Chapter

12 Integration and Growth in the Eastern Caribbean

Author(s):
David Robinson, Paul Cashin, and Ratna Sahay
Published Date:
September 2006
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Author(s)
Montfort Mlachila, Wendell Samuel and Patrick Njoroge 

This chapter explores the extent and effects of regional and international integration of the Eastern Caribbean Currency Union (ECCU) countries.1 It reviews their basic integration strategy, achievements, and shortcomings. It focuses on various aspects of integration to show how, despite being fairly open economies, the ECCU countries are not fully integrated into the global economy. The chapter then explores empirically the contribution of integration to growth in the ECCU.

ECCU countries have developed behind a wall of high protection, combined with significant product and factor market rigidities. While this helped increase intraregional trade to a limited extent, real income growth has significantly slowed over the past six years. The ECCU countries have developed uncompetitive production structures, and real wages have tended to increase more than productivity growth. The chapter draws on various aspects of the literature—with particular emphasis on factor market integration—to address one of the major policy challenges facing ECCU countries. The chapter takes a broad view of integration to encompass many aspects of liberalization of trade in goods and services and of factor markets through regional and multilateral integration arrangements.

Integration and Growth Literature

Traditional Approach

There is general agreement among mainstream economists that international trade promotes growth and development. The general consensus can be characterized as follows. International trade leads to higher growth by reallocating scarce resources to those sectors in which a country has a comparative advantage, thereby increasing output and income levels through gains from specialization. Measures to improve trade, such as integration at the regional and international level, can, therefore, be expected to raise growth rates.

According to Haveman, Lei, and Netz (2002), there are three channels to increase growth through integration and trade. First, integration increases communication, thereby facilitating the transmission of technology. Second, integration leads to an increase in the size of the market, thus increasing gains from economies of scale. Finally, greater competition promotes research and development. Moreover, knowledge spillovers, which reduce duplication of research and development, are an increasing function of the volume of trade between countries.

Among others, Sachs and Warner (1995) document that trade and integration are major determinants of growth in poor countries. Using cross-country indicators of trade openness for more than 100 developed and developing countries over a long period of time (about 40 years), and controlling for other policy variables, they show that the lack of economic convergence in income levels in most developing countries is explained by a closed trade regime. They also show that open economies are usually successful in avoiding balance of payments crises.

Recent Developments and Critique of the Traditional Approach

Much of the debate in recent years has been over whether the mere presence of trade, absent other factors, is a key ingredient in promoting growth. Recent literature (Frankel and Romer, 1999; Dollar and Kraay, 2004) focuses on problems related to the potential endogeneity of trade and integration with other growth-raising reforms. This literature notes that countries with liberal trade policies are likely to be those with other growth-inducing policies, such as those that promote physical and capital accumulation, as well as technological change. To counter critiques of the traditional approach, these authors have attempted to use instrumental variables techniques to test whether or not trade by itself leads to higher growth.

The research on liberalization of trade in services has generally been less successful in demonstrating the potential benefits of liberalization on growth. In a review of the literature, Whalley (2003) concludes that the studies are confusing and sometimes contradictory, and often fraught with serious methodological problems. Trade in services is typically subject to greater barriers than trade in goods, including rights of establishment, rules of conduct, and competition rules. Whalley concludes that studies that typically find a strong impact on income and welfare suffer from biases resulting from misspecification of models. Models that assume no accompanying liberalization of factor markets typically find a weak impact on income and welfare. On the other hand, if liberalization of services extends to removing impediments to factor flows, especially foreign direct investment (FDI), then gains are usually large, but also uneven across countries.

In a fundamental critique of the trade and growth literature, Rodrik, Subramanian, and Trebbi (2004) argue that it is erroneous to give the “integration view” a central role in fostering economic convergence between poor and rich countries. They argue that this approach focuses on superficial determinants of growth. In their view, it is necessary to answer the question of why some societies manage to accumulate and innovate more rapidly than others. They organize their approach by looking at what they consider to be “deeper” determinants of growth, citing three key ingredients (using various measures): geography, integration, and institutions. In contrast to most of the prevailing literature, they find that the quality of institutions trumps everything else. They show that once institutions are controlled for, integration has no direct effect on incomes, while geography has at best weak direct effects. Their measure of institutional quality—property rights and the rule of law—is statistically significant, and their results are very robust to various statistical tests, including endogeneity between institutions and integration.2

Application to the ECCU

By promoting transparency and nondiscriminatory practices, regional integration can promote good institutions. Although Rodrik, Subramanian, and Trebbi (2004) are quick to point out that their study does not offer clear policy implications, it can be argued that effective local and regional institutions foster regional integration and growth. What does the literature tell us about the merits of pursuing regional integration as a way to promote trade, investment and growth, and institution building? Does regional integration indeed lead to more trade in general? What about the evidence for the Caribbean Community and Common Market (CARICOM) and the ECCU?

From a theoretical perspective, the economic effects of integration in the form of a trading bloc are, in fact, ambiguous, and can lead to trade diversion. Gunning (2002) shows that in a South-South trading bloc, poorer members will typically suffer from the loss of revenue, and may well see a shift in the concentration of production into the wealthier and more industrialized members. Wealthier members benefit from protection from imports from the rest of the world through a common external tariff. A simple diagrammatic presentation from Gunning (2002) illustrates this point (Appendix 12.1).

Regional trading arrangements (RTAs) may well be the best way forward in as far as liberalization of services is concerned, according to Stephenson (2002). This has less to do with the intrinsic merits of RTAs, and more to do with the weaknesses of the General Agreement on Trade in Services (GATS). Stephenson shows that RTAs in services, including those of CARICOM, have surpassed those of the GATS in terms of promoting transparency and stability of agreements. While the GATS has a positive list approach for services to be liberalized, RTAs typically assume that all services will be liberalized with some exceptions (negative list). RTAs also usually have an explicit clause precluding the introduction of any new restrictions on services trade. Stephenson concludes that although in general the optimum level of liberalization is at the multilateral level in order to attract and accommodate investment from the most efficient service operators, the regional level may well be the most appropriate and realistic, given the practical limitations.

Most South-South RTAs have been found empirically to promote trade. Using a gravity model, Cernat (2003) shows empirically that RTAs are generally trade creating, with little trade diversion. For CARICOM, Egoumé-Bossogo and Mendis (2002)—using the gravity model framework for 1980–99—find that CARICOM promoted intra-CARICOM trade as well as trade with the rest of the world. In other words, they find little evidence of trade diversion within CARICOM. In a recent study on Vietnam, Tumbarello (2006) finds that RTAs in the Asia and Pacific region have indeed promoted trade among their members, and that this effect has been particularly strong for Vietnam, where little trade diversion has been observed.

ECCU Experience with Regional Integration and Growth

Objectives in the Caribbean

Regional integration in CARICOM was initially viewed as a way to facilitate import substitution and industrialization at the regional level after national opportunities were exhausted. Since the size of individual domestic markets was a major constraint to production (Demas, 1965, 1974), early efforts focused on market integration—removing impediments to regional trade of manufactured and agricultural goods and widening the protected domestic market. The initially-high common external tariff (70 percent) was a deliberate effort to divert trade from third countries, since none of the CARICOM countries would have been the least-cost producer of manufactured goods. The high tariffs were expected to have a secondary effect of encouraging FDI flows, as firms from third countries would establish branches behind the tariff walls to try to retain their markets. A second objective of regional integration was to exploit complementarities in the resources of the region through the integration of production (Brewster and Thomas, 1973; Blake, 1984).

