Is the Whole Greater than the Sum of its Parts? Strengthening Caribbean Regional Integration
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Deeper economic integration within the Caribbean has been a regional policy priority since the establishment of the Caribbean Community (CARICOM) and the decision to create the Caribbean Single Market and Economy (CSME). Implementation of integration initiatives has, however, been slow, despite the stated commitment of political leaders. The “implementation deficit” has led to skepticism about completing the CSME and controversy regarding its benefits. This paper analyzes how Caribbean integration has evolved, discusses the obstacles to progress, and explores the potential benefits from greater integration. It argues that further economic integration through liberalization of trade and labor mobility can generate significant macroeconomic benefits, but slow progress in completing the institutional arrangements has hindered implementation of the essential components of the CSME and progress in economic integration. Advancing institutional integration through harmonization and rationalization of key institutions and processes can reduce the fixed costs of institutions, providing the needed scale and boost to regional integration. Greater cooperation in several functional policy areas where the region is facing common challenges can also provide low-hanging fruit, creating momentum toward full integration as the Community continues to address the obstacles to full economic integration.

Abstract

Deeper economic integration within the Caribbean has been a regional policy priority since the establishment of the Caribbean Community (CARICOM) and the decision to create the Caribbean Single Market and Economy (CSME). Implementation of integration initiatives has, however, been slow, despite the stated commitment of political leaders. The “implementation deficit” has led to skepticism about completing the CSME and controversy regarding its benefits. This paper analyzes how Caribbean integration has evolved, discusses the obstacles to progress, and explores the potential benefits from greater integration. It argues that further economic integration through liberalization of trade and labor mobility can generate significant macroeconomic benefits, but slow progress in completing the institutional arrangements has hindered implementation of the essential components of the CSME and progress in economic integration. Advancing institutional integration through harmonization and rationalization of key institutions and processes can reduce the fixed costs of institutions, providing the needed scale and boost to regional integration. Greater cooperation in several functional policy areas where the region is facing common challenges can also provide low-hanging fruit, creating momentum toward full integration as the Community continues to address the obstacles to full economic integration.

Executive Summary

Deeper regional integration has been a long-standing objective for the Caribbean. The persistent interest in this quest led to the Treaty of Chaguaramas in 1973, which established the Caribbean Community (CARICOM) to address the constraints of small size on development, share the cost of common services, and pool bargaining power in international fora. Changing global conditions and the rise of globalization prompted the political leadership to seek a deeper form of integration by establishing the Single Market and Economy (CSME), with the Revised Treaty of 2001 setting up a roadmap. The goal was to create a common economic space and transform CARICOM into an economic union through policy coordination, harmonization of functional areas, and an eventual move to a currency union. CSME provisions focused on forming a free trade area, a customs union, a common market with free movement of capital, skilled labor, goods, and services, and an economic union with coordinated sectoral and macroeconomic policies.

While significant progress has been made, institutional integration within CARICOM has advanced slowly. Implementing the CSME provisions has been a gradual and incomplete process, with around 57 percent of the actions required to establish the CSME completed since the Revised Treaty. Most progress has been in the Free Trade Area stage of integration, with intra-CARICOM goods trade essentially free of tariffs, and some progress also made in promoting a common market in services and skilled labor. However, the customs union and common market stages remain incomplete with significant nontariff barriers (NTBs) to trade, divergent tariff rates applied to extra-CARICOM trade, and lack of harmonized regulations and duplication of processes affecting intraregional labor movement. Limited progress has been made in harmonizing/coordinating policies to support a single economic space, with continued restrictions on capital mobility, and lacking harmonization and coordination of investment codes, tax incentives, and macroeconomic policies. Integration within the Organization of Eastern Caribbean States (OECS) advanced faster, with free movement of labor and services within the OECS and some supranational institutions for policy harmonization.

The degree of economic integration also lags behind other well-integrated regions. Divergence of key macroeconomic variables across the region has fallen over time, but the fall has slowed down or even reversed recently, partly reflecting the different impact of external shocks on tourism-dependent CARICOM countries vis-à-vis commodity exporting members. While increasing, the share of intraregional trade in total trade remains at low levels compared to other integrated regions. The low degree of synchronization of business and credit cycles suggests a higher cost of pursuing common economic policies. Slower convergence of incomes and a widening gap between the lowest and highest income brackets across the region highlight the need to ensure the region benefits from integration as a group. While financial integration seems to have proceeded faster with tightly-interconnected financial systems, capital markets remain underdeveloped and fragmented. No Caribbean-wide capital market exists, with most activity concentrated in a few countries through cross-listing of securities.

The slow pace of regional integration reflects a combination of economic, institutional, and political economy factors, and resource and capacity constraints. The lack of a regional body with powers and accountability to effect decision making and of tools to transform community decisions to binding laws are key impediments. A decision-making process based on unanimity principle under which each member retains its sovereign authority also hinders progress, especially when combined with inadequate resources and technical expertise, and lacking prioritization needed to draft and ratify laws and secure public support for the decisions made. Misaligned incentives for integration add to these institutional constraints, with large up-front costs of implementing the necessary measures and the potential benefits for trade, growth, or employment perceived as uncertain, potentially uneven, or materializing over a longer horizon. Lack of diversification of export and production structures, diverging economic fortunes across commodity- and tourism-based economies, and diverse income and development levels add to diverging national interests, making the harmonization of economic and structural policies a challenge. The slow progress with institutional integration and harmonization of legal and administrative frameworks, in turn, hinders implementation of the essential components of the CSME and undermines economic integration.

The paper’s findings suggest that greater regional integration through further liberalization of trade and greater labor mobility across the Caribbean can generate significant economic benefits. In particular, reducing the high NTBs and trade costs within the region and vis-à-vis non-CARICOM trading partners will not only generate trade expansion and welfare gain for all members, but will also help restructure economies from contracting to expanding sectors, resulting in a net employment gain across the region. Further integration could also allow free movement of people and better allocation of skills and factors of production. Improved factors and skills allocation could increase labor productivity and create long-term growth benefits for the entire region, including by helping to limit the pervasive brain-drain through migration to other regions and rebalancing factor and product markets following external shocks.

The region therefore needs to focus its utmost attention to addressing the key impediments to progress in institutional integration. Accelerating efforts to harmonize and rationalize the key institutions and processes across the region can provide significant dividends for economic integration. Caribbean authorities remain committed to establishing a common economic space and acknowledge that greater collaboration is needed to tackle common challenges. Efforts in this direction are still seen by the regional authorities as worthwhile a goal to pursue today as at the inception of CARICOM. It is important to capitalize on this momentum.

Integration through functional policy cooperation can offer an effective way to create momentum toward full integration. As the Caribbean Community continues to resolve the impediments to full integration, advancing functional policy cooperation in areas where the region faces significant common challenges could provide low-hanging fruit, while building momentum toward full integration and helping realign incentives. These areas could include, for example: safeguarding regional financial stability in a tightly interconnected financial system; building resilience to more frequent and costly climate-related risks; fighting violent crime; and preventing a race to the bottom in granting incentives to foreign investors. As in furthering the CSME, deepening cooperation in these areas calls for accelerated efforts to harmonize/streamline the institutional frameworks given the significant fiscal and capacity constraints, improve their efficiency and transparency, and reduce disparities across countries, with a view to reducing costs and increasing the scale and resources.

  • Advancing policy coordination in the financial sector: While bringing benefits, integrated financial systems can also generate systemic risk and propagate shocks across national borders. A coordinated approach with effective information sharing and home-host supervisory arrangements and harmonized resolution frameworks is essential to limit regulatory arbitrage, respond to financial stress, and safeguard financial stability. The region has made progress in aligning regulatory and supervisory frameworks toward best practice, but more is needed to establish regional regulatory/resolution frameworks for cross-border institutions. Progress in these areas and effective AML/CFT regimes will also help with the loss of correspondent banking relationships and persistent weakness in asset quality—both regional challenges. A regional distressed-asset market and reduced data gaps are also key in this regard.

  • Building resilience to natural disaster and climate risks: In a region highly vulnerable to frequent and costly natural disasters with severe macroeconomic consequences, building resilience is a key policy priority. But the region underinvests in ex-ante resilience, reflecting in part resource and capacity constraints. With a shared goal of attaining a climate-resilient Caribbean, collaborative solutions should aim at pooling resources and capacity, building on the positive experience with facilitating speedy recovery and reconstruction after disasters and with mitigating financial costs of disasters through the Caribbean Catastrophe Risk Insurance Facility (CCRIF). An integrated Caribbean has also a better chance of acquiring necessary, low-cost financing from development partners, accessing more affordable insurance, raising its voice on climate mitigation policies, and building resilience to climate change risks.

  • Fighting crime: The high rates of crime impose a serious social and economic burden on the region. It impedes economic growth by discouraging tourism and business investment, reducing labor productivity, and diverting government spending away from growth-enhancing investments. Regional efforts could accompany national efforts to address the common challenge of crime, with its drivers and effects crossing national boundaries. CARICOM has taken significant steps to deal with crime (the fourth pillar of the regional integration movement), but limited national budgets continue to favor ex-post response through law enforcement, as opposed to ex-ante management of crime risk. Collaboration could focus on both preventive and response efforts, pooling regional resources and information, standardizing legal and institutional frameworks, enhancing intraregional labor mobility to create jobs and disincentivize crime, and safeguarding border security.

  • Avoiding a race to the bottom: Regional cooperation can be particularly fruitful in areas where it can facilitate solutions to collective action problems that encourage harmful competition and result in prisoners’ dilemma situations.

