Organization of Eastern Caribbean States Towards a New Agenda for Growth C

Public Disclosure Authorized Report No. 31863-LAC Report No. 31863-LAC Organization of Eastern Caribbean States Towards a New Agenda for Growth Towards a New Agenda for Growth Caribbean Country Management Unit Poverty Reduction and Economic Management Unit Latin America and the Caribbean Region Public Disclosure Authorized Public Disclosure Authorized Organization of Eastern Caribbean States Public Disclosure Authorized April 7, 2005 Document of the World Bank IDA IFS IMF INFOTEP IPA JAMPRO JCCP JSB LDC LIAT MDGs MFN MIGA MOU NBIA NCFMEA NIS NORAD NPL OAS ODA OECD OECS OECS EDU OERU OSPR oss PAHO PISA PSIP REER SARS SDT SEDU SFA SIGTAS STEP TFP TIC TIMSS UN ECLAC UNCTAD UNDP USMLE UTECH VAT WDR WIBDECO WITS WTO Industrial Development Authority International Financial Statistics International Monetary Fund Instituto Nacional de Formacidn Tkcnico Profesional InvestmentPromotion Agency Jamaica’s Investment Promotion Agency Jamaica Cluster Competitiveness Programme Jamaica Signature Beats Less-Developed Countries Leeward Island Air Transport Millennium Development Goals Most Favored Nation Multilateral Investment Guarantee Agency Memorandum o f Understanding U S National Business Incubator Association National Committee o f Foreign Medical Education and Accreditation National Insurance Scheme Norwegian Agency for Development N o n Performing Loan Organization o f American States Official Development Assistance Organization for Economic Cooperation and Development Organization o f Eastern Caribbean States OECS Export Development Unit OECS Education Reform Unit Office o f Private Sector Relations Open Source Software Pan American Health Organization Program for International Student Assessment Public Sector Investment Program Real Effective Exchange Rate Severe Acute Respiratory Syndrome Special and Differential Treatment Small Enterprise Development Unit Special Framework o f Assistance Standard Integrated Government Tax Administration System Small Tourism Enterprise Program Total Factor Productivity Technology Innovation Center Trends in International Mathematics and Science Studies United Nations Economic Commission for Latin America and the Caribbean United Nations Conference on Trade and Development United Nations Development Programme US Medical Licensing Exam University o f Technology Jamaica Value Added Tax World Development Report Windward Islands Banana Development and Exporting Company Limited World Integrated Trade Solutions World Trade Organization Vice President: Country Director: Sector Director: Sector Manager: Sector Leader: Task Team Leader: Pamela Cox Caroline Anstey Ernest0 M a y Mauricio Carrizosa Antonella Bassani Camille Nuamah 11 ORGANIZATION OF EASTERN CARIBBEAN STATES TOWARDS A NEW AGENDA FOR GROWTH TABLE OF CONTENTS ................................................................................................................................................ ACKNOWLEDGEMENTS........................................................................................................................ EXECUTIVE SUMMARY ........................................................................................................................ INTRODUCTION ......................................................................................................................................... FOREWORD A. B. C. Background .................................................................................................................. Objective of the study ................................................................................................... Outline of the study ...................................................................................................... CHAPTER 1. A. B. C. D. . MACROECONOMIC COMPETITIVENESS . THE EXTERNAL CLIMATE . THE INVESTMENT CLIMATE c. D. E. .......................................................... 18 ..................................................................................... 24 Macroeconomic conditions for investment .............................................. The role ofpublic investment .................................................................. The investment incentives regime ............................................................................... Investment promotion ................................................................................. The regulatory framework and administrative efficiency .. 43 . S K I L L S , WAGES, AND THE LABOR MARKET ................................................... Skills. education and training...................................................................................... Wages and the labor market........................................................................ . TECHNOLOGY, FINANCE AND INFRASTRUCTURE ....................................... F i r m capacity and technology adoption..................................................................... Finance for diverszjkation ......................................................................................... Telecoms. energy and transport .................................................. ........................ . CHAPTER 7 A. B. 6 37 CHAPTER 6 A. B. C. 1 3 4 ................................................................................ CHAPTER 5 A. B. 1 Special and differential treatment .............................................................................. 24 ...................30 Emerging trading arrangements ................................................... Globalization and the prospects for small states .......................... CHAPTER 4 A. B. C. D. E. vi11 The real exchange rate ........................................................................ Exportpei$ormance ............................................................................ Foreign direct investment .................................................................... CHAPTER 3 A. B. C. VII Growth trends............................................................................................................... 6 Sources ofgrowth ......................................................................................................... 7 Macroeconomic outcomes and impact ....................................................................... 14 ........................................................... 15 Current challenges CHAPTER 2 A. B. C. .................................................................................... THE GROWTH CHALLENGE VI .......... OPPORTUNITIES FOR EXPANDING EXPORTS OF SERVICES Tourism ............................................................................... Offshore education .............................................................. .......................... I C T clusters ......................................................................... .......................... Health and wellness sewices........................................................................ Offshore financial services ............................................ ........................... REFERENCES .......................................................................................................................................... ... 111 54 54 76 76 90 96 111 121 126 133 135 ANNEXES ANNEX 1: GRENADA INVESTMENT CLIMATE SURVEY ANNEX 2: CARIBBEAN FOREIGNINVESTORPERCEPTION SURVEY ANNEX 3: LABOR RIGIDITY INDEX ANNEX4: AN EXAMPLE OF DESTINATION-SPECIFIC “EXPORT READINESS” CRITERIA 143 145 150 152 TABLES TABLE1: SELECTED STATISTICS ..............................................,,.,,,...,,,,,.,,.,,,,,,,.,,,,......,.............,......................,.,... 1 TABLE2: SELECTED ECONOMIC INDICATORS, 1998-2003 ................................................................... TABLE1.1: SECTORAL COMPOSITION OF GDP* AND GDP GROWTH,1980-2003 ................................. ..*... TABLE1.2: TOTAL FACTOR PRODUCTIVITY GROWTH (SOLOW RESIDUALS),1980-2000. TABLE1.3: FACTOR DECOMPOSITION OF GROWTH ............................................................................................... 11 TABLE1.4: PERFORMANCE OF MAJOR EXPORTS, 1980-2003 ........................................ TABLE1.5: DEBT SUSTAINABILITY .......................... ................................... ........ ..... TABLE2.1 : EXPORT PERFORMANCE, 1980-2003 ................................................................................................... 20 TABLE2.2: TOPTEN* MERCHANDISE EXPORTS ................................................................................................... 2 1 TABLE2.3: FDI PERFORMANCE............................................................................................................. TABLE3.1: OECS SHARE OF INTRA-CARICOM TRADE,1980-2002 .................................................... TABLE3.2: TAIUFF AND TRADEBARRIERS ........................................................................................................... 28 TABLE3.3: GRENADIAN FIRMS’ PERCEPTIONS OF LIKELY IMPACT OF C S M E AND FTAA ON SALES ..... ........ .,....3 1 TABLE3.4: A C0MPARIS0N OF IRELAND AND THE OECS ........................................................................... TABLE 4.1: SECTORAL COMPOSITIONOF PUBLIC INVESTMENT, 1995-2001 ................................................ TABLE 4.2: TAX RATES ............................................................................................................................... TABLE4.3: THECOST OF INVESTMENTPROMOTION ..................................................................................... TABLE4.4: FIRM RESPONSES TO ADMINISTRATIVE PROCEDURES IN GRENADA ................................................... 52 TABLE5.1: TIME NEEDED TO FILL A VACANCY IN GRENADA .............................................................................. 56 TABLE5.2: INCREASING RETURNS TO EDUCATION .............................................................................................. 57 TABLE5.3: SECONDARY AND TERTIARYEDUCATION........................................... ...................................... 58 TABLE5.4: EDUCATION INDICATORS ............................. TABLE5.5: YOUTH UNEMPLOYMENT............................. TABLE 5.6: TYPES OF TRAINING INSTITUTIONS USED BY FIRMSIN GRENADA..................................................... 65 TABLE5.7: SELECTED WAGERATES.................................................................................................................... 68 TABLE5.8: UNEMPLOYMENT TRENDS .................................................................................................................. 68 TABLE5.9: GOVERNMENT EMPLOYMENT AND WAGES ........................................................................................ 7 0 TABLE 5.10: INDICES OF LABOR MARKET FLEXIBILITY ............................................................... TABLE6.1: DONOR-FINANCEDPRIVATE SECTOR DEVELOPMENT PROJECTS IN THE OECS .................................. 7 9 TABLE6.2: NOVELL C E R T ~ F ~ C AIN T THE ~ ~ NCARIBBEAN ..................................................................................... 89 TABLE6.3: SOURCES OF FINANCEFOR FIRMSIN GRENADA............................................... TABLE 6.4: A TEXTBOOK CHECKLIST FOR FIRMFINANCINGDECISIONS FOR NEW INVESTMENTS ..............,,,,,..,,94 TABLE6.5: SELECTED TELECOM AND ICT INDICATORS, 2002 ........................... TABLE6.6: IMPACT OF LIBERALIZATION ON THE OECS TELECOM SECTOR ....... TABLE6.7: ELECTRICITY PRODUCTIONAND PRICING ........................................ TABLE 6.8: TAXI FARES IN SELECTED CARIBBEANMARKETS ............................................................................ 109 TABLE7.1: TOURISM SEGMENTS, 2000 .............................................................................................................. 112 TABLE7.2: INTERNAT~~NAL TOURISTW A L S BY REGION OF DESTINATION ......................................... TABLE7.3: PUBLIC EXPENDITURE ON TOURISM ................................................... .................................. 121 TABLE7.4: STATISTICS ON THE us MEDICAL PROFESSION.................................. TABLE7.5: OFFSHORE MEDICAL SCHOOL U S M L E PASS RATES ....................................................................... 124 ................. 124 TABLE7.6: COMPARISON OF us AND OFFSHORE MEDICAL SCHOOLS ............................. TABLE7.7: OFFSHOREFINANCIALCENTERS...................................................................................................... 133 ~ Figures FIGURE1.1: FIGURE1.2: FIGURE1.3: FIGURE1.4: FIGURE 1.5: FIGURE1.6: FIGURE1.7: REALGDP GROWTHINTHE OECS, 1978-2003 ................................................................................. 7 EMPLOYMENT IN AGRICULTU ........................................................................................................... 8 TOTAL, FOREIGN AND DOMESTIC INVESTMENT, 1980-2003 ............................................................. 12 COMPOSITIONOF INVESTMENT, 1977-2003 ............................................................................ * 12 SOURCES OF FINANCE FOR INVESTMENT, 1980-2003 ....................................................................... 13 COMPOSITIONOF INVESTMENT, 1990-2003 ...................................................................................... 13 FISCAL ACCOUNTS, 1990-2003 .....................................,.,.....,..,..,.,.,.,...................,.........,.......,,..,,.., 15 iv FIGURE2.1: FIGURE 2.2: FIGURE3.1: FIGURE3.2: FIGURE3.3: FIGURE 4.1 : FIGURE4.2: FIGURE 4.3: FIGURE 4.4: FIGURE4.5: FIGURE5.1: FIGURE 5.2: FIGURE5.3: FIGURE5.4: FIGURE5.5: FIGURE5.6: FIGURE6.1 : FIGURE 6.2: FIGURE 6.3: FIGURE6.4: FIGURE 6.5: FIGURE 6.6: FIGURE6.7: FIGURE 7.1: FIGURE7.2: RER BASED ON DOMESTIC PRICE INDICES ONLY. 1990-2003 ........................................................... RER BASEDON DOMESTIC AND EXTERNAL PRICE INDICES, 1990-2003 .................................. VOLUME, VALUE AND PRICES OF BANANA EXPORTS, 1954-2002 ........................................... TRADERECPROCITY IMPROVES EXPORT PERFORMANCE ................................................................. ................................... IMPORTANCE OF EXPORT SALES IN GRENADA .......................................... COMPARISON OF INFRASTRUCTURECOSTS ................................................................... GRENADIANINVESTOR PERCEPTIONSOF THE FDI F ~ E W RK O ...................................................... SOURCES OF INFORMATION FOR FOREIGNINVESTORS ...................................................................... FOREIGN INVESTORS’ PERCEPTIONSOF THE INVESTMENT CLIMATE ................................................. STAGES OF E-GOVERNMENT ............................................................................................................. SKILLS COMPOSITION OF A SAMPLE OF FOREIGNFIRMS IN THE CARIBBEAN (%) ............................. MAJOR OBSTACLES TO FEW COMPETITIVENESS IN GRENADA ......................................................... TERTIARYEDUCATION:INVESTMENT AND ENROLLMENT (2000) ................................ SHARE OF FIRMSOFFERINGFORMALTRAININGIN GRENADA ................................................ ................................. DISTRIBUTION OF PUBLIC SPENDING ON TRAINING.......................... ... REMITTANCE FLOWS ........................................................................... DERTAKEN BY FIRMS IN GREN TYPES OF INNOVATIVE MORE C ~ M P E T ~ TPRESSURE, ~VE MORE INNOVATION .................................................. ............................................................ PROVIDING BUSINESS DEVELOPMENT SERVICES .......... ............................................................ How FIRMSIN GRENADAINNOVATE ............................ DISTRIBUTION OF BANKING SECTOR LOANS AND ADVANCES BY BORROWER ................................. INTERNET HOSTS, 2002 .................................................................................................................... ELECTRICITY COSTS ....................................................................................................................... .......................................... INDICES OF PRICE COMPETITIVENESS INTOURISM INTERNATIONAL MEDICAL GRADUATES INTHE US, 1984-2004..................................................... .......................... Boxes BOX 1.1: MEASURING AND INTERPRETING TOTALFACTOR PRODUCTIVITY (TFP) INTHE OECS ......................... BOX 4.1: THEEASTERN CARIBBEAN CENTRAL BANK .......................................................................................... BOX 4.2: ATTRACTING INVESTMENT, COSTARICAN-STYLE ............................................ ................................ BOX 4.3: ONE-STOP SHOP, OR ONE-MORE-STOP SHOP? .................................................... ................................ BOX 5.1: BOX 5.2: BOX 5.3: BOX 5.4: BOX 5.5: BOX6.1: BOX6.2: BOX 6.3: BOX 6.4: BOX 6.5: BOX 6.6: BOX 6.7: BOX 6.8: B O X 7.1: BOX 7.2: B O X 7.3: BOX 7.4: BOX 7.5: BOX 7.6: How THE SKILLS BASEHELPED BOSTON TO STAY ON TOP ..................................................................... A TALE OF TWO SCHOOLS ...................................................................................................................... ACCOMMODATING THE TRAINING NEEDS OF THE PRIVATE SECTOR ....................................................... SOCIAL PROTECTION REQUIRES MORE BUSINESS REGULATION............................. ............................ RETURN MIGRATION INIRELAND AND ISRAEL ...................................................... ............................ THEJAMAICA CLUSTERCOMPETITIVENESS PROGRAMME(JCCP) ........................................................ JAMAICA’S TECHNOLOGY INNOVATION CENTER(TIC) ............................................................... ELECTRICITY CROSS-SUBSIDIES IN DOMINICA ............................................................................. THECOST OF PRICE CONTROLS IN THE PETROLEUM SECTOR ................................................................ DOMINICA’S EXPERIENCE WITH PORT CARGO HANDLING OPERATIONS................................................ OPEN SKIES AGREEMENTS ...................................................................... ....................................... ....................................... CENTRALAMERICAN REGION COOPERATION INTHE PETROLEUM SECTOR ...................................... THESMALL TOURISM ENTERPRISES PROGRAM (STEP) ...................................................................... AMERICAN AIRLINES’ DATA PROCESSING OPERATION IN BARBADOS .................................................. CALL CENTERS ANTIGUA, LIMITED ..................................................................................................... HIGHTELECOM COSTS HINDER THE SOFTWARE DEVELOPMENT INDUSTRY .......................................... PROMOTING OPEN SOURCE SOFTWARE DEVELOPMENT IN ST. LUCIA................................................. WORLD CLASS WELLNESS FACILITIES IN THE OECS ..................................................................... A BRIEF HISTORY OF LIAT .... ............................................................. V 19 27 29 42 45 48 51 53 55 56 65 81 85 92 98 100 113 122 10 39 46 48 55 59 62 73 74 82 103 105 107 108 110 118 127 127 130 130 FOREWORD This report o n Growth and Competitiveness in the Organization o f Eastern Caribbean States i s a companion piece to the pan-regional report, “A Time to Choose; Caribbean Development in the 21st Century”. Both volumes are intended to serve as a launching pad for debate among political parties, civil society, the private sector, the media and academic groups, on the future directions o f development strategy at be& the national, sub-regional and regional levels. The time for such a debate could not be more opportune. While poverty has declined, many o f the sub-region’s impressive social gains risk being eroded. Unemployment, particularly o f youth, i s a major issue and there i s growing concern about recent increases in crime and violence. Tourism, too, i s under increasing pressure from new markets in Cuba and Central America, and the sub-region now has the dubious distinction o f hosting six o f the world’s most highly indebted emerging economies. While none o f these challenges i s insurmountable, all will require political leadership and strong national support. Deepening the bonds o f regionalism will also require considerable political will, but the pay-offs, we believe, in terms o f economies o f scale and long term improvements in growth and competitiveness, will be considerable. As this volume shows, there are also important new opportunities to be seized: in services such as education and health, in technology, and in tourism. A number o f these opportunities are already being explored in parts o f the OECS and w e have tried to bring together examples from across the region and beyond which can serve to illustrate a range o f possibilities and approaches. While focusing primarily o n decision makers and publics in the Caribbean, there i s a set of players who are largely absent from this report’s pages, but whose role i s none the less crucial. For more than three decades, the international donor community has supported Caribbean development. If wrong choices have been made, they have been made by donors together with Governments. This report i s not intended to ascribe blame, but to point to the fundamental need to choose a better path for the future. That choice must also include greater country ownership o f development programs, better harmonized and coordinated donor support, and a reduction in the burden donors too often impose on recipient countries, particularly small states such as those o f the OECS. W e hope that this volume will provide an opportunity for the international donor community to debate and finally resolve many o f these longstanding issues. Finally, both o f these reports have been informed by extensive consultations across the Caribbean. We would like to thank all those who took the time to share their expertise, their insights and their unique brand o f Caribbean hospitality. W e have endeavored to capture the richness o f the input we received, although ultimately the responsibility for the reports’ conclusions remains ours alone. Caroline Anstey Director Caribbean Country Management Unit The World Bank vi ACKNOWLEDGEMENTS This report was prepared by Camille Nuamah (Team Leader and Sr. Economist). The preparation was undertaken jointly w i t h the team preparing the companion report o n Growth and Competitiveness in the wider Caribbean: Sanjay Kathuria; Mustapha Rouis; Elizabeth Ruppert Bulmer; Harpinder Oberai and Michael Corlett; and has benefited from their excellent collaboration and exchange o f ideas. Technical assistance was provided by Phaedra Chrousos, Anna Musakova and Margarita Chavez de Silva. Special thanks i s reserved for Theresa Beltramo who provided outstanding support as a research analyst and for Antonella Bassani, Lead Economist for the Caribbean, who provided great coaching and technical advice. Preparation of the report has benefited from additional financial assistance provided by the European Community t o the World Bank, through the Investment Climate and Trade and Integration Trust Fund under the Knowledge for Change Program #TF050264. Background papers were prepared by Mizuho Kida (growth accounting), Caroline Freund, Adiitya Matoo, Mohammed Amin (impact o f trade liberalization), Elizabeth Ruppert-Bulmer (labor markets), Abhas Jha and Castalia, Inc. (infrastructure), Andreas B l o m ( s k i l l s and training), On the Frontier Group, Inc for infoDev (technoloy, Internet Communication Technology (1CT)based services and telecom), Gunnar Eskeland, CICERO and James Hanson (role o f the state), Donald Mitchell (sugar), Steve Jaffee (phystosanitary regulations), the Foreign Investment Advisory Service (investment climate in Grenada, and foreign investor survey), Swedish Development Advisers (offshore education), David Russell Consulting and Michael Corlett (tourism) and Logan Brenzel (health services). The W o r l d Bank peer reviewers were William Maloney (Lead Economist, Office o f the Chief Economist, Latin America and the Caribbean Region) and David Rosenblatt (Lead Economist, Development Economics, Vice President’s Office). External peer reviewers were Garth Nicholls (Director o f Research, Eastern Caribbean Central Bank), Paul Mullard (Lead Economist for the Caribbean, UK Department For International Development Caribbean (DFID - Caribbean) and Sarah Dunn (Private Sector Development Adviser, DFID - Caribbean). The W o r l d Bank wishes to extend i t s gratitude to the many officials from each o f the governments o f Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, and to the staff o f the Eastern Caribbean Central Bank and the OECS Secretariat and all i t s units, as well as to the numerous firms, development partners and their project teams, who graciously shared their perspectives, insights, reports, data and other information with the Bank in the preparation o f t h i s report. vii ORGANIZATION OF EASTERN CARIBBEAN STATES TOWARDS A NEW AGENDA FOR GROWTH EXECUTIVE SUMMARY 1. The Organization o f Eastern Caribbean States (OECS)’ i s at an economic crossroads. A secular slowdown in growth, a radical transformation o f the external environment, high debt and fiscal imbalances, and persistent unemployment and poverty have combined to create an imperative for redefining the OECS strategy for growth and economic development. 2. The crucial elements o f such a strategy are: (i) the formulation o f a long-term vision that positions the OECS Economic Union in the global economy; (ii)reorientation o f the basic development model toward greater openness, competition and a more level playing field in the sub-regional economy, and (iii) the creation o f new capacity in the labor force and the private sector to take advantage o f emerging opportunities in the global market place, and in the public sector to coordinate and support the process o f deeper regional (and global) integration. 3, This strategy builds on the assumption that a more complete Economic Union, based o n deeper sub-regional integration, i s not only a sine qua non for the member countries to successfully face their development challenges, but that t h i s approach has already been endorsed both by the Governments and people.of the OECS: “The rationale for the establishment of an economic union is anchored in an acceptance of the fact that the development challenges the microstates of the OECSface as a result of globalization and trade liberalization can only be effectively addressed through the creation of a single economic space which facilitates the free movement of people, goods, services and capital and as a result economic diversification and growth, greater export competitiveness and more employment and human resource development. ” http:llwww.oecs.org/union.htm 4. As discussed in Chapter 1, the OECS sub-region experienced a relatively strong decade o f growth in the 1980s (5.9 percent per year) driven mainly by tourism and banana exports, and public investment financed primarily by development assistance. This was followed by a steady decline in growth since the early 1990s. Initially, this decline was largely caused by a sharp reduction in productivity growth associated with shifts in the composition o f investment, weakening performance in the export sector and a growing inward orientation o f the private sector. I t has been further exacerbated by a severe and prolonged contraction in private investment. In the late 199Os, attempts by the OECS governments to offset the slowdown through an expansionary fiscal policy, financed largely by expensive commercial borrowing (both external and domestic) created persistent fiscal deficits and skyrocketed public sector debt to some o f the highest levels in the world. The large fiscal and debt imbalances are n o w further dampening growth and private investment. 5. The current challenge facing the sub-region i s how to reinvigorate and sustain growth alongside the following imperatives - reducing high unemployment and poverty rates, restoring fiscal and debt sustainability, and securing a more sustainable external position in an increasingly competitive global environment. Accelerating growth in the OECS will‘ largely depend o n the sub-region’s ability to strengthen i t s performance in the global economy, which in turn will The OECS comprises six independent members states: Antigua and Barbuda, the Commonwealth of Dominica, Grenada, the Federation o f St. Christopher and Nevis, St. Lucia, and St. Vincent and the Grenadines (all members o f the W o r l d B a n k Group) and three British dependencies: Montsen-at, Anguilla and the British Virgin Islands. In this report, the term “OECS” has been used, generally, t o refer to the six independent countries. viii require improving i t s competitiveness. At the macro level, competitiveness can be defined as an economy’s ability to attract the demand for i t s exports and the investment to supply that demand, all within social norms that result in an improved standard o f living for i t s citizens. This, in turn, depends o n the macro-. and micro-economic policies, regulations and institutions that affect the productivity o f the economy’s factors o f production and the costs o f doing business. 6. Chapter 2 o f the report looks at the key measures o f macroeconomic competitiveness, the real exchange rate, export performance and Foreign Direct Investment (FDI) inflows. Trends in the real exchange rate2 show that, in the latter half o f the 1990s, the OECS economies demonstrated a growing inward, rather than extemal, orientation, and a general loss o f price competitiveness. However, owing to a recent realignment driven mainly by extemal developments (notably the weakening o f the U S dollar), by mid 2003 the real exchange rate did not appear to be either over- or under-valued with respect to key fundamentals. There i s also some indication that real wages have grown faster than labor productivity further weakening the price competitiveness o f the sub-region (Chapter 6). 7. Since the 1990s, the sub-region’s key export, tourism, has lost market share in the Caribbean and worldwide, while key merchandise exports, including but not limited to the traditional agricultural products, have contracted or seen only marginal growth. Indeed, most o f the diversification in regional merchandise exports to date has been driven by preferential access to regional and North American markets. Invariably these preferences have not been directed to areas o f comparative advantage o n which the sub-region can hope to build sustainable sources o f competitive advantage. The majority o f the top ten exports from the sub-region are s t i l l commodity based - fish, nutmeg, essential oils, arrowroot - and are subject to large price and other variations, e.g. climate. Others are goods in which competitive production depends o n l o w wages or significant economies o f scale, neither o f which the sub-region can sustain. There are some indications that the OECS i s in the process o f identifying new exports - both o f goods and services -but these are s t i l l too small to impact macroeconomic performance. 8. In contrast to exports, the OECS has been extremely competitive in attracting foreign investment, with relatively stable flows as a share o f Gross Domestic Product (GDP) through the last two decades. The average ranking o f the OECS as a whole o n the UNCTAD’s FDI performance index in 2002 was 20th out o f 177 countries. However, in comparison to the Caribbean and the rest o f the world, the sub-region has been losing ground in recent years. A closer look reveals that extensive use o f statutory and discretionary fiscal incentives, often fueled by incentives-based competition for FDI, both in the sub-region and Caribbean wide, have played a key role in this performance. This issue i s further explored in Chapter 4. 9. As illustrated in Chapter 3, reliance o n special and differential treatment as a way o f relating to the world economy has not served the sub-region well, over the long term. Preferences and the maintenance o f non-reciprocal protection o f the domestic market have pushed the subregion, and i t s entrepreneurs, toward areas o f production in which they ultimately can not be competitive and which can not support the sustained growth in incomes and employment needed to reduce poverty and deepen social development. Non-reciprocal protection within the various trade agreements with the European U n i o n (EU), Canada and the U S has allowed the sub-region to stall o n trade liberalization, maintaining a relatively high level o f effective protection o f the domestic market which is, ultimately, too small to sustain growth. This protection has engendered a growing inward orientation o f the private sector whose efforts are spent trying t o maintain rents for a few local producers at the expense o f consumers and export sectors, whose costs are then raised above world prices. Governments have then turned to accommodate the export sectors with an administratively cumbersome and nontransparent system o f duty concessions, which in turn are negatively affecting fiscal performance. Meanwhile, managing the IMF (2004~). ix conflicting interests in such a system has distracted the sub-region’s governments from making headway in improving the general environment for the business sector and resulted in a slowdown in private investment. In summary, the sub-region appears to have reached the l i m i t s of growth under the current model o f development. 10. The emerging external trading environment, with the Caribbean Single Market Economy (CSME), Free Trade Area o f Americas (FTAA) and WTO offers opportunities to the sub-region to transform the current model o f development to a more sustainable one in which it i s integrated within larger markets and ultimately the global economy (Chapter 3). Among the micro states, the OECS countries have a unique opportunity for success because o f their proximity and affinity to major markets in Europe and the Americas, and a headstart o n integration within the subregion and the Caribbean. In addition, the OECS experience to date with tourism, internet gaming and offshore education points to the potential for expanding other service exports (Chapter 7). 11. Through the FTAA, there i s the potential to make headway in liberalizing trade in services, now the fastest growing component o f world trade in the last 14 years and accounting for onefifth of exports o f goods and services worldwide and h a l f o f annual FDI flows. Under the EPA, the sub-region will receive substantial assistance to mitigate the costs o f transition. H o w the subregion uses these resources w i l l be a critical factor for success. The rules-based WTO system has already shown, through the recent victory o f Antigua and Barbuda over the U S o n internet gaming, that i t can protect the rights o f small states. Finally through the CSME, the OECS stands to gain from several areas o f regional cooperation, including empowered joint regional negotiating mechanisms and the preparation o f a host o f behind-the-border rules, including standards, licensing, and competition rules, that can ensure fair trade in services and strengthen the ability o f domestic f i r m s to compete. 12. M u c h has been written about the challenges faced by small states in t h i s endeavor but, on close examination, the OECS countries appear to have overcome a number o f these, and are among a handful o f micro states, and a larger group o f small states that have performed relatively well over time, o n economic, external and social fronts. The sub-region has demonstrated resilience to both natural disasters and external shocks. Cooperation at the sub-regional level has already helped to reduce the fixed cost o f some public services, and has significant potential to do so in many others. The sub-region i s strategically located at the center o f a large regional market and s t i l l has some scope for cooperation to reduce transportation costs. In today’s world the scarcity o f physical resources that comes with small size i s no longer a major constraint o n diversification. The acquisition o f knowledge and technology, which are less susceptible to economies o f scale and distance, are key factors in today’s economy. 13. As such, the outlook for the OECS in the global economy need not be a pessimistic one. There are instructive examples o f other small states that have successfully integrated w i t h the global economy. Though not a micro state, Ireland had many o f the initial conditions facing the OECS today and has been extremely successful in carving out a place for itself within the European U n i o n (EU) and the world economy. This case study i s presented in Chapter 3. O f note i s the fact that the first step o n Ireland’s road to reform was a major and rapid fiscal adjustment over three years, which was achieved o n the basis o f a broad social pact including the wider population, private sector, labor unions and other civil society stakeholders. Given the transition ahead, such a pact may be an appropriate strategy for the OECS. 14. As illustrated in the sectoral case studies presented in Chapter 7, taking advantage o f t h i s potential will require a host o f general improvements in the business environment, namely strengthening the investment climate (Chapter 4), expanding the s k i l l s base (Chapter 5), promoting innovation and technology adoption, and improving teleconnectivity, international transport services and electricity supply (Chapter 6). X 15. As shown in Chapter 4, the size and role o f government in the OECS has a profound impact o n the climate for domestic and foreign investment. The government sector in the sub-region i s relatively large, as i s typical in small open states, but it has also been consistently growing in employment and spending as well. Experience in the wider Caribbean in the 1960s and 1970s, and in the OECS during the last two decades, confirms the dangers o f an over-reaching public sector and limitations o f public sector-led growth. Given the current fiscal imbalances and high levels o f indebtedness, the sub-region has little room for maneuver and will need to embark o n a sustained process o f fiscal adjustment and public sector reform. 16. Fiscal adjustment will also be required in the OECS in order to improve the climate for private investment by helping to reestablish macroeconomic stability and relieve pressures o n the domestic financial system. A key element o f this reform will be to streamline and refocus large public investment programs, which have contributed to the increasing indebtedness but not succeeded in crowding in private investment, in large part because o f the lack o f a strategic vision o f where the economy i s headed. There are numerous examples o f large public investments that have cost the sub-region dearly in fiscal terms, but not yielded sustainable economic gains. In this regard, reform o f public procurement systems can not only achieve cost reduction for the public sector but also improve competition in the private sector, and reform o f legislation and systems governing public debt can help to prevent future recurrences o f costly financing. 17. Efforts to strengthen the investment climate, in particular by rationalizing the investment regime and improving the delivery o f key government services, will also be critical. The incentive regime, used by the OECS governments to compete for foreign investment i s outdated, ill-suited to emerging service sectors and costly both to administer and in terms o f foregone revenue. In addition, the sub-region has further discouraged competition in the domestic market with the continued use o f price and investment controls. These have combined t o distort the playing field among domestic and foreign investors alike. International experience, in particular in Mauritius and Ireland, suggests that lowering tax rates and concentrating o n other means o f investment promotion may be more effective that an unwieldy collection o f concessions and controls. 18. T o complement the rationalization o f the investment regime, the sub-region will also have to strengthen i t s approach to investment promotion, which given the past reliance o n incentives, remains in i t s infancy. Little attention has been given t o key functions such as image building, and investment targeting and facilitation, in part because o f the absence o f a strategic vision for the economy in which the role o f FDI i s clearly identified. There also are significant savings to be made in eliminating layers o f approval and discretion in a variety o f government services such as land and business registrations, work permit processing, customs administration - that w i l l also improve the general investment climate. Making headway o n e-government initiatives i s one way to accomplish these multiple goals. T w o key administrative areas cited by f i r m s for improvement are tax and customs collection in which administrative weaknesses combine with cumbersome and non-transparent regimes to create obstacles for investors. By simplifying the tariff regime and tax code, the sub-region has the dual opportunity to broaden the tax base and to strengthen the investment climate by rationalizing the incentive and concessions regimes and creating a more level playing field for investors and domestic f i r m s . 19. As discussed in Chapter 5, the most critical constraint facing businesses in the OECS i s the limited s k i l l s base o f the labor force. In addition, moving to higher-end services w i l l require a larger number o f skilled workers. The shortage o f s k i l l s i s the result o f inadequate educational outcomes, and limited tertiary education and training opportunities. The OECS has made remarkable progress in expanding access to secondary education over the last decades, but quality and equity remain critical weaknesses. Indeed these issues are the main contributors to the very high youth unemployment rates which are n o w creating social problems. Though comparatively high, public expenditures o n education in the OECS are fraught with inefficiencies that result in xi poor quality and inequitable outcomes. Fortunately, the measures to address them, such as rationalizing teacher training and deployment schemes, shifting resources to better performing schools and reforming the secondary school curriculum, are neither complex nor prohibitively expensive. 20. The shortage o f tertiary education and training opportunities i s more difficult to tackle given the small scale o f the domestic and sub-regional markets. At a minimum, the OECS countries could increase cost recovery and involve the private sector in the governance o f public training institutions to ensure that the s k i l l s being provided are relevant to labor market needs, and could promote spillovers from local offshore education institutions to the domestic market, following the example o f St. George’s University in Grenada. Tertiary education and training are two areas where expanding the labor market space o f the OECS t o the broader Caribbean can serve the sub-region in two critical ways. First, a large market space may allow external training providers who are achieving economies o f scale in other markets the opportunity to expand services to the OECS. Second, greater freedom o f movement and wider opportunities for employment will also provide OECS nationals with a stronger incentives to be trained in specific technical skills. T o support this, the OECS should ensure that the accreditations and certifications that it supports are internationally portable. 21. An effectively functioning labor market i s a necessary complement to ensure that the expanding supply of skilled labor i s efficiently allocated. Comparatively high wages that appear to be growing faster than productivity, accompanied by persistently high unemployment, suggest that labor markets in the OECS may not be functioning efficiently. B o t h problems impact competitiveness negatively - high wages because they raise the cost o f production and unemployment because it wastes a crucial factor o f production. There are a number o f imperfections in the OECS labor market that prevent smooth adjustments, in particular skills mismatch, large and expanding government sector, distinct wage-setting mechanisms for the public and private sectors, labor regulations that raise the cost o f hiring and firing workers, fragmentation o f the sub-regional labor market, and significant migration flows. 22. The major challenge facing the OECS i s to equip the large numbers o f un- or underemployed with the s k i l l s required by growing sectors. In addition, public sector reform to reduce crowding out in the labor market and aligning public sector wage setting mechanisms with those for the private sector will also be critical. Disparities in wage rates and regulatory barriers to movement o f labor across the OECS indicate that the sub-regional labor market i s far from seamless. However, efforts to reduce the size o f government and increase the flexibility o f employment arrangements are likely to generate strong opposition f r o m trade unions and workers in protected sectors. Successful experiences in Ireland, Barbados and Jamaica with social pacts may thus need to be replicated in the sub-region. 23. The OECS has seen significant migration o f skilled personnel beyond the region over the past two decades, but it has also benefited and stands t o benefit from remittances and return migrants that transfer s k i l l s and technology, as well as investment capital, and overseas migrants who have created the demand and awareness for home country exports. Migration opportunities have generated an additional demand for education with spillovers to the local economy, but they have also raised reservations wages and led to queuing where workers delay entry into the labor force as they wait for overseas jobs. Greater integration o f the sub-regional and regional labor markets will reduce the frictional impact o f migration - as the markets are more integrated, workers can move more easily and wages become more aligned across countries. As such, the OECS should push for rapid implementation o f free movement o f labor in the sub-region and under the CSME and reduce as much as possible regulatory constraints to the flow o f workers. 24. If the OECS i s going to pursue a private sector-led, export-oriented growth strategy, local f i r m s accustomed to a protected domestic market w i l l have t o improve their capacity to compete xii globally. At the firm level, innovation i s the key to building and maintaining competitive advantage. Chapter 6 showcases some examples o f innovative f i r m s that are already changing the landscape o f the business sector in the sub-region (and in the Caribbean) using I C T as a means t o compete in the international market place. The chapter also reviews some o f the mechanisms for building private sector capacity and for strengthening the general environment for innovation and technology adoption. One finding i s that this too i s dependent o n the free movement o f labor, because it w i l l allow f i r m s to access services from private providers who may not necessarily have enough business to establish shop in any one o f the OECS countries. In addition, there i s a crucial role for governments in setting the standards against which f i r m s can measure their performance, and helping to coordinate clusters o f operators in similar fields across the sub-region. 25. The recent successes o f sub-regional institutions, namely the Eastern Caribbean Telecommunications Authority (in expanding teledensity, competition and cost reduction) and the Directorate o f C i v i l Aviation (in addressing security issues in the sub-region’s airports) provide examples o f how to move forward o n a number o f technical infrastructure issues facing the OECS. Although costs o f teleconnectivity are high, in particular for commercial (broadband) access and international telephone calls, and access to the internet i s rather limited, the Eastern Caribbean Telecommunications Authority (ECTEL) offers a proven mechanism for the subregion to address these issues. Regarding the expensive and, sometimes, unreliable supply o f electricity - cited as a key problem by many f i r m s - this report finds that the root cause i s not so much the small scale o f operations as often suggested, but, in fact, weak regulatory oversight. Given the technical nature o f this issue and the limited capacity o f member country governments, a regional approach, similar to ECTEL, offers significant advantages. Regional solutions also offer the possibility o f depoliticizing pricing issues in critical utility services. As small island economies, transportation remains a critical factor o f production, but also one in which subregional coordination i s critical. Given the serial (versus spoke and hub) pattern o f shipping services to the sub-region, new international security arrangements require each port in the queue to be “certified”. Finally, o n aviation, the report finds that the sub-region stands to gain from joint negotiation o n international airline service, and from formulation o n intra-regional aviation competition policy. Overarching Strategic Agenda 26. The foregoing analysis suggests the following strategic agenda: (i) Formulate a strategic sub-regional vision for the economy and key sectors 27. In looking at the past development o f the OECS, which largely depended on tourism, donor-financed public investment and preferential market access for inherited commodities, there i s a sense that this was not driven by a vision prepared and owned by the people o f the subregion. The recently agreed upon OECS Development Charter has taken this process forward in terms of a regional view o f broad developmental aspirations. The strategy for reaching those goals needs now to be more carefully specified in view o f the opportunities and constraints facing the sub-region. I t i s the recommendation o f this report that such a strategy acknowledge the limitations o f small domestic markets to provide sustainable growth in incomes, and focus heavily o n articulating a vision o f the position the OECS hopes to occupy in the global economy. 28. As noted above, and throughout this report, deepening integration through the completion of the OECS Economic Union will be a critical step to strengthening competitiveness o f the subregion. Unifying factor markets across the sub-region will allow for more efficient allocation o f capital, labor and entrepreneurship in order to achieve success in more competitive product markets. In addition, closer collaboration between the governments o n regulation, trade xiii negotiations, and provision o f public services, to name a few areas, can help to conserve limited fiscal resources and capacity while improving the effectiveness o f the public sector. 29. Most o f the smaller states that have successfully integrated in the global economy, Singapore, Israel, Iceland and Ireland, to name a few, have articulated such a vision at one time or another. One option, but by no means the only one, could be for the sub-region to capitalize on i t s strategic location and i t s tourism sector to move into a cluster o f mode 2 type services in education, health and wellness, financial services and entertainment. The articulation o f such a strategy and vision i s necessary for effective negotiation in trade arrangements, effective planning of public investment and formulation o f public policies and better use o f aid flows. 30. As illustrated in the case o n Ireland, to be viable and sustainable, such a vision must be articulated by and with the broader society, the private sector and key civil society organizations. (ii) Pursue greater openness, competition and a more level playing field in the domestic market e 0 Reduce barriers to trade and improve the mobility of labor and capital by: o Undertaking tax reform t o make fiscal space for a reduction in taxes o n trade. Countries should move quickly to implement broad based taxes such as the Value Added Tax (VAT), and in some cases, personal income tax, in order to provide fiscal room for the reduction in tariffs, customs service charges and other taxes o n international trade; o Phasing out exceptions within the Common External Tariff (CET) and eliminate nontrade barriers including licences and quotas. Gradual reductions in tariffs will not only provide a bargaining chip for trade negotiations but also create both the incentive and transition time for f i r m s to reorient their activities toward the external market; o Reducing and reforming the use o f duty concessions. Reducing tariff rates and nontrade barriers will also reduce the need for widespread use o f duty concessions and related costly and cumbersome administration; o Rapidly implementing free movement o f labor within the OECS and the CSME. Access to a greater pool o f s k i l l s i s a key to raising firm capacity. Wider opportunities for employment within the region create the demand for training and tertiary education, and a large market space for key service providers; o Pushing for critical market access in FTAA t o facilitate service exports. This w i l l not only help professionals from the OECS to market their services overseas, but may encourage service providers, such as training institutions, that benefit f r o m economies o f scale in other countries, to provide services in the OECS markets; and o Utilizing already-recognized international standards and certifications wherever possible, or where location-specific certifications will help to create a competitive advantage, work jointly with the Caribbean Community (CARICOM) to prepare and implement these. Promote fair competition and a more level playing field in the domestic market by: o Reducing the burden o f government o n the market for s k i l l s and investment resources by pursuing fiscal adjustment and public sector reform; o Reforming the tax and customs regime t o reducing the need for and use o f investment incentives and discretionary duty concessions; xiv Strengthening public procurement by harmonizing systems across the region to conserve limited technical capacity. This w i l l help to increase competition in the domestic market, prevent capture by local firms, improve accountability, and ultimately, reduce the costs o f public goods and services; Re-establishing rules-based administration by eliminating unnecessary layers o f approval and discretion in the administration o f registrations, permits and licenses administration; Reforming the public sector wage setting mechanism to align wage increases w i t h productivity improvements; Harmonizing labor regulations for both the public and private sector in order to reduce labor market segmentation; Improving the functioning o f the financial markets to reduce the costs o f borrowing by reducing administrative bottlenecks to the realization o f collateral; eliminating floor o n the savings deposit rate; and encouraging consolidation in the banking sector as a means to reduce operating costs and spreads; and Formulate a competition policy for the intra-regional airline market. (iii) Building new capacity in the labor force, private sector and government by: Improving efficiency of education spending o Reform teacher training and deployment schemes to make r o o m for an increase in non-wage spending in the education sector; o Reallocate spending to more needy schools in order to improve equity, address the growing problem o f youth-at-risk and reduce labor market segmentation; o Improve monitoring and international benchmarking of, and public information on, educational outcomes to increase accountability; and o Implement cost recovery in tertiary education and training and improve targeting o f student assistance and loan programs. Refocus curricula in schools and training institutions on labor market needs 0 0 o Expand s k i l l s training in IT, hospitality, non-hotel tourism services, accounting, finance and management; o Target vocational training o n linkages with export sectors rather than solely microenterprise s k i l l s for the domestic market; o Implement the Caribbean Knowledge and Learning Network and other distance learning efforts; and o Establish a key role for the private sector in the governance o f public education and training institutions and programs. Expand use of standards and certifications in the business sector to provide an incentive for improving firm capacity, e.g., o Strengthen accounting standards and practices; and o Expand tourism standards and certifications t o include non-hotel services. Publicly reward innovation, entrepreneurship and private sector formation of industry clusters xv 0 Improve the delivery of public services, in part through joint sub-regional provision and harmonized regulations, whereever possible o Reform and refocus public investment programs; o Refocus investment and tourism promotion away from incentives administration to image building, investment facilitation services, destination management and marketing, and coordination; o Strengthen regulatory frameworks for telecom, electricity, and maritime transport through regional cooperation; o Strengthen management o f the environment to ensure sustainable tourism development; o Strengthen participation in C S M E and FTAA negotiations, through an empowered Caribbean Regional Negotiating Machinery (CRNM), supported by the recently proposed sub-regional mechanism; and o Introduce e-government as a mechanism to improve transparency and enhance service delivery, as w e l l as to streamline the public sector. 3 1. N o doubt t h i s i s a daunting agenda, both broad and deep. But the transformation envisaged here i s fundamental for the OECS countries. It will require the concerted effort o n the part o f the OECS govemments, including the sub-regional institutions, the private sector and c i v i l society, as w e l l as sustained support from i t s development partners, over a medium-term horizon. Hence the need for broad-based participation in the formulation o f the strategic vision. Recommended Short-Term Priorities 32. Given the limited capacity o f the public sector to address a l l the recommendations at once, the following i s a proposal for some immediate priorities, which can be addressed over the short term. Fiscal and public sector reform 0 R o l l out VAT and reform the investment incentives regime; 0 Initiate public sector reform and refocus the public investment programs; and 0 Remove non-tariff barriers t o trade. Raise the s k i l l s base 0 Reform teacher training and deployment schemes; and 0 Accelerate curricula reform in schools and training institutions. Strengthen the enabling environment 0 Update tourism strategy to target new market segments; 0 Strengthen investment and tourism promotion; and 0 Strengthen and harmonize accreditation for offshore schools. Improve the business environment 0 Streamline customs administration; 0 Address monopoly pricing in remaining telecom segments; xvi 0 Improve oversight o f electricity utilities to reduce costs; 0 Formulate and implement an aviation competition policy; and 0 Reform petroleum pricing mechanisms. xvii INTRODUCTION A. Background 1. This study covers the six independent member states o f the Organization o f Eastern Caribbean States (OECS)3 - Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St.Vincent and the Grenadines. The single most defining characteristic o f the OECS countries i s their populations, which range from 47,000 in St. K i t t s and Nevis to 161,000 in St. Lucia. Among the world’s micro states4 the OECS countries have performed relatively well o n a number o f indicators (see Table 1). Per capita incomes range from US$3,400 in St. Vincent and the Grenadines’ to US$9,600 in Antigua and Barbuda, and growth has averaged 4.1 percent per annum over the last two decades. Social indicators are also quite good even relative to upper middle income countries, reflecting a history o f sustained investments in human and social capital. However, there are indications o f high poverty with an average headcount ratio o f 29 percent (although most estimates date from the mid 1990s) and high unemployment (most estimates are from the 2001 census), on average 16 percent for the sub-region. TABLE1: SELECTED STATISTICS Pop (‘000s) 2003 Antigua and Barbuda Dominica Grenada St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines GDP (us$m> 2003 GDPpc (US$) 2003 GDPpc Growth Growthpc Poverty Unemp HDI (PPP~) 2002 1980-2003 (%) 1980-2003 (%pop) latest (%LF) latest Rank 2004 (%I 79 71 105 757 255 439 9,629 3,590 4,199 9,847 5,469 7,178 4.6 3.2 3.8 4.2 2.9 2.8 12 33 32 7 25 13 55 95 93 47 161 370 693 7,929 4,314 12,227 5,437 4.7 4.3 4.7 3.2 31 25 5 19 39 71 109 371 3,403 6,549 4.2 3.5 38 21 87 Up mid inc 64,706 5,022 10,684 1.o 2.4 .*. 12 82 M i c r o states 193 3,139 9,552 17147 3.6 2.0 ... 5 ... Caribbean 3,338 5366 5,504 2.8 1.8 ... 13 ... Notes: OECS aggregates computed by: (a) sum; (b) GDP-weighted average; (c) population-weighted average; and (d) straight average. H u m a n Development Index rank i s out o f 177 countries. Source: W o r l d Bank (2004i), UNDP 2002, national poverty assessments and labor force surveys. 2. Consistent with their small economic size, the OECS countries are w e l l integrated within the international economy with an average high trade-to-GDP ratio o f 124 percent and are characterized by large government sectors. Government expenditures account for 34 percent o f GDP (not including subregional institutions), which i s similar to other micro states, but higher than other upper middle income countries. OECS investment rates are relatively high at 31 percent o f GDP, o f which a significant amount The OECS comprises six independent members states: Antigua and Barbuda, the Commonwealth o f Dominica, Grenada, the Federation o f St. Christopher and Nevis, St. Lucia, and St. Vincent and the Grenadines (all members o f the W o r l d Bank Group) and three British dependencies: Montserrat, Anguilla and the British Virgin Islands. In this report, the term “OECS” has been used, generally, to refer t o the six independent countries. Population less than 500,000. Throughout the report, the terms “Antigua”, “St. Kitts” and “St. Vincent” refer t o Antigua and Barbuda, St. Kitts and Nevis, and St. Vincent and the Grenadines, respectively. Purchasing power parity uses a conversion rate that reflects h o w m a n y goods local currency buys within the country. 1 has been financed from extemal sources. Despite i t s small size, the sub-region has had relatively sustained access to external financing to support these investment rates in the form o f foreign direct investment, overseas development assistance and, more recently, extensive commercial borrowing for public investment which has left the countries among the most indebted in the world. However, inflation has remained low, reflecting a sustained period o f prudent monetary policy by the sub-regional central bank, the Eastern Caribbean Central Bank. The countries are members o f the Eastern Caribbean Currency U n i o n that administers a quasi-currency board arrangement to support a fixed exchange rate pegged to the U S dollar. TABLE2: SELECTED ECONOMICINDICATORS, 1998-2003 External Sector Trade YoGDP FDI %GDP Public Sector Monetary Sector Domestic Govt Fiscal Public Financial ODA Investment savings spending balance debt* depth* Inflation* %GDP %GDP %GDP %GDP % G D P % G D P M2IGDP C P I % c h Antigua and 141 6.3 1.6 29 22 29 -7.9 142 80 1.8 Barbuda Dominica 117 5.4 7.2 21 6 41 -8.2 122 70 -0.3 Grenada 119 13.6 2.8 37 22 37 -7.1 113 95 2.1 St. Kitts and Nevis 113 20.3 3.2 46 25 43 -11.2 171 83 2.5 St. Lucia 120 3.2 2.8 26 17 29 -2.5 69 66 2.1 St. Vincent and the 117 11.9 3.4 32 35 33 -3.5 73 68 0.9 Grenadines OECS** 124 9.1 3.0 31 21 34 -6.4 113 77 1.7 M i c r o states 123 7.9 14.4 28 15 34 67 Upper mid inc 71 3.8 0.2 24 23 22 -1.9 41 Caribbean 72 20.0 3.0 13 20 30 -5.3 83 40 4.2 *2003 only. ** GDP-weighted averages Note: O f the 45 micro states listed in the World Development Indicators, 13 or close to one-third are upper middle income countries including the six OECS states. Likewise, o f the 37 upper middle income states listed, the same 13 micro states make up approximately one-third. Source: World Bank (2004i), IMF (2005), and IMF estimates. 3. The OECS was formed in 1981 through the Treaty o f Basseterre, amidst the independence movements o f i t s various members (1974-83). The Organization i s the culmination o f a long history o f imposed and voluntary federalism characterized by shifting country groupings, both during and after the colonial period. Notably, the sub-region was part o f the short-lived West Indies Federation with other Caribbean countries from 1958-62, and i s now part o f the Caribbean Community and Common Market (CARICOM). 4. With largely disenfranchised populations at the time o f independence, the countries embarked o n a much needed policy o f redistribution, including land reform and extensive social investments, to lay the basis for equitable growth. These policies combined to yield relatively good social indicators - the countries rank quite high o n the Human Development Index (see Table 1) - as w e l l as vibrant democratic traditions ranking high on indices o f voice and participation, and rule of law. Political parties are generally broad based with strong connections to the labor movement o n both sides o f the aisle. Combined with the close knit nature o f these small societies, this has made for somewhat difficult relations between public sector and trade unions in wage setting and employment issues which has resulted in overly large state sectors. In addition, shifting party affiliation i s not uncommon among political actors in the sub-region, which has, at times, affected policy stability. Despite t h i s generally positive picture, the OECS i s n o w at an economic crossroad. The region i s 5. experiencing a secular slowdown in growth and radical changes in i t s external environment. Growth has 2 slowed from 5.9 percent in the 1980s to 1.4 percent during 2000-03. Throughout the 1980s and early 1990s, the countries benefited from buoyant prices and preferential access for traditional agricultural exports, a growing demand for tourism, and sizeable flows o f foreign aid. M o r e recently, the global economic slowdown, declining preferential access for i t s exports, competition from newer tourism destinations, a marked increase in the incidence o f catastrophic weather events, and declining aid flows have taken a toll o n the economies. Since the early 199Os, production, employment and investment in the agricultural sector have collapsed due to changing conditions in the banana export markets. On the horizon i s a renewed wave o f globalization and evolving trading arrangements that offer challenges as w e l l as new opportunities for the future. 6. Almost a decade (1994-2004) of faltering adjustment to the changing economic realities has left the sub-region with high and rising unemployment, and some o f the highest debt burdens in the world, compounded by continuing deep fiscal imbalances. Unemployment i s rising and the social gains made in the past, as well as the stability o f the currency union, are now at risk. The situation has created an imperative for accelerating growth. Given the small size o f the domestic markets, the stimulus for renewed growth can only come from taking advantage o f opportunities in the global marketplace. Hence, the urgent need to improve competitiveness as well. B. Objective of the study 7. The objective o f this study, which covers the six member countries o f the OECS (Antigua and B a r b ~ d a Dominica, ,~ Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines), i s to provide the analytical basis for a strategy to accelerate growth and improve competitiveness in response to the challenges outlined above. The study w i l l endeavor to: identify the causes o f the slowdown in growth across the sub-region, in part by reviewing the sources o f growth and assessing the impact o f fiscal imbalances, high debt, external events, and changing terms o f trade; assess the likely impact o f further globalization, and in particular, impending trade arrangements on, inter alia, sources o f growth, comparative and competitive advantage, the domestic private sector, Foreign Direct Investment (FDI), and employment in the OECS; identify key constraints to, and drivers of, the sub-region’s international competitiveness in terms o f i t s ability to attract demand for i t s exports and the investment needed to translate that demand into economic growth and j o b creation; draw lessons from the successful strategies o f other (small) states in improving competitiveness, attracting investment and stimulating economic growth; and formulate appropriate and feasible recommendations to accelerate growth and improve competitiveness in the context o f the sub-region’s fiscal constraints, social development needs and political climate. 8. Scope of the study. This challenge to accelerate growth in the OECS i s not a newly recognized one, There have been a host o f studies, reports, and strategies prepared for the sub-region by the governments, other stakeholders, development partners and academia, addressing various aspects o f the issue. As such, many argue that, given this body o f work, it i s not the knowledge o f “what to do”, .but rather the “how to do it” which i s lacking. However, in reviewing the existing work, one finds a myriad of often competing philosophies, approaches and strategies that are in fact reflected in the ad hoc, piecemeal approach to growth, investments and interventions across the sub-region. This report tries to build o n t h i s extensive body o f earlier, and even some ongoing, work in two ways: (i) presenting a comprehensive review o f how to improve competitiveness and accelerate growth in the OECS; and (ii) Throughout the study, the term “Antigua” will refer to Antigua and Barbuda, “St. Kitts” o r “St. K i t t s and Nevis” will refer to the Federation o f St. Christopher and Nevis, “Dominica” to the Commonwealth o f Dominica, and “St. Vincent” to St. Vincent and the Grenadines, unless otherwise specified. 3 proposing an overarching strategic framework for growth and competitiveness that could serve to guide the various efforts by the private sector, national and regional authorities and their development partners in the future, and can serve as a launching pad for a discussion among c i v i l society, media, political parties and the private sector o n the future directions o f development in the OECS. The report can also provide an opportunity for donors to discuss h o w best to support such a strategic framework, once formulated, and better harmonize and coordinate their support around i t s priorities. 