Joint trade negotiations aimed to increase bargaining power and therefore raise the terms of trade, while at the same time CARICOM pursued the provision of common services to benefit from scale economies (Demas, 1974). Andriamananjara and Schiff (1998), using theoretical analysis of bargaining power and high fixed costs of negotiating, have argued that CARICOM has been exceptionally successful in enhancing its bargaining power beyond its size and economic importance by concluding agreements such as the Lomé Convention, Caribbean Basin Initiative, and the Caribbean-Canada Trade Agreement (CARIBCAN). The Lomé Convention and the successor Cotonou Agreement conferred higher export prices for Caribbean products. Similarly, high fixed costs of production have been used to justify the provision of common social services like tertiary education and some health services in CARICOM.

Figure 12.1.Regional Integration Groupings in the Caribbean

Notes: BVI denotes British Virgin Islands; CARICOM denotes Caribbean Community and Common Market; CSME denotes Caribbean Single Market and Economy; ECCU denotes Eastern Caribbean Currency Union; FTAA denotes Free Trade Area of the Americas; OECS denotes Organization of Eastern Caribbean States.

The ECCU countries participate in a series of concentric integration initiatives that cover a variety of areas (Box 12.1 and Figure 12.1). Amid the plethora of integration initiatives there are two distinct broad processes. The first involves the smaller group of Caribbean Leeward and Windward Islands (the ECCU countries) that have formed the Organization of Eastern Caribbean States (OECS),3 while the second covers the wider Caribbean region in the form of CARICOM. A description of the features and previous achievements of these regional integration initiatives can be found in the study by Njoroge (2003). Consequently, this section focuses on the recent achievements and agenda of both the OECS and CARICOM.

The Organization of Eastern Caribbean States

The OECS was established by the Treaty of Basseterre signed in June 1981 by seven of the region’s governments: Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines. Since then, the British Virgin Islands and Anguilla have both been admitted to the OECS as associate members.4

The overarching objective of the OECS is the creation of an economic union of its member states. Pursuing an economic union was first agreed to by the OECS Authority in July 2001.

At the January-February 2002 meeting of the OECS Authority, the heads of government agreed on, among others, the following measures for member states:

  • Legislative arrangements to facilitate the free movement of OECS nationals should come into effect not later than March 12, 2002.

  • Amending of the National Immigration Acts to allow OECS nationals to travel freely within the subregion and remain in another territory for a period of six months.

  • Not applying the Alien Land holding Licenses to OECS nationals in Dominica, Grenada, St. Lucia, and St. Vincent and the Grenadines; while the licenses remain in the other member states, measures would be contemplated to exempt OECS nationals from payment of the license fees.

  • In addition to regular passports and travel permits, accepting photo identification cards, including a driver’s license and national identification card, at ports of entry.

  • Introduction of a common passport for OECS nationals by January 2003. Persons granted economic citizenship would not be issued an OECS passport.

At its October 2002 meeting, the OECS Authority reiterated its commitment to creating the OECS Economic Union and agreed to appoint a committee that would review the Treaty of Basseterre and recommend how it could be aligned with the requirements of an economic union. The OECS Authority also established target dates for the free movement of goods and services (end–2003) and free movement of labor (end–2007), and endorsed the Eastern Caribbean Central Bank’s program to develop the financial and capital markets. It was expected that a draft of the revised treaty would be ready for review in the second half of 2005.

Box 12.1.Preferential Trade Arrangements in which ECCU Countries Participate

The countries of the Eastern Caribbean Currency Union (ECCU) participate in a series of concentric and sometimes overlapping trading arrangements that accord them varying degrees of trade preferences (Figure 12.1). These agreements coexist with the negotiations under the World Trade Organization (WTO) for multilateral trade liberalization. The following is a brief description of the major preferential trading agreements of the ECCU countries.

The Organization of Eastern Caribbean States (OECS) is the tightest integration grouping of the ECCU. Created in 1981, it includes all eight members of the ECCU and the British Virgin Islands. The major goals are to promote economic integration, manage a common currency via the Eastern Caribbean Central Bank, set up a common judicial system via a joint supreme court, coordinate civil aviation activities and telecommunication services, and maintain joint overseas missions. Discussions are under way to create an economic union by 2006 with free movement of labor.

The Caribbean Community and Common Market (CARICOM), established in 1973, originally included only English-speaking Caribbean countries, but was recently expanded to include Suriname and Haiti. It is essentially a common market for goods and capital, but without free movement of labor. It also provides a framework for common services in education, health, meteorology, and foreign policy. Goods originating within the region are generally traded duty free (there are only a few exceptions). Although a common external tariff was established in 1975 with a maximum rate of 70 percent, it has not been fully harmonized because of delays in implementation. In 1993, the countries agreed on a three-year program to reduce the common tariff to the range of 0 to 20 percent, but to date some members have not fully complied. The integration process is marred by slow implementation of decisions, because countries have been reluctant to surrender some amount of sovereignty to a regional body (Girvan, 2004).

The 1973 Lomé Convention between the European Union (EU) and the African, Caribbean, and Pacific countries, provided one-sided, duty-free access into EU markets for goods that meet the rules of origin. Imports of bananas, rice, and sugar were governed by protocols, which conferred higher than world market prices for these products in line with the EU’s Common Agricultural Policy. Thus, Dominica, Grenada, St. Lucia, and St. Vincent and the Grenadines benefited from higher banana prices, and St. Kitts and Nevis from higher sugar prices. Latin American banana producers successfully challenged the banana regime under the WTO, which has resulted in reforms that reduced the level of protection. A similar challenge to the sugar regime was upheld by the WTO in 2004. The Cotonou Agreement (2000) updated the Lomé Convention to be consistent with WTO policies, but the commodity protocols will continue, subject to periodic review. Negotiations are continuing for the eventual creation of reciprocal economic partnerships, which include reverse reciprocity of any preferences extended to third countries.

The Caribbean Basin Initiative (CBI), which began in 1984, also offers nonreciprocal, duty-free access of some goods to the United States that meet the rules of origin and some other criteria. The CBI has not been as beneficial as Lomé because of the initially narrow range of goods and the advent of the North American Free Trade Agreement (NAFTA), which later eroded the preferences. The list of goods was expanded in 2000 for eight years, and this has partially reversed the erosion.

The benefits of CARIBCAN—which provides nonreciprocal duty-free access into Canada—are also constrained by the range of goods, uncertainty of duration, and NAFTA. The Free Trade Area of the Americas agreement, under negotiation, will allow all countries in the Western Hemisphere (excluding Cuba) to trade freely in goods and services. The ECCU countries have argued for special and differential treatment in order to reduce the adjustment costs.

While progress has been made in implementing some measures, the countries of the OECS have not been able to meet the implementation schedule that was agreed upon in January 2002. Most progress has been in facilitating travel and freedom of movement in the subregion. For instance, the travel facilitation initiative legislated in 2002 allowed OECS nationals to travel freely within the area and remain in another territory for up to six months. On the matter of removing work permit requirements, the governments of Antigua and Barbuda, Montserrat, and St. Vincent and the Grenadines have agreed, on the basis of reciprocity, to remove those requirements for self-employed professionals and their immediate family, and for self-employed service providers, their technical and managerial staff, and immediate family. The governments of Grenada and St. Kitts and Nevis, while agreeing in principle, expressed the need to consult further with their respective cabinets. The remaining governments undertook to study the proposals and communicate their positions to the OECS Secretariat as early as possible. Regarding common citizenship, a draft of the Common Citizenship Act is already under review by member states.

Other areas of integration in which OECS countries have made progress are in joint representation at world fora and in providing civil aviation services. The OECS has set up a Technical Mission in Geneva to facilitate more effective representation of OECS interests in the WTO. With the passage in the national parliaments of the Eastern Caribbean Civil Aviation Authority (ECCAA) Agreement and a companion Civil Aviation Act, the ECCAA and the Civil Aviation Authority were established in November 2004. These entities evolved from the former OECS Directorate of Civil Aviation, which had been established in 1957. The ECCAA is an autonomous regional regulatory body that regulates and provides safety oversight over all aspects of civil aviation within the territories of the OECS members except for the British Virgin Islands. It is headquartered in Antigua and Barbuda.

