Regional Integration in a Globalizing World: Priorities for the CaribbeanKey Note Speech by Agustín Carstens
Deputy Managing Director, International Monetary Fund
At the Biennial International Conference on Business, Banking & Finance
Port of Spain, Trinidad & Tobago
May 1, 2006
Prime Minister Manning, Members of the Government, Ladies and Gentlemen. Good evening. Thank you Governor Williams for the kind introduction. I am delighted to be in Port of Spain today to once again experience the warm Caribbean hospitality that makes this region such a special place.
Let me start by thanking the Department of Management Studies of the University of the West Indies, The Central Bank of Trinidad & Tobago, and the Caribbean Money Market Brokers for hosting this important event and for their invitation for me to present the keynote address.
Ladies and Gentlemen, the areas of focus for this conference—Regional Integration, Financial Stability and Business Competitiveness—are probably the three most important issues facing the Caribbean region. Coincidentally, or not so coincidentally, they are also very much on our radar screens at the International Monetary Fund. We firmly believe that the path to greater prosperity for the Caribbean lies in greater integration, within the region and with the rest of the world. However, as we like to say at the Fund, all experiences bring both opportunities and challenges and that is no less true of integration than of anything else. In this regard, as the Caribbean region pursues greater integration in the context of a very dynamic world economy, it is essential that it improves its competitiveness and continues to ensure financial stability.
I will elaborate on these points below. I will begin by giving you my perspective of the Caribbean region and take stock of where it currently stands on the issue of integration. I will then address the question of what globalization means for the Caribbean and why integration is key to taking advantage of the opportunities afforded by this trend. I will then speak to the issues of the financial sector and the steps necessary to address and guard against the challenges and risks of globalization and greater integration. Finally, I will conclude by describing to you how the Fund's role in the Caribbean has been evolving as the region's external environment and the countries' own priorities change.
The Caribbean in perspective
A significant strength of the Caribbean, as it faces the forces of globalization, is the existence in most countries of vibrant democracies. In the decades since independence, Caribbean countries have exemplified transparent institutions and governance in the Western Hemisphere. Pluralism and democracy have flourished, and racial and gender equality have long underpinned the political process. It is no accident that this region is a world leader in attracting talented women to economic and political decision-making, starting from Dominica's Mary Eugenia Charles in 1980—the first woman prime minister in the Caribbean—to the present day, with Portia Simpson Miller holding the office of Prime Minister of Jamaica. CARICOM countries have healthy competitive political processes, decades of experience with regular national elections, and entrenched respect for civil and economic liberties. Economists widely attribute strong institutions as important contributors to sustained economic growth and stability. Hence, these exemplary achievements have, and will continue, to serve the Caribbean well in the environment of increasing globalization.
The inclusive political process has also been a contributory factor to another of the region's strengths—the impressive social indicators. Education and health indicators in the Caribbean are strong and poverty remains lower than in many other parts of the world. There is a strong consensus in the region that it is important to safeguard these achievements in the competitive global environment and we could not agree more with this view—human capital is the single most critical ingredient in making the most of the growth opportunities over the longer run.
Another attribute of the region is the demonstrated ability to seize on emerging comparative advantages—such as your thriving tourism sector. As the world economy integrates, encouraging specialization and developing the region's comparative advantage should indeed be of utmost importance to policy makers. But as you know, the task of transforming parts of the agricultural sector or improving the competitiveness of the manufacturing sector is not yet complete. In particular, the erosion of trading preferences with Europe has brought a sustained decline in traditional agricultural export earnings—the prospects going forward are not encouraging. This challenge—of continuing to transform the islands, while ensuring that the poor and vulnerable are protected and that workers are equipped with the skills necessary to compete in today's global economy—remains very relevant for much of the Caribbean. Of course, with the large emigration of skilled labor from the region to industrial countries, the task of ensuring that the retooling of skills meet the evolving demands of the region is even more formidable.