9. This study will not present a comprehensive strategy for regaining fiscal sustainability across the OECS countries. Although accelerating economic growth i s a primary element o f the solution, given the very high levels o f the public indebtedness, it i s not a sufficient condition. Deep fiscal adjustment, public sector reform, improved aid effectiveness and debt management are other necessary elements. Each o f these, in turn, affect the universe o f interventions that are available for improving competitiveness and accelerating growth. As such, the recommendations presented in this report have been designed with an overarching macroeconomic framework in mind, in particular taking into account medium-term fiscal constraints. 10. The report will look at the OECS as a group and does not specifically analyze individual country situations, nor suggest individual country strategies. Finally, the report will endeavor to explore critically h o w the issue o f small scale o f the OECS economies impacts b o t h the constraints that the countries face in integrating into the global economy, and the solutions to those constraints. C. Outline of the study 11. Chapter 1 focuses o n understanding more carefully the recent trends in growth performance o f the OECS, in particular the reasons for the major growth slowdown experienced in the 1990s and the new millennium. I t explores the role o f productivity growth, changing composition and financing o f investment, sectoral shifts and the overarching fiscal, monetary and trade policies. Chapter 2 looks at the recent trends in the real exchange rate, in export performance and in foreign direct investment flows as measures o f macroeconomic competitiveness. 12. Chapters 3 and 4 review the external and internal climate for investment. Chapter 3 examines the global context in which the OECS w i l l have to compete, b o t h in terms o f emerging trade arrangements and as small states. I t reviews the experience to date with special and differential treatment, examines the challenges and opportunities in the key trade arrangements in w h i c h the OECS may participate - the Caribbean Single Market Economy (CSME), the Free Trade Area o f the Americas and the W o r l d Trade Organization - and presents a case study o n Ireland as an example o f h o w one small state, facing very similar initial conditions as the OECS countries, achieved sustained and broad-based growth. Chapter 4 focuses o n the broad investment climate within the QECS countries, including the role o f macroeconomic environment, public sector investment and service delivery, and the investment regime. 13. Next, the report turns to direct factors o f production and h o w they are impacting the ability o f OECS f i r m s to produce efficiently and at competitive costs. Chapter 5 focuses o n skills, wages and the labor market and Chapter 6 o n finance, infrastructure and technology. A shortage o f appropriate s k i l l s has been named as the number one constraint by f i r m s across the sub-region to improving their competitiveness. Chapter 5 reviews both the education and training systems in order to identify h o w t h i s shortfall may be addressed. Chapter 5 also examines the juxtaposition o f high wages and high unemployment facing the OECS and reviews h o w the labor market in the OECS i s functioning, including the impact o f public sector employment, labor regulations and migration flows. 14. Chapter 6 covers technology, finance and infrastructure. The section o n technology summarizes and reviews the basic characteristics o f f i r m s in the OECS in terms o f their capacity to adopt new technologies and to innovate. It then presents some recent findings o n the role o f business development services, incubators, and national innovation systems in raising firm capacity and technology adoption. This section concludes with a case study o n h o w adoption o f ICT can help f i r m s in other sectors improve their competitiveness. In the section o n finance, the report reviews financial intermediation through b o t h 4 credit and equity markets in the sub-region. In the final section, the report examines key infrastructure services that are critical to the expansion o f exports for the sub-region - telecommunications, energy including electricity and petroleum, and maritime, air and domestic transportation - in particular h o w small scale affects costs and how these might b e overcome. 15. Finally, Chapter 7 presents several case studies o n existing and potential service exports from the sub-region - tourism, offshore education, ICTs, offshore finance and health services. 5 CHAPTER 1. THE GROWTHCHALLENGE 1. 1 This chapter examines the growth performance o f the OECS countries over the past three decades, taking a cross-country approach. I t analyzes the trends, sources (sectoral contribution as well as the relative importance o f factor accumulation and productivity) and determinants o f growth, taking into consideration the impact o f volatility. The chapter then reviews the OECS countries’ recent macroeconomic performance and current social, fiscal and external challenges. 1. 2 Growth has been relatively strong in the OECS at an average o f 4.1 percent per year during 19802003-higher than the average for the world, micro states and Caribbean countries. However, t h i s growth performance i s clouded by several factors. First, growth in the OECS has been slowing down since the early 1990s and this slowdown i s associated with a decline in productivity growth and a contraction in private investment. Second, while growth in the 1980s was in part supported by large public investment financed primarily by aid flows, OECS governments’ efforts in the late 1990s and early 2000s to offset exogenous shocks and the contraction in private investment through increased public investment have not translated into a revival o f growth. Rather, because these investments have been financed by expensive commercial borrowing, the result has been a significant build-up o f debt in the OECS countries, to levels that test the l i m i t s o f sustainability. Third, past growth does not appear to have been driven by a strategic agenda for competitiveness. Rather, it has been driven by special and preferential treatment o n export trade and the sectoral reallocation o f resources from agriculture to tourism, led by inflows o f foreign direct investment. 1. 3 The implication i s that, if current policies were to continue, prospects for growth in the OECS would be uncertain, given the decline in productivity, the increased macro-economic vulnerability and the lack o f a strategy for achieving global competitiveness. In addition, trade preferences are eroding and aid flows to the OECS are expected to continue to decline, while the traditional sun, sea and sand-based tourism product i s experiencing a slowdown in growth and market share. Three main policy conclusions arise from the growth analysis. The f i r s t i s a need to improve the sub-region’s economic productivity if the declining growth trend i s to be reversed and sustained at a relatively high level. Business as usual would no longer be able to sustain growth in the OECS countries in the next decade. Second, new areas for efficient and profitable investment are needed and would require, inter alia, improvement in the investment climate. Third, the OECS countries need to attach higher priority to sustainable fiscal policy and debt management, i f economic growth i s t o be sustained. A. Growth trends 1.4 Growth in the OECS has been relatively strong at an average o f 4.1 percent per year during 1980-2003 compared with a world’ average o f 2.9 percent, a micro statesg average o f 3.8 percent, upper middle income countries average o f 1.O percent, and the Caribbean average o f 3.1 percent (see Table 1 in Introduction). All the OECS countries are in the top two quintiles o f the world in terms o f average growth rates during 1980-2003. 195 countries. F o r the purposes o f this report, m i c r o states are identified as independent countries with populations o f less than 500,000 persons. 6 FIGURE1.1: REALGDP GROWTHIN THE OECS, 1978-2003 (% change) The sub-region has experienced a secular slowdown in growth since the early 1990s. Real GDP 1. 5 growth in the OECS averaged 5.9 percent per year in the 1980s, 3.3 percent in the 1990s and 1.4 percent in the new millennium (see Figure 1.1). Decomposing these growth rates into trend and cyclical components using the t w o most common techniques" shows similar patterns o f slowdown f r o m the 1980s to the 1990s for a l l member states. In Antigua and Barbuda, St. Kitts and Nevis and St. Vincent and the Grenadines, the slowdown was evident from the 1970s, whereas in Dominica and Grenada" growth was o n average stronger in the 1980s compared to the 1970s. The slowdown in the OECS was the sharpest felt in the broader Caribbean12 during this period. B. Sources o f growth 1. 6 Growth in the 1980s was driven largely by services, public investment and a positive resource balance supported by strong growth in tourism and banana exports. The slowdown in growth i s associated initially w i t h sharp declines in productivity growth and in public investment between the 1980s and 199Os, followed by a contraction in private domestic investment and a retrenchment in exports between the 1990s and the new millennium. OECS governments' efforts in the late 1990s and early 2000s to offset exogenous shocks and the contraction in private investment through increased public investment have not translated into a revival o f growth-rather they l e d t o a further contraction in private investment due to crowding out. The growing fiscal imbalances associated with the increased public investment have been financed by expensive commercial borrowing - b o t h domestic and external - and resulted in an unsustainably large debt burden. Simultaneously, a deterioration in the external environment causing a contraction in exports and in the resource balance exacerbated the situation. (i) Sectoral composition of growth 1. 7 The services sector has been the major impetus f o r overall growth in the OECS during the last t w o decades (see Table 1.1), accounting for around three quarters o f the growth in value added during 1980-2003, K e y drivers were construction, communications, banking and insurance, distribution (wholesale and retail trade), transport and, notably, government services which were the leading driver of growth in the 1980s and 2000s. Although the industrial sector has been growing at faster rates than services, this growth i s concentrated in non-tradables such as utilities and construction that i s likely to have been driven by expansion in the tourism and public investments. Hodrick-Prescott, and Baxter and King filters. See K i d a (2004). St. Lucia has insufficient data for this exercise. '21MF (2005). Io The 7 TABLE 1.1: SECTORAL COMPOSITION O I 3DP" AND GDP GROW -1980-2003 Shares of GDP 1980s Average growth rates (%) 1980s 1990s 2000s (%I 1990s 2000s Contribution to GDP growth (YO) 1980s 1990s 2000s Agriculture 14.3 10.3 7.4 3.0 -1.3 -1.6 0.4 -0.1 -0.1 Industry 19.3 0.7 7.4 2.9 21.0 0.9 6.6 3.8 9.8 23.2 0.9 6.3 4.8 11.1 8.1 14.6 6.9 7.4 9.0 3.7 3.0 1.5 7.0 4.2 2.0 0.3 0.9 3.7 2.1 1.6 0.1 0.5 0.2 0.8 0.0 0.1 0.3 0.5 0.0 0.1 0.2 0.8 0.4 0.2 76.1 78.8 1.5 1.3 0.2 1.7 4.0 3.6 1.0 63.5 12.0 8.6 3.8 4.8 3.8 4.6 2.6 60.6 12.6 9.2 6.0 6.6 3.0 0.5 0.4 0.9 0.0 0.1 11.4 8.6 9.3 5.5 15.5 4.1 11.1 10.9 11.1 5.5 15.3 4.2 3.2 9.8 6.5 2.2 1.9 4.2 3.3 0.9 1.o 2.5 2.8 2.7 1.8 1.4 0.4 0.8 0.6 0.1 0.3 0.2 3.3 0.1 0.1 0.3 0.2 0.4 0.1 1.4 Mining & Quarrying Manufacturing Electricity & Water Construction Services Services excl. Gov. Serv. Wholesale & Retail Trade Hotels & Restaurants Transport Communications Banks & Insurance Real Estate & Housing Government Services Other Services GDP at factor costs 8.3 71.5 52.8 11.7 8.2 10.9 4.2 6.9 6.7 18.7 4.2 ~ 5.4 6.9 7.5 14.4 8.0 3 .O 4.6 4.9 5.9 0.6 0.6 0.8 0.6 0.6 0.2 0.9 0.2 5.9 1. 8 Throughout the last two decades, production in the OECS has shifted from agriculture to industry and services, but this has been accompanied by much more modest shifts in employment, resulting in rising unemployment. The contribution o f agriculture to GDP declined f r o m 14 percent in the 1980s to 7 percent in the 2000s (see Table 1.1). However, agriculture s t i l l accounts for a significant 16 percent o f employment in the sub-region - over a quarter o f the labor force in Dominica in 1999, and one fifth in St. Lucia in 2000. The concentration o f the workforce in t h i s rapidly declining sector has resulted in rising unemployment (see Table 5.8). Sources: Available labor force surveys and censuses. Data for Antigua and Barbuda i s from 1991; for Dominica: 1991 and 1999; Grenada: 1991 and 1998; St. Kitts and Nevis: 1994 and 2001; St. Lucia: 1993 and 2000; and St. Vincent and the Grenadines: 200 1. 8 (ii) Productivity growth 1. 9 Basic estimates of total factor productivity (TFP) growth in the OECS countries show a dramatic decline in the 1990s compared with the 1980s, with the exception o f St. Kitts and Nevis (see Table 1.2). However, the interpretation o f these estimates must be conditioned by the data limitations faced in computing them. B o x 1.1 reviews some o f these data constraints and h o w they m a y affect these estimates and their interpretation. The basic conclusion that can b e drawn i s that the TFP estimates measure general productivity o f the economy (including productivity improvements coming f r o m a host of economic changes such as improvements in human capital, capacity utilization and shifts into more productive sectors) and not simply disembodied technical change. 1. 10 Taking these assumptions at face value, the OECS countries recorded an average 2.7 percent productivity growth during the 1980s, but only 1.3 percent productivity growth during the 1990s. In comparison to the relatively stable growth rates o f capital and labor over the period, the change in productivity growth i s clearly associated w i t h the slowdown f r o m the high growth rates in the 1980s to more moderate growth rates in the 1990s. St. Lucia and St. Vincent and the Grenadines experienced the sharpest reduction in productivity growth f r o m 4-5 percent per year in the 1980s to around near zero growth in the 1990s. Antigua and Barbuda, Dominica and Grenada saw declines f r o m around 4 percent productivity growth in the 1980s to around 1.5 percent in the 1990s. St. Kitts and Nevis stands out as recording an increase in productivity growth between the t w o periods, but also the least acute overall growth slowdown driven instead by a halving o f the growth rate o f capital. TABLE1.2: TOTALFACTOR PRODUCTIVITY GROWTH (SOLOW RESIDUALS),13 1980-2000 GDP Labor Capital TFP Dominica GDP Labor Capital TFP Grenada GDP Labor Capital TFP St. K i t t s and Nevis GDP Labor Capital TFP St. Lucia GDP Labor Capital TFP St. Vincent and the Grenadines GDP Labor Cauital TFP Source: K i d a (2004). Antigua and Barbuda 1981-2000 4.73 0.42 1.20 3.11 3.53 -0.11 0.84 2.80 4.62 0.32 1.23 3.07 4.86 -0.02 1.38 2.45 5.12 1.84 0.90 2.37 4.13 0.56 1.12 2.44 1981-1990 6.14 0.32 1.23 4.59 5.38 -0.10 0.98 4.50 5.57 0.26 1.13 4.18 5.47 -0.33 2.04 0.43 7.62 1.82 0.79 5.01 6.07 0.64 1.02 4.41 1991-2000 3.32 0.51 1.18 1.63 1.68 -0.12 0.70 1.10 3.68 0.38 1.34 1.96 4.24 0.29 1.31 2.65 2.61 1.86 1.01 -0.26 2.19 0.49 1.22 0.47 l3 W e report Solow residuals as a measure o f TFP growth - regression estimates and cyclically-adjusted regressions estimates were computed with the same results. 9 Gains in total factor productivity (TFP), rejecting more eficient use of inputs, have long been recognized as an important source of improvements in income and welfare. However, measuring TFP is diJEcult for two reasons. Different assumptions about the national production function, including returns to scale and elasticity of factor substitution, and diflerent estimates of the stocks and growth rates of labor and capital, can lead to very different estimates of TFP growth. Consequently, the interpretation of the TFP itself and its role in output growth should reflect clearly the assumptions and data estimation methods used. These issues are very relevant for interpreting estimates of TFP growth in the OECS where there continue to be serious data constraints. 1. 11 Data limitations prevent further specification on the reasons for the slowdown in productivity growth in the O E C S over the 1990s. However, there are a number o f possible explanations that can be explored. 1. 12 One hypothesis i s that productivity growth in the O E C S may be partly based on the transition shifts to more productive sectors. K i d a (2004) and World Bank (2005b) show that for the broader Caribbean a similar slowdown in productivity growth in the 1990s can be associated with a slowdown in the sectoral shifts. Most o f the transition to services in the rest o f the Caribbean took place in the 1980s, while this movement slowed significantly in the 1990s. However, in the OECS it appears to have continued at largely the same pace over the two decades. Services accounted for 72 percent o f GDP in 1980, 76 percent in 1990 and 79 percent in 2000. 10 1, 13 A second hypothesis i s that the shift in the composition and financing of investment over the decades resulted in lower productivity of ~ a p i t a l . ’The ~ larger share o f public investment in the 1980s concentrated in social and transport infrastructure supporting the booming tourism and banana sectors m a y have yielded higher productivity growth than in the 1990s when private domestic investment was leading but catering mainly to protected domestic markets and declining terms o f trade. Some have posited that the contraction o f donor financing and subsequent rise in commercial financing o f public investment in the OECS during the 1990s (see Figure 1.5) has been associated w i t h less rigorous analysis of individual projects and an increased number o f white elephants that lower overall productivity (discussed further in Chapter 4). Nonetheless, these remain hypothesis until additional data can be brought to bear o n the analysis. 1. 14 A third hypothesis relates to increasing volatility of growth or income that can lower productivity of capital because it shortens planning horizons for investors and results in sub-optimal decision-making by both the public and private sectors. However, in the OECS both real GDP levels and growth rates were less volatile in the 1990s compared with the 1980s as measured by the coefficient o f variation. 1. 15 A fourth and associated hypothesis i s that a n increased incidence of natural disasters reduced productivity growth.15 On the one hand, natural disasters disrupt the normal process o f learning by doing, as an economy takes “time out” for recovery, while o n the other, the periodic reconstruction o f capital stock that follows a disaster can provide an earlier opportunity for introducing new innovations than would otherwise have been affordable or efficient. For example, in Grenada, Hurricane I v a n has provided a window o f opportunity for investing in more productive variety o f nutmeg trees. In the OECS, the incidence o f natural disasters was similar in the 1980s and 1990s but, as noted above without additional data it i s impossible to ascertain whether the intensity o f these events or the duration o f the recovery periods was greater. (iii)Factor decomposition of growth 1. 16 T h e slowdown in the 1990s also reflects a major deceleration in investment growth, whereas the decline in the early 2000s reflects a contraction in the resource balance led predominantly b y a sharp reduction in export growth. Table 1.3 examines the factor decomposition o f growth in the OECS during 1980-2003. TABLE1.3: FACTOR DECOMPOSITION OF GROWTH Contribution to GDP growth (%) 1980s 1990s 2000s Resource balance 0.7 0.3 -0.9 Exports 4.7 1.5 -1.4 Imports 4.1 1.2 -0.5 Consumption 3.1 2.6 1.8 Investment 2.1 0.4 0.4 GDP 5.9 3.3 1.4 Source: World Bank (2004i). 1. 17 Throughout the last two decades, investment rates in the OECS have been persistently high. Gross domestic investment averaged 31 percent o f GDP (see Figure 1.3). This i s comparable with a l4In general, i t i s felt that labor productivity should have been improving over the 1990s as educational attainments continue their rapid expansion, albeit not at the same pace as wages (see further discussion in Chapter 5). Since 1970, on average a natural disaster occurred once every four and a half year in each o f the six OECS countries. N o t all these events were very large, however. Considering only incidents that affected at least 2 percent of a country’s population or inflicted damage o f at least 2 percent o f GDP, such events occurred in the individual countries once every nine years or somewhere in the OECS once every two and a half years. Among these large disasters, the median number o f affected amounted to 9 percent o f the country’s population and the median value o f damage was equivalent to 14 percent o f the country’s annual GDP (see IMF, 2004~). 11 Caribbean average o f 28 percent and that o f other micro states at 29 percent, but i s significantly higher than the average for upper middle income countries o f 25 percent over the same period.I6 O n average, during 1990-2003, FDI accounted for 29 percent o f gross domestic investment in the OECS, public investment for 33 percent and private domestic investment for 39 percent. 35% 30% $ 25% 2 20% 0 -Gross Dom Inv +FDI -m- Public & Private Domestic Inv Source: World Bank (2004i). 1, 18 T h e persistently high investment rates in the O E C S mask radical shifts in the composition of that investment over the last two decades. During the early 1990s, the region saw a large contraction in public investment (Figure 1.4) due primarily to reductions in aid flows, as donors refocused their assistance o n l o w income countries. In the early 1980s, public investment accounted for about h a l f o f total investment or 16 percent o f G D P during 1980-90, whereas in the 1990s the private sector drove overall investment. FIGURE1.4: COMPOSITION OF INVESTMENT, 1977-2003 1977-79 1980-84 1985-89 1990-95 1996-99 2000-03 Sources: World Bank (1990,2004i). 1. 19 Public investment in the 1980s was financed mainly b y large flows of development assistance, around 12 percent o f GDP during 1980-85 (see Figure 1.5). Shortly thereafter, aid flows began a rapid decline reaching about 5 percent o f GDP in the first h a l f o f the 1990s. Initially, public investment remained high during the second h a l f o f the 1980s, but eventually declined to around 8 percent o f GDP during the first h a l f o f the 1990s. l6 Investment rates worldwide averaged 23 percent and those for all developing countries’ averaged o f 24.5 percent over the same period. 12 FIGURE 1.5: SOURCES OF FINANCE FOR INVESTMENT, 1980-2003 .. 8% 6% 4% 2 Yo 0 Yo 1980-84 1985-89 1990-94 1995-99 2000-03 Note: External debt measures average annual increase in stock. Sources: IMF International Financial Statistics (IFS), and OECD. 1.20 During the late 1990s, the sub-region then experienced a rapid decline in private investment accompanied by a rapid recovery in public investment, as the sub-region pursued a n expansionary fiscal policy aimed at resuscitating growth. The decline in private investment was predominantly a severe contraction in private domestic investment, as FDI flows remained relatively stable (see Figure 1.6). Despite the reduced availability o f aid, there appears to have been an implicit policy to offset the decline in private investment with public investment (see Figure 1.6) resulting in a noticeable decline in the volatility o f overall investment from the 1980s to the 1990s (see Figure 1.3). During 1980-1991, the coefficient o f variation o f investment was 12.2 percent, compared with 3.6 percent during 1992-2003. Over the same periods, the correlation coefficient between FDI and domestic (including public) investment shifted from 0.44 to -0.55, and the correlation between public and private investment in the 1990s became sharply negative with a correlation coefficient of-0.45, FIGURE1.6: COMPOSITION OF INVESTMENT, 1990-2003 FDI O m ~ ~ m N m m m Y r m~ m l n m W m t . m~ m ~ o m o " P I P I o o ~ o~ N m ~ Source: W o r l d B a n k (2004i). 1.21 The expansion in public investment in the late 1990s and early 2000s was financed primarily by expensive commercial borrowing - a policy that became increasingly unsustainable, In the face o f sharply reduced aid flows, the increases in public investment in the late 1990s and early 2000s were not financed by raising revenues, but through expensive commercial borrowing (both domestic and external) and growing fiscal deficits (see Figure 1.7). IMF (2005) notes that interest payments increased for the more indebted OECS countries during 1998-2003, even when global interest 13 ~ ~ rates were declining. The impact o f the growing fiscal deficits and debt led to a further crowding out o f private investment. Eventually, public investment too contracted as the fiscal situation became unsustainable (see Figure 1.7). 1.22 T h e slowdown in growth across the decades i s mirrored in the performance of the subregion’s major exports - tourism and bananas. After growing by 16 percent in the 1980s and 5 percent in the 199Os, overall exports contracted by 4 percent during the new millennium. Specifically, during the 1980s tourism experienced strong growth in arrivals, receipts and room stock (see Table 1.4) and banana exports accounted for around 10 percent o f GDP and 14 percent o f exports o f goods and services. Tourism growth slowed down in the 1990s and came to a halt in the early 2000s, while banana exports contracted in the 1990s and experienced a significant decline in the early 2000s. TABLE1.4: PERFORMANCE OF MAJOR EXPORTS, 1980-2003 Tourism 1990s Bananas 1980s 1990s 2000s average annual growth rates (%) Rooms 8.3 4.3 -1.3 Arrivals 8.5 4.0 0.4 Volumes 12.8 -4.8 -11.3 Receipts 17.6 4.1 0.4 Values 20.7 -3.9 -14.7 % o f GDP 40.0 36.5 29.8 % o f GDP 9.7 5.1 1.7 % o f exports 60.7 57.9 54.1 % o f exports 14.4 7.9 3 .O Sources: Caribbean Tourism Organization (2003), West Indies Banana Development and Export Company, and W o r l d B a n k (2004i) 1980s 2000s C. Macroeconomic outcomes and impact 1.23 T h e impact of the declining growth rates combined with the response of expansionary fiscal policies in the O E C S has yielded significantly worse macroeconomic outcomes in the new millennium compared with a decade earlier. Public debt-to-GDP levels are critically high in all the countries. The six countries now rank among the top sixteen most indebted economies in the world and none of the countries have achieved the ECCB fiscal benchmark for public sector debt o f 60 percent o f GDP. Although most o f the OECS governments have recently been making efforts at fiscal adjustment and consolidation, these efforts have been piecemeal and a number have conceded periodic public sector wage increases despite declining productivity. The overall fiscal deficit for the sub-region increased from an average o f 2.9 percent o f regional GDP during 1990-97 to 6.4 percent in 1998-2003 and has been slightly reduced to an estimated 6.0 percent in 2004. Private investment continues to be weak at 16 percent o f GDP in 2003. 14 FIGURE 1.7: FISCAL ACCOUNTS,1990-2003 ______________------- DExpenditures -Revenues 1--------- (rl .- -4% -- -6% -- -8% e, 2 25% a 3 g x 3 8 20% % s* .-," G 15% 8 9 L f 10% .- -10% O 5o/' 0 OO/ a n il -- z -12% Source: World Bank (2004i) 1. 24 Despite the deteriorating macroeconomic situation, the current account balance has remained relatively stable at 12 percent o f GDP during 1996-2003 and continues to be financed by sufficient capital inflows to allow steady increases in international reserves. M o r e recently, however, the capital account i s demonstrating signs of growing vulnerability as evidenced by an increasing share o f portfolio inflows (from 5 percent of total capital inflows in 1996-99 to 23 percent in 2000-03), declining official grants (from 23 to 16 percent across the same periods), and increasing net outflows by commercial banks (from 0 to 22 percent o f the capital account). D. Current challenges 1.25 As noted above, the growth performance o f the OECS has been relatively strong over the past 25 years, but there has been a major slowdown over the past decade associated with weakening external performance and unsustainable fiscal policies. The current challenge facing the sub-region i s h o w t o reinvigorate growth in order to address the following imperatives - reducing high unemployment and poverty rates, restoring fiscal and debt sustainability, and securing a position for the sub-region in a more competitive global environment. W e examine each o f these imperatives below. 1. 26 The social imperative. The most recent Poverty Assessment in the sub-region (Dominica, 2002) paints a picture o f poverty that i s predominantly income- and employment- based, as opposed to rooted in lack o f access to broad social services. The latter reflects the sub-region's history o f investment in social and human capital. As such, reducing poverty will require an expansion ofjob-generating growth, as well as continuous efforts to increase human capital so that the poor can take advantage o f these opportunities. The sub-region has targeted 6 percent unemployment as i t s medium term goal. With a current average unemployment rate of 16 percent (and a population of approximately 570,000 persons), the OECS needs to create 57,000 new jobs over the medium term to achieve i t s target o f 6 percent unemployment assuming that the population growth rates remain near zero. However, given the need for fiscal adjustment, which may involve some reductions in public employment, and the continued decline in agriculture ( s t i l l accounting for a significant share o f the labor force), this number could be larger." One o f the key challenges in this regard will be to raise the s k i l l levels o f the poor and unemployed, as w e l l as l7 A t a first glance, i t would seem that these jobs are needed predominantly in the Windward Islands, but one should note carefully intra-regional migration flows. For example, Antigua and Barbuda's l o w unemployment rates have been due to a policy of employer-of-the-last resort pursued by the recent government which has shown i t s e l f to be clearly unsustainable. Yet, given the large share o f other OECS nationals in the Antiguan and Barbudian labor force, any rationalization o f the public sector will have implications for unemployment and therefore the need for job growth in the rest of the region. . 15 the population in general. This will be discussed in more detail in Chapter 5. Given that this will take time, there i s an urgent need to improve social protection and safety net programs during the transition period. This report will not address the details o f such efforts which have been reviewed in recent and ongoing work by the W o r l d Bank." 1. 27 Thefiscal imperative. Regaining fiscal and debt sustainability across the OECS i s critical not only to resuming growth, but also to safeguard the Eastern Caribbean Currency U n i o n currency board arrangement which has provided one element o f macroeconomic stability since independence. As such, the ECCB has established fiscal benchmarks for the individual countries, including minimum budget current balance o f 4-6 percent o f GDP, budget deficit o f 3 percent, and maximum central government debt o f 60 percent, to be achieved by 2007. In 2003, none o f the countries had achieved the debt targets. I 1. 28 Table 1.5 shows the estimated required fiscal adjustment needed to achieve the debt-to-GDP benchmark over the next five years.lg Clearly, there i s a relationship between the magnitude of debt reduction needed, growth, and the required fiscal adjustment. For a given level o f debt, faster growth will reduce the needed fiscal adjustment. OECS public debt stood at 113 percent o f GDP in 2003. Assuming real interest rates of 4 percent and growth rates o f 2.6 percent, the sub-region would need to achieve an average primary surplus o f 12 percent o f GDP in order to achieve the E C C B debt benchmark by 2008. This, in turn, would imply an OECS average fiscal adjustment o f 14 percent o f GDP. If, however, the sub-region achieves i t s target growth rate o f 6 percent, the required primary surplus would fall to 8 percent and the fiscal adjustment to 11 percent o f GDP. TABLE1.5: DEBTSUSTAINABILITY Public debt 2003 Average growth 1998-2003 Real interest % o f GDP rates Antigua and Barbuda 142 3.0 1.8 Dominica 122 -0.4 2.1 Grenada 113 4.1 6.6 St. Kitts and Nevis 171 2.3 3.8 St. Lucia 69 1.o 5.0 St. Vincent the and Grenadines 73 4.7 4.5 OECS 113 2.6 4.0 Source: IMF and World Bank staff estimates. Primary surplus required to achieve 60% debt-toGDP by 2008 Avg primary surplusideficit 1998-2003 Implied fiscal adjustment 14.7 15.5 13.4 -3.3 -2.2 -4.0 18 18 17 24.7 4.6 -6.5 0.4 31 4 2.5 12.2 0.4 -2.3 2 14 1. 29 I t i s important to note that the growth assumptions/targets and required fiscal balances are not independent. Jamaica provides an important lesson from within the region. Jamaica has been running a primary surplus in the order o f 8.5 percent o f GDP over the last decade (1991-2003) in order to reduce i t s public debt that stands at 142 percent o f GDP. Such a sustained tight fiscal policy has in turn contributed to a contraction in growth that averaged only 1 percent during 1998 to 2003. With respect to the OECS, the assignment and quality o f fiscal adjustment will be important for determining i t s impact o n growth. World Bank (2003c, 2003e, 2004f, 2004g, 2004h, forthcoming) and ongoing work o n a Caribbean Social Protection Strategy. l 9 The benchmark o f 60 percent o f GDP may be too high for the medium t e r m sustainability. Experience has shown that the median public debt-to-GDP ratios the year before in countries which have defaulted were about 50 percent. Moreover, high variability in revenues, typical for a small, highly open and vulnerable island economies, generally indicate a lower sustainable public debt ratio. 16 1. 30 A closer analysis of fiscal accounts presented in the recent W o r l d B a n k Analyses of Fiscal Issues for most of the OECS countries2' suggests that the adjustment should be focused on the expenditure side, in part because tax rates in the OECS are already high - corporate tax rates average 34 percent across the sub-region - and because unfettered increases in both current and capital expenditures across the sub-region has been at the root o f the current imbalances. Expenditure levels are relatively high averaging 34 percent o f GDP (see Table 2 in Introduction). Recent work by the W o r l d Bank has shown that there i s scope to reduce expenditures while maintaining or even improving the quality of public services. However, a significant portion o f the savings i s likely to come f r o m c i v i l services' reform which m a y aggravate the already difficult unemployment situation and thus needs to be undertaken together with efforts to encourage private sector activity. Public investment would also need to be selectively prioritized toward growth supporting interventions, i t s efficiency improved and i t s financing coming mainly from grants and concessional loans. 1. 3 1 At the same time, there i s scope for increasing the efficiency of revenue mobilization that in turn can positively affect growth. Widespread use of concessions has narrowed the tax base and created distortions in the economy, while reducing revenue intake. Attention to tax policy i s also warranted o n the ground that OECS countries are expected to lose tariff revenues as a result o f regional free trade arrangements. There also remains significant scope for improvement in tax administration. Recent work by the IMF and a sub-regional Tax Reform and Administration Commission (2004) presents a program of reform measures, including the introduction o f a value added tax that would broaden the tax base, 1. 32 The external imperative for accelerating growth stems from the rapidly increasing globalization that i s shaping the external climate for the OECS, and issues o f external sustainability. The former i s discussed in more detail in Chapter 3. As a very open economy, the OECS sub-region i s dependent o n imports for both domestic consumption and investment. In the past, these have been adequately financed by exports (primarily a positive services balance) and steady flows o f aid and FDI. Large foreign investment projects have often driven up the current account deficit in individual countries as they temporarily expand the imports o f materials and machinery. On average, the sub-regional current account balance has remained relatively stable at 12 percent of GDP during 1996-2003 and continues to be financed by sufficient capital inflows to allow steady increases in international reserves, However, in recent years, several factors have combined to bring the issue o f external sustainability to the forefront, notably the rapid increase in external indebtedness, the slowdown in export growth and the changing composition o f capital flows. The capital account i s now demonstrating signs o f growing vulnerability as evidenced by an increasing share o f portfolio inflows and growing net outflows by commercial banks as they offshore excess liquidity. 1, 33 The sub-region now faces several risks to i t s external sustainability, including the possibility of rising interest charges o n the external debt, reduced access to external finance or capital outflows in the event that creditors downgrade their OECS paper, and continued weakness in export earnings. Any deterioration in these accounts would severely impact the OECS economies. As such, accelerating growth through improving export performance i s thus critical to maintaining and increasing consumption levels. Externally, the OECS i s already facing steeper competition for i t s exports and the advent o f more liberal trade agreements that would expand and deepen globalization will increase these challenges. Thus, the sub-region needs to rapidly find and develop new sources o f competitiveness, or it will be at risk of being left behind and outside o f the world economy on which it depends so heavily, 2o World Bank (2003e, 2004f, 2004g, 2004h, forthcoming). 17 CHAPTER 2. MACROECONOMIC COMPETITIVENESS 2. 1 As discussed in Chapter 1, accelerating growth in the OECS w i l l largely depend o n the subregion’s ability to strengthen i t s performance in the global economy, which in turn w i l l require improving i t s competitiveness. At the macro level, competitiveness can be defined as an economy’s ability to attract the demand for i t s exports and the investment to supply that demand, all within social norms that result in an improved standard o f living for i t s citizens. This, in turn, depends o n the macro- and micro-economic policies, regulations and institutions that affect the productivity o f the economy’s factors o f production and the costs o f doing business. This chapter examines the sub-region’s recent performance o n three measures of macroeconomic competitiveness: the real exchange rate as a general indicator o f price competitiveness, the exports o f goods and services, and trends in FDI inflows to the sub-region. 2. 2 The analysis o f real exchange rate trends shows evidence that, in the latter h a l f o f the 1990s, the OECS economies demonstrated a growing inward, rather than outward, orientation, and a general loss o f price competitiveness. However, owing to a recent realignment driven mainly by external developments (notably the weakening of the U S dollar), the real exchange rate as o f mid 2003 did not appear to be either over- or under-valued with respect to key fundamentals. The analysis o f export trends shows that after strong growth during the 1980s, exports of both goods and services experienced relatively weak performance during the 1990s, and contractions in the 2000s. Since the 1990s, OECS tourism and offshore financial services have lost market share in the Caribbean and worldwide, while key merchandise exports, including but not limited to the traditional agricultural products, have contracted or seen only marginal growth. However, there are some indications that the sub-region i s in the process o f identifying new exports - both o f goods and services, but these are s t i l l too small to impact macroeconomic performance. In contrast to exports, the OECS has been extremely competitive in attracting foreign investment, w i t h relatively stable flows as a share o f GDP through the last two decades. However, in comparison to the Caribbean and the rest o f the world the sub-region has been losing ground, This analysis suggests that the focus going forward should be o n the trade and investment climates as well as o n the direct factors o f production rather than o n the exchange rate. A. The real exchange rate 2. 3 After suffering a general loss of price competitiveness and a growing inward orientation over the latter half of the 1990s, the O E C S experienced a relatively sharp correction in the real exchange rate, driven by external factors, so that b y mid 2003, it did not appear to be either overor under-valued. The real exchange rate (RER) index measures how a country’s international price competitiveness evolves over time with respect to i t s trading partners and competitors. Real exchange rates are computed by adjusting nominal exchange rates by the relative movements in costs o f production. The latter i s proxied by a variety o f indicators each having their o w n interpretation, but which can be grouped into two categories: (i) RERs which are adjusted by disaggregating domestic price indices into the relative movements o f the prices o f tradables versus non-tradables and can be interpreted as a measure of the internal versus external orientation o f the economy; and (ii) RERs which are computed using relative movements o f domestic and international price indices - the latter usually specified as a weighted average o f prices from the host country’s trading partners or competitors - and are generally interpreted as a measure o f international competitiveness. 2. 4 The IMF ( 2 0 0 4 ~ )constructs several alternative measures o f the RER illustrated in Figure 2.1 and Figure 2.2. T w o of the three measures that use domestic price indices -the CPI or the GDP deflator disaggregated into tradables and nontradables appreciated f r o m around 1995 through late 2002 indicating a growing inward orientation of the regional economy (see Figure 2.1). 18 90 I ~ N o t e : Increase = appreciation. Source: IMF (2004). 2. 5 The traditional RER fluctuated around i t s early 1990 level through mid 1997, then appreciated by 10 percent through late 2001. Since then, however, it experienced a depreciation that entirely offset the earlier appreciation. The RER based o n the unit prices o f export and imports shows a similar pattern but w i t h a much stronger appreciation during the late 1990s and weaker correction through 2003. With respect t o the OECS tourism customers - i t s trading partners - the RER fluctuated steadily around i t s early 1990 level until late 2001, after which it depreciated sharply. The post-2001 depreciation i s associated with the sharp depreciation o f the U S dollar (to which the EC dollar i s pegged) against major currencies. This illustrates that the OECS maintained its international price competitiveness through most of the 1990s, became increasingly uncompetitive in its non-tourism trade in the later part of the decade, but has since broadly regained price competitiveness as in the start of the decade. FIGURE 2.2: RER BASED ON DOMESTIC AND EXTERNAL PRICE INDICES, 1990-2003 160 .. +Traditional R E E R ........... 150 1 -0-Tourism Customers R E R t REER based on CPI and weighted unit price of exports and imports ............................................................................................................. 140 ........................................................... 130 - .......................................................... 120 J........................................................................................................... / N o t e : Increase = appreciation. Source: IMF (2004). 2. 6 In addition, the IMF (2004) estimates a co-integrating relationship between the real exchange rate and a set o f fundamentals specified as the terms o f trade, public sector external debt as a proxy for net foreign liabilities, and govemment expenditure to GDP. It extracts the trend component using the 19 Hodrick-Prescott filter to generate an estimate o f the equilibrium exchange rate. I t s work illustrates that a significant part o f the real exchange rate appreciation since 1995 and more recent depreciation could be accounted for by realignment to t h i s equilibrium rate. In addition, given these recent corrections, the FEER in mid 2003 appeared to be neither over- nor under-valued with respect to key fundamentals. B. Export performance 2. 7 After strong growth during the 1980s, the OECS experienced relatively weak performance in i t s exports of both goods and services during the 1990s, and contractions in the 2000s. Since the 1990s, OECS tourism and offshore financial services have lost market share in the Caribbean and worldwide, while key merchandise exports, including but not limited to the traditional agricultural products, have contracted or seen only marginal growth. There has been some diversification in merchandise exports, but the large majority o f the new products i s as dependent o n preferential access to i t s m a i n markets as traditional exports. Emerging exports o f services such as offshore medical education are not yet well measured by national statisticians, but offer potential for future growth as discussed in Chapter 7. Although the volatility o f total export growth has decreased over time, merchandise exports have remained much more volatile than service exports (as currently measured). TABLE2.1: EXPORT PERFORMANCE, 1980-2003 1980-2003 1980s 1990s 2000s Growth rate (average annual % change) Total 7.1 13.1 5.7 -4.0 Services 9.8 19.1 7.6 -5.2 Goods 2.9 6.2 0.7 -7.5 Volatility (coefficient o f variation) Total 1.3 0.8 1.2 -0.8 Services 1.2 0.7 0.8 -0.5 Goods 3.4 1.8 26.5 4.8 Source: W o r l d B a n k (2004i). 2. 8 During 1980-2003, the OECS experienced a 7 percent average annual growth in exports o f goods and services. However, this has deteriorated over time. Growth rates declined f r o m an average of 13 percent in the 1980s to 6 percent in the 1990s, and exports contracted by 4 percent during the new millennium (see Table 2.1). Service exports, which accounted for, o n average, 70 percent o f export earnings over the period, grew by 10 percent per year, while merchandise exports grew by 3 percent, Notably, merchandise exports have been far more volatile throughout the period than service exports, despite the fact that tourism - considered a very volatile sector - dominates the service earnings. The higher volatility i s due mainly to the concentration o f the merchandise exports in traditional agricultural commodities. 2. 9 OECS service exports are dominated by tourism and tourism-related transport receipts which account for 82 percent of earnings. During 1990-2003, the OECS has been losing market share in tourism both worldwide and in the broader Caribbean. OECS tourism receipts grew slower at 4.2 percent per year than worldwide tourism receipts, which grew by 5.0 percent per year, indicating a loss in market share. The OECS share o f Caribbean tourism earnings also declined from 7 percent in the early 1990s to just under 5 percent in 2002. Tourist arrivals to the OECS have also experienced a moderate but continuing decline in Caribbean market share f r o m 5.6 percent in 1992 to 3.9 percent in 2002. In 2003, however, the sub-region saw i t s market share rebound to 4.6 percent. Further details are presented in the case study o n tourism in Chapter 7. 2. 10 “Other service exports”, for which data i s only available since 1996, were growing through 1999, after which they have experienced a sharp reduction. In part, this reflects the decline in the offshore financial services sector following the downturn in the global equity markets, and the increased scrutiny under the OECD’s Financial Action Task Force (FATF) in 2000 and after the terrorist attacks in the U.S. o n September 11, 2001. However, offshore financial service exports account for at most 17 percent of 20 OECS “other service exports”. The largest share (43 percent o f other services, 12 percent o f services and 10 percent o f total exports o f goods and services) i s in “Other Business Services”, a category which i s not well defined, and does not appear to be dominated by any single activity. 2. 11 One issue going forward i s the need to strengthen the measurement of service exports both in the balance o f payments as well as in the national accounts. Currently, the balance o f payments accounts for the OECS do not capture data on educational service exports as the data i s not forthcoming from operators, with the exception o f one island in which expenditure by offshore medical students i s captured as a separate line item in Travel Credit. Receipts from offshore financial entities to government are captured in the balance o f payments, but there has been less success in recording payments from offshore financial entities to lawyers and other professional agents for the use o f their services (e.g. annual legal fees and retainer fees). With respect to offshore gaming, the balance o f payments only captures wages paid to local workers. Also, the national accounts statistics only capture data o n domestic investments of offshore entities. Since these entities are not mandated to keep records on island, acquiring data o n their financial operations has been difficult. 2. 12 Merchandise exports which have accounted, on average, for 30 percent of exports of goods and services f r o m the OECS have also seen major deterioration in performance during the 1990s followed b y a contraction during 2000-03. However, despite the recent collapse in banana and sugar exports which together account for one third o f export earnings - during 1998-2003 these exports contracted by 13 percent per year - merchandise exports as a whole only declined by 0.2 percent per year during the same period. This reflects the growing diversification o f the sub-region’s export base in the 1990s (see para. 2.14). However, the important question i s whether this diversification has been in sustainable directions, and therefore provides evidence o f improving competitiveness. TABLE2.2: TOPTEN*MERCHANDISE EXPORTS Direction of trade Total Share Growth OECS Caribbean Rest of the world US$m YO Yl I YOshare Total 172.2 100.0 19.8 22.2 58.0 -13.4 6.9 Bananas 39.6 23.0 85.9 7.2 9.7 16.1 Electrical apparatus 27.8 0.5 0.1 99.5 80.1 Soap & soap products 12.6 7.3 8.5 -6.6 11.5 6.3 98.4 1.3 1.3 0.3 Nutmeg & others spices 10.8 6.2 4.3 61.2 14.3 34.4 Beer 10.6 4.0 78.7 Essential oils 7.0 6.8 7.5 13.9 4.2 100.0 -3.1 Sugars & sugar confect. 7.3 0.0 0.0 -2.3 41.1 3.3 4.1 Paper products 5.6 54.8 48.2 -3.0 18.5 2.3 33.3 Arrowroot & other tubers 4.0 2.3 88.5 Fish. frozen & fresh 3.9 6.1 -2.7 5.4 Other products 43.1 25.0 52.0 18.2 29.8 * Outside the OECS sub-region. 8 Annual average growth rate for the period, 1998-2003. Source: W o r l d Integrated Trade Solution (available at wits.wor1dbank.org) and FTAA Tariff databases. 2. 13 Table 2.2 l i s t s the top 10 merchandise exports from the OECS to C A R I C O M and the rest o f the world in 2003 .2’ O f the just over h a l f o f the exports which go to the rest o f the world, some 70 percent are directed to markets for which the OECS have preferential access. Within CARICOM, almost h a l f o f these exports are protected by C E T rates o f over 10 percent. O f these top ten exports, only four - beer, electrical apparatus, nutmeg and essential oils - demonstrated positive growth during 1998-2003. 2. 14 The Herfindhal-Hirschmann Index22(HHI) for OECS merchandise exports as a whole i s 0.16 which indicates a reasonable level o f diversification for the sub-region. However, the HHI for individual Data from Antigua and Barbuda is from 1999, but this accounts for a very small share o f exports, none o f which comprise the top ten products for the sub-region. 22 Based o n shares o f the top 10 products only. 21 21 countries ranges f r o m 0.50 for St. Kitts to 0.22 for Antigua and Barbuda and Dominica, indicating much less diversification o n a country-by-country basis. Seven o f the top 10 exports originate predominantly from one or t w o countries in the sub-region: electrical apparatus and sugar comprising 92 percent o f merchandise exports from St. Kitts and Nevis, soap products and essential oils which represent 51 percent share o f merchandise exports from Dominica, fish and nutmeg which are 56 percent o f exports from Grenada, beer which comprises 20 percent o f St. Lucia’s exports, tubers from St. Vincent and the Grenadines and Dominica, and paper products from St. Lucia and Grenada. 2. 15 The predominance of these products derives from a combination of history (sugar and nutmeg23), efforts to capitalize on sources of comparative advantage (fish, soap products24 and essential oils2’) and preferential access (electrical apparatus from the US-Caribbean Basin Initiative, beer and wheat within CARICOM). The major issue i s how replicable these experiences will be in the future. Clearly those based o n preferential access w i l l face major risks in the evolving global environment. F o r sugar, the earlier source o f comparative advantage - cheap labor - has disappeared, and St. Kitts and Nevis’ small geographic size precludes it from the new source o f competitive advantage in this product which stems from economies o f scale. The comparative advantage o f nutmeg and essential oils continues t o persist - for both products the countries are in a very limited group o f producers worldwide. The survival o f the other products will depend o n how they are able to create competitive advantage in the new global economy. B o x 2.1 shows the uncertain prospects o f electronics assembly in St. Kitts and Nevis. BOX 2.1: ELECTRONICS ASSEMBLY IN ST. M T T S AND NEVIS The largest merchandise export in St. Kitts and Nevis is electronic - cable network filters and light dimmer switches exported by two firms. These companies are positioned in a relatively small market segment in the US in which most production has not yet b ced by North American manufacturers. Network filters enable cable companies facing increased compet US to diyerentiate their promotions across market segments. This requires just-in-time delivery to facilitate the rapid roll-out of new offerings. Thus, this f i r m competes on its lead time of three weeks between order and delivery versus the 6-8 weeks that would be possible j?om Asia where competitors offer cheaper wages. The second company is positioned to serve the growing construction market in the US. Its comparative advantage is being able to purchase inputs from around the world, cheaper than they would be available in the US. Both operations are fairly labor intensive - combined, they employ approximately 620persons - and require a significant amount of training for the production line stafJ: Proximity to the US allows the firms to source scarce specialized technical skills at short notice rather than install permanent technical s t a g as would be required in Asia. The firms report e small operations, to venture very far from the US in and the fact that the home co terms of both language, culture less footloose. They contend that the OECS still has a comparati $50-1 OOm turnover rm in a different market and requiring a small labor segment has already relocat that, as the Latino communi& in the USgrows, C. Foreign direct investment 2. 16 In contrast to exports, the OECS appears to be competitive in attracting foreign investment. T h e sub-region has historically attracted very high levels of FDI relative to i t s size and income levels, FDI accounted for around 9 percent o f GDP during 1998-2003, compared with 7.9 percent for other micro states and 3.8 for upper middle income states (see Table 2 in Introduction). On average, FDI represents about 27 percent o f gross fixed capital formation in the OECS compared with 15 percent for Latin America. O n the UNCTAD index o f FDI performance, the OECS countries had an average rank o f 20 in 2002, with St. Kitts and Nevis ranking 3rd after Luxembourg and Chad (see Table 2.3). Nutmeg was introduced to Grenada in the 18th century because o f the island‘s ideal soil conditions and to create a closer source to Europe than the D u t c h East Indies. 24 Dominica’s soap products started o n the basis o f earlier coconut plantations that have since been abandoned. Oils for soap production are n o w imported. 25 B a y o i l derives from the leaves o f a non-cultivable tree found solely in Dominica. 23 22 TABLE2.3: FDIPERFORMANCE 1980s 1990s 2000s (% share o f GDP) 11.0 6.4 7.3 9.3 5.8 4.1 14.1 8.6 3.5 12.5 22.8 11.3 7.9 1.1 11.5 3.0 15.0 9.0 8.1 9.2 8.8 4.1 3.0 5.2 2.6 8.0 0.7 20.3 12.3 3.7 Rank in UNCTAD FDI Performance Index 1990 2002 2 25 7 32 11 16 1 3 4 62 20 36 5 20 Antigua and Barbuda Dominica Grenada St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines OECS Caribbean * (simple avg.) Caribbean * (weighted avg.) OECS share of Caribbean FDI * not including the OECS Source: UNCTAD, IMF International Financial Statistics, World Bank (2004i) Figure 1.3 illustrates that, while cyclical, FDI inflows t o the OECS have been relatively stable averaging 8 percent o f GDP annually and the volatility f o r the sub-region as a whole has decreased over time. This stable average however masks significant changes in the FDI inflows across 2. 17 the OECS countries. Antigua and Barbuda and St. Lucia have seen a steady decline in FDI as a share of GDP since the 198Os, while Grenada and St. Kitts and Nevis have seen steady growth. Dominica and St. Vincent and the Grenadines experienced a boom in the 1990s which has since moderated (see Table 2.3). 2. 18 While FDI inflows t o t h e OECS remain large and their share o f GDP stable, the OECS has lost some ground over time, including to the r e s t o f the Caribbean and t h e r e s t o f the world. FDI inflows to the rest of the Caribbean have increased from around 0.7 percent o f GDP in the 1980s to almost equal the OECS ratio in the new millennium (8.0 percent). In addition, the OECS share o f inflows of FDI to the Caribbean has fallen from j u s t over 20 percent in the 1980s to around 4 percent in the new millennium. In terms o f the rest o f the world, the OECS average ranking o n the UNCTAD FDI Performance Index has fallen from 5 in 1990 to 20 in 2002, as the sub-region has been overtaken by other countries, which have succeeded in attracting large volumes o f FDI relative to their GDP. 23 CHAPTER 3. THE EXTERNAL CLIMATE 3. 1 The external trading environment in which the OECS countries operate has changed substantially over the past decade, and stands to change considerably over the medium term. If the sub-region i s to accelerate growth through a sustained expansion and diversification o f exports, it i s important to understand the environment in which the economies and f i r m s will have to operate. 3.2 Perhaps the most salient feature o f the external trade environment facing the OECS to date has been special and differential treatment (SDT) granted to the sub-region by i t s major trading partners CARICOM, the European U n i o n including the UK, Canada and the U S under various special arrangements. However, as globalization marches ahead, these arrangements are being reexamined and reworked to fit within the emerging broader regional and global trade agreements.26 The sub-region and many o f i t s small country counterparts around the world have consistently argued that any dismantling o f current forms o f SDT would gravely impact their ability to compete in the emerging trade arrangements, given the special characteristics o f small states. Others (DeRosa, 2000 and UNECLAC, 2003) argue that the specific SDT received to date has in fact hindered export diversification and weakened the export performance o f small states. This section looks f i r s t at what has been the impact o f past SDT o n OECS growth and competitiveness. Then it reviews challenges and opportunities for the OECS under the emerging trade agreements: the Caribbean Single Market and Economy (CSME), the Free Trade Area o f the Americas (FTAA), the Economic Partnership Agreement (EPA) with the European U n i o n and the W o r l d Trade Organization (WTO). Finally i t examines the performance o f other small states in the global economy for lessons and strategies that may be pertinent to the sub-region. A. Special and differential treatment 3. 3 Special and differential treatment o f the OECS has generally taken three forms: (i) preferential access for the sub-region’s exports, (ii)maintenance o f non-reciprocal protection within preferential trading arrangements, and (iii)longer adjustment periods within which to implement the agreed trade liberalization. 3. 4 Regarding preferential access, U N E C L A C (2003) argues, in general, that this type o f treatment has hampered export diversification and weakened export performance in small open economies by shaping a pattern of export specialization and import substitution that do not match either the structure o f production or the external demand facing these economies. Indeed, the preferential access for OECS banana exports to Europe does not appear to have delivered sustained benefits, less so because o f the recent erosion of preferences, than the sub-region’s geography that i s simply not competitive in this product. In addition, broader preferential access under arrangements like the Caribbean Basin Initiative (CBI) and Caribbean Canada Trade Agreement (CARIBCAN) have limited benefit for the OECS because the sub-region’s small size precludes competitiveness in manufactured products that require economies o f scale. Moreover, rules of origin under these arrangements often prevent the type o f vertical specialization in smaller parts o f the production chain that would be feasible for the sub-region. Regarding non-reciprocity, Ozden and Reinhardt (2004) show that countries that receive unilateral preferences tend to have more restrictive trade policies because they have not been subjected to the reciprocity-based trade regimes and that export growth often takes off only after countries are removed from preference schemes. Without preferences and with 26 In particular, CARICOM i s advancing the implementation o f the Caribbean Single Market Economy in preparation for the emerging Free Trade Area o f the Americas, which in turn i s expected to subsume the Caribbean’s arrangements with Canada under CARIBCAN, and with the U S under the Caribbean Basin Initiative and associated legislation. The EU has already made adjustments to the LomCICotonou Agreements with African, Caribbean and Pacific (ACP) countries to bring them in line with recent WTO rulings, and has initiated bilateral negotiations with CARICOM. 24 greater trade liberalization, producers face prices that are closer to world prices, and hence will make more efficient investments needed to raise long-run growth. 3. 5 The case of bananas. The OECS has had preferential access to the European and UK markets for i t s banana exports since before independence, starting with the Lome Convention in 1975 in which African, Caribbean and Pacific (ACP) countries enjoyed duty free access while other importers were subject to tariffs and non-tariff barriers. Yet an agriculture sector dominated by this crop only contributed 0.2 percentage points o f the average 5.9 percent real growth experienced by the sub-region between 1977 and 1990. Tourism earnings and other service exports, which do not benefit from trade preferences, have grown faster than merchandise exports in recent years (Table 2.1), and likely would have grown even faster had preferences-which attracted res,ources to other sectors-not been in place. 3. 6 I t i s important to acknowledge that the OECS banana export volumes did experience rapid and sustained growth, o n average 6.1 percent per year, during the Lome Convention period, 1975-93. However, t h i s expansion also coincided with sustained increase in world banana prices, which grew on average 6.8 percent per year between 1970 and 1990 (see Figure 3.1). In a recent report, NERA (2004) estimates that the supply o f bananas by the Windward Islands has been in fact very responsive to these price increases, with elasticities ranging from 4.8 to 11.2 across the individual countries, even after taking into account the impact o f the trade regime. 3. 7 In 1993, the EU switched to country specific quotas and tariff preferences under the Cotonou Convention's 'Banana Protocol' but these did not significantly affect OECS preferential access as the quotas were sufficient to cover current exports. However, during 1994-98, the sub-region only managed to fulfill 56 percent o f i t s annual quota. OECS banana producers had already started to contract production by reducing acreage, employment and investment in response to price fluctuations and growing competition from other producers. Meanwhile, lower ACP cost producers in Africa, namely Cameroon and Cote d'Ivoire, filled their quotas and have since then increased production by 33 percent and 26 percent, respectively. FIGURE 3.1: VOLUME, VALUE AND PRICES OF BANANA EXPORTS, 1954-2002 I 2 0s l 0 0 v ?-I ............................ ............ -z- 600 ...... so0 +St S! Vucent & the Grenadues hcia '. +&nada -100 5 c so too Source: World Bank (2004i). 3. 8 In 1999, under a WTO ruling, the EU moved to a general ACP quota but with country specific import licenses that continued t o favor Windward Island producers. However, despite t h i s continued protection and a temporary recovery in world prices, the sub-region's banana producers further contracted output to pre-Lome lows (Figure 3.1) reflecting their assessment that with l o w yields (on average 11 tonnes per hectare and 4 tonnes per worker, compared with 32 and 26 tonnes, respectively for Central 25 American producers)27 and higher wages and transport costs, they could not compete in t h i s sector even under SDT. During 1993-2001, the number o f registered banana farmers had fallen by 70 percent. At the end of the period, the banana sector accounted for only 6 percent o f goods and services exports and only 8 percent o f the working age population. 3. 9 The EU will move to a tariff-only regime in 2006, with a proposed tariff o f €230 per tonne. This tariff i s not sufficient to fill the price-gap between the OECS and the dominant Latin American competitors, estimated at around €259**, and based on the supply elasticities mentioned above could cause a further 40 percent contraction in OECS production. 3. 10 The Caribbean Basin Initiative and CARICOM. Under these two arrangements, the OECS has preferential access to the U S since 1984 and Caribbean markets since 1973. While the share o f OECS merchandise exports going to the U S increased from 14 percent in the early 1990s to 22 percent in 1996 and to 27 percent in 2003, the share o f US-destined exports entering under the CBI program actually fell from 48 to 41 percent over the same period. In general, Dean (2002) testing for both direct and indirect effects o f the Caribbean Basin Economic Recovery A c t (CBERA) o n Caribbean and Central American countries finds that the trade arrangement did not result in trade-induced investment-led growth, beyond that which resulted from the trade and foreign exchange reforms o f the countries themselves. 3. 11 O n the other hand, initial membership in C A R I C O M has yielded gains for the OECS. The subregion’s share o f intra-CARICOM trade rose from 15 in the early 1980s to 31 percent in the early 1990s. However, as the sub-region progressively implemented the CET, that share fell by almost h a l f to 14.6 percent in 2000-02. Meanwhile, EgoumC-Bossogo and Mendis (2002) show that controlling for membership in CARICOM, the OECS itself has not been trade-creating among members. t Yo) TABLE3.1: OECS SHARE OF INTRA-CARICOMTRADE,1980-2002 1980-85 1985-90 1990-95 1995-99 Dominica 2.4 5.2 4.8 3 .O Grenada 3.3 5.5 5.9 1.6 St. Kitts and Nevis 1.9 3.5 3.4 2.2 St. Lucia 4.6 8.7 10.3 4.5 St. Vincent and the Grenadines 3.2 5.4 6 2.1 OECS (wgtd avg) 15.3 28.3 30.5 16.2 Source: Egoume-Bossogo and Mendis (2002) and Caricom Statistics various years. 2000-02 2.8 2.9 1.5 4.0 3.2 14.6 3. 12 While preferential access did encourage export growth in the banana sector and the OECS did benefit marginally from the C B I and CARIBCAN, there are several reasons why these arrangements may not have served the sub-region’s long run interest. Most o f these arrangements were not designed explicitly to build export competitiveness based o n the sub-region’s productive structures and sources o f comparative advantage. As a result, they steered resources t o sectors that were not necessarily the most competitive internationally. Over time, t h i s raises the costs o f adjustment, for example, by creating a labor force that i s now ill-suited to new innovations in other sectors. 3. 13 Non-reciprocal protection. The second element o f Special and Differential Treatment i s nonreciprocal protection which allows beneficiary countries to maintain higher tariff rates and other trade barriers than yielded to them by their trading partners. The treatment was consistent with the nowdefunct strategy o f import substitution, in which industrial development was engineered through trade barriers (and often directed credit) aimed at creating selected industries. Growth from such a strategy has been shown to be limited o n several fronts. The choice o f sectors and industries often turns out to be inefficient. Resources are allocated to sectors in which the country either cannot or does not achieve efficiency or competitiveness over time. This raises costs for domestic consumers and exporters, and channels rents to the protected producers. Moreover, in small economies, import substitution ties up ’’N E W O P M (2004). N E W O P M (2004). 26 . limited entrepreneurial capital in inefficient sectors and because o f the small domestic market i s more likely to result in local monopolies or oligopolies who later become a powerful interest group lobbying for maintenance o f these preferences. 3. 