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Explaining Differences in Economic Performance in the Caribbean

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Explaining Differences in Economic Performance in the Caribbean

    Explaining Differences in Economic Performance in Caribbean

    Economies

    By

    Ronald Ramkissoon, Ph.D.

    Senior Economist, Republic Bank Ltd., Trinidad and Tobago

    Telephone: 1-868-625-4411

    Email: rramkissoon@republictt.com

Paper Presented to an International Conference on “Iceland and the World

    Economy: Small Island Economies in the Era of Globalization”, Center

    for International Development (CID), Harvard University, Cambridge, MA,

    May 20, 2002

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FIGURE 1

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    Abstract

    Explaining Differences in Economic Performance in Caribbean

    Economies

Most Caribbean states are small by conventional standards. As such they all

    face the common constraints of size including vulnerability to external

    shocks and natural disasters. Notwithstanding this, some of these states have

    done better than others in terms of economic performance. This paper

    investigates some of the factors that might explain the superior performance

    of some of these small states. It is found that within the selected Caribbean

    group of small states, the smaller or microstates performed better. Better

    performance was associated with a higher degree of openness, an economic

    structure of these economies in which tourism and offshore finance sectors

    featured significantly but not agriculture, greater political stability,

    endogenous capability expressed in a strong macro-economic framework

    and societal cohesion. Among the preliminary conclusions arrived at is that

    small states are not without possibilities in spite of a hostile external

    environment. Special treatment in international fora to complement

    appropriate domestic initiatives can give all small states a better chance for

    progress in a globalized environment.

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    Explaining Differences in Economic Performance in Caribbean

    Economies

    1. Introduction

Notwithstanding that all small states face common external and domestic

    challenges, the fact is that some do better than others. An enquiry into the

    explanations as to why this might be so, must be important for understanding

    and shaping domestic and regional policies.

The Caribbean for our purposes in this paper comprises fifteen (15) small

    territories i.e. islands and littorals all of which are sovereign states. These

    territories range in size from St Kitts and Nevis with a population of 41,000

    to the Dominican Republic with 8,373,000 persons. Grenada, the smallest

    island in our grouping has a land area of 340 square kilometers to Guyana

    with 196,850 square kilometers (Table 1). These territories were colonized

    by English, French, Dutch, Spanish and Portuguese settlers who for the most

    part removed the indigenous peoples, replacing them by African slaves and

    indentured laborers mainly from India but also from China and other parts of

    the Middle East and Asia. The population also includes descendants of the

    European settlers. For our purposes in this paper all the territories are

    considered small. While the population of Jamaica, Haiti and the Dominican

    Republic is over the “standard” 1.5 million, these countries generally share

    the major characteristics of smallness. The territories are a mixture of

    different economic performances, languages, fortunes and hopes.

The primary focus of this preliminary enquiry is not so much as to what

    distinguishes the performance of small economies from large economies,

    which issue dominates much of the literature on small economies. Rather it

    seeks to explain why, within a group of small economies some did better

    than others. This focus is not pervasive in the literature.

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    By way of approach the paper begins with a review of the literature in

    Section 2, which helps to identify the major explanations of growth of small

    economies. This forms the basis in Section 3, of an empirical investigation

    of the factors that might explain the performance of the group of selected

    Caribbean economies. Section 4 arrives at some tentative conclusions and

    suggests areas for further research. This research must be considered a

    preliminary effort due to the time constraint. The conclusions must therefore

    be taken as tentative.

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    TABLE 1

    SELECTED COUNTRIES BY SIZE AND POPULATION

    (IN ASCENDING ORDER)

    COUNTRY Size COUNTRY Population

     (sq km) Grenada 340 St Kitts & Nevis 41,000 St Kitts & Nevis 360 Antigua & Barbuda 68,000 St Vincent & the Grenadines 390 Dominica 73,000 Barbados 430 Grenada 98,000 Antigua & Barbuda 440 St Vincent & the Grenadines 115,000 St Lucia 610 St Lucia 156,000 Dominica 750 Belize 240,000 Trinidad & Tobago 5130 Barbados 267,000 Bahamas 10,010 Bahamas 303,000 Jamaica 10,830 Suriname 417,000 Belize 22,800 Guyana 761,000 Haiti 27,560 Trinidad & Tobago 1,301,000 Dominican Rep 48,380 Jamaica 2,633,000 Suriname 156,000 Haiti 7,959,000 Guyana 196,850 Dominican Rep 8,373,000