Since independence, the region has strived to develop advanced financial markets that have strong cross-border linkages, but a question you may wish to ask yourselves is: are these markets being tapped to serve the region's strengths? Lending to high growth sectors remain relatively low. Instead, they have been used to finance public debt to levels that are now among the highest in the world. These trends are highlighted by two sets of numbers. In the decade to 2005, financial depth indicators for the Caribbean showed great improvements. For example, the ratio of broad money to GDP increased, on average in the region, from about 50 percent to about 80 percent during the period. At the same time, however, public debt increased rapidly. Indeed, the region is now home to seven of the world's ten most indebted emerging market countries, with the average level of public debt to GDP rising above 90 percent in 2005, up from 70 percent in the mid 1990s.
Despite a shared history and many of the shared experiences since independence that I have noted, it is surprising that there has not been more significant progress at regional integration. As you know even more than I, it is not that the sentiment for integration has been absent—indeed, regional integration has been a top agenda item for Caribbean leaders for nearly half a century, but the action has not fully matched the rhetoric. It is encouraging, however, that a strong consensus to integrate remains in the region, as is evident with the launching of the Caribbean Single Market and Economy (CSME) initiative this year.
The challenge now is how to proceed and advance the integration process. Our own experience from looking at other countries around the world indicates to us that reduction of trade barriers—not only within the region but with the rest of the world, convergence and coordination of economic policies, and steps to strengthen financial sector linkages are key to successful integration. But before proceeding on these specific topics, it is important to ask why integration is imperative now. And with whom—that is, what should the balance be between regional and global integration?
The answer to these questions, Ladies and Gentlemen, lies in the fast pace of globalization which has fundamentally changed the external environment facing the region. Globalization provides great benefits but competition in the international arena is also fierce. As an illustration of the benefits, consider the increase in the market for tourists, or of investment funding, from an increasingly affluent Asia that is now more closely linked to the Western Hemisphere by more frequent and direct air routes. On the side of costs, consider the outlook for the Caribbean's traditional agricultural exports as regional neighbors, such as Brazil, have solidified their positions at the top of the world's league of efficient sugar exporters amidst cuts in European Union subsidies to the Caribbean.
Seizing the opportunities presented by globalization means, by definition, increasing integration with the world economy. As I just noted, however, globalization comes with new risks and vulnerabilities as well, and countries need to address these as part of their strategies. It is in these respects that greater regional integration gains prominence. In other words, greater regional integration—if done right—can be complementary to the process of global integration—in both seizing the opportunities presented by globalization, and in guarding against and overcoming the attendant vulnerabilities and challenges. Indeed, for small open economies, like the island nations of the Caribbean, regional integration may be critical in helping overcome some of the natural disadvantages and limitations that small nation states face with respect to the unavoidable forces of globalization.
Integration as a way to improve competitiveness
With greater regional integration, economies of scale in production of goods that are not available to individual islands may be feasible for the region as a whole. Moreover, politically challenging policy changes can often be achieved through regional agreements. In addition, gains from specialization within the region can be realized by pursuing different strands of the value-added chain, as has been observed in the differentiations among Caribbean countries between mass versus boutique tourism, and development of higher quality locally branded products, such as Jamaican Blue Mountain coffee.
But note the emphasis I placed earlier on the need to get regional integration right. When it comes to trade, for example, one needs to be careful with the issue of diversion. Trade diversion occurs when imports from a low cost third country are replaced by a higher cost intra-regional source. To avoid this phenomenon, it is important, as part of the process of regional integration, to continue to reduce trade barriers to the outside world. At the risk of repeating myself, Ladies and Gentlemen, this point emphasizes the fact that regional integration needs to complement, not substitute for, integration with the world economy.
Greater regional integration of product and factor markets is also necessary to facilitate adjustments to the very large exogenous shocks that the Caribbean region is very frequently subject to and that can have very detrimental impacts on competitiveness. Such integration serves to increase market flexibility and efficiency, and thereby increases the capacity of the region as a whole to recover from these shocks.