    • Tax incentives often entail large fiscal and social costs and can create negative externalities for other countries, yet empirical analyses do not find them benefiting the wider economy. Close cooperation on, and harmonization of, tax incentives can help safeguard fiscal revenues and limit potential adverse effects on fiscal sustainability, growth, and development. While streamlining tax incentives, efforts could focus on harmonizing systems for tax administration, sharing taxpayer information and transfer pricing methods, and improving the business environment. A regional institution can be helpful for monitoring implementation of policies on harmonizing tax incentives.

    • CBI programs have become an important source of public revenues, helped improve fiscal, growth, and external outcomes, and facilitated debt repayments. Developing a regional approach to manage CBI programs can improve their long-term viability and prevent a race to the bottom by relaxing rules to attract inflows and undermining, in turn, fiscal sustainability and integrity of the programs. A regional approach can also provide economies of scale and reduce costs, improve their long-term viability through best practices, and more rigorous due-diligence processes with a broadened information base. Close cooperation could also focus on regionalizing the CBI programs and best practices with management of inflows to limit potential macroeconomic risks from large inflows.

The CARICOM leadership has been taking recent decisions aimed at reinvigorating the efforts to complete the CSME agenda. These include the decision to move forward with liberalizing free movement of labor by select CARICOM states; a move by the OECS to harmonize CBI programs; the recent calls to establish a Caribbean-wide securities market and a multi-country implementation committee to prioritize progress on functional cooperation, and to form “a coalition of the willing, “ rather than waiting for unanimity; and calls for well-defined roadmaps and timelines to harmonize markets and institutions to avoid duplication. Actions along these lines can help demonstrate benefits from coordinated action and serve as a building block to the ultimate goal of full integration. IFIs, global and regional development partners, the private sector, labor unions, and civil society could join these efforts, to coordinate, advocate, and support the actions, including through funding and technical assistance (e.g., by leveraging on institutions such as the CARICOM Development Fund and benefiting from TA by IFIs in areas of common challenges) to make sure that benefits of integration are shared across the region. Importantly, regional integration should be seen as a means to the end of a globally better-integrated Caribbean that could take advantage of global value chains.

I. Introduction and Motivation

1. Deeper economic integration within the Caribbean has been a regional policy priority since the establishment of the Caribbean Community (CARICOM) in 1973. Comprising 12 island states or territories and three larger coastal states, CARICOM represents a diverse group, given the large differences in population, land sizes, levels of economic development and incomes, and exposure to diverse external shocks, notwithstanding the cultural and historical similarities and some common shocks and challenges in building and maintaining institutions with limited financial, technical, and human resources.2 A key objective of establishing CARICOM at the Treaty of Chaguaramas was to pursue regional integration, with a view to addressing the constraints of small size on development, sharing the cost of common services, and pooling bargaining power in international fora (Lewis 1950; Demas 1976 and 1997; Nicholls, Birchwood, Colthrust, and Boodoo 2000; Warner and Anatol 2015; and West Indian Commission 1992).

2. Nearly 30 years after CARICOM’s establishment, member countries signed the Revised Treaty of Chaguaramas to create an economic union, by initiating the CARICOM Single Market and Economy (CSME). Members felt that the Original Treaty fell short of addressing its stated objectives—of free movement of goods, services, capital and people, strengthening the region’s external position through coordination of foreign policies, and pooling limited resources through functional cooperation. The Revised Treaty in 2001 aimed to create a common economic space and transform CARICOM into a borderless community, with deeper economic policy coordination, increased harmonization of functional areas, and an eventual move to a currency union. The new architecture was hoped to permit the region pool resources and exploit opportunities that individual states would not be able to achieve separately (Review Commission Secretariat 2017).

3. The implementation of regional integration initiatives and the CSME has been slow, despite the stated commitments of the CARICOM members. As of end-2017, 18 years after the Revised Treaty, 57 percent of the actions required to establish the CSME had been completed. This implementation deficit has created increasing skepticism about completing the CSME and its benefits and may have taken a toll on the region’s commitment to the integration movement. The March 2017 Jamaican Commission Report on CARICOM and CARIFORUM frameworks stressed that regional integration remains as valuable and relevant today as at its inception, but called for specific, time-bound, measurable, and verifiable program of action to complete all the requirements for the CSME and make it operational within the next 5 years. Special Meeting of Heads of Government on the CSME (November 2018) and the 13th Intersessional of Heads of Government Meeting (February 2019) took decisions in several areas aimed at reinvigorating regional integration.

4. This paper documents the evolution of regional integration within CARICOM and discusses possible ways to move forward. It uses three main concepts of regional integration: institutional integration (defined as the outcome of joint policy decisions taken by regional inter-governmental fora designed to affect the depth and breadth of regional integration); economic integration (captured by the convergence of various indicators of monetary, real, and financial integration);3 and functional cooperation (in areas including, stability, security, environment, or disaster response). To track progress with integration, it constructs indices of institutional integration (Section II) and economic integration (Section III), compares them with other regions, and analyzes the interplay between institutional and economic integration and possible factors undermining their progress (Sections II, III, and IV). The paper then analyses potential economic benefits from further integration through further trade liberalization and labor mobility (Section V) and explores the scope for deeper functional cooperation as a way to build momentum for full integration (Section VI). Section VII concludes.

II. Tracking Institutional Integration in the Caribbean

The evolution of institutional integration within the Caribbean, based on the progress made in completing the five stages of institutional integration underlying the CSME—free trade area, customs union, common market, economic union, and economic policy integration—suggests that the region has advanced toward implementing the CSME, but the progress has been slow, and the integration movement has a long way to go. While progress has been made in liberalizing the movement of goods, services and skilled people within the region, establishing the single market and coordination or harmonization of policies to support a single economic space are well behind schedule.

A. The Context

5. Regional integration has been a long-standing goal in the Caribbean, dating back to the pre-independence period. The Treaty of Chaguaramas established the Caribbean Community (CARICOM) in 1973, with the objectives of deepening economic integration through free movement of goods, services, capital, and people, coordination of members’ foreign policies, and pooling their resources through functional cooperation in the areas of education, health, environment, science and technology, communications, and response to natural disasters—Warner and Anatole (2015). In a span of 46 years, CARICOM membership grew from 4 founding states (Barbados, Guyana, Jamaica, and Trinidad and Tobago) to 15 members, including now the members of the OECS, The Bahamas, Belize, Haiti, and Suriname (Figure 1). The Bahamas is outside the customs union, hence the CSME.

Figure 1.
Figure 1.

Caribbean Community (CARICOM) 1/

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

1/ The diagram does not show CARICOM’s associate members and countries with the observer status.2/ The diagram shows only full members. OECS’ associate members are Anguilla, BVI, Guadeloupe, and Martinique.3/ Haiti has a partial membership in the CSME.

6. One of the key milestones in the CARICOM integration process was the decision to create an economic union with a much deeper form of integration. The Revised Treaty of Chaguaramas in 2001 set out a roadmap for building the CSME to create a common economic space, through implementation of nine Protocols of Amendment to the original Treaty (Figure 2). Recognizing the importance of policy coordination for a single economic space, the provisions focus on facilitating a free movement of goods, services, capital and skilled labor in the region, and include additionally coordination of fiscal, monetary, and sectoral policies of the member states, along with increased harmonization of laws governing the treatment of labor and business, and eventually a currency union. In this context, the CSME agenda includes macroeconomic convergence, with the coordination pillars including an agreed Fiscal Responsibility Framework and Debt Management Strategy with prescribed fiscal and debt reduction targets achieved in the medium term, alignment of monetary policies, abolition of exchange controls, and full convertibility of currencies within the region.

Figure 2.
Figure 2.

Revised Treaty of Chaguaramas

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

7. Despite considerable progress, the integration objectives spelled out in the CSME agenda are not complete. The analysis below takes an in-depth look at the institutional integration process and its evolution for CARICOM, as well as separately for OECS and non-OECS members, with the former having taken much deeper steps toward integration through a common currency and a central bank that conducts a uniform monetary policy and oversees financial and banking integrity for the independent OECS states. The region’s progress in completing institutional integration is assessed by constructing an index of institutional integration following the Balassa (1961) framework applied by Dorucci and others (2002, 2015) to institutional integration within the European Union (EU).

B. The Evolution of Institutional Integration in the Caribbean

8. Institutional integration to assess implementation of the CSME focuses on the policy and regulatory aspects of integration, based on the outcome of joint policy decisions taken by regional inter-governmental fora toward deepening integration. With the CSME aiming for a much deeper form of integration with a free movement of goods and services, capital, and skilled labor, coordination or alignment of macroeconomic policies, and harmonization of laws, the seminal work of Balassa provides a useful framework to assess the region’s progress toward institutional integration. Balassa (1961) identifies 5 stages of regional institutional integration that broadly corresponds to the goals of the CSME: A Free Trade Area (FTA); a Customs Union (CU); a Common Market (CM); Economic Union (EUN); and Total Economic Policy Integration (TEI) (Figure 3). Progress in completing these five stages helps assess the progress with institutional integration within CARICOM.

Figure 3.
Figure 3.

The Five Stages of Regional Institutional Integration

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

9. More specifically, an Index of Institutional Integration is constructed following the approach of Dorucci and others (2002). In computing the index, a maximum score of 25 points is assigned to each of the four stages (FTA and CU are assessed jointly), with the overall index ranging from 0 (no integration) to 100 (full integration) depending on the progress with the implementation of integration initiatives. To track actual institutional integration, points are assigned based on implementation, rather than announcement of a decision to implement specific measures in the future. Importantly, implementation of stages could be non-sequential; that is, some elements from each stage can be implemented simultaneously. Relaxing restrictions on factor movements could, for instance, occur alongside the establishment of supranational institutions.