14 Ozden and Reinhart (2003) show that economies that have been left out o f the reciprocity-based system show lagging progress o n their o w n trade liberalization. Figure 3.2 shows how exports and export growth are generally higher for countries that have been removed from the Generalized System o f Preferences (GSP).29 Closer to home, EgoumC-Bossogo and Mendis (2002) show that trade liberalization within CARICOM, specifically, the gradual lowering o f the CET has, in fact, fueled trade with the rest o f the world in part by raising the competitiveness of Caribbean exports because exporters are now able to get their imported inputs at closer to world prices. FIGURE3.2: TRADE RECIPROCITYIMPROVES EXPORT PERFORMANCE 50 45 40 35 30 25 20 15 10 5 0 ExportslGDP Industrial exports/GDP Source: Ozden 8 Reinhardt (2004) Growth rate of exports 3. 15 CARZCOM’s Article 56. Perhaps the most liberal example o f non-reciprocal protection for the OECS i s CARICOM’s Article 5630under which the sub-region (designated Less Developed Countries (LDCs) despite their higher-than average income levels) can suspend common market tariff treatment and impose quantitative restrictions on imports from member states.31 A close examination o f the continued use of the tariff and non-tariff barriers to trade in the OECS reveals a much more fragmented and protected trading space than the exceptionally high levels o f trade-to-GDP would indicate in terms o f openness. Table 3.2 illustrates t h i s point. Broad implementation o f the CET has yielded an important degree o f harmonization within the OECS - average tariff rates are tightly grouped and there i s little deviation in the number o f tariff lines. However, the CET itself with i t s higher tariff rates reserved for agricultural and final manufactured products i s firmly based o n an import-substitution model ill-suited to the increasingly service-based and import-intensive OECS economy (WTO, 2001b). Moreover, regional implementation has allowed for a large number o f exceptions. The wide variation in maximum rates and the prevalent use o f import licenses and quotas shown in Table 3.2 reveal that the OECS s t i l l makes active use o f protection as industrial policy. Even within the OECS, there are reports by f i r m s o f intermittent and irregularly applied trade barriers between the member countries. For example, between September 2003 and April 2004, St. Kitts and Nevis imposed a 25 percent duty o n OECS goods in an effort to raise revenues. 3. 16 Although implementation o f the CET brought weighted average tariffs in the OECS down f r o m 21 percent in 1996 to 14 percent in 2001, all the countries introduced customs service charges ranging from 2 to 5 percent and other surcharges (in one case up to 15 percent) o n imports intended to mitigate the impact o f falling tariffs o n revenues, but which had the effect o f maintaining protection. Consequently, imports as a share of GDP actually declined from 51 percent in 1996 to 47 percent in 2001 and exports 29 The GSP is an international system in w h i c h developed countries provide non-reciprocal market access through tariff preferences to developing countries in a range o f goods. 30 Found in the Chapter VI1 o f the CARICOM Treaty. 31 By exception, reciprocity o n these trade barriers i s granted o n l y to other LDCs like Belize and Guyana, and to Barbados. 27 have been contracting by 1 percent per year over the same period. In general, this i s consistent with evidence presented above o f the growing inward orientation o f the sub-regional economy (see para. 2.4). TABLE3.2: TARIFF AND TRADEBARRIERS Simple average Tariff Country Antigua and Barbuda Dominica Grenada St. Kitts and Nevis St. Lucia StVincent and the Grenadines Average No. o f products on which import weighted Maximum quotas exist or import licenses are required tariff tariff CARICOM Non-CARICOM 6363 6334 6317 9.6 11.9 11.2 14.3 14.8 15.9 70 165 40 12 11 0 51 32 41 6339 6367 11.5 10.1 12.2 12.2 70 95 11 26 45 83 6330 10.9 11.5 40 16 42 Sources: UN Trade Analysis and Information System, Finger et a1 (1998), DeRosa (2000) and W T O (2001a, 2001b) and IMF estimates. 3. 17 In addition to the high tariffs, import licensing continues to be widely used by all six countries for trade both within C A R I C O M and with third countries. While many o f these licenses are required for sanitary, phytosanitary and safety reasons, there are numerous examples where the explicit intention i s to protect domestic producers from external competition. Import quotas are also maintained for a variety o f goods. Finally, all the countries have a national agency that retains the monopoly o n the importation o f selected food items, usually bulk rice, wheat, powdered milk and/or sugar.32 3. 18 In addition to the authorized exceptions to the CET, a number o f OECS countries has applied unilateral trade barriers to OECS and C A R I C O M imports. For example, in October 2004, C A R I C O M reported that: 0 0 0 0 St. Kitts and Nevis was applying unauthorized duties to imports o f beer, pasta and aerated beverages from St. Lucia; St. Vincent and the Grenadines was applying an unauthorized import equalization tax on C A R I C O M rum imports from within C A R I C O M and maintaining quantitative restrictions o n certain agricultural products from Grenada, Jamaica and Trinidad and Tobago; Antigua and Barbuda, Grenada, Dominica, and St. Vincent and the Grenadines were applying discriminatory environmental surcharges or levies o n selected C A R I C O M imports, mainly bottled beverages; and Antigua and Barbuda, St. Lucia and St. Vincent and the Grenadines were maintaining unauthorized importing licences for various C A R I C O M imports. 3. 19 A notable and widespread case o f non-reciprocal protection i s that o f beverages, one o f the most protected sectors in the sub-region, with tariffs averaging 29 percent33 and almost universal import licensing requirements in the individual member countries. Indeed beverages and tobacco are the only categories for which average tariff rates in the OECS did not decrease between 1996 and 2001. Imports of beer and malt from third countries and CARICOM non-LDCs are also subject to quantitative restrictions, even though the latter have been found to be inconsistent even with C A R I C O M Article 56. 32 Governments in the sub-region argue that these public import monopolies are necessary to protect l o w income consumers from private importers who may emerge as natural monopolies because o f small market size, However, given the l o w minimum efficient scale and l o w fixed costs o f trading firms, it i s likely that even the domestic markets in the OECS would support some competition, and at the least could maintain contestability in this area. 33 For beverages and tobacco. 28 These trade barriers may protect both domestic investors and employees in local breweries from extemal competition, but they also reduce the competitiveness o f the tourism and hospitality sectors for which imported beverages are an important input and which have to compete with operators in other countries that get their inputs at w o r l d prices. Although some countries have been prompted by this consideration to issue duty exemptions to hotels, in many cases this does not extend to local bars and restaurants which may also serve tourists. Moreover, breweries are increasingly capital intensive rather than labor-intensive activities, so continued protection does not give rise to significant amounts o f local employment. In another case, a monopoly paint manufacturer in one country with only 50 employees benefits f r o m tariffs in the order to 144 percent. 3. 20 By maintaining these non-reciprocal protections, the sub-region has also prolonged the misallocation o f domestic investment resources in particular entrepreneurial capital, reduced the competitiveness o f its exporting sectors by raising domestic costs, and increased the eventual cost o f adjustment. One o f the consequences o f the unfinished trade liberalization agenda i s that, despite the small domestic market, the majority o f f i r m s continue to focus o n the domestic market. In a recent survey of Grenadian f i r m s conducted for the Diagnostic o f the Investment Climate,34 it was found that two thirds of the Grenadian f i r m s serve only the domestic market (see Figure 3.3). O f the 29 companies or 15 percent o f the respondents which indicated significant exports - more than 50 percent o f their total sales a third are foreign companies and 45 percent are in tourism-related activities. FIGURE3.3: IMPORTANCE OF EXPORT SALES IN GRENADA Export in Total Sales 0 Source: World Bank (2004e). 3. 21 Longer transition periods and transition assistance. The third element o f S D T has been longer transition periods to achieve the required trade liberalization in the respective trade agreements and the provision o f technical and financial assistance to help beneficiaries adjust over time. There are often tradeoffs between non-reciprocity and transition periods. U N E C L A C (2003) points out that invariably these transition periods are extended giving the impression t o private operators that the status quo will be maintained overtime regardless of the initial agreement. The time and resources provided are spent in an effort to maintain the status quo rather than undertaking the adjustment that i s an essential part o f achieving the gains o f trade liberalization. Recent evaluations o f the EU’s Special Framework of Assistance for Traditional ACP Suppliers o f Bananas Special Framework o f Assistance (SFA) note that large amounts o f money have been used to support producers throughout the ACP whose eventual viability remains questionable. In the OECS, both the regional leadership and development partners continue to expend significant efforts - scarce negotiating capacity in international trade discussions and a substantial share o f aid flows, o n propping up an increasingly uncompetitive banana sector. 3. 22 Among the elements o f special and differential treatment, transition periods and transition assistance remain potentially the most useful as they provide a positive incentive to proceed with trade liberalization. 3. 23 SDTs are increasingly unreliable. There appears to be a general feeling within the OECS that the sub-region’s smallness will allow f o r a perpetuation o f Special and Differential Treatment within 34 See A n n e x 1. 29 international trading arrangements. However, the recent experiences with bananas and sugar has shown that SDT may not be a reliable basis on which to plan long term economic development. Whether or not SDTs w i l l be maintained, the sub-region needs to question the long term benefits o f such treatment. 3. 24 As seen in the above analysis o f the banana sector, the advantage conveyed by the special and differential treatment, in particular, preferential access, depends not only o n the relative administrative treatment by importing countries (tariffs or other trade barriers) o f OECS exports versus Most Favored Nation (MFN) goods, but also on the changes in the underlying cost competitiveness o f OECS exports vis-it-vis other producers. Indeed, many o f the industrial estates established across the sub-region to support a development strategy based o n C B I and C A R I B C A N preferences, or protection o f domestic markets and other incentives, have seen a revolving clientele as the trade and investment climates have changed. The St. Lucia Development Corporation was first occupied in the 1970s by garment and electronic assembly firms, and later in the 1980s by low-end data entry f i r m s . As it became clear that St. Lucia could not maintain international competitiveness in these areas due to high wages, the foreign investors were gradually replaced by regional firms operating behind the CET. Now, however, the agenda within the C S M E i s to reduce internal barriers to trade. Already, quantitative restrictions under Article 56 must be converted to tariffs by end 2005. And all three trading partners - Canada, EU and the U S have signaled their intention to dismantle bilateral preferential trading arrangements with the Caribbean in favor o f regional agreements with reciprocity. B. Emerging trading arrangements 3. 25 The following section looks at overarching issues3’ in the four main emerging trading arrangements in which the sub-region i s negotiating: the Caribbean Single Market and Economy (CSME), the Free Trade Area o f the Americas (FTAA), the Economic Partnership Agreement (EPA) w i t h the European Union, and the World Trade Organization (WTO). These evolving trading arrangements provide opportunities as w e l l as challenges for the OECS. Upcoming liberalization through these arrangements provides a chance for countries to remove distortionary policies, to improve efficiency by retreating f r o m essentially uncompetitive activities, and t o strengthen existing and emerging areas of competitive advantage. However, the adjustment process i s generally painful as the Schumpeterian process o f creative destruction takes place and resources are reallocated from previously protected but uncompetitive activities, in search o f emerging nodes o f competitiveness that are sustainable. Nonetheless, i f managed effectively, the long run growth effects will be positive. 3. 26 The CSME. Within C A R I C O M the movement toward trade liberalization has accelerated because o f advances in the hemispheric and global trade negotiations under the FTAA and WTO, respectively. The emerging C S M E has already established nine new protocols under the CARTCOM Treaty with the objective o f introducing free trade in goods and services, labor and capital mobility, coordination o f foreign exchange and interest rate policies, tax and incentive regimes, among other things. While implementation has lagged in most areas, steady progress i s being made in trade liberalization (although exceptions remain which may perpetuate the non-reciprocal protection by the OECS countries) and in the area o f labor mobility, where legislation has been implemented in all member states except Antigua and Barbuda and St. Kitts and Nevis to allow the free movement o f certain categories o f skilled workers. 3.27 Impact oflabor mobility. There i s general concern in the smaller states that the free movement of labor in the C S M E will accelerate emigration o f already limited skilled labor and increase inflows of unskilled workers from lower income countries. However, recent evidence (see Table 5.7) indicates that the OECS currently has higher nominal wages for skilled labor than i t s Caribbean counterparts. Even after adjusting by purchasing power parity factors to take into account local prices, the OECS skilled labor wages generally remain higher or are roughly similar to those in other C A R I C O M countries. With regards to semi and un-skilled workers, wages in the OECS are in fact lower (with the notable exception of Antigua and Barbuda where the government has pursued a full employment policy over the last 35 M o r e specific sector issues will be covered in Chapter 7 . 30 decade36)both nominally in U S dollars, and once adjusted for purchasing power parity. Combined with already higher unemployment rates than i t s C A R I C O M neighbors, the OECS should, therefore, not see a significant inflow o f unskilled labor as a result o f the CSME. Moreover, a substantial amount o f authorized and unauthorized migration has already taken place within the sub-region in terms o f farm and other unskilled workers in the tourism and construction sectors. 3. 28 Impact on the manufacturing sector. The other major concern with the OECS regarding the C S M E i s that their domestic manufacturing sectors w i l l not be able to face competition from larger producers within CARICOM, such as Trinidad and Tobago and Jamaica. Given the history o f protection described above, it i s likely that a number o f currently protected manufacturers in industries where there are significant economies o f scale w i l l face difficulties in maintaining their current operations. Indeed, this may only be a prelude to the impact o f hrther liberalization under the FTAA and WTO. 3. 29 Experience from Jamaica in the late 1980s and early 199Os, when the rapid depreciation o f the currency radically and quickly changed the operating environment for local f i r m s , shows that, rather than going directly out of business, companies can pursue a strategy o f gradually, but steadily, diversifying their activities away from producing solely for the protected domestic market into export sectors. What was essentially different in the Jamaica situation i s that the signal and incentives were very clear. In the face of the depreciation, f i r m s got the message - export or die! 3 . 30 In the OECS, efforts to maintain L D C treatment even behind the already substantial protection o f the CARICOM CET and to shore up uncompetitive sectors has sent a message to f i r m s that the status quo can somehow be maintained. In a survey o f f i r m s in Grenada, the largest group o f respondents (32 percent for the C S M E and 41 percent for the FTAA) expects no impact o f these regional liberalization efforts o n their sales (see Table 3.3). As a result, some manufacturing f i r m s which benefit heavily from current levels o f protection continue to a i m only at maintaining their competitiveness in domestic and sub-regional markets, where they expect to exploit already established brand loyalties and, perhaps, to intensify pre- and post-market service in order to compete against imports from C A R I C O M and beyond. TABLE3.3: GRENADIAN FIRMS’PERCEPTIONS OF LIKELYIMPACT OF CSME AND FTAA ON SALES YOo f respondents SME N o Effect Potential Effect on Sales Decrease Increase N o response 27 45 32 38 8 21 19 35 30 16 13 18 Domestic 42 36 Foreign 34 Manufacturing 23 Tourism Source: World Bank (2004e.). 18 29 37 3 21 10 17 34 19 26 14 43 Manufacturing Tourism Domestic F 3. 31 However, there i s already an emerging group o f manufacturers in the sub-region who are looking increasingly to the international market place. O f the respondents in manufacturing in the Grenada survey, 19 and 17 percent expect an increase in sales coming from the C S M E agreement and FTAA agreement respectively (see Table 3.3). Some o f these are existing producers who dominate local markets but who recognize that the environment has changed and are pursuing brand development, product diversification and upgrading aimed at establishing niches in international markets. Others are new entrepreneurs that uncovered sources o f competitive advantage in the manufacture o f higher-value-added products, like specialty foods and herbal preparations. Some o f these are targeted to ethnic markets 36 However, implementation o f the recently announced civil service reform program should put downward pressure on wages in that country. ^. overseas, while others are building o n the growing cultural reputation o f the Caribbean in North American and European markets to reach mainstream consumer. Several have been able to capitalize o n the local tourism sector as a channel for introducing their products to overseas customers. In all the cases, the additional value being captured by the specialty product i s sufficient to offset the higher production and transportation costs associated with manufacturing in, and exporting from, the OECS. The key for the governments o f the OECS i s to facilitate t h i s type o f transition rather than entertain the defense o f untenable positions. 3. 32 The FTAA and trade in services. With a combined population o f 800 million and a GDP o f US$9 trillion, the FTAA would be the largest free trade area in the world. Despite the recent set-backs in the negotiations, related mainly to agricultural products, there are indications that an eventual agreement will see good progress o n liberalization o f trade in services.37 Indeed, access to services markets has been one o f the driving factors in the proliferation o f regional trade arrangements, worldwide and liberalization of trade in services has been deepest in North-South trade agreements such as the FTAA (GEP, 2005). This provides both an opportunity and a challenge for the OECS. 3. 33 Services have been the fastest growing component o f world trade over the last 15 years and i s now estimated to account for over one-fifth o f world trade in goods and services. M o r e than h a l f o f annual world FDI flows are now in services - both market- and efficiency-seeking investments. These trends have been driven by both technological progress in information and communication technologies, and by a broad trend toward liberalization in key service industries -transport, utilities, finance, telecoms. 3. 34 Within the FTAA, the OECS countries are among the most specialized in services exports, although the sub-region’s market share has been stagnating since the mid 1980s (UN E C L A C (2004a). 3. 35 Trade in services under the FTAA i s intended to be consistent with the General Agreement o n Trade in Services (GATS) under the WTO. GATS sets out 4 possible modes in which services can be traded between countries: 0 0 M o d e 1: Cross Border Supply where the service crosses the border but neither provider nor supplier does; such as a lawyer reviewing documents for a client in another country. M o d e 2: Consumption Abroad where the service i s consumed in the territory o f the supplier, such as tourism; M o d e 3: Commercial Presence where the supplier establishes a service point in another country to supply that country’s resident(s) with the service, such as the overseas campus o f a university; and 0 M o d e 4: Temporary Movement of Persons where the supplier travels to another country to provide a resident there with the service. 3. 36 Given i t s small population and geographic size, the sub-region precludes the economies o f scale necessary to be competitive in traditional agriculture and manufacturing production, and given that the services sector i s already the driving domestic growth in the OECS, the sub-region may want to focus i t s energies o n building competitive advantages necessary t o benefit f r o m the growing trade in services worldwide. The sub-region has already proven i t s potential for M o d e 1 (offshore financial services and internet gambling) and M o d e 2 service exports (tourism and offshore education), although the performance o f the main services exports has been lagging over the past decade. In addition, any further concentration o n tourism would only increase the sub-region’s vulnerability to external shocks. The challenge facing the OECS w i l l be to revitalize the performance o f existing service exports, to convert the growth in services driving the domestic economy, albeit in communications, finance and construction, into sources o f additional export growth, and to lay the groundwork for the emergence o f new areas o f ~ 37 Current outstanding issues relate to whether the establishment o f services f i r m s in countries should b e covered under the services or by investment chapters. However, these are less relevant f o r the OECS countries that are l i k e l y to concentrate initially o n M o d e s 1,2 and 4 exports. 32 competitive advantage. Chapter 7 points to some o f the challenges in revitalizing tourism, and the potential already emerging in offshore education and health services which build o n the sub-region’s strategic location, climate, English language and cultural similarity to the main N o r t h American markets. 3. 37 The EU Economic Partnership Agreement and transition assistance. The OECS countries are part of the wider CARIFORUM grouping (CARICOM plus the Dominican Republic) which have commenced detailed negotiations with the European U n i o n o n an Economic Partnership Agreement that w i l l eventually replace the Cotonou Agreement between the EU and the African Caribbean and Pacific (ACP) countries. Negotiations will focus o n reinforcement and deepending o f the regional integration process within the Caribbean as an important starting line for the EPA. 3. 38 Recognizing that there w i l l be significant costs to the Caribbean, and especially to the OECS, o f pressing forward with trade liberalization, implementing new trading rules and arrangements and continuing the transformation from traditional agricultural exports to new areas o f international competitiveness, the EU has committed to continue providing substantial development assistance to the sub-region as part o f the EPA. However, these resources w i l l be geared toward the process o f deepening sub-regional and regional integration. The challenge for the OECS will be to use these resources effectively in making the needed transition. Within the EU, effective use o f the structural funds provided to new members of the Community has often differentiated which countries have benefited most from accession. Given the difficulties faced by the OECS in absorbing existing levels o f committed development assistance from the EU, i t will be critical for the sub-region to strengthen i t s aid coordination efforts between the member countries. 3. 39 The WTO and rules-based international trade. Achieving success in service exports will involve not only addressing supply side constraints at home, but also securing market access overseas. In turn, market access will depend o n the establishment o f appropriate trading rules. Multilateral arrangements like the FTAA and WTO are therefore crucially important for small states because they provide the rulesbased systems that can best protect the rights o f small states. The recent W T O ruling in favor o f Antigua and Barbuda and against the United States in a dispute over internet gaming i s proof o f the benefit that such arrangements can provide. Bernal (2004) contrasts t h i s to the less representative and transparent influence which the OECD’s FATF have had in applying i t s o w n standards to offshore financial sectors, worldwide. Preferential arrangements, such as those f r o m which the OECS has benefited, exist only at the behest o f the benefactor countries and leave the beneficiaries at risk o f changing political and economic influences outside their control. Multilateral systems also provide small states with the opportunity to raise their negotiating leverage by teaming up with different countries as their interests coincide. 3. 40 Regional efforts. In this trade climate, the OECS also stands to gain from the joint regional negotiating mechanisms and the joint regional preparation o f a variety o f harmonized behind-the-border rules necessary for accessing the emerging hemispheric and global trading arrangements. Although the Caribbean Regional Negotiating Machinery has been established to facilitate C A R I C O M member countries’ participation in FTAA, E U - C A R I C O M and WTO preparations, it has not been delegated negotiating power o n behalf o f the member countries. The recent initiative by the OECS to establish a true sub-regional negotiating body i s an important one in t h i s regard. 3 . 4 1 Behind-the-border rules and regulations such as standards, licensing requirements and competition rules w i l l play an important part in helping exporters o f both goods and services establish and maintain competitiveness in international markets. Preparation o f harmonized rules for the Caribbean i s already taking place under the C S M E protocols. One notable example i s the regional accreditation of health professionals by the Regional Nursing B o d y and the Caribbean Association o f Medical Councils. Participation in these regional undertakings by the OECS can save the sub-region considerable resources meanwhile paving the way for establishing competitiveness in a range o f emerging areas, in particular services. 33 C. Globalization and the prospects for small states 3. 42 There i s a broad literature o n the challenges facing small states in an increasingly integrated global economy, namely, remoteness leading to high transportation costs; openness resulting in exposure to external shocks; limited access to external capital that view small states as inherently risky; susceptibility to environmental shocks; narrow resource bases that constrain possibilities for diversification; limited institutional and organizational capacity exacerbated by migration; and diseconomies in cost o f social services and infrastructure. 3. 43 While the OECS countries faces many o f these challenges, they are, in fact, among a handful o f micro states and a larger group o f small states that have performed relatively w e l l over time o n economic, external and social fronts. Indeed, the OECS appears to have overcome a number o f the vulnerabilities identified above, including the additional vulnerability o f being in the hurricane belt. The sub-region has sustained access t o external capital - through FDI, remittances, ODA and commercial borrowing. It has demonstrated resilience to both environmental and external shocks. Cooperation at the sub-regional level has already helped to reduce the cost o f some public services, and has the potential to do so in many others. Other vulnerabilities such as remoteness and narrow resource bases are more critical for merchandise trade than service exports, which are already driving the OECS’ external performance. The sub-region i s in fact strategically located at the center o f a huge regional market and s t i l l has some scope for cooperation to reduce transportation costs. Moreover, for large and small economies alike physical resources are no longer a major constraint o n diversification. The acquisition o f knowledge and technology which are susceptible to economies o f scale and distance are key factors in today’s economy. 3 . 4 4 As such, the outlook for the OECS in the global economy need not b e a pessimistic one. In thinking about the way forward we look for lessons from other small states that have developed positive strategies for coping with the global environment. Among the noteworthy examples o f Singapore, Mauritius, Iceland and Ireland, the latter was chosen as a useful example because at the onset o f i t s reform program in 1987, i t s initial conditions and external performance were quite similar to those in the OECS today (see Table 3.4). 3. 45 The Celtic In 1987, the Irish economy was plagued with high unemployment at around 17 percent. Persistent fiscal deficits averaging 10 percent o f GDP over the previous five years had driven public sector debt to a high o f 117 percent o f GDP. Growth rates had slowed throughout the 1970s and there were some years o f actual contraction in the early 1980s. Inflation, however, was moderate - around 3 percent - while the real exchange rate which had seen some appreciation in recent years, was undergoing a small correction and was not thought to be out o f line with i t s long run equilibrium. 3.46 Ireland had joined the European Community a decade earlier and pursued trade liberalization within the Community’s policy. The country had benefited from both the Common External Tariff and the Common Agricultural Policy - exports had grown rapidly from 38 percent o f GDP in 1973 to 48 percent in 1987. At that time, the country was in the midst o f a transition f r o m agriculture to low-end manufacturing spurred by cheap labor, i t s comparative advantage within the European Community. Agricultural had stabilized at around 10 percent o f GDP from a high o f 18 percent in 1973, but s t i l l accounted for 29 percent o f exports. The majority o f trade was concentrated with the EU and the UK. Membership in the EU also entitled the country t o official development assistance transfers (called structural funds) on the order o f 2-6 percent o f GDP per annum. A strong tradition o f social welfare had maintained high social spending at around 6 percent o f GDP o n education and 7 percent o n health, which produced good social indicators, in particular, education outcomes, but also contributed to the fiscal imbalances. 38 39 Talon and Kraemer (1999). McCarthy (2001). 34 TABLE 3.4: A COMPARISON OF IRELAND AND THE OECS Population (million) GNI per cap Growth rate Inflation ("/o) Agriculture Manufacturing Tourism Government spending Public debt Fiscal balance Primary balance Unemployment Social spending ODA FDI OECS, today (2003) Ireland in 1987 Ireland in 2000 (in % o f GDP, unless otherwise specified) 3.4 0.6 3.9 7,790 5,056 22,970 4.6% 3.6% 11% 3.2% 1.8% -3.2% 10% 7.4% 4% 14.7% o f employmentb 19.8% o f employment 7.9% o f employment 29.2% o f exports 4.8 % o f exports 3 1.8% o f merch exports 70.4% o f merch exports 70% o f exports o f goods and services 35% 46% 4.3% 113% 117 % 39% -5.5% -8.2% 4.7% -1.2% -2% 7% 16.1% o f work age pop 16.9% o f labor force 4.3% o f labor force Educ: 7.1% Educ: 5.8 Yo Educ: 4.3 Yo Health: 5.4% Health: 6.6 YO Health: 4.7 % 2-6% 3%a 0.3% 9.0% 24.0% Exports of goods and non50.7% Growth 11% factor services (GNFS) External balance on GNFS 19% a. not including undisbursed balances o f EU commitments, b. 1981 Source: W o r l d B a n k (2004i), McCarthy (2001) 54.6% Growth 10% 4.4% 98.0% Growth 17% 13.6% 3.47 In 1987, Ireland embarked o n a major Program for National Recovery. The turnaround in the last decade and a h a l f has been remarkable. GDP grew at an average rate of 7 percent, unemployment plummeted from 18 percent to near full employment, the debt/GDP ratio fell from around 120 percent to 40 percent, and the primary balance went from a deficit o f nearly 2 percent to a surplus o f nearly 7 percent. Today, Ireland enjoys a per capita income o f nearly $23,000. L i k e all success stories there has been enormous debate o n the key determinants o f Ireland's achievements. The following are key lessons gleaned from this debate: 0 0 Strong early focus on fiscal adjustment emphasizing expenditure reductions, and wage moderation in exchange for tax cuts, was facilitated by a broad social pact (including the opposition and trade unions). Fiscal deficits were virtually eliminated within the first three years o f the reform program and expenditure reduced by 10 percent o f GDP. Notably, there was no early focus o n rapid reduction o f the debt stock. Instead, lower financing needs and higher growth rates allowed for a smooth reduction over time. Careful use of the EU structural funds to help sustain infrastructure and social investments, and to reduce the debt burden during the adjustment period. These included active labor market policies to retrain and retool the chronically unemployed for the new demands o f the business sector. Ireland i s considered by the EU Court o f Auditors t o have been one o f the more effective users o f t h i s aid. Early adaptation of the educational system to the needs of the business sector. A 1963 report by the OECD highlighted the poor condition o f educational facilities in Ireland. Fewer than half of all national schools had piped water and more than h a l f o f all children did not complete secondary schooling. A couple o f decades o f reforms reduced the dropout rate significantly while simultaneously increasing levels o f tertiary education. Technical colleges and universities were 40 Atlas method. 35 refocused o n the needs o f the business sector producing technical degrees and bilingual graduates. By the late 1990s, Ireland graduated, proportionally, the highest number o f scientists and engineers in the OECD, and i s now ranked as the second best educational system in the world in terms o f responsiveness to the needs o f a competitive economy. 0 0 0 0 Establishment of a transparent and favourable corporate tax regime - l o w uniform tax rate o f 10 percent for the manufacturing and service sectors, supported by double taxation treaties with key FDI sources countries. Ireland learned early o n that simply offering the conventional time-bound financial incentives and tax concessions only attracted footloose sub-assembly operations that employed little skilled labor, hardly traded with local suppliers, and subsequently did not leave any technological ‘footprint’ o n the domestic economy. Participation in the EU provided an institutional framework which both constrained and provided guidance to the macroeconomic investment and trade policies in a way that gave credibility t o the reform program. Well-coordinated investment promotion efforts with a focus on: (i) targeting flagship FDI that led to key spillovers to the domestic economy and (ii) strengthening the capacity o f domestic f i r m s . In the mid 199Os, the Irish authorities realized that technological spillovers were lagging, with s t i l l l o w levels o f IT use by domestic f i r m s and households. The agency responsible for promoting domestic investment began to offer a range o f technology services including audits and technology transfer programs to local f i r m s . An expansive and evolving vision of Ireland’s sources of competitive advantage. An unwavering and fonvard-looking focus o n external competitiveness has allowed the Irish authorities t o stay ahead o f structural changes and put in place the necessary supports needed. In addition, although Ireland focused o n the IT industry as a cluster, it has explored a broad range o f activities that built o n i t s initial competency - starting from assembly, mass market software manufacturing, niche software design, aftermarket customer care through call centers, and more recently targeting itself as the ideal location for the European headquarters o f overseas f i r m s , 3.48 Relevance for the OECS. Most o f the lessons outlined above are broadly relevant for the OECS. However, two are worth discussing further. While participation in the European U n i o n i s not an option for the OECS, increasing integration both within the sub-region and within broader regional trade arrangements can not only provide a larger market space, it can also help to provide the same checks and balances o n macroeconomic, trade and investment policies that the EU institutional framework provided to Ireland. Full participation in the C S M E and FTAA can give a sense o f credibility and permanence not just t o trade reforms, but the broader range o f behind-the-border reforms embodied in these agreements, 3. 49 The second issue relates to the formulation o f a strategic vision that guided the sectoral direction of Ireland’s development. Ireland’s precise path, in terms o f sectors and industries, i s not likely to be the appropriate one for the OECS, given differences in population, location, and endowments. The key lessons from the Irish experiences are: (i) their position role in the global economy was based in part o n existing comparative advantages and in part on competitive advantages that had to be carved out in new areas and (ii) i t was necessary for the society as a whole to formulate a precise vision for growth and competitiveness. Ireland started from the comparative advantage o f cheap labor and an already established manufacturing base and seized the opportunity to provide foreign f i r m s a favorable production site within the EU, and later moved up and across the value chain. The OECS may start from the basis o f strategic location, good climate, and a service orientation, to work toward a vision o f a cluster o f offshore services provided around the tourism industry. 36 CHAPTER 4. THE I N V E S T M E N T CLIMATE “In an increasingly global economy, factor inputs have become less and less important as sources ofproductivity and sustained growth. Countries are no longer constrained by their factor inheritance in creating competitive firms and environments. I n this sense, competitive advantage no longer rests on a country’s natural endowments, but on that ability to create a business environment, along with supporting institutions that allow the nation ’s inputs to be used and upgraded in the most productive manner. ” Porter, M. (1990). The Competitive Advantage o f Nations. 4. 1 As discussed in Chapter 1, the sub-region has experienced a secular decline in private investment over the 1990s (see Figure 1.6). This chapter seeks to understand which elements o f the investment climate within the OECS countries are contributing most to this trend and h o w they could be addressed. In addition, i t examines the success o f the OECS in attracting record levels o f FDI and the likelihood of these trends continuing in the future. 4. 2 The investment climate can b e defined as the “policy, institutional, and behavioral environment, b o t h present and expected, that influences the returns and risks associated with i n v e ~ t m e n t ” . ~ ’ This environment i s generally seen as having the following three main components: 0 Political and macroeconomic stability i s a pre-requisite for private investment, b o t h domestic and foreign. Numerous studies have demonstrated that a country’s macroeconomic conditions, including i t s fiscal, monetary and exchange rate policy, are among the most important determinants for FDI. 0 A sound regulatory framework and efficient supporting institutions to enforce the relevant laws and regulations are necessary for investors to enter the market and thrive. In a globally integrated competitive market, the costs o f starting and operating a business have a large impact o n choices o f country location by an investor and h o w much contribution the investment w i l l make to the host economy. 0 An adequate physical and social infrastructure complements a good policy and regulatory framework to create the necessary environment for attracting and retaining investment. These include the quantity and quality o f power, transport and communication systems, access to finance, a qualified labor force, and the provision o f social services. A. Macroeconomic conditions for investment 4. 3 ’ Numerous studies have demonstrated that a country’s macroeconomic conditions, including i t s fiscal, monetary and exchange rate policy, are among the most important determinants for both domestic and foreign investment. There are three m a i n channels through which macroeconomic conditions in the OECS affect investment: the impact o f macroeconomic stability o n f i r m s ’ investment plans and their assessment o f risk; the effect of the size o f government o n the space in which f i r m s have to operate; and the impact o f openness o n level o f competition in the market and o n the cost and availability o f inputs. The latter has been covered in Chapter 3. This section w i l l focus o n the first t w o channels. (i) Macroeconomic stability and private investment 4. 4 As discussed in Chapter 1, the O E C S has maintained relatively high investment rates over the last two decades, averaging 31 percent of GDP, but this stability masks significant shifts between public and private domestic investment over the period. In contrast, FDI has remained 41 Stern (2002). 37 relatively constant throughout. Private domestic investment grew significantly from the early 1980s through the mid 199Os, almost entirely offsetting the sharp drop in public investment due, in part, to a contraction in aid flows (see Figure 1.4). Then in the mid 1990s, private domestic investment began a steady downturn and has been declining since (see Figure 1.6). 4. 5 This decline in private investment coincides with a rapid deterioration in fiscal performance across the sub-region that began in the mid 1990s (see Figure 1.7). Over the last eight years, the fiscal position of the sub-region has declined sharply, resulting in public dis-savings, marked increases in public debt, and in several cases the accumulation o f both domestic and external payment arrears. The overall government deficit for the sub-region, which had averaged 3.5 percent o f GDP during 1990-1996, rose to 11 percent in 2002. Some o f the countries have been running primary deficits since the beginning o f the 1990s. In others -- St. Lucia and St. Vincent and the Grenadines -- the deterioration has come more recently after a period o f more prudent fiscal policy. Although the reasons for each country’s deteriorating performance vary, in general they have been associated with a steady rise in expenditures, from an average o f 29 percent o f GDP during 1990-1996, to 35 percent o f GDP in 2003. These increases were driven primarily by a rise in the wage bill and capital spending. In a number o f cases, the rise in public investment spending has been associated with reconstruction after natural disasters, but in many it has also been associated with the election cycles. Regardless, the impact o n private domestic investment has been substantial. 4. 6 Since 2002, most countries in the sub-region have taken steps to correct the growing fiscal imbalances, although to varying degrees. Thus, the overall central government balance in the OECS o n average improved to -6 percent o f GDP in 2003. Notably, Dominica’s stabilization and adjustment program has resulted in a turnaround in both economic growth and the earlier, very sharp, contraction in private investment. 4. 7 However, the very high levels of public indebtedness of the sub-region may continue to impact private investment for some time. Public sector debt reached 113 percent o f GDP in 2003 for the sub-region, ranging from 70 percent in St. Lucia to 172 percent in St. Kitts and Nevis. Theory states that in the presence o f high fiscal deficits and rising public debt, f i r m s w i l l adjust their investment plans downward in anticipation o f increases in future taxation needed to repay this debt. W h i l e f i r m s in the OECS may not anticipate that tax rates, which are already quite high, will rise, they may expect a reduction in widely used tax concessions. However, they may also foresee that the necessary fiscal adjustment will involve significant reductions in public expenditure reductions. In the short run, as wage and capital spending decline, f i r m s may anticipate a further contraction in the demand for their services, but in the long run, these reductions will create more space for the private sector in the economy. 4. 8 The impact of a deteriorating fiscal position and debt overhang has not affected FDI inflows as much as it has domestic investment. FDI inflows continued to rise as fiscal imbalances rose in Antigua and Barbuda, Grenada, and St. Kitts and Nevis, while in St. Lucia it declined throughout the 1990s including during the earlier period o f fiscal prudence, and in St. Vincent and the Grenadines the trends are in the opposite direction. Only in Dominica does there appear to have been an impact similar to the one seen in private domestic investment. 4. 9 Monetary and exchange rate policy has been instrumental in maintaining relatively stable levels of FDI. In a study o f the economic performance o f ten Caribbean islands from 1980 to 1992, McCarthy and Zanalda (1995) find that the high and steady levels o f FDI inflows to the OECS were made possible by having a monetary board (see B o x 4.1) which ensured monetary and exchange rate stability. 38 Box 4.1: THEEASTERN CARIBBEANCENTRALBANK. Caribbean dollar and the US. 4. 10 One reason may be that foreign investors coming to the O E C S have some level of confidence in their operations being insulated from the fiscal position of host countries. Take the case o f a large resort hotel that has been granted a 20 year tax holiday and duty concessions, which cogenerates i t s o w n electricity, desalinates i t s o w n drinking water, imports most o f i t s inputs, transports i t s guests to and f r o m the airport, and conducts the majority o f i t s business in U S dollars. With the exception of key public infrastructure like the air and sea ports, the state o f the country’s fiscal and economic position, short o f an exchange rate crisis or civil unrest, i s less o f a concern than conditions in the external market place. However, as the OECS pursue foreign investment with greater backward linkages, the macroeconomic conditions, both fiscal, real and monetary, w i l l be o f increasing importance to investors. (ii)The size of government 4. 11 The government sector in the O E C S i s relatively large, and has been growing during the 1990s. During 1998-2003, government spending represented 34 percent o f GDP - ranging from 29 percent in St. Lucia to 41 percent in Dominica. The sector has been growing in importance since the beginning o f the 199Os, when it represented 30 percent o f GDP (during 1990-1995). On average, the OECS countries have larger governments in terms o f spending than the rest o f the Caribbean where spending averages 30 percent and other upper middle income countries were it averages 22 percent o f GDP. Government services represent 15 percent o f GDP, and the state sector provides about 20 percent of employment. I t i s notable that the government services were a leading driver o f growth in the 1980s and 2000s. 4. 12 Small states have been shown to have large governments for several reasons. The size o f government in the OECS as measured by spending i s not out o f line with other micro states (see Table 2 in Introduction), Existing literature o n size o f government has shown that there i s a negative correlation between the share o f government consumption in GDP and population size. Alesina and Wacziarg (1997) interpret this result as evidence o f economies o f scale in the production o f public goods, while Rodrik (1998) argues that smaller economies are more open to trade with the rest o f the world and, as a result, more volatile, T o mitigate t h i s higher volatility, the argument goes, countries develop a larger government sector. Finally, Eskeland et a1 (2004) find that countries, like those in the Caribbean, with strong voice and governance and the associated strong democracies, tend to have larger government sectors, for example to provide basic education and health, as well as infrastructure. Intuitively, a l l o f these explanations could hold for the OECS countries, yet they do not explain the recent growth in the public sector. 4. 13 Experience in the wider Caribbean in the 1960s and 1970s, for example in Jamaica and the Dominican Republic, provides ample evidence that there are dangers to expanding the role of the public sector. During this period, governments intervened in markets through price and investment controls and the establishment o f public enterprises generally in a desire to speed development, and o n the basis o f traditional economic rationales for the public sector, such as addressing natural monopolies, income redistribution, “merit” goods and market failures, externalities and public goods. However, these market interventions protected high cost, inefficient public and private enterprises, and l e d to a slowdown in The public enterprises usually had difficulties in charging prices that covered costs or in 42 Worldwide, measured growth tends to rise when import substitution occurs. However, much o f that growth typically reflects deficiencies in national accounting methodology; the new f i r m s ’ value added i s added to national 39 collecting fees; they usually provided poor service, and often were “captured” by the employees or particular groups in society to the detriment o f customer service at reasonable costs. In general, the public sector had difficulty in replicating the pressures for efficiency generated by market discipline and in shielding itself f r o m corruption. 4. 14 Large government spending, particularly for a government that does not deliver services commensurate with the high tax level that supports it and the high debt it has incurred, tends to dampen private sector-led growth. First, high levels o f government debt generate high risk premiums and tend to deter and crowd-out private investment. Second, the high level o f taxes necessary to support large government, particularly taxes o n formal sector enterprises and persons in the formal sector, deters investment and foreign investors. Tax incentives to offset these taxes are undesirable because o f their distortionary effects. Third, high levels o f government spending that are not effective in delivering education, health and infrastructure services, do not contribute to private sector growth. Fourth, as a large employer, government wage-setting mechanisms which are generally not entirely market driven can distort the functioning o f the labor market, and create wage inflation through the economy. A private sector-led development strategy depends o n reforms in government that improve i t s effectiveness and reduce i t s cost. 4. 15 Across the Caribbean, the transition to private-sector led growth has been neither automatic nor easy. In the 1980s, these countries embarked o n a transition to a private sector-led, market-based development strategy and began to reform their public sectors, but the transition has been neither automatic nor easy. Protection o f inefficient import substitution was cut, exports were promoted and regulations limiting markets and red tape were reduced. Public sector reform and containment o f government expenditures have been less successful, however, in part due t o the political economy that has developed around the role o f the state, over many years o f government intervention. 4. 16 The O E C S countries will need to embark on a similar path o f public sector reform, if they are to depend on private-sector led growth. The path o f development o f the OECS during the last two decades has confirmed the limitations o f public sector-led growth. Given the current fiscal instability and high levels o f indebtedness, the sub-region has little room for maneuver. As with the rest o f the Caribbean, the challenge o f public sector reform i s a complex one given the political economy o f the subregion. 4. 17 The way forward will depend on addressing the political economy issues head on. As illustrated in the Ireland case study (Chapter 3), the governments o f the sub-region w i l l need to articulate a strategic vision o f the future, alongside private sector and c i v i l society, and to build a social pact for implementing the transition ahead. B. The role of public investment 4. 18 Most of the O E C S countries pursued expansionary fiscal policies during the 1990s mainly through increasing public investment, as a means of sustaining growth in the short run and crowding in private investment. However, the impact o f these policies has generally not been as expected. Notwithstanding the other contributing factors to the slowdown in growth and private investment, the effectiveness o f these public investments has been a key issue. ’ 4. 19 Table 4.1 presents the sectoral distribution o f public investments by OECS central governments during 1995-2001. Notably, the share o f expenditure going to economic infrastructure has been declining steadily since 1996, reallocated mainly to the social sectors, general public service and the category “Other”. Indeed, general public service and “Other” account for more than Social Sectors for most o f the period. As expected, the allocation for tourism has been increasing and that for agriculture decreasing. accounts without adjusting for the difference between international prices and the higher prices o f import substitutes resulting from protection. In the longer run, as import substitution possibilities are exhausted, growth becomes more capital intensive and tends to slow. 40 TABLE4.1: SECTORAL COMPOSITION OF PUBLIC INVESTMENT, 1995-2001 (% of actual capital expenditures) Avg 1995 1996 1997 1998 1999 2000 2001 1995-01 Economic Infrastructure 37 44 43 43 38 26 29 36 18 17 18 Economic Sectors 30 19 17 15 16 Agriculture 22 15 13 8 10 5 7 I1 4 6 Tourism 3 3 3 8 7 5 5 1 I 3 3 2 1 2 Other Social Sectors 16 22 19 18 23 29 27 23 General Public Service 5 7 11 10 9 14 12 10 12 8 8 12 13 16 17 13 Other Note: excludes Antigua and Barbuda for all years, St. Kitts and Nevis in 1995 and 2002, St. Vincent and the Grenadines in 1995 and 1996, and Dominica in 2002. Source: World Bank ( 2003e, 2004f, 2004g, 2004h, forthcoming). 4.20 One issue to be considered i s that a significant fraction of capital budgets has gone toward reconstruction after natural disasters, which have increased in frequency in the 1990s. In three out of the seven years presented in Table 4.1, the sub-region was struck by catastrophic hurricanes which devastated several islands in a short space o f time43. However, a closer examination o f the post-hurricane spending patterns in a number o f countries undertaken in the recent public expenditure reviews prepared by the W o r l d Bank (2004, 2005) also reveals that there i s a tendency for subsequent increases in capital spending to become permanent rather than temporary shocks. 4. 21 Weaknesses in the formulation and implementation of public investment programs appears to have been at the heart of the problem. As illustrated by the recent Analyses o f Fiscal Issues, projects in the Public Sector Investment Programs (PSIPs) are generally selected as a process of negotiation between Ministries and Cabinet members, and often announced to the public, prior to technical discussions o n their feasibility, if any. Some countries have formalized the process by introducing explicit procedures for project review and selection, prior to Cabinet consideration, but this practice i s not yet common across the sub-region. Generally, the tradeoffs between investments are not based on a comparison o f their projected economic and social impact. M a n y reportedly “strategic” public investments - such as sports stadiums, marinas, airport, fishing complexes - have not necessarily been supported by overall strategic plans embodied in sector analyses that indicate how these investments were to impact private investment. Financial and technical requirements for operating and maintaining these investments are discussed only toward the end o f construction. And consultation with stakeholders are rare during both project preparation and implementation. 4.22 These issues have been exacerbated b y a lack of coordination among donors, and inadequate oversight of project preparation b y financing agencies. In a number o f countries public investment figures have been overstated by the inclusion o f donor-financed projects that support recurrent spending (such as technical assistance and preparation o f reports). When Dominica recently began a process to rationalize i t s PSIP, there were over 100 projects for a total capital expenditure of EC$66 million ranging from EC$12,000 to EC$35 m i l l i o n supported by 16 different donors. Many o f these had been negotiated by the donors with line ministries without the significant involvement o f the Ministry of Finance and Planning. The plethora o f tiny projects, some with questionable priority or impact, overstretches planning ministries’ limited capacity to manage these programs. 4. 23 A third issue impacting the effectiveness of the public expenditure programs i s value for money. The World Bank’s experience with financing c i v i l works across the sub-region reveals a wide disparity o f unit costs among projects in different OECS countries. These reflect differences in 43 Hurricane Louis in 1995, Hurricane Georges in 1998, and Hurricane Jose and Hurricane Lenny in 1999. 41 procurement practices as well as the level o f competition in the different local construction sectors, Figure 4.1 presents a recent comparison o f costs o f some basic civil works inputs within the OECS. FIGURE4.1: COMPARISON OF INFRASTRUCTURE COSTS 0 Dominica I the Grenadines . _ _ _ _ _ _ _ _ _ Reinforced concrete Gabions Crushed stone bas e Source: Staff estimates. 4. 24 The following reasons have been suggested as contributing to the high costs o f public investment outputs. 0 0 0 0 L a c k of standardized procurement rules which can limit competition between suppliers and service providers. Over-design b y consultants, i.e. projects are often designed without consideration o f budget constraints and do not reflect actual needs and requirements. One donor official can be quoted as stating, after receiving early consultants reports o n an already agreed investment, “there i s definitely going to be a cost overrun, but we w i l l deal with that problem when w e get there, let’s just get this project started.” Poor contract management as evidenced by the large number o f contracts in which the actual output or expenditure varied f r o m what was contracted, but standard procedures were not followed to clarify or correct them. L a c k of oversight of ongoing works by ministries due to a shortage o f qualified staff. 4.25 Good procurement practices have a direct and positive impact on the cost and quality of all government purchases. Because the government i s a large player in the local economy, they also contribute to establishing a fair and competitive playing field for the private sector. Across the OECS, however, public procurement systems suffer f r o m a number of key weaknesses. The regulatory framework i s outdated and in some cases incomplete, practices are not transparent, controls are weak, enforcement o f rules lax, and there i s a tendency toward very highly-centralized discretionary decisionmaking o n contract awards. 4. 26 A full procurement assessment o f the OECS has been shared with the member countries44and an action plan prepared and discussed at a recent workshop. The following are a few recommendations (some additional) on how to address t h i s issue: ~ 44 World B a n k (20030. 42 0 0 0 A sub-regional program to reform and harmonize procurement systems would help to conserve limited technical capacity and help to strengthen controls and accountability. Opening local bidding to the sub-regional market will help to prevent capture by local f m s . Introducing a system o f peer review by donor agencies may help to provide better oversight and supplement local capacity. 4.27 As noted above, the financing of the expansion in public investment has been a key contributor to the rapid increase in debt levels across the sub-region. Expensive commercial borrowing or turnkey construction contracts contributed significantly to the rise in indebtedness in St. Kitts and Nevis, Dominica and Grenada. In many cases, these obligations were negotiated with persuasive regional financiers or international construction companies without sufficient competition between service providers or adequate expertise on the part o f the governments to weigh the financial risks. The back door nature o f these deals leaves governments open to risk. Some officials report that they have resorted to commercial financing when donor resources were “too slow” in coming and they were under pressure to provide targeted public infrastructure, such as access roads, to facilitate FDI projects. 4. 28 Capacity building can be addressed over time with technical assistance o n debt and financial management for Build-Operate-Transfer and similar operations. However, provided the upfront feasibility and strategic priorities o f the project have been established, the OECS Governments would do well to pursue more open and competitive approaches to securing financing, which allow for public scrutiny. In this regard, it i s the recommendation of this report that the sub-region undertakes an overhaul of the legislation and systems governing the contracting, management and disclosure of public debt, including contingent liabilities. C. The investment incentives regime 4. 29 As discussed in Chapter 3, the OECS countries have performed exceptionally well vis-a-vis the rest o f the world in attracting a record share o f FDI w i t h respect to their GDP. However, in recent years this rank has fallen and their share o f Caribbean FDI inflows has also declined. 4. 30 The OECS countries have traditionally relied primarily on a range of fiscal and financial incentives for attracting foreign investment. These include three m a i n types o f incentives: (i) statutory provisions which offer tax holidays or income tax relief, (ii) exemptions f r o m taxes o n imported products - some o f which are specified in legislation and others which are at the discretion o f high level government officials, and finally (iii) special packages negotiated at the discretion o f Cabinet members which have included government guarantees, special land deals, and targeted infiastructure investments. Most of the countries have a Fiscal Incentives Act, a Hotels A i d T o u r i s m Incentives Act, and an Aid to Pioneer/Development Industries A c t aimed at the exporters, hotels and manufacturing respectively. Tax holidays are provided for each o f these and in the Income Tax A c t as well. There i s involvement at a very high level o f government for the approval o f both statutory and discretionary incentives. 4. 31 Although most of these regimes were originally devised under the 1973 CARICOM Agreement on Harmonization of Incentives to Industry, countries have departed significantly from that agreement. For example, tax holidays under the Hotels (Aid) Acts in the OECS range from 5 years in Antigua and Barbuda to 20 years in Dominica. In St. Kitts and Nevis the duration depends o n the size of the property, and in St. Lucia i t i s share for extensions versus original construction, These incentives now violate the 1973 C A R I C O M agreement because they are awarded o n the basis o f sector and project characteristic rather than domestic value added. 4. 32 The result has been the development of very intense incentives-based competition for FDI across the sub-region and the Caribbean region as a whole. 43 4. 33 These incentives have been very costly in terms of foregone revenue. Unfortunately little data i s collected by any o f the governments o n foregone revenue due to tax holidays, in part because investors are rarely required to submit annual financial reports once they have set up operations. Data i s more readily available on customs duty and consumption tax concessions, for which foregone revenues amounted to an average o f 18 percent o f GDP in St. Kitts and Nevis during 1996-2000, 10 percent o f GDP in Antigua and Barbuda during 2001-2003, and 5 percent and 6 percent o f GDP in Dominica and St. Vincent and the Grenadines, respectively, in 2001. 4. 34 I n general, it i s difficult to measure the net benefit of investment incentives ex ante, first because the counterfactual that the investment would not have been realized without the incentive i s hard to prove, and second, because, if successful, it should have both direct and indirect impacts o n the economy. Value-added i s a very useful goal at the conceptual level, but precise calculations o f the value to be added by investment projects are nearly impossible in practice. 4. 35 T h e negative impact of incentives-based competition for FDI i s not only financial. Because they are not clearly based o n any clear economic rationale - market failures or public goods - these incentives distort the returns to investment across activities, sectors and enterprises leading to less efficient resource allocation. In addition, if they are applied in a discretionary manner as the majority are in the OECS, they create uncertainty among investors as well as open the door for corruption and rentseeking. 4. 36 T h e type of incentives used in the OECS are particularly inefficient. Tax holidays are not specific to investments per se, but rather to ongoing operations which could be expanding or shrinking over time. At a minimum, they should be replaced with alternatives such as investment tax credits, accelerated depreciation, and loss carry forward provisions as has been done in Barbados, In addition, they should not discriminate between new construction, maintenance, rehabilitation or extensions. These provisions are more closely targeted to actual investments and help to mitigate investment risk. 4. 37 N o t having been updated for some time, the incentives are also inappropriate for new service activities. For example, in Grenada, a hotel with 10 rooms may receive incentives, but a yacht that can accommodate many more guests i s not eligible. In St. Vincent and the Grenadines, t w o new yachting operators - a business that does not require a substantial investment in fixed costs (the companies manage yacht pools for individual private investors) - were given substantial tax holidays, which resulted in driving the incumbent operator out o f business. 4. 38 Duty concessions and other exemptions f r o m taxes on imports, which attempt to bring products closer to world market costs, are only required o r demanded because of the high tariffs and other trade-related service charges imposed b y the OECS countries (see further discussion in Chapter 4, and Table 3.2). A number o f the governments across the sub-region are making attempts to tighten the use o f duty exemptions, but this has been generally limited t o reducing those granted at the Cabinets’ discretion, while statutory concessions remain. At a minimum, concessions should apply to particular products, rather than prescribed by use or user, as i s commonly done in the sub-region. 4. 39 As barriers to international investment fall worldwide, competition for FDI has increased. Within that competition, incentives-based competition remains a global phenomenon. Developed and developing countries, and their sub-national regions engage in it worldwide. A recent survey o f 45 developing countries found that 85 percent offered some kind o f tax holiday or reduction o f corporate tax income for foreign investment .45 4 . 4 0 However, there has been a consistent stream of evidence46f r o m firm surveys showing that fiscal incentives are not the primary criteria in their overseas investment-location decisions. A survey conducted by the Multilateral Investment Guarantee Agency (MIGA) o f 191 companies with plans 45 46 World Bank (2004b). Lim (1983) and Ernest & Young (1994). 44 to expand operations overseas found that only 18 percent in manufacturing and 9 percent in services considered grants and incentives to be influential in their choice o f location (MIGA, 2002). O f 75 Fortune 500 companies surveyed by Wunder (2001), only four identified them as influential. The literature i s well summarized in a recent review by Zee, Stotsky and L e y (2002). 4 . 4 1 This research has shown that firms generally make their investment location decisions in a two-stage process. The first i s based o n ‘fundamentals” - the match between country-specific conditions and the investment, the general investment climate, and the availability and cost o f key factors of production, labor, infrastructure, etc. In the second stage, f i r m s draw up a short l i s t o f potential locations. At t h i s stage, when alternative locations are otherwise closely matched, differences in tax obligations can influence decisions at the margin. Annex 2 lists the alternative locations for OECS countries that were reported in a recent Caribbean Foreign Investor Perception Survey. 4.42 W h e n considering the FDI framework Caribbean investors did r a n k investment incentives as their second highest concern after “General attitude in the country toward FDI” (see Figure 4.2), but when considering the overall investment climate, investment incentives ranked only 16th out of 40 areas (see Annex 1). They were surpassed by several factors including the infrastructure and labor issues and, notably, by tax rates, favorable attitudes toward FDI, and clarity and faimess o f law and regulations, This suggests that foreign investors in the Caribbean do follow the general process described above, and that incentives may remain important at the second stage o f location decisions, after the fundamentals have been deemed appropriate. FIGURE 4.2: GRENADIAN INVESTOR PERCEPTIONS OF THE FDI FRAMEWORK -1 Favorable attitude in country towards F D I . ’ ”’ Inves tm en t i n c e n t i v e s lnvestm ent facilitation and services I Export incentives and E P Z s Access to local finance 1 I I I 1 60 10 I 1 I 1 1 1 I 1 I I 1 1 l l l l 1 l l l l 1 Government and venture capital financing 0 10 20 30 40 50 80 90 Source: World Bank (2004a). 