Social Security Minister. Further consideration should also be given as to whether labour market conditions in the post global crisis world and the need to examine the current strategy for dealing with youth unemployment mentioned above, change the balance between the costs and benefits of youth minimum wage rate.

Participation and incentives to work longer

Even  though  Jersey  has  consistently  high  rates  of  participation  in  employment detailed consideration needs to given as to the barriers preventing those currently not participation  in  the  labour  force  and  whether  government  policy  can  address particular market failures. This should include but not be limited to older workers.

The States, as a major employer, should lead the way in human resources and employment policies designed to support and encourage the older worker.

The  treatment  of  older  workers  under  the  current  tax/benefit  system  should  be reviewed to encourage individuals to remain in employment where appropriate.

The  roles  of  social  attitudes  and  access  to  lifelong  learning  also  need  to  be considered.

Labour market information

Skills Jersey, the States Head Statistician and Economic Adviser will work together to identify any information gaps and whether they can be filled effectively.

Competition and Consumer Policy

In theory competition, or the threat of competition, can be beneficial for productivity and growth in three main ways. In particular:3

• Between-firm  effects:  Competition  can  increase  aggregate  productivity  by encouraging firm turnover and the exit of less efficient firms.
• Within-firm effects: Competition increases the incentives for firms to increase their productivity in order to survive.
• Innovation: The relationship between innovation and competition is complex. While innovation and competition will usually be mutually beneficial, there may be cases in which too much' competition may harm innovation.

Significant advances have been made in this area since the last Economic Growth Plan.  The  Jersey  Competition  and  Regulatory  Authority  (JCRA)  is  now  well- established,  and  reforms  to  the  Jersey  Consumer  Council  have  recently  been announced that will build on its successes to date. However there may be scope to strengthen the current competition framework by keeping both under continual review

3 This categorisation is taken from OFT (2007) Productivity and Competition: An OFT Perspective on the Productivity Debate

to  ensure  they  are  in  line  with  best  practice  and  by  introducing  competition assessments as a standard part of policy development.

Next Steps

In order to strengthen the existing competition framework, it is suggested that:

• The  competition  framework  and  competition  law  should  continue  to  be reviewed at regular intervals to ensure that the JCRA can continue to take a pro-active approach to competition policy. Its powers and methodologies should be continually kept under review to ensure that they are in line with best practice around the world.
• Assessing policies for their impact on competition should be standard practice in  all areas  of  government  policy,  for  example  in  planning  and  RUDL decisions. How this can be done is set out in Section 6.
• Consumer policy should be kept under review to ensure that it is in line with best practice.

Investment and Physical Infrastructure

Investment in physical infrastructure or other forms of business investment can be key drivers of success, supporting productivity and economic growth. As a small island, Jersey does not have a large stock of physical infrastructure, however it is important that it is able to build and maintain the vital infrastructure it needs.

While business investment is important, it is not clear that there are market failures that justify government intervention. However, for physical infrastructure there are a number of such market failures that mean that there may be an active role for government. For example, transport infrastructure has many positive benefits to the Island that would not be considered in a narrow cost/benefit analysis.

The  most  important  conclusion  in  this  area  is  that  strategic  issues  relating  to important transport and communication links must be assessed on a regular basis, and where there is a case for government intervention or support, this is carefully considered.

• Infrastructure investment can have important economic benefits and regular and continued assessment is needed to identify and plan for future infrastructure needs.
• External transport links are strategically important in any economy but particularly an island economy and it will be important to:

– Strengthen the process of evaluation and appraisal of new air routes

– Investigate further critical mass' passenger issues at the airport and the implications for future funding

– Review ferry services and freight markets as further experience is gained under existing policy and assess performance relative to other approaches such as a licensing regime.

• Review and assess at regular intervals future information technology and communications requirements and the ability of the current market arrangements to deliver the investment that will be required to meet industry demands to remain competitive in the future.

Cross-cutting policy areas: Planning & RUDL

While all policy areas are likely to be affected by the considerations set out above to a greater or lesser extent, the two that are likely to have the most significant impact on economic growth are policies and decisions relating to planning and Regulation of Undertakings and Development (RUDL).

Planning

Planning laws and regulations play an important role in addressing a variety of market failures in the form of externalities such as aesthetic appearance, durability and build quality and so on. But they can also have a significant impact on the success or otherwise of an economy; badly designed policies can raise the price of inputs across the economy and reduce productivity and growth.

While accepting that planning laws have benefits, the objective should be to implement them in a way that is least damaging to productivity. A high priority should be given to encouraging and facilitating productivity improvements across all sectors of the economy. This may occur by either attracting high productivity businesses from

elsewhere, or encouraging the development of local businesses, existing and new. Planning policies can do this by ensuring that they facilitate the most productive use of land and do not act as a barrier to changes in the composition of the economy.

In turn this means that where possible market information such as prices (land values,  rents  and  yields),  vacancies  and  data  on  productivity  should  used  to understand the relative demands for different land uses across different locations. While this information will only be one input into planning decisions, they should be taken  seriously  as  an  indication  of  the  economic  value  of  different  land  use permissions. The Island Plan includes a list of such indicators, and so appears to be sufficiently flexible to allow this to happen, but the critical factor will be in how it is implemented.

Next Steps

It is proposed that:

• Senior officers from the Planning Department, Economic Development Department and Economics Unit should meet on a regular (quarterly) basis to consider the economic implications of key planning decisions, including the likely impacts on productivity and competition.
• This group of officers should also discuss how the presumption against a change of use, particularly within employment land, is being interpreted and applied with respect to new and pending decisions. Full consideration should be given as to whether decisions are unnecessarily restricting productivity and growth.