10. The institutional integration indices are constructed over 1965–2017 for the OECS members, as part of a currency union, and non-OECS members of CARICOM. Compiling the indices involves detailed examination of the key CARICOM institutions and implementation of the agreements associated with the establishment of the Caribbean Free Trade Association (CARIFTA), CARICOM, the Eastern Caribbean Currency Union (ECCU), and the CSME (Figures 4 and 5), and requires, in several cases, judgement about the timing and relative importance of certain steps in the integration process. The speed of institutional integration in the Caribbean is compared with that in other regions, by comparing the Caribbean institutional index with similar indices constructed for the EU and MERCOSUR (Southern Common Market) blocks—the latter indices are taken from Dorucci and others (2002).

Figure 4.
Figure 4.

Key Milestones of Institutional Integration in CARICOM

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Figure 5.
Figure 5.

Key Milestones of Institutional Integration in Eastern Caribbean

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

11. The indices suggest that progress with institutional integration within CARICOM has been slow and incomplete. Integration has proceeded in several waves, with periods of integration followed by slowdowns in progress, much of which seems to have been driven by the first two stages of institutional integration (i.e., free trade area and customs union, Figure 6). The process began when eleven countries joined CARIFTA in the late 1960s, starting the process of trade liberalization.4 In 1973, CARIFTA was superseded by CARICOM to facilitate economic integration of member states, at a time of the UK’s entry to European Economic Community and highlighting that integration efforts were in response to the need to adapt to the changing external environment. However, progress during much of the 1970s-1980s was limited, with the integration index among non-OECS CARICOM members rising only to 25 by 1990. Trade regimes were characterized by high and widely dispersed tariffs and considerable use of non-tariff barriers (NTBs), including quantitative restrictions such as discretionary licensing requirements. Protectionist policies also included high import duties on imports from within the region, which severely impeded intraregional trade growth.

Figure 6.
Figure 6.

Indices of Regional Integration

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: Dorucci et al (2002, 2015) and IMF staff estimates.

12. Integration started to accelerate in the 1990s, driven in part by external factors. In 1989, the Grand Anse Declaration issued by CARICOM Heads of State announced a goal to establish the CSME by 1993 with the rapid changes in the external environment. EU integration, the loss of trade preferences, and the emergence of a global market with new sources of competition led to a realization that the development model needed to shift from import substitution toward export-driven growth.5 This realization resulted in a marked shift in the development policy paradigm in some Caribbean countries, from a focus on protecting domestic markets and significant state involvement toward an outward-oriented strategy that emphasized export competitiveness, adoption of liberal policies to facilitate a more efficient functioning of markets, and reduced state role and intervention in the economy. Trade was liberalized, with quantitative restrictions phased out and replaced by temporarily higher import duties that were lowered over time. The effect of NTBs on imports was reduced from an estimated 40 percent of imports in the mid-1980s to 11 percent by 1997 (Baumann 2008).

13. As part of this process, membership in CARICOM brought more commonality to trade policy, with progress along the second stage of institutional integration. All countries subscribed to the common external tariff (CET) on extra-regional imports, and between the late 1990s and early 2000s, every country, except for The Bahamas, had a nearly 5½ percentage point reduction in average import tariff rates, from average levels of 19½ percent (Figure 7). Tariffs continued to fall but showed more modest declines since then. The CET and rules of origin are in operation in all CARICOM states except The Bahamas and Haiti, though differences across CET have remained (see below).6 The Bahamas maintained a relatively high average tariff, at 27 percent in 2016.

Figure 7.
Figure 7.

Average Tariff Rates (in percent)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: World Integrated Trade Solution (WITS) database.1/ Showing 2000 value for SUR.2/ Showing 2013 values for BRB, SUR and TTO due to limited data availability.

14. The CSME was formally launched in 2006, but the second stage of integration following its launch has been slow and important gaps remained—in particular in completing the common market and economic union stages of integration. The CARICOM has made significant progress in establishing the common market, in that with some notable exceptions, intra-CARICOM trade in goods is essentially free of tariff barriers, the customs union has been advanced, and there has been progress with promoting the common market in the areas of trade in services and free movement of skilled labor. However, issues with full implementation of the facilitation of travel regime and harmonization of processes for movement of skilled nationals and NTBs remain. There has also been limited progress in integrating capital markets (Section III) and in the last two integration phases in the Balassa taxonomy (economic union and total economic integration). At the time of the CSME launch, the index of institutional integration for non-OECS CARICOM members was close to 38, less than half of the EU level when the EU Common Market was established.

15. The OECS countries advanced integration faster than the rest of the Caribbean. Eastern Caribbean islands were a part of the British Caribbean Currency Board in 1935 and unified their currency system based on the West Indian dollar in 1949. Since the collapse of the West Indies Federation in 1962, members created some supranational institutions necessary for coordination and harmonization of policies, including the Eastern Caribbean Currency Authority, ECCA (1965), the Eastern Caribbean Common Market (1968) as a precondition for entry into CARIFTA, the OECS (1981), and the Eastern Caribbean Central Bank, ECCB (1983) to replace the ECCA with an additional mandate to conduct regional monetary policy. The revised Treaty of Basseterre (2011) provided the foundations for an economic union among OECS members, most notably with the free movement of people within the OECS. To advance capital market and financial sector integration, the Eastern Caribbean Securities Market and the Regional Government Securities Market were set up in 2002, facilitating issuance/trading of equities, corporate bonds, and government securities.

16. These advances helped the OECS sub-region to become more institutionally integrated than the rest of CARICOM. The institutional integration index for the OECS stood above 60 in 2017, compared to just above 40 for non-OECS CARICOM. In particular, the OECS is more advanced in establishing the common market, with the free labor mobility policy applying to non-skilled, as well as skilled, labor, the presence of a regional securities market, and capital flows free of restrictions within the OECS. Nonetheless, gaps remain in total economic integration, owing to the limited coordination of policies (particularly fiscal policy) and the limited setup of supranational institutions and policies in these areas.

17. The pace of integration has also been slow compared with the EU for the region as a whole. The CSME’s formal launch took much longer than expected, with the slow implementation of a comprehensive revision of the Treaty of Chaguaramas. To be fair, the gap with the EU partly reflects the very high bar set by the EU for institutional integration at the outset, as well as its greater resources and capacity for implementation. Strong political support for integration in the aftermath of World War II allowed European countries to pursue ambitious objectives, such as elimination of borders for trade in goods and factors of production, and delegation of many policies to supranational levels. The demise of the Bretton Woods System in 1971 and the realization that full benefits of a common market cannot be achieved with exchange rate uncertainty provided impetus to the European Monetary System and the common currency. For CARICOM, the objective of a common currency was seen overly ambitious and has been indefinitely deferred (Girvan 2005).

C. Current Gaps in the Implementation Status

18. As suggested by the institutional integration index, a detailed assessment of the implementation status of CSME actions also implies that the integration project has a long way to go (Table 1). Based on the CARICOM Secretariat CSME Status Reports, only 56.5 percent of the actions required to establish the CSME has been completed as of 2017, suggesting some limited progress since the last assessment in the early 2000s (Girvan 2005). Actions related to the Single Economy continue to be the areas where very limited progress has been made, but significant gaps also remain in implementing the Single Market provisions.

  • Goods and services: Continued progress has been made in liberalizing the movement of goods and some services. However, an unfinished trade agenda remains, particularly in removing all NTBs, as well as in full implementation of the CET by all member countries (Section V). Potential trade disputes can result from nonapplication of the CET to extra-regional goods imports, application of Sanitary and Phyto-Sanitary (SPS) measures and Technical Barriers to Trade (TBT) that limit the entry of CSME-originating goods, and maintenance of unauthorized taxes and other charges on specified CARICOM goods (Warner and Anatole 2015).7

  • Movement of people: While some progress has been made in the movement of skilled persons, issues of noncompliance, lack of harmonized processes, and duplication of processes among and within member states continue (COTED 2017).8 Some progress has been made in putting in place the legislation to provide for the movement of service providers, with some member states having enacted the omnibus model, Movement of Factors Act, or some variant of it.9 However, policy action to facilitate such movement has been limited; only two countries have procedures for certifying service providers. Several member states retain legal restrictions on the right to establish business, which also limit intraregional movement of labor.

  • Institutions: Progress has also been limited in other institutional areas. The CARICOM Competition Commission to ensure fair competition has been established, but the legal and institutional framework for enforcing the rules of competition at the national level remains to be initiated in several states. The Model Consumer Protection Bill approved in 2016 is with members for implementation. Intellectual Property legislation needs modernization, harmonization, and institutional arrangements need to be put in place at the regional level. The Caribbean Court of Justice, with prime responsibility for interpreting and applying the Revised Treaty of Chaguaramas, is vital to the functioning of the CSME, but while it is established as a court of original jurisdiction in all CARICOM countries, as an appeals court, it has been established only in a few member states (Barbados, Belize, Dominica, and Guyana).

  • Policy coordination and harmonization. The program for macroeconomic policy coordination and harmonization in support of the CSME has been endorsed in 2012, but implementation to establish a single economic space is well behind schedule. Technical work on the design of legal and regulatory frameworks for credit reporting and deposit protection has been completed and draft policies developed, but the work on coordination and harmonization of fiscal policy and exchange of information is ongoing, as well as the work of the CARICOM Commission on the Economy to advise on coordinating and promoting a growth agenda for member states. Little progress has been made in developing common/coordinated sectoral policies. Further work on financial services agreement, capital market integration and harmonization, currency convertibility, double taxation, and regional investment and tax incentives policy needs to be completed for effective functioning of a single market and to limit wasteful competition.