     Source: World Development Indicators Database, May 2002

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    2. Explanations of Economic Performance

    A brief review of the literature on growth theory suggests that there is still much debate on what might be the most relevant theory in the case of small economies. Mueller (1994) and Read (2001) are among those who argue that endogenous growth theory holds the most relevance because of its departure from the assumptions of the traditional neo-classical growth theory. Easterly and Kraay (2000) say the “good news is that the lessons of growth experience from all countries seem to be applicable to small states.” Notwithstanding this debate empirical research has gone ahead in the identification of factors that explains growth in small economies.

    The measurement of economic performance of small countries is not entirely a straightforward matter. This might be measured by growth in income or growth in per capita income in which case one might use GDP and GDP per capita, respectively. In the case of per capita GDP one may use the current position or an average over some period. This latter indicator is considered superior for the purpose at hand. Arguably, one may also measure economic performance by the scarcity of poverty since the less poverty in any country, one might argue, the better the performance. For this one might use a measure of the proportion of the population living under the poverty line. Alternatively, there is the UNDP’s Human Development Index, which is a

    broad measure of living conditions in individual countries. Yet another measure of economic performance might be the degree of competitiveness of an economy. All these measures have some limitation. In this paper we use an average GDP per capita (1975-2000) as the main indicator of economic performance.

Size

    Small economies are all faced with common constraints and size is considered a constraint to better economic performance. Constraints include (i) small size of the domestic market (ii) limited possibilities for the development of endogenous technology (iii) limited quantities of natural resources (iv) narrow structure of domestic output, exports and export markets (v) high level of imports and (vi) high transport costs. It is these characteristics, which combine to make most small economies especially vulnerable. Further, it is these characteristics which seem to describe at least some small states as sub-optimal in economic terms and which lead some

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    researchers and policy makers to adopt quasi-defeatist positions and attitudes upon which arguments for aid and special privileges are based.

    Despite the existence of common challenges the fact is that some small economies do better than others. In any case we share the view that size in itself is not a sufficient explanatory factor for economic performance. This is borne out in the literature on country experiences such as by Armstrong and Read, (1995, 2001) and Read, (2001). Indeed Armstrong and Read (1995) lament the lack of attention to “potential advantages, which might also arise.” In the same vein one Caribbean economist, Pantin (1994) argues that in the past, too much emphasis has been placed on the disadvantages of small states. Not surprisingly Read (2001) argues that the “literature tends to

    adopt a fatalistic tone.”

    But just as the pessimistic view seems overly skewed so too might be the more positive positions. Easterly and Kraay (2000) find that small states are nearly 40 percent richer than other states. Read (2001) points to the advantages of small size such as openness to trade and social cohesion.

    Perhaps unfortunately, there is a too strong a tendency in parts of the literature to argue as if there is a special virtue in being small. Briguglio (1998) however reminds those of that opinion that small states do tend to be successful “ not because they are small but in spite of this fact.”

    Our focus is on explaining the differences in economic performance amongst a group of economies, which are all considered small. Put another way, the issue to be investigated is this. What explains the varying performance amongst a group of small Caribbean economies?

    Our review of the literature indicates that the factors explaining growth in small economies might be classified differently depending on the variable(s) of interest of the researcher. Nevertheless certain main factors stand out. These are (1) geography (2) the degree of vulnerability, (3) natural resources (4) openness (5) economic structure (6) workers’ remittances (7) culture and

    social coherence (8) independence (9) endogenous policy and (10) political stability. I will now discuss each in turn.

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    Geography

    Geography is often identified as one factor explaining economic performance. Dimensions of this factor include island-ness, climate, location in relation to surrounding countries, distance from the equator (Krugman, 1998), strategic or locational importance, whether land-locked or littoral or the presence of large inland waterways. Some countries may lie along a fault line or in the case of the Caribbean, in a hurricane zone. These unique geographical features of small states will possess particular advantages or disadvantages. Most small states are islands and this feature of small islands has generated particular interest in the literature. However, Read (2001) finds a weak influence of “island-ness” on the performance of small states.

    Armstrong and Read (2001) accept that islands have distinctive challenges including higher transport costs and costly internal communication.