4. 43 Competition among countries has made these incentives a n even more risky and costly prospect for O E C S governments. There are numerous experiences around the Caribbean and in the OECS where incentives were granted that have not resulted in the expected job creation and income generation and have consumed public resources that could have been used to raise the quality o f the broader investment climate instead. St. Lucia’s recent experience with a government guarantee for a hotel that went bust and St. Vincent and the Grenadines’ experience with Ottley H a l l Marina are two of the more costly experiences in the sub-region. 4. 44 As para. 7.31 in the tourism case study shows, simply competing b y incentives in the general melee of worldwide FDI flows without paying sufficient attention to the fundamentals of the domestic investment climate will generally yield footloose o r enclave type investments that have a limited impact on the local economy. Other nations have taken a different strategy to attract investment lowering taxes and concentrating o n other elements o f the investment climate and investment promotion. International experience (e.g. Mauritius and Ireland) has suggested that lowering corporate tax rates may 45 be a far more effective mechanism for long-term investment attraction than an unwieldy collection o f tax holidays. 4.45 Given the amount of revenue that i s lost on these concessions, and the costly apparatus required to administer these concessions, the OECS countries would be advised to lower both taxes and tariffs and eliminate the general need for the concessions. The current level o f corporate taxes in the OECS - between 30-40 percent - i s relatively high, as are the tariffs and taxes o n imports (see Table 4.2 below and Table 3.2 in Chapter 3). Indeed, the surveyed investors ranked tax rates above investment incentives as a key issue in their choice o f location (See Annex 2). Corporate Income Tax TABLE4.2: TAXRATES Domestic Consumption Tax Antigua and 35 Barbuda Dominica 30 Grenada 30 St. Kitts and Nevis 35 St. Lucia 33 St. Vincent and the Grenadines 40 Source: Bain and dos Santos (2004). Import Consumption Tax Customs Service Charge 15 20 5-10 15-50 25 15 10 3 5 15 0-35 25 4-30 5 5 5-40 5-20 4 4 . 4 6 The investment incentive regime should be focused primarily on those investments which would have a clear strategic role (such as knowledge spillovers), or as the center piece to a cluster of activities for the country. Only those incentives should be considered for selective interventions. The difference between country experiences with FDI often depends o n whether their approach to incentives and promotion i s informed by an underlying and detailed development strategy. For example, Taiwan, Costa Rica and Ireland, which have significantly benefited from knowledge transfers from FDI, directly targeted f m s that would complement their o w n investments in education, training and national innovation systems. On the other hand, Mexico, whose approach to FDI was primarily as a source o f j o b s and tax revenues, has experiences much lower spillovers and backward linkages. Under the more strategic approach, investors are handpicked by the country and approached directly. In the OECS, t h i s w i l l require an appropriate export development strategy and a capable investment promotion agency. Box 4.2: ATTRACTINGINVESTMENT, COSTARICAN-STYLE The announcement th semiconductor assembly and of 3.5 million people was an unlikely r a d , Indonesia and Thailand. The notable absence of jrm-specific concessions for Intel, side-deals, or large govemment grants was remarkable. Intel’s criteria included supply of professional and technical operators, reasonable cost structure, a ‘bro-business environment, specific logistics and manufacturing lead time, and a fast-track permit process. For Costa Rica, Intel would provide the center piece of an ongoing strategy to develop an electronics sector - hence some of the ground ow the Costa Rican authorities accommodated the ts and the capacity of San Jose’s airport. The Costa iers, and accelerated plans for a new cargo terminal. Intel general airport trafic patterns. nned expansion of generation capacity. The Costa Rican ng for two new power stations, one dedicated to them and another to a neighboring industrial park. The Costa Rican authorities revised the electricity rates structure to diyerentiate large industrial users, not just Intel. Education. Intel was concerned about the supply of semi-skilled workers. The Costa Rican authorities undertook rapid reform to match the curricula of the country’s technical high schools and advanced training programs to Intel’s j o b descriptions, an troduce a one-year cert one-year degree program and language training. Source: Spar (1998). 46 4.47 One approach t o reducing investment-based competition i s harmonization o f regimes across the sub-region a n d the Caribbean region. However this i s likely t o be very difficult. Recognizing this, LeCraw (2003) suggests two options for C A R I C O M which i s in the process o f preparing a a uniform l o w tax rate for all investments projects or (ii) a l o w tax rate harmonized investment code: (i) combined with highly targeted incentives but w i t h l i m i t s o n the incentives that could b e granted by member countries. As a start, it i s recommended that the OECS countries improve the level o f transparency surrounding incentives by disclosing them to the public on a regular basis. Public scrutiny can go a l o n g way to reducing waste. In addition “sunshine laws” can b e instituted t o require opportunities for public comment and access to records. D. Investment promotion 4.48 Notwithstanding the sub-region’s success in attracting FDI, it i s safe t o say that investment promotion as a public sector function in t h e OECS i s s t i l l in i t s infancy. Few countries have an agency dedicated to this function. Usually this function rests in the hands o f the national development corporation that has responsibilities for administration o f fiscal incentives, development and marketing of industrial estates, management o f some state-owned companies or joint-ventures, perhaps housing development programs. In addition, other agencies such as a tourism authority, a Ministry o f Commerce or Finance, or an export development agency are separately involved in what can b e called investment promotion work, but t h i s i s rarely coordinated across the public sector. Sometimes as in St. Kitts and Nevis the function has been delegated to the offshore financial services marketing agency. M o r e recently, governments across the sub-region have recognized the need to consolidate and dedicate resources to t h i s function. St. Vincent and the Grenadines has recently established a new agency, the National Investment Promotions, Inc and St. Kitts and Nevis has recently refocused the offshore financial services marketing agency solely to investment promotion. 4. 49 There are four critical functions involved in effective investment promotion: image building, investment generation, investment facilitation and investment policy advocacy. O f the four functions, agencies in the OECS tend to focus most o f their efforts o n the last t w o functions. As a result, the process o f attracting investments remains a very reactive, rather than proactive one. 4. 50 Regarding investment facilitation, some OECS governments have established “one-stop shops” t o reduce the burden o n firms that need t o receive approvals f r o m a range o f different entities before starting operations. In 2001, f o r example, its new A c t established the St. Lucia Development Corporation as a one-stop shop for investors with the power to grant w o r k permits and some licenses. However, in discussions with various line ministries and special offices each revealed their o w n role in the investment approval process, not the least o f which was the Cabinet itself. This i s a common problem worldwide. T o the extent that approvals are a response to crucial policy concerns in technical areas, the one-stop shop would have to duplicate expertise and facilities elsewhere in the government. To the extent that -they are not, however, then the procedures should be eliminated. 4. 51 The implication i s that establishing a one-stop shop i s not simply transferring approval process but involves a whole review and possible re-engineering o f these procedures. F o r these reasons, most one-stop shops have narrower mandates, with the authority to grant some approvals and provide assistance o n others. In some cases, the one-stop shop m a y house staff f r o m relevant agencies, Box 4.3 showcases some remedies that have been tried in other countries with varying levels o f success. 47 BOX 4.3: ONE-STOP SHOP, OR ONE-MORE-STOP SHOP? The Tanzania Investment Center houses nine senior lsfrom other ministries, and normally manages to und is due in part to a “no objection” provision turn around applications within a few days. The rapid written into the investment code - unless a ministry objects within 14 days, the Center is entitled to approve the application. This approach has been less successful when the lines of authority are not clearly drawn. Set up in 1987, the One-Stop Action Center in the Philippines houses representatives from seven agencies who are responsible for providing information to applicants and acting on some applications. Lack of effective agency representatives and the non-reporting of some representatives led to poor results, requiring the government to reorganize the center in the late 1990s. When agencies lack authority to grant all necessary approvals, it is important that they still add value to the process and do not just constitute an additional regulatory burden. Ifi Thailand, the Investment Services Center can issue establishment licenses for non-polluting activities, but factories still have to get permission from the Ministry of Industry before production could actually start. To avoid delays later in the process, many firms prefer to obtain the necessary licenses directly from the Ministry, from the outset. One-stop shops with a narrower mandate have sometimes accelerated the process of gaining specific approvals. For example, by shifting from a pre-auditing to a post-verification system, the One-Stop Service Center for Visas and Work Permits in Thailand reduced the time it took foreign firms to get visas for foreign workers from about 45 days to just 3 hours. 4. 52 The relatively low attention paid to image building and investment generation in the OECS can be attributed to two factors: the lack of a strategic vision for the economy in which the role of FDI i s clearly identified and the high costs of these two functions. The first underscores the reactive nature o f governments in the OECS to FDI. However, as recommended throughout t h i s report, i t i s crucial that such a strategic vision be formulated to guide the whole approach to economic development in the future. Otherwise, the OECS countries stand the risk o f being buffeted by the waves o f globalization. 4. 53 Regional investment promotion agencies have not been very effective in reaching their targeted audience, or significantly influencing the decision-making processes of potential investors. Figure 4.3 reports the sources o f information most commonly used by investors in the Caribbean and in Grenada about a particular country. It was found that in most cases, f i r m s rely on their own companies’ internal reports and analysis to get information about a particular country. Personal visits are also quite important4’. By contrast, investors rarely depend on the more traditional promotional tools, such as trade missions, publications and presentations by country officials, to form their opinions about Caribbean locations. FIGURE4.3: SOURCES OF INFORMATION FOR FOREIGN INVESTORS GRENADA CARIBBEAN-WIDE - F’ublishedIC indicators 1 h t m l reports Discussions Wdl aquamtames Personal wit- acquaintances Source: World Bank (2004a). 47 Other sources include business contacts through personal relations, acquisition o f a local company, and various other informal channels. 48 4. 54 With a strategic vision in hand, the benefits of image building and investment generation will more likely outweigh the costs, but a sub-regional approach may be necessary. Investment promotion can b e m u c h better targeted to the types o f f i r m s that can facilitate the implementation o f that strategy. One study found that FDI increases by 0.25 percent for every 1 percent increase in the investment promotion agency’s budget. These agencies tend to be more successfbl in countries where the investment climate i s already amenable to foreign investors: increases in the budget o f an Investment Promotion Agency (PA) increase FDI nearly twice as much in countries with the most favorable investment climates as compared to countries with the least favorable. Nevertheless, as shown in Table 4.3, promotion has been costly in per capita terms, especially at the image building state. 4. 55 This analysis suggests the need for the O E C S to re-consider a joint approach to investment promotion4’ to reduce costs. This assumes that the sub-region agrees o n a j o i n t strategic vision for the OECS, and that competition among the countries for investments be reduced. TABLE4.3: THE COST OF INVESTMENT PROMOTION Annual FDI promotion budget (US$ million) 45.0 41.0 11.0 Population (millions 1999) Per capita budget (US$) 3.2 14.06 Singapore (EDB) 3.7 11.16 Ireland (IDA 1999) 3.5 3.14 Costa Rica (CINDE) Mauritius (MEDIA 1986) 3.1 1.2 2.58 Dominican Republic (IPC) 8.8 8.4 1.05 15.0 22.7 0.66 Malaysia (MIDA) Note: The text in the parentheses is the acronym o f the respective country’s investment promotion agency. Source: W o r l d Bank (2004b). E. The regulatory framework and administrative efficiency 4. 56 I n addition to being small economies, where markets face a greater risk of monopolies or oligopolies, the O E C S countries have further discouraged domestic competition through the use of price and investment controls, and government ownership of commercial enterprises. M o r e than half o f the f i r m s surveyed in the Grenada Investment Climate Assessment (ICA) reported that their market share exceeds 50 percent. This i s particularly notable for the manufacturing sector, where several products are s t i l l protected under quantitative import restrictions. In a number o f countries (refer to Chapter 3), the governments have assigned monopoly power for the importation and distribution o f key food and export commodities to national marketing boards. F o r example, the Nutmeg Board in Grenada retains a monopoly o n purchasing which i s currently hindering a new entrant seeking to produce value added products f r o m purchasing supplies at farm gate prices. In Dominica, the long-standing dominant position o f the Dominica Banana Marketing Corporation (in part because o f government subsidies) over farm input distribution prevented the development o f a competitive sector. N o w that the banana industry has declined, there i s an important gap in the supply chain for farmers. In other countries the government s t i l l retains significant or complete ownership in a number o f commercial state enterprises, ranging f r o m commercial banks, dairy farms, housing development projects, radio stations, hotels, flour m i l l s , which entitle these f i r m s to special treatment. 4. 57 I n general, the Government’s rationale for entering the market i s to prevent the abuse of monopoly power b y dominant private operators or to achieve some social goal not being delivered b y free market competition (for example through the bulk purchasing, packaging and distribution o n basic food items). Inthe latter, the resulting benefits are rarely effectively targeted to the poor and needy. 48 In this regard it will be important to revisit the experience o f the j o i n t Eastern Caribbean Investment Promotion Eastern Caribbean Investment Promotion Service (ECIPS). F o r several years, the OECS maintained ECIPS with donor support. The Service was geared t o building the investment image o f the region and targeting prospective investors, who could then be funneled to the national promotion agencies o f the region. However, that entity closed its operations after a few years due to fknding problems. 49 In the former, the products and services being monopolized are generally tradables whose markets are already being protected by high tariffs. Lowering these tariffs and allowing competition from imports would be a more effective way o f controlling the abuse o f monopoly power. Inthe case o f retail, uneven granting of duty concessions i s creating unfair competition between local operators. According to the Grenada ICA survey, anti-competitive practices were regarded as at least a moderate problem by nearly 20 percent o f the f i r m s that reported that they were a major-to-severe constraint to their businesses. While anti-trust rules in some sectors may not be appropriate for such small markets, the OECS should consider the establishment o f rules and regulations about the abuse o f dominant power and collusion in price setting. 4. 5 8 Finally, most OECS countries have an established negative l i s t o f industries ranging from hairdressing to retail and distribution that are reserved for nationals. Most OECS countries retain Alien (Landholding) Acts under which foreign investors must obtain a license to purchase land, to hold or transfer shares, or t o be the director o f a domestic company. In addition, transfers between local foreign residents usually attract a higher tax than transfers between local residents. While the issuance o f licenses and concessions o n the transfer tax are reportedly fairly common, these s t i l l incur costs and time delays for investors. The general intention o f the land licenses i s to deal w i t h the problems o f land price speculation and reduction in the access o f land to l o w or middle-income residents. However, it i s not clear that alien landholding regulations are the most effective mechanism to achieve t h i s goal. 4. 59 Outdated investment codes in some countries create a level o f policy uncertainty for the private sector as t o whether certain elements will be enforced or not depending o n government discretion. One of the possible areas for policy reform i s the updating and harmonization of member countries’ investment codes that provide a comprehensive position of the sub-region’s attitude and approach toward foreign direct investment and the provisions of i t s more unified investment regime. 4. 60 Although administrative efficiency in not generally thought of as a n area of strength for the OECS public sectors, firms interviewed and surveyed for this study did not raise it as a critical issue, Indeed in a comparison o f performance o f key areas o f the investment climate, foreign investors in Grenada had a more positive view o f government efficiency than investors in Jamaica, Barbados, Dominican Republic and Trinidad and Tobago (see Figure 4.4). In Grenada, the majority o f the private f i r m s have a fairly positive view o f government efficiency, and the consistency and predictability o f the officials’ interpretation o f rules. Regulations regarding the establishment o f new firms, such as business registration, licenses and permits, are not considered a big problem by most o f the surveyed companies. Procedures for access to land and buildings, however, can take a long time and are rated more problematic. But overall, they are s t i l l considered quite manageable. 50 FIGURE 4.4: FOREIGN INVESTORS’ PERCEPTIONS OF THE INVESTMENT CLIMATE Infrastructure I Labor 1 I 1 4 Policy & Legal EnGronment I Quality of Life 4 Taxation and Customs I FDI Framework Market Access Administrative Procedures 3 3.5 Grenada performance 4 4.5 Caribbean-wide performance 0 Caribbean-wide importance Importance rating for all investors surveyed: 3=moderate importance, 4=major importance, 5=critical importance. Performance rating: 3=neutral, +good, 5=excellent. Source: W o r l d Bank (2004a). 4. 61 There were two notable exceptions - tax and customs administration. Throughout the OECS tax administration i s cumbersome and often non-transparent. Few revenue authorities have sufficient capacity to effectively monitor taxpayers, much less offer taxpayer services that can ease the administrative burden for businesses. In most countries, the tax administration’s powers, taxpayers’ rights, penalties and interest provisions are dispersed in several tax acts, and i t i s hard to get an up-to-date version o f the tax laws including all amendments. This creates confusion, hinders compliance and facilitates evasion, Notably o n the incidence o f tax payments, the survey in Grenada revealed that half o f the business establishments were exempt from, or otherwise evading, the corporate income and consumption taxes in the previous 12 months. Few revenue authorities have specific arrangements for dealing with large taxpayers. Simplification o f the complex tax system and investment incentives regime (along the lines discussed in the previous section) could contribute significantly to reduce these problems. In addition, both the recent IMF study o n taxation administration in the OECS and the work o f the subregional Tax Reform and Administration Commission (2004) have recommended the establishment o f a regional tax authority as a way o f more effectively utilizing the limited capacity across the member countries. 51 TABLE4.4: FIRM RESPONSES TO ADMINISTRATIVE PROCEDURES IN GRENADA No A M i n o r 1Moderate Problem Obstacle Entry procedures 83.1 13.4 Business registration Business licensing 77.1 17.4 Proc. for access to land & premises 67.7 20.9 h o c . for utility hook-up 63.2 29.4 Operating procedures Business inspections 77.6 17.4 Fire, safety and sanitary regulation 74.6 17.9 Labor regulation 61.7 26.4 Tax administration 59.7 31.3 Customs regulation 39.8 40.8 Other procedures Patent and trademark reg. 81.1 14.4 Competition regulation 76.6 13.4 Foreign exchange regulation 74.1 19.9 Price regulation 68.7 20.4 Standards and certification 66.7 22.9 Source: World Bank (2004e). of respondents who rate the issues as: o/o A M a j o r 1 Severe Obstacle 1.5 3.0 9.0 5.5 2.5 5.5 10.0 7.0 16.9 1.5 7.5 4.0 9.0 8.5 4. 62 Among all government regulations that affect business operations, b y far the most serious constraint i s customs regulations. In Grenada, f i r m s report a median duration time o f four days to clear imports, despite the small volumes involved. Manual and lengthy procedures, inefficient approach to inspection, use o f reference prices for valuation (which i s not WTO compliant) and an inadequate breakout o f the classification system for goods contribute to these delays. The system i s further complicated by the plethora o f concessions that are granted. Rarely i s the customs department fully informed o f all the recipients and the duration o f the concessions. A large part o f the declaration process i s then spent verifying the claims o f importers. Notably, payment o f bribes appears to be fairly unusual, but not completely nonexistent, and i s generally associated with expediting process rather than tax avoidance. 4. 63 M a n y of the OECS countries are trying to reform their customs services, but few have h a d significant success in part because of the incentive structure facing customs departments. Given the countries' reliance o n trade taxes, the fiscal imperative t o raise revenues, and the widespread use o f concessions, customs departments are generally not oriented toward trade facilitation. However, because of the reliance o n imports throughout the whole productive structure o f the economies, these timeconsuming and costly procedures are a significant barrier to improving competitiveness. For example, one Antiguan manufacturer cites a two-week delay to clear a shipment o f r a w materials through customs, which reduced h i s manufacturing time by more than h a l f and jeopardized a significant export order, 4. 64 With both customs and tax administration, e-government can provide a n important mechanism to improve service, increase transparency and promote technological development. Systems such as the Automated System for Customs Data ( A S Y C U D A ) and Standard Integrated Government Tax Administration System (SIGTAS) already in place have the potential to improve the collection o f data, speed o f transactions and completeness o f information. There are numerous examples around the w o r l d in which countries have revolutionized b o t h their tax and customs administrations resulting in improved compliance, reduced cost o f doing business and raised collections in return. Moreover, implementing e-government can provide a strong impetus t o private businesses to upgrade their o w n systems in order to take advantage o f the new w a y o f doing business. Figure 4.5 below shows 52 the different levels o f e-government which have been achieved by various Caribbean governments to date. FIGURE4.5: STAGES OF E-GOVERNMENT COUNTRY Antigua and Barbuda Bahamas Barbados Belize Dom. Republic Dominica Grenada Guyana Haiti Jamaica St. Kittr and Vevis St. Lucia St. Vincent and the Grenadines Suriname Trinidad and Tobago United States Singapore Ireland Gumngh, Jassodra 2003, Source: InfoDev (2005). 4. 65 In implementing such systems, however, two considerations are worth noting for the OECS. The f i r s t i s that the cost of these systems, as recently shown b y t h e Caribbean Regional Technical Assistance Center (CARTAC) for ASYCUDA, may be prohibitively expensive for small administrations such as are found in t h e OECS. As such, a sub-regional effort for automating customs and tax administrations may be the best way forward. In this regard, C A R T A C i s undertaking a feasibility study o f such a system. 4.66 The second consideration i s that simply introducing the system without changing the underlying r u l e s will limit i t s potential to improve the business climate. Public sector administration in the OECS i s fraught with multiple layers o f approval that delay and obfuscate what are normally simple, rules-based administrative processes. F o r example, in Antigua and Barbuda the Minister o f Labor must s i g n every work permit application leading to long time delays for investors. As illustrated above by the discussion o n both procurement and investment promotion, these layers o f approval often do not add to the quality o f the decision-making, and often provide opportunities for patronage. Introducing egovernment provides an opportunity for administrative reform in the processes and procedures that would further enhance the business climate. 53 CHAPTER 5. S K I L L S , WAGES, AND THE LABOR MARKET 5. 1 The s k i l l endowments o f the labor force are indispensable for technology absorption, productivity improvement, diversification and overall competitiveness. Building a strong s k i l l base i s particularly important for competitiveness in the OECS countries because o f their reliance o n services and niche manufacturing. With the recent weakening o f the traditional sources o f growth, companies need to move up the value chain and into new market segments in order to remain competitive, making the need for a skilled labor force paramount. However, the shortage o f skilled labor has been cited by f i r m s in the OECS as the key constraint to improving competitiveness. Also, real wages in the OECS appear to be growing faster than productivity. These comparatively high wages accompanied by persistently high unemployment (especially among youth) suggest that labor markets in the OECS may not be functioning efficiently. Addressing the fundamental weaknesses in the labor market will also be needed to improve competitiveness, exports and aggregate demand, and increase employment, a key factor in reducing poverty and improving the quality o f life. 5. 2 This chapter presents an assessment o f the OECS countries’ education and training policies and examines whether OECS institutions provide the desired learning opportunities and outcomes required to build a skilled labor force. I t prioritizes policy recommendations around three themes of: (i) improving quality o f education, (ii)increasing access to tertiary education and j o b training through improved allocation o f public spending and greater private involvement, and (iii) producing s k i l l s demanded by employers. 5. 3 The chapter also examines OECS labor costs and the functioning o f labor markets, including the extent and nature o f unemployment and migration, and identifies some rigidities in labor market regulations. The chapter makes the case that the OECS countries can realize very significant gains from reducing the burden o f the public sector o n the labor market (both in terms o f wages and numbers), increasing the flexibility o f hiring and firing arrangements, and rapid implementation o f both the OECS mandate and the C S M E protocol o n free movement o f labor. A. Skills, education and training 5.4 Skills are important for achieving and maintaining competitiveness. The s k i l l s o f the labor force are crucial for a country’s competitiveness. A more skilled labor force raises productivity and, in turn, incomes. In addition, a strong s k i l l s base has the dynamic effect o f facilitating improvements in other growth-contributing areas, notably technology adoption, quality o f government and corporate governance. The complementarity between s k i l l s and technology adoption i s particularly strong, and i s manifested through three channels. First, skilled workers are more adept at dealing with changing technologies. Second, the availability o f more skilled workers creates incentives for f i r m s to adopt and develop new technologies that are more s k i l l intensive (Acemoglu, 2001). Third, skilled workers, engineers, and scientists are required to produce adaptations o f existing technologies and even more to create new ones. The s k i l l base i s also particularly important for economies in transition. B o x 5.1 illustrates how a skilled labor force can help a region in the search for new sources o f competitive advantage during a period o f structural adjustment. 54 BOX 5.1: H O W THE SKILLS BASE HELPED BOSTON TO STAY ON TOP may be even more important when facing adverse economic conditions. A high stock of human capital aliows both workers and firms i n a region to acquire new competencies and adopt new technologies faster, and thereby gain new areas of competitiveness. Glaeser (2003) examines Boston as a case study of regaining competitiveness. Boston successfully bounced back from three economic crises that each could have leJ2 the region stagnated and iving base of global shipping and fishing abandoned. First, the city transitioned from a dying seaport t operations; second, in the late 19th century its economy shift rds manufacturing building upon skilled immigrant labor; and third, in the late 20'hcentury it adaptedfro cturing city to the current vibrant competences in biotechnology Boston's excellent pe$ormance economy based on highly adva compared to other regions speci traced back to its leaming ability embedded in its high stock of human capital. Source: Glaeser (2003) and Glaeser and Saiz (2003). 5. 5 Building a strong s k i l l base i s particularly important for competitiveness in the OECS, because of the potential future reliance on services and niche manufacturing. Service industries are generally more labor and skills-intensive than traditional manufacturing and agriculture. Moreover, moving up the value chain in services w i l l entail increasing numbers and levels o f skills in the labor force, In a survey o f foreign investors across the Caribbean, f i r m s in the service sector stand out as requiring far more professional and skilled labor, than their manufacturing counterparts (see Figure 5.1). In addition, niche and specialty product manufacturing will require a continuous adaptation o f products to stay ahead of the competition. One commonly held myth across the Caribbean i s that small markets like the OECS do not provide opportunities for very specialized scientific skills, yet a number o f the highest value added niche manufactures now emerging as potentially competitive exports from the sub-region - specialty foods, beverages, herbal products, hurricane resistant windows - are all founded by entrepreneurs or have staff who are applying a high level o f scientific training in their work. FIGURE 5.1: SKILLS COMPOSITION OF A SAMPLE OF FOREIGN FIRMSIN THE CARIBBEAN (%) Agriculture Food p x e s i n g Textile & garments Electric & electronics Other Manufaclunng Tounsm Wrofessionals "Skilled Workers Financial services OUnskilledWorkers ICT-enabled semces M e d r al semces Professional Semces T"port Conslruction Energy Retailkholesa b Semces I 0 20 60 40 80 100 Source: World Bank (2004a). 5.6 The shortage of skilled labor has been cited by firms in the OECS as the number one constraint to improving competitiveness. Despite the frequent claim that one o f the comparative advantages o f the OECS i s a relatively well-educated English-speaking workforce, the public and private sector alike report severe shortages o f skilled labor across the sub-region. In a survey o f 24 export f i r m s undertaken for the OECS Export Development Unit, the education level o f labor was ranked as the 55 biggest problem.49 The shortage o f skilled labor was cited as the number one constraint to increasing competitiveness by f i r m s in Grenada, where a diagnostic o f the investment climate was conducted in 200450(see Annex 1). 5. 7 T h e shortages are found in very specific s k i l l s like equipment mechanics for food processing companies, as well as in more broadly applied s k i l l s such as accounting and information technology. As identified by the enterprises surveyed for the recent Diagnostic o f the Investment Climate in Grenada,” the key s k i l l s shortages are found in technical s k i l l s such as industrial engineering, and managerial s k i l l s at middle and senior management levels. FIGURE 5.2: MAJOR OBSTACLES TO FIRM COMPETITIVENESS IN GRENADA (% of respondents) Skills & e d u . o f available w o r k e r s Cost o f financing T a x rates A c c e s s to f i n an c i n g E l e c tric ity Crim e, theft & disorder Economic & reg. policy uncertainty T r a n s p o r t a tio n : in t e r n atio n a I Anti.com petitive practices M a c r o e c o n o m i c instability C o r r u p tio n L e g a 1 s y s t e m i c o n flic t r e s o h tio n W ater Transportation: Caricom L a b o r relations Telecommunications A c c e s s to land T r a n s p o r t a tio n : l o c a l Health o f w orkers ( A I D S I H I V ) O I 0 20 30 40 SO 8 M ajorobstacle OSevere obstacle Source: World Bank (2004e.) 5. 8 The dearth of skills i s further reflected by the difficulties with which firms recruit qualified personnel. A manufacturing firm that recently set up operations in St. Vincent and the Grenadines reported receiving over 400 applications for 10 posts, but only around 20 candidates were potential hires. Similarly, a hotelier in St. Vincent and the Grenadines reported receiving over 300 applications for 15 posts. O f the 50 applicants interviewed, only five had any prior experience in the tourism industry. A yachting operator could not find a single diesel mechanic or one with s k i l l s in marine refrigeration, and instead had to train a car mechanic. Table 5.1 shows that far fewer vacancies were reported for management and skilled posts in Grenada than for unskilled posts, but that when they do occur, it takes much longer to find suitable candidates to fill these vacancies than for unskilled posts. TABLE5.1: TIME NEEDED TO FILL A VACANCY IN GRENADA N o vacancies reported (“A firms) Median delay (weeks) Source: World Bank (2004e). Management 29.4 8 Madsen (2004). full description o f the survey i s provided in Annex 1. 5 1 World Bank (2004e). 49 50 A 56 Skilled worker 23.9 4 Unskilled worker 12.4 1 The shortage of s k i l l s i s also reflected in increasing returns to education. Table 5.2 reports 5. 9 the average difference in wages in various Caribbean countries, between workers with specific s k i l l s levels and workers with only primary education.52 The variation o f returns across countries reflects primarily differences in the quality o f education and thus worker productivity, the supply o f s k i l l s to the market, and wage-setting practices. Higher returns generally signal more scarcity. In the Caribbean, Barbados i s the star performer because the returns are lowest. For example, in St. Lucia a worker with secondary education has an average wage 73 percent higher than one with only primary education. Similarly, a worker with post secondary education earns a wage. 146 percent higher than a primary education holder. St. Lucia, while having a more adequate supply o f secondary graduates than Guyana or the Dominican Republic, suffers from the most severe shortages with respect to post-secondary and university educated workers. TABLE5.2: INCREASING RETURNS TO EDUCATION Percentage (YO)higher wage received Secondary Post-secondary than aprimary education holder: Barbados 17 35 Dominican Republic 72 146 Guyana 42 74 St. Lucia 34 165 Trinidad and Tobago 25 89 Source: Various national labor market surveys and W o r l d Bank staff estimates. University 72 210 110 223 186 5. 10 The shortage of skilled labor in the OECS results f r o m a number of compounding factors. The first i s relatively l o w educational attainment, in terms o f both numbers and quality o f secondary education graduates despite recent progress in expanding access, and l o w tertiary enrollment. This i s compounded by an under-supply o f tertiary education and training by both public and private providers and within firms. The latter is, in part, related to the higher costs o f in-firm training when the quality o f secondary output i s low. The situation i s further exacerbated by labor market rules which, although intended to protect workers, limit the degree o f flexibility that employers have to adapt to changing needs and circumstances. They raise the cost o f formal labor even beyond the s k i l l s differential and already high costs o f training, and as such limit the supply o f trainable jobs. Steady flows o f migration have served to fixther exacerbate the shortage o f skills. (i) Basic and secondary education 5. 11 The OECS has made remarkable progress on expanding access to education, but quality remains a major issue. As with the most successhl cases o f educational upgrading (the U S between 1850-1950, and Korea and Scandinavia between 1960-2000), the post-independence governments in the OECS did focus o n primary education first. A comparison o f educational attainment in St. Lucia between 1980 and 2000 indicate rates o f increase that may be o n the order o f those achieved by Korea between 1960-2000, around 1.7 years per decade.53 All the countries have achieved universal primary enrollment and completion and have rapid increases in secondary school enrollment rates, now around 81 percent, underway. However, completion rates are lagging at around 67 percent, and the quality o f secondary education remains a major issue. The few available indicators o f quality point to the mediocre outcomes from secondary education (see Table 5.3). The Caribbean Examinations Council publishes results by country, but these are only Caribbean-wide. Pass rates in the Caribbean Examinations Council (CXC) English and M a t h examinations averaging 56 and 38 percent, while higher than in other Caribbean countries, do not suggest adequate quality for maintaining international competitiveness. Further comparison internationally i s hindered by the fact that n o OECS country, indeed n o Caribbean country except the Dominican Republic, participates in internationally recognized assessments o f schooling This exercise was only completed for St. Lucia in the OECS because i t is the only country that produces regular labor force surveys. 53 However, it should be noted that there are some issues o f comparability between the t w o data periods. 52 57 quality such as Trends in Intemational Mathematics and Science Studies (TIMSS) or the Program for Intemational Student Assessment (PISA). TABLE5.3: SECONDARY AND TERTIARYEDUCATION Antigua and Barbuda Dominica Grenada St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines OECS (pop-wtd) Caribbean b,c M i c r o states Up middle inch L a t i n America World Gross enrollmen 81 91 88 100 77 Gross completion 67 81 75 80 83 69 70 51 67 56 84 67 72 Secondary C X C pass rates English Math 58 34 66 45 46 35 53 46 58 39 61 56 46 37 38 36 Range o f CXC passa Estimated tertiary enrollment 56% - 96% 18% - 90% 64% - 80% 36% - 96% 8 13 12 14 41% - 81% 5 11 21 NA 24 26 a. in General Proficiency. b. Not including the OECS countries. c. Belize, Barbados, Dominican Republic, Jamaica. Sources: di Gropello (2003). Caribbean Examinations Council (2003), World Bank (2004i), and Joseph (2003). 5. 12 Poor education outcomes have emerged despite high spending, indicating serious inefficiencies in the education system. The OECS, like much o f the Caribbean, has traditionally valued education as evidenced by very high public spending, 6.4 percent o f GDP compared to the Latin American and OECD averages o f 4.1 and 4.6s4percent, respectively. However, the OECS has become a showcase for the lesson that “it i s not how much i s spent o n education but how it i s spent that i s important”. Inefficiently l o w pupil-teacher ratios, inefficient teacher deployment, generous study leave provisions and scant in-service training, and cumbersome teacher training-hiring programs have combined to raise the personnel costs, meanwhile constraining the share o f trained teachers in classrooms across the sub-region to below 50 percent (see Table 5.4). The record high share o f education spending o n salaries (92 percent) leaves far too little for other critical inputs into learning outcomes, such as materials and school maintenance. 5. 13 I n addition, secondary school curricula are in dire need of reform. For example, some schools continue to offer manual typing as a separate subject with separate equipment, from computer literacy. I t i s important to note that while curriculum reform has been o n the sub-regional agenda for some years as evidenced by the establishment o f the OECS Education Reform Unit in 1993, most countries acknowledge that little has been achieved by the regional effort and have resorted to national, and generally, uncoordinated efforts. 5. 14 One could argue that the high spending o n education i s inefficient because o f the diseconomy of small population size, where fixed costs o f administration, 9 percent o f recurrent spending in the OECS, consume a lot o f the public budget. In a multivariate regression o f per capita public spending o n education for a sample o f 159 countries, Eskeland et a1 (2004) find evidence o f economies o f scale, after controlling for income levels and geographic size,s5 but this effect disappears in the Caribbean sub-sample including the OECS countries. In the Caribbean as w e l l as in states with populations under 10 million, primary school pupil-teacher ratios rise w i t h population, but without associated increases in per capita spending or reductions in primary education outcomes (as measured in secondary enrollment rates). This 54 I t i s important to note that in the O E C D countries, private spending o n education adds another 1.3 percent o f G D P to the latter figure. 55 Schools systems that are spread over large geographic areas could be more expensive to run. 58 suggests that there may be scope in the OECS to reallocate spending from teacher salaries to other areas, without radically increasing per capita spending or reducing outcomes. TABLE5.4: EDUCATIONINDICATORS Pupil teacher ratio YOtrained % of current Antigua and Barbuda Dominica Grenada St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines Pub. exp. on educ. as YOof 4.2 7.1 6.8 7.5 7.1 primary 17 18 23 18 26 secondary 15 18 23 13 18 teachers 67 23 31 29 57 salaries admin. 92 82 95 92 10 10 10 9 5.5 20 18 86 96 7 OECS weighted 6.1 19 16 49 92 9 Source: World Bank (2003e), (2004e.), (2004f.), (2004g.) and (forthcoming), and di Gropello (2003) and Joseph (2003). 5. 15 High spending on education also masks severe inequities in the system. Although the Caribbean has a more egalitarian distribution o f education than most other regions, as a result o f the early post-independence emphasis o n access, t h i s masks serious inequities in the quality o f education received by students. The range o f C X C pass rates across schools in the OECS varies f r o m as l o w as 18 percent to as high as 90 percent across very small numbers o f schools in each country (between 2 and 18 schools). This i s surprising in such small and egalitarian societies which have traditionally placed such a high value o n both education and o n the equitable distribution o f benefits from development. The striking disparities are illustrated in B o x 5.2 below in a comparison o f t w o high schools in one o f the countries. BOX 5.2: A TALE OF TWO SCHOOLS GHS and CHS are situated 20 minutesfiom each other in one of the OECS countries. The former is located in the capital and the latter just outside. At the CXC examinations in 2003, 2 percent of the exam-takers passed Math and 52 percent passed the general proficiency requirement at CHS, whereas at GHS, 89 percent passed Math and 96 percent passed the general proficiency requirement. Large differences equally exist between the schools in repetition, dropout and completion rates. A range of factors explain the disparities in learning outcomes, namely: (i) school financing; (ii) academic selection; (iii) familial and institutional enabling environments; (iv) quality of teaching stafl and (v) infiastructure. 0 School financing. I n the past, CHS received around half the per pupil funding fiom the government than did t passed the primary-to-secondary CHS has no student counselor and h employs both a counselor and nurse, and the GHS faver extra-curricular 0 School infrastructure. GHS sports a fairly well-equipped library and science labs in sharp contrast to CHS’ run-down infiastructure. 5. 16 There i s a common tendency in the OECS to spend relatively more public financing on the better performing schools which already have the benefit o f good selection and supportive family environments, instead of concentrating spending where needs are highest. This i s often reflected in the periodic national celebrations o f top students who have achieved regional successes in the C X C examinations, with little attention to the average performance o f the country as a whole. N o t only i s the public financing policy regressive, i t appears to pin the hopes o f an entire nation o n a few elite performers, when global competitiveness depends o n the average level and quality o f education o f the workforce. There i s a general shortage o f detailed public information o n the distribution o f inputs and individual school outcomes. F o r example, neither the Caribbean Examinations Council nor individual governments make publicly available annual results by school. This m a y have reduced accountability regarding the administration o f education systems t o the public by masking the l o w average quality o f education, thus dampening the demand f o r improvements. 59 5. 17 O n e outcome of the low quality and inequitable secondary outcomes i s high youth unemployment with 32 percent o f the 15-24 year old cohort in the OECS unable to find work, compared with an adult unemployment rate o f 11 percent.56 Youth unemployment imposes a high cost in the Caribbean in terms o f foregone productivity, partly because the youth make up approximately 18 percentage o f the working age population. A recent W o r l d Bank study o n youth development in the Caribbean57 estimated that if youth unemployment were reduced to the level o f adult unemployment, GDP could increase by 1.2 percent in Antigua and 2.6 percent in St. Lucia. High youth unemployment i s also an indication that l o w secondary education outcomes are contributing to l o w tertiary enrollment and inadequate j o b training, by reducing the pool of suitable candidates for these forms o f continuing education. TABLE5.5: YOUTHUNEMPLOYMENT Year of source data Unemployment rate Youth Adult Antigua and 1991 13.0 Barbuda Dominica 200 1 56.0 Grenada 1998 23.9 St. Kitts and 200 1 11.0 Nevis St. Lucia 200 1 36.8 St. Vincent and the Grenadines 200 1 39.4 OECS 31.9 Sources: Halcrow (2002), country labor force Youth share of unemployment 4.2 16.7 9.2 47.0 50.1 49.0 3.6 11.7 44.0 48.6 15.3 45.3 10.8 47.6 surveys, censuses and Bank staff estimates. (ii) Tertiary education 5. 18 The OECS also has a serious shortfall in tertiary education output. The OECS remains far behind i t s competitors in tertiary education with enrollment rates estimated at around 11 percent including nationals enrolled overseas. This rate i s almost 10 percentage points lower that in the Caribbean as a whole, and 13 and 15 percent lower than in Latin America and the rest o f the world, respectively (see Table 5.3). Given i t s average per capita income, the OECS should have tertiary enrollment rates o f around double the current rate.’* 5. 19 Both supply and demand factors explain the shortfall in tertiary education. On the demand side, the irregular quality o f secondary education reduces demand for tertiary education by reducing the pool o f potentially qualified graduates. Nevertheless, enrollment into tertiary education has not kept apace with the last decade’s expansion of secondary education and increase in secondary school graduates. In 2001, an estimated 57 percent o f the relevant population cohort graduated from secondary schools, but only 15 percent entered tertiary institutions. The primary bottleneck seems therefore to be an inadequate provision o f tertiary education services, although l o w demand due to inadequately qualified candidates i s s t i l l a factor. 5. 20 Supply of tertiary education has been predominantly publicly-financed and -provided. Up until recently, the OECS, and much o f the English-speaking Caribbean, relied exclusively o n public financing and provision o f tertiary education for the domestic/onshore market.59 Given the fiscal constraints facing all the govemments and the generally l o w cost-recovery f r o m students (with the exception o f Dominica where 13 percent o f costs i s collected in tuition fees), this has meant severe In Dominica where we have recent data, unemployment among poor youth i s even more acute - among both poor and indigent5615-24 year-olds, the unemployment rate i s estimated at an astonishing 74 percent. 57 World Bank (2003b). World Bank ( 2003e, 2004f, 2004g, 2004h, forthcoming). 59 The private sector i s the main provider o f offshore education (serving foreign students) in the OECS. 56 ’* 60 limitations o n the number o f places and quality o f instruction. The private sector i s n o w beginning to emerge as a significant provider in Grenada w i t h the entry o f St. George's University into the domestic and regional markets, and in Jamaica, where it accounts for approximately 19 percent o f tertiary enrollment. In contrast, the Dominican Republic relies predominantly o n private financing o f tertiary education. There, the public sector devotes only 0.3 percent o f GDP to tertiary education, while households invest a total o f 1 percent. FIGURE 5.3: TERTIARYEDUCATION: INVESTMENT AND ENROLLMENT (2000) 23.0 n p 8 2.5 rc O s 45 40 35 30 c, 25 20 g 15 2 10 15 5 0 2.0 z1.5 t c 2 1.0 8> 0.5 U 5 0.0 Source: U N E S C O (2002), various country sources and staff estimates. 5.21 Public institutions are inefficient and spending i s likely to be regressive. In addition t o the limited fiscal resources available for tertiary education, there are some key inefficiencies in h o w the resources are spent which serve to limit the number o f places in public institutions. These include full salary payments to student nurses and teachers while engaged in full-time trainings6' 5, 22 Relying predominantly on either private or public investment has pitfalls in terms of equity. Public financing o f higher education i s w e l l k n o w n to b e highly regressive spending, since limited places go to the best performing students who generally come f r o m middle-to-high income households. On the other hand, purely private financing i s associated with large inequities. F o r example, in the Dominican Republic where private households finance three times more o f tertiary education than the public sector, 47 percent o f tertiary students come from the top quintile o f households. In Jamaica, where a combination o f public and private providers exists, the top quintile accounts for only 19 percent o f tertiary enrollment. In all cases, reliable and available financial aid programs are necessary to assist low-income households with the burden o f tuition fees and foregone income. 5.23 Public spending on tertiary education m a y not be sufficiently geared to the needs of the private sector. In addition t o reforming the financing structure o f public tertiary institutions, the OECS needs to ensure that the curriculum and offerings are appropriate t o the needs o f the market place. The , sub-region's tertiary institutions cannot afford to devote themselves purely to a scholastic agenda, although it remains an important public good for understudied societies and cultures. There could b e an effective division o f labor between the University o f the West Indies which continues to serve the scholarly needs o f the whole Caribbean (albeit with relevant questions about i t s o w n sustainability) and national colleges which strive to produce knowledge workers for the local economy. 6o Further details can be found in the OECS Analysis o f Fiscal Issues series. 61 5 . 24 T o address the shortages, the O E C S will need to ensure that the few public tertiary institutions contribute efficiently and effectively to solving the s k i l l s shortages that affect competitiveness, and to find ways to increase the private supply of tertiary education. Adapting education institutions through reforms o f curricula, innovations in course offerings, investment in specialized equipment and formation of education-business networks, i s a lengthy but necessary process to ensure availability o f cutting-edge specialized competences to local enterprises. The Barbados Community College provides an excellent model o f governance strategies to improve the relevance of public tertiary institutions in the sub-region (see B o x 5.3). BOX 5.3: ACCOMMODATING THE TRAINING NEEDS OF THE PRIVATE SECTOR The Barbados Community College may be the region’s best example of how a public tertiary institution can ensure that its outputs meet the training needs of the private sector. The College has put into action several strategies to ensure that its offerings and graduates meet the private sector’s needs, including: (i) An external governing board that counts seven private sector representatives out of nine members, in the key areas of Retail, Banking, Oil, Manufacturing, Legal, Health, Education/Culture and the I T sector; (ii) Advisory committees for each division of the College, which consists of professionals directly related to the division S careers. The committees meet at least once a semester; (iii) Sale of training and consulting services to firms carried out via n Industry Service Unit located in the industrial area of Bridgetown. These activities not only contribute to the provision of relevant skills and business services and provide hands-on experience for students, but also augment the College’s revenue; and (iv) Facilitation of staff exchangedattachments with firms through flexible staff rules. 5. 25 Attracting additional private tertiary education providers to the OECS may be difficult given the small market sue. With the growing international trade in education, one possibility might be t o attract efficiency-seeking, rather than market-seeking foreign investors in this area, similar to the existing medical education exporters (see Chapter 7) who service an international market, but in areas that also have relevance to the OECS needs. The linkages between St. George’s University and the Grenada Community College are evidence that this can be done. The role o f the state would be to identify and encourage those investments that have the spillovers to areas o f greatest domestic needs, including through an appropriate trade stance o n the tertiary education services. In addition, the Governments could encourage more innovative use o f ICTs to provide local students with access t o distance learning opportunities as proposed under the Caribbean Knowledge and Learning Network. 5 . 26 At the minimum, the O E C S can improve the functioning of the market for tertiary education. Across the globe, govemments have been struggling to encourage private investment in tertiary education mainly by improving the functioning o f the market. Some strategies include: (i) reducing regulatory obstacles to non-governmental providers; while (ii) providing public information on quality, labor market value and relevance o f new training offerings through appropriate accreditation; (iii) diversifying tertiary education by recognizing shorter term technical and technological degrees; and (iv) expanding student loan programs. Regarding recognition o f shorter degrees and certification programs, there i s no need to reinvent the wheel. While ongoing efforts by the OERU to establish a sub-regional Associate Degree program are admirable, competitiveness in the OECS may b e best served by taking advantage o f already internationally-recognized certifications and relying as much as possible o n Caribbean regional efforts, such as the Regional Nursing Program. 5 . 27 Close attention should be paid to trade negotiations on the treatment of tertiary education. In this regard, the OECS needs to consider carefully i t s stance regarding the treatment o f tertiary education under the General Agreement o n Trade in Services. The US, the world leader in export of education services, has sought full market access and national treatment f r o m i t s trading partners for i t s modes 1,2, and 3 higher education and training services providers.61 In effect, they are seeking free entry o f U S education institutions to supply domestic markets and the same treatment from the public sector as 61 Within CAEUCOM, Jamaica, Haiti and Trinidad and Tobago have responded with varying commitments. Jamaica’s commitments are the most open with no limitations o n market access and on national treatment only in modes 1, 2 and 3, but requiring local certification, registration and licensing o f institutions in mode 3. Jamaica has no commitment in mode 4 which requires work permits and visas except from C A R I C O M citizens. 62 received by local institutions. Regarding the latter, there i s an outstanding issue as to whether ‘national treatment’ includes subsidies and concessions provided to public training and tertiary institutions, such as UWI and the Clarence Fitzroy Bryan College in St. K i t t s and Nevis. In the Caribbean, some educators have cited t h i s issue as reason to propose preventing entry by foreign training institutions, but t h i s would only perpetuate the shortage o f tertiary education offerings within the sub-region. Instead, the OECS trade stance in this area should aim to encourage the entry o f investors -both domestic and foreign. 5.28 Finally, the demand for certain types of tertiary education may be limited by the segmented labor market space in the OECS. The labor market in the OECS remains a geographically fragmented space, as most governments s t i l l restrict the free movement o f workers across countries. Under current agreements, the sub-region i s committed to free movement o f labor only by 2007. Although some rules have been relaxed in a few countries, work permits are s t i l l required for most OECS nationals to work in another member country. This has a dampening effect o n the demand for certain types o f specialized tertiary education. The smaller the market space, the more limited the scope o f opportunities as perceived by school graduates, who will only seek training for those positions in which there i s a deep enough market. A larger market space allows graduates to explore more specialized and technical skills. At a minimum, the OECS countries should rapidly accelerate progress toward economic union and the Caribbean Single Market Economy. (iii) Job training 5 . 29 Job training i s an important part of the supply chain for skilled labor. The aim o f j o b training i s to build upon existing abilities o f the worker by providing the opportunities for h i d h e r to acquire new competencies directly related to creation o f value-added within companies. Training should be seen as a complementary policy to education and technology, since f i r m s generally choose to train employees only if those employees are adequately educated, and opportunities for the introduction o f new technologies exist. Training therefore often has an incremental character. The decisions regarding training- the s k i l l s to be acquired, the duration o f the training programs, and the choice o f service providers-should be made by the firm itself, in order to ensure relevance and impact. Gill et a1 (2000) confirm through international evaluations the marked difference in outcomes between privately-financed training and publicly-provided courses. I t i s therefore critical that j o b training be highly demand driven in order to be effective in improving employee productivity as w e l l as ensuring job-placement for unemployed. 5 . 30 Job training appears to be lower in the OECS than in the rest of the Caribbean and Latin America. Approximately 65 percent o f f i r m s in the Caribbean provide training to their workers (85 percent o f f i r m s in the Dominican Republic, 65 percent in Belize, 54 percent in Haiti, 41 percent in Trinidad and Tobago, and 90 percent in Jamaica), which i s lower than the regional average o f 75 percent of f i r m s for Latin America. Less than 50 percent o f f m s surveyed in Grenada62provide formal training to their workers (see Figure 5.4). Although foreign companies are more likely t o offer training than domestic companies and larger establishments tend to train more than smaller ones, there remain a considerable number o f f i r m s - a third or more - that do not provide any training t o their workers. 62 World Bank (2004e). Also see details in Annex 1. 63 FIGURE5.4: SHARE OF FIRMS OFFERING FORMAL TRAINING IN GRENADA (% of respondents) Large Medium Small Micro Foreign Domestic Tourism Manufacturing Total 0 10 20 30 40 50 60 70 Source: World Bank (2004e). 5 , 3 1 Job-training i s a complement, not a substitute for basic education. Evidence from across the Caribbean confirms this. In Jamaica and the Dominican Republic, more than three quarters o f recipients of training h o l d a secondary education diploma (McArdle, 2004). Marquez (2002) finds that in all surveyed countries (Trinidad and Tobago, Haiti, Dominican Republic and Belize) technicians, supervisors and skilled workers are around twice as likely to receive training than unskilled workers. Ashton (2000) confirms the same ratio for Barbados. Among the companies that reported offering training to their workers in Grenada, 84 percent said they provided formal training to skilled workers in 2003, but only 3 1 percent indicated that they offered such opportunities for unskilled workers. Unskilled workers are generally not considered “investment-grade” in that they lack the foundations for learning, thus rendering training costly and ineffective. Training programs should, therefore, not be seen as a substitute for basic education or a placement for school dropouts. On the contrary, providing quality secondary education to all i s a must for a productive work force, and will increase the likelihood o f future upgrading o f the workforce through on-the-job training by f i r m s . 5. 32 Public training programs are not well geared toward the needs o f the private sector. Table 5.6 illustrates the distribution o f investments in training by f i r m s surveyed in Grenada. This suggests that although Grenadian firms under-invest in training in general, the private sector i s bearing the main responsibility o f upgrading the s k i l l s base o f the labor force - both inside the firm and through private training providers. Private training facilities are frequented several times more than public training institutes. Indeed, the public training centers in Grenada lag so far behind the private sector in offering the kind o f training demanded by the companies that they account for only 19 and 13 percent o f the total training provided to skilled and unskilled workers, respectively. For example, in St. Lucia, one hotel has been responsible, through i t s training program and high employee turnover for having trained most o f the local massage therapists, thus facilitating the introduction o f health and wellness services at other properties o n the island. Most of the companies surveyed in Grenada recognize the merit o f formal training in s k i l l s upgrading, but are not satisfied with the available training facilities. According t o these enterprises, the Government should collaborate with the private sector to provide more training programs in all areas, and schools should be encouraged to expose young people more to the world o f work in order to prepare them better for the j o b market. 64 TABLE 5.6: TYPES OF TRAININGINSTITUTIONS USED BY FIRMSIN GRENADA YOof respondents who used these types of institutions Total Manufacturing firms Tourism firms Domestic firms Foreign firms M i c r o firms Small firms Medium-sized firms Large firms Source: World Bank (2004e). Skilled Workers External Internal Private Public 77.6 52.0 19.4 61.9 36.6 1.5 56.3. 25.8 18.0 52.7 35.7 11.7 67.0 30.5 2.6 61.3 27.7 11.0 56.9 28.1 15.1 49.6 48.0 2.4 56.9 35.5 7.5 Unskilled Workers External Internal Private Public 92.6 31.5 13.0 96.4 3.6 0.0 79.8 16.8 3.3 79.1 16.5 4.4 91.4 8.6 0.0 98.0 2.0 0.0 91.7 1.1 7.2 68.9 28.5 2.5 78.3 18.3 3.3 5. 33 Public training programs in the OECS tend to focus almost entirely on youth training and basic vocational training aimed at remedying shortcomings of the secondary education system. These programs generally emphasize s k i l l s for traditional microenterprise development such as dressmaking and carpentry rather than building s k i l l s for the formal labor market. Though usehl, they have little impact o n the competitiveness o f private firms, and do not promote innovation in the economy. Instead, they act as safety nets and only provide limited income-earning opportunities for their beneficiaries. In St. Lucia, 84 percent o f public spending o n training goes toward youth and vocational training, with the remainder o n apprenticeships (see Figure 5.5). Further, the public agencies usually define and provide training with little involvement from private sector employers. Within the Caribbean, only the Dominican Republic and Barbados allocate a significant portion o f their budgets for j o b training towards demand-driven and incentive-based training schemes where f i r m s are the central decision makers. For example, at Instituto Nacional de Formaci6n TCcnico Profesional (INFOTEP), the apex organization for training in the Dominican Republic, over 75 percent o f training benefits employed workers, and the majority o f training takes place within f i r m s , aims at directly developing the capacities of the work force and thereby contributes to private sector productivity improvements. This appears t o be a Caribbean best practice in this area. Enterprise Training Youth and vocational training 0 Apprenticeship 0% Dominican Republic Source: McArdle (2004) Jamaica St. Lucia Trinidad 8 Tobago . 5. 34 Outcomes of donor-financed training programs have not been well measured. In the OECS, training programs geared to the private sector are also administered through stand-alone donor-financed programs like OECS Export Development Unit, the Small Enterprise Development Unit, CaribExport and Caribbean Regional HRD Program for Economic Competitiveness (CPEC) which support technical 65 assistance directly to firms, including some employee training. However, there i s a dearth o f rigorous evaluation to clarify the impact on f i r m s ’ productivity, sales or exports. In one case, an exit survey was done but the results are limited to whether the f m s were satisfied with the assistance provided, rather than a more precise measure o f improvements in worker productivity. 5. 35 Despite the apparent willingness of private firms to train their workers, the under-provision of job training in the O E C S will persist if left entirely to the private sector. This i s because f i r m s are reluctant t o train employees in general portable s k i l l s for fear o f losing their investment to other employers. This risk i s exacerbated in the OECS by the shortage o f skilled personnel and resulting high turnover. Hence, there i s a role for government in promoting training. 5. 36 The international best practice i s to separate public financing f r o m provision of training. Some Caribbean governments administer a payroll levy to finance training. Jamaica has an exceptionally high levy o f 3 percent, compared with the more common practice worldwide o f around 1 percent; however, the outcomes o f this spending are not clear. There have been few rigorous impact evaluations and the job-replacement data that exists, shows mixed results. In OECD and Latin American countries, governments have opted t o separate public financing from provision o f j o b training, because o f disappointing results with public training programs. Instead they now provide incentive schemes for f i r m s to use private providers and concentrate on the regulation o f those providers to ensure quality, There are many successful models o f the public sector being able t o provide financial incentives to f i r m s for training (Malaysia, Chile, Brazil, Mexico, to name a few) from which the OECS can draw. 5. 