Table 1.

Actions Taken Toward Implementation of the CSME

article image
Note: Haiti has not been able to participate in a large number of CSME actions.

Number of identified action elements multiplied by the number of countries required to take each element. CSME involves 13 countries.

Key actions: Common External Tariff and Rules of Origin; Implementation of the Harmonized Scheme 2012 (classification); and Harmonized Customs Bill and Regulations.

Key actions: Passage of Movement of Factors Act and administrative measures to facilitate entry of service providers.

Key actions: Passage of CARICOM Skilled Nationals Act; removal of work permit requirement, amendment of immigration laws of member states to provide for definite entry for the period of time needed by the CARICOM National Service provider (minimum 6 months) and indefinite stay for spouses of approved categories of skilled workers;

Key actions: Establishment of National Accreditation Bureau and Regional Accreditation Bureau togethe+A40r with National Vocational Qualifications Infrastructure

Financial Services Agreement approved by the Council on Finance and Planning in August 2013. Still to be finalized and Member States indicating need for further consultations.

Draft Securities Model Law and regulations to be reviewed by a working session of securities regulators.

Draft CARICOM Investment Code considered in 2017 and a Proposals for a Harmonized Regime of Investment Incentives has been prepared for further consultation with Member States.

Protocol seeks to amend the Intra-CARICOM Double Taxation Agreement that was adopted by Member States in 1994 to more explicitly provide for the global standard on exchange of information upon request. Draft Protocol is still under review by the Legal Affairs Committee.

Framework Regional Integrated Policy for Public Procurement (FRIP) has been adopted as the policy framework. The Draft Public Procurement Protocol has been adopted by Member States and sent to the Legal Affairs Committee for finalization and submission to the Conference of Heads of Government for signature.

Model Consumer Protection Bill was approved in September 2016 and now to be implemented by member States.

Figure 8.
Figure 8.

Intra-Regional Movement of Skilled Persons

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: ILO.

19. With long delays in implementing the CSME agenda, the CARICOM leadership recently took decisions to reinvigorate momentum to establish the CSME. At the November 2018 Special Eighteenth Meeting of Heads of Government on the CSME and the Thirtieth Intersessional Meeting of Heads of Government in February 2019, key decisions were taken to decisively move forward with implementation of the CSME agenda in critical areas such as free movement of labor: (i) agreement that those member states so willing would move towards full free movement of labor within the next three years; (ii) reiteration that a skills-certificate issued by one member state would be recognized by all member states; (iii) additional categories of skilled nationals entitled to move freely and seek employment within the Community; and (iv) agreement to complete legislative arrangements for free movement of all categories of skilled persons by all member states. All members signed the Protocol on Contingent Rights, a step forward for free movement of people. CARICOM also agreed in 2018 that Member States that wanted to proceed on a faster track to implementation of CSME decisions could do so. Actual implementation of these steps should boost the institutional integration index.

III. Tracking Economic Integration

Notwithstanding the significant progress made, the degree of Caribbean economic integration, as measured by comovement and evolution of a range of real, monetary, trade, and financial indicators, is low compared to other well-integrated regions. While increasing, the share of intraregional trade in total trade remains at lower levels compared to other integrated regions, the degree of synchronization of business and credit cycles is limited, and convergence of incomes between the lowest and highest income brackets has been slow. While financial integration seems to have proceeded faster with tightly-interconnected financial systems, financial markets remain underdeveloped and fragmented, with no region-wide capital market.

20. An economically-integrated region displays a high level of convergence of key economic indicators across its member countries. This section assesses the degree of Caribbean economic integration by analyzing the variability across countries of various indicators of real, financial, and monetary integration, including synchronization of business and financial cycles, convergence of inflation, interest rates, and incomes, exchange rate variability, and depth of trade and financial integration. Economic integration is measured here by the synchronization or comovement of these economic indicators over time, and is summarized in an overall index of economic integration. The index computed for CARICOM is compared with those for other regional blocks, such as the EU, MERCOSUR, and NAFTA, as well as with the evolution of the institutional integration index.

A. Inflation and Exchange Rate Convergence

21. Inflation convergence and falling exchange rate variability within the region can signal policymakers’ commitment toward the single economy component of economic integration. Countries can extract higher benefits from increased economic and institutional integration if inflation rates are converging over time, while inflation divergence can complicate implementation and harmonization of macroeconomic policies. Convergence of inflation can also help reduce variability in exchange rates across countries and diminish the likelihood of exchange rate misalignments. If real exchange rate variability is small and currencies are stable against each other, the cost of adopting a common currency or a common monetary policy framework will be lower (Dorucci 2005).

22. Inflation rates and effective exchange rates have been converging within CARICOM, though variation remains relatively high. While deviations among inflation rates across CARICOM countries have fallen drastically since mid-1990s, convergence has slowed down, or even reversed since mid-2000s, and inflation variation remains high relative to other regional groups, such as the EU, NAFTA, and the ECCU. Exchange rate variation in the region, which started increasing in the mid-2010s, after falling significantly from the mid-1990s, is also higher than the variation within the EU and the ECCU.

uA01fig01

CPI inflation standard deviation

(10-year rolling group average)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Sources: IMF staff calculations
uA01fig02

NEER Standard deviation

(10-yearrolling group average)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Sources: IMF staff calculations
uA01fig03

REER Standard deviation

(10-year rolling group average)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Sources: IMF staff calculations

B. Trade Integration

23. Trade integration within the region has been ongoing, but not at the levels of more integrated regional blocks. Intraregional goods trade has grown from about 2 percent of GDP in the mid-1980s to about 4 percent in recent years but has plateaued for more than a decade. Most of the increase in intraregional trade represents trade between commodity and non-commodity exporting CARICOM economies, while trade within each group has been no more than one percent of GDP, reflecting in part the specialization of production (or lack of diversification) and export structures, with insufficiently high variety of goods to form a basis for trade. Intra-Caribbean trade is well below that of some regional blocs, such as the EU where intraregional trade reached 13–20 percent of GDP. A large part of the CARICOM trade is with the rest of the world; the share of other CARICOM members is less than 20 percent of total trade, compared to above 50 percent for the EU and NAFTA. Close to 90 percent of CARICOM goods exports go to non-CARICOM states (the US, Europe, and Canada—Table 2), with intraregional trade dominated by a few countries (mainly Trinidad and Tobago—see above10). Similarly, intra-Caribbean tourism represents less than 10 percent of total tourism arrivals, and about 5 percent of total tourism receipts.

Table 2.

The Caribbean: Intra-Regional and Extra-Regional Goods Trade (in percent)

article image
Source: Direction of Trade Statistics; authors’ computations.
uA01fig04
Source: Direction of Trade Statistics; authors’ computations.
uA01fig05

Intra-bloc Trade

(in % of GDP)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Sources: IMF Staff calculations.
uA01fig06

Trade integration

(regional trade in percent of total trade turnover)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: IMF staff calculations

C. Synchronization of Economic Activity

24. Highly synchronized business cycles may suggest that economic activity is exposed to common external shocks or that the economies are highly interconnected. Highly-correlated real GDP growth and comovement of output and credit gaps across countries point to greater homogeneity in business cycle positions. The higher the synchronization, the lower would be the cost of pursuing common economic policies and of deepening integration. The rolling correlations of real GDP among countries in the CARICOM and ECCU have been increasing over time, but they are considerably below those of other regional groups. The correlations among CARICOM members’ output gaps have been broadly lower than those of the more-integrated EU6-group and the gaps have started to diverge recently—possibly owing to the varying economic performance between tourism-based and commodity-based economies in recent years and different external factors that affect their economies. Credit-cycle synchronicity across CARICOM has also been falling over time. With the significant presence of the same foreign banking groups in the region, the divergence may suggest changing portfolio choices by the banking groups (as suggested by the recent move of Scotia Bank out of nine Caribbean small states). Credit cycles of the ECCU countries seem more syncronized compared to the overall CARICOM.

uA01fig07

Ten-year rolling GDP correlation

(in percent)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Sources: IMF staff calculations
uA01fig08

Output Gap Correlation

(in percent)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: IMF staff calculations
uA01fig09

Credit Cycles Synchronicity

(10 year moving average)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: IMF Staff calculations.

D. Income Convergence

25. Greater economic integration should be associated with converging incomes across countries in a region. In particular, by facilitating greater mobility of factors of production (capital and labor), increased regional integration should result in converging income levels and greater, more equitable, standards of living, provided that countries are converging as a group to a higher income bracket. This can be observed in the low per capita GDP variation across the EU region and in the gradual pick up of the mean and median incomes with the higher income brackets. Within CARICOM, while variability of GDP per capita has been declining, it remains high, and average and median incomes do not seem to be catching up with the best-performing countries and the gap between the lowest and highest income brackets is widening. Together with weak business cycle synchronization, low income convergence highlights the need to ensure that the region benefits from integration as a group.

uA01fig10

Standard Deviation of Per Capita GDP

(in percent deviation from regional average)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: IMF staff calculations
uA01fig11

CARICOM Per Capita GDP (excluding Haiti)

(in USD)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: IMF staff calculations
uA01fig12

EU 16 Per Capita GDP

(in USD)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: IMF staff calculations

26. The limited convergence of incomes within CARICOM may be driven by a number of factors, including the limited factor movement within the Caribbean. The Revised Treaty of Chaguaramas provides provisions for the abolition of exchange controls and full currency convertibility within the region, removal of restrictions on the provision of banking, insurance and financial services, and on the movement of capital across national boundaries. Recent reviews by the CARICOM Secretariat of the progress with CSME suggest that two member states maintain exchange controls and liberalization of capital movement is incomplete (also see below from IMF, AREAER, which suggests that many CARICOM countries maintain controls on most capital account transactions). Capital accounts seem more open in the ECCU compared to the rest of the region.

