On the Economic Growth of the Caribbean Region: concepts and features.

1. On the Economic Growth of the Caribbean Region: concepts and features. Based on work by Rodrigo Fuentes (Catholic University of Chile), Karl Melgarejo and joint work with IDB Caribbean Economics Team Presentation for the 5th Biennal International Business and Finance Conference, Port of Spain, Trinidad May 2, 2013

2. Outline: how to approach the problem • Stylized facts and what we know from the literature • Evidence based on four characteristic: • Small size of the economies • Lack of diversification (related to small size) and volatility • Vulnerable: susceptible to natural disasters • Highly indebted • Growth in more recent years, and possible policy space.

3. All of the Caribbean countries have small populations—but differ greatly in terms of per-capita income. Per-capita income about average relative to larger peers and small states.

4. A fairly diverse crowd for major non-OECS countries

5. The Caribbean countries are losing ground against the U.S., and the slowdown is structural in nature • OECS/ECCU countries ’ growth has slowed down in the past 20 years. • Commodity exporters (TT, Suriname, Guyana) doing better in recent years, but GDP is extremely volatile. • ‘Other Caribbean’ (The Bahamas, Barbados, Belize and Jamaica) have a structural growth problem, losing ground for 30 years--even against the U.S.. • There is evidence of a productivity slowdown. Ratio of ECCU 1 Ratio of other Caribbean 2 Ratio of commodity exporters 3

6. Recent papers on economic growth pertaining to the Caribbean using a large sample of countries • Determinants of growth: • Loayza, Fajnzylber and Calderon (2005). Structural reforms, external conditions and stabilization policies are key determinants of growth in LAC region • Growth and public debt: • Calderon and Fuentes (2012). Negative effect of public debt on growth, but outward oriented policies and good domestic policies ameliorate the effect. • Small-country issue: • Easterly and Kraay (2000): No effect of small size on growth, vulnerability related to openness, so positive • Vulnerability: • Armstrong and Read (2004). Charveriart (2000). Conflicting results, no clear effect

7. Recent papers on economic growth using a large sample of countries (continued) • Tourism: • Sequeira and Nunes (2008). Positive effect of tourism on growth • Tourism and other factors: • Thacker and Acevedo (2010). Growth is positively related with tourism and negatively with volatility (period 1979-2007). Public debt is negatively associated with growth and increases volatility. • Thacker, Acevedo and Pirelli (2012). Country size and the condition of being island are negatively related to growth. Tourism ameliorates the effect of small island conditions. TFP explain an important part of growth in the region

8. Recent papers using data exclusively from Caribbean economies • Sources of growth • Peters (2001). Negative impact on growth of inflation, population growth and government spending. Positive impact on growth of investment, education, life expectancy, trade liberalization, financial development and IT. • Kida (2005). TFP is the main contributor to economic growth. Macroeconomic environment, quality of institutions and microeconomic efficiency are key for TFP growth. • ECLAC (2009). Capital and TFP are the main contributors to growth in 70’ and 80’, and labor in the 90’. • Public debt on growth • Greenidge et al (2012). Negative effect of public debt on growth when surpassing a threshold of 56%. Nonlinear relationship.

9. Recent paper using data exclusively from Caribbean Economies (continued) • Structural transformation • Hausmann and Klinger (2009). The structural change in the matrix of production is a determinant for growth. Current production matrix is “backward” and is unlikely to change to more sophisticated product. Integration allows a more diversified and sophisticated export matrix. The study does not include services. • Vulnerability, natural disaster • Crowards (2000): Natural disasters reduce growth in the second and third year after the date of the disaster. • Financial crisis, cycle • Kuoame and Reyes (2011). Caribbean countries experienced a strong reduction in the growth rate due to the 2009 international crisis. They tend to amplify the business cycle of the US economy

10. To find structural breakpoints we estimate the stochastic process of GDP per capita, which is an AR(2) with a deterministic trend

11. But no relationship between breakpoints and natural disasters: example of Trinidad and Tobago Source: Author’s estimation using Bai -Perron (1998, 2001) method and World Bank data Source: EM-DAT: The OFDA/CRED International Disaster Database 4 2 3 1 Source: WDI, The World Bank

12. We decomposed actual from projected growth into policy and institutional factors for pre-crisis era:

13. Small size: how much does it matter for growth? • Small economies grew equally or more than the rest up to 2000 (Easterly and Kraay) generally because small economies are more open than large ones and this has a positive effect on growth. • But recently small economies have not done as well, with microstates (population below 1 million) doing significantly worse than larger peers. • Economies of scale an issue—but controlling for labor, it goes away (related to migration?) • Alesina et al (2005) provides a model in which the benefits (i.e. economic growth) of trade openness and economic integration are larger, the smaller the size of a country. • IMF finds that small countries are affected by the limited economies of scale, as the public sector has to over-extend itself, financial sectors are somewhat shallow and finance a large portion of the government. Trade is also more costly, particularly the more remote. • Still a puzzle about the scale: trade can also be more costly. At what level of ‘size’ does it begin to matter?