37 Small market size m a y hinder entry of private training providers to the OECS. T o deal with this, the OECS should accelerate support for the establishment o f a seamless regional market for training providers under the Caribbean Association o f National Training Agencies through common occupational standards, common and portable accreditations and technical and vocational certificates. N o t only will this create a large market space and encourage more private suppliers, but it w i l l also strengthen demand by individual workers for training. Further, allowing providers to compete across the region for training of workers-financed by public and private resources-would increase the quality o f service to the employee and the company. (iv) Recommendations 5. 38 The challenge for the OECS in terms o f building and improving the s k i l l s base o f i t s workforce i s threefold: (i) improve the quality o f education; (ii) continue expanding access to secondary education, and begin expanding access to tertiary education; and (iii) refocus the education and training systems o n building s k i l l s demanded by employers. 5. 39 Improving the quality of education. K e y action here w i l l be to improve the efficiency o f public spending o n education by: 0 0 0 0 Reforming teacher training and deuloment schemes, by adopting a sub-regional approach to teacher training (i.e. common curriculum, delivery modality, and certification system) w i l l help to conserve limited resources, achieve economies o f scale and facilitate teacher mobility/deployment across the sub-region. Shifting resources f r o m better uerforming schools t o those where the needs are meatest in order to raise the average quality o f schooling, address youth unemployment and youth-at-risk issues at the source, and limit later labor market segmentation. Accelerating the reform o f secondary education curriculum to provide youth with appropriate competencies and s k i l l s for the further education a n d o r the transition from school to work. In this regard, the performance and accountability o f the OERU needs to be strengthened. Improving monitoring and international benchmarking of, and uublic information on. education outcomes across the sub-region. This i s intended to increase accountability o f education 66 providers for educational outcomes, and deepen involvement o f the public in achieving education goals. 5.40 Expanding access to secondary and tertiary education. In addition t o improving quality o f education, it i s imperative that the OECS continues the rapid expansion o f access t o secondary education undertaken in recent years, and begins to expand tertiary education, by: 0 0 0 0 Encouraging. greater participation o f the private sector in tertiarv education while ensuring. that adequate standards are maintained. A sub-regional approach to accreditations that emphasizes integration with regional and international standards w i l l help both to make the OECS market more attractive to external service providers, and stimulate greater demand by students, However, the latter will also depend on progress o n free movement o f labor within the OECS and under the CSME. Improving. the efficiency o f spending. on tertiarv education by increasing cost-sharing, and appropriately targeted loan or scholarship programs. In t h i s regard, the sub-region should take a close look at reforming teacher and nurse training programs. Negotiating. better terms o f trade for tertiarv education services to increase spillovers to domestic needs. In promoting further the development o f exports o f education services, the sub-region should target those areas that also have an impact o n domestic needs, such as tourism, IT, and other areas. Accelerating implementation o f C K L N and other distance learning. efforts. Greater use o f ICTs can not only help the sub-region overcome the issue o f small market size and remoteness, but it has also helped to increase collaboration among the public training institutions across the subregion to achieve economies o f scale. 5. 41 Refocusing education and training systems on the skills demanded by employers. Ultimately education and training systems in the sub-region need to be carefully focused o n the s k i l l s needed by employers and the labor market. In t h i s regard, the OECS needs to: 0 0 0 Strengthen the involvement o f the private sector in the secondary school curriculum reform, governance o f tertiary institutions, and the design and provision o f j o b training programs to ensure that curriculum and course offering are relevant to market needs. Expand s k i l l s training in some key areas such as IT, hospitality, non-hotel tourism services, accounting and management. Refocus public spending o n training by targeting vocational training o n linkages w i t h export sectors rather than o n microenterprise s k i l l s that only provide safety nets for beneficiaries, and promoting in-firmtraining through the judicious use o f financial incentives. B. Wages and the labor market 5, 42 Comparatively high wages accompanied b y persistently high unemployment suggest that labor markets in the O E C S may not be functioning efficiently. Table 5.7 presents data o n wage rates for a range of positions compiled recently by the Commonwealth Secretariat across 92 countries.63 In almost all the positions, with the exception o f kitchen porters, average OECS wages are higher than the comparators. One o f the challenges associated with labor market analysis in the OECS i s the incomplete and sometimes inconsistent nature o f the data. Only St. Lucia has collected data on the labor force, employment and unemployment on a consistent basis over the past decade. Labor market data for the other countries i s obtained from population censuses and special one-off labor force surveys. Data on wages, salaries and earnings are even more difficult to obtain on a consistent basis and come from the decadal censuses and one-off surveys by the Commonwealth Secretariat, Price Waterhouse Coopers, and the Barbados Employer’s Federation. 63 67 Constru ction Worker Checkout Clerk in Large Supmkt Kitche n Porter Hourly wage in US$ 2.09 1.70 1.78 2.03 1.76 1.65 2.01 1.90 1.83 Caribbean* Up mid inc* Micro state* OECS 3.45 1.84 1.51 Antigua and Barbuda 4.07 3.33 2.45 Dominica 2.30 1.84 1.30 Grenada 3.03 1.80 1.26 St. Kitts and Nevis 5.30 1.40 1.90 St. Vincent and the 2.53 0.81 0.63 Grenadines * Each comparator group excludes the OE( 1 Source: CommonwealthlUNCTAD (2002). Bank Clerk/ Teller, local bank Bank Clerk/ Teller, foreign 6.4 6.2 5.7 7.8 6.5 6.2 6.2 8.6 10.9 8.2 7.1 10.9 9.3 8.0 9.0 5.1 9.5 12.0 6.0 8.1 8.8 10.3 8.6 6.7 7.0 8.9’ 9.1 6.3 8.2 countries. 4.5 2.7 bank Garage Mech. Payroll Clerk Qualified Teacher in State School Branch Mgr, local bank Branch Mgr, foreign bank Gen. Reg’d Nurse 29.5 26.4 34.3 37.1 9.3 7.2 8.0 10.1 55.6 19.9 26.5 55.6 22.1 30.9 12.9 9.9 7.5 12.6 23.0 40.4 12.5 8.5 35.2 36.3 8.0 Annual wag in US$’OOOs 7.5 22.4 6.0 6.6 6.9 21.3 6.1 6.7 7.2 26.3 6.6 6.8 9.8 32.0 7.4 7.5 5. 43 In addition, real wages appear to be growing faster than productivity. Real average government wages have grown faster (except in St. Kitts and Nevis) at 2.1 percent per year between 1995 and 2002 than both real per capita GDP at 1.5 percent (see Table 5.9) and productivity growth (see Table 1.2), implying that public sector wage-setting mechanisms across the sub-region are not market driven. Although there i s no specific data o n the trends in private sector wages, the lack o f persistent vacancies, high turnover or long queues for government employment in most countries (again with the exception o f St. Kitts and Nevis) suggest that government remuneration i s not substantially out o f line with the market, As such, one can infer that private sector wages have been growing at similar rates as public sector wages, and also exceeding productivity growth. 5.44 H i g h labor costs unless justified by high productivity only serve to hurt competitiveness and limit job growth and generate unemployment. Indeed, unemployment has been persistently high in the OECS countries, except for Antigua and Barbuda and St. Kitts and Nevis, and in many cases has risen over the last decade (see Table 5.8). B o t h problems impact competitiveness negatively - high wages because it raises the cost o f production and unemployment because i t wastes a crucial factor o f production. TABLE5.8: UNEMPLOYMENT TRENDS 1991 Mid 90s 2001 Antigua and 6.0 Barbuda Dominica 23.1 (1997) 15.7 (1999) 25.0 Grenada 13.7 29.1 (1994) 15.5 (1997) St. Kitts and Nevis 4.5 (1994) 5.1 St. Lucia 16.0 (1995) 22.0 (1997) 18.9 St. Vincent and the Grenadines 19.8 26.8 Years in parentheses are dates o f labor force surveyslcensuses, if other than indicated above. Source: Various labor force surveys and censuses. 5.45 Across the sub-region, unemployment rates are higher for youth, r u r a l residents, and those with at most primary education. However, there are some variations that are worth noting. In St. 68 Lucia, workers in rural areas have a lower probability o f being unemployed, and in Dominica, where there has been a large retrenchment among banana workers over the last decade; farmers now report a shortage o f agricultural labor. In Dominica, unemployment rates do not vary that much across education levels - notably, 18 percent among those with junior secondary or lower education to 10 percent among those with community college education. In St. Kitts and Nevis and St. Vincent and the Grenadines, unemployment i s lower among women than among men, whereas the opposite holds in Dominica and St. Lucia. 5. 46 In addition, the duration of unemployment appears to be quite long with the majority of the unemployed experiencing spells of one year or longer. The shift toward services has implied a radical shift in the s k i l l s needed by new employers. Workers who are being increasingly retrenched from old sectors need time t o acquire the necessary human capital appropriate to the new economy jobs. Delays in adjusting the curricula o f j o b training programs only prolongs the s k i l l s mismatch in the economy and exacerbates the unemployment situation. Clearly, the major challenge for the OECS in the coming years will be to equip this large share o f the labor force that are currently chronically un- or under-employed with the s k i l l s required by growing and emerging sectors 5. 47 As a result, the OECS also appears to be experiencing a n increase in informal employment as workers f r o m declining sectors scramble to find alternative sources of income. Grenada’s labor force surveys record an increase in informal labor from 19 percent o f total employment in 1991 to 23 percent in 1998, St. Lucia’s from 27 percent in 1994 to 31 percent in 2000 and Dominica’s show rapid growth from 21 percent in 1997 to 35 percent in 1999. The informal labor market i s often a source o f income during economic downturns, as displaced workers engage in various l o w value-added service activities such as street vending and petty trading. In this respect, i t i s a source o f employment for l o w skilled workers who are otherwise unable to find jobs, thus raising aggregate employment. However, informal work also comprises many core economic activities, such as trading, transport and domestic work as well as some professional services that are either informal by definition (Le., own-account workers) or through evasion. Evasion often emerges as a flexible response to excessive labor regulation, But over-reliance o n informal sector jobs has economic costs - particularly in the long run - because workers tend to be unskilled and perform tasks with l o w value-added. So although informality in some ways helps labor market competitiveness through lower wages and increased flexibility, a forwardlooking strategy o f increased growth and competitiveness through higher labor productivity will require addressing the incentives for informality. 5.48 I n a fully functioning labor market, persistent unemployment should exert downward pressure on wage rates, stimulate additional demand for labor and lead to a reduction in unemployment over the medium term. In reality, however, there are a number o f labor market imperfections - both structural and frictional - that restrict j o b growth and keep unemployment high in the presence o f high wages. The labor market can be segmented in a number o f ways that prevent surplus labor for being channeled toward labor shortages. I t can also be restricted in ways that prevent wages from adjusting to balance supply and demand. The following are four key issues facing the OECS that may be preventing the smooth adjustments o f the labor market Skills mismatch and labor market segmentation. Workers cannot move from sectors with surplus labor, such as agriculture, to other sectors with labor shortages either because they lack s k i l l s or there i s a mismatch between their s k i l l s and those required by the demanding sector. There may be a long lag between changes in demand for certain s k i l l s in the market place and adjustments in the curricula o f the education system that create pools o f inappropriately skilled workers who remain unemployed despite the fact that the demand for skilled workers i s strong. In addition, workers have few means o f retooling. For example, they may not be able to afford the upfront costs or foregone income o f retraining or there i s a shortage o f appropriate training services. Furthermore, hiring f i r m s are often reluctant to provide training for unskilled workers because the kind o f s k i l l s required are very portable and the f i r m s risk training workers who then leave. In other cases, the worker’s s k i l l s deficit i s so large that investments in retooling may not 69 be efficient. This may be the case for older farm workers who cannot exit the labor force because they do not have appropriate safety nets. 0 Large governments and strong unions. Large government sectors put pressure o n the labor market by driving up both demand and wage levels. Strong unions can distort the wage-setting mechanisms by bargaining for wage increases that are not effectively linked to productivity. Separate wage-setting mechanisms for government or unionized workers can also lead to a wedge between the effective compensation o f those workers and other private sector employees. These separate mechanisms prevent wages from adjusting to surpluses or shortages in the labor market. For example, across the board improvements in the government wages (or allowances) m a y increase the average salaries o f a specific labor market group, say secretaries, despite the fact that there i s a surplus o f secretaries in the market. As a result, the costs to the private sector o f hiring good secretaries from that pool increase, despite the fact that the unemployment rate among secretaries i s high. 0 0 Rigid labor regulations. Labor regulations can make it difficult or costly for f i r m s to adjust the size o r the composition o f their workforce or simply replace less productive with more productive workers, as they try to implement improvements needed to become or stay competitive. Migration, remittances and regional integration of the labor market. Migration affects the functioning o f the labor market in several ways. Opportunities to migrate can lead to queuing where workers delay entry into the labor force as they wait for overseas jobs. In addition, remittance flows from nationals overseas can raise the reservation wages o f recipients and drive up domestic wage levels. Greater integration o f the sub-regional and regional labor markets will reduce the frictional impact o f migration - as the markets are more integrated, workers can move more easily and wages become more aligned across countries. 5.49 The issue o f s k i l l s has been discussed in detail in the previous section. 5 . 50 I n most o f the sub-region, large and growing government sectors are putting pressure on the labor market. The public sector - not including regional institutions such as the OECS Secretariat, ECCB, E C T E L - accounts for approximately 20 percent o f employment and the wage bill for 13 percent of GDP. In part this reflects the typically large public sector to be found in small, open economies, but also reflects a government sector in the OECS that has been growing steadily in employment during 1995-2002. TABLE5.9: GOVERNMENT EMPLOYMENT AND WAGES Central Government (2002) Wage bill Yo GDP Empl (000s) YO Emp YO Average Annual Growth (1995-2002) Y O No. positions Nom. wages CPI (Inflation) Real wages Real pc GDP 1.5 3.1 0.7 0.7 2.7 -1.1 2.6 2.3 -0.4 3.1 2.1 3.9 1.5 a LFa Pop Antigua and Barbuda 12 13.0b 34 31 17 Dominica 15 5.5' 20 17 5 2.1 2.8 1.3 Grenada 11 5.1 5 12 5 -0.5 5.0 1.9 St.Kitts and Nevis 15 4.7 29 28 10 4.4 2.3 3.4 9 4 0.7 4.7 2.1 St.Lucia 11 6.8 11 St.Vincent and the Grenadines 14 6.1 27 27 6 2.2 4.4 1.3 OECS 13 41.2 21 19 7 1.7 3.8 1.7 a. LF=labor force. Extrapolated from most recent labor force or census data. b. Broad estimate o f central government employment, because more precise numbers are not available. c. Includes an estimated 1600 non-established workers who may not be full-time equivalent employees. Sources: World Bank (2003e, 2004f, 2004g, 2004h, forthcoming) and IMF estimates. 70 5. 51 As noted above in para. 5.43, during 1995-2002 average real government wages grew faster than real per capita GDP implying that wages levels were outpacing productivity growth. Strong unions have succeeded in extracting near automatic annual salary increments, routine thirteen-month bonuses as well as relatively generous across-the-board wage increases for public sector workers, The vibrant trade union movement in the OECS emerged in conjunction with independence movements rather than as a result o f industrialization and worker discontent, as in Europe and the US. As a result, the unions have broad membership bases and strong historical l i n k s to political parties o n both sides o f the aisle. This has served to make wage and other negotiations with the public sector unions across the subregion are generally quite fractious, and has severely limited governments’ abilities to achieve wage moderation and contain public sector employment. 5. 52 Although public sector base salaries are generally lower than those in the private sector, many governments also provide a host of non-wage benefits, which make the comparison uncertain, For example, wage regressions using recent St. Lucia labor force data indicate a positive public sector wage premium (1 2 percent), while a rudimentary comparison o f selected positions illustrate consistently positive private sector premium. In St. Kitts and Nevis, where real wages in the public sector have been falling, a similar comparison shows a consistently positive private sector wage premium, where as in St. Vincent, the comparison indicates that the public sector may be paying a wage premium for clerical staff and mid-level professionals, while the private sector i s paying more for semi- and unskilled workers and senior professionals. Most governments in the sub-region supplement public sector salaries with a host o f non-wage benefits. These are generally embodied in separate legislation that differentiates public sector remuneration and employment rules from those for private sector workers, and i s itself a form o f labor market segmentation. For example, civil servants in Dominica are entitled to a year o f study leave at full pay, complemented in some cases by tuition assistance. Vacation leave i s equally generous between 21 and 36 days per year. According to the Dominica Employer’s Federation, this i s significantly more than i s provided in the private sector. However, as noted in para. 5.43, the lack o f persistent vacancies, high turnover or long queues for government employment in most countries (except for St. Kitts and Nevis) suggest that o n average government remuneration across the sub-region i s not substantially out o f line with the market. 5. 53 Regardless, public sector reform aimed at containing the size of government and aligning public sector remuneration and employment rules with those for the private sector will be an important p a r t of improving labor market conditions in the sub-region. 5. 54 Over the past three years, public sector labor relations seem to have moderated somewhat in the OECS, and a number of countries have made progress in slowing and containing public sector wage increases. None, however, has achieved any systematic link between wages and productivity such as has been realized in Barbados under i t s Protocol for the Implementation o f a Prices and Incomes Policy. Nevertheless, the trade union movement appears to be seeking a broader role in promoting general economic development and social welfare, versus the more limited one o f representing only the narrow interests o f the employed. In St. Vincent and the Grenadines, the trade unions participate in the National Economic Council. In Dominica, albeit not entirely smooth-sailing at first, trade unions participated fully in consultations o n the Economic Stabilization and Adjustment Program. This suggests that efforts to expand trade union involvement in national policy issues, in particular competitiveness issues, would be instrumental in broadening public ownership o f necessary reforms to contain the size o f government and i t s impact o n the economy. 5. 55 Across the sub-region there appears to be a very different tone in the relationship of unions with the government versus that with private sector firms. In the private sector, relations between management and labor appear t o be relatively cordial. M o s t o f the companies surveyed in Grenada, as well as the majority interviewed in other countries, reported generally cordial relationships between labor and management, which in turn was confirmed by the trade unions. Only three companies out o f the 201 surveyed in Grenada reported days lost due t o strikes or other labor disputes during the previous year. 71 Foreign companies cited the ease with which they can resolve company-wide labor related issues as an important reason for them to remain and expand their businesses in Grenada. 5. 56 I n comparison with other countries, labor market regulations in the O E C S are moderately rigid, but there are high costs to firms of laying off workers due to either redundancy or poor performance, and important limitations on their abilities to hire temporary or short term workers. Table 5.10 presents various labor rigidity indices (from the W o r l d Bank’s D o i n g Business database) computed for the OECS countries and how they ranked in terms o f quintiles from a sample o f 145 countries measured in January 2004. Although the sub-region ranks well, in the second best quintile, in terms o f overall rigidity o f employment, it performs poorly o n difficulty o f hiring and firing, and the cost o f firing indices. Regulation o f working hours seems to be least restrictive, and i s consistent with the needs o f the tourism and hospitality sector. I t i s important to note that the design o f the rigidity o f firing index and firing costs estimates focus on the difficulties associated with making workers redundant, whereas many employers around the sub-region also point to difficulties o f dismissing workers for poor performance. Whereas in other countries, weak enforcement or compliance sometimes mitigates the impact o f j o b security regulation, the strong rule o f law in the OECS translates to frequent and costly judicial actions o n both collective and individual labor disputes. TABLE5.10: INDICES OF LABOR MARKET FLEXIBILITY OECS Other micro states Upper middle inc Dominica Grenada St. Kitts and Nevis St. Luciaa Rigidityof Employment 22 7 28 37 20 7 39 Q 2 1 2 3 1 1 3 Difficulty o f Hiring 23 8 27 50 0 0 67 Q 3 1 3 4 1 1 4 Difficulty o f Firing 40 5 22 60 60 20 30 Q 4 1 2 4 4 2 3 Rigidity o f Hours 4 8 35 0 0 0 20 Q 1 1 2 1 1 1 1 Firing costs 59 15 38 57 28 62 108 Q 4 1 3 4 2 4 5 St. Vincent and the 10 1 0 1 30 3 Grenadines 0 1 42 3 Dominican Republic 40 3 11 2 30 3 80 5 70 4 24 2 11 2 20 2 40 2 26 2 Haiti 10 1 11 2 0 1 Jamaica 1 12 1 20 a. Computations for St. Lucia are based on the draft (new) Labor Code as o f October 2004. Each index ranges from 0 to 100, higher values indicate greater rigidity. Q = quintile among the sample o f 145 countries. Sources: Country legislation, World Bank staff estimates, World Bank (2004d); Annex 3 contains details on the sources, methodology and the raw data compiled for the OECS. 5. 57 Regarding the flexibility to dismiss workers, the O E C S countries impose tenure-based severance payments and provide for relatively complex appeals processes in a n attempt to safeguard job security and employment stability, especially in the absence o f other forms o f unemployment benefits. Generally, severance pay i s considered one o f the least appropriate means of providing income protection. Unless prohibitively high, it provides inadequate (one time lump sum payments only) and incomplete (coverage i s only provided to formal sector workers) protection, i t distorts the behavior o f workers and f i r m s , and it often leads to excessive litigation. There i s conclusive evidence that this form o f labor protection has a negative effect o n j o b creation (Heckman and Pages, 2000) and that reductions in severance pay generally favor more disadvantaged workers, l i k e youth (Gill et al, 2001). However severance pay does have three strengths - i t generally does not create an incentive to delay h t u r e j o b search, it i s easy t o administer, and it pools employee risks at the firm level. In trying to reduce these costs, countries have experimented with unemployment insurance or unemployment insurance savings accounts as alternative mechanisms, but these too can have negative impacts o n efficiency. For example, Vodopivec (2004) points to the risk that workers who would normally settle for temporary lower wage jobs while unemployed may substitute public or other forms o f guaranteed insurance that become available instead. Other factors such as the duration o f unemployment spells, 72 inter-household transfers and other informal social protection mechanisms, and the types o f employment shocks typically faced by workers in the OECS, will inform the appropriate design o f necessary severance payment reform. At the minimum however, the OECS countries should consider reduction o f severance payment levels in line with regional and intemational competitors. 5. 58 Limitations on fixed term and temporary work are only applied in Dominica and St. Lucia. Betcherman, Luinstra, and Ogawa (2001) show that restricting the use o f short term and temporary work contracts also results in lower employment rates, longer unemployment spells, greater informal employment and less j o b creation-with the key losers being women and youth. In other countries, liberalizing the use o f temporary contracts has, as expected, resulted in their widespread use and has been accompanied by higher employee turnover, but i t has also translated into higher formal employment creation. 5 . 5 9 Reforms aimed at reducing the burden of the public sector on the labor market - both in terms o f wages and numbers - and increasing flexibility of employment arrangements are likely to generate strong opposition from trade unions and workers in protected sectors. However, from the above analysis, they remain critical to improving competitiveness in the sub-region. In the short run, there i s clearly a tradeoff between workers who currently benefit from market segmentation and wages in excess of their productivity, and the unemployed who would benefit from more j o b creation even at lower real wages. In the long run, greater wage competitiveness and employment flexibility w i l l stimulate more investment and more j o b creation. And a larger share o f formally employed workers w i l l contribute more to increasing productivity, growth and incomes for all. Successful experiences in Ireland (discussed in Chapter 3) and in Jamaica with Social Pacts and in Barbados with the Social Partnership and Social Compact, suggest that the need for these reforms must first be internalized by the general public, including the employed and unemployed workers, in order to be successful. 5. 60 In making the case for labor market reform, i t w i l l also be important to note that business regulation i s neither an appropriate nor an effective tool for social protection. B o x 5.4 notes the lessons learned by the Nordic countries in t h i s regard. BOX 5.4: SOCIAL PROTECTION REQUIRES MORE BUSINESS REGULATION. The World Bank Doing Business in 2005 identifies several “myths” related to the regulatoly environment for investment and business. One is that social protection requires more business regulation. The report looks at the Nordic countries which are renowned for their defense of social welfare. According to the report, all four Nordic economies are on the list of countries that rank highest in terms of having simplest business regulation: Norway (#6), Sweden (#9), Denmark (#12) and Finland (#14). Few would argue they scrimp on social benejts relative to other countries, or regulate too little. Instead, they have simple regulations that allow businesses to be productive. And they focus regulation on where it counts -protecting property rights and providing social services. Estonia, Latvia and Lithuania, having leamed much fiom their richer neighbors, are also among the countries with the best business environment. Heavier business regulation is not associated with better social outcomes. Source: World Bank (2004d). 5. 61 The third critical issue in understanding the OECS labor markets relates to migration and the sub-regional labor market space. It i s now well acknowledged that migration can have both positive and negative effects o n the labor market. The OECS, and the wider Caribbean, have seen significant migration of skilled personnel beyond the region over the past t w o decades. Recent estimates based o n overseas census data indicate that the stock o f OECS migrants abroad represent just under 30 percent o f the combined labor force (residents at home and migrants overseas). This represents a significant “brain drain” or the loss of skilled labor over time. However, i t does not take into account the impact o f the broader phenomenon o f “brain circulation” which reflects the growing importance o f retum migrants in transferring s k i l l s and technology to the home country. B o x 5.5 illustrates the positive impact return migrants can have o n an economy. This may be even more important in the OECS where there i s a significant portion o f intra-OECS and intra-Caribbean migration o f shorter duration than the traditional South-North migration, and where foreign investment has been accompanied by in-migrants from more 73 developed countries.64At the same time, migration opportunities often provide an additional incentive for education among the. source country population, which has spillovers to the local economy (discussed in para. 5.28). BOX 5.5: RETURN MIGRATIONIN IRELAND AND ISRAEL I n both Israel and Ireland, the impact of recently returned migrants on innovation has been dramatic. The massive migration during 1989-1991 of one million immigrants from the former Soviet Union where the emphasis on theoretical sciences was very strong, contributed to making Israel 1 superpower. Israel has since h tech manufacturing sector. I n translated these skills into a technical and engineering skills base t had constituted the largest EU Ireland, software industries benefited f i urning expatriates many completed tertiary and rnia) in the 1980s an source of immigrants to the uter and software industries. acquired important skills in t Source: de Ferranti et a1 (2003). 5. 62 A second impact of migration on the labor market i s through remittances. Remittances to the OECS averaged 5 percent of GDP in 2003, and most countries experienced a small but steady decline over the period 1986-2003 (see Figure 5.6). Only Dominica and Grenada saw slight increases. Nevertheless, these flows are large enough to have an impact o n the labor market. Remittances provide an important element o f the safety net for the poor and ~ n e m p l o y e d . However, ~~ they have also been shown to raise the reservation wages o f recipients who delay entry into the labor force or queue for jobs in particularly lucrative sectors, tourism in neighboring islands and other migration opportunities. This has the impact o f raising voluntary unemployment, but also maintaining a higher average wage than would be competitive. FIGURE 5.6: REMITTANCE FLOWS (Yo of GDP) - 14% --O-Antigua and Barbuda -Dominica 12% st. Kitts and Nevis _ _ _ _ st. Lucia 10% - St. Vincent and the Grenadines OECS 8 0x7 6 Ox7 4% 2% Source: CARICOM and ECCB estimates. 5. 63 Finally, intra-regional migration flows both within the OECS and CARICOM, to date and in the future under the OECS Economic Union and the CSME, ultimately help to fill unmet labor demand at both the l o w and high ends o f the s k i l l spectrum and t o reduce wage pressures that negatively impact competitiveness. In fact, the OECS countries stand t o benefit from the former impact more than the larger states because the small market size may make it more difficult t o find specialized s k i l l s . 64 Up until recently Dominica, Grenada and St. Vincent and the Grenadines operated economic citizenship programs through which persons undertaking a certain amount o f investment qualified for citizenship. 65 However, findings from the recent Dominica poverty assessment (Halcrow Group, 2003) indicate that the poor and non-poor are equally likely to be recipients o f remittances. 74 5. 64 Disparities in wage rates and regulatory barriers to movement of labor across the OECS indicate that the sub-regional labor market i s far from seamless. Table 5.7 also illustrates the large variation in wage rates across the OECS countries. In addition, f i r m s generally report paying around EC$250 per week for unskilled labor in the Leeward Islands versus EC$180 per week in the Windward Islands. Moreover, when the wage and salary rates in Table 5.7 are adjusted to reflect local prices,66 the disparities across countries increase, rather than decrease, indicating that the wage variation reflects different labor market conditions - relative shortages and different wage-setting mechanisms - across countries. 5 . 6 5 Under current agreements, the sub-region i s committed to free movement of labor only b y 2007. Although some rules have been relaxed in a few countries, w o r k permits are s t i l l required for most OECS nationals t o work in another member country. In a number o f cases these permits are limited to a duration o f one year and require annual renewals that are lengthy and cumbersome. F o r example, in Antigua and Barbuda legislation requires the Minister o f Labor to personally s i g n each permit. This practice only serves to impede firms’ abilities to find the specialized s k i l l s that they need to expand production and jobs for local residents. 5. 66 Greater integration of the sub-regional and regional labor markets will reduce the frictional impact of migration - as the markets are more integrated workers can move more easily and wages become more aligned across countries. As such, the OECS should push for rapid implementation o f free movement o f labor in the sub-region and under the C S M E protocol and reduce as m u c h as possible regulatory constraints to the flow o f workers. 66 Using purchasing power parity factors. 75 CHAPTER 6. TECHNOLOGY, FINANCE AND I N F R A S T R U C T U R E A. Firm capacity and technology adoption 6. 1 I t has been well recognized that successful economies are built o n successful f i r m s . To improve the performance o f an economy, one must improve the ability o f f i r m s to compete in the global market place. However, government officials in the OECS often complain that the domestic private sector i s “weak” or “thin”. One official has been quoted as saying: “If this i s to be the engine o f growth, surely w e are going to stall”. 6. 2 There i s very little rigorously collected firm-level data in the OECS. As such, the following section i s based o n interviews with government officials, approximately 25 firms, various private sector associations and staff o n a number o f private sector development programs, firm level surveys conducted by the Foreign Investment Advisory Service (FIAS) for the Diagnostic of the Investment Climate in Grenada (see Annex 1) and for the Caribbean Foreign Investor Perceptions Survey (see Annex 2), a few academic papers based o n firm surveys in the OECS, and reports o n donor-financed private sector development programs throughout the sub-region. 6. 3 The Grenada case study indicates declining firm formation in recent years, which i s consistent with the decline in private domestic investment over the same period. Using Grenada as a case study, an examination o f the business registration records in Grenada reveals that in recent years, there has been a downward trend towards new business start-ups. For example, during 2000-03, the number o f new f i r m s registered each year went from 14 t o 9, 6 and 4, respectively. Although new firm investment i s only one part o f private investment, this trend i s consistent with the downward trend in private investment throughout the sub-region. 6.4 The second notable feature i s the extent of informality in the private sector. In Grenada, there are relatively few active limited liability companies. Most business activity i s undertaken by small and medium-sized family-owned f i r m s or sole proprietorships. Among the relatively few f i r m s that are incorporated, even fewer have outside independent investors. These f i r m s are financed predominantly by bank credit and retained earnings, and to a lesser extent by trade credit. Dominica i s reported to have a private sector with an even greater level o f informality, mainly because o f the predominance o f the agriculture trade in private sector activity. Larger f i r m s tend to be either foreign-owned or joint ventures between foreign f i r m s and the Government, and the majority are t o be found in export sectors, utilities or construction. 6. 5 However, small firm size and informality do not necessarily hinder performance and innovation in enterprises. M a n y reports posit that the size and informality o f f i r m s in the OECS limit their general capacity for innovation and, ultimately, competitiveness. However, Riddle (2002) shows that in the service sector particularly, smallness i s not necessarily a hindrance to performance. She points to the existence o f numerous one- and two-person f i r m s in Australia successfully exporting specialized expertise, and that according to the Australian Bureau o f Statistics data in 1997 service f i r m s o f fewer than five employees frequently outperformed their larger counterparts o n key financial ratios. While the level of informality might also suggest a dearth o f entrepreneurial capacity, one should also note that throughout the Caribbean, the informal sector has, in fact, proven t o be quite vibrant, as seen by regional traders (“huckstsers” or “higglers”) in Jamaica, throughout the Caribbean in the 1980s and the fishing industry in Guyana. Indeed, the Hucksters Association i s exploring the branding o f Dominica’s agricultural produce as a way to capture an increased share o f the informal trade in the sub-region. 6.6 Notwithstanding the above, a number of donor reports suggest weak managerial and business s k i l l s associated with family-owned operations, weak networks and linkages between firms, and limited access to capital for micro- and informal enterprises as crucial factors contributing to low 76 firm capacity in the sub-region. For example, the Grenada survey revealed that at least one third o f the medium and large companies, mainly the domestic firms, reported that their accounts were not being reviewed by external auditors. A survey undertaken among small hotel operators in 199ff7 reported the following management challenges: 0 0 0 0 0 a distinct lack o f awareness and expertise o n the part o f owners/operators about product quality, marketplace expectations and standards; one-third o f the sector appeared to be more interested in getting sales rather than operating their properties; 40 percent o f respondents, and 61 percent o f guesthouse operators, were unaware o f their market position. 85 percent o f the respondents did not have a formal marketing planning function in place (60 percent o f all respondents reported that marketing planning was an informal process for their properties while a further 25 percent had no marketing plans at all); and more than one-third o f properties surveyed had not undertaken a re-pricing o f their accommodation services in the last five years. The third feature worth noting i s that the sub-region does have a growing number of firms, 6. 7 entrepreneurs and investors that are gearing up for stiffer competition, both domestic and foreign, b y improving product quality, customer relations and productivity. M o r e than 60 percent o f the f i r m s surveyed in Grenada reported having taken some initiatives over the last three years in order t o improve productivity and meet the changing demands o f the market. Figure 6.1 shows the distribution o f the different types o f such initiatives. By far, the most common were the upgrading o f an existing product line and the introduction o f a new technology that changed the way their main product was produced. The median amount o f investment in product and technology upgrading over the last 12 months was 78 percent o f net profit, with close to a quarter o f the f i r m s reporting that they reinvested all o f their profits. Innovative activity was especially strong in food-processing, financial services, information and communications, and tourism. Meanwhile, around 15 percent dropped a product line in response to changes in market demand or for internal efficiency reasons. It i s noteworthy that the most important driving force behind the initiatives for reducing production costs and developing new products and services were first, customer demands and second, competition from domestic and foreign competitors. FIGURE6.1: TYPES OF INNOVATIVE ACTIVITY UNDERTAKEN BY FIRMSIN GRENADA Upgraded a n existing product line Introduced new technology Developed a new product line Discontinued a product line Opened a new plant Agreed a new joint venture with foreign partner Obtained a new licensing agreement Outsourced a major production activity Brought in-house a major production activity Closed an existing plant or outlet 0 Source: World Bank (2004e). 67 OAS Small Tourism Enterprises Project. 77 10 20 30 40 % of firms in sample 50 60 6. 8 The above evidence does not contradict additional reports that the private sector, both as individual firms and also through business organizations, persists in lobbying heavily for continued protection, preferences and concessions from the sub-regional governments. Indeed, a number o f even the most innovative f i r m s that were interviewed throughout the sub-region indicated that t h i s was their f i r s t line o f defense from competition. While it did not appear to detract from their awareness o f the need t o innovate, those who thought that they were most likely to succeed in extracting rents from the government were generally the least likely to have already implemented strategies to improve productivity and competitiveness. Indeed, this i s consistent with evidence from around the world showing that those f i r m s which are insulated from competitive pressures are the least likely to undertake innovative activity (see Figure 6.2). FIGURE6.2: MORE COMPETITIVE PRESSURE, MORE INNOVATION Major pressure Moderate pressure Some pressure Introduce new product Upgrade product Source: World Bank (2004b). 6. 9 Therefore, the challenge in the OECS w i t h regard to f i r m s i s three fold: 0 to provide an environment in which new entrepreneurs and investors can emerge and access the business development services that they need to build capacity to compete internationally. to allow competitive forces rather than public assistance to “pick the winners”. 0 to facilitate the transition of resources -- entrepreneurial, financial and otherwise - that are currently occupied in uncompetitive industries because o f artificial protections or preferences toward more competitive activities. (i) Building private sector capacity. 6. 10 In recognition o f the need to raise firm capacity throughout the sub-region, there are a large number o f regional and country-specific programs aimed at improving the enabling environment for f i r m s - a recent DFID report6’ identified 28 programs - but few that have a specific firm-level focus. This report identified eight sub-regional programs in the OECS that have some direct firm level assistance (see Table 6.1): OECS Export Development Unit (EDU) Export Capability Enhancement Program, CARICOM’s CaribExport, Canadian International Development Agency’s (CLDA’s) Caribbean Regional HRD Program for Economic Competitiveness (CPEC), USAID’s C-TradeCom, Organization o f American States (OAS) Small Tourism Enterprise Program (STEP), the Small Enterprise Development Unit (SEDU), EU/ACP Business Assistance Scheme (EBAS), and the EU’s ProInvest. In addition, there are a few regional private sector organizations - the Caribbean Tourism Organization and the Caribbean Hotel Association that provide direct technical assistance to members in the OECS through donorfinanced programs. At the country level, St. Lucia recently launched the National IT Fund which provides assistance to IT f i r m s to train professionals, and St. Vincent and the Grenadines has recently proposed a Business Gateway program which would provide technical assistance to new and ongoing ‘*DFID Law and DevelopmentPartnership (2002). 78 businesses. Dominica benefits from DFID’s Fiscal and Economic Recovery Program which has a private sector development component but t h i s focuses primarily o n business associations. As well, most o f the Windward Islands have EU-financed programs aimed at strengthening the banana sector and promoting diversification, although the latter have included few firm-level activities. Enterprises Program Caribbean HRD Program for Economic Competitiveness Agriculture, Tourism, Credit Unions, Construction 4 M a i n l y industry-wide training programs offered through govt agencies and trade associations Direct assistance to credit unions through their regional association, and to 16 manufacturing firms .i 4 Source: Various program reports. 6. 11 However, there are some crucial weaknesses in the approach taken by these programs. Among those programs that do provide assistance to firms, there appears to b e little coordination. Several companies indicated that many o f the programs tended to be either too broad-based or did not offer the qualified expertise that could “hand hold” companies through the necessary learning processes. In addition, none o f the programs has measured i t s impact in terms o f concrete business outputs - sales, employment, exports, although the OECS EDU has conducted a n important client satisfaction survey among the beneficiaries. Finally, several o f these program managers acknowledged that the models they use are based primarily o n merchandise exports and need to b e adapted t o the different needs facing service exporters. 6. 12 Among the individual country programs, St. Lucia has taken the lead in providing services aimed at strengthening the capacity of the local private sector. The Officer o f Private Sector Relations (OSPR) situated in the Prime Minister’s Office oversees the implementation o f a Private Sector 79 Development Strategy that has six prongs, the first o f which i s assistance to f i r m s for capacity building.69 The program provides grants for diagnoses, business plan development and professional services aimed to get firms and their products “export ready.” 6. 13 The following are some key issues to be considered when formulating the public sector efforts to raise private sector ~apacity.~’In general governments and development agencies should restrict their interventions to those that have strong public goods characteristics, and are not normally provided by the private sector either because o f the small size and fragmentation o f the industry, or the limited private returns to investing in knowledge. Examples of such interventions would include funding feasibility studies, providing information o n best practices applicable to promising industry clusters, and providing incentives for training and research. On a more motivational level, the government could help to galvanize entrepreneurship by publicizing and rewarding successful entrepreneurial and innovative activity to demonstrate the possibilities to other investors. At the least, the government would need to move away f r o m entertaining rent-seeking behavior o n the part o f investors, to allow the force of competition to be the driver o f innovation and growth. This section reviews a range o f tools aimed at raising the capacity o f the private sector to compete, specifically business development services, business incubators, support to the development o f industry clusters, and national innovation systems. 6. 14 Business development services71include a wide variety o f non-financial services such as labor and management training; extension, consultancy and counseling; marketing and information services; technology development and adoption; mechanisms to improve business linkages through subcontracting; and franchising and business clusters. Traditionally, governments and donors have provided these o n a free or subsidized basis, but there i s a general consensus that this approach suffers from being too general, supply-driven, o f poor quality, and usually having insufficient cost controls. Since resources are limited, coverage tends to be poor and not well targeted. The accepted strategy i s now to focus o n developing markets for services, first by understanding the existing market including f i r m s ’ willingness-to-pay, and the underlying reasons why these services may not be currently available from the private sector. For example, f i r m s tend to rely o n inter-firm relationships and informal sources o f information and assistance, Supply-side interventions, such as training to service providers can be used t o extend models of financially sustainable, cost effective services, while demand-side interventions, such as matching grants and vouchers, may be justified o n a temporary basis, because f i r m s lack knowledge o f the benefits o f the services. Efforts should always be complemented by an exit strategy and eventual reduction o f public sector involvement, for example through increases in cost sharing. Finally, rigorous monitoring and evaluation o f these types o f services is crucial to prevent the risks o f political capture or gradual drift toward a social development agenda. Other prongs include assistance to private sector organizations, strengthening parastatal organizations, policy formulation, strengthening capacity and coordination at the ministry level, and entrepreneurial s k i l l s development at the community level. 70 Additional information o n this topic can be found o n the Access t o Business Services Network o f the world Bank’s SME Development Program at http://www2. ifc. org/sme/htmI/capacity_bIdgJacility. html, as w e l l as the Committee o f Donor Agencies for Small Enterprise Development at www.sedonors.org which has published B D S Guidelines. 71 Webster (2004) and Hallberg (2000). 69 80 FIGURE6.3: PROVIDING BUSINESSDEVELOPMENT SERVICES The Old Approach: Substitutefor the Market ----------I Private- I I Government agency, Direct provision o f services The New Approach: Facilitate Market Development I Firm Firm L I ’ Firm Firm Private payment, commercial orientation Public funding, development Direct provision o f services ----b Facilitation o f demand & supply Source: Committee o f Donor Agencies on Small Enterprise Development (200 1). 6. 15 Small market size may hinder the development of private business development service providers locally. Although very little work has been done o n the issue o f whether there are significant economies o f scale in the market for business support services, one could imagine that this may be an obstacle for the development o f sufficient supply o f these services in the OECS, as per Figure 6.3. The OECS EDU and other programs source much o f the consulting services they provide to f i r m s from outside the sub-region. This provides yet another rationale for why the sub-region should pursue the increasing mobility o f service providers within the Caribbean and from beyond, as w e l l as improvements in firm level access to I C T services. In light o f the market size constraints, support for the development of local service providers should not jeopardize exporters’ access to the best services available worldwide. There are a number o f techniques including twinning domestic with external service providers in ways that may help to develop local capacity while maintaining competition and access. 6. 16 Industry clusters provide a n important avenue for the formal and informal interaction among firms that i s a critical element in the diffusion of learning and technology. While current research i s s t i l l unclear as to whether there i s a role for government in the emergence o f industry clusters, evidence does indicate that public support for technological development o f f i r m s i s best provided through these groupings. 6. 17 I n other countries in the region and beyond, private sector associations have spearheaded programs to provide technical assistance and other business development to their members. This report has already mentioned programs offered by the Caribbean Tourism Organization and the Caribbean Hotel Association. B o x 6.1 describes another such program managed by the Jamaica Exporters Association. In this regard, i t i s important to note that efforts by OECS EDU to develop an Association of Eastern Caribbean Exporters which could spearhead such an effort in the sub-region has not yet proven successful. 81 Jamaica. A j o i n t purchasing program in agribusiness, which resulted in a projected US$l million annual savings for cluster members, is being rapidly imitated with two other programs. An international marketing blitz in tourism, benefiting over 90 firms, has resulted in three new package tours ing offered through seven local and dozens of new international tour operators. I n entertainment, the you of the clusters, new distribution relationships have s and North American and Afi-ican distributors. already beenformed between Jamaican JCCP meets regularly with four different Ministers, has formed a close partnership with JAMPRO (Jamaica’s investment promotion agency), has deep linkages with academia, and appears regularly in the national media. I t remains however driven by the private sector. Although the original project called for the inclusion of two local consulting partners, more than twelve have participated and three are currently on the JCCP payroll. Thesepartners have helped lead cluster efforts, and one has been subcontracted (with OTF guidance) by the Printing and Packaging cluster, to implement a parallel cluster effort. I t is envisaged that the next phase w i l l further develop local capacity as well as move toward sel$funding by the private sector and participants. 6. 18 Business incubators are another method with which to help small firms overcome their capacity constraints at start-up. They provide a range o f services, from hands-on management and technical assistance and access to finance, to support services and infrastructure such as office space and communication facilities. Although their core competency i s not centered in providing access t o finance to SMEs, they can be a potent mechanism for intermediating venture capital and establishing networks o f investors. The goal o f an incubator i s to nurture new enterprises in their most vulnerable phase until they “graduate”-that is, they are financially viable and freestanding to leave the incubator. T o do so, incubators impose stringent selection criteria upon prospective firms, and monitor f i r m s ’ development with clear performance metrics and o n a regular basis. 6. 19 There are basically two types of incubator models: non-profit and for-profit incubators. The former are typically set up in pursuit o f public goals such as j o b creation, development o f technology infrastructure and commercializing new technologies. These incubators generally sustain themselves through rent and fees charged to clients at cost, and through complementary consulting and training fees. The second model usually involves the incubator taking equity stakes in the client companies in exchange for supplying office space and services. Research by the U.S. National Business Incubation Association (NEUA)72indicates that publicly-supported incubators create jobs at a much lower cost that other publiclysupported j o b creation mechanisms and that business incubators generally reduce the r i s k o f small business failure. Members o f the MIA report that more than 80 percent o f the companies that graduate are s t i l l in business after two years. 6.20 A recent development in this area i s the creation of “virtual” incubators, currently underway in Italy. These incubators put a strong emphasis o n international linkages. The incubators act as clearing houses to link up the client f i r m s with managerial expertise, finance, and technology f r o m anywhere around the world. The creation o f such incubators relies heavily o n available and affordable information technology services. 6. 21 K e y factors in the success of business incubators are the establishment and implementation of clear and strict performance metrics and success criteria for companies to “graduate”, and the early and continuous focus on financial sustainability and development of other sources of income. These lessons are illustrated in the experience o f the Technology Innovation Center in Jamaica, described ~~ 72 InfoDev (2005). 82 in Box 6.2. In particular, any efforts o n the part o f the incubator to intermediate finance for i t s clients should be clearly separated from the day-to-day operations and financial management o f the incubator itself. Box 6.2: JAMAICA’STECHNOLOGY INNOVATION CENTER(TIC) I n 2002 the University of eurial Center in Kingston. mmunication facilities and tec At t an incubator manager, an information te, TIC has approxima bator is overseen by a systems and marketing oflcer, Management Board chaired by member of the private sector. The to Jamaica, CIDA and own revenue generating activities. The latter comprising rent and tenant fees, and consulting and training programs offered to the private andpublic sector that represent 50 to 60percent of the budget. T I C is associated with the Western Association of Colleges and Employers and the National Business Association of Incubators in the US. Currently, the incubator is fully occupied mostly with firms developing Internet-based technology and customized computer software. One client is in quality control and another in commercial media productions. The largest firm has I7 full-time employees and 2-3 owners and the smallest one 1-2 employees. Their client base is quite mixedthey serve large Jamaican companies, public sector organizations and international businesses. Those that hold market presence abroad are mostly into software development or software solutions. Furthermore, some have established joint ventures with larger overseas organizations that work in Jamaica. Applicants are screened based on the extent that they satisfy the criteria of using technology to enhance business development. They then have to present a business plan to the Board. T I C usually facilitates this process by providing technical assistance in drafting business plans and proposals. Finally, applicants are assessed based on a range of expertise and entrepreneurial experience. The contract for tenancy obliges companies to share their financial information, so that the incubator can monitor company p as pointed out by TIC’S t as basis for choosing senior manager, this scree ’ s gain access to funds. This Currently TIC is also t t of high net worth individuals that want to provide seed capital to growth investment fu /Canadian billionaire, Michael Lee Chin has recently pledged a US$I emerging companies. million contribution to be disbursed to the institution over the next five years. The incubator also has in place a partnership with the National Export-Import Bank of Jamaica focused on grant start-ups ’ short-term loans at a fixed interest rate of 12 percent. So far, only one incubator client dedicated to commercial media production has been able to secure a total of J A $ 4 million in financing through this scheme. Companies “graduate when they transition fFom being start ups to anchors; however, the incubator does not have precise benchmarks or criteria for how the transition takes place. I’ Current Challenges As suggested by the center’s Senior Management, the challenges faced by the T I Cfall in four areas: 1. Providing financial assistance to client firms: although the incubator’s program for launching an Ange, Investment Network is underway, financing is one of the biggest challenges for start ups. The incubator sees itsel, more as an intermediary than the actual provider of funds. Ideally TIC would be aflliated to a fund set up by thir investment network. llenge for TIC is to adapt tht 2. Adapting to changing incubator’s technology since the incubator is very heavilj other profitable complementag bator becomes widely publicized Source: InfoDev (2005). 83 6 . 2 2 Finally, a lot of work has been undertaken on the development of national innovations systems as a way to promote the dynamic use and creation of new technologies by firms and workers in the economy in order to accelerate productivity and economic growth. The following attempts to adapt that literature - summarized in de Ferranti et aZ(2003) - to the particular characteristics of and conditions facing the OECS. 6. 23 D e Ferranti et al. (2003) identify three phases of technological development characterized mainly b y whether a country i s adopting, adapting or inventing new technologies. In each phase, there are appropriate public sector policies. 6. 24 I n Phase 1 countries transit up the technology ladder b y plugging into the global knowledge stock and adopting technologies that have been developed elsewhere. This i s achieved mainly through trade, FDI and licensing. The critical underlying conditions for this phase are the availability o f a labor force with general education and basic technical skills, openness to trade and FDI, sufficient competition among firms, and accessible communication and I C T infrastructure. Estimates o f threshold levels o f average educational attainment (for males 25 years and older) required to benefit at all from FDI-related technology transfers vary from 0.5 to 2.4 years.73 The comparable figure for St. Lucia for males, 15 years and older, i s 1.4 years. 6. 25 However, the composition of FDI matters for the impact on technology transfers. Servicerelated FDI such as i s common in the OECS i s characterized as being at the l o w end o f the traditional (hard) technology spectrum. However, the former may provide managerial, marketing and organizational models - the softer forms o f technology - that local f i r m s can mimic. For example, the former manager of a foreign owned hotel may go to work (or start her own) hotel using some o f the techniques she learned o n marketing and operations management. Local tour operators may mimic the service offerings o f tours organized by all inclusive properties. Backward linkages such as local purchasing by service i s another mechanism for technology transfer. However, this all depends o n the capacity o f local f i r m s to absorb or mimic. 6. 26 Figure 6.4, which illustrates the various ways firms in Grenada innovate, indicates that the technology transfer embodied in imported equipment i s by far the most important mechanism, followed b y the hiring of key skilled personnel. In terms o f trade; both access to high technology capital goods and lower end consumer goods can provide important transfers. An example o f the former can be found in St.Vincent and the Grenadines and the latter in Antigua and Barbuda. Mountaintop Inc, a bottled water company in St. Vincent and the Grenadines, was one o f the first o f these f i r m s in the Caribbean to purchase i t s o w n machinery to manufacture the plastic bottles that the water i s sold in. However, transport logistics made it difficult and costly to get servicing from the supplier in Miami, each time the machine broke down. So the manager and h i s staff basically reverse-engineered the machine. While this was a p a i n f i l process, the staff have now become so proficient that the M i a m i supplier contracts with them to provide services to other users in the OECS. At the consumer end, competition from imports o f consumption goods helps local manufacturers see first hand the packaging requirements for globally competitive products, whether it i s hand soap or spice bottles. While many o f the more innovative f i r m s in the sub-region have been started by returning immigrants with key skills, such as Benjo’s SeaMoss in Dominica and Barrons in St. Lucia which were started by food scientists, other f i r m s have had to hire needed expertise, such as Galeforce Windows in Antigua and Barbuda which hired a polymer scientist from the UK to run i t s operations. 73 Xu (2000) and Borzensztein, de Gregorio and L e e (1998). 84 FIGURE 6.4: H O W FIRMSIN GRENADA INNOVATE Others Embodied in new equipment 45% Developed within establishment international sources Trade FairdStudy Tours 10% By hiring key personnel 10% Source: World Bank (2004e). I n Phase I1 of the technology ladder, countries have reached a minimum adequate level of 6.27 the labor force and have adequate training institutions and universities. Own research and development (R&D) i s beginning to play a more significant role in maintaining competitiveness and i s requiring innovation-related institutions w i t h linkages to the private sector. M o b i l i t y o f labor between firms and pure research bodies i s increasingly important. The role o f government m a y shift from exclusively providing the enabling environment for trade, FDI, competition, education and training, to one o f providing leadership and addressing key market failures in the production o f R&D. In Phase 111, countries have become technological leaders where f i r m s make large investments in R&D to create new products and processes. Evidence f r o m the Grenada survey indicates that actual firm expenditure o n R&D in the OECS i s very limited, in contrast to the measures to import technology common in Phase I. Only eight companies indicated that they had spent money o n R&D activities in 2003 (three in tourism, t w o in manufacturing, one in telecommunications and one in construction). The total amount was a modest Eastern Caribbean Dollar (EC$) 1.4 million. 6.28 The ‘national’ innovation systems which support Phases I and I1 consist of networks of firms, research institutions and universities which are likely to be international; strong protection of intellectual property rights; adequate capital markets for financing long-term private R&D; and fiscal incentives for, and public financing of, R&D. I t i s unlikely that the OECS with i t s small population size could support the development o f such systems even within i t s major sectors. As such, and the sub-region should focus o n improving the enabling environment (required even for Phase I) should rely heavily o n integrating i t s f i r m s within regional or international innovation systems. This need to accumulate economies o f scale in research across the sub-region has been long recognized by the Caribbean governments as evidenced by the numerous regional research institutions associated with C A R I C O M and the University o f the West Indies. However, one k e y lesson f r o m the L a t i n American experience i s that universities and research institutions without sufficient and sustained linkages with private business needs do not really affect international competitiveness. D e Ferranti et a1 (2003) point to the fundamental differences in the approach to higher education in the US, where in 1919 MIT launched i t s Cooperative Course where students spent h a l f their time learning at General Electric, and the UK where universities were controlled more by the elites who used higher education as a means to set them apart from the working and commercial classes. As the countries that stand the most to gain from effective Caribbean-wide innovation systems, the OECS should both push for greater collaboration between i t s f i r m s and these research institutions, as w e l l as focus o n h o w these systems can help innovation in those industry clusters, such as tourism and certain niche products, that are important to the sub-region. 85 (ii) A case study on how ICTs can help build firm competiti~eness’~ 6.29 I C T can provide existing companies and new entrepreneurs an opportunity to engage in, and manage, the new dynamics o f the global marketplace. I C T can help f i r m s to learn, market, and sell more effectively. However, realizing the promise o f I C T requires not only the adoption o f ICT, but i t s appropriate use. These examples highlight five opportunities in the OECS for using ICT to improving firm level productivity in key sectors, some o f the lessons learned from actual firm and cluster experiences, and identifies recommendations for moving forward the use o f I C T in the sub-region for t h i s purpose. 