27. Limited intraregional labor mobility may also affect income convergence. CARICOM Free Movement Protocol in 1989 and the CSME envisage free movement of skilled labor and provide a framework for intraregional mobility of people. However, only five of ten categories of skilled labor have been granted the right to work in all member states without a work permit, and for the five newer categories, compliance varies across the membership. In addition to the possible difficulties at the national level that may discourage applications for skill certificates, lack of harmonization and duplication of processes also hinder mobility (CARICOM Secretariat 2018). At the same time, the region is characterized by net out-migration (mainly to the US, Canada, and Europe) with the limited growth and job prospects and environmental shocks reinforcing the pervasive brain drain (International Organization for Migration 2017, and Alleyne and others 2017). The intraregional migration is significant only for a small part of the region, although official statistics may not accurately measure movement of unskilled labor that may enter as visitors up to 6 months and stay.11 The island geography, limited and expensive sea and intraregional air connectivity likely also affect the intraregional mobility of people, as well as intraregional trade and tourism flows,12 and undermine the ability to tap into regional and global value chains (ECLAC 2014).13

uA01fig13

Degree of Capital Account Openness 1/

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

1/ Based on Chinn-lto Financial Openness Index which codifies the restrictions on cross-border financial transactions reported in the IMF Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER). See http://web.pdx.edu/~ito/Chinn-lto_website.htmSource: IMF staff calculations

E. Financial Integration

28. Financial integration is a key component of economic integration and has been an explicit objective of the CSME in creating a common economic space (Box 1). Regionally-integrated financial systems enhance the availability of capital, support efficient allocation of resources at reduced transaction costs, lead to convergence of interest rates and asset prices, and improve financial standards, all of which can support economic growth. Integrated financial systems also promote competition, efficiency, and risk sharing, but in the absence of adequate regulatory and supervisory frameworks within and across borders, they can facilitate transmission of adverse shocks and destabilize economic and financial systems.

29. Evidence suggests continued progress in financial sector integration within the Caribbean, but not all parts of the region and sectors of the financial system have proceeded at a similar pace. The Caribbean financial systems seem well-integrated, while the integration of financial markets is still ongoing, with markets remaining relatively underdeveloped and fragmented, likely reflecting the lack of harmonization of the regulatory frameworks across national securities markets and the paucity of cross-listings. Three major stock exchanges—in Jamaica, Trinidad and Tobago, and Barbados—lead the region’s equity markets, while bond markets are dominated by government securities. Interest rate and asset price convergence has been uneven across different segments.

Provisions for Financial Integration in Caribbean Community (CARICOM)

The Revised Treaty of Chaguaramas include several provisions and envisions to support financial integration:

  • Removal of discriminatory restrictions on banking, insurance and other financial services.

  • Removal of restrictions on movement of capital and current transactions, including equity/portfolio investments, short-term bank and credit transactions, payment of interest on loans and amortization, dividends and other investment income after taxes, repatriation of proceeds from the sale of assets, and other transfers/payments relating to investment flows.

  • Harmonized legal/administrative arrangements for the operation of partnerships, companies or other entities.

  • Abolition of exchange controls in the CARICOM and free convertibility of the currencies of member states.

  • Convergence of macroeconomic performance and policies through coordination or harmonization of monetary and fiscal policies, including, policies relating to interest rates, exchange rates, tax structures and national budget deficits.

Financial System Integration

30. The financial sector is highly-interconnected, within the region as well as with global institutions and markets (Canetti and others 2017). Evidence supports increasing integration in the banking sector, with active presence of domestically and foreign-owned common lenders that are structured as financial conglomerates with significant cross-border operations and complex, opaque ownership linkages.14 Cross-border lending and borrowing of commercial banks has been increasing particularly in the ECCU, where banks’ outstanding claims on other banks in the ECCU increased significantly since 2000 (Figure 9).

Figure 9.
Figure 9.

Banking System Interlinkages in the Caribbean

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

31. Regional financial conglomerates also dominate the insurance sector, and their ownership links with other financial and nonfinancial institutions add to the connectivity in the financial system. Findings from a recent IMF study (Canetti and others, 2017) suggest significant interlinkages across insurance companies, banks, and sovereigns, based on reported balance sheet information. A network representation of the cross-border and cross-sectoral linkages shows that cross-border operations of the Caribbean insurers are large as a share of their total assets and span many countries in the region. Banking systems of several countries are also highly interconnected (Barbados, Guyana and Trinidad and Tobago). In the insurance sector, Barbados and Trinidad and Tobago appear at the center of the regional financial system; the Barbados and Trinidad-based insurance companies—Sagicor and Guardian—carry out operations in 8 and 9 Caribbean countries, respectively.

32. Increased financial system integration has, in turn, resulted in converging interest rates in the region. In a financially-integrated region, where banks compete across borders, the margins they charge above the costs of funds (including the risk premium) will converge even if the latter may vary across markets. As such, declining cross-country standard deviation of lending-deposit rate spreads (sigma convergence) signals a more integrated banking sector (Sy 2006). In the Caribbean, although it remains relatively high, cross-country standard deviation of lending-deposit rate spreads have been falling since mid-2000s. The ECCU has greater convergence, likely reflecting the currency union that reduces cross-border transaction costs and the fixed exchange rate regime that facilitates more financial flows. A similar conclusion emerges from pairwise correlations of short-term interest rates across CARICOM: Interest rates are highly correlated across the ECCU block, as well as among Bahamas, Belize, and Guyana, and between Barbados and Trinidad and Tobago (Figure 10). At the same time, greater convergence could also be driven by the dominance of foreign banking groups, which can affect the lending spreads, and funds flowing from low rate countries to high rate countries.

Figure 10.
Figure 10.

Interest rate Correlations in the Caribbean, 2007–2016

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: Monetary and Financial Statistics (IMF); Correlations are computed across bank deposit rates.
uA01fig15

Banking Sector Convergence

(Standard Deviation of Cross Country Lending-Deposit Interest Rate Spread, Percent) 1/

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: World Bank, IMF Staff computation1/ Declining standard deviation indicates more convergence

Financial market integration

33. Capital markets remain relatively underdeveloped and fragmented, with a slow record of implementation of the formal integration arrangements. Progress has been made in liberalizing the movement of finance across borders, but very limited progress in harmonizing legal and administrative arrangements across the region. Formal capital market integration has been limited to facilities for cross-listing securities on the securities exchanges of Barbados, Eastern Caribbean, Jamaica, and Trinidad and Tobago, while the remaining CARICOM members remain outside this arrangement (Worrell and Jhinkoo 2009). High costs of regulatory compliance under lacking harmonization of the regulatory regimes could undermine cross-listings. No Caribbean-wide capital market exists to date, but CARICOM leaders announced plans to establish one at the 2018 CARICOM Conference of Heads of Government meeting, putting greater focus on advancing measures for a competitive Single Market.15

uA01fig16

Number of Cross Border Operations 1/

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Sources: Company Annual Reports1/ Based on number of subsidiaries/affiliates/branches or distribution channels within CARICOM member countries#: red dot based on 2011; #: red dot based on 2012; A; red dot based on

34. Notwithstanding the delays in implementing the formal commitments under the CSME, integration of the region’s financial markets seems to have progressed informally. Mergers, acquisitions, lending, and investments have accelerated across the region (Worrell and Jhinkoo 2009). Several large corporations have cross-border operations and regional linkages through distribution channels, branches, or joint ventures.16 The conglomerate with the widest network, for instance, has operations in 14 countries. One third of these firms have expanded cross-border operations during 2010–17 and engage in a wide range of activities (e.g., financial services, telecommunications, construction, manufacturing, hotel management, trading, and wholesale/retail operations). Several large companies have multiple listings across major stock exchanges. The Trinidad and Tobago, Barbados, and Jamaica exchanges have an arrangement for cross-listing and trading of shares and bonds in 1991 and feature more than one fifth of the companies listed in multiple regional exchanges. The exchanges have low liquidity and market capitalization, due in part to small size.

Cross-Listed Companies in 2018

article image
Source: Country Stock Exchanges.

35. Available data suggest converging share prices of actively-traded firms cross-listed in the three major Caribbean stock exchanges, helping to align the broader stock market indices. Some convergence of share prices of actively-traded cross-listed firms, albeit with a small time lag, is evidenced by pairwise correlations across the main exchanges and has influenced, to a certain extent, the co-movement in stock market indices in Barbados, Jamaica, and Trinidad and Tobago (Figures 11, 12), likely reflecting cross-border trading in the listed securities. At the same time, country specific macroeconomic risk factors remain important determinants of stock market volatility.

Figure 11.
Figure 11.

Integration of Stock Markets in the Caribbean

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Figure 12.
Figure 12.

Stock Prices of Actively-traded Companies Listed in Barbados, Jamaica, and Trinidad and Tobago

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: Bloomberg.