RUDL

RUDL exists in order to manage inward migration to the Island (in tandem with the Housing Law). However, this comes at a cost. RUDL can act as a barrier to entry for new  firms,  and  there  is  substantial  evidence  that  higher  barriers  to  entry  are associated with lower productivity growth. There are two main mechanisms through which this can occur. Firstly, new firms may be more productive than incumbent firms, so their entry into the market may attract resources from less productive incumbents, and thus increase the average level of productivity. If entry is prevented or made more difficult, this will not occur to the same extent. Secondly, new firms provide the threat of competition to incumbent firms, which raises the incentive for

them to innovate and raise their productivity in order to survive. In contrast, higher barriers to entry tend to be associated with higher mark-ups and lower productivity growth.

Given that RUDL is a barrier to entry, and accepting that it is a useful policy lever, the objective should be to use RUDL in such a way that its adverse effects as a barrier to entry are minimised. One way to do this would be to have explicit considerations to this effect in considerations of RUDL applications. For example, undertakings with the potential to be significantly innovative or the potential to shake up a concentrated or stagnant market (particularly where goods and services are consumed locally, but this applies to export businesses as well) – should be treated favourably in the RUDL process, if there are no conflicts with the other objectives of RUDL.

Next Steps

It is recommended that:

• RUDL and housing law application decisions continue to have regard to how they can affect economic growth. Advice could also continue to be sought from the Economics Unit by the Population Office and Housing Department about balancing the demand on resources and making efficient use of those resources.
• Evaluation of applications for (1)(i)(j) licenses should give weight to skills and potential  for  value-added,  as  well as  competition  while  that  for  (1)(i)(k) licenses  should  give  weight  to  potential  contribution  to  innovation  and entrepreneurship in the local economy.

Demand-Side and Competitiveness

An economy can be very productive and capable of producing high-value goods and services using minimal resources, but if there is no demand for these goods and services  then  the  capacity  on  supply-side  is  largely  irrelevant.  The  two  major determinants of demand, particularly in small-island economies where businesses are highly mobile, are competitiveness and macroeconomic stability.

Competitiveness

Competitiveness is difficult to measure, because it includes a number of qualitative factors as well as quantitative factors, however a number of attempts have been

made. One example is the Global Financial Centres Index (GFCI), which attempts to rank major financial centres according to competitiveness, using the following factors:

• Business environment, including ease of doing business, opacity, wage comparisons, corporate, employee and personal tax rates, bilateral tax information exchange agreements and country-risk assessments.
• People, including measures of intellectual capital, numbers of graduates, visa restrictions and quality of living.
• Infrastructure, including office occupancy costs, transport and office capacity.
• General competitiveness, including business confidence indices, investments and inflation indices.
• Market access, including measures of capital market access, credit ratings and volumes of financial trades.

While there is unlikely to be a measure that perfectly describes competitiveness, they do tend to be relatively volatile, suggesting that a competitive advantage can be lost fairly easily. Therefore while Jersey appears currently to be relatively competitive with respect to competing financial centres, it cannot afford to be complacent.

Macroeconomic Stability

Jersey has a good record of accomplishment of macroeconomic stability, with robust economic growth, low and stable inflation and prudent public finances. As in other areas though, a good record should still leave room for improvement.

One area that is particularly important, and which may require review is the Fiscal Framework. The Fiscal Framework refers to the overarching principles and structure of fiscal policy in Jersey. Specifically, this means the three main accounts and reserve funds (the Consolidated Fund, the Stabilisation Fund and the Strategic Reserve), the principles attached to their use, and the independent Fiscal Policy Panel that advises the States on the use of these accounts.

In keeping with the approach elsewhere in this strategy, policy should be reviewed and evaluated on an ongoing basis and the fiscal framework is no exception. Now would be a good time to review the existing fiscal framework and examine how it can best support the States fiscal and economic objectives going forward.

Maintaining and improving competitiveness and macroeconomic stability are critical to future economic growth. Therefore it is proposed that:

• The Fiscal Framework should be reviewed and evaluated by the Economics Unit to examine how it can best support the States fiscal and economic objectives going forward.
• Low inflation is a key aspect of competitiveness and high inflation undermines economic growth. The focus of policy should continue to be on growth driven by productivity and supply side improvements, supported by counter-cyclical fiscal policy, which will be more conducive to low inflation.
• Jersey's competitive position should continue to be monitored on an ongoing basis so that any changes in its overall position can be addressed if necessary. Competitiveness will also be a primary consideration for all areas of government policy.

Structural Change and Diversification

Structural change involves a change in the sectors and activities that make up the economy. It can be beneficial when it involves an economy moving from low-value activity to activities that are able to generate high-value. This is because it means that businesses generate more profits and/or a greater number of better paid jobs. A local example is the move towards financial services and away from tourism and agriculture in the years since the Second World War. However, a move from high value activity to low value activity is undesirable because it will mean lower profits, employment and/or earnings which is more representative of economic decline than economic growth.

Diversification is not the same as structural change. As outlined above, the latter refers to any shift in the composition of the economy. In contrast, the former refers to a shift in economic activity in an economy that reduces the reliance of that economy on a particular sector or activity. In other words, all diversification will involve structural change, but not all structural change can be called diversification.

Although often suggested as a desirable objective for the Jersey economy, diversification does not appear to have a clear definition, nor has the justification for such a strategy been robustly set out or the potential trade-offs recognised.

