"Caribbean Challenges, Growth, and Progress on the Small States Initiative" by Nemat (Minouche) Shafik, Deputy Managing Director, IMF
September 20, 2013by Nemat (Minouche) Shafik
Deputy Managing Director, IMF
September 20, 2013
Distinguished colleagues, good afternoon.
I am pleased to have this opportunity to talk to you about the IMF’s perspective on the Caribbean growth challenge, and tell you about our work in support of Small States.
I am particularly pleased to be able to speak to you at a lunch hosted by the World Bank—since much of my experience with the growth challenge comes from the Bank, and I have long been an advocate of closer ties between our institutions. Thank you, Hasan, for accommodating the change in the agenda.
The topic of our forum, how to raise growth while achieving sustainability, is the challenge being articulated by countries small and large the world over. While growth is recovering in the wake of the global crisis, it remains in low gear. Like the Caribbean, advanced countries burdened with high debt also recognize the importance of growth in allowing them to recover financial stability. So I want to start by assuring you that the Caribbean is not alone. The world is seeking a surer path to growth.
While the Caribbean shares the problems of advanced economies, last year’s Forum in Trinidad reaffirmed the message that Small States have additional economic challenges, due to their diseconomies of scale and vulnerability to natural disasters. At that time DMD Min Zhu promised that the IMF would bring the Small States agenda forward.
Since then, the Fund has prioritized work on how to generate inclusive growth, and how to understand better the problems of small states. I will use today’s session to comment on the messages from our work on both of these topics for the Caribbean.
Let me first start by taking stock of how Caribbean growth compares with the rest of the world.
Good news and bad news
Viewed with a longer-term horizon, the findings were quite positive. Over the last 30 years, despite the diseconomies of scale, growth in small states has kept pace with large countries. In the Caribbean, per capita income growth was, for instance, double that of larger Latin American peers. Average per capita incomes in the Caribbean are near $9,000, compared to under $6,000 for Latin American peers. Living standards and social indicators are as good as, if not better, than larger peers. In other words, ‘small’ is more beautiful than the literature might suggest.
The bad news is that these trends changed over the past 10 years. Economic growth and social indicators did not keep pace with rest of the world, and small economies have experienced significantly more volatility, particularly micro-states with populations of fewer than 200,000. In the Caribbean, private capital flows and external current accounts are two and three times more volatile than in larger Latin American countries.
It is also abundantly clear that small states, and particularly the Caribbean, are more vulnerable to natural disasters than the rest of the world. A disaster inflicting damage over 2 percent of GDP can be expected to hit the Caribbean region every two to three years. That is a significant economic and financial burden to absorb.
Additional challenges facing the Caribbean
There are other ways in which the Caribbean faces challenges beyond those faced in the rest of the world. Protracted weak rates of growth and high borrowing levels over many years have left the Caribbean the most heavily indebted region of the world. Average debt levels are more than twice the median for larger Latin American countries. This limits fiscal flexibility, discourages private investment, and pushes up borrowing costs, creating a vicious circle. Recent research has found a non-linear negative relation between growth and debt in small states.
Moreover, relatively high income levels for most Caribbean countries mean that most countries are not eligible for concessional financing or international debt relief.
Recent analysis also points to competitiveness issues: labor costs have typically risen faster than productivity in the region; electricity costs are among the highest in the world; tariff and non-price restrictions give rise to protectionism; and laws on deposit rates and loan recovery hamper credit availability.
Much of the region is also grappling with financial system weaknesses. Stronger supervision and regulation are needed to handle structurally weak indigenous banks and also to ensure that insurance and other non-bank financial institutions are being adequately overseen. Work has started in this area, but supervisory capacity and political interference remain an issue.