36. The region’s bond markets continue to be dominated by government debt securities, reflecting high public sector debt in most CARICOM countries. The Eastern Caribbean Regional Governments Securities Market (RGSM) is the only existing (sub)regional market, established in 2002 for trading ECCU debt instruments to support government financing needs at low borrowing costs, assist in debt management, deepen the region’s financial markets by integrating the eight fragmented markets of the ECCU, and create a single regional financial space. The RGSM has been successful in creating a regional market for government debt but is believed to be performing below its full potential.17 Beyond the RGSM, Barbados, The Bahamas, Jamaica, and Trinidad have the most developed markets in CARICOM, where short/long-term fixed income securities, equities, and collective investment funds are traded. Small markets in Belize, Haiti, Guyana, and Suriname largely trade government securities. Available data suggest low level of integration across the region’s bond markets, with short-term treasury bill rates, other than for the ECCU, largely uncorrelated (Figure 13).

Figure 13.
Figure 13.

Correlation Matrix of Treasury Bill Rates, 2015–2017

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: International Financial Statistics, IMF
uA01fig17

Public Debt and Share of Total Public Debt, 2017

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: IMF Staff calculations.

F. Economic Integration: Putting it all Together

37. While progress has been made, economic integration in the region, as measured by the comovement of its key indicators of nominal and real convergence, remained relatively low. Indicators of real economic convergence (Table 3) suggest that trade integration within CARICOM increased over the past two decades but remains at a much lower level compared to other regions, in particular Europe; real business cycles have been converging but their correlation within the region remains at a very low level; and while the variability of real per capita incomes have been falling for the region, the gap between the highest and lowest incomes have been widening, with high-income countries remaining as outliers. Nominal convergence indicators also suggest that inflation, interest, and exchange rates are converging but are not highly correlated compared to those in Europe.18

Table 3.

Selected Indicators of Economic Integration

article image

Includes on 12 of the EU16 countries due to data limitations

Chinn-lto index Regional Average

38. An overall index of economic integration summarizes this evolution. The index measures the extent to which the region has highly correlated business cycles, inflation rates, and real and nominal interest rates, while also having high trade integration and small differences in per capita incomes, real and nominal exchange rate volatility, and smaller deviations in interest rate spreads. The indices suggest that the EU countries have become more integrated over time (marked in the low level of and gradual decline in the index for broader EU, though diverging somewhat more recently). MERCOSUR countries seem to be in a period of divergence, reflecting large differences in inflation rates, variability of interest and exchange rates and more asynchronous business cycles. In CARICOM, the overall trend is toward economic integration as suggested by the gradual decline in the index, but the region overall seems much less integrated, including in relation to the ECCU subregion. The convergence seems to have gone back and forth—with occasional reversals breaking the momentum achieved. It is worth noting that economic integration within Europe was already high even at the inception of the Single Market in 1993, reflecting continuous integration efforts among sovereign countries, including through the various sub-regional agreements ever since the end of World War II (Annex III)—with the caveat of the more recent tensions in the context of Brexit talks. In contrast, CARICOM was established in the 1970s against the background of the collapse of a short-lived West Indies Federation and strong political concerns of “loss of sovereignty” across the region.

39. The evolution of economic integration along with institutional integration also suggests that CARICOM is moving in the right direction in both dimensions but still has considerable room to deepen integration. While there is a clear trend toward integration, as suggested by the trajectory of economic and institutional integration indices toward the axis origin, the region has a long way to go in both dimensions (see also Craigwell and Maurin, 2011).

uA01fig18

Overall Economic Integration Index

(lower value = more integrated)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: IMF staff calculations
uA01fig19

Economic and Institutional Integration Indices, 1995 – 2016

(three-year rolling index, lower value = more integrated)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: IMF staff calculations.

40. Weak economic integration may, in part, be the result of the prominent influence of external factors, given the small size of the Caribbean economies. The Caribbean economies are subject to a range of shocks (including commodity, external demand, or natural disaster shocks) at different frequencies and intensities. To the extent these external factors are not perfectly correlated, they can pull CARICOM economies away from the common growth trends in the region. The cointegration analyses conducted for the region suggest a long-run relationship between the growth rates of tourism-dependent CARICOM economies and the United States, the top tourism-source country for the region, as well as a long-run relationship between the small commodity exporters and global commodity cycles. For the region’s largest two economies, Jamaica and Trinidad and Tobago, no long-run relationship has been found with respect to partner country growth or commodity prices, suggesting that economic trends in these countries may be driven less by external factors compared to smaller Caribbean states. The overall results suggest, however, that beside regional integration, integration with the global economy is also important for the Caribbean countries (see below and McLean, Pantin, and Skerrette, 2014).

41. The interplay between the economic and institutional integration indices also suggest that economic integration has been affected by the slow and incremental progress in institutional integration. Trade integration, in particular, has been undermined by the slow progress in lowering high NTBs and trade costs in the absence of harmonized customs laws, regulations, and institutional processes and frameworks. The lack of harmonized processes and infrastructure to facilitate intraregional connectivity and other legal restrictions have constrained the free movement of people and capital within the region, undermining the essential components of the single market and economy. In the ECCU subregion, economic integration seems to have gained steam with the steady and significant advances in institutional integration. Accelerating institutional integration, including by harmonizing and rationalizing the key institutions and processes, can therefore provide significant dividends toward economic integration.

IV. Understanding the Implementation Challenges

The key observation that institutional and economic integration go hand in hand suggest that the region should focus its utmost attention to identifying and addressing the key impediments to progress in institutional integration. A combination of institutional, economic, structural, and political economy factors, as well as resource and capacity constraints, underlie the implementation challenges. Addressing these challenges swiftly should help reduce the fixed costs of institutions and doing business in the region and provide the necessary scale and boost to the regional integration move.

42. A combination of institutional, economic, structural, and political economy factors, and resource and capacity constraints have been undermining cooperation and challenging the Caribbean integration process. In a regional context, forging effective cooperation requires, first and foremost, appropriate institutional and governance mechanisms and tools, such as a regional authority with accountability and powers to effect, and ensure implementation of the outcomes of, decision making. In the absence of such authority, cooperation must rely on voluntary action, which works only if national interests are well-aligned around common or shared goals (see, e.g., Otker 2014). Cooperation (hence integration) would work best when incentives to cooperate are well-aligned to address common practical challenges. When perceived benefits from integration are limited, or are not widely shared, while requiring large costs, full regional cooperation would not occur. All of these obstacles are relevant in the case of the CSME.

43. First, the institutional and governance structures of CARICOM raise important challenges for furthering the CSME agenda. Except for the Caribbean Court of Justice, none of the bodies created to support the integration process (Annex II) has been given supranational powers for decision making and no instruments exist to transform Community decisions to binding laws across jurisdictions (Warner and Anatole 2015). Moreover, as a “Community of States,” decisions are taken by consensus, with the principle of discretionary intergovernmental cooperation, under which each member state retains its sovereign authority and regional policies and decisions can only be reached through unanimity, not by qualified majority. With the Revised Treaty providing no commitment to a form of Caribbean union, member states retain their frontiers, and the CSME agenda focuses on harmonizing selective legislation to facilitate economic transactions and creating a level- playing field. The difficulty in achieving the CSME through such cooperation is noted clearly by the political leadership:19

Our Caribbean Community has been conceived to be a Community of Sovereign States. Each sovereign state in such an arrangement retains exclusive powers in relation to the implementation of community decisions. There is also no provision for the transfer of sovereignty to any supranational regional institution and there is no body of community law that takes precedence over domestic legislation or is automatically applied in domestic jurisdictions. The Caribbean has therefore chosen the most difficult political form of integration by which to implement something that is as complex as a single market and economy. (Prime Minister Owen Arthur 2004)

44. In contrast, certain features of the institutional structure within the EU supports integration. The Single European Act was incorporated into the Treaty of Rome to “provide for an area without frontiers, in which free movement of goods, persons, services, and capital is ensured” (Brewster 2002). The EU, in general, does not require unanimity for decisions to be approved and relies on qualified majority voting.20 The Council of the European Union (with one representative from each member state) and the European Parliament (directly elected by voters in each member State) together exercise authority in specified areas that binds member states. All decisions are defined as European Directives and automatically have the force of EU law, and member states are required to incorporate them into national law.21 In addition to Directives, the EU legislature also adopts Regulations that are directly applicable and legally binding in all member states. Both Directives and Regulations are EU legal instruments. This process and the institutional capacity in the EU provide a stronger basis for deeper regional integration. These features of EU integration, as well as the closer integration within the ECCU region, where the creation of some supranational institutions has helped better coordination and harmonization of policies and institutions, could provide some food for thought to resolving the implementation challenges in the CARICOM context.

45. The incentives problem provides another key obstacle. Policymakers tend to assess the case for integration through the lens of costs vs. benefits from closer integration. Many of the CSME measures (e.g., reducing or eliminating tariffs, NTBs, or specific taxes) are likely to result in a loss of already small revenue base, at least in the short run, or displaced high-cost local production, and most measures will require some surrender of sovereignty (Bourne 2003; Girvan 2005). Most actions require significant resources, to draft laws and regulations, ratify them nationally, and secure support from the public. Against the large upfront costs, benefits for growth, employment, or trade may seem uncertain and uneven (given different production structures and development levels and dominance of trade with non-CARICOM states), or hard to quantify, or occur beyond the life-span of prevailing governments.22 Different development levels and structures also make it challenging to coordinate and harmonize policies across the broader Caribbean.