0 Communicate with customers and integrate forward. Properly executed business strategy starts with the customers’ needs. Successful f i r m s are able to identify demanding and underserved markets and develop methods to effectively service those customers. Firms compete by embedding unique insights into the products they produce and the channels through which they sell those products. Those insights can be captured through interactions with, and feedback from, customers. ICT provides a quick and cost effective way t o keep that communication active and permanent. This ability i s key in sectors such as tourism, which i s a cornerstone o f the OECS countries. Instead o f falling into l o w cost models, such as the all inclusive or enclave tourism, countries need to foster ‘a total island experience”. Countries who do so strive to make the entire country a destination, and in doing so create a wide range o f experiences from which a visitor might choose. Erica’s Country-Style is a manufacturer ofpepper sauces and food snacks in St. Vincent and the Grenadines, which employs 10persons andpurchasesfrom more than 200 farmers island-wide. With annual sales of US$200,000, they originally marketed their goods mainly in the Caribbean. The company has been able to benefit from the Internet to open theirproducts to whole new markets. I n 2001, after the launch of their website, the company started receiving requestsfor information and orders from the US market, which now account for 10 percent of revenues. This growth has prompted the company to partner with a US distributor to save on shipping charges. Thefirm hopes by year end to be able to handle online transactions. Unique Jamaica is a marketing campaign involving approximately IO0 small and medium-sized tourism operators tourist market. Members include a IO-room ecoaimed at developing an alternati ur. The primary goal was to unite cluster members retreat, a tour operator with four in customer and marketing alliances that would allow them to compete for high-paying visitors. Members came together to produce custom tour packages targeted to nature-adventure travelers, ofering jointly the services of the various cluster members. The marketing campaign was centered on making actual connections with international tour operators complemented by a web site (www.explorejamaica.org) complete with an interactive map providing guidance to the traveler, links to appropriate tours, individual property information and a customized booking engine. The net result is not only a reduced booking cost, but a more tailored selection and booking experience. This I C T application is ideally suited to this cluster of Caribbean businesses. Finally, by using digital customer surveys to elicit feedbackfiom appropriate agents and tourists, the cluster was able to design their site to best meet the needs ofthe customers they most value. The idea of Bermuda Escapes was simple and the technical solution was even simpler: catalog and coordinate tourism experiences through a single back-end database and provide points-of-presence throughout the island to allow anyone in the industry to cross-book each other’s business and receive a small commission for the effort. Concierges would be able to arrange complete itineraries for guests. Dive operators would arrange transport and food for guests. Small hotels could arrange dinner reservations at Hamilton restaurants. Taxis would know where to pick up guests, and guests would experience a completely integrated vacation. Not only would visitors have a have an accura better experience, but tors value. Operators could segment this data and create u because they created most value, not because they ofe capes has reason to celebrate, but ticipated. Bermuda Escapes learned the effort was more 74 This section i s based entirely o n a report prepared by the consulting firm, OTF Group, Inc., for the Information Development Program (infoDev, www.infodev.org), a consortium o f public, bilateral and multilateral development agencies including the World Bank, and assisted by an expert secretariat housed at the World Bank. 86 two important lessons that are applicable to any broad initiative using ICT to coordinate cluster activities. Both of these points are about issues of culture and trust. Thefirst lesson was not to underestimate the investment required . While the professional information and tyin second lesson was the need to enforce punishments for not adhering to the system. At first, many enterprises did not accurately reflect their offerings, honor bookings and there were disputes over commissions, all of which cause visitors and the system to suffer. 0 Improve productivity and logistics. I C T can improve efficiency when it i s incorporated both inside the organization and used to transact along the value chain, allowing for quicker responses to the market, improved coordination o f supply and demand and excellent customer service. The former often requires a deep reorganization o f the way the organization works: incorporating efficient back up systems and knowledge sharing databases, to achieve seamless communications between divisions. In agriculture, where most o f the players are small and fragmented, there i s an important benefit to eliminating information asymmetries. able to provide immediate pricing quotes by analyzing the AUTOCAD drawing sent electronically by architects and developers j?om around the Caribbean. This is vely helpful for architects and developers to accurately predict build-out costs. The plant is fully digitized with state of the art machinely *om Germany. This reduces human error and minimizes waste. Workers can weld thefour corners of a window in 70 seconds, instead of 40 minutes fi it were done manually. The company pays twice th inimum wagefor factory workers, employs young operators and onsiderably reduced turnover rates. As business grows and invests heavily in specialized training, which h reueat customers are the norm, online transactions may become a viable option. 0 M a k e distance irrelevant. Historically the time and effort required to move physical goods reduced - and often prevented - distant competition. Even as barriers to movement and shipment have been reduced over time, the difficulty o f coordination and communication s t i l l gave the edge to local firms. The advent o f global ICT has made it easier and cheaper than ever to stay in touch with customers and suppliers, and as knowledge and information become an increasing percentage o f the ‘value-add’ o f products, I C T creates significant value by allowing the free and instant transport o f digitized knowledge and information. Although popular examples o f I C T overcoming distance are often those o f international coordination o f production, or the ability to communicate with customers h a l f a world away, in many countries overcoming the physical distance i s not nearly as important as the elimination o f a barrier to competition. Imagine the local impact o f a fishing boat o n i t s way to shore using a cell phone to learn which harbors are offering better prices, or which markets have greater demand for the types o f fish in the holds. N o longer are producers beholden to middlemen who simply broker information; they negotiate in a market closer to perfect information, with each party benefiting in proportion to the value they contribute. Caribbean Medical Imaging Center is a privately-owned radiology center in St. Vincent and the Grenadines that to ultrasounds and mammography medical imaging. As the provides a range of services nd opinions or the judgment of sole radiology provider in St. Vinc rocedure of sending hard copies medical specialists in some was incorporated in the practice as a way to to colleges around the world. the Center started using digital improve diagnosis a volume of data transmitted also cameras to upload i made the process significantly long. With the advent of Digital Subscriber Lines (DSL), transmitting was made virtually instantaneous and of superior quality. I n fact, C M I C has received one of the first wireless commercial installation programs in the island. The current challenges are to convert *om analog to digital images, and perhaps to move to wireless transmission. Sourcing skilled technicians, both to handle and provide maintenance to the equipment remains a problem, as is the absence of a formal structure for reimbursing overseas physicians for telemedicine consultations. 87 0 Understand and improve competitive positioning. As globalization has eliminated the physical barriers between markets, it has also done the same with competitors. With competition n o longer confined to the neighbouring plantations, mines and factories, today’s companies need t o compete with global f i r m s that can more easily than ever enter existing markets and take away once loyal customers. Previously an area available only to the large f m s with deep pockets, I C T can now help f i r m s o f all sizes gather customer and competitor information in real time allowing them t o make timely and informed decisions about how and where to compete. Jamaica Signature Beats (JSB) is a non-profit company of music producers, studios and professionals which have joined forces to provide technical and creative expertise to the international music industry. The company used I C T to access information and online surveys to in ional labels to reposition themselves and find customers around Jamaica. Jamaica remains an attractive location because of the world that would be interested in record lower costs, a wide range of services and the e talents and culture. The company then created an interactive website (www.jamaicasignaturebeats.com) to market its booking and logistical services to overseas customers. The website also allows international labels and bands to browse the individual member pages which include bios, digital sound files, history, genre of expertise and track record, and to customize a package of the wide range of services (studio time, engineers, mixers, producers, musicians, etc) they would need to record in Jamaica. JSB also used the internet to conduct a public relations campaign by electronically distributing its press release to over IO0 US print publications at marginal cost. This campaign resulted in a dramatic increase in hits and enquiries. The website also displays JSB ’s strict membership criteria helping ensure the client of the quality of the service provision. JSB has an operational arm in charge of checking that members comply with standards of quality, service and security. They provide randomized surveys to track customer satisfaction to make sure that producers clients. I t is important to note that and studios are on time, fulfill their cont of low trust, communication and the collaboration around th had made interactions with the global music industry quite dgficult. collaboration within the indus 6. 30 Recommendations. The following are a number o f recommendations for the public sector and donor community o n how to promote the use o f ICT by f i r m s to build competitiveness: 0 0 Facilitate access. Access to technology, as seen above, i s essential for f i r m s to compete globally. While wiring every town with broadband connections may yield wide-ranging benefits, it may not deliver the same economic impact as connecting every firm with the digital marketplace. The liberalization o f telecom services i s taking place in mobile telephony, but the process needs to be sped up and in parallel, new technologies like Wi-Fi or W i - M a x (longer-range wireless technology) need to be encouraged and widely embraced. Further details o n access are presented in Ch. 6, Section C. Strengthen regulatory environment. As more people turn to ICT to complete more o f their day-to-day operations, it i s imperative that legislation i s kept attuned to ICT and i t s use. The legal enforcement o f electronic documents and contracts, protection o f intellectual property and privacy, and development o f a framework to support electronic transactions, for example, electronic signatures, Internet banking and transactions, and Internet crime, are amongst the priorities in t h i s realm. Laws o n intellectual property as it relates to the internet - in code, data, music or other content - has important implications for businesses selling into a multijurisdictional world. Keeping abreast o f these changes and providing up-to-date, enforceable legislation will affect the sub-region’s ability to transact with and attract foreign businesses. In addition, the more legislation i s harmonized in the sub-region, and made compatible to international standards, the greater the benefit to these economies and their attractiveness to foreign investors. Ideally, the Caribbean should proceed in these reforms as a regional block. Norway has been at the forefront of e-legislation. The authorities have recently put in place an initiative to use digital signatures in electronic interaction with and within public administration. Furthermore, through the Norwegian Agency for Development (NORAD) in partnership with UNDP, Norway is sharing its initial success with developing countries. I n addition, organizations like Internet Corporation F o r Assigned Names and Numbers and ITU can provide guidance on the latest standards. 88 0 Improve s k i l l s and capacity. As noted above, the s k i l l base i s an area that needs immediate and sustained attention across the OECS. Table 6.2 lists the numbers o f people in the different countries that have received certification to work w i t h Novell applications, a popular networking and computer software firm.” The OECS has only 0.3 persons per 10,000 people in the population, compared to 10 per 10,000 people in the Cayman Islands, and 3 in Barbados. However, with respect to ICT, i t i s not just the IT s k i l l s that count. The general level o f education and technology training o f an organization’s employees i s a factor in any f i r m s ’ ability to adopt any new technologies. In addition, appropriate managerial, marketing and research s k i l l s are needed for f i r m s to understand the potential offered by ICT and therefore be more willing to pay for i t s use. Regional certification boards can also improve and harmonize regional standards in I C T technical degrees to intemational standards. As such, some o f the key areas for targeted recommendations are: 0 0 0 0 formulate national training policies and programs in ICT- critical areas; reform curriculum at all levels o f education and training to include ICT-critical areas; develop programs for training o n market research & data collection systems; and create and strengthen partnerships between academia and the private sector. The St. Lucia National Information Technology Training Fund was established by the Government in collaboration with a local bank toJinance the training programs of IT companies, as well as computer training for unemployed secondary school graduates. Interest-bearing loans are provided for up to US$6,000 per person with maturities ranging 12-48 months. TABLE 6.2: NOVELL CERTIFICATION IN THE CARIBBEAN Antigua and Barbuda Dominica Grenada St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines OECS Cayman Islands Barbados Bahamas Trinidad and Tobago U.S.Virgin Islands Martinique Belize Jamaica Suriname Guadeloupe Guyana Source: Novell. 0 Number o f people with Novell certification 2 0 4 0 6 6 18 39 84 82 154 11 36 9 84 13 13 13 Novell certified workers per 10,000 people 0.255 0.000 0.382 0.000 0.374 0.550 0.315 10.000 3.123 2.61 1 1.181 1.ooo 0.838 0.356 0.321 0.300 0.292 0.170 Strengthen existing and emerging export clusters. One lesson from the above firm cases i s that although ICT can help overcome barriers to trust and collaboration among industry participants, i t requires the prior independent formation o f those groupings. Although there are some sector-specific industry associations, cooperatives and loose groupings within the OECS, many tend to be fragmented across the islands, limited in capacity and focused o n lobbying for ’’ Data for other popular certifications such as the Microsoft Certified Professional, or Oracle Certification Program do not release data on certified professionals by country. 89 concessions and preferences. These incipient clusters can provide a useful way o f galvanizing f i r m s around group efforts to use I C T to build competitiveness and need to be encouraged. coop (processing, composting, packaging, financing, R&D). Bay oil is produced by distillation from the leaves and young wood of a plant (Pimenta Acris) that is indigenous to Dominica. The oil is exported and further processed to yield some twenty-nine high-value derivatives that serve as stabilizers for pharmaceutical and cosmetic products. The cooperative is the worldwide leader in production of the essential oil, commanding some 88 percent of the world market. Besides the essential oil, the coop also produces bay rum, a lotion that is very popular in the Caribbean region. Gross sales amount to some US$2 million and value of exports has grown, on average, by 9.4 percent per year during 2000-03. ries of an ancient type; the coop owns and operates one new Members own and operate 35 and in output capacity. Management of the distillery unit, vastly superior in eflc nds. They have ambitious plans for coop is well-structured and has expansion following from a well crajied strategy allow not only expansion of bay-oil output and They are seeking to invest in added increase in productivity but also (since the distillery equipment is readily adaptable) diversijcation into distillery of other high-value plant extracts (e.g. fi-om sweet basil, geranium, thyme, marigold, grapehit). They aim to increase value-added by going downstream into extraction of derivatives (value added is estimated to be 3 times the price of a unit of the basic oil). They are seeking to diversify output of farmers by moving into cultivation of a variety of high-value “organic” roducts), using as fertilizer the compost products (value added is estimated to be twice the price of non-orga produced fi-om by-products of disti The planning process is now far a n extensive technical and market research, training ofpersonnel, preparation of a business plan, and proposals for financing options, including equity to be contributed from coop reserves for financing capital equipment). Donor contributions from the EU Business Challenge Fund helped to finance technical assistance and training. 0 Reward innovation and entrepreneurship. Government policies aimed at rewarding innovation and entrepreneurship can help to shift f i r m s away f r o m seeking out concessions and incentives as their predominant business model toward innovation, human initiatives, and learning as the strategy for success. The government should help publicize, reward and disseminate successful entrepreneurial activity to give people in the OECS the sense o f possibility. B. Finance for diversification “The least well developed financial sector activities in all of the Focus Countries [including the OECS] are those at the two extreme ends of the size spectrum - the capital markets at one end and the informal and entrepreneurial sectors at the other. The underdevelopment of these activities Deloitte Touche Tohmatsu (2004). constrains economic growth. ’I 6. 31 This section explores broad trends in financial intermediation in the OECS which are important to growth and competitiveness. The OECS financial sector i s dominated by commercial banks and compulsory savings institutions (mainly social security funds) which account for over 90 percent o f sector assets. Bank credit i s therefore the m a i n avenue o f financial intermediation. A large body o f analytical work has been done o n the stability o f the OECS financial sector in recent years, which w i l l not be repeated here. Despite the deteriorating r i s k profile o f the banking sector partly as a result o f the growth slowdown and deteriorating asset quality, deposit growth has remained strong and banks have sufficient liquidity to support private investment. In recent years, bank lending t o the private sector has fallen off, commensurate with the decline in private investment discussed in Chapter 1, and substituted progressively with consumer credit, government lending, and growth in net foreign assets. 90 6. 32 Yet i t i s a common complaint o f new emerging exporters in the OECS that they are credit constrained. One o f the reasons for this i s simply that bank credit i s not an appropriate source o f finance for r i s k y new ventures, and that instead these enterprises need risk or other forms o f equity capital. As i s common in developing countries the equity markets in the OECS are thin. The recently established stock exchange has been far more successful in channeling funds to the government versus the private sector. As the OECS tries to diversify into new areas, t h i s may become a key constraint. The financing needs and borrowing capacity o f service exporters are also different from traditional brick and mortar or agricultural establishments. Given the limitations o n equity markets to also serve small emerging exporters, and the difficulty o f developing more sophisticated equity instruments in small developing countries, the OECS will have to take measures to improve both the “bankability” o f these new investments by raising accounting standards and credit information, among other things. 6. 33 Firms in the O E C S appear to rely primarily on internal equity or retained earnings and bank credit to finance their working capital and investment needs. Table 6.3 shows that 35 percent of the 130 f i r m s surveyed in Grenada relied exclusively o n retained earnings to finance working capital w i t h 19 percent relying exclusively o n this source for new investment capital. The second major source of financing for the Grenadian f i r m s i s bank credit. Venture capital and equity reportedly account for only 2 percent o f finance for new investments in Grenada. TABLE6.3: SOURCES OF FINANCE FOR FIRMSIN GRENADA Retained Bank Earnings Credit Working Capital Average share in total finance (%) N o . f i r m s accessing the source N o . firms relying o n the source entirely New Investment Average share in total financing (%) N o . firms accessing the source N o . firms relying o n the source entirely Note: Total number o f respondents was 13 1. Source: W o r l d Bank (2004e). Trade Credit Venture Capital Other All Other Equity Sources 60.2 111 45 25.5 68 8 4.5 28 0 1.8 3 2 1.5 9 1 8.2 36 1 48.4 51 25 42.0 41 17 0.4 2 0 0.8 1 0 2.1 3 1 6.4 11 2 6. 34 These high ratios imply either a preference for internal and debt financing to prevent loss of control or real limitations in access to other sources of finance. Interestingly, a small survey o f 40 publicly-listed companies in the Caribbean76 (including several f i r m s in the OECS) found that the majority o f financial managers prefer to rely o n a hierarchy o f financing sources headed by internal finance and “straight debt” than trying to maintain a target debt-to-equity ratios when seeking financing for new investments. Correspondingly, they also reported that maintaining financial independence was a preferred goal in their financial planning ranking higher even than the goal o f maximizing firm value. 6. 35 Despite the heavy reliance on bank credit, there are critical issues constraining both the demand and supply for bank-intermediated finance to the private sector in the OECS. The private sector throughout the OECS complains o f their limited access to bank loans due to a highly conservative banking sector, and o f high interest rates. Conversely, the banking sector cites a shortage of bankable projects, deteriorating creditworthiness o f commercial borrowers, and problems with realizing collateral in the event o f a default. 6. 36 The banking sector which accounts for 51 percent of the sub-regional financial sector has experienced strong growth in deposits averaging 12 percent per year over the last two decades. Although growth has slowed since 2000, it s t i l l remained robust at 8 percent per year during 2000-2003, even in the face o f the recent deteriorating risk profile o f the banking sector. Part o f the reason for t h i s ~ 76 Robinson, C. Justin (2003). 91 has been the maintenance o f a floor on savings deposit rate now at 3 percent compared with an average U S savings rates o f 0.5 percent at end December 2004. 6. 37 However, bank lending to the corporate sector has been declining steadily since the early 1990s in part crowded out by increased lending to both the public sector and consumer markets (see Figure 6.5) and increased offshoring o f excess liquidity. Credit to the public sector now accounts for 15 percent o f bank lending up from 11 percent in 1992, while consumer lending now accounts for 46 percent o f loans and advances, w i t h per capita consumer lending relatively high at 120 percent o f per capita i n ~ o m e . ’ ~Notably, one segment o f consumer lending - residential housing loans - account for 26 percent o f total loans and advances.78 Foreign assets as a share o f banking sector assets have risen sharply f r o m 13 percent in 2000 to 20 percent in 2004. FIGURE6.5: DISTRIBUTION OF BANKING SECTOR LOANS AND ADVANCES BY BORROWER Others includes financial institution, subsidiary, affiliate, and non-resident loans Source: ECCB. 6.38 Banks appear to be competing with each other, as well as with non-bank financial institutions, such as the few mortgage institutions and 80 credit unions, for the consumer finance market, but there i s markedly less competition in the commercial market for bank credit. That market appears to be quite segmented with foreign and private banks catering to the top-tier domestic and international clients, state-owned and development banks catering to riskier but larger domestic clients (with commensurately lower asset quality) and credit unions, National Development Foundations and a few private microfinance institutions catering to the micro and S M E business. 6. 39 I n terms of credit instruments, the sub-region appears to be reasonably well supplied with both short and long t e r m credit. The latter accounts for 60 percent o f commercial bank loans and advances, although a large share i s for residential mortgages. However, export financing i s s t i l l not readily available. The ECCB does provide an Import-Export Guarantee Scheme, but f i r m s report that it i s burdensome in part because it requires a separate application for each shipment. There are some efforts underway to expand t h i s to include export credit insurance. 6. 40 Prime lending rates range f r o m 8 to 12 percent, and have remained at this level since the early 1990s. M a x i m u m lending rates remained high at 28 percent throughout the 1990s but have since declined to 25 percent in 2004. The reasons for these relatively high interest rates have been explored in , recent literature on the sub-region. Randall (1998) finds that the floor o n deposit rates adds significantly Includes mortgages. This m a y b e a concern given that prudential norms w o u l d require not more than 25 percent o f a bank’s portfolio in one sector. Moreover, the prevalence o f natural disasters together with l o w levels o f private insurance make this an even more risky scenario. 77 78 92 to cost o f lending, but also that high operating costs associated with small scale operations are a critical factors. Given the impact on the cost o f borrowing, discussed above, this report supports the recommendation that an in-depth analysis be undertaken to determine the net effect o f the deposit interest rate floor o n savings, versus the impact o f increased cost o f lending.” 6. 41 While small market size may be contributing to the high operating costs, the banking sector does not appear to be immune from other operating inefficiencies that encumber commercial borrowing. Forty six percent o f the f i r m s surveyed in Grenada reported that it took their banks three weeks or longer to process new loans, and collateral requirements appear to be relatively high. Close to 40 percent o f the f i r m s surveyed in Grenada with bank loans, have collateral-to-loan ratios o f more than 125 percent. However, these ratios may be a symptom o f high and rising non-performing loans and difficulties reported by many banks in realizing collateral in the event o f default. 6. 42 On the demand side, there i s some indication of a recent dampening in firms’ demand for bank credit, as well the need to strengthen firms’ capacity - both managerially and financially for borrowing. About h a l f o f the companies in the Grenada firm survey that reported using overdraft facilities or lines o f credit were using less than 50 percent o f the approved l i m i t s and for a significant group o f companies (47 percent) their last commercial bank loan was contracted several years ago. Three quarters o f the companies reported that they had not sought access to other sources o f funding than local bank loans, for a variety o f reasons including lack o f familiarity and belief that they would not be able to meet the requirements. In addition, several f i r m s that were interviewed noted that national development banks were not offering much more than commercial banks. 6. 43 I n terms of firms’ capacity to borrow, commercial banks cite inadequate financial information both from the firms and independent sources on project proposals, and the increasing number of overleveraged borrowers as some of the reasons for the decline in private sector credit. As such there are some measures t o strengthen financial intermediation through the banking sector. These include: 0 0 0 0 raise accounting standards t o increase the supply o f appropriate financial information by borrowers for lending; introduce a credit bureau in the OECSS0to provide greater information o n borrower risk profiles; encourage consolidation o f the banking sector t o create the economies o f scale needed to reduce operating costs; and address the legal and administrative issues regarding the realization o f collateral. 6. 44 Even with these measures, it i s unlikely that the domestic banking sector and credit institutions can serve all the financing needs o f the OECS private sector for i t s diversification and growth, for two reasons. The first i s that bank credit i s generally not suitable for all types o f investment financing needs, and the second i s that the financing needs o f the private sector in the OECS are changing, and indeed will continue to change, as the sub-region transforms and diversifies the structure o f i t s economy and export base. Table 6.4 presents a textbook check l i s t for firm financing decisions. In general, credit i s preferredhecommended when f i r m s are operating in a stable economic climate, have a relatively l o w risk and healthy financial outlook in terms o f sales and profitability, a larger share o f general purpose fixed assets that can be used for collateral, and face high tax rates. However, the economic transition already underway in the OECS, and which will need t o be accelerated, can be characterized as a period o f Schumpeterian creative-destruction in which there will be enormous churning as f i r m s seek out new and profitable ventures in an evolving external environment. 6.45 I n addition, service firms have different financing needs and borrowing capacities than brick and mortar, or agricultural operations. F o r example, they may have less fixed assets to serve as 79 IMF (2003a). A Barbadian firm has recently completed the feasibility for a regional credit bureau including the OECS. 93 collateral and require a much larger share o f working capital. Equity financing, and risk capital in general, are more suitable when f i r m s are facing uncertain futures, are already highly leveraged, and diversify into new areas that banks may have little experience with and which prudent management o f depositors funds would force them to shy away from. However, very few developing countries have managed to sustain these types o f markets. TABLE6.4: A TEXTBOOK CHECKLIST FOR FIRM FINANCING DECISIONS FOR NEWINVESTMENTS I I Profitability Asset structure Leverage Taxes Growth rate Debt i s preferred when the firm has: A more stable sales forecast A more stable outlook for profitability An adequate amount o f general fixed -purpose assets L o w enough operating leverage to allow for h r t h e r borrowing Higher tax rates that allow interest expense Rapid, but certain growth rates Lender attitudes General agreement with i t s lenders o n i t s appropriate capital structure Credit conditions Good market conditions for credit, including l o w interest rates Achieved some n e w operational goal such as product development o r improved efficiency that may not be w e l l understood by creditors Internal conditions I Equity i s preferred when the firm has: Riskier sales when branching into new I ___ _ _ areas Riskier but potentially high rates o f return Business specific assets that m a y be difficult to-resell in the event o f a default Reached some limits o n i t s borrowing capacity I I Rapid, but more uncertain growth projections Less agreement with its lenders o n its appropriate capital structure, perhaps because it is entering a field in which the lender has less familiarity and expertise Achieved some n e w operational goal such as product development or improved efficiency that m a y not b e w e l l understood by investors o r the stock market 6. 46 T o date, the Eastern Caribbean Stock Exchange (ECSE) has been more successful in channeling funds to the public sector rather than the private sector. At one end o f the spectrum, the introduction o f the Eastern Caribbean Stock Exchange (ECSE) in 2001 was intended to provide a useful avenue for channeling savings to finance private sector equity needs. However, in i t s three year history, most o f the activity has involved government companies and instruments. Unless competition between underwriters i s fierce and the market specifically designed for 'penny' stocks, public equity issues are generally too expensive for the smaller, start up f i r m s which may b e charting the way for the OECS into new sectors, Others have noted that limited competition between licensed brokers may have kept costs too high for even more established medium sized f i r m s to access t h i s form o f financial intermediation. Given progress o n the CSME, there will likely be pressure in the future to merge or integrate the ECSE with other stock exchangesg1in the region. 6.47 I n the middle of the equity market spectrum, the O E C S i s served b y a few fledgling venture capital institutions and a new regional private equity fund in Trinidad and Tobago. This segment o f the equity market i s characterized by private institutions that are organized t o connect investors with enterprises in a less organized fashion than public equity markets, but they play a crucial role in matchmaking available resources with investment needs. In recent years, the business models for these institutions have become quite sophisticated.82 In addition, the embryonic Eastern Caribbean Enterprise Fund (ECEF) to be established by the ECCB i s intended t o provide another participant in this market.83 6. 48 As currently envisaged, the ECEF represents a very ambitious effort to provide a wide range of financing and business development needs for various types of enterprises. These include " Jamaica, Barbados and Trinidad and Tobago. For recent developments see The Economist (2004). 83 E C C B (2004). 82 94 debt and equity financing, export insurance coverage, and business advisory and consulting services. In general, such omnibus efforts run the risk o f trying to do too much. As mentioned above, the financial markets have developed very specific, sustainable models for servicing different types o f business needs, f r o m funds for SME/micro credit to private equity fundss4to venture capital funds, to models for dealing with what are called ‘shoehorn lifestyle’85businesses. For example, the venture capital business model i s l o w volume (eight to ten deals) with exponential growth (two or three o f these deals with exponential revenue growth) but requiring lots o f hands on attention to each deal and having a structured means o f exit either through sale to other investors or listing o n the exchange. SME/micro finance i s a lower cost, high volume business requirement with some degree o f systematization closer in nature to a bank’s credit check than to the venture capital’s hand tailored approach. The business model for dealing with lifestyle businesses i s systematized to a degree to manage high volume, but it does not structure transactions to rely o n predetermined exit strategies. Instead other ways o f cash extraction to secure returns to the investor are devised that are consistent with enterprise structure. 6. 49 Notwithstanding the complexities illustrated above, there i s experience worldwide with utilizing a number of these models in developing country situations. There are a number o f private equity funds in Africa where the size o f the average economys6 i s comparable to that o f Barbados. However, these funds tend to be regional and may have some public or donor support for administrative costs. They face similar challenges to those that would be encountered in the OECS such as building trust outside ethnic and family groupings, building technical expertise at the enterprise level, promoting relevant banking and accounting services, trail-blazing w i t h regulatory and legal authorities to develop new equity and quasi-equity instruments, and limited exit strategies for the investors. As such, the subregion should seek technical assistance to re-examine and, if necessary, reformulate the ECEF proposal before proceeding. 6. 50 Finally, a t the least organized end of equity markets are the most idiosyncratic mechanisms connecting investors with enterprises. They range from entrepreneurs simply reaching out t o their circle o f family, friends and acquaintances for investment resources partners, to merchant banks brokering private placement o f funds. However, as with most developing countries, the OECS s t i l l faces critical cultural barriers t o the dilution o f ownership and control involved in taking o n outside investors. Very few o f the small f i r m s interviewed for this study that were facing financing constraints for new investments had considered the possibility o f seeking out private equity partners. The common phrase ‘partnership i s a leaky ship’ was repeated again and again. A renowned, but small, exporter in Antigua and Barbuda was discouraged by i t s financial advisers from taking o n new investors to finance the much needed development o f a small plant. At the same time, however, when t h i s option was raised for one small exporter during a meeting in Dominica, at least one o f the larger (and currently protected) manufacturing f i r m s jumped at the idea o f investing in this firm as a means o f diversifying i t s base toward more competitive exports. Some o f the barriers related to a lack o f awareness o f the range o f deals that are possible. Other barriers relate to a shortage o f technical expertise, both legal and financial, to help f i r m s arrange this type o f financing, as well as to the need for some legal infrastructure such as regulation to ensure protection o f minority shareholders. 6. 51 I n general, the role of the state in supporting the development of private equity markets should be limited to resolving administrative hindrances to equity finance such as promoting a culture o f entrepreneurship, equalizing tax treatment o f debt and equity financing, increasing measures to foster integration, and easing regulatory constraints and administrative procedures for setting up companies. 84 The Emerging Markets Private Equity Association provides a toolkit for developing private equity funds at www.gptoolkit. org. 85 Shoehorn lifestyle f i r m s are businesses which support one or more families, but do not have realistic prospects to become publicly listed companies. 86 N o t including Nigeria, South Africa, Zimbabwe, Cameroon, Kenya, Sudan, and C6te d’Ivoire. 95 C. Telecoms, energy and transport 6. 52 The O E C S still have uncompetitively high costs in a number of key utility and infrastructure-related services which are crucial for both the niche manufacturing and broad based services in which they may compete internationally. The provision o f utility services- energy, water and sewerage, telecom, waste disposal - are key inputs into any country’s production system. This section tries to understand whether high costs (which include issues o f reliability and quality o f supply) are the result o f diseconomies o f small size which may be insurmountable in the short run, or result from technical inefficiencies, management weaknesses or limited regulatory capacity that can be addressed by reform. 6. 53 Scale or organization? Even though recent technological advances have reduced economies o f scale in the production o f many utility services, as we shall see in electricity and telecommunications, in other areas, the very small size and island geography o f the OECS countries s t i l l engender natural monopolies in t h i s part o f the national supply chain. In some areas, new technologies have reduced the minimum efficient scale o f utility operators to such an extent as to pave the way for private competition, b o t h domestic and foreign, even in such small markets. Inothers, new advances m a y create opportunities for a single supplier to service the different islands thereby taking advantage o f remaining economies o f scale. As such, achieving the appropriate regulatory framework to ensure a reliable and competitively priced supply remains a crucial part o f overcoming some o f the scale disadvantages. 6. 54 With relatively good levels of access to utility services by the general population, the O E C S countries should now focus on improving reliability, quality of supply and costs to the productive sector. Utility services impact competitiveness directly through cost o f production and cost o f living, as w e l l as indirectly by affecting the productivity o f a country’s human resources. F o r example, poor access to clean water and sewerage w i l l affect health outcomes and in turn labor productivity. School children with access to electricity - or, o n another dimension, the internet - will be better prepared for the labor market. As such, there are often tradeoffs to b e faced in terms o f the provision and pricing o f utility services to consumers and producers, respectively. One advantage o f the OECS countries i s that, with relatively similar levels o f access to basic utility services by the general public and the poor, these tradeoffs in terms o f provision are less acute. There i s a clear need to improve reliability and quality o f supply to the productive sector. 6. 55 I n many cases the pricing of services s t i l l reflects the historical policies of redistribution aimed at achieving equitable growth, but resulting in a bias toward consumption and away from production, W h i l e it remains a common practice worldwide for utility tariff regimes to retain some cross transfers from one class o f users to another, the extent to which the private sector subsidizes non-poor consumers in the OECS i s significant. Any agenda for growth will necessitate some rebalancing o f these transfers in order to reduce costs t o the private sector as the engine o f growth and j o b creation. (i) Telecommunication services 6. 56 As we have seen earlier in this chapter, telecommunication services are critical to the development of service exports and improving competitiveness of firms in the O E C S . Despite recent advances in this area, with the establishment o f the Eastern Caribbean Telecommunications Authority and the successful dismantling o f the sub-regional monopoly in some k e y areas, the OECS w i l l have to make significant advances in lowering costs and expanding access. This issue i s a matter o f priority because o f the broad impact that access to the internet can have o n firms, households and the government. 6. 57 Teledensity in the O E C S remains low despite early success in establishing good mainline access. However, recent liberalization o f the mobile market has seen a rapid uptake in mobile service which may rapidly close the gap with the sub-region’s competitors. Costs o f fixed telephony remain high relative to competitors, probably a function o f small population size. With respect to the internet, access i s comparable to other Caribbean and upper middle income states, but m u c h less so than other small island states, which seem to have pursued the internet as a competitive strategy for overcoming scale and 96 remoteness disadvantages. Again costs are higher than the sub-region’s competitors and significantly more so for the business sector than for residential consumers. 6. 58 The OECS has somewhat lower teledensity (land and mobile lines) averaging 48 subscribers per 100 inhabitants than other upper middle income countries, which average 56 subscribers per 100 people. However, OECS mainline densities are higher at 34 subscribers per 100 inhabitants, achieved in the late 1990s, compared with 25 for upper middle income countries and 26 in the Caribbean. However, this masks wide disparities across the sub-region, ranging from 23 subscribers in St. Vincent and the, Grenadines to 50 subscribers in St. Kitts and Nevis. In addition, the OECS mobile density o f 15 subscribers per 100 people in 2002, although increasing o n average by 53 percent per year during 20002002, remained w e l l below the average density o f 35 in upper middle income countries. However, anecdotal evidence indicates an even faster increase over the past two years. In particular, one o f the major mobile operators reports that i t s subscribers alone in Grenada, St. Lucia, and St. Vincent and the Grenadines in M a y 2004 are more than double the total number o f subscribers in those countries in 2002. 6. 59 Fixed telephony costs for connections and monthly subscriptions as reported to the International Telecommunication Union in 2003 vary widely across the sub-region, with the highest costs generally incurred in non-ECTEL member Antigua and Barbuda, but also in Grenada. On average, however, the OECS compares reasonably w e l l with i t s competitors o n residential charges, again reflecting the regional tradition o f striving for equitable access, but less so o n the business charges. Unit charges for local calls and intemational calls in the OECS are higher than i t s competitors (see Table 6.5), but similar to other microstates, except in residential subscription rates. This suggests that fixed line telephony costs may be subject to economies o f scale. TABLE6.5: SELECTED TELECOM AND ICT INDICATORS, ResidentialCharges US$ Business Charges Connection Subscription Connection Subscription OECS Caribbean Americas Other micro states Upper middle income USA Source: World Bank (2004i), 2002 Cost of a 3-min call to N Y C Local Internet users per 100 people 59 8 70 18 1.36 0.09 13 45 7 49 19 0.91 0.04 13 88 8 115 16 0.65 0.05 10 61 11 64 18 1.60 0.07 21 62 8 82 12 1.01 0.09 14 23 428’ 72 44 55 International Telecommunications Union (October 2004), and InfoDev (2004). 6. 60 Small states face major cost disadvantages with respect to international calling charges, but a n advantage with respect to connection charges. Winters and Martins (2004) find a diseconomy o f scale with respect to connection charges (that is, connection charges increase with population size) and a disadvantage o f small size, although statistically insignificant, o n the order o f 20 percent for monthly subscriptions or line rental rates in microstates.” On the other hand, they find very significant and major cost disadvantages with respect t o per unit intemational calling charges, o n the order o f 130 percent, for microstates. However, it i s important to point out that the OECS averaged lower intemational call rates than their Pacific counterparts (as well as for calls to Tokyo and London). 6. 61 Data and internet services are now just as important as conventional voice communications. They are a crucial input to education and for export-oriented service businesses. Internet usage i s very difficult to measure, but the ITU provides estimates o f number o f internet users per 100 persons. The average for the OECS compares favorably with Latin America and other middle income states, but not with other micro states. The average also masks a wide range f r o m 6 users per 100 persons in St. Vincent and the Grenadines to 21 users in St. Kitts and Nevis. However, the sub-region w i l l need to broaden access significantly if it hopes to use the internet as a means o f raising competitiveness. charges may reflect relatively lower unit call charges because o f the plans offered by providers. Winters and Martins use a definition for microstates o f having populations less than 400,000 persons. ” H i g h subscription 88 97 6. 62 Some small states are pursuing aggressive expansion of internet usage as a way to overcome scale and remoteness. As a measure o f internet penetration o f the business sector, we look at the number of intemet hosts and compare it with GDP as a measure o f the size o f the economy to see where the OECS rank (Figure 6.6). In relation to GDP, w e see that the OECS has the following average number o f internet hosts relative to their economic size - Dominica and Antigua and Barbuda scoring relatively higher, and Grenada, St. Lucia and St. Vincent and the Grenadines coming in below the mean. It i s also notable here that the best performers with respect to their economic size are generally small countries, again implying that the internet provides a w a y t o overcome other scale disadvantages. FIGURE 6.6: INTERNET HOSTS, 2002 18 Taiwan, Prov. of China 0 6 lcelang 16 18 20 22 o 24 Log GDP (US$) 8 0 o 0 0 26 0 / 0 28 30 Source: ITU (2003). 6. 63 Commercial internet access in the O E C S i s very expensive, whereas residential access i s generally priced in line with the Caribbean and marginally higher than in the US. Little international data i s collected o n the costs o f business or residential internet access, but anecdotal evidence suggests that the cost o f access i s high, whereas the pricing o f residential access i s comparable to the Caribbean, but higher than the U S . One business user in Antigua and Barbuda reports that a T1 lines9costs around US$8,150/month making his unit costs o f transactions 25-30 percent more expensive than in Western Europe. A similar cost o f US$8,5OO/month (excluding any discounts for term contracts) was quoted by a provider in St. Vincent and the Grenadines. A cursory search o n the Internet for comparable rates in the Washington D C area yielded a range o f US$450-$850/month. Dial-up internet prices were also quite uniform across the OECS at US$22 for 20 hours o f monthly use (except for Dominica at US$17). These rates compare more favorably with a Caribbean average o f US$31, excluding Haiti, but are s t i l l a bit higher than, say, Mauritius which has the same costs as the U S at $15. The above analysis points to the recurring theme that, in general, businesses face greater disadvantages in the OECS vis-a-vis their international competitors than do private consumers. ~ A type o f high speed Internet connection that provides a great deal o f bandwith. M a n y businesses lease T1 lines, but they are generally expensive and offer more bandwith than most small businesses and homes need. 89 98 TABLE6.6: IMPACT OF LIBERALIZATION ON THE O E C S TELECOM SECTOR Pre-liberalization, 200 1 Post-liberalization, actual and planned for 2002-2004 No. o f telecom f i r m s ’ 12 24 Employees 84 1 1,77 1 Investment (EC$m) 90.3 (2000-01) 165.7 (includes licensed firms who are about to start operations) 1 includes incumbent, fixed, mobile, IT, Intemet, and Cable TV firms. Source: World Bank OECS Telecom Reform Project. 6. 64 The OECS has benefited from liberalization of the telecommunications market through a strong joint regional effort to establish the Eastern Caribbean Telecommunications Authority (ECTEL). The impact has not only been to introduce competition into the fixed and mobile markets resulting in lower prices, but also increased investment and employment in the sector (see Table 6.6). Average prices for calls f r o m the sub-region to the United States have been reduced by more than 70 percent since the start o f the liberalization process. Recent successes in negotiating price caps with the m a i n land l i n e provider and opening up the underwater cable market to competition should bring further improvements in competitiveness. However, additional regulations are needed in dispute resolution, consumer protection, market dominance, and interconnection. 6. 65 Given the limited capacity in the OECS, one issue to be resolved i s the sequencing of future reform efforts in the short t e r m between focusing on universal access to telephone and internet services versus business access and costs for more commercial technologies such as T1 lines and satellite services. This issue has been raised in Barbados and Jamaica, which despite n o w having high teledensity s t i l l suffer from high cost o f connectivity for the business sector. Given the small geographic size of the countries and the uptake in mobile services, universal access to fixed telephony i s less o f an issue, However, shortage o f s k i l l s i s a key factor constraining business development and competitiveness and internet access in schools and homes can b e an important factor in raising b o t h the quality o f public education, and private investments in distance learning as well. At the same time, if the OECS countries hope to use teleconnectivity as a key factor in building competitive advantage, and hence raise employment and incomes, they must simultaneously w o r k to reduce the costs o f these services to their business sector. (ii) Electricity 6. 66 Electricity supply and costs were the number one infrastructure related constraint cited b y many of the firms interviewed for this report. Figure 6.7 illustrates the relatively higher costs which plague the sub-region in comparison to the rest o f the Caribbean. As well, in some countries, in particular Antigua and Barbuda, Grenada and St. Kitts and Nevis, there are significant shortages in capacity resulting in periodic power cuts and b r o w n outs. In a survey o f 24 exporting f i r m s undertaken for the OECS Export Development Unit, ‘electricity supplied by local utilities’ was ranked as the second biggest problem.” In the Grenada investment climate survey (see Annex l), it was ranked as the most severe infrastructure-related problem with 13 percent o f the f i r m s reporting power problems at least once a month, and in 70 percent o f the cases the interruptions last more than a couple o f hours each time. 90 Madsen (2004). 99 FIGURE6.7: ELECTRICITY COSTS 30 Source: Castalia (2004). 6. 67 Electricity costs are driven primarily by four factors: (i) costs o f primary energy used to generate electricity; (ii) underlying costs o f generation, transmission and distribution assets; (iii)efficiency o f supply, generation, transmission and distribution systems; and (iv) government subsidies or taxes. 6. 68 The OECS could make some savings from retrofitting generators to use a heavier fuel oil than they currently do. Most o f the utilities in the OECS rely exclusively o n diesel fuel to run generators. I t i s estimated that making use o f heavy fuel oil, such as Bunker C, by retrofitting existing prime movers, would be economically viable and could reduce the cost o f supplying electricity by between US$0.02 and US$O.OS per kwh. TABLE6.7: ELECTRICITYPRODUCTION AND P R I C I N G Baseline Electricity Residential Rate (US#/kWh) Commercial Affordability (monthly medium household bill for 280kWh, no service charge, as % o f GDP per capita) Electricity production (bWh) Total installed generation capacity (MW) Antigua and Barbuda Dominica Grenada St .Kith Nevis St. Lucia St. Vincent and the Grenadi nes 15 17 21 26 14 16 12 16 19 19 12 17 16 18 0.4 178 50 1.9 80 20 45 0.9 153 40 0.5 121 19 0.7 0.8 288 66 1.5 99 28 9 Hydropower (% total production) 19 Transmission & distribution losses (% total 11 19 14 13 11 output) Employees per 1000 connections 11 8 6 5 8 Nevis i s listed separately because i t has i t s own electricity company which i s managed differently from St. Kitts. ", ." signifies not available, "-signifies " zero or negligible. Source: Castalia 2004, various utilities and staff calculations. 6. 69 The introduction o f alternative energy sources - wind, geothermal, natural gas - could provide some savings, but the technical and commercial feasibility o f each o f these options has yet to be 100 established. I t i s important to note that the two countries w i t h significant hydro generation - Dominica with 45 percent and St. Vincent and the Grenadines with 19 percent - also have the highest cost systems in the sub-region (see Table 6.7). 6. 70 While there are clear diseconomies of scale in the cost of generation assets for electricie’ there are a number of factors in the structure and phasing of generation capacity that can help reduce costs in very small systems. Inthe OECS, installed capacity ranges from 9 megawatts (MW) in Nevis to 66 M W in St. Lucia (see Table 6.7), not including the smaller systems in the Grenadines. In general electricity generation systems below 150 MW are significantly more expensive to purchase and run. However, recent changes in technology with smaller plants now being made in factories, rather than constructed o n site, have greatly reduced fixed cost o f construction and installation. For example, new diesel generator units are now available as small as 1 MW in capacity. Above a few MW, there appear to be economies o f scale in the cost o f supply.92Therefore, for a small system like St. Lucia’s, which has a load growth o f approximately 1.5 MW per year, unit costs o f new generation capacity w i l l be unavoidably higher than in a larger system. 6 . 71 Still utilities have a number of choices that can help to reduce the costs of expanding capacity overtime. While the very small high speed diesel generators are cheaper t o purchase, they are less fuel efficient than their medium sized counterparts. But larger units operating below their optimal load will also tend t o have lower fuel efficiency. Companies may also view buying larger units less often as a way to reduce the disruption created by construction, even if this i s minimized by completing the c i v i l works for a few capacity increments at one time. Systems need to allow for the failure o f the largest generating unit, so adding increments larger than existing plants increases margin requirement. 6. 72 I n the OECS, there i s some evidence that utilities may be choosing unit sizes that are too large. As such, increased regulatory scrutiny o f capacity plans o f both private and public utilities will be essential to reduce overall costs and prices. 6. 73 Operating inefficiencies among the electricity utilities are also quite high in the OECS. All but one of the systems are vertically integrated.93 Transmission and distribution losses are one common measure o f operating efficiencies. Singapore and N e w Zealand are two countries in which losses are considered close t o being optimal.94 They are 4 and 11 percent o f total amount generated, respectively. In the OECS, they range from 11 percent in Antigua and Barbuda and St. Vincent and the Grenadines to 19 percent in Dominica, which are considered quite high for small dense systems. In one case, however, instead of implementing the l o w cost solution to electricity theft (one cause o f commercial losses) installing checkpoint meters and rigorous technical inspections - the private utility opted for expensive pre-paid meters, an option what has not proved effective in most countries, and instead raises operating costs and ultimate electricity prices. On another measure o f operating efficiency - employees per 1,000 connections, there are clear instances o f overstaffing among both state-owned and private utilities in the sub-region, which only serves to protect highly paid employees at the expense o f broader competitiveness and lower costs o f living for the entire population. Again, closer regulatory scrutiny o f the utilities can help to reduce costs and prices. 6. 74 I n the OECS, it i s s t i l l common to find both subsidies and transfers in electricity pricing. These are generally intended to provide consumers with l o w cost energy, but this occurs at the expense o f the productive sector. While it i s common for tariff systems around the world to include some transfers 91 Winters reports a significantly negative correlation between population (as opposed to system demand) and a weaker one for income level, with electricity costs. I t i s important to note that the second largest system in the OECS i s in Antigua and Barbuda with the fourth smallest population. 92 The unit capital cost for 5 MW i s around USD$900/kW, while for higher capacities, costs appear to follow a 0.86 power law, up to the limit o f the unit sizes available. A plant x times as large w i l l cost xo,86 times as much. 93 The Antigua Public Utilities Authority which owns distribution network, purchases power from a private generator. 94 Optimal losses depend on energy sources as well as geographical dispersion o f the system. 101 from one class o f users to another, the cross-subsidies in the OECS are quite extensive. T o illustrate the extent o f these transfers, Table 6.7 presents rates for residential and commercial users. Under a system without cross subsidies, each o f these rates would be normally equal or lower for commercial users. 6. 75 I n general cross-subsidies are a distortion which creates disincentives against the efficient use of electricity and biases the national production system away from investment and production toward consumption. The exception i s the use o f lifeline rates for the poor and extremely small users, Typically, the cross-subsidies take the form o f transfers from industrial and large commercial users to billing and metering costs small household and commercial customers. The reasons are easy to grasp: (i) are less per unit (kwh) for larger users, since the costs do not vary that much by user; (ii) the costs to the system for meeting the peak demands o f small users are not fully covered by the tariff; and (iii) the number of residential and small commercial users generally greatly exceeds the larger industrial and commercials customers. 6 . 76 Some o f the cross subsidization in the OECS stems from the fact that governments and utilities find it more palatable to charge higher prices to the tourism sector - major users o f electricity - which represents “rich overseas consumers” not taking into account the effect o n competitiveness o f the sector. As a result, non-utility and self generators are already quite common in the islands, making regulation and management o f the system more complex. BOX 6.3: ELECTRICITYCROSS-SUBSIDIES IN DOMINICA Under the current system of electricity pricing in Dominica (as of November 2004), the extent of the subsidies ranges between 15-50 percent for residential and small industrial and commercial customers and increases the cost of the largest industrial and commercial customers by 10-30 percent. The increased costs are high because to subsidize residential consumers which make up 60-80 percent of all users, the industrial firms who would finance subsidies and to make them more the transfers are fm, 10-15, in numbers. One way to reduce these transparent is by first reallocating costs by both functional and customer categories. F o r each customer class there are separate charges for electrici@, wires, customer service, metering and billing, system control and purchased energy, The costs can be readily calculated, as can the impacts of changes in the structure of customers and supply. This would be followed by a gradual adjustment of the tariff regime to reflect these costs in the charges for each customer class, while retaining the subsidized lifeline rates for the poorest users. 6. 77 I n general, weak oversight and regulation of the electricity sector in the OECS has further exacerbated the situation, and not protected consumers - both residential and commercial - from either excessively high costs and/or supply shortages. In St.’Kitts, Nevis and Antigua and Barbuda, where the state operates the utility, blackouts s t i l l abound because o f generation and/or distribution constraints. In Dominica and St. Lucia, w h i c h have private operators, the regulatory frameworks do not provide the necessary incentives for efficiency both in terms o f day-to-day operations or investments. Indeed, prior to i t s ongoing regulatory reform Dominica’s legal framework provided the utility operation with a 15 percent retum by way o f automatic tariff adjustments based o n an almost complete pass-through o f costs. In effect, t h i s regime provided n o pragmatic incentives to the utility company to improve efficiency and effectiveness and reduce costs in the long run. 6. 78 Reforms are needed in both operation and oversight o f electricity companies, as w e l l as in pricing, The above analysis shows that the sub-region needs to reduce costs and improve supply o f electricity to improve competitiveness in i t s key sectors. In order t o do so, the sub-region should: 0 0 Strengthen the regulatory oversight of the operations, investments and pricing of electricity utilities, Given the technical nature o f this endeavour, one option would be to establish a regional regulator, similar to ECTEL which oversees the companies in each member country. Pursue greater private participation in ownership or operations. It i s important to note that this option may not b e viable for the very small utilities. Even if the state remains the owner o f the local utility which m a y b e too small to attract private participation, the arms-length nature o f a regional regulator w o u l d help t o insulate governments f r o m the political pressures that are 102 common in electricity issues and that can jeopardize good management o f these critical elements o f domestic infrastructure. 0 Regularly undertake a regional and international benchmarking of the electricity utilities. This w o u l d help to raise awareness both in government and with the public o f the relative performance o f the local utility and provide some element o f peer pressure. Regional associations such as the Caribbean Association o f Electricity Utilities or the Organization o f Caribbean Utility Regulators can be instrumental in this effort. (iii) Petroleum 6. 79 Given the small size of the market and the limited number of players in the petroleum sector in the sub-region, there i s a role for the governments to ensure local competition for the protection of consumers. The OECS petroleum markets are characterized by very small import volumes - the entire sub-region imports less than a tanker per shipment - and a small number o f importers who operate in many o f the countries, and who are often integrated downstream into retail sales. Under such market conditions, there i s clearly the potential for oligopolistic behavior, hence the need for government to take measures t o ensure local competition for the benefit o f the domestic consumers. Similar situations exist in many small non-oil producing countries around the world, a number o f which have achieved relatively efficient solutions. Dominica has recently implemented such a system in 2003 following these international best practices. The following analysis presents some o f the measures and h o w they. might be adapted for. These practices cover issues such as pricing, supply, infrastructure, transport and distribution. 6. 80 I n terms of pricing, the current standard i s for governments in small non-oil producing countries to set retail petroleum prices for the domestic market which reflect international oil price movements. These prices take the form o f cost-plus price ceilings which translate, o n a cargo-by-cargo basis, international o i l price movements into end-user prices. In order to promote competition domestically, governments build up the price from an intemational import price benchmark, and add o n common operating margins which are negotiated with industry operators o n a periodic basis. Price changes are automatic and based o n a predetermined periodicity. This system prevents cartel pricing within the local sector and provides for competition among industry operators - wholesalers and retailers -based o n efficiency gains and service quality. 6. 81 Except for Dominica, all the OECS countries currently set retail prices for petroleum products o n the basis o f formulas which includes some elements o f the cost-plus outlined above, but which are not adjusted regularly to reflect import prices. The use o f a residual, rather than fixed, tax absorbs any fluctuation in international prices leaving the consumers insulated. This system creates distortions in the local market as well as revenue instability. In 2001, St. Lucia announced i t s intention to fix the tax and periodically adjust retail prices in line with international prices, but has only done so o n a sporadic basis. B o x 6.4 below shows the costs o f this approach. BOX 6.4: THECOST OF PRICE CONTROLS IN THE PETROLEUM SECTOR ''In St. Lucia, where the price of gas at the pump still stands at EC$7.75 per gallon, the government has shielded ocketing at an unbridled pace, have million. However, resulted in pressur were more stable. Source: Government o f St. L u c i a (2004). 103 I 6. 82 Some countries have established a system in which national supplies are procured jointly b y private importers to save costs. In a number o f countries, notably Kenya, Tanzania and Ghana, national petroleum imports are procured jointly by private importers using a system o f international competitive bidding (ICB) for imports. The large volumes and the I C B process generally result in lower prices, and prevent unfair transfer pricing by importers who are affiliated with supplying refineries. However, the system requires a heavy and often complex administrative apparatus which i s run and paid for by the importers, while the government’s role i s limited to oversight. In considering such an option, the OECS countries would have to take into account the very small regional andor national import volumes and limited domestic capacity o f importing companies. Attempts by governments to manage and implement t h i s joint procurement have been universally ineffective and not t r a n ~ p a r e n t . ~ ~ 6. 83 T h e O E C S should work to eliminate the current use of an antiquated Caribbean postingsg6 system established in the 1950s in which the border price of petroleum imports i s based on quotations by oil companies (several o f which no longer supply the sub-region). Instead, the pricing o f petroleum imports into the sub-region should reflect international spot market prices, as it does in over 90 percent o f global o i l trade. Using such an international spot market benchmark, such as U S Gulf Coast Spot adjusted for ocean freight netback and small cargo sizes, could reduce import costs in the OECS by around US$S/gal for motor gasoline and US63 for diesel and kerosene. 6. 84 T h e sub-region should also challenge the CARICOM common external tariff of 20 percent9’ on gasoline and rules of origin which protect imports from Trinidad and Tobago and only serves to hamper competitive procurement and pricing of imports. A C A R I C O M Task Force o n Energy was formed in 2004 to approach Trinidad and Tobago o n the issues o f discriminatory pricing o f petroleum products between domestic users and regional importers, and on the issue o f the CET. The OECS i s currently preparing a Memorandum o f Understanding (MOU) with Trinidad and Tobago o n a range o f issues, but which should also include the issue o f these postings. 6. 