Three potential arguments for diversification can be identified; diversification may:

1. Reduce exposure to a dominant industry (i.e. the finance sector) in order to reduce year-to-year volatility in jobs, economic activity and tax revenue
2. Provide industries to fall-back on' if a dominant industry (the finance sector) were to leave
3. Provide a greater variety of job opportunities for local people

However, it is not clear that diversification would either reduce year-to-year economic volatility or provide a "fall-back" sector in the event that the finance sector leaves. Further, even if it could, this would be a necessary but not sufficient justification for diversification: it may be that there are better ways to achieve these objectives. For example, if the objective is economic stability, then an alternative to diversifying the economy is using the Fiscal Framework appropriately: building up the Stabilisation Fund during the good times to support the economy in the downturns. If the objective is to provide an insurance policy in case the finance sector leaves, a more effective policy response to diversification may also be a fiscal policy response – i.e. extracting as much value from the high-value sectors while they are here, and using this to build up the Strategic Reserve. If an external event caused the finance sector to diminish in size or leave the Island, then the Strategic Reserve could be used to ease the transition.

To the extent that diversification is able to achieve the objective of providing alternative job opportunities for local people, the costs and benefits of using diversification to achieve this objective would need to be carefully considered, along with whether there are any alternative approaches.

The ability of diversification to achieve these objectives is important because certain approaches to diversification would require giving up some of the value that could be obtained from high-value activities. Therefore achieving the objectives set out above requires making trade-offs, which may or may not be worthwhile.

Clearly it is desirable for the government's approach to diversification in the economy to be consistent with the strategy for growth. That is, it should be about creating the right environment for business to flourish and market forces to prevail. This involves creating an environment where the skills-base can meet business needs, enterprise can flourish and there is open competition across the economy. In other words, most of the policies to support economic growth will also encourage productive activities to locate in Jersey.

However, Jersey does have a range of sector specific industrial policies, whether or not they are explicitly acknowledged as industrial policy. For example, the

government dedicates  substantial  resources  to  supporting  the financial  services, agriculture  and  tourism  industries.  Recently  there  have  also  been  a  variety  of activities that have been considered for support in the form of expanded shipping and aircraft registries and intellectual property. Going forward, some of the support that is already in place is likely to continue in the future, and it is likely that requests for support from new industries and activities, such as renewable energy technologies, will emerge. All of this suggests that sector-specific support will continue to be an issue in Jersey, and the question is really about how to make it best support growth and diversification.

There is a growing economic literature on modern industrial policy which argues that industrial  policy  should  recognise  that  the  government  cannot  be  certain  which sectors will be successful and that there should a model of strategic collaboration between  government  and  the  private  sector  to  identify  the  most  significant bottlenecks and the most effective policy responses. Understanding and learning from mistakes is also a critical part of the process.

This approach relies on a willingness to experiment and building strong conditionality into government support to ensure that industries in receipt of support but that are not delivering their objectives do not continue to receive this support indefinitely.

Next steps

In essence, diversification can be thought of as being supported by general policies towards productivity and economic growth. Getting these policies right will create a level-playing field and thus will not prevent high-value activities from flourishing on the Island if the conditions are right. In addition, the process and principles set out above should ensure that the right type of diversification – into high-value activity – can take place without jeopardising the Island's economic success.

At the moment there is no clearly defined mechanism or process that could involve public/private collaboration and interaction, not least around the issues of identifying potential emerging industries and whether they merit government support.

Consideration  should  be  given  to  developing  a  process  that  will  ensure  that government support for industries and sectors is conducive to both diversification and growth. Specifically:

• Jersey's objectives and approach to diversification should be clearly defined.

• Consideration should be given to further work on developing a process with clearly  defined objectives  that  would ensure that  government  support for industries and sectors is conducive to both diversification and growth. This should include strengthening existing dialogues with industry, ensuring that candidates for new and emerging industries are identified early, and that information  can  be  gathered  on  the  barriers  to  their  development  and potential for government support.
• Any sector support should be carefully designed to address market failures or to  provide  pump-priming',  and  the  latter  should  be  time-limited.  Strong conditionality should be built into any support. This means that support should not be given without some combination of clear objectives, sunset clauses and mandatory reviews. Support should be discontinued unless it can be demonstrated that these pre-agreed objectives are being achieved.

Developing a new Economic Growth Strategy for Jersey

1. Introduction

The previous Economic Growth Plan was written in 2005 (P.38/2005). It set out how the Economic Development Department (then Committee), would deliver the target of 2% real economic growth per year for the next 5 years (i.e. until 2009) that had been agreed by the States in July 2004. No further commitment to an explicit growth target has been made and no new strategy has been written to replace the Economic Growth Plan.

The need for a new strategy is clear. Financial forecasts conducted after the global financial  crisis  suggested  that the  States faced a  structural  deficit  in  the  public finances in the near term. In addition, there are a variety of spending pressures that could add to the problem in the medium to long-term. This has been highlighted on several occasions by the Fiscal Policy Panel, which has urged the States to put in place a strategy to manage these pressures.

As a consequence, the Council of Ministers is implementing a three-part plan. First, it is proposed that expenditure is reviewed and reduced through the Comprehensive Spending Review. The objective is to save £65m a year by 2013. Second, revenues will need to increase, and the options have been examined as part of the Fiscal Strategy Review, and measures were agreed by the States in the 2011 Budget. Finally, the Council of Ministers has committed to doing what it can to maximise the contribution from economic growth.

The purpose of this new growth strategy is to set out how economic growth, and therefore its contribution to public spending pressures, can be maximised, while at the  same  time  taking  into  account  constraints  and  existing  commitments.  For example, the Council of Ministers strategy to deal with the ageing population which makes  assumptions  about  reasonable  levels  of  productivity  growth  and  inward migration. Only economic growth in excess of these assumptions can reasonably be earmarked  for  other  purposes such  as  financing  deficits,  proving  additional  tax revenues or additional spending pressures. Further, the current States Strategic Plan contains  a  commitment  to maintain  a  strong,  environmentally  sustainable  and diverse  economy' and  sets  out  to "lay  the  foundations  for  a  genuinely  diverse economy".  How this is to be achieved, and what it means in practice for policy development and economic growth is less clear.