A necessary policy imperative for the Caribbean today is, therefore, the relaxation of rigid laws governing the labor market, which can hinder economic flexibility and also distort wages and productivity. Greater labor mobility should serve to ameliorate shortages within the region as some regional economies inevitably grow faster than others. Another dimension of labor market reform relevant to globalization is the issue of migration, which is after all both a cause and a consequence of globalization. As you know, the Caribbean has some of the highest emigration rates in the world, in particular for the most skilled, and while the debate is not concluded, there is some evidence, based on studies conducted by my colleagues at the IMF, that the losses to the Caribbean from emigration to the OECD countries have outweighed the value of remittances received. Under these circumstances, it is incumbent upon Caribbean countries to assess their education and migration policies to consider how best social investment could be directed to benefiting the region first and foremost.
Policy Convergence and Coordination
Let me now turn to convergence and cooperation of policies. Such coordination is both a necessary ingredient for, and a necessary outcome of, greater regional integration. Moreover, the convergence of macroeconomic policies to a significant degree is essential before full monetary union, such as in the Euro area, can be considered. As such, it is critical for countries to try to meet the joint CARICOM policy objectives that you have established but the record, thus far, has not been encouraging. Not only does macroeconomic performance vary widely across countries, but the nature of the shocks also differs: for example, Trinidad and Tobago is facing the challenge of managing the windfall gains from the high energy prices, while other countries are having to adjust to the negative shock. Such differences should, however, not preclude the Caribbean countries from undertaking close coordination of, and consultations on, macroeconomic policies, including on exchange rate policies. Indeed, with greater integration comes the need to ensure that changes in monetary and exchange rate policy in one Caribbean country do not unduly impact on another.
A key policy area where coordination can make every country better off is that of tax concessions. Tax incentives and tax holidays have been used extensively in the Caribbean to promote investment. The associated revenue losses are large and the benefits in terms of new and profitable investments are questionable. Indeed, studies that we have carried out at the Fund suggest that regional competition for investments, including the prevalent tax holidays, create a phenomenon of a "race to the bottom", where marginal effective tax rates in most countries come down to near zero or become negative. Surely, this state of affairs is not beneficial for the region as a whole. Yet, the necessary coordination on tax policy has not come about. To take greater advantage of increasing integration, there is also a need to harmonize requirements and procedures for investors, yet significant differences remain across countries, even in the OECS (ECCU) area where, relatively speaking, there has been more integration.
Another area where the imperative for regional coordination is particularly severe is with respect to natural disasters that are severe and have become more frequent in recent years. We all know how prone this region is to such disasters and the sheer scale of the damage that can be inflicted on countries that lie in the path of a major hurricane. Typically, reconstruction costs far outweigh those of precautionary measures. In this regard, more progress needs to be made at risk mitigation—strengthening and enforcing building codes and land zoning, and there is potential here, too, of undertaking a coordinated, regional approach. From a macroeconomic perspective, contingencies should be incorporated into macroeconomic frameworks and budgets to the full extent possible. For the very highly indebted countries in the region, this reinforces the need to strengthen fiscal positions and reduce the debt burden as much, and as quickly, as possible, so as to increase the room for policy maneuverability in the event of a natural disaster. A regional risk pooling scheme, whose viability is currently being studied by the World Bank, is also an avenue to pursue seriously as the feasibility of obtaining insurance by individual countries at reasonable rates remains limited.
A third area, where the benefits of regional cooperation are clear is in providing collective government services. You have collectively built the expertise in trade negotiations with the rest of the world. Many other areas for cooperation—such as the creation of regional tax administration or regional financial oversight bodies—remain, however, to be tapped.
Ladies and Gentlemen, I, therefore, invite you to ask yourselves at this conference today why coordination and cooperation in practice have lagged the aspirations for greater integration.