46. Efforts are hence needed to align incentives across the region—including by providing evidence on the potential benefits from further integration and by leveraging on the existing mechanisms and institutions, such as the CARICOM Development Fund (CDF). The CDF was established in 2008 as an institution of the Caribbean Community to provide safety nets and financial and technical assistance to less developed states, regions and sectors in the Community disadvantaged by further integration. It aims at addressing disparities among CARICOM states that may result from implementation of the CSME and provide financing for projects that could strengthen economic development and boost capacity, but has limited resources. In the absence of well-structured, adequately resourced, and accepted mechanisms for distribution of the benefits from integration and compensation for its costs, and absent a duly-constituted supranational authority, there will be little incentive for individual states to cooperate across the board and reduce disparities.23

47. Resource and capacity constraints to implement a complex integration process in the absence of adequate prioritization or sequencing of actions add to the implementation deficit. The small economic size and limited institutional and technical capacity at national levels imply limited resources devoted to implementing the integration agenda. The initial deadlines to complete the CSME agenda do not seem to have taken into consideration the region’s capacity gaps and the complex undertaking required to draft protocols, negotiate texts, secure agreement by Heads of Government, ratify by individual parliaments, and implement the required changes in legislation and procedures at the national level.24 The 619 actions that need to be taken by 13 member states to establish the CSME underscore the complexity of the task. Most decisions have high resource costs and place demands on a limited pool of technical expertise and resources and require significant capacity building support, adequate fiscal space and access to low-cost financing in a highly-indebted region, and political will and prioritization at the national levels (Stoneman, Pollard and Inniss 2012). Recent calls by regional leaders that the CDF provide vital support to member states through technical and financial assistance and address social and economic disparities that may be caused by CSME implementation are positive steps in this direction.

48. Against this background, can CARICOM move towards firmly establishing the CSME and deeper integration without embracing a closer union? The current reliance on intergovernmental cooperation, a key factor affecting the implementation of CSME actions, means that unless governments are prepared to accept a level of supranationalism, effective functioning of key regional institutions will be impeded (Brewster 2002). Failing to bring in supranationalism to the integration process means that full cooperation will not occur unless member states are convinced of the benefits of integration, ensure an equitable distribution of these benefits, and in so doing focus their efforts on aligning national incentives with the interests of the region.

49. The CSME, if fully implemented, should be viewed as having a positive impact on the region, strengthening its competitiveness and addressing key impediments to growth. While the small size and scale of the Caribbean economies, and the associated supply-side constraints, may potentially limit how much benefit can be extracted from economic integration in the form of regional value chains, acting as a group will enhance their scale, and benefits will likely exceed what can be gained by acting individually; that is, the whole could be greater than the sum of its parts. Recent discussions of the region’s policymakers stress that regional integration remains as valuable and relevant today as at the inception of CARICOM. The lack of free movement of labor and capital are also seen as key obstacles to conducting business within CARICOM and high production costs and limited access to finance as constraints for expanding exports—challenges that could be addressed by increased scale and reduced skills and funding gaps through labor and capital mobility. The following sections analyze the potential benefits from greater integration through further liberalization of goods and factor markets and greater functional cooperation.

V. Economic Benefits from Regional Integration

Greater regional integration through further trade liberalization and increased labor mobility among the Caribbean economies can generate significant macroeconomic benefits, providing incentives for further integration within the region. Granular trade and tariff data indicate that intra-CARICOM tariff barriers are low but NTBs and trade costs are still relatively high, both within the region and vis-à-vis non-CARICOM trading partners. Reducing such barriers and costs will not only generate trade expansion and welfare gains for all CARICOM members, but will also stimulate a restructuring of economies from contracting to expanding sectors, leading to a net employment gain across the region. Further integration could also allow free movement of people and better allocation of skills and factors of production, which could, in turn, increase labor productivity and create long-term growth benefits for the entire region.

50. Earlier sections stressed that national and regional efforts will need to focus on aligning national incentives with the interests of the region, absent binding regional enforcement mechanisms to ensure implementation of actions toward regional integration. This section explores two areas where further regional integration can bring potential economic benefits—liberalization of trade within and outside the region and increased intraregional labor mobility—using two general equilibrium model approaches to explore potential benefits: (1) a global, multisector, computable-general-equilibrium (CGE) model that offers a tool for controlled experiments in which the sectoral and macroeconomic effects of a change in trade policy can be identified, while holding all other effects constant; and (2) a dynamic general equilibrium model to illustrate the main channels through which labor market integration could affect macroeconomic outcomes.

A. Potential Benefits from Trade Liberalization—A CGE Model Analysis

51. A standard, static CGE framework (the Global Trade Analysis Project, GTAP) provides a useful tool to analyze potential economic effects of further liberalization of trade. The model solves for a new, market-clearing equilibrium solution after all prices and quantities adjust following an economic policy shock. In a medium-term timeframe of 5–7 years, skilled workers, capital stock and land resources are assumed to be fixed in national supply, fully employed and mobile across sectors, while unemployment is considered in the unskilled labor market, allowing the unskilled labor supply to accommodate changes in labor demand at a fixed real wage. The analysis aggregates 141 regions of the database into 13 regions (5 in CARICOM–Jamaica, Trinidad and Tobago, Belize, Suriname and Guyana, and “Other Caribbean”—and 8 major CARICOM trading partners),25 16 industries (with 6 in agriculture and resource sectors, 6 in manufacturing sectors, and 4 in services sectors). Eight factors of production are aggregated into capital, land, unskilled labor and skilled labor.

52. Data indicate that intra-CARICOM tariff barriers are low. The trade-weighted average tariffs on trade within CARICOM are mostly zero, except for trade with the Other Caribbean region, which includes some non-CARICOM countries (Figure 14; Table 4). The mostly zero tariffs on intra-CARICOM trade contrast with the much higher tariffs CARICOM countries impose on imports from their major non-CARICOM trade partners. The trade-weighted average tariffs on imports from non-CARICOM regions range from 5 percent for Trinidad and Tobago to 12 percent for Suriname/Guyana.

Figure 14.
Figure 14.

The Caribbean: Average Tariff Rates, in %

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Other Caribbean includes the rest of CARICOM members and four non-CARICOM economies Aruba, Cuba, Curacao and Sint Maarten, and U.S. Virgin Islands.Source: GTAP v10, 2014 base year.
Table 4.

Trade-weighted Average Tariff Rates of CARICOM Members

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Note: Tariff rates exclude NTMs.Sources: GTAP v10, 2014 base year, TASTE, WITS.

53. Intraregional nontariff barriers are relatively high. The availability of data on the NTBs of the Caribbean countries is limited and does not provide a fully satisfactory basis for describing nontariff measures (NTMs) on a country and commodity basis. This analysis uses multiple sources of information that, taken as a whole, indicate that the NTMs imposed by at least some CARICOM economies affect their trade volumes and trade costs, and should be accounted for in a trade policy analysis. 26 It incorporates the ad valorem equivalents (AVEs) of import tariffs of sanitary and phytosanitary measures (SPS—used to protect plant, animal, human health) and technical barriers to trade (TBTs) used by Belize, Jamaica, Suriname, and Trinidad and Tobago, as estimated by Ghodsi, et al (2016).27 The AVEs of NTMs in services are drawn from Fontagne et al (2016). The estimations of Fontagne et al (2016) for Jamaica and Trinidad/Tobago are extrapolated across CARICOM by imposing the average of the two countries’ services AVEs on the imports of trade/transport, business and other services of other CARICOM members (Table 5). The CGE model is recalibrated to represent the AVEs of goods and services NTMs as surcharges to import tariffs.

Table 5.

Ad valorem Equivalents of NTMs in CARICOM

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Notes: SPS and TBT data are trade-weighted aggregations of AVEs of NTMs estimated at HS 6 level to the sectors in the model.Sources: Ghodsi, Greubler and Stehrer (2016) and Fontagne et al. (2016).

54. Trade costs are also high in the Caribbean. They include time expenditures, fees, and other burdens entailed in transporting goods across borders. The OECD defines a trade facilitation index (TFI) that describes 11 dimensions of trade costs, including, formalities, procedures, fees, and adjudication processes. Trade costs in CARICOM are relatively high, with an average index value as low as 0.23 (related to customs fees and charges), compared to an index value of 2 when customs performance is optimal. Moise and Sorescu (2013) estimate the AVEs of trade costs, concluding that they add 16.2 percent to the price of imports by the aggregated Latin American and Caribbean region. In the model used in this analysis, the AVE of trade costs is applied uniformly across all CARICOM countries and represented as iceberg-type trade costs.

55. With these estimations of AVEs of NTMs and trade costs, three trade liberalization scenarios are explored. First, tariffs among CARICOM countries are eliminated.28 Second, the AVEs of SPS, TBT and services-trade NTMs are reduced by 25 percent. This partial reduction reflects that only some NTMs are likely to be actionable or without some desirable protective benefit. The partial reduction rate is similar in magnitude to the degree of liberalization often assumed in other trade policy studies, following Francois et al (2013). Third, trade costs are also reduced by 25 percent, to describe possible gains in customs efficiency such as electronically posted fee schedules. SPS and TBT measures and efficiency gains in trade and customs procedures are likely to affect all trade partners of a country. Therefore, reductions of NTMs and trade costs by CARICOM are introduced in the model experiment on a multilateral basis, rather than the bilateral treatment given tariff reforms. The reporting of model results decomposes the effects of NTM and trade cost reductions within CARICOM and external to the region.