85 I n some O E C S countries there i s a n excess capacity of storage, transportation and distribution infrastructure that raises the retail costs for petroleum products. This situation occurs when individual importers establish their o w n storage depots and their o w n trucking fleets, and there are too many gas stations for the market volumes. For example, in Dominica, it was found that average service station throughput in 2002 was 200,000 imp gal, which i s very l o w even for developing countries with small markets. This situation i s often caused by setting operating margins too high so that there are excess returns to these operators. While i t i s advisable to use international benchmarks to review these costs regularly, local market conditions have to be taken into account. The implementation o f hospitality and open access rules can encourage operators to pool logistics’ infrastructure over time. Also the use o f common industry margins for these services promotes competition and cooperation for efficiency gains. 6. 86 This regulatory and administrative framework described above requires a lot of information and negotiation with operators during i t s establishment, but once it i s set up it i s quite simple to administer, requiring only regular information collection and periodic recalibration o f operator margins, The major hurdle to overcome, as found in Dominica’s experience, was resistance o f the various actors “to do things differently”. In the end, the de-politicization of petroleum prices was a n important attraction for the authorities and the industry operators. The fact that (a) many o f the industry participants operate in all o f the OECS countries; (b) the reforms being proposed are common practices faced by the parent multinationals across the world; and (c) the same information would be The W o r l d Bank i s currently undertaking a study o n the feasibility o f j o i n t petroleum procurement within the subregion. 96 Postings are based o n quotations f r o m Petrotrin and Shell (which does n o t supply the sub-region). This system dates back to the 1950s and 60s when most o f the world trade was within major o i l companies’ integrated systems and SPOT market was less than 10 percent o f transactions. The postings are unilaterally prepared by each individual (major) company. They are not prices generated in a n open, competitive market and are often used by majors for inter-affiliate transfer pricing. 97 F o r gasoline only. Diesel has a CET o f 10 percent and L P G and kerosene 0 percent. 95 104 needed by each authority in order to properly administer the system, provides enormous scope for collaboration across the sub-region. (iv) M a r i t i m e Transport and Ports 6. 87 For small island economies, competitive shipping and port costs are critical to competitiveness. Worldwide, the port and maritime transport sectors have undergone major changes over the past three decades. These changes have been driven by globalization, expansion o f trade, growth in containerization, improvements in port logistics technology, and evolution o f the governance and public and private management structures for the port industry. 6. 88 The m a i n issue in maritime transport for the OECS relates to intra-regional shipping. Exporters and government officials alike have noted that, despite being competitively provided, intra-regional cargo services are often irregular and the vessels are in poor condition. For example, there i s only one shipping line providing frequent service between Grenada and Trinidad and Tobago, and f i r m s have reported that it i s not always reliable. On the export side, one result i s that i t i s easier and more reliable to move the predominantly agricultural cargo through informal traders which have much smaller volumes and use the smaller (and more frequent) vessels. On the import side, f i r m s have to keep much larger stocks of inventory in order to make up for irregular shipping services. In Grenada, two thirds o f the respondents o n the firm survey report keeping stocks o f more than one month and 10 percent o f them report having inventory periods that last as long as h a l f a year. Such substantial inventory not only ties down the f i r m s working capital resources, but also incurs additional costs in terms o f storage and safekeeping. As w e shall see below with intra-regional air transport, there i s a need for additional analysis of the intra-regional transport market to understand the constraints facing the current operators in terms of improving service. At the moment, individual countries are proposing and some pursuing disjointed efforts to resolve the situation which requires an integrated regional approach. 6. 89 Compounding the more intractable problem of high freight costs are the notoriously high cost ports in the OECS. The main contributors are excessive cargo handling charges caused by antiquated work rules and strong union opposition to reform. These represent about 10 percent o f freight rates from Miami. Most o f the ports in the sub-region are operated o n the public service port model in which the port authority owns, maintains and operates all assets. In a number o f ports, attempts have been made to use private companies for cargo handling, but without the appropriate regulatory framework this resulted in an escalation o f labor costs without commensurate improvements in productivity. In at least one case, described in B o x 6.5, t h i s resulted in the port resuming control o f cargo handling in order to resolve the situation. BOX 6.5: DOMINICA'SEXPERIENCE WITH PORT CARGO HANDLING OPERATIONS The Dominica Port Authority (DPA) had labor contract with the cargo handlers ' argo handling charges in the OECS owing to an outdated r to late 2001, stevedoring services at the Dominica Port work rules dating back to firm made no eflort to renego Port Authority resumed man sequently, the D P A situation), it accepted the co . As an interim measure, attempted to renegotiate w i the port management a constructed for this purpose, in order to avoid the high charges associated with the work arrangements. These charges added to the high sts associated with Dominica 's remote location, which has essentially onethin the OECS. After overtuming two injunctions by the way fieight traffic and fac place new work arrangements at the Dominica Port Authority that union, the Government ha have reduced stevedoring and rges by 25percent and charges for handling break-bulk cargo by 30 tiated reductions in, and eliminations oJ; surcharges by percent. I n addition, the Po the antiquated work arrangements. For example, the various shipping lines which ed a surcharge of EC$190per 20-foot container. Caribbean Ship Owners A 105 6. 90 T h e OECS countries will need to coordinate the implementation of maritime security measures to ensure that their shipping links are maintained. Following the terrorist attacks o f September 11, 2001, the International Maritime Organization’s new International Ship and Port Facility Security Code (ISPS) and the U.S. Maritime Transport Security Act (2002) now require a range of ongoing security improvements at OECS ports if the ships that dock there are to be accepted in other ports worldwide. Recent cost estimates for implementing the necessary changes average $700,000 per port, Given the nature o f the shipping services to the sub-region, where vessels stop at each port in succession, it w i l l be crucial for all the ports in the OECS to rapidly achieve and maintain the necessary security certifications in unison, so as to preserve the supply chain along the arc,hipelago. This suggests that the OECS should embark on a joint effort to address t h i s issue. There are currently some proposals for the establishment o f a sub-regional regulatory authority which would handle regulation, oversight, training and capacity building in security and other areas, which should be seriously considered. 6. 91 T h e two remaining areas of maritime transport are important segments of the OECS tourism industry - cruise and yachting sub- sector^.^^ The OECS countries have invested a significant amount o f public resources o n the development o f cruise ports whereas, with a few exceptions, yachting marinas are generally privately owned and operated. Moreover, a concerted effort i s currently underway, spearheaded by the OECS Secretariat, to strengthen the enabling environment for the yachting sector by harmonizing regulations across the sub-region in order to create a seamless space for operators and tourists. 6. 92 I n light o f the developments in the port sector worldwide with various models of private participation, the O E C S might well explore the possibility of extending these models to i t s cruise ports, in order to reduce the burden on the public sector. Within the region, Jamaica has been well served by contracting out port operations, including cruise ports, to private companies, both local and foreign. The small physical size o f the ports in Jamaica did not attract sufficient private interest in infrastructure development. However, the commercial infrastructure alongside the ports, tourist shops and restaurants has benefited from private participation both in leasing and new construction. This suggests that the OECS should consider a regional approach to private participation in cruise port operations or investments. One obvious party, although this report i s not aware o f any other cases o f this worldwide, could be the cruise lines. Several countries have already received overtures from cruise line companies regarding financing o f port infrastructure. However, financing alone, while i t would provide investment resources, would not achieve the important goal o f redistributing risk between the public and private sectors that i s achieved through a carefully structured deal leading to private investment, ownership andor operation. (v) Air transport 6. 93 Given the reliance on tourism, airlift i s a critical component of transport for the sub-region, both intra- and inter-regionally. There are differing opinions across the sub-region as to whether the current airlift capacity into, and around, the OECS i s adequate for the volume o f tourist traffic being generated. Individual countries differ in particular because o f limitations on the current airport capacity -neither Dominica nor St. Vincent and the Grenadines can accommodate medium sized jets and Dominica does not have night landing -- but also because o f the different traffic volumes and arrangements with various airlines. However, there i s uniform agreement across the sub-region that a more coordinated response to airlift and aviation issues can help to reduce costs and safeguard this crucial input into the tourism industry. 6. 94 The O E C S i s served by several regional airlines in which governments continue to have a major stake but which are also plagued by financial problems. LIAT serves the intra-regional market and i s part-owned by most of the OECS governments and the Government o f Trinidad and Tobago. It has undergone several financial restructurings but i s s t i l l struggling for viability (see B o x 6.7 below), BWIA, which provides service between the OECS and i t s various hubs in the Caribbean and l i n k s to i t s 98 UNECLAC (2004b). 106 international destinations, i s owned primarily by the Government o f Trinidad and Tobago and also faces financial problems. M o r e recently, the OECS has been served by Air Jamaica, in w h i c h the Government of Jamaica has recently re-acquired a significant stake after an unsuccessful privatization effort. 6 . 95 T h e main objective of government policy on air transport i s to ensure reliable, competitively-priced supply of airlift that keeps apace with the demands of the market. Against this background, continued protection o f routes for regional carriers, l i k e BWIA and LIAT, i s usually intended t o serve t w o purposes: to ensure a minimum level o f service and continuity in markets that are not expected to attract adequate supply from the private sector and to prevent anti-competitive or monopolistic behavior in markets that may be considered small enough to be natural monopolies. However, over time, this protection of route rights for LIAT and BWIA has resulted in large public expenditures to ensure the viability of both airlines as ‘national carriers’, and has not contributed to lowering prices or safeguarding supply. 6. 96 A lack of coordination among the O E C S countries when securing inter-regional airlift capacity m a y have resulted in missed opportunities to reduce the budgetary costs of these arrangements. With respect to the inter-regional market, several governments in the OECS have been concerned that a purely-market based approach may not provide adequate services. As such, individual countries have been offering incentives to secure airlift f r o m overseas locations in w h i c h they anticipate growing demand or which appear to b e underserved. These incentives have been offered both o n a long term basis or to initiate a new route at the early stages o f the market development. The countries have provided three types o f fiscal supports: (i)the traditional marketing support incentive provided to the the more airline in the form o f a lump sum payment for joint marketing o f the route and destination; (ii) recent seat o r load guarantee for a minimum certain revenue per flight to the airline o r charter company; (iii) and direct lump sum payments to the airline simply for maintaining a particular route. Experience across the sub-region shows that seat or load guarantees need to be carefully negotiated in order to avoid airlines filling guaranteed seats with frequent flyer award travelers or over-pricing seats and t o clearly specify the transfer pricing mechanism when airlines are providing multiple segments o f a trip terminating in the country. 6 . 97 In general, these incentives are negotiated bilaterally between a single country and a preidentified airline which has already demonstrated interest in the sub-region. However, it may be the case that regional cooperation around well-structured competitive bids to award contracts for providing specified capacities and frequencies o n key routes m a y help to minimize the subsidies being provided to airlines. Periodic renewal o f these contracts may help to mitigate the risks f r o m cyclical financial instability within the international airline sector, such as i s n o w being observed with the spate o f bankruptcies. 6. 98 Despite the relative, though costly, success in securing international airlift and the lack of a viable national carrier to protect inter-regional routes, the O E C S countries appear to be reluctant to enter into a n Open Skies agreement with U S or European partners (see B o x 6.6). There may be a fear that ‘opening the skies’ without first achieving the requirements” that would allow BWIA, as the designated national carrier, to land and code-share in U S markets, w o u l d condemn the sub-region to a perpetual dependence o n overseas-based carriers. However, the universal experience i s that protected national carriers become liabilities, not assets, and that liberalization can significantly reduce fares and increase volumes, providing a major boost to business and tourism. Given the financial state o f both BWIA and LIAT, the OECS experience i s n o different. Box 6.6: OPENSKIES AGREEMENTS International air service among states a complementary bilateral Air Services Agr passengers and cargo) into and beyond 99 FAA category 1 status. a1 Air Services Transit Agreement and by the airlines of one state to fly (and carry and capacity offlights, as well as other 107 five defined 'Ifreedoms of operational issues are normally covered in t the air": The 1'' freedom relates The 2"d fieedom relates The 3rdfreedom relates to carriers The 4"freedom relates to carriers f i o m State A picking up passengers from State B. The jthfreedom relates to carriers from State A picking up passengers in State B destined for State C. . or setting down passengers in State B originating in State C. The Si and 2"dfreedoms have been included in the International Air Services Transit Agreement. The other fieedoms are covered in bilateral agreements. For many years, the number and capacities of carriers with 3rd and 4Ih j?eedom rights have been limited, j t hfreedom rights a degree of monopoly or duopo However, since 1992, the been reached to date, includ Caribbean. These agreements each other's territory. Th unrestricted trafic rights, i and Aruba in the The other countries in CAMCOM, Services Agreement which provide designate each others carriers in extra-regional bilateral Air Services Agreements. Discussions with the US on a multilateral Open Skies agreement has stalled since 2001. I n addition, each country provides individual economic regulations through Air Transport Licensing Authorities or Boards. However, there is no clear implementation oj enforcement of these policies or regulations. 6. 99 On the intra-regional market, the substantially state-owned LIAT i s also having major difficulties competing with the privately-owned Caribbean Star whose recent entry has succeeded in driving prices down and stimulating the regional market. The OECS and Trinidad and Tobago governments - LIAT's main shareholders and creditors - have been reluctant to either allow the airline to go under for fear o f creating a near monopoly situation in intra-regional air services or to support the necessary financial restructuring and capital injection needed to ensure a recovery o f the operation which has been undercapitalized and cash-strapped almost since the current incarnation in 1974 (see B o x 6.7). 6. 100 The current situation i s a symptom of the general lack of clarity that may stem from a lack of critical information about the market capacity to support more than one airline. The OECS needs to undertake a thorough analysis o f the intra-regional market and reach an agreement o n subregional aviation competition policy, in order to resolve the LIAT situation and encourage the emergence of a reliable and stable market situation. BOX 6.7: A BRIEF HISTORY OF LIAT LIAT has suffered from poor financial performance in part due to initial undercapitalization, frequent shareholder interference, unwritten requirements to f y certain routes with varying frequency, and continual changes in senior management. A Antigua and Barbuda and Tr from the Caribbean governments, years L I A T has received th e. Yet, the airline still faces deep further diluting private sha financial troubles. Studies convert some of its massive decision. Source: BBC (200.5). 6. 101 As mentioned above airport infrastructure i s only a critical problem in Dominica and St. Vincent and the Grenadines because of the topological constraints on expanding runway lengths. Both countries are undertaking major capital investments funded by donors aimed at providing additional capacity. However, the countries need to take heed o f past experience in Dominica where poorly conceived projects resulted in wasted public resources and increased indebtedness. 108 6. 102 U n l i k e with ports, the existence of the O E C S Directorate of Civil Aviation has been instrumental in addressing the security issues that could jeopardize air access for all the countries. Because the airport operations are managed differently across the sub-region, there i s little comparable data o n the financial performance o f individual airports. In some countries, airports turnover all the airport charges collected from passengers and airlines to the public treasury and receive an annual subvention f r o m the budget, whereas in others they retain the funds and are run as statutory corporations. 6. 103 I n most O E C S countries, taxi cartels have negatively impacted the competitiveness of the tourism industry b y negotiating excessively high rates and competition-reducing regulations from the governments. Table 6.8 presents a comparison o f taxi fares and market arrangements in the Eastern Caribbean. W h i l e most taxi systems worldwide involve some regulation such as licensing fees that l i m i t entry and ensure quality of service and financial viability o f the operators, it i s common in the OECS to find a host o f additional restrictions that turn the industry into a set o f overlapping monopolies designed to extract the m a x i m u m rents from visitors. For example, taxi associations establish arrangements with individual hotels w h i c h restrict operations at that location to their members only. Dispatchers at airports manage visitors to distribute business evenly to certain operators rather than to maximize visitor service and satisfaction. L i t t l e public information i s provided to visitors o n rates to various destinations and meters are not commonly used. In some cases, the “rules” are not enshrined in government documents, but have been simply established by the operators and either implicitly endorsed or not explicitly challenged by the authorities. Given the dependence o f the sub-region o n tourism, it behooves the OECS countries to address this issue as part o f any attempt to strengthen competitiveness o f the sector. Again a regional approach may help to diffuse the domestic political tensions that relate to this sector, TABLE6.8: TAXI FARES IN SELECTED CARIBBEANMARKETS Fares regulated by government? $/Mile Antigua and Barbuda 1.5 1 Yes 3 .OO Yes Grenada 2.40 Yes St. Lucia U S Virgin Islands 1.11 yes Source: Staff interviews with taxi associations. M a r k e t entrants regulated by government? Taxi Association regulate locations for pick up and drop off? Yes no no Yes Yes Yes Yes No 6. 104 There i s a general need to strengthen regulatory oversight of key utility, energy and transport sectors in the O E C S - in order to promote competition and efficiency among private operators and to address market failures which interfere with the supply of services. One general lesson from the telecom, electricity and petroleum supply i s that while private participation can be important for ensuring adequate investments in system capacity, it does not by itself guarantee efficient operations and competitive pricing in the presence o f a natural monopoly. The cost-plus approach to electricity pricing in Dominica without sufficient oversight by the govemment resulted in serious inefficiencies under private management that inflated electricity costs. 6. 105 Limited local capacity for regulatory oversight can be addressed b y pooling resources across the OECS, as in ECTEL where transparent and effective regulation in telecom i s beginning to result in lower prices, increased investment and competition. In the case where private participation m a y not be feasible due to the small size o f the systems, regional monitoring and benchmarking of costs, quality, reliability and efficiency o f operations can help local authorities and the general public better h o l d public (and private) entities accountable. Regional oversight m a y also help to dilute the political pressures to subsidize or cross-subsidize the electorate, w h i c h inevitably transfers national resources away from investment and production to consumption. Box 6.8 describes briefly h o w even limited cooperation in Central America o n the petroleum sector has helped t o achieve more efficient pricing and taxation in that region. 109 BOX 6.8: CENTRAL AMERICAN REGIONAL COOPERATION IN THE PETROLEUM SECTOR pricing and taxation as well as 6. 106 Finally, in transport there i s a case for further in depth analysis of the sub-regional markets for both shipping and airline services in order to resolve some outstanding issues that affect competitiveness o f exporters and tourism operators. In addition, regional cooperation in port security issues, joint negotiations with inter-regional airline carriers and intra-regional airline competition policy are three other areas in which the sub-region could benefit substantially. 110 CHAPTER 7. OPPORTUNITIES FOR EXPANDING EXPORTS OF SERVICES 7.1 Services have become the most important source of growth in the OECS countries, with a growth rate of 4.3 percent per year during 1980-2003. As a result, the share o f services in G D P (excluding the government sector) increased from 53 percent in the 1980s to 64 percent during 2000-2003 (see Chapter 1). As the OECS countries continue their transition to service economies, developing innovative and competitive clusters around areas o f identified comparative advantage w i l l be critical for future growth. Given relatively high wages, it i s unlikely that the OECS can b e competitive in labor- intensive manufacturing o r in traditional agricultural production in a more open market trading regime. However, there are several sectors, especially in services, where small economies can be competitive. While some diversification has already taken place, including in niche manufacturing and various service sectors, this process needs to be accelerated to reverse the growth decline o f the 1990s in a sustainable way. In creating successful service and niche manufacturing exports, the OECS can leverage i t s geographical location, i t s English speaking population, i t s alluring natural beauty, and r i c h culture. There are numerous examples o f service exporters that have successfully exploited these advantages and there are already emerging examples o f dynamic service exporters that point to potential for further growth. 7.2 This chapter explores illustrative case studies for further growth and diversification o f tourism activities, offshore education, ICT-enabled products and services, health and wellness activities, and offshore financial services. While these sectors present opportunities for the OECS, they are meant to be illustrative o f the issues and constraints facing all service sector f i r m s in the sub-region. As the case studies demonstrate, success in moving to higher-end services w i l l require raising s k i l l levels and expanding numbers o f skilled workers, reducing costs o f interconnectivity and increasing collaboration among industry actors. There i s a critical role for governments in coordinating private and public sector efforts and establishing the standards and certifications that raise the quality o f service. It should b e noted that t h i s i s different from “picking winners”, since it only creates an enabling environment that allows market forces to channel investment into competitive sectors, such as services. A. Tourism 7.3 Given the numerous competitive advantages of the sub-region in tourism, this sector i s likely to remain a major contributor to growth, employment and export earnings in the OECS for some time. Despite a strong start during the 1970s and 1980s, recent performance both in terms o f market share within the Caribbean and worldwide has been lagging. The major reasons are declining cost competitiveness in key market segments against new destinations in the Caribbean and beyond, and slow response to the changing nature o f the tourism business worldwide. However, the strong growth projected in global tourism and the emergence o f new market segments in which the OECS has potential to compete have created the possibility for the sub-region to reinvigorate tourism and, further, to make i t the centerpiece o f a cluster o f new service exports. In order to realize t h i s potential, the sub-region will need to update i t s strategy for managing and marketing the sector, focus public interventions and expenditures more closely o n critical constraints such as the s k i l l s shortage and coordination with the private sector, and cooperate more effectively at a sub-regional and regional level. 7.4 Tourism currently accounts for 28.8 percent of GDP, 38.7loopercent of employment and 54.2 percent of export earnings in the OECS. Although these shares vary across countries, with Dominica having the smallest sector, a l l o f the OECS countries hope t o expand and deepen the sector over the near future. The industry i s mainly divided into stay over and cruise business, with cruise accounting for 64 percent o f arrivals but only 6 percent o f receipts (see Table 7.1). loo WTTC (2004) data o n employment measure both the direct and indirect impacts o f tourism o n the economy. 111 TABLE7.1: TOURISMSEGMENTS, 2000 Arrivals ('000s) Stayover 852 Cruise 1,544 Source: CTO (2003). share 36% 64% Receipts (US$ millions) 861 52 share 94% 6% Spending per arrival (US$) 1,011 34 7.5 Comparatively, the O E C S has under-performed in tourism both within the Caribbean and worldwide over the period 1990-2002. Tourist arrivals have grown at 2.8 percent, slightly slower than the Caribbean as a whole (including the Dominican Republic and Cuba) but much slower than the world tourist arrivals which grew at 3.7 percent over the same period. Similarly, OECS tourism earnings have grown at only at 1.9 percent compared with 4.7 percent for the Caribbean (including the Dominican Republic and Cuba) and 4.9 percent for the world. As a result, the OECS market share of Caribbean tourism receipts f e l l from 14.6 percent to 10.5 percent, and from 0.24 percent o f world tourism to 0.17 percent between 1990 and 2002. Spending per arrival, although higher in level than the Caribbean, grew by only 3 percent per year during 1990-2002, compared with 17 percent for the Anglophone Caribbean and 21 percent for the Dominican Republic and Cuba over the same period. TABLE 7.2: INTERNATIONAL TOURISTARRIVALS BY REGION OF DESTINATION Share of world market (%) 1990 1995 2000 2001 2002 Africa 3.3 3.6 4.0 4.1 4.2 Americas (excl Carib) 17.9 17.2 16.1 15.1 14.1 Caribbean 2.5 2.6 2.5 2.5 2.3 CARICOM 0.9 0.8 0.7 0.7 0.7 OECS 0.13 0.14 0.12 0.11 0.12 Dominican Republic and Cuba 0.4 0.5 0.7 0.7 0.6 Asia (excl NE Asia) 6.5 7.5 7.7 , 8.1 8.2 North East Asia 6.1 8.0 9.1 9.6 10.5 Europe 61.5 58.6 57.1 57.1 56.9 Middle East 2.1 2.5 3.5 3.5 3.9 Source: World Tourism Organization (2004). 7.6 The slowdown in growth in tourism i s accounted almost entirely b y lagging performance in stay over arrivals. Growth in stay over arrivals fell from an average 8 percent per year during 198594, to 0.1 percent in 1995-2003. Meanwhile the cruise sector has seen stronger, but also declining growth in arrivals, from 15 percent in 1985-94 to 4.4 percent in 1995-2003. The yachting segment appears'" to be growing fast in the Eastern Caribbean, and the market currently remains dominated by the French Antilles and St. Maarten. St. Vincent and the Grenadines, for which this segment accounts for about 40 percent o f tourist expenditures, and Antigua and Barbuda are the major players in the OECS group. W h i l e the cruise segment remains a minor player in terms o f receipts accounting for only a 6 percent share o f tourism earnings, the yachting sector i s strengthening as a key segment because o f the higher per capita spending o f these visitors. Like yachting, other new and emerging segments are not yet being measured systematically. M o r e recently, tourism in the sub-region has rebounded f r o m the effects of the terrorist 7.7 attacks in the U S in 2001. Arrivals grew by 7.6 percent between 2002 and 2003, compared with an average decline o f 2.3 percent per year in 2001 and 2002. This performance surpassed that o f world tourism which continued to contract in 2003 o n account o f S A R S and the war in Iraq, and o f the Caribbean which grew by 6.5 percent in 2003. The loss of market share in both the Caribbean and world markets during 1990-2002 can be 7.8 attributed to a loss of tourism-related price competitiveness in the principal sun, sea and sand ~ lo' The yachting sub-sector i s not yet being systematically measured. 112 product offering. Until recently, the OECS tourism product comprised a dominant beach resort tourism segment which offered the traditional sun, sea and sand tourism complemented by a host o f very small properties which attempted to specialize in more experiential tourism, but represent a relatively very small share o f stay over guests. However, the demand for sun, sea and sand product has become very price elastic (Maloney and Rojas, forthcoming). The experience in the 2001/2002 winter season, following the terrorist attacks in the U S in 2001 revealed that resorts were able to substantially dampen the contraction in demand through price discounting. Unfortunately, the OECS countries are among the least price competitive within the Caribbean, which itself i s much less competitive in terms o f prices than other regions o f the world (see Figure 7.1). As a result, during the 199Os, the expansion o f lower cost sun, sea and sand offerings combined with mass marketing techniques by the emerging destinations in the Caribbean - mainly the Dominican Republic, the C a n c d C o z u m e l region in Mexico and more recently Cuba - were able to capture market share from both the OECS and broader C A R I C O M destinations. In addition, with the decline in transportation costs worldwide, long haul destinations have become increasingly attractive, as evidenced by the rising share o f tourists worldwide traveling to Africa, Asia, and the Middle East (see Table 7.2). To exacerbate the problem, the WTO now describes the sun, sea, and sand product as “approaching the maturehaturation stage for the product l i f e cycle” (WTO 2004). FIGURE7.1: INDICES OF PRICE COMPETITIVENESS IN TOURISM 80 70 I” 60 60 -~ 50 50 -~ 40 40 -. 30 -. 30 20 10 0 20 -~ 10 - 0. Note: These indices are based o n hotel price comparisons, purchasing power parity and consumer price indices adjusted for taxes on goods and service. Source: W T T C (2004). 7.9 Nevertheless, the OECS has the potential to strengthen its market position in some of the fastest growing segments of tourism. Globally, tourism i s expected to grow by 4.1 percent per year through 2020. High growth segments include adventure and nature-based tourism, expected to grow annually by 20 percent per annum, cultural, meetings and conference tourism by 10 percent, and health and wellness tourism by 6 percent. Given i t s physical and cultural assets, the OECS i s in a position to capture a growing market share o f these segments. Indeed, the sub-region has already demonstrated i t s ability t o expand product offerings into these segments, for example, with St. Lucia’s Jazz Festival and world class spa hotel, Dominica’s Creole Musical Festival and world-renowned diving market, Antigua’s nascent health tourism operations, plantation tourism in St. K i t t s and Nevis, and yachting in St. Vincent and the Grenadines and Antigua and Barbuda. In a recent market test with specialty tour operators in Dominica, 34 out o f the 40 operators expressed interest in exploring further business opportunities in adventure, nature, culture and heritage packages. 113 7.10 The small hotel sub-sector which has been languishing for some time can be a key participant in these emerging segments. The OECS tourism sector has a larger share o f small properties (75 rooms or less) than much o f the Caribbean. Notably, guest houses account now for 11 percent o f available accommodation in the OECS, compared with 2.1 percent for other Caribbean destinations. In Dominica, St. K i t t s and Nevis and St. Vincent and the Grenadines,lo2 less than 40 percent of properties have 100 or more rooms. However, the small hotel sector has generally under-performed in comparison to larger properties. Occupancy rates for these hotels have been persistently below sustainable levels averaging 40-55 percent compared with island-wide occupancy rates o f 60-75 percent. The problem has been exacerbated in recent years by the introduction o f electronic booking agents, such as Orbitz and Expedia, which charge a significant share (20-30 percent) o f room revenues for their services rendering them prohibitively expensive for smaller properties. That said, the growing specialty market niches identified above are particularly well matched to the products and services o f small tourism enterprises which tend to offer more by way o f local culture and adventure. 7.11 These emerging market niches have the potential to deepen the impact o f tourism o n the local economy but require a more complex role for the public sector - old management techniques and investment regimes are not adequate for these emerging activities. In the past, the tourism sector in the OECS was viewed as comprising mainly airlines, cruise lines and hotels which combined to produce the traditional, but now maturing, sun, sea and sand product which failed to create significant linkages with the domestic economy. However, tourists worldwide, and particularly in the growing market segments identified above, are now demanding much more from their vacation ‘packages’. The new business model for competitive tourism involves managing the customer experience from the planning and booking stage through post-trip activities, and spanning the entire destination including hotels, restaurants, taxis and tour operators, activities, cultural and heritage sites, and scenic locations. While t h i s model has the potential to create more linkages with the economy as a whole, it also means that management o f the tourism sector, and by extension the role o f the public sector, i s much more complex ifi t i s to ensure competitiveness. 7.12 This interest of visitors in experiencing more of the destination as a whole has deepened the public good factor in the tourism production function, and presents challenges to the public sector. The role o f the state sector in tourism can no longer be limited to general destination marketing, administering investment incentives for large enclave-type resort hotels, directing credit to locally-owned properties, and maintaining adequate air services and transportation infrastructure. The entire destination has become the tourism plant. As such, the management o f tourism must now embrace a host of new areas including but not limited to environmental protection and solid waste management, land use planning to ensure the maintenance o f scenic views, policies to protect and showcase culture and heritage sites, establishment o f quality standards in broad ranges o f services, and ensuring a legal Eramework for consumer protection. Moreover, the role o f the public sector in developing overarching destination development and management strategies and coordinating the various actors in the sector, i s even more fundamental. In order for the OECS to take advantage o f the emerging market segments and to transform i t s 7.13 tourism from the sun, sea and sand model to the destination model, the sub-region will have to: 0 strengthen management and marketing o f the destination, including environmental management; 0 raise the capacity o f the industry to deliver quality services; 0 reform investment promotion strategies; 0 promote backward linkages in tourism; 0 improve allocation o f public expenditures o n tourism; and lo’ Based o n CTO, 2002-2003 data. This m a y have changed for St. Vincent and the Grenadines recently with the opening o f the Raffles Resort o n Canouan Island in the Grenadines, 114 0 address trade-related constraints to tourism. 7.14 Destination management and marketing. The destination model requires a moderate and consistent level o f infrastructure and security throughout the country, and maintaining the model requires a robust tourism cluster that coordinates various sectors’ efforts for mutual benefits. Around the sub-region, many destinations have not paid sufficient attention to the impact o n tourist spending o f general island-wide infrastructure that could encourage visitor exploration and increased visitor spending. Roads often lack adequate signage and tourism facilities such as pull-offs at scenic viewing points. Taxis, local tours and activities are expensively priced. Public information for tourists i s fragmented and not delivered in a user-friendly way. Land use and environmental policies may not recognize and protect important scenic, natural, and heritage resources o f interest t o visitors. Antigua and Barbuda’s experience with the location o f open-faced quarries that mar the landscape i s one example. In addition, tackling the issue o f rising crime takes o n added urgency, for both tourists and investors alike, as destinations move from “safe” enclave tourism to more complete “island experiences”. 7.15 As such, improved coordination among public sector actors i s key for successful destination management. In order to address the above concerns, the government w i l l need to integrate tourism issues into other parts o f public sector management - such as public works, land use planning, transportation policy and cultural preservation. This will involve expanding the ambit o f the tourism ministry or board, andor placing a priority o n mainstreaming tourism into public sector management. Given the more intrusive nature o f the tourism destination model, such a strategy may generate a perception that the government i s concentrating o n visitor needs at the expense o f the general public or the poor, and so a public education campaign may b e required to explain the destination model and i t s beneficial spillovers t o the society as a whole. 7.16 The destination model also puts a premium on coordination between the public and private sectors and within the private sector because so many more actors are part o f the supply chain - for example, restaurant owners, cultural site operators, community guides - and because the strategic positioning o f a tourism sector or cluster w i l l generally require some common approaches or/even cooperative activities among private enterprises. Efforts to date in the OECS to strengthen collaboration between the public and private sector in tourism have not been fully effective in part because o f weak private sector organizations, but also because the government’s strategy may have been to focus i t s attention o n the needs o f key investors, rather than the sector as a whole. This type o f coordination i s never straightforward, and particularly so if private sector organizations are not considered representative by the industry participant^."^ For example, a survey for the Small Tourism Enterprises Program (STEP) (Box 7.1) revealed that 71 percent o f small hotels were not members o f national hotel associations, Over time, ongoing efforts by CPEC and donors to strengthen the capacity o f private sector organizations in tourism, combined with the governments’ ongoing efforts to engage with industry representatives rather than individual operators should close the gap over time. 7.17 Collaborative strategic planning and improved monitoring of implementation and outcomes can serve to strengthen coordination. In a number o f cases in the sub-region, the national tourism strategy has been prepared by an external consultant for the government. Other than the early fact-finding interview, discussions with the private sector are limited t o a few industry representatives, and take place after the fact. Although complicated to organize, joint strategic planning exercises with the private sector as much at the helm as the public sector, will help t o improve coordination. Inaddition, there i s a need to strengthen monitoring o f tourism sector performance, as well as implementation o f any agreed action plans.. The data currently collected by the government statistics departments for the national accounts or balance o f payments are not sufficient to fully understand the performance o f the sector from a business point o f view. There i s a need to strengthen the collection o f data by both the tourism authorities and private associations to effectively monitor developments. Regional coordination o n the development o f lo3 The m a i n challenge for the public sector is often in choosing between when and h o w t o motivate and when t o stipulate actions o n the part o f the individual private enterprises, while maintaining an enabling investment climate. 115 appropriate monitoring indicators, and perhaps introduction o f periodic regional surveys may help to overcome the capacity constraints o f local authorities and associations. 7.18 The OECS countries need to strengthen their commitment and update their approaches to tourism marketing. The traditional marketing model in the Eastern Caribbean relies heavily o n the large resort and hotel properties driving business through their tour operator’s relationships and reservations systems. Small tourism enterprises are not well integrated into national marketing strategies. Weaknesses in the marketing system, however, compromise results. Many countries have neither a strategic marketing plan nor the marketing infrastructure necessary t o compete in today’s marketplace. Effective use o f the internet to support marketing strategies i s rare. The strong growth o f new niches has spawned a growing number o f travel intermediaries who are constantly looking for new products to deliver to their customers. Destination marketing success requires building relationships with these specialty tour operators and travel agents, providing destination information tailored to their interests, and ensuring that destination suppliers have the skills, capabilities and systems to engage with the international travel trade. 7.19 Given the relatively weak private sector organizations, the public sector may have to assume/continue leadership of the marketing program in the short term. However, some element o f cost recovery should be instituted at an early stage to both reduce the incentives for free-riding, as well as to strengthen accountability. Coordination with the marketing programs o f the large properties, tour operators and airlines as well as attention to the needs o f the smaller hotel sector w i l l be crucial. 7.20 As a matter of priority, improved destination management will also require improved environmental management. Regardless o f the direction o f diversification o f tourism in the OECS, the industry will continue to depend heavily o n the natural resources o f the sub-region. Hence the need to strengthen management o f the environment as a strategic development priority. In order to achieve sustainable tourism development, the OECS needs to urgently address key environmental problems such as degradation o f coral reefs, coastal and marine habitats, forests and woodlands, and preservation o f the overall landscape, urban and rural. In addition, the sub-region needs to extend advances made in solid and shipwaste management to wastewater, and address issues such as agro-industrial pollution, agricultural run-off and soil erosion stemming f r o m increased residential construction. 7.21 The sub-region will need to: (i) strengthen enforcement o f environmental policies for land use planning, urban-rural zoning regulations and landscaping; (ii)expand protected areas; (iii) improve monitoring o f the quality o f coastal waters and beaches; and (iv) make additional efforts in solid waste and wastewater management, air and water pollution control, and natural disaster mitigation. Necessary policy reforms include enabling legislation for national environmental units, and enactment o f regulations to strengthen existing Environmental Impact Assessment laws. Finally, the OECS needs t o embark o n a sub-regional effort to monitor critical eco-systems in collaboration with ongoing initiatives in the wider Caribbean. 7.22 Improving product quality through training, standard setting and certiflcation. Targeting the new high growth segments o f the tourism market i s essentially a strategy to concentrate o n less price elastic and higher price portions o f the demand curve, as a way t o offset high costs. However, without real improvements in quality o f service to justify the higher spending by visitors, this strategy w i l l fail. Improvements in quality require an increase in the numbers o f trained staff. For example, one o f the differences between a three-star and four-star hotel as rated by the Automobile Association i s that the ratio o f staff to guest rises substantially, “Reception i s staffed 24 hours a day, with porters available o n request [and] services such as porterage, 24-hour room service, laundry and dry-cleaning w i l l be available.”’04 M o v i n g to the destination model will require an increase in the range o f s k i l l s required by the sector. Given the shortage o f skilled labor in the OECS (see Chapter 5) t h i s i s an important constraint that has to be addressed. Hotels in London (2005). 116 7.23 Tourism sector’s human resource development i s a real challenge for small countries, given their small market size. In order to address this, the OECS has established Hubs o f Excellence for training such as in the British Virgin Islands for culinary arts, St. Lucia for front office operations, and Antigua and Barbuda for general customer service, but it i s not clear whether the nomenclature has been accompanied by increased investments in training in those fields. Some training i s provided by community colleges, tourist boards and associations in a limited number o f areas, including general degree/diploma programs in hospitality. However, there does not appear to be any standardization o f these programs across the sub-region. The delivery o f much o f the applied s k i l l s training remains particularly dependent o n donor projects or o n internal training by the larger hotels. One hotel in St. Lucia suggested that it has probably trained all o f the massage therapists in the island through i t s in-house training program, because there are no other facilities locally that offer this expertise. Notwithstanding the above, the shortages o f skilled labor in the tourism sector are likely to be a major constraint to improving destination and product quality. 7.24 The International trend i s for tourism training to be left to the private sector and for technical education systems specializing in skills training, and toward accreditations that are internationally recognized and portable. The OECS should build o n regional programs such as the OAS Small Tourism Enterprise Program (see B o x 7.1), to help standardize training across the sub-region, whether financed by donors or the public purse. Efforts should be taken to encourage private provision o f training by larger operators. 7.25 The establishment of standards and certifications can be a n important incentive for the private sector to improve quality. In a recent inspection o f 21 1 small hotel properties in the Caribbean conducted for the STEP program (see B o x 7.1), the majority o f which were in the OECS, the inspection team found that product quality did not meet commonly accepted basic marketplace standards in more than 70 percent o f the cases. An estimated 15-20 percent o f the cases could easily have been rectified without major expenditures or incurring capital costs (e.g. clean-up o f the property, fresh coat o f paint, new drapes, front desk hospitality, etc.), but most o f the hoteliers were not aware o f the shortfalls in their property because o f a lack o f awareness o f these standards. 7.26 Worldwide, there has been a n explosion of both public and private programs to establish quality standards and use brands or ratings to signal product quality to consumers. Most o f the OECS countries are undertaking the establishment o f national standards and certifications for a variety o f tourism related services. However, it i s not clear how harmonized these efforts are across countries or whether already-developed intemational standards that are easily recognizable by visitors are being used. At least in the area o f environmental conservation - one o f the early areas o f t h i s type o f branding and certification - a growing number o f hotels are using international standards. In a survey o f 180 hotel operators undertaken in 2004 for a recent World Bank report o n the environmental sustainability in OECS tourism sector,lo5 just under 20 percent o f the respondents reported participating in voluntary environmental certification schemes. However, another 43 percent saw n o benefits for their operation. Notably, Dominica i s currently undertaking the process o f becoming the first entire destination, rather than property, to be certified by Green Globe 21 .‘06 7.27 One form of certification which should be destination-specific i s that of “market” or “export readiness” increasingly used by tourist boards and associations to certify enterprises for participation in publicly- or cooperatively-financed marketing and investment promotion programs. This concept combines market ready standard requirements with international business procedures. For example, the British Columbia Export Ready Criteria include being in business at least one year, having an adequate budget and marketing plan including tour operators, being willing to contract and honor wholesale net rates, being able t o communicate and accept reservations by phone, fax or email and lo5 World Bank (2005a). Green Globe 21 i s a worldwide benchmarking and certification program for sustainable tourism. I t i s based on Agenda 2 1 and principles for Sustainable Development endorsed by 182 governments at the United Nations Rio de Janeiro Earth Summit in 1992. IO6 117 providing same day confirmations, and being willing to consider the development o f a website with possible digital video footage (for a full description, see Annex 4). Since these criteria are used to coordinate enterprises, they will need to be country specific and agreed through consultation with the private sector. The STEP program (see B o x 7.1) created such a standard for assessing the capacity needs of the small hotel sector, and during i t s baseline survey found that two-thirds o f a l l small hotels in the Caribbean were not “market ready”. Box 7.1: THESMALL TOURISMENTERPRISES PROGRAM (STEP) The Small Tourism Enterprises Program (STEP) was developed by Organization of American States to assist small hotels in the CARlFORUM to enhance their competitiveness and perfomzance. The majority of the hotels taking advantage of this program are in the OECS. More recently, the program has expanded its services to non-hotel small tourism enterprises. The range of interventions and assistance include: - the development of a branded marketing cooperative, caribbeanexperiencesTM modeled after the Best Western cooperative, along with an investmentfacility for memberfinancing; - a small property rating system designed speciJically for the Caribbean that covers dixerent types of small operationsfiom guest houses to inns and holiday villas; - training and certification programs, developed with partners such as the American Hotel and Lodging Association (AHLA), ting and management t on the environment, Reform investment promotion strategies. The OECS countries also need to reform their 7.28 investment promotion strategy in tourism OECS governments have long relied almost exclusively o n the use o f fiscal incentives (and directed credit) to promote b o t h foreign and domestic investment in the tourism industry. As noted above in Chapter 4 o n the investment incentives, there i s n o real economic rationale - based o n a market failure or public good situation - for most o f these particular incentives in the tourism sector, other than cross-country competition for investors. The Statutory Hotels (Aid) Acts in the .OECS provides corporate tax holidays ranging from 5 years in Antigua and Barbuda to 20 years in Dominica, and duty free importation o f materials and equipment for new construction during the tax holiday period only. In St. K i t t s and Nevis the duration o f the tax holiday depends o n the size o f the property, and in St. Lucia it i s lower for extensions versus original construction. These incentives violate the 1973 CAFUCOM agreement because they are awarded o n the basis o f sector and project characteristic rather than domestic value added. In general, tax holidays should be avoided because they are not targeted to investments per se, but rather general operations which could be expanding or shrinking over time. If the incentives are really deemed necessary, they should be replaced with alternatives such as investment tax credits, accelerated depreciation, and loss carry forward provisions as has been done in Barbados. The provisions are more closely targeted t o actual investments and help to mitigate investment risk. In addition, incentives should not discriminate between new construction, maintenance, rehabilitation or extensions. Import duty concessions should apply to particular products, such as construction materials, rather than prescribed by use. 7.29 The incentives-based competition among countries i s facilitated by their often discretionary, rather than rules-based, application. In addition, the discretionary application also creates an environment o f policy uncertainty for industry participants, including foreign investors, about the treatment o f competitors in the same market. In one fairly egregious case, t w o new foreign entrants were granted certain concessions that had not been granted to the incumbent local operator who had in fact paved the way for this line o f business in that country. In the end, the incumbent was unable to compete due to higher costs, and went out o f business. 118 7.30 I t should b e noted that even though there i s intense incentives-based competition for investors across the sub-region, a recent W o r l d B a n k report on sustainable development in t o ~ r i s m ’ ~found ’ that there i s no evidence of a race-to-the-bottom on environmental standards, although there i s some anecdotal evidence o f “fast-tracking” environmental impact assessments in order to attract investment. The absence o f sound technical baseline information o n the state o f the environment, however, m a y provide an excuse for decision makers to avoid the issue, particularly if the prevalent belief i s that rigorous environmental mitigation requirements may scare o f f potential investors. The risk remains that the costs o f inducements outweigh the long-term benefits o f safeguarding the sub-region’s main natural resource. 7.31 T h e singular focus on fiscal incentives had the inadvertent result of attracting only investments that had limited impact on the local economy. By concentrating their limited capacity o n administering fiscal incentives, tourism authorities have not paid sufficient attention to strengthening the broader environment in which investors operate. In response, the investors that were most attracted to the Caribbean were the ones who found ways o f mitigating the risks o f operating in a less than adequate environment (other than the spectacular beaches) where something in the local environment might prevent repeat visits o f their clientele. Hence, the development and popularization o f the all-inclusive concept in the Caribbean in which hotels organize their o w n transportation from the airport, eliminate the need for their guest to frequent outside restaurants and bars, provide competing recreational activity o n site, and arrange their o w n tours to a hand selected group o f sites. 7.32 Given the increasing importance of destination quality to the competitiveness of individual properties, investors are now more dependent on public policy and thus paying closer attention to other issues like the government’s commitment to destination marketing which mitigates their investment risk. Investor risk encompasses marketing, management, costs associated with creating the investment, operating costs, and the degree to which the product might b e placed at risk by external forces that are not controlled by the investor. In general, investors are looking for a commitment to the tourism sector as reflected in infrastructure programs, economic policy and planning related to critical infrastructure and a (financial) commitment to destination marketing that i s consistent with the destination’s positioning, and directed at markets in which the investor also hopes to source clients. 7.33 N o t only do tourism authorities have to manage the broader environment better, they have to devise effective ways of communicating the government’s strategies and actions to potential investors. F o r example, a recent group o f investors o n tour in Dominica needed precise and regular information f r o m the Government about the implementation o f the airport upgrading project and rehabilitation o f the road between the airport and the capital city, Roseau. Yet communications between the tourism authorities and the Ministry o f Construction, Works and Housing i s not systematic. 7.34 Finally, despite the underlying competition for investors, there i s scope in the OECS for sub-regional collaboration on investment promotion and destination marketing in tourism. The recent activities by the Heads o f Government to establish a Ministerial Committee o n Tourism, and by the OECS Secretariat to coordinate efforts to promote the yachting sector mark important developments in this regard, and should be enhanced. Promote backward linkages. The destination model also offers a new way to promote 7.35 backward linkages f r o m the tourism sector to the local economy. Visitors and governments alike have lamented the limited backward linkages f r o m the tourism sector to the domestic economy a l l across the OECS. In part, t h i s has stemmed f r o m the predominance o f enclave type resort hotels attracted by the earlier investment promotion strategies (see para. 7.31). In an attempt to encourage some linkages, most OECS countries imposed high duties o n beverage imports, in particular beer, in order to boost sales f r o m local breweries and rum distilleries to the tourism sector. However, while these policies have provided rents to the local breweries, they have also raised costs for hotels o f maintaining a wide range o f popular beverages for their guests, reducing their international competitiveness. IO7 World Bank (2005a). 119 7.36 The new destination model o f tourism deepens the linkages between the visitor and the domestic economy, because the tourists are seeking to have a broader experience o f the destination. To ensure these linkages are effective in transferring resources from the visitors to a much wider range of local enterprises, it i s necessary to ensure that local firms have the capacity and knowledge about how to provide these services. The public sector can support training and certification for a wide range of service providers including restaurateurs, tour operators, beauty salons, and community guides. I t can facilitate coordination between hoteliers and other service providers, and encourage competition between service providers. The growth o f the specialty manufactured goods, such as handmade soaps and pepper sauces, provides other linkages with the tourism sector. Marketing these goods to visitors i s another channel for increasing market penetration and awareness overseas. Conversely, the sale o f these goods in overseas markets can raise awareness about the destination. Improve allocation of public expenditures on tourism. I n line with the reforms proposed above on the investment promotion strategy, governments in the sub-region will need to rethink the allocation of their public expenditure on tourism. Public resources allocated to tax incentives, 7.37 guarantees and investor-specific infrastructure raise the return to a single private operator, as opposed to spending o n destination marketing, training, and development o f standards which raise the return to the entire sector. 7.38 Given the size o f the industry which varies from around US$45 m i l l i o n in Dominica to under US$300 m i l l i o n in Antigua, the budgets for management of the tourism sector in the OECS, and in the Caribbean, are quite small, at 1.7 percent and 2.1 percent o f visitor spending respectively (see Table 7.3). In terms o f public spending per visitor, the OECS averages about US$7 per arrival, compared with US$10 per visitor for the Caribbean, US$17 per visitor for Barbados and a whopping US$64 per visitor by Bermuda. Savings from any reduction of fiscal incentives should be targeted to strengthening the capacity of tourism authorities,"* maintaining and improving destination marketing programs, maintaining and improving general public infrastructure, environmental conservation and providing incentives for the private sector to undertake training. TABLE7.3: PUBLIC EXPENDITUREON TOURISM Tourism authority budget as a percentage o f visitor expenditures (2001) 0.92 1.67 2.21 4.92 1.94 Public investment classified under Tourism a as share o f total capital expenditure (Avg 1995-2001) Antigua and Barbuda Dominica 2.6 Grenada 3.5 St. Kitts and Nevisb 3.1 St. Lucia 11.4 St. Vincent and the 1.6 Grenadines 1.07 OECS 1.74 5.2 Other Caribbean' 2.05 a. Does not include public investment classified under Transport and Communication or Infrastructure that would include re/construction o f cruise ship ports, access roads to attractions, etc, and in some cases includes non-capital spending on donor-financed tourism projects. b. Includes capital spending on culture and environment. c. Does not include Jamaica. Sources: Caribbean Tourism Organization (2003). 7.39 Address trade-related constraints to tourism. Finally, although tourism i s a relatively competitive industry worldwide with few barriers to trade, as i s the case for many services, there are lo* Many o f the tourism authorities in the sub-region are understaffed, and in some cases with non-established or contract positions that provide little performance incentives to the staff. 120 some constraints that should be addressed through ongoing bilateral, regional and multilateral trade negotiations. The Caribbean Regional Negotiating Machinery (2003) has identified some important constraints to the development o f a competitive tourism sector that need to be addressed through trade negotiation fora. These include: 0 0 0 0 restrictions to intra-regional travel which represent a growing share o f OECS arrivals, in the form o f taxes and visas, which could be facilitated by the introduction o f a C A R I C O M passport; M o d e 2 restrictions o n "consumption abroad" in the form o f various types o f travel taxes imposed by source markets when their residents travel overseas including to tourist destinations; prohibitively l o w duty free exemptions for EU, US, and Canadian residents returning from C A R I C O M countries which encourage both cruise and stay over tourists to make purchases in the U S Virgin Islands where exemptions are substantially higher. For example, taxes and other costs can amount to 30 percent o f vacation costs for Europeans; and barriers t o mode 4 movement o f tourism professionals and students hamper the Caribbean's marketing efforts and limit educational opportunities for i t s tourism students. B. Offshore education 7.40 There i s a n emerging cluster of education exports in the Caribbean, comprised mainly of twenty-four medical, and one veterinary, schools throughout the sub-region of which more than half are in the OECS and a small, but growing, number o f English language training providers in Dominica, Guyana and Barbados. The following analysis focuses o n the offshore medical schools.'0g 7.41 There i s currently a shortage o f both North American medical school places and licensed physicians in the US. As such, the factors affecting the demand for offshore medical education are the US government's decision to increase or decrease support to medical education within i t s borders and the current and future shortage o f physicians in North America. However, the number and enrollment o f medical schools in the US has remained flat over the past 20 years at around 126 schools accepting around 17,500 students per year from a cyclical but growing number o f applicants. The current ratio o f applicants t o accepted applicants i s around 2: 1. 7.42 Recent reports in the U S have pointed to imminent shortages o f primary care physicians, certain specialties, and o f physicians in rural areas and metropolitan centers."' These shortages have been attributed to faster-than-proj ected population growth, the growing share o f older and female physicians who generally work less hours"' (see Table 7.4), an aging population requiring more medical care, increasing indebtedness o f medical graduates who in turn choose only high paying specialties, rising malpractice insurance costs forcing practitioners out o f service and increasing difficulties for foreign physicians to obtain visas to work in the US.112 TABLE7.4: STATISTICS ON THE us MEDICAL PROFESSION 1970 83% 8% 12% 17 Active physicians to total physicians Women physicians as % o f total physicians Physicians over 65 as % o f total physicians International medical graduates as % o f total physicians Source: Swedish Development Advisers (2004). 1980 80% 12% 14% 21 1990 66% 17% 15% 21 2000 77% 24% 18% 24 This section i s based entirely on a background paper by Swedish Development Advisors (2004). (2004). Ibid. More than one third o f all international medical graduates are on exchange visitor visas, requiring them to return home for at least two years before applying to reenter the US. IO9 'lo Swedish Development Advisors ''* 121 7.43 In response to the growing demand for physicians, the number o f residency positions at U S hospitals has g r o w n to around 20,000 positions per year, but in 2003 only 65 percent o f these positions were filled by U S medical school graduates.Il3 7.44 This has paved the way for offshore schools to play a “gap-filling” role between the 17,000 rejected applications each year and the 35 percent of residency positions that are not filled b y U S medical graduates. In order to fill the gap, U S medical schools would need to increase annual enrollment by around 7,500 students or 43 percent o f current enrollment. Given current levels o f support f r o m Federal, state and local governments (around US$17.1 b i l l i o n per year,114or o n average US$254,000 per student) this w o u l d imply an increase in government support by US$1.9 b i l l i o n per year. Moreover since 1990, only one new medical school has been opened in the U S and f i r s t year enrollment has increased by only 300 students. Even if one new U S medical school opened every three years starting in 2005 with an average intake o f 500 students, it would take 15 years to close the gap. Therefore, assuming the stream o f applicants continues to grow, there would s t i l l b e demand for offshore medical education in the medium-term. 7.45 On the other side, based o n current trends in retirement and changing demographics o f the physician stock, the U S will need to replace 18 percent o f physicians due to retire in the next few years, as w e l l as increase the number o f physicians to offset the increasing share o f female physicians. Although only 24 percent o f active physicians are female, 48 percent o f medical school enrollees are currently female. As such, there i s likely to be continued high demand for international medical graduates as physicians in the U S over the medium term. O f course, in the longer term, prospects for the sector will depend o n h o w the U S market responds to the shortages in medical education. 