To this end, this report recommends ways in which policy needs to change in order to maximise Jersey's growth potential. It is based on a review of the most recent literature on economic growth and productivity from academics, think-tanks and other respected organisations and analysis of the situation in Jersey. It also looks at the links between policies to support economic growth and other policy objectives such as diversification.

This  document  is  intended  to  set  out  the  over-arching  principles and  create  a framework under which the policies for the new Economic Growth Strategy can be developed. It is envisaged that a series of derivative strategies covering issues such as enterprise and skills will follow. These will build on the principles set out here, and will set out more specific and detailed policies that will deliver sustainable economic growth (Figure 1.1). The new Economic Growth Strategy will also form the basis of the economic aspects of the 2012 Strategic Plan.

There is no target set for economic growth, as there are reasons to believe that GVA growth alone may not be a good measure of success and that the nature and type of economic growth is as important as the rate. Under such circumstances a medium- term target could simply serve to confuse and distort economic growth policy. Neither is there a time limit set on the growth strategy, as the over-arching principles and strategy  should  remain  relevant indefinitely and  a  successful  strategy  must  be ongoing  and  self-reinforcing.  However  the  policies  and  programmes  that  are implemented to achieve economic growth need to be continuously reviewed and evaluated against their objectives, and where relevant, revised or stopped.

Figure 1.1 Economic Growth Strategy and policy development

1. What is economic growth and why do we need it?

Economic growth is about increasing the value of the goods and services that are provided locally for both the domestic and international market. It is not, as is often perceived, a goal in its own right, but instead a means to an end. The end is a higher standard of living for local residents through higher incomes, greater job opportunities, lower tax rates and better public services – not just an increase in measured GVA.

Growth can, and should, be consistent with well-being, environmental sustainability and social cohesion. Inequality, discontent and negative environmental effects are not the consequences of growth per se, but the consequences of inappropriately managed growth. Government can and should use its capacity to intervene to ensure that growth is achieved in a sustainable and fair manner.

Economic growth is generally measured as the change in gross-value added (GVA), which measures the value of employment – the number of jobs and their rates of pay (i.e. total wages) – and the value of the profitability of businesses based in the Island. The change in GVA is a measure of the change in economic activity over time. It has to be accepted that while prudent macroeconomic management can reduce the extent of economic cycles (covered in Section 7 in Macroeconomic Stability), it is likely that there will always be periods of rapid growth and periods of falls in economic activity.

Notwithstanding inevitable cyclical fluctuations, the objective of economic policy should be for the general trend in economic activity to be upward in a manner that increases living standards as much as possible while also being sustainable. Sustainability in this context means that growth in economic activity now is not being achieved at the expense of future prosperity. For example, raising economic growth by increasing inward migration significantly or by using more natural resources could under certain circumstances simply result in more output being shared among more people or deplete the natural environment. Similarly, simply working longer hours would reduce leisure time and perhaps increase negative health impacts such as stress, and therefore growth driven by such a change will not be unambiguously beneficial.

This generally means that growth should be driven by improvements in productivity – i.e. achieving more outputs from the same inputs (labour, land and capital) – rather than by increases in the quantity resources used (discussed further in Section 1.2).

Figure  1.2 illustrates  both the  cyclical  nature  and  the  general  upward  trend  in economic activity in Jersey.

Figure 1.2 Economic activity in Jersey (adjusted for Jersey inflation)

Real GVA, index, 1998=100 Annual change in real GVA, %

120 100 80 60 40 20 0

1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

15% 10% 5% 0% -5% -10%

1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

Source: Statistics Unit. Pre-1998 figures are indicative only.

2. What drives economic growth?

Economic growth is determined by a number of different factors. It is useful to distinguish between growth in the ability of an economy to create value – potential output – and growth in actual economic activity. The first of these is determined by supply-side factors. In essence, economic activity is determined by three things: the number of people that are working, the number of hours that they each work, and how much value each employee is able to generate. Each of these determinants can be further broken down into their components, as illustrated in Figure 1.3.

Figure 1.3 The determinants of potential economic growth for the economy

Trend GVA growth

Productivity Hours worked Number of FTEs (GVA/FTE/per hour)

Working age Underlying Productivity Structural change Employment rate

population

Number  Participation  Retirement  Inward

of jobs rate age migration

However, this is only one side of the story. Actual economic growth is determined by the interaction between demand and supply. For example, if the productive capacity of an economy is increasing significantly, but there is no demand for the goods or

services it produces, then potential economic output will have grown, but actual economic output need not. Therefore policy to encourage growth should not neglect the demand-side. In particular, demand-side factors that influence economic growth are competitiveness and macro-economic stability.

An economic growth strategy needs to address both the demand and supply aspects of economic growth. A focus on the demand side would encourage demand for output without increasing the economy's capacity to supply, which would lead to inflation and other undesirable outcomes. On the other hand, a focus purely on the supply side would leave open the possibility that the economy is able to produce more at the same time that demand for the output is falling, which would be wasteful.

In order to raise economic growth in a sustainable manner, the government has to have policies in place that influence these determinants of growth. Each is covered in detail later in this paper.

3. The Jersey Economy

In  2009  the Jersey  economy  generated  £3.6bn  worth  of  profits  and  earnings (measured by gross value-added or GVA). Figure 1.4 (a) and (b) show the structure of the Jersey economy. As is well known, the economy relies heavily on financial services (in 2009 it was 43% of economic activity, and 27% of employment).