The OECS Authority has also adopted the OECS Development Charter, which provides general guidance on the region’s development agenda. Agreement was reached on medium-term targets that included sustained annual real growth of 6 percent, high-quality employment with unemployment of less than 6 percent, poverty levels below 6 percent, Human Development Index targets consistent with international standards, and the establishment of diversified and competitive economies. The agreement also initiated a reform and transformation process that began in January 2003, with the first phase scheduled to end in December 2007. Key priorities of that process include:

  • free circulation of goods and services within the OECS by end–2003;

  • free movement of labor within the OECS by end–2007;

  • maintaining the existing fixed exchange rate system and low inflation;

  • strengthening the fiscal situation by implementing adjustment programs that include tax reform in line with the advice from the OECS Tax Commission, public sector reform that establishes an appropriate expenditure system, greater efficiency of expenditures, particularly in the social sector and the Public Sector Investment Program (PSIP), and improved debt management;

  • reaching agreement on income policies through tripartite committees representing the government, trade unions and the private sector for an equitable distribution of productivity gains; and

  • outlining immediate priorities in tourism, agriculture, manufacturing, and the information technology sectors.

As of mid–2005, progress had been made in each of these areas, especially toward the free movement of labor. Member governments had passed legislation in their national parliaments allowing OECS nationals to travel through the region on a valid photo ID card. A draft Common Citizenship Act is under discussion and agreement has been reached for a common OECS passport. However, the removal of work permit requirements and Alien Land Holding regulations continues to lag. While goods and services move quite freely across the region, there has been little progress toward the removal of remaining barriers.

The OECS governments have agreed to broaden joint international representation to benefit from economies of scale. A joint High Commission has been established in Ottawa, Canada (for OECS members except Anguilla and the British Virgin Islands), and in Brussels, Belgium (for OECS members except Anguilla, Antigua and Barbuda, Montserrat, and Grenada). In June 2005, a technical mission to the World Trade Organization was established in Geneva (for OECS members except Anguilla, Montserrat, and the British Virgin Islands).

Caribbean Community and Common Market

CARICOM was established by the Treaty of Chaguaramas signed in Trinidad in July 1973 by Barbados, Jamaica, Guyana, and Trinidad and Tobago. These countries were joined shortly thereafter by eight other territories, principally from the eastern Caribbean.5

In the 1989 Grand Anse Declaration, the Conference of Heads of Government (the highest decision-making body of CARICOM) established a Caribbean Single Market and Economy (CSME) to integrate the CARICOM economies into a unified market with free movement of goods and services, capital, and labor, thus creating a single economy that operates under the same coordinated and harmonized economic policies. The objective was that this would allow the region to exploit economies of scale from a large internal market and strengthen its international bargaining position in an effort to deal with globalization, but without establishing a political union.

Progress Toward Stated Integration Objectives

CARICOM does not have a good record of implementing the stated objectives. There has been some success in eliminating tariffs on goods originating within the region, reducing the level of the common external tariff, joint international negotiations, and the provision of common services. However, many of the initiatives remain on the books and have yet to be implemented, including rights of establishment, free movement of capital, a regime for free trade in services, and a common currency (CARICOM, 2004). Meanwhile, free movement of labor is limited to some very restrictive categories, such as university graduates, artists, and media workers. This has precluded firms from obtaining factors of production from lower-cost sources, especially in areas where there is a shortage of skills.

To address shortcomings, the original CARICOM treaty was amended by a series of protocols starting in the mid–1990s, but key limitations to integration remain. There are nine protocols, of which the most important deal with organizational structure and administration to help speed up implementation of decisions, rights of establishment and free movement of capital, competition policy, industrial policy, and disadvantaged regions. The full implementation of these protocols as well as the completion of the program for reducing the common external tariff from 5 to 45 percent to a range of 0 to 20 percent was scheduled for 2005 in the context of introducing the CSME (Table 12.1). Free movement of labor would still be confined to limited categories of workers, which have been expand ed to include service providers who have to relocate to trade their services.

Mechanisms to address trade imbalances and assist disadvantaged countries have resurfaced as potential stumbling blocks. OECS members have recently reiterated their commitment to the CSME, but issues such as the imbalances of intraregional trade—for example, Trinidad and Tobago supplies about 65 percent of OECS intraregional imports—have been flagged as requiring urgent resolution. OECS members have also advocated that mechanisms be established to assist the disadvantaged nations within the CSME.

Two factors have hindered the adoption of CSME. First, progress has been slow in bringing national laws into line with the tenets of the protocols. The risk that the CSME may eventually lead to a process of political unification has been a source of concern for many countries. Second, there has been a lack of awareness—and, therefore, ownership—by the public in the member countries.

An important step forward was made in July of 2003 with the signature of four legal instruments related to the establishment and operation of the Caribbean Court of Justice (CCJ). The CCJ was inaugurated in April 2005. When fully constituted, it will replace the Privy Council as the final court of appeal, as well as adjudicate matters related to the interpretation of the CARICOM treaty. While all of the CARICOM members can easily participate in the CCJ, it is uncertain how many members would make it their final court. To switch from the Privy Council, a number of countries require a two-thirds majority in a referendum.

Table 12.1.Status of Implementation of Key Elements of the CARICOM Single Market and Economy 1
Key ElementsOriginal DeadlineNew DeadlineStatusAction Required
Treaty establishing the single market: To encourage competition20002005All 12 countries to which it applies have signed and ratified the revised treatyAll countries except Barbados, Belize, St. Lucia, and Suriname to enact treaty
Free movement of goods: Removal of unauthorized import and export duties on goods of regional origin and removal of discriminatory internal fiscal charges19962005Belize, St Kitts Nevis and Nevis, and St. Vincent and the Grenadines apply duties on a limited range of imported goods;Suriname on export of lumber; environmental taxes apply in some countriesCountries to remove duties and discriminatory charges
Free movement of services: Removal of restrictions on the provision of services20022005List of existing restrictions ratified in 2000; none of the countries has removed all restrictionsLegislative and administrative actions to remove remaining restrictions
Free movement of persons. Provides for free movement of university graduates, media workers, musicians, athletes, and self-employed service providers2002200510 countries have enacted legislation and put administrative arrangements in place for first three categories; Jamaica and St. Vincent and the Grenadines for the last categoryAntigua and Barbuda and St Kitts and Nevis to amend legislation; other countries to take necessary action for the last category–
Free movement of capital: Removal of restriction on the movement of capital within CARICOM and cross-listing and trading on stock exchanges2002200510 countries have liberalized capital account; list of restrictions notified by all members in 2000 and schedule of commitmentsfor removal approved in February 2002Legislative and administrative action to be taken by all countries
Intraregional double taxation agreement1998200511 countries have signed and ratified the agreement and nine have enacted the legislationMontserrat and Suriname to sign and ratify and enact laws; Grenada and St. Kitts and Nevis to enact laws
Rights of establishment: The removal of restrictions on CARICOM individuals and Turns to set up business in other CARICOM countries20022005List of restrictions notified in 2002; schedule of commitments for removal approved in February 2002; Jamaica has taken action toward meeting requirementLegislative and administrative action to be taken by all member states
Common external tariff (CET): Implementation of four phases of the CET, and implementation of revised structure based on 2002 haimonized system (HS) codes1998200511 countries have implemented the fourth phase of CET, and Jamaica and Trinidad and Tobago have implemented the revised structureSt. Kitts and Nevis to implement CET; countries except Barbados, Guyana, Jamaica, and Trinidad and Tobago to implement revised structure
Competition Law: To provide a level playing field for doing business2005Draft law approved; Barbados, Jamaica, and St. Vincent and the Grenadines have taken actionOther countries to enact legislation
Implementation of harmonized customs legislation, regulation, and forms20052005The draft law is being finalizedEnactment of the law
Memorandum Item:
OECS economic union: Initiatives under the Caribbean Single Market and Economy (CSME) plus free movement of labor20062006Most countries have passed legislation for movement of persons under the CSMEAction under the CSME; permit free movement of labor
Source: CARICOM Secretariat website: www.caricom.org.