56. Key findings from the trade liberalization simulations are as follows.

  • All CARICOM countries achieve welfare gains from the trade liberalization, with a $6.2 billion gain for the region as a whole (Table 6), equivalent to 7.6 percent of the region’s GDP in 2018. Welfare gains describe the monetary income equivalent of the gain in purchasing power made possible by trade liberalization. Most of the welfare gains are generated by reducing NTMs and facilitating trade with non-CARICOM countries, reflecting their market share in CARICOM imports. NTM reductions among CARICOM countries can generate welfare gains for all members. With tariffs within CARICOM already at or near zero, further tariff reductions are of negligible benefit. All CARICOM countries achieve real GDP growth as a result of trade liberalization, with gains ranging up to 7 percent for Belize (Table 7, Figure 15).

  • Gains from trade liberalization in terms of trade balance can be uneven. Trade balances for Jamaica, Belize, and the Other Caribbean region deteriorate, as their imports grow more than exports with the fall in their trade barriers (Table 8). For Trinidad and Tobago and Suriname/Guyana, import growth is more than fully offset by export growth, resulting in an increase in their initial trade surpluses.

  • Trade expansion leads to increased demand for the region’s workers. Unskilled labor employment increases in all CARICOM regions, reaching over 8 percent increase in Belize (Table 9). Higher demand for skilled labor causes their wage to increase in all CARICOM countries. Most of the benefits of trade reform for factor markets stems from liberalizing trade with the non-CARICOM market, but trade facilitation and liberalization of both intra- and non-CARICOM trade will be beneficial.

  • Trade reforms stimulate a restructuring of economies as sectoral output and trade respond to trade policy changes that differ by industry, as well as the general-equilibrium effects of sectoral competition for labor and capital resources as some sectors expand. Sectoral gains and losses in production will require workers to shift their employment from contracting to expanding sectors.

  • Due to data limitations on AVEs of NTMs and trade costs, there is uncertainty regarding the trade-restrictive effects of the estimated NTMs, particularly in services trade, suggesting interpreting the results with caution.

Table 6.

Impacts of CARICOM Trade Liberalization

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Table 7.

Effects of CARICOM Trade Liberalization on Real Factor Prices and Unskilled Employment (percent change)

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Figure 15.
Figure 15.

The Caribbean: Impacts of Further Trade Liberalization

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

Source: GTAP Database and authors’ computations.

57. The GTAP model results overall indicate that the Caribbean economies stand to benefit the most from reducing NTMs and trade costs for trade within and outside the region. We introduce the reductions of NTMs and trade costs on a multilateral basis. However, there may be some potential to reduce NTMs on a bilateral basis among the Caribbean countries to further facilitate intraregional trade. To that end, the region would benefit from coordinating efforts to strengthen, streamline, and harmonize trade processes and procedures, modernize regulations and legislation, and facilitate conflict and dispute resolution in the CARICOM market.

B. Benefits of Labor Market Integration—A GIMF Model Analysis

58. Free movement of people can generate better matching of skills and improve labor productivity. Previous studies find that with labor market liberalization and trade unions, there would be a migration of workers from countries with low productivity and wages to countries with high productivity and higher wages (Kahanec and Zimmermann 2016; IMF 2018). For example, in Europe, the enlargement of the EU common market and removal of frictions to allocation of resources in 2014 led to increased migration flows from the 8 new EU accession countries to the former core EU15, with the share of those migrants in EU15 doubling in size. Migration also created some temporary small compression in wage growth/markups in the destination countries, and a mild acceleration in wage growth in the countries of origin (Blanchflower and Shadforth, 2009).

59. To estimate the economic effects of migration and productivity arising from improved labor market integration, this section uses a dynamic general equilibrium model, GIMF—the IMF Global Integrated Monetary and Fiscal model.29 The model allows to quantify gains for firms and households while modeling explicit trade relationships with the main partner countries. It features agents who behave according to a life-cycle framework (overlapping generations (OLG) agents a la Blanchard, 1985) and liquidity-constrained households, who have no access to financial markets. Firms produce tradable and non-tradable intermediate and final goods. A series of nominal and real rigidities prevent sudden changes in investment and consumption.30 The model also features a monetary authority and government that respond to shocks to stabilize the economy as rigidities amplify their impact. It captures regional migration by applying changes to the labor force, where inflows of workers could lead to increased labor supply, a contemporaneous fall of reservation wage and inflation, and increased investment; the opposite could materialize in countries experiencing an outflow of labor. The model’s general-equilibrium feature allows endogenous adjustments of the labor and product markets to mimic these developments.

60. The GIMF model is applied to analyze the effects of increased labor mobility in the Caribbean, by specifying the model to include six regions: Caribbean 1 (C1), Caribbean 2 (C2), Caribbean 3 (C3), North America (the US and Canada, UC), Latin America (LA) and the Rest of the World (RW). Bilateral migration flows from a World Bank database show that the more developed islands of the three Caribbean regions have attracted larger immigrant flows. Between 2013 and 2017, there was an increase in net inflow of migrants from less developed countries in the Caribbean (St. Vincent and the Grenadines, Grenada, St. Lucia from C1 and Guyana from C3 and to some extent from Jamaica from C2) to more developed ones (The Bahamas, Barbados from C2, Trinidad and Tobago from C3). These bilateral migration patterns between 2013–2017 are used to identify the countries more likely to be the recipients of future migration flows if labor mobility in the region improves.31

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61. Shocks to migration flows to simulate greater intraregional labor mobility are calibrated based on the recent developments.32 Since 2011, The Bahamas and Trinidad and Tobago experienced an increase of about 1 percent of the total labor force in the number of migrants coming mostly from other CARICOM countries. In the case of a further liberalization of labor mobility, the same countries are assumed to experience a similar influx of population/workers from the other Caribbean regions. Based on the previous observations, most migrants are assumed to come from C1 countries, and some migration is assumed to take place from C3 to C2 countries. Accounting for the relative size of each of the countries involved in the migration, the shock could lead to a (net) increase in labor supply in C2 (by 0.2 ppt) and C3 (by 0.5 ppt) and a decrease in C1 (3 ppt), with the shocks assumed to be permanent.

uA01fig20

Migration flows within CARICOM: Main countries

(changes 2013–17)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

62. In addition to resulting in greater intraregional labor mobility, the improved factor and skill allocation could boost labor productivity, with associated growth benefits in all countries participating in the labor market. In the EU experience, labor productivity in the new-admitted countries grew by about 2 percentage points faster than in the original more advanced members (EU15) in 2004. The exercise for CARICOM assumes that labor productivity improves by 6 percent across the region (with improvement assumed to be gradual and accrue in 10 years), based on the evidence from the OECS countries following the Revised Treaty of Basseterre to form an economic union and allow free movement of labor within the OECS (Box 2). Such gains in productivity are conceivable, including through positive effects of a temporary/permanent migration of skilled labor on the less endowed countries’ human capital (including through transfer of technology and know-how), the impact on production capacity, competitiveness, and production bottlenecks associated with unavailability of local labor at affordable wage rates (Bourne 2003). Greater intraregional labor mobility can also boost productivity by keeping high-skilled labor in the region and limiting the pervasive brain drain through out-migration.

The Divergence of Labor Productivity Growth in the Caribbean

Labor productivity, measured as output per worker, seems to have grown at a faster pace in the OECS countries in recent years than in the rest of the Caribbean. According to the data published by the Penn World Table (PWT), the three OECS countries covered by PWT (Grenada, St. Lucia and St. Vincent and the Grenadines) saw a steady increase in their labor productivity since the early 2010s, while in the rest of the region labor productivity remains stagnant, if not decreasing, over the same period. In tourism-based countries such as the Bahamas, Belize and Jamaica, labor productivity has been trending down since 2000.1

uA01fig21

Labor Productivity in Selected CARICOM Countries (2000=100)

Citation: IMF Working Papers 2020, 008; 10.5089/9781513525860.001.A001

What may explain the divergence between the OECS countries and the non-OECS ones? It is well documented in the literature that a variety of country-level structural factors, such as macroeconomic stability, competitiveness and FDI, can be associated with the performance of labor productivity. At the regional level, an important development for the OECS countries was the establishment of the OECS Economic Union in 2011 (the Revised Treaty of Basseterre was signed in June 2010 and ratified by most member economies in the following year). The Revised Treaty granted OECS citizens the full freedom of movement within the region for an indefinite period to work, establish businesses, provide services or reside. Although the OECS countries are still in the process of enacting all domestic legislation required to give effect to the Revised Treaty, the OECS authorities have also agreed in principle to the free circulation of goods and services within the Economic Union.

As shown by the experience of the European Union, free movement of labor could provide a boost labor productivity, through improved skill matching and job placement, positive externalities of innovation, reduced costs for cross-border services and various other channels. To examine whether this is also the case for the OECS countries following the establishment of the OECS Economic Union, we perform a difference-in-difference analysis using the non-OECS countries as the control group. Given the high homogeneity of the Caribbean economies, especially those dependent on tourism and susceptible to the same types of external shocks, the non-OECS countries serve as an ideal control group. To isolate the causal effect of the regime change (treatment) for the OECS countries after 2011, we also control for country-level factors including inflation, FDI (as percent of GDP), income level (PPP-GDP per capita), and the real effective exchange rate. Our analysis indeed points to a positive impact of the treatment on labor productivity growth for the OECS countries by 6–7 percentage points. The results are robust if we exclude the commodity exporting countries from the control group.

Dependent variable: Log of labor productivity

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***p<0.01, **p<0.05, *p<0.1 z-scores in parentheses(1) includes the full sample of 9 countries for 2000–2017.(2) excludes the two commodity exporting countries Suriname and Trinidad and Tobago.
1https://www.rug.nl/ggdc/productivity/pwt/.

63. The simulation results suggest that the benefit