Figure 1.4 The composition of the Jersey economy

(a) Value-added by sector (2009) (b) Employment by sector (2009)

Error! Not a valid link.

Distribution 15%

Financial intermediation 27%

Other business activities

14%

Electricity, gas & water 1%

Manufacturing 2%

Agriculture 4%

Public administration Transport and 12% communication

5% Hotels, restaurants,

bars Construction

10% 10%

Source: States of Jersey Statistics Unit

Jersey is a small Island economy and, as such, is constrained in several dimensions. Business must compete for a limited number of resources, particularly in respect to employees and land, although capital may be scarce as well. The small size of many local markets for products and services means that local businesses aimed at the local market are unable to exploit economies of scale (although they may be able to take advantage  of economies  of  scale  available  elsewhere).  Due  to  the  limited amount  of  capital  available  locally,  they  likely  cannot  raise  large  amounts  of capital/finance on the home market (although this is probably less true in Jersey than in other small island jurisdictions given the expertise of the local finance industry). Transport costs are higher than they might be elsewhere and there is an inevitable dependency upon a limited number of transport links.

Because the local currency is pegged to UK pound and the economy is highly dependent on imports, it is likely that a significant proportion of inflation is imported, with local conditions and policies playing an important role in determining the wedge between UK and Jersey inflation. Further, since the exchange rate is pegged to the UK currency, monetary policy (i.e. the ability to influence/set the interest rates in the local economy) is not available as a policy lever to influence the Jersey economy.

As a consequence, while many of the drivers of economic growth will be the same, the approach to economic growth in Jersey will have to take these constraints into account more than might be the case in larger, less constrained, economies.

4. Recent economic growth performance and measures of success

In  the  post-war  period,  and  particularly  in  the  1980s  and  1990s,  Jersey  saw substantial growth in measured economic activity. Figure 1.5 (a) shows actual GVA (in blue) and the trend, or potential' GVA (in red) between 1976 and 2009. This growth was driven in no small part by the growth of the financial services industry in the Island. It is clear that the last ten or so years have not seen the same rates of growth as the Island previously experienced. In fact, over the last economic cycle, overall activity was broadly flat (Figure 1.5 (b)) and measured productivity actually fell.4

4 The compound annual growth rate (CAGR) of GVA per FTE over the economic cycle 2000-2007 (both peak years) was slightly negative ( -0.5%).

Figure 1.5 Recent economic performance in Jersey

(a) GVA since 1976 (b) Most recent economic cycle

Index, 1998=100

130 120 110 100 90 80 70

60 50 40

1976 1980 1984 1988 1992 1996 2000 2004 2008 2012

£mn, 2003 constant prices 3,600

Full economic cycle 3,500

(peak-to-peak)

3,400 3,300 3,200 3,100 3,000 2,900

1999 2001 2003 2005 2007 2009

Source: States of Jersey Statistics Unit, Economics Unit calculations

However, measured economic activity in Jersey needs to be interpreted with care. A substantial proportion of GVA is made up of the profits of the financial services sector, which can be quite volatile and which fell nearly 30% over the past economic cycle. The trends in this component of GVA can be vulnerable to one-off factors which  may  or  may  not  relate  to  changes  in  the  real'  economy  in  terms  of employment  and/or  tax  revenue.  Excluding  financial  sector  profits, the  other components of GVA actually grew by around 13% or 1.5% p.a. over the economic cycle (Figure 1.6 (b)).

Figure 1.6 A more detailed look at GVA

1. Real GVA £m 2003 prices

3,500 3,300 3,100 2,900 2,700 2,500 2,300 2,100

1,900 1,700 1,500

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

2. Change and contribution to GVA growth over last economic cycle

Total % change, 2000-2007. Figures over the bars are the compound annual growth rates

20% 15% 10% 5% 0% -5% -10% -15% -20% -25%

Exc. Financial GOS Financial GOS Total

Note: GOS stands for Gross Operating Surplus, and is essentially the profits of companies. GOS, together with Compensation of Employees and the profit/income of sole traders, add up to total GVA.

Source: States of Jersey Statistics Unit, Economics Unit calculations

Further, the relatively small size of the economy and the large size of some financial services firms can mean that one-off events in certain organisations can affect the headline figures, whereas in larger economies they would get lost in the fluctuations of the rest of the economy.

All this suggests that a focus on measured GVA growth is perhaps not the right approach. Therefore, while it is a useful indicator, the approach taken by this growth strategy is not to specify a target rate of economic growth measured by GVA, as has been done in the past. In addition, it is suggested that a wider basket of indicators are taken into account when considering the success of this strategy, for example including, but not limited to:

• Employment
• Unemployment
• Average earnings and income distribution
• Economic participation
• Sustainable public finances
• Improved infrastructure

• Population
• Islanders' perceptions of quality of life
• Environmental objectives
• Highly valued public services
• Life expectancy
• Public safety and levels of crime

5. Existing strategies and commitments

The previous Economic Growth Plan was written in 2005 (P.38/2005). It set out how the Economic Development Department (then Committee), would deliver the target of 2% real economic growth per year for the next 5 years (i.e. until 2009) that had been agreed by the States in July 2004. This has guided and shaped a variety of policies that the States has implemented since, and continues to implement to this day, that are designed to encourage economic growth. However, now is an appropriate time to set out a new strategy to build on the successes of the Economic Growth Plan.

As outlined in the introduction, there are 2 other existing policies that are likely to interact with economic growth and its determinants. These are the strategy to deal with the ageing population and the 2009-2014 States Strategic Plan.