Quantification of Integration Indicators

Trade in Goods

Regional integration resulted in the expansion of intraregional trade in the early years of CARICOM. Intraregional trade expanded rapidly during the late 1970s up to the early 1980s, and then declined significantly following the collapse of the CARICOM Multilateral Clearing Facility in 1981. The facility collapsed after the indebtedness of some countries related to payments for oil imports exceeded the credit limits of the agreement. Although the facility was never revived, trade recovered during the 1990s as payment arrangements improved and foreign exchange constraints were relaxed. As noted earlier, Egoumé-Bossogo and Mendis (2002) showed that tariff reductions, although still incomplete (Table 12.2), had a positive impact in the context of regional integration on total and intraregional trade in the 1990s. By contrast, membership of the WTO has had a negative impact on the total trade of the region, largely through the dismantling of preferential trading arrangements for banana and sugar exports. This evidence prompts a mixed reaction to integration, but this also could be related to slow progress and short-run adjustment costs of dismantling protective trading arrangements.

Table 12.2.Implementation of Tariff Reductions in CARICOM 1
Phase I

January–June 1993

0 to 35 percent
Phase II

January–June 1995

0 to 30 percent
Phase III

January–June 1997

0 to 25 percent
Phase IV

January–June 1998

0 to 20 percent
Organization of Eastern Caribbean States
Antigua & BarbudaJanuary 2, 1995Not implementedNot implementedNot implemented
DominicaSeptember 1, 1993October 1, 1995January 1, 1999July 1, 2002
GrenadaJuly 1, 1993June 30, 1995January 1, 1999January 15, 2000
St. Kitts & NevisJuly 1, 1993January 1, 1995Not implementedNot implemented
St. LuciaJuly 1, 1993July 1, 1997Not implementedJanuary 1, 2000
St. Vincent & the GrenadinesApril 1, 1993January 1, 1996January 1, 1997January 1, 1998
BarbadosApril 1, 1993April 1, 1995April 1, 1997April 1, 1998
Belize 2Not implementedApril 1, 1997April 1, 1998April 1, 2000
GuyanaJanuary 1, 1994September 5, 1995November 1, 1997April 30, 1999
Haiti 3. . .. . .. . .. . .
Jamaica 4April 1, 1993April 1, 1993January 1, 1995January 1, 1999
Suriname5. . .January 1, 1996July 1, 1997July 1,2000
Trinidad & TobagoJanuary 1, 1993January 1, 1996January 1, 1997July 1, 1998
Source: CARICOM Secretariat.

Average tariff rates in all ECCU countries fell sharply in 1998, and (with the exception of Dominica) increased marginally thereafter. The decline in ECCU tariff rates in 1998 was most likely a reflection of the implementation of the second phase of the common external tariff. In Antigua and Barbuda, effective tariff rates spiked in 2000 before returning to their pre-2000 level.

The expansion of intraregional trade within CARICOM also resulted in some diversification of the region’s production base. Petroleum products constitute about a third of intraregional trade and hence dominate trade flows. Of the non-oil trade, processed food and agricultural products, which are the most protected, have the largest share, followed by manufactured products. The concentration of non-oil intraregional trade on import-substitution activities would seem to suggest more trade diversion, and would likely result in incentives that go against global integration (Krueger, 1999).

While the CARICOM integration initiative has increased intraregional trade in goods, its impact on ECCU countries has been disappointing, particularly during the 1990s. Although ECCU countries are quite open in terms of trade-to-GDP ratios Figure 12.2, the level of total exports of goods by ECCU countries remained virtually unchanged in nominal terms during 1991–2003 (Table 12.3 and Figure 12.3, in part due to the increasing international competition in two key export products, bananas and sugar. At the same time, the available evidence seems to suggest the growth of trade-diverting integration, as intra-ECCU exports increased from about 12 to 23 percent of total exports (Figure 12.4), while the overall level of intra-ECCU exports as a percent of GDP remains very low (Figure 12.5).

Figure 12.2.Indicators of Economic Integration for Selected Caribbean and Other Countries, 1976–2003

(In percent)

Sources: IMF, World Economic Outlook database; and IMF staff estimates.

1 For 1980–2003.

Figure 12.3.Eastern Caribbean Currency Union: Exports of Goods and Tourism Receipts

(In percent of GDP)

Sources: IMF Direction of Trade and Balance of Payments Statistics; and IMF staff estimates.

Figure 12.4.Trade Flows Among Eastern Caribbean Currency Union (ECCU) Members as a Share of Total Trade Flows

(In percent)

Sources: ECCU country authorities; and IMF staff estimates

Figure 12.5.Trade Flows Among Eastern Caribbean Currency Union (ECCU) Members as a Share of GDP

(In percent)

Sources: ECCU country authorities; and IMF staff estimates.

Table 12.3.Share of Exports of Goods of Members of the Organization of Eastern Caribbean States(In millions of U.S. dollars)
1991199219931994199519961997199819992000200120022003
Total exports to the world319.4383.0337.9286.2309.1313.3321.8297.4283.2302.0344.5321.1315.6
Growth rate 1. . .19.9–11.8–15.38.01.42.7–7.6–4.86.614.0–6.8–1.7
Share of intraregional exports in total exports19.09.412.112.912.610.610.712.013.112.611.513.417.3
Antigua & Barbuda4.41.42.03.61.61.42.43.011.05.86.26.78.3
Dominica8.89.310.714.015.113.413.315.214.615.817.613.316.8
Grenada8.85.417.513.616.320.520.314.29.010.512.022.425.7
St. Kitts & Nevis2.90.90.62.32.11.70.31.32.54.22.22.22.6
St. Lucia5.46.911.38.28.67.15.88.29.711.67.910.818.2
St. Vincent & the Grenadines19.923.329.733.638.727.336.027.628.424.530.033.840.7
Source: IMF, Direction of Trade Statistics.

Product Market Restrictions

Apart from the common external tariff, major product market distortions in the ECCU arise from nontariff barriers, monopolies, and state-owned enterprises. Some nontariff barriers have been retained in an effort to minimize the short-run impact on real income and unemployment that would otherwise result from the closure of less efficient domestic firms.6 The special regime for the ECCU countries and Belize has also fostered inefficiencies and distortions.7 While most utilities are provided by monopolies, the telecommunications sector is currently being liberalized on a regional basis.8 A number of products, including basic food products and fuel, are imported by state-owned or licensed monopolies. The participation of the public sector in the economy varies across the countries and is most widespread in St. Kitts and Nevis, where the sugar industry,9 electricity, and imports of some basic foods are controlled by public enterprises. There also is public sector participation in banking and telecommunications. As a result, there is some evidence that the average level of product mark-up and prices is quite high in the ECCU. While there are no data available for the ECCU countries, given their similarities to Barbados (McLean, 1981), a mark-up of 33 to 45 percent in the distributive sector seems likely.

In a number of ECCU countries, state monopolies import key products and there are nontariff barriers (such as quantitative restrictions) on some imports. In contrast, non-ECCU countries generally have licensing systems. Further liberalization of trade regimes in ECCU countries has been constrained in part by a lack of trained personnel and by high administration costs.