    Strategic geographic location is often posited as an explanation of performance. For example, a country might be located along a major trading route. The location of a country in relation to other countries has been also identified as a possible factor explaining economic performance. Specifically, if a poor country were located in a prosperous region of the world, one would expect that its performance is likely to converge over time with the prosperous countries around it (Read, 2001). The reverse is also to be expected. If some countries are doing well, in line with their more prosperous neighbor(s) and others are not, then this is also of interest.

Vulnerability

A priori one would expect that economic performance would be correlated

    with vulnerability. That is, the more vulnerable a country to external factors the worse that country is likely to perform. Vulnerability is defined as the degree of exposure to external economic forces and environmental hazards (Commonwealth Secretariat/World Bank, 1999). Vulnerability with its multidimensional aspects has been proposed as a factor, which explains a particular weakness of small states. On this basis the case is being made in international trade fora for the special treatment of small states. For our purposes here we will assume that even among small states some might be more vulnerable than others and therefore it is legitimate to consider this factor in determining the economic performance among a group of small states.

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Natural Resources

    Abundant natural resources have played an important role in the economic development of many states, large and small, often notwithstanding the negative effects associated with growth which is so based. Armstrong et al (1998) find that among the explanations for successful microstates is a natural resource base. This finding, Read (2001) argues is contrary to the “Dutch disease resource curse thesis.” The so-called “curse” argues that a

    mineral resource boom might have an overall greater negative impact

    compared to the benefits that it might bring. He explains that this

    inapplicability might be due to the “greater social cohesion” that is thought to characterize small states. This point would be explored later in the paper. Alexander and Read (2001) more broadly, point to “factor endowments” as one of the possible explanations for superior performance of small states. This broader definition is perhaps more useful for our purposes here as it allows for certain broader considerations of resource rich but not mineral rich islands.

    Kuznets (1963) is one of the earlier economists who pointed out, that countries with natural resources need not do better when compared to countries without. The crucial variables he says lie in the “nation’s social and economic institutions.” This contention is especially relevant in the Caribbean today.

    Openness

    Openness to international trade in goods and services is considered a positive factor by many, in explaining economic performance in small economies. Read (2001) argues for example, that “small states are …likely to be the biggest beneficiaries of a relatively liberal international trade regime.” This is partly because imported technology, which many small states are unable to develop, will be more easily available. Easterly and Kraay (2000) find that some negative effects of such factors as high volatility “are roughly offset by the positive effect of trade openness…” Read (2001) even contends that G.A.T.T. and the W.T.O. are favorable to small states. In the case of Iceland, Kristinsson (2000) claims that “free trade

    policies…have contributed to Iceland’s well being….”

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    These arguments are not without controversy. For one thing, up until the nineties, many small states did not pursue an especially liberalized trade regime. Even where there is movement towards freer trade, many

    protectionist barriers still characterize the trade of most small states. Indeed, De Rosa (2000) laments that small states in the Eastern Caribbean risk being marginalized because of the pursuit of protection and special treatment.

    The fact is that notwithstanding the theoretical arguments for free trade, many small countries are still not convinced. I daresay, that in several respects, neither are all the developed countries.

    Financial openness is one dimension of overall openness. Easterly and Kraay (2000) find that small states do not take “full advantage of the opportunities for risk diversification afforded by international capital markets.” There is much truth here as financial openness can allow small states to hold claims on assets abroad whose returns are not normally correlated with domestic assets.

    For our analysis here however, one would consider that small states with a higher degree of openness do better.

Economic Structure

    Research by Armstrong and Read (2000) found that certain sectors in small states made a positive contribution to the superior economic performance of those states. These sectors were natural resources, financial services and tourism.

    Financial services (usually offshore) were found to explain the better economic performance of small economies. This activity is noted by Read (2001) who however, refers to it as a form of “international rent seeking.” In a criticism of small states Armstrong and Read (2001) speak of “lax

    regulations and laws” which they claim small states can get away with due to the “importance of being unimportant.” Recent experience suggests however, that small states are not viewed as “unimportant” by the developed

    world as far as offshore finance is concerned. The position of the OECD and the Financial Action Task Force on offshore financial services are well known in the region. Indeed, stringent supervision has become even more so since September 11. In this context the arguments by Baldachinno and Milne

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