I would now like to turn to the issue of financial stability, central to the theme of this conference. The regional financial markets have increasingly become integrated over the last decade. Interest rates in regional countries are much closer to each other than they were a decade ago. Also, cross-listed companies in regional stock exchanges currently account for nearly 60 percent of total market capitalization, up from zero a decade ago. Trinidad and Tobago, the financial hub of the region, has clearly played a leading role in bringing about greater financial integration by channeling its large oil windfall savings to neighboring countries. This impetus toward regional financial integration has also been contributed to by the extremely rapid growth of non-banking financial firms and attendant securitization, particularly in Jamaica and Trinidad and Tobago. Currently, total bank deposits are exceeded by funds managed by securities dealers in Jamaica and mutual funds in Trinidad. As I noted before, the financial sector in much of the Caribbean, however, still appears largely to be geared toward meeting the need to finance government deficits. Nowhere is this more true than in Jamaica where the core business of the security dealers is to serve as retail outlets for government debt.
While the deepening financial integration of the region is clearly encouraging in that it has the potential to make more capital available to the most efficient regional firms, this potential has not been fully tapped. From a macroeconomic perspective, reducing fiscal imbalances and the large debt burdens is a precondition for such resources to be directed to the private sector. In addition, there is uneven regulatory oversight of the financial sector and limited corporate governance in an environment of rapidly growing financial derivatives and increasing cross-border financial flows.
As linkages grow, so do the risks of financial contagion, especially when fiscal policies are not as strong as they should be. As we have observed in other emerging market countries, and there are some examples in the this region also, when financial conditions tighten, markets are quick and ruthless in punishing vulnerable economies. Hence, existing vulnerabilities need to be addressed. The stability of the financial sector would need to be safeguarded by enhanced supervision. With increasing linkages, there is a clear need for close coordination in regulation and supervision among country authorities, and possibly the creation of a regional oversight body. Reducing remaining entry barriers and capital controls and harmonizing taxation, regulatory and supervisory frameworks and improving market infrastructure will go a long way toward maximizing the benefits from financial integration. Extending financial integration beyond the region would also help reap the full benefits by diversifying risks and enlarging financing flexibility.
Role of the Fund
Let me conclude by briefly describing to you how the Fund's role in the region is evolving in the broad context of the issues I have outlined above. In forging new policy directions and by changing the way we conduct our operations, the Fund is guided now by the objective of increasing the effectiveness with which we can help our members make the most of globalization. In this regard, one key initiative that we have now embarked upon that has a particularly important bearing on the Caribbean is the increased regional dimension of Fund surveillance.
There has already been a heightened focus at the Fund on regional surveillance of the Caribbean for some time. A few years ago, we began by stepping up our work on the Eastern Caribbean Currency Union (ECCU) area to include a regional component. The Medium-term Strategy for the Fund endorsed by the membership during the Spring meetings a few days ago has now provided a renewed impetus for regional surveillance across the globe. By focusing on systemic and cross-cutting issues that fall outside the rubric of either bilateral surveillance (such as the annual Article IV consultations we have with all member countries), or multilateral surveillance that focuses on global matters, we hope to bring our analysis and policy advice to bear on issues of regional importance to our members. Clearly the imperatives for, and challenges of, regional integration belong naturally with this initiative. In practical terms, we at the Fund are now in the process of extending the regional work, which had hitherto been limited to the ECCU, to encompass the entire Caribbean. During the coming year, our work will focus on many of the same issues raised above, organized around three themes: tax concessions, loss of trade preferences; and financial integration.
Our regional focus will continue to be supported by our other activities. In this regard, I would like to mention in particular our efforts at capacity-building, through the provision of technical assistance, and the provision of financial resources under a variety of lending windows adapted to the particular circumstances that different countries may find themselves in. To mention just two facilities—we provide relatively quick disbursing loans when economies are hit by natural disasters and in the face of adverse terms of trade shock, such as the loss of trade preferences And, in all of our activities, we have placed a strong emphasis on outreach and engagement with not just our regular interlocutors in the governments but also business and labor leaders and indeed all of civil society.
So yes, ladies and gentlemen, the Caribbean is at cross roads in facing globalization. But exploiting the full opportunities at the right time is key. And the right time is now. The Fund stands ready to assist you, in every way that it can, in helping globalization and regional integration improve the living standards of the people of the Caribbean—the ultimate objectives of the policy makers in this region as well as ours. With these remarks, I wish you a very fruitful outcome to the deliberations for this conference that is organized around such a critical set of issues for the Caribbean. Thank you.