Other charges on traded goods also confirm that that ECCU countries are typically more restrictive than other Caribbean countries. ECCU countries impose a flat rate customs charge on imports (ranging from 4 to 10 percent), while two countries (St. Kitts and Nevis and St. Lucia) impose a consumption tax on imports. This is more restrictive than in non-ECCU countries, where stamp taxes or surcharges on a small number of imports are generally imposed. The higher customs duties in the ECCU partly reflect these countries’ dependence on revenues from trade and their lack of administrative capacity to implement other revenue measures to substitute for any lowered tariff revenues. In other non-ECCU Caribbean countries, a value-added tax or an income tax serve as alternate sources of revenue.10

Financial Market Segmentation

Despite sharing a common currency for most of their recent history, monetary and financial integration is far from complete in the ECCU. Legal and regulatory restrictions that deter the free flow of capital have led to fragmentation of the financial sector, as evidenced by large interest rate differentials between the countries (Table 12.4). Regulatory barriers like alien land holding licenses and differential tax polices such as withholding taxes on nonresidents, as well as limits to the enforceability of contracts across territories, have essentially created a collection of mini financial systems within the currency union (World Bank, 1998). Prime lending rates can differ by more than 300 basis points, with greater variance between other lending rates. Such differentials in interest rates as well as asymmetric liquidity across countries and institutions imply that financial resources are not efficiently utilized, thereby dampening growth potential.

Table 12.4.Interest Rates in Selected Countries of the Organization of Eastern Caribbean States, end–2004(In percent)
Prime

Lending Rate
Other

Lending Rates
Six-Month Time

Deposits
Savings

Deposits
Antigua & Barbuda10 to 11.53 to 23.611 to 53 to 5
Dominica8.5 to 107.5 to 201 to 3.253 to 3.5
Grenada8.5 to 9.53 to 161 to 43 to 4
St. Kitts & Nevis8.5 to 97.5 to 221 to 5.53 to 5.5
St. Lucia9.5 to 106 to 23.51 to 5.53 to 4.75
St. Vincent & the Grenadines9 to 113 to 21.641 to 3.753 to 4.5
Source: Eastern Caribbean Central Bank.

The fragmentation of the financial system results in higher operating costs because of the absence of economies of scale, and it also diminishes the capacity of the financial system to help spread risks. The Eastern Caribbean Central Bank has, in recent years, created a number of regional institutions to reduce that fragmentation. A regional government securities market (RGSM) has been established to facilitate the issuance of and secondary market trading in government securities, as well as an over-the counter exchange for equities (Eastern Caribbean Securities Exchange). However, as of end–2005, the RGSM still does not cover all territories (Antigua and Barbuda and Dominica have not met the criteria), and only five of a possible 30 public companies are listed on the stock exchange.

The external capital account has been progressively liberalized. Current transactions were free of restrictions since the 1970s, and an already-liberal regime of capital controls was reformed in 1996, requiring authorization only for transactions of more than US$90,000.11 The limit was progressively raised until it was eliminated in 2003. However, the legal and regulatory barriers identified above also curtail the benefits of a more open capital account, even while they spare the countries some of the negative effects of volatile short-term capital flows.

Intraregional capital flows have been facilitated mainly through Trinidad-based financial groups and, to a lesser extent, through cross-listing on the national stock exchanges. Trinidadian financial institutions have engaged in regional financial intermediation, mobilizing significant financial resources across the region through their insurance and investment arms, as well as recycling oil surpluses to finance significant investments in these economies (Table 12.5).

Table 12.5.Trinidad and Tobago: Geographic Exposure of Financial System Loans and Investments, end–2004
In millions of U.S. dollarsPercent
Total10,600100.0
Domestic8,08876.3
Caribbean2,17320.5
Of which
Barbados3783.6
Dominican Republic1171.1
Grenada1181.1
Jamaica4133.9
St. Lucia6145.8
St. Maarten1411.3
Rest of Western Hemisphere3393.2
Of which
United States2592.4
Source: Central Bank of Trinidad and Tobago.Notes: Geographical allocation of equity, and investment portfolio of commercial, merchant, and investment banks, finance companies and trusts licensed by the Central Bank of Trinidad and Tobago.

ECCU Labor Markets

There is a relatively high level of wage inflexibility in ECCU countries for several reasons. First, wages are determined mainly by collective bargaining agreements. With strong unions, wages are determined more by bargaining strength and political pressures, rather than productivity growth. These wage settlements result in relatively higher production costs, which affect the international competitiveness of production (ABT Associates, 1998). The level of unionization ranges from 12 percent in St. Vincent and the Grenadines to 33 percent in St. Kitts and Nevis (Table 12.6). Second, public sector wage agreements exert a very strong influence on wages in the private sector, given the relative size of government employment, which averages about 21 percent of the work force in the ECCU. Thus, the wage determination process in the private sector results in a distribution of rents between employers and workers similar to that described in Blanchard and Giavazzi (2003). Third, minimum wage laws and high reservation wages add to wage inflexibility. All ECCU countries have enacted minimum wage laws for different categories of workers (Table 12.6). Finally, migration of high-skilled workers and inflows of remittances push up the reservation wage of the relatively lower-skilled workers who remain in the region, and who may prefer to remain unemployed because they receive significant income from remittances (Mishra, 2006).

Table 12.6.Labor Market Policies and Institutions in Selected Caribbean Countries
ILO

Conventions

Ratified
Annual

Leave

with Pay

(days)
Maternity

Leave

(days)
Social

Security

Contributions

(% of wage)
Government

Employment

(% of labor force)
Minimum

Wage/Avg.

Wage (%)
Severance

Pay (days)
Unionization

of Labor

Force (%)
Index of

Labor Market

Rigidity 1
Organization of Eastern Caribbean States
Antigua & Barbuda15125510.627.549.6240240.380
Dominica2010503.917.718.8245250.223
Grenada25. . .503.026.2. . .0470.328
Sr. Kitts & Nevis. . .. . .6410.5. . .. . .260330.476
Sr. Lucia25. . .5710.014.1. . .245200.306
Sr. Vincent & the Grenadines. . .. . .557.820.749.5200120.251
Other Caribbean
Bahamas, The. . .. . .. . .. . .21.0. . .025. . .
Barbados35158412.038.0. . .112.5310.580
Belize276507.016.021.9100130.182
Dominican Republic26114212.0. . .. . .. . .120.227
Guyana. . .125912.525.0. . .0320.415
Haiti23138415.3. . .37.2. . .20.393
Jamaica2510565.09.7. . .250240.278
Suriname2612. . .2.045.0. . .0420.283
Trinidad & Tobago1314553.429.830.8275230.354
Other Countries
Bolivia42157421.3. . .25.4. . .290.480
Costa Rica47104527.0. . .57.7. . .250.223
Sources: Rama (1995); International Labor Organization (ILO); and IMF staff estimates.

Wage rigidities are further reinforced by employment rigidities resulting from limited labor mobility and high severance costs. However, despite shortages in many skills, there is rigorous implementation of work permit requirements. Thus, while there is significant migration of workers from the ECCU to third countries, there is relatively limited movement of labor among them (Guengant, 1993). In the absence of unemployment insurance, severance regulations provide the only redundancy benefits. Nonetheless, they create barriers to hiring and firing workers, resulting in limited employer flexibility, the replacement of permanent workers with casual or contract workers, increased labor costs, and lower employment (ABT Associates, 1998). Other nonwage costs that increase labor market rigidity include social security payments in all ECCU countries introduced during the 1970s, and education and social services levies in Antigua and Barbuda and St. Kitts and Nevis (Table 12.6).