The 2009-2014 States Strategic Plan contains a commitment to maintain a strong, environmentally sustainable and diverse economy', and to continue work to diversify the economy, support new and existing businesses, attract low footprint / high value business from elsewhere and foster innovation.' Other commitments that are relevant for  economic  growth  are  the  commitment  to  maintain  and develop  the  Islands' infrastructure' and to maintain high quality education and skills.' There is no explicit target  within  this  document  with  respect  to  economic  growth  or  any  of  its determinants,  with  the  exception  of  the  reiteration  of  inward  migration  target, discussed further below.

Ageing Population

Jersey, like many economies, is facing the prospect of an ageing population as fertility declines and longevity increases. Figure 1.7 illustrates what this is projected to look like in Jersey in the scenario without any net inward migration: not only would the total population be projected to fall, but the ratio of the number of people in the working population to those that are not of working age, or dependent' (i.e. those too young or old to work) will change substantially over the next 20 years. Specifically, in this scenario it is estimated that the Island would go from a situation where there are two people of working age for every dependent, to a situation where there was just 1.3. This has substantial implications for the ability of the government to provide public services as there are less people working to support a growing number of dependents and also the total level of economic activity that can be sustained by a shrinking working age population.

Figure 1.7: Projections of total population and the support ratio in Jersey

Support ratio is calculated as the working age population divided by number of those not of working age. It is also the inverse of the dependency ratio.

1. Total Population

180,000 160,000 140,000 120,000

100,000 80,000 60,000

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065

2. Support Ratio

2.2 2.0 1.8 1.6 1.4 1.2 1.0

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065

Source: States of Jersey Statistics Unit

The previous Council of Ministers looked at this issue, and found that the net cost of the ageing population was likely to be in the region of £190m by 2035, under the assumption of no net inward migration (CoM Population Policy, 2009). The CoM proposed to deal with it in several ways, as set out in Imagine Jersey 2035 and the most recent Population Policy supporting the Strategic Plan. One of the ways in which the costs of an ageing society are to be met is by raising the level and growth rate of economic activity, through policies that affect its determinants. As set out above, these are productivity, structural change, hours worked, participation rate, the pension age and the level of inward migration.

Thus the Population Policy set out the key commitments concerning population size and inward migration, which are to:

• Maintain the absolute level of the working age population in the Island
• Ensure the total population does not exceed 100,000
• Ensure population levels do not increase continuously in the longer term
• Protect the countryside and green fields
• Maintain inward migration within a range between 150 and 200 heads of households per year in the long term
• In the short term, allow maximum inward migration at a rolling five-year average of 150 heads of household per year.

The net contribution to the cost of the ageing population (relative to net nil inward migration) of 150 heads of household per year has been estimated at approximately £11m per year by 2035 and £19m per year by 2065 (Figure 1.10).

Further proposals have been made which would see increases in the age at which the state pension was payable, increasing workforce participation, and new forms of public contributions to fund the costs of an ageing population such as residential care insurance and health insurance. The latter does not increase economic growth, but the former will do by increasing the number of people of working age who are in work or looking for work.

Figure 1.8 summarises the assumptions behind the determinants of economic growth that were used by the Population Policy and the most recent Strategic Plan.

Figure 1.8: Existing commitments concerning economic growth and its determinants

Ageing Population

Measure Fiscal Impact  Strategic Plan

by 2035

Productivity 1% per year £40-70m

continue work to diversify the economy, support new and Shift 2-3k into high

Structural Change £10-15m existing businesses, attract low footprint / high value

value

business from elsewhere and foster innovation Hours Worked

2-3k more people

Participation Rate £10-15m

active in labour market

Number of Jobs

reviewing pension provision, including a review of the age at Pension Age Increased by 3-6 years £30-60m which the Social

Security pension is first payable

Inward Migration +150 HH p.a £10m +150 HH p.a.

Islanders pay more in

£30-50m taxes/contributions

TOTAL £140-235m

Source: Council of Ministers – Population Policy

It is important to note that realising the assumed economic growth of 1% per annum is going to be a crucial component ensuring that Jersey is able to meet the challenge of the ageing society. If these commitments to raise the level of economic activity cannot be achieved, it will be much harder to tackle the rising costs of an ageing population.

It also needs to be recognised that to some extent the economic growth that could be achieved within the constraints of these assumptions has already been earmarked to finance the costs of an ageing population. Only growth over and above this can be used to finance other policies or fiscal deficits, and it is important that potential growth is not "double-counted".

6. Can more be extracted from economic growth?

In order to use the proceeds of economic growth for anything over and above what has already been allocated to deal with the ageing population – for example, to raise money to close structural deficits in the public finances or to finance investment and improved public services – a higher level of economic growth would have to be achieved.

Work  by  the  Economics  Unit  suggests  that  the  economy  was  operating  near sustainable level of economic activity in 2006 (Figure 1.5 (a)). This analysis was based on a combination of statistical and theoretical methods to determine trend growth in the past and then corroborated by data on other variables.

Taking  2006  as  the  most  recent  year  when  the  economy  was  producing  at  a sustainable  level,  Figure  1.9 illustrates  the  path  of  potential  output  under  three different scenarios of 0%, 1%, and 2% trend growth. Clearly small differences in growth rates can make a substantial difference in the level of potential output after only a few years, due to the compound nature of growth rates.

Figure 1.9 Illustration of different trend rates of growth Real GVA, index 1998=100

200 175 150 125 100 75 50 25 0

1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020 2024 2028

Source: Statistics Unit. Economics Unit calculations

However, while small differences in growth rates make a large difference over the medium and long term, achieving even small increases in the growth rate can be very difficult. Governments of already highly developed economies have found it extremely difficult to identify a solution that leads to long-term increases in the rate of productivity growth.