7.46 The OECS has already demonstrated a comparative advantage in the area of off-shore education, Seventy percent o f the international medical graduates entering the U S between 1984-2004 have been f r o m the Caribbean offshore medical schools. Currently, there are an estimated 11,000 offshore students enrolled in these schools, h a l f o f which attend schools in the OECS. Indeed, the two largest medical schools serving the U S market are in Dominica and Grenada. FIGURE 7.2: INTERNATIONAL MEDICAL GRADUATES IN THE 4,000 3,500 4 9 * 1 us, 1984-2004 International Medical Graduates into the US 1984-2004 3,000 2,500 rA “0 2,000 b E 1,500 0 i 1,000 500 Source: Swedish Development Advisors (2004). ‘13 ‘14 Swedish Development Advisors (2004). Ibid. 122 7.47 Moreover, there has been an increase in investment in this area in recent years. O f the 23 primarily'" offshore medical and veterinary schools in the Caribbean, four were, established before 1990, seven between 1990 and 2000, and twelve in the last four years. The sub-region i s attractive to investors because o f location, language, and security, meanwhile the programs are attractive to students because o f the lower cost and shorter time to completion compared to U S medical schools. 7.48 The business model. The offshore medical schools in the Caribbean are all geared to the U S market. The main difference between the U S medical schools and offshore medical schools are the latter only offer the first t w o stages in the training o f physicians for the U S market (see Figure 7.3) - with the first stage provided in the Caribbean, and the second stage completed at a U S hospital - and they are established as commercial, not not-for-profit, ventures. Basic Science curriculum (60 weeks) Enrollment into M.D. program U S M L E Step 2, MD degree and National Resident Matching Program U S Medical Licensing Examination (USMLE) Step 1 USMLE Step 3 7.49 Accreditation requirements (a state-level function) for U S medical schools include notably that they be not-for-profit institutions, associated with a full service university, and have established research programs for both faculty and student participation, and maintain a full service hospital. This latter requirement substantially raises the costs o f establishing such schools. Funding comes mainly from medical service revenues (50 percent), government support and research grants (2 1 percent), endowments and charities (1 6 percent), with very little f r o m tuition and fees (3 percent). 7.50 I t i s significantly less expensive and easier to establish a n offshore medical school in the Caribbean where accreditation requirements do not include research programs, full service universities or hospitals. The schools are accredited by local institutions, w h i c h in tum may be reviewed by the U S National Committee o f Foreign Medical Education and Accreditation (NCFMEA) but only for eligibility in federal student loan programs.II6 7.5 1 Because the schools concentrate o n basic sciences instruction and contract out clinical rotations to U S hospitals, they forego the investment costs o f research, hospital and clinical facilities. Faculty salaries are lower because they are not required to engage in research, and many are o n short-term contracts. The teaching staff i s a m i x o f older experienced MDs or PhDs who have practiced or taught medicine in the US, or younger physicians who want to l i v e in the Caribbean for a short period. None o f the schools interviewed indicated any difficulties in recruiting teaching staff. Operating costs are also lower, because of lower costs o f living in the Caribbean, and o f non-medical staffing. Finally, the schools are able to boost revenue by taking in a new batch o f students each trimester, rather than each year as i s common in U S medical schools. Rough estimates based o n survey information o f the profit margin for a small school o f 100 students in the Caribbean are o n the order o f 28 percent before taxes and financial charges. 7.52 As such, the offshore schools can compete with U S schools b y significantly reducing the cost and duration of medical training to the students. Tuition runs between US$lO-40,000 per year compared with private and non-state resident tuition o f US$34,000 per year. M o s t have shortened the '15 The Caribbean has 37 medical schools registered with the WHO, but those in Trinidad and Tobago (l), Jamaica (1) and the Dominica Republic (9), and one o f the schools in Guyana, cater primarily to domestic or regional students. 'I6 In the Caribbean, the Cayman Islands, Dominica, the Dominican Republic, Grenada, Monserrat, Saba, St. Lucia and St. Maarten have been accepted by the N C F M E A as having appropriate accreditation standards for this purpose. 123 instruction period for the basic science curriculum by running trimester, instead o f semester, systems with n o summer break. 7.53 Inorder to attract students, the schools prepare students specifically for the U S Medical Licensing Examinations (USMLE) and arrange clinical rotations at U S hospitals, regardless o f the local accreditation requirements. Indeed, many o f the local accreditation bodies were developed specifically to facilitate these investments. The U S M L E pass rates for a subset o f the schools surveyed, including the t w o largest, are as follows: TABLE7.5: OFFSHORE MEDICAL SCHOOL USMLE PASS RATES Number of schools 3 2 1 3 9 Pass rate 90% or above Pass rate above 80% Pass rate below 80% Information not provided Total 7.54 In addition, the N e w Y o r k and California state medical boards, which oversee a large number o f residency positions, do accredit foreign institutions - the t w o largest schools in the Caribbean have been accredited by the NY board which allows their students to compete in residency programs in other states as well. Research program Research program not required Financially independent board Private company boards Generally, 60 weeks o f Basic Science instruction in situ plus 80-100 weeks o f clinical rotations in the USiCanada 130 weeks o f instruction Evaluation system in place for programs counselling aid programs residency and debt Provision o f health services & insurance to students Many rely only on USMLE results for evaluation Few have placement systems but most help to organize clinical rotations in U~Khnada Some schools are eligible for U S Federal loan programs Some have health clinics, most do not provide health insurance Student pop Avg age: 24 years GPA: minimum 3.6 Avg age: 27-30 years GPA: average 3.0 124 Source: Swedish Development Advisors (2004). 7.55 These lower thresholds and high profit margins have allowed for more entry and competition. Following the model of the earlier schools, there has been a steady increase in entrants to this market over time. Investments have generally been undertaken by groups o f physicians and entrepreneurs intending to reap a profit. M o r e recently, however, institutional investors have gotten involved, w i t h the purchase o f Ross University, first by venture capitalists and then by D e V r y Inc., one o f the largest publicly-held higher education companies in N o r t h America. 7.56 I n relatively small economies, a number of smaller offshore medical schools or a large one could have a potentially large impact on the local economy. All the surveyed offshore medical schools are registered as for-profit educational institutions in each o f the countries where they are located, however FDI incentive regimes allow for tax holidays and duty concessions, and repatriation o f profits, dividends and imported capital. The regimes vary not only across countries, but also between schools in the same country. In all but two o f the countries surveyed, the schools were exempt from corporate tax, whereas in others, schools enjoyed concessional income tax rates. Foreign instructors are also generally exempt from local income taxes and all the schools received either reduced duty, or duty exemptions o n imports of intermediate goods. Instead, most countries levy an annual per student tax or fixed annual fees o n schools, but these also vary by country and institution. The annual fiscal yield ranged from US$50,000 to US$300,000 per year. Recognizing the non-transparent and discriminatory treatment o f different schools, one country reported plans to harmonize the tax treatment across institutions. 7.57 Estimates o f annual spending by students range f r o m US$6,500 to US$21,000 for the countries surveyed. The surveyed schools employed some 710 local staff, paying higher than average wages in the domestic market. The ratio of local non-medical staff t o students ranges from 1-30, decreasing for the larger schools. The smallest schools typically have more persons employed in the U S tasked with recruitment, enrollment, marketing and finance. As they grow, these tasks are often transferred t o the islands, but the employment benefit i s offset by the reduced ratio o f local support staff to students. 7.58 Overall, the estimated direct impact on the economy ranges from 0.2 percent of GDP in St. Lucia to 8.3 percent in Dominica. The indirect impact however i s substantially large. First, the schools have an impact o n local health care institutions to which they provide a range o f support in terms of financial and equipment donations in exchange for clinical exposure for their students, and incidental training for local medical professionals. Most o f the schools offer a few scholarships to local students. One school has diversified into other areas o f post-secondary training and i s targeting the local and regional tertiary education market which i s notably under-served. 7.59 The growing number of schools being established in the Caribbean (including by DeVry) i s evidence of the market’s outlook for further potential for growth in this area. Lobbying and accrediting agencies in the U S and Canada have begun to take notice. N e w entrants are beginning to differentiate their instructional approaches - one school has started a distance learning program, while another i s focusing o n a holistic approach t o training a “good” doctor with l i n k s to similar-minded clinical and residency programs in the U S . Older entrants have achieved direct accreditation by state medical boards and established reputations that allow their graduates to enter competitive residency programs in the US. However, the growth encouraged by strong demand and the l o w entry requirements (both in terms o f finance and accreditation) has been accompanied by increased churning as some new entrants 125 succeed and others fail. This can risk damaging the reputation o f a country if one operator misleads students and provides sub-standard services. 7.60 Countries can encourage the appropriate types of investments by raising accreditation standards to allow for NCFMEA, federal loan program, and key state board accreditations. This may also help t o difhse negative attention from U S associations that may lobby for expansion of domestic education in response to challenges o n quality. Costs o f an accreditation body could be minimized by supporting a regional, rather than national, accreditation agency. 7.61 Second, given the demonstrated supply o f investors, it would be unfortunate for the OECS, as w e l l as the other Caribbean countries, to engage in tax competition to attract entrants. A harmonized, transparent and non-discriminatory investment regime would be more appropriate to position the sub-region for continued flows of investment. 7.62 Finally, the sub-region needs to strategize on how to build on i t s success in this area to maximize the impact on the domestic economy and the local provision of training, but also expand offshore education exports into other related areas. U S imports o f education services have been growing o n average at 11 percent per year since 1984. The emergence o f an English training cluster i s a notable development in t h i s regard. C. I C T clusters An important distinction to be made i s between I C T as an output sector and ICT as a technology that enables the production of other goods and services in the economy. The former 7.63 focuses o n production o f direct I C T goods and services, such as Business Processes Outsourcing services, call centers, software development and production, communication services and telecodcomputer equipment production. The latter emphasizes the adoption o f I C T technologies throughout the economy and calls for attention to the development o f appropriate infrastructure, expansion .of ICT s k i l l s and services, the introduction o f e-government, and a broadly enabling environment including such elements as a legislative framework for e-commerce. 7.64 Throughout the Caribbean and in the OECS, ICT as an output sector has been, and i s being, over-relied upon to be a major source of growth in the coming future. Most o f the efforts to trigger the development o f I C T sectors have failed to live up to expectations. There are some good reasons for this, particularly the choice o f l o w wage-centric clusters such as call centers, and the failure to link foreign investment to local s k i l l s and generate spillovers. This section focuses o n the experiences t o date with trying to develop I C T and ICT-related services as an output sector in the OECS and the broader Caribbean and extracts some o f the lessons for the way forward. In Chapter 6, I C T as a factor o f production i s covered in Section A and telecom infrastructure i s covered in Section C. (i) Call centers and offshore business proce~ses"~ 7.65 The outsourcing of business processes to the Caribbean began as early as the 1980s when U S companies started looking for l o w cost markets nearby. The Caribbean did manage to become a hub for a near shore data processing industry coming out o f the US. Notably American Airlines established i t s data processing services in Barbados (see B o x 7.2). However, when the U S companies began to face lower cost pressures, business fled to l o w wage countries like India and the Philippines. A t the same time, the market began to open up for higher valued-added services that were more complex and required staying at the cusp o f technological innovations. In general, the Caribbean was unable t o keep up with s k i l l s and infrastructure requirements and was unable to compete for these new lines o f business. 'I7 This section i s based on a report prepared by the consulting firm, OTF Group, Inc., for the Information Development Program (infiDev, www.infodev.org), a consortium of public, bilateral and multilateral development agencies including the World Bank, and assisted by an expert secretariat housed at the World Bank. 126 BOX 7.2: AMERICAN AIRLINES’ DATA PROCESSING OPERATION IN BARBADOS subsidiary devoted to data In 1981, American Airlines ass ent, customer queries and processing services training, the work ethic, the stable upgrades). I t decided to invest in Bar in 1998, the company, known as environment and of the proximity to 1 that it started servicing Caribbean Data Sew the Dominican Republic other big US compan and Jamaica. By end of However, Caribbean take its services to the next level of complexity. As data processing began to rely more on the use of the internet and online transactions, telecommunications costs in Barbados became prohibitive for this type of business. At the same time, the client companies were also facing increasedpressure to reduce costs. Once countries such as India, China and the Philippines with an abundance of cheaper labor made a full-fledged entrance into the business, the Caribbean could no longer compete and eventually the operation closed. Notwithstanding the low wage competition, the company and the country did miss an opportunity to make a strategic shift to more value added tourism customer service, in part because of the services in some core competencies, such as airlines, healt poor technology platform and high costs of connectivity. 7.66 Almost every Caribbean country has experimented with call centers. The OECS embraced them as potential unemployment buffers, and some governments offered to fund training, engage in joint ventures, provide fiscal incentives or straight subsidies to both local and foreign operators. Despite the use o f basic technologies (telephony), many foreign companies demanded generous concessions promising spillover effects. Whereas the governments supported call centers in Jamaica, Antigua and Barbuda and the Dominican Republic, these activities did not receive preferential government support in Barbados and St. Lucia. 7.67 Wide-scale unemployment absorption was either not achieved or was not sustained, in general because countries h a d positioned themselves at the wrong end of the market. There are basically two types o f call centers operations: telemarketing and customer care. Telemarketing involves outbound calling t o sell products and services and receive commissions o n sales closed. Typically, a call center will purchase call lists i s paid by a credit card company based o n h o w many credit cards are sold. Customer service centers mostly do inbound calls answering concerns and solving customer problems. In the OECS, the early emphasis was o n telemarketing and low-end customer service as a means to reduce widespread unemployment among the less skilled workers. This business generally competes o n l o w labor and l o w connectivity costs. Because o f the relatively lower wages and the commission-based system, workers in the OECS attracted to the call center business saw i t mainly as temporary employment where they could gain “hands-on” IT experience. Employee turnover was high resulting in transient customer relationships and higher training costs and thus high costs to close sales. Add o n the high telephone rates for outbound calls (see para. 6.59), and the call centers were unable to produce the margins required by U S firms. The case o f Call Centers Antigua Limited (see B o x 7.3) i s illustrative o n a number o f these points. Call Centers A Box 7.3: CALLCENTERSANTIGUA,LIMITED The hope was that skill 127 the call center became the ere was low employee morale e a higher level of computer At these wage levels, isbing jobs andpositions. The 7.68 Despite recent examples, there are viable opportunities in the call center business, if the O E C S can re-enter at the high end of customer service for larger U S companies, instead of continuing with the low-cost telemarketing model. Whereas the earlier pressure o n U S f i r m s was to lower costs, quality o f customer service i s fast becoming a key source o f differentiation in the market place. For instance, in 2001 the worldwide customer care industry was estimated to represent a US$34.9 billion market; experts project the market will exceed US$90 billion by 2006.118 7.69 The advantage of higher-end customer service accounts i s three fold. First, the business i s usually based o n longer-term contracts (2 years plus) because the call center has to make greater commitment in training which, focuses not only o n customer service skills, but also o n the company products, policies and procedures, and generally involves more sophisticated software applications. This supply o f training in technology and customer service could have spillovers both in the hospitality industry and the broader economy. Second, the call center employees generally become part o f the outsourcing company, improving motivation and reducing turn over rates. Finally, because large companies and their clients tend to have more direct contact with their customer service operations offshore and thus visit more often; the proximity o f the Caribbean and the cultural affinity t o the U S i s a comparative advantage. 7.70 Establishing cyber parks i s another option that has been considered as a means to attract ICT clusters to the OECS. Unfortunately, many governments have seen cyber parks as simply the development o f an industrial park with high tech connectivity, with the mentality o f “if w e build it, they will come”. However, successful parks, such as the ones in Taiwan, Indonesia, Malaysia and the Philippines, are established to spur the development o f high-tech industries by integrating technologically modem facilities with technical training, education and research centers, business incubators and other support services. Their development requires a long-term commitment to provide the expensive infrastructure, establish the learning institutions, and attract the skilled management to integrate the many components. The experience o f prospering cyber parks throughout Asia shows that it can take up to 15 years for the model to h l l y develop to a stage where all o f i t s components are pushing towards a common objective - to enable innovation and increase competitiveness through cooperation. In the earlier stages, complementary institutions may not be an immediate necessity to attract initial investment, but as these supportive components develop, so do the types o f businesses within the park and the human capital it employs. In the Caribbean, Barbados has pursued a private-sector led approach where private entrepreneurs have invested in high-tech conference centers and industrial parks at the request o f international interests, whereas Trinidad and Tobago i s currently constructing a cyber park. The most notable experience in the region i s in the Dominican Republic, where the government’s experiment cost US$ 30 million, but failed to live up t o expectations due to wavering political commitment and inconsistent management. As such, the decision to establish a cyber p a r k needs to be a strategic one that i s integrated into a clear vision of where the economy i s headed, and a detailed understanding of competencies and infrastructure needed to get there. (ii) Internet gaming in Antigua and Barbuda 7.71 Antigua and Barbuda’s development of the internet gaming industry shows the potential for the OECS to make strategic inroads into ICT-enabled clusters. Antigua and Barbuda’s government approached t h i s sector as an opportunity to compete in a growing business worldwide. The ~~ InfoDev (2005). 128 internet gaming sector has around US$6 billion in sales worldwide and continues to grow - especially in Asia, where Australia i s a big player. Antigua and Barbuda positioned itself carefully to enter the industry early on, based o n the comparative advantages o f having a population with solid communications s k i l l s and in the same time zone as i t s main U S market, which up until then was under-served. The development o f the industry was undertaken in a very proactive manner. Even more importantly than the fiscal incentives provided to attract f i r m s , the government took the necessary steps to establish the right enabling environment. In internet gaming this meant putting in place a strong regulatory environment that would allow f i r m s with the cover o f being in a reputable environment. The country invited experts from around the world and studied legislation in major gaming markets like the UK and Australia. The result was a well-regulated environment whose seal o f approval has become a stamp o f credibility in the industry and attracted companies to Antigua and Barbuda despite higher licensing fees and in many cases higher wages. Licensing fees range from US$50-80,000 and involve an in depth due-diligence process, compared with Costa Rica that offers fees as l o w as US$800. 7.72 The industry grew quickly and successfully. During 1996-2000, it provided US$25 million in revenue for the government. In 2000, there were close to 100 f i r m s operating in Antigua and Barbuda. Firms were moving to Antigua and Barbuda from other locations where the environment was less favorable, for example Austria which had changed i t s rules to allow only state-owned players in the sector. In line with international regulations, companies are required to keep their servers o n the island and so they employ highly skilled engineers, web-designers, customer service representatives, etc. Salaries are relatively attractive, paying US$15-18 per hour. Further, companies generally invest in training. The demand has spurred the development o f a local training institute, with spillovers to the local economy. Despite the negative societal connotations, young IT professionals are eager t o take jobs in the gaming industry and there i s l o w turnover, because aside from the pay, “it’s much more fun to be in a laid back atmosphere, watching the NFL games, dealing with customers, than working in a bank”, according to one manager. 7.73 The industry continues to face some challenges - one being high telecom rates. This has prompted Antigua and Barbuda to move quickly on joining the Eastern Caribbean Telecom Authority (ECTEL). Notwithstanding the high charges, the private telephone company has been cooperative in upgrading their equipment to manage the increased traffic brought by gaming companies. A second issue i s the operations of customs, which can delay the delivery o f servers and IT equipment for weeks. 7.74 The development of the industry has not been without setbacks. The government made some mistakes in the past, but demonstrated quick resolve to correct them. The first was the introduction o f a 3 percent tax o n gross earnings which caused massive exit and was later rescinded. This experience i s similar to that o f the UK which imposed a s i m i l a r tax only to rescind it when many operators moved to Gibraltar. The second mistake was the decision to introduce a black box into every operator’s servers so that all betting transactions would be monitored by the regulating agency. This interfered with transactions speed and reduced enterprise productivity significantly, but was eventually reversed. M o r e recently, the U S imposed a restriction prohibiting credit card transactions for online betting which severely reduced revenues. Antigua and Barbuda challenged this restriction in the WTO and in August 2004 w o n an important victory. Negotiations with the U S are underway t o reach a solution. The collaboration between the Gaming Commission and the industry o n the WTO case i s a good example o f how the government can work with the private sector to solve the problems o f the sector, enabling continued growth and competitiveness. I t i s also a good example o f h o w the rules-based trading system of the WTO can work to the benefit o f small states. ’ (iii) Software development 7.75 The computer software industry i s a fairly new and fragmented sector in the Caribbean. Some o f the first f i r m s sprang up during the mid-1990s as a natural extension o f back office business data processing. The majority were foreign owned companies, outsourcing part o f their software engineering process to the Caribbean mainly because o f the incentives provided by national governments. Most operated under the offshore jurisdiction, receiving favorable tax treatments and other enticements for 129 setting up shop. The two major players were Barbados (in areas such as coding and abstraction) and J a m a i ~ a . " ~However, this was not supported by a comprehensive strategy for the development o f the industry. The experience o f one firm in Barbados (see B o x 7.4) illustrates that fiscal incentives are rarely sufficient if there are other underlying constraints related to the business environment facing the sector. BOX 7.4: HIGHTELECOM COSTS HINDER THE SOFTWARE DEVELOPMENT INDUSTRY P R T L t d was one of thefirst software development companies in the Caribbean. This US company set up operations in Barbados in 1996 and employed close to 300 Indian programmers to develop software for companies such as JP Morgan and Prudential Insurance. PRT was classiJed as an offsho ompany enjoying tax benefits and rent-free facilities. I n turn, the company employed and trained locals an nvinced the government to procure high peformance communications equipment. One problem, although seemingly trivial, was a shortage of quality housing for such a large overseas worJ$orce migrating to Barbados. The second was that telecommunications costs remained high, When the Internet bubble burst in the US, the company wasforced to lower costs, Even though the Barbados Investment and Development Corporation managed to negotiate a 50 percent reduction in broad band charges by the private telephone company, the cost remained prohibitively high and the f i r m eventually closed its operations in Barbados. 7.76 Recently, there has been a new wave of interest in the software industry in the Caribbean following the advent of Open Source Software (OSS).'20 OSS i s advocated as an attractive option for developing countries because the programming code used t o create software i s available for inspection, modification, re-use, and distribution by others;12' hence software applications can readily be adapted to address local needs and are often cheaper than established off-the-shelf software. For example, a start-up gourmet delivery company in the Dominican Republic had a local programmer create CRM and logistics back end system customized to i t s customer base for less than one tenth o f the price o f established o f f the shelf software. In turn, the software developing process and upgrading can also help cultivate domestic talent that flows into a local computer software industry serving both the private and public. 7.77 The OSS industry in the Caribbean i s s t i l l quite fragmented. Most o f these companies are sole proprietorships.122 Currently, there are a lot o f individual efforts and small scale businesses, but n o one really knows what the other players are doing in the region. However, a few o f these players are trying to foster collaboration throughout the industry to create a forum to share innovative ways in which OSS has been used, and to reduce the amount o f duplication and replication across the region. Digisolv, Inc in St. Lucia i s one such firm (see B o x 7.5). BOX 7.5: PROMOTING OPEN SOURCE SOFTWARE DEVELOPMENT IN ST. LUCIA Digisolv, Inc is a software company in St. Lucia that provides networking and network-oriented solutions to private companies, governments and NGOs. The company started out in hardware sales but quickly moved to offering sophisticated I C T solutions using OSS. The company sees potential for growth in areas such as networking, business communication applications, email group work, scheduling, and document, content and project management. The main challenges include lack of awareness of the potential, a shortage of trained personnel in OSS-Linux operating systems, and financing. The company is currently organizing seminars with the trade iations in St. Lucia to raise awareness a to bring sses and individuals ng on OSS. 7.78 These types o f initiatives taken by the private sector are generally a much stronger signal o f the potential o f an industry than "feasibility studies" prepared by donors and government officials. As such, Cleland and Gomez (2003). Open Source Software is software for which the underlying programming code i s available to the users so that they can read it, make changes to it, and build new versions o f the software incorporating their changes. Types o f Open Source Software differ in the licensing terms under which altered copies o f the source code m a y b e redistributed. 12' InfoDev (2005). Data o n the number o f firms operating in this sector does n o t exist, and information pertaining to the ICT sector overestimates the number o f companies since it includes a wide range o f operations from telemarketing t o I T training to more sophisticated business segments. 'I9 I2O 130 mechanisms for identifying and supporting similarly innovative and proactive entrepreneurs should be a n important part of the government’s private sector development strategy. D. Health and wellness services 7.79 Some emerging trends in the O E C S point to potential for joining the growing cross-border delivery of health and wellness services worldwide. These trends include: (i) an increasing number o f hotels offering spa and wellness services including the world class facilities, L e Sport spa in St. Lucia and the Crossroads Center in Antigua and Barbuda providing spa, wellness and rehabilitation services (see B o x 7.6); (ii) a steady stream o f medical professional recruits to North America; (iii) the offshore medical education sector; and (iv) the proposed private development o f a regional nursing training school in St. Kitts and Nevis. BOX 7.6: WORLD CLASS WELLNESS FACILITIES IN THE O E C S L e Sport Spa Resort in St. Lucia is one of the world’s most acclaimed health spas. European readers of Condd Nast Traveller recently named L e Sport the number one destination spa in the world and one of the 100 Best of The Best in Travel. The resort’s main ofering, the Body Holiday, combines a beach vacation with the personalized aesthetic and spa services ranging from yoga, Tai Chi, meditation, aerobics, stress management, fitness with personal trainers, stress and tone classes, aromatherapy, hydrotherapy, thalassotherapy, Swedish and Shiatsu massage, ayurvedic treatments, acupuncture and acupressure, reflexology, and skin clinics. Le Sport caters primarily to couples, but has facilities for families and those traveling alone. L e Sport targets the European market, primarily UK and Germany. I t is owned and operated by a St. Lucian family under the Sun Swept Resorts which also has facilities in the US, Canada, UK and Europe. Stafis primarily from St. Lucia and the Caribbean and has received training in treatments and therapies. Thefacility has 154 tively high occupancy rates. Clapton in 1998. I t has since providing services to individuals efective therapies to address add lizes a combination oj 29-day residential 12- UK). I n terms of treatment and Betty Ford and Hazelden centers, but costs much less at about US$14,500 for the month-long inpatient program inclusive of lodging. An equivalent program at a Betty Ford or Hazelden center is about US $21,0 The center strives to maintain a high staff to patient ratio. The cost advantage health-care worker costs in the Caribbean, and the fact that the organization Crossroads is a lot more simple and streamlined. For example, since admissions at Crossroads a ounts receivable department. 7.80 It has been estimated that by 2005, the global health services sector will amount to US$4 trillion, and that the value o f health services exports w i l l be approximately 5 percent o f that market or US$140 billion. Expected growth in exported health services (Mode 4) i s estimated to be six percent annually, but given the growth in information and communications technology and greater openness o f health systems, trade in health services including Modes 1 and 2 may in fact grow at much higher rates. 7.81 The O E C S has several characteristics which make it an appealing destination for visitors seeking offshore health and wellness services. These include i t s proximity to N o r t h American and European markets; climate and natural environment; a steady supply o f well-trained health practitioners; lower cost labor; reasonably reliable telecommunications and transport services; a well-developed hospitality sector; and an established health and medical service sector with both public and private operators. 7.82 The approaches that countries have taken with respect to fostering trade in health services can be grouped into three categories. The ‘first, a government-led approach, i s based o n a national policy or strategy o f export-promotion to pursue medical or health tourism as a means o f generating needed revenues for the health sector. Countries such as Cuba, Jordan, and Singapore provide examples o f such approaches. In the second, a private-sector led approach, countries have left development o f medical 131 tourism to private entrepreneurship, with governments developing the legal and regulatory enabling environment necessary for private investment and private sector expansion. India i s an example o f t h i s approach. Finally, Latin American and East Asian countries have both adopted national policies or strategies and also have expanded private sector growth in this area (mixed). 7.83 Notwithstanding the above, the range o f services that could be developed will depend upon where the private sector sees the most potential for profitable business, and how the public sector regulates these activities. There i s good potential for expanded trade in rehabilitation and addiction services, as well as alternative and complementary medicine. The expansion o f spa and wellness tourism services can be implemented without drawing too heavily on the pool o f skilled health professionals. Medical tourism, however, w i l l be limited by the availability o f adequate referral and skilled staff, and the quality o f secondary care. Because the OECS countries do not have large private health sectors nor excess capacity in public health systems, it i s likely that any growth in health and wellness service exports will evolve initially through the tourism sector and the wellness and spa business. There are a number o f constraints and issues that would s t i l l need to be addressed w i t h public 7.84 sector involvement: 7.85 One overarching issue will be to avoid the development of a dual and inequitable health system with enclaves of high quality health facilities catering to foreign visitors, at the expense of the national health system. Just as with the offshore medical schools, there may b e a need for explicit linkages between the private and public health sectors, and between state-of the art health services and community health needs. 7.86 The second issue would be to address any s k ills shortages. Distribution o f human resources between primary and secondary care i s o f concern, as i s shortage o f health professionals in general. Migration and retirement o f staff have left a large void. Increased trade may induce repatriation and retention o f health professionals to work in joint private sector ventures. There may be scope for offshore training facilities to provide staff for local markets. The experience o f the offshore medical schools shows that the OECS does not face any particular difficulty in recruiting overseas physicians to work in the islands, provided remuneration i s competitive. While the quality o f nurse training in the OECS appears to be adequate as evidenced by the steady training-recruitment-migration path for nurses, the overseas opportunities could raise reservation wages for trained nurses in the OECS, eventually offsetting some o f the cost competitiveness in t h i s sector. Greater flexibility o n intra and inter-regional mobility o f health professionals would help to mitigate some of this effect. 7.87 I n the event medical tourism i s pursued, licensing and accreditation for medical services will have to be strengthened in order to satisfy the demands of the discerning health tourist, to safeguard residents who may access new private services, and encourage coverage of overseas services b y insurance companies and other third parties. The OECS should support and fully participate in ongoing regional efforts in this area, with the support o f the Caribbean Association o f Medical Councils, nursing bodies and the Joint Commission International. 7.88 Increasing the portability of health insurance both within the Caribbean and from beyond can provide impetus to the sector. At the moment, few health insurance plans offer coverage for nonemergency medical treatments overseas. This would limit the market to those who can afford to pay out of pocket. Discussions with operators in the insurance and care management organizations suggest that innovations in case management across international borders may be lessening this problem. In addition, the OECS countries may want to ensure that t h i s issue i s adequately addressed in the FTAA negotiations. 7.89 An appropriate legal framework for medical liability and consumer protection would have to be established to safeguard both practitioners and patients. However, care should be taken not to replicate the shortcomings o f the current U S system, as t h i s would further reduce cost competitiveness. 7.90 Other recommended measures include: 132 Facilitate public-private sector partnerships. There i s a need to provide support to local entrepreneurs in development o f viable business plans for expansion o f spdwellness services, and in development o f public-private partnerships, including careful market analysis. Generate linkages with care management companies, such as the Canadian Medical NetworWCare Management Network National which will reduce search costs for potential consumers and provide a mechanism for reimbursement and financing. Strengthen marketing o f health tourism in the UK, N o r t h America, and Asia. The Caribbean might be informed by the experiences o f other countries with health tourism, particularly from the Apollo Health Services in India which caters to both national and international consumers. Develop indicators and a tracking system to monitor development o f this sub-sector. Because o f the dearth o f information regarding the number, origin, expenditures, and characteristics o f tourists who may be coming to the Caribbean for health and health-related services, i t i s highly recommended that a tracking system be developed and implemented, either by CARICOM, with the support o f the Pan American Health Organization (PAHO) and the Caribbean Development Bank (CDB) or other appropriate regional agency such as the Caribbean Tourism Organization (CTO). As part o f t h i s effort, i t may be useful to establish a health tourism desk at the national level to collect and evaluate data. E. Offshore financial services 7.91 While the offshore financial sector has yielded sizeable revenues for the OECS countries in the past, the sector has declined in most countries since the late 1990s. This decline was initiated by the cyclical downturn in the financial markets in the late 1990s and then exacerbated by the increased international scrutiny o n offshore financial flows from the OECD Financial Action Task Force and others, and then again following the terrorist attacks in the U S in 2001. This decline combined w i t h the increasing cost o f regulation and supervision has motivated several OECS countries to actively re-think whether to maintain these sectors. However, little analysis has been done o n the impact o f the sectors beyond the contribution o f registration fees to government revenues.'23 One additional consideration i s that having an offshore financial service regime complicates the negotiation o f bilateral tax treaties that may encourage onshore foreign investment. Banks TABLE 7.7: OFFSHOREFINANCIALCENTERS IBCs* Antigua and Barbuda Dominica Grenada St. Kitts Nevis St. Lucia 15 1 44 1 1 1 6,000 8,000 3,400 13,800 17,000 61 St. Vincent and the Grenadines 9 6,000 OECS Trusts Mutual hnds Insurance companies -- ------ ----- 117,520 30,000 314,000 * International business companies. Sources: Suss, Williams and Mendis (2002) The Bahamas Cayman Is. Br. Virgin I s . 200 450 0 -- 11 ---- 350 n.a. n.a. n.a 2 15 17 700 2300 2000 -- M a x % o f current revenues collected during 1995-2000 6.6 5.2 4.6 3.3 (1999) (1998) (2000) (2002) -- ... 9 1.5 (2000) 3.6 (2000) 1.3 14.6 54.6 230 500 360 and U S Department o f State (2004). Fees paid t o government are captured in the balance o f payments accounts. In addition, there is an attempt to measure payments made t o local service providers as w e l l in the balance o f payments. National accounts statistics only captures data o n domestic investments o f offshore entities. 133 7.92 With the exception of Nevis, none of the O E C S countries have succeeded in establishing a significant market presence in any of the offshore financial services market segments. Table 7.7 provides comparative data o n offshore financial centers in the Caribbean. Among the other Caribbean jurisdictions, Bermuda dominates the global captive insurance and reinsurance markets; the Cayman Islands i s a major player in offshore banking with over 450 banks, and has recently become the second largest captive insurance center; the British Virgin Islands i s a significant player in the registration of international business companies (IBC) with over 300,000, followed by the Bahamas with around 120,000 IBCs registered. 7.93 T h e general outlook for this segment i s that, as OECD and other international efforts result in a tightening and harmonization of regulations regarding tax and other treatment, the demand will likely shift from tax minimization toward asset protection and regulatory arbitrage in the mutual fund and insurance business. As such, any h r t h e r growth in the market i s likely to come f r o m increasing complexity o f the services provided to the holders o f offshore assets, rather than simply in the volume o f assets registered. In addition, some countries like the Bahamas are migrating from ‘banner like’ companies without a physical presence to “virtual headquarters” that requires trained staff using sophisticated interface to communicate with their client base. These types o f services provide positive spillovers because o f their demand o f supporting staff, specialized software applications, and strategic and legal consulting services, among others. A number o f OECS countries have also begun preparing for the introduction o f offshore mutual fund administration and insurance services. However, these segments also demand a much higher level o f s k i l l s in terms o f services to be provided by local agents and I C T infrastructure, and require much more complex regulation and supervision infrastructure than the traditional offshore banking, IBC or trust business. Without the adequate regulatory capacity, jurisdictions run the risk o f reputational events that could dampen future growth. 7.94 With the recent upward trend in international financial markets, there i s some potential for a rebound in the offshore financial services sector o n the volume side o f the business. However, without strengthening the types o f services offered in the OECS, offshore financial services are likely to remain at the current l o w end commodity-side o f the market, which will continue to face pressure as international scrutiny and financial regulations tighten worldwide. 7.95 Given the increasing complexity of the business, any growth in the O E C S offshore financial sectors will require a major expansion of accounting, financial and IT-related s k i l l s as well as improvements in the telecom infrastructure for data transmission. 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Ley (2002). “Tax incentives for business investment: a primer for policy makers in developing countries” World Development (U.K.); 30(9): 1497-15 16. 142 ANNEX1: GRENADA INVESTMENT CLIMATE SURVEY A survey o f 201 f i r m s was conducted in Grenada between January - April 2004 in order t o gather the firm-level data for A Diagnostic Review of the Investment Climate conducted by FIAS. The survey instrument shares much o f i t s structure and focus with other investment climate assessments carried out under the W o r l d Bank Group investment climate initiative, but i s at the same time shaped by the distinctive priorities o f the country. The sample was selected from a l i s t o f f i r m s that make contributions to the national insurance scheme (NIS) for their ~ 0 r k e r s . The l ~ ~ sampled f i r m s were chosen to ensure that they broadly reflect the Grenadian economic structure and focus o n the areas where the Government actively encourages more investment, In addition, special attention was paid to large companies (those with 25 or more employees), f i r m s in manufacturing and tourism and tourism-related sectors, as well as foreign owned establishments in order to gain a deeper understanding o f their dynamics. Although most o f the sampled f i r m s are located in St. George’s town (98 firms) and St. George’s parish (68 firms), other parishes are represented as well, including 12 f i r m s in St. David’s, 11 f i r m s in St. Andrew’s, 3 f i r m s in St. John’s parishes, and 5 f i r m s in Carriacou. Some o f the key features o f the sample are highlighted here, while a more detailed breakdown o f the participating f i r m s by size and sector can be found in the table below. Sector distribution. The sample includes 44 manufacturing f i r m s and 56 tourism-related firms. The tourism sectors are broken down into hotels, including f i r m s with hotel services as the main activity, and other tourism services, which include restaurants, yachting activities, tour guides, diving shops, travel bureaus, and shops catering t o tourists (e.g. duty free shops). The classification o f enterprises by sector i s based o n the recording o f primary activity. It should be noted that five o f the retail f i r m s have manufacturing as secondary activity. Foreign companies. The sampled f i r m s include 45 companies w i t h foreign ownership. Among the foreign-owned firms, 60 percent are fully foreign owned and only four out o f 45 have a foreign ownership of less than 50 percent. The largest source o f foreign ownership i s other C A R I C O M countries (19 firms), followed by the U S A (12 firms) and the UK (7 firms). Age of establishments. Most of the f i r m s (63 percent) have been in operation for more than 10 years, and just under h a l f o f these were established over 20 years ago. Women in business. Overall, very few f i r m s (21 percent) are owned by women.125Female directors and managers are more common (45 percent), especially in food processing, retail trade, hotels and restaurants, and other tourism-related businesses. However, the overall figures disguise a large discrepancy between domestic and foreign owned f i r m s - women figure far more prominently in domestic f i r m s than in foreign owned f i r m s . Whereas only 18 percent o f the owners o f the foreign companies are women, 30 percent o f the indigenous establishments have female owners. When i t comes to female directors and managers, the ratios rise to 29 and 51 percent for foreign owned and domestic companies, respectively. ‘24 In constructing the sample frame, a number o f sources were considered. The Company Registrar’s Office provided a list, but not all companies on the l i s t are actually operating and that there i s no information on employment. The Grenada Industrial Development Council (GIDC) also maintains several company lists, but they cover only selected sectors and in particular companies accessing incentives. They also lack employment information. The NIS provided the most consistent l i s t o f companies with information on employment, sector and location, facilitating the breakdown o f the sample frame to focus o n specific target groups o f companies. ‘25 Including having women as the largest shareholders. 143 DISTRIBUTIONOF FIRMSI N SAMPLE BY SIZE AND SECTOR Micro <10 employees Small 10-24 Medium Large 25-74 75+ Total 71 55 43 32 201 156 45 Agriculture Food processing Garment & textile Other manufacturing Retail trade Wholesale trade Financial services Information & Comm. Construction Hotels and restaurants Other tourism related Other 2 7 2 6 9 4 5 2 3 3 21 7 2 7 3 4 3 2 3 3 5 3 10 10 0 6 1 4 7 3 4 0 1 8 4 5 1 2 0 2 3 2 2 3 5 5 5 22 19 5 2 5 19 12 37 29 24 0 3 0 1 5 3 8 3 4 7 8 3 Manufacturing Tourism 15 14 11 4 44 40 4 24 13 12 7 56 41 15 Foreign-owned 15 7 8 15 45 144 Total Domestic Foreign 6 6 16 22 15 17 11 8 14 6 8 14 5 10 27 ANNEX 2: CARIBBEAN FOREIGNINVESTOR PERCEPTIONSURVEY A Foreign Investor Perception Survey o f 159 multinational f i r m s operating in the Caribbean was conducted by the World Bank’s Foreign Investor Advisory Service (FVLS)’*~ between February - M a y 2004. The objective was to gauge the relative importance o f the various factors influencing foreign investors’ location decisions in the Caribbean region, as well as the attractiveness o f different countries for FDI. Instrument. The questionnaire was designed to collect information o n key firm characteristics, the firm’s evaluation o f 42 factors in 8 categories that constitute a country’s investment climate, the f i r m ’ s assessment o f the country where it had invested and o f the alternatives considered. The 8 categories of factors include policy and legal environment, FDI framework, market access, labor characteristics, administrative procedures, taxation and customs, infrastructure and quality o f life. Information was also collected on the sources f i r m s relied on to form their views o f the countries in the Caribbean, which should be o f interest to the investment promotion institutions o f the region. The survey was conducted primarily via telephone with the Chief Executive Officers andor Chief Financial Officers o f the subsidiaries in the Caribbean. Sample Selection. The sample was selected from an extensive l i s t o f f i r m s obtained f r o m the investment promotion agencies and chambers o f commerce in the Caribbean. O f 1,400 actual and potential investors compiled f r o m these sources, 650 companies were selected as interview candidates. These f i r m s were selected because they have international investments, represent a wide variety o f sectors, and provide a fair representation o f the different countries in the Caribbean. In total, 201 companies were interviewed. O f these, 20 f i r m s have headquarters in the Caribbean and are potential investors in another country in the region. However, the data collected f r o m these investors was inadequate for an in-depth analysis. In addition, 22 enterprises were removed from the analysis because upon close scrutiny their investments should be classified as 100 percent local. Therefore, most o f the analysis in the report i s based o n the information provided by 159 firms. While one o f the aims was to include f i r m s at different stages o f investment, information o n past and prospective investments was difficult to obtain as very few enterprises are willing to discuss their future projects, or past failed efforts. Thus, w i t h the exception of a few cases, information collected reflects the views o f the enterprises that have invested in at least one country in the Caribbean. Sources of investment. Firms with headquarters in N o r t h America account for the largest share o f firms, at 45 percent o f the total. Latin American and the Caribbean f m s account for 40 percent o f the firms. The remaining 15 percent o f the surveyed f i r m s originate from Europe and one f r o m Japan. Over a third o f the f i r m s have a global workforce o f only less than 100 people, but 23 percent o f the f i r m s have more than 10,000 workers globally. Size of investments. The majority o f the foreign f i r m s interviewed were small in scale: 22 percent o f the f i r m s are micro businesses (1-10 employees), and 40 percent are small and medium enterprises (11-100 employees) account for another 40 percent o f total f i r m s . Correspondingly, the realized investments are also limited in size, w i t h more than a third o f the f i r m s making investments o f less than US$1 million. Characteristics of the Caribbean subsidiaries. Most o f the companies (52 percent) are privately-held companies with limited liabilities. Publicly listed companies account for another 36 percent, while other forms o f legal status (such as partnership, cooperative, etc.) are only marginally represented. The majority o f the f i r m s serve only the local market, although a significant share o f the foreign-owned f i r m s (20 percent) export all their production. lZ6 Foreign Investment Advisory Service (World Bank/IFC). 145 Table 1 presents the distribution o f the f i r m s by leading activities, as w e l l as the average size o f the w o r k force, and levels o f investment. Firms in textile and garments industries, which have one o f the lowest capital intensities among all types o f companies, are large employers and foreign exchange earners due to their export-orientation. By contrast, f i r m s in the ICT-enabled services bring in much more capital o n average, but do n o t provide as much employment and are much more geared towards serving the domestic market. DISTRIBUTION OF FIRMSIN SAMPLE BY SECTOR Number o f f m s in sample Agriculture F o o d processing Textile & garments Electric and electronics Other Manufacturing Tourism Financial services ICT-enabled services Transport Medical services Professional Services Construction Energy RetaiUwholesale Services 5 20 10 12 19 10 11 13 5 11 10 4 12 17 Average number o f employees 49 296 682 325 223 249 124 91 40 348 55 208 174 135 Average investment (US$’OOO) 255 21,575 3,472 85,950 28,707 29,536 38,303 97,011 1,830 8 1,756 6,047 525 669,363 5,133 FIRMS’RANKING OF INVESTMENT CLIMATE COMPONENTS Percentage (YO)of respondents that considered either m a j o r o r critical Rank ‘ I 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Telecommunication Power supply PoliticaUregime stability Favorable attitude in country towards FDI Labor productivity Shipping and ports Exchange rate stability Tax rates Skilled labor cost Clarity and fairness o f laws and Availability o f skilled technicians Labor relations Water supply Quality o f life Health o f the workforce Investment incentives L o c a l market size Air transportation Roads Customs clearance procedures Import tariff Security and absence o f crime 146 Major 46.4 43.5 41.8 48.8 41.8 39.9 44.4 45.7 44.9 51.3 45.8 46.6 43.0 52.6 48.1 42.7 42.6 38.3 39.2 39.0 39.9 41.6 Critical 42.8 42.5 43.9 34.1 40.7 41.5 35.7 33.5 34.2 27.4 32.1 31.1 34.2 23.2 27.6 32.6 31.6 34.7 33.0 33.1 31.5 28.9 Both 89.2 86.0 85.7 82.9 82.5 81.4 80.1 79.3 79.1 78.7 77.9 77.7 77.2 75.8 75.7 75.3 74.2 73.1 72.2 72.1 71.3 70.6 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 Unskilled labor cost Tax administration and auditing Investment facilitation and services Government efficiency Labor market flexibility Business registration and licensing Judiciary and contract enforcement Foreign exchange restrictions Export incentives and EPZs Local supply o f inputs Access to local finance Quantitative restrictions Availability o f unskilled labor Anti-monopoly practices Proximity to your other operations Access to natural resources Access to land Government and venture capital financing 48.1 43.0 44.3 49.5 47.6 40.5 43.1 41.8 33.6 37.1 36.9 32.5 32.8 36.3 31.4 29.5 28.1 26.0 21.6 26.3 24.7 18.9 20.3 27.2 21.3 22.3 26.7 19.7 19.6 22.1 21.7 16.4 17.1 17.5 14.0 14.5 69.8 69.4 69.0 68.4 67.9 67.7 64.4 64.1 60.3 56.7 56.4 54.5 54.4 52.6 48.6 47.0 42.1 40.5 RANKING OF THE FIVE COUNTRIES FOR EACH INVESTMENT CLIMATE ASPECT Policy and legal environment 1 - Politicahegime stability 2 - Exchange rate stability 3 - Clarity and fairness o f laws and regulations 4 - Government efficiency 5 - Security and absence o f crime 6 - Judiciary and contract enforcement 7 - Anti-monopoly practices FDIframework 8 - Favorable attitude in country towards FDI 9 - Investment incentives 10 - Export incentives and EPZs 11 - Investment facilitation and services 12 - Access to local finance 13 - Government and venture capital financing Market access 14 - Local market size 15 - Local supply o f inputs 16 - Proximity to your other operations Labor 17 - Availability o f professional workers 18 - Availability o f skilled technicians 19 - Availability o f unskilled labor 23 - Labor productivity 24 - Labor relations 25 - Labor market flexibility 26 - Health o f the workforce Administrativeprocedures 27 - Business registration and licensing Barbados Dominican Republic Grenada Jamaica Trinidad and Tobago 1 1 1 1 3 1 1 5 5 4 4 2 5 3 4 3 2 2 1 4 4 3 4 5 5 4 3 2 2 2 3 3 5 2 5 4 1 2 2 1 1 3 2 1 3 2 2 5 5 4 5 3 5 1 3 5 1 5 3 2 5 3 4 4 4 2 4 4 3 3 1 5 5 3 1 2 2 3 1 5 3 2 2 2 2 2 4 1 1 1 1 1 1 1 5 5 4 5 5 5 3 2 3 5 4 3 3 2 4 3 3 2 4 4 5 5 3 4 1 2 147 28 - Foreign exchange restrictions 2 9 - Access to land 3 0 - Access to natural resources Taxation and Customs 3 1 - Tax rates 32 - Tax administration and auditing 34 - Quantitative restrictions 35 - Customs clearance procedures Barbados Dominican Republic Grenada Jamaica 2 2 2 1 5 1 2 4 5 5 Trinidad and Tobago 1 3 4 4 3 4 1 2 3 3 5 5 2 5 3 1 5 4 2 3 1 1 1 5 5 1 2 2 2 3 4 2 5 4 4 4 3 3 1 1 5 2 2 4 4 3 5 2 4 1 4 3 2 Injiastructure 36 - Telecommunication 3 1 - Power supply 38 - Water supply 39 - Roads 40 - Air transportation 41 - Shipping and ports Other 42 - Quality o f life 3 SUMMARY OF IMPORTANCE ININVESTMENT CLIMATE FACTORS Sector Agriculture Food processing Garments and textile Electric and electronics Other manufacturing Tourism M o s t Important Factors Favorable attitude in country towards FDI PoliticaYregime stability Labor productivity Labor relations Shipping and ports Exchange rate stability Tax and investment incentives Shipping services and ports PoliticaYregime stability Telecommunication facilities Import tariffs PoliticaYregime stability Favorable attitude in country towards FDI Labor productivity Availability o f skilled technicians Labor productivity Telecommunication facilities Power supply Exchange rate stability Availability o f skilled technicians Shipping services and ports Power supply PoliticaYregime stability Availability o f skilled technicians Labor productivity Air transportation Availability o f skilled technicians Business registration and licensing Favorable attitude in country 148 N o t So I m p o r t a n t Factors Access to local financing Proximity to f i r m ’ s other operations Availability o f unskilled labor Access to land and natural resources Proximity to f i r m ’ s other operations Anti-monopoly practices Access to natural resources Anti-monopoly practices Foreign exchange restrictions Local supply o f inputs Quantitative restrictions Access to land and natural resources Proximity to f i r m ’ s other operations Government and venture capital financing Anti-monopoly practices Proximity to f i r m ’ s other operations Export incentives and EPZs Quantitative restrictions Sector 0 Financial services 0 0 0 0 0 ICT-enabled services 0 0 0 0 Transport 0 0 0 0 0 Medical services 0 0 0 0 0 0 Professional services 0 0 0 Construction Energy M o s t Important Factors towards FDI Investment incentives Telecommunication facilities Politicallregime stability Investment incentives Power supply Cost o f professional labor Telecommunication facilities Power supply Cost o f professional labor Labor productivity Local market size Export incentives and EPZs Customs clearance procedures Air transportation Telecommunication facilities Power supply Telecommunication facilities Customs clearance procedures Favorable attitude in country towards FDI Labor productivity Shipping services and ports Cost o f unskilled labor Availability o f unskilled labor Labor relations Cost o f skilled labor Favorable attitude in country towards FDI Security and absence o f crime Local market size and supply o f inputs Availability o f skilled technicians Import tariffs Quality o f roads Access to natural resources Cost o f professional labor Shipping services and ports Power supply Judiciary and contract enforcemenIt N o t So Important Factors Proximity to firm’s other operations Access to land and natural resources Availability o f unskilled labor Access to land and natural resources Availability o f unskilled labor Cost o f unskilled labor Import tariffs Access to natural resources Availability o f skilled technicians Access to land and natural resources Local supply o f inputs Local financing options Anti-monopoly practices Access to land Government and venture capital financing Quantitative restrictions Export incentives and EPZs Government and venture capital financing 0 0 Retail and wholesale trade 0 0 0 0 Shipping services and ports Air transportation Telecommunication facilities Labor productivity Power s u m l v 149 0 Government and venture capital financing, o r other local financing options Proximity to firm’s other operations Availability o f unskilled labor Access to land and natural resources Local supply o f inputs L o c a l financing options ANNEX3: LABOR RIGIDITYINDEX Dominica Grenada St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines Sources Laws a n d Regulations Labor Force Survey, 1999 Industrial Relations Act: Chapter 89:Ol Protection o f Employment Act: Chapter 89:02 Labor Contracts Act: Chapter 89:04 Labor Standards Act: Chapter 89:05 Employment Safety Act: Chapter 90:08 Employment Act 1999, Act. 14 Statutory Rules and Orders, No. 11, the Minimum Wages Order, 2002 MinimumWage Code 625,2004. Protection o f Employment Act, N o 6, 1986. Draft Labor Code, 2004. Protection o f Employment Act, 2003, Statutory Rules and Orders 2003 Nos. 12, 13, 14, 15, 16, 17, 18. Persons Interviewed Leo J. Bernard Nichols, General Secretary, Dominica Trade Union Sonia Alexis, Ministry o f Labor Clifford Thomas, Labor Department F. Williams, Public Service Union The Cost o f F i r i n g Legally mandated notice Severance pay f o r period for redundancy redundancy dismissal as dismissal (in weeks) after number o f weeks f o r which twenty years o f continuous full wages are payable after employment? continuous employment o f twenty years? Antigua and Barbuda Dominica Grenada St.Kitts and Nevis St. Lucia St. Vincent and the Grenadines W h a t i s the legally F i r i n g Costs = mandated penalty for sum o f weeks redundancy dismissal? (weekly wages) 8 weeks 8 weeks 34 weeks 49 weeks 20 weeks 0 0 57 28 10 weeks 6 weeks 52 weeks 102 weeks 0 0 62 108 4 weeks 38 weeks 0 42 The Rigidity o f Hours Index C a n the Does w o r k Are there A r e there Days o f annual leave Rigidity o f workday week consist restrictions with pay in H o u r s Index restrictions extend to 12 o f 5.5 days o r o n night w o r k o n "weekly manufacturing after 20 hours o r more? N=l, ? N=O, Y=l holiday" years o f continuous work? N=O, employment? I s this more? N=l, Y=O Y=l. Y=O leave 21 days o r less? N=l, Y=O Dominica 0 0 No 0 0 0 0 0 No 0 0 0 Grenada St. Kitts and Nevis 0 0 No 0 0 0 St. Lucia 1 0 No 0 0 20 St. Vincent and the Genadines 0 0 No 150 0 0 0 R a t i o of min to average wage (a) Dominica Grenada St. K i t t s and Nevis St. L u c i a St. Vincent and the Grenadines 0.02 0.04 The Difficulty o f H i r i n g Index Fixed-term contracts are only W h a t i s the m a x i m u m duration allowed for fixed-term tasks? o f fixed-term contracts (in Y=l, N=O. months)? (b) 1 36 0 N o limit Difficulty o f H i r i n g Index 50 0 0.10 0.00 0 1 N o limit 24 0 67 0.02 0 N o limit 0 (a) Average wage i s estimated by the GDP per working age person. Assuming positive non-wage income, this estimate clearly overstates the average wage and understates the ratio. A score o f 1 i s assigned if the ratio o f i s greater than 0.75; 0.33 for ratios between 0.25 and 0.50; and a score o f 0 if the ratio i s below 0.25. (b) A score o f 1 i s assigned ifthe duration o f term contracts i s 36 months or less; 0.5 if the duration i s between 36 and 60 months; and 0 if term contracts can last more than 60 months. To aggregate these components into the final score, the three scores are averaged and multiplied by 100. The Difficulty o f F i r i n g Index Is redundancy considered grounds for dismissal? Dominica Grenada St. K i t t s and Nevis St. L u c i a St. Vincent and the Grenadines Yes Yes The employer The employer The employer The employer The law There are There are Difficulty must notify a needs the needs the must notify a mandates priority rules priority rules of Firing third party approval of a approval of a third party retraining or applying to applying to re- Index before third party third party to prior to a replacement dismissal or employment? dismissing prior to a dismiss one collective prior to lay-offs? one collective redundant dismissal? dismissal? redundant dismissal? worker? employee? Yes Yes Yes Yes Yes Yes Yes Yes No No Yes Yes No No 60 60 20 Yes Yes Yes No Yes Yes Yes Yes Yes No No No No No No 151 No No No Yes Yes No No No Yes 30 30 ANNEX 4: A N EXAMPLE OF DESTINATION-SPECIFIC"EXPORT READINESS" CRITERIA t" Tourism British Cblurnbia Export Ready Criteria The follo~vi~tg criteria are used by T r i u i m Bntrsh Columbia when detesmruing if a supplier or DMO IS ready 80 work with Tousism BC LD offering "expoIt ready' prodilict to iutemanonal markets: Suppliers Must: * * I * I c * I Be in buciness at least oue year. wirh aproven track record for safe and profe5sioiial opemtion. Demonsmate a n a&quare budget and marketins plan h a [ includes innmanonal IOU operators. Undersltsmd the roles played by receptive tour operators (F.Tr3.5). tour operator%tra:-el xvholesalers: and retail rrar-el agena. Tlus iuchidw an uudersauduq o f rack or retail pricm~.a p t comaxus';iouj and wholesale Bet sates and client reJarionrkpipr:ar each level. Be wilEiug to iaclude meptrde tom operators in your mal'lie~lllgand sales pian and implement rl regular sales call p r o y a m directed toward thew operatork. Be n d l ~ to g proride connacwd wholesale net rates to recepttve tour opemtorr.. A s a general mideline, requuemena are: 15% off the r e t d price for day acnviues and transportation and ?cS-3D?b off*retad pricing for accomrJloda~ousfigher discountr are c o n " n for rolilllre producdou). Honour tlie cmmacted net ram. no price changes before the expiqr o f h e conrracted ayeemat. Provide beailed propam iafomaticn to t o m opeeratoas and receptive operators a i least one yew in advance ~ S O M .1.e. May 1999 for the su"er:'fall ,000 season. Be preyxed to coiumuuicate and accepc reseT["ms by rekpholme. fax and:or e-mail. Prowle sanieday c o u f i m t i o u o f bookiug amgeuaents. Set up billing anaqemenis wita t5e operator. a g e x y or receptive t o w operator. Aecep: client rouchen as c o n h a t i o n o f palimmt for reservations. De;er&e busmess priorities in t e r m o f g o u p or FIT business. I f you plan to p m u e group business. consider ~ C C C S by S t o m h e - 3 . parkiqy'timarouud areag: ~vashoomr l i w s etc. Detenuine your mx~miw youp size. Caw adeqnate msmauce (muhim '$3 mllion liabihty iusiumce for a&;ennue product cj recommended). Discuss this with your receptive operator (sometimes they can add sup esismg pohcies at nominal cczt). h m d e mpyort ( h e OF reduced rates] for mtemationd media and travel trade fauntharizatioa t o m . In addtion to t h e above, &e f o l l o ~ l n gshould be cousidered '-next step<' for considerah as business and niaaket presence expands. * + * I I * Consider atrcndmg travel twde &oxn mvol7,iq utematronal b y m . eitlier u I i o d . h e r i c a or overseas. E s p d ;he s a b c c a l l psopam to luolfude overseas contacts a I!a5 Cmada-based receptive operators. Be prepared to pror.ide EQUI operazors and media wih 3 5 m slide. Cf) ROM or standard computer fomar m a p o f the product or operation. for w e in brochures, promotions and editorials. Consider produc&r video footage o f product cr operadon for promotianal and r r a i n i q p ~ ~ ~ Consider kelopment of R website offerh f o m t i o n on your product. Be prepared ro adapt to uniqueness o f ce vmea-3 markets. Flexibility may be requmd with regard to last &ut@ bookiugs wd chanzes. Consider h m g f r o n t h e staff that speaks the laupage o f tlre markets you are mTeFc3ted lu. piu"uiug. Source: http://www.designingnations.com/pdf_s/TBC%2OExport%2OReady%2OCriteria.pdf 152 e ~ .

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