ECCU wage levels are consequently quite high, denoting the presence of considerable wage premia. Using the only detailed data for an ECCU country (St. Lucia, available only for 2001), it is evident that the wage levels are much higher than in comparable Caribbean and Latin American countries (Table 12.7). Indeed, in one category—hotels and restaurants—the average wage was even higher than in Canada. A different metric, comparing the wage levels with the per capita gross national income, confirms this pattern. Unlike in most developing countries but similar to North America, wages in the ECCU countries are much higher than the average per capita national income level. Moreover, wage growth accelerated during the period when GDP growth was low, indicating a rising wage-productivity gap (Figure 12.6). At the same time, the regional unemployment rate has remained high, at over 20 percent. The high rate of migration to the United States, Canada, and the United Kingdom has somewhat reduced the pressures on the labor market.12

Figure 12.6.Eastern Caribbean Currency Union: Average Annual Wage per Worker

(Eastern Caribbean dollars)

Source: Country authorities.

Table 12.7.International Wage Comparisons, 2001
Per capita GDP 1Per capita GNI 1ManufacturingConstructionHotels and RestaurantsPublic AdministrationEducationAverageAll Categories
AnnualMonthlyAnnualMonthlyAgriculture
(In U.S. dollars per month)
Eastern Caribbean
Currency Union
St. Lucia 25,59046.65,9104935286017548511,709587838. . .
Caribbean6,3135266,110509. . .262254216. . .. . .. . .302
Jamaica 33,6703063,510293. . .124140111. . .. . .. . .170
Trinidad & Tobago8,9607473,710726225401369321. . .. . .. . .433
Latin America6,9465796,720560161392347254492481367. . .
Brazil7,6406377,350613169353255166461462312352
Costa Rica8,7907338,360697206390361309639570413. . .
El Salvador 44,5903834,48037392200218232386357247. . .
Mexico8,9407458,740728177360324262483503352. . .
Peru4,7703984,670389. . .652576301. . .515511. . .
North America31,6552,63831,5802,632. . .2,5202,8351,157. . .1,7932,2532,315
Canada28,5702,38127,9402,3282,1462,0872,0697391,9431,7931,7961,724
United States34,7402,89535,2202,935. . .2,9523,6001,576. . .. . .2,7092,906
(Radio of monthly wage to monthly per capita GNI, in percent)
Eastern Caribbean
Currency Union
St. Lucia107.2122.0153.1172.8347.1119.3170.2. . .
Caribbean. . .51.549.942.4. . .. . .. . .59.3
Jamaica 342.347.737.8. . .. . .. . .58.3
Trinidad & Tobago30.955.350.844.2. . .. . .. . .59.7
Latin America28.770.061.945.487.836.065.5. . .
Brazil27.558.541.627.175.275.450.957.5
Costa Rica29.656.051.844.491.781.959.2. . .
El Salvador 424.553.558.562.2103.395.666.3. . .
Mexico24.349.444.536.066.269.148.3. . .
Peru. . .167.6148.077.4. . .132.4131.3. . .
North America. . .95.7107.744.0. . .68.185.688.0
Canada92.289.688.931.783.577.077.174.0
United States. . .100.6122.753.7. . .. . .92.399.0
Source: International Labor Organization; World Bank, World Development Indicators database; Statistical Institute of Jamaica; Central Statistical Office, Trinidad and Tobago; and authors’ calculations.

Modeling the Contribution of Integration to Growth in the ECCU

Basic Model and Data

The main objective of the model developed here is to analyze the relative contribution of various measures of integration to real GDP growth over time in ECCU countries, as well as in other Caribbean states. The model does not attempt to answer the question whether integration causes growth; to do this, a much wider cross-section of data and a robust set of instrumental variables would be required, which have not been possible to construct for this exercise. Given the preponderance of trade in services such as tourism for the countries in the sample (Table 12.8), for which there is no direction of trade data, the traditional gravity model cannot be used to analyze this question.13 Even if the direction of trade in services data were available, it is still problematic to use a gravity model for tourism, which is driven more by factors such as “sea, sun, and sand” and less by distance and relative size.14

Table 12.8.Eastern Caribbean Currency Union: External Services Receipts and Payments
199619971998199920002001200220032004
(In millions of Eastern Caribbean dollars)
Receipts
Total2,8733,1273,3933,5333,4763,2403,1323,4273,871
Transportation285310307288313337333344356
Travel2,1842,3362,4472,4622,4732,3112,2542,6242,958
Insurance services39378711386746858140
Other business services347410473596535457429359376
Government services193579746961484142
(In percent of GDP)
Memorandum items:
Total49.050.551.050.347.544.141.843.546.6
Transportation4.95.04.64.14.34.64.44.44.3
Travel37.337.736.835.033.831.530.133.335.6
Insurance services0.70.61.31.61.21.00.90.71.7
Other business services5.96.67.18.57.36.25.74.64.5
Government services0.30.61.21.10.90.80.60.50.5
(Annual percentage change)
Total. . .8.88.54.1–1.6–6.8–3.39.413.0
Transportation. . .8.7–1.0–6.28.67.7–1.13.43.5
Travel. . .7.04.80.60.5–6.5–2.516.512.7
Insurance services. . .–5.0135.730.8–23.8–14.5–7.8–14.2139.7
Other business services. . .18.215.426.0–10.2–14.5–6.1–16.44.7
Government services. . .84.2127.3–6.1–6.9–11.8–21.3–14.52.7
(In millions of Eastern Caribbean dollars)
Payments
Total1,4531,5701,6941,7661,6911,6971,7081,7711,882
Transportation550581614647648639616703754
Travel241245263285295293301317342
Insurance services128127129168146177191198210
Other business services440529543555474471496449466
Government services9489144111126117103104111
(In percent of CDP)
Memorandum items:
Total24.825.425.425.123.123.122.822.522.7
Transportation9.49.49.29.28.98.78.28.99.1
Travel4.14.03.94.14.04.04.04.04.1
Insurance services2.22.11.92.42.02.42.62.52.5
Other business services7.58.58.27.96.56.46.65.75.6
Government services1.61.42.21.61.71.61.41.31.3
(Annual percentage change)
Total. . .8.17.84.3–4.30.40.63.76.3
Transportation. . .5.65.85.30.3–1.4–3.714.07.3
Travel. . .1.47.48.43.6–0.72.85.27.9
Insurance services. . .–1.11.630.6–13.220.88.23.86.0
Other business services. . .20.42.62.2–14.5–0.75.4–9.53.7
Government services. . .–5.662.6–23.414.1–7.2–12.11.36.3
Sources: Eastern Caribbean Central Bank; and IMF staff estimates.

The aim of this section, therefore, is simply to explore the contribution of integration to growth over time, controlling for exogenous factors and domestic policy changes.15 The following general equation is estimated:

Box 12.2.Estimated Model and Data

The model estimated for the Eastern Caribbean Currency Union countries, and then for 14 Caribbean countries, Bolivia, and Costa Rica, is the following:

The data used in the model are annual observations for the 16 countries in the sample for 1980–2003 (see Figure 12.7 for a scatter plot). The data are largely derived from the IMF’s World Economic Outlook database and International Financial Statistics. In several instances with missing data, secondary sources such as IMF country reports are also used. The following is a description of the various variables:

Growth

g: the real growth rate of the GDP (in domestic currency terms).

Integration Variables (T)

  • τ the effective duty rate, calculated as the ratio between customs duties and surcharges, and imports of goods. This variable is a good proxy of what the countries have effectively done to reduce barriers to trade (Senhadji and Ginting, 2004).1 It is expected that the sign of the coefficient for this variable would be negative, i.e., the higher the effective trade taxes, the lower will be the growth.

  • OPEN : the openness index is calculated as the ratio of (exports plus imports of goods and services) to current nominal GDP. Openness is expected to have a positive impact on growth.

  • FDI : the ratio of foreign direct investment (in U.S. dollars) to GDP (converted at current exchange rates). FDI is expected to have a positive impact on growth.