A. The Broader Agenda for Growth
The IMF’s work on growth this year has confirmed the validity of some longstanding messages about prerequisites for growth. Let me propose to you two major themes:
1. The first message is that “macroeconomic policies matter”.
During this long global crisis, we have seen that sound macro fundamentals and healthy buffers helped cushion against external shocks and sustain confidence and investment. Countries with these fared better and rebounded much faster. The thirteen fastest-growing countries in the world, as identified by the Spence Commission for Growth and Development were all characterized by macroeconomic stability, high savings and investment rates, openness, market allocation of resources and committed, credible, and capable governments.
With this in mind, the Fund continues to recommend for all Caribbean members, including commodity exporters, the following priorities:
- Rebuild policy space and reserve buffers;
- Provide a stable macroeconomic environment which, together with the rebuilt buffers, are the building blocks for higher savings and investment;
- Make growth more inclusive by strengthening social programs and education, and making sure the broader society has access to economic opportunities;
- Pursue active labor market initiatives to help workers enter or return to the workforce, such as insurance, retraining, incentives for job search, and investment in education; and
- Prepare more for climate risks, so strengthen risk management, provide structural incentives for cost mitigation, and make use of existing tools such as regional risk-pooling initiatives and commodity hedging.
More specifically, for heavily indebted states, such as the tourist-dependent countries of the Caribbean:
- Fiscal adjustment is urgent and unfortunately there is no alternative;
- Most of the consolidation should come from lowering current spending. In small states, cuts to current expenditure have been found to be the most growth-friendly approach.
- In some cases, debt restructuring may be needed to restore sustainability. However, each country faces unique considerations, so a case-by-case approach is the most appropriate.
2. The second broad message may be summarized as: “do what it takes to raise growth”.
Growth is essential for addressing fiscal imbalances and for overall resilience. There is no question that high public debt levels must be lowered, but can this be achieved without growth? To borrow from my colleague David Lipton, “there is no lasting growth without sustainable fiscal policies, but there is no sustainable fiscal adjustment without growth.”
Right now the forecast for growth in the tourism-based Caribbean in 2013 is about 1 percent—too low to improve debt ratios or to create sufficient jobs to lower unemployment.
What is to be done? We would suggest the region zero in on a short list of priorities:
First, improve the business environment and boost investor confidence.
Some would say that the Caribbean needs a cultural shift to reduce reliance on the state in what would normally be private-sector led activities. The Caribbean has very clear advantages that it could exploit with supportive policies. Among the most obvious—its proximity to key markets and an educated workforce. Much of the region continues to rank relatively well in “Doing Business” surveys, and places comparably with Asia.
The same IMF study found that growth was higher in small states that had smaller government and lower debt. Some countries are taking steps in the right direction. Barbados just announced new measures to reduce the number of statutory corporations with overlapping functions.
Second, implement development plans that support sustainable growth.
Our sister IFIs have given interesting presentations on this issue yesterday. Let me just note that most countries have prepared solid development plans. The next step is for these to be integrated into budget frameworks to prevent pro-cyclical spending, ensure consistency of expenditure, and prioritize scarce resources.
Third, strengthen technical capacities, laws and institutions to improve governance.
Research has linked higher public debt in small states with weak governance. The overall governance framework is critical. We know that weaknesses are well documented in areas of property registration, contract enforcement, and insolvency. The challenge is how governments can be more results-oriented and empower private sector demand to step in where the private sector should lead.
Fourth, push harder for regional collaboration, coordination to address common problems.
There would surely be a high payoff if countries could lower costs, namely wage costs, electricity and energy costs, trade protection, and financing costs. Despite the documented disadvantages of smallness, there still remains much scope for collaboration, regional ventures and infrastructure projects that could provide economies of scale, reduce duplication, increase market size, and spread the costs of public services.
In this regard, national efforts should give way to strengthening the capacities and reach of regional institutions. Here the Caribbean can point to some real successes: the University of the West Indies, the Caribbean Disaster Emergency Management Agency, and the functional cooperation of the OECS in the areas of justice, pharmaceutical imports, and the Eastern Caribbean Telecommunications Authority.