Analysis by the Economics Unit suggests potential productivity growth per worker in the future in the region of 0.4% to 1.2%. As a consequence, even with active policies to encourage and promote economic growth, the 1% productivity growth assumed as part of the strategy to deal with the ageing population appears to be at the top end of the range of reasonable assumptions.

This is likely to be particularly the case when:

• The  number  of  hours  worked  by  those  in  work  is  not  something  that government  has  much  influence  over,  and  may  not  be  a  desirable  or sustainable route to economic growth.
• The participation rate is already high, and the goal of getting an additional 2,000-3,000 more people active in the labour market is probably the most that could be relied upon.

• The number of jobs is not something that the States can influence directly. Further, it  is  already  doing  what  it  can  in  terms  of  keeping  the  Island competitive and attractive for businesses.
• The discussion about the age at which the Social Security pension is first payable is an ongoing one, but the assumption that 3-6 years could be added to it remains a reasonable one, and anything more, while possible, should not be relied upon.

Consequently, achieving  a higher  level  of  economic  growth  would  require  more radical approaches taken towards the determinants of economic growth that remain, particularly, inward migration and structural change.

There is unlikely to be much scope to change policy on inward migration in the near future. In the most recent restatement of the Population Policy the CoM stated that:

Despite what could be argued is a more acute need to maintain the level of the working population in the Island, having listened to public opinion, the CoM has revised its policy proposal for inward migration from 200 heads of household (c.430 people) per annum to 150 heads of household (c.325 people).'

As Figure 1.10 shows, increasing the level of inward migration would have a positive impact on the fiscal position of £4m a year by 2035 and £6m a year by 2050. But inward migration is not simply important for the fiscal position. As pointed out above, an ageing population leads to a higher dependency ratio and a lower working age population. This in turn can lead to shortages of sufficient labour to maintain the success of the economy, and thus risk the prosperity of the Island. In contrast, allowing controlled inward migration can mitigate these risks and allow the economy to continue to prosper even in the face of challenges from an ageing population.

Figure 1.10: The net effect on the fiscal position of inward migration

£m, relative to nil net inward migration

2035 2050

Source: Oxera calculations

With respect to structural change in the economy, again there is not a lot of scope to be more radical than that which has already been committed to i.e. shifting a total of 2,000-3,000 jobs into higher-value sectors. If it were possible to shift a further 2- 3,000 jobs (making 4,000-6,000 relative to 2005) into higher value sectors, this could be expected to raise £20-30m in additional taxes.

Analysis for Imagine Jersey suggested that the absolute maximum proportion of the private sector that could be directly employed in financial services is around half. This would be equivalent to 40% of the working population (as the public sector is around 12%). Currently around 25% of the working population is employed by the financial sector, and the commitment to shift 2-3,000 more jobs across would bring this number to 30%. Shifting another 2-3,000 jobs would raise it further to around 35%, and approaching the maximum.

Two options are shifting jobs from relatively low value-added sectors into either (a) the finance sector, or (b) other, non-financial, but high-value, low footprint sectors.

The first option may be seen to contradict the existing commitment to maintain a strong, environmentally sustainable and diverse economy', since shifting a greater number of jobs into finance could be seen as the opposite of diversification. Although it is conceivable this could be achieved by diversification within finance as discussed in more detail in Section 8.

While the second option of diversifying into non-finance business that is high-value added and low-footprint would be consistent with a diversification agenda, it would also require new sectors of the economy that can deliver wages and value-added of a similar magnitude as the finance sector currently delivers. Very few candidate sectors currently exist. Should one emerge this would raise additional revenue, however relying on the emergence of such a sector would not be prudent. In addition, this is also exactly the type of employment that all economies (and in particular other small island economies) are looking for, so Jersey would need to be fleet of foot to ensure that it became the place where these new sectors located.

In summary, most of what is achievable in terms of economic growth has already been factored in to policy decisions concerning the ageing population, although clearly a new Economic Growth Strategy is still needed to set out how to achieve it. While it will still be important to encourage productivity growth, experience suggests that raising trend growth in this manner is very difficult. The only other plausible way to increase economic growth is through further structural change. Diversification into high footprint/low value industries would contradict the objective of maintaining a strong economy, and would not provide extra revenues for dealing with fiscal pressures. However, using structural change to boost economic growth could be consistent with a diversification objective provided that the commitment to diversify the economy and the commitment to attract low footprint/high value business from elsewhere are taken together, and that any diversification is achieved through encouraging low footprint/high value industries. This could include diversification

within the finance industry into new markets and products. The issue of diversification is explored further in Section 8.

7. Justifying Government Intervention

There may be a number of different ways for a government to intervene to promote economic growth, whether it be through government providing certain goods and services, or by setting up rules and structures. Regardless how the government intervenes, it is important that is does so in a manner that is effective and leads to the most desirable outcomes.

When the issue is government expenditure, a key issue is to ensure that limited government funds (for any given level of taxation) are spent on the activities that provide the greatest benefits to society and that they are spent in the most efficient way. Similarly, when the government is intervening in other ways, for example by introducing new laws or regulations, it is important that are designed to minimise costs and maximise benefits.

This section provides a consistent framework for assessing potential government interventions and ensuring that the States of Jersey only implements policies, programmes and projects that will maximize improvements in efficiency.

The first step is to make the case for action by identifying a clear need which is in the national interest for the government to address. The rationale for government intervention is essentially two-fold:

• Improving economic efficiency by working with markets to achieve more desirable outcomes
• Achieving social objectives such as equity.