Exogenous Variables (E)

  • TOT : terms of trade index. Changes in terms of trade could have either a positive or negative impact on growth.

  • FDEM : index of final demand in industrial countries. Changes in this variable are expected to be positively correlated with growth in our sample.

  • XGRO: growth of exports of good and services (in U.S. dollars).

Domestic Policy Variables (P)

  • GCB : central government overall balance-to-GDP ratio. The sign of the coefficient is a matter of empirical investigation. In the short run, a deficit may increase growth if it results from an expansionary fiscal policy; in the long run, deficits probably have a negative impact.

  • PINV : public-investment-to-GDP ratio. The sign of the coefficient could be positive or negative, i.e., investment in infrastructure (for example) could be growth inducing. On the other h and, public investment, to the extent that it leads to crowding out of the private sector or if the quality of investment is inferior, could also have a negative impact on growth.

1 A more satisfactory approach would be to construct a trade liberalization index over time, which could also comprise nontariff barriers, and also cover services. However, it is extremely difficult to construct such an index, given the lack of time series data.

Figure 12.7.Eastern Caribbean Currency Union: Real GDP Growth and Its Determinants, 1980–2003

Source: Authors’ calculations.

where: git is real GDP growth for country i during time t; Tit is a vector of international integration variables; Eit is a vector of exogenous variables; Pit is a vector of domestic policy variables; and εit is the random disturbance term. Box 12.2 gives a more detailed description of the model and data used.

Empirical Results

The basic regression results suggest that while some integration effort variables are important, the international economic environment plays a greater role in explaining growth in the ECCU (Table 12.9).16 The latter is consistent with the findings in Cashin and Wang (2005). The main integration effort variable, the effective tariff rate, is highly significant with the correct sign, but openness is insignificant. Openness is possibly insignificant due to threshold effects, i.e., because of the initial very high level of openness among ECCU countries, the marginal gain from further openness is negligible. Of the three international economic variables, proxied by income in the industrial countries, growth in exports, and changes in the terms of trade, the first two have the strongest effects. Changes in the terms of trade have a negative effect on growth, while foreign direct investment is statistically insignificant. The domestic policy variables are generally insignificant—except in two specifications at the 10 percent significance level. The government capital expenditure variable has a negative sign, suggesting that government expenditure was either counter cyclical or ineffective.

Table 12.9.Regression Results for Real GDP Growth Equation (OECS)1

Estimated equation: git=α0+βTit+γEit+θPit+ϵit

VariablesOLS 2Panel

Fixed

Effects
Panel

Fixed

Effects 3
Panel

IV2SLS 3,4
Panel

SUR 5
ConstantC0.193***

(3.56)
0.01**

(2.95)
0.104***

(3.56)
0.100***

(3.13)
0.062*

(1.88)
Integration variables (T)
OpennessOPEN–0.012

(–1.16)
–0.009

(–0.61)
–0.012

(–1.16)
–0.013

(–1.12)
–0.002

(–0.15)
Effective tariff rateτ–0.304***

(–4.77)
–0.303***

(–4.19)
–0.304***

(–4.77)
–0.293***

(–4.29)
–0.255***

(–3.01)
Exogenous variables(E)
Foreign demandΔFDEM0.936***

(4.30)
0.955***

(4.27)
0.937***

(4.30)
1.05***

(4.35)
0.988***

(4.40)
Export of goods and servicesXGRO0.103***

(4.94)
0.102***

(4.69)
0.103***

(4.94)
0.096***

(3.90)
0.095***

(5.31)
Terms of tradeΔTOT–0.102***

(–3.92)
–0.102***

(–3.77)
–0.102***

(–3.92)
–0.096***

(–3.38)
–0.104***

(–3.31)
Foreign direct investmentFDI–0.523

(–1.51)
–0.059

(–1.58)
–0.523

(–1.51)
–0.053

(–1.45)
–0.050

(–1.55)
Domestic policy variables (P)
Government investmentPINV–0.669

(–1.79)*
–0.073

(–1.57)
–0.669

(–1.79)*
–0.068

(–1.56)
–0.049

(–1.13)
Central government balanceGCB0.041

(0.80)
0.018

(0.30)
0.041

(0.80)
0.044

(0.80)
0.037

(0.82)
Summary statisticsR20.4260.4250.4260.4090.513
Adjusted R20.3910.3850.3860.3650.483
F-statistic11.98***10.91***95.85***85.03***16.98***
Cross sections06666
Sample1981–031981–031981–031981–031981–03
Observations138138138132138
Source: Authors’ calculations.Notes: OECS denotes Organization of Eastern Caribbean States; * significant at 10 percent level; ** significant at 5 percent level; *** significant at 1 percent level.

When the basic regressions were augmented by including the remaining Caribbean countries in the sample, the results were broadly similar to the ECCU, but, in addition, openness, foreign direct investment, and the domestic policy variables become statistically significant in most cases (Table 12.10). Growth in industrial countries, export growth, and changes in the terms of trade remain the most significant variables, while FDI becomes a significant explanatory variable for the region as a whole. Openness and the effective tariff rate are both significant in the random effects model, the relevant model for the Caribbean panel. The domestic policy variables also become significant in the augmented panel.

Table 12.10.Regression Results for Real GDP Growth Equation (Caribbean, Bolivia, and Costa Rica)1

Estimated equation: git=α0+βTit+γEit+θPit+ϵit

VariablesOLS 2Panel

Fixed

Effects
Panel

Random

Effects 3
Panel

IV2SLS 3,4
Panel

SUR 5
ConstantC–0.0100.031**–0.002–0.011–0.001
(–1.43)(2.43)(–0.23)(–1.46)(–0.40)
Integration variables (T)
OpennessOPEN0.013***0.0080.013***0.013***0.005*
(3.15)(1.07)(2.40)(3.14)(1.65)
Effective tariff rateƬ–0.026–0.214***–0.065**–0.301–0.051***
(–1.11)(–4.64)(–2.16)(–1.26)(–3.49)
Exogenous variables (E)
Foreign demandΔFDEM0.560***0.62***0.57***0.600***0.507***
(3.17)(3.73)(3.63)(3.20)(7.91)
Export of goods and servicesXGRO0.107***

(7.11)
0.094***

(6.42)
0.101***

(6.91)
0.100***

(6.25)
0.116***

(14.13)
Terms of tradeΔTOT–0.060***–0.066***–0.062***–0.057***–0.037**
(–2.84)(–3.29)(–3.05)(–2.63)(–2.69)
Foreign directFDI0.087***0.0070.062**0.086***0.111***
investment(2.97)(0.18)(1.96)(2.83)(6.88)
Domestic policy variables (P)
Government investmentPINV0.101***0.0270.085**0.115***0.171***
(2.89)(0.64)(2.23)(2.93)(11.95)
Central governmentGCB0.156***0.137***0.151**0.173***0.136***
balance(3.75)(3.21)(3.58)(4.06)(6.47)
Summary statisticsR20.2860.1010.2740.2830.877
Adjusted R20.2690.0760.2540.2620.873
F-statistic16.18***14.76***111.4***120.93***296.961***
Cross sections015151515
Sample1981–031981–031981–031982–031981–03
Observations331331331317331
Source: Authors’ calculations.Notes: OECS denotes Organization of Eastern Caribbean States; * significant at 10 percent level; ** significant at 5 percent level; *** significant at 1 percent level.

Reestimating the growth equation to take account of spillover effects of integration yields a dramatically better fit with largely stable coefficients. The panel generalized least squares estimator, using cross-section weights along the lines of seemingly unrelated regression model, takes account of spillovers in the context of an integration movement. The method also corrects for cross-section heteroscedasticity. In the case of the ECCU, the parameter estimates remain largely the same, but the adjusted R-squared rises from about 0.40 to 0.48. Similarly, for the Caribbean panel, the coefficients of growth in industrial countries, export growth, and terms of trade are very stable, but the R-squared rises from about 0.30 to about 0.88. The increase in the explanatory power of the equation seems to suggest that there are some contemporaneous spillover effects that may be due to regional integration, and that such effects are larger for the wider Caribbean than for the ECCU.