Still, there is much room for improvement. For example, intra-Caribbean trade stands at just 13 percent of the total.
Hence, it is appropriate that yesterday’s sessions in the Forum addressed these issues.
B. Small States Analysis and Work Program
Let me now turn to what the IMF is doing to respond to the challenges facing small states.
The IMF began to pay special attention to small states a few years ago with the creation of an informal working group of the Executive Board and a “Small Islands” group of Fund staff. As you may know, we have had a series of conferences dedicated to small states, in the Pacific as well in Trinidad last year. Following Trinidad, the IMF undertook a comprehensive assessment of the “state of small States”, which culminated in a series of papers that were discussed by the Executive Board in March.
The starting point for this work, drawn from well-established literature on small states, emphasizes two key handicaps to their economic performance: (1) diseconomies of scale, and (2) vulnerability to external shocks and natural disasters.
In response to the Small States paper’s diagnostic, the Executive Board set out the following work agenda:
1) Continue a targeted research/analytical work program on small states;
2) Ensure that program design meets small states’ needs;
3) Continue capacity building with technical assistance and staff exchanges;
4) Undertake more outreach, including through the Small States Forum; and
5) Improve collaboration with other IFIs.
These recommendations have guided our work since March.
As regards the analytical work agenda for the coming year, we are switching gears to address specific problems of high priority to small Caribbean states. We have begun to:
1) Explore ways to strengthen insurance against vulnerabilities;
2) Take stock of regional financial interconnectedness, with a view to being more prepared to head off financial instability before a crisis. This important study will be possible only with the collaboration of the central banks of the region.
3) Apply our recent reforms in exchange rate assessments specifically to the Caribbean, to give us a deeper understanding of the prerequisites for external sustainability.
At the operational level, the IMF is preparing a Guidance Note for staff to ensure that policy advice and surveillance are tailored to the needs of small states. Moreover, technical assistance and training, particularly through our regional technical centers (including in Barbados), will continue to play a vital role in building small states’ capacities. And, this conference is intended to signal our commitment to work with IFIs to leverage our knowledge as effectively as possible.
But let me use this opportunity to formalize our operational intentions into a broader commitment to Small States and the Caribbean going forward. Given the centrality of growth to sustainability, “ensuring that program design meets small states’ needs” must translate into more focus on growth in our programs. We should be straightforward in acknowledging this. Hence we propose to ask all IMF mission chiefs to small states with Fund-supported programs to include an explicit growth agenda. Obviously the content of such a section will depend on each government’s preferences and capacity, and we do not envisage imposing any new Fund conditionality.
I would welcome your reactions to this proposal, as well as any additional suggestions on our work agenda that you may have, as we draw this conference to a close.
C. PRGT Eligibility
Let me turn separately to our work on small states’ access to concessional financing, which has been a concern to a number of countries in the region.
A separate review of PRGT eligibility found that the problems of small states are more intense for micro states. Caribbean micro states have seen particularly slow growth and high economic volatility. This has led to emigration, large expatriate populations, and considerable social dislocation.
Following this analysis, the IMF this year extended eligibility for concessional financing to three more micro states in the Pacific, and raised the per capita ceiling, thereby retaining the PRGT eligibility of Dominica and St. Vincent & Grenadines—which would otherwise have graduated.
With this in hand, our Board concluded that our financing toolkit currently meets the needs of small states—as evidenced by the use of the various different instruments in recent years.
To conclude, let me stress that the success of this conference and this agenda depends not only on economists and economics, but on the strengths of national self-reliance.
To quote the book by E.F. Schumacher called “Small is Beautiful: Economics as if People Mattered”:
“Economic development is something much wider and deeper than economics, let alone econometrics. Its roots lie outside the economic sphere, in education, organization, discipline and, beyond that, in political independence and a national consciousness of self-reliance.”
The IMF will continue to work closely with the region for growth and sustainability. We can help with financing and policy advice, and in technical training; but ultimately, the region’s economic destiny rests in your hands.