14. Tourism dependent Commodities exporters The Caribbean (CCB) has continuously lost ground in the last 30 years relative to other small economies.

15. Not only the observed growth but also the potential that has been lower than that of other small economies in the last 30 year. We also found that the volatility of the potential growth has risen in the last decade.

16. The exposure to natural disasters decreases with the size of the economy; i.e. smaller economies have a higher exposure to natural disasters.

17. Lack of diversification by trading goods and by trading partner exacerbate external shocks for open economies (all countries except Jamaica have de-facto fixed exchange rates).

18. ..and relatively speaking, small economies’ GDP is more volatile. Many factors help increase the volatility of the GDP in small economies, and the Caribbean countries also show a high degree of volatility relatively to the rest of small economies

19. Larger incidence of external shocks and skewed towards negative zone, and smaller buffers with which to deal with them. External Shocks Policy buffer index combines the primary fiscal balance, public debt, the current account of the balance of payments net of direct foreign investment, foreign reserves in months of imports, and the inflation rate . Median shock and its distribution, average, 1990-2011

20. Small Economies …which has led to indebtedness problems. Thesmaller, thebigger…. Gross public debt is bigger in small economies Source: IMF

21. Stylized Shape of the Threshold Effects of Public Debt on Growth Among the CCB countries 3 out of 6 (50%) are located in the positive growth zone; while among the Small Econ. 10 out of 17 (59%) are in the positive zone. The highest level of debt ratio in CCB countries is 140%; while for Small Econ. Is just 99% Source: Greenidge et al. (2012) IMF.

22. Estimated Loss in Real GDP Growth (In Percentage Points) Indebtedness has led to large losses, according to Greenidge and others. 2.- Is the high level of indebtedness? Source: Greenidge et al. (2012) IMF. • CCB countries have the highest losses!

23. CCB also does worse on competitiveness relative to small economies Source: WEF

24. More recent impacts and effects on policy options..

25. Long-run output is mostly explained by a few external variables for the 6 Caribbean countries.

26. The 2007-08 global recession had a detrimental effect on growth. Simulations: CCB Growth Assuming Global Recession had not happened. (Actual and IMF pre-recession projections, Index 2004=100)

27. Can fiscal policy improve growth performance in the CCB countries? • We estimate the following for our countries using annual data: • Where gt and yt are the cyclical components of government expenses and output. First refers to fiscal stance, second to expansionary policy. We found that, with the exception of Barbados, the fiscal multiplier related to capital expenditures is smaller than that for current expenditure (0.13 vs. 0.36 in average) and that the fiscal policy is highly pro-cyclical. More importantly, investment expenditures react more aggressively to the output cycle than current expenditures, suggesting that public investment constitutes a more active policy tool than public consumption.

29. Conclusions Small economies have not grown as quickly as its larger peers in the last few years Lower growth in the Caribbean is only partially explained by being ‘small and vulnerable’. Its indebtedness and neighborhood may have played a role. Few policy buffers and issues with competitiveness are at the heart of the problem. But even with buffers, multiplier effect is negligible.

30. Thank you

31. The Bahamas Source: Author’s estimation using Bai -Perron (1998, 2001) method and World Bank data Source: EM-DAT: The OFDA/CRED International Disaster Database 4 2 3 5 1 Source: WDI, The World Bank

32. Barbados Source: Author’s estimation using Bai -Perron (1998, 2001) method and World Bank data Source: EM-DAT: The OFDA/CRED International Disaster Database 4 5 3 1 2 Source: WDI, The World Bank

33. Guyana Source: Author’s estimation using Bai -Perron (1998, 2001) method and World Bank data Source: EM-DAT: The OFDA/CRED International Disaster Database 5 4 3 1 2 Source: WDI, The World Bank

34. Jamaica Source: Author’s estimation using Bai -Perron (1998, 2001) method and World Bank data Source: EM-DAT: The OFDA/CRED International Disaster Database 5 4 1 3 2 Source: WDI, The World Bank

35. Suriname Source: Author’s estimation using Bai -Perron (1998, 2001) method and World Bank data Source: EM-DAT: The OFDA/CRED International Disaster Database 3 2 Source: WDI, The World Bank