Concluding Remarks

Efforts at regional integration in the ECCU have met with limited success in promoting trade and growth in recent years, but the potential for leveraging regional initiatives to do so remains high. ECCU countries currently face considerable challenges: economic growth has slowed dramatically since the 1990s, and public debt has risen to very high levels in most countries. Unemployment and wage levels are high compared to countries at a similar level of development. Given the currency board arrangement, exchange rate policy cannot be used to increase competitiveness or to respond to real shocks such as natural disasters.17 There have been many regional initiatives, particularly in the provision of common services, that have been relatively successful, including a common judiciary, joint external representation in the OECS, university education, and epidemiological services in CARICOM. However, more can be done even in this area, for example, through better coordination of security and customs services and the granting of tax incentives.

The theoretical and empirical work reviewed in this chapter suggests that integration has a positive effect on growth. Increases in market size, the transmission of technology, and greater competition, all of which raise the efficiency of the economy, are among the key benefits of integration. For trade in services, in which the Caribbean has some competitive advantage, regional trading arrangements are more likely to facilitate liberalization. In the case of CARICOM, the positive effects of integration may have been limited by the slow progress in implementing the agreements, including the reduction in the common external tariff and the adoption of initiatives to complete the single market and economy, particularly those related to trade in services and free movement of labor.

The empirical investigation finds that growth in the Caribbean is strongly influenced by growth in industrial countries, export growth, and changes in the terms of trade. The openness of the economies is also an important factor, but there are probably threshold effects, given the region’s already high level of openness. At the same time there is strong evidence that a reduction in the overall effective tariff rate (a proxy for trade reforms and international integration) is good for growth.18 Foreign direct investment and domestic policy variables (government capital spending and the central government balance) also appear to be statistically significant determinants of growth in the Caribbean.

Given the current trend in the erosion of preferential access to European Union markets under the sugar and banana regimes, further integration of the ECCU economies into the global economy is inevitable. The theoretical literature and empirical evidence reviewed suggest that product and labor market deregulation would have a positive impact on employment and growth in the long run. However, there could be short-run costs related to lower nominal wages resulting from the elimination of protection-induced rents, which could be partially mitigated by possible declines in product prices.19 Since net benefits of integration are likely to be positive, particularly if integration is carried out effectively, the ECCU countries should move quickly toward implementing the required reforms. Delaying this process will only postpone the benefits and make it harder to achieve a consensus for reform (DeRosa, 2000). The countries should also press forward with liberalization of the regime of trade in services under the CARICOM agreement and the free movement of labor and other labor market reforms under the initiative for economic union among the ECCU countries. They should use integration at the regional level as a stepping stone to greater international integration, which would yield significantly more benefits given the dependence of growth rates of ECCU countries on demand in industrial countries.

Appendix 12.1. Economic Effects of Creating a Trading Bloc

Suppose two countries—A (poorer) and B (richer)—form a trade bloc. They can import from the rest of the world (W), which faces zero marginal costs to supply the bloc, i.e., a horizontal supply curve, SW. Country B has an upward-sloping supply curve, SB. If A imposes import tariff t on all countries, this has the effect of moving the supply curves upward for both suppliers by the amount of the tax. At the equilibrium point E, the supply is HG from Band GE from W. If the tariff is removed for B, B can supply an additional GF (or Q1Q2), thereby leading to a trade diversion. Under constant marginal costs for W, country A suffers from tariff loss, without a commensurate gain in consumer surplus (Figure A12.1). Gunning (2002) argues that most trade blocs, such as those in Africa, are pursued mostly for political reasons, and that it is usually more economically beneficial to undertake a unilateral lowering of tariffs.

Figure A12.1.Effects of Creating a Trade Bloc

The question that arises is whether there is a case for a South-South regional trading arrangement (RTA). Are RTAs a distraction from the more economically desirable multilateral trade agreements? Schiff (2002) argues that, in general, it is best for RTA participants to sign agreements with bigger countries or blocs in order to fully benefit from the benefits of integration. He does point to a number of advantages of RTAs. First, in the area of regional public goods (security, transportation, the environment), it makes sense to have regional cooperation. Second, an RTA is better able to negotiate with bigger countries or other RTAs by pooling the resources of its regional participants.

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Unless otherwise specified, the ECCU countries referred to in this chapter are those that also are members of the International Monetary Fund: Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.

Their approach is to use instrumental variables developed by Frankel and Romer (1999) and Acemoglu, Johnson, and Robinson (2001).

The members of the ECCU are also engaged in external trade negotiations at the multilateral level (Doha Agenda), interregional level (Economic Partnership Agreement with the European Union), and hemispheric level (Free Trade Area of the Americas). This broader integration agenda is being approached by the countries of the ECCU and CARICOM using a coordination strategy. The OECS members coordinate their joint negotiating position through the OECS Secretariat. In turn, the OECS Secretariat, through the Caribbean Regional Negotiating Machinery (RNM), coordinates these views with those of other CARICOM members, thereby yielding a common position that is presented at trade negotiations by the RNM on behalf of all CARICOM members.

Thus, the OECS comprises the eight member countries and territories of the ECCU and the British Virgin Islands, which was admitted in 1984. Anguilla was admitted in 1995. Unlike a full member, an associate member’s rights and obligations do not extend to all aspects of the treaty. This is specified when the associate member is admitted.

The current 15 members of CARICOM are Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Haiti, Jamaica, Montserrat, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago. Haiti is the newest member, as of July 2002. Anguilla, the British Virgin Islands, Cayman Islands, and Turks and Caicos are associate members.

Finger, Ng, and Sloaga (1998) have compiled a list of the countries’ trade restrictions, which include import licenses, quantitative restrictions, and imports by state monopolies. Suss, Njoroge, Cashin and Rodriguez (2004) also gives a detailed description of the trade regime.

See Commonwealth Secretariat (1999) for a discussion of the effects of Article 56 of the Treaty of Chaguaramas, which allowed countries to maintain nontariff barriers against specific products from the “more developed (CARICOM) countries.”

For many years, telecommunications services in the ECCU were dominated by a single monopoly service provider under long-term exclusive contracts. Five ECCU countries jointly negotiated the termination of these contracts and, starting in 2002, competition was permitted in a number of telecom services, with the sector being jointly regulated by a regional agency, the Eastern Caribbean Telecommunications Authority.

Until its closure in July 2005.

Several ECCU countries plan to introduce value-added taxes in 2006 and 2007.

Although capital outflows required exchange control authorization, the de facto regime was very liberal. Registered FDI inflows could be withdrawn without the need for approval, and other applications were routinely approved.

According to U.S. Census data, about 20 percent of the ECCU labor force emigrated to the United States between 1970 and 2000 (Mishra, 2006).

The gravity model is usually used to construct a “trade instrument,” i.e., the amount of trade that would be expected between any pair of countries given their relative size and distance. see and Anderson (1979) for a detailed exposition on the gravity model.

See Egoumé-Bossogo and Mendis (2002) for an elaboration of this point.

The methodology is drawn, in part, from Mattoo, Rathindran, and Subramanian (2001).

Ordinary least squares, panel fixed effects, and random effects models were estimated for both groups. In the case of the ECCU, the random effects model was rejected by the Hausman and Breush-Pagan tests, but the fixed-effects model could not be rejected.

According to Rasmussen (2004) and Chapter 7, ECCU countries are among the most vulnerable Countries in the world, judging by the number of disasters and the cost of damage.

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