Satisfying one of these conditions is  necessary, but  not sufficient to justify government intervention; in addition, it is crucial that such intervention would improve the situation and to a greater extent than alternative options. In other words, the expected net benefit of a proposed government intervention needs to be compared against the alternative of doing nothing as well as against other policy options.

It should be noted that although the implication is that no government intervention is the default position, this is not necessarily because markets are generally to be trusted to deliver the right outcome and market failures are the exception. In contrast, the instances of market failure may well be in the majority. However, government intervention still needs to be justified on the basis of both (a) the existence of market

failure, and (b) the likelihood that intervention will improve matters. This not only guards against distorting those markets that would otherwise function well, but it should, as part of the process, clarify the reasons for government involvement and therefore give an indication as to what the appropriate and most effective intervention may be.

Economic efficiency

Economic efficiency is reached when it is not possible to make anyone better off without reallocating resources from someone else, thus making them worse off by the same amount or more. If an economically efficient outcome is achieved, this ensures that total resources (inputs) are allocated in the most productive manner (i.e. maximising output).

In some cases the market mechanism is able to achieve an economically efficient outcome; however this is not always the case. Where the market mechanism cannot achieve economic efficiency it is referred to as a market failure', and can occur for the following 4 reasons:

1. Externalities: These occur when an activity produces benefits or costs for other activities that are not taken into account by market prices. For example, the private returns which an individual receives from a particular action (e.g. pay or profits) differ from the returns to society as a whole (e.g. the actions incur additional costs, such as pollution, which fall on others). The typical example is where a firm polluting a river does not take into account the costs it is imposing on those who have to clean the water for their use.
2. Public goods: The market may have difficulty in supplying and allocating certain types of products and services that can be classed as public goods. Public goods generally exhibit one or both of 2 characteristics:

1. Non-rival – consumption of the good by one person does not prevent someone else using or consuming that good e.g. knowledge, clean air.
2. Non-excludable – means that if the good is made available to one consumer it is effectively made available to everyone e.g. national defence. This can give rise to free riding where some consumers fail to pay for the provision of the public good and let others do so.

3. Imperfect information: Buyers need to know the quality of a good or service to judge the benefit it can bring them and sellers need to know the reliability of a buyer. Where such information is not available to both sides of the market there is asymmetry of information and market failure can exist. This can lead to moral hazard (e.g. people with insurance taking less care) and adverse selection (e.g. only those who known they have the highest risks take out insurance).
4. Market power: This arises as a result of insufficient actual or potential competition to ensure that the market operates efficiently. This can occur where high start-up costs deter entry by competitors, economies of scale or through organisations acting strategically to protect their position.

Equity

The other key rationale for government intervention is to achieve equity objectives. Government can use policy to achieve distributional impacts through the way the different costs and benefits are distributed across different groups.

Additionality

To calculate the success of a government intervention (in terms of employment or output) it is necessary to calculate its additionality. That is, the net impact after taking into account what would have happened in the absence of the intervention. There are 3 specific ways in which the net benefits may not be as large as they first appear: deadweight, displacement and leakage.

In the context of public policy interventions, the term deadweight is used to refer to the costs of achieving outcomes which would have occurred without the intervention.5

Displacement (or substitution) measures the extent to which benefits of a project are offset  by  costs  elsewhere  – for  example,  reductions  of  output  or  employment elsewhere in the economy.6 Leakage refers to cases where the benefits of (Jersey government)  expenditure  accrue  to  those  outside  the  Island.  For  example, expenditure by Islanders on imports sends money away from the Island and the benefits such as jobs will be found in the country of origin.

5 This is slightly different from the other use of the term deadweight in economics, as in deadweight loss, which is the inefficiency or lost value that arises from a policy intervention such as a tax.

6 The difference between displacement and substitution is a subtle one. If, for example, a public intervention increased employment in activity A in Town 1, this would be the gross benefit. To the extent

that activity A falls in Town 2, there would be displacement. To the extent that there is less activity B (wherever it may take place), there would be substitution.

Implications for Policy

In order to ensure that limited public funds are being used to maximum effect, department policies relating to economic growth and development should be evaluated against the following questions in a comprehensive but proportionate manner:

• Can government intervention be justified?

• Is there a market failure or a social objective that the market outcome will not achieve on its own?
• Can government intervention improve the situation relative to the do nothing' alternative?

• Is the proposed intervention an effective use of public money? Have other options been examined and is the proposed intervention the most effective way of achieving the objectives?
• Does the proposed intervention encourage sustainable economic growth, or at the very least, is it consistent with it?

Government intervention can then be validated, objectives set and options reviewed by analysing their costs and benefits. In each case a range of possible approaches and policy options which may achieve similar results should be considered, where possible attributing monetary values to all impacts of any proposed policy and assessing the costs and benefits for relevant options. A good guide to undertaking analyses of this sort can be found in the Green Book produced by the UK Treasury, and Figure 1.11 illustrates how the policy process should work in theory. The advice of the Economics Unit could be sought at the key stages in the cycle, although clearly implementation is a matter for the States department concerned.

Figure 1.11 The Policy Cycle

Rationale

Feedback Objectives

Evaluation Appraisal

Implementation

Monitoring

Discontinue ineffective policies

Source: Adapted from HM Treasury – Green Book

The intention is that this growth strategy forms an overarching set of principles by which policies can be guided. While these principles are unlikely to change over the short- to medium-term, the policies that are intended to encourage economic growth should be  developed  within  the  policy  cycle;  that  is, they  should be  continually assessed, evaluated and revised where appropriate to ensure that they are still consistent with these principles and that they are effective in achieving the objectives that they were designed for. There should be a standard policy development process across all the key elements of the economic growth strategy.