Whenever economists talk about the economic growth of Mauritius, the debate inherently tilts towards investment and savings. It is certainly true that the current investment savings gap remains a major challenge to the sustainability of the current growth path, especially if the largely IRS-driven foreign direct investment inflows begin to plateau over the next few years.

Traditional economic theory has always maintained that the causality runs from savings (with investment correlated to savings) to economic growth.

Essentially, the more you invest, the more you grow. However, recent economic studies around the world have shown that for certain countries it is actually higher growth that has caused higher savings. Furthermore as you continue to increase your capital stock (through investment), it becomes increasingly difficult to generate extra returns. Hence one should not ignore the importance and contribution of total factor productivity growth to long term economic growth.

If one consults Central Statistics Office data, between 1995 and 2005, total factor productivity growth averaged a dismal 0.6% and contributed a mere 12% to total GDP growth, while growth in the capital stock averaged 5.3% and its contribution to overall GDP growth stood at 77%.

Growth in labor input (the third input in an economy?s production function) averaged 1% and contributed 11% to overall GDP growth. What is even more striking about our economy is the fact that while labor productivity averaged 3.7% during that time, unit labor costs expanded by 4% as compensation to employees increased by an average 7.9% per annum.

Fortunately, with our Rupee on average having depreciated vs. the US dollar during the same time period, unit labor cost actually averaged a decrease of 0.8% per annum in US dollar terms. In sum, our lack of competitiveness and high rates of compensation were made up by a weakening domestic currency and trade preferences.

While politically unpopular, it will be important for the Government to continue to limit growth in compensation and link it to productivity growth in order for the country to be better off in the longer term. The current interest rate environment remains high and imposes obvious limits to capital expenditure by the private sector. This is simply because the weighted average cost of capital for many companies remains above the return that they can potentially get on the project that they wish to invest in.

<B>Enhance economic efficiency</B>

Despite the fact that the reform process remains our best chance for a better future, capital input growth from the domestic side is not likely to be able to maintain a high growth momentum for many years unless the cost of capital (read inflation) is brought down and converges to the global average. In this context, we should do everything we can in order to improve productivity growth by gearing policy towards improving technology, efficiency and human capital. Whether we like it or not, we live in an increasingly competitive and globalizing economy, where leftist policies and inflexible labor unions hinder overall growth.

Moreover, the country will constantly need to move up the value chain in order to improve productivity and remain competitive.

India for example has shown that human capital can drive economic growth forward. It is in this light that one should view the funding given to the University of Mauritius as being insufficient.

We recently conducted a Granger causality test on savings and growth in order to establish the direction of causality at the most efficient lag.

While our sample size remains relatively small, our initial results indicated that at the most efficient lag level, the direction of the causality was bilateral in nature (no single variable was causing the other variable to change but rather both were).

While we do not wish to draw conclusions on the validity of such a test on the limited sample size that we had, policy geared towards enhancing economic efficiency should not be ignored as it remains the key to long term sustainable growth.

<B>Contributed by INVESTMENT PROFESSIONALS LTD</B> (Feedback: [email protected])